** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D. C. 20549**

**FORM 10-Q**

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

**x**                              Forthe Quarterly Period Ended June 30, 2006

**OR**

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

**Forthe transition period from                     to                     **

**CommissionFile Number 0-22081**

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**EPIQ SYSTEMS, INC.**

(Exact name of registrant as specified in its charter)

 

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

 

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

(Address of principalexecutive 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 xNo 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 July 18, 2006:

|                               | **Class** | ** ** | ** ** | ** ** | **Outstanding** | ** ** |
|-------------------------------|-----------|------------|------------|------------|-----------------|------------|
| Common Stock,  $.01 par value |      | 19,403,061 |

 

 

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

**CONTENTS**
|                                     | ** **                                                                                                          | **Page**   |
|-------------------------------------|---------------------------------------------------------------------------------------------------------------------|------------|
| **PART I - FINANCIAL  INFORMATION** | ** **                                                                                                          | ** ** |
| ** **                          | ** **                                                                                                          | ** ** | ** ** |
| Item 1.                             | Condensed  Consolidated Financial Statements                                                                        |       |   |
|                                |                                                                                                                |       |   |
|                                | Condensed  Consolidated Statements of Income —   Three and six months ended June 30, 2006 and 2005 (Unaudited) |       | 1 |
|                                |                                                                                                                |       |   |
|                                | Condensed  Consolidated Balance Sheets —   June 30, 2006 and December 31, 2005 (Unaudited)                     |       | 2 |
|                                |                                                                                                                |       |   |
|                                | Condensed  Consolidated Statements of Cash Flows —   Six months ended June 30, 2006 and 2005 (Unaudited)       |       | 3 |
|                                |                                                                                                                |       |   |
|                                | Notes to  Condensed Consolidated Financial Statements (Unaudited)                                                   |       | 5 |
|                                |                                                                                                                |       |   |
| Item 2.                             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |       | 21 |
|                                |                                                                                                                |       |   |
| Item  3.                            | Quantitative  and Qualitative Disclosures about Market Risk                                                         |       | 33 |
|                                |                                                                                                                |       |   |
| Item 4.                             | Controls and Procedures                                                                                             |       | 33 |
|                                |                                                                                                                |       |   |
| **PART  II - OTHER INFORMATION**    | ** **                                                                                                          | ** ** |
| ** **                          | ** **                                                                                                          | ** ** | ** ** |
| Item  1A.                           | Risk  Factors                                                                                                       |       | 34 |
|                                |                                                                                                                |       |   |
| Item 4.                             | Submission of  Matters to a Vote of Security Holders                                                                |       | 36 |
|                                |                                                                                                                |       |   |
| Item  6.                            | Exhibits                                                                                                            |       | 36 |
|                                |                                                                                                                |       |   |
| Signatures                          |                                                                                                                | 37         |

 

 

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**PART I —FINANCIAL INFORMATION**

**ITEM 1. Condensed Consolidated Financial Statements.**

**EPIQ SYSTEMS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME**

**(In Thousands, Except Per ShareData)**

**(Unaudited)**

 
| ** **                                            | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                            | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| **REVENUE:**                                          |       |                                            |       |                                          |       |   |   |   |   |
| Case management  services                             |       | $                                               | 25,106     |                                          | $          | 19,746 |   | $ | 51,130 |   | $ | 39,631 |   |
| Document  management services                         |       | 8,929                                           |       | 6,441                                         |       | 21,904 |   | 12,522 |   |
| Operating  revenue before reimbursed direct costs     |       | 34,035                                          |       | 26,187                                        |       | 73,034 |   | 52,153 |   |
| Operating  revenue from reimbursed direct costs       |       | 6,376                                           |       | 5,448                                         |       | 12,033 |   | 10,944 |   |
| Total Revenue                                         |       | 40,411                                          |       | 31,635                                        |       | 85,067 |   | 63,097 |   |
|                                                  |       |                                            |       |                                          |       |   |   |   |   |
| **COSTS AND EXPENSES:**                               |       |                                            |       |                                          |       |   |   |   |   |
| Direct costs of  services                             |       | 18,179                                          |       | 13,564                                        |       | 39,310 |   | 27,300 |   |
| General and  administrative                           |       | 12,359                                          |       | 8,044                                         |       | 24,058 |   | 16,036 |   |
| Depreciation and  software and leasehold amortization |       | 2,494                                           |       | 1,775                                         |       | 4,791 |   | 3,549 |   |
| Amortization of  identifiable intangible assets       |       | 2,878                                           |       | 1,427                                         |       | 5,645 |   | 3,050 |   |
| Acquisition  related                                  |       | 250                                             |       | —                                        |       | 250 |   | — |   |
| Total Operating  Expenses                             |       | 36,160                                          |       | 24,810                                        |       | 74,054 |   | 49,935 |   |
|                                                  |       |                                            |       |                                          |       |   |   |   |   |
| **INCOME FROM OPERATIONS**                            |       | 4,251                                           |       | 6,825                                         |       | 11,013 |   | 13,162 |   |
|                                                  |       |                                            |       |                                          |       |   |   |   |   |
| **INTEREST EXPENSE (INCOME):**                        |       |                                            |       |                                          |       |   |   |   |   |
| Interest income                                       |       | (42                                             | )          | (40                                           | )          | (88 | ) | (78 | ) |
| Interest expense                                      |       | 3,382                                           |       | 1,884                                         |       | 6,692 |   | 2,685 |   |
| Net Interest  Expense (Income)                        |       | 3,340                                           |       | 1,844                                         |       | 6,604 |   | 2,607 |   |
|                                                  |       |                                            |       |                                          |       |   |   |   |   |
| **INCOME FROM OPERATIONS BEFORE  INCOME TAXES**       |       | 911                                             |       | 4,981                                         |       | 4,409 |   | 10,555 |   |
|                                                  |       |                                            |       |                                          |       |   |   |   |   |
| **PROVISION FOR INCOME TAXES**                        |       | 383                                             |       | 2,077                                         |       | 1,851 |   | 4,401 |   |
|                                                  |       |                                            |       |                                          |       |   |   |   |   |
| **NET INCOME**                                        |       | $                                               | 528        |                                          | $          | 2,904 |   | $ | 2,558 |   | $ | 6,154 |   |
|                                                  |       |                                            |       |                                          |       |   |   |   |   |
|                                                  |       |                                            |       |                                          |       |   |   |   |   |
| **NET INCOME PER SHARE  INFORMATION:**                |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                                 |       | $                                               | 0.03       |                                          | $          | 0.16 |   | $ | 0.13 |   | $ | 0.34 |   |
| Diluted                                               |       | $                                               | 0.03       |                                          | $          | 0.15 |   | $ | 0.13 |   | $ | 0.32 |   |
|                                                  |       |                                            |       |                                          |       |   |   |   |   |
| **WEIGHTED AVERAGE COMMON SHARES  OUTSTANDING:**      |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                                 |       | 19,388                                          |       | 17,904                                        |       | 19,337 |   | 17,896 |   |
| Diluted                                               |       | 20,147                                          |       | 21,289                                        |       | 20,302 |   | 21,187 |   |

**See accompanying notes to condensed consolidated financial statements.**

1

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**EPIQ SYSTEMS, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

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

**(Unaudited)**

** **
| ** **                                                                                                                                                                             | ** ** | **June 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| **ASSETS**                                                                                                                                                                             |       |                        |       |                            |       |
| **CURRENT ASSETS:**                                                                                                                                                                    |       |                        |       |                            |       |
| Cash and cash equivalents                                                                                                                                                              |       | $                           | 6,813      |                            | $          | 13,563 |   |
| Trade accounts receivable,  less allowance for doubtful accounts of $3,232 and $3,481, respectively                                                                                    |       | 32,155                      |       | 33,504                          |       |
| Prepaid expenses                                                                                                                                                                       |       | 2,813                       |       | 2,818                           |       |
| Income taxes refundable                                                                                                                                                                |       | 1,766                       |       | 4,643                           |       |
| Deferred income taxes                                                                                                                                                                  |       | 1,984                       |       | 1,978                           |       |
| Other current assets                                                                                                                                                                   |       | 413                         |       | 85                              |       |
| Total Current Assets                                                                                                                                                                   |       | 45,944                      |       | 56,591                          |       |
|                                                                                                                                                                                   |       |                        |       |                            |       |
| **LONG-TERM ASSETS:**                                                                                                                                                                  |       |                        |       |                            |       |
| Property, equipment and  leasehold improvements, net                                                                                                                                   |       | 23,949                      |       | 23,751                          |       |
| Software development costs,  net                                                                                                                                                       |       | 9,061                       |       | 8,848                           |       |
| Goodwill                                                                                                                                                                               |       | 261,119                     |       | 249,427                         |       |
| Identifiable intangible  assets, net of accumulated amortization of $19,402 and $13,758, respectively                                                                                  |       | 49,825                      |       | 53,399                          |       |
| Other                                                                                                                                                                                  |       | 2,482                       |       | 2,854                           |       |
| Total Long-term Assets, net                                                                                                                                                            |       | 346,436                     |       | 338,279                         |       |
| **Total Assets**                                                                                                                                                                       |       | $                           | 392,380    |                            | $          | 394,870 |   |
|                                                                                                                                                                                   |       |                        |       |                            |       |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                                         |       |                        |       |                            |       |
| **CURRENT LIABILITIES:**                                                                                                                                                               |       |                        |       |                            |       |
| Accounts payable                                                                                                                                                                       |       | $                           | 5,701      |                            | $          | 7,954 |   |
| Customer deposits                                                                                                                                                                      |       | 2,167                       |       | 2,196                           |       |
| Accrued compensation                                                                                                                                                                   |       | 2,513                       |       | 3,944                           |       |
| Other accrued expenses                                                                                                                                                                 |       | 5,161                       |       | 3,872                           |       |
| Current maturities of long-term  obligations                                                                                                                                           |       | 73,426                      |       | 27,642                          |       |
| Total Current Liabilities                                                                                                                                                              |       | 88,968                      |       | 45,608                          |       |
|                                                                                                                                                                                   |       |                        |       |                            |       |
| **LONG-TERM LIABILITIES:**                                                                                                                                                             |       |                        |       |                            |       |
| Long-term obligations  (excluding current maturities)                                                                                                                                  |       | 94,202                      |       | 145,906                         |       |
| Deferred income taxes                                                                                                                                                                  |       | 25,981                      |       | 26,815                          |       |
| Other long-term liabilities                                                                                                                                                            |       | 998                         |       | —                          |       |
| Total Long-term Liabilities                                                                                                                                                            |       | 121,181                     |       | 172,721                         |       |
|                                                                                                                                                                                   |       |                        |       |                            |       |
| **COMMITMENTS AND CONTINGENCIES**                                                                                                                                                      |       |                        |       |                            |       |
| ** **                                                                                                                                                                             |       |                        |       |                            |       |
| **STOCKHOLDERS’ EQUITY:**                                                                                                                                                         |       |                        |       |                            |       |
| Common stock—$0.01 par value;  50,000,000 shares authorized; issued  and outstanding — 19,394,217 and 19,253,466 shares at June 30, 2006 and December 31, 2005, respectively |       | 194                         |       | 193                             |       |
| Additional paid-in capital                                                                                                                                                             |       | 131,617                     |       | 128,484                         |       |
| Retained earnings                                                                                                                                                                      |       | 50,421                      |       | 47,864                          |       |
| Accumulated other  comprehensive income                                                                                                                                                |       | (1                          | )          | —                          |       |
| Total Stockholders’ Equity                                                                                                                                                        |       | 182,231                     |       | 176,541                         |       |
| **Total  Liabilities and Stockholders’ Equity**                                                                                                                                   |       | $                           | 392,380    |                            | $          | 394,870 |   |

**See accompanying notes to condensed consolidated financial statements.**

2

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**EPIQ SYSTEMS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In Thousands)**

**(Unaudited)**

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                              |       |   |   |
| Net income                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       | $                                                 | 2,558      |   | $ | 6,154 |   |
| Adjustments to reconcile net income to net cash from  operating activities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |                                              |       |   |   |
| Share-based compensation expense                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       | 1,092                                             |       | — |   |
| Depreciation and software and leasehold amortization                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |       | 4,791                                             |       | 3,549 |   |
| Loan fee amortization                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       | 717                                               |       | 561 |   |
| Amortization of identifiable intangible assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       | 5,645                                             |       | 3,050 |   |
| Other                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       | (338                                              | )          | 695 |   |
| Changes in operating assets and liabilities, net of  effects from business acquisition:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |       |                                              |       |   |   |
| Trade accounts receivable                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       | 1,621                                             |       | (4,573 | ) |
| Prepaid expenses and other assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |       | (533                                              | )          | (654 | ) |
| Accounts payable and other liabilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |       | (369                                              | )          | 710 |   |
| Excess tax benefit related to share-based  compensation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |       | (154                                              | )          | — |   |
| Income taxes (including $419 and $117 of tax benefit  related to share-based compensation, respectively)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |       | 3,296                                             |       | 822 |   |
| Net cash provided by operating activities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       | 18,326                                            |       | 10,314 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                                              |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                              |       |   |   |
| Purchase of property and equipment                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       | (4,358                                            | )          | (896 | ) |
| Software development costs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       | (2,020                                            | )          | (957 | ) |
| Cash paid for acquisition of business                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       | (3,485                                            | )          | — |   |
| Purchase of short-term investments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       | —                                            |       | (6,000 | ) |
| Sale of short-term investments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       | —                                            |       | 6,000 |   |
| Other                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       | (133                                              | )          | 447 |   |
| Net cash used in investing activities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       | (9,996                                            | )          | (1,406 | ) |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                                              |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                              |       |   |   |
| Proceeds from long-term debt borrowings                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |       | —                                            |       | 5,000 |   |
| Principal payments under long-term debt obligations                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |       | (16,720                                           | )          | (13,681 | ) |
| Excess tax benefit related to share-based  compensation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |       | 154                                               |       | — |   |
| Proceeds from exercise of share options                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |       | 1,623                                             |       | 179 |   |
| Other                                                                                                                                |       | (137                                              | )          | — |   |
| Net cash used in financing activities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       | (15,080                                           | )          | (8,502 | ) |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |                                              |       |   |   |
| **NET  (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       | (6,750                                            | )          | 406 |   |
| **CASH  AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |       | 13,563                                            |       | 13,330 |   |
| **CASH  AND CASH EQUIVALENTS, END OF PERIOD**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |       | $                                                 | 6,813      |   | $ | 13,736 |   |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                                              |       |   |   |
| **SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |       |                                              |       |   |   |
| Interest paid                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |       | $                                                 | 4,880      |   | $ | 1,682 |   |
| Income taxes  (received) paid, net                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       | $                                                 | (835       | ) | $ | 3,861 |   |

**See accompanying notes to condensed consolidated financial statements.**

3

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**EPIQ SYSTEMS, INC.**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

**(In Thousands)**

**(Unaudited)**

** **

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

We had propertyand equipment purchases accrued in accounts payable of approximately $0.3million as of June 30, 2006.

During the sixmonths ended June 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.**

 

4

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

**NOTE1:   NATURE OF OPERATIONS AND SUMMARY OFRECENTLY ADOPTED ACCOUNTING POLICIES**

***Principlesof Consolidation***The consolidated financial statements include theaccounts of EPIQ Systems, Inc. (“EPIQ”) and its wholly-owned subsidiaries.  All significant intercompany transactions andbalances have been eliminated in consolidation.

***Natureof 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 litigation 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 extensive businessrequirements.

***Revenue Recognition***We have agreements with clients pursuant to which wedeliver various case management and document management solutions each month.

Significant sources of case management revenueinclude:

·                  Feescontingent upon the month-to-month delivery of case management services definedby client contracts, such as claim processing, claim 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 ongoing engagement;

·                  Hostingfees based on the amount of data stored; and

·                  Volume-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, certain hardware,software and services.

Document management revenue, which consists primarilyof legal notification and reimbursed postage costs, varies based on the sizeand complexity of the noticing requested by the client.  Consistent with guidance provided by theEmerging Issues Task Force (EITF) in EITF No. 01-14, *IncomeStatement Characterization of Reimbursements Received for “Out-of-Pocket”Expenses Incurred*, reimbursed postage and other reimbursable directcosts are recorded gross as revenue and direct cost.  Payments received in advance of satisfactionof the related revenue recognition criteria are recognized as a customerdeposit until all revenue recognition criteria have been satisfied.

For all services we provide to clients, revenue is recognizedonly when we have persuasive evidence of an arrangement, the service has beenprovided and is not subject to refund, the amount due is fixed anddeterminable, and collectibility is reasonably assured.

5

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***ComprehensiveIncome***Statement of Financial Accounting Standards No. 130, *Reporting Comprehensive Income*, establishes requirements forreporting and display of comprehensive income and its components.  Our total comprehensive income, whichincludes net earnings and foreign currency translation adjustments, was asfollows (in thousands):
| ** **                               | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                               | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                     |       |                                            |       |                                          |       |   |   |   |   |
| Net income                               |       | $                                               | 528        |                                          | $          | 2,904 |   | $ | 2,558 |   | $ | 6,154 |   |
| Foreign currency  translation adjustment |       | 15                                              |       | —                                        |       | (1 | ) | — |   |
| Total other comprehensive  income        |       | $                                               | 543        |                                          | $          | 2,904 |   | $ | 2,557 |   | $ | 6,154 |   |

 

***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 have recognizedcompensation costs related to share-based compensation beginning with thequarter ended March 31, 2006.  Werecognize this expense on a straight-line basis over the requisite serviceperiod of the last separately vesting portion of the award.  Prior to 2006, 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, betweenthe quoted market price at the date of grant and the amount an employee mustpay to acquire stock.  Compensation costsrelated to share-based compensation for periods ended on or before December 31,2005 are reflected on a pro forma basis in Note 6 of these condensedconsolidated financial statements.

***Recent Accounting Pronouncements***In June 2006, the Financial Accounting StandardsBoard (FASB) issued Interpretation 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 on itstechnical 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 didnot contain 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 June 28, 2006. We do not anticipate thatadoption of this statement will have a material impact on our consolidatedfinancial statements.

6

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In March 2006, the FASBissued Statement of Financial Accounting Standard No. 156, *Accountingfor Servicing of Financial Assets*(SFAS 156).  SFAS 156 requires that an entity separatelyrecognize a servicing asset or a servicing liability when it undertakes anobligation to service a financial asset under a servicing contract in certainsituations.  Such servicing assets orservicing liabilities are required to be initially measured at fair value, ifpracticable.  SFAS 156 allows an entityto choose whether to subsequently measure its servicing assets and servicingliabilities using the amortization method or the fair value measurementmethod.  SFAS 156 is effective for anentity’s first fiscal year that begins after September 15, 2006 and should beapplied prospectively to all transactions after adoption.  We do not anticipate that adoption of thisstatement will have a material impact on our consolidated financial 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.

**NOTE2:   INTERIM FINANCIAL STATEMENTS**

The accompanyingcondensed consolidated financial statements have been prepared in accordancewith the instructions to Form 10-Q of the Securities and ExchangeCommission and in accordance with accounting principles generally accepted inthe United States of America (“GAAP”) applicable to interim financialstatements, and do not include all the information and notes required by GAAPfor complete financial statements.  Thefinancial statements should be read in conjunction with our audited financialstatements and accompanying notes, which are included in our Form 10-K for theyear ended December 31, 2005.

In the opinion of ourmanagement, the accompanying condensed consolidated financial statementsreflect all adjustments necessary (consisting solely of normal recurringadjustments) to present fairly our financial position as of June 30, 2006, theresults of operations for the three and six month periods ended June 30, 2006and 2005, and cash flows for the six month periods ended June 30, 2006 and2005.

The results of operationsfor the three and six month periods ended June 30, 2006 are not necessarilyindicative of the results to be expected for the entire year.

7

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**NOTE 3:   GOODWILL AND INTANGIBLE ASSETS**

Amortizing identifiable intangible assets at June 30, 2006 and December31, 2005 consisted of the following (in thousands):
| ** **              | ** ** | **June 30, 2006**     | ** ** | **December 31, 2005** | ** ** |
|-------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization**   | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Customer  contracts     |       | $                               | 39,287     |                            | $          | 9,241 |   | $ | 37,313 |   | $ | 6,170 |   |
| Trade names             |       | 2,414                           |       | 2,020                           |       | 2,319 |   | 1,578 |   |
| Non-compete  agreements |       | 27,526                          |       | 8,141                           |       | 27,525 |   | 6,010 |   |
|                    |       | $                               | 69,227     |                            | $          | 19,402 |   | $ | 67,157 |   | $ | 13,758 |   |

 

Aggregate amortization expense related to identifiable intangible assetswas $2.9 million and $1.4 million for the three month periods ended June 30,2006 and 2005, respectively and was $5.6 million and $3.1 million for the sixmonth periods ended June 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 the carryingamounts of goodwill by segment are as follows (in thousands):
| ** **                                           | ** ** | **Six Month Period Ended June 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 |       | 11,736                                                                 |       | (44                                                  | )          | 11,692 |   | 94,565 |   | 7,134 |   | 101,699 |   |
| Balance, end of period                               |       | $                                                                      | 212,672    |                                                 | $          | 48,447 |   | $ | 261,119 |   | $ | 200,936 |   | $ | 48,491 |   | $ | 249,427 |   |

 

We assess goodwill forimpairment as of each July 31 and also at any other date when events or changesin circumstances indicate that the carrying value of these assets may exceedtheir fair value.  We did not recognizeany impairment loss during the three and six month periods ended June 30, 2006and 2005.

8

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**NOTE 4:   BUSINESS ACQUISITIONS**

***EPIQAdvisory 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 $13.7 million, consisting of $3.0 million of cash paidon closing, $10.2 million of deferred payments, and $0.5 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:  $0.1 million to netassets, $2.4 million to customer contracts, amortizable on a straight-linebasis over two years, and $11.2 million to goodwill.  The purchase price in excess of the tax basisof the assets is expected to be deductible for tax purposes.  This acquisition further expands our casemanagement service offerings.

The acquisition wasaccounted for using the purchase method of accounting with the operatingresults included in the accompanying condensed consolidated financialstatements from the date of acquisition. The operating results of EPIQ Advisory Services are included within ourcase management segment.

***nMatrix***On November 15, 2005, EPIQ, acting through awholly-owned subsidiary, acquired all the issued and outstanding shares ofcapital stock of nMatrix, Inc., nMatrix Australia Pty. Ltd., and nMatrix Ltd.(collectively, “nMatrix”) for approximately $126.3 million, including capitalizedacquisition costs.  We believe thisacquisition further expands the service offerings of our legal servicesbusiness.  The purchase price consistedof cash of $100.0 million and approximately 1.2 million shares of our commonstock.  The fair value of our commonstock issued, calculated based upon the five-day average of the closing priceof the common stock two days before and two days after the acquisition wasconsummated, was approximately $24.2 million. In conjunction with the acquisition, we entered into an agreement withthe selling shareholder to register the shares of common stock issued as a partof the acquisition consideration.  Withinthis agreement, we guaranteed the common stock price of $20.35 per share,valued as the average closing price of our common stock for the 40 consecutivetrading days ending on the date four trading days prior to the closingdate.  This guarantee terminates as ofthe close of business on the date that is after any 15 trading days on whichthe selling shareholder may lawfully sell shares under a registration statementand the last sale price for our common stock has been equal to or greater thanthe $20.35.  Based on our June 30, 2006closing price of $16.64 per share, as of June 30, 2006 the guarantee amountwould be approximately $4.6 million.  Aliability will not be recorded for this guarantee until the contingency isresolved.  If a payment is made underthis guarantee, we will reduce the equity proceeds recorded as a part of theacquisition transaction.  Based on ourvaluation, the purchase price has been allocated as follows (in thousands):

 

|                         |   |    |    |
|-------------------------|--------|---------|---------|
| Accounts  receivable    |   | $       | 11,844  |   |
| Other current  assets   |   | 2,926   |    |
| Property and  software  |   | 7,236   |    |
| Trade names             |   | 569     |    |
| Customer  relationships |   | 24,614  |    |
| Non-compete  agreements |   | 6,676   |    |
| Current  liabilities    |   | (6,452  | )       |
| Deferred tax  liability |   | (16,173 | )       |
| Goodwill                |   | 95,056  |    |
|                    |   |    |    |
| Total purchase price    |   | $       | 126,296 |   |

 

Trade names, customerrelationships, and the non-compete agreements are amortized using the straight-linemethod over one year, eight years, and five years, respectively.  The excess purchase price of $95.1 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 June 30,2006, 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 payclaims will be distributed to the seller. Also, $4.0 million of the cash

9

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**considerationwas initially placed in a separate escrow pending collection of certainpre-acquisition receivables.  Each month,a portion of this escrow is released to the seller based on the prior month’scollection of these pre-acquisition receivables.  As of June 30, 2006, approximately $0.3million remained in this escrow account. This escrow arrangement terminates following the payment for collectionsmade through September 2006 of these pre-acquisition receivables, at which timeany amount that remains in escrow will be distributed to us.**

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

***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 wasaccounted for using the purchase method of accounting with the operatingresults included in the accompanying condensed consolidated financialstatements from the date of acquisition. The operating results are included within our document managementsegment.

***ProForma Results***Pro forma results of operations assuming the aboveacquisitions were made at the beginning of 2005 are shown below (in thousands,except per share data):

|                       | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **            | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|                  |       |                                            |       |                                          |       |   |   |   |   |
| Total revenue         |       | $                                               | 40,815     |                                          | $          | 40,574 |   | $ | 86,279 |   | $ | 80,116 |   |
|                  |       |                                            |       |                                          |       |   |   |   |   |
| Net income            |       | $                                               | 495        |                                          | $          | 2,738 |   | $ | 2,460 |   | $ | 5,705 |   |
| Net income per  share |       |                                            |       |                                          |       |   |   |   |   |
| Basic                 |       | $                                               | 0.03       |                                          | $          | 0.14 |   | $ | 0.13 |   | $ | 0.30 |   |
| Diluted               |       | $                                               | 0.02       |                                          | $          | 0.13 |   | $ | 0.12 |   | $ | 0.28 |   |

 

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):

|                                                                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                           | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| Senior term loan                                                     |       | $                 | 15,000     |                  | $          | 25,000 |   |
| Senior revolving  loan                                               |       | 88,028            |       | 93,028                |       |
| Contingent  convertible subordinated debt, including embedded option |       | 51,778            |       | 51,326                |       |
| Capital leases                                                       |       | 955               |       | 972                   |       |
| Deferred  acquisition price                                          |       | 11,867            |       | 3,222                 |       |
| Total indebtedness                                                   |       | $                 | 167,628    |                  | $          | 173,548 |   |

 

***CreditFacilities***We have acredit facility with KeyBank National Association as administrative agent.  At inception, this facility consisted of a$25.0 million senior term loan, maturing in August 2006, and a $100.0 millionsenior 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 and contains financial covenants related to:  earnings before interest, provision forincome taxes, depreciation and amortization (“EBITDA”); total debt; seniordebt; fixed charges; and working capital. We were in compliance with all financial covenants as of June 30,2006.  As of June 30, 2006, ourborrowings under the credit facility totaled $103.0 million, consisting of$15.0 million under the senior term loan and $88.0 million under the seniorrevolving loan.  Interest on the creditfacility is generally 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 ofJune 30, 2006, the interest rate charged on outstanding borrowings ranged from8.1% to 8.6%.

***ContingentConvertible Subordinated Debt***During June 2004, we issued $50.0 million ofcontingent convertible subordinated notes. Net proceeds of $47.4 million were used to repay and terminate anoutstanding subordinated term loan and to pay in full our then outstandingrevolving loan balance.  The contingencyhas been satisfied and the notes may, at the option of the holders, beconverted into shares of our common stock at any time. These convertiblesubordinated notes:

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

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

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

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

11

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**Theholders of the notes have the right to extend the maturity of the notes for aperiod not to exceed three years.  UnderSFAS No. 133, *Accounting for Derivative Instruments andHedging Activities*, the right to extend the maturity of the notesrepresents an embedded option subject to bifurcation.  The embedded option was initially valued at$1.2 million and the convertible debt balance was reduced by the sameamount.  The convertible debt is accretedapproximately $0.1 million each quarter such that, at the end of three years,the convertible debt balance will total $50.0 million.  On our accompanying condensed consolidatedstatements of income, this accretion is a component of interest expense.  The embedded option must be revalued at eachperiod end based on the probability weighted discounted cash flows related tothe additional 4% interest rate payments that will be made if the convertibledebt maturity is extended an additional three years.  Under this methodology, the embedded optionhas a current value of approximately $2.2 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 months ended June 30, 2006, the value of the embeddedoption increased by approximately $0.1 million and this increase is included asa component of interest expense on our accompanying condensed consolidatedstatements of income.  The changes incarrying value of the convertible debt and fair value of the embedded option donot affect our cash flow and, if the embedded option is exercised, the valueassigned to the embedded option will be amortized as a reduction to our 4%convertible debt interest expense over the periods payments are made.  If 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.**

The notes evidencing thecontingent subordinated convertible debt contain financial covenants related toEBITDA, total debt, and senior debt.  Wewere in compliance with all financial covenants as of June 30, 2006.

***CapitalLease***At June 30,2006, our debt obligation related to capital leases, classified as a currentliability, was approximately $1.0 million.

***DeferredAcquisition Price***We have madethree 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 June 30,2006, the discounted value of the remaining note payments was approximately$11.9 million of which approximately $5.7 million was classified as a currentliability.

***ScheduledPrincipal Payments***Our long-termobligations, including credit facility debt, convertible debt (includingembedded option), deferred acquisition costs, and capitalized leases, mature asfollows for each twelve-month period ending June 30 (in thousands):

|       |   |   |    |
|-------|--------|--------|---------|
| 2007  |   | $      | 73,426  |   |
| 2008  |   | 2,944  |    |
| 2009  |   | 89,434 |    |
| 2010  |   | 1,359  |    |
| 2011  |   | 465    |    |
| Total |   | $      | 167,628 |   |

 

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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.  Compensationcosts related to share-based compensation for periods ended on or beforeDecember 31, 2005 are reflected on a pro forma basis in this note to ourcondensed consolidated financial statements. We have not made an election as to the transition method we will use forpurposes of calculating the pool of excess tax benefits available to absorb taxdeficiencies recognized subsequent to the adoption 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 on adoption of SFAS 123R byapproximately $2.2 million (approximately $0.2 million and $0.4 million duringthe three months and six month periods ended June 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-basedinstruments.  Although various forms ofequity instruments may be issued, to date we have issued only incentive share optionsand nonqualified 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 six month periods ended June30, 2006 we recognized expense related to share options issued prior to butunvested as of January 1, 2006 as well as expense related to share optionsissued 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 six month period ended June 30, 2006, the share options werealso 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.

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

|                                       |   |      |   |
|---------------------------------------|--------|-----------|--------|
| Expected term  (years)                |   | 5         | .0     |
| Expected  volatility                  |   | 36.0%-38. | 0%     |
| Weighted average  expected volatility |   | 37.       | 4%     |
| Risk-free  interest rate              |   | 4.3%-4.   | 9%     |
| Dividend yield                        |   | 0         | %      |

 

Compensation expense for the three and six monthperiods ended June 30, 2006 was adjusted for share options we estimate will beforfeited prior to vesting.  We usehistorical information to estimate employee termination and the resultingoption forfeiture rate.

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

|                                     | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-------------------------------------|------------|------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
|                                |       |       |       |                                   |       |                                                |       |                            |       |
| Outstanding,  beginning of period   |       | 4,783      |       | $                                      | 14.70      |                                                |       |                            |       |   |
| Granted                             |       | 72         |       | 17.83                                  |       |                                                |       |                            |       |
| Exercised                           |       | (15        | )          | 6.48                                   |       |                                                |       |                            |       |
| Forfeited                           |       | (31        | )          | 16.03                                  |       |                                                |       |                            |       |
| Outstanding, end  of period         |       | 4,809      |       | 14.77                                  |       | 7.55                                                |       | $                               | 12,155     |   |
|                                |       |       |       |                                   |       |                                                |       |                            |       |
| Options exercisable,  end of period |       | 3,324      |       | 13.58                                  |       | 6.99                                                |       | $                               | 10,957     |   |
|                                     |            |            |            |                                        |            |                                                     |            |                                 |            |  |  |

 

The aggregate intrinsicvalue was calculated using the difference between the June 30, 2006 marketprice and the grant price for only those awards that have a grant price that isless than the June 30, 2006 market price. The weighted average grant-date fair value of share options grantedduring the three months ended June 30, 2006 was $7.09.  No share options were granted during thethree months ended June 30, 2005.  Thetotal intrinsic value of share options exercised during the three months endedJune 30, 2006 was $0.2 million.  Duringthe three months ended June 30, 2006, we received cash for payment of the grantprice of exercised share options of approximately $0.4 million and weanticipate we will realize a tax benefit related to these exercised shareoptions of less than $0.1 million.  Thecash received for payment of the grant price is included as a component of cashflow from financing activities.

During the three months ended June 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” and $0.4 million is included under the caption “General andadministrative” on the accompanying condensed consolidated statements ofincome.  During the three months endedJune 30, 2006, we recognized a net tax benefit of approximately $0.2 million relatedto aggregate share-based compensation expense recognized during the sameperiod.  As a result, income beforeincome taxes was reduced by approximately $0.6 million, net income was reducedby approximately $0.4 million, net income per share — basic was reduced byapproximately $0.02 per share, and net income per share — diluted was reducedby approximately $0.02 per share.

14

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A summary of optionactivity during the six months ended June 30, 2006 is presented below (sharesand 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                            |       | 227        |       | 18.67                                                          |       |                                                |       |                            |       |
| Exercised                          |       | (144       | )          | 11.35                                                          |       |                                                |       |                            |       |
| Forfeited                          |       | (43        | )          | 15.81                                                          |       |                                                |       |                            |       |
| Outstanding, end of  period        |       | 4,809      |       | 14.77                                                          |       | 7.55                                                |       | $                               | 12,155     |   |
|                               |       |       |       |                                                           |       |                                                |       |                            |       |
| Options exercisable, end of period |       | 3,324      |       | 13.58                                                          |       | 6.99                                                |       | $                               | 10,957     |   |
|                                    |            |            |            |                                                                |            |                                                     |            |                                 |            |  |  |

 

The aggregate intrinsicvalue was calculated using the difference between the June 30, 2006 marketprice and the grant price for only those awards that have a grant price that isless than the June 30, 2006 market price. The weighted average grant-date fair value of share options grantedduring the six months ended June 30, 2006 and 2005 were $7.50 and $5.17,respectively.  The total intrinsic valueof share options exercised during the six months ended June 30, 2006 was $1.3million.  During the six months endedJune 30, 2006, we received cash for payment of the grant price of exercisedshare options of approximately $1.6, million and we anticipate we will realizea tax benefit related to these exercised share options of approximately $0.4million.  The cash received for paymentof the grant price is included as a component of cash flow from financingactivities.  The tax benefit related tothe option exercise price in excess of the option fair value at grant date isseparately disclosed as a component of cash flow from financing activities; theremainder of the tax benefit is included as a component of cash flow fromoperating activities.

During the six months ended June 30, 2006, werecognized share-based compensation expense, which is a non-cash charge, ofapproximately $1.1 million, of which $0.3 million is included under the caption“Direct costs” and $0.8 million is included under the caption “General andadministrative” on the accompanying condensed consolidated statements ofincome.  During the six months ended June30, 2006, we recognized a net tax benefit of approximately $0.4 million relatedto aggregate share-based compensation expense recognized during the same period.  As a result, income before income taxes wasreduced by approximately $1.1 million, net income was reduced by approximately$0.7 million, net income per share — basic was reduced by approximately $0.04per share, and net income per share — diluted was reduced by approximately$0.04 per share.  As of June 30, 2006,there was $7.7 million of total unrecognized compensation cost related tononvested share-based compensation arrangements, which will be recognized overa weighted-average period of 2.4 years.

15

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Prior to adoption of SFAS123R, we accounted for stock-based compensation awards under the intrinsicmethod of Accounting Principles Board Opinion No. 25, *Accountingfor Stock Issued to Employees,*which required compensation cost tobe recognized based on the excess, if any, between the quoted market price atthe date of grant and the amount an employee must pay to acquire stock. 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 six month periods ended June 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, *Accounting for Stock-Based Compensation,* our net income andnet income per share for the three month and six month periods ended June 30,2005 would have been adjusted to the following pro forma amounts (in thousands,except per share data):

 
| ** **                                                                                                | ** ** | ** **   | ** ** | **Three Months Ended  June 30, 2005** | ** ** | **Six Months Ended  June 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|--------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
|                                                                                                      |       |         |       |                                                      |       |                                                    |       |
| Net income, as  reported                                                                                  |       |         |       | $                                                         | 2,904      |                                                    | $          | 6,154 |   |
| 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 |       |         |       | (2,200                                                    | )          | (5,266                                                  | )          |
| Net income, pro  forma                                                                                    |       |         |       | $                                                         | 704        |                                                    | $          | 888 |   |
|                                                                                                      |       |         |       |                                                      |       |                                                    |       |
| Net income per  share — Basic                                                                        |       | As  reported |       | $                                                         | 0.16       |                                                    | $          | 0.34 |   |
|                                                                                                      |       | Pro  forma   |       | $                                                         | 0.04       |                                                    | $          | 0.05 |   |
|                                                                                                      |       |         |       |                                                      |       |                                                    |       |
| Net income per  share — Diluted                                                                      |       | As  reported |       | $                                                         | 0.15       |                                                    | $          | 0.32 |   |
|                                                                                                      |       | Pro forma    |       | $                                                         | 0.04       |                                                    | $          | 0.05 |   |

 

Pro forma amounts presented here are based on actualearnings and consider only the effects of estimated fair values of shareoptions.  For the three and six monthperiods ended June 30, 2005, we did not assume conversion of the convertiblenotes as the effect was antidilutive.

16

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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.  When calculatingincremental shares related to outstanding share options, we apply the treasurystock method.  The treasury stock methodassumes that proceeds, consisting of the amount the employee must pay onexercise, 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 June 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     |       | $                                                   | 528        |   | 19,388 |   | $ | 0.03 |   | $ | 2,904 |   | 17,904 |   | $ | 0.16 |   |
|                            |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Effect of  dilutive securities: |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Share options                   |       |                                                |       | 759 |   |   |   |   |   | 528 |   |   |   |
| Convertible debt                |       | —                                              |       | — |   |   |   | 291 |   | 2,857 |   |   |   |
|                            |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Diluted net income per  share   |       | $                                                   | 528        |   | 20,147 |   | $ | 0.03 |   | $ | 3,195 |   | 21,289 |   | $ | 0.15 |   |

 

#### For the threemonth periods ended June 30, 2006 and 2005, weighted-average outstanding shareoptions totaling approximately 1.9 million and 1.5 million shares of commonstock, respectively, were antidilutive and therefore not included in thecomputation of diluted earnings per share. For the three months ended June 30,2006, we did not assume conversion of the convertible notes as the effect wasantidilutive.

 
| ** **                      | ** ** | **Six Months Ended June 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     |       | $                                                 | 2,558      |   | 19,337 |   | $ | 0.13 |   | $ | 6,154 |   | 17,896 |   | $ | 0.34 |   |
|                            |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Effect of  dilutive securities: |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Share options                   |       |                                              |       | 965 |   |   |   |   |   | 434 |   |   |   |
| Convertible debt                |       | —                                            |       | — |   |   |   | 578 |   | 2,857 |   |   |   |
|                            |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Diluted net  income per share   |       | $                                                 | 2,558      |   | 20,302 |   | $ | 0.13 |   | $ | 6,732 |   | 21,187 |   | $ | 0.32 |   |

 

#### For the sixmonth periods ended June 30, 2006 and 2005, weighted-average outstanding shareoptions totaling approximately 1.3 million and 2.0 million shares of commonstock, respectively, were antidilutive and therefore not included in thecomputation of diluted earnings per share. For the six months ended June 30, 2006, we did not assume conversion ofthe convertible notes as the effect was antidilutive.

17

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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 andinsurance).  Additionally, we havenon-cancelable operating leases for office equipment and automobiles expiringthrough 2009.

Future minimum leasepayments during each of the twelve months ending June 30 are as follows (inthousands):

 

| 2007                          |   | $      | 5,525  |   |
|-------------------------------|--------|--------|--------|--------|
| 2008                          |   | 4,386  |   |
| 2009                          |   | 4,466  |   |
| 2010                          |   | 4,254  |   |
| 2011                          |   | 4,004  |   |
| Thereafter                    |   | 13,466 |   |
| Total minimum lease  payments |   | $      | 36,101 |   |

 

Rent expense related tooperating leases was approximately $1.4 million and $0.7 million for the threemonth periods ended June 30, 2006 and 2005, respectively, and approximately$2.5 million and $1.4 million for the six month periods ended June 30, 2006 and2005, 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 directly attributableto each segment.  In the evaluation ofperformance, certain costs, such as shared services, administrative staff, andexecutive management, are not allocated by segment and, accordingly, thefollowing operating segment results do not include such unallocated costs.  Assets reported within a segment are thoseassets used by the segment in its operations and consist of property, equipmentand leasehold improvements, software, identifiable intangible assets and goodwill.  All other assets are classified asunallocated.

Following is a summary ofsegment information (in thousands):

18

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| ** **                                                                                               | ** ** | **Three Months Ended June 30, 2006** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **Case  Management**                                          | ** ** | **Document  Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                                                 |       |                                                          |       |   |   |   |   |   |   |
| Operating revenue before reimbursed direct costs                                                         |       | $                                                             | 25,106     |   | $ | 8,929 |   | $ | — |   | $ | 34,035 |   |
| Operating revenue from reimbursed direct costs                                                           |       | 733                                                           |       | 5,643 |   | — |   | 6,376 |   |
| Total revenue                                                                                            |       | 25,839                                                        |       | 14,572 |   | — |   | 40,411 |   |
|                                                                                                     |       |                                                          |       |   |   |   |   |   |   |
| Costs and  expenses:                                                                                     |       |                                                          |       |   |   |   |   |   |   |
| Direct costs, general and administrative costs and  depreciation and software and leasehold amortization |       | 13,131                                                        |       | 11,712 |   | 8,189 |   | 33,032 |   |
| Amortization of identifiable intangible assets                                                           |       | 2,393                                                         |       | 485 |   | — |   | 2,878 |   |
| Acquisition related                                                                                      |       | —                                                        |       | — |   | 250 |   | 250 |   |
| Total operating expenses                                                                                 |       | 15,524                                                        |       | 12,197 |   | 8,439 |   | 36,160 |   |
| Income from  operations                                                                                  |       | $                                                             | 10,315     |   | $ | 2,375 |   | $ | (8,439 | ) | 4,251 |   |
| Interest  expense, net                                                                                   |       |                                                          |       |   |   |   |   | 3,340 |   |
| Income from  operations before income taxes                                                              |       |                                                          |       |   |   |   |   | 911 |   |
| Provision for  income taxes                                                                              |       |                                                          |       |   |   |   |   | 383 |   |
|                                                                                                     |       |                                                          |       |   |   |   |   |   |   |
| Net income                                                                                               |       |                                                          |       |   |   |   |   | $ | 528 |   |
|                                                                                                     |       |                                                          |       |   |   |   |   |   |   |
| Provision for  depreciation and amortization                                                             |       | $                                                             | 4,200      |   | $ | 576 |   | $ | 596 |   | $ | 5,372 |   |

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

 

19

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| ** **                                                                                               | ** ** | **Six Months Ended June 30, 2006** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **Case  Management**                                        | ** ** | **Document  Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                                                 |       |                                                        |       |   |   |   |   |   |   |
| Operating revenue before reimbursed direct costs                                                         |       | $                                                           | 51,130     |   | $ | 21,904 |   | $ | — |   | $ | 73,034 |   |
| Operating revenue from reimbursed direct costs                                                           |       | 1,514                                                       |       | 10,519 |   | — |   | 12,033 |   |
| Total revenue                                                                                            |       | 52,644                                                      |       | 32,423 |   | — |   | 85,067 |   |
|                                                                                                     |       |                                                        |       |   |   |   |   |   |   |
| Costs and  expenses:                                                                                     |       |                                                        |       |   |   |   |   |   |   |
| Direct costs, general and administrative costs and  depreciation and software and leasehold amortization |       | 24,852                                                      |       | 26,697 |   | 16,610 |   | 68,159 |   |
| Amortization of identifiable intangible assets                                                           |       | 4,643                                                       |       | 1,002 |   | — |   | 5,645 |   |
| Acquisition related                                                                                      |       | —                                                      |       | — |   | 250 |   | 250 |   |
| Total operating expenses                                                                                 |       | 29,495                                                      |       | 27,699 |   | 16,860 |   | 74,054 |   |
| Income from  operations                                                                                  |       | $                                                           | 23,149     |   | $ | 4,724 |   | $ | (16,860 | ) | 11,013 |   |
| Interest  expense, net                                                                                   |       |                                                        |       |   |   |   |   | 6,604 |   |
| Income from operations  before income taxes                                                              |       |                                                        |       |   |   |   |   | 4,409 |   |
| Provision for  income taxes                                                                              |       |                                                        |       |   |   |   |   | 1,851 |   |
|                                                                                                     |       |                                                        |       |   |   |   |   |   |   |
| Net income                                                                                               |       |                                                        |       |   |   |   |   | $ | 2,558 |   |
|                                                                                                     |       |                                                        |       |   |   |   |   |   |   |
| Provision for  depreciation and amortization                                                             |       | $                                                           | 8,091      |   | $ | 1,182 |   | $ | 1,163 |   | $ | 10,436 |   |

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

 

 

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

### **Overview**

***BusinessSolutions***

EPIQSystems, Inc. is a provider of technology-based solutions for the legal andfiduciary services industries.  Our twooperating segments, case management and document management, assist clientswith the administration of complex legal proceedings, including electroniclitigation discovery, bankruptcy administration and class actionadministration. Our clients include leading law firms, corporations, bankruptcytrustees, and other professional advisors who require sophisticated caseadministration and document management capabilities, extensive subject matterexpertise and a high service capacity.

Our case and documentmanagement segments provide our clients with a broad range of technology andservice offerings to meet the unique needs and requirements of each clientmatter.  For example, a particular classaction matter may require professional services, call center support, claims processingand settlement processing from our case management segment and a uniquelydeveloped media campaign to provide notice to a class of unknown claimants anddocument custody services from our document management segment, while anotherclass action matter may only require claims processing services from our casemanagement segment and a simple mailing notification to a class of knownclaimants from our document management segment. Not all cases have the same business requirements, and our expanded technologyand service offerings allow clients to procure services from our broad range ofcase management and document management solutions.

Our case management anddocument management technology and service offerings provide solutionsprimarily for the bankruptcy, class action and mass tort, and electronicdiscovery markets. These technology and service offerings can cross the variousmarkets and clients we serve.  Forexample, our legal notification expert may develop a document management noticeprogram for either a bankruptcy matter or a class action matter.  Our proprietary search technology solution,which may be used for an electronic discovery, class action, or bankruptcymatter, supports a unique set of case management and document managementrequirements.

***Marketplace Information***

The substantial increase of electronic documents in thebusiness community has changed the dynamics of how attorneys support discoveryin complex litigation matters.  Accordingto the 2005 Socha-Gelbmann Electronic Discovery Survey, 2004 domesticcommercial electronic discovery revenues were estimated at $832 million, anapproximate 94% increase from 2003. According to this same source, the market is expected to continue togrow 50% to 60% each year from 2005 to 2007. Due to the increasing complexity of cases, the increasing volume of datathat are maintained electronically, and the increasing volume of documents thatare produced in all types of litigation, law firms are increasingly reliant onelectronic evidence management systems to organize and manage the litigationdiscovery process.

The number of newbankruptcy filings each year may vary based on the level of consumer andbusiness debt, the general economy, interest rate levels and otherfactors.  We believe the level ofconsumer and business debt is among the most important indicators of futurebankruptcy filings.  The most recentavailable Federal Reserve *Flow of Funds Accounts ofthe United States*, dated June 8, 2006, reported increases in bothconsumer and business debt outstanding as compared with the same period of theprior year.  The increase in consumerdebt was the result of a significant increase in home mortgage debt, partlyoffset by a slight decline in consumer credit debt.

Theclass action and mass tort marketplace is significant, with estimated annualtort claim costs in excess of $250 billion according to an update study issuedin 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 numberof businesses during the past several years. In January 2003, we acquired Bankruptcy Services, which expanded ourofferings to include an integrated solution of a proprietary technologyplatform and professional services for Chapter 11 corporate restructurings. InJanuary 2004, we acquired Poorman-Douglas and expanded our offerings to includeclass action, mass tort, and other similar legal proceedings.  In October 2005, we acquired Hilsoft,enhancing our expert legal notification. In November 2005, we acquired nMatrix which expanded our service offeringsto include electronic litigation discovery and in May 2006, we acquired EPIQAdvisory Services to further expand our bankruptcy case management serviceofferings.

21

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***CaseManagement Segment***

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

***DocumentManagement Segment***

Document managementrevenue is generally non-recurring due to the unpredictable nature of thefrequency, timing and magnitude of the clients’ business requirements.  Our document management segment generatesrevenue primarily through the following services.

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

·                  Reimbursementfor costs incurred related to postage on mailing services.

**CriticalAccounting Policies**

We consider ouraccounting policies related to revenue recognition, share-based compensation,business combinations, goodwill, and identifiable intangible assets to becritical policies in understanding our historical and future performance.

***Revenue recognition***.  We have arrangements with clients pursuant towhich we deliver various case management and document management solutions eachmonth.

Significant sources of case management revenueinclude:

·                  Feescontingent upon the month-to-month delivery of case management services definedby client contracts, such as claim processing, claim 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 ongoing engagement;

·                  Hostingfees based on the amount of data stored; and

·                  Volume-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, certain hardware,software and services.

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Document management revenue, which consists primarilyof legal notification and reimbursed postage costs, varies based on the sizeand complexity of the noticing requested by the client.  Consistent with guidance provided by theEmerging Issues Task Force (EITF) in EITF No. 01-14, *IncomeStatement Characterization of Reimbursements Received for “Out-of-Pocket”Expenses Incurred*, reimbursed postage and other reimbursable directcosts are recorded gross as revenue and direct cost.  Payments received in advance of satisfactionof the related revenue recognition criteria are recognized as a customerdeposit until all revenue recognition criteria have been satisfied.

For all services we provide to clients, revenue isrecognized only when we have persuasive evidence of an arrangement, the servicehas been provided and is not subject to refund, the amount due is fixed anddeterminable, and collectibility is reasonably assured.

***Share-basedcompensation.*** Effective January 1, 2006, we began accounting for share-basedcompensation 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.  We recognize this expense on a straight-linebasis over the requisite service period of the last separately vesting portionof the award.  Recognition of share-basedcompensation expense had, and will likely continue to have, a material affecton our direct costs and general and administrative line items within ourcondensed consolidated statements of income and also may have a material affecton our deferred income taxes and additional paid-in capital line items withinour condensed consolidated balance sheets. Adoption of SFAS No. 123R affects the classification within ourcondensed consolidated statement of cash flows of certain tax benefits ascertain tax benefits formerly classified as an operating cash flow are now classifiedas a financing cash flow.  To date, theonly share-based compensation we have issued is share options.

Determining thefair value of a share option grant at the date of the award requires the use ofestimates related to expected volatility, expected term of share optionsgranted, expected risk-free interest rate, and the expected dividend rate.  We estimate our expected volatility based onimplied volatilities from traded options on our stock and on our stock’shistorical volatility.  We have estimatedthe expected term of our share options based on the historical exercise patternof groups of employees that have similar historical exercise behavior.  The expected risk-free interest rate is basedon the U.S. Treasury yield curve in effect at the time of the grant.  Historically, we have not paid dividends andwe do not anticipate paying dividends in the foreseeable future; accordingly,our expected dividend rate is zero.  Theestimate of fair value at grant date is not revised based on subsequentexperience.  Net share-based compensationexpense recognized is also affected by our estimate of the number of stockoption grants that will be forfeited prior to vesting and the tax benefit thatwill be realized if the stock option grants are exercised.  We use historical information to estimateemployee termination and the resulting option forfeiture rate.  These factors are revised based on subsequentexperience, and such revised estimates may have a material impact on ourexpense recognition and adjustments to additional paid-in capital in futureperiods.

***Business combination**accounting****. *We have acquired anumber of businesses during the last several years, and we may acquireadditional businesses in the future. Business combination accounting, often referred to as purchaseaccounting, requires us to determine the fair value of all assets acquired,including identifiable intangible assets, and liabilities assumed.  The cost of the acquisition is allocated tothe assets acquired and liabilities assumed in amounts equal to the fair valueof each asset and liability, and any remaining acquisition cost is classifiedas goodwill.  This allocation processrequires extensive use of estimates and assumptions, including estimates offuture cash flows to be generated by the acquired assets.  Certain identifiable intangible assets, suchas customer lists and covenants not to compete, are amortized on astraight-line basis over the intangible asset’s estimated useful life.  The estimated useful lives of amortizableidentifiable intangible assets range from 1 to 14 years.  Goodwill is not amortized.  Accordingly, the acquisition cost allocationhas had, and will continue to have, a significant impact on our currentoperating results.

***Goodwill****.* We assess goodwill, which is not subject to amortization, for impairmentas of each July 31 and also at any other date when events or changes incircumstances indicate that the carrying value of these assets may exceed theirfair value.  This assessment is performedat a reporting unit level.  A reportingunit is a component of a segment that constitutes a business, for whichdiscrete financial information is available, and for which the operatingresults are regularly reviewed by management. We develop an estimate of the fair value of each reporting unit, usingboth a market approach and an income approach.

A change in events orcircumstances, including a decision to hold an asset or group of assets forsale, a change in strategic direction, or a change in the competitiveenvironment, could adversely affect the fair value of one or more reportingunits.  The estimate of fair value ishighly subjective and requires significant judgment.  If we determine that the fair value of anyreporting unit is less than the reporting unit’s carrying value, then we willrecognize an impairment charge.  Ifgoodwill on our 

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balance sheet becomesimpaired during a future period, the resulting impairment charge could have amaterial impact on our results of operations and financial condition.  Our goodwill totaled $261.1 million as ofJune 30, 2006.

***Identifiable intangible assets****.** ***Eachperiod we evaluate whether events and circumstances warrant a revision to theremaining estimated useful life of each identifiable intangible asset.  If events and circumstances warrant a changeto the estimate of an identifiable intangible asset’s remaining useful life,then the remaining carrying amount of the identifiable intangible asset wouldbe amortized prospectively over that revised 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 estimateof the remaining life of one or more identifiable intangible assets or theimpairment of one or more identifiable intangible assets could have a materialimpact on our results of operations and financial condition.  Our identifiable intangible assets’ carryingvalue, net of amortization, was $49.8 million as of June 30, 2006.

**Resultsof Operations for the Three Months Ended June 30, 2006 Compared with the ThreeMonths Ended June 30, 2005**

### **Consolidated Results**

### ***Revenue***Total revenue of $40.4 million for the threemonths ended June 30, 2006 represents an $8.8 million, or approximately 28%,increase compared to $31.6 million of revenue during the same period in theprior year.  A significant part of ourtotal revenue consists of reimbursement for direct costs we incur, such aspostage related to document management services.  We reflect the operating revenue from thesereimbursed direct costs as a separate line item on our accompanying condensedconsolidated statements of income. Although reimbursed operating revenue and expenses may fluctuatesignificantly from quarter to quarter, these fluctuations have a minimal effecton our operating income as we realize little or no margin from thisrevenue.  Operating revenue exclusive ofrevenue from reimbursed direct costs, which we refer to as operating revenuebefore reimbursed direct costs, increased $7.8 million, or approximately 30%,to $34.0 million for the three months ended June 30, 2006 compared to $26.2million for the same period in the prior year. Exclusive of businesses acquired after June 30, 2005, operating revenuebefore reimbursed direct costs decreased $2.2 million, or approximately 9%, to$24.0 million for the three months ended June 30, 2006 compared to $26.2million for the same period in the prior year, primarily as a result of anapproximate $2.4 million decrease in case management revenue partly offset by a$0.2 million increase in document management revenue.  Operating revenue exclusive of revenue fromreimbursed direct costs may fluctuate considerably from period to period basedon clients’ business requirements.   Allrevenue is directly related to a segment, and changes in revenue by segment arediscussed below.

### ***Costs and Expenses***Direct costs increased $4.6 million, orapproximately 34%, to $18.2 million for the three months ended June 30, 2006compared with $13.6 million during the same period in the prior year.  Exclusive of direct costs related to businessesacquired after June 30, 2005, direct costs increased $1.4 million, orapproximately 10%, to $15.0 million for the three months ended June 30, 2006compared with $13.6 million for the same period in the prior year.  This increase is primarily attributable to a$0.8 million increase in reimbursable direct costs to support increaseddocument management revenue, a $1.0 million increase in compensation andoutside services expenses, and a $0.2 million increase in share-basedcompensation expense resulting from adoption of SFAS 123R, partly offset by areduction in class action outside services and compensation expense of $0.8million.  Changes in our segment coststructure are discussed below.

General andadministrative costs increased approximately $4.4 million, or approximately54%, to $12.4 million for the three months ended June 30, 2006 compared to $8.0million for the same period in the prior year. Exclusive of general and administrative costs related to businessesacquired after June 30, 2005, these costs increased $0.7 million, orapproximately 9%, for the three months ended June 30, 2006 compared with thesame period in the prior year.  Thisincrease is primarily attributable to recognition of share-based expense of$0.4 million resulting from adoption of SFAS 123R combined with an increase intravel and meeting expense of $0.3 million related to the expansion of ourbusiness.  Changes in our segment coststructure are discussed below.

Depreciation and softwareand leasehold amortization costs increased approximately $0.7 million, orapproximately 40%, to $2.5 million for the three months ended June 30, 2006compared with $1.8 million during the same period in the prior year.  Exclusive of depreciation and software andleasehold amortization costs related to businesses acquired after June 30,2005, 

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these costs increasedslightly to $1.9 million for the three months ended June 30, 2006 compared with$1.8 million for the same period in the prior year.  Changes in our segment cost structure arediscussed below.

Amortization ofidentifiable intangible assets, compared with the same period in the prioryear, increased $1.5 million to $2.9 million for the three months ended June30, 2006.  All identifiable intangibleassets are directly related to a segment, and changes in amortization ofidentifiable intangible assets by segment are discussed below.

Acquisitionrelated expenses of $0.3 million for the three months ended June 30, 2006result from non-capitalized expenses incurred in connection with completed transactions.

***InterestExpense***We incurred interest expense of $3.4 million for thethree months ended June 30, 2006 compared with interest expense of $1.9 millionduring the same period in the prior year. The increase in interest expense during the three months ended June 30,2006 compared with the same period in the prior year resulted primarily from a$1.8 million increase in interest expense related to increased borrowings underour credit facility in support of the acquisition of our electronic discoverybusiness in November 2005.  This increasewas partly offset by a $0.5 million decrease in interest expense related to thechange in value of the embedded option related to the outstanding convertibledebt.

***EffectiveTax Rate***Our effective tax rate increased from 41.7% for the threemonths ended June 30, 2005 to 42.0% for the three months ended June 30, 2006primarily as a result of share-based compensation expense resulting fromincentive share options for which we will not recognize a tax benefit unlessthe share options are disposed of in a disqualifying transaction.  Our tax rate is higher than the statutoryfederal rate of 35% primarily due to state taxes.  We have significant operations located in NewYork City that are subject to state and local New York tax rates, which arehigher than the tax rates assessed by other jurisdictions where we operate.

***NetIncome***Net income decreased to $0.5 million for the three monthsended June 30, 2006 compared with $2.9 million for the same period in the prioryear primarily as a result of a $1.5 million increase in interest expense, a$1.5 million increase in intangible amortization, and a $0.6 million increasein recognized share-based compensation expense, partly offset by a $1.7 milliondecrease in our tax expense.

**BusinessSegments**

The followingmanagement discussion and analysis is presented on a basis consistent with oursegment disclosure contained in Note 9 of our Notes to Condensed ConsolidatedFinancial Statements.

***Case ManagementSegment***Case management operating revenue before reimburseddirect costs increased $5.4 million, or approximately 27%, to $25.1 million forthe three months ended June 30, 2006 compared to $19.7 million during the sameperiod in the prior year.  During thethree months ended June 30, 2006, operating revenue before reimbursed directcosts from businesses acquired after June 30, 2005 totaled $7.8 million.  Exclusive of these recently acquiredbusinesses, operating revenue before reimbursed direct costs decreased by $2.4million compared to the same period in the prior year.  The decrease in operating revenue isprimarily attributable to an approximate $3.2 million decrease in class actioncase management revenue which was partly offset by an increase in bankruptcycase management revenue.  Class actioncase management revenue was adversely affected by competitive pricingpressures, primarily affecting retentions of larger cases.

Case management directand administrative expenses, including depreciation and software and leaseholdamortization, of $13.1 million increased $5.4 million, or approximately 70%,for the three months ended June 30, 2006 compared with $7.7 million during thesame period in the prior year.  Duringthe three months ended June 30, 2006, direct and administrative expenses,including depreciation and software and leasehold amortization, from businessesacquired after June 30, 2005 totaled $5.3 million.  Exclusive of these recently acquiredbusinesses, our direct and administrative expenses, including depreciation andsoftware and leasehold amortization, increased by $0.1 million compared to thesame period in the prior year, primarily from an increase in compensationexpense.

Amortization of casemanagement’s identifiable intangible assets increased to $2.4 million for thethree months ended June 30, 2006 compared with $1.1 million for the same periodin the prior year.  This increase isprimarily the result of 

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amortization ofadditional other intangible assets, resulting primarily from the acquisition inNovember 2005 of our electronic discovery business.

***DocumentManagement Segment***Document management operating revenue before reimburseddirect costs increased $2.5 million, or approximately 40%, to $8.9 million forthe three months ended June 30, 2006 compared to $6.4 million during the sameperiod in the prior year.  For the threemonths ended June 30, 2006, operating revenue before reimbursed direct costs fromthe business acquired after June 30, 2005 totaled $2.3 million.  Exclusive of this recently acquired business,operating revenue before reimbursed direct costs increased $0.2 million,primarily as a result of increased bankruptcy document management revenue,partly offset by an approximate $1.0 million decrease in class action documentmanagement revenue.  Document managementrevenues can fluctuate considerably from period to period based on clients’business requirements.

Document managementdirect and administrative expenses, including depreciation and software andleasehold amortization, of $11.7 million increased $3.2 million, orapproximately 37%, for the three months ended June 30, 2006 compared with $8.5million for the same period in the prior year. This increase is primarily attributable to the inclusion of $2.1 millionof direct and administrative expenses, including depreciation and software andleasehold amortization, related to the business acquired after June 30,2005.  Exclusive of this recentlyacquired business, direct and administrative expenses, including depreciationand software and leasehold amortization, increased $1.1 million, or 13%,primarily as a result of an increase in reimbursable direct costs and anincrease in outside services related to bankruptcy document management.  Document management direct expenses includereimbursed expenses and other operating expenses which are more variable innature than case management direct expenses. Outside service costs will vary depending on the nature and complexityof services provided.  Documentmanagement expenses can fluctuate from quarter to quarter based on documentmanagement business requirements delivered during each quarter.

Amortization of documentmanagement’s identifiable intangible assets increased to $0.5 million for thethree months ended June 30, 2006 compared with $0.4 million for the same periodin the prior year.  This increase isprimarily the result of amortization of other intangible assets, resulting fromthe acquisition of our legal notification business.

**Resultsof Operations for the Six Months Ended June 30, 2006 Compared with the SixMonths Ended June 30, 2005**

### **Consolidated Results**

### ***Revenue***Total revenue of $85.1 million for the six monthsended June 30, 2006 represents an approximate 35% increase compared to $63.1million of total revenue for the same period in the prior year.  A significant part of our total revenueconsists of reimbursement for direct costs we incur, such as postage related todocument management services.  We reflectthe operating revenue from these reimbursed direct costs as a separate lineitem on our accompanying condensed consolidated statements of income.  Although reimbursed operating revenue and therelated direct costs may fluctuate significantly from period to period, thesefluctuations have a minimal effect on our operating income as we realize littleor no margin from this revenue.  Revenueexclusive of reimbursed direct costs, which we refer to as operating revenuebefore reimbursed direct costs, increased approximately $20.8 million, orapproximately 40%, to $73.0 million for the six months ended June 30, 2006compared to $52.2 million for the same period in the prior year.  Exclusive of businesses acquired after June30, 2005, operating revenue before reimbursed direct costs decreasedapproximately $4.5 million, or approximately 9%, to approximately $47.7 millionfor the six months ended June 30, 2006 compared to approximately $52.2 millionfor the same period in the prior year, primarily as a result of an approximate$4.9 million decrease in case management revenue partly offset by an approximate$0.4 million increase in document management revenue.  Operating revenue exclusive of revenue fromreimbursed direct costs may fluctuate from 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 costs increased $12.0 million, orapproximately 44%, to $39.3 million for the six months ended June 30, 2006compared with $27.3 million for the same period in the prior year.  Exclusive of direct costs related tobusinesses acquired after June 30, 2005, direct costs increased $1.5 million,or approximately 5%, to $28.8 million for the six months ended June 30, 2006compared with $27.3 million for the same period in the prior year. Thisincrease is primarily attributable to a $2.2 million of increases inreimbursable direct costs, compensation and outside services expense and a $0.3million increase in share-based compensation expense resulting from adoption ofSFAS 123R, partly offset by a $1.2 million reduction in our class actionoutside services and compensation expense. Changes in our segment cost structure are discussed below.

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General andadministrative costs increased approximately $8.1 million, or approximately50%, to $24.1 million for the six months ended June 30, 2006 compared with$16.0 million for the same period in the prior year.  Exclusive of general and administrative costsrelated to businesses acquired after June 30, 2005, these costs increasedapproximately $1.8 million, or approximately 11%, to $17.8 million for the sixmonths ended June 30, 2006 compared with $16.0 million for the same period inthe prior year.  This increase isprimarily attributable to $0.8 million of share-based expense resulting fromadoption of SFAS 123R combined with a $0.8 million increase in travel expenserelated to the expansion of our business. Changes in our segment cost structure are discussed below.

Depreciation and softwareand leasehold amortization costs increased approximately $1.2 million to $4.8million for the six months ended June 30, 2006 compared with $3.6 million forthe same period in the prior year. Exclusive of depreciation and software and leasehold amortization costsrelated to businesses acquired after June 30, 2005, these costs increasedslightly to $3.7 million for the six months ended June 30, 2006 compared with$3.6 million for the same period in the prior year.  Changes in our segment cost structure arediscussed below.

Amortization ofidentifiable intangible assets, compared with the same period in the prioryear, increased $2.6 million to $5.6 million for the six months ended June 30,2006.  All identifiable intangible assetsare directly related to a segment, and changes in amortization of identifiableintangible assets by segment are discussed below.

Acquisitionrelated expenses of $0.3 million for the six months ended June 30, 2006 resultfrom non-capitalized expenses incurred in connection with completedtransactions.

***InterestExpense***We incurred interest expense of $6.7 million for the sixmonths ended June 30, 2006 compared with interest expense of $2.7 million forthe same period in the prior year.  Thisincrease primarily is the result of a $3.6 million increase in interest expenserelated to our credit facility, 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.  Also contributing to the increase in interestexpense were an increase in loan fee amortization expense and an increase inthe value of the embedded option related to the outstanding convertible debt,which resulted in an increase to interest expense, compared with the six monthsended June 30, 2005.

***EffectiveTax Rate***Our effective tax rate increased from 41.7% for the sixmonths ended June 30, 2005 to 42.0% for the six months ended June 30, 2006primarily as a result of share-based compensation expense resulting fromincentive share options for which we will not recognize a tax benefit unlessthe share options are disposed of in a disqualifying transaction.  Our tax rate is higher than the statutoryfederal rate of 35% primarily due to state taxes.  We have significant operations located in NewYork City that are subject to state and local New York tax rates, which arehigher than the tax rates assessed by other jurisdictions where we operate.

***NetIncome***Net income decreased approximately $3.6 million to $2.6million for the six months ended June 30, 2006 compared with $6.2 million forthe same period in the prior year primarily as a result of a $4.0 millionincrease in interest expense, a $2.6 million increase in intangibleamortization, and a $1.1 million increase in recognized share-basedcompensation expense, partly offset by a $2.6 million decrease in our taxexpense.

**BusinessSegments**

The followingmanagement discussion and analysis is presented on a basis consistent with oursegment disclosure contained in Note 9 of our Notes to Condensed ConsolidatedFinancial Statements.

***Case ManagementRevenue***Case management operating revenue before reimburseddirect costs increased $11.5 million, or approximately 29%, to $51.1 millionfor the six months ended June 30, 2006 compared to $39.6 million for the sameperiod in the prior year.  During the sixmonths ended June 30, 2006, operating revenue before reimbursed direct costsfrom businesses acquired after June 30, 2005 totaled $16.4 million.  Exclusive of these recently acquiredbusinesses, operating revenue before reimbursed direct costs decreased by $4.9million compared to the same period in the prior year.  The change in operating revenue is primarilyattributable to an approximate $6.6 million decline in class action casemanagement revenue which was partly offset by an increase in bankruptcy casemanagement revenue.  Class action casemanagement revenue was adversely affected by competitive pricing pressures,primarily affecting retentions on larger cases.

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Case management directand administrative expenses, including depreciation and software and leaseholdamortization, of $24.9 million increased $9.1 million, or approximately 57%,for the six months ended June 30, 2006 compared with $15.8 million for the sameperiod in the prior year.  During the sixmonths ended June 30, 2006, direct and administrative expenses, includingdepreciation and software and leasehold amortization, from businesses acquiredafter June 30, 2005 totaled $9.5 million. Exclusive of these recently acquired businesses, our direct andadministrative expenses, including depreciation and software leaseholdamortization, decreased by approximately $0.4 million.  This decrease in direct and administrativeexpenses, including depreciation and software and leasehold amortization, isprimarily attributable to a $1.1 million decrease in class action compensationand outside services expenses, partly offset by a $0.6 million increase incompensation expense in bankruptcy.

Amortization of casemanagement’s identifiable intangible assets increased to $4.6 million for thesix months ended June 30, 2006 compared with $2.2 million for the same periodin the prior year.  This increase isprimarily the result of amortization of additional other intangible assets,resulting primarily from the acquisition of our electronic discovery business.

***DocumentManagement Segment***Document management operating revenue before reimburseddirect costs increased $9.4 million, or approximately 75%, to $21.9 million forthe six months ended June 30, 2006 compared to $12.5 million for the sameperiod in the prior year.  For the sixmonths ended June 30, 2006, operating revenue before reimbursed direct costsfrom the business acquired after June 30, 2005 totaled $9.0 million.  Exclusive of this recently acquired business,operating revenue before reimbursed direct costs increased $0.4 million,primarily from an increase in bankruptcy document management revenue, partlyoffset by an approximate $1.1 million decrease in class action revenue.  Document management revenue can fluctuatefrom period to period based on clients’ business requirements.

Document managementdirect and administrative expenses, including depreciation and software andleasehold amortization, of $26.7 million increased $10.0 million, orapproximately 60%, for the six months ended June 30, 2006 compared to $16.7million for the same period in the prior year. This increase is primarily attributable to the inclusion of $8.4 millionof direct and administrative expenses, including depreciation and software andleasehold amortization, related to the business acquired after June 30,2005.  Exclusive of this recentlyacquired business, direct and administrative expenses, including depreciationand software and leasehold amortization, increased $1.6 million primarily from increasesin reimbursable direct costs and an increase in outside services related tobankruptcy document management.  Outsideservice costs will vary depending on the nature and complexity of servicesprovided.  Document management directexpenses include reimbursed expenses and other operating expenses which aremore variable in nature than case management direct expenses.  Document management expenses will fluctuatefrom period to period based on document management business requirementsdelivered during each period.

Amortization of documentmanagement’s identifiable intangible assets increased $1.0 million, for the sixmonths ended June 30, 2006 compared to $0.8 million for the same period in theprior year.  This increase is primarilythe result of amortization of additional other intangible assets, resultingfrom the acquisition of our acquired legal notification business.

**Liquidity and Capital Resources**

***OperatingActivities***During the six months ended June 30, 2006, the primarysource of cash from operating activities was net income of $2.6 million,adjusted for $11.9 million of non-cash charges and credits, primarilydepreciation and amortization.  Inaddition, $3.8 million of cash was generated related to changes in net operatingassets, primarily as a result of a decrease in trade accounts receivable andincome taxes refundable.  Trade accountsreceivable, which will fluctuate from period to period depending on the timingof collections, decreased primarily as a result of increased collectionsrelated to our recently acquired electronic discovery business.  Income taxes refundable decreased primarilyas a result of the receipt of refunds due to us.  Additionally, our accrual of estimatedcurrent income taxes payable exceeded our estimated tax payments.  As a result, our operating activitiesgenerated net cash of $18.3 million for the six months ended June 30, 2006.

***InvestingActivities***During the six months ended June 30, 2006, we used cashof approximately $4.4 million to purchase property and equipment.  Our property and equipment purchasesconsisted primarily of computer related hardware to support our electronicdiscovery and bankruptcy businesses. Enhancements to our existing software and development of new software isessential to our continued growth and, during the six months ended June 30,2006, we used cash of approximately $2.0 million to fund internal costs relatedto development of software for which technological feasibility has beenestablished.  During November 

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2005, we acquired ourelectronic discovery business.  Tosupport this new business, we anticipate increases in software development andhardware purchases during 2006 compared with 2005.  We also used approximately $3.5 million ofcash to partly fund an acquisition.  Webelieve that cash generated from operations will be adequate to fund ouranticipated property, equipment and software spending over the next year.

***FinancingActivities***During the six months ended June 30, 2006, we paidapproximately $10.0 million as a principal reduction on our senior term loanand $1.7 million as a principal reduction on the BSI deferred acquisitionprice, and we repaid $5.0 million of our senior revolving loan.  This financing use of cash was partly offsetby $1.6 million of net proceeds from stock issued in connection with theexercise of employee share options.  As aresult of adoption of SFAS 123R, we also classify a portion of the tax benefit,referred to as excess tax benefit, that we realize on exercise of employeeshare options as a financing cash flow. The effect of this accounting change during the six months ended June30, 2006 was to recognize $0.2 million of excess tax benefit as a financingcash flow rather than as an operating cash flow.

As of June 30, 2006, ourborrowings consisted of $51.8 million from the contingent convertiblesubordinated notes (including the fair value of the embedded option), $15.0million under our senior term loan, $88.0 million under our senior revolvingloan, and approximately $12.8 million of obligations related to capitalizedleases and deferred acquisition price.

We believe that the fundsgenerated from operations plus our existing cash resources and amountsavailable under our senior revolving loan facility will be sufficient over thenext 12 months to finance currently anticipated working capital requirements,software expenditures, property and equipment expenditures, common share priceprotection payments, if any, related to common shares issued in conjunctionwith the acquisition of nMatrix, principal payments due under the creditfacility, deferred acquisition price agreements and capital leases, interestpayments due on our outstanding borrowings, and payments for other contractualobligations.  Funds generated byoperations are unlikely to be adequate to repay the $50.0 million convertibledebt which matures in June 2007.  Theconvertible debt may not require the use of cash during the next 12 months asthe holders have the right to convert (conversion price is $17.50 per share) orto extend the convertible debt maturity by three years.  In addition to the current sources ofliquidity discussed above, we may consider other alternatives, such as anequity offering of our common shares, to generate additional liquidity.

Subject to compliancewith certain covenants under the amended credit facility, we have the right toincrease the senior revolving loan by $75.0 million to $175.0 million.  As of June 30, 2006, significant covenants,all as defined within our credit facility agreement, include a leverage rationot to exceed 3.25 to 1.00, a senior leverage ratio not to exceed 2.25 to 1.00,a fixed charge coverage ratio of not less than 1.25 to 1.00, and a currentratio of not less than 1.50 to 1.00.  Asof June 30, 2006, we were in compliance with all covenants in our creditfacility, including all financial covenants.

We may pursue acquisitions in the future.  We may use our then available cash and unusedborrowing capacity to finance a future acquisition, or we may decide to issueequity, restructure our credit facility, partly finance the acquisition with anote payable, or some combination of the preceding.  Covenants contained in our credit facilityand in our convertible notes may limit our ability to consummate an acquisition.  Pursuant to the terms of our credit facility,we generally cannot incur indebtedness outside the credit facility with theexception of capital leases and additional subordinated debt, with a limit of$100.0 million of aggregate subordinated debt. Furthermore, for any acquisition we must be able to demonstrate that, ona pro forma basis, we would be in compliance with our covenants during the fourquarters prior to the acquisition and we must obtain bank permission for anyacquisition for which cash consideration exceeds $65.0 million or totalconsideration exceeds $125.0 million.

**Off-balanceSheet Arrangements**

As a part of the purchaseprice consideration to acquire nMatrix, we issued 1.2 million shares of ourcommon stock to the seller.  As explainedin Note 4 to the condensed consolidated financial statements, under certaincircumstances we may be required to pay the difference between $20.35 per shareand the price at which the seller sells the shares.  Payments, if any, made under this arrangementwill result in cash outflows.  Based onour June 30, 2006 closing price of $16.64 per share, as of June 30, 2006, theguarantee amount was approximately $4.6 million.  As discussed under the caption “Liquidity andCapital Resources — Financing Activities” above, we believe cash generated fromoperations plus amounts available under our senior revolving loan facility willprovide adequate liquidity to make any required payments under thisarrangement.  The shares subject to thisarrangement are currently unregistered; however, we anticipate these shareswill be registered and 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 June 30 (inthousands):

 
| ** **                               | ** ** | **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) |       | $                                         | 165,513    |   | $ | 70,893 |   | $ | 92,620 |   | $ | 2,000 |   | $ | — |   |
| Employment  agreements (2)               |       | 10,743                                    |       | 4,354 |   | 4,441 |   | 1,948 |   | — |   |
| Capital lease  obligations               |       | 955                                       |       | 949 |   | 6 |   | — |   | — |   |
| Operating leases                         |       | 36,101                                    |       | 5,525 |   | 8,852 |   | 8,258 |   | 13,466 |   |
| Total                                    |       | $                                         | 213,312    |   | $ | 81,721 |   | $ | 105,919 |   | $ | 12,206 |   | $ | 13,466 |   |

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(1)             Aportion of the purchase price of certain acquisitions were in the form of noteson which the interest rate was below our incremental borrowing rate, and whichwere discounted using our estimated incremental borrowing rate.  The discounts are accreted over the life ofthe note and each period’s accretion is added to the principal of therespective note.  The amount in the abovecontractual obligations table includes both the notes’ principal, as reflectedon our June 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. Convertible debt is included at the stated value of the principalredemption and excludes adjustments related to the embedded option, which willnot be paid in cash.  Any conversion toour common stock of part or all of the convertible debt will reduce our cashobligation related to the convertible debt.

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

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**Recent Accounting Pronouncements**

In June 2006, theFinancial Accounting Standards Board (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, theEmerging Issues Task Force (EITF) reached a consensus regarding EITF 05-1, *Accounting for the Conversion of an Instrument That Becomes ConvertibleUpon 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 June 28, 2006. We do notanticipate that adoption of this statement will have a material impact on ourconsolidated financial statements.

In March 2006, the FASBissued Statement of Financial Accounting Standard 156, *Accountingfor Servicing of Financial Assets*(SFAS 156).  SFAS 156 requires that an entity separatelyrecognize a servicing asset or a servicing liability when it undertakes anobligation to service a financial asset under a servicing contract in certainsituations.  Such servicing assets orservicing liabilities are required to be initially measured at fair value, ifpracticable.  SFAS 156 allows an entityto choose whether to subsequently measure its servicing assets and servicingliabilities using the amortization method or the fair value measurement method.  SFAS 156 is effective for an entity’s firstfiscal year that begins after September 15, 2006 and should be appliedprospectively to all transactions after adoption.  We do not anticipate that adoption of thisstatement will have a material impact on our consolidated financial statements.

In February 2006, theFASB issued Statement of Financial Accounting Standard 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-looking statementsmay 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)any material changes in our total number of client engagements, the volume associatedwith each engagement, or the loss of a significant client, (2) any materialchanges in our Chapter 7 deposit portfolio, the services required or selectedby our electronic discovery, Chapter 11, Chapter 13, class action or mass tortengagements, or the number of cases processed by our Chapter 13 bankruptcytrustee clients,  (3) material changes inthe number of bankruptcy filings, class action filings or mass tort actionseach year, (4) our reliance on our marketing and pricing arrangements with ourdepository banks,  (5) the impact ofrecently enacted tort reform and bankruptcy reform legislation on the volumeand timing of disposition of client engagements, (6) risks associated with theintegration of acquisitions, particularly nMatrix, into our existing businessoperations, (7) risks associated with our indebtedness, and (8) other risksdetailed from time to time in our SEC filings, including our annual report onForm 10-K.   In addition, there may be other factors notincluded in our SEC filings that may cause actual results to differ materiallyfrom any forward-looking statements.  Weundertake no obligations to update any forward-looking statements containedherein to reflect future events 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.**

Under the supervision andwith the participation of our management, including our principal executiveofficer and principal financial officer, we conducted an evaluation of theeffectiveness of the design and operation of our disclosure controls andprocedures, as defined in Rules 13a-15(e) and 15d-15(e) of the SecuritiesExchange Act of 1934.  Based on theirevaluation as of June 30, 2006, the end of the period covered by this report,our principal executive officer and principal financial officer concluded thatour disclosure controls and procedures were effective at a reasonable assurancelevel to ensure that the information required to be disclosed in reports filedor submitted under the Securities Exchange Act of 1934, including this  report, were recorded, processed, summarizedand reported within the time periods specified in the SEC’s rules and forms,and was accumulated and communicated to management, including our principalexecutive officer and principal financial officer, as appropriate to allowtimely decisions regarding required disclosure.

There have been nochanges in the our internal controls over financial reporting during thequarter ended June 30, 2006, that have materially affected, or are reasonablylikely to materially affect, our internal controls over financial reporting.

 

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**PART II - OTHERINFORMATION**

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

The following riskfactors update and replace the risk factors that are similarly captioned anddisclosed in our Annual Report on Form 10-K for the year ended December 31,2005 or are in addition to the risk factors included in our 2005 Annual Report,and should be considered in conjunction with the risk factors disclosed in our2005 Annual Report. There have been no other material changes to our RiskFactors as disclosed in Item 1A, “Risk Factors,” in our 2005 Annual Report onForm 10-K.

**Substantially all of our Chapter 7revenues are collected through a single financial institution, and thetermination of that marketing arrangement could cause uncertainty and adverselyaffect our future Chapter 7 revenue and earnings.**

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

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

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

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

These bankruptcy volume-basedfees are the largest component of our Chapter 7 revenues.

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

Chapter 7 revenue fromBank of America comprised 21%, 24% and 50% of our total revenue for the yearsended December 31, 2005, 2004, and 2003, respectively.

**Bankruptcy reform legislation couldalter the market for our products and services, which could cause a reductionin our revenue and earnings.**

InApril 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005was passed and signed by President Bush. The intent of this legislation, which became effective October 2005, isto move certain individual bankruptcy filings from Chapter 7, which liquidatesmost of the debtor’s assets and discharges most of the debtor’s liabilities, toChapter 13 bankruptcy filings, which do not liquidate the debtor’s assets butwhich requires a debtor to pay disposable income to their creditors.  The legislation also affects corporaterestructuring bankruptcy filings, in part by placing more strict limits on theperiod of time in which the debtor has an exclusive right to propose a reorganizationplan, accelerating the time frame in which a debtor must determine whether toreject a lease, and potentially increasing certain priority claims.  To date, the legislation appears tohave had two effects:  (1) a significantincrease in the number of bankruptcy filings prior to the effective date of thelegislation, and (2) a corresponding decline in bankruptcy filings in the fewmonths after the effective date of the legislation.  While neither of these two effects had animmediate material impact on our bankruptcy-related revenues, it is possiblethat there could be longer-term consequences to the reform legislation that wehave not yet identified.  As a result, we cannot predict the effect, if any,that this legislation will have on our business.

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**We rely on third-party hardware and software, which couldcause errors or failures of our service.**

We rely on hardware purchased or leased and softwarelicensed from third parties in order to offer certain services.  Any errors or defects in third-party hardwareor software could result in errors or a failure of our service, which couldharm our business.

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

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

As a result of theimminent expiration of the limited price protection, the shareholder may chooseto sell all or substantially all the shares of our common stock then held bythat shareholder subject to these agreements. Those sales could adversely affect the market price of our common stockat that time.

**Our articles of incorporation contain aprovision that could be used by us, without shareholder approval, to discourageor prevent a takeover of our company.**

Someprovisions of our articles of incorporation could make it more difficult for athird party to acquire control of our company, even if the change of controlwould be beneficial to certain shareholders. For example, our articles of incorporation include “blank check”preferred stock provisions, which permit our board of directors to issue one ormore series of preferred stock without shareholder approval.  In conjunction with the issuance of a seriesof preferred stock, the board is authorized to fix the rights of that series,including voting rights, liquidation preferences, conversion rights andredemption privileges.  The board couldissue a series of preferred stock to a friendly investor and use one or more ofthese features of the preferred stock to discourage or prevent a takeover ofthe company.  Additionally, our articlesof incorporation do not permit cumulative voting in the election ofdirectors.  Cumulative voting, ifavailable, would enable minority shareholders to elect one or morerepresentatives to the board in certain circumstances, which could be used bythird parties to facilitate a takeover of our company that was opposed by ourboard or management.

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### **ITEM 4: Submission of Matters to a Vote of Security Holders**

Our annual meeting of theshareholders was held on June 7, 2006, at which the shareholders elected thedirectors named below, approved a proposal to amend the 2004 Equity IncentivePlan to approve performance based awards, and approved a proposal to amend the2004 Equity Incentive Plan to increase the number of common shares availablefor issuance pursuant to the plan.  Theresults of the voting at the annual meeting were as follows:

 

| Election of Directors | ** ** | **For**    | ** ** | **Withhold  Authority** | ** ** |
|---------------------------------|------------|------------|------------|-------------------------|------------|
|                            |       |       |       |                    |       |
| Tom W. Olofson                  |       | 17,977,530 |       | 842,456                 |       |
| Christopher E.  Olofson         |       | 18,288,859 |       | 531,127                 |       |
| W. Bryan  Satterlee             |       | 17,331,705 |       | 1,488,281               |       |
| Edward M.  Connolly, Jr.        |       | 17,331,618 |       | 1,488,368               |       |
| James A. Byrnes                 |       | 17,639,444 |       | 1,180,542               |       |
| Joel Pelofsky                   |       | 17,638,805 |       | 1,181,181               |       |

 

| Other Matters                                                                                       | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker  Non-Votes** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|-----------------------|------------|
|                                                                                                     |       |       |       |        |       |        |       |                  |       |
| Amend the 2004  Equity   Incentive Plan to approve  performance based awards                             |       | 14,158,136 |       | 1,689,436   |       | 417,791     |       | 2,554,623             |       |
|                                                                                                     |       |       |       |        |       |        |       |                  |       |
| Amend the 2004 Equity   Incentive Plan to increase   common shares available   for issuance to 5,000,000 |       | 8,632,919  |       | 7,307,272   |       | 325,172     |       | 2,554,623             |       |

 

No other matters weresubmitted to a vote of the shareholders at the annual meeting.

**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:  August 8, 2006 | /s/ Tom W. Olofson                                |
|                       | Tom W. Olofson                                    |
|                       | Chairman of the Board                             |
|                       | Chief Executive Officer                           |
|                       | Director                                          |
|                       | (Principal Executive Officer)                     |
|                       |                                              |
| Date:  August 8, 2006 | /s/ Elizabeth M. Braham                           |
|                       | Elizabeth M. Braham                               |
|                       | Executive Vice President, Chief Financial Officer |
|                       | (Principal Financial Officer)                     |
|                       |                                              |
| Date:  August 8, 2006 | /s/ Douglas W. Fleming                            |
|                       | Douglas W. Fleming                                |
|                       | Director of Finance                               |
|                       | (Principal Accounting Officer)                    |

 

 

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