0001104659-07-008671.txt : 20070208 0001104659-07-008671.hdr.sgml : 20070208 20070208162726 ACCESSION NUMBER: 0001104659-07-008671 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20070208 DATE AS OF CHANGE: 20070208 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EPIQ SYSTEMS INC CENTRAL INDEX KEY: 0001027207 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING SERVICES [7371] IRS NUMBER: 481056429 STATE OF INCORPORATION: MO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-22081 FILM NUMBER: 07592940 BUSINESS ADDRESS: STREET 1: 501 KANSAS AVENUE CITY: KANSAS CITY STATE: KS ZIP: 66105-1309 BUSINESS PHONE: 9136219500 MAIL ADDRESS: STREET 1: 501 KANSAS AVENUE CITY: KANSAS CITY STATE: MO ZIP: 66105-1309 FORMER COMPANY: FORMER CONFORMED NAME: ELECTRONIC PROCESSING INC DATE OF NAME CHANGE: 19961116 10-Q/A 1 a07-3469_110qa.htm 10-Q/A

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q/A

Amendment No. 1

(Mark One)

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

		For the Quarterly Period Ended March 31, 2006

		OR

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

For the transition period from to

Commission File Number 0-22081

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, Kansas City, Kansas 66105-1300

(Address of principal executive office)

913-621-9500

(Registrant’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days

Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o

Accelerated Filer x

Non-Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o No x

The number of shares outstanding of registrant’s common stock at May 4, 2006:

Class		Outstanding
Common Stock, $.01 par value		19,385,717

EPIQ SYSTEMS, INC.

FORM 10-Q/A

QUARTER ENDED MARCH 31, 2006

CONTENTS



PART I - FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements	1

	Condensed Consolidated Statements of Operations (Restated)–Three months ended March 31, 2006 and 2005 (Unaudited)	1

	Condensed Consolidated Balance Sheets (Restated)– March 31, 2006 and December 31, 2005 (Unaudited)	2

	Condensed Consolidated Statements of Cash Flows (Restated)– Three months ended March 31, 2006 and 2005 (Unaudited)	3

	Notes to Condensed Consolidated Financial Statements (Unaudited)	4

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	34

Item 4.	Controls and Procedures	34

PART II - OTHER INFORMATION		35

Item 1A.	Risk Factors	35

Item 6.	Exhibits	35

Signatures		36

Explanatory Note

Epiq Systems, Inc. is filing this Amendment No. 1 to its Quarterly Report on Form 10-Q for the three months ended March 31, 2006 (Form 10-Q/A) to restate our previously issued financial statements initially filed with the Securities and Exchange Commission (SEC) on May 9, 2006, as discussed in note 10 to the condensed consolidated financial statements.

This Form 10-Q/A amends and restates Items 1, 2 and 4 of Part I of the original filing to reflect the effects of this restatement. The remaining Items contained in this Form 10-Q/A consist of all other Items contained in the original Form 10-Q for the three months ended March 31, 2006. These remaining Items are not amended by this filing. Except for the foregoing amended information, this 10-Q/A continues to describe conditions as of the date of the original filing, and we have not updated the disclosures contained herein to reflect events that occurred at a later date. In addition, pursuant to the rules of the SEC, Exhibits 31.1, 31.2, 32.1, and 32.2 of the original filing have been amended to contain currently dated certifications from our Chief Executive Officer and Chief Financial Officer. The updated certifications are attached to this Form 10-Q/A as Exhibits 31.1, 31.2, 32.1, and 32.2.

PART I - FINANCIAL INFORMATION

ITEM 1. Condensed Consolidated Financial Statements.

EPIQ SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Data)

(Unaudited)

	Three Months Ended March 31,
	2006			2005
	(As Restated, see note 10)			(As Restated, see note 10)
REVENUE:
Case management services	$	18,901		$	12,807
Case management bundled software license, software upgrade and postcontract customer support services	685			261
Document management services	12,975			6,081
Operating revenue before reimbursed direct costs	32,561			19,149
Operating revenue from reimbursed direct costs	5,657			5,495
Total Revenue	38,218			24,644

OPERATING EXPENSES:
Direct costs of services (exclusive of depreciation and amortization shown separately below)	14,376			7,247
Direct cost of bundled software license, software upgrade and postcontract customer support services (exclusive of depreciation and amortization shown separately below)	1,035			937
Reimbursed direct costs	5,720			5,552
General and administrative	11,699			7,992
Depreciation and software and leasehold amortization	2,297			1,774
Amortization of other intangibles	2,767			1,623
Total Operating Expenses	37,894			25,125

INCOME (LOSS) FROM OPERATIONS	324			(481		)

EXPENSES (INCOME) RELATED TO FINANCING:
Interest income	(46		)	(39		)
Interest expense	3,310			801
Net Expenses Related To Financing	3,264			762

LOSS BEFORE INCOME TAXES	(2,940		)	(1,243		)

PROVISION (BENEFIT) FOR INCOME TAXES	(1,191		)	885

NET LOSS	$	(1,749	)	$	(2,128	)

NET LOSS PER SHARE INFORMATION:
Basic	$	(0.09	)	$	(0.12	)
Diluted	$	(0.09	)	$	(0.12	)

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic	19,284			17,887
Diluted	19,284			17,887

See accompanying notes to condensed consolidated financial statements.

EPIQ SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share Data)

(Unaudited)

	March 31, 2006			December 31, 2005
	(As Restated, see note 10)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	6,827		$	13,563
Trade accounts receivable, less allowance for doubtful accounts of $3,229 and $3,481, respectively	35,765			33,504
Prepaid expenses	3,125			2,818
Income taxes refundable	3,415			4,643
Deferred income taxes	27,853			25,579
Other current assets	516			85
Total Current Assets	77,501			80,192

LONG-TERM ASSETS:
Property, equipment and leasehold improvements, net	24,295			23,751
Software development costs, net	8,913			8,848
Goodwill	249,729			249,427
Other intangibles, net of accumulated amortization of $16,525 and $13,758, respectively	50,302			53,399
Other	2,722			2,854
Total Long-term Assets, net	335,961			338,279
Total Assets	$	413,462		$	418,471

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	7,684		$	7,954
Customer deposits	2,359			2,196
Accrued compensation	1,151			3,944
Other accrued expenses	3,387			3,322
Deferred revenue	67,027			60,224
Current maturities of long-term obligations	18,496			27,642
Total Current Liabilities	100,104			105,282

LONG-TERM LIABILITIES:
Long-term obligations (excluding current maturities)	145,645			145,906
Deferred income taxes	26,351			26,815
Other long-term liabilities	481			—
Total Long-term Liabilities	172,477			172,721

STOCKHOLDERS’ EQUITY:
Common stock - $0.01 par value; 50,000,000 shares authorized; issued and outstanding – 19,358,717 and 19,253,466 shares at March 31, 2006 and December 31, 2005, respectively	194			193
Additional paid-in capital	130,661			128,484
Retained earnings	10,042			11,791
Accumulated other comprehensive loss	(16		)	—
Total Stockholders’ Equity	140,881			140,468
Total Liabilities and Stockholders’ Equity	$	413,462		$	418,471

See accompanying notes to condensed consolidated financial statements.

EPIQ SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

	Three Months Ended March 31,
	2006			2005
	(As Restated, see note 10)			(As Restated, see note 10)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(1,749	)	$	(2,128	)
Adjustments to reconcile net loss to net cash from operating activities:
Share-based compensation expense	530			—
Benefit for deferred income taxes	(2,547		)	(2,453		)
Depreciation and software and leasehold amortization	2,297			1,774
Loan fee amortization	337			284
Amortization of other intangibles	2,767			1,623
Other	39			(57		)
Changes in operating assets and liabilities, net of effects from business acquisition:
Trade accounts receivable	(1,986		)	(6,230		)
Prepaid expenses and other assets	(943		)	(757		)
Accounts payable and other liabilities	(1,377		)	(459		)
Deferred revenue	6,803			6,818
Excess tax benefit related to share-based compensation	(145		)	—
Income taxes (including $402 and $18 of tax benefit related to share-based compensation, respectively)	1,630			3,292
Net cash provided by operating activities	5,656			1,707

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment	(2,990		)	(404		)
Software development costs	(935		)	(437		)
Cash paid for acquisition of business, net of cash acquired	(150		)	—
Purchase of short-term investments	—			(4,000		)
Sale of short-term investments	—			2,150
Other	3			(1,767		)
Net cash used in investing activities	(4,072		)	(4,458		)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt borrowings	—			5,000
Principal payments under long-term debt obligations	(9,712		)	(7,118		)
Excess tax benefit related to share-based compensation	145			—
Proceeds from exercise of stock options	1,247			46
Net cash used in financing activities	(8,320		)	(2,072		)

NET DECREASE IN CASH AND CASH EQUIVALENTS	(6,736		)	(4,823		)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	13,563			13,330
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	6,827		$	8,507

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid	$	2,913		$	834
Income taxes paid (received)	$	(275	)	$	46

See accompanying notes to condensed consolidated financial statements.

EPIQ SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF RECENTLY ADOPTED ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of Epiq Systems, Inc. (“Epiq”) and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

Nature of Operations

Epiq is a national provider of technology-based solutions for the legal and fiduciary services industries. Our products and services assist clients with the administration of complex legal proceedings, including electronic litigation discovery, bankruptcy administration and class action administration. Our clients include leading law firms, corporate legal departments, bankruptcy trustees, and other professional advisors who require sophisticated case administration and document management capabilities, extensive subject matter expertise and a high service capacity. We provide clients with an integrated offering of both proprietary technology and value-added services that comprehensively address their extensive business requirements.

Comprehensive Loss

Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income, establishes requirements for reporting and display of comprehensive income or loss and its components. Our total comprehensive loss, which includes net earnings and foreign currency translation adjustments, was as follows (in thousands):

	Three Months Ended
	March 31, 2006			March 31, 2005

Net loss	$	(1,749	)	$	(2,128	)
Foreign currency translation adjustment	(16		)	—
Total comprehensive loss	$	(1,765	)	$	(2,128	)

Share-based Compensation

During the quarter ended March 31, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004) (SFAS No. 123R), Share-Based Payment. SFAS No. 123R establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods and services or incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize that cost over the period during which an employee is required to provide service in exchange for the award.

We elected to adopt SFAS No. 123R using the modified version of prospective application. Under the modified version of prospective application, we have recognized compensation costs related to share-based compensation beginning with the quarter ended March 31, 2006. We recognize this expense on a straight-line basis over the requisite service period of the last separately vesting portion of the award. Prior to 2006, we accounted for stock-based compensation awards under the intrinsic method of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, which required compensation cost to be recognized based on the excess, if any, between the quoted market price at the date of grant and the amount an employee must pay to acquire stock. Compensation costs related 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 notes to condensed consolidated financial statements.

RevenueRrecognition.

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

Significant sources of revenue include:

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

· Hosting fees based on the amount of data stored;

· Deposit-based fees from financial institutions, primarily based on a percentage of total liquidated assets placed on deposit at that financial institution by our bankruptcy trustee clients, to whom we provide, at no charge, software licenses, limited hardware and hardware maintenance, and postcontract customer support (PCS) services;

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

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

Non-Software Arrangements

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

· Electronic Discovery

· Data processing

· Hosting

· Corporate Restructuring

· Consulting

· Claims management

· Printing and reproduction

· Mailing and noticing

· Document management

· Class Action

· Consulting

· Notice campaigns

· Toll free customer support

· Web site design/hosting

· Claims administration

· Distribution

Based on our evaluation of each element, we have determined that each element delivered has standalone value to our customers because we or other vendors sell such services separately from any other services/deliverables. We have also obtained objective and reliable evidence of the fair value of each element based either on the price we charge when we sell an element on a standalone basis or based on third-party evidence of fair value of such services. Lastly, our arrangements do not include general rights of return. Accordingly, each of the service elements in our multiple element case and document management arrangements qualifies as a separate unit of accounting under EITF 00-21. We allocate revenue to the various units of accounting in our arrangements based on the fair value of each unit of accounting, which is generally consistent with the stated prices in our arrangements. As we have evidence of an arrangement, revenue for each separate unit of accounting is recognized each period in accordance with Staff Accounting Bulletin Topic 13, Revenue Recognition (SAB Topic 13). As the services are rendered, our fee becomes fixed and determinable, and collectibility is reasonably assured. Payments

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

Software Arrangements

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

For Chapter 7 related arrangements with financial institutions, we earn contingent monthly fees from the financial institution related to the software license, hardware lease, hardware maintenance, and PCS services. We account for the software license and PCS service elements in accordance with Statement of Position 97-2, Software Revenue Recognition (SOP 97-2). Since we have not established vendor specific objective evidence (VSOE) of the fair value of the software license, we do not recognize any revenue on delivery of the software. The software element is deferred and included with the remaining undelivered element, which is PCS services. This revenue, when recognized, is included on our condensed consolidated statements of operations as a component of “Case management bundled software license, software upgrade and postcontract customer support services” revenue. Revenue related to PCS services is entirely contingent on the placement of liquidated estate deposits by the trustee with the financial institution. Accordingly, we recognize this contingent usage based revenue consistent with the guidance provided by the American Institute of Certified Public Accountants’ Technical Practice Aid (TPA) 5100.76, Fair Value in Multiple-Element Arrangements That Include Contingent Usage-Based Fees and Software Revenue Recognition as the fee becomes fixed or determinable at the time actual usage occurs and collectibility is probable. This occurs monthly as a result of the computation, billing and collection of monthly deposit fees contractually agreed to. At that time, we have also satisfied the other revenue recognition criteria contained in SOP 97-2, since we have persuasive evidence that an arrangement exists, services have been rendered, the price is fixed and determinable, and collectibility is reasonably assured.

We also provide our trustees with certain hardware, such as desktop computers, monitors, and printers, and hardware maintenance. We retain ownership of all hardware provided and, based on guidance provided in EITF 01-8, Determining Whether an Arrangement Contains a Lease, we account for this hardware as a lease. As the hardware maintenance arrangement is an executory contract similar to an operating lease, we use guidance related to contingent rentals in operating lease arrangements for hardware maintenance as well as for the hardware lease. Since all of the payments under our arrangements are contingent upon the level of trustee deposits and the delivery of upgrades and other services and there remain important uncertainties regarding the amount of unreimbursable costs yet to be incurred by us, we account for the hardware lease as an operating lease in accordance with SFAS 13, Accounting for Leases. Therefore, all lease payments were accounted for as contingent rentals under EITF Issue No. 98-9, Accounting for Contingent Rent and SAB Topic 13, which requires that we recognize rental income when the changes in the factor on which the contingent lease payment is based actually occur. This occurred at the end of each period as we achieve our target when deposits are held at the depository financial institution as, at that time, evidence of an arrangement exists, delivery has occurred, the amount has become fixed and determinable, and collection is reasonably assured. This revenue, which is less than ten percent of our total revenue, is included in our condensed consolidated statements of operations as a component of “Case management services” revenue.

Effective October 1, 2003, we entered into an arrangement with our primary depository financial institution under which we deliver two specified upgrades annually with the last specified upgrade to occur in the second quarter of 2006. This arrangement included specific pricing for each software upgrade and certain special projects in addition to the contingent deposit-based pricing related to the software license, hardware, hardware maintenance, and PCS to each trustee client. Therefore, the software upgrades and special projects are part of a bundled arrangement. Each software upgrade is considered a separate and discrete product and, as we do not sell each software upgrade on a standalone basis, we were unable to establish VSOE of the fair value of the software upgrades. As a result, the licensed software, software upgrade, special projects and PCS are a combined unit of accounting. Revenue for this combined unit of accounting, when recognized, is included as a component of case management services revenue. Since we do not have VSOE of the fair value of each separate upgrade, we have deferred recognition of substantially all revenue under this arrangement until delivery of the final upgrade. The ongoing costs related to this arrangement were recognized as expense when incurred. When the final upgrade is delivered and the only remaining undelivered element is PCS services, we will recognize revenue on a pro-rata basis over the term of the agreement. Payments received in advance of satisfaction of the related revenue recognition criteria are recognized as deferred revenue until all revenue recognition criteria have been satisfied. As of March 31, 2006 and 2005, we had recorded on our consolidated balance sheets $66.1 million and $42.0 million, respectively, of deferred revenue under the October 2003 Arrangement. Once the final upgrade is delivered and the only remaining undelivered element is PCS, we will recognize income on a pro-rata basis over the term of the agreement.

Reimbursements

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

Recent Accounting Pronouncements

In March 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard 156, Accounting for Servicing of Financial Assets (SFAS 156). SFAS 156 requires that an entity separately recognize a servicing asset or a servicing liability when it undertakes an obligation to service a financial asset under a servicing contract in certain situations. Such servicing assets or servicing liabilities are required to be initially measured at fair value, if practicable. SFAS 156 allows an entity to choose whether to subsequently measure its servicing assets and servicing liabilities using the amortization method or the fair value measurement method. SFAS 156 is effective for an entity’s first fiscal year that begins after September 15, 2006 and should be applied prospectively to all transactions after adoption. We do not anticipate that adoption of this statement will have a material impact on our consolidated financial statements.

In February 2006, the FASB issued Statement of Financial Accounting Standard 155, Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140. (SFAS 155). SFAS 155 allows an entity to make an irrevocable election to measure a financial instrument with an embedded derivative, referred to as a hybrid financial instrument, at fair value in its entirety rather than bifurcating and separately valuing the embedded derivative instrument. SFAS 155 is effective for all financial instruments acquired, issued, or subject to a remeasurement (new basis) event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We do not anticipate that adoption of this statement will have a material impact on our consolidated financial statements.

NOTE 2: INTERIM FINANCIAL STATEMENTS

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and with the rules and regulations for reporting on Form 10-Q for interim financial statements. Accordingly, they do not include certain information and disclosures required for comprehensive annual financial statements. The interim financial statements have not been audited. The financial statements should be read in conjunction with our audited financial statements and accompanying notes, which are included in our Form 10-K/A for the year ended December 31, 2005.

In the opinion of our management, the accompanying condensed consolidated financial statements reflect all adjustments necessary (consisting solely of normal recurring adjustments) to present fairly our financial position as of March 31, 2006 and the results of operations and cash flows for the three months ended March 31, 2006 and 2005.

The results of operations for the period ended March 31, 2006 are not necessarily indicative of the results to be expected for the entire year.

NOTE 3: GOODWILL AND INTANGIBLE ASSETS

Amortizing identifiable intangible assets at March 31, 2006 and December 31, 2005 consisted of the following (in thousands):

	March 31, 2006				December 31, 2005
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Customer contracts	$	36,887	$	7,623	$	37,313	$	6,170
Trade names	2,414		1,844		2,319		1,578
Non-compete agreements	27,526		7,058		27,525		6,010
	$	66,827	$	16,525	$	67,157	$	13,758

Aggregate amortization expense related to identifiable intangible assets was $2.8 million and $1.6 million for the three-month periods ended March 31, 2006 and 2005, respectively. Amortization expense related to identifiable intangible assets for 2006 and the following five years is estimated as follows (in thousands):

Year Ending December 31,	Estimated Amortization Expense
2006	$	10,853
2007	8,384
2008	7,964
2009	6,882
2010	6,492
2011	4,759

	$	45,334

During the three months ended March 31, 2006, we received additional information regarding our preliminary valuation of nMatrix net assets acquired in November 2005 (see note 4 of these notes to condensed consolidated financial statements). Based on this information, we adjusted both the recorded value of net assets acquired and the carrying value of goodwill by approximately $0.3 million. At both March 31, 2006 and December 31, 2005, intangible assets not subject to amortization, consisting solely of goodwill, had carrying values of $249.7 million and $249.4 million, respectively.

NOTE 4: BUSINESS ACQUISITIONS

nMatrix

On November 15, 2005, Epiq, acting through a wholly-owned subsidiary, acquired all the issued and outstanding shares of capital stock of nMatrix, Inc., nMatrix Australia Pty. Ltd., and nMatrix Ltd. (collectively, “nMatrix”) for approximately $126.3 million, including capitalized acquisition costs. We believe this acquisition further expands the product and service offerings of our legal services business. The purchase price consisted of cash of $100.0 million and approximately 1.2 million shares of our common stock. The fair value of our common stock issued, calculated based upon the five-day average of the closing price of the common stock two days before and two days after the acquisition was consummated, was approximately $24.2 million. In conjunction with the acquisition, we entered into an agreement with the selling shareholder to register the shares of common stock issued as a part of the acquisition consideration. Within this 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 consecutive trading days ending on the date four trading days prior to the closing date. This guarantee terminates as of the close of business on the date that is after any 15 trading days on which the selling shareholder may lawfully sell shares under a registration statement and the last sale price for our common stock has been equal to or greater than the $20.35. Based on our March 31, 2006 closing price of $19.00 per share, as of March 31, 2006 the guarantee amount was approximately $1.7 million. We will not record a liability for this guarantee until the contingency is resolved. If a payment is made under this guarantee, we will reduce the equity proceeds recorded as a part of the acquisition transaction. Based on our valuation, 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	(6,395		)
Deferred tax liability	(16,110		)
Goodwill	94,947

Total purchase price	$	126,307

Trade names, customer relationships, and the non-compete agreements are amortized using the straight-line method over one year, eight years, and five years, respectively. The excess purchase price of $94.9 million was allocated to goodwill and is not amortized but will be reviewed for impairment annually and between annual reviews if events or changes in circumstances indicate that the asset might be impaired. The purchase price in excess of the tax basis of the assets, primarily allocated to identifiable intangible assets and goodwill, is not expected to be deductible for tax purposes. Of our common shares issued as consideration, approximately 246,000 are held in escrow. On submission of properly approved indemnification claims, the escrow trustee will liquidate sufficient shares to pay the indemnification claim. As of March 31, 2006, we have not submitted any claims related to this escrow. The escrow arrangement terminates May 14, 2007, at which time any of our common shares that have not been liquidated to pay claims will be distributed to the seller. Also, $4.0 million of the cash consideration is held in escrow pending collection of certain pre-acquisition receivables. Each month, a portion of the escrow is released to the seller based on the prior month’s collection of these pre-acquisition receivables. As of March 31, 2006, approximately $1.0 million remained in this escrow account. This escrow arrangement terminates following the payment for collections made through September 2006 of these pre-acquisition receivables, at which time any amount that remains in escrow will be distributed to us.

The acquisition was accounted for using the purchase method of accounting with the operating results included in the accompanying condensed consolidated financial statements from the date of acquisition. The operating results of nMatrix are included within our case management segment.

Hilsoft, Inc.

On October 20, 2005, we acquired for cash all the issued and outstanding shares of capital stock of Hilsoft, Inc. We believe this acquisition provides complementary diversification to our existing class action business, as Hilsoft is a specialty provider of legal notification services, primarily for class action engagements. The total value of the transaction, including capitalized transaction costs, was $9.3 million. If certain revenue objectives are satisfied, we will be required to make additional payments of up to $3.0 million to the former owners of Hilsoft.

The acquisition was accounted for using the purchase method of accounting with the operating results included in the accompanying condensed consolidated financial statements from the date of acquisition. The operating results of Hilsoft are included within our document management segment.

Pro Forma Results

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

	Three Months Ended March 31, 2005

Total revenues	$	31,470

Net loss	$	(2,513	)
Net loss per share:
Basic	$	(0.14	)
Diluted	$	(0.14	)

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

NOTE 5: INDEBTEDNESS

The following is a summary of indebtedness outstanding (in thousands):

	March 31,		December 31,
	2006		2005
Senior term loan	$	17,000	$	25,000
Senior revolving loan	93,028		93,028
Contingent convertible subordinated debt, including embedded option	51,597		51,326
Capital leases	964		972
Deferred acquisition price	1,552		3,222
Total indebtedness	$	164,141	$	173,548

Credit Facilities

We have a credit facility with KeyBank National Association as administrative agent. At inception, this facility consisted of a $25.0 million senior term loan and a $100.0 million senior revolving loan. The senior term loan matures in August 2006 and the senior revolving loan matures in November 2008. The senior term loan does not have any required amortizing payments. During the term 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 is secured by liens on our real property and a significant portion of our personal property. As of March 31, 2006, our borrowings under the credit facility totaled $110.0 million, consisting of $17.0 million under the senior term loan and $93.0 million under the senior revolving loan. Interest on the credit facility is generally based on a spread over the LIBOR rate. Effective July 1, 2006, the calculation of the interest rate for the senior term loan will be adjusted to increase the spread over the LIBOR rate by 2%. As of March 31, 2006, the interest rate charged on outstanding borrowings ranged from 7.6% to 7.8%.

Contingent Convertible Subordinated Debt

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

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

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

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

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

The holders of the notes have the right to extend the maturity of the notes for a period not to exceed three years. Under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, the right to extend the maturity of the notes represents 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 same amount. The convertible debt is accreted approximately $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 consolidated statements of operations, this accretion is a component of interest expense. The embedded option must be revalued at each period end based on the probability weighted discounted cash flows related to the additional 4% interest rate payments that will be made if the convertible debt maturity is extended an additional three years. Under this methodology, the embedded option has a current value of approximately $2.1 million. On our accompanying condensed consolidated balance sheets, our obligation related to the embedded option has been included as a component of the convertible note payable. For the three months ended March 31, 2006, the value of the embedded option increased by approximately $0.2 million and this increase is included as a component of interest expense on our accompanying condensed consolidated statements of operations. The changes in carrying value of the convertible debt and fair value of the embedded

option do not affect our cash flow and, if the embedded option is exercised, the value assigned 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 all convertible debt holders, any remaining related value assigned to the embedded option will be recognized as a gain during that period.

Covenant Compliance

Our credit facility contains financial covenants related to earnings before interest, provision for income taxes, depreciation, amortization and other adjustments as defined in the agreements (EBITDA) and total debt. In addition, our credit facility also contains financial covenants related to senior debt, fixed charges, and working capital. As a result of the restatement, which resulted in the deferral of a substantial portion of revenue as described in note 10, we were not in compliance with these financial covenants as of March 31, 2006. As a result of the recognition of the deferred revenue during the second and third quarters of 2006; we were in compliance with all financial covenants as of June 30 and September 30, 2006. The deferral of revenue and subsequent recognition of revenue was not anticipated by us or the banks at the time we established the current financial covenants in the credit facility. On December 14, 2006, we obtained a waiver regarding this event of noncompliance from our credit facility syndicate. Accordingly, we have classified this debt as current or long-term based on the debt’s original scheduled maturity.

Capital Lease

At March 31, 2006, our debt obligation related to capital leases, classified as a current liability, was approximately $1.0 million.

Deferred Acquisition Price

On January 31, 2003, we acquired 100% of the membership interests of Bankruptcy Services, LLC (“BSI”), a provider of technology-based case management, consulting and administrative services for Chapter 11 restructurings, for a purchase price of $67.0 million. A portion of the purchase price, $4.0 million, was deferred. This deferred payment, which is non-interest bearing and payable in five annual installments, was discounted using an imputed interest rate of 5% per annum. At March 31, 2006, the discounted value of the remaining note payments was approximately $1.1 million of which approximately $0.6 million was classified as a current liability.

On October 20, 2005, we acquired 100% of the equity of Hilsoft, a specialty provider of legal notification services primarily for class action engagements. A portion of the purchase price, $0.5 million, was deferred. This deferred payment, which is non-interest bearing and is payable on October 20, 2007, was discounted using an imputed interest rate of 8% per annum. At March 31, 2006, the discounted value of this deferred payment was approximately $0.5 million and is classified entirely as a noncurrent liability.

Scheduled Principal Payments

Our long-term obligations, including credit facility debt, convertible debt (including embedded option), deferred acquisition costs, and capitalized leases, mature as follows for each twelve-month period ending March 31 (in thousands):

2007	$	18,496
2008	52,617
2009	93,028
Total	$	164,141

NOTE 6: SHARE-BASED COMPENSATION

During the quarter ended March 31, 2006, we adopted SFAS No. 123R, Share-Based Payment. SFAS No. 123R establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods and services or incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize that cost over the period during which an employee is required to provide service in exchange for the award.

As disclosed in our February 18, 2005 filing on Form 8-K, during February 2005 our compensation committee approved acceleration of the vesting of approximately 0.5 million unvested options, with a weighted-average exercise price of $14.28 per share, for certain employees, including an executive officer and non-employee directors. Unvested options to purchase approximately 1.2 million shares, with a weighted-average exercise price of approximately $15.26 per share, were not accelerated as the employees holding the unvested options did not meet the criteria established by our compensation committee. The decision to accelerate the vesting of these options and eliminate future compensation expense was based primarily on a review of our long-term incentive programs considering the effect on our financial statements of the then pending change in accounting rules for stock options. This action, which had an immaterial effect on our financial statements for the year ended December 31, 2005, reduced the amount of expense we would have recognized on adoption of SFAS 123R by approximately $2.2 million (approximately $0.2 million during the three months ended March 31, 2006, and approximately $0.8 million, $0.7 million, $0.5 million and $0.2 million for the years ending December 31, 2006, 2007, 2008, and 2009, respectively).

Our 2004 Equity Incentive Plan (the Plan), which is shareholder approved, permits us to grant up to 3 million equity based instruments. Although various forms of equity instruments may be issued, to date we have issued only incentive share options and nonqualified share options under this Plan. These share options, which have a contractual term of 10 years, are issued with an exercise price equal to the grant date closing market price of our common stock. The vesting periods range from immediate to 5 years. Share options which vest over 5 years generally vest either 20% per year on the first five anniversaries of the grant date, or 25% per year on the second through fifth anniversaries of the grant date. Shares vesting over a shorter period will generally vest 100% as of the designated vesting date. We issue new shares to satisfy share option exercises. We do not anticipate that we will repurchase shares on the open market during 2006 for the purpose of satisfying share option exercises.

As a result of our adoption of SFAS No. 123R, during the quarter ended March 31, 2006, we recognized expense related to options issued prior to but unvested as of January 1, 2006 as well as expense related to options issued during the quarter. For options issued prior to but unvested as of January 1, 2006, compensation expense was based on the fair value of those options as calculated using the Black-Scholes option valuation model at the date the options were issued. Key assumptions for the Black-Scholes option valuation model include expected volatility, expected term of options granted, the expected risk-free interest rate, and the expected dividend rate. The assumptions used in those fair value calculations have been disclosed in our Annual Reports on Form 10-K previously filed with the SEC. For options issued during the quarter ended March 31, 2006, the options were also valued using the Black-Scholes option valuation models and with key assumptions related to expected volatility, expected term of options granted, the expected risk-free interest rate, and the expected dividend rate. We estimate our expected volatility based on implied volatilities from traded options on our stock and on our stock’s historical volatility. We have estimated the expected term of our options based on the historical exercise pattern of groups of employees that have similar historical exercise behavior. The expected risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. Historically, we have not paid dividends and we do not anticipate paying dividends in the foreseeable future; accordingly, our expected dividend rate is zero.

Following is a summary of key assumptions used to value options granted during the three months ended March 31, 2006.

Expected term (years)		5.0
Expected volatility		34.5% - 40.7%
Weighted-average volatility		38.0%
Risk-free interest rate		4.3% - 4.8%
Dividend yield		0%

Compensation expense for the quarter ended March 31, 2006 was adjusted for options we estimate will be forfeited prior to vesting. We use historical information to estimate employee termination and the resulting option forfeiture rate.

A summary of option activity during the three months ended March 31, 2006 is presented below (shares and aggregate intrinsic value in thousands):

	Shares		Weighted- Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value

Outstanding, beginning of period	4,769		$	14.49
Granted	155		19.05
Exercised	(129	)	11.91
Forfeited	(12	)	15.28
Outstanding, end of period	4,783		14.70		7.75	$	20,977

Options exercisable, end of period	3,296		13.53		7.22	$	18,027

The weighted average grant-date fair value of options granted during the three months ended March 31, 2006 and 2005 were $7.69 and $5.17, respectively. The total intrinsic value of options exercised during the three months ended March 31, 2006 was $1.1 million. During the three months ended March 31, 2006, we received cash for payment of the grant price of exercised options of approximately $1.2 million and we anticipate we will realize a tax benefit related to these exercised options of approximately $0.4 million. The cash received for payment of the grant price is included as a component of cash flow from financing activities. The tax benefit related to the option exercise price in excess of the option fair value at grant date ($0.1 million) is also included as a component of cash flow from financing activities; the remainder of the tax benefit ($0.3 million) is included as a component of cash flow from operating activities.

During the three months ended March 31, 2006, we recognized share-based compensation expense, which is a non-cash charge, of approximately $0.5 million, of which $0.1 million is included under the caption “Direct costs” and $0.4 million is included under the caption “General and administrative” on the accompanying condensed consolidated statements of operations. During the three months ended March 31, 2006, we recognized a net tax benefit of approximately $0.2 million related to aggregate share-based compensation expense recognized during the same period. As a result, our loss before income taxes increased by approximately $0.5 million, our net loss increased by approximately $0.3 million, and both our basic and diluted net loss per share increased by approximately $0.02 per share. As of March 31, 2006, there was $7.8 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements, which will be recognized over a weighted-average period of 2.5 years.

Prior to adoption of SFAS 123R, we accounted for stock-based compensation awards under the intrinsic method of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, which required compensation cost to be recognized based on the excess, if any, between the quoted market price at the date of grant and the amount an employee must pay to acquire stock. Options awarded under our option plans are granted with an exercise price equal to the fair market value on the date of the grant. As a result, our condensed consolidated statements of operations does not include expense related to share-based compensation for the three months ended March 31, 2005. Had the compensation cost been determined based on the fair value at the grant dates based on the guidance provided by Statement of Financial Accounting Standard (“SFAS”) No. 123, Accounting for Stock-Based Compensation, our net loss and net loss per share for the three months ended March 31, 2005 would have been adjusted to the following pro forma amounts (in thousands, except per share data):

		Three Months Ended March 31, 2005

Net loss, as reported		$	(2,128	)
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		(3,066		)
Net loss, pro forma		$	(5,194	)

Net loss per share – Basic	As reported	$	(0.12	)
	Pro forma	$	(0.29	)

Net loss per share – Diluted	As reported	$	(0.12	)
	Pro forma	$	(0.29	)

Pro forma amounts presented here are based on actual earnings and consider only the effects of estimated fair values of stock options. For the three months ended March 31, 2005, we did not assume conversion of the convertible notes or exercise of share-based options as the effect was antidilutive.

NOTE 7: NET LOSS PER SHARE

Basic net loss per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted net loss per share is computed by dividing net income available to common shareholders, increased by the amount of interest expense, net of tax, related to outstanding convertible debt, by the weighted average number of outstanding common shares and incremental shares that may be issued in future periods relating to outstanding stock options and convertible debt, if dilutive. When calculating incremental shares related to outstanding stock options, we apply the treasury stock method. The treasury stock method assumes that proceeds, consisting of the amount the employee must pay on exercise, compensation cost attributed to future services and not yet recognized, and excess tax benefits that would be credited to additional paid-in capital on exercise of the options, are used to repurchase outstanding shares at the average market price for the period. The treasury stock method is applied only to share grants for which the effect is dilutive.

The computations of basic and diluted net loss per share are as follows (in thousands, except per share data):

	Three Months Ended March 31,
	2006							2005
	Net Loss			Weighted Average Shares Outstanding	Per Share Amount			Net Loss			Weighted Average Shares Outstanding	Per Share Amount

Basic net loss per share	$	(1,749	)	19,284	$	(0.09	)	$	(2,128	)	17,887	$	(0.12	)

Effect of dilutive securities:
Stock options				—							—
Convertible debt	—			—				—			—

Diluted net loss per share	$	(1,749	)	19,284	$	(0.09	)	$	(2,128	)	17,887	$	(0.12	)

For the three months ended March 31, 2006 and 2005, we did not assume conversion of the convertible debt or exercise of any share-based options as the effect would be anti-dilutive.

NOTE 8: OPERATING LEASES

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

Future minimum lease payments during each of the twelve months ending March 31 are as follows (in thousands):

2007	$	5,159
2008	4,683
2009	4,250
2010	3,553
2011	3,520
Thereafter	15,969
Total minimum lease payments	$	37,134

Expense related to operating leases was approximately $1.2 million and $0.7 million for the three months ended March 31, 2006 and 2005, respectively.

NOTE 9: SEGMENT REPORTING

We have two operating segments: (i) case management and (ii) document management. Case management solutions provide clients with integrated technology-based products and services for the automation of administrative tasks to address their business requirements related to a case. Document management solutions include proprietary technology and production services to ensure timely, accurate and complete execution of documents related to a case.

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

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

	Three Months Ended March 31, 2006
	Case		Document
	Management		Management		Unallocated			Consolidated

Revenue:
Operating revenue before reimbursed direct costs	$	19,586	$	12,975	$	—		$	32,561
Operating revenue from reimbursed direct costs	781		4,876		—			5,657
Total revenue	20,367		17,851		—			38,218

Costs and expenses:
Direct costs, general and administrative costs and depreciation and software and leasehold amortization	11,723		14,983		8,421			35,127
Amortization of identifiable intangible assets	2,250		517		—			2,767
Total operating expenses	13,973		15,500		8,421			37,894
Operating income	$	6,664	$	2,351	$	(8,421	)	324
Interest expense, net								3,264

Loss before income taxes								(2,940		)
Benefit for income taxes								(1,191		)

Net loss								$	(1,749	)

Depreciation and amortization expense	$	3,890	$	607	$	567		$	5,064

	Three Months Ended March 31, 2005
	Case		Document
	Management		Management		Unallocated			Consolidated

Revenue:
Operating revenue before reimbursed direct costs	$	13,068	$	6,081	$	—		$	19,149
Operating revenue from reimbursed direct costs	896		4,599		—			5,495
Total revenue	13,964		10,680		—			24,644

Costs and expenses:
Direct costs, general and administrative costs and depreciation and software and leasehold amortization	8,094		8,144		7,264			23,502
Amortization of identifiable intangible assets	1,157		466		—			1,623
Total operating expenses	9,251		8,610		7,264			25,125
Operating loss	$	4,713	$	2,070	$	(7,264	)	(481		)
Interest expense, net								762
Loss before income taxes								(1,243		)
Provision for income taxes								885

Net loss								$	(2,128	)

Depreciation and amortization expense	$	2,244	$	592	$	561		$	3,397

NOTE 10: RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

Subsequent to the issuance of our consolidated financial statements for the year ended December 31, 2005, management identified an accounting error in its historical consolidated financial statements related to the appropriate accounting treatment for certain complex aspects of revenue recognition, specifically the evaluation of vendor specific objective evidence (VSOE) of fair value for specified software upgrades provided within a bundled arrangement as required by Statement of Position 97-2, Software Revenue Recognition (SOP 97-2). As a result, we have restated our financial statements as of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005, included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, initially filed with the SEC on March 8, 2006, for the quarterly information included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005 initially filed with the SEC on March 8, 2006, for the three months ended March 31, 2006 and 2005, included in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, initially filed with the SEC on May 9, 2006, for the three and six months ended June 30, 2006 and 2005, included in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, initially filed with the SEC on August 8, 2006, and for the three and nine months ended September 30, 2005, included in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006, filed with the SEC on November 14, 2006.

As background, our Chapter 7 bankruptcy services end-user customers are professional bankruptcy trustees. The application of Chapter 7 bankruptcy regulations has the practical effect of discouraging trustee customers from incurring direct administrative costs for computer systems. As a result, we provide our Chapter 7 services to trustee customers at no direct charge, and our trustee customers maintain deposit accounts for bankruptcy cases under their administration at a designated banking institution. We have marketing arrangements with various banks under which we provide Chapter 7 trustee case management software and related services and the bank provides the Chapter 7 bankruptcy trustee with deposit-related banking services. Under our primary depository financial arrangement, we primarily receive cash based on the aggregate amount of trustee deposits maintained at the bank and the number of Chapter 7 trustees with deposits placed with the bank, which we refer to collectively as volume-based fees. These volume-based fees compensate us for the software license, hardware and postcontract customer support (PCS) services that we provide to the Chapter 7 trustees.

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

In October 2003, we entered into a three year arrangement (the 2003 Arrangement) with our primary financial institution. As a part of the 2003 Arrangement, we continued to perform each of our first and second quarter specified software upgrades through the term of the arrangement (September 30, 2006), and the bank agreed to compensate us for these upgrades on terms similar to our historical terms when we delivered the upgrades on a standalone basis. As a result, in our previously reported financial statements, we concluded that we had established VSOE for the software upgrades. Accordingly, we recognized revenue for the software upgrades on delivery. Revenue related to hardware and hardware maintenance was recognized as explained in note 1 above. As we did not have VSOE for the software license, we combined the software license with the remaining undelivered element, PCS, as a single unit of accounting. Revenue related to PCS was entirely contingent on the placement of deposits by the trustee with the financial institution. Accordingly, we recognized this contingent usage based revenue consistent with the guidance provided by American Institute of Certified Public Accountants’ Technical Practice Aid (TPA) 5100.76, Fair Value in Multiple-Element Arrangements That Include Contingent Usage-Based Fees and Software Revenue Recognition as the fee became fixed or determinable at the time actual usage occurred and collectibility was probable. This occurred monthly as a result of the computation, billing and collection of monthly deposit fees. At that time, we had also satisfied the revenue recognition criteria contained in SAB Topic 13, since we had persuasive evidence that an arrangement existed, services had been rendered, the price was fixed and determinable, and collectibility was reasonably assured.

Subsequent to the issuance of the financial statements referenced above, we concluded that, although we historically sold software upgrades on a standalone basis, each specified software upgrade should be considered a separate product and, therefore, the price of prior software upgrades cannot be used to establish the price of future software upgrades. As our primary financial institution was the only payee for software upgrades during the period of the 2003 Arrangement, we were unable to establish VSOE for the software upgrades. Under SOP 97-2, if VSOE cannot be established for software upgrades, then consideration received under the 2003 Arrangement, except for consideration related to the provision of hardware and hardware maintenance, must be deferred until all software upgrades have been delivered. Although we continued to invoice,

and the bank continued to pay, our volume-based fees related to software licenses and post contract customer support as well as our semi-annual software upgrades, these amounts cannot be recognized as revenue when we provide the services. Instead, these amounts are recorded as deferred revenue liability on our condensed consolidated balance sheet. The ongoing costs related to this arrangement were recognized as expense when incurred. From inception of the arrangement through March 31, 2006, we recorded as deferred revenue $66.1 million of amounts invoiced under the 2003 Arrangement. On delivery of the final upgrade during the second quarter of 2006, the only remaining undelivered element was PCS services. In accordance with SOP 97-2, on delivery of the final software upgrade we recognized revenue previously deferred on a proportionate basis over the three year term of the contract. As the contract commenced October 1, 2003 and terminated September 30, 2006, we recognized approximately $60.1 million of net deferred revenue related to this arrangement during the second quarter of 2006 and we recognized $6.0 million of deferred revenue related to this arrangement during the third quarter of 2006.

With this restatement, we have also reclassified revenue related to software arrangements which include both product (software license and upgrades) with services (PCS) to a separate line item, “Case management bundled software license, software upgrade and post contract customer support services,” within the revenue section of our condensed consolidated statements of operations. We have also disaggregated direct costs related to operating revenue into three line items, “Direct costs of services,” “Reimbursed direct costs,” and “Direct costs of bundled software license, software upgrade and postcontract customer support services,” within the costs and expenses section of our condensed consolidated statements of income.

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

The restatement also affects taxable income, which resulted in a change to our provision for income taxes. In addition, as a result of the deferral of revenue, which had been included in our taxable income, we have restated our deferred tax assets and liabilities.

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

	March 31, 2006
	As Previously Reported		As Restated
Consolidated Balance Sheet

Income taxes refundable	$	3,302	$	3,415
Deferred income taxes	1,706		27,853
Total Current Assets	51,241		77,501
Total Assets	387,202		413,462

Other accrued expenses	4,302		3,387
Deferred revenue	—		67,027
Total Current Liabilities	33,992		100,104

Retained earnings	49,894		10,042
Total Stockholders’ Equity	180,733		140,881
Total Liabilities and Stockholders’ Equity	387,202		413,462

Consolidated Statements of Operations

	Three Months Ended
	March 31, 2006					March 31, 2005
	As Previously Reported		As Restated			As Previously Reported		As Restated

Case management services	$	26,024	$	18,901		$	19,885	$	12,807
Case management bundled software license, software upgrade and postcontract customer support services	—		685			—		261
Total Revenue	44,656		38,218			31,461		24,644
Direct costs of services (exclusive of depreciation and amortization)	21,131		14,376			13,736		7,247
Direct costs of bundled software license, software upgrade and postcontract customer support services (exclusive of depreciation and amortization)	—		1,035			—		937
Reimbursed direct costs	—		5,720			—		5,552
Income (Loss) from Operations	6,762		324			6,336		(481		)
Income(Loss) Before Income Taxes	3,498		(2,940		)	5,574		(1,243		)
Provision (Benefit) For Income Taxes	1,468		(1,191		)	2,324		885
Net Income (Loss)	2,030		(1,749		)	3,250		(2,128		)

Net Income (Loss) per Share
Basic – net income (loss) per share	$	0.11	$	(0.09	)	$	0.18	$	(0.12	)
Diluted – net income (loss) per share	$	0.10	$	(0.09	)	$	0.17	$	(0.12	)

Weighted Average Common Shares Outstanding – Diluted	23,325		19,284			21,112		17,887

Consolidated Statements of Cash Flow

	Three Months Ended
	March 31, 2006						March 31, 2005
	As Previously Reported			As Restated			As Previously Reported			As Restated

Cash Flows from Operating Activities
Net income (loss)	$	2,030		$	(1,749	)	$	3,250		$	(2,128	)
Benefit for deferred income taxes	—			(2,547		)	—			(2,453		)
Other	38			39			186			(57		)
Accounts payable and other liabilities	(1,012		)	(1,377		)	(458		)	(459		)
Deferred revenue	—			6,803			—			6,818
Income taxes, including tax benefit from exercise of stock options	1,743			1,630			2,035			3,292
Net Cash Provided by Operating Activities	5,656			5,656			1,707			1,707

* * *

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

This discussion and analysis should be read in conjunction with the condensed consolidated financial statements and the accompanying notes to the condensed consolidated financial statements included in the Form 10-Q/A and gives effect to the restatement described in note 10 to the condensed consolidated financial statements.

Overview

Epiq Systems is a provider of technology-based solutions for the legal and fiduciary services industries. Our products and services assist clients with the administration of complex legal proceedings, including electronic litigation discovery, bankruptcy administration and class action administration. Our clients include leading law firms, corporations, bankruptcy trustees, and other professional advisors who require sophisticated case administration and document management capabilities, extensive subject matter expertise and a high service capacity. We provide clients with an integrated offering of both proprietary technology and value-added services that comprehensively address their extensive business requirements.

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

The number of new bankruptcy filings each year may vary based on the level of consumer and business debt, the general economy, interest rate levels and other factors. We believe the level of consumer and business debt are important indicators of future bankruptcy filings. The most recent available Federal Reserve Flow of Funds Accounts of the United States, dated March 9, 2006, reported increases in both consumer and business debt outstanding as compared with the same period of the prior year. The increase in consumer debt was the result of a significant increase in home mortgage debt, partly offset by a slight decline in consumer credit debt.

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

We have acquired a number of businesses during the past several years. In January 2003, we acquired BSI to expand our offerings to include an integrated solution of a proprietary technology platform and professional services for Chapter 11 corporate restructurings. In January 2004, we acquired Poorman-Douglas and expanded our product and service offerings to include class action, mass tort, and other similar legal proceedings. In October 2005, we acquired Hilsoft to enhance our expert legal notification services related to class action, mass tort and bankruptcy noticing. In November 2005, we acquired nMatrix to expand our product and service offerings to include electronic litigation discovery.

We have two operating segments: case management and document management.

Case Management Segment

Case management support for client engagements may last several years and has a revenue profile that typically includes a recurring component. Our case management segment generates revenue primarily through the following services.

· Professional and support services, including case management, claims processing, specialty bankruptcy consulting, claims administration, and customized programming and technology services.

· Data hosting fees, volume-based fees, and professional services fees related to the management of large volumes of electronic data in support of a legal proceeding.

· Proprietary electronic discovery software to sort, cleanse, organize and perform searches on large databases in support of a legal proceeding.

· Software installed in bankruptcy trustee offices and provided over the internet that facilitates the administration of Chapter 7 and Chapter 13 bankruptcy cases.

· Database maintenance and processing, such as for creditor and class action claims, and conversion of that data into an organized, searchable, electronic database that we maintain on our servers and use, with our client, to manage the particular case.

· Call center support to process and respond to telephone inquiries related to creditor and class action claims.

Document Management Segment

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

· Reimbursement for costs incurred related to postage on mailing services.

Critical Accounting Policies

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

Revenue recognition.

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

Significant sources of revenue include:

· Hosting fees based on the amount of data stored;

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

Non-Software Arrangements

· Electronic Discovery

· Data processing

· Hosting

· Corporate Restructuring

· Consulting

· Claims management

· Printing and reproduction

· Mailing and noticing

· Document management

· Class Action

· Consulting

· Notice campaigns

· Toll free customer support

· Web site design/hosting

· Claims administration

· Distribution

Software Arrangements

evidence that an arrangement exists, services have been rendered, the price is fixed and determinable, and collectibility is reasonably assured.

Reimbursements

Share-based compensation. Effective January 1, 2006, we began accounting for share-based compensation under SFAS No. 123R. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize that cost over the period during which an employee is required to provide service in exchange for the award. We recognize this expense on a straight-line basis over the requisite service period of the last separately vesting portion of the award. Recognition of share-based compensation expense had, and will likely continue to have, a material affect on our direct costs and general and administrative line items within our condensed consolidated statements of operations and also may have a material affect on our deferred income taxes and additional paid-in capital line items within our condensed consolidated balance sheets. Adoption of SFAS No. 123R affects the classification within our condensed consolidated statement of cash flows of certain tax benefits as certain tax benefits formerly classified as an operating cash flow are now classified as a financing cash flow. To date, the only share-based compensation we have issued is share options.

Determining the fair value of a share option grant at the date of the award requires the use of estimates related to expected volatility, expected term of share options granted, expected risk-free interest rate, and the expected dividend rate. We estimate our expected volatility based on implied volatilities from traded options on our stock and on our stock’s historical volatility. We have estimated the expected term of our share options based on the historical exercise pattern of groups of

employees that have similar historical exercise behavior. The expected risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. Historically, we have not paid dividends and we do not anticipate paying dividends in the foreseeable future; accordingly, our expected dividend rate is zero. The estimate of fair value at grant date is not revised based on subsequent experience. Net share-based compensation expense recognized is also affected by our estimate of the number of stock option grants that will be forfeited prior to vesting and the tax benefit that will be realized if the stock option grants are exercised. We use historical information to estimate employee termination and the resulting option forfeiture rate. These factors are revised based on subsequent experience, and such revised estimates may have a material impact on our expense recognition and adjustments to additional paid-in capital in future periods.

Business combination accounting. We have acquired a number of businesses during the last several years, and we may acquire additional businesses in the future. Business combination accounting, often referred to as purchase accounting, 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 to the assets acquired and liabilities assumed in amounts equal to the fair value of each asset and liability, and any remaining acquisition cost is classified as goodwill. This allocation process requires extensive use of estimates and assumptions, including estimates of future cash flows to be generated by the acquired assets. Certain identifiable intangible assets, such as customer lists and covenants not to compete, are amortized on a straight-line basis over the intangible asset’s estimated useful life. The estimated useful lives of amortizable identifiable intangible assets range from 1 to 14 years. Goodwill and certain other identifiable intangible assets are not amortized. Accordingly, the acquisition cost allocation has had, and will continue to have, a significant impact on our current operating results.

Goodwill. We assess goodwill, which is not subject to amortization, for impairment as of each July 31 and also at any other date when events or changes in circumstances indicate that the carrying value of these assets may exceed their fair value. This assessment is performed at a reporting unit level. A reporting unit is a component of a segment that constitutes a business, for which discrete financial information is available, and for which the operating results are regularly reviewed by management.

A change in events or circumstances, including a decision to hold an asset or group of assets for sale, a change in strategic direction, or a change in the competitive environment could adversely affect the fair value of one or more reporting units. The estimate of fair value is highly subjective and requires significant judgment. If we determine that the fair value of any reporting unit is less than the reporting unit’s carrying value, then we will recognize an impairment charge. If goodwill on our balance sheet becomes impaired during a future period, the resulting impairment charge could have a material impact on our results of operations and financial condition. Our goodwill totaled $249.7 million as of March 31, 2006.

Identifiable intangible assets. Each period we evaluate whether events and circumstances warrant a revision to the remaining estimated useful life of each identifiable intangible asset. If events and circumstances warrant a change to the estimate of an identifiable intangible asset’s remaining useful life, then the remaining carrying amount of the identifiable intangible asset would be amortized prospectively over that revised remaining useful life. Furthermore, information developed during our annual assessment, or other events and circumstances, may indicate that the carrying value of one or more identifiable intangible assets is not recoverable and its fair value is less than the identifiable intangible asset’s carrying value and would result in recognition of an impairment charge.

A change in the estimate of the remaining life of one or more identifiable intangible assets or the impairment of one or more identifiable intangible assets could have a material impact on our results of operations and financial condition. Our identifiable intangible assets’ carrying value, net of amortization, was $50.3 million as of March 31, 2006.

Results of Operations for the Three Months Ended March 31, 2006 Compared with the Three Months Ended March 31, 2005

Consolidated Results

Revenue

Total revenue of $38.2 million for the three months ended March 31, 2006 represents a $13.6 million, or an approximate 55% increase, compared to $24.6 million of revenue for the same period in the prior year. A significant part of our total revenue consists of reimbursement for direct costs we incur, such as postage related to document management services. We reflect the operating revenue from these reimbursed direct costs as a separate line item on our accompanying condensed consolidated statements of operations. Although reimbursed operating revenue and direct costs may fluctuate significantly from quarter to quarter, these fluctuations have a minimal effect on our operating income as we realize little or no margin from this revenue. Operating revenue exclusive of revenue from reimbursed direct costs, which we refer to as operating revenue before reimbursed direct costs, increased approximately 70% to $32.6 million for the three months ended March 31, 2006 compared to $19.1 million for the same period in the prior year. All revenue is directly related to a segment, and changes in revenue by segment are discussed below.

Costs and Expenses

Direct costs of services, exclusive of depreciation and amortization, increased to $14.4 million for the three months ended March 31, 2006 compared with $7.2 million during the same period in the prior year. Exclusive of direct costs related to businesses acquired after March 31, 2005, direct costs had a small increase to approximately $7.5 million for the three months ended March 31, 2006 compared with $7.2 million for the same period in the prior year. Changes in our segment cost structure are discussed below.

Direct cost of bundled software license, software upgrade and postcontract customer support services, exclusive of depreciation and amortization, increased approximately $0.1 million to $1.0 million for three months ended March 31, 2006 compared with $0.9 million for the same period in the prior year primarily as a result of increased compensation costs. Changes in our segment cost structure are discussed below.

Reimbursed direct costs increased to $5.7 million for the three months ended March 31, 2006 compared with $5.6 million during the same period in the prior year. Exclusive of reimbursed direct costs related to recently acquired entities, reimbursed direct costs decreased to approximately $5.3 million for the three months ended March 31, 2006, compared with approximately $5.6 million for the same period in the prior year. These changes are directly attributable to the changes in operating revenue from reimbursed direct costs.

General and administrative costs increased $3.7 million, or approximately 46%, to $11.7 million for the three months ended March 31, 2006 compared with $8.0 million for the same period in the prior year. Exclusive of costs related to recently acquired entities, general and administrative costs increased to approximately 13% to $9.0 million for the three months ended March 31, 2006, compared with approximately $8.0 million for the same period in the prior year. The primary reasons for the increase in general and administrative costs was the recognition of $0.5 million of share-based compensation expense resulting from adoption of Statement of Financial Accounting Standards No. 123 (revised) (SFAS 123R), Share-based Payment, combined with a $0.5 million increase in travel and meeting expense related to the expansion of our business.

Depreciation and software and leasehold amortization costs increased $0.5 million, or approximately 29%, to $2.3 million for the three months ended March 31, 2006 compared with $1.8 million for the same period in the prior year. Exclusive of costs related to recently acquired entities, depreciation and software and leasehold amortization costs were approximately $1.8 million for both the three months ended March 31, 2006 and 2005.

Amortization of identifiable intangible assets, compared with the same period in the prior year, increased $1.1 million to $2.8 million for the three months ended March 31, 2006. All identifiable intangible assets are directly related to a segment, and changes in amortization of identifiable intangible assets by segment are discussed below.

Interest Expense

We incurred interest expense of $3.3 million for the three months ended March 31, 2006 compared with interest expense of $0.8 million for the same period in the prior year. The increase in interest expense during the three months ended March 31, 2006 compared with the same period in the prior year resulted primarily from an increase in average borrowings outstanding under our credit facility as a result of our acquisition of the nMatrix electronic discovery business. Also contributing to the

increase in interest expense was an increase in the value of the embedded option related to the outstanding convertible debt during the three months ended March 31, 2006, which resulted in a increase to interest expense, compared with decrease in the value of the embedded option during the three months ended March 31, 2005, which resulted in a decrease to interest expense, and an increase in interest rates during the three months ended March 31, 2006 compared with the same period in the prior year.

Effective Tax Rate

Our effective tax rate to record the tax benefit related to our net loss was 40.5% for the three months ended March 31, 2006 compared with a tax expense related to our net loss at an effective tax rate of 71.2% for the three months ended March 31, 2005. We had tax expense related to our net loss for the three months ended March 31, 2005 as, although we have net losses before income taxes, we are unable to record a tax benefit for certain expenses that are not deductible for tax purposes. These nondeductible expenses exceed our pre-tax net loss resulting in taxable income and, therefore, resulted in tax expense. Our 2006 tax rate is higher than the statutory federal rate of 35% primarily due to state taxes. We have significant operations located in New York City that are subject to state and local tax rates which are higher than the tax rates assessed by other jurisdictions where we operate.

Net Loss

Our net loss was approximately $1.7 million for the three months ended March 31, 2006 compared with a net loss of approximately $2.1 million for the same period in the prior year. This change is primarily the result of a $2.1 million increase in our income tax benefit and a $0.8 million improvement in operating income, offset by a $2.5 million increase in interest expense.

Case Management Segment

Case management operating revenue before reimbursed direct costs increased $6.5 million, or approximately 50%, to $19.6 million for the three months ended March 31, 2006 compared to $13.1 million for the same period in the prior year. During the three months ended March 31, 2006, operating revenue before reimbursed direct costs from businesses acquired after March 31, 2005 totaled $8.6 million. Exclusive of these newly acquired businesses, operating revenues before reimbursed direct costs decreased by $2.1 million compared to the same period in the prior year. This operating revenue decrease is primarily attributable to a decline in class action case management revenue, which will vary from period to period based on the size and complexity of cases being administered and the timing of class action settlements.

Case management direct and administrative expenses, including depreciation and software and leasehold amortization, increased $3.6 million, or approximately 45%, to $11.7 million for the three months ended March 31, 2006 compared with $8.1 million for the same period in the prior year. During the three months ended March 31, 2006, direct and administrative expenses, including depreciation and software and leasehold amortization, from businesses acquired after March 31, 2005 totaled $4.1 million. Exclusive of these newly acquired businesses, our direct and administrative expenses, including depreciation and software leasehold amortization, decreased by $0.5 million, or 6%, compared to the same period in the prior year. This decrease is primarily the result of a decrease in class action direct expenses, primarily as a result of temporary help and outside services expense reductions which were required last year to support the administration of a large case, partly offset by an increase in corporate restructuring direct and administrative expenses, primarily as a result of increased staffing.

Amortization of case management’s identifiable intangible assets increased to $2.2 million for the three months ended March 31, 2006 compared with $1.2 million for the same period in the prior year. This increase is primarily the result of amortization of other intangible assets resulting from the acquisition of our electronic discovery business during the three month period ended March 31, 2006.

Document Management Segment

Document management operating revenue before reimbursed direct costs increased $6.9 million, or approximately 113%, to $13.0 million for the three months ended March 31, 2006 compared to $6.1 million for the same period in the prior year. This increase is primarily attributable to the inclusion of $6.7 million of legal notification operating revenue before reimbursed direct costs generated from Hilsoft, which was acquired during October 2005. Exclusive of Hilsoft, operating revenue before reimbursed direct costs increased $0.2 million primarily as a result of an increase in our corporate restructuring operating revenues. Document management revenues can fluctuate materially from period to period based on clients’ business requirements.

Document management direct and administrative expenses, including depreciation and software and leasehold amortization, million increased approximately 84% to approximately $15.0 for the three months ended March 31, 2006 compared with approximately $8.1 million in the same period in the prior year. This increase is primarily attributable to the inclusion of $6.3 million of direct and administrative expenses, including depreciation and software and leasehold amortization, related to our Hilsoft legal notification business acquired in October 2005. Exclusive of Hilsoft, direct and administrative expenses, including depreciation and software and leasehold amortization, increased $0.5 million, or 6%, primarily as a result of an increase in outside services related to corporate restructuring and class action legal notification. Outside service costs will vary depending on the nature and complexity of services provided. Document management direct expenses include reimbursed expenses and other operating expenses which are more variable in nature than case management direct expenses. Document management expenses will fluctuate from quarter to quarter based on document management business requirements delivered during each quarter.

Amortization of document management’s identifiable intangible assets increased 11%, to $0.5 million, for the three months ended March 31, 2006 compared with the same period in the prior year. This increase is primarily the result of amortization of other intangible assets, resulting from the acquisition of our Hilsoft legal notification business, during the three month period ended March 31, 2006.

Liquidity and Capital Resources

Operating Activities

During the three months ended March 31, 2006, our operating activities provided net cash of $5.7 million. The primary sources of cash from operating activities were adjustments for non-cash charges and credits, primarily depreciation and amortization, of $3.4 million and changes in operating assets and liabilities, net of effects from business acquisitions, which increased our operating cash flow by $4.0 million primarily as a result of an increase in the deferred revenue liability partly offset by an increase in trade accounts receivable. These sources of cash were partly offset by our net loss of $1.7 million. Deferred revenue increased $6.8 million primarily as the result of deferral of substantially all of our Chapter 7 bankruptcy trustee revenue as we did not satisfy the revenue recognition criteria set forth in SOP 97-2. This increase represents a net source of cash. Receivables, which increased $2.0 million, will fluctuate from period to period depending on the timing of collections. This increase represents a net use of cash.

Investing Activities

During the three months ended March 31, 2006, we used cash of approximately $3.0 million to pay for property and equipment purchases, including approximately $0.9 million of purchases that, in the normal course of business, were made prior to year end but paid for early this year. Our property and equipment purchases consisted primarily of computer related hardware to support our electronic discovery and bankruptcy businesses. Enhancements to our existing software and development of new software is essential to our continued growth and, during the three months ended March 31, 2006, we used cash of approximately $0.9 million to fund internal costs related to development of software for which technological feasibility has been established. We believe the nature of our current business mix will continue to result in increased spending for property, equipment and software development during 2006 compared with 2005. We anticipate that cash generated from operations will be adequate to fund our anticipated property, equipment and software spending over the next year.

Financing Activities

During the three months ended March 31, 2006, we paid approximately $8.0 million as a principal reduction on our senior term loan and $1.7 million as a principal reduction on our BSI deferred acquisition price. This financing use of cash was partly offset by $1.2 million of net proceeds from stock issued in connection with the exercise of employee stock options. As a result of adoption of SFAS 123R, we also classify a portion of the tax benefit, referred to as excess tax benefit, we realize on exercise of employee stock options as a financing cash flow. The effect of this accounting change during the three months ended March 31, 2006 was to recognize $0.1 million of excess tax benefit as a financing cash flow rather than as an operating cash flow.

As of March 31, 2006, our borrowings consisted of $51.6 million from the contingent convertible subordinated notes (including the fair value of the embedded option), $17.0 million under our senior term loan, $93.0 million under our senior revolving loan, and approximately $2.5 million of obligations related to capitalized leases and deferred acquisition price.

As of March 31, 2006, significant covenants, all as defined within our credit facility agreement, include a leverage ratio not to exceed 3.50 to 1.00, a senior leverage ratio not to exceed 2.50 to 1.00, a fixed charge coverage ratio of not less than 1.25 to 1.00, and a current ratio of not less than 1.50 to 1.00. As a result of the restatement, which resulted in the deferral of a

substantial portion of revenue as described in note 10, we were not in compliance with these financial covenants as of March 31, 2006. As a result of the recognition of the deferred revenue during the second and third quarters of 2006, we were in compliance with all financial covenants as of June 30 and September 30, 2006. The deferral of revenue and subsequent recognition of revenue was not anticipated by us or the banks at the time we established the current financial covenants in the credit facility. On December 14, 2006, we obtained a waiver regarding this event of noncompliance from our credit facility syndicate. Accordingly, we have classified this debt as current or long-term based on the debt’s original scheduled maturity.

We believe that the funds generated from operations plus amounts available under our credit facility’s senior revolving loan will be sufficient over the next year to finance currently anticipated working capital requirements, software expenditures, property and equipment expenditures, common share price protection payments, if any, related to common shares issued in conjunction with our acquisition of nMatrix, interest payments due on our outstanding borrowings, and payments for contractual obligations (exclusive of our term loan obligation). Subsequent to March 31, 2006, the $17.0 million term loan under our credit facility, with an original maturity of August 2006, was paid down to $15.0 million and the maturity was extended to June 2007.

We may pursue acquisitions in the future. If the acquisition price exceeds our then available cash and unused borrowing capacity, we may decide to issue equity, restructure our credit facility, partly finance the acquisition with a note payable, or some combination of the preceding. Covenants contained in our credit facility may limit our ability to consummate an acquisition. Pursuant to the terms of our credit facility, we generally cannot incur indebtedness outside the credit facility with the exception 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, on a pro forma basis, we would be in compliance with our covenants during the four quarters prior to the acquisition and we must obtain bank permission for any acquisition for which cash consideration exceeds $65.0 million or total consideration exceeds $125.0 million.

Off-balance Sheet Arrangements

As a part of the purchase price consideration to acquire nMatrix, we issued 1.2 million shares of our common stock to the seller. As explained in note 4 to the condensed consolidated financial statements, under certain circumstances we may be required to pay the difference between $20.35 per share and the price at which the seller sells the shares. Payments, if any, made under this arrangement will result in cash outflows. As discussed under the caption “Liquidity and Capital Resources – Financing Activities” above, we believe cash generated from operations plus amounts available under our credit facility’s senior revolving loan will provide adequate liquidity to make any required payment under this arrangement. The shares subject to this arrangement are currently unregistered; however, we anticipate these shares will be registered and available for sale in the future.

Contractual Obligations

The following table sets forth a summary of our contractual obligations and commitments, excluding periodic interest payments, for each twelve month period ending March 31 (in thousands):

	Payments Due By Period
Contractual Obligation	Total		Less than 1 Year		1 – 3 Years		3 – 5 Years		More Than 5 Years

Long-term debt and future accretion (1)	$	161,714	$	17,593	$	144,121	$	—	$	—
Employment agreements (2)	9,736		4,580		3,896		1,260		—
Capital lease obligations	964		950		14		—		—
Operating leases	37,134		5,159		8,933		7,073		15,969
Total	$	209,548	$	28,282	$	156,964	$	8,333	$	15,969

(1) A portion of the BSI and Hilsoft purchase price were established in the form of a non-interest bearing notes, which were discounted using an imputed rate of 5% and 8%, respectively, per annum. The discounts are accreted over the life of the note and each period’s accretion is added to the principal of the respective note. The amount in the above contractual obligation table includes both the notes’ principal, as reflected on our March 31, 2006 condensed consolidated balance sheet, and all future accretion. If certain revenue objectives are satisfied, we will make additional payments, not to exceed $3.0 million, over the next five years to the former owners of Hilsoft. Such payments, if any, are not included in the above contractual obligation table. Convertible debt is included at the stated value of the principal redemption and excludes adjustments related to the embedded option, which will not be paid in cash. Any conversion to our common stock of part or all of the convertible debt will reduce our cash obligation related to the convertible debt.

(2) In conjunction with acquisitions, we have entered into employment agreements with certain key employees of the acquired companies.

Recent Accounting Pronouncements

In March 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard 156, Accounting for Servicing of Financial Assets (SFAS 156). SFAS 156 requires that an entity separately recognize a servicing asset or a servicing liability when it undertakes an obligation to service a financial asset under a servicing contract in certain situations. Such servicing assets or servicing liabilities are required to be initially measured at fair value, if practicable. SFAS 156 allows an entity to choose whether to subsequently measure its servicing assets and servicing liabilities using the amortization method or the fair value measurement method. SFAS is effective for an entity’s first fiscal year that begins after September 15, 2006 and should be applied prospectively to all transactions after adoption. We do not anticipate that adoption of this statement will have a material impact on our Consolidated Financial Statements.

In February 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard 155, Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140. (SFAS 155). SFAS 155 allows an entity to make an irrevocable election to measure a financial instrument with an embedded derivative, referred to as a hybrid financial instrument, at fair value in its entirety rather than bifurcating and separately valuing the embedded derivative instrument. SFAS 155 is effective for all financial instruments acquired, issued, or subject to a remeasurement (new basis) event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We do not anticipate that adoption of this statement will have a material impact on our Consolidated Financial Statements.

Forward-Looking Statements

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

Forward-looking statements may be identified by words or phrases such as “believe,” “expect,” “anticipate,” “should,” “planned,” “may,” “estimated,” “goal,” “objective” and “potential.” Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, provide a “safe harbor” for forward-looking statements. Because forward-looking statements involve future risks and uncertainties, listed below are a variety of factors that could cause actual results and experience to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. These factors include (1) risks associated with the application of complex accounting rules to unique transactions, including the risk that good faith application of those rules and audits of those results may be later reversed by new interpretations of those rules or new views regarding the application of those rules, (2) any material changes in our total number of client engagements and the volume associated with each engagement, including the results for 2006 to date in our class action client engagements, (3) any material changes in our Chapter 7 deposit portfolio, the services required or selected by our electronic discovery, Chapter 11, Chapter 13, class action or mass tort engagements, or the number of cases processed by our Chapter 13 bankruptcy trustee clients, (4) material changes in the number of bankruptcy filings, class action filings or mass tort actions each year, (5) our reliance on our marketing and pricing arrangements with Bank of America and other depository banks (6) risks associated with the integration of acquisitions into our existing business operations, (7) risks associated without indebtedness, and (8) other risks detailed from time to time in our SEC filings, including our annual report on Form 10-K/A. In addition, there may be other factors not included in our SEC filings that may cause actual results to differ materially from any forward-looking statements. We undertake no obligations to update any forward-looking statements contained herein to reflect future events or developments.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.

Market risk refers to the risk that a change in the level of one or more market prices, interest rates, indices, volatilities, correlations or other market factors, such as liquidity, will result in losses for a certain financial instrument or group of financial instruments. Our exposure to market risk has not changed significantly since December 31, 2005.

ITEM 4. Controls and Procedures.

Disclosure Controls and Procedures

An evaluation was carried out by the Epiq Systems, Inc.’s (the Company’s) Chief Executive Officer and Chief Financial Officer of the effectiveness of the design and operations of the Company’s disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in its periodic filings with the SEC is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits to the SEC is accumulated and communicated to Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

During fiscal year 2006, management identified an accounting error in its consolidated financial statements related to determination of the appropriate accounting treatment for certain complex aspects of revenue recognition, specifically the evaluation of vendor specific objective evidence of fair value for specified software upgrades provided within a bundled arrangement as required by Statement of Position 97-2 (SOP 97-2), Software Revenue Recognition. On November 14, 2006, our audit committee determined that our previously issued financial statements for the fiscal years ended December 31, 2005, 2004 and 2003, included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, for the quarterly information included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, and for the quarterly information included in our Quarterly Report on Form 10-Q for the quarters ended March 31, 2006 and June 30, 2006, should be restated. The restatement is further discussed in note 10 to the accompanying condensed consolidated financial statements. Management of the company, under the direction of our CEO and CFO, has reevaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, 2006. As a result of this evaluation, management determined that a material weakness existed in internal control over financial reporting. Specifically, management has concluded that the control deficiency surrounding management’s oversight of the determination of the appropriate accounting treatment for certain complex aspects of revenue recognition, specifically the evaluation of vendor specific objective evidence of fair value for specified software upgrades provided within a bundled arrangement as required by SOP 97-2 represented a material weakness in internal control over financial reporting. Our management, including our CEO and CFO, concluded that our disclosure controls and procedures were not effective as of March 31, 2006.

Changes in Internal Control Over Financial Reporting

There have been no other changes in our internal controls over financial reporting during the quarter ended March 31, 2006, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

After identifying the material weakness subsequent to the original issuance of our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, management initiated changes to remediate the material weakness described above. We believe that, prior to December 31, 2006, we completed our remediation of the aforementioned material weakness in our internal control over financial reporting. The completed remediation measures include the implementation of appropriate controls related to contracts or other arrangements that are within the scope of SOP 97-2 to provide a written analysis of the appropriate accounting for these contracts or other arrangement and the review of our conclusions with qualified internal accounting personnel or third party accounting experts. In addition, we have provided our accounting staff with additional training related to generally accepted accounting principles and financial statement reporting matters.

PART II - OTHER INFORMATION

ITEM 1A. Risk Factors.

There have been no material changes in our Risk Factors from those disclosed in our 2005 Annual Report on Form 10-K/A.

ITEM 6. Exhibits.

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

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

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

SIGNATURES

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

		Epiq Systems, Inc.

Date:	February 8, 2007	/s/ Tom W. Olofson
		Tom W. Olofson
		Chairman of the Board
		Chief Executive Officer
		Director
		(Principal Executive Officer)


Date:	February 8, 2007	/s/ Elizabeth M. Braham
		Elizabeth M. Braham
		Executive Vice President, Chief Financial Officer
		(Principal Financial Officer)


Date:	February 8, 2007	/s/ Douglas W. Fleming
		Douglas W. Fleming
		Director of Finance
		(Principal Accounting Officer)

EX-31.1 2 a07-3469_1ex31d1.htm EX-31.1

Exhibit 31.1

CERTIFICATIONS

I, Tom W. Olofson, certify that:

1. I have reviewed this quarterly report on Form 10-Q/A of Epiq Systems, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and

(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 8, 2007

/s/ Tom W. Olofson
Tom W. Olofson
Chairman of the Board
Chief Executive Officer

EX-31.2 3 a07-3469_1ex31d2.htm EX-31.2

Exhibit 31.2

CERTIFICATIONS

I, Elizabeth M. Braham, certify that:

1. I have reviewed this quarterly report on Form 10-Q/A of Epiq Systems, Inc.;

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 8, 2007

/s/ Elizabeth M. Braham
Elizabeth M. Braham
Executive Vice President, Chief Financial Officer

EX-32.1 4 a07-3469_1ex32d1.htm EX-32.1

Exhibit 32.1

CERFIFICATIONS OF CEO AND CFO PURSUANT TO 18 U.S.C. SECTION 1350.

I, Tom W. Olofson, Chief Executive Officer of Epiq Systems, Inc. (the “Company”), hereby certify pursuant to Section 1350, of chapter 63 of title 18, United States Code, and Section 906 of the Sarbanes – Oxley Act of 2002, that, to the best of my knowledge, (1) the quarterly report on Form 10-Q/A of the Company to which this Exhibit is attached (the “Report”) fully complies with the requirements of section 15(d) of the Securities Exchange Act of 1934, and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Tom W. Olofson
Tom W. Olofson

Dated: February 8, 2007

I, Elizabeth M. Braham, Chief Financial Officer of Epiq Systems, Inc. (the “Company”), hereby certify pursuant to Section 1350, of chapter 63 of title 18, United States Code, and Section 906 of the Sarbanes – Oxley Act of 2002, that, to the best of my knowledge, (1) the quarterly report on Form 10-Q/A of the Company to which this Exhibit is attached (the “Report”) fully complies with the requirements of section 15(d) of the Securities Exchange Act of 1934, and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Elizabeth M. Braham
Elizabeth M. Braham

Dated: February 8, 2007