**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, D. C. 20549**

**FORM10-K/AAMENDMENT NO. 1**

**ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

**For thefiscal year ended December 31, 2005**

**Commissionfile number 0-22081**

**EPIQSYSTEMS, INC.**(Exact name of registrant as specified in its charter)

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

 

Registrant’stelephone number, including area code **(913)621-9500**

Securitiesregistered pursuant to Section 12(b) of the Act:  **None**

Securitiesregistered pursuant to Section 12(g) of the Act:  **CommonStock, $.01 par value**

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act.Yes  o     No  x

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

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.   Yes  x     No  o

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K (229.405 of this chapter) is not contained herein, and will notbe contained, to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  x

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

| 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-2 of theAct). Yes  o    No  x

The aggregatemarket value of voting common stock held by non-affiliates of the registrant(based upon the last reported sale price on the Nasdaq National Market), as ofthe last business day of the registrant’s most recently completed second fiscalquarter (June 30, 2005) was approximately $293,000,000.

There were19,264,871 shares of common stock of the registrant outstanding as of February22, 2006.

Documents incorporated byreference:  The information required byPart III of 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/ATABLE OF CONTENTS**

**PART I**
| **ITEM 1.**   | ** ** | **Business**                                             | ** ** | 1      |   |
|---------------|------------|----------------------------------------------------------|------------|--------|--------|
| ** **    | ** ** | ** **                                               | ** ** |   |   |
| **ITEM  1A.** | ** ** | **Risk Factors**                                         | ** ** | 7      |   |
| ** **    | ** ** | ** **                                               | ** ** |   |   |
| **ITEM 1B.**  | ** ** | **Unresolved Staff  Comments**                           | ** ** | 18     |   |
| ** **    | ** ** | ** **                                               | ** ** |   |   |
| **ITEM  2.**  | ** ** | **Properties**                                           | ** ** | 18     |   |
| ** **    | ** ** | ** **                                               | ** ** |   |   |
| **ITEM 3.**   | ** ** | **Legal Proceedings**                                    | ** ** | 18     |   |
| ** **    | ** ** | ** **                                               | ** ** |   |   |
| **ITEM 4.**   | ** ** | **Submission of  Matters to a Vote of Security Holders** | ** ** | 18     |   |

 

**PART II**
| **ITEM 5.**  | ** ** | **Market for the  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities** | ** ** | 19     |   |
|--------------|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|--------|--------|
| ** **   | ** ** | ** **                                                                                                                  | ** ** |   |   |
| **ITEM 6.**  | ** ** | **Selected Financial  Data**                                                                                                | ** ** | 22     |   |
| ** **   | ** ** | ** **                                                                                                                  | ** ** |   |   |
| **ITEM 7.**  | ** ** | **Management’s  Discussion and Analysis of Financial Condition And Results of Operation**                              | ** ** | 23     |   |
| ** **   | ** ** | ** **                                                                                                                  | ** ** |   |   |
| **ITEM 7A.** | ** ** | **Quantitative  and Qualitative Disclosures About Market Risk**                                                             | ** ** | 41     |   |
| ** **   | ** ** | ** **                                                                                                                  | ** ** |   |   |
| **ITEM 8.**  | ** ** | **Financial  Statements and Supplementary Data**                                                                            | ** ** | 42     |   |
| ** **   | ** ** | ** **                                                                                                                  | ** ** |   |   |
| **ITEM 9.**  | ** ** | **Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure**                                   | ** ** | 44     |   |
| ** **   | ** ** | ** **                                                                                                                  | ** ** |   |   |
| **ITEM 9A.** | ** ** | **Controls and  Procedures**                                                                                                | ** ** | 44     |   |
| ** **   | ** ** | ** **                                                                                                                  | ** ** |   |   |
| **ITEM 9B.** | ** ** | **Other Information**                                                                                                       | ** ** | 49     |   |

 

**PART III**
| **ITEM 10.** | ** ** | **Directors and  Executive Officers of the Registrant**                                              | ** ** | 49     |   |
|--------------|------------|------------------------------------------------------------------------------------------------------|------------|--------|--------|
| ** **   | ** ** | ** **                                                                                           | ** ** |   |   |
| **ITEM 11.** | ** ** | **Executive  Compensation**                                                                          | ** ** | 49     |   |
| ** **   | ** ** | ** **                                                                                           | ** ** |   |   |
| **ITEM 12.** | ** ** | **Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters** | ** ** | 49     |   |
| ** **   | ** ** | ** **                                                                                           | ** ** |   |   |
| **ITEM 13.** | ** ** | **Certain  Relationships and Related Transactions**                                                  | ** ** | 49     |   |
| ** **   | ** ** | ** **                                                                                           | ** ** |   |   |
| **ITEM 14.** | ** ** | **Principal  Accounting Fees and Services**                                                          | ** ** | 49     |   |

 

**PART IV**
| **ITEM 15.** | ** ** | **Exhibits and  Financial Statement Schedules** | ** ** | 50 |   |
|--------------|------------|-------------------------------------------------|------------|----|--------|

 

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**Explanatory Note**

EpiqSystems, Inc. is filing this Amendment No. 1 to our Annual Report on Form 10-K(Form 10-K/A) to restate our previously issued financial statements as ofDecember 31, 2005 and 2004, and for each of the three years in the period endedDecember 31, 2005, included in our Annual Report on Form 10-K for the yearended December 31, 2005, initially filed with the SEC on March 8, 2006 and torestate the quarterly financial information included in that Annual Report onForm 10-K for the fiscal year ended December 31, 2005 initially filed with theSEC on March 8, 2006, as discussed in note 17 of the accompanying notes to theconsolidated financial statements.

Duringfiscal year 2006, and subsequent to the original issuance of our Annual Reporton Form 10-K for the fiscal year ended December 31, 2005, management identifiedan accounting error in its consolidated financial statements related todetermination of the appropriate accounting treatment for certain complexaspects of revenue recognition, specifically the evaluation of vendor specificobjective evidence of fair value for specified software upgrades providedwithin a bundled arrangement as required by Statement of Position 97-2 (SOP97-2), *Software Revenue Recognition*.  On November 14, 2006, our audit committee, inconsultation with management, determined that our previously issued financialstatements for the fiscal years ended December 31, 2005, 2004 and 2003,included in our Annual Report on Form 10-K for the fiscal year ended December31, 2005, for the quarters ended March 31, 2006 and 2005, included in ourQuarterly Report on Form 10-Q for the quarter ended March 31, 2006, and for thequarters ended June 30, 2006 and 2005, included in our Quarterly Report on Form10-Q for the quarter ended June 30, 2006, should be restated.  The restatement is further discussed in note17 of the accompanying consolidated financial statements.

ThisForm 10-K/A amends and restates Items 1, 1A, 2 and 5 of Part I, Items 6, 7, 8and 9A of Part II, and Item 15 of Part IV of the original filing to reflect theeffects of this restatement and to incorporate additional comments as a resultof our receipt of comment letters from the SEC’s Division of CorporationFinance.  The remaining Items containedwithin this Form 10-K/A consist of all other Items originally contained in Form10-K for the fiscal year ended December 31, 2005.  These remaining Items are not amended by thisfiling.  Except for the forgoing amendedinformation, this Form 10-K/A continues to describe conditions as of the dateof the original filing, and we have not updated the disclosures containedherein to reflect events that occurred at a later date.  In addition, pursuant to the rules of theSEC, Exhibits 31.1, 31.2, 32.1, and 32.2 of the original filing have beenamended to contain currently dated certification from our Chief ExecutiveOfficer and Chief Financial Officer.  Theupdated certifications are attached to this Form 10-K/A as Exhibits 31.1, 31.2,32.1, and 32.2.

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**CAUTIONARYSTATEMENT CONCERNING FORWARD-LOOKING STATEMENTS**

In this report, inother filings with the SEC and in press releases and other public statements byour officers throughout the year, Epiq Systems, Inc. makes or will makestatements that plan for or anticipate the future.  These forward-looking statements includestatements about our future business plans and strategies, and other statementsthat are not historical in nature.  Theseforward-looking statements are based on our current expectations.  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-lookingstatements may be identified by words or phrases such as “believe,” “expect,” “anticipate,”“should,” “planned,” “may,” “estimated,” “potential,” “goal,” and “objective.”  Section 27A of the Securities Act of 1933, asamended and Section 21E of the Securities Exchange Act of 1934, as amended,provide a “safe harbor” for forward-looking statements.  In order to comply with the terms of the safeharbor, and because forward-looking statements involve future risks anduncertainties, listed in Item 1A, **“RiskFactors,”**of this report area variety of factors that could cause actual results and experience to differmaterially from the anticipated results or other expectations expressed in ourforward-looking statements.  We undertakeno obligation to update any forward-looking statements contained herein or infuture communications to reflect future events or developments.

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**PART I**

**ITEM 1.**                    BUSINESS

**General**

Epiq Systems, Inc. (Epiq)is a provider oftechnology-based solutions for the legal and fiduciary servicesindustries.  Our products and servicesassist clients with the administration of complex legal proceedings, includingelectronic discovery, bankruptcy administration and class actionadministration.  Our clients includeleading law firms, corporate legal departments, bankruptcy trustees, and otherprofessional advisors who require sophisticated case administration and documentmanagement capabilities, extensive subject matter expertise and a high servicecapacity.  We provide clients with anintegrated offering of both proprietary technology and value-added servicesthat comprehensively address their extensive business requirements.

Wehave acquired several companies as part of our strategic business plan.  During 2005, we acquired nMatrix, Inc. toenter the market for electronic litigation discovery, Hilsoft, Inc. to enhanceour capabilities in legal notification services, and Novare, Inc. to supplementour professional services for corporate restructuring client engagements.  During 2004, we acquired Poorman-DouglasCorporation to enter the market for class action and mass tort administrativeservices.  During 2003, we acquiredBankruptcy Services LLC (BSI) to enter the market for corporate restructuringbankruptcy reorganization administrative services.

InNovember 2003, we determined that our infrastructure software business, whichoperated in the automated data exchange software market, was no longer alignedwith 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.  Our shareholders approved an amendment to ourArticles of Incorporation on June 7, 2000 to change our name from ElectronicProcessing, Inc. to Epiq Systems, Inc.

Our principal executive office is located at 501 KansasAvenue, Kansas City, Kansas 66105.  Thetelephone number at that address is (913) 621-9500, and our website address iswww.epiqsystems.com.  We make availablefree of charge through our internet website our annual report on Form 10-K, ourquarterly reports on Form 10-Q, our current reports on Form 8-K and amendmentsto those reports filed with or furnished to the SEC as soon as reasonablypracticable after we electronically file those reports with or furnish them tothe SEC.  The public may read and copyany materials filed by us with the SEC at the SEC’s Public Reference Room at100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the PublicReference Room by calling the SEC at 1-800-SEC-0330.  The SEC maintains an internet site thatcontains reports, proxy and information statements and other informationregarding issuers that file electronically with the SEC at http://www.sec.gov.  The contents of these websites are notincorporated into this report.  Further,our references to the URLs for these websites are intended to be inactivetextual references only.

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**IndustryEnvironment**

Both our case managementsegment and our document management segment provide products and servicesprimarily to the legaland fiduciary services industries.  Segmentinformation related to revenues from external customers, a measure of profit orloss, and total assets is contained in note 15 of the notes to consolidatedfinancial 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, bankruptcyadministration and class action administration.

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

Our case management anddocument management technology and service offerings provide solutionsprimarily for the bankruptcy, class action and mass tort and electronicdiscovery markets. These technology and service offerings can cross the variousmarkets and customers we serve.  Forexample, our legal notification expert may develop a document management noticeprogram for either a bankruptcy matter or a class action matter.  Our various proprietary technology solutionsare used individually or in a unique combination for electronic discovery, classaction, or bankruptcy matters.  Weprovide a unique set of case management and document management capabilitiesfor each particular matter.

We view each segment asproviding a distinct group of services and solutions to our customers.  Both groups of services and solutions arecritical to our business as many of our customers will require both casemanagement and document management solutions. By having both groups of services, we are able to provide the customer withan end-to-end solution.  Our customerstypically have a large amount of discrete information to organize andprocess.  Case management provides a setof services to facilitate the “back-office” administration of cases for thebankruptcy, class action and electronic discovery markets.  Document management consists primarily ofnotification for bankruptcy and class action customers.  Our expertise enables us to provide thisnotification on a timely basis.

*Electronic Discovery*

The substantial increase of electronic documents in thebusiness community has changed the dynamics of how attorney’s support discoveryin complex litigation matters.  Accordingto the 2005 Socha-Gelbmann Electronic Discovery Survey, the 2004 domesticcommercial electronic discovery revenues were estimated at $832 million, anapproximate 94% increase from 2003. According to this same source, the market is expected to continue togrow at a substantial rate from 2005 to 2007, with expected increases of 50% to60% each year.  Due to the increasingcomplexity of cases, the increasing volume of data that are maintainedelectronically, and the increasing volume of documents (both paper andelectronic) that are produced in all types of litigation, law firms areincreasingly reliant on electronic evidence management systems to organize andmanage the litigation discovery process.

*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 theAdministrative Office of the U.S. Courts for the

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government fiscal years ended September 30, 2003, 2004,and 2005, there were approximately 1.66 million, 1.62 million, and 1.78million new bankruptcy filings, respectively.

There are five chapters of the U.S. Bankruptcy Code thatserve different purposes and require various types of services andinformation.  Our products and servicesare designed for cases filed under the following three chapters:

·                  Chapter 7 is a liquidation bankruptcy forindividuals or businesses that, as measured by the number of new cases filed in2005, accounted for approximately 75% of all 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 7cases typically last several years.

·                  Chapter 11 is a reorganization model of bankruptcyfor corporations that, as measured by the number of new cases filed in fiscal2005, accounted for approximately 1% of all bankruptcy filings.  Chapter 11 generally allows a company tocontinue operating under a plan of reorganization to restructure its businessand to modify payment terms of both secured and unsecured obligations.  Chapter 11 cases may last several years.

·                  Chapter 13 is a reorganization model of bankruptcyfor individuals that, as measured by the number of new cases filed in 2005,accounted for approximately 24% of all bankruptcy filings.  In a Chapter 13 case, debtors make periodiccash payments into a reorganization plan and a Chapter 13 bankruptcy trusteeuses these cash payments to make monthly distributions to creditors.  Chapter 13 cases typically last between threeand five years.

The participants in a bankruptcy proceeding include thedebtor, 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 13bankruptcy products and services, our customers are professional bankruptcytrustees.  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 become adiscrete component within the United States’ economy.  Class action and mass tort refer tolitigation in which class representatives bring a lawsuit against a defendantcompany or other persons on behalf of a large group of similarly affectedpersons (the class).  Mass action or masstort refers to class action cases that are particularly large or prominent.

The class action and mass tort marketplace issignificant, with estimated annual tort claim costs in excess of $250 billionaccording to an update study issued in 2004 by Towers Perrin.  Administrative costs, which include costs,other than defense costs, incurred by either the insurance company orself-insured entity in the administration of claims, comprise approximately 20%of this total.  Key participants in thismarketplace include law firms that specialize in representing class action andmass tort plaintiffs and other law firms that specialize in representingdefendants.  Class action and mass tortlitigation is often complicated and the cases, including administration of anysettlement, may last several years.

**Products and Services**

*Case Management Segment*

Casemanagement support for client engagements may last several years and has arevenue profile that typically includes a recurring component.  Our case management segment generates revenueprimarily through the following integrated technology-based products andservices.

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·                  Anintegrated solution of a proprietary technology platform and relatedprofessional services that facilitates case administration of bankruptcy, classaction, commercial litigation, financial transaction, government settlements,and mass tort client engagements.

·                  Professionaland support services, including case management, claims processing, specialtybankruptcy consulting, claims administration, project management, andcustomized programming and technology services.

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

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

·                  Software installedin bankruptcy trustee offices and provided over the internet that facilitatesthe administration of Chapter 7 and Chapter 13 bankruptcy cases.

·                  Databaseconversions, maintenance and processing, such as creditor and class actionclaims, and conversion of that data into an organized, searchable, electronicdatabase that we maintain on our servers and use, with our customer, to managethe particular case.

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

*DocumentManagement Segment*

Documentmanagement revenue is generally non-recurring due to the unpredictable natureof the frequency, timing and magnitude of the clients’ businessrequirements.  Our document managementsegment generates revenue primarily through the following services.

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

·                  Reimbursementfor costs incurred related to postage on mailing services.

·                  Mediacampaign and advertising management in which we coordinate notification throughvarious media outlets, such as print, radio and television, to potentialparties of interest for a particular client engagement.

·                Document custody services in which wemaintain custody of key case documents and store those documents for ourcustomer.

**Customers**

Our clients for both case management and documentmanagement segments include law firms, corporate legal departments, bankruptcytrustees and other professional advisors. Frequently, law firms act as 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 maysometimes be involved in only a single engagement with us, our relationshipwith the law firm is longer and normally spans multiple clientengagements.  Accordingly, we relyextensively on our network of law firm relationships and expend considerableresources to develop and extend those relationships.

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*Electronic Litigation Discovery*

For electronic litigation discovery, our customers aretypically large corporations that use our products and services cooperativelywith their legal counsel or other professional advisors to manage theelectronic litigation discovery process.

*Bankruptcy*

Forour Chapter 7 and Chapter 13 bankruptcy trustee products, our end-usercustomers are professional bankruptcy trustees.  The Executive Officefor United States Trustees, a division of the U.S. Department of Justice,appoints all bankruptcy trustees.  AUnited States Trustee is appointed in most federal court districts andgenerally has responsibility for overseeing the integrity of the bankruptcysystem.  The bankruptcy trustee’s primaryresponsibilities include liquidating the debtor’s assets (Chapter 7) orcollecting funds from the debtor (Chapter 13), distributing the collectedfunds to creditors pursuant to the orders of the bankruptcy court and preparingregular status reports for the Executive Office for United States Trustees andfor the bankruptcy court.  Trusteestypically manage an entire caseload of bankruptcy cases simultaneously.

The application of Chapter 7 bankruptcy regulations hasthe practical effect of discouraging trustee customers from incurring directadministrative costs for computer system expenses.  As a result, we provide our Chapter 7products and services to trustee customers at no direct charge, and our trusteecustomers agree to maintain deposit accounts for bankruptcy cases under theiradministration at a designated banking institution.  We have marketing arrangements withvarious banks 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 deposit relationships, we receive revenues basedon factors such as the aggregate amount of trustee deposits maintained at thebank, the number of customers using our product, software upgrades, andancillary professional services.  Priorto April 1, 2004, we had an exclusive marketing arrangement with Bank ofAmerica for Chapter 7 trustee products and services.  Effective April 1, 2004, this relationshipbecame a non-exclusive marketing arrangement.  During February 2006, theparties agreed to extend the arrangement indefinitely.  Either party may, with appropriate notice,wind down the arrangement over a period, including the notice period, of threeyears.  Since April 1, 2004, wehave established new deposit relationships with additional financialinstitutions.  During the year endedDecember 31, 2005, a substantial majority of our Chapter 7 trustee clients’deposits were maintained at Bank of America.

Our customers for corporate restructuring bankruptcysolutions are debtor corporations or businesses that file a plan ofreorganization.  Law firms representingthese companies are a key conduit through which both we and our competitorsgain access to the debtor companies prior to their filing for bankruptcy.  Debtor’s counsel often uses our services andproducts directly on behalf of their client, and we have developedrelationships with the bankruptcy departments at various law firms.

*Class Action*

Our customers for class action and mass tort solutionsare primarily large corporations that are administering the settlement orresolution of class action or mass tort cases. We sell our services directly to those customers; however, ourrelationships with other interested parties, including plaintiff and defenselaw firms, often provide access to these customers.

**Sales and Marketing**

Our sales department markets our case management anddocument management products and services directly to prospective customers andreferral law firms through on-site sales calls. We focus on attracting and retaining customers by providing integratedtechnology solutions with leading edge features and by providing exceptionalcustomer service.  Our accountexecutives, case managers and relationship managers 

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are responsible for providing ongoing support servicesfor existing customers. Various relationship managers, case managers and salesrepresentatives attend industry trade shows. We also conduct direct mail campaigns and advertise in trade journals.

**Competition**

There are a variety of companies competing, primarilyon the basis of quality of service, technology innovations, and price, for thefinite number of available client engagements that become available eachyear.  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, management consultant firms, turnaround specialists andcrisis management firms offer certain products and services that compete withours.

**Government Regulation**

Ourproducts and services are not directly regulated by the government.  Our bankruptcy trustee customers andcorporate restructuring debtor customers are, however, subject to significant regulationunder the United States Bankruptcy Code, the Federal Rules of BankruptcyProcedure and local rules and procedures established by bankruptcy courts.  The Executive Office for United StatesTrustees, a division of the United States Department of Justice, oversees thebankruptcy industry and establishes administrative rules governing our clients’activities.  Our class action and masstort cases are subject to various federal and state laws as well as rules andprocedures established by the courts.

In February 2005, new federal class action and tortreform legislation was passed and signed by President Bush.  The primary impact of the new federallegislation is to require that certain types of class action lawsuits bebrought in federal court rather than state courts.  We believe the new federal legislation willlikely result in fewer class action lawsuits in state courts.  The slower processing of class actionlawsuits in federal courts could delay the ultimate settlement of those cases,which could adversely affect the timing of services we provide in thosecases.  Similar to this recent federallegislation, there have been various efforts at the state level to modify andreform the laws and procedures related to class action and mass tort.  We cannot predict the effect, if any, thatstate legislative action would have on the number or size of class action andmass tort lawsuits filed or on the claims administration process.

InApril 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005was passed and signed by President Bush. The intent of this legislation, which became effective October 2005, isto move certain individual bankruptcy filings from Chapter 7, which liquidatesmost of the debtor’s assets and discharges most of the debtor’s liabilities, toChapter 13 which does not liquidate the debtor’s assets but which requires adebtor to pay disposable income to their creditors.  The legislation also affects Chapter 11bankruptcy 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 or other executory contract, and potentially increasing certainpriority claims.  The legislation appearsto have had the effect of increasing bankruptcy filings prior to the effectivedate of the legislation.  It is unclearwhat impact, if any, the legislation will have on bankruptcy filings after thelegislation’s October 2005 effective date. As a result, we cannot predict the effect, if any, that this legislationwill have on our business.

**Employees**

As of December 31, 2005, we employed approximately 500full-time employees, none of whom is covered by a collective bargaining agreement.  We believe the relationship with ouremployees is good.

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**ITEM 1A.**           RISKFACTORS

*This report, other reports to be filed by us with the SEC,press releases made by us and other public statements by our officers, oral andwritten, contain or will contain forward-looking statements**within the meaning of Section 27A of the Securities Act of 1933, asamended and Section 21E of the Securities Exchange Act of 1934, as amended,including those relating to the possible or assumed future results ofoperations and financial condition.  Becausethose statements are subject to a number of uncertainties and risks, actualresults may differ materially from those expressed or implied by theforward-looking statements.  Listed beloware risks associated with an investment in our securities that could causeactual results to differ from those expressed or implied.*

**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.**

Theapplication of Chapter 7 bankruptcy regulations discourages Chapter 7 trusteesfrom incurring direct administrative costs for computer system expenses.  As a result, we provide our products andservices to Chapter 7 trustee customers at no direct charge, and our Chapter 7trustee customers agree to deposit the cash proceeds from liquidations ofdebtors’ assets with a designated financial institution with which we have aChapter 7 marketing arrangement.  We havearrangements with several financial institutions under which our Chapter 7trustees deposit the Chapter 7 liquidated assets at one of those financialinstitutions.  Under these arrangements:

·                  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.

Thesebankruptcy deposit-based fees are the largest component of our Chapter 7revenues.

Previously,we promoted our Chapter 7 product exclusively through a marketing arrangementestablished with Bank of America in November 1993.  Substantially all of our Chapter 7 revenuesare collected through this relationship. On April 1, 2004,this exclusive marketing arrangement became a non-exclusive arrangement.  During February 2006, the parties agreed toextend the non-exclusive arrangement indefinitely.  Either party may, with appropriate notice,wind down the arrangement over a period of three years, including the noticeperiod.  If either party were to givenotice of termination of this arrangement, we could experience uncertaintyrelating to the transfer of Chapter 7 trustee deposits to other financialinstitutions, and we could experience a decline in revenues and earnings asthose deposits were transferred during the wind-down period.

Chapter 7 revenues from Bank of America comprised 3%,3% and 44% of our total revenue recognized for the years ended December 31,2005, 2004, and 2003, respectively.  As of December 31,2005, 2004, and 2003, we had recorded on our consolidated balance sheets $59.7million,  $35.2 million,  and $8.2 million, respectively, of deferredrevenue related to Bank of America.

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**We haveestablished 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 depository bank relationships inthe future.  Changes in the terms of oneor more of those marketing arrangements or the termination of any of thosemarketing arrangements could create uncertainty with current and prospectivetrustee customers or operational difficulties for trustees, which couldadversely affect our relationships with those joint customers and our Chapter 7revenues and earnings.

**Some of ourpricing models for Chapter 7 trustee clients have or are scheduled to have acomponent of pricing tied to prevailing interest rates, and a significantdecline in interest rates would adversely affect our revenues and earnings.**

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

**If a financial institutionwith which we have a marketing arrangement for Chapter 7 products and servicesis perceived negatively by current or prospective trustee clients, our casemanagement revenue and earnings could be adversely affected.**

The Chapter 7 depository banks,with which we have joint marketing arrangements, provide banking products andservices directly to our trustee clients. If the financial institution provides ineffective banking products or servicesto the joint customers or has errors or omissions in its processing, we couldexperience collateral damage to our reputation. We cannot control the quality of products and services provided by theChapter 7 depository banks to the joint customers.  Additionally, if a depository bankarrangement is discontinued, it could disrupt the effective delivery of bankingservices to trustees.  If the migrationto a successor depository bank is not completed smoothly or if we were unableto move the trustee customer’s deposits to a different banking arrangementprior to the expiration, we could lose trustee customers, which could adverselyaffect our case 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.**

InApril 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005was passed and signed by President Bush. The intent of this legislation, which became effective October 2005, isto move certain individual bankruptcy filings from Chapter 7, which liquidatesmost of the debtor’s assets and discharges most of the debtor’s liabilities, toChapter 13 bankruptcy filings, which do not liquidate the debtor’s assets butwhich requires a debtor to pay disposable income to their creditors.  The legislation also affects corporaterestructuring bankruptcy filings, in part by placing more strict limits on theperiod of time in which the debtor has an exclusive right to propose areorganization plan, accelerating the time frame in which a debtor mustdetermine whether to reject a lease, and potentially increasing certainpriority claims.  To date, thelegislation appears to have had two effects: (1) a significant increase in the number of bankruptcy filings prior tothe effective date of the legislation, and (2) a corresponding decline inbankruptcy filings in the few months after the effective date of thelegislation.  While neither of these twoeffects had an immediate material impact on our bankruptcy-related revenues, itis possible that there could be longer-term consequences to the reformlegislation that we have not yet identified. As a result, we cannot predict theeffect, if any, that this legislation will have on our business.

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**Tort reform legislation could reduce the number and scope ofclass action and mass action cases, thus reducing our business prospects in theclass action market.**

InFebruary 2005, new federal class action and tort reform legislation was passedand signed by President Bush.  Theprimary impact of the new federal legislation is to require that certain typesof class action lawsuits be brought in federal court rather than state courts.  We believe the new federal legislation willlikely result in fewer class action lawsuits in state courts, which aregenerally perceived as faster and more plaintiff-friendly than federalcourts.  The slower processing of classaction lawsuits in federal courts could delay the ultimate settlement of thosecases, which could adversely affect the timing of services we provide in thosecases.  Likewise, the new federallegislation could have the effect of lowering the overall number of classaction cases, whether filed in federal or state courts.  Similar to this recent federal experience,there have been various efforts at the state level to modify and reform thelaws and procedures related 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 predictwhether any tort reform legislation will pass at the state levels or thesubstance of any future changes, any legislative efforts that are successful inreducing the number or scope of class action or mass action cases would likelyhave an adverse effect on our results of operations.

**We have a limited number ofbankruptcy trustee clients and a limited number of significant referral sourcesfor corporate restructuring and class action and mass tort engagements. The loss of even a limited number of our trustee customers or referral sourcescould result in a loss of revenue and earnings.**

There is a limited number of Chapter 7 andChapter 13 bankruptcy trustees to whom we can market our bankruptcy productsand services.  Additionally, we relyheavily on a limited number of corporate restructuring and class actionreferral sources to earn new business engagements.  Our future financialperformance will depend on our ability to maintain existing trustee customeraccounts, to attract business from trustees that are currently using acompetitor’s software product, to maintain our existing referral relationships,and to develop new referral relationships.  The loss of even a limitednumber of trustee customers or a reduction in referral sources could result ina material loss of revenue and earnings.

**We encountercompetition for our products and services from other third party providers andwe could lose existing customers and fail to attract new business.**

Themarkets for case and document management products and services are competitive,continually evolving and 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 successwill depend upon our ability to keep pace with technological change and tointroduce, on a timely and cost-effective basis, new and enhanced softwaresolutions and services that satisfy changing client requirements and achievemarket 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.**

Theinitiation or termination of a large corporate restructuring, class action ormass tort engagement can directly affect our revenues and earnings for aparticular quarter, and the levels of services, particularly services relatedto document management required for an ongoing corporate restructuring or classaction engagement can fluctuate quarter to quarter during the time that thedebtor is in Chapter 11 corporate restructuring or the class action lawsuit isactive.

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**Our quarterlyresults have fluctuated in the past and may fluctuate in the future.  If they do, our operating results may notmeet the expectations of securities analysts or investors.  This could cause fluctuations in the marketprice of our common stock.**

Our quarterly results havefluctuated during the last year and may fluctuate in the future.  As a result, our quarterly revenues andoperating results are increasingly difficult to forecast.  It is possible that our future quarterlyresults from operations from time to time will not meet the expectations ofsecurities analysts or investors.  Thiscould cause a material drop in the market price of our common stock.

Our business will continue tobe affected by a number of factors, any one of which could substantially affectour results of operations for a particular fiscal quarter.  Specifically, our quarterly results fromoperations can vary due to:

·                  fluctuations inbankruptcy trustees’ deposit balances or caseloads;

·                  unanticipated expensesrelated to software maintenance or customer service;

·                  the timing, size,cancellation or rescheduling of customer orders; and

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

**Our stockprice may be volatile even if our quarterly results do not fluctuatesignificantly.**

If our quarterly resultsfluctuate, the market price for our common stock may fluctuate as well andthose fluctuations may be significant. Even if we report stable or increased earnings, the market price of ourcommon stock may be volatile.  There area number of factors, beyond earnings fluctuations, that can affect the marketprice of our common stock, including the following:

·                  a decrease in marketdemand for our stock;

·                  downward revisions insecurities analysts’ estimates;

·                  announcements oftechnological innovations or new products developed by us or our competitors;

·                  the degree of customeracceptance of new products or enhancements offered by us;

·                  general marketconditions and other economic factors; and

·                  actual or perceivedimprovements in the national economy and the corresponding assumption that ourbankruptcy business will decline as the economy improves.

In addition, the stock markethas 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 ourcommon stock has been volatile and this is likely to continue.

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**If corporaterestructuring cases on which we are retained convert to Chapter 7, we may notbe paid for the products and services we have provided.**

In corporate restructuring engagementswe provide services directly to the debtor and we are paid directly by thedebtor.  If a debtor’s corporaterestructuring case converts to Chapter 7 liquidation, we might not be paid forproducts and services previously provided and we would most likely lose allfuture revenue from the case.  We havehad corporate restructuring cases convert to Chapter 7 cases in the past.  The conversion of a major corporate restructuringcase to Chapter 7 could have a material adverse effect on our results of operations.

**If thebankruptcy court reduces or eliminates our fees in major****corporaterestructuring****cases, our results of operationscould be impaired.**

In corporate restructuringcases, the bankruptcy court may reduce or eliminate fees paid for administrativeservices such as those we provide.  Ifthe court reduced or eliminated fees due to us in a major corporaterestructuring case, our results of operations could be materially affected.

**If we areunable to develop new technologies, we could lose existing customers and failto attract new business.**

We regularly undertake newprojects and initiatives in order to meet the changing needs of ourcustomers.  In doing so, we investsubstantial resources with no assurance of the ultimate success of the projector initiative.  We believe our futuresuccess will depend, in part, upon our ability to:

·                  enhance our existingproducts;

·                  design and introduce newsolutions that address the increasingly sophisticated and varied needs of ourcurrent and prospective customers;

·                  maintain our technologyskills; and

·                  respond to technologicaladvances and emerging industry standards on a timely and cost-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 ourbusiness.  In addition, keeping abreastof technological advances in our business may require substantial expendituresand lead-time.  We may not be successfulin using new technologies, adapting our solutions to emerging industrystandards, or developing, introducing and marketing new products orenhancements.  Furthermore, we mayexperience difficulties that could delay or prevent the successful development,introduction or marketing of these products. If we incur increased costs or are unable, for technical or otherreasons, to develop and introduce new products or enhancements in a timelymanner in response to changing market conditions or customer requirements, wecould lose existing customers and fail to attract new business.

**New releases of our software productsmay have undetected errors, which could cause litigation claims against us ordamage to our reputation.**

We intend to continue to issue new releases of oursoftware products periodically.  Complexsoftware products, such as those we offer, can contain undetected errors whenfirst introduced or as new versions are released.  Any introduction of new products and futurereleases has a risk of undetected errors. These undetected errors may be discovered only after a product has beeninstalled and used by our customers. Likewise, the software products we acquire in business acquisitions havea risk of undetected errors.

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Errors may be found in oursoftware products in the future.  Anyundetected errors, as well as any difficulties in installing and maintainingour new software and releases or difficulties training customers and theirstaffs on the utilization of new products and releases, may result in a delayor loss of revenue, diversion of development resources, damage to ourreputation, increased service costs, increased expense for litigation andimpaired market acceptance of our products.

**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 securityfeatures in our products that are intended to protect the privacy and integrityof data.  Security for our products iscritical given the highly confidential nature of the information our softwareprocesses.  Our software products and theservers on which the products are used may not be impervious to intentionalbreak-ins (“hacking”) or other disruptive problems caused by the internet or byother users.  Hacking or other disruptiveproblems could result in the diversion of development resources, damage to ourreputation, increased service costs or impaired market acceptance of our products,any of which could result in higher expenses or lower revenues.  Additionally, we could be exposed topotential liability related to hacking or other disruptive problems.  Defending these liability claims could resultin increased expenses for litigation and a significant diversion of our management’sattention.

Furthermore, we administer claims for thirdparties.  Errors or fraud related to theprocessing or payment of these claims could result in the diversion ofmanagement resources, damage to our reputation,increased service costs or impaired market acceptance of our services, any ofwhich could result in higher expenses and/or lower revenues.  Additionally, such errors or fraud related tothe processing or payment of claims could result in lawsuits allegingdamages.  Defending such claims couldresult in increased expenses for litigation and a significant diversion of ourmanagement’s attention.

**Interruptions or delays in service fromour third-party Web hosting facility could impair the delivery of our serviceand 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 the operation of thisfacility, and it is subject to damage or interruption from earthquakes, floods,fires, power loss, terrorist attacks, telecommunications failures and similarevents.  It is also subject to break-ins,sabotage, intentional acts of vandalism and similar misconduct.  The occurrence of a natural disaster, adecision to close the facility without adequate notice or other unanticipatedproblems at the facility could result in lengthy interruptions in our service.In addition, the failure by our vendor to provide our required datacommunications capacity could result in interruptions in our service.  Any damage to, or failure of, our systemscould result in interruptions in our service. Interruptions in our service may reduce our revenue, cause us to issuecredits or pay penalties, cause customers to terminate their agreements with usand adversely affect our ability to secure business in the future.  Our business will be harmed if our customersand potential customers believe our service is unreliable.

**If our security measures are breachedand unauthorized access is obtained to a customer’s data, our service may beperceived as not being secure, customers may curtail or stop using our serviceand 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 securitymeasures are breached as a result of third-party action, employee error,malfeasance or otherwise and, as a result, someone obtains unauthorized accessto one of our customers’ data, our reputation will be damaged, our business maysuffer and we could incur significant liability.  Because techniques used to obtainunauthorized access or to sabotage systems change frequently and generally arenot recognized until launched against a target, we may be unable to anticipatethese techniques or to implement adequate 

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preventative measures.  If an actual or perceived breach of oursecurity occurs, the market perception of the effectiveness of our securitymeasures could be harmed and we could lose sales and customers.

**We may be sued by third parties foralleged infringement of their proprietary rights.**

The software and internetindustries are characterized by the existence of a large number of patents,trademarks, and copyrights and by frequent litigation based on allegations ofinfringement or other violations of intellectual property rights.  We have received in the past, and may receivein the future, communications from third parties claiming that we haveinfringed on the intellectual property rights of others.  Our technologies may not be able to withstandany third-party claims or rights against their use. Any intellectual propertyclaims, with or without merit, could be time-consuming and expensive toresolve, could divert management attention from executing our business plan,and could require us to pay monetary damages or enter into royalty or licensingagreements. In addition, certain customer agreements require us to indemnify ourcustomers for third-party intellectual property infringement claims, whichwould increase the cost to us of an adverse ruling on such a claim.  An adverse determination could also preventus from offering our service to others.

**We rely on third-party hardware andsoftware, which could cause errors or failures of our service.**

We rely on hardware purchasedor leased and software licensed from third parties in order to offer certainservices.  Any errors or defects inthird-party hardware or software could result in errors or a failure of ourservice which could harm our business.

**Ourintellectual property is not protected through patents or formal copyrightregistration.  Therefore, we do not havethe full benefit of patent or copyright laws to prevent others from replicatingour software.**

Our intellectual propertyrights are not protected through patents or formal copyright registration.  We may not be able to protect our tradesecrets or prevent others from independently developing substantially equivalentproprietary information and techniques or from otherwise gaining access to ourtrade secrets.  In addition, foreignintellectual property laws may not protect our intellectual property rights.  Moreover, litigation may be necessary toenforce our intellectual property rights, to protect our trade secrets, todetermine the validity and scope of the proprietary rights of others or todefend against claims of infringements. Litigation of this nature could result in substantial expense for us anddiversion of management and other resources, which could result in a loss ofrevenue and profits.

**Our failure todevelop and maintain products and services that assist our customers incomplying with significant government regulation could result in decreaseddemand for our products and services.**

Our products and services arenot directly regulated by the government. Our bankruptcy customers are, however, subject to significantregulation, including the United States Bankruptcy Code, the Federal Rules ofBankruptcy Procedure and local rules and procedures established by bankruptcycourts.  The Executive Office for UnitedStates Trustees, a division of the United States Department of Justice,oversees bankruptcy trustees and establishes administrative rules governingtrustees’ activities.  Additionally, theprocess of administering the settlement of class action or mass tort cases issubject to court supervision and review by opposing plaintiffs’ and defendants’counsel.  The success of our business hasbeen, and will continue to be, partly dependent on our ability to develop andmaintain products and provide services that allow clients to perform theirduties within applicable regulatory and judicial rules and procedures and thatallow corporate restructuring debtors to make filings and send required noticeson 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 ourproducts and services to 

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changes in the Bankruptcy Codeand applicable legislative and judicial rules and procedures could cause us tolose existing customers or fail to attract new customers.

**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 acquirednMatrix for approximately $126 million in cash and stock.  In January 2004, we acquired Poorman-Douglasfor approximately $116 million in cash. In addition to these acquisitions, during the five years ended December31, 2005, we acquired five other businesses at a combined cost of approximately$90 million.  We may consider additionalopportunities to acquire other companies, assets or product lines thatcomplement or expand our business.  If weare unsuccessful in integrating these companies or product lines with ourexisting operations, or if integration is more difficult than anticipated, wemay experience disruptions to our operations. A difficult or unsuccessful integration of an acquired business wouldlikely have a material adverse effect on our results of operations.

Some of the risks that may affect our ability tointegrate or realize any anticipated benefits from companies we acquire includethose associated with:

·                  unexpected losses of keyemployees or customers of the acquired company;

·                  conforming the acquiredcompany’s standards, processes, procedures and controls with our operations;

·                  increasing the scope,geographic diversity and complexity of our operations;

·                  difficulties intransferring processes and know-how;

·                  difficulties in theassimilation of acquired operations, technologies or products;

·                  diversion of management’sattention from other business concerns;

·                  adverse effects onexisting business relationships with customers; and

·                  the challenges ofoperating internationally after the nMatrix acquisition.

**Incertain circumstances, we may be obligated to pay one of our shareholders thedifference between $20.35 per share and the price at which that shareholdersells up to 1,228,501 shares of our common stock, which could adversely affectthe market price of our common stock.**

We issued to the former owner of nMatrix 1.2 million shares as a partof the purchase price for the nMatrix business. We are required to maintain an effective registration statement for theresale of those shares by that shareholder until November 15, 2007.  Our agreement with that shareholder includesa limited price protection provision, which provides that if the shareholdersells any of those shares pursuant to the registration statement at a per shareprice (before commissions and other transaction expenses) lower than $20.35,then we will pay that selling shareholder an amount in cash equal to the numberof shares sold by the shareholder multiplied by the difference between the$20.35 minus the sale price.  The limitedprice protection will terminate permanently upon the earlier of termination ofour obligation to maintain effectiveness of the registration statement or,during the period of effectiveness of the registration statement, after any 15trading days (which need not be consecutive trading days) on which both of thefollowing conditions are satisfied:  (1)the shareholder may lawfully sell shares under the registration statement, and(2) the closing price for our common stock has been equal to or greater than$20.35 per share.

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

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

Certain businesses wehave acquired, including most recently the nMatrix business, have experiencedsubstantial growth immediately prior to the time we acquired the business.  The success of those types of acquisitions isdependent upon a number of factors, including the ability to hire, train andretain an adequate number of experienced managers and employees for thoserapidly growing businesses, the establishment of policies, procedures andinternal controls to allow us to monitor the growth of those businesses, andother factors that are beyond our control. Expansion internationally will increase demands on management and diverttheir attention, which could have an adverse impact on our business andfinancial results.  The challenges ofmanaging the growth of an acquired business may distract our management fromtheir normal duties associated with our historical core businesses.

**We have non-U.S. operations which aresubject to certain inherent risks.**

As a result of our recent acquisition of nMatrix, we nowmaintain small offices in the United Kingdom and Australia.  We anticipate that we will seek to expand ourcurrently limited global operations and may enter new global markets.  Our foreign business is transacted in thelocal functional currency, but we do not currently have any material exposureto foreign currency transaction gains or losses.  All other business transactions are in U.S.dollars.  To date, we have not enteredinto any derivative financial instruments to manage our foreign currency risk.  Our current and proposed internationalactivities are subject to certain inherent risks, including specific countryeconomic conditions, exchange rate fluctuation, changes in regulatoryrequirements, reduced protection of intellectual property rights, potentialadverse tax consequences, different or additional product functionality requirements,and cultural differences.

**The use of our common stock tofund acquisitions or to refinance debt incurred for acquisitions could diluteexisting shares.**

We have used our common stock to refinance debt incurredfor several prior acquisitions.  DuringJune 2004, we issued $50 million of convertible notes, which are convertibleinto approximately 2.9 million shares of common stock, to refinance a portionof the purchase price for the January 2004 Poorman-Douglas acquisition.  During November 2005, we issued approximately1.2 million shares of common stock and incurred approximately $101 million ofbank indebtedness in connection with our nMatrix acquisition.  We may consider issuing additional commonshares and using the proceeds to pay part or all of this additionalindebtedness.

We may consider further opportunities to acquirecompanies, assets or product lines that complement or expand our business.  We expect that future acquisitions, if any,could provide for consideration to be paid in cash, shares of our common stock,or a combination of cash and shares.  Ifthe consideration for an acquisition is paid in common stock, existingshareholders’ investments could be diluted. Furthermore, we may decide to issue convertible debt or additionalshares of common stock and use part or all of the proceeds to finance orrefinance the costs of any past or future acquisitions.

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**We depend uponour key personnel and we may not be able to retain them or to attract,assimilate and retain highly qualified employees in the future.**

Our future success will dependin significant part upon the continued service of our senior management andcertain of our key technical personnel and our continuing ability to attract,assimilate and retain highly qualified technical, managerial, and sales andmarketing personnel.  We do not haveemployment agreements with our Chief Executive Officer, President, or ChiefFinancial Officer.  We do have employmentagreements with our Chief Executive Officer — Poorman-Douglas Corporation, ourPresident — Bankruptcy Services LLC., and key executives of nMatrix.  We maintain key-man life insurance policieson our Chief Executive Officer and our President.  The loss of the services of any of theseexecutives or other key personnel or the inability to hire or retain qualifiedpersonnel in the future could have a material adverse impact on our results ofoperations.

**We do not paycash dividends on our common stock and our common stock may not appreciate invalue or even maintain the price at which you purchased your shares.**

We presently do not intend topay any cash dividends on our common stock. Subject to any financial covenants in current or future financingagreements that directly or indirectly restrict the payment of dividends, thepayment of dividends is within the discretion of our board of directors andwill depend upon our future earnings, if any, our capital requirements, ourfinancial condition and any other factors that the board of directors mayconsider.  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 all earnings to reduce our debt and foruse in the operation and expansion of our business.  As a result, the success of your investmentin our common stock will depend entirely upon its future appreciation.  Our common stock may not appreciate in valueor even maintain the price at which you purchased your shares.

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

Some provisions of our articles of incorporation couldmake it more difficult for a third party to acquire control of our company,even if the change of control would be beneficial to certain shareholders.  For example, our articles ofincorporation include “blank check” preferred stock provisions, which permitour board of directors to issue one or more series of preferred stock without shareholderapproval.  In conjunction with theissuance of a series of preferred stock, the board is authorized to fix therights of that series, including voting rights, liquidation preferences,conversion rights and redemption privileges. The board could issue a series of preferred stock to a friendly investorand use one or more of these features of the preferred stock to discourage orprevent a takeover of the company. Additionally, our articles of incorporation do not permit cumulativevoting in the election of directors. Cumulative voting, if available, would enable minority shareholders toelect one or more representatives to the board in certain circumstances, whichcould be used by third parties to facilitate a takeover of our company that wasopposed by our board or management.

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**Compliance withchanging regulation of corporate governance and public disclosure may result inadditional expenses.**

Compliance with changing laws,regulations and standards relating to corporate governance and public disclosure,including the Sarbanes-Oxley Act of 2002, new SEC regulations, and NasdaqNational Market rules, are time consuming and expensive.  Since 2002, we have spent substantial amountsof management time and have incurred substantial legal and accounting expensein complying with the Sarbanes-Oxley Act and regulatory initiatives resultingfrom that Act.  Complying with these newlaws and regulations also creates uncertainty for companies such as ours.  These new or changed laws, regulations andstandards are subject to varying interpretations in many cases due to theirlack of specificity.  As a result, theirapplication in practice may evolve over time as new guidance is provided byregulatory and governing bodies, which could result in continuing uncertaintyregarding compliance matters and higher costs necessitated by ongoing revisionsto disclosure and governance practices. We are committed to maintaining high standards of corporate governanceand public disclosure.  As a result, ourefforts to comply with evolving laws, regulations and standards have resultedin, and are likely to continue to result in, increased general andadministrative expenses and a diversion of management time and attention fromrevenue-generating activities to 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.  We expect these efforts to require thecontinued commitment of significant resources.

SEC rules implementing Section 404 ofSarbanes-Oxley require disclosure of the remediation of significantdeficiencies or material weaknesses in internal controls over financialreporting and the existence, at year-end, of material weaknesses related to ourinternal control over financial reporting. If we are required to make any of these types of disclosures in thefuture, these disclosures could adversely affect the price of our common stock.

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**ITEM 1B.**           UNRESOLVED STAFFCOMMENTS

None.

**ITEM 2.**                    PROPERTIES

Our corporateheadquarters are located in a 49,000-square-foot facility in KansasCity, Kansas.  This owned property servesas collateral under our credit facility. We also have significant corporate offices in New York City and inmetropolitan Portland, Oregon, and maintain smaller offices in Chicago, Miami,Washington, D.C., Los Angeles, Philadelphia and London.

**ITEM 3.**                    LEGALPROCEEDINGS

We occasionallybecome involved in litigation arising in the normal course of business.  There is no currently pending or, to theknowledge of management, threatened material litigation against us.

**ITEM 4.**                    SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted in the fourth quarter of2005 to a vote of security holders.

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**PART II**

**ITEM 5.**                    MARKET FOR THEREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES

**Market Information**

Our common stockis traded under the symbol “EPIQ” on the Nasdaq National Market.  The following table shows the reported highand low sales prices for the common stock for the calendar quarters of 2005 and2004 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 intendto retain 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 any cash dividends in the foreseeablefuture.  Under the terms of oursubordinated convertible debt agreement, we are restricted from payment ofdividends while the subordinated convertible debt is outstanding.  Thereafter, 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.  Various financial covenants in our creditagreement and our outstanding convertible notes may have the effect of limitingthe ability of our board of directors to declare and pay cash dividends on ourcommon stock.  There is no restriction onthe ability of our subsidiaries to transfer funds to Epiq in the form of cashdividends, loans or advances.

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**Equity Compensation Plan Information**

The following tablesets forth as of December 31, 2005 (a) the number of securities to be issuedupon exercise of outstanding options, warrants and rights, (b) the weightedaverage exercise price of outstanding options, warrants and rights and (c) thenumber of securities remaining available for future issuance under equitycompensation plans (excluding securities reflected 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    |   |
|                                                                 |            |            |            |                                                                                                                                                                        |            |                                                                                                             |            |  |  |  |

 

As of December 31, 2005,equity compensation plans approved by security holders consist of our 1995Stock Option Plan and our 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.  Securities remaining available for futureissuance under our 2004 Equity Incentive Plan may be issued, in anycombination, as incentive stock options, non-qualified stock options, stockappreciation rights or restricted stock.

As of December 31, 2005,equity compensation plans not approved by security shareholders consist solelyof stock options issued in conjunction with our acquisitions of BSI,Poorman-Douglas, and nMatrix.  The stock options issued to key employees ofBSI, Poorman-Douglas, and nMatrix were inducement stock options issued inconjunction with the execution of employment agreements with each of those keyemployees to become employees of our newly acquired subsidiaries.  In accordance with the Nasdaq corporategovernance rules, shareholder approval of these inducement stock option grantswas not required.

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 on thedate of grant, are non-qualified options, are exercisable for up to 10 yearsfrom the date of grant, and otherwise have terms substantially identical to thematerial terms of the 1995 Stock Option Plan and the 2004 Equity IncentivePlan.  Stock options granted inconjunction with the acquisition of BSI vested 20% on January 31, 2003,the grant date thereof, and continue to vest 20% per year on each anniversaryof the grant date until fully vested on 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 granted in conjunction with theacquisition of nMatrix vest 25% per year, with the initial vesting to occurNovember 15, 2007, over five years.

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**RecentSales of Unregistered Securities**

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

The 1.2 million shares issued in the nMatrixacquisition were issued to the sole owner of nMatrix (Seller), which alsoreceived approximately $100 million in cash in that transaction.  The stock purchase agreement includedcustomary representations by Seller that, among other things, Seller is an “accreditedinvestor” and is capable of evaluating the merits and risks of acquiring theshares, that Seller has received and reviewed certain material from thecompany, including our periodic reports under the Exchange Act, that Seller wasacquiring the share consideration for investment and not with a view toward, orfor sale in connection with, any distribution thereof, or with any presentintention of distributing or selling the share consideration, other thanpursuant to a valid registration statement. In addition, Seller acknowledged in the stock purchase agreement thatthe shares had not been registered under the Securities Act or the securitiesor “blue sky” laws of any state, and agreed that the shares would not be sold,transferred, offered for sale, pledged, hypothecated or otherwise disposed ofwithout registration under the Securities Act, except pursuant to registrationof the reoffer and resale of the share consideration pursuant to the SecuritiesAct, or pursuant to an exemption from registration available under theSecurities Act.

**Purchases of Equity Securities by the Issuer andAffiliated Purchasers**

None.

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**ITEM 6.**                    SELECTEDFINANCIAL DATA

The followingtable presents selected historical financial data for the years ended December31, 2005, 2004, 2003, 2002, and 2001. The selected financial data gives effect to the restatement discussed innote 17 to the consolidated financial statements.
| ** **                                         | ** ** | **(In Thousands, Except Per Share Data)** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                         | ** ** | **Years Ended December 31,**                        | ** ** |
| ** **                                         | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                         | ** ** | **(As Restated)**                                             | ** ** | **(As Restated)** | ** ** | **(As Restated)** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                               |       |                                                               |       |   |   |   |   |   |   |   |   |
|                                               |       |                                                               |       |   |   |   |   |   |   |   |   |
| INCOME  STATEMENT DATA:                            |       |                                                               |       |   |   |   |   |   |   |   |   |
| Revenues  from continuing operations               |       | $                                                                  | 106,330    |   | $ | 98,368 |   | $ | 59,780 |   | $ | 36,256 |   | $ | 28,149 |   |
| Income  (loss) from continuing operations          |       | (3,842                                                             | )          | (7,290 | ) | 9,595 |   | 9,766 |   | 6,253 |   |
| Income  (loss) from discontinued operations        |       | —                                                             |       | 667 |   | (5,818 | ) | (1,533 | ) | (1,311 | ) |
| Net  income (loss)                                 |       | (3,842                                                             | )          | (6,623 | ) | 3,777 |   | 8,233 |   | 4,942 |   |
| Income  (loss) per share — Diluted            |       |                                                               |       |   |   |   |   |   |   |   |   |
| from continuing operations                         |       | $                                                                  | (0.21      | ) | $ | (0.41 | ) | $ | 0.53 |   | $ | 0.64 |   | $ | 0.44 |   |
| from discontinued operations                       |       | $                                                                  | —     |   | $ | 0.04 |   | $ | (0.32 | ) | $ | (0.10 | ) | $ | (0.09 | ) |
| Net income (loss) per share — Diluted         |       | $                                                                  | (0.21      | ) | $ | (0.37 | ) | $ | 0.21 |   | $ | 0.54 |   | $ | 0.35 |   |
|                                               |       |                                                               |       |   |   |   |   |   |   |   |   |
| BALANCE  SHEET DATA:                               |       |                                                               |       |   |   |   |   |   |   |   |   |
| Working  capital related to continuing  operations |       | $                                                                  | (25,090    | ) | $ | 22,979 |   | $ | 39,023 |   | $ | 63,503 |   | $ | 27,286 |   |
| Total  assets                                      |       | 418,471                                                            |       | 244,317 |   | 143,186 |   | 108,037 |   | 70,648 |   |
| Long-term  debt                                    |       | 145,906                                                            |       | 74,499 |   | 3,066 |   | 289 |   | 594 |   |
| Stockholders’ equity                          |       | 140,468                                                            |       | 118,550 |   | 124,325 |   | 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.  The acquisition was accounted for using thepurchase method of accounting with the operating results of ROC Technologiesincluded in our statements of operations since the date of acquisition.

During July 2002, we acquired the Chapter 7 trustee business of CPTGroup, Inc.  The acquisition wasaccounted for using the purchase method of accounting with the operatingresults of CPT Group included in our statements of operations since the date ofacquisition.

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

DuringJanuary 2003, we acquired the member interests of BSI.  The acquisition was accounted for using thepurchase method of accounting with the operating results of BSI included in ourstatements of operations since the date of acquisition.  See note 13 of the notes to consolidatedfinancial statements.

Asexplained in note 17 of the notes to consolidated financial statements, inOctober 2003 we entered into a three-year arrangement related to our Chapter 7bankruptcy trustee business that included various elements which had previouslybeen provided on a standalone basis.  Asa result, subsequent to October 1, 2003 we deferred substantially all of ourChapter 7 bankruptcy trustee revenue. The effect of this deferral reduced revenue recognized for the yearsended December 31, 2005, 2004 and 2003; substantially decreased our net incomefor the year ended December 31, 2003 and increased our net loss for the yearsended December 31, 2005 and 2004 compared with prior years; and substantiallydecreased our working capital as of December 31, 2005.

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DuringNovember 2003, the decision was made to dispose of our infrastructure softwarebusiness and the business was sold in April 2004.  Accordingly, all revenues, cost of sales,operating expenses, assets and liabilities related to infrastructure softwarehave been reclassified as discontinued operations for all periodspresented.  See note 14 of the notes toconsolidated financial statements.

DuringJanuary 2004, we acquired the equity of P-D Holding Corp. and its wholly-ownedoperating subsidiary, Poorman-Douglas Company (Poorman-Douglas).  The acquisition was accounted for using thepurchase method of accounting with the operating results of Poorman-Douglasincluded in our statement of operations since the date of acquisition.  See note 13 of the notes to consolidatedfinancial statements.

DuringOctober 2005, we acquired the equity of Hilsoft, Inc. (Hilsoft).  The acquisition was accounted for using thepurchase method of accounting with the operating results of Hilsoft included inour statement of operations since the date of acquisition.  See note 13 of the notes to consolidatedfinancial statements.

DuringNovember 2005, we acquired the equity of nMatrix, Inc. and nMatrix AustraliaPty. Ltd. (collectively, nMatrix).  Theacquisition was accounted for using the purchase method of accounting with theoperating results of nMatrix included in our statement of operations since thedate of acquisition.  See note 13 of thenotes to consolidated financial statements.

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

Thisdiscussion and analysis should be read in conjunction with the consolidatedfinancial statements and the accompanying notes to the consolidated financialstatements included in the Form 10-K/A and gives effect to the restatementdescribed in note 17 to the accompanying consolidated financial statements.

**Management’sOverview**

Weare a provider oftechnology-based solutions for the legal and fiduciary services industries. Ourproducts and services assist clients with the administration of complex legalproceedings, including electronic litigation discovery, bankruptcyadministration and class action administration. We have two operating segments: case management and document management.

Ourcase management segment generates revenue primarily through integratedtechnology-based products and services that support client engagements forelectronic litigation discovery, class action and mass tort, and bankruptcyproceedings that can last several years and has a revenue profile thattypically includes a recurring component. Our document management segment generates revenue primarily throughlegal noticing services, reimbursement for costs incurred related to postage onmailing services, media campaign and advertising management and documentcustody services.  Document managementrevenue is generally less recurring due to the unpredictable nature of thefrequency, timing, and magnitude of the clients’ business requirements.

Thenumber of new bankruptcy filings each year may vary based on the level ofconsumer and business debt, the general economy, interest rate levels and otherfactors.  For the government fiscal years endedSeptember 30, 2003, 2004, and 2005, the Administrative Office of the U.S. Courtsreported approximately 1.66 million, 1.62 million, and 1.78 millionnew bankruptcy filings, respectively.** **We believe an important indicator of futurebankruptcy filings is the level of consumer and business debt outstanding.  The most recent available Federal Reserve *Flow of Funds Accounts of the United States*, dated December8, 2005, reported increases in both consumer and business debt outstanding ascompared with the same period of the prior year.

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Forour Chapter 7 bankruptcy services, our end-user customers are professionalbankruptcy trustees.  The application of Chapter 7 bankruptcyregulations has the practical effect of discouraging trustee customers fromincurring direct administrative costs for computer system expenses.  As a result, we provide our Chapter 7 servicesto trustee customers at no direct charge, and our trustee customers maintaindeposit accounts for bankruptcy cases under their administration at adesignated banking institution.  Wehave marketing arrangements with various banks under which we provide Chapter 7bankruptcy trustee case management software and related services and the bankprovides the Chapter 7 bankruptcy trustee with deposit-related bankingservices.  Our most significant marketingarrangement is with our primary depository institution, Bank of America.  Under this arrangement, we primarily receiverevenue based on the aggregate amount of trustee deposits and the number ofChapter 7 trustees which we refer to collectively as volume-based fees.  These volume-based fees compensate us for thesoftware license, hardware and postcontract customer support services which weprovide to the Chapter 7 bankruptcy trustees.

Prior to October 2003,our primary depository institution engaged us to provide the trustees withsoftware upgrades in the first and second quarter of each year.  These software upgrades were documented inarrangements which were separate from our volume-based fee arrangement.  Once the upgrade was delivered to thetrustees and we had provided satisfactory evidence of the delivery, we wouldinvoice the primary depository institution for the agreed upon amount andrecognize revenue related to the software upgrade.

In October 2003, weentered into a new arrangement (the 2003 Arrangement) with the primarydepository institution.  As a part of the2003 Arrangement, we agreed to continue to perform each of our first and secondquarter software upgrades through the term of the arrangement, and the primarydepository institution agreed to compensate us for these upgrades on termssimilar to our historical terms when we delivered the upgrades on a standalonebasis.  As the 2003 Arrangement includedvolume-based pricing related to our software license, hardware and postcontractcustomer support services, as well as pricing related to software upgrades andspecial projects, the 2003 Arrangement was considered a bundledarrangement.  As the 2003 Arrangementinvolved the delivery of software, we accounted for this arrangement pursuantto Statement Of Position 97-2, *Software RevenueRecognition* (SOP 97-2).  Forbundled arrangements, SOP 97-2 requires that for separate elements of thearrangement, such as software upgrades, we must be able to establish vendorspecific objective evidence (VSOE) of fair value.  VSOE is established based on the price chargedwhen the same element is sold on a standalone basis.  Although we historically sold softwareupgrades on a standalone basis, each software upgrade is considered a separateproduct and, therefore, we determined that the price of prior software upgradescannot be used to establish the price of future software upgrades.  As the primary financial institution was ouronly payee for software upgrades during the period of the 2003 Arrangement, wewere unable to establish VSOE for the software upgrades.  Under SOP 97-2, if VSOE cannot be establishedfor software upgrades, then consideration received under the 2003 Arrangement,except for consideration related to the provision of hardware and hardwaremaintenance, must be deferred until all software upgrades have been delivered.  Under the terms of the 2003 Arrangement, thefinal software upgrade will be delivered in the second quarter of 2006.  Although, during the period of the 2003Arrangement, we continued to invoice, and the primary financial institution continuedto pay, our volume-based fees related to software licenses and postcontractcustomer support as well as our semi-annual software upgrades, we did notrecognize these amounts as revenue. Instead, these amounts are recorded as deferred revenue liability.  The ongoing costs related to this arrangement were recognized asexpense when incurred.  Substantiallyall deferred revenue was recognized during the second quarter of 2006 when thefinal upgrade was delivered. The remaining amount of deferred revenue wasrecognized during the third quarter of 2006 when the 2003 Arrangementterminated.  Throughout the period of the2003 Arrangement, we continued to recognize revenue related to the hardware andhardware maintenance we provided to Chapter 7 trustees as this revenue isaccounted for pursuant to Statement of Financial Accounting Standards No. 13(SFAS 13), *Accounting for Leases*.  This revenue is a relatively minor componentof the 2003 Arrangement.

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During February 2006, weentered into a new arrangement with our primary financial institution, whichbecame effective October 1, 2006. Specified software upgrades and special projects are not contained inthis contract, and we anticipate that this arrangement will not require us todefer recognition of revenue.

During 2003, wedetermined that our infrastructure software segment was no longer aligned withour long-term strategic objectives and we developed a plan to sell this segmentwithin 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.

Wehave acquired a number of businesses during the past several years.  In January 2003, we acquired BSI to expandour offerings to include an integrated solution of a proprietary technologyplatform and professional services for corporate restructurings.  In January 2004, we acquired Poorman-Douglasand expanded our product and service offerings to include class action, masstort, and other similar legal proceedings. In October 2005, we acquired Hilsoft to enhance our ability to providespecialized media placement services related to class action, mass tort andbankruptcy noticing.  In November 2005,we acquired nMatrix to expand our product and service offerings to includeelectronic litigation discovery.

Inconjunction with our acquisition of nMatrix, we had notable changes to ourcapital structure.  As partial purchaseprice consideration, we issued approximately 1.2 million shares of our commonstock.  To provide us with increasedfinancial flexibility, we also restructured our credit facility.  Our amended credit facility now consists of a$25 million senior term loan, due September 2006, and a $100 million seniorrevolving loan, due November 2008. During the term of the loan we have the right, subject to compliancewith our covenants, to increase the senior revolving loan to $175 million.

**Critical Accounting Policies**

We consider ouraccounting policies related to revenue recognition, business combinations,goodwill, and identifiable intangible assets to be critical policies inunderstanding our historical and future performance.

***Revenuerecognition*.**  We have agreements with clients pursuant towhich we deliver various case management and document management services eachmonth.

Significant sources ofrevenue include:

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

·                  Hostingfees based on the amount of data stored;

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

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

·                  Reimbursementfor costs incurred related to postage on mailing services.

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*Non-Software Arrangements*

Case and document management servicesrelated to electronic discovery, corporate restructuring, and class actionrevenue, which are billed based on volume, are evaluated pursuant to EmergingIssues Task Force (EITF) 00-21, *RevenueArrangements with Multiple Deliverables*.  For each of these contractual arrangements,we have identified the following deliverables and/or services:

·                  Electronic Discovery

·               Data processing

·               Hosting

·                  Corporate Restructuring

·               Consulting

·               Claims management

·               Printing and reproduction

·               Mailing and noticing

·               Document management

·                  Class Action

·               Consulting

·               Notice campaigns

·               Toll free customer support

·               Web site design/hosting

·               Claims administration

·               Distribution

Based on our evaluation of each element, wehave determined that each element delivered has standalone value to ourcustomers because we or other vendors sell such services separately from anyother services/deliverables.  We havealso obtained objective and reliable evidence of the fair value of each elementbased either on the price we charge when we sell an element on a standalonebasis or based on third-party evidence of fair value of such services.  Lastly, our arrangements do not includegeneral rights of return.  Accordingly,each of the service elements in our multiple element case and documentmanagement arrangements qualifies as a separate unit of accounting under EITF00-21.  We allocate revenue to thevarious units of accounting in our arrangements based on the fair value of eachunit of accounting, which is generally consistent with the stated prices in ourarrangements. As we have evidence of an arrangement, revenue for each separateunit of accounting is recognized each period in accordance with StaffAccounting Bulletin Topic 13, *RevenueRecognition* (SAB Topic 13).  Asthe services are rendered, our fee becomes fixed and determinable, andcollectibility is reasonably assured. Payments received in advance of satisfaction of the related revenuerecognition criteria are recognized as a customer deposit until all revenue recognitioncriteria have been satisfied.

*Software Arrangements*

For our Chapter 7 bankruptcytrustee arrangements, we provide our trustee clients with a software license,hardware lease, hardware maintenance, and PCS services, all at no charge to thetrustee.  The trustees place theirliquidated estate deposits with a financial institution with which we have anarrangement.  The financial institutionpays us a monthly fee contingent on the dollar level of average monthlydeposits placed by the trustees with that financial institution.

Wehave arrangements with various depository financial institutions and, prior toOctober 1, 2003, we had an open ended arrangement with our primary depositoryfinancial institution.  We also had openended arrangements with each Chapter 7 trustee client.  Under these arrangements, we provided ourChapter 7 trustee clients with a software license, hardware lease, hardwaremaintenance, and PCS services, all at no charge to the trustee.  The trustees placed their liquidating estatedeposits with a financial institution with which we had a joint marketingarrangement, typically our primary depository financial institution.  We account for the software license and PCS elements in accordance withStatement of Position 97-2, *Software RevenueRecognition* (SOP 97-2).  Sincewe have not established vendor specific objective evidence (VSOE) of the fairvalue of the software license, we do not recognize any revenue on delivery of 

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the software.  The software element is deferred and includedwith the remaining undelivered element, which is PCS services.  This revenue, when recognized, is included onour consolidated statements of operations as a component of “Case managementbundled software license, software upgrade and postcontract customer supportservices” revenue.  Revenue related toPCS is entirely contingent on the placement of liquidated estate deposits bythe trustee with the financial institution. Accordingly, we recognize this contingent usage based revenue consistentwith the guidance provided by the American Institute of Certified PublicAccountants’ Technical Practice Aid (TPA) 5100.76, *Fair Valuein Multiple-Element Arrangements That Include Contingent Usage-Based Fees andSoftware Revenue Recognition* as the fee becomes fixed ordeterminable at the time actual usage occurs and collectibility isprobable.  This occurs monthly as aresult of the computation, billing and collection of monthly deposit fees.  At that time, we have also satisfied theother revenue recognition criteria contained in SOP 97-2, as we have persuasiveevidence that an arrangement exists, services have been rendered, the price isfixed and determinable, and collectibility is reasonably assured.

Prior to October 1, 2003, from time to timewe would separately negotiate a contract with our primary financial institutionto provide the trustee clients with a software upgrade or a specialproject.  For these single elementcontracts, in accordance with SAB Topic 13, we recognized revenue whenpersuasive evidence of an arrangement existed, services had been rendered, theprice was fixed and determinable, and collectibility was reasonablyassured.  This occurred on delivery ofthe single element.

Wealso provide our trustee clients with certain hardware, such as desktopcomputers, monitors, and printers, and hardware maintenance.  We retain ownership of all hardware providedand, based on guidance provided in EITF 01-8, *DeterminingWhether an Arrangement Contains a Lease*, we account for thishardware as a lease.  As the hardwaremaintenance arrangement is an executory contract similar to an operating lease,we use guidance related to contingent rentals in operating lease arrangementsfor hardware maintenance as well as for the hardware lease.  Since the payments under all of ourarrangements are contingent upon the level of trustee deposits and the deliveryof upgrades and other services, there remain important uncertainties regardingthe amount of unreimbursable costs yet to be incurred by us, we account for thehardware lease as an operating lease in accordance with SFAS 13, *Accounting for Leases*.  Therefore, all lease payments, based on theestimated fair value of hardware provided, were accounted for as contingentrentals under EITF Issue No. 98-9, *Accountingfor Contingent Rent* and SAB Topic 13, which requires that werecognize rental income when the changes in the factor on which the contingentlease payment is based actually occur. This occurs at the end of each period as we achieved our target whendeposits are held at the depository financial institution as, at that time,evidence of an arrangement exists, delivery has occurred, the amount has becomefixed and determinable, and collection is reasonably assured.  This revenue, which is less than ten percentof our total revenue, is included in our consolidated statements of operationsas a component of “Case management services” revenue.

Effective October 1, 2003, we entered into a three-year arrangement(the 2003 Arrangement) with our primary financial institution under which wedelivered two specified upgrades annually with the last specified upgrade tooccur in the second quarter of 2006. This arrangement included specific pricing for each software upgrade andcertain special projects in addition to the contingent deposit-based pricingrelated to the software license, hardware, hardware maintenance, and PCSservices provided to each trustee client. Therefore, the softwareupgrades and special projects are part of a bundled arrangement.  Each software upgrade is considered aseparate and discrete product and, as we do not sell each software upgrade on astandalone basis, we were unable to establish VSOE of the fair value of thesoftware upgrades.  As a result, thelicensed software, software upgrade, special projects and PCS are a combinedunit of accounting.  Under the guidanceof SOP 97-2, all revenue related to this combined unit of accounting isdeferred until the final upgrade is delivered. The ongoing costs related to this arrangement were recognized asexpense when incurred.  When the final upgrade is delivered and theonly remaining undelivered element is PCS, we will then recognize revenue on apro-rata basis over the term of the agreement. Payments received in advance of satisfaction of the related revenue recognitioncriteria are recognized as deferred revenue until all revenue recognitioncriteria have been satisfied.  As ofDecember 

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31, 2005 and 2004, we had recorded on ourconsolidated balance sheets $59.7 million and $35.2 million, respectively, ofdeferred revenue under the 2003 Arrangement. This deferred revenue was recognized during the second and thirdquarters of 2006.  The 2003 Arrangementdid not affect our accounting, as described above, for fees received from otherfinancial institutions or our accounting related to hardware and hardwaremaintenance.

*Reimbursements*

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

***Businesscombination**accounting****. *Wehave acquired a number of businesses during the last several years, and we mayacquire additional businesses in the future. Business combination accounting, often referred to as purchaseaccounting, requires us to determine the fair value of all assets acquired,including identifiable intangible assets, and liabilities assumed.  The cost of the acquisition is allocated tothe assets acquired and liabilities assumed in amounts equal to the fair valueof each asset and liability, and any remaining acquisition cost is classifiedas goodwill.  This allocation processrequires extensive use of estimates and assumptions, including estimates offuture cash flows to be generated 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.  The estimated useful life of amortizableidentifiable intangible assets range from one to fourteen years.  Goodwill is not amortized.  Accordingly, the acquisition cost allocationhas had, and will continue to have, a significant impact on our currentoperating results.

***Goodwill.***  We assess goodwill, which is not subject toamortization, for impairment as of each July 31 and also at any other date whenevents or changes in circumstances indicate that the carrying value of theseassets may exceed their fair value.  Thisassessment is performed at a reporting unit level.  A reporting unit is a component of a segmentthat constitutes a business, for which discrete financial information isavailable, and for which the operating results are regularly reviewed bymanagement.  We develop an estimate ofthe fair value of each reporting unit, using both a market approach and anincome approach.  For each reportingunit, the fair value estimate for our 2005 annual assessment was consistentwith the fair value estimate for our 2004 annual assessment.

A change in events orcircumstances, including a decision to hold an asset or group of assets forsale, a change in strategic direction, or a change in the competitiveenvironment could adversely affect the fair value of one or more reportingunits.  During November 2003, we determined that ourinfrastructure software segment was no longer aligned with our long-termstrategic objectives and we developed a plan to sell this segment within ayear.  As a result, we recognized apre-tax impairment charge of approximately $3.8 million related to goodwillduring the year ended December 31, 2003.

The estimate of fairvalue is highly subjective and requires 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 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.  Ourunimpaired, recognized goodwill totaled $249.4 million as of December 31, 2005.

***Identifiable intangibleassets. ***Each period we evaluate whether events andcircumstances warrant a revision to the remaining estimated useful life of eachidentifiable intangible asset.  If eventsand 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 our annual assessment, orother events and circumstances, may indicate that the carrying value of one ormore 

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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 ourinfrastructure software segment was no longer aligned with our long-termstrategic objectives and we developed a plan to sell this segment within ayear.  As a result, we recognized apre-tax impairment charge of approximately $0.9 million related to identifiableintangible assets during the year ended December 31, 2003.

Achange in the estimate of the remaining life of one or more identifiableintangible assets or the impairment of one or more identifiable intangibleassets could have a material impact on our results of operations and financialcondition.  Our identifiable intangibleassets’ carrying value, net of amortization, was $53.4 million as of December31, 2005.

**Results of Operations for theYear Ended December 31, 2005 Compared with the Year Ended December 31, 2004**

**ConsolidatedResults**

***Revenue***

Total revenue fromoperations of $106.3 million for the year ended December 31, 2005 represents anapproximate $7.9 million, or 8%, increase compared with $98.4 million ofrevenue for the prior year.  Totalrevenue includes operating revenue from reimbursed direct costs, which arepresented as a separate line item captioned “Operating revenue from reimburseddirect costs” on our consolidated statement of operations.  While operating revenue from reimburseddirect costs may fluctuate significantly from period to period, thesefluctuations have a minimal effect on our operating income or loss as werealize little or no margin from this revenue. Operating revenue before reimbursed direct costs, which is alsopresented as a separate line item on our consolidated statement of operations,increased $4.7 million, or approximately 6%, to $82.7 million for the yearended December 31, 2005 compared with $78.0 million for the same period in theprior year.  All revenue is directlyrelated to a segment and changes in revenue by segment are discussed below.

***Operating Expenses***

Directcost of services, exclusive of depreciation and amortization, decreasedapproximately $7.2 million, or 19% to $30.2 million for the year endedDecember 31, 2005 compared with $37.4 million for the prior year.  Excluding our subsidiaries acquired during 2005,direct costs of services decreased $8.1 million, or approximately 22%, comparedwith the prior year.  This decrease isprimarily the result of a decrease in cost of advertising.  Changes in our segment cost structure arediscussed below.

Directcost of bundled software license, software upgrade and postcontract customersupport services, exclusive of depreciation and amortization, increasedapproximately $1.0 million to $3.8 million for the year ended December 31, 2005compared with $2.8 million for the prior year primarily as a result ofincreased compensation costs.  Changes inour segment cost structure are discussed below.

Reimburseddirect costs increased approximately 18% to $23.8 million for the year endedDecember 31, 2005 compared with $20.1 million for the prior year.  This increase is directly attributable to theincrease in operating revenue from reimbursed direct costs.

Generaland administrative expenses increased $5.2 million, or approximately 20%, to$31.1 million for the year ended December 31, 2005 compared with $25.9 millionfor the prior year.  Excluding oursubsidiaries acquired during 2005, general and administrative expensesincreased $4.4 million, or approximately 17%, compared with the prioryear.  This increase primarily resultsfrom the increase in the scope and complexity of our business, and is primarilythe result of increases in compensation and related expenses, travel, andprofessional services.  Changes in oursegment cost structure are discussed below.

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Depreciationand software amortization expenses increased $0.8 million, or approximately12%, to $7.3 million for the year ended December 31, 2005 compared with $6.5million for the prior year.  Excludingour subsidiaries acquired during 2005, depreciation and software amortizationexpenses increased $0.5 million, or approximately 8%, compared with the prioryear primarily as a result of increased software amortization.  Changes in our segment cost structure arediscussed below.

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

Acquisitionrelated expenses 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.

***Interest Expense***

Interestexpense increased $0.5 million, to $6.8 million for the year ended December 31,2005 compared with $6.3 million of interest expense for the prior year.  This increase related to various components:

·                  Variableinterest expense related to our credit facilities and fixed interest expenserelated to our convertible debt increased $0.7 million to $4.5 million duringthe year ended December 31, 2005 compared to $3.8 million for the prior yearprimarily 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, 2005compared to $2.1 million for the prior year. This decrease is primarily a result of amortization related to ashort-term subordinated borrowing under the credit facility used to finance theacquisition of Poorman-Douglas in January 2004. All fees related to this subordinated borrowing were amortized during2004.

·                  Ourconvertible debt facility includes a provision allowing the convertible debtholders to extend the debt maturity from three years to six years.  Under SFAS 133, *Accountingfor Derivative Instruments and Hedging Activities*, this provision isaccounted for as an embedded option.  Atinception, the embedded option was valued at $1.2 million and the convertibledebt balance was reduced by the same amount. The convertible debt accretes approximately $0.1 million each quartersuch that, at the end of three years, the convertible debt balance will total$50.0 million.  The embedded option mustbe revalued at each period end based on the probability weighted discountedcash flows related to the additional 4% interest rate payments which would bemade if the convertible debt maturity is extended an additional three years.  While the changes in fair value of theembedded option and carrying value of the convertible debt do not affect ourcurrent cash flow, the aggregate of these changes in value is accounted for asa current income or expense item and is included on our accompanying consolidated statement of operations asa component of interest expense.  Duringthe year ended December 31, 2005, we recognized expense related to theconvertible debt accretion and change in value of the embedded option of $1.0million, compared with $0.3 million of such expense in the prior year.  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 optionis not exercised by some or all convertible debt holders, any remaining relatedvalue assigned to the embedded option will be recognized as a gain during thatperiod.

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***Debt Extinguishment***

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 December31, 2004, we recognized a $1.0 million charge for the write-off of loan feesrelated to the terminated credit facility. We did not recognize any debt extinguishment expense during 2005.

***Effective Tax Rate***

Oureffective tax rate to record the tax benefit related to our loss fromcontinuing operations increased from 37.2% for the year ended December 31, 2004to 38.4% for the year ended December 31, 2005. The change in our 2005 effective tax benefit rate compared to theprior year is primarily the result of discrete events, includingcharacterization of the loss from disposal of our discontinued operations froma business loss to a non-business loss and an increase in our research andexpenditure credit.  Our tax benefit rate is higher than thestatutory federal rate of 34% 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 tax rates which are higher than the tax rates assessed by otherjurisdictions where we operate.

***Net Loss***

Ournet loss decreased to a $3.8 million net loss for the year ended December 31,2005 compared with a $6.6 million net loss for the prior year.  This decrease in our net loss was primarilythe result of an $8.0 million increase in revenues, primarily resulting from theinclusion of revenue from our electronic discovery business acquired duringNovember 2005, and a $2.6 million decrease in direct costs, primarily resultingfrom a decrease in media campaign and advertising direct costs.  This decrease in our net loss was partlyoffset by a $5.2 million increase in our general and administrative expenses, a$1.9 million decrease in our tax benefit primarily resulting from the reducedpre-tax loss, and a $0.7 million decrease of income from operations of ourdiscontinued infrastructure segment compared with 2004.

**Business Segments**

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

***Revenue***

Casemanagement operating revenue before reimbursed direct costs increasedapproximately 32% to $54.8 million for the year ended December 31, 2005compared with $41.5 million for the year ended December 31, 2004.  nMatrix, which was acquired on November 15,2005, accounted for approximately $3.7 million of the increase in operatingrevenue before reimbursed direct costs.  Theremainder of the increase is primarily attributable to a $5.7 million increasein class action operating revenues before reimbursed direct costs resultingfrom the timing of several large cases and a $2.8 million increase resultingfrom a net increase in corporate restructuring professional services.

DuringFebruary 2006, we entered into a new pricing arrangement with our primaryChapter 7 depository financial institution. This new pricing arrangement will be effective beginning October2006.  Chapter 7 depository fees areincluded entirely within our case management segment.  Under this arrangement, the fees we earn fordeposits placed with this financial institution could have, within certainlimits, variability based on fluctuations in short-term interest rates.  Based on the terms of the pricing arrangementand the current interest rate environment, we do not anticipate that this newpricing arrangement will have a material impact on our 2006 operating cashflows, but the arrangement will affect the timing of our revenue recognition aswe anticipate that we will not defer recognition of revenue under thisarrangement.

Documentmanagement operating revenue before reimbursed direct costs decreasedapproximately $8.6 million, or approximately 24%, to $27.9 million for the yearended December 31, 2005 compared with $36.5 million for the prior year.  This decrease is primarily attributable to adecline in media campaign and advertising services.  Our media campaign and advertising servicesare primarily connected with 

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classaction and bankruptcy customers for whom we provide case administrationservices.  Media campaign and advertisingservices vary significantly depending on the characteristics of the case.  Generally, cases in which the specificidentity of members of the plaintiff class is unknown will requiresignificantly more media campaign and advertising services than cases in whichthe specific identity of the members of the plaintiff class is known.  During 2004, we had several large cases inwhich the specific identity of the members of the plaintiff class was unknownand, therefore, required extensive media campaign and advertising services.  During 2005, the identities of the members ofthe plaintiff class on our large cases were known and, therefore, did notrequire extensive media campaign and advertising services.  We anticipate that these media campaign andadvertising services will increase in 2006 because Hilsoft provides significantlevels of media campaign and advertising services and their financial resultswill be included in our operating results for the entire calendar year 2006, but are only included for slightly morethan two months of 2005following the October 20, 2005 acquisition of that business.  Documentmanagement operating revenue from reimbursed direct costs of $20.5 million forthe year ended December 31, 2005 increased approximately 15% compared withthe same period in the prior year. Operating revenue from reimbursed direct costs has little or no marginand, accordingly, this increase in operating revenue from reimbursed directcosts did not have a material effect on our income from operations.  Document management revenues, includingrevenues related to media campaign and services, can fluctuate materially fromperiod to period based on clients’ business requirements.

***Operating Expenses***

Casemanagement direct costs, general and administrative expenses, and depreciationand software amortization increased $3.5 million, or approximately 12%, to$32.6 million for the year ended December 31, 2005 compared with $29.1million for the same period in the prior year. nMatrix, which was acquired on November 15, 2005, accounted forapproximately $1.4 million of the increase in direct costs, general andadministrative 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 primarily attributable to an increase in reimbursedexpenses and expenses related to the expansion of our bankruptcy serviceofferings.  Our case management coststructure is relatively stable and generally does not fluctuate materially withchanges in operating revenues.

Documentmanagement direct costs, general and administrative expenses, and depreciationand software amortization decreased $4.0 million, or 10%, to $36.6 million for theyear ended December 31, 2005 compared with $40.6 million for the prioryear.  This decrease primarily resultsfrom a decrease in cost of media campaign and advertising, related to thedecline in media campaign and advertising service revenue discussed above,partly offset by an increase in reimbursed expenses, the inclusion of Hilsoftoperating expenses, and an increase in expenses paid to third parties forproduction services.  Our documentmanagement cost structure is more variable than case management and willfluctuate based on document management business requirements delivered.

Boththe case management and document management segments have identifiableintangible assets.  Amortization of casemanagement’s identifiable intangible assets decreased $0.2 million to $5.0million for the year ended December 31, 2005 compared with $5.2 million for theprior year.  This decrease is primarilyattributable to certain intangible assets acquired in the BSI acquisition thatbecame fully amortized during 2005, largely offset by an increase inamortization related to intangible assets acquired in the nMatrixacquisition.  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 million for theprior year.  This decrease is primarilyattributable to certain intangible assets acquired in the BSI acquisition thatbecame fully amortized during 2005, partly offset by an increase inamortization related to intangible assets acquired in the Hilsoftacquisition.  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.

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**Results of Operations for theYear Ended December 31, 2004 Compared with the Year Ended December 31, 2003**

**ConsolidatedResults**

***Revenue***

Totalrevenue of $98.4 million for the year ended December 31, 2004 represents a$38.6 million, or approximately 65% increase compared with $59.8 million ofrevenue for the same period in the prior year. With our acquisition of Poorman-Douglas in January 2004, operatingrevenue from reimbursed direct costs, such as postage pertaining to documentmanagement services, increased significantly during 2004.  We reflect the operating revenue fromreimbursed direct costs as a separate line item captioned “Operating revenuefrom reimbursed direct costs” on our consolidatedstatement of operations.  Whileoperating revenue from reimbursed direct costs may fluctuate significantly fromperiod to period, these fluctuations have a minimal effect on our operatingincome or loss as we realize little or no margin from this revenue.  Operating revenue before reimbursed directcosts, which is also presented as a separate line item on our consolidatedstatement of operations,increased approximately $23.7 million, or approximately 44%, to $78.0 millionfor the year ended December 31, 2004 compared with $54.3 million for the sameperiod in the prior year.  All revenue isdirectly related to a segment and changes in revenue by segment are discussedbelow.

***Operating Expenses***

Directcost of services, exclusive of depreciation and amortization, increasedapproximately $29.0 million to $37.4 million for the year ended December 31,2004 compared with $8.4 million for the same period in the prior year.  This increase primarily results from theinclusion of Poorman-Douglas’ expenses subsequent to the acquisition date.  Excluding the effect of our Poorman-Douglasacquisition, direct cost of services decreased $0.8 million, or approximately9%, primarily as a result of a decline in bankruptcy noticing services.  Changes in our segment cost structure arediscussed below.

Directcost of bundled software license, software upgrade and postcontract customersupport services, exclusive of depreciation and amortization, increasedapproximately $0.3 million to $2.8 million for the year ended December 31, 2004compared with $2.5 million for the prior year primarily as a result ofincreased compensation costs.  Changes inour segment cost structure are discussed below.

Reimburseddirect costs increased approximately $14.5 million to $20.1 million for theyear ended December 31, 2004 compared with $5.6 million for the prioryear.  Exclusive of reimbursed directcosts related to the inclusion of Poorman-Douglas, reimbursed direct costsdecreased approximately $1.6 million, or approximately 29%, to approximately$4.0 million for the year ended December 31, 2004, compared with approximately$5.6 million for the prior year.  Thisdecrease is directly attributable to the decrease, exclusive of Poorman-Douglas,in operating revenue from reimbursed direct costs.

Generaland administrative expenses increased $9.0 million, or approximately 53%, to$25.9 million for the year ended December 31, 2004 compared with $16.9 millionfor the same period in the prior year. This increase primarily results from the inclusion of Poorman-Douglas’expenses subsequent to the acquisition date. Excluding the effect of our Poorman-Douglas acquisition, general andadministrative expenses increased $2.5 million for the year ended December 31,2004, or approximately 15%, compared with the same period in the prior yearprimarily due to significant increased expenses related to compliance withregulations and standards imposed by Section 404 of the Sarbanes-Oxley Act of2002, increased travel expense primarily related to additional locations, andincreases in compensation and related benefits and insurance coverage due tobusiness expansion.  Changes in oursegment cost structure are discussed below.

Depreciationand software amortization expenses increased $1.9 million, or approximately43%, to $6.5 million for the year ended December 31, 2004 compared with $4.6million for the same period in the prior year. This increase primarily results from the inclusion of Poorman-Douglas’expenses subsequent to the 

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acquisitiondate.  Excluding the effect of ourPoorman-Douglas acquisition, depreciation and software amortization increased$0.2 million, or approximately 5%, compared with the same period in the prioryear primarily as a result of our acquisition of additional operating softwarelicenses.  Changes in our segment coststructure are discussed below.

Amortizationof identifiable intangible assets increased $4.2 million to $7.8 million forthe year ended December 31, 2004 compared with $3.6 million for the same periodin the prior year.  All identifiableintangible assets are directly related to a segment and changes in amortizationof identifiable intangible assets by segment are discussed below.

Acquisitionrelated expenses 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.

***Interest Expense***

Interest expense totaled$6.3 million during the year ended December 31, 2004 compared with $0.2 millionof interest expense during the same period in the prior year.  This increase related to various financingcomponents.  Variable interest expenserelated to our credit facilities, fixed interest expense related to ourconvertible debt, and interest accreted on debt with no stated interest ratetotaled $3.8 million during the year ended December 31, 2004.  Amortization of loan fees related to ourcredit facilities and related to our convertible debt offering totaled $2.1million during the year ended December 31, 2004.  Our convertible debt facility includes aprovision allowing the convertible debt holders to extend the debt maturityfrom three years to six years.  UnderSFAS 133, *Accounting for Derivative Instruments and HedgingActivities*, this provision is accounted for as an embeddedoption.  At inception, the embeddedoption was valued at $1.2 million and the convertible debt balance was reducedby the same amount.  The convertible debtaccretes approximately $0.1 million each quarter such that, at the end of threeyears, the convertible debt balance 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 fair value of theembedded option and carrying value of the convertible debt do not affect ourcurrent cash flow, the aggregate of these changes in value, totaling $0.3million of expense for the year ended December 31, 2004, is accounted for as acurrent income or expense item and is included on our accompanying consolidated statement of operations asa 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 optionis not exercised by some or all convertible debt holders, any remaining relatedvalue assigned to the embedded option will be recognized as a gain during thatperiod.

***Debt Extinguishment***

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 December31, 2004, we recognized a $1.0 million charge for the write-off of loan feesrelated to the terminated credit facility. We did not recognize any debt extinguishment expense during 2003.

***Effective Tax Rate***

Oureffective tax rate to record the tax benefit related to our loss fromcontinuing operations was 37.2% for the year ended December 31, 2004 comparedto a 42% effective tax rate related to our income from continuing operationsfor the year ended December 31, 2003. Our tax rate is higher than the statutory federal rate of 34% primarilydue to state taxes.  Our corporaterestructuring subsidiary, BSI, operates primarily in New York City and issubject to state and local tax rates, which are higher than the tax ratesassessed by other jurisdictions where we operate.  Our effective tax benefit rate related to2004 losses is less than the 2003 effective tax rate primarily due to expensesthat are not deductible for tax purposes.

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***Discontinued Operations***

Ourinfrastructure software results are included entirely within the discontinuedoperations section of our income statement. Pre-tax income from discontinued operations of $1.1 million for the yearended December 31, 2004 resulted primarily from our gain on sale of thebusiness, partly offset by operating losses through the date of sale, which wasApril 30, 2004.  Pre-tax loss fromdiscontinued operations of $9.6 million for the year ended December 31, 2003was primarily the result of a $7.6 million impairment charge to reducegoodwill, other intangible assets, software and other long-lived assets totheir estimated fair value.

***Net Income (Loss)***

During2004, we had a net loss of $6.6 million compared with net income of $3.8million during 2003.  This change of$10.4 million is primarily the result of the change in revenue recognitionrelated to 2003 Arrangement which was effective October 1, 2003.  Subsequent to inception of the 2003Arrangement, we have deferred substantially all revenue related to our Chapter7 trustee business.  For all trusteeswith deposits held with the our primary financial institution, we deferredrecognition for all volume-based revenue related to software licensing,postcontract customer support and all software upgrade revenue effective withthe October 1, 2003 commencement of the 2003 Arrangement as discussed in “Management’sDiscussion and Analysis of Financial Condition and Results of Operation,Management Overview” above. As a result, during the year ended December 31, 2004, we recognized approximately$23.7 million less in Chapter 7 revenue than during the year ended December 31,2003.  Additionally, net expenses relatedto financing increased approximately $7.3 million.  This revenue decrease and this expenseincrease were partly offset by the recognition of a $0.7 million gain on saleof our discontinued segment during 2004 compared with a $5.8 million loss fromoperations of the discontinued segment during 2003 and a change in ourprovision for income taxes from a $6.9 million tax expense to a $4.3 milliontax benefit.

**Business Segments**

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

***Revenue***

Case management operatingrevenue before reimbursed direct costs was approximately $41.5 million for boththe year ended December 31, 2004 and the year ended December 31, 2003.  Case management operating revenue includesoperating revenue before reimbursed direct costs related to the Poorman-Douglasacquisition subsequent to the acquisition date. Exclusive of Poorman-Douglas, operating revenue before reimbursed directcosts declined by $22.5 million due primarily to a $23.7 decrease in bankruptcyvolume-based and software upgrade revenue. The primary reason for this decrease is that, for all trustees withdeposits held with our primary financial institution, we deferred recognitionfor all volume-based revenue related to software licensing, postcontractcustomer support and all software upgrade revenue effective with the October 1,2003 commencement of the 2003 Arrangement as discussed in “Management’sDiscussion and Analysis of Financial Condition and Results of Operation,Management Overview” above.

Documentmanagement operating revenue before reimbursed direct costs increased $23.8million, or approximately 187%, to $36.5 million for the year ended December31, 2004 compared with $12.7 million for the year ended December 31, 2003.  The increase in operating revenue beforereimbursed direct costs was primarily the result of the acquisition ofPoorman-Douglas.  Exclusive ofPoorman-Douglas, our document management operating revenue before reimburseddirect costs declined $3.4 million due primarily to a decrease in bankruptcynoticing services.  Document managementoperating revenue from reimbursed direct costs of $17.9 million for the yearended December 31, 2004 increased approximately 243% compared with the sameperiod in the prior year.  Operatingrevenue from reimbursed direct costs has little or no margin and, accordingly,this increase did not have a material 

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effect on our income fromoperations.  Document management revenues can fluctuatematerially from period to period based on clients’ business requirements.

***Operating Expenses***

Casemanagement direct costs, general and administrative expenses, and depreciationand software amortization increased $16.0 million, or approximately 122%, to$29.1 million for the year ended December 31, 2004 compared with $13.1 millionfor the same period in the prior year. This increase primarily results from the inclusion of Poorman-Douglas’expenses subsequent to the acquisition date. Exclusive of Poorman-Douglas expenses, case management’s direct andadministrative expenses, including depreciation and software amortization,increased $0.9 million due primarily to increases in operating softwareamortization and wage related expense. Our case management cost structure is relatively stable and generallydoes not fluctuate materially with changes in operating revenues beforereimbursed expenses.

Documentmanagement direct costs, general and administrative expenses, and depreciationand software amortization increased $30.9 million to $40.6 million for the yearended December 31, 2004 compared with $9.7 million for the prior year.  This increase primarily results from theinclusion of Poorman-Douglas’ expenses, including reimbursed expenses,subsequent to the acquisition date. Exclusive of Poorman-Douglas’ expenses, our document management expensesdeclined $2.4 million due primarily to a decline in postage and print expenserelated to a decrease in noticing services. Our document management cost structure is more variable than casemanagement and will fluctuate based on document management businessrequirements delivered.

Boththe case management and document management segments have identifiableintangible assets.  Amortization of casemanagement’s identifiable intangible assets increased $3.1 million to $5.2million for the year ended December 31, 2004 compared with $2.1 million for theprior year.  Amortization of documentmanagement’s identifiable intangible assets increased $1.0 million to $2.5million for the year ended December 31, 2004 compared with $1.5 million for theprior year.  For both segments, thisincrease is due primarily to the amortization expense related to the acquiredintangible assets resulting from the Poorman-Douglas transaction and theFebruary 2004 commencement of amortization related to the BSI trade name.

**Liquidity and Capital Resources**

***Operating Activities***

Duringthe year ended December 31, 2005, our operating activities provided net cash of$27.2 million.  The primary sources ofcash from operating activities were adjustments for non-cash charges andcredits of $7.4 million, primarily as a result of depreciation and amortizationof software, loan fees, and identifiable intangible assets partly offset by thebenefit for deferred income taxes, and changes in operating assets andliabilities, net of effects from business acquisitions, which increased ouroperating cash flow by $23.7 million primarily as a result of an increase in deferredrevenue and accounts payable and other liabilities partly offset by an increasein trade accounts receivable.  Thesesources of cash were partly offset by our net loss of $3.8 million.  Trade payables and other liabilities,excluding acquired trade payables and other liabilities, increased by $27.9million primarily as a result of a $24.7 million increase in deferredrevenue.  Deferred revenue increasedprimarily as the result of deferral of substantially all Chapter 7 bankruptcytrustee revenue.  Also contributing tothe increase in trade payables and other liabilities were increases in tradepayables, accrued interest expense, and accrued bonus.  The increase in trade payables was the resultof the timing of payments.  The increasein accrued interest expense was due to an increase in our debt level and thetiming of interest payments.  Theincrease in accrued bonus was primarily due to the timing of bonuspayments.  These increases represent anet source of cash.  Trade accountsreceivable, excluding acquired trade receivables, increased by $3.1million.  This increase represents a netuse of cash.  The increase in tradeaccounts receivable was the result of timing of collections.  We anticipate that our trade accountsreceivable will continue to fluctuate from period to period depending on thetiming of collections.

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Changesin operating assets and liabilities as a direct result of assets acquired orliabilities assumed have been excluded from our consolidated statements of cashflows.  However, subsequent toacquisition, cash flows related to these acquired assets and assumedliabilities are reflected in our consolidated statements of cash flows.  For example, accounts receivable and accountspayable acquired or assumed as a part of the transaction are not reflected,respectively, as a use or source of cash. 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***

Ourmost significant use of cash for investing activities was to expand ourbusiness through acquisitions.  Totalcash used in 2005 to acquire businesses, net of $0.9 million cash acquired inthe acquisitions, was approximately $110.5 million.  During the year ended December 31, 2005, weused cash of approximately $4.6 million to purchase property andequipment.  Enhancements to our existingsoftware and development of new software is essential to our continued growthand, during the year ended December 31, 2005, we used cash of approximately$2.3 million to fund internal costs related to development of software forwhich technological feasibility has been established.  During November 2005 we acquired nMatrix,which expanded our business into the electronic discovery market.  In support of this expansion, we anticipatesoftware development and purchases of hardware and equipment and softwarespending will increase during 2006 compared with 2005.  We anticipate that cash generated from operationswill be adequate to fund our anticipated property, equipment and softwarespending in 2006.

***Financing Activities***

Inconjunction with our acquisition of nMatrix, during November 2005 we amendedour credit facility.  Based on the termsof our amended credit facility, we increased our senior term loan borrowingsfrom $17.2 million to $25.0 million.  Theamended credit facility eliminated the requirement for quarterly amortizingpayments on the senior term loan, but shortened the maturity of the senior termloan from June 2008 to August 2006.  Theamended credit facility also increased our senior revolving loan from $75.0million to $100.0 million.  The maturityof the senior revolving loan was extended from June 2008 to November 2008.  During the term of the loan, we have theright, subject to compliance with our covenants, to increase the seniorrevolving loan to $175.0 million.

DuringNovember 2005, under the amended credit facility we borrowed an additional $7.8million under the senior term loan and $93.0 million under the senior revolvingloan to finance the cash portion of our acquisition of nMatrix.

Asof December 31, 2005, our borrowings consisted of $51.3 million from thecontingent convertible subordinated notes (including the fair value of theembedded option), $25.0 million under the credit facility’s senior term loan,$93.0 million under the credit facility’s senior revolving loan, andapproximately $4.2 million of obligations related to capitalized leases anddeferred acquisition price.

As of December 31, 2005,significant covenants, all as defined within our credit facility agreement,include a leverage ratio not to exceed 3.50 to 1.00, a senior leverage rationot to exceed 2.50 to 1.00, a fixed charge coverage ratio of not less than 1.25to 1.00, and a current ratio of not less than 1.50 to 1.00.  However, as a result of the restatement (see note 17of the accompanying notes to consolidated financial statements) that resultedin the deferral through December 31, 2005, of $59.7 million of revenue relatedto our Chapter 7 trustee business, we determined that we were not in compliancewith these financial covenants as of December 31, 2005.  Subsequent to year end, during the secondquarter of 2006, we recognized approximately $60.1 million of net deferredrevenue and were in compliance with all financial covenants as of June 30,2006.  The deferral of revenue andsubsequent recognition of revenue was not anticipated by us or the banks at thetime we established the current financial covenants in the creditfacility.  On December 14, 2006, weobtained a waiver regarding this event of noncompliance from our 

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creditfacility syndicate.  Accordingly, we haveclassified this debt as current or long-term based on the debt’s originalscheduled maturity.

Webelieve that the funds generated from operations plus amounts available underour credit facility’s senior revolving loan will be sufficient over the nextyear to finance currently anticipated working capital requirements, softwareexpenditures, property and equipment expenditures, payments for contractualobligations, and interest payments due on our outstanding borrowings.  Funds generated from operations may not beadequate to repay the $25.0 million term loan under our credit facilitywith an original maturity of August 2006. Sources of liquidity include an amendment to our credit facility toextend the maturity of the term loan(during June 2006, the maturity date of theremaining term loan principal of $15.0 million was extended to June 2007) or,an equity offering of our common shares.

We may pursueacquisitions in the future.  If theacquisition price exceeds our then available cash and unused borrowingcapacity, we may decide to issue equity, restructure our credit facility,partly finance the acquisition with a note payable, or some combination of thepreceding.  Covenants contained in ourcredit facility may limit our ability to consummate an acquisition.  Pursuant to the terms of our credit facility,we generally cannot incur indebtedness outside the credit facility with theexception of capital leases and additional subordinated debt, with a limit of$100.0 million of aggregate subordinated debt.  Furthermore, for anyacquisition we must be able to demonstrate that, on a pro forma basis, we wouldbe in compliance with our covenants during the four quarters prior to theacquisition and we must obtain bank permission for any acquisition for whichcash consideration exceeds $65.0 million or total consideration exceeds $125.0million.

**Off-balance Sheet Arrangements**

Although we generally do not utilizeoff-balance sheet arrangements in our operations, we enter into operatingleases in the normal course of business. Our operating lease obligations are disclosed below under “ContractualObligations” and also in note 6 of the notes to consolidated financialstatements.

**ContractualObligations**

The following table setsforth a summary of our contractual obligations and commitments, excludingperiodic interest payments, as of December 31, 2005.

 
| ** **                               | ** ** | **Payments Due By Period** | ** ** |
|------------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligation**          | ** ** | ** **                                | ** ** | **Total** | ** ** | **Less than  1 Year** | ** ** | **1 – 3 Years** | ** ** | **3 – 5 Years** | ** ** | **More Than  5 Years** | ** ** |
| ** **                               | ** ** | **(In Thousands)**                   | ** ** |
|                                     |       |                                      |       |   |   |   |   |   |   |   |   |
| Long-term 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 and Hilsoft purchaseprice were paid in the form of a non-interest bearing notes, which werediscounted using an imputed rate of 5% and 8%, respectively, per annum.  The discounts are accreted over the life ofthe note and each period’s accretion is added to the principal of therespective note.  The amount in the abovecontractual obligation table includes both the notes’ principal, as reflectedon our December 31, 2005 consolidated balance sheet, and all futureaccretion.  If certain revenue objectivesare satisfied, we will make additional payments, not to exceed $3.0 million, overthe next five years to the former owners of Hilsoft.  Such payments, if any, are not included inthe above contractual obligation table. Convertible debt is included at stated value of the principal redemptionand excludes adjustments related to the embedded option, which will not be paid

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in cash.  Any conversion to our common stock of part orall of the convertible debt will reduce our cash obligation related to theconvertible debt.

(2)         In conjunction with acquisitions, we haveentered into employment agreements with certain key employees of the acquiredcompanies.

**RecentAccounting Pronouncements**

InSeptember 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, when a modification of a convertible debtinstrument 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 extinguishment.  EITF 05-07 alsorequires subsequent recognition of interest expense for any change in the fairvalue of the embedded conversion option resulting from a modification of aconvertible debt instrument.  EITF 05-07is effective beginning in the first interim or annual reporting periodbeginning after December 15, 2005.  We donot anticipate that the adoption of EITF 05-07 will have a material impact onour consolidated financial statements.

InMay 2005, the Financial Accounting Standards Board (FASB) issued Statement ofFinancial Accounting Standards (SFAS) No. 154, *AccountingChanges and Error Corrections, a replacement of APB Opinion No. 20 and FASBStatement No. 3*.  SFAS No. 154requires retrospective application for reporting a change in accountingprinciple unless such application is impracticable or unless transitionrequirements specific to a newly adopted accounting principle requireotherwise.  SFAS No. 154 also requiresthe reporting of a correction of an error by restating previously issuedfinancial statements.  SFAS No. 154 iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005.

In December 2004, the FASBissued SFAS No. 123 (revised 2004) (SFAS No. 123R), *Share-BasedPayment*.  SFAS No. 123Restablishes standards for the accounting for transactions in which an entityexchanges its equity instruments for goods and services or incurs liabilitiesin exchange for goods or services that are based on the fair value of theentity’s equity instruments or that may be settled by the issuance of thoseequity instruments.  SFAS No. 123Rrequires a public entity to measure the cost of employee services received inexchange for an award of equity instruments based on the grant-date fair valueof the award and to recognize that cost over the period during which anemployee is required to provide service in exchange for the award.  SFAS No. 123R is effective for Epiq beginningJanuary 1, 2006.  Accordingly, we willadopt SFAS No. 123R, likely using the modified version of prospectiveapplication, beginning with our quarter ending March 31, 2006.  Under the modified version of prospectiveapplication, compensation costs related to share-based compensation will berecognized in our financial statements for all periods beginning after December31, 2005.  For comparative periods endedon or before December 31, 2005, which are presented in our 2006 and subsequentfinancial statements, share-based compensation costs will continue to beexcluded from our consolidatedstatement of operations, but we will disclose these share-basedcompensation costs on a pro forma basis in a note to the consolidated financialstatements.  During February 2005, ourcompensation committee approved acceleration of the vesting of certain unvestedoptions for employees, including an executive officer, 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 animmaterial effect on our financial statements for the year ended December 31,2005, will reduce the impact of adoption of SFAS No. 123R on our futureconsolidated financial statements. Adoption of SFAS No. 123R will materially increase our recognizedcompensation expense and will have a material impact on our consolidated statement of operations andour consolidated balance sheet.  We areworking with independent valuation experts to document and validate keyvaluation variables, such as 

39

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forfeiture rate, expectedterm, segmentation of employee population, expected term suboptimal exerciseprice, and expected volatility.  Untilthis work is completed, we are unable to estimate the impact of adoption of thisstatement on our consolidated financial statements.  However, if subsequent to December 31, 2005no new awards were issued and no existing awards were forfeited, we estimatethat adoption of SFAS No. 123R would decrease our net income for the year endingDecember 31, 2006 by approximately $1.4 million.  We do not anticipate that adoption of SFASNo. 123R will have a material impact on our consolidated statement of cashflows.

In August 2005, the FASBissued FASB Staff Position (FSP) No. FAS 123(R)-1, *Classificationand Measurement of Freestanding Financial Instruments Originally Issued inExchange for Employee Services under FASB Statement No. 123(R)*, todefer the 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 in this FSP is effective uponinitial adoption of SFAS No. 123R.  We donot anticipate that adoption of FSP No. FAS 123(R)-1 will have a material impacton our consolidated financial statements.

In October 2005, the FASBissued FSP No. FAS 123(R)-2, *Practical Accommodation tothe Application of Grant Date as Defined in FASB Statement No. 123(R).*  This FSP states that, in determining thegrant date of an award subject to SFAS No. 123R, a mutual understanding of thekey terms and conditions of an award to an individual employee shall bepresumed to exist at the date the award is approved in 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.  The guidance in this FSP is effective uponinitial adoption of SFAS No. 123R.  We donot anticipate that adoption of FSP No. FAS 123(R)-2 will have a materialimpact on our consolidated financial statements.

In November 2005, the FASBissued FSP No. FAS 123(R)-3, *Transition ElectionRelated to Accounting for the Tax Effects of Share-Based Payment Awards. *This FSP provides a simplifiedmethod for calculating the pool of excess tax benefits available to absorb taxdeficiencies recognized subsequent to the adoption of SFAS No. 123R.  We have until December 31, 2006, to determinewhether to make a one-time election to adopt the transition method described inthis FSP.  At this time, management isuncertain whether we will make the election to adopt the transition methoddescribed in this FSP and we are unable to estimate the impact, if any, on ourconsolidated financial statements if we elect to use the transition methoddescribed in this FSP.

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**ITEM 7A.**           QUANTITATIVE ANDQUALITATIVE 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.  Our convertible debt and credit facilityborrowings create market risks for us. We do 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 risk related to this instrument, theinstrument does contain an embedded option related to the right of securityholders to extend the maturity of the convertible notes which creates anearnings risk.  A 10% increase in ourstock value would result in a $0.2 million increase in the fair value of theembedded option and a corresponding decrease in pre-tax earnings.  A 10% decrease in our stock value wouldresult in a $0.2 million decrease in the fair value of the embedded option anda 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.

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

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**ITEM 8.**                    FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

Our consolidatedfinancial statements appear following Item 15 of this Report.

**Supplementary Data - QuarterlyFinancial Information**

The following table setsforth quarterly financial data for the quarters of the years ended December 31,2005 and 2004 (in thousands, except per share data) as reported previous to ourrestatement.
| ** **                                      | ** ** | **Quarters**                           | ** ** |
|-------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                      | ** ** | **1st**                                | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th** | ** ** |
| ** **                                      | ** ** | **(As Previously Reported)** | ** ** |
| ** **                                      |       |                                   |       |   |   |   |   |   |   |
| **Year  ended December 31, 2005**               |       |                                   |       |   |   |   |   |   |   |
| Revenues from  continuing operations            |       | $                                      | 31,461     |   | $ | 31,635 |   | $ | 32,016 |   | $ | 35,684 |   |
| Gross profit (3)                                |       | 16,531                                 |       | 16,875 |   | 16,071 |   | 18,535 |   |
| Net income                                      |       | 3,250                                  |       | 2,904 |   | 3,087 |   | 1,707 |   |
| Net income per  share—Basic (1)            |       | $                                      | 0.18       |   | $ | 0.16 |   | $ | 0.17 |   | $ | 0.09 |   |
| 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 |   |
| Gross profit (3)                                |       | 14,736                                 |       | 16,114 |   | 15,937 |   | 13,752 |   |
| 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—Basic (1)            |       | $                                      | 0.10       |   | $ | 0.22 |   | $ | 0.11 |   | $ | 0.11 |   |
| Net income per  share—Diluted (1)          |       | $                                      | 0.10       |   | $ | 0.22 |   | $ | 0.11 |   | $ | 0.10 |   |

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(1)             Thesum of the quarters may not equal the total of the respective year’s net income(loss) per share due to changes in the weighted average shares outstandingthroughout the year.

(2)             Discontinuedoperations relates entirely to the sale of our infrastructure business.  See note 14 of the accompanying notes toconsolidated financial statements.

(3)             Grossprofit, which was not previously reported, as been added to this table.  Gross profit is calculated as total revenueless direct costs of services, reimbursed direct costs, and the portion ofdepreciation and software amortization attributable to direct costs ofservices.

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The followingtable sets forth the restated (see note 17 of the accompanying notes to theconsolidated financial statements) quarterly financial data for the quarters ofthe years ended December 31, 2005 and 2004 (in thousands, except per sharedata):
| ** **                                      | ** ** | **Quarters**           | ** ** |
|-------------------------------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **1st**                | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th** | ** ** |
| ** **                                      | ** ** | **(As Restated)** | ** ** | **(As Restated)** | ** ** | **(As Restated)** | ** ** | **(As Restated)** | ** ** |
| **Year  ended December 31, 2005**               |       |                   |       |   |   |   |   |   |   |
| Revenues from continuing  operations            |       | $                      | 24,644     |   | $ | 25,352 |   | $ | 26,294 |   | $ | 30,040 |   |
| Gross profit (3)                                |       | 9,714                  |       | 10,592 |   | 10,349 |   | 12,891 |   |
| Net income  (loss)                              |       | (2,128                 | )          | 1,836 |   | 495 |   | (4,045 | ) |
| Net income  (loss) per share—Basic (1)     |       | $                      | (0.12      | ) | $ | 0.10 |   | $ | 0.03 |   | $ | (0.22 | ) |
| Net income  (loss) per share—Diluted (1)   |       | $                      | (0.12      | ) | $ | 0.10 |   | $ | 0.03 |   | $ | (0.22 | ) |
| ** **                                      |       |                   |       |   |   |   |   |   |   |
| **Year  ended December 31, 2004**               |       |                   |       |   |   |   |   |   |   |
| Revenues from  continuing operations            |       | $                      | 17,651     |   | $ | 28,268 |   | $ | 29,626 |   | $ | 22,823 |   |
| Gross profit (3)                                |       | 6,375                  |       | 9,474 |   | 9,869 |   | 7,769 |   |
| Loss from  continuing operations                |       | (2,198                 | )          | (1,245 | ) | (2,397 | ) | (1,450 | ) |
| Income (loss)  from discontinued operations (2) |       | (264                   | )          | 1,008 |   | (77 | ) | — |   |
| Net loss                                        |       | (2,462                 | )          | (237 | ) | (2,474 | ) | (1,450 | ) |
| Net loss per  share—Basic (1)              |       | $                      | (0.14      | ) | $ | (0.01 | ) | $ | (0.14 | ) | $ | (0.08 | ) |
| Net loss per share—Diluted  (1)            |       | $                      | (0.14      | ) | $ | (0.01 | ) | $ | (0.14 | ) | $ | (0.08 | ) |

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(1)             Thesum of the quarters may not equal the total of the respective year’s net lossper share due to changes in the weighted average shares outstanding throughoutthe year.

(2)             Discontinuedoperations relates entirely to the sale of our infrastructure business.  See note 14 of the accompanying notes toconsolidated financial statements.

(3)             Grossprofit is calculated as total revenue less direct costs of services, reimburseddirect costs, and the portion of depreciation and software amortizationattributable to direct costs of services.

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**ITEM 9.**                    CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**           CONTROLS AND PROCEDURES

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

Underthe supervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of the effectiveness of the design and operation of our disclosurecontrols and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of theSecurities Exchange Act of 1934.  Basedon their evaluation as of December 31, 2005, the end of the period covered bythe original Annual Report on 10-K, our principal executive officer andprincipal financial officer previously concluded that our disclosure controlsand procedures were effective at a reasonable assurance level to ensure thatthe information required to be disclosed in reports filed or submitted underthe Securities Exchange Act of 1934, were recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms, and wasaccumulated and communicated to management, including our principal executiveofficer and principal financial officer, as appropriate to allow timelydecisions regarding required disclosure. Subsequently, we determined that we had a material weakness, asdescribed below, in our internal control over financial reporting.  Therefore in connection with filing thisamended Annual Report on Form 10-K/A, our principal executive officer andprincipal financial officer re-evaluated the effectiveness of disclosurecontrols and procedures and each concluded that, as of the end of the periodcovered by this report, our disclosure controls and procedures were noteffective.

**Management’sReport on Internal Control Over Financial Reporting (as revised)**

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting.  Ourinternal control over financial reporting is designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles and includes those policies and procedures that:

·                  Pertain to the maintenance of records that inreasonable detail accurately and fairly reflect the transactions anddispositions of the assets of the company;

·                  Provide reasonable assurance that thetransactions are recorded as necessary to permit preparation of financial statementsin accordance with generally accepted accounting principles, and that receiptsand expenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and

·                  Provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof the company’s assets that could have a material effect on the financialstatements.

Allinternal control systems, no matter how well designed, have inherentlimitations.  Therefore, even thosesystems determined to be effective can provide only reasonable assurance withrespect to financial statement preparation and presentation.  Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements.  Projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions or that the degree of compliancewith the policies or procedures may deteriorate.

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Inconnection with the original filing of our Annual Report on Form 10-K, ourmanagement assessed the effectiveness of our internal control over financialreporting 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*(COSO).  Based on our assessment using those criteria,management originally concluded that, as of December 31, 2005, our internalcontrol over financial reporting was effective.

Duringfiscal year 2006, and subsequent to the original issuance of our Annual Reporton Form 10-K for the fiscal year ended December 31, 2005, management identifiedan accounting error in its consolidated financial statements related todetermination of the appropriate accounting treatment for certain complexaspects of revenue recognition, specifically the evaluation of vendor specificobjective evidence of fair value for specified software upgrades providedwithin a bundled arrangement as required by the AICPA’s Statement of Position97-2 (SOP 97-2), *Software Revenue Recognition*.  On November 14, 2006, our audit committeedetermined that our previously issued financial statements for the fiscal yearsended December 31, 2005, 2004 and 2003, included in our Annual Report on Form10-K for the fiscal year ended December 31, 2005, for the quarters ended March31, 2006 and 2005, included in our Quarterly Report on Form 10-Q for thequarter ended March 31, 2006, and for the quarters ended June 30, 2006 and2005, included in our Quarterly Report on Form 10-Q for the quarter ended June30, 2006, should be restated.  Therestatement is further discussed in note 17 to the accompanying consolidatedfinancial statements.  In connection withthe restatement management evaluated the control failure that resulted in theerror related to revenue recognition.  Asa result of this evaluation management determined that a material weaknessexisted in internal control over financial reporting as of December 31,2005.  Specifically, management has concluded that the Company did not have adequate controlsincluding management oversight related to the evaluation of contracts and therelated determination of the appropriate application of generally acceptedaccounting principles related certain complex aspects of revenue recognition,specifically the evaluation of vendor specific objective evidence of fair valuefor specified software upgrades provided within a bundled arrangement asrequired by the AICPA’s Statement of Position 97-2, “*SoftwareRevenue Recognition*.”  Thisweakness was the result of a material weakness in the design of internalcontrol over financial reporting.

As a result of the material weakness, management ofthe Company, under the direction of its CEO and CFO, has revised theirassessment of the effectiveness of internal control over financial reporting asof December 31, 2005.  This revisedassessment was based on the COSO criteria. As a result of the revised assessment the Company’s management,including its CEO and CFO, concluded that its internal control over financialreporting was not effective as of December 31, 2005.

Management has excludedHilsoft, Inc., nMatrix, Inc., nMatrix Australia Pty. Ltd., and nMatrix Ltd.from the assessment of internal control over financial reporting as of December31, 2005 because we completed the acquisition of these entities during2005.  Hilsoft, Inc., nMatrix, Inc.,nMatrix Australia Pty. Ltd., and nMatrix Ltd. are wholly-owned subsidiaries allof which 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 12% and 6% of net and total assets, respectively, 4% ofrevenues and (22)% of net loss of the consolidated financial statement amountsas of and for the year ended December 31, 2005.  Our conclusion in this Annual Report on Form10-K/A regarding the effectiveness of our internal control over financialreporting as of December 31, 2005 does not include the internal control overfinancial reporting of Hilsoft, Inc., nMatrix, Inc., nMatrix Australia Pty.Ltd., and nMatrix Ltd.

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 statedin their report which appears beginning on page 47.

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**Remediation Activities**

After identifying the material weakness subsequentto the original issuance of our Annual Report on Form 10-K for the fiscal yearended December 31, 2005, management initiated changes to remediate the materialweakness described above.  We believethat, prior to December 31, 2006, we completed our remediation of theaforementioned material weakness in our internal control over financialreporting.  The completed remediationmeasures included the implementation of appropriate controls related tocontracts or other arrangements that are within the scope of SOP 97-2 toprovide a written analysis of the appropriate accounting for these contracts orother arrangement and the review of our conclusions with qualified internalaccounting personnel or third party accounting experts.  In addition, we have provided our accountingstaff with additional training related to generally accepted accountingprinciples and financial statement reporting matters.

**Changesin Internal Control Over Financial Reporting**

There have been nochanges in our internal control over financial reporting during the quarterended December 31, 2005 that have materially affected, or are reasonably likelyto materially affect, our internal control over financial reporting.

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

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

Wehave audited management’s revised assessment, included in Management’s Reporton Internal Control Over Financial Reporting (as revised) appearing under Item9A of this Annual Report on Form 10-K/A, that Epiq Systems, Inc. andsubsidiaries (the “Company”) did not maintain effective internal control overfinancial reporting as of December 31, 2005, because of the effect of thematerial weakness identified in management’s assessment based on criteriaestablished in* InternalControl—Integrated Framework*  issuedby the Committee of Sponsoring Organizations of the Treadway Commission (COSO).As described in Management’s Report on Internal Control Over FinancialReporting (as revised), management excluded from its assessment the internalcontrol over financial reporting at Hilsoft, Inc., nMatrix, Inc.,nMatrix Australia Pty. Ltd., and nMatrix Ltd., all of which were acquired duringthe 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, constitute 12% and 6% of net and total assets,respectively, 4% of revenues and (22)% of net income of the consolidatedfinancial statement amounts as of and for the year ended December 31,2005. Accordingly, our audit did not include the internal control over financialreporting at Hilsoft, Inc., nMatrix, Inc., nMatrix Australia Pty.Ltd., and nMatrix Ltd. The Company’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinions.

Acompany’s internal control over financial reporting is a process designed by,or under the supervision of, the company’s principal executive and principalfinancial officers, or persons performing similar functions, and effected bythe company’s board of directors, management, and other personnel to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internal control overfinancial reporting includes those policies and procedures that(1) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of the assetsof the company; (2) provide reasonable assurance that transactions arerecorded 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.

Becauseof the inherent limitations of internal control over financial reporting,including the possibility of collusion or improper management override ofcontrols, material misstatements due to error or fraud may not be prevented ordetected on a timely basis. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that the controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

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Inour report dated March 7, 2006, we expressed an unqualified opinion on management’sassessment that the Company maintained effective internal control overfinancial reporting and an unqualified opinion on the effectiveness of internalcontrol over financial reporting. As described in the following paragraph, theCompany subsequently identified material misstatements in its financialstatements for the years ended December 31, 2005, 2004, and 2003, which causedsuch financial statements to be restated. Management subsequently revised itsassessment due to the identification of a material weakness, described in thefollowing paragraph, which resulted in the errors and related financialstatement restatement. Accordingly, our opinion on the effectiveness of theCompany’s internal control over financial reporting as of December 31, 2005expressed herein is different from that expressed in our previous report.

Amaterial weakness is a significant deficiency, or combination of significantdeficiencies, that results in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not beprevented or detected.  The followingmaterial weakness has been identified and included in management’s assessment:

**Inadequate internal controlsrelated to revenue recognition**: The Company did not have adequate controls including managementoversight related to the evaluation of contracts and the related determinationof the appropriate application of generally accepted accounting principlesrelated to certain complex aspects of revenue recognition, specifically theevaluation of vendor specific objective evidence of fair value for specifiedsoftware upgrades provided within a bundled arrangement as required by theAICPA’s Statement of Position 97-2, “*Software RevenueRecognition*.”  This weaknessconstitutes a material weakness in the design of internal control overfinancial reporting, and resulted in material adjustments to the consolidatedfinancial statements as of December 31, 2005 and 2004 and for the fiscal yearsended December 31, 2005, 2004, and 2003 as discussed in note 17 to theconsolidated financial statements.

Thismaterial weakness was considered in determining the nature, timing, and extentof audit tests applied in our audit of the consolidated financial statementsand consolidated financial statement schedule as of and for the year endedDecember 31, 2005 (as restated) of the Company and this report does not affectour report on such financial statements and financial statement schedule.

Inour opinion, management’s revised assessment that the Company did not maintaineffective internal control over financial reporting as of December 31,2005, is fairly stated, in all material respects, based on criteria establishedin* Internal Control—Integrated Framework*  issued by the COSO. Also in our opinion,because of the effects of the material weakness described above on theachievement of the objectives of the control criteria, the Company has notmaintained effective internal control over financial reporting as ofDecember 31, 2005, based on criteria established in* InternalControl—Integrated Framework*  issuedby the COSO.

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated financialstatements and consolidated financial statement schedule as of and for the yearended December 31, 2005 of the Company and our report dated March 7,2006 (February 3, 2007 as to note 5 and the effect of the restatement discussedin note 17) expressed an unqualified opinion on those consolidated financialstatements and the consolidated financial statement schedule.

DELOITTE & TOUCHE LLPKansas City, MissouriMarch 7, 2006 (February 3, 2007 as to the effects of the material weaknessdiscussed in Management’sReport on Internal Control Over Financial Reporting (as revised))

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**ITEM 9B.**           OTHER INFORMATION

None.

**PART III**

**ITEM 10.**             DIRECTORS ANDEXECUTIVE OFFICERS OF THE REGISTRANT

Incorporated by referenceto our Proxy Statement for our 2006 Annual Meeting of Shareholders filed withthe Securities and Exchange Commission on April 28, 2006.

**ITEM 11.**             EXECUTIVECOMPENSATION

Incorporated by referenceto our Proxy Statement for our 2006 Annual Meeting of Shareholders filed withthe Securities and Exchange Commission on April 28, 2006.

**ITEM 12.   SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS**

Incorporated by referenceto our Proxy Statement for our 2006 Annual Meeting of Shareholders filed withthe Securities and Exchange Commission on April 28, 2006.

**ITEM 13.**             CERTAIN RELATIONSHIPSAND RELATED TRANSACTIONS

Incorporated by referenceto our Proxy Statement for our 2006 Annual Meeting of Shareholders filed withthe Securities and Exchange Commission on April 28, 2006.

**ITEM 14.**             PRINCIPAL ACCOUNTINGFEES AND SERVICES

Incorporated by referenceto our Proxy Statement for our 2006 Annual Meeting of Shareholders filed withthe Securities and Exchange Commission on April 28, 2006.

49

----

**PART IV**

**ITEM 15.**             EXHIBITS ANDFINANCIAL STATEMENT SCHEDULES

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

**(1) Financial Statements.** The following consolidated financial statements, contained on pages F-1through F-39 of this report, are filed as part of this report under Item 8 “FinancialStatements and Supplementary Data.”

| Report of Independent  Registered Public Accounting Firm                                                                         |   |   |   |
|----------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| Consolidated Balance  Sheets (Restated) — December 31, 2005 and 2004                                                        |   |   |   |
| Consolidated Statements  of Operations (Restated) — Years Ended December 31, 2005, 2004 and 2003                            |   |   |   |
| Consolidated Statements  of Changes in Stockholders’ Equity (Restated) — Years Ended December 31,  2005, 2004 and 2003 |   |   |   |
| Consolidated Statements  of Cash Flows (Restated) — Years Ended December 31, 2005, 2004 and 2003                            |   |   |   |
| Notes to Consolidated Financial Statements                                                                                       |   |   |   |

 

**(2) Financial Statement Schedules. **EpiqSystems, Inc. and subsidiaries for each of the years in the three-year periodended December 31, 2005.Schedule II — Valuation and qualifying accounts

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

50

----

**SIGNATURES**

In accordance withSection 13 or 15(d) of the Exchange Act, the registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.
| Dated: February 8, 2007 | EPIQ SYSTEMS, INC. |
|-------------------------|--------------------|
|                    | By:                | /s/  Tom W. Olofson |
|                    |               | Tom W. Olofson |
|                    |               | Chairman of the Board, Chief Executive |
|                    |               | Officer and Director |

 

In accordance with theExchange Act this report has been signed below by the following persons onbehalf of the registrant and in the capacities indicated on the datesindicated.
| Signature                                    | ** ** | **Name and Title**                                                                         | ** ** | **Date**         |
|----------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|------------------|
|                                         |       |                                                                                       |       |             |
|  /s/   Tom W. Olofson    |       | Tom W. Olofson                                                                             |       | February 8, 2007 |
|                                         |       | Chairman of the Board, Chief Executive Officer and  Director (Principal Executive Officer) |       |             |
|                                         |       |                                                                                       |       |             |
| /s/   Christopher E. Olofson  |       | Christopher E. Olofson                                                                     |       | February 8, 2007 |
|                                         |       | President, Chief Operating Officer and Director                                            |       |             |
|                                         |       |                                                                                       |       |             |
| /s/   Elizabeth M. Braham     |       | Elizabeth M. Braham                                                                        |       | February 8, 2007 |
|                                         |       | Executive Vice President, Chief Financial Officer  (Principal Financial Officer)           |       |             |
|                                         |       |                                                                                       |       |             |
| /s/   Douglas W. Fleming      |       | Douglas W. Fleming                                                                         |       | February 8, 2007 |
|                                         |       | Director of Finance, Chief Accounting Officer  (Principal Accounting Officer)              |       |             |
|                                         |       |                                                                                       |       |             |
| /s/   W. Bryan Satterlee      |       | W. Bryan Satterlee                                                                         |       | February 8, 2007 |
|                                         |       | Director                                                                                   |       |             |
|                                         |       |                                                                                       |       |             |
| /s/   Edward M. Connolly, Jr. |       | Edward M. Connolly, Jr.                                                                    |       | February 8, 2007 |
|                                         |       | Director                                                                                   |       |             |
|                                         |       |                                                                                       |       |             |
| /s/   James A. Byrnes         |       | James A. Byrnes                                                                            |       | February 8, 2007 |
|                                         |       | Director                                                                                   |       |             |
|                                         |       |                                                                                       |       |             |
| /s/   Joel Pelofsky           |       | Joel Pelofsky                                                                              |       | February 8, 2007 |
|                                         |       | Director                                                                                   |       |             |

 

51

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

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

We have audited theaccompanying consolidated balance sheets of Epiq Systems, Inc. andsubsidiaries (the “Company”) as of December 31, 2005 and 2004, and therelated consolidated statements of operations, changes in stockholders’ equity,and cash flows for each of the three years in the period endedDecember 31, 2005. Our audits also included the financial statement schedulelisted in the Index at Item 15(a)(2). These financial statements and financialstatement schedule are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements andfinancial statement schedule based on our audits.

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of Epiq Systems, Inc. and subsidiaries as ofDecember 31, 2005 and 2004, and the results of their operations and theircash flows for each of the three years in the period ended December 31,2005, in conformity with accounting principles generally accepted in the UnitedStates of America. Also, in our opinion, such financial statement schedule,when considered in relation to the basic consolidated financial statementstaken as a whole, present fairly in all material respects the information setforth therein.

As discussed in note 17,the accompanying consolidated balance sheets as of December 31, 2005 and 2004and the related consolidated statements of operations, changes in stockholders’equity, and cash flows for each of the three years in the period endedDecember 31, 2005 have been restated.

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 over financialreporting as of December 31, 2005, based on the criteria established in* Internal Control—Integrated Framework*  issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated March 7,2006 (February 3, 2007  as to the effects of the materialweakness discussed in Management’s Report on Internal Control Over FinancialReporting, as revised) expressed an unqualified opinion on management’sassessment of the effectiveness of the Company’s internal control over financialreporting and an adverse opinion on the effectiveness of the Company’s internalcontrol over financial reporting because of a material weakness.

*/s/ DELOITTE **& TOUCHE LLP*Kansas City, MissouriMarch 7, 2006 (February 3, 2007 as to note 5 and the effects of therestatement discussed in note 17)

F-1

----

**EPIQ SYSTEMS, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(In Thousands, Except Share andPer Share Data)**

 
| ** **                                                                                                                                                           | ** ** | **As of December 31,**          | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
| ** **                                                                                                                                                           | ** ** | **(As Restated,  see note 17)** | ** ** | **(As Restated,  see note 17)** | ** ** |
| **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                                                                                                                                                |       | 25,579                                         |       | 754 |   |
| Other current assets                                                                                                                                                 |       | 85                                             |       | 736 |   |
| Total Current Assets                                                                                                                                                 |       | 80,192                                         |       | 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 |   |
| Deferred income taxes                                                                                                                                                |       | —                                         |       | 4,229 |   |
| Other                                                                                                                                                                |       | 2,854                                          |       | 2,995 |   |
| Total Long-term Assets, net                                                                                                                                          |       | 338,279                                        |       | 205,278 |   |
| **Total  Assets**                                                                                                                                                    |       | $                                              | 418,471    |   | $ | 244,317 |   |
|                                                                                                                                                                 |       |                                           |       |   |   |
| **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                                                                                                                                               |       | 3,322                                          |       | 841 |   |
| Deferred revenue                                                                                                                                                     |       | 60,224                                         |       | 58 |   |
| Current maturities of long-term obligations                                                                                                                          |       | 27,642                                         |       | 7,650 |   |
| Total Current Liabilities                                                                                                                                            |       | 105,282                                        |       | 16,060 |   |
|                                                                                                                                                                 |       |                                           |       |   |   |
| **LONG-TERM  LIABILITIES:**                                                                                                                                          |       |                                           |       |   |   |
| Deferred income taxes                                                                                                                                                |       | 26,815                                         |       | — |   |
| Deferred revenue                                                                                                                                                     |       | —                                         |       | 35,208 |   |
| Long-term obligations (excluding current maturities)                                                                                                                 |       | 145,906                                        |       | 74,499 |   |
| Total Long-term Liabilities                                                                                                                                          |       | 172,721                                        |       | 109,707 |   |
|                                                                                                                                                                 |       |                                           |       |   |   |
| **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                                                                                                                                                    |       | 11,791                                         |       | 15,633 |   |
| Total Stockholders’ Equity                                                                                                                                      |       | 140,468                                        |       | 118,550 |   |
| **Total Liabilities and  Stockholders’ Equity**                                                                                                                 |       | $                                              | 418,471    |   | $ | 244,317 |   |

 

**Seeaccompanying notes to consolidated financial statements.**

F-2

----

**EPIQ SYSTEMS, INC.**

**CONSOLIDATED STATEMENTS OFOPERATIONS**

**(InThousands, Except Per Share Data)**
| ** **                                                                                                                                                                   | ** ** | **Years Ended December 31,**    | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                                                                                                   | ** ** | **2005**                                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                                                                   | ** ** | **(As Restated,  see note 17)** | ** ** | **(As Restated,  see note 17)** | ** ** | **(As Restated,  see note 17)** | ** ** |
|                                                                                                                                                                         |       |                                           |       |   |   |   |   |
| **REVENUE:**                                                                                                                                                                 |       |                                           |       |   |   |   |   |
| Case management services                                                                                                                                                     |       | $                                              | 53,042     |   | $ | 41,275 |   | $ | 23,063 |   |
| Case management bundled software license, software  upgrade and postcontract customer support  services                                                                      |       | 1,771                                          |       | 199 |   | 18,469 |   |
| Document management services                                                                                                                                                 |       | 27,874                                         |       | 36,549 |   | 12,730 |   |
| Operating revenue before reimbursed direct costs                                                                                                                             |       | 82,687                                         |       | 78,023 |   | 54,262 |   |
| Operating revenue from reimbursed direct costs                                                                                                                               |       | 23,643                                         |       | 20,345 |   | 5,518 |   |
| Total Revenue                                                                                                                                                                |       | 106,330                                        |       | 98,368 |   | 59,780 |   |
|                                                                                                                                                                         |       |                                           |       |   |   |   |   |
| **OPERATING  EXPENSES:**                                                                                                                                                     |       |                                           |       |   |   |   |   |
| Direct cost of services (exclusive of depreciation and  amortization shown separately below)                                                                                 |       | 30,225                                         |       | 37,411 |   | 8,380 |   |
| Direct cost of bundled software license, software upgrade  and postcontract customer support services  (exclusive  of depreciation and  amortization shown separately below) |       | 3,809                                          |       | 2,849 |   | 2,491 |   |
| Reimbursed direct costs                                                                                                                                                      |       | 23,756                                         |       | 20,124 |   | 5,619 |   |
| 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  (LOSS) FROM OPERATIONS**                                                                                                                                           |       | 445                                            |       | (4,393 | ) | 16,451 |   |
|                                                                                                                                                                         |       |                                           |       |   |   |   |   |
| **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  (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES**                                                                                                            |       | (6,242                                         | )          | (11,603 | ) | 16,534 |   |
|                                                                                                                                                                         |       |                                           |       |   |   |   |   |
| **PROVISION  (BENEFIT) FOR INCOME TAXES**                                                                                                                                    |       | (2,400                                         | )          | (4,313 | ) | 6,939 |   |
|                                                                                                                                                                         |       |                                           |       |   |   |   |   |
| **INCOME  (LOSS) FROM CONTINUING OPERATIONS**                                                                                                                                |       | (3,842                                         | )          | (7,290 | ) | 9,595 |   |
|                                                                                                                                                                         |       |                                           |       |   |   |   |   |
| **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 (LOSS)**                                                                                                                                                        |       | $                                              | (3,842     | ) | $ | (6,623 | ) | $ | 3,777 |   |

 

F-3

----

**EPIQ SYSTEMS, INC.**

**CONSOLIDATED STATEMENTS OFOPERATIONS**

**(Continued)**

**(In Thousands, Except Per Share Data)**

 
| ** **                                       | ** ** | **Years Ended December 31,**    | ** ** |
|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                       | ** ** | **2005**                                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                       | ** ** | **(As Restated,  see note 17)** | ** ** | **(As Restated,  see note 17)** | ** ** | **(As Restated,  see note 17)** | ** ** |
| **NET  INCOME (LOSS) PER SHARE INFORMATION:**    |       |                                           |       |   |   |   |   |
| Income (loss) per share — Basic             |       |                                           |       |   |   |   |   |
| Income (loss) from continuing operations         |       | $                                              | (0.21      | ) | $ | (0.41 | ) | $ | 0.54 |   |
| Income (loss) from discontinued operations       |       | —                                         |       | 0.04 |   | (0.33 | ) |
| Net income (loss) per share — Basic         |       | $                                              | (0.21      | ) | $ | (0.37 | ) | $ | 0.21 |   |
|                                             |       |                                           |       |   |   |   |   |
| Income (loss) per share — Diluted           |       |                                           |       |   |   |   |   |
| Income (loss) from continuing operations         |       | $                                              | (0.21      | ) | $ | (0.41 | ) | $ | 0.53 |   |
| Income (loss) from discontinued operations       |       | —                                         |       | 0.04 |   | (0.32 | ) |
| Net income (loss) per share — Diluted       |       | $                                              | (0.21      | ) | $ | (0.37 | ) | $ | 0.21 |   |
|                                             |       |                                           |       |   |   |   |   |
| **WEIGHTED  AVERAGE COMMON SHARES OUTSTANDING:** |       |                                           |       |   |   |   |   |
| Basic                                            |       | 18,092                                         |       | 17,848 |   | 17,619 |   |
| Diluted                                          |       | 18,092                                         |       | 17,848 |   | 18,104 |   |

 

**Seeaccompanying notes to consolidated financial statements.**

F-4

----

**EPIQ SYSTEMS, INC.CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY(In Thousands)**
| ** **                                                   | ** ** | **As of December 31,**          | ** ** |
|--------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                   | ** ** | **2005**                                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                   | ** ** | **(As Restated,  see note 17)** | ** ** | **(As Restated,  see note 17)** | ** ** | **(As Restated,  see note 17)** | ** ** |
| 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 PERSHARE:               |       |                                           |       |   |   |   |   |
| 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                                   |       | 15,633                                         |       | 22,256 |   | 18,479 |   |
| Net income (loss)                                            |       | (3,842                                         | )          | (6,623 | ) | 3,777 |   |
|  Balance,  end of year                                  |       | 11,791                                         |       | 15,633 |   | 22,256 |   |
|                                                         |       |                                           |       |   |   |   |   |
| TOTAL STOCKHOLDERS’ EQUITY                              |       | $                                              | 140,468    |   | $ | 118,550 |   | $ | 124,325 |   |

 

**See accompanyingnotes to consolidated financial statements.**

F-5

----

**EPIQ SYSTEMS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(In Thousands)**
| ** **                                                                               | ** ** | **Years Ended December 31,**    | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2005**                                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                               | ** ** | **(As Restated,  see note 17)** | ** ** | **(As Restated,  see note 17)** | ** ** | **(As Restated,  see note 17)** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                               |       |                                           |       |   |   |   |   |
| Net income (loss)                                                                        |       | $                                              | (3,842     | ) | $ | (6,623 | ) | $ | 3,777 |   |
| Adjustments to reconcile net income (loss) to net cash from operating  activities:       |       |                                           |       |   |   |   |   |
| Benefit for deferred income taxes                                                        |       | (9,864                                         | )          | (2,491 | ) | (5,081 | ) |
| 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                                                   |       | 3,126                                          |       | (10,779 | ) | 2,618 |   |
| Deferred revenue                                                                         |       | 24,742                                         |       | 27,069 |   | 8,145 |   |
| 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 |   |

 

**Seeaccompanying notes to consolidated financial statements.**

F-6

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**EPIQ SYSTEMS, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2005, 2004 AND 2003**

**NOTE 1:****                        NATURE OFOPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

***Principlesof Consolidation***

The consolidatedfinancial statements include the accounts of Epiq Systems, Inc. (“Epiq”) andits wholly-owned subsidiaries.  Allsignificant intercompany transactions and balances have been eliminated inconsolidation.

***Natureof 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.

***Cashand 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.

***SoftwareDevelopment Costs***

Certain internal software developmentcosts incurred in the creation of computer software products are capitalizedonce technological feasibility has been established.  Capitalized costs are amortized based on theratio of current revenue to current and estimated future revenue for eachproduct with minimum annual amortization equal to the straight-lineamortization over the remaining estimated economic life of the product.

***Goodwilland Identifiable Intangible Assets***

Goodwill is not amortizedbut is assigned to a reporting unit and tested for impairment at least annuallyand between annual tests if events or changes in circumstances have indicatedthat the assets might be impaired.  Ourannual impairment test, performed in July 2005 and using a discounted cash flowanalysis to determine the fair value of each reporting unit, indicated thatthere were no impairments.

Identifiable intangibleassets, resulting from various business acquisitions, consist primarily ofcustomer relationships, trade names and agreements not to compete.  Customer relationships, trade names andagreements not to compete are being amortized on a straight-line basis overtheir estimated economic benefit period, generally from one to 14 years.  Identifiable intangibles assets are reviewedfor impairment whenever events or changes in circumstances have indicated thatthe carrying amount of these assets might not be recoverable.

***Impairmentof 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.

***DeferredLoan 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 includedas a component of other long-term assets on our consolidated balancesheets.  Amortization costs are includedas a component of interest expense on our consolidated statements ofoperations.  Unamortized costs related todebt extinguished prior to maturity due to refinancing were expensed andcomprise debt extinguishment on our consolidated statements of operations.

F-7

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***Stock-BasedCompensation***

Stock compensation awardsare accounted for under the intrinsic method of Accounting Principles BoardOpinion No. 25, *Accounting for Stock Issued to Employees*.  Opinion No. 25 requires compensation cost tobe recognized based on the excess, if any, between the quoted market price atthe date of grant and the amount an employee must pay to acquire stock.  Stock options awarded by us are granted withan exercise price equal to the fair market 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 and 2003(in thousands, except per share data):
| ** **                                                                                                                     | ** ** | ** **   | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|--------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                     | ** ** | ** **   | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                           |       |         |       |                                        |       |   |   |   |   |
| Net income (loss), as reported                                                                                                 |       |         |       | $                                           | (3,842     | ) | $ | (6,623 | ) | $ | 3,777 |   |
| 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 (loss), pro forma                                                                                                   |       |         |       | $                                           | (10,447    | ) | $ | (9,598 | ) | $ | 1,582 |   |
|                                                                                                                           |       |         |       |                                        |       |   |   |   |   |
| Net income (loss) per share — Basic                                                                                       |       | As  reported |       | $                                           | (0.21      | ) | $ | (0.37 | ) | $ | 0.21 |   |
|                                                                                                                           |       | Pro  forma   |       | $                                           | (0.58      | ) | $ | (0.54 | ) | $ | 0.09 |   |
|                                                                                                                           |       |         |       |                                        |       |   |   |   |   |
| Net income (loss) per share — Diluted                                                                                     |       | As  reported |       | $                                           | (0.21      | ) | $ | (0.37 | ) | $ | 0.21 |   |
|                                                                                                                           |       | Pro forma    |       | $                                           | (0.58      | ) | $ | (0.54 | ) | $ | 0.09 |   |

 

Pro forma amounts presented above arebased on actual earnings and consider only the effects of estimated fair valuesof stock options.  For the year endedDecember 31, 2005, we did not assume conversion of the convertible notes as theeffect was antidilutive.  The convertiblenotes, if converted, would result in issuance of 2,857,000 shares of our commonstock.

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%           |       |

 

***IncomeTaxes***

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 taxassets and liabilities are measured using enacted tax rates expected to applyto taxable income in the years in which those temporary differences are expectedto be recovered or settled.  A valuationallowance is provided when, in the opinion of management, it is more likelythan not that some portion or all of a deferred tax asset will not be realized.

F-8

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***RevenueRecognition***

We have agreements with clients pursuant to which wedeliver various case management and document management services each month.

Significant sources of revenue include:

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

·                  Hostingfees based on the amount of data stored;

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

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

·                  Reimbursementfor costs incurred, primarily related to postage on mailing services.

*Non-SoftwareArrangements*

Case and document management services related to electronic discovery,corporate restructuring, and class action revenue, which are billed based onvolume, are evaluated pursuant to Emerging Issues Task Force (EITF) 00-21, *Revenue Arrangements with Multiple Deliverables*.  For each of these contractual arrangements,we have identified the following deliverables and/or services:

·                  ElectronicDiscovery

·               Data processing

·               Hosting

·                  CorporateRestructuring

·               Consulting

·               Claims management

·               Printing and reproduction

·               Mailing andnoticing

·               Document management

·                  Class Action

·               Consulting

·               Notice campaigns

·               Toll free customersupport

·               Web sitedesign/hosting

·               Claimsadministration

·               Distribution

Based on our evaluation of each element, we have determined that eachelement delivered has standalone value to our customers because we or othervendors sell such services separately from any otherservices/deliverables.  We have alsoobtained objective and reliable evidence of the fair value of each elementbased either on the price we charge when we sell an element on a standalonebasis or based on third-party evidence of fair value of such services.  Lastly, our arrangements do not includegeneral rights of return.  Accordingly,each of the service elements in our multiple element case and documentmanagement arrangements qualifies as a separate unit of accounting under EITF00-21.  We allocate revenue to thevarious units of accounting in our arrangements based on the fair value of eachunit of accounting, which is generally consistent with the stated prices in ourarrangements. As we have evidence of an arrangement, revenue for each separateunit of accounting is recognized each period in accordance with StaffAccounting Bulletin Topic 13, *RevenueRecognition* (SAB Topic 13). As the services are rendered, our fee becomes fixed and determinable,and collectibility is reasonably assured. Payments 

F-9

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received in advance of satisfaction of the related revenue recognitioncriteria are recognized as a customer deposit until all revenue recognitioncriteria have been satisfied.

*SoftwareArrangements*

For our Chapter 7 bankruptcy trustee arrangements, weprovide our trustee clients with a software license, hardware lease, hardwaremaintenance, and PCS services, all at no charge to the trustee.  The trustees place their liquidated estatedeposits with a financial institution with which we have an arrangement.  The financial institution pays us a monthlyfee contingent on the dollar level of average monthly deposits placed by thetrustees with that financial institution.

We have arrangements withvarious depository financial institutions and, prior to October 1, 2003, we hadan open ended arrangement with our primary depository financialinstitution.  We also had open ended arrangementswith each Chapter 7 trustee client. Under these arrangements, we provided our Chapter 7 trustee clients witha software license, hardware lease, hardware maintenance, and PCS services, allat no charge to the trustee.  Thetrustees placed their liquidating estate deposits with a financial institutionwith which we had a joint marketing arrangement, typically our primarydepository financial institution.  Weaccount for the software license and PCS elements in accordance with Statementof Position 97-2, *Software Revenue Recognition* (SOP97-2).  Since we have not establishedvendor specific objective evidence (VSOE) of the fair value of the softwarelicense, we do not recognize any revenue on delivery of the software.  The software element is deferred and includedwith the remaining undelivered element, which is PCS services.  This revenue, when recognized, is included onour consolidated statements of operations as a component of “Case managementbundled software license, software upgrade and postcontract customer supportservices” revenue.  Revenue related toPCS is entirely contingent on the placement of liquidated estate deposits bythe trustee with the financial institution. Accordingly, we recognize this contingent usage based revenue consistentwith the guidance provided by the American Institute of Certified PublicAccountants’ Technical Practice Aid (TPA) 5100.76, *Fair Valuein Multiple-Element Arrangements That Include Contingent Usage-Based Fees andSoftware Revenue Recognition* as the fee becomes fixed ordeterminable at the time actual usage occurs and collectibility isprobable.  This occurs monthly as aresult of the computation, billing and collection of monthly deposit feescontractually agreed to.  At that time,we have also satisfied the other revenue recognition criteria contained in SOP97-2, as we have persuasive evidence that an arrangement exists, services havebeen rendered, the price is fixed and determinable, and collectibility isreasonably assured.

Prior to October 1, 2003, from time to time we would separatelynegotiate a contract with our primary financial institution to provide thetrustee clients with a software upgrade or a special project.  For these single element contracts, in accordancewith SAB Topic 13, we recognized revenue when persuasive evidence of anarrangement existed, services had been rendered, the price was fixed anddeterminable, and collectibility was reasonably assured.  This occurred on delivery of the single element.

We also provide ourtrustees with certain hardware, such as desktop computers, monitors, andprinters, and hardware maintenance.  Weretain ownership of all hardware provided and, based on guidance provided inEITF 01-8, *Determining Whether anArrangement Contains a Lease*, we account for this hardware as alease.  As the hardware maintenancearrangement is an executory contract similar to an operating lease, we useguidance related to contingent rentals in operating lease arrangements forhardware maintenance as well as for the hardware lease.  Since all of the payments under all of ourarrangements are contingent upon the level of trustee deposits and the deliveryof upgrades and other services, and there remain important uncertaintiesregarding the amount of unreimbursable costs yet to be incurred by us, weaccount for the hardware lease as an operating lease in accordance with SFAS13, *Accounting for Leases*.  Therefore, all lease payments, based on theestimated fair value of hardware provided, were accounted for as contingentrentals under EITF Issue No. 98-9, *Accountingfor Contingent Rent* and SAB Topic 13, which requires that werecognize rental income when the changes in the factor on which the contingentlease payment is based actually occur. This occurred at the end of each period as we achieve our target whendeposits are held at the depository financial institution as, at that time,evidence of an arrangement exists, delivery has occurred, the amount has becomefixed and determinable, and collection is reasonably assured.  This revenue, which is less than ten percentof our total revenue, is included in our consolidated statements of operationsas a component of “Case management services” revenue.

Effective October1, 2003, we entered into a three-year arrangement (the 2003 Arrangement) withour primary financial institution under which we delivered two specifiedupgrades annually with the last specified upgrade to occur in the secondquarter of 2006.  This arrangementincluded specific pricing for each software upgrade and certain specialprojects in addition to the contingent deposit-based pricing related to thesoftware license, hardware, hardware maintenance, and PCS services provided toeach trustee client.  Therefore, the software upgrades and specialprojects are part of a bundled arrangement. Each software upgrade is considered a separate and discrete product and,as we do not sell each software upgrade on a 

F-10

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standalone basis, we were unable to establish VSOE of the fair value ofthe software upgrades.  As a result, thelicensed software, software upgrade, special projects and PCS are a combinedunit of accounting.  Under the guidanceof SOP 97-2, all revenue related to this combined unit of accounting isdeferred until the final upgrade is delivered. The ongoing costs related to this arrangement were recognized asexpense when incurred.  When the final upgrade is delivered and theonly remaining undelivered element is PCS, we will then recognize revenue on apro-rata basis over the term of the agreement. Payments received in advance of satisfaction of the related revenuerecognition criteria are recognized as deferred revenue until all revenuerecognition criteria have been satisfied. As of December 31, 2005 and 2004, we had recorded on our consolidatedbalance sheets $59.7 million and $35.2 million, respectively, of deferredrevenue under the 2003 Arrangement.  Thisdeferred revenue was recognized during the second and third quarters of2006.  The 2003 Arrangement did notaffect our accounting, as described above, for fees received from otherfinancial institutions or our accounting related to hardware and hardwaremaintenance.

*Reimbursements*

Our case anddocument management businesses both have revenue related to the reimbursementof certain costs, primarily postage. Consistent with guidance provided by EITF No. 01-14, *Income Statement Characterization of Reimbursements Received for “Out-of-Pocket”Expenses Incurred*, reimbursed postage and other reimbursable directcosts are recorded gross in the consolidatedstatement of operations as “Operating revenue from reimbursed directcosts” and as “Reimbursed direct costs”.

***Costs related to contractacquisition, origination, and set-up***

SAB Topic 13 provides guidance that contractacquisition, origination, and set-up costs may be expensed as incurred orcapitalized and amortized in accordance with FASB Technical Bulletin No. 90-1, *“Accounting for Separately Priced Extended Warranty and ProductMaintenance Contracts”* or Statement of Financial AccountingStandards No. 91, *“Accounting for Nonrefundable Fees and CostsAssociated with Originating or Acquiring Loans and Initial Direct costs ofLeases.” *We have elected toexpense these costs as incurred.

***DerivativeFinancial 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, *Accountingfor Derivative Instruments and Hedging Activities*, the right toextend the maturity of the notes represents an embedded option and is accountedfor as a derivative financial instrument. The fair value of our obligation related to the embedded option has beenincluded as a component of our long-term obligations on our accompanyingconsolidated balance sheets.  Changes inthe fair value of the embedded option are recorded each period as a componentof interest expense on our accompanying consolidated statements ofoperations.  Changes in the fair value ofthe embedded option do not affect our cash flows and, accordingly, are reflectedas an adjustment to reconcile net income to net cash from operating activitieson our accompanying consolidated statements of cash flows.

***ComprehensiveIncome (Loss)***

We do not have anycomponents of other comprehensive income; therefore comprehensive income (loss)equals net income (loss) for each of the three years ended December 31, 2005,2004 and 2003.

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

Basic net income (loss)per share is computed by dividing net income available to common shareholdersby the weighted average number of common shares outstanding for theperiod.  Diluted net income (loss) pershare is computed by dividing net income available to common shareholders,increased by the amount of interest expense, net of tax, related to outstandingconvertible debt by the weighted average number of outstanding common sharesand shares that may be issued in future periods relating to outstanding stockoptions and convertible debt, if dilutive.

***SegmentInformation***

In determining ourreportable segments, we consider how we organize our business internally formaking operating decisions and assessing business performance.  Substantially all our revenues are derivedfrom sources within the United States of America and substantially all of ourlong-lived assets are located in the United States of America.

***Useof Estimates***

The preparation of financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements.  Estimates also affect the reported amounts ofrevenues and expenses during the periods reported.  Actual results could differ from thoseestimates.

F-11

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***RecentAccounting Pronouncements***

InSeptember 2005, the EITF issued EITF 05-07, *Accounting forModifications to Conversion Options Embedded in Debt Instruments and RelatedIssues.*  EITF 05-07 requiresthat, when a modification of a convertible debt instrument results in a changein the fair value of an embedded conversion option, the change in fair value ofthe embedded 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 extinguished.  EITF 05-07 also requires subsequentrecognition of interest expense for any change in the fair value of theembedded conversion option resulting from a modification of a convertible debtinstrument.  EITF 05-07 is effectivebeginning in the first interim or annual reporting period beginning afterDecember 15, 2005.  We do not anticipatethat the adoption of EITF 05-07 will have a material impact on our consolidatedfinancial statements.

In May2005, 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 retrospectiveapplication for reporting a change in accounting principle unless suchapplication is impracticable or unless transition requirements specific to anewly adopted accounting principle require otherwise.  SFAS No. 154 also requires the reporting of acorrection of an error by restating previously issued financialstatements.  SFAS No. 154 is effectivefor accounting changes and corrections of errors made in fiscal years beginningafter 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 theaccounting for transactions in which an entity exchanges its equity instrumentsfor goods and services or incurs liabilities in exchange for goods or servicesthat are based on the fair value of the entity’s equity instruments or that maybe settled by the issuance of 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 for Epiq 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.  Underthe modified version of prospective application, compensation costs related toshare-based compensation will be recognized in our financial statements for allperiods beginning after December 31, 2005. For comparative periods ended on or before December 31, 2005, which arepresented in our 2006 and subsequent financial statements, share-basedcompensation costs will continue to be excluded from our consolidatedstatements of operations, but we will disclose these share-based compensationcosts on a pro forma basis in a note to the consolidated financialstatements.  During February 2005, ourcompensation committee approved acceleration of the vesting of certain unvestedoptions for employees, including an executive officer, and non-employeedirectors.  The decision to acceleratethe vesting of these options and eliminate future compensation expense wasbased primarily on a review of our long-term incentive programs considering theeffect on our financial statements of changes in accounting rules that we mustadopt in 2006.  This action, which had animmaterial effect on our financial statements for the year ended December 31,2005, will reduce the impact of adoption of SFAS No. 123R on our futureconsolidated financial statements. Adoption of SFAS No. 123R will materially increase our recognizedcompensation expense and will have a material impact on our consolidated incomestatement and balance sheet.  We areworking with independent valuation experts to document and validate keyvaluation variables, such as forfeiture rate, expected term, segmentation ofemployee population, expected term suboptimal exercise price, and expectedvolatility.  Until this work iscompleted, we are unable to estimate the impact of adoption of this statementon our consolidated financial statements. However, if subsequent to December 31, 2005 no new awards were issuedand no existing awards were forfeited, we estimate that adoption of SFAS No.123R would decrease our net income for the year ending December 31, 2006 byapproximately $1.4 million.  We do notanticipate that adoption of SFAS No. 123R will have a material impact on ourconsolidated statement of cash flows.

In August 2005, the FASB issued FASB Staff Position(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 defer therequirement 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 in this FSP is effective uponinitial adoption of SFAS No. 123R.  We donot anticipate that adoption of FSP No. FAS 123(R)-1 will have a materialimpact on our consolidated financial statements.

In October 2005, the FASB issued FSP No. FAS 123(R)-2,*Practical Accommodation to the Application of GrantDate as Defined in FASB Statement No. 123(R).*  This FSP states that, in determining thegrant date of an award subject to SFAS No. 

F-12

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123R, a mutual understanding of the key terms andconditions of an award to an individual employee shall be presumed to exist atthe date the award is approved in accordance with the relevant corporategovernance requirements if both of the following conditions are met:  a) the award is a unilateral grant and,therefore, the recipient does not have the ability to negotiate the key termsand conditions of the award with the employer; and b) the key terms andconditions of the award are expected to be communicated to an individualrecipient within a relatively short time period from the date of approval.  The guidance in this FSP is effective uponinitial adoption of SFAS No. 123R.  We donot anticipate that adoption of FSP No. FAS 123(R)-2 will have a materialimpact on our consolidated financial statements.

In November 2005, the FASB issued FSP No. FAS123(R)-3, *Transition Election Related to Accounting for theTax Effects of Share-Based Payment Awards. *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-timeelection to adopt the transition method described in this FSP.  At this time, management is uncertain whetherwe will make the election to adopt the transition method described in this FSPand we are unable to estimate the impact, if any, on our consolidated financialstatements if we elect to use the transition method described in this FSP.

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**NOTE 2:        PROPERTY AND 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 and their estimated useful lives is asfollows (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 andoffice equipment includes property acquired under capital leases.  As of December 31, 2005 and 2004, assets acquiredunder capital lease had a historical cost basis of $2.9 million and $2.7million, respectively, and accumulated amortization of $1.4 million and $0.5million, respectively.  Amortizationexpense related to these assets has been included as a component of “Depreciationand software amortization” in the accompanying consolidated statements ofoperations.  “Depreciation and softwareamortization” includes approximately $5.0 million, $4.5 million, and $3.3million of expenses related to direct costs of services and direct costs ofbundled software license, software upgrade and postcontract customer supportservices for the years ended December 31, 2005, 2004 and 2003, respectively.

**NOTE 3:       SOFTWARE DEVELOPMENT 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 aboveare capitalized software development costs for unreleased products of $1.0million and $1.3 million at December 31, 2005 and 2004, respectively.  During the years ended December 31, 2005,2004 and 2003, we recognized amortization expense related to capitalizedsoftware development costs of $2.1 million, $1.8 million, and $1.9 million,respectively.

F-14

----

**NOTE 4:****                        GOODWILLAND INTANGIBLE ASSETS**

Changes in thecarrying 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 |   |

 

Other intangible assetsas of December 31, 2005 and 2004 consisted of the following (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 |   |   |   |

 

Theweighted average life for identifiable intangibles acquired during 2005 are asfollows:

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

 

F-15

----

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 withSFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets,*long-lived assets classified as held for salewere measured at the lower of their carrying amounts or fair value less cost tosell.  Accordingly, as of the MeasurementDate, we performed an impairment analysis based on estimated proceeds from thesale less selling costs.  Based on thisanalysis, the carrying amount of goodwill and identified intangible assetsrelated to the infrastructure software segment, with an aggregate balance of$4.8 million as of January 1, 2003, was entirely impaired.  The related impairment charge is included asa component of discontinued operations on our consolidated statements ofoperations for 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 |   |

 

***CreditFacilities***

As of December 31, 2004,we had a credit facility, with KeyBankNational Association as administrative agent, which consisted of a $25.0million senior term loan, with amortizing quarterly principal payments of $1.6million, 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 ofour amended credit facility, we increased 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 facility also increased our senior revolving loanfrom $75.0 million to $100.0 million. The maturity of the senior revolving loan was extended from June 2008 toNovember 2008.

F-16

----

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.  As of December 31, 2005, our borrowings underthe new credit facility totaled $118.0 million, consisting of $25.0 millionborrowed under the senior term loan and $93.0 million borrowed under the seniorrevolving loan.  Interest on the creditfacility is generally based on a spread, which as of December 31, 2005 was 300basis points, over the LIBOR rate.  As ofDecember 31, 2005, the interest rate charged on outstanding borrowings underthe credit facility ranged from 7.4% to 7.6%.

***ConvertibleSubordinated Debt***

During June 2004, weissued $50.0 million of contingent convertible subordinated notes.  Net proceeds of $47.4 million were used torepay and terminate an outstanding subordinated term loan and to pay in fullour then outstanding revolving loan balance. The contingency has been satisfied and the notes may, at the option ofthe holders, be converted into shares of our common stock at any time. Theseconvertible subordinated notes:

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

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

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

If all shares wereconverted, the notes would convert into approximately 2.9 million shares of ourcommon stock.  If we change our capitalstructure (for example, through a stock dividend or stock split) while thenotes 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 noteshave the right to extend the maturity of the notes for a period not to exceedthree years.  Under SFAS No. 133, *Accounting for Derivative Instruments and Hedging Activities*,the right to extend the maturity of the notes represents an embedded optionsubject to bifurcation.  The embeddedoption was initially valued at $1.2 million and the convertible debt balancewas reduced by the same amount.  The convertibledebt is accreted approximately $0.1 million each quarter such that, at the endof three years, the convertible debt balance will total $50.0 million.  On our accompanying consolidated statementsof operations, this accretion is a component of interest expense.  The embedded option must be revalued at eachperiod end based on the probability weighted discounted cash flows related tothe additional 4% interest rate payments that will be made if the convertible debtmaturity is extended an additional three years. Under this methodology, the embedded option has a current value ofapproximately $1.9 million.  On ouraccompanying consolidated balance sheets, our obligation related to theembedded option has been included as a component of the convertible notepayable.  During the year ended December31, 2005, the value of the embedded option increased by approximately $0.6million and this increase is included as a component of interest expense on ouraccompanying consolidated statements of operations for the year ended December31, 2005.  The changes in carrying valueof the convertible debt and fair value of the embedded option do not affect ourcash flow 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 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.

***CovenantCompliance***

Our credit facilitycontains financial covenants related to earnings before interest, provision forincome taxes, depreciation, amortization and other adjustments as defined inthe agreements (EBITDA) and total debt. In addition, our credit facility also contains financial covenantsrelated to senior debt, fixed charges, and working capital.  As a result of the restatement, which resultedin the deferral of a substantial portion of revenue related to the 2003 Arrangementas described in note 17, we were not in compliance with these financialcovenants as of December 31, 2005. Subsequent to year end, as a result of recognition of the deferredrevenue during the second and third quarters of 2006; we were in compliancewith all financial covenants as of June 30, 2006 and September 30, 2006.  The deferral of revenue through March 31,2006, and the recognition of the deferred revenue during the second and thirdquarter of 2006, was not anticipated by us or the banks at the time weestablished the financial covenants in the credit facility.  On December 14, 2006, we obtained a waiverregarding this event of noncompliance from our credit facility syndicate.  Accordingly, we have classified this debt ascurrent or long-term based on the debt’s original scheduled maturity.

F-17

----

***CapitalLease***

AtDecember 31, 2005, our debt obligation related to capital leases, classified asa current liability, was approximately $1.0 million.

***DeferredAcquisition Price***

OnJanuary 31, 2003, we acquired 100% of the membership interests of BankruptcyServices LLC (“BSI”), a provider of technology-based case management,consulting and administrative services for corporate restructurings,.  A portion of the purchase price, $4.0million, was deferred.  This deferredpurchase price, which is payable in five annual installments through January2008, was discounted using an imputed interest rate of 5% per annum.  At December 31, 2005, the discounted value ofthe remaining note payments was approximately $2.8 million of whichapproximately $1.7 million was classified as a current liability.

OnOctober 20, 2005, we acquired 100% of the equity of Hilsoft, Inc. (“Hilsoft”),a specialty provider of legal notification services, primarily for class actionengagements.  A portion of the purchaseprice, $0.5 million, was deferred.  Thisdeferred payment, 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 ofthis deferred payment was approximately $0.4 million and is classified entirelyas a noncurrent liability.

***ScheduledPrincipal Payments***

Our long-term obligations, including credit facility debt outstanding asof December 31, 2005, convertible debt (including embedded option), deferredacquisition costs, and capitalized leases, mature as follows for years endingDecember 31 (in thousands):

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

 

F-18

----

**NOTE 6:        OPERATING LEASES**

We have non-cancelableoperating leases for office space at various locations expiring at varioustimes through 2015.  Each of the leasesrequires us to pay all executory costs (property taxes, maintenance and insurance).  Additionally, we have non-cancelableoperating leases for office equipment and automobiles expiring through 2009.

Future minimumlease payments during the years ending December 31 are as follows (inthousands):
| 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$2.9 million, $2.5 million, and $1.0 million for the years endedDecember 31, 2005, 2004 and 2003, respectively.

Subsequent to year-end,we entered into a lease for new office space for our electronic litigationdiscovery operations.  This lease extendsthrough 2015 and has total minimum lease of approximately $17.9 million.

**NOTE 7:        STOCKHOLDERS’ EQUITY**

On November 15, 2005, weissued approximately 1.2 million shares of restricted common stock, valued atapproximately $24.2 million, as a part of the transaction to purchasenMatrix.  Under the terms of aregistration rights agreement executed concurrent with the acquisition agreement,we have agreed to prepare and file with the SEC a registration statement, andto use our best efforts to cause the registration statement to become effectiveas soon as reasonably practicable thereafter, to enable the resale of theseshares on a delayed or continuous basis under Rule 415 of the Securities Act of1933, as amended.

On January 31, 2003, weissued approximately 1.1 million shares of restricted common stock, valued atapproximately $16.5 million, as a part of the transaction to purchase themembership interests of BSI.  Half of therestricted shares could not be sold, transferred or encumbered for a period ofone year from the date of issue, and the other half of the restricted sharescould not be sold, transferred or encumbered for a period of two years from thedate of issue.  All shares of our commonstock issued in connection with the BSI acquisition are now unrestricted.

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

F-19

----

**NOTE 8:        EMPLOYEE BENEFIT PLANS**

***Stock Purchase Plan***

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

***Defined Contribution Plan***

We have definedcontribution 401(k) plans covering substantially all employees.  For Epiq and BSI employees, we match 60% ofthe first 10% of employee contributions and also have the option of makingdiscretionary contributions.  ForPoorman-Douglas employees, the percent match is based on years of service.  After three years of service, we match 100%of the first 6% of employee contributions. Our contributions under both plans were approximately $0.8 million, $0.8million, and $0.4 million for the years ended December 31, 2005, 2004, and2003, respectively.

**NOTE 9:        FINANCIAL INSTRUMENTS AND CONCENTRATIONS**

***FairValue of Financial Instruments***

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

As of December 31, 2005,the carrying value of cash, cash equivalents, and trade receivables approximatefair value.  Borrowings under our creditfacility are repriced frequently at market rates and approximate fairvalue.  Our notes related to the BSI andHilsoft deferred acquisition price are discounted at an imputed interest rateof 5% and 8%, respectively, and their combined carrying value of $3.2 millionapproximates fair value as of December 31, 2005.  As of December 31, 2005, our convertiblenotes, which have a fixed interest rate of 4%, have a carrying value of $51.3million and a fair value of $50.3 million. The fair value was calculated using a pricing model that incorporatesassumptions regarding future volatility, interest rates and credit risk.

***Significant Customer 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 partiesagreed to extend the arrangement indefinitely. Either party may, with appropriate notice, wind down the agreement overa period, including the notice period, of three years.  We currently promote our Chapter 7 *TCMS*âsoftware related products and services through marketing arrangements withvarious financial institutions.  Bank ofAmerica has been, and continues to be, a significant partner for thesemarketing arrangements.  Revenuesrecognized by us from Bank of America, all related to our case managementsegment, were approximately 3%, 3% and 44% of our total revenues for the yearsended December 31, 2005, 2004 and 2003, respectively.  Additionally, Bank of America representedapproximately 13% and 12% of our accounts receivable balance as ofDecember 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.

F-20

----

**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 (loss) from continuing operations before  income taxes       |       | $                                           | (6,242     | ) | $ | (11,603 | ) | $ | 16,534 |   |
|                                                                |       |                                        |       |   |   |   |   |
| Provision  (benefit) 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                                                             |       | (8,560                                      | )          | (2,962 | ) | (2,627 | ) |
| State                                                               |       | (1,304                                      | )          | (1,418 | ) | (565 | ) |
| Total                                                               |       | (9,864                                      | )          | (4,380 | ) | (3,192 | ) |
|                                                                |       |                                        |       |   |   |   |   |
| Provision  (benefit) for income taxes from continuing operations    |       | (2,400                                      | )          | (4,313 | ) | 6,939 |   |
|                                                                |       |                                        |       |   |   |   |   |
| 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 (benefit)                        |       | $                                           | (2,400     | ) | $ | (3,876 | ) | $ | 3,195 |   |

 

F-21

----

Areconciliation of the provision (benefit) for income taxes from continuingoperations at the statutory rate of 34% for the years ended December 31, 2005and 2004 and 35% for the year ended December 31, 2003 to the provision(benefit) for income taxes from continuing operations at our effective rate isshown below (in thousands):
| ** **                                                      | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                      | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                            |       |                         |       |   |   |   |   |
|                                                            |       |                         |       |   |   |   |   |
| Computed at the statutory rate                                  |       | $(2,122                      | )          | $(3,945 | ) | $5,787 |   |
| Change in taxes resulting from:                                 |       |                         |       |   |   |   |   |
| State income taxes, net  of federal tax effect                  |       | (274                         | )          | (514 | ) | 1,000 |   |
| Research and  development credits                               |       | (196                         | )          | (99 | ) | (92 | ) |
| Permanent differences                                           |       | 299                          |       | 239 |   | 83 |   |
| Other                                                           |       | (107                         | )          | 6 |   | 161 |   |
| Provision (benefit) for income taxes from continuing operations |       | $(2,400                      | )          | $(4,313 | ) | $6,939 |   |

 

Tax benefitsrelated to acquisitions of $0.3 million and $0.5 million were recorded as areduction to goodwill for the years ended December 31, 2005 and 2004,respectively.

Thetax effects of temporary differences that give rise to significant portions ofdeferred tax assets and deferred tax liabilities on the accompanyingconsolidated balance sheets are as follows (in thousands):
| ** **                                             | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------|------------|------------------|------------|
| ** **                                             | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                                   |       |             |       |   |   |
|                                                   |       |             |       |   |   |
| Deferred tax assets:                                   |       |             |       |   |   |
| Deferred revenue                                       |       | $23,601          |       | $13,925 |   |
| 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                             |       | 27,745           |       | 15,415 |   |
|                                                   |       |             |       |   |   |
| 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 asset (liability)                     |       | $(1,236          | )          | $4,983 |   |

 

As of December 31, 2005,we have aggregate state operating loss carryforwards, primarily related to ouracquisitions of Poorman-Douglas and nMatrix, of $9.9 million.  These carryforwards expire as follows:  $7.5 million in 2019 and $2.4 million in2025.  Management believes that it ismore likely than not that we will be able to utilize these carryforwards and,therefore, no valuation allowance is necessary.

F-22

----

Theabove net deferred tax asset (liability) is presented on the consolidatedbalance sheets as follows (in thousands):
| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|------------------|------------|
| ** **                                      | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                            |       |             |       |   |   |
|                                            |       |             |       |   |   |
| Current deferred income tax asset               |       | $25,579          |       | $754 |   |
| Long-term deferred income tax asset (liability) |       | (26,815          | )          | 4,229 |   |
|                                            |       | $(1,236          | )          | $4,983 |   |

 

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

Basic net income (loss) per share is computed bydividing net income (loss) available to common shareholders by the weightedaverage number of common shares outstanding for the period.  Diluted net income (loss) per share iscomputed by dividing net income (loss) available to common shareholders,increased by the amount of interest expense, net of tax, related to outstandingconvertible debt, by the weighted average number of outstanding common sharesand incremental shares that may be issued in future periods relating to outstandingstock options and convertible debt, if dilutive.  When calculating incremental shares relatedto outstanding stock options, we apply the treasury stock method.  The treasury stock method assumes thatproceeds, consisting of the amount the employee must pay on exercise,compensation cost attributed to future services and not yet recognized, andexcess tax benefits that would be credited to additional paid-in capital onexercise of the options, are used to repurchase outstanding shares at the averagemarket price for the period.  Thetreasury stock method is applied only to share grants for which the effect isdilutive (in thousands, except per share data).
| ** **                                                  | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                  | ** ** | **Net Loss**                          | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per Share  Amount** | ** ** | **Net Loss** | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per Share  Amount** | ** ** | ** Net Income** | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per Share  Amount** | *** *** |
|                                                        |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                        |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic income  (loss) per share from continuing operations   |       | $                                          | (3,842     | ) | 18,092 |   | $ | (0.21 | ) | $ | (7,290 | ) | 17,848 |   | $ | (0.41 | ) | $ | 9,595 |   | 17,619 |   | $ | 0.54 |   |
|                                                        |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Effect of  dilutive securities:                             |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Stock options                                               |       |                                       |       | — |   |   |   |   |   | — |   |   |   |   |   | 485 |   |   |   |
| Convertible debt                                            |       |                                       |       | — |   |   |   |   |   | — |   |   |   |   |   | — |   |   |   |
|                                                        |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Diluted income (loss)  per share from continuing operations |       | $                                          | (3,842     | ) | 18,092 |   | $ | (0.21 | ) | $ | (7,290 | ) | 17,848 |   | $ | (0.41 | ) | $ | 9,595 |   | 18,104 |   | $ | 0.53 |   |

 

For the years endedDecember 31, 2005 and 2004, we did not assume conversion of the convertibledebt or exercise of any share-based options as the effect would beanti-dilutive.  For the year endedDecember 31, 2003, weighted-average outstanding stock options totalingapproximately 0.1 million shares of common stock were antidilutive and,therefore, not included in the computation of diluted earnings per share.  For the convertible notes, issued in June2004, we did not assume conversion for the years ended December 31, 2005 and2004 as the effect would be anti-dilutive.

F-23

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**NOTE 12:      STOCK OPTIONS**

During June 2004, our2004 Equity Incentive Plan (the “2004 Plan”) was approved by our shareholdersand replaced our 1995 Stock Option Plan, as amended (the “1995 Plan”).  The 2004 Plan limits the combined grant ofoptions to acquire shares of common stock, stock appreciation rights, andrestricted stock to 3,000,000 shares. Any grant under the 2004 Plan that expires or terminates unexercised,becomes unexercisable or is forfeited will be available for further grantsunless, in the case of options granted, related stock appreciation rights areexercised.  At December 31, 2005,there were approximately 986,000 options available for future grants under the2004 Plan.  Under the 2004 Plan, theoption price may not be less than 100% of the fair market value of the commonstock on the date of grant for a non-qualified stock option or an incentivestock option (“ISO”).  In the case of anISO granted to an employee owning more than 10% of the voting stock of Epiq,the option price may not be less than 110% of the fair market value of thecommon stock on the date of grant.

The CompensationCommittee of the Board of Directors administers the 2004 Plan and hasdiscretion to determine the term of an option, which may not be exercised morethan 10 years after the date of grant. In the case of an ISO granted to an employee owning more than 10% of thevoting stock of Epiq, the term may not exceed five years from the date ofgrant.  Options may not be transferred byan optionee except by will or the laws of descent and distribution or to afamily member by gift or qualified domestic relations order and are exercisableduring the lifetime of an optionee only by the optionee or the optionee’sguardian or legal representatives. Assuming the option is otherwise still exercisable, options must beexercised within one year after termination of employment due to death ordisability and within three months of any other termination of employment.

The Board of Directorsmay require in its discretion that any option granted becomes exercisable onlyin installments or after some minimum period of time, or both.  The vesting schedule for outstanding optionsranges from immediate to five years.

During November 2005, aspart of the nMatrix acquisition, inducement stock options were granted, outsidethe 2004 Plan, to key employees to acquire up to 370,000 shares of commonstock.  The options were granted at anoption exercise price equal to fair market value of the common stock on thedate of grant, were non-qualified options, were exercisable for up to 10 yearsfrom the date of grant and vested 25% on the second anniversary of the grantdate and continue to vest 25% per year on each anniversary of the grant dateuntil fully vested.

During February 2005, ourcompensation committee approved acceleration of the vesting of certain unvestedoptions for employees, including an executive officer, and non-employeedirectors.  The decision to acceleratethe vesting of these options and eliminate future compensation expense was basedprimarily on a review of our long-term incentive programs considering theeffect on our financial statements of changes in accounting rules that we mustadopt in 2006.  This action, which had animmaterial effect on our financial statements for the year ended December 31,2005, will reduce the impact of adoption of SFAS No. 123R on our futureconsolidated financial statements.

During the year endedDecember 31, 2004, as part of the Poorman-Douglas acquisition, inducement stockoptions were granted, outside the 1995 Plan and 2004 Plan, to key executives toacquire up to 300,000 shares of common stock. The options were 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 10 years from the date of grant and vested20% on the first anniversary of the grant date and continue to vest 20% peryear on each anniversary of the grant date until fully vested.  During the year, one of the executivestransitioned from full-time employee status to a consulting role and his optionto purchase 100,000 shares of common stock was terminated.

During the year endedDecember 31, 2003, as part of the BSI acquisition, inducement stock optionswere granted, outside the 1995 Plan and 2004 Plan, to a key executive toacquire up to 100,000 shares of common stock. The option was granted at an option exercise price equal to fair marketvalue of the common stock on the date of grant, were non-qualified options,were exercisable for up to ten years from the date of grant and vested 20% onthe grant date and continues to vest 20% per year on each anniversary of thegrant date until fully vested.  Duringthe year ended December 31, 2003, the vested portion of the option wasexercised to purchase 20,000 shares of common stock.

F-24

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Following is a summary ofour stock options outstanding as of each year ended December 31 (in thousands,except price data):
| ** **                                                      | *** *** | **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 |   |   |   |
|                                                                 |              |            |            |                                         |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The followingtable summarizes information about stock options outstanding as ofDecember 31, 2005 (in thousands, except life and price data):
| ** **                              | ** ** | **Options Outstanding**  | ** ** | **Options Exercisable**                             | ** ** |
|-----------------------------------------|------------|-------------------------------|------------|----------------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | ** Number  Outstanding** | ** ** | **Weighted-  Average  Remaining  Contractual Life** | ** ** | **Weighted-  Average  Exercise      Price** | ** ** | ** Number  Exercisable** | ** ** | **Weighted-  Average  Exercise      Price** | ** ** |
|                                    |       |                          |       |                                                     |       |   |   |   |   |   |   |
| $1.56 to $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 |   |
|                                         |            |                               |            |                                                          |            |  |  |  |  |  |  |  |  |

 

F-25

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**NOTE 13:      BUSINESS ACQUISITIONS**

***nMatrix***

On November 15,2005, Epiq, acting through a wholly-owned subsidiary, acquired all the issuedand outstanding shares of capital stock of nMatrix, Inc., nMatrix AustraliaPtd. Ltd., and nMatrix Ltd. (collectively, “nMatrix”) for approximately $126.2million, including capitalized 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 priceconsisted of cash of $100.0 million and approximately 1.2 million shares of ourcommon 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 ourcase management segment, will be operated from its current locations in NewYork, the United Kingdom, and Australia. Based on our preliminary valuation, the purchase price has beenallocated 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, customerrelationships, and the non-compete agreements are amortized using thestraight-line method over one year, eight years, and five years,respectively.  The excess purchase priceof $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 price in excess of the tax basisof the assets, primarily allocated to identifiable intangible assets and goodwill,is not expected to be deductible for tax purposes.  Of our common shares issued as consideration,approximately 246,000 are held in escrow. On submission of properly approved indemnification claims, the escrowtrustee will liquidate sufficient shares to pay the indemnification claim.  As of December 31, 2005, we have notsubmitted any claims related to this escrow. The escrow arrangement terminates May 14, 2007, at which time any of ourcommon shares that have not been liquidated to pay claims will be distributedto the seller.  Also, $4.0 million of thecash consideration is held in escrow pending collection of certainpre-acquisition receivables.  Each month,a portion of the escrow is released to the seller based on the prior month’scollection of these pre-acquisition receivables.  As of December 31, 2005, $2.6 millionremained in this escrow account.  Thisescrow arrangement terminates following the payment for collections made duringSeptember 2006 of these pre-acquisition receivables, at which time any amountthat remains in escrow will be distributed to us.

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

F-26

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***Hilsoft, Inc.***

On October 20, 2005, weacquired for cash all the issued and outstanding shares of capital stock ofHilsoft Inc.  We believe this acquisitionprovides complementary diversification to our existing class action business asHilsoft is a specialty provider oflegal notification services, primarily for class action engagements.  The total value of the transaction, includingcapitalized transaction costs, was $9.3 million.  If certain revenue objectives are satisfied,we may be required to make additional payments of up to $3.0 million to theformer owners of Hilsoft.  Hilsoft, whichwill be included entirely within our document management segment, will beoperated from its current location in Pennsylvania.  Based on our preliminary valuation, thepurchase price has been allocated as follows (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 thetrade name are amortized using the straight-line method over two years.  The non-compete agreements are amortizedusing the straight-line method over five years. The excess purchase price of $7.2 million was allocated to goodwill andis not amortized but will be reviewed for impairment annually and betweenannual tests if events or changes in circumstances indicate that the assetmight be impaired.  The purchase price inexcess of the tax basis of the assets, primarily allocated to identifiable intangibleassets and goodwill, is not expected to be deductible for tax purposes.

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

F-27

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***P-DHolding Corp.***

On January 30, 2004, weacquired for cash 100% of the equity of P-D Holding Corp. and its wholly-ownedsubsidiary, Poorman-Douglas Corporation (collectively, “Poorman-Douglas”).  We believe this acquisition provides complementarydiversification to our existing legal services business as Poorman-Douglas is aprovider of technology-based products and services for class action, mass tortand bankruptcy case administration.  Thetotal value of the transaction, including capitalized acquisition costs, wasapproximately $115.7 million.  Based onour valuation, 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 intangibleassets are amortized on a straight-line basis as follows:  the trade names over two years, the customerbacklog over three years, the customer relationships over twelve years, and thenon-compete agreements over five years. The excess purchase price of $83.1 million was allocated to goodwill andis 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 purchaseprice 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 wasaccounted for using the purchase method of accounting with the operatingresults included in the accompanying consolidated financial statements from thedate of acquisition.

F-28

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***Bankruptcy Services LLC***

On January 31, 2003, weacquired 100% of the membership interests of Bankruptcy Services LLC (“BSI”), aprovider of technology-based case management, consulting and administrativeservices for corporate restructuring cases. The total value of the transaction,including capitalized transaction costs, was $67.0 million of which $45.5million was paid in cash, $16.5 million (approximately 1.1 million shares) waspaid in our common stock, $3.4 million was deferred in the form of anon-interest bearing note with a face value of $4.0 million discounted using animputed interest rate of 5% per annum, $1.3 million of liabilities wereassumed, and $0.3 million was paid in acquisition costs.  The purchase price was allocated as follows(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 |   |

 

Customer backlog and thenon-compete agreements are amortized using the straight-line method over,respectively, two years and ten years. Initially, the trade name was not amortized as it had an indefinitelife.  In conjunction with ouracquisition of Poorman-Douglas we reassessed our use of all trade names.  Accordingly, in February 2004 we commencedamortizing the BSI trade name on a straight-line basis over two years.  The excess purchase price of $46.7 millionwas allocated to goodwill and is not amortized but will be reviewed forimpairment annually and between annual tests if events or changes incircumstances indicate that the asset might be impaired.  The purchase price in excess of the tax basisof the assets, primarily allocated to identifiable intangible assets andgoodwill, has been determined to be deductible for tax purposes.

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

F-29

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***ProForma Information***

Unaudited pro formaoperations, assuming each purchase acquisition was made at the beginning of theyear preceding the acquisition, are shown below (in thousands, except per sharedata):
| ** **                                  | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                        |       |                                                          |       |   |   |   |   |
| Total revenues                              |       | $                                                             | 133,618    |   | $ | 119,875 |   | $ | 125,376 |   |
|                                        |       |                                                          |       |   |   |   |   |
| Income (loss)  from continuing operations   |       | $                                                             | (4,122     | ) | $ | (12,424 | ) | $ | 10,508 |   |
| Discontinued  operations                    |       | —                                                        |       | 667 |   | (5,818 | ) |
| Net loss                                    |       | $                                                             | (4,122     | ) | $ | (11,757 | ) | $ | 4,690 |   |
|                                        |       |                                                          |       |   |   |   |   |
| Net income  (loss) per share:               |       |                                                          |       |   |   |   |   |
| Net income (loss) per share — Basic    |       |                                                          |       |   |   |   |   |
| Income (loss) from continuing operations    |       | $                                                             | (0.23      | ) | $ | (0.70 | ) | $ | 0.60 |   |
| Income (loss) from discontinued operations  |       | —                                                        |       | 0.04 |   | (0.33 | ) |
| Net income per share — Basic           |       | $                                                             | (0.23      | ) | $ | (0.66 | ) | $ | 0.27 |   |
|                                        |       |                                                          |       |   |   |   |   |
| Income (loss) per share — Diluted      |       |                                                          |       |   |   |   |   |
| Income (loss) from continuing operations    |       | $                                                             | (0.23      | ) | $ | (0.70 | ) | $ | 0.58 |   |
| Income (loss) from discontinued operations  |       | —                                                        |       | 0.04 |   | (0.32 | ) |
| Net income  (loss) per share — Diluted |       | $                                                             | (0.23      | ) | $ | (0.66 | ) | $ | 0.26 |   |

 

Pro forma data reflects the difference in amortization expense betweenEpiq and the acquired companies as well as other adjustments, including incometaxes and management compensation.  Thepro forma information is not necessarily indicative of what would have occurredif the acquisition had been completed on that date nor is it necessarilyindicative of future operating results.

F-30

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**NOTE 14:      DISCONTINUED OPERATIONS**

During November 2003, wedetermined that the infrastructure software business was no longer aligned withour long-term strategic objectives. Accordingly, we developed a plan to sell, within one year, ourinfrastructure software business.  At thetime, we determined that this business should be classified as a discontinuedoperation and that the related long-lived assets should be measured at thelower of their carrying amounts or fair value less cost to sell.  Our estimated proceeds from the sale of ourinfrastructure software business, net of estimated selling costs, was less thanthe carrying amount of this business.  Asa result, for the year ended December 31, 2003, we reduced the carrying valueof these assets, consisting of property and equipment, goodwill and otherintangible assets, and recorded a pre-tax impairment charge, included indiscontinued operations in the consolidated statements of operations, ofapproximately $7.6 million.  The taxbenefit related to this impairment charge, also included in discontinuedoperations in the consolidated statements of operations, was approximately $3.0million.

On April 30, 2004, wesold our infrastructure software business to a private company with expertisein file transfer technology for consideration consisting of cash and a notereceivable.  As of December 31, 2005, wehad collected all amounts due related to the note receivable.  During the year ended December 31, 2004, werecognized a gain related to this sale, included in discontinued operations inthe consolidated statements of operations, of approximately $1.0 million, netof tax.

As of December 31,2004 and 2005, we did not hold any assets or liabilities related to thisdiscontinued business.  Revenues, cost ofsales, and operating expenses related to this discontinued business have beenincluded in discontinued operations” in the accompanying consolidatedstatements of operations for all periods presented.  Following is summary financial informationfor discontinued operations (in thousands):

**Net revenue andpre-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 | ) |

 

F-31

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**NOTE 15:      SEGMENT REPORTING**

Duringthe quarter ended March 31, 2004, we changed the structure of our operatingsegments as a result of changes in our business operations.  These changes included our decision, duringNovember 2003, to hold for sale our infrastructure business and ouracquisition, in January 2004, of Poorman-Douglas,a provider of technology-based products and services for class action, masstort and bankruptcy case administration.

Withthese changes, performance is now assessed for our case management and documentmanagement operating segments.  Casemanagement solutions provide clients with integrated technology-based productsand services for the automation of various administrative tasks.  Document management solutions includeproprietary technology and production services to ensure timely, accurate andcomplete execution of the many documents associated with multi-faceted legalcases and communications applications.

Eachsegment’s performance is assessed based on segment revenues less costs directlyattributable 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 reportedwithin a segment are those assets used by the segment in its operations andconsist of property and equipment, software, identifiable intangible assets andgoodwill.  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 before reimbursed direct costs                                           |       | $                                                    | 54,813     |   | $ | 27,874 |   | $ | — |   | $ | 82,687 |   |
| Operating revenue from reimbursed direct costs                                             |       | 3,138                                                |       | 20,505 |   | — |   | 23,643 |   |
| Total revenue                                                                              |       | 57,951                                               |       | 48,379 |   | — |   | 106,330 |   |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Costs and  expenses:                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Direct costs, general and administrative costs and  depreciation and software amortization |       | 32,580                                               |       | 36,581 |   | 26,989 |   | 96,150 |   |
| Amortization of identifiable intangible assets                                             |       | 5,027                                                |       | 1,724 |   | — |   | 6,751 |   |
| Acquisition related                                                                        |       | —                                               |       | — |   | 2,984 |   | 2,984 |   |
| Total operating expenses                                                                   |       | 37,607                                               |       | 38,305 |   | 29,973 |   | 105,885 |   |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Operating income                                                                           |       | $                                                    | 20,344     |   | $ | 10,074 |   | $ | (29,973 | ) | 445 |   |
| Net expenses  related to financing                                                         |       |                                                 |       |   |   |   |   | (6,687 | ) |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Loss from  continuing operations before income taxes                                       |       |                                                 |       |   |   |   |   | (6,242 | ) |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Provision for  income tax benefit                                                          |       |                                                 |       |   |   |   |   | (2,400 | ) |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Net loss from  continuing operations                                                       |       |                                                 |       |   |   |   |   | $ | (3,842 | ) |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Total assets                                                                               |       | $                                                    | 260,831    |   | $ | 59,581 |   | $ | 98,059 |   | $ | 418,471 |   |
| Provisions for  depreciation and amortization                                              |       | $                                                    | 9,681      |   | $ | 2,155 |   | $ | 2,203 |   | $ | 14,039 |   |
| Capital expenditures                                                                       |       | $                                                    | 4,961      |   | $ | 38 |   | $ | 1,825 |   | $ | 6,824 |   |

 

F-32

----

####  

| ** **                                                                                 | ** ** | **Year Ended December 31, 2004** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **Case**                                             | ** ** | **Document** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                 | ** ** | **Management**                                       | ** ** | **Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Revenue:                                                                                   |       |                                                 |       |   |   |   |   |   |   |
| Operating  revenue before reimbursed direct costs                                          |       | $                                                    | 41,474     |   | $ | 36,549 |   | $ | — |   | $ | 78,023 |   |
| Operating  revenue from reimbursed direct costs                                            |       | 2,465                                                |       | 17,880 |   | — |   | 20,345 |   |
| Total revenue                                                                              |       | 43,939                                               |       | 54,429 |   | — |   | 98,368 |   |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Costs and expenses:                                                                        |       |                                                 |       |   |   |   |   |   |   |
| Direct costs,  general and administrative costs and depreciation and software amortization |       | 29,107                                               |       | 40,604 |   | 23,086 |   | 92,797 |   |
| Amortization of  identifiable intangible assets                                            |       | 5,243                                                |       | 2,524 |   | — |   | 7,767 |   |
| Acquisition  related                                                                       |       | —                                               |       | — |   | 2,197 |   | 2,197 |   |
| Total operating expenses                                                                   |       | 34,350                                               |       | 43,128 |   | 25,283 |   | 102,761 |   |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Operating loss                                                                             |       | $                                                    | 9,589      |   | $ | 11,301 |   | $ | (25,283 | ) | (4,393 | ) |
| Net expenses related to  financing                                                         |       |                                                 |       |   |   |   |   | (7,210 | ) |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Loss from continuing  operations before income taxes                                       |       |                                                 |       |   |   |   |   | (11,603 | ) |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Provision for income  tax benefit                                                          |       |                                                 |       |   |   |   |   | (4,313 | ) |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Net loss from  continuing operations                                                       |       |                                                 |       |   |   |   |   | $ | (7,290 | ) |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Total assets                                                                               |       | $                                                    | 131,233    |   | $ | 51,264 |   | $ | 61,820 |   | $ | 244,317 |   |
| 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 |   |

 

F-33

----

####  

| ** **                                                                                 | ** ** | **Year Ended December 31, 2003** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **Case**                                             | ** ** | **Document** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                 | ** ** | **Management**                                       | ** ** | **Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Revenue:                                                                                   |       |                                                 |       |   |   |   |   |   |   |
| Operating revenue before reimbursed direct costs                                           |       | $                                                    | 41,532     |   | $ | 12,730 |   | $ | — |   | $ | 54,262 |   |
| Operating revenue from reimbursed direct costs                                             |       | 311                                                  |       | 5,207 |   | — |   | 5,518 |   |
| Total revenue                                                                              |       | 41,843                                               |       | 17,937 |   | — |   | 59,780 |   |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Costs and  expenses:                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Direct costs, general 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                                                                           |       | $                                                    | 26,623     |   | $ | 6,771 |   | $ | (16,943 | ) | 16,451 |   |
|  Net income related to financing                                                      |       |                                                 |       |   |   |   |   | 83 |   |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Income from  continuing operations before income taxes                                     |       |                                                 |       |   |   |   |   | 16,534 |   |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Provision for  income tax expense                                                          |       |                                                 |       |   |   |   |   | 6,939 |   |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Net income from  continuing operations                                                     |       |                                                 |       |   |   |   |   | $ | 9,595 |   |
|                                                                                       |       |                                                 |       |   |   |   |   |   |   |
| Total assets                                                                               |       | $                                                    | 59,518     |   | $ | 26,806 |   | $ | 56,862 |   | $ | 143,186 |   |
| Provisions for  depreciation and amortization                                              |       | $                                                    | 5,881      |   | $ | 1,516 |   | $ | 781 |   | $ | 8,178 |   |
| Capital expenditures                                                                       |       | $                                                    | 3,609      |   | $ | — |   | $ | 2,916 |   | $ | 6,525 |   |

 

F-34

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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 |   |
|                                                     |            |                                            |            |  |  |  |  |  |  |  |

 

**NOTE 17:      RESTATEMENTOF PREVIOUSLY ISSUED FINANCIAL STATEMENTS**

Subsequent to theissuance of our consolidated financial statements for the year ended December31, 2005, management identified anaccounting error in its historical consolidated financial statements related tothe appropriate accounting treatment for certain complex aspects of revenuerecognition, specifically the evaluation of vendor specific objective evidence(VSOE) of fair value for specified software upgrades provided within a bundled arrangementas required by Statement of Position 97-2, *Software RevenueRecognition* (SOP 97-2).  As aresult, we have restated our financial statements as of December 31,2005 and 2004, and for each of the three years in the period ended December 31,2005, included in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2005, initially filed with the SEC on March 8, 2006, for thequarterly information included in our Annual Report on Form 10-K for the fiscalyear ended December 31, 2005 initially filed with the SEC on March 8, 2006, for the three months ended March 31, 2006 and2005, included in our Quarterly Report on Form 10-Q for the quarter ended March31, 2006, initially filed with the SEC on May 9, 2006, for the three and sixmonths ended June 30, 2006 and 2005, included in our Quarterly Report on Form10-Q for the quarter ended June 30, 2006, initially filed with the SEC onAugust 8, 2006, and for the three and nine months ended September 20, 2005,included in our Quarterly Report on Form 10-Q for the quarter ended September30, 2006, filed with the SEC on November 14, 2006.

Asbackground, our Chapter 7 bankruptcy services end-user customers areprofessional bankruptcy trustees.  The application of Chapter 7 bankruptcyregulations has the practical effect of discouraging trustee customers fromincurring direct administrative costs for computer systems.  As a result, we provide our Chapter 7services to trustee customers at no direct charge, and our trustee customersmaintain deposit accounts for bankruptcy cases under their administration at adesignated banking institution.  Wehave marketing arrangements with various banks under which we provide Chapter 7trustee case management software and related services and the bank provides theChapter 7 bankruptcy trustee with deposit-related banking services.  Under our primary depository financialarrangement, we primarily receive cash based on the aggregate amount of trusteedeposits maintained at the bank and the number of Chapter 7 trustees withdeposits placed with the bank, which we refer to collectively as volume-basedfees.  These volume-based fees compensateus for the software license, hardware and postcontract customer support (PCS)services that we provide to the Chapter 7 trustees.

Prior to October 1, 2003,our primary financial institution engaged us to provide the trustees withsoftware upgrades in the first and second quarter of each year.  These software upgrades were documented inarrangements that were separate from our volume-based fee arrangement.  Once the upgrade was delivered to thetrustees and we had provided the bank with satisfactory evidence of thedelivery, we would invoice the bank for the agreed upon amount and recognizerevenue related to the software upgrade.

In October 2003, weentered into a three year arrangement (the 2003 Arrangement) with our primaryfinancial institution.  As a part of the2003 Arrangement, we continued to perform each of our first and second quarterspecified software upgrades 

F-35

----

through the term of thearrangement (September 30, 2006), and the bank agreed to compensate us forthese upgrades on terms similar to our historical terms when we delivered theupgrades on a standalone basis.  As aresult, in our previously reported financial statements, we concluded that wehad established VSOE for the software upgrades and we recognized revenue forthe software upgrades on delivery. Revenue related to hardware and hardware maintenance was recognized asexplained in the “Revenue Recognition” accounting policy contained in note1.  As we did not have VSOE for thesoftware license, we combined the software license with the remainingundelivered element, PCS, as a single unit of accounting.  Revenue related to PCS was entirelycontingent on the placement of deposits by the trustee with the financialinstitution.  Accordingly, we recognizedthis contingent usage based revenue consistent with the guidance provided byAmerican Institute of Certified Public Accountants’ Technical Practice Aid(TPA) 5100.76, *Fair Value in Multiple-Element ArrangementsThat Include Contingent Usage-Based Fees and Software Revenue Recognition*as the fee became fixed or determinable at the time actual usage occurred andcollectibility was probable.  Thisoccurred monthly as a result of the computation, billing and collection ofmonthly deposit fees contractually agreed to with the bankruptcy trusteeclient. At that time, we had also satisfied the revenue recognition criteriacontained in SAB Topic 13, since we had persuasive evidence that an arrangementexisted, services had been rendered, the price was fixed and determinable, andcollectibility was reasonably assured.

Subsequent to theissuance of the financial statements referenced above, we concluded that,although we historically sold software upgrades on a standalone basis, eachspecified software upgrade should be considered a separate product and,therefore, the price of prior software upgrades cannot be used to establish theprice of future software upgrades.  Asour primary financial institution was the only payee for software upgradesduring the period of the 2003 Arrangement, we were unable to establish VSOE forthe software upgrades.  Under SOP 97-2,if VSOE cannot be established for software upgrades, then consideration receivedunder the 2003 Arrangement, except for consideration related to the provisionof hardware and hardware maintenance, must be deferred until all softwareupgrades have been delivered.  Althoughwe continued to invoice, and the bank continued to pay, our volume-based feesrelated to software licenses and postcontract customer support as well as oursemi-annual software upgrades, these amounts cannot be recognized as revenuewhen we provide the services.  Instead, theseamounts are recorded as a deferred revenue liability on our consolidatedbalance sheet.  From inception of thearrangement through December 31, 2005 and March 31, 2006, we recorded asdeferred revenue $59.7 million and $66.1 million, respectively, of amountsinvoiced under the 2003 Arrangement. On delivery of the final upgrade duringthe second quarter of 2006, the only remaining undelivered element was PCSservices.  In accordance with SOP 97-2,on delivery of the final software upgrade we recognized revenue previouslydeferred on a proportionate basis over the three year term of thecontract.  As the contract commencedOctober 1, 2003 and terminated September 30, 2006, we recognized approximately$60.1 million of net deferred revenue related to this arrangement during thesecond quarter of 2006 and we recognized approximately $6.0 million of deferredrevenue related to this arrangement during the third quarter of 2006.

With this restatement, we have also included thepresentation of revenue related to software arrangements which include bothproduct (software license and upgrades) with services (PCS) on a separate lineitem, “Case management bundled software license, software upgrade andpostcontract customer support services,” within the revenue section of ourconsolidated statements of operations. We have also disaggregated direct costs related to operating revenueinto three line items, “Direct costs of services,”  “Reimbursed direct costs,” and “Direct costsof bundled software license, software upgrade and postcontract customer supportservices,” within the costs and expenses section of our consolidated statementsof operations.

Prior to our restatement, our aggregate deferredrevenue was immaterial and was classified as a component of other accruedexpenses. With our restatement, deferred revenue is material and is reflectedas a separate line item on our condensed consolidated balance sheet.  Therefore, we have reclassified deferredrevenue previously included as a component of other accrued expenses to theline item deferred revenue.

The restatement alsoaffects taxable income, which resulted in a change to our provision for incometaxes.  As a result of the deferral ofrevenue, which had been included in our taxable income, we have restated our deferredtax assets and liabilities.

F-36

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A summary of the significant effects of therestatement is as follows:  (inthousands, except per share data)
| ** **                                        | ** ** | **As of December 31,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                        | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                                        | ** ** | **As  Previously  Reported**          | ** ** | **As  Restated** | ** ** | **As  Previously  Reported** | ** ** | **As  Restated** | ** ** |
|                                              |       |                                  |       |   |   |   |   |   |   |
| **Consolidated  Balance Sheet**                   |       |                                  |       |   |   |   |   |   |   |
| Deferred income  taxes                            |       | $                                     | 1,978      |   | $ | 25,579 |   |   |   |   |   |
| Total Current Assets                              |       | 56,591                                |       | 80,192 |   |   |   |   |   |
| Deferred income  taxes                            |       | —                                |       | — |   | $ | — |   | $ | 4,229 |   |
| Total Long-term Assets                            |       | —                                |       | — |   | 201,049 |   | 205,278 |   |
| Total Assets                                      |       | 394,870                               |       | 418,471 |   | 240,088 |   | 244,317 |   |
| Other accrued  expenses                           |       | 3,872                                 |       | 3,322 |   | 899 |   | 841 |   |
| Deferred revenue                                  |       | —                                |       | 60,224 |   | — |   | 58 |   |
| Total Current Liabilities                         |       | 45,608                                |       | 105,282 |   | 16,060 |   | 16,060 |   |
| Deferred income  taxes                            |       |                                  |       |   |   | 9,696 |   | — |   |
| Deferred revenue                                  |       |                                  |       |   |   | — |   | 35,208 |   |
| Total Long-term Liabilities                       |       |                                  |       |   |   | 84,195 |   | 109,707 |   |
| Retained  earnings                                |       | 47,864                                |       | 11,791 |   | 36,916 |   | 15,633 |   |
| Total Stockholders’ Equity                   |       | 176,541                               |       | 140,468 |   | 139,833 |   | 118,550 |   |
| Total  Liabilities and Stockholders’ Equity. |       | 394,870                               |       | 418,471 |   | 240,088 |   | 244,317 |   |
|                                                   |            |                                       |            |  |  |  |  |  |  |  |  |  |  |

 

F-37

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| ** **                                                                                                                                           | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                           | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                                           | ** ** | **As  Previously  Reported**                | ** ** | **As  Restated** | ** ** | **As  Previously  Reported** | ** ** | **As  Restated** | ** ** | **As  Previously  Reported** | ** ** | **As  Restated** | ** ** |
|                                                                                                                                                 |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| **Consolidated  Statements of Operations**                                                                                                           |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Case management  services                                                                                                                            |       | $                                           | 79,279     |   | $ | 53,042 |   | $ | 68,526 |   | $ | 41,275 |   | $ | 49,688 |   | $ | 23,063 |   |
| Case management  bundled software license, software upgrade and postcontract customer support  services                                              |       | —                                      |       | 1,771 |   | — |   | 199 |   | — |   | 18,469 |   |
| Total Revenue                                                                                                                                        |       | 130,796                                     |       | 106,330 |   | 125,420 |   | 98,368 |   | 67,936 |   | 59,780 |   |
| Direct costs of  services (exclusive of depreciation and amortization)                                                                               |       | 57,790                                      |       | 30,225 |   | 60,384 |   | 37,411 |   | 16,490 |   | 8,380 |   |
| Direct costs of  bundled software license, software upgrade and postcontract customer support  services (exclusive of depreciation and amortization) |       | —                                      |       | 3,809 |   | — |   | 2,849 |   | — |   | 2,491 |   |
| Reimbursed  direct costs                                                                                                                             |       | —                                      |       | 23,756 |   | — |   | 20,124 |   | — |   | 5,619 |   |
| Income (Loss)  from Operations                                                                                                                       |       | 24,911                                      |       | 445 |   | 22,659 |   | (4,393 | ) | 24,607 |   | 16,451 |   |
| Income (Loss)  from Continuing Operations Before Income Taxes                                                                                        |       | 18,224                                      |       | (6,242 | ) | 15,449 |   | (11,603 | ) | 24,690 |   | 16,534 |   |
| Provision  (Benefit) for Income Taxes                                                                                                                |       | 7,276                                       |       | (2,400 | ) | 6,386 |   | (4,313 | ) | 10,165 |   | 6,939 |   |
| Income (loss)  from Continuing Operations                                                                                                            |       | 10,948                                      |       | (3,842 | ) | 9,063 |   | (7,290 | ) | 14,525 |   | 9,595 |   |
| Net Income  (Loss)                                                                                                                                   |       | 10,948                                      |       | (3,842 | ) | 9,730 |   | (6,623 | ) | 8,707 |   | 3,777 |   |
|                                                                                                                                                 |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Net Income  (Loss) per Share                                                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Basic — income (loss) from continuing operations                                                                                                |       | $                                           | 0.61       |   | $ | (0.21 | ) | $ | 0.51 |   | $ | (0.41 | ) | $ | 0.82 |   | $ | 0.54 |   |
| Basic — net income (loss) per share                                                                                                             |       | 0.61                                        |       | (0.21 | ) | 0.55 |   | (0.37 | ) | 0.49 |   | 0.21 |   |
| Diluted — income (loss) from continuing operations                                                                                              |       | 0.56                                        |       | (0.21 | ) | 0.49 |   | (0.41 | ) | 0.80 |   | 0.53 |   |
| Diluted — income (loss) from discontinued operations                                                                                            |       |                                        |       |   |   | 0.03 |   | 0.04 |   |   |   |   |   |
| Diluted — net income (loss) per share                                                                                                           |       | 0.56                                        |       | (0.21 | ) | 0.52 |   | (0.37 | ) | 0.48 |   | 0.21 |   |
|                                                                                                                                                 |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Weighted Average Common  Shares Outstanding — Diluted                                                                                           |       | 21,551                                      |       | 18,092 |   | 19,828 |   | 17,848 |   |   |   |   |   |

 

F-38

----

 
| ** **                                     | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                     | ** ** | **As  Previously  Reported**                | ** ** | **As  Restated** | ** ** | **As  Previously  Reported** | ** ** | **As  Restated** | ** ** | **As  Previously  Reported** | ** ** | **As  Restated** | ** ** |
|                                           |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| **Consolidated  Statements of Cash Flow**      |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Cash Flows from  Operating Activities          |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Net income  (loss)                             |       | $                                           | 10,948     |   | $ | (3,842 | ) | $ | 9,730 |   | $ | (6,623 | ) | $ | 8,707 |   | $ | 3,777 |   |
| Provision  (benefit) for deferred income taxes |       | (188                                        | )          | (9,864 | ) | 8,208 |   | (2,491 | ) | (1,855 | ) | (5,081 | ) |
| Accounts payable  and other liabilities        |       | 3,402                                       |       | 3,126 |   | (10,762 | ) | (10,779 | ) | 2,607 |   | 2,618 |   |
| Deferred revenue                               |       | —                                      |       | 24,742 |   | — |   | 27,069 |   | — |   | 8,145 |   |
| Net Cash Provided by  Operating Activities     |       | 27,238                                      |       | 27,238 |   | 31,589 |   | 31,589 |   | 20,651 |   | 20,651 |   |
|                                                |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*     *     *

F-39

----

**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)             Consists primarily of allowance related toacquired receivables.

----

**EXHIBIT INDEX**

The following exhibits are filed with this Form 10-K/A or areincorporated herein by reference:
| Exhibit Number | ** **      | **Description** | ** ** |
|---------------------|-----------------|-----------------|------------|
|                |   3.1 |            |       | Articles of Incorporation, as amended through June 2,  2004. Previously filed as an exhibit to the annual report on Form 10-K for  the year ended December 31, 2005, filed with the Securities and Exchange  Commission on March 8, 2006. |   |
|                |   3.2 |            |       | Bylaws, as amended and restated.Incorporated by reference and previously filed  as an exhibit to the quarterly report on Form 10-Q for the quarter ended  March 31, 2001, filed with the Securities and Exchange Commission on May 11,  2001. |   |
|                |   4.1 |            |       | Reference is made to exhibits 3.1 and 3.2. |   |
|                |   4.2 |            |       | Securities Purchase Agreement dated as of June 10,  2004, among Epiq Systems, Inc. and the Buyers listed on Exhibit A thereto.  Incorporated by reference and previously filed as an exhibit to the current  report on Form 8-K filed with the Securities and Exchange Commission on June  14, 2004. |   |
|                |   4.3 |            |       | Amendment  No. 1 to Securities Purchase Agreement among Epiq Systems, Inc. and the  Holders, dated as of December 15, 2005. Incorporated by reference and  previously filed as an exhibit to the current report on Form 8-K filed with  the Securities and Exchange Commission on December 21, 2005. |   |
|                |   4.4 |            |       | Registration Rights Agreement dated as of June 10,  2004, among Epiq Systems, Inc. and the Buyers listed on the Schedule of  Buyers attached thereto. Incorporated by reference and previously filed as an  exhibit to the current report on Form 8-K filed with the Securities and  Exchange Commission on June 14, 2004. |   |
|                |   4.5 |            |       | Form of Contingent Convertible Subordinated Note, as  amended. Previously filed as an exhibit to the annual report on Form 10-K for  the year ended December 31, 2005, filed with the Securities and Exchange  Commission on March 8, 2006. |   |
|                | 10.1            |            |       | 1995 Stock Option Plan, as amended.Incorporated by reference and previously filed  as an exhibit to the registration statement on Form SB-2 filed with the  Securities and Exchange Commission (File No. 333-51525) on May 1, 1998. |   |
|                | 10.2            |            |       | 2004 Equity Incentive Plan. 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, EpiqSystems, 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. |   |

 

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|        | 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. Previously filed as an exhibit to the annual  report on Form 10-K for the year ended December 31, 2005, filed with the  Securities and Exchange Commission on March 8, 2006.                                                                                                                                                                          |   |
|   | 10.16 |   |   | Escrow  Agreement among Epiq Systems, Inc., Ajuta International Pty. Ltd., as trustee  of Hypatia Trust, and Wells Fargo Bank, N.A. dated as of November 15, 2005.  Incorporated by reference and previously filed as an exhibit to the  Registration Statement No. 333-133296 on Form S-3/A filed with the Securities  and Exchange Commission on June 14, 2006.                                                                         |   |
|   | 10.17 |   |   | Letter  Agreement dated February 7, 2006, between Epiq Systems, Inc. and Bank of America,  N.A. (redacted — request for confidential treatment pending).*+                                                                                                                                                                                                                                                                           |   |
|   | 12.1  |   |   | Statement  regarding computation of earnings to fixed charges. *                                                                                                                                                                                                                                                                                                                                                                          |   |
|   | 21.1  |   |   | List  of Subsidiaries. Previously filed as an  exhibit to the annual report on Form 10-K for the year ended  December 31, 2005, filed with the Securities and Exchange Commission on  March 8, 2006.                                                                                                                                                                                                                            |   |
|   | 23.1  |   |   | Consent of Deloitte & Touche LLP, Independent  Registered Public Accounting Firm.*                                                                                                                                                                                                                                                                                                                                                    |   |
|   | 31.1  |   |   | Certifications  of Chief Executive Officer of the Company under Rule 13a-14(a), as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*                                                                                                                                                                                                                                                                                   |   |
|   | 31.2  |   |   | Certifications  of Chief Financial Officer of the Company under Rule 13a-14(a), as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*                                                                                                                                                                                                                                                                                   |   |
|   | 32.1  |   |   | Certifications of CEO  and CFO pursuant to 18 U.S.C. Section 1350.*                                                                                                                                                                                                                                                                                                                                                                       |   |

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*                    Filed herewith.

+                    Certain confidential portions of this exhibithave been redacted.  A complete versionof this exhibit has been filed with the Secretary of the Securities and ExchangeCommission pursuant to an application requesting confidential treatment underRule 24b-2 of the Securities Exchange Act of 1934.

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