UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q/A
Amendment No. 1

Quarterly Report Under Section 13 or 15(d)

of the Securities Exchange Act of 1934

x	For the Quarterly Period Ended June 30, 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 July 18, 2006:

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

EPIQ SYSTEMS, INC.

FORM 10-Q/A

QUARTER ENDED JUNE 30, 2006

CONTENTS

		Page
PART I - FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements	1
	Condensed Consolidated Statements of Operations (Restated) – Three and six months ended June 30, 2006 and 2005 (Unaudited)	1
	Condensed Consolidated Balance Sheets (Restated) – June 30, 2006 and December 31, 2005 (Unaudited)	2
	Condensed Consolidated Statements of Cash Flows (Restated) – Six months ended June 30, 2006 and 2005 (Unaudited)	3
	Notes to Condensed Consolidated Financial Statements (Unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	42
Item 4.	Controls and Procedures	42
PART II - OTHER INFORMATION
Item 1A.	Risk Factors	43
Item 4.	Submission of Matters to a Vote of Security Holders	43
Item 6.	Exhibits	43
Signatures		44

Explanatory Note

Epiq Systems, Inc. is filing this Amendment No. 1 to its Quarterly Report on Form 10-Q for the three and six months ended June 30, 2006 (Form 10-Q/A) to restate our previously issued financial statements initially filed with the Securities and Exchange Commission (SEC) on August 8, 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, and Item 1A of Part II 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 and six months ended June 30, 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 June 30,						Six months ended June 30,
	2006			2005			2006			2005
	(As Restated see note 10)			(As Restated see note 10)			(As Restated see note 10)			(As Restated see note 10)
REVENUE:
Case management services	$	18,182		$	13,128		$	37,083		$	25,935
Case management bundled software license, software upgrade and postcontract customer support services	67,009			335			67,694			596
Document management services	8,929			6,441			21,904			12,522
Operating revenue before reimbursed direct costs	94,120			19,904			126,681			39,053
Operating revenue from reimbursed direct costs	6,376			5,448			12,033			10,944
Total Revenue	100,496			25,352			138,714			49,997
COSTS AND EXPENSES:
Direct costs of services (exclusive of depreciation and amortization shown separately below)	10,752			7,097			25,128			14,344
Direct cost of bundled software license, software upgrade and postcontract customer support services (exclusive of depreciation and amortization shown separately below)	980			923			2,015			1,860
Reimbursed direct costs	6,447			5,544			12,167			11,096
General and administrative	12,359			8,044			24,058			16,036
Depreciation and software and leasehold amortization	2,494			1,775			4,791			3,549
Amortization of identifiable intangible assets	2,878			1,427			5,645			3,050
Acquisition related	250			—			250			—
Total Operating Expenses	36,160			24,810			74,054			49,935
INCOME FROM OPERATIONS	64,336			542			64,660			62
INTEREST EXPENSE (INCOME):
Interest income	(42		)	(40		)	(88		)	(78		)
Interest expense	3,382			1,884			6,692			2,685
Net Interest Expense (Income)	3,340			1,844			6,604			2,607
INCOME (LOSS) FROM OPERATIONS BEFORE INCOME TAXES	60,996			(1,302		)	58,056			(2,545		)
PROVISION (BENEFIT) FOR INCOME TAXES	24,704			(3,138		)	23,513			(2,253		)
NET INCOME (LOSS)	$	36,292		$	1,836		$	34,543		$	(292	)
NET INCOME (LOSS) PER SHARE INFORMATION:
Basic	$	1.87		$	0.10		$	1.79		$	(0.02	)
Diluted	$	1.59		$	0.10		$	1.52		$	(0.02	)
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic	19,388			17,904			19,337			17,896
Diluted	23,004			18,432			23,159			17,896

See accompanying notes to condensed consolidated financial statements.

1

EPIQ SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share Data)

(Unaudited)

	June 30, 2006			December 31, 2005
	(As Restated see note 10)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	6,813		$	13,563
Trade accounts receivable, less allowance for doubtful accounts of $3,232 and $3,481, respectively	32,155			33,504
Prepaid expenses	2,813			2,818
Income taxes refundable	1,322			4,643
Deferred income taxes	4,367			25,579
Other current assets	413			85
Total Current Assets	47,883			80,192
LONG-TERM ASSETS:
Property, equipment and leasehold improvements, net	23,949			23,751
Software development costs, net	9,061			8,848
Goodwill	261,119			249,427
Identifiable intangible assets, net of accumulated amortization of $19,402 and $13,758, respectively	49,825			53,399
Other	2,482			2,854
Total Long-term Assets, net	346,436			338,279
Total Assets	$	394,319		$	418,471
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	5,701		$	7,954
Customer deposits	2,167			2,196
Accrued compensation	2,513			3,944
Other accrued expenses	4,343			3,322
Deferred revenue	6,845			60,224
Current maturities of long-term obligations	73,426			27,642
Total Current Liabilities	94,995			105,282
LONG-TERM LIABILITIES:
Long-term obligations (excluding current maturities)	94,202			145,906
Deferred income taxes	25,981			26,815
Other long-term liabilities	998			—
Total Long-term Liabilities	121,181			172,721
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Common stock - $0.01 par value; 50,000,000 shares authorized; issued and outstanding – 19,394,217 and 19,253,466 shares at June 30, 2006 and December 31, 2005, respectively	194			193
Additional paid-in capital	131,617			128,484
Retained earnings	46,333			11,791
Accumulated other comprehensive loss	(1		)	—
Total Stockholders’ Equity	178,143			140,468
Total Liabilities and Stockholders’ Equity	$	394,319		$	418,471

See accompanying notes to condensed consolidated financial statements.

2

EPIQ SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

	Six Months Ended June 30,
	2006			2005
	(As Restated see note 10)			(As Restated see note 10)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	34,543		$	(292	)
Adjustments to reconcile net income (loss) to net cash from operating activities:
Share-based compensation expense	1,092			—
Provision (benefit) for deferred income taxes	20,505			(5,485		)
Depreciation and software and leasehold amortization	4,791			3,549
Loan fee amortization	717			561
Amortization of identifiable intangible assets	5,645			3,050
Other	375			999
Changes in operating assets and liabilities, net of effects from business acquisition:
Trade accounts receivable	1,621			(4,573		)
Prepaid expenses and other assets	(533		)	(654		)
Accounts payable and other liabilities	(637		)	708
Deferred revenue	(53,379		)	13,102
Excess tax benefit related to share-based compensation	(154		)	—
Income taxes (including $419 and $117 of tax benefit related to share-based compensation, respectively)	3,740			(651		)
Net cash provided by operating activities	18,326			10,314
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment	(4,358		)	(896		)
Software development costs	(2,020		)	(957		)
Cash paid for acquisition of business	(3,485		)	—
Purchase of short-term investments	—			(6,000		)
Sale of short-term investments	—			6,000
Other	(133		)	447
Net cash used in investing activities	(9,996		)	(1,406		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt borrowings	—			5,000
Principal payments under long-term debt obligations	(16,720		)	(13,681		)
Excess tax benefit related to share-based compensation	154			—
Proceeds from exercise of share options	1,623			179
Other	(137		)	—
Net cash used in financing activities	(15,080		)	(8,502		)
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS	(6,750		)	406
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	13,563			13,330
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	6,813		$	13,736
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid	$	4,880		$	1,682
Income taxes (received) paid, net	$	(835	)	$	3,861

See accompanying notes to condensed consolidated financial statements.

3

EPIQ SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

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

During the six months ended June 30, 2006, we incurred an obligation in a business acquisition, classified as a component of both current maturities of long-term obligations and long-term obligations, of approximately $10.2 million.

See accompanying notes to condensed consolidated financial statements.

4

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 solutions 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.

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:

·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

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·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 all of 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, based on the estimated fair value of hardware provided, 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,

6

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 delivered two specified upgrades annually with the last specified upgrade occurring 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 did not have VSOE of the fair value of each separate upgrade, we deferred recognition of substantially all revenue under this arrangement until the final upgrade was delivered.  The ongoing costs related to this arrangement were recognized as expense when incurred.  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 terminates September 30, 2006, we recognized approximately $60.1 million of net deferred revenue during the second quarter of 2006 and we recognized approximately $6.0 million of deferred revenue related to this arrangement during the third quarter of 2006.

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.

Comprehensive Income(Loss)

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

	Three months ended June 30,				Six months ended June 30,
	2006		2005		2006			2005
Net income (loss)	$	36,292	$	1,836	$	34,543		$	(292	)
Foreign currency translation adjustment	15		—		(1		)	—
Total comprehensive income (loss)	$	36,307	$	1,836	$	34,542		$	(292	)

Share-based Compensation

On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004) (SFAS No. 123R), Share-Based Payment.  SFAS No. 123R established 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

7

on or before December 31, 2005 are reflected on a pro forma basis in note 6 of these condensed consolidated financial statements.

Recent Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48).  FIN 48 applies to tax positions accounted for under Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes.  A tax position includes a current or future reduction in taxable income reported or expected to be reported on a tax return, the decision not to report a transaction in a tax return, and an assertion that a company is not subject to taxation.  FIN 48 requires that a tax position be recognized only if it is more-likely-than-not to be sustained based solely on its technical merits as of the reporting date.  A recognized tax benefit is measured based on the largest benefit that is more than 50 percent likely to be realized.  FIN 48 is effective for an entity’s first fiscal year that begins after December 15, 2006.  At adoption, any necessary adjustment to our financial statements will be recorded directly to the beginning balance of retained earnings in the period of adoption and reported as a change in accounting principle.  At this time, we are unable to predict the impact, if any, that adoption of FIN 48 will have on our consolidated financial statements.

In June 2006, the EITF reached a consensus regarding EITF 05-1, Accounting for the Conversion of an Instrument That Becomes Convertible Upon the Issuer’s Exercise of a Call Option.  EITF 05-1 pertains only to debt instruments that become convertible at the time the issuer calls the debt, but are not convertible before the call is exercised.  Conversions of these instruments triggered by the call option would be accounted for as debt conversions and recognized as debt extinguishments if the debt instrument did not contain a substantive conversion feature at issuance.  EITF 05-1 will be effective for conversions that occur as a result of the issuer’s exercise of a call option in the interim or annual period beginning after June 28, 2006. We do not anticipate that adoption of this statement will have a material impact on our consolidated financial statements.

In March 2006, the FASB issued Statement of Financial Accounting Standard No. 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 No. 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 June 30, 2006, the results of operations for the three and six month periods ended June 30, 2006 and 2005, and cash flows for the six month periods ended June 30, 2006 and 2005.

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

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NOTE 3:   GOODWILL AND INTANGIBLE ASSETS

Amortizing identifiable intangible assets at June 30, 2006 and December 31, 2005 consisted of the following (in thousands):

	June 30, 2006				December 31, 2005
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Customer contracts	$	39,287	$	9,241	$	37,313	$	6,170
Trade names	2,414		2,020		2,319		1,578
Non-compete agreements	27,526		8,141		27,525		6,010
	$	69,227	$	19,402	$	67,157	$	13,758

Aggregate amortization expense related to identifiable intangible assets was $2.9 million and $1.4 million for the three month periods ended June 30, 2006 and 2005, respectively and was $5.6 million and $3.1 million for the six month periods ended June 30, 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	$	11,620
2007	9,531
2008	8,361
2009	6,829
2010	6,439
2011	4,706
	$	47,486

Changes in the carrying amounts of goodwill by segment are as follows (in thousands):

	Six Month Period Ended June 30, 2006							Year Ended December 31, 2005
	Case Management		Document Management			Total		Case Management		Document Management		Total
Balance, beginning of period	$	200,936	$	48,491		$	249,427	$	106,371	$	41,357	$	147,728
Goodwill acquired during the period and adjustments	11,736		(44		)	11,692		94,565		7,134		101,699
Balance, end of period	$	212,672	$	48,447		$	261,119	$	200,936	$	48,491	$	249,427

We assess goodwill for impairment as of 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.  We did not recognize any impairment loss during the three and six month periods ended June 30, 2006 and 2005.

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NOTE 4:   BUSINESS ACQUISITIONS

Epiq Advisory Services, Inc.

On May 16, 2006, our wholly-owned subsidiary, Epiq Advisory Services Inc., in an asset acquisition, acquired the claims preference business of Gazes LLC.  The total value of the transaction was $13.7 million, consisting of $3.0 million of cash paid on closing, $10.2 million of deferred payments, and $0.5 million of capitalized transaction costs.  If certain income targets are satisfied, we may be required to make additional payments, which would be recorded as compensation expense, to the seller.  The preliminary allocation of the purchase price is as follows:  $0.1 million to tangible net assets, $2.4 million to customer contracts, amortizable on a straight-line basis over two years, and $11.2 million to goodwill.  The purchase price in excess of the tax basis of the assets is expected to be deductible for tax purposes.  This acquisition further expands our case management service offerings.

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 Epiq Advisory Services are included within our case management segment.

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 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 June 30, 2006 closing price of $16.64 per share, as of June 30, 2006 the guarantee amount would be approximately $4.6 million.  A liability will not be recorded 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	(6,452		)
Deferred tax liability	(16,173		)
Goodwill	95,056
Total purchase price	$	126,296

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 $95.1 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 1.2 million common shares issued as consideration, approximately 246,000 are held in escrow.  On submission of properly approved indemnification claims, the escrow agent will sell sufficient shares to pay the indemnification claim.  As of June 30, 2006, we have not submitted any claims related to this escrow.  This escrow arrangement terminates May 14, 2007, at which time any of our common shares that have not been sold to pay claims will be distributed to the seller.  Also, $4.0 million of the cash consideration was initially placed in a separate escrow pending collection of certain pre-acquisition receivables.  Each month,

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a portion of this escrow is released to the seller based on the prior month’s collection of these pre-acquisition receivables.  As of June 30, 2006, approximately $0.3 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.  The specialty legal notification services of Hilsoft further expand our document management capabilities.  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.

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 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 June 30,				Six months ended June 30,
	2006		2005		2006		2005
Total revenue	$	100,900	$	34,291	$	139,926	$	67,016
Net income (loss)	$	36,259	$	1,670	$	34,445	$	(741	)
Net income (loss) per share
Basic	$	1.87	$	0.09	$	1.78	$	(0.04	)
Diluted	$	1.59	$	0.09	$	1.51	$	(0.04	)

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.

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NOTE 5:   INDEBTEDNESS

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

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

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, maturing in August 2006, and a $100.0 million senior revolving loan, maturing in November 2008.  During 2006, we repaid $10.0 million of the senior term loan and, in June 2006, our credit facility was amended to extend the maturity of the outstanding senior term loan balance to June 30, 2007.  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 and contains financial covenants related to:  earnings before interest, provision for income taxes, depreciation and amortization (“EBITDA”); total debt; senior debt; fixed charges; and working capital.  As of June 30, 2006, our borrowings under the credit facility totaled $103.0 million, consisting of $15.0 million under the senior term loan and $88.0 million under the senior revolving loan.  Interest on the credit facility is generally based on a spread over the LIBOR rate.  Effective April 16, 2007, 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 June 30, 2006, the interest rate charged on outstanding borrowings ranged from 8.1% to 8.6%.

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%, 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 $2.2 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 June 30, 2006, the value of the embedded option increased by

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approximately $0.1 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.

The notes evidencing the contingent subordinated convertible debt contain financial covenants related to EBITDA, total debt, and senior debt.

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 through March 31, 2006.  As a result of recognition of the deferred revenue during the second quarter of 2006; we are in compliance with all financial covenants as of June 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 June 30, 2006, our debt obligation related to capital leases, classified as a current liability, was approximately $1.0 million.

Deferred Acquisition Price

We have made three acquisitions, Bankruptcy Services, Hilsoft, and Epiq Advisory Services, for which a portion of the purchase price was deferred.  These deferred payments, which are either non-interest bearing or have a below market interest rate, have been discounted at imputed interest rates (Bankruptcy Services at 5% and Hilsoft and Epiq Advisory Services at 8%).  At June 30, 2006, the discounted value of the remaining note payments was approximately $11.9 million of which approximately $5.7 million was classified as a current 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 June 30 (in thousands):

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

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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.

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

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 share options, with a weighted-average exercise price of $14.28 per share, for certain employees, including an executive officer and non-employee directors.  Unvested share 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 share options did not meet the criteria established by our compensation committee.  The decision to accelerate the vesting of these share 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 share-based compensation.  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 and $0.4 million during the three months and six month periods ended June 30, 2006, respectively, 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 5 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 three and six month periods ended June 30, 2006 we recognized expense related to share options issued prior to but unvested as of January 1, 2006 as well as expense related to share options issued subsequent to January 1, 2006.  For share options issued prior to but unvested as of January 1, 2006, compensation expense was based on the fair value of those share options as calculated using the Black-Scholes option valuation model at the date the share options were issued. Key assumptions for the Black-Scholes option valuation model include expected volatility, expected term of share 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 share options issued during the six month period ended June 30, 2006, the share options were also valued using the Black-Scholes option valuation models and with key assumptions related to expected volatility, expected term of share options granted, the expected risk-free interest rate, and the expected dividend rate.  We estimate our expected volatility based on implied volatilities from traded share 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.

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Following is a summary of key assumptions used to value share options granted during the six months ended June 30, 2006.

Expected term (years)	5.0
Expected volatility	36.0% - 38.0%
Weighted average expected volatility	37.4%
Risk-free interest rate	4.3% - 4.9%
Dividend yield	0%

Compensation expense for the three and six month periods ended June 30, 2006 was adjusted for share 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 June 30, 2006 is presented below (shares and aggregate intrinsic value in thousands):

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

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

During the three months ended June 30, 2006, we recognized share-based compensation expense, which is a non-cash charge, of approximately $0.6 million, of which $0.2 million is included under the caption “Direct costs” and $0.4 million is included under the caption “General and administrative” on the accompanying condensed consolidated statements of operations.  During the three months ended June 30, 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, income before income taxes was reduced by approximately $0.6 million, net income was reduced by approximately $0.4 million, net income per share – basic was reduced by approximately $0.02 per share, and net income per share – diluted was reduced by approximately $0.02 per share.

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A summary of option activity during the six months ended June 30, 2006 is presented below (shares and aggregate intrinsic value in thousands):

	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding, beginning of period	4,769		$	14.49
Granted	227		18.67
Exercised	(144	)	11.35
Forfeited	(43	)	15.81
Outstanding, end of period	4,809		14.77		7.55	$	12,155
Options exercisable, end of period	3,324		13.58		6.99	$	10,957

The aggregate intrinsic value was calculated using the difference between the June 30, 2006 market price and the grant price for only those awards that have a grant price that is less than the June 30, 2006 market price.  The weighted average grant-date fair value of share options granted during the six months ended June 30, 2006 and 2005 were $7.50 and $5.17, respectively.  The total intrinsic value of share options exercised during the six months ended June 30, 2006 was $1.3 million.  During the six months ended June 30, 2006, we received cash for payment of the grant price of exercised share options of approximately $1.6, million and we anticipate we will realize a tax benefit related to these exercised share 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 is separately disclosed as a component of cash flow from financing activities; the remainder of the tax benefit is included as a component of cash flow from operating activities.

During the six months ended June 30, 2006, we recognized share-based compensation expense, which is a non-cash charge, of approximately $1.1 million, of which $0.3 million is included under the caption “Direct costs” and $0.8 million is included under the caption “General and administrative” on the accompanying condensed consolidated statements of operations.  During the six months ended June 30, 2006, we recognized a net tax benefit of approximately $0.4 million related to aggregate share-based compensation expense recognized during the same period.  As a result, income before income taxes was reduced by approximately $1.1 million, net income was reduced by approximately $0.7 million, net income per share – basic was reduced by approximately $0.04 per share, and net income per share – diluted was reduced by approximately $0.03 per share.  As of June 30, 2006, there was $7.7 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements, which will be recognized over a weighted-average period of 2.4 years.

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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. Share options awarded under our share 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 do not include expense related to share-based compensation for the three and six month periods ended June 30, 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 income (loss) and net income (loss) per share for the three month and six month periods ended June 30, 2005 would have been adjusted to the following pro forma amounts (in thousands, except per share data):

		Three Months Ended  June 30, 2005			Six Months Ended June 30, 2005
Net income (loss), as reported		$	1,836		$	(292	)
Add: stock-based employee compensation included in reported net earnings, net of tax		—			—
Deduct: stock-based employee compensation expense determined under the fair value method, net of tax		(2,200		)	(5,266		)
Net loss, pro forma		$	(364	)	$	(5,558	)
Net income (loss) per share – Basic	As reported	$	0.10		$	(0.02	)
	Pro forma	$	(0.02	)	$	(0.31	)
Net income (loss) per share – Diluted	As reported	$	0.10		$	(0.02	)
	Pro forma	$	(0.02	)	$	(0.31	)

Pro forma amounts presented here are based on actual earnings and consider only the effects of estimated fair values of share options.  For the three and six month periods ended June 30, 2005, we did not assume conversion of the convertible notes or exercise of share-based options as the effect was antidilutive.

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NOTE 7:   NET INCOME (LOSS) PER SHARE

Basic net income (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 income (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 share options and convertible debt, if dilutive.  When calculating incremental shares related to outstanding share 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 share 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 income (loss) per share are as follows (in thousands, except per share data):

	Three Months Ended June 30,
	2006					2005
	Net Income		Weighted Average Shares Outstanding	Per Share Amount		Net Income		Weighted Average Shares Outstanding	Per Share Amount
Basic net income per share	$	36,292	19,388	$	1.87	$	1,836	17,904	$	0.10
Effect of dilutive securities:
Share options			759					528
Convertible debt	301		2,857			—		—
Diluted net income per share	$	36,593	23,004	$	1.59	$	1,836	18,432	$	0.10

For the three month periods ended June 30, 2006 and 2005, weighted-average outstanding share options totaling approximately 1.9 million and 1.5 million shares of common stock, respectively, were antidilutive and therefore not included in the computation of diluted earnings per share. For the three months ended June 30, 2005, we did not assume conversion of the convertible notes as the effect was antidilutive.

	Six Months Ended June 30,
	2006					2005
	Net Income		Weighted Average Shares Outstanding	Per Share Amount		Net Loss			Weighted Average Shares Outstanding	Per Share Amount
Basic net income (loss) per share	$	34,543	19,337	$	1.79	$	(292	)	17,896	$	(0.02	)
Effect of dilutive securities:
Share options			965						—
Convertible debt	600		2,857			—			—
Diluted net income (loss) per share	$	35,143	23,159	$	1.52	$	(292	)	17,896	$	(0.02	)

For the six month periods ended June 30, 2006, weighted-average outstanding share options totaling approximately 1.3 million shares of common stock were antidilutive and therefore not included in the computation of diluted earnings per share.  For the six months ended June 30, 2005, we did not assume conversion of the convertible debt or exercise of any share-based options as the effect would be anti-dilutive.

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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 June 30 are as follows (in thousands):

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

Rent expense related to operating leases was approximately $1.4 million and $0.7 million for the three month periods ended June 30, 2006 and 2005, respectively, and approximately $2.5 million and $1.4 million for the six month periods ended June 30, 2006 and 2005, respectively.

NOTE 9:   SEGMENT REPORTING

We have two operating segments: (i) case management and (ii) document management.  Case management solutions include proprietary technology and integrated services to address the administrative business requirements of 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 the 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):

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	Three Months Ended June 30, 2006
	Case		Document
	Management		Management		Unallocated			Consolidated
Revenue:
Operating revenue before reimbursed direct costs	$	85,191	$	8,929	$	—		$	94,120
Operating revenue from reimbursed direct costs	733		5,643		—			6,376
Total revenue	85,924		14,572		—			100,496
Costs and expenses:
Direct costs, general and administrative costs and depreciation and software and leasehold amortization	13,131		11,712		8,189			33,032
Amortization of identifiable intangible assets	2,393		485		—			2,878
Acquisition related	—		—		250			250
Total operating expenses	15,524		12,197		8,439			36,160
Income from operations	$	70,400	$	2,375	$	(8,439	)	64,336
Interest expense, net								3,340
Income before income taxes								60,996
Provision for income taxes								24,704
Net income								$	36,292
Depreciation and amortization expense	$	4,200	$	576	$	596		$	5,372

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	Three Months Ended June 30, 2005
	Case		Document
	Management		Management		Unallocated			Consolidated
Revenue:
Operating revenue before reimbursed direct costs	$	13,463	$	6,441	$	—		$	19,904
Operating revenue from reimbursed direct costs	747		4,701		—			5,448
Total revenue	14,210		11,142		—			25,352
Costs and expenses:
Direct costs, general and administrative costs and depreciation and software and leasehold amortization	7,729		8,518		7,136			23,383
Amortization of identifiable intangible assets	1,054		373		—			1,427
Total operating expenses	8,783		8,891		7,136			24,810
Income from operations	$	5,427	$	2,251	$	(7,136	)	542
Interest expense, net								1,844
Loss before income taxes								(1,302		)
Provision for income taxes								(3,138		)
Net income								$	1,836
Depreciation and amortization expense	$	2,145	$	497	$	560		$	3,202

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	Six Months Ended June 30, 2006
	Case		Document
	Management		Management		Unallocated			Consolidated
Revenue:
Operating revenue before reimbursed direct costs	$	104,777	$	21,904	$	—		$	126,681
Operating revenue from reimbursed direct costs	1,514		10,519		—			12,033
Total revenue	106,291		32,423		—			138,714
Costs and expenses:
Direct costs, general and administrative costs and depreciation and software and leasehold amortization	24,852		26,697		16,610			68,159
Amortization of identifiable intangible assets	4,643		1,002		—			5,645
Acquisition related	—		—		250			250
Total operating expenses	29,495		27,699		16,860			74,054
Income from operations	$	76,796	$	4,724	$	(16,860	)	64,660
Interest expense, net								6,604
Income before income taxes								58,056
Provision for income taxes								23,513
Net income								$	34,543
Depreciation and amortization expense	$	8,091	$	1,182	$	1,163		$	10,436

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	Six Months Ended June 30, 2005
	Case		Document
	Management		Management		Unallocated			Consolidated
Revenue:
Operating revenue before reimbursed direct costs	$	26,531	$	12,522	$	—		$	39,053
Operating revenue from reimbursed direct costs	1,643		9,301		—			10,944
Total revenue	28,174		21,823		—			49,997
Costs and expenses:
Direct costs, general and administrative costs and depreciation and software and leasehold amortization	15,824		16,663		14,398			46,885
Amortization of identifiable intangible assets	2,211		839		—			3,050
Total operating expenses	18,035		17,502		14,398			49,935
Income from operations	$	10,139	$	4,321	$	(14,398	)	62
Interest expense, net								2,607
Loss before income taxes								(2,545		)
Provision for income taxes								(2,253		)
Net loss								$	(292	)
Depreciation and amortization expense	$	4,389	$	1,089	$	1,121		$	6,599

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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 contractually agreed to. 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,

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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 terminates 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 anticipate that we will recognize approximately $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)

	June 30, 2006
	As Previously Reported		As Restated
Consolidated Balance Sheets
Income taxes refundable	$	1,766	$	1,322
Deferred income taxes	1,984		4,367
Total Current Assets	45,944		47,883
Total Assets	392,380		394,319
Other accrued expenses	5,161		4,343
Deferred revenue	—		6,845
Total Current Liabilities	88,968		94,995
Deferred revenue
Retained earnings	50,421		46,333
Total Stockholders’ Equity	182,231		178,143
Total Liabilities and Stockholders’ Equity	392,380		394,319

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Consolidated Statements of Operations

	For the Three Months Ending
	June 30, 2006				June 30, 2005
	As Previously Reported		As Restated		As Previously Reported		As Restated
Case management services	$	25,106	$	18,182	$	19,746	$	13,128
Case management bundled software license, software upgrade and postcontract customer support services	—		67,009		—		335
Total Revenue	40,411		100,496		31,635		25,352
Direct costs of services (exclusive of depreciation and amortization)	18,179		10,752		13,564		7,097
Direct costs of bundled software license, software upgrade and postcontract customer support services (exclusive of depreciation and amortization)	—		980		—		923
Reimbursed direct costs	—		6,447		—		5,544
Income from Operations	4,251		64,336		6,825		542
Income (Loss) from Operations Before
Income Taxes	911		60,996		4,981		(1,302		)
Provision (Benefit) for Income Taxes	383		24,704		2,077		(3,138		)
Net Income	528		36,292		2,904		1,836
Net Income per Share — Basic	$	0.03	$	1.87	$	0.16	$	0.10
Net Income per Share - Diluted	$	0.03	$	1.59	$	0.15	$	0.10
Weighted Average Common Shares Outstanding — Diluted	20,147		23,004		21,289		18,432

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Consolidated Statements of Operations

	For the Six Months Ending
	June 30, 2006				June 30, 2005
	As Previously Reported		As Restated		As Previously Reported		As Restated
Case management services	$	51,130	$	37,083	$	39,631	$	25,935
Case management bundled software license, software upgrade and postcontract customer support services	—		67,694		—		596
Total Revenue	85,067		138,714		63,097		49,997
Direct costs of services (exclusive of depreciation and amortization)	39,310		25,128		27,300		14,344
Direct costs of bundled software license, software upgrade and postcontract customer support services (exclusive of depreciation and amortization)	—		2,015		—		1,860
Reimbursed direct costs	—		12,167		—		11,096
Income from Operations	11,013		64,660		13,162		62
Income (Loss) from Operations Before
Income Taxes	4,409		58,056		10,555		(2,545		)
Provision (Benefit) for Income Taxes	1,851		23,513		4,401		(2,253		)
Net Income (Loss)	2,558		34,543		6,154		(292		)
Net Income (Loss) per Share – Basic	$	0.13	$	1.79	$	0.34	$	(0.02	)
Net Income (Loss) per Share - Diluted	$	0.13	$	1.52	$	0.32	$	(0.02	)
Weighted Average Common Shares Outstanding – Diluted	20,302		23,159		21,187		17,896

Consolidated Statements of Cash Flow

	For the Six Months ending
	June 30, 2006						June 30, 2005
	As Previously Reported			As Restated			As Previously Reported		As Restated
Cash Flows from Operating Activities
Net income (loss)	$	2,558		$	34,543		$	6,154	$	(292	)
Provision (benefit) for deferred income taxes	—			20,505			—		(5,485		)
Other	(338		)	375			695		999
Accounts payable and other liabilities	(369		)	(637		)	710		708
Deferred revenue	—			(53,379		)	—		13,102
Income taxes, including tax benefit from exercise of stock options	3,296			3,740			822		(651		)
Net Cash Provided by Operating Activities	18,326			18,326			10,314		10,314

*     *     *

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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

Business Solutions

Epiq Systems, Inc. is a provider of technology-based solutions for the legal and fiduciary services industries.  Our two operating segments, case management and document management, 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.

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

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

Marketplace Information

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, 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 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 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 June 8, 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 Bankruptcy Services, which expanded our offerings to

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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 offerings to include class action, mass tort, and other similar legal proceedings.  In October 2005, we acquired Hilsoft, enhancing our expert legal notification.  In November 2005, we acquired nMatrix which expanded our service offerings to include electronic litigation discovery and in May 2006, we acquired Epiq Advisory Services to further expand our bankruptcy case management service offerings.

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.

·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.

·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 arrangements with clients pursuant to which we deliver various case management and document management solutions 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;

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·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

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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 all of 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, based on the estimated fair value of hardware provided, 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 delivered two specified upgrades annually with the last specified upgrade occurring 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 did not have VSOE of the fair value of each separate upgrade, we deferred recognition of substantially all revenue under this arrangement until the final upgrade was delivered.  The ongoing costs related to this arrangement were recognized as expense when incurred.  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 terminates September 30, 2006, we recognized approximately $60.1 million of net deferred revenue during the second quarter of 2006 and we recognized approximately $6.0 million of deferred revenue related to this arrangement during the third quarter of 2006.

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.

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

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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 is 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.  We develop an estimate of the fair value of each reporting unit, using both a market approach and an income approach.

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 $261.1 million as of June 30, 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 $49.8 million as of June 30, 2006.

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Results of Operations for the Three Months Ended June 30, 2006 Compared with the Three Months Ended June 30, 2005

Consolidated Results

Revenue

Total revenue of $100.5 million for the three months ended June 30, 2006 represents an approximate $75.1 million, or approximately 296%, increase compared to $25.4 million of revenue during 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 expenses 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 $74.2 million, or approximately 373%, to $94.1 million for the three months ended June 30, 2006 compared to $19.9 million for the same period in the prior year.  Exclusive of businesses acquired after June 30, 2005, operating revenue before reimbursed direct costs increased $64.2 million, or approximately 322%, to $84.1 million for the three months ended June 30, 2006 compared to $19.9 million for the same period in the prior year, primarily as a result of an approximate $63.9 million increase in case management operating revenue before reimbursed direct costs combined with a $0.2 million increase in document management operating revenue before reimbursed direct costs.  Operating revenue before reimbursed direct costs may fluctuate considerably from period to period based on clients’ business requirements.   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 $3.7 million, or approximately 52%, to $10.8 million for the three months ended June 30, 2006 compared with $7.1 million during the same period in the prior year.  Exclusive of direct costs related to businesses acquired after June 30, 2005, direct costs increased approximately $0.6 million, or approximately 8%, to $7.7 million for the three months ended June 30, 2006 compared with $7.1 million for the same period in the prior year.  This increase is primarily attributable to a $1.0 million increase in compensation and outside services expenses and a $0.2 million increase in share-based compensation expense resulting from adoption of SFAS 123R, partly offset by a reduction in class action outside services and compensation expense of $0.8 million.  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 less than $0.1 million to approximately $1.0 million for three months ended June 30, 2006 compared with approximately $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 approximately $0.9 million, or approximately 16%, to $6.4 million for the three months ended June 30, 2006 compared with $5.5 million during the same period in the prior year.  Exclusive of reimbursed direct costs related to recently acquired entities, reimbursed direct costs increased approximately $0.8 million, or approximately 14%, to approximately $6.3 million for the three months ended June 30, 2006, compared with approximately $5.5 million for the same period in the prior year.  This increase is directly attributable to the increase in operating revenue from reimbursed direct costs.

General and administrative costs increased approximately $4.4 million, or approximately 54%, to $12.4 million for the three months ended June 30, 2006 compared to $8.0 million for the same period in the prior year.  Exclusive of general and administrative costs related to businesses acquired after June 30, 2005, these costs increased $0.7 million, or approximately 9%, for the three months ended June 30, 2006 compared with the same period in the prior year.  This increase is primarily attributable to recognition of share-based expense of $0.4 million resulting from adoption of SFAS 123R combined with an increase in travel and meeting expense of $0.3 million related to the expansion of our business.  Changes in our segment cost structure are discussed below.

Depreciation and software and leasehold amortization costs increased approximately $0.7 million, or approximately 40%, to $2.5 million for the three months ended June 30, 2006 compared with $1.8 million during the same period in the prior year.  Exclusive of depreciation and software and leasehold amortization costs related to businesses acquired after June 30, 2005, these costs increased slightly to $1.9 million for the three months ended June 30, 2006 compared with $1.8 million for the same period in the prior year.  Changes in our segment cost structure are discussed below.

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Amortization of identifiable intangible assets, compared with the same period in the prior year, increased $1.5 million to $2.9 million for the three months ended June 30, 2006.  All identifiable intangible assets are directly related to a segment, and changes in amortization of identifiable intangible assets by segment are discussed below.

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

Interest Expense

We incurred interest expense of $3.4 million for the three months ended June 30, 2006 compared with interest expense of $1.9 million during the same period in the prior year.  The increase in interest expense during the three months ended June 30, 2006 compared with the same period in the prior year resulted primarily from a $1.8 million increase in interest expense related to increased borrowings under our credit facility in support of the acquisition of our electronic discovery business in November 2005.  This increase was partly offset by a $0.5 million decrease in interest expense related to the change in value of the embedded option related to the outstanding convertible debt.

Effective Tax Rate

Our effective tax rate to record the tax expense related to our net income was 40.5% for the three months ended June 30, 2006 compared to a 241% effective tax benefit rate to record the tax benefit related to our net loss for the three months ended June 30, 2005.  The effective tax rate for the three months ended June 30, 2005 is unusually high as we estimate that the aggregate annual expenses not deductible for tax purposes will be significant in relation to income.  The 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 Income

Net income was $36.3 million for the three months ended June 30, 2006 compared with net income of $1.8 million for the same period in the prior year.  This change is primarily as a result of a $66.8 million increase in revenues related to our bankruptcy trustee business, primarily as the result of recognition of $60.1 million of net deferred revenue related to our bankruptcy trustee business, partly offset by a $27.8 million increase in our tax expense, a $1.5 million increase in interest expense, and a $1.5 million increase in intangible amortization expense.

Business Segments

The following management discussion and analysis is presented on a basis consistent with our segment disclosure contained in note 9 of our notes to condensed consolidated financial statements.

Case Management Segment

Case management operating revenue before reimbursed direct costs increased $71.7 million, or approximately 533%, to $85.2 million for the three months ended June 30, 2006 compared to $13.5 million during the same period in the prior year. During the three months ended June 30, 2006, operating revenue before reimbursed direct costs from businesses acquired after June 30, 2005 totaled approximately $7.8 million.  Exclusive of these recently acquired businesses, operating revenue before reimbursed direct costs increased by $63.9 million compared to the same period in the prior year.  The increase in operating revenue is primarily attributable to an approximate $66.8 million increase in revenue related to our case management trustee business primarily as a result of recognition of previously deferred revenue, partly offset by a $3.2 million decrease in class action case management revenue.  Class action case management revenue was adversely affected by competitive pricing pressures, primarily affecting retentions of larger cases.

Case management direct and administrative expenses, including depreciation and software and leasehold amortization, increased $5.4 million, or approximately 70%, to $13.1 million for the three months ended June 30, 2006 compared with $7.7 million during the same period in the prior year.  During the three months ended June 30, 2006, direct and administrative expenses, including depreciation and software and leasehold amortization, from businesses acquired after June 30, 2005 totaled $5.3 million.  Exclusive of these recently acquired businesses, our direct and administrative expenses, including depreciation and software and leasehold amortization, increased by $0.1 million compared to the same period in the prior year, primarily from an increase in compensation expense.

Amortization of case management’s identifiable intangible assets increased to $2.4 million for the three months ended June 30, 2006 compared with $1.1 million for the same period in the prior year.  This increase is primarily the result of

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amortization of additional other intangible assets, resulting primarily from the acquisition in November 2005 of our electronic discovery business.

Document Management Segment

Document management operating revenue before reimbursed direct costs increased $2.5 million, or approximately 39%, to $8.9 million for the three months ended June 30, 2006 compared to $6.4 million during the same period in the prior year.  For the three months ended June 30, 2006, operating revenue before reimbursed direct costs from the business acquired after June 30, 2005 totaled $2.3 million.  Exclusive of this recently acquired business, operating revenue before reimbursed direct costs increased $0.2 million, primarily as a result of increased bankruptcy document management revenue, partly offset by an approximate $1.0 million decrease in class action document management revenue.  Document management revenues can fluctuate considerably from period to period based on clients’ business requirements.

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

Amortization of document management’s identifiable intangible assets increased to $0.5 million for the three months ended June 30, 2006 compared with $0.4 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 legal notification business.

Results of Operations for the Six Months Ended June 30, 2006 Compared with the Six Months Ended June 30, 2005

Consolidated Results

Revenue

Total revenue of $138.7 million for the six months ended June 30, 2006 represents a $88.7 million, or approximately 177% increase compared to $50.0 million of total 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 the related direct costs may fluctuate significantly from period to period, these fluctuations have a minimal effect on our operating income as we realize little or no margin from this revenue.  Revenue exclusive of reimbursed direct costs, which we refer to as operating revenue before reimbursed direct costs, increased approximately $87.6 million, or approximately 224%, to $126.7 million for the six months ended June 30, 2006 compared to $39.1 million for the same period in the prior year.  Exclusive of businesses acquired after June 30, 2005, operating revenue before reimbursed direct costs increased approximately $62.2 million, or approximately 159%, to approximately $101.3 million for the six months ended June 30, 2006 compared to approximately $39.1 million for the same period in the prior year, primarily as a result of an approximate $61.8 million increase in case management revenue combined with an approximate $0.4 million increase in document management revenue.  Operating revenue exclusive of revenue from reimbursed direct costs may fluctuate from period to period based on clients’ business requirements.  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 $10.8 million, or approximately 75%, to $25.1 million for the six months ended June 30, 2006 compared with $14.3 million for the same period in the prior year.  Exclusive of direct costs related to businesses acquired after June 30, 2005, direct costs increased approximately 6% to $15.2 million for the six months ended June 30, 2006 compared with $14.3 million for the same period in the prior year. This increase is primarily attributable to a $1.3 million of increases in compensation and outside services expense and a $0.3 million increase in share-based compensation expense resulting from adoption of SFAS 123R, partly offset by a $1.2 million reduction in our class action outside services and compensation expense.  Changes in our segment cost structure are discussed below.

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Direct cost of bundled software license, software upgrade and postcontract customer support services, exclusive of depreciation and amortization, increased to $2.0 million for six months ended June 30, 2006 compared with $1.9 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 approximately $1.1 million, or approximately 10%, to $12.2 million for the six months ended June 30, 2006 compared with $11.1 million during the same period in the prior year.  Exclusive of reimbursed direct costs related to recently acquired entities, reimbursed direct costs increased approximately $0.5 million, or approximately 5%, to approximately $11.6 million for the six months ended June 30, 2006, compared with approximately $11.1 million for the same period in the prior year.  This increase is directly attributable to the increase in operating revenue from reimbursed direct costs.

General and administrative costs increased approximately $8.1 million, or approximately 50%, to $24.1 million for the six months ended June 30, 2006 compared with $16.0 million for the same period in the prior year.  Exclusive of general and administrative costs related to businesses acquired after June 30, 2005, these costs increased approximately $1.8 million, or approximately 11%, to $17.8 million for the six months ended June 30, 2006 compared with $16.0 million for the same period in the prior year.  This increase is primarily attributable to $0.8 million of share-based expense resulting from adoption of SFAS 123R combined with a $0.8 million increase in travel expense related to the expansion of our business.  Changes in our segment cost structure are discussed below.

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

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

Acquisition related expenses of $0.3 million for the six months ended June 30, 2006 resulted from non-capitalized expenses incurred in connection with completed transactions.

Interest Expense

We incurred interest expense of $6.7 million for the six months ended June 30, 2006 compared with interest expense of $2.7 million for the same period in the prior year.  This increase primarily is the result of a $3.6 million increase in interest expense related to our credit facility, primarily resulting from the increase in average borrowings outstanding under our credit facility as a result of our acquisition of our electronic discovery business in November 2005.  Also contributing to the increase in interest expense were an increase in loan fee amortization expense and an increase in the value of the embedded option related to the outstanding convertible debt, which resulted in an increase to interest expense, compared with the six months ended June 30, 2005.

Effective Tax Rate

Our effective tax rate to record the tax expense related to our net income was 40.5% for the six months ended June 30, 2006 compared a 88.5% effective tax benefit rate to record the tax benefit related to our net loss for the six months ended June 30, 2005.  The effective tax rate for the six months ended June 30, 2005 is unusually high as we estimate that the aggregate annual expenses not deductible for tax purposes will be significant in relation to income.  The 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 Income (Loss)

Net income was approximately $34.5 million for the six months ended June 30, 2006 compared with a net loss of approximately $0.3 million for the same period in the prior year.  This change is primarily as a result of a $67.2 million increase in revenues related to our bankruptcy trustee business, primarily as the result of recognition of $60.1 million of previously deferred revenue related to our bankruptcy trustee business, partly offset by a $25.8 million increase in our tax expense, a $4.0 million increase in interest expense, and a $2.6 million increase in intangible amortization expense.

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Business Segments

The following management discussion and analysis is presented on a basis consistent with our segment disclosure contained in note 9 of our notes to condensed consolidated financial statements.

Case Management Revenue

Case management operating revenue before reimbursed direct costs increased approximately $78.3 million, or approximately 295%, to $104.8 million for the six months ended June 30, 2006 compared to $26.5 million for the same period in the prior year.  During the six months ended June 30, 2006, operating revenue before reimbursed direct costs from businesses acquired after June 30, 2005 totaled $16.4 million.  Exclusive of these recently acquired businesses, operating revenue before reimbursed direct costs increased by $61.8 million compared to the same period in the prior year.  The increase in operating revenue is primarily attributable to an approximate $67.2 million increase in revenue related to our case management trustee business primarily as a result of recognition of approximately $60.1 million net deferred revenue, partly offset by an approximate $6.6 million decline in class action case management revenue.  Class action case management revenue was adversely affected, in part, by competitive pricing pressures, primarily affecting retentions on larger cases.

Case management direct and administrative expenses, including depreciation and software and leasehold amortization, increased $9.1 million, or approximately 57%, to $24.9 million for the six months ended June 30, 2006 compared with $15.8 million for the same period in the prior year.  During the six months ended June 30, 2006, direct and administrative expenses, including depreciation and software and leasehold amortization, from businesses acquired after June 30, 2005 totaled $9.5 million.  Exclusive of these recently acquired businesses, our direct and administrative expenses, including depreciation and software leasehold amortization, decreased by approximately $0.4 million.  This decrease in direct and administrative expenses, including depreciation and software and leasehold amortization, is primarily attributable to a $1.1 million decrease in class action compensation and outside services expenses, partly offset by a $0.6 million increase in compensation expense in bankruptcy.

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

Document Management Segment

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

Document management direct and administrative expenses, including depreciation and software and leasehold amortization, increased $10.0 million, or approximately 60%, to $26.7 million for the six months ended June 30, 2006 compared to $16.7 million for the same period in the prior year.  This increase is primarily attributable to the inclusion of $8.4 million of direct and administrative expenses, including depreciation and software and leasehold amortization, related to the business acquired after June 30, 2005.  Exclusive of this recently acquired business, direct and administrative expenses, including depreciation and software and leasehold amortization, increased $1.6 million primarily from increases in reimbursable direct costs and an increase in outside services related to bankruptcy document management.  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 period to period based on document management business requirements delivered during each period.

Amortization of document management’s identifiable intangible assets increased to $1.0 million, for the six months ended June 30, 2006 compared to $0.8 million for the same period in the prior year.  This increase is primarily the result of amortization of additional other intangible assets, resulting from the acquisition of our acquired legal notification business.

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Liquidity and Capital Resources

Operating Activities

During the six months ended June 30, 2006, the primary source of cash from operating activities was net income of $34.5 million, adjusted for $33.1 million of non-cash charges and credits, primarily related to the reversal of our deferred tax asset on recognition of previously deferred revenue, depreciation and software and leasehold amortization, and amortization of identifiable intangible assets.  This source of cash was partly offset by the $49.3 million increase in net operating assets, primarily as a result of a decrease in deferred revenue as we recognized a substantial portion of the revenue we had previously deferred related to our trustee business.  This decrease related to the recognition of deferred revenue was partly offset by decreases in our trade accounts receivable and income taxes refundable operating assets.  Trade accounts receivable, which will fluctuate from period to period depending on the timing of collections, decreased primarily as a result of increased collections related to our recently acquired electronic discovery business.  Income taxes refundable decreased primarily as a result of the receipt of refunds due to us.  Additionally, our accrual of estimated current income taxes payable exceeded our estimated tax payments.  As a result, our operating activities generated net cash of $18.3 million for the six months ended June 30, 2006.

Investing Activities

During the six months ended June 30, 2006, we used cash of approximately $4.4 million to purchase property and equipment.  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 six months ended June 30, 2006, we used cash of approximately $2.0 million to fund internal costs related to development of software for which technological feasibility has been established.  During November 2005, we acquired our electronic discovery business.  To support this new business, we anticipate increases in software development and hardware purchases during 2006 compared with 2005.  We also used approximately $3.5 million of cash to partly fund an acquisition.  We believe 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 six months ended June 30, 2006, we paid approximately $10.0 million as a principal reduction on our senior term loan and $1.7 million as a principal reduction on the BSI deferred acquisition price, and we repaid $5.0 million of our senior revolving loan.  This financing use of cash was partly offset by $1.6 million of net proceeds from stock issued in connection with the exercise of employee share options.  As a result of adoption of SFAS 123R, we also classify a portion of the tax benefit, referred to as excess tax benefit, that we realize on exercise of employee share options as a financing cash flow.  The effect of this accounting change during the six months ended June 30, 2006 was to recognize $0.2 million of excess tax benefit as a financing cash flow rather than as an operating cash flow.

As of June 30, 2006, our borrowings consisted of $51.8 million from the contingent convertible subordinated notes (including the fair value of the embedded option), $15.0 million under our senior term loan, $88.0 million under our senior revolving loan, and approximately $12.8 million of obligations related to capitalized leases and deferred acquisition price.

We believe that the funds generated from operations plus our existing cash resources and amounts available under our senior revolving loan facility will be sufficient over the next 12 months 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 the acquisition of nMatrix, principal payments due under the credit facility, deferred acquisition price agreements and capital leases, interest payments due on our outstanding borrowings, and payments for other contractual obligations.  Funds generated by operations are unlikely to be adequate to repay the $50.0 million convertible debt which matures in June 2007.  The convertible debt may not require the use of cash during the next 12 months as the holders have the right to convert (conversion price is $17.50 per share) or to extend the convertible debt maturity by three years.  In addition to the current sources of liquidity discussed above, we may consider other alternatives, such as an equity offering of our common shares, to generate additional liquidity.

Subject to compliance with certain covenants under the amended credit facility, we have the right to increase the senior revolving loan by $75.0 million to $175.0 million.  As of June 30, 2006, significant covenants, all as defined within our credit facility agreement, include a leverage ratio not to exceed 3.25 to 1.00, a senior leverage ratio not to exceed 2.25 to 1.00, a fixed charge coverage ratio of not less than 1.25 to 1.00, and a 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 through March 31, 2006.  As a result of recognition of the deferred revenue during the second quarter of 2006, we are in compliance with all financial covenants as of June 30, 2006.  The deferral of revenue

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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 may pursue acquisitions in the future.  We may use our then available cash and unused borrowing capacity to finance a future acquisition, or 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 and in our convertible notes may limit our ability to consummate an acquisition.  Pursuant to the terms of our credit facility, we generally cannot incur indebtedness outside the credit facility with 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.  Based on our June 30, 2006 closing price of $16.64 per share, as of June 30, 2006, the guarantee amount was approximately $4.6 million.  As discussed under the caption “Liquidity and Capital Resources — Financing Activities” above, we believe cash generated from operations plus amounts available under our senior revolving loan facility will provide adequate liquidity to make any required payments 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 June 30 (in thousands):

	Payments Due By Period
Contractual Obligation	Total		Less than 1 Year		1 – 3 Years		3 – 5 Years		More Than 5 Years
Long-term debt and future accretion (1)	$	165,513	$	70,893	$	92,620	$	2,000	$	—
Employment agreements (2)	10,743		4,354		4,441		1,948		—
Capital lease obligations	955		949		6		—		—
Operating leases	36,101		5,525		8,852		8,258		13,466
Total	$	213,312	$	81,721	$	105,919	$	12,206	$	13,466

(1)A portion of the purchase price of certain acquisitions were in the form of notes on which the interest rate was below our incremental borrowing rate, and which were discounted using our estimated incremental borrowing rate.  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 obligations table includes both the notes’ principal, as reflected on our June 30, 2006 condensed consolidated balance sheet, and all future accretion.  If certain financial objectives are satisfied, we will make additional payments over the next five years related to our acquisition of Hilsoft and Epiq Advisory Services.  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.

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Recent Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48).  FIN 48 applies to tax positions accounted for under Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes.  A tax position includes a current or future reduction in taxable income reported or expected to be reported on a tax return, the decision not to report a transaction in a tax return, and an assertion that a company is not subject to taxation.  FIN 48 requires that a tax position be recognized only if it is more-likely-than-not to be sustained based solely on its technical merits as of the reporting date.  A recognized tax benefit is measured based on the largest benefit that is more than 50 percent likely to be realized.  FIN 48 is effective for an entity’s first fiscal year that begins after December 15, 2006.  At adoption, any necessary adjustment to our financial statements will be recorded directly to the beginning balance of retained earnings in the period of adoption and reported as a change in accounting principle.  At this time, we are unable to predict the impact, if any, that adoption of FIN 48 will have on our consolidated financial statements.

In June 2006, the Emerging Issues Task Force (EITF) reached a consensus regarding EITF 05-1, Accounting for the Conversion of an Instrument That Becomes Convertible Upon the Issuer’s Exercise of a Call Option.  EITF 05-1 pertains only to debt instruments that become convertible at the time the issuer calls the debt, but are not convertible before the call is exercised.  Conversions of these instruments triggered by the call option would be accounted for as debt conversions and recognized as debt extinguishments if the debt instrument did not contain a substantive conversion feature at issuance.  EITF 05-1 will be effective for conversions that occur as a result of the issuer’s exercise of a call option in the interim or annual period beginning after June 28, 2006. We do not anticipate that adoption of this statement will have a material impact on our consolidated financial statements.

In March 2006, the 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.

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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, 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.

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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.

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 June 30, 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 June 30, 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 June 30, 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.

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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 4:  Submission of Matters to a Vote of Security Holders

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

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

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

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

ITEM 6. Exhibits.

31.1	Certifications of Chief Executive Officer of the Company under Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certifications of Chief Financial Officer of the Company under Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certifications of CEO and CFO pursuant to 18 U.S.C. Section 1350.

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SIGNATURES

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)

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