**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D. C. 20549**

**FORM 10-Q**

**QuarterlyReport Under Section 13 or 15(d)of the Securities Exchange Act of 1934**

**x**** For the Quarterly Period Ended September 30, 2006**

**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 ofregistrant as specified in its charter)

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

 

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

(Address ofprincipal executive office)

**913-621-9500**

(Registrant’s telephonenumber)

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

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the ExchangeAct.

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theAct).    Yes  o    No  x

The number of sharesoutstanding of registrant’s common stock at November 1, 2006:

| **Class**                     |   | **Outstanding** |
|-------------------------------|--------|-----------------|
| Common Stock,  $.01 par value |   | 19,475,194      |

 

 

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**EPIQ SYSTEMS, INC.FORM 10-QQUARTER ENDED SEPTEMBER 30, 2006**

**CONTENTS**
|                                     | ** **                                                                                                                          | Page   |
|-------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------|--------|
| **PART I - FINANCIAL  INFORMATION** |                                                                                                                                |
| ** **                          | ** **                                                                                                                          |   |
| Item 1.                             | Condensed  Consolidated Financial Statements                                                                                        |   |
|                                |                                                                                                                                |   |
|                                | Condensed  Consolidated Statements of Income —  Three and nine months ended September 30, 2006 and 2005 (restated) (Unaudited) | 3      |
|                                |                                                                                                                                |   |
|                                | Condensed  Consolidated Balance Sheets—  September 30, 2006 and December 31, 2005 (restated) (Unaudited)                       | 4      |
|                                |                                                                                                                                |   |
|                                | Condensed  Consolidated Statements of Cash Flows—  Nine months ended September 30, 2006 and 2005 (restated) (Unaudited)        | 5      |
|                                |                                                                                                                                |   |
|                                | Notes to  Condensed Consolidated Financial Statements (Unaudited)                                                                   | 7      |
|                                |                                                                                                                                |   |
| Item 2.                             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                         | 30     |
|                                |                                                                                                                                |   |
| Item 3.                             | Quantitative  and Qualitative Disclosures about Market Risk                                                                         | 45     |
|                                |                                                                                                                                |   |
| Item 4.                             | Controls and  Procedures                                                                                                            | 45     |
|                                |                                                                                                                                |   |
| **PART II - OTHER  INFORMATION**    |                                                                                                                                |
| ** **                          | ** **                                                                                                                          |   |
| Item  1A.                           | Risk  Factors                                                                                                                       | 46     |
|                                |                                                                                                                                |   |
| Item 3.                             | Defaults Upon  Senior Securities                                                                                                    | 46     |
|                                |                                                                                                                                |   |
| Item  6.                            | Exhibits                                                                                                                            | 46     |
|                                |                                                                                                                                |   |
| Signatures                          | 47                                                                                                                                  |

 

 

 

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**Explanatory Note**

Within this filing, EpiqSystems, Inc. (the Company) is restating its previously issued financialstatements for the three and nine months ended September 30, 2005 whichinitially were filed with the Securities and Exchange Commission (SEC) onOctober 28, 2005, as well as the consolidated balance sheet as of December 31,2005 which was initially filed with the SEC on March 8, 2006, as discussed inNote 10 to the condensed consolidated financial statements.

In addition, the Companywill restate, as soon as practicable, the following previously issued financialstatements included in its SEC prior periodic reports:

·                  Its previouslyissued financial statements as of December 31, 2005 and 2004, and for each ofthe three years included in the Company’s Annual Report on Form 10-K for thefiscal year ended December 31, 2005, initially filed with the SEC on March 8,2006;

·                  its previouslyissued financial statements included in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006,initially filed with the SEC on May 9, 2006; and

·                  its previouslyissued financial statements included in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006,initially filed with the SEC on August 8, 2006.

 

2

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**PART I — FINANCIALINFORMATION**

**ITEM 1.**                    CondensedConsolidated Financial Statements.

**EPIQ SYSTEMS, INC.CONDENSED CONSOLIDATED STATEMENTS OF INCOME(In Thousands, Except Per Share Data)(Unaudited)**
| ** **                                                                                              | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                              | ** ** | ** **                                           | ** ** | **(As Restated,  see Note 10)**      | ** ** | ** ** | ** ** | **(As Restated,  see Note 10)** | ** ** |
| **REVENUE:**                                                                                            | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Case management  services                                                                               |       | $                                                    | 22,353     |                                                | $          | 12,197 |   | $ | 65,653 |   | $ | 38,132 |   |
| Case management  bundled software license, software upgrade and postcontract customer support  services |       | 7,445                                                |       | 550                                                 |       | 68,922 |   | 1,146 |   |
| Document  management services                                                                           |       | 4,591                                                |       | 7,373                                               |       | 26,495 |   | 19,895 |   |
| Operating  revenue before reimbursed direct costs                                                       |       | 34,389                                               |       | 20,120                                              |       | 161,070 |   | 59,173 |   |
| Operating  revenue from reimbursed direct costs                                                         |       | 4,643                                                |       | 6,174                                               |       | 16,676 |   | 17,118 |   |
| Total Revenue                                                                                           |       | 39,032                                               |       | 26,294                                              |       | 177,746 |   | 76,291 |   |
|                                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| **COSTS AND EXPENSES:**                                                                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Direct costs of  services (exclusive of depreciation and amortization shown separately below)           |       | 9,260                                                |       | 8,576                                               |       | 36,403 |   | 24,778 |   |
| Reimbursed  direct costs                                                                                |       | 4,685                                                |       | 6,199                                               |       | 16,852 |   | 17,296 |   |
| General and  administrative                                                                             |       | 12,411                                               |       | 7,035                                               |       | 36,469 |   | 23,071 |   |
| Depreciation and  software and leasehold amortization                                                   |       | 2,633                                                |       | 1,732                                               |       | 7,424 |   | 5,281 |   |
| Amortization of  identifiable intangible assets                                                         |       | 3,027                                                |       | 1,442                                               |       | 8,672 |   | 4,492 |   |
| Acquisition  related                                                                                    |       | —                                               |       | 114                                                 |       | 250 |   | 114 |   |
| Total Operating  Expenses                                                                               |       | 32,016                                               |       | 25,098                                              |       | 106,070 |   | 75,032 |   |
|                                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| **INCOME FROM OPERATIONS**                                                                              |       | 7,016                                                |       | 1,196                                               |       | 71,676 |   | 1,259 |   |
|                                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| **INTEREST EXPENSE (INCOME):**                                                                          |       |                                                 |       |                                                |       |   |   |   |   |
| Interest income                                                                                         |       | (23                                                  | )          | (28                                                 | )          | (111 | ) | (106 | ) |
| Interest expense                                                                                        |       | 2,523                                                |       | 1,623                                               |       | 9,215 |   | 4,309 |   |
| Net Interest  Expense                                                                                   |       | 2,500                                                |       | 1,595                                               |       | 9,104 |   | 4,203 |   |
|                                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| **INCOME (LOSS) FROM OPERATIONS  BEFORE INCOME TAXES**                                                  |       | 4,516                                                |       | (399                                                | )          | 62,572 |   | (2,944 | ) |
|                                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| **INCOME TAX PROVISION (BENEFIT)**                                                                      |       | 1,835                                                |       | (894                                                | )          | 25,348 |   | (3,147 | ) |
|                                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| **NET INCOME**                                                                                          |       | $                                                    | 2,681      |                                                | $          | 495 |   | $ | 37,224 |   | $ | 203 |   |
| ** **                                                                                              |       |                                                 |       |                                                |       |   |   |   |   |
| **NET INCOME PER SHARE INFORMATION:**                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                                                                   |       | $                                                    | 0.14       |                                                | $          | 0.03 |   | $ | 1.92 |   | $ | 0.01 |   |
| Diluted                                                                                                 |       | $                                                    | 0.13       |                                                | $          | 0.03 |   | $ | 1.65 |   | $ | 0.01 |   |
| ** **                                                                                              |       |                                                 |       |                                                |       |   |   |   |   |
| **WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:**                                                         |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                                                                   |       | 19,442                                               |       | 17,942                                              |       | 19,372 |   | 17,911 |   |
| Diluted                                                                                                 |       | 22,911                                               |       | 18,861                                              |       | 23,065 |   | 18,402 |   |

 

**See accompanying notes tocondensed consolidated financial statements.**

 

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**EPIQ SYSTEMS, INC.CONDENSED CONSOLIDATED BALANCE SHEETS(In Thousands, Except Share Data)(Unaudited)**
| ** **                                                                                                                                                                                         | ** ** | **September 30, 2006** | ** ** | **December 31, 2005**                | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                                                                                                                         | ** ** | ** **                       | ** ** | **(As Restated,  see Note 10)** | ** ** |
| **ASSETS**                                                                                                                                                                                         |       |                             |       |                                           |       |
| **CURRENT ASSETS:**                                                                                                                                                                                |       |                             |       |                                           |       |
| Cash and cash equivalents                                                                                                                                                                          |       | $                                | 4,026      |                                           | $          | 13,563 |   |
| Trade accounts receivable,  less allowance for doubtful accounts of $1,739 and $3,481, respectively                                                                                                |       | 32,634                           |       | 33,504                                         |       |
| Prepaid expenses                                                                                                                                                                                   |       | 2,249                            |       | 2,818                                          |       |
| Income taxes refundable                                                                                                                                                                            |       | 705                              |       | 4,643                                          |       |
| Deferred income taxes                                                                                                                                                                              |       | 1,725                            |       | 25,579                                         |       |
| Other current assets                                                                                                                                                                               |       | 578                              |       | 85                                             |       |
| Total Current Assets                                                                                                                                                                               |       | 41,917                           |       | 80,192                                         |       |
|                                                                                                                                                                                               |       |                             |       |                                           |       |
| **LONG-TERM ASSETS:**                                                                                                                                                                              |       |                             |       |                                           |       |
| Property, equipment and  leasehold improvements, net                                                                                                                                               |       | 23,186                           |       | 23,751                                         |       |
| Software development costs,  net                                                                                                                                                                   |       | 9,343                            |       | 8,848                                          |       |
| Goodwill                                                                                                                                                                                           |       | 260,834                          |       | 249,427                                        |       |
| Identifiable intangible  assets, net of accumulated amortization of $22,430 and $13,758, respectively                                                                                              |       | 46,797                           |       | 53,399                                         |       |
| Other                                                                                                                                                                                              |       | 1,962                            |       | 2,854                                          |       |
| Total Long-term Assets, net                                                                                                                                                                        |       | 342,122                          |       | 338,279                                        |       |
| **Total Assets**                                                                                                                                                                                   |       | $                                | 384,039    |                                           | $          | 418,471 |   |
|                                                                                                                                                                                               |       |                             |       |                                           |       |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                                                     |       |                             |       |                                           |       |
| **CURRENT LIABILITIES:**                                                                                                                                                                           |       |                             |       |                                           |       |
| Accounts payable                                                                                                                                                                                   |       | $                                | 5,053      |                                           | $          | 7,954 |   |
| Customer deposits                                                                                                                                                                                  |       | 2,322                            |       | 2,196                                          |       |
| Accrued compensation                                                                                                                                                                               |       | 1,907                            |       | 3,944                                          |       |
| Other accrued expenses                                                                                                                                                                             |       | 3,760                            |       | 3,322                                          |       |
| Deferred revenue                                                                                                                                                                                   |       | 826                              |       | 60,224                                         |       |
| Current maturities of  long-term obligations                                                                                                                                                       |       | 154,028                          |       | 171,996                                        |       |
| Total Current Liabilities                                                                                                                                                                          |       | 167,896                          |       | 249,636                                        |       |
|                                                                                                                                                                                               |       |                             |       |                                           |       |
| **LONG-TERM LIABILITIES:**                                                                                                                                                                         |       |                             |       |                                           |       |
| Long-term obligations  (excluding current maturities)                                                                                                                                              |       | 6,178                            |       | 1,552                                          |       |
| Deferred income taxes                                                                                                                                                                              |       | 26,077                           |       | 26,815                                         |       |
| Other long-term liabilities                                                                                                                                                                        |       | 1,454                            |       | —                                         |       |
| Total Long-term Liabilities                                                                                                                                                                        |       | 33,709                           |       | 28,367                                         |       |
|                                                                                                                                                                                               |       |                             |       |                                           |       |
| **COMMITMENTS AND CONTINGENCIES**                                                                                                                                                                  |       |                             |       |                                           |       |
| ** **                                                                                                                                                                                         |       |                             |       |                                           |       |
| **STOCKHOLDERS’ EQUITY:**                                                                                                                                                                     |       |                             |       |                                           |       |
| Common stock — $0.01 par  value; 50,000,000 shares authorized; issued and outstanding — 19,475,194 and 19,253,466 shares at September 30, 2006 and December 31,  2005, respectively |       | 194                              |       | 193                                            |       |
| Additional paid-in capital                                                                                                                                                                         |       | 133,224                          |       | 128,484                                        |       |
| Retained earnings                                                                                                                                                                                  |       | 49,015                           |       | 11,791                                         |       |
| Accumulated other  comprehensive income, net                                                                                                                                                       |       | 1                                |       | —                                         |       |
| Total Stockholders’ Equity                                                                                                                                                                    |       | 182,434                          |       | 140,468                                        |       |
| **Total  Liabilities and Stockholders’ Equity**                                                                                                                                               |       | $                                | 384,039    |                                           | $          | 418,471 |   |

 

**Seeaccompanying notes to condensed consolidated financial statements.**

 

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**EPIQ SYSTEMS, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(In Thousands)(Unaudited)**
| ** **                                                                                               | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                                                                                               | ** ** | ** **                                              | ** ** | **(As Restated,  see Note 10)** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                                               |       |                                                    |       |   |   |
| Net income                                                                                               |       | $                                                       | 37,224     |   | $ | 203 |   |
| Adjustments to reconcile net income to net cash from  operating activities:                              |       |                                                    |       |   |   |
| Share-based compensation expense                                                                         |       | 1,671                                                   |       | — |   |
| Provision (benefit) for deferred income taxes                                                            |       | 22,761                                                  |       | (7,428 | ) |
| Depreciation and software and leasehold amortization                                                     |       | 7,424                                                   |       | 5,281 |   |
| Loan fee amortization                                                                                    |       | 1,077                                                   |       | 833 |   |
| Amortization of identifiable intangible assets                                                           |       | 8,672                                                   |       | 4,492 |   |
| Other                                                                                                    |       | (839                                                    | )          | 1,735 |   |
| Changes in  operating assets and liabilities, net of effects from business acquisition:                  |       |                                                    |       |   |   |
| Trade accounts receivable                                                                                |       | 2,632                                                   |       | (8,632 | ) |
| Prepaid expenses and other assets                                                                        |       | 28                                                      |       | (1,374 | ) |
| Accounts payable and other liabilities                                                                   |       | (1,878                                                  | )          | 968 |   |
| Deferred revenue                                                                                         |       | (59,398                                                 | )          | 19,724 |   |
| Excess tax benefit related to share-based  compensation                                                  |       | (154                                                    | )          | — |   |
| Income taxes (including $469 and $415 of tax benefit  related to share-based compensation, respectively) |       | 4,355                                                   |       | (2,065 | ) |
| Net cash provided by operating activities                                                                |       | 23,575                                                  |       | 13,737 |   |
|                                                                                                     |       |                                                    |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Purchase of property and equipment                                                                       |       | (5,182                                                  | )          | (3,035 | ) |
| Software development costs                                                                               |       | (3,275                                                  | )          | (1,480 | ) |
| Cash paid for acquisition of business                                                                    |       | (3,586                                                  | )          | (650 | ) |
| Purchase of short-term investments                                                                       |       | —                                                  |       | (6,000 | ) |
| Sale of short-term investments                                                                           |       | —                                                  |       | 6,000 |   |
| Other                                                                                                    |       | (45                                                     | )          | 502 |   |
| Net cash used in investing activities                                                                    |       | (12,088                                                 | )          | (4,663 | ) |
|                                                                                                     |       |                                                    |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Proceeds from long-term debt borrowings                                                                  |       | 3,000                                                   |       | 6,000 |   |
| Principal payments under long-term debt obligations                                                      |       | (26,643                                                 | )          | (16,104 | ) |
| Excess tax benefit related to share-based compensation                                                   |       | 154                                                     |       | — |   |
| Proceeds from exercise of share options                                                                  |       | 2,602                                                   |       | 903 |   |
| Other                                                                                                    |       | (137                                                    | )          | — |   |
| Net cash used in financing activities                                                                    |       | (21,024                                                 | )          | (9,201 | ) |
|                                                                                                     |       |                                                    |       |   |   |
| **NET  DECREASE IN CASH AND CASH EQUIVALENTS**                                                           |       | (9,537                                                  | )          | (127 | ) |
| **CASH  AND CASH EQUIVALENTS, BEGINNING OF YEAR**                                                        |       | 13,563                                                  |       | 13,330 |   |
| **CASH  AND CASH EQUIVALENTS, END OF PERIOD**                                                            |       | $                                                       | 4,026      |   | $ | 13,203 |   |
| ** **                                                                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| **SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:**                                                  | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Interest paid                                                                                            |       | $                                                       | 7,730      |   | $ | 2,649 |   |
| Income taxes  (received) paid, net                                                                       |       | $                                                       | (1,758     | ) | $ | 6,339 |   |

 

5

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**SUPPLEMENTALDISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:**

We had propertyand equipment purchases accrued in accounts payable of approximately $0.4million as of September 30, 2006.

During the ninemonths ended September 30, 2006, we incurred an obligation in a businessacquisition, classified as a component of both current maturities of long-termobligations and long-term obligations, of approximately $10.2 million.

**Seeaccompanying notes to condensed consolidated financial statements.**

 

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**EPIQSYSTEMS, INC.****NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS****(Unaudited)**

**NOTE 1:   NATUREOF OPERATIONS AND SUMMARY OF RECENTLY ADOPTED ACCOUNTING POLICIES**

***Principles of Consolidation***

The condensed consolidated financial statementsinclude the accounts of Epiq Systems, Inc. (Epiq) and its wholly-ownedsubsidiaries.  All significantintercompany transactions and balances have been eliminated in consolidation.

***Nature of Operations***

Epiq is a national provider of technology-basedsolutions for the legal and fiduciary services industries. Our solutions assistclients with the administration of complex legal proceedings, includingelectronic discovery, bankruptcy administration and class actionadministration. Our clients include leading law firms, corporate legaldepartments, bankruptcy trustees, and other professional advisors who requiresophisticated case administration and document management capabilities,extensive subject matter expertise and a high service capacity. We provideclients with an integrated offering of both proprietary technology andvalue-added services that comprehensively address their case and documentmanagement business requirements.

***Comprehensive Income***

Statement ofFinancial Accounting Standards No. 130, *Reporting ComprehensiveIncome*, establishes requirements for reporting and display ofcomprehensive income and its components. Our total comprehensive income, which includes net income and foreigncurrency translation adjustments, was as follows (in thousands):
| ** **                                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                          |       |                                                 |       |                                                |       |   |   |   |   |
| Net income                                    |       | $                                                    | 2,681      |                                                | $          | 495 |   | $ | 37,224 |   | $ | 203 |   |
| Foreign currency  translation adjustment, net |       | 2                                                    |       | —                                              |       | 1 |   | — |   |
| Total comprehensive  income                   |       | $                                                    | 2,683      |                                                | $          | 495 |   | $ | 37,225 |   | $ | 203 |   |

 

***Revenue Recognition***

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

Significant sources of revenue include:

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

·                  Hosting feesbased on the amount of data stored;

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

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

·                  Reimbursementfor costs incurred related to postage on mailing services.

7

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*Non-SoftwareArrangements*

Case and document management services related toelectronic discovery, corporate restructuring, and class action revenue, whichare billed based on volume, are evaluated pursuant to Emerging Issues TaskForce (EITF) 00-21, *Revenue Arrangements withMultiple Deliverables*.  Foreach of these contractual arrangements, we have identified the followingdeliverables and/or services:

·                  ElectronicDiscovery

·               Data processing

·               Hosting

·                  CorporateRestructuring

·               Consulting

·               Claims management

·               Printing andreproduction

·               Mailing andnoticing

·               Document management

·                  ClassAction

·               Consulting

·               Notice campaigns

·               Toll free customersupport

·               Web sitedesign/hosting

·               Claimsadministration

·               Distribution

Based on our evaluation of each element, we havedetermined that each element delivered has standalone value to our customersbecause we or other vendors sell such services separately from any otherservices/deliverables.  We have alsoobtained objective and reliable evidence of the fair value of each elementbased either on the price we charge when we sell an element on a standalonebasis or based on third-party evidence of fair value of such services.  Lastly, our arrangements do not includegeneral rights of return.  Accordingly,each of the service elements in our multiple element case and documentmanagement arrangements qualifies as a separate unit of accounting under EITF00-21.  We allocate revenue to thevarious units of accounting in our arrangements based on the fair value of eachunit of accounting, which is generally consistent with the stated prices in ourarrangements. As we have evidence of an arrangement, revenue for each separateunit of accounting is recognized each period in accordance with StaffAccounting Bulletin Topic 13, *Revenue Recognition*(SAB Topic 13).  As the services arerendered, our fee becomes fixed and determinable, and collectibility isreasonably assured.  Payments received inadvance of satisfaction of the related revenue recognition criteria arerecognized as a customer deposit until all revenue recognition criteria havebeen satisfied.

*SoftwareArrangements*

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

For Chapter 7 related arrangements with financialinstitutions, we earn contingent monthly fees from the financial institutionrelated to the software license, hardware lease, hardware maintenance, and PCSservices.  We account for the softwarelicense and PCS elements in accordance with Statement of Position 97-2, *Software Revenue Recognition* (SOP 97-2).  Since we have not established vendor specificobjective evidence (VSOE) of the fair value of the software license, we do notrecognize any revenue on delivery of the software.  The software element is deferred and includedwith the remaining undelivered element, which is PCS.  This revenue, when recognized, is included asa component of case management services revenue.  Revenue related to PCS is entirely contingenton the placement of liquidated estate deposits by the trustee with thefinancial institution.  Accordingly, werecognize this contingent usage based revenue consistent with the guidanceprovided by the American Institute of Certified Public Accountants’ TechnicalPractice Aid (TPA) 5100.76, *Fair Value inMultiple-Element Arrangements That Include Contingent Usage-Based Fees andSoftware Revenue Recognition* as the fee becomes fixed ordeterminable at the time actual usage occurs and collectibility isprobable.  This occurs monthly as aresult of the computation, billing and collection of monthly deposit feescontractually agreed to.  At that time,we have also satisfied the other revenue recognition criteria contained in SOP97-2, since we have persuasive evidence that an arrangement exists, serviceshave been rendered, the price is fixed and determinable, and collectibility isreasonably assured.

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We also provide our trustee clients with certainhardware, such as desktop computers, monitors, and printers, and hardwaremaintenance.  We retain ownership of allhardware provided and, based on guidance provided in EITF 01-8, *Determining Whether an Arrangement Contains a Lease*, weaccount for this hardware as a lease.  Asthe hardware maintenance arrangement is an executory contract similar to anoperating lease, we use guidance related to contingent rentals in operatinglease arrangements for hardware maintenance as well as for the hardwarelease.  Since the payments under all ofour arrangements are contingent upon the level of trustee deposits and thedelivery of upgrades and other services, there remain important uncertaintiesregarding the amount of unreimbursable costs yet to be incurred by us, weaccount for the hardware lease as an operating lease in accordance with SFAS13, *Accounting for Leases*.  Therefore, all lease payments, based on theestimated fair value of hardware provided, were accounted for as contingentrentals under EITF Issue No. 98-9, *Accounting for ContingentRent* and SAB Topic 13, which requires that we recognize rentalincome when the changes in the factor on which the contingent lease payment isbased actually occur.  This occurs at theend of each period as we achieved our target when deposits are held at thedepository financial institution as, at that time, evidence of an arrangementexists, delivery has occurred, the amount has become fixed and determinable,and collection is reasonably assured. This revenue, which is less than ten percent of our total revenue, isincluded as a component of case management services revenue.

Effective October 1, 2003, we entered into anarrangement with our primary depository financial institution under which wedelivered two specified upgrades annually with the last specified upgradeoccurring in the second quarter of 2006. This arrangement included specific pricing for each software upgrade andcertain special projects in addition to the contingent deposit-based pricingrelated to the software license, hardware, hardware maintenance, and PCS toeach trustee client.  Therefore, the software upgrades and specialprojects are part of a bundled arrangement.  Each software upgrade is considered a separateand discrete product and, as we do not sell each software upgrade on astandalone basis, we were unable to establish VSOE of the fair value of thesoftware upgrades.  As a result, thelicensed software, software upgrade, special projects and PCS are a combinedunit of accounting.  Revenue for thiscombined unit of accounting, when recognized, is included as a component ofcase management services revenue.  Sincewe did not have VSOE of the fair value of each separate upgrade, we deferredrecognition of substantially all revenue under this arrangement until the finalupgrade was delivered.  On delivery ofthe final upgrade during the second quarter of 2006, the only remainingundelivered element was PCS services.  Inaccordance with SOP 97-2, on delivery of the final software upgrade, werecognized revenue previously deferred on a proportionate basis over the threeyear term of the contract.  As thecontract commenced October 1, 2003 and terminated September 30, 2006, werecognized approximately $60.1 million of net deferred revenue during thesecond quarter of 2006 and we recognized approximately $6.0 million of deferredrevenue related to this arrangement during the third quarter of 2006.

*Reimbursements*

Our case and document management businesses both haverevenue related to the reimbursement of certain costs, primarily postage.  Consistent with guidance provided by EITF No.01-14, *Income Statement Characterization of ReimbursementsReceived for “Out-of-Pocket” Expenses Incurred*, reimbursed postageand other reimbursable direct costs are recorded gross as revenue fromreimbursed direct costs and as reimbursed direct costs.

***Share-based Compensation***

On January 1, 2006, we adopted Statement of FinancialAccounting Standards No. 123 (revised 2004) (SFAS No. 123R), *Share-Based Payment*. SFAS No. 123R established standards for the accounting for transactionsin which an entity exchanges its equity instruments for goods and services orincurs liabilities in exchange for goods or services that are based on the fairvalue of the entity’s equity instruments or that may be settled by the issuanceof those equity instruments.  SFAS No.123R requires a public entity to measure the cost of employee services receivedin exchange for an award of equity instruments based on the grant-date fairvalue of the award and to recognize that cost over the period during which anemployee is required to provide service in exchange for the award.

We elected to adopt SFAS No. 123R using the modifiedversion of prospective application. Under the modified version of prospective application, we haverecognized compensation costs related to share-based compensation beginningwith the quarter ended March 31, 2006. We recognize this expense on a straight-line basis over the requisiteservice period of the last separately vesting portion of the award.  Prior to 2006, we accounted for stock-basedcompensation awards under the intrinsic method of Accounting Principles BoardOpinion No. 25, *Accounting for Stock Issued to Employees,*whichrequired compensation cost to be recognized based on the excess, if any,between the quoted market price at the date of grant and the amount an employeemust pay to acquire stock.  Compensationcosts related to share-based compensation for periods ended on or beforeDecember 31, 2005 are reflected on a pro forma basis in Note 6 of thesecondensed consolidated financial statements.

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***Recent Accounting Pronouncements***

In September 2006, the Financial Accounting StandardsBoard (FASB) issued Statement of Financial Accounting Standards No. 157, *Fair Value Measurements* (SFAS 157).  SFAS 157 defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements.  SFAS 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those fiscal years. We do not anticipate that adoption of this statement will have amaterial impact on our consolidated financial statements.

In June 2006, the FASB issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes* (FIN 48).  FIN 48 applies to tax positions accounted forunder Statement of Financial Accounting Standard No. 109, *Accountingfor Income Taxes*.  A taxposition includes a current or future reduction in taxable income reported orexpected to be reported on a tax return, the decision not to report atransaction in a tax return, and an assertion that a company is not subject totaxation.  FIN 48 requires that a taxposition be recognized only if it is more-likely-than-not to be sustained basedsolely on its technical merits as of the reporting date.  A recognized tax benefit is measured based onthe largest benefit that is more than 50 percent likely to be realized.  FIN 48 is effective for an entity’s firstfiscal year that begins after December 15, 2006.  At adoption, any necessary adjustment to ourfinancial statements will be recorded directly to the beginning balance ofretained earnings in the period of adoption and reported as a change inaccounting principle.  At this time, weare unable to predict the impact, if any, that adoption of FIN 48 will have onour consolidated financial statements.

In June 2006, the EITF reached a consensus regardingEITF 05-1, *Accounting for the Conversion of an Instrument ThatBecomes Convertible Upon the Issuer’s Exercise of a Call Option*.  EITF 05-1 pertains only to debt instrumentsthat become convertible at the time the issuer calls the debt, but are notconvertible before the call is exercised. Conversions of these instruments triggered by the call option would beaccounted for as debt conversions and recognized as debt extinguishments if thedebt instrument did not contain a substantive conversion feature atissuance.  EITF 05-1 will be effectivefor conversions that occur as a result of the issuer’s exercise of a calloption in the interim or annual period beginning after September 28, 2006. Wedo not anticipate that adoption of this statement will have a material impacton our consolidated financial statements.

In February 2006, the FASB issued Statement ofFinancial Accounting Standard No. 155, *Accounting for CertainHybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140*(SFAS 155).  SFAS 155 allows an entity tomake an irrevocable election to measure a financial instrument with an embeddedderivative, referred to as a hybrid financial instrument, at fair value in itsentirety rather than bifurcating and separately valuing the embedded derivativeinstrument.  SFAS 155 is effective forall financial instruments acquired, issued, or subject to a remeasurement (newbasis) event occurring after the beginning of an entity’s first fiscal yearthat begins after September 15, 2006.  Wedo not anticipate that adoption of this statement will have a material impacton our consolidated financial statements.

**NOTE 2:   INTERIM FINANCIAL STATEMENTS**

The accompanying condensed consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States of America (GAAP) and with the rulesand regulations for reporting on Form 10-Q for interim financialstatements.  Accordingly, they do notinclude certain information and disclosures required for comprehensive annualfinancial statements.  The interimfinancial statements have not been audited. As noted in the Explanatory Note at the beginning of this report, wehave previously determined that the audited financial statements included inour Annual Report on Form 10-K as filed with the SEC on March 8, 2006, shouldno longer be relied upon.  We anticipatefiling an amended Form 10-K for the year ended December 31, 2005 as soon aspracticable.

In the opinion of our management, the accompanyingcondensed consolidated financial statements reflect all adjustments necessary(consisting solely of normal recurring adjustments) to present fairly ourfinancial position as of September 30, 2006, the results of operations for thethree and nine month periods ended September 30, 2006 and 2005, and cash flowsfor the nine month periods ended September 30, 2006 and 2005.

The results of operations for the three and nine monthperiods ended September 30, 2006 are not necessarily indicative of the resultsto be expected for the entire year.

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**NOTE 3:   GOODWILL AND INTANGIBLE ASSETS**

Amortizingidentifiable intangible assets at September 30, 2006 and December 31, 2005consisted of the following (in thousands):
| ** **              | ** ** | **September 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|-------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **Gross Carrying  Amount**  | ** ** | **Accumulated  Amortization**   | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Customer  contracts     |       | $                                | 39,287     |                            | $          | 11,010 |   | $ | 37,313 |   | $ | 6,170 |   |
| Trade names             |       | 2,414                            |       | 2,196                           |       | 2,319 |   | 1,578 |   |
| Non-compete  agreements |       | 27,526                           |       | 9,224                           |       | 27,525 |   | 6,010 |   |
|                    |       | $                                | 69,227     |                            | $          | 22,430 |   | $ | 67,157 |   | $ | 13,758 |   |
|                    |       |                             |       |                            |       |   |   |   |   |

 

Aggregateamortization expense related to identifiable intangible assets was $3.0 millionand $1.4 million for the three month periods ended September 30, 2006 and 2005,respectively and was $8.7 million and $4.5 million for the nine month periodsended September 30, 2006 and 2005, respectively.  Amortization expense related to identifiableintangible assets for 2006 and the following five years is estimated as follows(in thousands):

| Year Ending  December 31, | ** ** | **Estimated  Amortization  Expense** | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|
| 2006                                |       | $                                    | 11,620     |   |
| 2007                                |       | 9,531                                |       |
| 2008                                |       | 8,361                                |       |
| 2009                                |       | 6,829                                |       |
| 2010                                |       | 6,439                                |       |
| 2011                                |       | 4,706                                |       |
|                                |       |                                 |       |
|                                |       | $                                    | 47,486     |   |

 

Changes in thecarrying amounts of goodwill by segment are as follows (in thousands):
| ** **                                           | ** ** | **Nine Month Period Ended September 30, 2006** | ** ** | **Year Ended December 31, 2005** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                           | ** ** | **Case  Management**                                                         | ** ** | **Document  Management**                             | ** ** | **Total** | ** ** | **Case  Management** | ** ** | **Document  Management** | ** ** | **Total** | ** ** |
| Balance,  beginning of period                        |       | $                                                                            | 200,936    |                                                 | $          | 48,491 |   | $ | 249,427 |   | $ | 106,371 |   | $ | 41,357 |   | $ | 147,728 |   |
| Goodwill  acquired during the period and adjustments |       | 11,430                                                                       |       | (23                                                  | )          | 11,407 |   | 94,565 |   | 7,134 |   | 101,699 |   |
| Balance, end of period                               |       | $                                                                            | 212,366    |                                                 | $          | 48,468 |   | $ | 260,834 |   | $ | 200,936 |   | $ | 48,491 |   | $ | 249,427 |   |

 

We assess goodwill for impairment as of each July 31and also at any other date when events or changes in circumstances indicatethat the carrying value of these assets may exceed their fair value.  We did not recognize any impairment lossduring the three and nine month periods ended September 30, 2006 and 2005.

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**NOTE 4:   BUSINESS ACQUISITIONS**

***Epiq Advisory Services, Inc.***

On May 16, 2006, our wholly-owned subsidiary, EpiqAdvisory Services Inc., in an asset acquisition, acquired the claims preferencebusiness of Gazes LLC.  The total valueof the transaction was $13.8 million, consisting of $3.0 million of cash paidon closing, $10.2 million of deferred payments, and $0.6 million of capitalizedtransaction costs.  If certain incometargets are satisfied, we may be required to make additional payments, whichwould be recorded as compensation expense, to the seller.  The preliminary allocation of the purchaseprice is as follows:  less than $0.1million to net assets, approximately $2.4 million to customer contracts,amortizable on a straight-line basis over two years, and approximately $11.4million to goodwill.  The purchase pricein excess of the tax basis of the assets is expected to be deductible for taxpurposes.  This acquisition furtherexpands our case management service offerings.

The acquisition was accounted for using the purchasemethod of accounting with the operating results included in the accompanyingcondensed consolidated financial statements from the date of acquisition.  The operating results of Epiq AdvisoryServices are included within our case management segment.

***nMatrix***

On November 15,2005, Epiq, acting through a wholly-owned subsidiary, acquired all the issuedand outstanding shares of capital stock of nMatrix, Inc., nMatrix AustraliaPty. Ltd., and nMatrix Ltd. (collectively, nMatrix) for approximately $126.3million, including capitalized acquisition costs.  The electronic discovery services of nMatrixfurther expands the service offerings of our legal services business.  The purchase price consisted of cash of$100.0 million and approximately 1.2 million shares of our common stock.  The fair value of our common stock issued,calculated based upon the five-day average of the closing price of the commonstock two days before and two days after the acquisition was consummated, was approximately$24.2 million.  In conjunction with theacquisition, we entered into an agreement with the selling shareholder toregister the shares of common stock issued as a part of the acquisitionconsideration.  Within this agreement, weguaranteed the common stock price of $20.35 per share, valued as the averageclosing price of our common stock for the 40 consecutive trading days ending onthe date four trading days prior to the closing date.  This guarantee terminates as of the close ofbusiness on the date that is after any 15 trading days on which the sellingshareholder may lawfully sell shares under a registration statement and thelast sale price for our common stock has been equal to or greater than the$20.35.  Based on our September 30, 2006closing price of $14.71 per share, as of September 30, 2006 the guaranteeamount would be approximately $6.9 million. A liability will not be recorded for this guarantee until thecontingency is resolved.  If a payment ismade under this guarantee, we will reduce the equity proceeds recorded as apart of the acquisition transaction. Based on our valuation, the purchase price has been allocated as follows(in thousands):

| Accounts receivable     |   | $       | 12,615  |   |
|-------------------------|--------|---------|---------|--------|
| Other current  assets   |   | 2,926   |    |
| Property and  software  |   | 7,236   |    |
| Trade names             |   | 569     |    |
| Customer  relationships |   | 24,614  |    |
| Non-compete  agreements |   | 6,676   |    |
| Current  liabilities    |   | (6,197  | )       |
| Deferred tax  liability |   | (16,807 | )       |
| Goodwill                |   | 94,664  |    |
|                    |   |    |    |
| Total purchase price    |   | $       | 126,296 |   |

 

Trade names, customer relationships, and thenon-compete agreements are amortized using the straight-line method over oneyear, eight years, and five years, respectively.  The excess purchase price of $94.7 millionwas allocated to goodwill and is not amortized but will be reviewed forimpairment annually and between annual reviews if events or changes incircumstances indicate that the asset might be impaired.  The purchase price in excess of the tax basisof the assets, primarily allocated to identifiable intangible assets andgoodwill, is not expected to be deductible for tax purposes.  Of our 1.2 million common shares issued asconsideration, approximately 246,000 are held in escrow.  On submission of properly approvedindemnification claims, the escrow agent will sell sufficient shares to pay theindemnification claim.  As of September30, 2006, we have not submitted any claims related to this escrow.  This escrow arrangement terminates May 14,2007, at which time any of our common shares that have not been sold to pay claimswill be distributed to the seller.  Also,$4.0 million of the cash consideration was initially placed in a separateescrow pending collection of certain pre-acquisition receivables.  

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Each month, a portion ofthis escrow is released to the seller based on the prior month’s collection ofthese pre-acquisition receivables.  As ofSeptember 30, 2006, approximately $0.3 million remained in this escrowaccount.  This escrow arrangementterminates following the payment for collections made through September 2006 ofthese pre-acquisition receivables, at which time any amount that remains inescrow will be distributed to Epiq.

The acquisition was accounted for using the purchasemethod of accounting with the operating results included in the accompanyingcondensed consolidated financial statements from the date of acquisition.  The operating results of nMatrix are includedwithin our case management segment.

***Hilsoft, Inc.***

On October 20, 2005, we acquired for cash all theissued and outstanding shares of capital stock of Hilsoft, Inc.  Thespecialty legal notification services of Hilsoft further expand our documentmanagement capabilities.  Thetotal value of the transaction, including capitalized transaction costs, was$9.3 million.  If certain revenueobjectives are satisfied, we will be required to make additional payments of upto $3.0 million.

The acquisition was accounted for using the purchasemethod of accounting with the operating results included in the accompanyingcondensed consolidated financial statements from the date of acquisition.  The operating results are included within ourdocument management segment.

***Pro Forma Results***

Pro forma resultsof operations assuming the above acquisitions were made at the beginning of2005 are shown below (in thousands, except per share data):
| ** **                   | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                   | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
|                         |       |                                                 |       |                                                |       |   |   |
| Total revenue                |       | $                                                    | 36,312     |                                                | $          | 178,958 |   | $ | 103,328 |   |
|                         |       |                                                 |       |                                                |       |   |   |
| Net income  (loss)           |       | $                                                    | 573        |                                                | $          | 37,126 |   | $ | (168 | ) |
| Net income  (loss) per share |       |                                                 |       |                                                |       |   |   |
| Basic                        |       | $                                                    | 0.03       |                                                | $          | 1.92 |   | $ | (0.01 | ) |
| Diluted                      |       | $                                                    | 0.03       |                                                | $          | 1.65 |   | $ | (0.01 | ) |

 

Pro forma adjustments include estimated amortizationexpense, interest expense, management compensation and income taxes.  The pro forma information is not necessarilyindicative of what would have occurred if the acquisitions had been completedon that date nor is it necessarily indicative of future operating results.

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#### **NOTE 5:  INDEBTEDNESS**

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

|                                                                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                           | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Senior term loan                                                     |       | $                      | 15,000     |                  | $          | 25,000 |   |
| Senior revolving loan                                                |       | 82,028                 |       | 93,028                |       |
| Contingent convertible  subordinated debt, including embedded option |       | 51,049                 |       | 51,326                |       |
| Capital leases                                                       |       | 31                     |       | 972                   |       |
| Deferred acquisition  price                                          |       | 12,098                 |       | 3,222                 |       |
| Total indebtedness                                                   |       | $                      | 160,206    |                  | $          | 173,548 |   |

 

***CreditFacilities***

Wehave a credit facility with KeyBank National Association as administrativeagent.  At inception, this facilityconsisted of a $25.0 million senior term loan, maturing in August 2006,and a $100.0 million senior revolving loan, maturing in November 2008.  During 2006, we repaid $10.0 million of thesenior term loan and, in June 2006, our credit facility was amended to extendthe maturity of the outstanding senior term loan balance to June 30, 2007.  The senior term loan does not have anyrequired amortizing payments.  During theterm of the loan we have the right, subject to compliance with our covenants,to increase the senior revolving loan to $175.0 million.

The credit facility issecured by liens on our real property and a significant portion of our personalproperty.  As of September 30, 2006, our borrowingsunder the credit facility totaled $97.0 million, consisting of $15.0 millionunder the senior term loan and $82.0 million under the senior revolvingloan.  Interest on the credit facility isgenerally based on a spread over the LIBOR rate.  Effective April 16, 2007, the calculation ofthe interest rate for the senior term loan will be adjusted to increase thespread over the LIBOR rate by 2%.  As ofSeptember 30, 2006, the interest rate charged on outstanding borrowings rangedfrom 8.3% to 9.5%.

***ContingentConvertible Subordinated Debt***

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

·                  bear interest ata fixed rate of 4% per annum, payable quarterly;

·                  are convertibleinto shares of our common stock at a price of $17.50 per share; and

·                  mature on June15, 2007, subject to extension of maturity to June 15, 2010 at the option ofthe note holders.

If all notes were converted,the notes would convert into approximately 2.9 million shares of our commonstock.  If we change our capitalstructure (for example, through a stock dividend or stock split) while thenotes are outstanding, the conversion price will be adjusted on a consistentbasis and, accordingly, the number of shares of common stock we would issue onconversion would be adjusted.

The holders of the noteshave the right to extend the maturity of the notes for a period not to exceedthree years.  Under SFAS No. 133, *Accounting for Derivative Instruments and Hedging Activities*,the right to extend the maturity of the notes represents an embedded optionsubject to bifurcation.  The embeddedoption was initially valued at $1.2 million and the convertible debt balancewas reduced by the same amount.  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 sheets, our obligation related to the embedded option has been includedas a component of the convertible note payable. For the three and nine month periods ended September 30, 2006, the valueof the embedded option decreased by approximately $0.8 million and $0.6 million,respectively, and these decreases have been included as a 

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component of interestexpense on our accompanying condensed consolidated statements of income.  The changes in carrying value of theconvertible debt and fair value of the embedded option do not affect our cashflow and, if the embedded option is exercised, the value assigned to theembedded option will be amortized as a reduction to our 4% convertible debtinterest expense over the periods payments are made.  If the option is not exercised by some or allconvertible debt holders, any remaining related value assigned to the embeddedoption will be recognized as a gain during that period.

***CovenantCompliance***

Both our credit facilityand subordinated debt contain financial covenants related to earnings beforeinterest, provision for income taxes, depreciation , amortization and otheradjustments as defined in the agreements (EBITDA) and total debt.  In addition, our credit facility alsocontains financial covenants related to senior debt, fixed charges, and workingcapital.  As a result of the restatement,which resulted in the deferral of a substantial portion of revenue related tothe 2003 Arrangement as described in Note 10, we were not in compliance withthese financial covenants through March 31, 2006.  As a result of recognition of the deferredrevenue during the second and third quarters of 2006; we are in compliance withall financial covenants as of June 30 and September 30, 2006.  The deferral of revenue through March 31,2006, and the recognition of the deferred revenue during the second and thirdquarter of 2006, were not anticipated by us or the banks at the time weestablished the current financial covenants in the credit facility.  We will request waivers, as deemed necessary,for the pre-existing events of noncompliance related to the financialrestatement. We have classified such debt as a current liability in theaccompanying condensed consolidated balance sheets.

***DeferredAcquisition Price***

Wehave made three acquisitions, Bankruptcy Services, Hilsoft, and Epiq Advisory Services,for which a portion of the purchase price was deferred.  These deferred payments, which are eithernon-interest bearing or have a below market interest rate, have been discountedat imputed interest rates (Bankruptcy Services at 5% and Hilsoft and EpiqAdvisory Services at 8%).  At September30, 2006, the discounted value of the remaining note payments was approximately$12.1 million of which approximately $5.9 million was classified as a currentliability.

***ScheduledPrincipal Payments***

Ourlong-term obligations, including credit facility debt, convertible debt(including embedded option), deferred acquisition costs, and capitalizedleases, mature as follows for each twelve-month period ending September 30 (inthousands):

| 2007  |   | $     | 154,028 |   |
|-------|--------|-------|---------|--------|
| 2008  |   | 2,952 |    |
| 2009  |   | 1,407 |    |
| 2010  |   | 1,360 |    |
| 2011  |   | 459   |    |
| Total |   | $     | 160,206 |   |

 

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**NOTE6:   SHARE-BASED COMPENSATION**

During the quarter endedMarch 31, 2006, we adopted SFAS No. 123R, *Share-Based Payment*.  SFAS No. 123R establishes standards for theaccounting for transactions in which an entity exchanges its equity instrumentsfor goods and services or incurs liabilities in exchange for goods or servicesthat are based on the fair value of the entity’s equity instruments or that maybe settled by the issuance of those equity instruments.  SFAS No. 123R requires a public entity tomeasure the cost of employee services received in exchange for an award ofequity instruments based on the grant-date fair value of the award and torecognize that cost over the period during which an employee is required toprovide service in exchange for the award.

We elected to adopt SFASNo. 123R using the modified version of prospective application.  Using this method, we have recognizedcompensation costs related to share-based compensation beginning with thequarter ended March 31, 2006. Compensation costs related to share-based compensation for periods endedon or before December 31, 2005 are reflected on a pro forma basis in this noteto our condensed consolidated financial statements.  We have not made an election as to thetransition method we will use for purposes of calculating the pool of excesstax benefits available to absorb tax deficiencies recognized subsequent to theadoption of SFAS No. 123R.

As disclosed in our February 18, 2005 filing on Form8-K, during February 2005 our compensation committee approved acceleration ofthe vesting of approximately 0.5 million unvested share options, with aweighted-average exercise price of $14.28 per share, for certain employees,including an executive officer and non-employee directors.  Unvested share options to purchaseapproximately 1.2 million shares, with a weighted-average exercise price ofapproximately $15.26 per share, were not accelerated as the employees holdingthe unvested share options did not meet the criteria established by ourcompensation committee.  The decision toaccelerate the vesting of these share options and eliminate future compensationexpense was based primarily on a review of our long-term incentive programsconsidering the effect on our financial statements of the then pending changein accounting rules for share-based compensation.  This action, which had an immaterial effecton our financial statements for the year ended December 31, 2005, reduced theamount of expense we would have recognized under SFAS 123R by approximately$2.2 million (approximately $0.2 million and $0.6 million during the threemonths and nine month periods ended September 30, 2006, respectively, andapproximately $0.8 million, $0.7 million, $0.5 million and $0.2 million for theyears ending December 31, 2006, 2007, 2008, and 2009, respectively).

Our 2004 Equity Incentive Plan (the Plan), which isshareholder approved, permits us to grant up to 5 million equity-based instruments.  Although various forms of equity instrumentsmay be issued, to date we have issued only incentive share options andnonqualified share options under this Plan. These share options, which have a contractual term of 10 years, areissued with an exercise price equal to the grant date closing market price ofour common stock.  The vesting periodsrange from immediate to 5 years.  Shareoptions which vest over 5 years generally vest either 20% per year on the firstfive anniversaries of the grant date, or 25% per year on the second throughfifth anniversaries of the grant date. Shares vesting over a shorter period will generally vest 100% as of thedesignated vesting date.  We issue newshares to satisfy share option exercises. We do not anticipate that we will repurchase shares on the open marketduring 2006 for the purpose of satisfying share option exercises.

As a result of ouradoption of SFAS No. 123R, during the three and nine month periods endedSeptember 30, 2006 we recognized expense related to share options issued priorto but unvested as of January 1, 2006 as well as expense related to shareoptions issued subsequent to January 1, 2006. For share options issued prior to but unvested as of January 1, 2006,compensation expense was based on the fair value of those share options ascalculated using the Black-Scholes option valuation model at the date the shareoptions were issued. Key assumptions for the Black-Scholes option valuationmodel include expected volatility, expected term of share options granted, theexpected risk-free interest rate, and the expected dividend rate.  The assumptions used in those fair valuecalculations have been disclosed in our Annual Reports on Form 10-K previouslyfiled with the SEC.  For share optionsissued during the nine month period ended September 30, 2006, the share optionswere also valued using the Black-Scholes option valuation models and with keyassumptions related to expected volatility, expected term of share optionsgranted, the expected risk-free interest rate, and the expected dividendrate.  We estimate our expectedvolatility based on implied volatilities from traded share options on our stockand on our stock’s historical volatility. We have estimated the expected term of our share options based on thehistorical exercise pattern of groups of employees that have similar historicalexercise behavior.  The expectedrisk-free interest rate is based on the U.S. Treasury yield curve in effect atthe time of the grant.  Historically, wehave not paid dividends and we do not anticipate paying dividends in theforeseeable future; accordingly, our expected dividend rate is zero.

16

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Following is a summary ofkey assumptions we used to value share options granted during the nine monthsended September 30, 2006.

| Expected term (years)                |   | 5.0           |
|--------------------------------------|--------|---------------|
| Expected volatility                  |   | 30.0% - 38.0% |
| Weighted average expected volatility |   | 37.1%         |
| Risk-free interest rate              |   | 4.3% - 5.0%   |
| Dividend yield                       |   | 0%            |

 

Compensation expense for the three and nine monthperiods ended September 30, 2006 was adjusted for share options we estimatewill be forfeited prior to vesting.  Weuse historical information to estimate employee termination and the resultingoption forfeiture rate.

A summary of optionactivity during the three months ended September 30, 2006 is presented below(shares and aggregate intrinsic value in thousands):

|                                    | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------|------------|------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| Outstanding, beginning  of period  |       | 4,809      |       | $                                      | 14.77      |                                                |       |                            |       |   |
| Granted                            |       | 10         |       | 15.47                                  |       |                                                |       |                            |       |
| Exercised                          |       | (78        | )          | 12.45                                  |       |                                                |       |                            |       |
| Forfeited                          |       | (57        | )          | 18.00                                  |       |                                                |       |                            |       |
| Outstanding, end of  period        |       | 4,684      |       | 14.77                                  |       | 7.29                                                |       | $                               | 7,106      |   |
|                               |       |       |       |                                   |       |                                                |       |                            |       |
| Options exercisable, end of period |       | 3,272      |       | 13.62                                  |       | 6.75                                                |       | $                               | 6,703      |   |
|                                    |            |            |            |                                        |            |                                                     |            |                                 |            |  |  |

 

The aggregate intrinsicvalue was calculated using the difference between the September 30, 2006 marketprice and the grant price for only those awards that have a grant price that isless than the September 30, 2006 market price. The weighted average grant-date fair value of share options grantedduring the three months ended September 30, 2006 and 2005 were $5.52 and $7.23,respectively.  No share options weregranted during the three months ended September 30, 2005.  The total intrinsic value of share optionsexercised during the three months ended September 30, 2006 was $0.2million.  During the three months endedSeptember 30, 2006, we received cash for payment of the grant price ofexercised share options of approximately $1.0 million and we anticipate we willrealize a tax benefit related to these exercised share options of less than$0.1 million.  The cash received forpayment of the grant price is included as a component of cash flow fromfinancing activities on the condensed consolidated statement of cash flows.

During the three months ended September 30, 2006, werecognized share-based compensation expense, which is a non-cash charge, ofapproximately $0.6 million, of which $0.2 million is included under the caption“Direct costs of services” and $0.4 million is included under the caption “Generaland administrative” on the accompanying condensed consolidated statements ofincome.  During the three months endedSeptember 30, 2006, we recognized a net tax benefit of approximately $0.2million related to aggregate share-based compensation expense recognized duringthe same period.  As a result, incomebefore income taxes was reduced by approximately $0.6 million, net income wasreduced by approximately $0.4 million, net income per share — basic was reducedby approximately $0.02 per share, and net income per share — diluted wasreduced by approximately $0.02 per share.

17

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A summary of optionactivity during the nine months ended September 30, 2006 is presented below(shares and aggregate intrinsic value in thousands):

|                                    | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------|------------|------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| Outstanding, beginning  of period  |       | 4,769      |       | $                                      | 14.49      |                                                |       |                            |       |   |
| Granted                            |       | 237        |       | 18.53                                  |       |                                                |       |                            |       |
| Exercised                          |       | (221       | )          | 11.74                                  |       |                                                |       |                            |       |
| Forfeited                          |       | (101       | )          | 17.06                                  |       |                                                |       |                            |       |
| Outstanding, end of  period        |       | 4,684      |       | 14.77                                  |       | 7.29                                                |       | $                               | 7,106      |   |
|                               |       |       |       |                                   |       |                                                |       |                            |       |
| Options exercisable, end of period |       | 3,272      |       | 13.62                                  |       | 6.75                                                |       | $                               | 6,703      |   |
|                                    |            |            |            |                                        |            |                                                     |            |                                 |            |  |  |

 

The aggregate intrinsicvalue was calculated using the difference between the September 30, 2006 marketprice and the grant price for only those awards that have a grant price that isless than the September 30, 2006 market price. The weighted average grant-date fair value of share options grantedduring the nine months ended September 30, 2006 and 2005 were $7.42 and $5.30,respectively.  The total intrinsic valueof share options exercised during the nine months ended September 30, 2006 was$1.5 million.  During the nine monthsended September 30, 2006, we received cash for payment of the grant price ofexercised share options of approximately $2.6 million and we anticipate we willrealize a tax benefit related to these exercised share options of approximately$0.5 million.  The cash received forpayment of the grant price is included as a component of cash flow fromfinancing activities.  The tax benefitrelated to the option exercise price in excess of the option fair value atgrant date is separately disclosed as a component of cash flow from financingactivities on the condensed consolidated statement of cash flows; the remainderof the tax benefit is included as a component of cash flow from operatingactivities.

During the nine months ended September 30, 2006, werecognized share-based compensation expense, which is a non-cash charge, ofapproximately $1.7 million, of which $0.4 million is included under the caption“Direct costs of services” and $1.3 million is included under the caption “Generaland administrative” on the accompanying condensed consolidated statements ofincome.  During the nine months endedSeptember 30, 2006, we recognized a net tax benefit of approximately $0.6million related to aggregate share-based compensation expense recognized duringthe same period.  As a result, incomebefore income taxes was reduced by approximately $1.7 million, net income wasreduced by approximately $1.1 million, net income per share — basic was reducedby approximately $0.06 per share, and net income per share — diluted wasreduced by approximately $0.05 per share. As of September 30, 2006, there was $7.1 million of total unrecognizedcompensation cost related to nonvested share-based compensation arrangements,which will be recognized over a weighted-average period of 2.2 years.

18

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Prior to adoption of SFAS 123R, we accounted forstock-based compensation awards under the intrinsic method of AccountingPrinciples Board Opinion No. 25, *Accounting for StockIssued to Employees,*which required 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. Shareoptions awarded under our share option plans are granted with an exercise priceequal to the fair market value on the date of the grant.  As a result, our condensed consolidatedstatements of income do not include expense related to share-based compensationfor the three and nine month periods ended September 30, 2005.  Had the compensation cost been determinedbased on the fair value at the grant dates based on the guidance provided byStatement of Financial Accounting Standard (SFAS) No. 123, *Accountingfor Stock-Based Compensation,* our net income and net income pershare for the three month and nine month periods ended September 30, 2005 wouldhave been adjusted to the following pro forma amounts (in thousands, except pershare data):
| ** **                                                                                             | ** ** | ** **   | ** ** | **Three Months Ended  September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Net income, as reported                                                                                |       |         |       | $                                                              | 495        |                                                          | $          | 203 |   |
| Add: stock-based  employee compensation Included in reported net earnings, net of tax                  |       |         |       | —                                                         |       | —                                                        |       |
| Deduct: stock-based  employee compensation expense determined under the fair value method, net of  tax |       |         |       | (216                                                           | )          | (5,482                                                        | )          |
| Net income (loss), pro  forma                                                                          |       |         |       | $                                                              | 279        |                                                          | $          | (5,279 | ) |
|                                                                                                   |       |         |       |                                                           |       |                                                          |       |
| Net income (loss) per  share — Basic                                                              |       | As  reported |       | $                                                              | 0.03       |                                                          | $          | 0.01 |   |
|                                                                                                   |       | Pro  forma   |       | $                                                              | 0.02       |                                                          | $          | (0.29 | ) |
|                                                                                                   |       |         |       |                                                           |       |                                                          |       |
| Net income (loss) per  share — Diluted                                                            |       | As  reported |       | $                                                              | 0.03       |                                                          | $          | 0.01 |   |
|                                                                                                   |       | Pro forma    |       | $                                                              | 0.01       |                                                          | $          | (0.29 | ) |

 

Pro forma amounts presented here are based on actualearnings and consider only the effects of estimated fair values of shareoptions.  For the three and nine monthperiod ended September 30, 2005, we did not assume conversion of theconvertible notes as the effect was antidilutive.  For the three and nine month periods endedSeptember 30, 2005, we did not assume exercise of share options as the effectwas antidilutive.

19

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**NOTE7:   NET INCOME PER SHARE**

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

The computations of basic and diluted net income per share are asfollows (in thousands, except per share data):
| ** **                      | ** ** | **Three Months Ended September 30,** | ** ** |
|---------------------------------|------------|----------------------------------------------------------|------------|
| ** **                      | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| ** **                      | ** ** | **Net  Income**                                          | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per  Share  Amount** | ** ** | **Net  Income** | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per  Share  Amount** | ** ** |
| Basic net income per  share     |       | $                                                        | 2,681      |   | 19,442 |   | $ | 0.14 |   | $ | 495 |   | 17,942 |   | $ | 0.03 |   |
|                            |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Effect of dilutive  securities: |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Share options                   |       |                                                     |       | 612 |   |   |   |   |   | 919 |   |   |   |
| Convertible debt                |       | 305                                                      |       | 2,857 |   |   |   | — |   | — |   |   |   |
|                            |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Diluted net income per share    |       | $                                                        | 2,986      |   | 22,911 |   | $ | 0.13 |   | $ | 495 |   | 18,861 |   | $ | 0.03 |   |

 

For the three month periods ended September 30, 2006and 2005, weighted-average outstanding share options totaling approximately 2.8million and 0.1 million shares of common stock, respectively, were antidilutiveand therefore not included in the computation of diluted earnings pershare.  For the three months endedSeptember 30, 2005, we did not assume conversion of the convertible notes asthe effect was antidilutive.
| ** **                      | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------|------------|---------------------------------------------------------|------------|
| ** **                      | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                      | ** ** | **Net  Income**                                         | ** ** | **Weighted  Average  Shares**

**Outstanding** | ** ** | **Per   Share  Amount** | ** ** | **Net  Income** | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per  Share  Amount** | ** ** |
| Basic net income per  share     |       | $                                                       | 37,224     |   | 19,372 |   | $ | 1.92 |   | $ | 203 |   | 17,911 |   | $ | 0.01 |   |
|                            |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Effect of dilutive  securities: |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Share options                   |       |                                                    |       | 836 |   |   |   |   |   | 491 |   |   |   |
| Convertible debt                |       | 904                                                     |       | 2,857 |   |   |   | — |   | — |   |   |   |
|                            |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Diluted net income per  share   |       | $                                                       | 38,128     |   | 23,065 |   | $ | 1.65 |   | $ | 203 |   | 18,402 |   | $ | 0.01 |   |

 

For the nine month periods ended September 30, 2006and 2005, weighted-average outstanding share options totaling approximately 1.6million and 1.5 million shares of common stock, respectively, were antidilutiveand therefore not included in the computation of diluted earnings pershare.  For the nine months endedSeptember 30, 2005, we did not assume conversion of the convertible notes asthe effect was antidilutive.

20

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#### **NOTE 8:  OPERATING LEASES**

We have non-cancelableoperating leases for office space at various locations expiring at varioustimes through 2015.  Each of the leasesrequires us to pay all executory costs (property taxes, maintenance and insurance).  Additionally, we have non-cancelableoperating leases for office equipment and automobiles expiring through 2010.

Future minimum leasepayments during each of the twelve months ending September 30 are as follows(in thousands):

| 2007                         |   | $      | 5,356  |   |
|------------------------------|--------|--------|--------|--------|
| 2008                         |   | 4,754  |   |
| 2009                         |   | 4,319  |   |
| 2010                         |   | 4,194  |   |
| 2011                         |   | 3,771  |   |
| Thereafter                   |   | 12,868 |   |
| Total minimum lease payments |   | $      | 35,262 |   |

 

Rent expense related tooperating leases was approximately $1.5 million and $0.7 million for the threemonth periods ended September 30, 2006 and 2005, respectively, andapproximately $4.0 million and $2.1 million for the nine month periods endedSeptember 30, 2006 and 2005, respectively.

**NOTE9:   SEGMENT REPORTING**

We have two operatingsegments: (i) case management and (ii) document management.  Case management solutions include proprietarytechnology and integrated services to address the administrative businessrequirements of a case.  Documentmanagement solutions include proprietary technology and production services toensure timely, accurate and complete execution of documents related to a case.

Each segment’sperformance is assessed based on segment revenues less costs directlyattributable to each segment.  In theevaluation of performance, certain costs, such as shared services,administrative staff, and executive management, are not allocated by segmentand, accordingly, the following operating segment results do not include suchunallocated costs.  Assets reportedwithin a segment are those assets used by the segment in its operations andconsist of property, equipment and leasehold improvements, software,identifiable intangible assets and goodwill. All other assets are classified as unallocated.

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Following is a summary ofsegment information (in thousands):
| ** **                                                                                                | ** ** | **Three Months Ended September 30, 2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                | ** ** | **Case**                                                           | ** ** | **Document** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                | ** ** | **Management**                                                     | ** ** | **Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                                                  |       |                                                               |       |   |   |   |   |   |   |
| Operating  revenue before reimbursed direct costs                                                         |       | $                                                                  | 29,798     |   | $ | 4,591 |   | $ | — |   | $ | 34,389 |   |
| Operating  revenue from reimbursed direct costs                                                           |       | 813                                                                |       | 3,830 |   | — |   | 4,643 |   |
| Total revenue                                                                                             |       | 30,611                                                             |       | 8,421 |   | — |   | 39,032 |   |
|                                                                                                      |       |                                                               |       |   |   |   |   |   |   |
| Costs and expenses:                                                                                       |       |                                                               |       |   |   |   |   |   |   |
| Direct costs,  general and administrative costs and depreciation and software and leasehold  amortization |       | 12,800                                                             |       | 7,353 |   | 8,836 |   | 28,989 |   |
| Amortization of  identifiable intangible assets                                                           |       | 2,542                                                              |       | 485 |   | — |   | 3,027 |   |
| Total operating  expenses                                                                                 |       | 15,342                                                             |       | 7,838 |   | 8,836 |   | 32,016 |   |
| Income from operations                                                                                    |       | $                                                                  | 15,269     |   | $ | 583 |   | $ | (8,836 | ) | 7,016 |   |
| Interest expense, net                                                                                     |       |                                                               |       |   |   |   |   | 2,500 |   |
| Income from  operations before income taxes                                                               |       |                                                               |       |   |   |   |   | 4,516 |   |
| Provision for income  taxes                                                                               |       |                                                               |       |   |   |   |   | 1,835 |   |
|                                                                                                      |       |                                                               |       |   |   |   |   |   |   |
| Net income                                                                                                |       |                                                               |       |   |   |   |   | $ | 2,681 |   |
|                                                                                                      |       |                                                               |       |   |   |   |   |   |   |
| Provision for depreciation and software and leasehold amortization                                        |       | $                                                                  | 4,380      |   | $ | 574 |   | $ | 706 |   | $ | 5,660 |   |

 

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| ** **                                                                                                | ** ** | **Three Months Ended September 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                | ** ** | **Case**                                                           | ** ** | **Document** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                | ** ** | **Management**                                                     | ** ** | **Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                                                  |       |                                                               |       |   |   |   |   |   |   |
| Operating  revenue before reimbursed direct costs                                                         |       | $                                                                  | 12,747     |   | $ | 7,373 |   | $ | — |   | $ | 20,120 |   |
| Operating  revenue from reimbursed direct costs                                                           |       | 622                                                                |       | 5,552 |   | — |   | 6,174 |   |
| Total revenue                                                                                             |       | 13,369                                                             |       | 12,925 |   | — |   | 26,294 |   |
|                                                                                                      |       |                                                               |       |   |   |   |   |   |   |
| Costs and expenses:                                                                                       |       |                                                               |       |   |   |   |   |   |   |
| Direct costs,  general and administrative costs and depreciation and software and leasehold  amortization |       | 7,613                                                              |       | 9,692 |   | 6,237 |   | 23,542 |   |
| Amortization of  identifiable intangible assets                                                           |       | 1,069                                                              |       | 373 |   | — |   | 1,442 |   |
| Acquisition  related                                                                                      |       | —                                                             |       | — |   | 114 |   | 114 |   |
| Total operating  expenses                                                                                 |       | 8,682                                                              |       | 10,065 |   | 6,351 |   | 25,098 |   |
| Income from operations                                                                                    |       | $                                                                  | 4,687      |   | $ | 2,860 |   | $ | (6,351 | ) | 1,196 |   |
| Interest expense, net                                                                                     |       |                                                               |       |   |   |   |   | 1,595 |   |
| Loss from operations  before income taxes                                                                 |       |                                                               |       |   |   |   |   | (399 | ) |
| Benefit for income  taxes                                                                                 |       |                                                               |       |   |   |   |   | (894 | ) |
|                                                                                                      |       |                                                               |       |   |   |   |   |   |   |
| Net income                                                                                                |       |                                                               |       |   |   |   |   | $ | 495 |   |
|                                                                                                      |       |                                                               |       |   |   |   |   |   |   |
| Provision for depreciation and software and leasehold amortization                                        |       | $                                                                  | 2,168      |   | $ | 464 |   | $ | 542 |   | $ | 3,174 |   |

 

23

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| ** **                                                                                                | ** ** | **Nine Months Ended September 30, 2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                                                | ** ** | **Case**                                                          | ** ** | **Document** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                | ** ** | **Management**                                                    | ** ** | **Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                                                  |       |                                                              |       |   |   |   |   |   |   |
| Operating  revenue before reimbursed direct costs                                                         |       | $                                                                 | 134,575    |   | $ | 26,495 |   | $ | — |   | $ | 161,070 |   |
| Operating  revenue from reimbursed direct costs                                                           |       | 2,327                                                             |       | 14,349 |   | — |   | 16,676 |   |
| Total revenue                                                                                             |       | 136,902                                                           |       | 40,844 |   | — |   | 177,746 |   |
|                                                                                                      |       |                                                              |       |   |   |   |   |   |   |
| Costs and expenses:                                                                                       |       |                                                              |       |   |   |   |   |   |   |
| Direct costs,  general and administrative costs and depreciation and software and leasehold  amortization |       | 37,652                                                            |       | 34,050 |   | 25,446 |   | 97,148 |   |
| Amortization of  identifiable intangible assets                                                           |       | 7,185                                                             |       | 1,487 |   | — |   | 8,672 |   |
| Acquisition  related                                                                                      |       | —                                                            |       | — |   | 250 |   | 250 |   |
| Total operating  expenses                                                                                 |       | 44,837                                                            |       | 35,537 |   | 25,696 |   | 106,070 |   |
| Income from operations                                                                                    |       | $                                                                 | 92,065     |   | $ | 5,307 |   | $ | (25,696 | ) | 71,676 |   |
| Interest expense, net                                                                                     |       |                                                              |       |   |   |   |   | 9,104 |   |
| Income from operations  before income taxes                                                               |       |                                                              |       |   |   |   |   | 62,572 |   |
| Provision for income  taxes                                                                               |       |                                                              |       |   |   |   |   | 25,348 |   |
|                                                                                                      |       |                                                              |       |   |   |   |   |   |   |
| Net income                                                                                                |       |                                                              |       |   |   |   |   | $ | 37,224 |   |
|                                                                                                      |       |                                                              |       |   |   |   |   |   |   |
| Provision for depreciation and software and leasehold amortization                                        |       | $                                                                 | 12,471     |   | $ | 1,755 |   | $ | 1,870 |   | $ | 16,096 |   |

 

24

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| ** **                                                                                                | ** ** | **Nine Months Ended September 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                                                | ** ** | **Case**                                                          | ** ** | **Document** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                | ** ** | **Management**                                                    | ** ** | **Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                                                  |       |                                                              |       |   |   |   |   |   |   |
| Operating  revenue before reimbursed direct costs                                                         |       | $                                                                 | 39,278     |   | $ | 19,895 |   | $ | — |   | $ | 59,173 |   |
| Operating  revenue from reimbursed direct costs                                                           |       | 2,266                                                             |       | 14,852 |   | — |   | 17,118 |   |
| Total revenue                                                                                             |       | 41,544                                                            |       | 34,747 |   | — |   | 76,291 |   |
|                                                                                                      |       |                                                              |       |   |   |   |   |   |   |
| Costs and expenses:                                                                                       |       |                                                              |       |   |   |   |   |   |   |
| Direct costs,  general and administrative costs and depreciation and software and leasehold  amortization |       | 23,436                                                            |       | 26,355 |   | 20,635 |   | 70,426 |   |
| Amortization of  identifiable intangible assets                                                           |       | 3,280                                                             |       | 1,212 |   | — |   | 4,492 |   |
| Acquisition  related                                                                                      |       | —                                                            |       | — |   | 114 |   | 114 |   |
| Total operating  expenses                                                                                 |       | 26,716                                                            |       | 27,567 |   | 20,749 |   | 75,032 |   |
| Income from operations                                                                                    |       | $                                                                 | 14,828     |   | $ | 7,180 |   | $ | (20,749 | ) | 1,259 |   |
| Interest expense, net                                                                                     |       |                                                              |       |   |   |   |   | 4,203 |   |
| Loss from operations  before income taxes                                                                 |       |                                                              |       |   |   |   |   | (2,944 | ) |
| Benefit for income  taxes                                                                                 |       |                                                              |       |   |   |   |   | (3,147 | ) |
|                                                                                                      |       |                                                              |       |   |   |   |   |   |   |
| Net income                                                                                                |       |                                                              |       |   |   |   |   | $ | 203 |   |
|                                                                                                      |       |                                                              |       |   |   |   |   |   |   |
| Provision for depreciation and software and leasehold amortization                                        |       | $                                                                 | 6,557      |   | $ | 1,553 |   | $ | 1,663 |   | $ | 9,773 |   |

 

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**NOTE 10:   RESTATEMENT OFPREVIOUSLY ISSUED FINANCIAL STATEMENTS**

Subsequent to theissuance of our consolidated financial statements for the year ended December31, 2005, management identified anaccounting error in its historical consolidated financial statements related tothe appropriate accounting treatment for certain complex aspects of revenuerecognition, specifically the evaluation of vendor specific objective evidence(VSOE) of fair value for specified software upgrades provided within a bundledarrangement as required by Statement of Position 97-2, *SoftwareRevenue Recognition* (SOP 97-2). As a result, we have restated our financial statements for the three andnine months ended September 30, 2005.  Inaddition, we will restate, as soon as practicable, our previously issuedfinancial statements as of December 31, 2005 and 2004, and for each of thethree years in the period ended December 31, 2005, included in our AnnualReport on Form 10-K for the fiscal year ended December 31, 2005, initiallyfiled with the SEC on March 8, 2006, for the quarterly information included inour Annual Report on Form 10-K for the fiscal year ended December 31, 2005initially filed with the SEC on March 8, 2006, for the three months ended March 31, 2006 and 2005, included in ourQuarterly Report on Form 10-Q for the quarter ended March 31, 2006, initiallyfiled with the SEC on May 9, 2006, and for the three and six months ended June30, 2006 and 2005, included in our Quarterly Report on Form 10-Q for the quarterended June 30, 2006, initially filed with the SEC on August 8, 2006.

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

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

In October 2003, weentered into a three year arrangement (the 2003 Arrangement) with our primaryfinancial institution.  As a part of the2003 Arrangement, we continued to perform each of our first and second quarterspecified software upgrades through the term of the arrangement (September 30,2006), and the bank agreed to compensate us for these upgrades on terms similarto our historical terms when we delivered the upgrades on a standalonebasis.  As a result, in our previouslyreported financial statements, we concluded that we had established VSOE forthe software upgrades.  Accordingly, werecognized revenue for the software upgrades on delivery.  Revenue related to hardware and hardwaremaintenance was recognized as explained in Note 1 above.  As we did not have VSOE for the softwarelicense, we combined the software license with the remaining undeliveredelement, PCS, as a single unit of accounting. Revenue related to PCS was entirely contingent on the placement ofdeposits by the trustee with the financial institution.  Accordingly, we recognized this contingentusage based revenue consistent with the guidance provided by American Instituteof Certified Public Accountants’ Technical Practice Aid (TPA) 5100.76, *Fair Value in Multiple-Element Arrangements That Include ContingentUsage-Based Fees and Software Revenue Recognition* as the fee becamefixed or determinable at the time actual usage occurred and collectibility wasprobable.  This occurred monthly as aresult of the computation, billing and collection of monthly deposit feescontractually agreed to. At that time, we had also satisfied the revenuerecognition criteria contained in SAB Topic 13, since we had persuasiveevidence that an arrangement existed, services had been rendered, the price wasfixed and determinable, and collectibility was reasonably assured.

Subsequent to theissuance of the financial statements referenced above, we concluded that,although we historically sold software upgrades on a standalone basis, eachspecified software upgrade should be considered a separate product and,therefore, the price of prior software upgrades cannot be used to establish theprice of future software upgrades.  Asour primary financial institution was the only payee for software upgradesduring the period of the 2003 Arrangement, we were unable to establish VSOE forthe software upgrades.  Under SOP 97-2,if VSOE cannot be established for software upgrades, then considerationreceived under the 2003 Arrangement, except for consideration related to theprovision of hardware and hardware maintenance, must be deferred until allsoftware upgrades have been delivered. Although we continued to invoice, 

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and the bank continued topay, our volume-based fees related to software licenses and post contractcustomer support as well as our semi-annual software upgrades, these amountscannot be recognized as revenue when we provide the services.  Instead, these amounts are recorded asdeferred revenue liability on our condensed consolidated balance sheet.  From inception of the arrangement throughMarch 31, 2006, we recorded as deferred revenue $66.1 million of amountsinvoiced under the 2003 Arrangement. On delivery of the final upgrade duringthe second quarter of 2006, the only remaining undelivered element was PCSservices.  In accordance with SOP 97-2,on delivery of the final software upgrade we recognized revenue previouslydeferred on a proportionate basis over the three year term of thecontract.  As the contract commencedOctober 1, 2003 and terminated September 30, 2006, we recognized approximately$60.1 million of net deferred revenue related to this arrangement during thesecond quarter of 2006 and we recognized $6.0 million of deferred revenuerelated to this arrangement during the third quarter of 2006.

With this restatement, we have also reclassifiedrevenue related to software arrangements which include both product (softwarelicense and upgrades) with services (PCS) to a separate line item, “Casemanagement bundled software license, software upgrade and post contractcustomer support services,” within the revenue section of our condensedconsolidated statements of income.  Wehave also reclassified direct costs related to operating revenue fromreimbursed direct costs to a separate line item, “Reimbursed direct costs,”within the costs and expenses section of our condensed consolidated statementsof income.

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

As a result of thedeferral of a substantial portion of revenue related to the 2003 Arrangement,we were not in compliance with our senior and subordinated debt financialcovenants.  As a result of recognition ofthe deferred revenue during the second and third quarters of 2006, we are incompliance with all financial covenants as of June 30 and September 30,2006.  The deferral of revenue throughMarch 31, 2006, and the recognition of the deferred revenue during the secondand third quarter of 2006, were not anticipated by us or the banks at the timewe established the current financial covenants in the credit facility.  We will request waivers, as deemed necessary,for the pre-existing events of noncompliance related to the financialrestatement.  We have classified thatdebt as a current liability in the accompanying condensed consolidated balancesheets.

The restatement alsoaffects taxable income, which resulted in a change to our provision for incometaxes.  In addition, as a result of thedeferral of revenue, which had been included in our taxable income, we haverestated our deferred tax assets and liabilities.

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A summary of the significant effects of therestatement is as follows (in thousands, except per share data):

**CondensedConsolidated Balance Sheet Effects**

|                                                       | ** ** | **December 31, 2005** | ** ** |
|-------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                            | ** ** | **As  Previously  Reported**    | ** ** | **As Restated** | ** ** |
|                                                  |       |                            |       |   |   |
| Deferred income taxes                                 |       | $                               | 1,978      |   | $ | 25,579 |   |
| Total Current Assets                                  |       | 56,591                          |       | 80,192 |   |
| Total Assets                                          |       | 394,870                         |       | 418,471 |   |
|                                                  |       |                            |       |   |   |
| Other accrued expenses                                |       | 3,872                           |       | 3,322 |   |
| Current maturities of  long-term obligations          |       | 27,642                          |       | 171,996 |   |
| Deferred revenue                                      |       | —                          |       | 60,224 |   |
| Total Current  Liabilities                            |       | 45,608                          |       | 249,636 |   |
| Long-term obligations  (excluding current maturities) |       | 145,906                         |       | 1,552 |   |
| Total Long-term  Liabilities                          |       | 172,721                         |       | 28,367 |   |
|                                                  |       |                            |       |   |   |
| Retained earnings                                     |       | 47,864                          |       | 11,791 |   |
| Total Stockholders’  Equity                      |       | 176,541                         |       | 140,468 |   |
| Total Liabilities and                                 |       |                            |       |   |   |
| Stockholders’ Equity                             |       | 394,870                         |       | 418,471 |   |
|                                                       |            |                                 |            |  |  |  |  |

 

**CondensedConsolidated Statements of Income Effects**

|                                                                                                        | ** ** | **For the Three Months Ended  September 30, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **As  Previously  Reported**                                                     | ** ** | **As Restated** | ** ** |
|                                                                                                   |       |                                                                             |       |   |   |
| Case management services                                                                               |       | $                                                                                | 18,469     |   | $ | 12,197 |   |
| Case management bundled  software license, software upgrade and postcontract customer support services |       | —                                                                           |       | 550 |   |
| Total Revenue                                                                                          |       | 32,016                                                                           |       | 26,294 |   |
| Direct costs of  services                                                                              |       | 14,775                                                                           |       | 8,576 |   |
| Reimbursed direct costs                                                                                |       | —                                                                           |       | 6,199 |   |
| Income from Operations                                                                                 |       | 6,918                                                                            |       | 1,196 |   |
| Income (Loss) from  Operations Before Income Taxes                                                     |       | 5,323                                                                            |       | (399 | ) |
| Provision (Benefit) for  Income Taxes                                                                  |       | 2,236                                                                            |       | (894 | ) |
| Net Income                                                                                             |       | 3,087                                                                            |       | 495 |   |
|                                                                                                   |       |                                                                             |       |   |   |
| Net Income per Share — Basic                                                                      |       | $                                                                                | 0.17       |   | $ | 0.03 |   |
| Net Income per Share — Diluted                                                                    |       | $                                                                                | 0.16       |   | $ | 0.03 |   |
|                                                                                                   |       |                                                                             |       |   |   |
| Weighted Average Common                                                                                |       |                                                                             |       |   |   |
| Shares Outstanding — Diluted                                                                      |       | 21,718                                                                           |       | 18,861 |   |

 

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**CondensedConsolidated Statements of Income Effects**

|                                                                                                        | ** ** | **For the Nine Months Ended  September 30, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **As  Previously  Reported**                                                    | ** ** | **As Restated** | ** ** |
|                                                                                                   |       |                                                                            |       |   |   |
| Case management                                                                                        |       | $                                                                               | 58,100     |   | $ | 38,132 |   |
| Case management bundled  software license, software upgrade and postcontract customer support services |       | —                                                                          |       | 1,146 |   |
| Total Revenue                                                                                          |       | 95,113                                                                          |       | 76,291 |   |
| Direct costs of  services                                                                              |       | 42,074                                                                          |       | 24,778 |   |
| Reimbursed direct costs                                                                                |       | —                                                                          |       | 17,296 |   |
| Income from Operations                                                                                 |       | 20,081                                                                          |       | 1,259 |   |
| Income (Loss) from  Operations Before Income Taxes                                                     |       | 15,878                                                                          |       | (2,944 | ) |
| Provision (Benefit) for  Income Taxes                                                                  |       | 6,637                                                                           |       | (3,147 | ) |
| Net Income                                                                                             |       | 9,241                                                                           |       | 203 |   |
|                                                                                                   |       |                                                                            |       |   |   |
| Net Income per Share — Basic                                                                      |       | $                                                                               | 0.52       |   | $ | 0.01 |   |
| Net Income per Share — Diluted                                                                    |       | $                                                                               | 0.48       |   | $ | 0.01 |   |
|                                                                                                   |       |                                                                            |       |   |   |
| Weighted Average Common                                                                                |       |                                                                            |       |   |   |
| Shares Outstanding — Diluted                                                                      |       | 21,259                                                                          |       | 18,402 |   |

 

**CondensedConsolidated Statements of Cash Flow Effect**

|                                                                     | ** ** | **For the Nine Months Ended  September 30, 2005** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                                          | ** ** | **As  Previously  Reported**                                                    | ** ** | **As Restated** | ** ** |
|                                                                |       |                                                                            |       |   |   |
| Cash Flows from  Operating Activities                               |       |                                                                            |       |   |   |
| Net income                                                          |       | $                                                                               | 9,241      |   | $ | 203 |   |
| Provision  (benefit) for deferred income taxes                      |       | 16                                                                              |       | (7,428 | ) |
| Accounts payable  and other Liabilities                             |       | 1,870                                                                           |       | 968 |   |
| Deferred revenue                                                    |       | —                                                                          |       | 19,724 |   |
| Income taxes,  including tax benefit from exercise of stock options |       | 275                                                                             |       | (2,065 | ) |
| Net Cash Provided by Operating Activities                           |       | 13,737                                                                          |       | 13,737 |   |
|                                                                     |            |                                                                                 |            |  |  |  |  |

 

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

**Overview**

***Business Solutions***

Epiq Systems, Inc. is a provider of technology-basedsolutions for the legal and fiduciary services industries. Our two operatingsegments, case management and document management, assist clients with theadministration of complex legal proceedings, including electronic discovery,bankruptcy administration and class action administration. Our clients includeleading law firms, corporations, bankruptcy trustees, and other professionaladvisors who require sophisticated case administration and document managementcapabilities, extensive subject matter expertise and a high service capacity.

Our case and document management segments provide ourclients with a broad range of technology and service offerings to meet theunique needs and requirements of each client matter. For example, a particularclass action matter may require professional services, call center support,claims processing and settlement processing from our case management segmentand a uniquely developed media campaign to provide notice to a class of unknownclaimants and document custody services from our document management segment,while another class action matter may only require claims processing servicesfrom our case management segment and a simple mailing notification to a classof known claimants from our document management segment. Not all cases have thesame business requirements, and our expanded technology and service offeringsallow clients to procure services from our broad range of case management anddocument management solutions.

Our case management and document management technologyand service offerings provide solutions primarily for the bankruptcy, classaction and mass tort, and electronic discovery markets. These technology and serviceofferings can cross the various markets and clients we serve. For example, ourlegal notification expert may develop a document management notice program foreither a bankruptcy matter or a class action matter. Our proprietary searchtechnology solution, which may be used for an electronic discovery, classaction, or bankruptcy matter, supports a unique set of case management anddocument management requirements.

***Marketplace Information***

The substantial increase of electronic documents inthe business community has changed the dynamics of how attorneys supportdiscovery in complex litigation matters. According to the 2005 Socha-GelbmannElectronic Discovery Survey, 2004 domestic commercial electronic discoveryrevenues were estimated at $832 million, an approximate 94% increase from 2003.According to this same source, the market is expected to continue to grow 50%to 60% each year from 2005 to 2007. Due to the increasing complexity of cases,the increasing volume of data that are maintained electronically, and theincreasing volume of documents that are produced in all types of litigation,law firms are increasingly reliant on electronic evidence management systems toorganize and manage the litigation discovery process.

The number of new bankruptcy filings each year mayvary based on the level of consumer and business debt, the general economy,interest rate levels and other factors. We believe the level of consumer andbusiness debt are important indicators of future bankruptcy filings. The mostrecent available Federal Reserve *Flow of Funds Accounts ofthe United States*, dated September 19, 2006, reported increases inboth consumer and business debt outstanding as compared with the same period ofthe prior year. The increase in consumer debt was the result of a significantincrease in home mortgage debt, partly offset by a slight decline in consumercredit debt.

The class action and mass tort marketplace issignificant, with estimated annual tort claim costs in excess of $250 billionaccording to an update study issued in 2004 by Towers Perrin. Administrativecosts, which include costs, other than defense costs, incurred by either theinsurance company or self-insured entity in the administration of claims,comprise approximately 20% of this total.

We have acquired a number of businesses during thepast several years. In January 2003, we acquired Bankruptcy Services, whichexpanded our offerings to include an integrated solution of a proprietarytechnology platform and professional services for Chapter 11 corporaterestructurings. In January 2004, we acquired Poorman-Douglas and expanded ourofferings to include class action, mass tort, and other similar legalproceedings. In October 2005, we acquired Hilsoft, enhancing our expert legalnotification. In November 2005, we acquired nMatrix which expanded our serviceofferings to include electronic discovery and in August 2005 and May 2006, weacquired Novare and Epiq Advisory Services, respectively, to further expand ourbankruptcy case management service offerings.

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***Case Management Segment***

Case management supportfor client engagements may last several years and has a revenue profile thattypically includes a recurring component. Our case management segment generatesrevenue primarily through the following services.

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

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

·                  Proprietaryelectronic discovery software to sort, cleanse, organize and perform searcheson large databases in support of a legal proceeding.

·                  Software installed in bankruptcy trusteeoffices and provided over the internet that facilitates the administration ofChapter 7 and Chapter 13 bankruptcy cases.

·                  Databasemaintenance and processing, such as for creditor and class action claims, andconversion of that data into an organized, searchable, electronic database thatwe maintain on our servers and use, with our client, to manage the particularcase.

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

***Document Management Segment***

Document management revenue is generally non-recurringdue to the unpredictable nature of the frequency, timing and magnitude of theclients’ business requirements. Our document management segment generates revenueprimarily through the following services.

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

·                  Reimbursementfor costs incurred related to postage on mailing services.

**CriticalAccounting Policies**

We consider our accounting policies related to revenuerecognition, share-based compensation, business combinations, goodwill, andidentifiable intangible assets to be critical policies in understanding ourhistorical and future performance.

***Revenuerecognition.***   We have agreementswith clients pursuant to which we deliver various case management and documentmanagement services each month.

Significant sources of revenue include:

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

·                  Hostingfees based on the amount of data stored;

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

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

·                  Reimbursementfor costs incurred related to postage on mailing services.

*Non-SoftwareArrangements*

Case and document management services related toelectronic discovery, corporate restructuring, and class action revenue, whichare billed based on volume, are evaluated pursuant to Emerging Issues TaskForce (EITF) 00-21, *Revenue Arrangements withMultiple Deliverables*. For each of these contractual arrangements,we have identified the following deliverables and/or services:

·                  ElectronicDiscovery

·               Data processing

·               Hosting

·                  Corporate Restructuring

·               Consulting

·               Claims management

·               Printing andreproduction

·               Mailing andnoticing

·               Document management

·                  Class Action

·               Consulting

·               Notice campaigns

·               Toll free customersupport

·               Web sitedesign/hosting

·               Claimsadministration

·               Distribution

Based on our evaluation of each element, we havedetermined that each element delivered has standalone value to our customersbecause we or other vendors sell such services separately from any otherservices/deliverables. We have also obtained objective and reliable evidence ofthe fair value of each element based either on the price we charge when we sellan element on a standalone basis or based on third-party evidence of fair valueof such services. Lastly, our arrangements do not include general rights ofreturn. Accordingly, each of the service elements in our multiple element caseand document management arrangements qualifies as a separate unit of accountingunder EITF 00-21. We allocate revenue to the various units of accounting in ourarrangements based on the fair value of each unit of accounting, which isgenerally consistent with the stated prices in our arrangements. As we haveevidence of an arrangement, revenue for each separate unit of accounting isrecognized each period in accordance with Staff Accounting Bulletin Topic 13, *Revenue Recognition* (SAB Topic 13). As the services arerendered, our fee becomes fixed and determinable, and collectibility isreasonably assured. Payments received in advance of satisfaction of the relatedrevenue recognition criteria are recognized as a customer deposit until allrevenue recognition criteria have been satisfied.

*SoftwareArrangements*

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

For Chapter 7 related arrangements with financialinstitutions, we earn contingent monthly fees from the financial institutionrelated to the software license, hardware lease, hardware maintenance, and PCSservices. We account for the software license and PCS elements in accordancewith Statement of Position 97-2, *Software RevenueRecognition* (SOP 97-2). Since we have not established vendorspecific objective evidence (VSOE) of the fair value of the software license,we do not recognize any revenue on delivery of the software. The softwareelement is deferred and included with the remaining undelivered element, whichis PCS. This revenue, when recognized, is included as a component of casemanagement services revenue. Revenue related to PCS is entirely contingent onthe placement of liquidated estate deposits by the trustee with the financialinstitution. Accordingly, we recognize this contingent usage based revenueconsistent with the guidance provided by the American Institute of CertifiedPublic Accountants’ Technical Practice Aid (TPA) 5100.76, *Fair Valuein Multiple-Element*

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*Arrangements That Include Contingent Usage-BasedFees and Software Revenue Recognition* as the fee becomesfixed or determinable at the time actual usage occurs and collectibility isprobable. This occurs monthly as a result of the computation, billing andcollection of monthly deposit fees contractually agreed to. At that time, wehave also satisfied the other revenue recognition criteria contained in SOP97-2, since we have persuasive evidence that an arrangement exists, serviceshave been rendered, the price is fixed and determinable, and collectibility isreasonably assured.

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

Effective October 1, 2003, we entered into anarrangement with our primary depository financial institution under which we deliveredtwo specified upgrades annually with the last specified upgrade occurring inthe second quarter of 2006. This arrangement included specific pricing for eachsoftware upgrade and certain special projects in addition to the contingentdeposit-based pricing related to the software license, hardware, hardwaremaintenance, and PCS to each trustee client. Therefore, the software upgrades and special projects are part of abundled arrangement. Each software upgrade is considered a separate anddiscrete product and, as we do not sell each software upgrade on a standalonebasis, we were unable to establish VSOE of the fair value of the softwareupgrades. As a result, the licensed software, software upgrade, specialprojects and PCS are a combined unit of accounting. Revenue for this combinedunit of accounting, when recognized, is included as a component of casemanagement services revenue. Since we did not have VSOE of the fairvalue of each separate upgrade, we deferred recognition of substantially allrevenue under this arrangement until the final upgrade was delivered. Ondelivery of the final upgrade during the second quarter of 2006, the onlyremaining undelivered element was PCS services. In accordance with SOP 97-2, ondelivery of the final software upgrade, we recognized revenue previouslydeferred on a proportionate basis over the three year term of the contract. Asthe contract commenced October 1, 2003 and terminated September 30, 2006, werecognized approximately $60.1 million of net deferred revenue during thesecond quarter of 2006 and we recognized approximately $6.0 million of deferredrevenue related to this arrangement during the third quarter of 2006.

*Reimbursements*

Our case and document management businesses both haverevenue related to the reimbursement of certain costs, primarily postage. Consistentwith guidance provided by EITF No. 01-14, *Income StatementCharacterization of Reimbursements Received for “Out-of-Pocket” ExpensesIncurred*, reimbursed postage and other reimbursable direct costs arerecorded gross as revenue from reimbursed direct costs and as reimbursed directcosts.

***Share-basedcompensation.***   Effective January1, 2006, we began accounting for share-based compensation under SFAS No. 123R. SFASNo. 123R requires a public entity to measure the cost of employee servicesreceived in exchange for an award of equity instruments based on the grant-datefair value of the award and to recognize that cost over the period during whichan employee is required to provide service in exchange for the award. Werecognize this expense on a straight-line basis over the requisite serviceperiod of the last separately vesting portion of the award. Recognition ofshare-based compensation expense had, and will likely continue to have, amaterial affect on our direct costs and general and administrative line itemswithin our condensed consolidated statements of income and also may have amaterial affect on our deferred income taxes and additional paid-in capitalline items within our condensed consolidated balance sheets. Adoption of SFASNo. 123R affects the classification within our condensed consolidated statementof cash flows of certain tax benefits as certain tax benefits formerlyclassified as an operating cash flow are now classified as a financing cashflow. To date, the only share-based compensation we have issued is shareoptions.

Determining the fair value of a share option grant atthe date of the award requires the use of estimates related to expectedvolatility, expected term of share options granted, expected risk-free interestrate, and the expected dividend rate. We 

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estimate our expected volatility based on impliedvolatilities from traded options on our stock and on our stock’s historicalvolatility. We have estimated the expected term of our share options based onthe historical exercise pattern of groups of employees that have similarhistorical exercise behavior. The expected risk-free interest rate is based onthe U.S. Treasury yield curve in effect at the time of the grant. Historically,we have not paid dividends and we do not anticipate paying dividends in theforeseeable future; accordingly, our expected dividend rate is zero. Theestimate of fair value at grant date is not revised based on subsequentexperience. Net share-based compensation expense recognized is also affected byour estimate of the number of stock option grants that will be forfeited priorto vesting and the tax benefit that will be realized if the stock option grantsare exercised. We use historical information to estimate employee terminationand the resulting option forfeiture rate. These factors are revised based onsubsequent experience, and such revised estimates may have a material impact onour expense recognition and adjustments to additional paid-in capital in futureperiods.

***Businesscombination accounting.****  *We have acquired a number of businesses duringthe last several years, and we may acquire additional businesses in the future.Business combination accounting, often referred to as purchase accounting,requires us to determine the fair value of all assets acquired, includingidentifiable intangible assets, and liabilities assumed. The cost of theacquisition is allocated to the assets acquired and liabilities assumed inamounts equal to the fair value of each asset and liability, and any remainingacquisition cost is classified as goodwill. This allocation process requiresextensive use of estimates and assumptions, including estimates of future cashflows to be generated by the acquired assets. 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. Theestimated useful lives of amortizable identifiable intangible assets range from1 to 14 years. Goodwill is not amortized. Accordingly, the acquisition costallocation has had, and will continue to have, a significant impact on ourcurrent operating results.

***Goodwill.***   Weassess goodwill, which is not subject to amortization, for impairment as ofeach July 31 and also at any other date when events or changes in circumstancesindicate that the carrying value of these assets may exceed their fair value. Thisassessment is performed at a reporting unit level. A reporting unit is acomponent of a segment that constitutes a business, for which discretefinancial information is available, and for which the operating results areregularly reviewed by management. We develop an estimate of the fair value ofeach reporting unit, using both a market approach and an income approach.

A change in events or circumstances, including adecision to hold an asset or group of assets for sale, a change in strategicdirection, or a change in the competitive environment, could adversely affectthe fair value of one or more reporting units. The estimate of fair value ishighly subjective and requires significant judgment. If we determine that thefair value of any reporting unit is less than the reporting unit’s carryingvalue, then we will recognize an impairment charge. If goodwill on our balancesheet becomes impaired during a future period, the resulting impairment chargecould have a material impact on our results of operations and financial condition.Our goodwill totaled $260.8 million as of September 30, 2006.

***Identifiableintangible assets.***   Each period weevaluate whether events and circumstances warrant a revision to the remainingestimated useful life of each identifiable intangible asset. If events andcircumstances warrant a change to the estimate of an identifiable intangibleasset’s remaining useful life, then the remaining carrying amount of theidentifiable intangible asset would be amortized prospectively over thatrevised remaining useful life. Furthermore, information developed during ourannual assessment, or other events and circumstances, may indicate that thecarrying value of one or more identifiable intangible assets is not recoverableand its fair value is less than the identifiable intangible asset’s carryingvalue and would result in recognition of an impairment charge.

A change in the estimate of the remaining life of oneor more identifiable intangible assets or the impairment of one or moreidentifiable intangible assets could have a material impact on our results ofoperations and financial condition. Our identifiable intangible assets’carrying value, net of amortization, was $46.8 million as of September 30,2006.

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**Results ofOperations for the Three Months Ended September 30, 2006 Compared with theThree Months EndedSeptember 30, 2005**

To enhance comparability to prior periods, throughoutour management discussion and analysis we separately identify the operating resultsof the recently acquired entities, nMatrix, Hilsoft, Epiq Advisory Services(collectively, the recently acquired entities), which were not included in ouroperating results for the same period in the prior year.

Certain amounts related to our results for the threemonths ended September 30, 2005 have been restated (see Note 10 to thecondensed consolidated financial statements). As applicable, all referencesbelow are to the restated amounts.

**ConsolidatedResults**

***Revenue***

Total revenue of $39.0 million for the three monthsended September 30, 2006 represents an increase of $12.7 million, orapproximately 48%, compared to $26.3 million of revenue during the same periodin the prior year. A significant part of our total revenue consists ofreimbursement for direct costs we incur, such as postage related to documentmanagement services. We reflect the operating revenue from these reimburseddirect costs as a separate line item on our accompanying condensed consolidatedstatements of income. Although reimbursed operating revenue and expenses mayfluctuate significantly from quarter to quarter, these fluctuations have aminimal effect on our operating income as we realize little or no margin fromthis revenue. Operating revenue exclusive of revenue from reimbursed directcosts, which we refer to as operating revenue before reimbursed direct costs,increased approximately $14.3 million, or approximately 71%, to $34.4 millionfor the three months ended September 30, 2006 compared to $20.1 million for thesame period in the prior year. Exclusive of the results of recently acquiredentities, operating revenue before reimbursed direct costs increasedapproximately $6.0 million, or approximately 30%, to approximately $26.1million for the three months ended September 30, 2006 compared to approximately$20.1 million for the same period in the prior year primarily as a result of anapproximate $9.2 million increase in case management revenue combined with a$3.2 million decrease in document management revenue. Operating revenueexclusive of revenue from reimbursed direct costs may fluctuate considerablyfrom period to period based on clients’ business requirements. All revenue isdirectly related to a segment, and changes in revenue by segment are discussedbelow.

***Costs and Expenses***

Direct cost of services increased approximately $0.7million, or approximately 8%, to $9.3 million for the three months endedSeptember 30, 2006 compared with $8.6 million during the same period in theprior year. Exclusive of direct costs related to recently acquired entities,direct costs decreased approximately $1.2 million, or approximately 14%, toapproximately $7.4 million for the three months ended September 30, 2006compared with approximately $8.6 million for the same period in the prior year.This decrease is primarily attributable to a $0.9 million decrease in outsideservices as lower class action sales reduced the need for such services. Changesin segment costs are discussed, by segment, below.

Reimbursed direct costs decreased approximately $1.5million, or approximately 24%, to $4.7 million for the three months endedSeptember 30, 2006 compared with $6.2 million during the same period in theprior year. Exclusive of direct costs related to recently acquired entities,direct costs decreased approximately $1.7 million, or approximately 27%, toapproximately $4.5 million for the three months ended September 30, 2006,compared with approximately $6.2 million for the same period in the prior year.This decrease is directly attributable to the decrease in operating revenuefrom reimbursed direct costs.

General and administrative costs increasedapproximately $5.4 million, or approximately 76%, to $12.4 million for thethree months ended September 30, 2006 compared to $7.0 million for the sameperiod in the prior year. Exclusive of general and administrative costs relatedto recently acquired entities, these costs increased $2.3 million, orapproximately 32%, to approximately $9.3 million for the three months endedSeptember 30, 2006 compared with approximately $7.0 million for the same periodin the prior year. This increase is primarily attributable to an increase inadministrative expenses to support the expansion of our business, including a$1.0 million increase in travel and promotional expense and a $0.8 millionincrease in professional fees. In addition, we also recognized share-basedexpense of $0.4 million resulting from adoption of SFAS 123R. Changes insegment costs are discussed, by segment, below.

Depreciation and software and leasehold amortizationcosts increased approximately $0.9 million, or approximately 52%, to $2.6million for the three months ended September 30, 2006 compared with $1.7million during the same period in the prior year. Exclusive of depreciation andsoftware and leasehold amortization costs related to recently acquiredentities, these costs 

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increased $0.3 million to approximately $2.0 millionfor the three months ended September 30, 2006 compared with approximately $1.7million for the same period in the prior year. Changes in segment costs arediscussed, by segment, below.

Amortization of identifiable intangible assets,compared with the same period in the prior year, increased $1.6 million to $3.0million for the three months ended September 30, 2006. All identifiableintangible assets are directly related to a segment, and changes inamortization of identifiable intangible assets by segment are discussed below.

We did not recognize any acquisition related expenseduring the three months ended September 30, 2006. During the three months endedSeptember 30, 2005, we recognized acquisition related expense of $0.1 millionresulting from incremental third party expenses incurred in connection withpotential transactions that were not completed.

***Interest Expense***

We incurred interest expense of $2.5 million for thethree months ended September 30, 2006 compared with interest expense of $1.6million during the same period in the prior year. The increase in interestexpense during the three months ended September 30, 2006 compared with the sameperiod in the prior year resulted primarily from a $1.8 million increase ininterest expense related to increased borrowings under our credit facility insupport of the acquisition of our electronic discovery business in November2005. Also contributing to the increase in interest expense was an increase of$0.3 million in loan fee amortization and accretion expense. These increaseswere partly offset by a $1.2 million decrease in interest expense related tothe change in value of the embedded option related to the outstandingconvertible debt.

***Effective Tax Rate***

Our effective tax rate to record the tax expenserelated to our net income was 40.6% for the three months ended September 30,2006 compared with a 224% effective tax benefit rate to record the tax benefitrelated to our pre-tax loss for the three months ended September 30, 2005. Theeffective tax rate for the three months ended September 30, 2005 was unusuallyhigh as the estimated aggregate annual expenses not deductible for tax purposeswere significant in relation to income. The 2006 tax rate is higher than thestatutory federal rate of 35% primarily due to state taxes. We have significantoperations located in New York City that are subject to state and local taxrates that are higher than the tax rates assessed by other jurisdictions wherewe operate.

***Net Income***

During the three months ended September 30, 2006, wehad net income of $2.7 million compared with net income of $0.5 million for thesame period in the prior year. This change is attributable to a combination offactors. As a result of our 2003 Arrangement discussed above, during the threemonths ended September 30, 2006, we recognized $6.0 million of previouslydeferred revenue; during the same period in the prior year, we had deferred$5.7 million of revenue related to the 2003 Arrangement. This increase waspartly offset by a decline in class action revenue as a result of fewer newclient retentions, a $2.7 million increase in our tax expense, a $1.6 million increasein intangible amortization as a result of our recent acquisitions, a $0.9million increase in interest expense primarily resulting from the increase inaverage borrowings outstanding under our credit facility as a result of ouracquisition of our electronic discovery business in November 2005, and a $0.6million increase in recognized share-based compensation expense as a result ofthe adoption of SFAS 123R.

**Business Segments**

The following management discussion and analysis ispresented on a basis consistent with our segment disclosure contained in Note 9of our Notes to Condensed Consolidated Financial Statements.

***Case Management Segment***

Case management operating revenue before reimburseddirect costs increased $17.1 million, or approximately 134%, to $29.8 millionfor the three months ended September 30, 2006 compared to $12.7 million duringthe same period in the prior year. During the three months ended September 30,2006, operating revenue before reimbursed direct costs from recently acquiredentities totaled $7.8 million. The remainder of the increase is primarily dueto an increase in bankruptcy operating revenue. As a result of our 2003Arrangement discussed above, during the three months ended September 30, 2006,we recognized $6.0 million of previously deferred revenue; during the sameperiod in the prior year, we had deferred $5.7 million of revenue related tothe 2003 Arrangement. This increase was partly offset by an approximate $2.3million decrease in class action case management revenue.

Case management direct and administrative expenses,including depreciation and software and leasehold amortization, of $12.8million increased $5.2 million, or approximately 68%, for the three monthsended September 30, 2006 compared with $7.6 million during the same period inthe prior year. During the three months ended September 30, 2006, direct and 

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administrative expenses, including depreciation andsoftware and leasehold amortization, from recently acquired entities totaled$5.2 million. Exclusive of these recently acquired businesses, our direct andadministrative expenses, including depreciation and software and leaseholdamortization, totaled approximately $7.6 million for both the three monthsended September 30, 2006 and 2005.

Amortization of case management’s identifiableintangible assets increased to $2.5 million for the three months endedSeptember 30, 2006 compared with $1.1 million for the same period in the prioryear. This increase is primarily the result of amortization of additional identifiableintangible assets, resulting primarily from the acquisition in November 2005 ofour electronic discovery business.

***Document Management Segment***

Document management operating revenue beforereimbursed direct costs decreased $2.8 million, or approximately 38%, to $4.6million for the three months ended September 30, 2006 compared to $7.4 millionduring the same period in the prior year. For the three months ended September30, 2006, operating revenue before reimbursed direct costs from recently acquiredentities totaled $0.4 million. Exclusive of this recently acquired business,operating revenue before reimbursed direct costs decreased $3.2 million. Thisdecrease primarily relates to noticing activity resulting from fewer clientretentions in our class action business. Additionally, even large notices arecompleted in a short time frame and, therefore, this revenue tends to bevolatile. During the three months ended September 30, 2005 we had several largecorporate restructuring and class action noticing activities, while during thethree months ended September 30, 2006 our client’s did not have any largenotice requirements. Document management revenues can fluctuate considerablyfrom period to period based on clients’ business requirements.

Document management direct and administrativeexpenses, including depreciation and software and leasehold amortization, of$7.4 million decreased $2.3 million, or approximately 24%, for the three monthsended September 30, 2006 compared with $9.7 million for the same period in theprior year. For the three months ended September 30, 2006, such expensesincluded $0.6 million of direct and administrative expenses, includingdepreciation and software and leasehold amortization, related to recentlyacquired entities. Exclusive of this recently acquired business, direct andadministrative expenses, including depreciation and software and leaseholdamortization, decreased $2.9 million, or 30%, primarily as a result of adecreases in reimbursable direct costs and outside services, both of which areprimarily attributable to the decrease in operating revenue. Documentmanagement expenses can fluctuate from quarter to quarter based on documentmanagement business requirements delivered during each quarter.

Amortization of document management’s identifiableintangible assets increased to $0.5 million for the three months endedSeptember 30, 2006 compared with $0.4 million for the same period in the prioryear. This increase is primarily the result of amortization of other intangibleassets, resulting from the acquisition of our legal notification business.

**Results of Operations for the Nine Months EndedSeptember 30, 2006 Compared with the Nine Months Ended September 30, 2005**

To enhance comparability to prior periods, throughout ourmanagement discussion and analysis we separately identify the operating resultsof the recently acquired entities, nMatrix, Hilsoft, Epiq Advisory Services(collectively, the recently acquired entities), which were not included in ouroperating results for the same period in the prior year.

Certain amounts related to our results for the ninemonths ended September 30, 2005 have been restated (see Note 10 to thecondensed consolidated financial statements). As applicable, all referencesbelow are to the restated amounts.

**ConsolidatedResults**

***Revenue***

Total revenue of $177.7 million for the nine monthsended September 30, 2006 increased approximately 133% compared with $76.3million of total revenue for the same period in the prior year. A significantpart of our total revenue consists of reimbursement for direct costs we incur,such as postage related to document management services. We reflect theoperating revenue from these reimbursed direct costs as a separate line item onour accompanying condensed consolidated statements of income. Althoughreimbursed operating revenue and the related direct costs may fluctuatesignificantly from period to period, these fluctuations have a minimal effecton our operating income as we realize little or no margin from this revenue. Revenueexclusive of reimbursed direct costs, which we refer to as operating revenuebefore reimbursed direct costs, increased approximately $101.9 million, orapproximately 172%, to $161.1 million for the nine months ended September 30,2006 compared to $59.2 million for the same period in the prior year. Exclusiveof the results of recently acquired entities, 

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operating revenue before reimbursed direct costsincreased approximately $68.3 million, or approximately 115%, to approximately$127.5 million for the nine months ended September 30, 2006 compared toapproximately $59.2 million for the same period in the prior year. Thisincrease is primarily as a result of an approximate $71.1 million increase incase management revenue partly offset by a $2.8 million decrease in documentmanagement revenue. Operating revenue exclusive of revenue from reimburseddirect costs may fluctuate considerably from period to period based on clients’business requirements. All revenue is directly related to a segment, andchanges in revenue by segment are discussed below.

***Costs and Expenses***

Direct cost of services increased $11.6 million, orapproximately 47%, to $36.4 million for the nine months ended September 30,2006 compared with $24.8 million for the same period in the prior year. Exclusiveof direct costs related to recently acquired entities, direct cost of servicesdecreased $0.2 million, or approximately 1%, to $24.6 million for the ninemonths ended September 30, 2006 compared with $24.8 million for the same periodin the prior year. This decrease is primarily attributable to a $0.9 milliondecrease in outside service costs, partly offset by a $0.4 million increase inshare-based compensation expense resulting from adoption of SFAS 123R. Changesin segment costs are discussed, by segment, below.

Reimbursed direct costs decreased approximately $0.4million, or approximately 3%, to $16.9 million for the nine months endedSeptember 30, 2006 compared with $17.3 million during the same period in theprior year. Exclusive of direct costs related to recently acquired entities,direct costs decreased approximately $1.2 million, or approximately 7%, toapproximately $16.1 million for the nine months ended September 30, 2006compared with approximately $17.3 million for the same period in the prioryear. This decrease is directly attributable to the decrease in operatingrevenue from reimbursed direct costs.

General and administrative costs increasedapproximately $13.4 million, or approximately 58%, to $36.5 million for thenine months ended September 30, 2006 compared with $23.1 million for the sameperiod in the prior year. Exclusive of general and administrative costs relatedto recently acquired entities, these costs increased approximately $4.0million, or approximately 17%, to $27.1 million for the nine months endedSeptember 30, 2006 compared with $23.1 million for the same period in the prioryear. This increase is primarily attributable to an increase in administrativeexpenses to support the expansion of our business, including a $1.8 millionincrease in travel and promotional expense related to the expansion of ourbusiness and a $1.9 million increase in compensation expense, primarily relatedto the recognition of share-based expense resulting from adoption of SFAS 123R.Changes in segment costs are discussed, by segment, below.

Depreciation and software and leasehold amortizationcosts increased approximately $2.1 million, or approximately 41%, to $7.4million for the nine months ended September 30, 2006 compared with $5.3 millionfor the same period in the prior year. Exclusive of depreciation and softwareand leasehold amortization costs related to recently acquired entities, thesecosts increased approximately $0.4 million, or approximately 8%, to $5.7 millionfor the nine months ended September 30, 2006 compared with $5.3 million for thesame period in the prior year. Changes in segment costs are discussed, bysegment, below.

Amortization of identifiable intangible assets,compared with the same period in the prior year, increased $4.2 million to $8.7million for the nine months ended September 30, 2006 compared with $4.5 millionfor the same period in the prior year. All identifiable intangible assets aredirectly related to a segment, and changes in amortization of identifiableintangible assets by segment are discussed below.

Acquisition related expenses were $0.3 million for thenine months ended September 30, 2006 compared with $0.1 million for the sameperiod in the prior year. These expenses result from non-capitalized expensesincurred in connection with completed transactions and from incremental thirdparty expenses incurred in connection with potential transactions which werenot completed.

***Interest Expense***

We incurred interest expense of $9.2 million for thenine months ended September 30, 2006 compared with interest expense of $4.3million for the same period in the prior year. This increase primarily is theresult of a $5.4 million increase in interest expense related to our creditfacility, primarily resulting from the increase in average borrowingsoutstanding under our credit facility as a result of our acquisition of ourelectronic discovery business in November 2005. Also contributing to theincrease in interest expense was an increase of $0.5 million in loan feeamortization and accretion expense. These increases were partly offset by a$1.0 million decrease in interest expense related to the change in value of theembedded option related to the outstanding convertible debt.

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***Effective Tax Rate***

Our effective tax rate to record the tax expenserelated to our net income was 40.5% for the nine months ended September 30,2006 compared with a 107% effective tax benefit rate to record the tax benefitrelated to our pre-tax loss for the nine months ended September 30, 2005. Theeffective tax rate for the nine months ended September 30, 2005 was unusuallyhigh as the estimated aggregate annual expenses not deductible for tax purposeswere significant in relation to income. The 2006 tax rate is higher than thestatutory federal rate of 35% primarily due to state taxes. We have significantoperations located in New York City that are subject to state and local taxrates which are higher than the tax rates assessed by other jurisdictions wherewe operate.

***Net Income***

Net income increased approximately $37.0 million to$37.2 million for the nine months ended September 30, 2006 compared with $0.2million for the same period in the prior year. This change is attributable to acombination of factors. As a result of our 2003 Arrangement discussed above,during the nine months ended September 30, 2006, we recognized $59.7 million ofpreviously deferred revenue; during the same period in the prior year, we haddeferred $18.8 million of revenue related to the 2003 Arrangement. Thisincrease was partly offset by a decline in class action revenue as a result offewer new client retentions, a $28.5 million increase in our tax expense, a$4.9 million increase in interest expense primarily resulting from the increasein average borrowings outstanding under our credit facility as a result of ouracquisition of our electronic discovery business in November 2005, a $4.2million increase in intangible amortization as a result of our recentacquisitions, and a $1.7 million increase in recognized share-basedcompensation expense as a result of the adoption of SFAS 123R.

**Business Segments**

The following management discussion and analysis ispresented on a basis consistent with our segment disclosure contained in Note 9of our Notes to Condensed Consolidated Financial Statements.

***Case Management Revenue***

Case management operating revenue before reimburseddirect costs increased $95.3 million, or approximately 243%, to $134.6 millionfor the nine months ended September 30, 2006 compared to $39.3 million for thesame period in the prior year. During the nine months ended September 30, 2006,operating revenue before reimbursed direct costs from recently acquiredentities totaled $24.3 million. Exclusive of the recently acquired entities revenues,operating revenue before reimbursed direct costs increased by $71.1 millioncompared to the same period in the prior year. This increase is primarily dueto an increase in bankruptcy operating revenue. As a result of our 2003Arrangement discussed above, during the nine months ended September 30, 2006,we recognized $59.7 million of previously deferred revenue; during the sameperiod in the prior year, we had deferred $18.8 million of revenue related tothe 2003 Arrangement. This increase was partly offset by an approximate $9.0million decrease in class action case management revenue.

Case management direct and administrative expenses,including depreciation and software and leasehold amortization, increasedapproximately 61% to $37.7 million for the nine months ended September 30, 2006compared with $23.4 million for the same period in the prior year. During thenine months ended September 30, 2006, direct and administrative expenses,including depreciation and software and leasehold amortization, from recentlyacquired entities totaled $14.7 million. Exclusive of these recently acquiredentities expenses, our direct and administrative expenses, includingdepreciation and software leasehold amortization, decreased by approximately$0.4 million. This decrease in direct and administrative expenses, includingdepreciation and software and leasehold amortization, is primarily attributableto a $0.9 million decrease in class action outside services expenses.

Amortization of case management’s identifiable intangibleassets increased to $7.2 million for the nine months ended September 30, 2006compared with $3.3 million for the same period in the prior year. This increaseis primarily the result of amortization of additional other intangible assets,resulting primarily from the acquisition of our electronic discovery business.

***Document Management Segment***

Document management operating revenue beforereimbursed direct costs increased $6.6 million, or approximately 33%, to $26.5million for the nine months ended September 30, 2006 compared to $19.9 millionfor the same period in the prior year. For the nine months ended September 30,2006, operating revenue before reimbursed direct costs from recently acquiredentities totaled $9.4 million. Exclusive of these recently acquired entitiesrevenues, operating revenue before reimbursed direct costs decreased $2.8million. This decrease is primarily attributable to fewer client retentions inour class action business. Document management revenue can fluctuate fromperiod to period based on clients’ business requirements.

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Document management direct and administrativeexpenses, including depreciation and software and leasehold amortization, of$34.1 million increased $7.7 million, or approximately 29%, for the nine monthsended September 30, 2006 compared to $26.4 million for the same period in theprior year. This increase is primarily attributable to the inclusion of $9.0million of direct and administrative expenses, including depreciation andsoftware and leasehold amortization, related to recently acquired entities. Exclusiveof these recently acquired entities expenses, direct and administrativeexpenses, including depreciation and software and leasehold amortization,decreased $1.3 million primarily from decreases in reimbursable direct costsand outside services. Outside service costs will vary depending on the natureand complexity of services provided. Document management expenses willfluctuate from period to period based on document management businessrequirements delivered during each period.

Amortization of document management’s identifiableintangible assets increased to $1.5 million, for the nine months endedSeptember 30, 2006 compared to $1.2 million for the same period in the prioryear. This increase is primarily the result of amortization of additional otherintangible assets, resulting from the acquisition of our acquired legalnotification business.

**Liquidity andCapital Resources**

***Operating Activities***

During the nine months ended September 30, 2006, the primarysource of cash from operating activities was net income of $37.2 million,adjusted for $40.8 million of non-cash charges and credits, primarilydepreciation and amortization. Changes in net operating assets, primarily as aresult of a decrease in deferred revenue, partly offset by decreases in tradeaccounts receivable and income taxes refundable, resulted in a $54.4 millionuse of cash. Deferred revenue decreased by approximately $59.4 million,primarily as a result of recognition of previously deferred amounts on deliveryin the second quarter 2006 of our final software upgrade under our 2003Arrangement. Trade accounts receivable, which will fluctuate from period toperiod depending on the timing of collections, decreased primarily as a resultof increased collections related to our electronic discovery business. Incometaxes refundable decreased primarily as a result of the receipt of refunds dueto us. As a result, our operating activities generated net cash of $23.6million for the nine months ended September 30, 2006.

***Investing Activities***

During the nine months ended September 30, 2006, weused cash of approximately $5.2 million to purchase property and equipment. Ourproperty and equipment purchases consisted primarily of computer related hardwareto support our electronic discovery and bankruptcy businesses. Enhancements toour existing software and development of new software is essential to ourcontinued growth and we used cash of approximately $3.3 million to fundinternal costs related to development of software for which technologicalfeasibility has been established. We also used approximately $3.6 million ofcash to partly fund an acquisition. We believe that cash generated fromoperations will be adequate to fund our anticipated property, equipment andsoftware spending over the next year.

***Financing Activities***

During the nine months ended September 30, 2006, wepaid approximately $10.0 million as a principal reduction on our senior termloan, $1.7 million as a principal reduction on deferred acquisition debt, and$0.9 million due on capital leases, and we repaid, net of borrowings, $14.0million of our senior revolving loan. This financing use of cash was partlyoffset by $2.6 million of net proceeds from stock issued in connection with theexercise of employee share options. As a result of adoption of SFAS 123R, wealso classify a portion of the tax benefit, referred to as excess tax benefit,that we realize on exercise of employee share options as a financing cash flow.The effect of this accounting change was to recognize $0.2 million of excesstax benefit as a financing cash flow rather than as an operating cash flow.

As of September 30, 2006, our borrowings consisted of$51.0 million from the contingent convertible subordinated notes (including thefair value of the embedded option), $15.0 million under our senior term loan,$82.0 million under our senior revolving loan, and approximately $12.1 millionof obligations related to capitalized leases and deferred acquisition price.Our convertible debt of $50.0 million matures on June 15, 2007. The convertiblenotes will require the use of cash at their scheduled maturity in June 2007 ifthe note holders do not extend the maturity of the notes, at their option, anddo not convert the notes into shares of our common stock. If the maturity ofthe notes is extended or if they are converted into shares of our common stockprior to the scheduled maturity of those notes, then there will be no cashrequirements associated with those convertible notes, other than the regularpayment of interest on the outstanding notes. We anticipate continuing to payinterest on the notes from cash flow from operations, and we anticipate payingthe principal of any maturing notes from the sources discussed below.

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As of September 30, 2006, significant financialcovenants, all as defined within our credit facility agreement, include aleverage ratio not to exceed 3.50 to 1.00, a senior leverage ratio not toexceed 2.50 to 1.00, a fixed charge coverage ratio of not less than 1.25 to1.00, and a current ratio of not less than 1.50 to 1.00. As of September 30,2006, we were in compliance with all covenants in our credit facility,including all financial covenants. However, as a result of the restatement thatresulted in the deferral of a substantial portion of revenue related to the2003 Arrangement as described in Note 10, we were not in compliance with thesefinancial covenants through March 31, 2006. The deferral of revenue throughMarch 31, 2006, and the recognition of the deferred revenue during the secondand third quarter of 2006, were not anticipated by us or the banks at the timewe established the current financial covenants in the credit facility. We willrequest waivers, as deemed necessary, for the pre-existing events ofnoncompliance related to the financial restatement. We have classified thisdebt as a current liability in the accompanying condensed consolidated balancesheets.

We may pursue acquisitions in the future. Covenantscontained in our credit facility and in our convertible notes may limit ourability to consummate an acquisition. Pursuant to the terms of our creditfacility, we generally cannot incur indebtedness outside the credit facilitywith the exception of capital leases and additional subordinated debt, with alimit of $100.0 million of aggregate subordinated debt. Furthermore, for anyacquisition we must be able to demonstrate that, on a pro forma basis, we wouldbe in compliance with our covenants during the four quarters prior to theacquisition and we must obtain bank permission for any acquisition for whichcash consideration exceeds $65.0 million or total consideration exceeds $125.0million.

We believe that the funds generated from operationsplus our existing cash resources and amounts available under our seniorrevolving loan facility will be sufficient over the next 12 months to financecurrently anticipated working capital requirements, software expenditures,property and equipment expenditures, common share price protection payments, ifany, related to common shares issued in conjunction with the acquisition of ourelectronic discovery business, principal payments due under the creditfacility, deferred acquisition price agreements and capital leases, interestpayments due on our outstanding borrowings, and payments for other contractualobligations. As noted above, if the holders of our outstanding convertiblenotes do not either (i) extend the maturity of those notes, at the option ofthe note holders, or (ii) convert the notes into shares of our common stock inaccordance with the terms of the notes, those notes, in the outstandingprincipal amount of $50 million, will mature on June 15, 2007. If those notesmature at that time, our cash flow from operations from the date of this reportthrough that maturity date is not anticipated to be sufficient to pay thosenotes (after the uses of anticipated cash flow from operations to meet ourother normal uses of cash described above).

Based on our current covenant calculations, as ofSeptember 30, 2006, we would have the ability to borrow all of our revolvingloan capacity, including the increase in capacity from the current $100.0million to $175.0 million. However, this borrowing capacity is substantiallythe result of the recognition of $66.1 million of deferred revenue from therestatement during the second and third quarters of 2006; deferral of thatrevenue in the past and recognition of the deferred revenue in 2006 was notanticipated by us or the banks at the time we established the current financialcovenants contained in the credit facility. We anticipate working with thelending banks to modify these covenants to exclude the significant effect ofthe recognition of this deferred revenue. We could increase liquidity byincreasing our current senior revolving loan from $100.0 million to $175.0million, subject to compliance with certain covenants under the amended creditfacility, by restructuring our credit facility, through the disposition ofnon-strategic assets, or through the issuance of debt or equity securities.

**Off-balance SheetArrangements**

As a part of the purchase price consideration toacquire nMatrix, we issued 1.2 million shares of our common stock to theseller. As explained in Note 4 to the condensed consolidated financial statements,under certain circumstances we may be required to pay the difference between$20.35 per share and the price at which the seller sells the shares. Payments,if any, made under this arrangement will result in cash outflows. Based on ourSeptember 30, 2006 closing price of $14.71 per share, as of September 30, 2006,the guarantee amount was approximately $6.9 million. As discussed under thecaption “Liquidity and Capital Resources — Financing Activities” above, webelieve cash generated from operations plus amounts available under our seniorrevolving loan facility will provide adequate liquidity to make any requiredpayments under this arrangement. The shares subject to this arrangement arecurrently unregistered; however, we anticipate these shares will be registeredand available for sale in the future.

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**Contractual Obligations**

The following table setsforth a summary of our contractual obligations and commitments, excludingperiodic interest payments, for each twelve month period ending September 30(in thousands):
| ** **                                   | ** ** | **Payments Due By Period** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligation**              | ** ** | **Total**                                 | ** ** | **Less than  1 Year** | ** ** | **1 - 3 Years** | ** ** | **3 - 5 Years** | ** ** | **More Than  5 Years** | ** ** |
|                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Long-term debt and  future accretion (1) (3) |       | $                                         | 159,513    |   | $ | 152,920 |   | $ | 4,593 |   | $ | 2,000 |   | $ | — |   |
| Employment agreements (2)                    |       | 9,216                                     |       | 3,397 |   | 4,206 |   | 1,613 |   | — |   |
| Capital lease  obligations                   |       | 31                                        |       | 31 |   | — |   | — |   | — |   |
| Operating leases                             |       | 35,262                                    |       | 5,356 |   | 9,073 |   | 7,965 |   | 12,868 |   |
| Total                                        |       | $                                         | 204,022    |   | $ | 161,704 |   | $ | 17,872 |   | $ | 11,578 |   | $ | 12,868 |   |

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(1)         A portion of the purchaseprice of certain acquisitions were in the form of notes on which the interestrate was below our incremental borrowing rate, and which were discounted usingour estimated incremental borrowing rate. The discounts are accreted over the life of the note and each period’saccretion is added to the principal of the respective note.  The amount in the above contractualobligations table includes both the notes’ principal, as reflected on ourSeptember 30, 2006 condensed consolidated balance sheet, and all futureaccretion.  If certain financialobjectives are satisfied, we will make additional payments over the next fiveyears related to our acquisition of Hilsoft and Epiq Advisory Services.  Such payments, if any, are not included inthe above contractual obligation table. To date, no such payments have been made or accrued.  Convertible debt is included at the statedvalue of the principal redemption and excludes adjustments related to theembedded option, which will not be paid in cash.  Any conversion to our common stock of part orall of the convertible debt will reduce our cash obligation related to theconvertible debt.

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

(3)       As a result of ourrestatement (see Note 10 to the condensed consolidated financial statements),we were not in compliance with the financial covenants contained in our primarydebt instruments as of or prior to March 31, 2005.  Although we are in compliance with ourfinancial covenants as of September 30, 2006, we have not yet requested awaiver of our prior event of noncompliance and, accordingly, we have classifiedthe related debt as a current liability. The deferral of revenue through March 31, 2006, and the recognition ofthe deferred revenue during the second and third quarter of 2006, were notanticipated by us or the banks at the time we established the current financialcovenants in the credit facility.

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**Recent Accounting Pronouncements**

In September 2006, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards No. 157, *Fair Value Measurements*(SFAS 157).  SFAS 157 defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair value measurements.  SFAS 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those fiscal years. We do not anticipate that adoption of this statement will have amaterial impact on our consolidated financial statements.

In June 2006, FASB issuedInterpretation No. 48, *Accounting for Uncertaintyin Income Taxes* (FIN 48).  FIN48 applies to tax positions accounted for under Statement of FinancialAccounting Standard No. 109, *Accounting for IncomeTaxes*.  A tax positionincludes a current or future reduction in taxable income reported or expectedto be reported on a tax return, the decision not to report a transaction in atax return, and an assertion that a company is not subject to taxation.  FIN 48 requires that a tax position berecognized only if it is more-likely-than-not to be sustained based solely onits technical merits as of the reporting date. A recognized tax benefit is measured based on the largest benefit thatis more than 50 percent likely to be realized. FIN 48 is effective for an entity’s first fiscal year that begins afterDecember 15, 2006.  At adoption, anynecessary adjustment to our financial statements will be recorded directly tothe beginning balance of retained earnings in the period of adoption andreported as a change in accounting principle. At this time, we are unable to predict the impact, if any, that adoptionof FIN 48 will have on our consolidated financial statements.

In June 2006, the EITFreached a consensus regarding EITF 05-1, *Accounting for theConversion of an Instrument That Becomes Convertible Upon the Issuer’s Exerciseof a Call Option*.  EITF 05-1pertains only to debt instruments that become convertible at the time theissuer calls the debt, but are not convertible before the call isexercised.  Conversions of theseinstruments triggered by the call option would be accounted for as debtconversions and recognized as debt extinguishments if the debt instrument did notcontain a substantive conversion feature at issuance.  EITF 05-1 will be effective for conversionsthat occur as a result of the issuer’s exercise of a call option in the interimor annual period beginning after September 28, 2006. We do not anticipate thatadoption of this statement will have a material impact on our consolidatedfinancial statements.

In February 2006, theFASB issued Statement of Financial Accounting Standard No. 155, *Accounting for Certain Hybrid Financial Instruments—an amendment ofFASB Statements No. 133 and 140* (SFAS 155).  SFAS 155 allows an entity to make anirrevocable election to measure a financial instrument with an embeddedderivative, referred to as a hybrid financial instrument, at fair value in itsentirety rather than bifurcating and separately valuing the embedded derivativeinstrument.  SFAS 155 is effective forall financial instruments acquired, issued, or subject to a remeasurement (newbasis) event occurring after the beginning of an entity’s first fiscal yearthat begins after September 15, 2006.  Wedo not anticipate that adoption of this statement will have a material impacton our consolidated financial statements.

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**Forward-Looking Statements**

In this report, inother filings with the SEC, and in press releases and other public statementsby our officers throughout the year, Epiq Systems, Inc. makes or will makestatements that plan for or anticipate the future.  These forward-looking statements includestatements about our future business plans and strategies, and other statementsthat are not historical in nature.  Theseforward-looking statements are based on our current expectations.  In this Quarterly Report on Form 10-Q, wemake 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 of 1933, asamended, 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)the resolution of the accounting matter that we have presented to the SECOffice of the Chief Accountant and risks associated with the market reaction tothe restatement of our financial statements as a result, (2) potential eventsof non-compliance under our senior credit agreement and convertible notesagreement as a result of the restatement of our financial statements and otherrisks associated with our indebtedness, (3) the expenses associated with theresolution of this technical accounting matter, including anticipated futureexpenses associated with the restatement, waivers or amendments under our debtagreements and related regulatory-related accounting and legal expenses, (4)risks associated with the application of complex accounting rules to uniquetransactions, including the risk that good faith application of those rules andaudits of those results may be later reversed by new interpretations of thoserules or new views regarding the application of those rules, (5) any materialchanges in our total number of client engagements and the volume associatedwith each engagement, including the results for 2006 to date in our classaction client engagements, (6) any material changes in our Chapter 7 depositportfolio, the services required or selected by our electronic discovery,Chapter 11, Chapter 13, class action or mass tort engagements, or the number ofcases processed by our Chapter 13 bankruptcy trustee clients, (7) materialchanges in the number of bankruptcy filings, class action filings or mass tortactions each year, (8) our reliance on our marketing and pricing arrangementswith Bank of America and other depository banks (9) risks associated with theintegration of acquisitions, particularly nMatrix, into our existing businessoperations, and (10) other risks detailed from time to time in our SEC filings,including our annual report on Form 10-K. 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 MarketRisk.**

Marketrisk refers to the risk that a change in the level of one or more marketprices, interest rates, indices, volatilities, correlations or other marketfactors, such as liquidity, will result in losses for a certain financialinstrument or group of financial instruments. Our exposure to market risk has not changed significantly since December31, 2005.

**ITEM 4.          Controlsand Procedures.**

***Disclosure Controls and Procedures***

Anevaluation was carried out by the Epiq Systems, Inc.’s (the Company’s) ChiefExecutive Officer and Chief Financial Officer of the effectiveness of thedesign and operations of the Company’s disclosure controls and procedures asdefined in Exchange Act Rule 13a-15(e). Disclosure controls and procedures are designed to ensure thatinformation required to be disclosed by the Company in its periodic filingswith the SEC is recorded, processed, summarized and reported, within the timeperiods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controlsand procedures designed to ensure that information required to be disclosed bythe Company in the reports that it files or submits to the SEC is accumulatedand communicated to Company’s management, including its principal executive andprincipal financial officers, or persons performing similar functions, asappropriate to allow timely decisions regarding required disclosure.

Duringfiscal year 2006, management identified an accounting error in its consolidatedfinancial statements related to determination of the appropriate accountingtreatment for certain complex aspects of revenue recognition, specifically theevaluation of vendor specific objective evidence of fair value for specifiedsoftware upgrades provided within a bundled arrangement as required byStatement of Position 97-2 (SOP 97-2), *Software RevenueRecognition*.  On November 14,2006, our audit committee determined that our previously issued financialstatements for the fiscal years ended December 31, 2005, 2004 and 2003,included in our Annual Report on Form 10-K for the fiscal year ended December31, 2005, for the quarterly information included in our Annual Report on Form10-K for the fiscal year ended December 31, 2005, and for the quarterlyinformation included in our Quarterly Report on Form 10-Q for the quartersended March 31, 2006 and June 30, 2006, should be restated.  The restatement is further discussed in Note10 to the accompanying condensed consolidated financial statements.  Public Company Accounting Oversight Board’sAuditing Standard No. 2, *An Audit of InternalControl over Financial Reporting Performed in Conjunction with an Audit ofFinancial Statements*, provides that a restatement of previouslyissued financial statements is a strong indicator of the existence of amaterial weakness in the design or operation of internal control over financialreporting.  Management of the Company,under the direction of its CEO and CFO, has reevaluated the effectiveness ofits disclosure controls and procedures (as defined in Exchange Act Rules13a-15(e) and 15d-15(e)) asof September 30, 2006.  Based upon thisevaluation, management has concluded that the control deficiency surroundingmanagement’s oversight of the determination of the appropriate accountingtreatment for certain complex aspects of revenue recognition, specifically theevaluation of vendor specific objective evidence of fair value for specifiedsoftware upgrades provided within a bundled arrangement as required by SOP 97-2represented a material weakness in internal control over financial reporting.  The Company’s management, including its CEOand CFO, concluded that its disclosure controls and procedures were noteffective as of September 30, 2006.

***Changes in Internal Control OverFinancial Reporting***

Therehave been no changes in the Company’s internal controls over financialreporting during the quarter ended September 30, 2006, that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrols over financial reporting.

Afteridentifying the material weakness subsequent to the original issuance of ourAnnual Report on Form 10-K for the fiscal year ended December 31, 2005,management has initiated changes to remediate the material weakness describedabove.  The initiated remedial measures relatedto the identified material weakness in internal control over financialreporting will require, within our internal control framework, that weestablish appropriate controls related to contracts or other arrangements thatare within the scope of SOP 97-2 to provide a written analysis of theappropriate accounting for these contracts or other arrangement and to reviewour conclusions with qualified internal accounting personnel or third partyaccounting experts.  In addition, we willprovide our accounting staff with additional training related to generallyaccepted accounting principles and financial statement reporting matters.  We intend to complete this remediationprocess by December 31, 2006.

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**PART II -OTHER INFORMATION**

**ITEM 1A**.       **Risk Factors.**

There have been nomaterial changes from the risk factors disclosed under the heading “RiskFactors” in Item 1A of our Annual Report on Form 10-K for the year endedDecember 31, 2005, as updated by the risk factors disclosed under the heading “RiskFactors” in Item 1A of our Quarterly Report on Form 10-Q for the three monthsended June 30, 2006.

**Item3.    Defaults Upon Senior Securities.**

Both our credit facilityand subordinated debt contain financial covenants related to earnings beforeinterest, provision for income taxes, depreciation, amortization and otheradjustments as defined in the agreements (EBITDA) and total debt.  In addition, our credit facility alsocontains financial covenants related to senior debt, fixed charges, and workingcapital.  As a result of the restatement,which resulted in the deferral of a substantial portion of revenue related tothe 2003 Arrangement as described in Note 10 to the financial statementsforming a part of this report, we were not in compliance with these financialcovenants through March 31, 2006.  As aresult of recognition of the deferred revenue during the second and thirdquarters of 2006, we are in compliance with all financial covenants as of June30 and September 30, 2006.  The deferralof revenue through March 31, 2006, and the recognition of the deferred revenueduring the second and third quarter of 2006, were not anticipated by us or thebanks at the time we established the current financial covenants in the creditfacility.  We will request waivers, asdeemed necessary, for the pre-existing events of noncompliance related to thefinancial restatement. We have classified this senior credit facility debt as acurrent liability in the condensed consolidated balance sheets included in thisreport.

We have never been indefault in the payment of principal, interest or other installments under thiscredit facility, either before or after the restatement discussed in thisreport.  We have discussed therestatement of our financial statements with representatives of the seniorlenders and anticipate obtaining any required waivers relating to thepre-existing events of noncompliance as a result of the restatements.

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

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

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

32.1                           Certificationsof 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: November  14, 2006 | /s/ Tom W.  Olofson                                |
|                     | Tom W. Olofson                                     |
|                     | Chairman of the  Board                             |
|                     | Chief Executive  Officer                           |
|                     | Director                                           |
|                     | (Principal  Executive Officer)                     |
|                     |                                               |
|                     |                                               |
| Date: November  14, 2006 | /s/ Elizabeth M.  Braham                           |
|                     | Elizabeth M.  Braham                               |
|                     | Executive Vice  President, Chief Financial Officer |
|                     | (Principal  Financial Officer)                     |
|                     |                                               |
|                     |                                               |
| Date: November  14, 2006 | /s/ Douglas W.  Fleming                            |
|                     | Douglas W.  Fleming                                |
|                     | Director of  Finance                               |
|                     | (Principal  Accounting Officer)                    |

 

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