**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D. C. 20549**

 

**FORM 10-Q**

 

**ý****Quarterly Report Under Section 13or 15(d)of the Securities Exchange Act of 1934**

 

**For theQuarterly Period Ended June 30, 2005**

** **

**OR**

 

**o********Transition Report Pursuant to Section 13 or 15(d)of the Securities Exchange Act of 1934**

 

**For thetransition period from                to                **

** **

**CommissionFile Number 0-22081**

 

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**EPIQ SYSTEMS, INC.**

(Exact name of registrant asspecified in its charter)

 

| **Missouri**                     | ** ** | **48-1056429**                        |
|----------------------------------|------------|---------------------------------------|
| (State or  other jurisdiction of |       | (IRS  Employer Identification Number) |
| incorporation  or organization)  |       |                                  |

 

**501 KansasAvenue, Kansas City, Kansas 66105-1300**

(Address of principal executiveoffice)

 

**913-621-9500**

(Registrant’s telephone number)

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days Yes  ý No  o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Act).  Yes  ýNo  o

 

The number of shares outstanding of registrant’s common stock at July 15,2005:

 

| **Class**                     | ** ** | **Outstanding** |
|-------------------------------|------------|-----------------|
| Common  Stock, $.01 par value |       | 17,925,627      |

 

 

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**EPIQSYSTEMS, INC. AND SUBSIDIARIES**

**FORM 10-Q**

**QUARTERENDED JUNE 30, 2005**

 

**CONTENTS**

 
|                                    |                                                                                                                    | **Page**   |
|-----------------------------------------|-------------------------------------------------------------------------------------------------------------------------|------------|
|                                    |                                                                                                                    | ** ** |
| **PART I - FINANCIAL INFORMATION** |                                                                                                                    |
|                                    |                                                                                                                    |       |
| Item 1.                                 | Financial  Statements                                                                                                   |       |
|                                    |                                                                                                                    |       |
|                                    | Condensed Consolidated Statements of Income  –  Three and six months ended June 30, 2005 and 2004 (Unaudited) | 1          |
|                                    |                                                                                                                    |       |
|                                    | Condensed Consolidated Balance Sheets –  June 30, 2005 and December 31, 2004 (Unaudited)                 | 3          |
|                                    |                                                                                                                    |       |
|                                    | Condensed Consolidated Statements of Cash  Flows –  Six months ended June 30, 2005 and 2004 (Unaudited)       | 4          |
|                                    |                                                                                                                    |       |
|                                    | Notes to Condensed Consolidated Financial  Statements (Unaudited)                                                       | 5          |
|                                    |                                                                                                                    |       |
| Item 2.                                 | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                             | 17         |
|                                    |                                                                                                                    |       |
| Item 3.                                 | Quantitative and Qualitative Disclosures  about Market Risk                                                             | 25         |
|                                    |                                                                                                                    |       |
| Item 4.                                 | Controls and Procedures                                                                                                 | 25         |
|                                    |                                                                                                                    |       |
| **PART II - OTHER INFORMATION**    |                                                                                                                    |
|                                    |                                                                                                                    |       |
| Item 4.                                 | Submission of Matters to a Vote of Security  Holders                                                                    | 26         |
|                                    |                                                                                                                    |       |
| Item 6.                                 | Exhibits                                                                                                                | 26         |
|                                    |                                                                                                                    |       |
| Signatures                              | 27                                                                                                                      |
|                                         |                                                                                                                         |            |  |

 

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**PART I - FINANCIAL INFORMATION**

 

**ITEM 1.****  Condensed ConsolidatedFinancial Statements.**

 

##### **EPIQ SYSTEMS, INC. ANDSUBSIDIARIES**

##### **CONDENSED CONSOLIDATEDSTATEMENTS OF INCOME**

**(InThousands, Except Per Share Data)**

**(Unaudited)**

 
| ** **                                                                                                                   | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                   | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| **REVENUE:**                                                                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Case management                                                                                                              |       | $                                     | 19,746     |                                | $          | 17,372 |   | $ | 39,631 |   | $ | 34,298 |   |
| Document management                                                                                                          |       | 6,441                                 |       | 12,224                              |       | 12,522 |   | 18,290 |   |
| Operating revenue                                                                                                            |       | 26,187                                |       | 29,596                              |       | 52,153 |   | 52,588 |   |
| Reimbursed expenses                                                                                                          |       | 5,448                                 |       | 5,312                               |       | 10,944 |   | 8,332 |   |
| Total Revenue                                                                                                                |       | 31,635                                |       | 34,908                              |       | 63,097 |   | 60,920 |   |
|                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| **COSTS AND EXPENSES:**                                                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Direct costs                                                                                                                 |       | 13,564                                |       | 17,672                              |       | 27,300 |   | 27,976 |   |
| General and administrative                                                                                                   |       | 8,044                                 |       | 6,573                               |       | 16,036 |   | 12,211 |   |
| Depreciation and software amortization                                                                                       |       | 1,775                                 |       | 1,578                               |       | 3,549 |   | 2,959 |   |
| Amortization of identifiable intangible  assets                                                                              |       | 1,427                                 |       | 2,032                               |       | 3,050 |   | 3,712 |   |
| Acquisition related                                                                                                          |       | —                                |       | —                              |       | — |   | 2,181 |   |
| Total Operating Expenses                                                                                                     |       | 24,810                                |       | 27,855                              |       | 49,935 |   | 49,039 |   |
|                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| **INCOME FROM OPERATIONS**                                                                                                   |       | 6,825                                 |       | 7,053                               |       | 13,162 |   | 11,881 |   |
|                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| **INTEREST EXPENSE (INCOME):**                                                                                               |       |                                  |       |                                |       |   |   |   |   |
| Interest income                                                                                                              |       | (40                                   | )          | (32                                 | )          | (78 | ) | (66 | ) |
| Interest expense                                                                                                             |       | 1,884                                 |       | 2,007                               |       | 2,685 |   | 3,529 |   |
| Net Interest Expense (Income)                                                                                                |       | 1,844                                 |       | 1,975                               |       | 2,607 |   | 3,463 |   |
|                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| **INCOME FROM CONTINUING OPERATIONS BEFORE  INCOME TAXES**                                                                   |       | 4,981                                 |       | 5,078                               |       | 10,555 |   | 8,418 |   |
|                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| **PROVISION FOR INCOME TAXES**                                                                                               |       | 2,077                                 |       | 2,095                               |       | 4,401 |   | 3,433 |   |
|                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| **NET INCOME FROM CONTINUING OPERATIONS**                                                                                    |       | 2,904                                 |       | 2,983                               |       | 6,154 |   | 4,985 |   |
|                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| **DISCONTINUED OPERATIONS:**                                                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Income from operations of  discontinued  infrastructure  software segment (including  gain  on disposal of $1,626) |       | —                                |       | 1,667                               |       | — |   | 1,231 |   |
| Income tax expense related to  discontinued  infrastructure  software segment                                           |       | —                                |       | (659                                | )          | — |   | (487 | ) |
| **TOTAL DISCONTINUED OPERATIONS**                                                                                            |       | —                                |       | 1,008                               |       | — |   | 744 |   |
|                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| **NET INCOME**                                                                                                               |       | $                                     | 2,904      |                                | $          | 3,991 |   | $ | 6,154 |   | $ | 5,729 |   |

 

1

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| ** **                                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                      | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| **NET INCOME PER SHARE INFORMATION:**           |       |                                 |       |                               |       |   |   |   |   |
| Income per share – Basic                   |       |                                 |       |                               |       |   |   |   |   |
| Income from continuing  operations              |       | $                                    | 0.16       |                               | $          | 0.16 |   | $ | 0.34 |   | $ | 0.28 |   |
| Income from discontinued  operations            |       | —                               |       | 0.06                               |       | — |   | 0.04 |   |
| Net income per share – Basic               |       | $                                    | 0.16       |                               | $          | 0.22 |   | $ | 0.34 |   | $ | 0.32 |   |
|                                            |       |                                 |       |                               |       |   |   |   |   |
| Income per share – Diluted                 |       |                                 |       |                               |       |   |   |   |   |
| Income from continuing  operations              |       | $                                    | 0.15       |                               | $          | 0.16 |   | $ | 0.32 |   | $ | 0.27 |   |
| Income from discontinued  operations            |       | —                               |       | 0.06                               |       | — |   | 0.04 |   |
| Net income per share – Diluted             |       | $                                    | 0.15       |                               | $          | 0.22 |   | $ | 0.32 |   | $ | 0.31 |   |
|                                            |       |                                 |       |                               |       |   |   |   |   |
| **WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:** |       |                                 |       |                               |       |   |   |   |   |
| Basic                                           |       | 17,904                               |       | 17,831                             |       | 17,896 |   | 17,822 |   |
| Diluted                                         |       | 21,289                               |       | 18,782                             |       | 21,187 |   | 18,507 |   |

 

**See accompanying notes to condensedconsolidated financial statements.**

 

2

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**EPIQ SYSTEMS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(In Thousands)**

**(Unaudited)**

** **
| ** **                                                                                                | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| **ASSETS**                                                                                                |       |                   |       |                       |       |
| **CURRENT ASSETS:**                                                                                       |       |                   |       |                       |       |
| Cash and cash equivalents                                                                                 |       | $                      | 13,736     |                       | $          | 13,330 |   |
| Trade accounts receivable, less  allowance for doubtful accounts  of $1,658 and $1,069, respectively |       | 22,674                 |       | 18,690                     |       |
| Prepaid expenses                                                                                          |       | 1,984                  |       | 2,052                      |       |
| Income taxes refundable                                                                                   |       | 2,772                  |       | 3,477                      |       |
| Other current assets                                                                                      |       | 1,055                  |       | 1,490                      |       |
| Total Current Assets                                                                                      |       | 42,221                 |       | 39,039                     |       |
|                                                                                                      |       |                   |       |                       |       |
| **LONG-TERM ASSETS:**                                                                                     |       |                   |       |                       |       |
| Property and equipment, net                                                                               |       | 18,722                 |       | 20,431                     |       |
| Software development costs, net                                                                           |       | 5,843                  |       | 5,838                      |       |
| Goodwill                                                                                                  |       | 147,728                |       | 147,728                    |       |
| Other intangibles, net of  accumulated amortization of $10,057 and  $11,707, respectively            |       | 21,007                 |       | 24,057                     |       |
| Other                                                                                                     |       | 3,376                  |       | 2,995                      |       |
| Total Long-term Assets, net                                                                               |       | 196,676                |       | 201,049                    |       |
| **Total Assets**                                                                                          |       | $                      | 238,897    |                       | $          | 240,088 |   |
|                                                                                                      |       |                   |       |                       |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                             |       |                   |       |                       |       |
| **CURRENT LIABILITIES:**                                                                                  |       |                   |       |                       |       |
| Accounts payable                                                                                          |       | $                      | 3,408      |                       | $          | 4,263 |   |
| Customer deposits                                                                                         |       | 2,466                  |       | 2,375                      |       |
| Accrued compensation                                                                                      |       | 1,908                  |       | 873                        |       |
| Other accrued expenses                                                                                    |       | 1,338                  |       | 899                        |       |
| Current maturities of long-term  obligations                                                              |       | 8,732                  |       | 7,650                      |       |
| Total Current Liabilities                                                                                 |       | 17,852                 |       | 16,060                     |       |
|                                                                                                      |       |                   |       |                       |       |
| **LONG-TERM LIABILITIES:**                                                                                |       |                   |       |                       |       |
| Deferred income taxes                                                                                     |       | 9,626                  |       | 9,696                      |       |
| Long-term obligations  (excluding current maturities)                                                     |       | 65,128                 |       | 74,499                     |       |
| Total Long-term Liabilities                                                                               |       | 74,754                 |       | 84,195                     |       |
|                                                                                                      |       |                   |       |                       |       |
| **STOCKHOLDERS’ EQUITY:**                                                                            |       |                   |       |                       |       |
| Common stockholder’s equity                                                                          |       | 146,291                |       | 139,833                    |       |
| Total Stockholders’ Equity                                                                           |       | 146,291                |       | 139,833                    |       |
| **Total Liabilities and  Stockholders’ Equity**                                                      |       | $                      | 238,897    |                       | $          | 240,088 |   |

** **

**See accompanyingnotes to condensed consolidated financial statements.**

 

3

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**EPIQSYSTEMS, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(InThousands)**

**(Unaudited)**

 
| ** **                                                                                          | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                           |       |                               |       |   |   |
| Net income                                                                                          |       | $                                  | 6,154      |   | $ | 5,729 |   |
| Adjustments to reconcile net income to net  cash from operating activities:                         |       |                               |       |   |   |
| Provision (benefit) for deferred income  taxes                                                      |       | (304                               | )          | 2,855 |   |
| Depreciation and software amortization                                                              |       | 3,549                              |       | 2,959 |   |
| Loan fee amortization                                                                               |       | 561                                |       | 1,493 |   |
| Amortization of other intangible assets                                                             |       | 3,050                              |       | 3,712 |   |
| Gain on disposal of discontinued operations                                                         |       | —                             |       | (1,626 | ) |
| Other, net                                                                                          |       | 999                                |       | (176 | ) |
| Changes in operating assets and  liabilities, net of effects from business acquisition:             |       |                               |       |   |   |
| Trade accounts receivable                                                                           |       | (4,573                             | )          | 6,544 |   |
| Prepaid expenses and other current assets                                                           |       | (654                               | )          | 1,667 |   |
| Accounts payable, customer deposits and  accrued expenses                                           |       | 710                                |       | (1,488 | ) |
| Withholding and related liabilities assumed  in the acquisition of a business and subsequently paid |       | —                             |       | (7,973 | ) |
| Income taxes, including tax benefit from  exercise of stock options                                 |       | 822                                |       | 1,297 |   |
| Other, net                                                                                          |       | —                             |       | 276 |   |
| Net cash provided by operating activities                                                           |       | 10,314                             |       | 15,269 |   |
|                                                                                                |       |                               |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                           |       |                               |       |   |   |
| Purchase of property and equipment                                                                  |       | (896                               | )          | (3,236 | ) |
| Software development costs                                                                          |       | (957                               | )          | (869 | ) |
| Cash paid for acquisition of business, net  of cash acquired                                        |       | —                             |       | (113,115 | ) |
| Purchase of short-term investments                                                                  |       | (6,000                             | )          | — |   |
| Sale of short-term investments                                                                      |       | 6,000                              |       | — |   |
| Other, net                                                                                          |       | 447                                |       | 676 |   |
| Net cash used in investing activities                                                               |       | (1,406                             | )          | (116,544 | ) |
|                                                                                                |       |                               |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                           |       |                               |       |   |   |
| Proceeds from long-term debt borrowings                                                             |       | 5,000                              |       | 145,500 |   |
| Debt issuance costs                                                                                 |       | —                             |       | (5,088 | ) |
| Principal payments under long-term debt  obligations                                                |       | (13,681                            | )          | (56,254 | ) |
| Proceeds from exercise of stock options and  warrants                                               |       | 179                                |       | 287 |   |
| Net cash provided by (used in) financing  activities                                                |       | (8,502                             | )          | 84,445 |   |
|                                                                                                |       |                               |       |   |   |
| **NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS**                                           |       | 406                                |       | (16,830 | ) |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF  PERIOD**                                                 |       | 13,330                             |       | 30,347 |   |
| Decrease in cash classified as held for  sale                                                       |       | —                             |       | 714 |   |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD**                                                        |       | $                                  | 13,736     |   | $ | 14,231 |   |
|                                                                                                |       |                               |       |   |   |
| **SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:**                                             |       |                               |       |   |   |
| Interest paid                                                                                       |       | $                                  | 1,682      |   | $ | 1,895 |   |
| Income taxes paid                                                                                   |       | $                                  | 3,861      |   | $ | (573 | ) |

 

**See accompanying notes to condensedconsolidated financial statements.**

 

4

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**EPIQSYSTEMS, INC. AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

***Nature of Operations***

 

EPIQ Systems, Inc. is a national provider ofintegrated technology-based products and services for fiduciary management andclaims administration applications used by attorneys, trustees, andcorporations primarily engaged in bankruptcy, class action, mass tort, andother similarly complex legal proceedings. Our solutions combine advanced technology with in-depth subject matterexpertise to offer customers an efficient environment in which tocomprehensively manage the complexities of case administration and documentmanagement.

 

***Stock-Based Compensation***

 

We account forstock-based compensation awards under the intrinsic method of AccountingPrinciples Board Opinion No. 25, *Accounting for StockIssued to Employees,*which requires compensation cost to berecognized based on the excess, if any, between the quoted market price at thedate of grant and the amount an employee must pay to acquire stock. Optionsawarded under our option plans are granted with an exercise price equal to thefair market value on the date of the grant. Had the compensation cost beendetermined based on the fair value at the grant dates based on the guidanceprovided by Statement of Financial Accounting Standard (“SFAS”) No. 123, *Accounting for Stock-Based Compensation,* our net income andnet income per share for the three and six months ended June 30, 2005 and2004 would have been adjusted to the following pro forma amounts (in thousands,except per share data):

 

 
| ** **                                                                                                    | ** ** | ** **  | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                    | ** ** | ** **  | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income, as reported                                                                                       |       |        |       | $                                     | 2,904      |                                | $          | 3,991 |   | $ | 6,154 |   | $ | 5,729 |   |
| 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, net of tax |       |        |       | (2,200                                | )          | (275                                | )          | (5,266 | ) | (1,430 | ) |
| Net income, pro forma                                                                                         |       |        |       | $                                     | 704        |                                | $          | 3,716 |   | $ | 888 |   | $ | 4,299 |   |
| ** **                                                                                                    |       |        |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |
| Net income per share – Basic                                                                             | ** ** | As reported |       | $                                     | 0.16       |                                | $          | 0.22 |   | $ | 0.34 |   | $ | 0.32 |   |
|                                                                                                          |       | Pro forma   |       | $                                     | 0.04       |                                | $          | 0.21 |   | $ | 0.05 |   | $ | 0.24 |   |
|                                                                                                          |       |        |       |                                  |       |                                |       |   |   |   |   |
| Net income per share – Diluted                                                                           |       | As reported |       | $                                     | 0.15       |                                | $          | 0.22 |   | $ | 0.32 |   | $ | 0.31 |   |
|                                                                                                          |       | Pro forma   |       | $                                     | 0.04       |                                | $          | 0.20 |   | $ | 0.05 |   | $ | 0.24 |   |

 

Pro formaamounts presented here are based on actual earnings and consider only theeffects of estimated fair values of stock options.  For the three month and six month periodsended June 30, 2005, we did not assume conversion of the convertible notesas the effect was antidilutive.

 

***Comprehensive Income***

 

We do not haveany components of other comprehensive income; therefore comprehensive incomeequals net income.

 

5

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***Recent Accounting Pronouncements***

 

In May 2005,the Financial Accounting Standards Board (FASB) issued SFAS No. 154, *Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20and FASB Statement No. 3*. SFAS 154 requires retrospective application for reporting a change inaccounting principle unless such application is impracticable or unlesstransition requirements specific to a newly adopted accounting principlerequire otherwise.  SFAS No. 154also requires the reporting of a correction of an error by restating previouslyissued financial statements.  SFAS No. 154is effective for accounting changes and corrections of errors made in fiscalyears beginning after December 15, 2005. We do not anticipate that adoption of the statement will have a materialimpact on our consolidated financial statements.

 

In December 2004,the FASB issued SFAS No. 153, *Exchanges of NonmonetaryAssets, an amendment of APB Opinion No. 29.*  SFAS No. 153 expanded the scope of APBOpinion No. 29 to require that the nonmonetary exchange of similarproductive assetsshould be measured based on the fair value of the assets exchanged.  We are required to adopt the provisions ofSFAS No.153 for our quarter ending September 30, 2005.  We do not anticipate that adoption of thisstatement will have a material impact on our consolidated financial statements.

 

In December 2004, the FASB issued SFAS No. 123(revised 2004) (SFAS No. 123R), *Share-Based Payment*.  SFAS No. 123R establishes standards forthe accounting for transactions in which an entity exchanges its equityinstruments for goods and services or incurs liabilities in exchange for goodsor services that are based on the fair value of the entity’s equity instrumentsor that may be settled by the issuance of those equity instruments.  SFAS No. 123R requires a public entityto measure 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 fiscal years beginning after June 15,2005.  Accordingly, we will adopt SFAS No. 123R,likely using the modified version of prospective application, beginning withour quarter ending March 31, 2006. Under the modified version of prospective application, compensation costsrelated to share-based compensation will be recognized in our financialstatements for all periods beginning after December 31, 2005.  For comparative periods ending on or before December 31,2005, which are presented in our 2006 and subsequent financial statements,share-based compensation costs will continue to be excluded from the financialstatements, but we will disclose these share-based compensation costs on a proforma basis in a note to the consolidated financial statements.  Adoption of SFAS No. 123R willmaterially increase our recognized compensation expense and will have amaterial impact on our consolidated income statement and balance sheet.  We are unable to estimate the impact ofadoption of this statement on our consolidated financial statements as theimpact will depend, in part, on future stock awards and stock option awardsmade prior to the adoption date, whether any such awards are qualified ornon-qualified, the vesting period of those awards, and forfeitures related toboth existing awards and new awards. Subsequent to December 31, 2004, our compensation committeeapproved acceleration of the vesting of certain unvested options 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 inthe future.  This action, which had animmaterial affect on our financial statements for the three month and six monthperiods ended June 30, 2005, will reduce the impact of adoption of SFAS No. 123Ron our future consolidated financial statements. If, subsequent to June 30,2005, no new awards were issued and no existing awards were forfeited, weestimate that adoption of SFAS No. 123R would decrease our net income forthe year ending December 31, 2006 by approximately $1.0 million.  We do not anticipate that adoption of SFAS No. 123Rwill have a material impact on our consolidated statement of cash flows.

 

6

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**NOTE 2:  INTERIM FINANCIAL STATEMENTS**

 

The accompanying condensed consolidated financial statements have beenprepared in accordance with the instructions to Form 10-Q of theSecurities and Exchange Commission and in accordance with accounting principlesgenerally accepted in the United States of America (“GAAP”) applicable tointerim financial statements, and do not include all the information and notesrequired by GAAP for complete financial statements.  The financial statements should be read inconjunction with our audited financial statements and accompanying notes, whichare included in our Form 10-K for the year ended December 31, 2004.

 

In the opinion of our management, the accompanying financial statementsreflect all adjustments necessary (consisting solely of normal recurringadjustments) to present fairly our financial position as of June 30, 2005,the results of operations for the three month and six month periods ended June 30,2005 and 2004, and the results of cash flows for the six months ended June 30,2005 and 2004.

 

The results of operations for the three month and six month periodsended June 30, 2005 are not necessarily indicative of the results to beexpected for the entire year.

 

7

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**NOTE 3:  NET INCOME PER SHARE**

 

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

 

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

 

| ** **                                               | ** ** | **Three  Months Ended June 30,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                               | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                                               | ** ** | **Net  Income**                       | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per  Share  Amount** | ** ** | **Net  Income** | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per  Share  Amount** | ** ** |
| Basic net income per share from continuing  operations   |       | $                                     | 2,904      |   | 17,904 |   | $ | 0.16 |   | $ | 2,983 |   | 17,831 |   | $ | 0.16 |   |
|                                                     |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Effect of dilutive securities:                           |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Stock options                                            |       |                                  |       | 528 |   |   |   |   |   | 417 |   |   |   |
| Convertible debt                                         |       | 291                                   |       | 2,857 |   |   |   | 55 |   | 534 |   |   |   |
|                                                     |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Diluted net income per share from  continuing operations |       | $                                     | 3,195      |   | 21,289 |   | $ | 0.15 |   | $ | 3,038 |   | 18,782 |   | $ | 0.16 |   |

 

Options to purchaseapproximately 1,467,000 and 1,593,000 shares of common stock for the threemonth periods ended June 30, 2005 and 2004, respectively, wereantidilutive and therefore not included in the computation of diluted netincome per share from continuing operations.

 

| ** **                                               | ** ** | **Six  Months Ended June 30,** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                               | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                               | ** ** | **Net  Income**                     | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per  Share  Amount** | ** ** | **Net  Income** | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per  Share  Amount** | ** ** |
| Basic net income per share from continuing  operations   |       | $                                   | 6,154      |   | 17,896 |   | $ | 0.34 |   | $ | 4,985 |   | 17,822 |   | $ | 0.28 |   |
|                                                     |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Effect of dilutive securities:                           |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Stock options                                            |       |                                |       | 434 |   |   |   |   |   | 418 |   |   |   |
| Convertible debt                                         |       | 578                                 |       | 2,857 |   |   |   | 55 |   | 267 |   |   |   |
|                                                     |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Diluted net income per share from  continuing operations |       | $                                   | 6,732      |   | 21,187 |   | $ | 0.32 |   | $ | 5,040 |   | 18,507 |   | $ | 0.27 |   |

 

#### **Options to purchase approximately 2,020,000 and952,000 shares of common stock for the six month periods ended June 30,2005 and 2004, respectively, were antidilutive and therefore not included inthe computation of diluted net income per share from continuing operations.**

 

8

----

 

#### **NOTE 4:   GOODWILL AND INTANGIBLE ASSETS**

#### ** **

Amortizing identifiable intangible assets at June 30,2005 and December 31, 2004 consisted of the following (in thousands):

 

 
| ** **             | ** ** | **June 30, 2005**     | ** ** | **December 31, 2004**    | ** ** |
|------------------------|------------|----------------------------|------------|-------------------------------|------------|
| ** **             | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Customer contracts     |       | $                          | 11,860     |                          | $          | 4,436 |   | $ | 16,560 |   | $ | 7,656 |   |
| Trade names            |       | 1,574                      |       | 1,115                         |       | 1,574 |   | 721 |   |
| Non-compete agreements |       | 17,630                     |       | 4,506                         |       | 17,630 |   | 3,330 |   |
|                   |       | $                          | 31,064     |                          | $          | 10,057 |   | $ | 35,764 |   | $ | 11,707 |   |

 

 

During the six months ended June 30,2005, $4.7 million of identifiable intangible assets related to BankruptcyServices LLC (“BSI”) customer contracts became fully amortized.  Accordingly, we wrote off both theidentifiable intangible assets and the related accumulated amortization.

 

Aggregate amortization expense related toidentifiable intangible assets was $1.4 million and $2.0 million for the threemonth periods ended June 30, 2005 and 2004, respectively and was $3.1million and $3.7 million for the six month periods ended June 30, 2005 and2004, respectively.  Amortization expenserelated to identifiable intangible assets for 2005 and the following five yearsis estimated as follows (in thousands):

 

| **Year Ended  December 31,** | ** ** | ** ** | ** ** |
|-----------------------------------|------------|------------|------------|
| 2005                              |       | $          | 5,904      |   |
| 2006                              |       | 4,987      |       |
| 2007                              |       | 3,027      |       |
| 2008                              |       | 2,855      |       |
| 2009                              |       | 1,773      |       |
| 2010                              |       | 1,675      |       |
|                              |       |       |       |
|                              |       | $          | 20,221     |   |

 

At both June 30, 2005 and December 31,2004, intangible assets not subject to amortization, consisting solely ofgoodwill, had a carrying value of $147.7 million.

 

9

----

 

### **NOTE 5:   BUSINESS ACQUISITION**

### ** **

On January 30, 2004, we acquired forcash 100% of the equity of P-D Holding Corp. and its wholly-owned subsidiary,Poorman-Douglas Corporation (collectively, “Poorman-Douglas”).  We believe this acquisition providescomplementary diversification to our existing legal services business asPoorman-Douglas is a provider of technology-based products and services forclass action, mass tort and bankruptcy case administration.  The total value of the transaction, includingcapitalized acquisition costs, was approximately $115.9 million.  Based on our valuation, the purchase pricehas been allocated as follows (in thousands):

 

| Current assets           |   | $       | 21,870  |   |
|--------------------------|--------|---------|---------|--------|
| Deferred tax assets      |   | 6,620   |    |
| Property and software    |   | 8,391   |    |
| Trade names              |   | 1,100   |    |
| Customer backlog         |   | 6,200   |    |
| Customer relationships   |   | 2,300   |    |
| Non-compete agreements   |   | 5,900   |    |
| Goodwill                 |   | 83,540  |    |
| Current liabilities      |   | (12,920 | )       |
| Deferred tax liabilities |   | (7,125  | )       |
|                     |   |    |    |
| Total purchase price     |   | $       | 115,876 |   |

 

All acquired identifiable intangible assetsamortize on a straight-line basis as follows: the trade names over two years, the customer backlog over three years,the customer relationships over twelve years, and the non-compete agreementsover five years.  The excess purchaseprice of $83.5 million was allocated to goodwill and, in accordance with SFAS No. 142*Goodwill and Other Intangible Assets,* isnot being amortized but will be reviewed for impairment annuallyand between annual tests if events or changes in circumstances indicate thatthe asset might be impaired.  Thepurchase price in excess of the tax basis of the assets, primarily allocated toidentifiable intangible assets and goodwill, is not expected to be deductiblefor tax purposes.

 

The acquisition was accounted for using the purchase method ofaccounting, with the operating results included in the accompanying condensedconsolidated financial statements from the date of acquisition.

 

Unaudited pro forma results of operations, assuming the purchaseacquisition was made at the beginning of 2004, are shown below (in thousands,except per share data):

 
| ** **                                        | ** ** | **Six Months Ended  June 30, 2004** | ** ** |
|---------------------------------------------------|------------|------------------------------------------|------------|
|                                              |       |                                     |       |
| Revenue                                           |       | $                                        | 67,603     |   |
|                                              |       |                                     |       |
| Net income from continuing operations             |       | $                                        | 5,550      |   |
| Net income per share from continuing  operations: |       |                                     |       |
| Basic                                             |       | $                                        | 0.31       |   |
| Diluted                                           |       | $                                        | 0.30       |   |

 

The pro forma financial information is not necessarily indicative ofwhat would have occurred had the acquisition been completed on that date nor isit necessarily indicative of future operations.

 

10

----

 

**NOTE 6:  SEGMENT REPORTING**

 

We have two operating segments: (i) case management and (ii) documentmanagement.  Case management solutionsprovide clients with integrated technology-based products and services for theautomation of administrative tasks to address their business requirements.  Document management solutions includeproprietary technology and production services to ensure timely, accurate andcomplete execution of documents related to a case.

 

Each segment’s performance is assessed based on segment revenues lesscosts directly attributable to each segment. In management’s evaluation of performance, certain costs, such as sharedservices, administrative staff, and executive management, are not allocated bysegment and, accordingly, the following operating segment results do notinclude such unallocated costs.  Allother assets are classified as unallocated. Infrastructure software was held for sale and is presented as adiscontinued operation.  Consistent withguidance provided related to SFAS No. 131, we have not presented segmentinformation related to our discontinued operation.

 

During the current year, we determined thatcertain revenues from reimbursed expenses and certain expenses, includingreimbursed expenses, related to our Poorman-Douglas subsidiary acquired in January 2004had not been recorded in the correct segment. These classification errors did not affect our Consolidated Statementsof Income, Balance Sheets, Statements of Cash Flows, or Statement of Changes inStockholders’ Equity for any period previously reported.  Additionally, these errors did not affect netcash flows or compliance with any debt covenants.  However, the classification errors did affectour previously reported segment information disclosed in our 2004 quarterlyreports filed on Form 10-Q and on our annual report filed on Form 10-Kfor the year ended December 31, 2004. We will not amend our previously filed 2004 quarterly reports filed on Form 10-Qor our 2004 annual report filed on Form 10-K, but are restating ourcomparative 2004 quarterly segment information to correct these classificationerrors in our 2005 quarterly reports filed on Form 10-Q and our 2005annual report filed on Form 10-K.  See Item 5 contained in Part II of ourquarterly report on Form 10-Q for the three months ended March 31,2005 for additional information regarding this restatement.

 

Following is a summary of segment information (in thousands):

 
| ** **                                                                  | ** ** | **Three Months Ended June 30, 2005** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                  | ** ** | **Case**                                  | ** ** | **Document** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | **Management**                            | ** ** | **Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                    |       |                                      |       |   |   |   |   |   |   |
| Operating revenue                                                           |       | $                                         | 19,746     |   | $ | 6,441 |   | $ | — |   | $ | 26,187 |   |
| Reimbursed expenses                                                         |       | 747                                       |       | 4,701 |   | — |   | 5,448 |   |
| Total revenue                                                               |       | 20,493                                    |       | 11,142 |   | — |   | 31,635 |   |
|                                                                        |       |                                      |       |   |   |   |   |   |   |
| Costs and expenses:                                                         |       |                                      |       |   |   |   |   |   |   |
| Direct and administrative costs and  depreciation and software amortization |       | 7,729                                     |       | 8,518 |   | 7,136 |   | 23,383 |   |
| Amortization of identifiable intangible  assets                             |       | 1,054                                     |       | 373 |   | — |   | 1,427 |   |
| Acquisition related                                                         |       | —                                    |       | — |   | — |   | — |   |
| Total operating expenses                                                    |       | 8,783                                     |       | 8,891 |   | 7,136 |   | 24,810 |   |
|                                                                        |       |                                      |       |   |   |   |   |   |   |
| Operating income                                                            |       | $                                         | 11,710     |   | $ | 2,251 |   | $ | (7,136 | ) | 6,825 |   |
| Interest expense, net                                                       |       |                                      |       |   |   |   |   | 1,844 |   |
| Income from continuing operations before  income taxes                      |       |                                      |       |   |   |   |   | 4,981 |   |
| Provision for income taxes                                                  |       |                                      |       |   |   |   |   | 2,077 |   |
|                                                                        |       |                                      |       |   |   |   |   |   |   |
| Net income from continuing operations                                       |       |                                      |       |   |   |   |   | $ | 2,904 |   |
|                                                                        |       |                                      |       |   |   |   |   |   |   |
| Provisions for depreciation and  amortization                               |       | $                                         | 2,145      |   | $ | 497 |   | $ | 560 |   | $ | 3,202 |   |

 

11

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| ** **                                                                  | ** ** | **Three Months Ended June 30, 2004** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                  | ** ** | **(as restated)**                         | ** ** |
| ** **                                                                  | ** ** | **Case**                                  | ** ** | **Document** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | **Management**                            | ** ** | **Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                    |       |                                      |       |   |   |   |   |   |   |
| Operating revenue                                                           |       | $                                         | 17,372     |   | $ | 12,224 |   | $ | — |   | $ | 29,596 |   |
| Reimbursed expenses                                                         |       | 675                                       |       | 4,637 |   | — |   | 5,312 |   |
| Total revenue                                                               |       | 18,047                                    |       | 16,861 |   | — |   | 34,908 |   |
|                                                                        |       |                                      |       |   |   |   |   |   |   |
| Costs and expenses:                                                         |       |                                      |       |   |   |   |   |   |   |
| Direct and administrative costs and  depreciation and software amortization |       | 7,527                                     |       | 12,503 |   | 5,793 |   | 25,823 |   |
| Amortization of identifiable intangible  assets                             |       | 1,381                                     |       | 651 |   | — |   | 2,032 |   |
| Acquisition related                                                         |       | —                                    |       | — |   | — |   | — |   |
| Total operating expenses                                                    |       | 8,908                                     |       | 13,154 |   | 5,793 |   | 27,855 |   |
|                                                                        |       |                                      |       |   |   |   |   |   |   |
| Operating income                                                            |       | $                                         | 9,139      |   | $ | 3,707 |   | $ | (5,793 | ) | 7,053 |   |
| Interest expense, net                                                       |       |                                      |       |   |   |   |   | 1,975 |   |
|                                                                        |       |                                      |       |   |   |   |   |   |   |
| Income from continuing operations before  income taxes                      |       |                                      |       |   |   |   |   | 5,078 |   |
| Provision for income taxes                                                  |       |                                      |       |   |   |   |   | 2,095 |   |
|                                                                        |       |                                      |       |   |   |   |   |   |   |
| Net income from continuing operations                                       |       |                                      |       |   |   |   |   | $ | 2,983 |   |
|                                                                        |       |                                      |       |   |   |   |   |   |   |
| Provisions for depreciation and  amortization                               |       | $                                         | 2,410      |   | $ | 731 |   | $ | 469 |   | $ | 3,610 |   |

 

12

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| ** **                                                                  | ** ** | **Six Months Ended June 30, 2005** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                  | ** ** | **Case**                                | ** ** | **Document** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | **Management**                          | ** ** | **Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                    | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating revenue                                                           |       | $                                       | 39,631     |   | $ | 12,522 |   | $ | — |   | $ | 52,153 |   |
| Reimbursed expenses                                                         |       | 1,643                                   |       | 9,301 |   | — |   | 10,944 |   |
| Total revenue                                                               |       | 41,274                                  |       | 21,823 |   | — |   | 63,097 |   |
|                                                                        |       |                                    |       |   |   |   |   |   |   |
| Costs and expenses:                                                         |       |                                    |       |   |   |   |   |   |   |
| Direct and administrative costs and  depreciation and software amortization |       | 15,824                                  |       | 16,663 |   | 14,398 |   | 46,885 |   |
| Amortization of identifiable intangible  assets                             |       | 2,211                                   |       | 839 |   | — |   | 3,050 |   |
| Acquisition related                                                         |       | —                                  |       | — |   | — |   | — |   |
| Total operating expenses                                                    |       | 18,035                                  |       | 17,502 |   | 14,398 |   | 49,935 |   |
|                                                                        |       |                                    |       |   |   |   |   |   |   |
| Operating income                                                            |       | $                                       | 23,239     |   | $ | 4,321 |   | $ | (14,398 | ) | 13,162 |   |
| Interest expense, net                                                       |       |                                    |       |   |   |   |   | 2,607 |   |
| Income from continuing operations before  income taxes                      |       |                                    |       |   |   |   |   | 10,555 |   |
| Provision for income taxes                                                  |       |                                    |       |   |   |   |   | 4,401 |   |
|                                                                        |       |                                    |       |   |   |   |   |   |   |
| Net income from continuing operations                                       |       |                                    |       |   |   |   |   | $ | 6,154 |   |
|                                                                        |       |                                    |       |   |   |   |   |   |   |
| Provisions for depreciation and  amortization                               |       | $                                       | 4,389      |   | $ | 1,089 |   | $ | 1,121 |   | $ | 6,599 |   |

 
| ** **                                                                  | ** ** | **Six Months Ended June 30, 2004** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                  | ** ** | **(as restated)**                       | ** ** |
| ** **                                                                  | ** ** | **Case**                                | ** ** | **Document** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | **Management**                          | ** ** | **Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                    |       |                                    |       |   |   |   |   |   |   |
| Operating revenue                                                           |       | $                                       | 34,298     |   | $ | 18,290 |   | $ | — |   | $ | 52,588 |   |
| Reimbursed expenses                                                         |       | 1,331                                   |       | 7,001 |   | — |   | 8,332 |   |
| Total revenue                                                               |       | 35,629                                  |       | 25,291 |   | — |   | 60,920 |   |
|                                                                        |       |                                    |       |   |   |   |   |   |   |
| Costs and expenses:                                                         |       |                                    |       |   |   |   |   |   |   |
| Direct and administrative costs and  depreciation and software amortization |       | 13,580                                  |       | 18,664 |   | 10,902 |   | 43,146 |   |
| Amortization of identifiable intangible  assets                             |       | 2,490                                   |       | 1,222 |   | — |   | 3,712 |   |
| Acquisition related                                                         |       | —                                  |       | — |   | 2,181 |   | 2,181 |   |
| Total operating expenses                                                    |       | 16,070                                  |       | 19,886 |   | 13,083 |   | 49,039 |   |
|                                                                        |       |                                    |       |   |   |   |   |   |   |
| Operating income                                                            |       | $                                       | 19,559     |   | $ | 5,405 |   | $ | (13,083 | ) | 11,881 |   |
| Interest expense, net                                                       |       |                                    |       |   |   |   |   | 3,463 |   |
| Income from continuing operations before  income taxes                      |       |                                    |       |   |   |   |   | 8,418 |   |
| Provision for income taxes                                                  |       |                                    |       |   |   |   |   | 3,433 |   |
|                                                                        |       |                                    |       |   |   |   |   |   |   |
| Net income from continuing operations                                       |       |                                    |       |   |   |   |   | $ | 4,985 |   |
|                                                                        |       |                                    |       |   |   |   |   |   |   |
| Provisions for depreciation and  amortization                               |       | $                                       | 4,495      |   | $ | 1,440 |   | $ | 736 |   | $ | 6,671 |   |

 

13

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#### **NOTE 7:   LONG-TERM OBLIGATIONS**

#### ** **

The following is asummary of indebtedness outstanding (in thousands):

 
| ** **                                                           | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Senior term loan                                                     |       | $                       | 18,750     |                        | $          | 21,875 |   |
| Senior revolving loan                                                |       | —                  |       | 5,000                       |       |
| Contingent convertible subordinated debt,  including embedded option |       | 50,614                  |       | 50,292                      |       |
| Capital leases                                                       |       | 1,773                   |       | 1,773                       |       |
| Deferred acquisition price                                           |       | 2,723                   |       | 3,209                       |       |
| Total indebtedness                                                   |       | $                       | 73,860     |                        | $          | 82,149 |   |
|                                                                      |            |                         |            |                             |            |  |  |  |  |

 

***Credit Facilities***

 

We have a credit facility with KeyBankNational Association as administrative agent. This facility consists of a $25.0 million senior termloan, with amortizing quarterly principal payments of $1.6 million, and a $50.0million senior revolving loan.  Both thesenior term loan and the senior revolving loan mature June 30, 2008.  During the term of the loan we have theright, subject to compliance with our covenants, to increase the seniorrevolving loan to $75.0 million.

 

The credit facility is secured by liens on our real property and asignificant portion of our personal property and contains financial covenantsrelated to earnings before interest, provision for income taxes, depreciationand amortization (“EBITDA”), total debt, senior debt, fixed charges and workingcapital.  We were in compliance with allfinancial covenants as of June 30, 2005. As calculated at June 30, 2005, additional availability under thesenior revolving loan was approximately $34.1 million.  As of June 30, 2005, our borrowingsunder the credit facility totaled $18.8 million, consisting solely ofborrowings under the senior term loan. Interest on the credit facility is generally based on a spread over theLIBOR rate.  As of June 30, 2005,the interest rate charged on outstanding borrowings under the senior term loanwas 6.0%.

 

***Contingent Convertible Subordinated Debt***

 

During June 2004, we issued $50.0 million of contingentconvertible subordinated notes.  Thesecontingent convertible subordinated notes:

 

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

•                  undercertain circumstances are convertible into shares of our common stock at aprice of $17.50 per share; and

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

 

The note holders’ right to convert the notes is contingent on themarket price of our common stock.  Theshares are convertible only if the weighted average of the price of our commonstock equals or exceeds $19.25 on any five consecutive trading days or if theweighted average price of our common stock is less than $10.75 on any fiveconsecutive trading days.

 

The contingency has not been satisfied and, accordingly, the notes arenot currently convertible.  If thecontingency were satisfied and all shares were converted, the notes wouldconvert into approximately 2,857,000 shares of our common stock.  If we change our capital structure (forexample, through a stock dividend or stock split) while the notes areoutstanding, the conversion price will be adjusted on a consistent basis and,accordingly, the number of shares of common stock we would issue on conversionwould be adjusted.

 

The Emerging Issues Task Force (EITF) reached a consensus regardingIssue No. 04-08, *The Effect of ContingentlyConvertible Debt on EPS,*that the dilutive effect of contingentlyconvertible debt instruments should be included in the diluted earnings pershare calculations in all periods, regardless of whether the contingency ismet, unless the effect of such inclusion would be antidilutive.  This consensus, which was effective forreporting periods ending on or after December 15, 2004, also required thatcomparative prior periods be presented in conformity with EITF 04-08.  Accordingly, the shares issuable onconversion have been included in our diluted shares calculation for both thethree month and six month periods ended June 30, 2005 and 2004.

 

14

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The note holders have the right to extend the maturity of thecontingent convertible subordinated notes for a period not to exceed threeyears.  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.  Theconvertible debt is accreted approximately $0.1 million each quarter such that,at the end of three years, the convertible debt balance will total $50.0million.  On our accompanying CondensedConsolidated Statements of Income, this accretion is a component of interestexpense.  The embedded option must berevalued at each period end based on the probability weighted discounted cashflows related to the additional 4% interest rate payments that will be made ifthe convertible debt maturity is extended an additional three years.  Under this methodology, the embedded optionhas a current value of approximately $1.4 million.  On our accompanying Condensed ConsolidatedBalance Sheet, our obligation related to the embedded option has been includedas a component of the convertible note payable. During the three month and six month periods ended June 30, 2005,the value of the embedded option increased by approximately $0.6 million and$0.1 million, respectively.  Theseincreases are included as a component of interest expense on our accompanyingCondensed Consolidated Statements of Income for the three month and six monthperiods ended June 30, 2005.  Thechanges in carrying value of the convertible debt and fair value of theembedded option do not affect our cash flow and, if the embedded option isexercised, the value assigned to the embedded option will be amortized as areduction to our 4% convertible debt interest expense over the periods paymentsare made.  If the option is not exercisedby some or all note holders, any remaining related value assigned to theembedded option will be recognized as a gain during that period.

 

The notes evidencing the contingent convertible subordinated debtcontains financial covenants related to EBITDA, total debt, and seniordebt.  We were in compliance with allfinancial covenants as of June 30, 2005.

 

***Capital Lease***

 

On June 30, 2004, we entered into acapital lease to finance the purchase of operating software.  At inception of the capital lease, werecorded this transaction as a debt obligation in the amount of $2.7 millionand as purchased software, also in the amount of $2.7 million, included on thebalance sheet as a component of property and equipment.  As this was a non-cash investing andfinancing activity, these initial amounts were not included on our CondensedConsolidated Statement of Cash Flows. Subsequent payments on the capital lease are included in our statementof cash flows during the period in which they are made.  As of June 30, 2005, our debt obligationrelated to this capital lease was approximately $1.8 million, of whichapproximately $0.9 million was classified as a current liability.

 

***Deferred AcquisitionPrice***

 

On January 31, 2003, we acquired 100% ofthe membership interests of BSI, a provider of technology-based casemanagement, consulting and administrative services for Chapter 11 bankruptcyrestructurings, for a purchase price of $67.0 million.  A portion of the purchase price was deferredwhich consists of a $4.0 million non-interest bearing note, payable in fiveannual installments, discounted using an imputed interest rate of 5% perannum.  At June 30, 2005, the discountedvalue of the remaining note payments was approximately $2.7 million of whichapproximately $1.6 million was classified as a current liability.

 

***Scheduled Principal Payments***

 

Our long-term obligations, including creditfacility debt, convertible debt (including embedded option), deferredacquisition costs, and capitalized leases, mature as follows for each twelvemonth period ending June 30 (in thousands):

 
| 2006  |   | $      | 8,732  |   |
|-------|--------|--------|--------|--------|
| 2007  |   | 58,342 |   |
| 2008  |   | 6,786  |   |
| Total |   | $      | 73,860 |   |

 

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**NOTE 8:  DISCONTINUED OPERATIONS**

 

The primary offering of our former infrastructure software business was*DataExpress®*, a software productline that automates the exchange of data files between a company’s customersand their business partners.  During November 2003(the “Measurement Date”), we determined that the infrastructure softwaresegment was no longer aligned with our long-term strategic objectives.  Accordingly, we developed a plan to sell,within one year, the infrastructure software business.

 

On April 30, 2004, we sold our infrastructure software business toa private company with expertise in file transfer technology.  As consideration, we received $0.5 million incash and a $1.1 million note receivable bearing 6.5% interest and due July 31,2005.  The buyer also acquired certainassets and assumed certain liabilities related to our infrastructure business.

 

The disposal of the infrastructure business represents a discontinuedoperation.  Accordingly, for the three monthand six month periods ended June 30, 2004, revenues, cost of sales, andoperating expenses related to this segment have been presented on theaccompanying Condensed Consolidated Statements of Income under the caption “DiscontinuedOperations.”

 

The following table summarizes financial information for discontinuedoperations (in thousands):

 

**Net revenue and pre-tax income fromdiscontinued operations:**

 
| ** **                                  | ** ** | **Three Months Ended June 30,** | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|
| ** **                                  | ** ** | **2005**                             | ** ** | **2004** | ** ** |
|                                        |       |                                 |       |   |   |
| Net revenue from discontinued operations    |       | $                                    | —     |   | $ | 281 |   |
|                                        |       |                                 |       |   |   |
| Pre-tax income from discontinued operations |       | $                                    | —     |   | $ | 1,667 |   |

### ** **

### **Net revenue and pre-taxincome from discontinued operations:**

 
| ** **                                  | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------|------------|
| ** **                                  | ** ** | **2005**                           | ** ** | **2004** | ** ** |
|                                        |       |                               |       |   |   |
| Net revenue from discontinued operations    |       | $                                  | —     |   | $ | 661 |   |
|                                        |       |                               |       |   |   |
| Pre-tax income from discontinued operations |       | $                                  | —     |   | $ | 1,231 |   |

 

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### **ITEM 2**.                             Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

 

### **Overview**

### ** **

Weprovide technology-based products and services for fiduciary management andclaims administration applications. Our solutions enable clients to optimizethe administration of large and complex bankruptcy, class action, mass tort,and other similar legal proceedings.  Ourclients include corporations, attorneys, bankruptcy trustees and administrativeprofessionals who require sophisticated case administration and documentmanagement capabilities, extensive subject matter expertise and a high servicecapacity. We provide clients with an integrated offering of both proprietarytechnology and value-added services that comprehensively address their extensivebusiness requirements.

 

Wehave two operating segments: case management and document management.

 

***Case Management Segment***

 

Casemanagement support for client engagements generally lasts several years and hasa revenue profile that typically includes a recurring component.  Our case management segment generates revenueprimarily through the following integrated technology-based products andservices.

 

•                  An integrated solution of a proprietarytechnology platform and related professional services that facilitates caseadministration of class action, mass tort and Chapter 11 client engagements.

 

•                  Comprehensive support for the balloting andvoting activities that accompany Chapter 11 bankruptcy restructurings.

 

•                  *TCMS*®, an integrated solution comprised of aproprietary software product, computer hardware, and support services,installed in Chapter 7 bankruptcy trustee offices to facilitate the efficientmanagement of asset liquidations, creditor distributions, and governmentreporting.

 

•                  *CasePowe*r®, proprietary software designed to enableChapter 13 bankruptcy trustees to manage efficiently debtor payments, creditordistributions and government reporting.

 

•                  Database conversions, maintenance andprocessing.

 

•                  Professional and support services, includingcase management, claims processing, claims reconciliation, and customizedprogramming and technology services.

 

•                  Call center support.

 

***Document Management Segment***

 

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

 

•                  Legal noticing services to parties ofinterest in bankruptcy and class action and mass tort matters.

 

•                  Reimbursement for costs incurred related topostage on mailing services.

 

•                  Media campaign and advertising management.

 

•                  Document custody services.

 

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**Critical Accounting Policies**

 

Weconsider our accounting policies related to revenue recognition, businesscombinations, goodwill, and identifiable intangible assets to be criticalpolicies in understanding our historical and future performance.

 

***Revenue recognition***.  Wehave agreements with customers obligating us to deliver various products andservices each month.  Case managementfees paid are contingent upon the month-to-month delivery of the products andservices defined by the contracts and are related primarily to the size andcomplexity of the ongoing engagement. The formula-based fees earned each month become fixed and determinableon a monthly basis as a result of our completion of all contractually requiredperformance obligations related to products delivered and services rendered byus during the month.  Document managementrevenues are recognized in the period the services are provided.  Significant sources of revenue include:

 

•                  a monthly fee from financial institutionsbased on a percentage of total liquidated assets on deposit and on the numberof trustees;

 

•                  fees for database conversions, databaseprocessing, maintenance and software upgrades;

 

•                  monthly revenue based on the number of casesin a database;

 

•                  feesbased on the number of claims in a case;

 

•                  fees for services, including technologyservices, claims reconciliation, document printing, noticing, balloting, votingtabulation and other professional services; and

 

•                  reimbursement for costs incurred related topostage on mailing services.

 

***Business combination******accounting****. *We have acquired a number of businesses during the last several years,and we may acquire additional businesses in the future.  Business combination accounting, oftenreferred to as purchase accounting, requires us to determine the fair value ofall assets acquired, including identifiable intangible assets, and liabilitiesassumed.  The cost of the acquisition isallocated to the assets acquired and liabilities assumed in amounts equal tothe fair value of each asset and liability, and any remaining acquisition costis classified as goodwill.  Thisallocation process requires extensive use of estimates and assumptions,including estimates of future cash flows to be generated by the acquiredassets.  Certain identifiable intangibleassets, such as 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 two to 14 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 datewhen events or changes in circumstances indicate that the carrying value ofthese assets may exceed their fair value. This assessment 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.

 

Achange in events or circumstances, including a decision to hold an asset orgroup of assets for sale, a change in strategic direction, or a change in thecompetitive environment could adversely affect the fair value of one or morereporting units.  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.  Ourgoodwill totaled $147.7 million as of June 30, 2005 and $148.5 million asof June 30, 2004.

 

***Identifiable intangible assets****.** ***Each period we evaluate whether events and circumstances warrant arevision to the remaining estimated useful life of each identifiable intangibleasset.  If events and circumstanceswarrant a change to the estimate of an identifiable intangible asset’sremaining useful life, then the remaining carrying amount of the identifiable intangibleasset would be amortized prospectively over that revised remaining usefullife.  Furthermore, information developedduring our annual assessment, or other events and circumstances, may indicatethat the carrying value of one or more identifiable intangible assets is notrecoverable and its fair value is less than the identifiable intangible asset’scarrying value and would result in recognition of an impairment charge.

 

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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 $21.0 million as of June 30,2005 and $28.1 million as of June 30, 2004.

 

**Results of Operations**

 

### **Management Overview**

### ** **

Ouroperations consist primarily of integrated technology-based products andservices for fiduciary management and claims administration applications. Oursolutions enable clients to optimize the administration of large and complexbankruptcy, class action, mass tort, and other similar legal proceedings.  We have two operating segments: casemanagement and document management.

 

Ourcase management segment generates revenue primarily through integratedtechnology-based products and services for class action, mass tort andbankruptcy proceedings that support client engagements that generally lastseveral years and has a revenue profile that typically includes a recurringcomponent.  Our document managementsegment generates revenue primarily through legal noticing services,reimbursement for costs incurred related to postage on mailing services, mediacampaign and advertising management and document custody services.  Document management revenue is generally lessrecurring due to the less predictable nature of the frequency, timing andmagnitude 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.  We believe the level ofconsumer and business debt is among the most important indicators of futurebankruptcy filings.  The most recentavailable Federal Reserve *Flow of Funds Accounts ofthe United States*, dated June 9, 2005, reported increases inboth consumer and business debt outstanding as compared with the same period ofthe prior year.

 

InFebruary 2005, new federal class action and tort reform legislation waspassed and 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 statecourts.  We believe the new federallegislation will likely result in fewer class action lawsuits in statecourts.  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.  Similar to this recent federalexperience, 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, new federal bankruptcy legislation was passed and signed byPresident Bush.  The intent of thislegislation, which is effective October 2005, is to move certainindividual bankruptcy filings from Chapter 7, which liquidates most of theassets of the debtor and discharges most of the debtor’s liabilities, toChapter 13 bankruptcy filings, which do not liquidate the debtor’s assets butwhich requires partial repayment of the debtor’s liabilities.  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, and potentially increasing certain priority claims.  We cannot predict the effect, if any, thatthis legislation will have on the number or type of bankruptcy filings.

 

Wehave acquired a number of businesses during the past several years.  In January 2003, we acquired BSI toexpand our offerings to include an integrated solution of a proprietarytechnology platform and professional services for Chapter 11 bankruptcyrestructurings. In January 2004, we acquired Poorman-Douglas and expandedour product and service offerings to include class action, mass tort, and othersimilar legal proceedings.

 

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**Results of Operations for the Six Months Ended June 30,2005 Compared with the Six Months Ended June 30, 2004**

 

### **Consolidated Results**

### ** **

### ***Revenue***

### ** **

Totalrevenue of $63.1 million for the six months ended June 30, 2005 representsan approximate 4% increase compared to $60.9 million of revenue for the sameperiod in the prior year.  A significantpart of our total revenue consists of reimbursement for certain expenses weincur, such as postage related to document management services.  We reflect the revenue from these reimbursedexpenses as a separate line item on our accompanying Condensed ConsolidatedStatements of Income.  Althoughreimbursed revenue and expenses may fluctuate significantly from quarter toquarter, these fluctuations have a minimal effect on our operating income as werealize little or no margin from this revenue. Revenue exclusive of reimbursed expenses, which we refer to as operatingrevenue, was stable at $52.2 million for the six months ended June 30,2005 compared to $52.6 million for the same period in the prior year.  All revenue is directly related to a segment,and changes in revenue by segment are discussed below.

 

### ***Costs and Expenses***

### ** **

Directand administrative costs, including depreciation and software amortization,increased $3.8 million, or approximately 9%, to $46.9 million for the sixmonths ended June 30, 2005 compared with $43.1 million for the same periodin the prior year.

 

Directand administrative costs, including depreciation and software amortization, notallocated to a segment increased $3.5 million, or 32%, to $14.4 million for thesix months ended June 30, 2005 compared with $10.9 million for the sixmonths ended June 30, 2004. Unallocated direct and administrative costs, including depreciation andsoftware amortization, increased due to a combination of factors, including anincrease in estimated expense related to annual bonuses, increased professionalfees, increased bad debt charges, an increase in operating softwareamortization expense, and the inclusion of six months of Poorman-Douglas’soperating expenses during the six months ended June 30, 2005 compared tofive months of Poorman-Douglas’s unallocated expenses included in the sixmonths ended June 30, 2004.

 

Amortizationof identifiable intangible assets decreased $0.6 million to $3.1 million forthe six months ended June 30, 2005 compared with $3.7 million for the sameperiod in the prior year.  Allidentifiable intangible assets are directly related to a segment, and changesin amortization of identifiable intangible assets by segment are discussedbelow.

 

Duringthe six months ended June 30, 2005, we did not have any acquisitionrelated expenses.  Acquisition relatedexpenses of $2.2 million for the six months ended June 30, 2004, resultedfrom non-capitalizable expenses consisting of executive bonuses, legal,accounting and valuation services, and travel incurred in connection withpotential and completed transactions.

 

***Interest***

 

Weincurred net interest expense of $2.6 million for the six months ended June 30,2005 compared with net interest expense of $3.5 million for the six monthsended June 30, 2004.  The decreasein interest expense resulted primarily from a decrease in amortized loan feeexpenses and a decrease in borrowings, partly offset by an increase in thevalue of the embedded option related to the outstanding convertible debt.

 

***Effective Tax Rate***

 

Oureffective tax rate related to income from continuing operations increased from40.8% for the six months ended June 30, 2004 to 41.7% for the six monthsended June 30, 2005.  Our tax rateis higher than the statutory federal rate of 35% primarily due to state taxes,including taxes related to our New York operations that are subject torelatively high state and local New York tax rates, which have a combined17.88% tax rate.

 

**Business Segments**

 

***Revenue***

 

Casemanagement operating revenue increased $5.3 million, or approximately 16%, to$39.6 million for the six months ended June 30, 2005 compared to $34.3million for the six months ended June 30, 2004.  This increase is primarily attributable to anincrease in class action operating revenues resulting from the timing ofseveral large cases as well as the inclusion of six months of Poorman-Douglas’soperating revenue during the six months ended June 30, 2005 compared tofive months of Poorman-Douglas’s operating revenue during the six months ended June 30,2004.

 

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Documentmanagement operating revenue declined $5.8 million, or approximately 32%, to$12.5 million for the six months ended June 30, 2005 compared to $18.3million for the six months ended June 30, 2004.  This decrease is primarily attributable to adecline in advertising services.  Thelevel, if any, of advertising services provided varies significantly dependingon the characteristics of an individual case. During the six months ended June 30, 2004, we had several largecases which required advertising services. During the six months ended June 30, 2005, our case mix did notrequire significant advertising services.

 

***Operating Expense***

 

Casemanagement direct and administrative expenses, including depreciation andsoftware amortization, of $15.8 million increased $2.2 million, orapproximately 17%, for the six months ended June 30, 2005 compared with$13.6 million for the same period in the prior year.  This increase primarily results from theinclusion of six months of Poorman-Douglas’s expenses during the six monthsended June 30, 2005 compared to the inclusion of five months ofPoorman-Douglas’s expenses for the six months ended June 30, 2004, as wellas increased reimbursed costs and operating costs, primarily temporary laborand outside services, to support the increase in case management’s class actionoperating revenues.

 

Documentmanagement direct and administrative expenses, including depreciation andsoftware amortization, of $16.7 million decreased $2.0 million, orapproximately 11%, for the six months ended June 30, 2005 compared with$18.7 million for the same period in the prior year.  This decrease primarily results fromdecreased costs related to advertising revenue, partly offset by an increase inreimbursed expenses and the inclusion of six months of Poorman-Douglas’sexpenses for the six months ended June 30, 2005 compared to the inclusionof five months of Poorman-Douglas’s expenses for the six months ended June 30,2004.  Document management directexpenses include reimbursed expenses and other operating expenses which aremore variable in nature than case management direct expenses.  Document management expenses will fluctuatefrom quarter to quarter based on document management business requirementsdelivered during each quarter.

 

Boththe case management and document management segments have identifiable intangibleassets.  Certain intangible assetsacquired in the BSI acquisition became fully amortized during 2005.  As a result, amortization of case managementidentifiable intangible assets decreased $0.3 million to $2.2 million for thesix months ended June 30, 2005 compared with $2.5 million for the sameperiod in the prior year and amortization of document management identifiableintangible assets decreased $0.4 million to $0.8 million for the six monthsended June 30, 2005 compared with $1.2 million for the same period in theprior year.

 

**Results of Operations for the Three Months Ended June 30,2005 Compared with the Three Months Ended June 30, 2004**

 

### **Consolidated Results**

### ** **

### ***Revenue***

### ** **

Totalrevenue of $31.6 million for the three months ended June 30, 2005 representsan approximate 9% decrease compared to $34.9 million of revenue for the sameperiod in the prior year.  A significantpart of our total revenue consists of reimbursement for certain expenses weincur, such as postage related to document management services.  We reflect the revenue from these reimbursedexpenses as a separate line item on our accompanying Condensed ConsolidatedStatements of Income.  Althoughreimbursed revenue and expenses may fluctuate significantly from quarter toquarter, these fluctuations have a minimal effect on our operating income as werealize little or no margin from this revenue. Revenue exclusive of reimbursed expenses, which we refer to as operatingrevenue, decreased $3.4 million, or approximately 12%, to $26.2 million for thethree months ended June 30, 2005 compared to $29.6 million for the sameperiod in the prior year.  All revenue isdirectly related to a segment, and changes in revenue by segment are discussedbelow.

 

### ***Costs and Expenses***

### ** **

Directand administrative costs, including depreciation and software amortization,decreased $2.4 million, or approximately 9%, to $23.4 million for the threemonths ended June 30, 2005 compared with $25.8 million for the same periodin the prior year.

 

Directand administrative costs, including depreciation and software amortization notallocated to a segment, increased $1.3 million, or 23%, to $7.1 million for thethree months ended June 30, 2005 compared with $5.8 million for the threemonths ended June 30, 2004. Unallocated direct and administrative costs, including depreciation andsoftware amortization, increased due to a combination of factors, including anincrease in estimated expense related to annual bonuses, increased professionalfees, and an increase in operating system software amortization expense.

 

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Amortizationof identifiable intangible assets decreased $0.6 million to $1.4 million forthe three months ended June 30, 2005 compared with $2.0 million for thesame period in the prior year.  Allidentifiable intangible assets are directly related to a segment, and changesin amortization of identifiable intangible assets by segment are discussedbelow.

 

***Interest***

 

Weincurred net interest expense of $1.8 million for the three months ended June 30,2005 compared with net interest expense of $2.0 million for the three monthsended June 30, 2004.  The decreasein interest expense resulted primarily from a decrease in amortized loan feeexpenses and a decrease in borrowings, partly offset by an increase in thevalue of the embedded option related to the outstanding convertible debt.

 

***Effective Tax Rate***

 

Oureffective tax rate related to income from continuing operations increased from41.3% for the three months ended June 30, 2004 to 41.7% for the threemonths ended June 30, 2005.  Our taxrate is higher than the statutory federal rate of 35% primarily due to statetaxes, including taxes related to our New York operations that are subject torelatively high state and local New York tax rates, which have a combined17.88% tax rate.

 

**Business Segments**

 

***Revenue***

 

Casemanagement operating revenue increased approximately $2.3 million, or 14%, to$19.7 million for the three months ended June 30, 2005 compared to $17.4million for the three months ended June 30, 2004.  This increase is primarily attributable to anincrease in class action operating revenues, partly offset by a decrease inbankruptcy database maintenance fees.

 

Documentmanagement operating revenue decreased by $5.8 million, or approximately 47%,to $6.4 million for the three months ended June 30, 2005 compared to $12.2million for the three months ended June 30, 2004.  This decrease is primarily attributable to adecline in advertising services.  Thelevel, if any, of advertising services provided varies significantly dependingon the characteristics of an individual case. During the three months ended June 30, 2004, we had several largecases which required advertising services. During the three months ended June 30, 2005, our case mix did notrequire significant advertising services.

 

***Operating Expense***

 

Casemanagement direct and administrative expenses, including depreciation andsoftware amortization, of $7.7 million increased $0.2 million, or approximately3%, for the three months ended June 30, 2005 compared with $7.5 millionfor the same period in the prior year. This increase primarily results from an increase in expense fortemporary labor.

 

Documentmanagement direct and administrative expenses, including depreciation andsoftware amortization, of $8.5 million decreased $4.0 million, or approximately32%, for the three months ended June 30, 2005 compared with $12.5 millionfor the same period in the prior year. This decrease was primarily due to decreased costs related toadvertising-related revenue.  Documentmanagement direct expenses include reimbursed expenses and other operatingexpenses which are more variable in nature than case management directexpenses.  Document management expenseswill fluctuate from quarter to quarter based on document management businessrequirements delivered during each quarter.

 

Boththe case management and document management segments have identifiableintangible assets.  Certain intangibleassets acquired in the BSI acquisition became fully amortized during 2005.  As a result, amortization of case management’sidentifiable intangible assets decreased $0.3 million to $1.1 million for thethree months ended June 30, 2005 compared with $1.4 million for the sameperiod in the prior year and amortization of document management’s identifiableintangible assets decreased $0.3 million to $0.4 million for the three monthsended June 30, 2005 compared with $0.7 million for the same period in theprior year.

 

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**Liquidity and Capital Resources**

 

***Operating Activities***

 

Duringthe six months ended June 30, 2005, the primary sources of cash fromoperating activities were from net income of $6.2 million and adjustments of$7.9 million for non-cash charges and credits, primarily depreciation andamortization.  These operating sources ofcash were largely offset by a $4.6 million use of cash related to an increasein trade accounts receivable.  Tradeaccounts receivable increased primarily as the result of the timing ofcollections.  As a result, our operatingactivities generated net cash of $10.3 million for the six months ended June 30,2005.

 

***Investing Activities***

 

Duringthe six months ended June 30, 2005, we used approximately $0.9 million ofnet cash to purchase property and equipment and $1.0 million of cash to fundinternal costs related to development of computer software for whichtechnological feasibility has been established.

 

***Financing Activities***

 

Duringthe six months ended June 30, 2005, we paid approximately $5.0 million,net, related to our revolving loan, $3.1 million related to our senior termloan and $0.6 million related to the BSI deferred acquisition price.

 

Asof June 30, 2005, our borrowings consisted of $50.6 million from the contingentconvertible subordinated notes (including the fair value of the embeddedoption), $18.8 million under our senior term loan, and approximately $4.5million of obligations related to capitalized leases and deferred acquisitionprice.

 

We believe that the fundsgenerated from operations plus amounts available under our senior revolvingloan will be sufficient over the next year to finance currently anticipatedworking capital requirements, software expenditures, property and equipmentexpenditures, payments for contractual obligations, interest payments due onour credit facility borrowings, and the required quarterly principal paymentsof $1.6 million on our senior term loan. As calculated at June 30, 2005, additional availability under thesenior revolving loan was approximately $34.1 million.

 

We may pursue an acquisitionin the future, and we may use the availability under our revolving loan andcash on hand to finance a future acquisition. If the acquisition price exceeds the capacity of these sources offinancing, 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 and our convertible debt agreement may limit our ability toconsummate an acquisition.

 

**Recent Accounting Pronouncements**

 

In May 2005, the FinancialAccounting Standards Board (FASB) issued SFAS No. 154, *Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20and FASB Statement No. 3*. SFAS 154 requires retrospective application for reporting a change inaccounting principle unless such application is impracticable or unlesstransition requirements specific to a newly adopted accounting principlerequire otherwise.  SFAS No. 154also requires the reporting of a correction of an error by restating previouslyissued financial statements.  SFAS No. 154is effective for accounting changes and corrections of errors made in fiscalyears beginning after December 15, 2005. We do not anticipate that adoption of the statement will have a materialimpact on our consolidated financial statements.

 

In December 2004, theFASB issued SFAS No. 153, *Exchanges of NonmonetaryAssets, an amendment of APB Opinion No. 29.*  SFAS No. 153 expanded the scope of APBOpinion No. 29 to require that the nonmonetary exchange of similarproductive assetsshould be measured based on the fair value of the assets exchanged.  We are required to adopt the provisions ofSFAS No.153 for our quarter ending September 30, 2005.  We do not anticipate that adoption of thisstatement will have a material impact on our consolidated financial statements.

 

InDecember 2004, the FASB issued SFAS No. 123 (revised 2004) (SFAS No. 123R),*Share-Based Payment*.  SFAS No. 123R establishes standards forthe accounting for transactions in which an entity exchanges its equityinstruments for goods and services or incurs liabilities in exchange for goodsor services that are based on the fair value of the entity’s equity instrumentsor that may be settled by the issuance of those equity instruments.  SFAS No. 123R requires a public entityto measure the cost of employee services received in exchange for an award ofequity instruments based on the grant-date fair value of the award and to recognizethat cost over the period during which an employee is required to provideservice in exchange for the award.  SFAS No. 123Ris effective for fiscal years beginning after June 15, 2005.  Accordingly, we will 

 

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adoptSFAS 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 December 31,2005.  For comparative periods ending onor before December 31, 2005, which are presented in our 2006 andsubsequent financial statements, share-based compensation costs will continueto be excluded from the financial statements, but we will disclose theseshare-based compensation costs on a pro forma basis in a note to theconsolidated 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 areunable to estimate the impact of adoption of this statement on our consolidatedfinancial statements as the impact will depend, in part, on future stock awardsand stock option awards made prior to the adoption date, whether any suchawards are qualified or non-qualified, the vesting period of those awards, andforfeitures related to both existing awards and new awards.  Subsequent to December 31, 2004, 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 wemust adopt in the future.  This action,which had an immaterial affect on our financial statements for the three monthand six month periods ended June 30, 2005, will reduce the impact ofadoption of SFAS No. 123R on our future consolidated financial statements.If, subsequent to June 30, 2005, no new awards were issued and no existingawards were forfeited, we estimate that adoption of SFAS No. 123R woulddecrease our net income for the year ending December 31, 2006 byapproximately $1.0 million.  We do notanticipate that adoption of SFAS No. 123R will have a material impact onour consolidated statement of cash flows.

 

**Forward-Looking Statements**

 

Inthis report, in other filings with the SEC and in press releases and otherpublic statements by our officers throughout the year, EPIQ Systems, Inc.makes or will make statements that plan for or anticipate the future.  These forward-looking statements includestatements about our future business plans and strategies, and other statementsthat are not historical in nature.  Theseforward-looking statements are based on our current expectations.  In this Quarterly Report on Form 10-Q,we make statements that plan for or anticipate the future.  Many of these statements are found in the **“Management’s Discussion and Analysis of Financial Condition andResults of Operations”** section of this report.

 

Forward-lookingstatements may be identified by words or phrases such as “believe,” “expect,” “anticipate,”“should,” “planned,” “may,” “estimated,” “goal,” “objective” and “potential.”  Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended, provide a “safe harbor” for forward-looking statements.  Because forward-looking statements involvefuture risks and uncertainties, listed below are a variety of factors thatcould cause actual results and experience to differ materially from theanticipated results or other expectations expressed in our forward-lookingstatements.  These factors include (1) anymaterial changes in our total number of client engagements and the volumeassociated with each engagement, (2) any material changes in our Chapter 7deposit portfolio, the services required or selected by our Chapter 11, Chapter13, class action or mass tort engagements, or the number of cases processed byour Chapter 13 bankruptcy trustee clients, (3) material changes in thenumber of bankruptcy filings, class action filings or mass tort actions eachyear, (4) our reliance on and future changes in our marketing arrangementand pricing arrangements with Bank of America for Chapter 7 revenue, (5) themarketing and pricing arrangements with other Chapter 7 depository banks,  (6) the impact of recently enacted tortreform and bankruptcy reform legislation on the volume and timing ofdisposition of client engagements, (7) risks associated with theintegration of acquisitions into our existing business operations, (8) risksassociated with our indebtedness, and (9) other risks detailed from timeto time in our SEC filings, including our annual report on Form 10-K forthe year ended December 31, 2004. In addition, there may be other factors not included in our SEC filingsthat may cause actual results to differ materially from any forward-lookingstatements.  We undertake no obligationsto update any forward-looking statements contained herein to reflect futureevents or developments.

 

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**ITEM 3****.  Quantitative and Qualitative Disclosures About Market Risk.**

 

Market risk refers to the risk that a change in 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 exposure to market risk has not changedsignificantly since December 31, 2004.

 

**ITEM 4.****  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) ofthe Securities Exchange Act of 1934. Based on their evaluation as of the end of the period covered by thisquarterly report, our principal executive officer and principal financialofficer concluded that our disclosure controls and procedures were sufficientlyeffective at a reasonable assurance level to ensure that the informationrequired to be disclosed in this quarterly report was recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms for Form 10-Q, and was accumulated and communicated to management,including our principal executive officer and principal financial officer, asappropriate to allow timely decisions regarding required disclosure.

 

Therehave been no changes in our internal controls over financial reporting duringthe quarter ended June 30, 2005, that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting, other than as follows:

 

•                  We implemented anew general ledger system for certain of our legal entities;

•                  We changed thesoftware we are using for our consolidation process; and

•                  We have appointed acorporate controller.

 

Managementbelieves that the conversion to the new general ledger system was adequatelytested and that we have established controls over financial reporting relatedto the new general ledger system and consolidation process sufficient toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. We believe the appointment of a corporate controller will enhance ourcontrols over financial reporting by providing additional review and oversight.

 

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**PART II- OTHER INFORMATION**

 

### **ITEM 4**: Submission of Matters to a Vote of SecurityHolders

### ** **

Ourannual meeting of the shareholders was held on June 8, 2005, at which theshareholders elected the directors named below. The results of the voting at the annual meeting were as follows:

 
| **Election of Directors**    | ** ** | **For**    | ** ** | **Withhold  Authority** | ** ** |
|------------------------------|------------|------------|------------|-------------------------|------------|
|                         |       |       |       |                    |       |
| Tom W. Olofson               |       | 16,338,445 |       | 168,454                 |       |
| Christopher E. Olofson       |       | 16,391,568 |       | 115,331                 |       |
| W. Bryan Satterlee           |       | 16,002,161 |       | 504,738                 |       |
| Edward M. Connolly, Jr. |       | 16,000,586 |       | 506,313                 |       |
| James A. Byrnes              |       | 16,001,001 |       | 505,898                 |       |
| Joel Pelofsky                |       | 16,056,283 |       | 450,616                 |       |

 

Noother matters were submitted to a vote of the shareholders at the annualmeeting.

 

**ITEM 6**.  **Exhibits.**

 

31.1                           Certifications of Chief Executive Officer of the Company under Rule 13a-14(a),as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2                           Certifications of Chief Financial Officer of the Company under Rule 13a-14(a),as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1                           Certifications of CEO and CFO pursuant to 18 U.S.C. Section 1350.

 

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##### **SIGNATURES**

 

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

 
|   |                | **EPIQ  Systems, Inc.**                       |
|--------|---------------------|----------------------------------------------------|
|   |                |                                               |
| Date:  | July 29,  2005 | /s/  Tom W. Olofson                                |   |
|   |                | Tom W. Olofson                                     |
|   |                | Chairman  of the Board                             |
|   |                | Chief  Executive Officer                           |
|   |                | Director                                           |
|   |                | (Principal  Executive Officer)                     |
|   |                |                                               |
|   |                |                                               |
| Date:  | July 29,  2005 | /s/  Elizabeth M. Braham                           |   |
|   |                | Elizabeth  M. Braham                               |
|   |                | Executive  Vice President, Chief Financial Officer |
|   |                | (Principal  Financial Officer)                     |
|   |                |                                               |
|   |                |                                               |
| Date:  | July 29,  2005 | /s/  Douglas W. Fleming                            |   |
|   |                | Douglas  W. Fleming                                |
|   |                | Director  of Finance                               |
|   |                | (Principal  Accounting Officer)                    |
|        |                     |                                                    |  |  |

 

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