**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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FORM 10-K

**(Mark One)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

**Forthe fiscal year ended December 31, 2004**

**OR**

** ̈**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

**Forthe transition periodfrom                    to**

**Commissionfile number 0-27444**

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SOURCECORP, Incorporated

(Exact name of Registrantas specified in its charter)

| **DELAWARE**                                                     | **75-2560895**                        |
|------------------------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) | (I.R.S. Employer  Identification No.) |
| **3232 MCKINNEY AVE.,   SUITE 1000, DALLAS, TEXAS**              | **75204**                             |
| (Address of principal  executive offices)                        | (zip code)                            |

 

**(214) 740-6500**

Registrant’stelephone number, (including area code)

Securitiesregistered pursuant to Section 12(b) of the Act:

| **TITLE OF EACH CLASS** | ** ** | **NAME OF  EACH EXCHANGE   ON WHICH REGISTERED** |
|-------------------------|------------|--------------------------------------------------|
| None                    |       | None                                             |

 

Securities registeredpursuant to Section 12(g) of the Act:

**COMMON STOCK, PAR VALUE$.01 PER SHARE**

(Title of Class)

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Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the Registrant was required to file such reports) and (2) hasbeen subject to such filing requirements for the past90 days. Yes x No  ̈

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. Yes x  No  ̈

Indicate by check markwhether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).Yes x   No  ̈

The aggregate market valueof voting stock held by non-affiliates of the Registrant as of June 30,2004 (the last business day of the Company’s most recently completed secondfiscal quarter) was $433,445,944 based on the last sale price of $27.52 of theRegistrant’s Common Stock, $.01 par value per share, on the Nasdaq NationalMarket on June 30, 2004.

As of February 28,2005, 15,666,916 shares of the Registrant’s Common Stock were outstanding.

**DOCUMENTS INCORPORATED BYREFERENCE:**

Portionsof the Proxy Statement for the 2005 Annual Meeting of Stockholders to be filedwith the Securities and Exchange Commission not later than 120 days afterthe end of our fiscal year ended December 31, 2004 are incorporated byreference into Part III of this Form 10-K.

 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIESFORM 10-KYEAR ENDED DECEMBER 31, 2004EXPLANATORY NOTE**

This Annual Report on Form 10-K giveseffect to the restatement of the Company’s consolidated financial statements asdiscussed in Note 3 to the consolidated financial statements for the yearsended December 31, 2001, 2002 and 2003. The restated financial statementsfor the years ended December 31, 2002 and 2003 have been audited byDeloitte & Touche, LLP. Selected restated financial data presented forthe year ended December 31, 2001 has been derived from consolidatedfinancial statements audited by Arthur Andersen, LLP.

On October 27, 2004, the Company filed a CurrentReport on Form 8-K (as amended by Form 8-K/A filed October 27,2004) with the Securities and Exchange Commission (the “SEC”) disclosing thatthe Company’s previously issued financial statements and related independentauditors’ report for the year ended December 31, 2003, as well as itspreviously issued financial statements for the 2004 quarterly periods ended March 31,2004 and June 30, 2004, should no longer be relied upon, and that theCompany, under the guidance of the Audit Committee of the Board of Directors ofthe Company, had initiated an investigation into the financial results of oneof the Company’s Operating Subsidiaries in the Information Management andDistribution segment (the “Operating Subsidiary”). Additionally, on January 21,2005, the Company issued a press release and subsequently filed a relatedCurrent Report on Form 8-K, disclosing that its previously issuedfinancial statements and related independent auditors’ reports for the yearsended December 31, 2001 and 2002 should also no longer be relied upon.

On March 7, 2005, the Company filed a CurrentReport on Form 8-K with the SEC and issued a press release, whichwas filed as an Exhibit to such Form 8-K, disclosing that theCompany’s internal investigation has been concluded.

Based on the results of the investigation, it wasdetermined that the Operating Subsidiary had incorrectly recognized revenue forcertain customer arrangements and omitted certain operating expenses from itsreported financial results which in turn resulted in overpayments and overaccruals of contingent consideration amounts due under the earn-out provisionsof the acquisition agreement for the Operating Subsidiary which had beenoriginally recognized as additional goodwill of the acquired business. Inconnection with the Restatement, the Company has expensed such contingentconsideration overpayments and adjusted goodwill and the related accruedliability (See Note 3 to the consolidated financial statements).

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**SOURCECORP,Incorporated2004 FORM 10-K ANNUAL REPORT**

**TABLEOF CONTENTS**
|                   | ** **                                                                                                                 | ** ** | **Page** | ** ** |
|-------------------|----------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| **PART I**   |
| Item 1.           | Business                                                                                                                   | 4          |     |
| Item 2.           | Properties                                                                                                                 | 17         |     |
| Item 3.           | Legal  Proceedings                                                                                                         | 17         |     |
| Item 4.           | Submission of Matters to a Vote of Security Holders                                                                        | 19         |     |
| **PART II**  |
| Item 5.           | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer’s  Purchases of Equity Securities | 20         |     |
| Item 6.           | Selected  Financial Data                                                                                                   | 21         |     |
| Item 7.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                           | 24         |     |
| Item 7A.          | Quantitative  and Qualitative Disclosures About Market Risk                                                                | 42         |     |
| Item 8.           | Financial  Statements and Supplementary Data                                                                               | 43         |     |
| Item 9.           | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure                                 | 82         |     |
| Item 9A.          | Controls  and Procedures                                                                                                   | 82         |     |
| Item 9B.          | Other  Information                                                                                                         | 83         |     |
| **PART III** |
| Item 10.          | Directors and Executive Officers of the Registrant                                                                         | 84         |     |
| Item 11.          | Executive Compensation                                                                                                     | 84         |     |
| Item 12.          | Security Ownership of Certain Beneficial Owners and Management and  Related Stockholder Information                        | 84         |     |
| Item 13.          | Certain Relationships and Related Transactions                                                                             | 84         |     |
| Item 14.          | Principal Accounting Fees and Services                                                                                     | 84         |     |
| **PART IV**  |
| Item 15.          | Exhibits and Financial Statement Schedules                                                                                 | 84         |     |

 

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This Annual Report on Form 10-K(the “Report”) contains certain forward-looking statements such as ourintentions, beliefs, expectations, strategies, predictions or any othervariation thereof or comparable phraseology of our future activities or otherfuture events or conditions within the meaning of Section 27A of theSecurities Act of 1993, as amended (the “Act”), and Section 21E of theSecurities Exchange Act of 1934, as amended, which are intended to be coveredby the safe harbors created thereby. Investors are cautioned that all forward-lookingstatements involve risks and uncertainties, including, without limitation, theresults of the Company’s ongoing Securities and Exchange Commission (SEC)investigation, the potential customer impact of the results of ourinvestigation, the effect of our investigation and financial statementrestatement on the trading price of our stock, the risks of integrating ouroperating companies, of the timing and magnitude of technological advances, ofthe occurrences of future events that could diminish our customers’ needs forour services, and of a change in the degree to which companies continue tooutsource business processes, as well as such other risks set forth under theheading Risk Factors included in this report. Although we believe that theassumptions underlying the forward-looking statements contained hereinare reasonable, any of the assumptions could be inaccurate, and, therefore,there can be no assurance that the forward-looking statements included inthis Report will prove to be accurate. In light of the significantuncertainties inherent in the forward-looking statements included herein,the inclusion of such information should not be regarded as a representation byus or any other person that our objectives and plans will be achieved.

**PART I**

**ITEM 1**.                *Business*

**General**

SOURCECORP, Incorporated is a provider of businessprocess outsourcing solutions specializing in document and informationmanagement and a provider of specialized knowledge-based processing and/orconsulting solutions. We offer clients in information-intensiveindustries—such as financial services, healthcare, legal, government, andtransportation—the solutions to manage their information and document intensivebusiness processes and the solutions to fulfill certain specialized knowledge-basedprocessing and consulting requirements, enabling these organizations toconcentrate on their core competencies.

As a national business process outsourcing provider,we operate approximately 83 facilities in 24 states, Washington, D.C. andMexico, with approximately 5,800 employees at December 31, 2004.

We serve a diverse client base, including customers inthe financial services, healthcare insurance, healthcare provider, legal andtransportation/logistics industries as well as public sector agencies.Enterprises can outsource many of their information management, distributionand specific information-intensive processes as well as certain specificknowledge-based processing and/or specialized subject matter needs to usdue to the breadth of our outsourcing capabilities and subject matterexpertise.

We believe that the business process outsourcingsolutions and consulting markets are growing due to several factors, including:(i) government regulations that require lengthy document retention periodsand rapid accessibility for many types of records; (ii) continuingadvancements in computer, networking, facsimile, printing and othertechnologies that have greatly facilitated the production and wide distributionof documents; (iii) the increasing litigiousness of society, necessitatingaccess to relevant documents and records for extended periods of time andrequiring specialized subject matter expertise; and (iv) increasedcustomer expectations of low cost access to records on short notice.

Our customer profileincludes enterprises, both commercial and public-sector, that haveinformation-intensive business processes involving large volumes ofdocuments, forms, case files and storage, with frequent access and distributionrequirements or that have other types of information needs 

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thatrequire specialized processing and/or subject matter expertise. We believe thatthese clients will continue to increase their outsourcing for these needs inorder to further focus on their core operating competencies and revenuegenerating activities; reduce fixed costs, including labor and equipment costs;utilize, on a project basis, highly qualified subject matter experts withoutincurring the ongoing costs; and gain access to new technologies withoutincurring the investments and risks of obsolescence associated with thetechnologies required to effectively meet these needs.

**Business Strategy**

Our goal is to become a leading provider in the U.S.of business process outsourcing solutions for information and documentintensive vertical markets, including healthcare insurance, financial services,healthcare provider, transportation/logistics, federal and state government,and legal industries and a leading provider of certain knowledge-basedprocessing and consulting services. Achieving our goal will involve extendingour involvement in key business processes that we support today with additionalprocessing and consulting capabilities. We have implemented the followingfocused business strategy, which we believe will attract and retain clients:

**Economies and Efficiencies.  **Weintend to deliver superior, faster and more cost effective services than ourcustomers can provide for themselves.

**Scope and Scale.  **Weplan to continue to establish a range of business process outsourcing servicesto meet the diverse needs of our customers by expanding existing platforms andmaking selected strategic acquisitions. We intend to continue to handle largevolume engagements associated with information-intensive processes.

**Flexible Service Delivery.  **Weintend to continue to provide outsourced service facilities, on-site facilitymanagement and dedicated customer operations through our network of domesticand international workforce and vendor relationships.

**Information and Technology Lifecycles.  **Weintend to continue to be involved during the stages of the informationlifecycle from mailroom operations, data capture, conversion and storage toanalysis and output processing. In addition, we intend to further developprocessing capabilities and expect to continue to be involved in the technologylifecycles from paper to electronic, making use of web-based and othertechnologies.

**Invest in Sales Resources.  **Weintend to expand investments in sales and sales support personnel and resourcesto expand our pursuit of long-term customer relationships within our keymarkets. We intend to increase the number of large accounts we can pursue at agiven time and, over time increase our win rates through additional clientreferences and successful testimonials.

**Emphasize Account Penetration.  **Weintend to emphasize account penetration in two primary ways. First, we intendto continue to sell our existing clients additional business processoutsourcing solutions. Second, we intend to use our technology advances andindustry specific knowledge to sell solutions to new clients.

**Invest in Technology.  **Weintend to continue our investments in technology in order to expand our businessprocess outsourcing solutions, facilitate the integration of our serviceplatforms, reduce labor costs relative to our growth, and provide our servicesin more efficient ways. These investments include the acquisition ofnew-generation high speed scanning equipment, optical character recognitionsoftware and systems, communication systems, and other infrastructure relatedto our service platforms.

**Internet.  **Weintend to continue to utilize web-based technologies. Our plans includebusiness-to-business e-commerce enabler products to provide critical backoffice functions.

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**Retainand recruit highly qualified consultative professionals.  **Weintend to continue our recruiting activities for highly qualified consultativeprofessionals in order to expand our professional economic research andlitigation support services. Additionally, we intend to maintain a criticalmass of consultative professionals in order to handle multiple large, complexassignments simultaneously.

**Acquisition andDivestiture Strategy**

We have transitioned to an operating company supportedby a strategic acquisition program. Since our inception, we have acquired 73companies and divested 20 operating units as of December 31, 2004. Ofthese acquisitions, 85% were completed in the first four years following ourinitial public offering, in January 1996, as we established a geographicfootprint to enable us to provide services nationally. Periodically, weevaluate candidates for acquisition, as well as our operating units forpossible divestiture, as a part of our strategic plan. From time to time wealso evaluate joint ventures, strategic alternatives and other avenues to helpmaximize shareholder value. Acquisition candidates are evaluated in conjunctionwith our operating management team in order to acquire those candidates thatmeet certain strategic requirements. These criteria include service expansionto broaden service offerings, additional technology, added management strength,industry expertise, expansion of our customer base and geographic need. Webelieve that we will continue to be a successful acquirer of other businessprocess outsourcing solution and knowledge management companies, nevertheless,there are numerous risks associated with our acquisition program. See “RiskFactors.” We evaluate the strategic fit of our operations in order to optimizethe use of our capital and management resources. Examples of the criteria usedin determining strategic fit include, but are not limited to, cash flowgenerating capability, revenue and earnings growth opportunity, return oninvested capital requirements, market growth potential, and expected ongoingcapital requirements.

During the first quarterof 2004, we completed a strategic evaluation of our operations based on certaincriteria, such as strategic and financial fit, and future growth prospects. Asa result, on May 6, 2004, we formally committed to a plan of divestiturefor certain non-strategic asset groups related to our Direct Mail operationsreported in the Information Management and Distribution segment in priorperiods, and two medical records management operations reported in theHealthcare, Regulatory and Legal Compliance segment in prior periods. The assetgroups divested during 2004 were sold during the second and third quarters.

**Services Offered**

We provide a variety of business process outsourcingsolutions and knowledge-based services and draw upon our availableservices and expertise to develop solutions for our clients based on theirspecific needs. We aggregate our service offerings and operations into tworeportable segements: (i) Information Management and Distribution, and (ii) Healthcare,Regulatory, and Legal Compliance. See Note 19, Segment Reporting, of Notesto Consolidated Financial Statements of SOURCECORP, Incorporated and subsidiaries(the “Consolidated Financial Statements”) for the last three years’ financialresults under these segments.

**Information Management andDistribution.  **We offer Business Process Outsourcing (“BPO”)solutions that help our customers manage the *DocumentIn-flow*, *Workflow Processing*and *Statement Out-flow* of theirmission critical business document processes. Our BPO solutions enablecustomers to automate their complex workflow processes by digitizing extremelylarge volumes of documents, capturing information from the documents, hostingelectronic documents on our Web-based repository, and preparing statements thatcustomers mail or present electronically to their end users. We offer our BPOsolutions to businesses in document intensive industries, such as healthcareinsurance, financial services, healthcare provider, transportation/logistics,and federal and state government. Information Management and Distributionrepresented 50.5% of revenue during 2004.

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*Document In-flow:  *OurBPO solutions start with our ability to receive and process customer documentsat more than twenty sites located throughout the United States and multipleoffshore venues. Our services include outsourced mailroom management,high-speed electronic scanning, automated data capture using optical characterrecognition (OCR) software, and domestic and offshore data entry. Each day, weprocess millions of document pages in our highly efficient processingfacilities.

*Workflow Processing:  *Oncethe documents are digitized and key information is captured in a database, wecan host customers’ electronic documents and enterprise workflow applicationson *FASTRIEVE*, our Web-baseddocument repository and workflow platform. *FASTRIEVE*allows customers to quickly implement enterprise workflow applications withoutthe capital investment and ongoing maintenance costs required by an in-housesystem. Each day, thousands of users at more than thirty companies access *FASTRIEVE*’s secure data center tointegrate their electronic documents with workflow applications specific totheir industries. *FASTRIEVE*’sonline document repository enables workflow processes involving mortgage loandocuments, healthcare claims, patient records, personnel files, tax files andother mission critical business document processes.

*Statement Out-flow:  *Wealso process customer data to create, print, and mail statements to ourcustomers’ end users. We operate three large statement processing and out-boundmail facilities in the Eastern, Midwest, and Western United States. Ournational “footprint” allows us to efficiently deliver statements to any mailzone in the United States. We also provide our customers with the ability topresent electronic statements to their end users through our Web-basedstatement repository or by email. Each day, we create, print, and mailthousands of statements including brokerage statements, bank statements, andcustomer invoices.

**Healthcare, Regulatory, and LegalCompliance.  **We offer specialized knowledge-basedprocessing and consulting services that include medical records releaseservices, record management services for healthcare institutions, temporarystaffing for healthcare institutions, providing managed care payment compliancereviews, class action claims administration services, and professional economicresearch and litigation services. Healthcare, Regulatory, and Legal Compliancerepresented 49.5% of revenue during 2004.

*Medical records release services*consists of processing a request for a patient’s medical records from aphysician, insurance company, attorney, healthcare institution, or individual.The medical records release service provider initially verifies that therelease is properly authorized, coordinates the retrieval of the record,determines the relevant parts of the record to be copied and delivers thecopied records (or portions thereof) to the requesting party. Medical recordsrelease services are provided on-site and off-site pursuant to contracts withhospitals, other large healthcare institutions and insurance companies. Themedical records release service provider bills the recipient directly andsometimes pays a fee to the hospital.

*Record management services*consist primarily of active or open shelf storage. Active or open shelf storageservices involve the storage, processing (i.e., indexing and formatting),retrieval, delivery and return to storage of documents in a rapid time frame.Many of these services are provided electronically through web-enabledapplications. Service fees generally include a monthly fee based on activitylevels and volumes stored, with additional billing for specialized requests. Toa smaller extent, we store inactive documents.

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*Additional Healthcare and Complianceservices* include document and data conversion, archiving andimaging services for hospital radiology departments, imaging and electronicstorage of medical records for hospitals, coding and abstracting of medicalrecords, managed care payment compliance reviews, and temporary staffingservices for hospital information management departments.

*Class Action ClaimsAdministration Services* include turnkey services toadminister legal settlements. Services include compiling and managing claimsdatabases, conducting mail campaigns for settlement communications andproviding communication support for settlements through our in-bound callcenters. We identify and notify members of class action lawsuits or othergroups, answer questions, track and record contact with class action or othergroup members, process claims, and distribute settlement funds.

*Professional Economic Research andLitigation Services* include the utilization of highly skilledand experienced professionals and the application of key intellectual property andexperience based proprietary data to provide help in solving client problems.We are engaged in complex, high profile and high economic risk litigationmatters to offer expert analysis and testimony. Our high level consultingservices range from fair lending, labor discrimination and forensic analysis totrial support for law firms and corporations.

*TaxBenefit Services* provide consulting and process managementservices around niche tax areas to a variety of industries. Working through anetwork of C.P.A. firms, we provide niche tax services related to LIFOinventory accounting for auto dealerships and assist commercial property ownersin optimizing their deductions for depreciation.

**Sales and Marketing**

We have a broad customerbase with no customer accounting for more than 10% of revenue. However, one ofour industry customers accounted for approximately 11% of gross profit for theyear ended December 31, 2004. The loss of any one of our significantclients could leave us with a significantly higher level of fixed costs than isnecessary to serve our remaining clients, and could have a material adverseeffect on our results of operations. Our sales efforts are accomplished on anational basis through regionally based sales teams with vertical market focus.We continue to focus on increasing revenue from our current customer basethrough major account management focused on increasing service levels, sellingadditional services to existing and new departments, and piloting new serviceoffering content.

**Competition**

The business process outsourcing solution andconsulting markets in which we compete and expect to compete are highlycompetitive. A significant source of competition is the in-house capability ofour target client base. There can be no assurance that these businesses willoutsource more of their business processing or consulting needs or that theywill not bring in-house the services that they currently outsource. Inaddition, certain of our competitors are larger businesses and have greaterfinancial resources than we do. Certain of these competitors operate in broadergeographic areas or offer a broader set of capabilities than we do, and othersmay choose to enter our areas of operation in the future. We intend to continueto enter new geographic areas through internal growth and potentially throughacquisitions and expect to encounter significant competition from establishedcompetitors in each of such areas. As a result of this highly competitiveenvironment, we may lose clients or have difficulty in acquiring new customersand new companies and our results of operations may be adversely affected.

We believe that theprincipal competitive factors in providing business process outsourcing orconsulting services include quality, reliability and security of service,industry specific knowledge, and price. We compete primarily on the basis ofquality of service and client segment specific knowledge as well as our abilityto handle large volumes and projects, and believe that we compete favorablywith respect to these factors. We continue to integrate best practice deliveryprocesses into all of our service-delivery 

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capabilitiesto improve our quality and service levels and to increase operationalefficiencies. We have also integrated the use of offshore resources andpersonnel in order to increase pricing competitiveness.

**Employees**

At December 31, 2004,we had approximately 5,100 full-time and approximately 700 part-time employees.Our employee count fluctuates from time to time based upon the timing andduration of certain project revenue engagements. We also utilize contract laborin certain functions of our business. At December 31, 2004, we hadapproximately 125 employees represented by labor unions. We consider ourrelations with our employees to be good.

**AvailableInformation**

Our annual reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K, and allamendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934 are available free of chargeon our website (*www.sourcecorp.com*)as soon as reasonably practicable after they are filed with, or furnished to,the SEC.

**Our ExecutiveOfficers**

Thefollowing table sets forth certain information concerning each of our executiveofficers as of February 28, 2005:
| **NAME**               | ** ** | ** ** | ** ** | **AGE**                                                                                   | ** ** | **POSITION** |
|------------------------|------------|------------|------------|-------------------------------------------------------------------------------------------|------------|--------------|
| Thomas C. Walker       |       | 72         |       | Chairman of the Board  and Chief Development Officer                                      |
| Ed H. Bowman, Jr. |       | 58         |       | President, Chief  Executive Officer and Director                                          |
| Barry L. Edwards       |       | 57         |       | Executive Vice President  and Chief Financial Officer                                     |
| Charles S. Gilbert     |       | 38         |       | Senior Vice President,  General Counsel and Secretary                                     |
| Kerry Walbridge        |       | 53         |       | Senior Vice President  and President—Business Process Solutions Division             |
| Ronald Zazworsky       |       | 60         |       | Senior Vice President  and President*—HealthSERVE*Division                           |
| Dave Delgado           |       | 44         |       | Senior Vice President  and President—Legal Claims and Regulatory Compliance Division |
| Steve Davis            |       | 37         |       | Senior Vice President  and Chief Information Officer                                      |
| Ralph D. Burns         |       | 50         |       | Vice President of  Corporate Development                                                  |
| W. Bryan Hill          |       | 38         |       | Vice President and Chief Accounting Officer                                               |

 

Thomas C. Walker has been our Chairman of the Boardsince our inception in September 1994 and has been our Chief DevelopmentOfficer since November 1995. From September 1994 until November 1995,Mr. Walker held the positions of President and Chief Executive Officer.From August 1991 to December 1994, Mr. Walker was VicePresident, Corporate Development, of Laidlaw Waste Systems, Inc., asubsidiary of Laidlaw, Inc., a waste management company, where he wasresponsible for its acquisition and divestiture program in the United Statesand Mexico. Mr. Walker has been responsible for the acquisition ordivestiture of several hundred businesses over a 30-year period. Mr. Walkercurrently serves as a director of Renew Data, a privately held provider ofelectronic evidence services and preservation archiving. Mr. Walker holdsa B.S. degree in Industrial Engineering from Lafayette College.

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Ed H. Bowman, Jr. has been our President andChief Executive Officer and a Director since November 1995. From 1993 to1995, Mr. Bowman was Executive Vice President and Chief Operating Officerof the Health Systems Group for First Data Corporation, a financial servicescompany. Mr. Bowman was responsible for the day-to-day operations ofresearch and development, marketing and customer service. From 1983 to1993, Mr. Bowman served in a number of executive positions with aleading healthcare information systems company; responsibilities includedVP—International, VP—Marketing, Senior VP—Customer Services, Group SeniorVP—Research and Development, and last serving as Executive Vice President andChief Operating Officer with responsibility for domestic operations. Prior to1983, Mr. Bowman was with Andersen Consulting (currently known asAccenture), where he was elected a Partner. Mr. Bowman holds an M.S.degree from Georgia Institute of Technology and a B.B.A. from Georgia StateUniversity. Mr. Bowman has served on the Board of the Advanced TechnologyDevelopment Center at Georgia Tech. Mr. Bowman currently serves on theAdvisory Board to the President of Georgia Tech and on the Advisory Board ofthe Robinson School of Business at Georgia State University.

Barry L. Edwards has been an Executive Vice Presidentand our Chief Financial Officer since August 2000. From November 1994to March 2000, Mr. Edwards was Executive Vice President and ChiefFinancial Officer for AMRESCO, a nationwide financial services company. He wasresponsible for the company’s financial reporting, treasury and riskmanagement, corporate accounting, information technology, internal auditfunctions, human resources, and investor relations. From December 1978 to November 1994,Mr. Edwards was Vice President and Treasurer of Liberty Corporation, aninsurance and broadcasting holding company, where he was responsible for allaspects of finance, including SEC reporting, financing, tax, and internal auditfunctions. Mr. Edwards received a B.S. degree in Finance and Economicsfrom Lehigh University in 1969 and an M.B.A. degree from the University ofVirginia Darden School Of Business in 1972. Mr. Edwards is a board member ofRyan’s Restaurant Group Inc. and Robert Harris Homes.

Charles S. Gilbert has been a Senior Vice President,Secretary, and General Counsel since January 2001, a Vice President,Secretary and General Counsel since August 2000, our Secretary and actingGeneral Counsel since July 2000 and corporate counsel since April 2000.From 1991 until joining us he practiced law in the corporate securities sectionof Jackson Walker LLP, Dallas, where he was elected partner. Mr. Gilbertholds a B.S. degree in Physics from The University of Texas and a J.D. from TheUniversity of Texas School of Law.

Kerry Walbridge, age 53, has been a Division Presidentsince March 2001. From April 2000 to December 2000, Mr. Walbridge was Presidentand CEO of eMake Corporation, a first-to-market provider of web hostedEnterprise Resource Planning (ERP) software solutions and electronic supplychain services to the manufacturing market. From August 1998 to April 2000, Mr.Walbridge was Senior Vice President Sales and Marketing for Outsourcing Solutions,Inc., the nation’s largest provider of accounts receivable management services.From November 1991 to June 1993 and from June 1996 to August 1998, Mr. Walbridgewas a Division Vice President for Electronic Data Systems (EDS) and from April1998 to November 1991 Mr. Walbridge was a Division Vice President for McDonnellDouglas Systems Integration. Mr. Walbridge received a B.S. in business from St.Louis University.

Ronald Zazworsky has been a Division President since November 2000.From October 1997 until November 2000, Mr. Zazworsky was ourSenior Vice President—HealthSERVE. From February 1994 until July 1997,Mr. Zazworsky was Senior Vice President at Medaphis Corporation, anoutsourcer of financial and business management services for hospitals andphysician groups. From April 1992 to February 1994, Mr. Zazworskywas President and CEO at Habersham Banking Solutions, Inc., a privatecheck imaging software firm, where he also served on its board of directors.Prior to 1992, Mr. Zazworsky was employed at HBOC, a healthcare systemsand services organization, as Regional Vice President for 

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eight years. Previously, Mr. Zazworskyheld various sales, marketing, and management positions at IBM. Mr. Zazworskyholds a B.A. degree from Gettysburg College and a M.B.A. degree from EmoryUniversity.

Dave Delgado has been a Division President since January 2004.Mr. Delgado joined the Company in September 1996 as a result ofSOURCECORP acquiring Zia Information Analysis Group. From July 1999 to January 2004,Mr. Delgado was responsible for the legal consulting business segment atSOURCECORP. Prior to joining SOURCECORP, Mr. Delgado founded and served asthe President and Chief Executive Officer of Zia Information Analysis Groupspecializing in expert witness testimony and case management services. Prior tofounding Zia Information Analysis Group, Mr. Delgado was a Partner withPeterson Consulting, a national consulting firm specializing in economic damageand expert witness testimony. Mr. Delgado has provided expert witnesstestimony in both California State Court and Federal Court. Mr. Delgadograduated from Stanford University where he majored in civil engineering andminored in economics.

Steve Davis has been Chief Information Officer since January 2004.From April 2002 to January 2004, Mr. Davis was Chief TechnologyOfficer for SOURCECORP’s Business Process Solutions Division. From December 1999until joining SOURCECORP, Mr. Davis was Executive Vice President atMichael’s Stores where Mr. Davis led advanced technology initiatives,including the launch of Michaels’ first electronic commerce business and callcenter operations, as well as supply chain enablement programs. Mr. Davisalso held various technology management positions at IBM and led the e-BusinessSolutions Group for IBM’s Western Geography, providing leadership for large-scaleprofessional services and systems integration projects. Mr. Davis has asuccessful 16 year track record in technology management focused oncustomer-oriented, high-impact technology solutions. Mr. Davis is anhonors graduate of Texas A&M University where he majored in InformationManagement Systems.

Ralph D. Burns has been Vice President of CorporateDevelopment for SOURCECORP since May of 2003. From 1999 until May 2003,Mr. Burns held several senior management roles at EDS including VicePresident of Marketing and Portfolio Management globally for E solutions, thesolutions consulting division of EDS, responsible for global business strategy,M&A, Alliances, Marketing, Communications, Portfolio Management, and MarketAnalyst Relations. In 1998 and 1999, Mr. Burns was Director for Cap GeminiAmerica responsible for the Financial and E-Commerce practices in thesouthwest. From 1979 until 1998, Mr. Burns held various positions at MTech(acquired by EDS in 1988) including VP Corporate Operations and VP EmergingBusiness Development where he was responsible for developing new businessesareas. From 1973 until 1979, Mr. Burns held various management positionsat Republic National Bank in Dallas.

W. Bryan Hill has been a Vice President and our ChiefAccounting Officer since November 2001. From August 2000 to October 2001,Mr. Hill served with us as a Director of Accounting. From July 1996until joining us, Mr. Hill was Senior Vice President of Accounting andFinance with FirstPlus Consumer Finance. Previously, Mr. Hill held variousaccounting and finance positions with Associates First Capital for over sevenyears with Director of Corporate Finance being his last position. Mr. Hillholds a B.B.A. degree in Accounting from Texas Christian University and hasbeen a C.P.A and a C.M.A from 1996 and 2000, respectively.

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**RISK FACTORS**

**IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OURBUSINESS, FINANCIAL CONDITION, RESULTS OF OPERATIONS OR CASH FLOWS COULD BE MATERIALLYADVERSELY AFFECTED, THE PRICE OF OUR SECURITIES COULD DECLINE, WE MAY NOTBE ABLE TO REPAY OUR DEBT SECURITIES, IF ANY, AND YOU MAY LOSE ALL OR PART OFYOUR INVESTMENT. YOU SHOULD ALSO REFER TO THE OTHER INFORMATION CONTAINED INTHIS REPORT AND INCORPORATED IN THIS REPORT BY REFERENCE, INCLUDING OURCONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES. THE RISKS DESCRIBED BELOW ARE NOT THE ONLYONES FACING US. ADDITIONAL RISKS NOT CURRENTLY KNOWN TO US, THAT WE CURRENTLYBELIEVE ARE IMMATERIAL OR ARE OTHERWISE NOT LISTED BELOW MAY ALSO IMPAIROUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION.**

**SEC investigation**

The Company receivedwritten confirmation from the SEC on January 14, 2005, that the SEC hasconverted its informal inquiry in connection with the Company’s internalinvestigation and restatement into a formal investigation. The Company intendsto fully cooperate with the SEC in connection with the investigation. TheCompany initially had contacted the enforcement division of the SEC on avoluntary basis to notify the agency of the Company’s understanding of theevents leading to its internal investigation. We are unable to predict theoutcome of the investigation, the scope of matters that the SEC may choose toinvestigate in the course of this investigation or in the future, the SEC’sviews of the issues being investigated, or any action that the SEC might take,including the imposition of fines, penalties, or other available remedies

**Nasdaq listing**

The Nasdaq ListingQualification Panel previously granted the Company a listing requirementsexception that, as subsequently modified, contemplated among other things thatthe Company would file its third quarter 2004 Quarterly Report on Form 10-Qand certain prior period financial information by March 23, 2005 (whichthe Company believes it has complied with) and the filing of its 2004 AnnualReport on Form 10-K by March 31, 2005. Such exception alsocontemplates that the Company, by March 31, 2005, provide the Panel with abrief written summary of the status and focus of the above referenced SECinvestigation, which the Company is providing. The Company believes that thefiling of this Annual Report on Form 10-K by March 31, 2005, will be the lastremaining requirement to such modified exception; however, if the Company isunable to satisfy all of the requirements of the modified exception, theCompany’s Common Stock would be delisted from trading on the Nasdaq StockMarket unless an additional exception is considered and granted.

**Pending litigation**

We are party tosignificant litigation, which is described in more detail in “Item 3—LegalProceedings.” If any of these proceedings is decided against us, we could besubject to substantial damages or other penalties.

**Customer arrangements**

Some of the issuesidentified in our internal investigation may impact the degree to which somecustomers are willing to continue to do business with us.  Further, as some of the issues identified inour internal investigation involved contracts with State and Federal agencies,we may be subject to penalties or charges that potentially could include asuspension or other impairment of our (or the subject Operating Subsidiary’s)ability to enter into future arrangements with such governmental bodies.  We believe we have 

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mitigatedthe risk of such penalties and charges by promptly and proactively approachingaffected customers and offering appropriate remediation; however, we cannot predictwith certainty the amount of such potential remediation costs or whether suchremediation offers will be accepted.

**Contract pricing/capitalinvestments**

The pricing and otherterms of our client contracts require us to make estimates and assumptions atthe time we enter into these contracts that could differ from actual results.These estimates reflect our best judgments regarding the nature of theengagement and our expected costs to provide the contracted services. Further,some of our client contracts require significant investments in the early stages,which investments are intended to be recovered through billings over the lifeof the contract. Any increased or unexpected costs or unanticipated delays inconnection with the performance of these engagements, or decrease in the actualwork volumes generated under the contracts, including as a result of eventscaused by factors outside our control, could make these contracts lessprofitable or unprofitable.

**Competition**

The business processoutsourcing services industry is highly competitive. We cannot guarantee thatwe will be able to compete successfully in the future. A significant source ofcompetition is the in-house capability of our targeted client base. We cannotassure you that these businesses will outsource more of their document andinformation management needs or that such businesses will not bring in-housethe services that they currently outsource. In addition, certain of ourcompetitors have greater financial resources than we do, operate in broadergeographic areas than we do, have a greater international presence than we do,and/or offer a broader range of services in certain segments. In such anincreasingly competitive environment, we may lose clients or have difficulty inacquiring new clients and new companies.

**Revenue mix**

Project revenue includesone-time projects in which the customer relationship is not expected tocontinue after project completion. Conversely, recurring revenue ischaracterized by customer relationships that are generally for one year and maycontinue for longer. Recurring revenue is typically based on transactionvolumes sent to us by our customers and these volumes are typically notcontractual or otherwise guaranteed. Project revenue margins are usually higherthan our average margins and the workload can be highly volatile. Recurringrevenue typically has lower margins than project revenue but is usually morepredictable. To the extent our business mix shifts from project-orientedto recurring service offerings, our gross margins, operating income, andoperating cash flow may decline.

**Contracttermination provisions**

Some of our government andother clients can terminate their contracts for any reason, provided thenotification procedures stated in the contract are followed, regardless of ourperformance. In addition, public sector contracts are subject to public policyand funding priorities. Some of our contracts with clients provide fortermination, fee credits or financial penalties in the event our performance isnot consistent with the service levels specified in those contracts.

**Client industries**

We derive our revenueprimarily from document and information intensive industries. Fundamentalchanges in the business practices of any of these client industries, whetherdue to regulatory, technological, the internet or other developments, couldcause a material reduction in demand by our clients for the services offered byus. Any reduction in demand could have a material adverse effect on our resultsof 

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operations.The business process outsourcing service industry is characterized bytechnological change, evolving client needs, and emerging technical standards.Although we believe that we will be able to continue to offer services based onnew technologies, we cannot assure you that we will be able to obtain any ofthese technologies, that we will be able to effectively implement thesetechnologies on a cost-effective or timely basis or that such technologies willnot render obsolete our role as a third party provider of business processoutsourcing services.

**Client concentration/investmentsin clients**

Our success dependssubstantially upon retaining our significant clients. One of our customersrepresents 9% of our revenue and 11% of our gross profit for the period ended December 31,2004. Generally, we may lose clients due to a merger or acquisition, businessfailure, contract expiration, conversion to a competitor, or conversion to anin-house system. We cannot guarantee that we will be able to retain long-termrelationships or secure renewals of short-term relationships with oursignificant clients in the future. We incur a high level of fixed costs relatedto certain of our business process outsourcing clients. These fixed costsresult from significant investments, including computer hardware platforms,computer software, facilities, and client service infrastructure. The loss ofany one of our significant clients could leave us with a significantly higherlevel of fixed costs than is necessary to serve our remaining clients.

**Key personnel**

Our operations depend onthe continued efforts of our executive officers and on senior management of ouroperating companies. If any of these people are unable or unwilling to continuein their present role, or if we are unable to attract and retain additionalmanagers and skilled employees, our business could be adversely affected. We donot currently have key person life insurance covering any of our executiveofficers. Our success also depends upon our ability to attract, retain andmotivate highly skilled and qualified personnel. If we fail to attract, train,and retain sufficient numbers of these technically-skilled people, ourbusiness, financial condition, and results of operations could be materiallyand adversely affected. Further, parts of our business are individual orrelationship driven. In particular, our economic research and litigationservices business is highly dependant on our staff of professionals who haveexpertise, reputations and client relationships critical to maintaining anddeveloping our business.

**Technology risks**

The markets for ourbusiness process outsourcing services are subject to rapid technologicalchanges and rapid changes in client requirements. To compete, we commitsubstantial resources to operating multiple hardware platforms, to customizingthird-party software programs, and to training client personnel and ourpersonnel in the use of new technologies. Future hardware, software, and otherproducts may be able to manipulate large amounts of documents and informationmore cost effectively than existing products that we use. Informationprocessing is shifting toward client-server and web-based systems, inwhich individual computers or groups of personal computers and mid-range systemsreplace older systems. This trend could adversely affect our business andfinancial results and result in us losing clients and being unable to attractnew clients. We have committed substantial resources to developing outsourcingsolutions for these distributed computing environments. We cannot guaranteethat we will be successful in customizing products and services thatincorporate new technology on a timely basis. We also cannot guarantee that wewill continue to be able to deliver the services and products demanded by themarketplace.

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**Businessinterruptions**

Certain of our operationsare performed at a single location and are dependent on continuous computer,electrical, and telephone service. As a result, any disruption of our day-to-dayoperations could have a material adverse effect upon us. We cannot assure youthat a fire, flood, earthquake, terrorist activities, power loss, telephoneservice loss, problems caused by computer or technology issues, or other eventsaffecting one or more of our facilities would not disable these services. Anysignificant damage to any facility or other failure that causes significantinterruptions in our operations may not be covered by insurance.

**Acquisitions requirefinancing**

We currently intend tofinance any future acquisitions by using cash and in some cases our commonstock for all or a portion of the consideration to be paid. In the event thatour common stock is not at a sufficient value at the time of an acquisition, orpotential acquisition candidates are unwilling to accept our common stock asconsideration for the sale of their businesses, we may be required to use morecash, if available, in order to consummate acquisitions. If we do not havesufficient cash, our growth through acquisitions could be limited unless we areable to obtain capital through additional debt or equity financings. At December 31,2004, under our line of credit with a group of banks led by Bank of America,SunTrust, and Wells Fargo, we and our subsidiaries could borrow, on a revolvingcredit basis, loans in an aggregate outstanding principal amount up to$290.0 million for working capital, general corporate purposes, andacquisitions, subject to certain financial covenants and ratios in the line ofcredit. We cannot assure you, however, that funds available under our line ofcredit will be sufficient for our needs.

**Financial covenants**

Under our line of creditagreement, we are subject to certain reporting requirements and financialcovenants, including requirements that we maintain minimum levels of net worth,a maximum ratio of funded debt to EBITDA and other financial leverage ratios.An erosion of our business could place the Company out of compliance with thesecovenants. Potential remedies for the lenders include declaring all outstandingamounts immediately payable, terminating commitments and enforcing any liens;however, in the event of any future noncompliance the Company may seek a waiverfrom such lenders. See Note 10, Long-term Obligations and CreditFacilities, of Notes to Consolidated Financial Statements.

**Goodwillimpairments**

Due to the adoption ofStatement of Financial Accounting Standards (“SFAS”) No. 142, *Goodwill and Other Intangible Assets*,goodwill and other intangible assets that have indefinite useful lives are notamortized but rather are evaluated at least annually for impairment. Thevaluation of goodwill for impairment involves a high degree of judgment. Basedon our estimates and assumptions underlying the valuation, impairment isdetermined by estimating the fair value of a reporting unit and comparing thatvalue to the reporting unit’s book value. If economic events occur that causeus to revise our estimates and assumptions used in determining the fair valueof our goodwill, such revisions could result in an impairment charge that couldhave a material adverse impact on our financial statements during the periodincurred. A reporting unit is either at the operating segment level or onereporting level below and could consist of several service offerings aggregatedinto a single reporting unit. Service offerings are aggregated when they aresimilar in the following areas: economic characteristics, products andservices, production processes, methods for distributing or deliveringproducts, and type or class of customers.

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**Divestitures**

Periodically, we evaluatethe strategic fit of our operations in order to optimize the use of our capitaland management resources. Examples of the criteria used in determiningstrategic fit include, but are not limited to, cash flow generating capability,revenue and earnings growth opportunity, return on invested capitalrequirements, market growth potential, and expected ongoing capitalrequirements. Service offerings determined to be non-strategic could be sold orotherwise divested. Any such divestiture activity could result in a significantloss on disposal dependent upon many factors, such as: the expected financialperformance of the service offering, the growth potential of the serviceoffering, and the current economic conditions at the time of divestiture.

**Intellectual property infringement claims**

We do not own the majorityof the software that we use to run our business; instead we license thissoftware from a number of vendors. If these vendors assert claims that we orour clients are infringing on their software or related intellectual property,we could incur substantial costs to defend these claims. In addition, if anyvendors’ infringement claims are ultimately successful, our vendors couldrequire us: (i) to cease selling or using products or services thatincorporate the challenged software or technology; (ii) to obtain alicense or additional licenses from our vendors; or (iii) to redesign ourproducts and services that rely on the challenged software or technology.

**Breach ofconfidentiality**

A substantial portion ofour business involves the handling of documents containing privacy controlled,confidential and other sensitive information. Although we have establishedprocedures intended to prevent any unauthorized disclosure of confidentialinformation and, in some cases, have contractually limited our potentialliability for unauthorized disclosure of such information, we cannot assure youthat unauthorized disclosures will not result in a material liability to us.

**Governmentregulations**

In our medical recordsrelease of information business, there is state legislation from time to timedesigned to limit the price that can be charged for copying and distributingmedical records information. Depending on the severity of such pricinglegislation, there can be significant pressure on the profit margins associatedwith providing medical records release services. Today, some form of pricinglegislation exists in many states in the United States. Further, such pricinglegislation from time to time results in putative class action lawsuitsalleging that the charge for reproducing certain medical records is not inconformity with such plaintiffs’ reading of the applicable regulated charge. Weare from time to time a party to such putative class action lawsuits. Thedefense of these putative class action law suits can exert further pressure onrelated profit margins.

**HIPAA regulations**

As a result of statutoryauthority granted pursuant to the Health Insurance Portability andAccountability Act of 1996 (“HIPAA”), the United States Department of Healthand Human Services has recently issued regulations regarding the use anddisclosure of personal health information by healthcare providers, healthplans, and certain other “covered entities” operating in the healthcareindustry. The HIPAA regulations require covered entities to take steps tomaintain the privacy and security of personal health information. While we arenot a “covered entity” directly governed by these regulations (though in somecases the Company’s group health plans may be “covered entities”), many of ourcustomers are covered entities under the HIPAA regulations, and these customersare required to adjust their business arrangements to comply with HIPAA. Thesecustomers will be required to enter into “business associate 

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arrangements”with us that conform to the requirements of HIPAA. The requirements of HIPAA,and the costs of complying with HIPAA, may adversely affect the businessoperations of these customers, which could have a negative impact on ourbusiness operations. Furthermore, the requirements of the “business associatearrangements,” and the changes we will have to make in our operations to complywith such agreements, will increase our costs of operations. To the extent weare unable to comply with the provisions of such agreements, we could lose thebusiness generated by those clients or could be subject to damages forviolation of its “business associate agreements” with those clients.

**Our Board ofDirectors may be able to delay or prevent takeovers**

Our Board of Directors isempowered to issue preferred stock without stockholder action. The existence ofthis “blank-check” preferred stock could render more difficult ordiscourage an attempt to obtain control of us by means of a tender offer,merger, proxy contest or otherwise.

**Other risks,unknown or immaterial today, may become known or material in the future**

We have attempted toidentify certain material risk factors currently affecting us. However,additional risks that we do not yet know of, that are not described herein, orthat we currently think are immaterial, may occur or become material. Theserisks could impair our business operations or adversely affect our results ofoperations.

**ITEM 2**.                *Properties*

As of December 31, 2004, we operatedapproximately 83 facilities in 24 states. Except for the three facilities weown (which are located in Maryland, Florida and Alabama) all of thesefacilities were leased and were principally used for operations and generaladministrative functions. As of December 31, 2004, such leased facilitiesconsisted of approximately 1.8 million square feet. In addition, ouremployees are in numerous client locations where we neither own nor lease theoccupied space, primarily in connection with our Healthcare, Regulatory andLegal Compliance segment. See Note 11, Lease Commitments, of Notes toConsolidated Financial Statements for further information relating to leases.

In order to secure our obligations under our currentline of credit, we granted to Bank of America, SunTrust Bank, and Wells FargoBank, as co-agents for our lenders, a security interest in the capital stock ofour material subsidiaries and, in the event we exceed a designated leverageratio, a lien on substantially all of our properties and other assets. See “Item7. Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Liquidity and Capital Resources.” See Note 10, Long-termObligations and Credit Facilities, of Notes to Consolidated FinancialStatements.

We believe that ourproperties are generally well maintained, in good condition, and adequate for ourpresent needs. Furthermore, we believe that suitable additional or replacementspace will be available when required.

**ITEM 3**.                *Legal Proceedings*

We are, from time to time, a party to litigationarising in the normal course of business. The following is a description of themost significant legal matters that we are involved in. In the event of anadverse outcome in one or more of our legal proceedings, our business,financial condition, results of operations or cash flows could be materiallyadversely affected.

*Putative SecuritiesClass Action*

The Company, and theCompany’s CEO and CFO individually, have been named as defendants in severalputative securities class actions, in response to the Company’s press releasesdated October 27, 

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2004, inwhich the Company disclosed that its financial statements for certain priorperiods should no longer be relied upon, and also provided updated financialguidance. The complaints (collectively, the “Actions”) were filed in the UnitedStates District Court for the Northern District of Texas, Dallas Division. TheActions are putative shareholder class action lawsuits alleging violations ofFederal Securities Laws, including alleged violations of Sections 10(b) and20(a), and Rule 10b-5 of the Securities Exchange Act of 1934, asamended. The Actions are purportedly on behalf of all persons who purchased theCompany’s common stock during the period between May 7, 2003, and October 26,2004 or October 27, 2004, depending on the Action, and seek unspecifieddamages. The four Actions have been transferred to a single judge in theNorthern District of Texas, Dallas Division and these actions have beenconsolidated into a single action styled *Richard Bassin v.Sourcecorp, Inc., et al*.

*PurportedDerivative Action and Demand Letter*

A purported stockholderderivative action was filed on December 28, 2004, against certain of theCompany’s current and former officers and directors as individual defendantsand the Company as a nominal defendant in the 116th District Court for DallasCounty, Texas (the “Purported Derivative Action”). The Purported DerivativeAction alleges breach of fiduciary duty, abuse of control, gross mismanagement,waste of assets, and unjust enrichment related to the Company’s press releasedated October 27, 2004, in which the Company disclosed that its financialstatements for certain prior periods should no longer be relied upon, and alsoprovided updated financial guidance. All of these claims are assertedderivatively on behalf of the Company. Further, the Chairman of the Company’sBoard of Directors received from a purported shareholder a demand letter (the “DemandLetter”) based on the same set of facts as the Purported Derivative Action. TheCompany has formed a special committee of the Board of Directors to evaluatethe claims made in the Purported Derivative Action and the Demand Letter.

*Digital ImagingSystems*

On August 5,2004, Digital Imaging Systems, Inc. filed suit against the Company inthe United States District Court-Southern District of New York alleging, amongother things, that a portion of the Company’s process for scanning and indexingimages violates one of Digital Imaging Systems’ patents. The Company hastendered this matter to one of its software/hardware vendors forindemnification, which such vendor is evaluating. The suit demands unspecifieddamages.

*Various ROI CopyCharge Matters*

From time to time, variousof our subsidiaries that perform release of information (“ROI”) services becomedefendants to putative class action lawsuits generally alleging that the chargefor reproducing certain medical records is not in conformity with suchplaintiffs’ reading of the applicable regulated charge. Such suits typicallyinclude multiple ROI companies and hospitals as defendants and demandreimbursement for prior charges as well as for prospective pricing adjustments.We are currently a party to several such suits in various stages of development.One such suit is styled *McShane v. RecordexAcquisition Corp. & Sourcecorp, Incorporated*, filed in theCourt of Common Pleas Philadelphia County in Pennsylvania, alleges among otherthings that the Company intentionally charges more for providing copies ofmedical records than is permitted under Pennsylvania law. In September 2004,the court entered its order certifying a class in this matter.

*Spohr, et al. v.F.Y.I. Incorporated, et. al.*

In June 2000, theCompany filed an action styled *F.Y.I.Incorporated v. Spohr, et al.* in Dallas, Texas, in which we assertedclaims for breach of contract, fraud, and negligent misrepresentation againstthe sellers of two related companies that we acquired in December 1998(the “Texas Action”). The Texas Action was 

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laterremoved to federal court and ultimately dismissed on jurisdictional grounds. Wereasserted these claims in two actions that were later consolidated; one styled*F.Y.I. Incorporated v. Spohr, et. al.*in Superior Court of the State of California in the County of Sacramento, Case No. 01-AS-00721(the “Sacramento Action”) and one styled *Spohr,et. al. v. F.Y.I. Incorporated, et. al.* in the Superior Court of theState of California in the County of San Francisco, Case No. 318703 (the “SanFrancisco Action”). In the consolidated action, we additionally filed claimsagainst the sellers’ accountants and the two sellers filed claims against us;however, in February 2004, the judge in the Sacramento Action dismissedour claims against the sellers’ accountants. The sellers allege that our formersubsidiary wrongfully failed and refused to execute and deliver a requestedestoppel certificate, and that the failure to provide such estoppel certificateharmed the landlord in that they were allegedly denied favorable terms on arefinancing of the property and were allegedly prevented from completing atimely sale of the property. Sellers alleged damages of approximately$1.5 million. We asserted damages in excess of $8 million. On February 3,2005, the parties settled this matter on mutually acceptable terms.

**ITEM 4**.                *Submission of Matters to a Vote of Security Holders*

During the fourth quarter of the year ended December 31,2004, no matters were submitted to a vote of the security holders.

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**PART II**

**ITEM 5.**                *Market for Registrant’s Common Equity, Related Stockholder Matters, andIssuer’s Purchase of**Equity Securities*

**Market Information**

Ourcommon stock trades on The Nasdaq Stock Market under the symbol “SRCPE”(formerly “SRCP”). The following table sets forth, for our fiscal periodsindicated, the range of high and low reported sale prices for our common stock.
| ** **            | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------------|------------|----------|------------|---------|------------|
| **Fiscal  Year 2003** |       |     |       |    |       |
| First Quarter         |       | $        | 19.46      |    | $          | 13.50 |   |
| Second Quarter        |       | $        | 22.63      |    | $          | 13.70 |   |
| Third Quarter         |       | $        | 27.41      |    | $          | 20.86 |   |
| Fourth Quarter        |       | $        | 27.79      |    | $          | 22.65 |   |
| **Fiscal  Year 2004** |       |     |       |    |       |
| First Quarter         |       | $        | 28.78      |    | $          | 24.21 |   |
| Second Quarter        |       | $        | 28.97      |    | $          | 21.85 |   |
| Third Quarter         |       | $        | 27.89      |    | $          | 21.08 |   |
| Fourth Quarter        |       | $        | 23.41      |    | $          | 14.92 |   |

 

**Holders**

On February 28, 2005,the last reported sale price of our common stock on the Nasdaq Stock Market was$20.88 per share. At February 28, 2005, there were 70 holders of record ofour common stock and 15,666,916 shares outstanding.

**Dividends**

We have not declared any cash dividends on our commonstock. We do not anticipate paying any cash dividends on our common stock inthe foreseeable future and intend to retain our earnings, if any, to financethe expansion of our business and for general corporate purposes. Further, ourcredit facility prohibits payment of cash and similar dividends. Any payment offuture dividends will be at the discretion of our Board of Directors and willdepend upon, among other things, our earnings, financial condition, capitalrequirements, levelof indebtedness, contractual restrictions and other factorsthat our Board of Directors deems relevant.

During2004, the Company purchased 478,939 shares of its common stock at a cost ofapproximately $11.9 million. The following table contains information forshares repurchased during the fourth quarter of 2004.
| **Period**                       | ** ** | ** ** | ** ** | **(a) Total Number of  Shares Purchased** | ** ** | **(b) Average  Price Paid per  Share** | ** ** | **(c) Total Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs** | ** ** | **(d) Maximum Number of Shares (or  Approximate Dollar Value) of Shares  that May Yet Be Purchased  Under the Plans or Programs** | ** ** |
|----------------------------------|------------|------------|------------|---------------------------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Oct 1, 2004 – Oct 31,  2004 |       |       | 82,724     |                                                          |       |                                                  | $          | 21.91                                                                                                                                     |       |                                                                                                                                                                                                                   |       | 117,527 |   |   |   | $ | 17,415,551 |   |   |
| Nov 1, 2004 – Nov  30, 2004 |       |       | —     |                                                          |       |                                                  | —     |                                                                                                                                      |       |                                                                                                                                                                                                                   | —     |   |   |   | $ | 17,415,551 |   |   |
| Dec 1, 2004 – Dec 31,  2004 |       |       | —     |                                                          |       |                                                  | —     |                                                                                                                                      |       |                                                                                                                                                                                                                   | —     |   |   |   | $ | 17,415,551 |   |   |

 

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**ITEM 6.**                *Selected Financial Data*

**Selected FinancialData**

We were founded in September 1994, and weeffectively began our operations on January 26, 1996, following thecompletion of our initial public offering (“IPO”). We acquired, simultaneouslywith and as a condition to the closing of the IPO, seven founding companies.

Since the IPO and through December 31, 2004, wehave acquired 66 companies and have divested 21 operating units by sale orclosure. Our results of operations, for the periods presented, include theresults of the acquired companies from the date of their respective acquisitionand the results of the divestitures up to the effective date of thedivestiture.

Our Selected Financial Data have been derived from ourconsolidated financial statements. Arthur Andersen LLP audited our 2000 and2001 consolidated financial statements not including the restatement adjustmentfor 2001, more fully discussed in Item 8. Financial Statements.—Note 3.Restatement. Deloitte & Touche LLP audited our 2002, 2003 and 2004consolidated financial statements, including our restatement adjustments for2002 and 2003. The 2001 restated financial statements presented below have beenderived from the 2001 financial statements audited by Arthur Anderson LLP.

Our Selected FinancialData has been revised to reflect the restatement discussed in Item 8. FinancialStatements.—Note 3. Restatement. Additionally, the results of the operatingunits divested in 2004 are included up to the effective date of the divestitureand are reported as discontinued operations for all periods presented asdiscussed in Item 8. Financial Statements—Note 5 Discontinued Operations. OurSelected Financial Data provided below should be read in conjunction with ourconsolidated financial statements and the related notes thereto and “Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations” that appear elsewhere in this Report.

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**SelectedFinancial Data(In thousands, except per share data)**
| ** **                                                    | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                    | ** ** | **2000 **                             | ** ** | **2001 Restated** | ** ** | **2002 Restated** | ** ** | **2003 Restated** | ** ** | **2004** | ** ** |
| **Statement  of Operations Data (1):**                        |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                       |       | $                                          | 410,828    |   |   | $ | 396,894 |   |   |   | $ | 378,544 |   |   |   | $ | 378,159 |   |   | $ | 385,303 |   |
| Cost of services  exclusive of depreciation                   |       | 248,908                                    |       |   | 235,435 |   |   |   | 224,510 |   |   |   | 222,065 |   |   | 231,953 |   |
| Special charges (2)                                           |       | —                                     |       |   | 417 |   |   |   | — |   |   |   | — |   |   | — |   |
| Depreciation                                                  |       | 12,348                                     |       |   | 13,026 |   |   |   | 12,500 |   |   |   | 12,689 |   |   | 12,759 |   |
| Gross profit                                                  |       | 149,572                                    |       |   | 148,016 |   |   |   | 141,534 |   |   |   | 143,405 |   |   | 140,591 |   |
| Selling, general  and administrative  expenses                |       | 87,920                                     |       |   | 92,572 |   |   |   | 94,245 |   |   |   | 99,008 |   |   | 110,840 |   |
| Contingent  consideration  overpayment (3)                    |       | —                                     |       |   | — |   |   |   | 8,605 |   |   |   | 7,223 |   |   | 10,165 |   |
| Special charges (2)                                           |       | —                                     |       |   | 62,167 |   |   |   | — |   |   |   | — |   |   | — |   |
| Amortization (4)                                              |       | 7,801                                      |       |   | 9,205 |   |   |   | 356 |   |   |   | 355 |   |   | 991 |   |
| Operating income (loss)                                       |       | 53,851                                     |       |   | (15,928 | ) |   |   | 38,328 |   |   |   | 36,819 |   |   | 18,595 |   |
| Interest and  other (income) expense, net                     |       | 9,256                                      |       |   | 9,370 |   |   |   | 6,500 |   |   |   | 3,601 |   |   | 4,598 |   |
| Income (loss)  from continuing operations before income taxes |       | 44,595                                     |       |   | (25,298 | ) |   |   | 31,828 |   |   |   | 33,218 |   |   | 13,997 |   |
| Provision for  income taxes                                   |       | 17,596                                     |       |   | (1,260 | ) |   |   | 11,920 |   |   |   | 13,294 |   |   | 3,461 |   |
| Income (loss)  from continuing operations                     |       | 26,999                                     |       |   | (24,038 | ) |   |   | 19,908 |   |   |   | 19,924 |   |   | 10,536 |   |
| Income (loss)  from discontinued operations, net of tax (5)   |       | 5,102                                      |       |   | 3,350 |   |   |   | 731 |   |   |   | (843 | ) |   | (2,437 | ) |
| Net income (loss)                                             |       | $                                          | 32,101     |   |   | $ | (20,688 | ) |   |   | $ | 20,639 |   |   |   | $ | 19,081 |   |   | $ | 8,099 |   |
| Net income (loss) per common share                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic:                                                        |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Continuing Operations                                         |       | $                                          | 1.77       |   |   | $ | (1.44 | ) |   |   | $ | 1.15 |   |   |   | $ | 1.21 |   |   | $ | 0.66 |   |
| Discontinued Operations                                       |       | 0.33                                       |       |   | 0.20 |   |   |   | 0.04 |   |   |   | (0.05 | ) |   | (0.15 | ) |
| Total                                                         |       | $                                          | 2.10       |   |   | $ | (1.24 | ) |   |   | $ | 1.19 |   |   |   | $ | 1.16 |   |   | $ | 0.51 |   |
| Diluted:                                                      |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Continuing Operations                                         |       | $                                          | 1.68       |   |   | $ | (1.44 | ) |   |   | $ | 1.13 |   |   |   | $ | 1.20 |   |   | $ | 0.65 |   |
| Discontinued Operations                                       |       | 0.32                                       |       |   | 0.20 |   |   |   | 0.04 |   |   |   | (0.05 | ) |   | (0.15 | ) |
| Total                                                         |       | $                                          | 2.00       |   |   | $ | (1.24 | ) |   |   | $ | 1.17 |   |   |   | $ | 1.15 |   |   | $ | 0.50 |   |
| Weighted average  common shares outstanding                   |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                         |       | 15,284                                     |       |   | 16,748 |   |   |   | 17,334 |   |   |   | 16,452 |   |   | 15,893 |   |
| Diluted                                                       |       | 16,065                                     |       |   | 16,748 |   |   |   | 17,609 |   |   |   | 16,565 |   |   | 16,217 |   |
| **Balance  Sheet Data:**                                      |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Working capital                                               |       | $                                          | 55,920     |   |   | $ | 58,534 |   |   |   | $ | 38,988 |   |   |   | $ | 36,600 |   |   | $ | 34,018 |   |
| Total assets                                                  |       | 454,709                                    |       |   | 457,780 |   |   |   | 457,342 |   |   |   | 452,536 |   |   | 469,415 |   |
| Long-term  obligations, net of current maturities             |       | 123,784                                    |       |   | 116,055 |   |   |   | 89,640 |   |   |   | 73,390 |   |   | 87,547 |   |
| Stockholders’ equity                                     |       | 253,392                                    |       |   | 268,634 |   |   |   | 292,944 |   |   |   | 293,084 |   |   | 292,421 |   |

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(1)          Includes the results ofthe operating units divested as part of the 2001 strategic realignment plan upto the effective date of the divestiture.

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(2)          Special chargesrepresent expenses and asset write-downs associated with the 2001 strategicrealignment plan. We sold or closed 15 operating units pursuant to this plan. Specialcharges consist primarily of net loss or gain on sale or closure, other assetwrite-downs, and accrued contingencies such as legal claims, contracttermination costs, and various disposal expenses.

(3)          As discussed in Note 3,Restatement, of the Notes to Consolidated Financial Statements, revenuerecognition and expense omission issues at the Operating Subsidiary affectedpreviously paid contingent consideration payments related to the acquisition ofthe operating subsidiary. As a result, earnings before interest and taxesattributable to the Operating Subsidiary were overstated during the Earn-OutPeriod(s) resulting in payments made under the provisions of the Earn-outAgreements that otherwise would not have been made. The earn-out overpaymentshave been expensed in the periods paid.

(4)          On January 1, 2002,we adopted the provisions of SFAS No. 142, *Goodwill and Other Intangible Assets*, which eliminatedamortization, on a prospective basis, of goodwill and other intangible assetsthat have indefinite useful lives.

(5)          Represents the resultsof the operating units divested in 2004 as part of the 2004 plan of divestiturefor certain non-strategic asset groups. The results of these asset groups arereported up to the effective date of the divestiture as discontinued operationsfor all periods presented.

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**ITEM 7.**                *Management’s Discussion and Analysis of Financial Condition and Resultsof Operations*

**InternalInvestigation**

During October 2004, the Company, with theoversight and approval of the Audit Committee of our Board of Directors,initiated an investigation of the financial results of one of our operatingsubsidiaries in the Information Management and Distribution reportable segment(the “Operating Subsidiary”). The findings of the investigation concluded thatthe Operating Subsidiary had incorrectly recognized revenue for certaincustomer arrangements and omitted certain operating expenses from its financialresults which in turn resulted in overpayments and over accruals of contingentconsideration amounts due under the earn-out provisions of the acquisitionagreement for the Operating Subsidiary which had been originally recognized asadditional goodwill of the acquired business. As a result, the consolidatedfinancial statements for the years ended December 31, 2001, 2002, and 2003have been restated from the amounts previously reported, as discussed below.

Asdescribed in our critical accounting policies, revenue is recognizable wheneach of the following conditions is met: persuasive evidence of anarrangement exists, the price is fixed or determinable, delivery has occurredor services have been rendered and collection is reasonably assured. We haveidentified certain instances where one or more of the aforementioned revenuerecognition conditions as applied to certain customer contracts were not met bythe Operating Subsidiary. As a result, the revenue previously recognized thatdid not meet all the mentioned revenue recognition conditions has beenreversed, resulting in a downward adjustment to certain asset accounts or therecognition of a customer liability or deferred revenue, if the customer haspaid the invoices related to the reversed revenue. Notwithstanding the reversalof revenue, the direct costs associated with the reversed revenue continue tobe reported in the period incurred. In addition, we have evaluated the directcosts related to deferred revenue and have determined to continue to includethe direct costs in the period incurred due to the uncertainty regarding thefuture recoverability of the associated costs. The following table identifiesthe revenue adjustments by issue that are reflected in the restated financialstatements:
| ** **                    | ** ** | **Year Ended  Dec. 31, 2001** | ** ** | **Year Ended  Dec. 31, 2002** | ** ** | **Year Ended  Dec. 31, 2003** | ** ** |
|-------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                    | ** ** | **(In Thousands)**                      | ** ** |
| Asset accounts                |       |                                         | $          | (887                                         | )          |                                         |       | $ | (267 | ) |   |   | $ | 133 |   |   |
| Customer liability,  net      |       |                                         | (675       | )                                            |       |                                         | (593       | ) |   |   | (2,631 | ) |   |
| Deferred revenue,  net        |       |                                         | (1,745     | )                                            |       |                                         | (1,752     | ) |   |   | (3,817 | ) |   |
| Total Net Revenue  Adjustment |       |                                         | $          | (3,307                                       | )          |                                         |       | $ | (2,612 | ) |   |   | $ | (6,315 | ) |   |

 

**Asset accounts:**

Represents the reversal ofpreviously recognized revenue through the downward adjustment of certain assetaccounts where one or more of the aforementioned revenue recognition conditionsas applied to certain customer contracts were not met by the OperatingSubsidiary. To the extent that the write-down relates to performedservices that exceeded the contractual funding limitation, a portion of therevenue may be recognized in future periods upon customer authorization.

**Customer liability,net:**

The Operating Subsidiaryin certain instances recognized revenue for services that were never performed.The customers were invoiced for the non-performed services and collection ofthe invoices has occurred. A portion of the customer liability may berecognized as revenue in future periods upon successful completion of servicesor negotiations with the Operating Subsidiary’s customer(s). Remaining customerliability balances will be extinguished through either customer refund orapplying such remaining customer liability against future provided services.

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**Deferred revenue,net:**

The Operating Subsidiary recognized revenue forperformed services although the related contractually required servicesdesigned to meet customer-specific acceptance provisions (i.e. qualitystandards) were not performed. The customers were invoiced for the performedservices and collection of the invoices has occurred. However, by not complyingwith the contract, the Operating Subsidiary is unable to reasonably demonstratethat the performed services met the required quality standard(s). This has resultedin the deferral of revenue for performed services for which acceptance iscontingent upon meeting the required quality standard(s). The OperatingSubsidiary will recognize the revenue for performed services upon obtainingexplicit acceptance from the customer(s). In the event customer acceptance isnot obtained, the deferred revenue will be reclassified to a customer liability.The customer liability will be extinguished through either customer refund orapplying such remaining customer liability against future provided services.

The investigation identified certain expenses of theOperating Subsidiary that were not properly recorded in the OperatingSubsidiary’s consolidated statement of operations. Certain former members ofthe Operating Subsidiary’s management allegedly diverted expenses to entitiesthey controlled, but that are unrelated to the Company, resulting in theomission of the related expenses from the Operating Subsidiary’s financialresults and, as a result, our previously reported financial results. We haveidentified the unrecorded expenses and have recorded them in the period theexpenses were incurred as an adjustment to selling, general and administrativeexpense. A liability for such an amount has been recorded to other long-term obligationsin the restated financial statements. The liability will be eliminated at suchtime as we recover any contingent consideration overpayments paid to the formerowners of the Operating Subsidiary or at such time management determines theliability has been extinguished, as discussed below.

The revenue recognition and expense omission issuesaffected previously paid contingent consideration related to the acquisition ofthe Operating Subsidiary. As a result of the structure of the acquisitionagreement, the former owners of the Operating Subsidiary had the opportunity toearn additional purchase consideration for the twelve-month periods ended February 28,2002, February 28, 2003 and February 29, 2004 (the “Earn-outPeriod(s)”) based on earnings before interest and taxes of the OperatingSubsidiary, in excess of designated thresholds, calculated in accordance withaccounting principles generally accepted in the United States of America foreach respective period (the “Earn-out Agreement”). Based on the findings of theinvestigation, earnings before interest and taxes attributable to the OperatingSubsidiary were overstated during the Earn-out Period(s) resulting inoverpayments and overaccruals under the provisions of the Earn-out Agreementthat otherwise would not have been made. We have expensed the contingentconsideration overpayments in the financial statements in the periods in whichthey were paid, resulting in expense of $8.6 million, $7.2 million and $10.2million for the years ended December 31, 2002, 2003 and 2004, respectively.These amounts had previously been accrued as contingent consideration and anaddition to goodwill. We have reversed these accruals and related goodwill inthe periods originally recorded. We will record a gain in future periods to theextent such contingent consideration overpayments are recovered.

Restating the financial statements for the revenuerecognition, expense omission and contingent consideration overpayment issuesresults in an adjustment to the provision for income taxes and to certain otherbalance sheet tax accounts for the periods restated.

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A summary of thesignificant effects of the restatement is as follows (in thousands, except pershare data):

**BALANCESHEET INFORMATION**
| ** **                               | ** ** | **At December 31, 2001** | ** **        | **At December 31, 2002** | ** ** | **At December 31, 2003** | ** ** |
|------------------------------------------|------------|-----------------------------------------|-------------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                               | ** ** | **As**                                  | ** **        | ** **                              | ** ** | **As**                                  | ** ** | ** ** | ** ** | **As** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Previously**                          | ** **        | **As**                                  | ** ** | **Previously**                          | ** ** | **As** | ** ** | **Previously** | ** ** | **As** | ** ** |
| ** **                               | ** ** | **Reported**                            | ** **        | **Restated**                            | ** ** | **Reported**                            | ** ** | **Restated** | ** ** | **Reported** | ** ** | **Restated** | ** ** |
| ** **                               | ** ** | ** **                              | **(Item 1)** | ** **                              | ** ** | ** **                              | ** ** | **(Item 1)** | ** ** | ** ** | ** ** | **(Item 1)** | ** ** | ** ** | ** ** |
| Accounts and  Notes Receivable, Net      |       |                                    | $                 | 78,411                                  |       |                                    | $          | 78,164 | ** ** | $ | 70,241 |   | $ | 69,800 | ** ** | $ | 67,873 |   | $ | 63,522 | ** ** |
| Income Tax Receivable                    |       |                                    | NC                |                                    |       | NC                                      | ** ** | $ | — |   | $ | 2,406 | ** ** | $ | — |   | $ | 3,006 | ** ** |
| Goodwill                                 |       |                                    | $                 | 298,519                                 |       |                                    | $          | 293,475 | ** ** | $ | 317,256 |   | $ | 305,026 | ** ** | $ | 324,305 |   | $ | 307,913 | ** ** |
| Total Assets                             |       |                                    | $                 | 463,071                                 |       |                                    | $          | 457,780 | ** ** | $ | 467,607 |   | $ | 457,342 | ** ** | $ | 470,273 |   | $ | 452,536 | ** ** |
| Accounts Payable and Accrued Liabilities |       |                                    | $                 | 43,802                                  |       |                                    | $          | 39,645 | ** ** | $ | 51,739 |   | $ | 49,001 | ** ** | $ | 52,054 |   | $ | 52,375 | ** ** |
| Income Tax Payable                       |       |                                    | $                 | 4,588                                   |       |                                    | $          | 3,258 | ** ** | $ | 180 |   | $ | — | ** ** | $ | 2,186 |   | $ | — | ** ** |
| Deferred Income Taxes                    |       |                                    | NC                |                                    |       | NC                                      | ** ** | $ | 11,679 |   | $ | 7,873 | ** ** | $ | 18,084 |   | $ | 11,753 | ** ** |
| Long-term  Customer Liability            |       |                                    | $                 | —                                  |       |                                    | $          | 615 | ** ** | $ | — |   | $ | 1,255 | ** ** | $ | — |   | $ | 1,862 | ** ** |
| Deferred Revenue                         |       |                                    | $                 | —                                  |       |                                    | $          | 1,558 | ** ** | $ | — |   | $ | 3,337 | ** ** | $ | — |   | $ | 5,135 | ** ** |
| Other Long-term  Obligations             |       |                                    | $                 | 18,005                                  |       |                                    | $          | 18,567 | ** ** | $ | 5,290 |   | $ | 6,518 | ** ** | $ | 7,839 |   | $ | 9,306 | ** ** |
| Retained Earnings                        |       |                                    | $                 | 69,137                                  |       |                                    | $          | 66,598 | ** ** | $ | 96,969 |   | $ | 87,237 | ** ** | $ | 119,236 |   | $ | 101,232 | ** ** |
| Total Stockholdes’ Equity           |       |                                    | $                 | 271,173                                 |       |                                    | $          | 268,634 | ** ** | $ | 302,676 |   | $ | 292,944 | ** ** | $ | 311,088 |   | $ | 293,084 | ** ** |

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**Item 1:  **Amounts as previously reported after givingeffect to adjustments required to reflect the Company’s discontinued operationsdiscussed in Note 5 to the consolidated financial statements.

**Item 2:  **NCdenotes no change from the previously reported amount.

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**STATEMENTOF OPERATIONS INFORMATION**
| ** **                                                    | ** ** | **Year Ended  December 31, 2001** | ** ** | **Year Ended  December 31, 2002** | ** ** | **Year Ended  December 31, 2003** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                    | ** ** | **As**                                           | ** ** | ** **                                       | ** ** | **As**                                           | ** ** | ** ** | ** ** | **As** | ** ** | ** ** | ** ** |
| ** **                                                    | ** ** | **Previously**                                   | ** ** | **As**                                           | ** ** | **Previously**                                   | ** ** | **As** | ** ** | **Previously** | ** ** | **As** | ** ** |
| ** **                                                    | ** ** | **Reported**                                     | ** ** | **Restated**                                     | ** ** | **Reported**                                     | ** ** | **Restated** | ** ** | **Reported** | ** ** | **Restated** | ** ** |
| ** **                                                    | ** ** | **(Item 1)**                                | ** ** | ** **                                       | ** ** | **(Item 1)**                                | ** ** | ** ** | ** ** | **(Item 1)** | ** ** | ** ** | ** ** |
| Revenue                                                       |       | $                                                | 400,201    |                                             | $          | 396,894                                          |       | $ | 381,156 |   | $ | 378,544 |   | $ | 384,474 |   | $ | 378,159 |   |
| Gross Profit                                                  |       | $                                                | 151,323    |                                             | $          | 148,016                                          |       | $ | 144,146 |   | $ | 141,534 |   | $ | 149,720 |   | $ | 143,405 |   |
| Selling, General & Administrative Expense            |       | $                                                | 92,010     |                                             | $          | 92,572                                           |       | $ | 93,578 |   | $ | 94,245 |   | $ | 98,770 |   | $ | 99,008 |   |
| Contingent Consideration Overpayments                    |       | $                                                | —     |                                             | $          | —                                           |       | $ | — |   | $ | 8,605 |   | $ | — |   | $ | 7,223 |   |
| Income (Loss) From Continuing Operations Before  Income Taxes |       | $                                                | (21,429    | )                                                | $          | (25,298                                          | )          | $ | 43,712 |   | $ | 31,828 |   | $ | 46,994 |   | $ | 33,218 |   |
| Provision for Income Taxes                                    |       | $                                                | 70         |                                             | $          | (1,260                                           | )          | $ | 16,611 |   | $ | 11,920 |   | $ | 18,798 |   | $ | 13,294 |   |
| Income (Loss) From Continuing Operations                      |       | $                                                | (21,499    | )                                                | $          | (24,038                                          | )          | $ | 27,101 |   | $ | 19,908 |   | $ | 28,196 |   | $ | 19,924 |   |
| Net Income (Loss)                                             |       | $                                                | (18,149    | )                                                | $          | (20,688                                          | )          | $ | 27,832 |   | $ | 20,639 |   | $ | 27,353 |   | $ | 19,081 |   |
| **Net Income (Loss) Per Common Share**                        |       |                                             |       |                                             |       |                                             |       |   |   |   |   |   |   |
| **Basic**                                                     |       |                                             |       |                                             |       |                                             |       |   |   |   |   |   |   |
| Continuing                                                    |       | $                                                | (1.28      | )                                                | $          | (1.44                                            | )          | $ | 1.57 |   | $ | 1.15 |   | $ | 1.71 |   | $ | 1.21 |   |
| Total                                                         |       | $                                                | (1.08      | )                                                | $          | (1.24                                            | )          | $ | 1.61 |   | $ | 1.19 |   | $ | 1.66 |   | $ | 1.16 |   |
| **Diluted**                                                   |       |                                             |       |                                             |       |                                             |       |   |   |   |   |   |   |
| Continuing                                                    |       | $                                                | (1.28      | )                                                | $          | (1.44                                            | )          | $ | 1.54 |   | $ | 1.13 |   | $ | 1.70 |   | $ | 1.20 |   |
| Total                                                         |       | $                                                | (1.08      | )                                                | $          | (1.24                                            | )          | $ | 1.58 |   | $ | 1.17 |   | $ | 1.65 |   | $ | 1.15 |   |

----

**Item 1:  **Amounts as previously reported after givingeffect to adjustments required to reflect the Company’s discontinued operationsdiscussed in Note 5 to the consolidated financial statements.

27

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**STATEMENTOF CASH FLOW INFORMATION**
| ** **                                                            | ** ** | **Year Ended  December 31, 2002** | ** ** | **Year Ended  December 31, 2003** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                            | ** ** | **As**                                           | ** ** | ** **                                       | ** ** | **As** | ** ** | ** ** | ** ** |
| ** **                                                            | ** ** | **Previously**                                   | ** ** | **As**                                           | ** ** | **Previously** | ** ** | **As** | ** ** |
| ** **                                                            | ** ** | **Reported**                                     | ** ** | **Restated**                                     | ** ** | **Reported** | ** ** | **Restated** | ** ** |
| ** **                                                            | ** ** | **(Item 1)**                                | ** ** | ** **                                       | ** ** | **(Item 1)** | ** ** | ** ** | ** ** |
| Net cash provided by operating activities from  continuing operations |       |                                             | $          | 64,429                                           |       |   | $ | 55,824 |   |   | $ | 59,412 |   |   | $ | 52,189 |   |
| Net cash used in investing activities from  continuing operations     |       |                                             | $          | (43,154                                          | )          |   | $ | (34,549 | ) |   | $ | (26,184 | ) |   | $ | (18,961 | ) |

----

**Item 1:  **Amounts as previouslyreported after giving effect to adjustments required to reflect the Company’sdiscontinued operations discussed in Note 5 to the consolidated financialstatements.

The above cash flowcategories are impacted as a result of reclassifying the contingentconsideration overpayments previously discussed, from cash paid foracquisitions (included in net cash used in investing activities from continuingoperations) to cash provided by operating activities from continuing operationsas a period expense.

The following discussionshould be read in conjunction with our consolidated financial statements andthe related notes thereto and “Item 6. Selected Financial Data” appearingelsewhere in this Report. Additional information concerning factors that couldcause results to differ materially from those in the forward-lookingstatements is contained under “Item 1. Business—Risk Factors.”

In addition, the followingdiscussion gives effect to the restatement adjustments discussed above. SeeNote 3, Restatement, of the Notes to Consolidated Financial Statements.

**Overview**

We were founded in September 1994,to create a national, single source provider of document and informationoutsourcing solutions to document and information intensive industries,including healthcare insurance, financial services, healthcare provider,transportation/logistics, federal and state government, and legal industries.We acquired the seven founding companies (the “Founding Companies”)simultaneously with the closing of our initial public offering (the “IPO”) on January 26,1996, and effectively began operations at that time. The consideration for theFounding Companies consisted of a combination of cash and common stock of ourCompany.

Since the IPO, we haveacquired 66 companies and divested 21 operating units by sales or closures. Weevaluate candidates for acquisition and periodically for divestiture as a partof our strategic plan of providing customers a single solution for businessprocess outsourcing and knowledge-based processing and consultingservices. The criteria for evaluation include geographic need, additionaltechnology, market growth potential, industry expertise, service expansion tobroaden service offerings, expansion of our customer base, revenue and earningsgrowth potential, and expected sources and uses of capital.

On May 4, 2004, weannounced the acquisition of KeyPoint Consulting, LLC (“KeyPoint”). KeyPoint isan economic consulting firm with approximately 26 principals and staff, and anetwork of academic affiliates. KeyPoint provides economic, financial, andforensic accounting services in matters involving complex litigation andregulation. KeyPoint’s clients include companies, law firms, and government andregulatory agencies. The acquisition of KeyPoint significantly expands ourexpertise in new practice areas and helps us strategically position foradditional growth in our legal consulting area. Keypoint joined our legalconsulting service offering and is reported in the Healthcare, Regulatory andLegal Compliance segment. Key Point contributed $5.6 million in revenue in2004, or approximately 2.9% of total segment revenue, and was moderatelyaccretive to 2004 earnings after consideration of related financing costs andamortization of identified intangibles.

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During the first quarterof 2004, we completed a strategic evaluation of our operations based on certaincriteria, such as strategic and financial fit, and future growth prospects. Asa result, on May 6, 2004, we formally committed to a plan of divestiturefor certain non-strategic asset groups. The asset groups to be divested includethe Direct Mail operations, previously reported in our Information Managementand Distribution segment, and two medical records management operations thatwere reported in our Healthcare, Regulatory and Legal Compliance segment.Collectively, these asset groups incurred losses, net of tax, of $0.8 millionfor the full year ended December 31, 2003. During the quarter ended June 30,2004, we completed the sale of one of the medical records management operations.The divestiture of the other medical records management operation and theDirect Mail operations were completed during the quarter ended September 30,2004. See Note 5, Discontinued Operations, of the Notes to the ConsolidatedFinancial Statements, for a more detailed discussion.

During the first quarterof 2005, we entered into an agreement with one of our customers impacted by thefacts relating to the subject of our internal investigation, more fullydescribed above in “Internal Investigation” and in Note 3 of the Notes to theConsolidated Financial Statements. As a result of the agreement, we expect torecognize, during the first quarter of 2005, revenue of $4.1 million related todeferred revenue and customer liability restatement adjustments; however, suchrevenue will not contribute to the Company’s operating cash flow.

During the first quarterof 2005 we expect to incur additional legal and related expenses of approximately$1.3 million as part of the finalization of our internal investigation.

**Business Segments**

We aggregate our serviceofferings and operations into two reportable segments: (i) InformationManagement and Distribution, and (ii) Healthcare, Regulatory, and LegalCompliance. Service offerings are aggregated when they are similar in thefollowing areas: economic characteristics, products and services, productionprocesses, methods for distributing or delivering products, and type or classof customers. We evaluate segment performance based on revenue and incomebefore income taxes. All centrally incurred corporate costs are allocated tothe segments based principally on operating income of the segments measuredbefore the inclusion of the expense related to contingent considerationoverpayments discussed in Note 3 to the Consolidated Financial Statements. Thereporting segments follow the same accounting policies used for ourconsolidated financial statements as described in the summary of significantaccounting policies in the notes to our consolidated financial statements.

At January 1, 2002,we transferred four operating units from the Healthcare, Regulatory and LegalCompliance segment to the Information Management and Distribution segment andone operating unit from the Information Management and Distribution segment tothe Healthcare, Regulatory, and Legal Compliance segment. These transfers werecompleted to better align these operating units’ results with operating unitsof similar core competencies.

During the year ended December 31,2004, the Company realigned certain operations in order to leverage managementexpertise, reduce costs, maximize profitability, and better align theseoperations with other operating units of similar core competencies. Therealignment resulted in certain operations being transferred from theInformation Management and Distribution reportable segment to the Healthcare,Regulatory and Legal Compliance reportable segment.

The Company hasreclassified prior period amounts to be consistent with the current segmentreporting. The identified segments are as follows:

**InformationManagement and Distribution.  **We offer Business ProcessOutsourcing (“BPO”) solutions that help our customers manage the *Document In-flow*, *Workflow Processing* and *Statement Out-flow* of their missioncritical business document processes. Our BPO solutions enable customers toautomate their complex workflow processes by digitizing extremely large volumesof documents, capturing 

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information fromthe documents, hosting electronic documents on our Web-based repository, andpreparing statements that customers mail or present electronically to their endusers. We offer our BPO solutions to businesses in document intensiveindustries, such as healthcare insurance, financial services, healthcareprovider, transportation/logistics, and federal and state government. In 2004,Information Management and Distribution represented 50.5% of revenue. Projectrevenue accounted for 10.5% of the segment’s revenue with recurring revenueaccounting for the remaining 89.5% during 2004.

**Healthcare,Regulatory, and Legal Compliance.  **We offer specializedknowledge-based processing and consulting services that include medicalrecords release services, record management services for healthcareinstitutions, temporary staffing for healthcare institutions, providing managedcare payment compliance reviews, class action claims administration services,professional economic research and litigation services, and tax benefitservices. In 2004, Healthcare Regulatory and Legal Compliance represented 49.5%of revenue. Project revenue accounted for 59.4% of the segment’s revenue withrecurring revenue accounting for the remaining 40.6% during 2004.

**Results of Operations**

Thefollowing table sets forth certain items as shown in “Item 6. SelectedFinancial Data” expressed as a percentage of total revenue for the periodsindicated:
| ** **                                                | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenue                                                   |       | 100.0                                      | %          | 100.0 | % | 100.0 | % |
| Cost of services (1)                                      |       | 59.3                                       |       | 58.7 |   | 60.2 |   |
| Depreciation                                              |       | 3.3                                        |       | 3.4 |   | 3.3 |   |
| Gross profit                                              |       | 37.4                                       |       | 37.9 |   | 36.5 |   |
| Selling, general and administrative  expenses (2)         |       | 24.9                                       |       | 26.2 |   | 28.8 |   |
| Contingent consideration  overpayment (3)                 |       | 2.3                                        |       | 1.9 |   | 2.6 |   |
| Amortization                                              |       | 0.1                                        |       | 0.1 |   | 0.3 |   |
| Operating income                                          |       | 10.1                                       |       | 9.7 |   | 4.8 |   |
| Interest and other  expense, net                          |       | 1.7                                        |       | 0.9 |   | 1.2 |   |
| Income from continuing  operations before income taxes    |       | 8.4                                        |       | 8.8 |   | 3.6 |   |
| Provision for income  taxes                               |       | 3.1                                        |       | 3.5 |   | 0.9 |   |
| Income from continuing  operations                        |       | 5.3                                        |       | 5.3 |   | 2.7 |   |
| Income (loss) from  discontinued operations, net of taxes |       | 0.2                                        |       | (0.2 | ) | (0.6 | ) |
| Net income                                                |       | 5.5                                        | %          | 5.1 | % | 2.1 | % |

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(1)   Cost of services consists primarily of compensation and benefitsto employees providing goods and services to our clients; occupancy costs;equipment costs; and supplies. Our cost of services also includes, to a limitedextent, the cost of products sold for micrographics supplies and equipment;computer hardware and software; and business imaging supplies and equipment.

(2)   Selling, general and administrative expenses (“SG&A”) consistprimarily of compensation and related benefits to sales and marketing,executive management, accounting, human resources and other administrativeemployees; other sales and marketing costs; communications costs; insurancecosts; and legal and accounting professional fees and expenses.

(3)   As discussed in Note 3, Restatement, of the Notes to ConsolidatedFinancial Statements, revenue recognition and expense omission issues at anoperating subsidiary affected previously paid contingent consideration paymentsrelated to the acquisition of the operating subsidiary. As a result, earningsbefore interest and taxes attributable to the Operating Subsidiary wereoverstated during the Earn-Out Period(s) resulting in payments madeunder the provisions of the Earn-out Agreements that otherwise would not havebeen made. The earn-out overpayments have been expensed in the periods paid.

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***Year Ended December 31,2004 Compared to Year Ended December 31, 2003***
| ** **                                        | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                        | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| ** **                                        | ** ** | **($000’s)**                          | ** ** | **% of  Revenue** | ** ** | **($000’s)** | ** ** | **% of  Revenue** | ** ** |
| **Revenue**                                       |       | $                                          | 385,303    |   |   | 100.0 | % |   | $ | 378,159 |   |   | 100.0 | % |   |
| **Gross  Profit**                                 |       | 140,591                                    |       |   | 36.5 | % |   | 143,405 |   |   | 37.9 | % |   |
| **SG&A**                                      |       | 110,840                                    |       |   | 28.8 | % |   | 99,008 |   |   | 26.2 | % |   |
| **Operating  income**                             |       | 18,595                                     |       |   | 4.8 | % |   | 36,819 |   |   | 9.7 | % |   |
| **Income  from continuing operations before tax** |       | 13,997                                     |       |   | 3.6 | % |   | 33,218 |   |   | 8.8 | % |   |
| **Income from continuing  operations**            |       | 10,536                                     |       |   | 2.7 | % |   | 19,924 |   |   | 5.3 | % |   |
|                                                   |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Revenue*

Our revenue possesses both project and recurringcharacteristics. Project revenue includes one-time projects in which thecustomer relationship is not expected to continue after project completion.Project revenue margins are usually higher than our average margins and theworkload can be highly volatile. Project revenue is typically based on time andmaterial arrangements and predominately occurs within our Healthcare,Regulatory, and Legal Compliance segment. Recurring revenue is characterized bycustomer relationships that are generally for one year and may continue forlonger. Recurring revenue is typically based on transaction volumes sent to usby our customers at an agreed upon fixed rate per unit. Our customers’ volumesare generally not contractually or otherwise guaranteed. Recurring revenuetypically possesses lower margins than project revenue but is usually morepredictable. Project revenue accounted for $133.8 million or 34.7% of revenuein the current year compared to $138.7 million or 36.7% of revenue in the prioryear.

Our operations generated revenues of $385.3 millionfor the year ended December 31, 2004, an increase of $7.1 million or 1.9%compared to the prior year. During the second quarter of 2004, we acquiredKeyPoint Consulting, LLC (“KeyPoint”) as a part of our Healthcare, Regulatory,and Legal Compliance segment. KeyPoint contributed approximately $5.6 millionto the revenue increase.

Revenue within our Information Management andDistribution segment increased 3.9% from $187.2 million in the prior year to$194.5 million in the current year. Project revenue accounted for 10.5% ofsegment revenue in the current year compared to 12.3% last year. The increasein segment revenue was primarily the result of higher volumes from existingcustomers and volumes from new customer contracts in our Information Managementservice offering. Also contributing to the increase in segment revenue werehigher volumes in our statement processing service offering which increased7.4%, or $2.4 million, during the current year.

Revenue within ourHealthcare, Regulatory and Legal Compliance segment declined 0.1% from $190.9million in 2003 to $190.8 million in 2004. The acquisition of KeyPointcontributed approximately $5.6 million of revenue in the current year. Thedecline was primarily the result of lower volumes in our legal consultingservice offering and in our medical coding and records release of informationservice offerings. Volumes in our legal consulting service offering were lowerdue to three significant projects in production during the 2003. Increasedmarket competition was a primary driver for the decline in medical coding andrelease of information. Partially offsetting the declines discussed above washigher project volumes in our class action claims administration serviceoffering, which increased approximately 7%, or $2.3 million.

**Gross profit**

Gross profit decreased 2.0% from $143.4 million, or37.9% of revenue, in 2003 to $140.6 million, or 36.5% of revenue, in thecurrent year. Factors impacting gross profit and gross margin are discussedbelow.

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Contributing to the decline in gross profit werehigher facilities related expenses of approximately $4.3 million related to theopening of new production facilities, mainly to support growth initiativeswithin our Information Management and Distribution segment, and higher bad debtexpense of approximately $2.1 million as the prior year reflected unusuallylarge collections of accounts receivable balances outstanding greater thanninety days.

As discussed above in “Internal Investigation”,certain revenue generated at an operating subsidiary in our InformationManagement and Distribution segment has been reversed, resulting in a downwardadjustment to certain asset accounts or the recognition of a customer liabilityor deferred revenue, if the customer has paid the invoices related to thereversed revenue Notwithstanding the reversal of revenue, the costs associatedwith the adjusted revenue continues to be reported in the period incurred. As aresult of the reversed revenue, gross margin was negatively impacted 1.0% in2003 and 0.7% in 2004.

Partially offsetting thedeclines in gross margin discussed above were lower personnel related costs, asa percentage of revenue. Personnel related costs decreased from 45.1% in theprior year to 44.1% in the current year due primarily to our productivity andtechnology initiatives, such as high speed scanners, offshore production andpay-for-performance compensation plans, and expense of $1.1 million incurred inthe prior year related to an unusually large medical claim.

**Selling, generaland administrative expenses**

SG&A increased 12.0%from $99.0 million, or 26.2% of revenue, in 2003 to $110.8 million, or 28.8% ofrevenue in the current year. The increase in SG&A expense is largelyattributable to: (i) the costs associated with the settlement of asignificant legal matter in the Information Management and Distribution segmentduring the first quarter of 2004 of approximately $2.1 million, (ii) legaland accounting costs of $2.0 million associated with the investigation of thefinancial results of one of our operating subsidiaries, (iii) an increasein deferred compensation expense related to restricted stock of approximately$1.8 million and other personnel related expense of approximately $3.7 million,(iv) higher travel and marketing costs of approximately $0.9 million, (v) higherhardware and software maintenance costs of approximately $0.6 million, and (vi) higherprofessional fees associated with Sarbanes Oxley compliance activity ofapproximately $1.2 million.

**Income fromcontinuing operations before income taxes**

Income from continuing operations before income taxesdecreased from $33.2 million in 2003 to $14.0 million in the current year. Thedecrease was largely the result of the factors impacting gross margin andSG&A discussed above. In addition, as discussed above, revenue recognitionand expense omission issues at an operating subsidiary affected previously paidcontingent consideration payments related to the acquisition of the operatingsubsidiary. As a result, payments made under the provisions of the Earn-outAgreements that otherwise would not have been made have been expensed in theperiods paid resulting in expense of $7.2 million and $10.2 million in 2003 and2004, respectively. Finally, the current year includes a net loss of $0.9million on the disposition of property, plant and equipment compared to a gainof $0.1 million in the prior year.

Interest expense was lowerby approximately $0.2 million in the current year due the expiration of theinterest rate swap on March 31, 2003 and a more favorable interest rateenvironment during the current year. Interest income in the prior year includeda one-time payment of $0.2 million related to a $2.3 million income taxreceivable that was also collected during 2003.

**Provision (benefit)for/(from) income taxes**

We reported provision forincome taxes in the amount of $3.5 million during 2004. This amount included abenefit of $1.8 million related to favorable resolution of certain open taxissues as well as the 

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expirationof statutes of limitations on certain strategic tax positions and an additionalbenefit of approximately $0.3 million related to increased state tax credits. Collectively,the benefit from income taxes had the affect of lowering our effective tax rateto 24.7% during 2004 from 40% during 2003.

***Year Ended December 31,2003 Compared to Year Ended December 31, 2002***
| ** **                                        | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                        | ** ** | **2003**                                   | ** ** | **2002** | ** ** |
| ** **                                        | ** ** | **($000’s)**                          | ** ** | **% of  Revenue** | ** ** | **($000’s)** | ** ** | **% of  Revenue** | ** ** |
| **Revenue**                                       |       | $                                          | 378,159    |   |   | 100.0 | % |   | $ | 378,544 |   |   | 100.0 | % |   |
| **Gross  Profit**                                 |       | 143,405                                    |       |   | 37.9 | % |   | 141,534 |   |   | 37.4 | % |   |
| **SG&A**                                      |       | 99,008                                     |       |   | 26.2 | % |   | 94,245 |   |   | 24.9 | % |   |
| **Operating  income**                             |       | 36,819                                     |       |   | 9.7 | % |   | 38,328 |   |   | 10.1 | % |   |
| **Income  from continuing operations before tax** |       | 33,218                                     |       |   | 8.8 | % |   | 31,828 |   |   | 8.4 | % |   |
| **Income from continuing  operations**            |       | 19,924                                     |       |   | 5.3 | % |   | 19,908 |   |   | 5.3 | % |   |
|                                                   |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Revenue*

Total revenue decreased 0.1% from $378.5 millionfor the year ended December 31, 2002 to $378.2 million for the yearended December 31, 2003. Slightly lower project revenue was the primaryreason for the revenue decline.

Revenue within our Information Management andDistribution segment declined $0.1 million to $187.2 million. Strong revenuegrowth from our mortgage industry customers for data capture and repositoryservices produced volume gains of $17.0 million as we added several newmortgage applications for current and new customers. We also experienced strongrevenue growth of $1.9 million, or 6.1%, from our statement processing serviceoffering. Partially offsetting these revenue gains were the following: (i) theloss of our service contract with the City of New York’s Human ResourceAdministration; (ii) non repeating 2002 project work representing a declineof $3.8 million; (iii) lower volumes from transportation customersrepresenting a decline of $2.5 million; and (iv) lower revenue fromcredit card customers representing a decline of $2.0 million. During thethird quarter of 2002, the City of New York’s Human Resource Administrationinformed us that we did not receive their renewal contract award. The contractwas transitioned to the new vendor during the second quarter of 2003 resultingin $7.6 million of lower revenue for 2003 within our InformationManagement service offering.  However,the loss of this contract did not result in a goodwill impairment as the fairvalue of the reporting unit continued to exceed its carrying value. Projectrevenue accounted for 15.5% of the Information Management and Distributionsegment’s revenue in 2002 compared to 12.3% in 2003. 

Revenue within ourHealthcare, Regulatory, and Legal Compliance segment decreased 0.2% from$191.2 million for the year ended December 31, 2002 to$190.9 million for the year ended December 31, 2003. Project revenuewithin our class action claims administration and professional economicresearch and litigation support service offerings collectively increased$8.1 million or 12.9% derived from several large matters related to large,multi-national clients. Offsetting the strong revenue achievement fromthese service offerings was lower revenue performance from our medical codingand records release of medical information service offerings that declined$7.9 million, or 6.6%, during 2003. Increased competition at the localmarket level was the primary factor driving the decline from prior year.However, we expect to continue to leverage our market position through acentralized, low cost model more fully integrated with electronic document anddata management solutions. Project revenue accounted for 58.0% of theHealthcare, Regulatory, and Legal Compliance segment’s revenue in 2002 comparedto 60.6% in 2003.

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*Gross profit*

Gross profit increased 1.3% from $141.5 millionor 37.4% of revenue for the year ended December 31, 2002 to$143.4 million or 37.9% of revenue for the year ended December 31,2003. We began productivity initiatives during 2003 aimed at lowering the laborcomponent of our production cost structures. Examples of these initiativesinclude: deployment of our high speed scanning solution, development of commonproduction control systems including optical character recognition technology,pay-for-performance pay strategies, and strategic offshore vendorrelationships. Collectively, these initiatives resulted in lower productionpersonnel costs of $6.0 million when compared with 2002 personnel costs.We also lowered the amount of bad debt expense incurred during 2003. Ourheightened focus for improved accounts receivable collections has benefitedoperating cash flow and had the effect of lowering bad debt expense$4.3 million during 2003. Significant factors offsetting the areas ofgross profit improvement were higher employee medical insurance costs in theamount of $3.0 million and higher worker’s compensation and businessinsurance in the amount of $1.0 million.

As discussed above in “InternalInvestigation”, certain revenue generated at an operating subsidiary in ourInformation Management and Distribution segment has been reversed, resulting ina downward adjustment to certain asset accounts or the recognition of acustomer liability or deferred revenue, if the customer has paid the invoicesrelated to the reversed revenue. Notwithstanding the reversal of revenue, thecosts associated with the adjusted revenue continues to be reported in theperiod incurred. As a result of the reversed revenue, gross margin wasnegatively impacted 0.4% in 2002 and 1.0% in 2003.

*Selling, generaland administrative*

SG&A increased 5.1%from $94.2 million, or 24.9% of revenue, for the year ended December 31,2002 to $99.0 million, or 26.2% of revenue, for the year ended December 31,2003. Our SG&A increased primarily from higher personnel costs related toour company-wide internal revenue growth initiatives and the technology basedproductivity initiatives that improved gross profit within our InformationManagement and Distribution operating segment. When compared to 2002, personnelcosts increased $4.7 million driving the increase in SG&A as apercentage of revenue.

*Income fromcontinuing operations before income taxes*

Income from continuing operations before income taxesincreased from $31.8 million for the year ended December 31, 2002 to $33.2million for the year ended December 31, 2003. Contributors to the yearover year increase were: (i) factors impacting gross profit and SG&Adiscussed above; (ii) excess contingent consideration discussed below; and(iii) lower interest and other expense.

As discussed above, revenue recognition and expenseomission issues at an operating subsidiary affected previously paid contingentconsideration payments related to the acquisition of the operating subsidiary. Asa result, payments made under the provisions of the Earn-out Agreements thatotherwise would not have been made have been expensed in the periods paidresulting in expense of $8.6 million and $7.2 million in 2002 and 2003,respectively.

Interest and other expensedecreased 44.6% from $6.5 million for the year ended December 31,2002 to $3.6 million for the year ended December 31, 2003. Thisdecrease was due to lower balances on long-term obligations, a lowerinterest rate environment, and the expiration of our interest rate hedge. Theaverage interest rate on borrowings decreased from 4.5% in 2002 to 4.2% in2003. Our 2003 interest rate on borrowings were predominantly variable innature with the exception of the interest rate hedge which expired during March 2003.(See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk”).Therefore, interest rate risk exists for our long-term obligations at December 31,2003. Increases in short-term rates would have the effect of increasinginterest expense and lowering operating results in future periods.

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**Fluctuations in Quarterly Results of Operations**

Revenue from our servicesshows no overall significant seasonal variations; however, some seasonalityexists at the operating unit level. Further, service revenue can vary fromperiod to period due to the impact of specific projects and the level oftransaction volumes sent to us by our customers. Quarterly results may alsovary as a result of the timing of acquisitions and the timing and magnitude ofcosts related to such acquisitions.

**Liquidity and Capital Resources**

At December 31, 2004,we had $34.0 million of working capital, including $3.7 million of cash.Working capital at December 31, 2003 was $36.6 million, including $2.1million of cash. Net cash provided by operating activities from continuingoperations for the year ended December 31, 2004 was $29.8 million comparedto $52.2 million for the same period in 2003. Factors contributing to thedecline in operating cash flow from continuing operations consist of: (i) lowerearnings in the current year, (ii) slower cash collections during thecurrent year resulting in $7.8 million of lower cash provided by operatingactivities, (iii) the payment of significant legal settlements during thecurrent year totaling $7.5 million, (iv) higher annual incentivecompensation payments compared to the prior year, (v) the receipt ofincome tax refunds of $2.3 million in the prior year, and (vi) highercontingent consideration overpayments in the amount of $3.0 million related tothe Operating Subsidiary under investigation, as more fully described above in“Internal Investigation” and in Note 3 to the consolidated financialstatements.

Days sales outstandingincreased four business days to 45 business days at December 31, 2004compared to 41 business days at December 31, 2003.

For the year ended December 31,2004, investing activities from continuing operations consisted of acquisitionsof property, plant and equipment of $17.1 million and net acquisition relatedpayments of $17.5 million of which $13.7 million relates to the acquisition ofKeyPoint Consulting LLC and $3.8 million represents the settlement ofcontingent consideration and other acquisition related payments. Partiallyoffsetting the capital expenditures and cash paid for acquisitions wasdivestiture proceeds of $6.8 million, related to the divestiture of our DirectMail operations and two medical records management operations. Some futurequarters will include additional settlements of contingent consideration onpast acquisitions. Not all of the periods applicable for contingentconsideration targets have been completed and additional amounts may be payablein future periods under the terms of the agreements based upon the achievementof specified revenue and/or earnings targets. If all contingent considerationtargets under the current agreements were achieved, the maximum amount ofconsideration to be paid would be $5.3 million, and would be paid in 2005.In accordance with the agreements, the Company has the option to satisfy theentire $5.3 million potential liability in common stock with finalvaluation determined at date of issuance.

Net cash provided byfinancing activities from continuing operations was $2.2 million for the yearended December 31, 2004. Borrowings from our line of credit of $301.0million were partially offset by payments on our line of credit of $287.0million. Additionally, net proceeds from common stock issuances of $0.5 millionwere more than offset by payments of $11.9 million related to sharesrepurchased. We utilize our line of credit to fund general operatingrequirements of the Company as well as fund significant investments such asacquisitions or capital expenditures.

At December 31, 2003,we had $36.6 million of working capital, including $2.1 million ofcash. Cash flows provided by operating activities for the year ended December 31,2003 were $52.2 million compared to $55.8 million for the year ended December 31,2002. Days sales outstanding improved 2 days to 41 business days at December 31,2003 compared to 43 business days at December 31, 2002

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For the year ended December 31, 2003, investingactivities consisted primarily of additions to property, plant and equipment of$16.4 million and acquisition-related payments of $3.0 million.During 2003, we made investments in 30 high-speed scanning systems in order toincrease productivity in our Information Management service offering andexpanded our production facilities through the addition of 3 major facilitiesin Burbank, CA; Denver, CO; and Irving, TX. Acquisition-related paymentsconsisted primarily of settlements of contingent consideration obligations onpast acquisitions.

Net cash used for financing activities was$36.9 million for the year ended December 31, 2003. We made paymentsfor common stock repurchases of $20.7 million. In April 2001, ourBoard of Directors authorized the repurchase of up to $30 million of ouroutstanding common stock. Under this program, share repurchases may be madefrom time to time on the open market as market conditions warrant. Repurchasedshares will be retired and restored to the status of authorized but unissuedshares of the Company. During 2003, we activated the share repurchase programand repurchased 1,306,979 shares at an average cost of $15.84 per share(including 75,000 shares repurchased during the three months ended December 31,2003 at an average price of $23.89 per share). Additionally, we made paymentsof $246.0 million on our line of credit, net of proceeds borrowed from ourline of credit of $229.7 million.

At December 31, 2002, we had $39.0 millionof working capital, including $3.2 million of cash. Cash flows provided byoperating activities for the year ended December 31, 2002 were $55.8 million.Days sales outstanding at December 31, 2002 were 43 business days. Duringthe year ended December 31, 2002, $13.7 million of uncollectibletrade receivables were written-off against the allowance for doubtful accounts.While these write-offs had no impact on cash flows or operating results during2002, these write-offs lowered our cash taxes paid during 2002 due to therelated tax deduction.

For the year ended December 31, 2002, investingactivities consisted primarily of additions to property, plant and equipment of$10.5 million and acquisition related payments of $24.4 million.Acquisition-related payments consist of the purchase of UIS in the firstquarter of 2002 and certain other cash payments related to contingentconsideration agreements of past acquisitions.

Net cash used for financing activities was$27.0 million for the year ended December 31, 2002, primarily relatedto payments of $307.0 million on our line of credit, net of proceedsborrowed from our line of credit of $280.2 million.

In April 2001, we entered into a line of creditagreement with Bank of America, SunTrust Bank, and Wells Fargo Bank, asco-agents (the “2001 Credit Agreement”). Under this agreement, we could fromtime to time borrow up to $297.5 million through April 2, 2004,subject to certain financial covenants and ratios. Meeting these requirementsis highly dependent upon maintaining a minimum level of operating results andthe continued demand for our services, among other factors.

Effective April 3, 2002, we extended$220.0 million of the $297.5 million commitment for an additionalyear to April 2, 2005. In September 2002, additional extensions weregranted by member banks, bringing the total commitment extended to April 2,2005 to $290.0 million. Total fees paid in 2002 related to the extensionsand amendments to the 2001 Credit Agreement were $0.3 million.

Effective April 3, 2003, we extended$230.0 million of the $297.5 million commitment to April 1,2006. During the fourth quarter of 2003, a participating bank in the 2001Credit Agreement assigned $7.5 million of its commitment to another bankwho, effective December 4, 2003, extended this commitment to April 1,2006. Total fees paid in 2003 related to the extensions and amendments to the2001 Credit Agreement were $0.3 million.

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At December 31,2004, the remaining commitment under the 2001 Credit Agreement is $290.0million and is scheduled to mature as follows (in millions):
| **Maturity Date** | ** ** | ** ** | ** ** | **Commitment** | ** ** | **Remaining  Commitment** | ** ** |
|------------------------|------------|------------|------------|----------------|------------|---------------------------|------------|
| April 2, 2005     |       |       | $          | 52.5           |       |                      |       | $ | 237.5 |   |   |
| April 1, 2006     |       |       | 237.5      |           |       |                      |       |   |   |
| Total                  |       |       | $          | 290.0          |       |                      |       |   |   |   |

 

As of December 31, 2004 and through March 31, 2005, weare in compliance with loan covenants after giving effect to the amendments andwaivers discussed below, which among other things provided for an amendeddefinition of EBITDA. As of December 31, 2004, the availability under the 2001 CreditAgreement was approximately $8.7 million.

Our ability to borrow iscontingent on certain leverage and fixed cost coverage ratios. These ratioswere scheduled to become more restrictive beginning in the quarter ended December 31,2002 with the leverage ratio declining from 3.0 times to 2.5 times and thefixed charge coverage ratio increasing from 1.25 times to 1.50 times. However,in September 2002, an amendment was approved that extended the fixed costcoverage ratio requirement of 1.25 until January 1, 2004 and will increaseto 1.35 at all times thereafter. In addition to the leverage and fixed costcoverage ratios, we are subject to minimum net worth requirements. Effective March 26,2003, an amendment was approved that allows for the reduction to the minimumnet worth requirement for up to $30 million of share repurchases. Inaddition, effective July 30, 2004, an amendment was approved that allowsfor the reduction to the minimum net worth requirement for an additional $30million of share repurchases.

As a result of ourinternal investigation, more fully described above in “Internal Investigation”and in Note 3 to the consolidated financial statements, we were unable to fileour September 30, 2004 Quarterly Report on Form 10-Q within thetimeframe prescribed by the Securities Exchange Act of 1934. The failure totimely file the September 30, 2004 Quarterly Report on Form 10-Q resultedin a default under the 2001 Credit Agreement. We entered into a waiveragreement on November 12, 2004 with the lenders party to the 2001 CreditAgreement. Pursuant to the terms of the waiver agreement, the lenders agreed,among other things, to waive any default under the 2001 Credit Agreement thatresulted from potential non-compliance with a designated fixed chargecoverage ratio, and our failure to timely file our Quarterly Report on Form 10-Qfor the September 30, 2004 quarter. The waiver agreement also providesthat during the period that the waiver agreement is in effect, the outstandingprincipal amount of the loans under the 2001 Credit Agreement may not exceed$112,000,000. The waiver agreement was to expire on March 15, 2005; however,on March 15, 2005, we entered into on Extension and Modification of Waiverto Credit Agreement, which extended such waiver through March 23, 2005. Theforegoing summary of the Extension and Modification and Waiver to CreditAgreement is qualified by and should be read in connection with the actual textof the Extension and Modification of Waiver to Credit Agreement, which isreferenced as Exhibit 10.123 to this Annual Report.

Effective March 23, 2005, we entered into anamendment to the 2001 Credit Agreement that allows for the exclusion of certaincontingent consideration overpayments to the former owners of the OperatingSubsidiary, as described more fully above in “Internal Investigation” and inNote 3 to the consolidated financial statements, from the definition ofEarnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”). Pursuantto the terms of the Company’s 2001 Credit Agreement, EBITDA is used incalculating certain leverage and fixed cost coverage ratios. By not having the March 23,2005 amendment in place, the Company was in a default under the 2001 CreditAgreement due to the Company exceeding the allowable leverage ratio of 2.5times for the quarters ended June 30, 2004 and September 30, 2004 asa result of the contingent consideration overpayments, previously discussed. Asa result, the Company classified the debt under such Credit Agreement as aCurrent Maturity included in the current 

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liability section of itsbalance sheet at June 30 and September 30, 2004. Upon entering the March 23,2005 amendment, the Company cured the default under the 2001 Credit Agreement,as such, reclassifying debt under the Credit Agreement as Long-Term Obligations.In any event, as the maturity date of the debt under the 2001 Credit Agreementis April 1, 2006, unless the maturity date of such debt is subsequentlymodified, such debt will be classified as a Current Maturity on and after April 1,2005.

Management believes thatit has sufficient liquidity from its cash flow and its revolving creditfacility to meet ongoing business needs. Additionally, depending on the mix ofstock and cash used in our strategic acquisition program, if any, we may needto seek further financing through the public or private sale of equity or debtsecurities. However, there can be no assurance we could secure such financingif and when it is needed or with terms we deem acceptable.

Management fully expectsto replace or refinance the 2001 Credit Agreement upon its maturity scheduledfor April 1, 2006.

In January 2000, weregistered on Form S-4 (Registration No. 333-92981) 3,012,217 sharesof common stock for issuance in connection with our acquisition program (the “AcquisitionShelf”), of which 1,359,852 shares were available as of December 31, 2004;however, such registration statement may require amendment prior to use.

Thefollowing table summarizes our total contractual cash obligations as of December 31,2004 (in thousands):
| ** **                         | ** ** | **Payments Due by Period** | ** ** |
|------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligation**    | ** ** | ** **                                | ** ** | **Total** | ** ** | **Less than 1  Year** | ** ** | **1 to 3  Years** | ** ** | **4 to 5  Years** | ** ** | **After 5  Years** | ** ** |
| Long-Term Debt                     |       | $                                         | 87,511     |   |   | $ | 126 |   |   | $ | 86,036 |   | $ | 299 |   | $ | 1,050 |   |
| Capital Lease  Obligations         |       | 294                                       |       |   | 132 |   |   | 140 |   | 22 |   | — |   |
| Operating Leases                   |       | 63,986                                    |       |   | 17,314 |   |   | 26,038 |   | 12,076 |   | 8,558 |   |
| Total Contractual Cash Obligations |       | $151,791                                  |       |   | $17,572 |   |   | $112,214 |   | $12,397 |   | $ | 9,608 |   |
|                                    |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We have total commercialcommitments of $12.3 million for standby letters of credit as of December 31,2004. We have letters of credit in the amount of $8.0 million to serve assecurity for our self-insured workmen’s compensation program. We have a$2.5 million letter of credit to serve as a guarantee for performanceunder a contract with the New York State Workers Compensation Board. We have aletter of credit for $1.8 million to serve as a guarantee for periodicprincipal and interest payments related to debt.

We expect to pay approximately $3.5 million to$4.5 million in interest in 2005.

**Critical AccountingPolicies**

Management’s Discussionand Analysis of Financial Condition and Results of Opperations are based on therelated consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America. The preparation of the financial statements requires the use ofestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses.

We have identified thefollowing critical accounting policies that, as a result of the judgments,uncertainties, uniqueness and complexities of the underlying accountingstandards and operations involved, could result in material changes to ourfinancial condition or results of operations under different conditions orusing different assumptions. We apply a consistent methodology at the end ofeach quarter to determine our account balances that require judgmentalanalysis.

**RevenueRecognition.  **We recognize our revenue as it becomesrealized or realizable and earned according to the criteria provided by StaffAccounting Bulletin 104, *RevenueRecognition*. Revenue 

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recognition occursonce persuasive evidence of an arrangement exists, delivery has occurred orservices have been rendered, the sales price is fixed or otherwisedeterminable, and collection is reasonably assured. Our revenue-earningsactivities possess both project and recurring customer relationships.

Project revenue includesone-time projects in which the customer relationship is not expected tocontinue after project completion. Project revenue is typically based on timeand material arrangements. Revenue recognition occurs at the contractual ratesas the labor hours and direct expenses are incurred. Project revenue representsapproximately 35% of total 2004 revenues and typically occurs within ourHealthcare, Regulatory, and Legal Compliance segment.

Recurring revenue ischaracterized by customer relationships that are generally for one year and maycontinue for longer. Recurring revenue is typically based on the transactionvolumes provided by our customer at an agreed upon fixed rate per unit. Ourcustomer’s volumes are typically not contractual or otherwise guaranteed.Revenue recognition occurs once work is completed and delivery has occurred orservices have been rendered. Recurring revenue represents the remaining 65% oftotal 2004 revenues and typically occurs within our Information Management andDistribution segment.

Revenue recognitionpolicies related to offerings within the our Information Management andDistribution segment are based upon objective criteria that do not requiresignificant estimates or uncertainties. For example, business processoutsourcing services are recognized proportionally as services are rendered,based on specific, objective criteria under the contracts for the number ofaccounts or transactions processed. Accordingly, revenues recognized underthese methods do not require the use of significant estimates that aresusceptible to change.

Revenue recognitionpolicies within our Healthcare, Regulatory, and Legal Compliance segment arebased upon objective criteria that do not require significant estimates oruncertainties. For example, transaction volumes and time and costs under timeand material and cost reimbursable arrangements are based on specific,objective criteria under the contracts. The following outlines specific revenuerecognition policies related to certain offerings within this segment:

*Medical records releaseservices*—revenue is recognized upon completion of theprocessing of the requested medical records. Revenue recognition for thisservice is based on an agreed upon and in some cases, a regulated rate appliedto the number of records processed. When a fee is paid to the hospital, therevenue related to that fee is reported on a net basis in accordance withEmerging Issues Task Force (“EITF”) 99-19, *Reporting Revenue Gross as a Principal versus Net as an Agent,*due to the fact that: (a) the primary obligation in the arrangement isborne partially by both SOURCECORP and the hospital; (b) SOURCECORP has nodiscretion with respect to the supplier of the medical record; and (c) SOURCECORPis not involved in the determination of product or service specifications.

*Record management services*—revenueis recognized as storage services are provided based on linear feet ofdocuments stored times a monthly rate for shelf storage and based on a monthlyper image rate for images stored electronically. We recognize fees forprocessing, retrieval, delivery and return to storage as revenue uponcompletion of the service at the agreed upon rate applied to the unit count ofitems serviced.

*Additional healthcare andcompliance services*—revenue is recognized for documentand data conversion services as the services are provided based upon an agreedupon rate per patient file applied to the number of files processed. Storageand archiving fees are recognized as revenue as the services are provided basedupon an agreed upon monthly rate per file stored or otherwise archived. Revenuerelated to coding and abstracting of medical records and staffing services isrecognized as the services are provided based on an agreed upon rate applied tothe billable hours worked and eligible out-of-pocket expenses defined by theservice agreement. The out-of-pocket expense component is recognized as revenueand cost of services on a gross basis in accordance with EITF Issue 01-14,*Income Statement Characterization ofReimbursements Received for “Out-of-Pocket” Expenses Incurred.*Revenuerelated to compliance reviews is based primarily on an agreed upon percentage(or commission) of amounts identified and recovered from 

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the third partypayers as a fee for services provided. Revenue is recognized upon successfulrecovery of underpayments to our clients by their managed care and commercialpayers at the agreed upon percentage (or commission).

*Class actionclaims administration services*—revenue is recognizedas these services are provided based on the agreed upon rate applied to thenumber of hours spent providing services related to administering the legalsettlements and expenses incurred. The out-of-pocket expense component isrecognized as revenue and cost of services on a gross basis in accordance withEITF Issue 01-14, *Income StatementCharacterization of Reimbursements Received for “Out-of-Pocket” ExpensesIncurred.*In addition, revenue related to the design andimplementation of comprehensive notification plans is based on an agreed uponpercentage (i.e. commission) of the cost to place the media communication. Revenueis recognized at the time of public delivery of the notification through thevarious media outlets at the agreed upon percentage (or commission).

*Professionaleconomic research and litigation services*—revenue isrecognized as these services are provided based on consulting hours worked atagreed upon rates at the time services are rendered and expenses are incurred. Theout-of-pocket expense component is recognized as revenue and cost of serviceson a gross basis in accordance with EITF Issue 01-14, *Income Statement Characterization of ReimbursementsReceived for “Out-of-Pocket” Expenses Incurred.*

As a part of providing services to our customers, weincur incidental expenses commonly referred to as “out-of-pocket” expenses.These expenses include items such as airfare, hotels, and mileage and are oftenreimbursable by our customers. When reimbursable, we record both revenue anddirect cost of services in accordance with the provisions of Emerging IssuesTask Force (“EITF”) Issue 01-14, *IncomeStatement Characterization of Reimbursements Received for “Out-of-Pocket”Expenses Incurred.*

Unearned income, included in other currentliabilities, represents payments from our customers in advance of servicesbeing provided. Advanced payments are deferred as unearned income when receivedand recognized as revenue as services are rendered.

**Allowance for Doubtful Accounts.  **Theallowance for doubtful accounts is established and maintained based on ourestimate of accounts receivable collectibility. Management estimatescollectibility by specifically analyzing accounts receivable aging and otherhistorical factors that affect collections. Such factors include the historicaltrends of write-offs and recovery of previously written-off accounts, thefinancial strength of the customer and projected economic and marketconditions. The evaluation of these factors involves subjective judgments andchanges in these factors may significantly impact our consolidated financialstatements.

**Long-Lived Assets and IntangiblesImpairment.  **As required by SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets,*management continually evaluates whether eventsand circumstances indicate that the carrying value of long-lived assets andintangible assets may not be recoverable. When events require, managementperforms the valuation by comparing the estimated undiscounted future cashflows over the remaining life of the long-lived assets and intangibles to thecarrying amount of the asset being evaluated. An impairment loss is recognizedif the carrying amount of assets being evaluated exceeds the expected futureundiscounted cash flow based on the difference between the carrying value andfair value. At December 31, 2004, no events were evident that requiredvaluation for potential impairment.

**GoodwillImpairment.  **On January 1, 2002, we adopted SFAS No. 142,*Goodwill and Other Intangible Assets.*This statement states that goodwill and intangible assets that have indefiniteuseful lives will not be amortized but rather will be tested at least annuallyfor impairment. The impairment test is based on fair value rather thanundiscounted cash flows. Additionally, goodwill and other intangible assets aretested at a reporting unit level rather than the individual operating unitlevel. A reporting unit is either at the 

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operating segmentlevel or one reporting level below and could consists of several serviceofferings aggregated into a single reporting unit. Service offerings areaggregated when they are similar in the following areas: economiccharacteristics, products and services, production processes, methods fordistributing or delivering products, and type or class of customers. Valuationmethods used in determining fair value include an analysis of the cash flowsthat the reporting units can be expected to generate in the future (IncomeApproach) and the fair value of a reporting unit as compared to similar publiclytraded companies (Market Approach). In preparing these valuations managementutilizes estimates to determine fair value of the reporting units. Theseestimates include future cash flows, growth rates, capital needs, and projectedearning margins among other factors. Estimates utilized in future calculationscould differ from estimates used in the current period. Future years’ estimatesthat are unfavorable compared to current estimates could cause an impairment ofgoodwill and other intangible assets. Due to the fact that we are primarily aservices company, our business acquisitions typically result in significantamounts of goodwill and other intangible assets. Therefore, an impairmentcharge resulting from goodwill or other intangible assets could result in amaterial adverse impact on our financial statements during the period incurred.

**Self-InsuranceLiabilities and Reserves.  **We are self-insured forworkmen’s compensation liabilities and a significant portion of our employeemedical costs. We account for our self-insurance programs based on actuarialestimates of the amount of loss inherent in that period’s claims, including lossesfor which claims have not been reported. These loss estimates rely on actuarialobservations of ultimate loss experience for similar historical events. Welimit our risk by carrying stop-loss policies for significant claims incurredfor both workmen’s compensation liabilities and medical costs.

**OtherLoss Contingencies.  **We record liabilities when it isprobable that a liability has been incurred and the amount of the loss isreasonably estimable in accordance with SFAS No. 5, *Accounting for Contingencies*. Disclosureis required when there is a reasonable possibility that the ultimate loss willexceed the recorded provision. Contingent liabilities are often resolved overlong periods of time. Estimating probable losses requires analysis of multipleforecasts that often depend on judgments about potential actions by third partiessuch as regulators. Our loss contingencies consist primarily of estimatesrelated to the probable outcome of current litigation. See Note 17,Commitments and Contingencies, of Notes to Consolidated Financial Statements.

**Recent Accounting Pronouncements**

In December 2004, theFinancial Accounting Standards board (“FASB”) issued SFAS No. 123(R), *Share-Based Payment*, which establishes accounting standardsfor all transactions in which an entity exchanges its equity instruments forgoods and services. SFAS No. 123(R) focuses primarily on accountingfor transactions with employees, and carries forward without change priorguidance for share-based payments for transactions with non employees.

SFAS No. 123(R) eliminatesthe intrinsic value measurement objective in APB Opinion 25 and generallyrequires an entity to measure the cost of employee services received inexchange for an award of equity instruments based on the fair value of theaward on the date of the grant. The standard requires grant date fair value tobe estimated using either an option-pricing model which is consistent with theterms of the award or a market observed price, if such a price exists. Suchcost must be recognized over the period during which an employee is required toprovide service in exchange for the award over the requisite service period(typically the vesting period). The standard also requires an entity toestimate the number of instruments that will ultimately be issued, rather thanaccounting for forfeitures as they occur.

The Company is required toapply SFAS No. 123(R) to all awards granted, modified or settled inthe first reporting period under U.S. GAAP after June 15, 2005. TheCompany is also required to use either the “modified prospective method’’ orthe “modified retrospective method.’’ Under the modified prospective method,the Company must recognize compensation cost for all awards granted afteradopting the standard and for the unvested portion of previously granted awardsthat are outstanding on that date.

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Under the modifiedretrospective method, the Company must restate its previously issued financialstatements to recognize the amounts previously calculated and reported on a proforma basis, as if the prior standard had been adopted.

Under both methods, the Company is permitted to useeither a straight line or an accelerated method to amortize the cost as anexpense for awards with graded vesting. The standard permits and encouragesearly adoption.

The Company has commenced an analysis of the impact ofSFAS 123(R), but has not yet decided: (1) whether to adopt early, (2) ifadopted early, then at what date to do so, (3) whether to use the modifiedprospective method or elect to use the modified retrospective method, and (4) whetherto elect to use straight line amortization or an accelerated method.Additionally, the Company cannot predict with reasonable certainty the numberof options that will be unvested and outstanding on the adoption date.

Accordingly, the Company cannot currently quantifywith precision the effect that this standard would have on its financialposition or results of operations in the future, except that the Company willprobably recognize a greater expense for any awards that are granted in thefuture than if granted under the current guidance.

In December 2004, theFASB issued SFAS No. 153, Exchanges of Nonmonetary Assets an amendment ofAPB No. 29. This Statement amends Opinion 29 to eliminate the exceptionfor nonmonetary exchanges of similar productive assets and replaces it with ageneral exception for exchanges of nonmonetary assets that do not havecommercial substance. The Statement specifies that a nonmonetary exchange hascommercial substance if the future cash flows of the entity are expected tochange significantly as a result of the exchange. This Statement is effectivefor nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,2005. Earlier application is permitted for nonmonetary asset exchangesoccurring in fiscal periods beginning after the date this Statement is issued. Retroactiveapplication is not permitted. Management is analyzing the requirements of thisnew Statement and believes that its adoption will not have any significantimpact on the Company’s financial position, results of operations or cash flows.

**ITEM 7A.**        *Quantitativeand Qualitative Disclosures About Market Risk*

We are subject to interest rate risk on our termloans, revolving credit facility and Industrial Revenue Bonds. Interest ratesare fixed on the capitalized lease obligations. A 100 basis point increase inshort-term interest rates would result in approximately $0.7 million ofadditional expense in 2005 based on our expected average balance outstandingunder the credit facility during 2005.

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**ITEM 8.**                *Financial Statements and Supplementary Data*

**INDEX TO FINANCIAL STATEMENTS**
|                                                                                                                    | ** ** | **Page** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| SOURCECORP, INCORPORATED AND SUBSIDIARIES                                                                          |       |     |
| Report of Independent Registered Public Accounting Firm                                                            | 44         |     |
| Consolidated  Balance Sheets—At December 31, 2003 (restated) and 2004                                    | 45         |     |
| Consolidated Statements of Operations—Years ended December 31,  2002 and 2003 (restated) and 2004        | 46         |     |
| Consolidated  Statements of Stockholders’ Equity—At December 31, 2002 and 2003  (restated) and 2004 | 47         |     |
| Consolidated  Statements of Cash Flows—Years ended December 31, 2002 and 2003  (restated) and 2004       | 48         |     |
| Notes to  Consolidated Financial Statements                                                                        | 49         |     |
|                                                                                                                    |            |          |            |  |

 

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**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

To the Board of Directors and Stockholders ofSOURCECORP, IncorporatedDallas, Texas

We have audited the accompanying consolidated balancesheets of SOURCECORP, Incorporated and subsidiaries (the “Company”) as ofDecember 31, 2004 and 2003, and the related consolidated statements ofoperations, stockholders’ equity, and cash flows for each of the three years inthe period ended December 31, 2004.  These financial statements are theresponsibility of the Company’s management.  Our responsibility is toexpress an opinion on these financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of SOURCECORP,Incorporated and subsidiaries as of December 31, 2004 and 2003, and the resultsof their operations and their cash flows for each of the three years in theperiod ended December 31, 2004, in conformity with accounting principlesgenerally accepted in the United States of America.

As discussed in Note 3,the accompanying 2002 and 2003 financial statements have been restated.

DELOITTE & TOUCHE LLP

Dallas, TexasMarch 31, 2005

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**SOURCECORP,INCORPORATED AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(IN THOUSANDS, EXCEPT SHARE DATA)**
| ** **                                                                                                                                                                                                                 | ** ** | **December 31,**                            | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                                                                                                                                 | ** ** | **2003**                                         | ** ** | **      2004      ** | ** ** |
| ** **                                                                                                                                                                                                                 | ** ** | **   Restated   ** | ** ** | ** ** | ** ** |
| **ASSETS**                                                                                                                                                                                                                 |       |                                             |       |   |   |   |   |   |   |
| **CURRENT ASSETS:**                                                                                                                                                                                                        |       |                                             |       |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                 |       |                                             | $          | 2,097 |   |   |   | $ | 3,722 |   |   |
| Accounts and notes  receivable, less allowance for doubtful accounts of $6,843 and $9,437,  respectively                                                                                                                   |       |                                             | 63,522     |   |   |   | 66,046 |   |   |
| Inventories                                                                                                                                                                                                                |       |                                             | 933        |   |   |   | 875 |   |   |
| Deferred income  taxes                                                                                                                                                                                                     |       |                                             | 6,072      |   |   |   | 5,272 |   |   |
| Income tax  receivable                                                                                                                                                                                                     |       |                                             | 3,006      |   |   |   | 5,077 |   |   |
| Prepaid expenses  and other current assets                                                                                                                                                                                 |       |                                             | 4,318      |   |   |   | 6,159 |   |   |
| Assets of  discontinued operations                                                                                                                                                                                         |       |                                             | 14,658     |   |   |   | — |   |   |
| Total current  assets                                                                                                                                                                                                      |       |                                             | 94,606     |   |   |   | 87,151 |   |   |
| **PROPERTY,  PLANT AND EQUIPMENT,** net of accumulated depreciation of $53,393 and  $45,734, respectively                                                                                                             |       |                                             | 35,902     |   |   |   | 39,697 |   |   |
| **GOODWILL**                                                                                                                                                                                                               |       |                                             | 307,913    |   |   |   | 326,139 |   |   |
| **INTANGIBLES,** net of amortization of $709 and $1,700,  respectively                                                                                                                                                |       |                                             | 3,731      |   |   |   | 4,904 |   |   |
| **OTHER  NONCURRENT ASSETS**                                                                                                                                                                                               |       |                                             | 10,384     |   |   |   | 11,524 |   |   |
| Total assets                                                                                                                                                                                                               |       |                                             | $          | 452,536 |   |   |   | $ | 469,415 |   |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                             |       |                                             |       |   |   |   |   |   |   |
| **CURRENT LIABILITIES:**                                                                                                                                                                                                   |       |                                             |       |   |   |   |   |   |   |
| Accounts payable  and accrued liabilities                                                                                                                                                                                  |       |                                             | $          | 10,645 |   |   |   | $ | 14,972 |   |   |
| Accrued  compensation and benefits                                                                                                                                                                                         |       |                                             | 25,624     |   |   |   | 22,977 |   |   |
| Customer deposits                                                                                                                                                                                                          |       |                                             | 5,048      |   |   |   | 6,675 |   |   |
| Other current  liabilities                                                                                                                                                                                                 |       |                                             | 11,057     |   |   |   | 8,251 |   |   |
| Current maturities  of long-term obligations                                                                                                                                                                               |       |                                             | 209        |   |   |   | 258 |   |   |
| Liabilities of  discontinued operations                                                                                                                                                                                    |       |                                             | 5,423      |   |   |   | — |   |   |
| Total current  liabilities                                                                                                                                                                                                 |       |                                             | 58,006     |   |   |   | 53,133 |   |   |
| **LONG-TERM  OBLIGATIONS,** net of current maturities                                                                                                                                                                 |       |                                             | 73,390     |   |   |   | 87,547 |   |   |
| **DEFERRED  INCOME TAXES**                                                                                                                                                                                                 |       |                                             | 11,753     |   |   |   | 13,210 |   |   |
| **LONG-TERM  CUSTOMER LIABILITY**                                                                                                                                                                                          |       |                                             | 1,862      |   |   |   | 4,147 |   |   |
| **DEFERRED  REVENUE**                                                                                                                                                                                                      |       |                                             | 5,135      |   |   |   | 8,010 |   |   |
| **OTHER  LONG-TERM OBLIGATIONS**                                                                                                                                                                                           |       |                                             | 9,306      |   |   |   | 10,947 |   |   |
| Total liabilities                                                                                                                                                                                                          |       |                                             | 159,452    |   |   |   | 176,994 |   |   |
| **COMMITMENTS AND CONTINGENCIES**                                                                                                                                                                                          | ** ** |                                             |       |   |   |   |   |   |   |
| **STOCKHOLDERS’ EQUITY:**                                                                                                                                                                                             |       |                                             |       |   |   |   |   |   |   |
| Preferred stock,  $.01 par value, 1,000,000 shares authorized, no shares issued or  outstanding                                                                                                                            |       |                                             | —     |   |   |   | — |   |   |
| Common stock, $.01  par value, 26,000,000 shares authorized, 16,150,184 and 15,703,586 shares issued  and 16,094,156 and 15,666,916 shares outstanding at December 31, 2003  and December 31, 2004, respectively |       |                                             | 162        |   |   |   | 157 |   |   |
| Additional paid-in-capital                                                                                                                                                                                                 |       |                                             | 194,999    |   |   |   | 193,925 |   |   |
| Retained earnings                                                                                                                                                                                                          |       |                                             | 101,232    |   |   |   | 103,136 |   |   |
|                                                                                                                                                                                                                       |       |                                             | 296,393    |   |   |   | 297,218 |   |   |
| Less—Treasury  stock, at cost, 56,028 and 36,670 shares at December 31, 2003 and  December 31, 2004, respectively                                                                                           |       |                                             | (982       | ) |   |   | (501 | ) |   |
| Less—Deferred  compensation                                                                                                                                                                                           |       |                                             | (2,327     | ) |   |   | (4,296 | ) |   |
| Total  stockholders’ equity                                                                                                                                                                                           |       |                                             | 293,084    |   |   |   | 292,421 |   |   |
| Total liabilities  and stockholders’ equity                                                                                                                                                                           |       |                                             | $          | 452,536 |   |   |   | $ | 469,415 |   |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**SOURCECORP, INCORPORATED AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFOPERATIONS(IN THOUSANDS, EXCEPT SHARE DATA)**
| ** **                                               | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                               | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                               | ** ** | **Restated**                               | ** ** | **Restated** | ** ** | ** ** | ** ** |
| REVENUE                                                  |       | $                                          | 378,544    |   | $ | 378,159 |   | $ | 385,303 |   |
| COST OF SERVICES  EXCLUSIVE OF DEPRECIATION              |       | 224,510                                    |       | 222,065 |   | 231,953 |   |
| DEPRECIATION                                             |       | 12,500                                     |       | 12,689 |   | 12,759 |   |
| Gross profit                                             |       | 141,534                                    |       | 143,405 |   | 140,591 |   |
| SELLING, GENERAL  AND ADMINISTRATIVE EXPENSES            |       | 94,245                                     |       | 99,008 |   | 110,840 |   |
| CONTINGENT  CONSIDERATION OVERPAYMENT                    |       | 8.605                                      |       | 7,223 |   | 10,165 |   |
| AMORTIZATION                                             |       | 356                                        |       | 355 |   | 991 |   |
| Operating income                                         |       | 38,328                                     |       | 36,819 |   | 18,595 |   |
| OTHER (INCOME) EXPENSE:                                  |       |                                       |       |   |   |   |   |
| Interest expense                                         |       | 6,088                                      |       | 3,489 |   | 3,241 |   |
| Interest income                                          |       | (193                                       | )          | (301 | ) | (61 | ) |
| Other expense, net                                       |       | 605                                        |       | 413 |   | 1,418 |   |
| Income from continuing operations before income  taxes   |       | 31,828                                     |       | 33,218 |   | 13,997 |   |
| PROVISION FOR  INCOME TAXES                              |       | 11,920                                     |       | 13,294 |   | 3,461 |   |
| INCOME FROM  CONTINUING OPERATIONS                       |       | 19,908                                     |       | 19,924 |   | 10,536 |   |
| INCOME (LOSS)  FROM DISCONTINUED OPERATIONS,  NET OF TAX |       | 731                                        |       | (843 | ) | (2,437 | ) |
| NET INCOME                                               |       | $                                          | 20,639     |   | $ | 19,081 |   | $ | 8,099 |   |
| NET INCOME (LOSS) PER  COMMON SHARE                      |       |                                       |       |   |   |   |   |
| BASIC                                                    |       |                                       |       |   |   |   |   |
| Continuing Operations                                    |       | $                                          | 1.15       |   | $ | 1.21 |   | $ | 0.66 |   |
| Discontinued Operations                                  |       | 0.04                                       |       | (0.05 | ) | (0.15 | ) |
| Total                                                    |       | $                                          | 1.19       |   | $ | 1.16 |   | $ | 0.51 |   |
| DILUTED                                                  |       |                                       |       |   |   |   |   |
| Continuing Operations                                    |       | $                                          | 1.13       |   | $ | 1.20 |   | $ | 0.65 |   |
| Discontinued Operations                                  |       | 0.04                                       |       | (0.05 | ) | (0.15 | ) |
| Total                                                    |       | $                                          | 1.17       |   | $ | 1.15 |   | $ | 0.50 |   |
| WEIGHTED AVERAGE COMMON  SHARES OUTSTANDING              |       |                                       |       |   |   |   |   |
| BASIC                                                    |       | 17,334                                     |       | 16,452 |   | 15,893 |   |
| DILUTED                                                  |       | 17,609                                     |       | 16,565 |   | 16,217 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**SOURCECORP,INCORPORATED AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(IN THOUSANDS)**
| ** **                                                               | ** ** | **Common Stock** | ** ** | **Additional  Paid-in-** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Retained**           | ** **     | **Treasury**                         | ** ** | **Deferred** | ** **                                  | **Total  Stockholders’** | ** ** | **Comprehensive** | ** **     |
|--------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------|------------|---------------------------------------|------------|------------------------|----------------|--------------------------------------|------------|--------------|---------------------------------------------|-------------------------------|------------|-------------------|----------------|
| ** **                                                               | ** ** | **Shares**            | ** ** | **Amount**               | ** ** | **Capital**                           | ** ** | **Income (Loss)** | ** **     | **  Earnings  ** | ** ** | **Stock**    | ** **                                  | **Compensation**              | ** ** | **Equity**        | ** **     | **Income** | ** ** |
| Balance, January  1, 2002 (as previously reported)                       |       | 17,342                |       |                     | $ 174 |                                  |       |                   | $ 204,086 |                                 |       |         | $ (1,242                               | )                             |       |              | $ 69,137  |   |   |   | $ (982 | ) |   |   | $      — |   |   |   | $ 271,173 |   |   |   |   |   |   |
| Prior period adjustment  (see Note 3)                                    |       | —                |       |                     | —     |                                  |       |                   | —         |                                 |       |         | —                                      |                          |       |              | (2,539         | ) |   |   | — |   |   |   | — |   |   |   | (2,539 | ) |   |   | — |   |   |
| Balance,  January 1, 2002 (as restated)                             |       | 17,342                |       |                     | 174        |                                  |       |                   | 204,086        |                                 |       |         | (1,242                                      | )                             |       |              | 66,598         |   |   |   | (982 | ) |   |   | — |   |   |   | 268,634 |   |   |   |   |   |   |
| Common stock  issued in connection with  acquisitions                    |       | 114                   |       |                     | 1          |                                  |       |                   | 3,334          |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | 3,335 |   |   |   | — |   |   |
| Common stock  earned and held in escrow related to business acquisitions |       | —                |       |                     | —     |                                  |       |                   | 377            |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | 377 |   |   |   | — |   |   |
| Exercise of awards  and related tax benefit                              |       | 5                     |       |                     | —     |                                  |       |                   | 117            |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | 117 |   |   |   | — |   |   |
| Common shares  retired                                                   |       | (40                   | )          |                     | —     |                                  |       |                   | (1,071         | )                                    |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | (1,071 | ) |   |   | — |   |   |
| Interest rate  swap, net of $542 tax                                     |       | —                |       |                     | —     |                                  |       |                   | —         |                                 |       |         | 913                                         |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | 913 |   |   |   | $   913 |   |   |
| Net income, as  restated                                                 |       | —                |       |                     | —     |                                  |       |                   | —         |                                 |       |         | —                                      |                          |       |              | 20,639         |   |   |   | — |   |   |   | — |   |   |   | 20,639 |   |   |   | 20,639 |   |   |
| Comprehensive  income                                                    |       | —                |       |                     | —     |                                  |       |                   | —         |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | $ 21,552 |   |   |
| Balance,  December 31, 2002 (as restated)                           |       | 17,421                |       |                     | 175        |                                  |       |                   | 206,843        |                                 |       |         | (329                                        | )                             |       |              | 87,237         |   |   |   | (982 | ) |   |   | — |   |   |   | 292,944 |   |   |   |   |   |   |
| Common stock  released from escrow in connection with acquisitions       |       | 20                    |       |                     | —     |                                  |       |                   | (94            | )                                    |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | (94 | ) |   |   | — |   |   |
| Common stock  earned and held in escrow related to business acquisitions |       | —                |       |                     | —     |                                  |       |                   | 532            |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | 532 |   |   |   | — |   |   |
| Exercise of awards  and related tax benefit                              |       | 16                    |       |                     | —     |                                  |       |                   | 368            |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | 368 |   |   |   | — |   |   |
| Common shares  retired                                                   |       | (1,307                | )          |                     | (13        | )                                     |       |                   | (15,600        | )                                    |       |         | —                                      |                          |       |              | (5,086         | ) |   |   | — |   |   |   | — |   |   |   | (20,699 | ) |   |   | — |   |   |
| Grants of  restricted stock                                              |       | —                |       |                     | —     |                                  |       |                   | 2,950          |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | (2,950 | ) |   |   | — |   |   |   | — |   |   |
| Amortization of  deferred compensation                                   |       | —                |       |                     | —     |                                  |       |                   | —         |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | 623 |   |   |   | 623 |   |   |   | — |   |   |
| Interest rate  swap, net of $219 tax                                     |       | —                |       |                     | —     |                                  |       |                   | —         |                                 |       |         | 329                                         |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | 329 |   |   |   | $   329 |   |   |
| Net income, as  restated                                                 |       | —                |       |                     | —     |                                  |       |                   | —         |                                 |       |         | —                                      |                          |       |              | 19,081         |   |   |   | — |   |   |   | — |   |   |   | 19,081 |   |   |   | 19,081 |   |   |
| Comprehensive  income                                                    |       | —                |       |                     | —     |                                  |       |                   | —         |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | $ 19,410 |   |   |
| Balance,  December 31, 2003 (as restated)                           |       | 16,150                |       |                     | 162        |                                  |       |                   | 194,999        |                                 |       |         | —                                      |                          |       |              | 101,232        |   |   |   | (982 | ) |   |   | (2,327 | ) |   |   | 293,084 |   |   |   |   |   |   |
| Common stock  issued in connection with  acquisitions                    |       | 10                    |       |                     | —     |                                  |       |                   | 255            |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | 255 |   |   |   | — |   |   |
| Common stock  released from escrow in connection with acquisitions       |       | 20                    |       |                     | —     |                                  |       |                   | 6              |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | 6 |   |   |   | — |   |   |
| Exercise of awards  and related tax benefit                              |       | 21                    |       |                     | —     |                                  |       |                   | 512            |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | 512 |   |   |   | — |   |   |
| Common shares  retired                                                   |       | (478                  | )          |                     | (5         | )                                     |       |                   | (5,924         | )                                    |       |         | —                                      |                          |       |              | (5,955         | ) |   |   | — |   |   |   | — |   |   |   | (11,884 | ) |   |   | — |   |   |
| Treasury shares  retired                                                 |       | (19                   | )          |                     | —     |                                  |       |                   | (241           | )                                    |       |         | —                                      |                          |       |              | (240           | ) |   |   | 481 |   |   |   | — |   |   |   | — |   |   |   |   |   |   |
| Grants of  restricted stock                                              |       | —                |       |                     | —     |                                  |       |                   | 4,318          |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | (4,318 | ) |   |   | — |   |   |   | — |   |   |
| Amortization of  deferred compensation                                   |       | —                |       |                     | —     |                                  |       |                   | —         |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | 2,349 |   |   |   | 2,349 |   |   |   | — |   |   |
| Net income                                                               |       | —                |       |                     | —     |                                  |       |                   | —         |                                 |       |         | —                                      |                          |       |              | 8,099          |   |   |   | — |   |   |   | — |   |   |   | 8,099 |   |   |   | $ 8,099 |   |   |
| Comprehensive  income                                                    |       | —                |       |                     | —     |                                  |       |                   | —         |                                 |       |         | —                                      |                          |       |              | —         |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | $ 8,099 |   |   |
| Balance,  December 31, 2004                                         |       | 15,704                |       |                     | $ 157 |                                  |       |                   | $ 193,925 |                                 |       |         | $      — |                          |       |              | $ 103,136 |   |   |   | $ (501 | ) |   |   | $ (4,296 | ) |   |   | $ 292,421 |   |   |   |   |   |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**SOURCECORP, INCORPORATED AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(IN THOUSANDS EXCEPT SHARE DATA)**
| ** **                                                                                                            | ** ** | **Year Ended December 31,**                                                               | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                            | ** ** | **        2002        ** | ** ** | **        2003        ** | ** ** | **        2004        ** | ** ** |
| ** **                                                                                                            | ** ** | **Restated**                                                                                             | ** ** | **Restated** | ** ** | ** ** | ** ** |
| OPERATING ACTIVITIES:                                                                                                 |       |                                                                                                     | ** ** |   |   |   | ** ** |   |   |   |   |   |   |
| Income from  continuing operations                                                                                    |       |                                                                                                     | $          | 19,908 |   |   |   | $ | 19,924 |   |   |   | $ | 10,536 |   |   |
| Adjustments to reconcile income from continuing  operations to net cash provided by operating activities:             |       |                                                                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Depreciation and  amortization                                                                                        |       |                                                                                                     | 12,856     |   |   |   | 13,044 |   |   |   | 13,750 |   |   |
| Deferred tax  provision                                                                                               |       |                                                                                                     | 7,190      |   |   |   | 6,457 |   |   |   | 3,229 |   |   |
| Compensation  expense on restricted stock grants                                                                      |       |                                                                                                     | —     |   |   |   | 590 |   |   |   | 2,383 |   |   |
| Loss (gain) on sale of  property, plant and equipment                                                                 |       |                                                                                                     | 93         |   |   |   | (131 | ) |   |   | 858 |   |   |
| Change in operating assets and liabilities:                                                                           |       |                                                                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Accounts  receivable and notes receivable                                                                             |       |                                                                                                     | 6,954      |   |   |   | 6,738 |   |   |   | (1,020 | ) |   |
| Inventories,  prepaid expenses and other assets                                                                       |       |                                                                                                     | 3,000      |   |   |   | (626 | ) |   |   | (1,124 | ) |   |
| Accounts payable,  accrued liabilities and other                                                                      |       |                                                                                                     | 5,823      |   |   |   | 6,193 |   |   |   | 1,148 |   |   |
| Net cash provided  by operating activities from continuing operations                                                 |       |                                                                                                     | 55,824     |   |   |   | 52,189 |   |   |   | 29,760 |   |   |
| Net cash provided  by (used in) operating activities from discontinued operations                                     |       |                                                                                                     | 3,344      |   |   |   | 2,912 |   |   |   | (2,476 | ) |   |
| Net cash provided  by operating activities                                                                            |       |                                                                                                     | 59,168     |   |   |   | 55,101 |   |   |   | 27,284 |   |   |
| INVESTING ACTIVITIES:                                                                                                 |       |                                                                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net proceeds  received from divestitures                                                                              |       |                                                                                                     | 259        |   |   |   | — |   |   |   | 6,805 |   |   |
| Proceeds from sale  of property, plant and equipment                                                                  |       |                                                                                                     | —     |   |   |   | 388 |   |   |   | 49 |   |   |
| Purchase of  property, plant and equipment                                                                            |       |                                                                                                     | (10,454    | ) |   |   | (16,395 | ) |   |   | (17,068 | ) |   |
| Cash paid for  acquisitions, net of cash acquired                                                                     |       |                                                                                                     | (24,354    | ) |   |   | (2,954 | ) |   |   | (17,495 | ) |   |
| Net cash used in  investing activities from continuing operations                                                     |       |                                                                                                     | (34,549    | ) |   |   | (18,961 | ) |   |   | (27,709 | ) |   |
| Net cash used in investing  activities from discontinued operations                                                   |       |                                                                                                     | (1,566     | ) |   |   | (335 | ) |   |   | (185 | ) |   |
| Net cash used in  investing activities                                                                                |       |                                                                                                     | (36,115    | ) |   |   | (19,296 | ) |   |   | (27,894 | ) |   |
| FINANCING ACTIVITIES:                                                                                                 |       |                                                                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Proceeds from  common stock issuance, net                                                                             |       |                                                                                                     | 108        |   |   |   | 349 |   |   |   | 482 |   |   |
| Cash paid for  common stock repurchased and retired                                                                   |       |                                                                                                     | —     |   |   |   | (20,699 | ) |   |   | (11,884 | ) |   |
| Proceeds from long-term  obligations                                                                                  |       |                                                                                                     | 280,228    |   |   |   | 229,725 |   |   |   | 300,962 |   |   |
| Principal payments  on long-term obligations                                                                          |       |                                                                                                     | (307,015   | ) |   |   | (245,995 | ) |   |   | (287,035 | ) |   |
| Cash paid for debt  issuance costs                                                                                    |       |                                                                                                     | (339       | ) |   |   | (305 | ) |   |   | (290 | ) |   |
| Net cash provided  by (used in) financing activities from continuing operations                                       |       |                                                                                                     | (27,018    | ) |   |   | (36,925 | ) |   |   | 2,235 |   |   |
| NET (DECREASE)  INCREASE IN CASH AND CASH EQUIVALENTS                                                                 |       |                                                                                                     | (3,965     | ) |   |   | (1,120 | ) |   |   | 1,625 |   |   |
| CASH AND CASH  EQUIVALENTS, beginning of year                                                                         |       |                                                                                                     | 7,182      |   |   |   | 3,217 |   |   |   | 2,097 |   |   |
| CASH AND CASH  EQUIVALENTS, end of year                                                                               |       |                                                                                                     | $          | 3,217 |   |   |   | $ | 2,097 |   |   |   | $ | 3,722 |   |   |
| SUPPLEMENTAL DATA:                                                                                                    |       |                                                                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Cash paid for:                                                                                                        |       |                                                                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Income taxes, net  of income tax refunds                                                                              |       |                                                                                                     | $          | 11,189 |   |   |   | $ | 6,775 |   |   |   | $ | 1,567 |   |   |
| Interest                                                                                                              |       |                                                                                                     | $          | 6,149 |   |   |   | $ | 3,487 |   |   |   | $ | 3,187 |   |   |
| NONCASH INVESTING AND FINANCING TRANSACTIONS:                                                                         |       |                                                                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Assets acquired  through financing and capital lease arrangements                                                     |       |                                                                                                     | $          | 167 |   |   |   | $ | 117 |   |   |   | $ | 278 |   |   |
| Fair value of  assets acquired in business acquisitions                                                               |       |                                                                                                     | $          | 3,454 |   |   |   | $ | — |   |   |   | $ | 2,424 |   |   |
| Liabilities  assumed in business acquisitions                                                                         |       |                                                                                                     | $          | 2,451 |   |   |   | $ | — |   |   |   | $ | 1,635 |   |   |
| Common stock  issued related to business acquisitions (114,112, 20,268 and 30,324 shares,  respectively)              |       |                                                                                                     | $          | 3,335 |   |   |   | $ | (94 | ) |   |   | $ | 261 |   |   |
| Common stock  retired related to business acquisitions (40,051, 0 and  19,358 shares, respectively)                   |       |                                                                                                     | $          | 1,071 |   |   |   | $ | — |   |   |   | $ | 481 |   |   |
| Common stock  earned and held in escrow related to business acquisitions (20,268, 20,268  and 0 shares, respectively) |       |                                                                                                     | $          | 377 |   |   |   | $ | 532 |   |   |   | $ | — |   |   |
| Interest rate  swap, net of tax                                                                                       |       |                                                                                                     | $          | 913 |   |   |   | $ | 329 |   |   |   | $ | — |   |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

48

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1. Organization andBasis of Presentation**

SOURCECORP, Incorporated (the “Company”) was foundedin September 1994, to create a leading provider of document andinformation outsourcing solutions for document and information intensiveindustries, including: financial services, government, legal, healthcare, andtransportation. The Company acquired seven document management servicesbusinesses (the “Founding Companies”) simultaneously with the closing of theinitial public offering (“IPO”) on January 26, 1996, and effectively beganoperations at that time. The consideration for the Founding Companies consistedof a combination of cash and common stock of the Company.

After the IPO and through December 1998, the Company acquirednine companies in transactions that were accounted for as poolings-of-interests.

Subsequent to the IPO and through December 31,2004, the Company has acquired 57 additional companies in transactionsaccounted for as purchases and has divested of 21 operating units by sale orclosure. The results of operations include the results of these acquisitionsfrom the date of their respective acquisitions and the results of thedivestitures up to the effective date of divestiture. The operating unitsdivested as part of the 2004 divestiture plan have been reclassified as discontinuedoperations for all periods presented.

Certain reclassificationshave been made to conform prior year data to the current year presentation.

**2. Summary of SignificantAccounting Policies**

***Revenue Recognition***

Revenue is recognized as it becomes realized orrealizable and earned according to the criteria provided by Staff AccountingBulletin 104, *Revenue Recognition*.Revenue recognition occurs once persuasive evidence of an arrangement exists,delivery has occurred or services have been rendered, the sales price is fixedor otherwise determinable, and collection is reasonably assured. The Company’srevenue-earnings activities possess project and recurring customerrelationships.

Recurring revenue is characterized by customerrelationships that are generally for one year or longer. Recurring revenue istypically based on the transaction volumes provided by the Company’s customerat an agreed upon fixed rate per unit. The Company’s customer volumes aretypically not contractual or otherwise guaranteed. Revenue recognition occursonce work is completed and delivery has occurred or services have beenrendered. Recurring revenue represents 65% of total 2004 revenues and typicallyoccurs within the Company’s Information Management and Distribution segment.

Project revenue includes one-time projects in whichthe customer relationship is not expected to continue after project completion.Project revenue is typically based on time and material arrangements. Revenuerecognition occurs at the contractual rates as the labor hours and direct expensesare incurred. Project revenue represents approximately 35% of total 2004revenues and typically occurs within the Company’s Healthcare, Regulatory, andLegal Compliance segment.

Revenue recognition policies related to offeringswithin the Company’s Information Management and Distribution segment are basedupon objective criteria that do not require significant estimates oruncertainties. For example, business process outsourcing services arerecognized proportionally as services are rendered, based on specific,objective criteria under the contracts for the number of accounts or 

49

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.Summary of Significant Accounting Policies (Continued)**

transactions processed.Accordingly, revenues recognized under these methods do not require the use ofsignificant estimates that are susceptible to change.

Revenue recognitionpolicies within the Company’s Healthcare, Regulatory, and Legal Compliancesegment are based upon objective criteria that do not require significantestimates or uncertainties. For example, transaction volumes and time and costsunder time and material and cost reimbursable arrangements are based onspecific, objective criteria under the contracts. The following outlines specificrevenue recognition policies related to certain offerings within this segment:

*Medical Records Release Services*

Revenue is recognized uponcompletion of the processing of the requested medical records. Revenuerecognition for this service is based on an agreed upon and in some cases, aregulated rate applied to the number of records processed. When a fee is paidto the hospital, the revenue related to that fee is reported on a net basis inaccordance with Emerging Issues Task Force (“EITF”) 99-19, *Reporting Revenue Gross as a Principal versus Net asan Agent,* due to the fact that: (a) the primary obligation in thearrangement is borne partially by both SOURCECORP and the hospital; (b)SOURCECORP has no discretion with respect to the supplier of the medicalrecord; and (c) SOURCECORP is not involved in the determination of product orservice specifications.

*Record Management Services*

Revenue is recognized asstorage services are provided based on linear feet of documents stored times amonthly rate for shelf storage and based on a monthly per image rate for imagesstored electronically. The Company recognizes fees for processing, retrieval,delivery, and return to storage as revenue upon completion of the service atthe agreed upon rate applied to the unit count of items serviced.

*Additional Healthcare and Compliance Services*

Revenue is recognized for document and data conversionservices as the services are provided based upon an agreed upon rate perpatient file applied to the number of files processed. Storage and archivingfees are recognized as revenue as the services are provided based upon anagreed upon monthly rate per file stored or otherwise archived. Revenue relatedto coding and abstracting of medical records and staffing services isrecognized as the services are provided based on an agreed upon rate applied tothe billable hours worked and eligible out-of-pocket expenses defined by theservice agreement. The out-of-pocket expense component is recognized as revenueand cost of services on a gross basis in accordance with EITF Issue 01-14, *Income Statement Characterization of ReimbursementsReceived for “Out-of-Pocket” Expenses Incurred.*Revenue related tocompliance reviews is based primarily on an agreed upon percentage (orcommission) of amounts identified and recovered from the third party payers asa fee for services provided. Revenue is recognized upon successful recovery ofunderpayments to our clients by their managed care and commercial payers at theagreed upon percentage (or commission).

50

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.Summary of Significant Accounting Policies (Continued)**

*Class Action Claims Administration Services*

Revenue is recognized asthese services are provided based on the agreed upon rate applied to the numberof hours spent providing services related to administering the legalsettlements and expenses incurred. The out-of-pocket expense component isrecognized as revenue and cost of services on a gross basis in accordance withEITF Issue 01-14, *Income Statement Characterizationof Reimbursements Received for “Out-of-Pocket” Expenses Incurred.*Inaddition, revenue related to the design and implementation of comprehensivenotification plans is based on an agreed upon percentage (i.e., commission) ofthe cost to place the media communication. Revenue is recognized at the time ofpublic delivery of the notification through the various media outlets at theagreed upon percentage (or commission).

*Professional Economic Research and Litigation Services*

Revenue is recognized as these services are providedbased on consulting hours worked at agreed upon rates at the time services arerendered and expenses are incurred. The out-of-pocket expense component isrecognized as revenue and cost of services on a gross basis in accordance withEITF Issue 01-14, *IncomeStatement Characterization of Reimbursements Received for “Out-of-Pocket”Expenses Incurred.*

As a part of providing services to its customers, theCompany incurs incidental expenses commonly referred to as “out-of-pocket” expenses.These expenses include items such as airfare, hotels, mileage, etc. and areoften reimbursable by the Company’s customers. When reimbursable, the Companyrecords both revenue and direct cost of services in accordance with theprovisions of EITF Issue 01-14, *IncomeStatement Characterization of Reimbursements Received for “Out-of-Pocket’Expenses Incurred.*

Unearned income, includedin other current liabilities, represents payments from the Company’s customersin advance of the services being provided. Advanced payments are deferred asunearned income when received and recognized as revenue as services arerendered.

***Allowance for Doubtful Accounts***

The allowance for doubtfulaccounts is established and maintained based on the Company’s estimate of accountsreceivable collectibility. Management estimates collectibility by specificallyanalyzing accounts receivable aging and other historical factors that affectcollections. Such factors include the historical trends of write-offs andrecovery of previously written-off accounts, the financial strength of thecustomer and projected economic and market conditions. The evaluation of thesefactors involves subjective judgments and changes in these factors maysignificantly impact the Consolidated Financial Statements.

***Goodwill***

The Company adopted theprovisions of Statement of Financial Accounting Standards (“SFAS”)No. 142, *Goodwill and Other IntangibleAssets,* on January 1, 2002. Upon the adoption of SFASNo. 142, goodwill is not amortized but rather is tested at least annuallyfor impairment. The impairment test is based on fair value rather thanundiscounted cash flows. Additionally, goodwill is tested at a reporting unitlevel rather than the individual operating unit level. Reporting units aredefined as an operating segment 

51

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.Summary of Significant Accounting Policies (Continued)**

or one level below. At January 1, 2002, theCompany compared the fair values of the reporting units to their carryingvalues. Valuation methods used in determining fair value include an analysis ofthe cash flows that the reporting units can be expected to generate in thefuture (“Income Approach”) and the fair value of a reporting unit as comparedto similar publicly traded companies (“Market Approach”). In preparing thesevaluations, management utilizes estimates to determine fair value of thereporting units. These estimates include future cash flows, growth rates,capital needs and projected margins among other factors. Since the fair valueof each reporting unit exceeded the carrying value, no impairment was recordedat January 1, 2002. In October 2002, 2003 and 2004, the Companyperformed the annual test for impairment using the Income Approach and theMarket Approach method. Since the fair value of each reporting unit exceededthe carrying value, no impairment was recorded. Estimates utilized in futurecalculations could differ from estimates used in the current period. Futureyears' estimates that are unfavorable compared to current estimates could causean impairment of goodwill.

***Self-Insurance Liabilities and Reserves***

The Company isself-insured for workmen's compensation liabilities and a significant portionof its employee medical costs. The Company accounts for its self-insuranceprograms based on actuarial estimates of the amount of the loss inherent inthat period’s claims, including losses for which claims have not been reported.These loss estimates rely on actuarial observations of ultimate loss experiencefor similar historical events. The Company limits its risk by carryingstop-loss policies for significant claims incurred for both workmen’scompensation liabilities and medical costs. The Company’s exposure under thestop-loss policies for workmen’s compensation and medical costs is limitedbased on fixed dollar amounts. For workmen’s compensation, the fixed dollaramount of stop-loss coverage is $500,000 per occurrence. For medical costs, thefixed dollar amount of stop-loss coverage is $100,000 per covered participantfor the fiscal plan year, with a lifetime limit of liability per coveredparticipant of $1,900,000.

***Other Loss Contingencies***

The Company recordsliabilities when it is probable that a liability has been incurred and theamount of the loss is reasonably estimable in accordance with SFAS No. 5, *Accounting for Contingencies*. Disclosure is required whenthere is a reasonable possibility that the ultimate loss will exceed therecorded provision. Contingent liabilities are often resolved over long periodsof time. Estimating probable losses requires analysis of multiple forecaststhat often depend on judgments about potential actions by third parties, suchas regulators. The Company’s loss contingencies consist primarily of estimatesrelated to the probable outcome of current litigation.

***Long-Lived Assets and Intangibles Impairment***

Management continuallyevaluates whether events and circumstances indicate that the carrying value oflong-lived assets and intangibles may not be recoverable. When events require,management makes the valuation by comparing the estimated undiscounted futurecash flows over the remaining life of the long-lived assets and intangibles tothe carrying amount of the asset being evaluated. An impairment loss equal 

52

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.Summary of Significant Accounting Policies (Continued)**

to the difference in carrying value and fair value isrecognized if the carrying amount of assets being evaluated exceeds theexpected future undiscounted cash flow. Management believes atDecember 31, 2004, no events existed that required evaluation of potentialimpairment.

***Cash and Cash Equivalents***

The Company considershighly liquid investments with original maturities of three months or less tobe cash equivalents. Cash equivalents are carried at cost, which approximatesmarket value.

***Property, Plant and Equipment***

Property, plant andequipment are recorded at cost. Depreciation is computed using thestraight-line method over the estimated useful lives of the assets. Leaseholdimprovements are depreciated over the lesser of the estimated useful life orthe lease term. Repair and maintenance costs are expensed as incurred.

***Income Taxes***

Income taxes are accountedfor using the asset and liability method. Deferred income taxes are recognizedfor tax consequences of temporary differences by applying enacted statutory taxrates applicable in future years to differences between the financial statementcarrying amounts and the tax bases of existing assets and liabilities.

***Net Income (Loss) Per Share***

Basic net income (loss)per share has been computed by dividing net income (loss) by the weightedaverage number of common shares outstanding for the period. Diluted net income(loss) per share has been computed by dividing net income (loss) by theweighted average number of common shares and potentially dilutive common sharesoutstanding for the period. See Note 13, Stockholders' Equity.

***Use of Estimates in Financial Statements***

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America (“GAAP”) requires management to makeestimates and assumptions that affect the reported amounts of certain assetsand liabilities and disclosure of contingent liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from those estimates.

***Consolidation***

The accompanyingconsolidated financial statements and related notes to consolidated financialstatements include the accounts of SOURCECORP, Incorporated and itssubsidiaries. All significant intercompany balances and transactions have beeneliminated.

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.Summary of Significant Accounting Policies (Continued)**

***Fair Value of Financial Instruments***

The carrying amounts ofcash and cash equivalents approximate fair value due to the short maturities ofthese instruments. The carrying amount of long-term debt approximates fairvalue due to interest rates that approximate current market rates forinstruments of similar size and duration.

***Treasury Stock***

Treasury stock transactionsare accounted for under the cost method. At December 31, 2003 and 2004,the Company had 56,028 and 36,670, respectively of shares in treasury.

***Stock Based Compensation***

The Company has elected to follow AccountingPrinciples Board Opinion (“APB”) No. 25, *Accountingfor Stock Issued to Employees*. Under APB No. 25, compensationexpense is recorded when the exercise price of employee stock options is lessthan the fair value of the underlying stock on the measurement date. TheCompany has adopted the disclosure-only provisions of SFAS No. 148, *Accounting for Stock-Based Compensation—Transition and Disclosure*,as discussed in Note 13, Stockholders' Equity.

Stock option and warrantawards are granted at the market price of the common stock on the date of grant.Accordingly, no compensation expense has been recognized for stock options andwarrants. Had compensation expense been determined based upon the fair value atgrant dates for stock options and warrants consistent with the method of SFASNo. 123, *Accounting for Stock BasedCompensation*, the Company's net income and earnings per share wouldhave been as follows (in thousands, except per share data):
| ** **                                                                                                                           | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                           | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net income as reported                                                                                                               |       | $                                          | 20,639     |   | $ | 19,081 |   | $ | 8,099 |   |
| Add: Compensation  expense included in reported net income, net of tax effect                                                        |       | —                                     |       | 374 |   | 1,410 |   |
| Deduct: Total stock-based  employee compensation expense determined under fair value based method for  all awards, net of tax effect |       | (3,947                                     | )          | (3,251 | ) | (5,470 | ) |
| Proforma net income                                                                                                                  |       | $                                          | 16,692     |   | $ | 16,204 |   | $ | 4,039 |   |
| Earnings per share:                                                                                                                  |       |                                       |       |   |   |   |   |
| Reported basic earnings  per share                                                                                                   |       | $                                          | 1.19       |   | $ | 1.16 |   | $ | 0.51 |   |
| Proforma basic earnings  per share                                                                                                   |       | $                                          | 0.96       |   | $ | 0.98 |   | $ | 0.25 |   |
| Reported diluted  earnings per share                                                                                                 |       | $                                          | 1.17       |   | $ | 1.15 |   | $ | 0.50 |   |
| Proforma diluted earnings per share                                                                                                  |       | $                                          | 0.95       |   | $ | 0.98 |   | $ | 0.25 |   |

 

54

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.Summary of Significant Accounting Policies (Continued)**

The fair value of thestock options and warrants was estimated on the date of the grant using theBlack-Scholes option pricing model using the following assumptions:
| ** **                                | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2004** | ** ** |
| Weighted-average  risk-free interest rate |       | 4.4                                        | %          | 2.4 | % | 3.3 | % |
| Weighted-average  dividend yield          |       | 0.0                                        | %          | 0.0 | % | 0.0 | % |
| Weighted-average  volatility              |       | 40.2                                       | %          | 44.2 | % | 41.5 | % |
| Weighted-average  expected life           |       | 3.0 years                                  |       | 4.0 years |   | 4.0 years |   |

 

On December 18, 2004,the Compensation Committee of the Board of Directors approved, and the Board ofDirectors ratified, the acceleration of the vesting of certain options andwarrants (specifically options and warrants issued in 2002 or earlier, and onlythose options and warrants that by their terms would not vest beforeJune 30, 2005), provided that the holders were employed by the Company asof December 31, 2004. The action was taken as a method to provide afurther incentive to option holders to maximize shareholder value withoutcreating an immediate windfall (as substantially all of such options andwarrants had exercise prices above $30 per share). In taking such action, theCompensation Committee and the Board were mindful that the accounting treatmentof stock options and warrants is required to change in the second half of 2005,requiring the expensing of unvested stock options and warrants. As such, theCompensation Committee and the Board were mindful that accelerating the vestingof such options and warrants would avoid an expense in future periods that didnot provide any direct associated benefit to individuals and that couldotherwise negatively impact the Company’s reported results in future periods.This action resulted in the acceleration of vesting of 364,100 stock optionsand warrants at a weighted-average strike price of $30.38 during the fourthquarter of 2004. Although this action established a new measurement date forthe stock options and warrants under the intrinsic value method, there was nocompensation expense associated with the vesting acceleration as the strikeprice related to the accelerated stock options and warrants was above the fairmarket value of the Company’s common stock on December 17, 2004. As aresult of the acceleration, the pro forma expense disclosure shown above includesapproximately $2.1 million, net of tax, of additional expense related to theacceleration.

***Recent Accounting Pronouncements***

In December 2004, the Financial Accounting Standardsboard (“FASB”) issued SFAS No. 123(R), *Share-Based Payment*,which establishes accounting standards for all transactions in which an entityexchanges its equity instruments for goods and services. SFAS No. 123(R)focuses primarily on accounting for transactions with employees, and carriesforward without change prior guidance for share-based payments for transactionswith non employees.

SFAS No. 123(R) eliminates the intrinsic valuemeasurement objective in APB Opinion 25 and generally requires an entity tomeasure the cost of employee services received in exchange for an award ofequity instruments based on the fair value of the award on the date of thegrant. The standard requires grant date fair value to be estimated using eitheran option-pricing model which is consistent with the terms of the award or amarket observed price, if such a price exists. Such cost must be recognizedover the period during which an employee is required to provide service inexchange for the award over the 

55

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2.Summary of Significant Accounting Policies (Continued)**

requisite service period(typically the vesting period). The standard also requires an entity toestimate the number of instruments that will ultimately be issued, rather thanaccounting for forfeitures as they occur.

The Company is required toapply SFAS No. 123(R) to all awards granted, modified or settled in the firstreporting period under U.S. GAAP after June 15, 2005. The Company is alsorequired to use either the “modified prospective method'' or the “modifiedretrospective method.'' Under the modified prospective method, the Company mustrecognize compensation cost for all awards granted after adopting the standardand for the unvested portion of previously granted awards that are outstandingon that date.

Under the modifiedretrospective method, the Company must restate its previously issued financialstatements to recognize the amounts previously calculated and reported on a proforma basis, as if the prior standard had been adopted.

Under both methods, theCompany is permitted to use either a straight line or an accelerated method toamortize the cost as an expense for awards with graded vesting. The standardpermits and encourages early adoption.

The Company has commencedan analysis of the impact of SFAS 123(R), but has not yet decided: (1) whetherto adopt early, (2) if adopted early, then at what date to do so, (3) whetherto use the modified prospective method or elect to use the modified retrospectivemethod, and (4) whether to elect to use straight line amortization or anaccelerated method. Additionally, the Company cannot predict with reasonablecertainty the number of options that will be unvested and outstanding on theadoption date.

Accordingly, the Companycannot currently quantify with precision the effect that this standard wouldhave on its financial position or results of operations in the future, exceptthat the Company will probably recognize a greater expense for any awards thatare granted in the future than if granted under the current guidance.

In December 2004,the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets an amendmentof APB No. 29. This Statement amends Opinion 29 to eliminate the exceptionfor nonmonetary exchanges of similar productive assets and replaces it with ageneral exception for exchanges of nonmonetary assets that do not havecommercial substance. The Statement specifies that a nonmonetary exchange hascommercial substance if the future cash flows of the entity are expected tochange significantly as a result of the exchange. This Statement is effectivefor nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,2005. Earlier application is permitted for nonmonetary asset exchangesoccurring in fiscal periods beginning after the date this Statement is issued. Retroactiveapplication is not permitted. Management is analyzing the requirements of thisnew Statement and believes that its adoption will not have any significant impacton the Company’s financial position, results of operations or cash flows.

56

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**3. Restatement**

During October 2004, the Company, with the oversightand approval of the Audit Committee of the Board of Directors, initiated aninvestigation of the financial results of one of the Company’s operatingsubsidiaries in the Information Management and Distribution reportable segment(the “Operating Subsidiary”). The findings of the investigation concluded thatthe Operating Subsidiary had incorrectly recognized revenue for certaincustomer arrangements and omitted certain operating expenses from its reportedfinancial results which in turn resulted in overpayments and over accruals ofcontingent consideration amounts due under the earn-out provisions of theacquisition agreement for the Operating Subsidiary which had been originallyrecognized as additional goodwill of the acquired business. As a result, theconsolidated financial statements for the years ended December 31, 2002and 2003 have been restated from the amounts previously reported, as discussedbelow.

Asdescribed in the Company’s summary of significant accounting policies, revenueis recognizable when each of the following conditions is met: persuasiveevidence of an arrangement exists, the price is fixed or determinable, deliveryhas occurred or services have been rendered and collection is reasonablyassured. The investigation identified certain instances where one or more ofthe aforementioned revenue recognition conditions as applied to certaincustomer contracts were not met by the Operating Subsidiary. As a result, therevenue previously recognized that did not meet all the revenue recognitionconditions mentioned above has been reversed, resulting in a downwardadjustment to certain asset accounts, or the recognition of a customerliability or deferred revenue if the customer has paid the invoices related tothe reversed revenue.   Notwithstanding the reversal of revenue, thedirect costs associated with the reversed revenue continue to be reported inthe period incurred. In addition, the Company has evaluated the direct costsrelated to deferred revenue and has determined to continue to include the costsin the period incurred due to the uncertainty regarding the futurerecoverability of the associated costs. The revenue adjustments that wereidentified are reflected in the restated financial statements as follows:
| ** **                    | ** ** | **Year Ended**             | ** ** | **Year Ended**                   | ** ** |
|-------------------------------|------------|---------------------------------|------------|---------------------------------------|------------|
| ** **                    | ** ** | **December 31, 2002** | ** ** | **December  31, 2003** | ** ** |
| ** **                    | ** ** | **(In Thousands)**         | ** ** |
| Asset accounts                |       |                            | $          | (267                                  | )          |   |   | $ | 133 |   |   |
| Customer  liability, net      |       |                            | (593       | )                                     |       |   | (2,631 | ) |   |
| Deferred revenue,  net        |       |                            | (1,752     | )                                     |       |   | (3,817 | ) |   |
| Total Net Revenue  Adjustment |       |                            | $          | (2,612                                | )          |   |   | $ | (6,315 | ) |   |

 

**Asset accounts:**

Represents the reversal ofpreviously recognized revenue through the downward adjustment of certain assetaccounts where one or more of the aforementioned revenue recognition conditionsas applied to certain customer contracts were not met by the OperatingSubsidiary.   To the extent that the write-down relates to performedservices that exceeded the contractual funding limitation, a portion of therevenue may be recognized in future periods upon customer authorization.

**Customer liability,net:**

The Operating Subsidiary,in certain instances, recognized revenue for services that were neverperformed. The customers were invoiced for the non-performed services andcollection of the invoices has occurred. A portion of the customer liability maybe recognized as revenue in future periods upon 

57

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**3.Restatement (Continued)**

successfulcompletion of services or negotiations with the Operating Subsidiary’scustomer(s). Remaining customer liability balances will be extinguished througheither customer refund or applying such remaining customer liability againstfuture provided services.

**Deferred revenue,net:**

The Operating Subsidiary recognized revenue forperformed services although the related contractually required servicesdesigned to meet customer-specific acceptance provisions (i.e. qualitystandards) were not performed. The customers were invoiced for the performedservices and collection of the invoices has occurred. However, by not complyingwith the contract, the Operating Subsidiary is unable to reasonably demonstratethat the performed services met the required quality standard(s). This hasresulted in the deferral of revenue for performed services for which acceptanceis contingent upon meeting the required quality standard(s). The OperatingSubsidiary will recognize the revenue for performed services upon obtainingexplicit acceptance from the customer(s). In the event customer acceptance isnot obtained, the deferred revenue will be reclassified to a customer liability.The customer liability will be extinguished through either customer refund orapplying such remaining customer liability against future provided services.

The investigation identified certain expenses of theOperating Subsidiary that were not properly recorded in the OperatingSubsidiary’s consolidated statement of operations. Certain former members ofthe Operating Subsidiary’s management allegedly diverted expenses to entitiesthey controlled, but that are unrelated to the Company, resulting in theomission of the related expenses from the Operating Subsidiary’s financialresults and, as a result, the Company’s previously reported financial results.  The Company has identified the unrecordedexpenses and has recorded them in the period the expenses were incurred as anadjustment to selling, general and administrative expense. A liability for suchan amount has been recorded in other long-term obligations in the restatedfinancial statements. The liability will be eliminated at such time the Companyrecovers any contingent consideration overpayments paid to the former owners ofthe Operating Subsidiary or at such time management determines the liabilityhas been extinguished, as discussed below.

The revenue recognitionand expense omission issues affected previously paid contingent considerationrelated to the acquisition of the Operating Subsidiary. As a result of thestructure of the acquisition agreement, the former owners of the OperatingSubsidiary had the opportunity to earn additional purchase consideration forthe twelve-month periods ended February 28, 2002, February 28, 2003and February 29, 2004 (the “Earn-out Period(s)”) based on earnings beforeinterest and taxes of the Operating Subsidiary, in excess of designated thresholds,calculated in accordance with accounting principles generally accepted in theUnited States of America for each respective period (the “Earn-out Agreement”).Based on the findings of the Company’s investigation, earnings before interestand taxes attributable to the Operating Subsidiary were overstated during theEarn-out Period(s) resulting in overpayments and overaccruals made by theCompany under the provisions of the Earn-out Agreement that otherwise would nothave been made. The Company has expensed the contingent considerationoverpayments in the financial statements in the period(s) in which theywere paid resulting in expense of $8.6 million, $7.2 million and $10.2 millionfor the years ended December 31, 2002, 2003, and 2004, respectively. Theseamounts had previously been accrued as contingent consideration and an additionto goodwill. The Company has reversed these accruals and related goodwill inthe periods originally recorded. 

58

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**3.Restatement (Continued)**

TheCompany will record a gain in future periods to the extent such contingentconsideration overpayments are recovered.

Restating the financial statements for the revenuerecognition, expense omission and contingent consideration****overpaymentissues results in an adjustment to the provision for income taxes and tocertain other balance sheet tax accounts for the periods restated.

A summary of thesignificant effects of the restatement is as follows (in thousands, except pershare data):

**BALANCE SHEETINFORMATION**
| ** **                               | ** ** | **At December 31, 2003** | ** ** |
|------------------------------------------|------------|-----------------------------------------|------------|
| ** **                               | ** ** | **As  Previously  Reported**            | ** ** | **As  Restated** | ** ** |
| ** **                               | ** ** | **(Item 1)**                            | ** ** | ** ** | ** ** |
| ** **                               | ** ** | ** **                              | ** ** | ** ** | ** ** |
| Accounts and  Notes Receivable, Net      |       | $                                       | 67,873     |   | $ | 63,522 |   |
| Income Tax Receivable                    |       | $                                       | —     |   | $ | 3,006 |   |
| Goodwill                                 |       | $                                       | 324,305    |   | $ | 307,913 |   |
| Total Assets                             |       | $                                       | 470,273    |   | $ | 452,536 |   |
| Accounts Payable and Accrued Liabilities |       | $                                       | 52,054     |   | $ | 52,374 |   |
| Income Tax Payable                       |       | $                                       | 2,186      |   | $ | — |   |
| Deferred Income Taxes                    |       | $                                       | 18,084     |   | $ | 11,753 |   |
| Long-term Customer Liability             |       | $                                       | —     |   | $ | 1,862 |   |
| Deferred Revenue                         |       | $                                       | —     |   | $ | 5,135 |   |
| Other Long-term Obligations              |       | $                                       | 7,839      |   | $ | 9,306 |   |
| Retained Earnings                        |       | $                                       | 119,236    |   | $ | 101,232 |   |
| Total Stockholders’  Equity         |       | $                                       | 311,088    |   | $ | 293,084 |   |

 

----

**Item 1:** Amountsas previously reported after giving effect to adjustments required to reflectthe Company’s discontinued operations discussed in Note 5 to the consolidatedfinancial statements.

59

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**3. Restatement (Continued)**

**STATEMENT OFOPERATIONS INFORMATION**
| ** **                                                   | ** ** | **Year Ended  December 31, 2002** | ** ** | **Year Ended  December 31, 2003** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                   | ** ** | **As  Previously  Reported**                     | ** ** | **As  Restated**                                 | ** ** | **As  Previously  Reported** | ** ** | **As  Restated** | ** ** |
| ** **                                                   | ** ** | **(Item 1)**                                     | ** ** | ** **                                       | ** ** | **(Item 1)** | ** ** | ** ** | ** ** |
| Revenue                                                      |       | $                                                | 381,156    |                                             | $          | 378,544 |   | $ | 384,474 |   | $ | 378,159 |   |
| Gross Profit                                                 |       | $                                                | 144,146    |                                             | $          | 141,534 |   | $ | 149,720 |   | $ | 143,405 |   |
| Selling,  General & Administrative Expense          |       | $                                                | 93,578     |                                             | $          | 94,245 |   | $ | 98,770 |   | $ | 99,008 |   |
| Contingent Consideration  Overpayments                       |       | $                                                | —     |                                             | $          | 8,605 |   | $ | — |   | $ | 7,223 |   |
| Income From Continuing  Operations Before Income Taxes  |       | $                                                | 43,712     |                                             | $          | 31,828 |   | $ | 46,994 |   | $ | 33,218 |   |
| Provision for Income  Taxes                                  |       | $                                                | 16,611     |                                             | $          | 11,920 |   | $ | 18,798 |   | $ | 13,294 |   |
| Income From Continuing  Operations                           |       | $                                                | 27,101     |                                             | $          | 19,908 |   | $ | 28,196 |   | $ | 19,924 |   |
| Net Income                                                   |       | $                                                | 27,832     |                                             | $          | 20,639 |   | $ | 27,353 |   | $ | 19,081 |   |
| **Net Income Per Common Share**                              |       |                                             |       |                                             |       |   |   |   |   |
| **Basic**                                                    |       |                                             |       |                                             |       |   |   |   |   |
| Continuing                                                   |       | $                                                | 1.57       |                                             | $          | 1.15 |   | $ | 1.71 |   | $ | 1.21 |   |
| Total                                                        |       | $                                                | 1.61       |                                             | $          | 1.19 |   | $ | 1.66 |   | $ | 1.16 |   |
| **Diluted**                                                  |       |                                             |       |                                             |       |   |   |   |   |
| Continuing                                                   |       | $                                                | 1.54       |                                             | $          | 1.13 |   | $ | 1.70 |   | $ | 1.20 |   |
| Total                                                        |       | $                                                | 1.58       |                                             | $          | 1.17 |   | $ | 1.65 |   | $ | 1.15 |   |

----

**Item 1:** Amountsas previously reported after giving effect to adjustments required to reflectthe Company’s discontinued operations discussed in Note 5 to the consolidatedfinancial statements.

**STATEMENT OF CASHFLOW INFORMATION**
| ** **                                                            | ** ** | **Year Ended  December 31, 2002** | ** ** | **Year Ended  December 31, 2003** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                            | ** ** | **As  Previously  Reported**                     | ** ** | **As  Restated**                                 | ** ** | **As  Previously  Reported** | ** ** | **As  Restated** | ** ** |
| ** **                                                            | ** ** | **(Item 1)**                                | ** ** | ** **                                       | ** ** | **(Item 1)** | ** ** | ** ** | ** ** |
| Net cash provided by  operating activities from continuing operations |       | $                                                | 64,429     |                                             | $          | 55,824 |   | $ | 59,412 |   | $ | 52,189 |   |
| Net cash used in investing activities from  continuing operations     |       | $                                                | (43,154    | )                                                | $          | (34,549 | ) | $ | (26,184 | ) | $ | (18,961 | ) |

----

**Item 1:**Amounts as previously reported after giving effect toadjustments required to reflect the Company’s discontinued operations discussedin Note 5 to the consolidated financial statements.

The above cash flowcategories are impacted as a result of reclassifying the contingentconsideration overpayments previously discussed, from cash paid foracquisitions (included in net cash used in investing activities from continuingoperations) to cash provided by operating activities from continuing operationsas a period expense.

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**4. Reserves and Other LossContingencies**

*Self-InsuranceLiabilities and Reserves*

The Company is self-insured for workmen’s compensationliabilities and a significant portion of its employee medical costs. TheCompany accounts for its self-insurance programs based on actuarial estimatesof the amount of loss inherent in that period’s claims, including losses forwhich claims have not been reported. These loss estimates rely on actuarialobservations of ultimate loss experience for similar historical events. TheCompany limits its risk by carrying stop-loss policies for significant claimsincurred for both workmen’s compensation liabilities and medical costs. TheCompany’s exposure under the stop-loss policies for workmen’scompensation and medical costs is limited based on fixed dollar amounts. Forworkman’s compensation, the fixed dollar amount of stop-loss coverage is$500,000 per occurrence. For medical costs, the fixed dollar amount ofstop-loss coverage is $100,000 per covered participant for the fiscal planyear, with a lifetime limit of liability per covered participant of $1,900,000.

Accrualbalances related to workmen’s compensation and medical costs are as follows (inthousands):
| ** **                   | ** ** | **December 31,** | ** ** |
|------------------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Workmen’s  Compensation |       | $                     | 1,936      |   | $ | 2,407 |   |
| Employee Medical  Insurance  |       | 2,208                 |       | 2,229 |   |
|                         |       | $                     | 4,144      |   | $ | 4,636 |   |

 

*Other LossContingencies*

The Company recordsliabilities when it is probable that a liability has been incurred and theamount of the loss is reasonably estimable in accordance with SFAS No. 5, *Accounting for Contingencies*. Disclosureis required when there is a reasonable possibility that the ultimate loss willexceed the recorded provision. Contingent liabilities are often resolved over longperiods of time. Estimating probable losses requires analysis of multipleforecasts that often depend on judgments about potential actions by thirdparties such as regulators. The Company’s loss contingencies consist primarilyof estimates related to the probable outcome of current litigation.

**5. Discontinued Operations**

During the first quarter of 2004, the Companycompleted a strategic evaluation of its operations based on certain criteria,such as strategic and financial fit, and future growth prospects. As a result,on May 6, 2004, the Company formally committed to a plan of divestiturefor certain non-strategic asset groups related to its Direct Mail operationsreported in the Information Management and Distribution segment in priorperiods, and two medical records management operations reported in theHealthcare, Regulatory and Legal Compliance segment in prior periods. TheDirect Mail operations and the two medical records management operations areaccounted for as discontinued operations. As such, the operating assets andliabilities of these operations are presented in the consolidated balance sheetas Assets and Liabilities of Discontinued Operations and the results associatedwith these operations are presented in the consolidated statement of operationsas Income (Loss) from Discontinued Operations, net of tax.

During the second quarter of 2004, the Companycompleted the sale of one of the medical records management operations, whichresulted in approximately $0.7 million of cash proceeds and a pre-tax gain 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**5.Discontinued Operations (Continued)**

on disposal ofapproximately $0.5 million. Additionally, the Company recognized a pre-tax losson disposal related to the Direct Mail operations of approximately $2.2 million.

During the third quarter of 2004, the Companycompleted the sale of the Direct Mail operations and the remaining medicalrecords management operation, resulting in the recognition of a net pretax gainof $0.4 million. In connection with these transactions, the Company receivedapproximately $6.1 million of cash proceeds, net of transaction costs, approximately$1.5 million of 12 percent secured subordinated notes, which the Company fullyreserved, related to the Direct Mail operations, and $0.6 million of contingentconsideration related to a contract renewal at the medical records managementoperation.

During the fourth quarter of 2004, the contingencysurrounding the contract renewal at the medical records management operationwas resolved. As such, the Company recognized additional consideration of $0.6million offset by approximately $0.1 million of incremental loss related tofinalizing the consideration related to the divestiture.

The collection of the reserved subordinated notescould result in a future reduction of the total loss related to the dispositionof the Direct Mail operations.

Summarizedselected financial information for the discontinued operations is as follows(in thousands except per share data):
| ** **                                                      | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                      | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2004** | ** ** |
| **REVENUE**                                                     |       | $                                          | 48,224     |   | $ | 39,613 |   | $ | 15,800 |   |
| **COST OF  SERVICES**                                           |       | 34,889                                     |       | 29,849 |   | 13,681 |   |
| **DEPRECIATION**                                                |       | 1,784                                      |       | 1,690 |   | 528 |   |
| Gross profit                                                    |       | 11,551                                     |       | 8,073 |   | 1,591 |   |
| **SELLING,  GENERAL AND ADMINISTRATIVE EXPENSES**               |       | 10,273                                     |       | 9,525 |   | 4,859 |   |
| Operating income (loss)                                         |       | 1,278                                      |       | (1,451 | ) | (3,267 | ) |
| **OTHER (INCOME) EXPENSE:**                                     |       |                                       |       |   |   |   |   |
| Interest and other (income) expense, net                        |       | 99                                         |       | (46 | ) | (63 | ) |
| Loss on sale of asset groups                                    |       | —                                     |       | — |   | 856 |   |
| Income (loss) from discontinued operations before  income taxes |       | 1,179                                      |       | (1,405 | ) | (4,060 | ) |
| **PROVISION  FOR INCOME TAXES**                                 |       | 448                                        |       | (562 | ) | (1,623 | ) |
| **NET INCOME (LOSS) FROM  DISCONTINUED OPERATIONS**             |       | $                                          | 731        |   | $ | (843 | ) | $ | (2,437 | ) |

 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**5. Discontinued Operations(Continued)**

Theassets and liabilities of the discontinued operations are stated separately in theConsolidated Balance Sheets. The major asset and liability categories are asfollows (in thousands):
| ** **                                                             | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                             | ** ** | **2003**              | ** ** | **2004** | ** ** |
| ASSETS OF DISCONTINUED OPERATIONS                                      |       |                  |       |   |   |
| CURRENT ASSETS:                                                        |       |                  |       |   |   |
| Accounts and notes receivable, net of allowance for  doubtful accounts |       | $                     | 5,693      |   | $ | — |   |
| Inventories                                                            |       | 1,130                 |       | — |   |
| Prepaid expenses and other current assets                              |       | 730                   |       | — |   |
| Total current assets                                                   |       | 7,553                 |       | — |   |
| PROPERTY, PLANT  AND EQUIPMENT, net of accumulated depreciation        |       | 6,923                 |       | — |   |
| OTHER NONCURRENT  ASSETS                                               |       | 182                   |       | — |   |
| Total assets of discontinued operations                                |       | $                     | 14,658     |   | $ | — |   |
| LIABILITIES OF DISCONTINUED OPERATIONS                                 |       |                  |       |   |   |
| CURRENT LIABILITIES:                                                   |       |                  |       |   |   |
| Accounts payable and accrued liabilities                               |       | $                     | 5,423      |   | $ | — |   |
| Total liabilities  of discontinued operations                          |       | $                     | 5,423      |   | $ | — |   |

 

**6. Allowance for DoubtfulAccounts and Notes Receivable**

Theactivity in the allowance for doubtful accounts and notes receivable is asfollows (in thousands):
| ** **                         | ** ** | **  Balance at    Beginning  Of Year** | ** ** | **Balance  Acquired** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **  Write-offs  ** | ** ** | **Balance at  End of Year** | ** ** |
|------------------------------------|------------|----------------------------------------------------------------------|------------|-----------------------|------------|-----------------------------------------------|------------|----------------------------------------|------------|--------------------------------------------|------------|
| Year ended  December 31, 2003 |       |                                                                 | $          | 12,036                |       |                                          |       | $                                      | —     |                                       |       |   | $ | (174 | ) |   |   | $ | (5,019 | ) |   |   | $ | 6,843 |   |   |
| Year ended December 31,  2004 |       |                                                                 | $          | 6,843                 |       |                                          |       | $                                      | 17         |                                       |       |   | $ | 5,948 |   |   |   | $ | (3,371 | ) |   |   | $ | 9,437 |   |   |

 

**7. Property, Plant andEquipment**

Property,plant and equipment consist of the following (in thousands):
| ** **                          | ** ** | **Estimated  Useful  Lives** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|------------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **in Years**            | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Land                                |       |                         | N/A        |                  |       | $ | 911 |   | $ | 911 |   |
| Buildings and  improvements         |       |                         | 7-18       |                  |       | 3,284 |   | 3,159 |   |
| Leasehold  improvements             |       |                         | 1-8        |                  |       | 6,197 |   | 8,283 |   |
| Vehicles                            |       |                         | 5-7        |                  |       | 2,207 |   | 1,958 |   |
| Machinery and  equipment            |       |                         | 5-15       |                  |       | 29,312 |   | 23,723 |   |
| Computer  equipment and software    |       |                         | 3-7        |                  |       | 41,591 |   | 42,097 |   |
| Furniture and  fixtures             |       |                         | 5-15       |                  |       | 5,793 |   | 5,300 |   |
|                                |       |                         |       |                  |       | 89,295 |   | 85,431 |   |
| Less—Accumulated  depreciation |       |                         |       |                  |       | (53,393 | ) | (45,734 | ) |
|                                |       |                         |       |                  |       | $ | 35,902 |   | $ | 39,697 |   |

 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**8. Other CurrentLiabilities**

Othercurrent liabilities consist of the following (in thousands):
| ** **                        | ** ** | **December 31,** | ** ** |
|-----------------------------------|------------|-----------------------|------------|
| ** **                        | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Unearned revenue                  |       | $                     | 1,831      |   | $ | 1,720 |   |
| Accrued  contingent consideration |       | 3,416                 |       | 5,387 |   |
| Accrued  professional fees        |       | 5,810                 |       | 1,144 |   |
|                              |       | $                     | 11,057     |   | $ | 8,251 |   |

 

**9. Business Combinations**

*2004 Acquisitions*

On April 15, 2004, the Company acquired 100% ofthe membership interests of KeyPoint Consulting LLC (“KeyPoint”), locatedin Emeryville and Los Angeles, California. KeyPoint is an economic consultingfirm with approximately 26 principals and staff, and a network of academicaffiliates. KeyPoint provides economic, financial, and forensic accountingservices in matters involving complex litigation and regulation. KeyPoint’sclients include companies, law firms, and government and regulatory agencies. Theacquisition of KeyPoint significantly expands the Company’s expertise in newpractice areas and helps strategically position the Company for additionalgrowth in its legal consulting area reported in the Healthcare, Regulatory, andLegal Compliance segment. Key Point contributed $5.6 million in revenue in2004, or approximately 2.9% of total segment revenue, and was moderatelyaccretive to 2004 earnings after consideration of related financing costs andamortization of identified intangibles.

Theaggregate consideration paid during the second quarter for KeyPoint consistedof $13.7 million in cash. An additional $1.5 million in cash was paidduring the third quarter, in accordance with the acquisition agreement. Theallocation of the purchase price is set forth below (in thousands):
| Total consideration                                |   | $      | 15,020 |   |
|----------------------------------------------------|--------|--------|--------|--------|
| Less Estimated Fair  Value of Identifiable Assets: |   |   |   |
| Cash                                               |   | (1,427 | )      |
| Receivables                                        |   | (864   | )      |
| Prepaid expenses                                   |   | (21    | )      |
| Property, plant and equipment, net                 |   | (112   | )      |
| Total Assets                                       |   | (2,424 | )      |
| Plus Estimated Fair  Value of Liabilities:         |   |   |   |
| Accounts payable and accrued expenses              |   | 294    |   |
| Accrued compensation                               |   | 233    |   |
| Deferred tax liability                             |   | 32     |   |
| Other liabilities                                  |   | 1,076  |   |
| Total Liabilities                                  |   | 1,635  |   |
| Goodwill and other  intangibles                    |   | $      | 14,231 |   |

 

Of the $14.2 million of goodwill and other intangiblesrecorded from the acquisition, approximately $0.3 million was assigned tocustomer relationships with a useful life of eight months and approximately 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**9.Business Combinations (Continued)**

$1.9 million was assignedto non-compete agreements with a useful life of four years. The remaininggoodwill of $12.0 million will be tested annually for impairment. Approximately$4.6 million of the goodwill is deductible for tax purposes.

*2002 Acquisitions*

EffectiveJanuary 1, 2002, the Company acquired 100% of the outstanding shares ofUnited Information Services, Inc. (“UIS”), located in Iowa, and expandedthe Company’s statement processing service offering within the InformationManagement and Distribution segment, which had existing locations in Arizonaand New York. The aggregate consideration paid for UIS consisted of$17.2 million in cash. Also, the former shareholders of UIS are eligibleto receive up to an additional $10.0 million in the Company’s common stockand cash if there is no breach in representations and warranties of theacquisition agreement, and certain future revenue, earnings and cash flowtargets are achieved over the three year period ended December 31, 2004.The allocation of the purchase price is set forth below (in thousands):
| Consideration  paid                                |   | $      | 17,160 |   |
|----------------------------------------------------|--------|--------|--------|--------|
| Less Estimated Fair  Value of Identifiable Assets: |   |   |   |
| Cash                                               |   | (1,944 | )      |
| Receivables                                        |   | (615   | )      |
| Prepaid expenses                                   |   | (157   | )      |
| Property, plant and equipment, net                 |   | (359   | )      |
| Other assets                                       |   | (379   | )      |
| Total Assets                                       |   | (3,454 | )      |
| Plus Estimated Fair  Value of Liabilities:         |   |   |   |
| Accounts payable and accrued expenses              |   | 1,824  |   |
| Accrued compensation                               |   | 224    |   |
| Deferred tax liability                             |   | 98     |   |
| Note payable                                       |   | 305    |   |
| Total Liabilities                                  |   | 2,451  |   |
| Goodwill and other  intangibles                    |   | $      | 16,157 |   |

 

Of the $16.2 million of goodwill and otherintangibles recorded from the acquisition, $4.0 million was assigned tocustomer relationships with a useful life of 15 years and approximately$0.4 million was assigned to non-compete agreements with a useful life of5 years. The remaining goodwill of $11.7 million is tested annuallyfor impairment and is not deductible for tax purposes.

At December 31, 2004,all of the $10.0 million of additional consideration has been recorded asadditional goodwill related to this acquisition in accordance with theacquisition agreement.

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**9.Business Combinations (Continued)**

*Goodwill andIntangibles*

The changes in thecarrying value of goodwill and intangibles are as follows (in thousands):

Goodwill:
| ** **                                              | ** ** | **Information  Management and  Distribution** | ** ** | **Healthcare,  Regulatory and  Legal Compliance** | ** ** | **Total** | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------------------------------|------------|-----------|------------|
| Net balance as of  January 1, 2003                 |       |                                               | $          | 159,755                                                     |       |      |       | $ | 144,816 |   |   | $ | 304,571 |   |
| Additional  accrued consideration and adjustments       |       |                                               | 2,252      |                                                        |       |      | 1,090      |   |   | 3,342 |   |
| Net balance as of  December 31, 2003               |       |                                               | 162,007    |                                                        |       |      | 145,906    |   |   | 307,913 |   |
| Goodwill acquired  (excluding contingent consideration) |       |                                               | —     |                                                        |       |      | 12,067     |   |   | 12,067 |   |
| Additional  accrued consideration and adjustments       |       |                                               | 5,653      |                                                        |       |      | 506        |   |   | 6,159 |   |
| Net balance as of  December 31, 2004               |       |                                               | $          | 167,660                                                     |       |      |       | $ | 158,479 |   |   | $ | 326,139 |   |

 

Intangibles:
| ** **              | ** ** | **2003**                       | ** ** | **2004**                      | ** ** |
|-------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **              | ** ** | **Gross Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** | **Gross Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** |
| Customer  relationships |       |                           | $          | 4,000                         |       |   |   | $ | (534 | ) |   |   | $ | 4,283 |   |   |   | $ | (1,084 | ) |   |
| Non-compete  agreements |       |                           | 440        |                          |       |   | (175 | ) |   |   | 2,321 |   |   |   | (616 | ) |   |
| Total                   |       |                           | $          | 4,440                         |       |   |   | $ | (709 | ) |   |   | $ | 6,604 |   |   |   | $ | (1,700 | ) |   |

 

Aggregateamortization expense related to intangibles for the years endedDecember 31, 2002, 2003 and 2004 was approximately $0.4 million, $0.4million and $1.0 million, respectively. Estimated amortization expense for theperiods ending December 31, 2005 through December 31, 2016 ispresented in the table below.
| **Years Ending December 31,** | ** ** | ** **              | ** ** | **Estimated  Amortization  Expense** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|--------------------------------------|------------|
| ** **                                   | ** ** | **(in thousands)** | ** ** |
| 2005                                         |       |                    | $          | 825                                  |       |   |
| 2006                                         |       |                    | 825        |                                 |       |
| 2007                                         |       |                    | 737        |                                 |       |
| 2008                                         |       |                    | 384        |                                 |       |
| 2009                                         |       |                    | 267        |                                 |       |
| Thereafter                                   |       |                    | 1,866      |                                 |       |
| Total                                        |       |                    | $          | 4,904                                |       |   |

 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**9. BusinessCombinations (Continued)**

At October 31, 2004, the Company performed theannual goodwill impairment test as required by SFAS No. 142. The Companycompared the fair values of the reporting units to their carrying values. Indetermining the fair value of the reporting units, the Company used the IncomeApproach and the Market Approach. The fair value of all reporting unitsexceeded their carrying value at October 31, 2004. As such, no impairmentfor goodwill was recognized.

At December 31, 2004, net aggregate goodwilldeductible for tax purposes was approximately $151.5 million.

Due to the fact that the Company is primarily aservices company, its business acquisitions typically result in significantamounts of goodwill and other intangibles. Therefore, an impairment chargeresulting from goodwill and other intangibles could result in a materialadverse impact on the Company’s financial statements during the periodincurred.

*ContingentConsideration*

Certain of the Company’s acquisitions are subject toadjustments in overall consideration and recorded goodwill based upon theachievement of specified revenue and/or earnings targets generally over one tothree year periods. In certain agreements, the Company reserves the right tochange the payment mix to use common stock versus cash in satisfying contingentconsideration liabilities. In transactions where the Company acquired asubsidiary through a tax-free stock merger, the Company is required to pay aminimum amount of total consideration in common stock rather than cash,including any contingent consideration payments.

Management’s evaluation of the cumulative earnings ofacquired companies through December 31, 2004 indicated that certainacquired companies have met specified earnings targets beyond a reasonabledoubt; therefore the Company accrued aggregate additional consideration ofapproximately $5.8 million during the year ended December 31, 2004. As of December 31,2004, in connection with the 2002 purchase of UIS, approximately $5.3 millionof additional consideration remains accrued which is classified as othercurrent liabilities and is expected to be settled in cash during 2005. Inaccordance with the agreements, the Company has the option to satisfy theentire $5.3 million (or any part thereof) in common stock with final valuationdetermined at date of issuance.

As of December 31, 2004, all periods applicablefor earnout targets of past acquisitions are completed.

*Acquisition RelatedReceipts/Payments*

The Company made net acquisition related payments of $3.0 millionin cash during the year ended December 31, 2003 and released 20,268 sharesof common stock from escrow at a price of $13.96 per share at March 31,2003. In addition, the Company received reimbursements of approximately$1.1 million of purchase price related to a past acquisition unrelated tothe Company’s restatement, more fully discussed, in Note 3, recorded as areduction to goodwill, in the Information Management and Distribution segmentand made other acquisition related payments of approximately $0.3 million.

During the year ended December 31, 2004, theCompany paid net consideration of approximately $3.4 million in cash and 30,324shares of common stock at an average price of $26.12 per share related tocontingent consideration agreements of past acquisitions. Additionally, theCompany paid $13.7 million, net of cash acquired, related to the KeyPointacquisition and the associated transaction costs and $0.3 of additionalpurchase proceeds related to the purchase agreement of a past acquisition.

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**9.Business Combinations (Continued)**

*Unaudited Pro FormaFinancial Data*

Pro forma financialinformation is not presented as neither of the acquisitions in 2002 or 2004qualifies as a significant subsidiary.

**10. Long-term Obligationsand Credit Facilities**

*Long-termObligations*

Long-termobligations consist of the following (in thousands):
| ** **                                                                                                                                                                                                                                                                   | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                   | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Line of credit,  expiring April 2006, interest at prime rate plus applicable margin or  LIBOR plus applicable margin (2.38% to 2.42% at December 31, 2003 and  3.92% to 4.17% at December 31, 2004)                                                           |       | $                     | 68,000     |   | $ | 82,490 |   |
| Industrial  Revenue Bonds: Variable Rate (1.25% at December 31, 2003 and 2.00% at  December 31, 2004) Demand/Fixed Rate Revenue Bonds, Prince George’s  County, Maryland; due beginning in 1996 through 2014 secured by an  irrevocable letter of credit |       | 1,750                 |       | 1,650 |   |
| All other  obligations                                                                                                                                                                                                                                                       |       | 3,849                 |       | 3,665 |   |
| Total                                                                                                                                                                                                                                                                        |       | 73,599                |       | 87,805 |   |
| Less—Current  maturities of long-term obligations                                                                                                                                                                                                                       |       | (209                  | )          | (258 | ) |
| Total long-term  obligations                                                                                                                                                                                                                                                 |       | $                     | 73,390     |   | $ | 87,547 |   |

 

In April 2001, the Company entered into a line ofcredit with a group of banks led by Bank of America, SunTrust Bank and WellsFargo Bank, as co-agents (the “2001 Credit Agreement”) and terminated theprevious line of credit agreement. At December 31, 2004, under the 2001Credit Agreement, the Company may borrow on a revolving credit basis loans inan aggregate outstanding principal amount up to $290.0 million, subject tocertain financial covenants and ratios. Through April 1, 2006, the 2001Credit Agreement is secured by the stock of the Company’s materialsubsidiaries, and in the event the Company exceeds a designated leverage ratio,by the assets of the Company and subsidiaries.

At December 31,2004, the remaining commitment under the 2001 Credit Agreement is $290.0million and is scheduled to mature as follows (in millions):
| **Maturity Date** | ** ** | ** ** | ** ** | **Commitment** | ** ** | **Remaining  Commitment** | ** ** |
|------------------------|------------|------------|------------|----------------|------------|---------------------------|------------|
| April 2,  2005    |       |       | $          | 52.5           |       |                      |       | $ | 237.5 |   |   |
| April 1,  2006    |       |       | 237.5      |           |       |                      | —     |   |   |
| Total                  |       |       | $          | 290.0          |       |                      |       |   |   |   |

 

The annual interest rate applicable to borrowingsunder this facility is, at the Company’s option, (i) grid pricing rangingfrom 0.0% to 0.5% plus the prime rate based on the ratio of funded debt toearnings before interest, taxes, depreciation and amortization (“EBITDA”) (asdefined in the credit agreement) or (ii) grid pricing ranging from 1.125%to 2.0% plus LIBOR based on the ratio of funded debt to EBITDA. The 2001 CreditAgreement requires mandatory prepayments in certain circumstances, 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**10.Long-term Obligations and Credit Facilities (Continued)**

such as assetdispositions. The outstanding principal balance of revolving credit loans isdue and payable on April 1, 2006.

At December 31, 2004, the Company has outstandingirrevocable letters of credit totaling approximately $12.3 million. Lettersof credit in the amount of approximately $8.0 million serves as securityfor the Company’s self-insured workmen’s compensation program. A letter ofcredit in the amount of $2.5 million serves as a guarantee for performanceunder a contract with New York State Workers Compensation Board. A letter ofcredit in the amount of approximately $1.8 million serves as guarantee forperiodic principal and interest payments related to the Industrial RevenueBonds.

The weighted average interest rate on long-termobligations during 2003 and 2004 was 4.2% and 3.7%, respectively.

The 2001 Credit Agreement contains certain reportingrequirements and financial covenants, including requirements that the Companymaintain minimum levels of net worth, a maximum ratio of funded debt to EBITDAand other financial ratios, and prohibits the payment of cash and similardividends. These ratios were scheduled to become more restrictive beginning inthe quarter ended December 31, 2002 with the leverage ratio declining from3.0 times to 2.5 times and the fixed charge coverage ratio increasing from 1.25times to 1.50 times. However, in September 2002, an amendment was approvedthat extended the fixed cost coverage ratio requirement of 1.25 until January 1,2004 and will increase to 1.35 at all times thereafter. In addition to theleverage and fixed cost coverage ratios, the Company is subject to minimum networth requirements. Effective March 26, 2003, an amendment was approvedthat allows for the reduction to the minimum net worth requirement for up to$30 million of share repurchases. In addition, effective July 30,2004, an amendment was approved that allows for the reduction to the minimumnet worth requirement for an additional $30 million of share repurchases.

As a result of the Company’s internal investigation,more fully described in Note 3 to these consolidated financial statements, theCompany was unable to file its September 30, 2004 Quarterly Report on Form 10-Qwithin the timeframe prescribed by the Securities Exchange Act of 1934. Thefailure to timely file the September 30, 2004 Quarterly Report on Form 10-Qresulted in a default under the 2001 Credit Agreement. The Company entered intoa waiver agreement on November 12, 2004 with the lenders party to the 2001Credit Agreement. Pursuant to the terms of the waiver agreement, the lendersagreed, among other things, to waive any default under the 2001 CreditAgreement that resulted from potential non-compliance with a designated fixedcharge coverage ratio, and our failure to timely file our Quarterly Report on Form 10-Qfor the September 30, 2004 quarter. The waiver agreement also providesthat during the period that the waiver agreement is in effect, the outstandingprincipal amount of the loans under the 2001 Credit Agreement may not exceed$112,000,000. The waiver agreement was to expire on March 15,2005; however, on March 15, 2005, the Company entered into on Extensionand Modification of Waiver to Credit Agreement, which extended such waiverthrough March 23, 2005.

Effective March 23, 2005, the Company enteredinto an amendment to the 2001 Credit Agreement that allows for the exclusion ofcertain contingent consideration overpayments to the former owners of theOperating Subsidiary, as described more fully in Note 3 to these consolidatedfinancial statements, from the definition of EBITDA. Pursuant to the terms ofthe Company’s 2001 Credit Agreement, EBITDA is used in calculating certainleverage and fixed cost coverage ratios. By not having the March 23, 2005amendment in place, the Company was in a default under the 2001 CreditAgreement due to the Company 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**10.Long-term Obligations and Credit Facilities (Continued)**

exceeding the allowableleverage ratio of 2.5 times for the quarters ended June 30, 2004 and September 30,2004, as a result of the contingent consideration overpayments, previouslydiscussed. As a result, the Company classified the debt under such CreditAgreement as a Current Maturity included in the current liability section ofits balance sheet at June 30 and September 30, 2004. Upon enteringthe March 23, 2005 amendment, the Company cured the default under the 2001Credit Agreement, as such, reclassifying debt under the Credit Agreement asLong-Term Obligations. Because the maturity date of the debt under the 2001Credit Agreement is April 1, 2006, unless the maturity date of such debtis subsequently modified, such debt will be classified to Current Maturity onand after April 1, 2005.

As of December 31, 2004 and through March 31, 2005,the Company is in compliance with loan covenants after giving effect to theamendments and waivers described above, which among other things provided foran amended definition of EBITDA. As of December 31, 2004, the availabilityunder the 2001 Credit Agreement was $8.7 million.

In December 2000, inorder to mitigate interest rate risk related to the line of credit, the Companyentered into an interest rate hedge agreement in the amount of$50.0 million, whereby the Company effectively fixed the interest ratethrough March 2003 on the amount of the hedge agreement at 5.775%. Theinterest rate hedge agreement expired on March 31, 2003 and was notreplaced. See Note 14, Interest Rate Swap, regarding the interest ratehedge.

*Maturities of Long-TermObligations*

As of December 31,2004, maturities of long-term obligations are as follows (in thousands):
| **Years Ending December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|
| 2005                                         |       | $          | 258        |       |
| 2006                                         |       | 86,051     |       |
| 2007                                         |       | 125        |       |
| 2008                                         |       | 164        |       |
| 2009                                         |       | 157        |       |
| Thereafter                                   |       | 1,050      |       |
| Total                                        |       | $          | 87,805     |       |

 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**11. Lease Commitments**

TheCompany leases various office buildings, machinery, equipment and vehicles.Future minimum lease payments under capital leases, included in long-termobligations, and noncancelable operating leases are as follows (in thousands):
| **Years Ending December 31,**                   | ** ** | ** ** | ** ** | ** Capital   Leases** | ** ** | ** Operating   Leases** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|---------------------------------|------------|-----------------------------------|------------|
| 2005                                                           |       |       | $          | 132                             |       |                              |       | $ | 17,314 |   |   |
| 2006                                                           |       |       | 114        |                            |       |                              | 14,195     |   |   |
| 2007                                                           |       |       | 26         |                            |       |                              | 11,843     |   |   |
| 2008                                                           |       |       | 14         |                            |       |                              | 8,443      |   |   |
| 2009                                                           |       |       | 8          |                            |       |                              | 3,633      |   |   |
| Thereafter                                                     |       |       | —     |                            |       |                              | 8,558      |   |   |
| Total minimum lease payments                                   |       |       | 294        |                            |       |                              | $          | 63,986 |   |   |
| Less—Amounts  representing interest                       |       |       | (13        | )                               |       |                              |       |   |   |
| Net minimum lease  payments                                    |       |       | 281        |                            |       |                              |       |   |   |
| Less—Current  portion of obligations under capital leases |       |       | (124       | )                               |       |                              |       |   |   |
| Long-term  portion of obligations under capital leases         |       |       | $          | 157                             |       |                              |       |   |   |   |

 

Rent expense for alloperating leases for the years ended December 31, 2002, 2003 and 2004 wasapproximately $23.6 million, $23.7 million, and $24.4 million,respectively.

**12. Income Taxes**

Theprovision for federal and state income taxes consists of the following (inthousands):
| ** **    | ** ** | **Year Ended December 31,** | ** ** |
|---------------|------------|--------------------------------------------|------------|
| ** **    | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2004** | ** ** |
| Federal— |       |                                       |       |   |   |   |   |
| Current       |       | $                                          | 4,124      |   | $ | 5,344 |   | $ | (644 | ) |
| Deferred      |       | 6,136                                      |       | 5,043 |   | 2,280 |   |
| State—   |       |                                       |       |   |   |   |   |
| Current       |       | 1,054                                      |       | 931 |   | 220 |   |
| Deferred      |       | 1,054                                      |       | 1,414 |   | (23 | ) |
|          |       | $                                          | 12,368     |   | $ | 12,732 |   | $ | 1,833 |   |

 

The provision amounts above include approximately$448,000, ($562,000) and ($1,623,000) of income tax expense (benefit) relatedto discontinued operations in 2002, 2003 and 2004, respectively.

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**12.Income Taxes (Continued)**

The differences in income taxes provided and theamounts determined by applying the federal statutory tax rate to income beforeincome taxes result from the following (in thousands):
| ** **                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                 | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2004** | ** ** |
| Tax at statutory  rate                     |       | $                                          | 11,552     |   | $ | 11,134 |   | $ | 3,478 |   |
| Add (deduct)—                         |       |                                       |       |   |   |   |   |
| State income taxes                         |       | 1,696                                      |       | 1,703 |   | 207 |   |
| Tax credits                                |       | (549                                       | )          | (633 | ) | (358 | ) |
| Nondeductible expenses                     |       | 224                                        |       | 421 |   | 375 |   |
| Reduction of estimated income tax accruals |       | —                                     |       | — |   | (1,331 | ) |
| Other                                      |       | (555                                       | )          | 107 |   | (538 | ) |
|                                       |       | $                                          | 12,368     |   | $ | 12,732 |   | $ | 1,833 |   |

 

The reduction of estimated income tax accruals relatesprimarily to the favorable resolution of certain federal and state taxcontingencies in 2004.

The components ofdeferred income tax liabilities and assets are as follows (in thousands):
| ** **                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Deferred income tax liabilities—          |       |                  |       |   |   |
| Tax over book  depreciation and amortization   |       | $                     | (14,583    | ) | $ | (17,325 | ) |
| Other, net                                     |       | (1,278                | )          | (2,202 | ) |
| Total deferred income  tax liabilities         |       | (15,861               | )          | (19,527 | ) |
| Deferred income tax assets—               |       |                  |       |   |   |
| Allowance for doubtful  accounts               |       | 2,940                 |       | 3,349 |   |
| Accrued liabilities                            |       | 3,729                 |       | 2,671 |   |
| Other reserves, net                            |       | 3,511                 |       | 5,569 |   |
| Total deferred income  tax assets              |       | 10,180                |       | 11,589 |   |
| Total net deferred  income tax liabilities     |       | $                     | (5,681     | ) | $ | (7,938 | ) |
| Current portion of  deferred income tax assets |       | $                     | 6,072      |   | $ | 5,272 |   |
| Long-term deferred  income tax liabilities     |       | (11,753               | )          | (13,210 | ) |
|                                           |       | $                     | (5,681     | ) | $ | (7,938 | ) |

 

At December 31, 2004,the Company had approximately $0.2 million of net operating losses and$1.1 million of state tax credits available for carryover to future years.The net operating losses are subject to certain limitations but the Companyexpects to fully utilize these losses as well as the state tax credit carryforwards.

**13. Stockholders’ Equity**

*Stock-BasedCompensation:*

In 2002, the Board of Directors and Shareholders ofthe Company approved the 2002 Long-Term Incentive Plan (the “2002 Plan”), whichis described below. The 2002 Plan replaced the 1995 Stock Option Plan, asamended (the “1995 Plan”). Grants outstanding under the 1995 Plan will continueto be subject to the provisions of the 1995 Plan; no additional awards will begranted under the 1995 Plan.

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**13. Stockholders’ Equity**(Continued)

The 2002 Plan authorizes awards of options to purchasecommon stock and may include incentive stock options (“ISOs”) and/ornon-qualified stock options (“NQSOs”), stock appreciation rights, restrictedstock, deferred stock, bonus stock and awards in lieu of cash obligations,dividend equivalents and other stock-based awards. In addition, theCompany issued warrants (the “Warrants”) to certain key employees and employeesof its subsidiaries. The Company refers to awards under the 2002 Plan and the1995 Plan collectively as “Awards” and refers to warrants granted from time totime as Warrants.

The Board of Directors has appointed a committee (the “Committee”),which is composed of independent, non-employee directors, to administer the2002 Plan. Persons eligible to receive awards under the plan include directors,officers and employees of the Company and its subsidiaries, and persons whoprovide consulting services to the Company deemed by the Committee to be ofsubstantial value to the Company, persons who have been offered employment bythe Company or its subsidiaries, and persons employed by an entity that theCommittee reasonably expects to become a subsidiary of the Company. Awardsgranted under the plan may, at the discretion of the Committee, be grantedeither alone or in addition to, in tandem with or in substitution for any otheraward granted under the Plan or any other plan of the Company, any subsidiaryor any business entity to be acquired by the Company or one of itssubsidiaries. The Committee determines vesting in awards granted under theplan. Historically, when the Company has issued Warrants, it has been either atthe recommendation of the Compensation Committee or the full Board. Each of the1995 Plan, the 2002 Plan and individual grants of Warrants have been previouslyapproved by the Company’s stockholders.

The total number of shares of common stock that may besubject to outstanding awards shall not exceed 16% of the total number ofshares of common stock outstanding at the effective time of such grant (or650,000, whichever is greater), plus an additional 600,000 shares. The numberof shares of common stock that may be issued upon the exercise of ISOs cannotexceed 650,000. To date, the Company has not issued any isos. In addition, during any calendar year, no participantmay be granted awards that may be settled by delivery of more than 500,000shares of common stock, or, in the case of awards that may be settled in cash,by payment of cash that exceeds the fair market value of 500,000 shares ofcommon stock, determined either at the time of grant or at the time of payment,whichever is greater.

During 2003, the Company awarded 164,300 shares ofrestricted stock under the 2002 Plan. The restricted shares were issued at nocost to the recipients; therefore, the Company recorded deferred compensationof approximately $2.9 million based on the market value of the stock atthe date of issuance. Subsequent to the grant date, certain forfeitures ofrestricted stock occurred resulting in a total award of 155,000 shares andtotal deferred compensation of $2.8 million. The deferred compensation chargeis being amortized to expense over the vesting period of the restricted stock.The restricted shares vest over a three-year period ending July 1, 2006,with acceleration of the vesting period occurring if a certain stock price orperformance target is achieved. For the twelve months ended December 31,2003 and 2004, approximately $0.6 million and $0.9 million, respectively,of deferred compensation was amortized to expense related to the 2003 grants ofrestricted stock.

During 2004, the Company awarded 182,550 shares ofrestricted stock under the 2002 Plan. The restricted shares were issued at nocost to the recipients; therefore, the Company recorded deferred compensationof approximately $4.6 million based on the market value of the stock at thedate of issuance. Subsequent to the grant date, certain forfeitures ofrestricted stock occurred resulting in a total award of 177,300 shares andtotal deferred compensation of $4.5 million. The deferred compensation chargeis 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**13.Stockholders’ Equity (Continued)**

being amortized to expenseover the vesting period of the restricted stock. The restricted shares vest on January 10,2007 and May 26, 2007, with acceleration of the vesting period for certainshares occurring if certain performance targets are achieved. For the twelvemonths ended December 31, 2004, approximately $1.4 million ofdeferred compensation was amortized to expense related to the 2004 grants ofrestricted stock.

At December 31, 2004, there were no outstandinggrants of stock appreciation rights, deferred stock, bonus stock and awards inlieu of cash obligations, dividend equivalents or other stock-basedawards under the 2002 Plan.

TheCompany had 2,190,949 Awards and 1,042,094 Warrants outstanding at December 31,2004. These Awards and Warrants generally have 10-year expirations with certainAwards granted to non-employee directors having 5-year expirations. At December 31,2003 and 2004, approximately 618,013 and 636,626 shares, respectively, wereavailable for issuance.
| ** **                           | ** ** | **Option and Warrant  Awards Outstanding** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                           | ** ** | **Shares**                                                | ** ** | **Weighted Average  Exercise Price** | ** ** |
| ** **                           | ** ** | **(in thousands)**                                   | ** ** | ** ** | ** ** |
| Balance,  January 1, 2002       |       |                                                      | 2,940      |   |   |   | $ | 28.52 |   |   |
| Granted                              |       |                                                      | 806        |   |   |   | $ | 24.84 |   |   |
| Exercised                            |       |                                                      | (5         | ) |   |   | $ | 22.23 |   |   |
| Forfeited                            |       |                                                      | (139       | ) |   |   | $ | 28.45 |   |   |
| Balance,  December 31, 2002     |       |                                                      | 3,602      |   |   |   | $ | 27.71 |   |   |
| Granted                              |       |                                                      | 249        |   |   |   | $ | 17.68 |   |   |
| Exercised                            |       |                                                      | (17        | ) |   |   | $ | 21.59 |   |   |
| Forfeited                            |       |                                                      | (340       | ) |   |   | $ | 27.83 |   |   |
| Balance,  December 31, 2003     |       |                                                      | 3,494      |   |   |   | $ | 27.04 |   |   |
| Granted                              |       |                                                      | 35         |   |   |   | $ | 26.51 |   |   |
| Exercised                            |       |                                                      | (22        | ) |   |   | $ | 22.49 |   |   |
| Forfeited                            |       |                                                      | (274       | ) |   |   | $ | 30.33 |   |   |
| Balance, December 31, 2004      |       |                                                      | 3,233      |   |   |   | $ | 26.80 |   |   |
| Exercisable, December 31, 2002  |       |                                                      | 1,753      |   |   |   | $ | 27.33 |   |   |
| Exercisable, December 31, 2003  |       |                                                      | 2,099      |   |   |   | $ | 27.59 |   |   |
| Exercisable,  December 31, 2004 |       |                                                      | 2,581      |   |   |   | $ | 27.66 |   |   |

 

The weighted-average grant-date fair value of optionawards granted during 2002, 2003 and 2004 was approximately $7.99, $6.63 and$9.71 per share, respectively.

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**13.Stockholders’ Equity (Continued)**

The following tablesummarizes information about Option and Warrant Awards granted under the Plansthat were outstanding at December 31, 2004:
| ** **                              | ** ** | **Option and Warrant Awards Outstanding** | ** ** | **Option and Warrant  Awards Exercisable** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | ** **                                                    | ** ** | **Number  Outstanding at  December 31,  2004**  | ** ** | **Weighted-Average  Remaining  Contractual Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable at  December 31,  2004** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $13.00-23.70                            |       |                                                          | 800,481    |                                                      |       |   | 5.57 |   |   |   | $ | 21.23 |   |   |   | 527,101 |   |   |   | $ | 22.10 |   |   |
| $23.75-26.38                            |       |                                                          | 803,667    |                                                      |       |   | 5.87 |   |   |   | $ | 25.72 |   |   |   | 469,307 |   |   |   | $ | 25.71 |   |   |
| $26.40-29.25                            |       |                                                          | 642,440    |                                                      |       |   | 4.30 |   |   |   | $ | 27.99 |   |   |   | 614,865 |   |   |   | $ | 28.01 |   |   |
| $29.25-30.38                            |       |                                                          | 686,475    |                                                      |       |   | 5.92 |   |   |   | $ | 30.38 |   |   |   | 686,475 |   |   |   | $ | 30.38 |   |   |
| $31.00-36.19                            |       |                                                          | 299,980    |                                                      |       |   | 5.35 |   |   |   | $ | 33.80 |   |   |   | 283,300 |   |   |   | $ | 33.88 |   |   |
|                                         |            |                                                               |            |                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Common StockRepurchase Program*

During 2003, the Company activated the$30.0 million stock repurchase program authorized by the Board ofDirectors in April 2001 and purchased 1,306,979 shares of its common stockat a cost of approximately $20.7 million. During the second quarter of2004, the Company purchased an additional 361,415 shares of its commonstock at a cost of approximately $9.3 million completing the authorized repurchaseprogram. The repurchased shares were recorded in the accompanying balance sheetas a reduction in common stock for the par value of the shares, in additionalpaid-in-capital in the amount of $20.0 million and in retained earnings inthe amount of $10.0 million. These shares were retired and returned to thestatus of authorized but unissued shares of the Company.

During the third quarterof 2004, the Board of Directors authorized the purchase of an additional $20.0million of shares from time to time on the open market as conditions warrant. Duringthe third and fourth quarters of 2004, the Company purchased 117,524 shares ofits common stock at a cost of approximately $2.6 million. The repurchasedshares were recorded in the accompanying balance sheet as a reduction in commonstock for the par value of the shares, in additional paid-in-capital in theamount of $1.5 million and in retained earnings in the amount of $1.1million. These shares were retired and returned to the status of authorized butunissued shares of the Company.

*Net Income (Loss)Per Share*

Basicand diluted net income per share were computed in accordance with SFAS No. 128,*Earnings Per Share*. Thedifferences between basic weighted average common shares and diluted weightedaverage common shares and potentially dilutive common shares are as follows (inthousands):
| ** **                                                | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2004** | ** ** |
| Basic weighted  average common shares outstanding         |       | 17,334                                     |       | 16,452 |   | 15,893 |   |
| Weighted average  options, warrants, and restricted stock |       | 59                                         |       | 98 |   | 310 |   |
| Other contingent  consideration                           |       | 216                                        |       | 15 |   | 14 |   |
| Diluted weighted  average common shares outstanding       |       | 17,609                                     |       | 16,565 |   | 16,217 |   |

 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**13. Stockholders’ Equity (Continued)**

At December 31, 2002,2003 and 2004 approximately 3,579,000, 2,569,000 and 2,997,000 respectively, ofcommon shares were not included in the diluted earnings per share calculationbecause they were anti-dilutive. These common shares may be dilutive infuture earnings per share calculations.

**14. Interest Rate Swap**

On December 22, 2000,the Company entered into an interest rate swap to hedge, through March 31,2003, its exposure to fluctuations in interest rates on $50 million of itsdebt. This interest rate swap had the effect of fixing the interest rate on$50 million of the Company’s debt at 5.775%. In accordance with SFAS No. 133,the Company concluded the interest rate swap qualified as a cash flow hedge.The hedge expired on March 31, 2003 and was not replaced.

**15. Employee Benefit Plans**

The Company maintains a defined contribution plan (the“401(k) plan”) that covers the Company’s employees and the employees ofthe majority of its subsidiaries. The employees must be at least 21 yearsof age and are eligible for the plan on the first of the month following90 days of service. The Company also maintains a non-qualified plan (“RabbiTrust”) that permits eligible officers and certain highly compensated employeesto defer a portion of their compensation. Contributions to both the 401(k) planand the non-qualified compensation plan consist of employee pre-taxcontributions determined as a percentage of each participating employee’scompensation. The Company may make contributions to either or both plans at thediscretion of the Board of Directors. The Company incurred costs of $0.3 millionand a reduction to expense of $0.3 million related to the 401(k) planfor the years ended December 31, 2002 and 2003, respectively. No costswere incurred related to the 401(k) plan fur the year ended December 31,2004. The Company incurred costs of $0.2 million, $0.1 million and$0.3 million related to the non-qualified compensation plan for the yearsended December 31, 2002, 2003 and 2004, respectively. The total value ofthe Rabbi Trust at December 31, 2004 was approximately $8.9 millionand was included in the Company’s consolidated balance sheet as OtherNoncurrent Assets with a corresponding balance in Other Long-Term Obligations.The Company offers no post-employment or post-retirement benefits.

Certain of the operatingcompanies have separate qualified defined contribution employee benefit plans(the “Plans”), the majority of which allow for voluntary pre-tax contributionsby employees. The subsidiaries pay all general and administrative expenses ofthe Plans and, in some cases, the subsidiaries make matching and discretionarycontributions to the Plans. The subsidiaries offer no post-employment orpost-retirement benefits. The expense incurred related to the Plans wasapproximately $0.1 million in each of the years ended December 31, 2002,2003 and 2004.

**16. Related Party Transactions**

*LeasingTransactions*

Certain operatingcompanies lease their operating facilities from selling parties who remained asemployees. These leases are for various lengths and annual amounts. The rentalexpense for these operating leases for the years ended December 31, 2002,2003 and 2004 was approximately $1.6 million, $1.6 million and $1.2 million,respectively. None of these arrangements are with any of the Company’sdirectors or executive officers.

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**17. Commitments and Contingencies**

***Litigation***

The Company is, from timeto time, a party to litigation arising in the normal course of business. Thefollowing is a description of the most significant legal matters that theCompany is involved in. In the event of an adverse outcome in one or more ofthe legal proceedings our business, financial condition, results of operationsor cash flows could be materially adversely affected.

*Putative SecuritiesClass Action*

The Company, and theCompany’s CEO and CFO individually, have been named as defendants in severalputative securities class actions, in response to the Company’s press releasesdated October 27, 2004, in which the Company disclosed that itsfinancial statements for certain prior periods should no longer be relied upon,and also provided updated financial guidance. The complaints (collectively, the“Actions”) were filed in the United States District Court for the NorthernDistrict of Texas, Dallas Division. The Actions are putative shareholder classaction lawsuits alleging violations of Federal Securities Laws, includingalleged violations of Sections 10(b) and 20(a), and Rule 10b-5of the Securities Exchange Act of 1934, as amended. The Actions are purportedlyon behalf of all persons who purchased the Company’s common stock during theperiod between May 7, 2003, and October 26, 2004 or October 27,2004, depending on the Action, and seek unspecified damages. The four Actionshave been transferred to a single judge in the Northern District of Texas,Dallas Division and these actions have been consolidated and a motion ispending to consolidate each of the actions into a single action styled *Richard Bassin v. Sourcecorp, Inc., et al*.

*PurportedDerivative Action and Demand Letter*

A purported stockholderderivative action was filed on December 28, 2004, against certain of theCompany’s current and former officers and directors as individual defendantsand the Company as a nominal defendant in the 116th District Court for DallasCounty, Texas (the “Purported Derivative Action”). The Purported DerivativeAction alleges breach of fiduciary duty, abuse of control, gross mismanagement,waste of assets, and unjust enrichment related to the Company’s press releasedated October 27, 2004, in which the Company disclosed that its financialstatements for certain prior periods should no longer be relied upon. All ofthese claims are asserted derivatively on behalf of the Company. Further, theChairman of the Company’s Board of Directors received from a purportedshareholder a demand letter (the “Demand Letter”) based on the same set offacts as the Purported Derivative Action. The Company has formed a specialcommittee of the Board of Directors to evaluate the claims made in thePurported Derivative Action and the Demand Letter.

*Digital ImagingSystems*

On August 5, 2004,Digital Imaging Systems, Inc. filed suit against the Company in the UnitedStates District Court-Southern District of New York alleging, among otherthings, that a portion of the Company’s process for scanning and indexingimages violates one of Digital Imaging Systems’ patents. The Company hastendered this matter to one of its software/hardware vendors forindemnification, which such vendor is evaluating. The suit demands unspecifieddamages.

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**17.Commitments and Contingencies (Continued)**

*Various ROI CopyCharge Matters*

From time to time, varioussubsidiaries of the Company that perform release of information (“ROI”)services become defendants to putative class action lawsuits generally allegingthat the charge for reproducing certain medical records is not in conformitywith such plaintiffs’ reading of the applicable regulated charge. Such suitstypically include multiple ROI companies and hospitals as defendants and demandreimbursement for prior charges as well as for prospective pricing adjustments.The Company is currently a party to several such suits in various stages ofdevelopment. One such suit styled *McShane v.Recordex Acquisition Corp. & Sourcecorp, Incorporated*,filed in the Court of Common Pleas Philadelphia County, Pennsylvania,alleges among other things that the Company intentionally charges more forproviding copies of medical records than is permitted under Pennsylvania law. InSeptember 2004, the court entered its order certifying a class in thismatter.

*Spohr. et. al. v.F.Y.I. Incorporated, et. al.*

In June 2000, theCompany filed an action styled *F.Y.I.Incorporated v. Spohr, et. al.* in Dallas, Texas, in which itasserted claims for breach of contract, fraud, and negligent misrepresentationagainst the sellers of two related companies the Company acquired in December 1998(the “Texas Action”). The Texas Action was later removed to federal court andultimately dismissed on jurisdictional grounds. The Company reasserted theseclaims in two actions that were later consolidated; one styled *F.Y.I. Incorporated v. Spohr, et. al.* inSuperior Court of the State of California in the County of Sacramento, Case No. 01-AS-00721(the “Sacramento Action”) and one styled *Spohr,et. al. v. F.Y.I. Incorporated, et. al.* in the Superior Court of theState of California in the County of San Francisco, Case No. 318703 (the “SanFrancisco Action”). In the consolidated action, the Company additionally filedclaims against the sellers’ accountants and the two sellers filed claimsagainst the Company; however, in February 2004, the judge in theSacramento Action dismissed the Company’s claims against the sellers’accountants. The sellers allege that the Company’s former subsidiary wrongfullyfailed and refused to execute and deliver a requested estoppel certificate, andthat the failure to provide such estoppel certificate harmed the landlord inthat they were allegedly denied favorable terms on a refinancing of theproperty and were allegedly prevented from completing a timely sale of theproperty. Sellers alleged damages of approximately $1.5 million. TheCompany asserted damages in excess of $8 million. On February 3, 2005,the parties settled this matter on mutually acceptable terms consistent withprevious amounts accrued.

***Contract-related Contingencies***

The Company has certaincontingent liabilities that arise in the ordinary course of providing servicesto its customers. These contingencies are generally the result of contractsthat require the Company to comply with certain performance measurements or thedelivery of certain services by a specified deadline. The Company believes thatthe ultimate liability, if any, incurred under these contract provisions willnot have a material adverse effect on the Company’s consolidated financialcondition, results of operations or cash flows.

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**17. Commitments and Contingencies**(Continued)

***Concentration of Credit Risk***

Financial instruments thatpotentially subject the Company to concentration of credit risk consistprimarily of cash and cash equivalents and trade receivables. The Companymaintains cash and cash equivalents and certain other financial instruments atvarious major financial institutions across many geographic areas. Credit riskon trade receivables is minimized as a result of the large number of entitiescomprising our client base and their dispersion across many industries andgeographic areas.

**18. Subsequent Events**

*DiscontinuedOperations*

During the first quarterof 2005, the Company formally committed to a plan of divestiture for anon-strategic asset group related to its litigation service operations reportedin the Healthcare, Regulatory and Legal Compliance segment in prior periods. During2004, the operation contributed approximately $3.7 million of revenue and lossbefore income taxes of approximately $0.3 million. The Company has concludedthe asset group meets the requirements for discontinued operations accountingtreatment as outlined in SFAS No. 144, “*Accountingfor the Impairment or Disposal of Long-Lived Assets*” subsequent toDecember 31, 2004. As such, the results associated with this litigationservice operation will be accounted for as discontinued operations beginning inthe first quarter of 2005.

**19. Segment Reporting**

The Company aggregates its service offerings andoperations into two reportable segments: (i) Information Management andDistribution, and (ii) Healthcare, Regulatory, and Legal Compliance. TheCompany’s reportable segments are organized around customer types and serviceofferings possessing similar economic characteristics. Management evaluatessegment performance based on revenue and income before income taxes. Allcentrally incurred corporate costs are allocated to the segments basedprincipally on operating income of the reportable segments measured before theinclusion of the expense related to the contingent consideration overpaymentsdiscussed in Note 3. The reporting segments follow the same accounting policiesused for the Company’s consolidated financial statements as described in thesummary of significant accounting policies.

The identified segments are as follows:

**Information Management andDistribution.  **This segment offers Business ProcessOutsourcing (“BPO”) solutions that help its customers manage the *Document In-flow*, *Workflow Processing* and *Statement Out-flow* of their missioncritical business document processes. This segment’s BPO solutions enable customersto automate their complex workflow processes by digitizing extremely largevolumes of documents, capturing information from the documents, hostingelectronic documents on the Company’s Web-based repository, and preparingstatements that customers mail or present electronically to their end users. In2004, Information Management and Distribution represented 50.5% of revenue.During 2004, revenue in the Information Management and Distribution segmentconsisted of approximately $174.1 million of recurring revenue andapproximately $20.4 million of project revenue.

**Healthcare, Regulatory, and LegalCompliance.  **This segment offers specialized knowledge-basedprocessing and consulting services that include medical records releaseservices, record management 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**19.Segment Reporting (Continued)**

services for healthcareinstitutions, temporary staffing for healthcare institutions, providing managedcare payment compliance reviews, class action claims administration services,and professional economic research and litigation services. In 2004,Healthcare, Regulatory, and Legal Compliance represented 49.5% of revenue.During 2004, revenue in the Healthcare, Regulatory and Legal Compliance segmentconsisted of approximately $113.4 million of project revenue andapproximately $77.4 million of recurring revenue.

The Company measures segment profit as income fromcontinuing operations before taxes. Information on the segments follows (inthousands):
| ** **                                                    | ** ** | **Year Ended December 31, 2004**   | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                    | ** ** | **Information Management  and Distribution** | ** ** | **Healthcare, Regulatory  and Legal Compliance** | ** ** | **Discontinued  Operations** | ** ** | **Consolidated** | ** ** |
| Revenue                                                       |       |                                                   | $          | 194,483 |   |   |   | $ | 190,820 |   |   |   | $ | — |   |   |   | $ | 385,303 |   |   |
| Depreciation and  amortization                                |       |                                                   | 9,967      |   |   |   | 3,783 |   |   |   | — |   |   |   | 13,750 |   |   |
| Operating income  (loss)                                      |       |                                                   | (4,296     | ) |   |   | 22,891 |   |   |   | — |   |   |   | 18,595 |   |   |
| Interest expense                                              |       |                                                   | 1,646      |   |   |   | 1,595 |   |   |   | — |   |   |   | 3,241 |   |   |
| Income (loss)  from continuing operations before income taxes |       |                                                   | (6,015     | ) |   |   | 20,012 |   |   |   | — |   |   |   | 13,997 |   |   |
| Total assets                                                  |       |                                                   | 247,478    |   |   |   | 221,937 |   |   |   | — |   |   |   | 469,415 |   |   |

 
| ** **                                             | ** ** | **Year Ended December 31, 2003**   | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                             | ** ** | **Information Management  and Distribution** | ** ** | **Healthcare, Regulatory  and Legal Compliance** | ** ** | **Discontinued  Operations** | ** ** | **Consolidated** | ** ** |
| Revenue                                                |       |                                                   | $          | 187,236 |   |   |   | $ | 190,923 |   |   |   | $ | — |   |   |   | $ | 378,159 |   |   |
| Depreciation and  amortization                         |       |                                                   | 8,717      |   |   |   | 4,327 |   |   |   | — |   |   |   | 13,044 |   |   |
| Operating income                                       |       |                                                   | 8,762      |   |   |   | 28,057 |   |   |   | — |   |   |   | 36,819 |   |   |
| Interest expense                                       |       |                                                   | 1,749      |   |   |   | 1,740 |   |   |   | — |   |   |   | 3,489 |   |   |
| Income from  continuing operations before income taxes |       |                                                   | 7,088      |   |   |   | 26,130 |   |   |   | — |   |   |   | 33,218 |   |   |
| Total assets                                           |       |                                                   | 236,873    |   |   |   | 201,005 |   |   |   | 14,658 |   |   |   | 452,536 |   |   |

 
| ** **                                             | ** ** | **Year Ended December 31, 2002**   | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                             | ** ** | **Information Management  and Distribution** | ** ** | **Healthcare, Regulatory  and Legal Compliance** | ** ** | **Discontinued  Operations** | ** ** | **Consolidated** | ** ** |
| Revenue                                                |       |                                                   | $          | 187,326 |   |   |   | $ | 191,218 |   |   |   | $ | — |   |   |   | $ | 378,544 |   |   |
| Depreciation and  amortization                         |       |                                                   | 7,952      |   |   |   | 4,904 |   |   |   | — |   |   |   | 12,856 |   |   |
| Operating income                                       |       |                                                   | 10,488     |   |   |   | 27,840 |   |   |   | — |   |   |   | 38,328 |   |   |
| Interest expense                                       |       |                                                   | 3,062      |   |   |   | 3,026 |   |   |   | — |   |   |   | 6,088 |   |   |
| Income from  continuing operations before income taxes |       |                                                   | 7,908      |   |   |   | 23,920 |   |   |   | — |   |   |   | 31,828 |   |   |
| Total assets                                           |       |                                                   | 240,977    |   |   |   | 197,316 |   |   |   | 19,049 |   |   |   | 457,342 |   |   |

 

During the year ended December 31, 2004, theCompany realigned certain operations in order to leverage management expertise,reduce costs, maximize profitability and better align these operations withother operating units of similar core competencies. The realignment resulted incertain operations being 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**19.Segment Reporting (Continued)**

transferred from theInformation Management and Distribution reportable segment to the Healthcare,Regulatory, and Legal Compliance reportable segment. The Company hasreclassified prior period amounts to be consistent with the current yearsegment reporting.

During the years ended December 31,2002, 2003 and 2004, capital expenditures were approximately $7.8 million,$13.6 million and $13.8 million, respectively, in the InformationManagement and Distribution segment and approximately $2.7 million,$2.8 million and $3.3 million, respectively, in the Healthcare,Regulatory, and Legal Compliance segment.

**20.Quarterly Information (Unaudited)**
| ** **                                                    | ** ** | **SOURCECORP, Incorporated** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                    | ** ** | **2003 Quarter Ended**  | ** ** | **2004 Quarter Ended** | ** ** |
| ** **                                                    | ** ** | **Mar 31**                   | ** ** | **Jun 30** | ** ** | **Sep 30** | ** ** | **Dec 31** | ** ** | **Mar 31** | ** ** | **Jun 30** | ** ** | **Sep 30** | ** ** | **Dec 31** | ** ** |
| ** **                                                    | ** ** | **Restated**                      | ** ** | **Restated** | ** ** | **Restated** | ** ** | **Restated** | ** ** | **Restated** | ** ** | **Restated** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total revenue                                                 |       | $                                 | 97,357     |   | $ | 91,256 |   | $ | 91,728 |   | $ | 97,818 |   | $ | 96,876 |   | $ | 97,947 |   | $ | 97,674 |   | $ | 92,806 |   |
| Gross profit                                                  |       | 37,430                            |       | 33,810 |   | 35,994 |   | 36,171 |   | 36,514 |   | 36,770 |   | 34,452 |   | 32,855 |   |
| Income (loss) from  continuing operations before income taxes |       | 12,179                            |       | 9,053 |   | 4,044 |   | 7,942 |   | 4,253 |   | 11,098 |   | (2,221 | ) | 867 |   |
| Income (loss) from  continuing operations                     |       | 7,306                             |       | 5,430 |   | 2,425 |   | 4,763 |   | 2,552 |   | 6,659 |   | (416 | ) | 1,741 |   |
| Net income (loss)                                             |       | 7,490                             |       | 5,083 |   | 2,307 |   | 4,201 |   | 2,065 |   | 4,846 |   | (677 | ) | 1,865 |   |
| Net income (loss) per  common share—                     |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                         |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Continuing Operations                                         |       | $                                 | 0.43       |   | $ | 0.33 |   | $ | 0.15 |   | $ | 0.29 |   | $ | 0.16 |   | $ | 0.42 |   | $ | (0.02 | ) | $ | 0.11 |   |
| Total Operations                                              |       | $                                 | 0.44       |   | $ | 0.31 |   | $ | 0.14 |   | $ | 0.26 |   | $ | 0.13 |   | $ | 0.30 |   | $ | (0.04 | ) | $ | 0.12 |   |
| Diluted                                                       |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Continuing Operations                                         |       | $                                 | 0.42       |   | $ | 0.33 |   | $ | 0.15 |   | $ | 0.29 |   | $ | 0.16 |   | $ | 0.41 |   | $ | (0.02 | ) | $ | 0.11 |   |
| Total Operations                                              |       | $                                 | 0.43       |   | $ | 0.31 |   | $ | 0.14 |   | $ | 0.26 |   | $ | 0.13 |   | $ | 0.30 |   | $ | (0.04 | ) | $ | 0.12 |   |
| Weighted average common  shares outstanding—             |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                         |       | 17,205                            |       | 16,319 |   | 16,188 |   | 16,094 |   | 16,096 |   | 16,014 |   | 15,781 |   | 15,681 |   |
| Diluted                                                       |       | 17,226                            |       | 16,381 |   | 16,355 |   | 16,298 |   | 16,448 |   | 16,374 |   | 15,781 |   | 15,965 |   |

 

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**ITEM 9.**                *Changes in and Disagreements with Accountants on Accounting andFinancial Disclosure*

None

**ITEM 9A.**        *Controls andProcedures*

*(a) Evaluation of disclosure controls andprocedures.*

TheCompany maintains disclosure controls and procedures, which it has designed toensure that material information related to the Company, including itsconsolidated subsidiaries, is made known to a group comprised of designatedmembers of the Company’s senior management, designated members of functionaldivisions of the Company, and/or the certifying officers (i.e. Chief ExecutiveOfficer and Chief Financial Officer) (collectively, the “Disclosure Committee”),on a timely basis, and that information required to be disclosed in reports itfiles under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms. As of December 31, 2004, the Company carried out an evaluation,under the supervision and with the participation of the Company’s management,including the Company’s Chief Executive Officer and Chief Financial Officer, ofthe effectiveness of the design and operation of the Company’s disclosurecontrols and procedures pursuant to Securities Exchange Act of 1934, asamended, Rule 13a-15 and 15d-15. Based upon that evaluation,the Chief Executive Officer and Chief Financial Officer concluded that theCompany’s disclosure controls and procedures are effective in timely alertingthem to material information relating to the Company (including itsconsolidated subsidiaries) required to be included in the Company’s periodicSEC filings. Because of the inherent limitations of disclosure controls,including the possibility of collusion or improper management override ofcontrols, no matter how comprehensive or well designed such controls are,management may not in all cases be alerted to material information relating tothe Company (including its consolidated subsidiaries) required to be includedin the Company’s periodic SEC filings.

*(b) Changes in internal controls*

In light of the eventsgiving rise to the Company’s restatement, more fully described in Item 7, Management’s Discussion and Analysisof Financial Condition and Results of Operations and in Note 3 to theconsolidated financial statements, the Company’s Chief Executive Officer andChief Financial Officer have made changes in internal control over financialreporting in order to address the causes of the restatement.

The Company’sinvestigation of the circumstances giving rise to the accounting errors thatwere corrected in the restatement identified the following issues, whichcollectively were a material weakness in our internal control over financialreporting that were found to have existed through September 30, 2004:

·       Certain employees of theOperating Subsidiary responsible for the internal control processes at theOperating Subsidiary either colluded with or coerced individuals to overridethe internal controls related to the following processes:

·                     Billing andrevenue recognition.

·                     Contractualcompliance.

·                     Changemanagement controls over the IT environment, specifically with regard tosoftware programs designed to calculate customer invoicing and revenuerecognition.

·       Monitoringof non-system generated journal entries of the Operating Subsidiary that wererecorded by those individuals involved in the activities mentioned above.

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TheCompany took the following actions to correct the underlying materialweaknesses giving rise to the restatement:

·       Terminatedcertain individuals involved in overriding the internal controls at theOperating Subsidiary and replace them with new management.

·       Performeda review and made improvements to the production and revenue accounting systemsaffecting our revenue accounting and customer invoicing at the OperatingSubsidiary.

·       Furthersegregated internal control responsibilities of the Operating Subsidiarythrough the centralization of accounting related functions into the Company’scorporate accounting department.

·       Establishedadditional monitoring controls and procedures regarding compliance with theCompany’s customer arrangements.

·       IncreasedInternal Audit’s company-wide testing of internal controls related to customerinvoicing and revenue recognition to help ensure the internal controls areoperating as designed.

·       Performedadditional contract review procedures as an interim step to adding acompany-wide contract compliance function.

The changes to internalcontrol over financial reporting described above were either implemented in thefourth quarter of 2004, or in the case of the addition of a company-widecontract compliance function, is in the process of being implemented. Inaddition, during the fourth quarter, the Company augmented its documentation ofcertain policies, procedures and processes and modified certain process levelcontrols. Except as described above, there has been no significant change inour internal control over financial reporting during the fourth quarter whichmaterially affected, or is reasonably likely to affect, our internal controlover financial reporting.

Under Section 404 of theSarbanes-Oxley Act of 2002, we are required to include in this Annual Report onForm 10-K (i) a report from our management regarding the Company’s internalcontrols over financial reporting, which report is required to include, amongother things, an assessment and statement as to the effectiveness of ourinternal controls over financial reporting as of December 31, 2004 and (ii) anattestation report of our independent registered public accounting firm onmanagement’s assessment of such internal controls.

On November 30, 2004, theSEC issued an exemptive order (SEC Release No. 50754) which provides a 45-dayextension for the filing of the management report and the related attestationreport by eligible companies. We have elected to rely on this 45-day extension,and therefore, this Annual Report on Form 10-K does not include suchreports. We intend to include such reports in an amendment to this AnnualReport on Form 10-K in accordance with the SEC’s exemptive order.

During 2004, we spentconsiderable time and internal and external resources analyzing, documentingand testing our system of internal controls over financing reporting and havesubstantially completed our internal evaluation.

There can be no assurance,however, that one or more material weaknesses in our internal controls overfinancial reporting will not be identified during the 45-day extension period,that management will be able to assert that our internal controls overfinancial reporting are effective as of December 31, 2004 or that ourindependent registered public accounting firm will be able to attest thatmanagement’s report is fairly stated or express an unqualified opinion on theeffectiveness of our internal controls. If such weaknesses are identified or ifour independent registered public accounting firm does not render anunqualified attestation, it could result in a loss of investor confidence inour financial reports, adversely affect our stock price and/or subject us tosanctions or investigation by regulatory authorities.

**ITEM 9B.**       *OtherInformation*

None.

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**PART III**

**ITEM 10.**         *Directorsand Executive Officers of the Registrant*

Information called for byItem 10 will be set forth under the captions “Election of Directors” “CorporateGovernance” and “Section 16(a) Beneficial Ownership ReportingCompliance” in our 2005 Proxy Statement, which will be filed not later than120 days after the end of our fiscal year ended December 31, 2004,and which is incorporated herein by this reference.

**ITEM 11.**         *ExecutiveCompensation*

Information called for byItem 11 will be set forth under the caption “Executive Compensation” in our 2005Proxy Statement, which will be filed not later than 120 days after the endof our fiscal year ended December 31, 2004, and which is incorporatedherein by this reference.

**ITEM 12.**         *SecurityOwnership of Certain Beneficial Owners and Management and Related Stockholder Matters*

Information called for byItem 12 will be set forth under the captions “Equity Compensation PlanInformation” and “Security Ownership of Certain Beneficial Owners andManagement”, respectively, in our 2005 Proxy Statement, which will be filed notlater than 120 days after the end of our fiscal year ended December 31,2004, and which is incorporated herein by this reference.

**ITEM 13.**         *CertainRelationships and Related Transactions*

Information called for byItem 13 will be set forth under the caption “Certain Relationships and RelatedTransactions” in our 2005 Proxy Statement, which will be filed not later than120 days after the end of our fiscal year ended December 31, 2004,and which is incorporated herein by this reference.

**ITEM 14.**         *PrincipalAccounting Fees and Services*

Information called for byItem 14 will be set forth under the caption “Independent Accountants” in our2005 Proxy Statement, which will be filed not later than 120 days afterthe end of our fiscal year ended December 31, 2004, and which isincorporated herein by this reference.

**PART IV**

**ITEM 15.**         *Exhibits andFinancial Statement Schedules*

The followingdocuments are being filed as part of this Report:

(a)(1)*   Consolidated Financial Statements*

See Index to Consolidated Financial Statements on page43.

All other schedules are omitted because they are notapplicable, not required or the required information is in the FinancialStatements or the Notes thereto.

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(a)(3)   The following Exhibits are filed as part ofthis Report as required by Item 601 of Regulation S-K. The Exhibitsdesignated by an asterisk are management contracts and compensatory plans andarrangements required to be filed as Exhibits to this Report.
| EXHIBIT   NUMBER | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                       | ** ** | **DESCRIPTION** |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 2.1              |       | Certificate of Ownership  and Merger filed with the Secretary of State of Delaware effective  February 14, 2002 merging SourceCorp Incorporated with and into the  Registrant and changing the name of the Registrant to SOURCECORP,  Incorporated (Incorporated by reference to Exhibit 99.2 to the  Registrant’s Current Report on Form 8-K filed February 15,  2002) |
| 3.1              |       | Restated Certificate of  Incorporation of SOURCECORP, Incorporated (Incorporated by reference to  Exhibit 99.3 to Amendment No. 1 to the Company’s Registration  Statement on Form 8-A filed on February 15, 2002)                                                                                                                                                      |
| 3.2              |       | Amended and Restated By-Laws  of SOURCECORP, Incorporated (Incorporated by reference to Exhibit 99.4  to Amendment No. 1 to the Company’s Registration Statement on  Form 8-A filed on February 15, 2002)                                                                                                                                                               |
| 4                |       | Specimen certificate for  the Common Stock, par value $.01 per share, of the Registrant. (Incorporated  by reference to Exhibit 99.1 to Amendment No. 1 to the Company’s  Registration Statement on Form 8-A filed on February 15,  2002)                                                                                                                               |
| 10.1*            |       | F.Y.I. Incorporated 1995  Stock Option Plan (Incorporated by reference to Exhibit 10.1 to the  Company’s Registration Statement on Form S-1 (Registration  No. 33-98608) effective January 12, 1996)                                                                                                                                                                    |
| 10.2*            |       | SOURCECORP, Incorporated  2002 Long-Term Incentive Plan (Incorporated by reference to  Exhibit 10.4 to the Company’s Form 10-Q filed August 14,  2002)                                                                                                                                                                                                                       |
| 10.3             |       | Form of  Indemnification Agreement between Registrant and each director (Incorporated  by reference to Exhibit 10.8 to Company’s Registration Statement on  Form S-1 (Registration No. 33-98608) effective  January 12, 1996)                                                                                                                                      |
| 10.4             |       | Agreement between New  York State Workers’ Compensation Board and QCSInet Acquisition Corp., dated  January 21, 1998 (Incorporated by reference to Exhibit 10.38 to the  Company’s Form 8-K filed on March 20, 1998)                                                                                                                                               |
| 10.5             |       | Warrant No. 6  issued to Mary D. Baker, dated October 27, 1998 (Incorporated by  reference to Exhibit 4.3 to the Registrant’s Registration Statement on  Form S-8 filed on December 29, 1998)                                                                                                                                                                      |
| 10.6             |       | Warrant No. 7  issued to Sharon Kelly, dated October 27, 1998 (Incorporated by  reference to Exhibit 4.4 to the Registrant’s Registration Statement on  Form S-8 filed on December 29, 1998)                                                                                                                                                                       |
| 10.7             |       | Warrant No. 8  issued to C. Stuart Haworth, dated October 27, 1998 (Incorporated by  reference to Exhibit 4.5 to the Registrant’s Registration Statement on  Form S-8 filed on December 29, 1998)                                                                                                                                                                  |
| 10.8             |       | Warrant No. 9  issued to Janet Thornton, dated October 27, 1998. (Incorporated by  reference to Exhibit 4.6 to the Registrant’s Registration Statement on  Form S-8 filed on December 29, 1998)                                                                                                                                                                    |
| 10.9             |       | Warrant No. 10  issued to Stephen D. Swartz, dated October 27, 1998. (Incorporated by  reference to Exhibit 4.7 to the Registrant’s Registration Statement on  Form S-8 filed on December 29, 1998)                                                                                                                                                                |

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| 10.10  |   | Warrant No. 11  issued to Hossein Borhani, dated October 27, 1998. (Incorporated by  reference to Exhibit 4.8 to the Registrant’s Registration Statement on  Form S-8 filed on December 29, 1998)      |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.11  |   | Warrant  No. 12 issued to George Desloge, dated October 27, 1998.  (Incorporated by reference to Exhibit 4.9 to the Registrant’s  Registration Statement on Form S-8 filed on December 29,  1998)      |
| 10.12  |   | Warrant No. 13  issued to Paul White, dated October 27, 1998. (Incorporated by reference  to Exhibit 4.10 to the Registrant’s Registration Statement on  Form S-8 filed on December 29, 1998)          |
| 10.13  |   | Warrant No. 14  issued to Kaye Hall, dated October 27, 1998. (Incorporated by reference  to Exhibit 4.11 to the Registrant’s Registration Statement on  Form S-8 filed on December 29, 1998)      |
| 10.14* |   | Warrant No. 16  issued to Ronald Zazworsky, dated May 19, 1999. (Incorporated by  reference to Exhibit 4.4 to the Registrant’s Registration Statement on  Form S-8 filed on September 17, 1999)        |
| 10.15* |   | Warrant No. 17  issued to Joe A. Rose, dated May 19, 1999. (Incorporated by reference to  Exhibit 4.3 to the Registrant’s Registration Statement on Form S-8  filed on September 17, 1999)             |
| 10.16  |   | Warrant No. 18  issued to Margot T. Lebenberg, dated May 19, 1999. (Incorporated by  reference to Exhibit 4.6 to the Registrant’s Registration Statement on  Form S-8 filed on September 17, 1999)     |
| 10.17* |   | Warrant No. 21  issued to Thomas C. Walker, dated May 19, 1999. (Incorporated by  reference to Exhibit 4.9 to the Registrant’s Registration Statement on  Form S-8 filed on September 17, 1999)        |
| 10.18* |   | Warrant No. 22  issued to Ed H. Bowman, Jr., dated May 19, 1999. (Incorporated by  reference to Exhibit 4.10 to the Registrant’s Registration Statement on  Form S-8 filed on September 17, 1999) |
| 10.19* |   | Special Warrant  No. 24 issued to Joe A. Rose, dated May 19, 1999. (Incorporated by  reference to Exhibit 4.11 to the Registrant’s Registration Statement on  Form S-8 filed on September 17, 1999)    |
| 10.20  |   | Warrant No. 25 issued  to Jeffrey T. Pelcher, dated January 12, 2000. (Incorporated by  reference to Exhibit 4.3 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)      |
| 10.21  |   | Warrant No. 26  issued to Barrie Robertson, dated February 25, 2000. (Incorporated by  reference to Exhibit 4.4 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)       |
| 10.22  |   | Warrant No. 27  issued to Barrie Robertson, dated February 25, 2000. (Incorporated by  reference to Exhibit 4.5 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)       |
| 10.23  |   | Warrant No. 28  issued to James Helm, dated February 25, 2000. (Incorporated by  reference to Exhibit 4.6 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)             |
| 10.24  |   | Warrant No. 29  issued to James Helm, dated February 25, 2000. (Incorporated by  reference to Exhibit 4.7 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)             |
| 10.25  |   | Warrant No. 30  issued to Margot T. Lebenberg, dated March 16, 2000. (Incorporated by  reference to Exhibit 4.8 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)       |

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| 10.26* |   | Warrant No. 31 issued to Ronald Zazworsky,  dated March 16, 2000. (Incorporated by reference to Exhibit 4.9 to  the Registrant’s Registration Statement on Form S-8 filed on  April 25, 2000)    |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.27  |   | Warrant  No. 32 issued to Timothy J. Barker, dated March 16, 2000.  (Incorporated by reference to Exhibit 4.10 to the Registrant’s  Registration Statement on Form S-8 filed on April 25, 2000)  |
| 10.28* |   | Warrant No. 33  issued to Joe A. Rose, dated March 16, 2000. (Incorporated by reference  to Exhibit 4.11 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)        |
| 10.29  |   | Warrant No. 34  issued to Joy Karns, dated February 25, 2000. (Incorporated by reference  to Exhibit 4.12 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)       |
| 10.30  |   | Warrant No. 36  issued to Suzette Estaban, dated February 25, 2000. (Incorporated by  reference to Exhibit 4.14 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000) |
| 10.31  |   | Warrant No. 37  issued to Francis Esteban, dated February 25, 2000. (Incorporated by  reference to Exhibit 4.15 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000) |
| 10.32  |   | Warrant No. 38  issued to Ruben Luna, dated February 25, 2000. (Incorporated by  reference to Exhibit 4.16 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)      |
| 10.33  |   | Warrant No. 39  issued to Maria Olvera, dated February 25, 2000. (Incorporated by  reference to Exhibit 4.17 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)    |
| 10.34  |   | Warrant No. 40  issued to C. Stuart Haworth, dated March 16, 2000. (Incorporated by  reference to Exhibit 4.18 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)  |
| 10.35  |   | Warrant No. 41  issued to David Byerley, dated March 16, 2000. (Incorporated by  reference to Exhibit 4.19 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)      |
| 10.36  |   | Warrant No. 44  issued to David Delgado, dated March 16, 2000. (Incorporated by  reference to Exhibit 4.22 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)      |
| 10.37  |   | Warrant No. 45  issued to Gene Marzano, dated March 16, 2000. (Incorporated by reference  to Exhibit 4.22 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)       |
| 10.38  |   | Warrant No. 46  issued to Joan G. Haworth, dated March 16, 2000. (Incorporated by  reference to Exhibit 4.24 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)    |
| 10.39  |   | Warrant No. 47  issued to Charles T. Haworth, dated March 16, 2000. (Incorporated by  reference to Exhibit 4.25 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000) |
| 10.40  |   | Warrant No. 48  issued to David Delgado, dated March 16, 2000. (Incorporated by  reference to Exhibit 4.26 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)      |
| 10.41  |   | Warrant No. 49  issued to Joan G. Haworth, dated March 16, 2000. (Incorporated by  reference to Exhibit 4.27 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)    |

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| 10.42  |   | Warrant No. 50  issued to Charles T. Haworth, dated March 16, 2000. (Incorporated by  reference to Exhibit 4.28 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)      |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.43  |   | Warrant No. 51  issued to Michael Wickman, dated March 16, 2000. (Incorporated by  reference to Exhibit 4.29 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)         |
| 10.44  |   | Warrant No. 52  issued to David Delgado, dated March 16, 2000. (Incorporated by  reference to Exhibit 4.30 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)           |
| 10.45  |   | Warrant No. 53  issued to Leo Cooper, dated March 16, 2000. (Incorporated by reference  to Exhibit 4.31 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)              |
| 10.46  |   | Warrant No. 54  issued to C. Stuart Haworth, dated March 16, 2000. (Incorporated by  reference to Exhibit 4.32 to the Registrant’s Registration Statement on  Form S-8 filed on April 25, 2000)       |
| 10.47* |   | Warrant No. W057  issued to Thomas C. Walker, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.3 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)       |
| 10.48* |   | Warrant No. W058  issued to Ed H. Bowman, Jr., dated January 24, 2001. (Incorporated  by reference to Exhibit 4.4 to the Registrant’s Registration Statement  on Form S-8 filed on May 11, 2001) |
| 10.49* |   | Warrant No. W059  issued to Joe A. Rose, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.5 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)            |
| 10.50* |   | Warrant No. W060  issued to Barry L. Edwards, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.6 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)       |
| 10.51* |   | Warrant No. W061  issued to Charles S. Gilbert, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.7 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)     |
| 10.52* |   | Warrant No. W062  issued to Michael S. Rupe, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.8 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)        |
| 10.53* |   | Warrant No. W063  issued to Ronald Zazworsky, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.9 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)       |
| 10.54  |   | Warrant No. W064  issued to Gary Patton, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.10 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)           |
| 10.55  |   | Warrant No. W065  issued to David Byerley, dated January 24, 2001. (Incorporated by reference  to Exhibit 4.11 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)         |
| 10.56  |   | Warrant No. W066  issued to Mary Baker, dated January 24, 2001. (Incorporated by reference  to Exhibit 4.12 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)            |
| 10.57  |   | Warrant No. W067  issued to Hossein Borhani, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.13 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)       |

88

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| 10.58  |   | Warrant No. W068  issued to Charles Haworth, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.14 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)                                                                                                                       |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.59  |   | Warrant No. W069  issued to Joan Haworth, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.15 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)                                                                                                                          |
| 10.60  |   | Warrant No. W070  issued to Stuart Haworth, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.16 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)                                                                                                                        |
| 10.61  |   | Warrant  No. W071 issued to Sharon Kelly, dated January 24, 2001.  (Incorporated by reference to Exhibit 4.17 to the Registrant’s  Registration Statement on Form S-8 filed on May 11, 2001)                                                                                                                          |
| 10.62  |   | Warrant No. W072  issued to Sam Kimelman, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.18 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)                                                                                                                          |
| 10.63  |   | Warrant No. W073  issued to Steve Swartz, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.19 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)                                                                                                                          |
| 10.64  |   | Warrant No. W074  issued to Janet Thornton, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.20 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)                                                                                                                        |
| 10.65  |   | Warrant No. W075  issued to Paul White, dated January 24, 2001. (Incorporated by reference  to Exhibit 4.21 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)                                                                                                                            |
| 10.66  |   | Warrant No. W076  issued to Holly Barnett, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.22 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)                                                                                                                         |
| 10.67  |   | Warrant No. W077  issued to Dennis Reinhold, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.23 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)                                                                                                                       |
| 10.68  |   | Warrant No. W078  issued to E. Leo Cooper, dated January 24, 2001. (Incorporated by  reference to Exhibit 4.24 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)                                                                                                                         |
| 10.69* |   | Warrant No. W079  issued to Kerry D. Walbridge, dated March 22, 2001. (Incorporated by  reference to Exhibit 4.25 to the Registrant’s Registration Statement on  Form S-8 filed on May 11, 2001)                                                                                                                      |
| 10.70* |   | Amended and Restated  Employment Agreement, entered into on December 19, 2003 and effective as  of January 1, 2004 between SOURCECORP, Incorporated, SOURCECORP  Management, L.P. and Ed H. Bowman, Jr. (Incorporated by reference to Exhibit  10.70 to the Registrant’s 2003 Annual Report on Form 10-K filed March 12,  2004) |
| 10.71* |   | Employment Agreement,  entered into on December 22, 2003 between SOURCECORP, Incorporated,  SOURCECORP Management, L.P. and David Delgado (Incorporated by reference to  Exhibit 10.71 to the Registrant’s 2003 Annual Report on Form 10-K filed March 12,  2004)                                                                    |

89

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| 10.72* |   | Amended and Restated  Employment Agreement, entered into on December 19, 2003 and effective as  of January 1, 2004 between SOURCECORP, Incorporated, SOURCECORP  Management, L.P. and Barry L. Edwards (Incorporated by reference to Exhibit  10.72 to the Registrant’s 2003 Annual Report on Form 10-K filed March 12,  2004)   |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.73* |   | Amended and Restated  Employment Agreement, entered into on December 19, 2003 and effective as  of January 1, 2004 between SOURCECORP, Incorporated, SOURCECORP  Management, L.P. and Charles S. Gilbert (Incorporated by reference to Exhibit  10.73 to the Registrant’s 2003 Annual Report on Form 10-K filed March 12,  2004) |
| 10.74* |   | Amended and Restated Employment Agreement, entered  into on December 19, 2003 between SOURCECORP, Incorporated, SOURCECORP  Management, L.P. and W. Bryan Hill (Incorporated by reference to Exhibit  10.74 to the Registrant’s 2003 Annual Report on Form 10-K filed March 12,  2004)                                           |
| 10.75* |   | Intentionally Left Blank                                                                                                                                                                                                                                                                                                                        |
| 10.76* |   | Amended and Restated  Employment Agreement, entered into on January 1, 2004 between  SOURCECORP, Incorporated, SOURCECORP Management, L.P. and Kerry D. Walbridge (Incorporated  by reference to Exhibit 10.76 to the Registrant’s 2003 Annual Report on Form  10-K filed March 12, 2004)                                             |
| 10.77* |   | Amended and Restated Employment  Agreement, entered into on December 19, 2003 and effective as of  January 1, 2004 between SOURCECORP, Incorporated, SOURCECORP Management,  L.P. and Thomas C. Walker (Incorporated by reference to Exhibit 10.77 to the  Registrant’s 2003 Annual Report on Form 10-K filed March 12, 2004)    |
| 10.78* |   | Amended and Restated  Employment Agreement, effective as of January 1, 2004 between  SOURCECORP, Incorporated, SOURCECORP Management, L.P. and Ronald Zazworsky (Incorporated  by reference to Exhibit 10.78 to the Registrant’s 2003 Annual Report on Form  10-K filed March 12, 2004)                                               |
| 10.79* |   | Consulting Agreement  between F.Y.I. Incorporated and David Lowenstein (Incorporated by reference  to Exhibit 10.65 of the Company’s Form 10-K filed on  March 23, 2000)                                                                                                                                                    |
| 10.80* |   | Amended and Restated  Employment Agreement, dated as of April 24, 2002 between SOURCECORP,  Incorporated, SOURCECORP Management, L.P. and Barry L. Edwards  (Incorporated by reference to Exhibit 10.8 on the Company’s Form 10-Q  filed May 15, 2002)                                                            |
| 10.81* |   | Amended and Restated  Employment Agreement, dated as of April 24, 2002 between SOURCECORP,  Incorporated, SOURCECORP Management, L.P. and Charles S. Gilbert  (Incorporated by reference to Exhibit 10.2 on the Company’s Form 10-Q  filed May 15, 2002)                                                               |
| 10.82* |   | Amended and Restated  Employment Agreement, dated as of April 8, 2002 between SOURCECORP,  Incorporated, SOURCECORP Management, L.P. and Ed H. Bowman, Jr.  (Incorporated by reference to Exhibit 10.3 on the Company’s Form 10-Q  filed May 15, 2002)                                                            |
| 10.83* |   | First Amendment to Amended  and Restated Employment Agreement, dated as of May 8, 2002 between  SOURCECORP, Incorporated, SOURCECORP Management, L.P. and Ed H.  Bowman, Jr. (Incorporated by reference to Exhibit 10.3 to the  Company’s Form 10-Q filed August 14, 2002)                                        |
| 10.84* |   | Amended and Restated  Employment Agreement, dated as of May 10, 2002 between SOURCECORP,  Incorporated, SOURCECORP Management, L.P. and Joe A. Rose (Incorporated  by reference to Exhibit 10.4 on the Company’s Form 10-Q filed  May 15, 2002)                                                                   |

90

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| 10.85* |   | First Amendment to  Amended and Restated Employment Agreement, dated as of May 10, 2002  between SOURCECORP, Incorporated, SOURCECORP Management, L.P. and Joe A.  Rose (Incorporated by reference to Exhibit 10.1 on the Company’s  Form 10-Q filed August 14, 2002)                                               |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.86* |   | Employment Agreement,  dated as of April 23, 2002 between SOURCECORP, Incorporated, SOURCECORP  Management, L.P. and Kerry D. Walbridge (Incorporated by reference to  Exhibit 10.1 on the Company’s Form 10-Q filed May 15,  2002)                                                                                      |
| 10.87* |   | Employment Agreement,  dated as of February 7, 2003 between SOURCECORP, Incorporated,  SOURCECORP Management, L.P. and Michael S. Rupe (Incorporated by reference to  Exhibit 10.78 on the Company’s Form 10-K filed March 31,  2003)                                                                                    |
| 10.88* |   | Amended and Restated  Employment Agreement, dated as of May 18, 2001 between F.Y.I.  Incorporated and Ronald Zazworsky (Incorporated by reference to  Exhibit 10.90 on the Company’s Form 10-Q filed  August 14, 2001)                                                                                                   |
| 10.89* |   | First Amendment to  Amended and Restated Employment Agreement, dated as of April 10, 2002  between SOURCECORP, Incorporated, SOURCECORP Management, L.P. and Ronald  Zazworsky (Incorporated by reference to Exhibit 10.6 on the Company’s  Form 10-Q filed May 15, 2002)                                                |
| 10.90* |   | Amended and Restated  Employment Agreement, dated as of April 8, 2002 between SOURCECORP,  Incorporated, SOURCECORP Management, L.P. and Thomas C. Walker  (Incorporated by reference to Exhibit 10.7 on the Company’s Form 10-Q  filed May 15, 2002)                                                               |
| 10.91* |   | First Amendment to  Amended and Restated Employment Agreement, dated as of April 8, 2002  between SOURCECORP, Incorporated, SOURCECORP Management, L.P. and Thomas C.  Walker (Incorporated by reference to Exhibit 10.2 on the Company’s  Form 10-Q filed August 14, 2002)                                              |
| 10.92  |   | Credit Agreement, dated  as of April 3, 2001, by and among F.Y.I. Incorporated, Bank of America,  N.A., and the other signatories thereto (Incorporated by reference to  Exhibit 10.1 on the Company’s Form 10-Q filed  November 14, 2001)                                                                               |
| 10.93  |   | First Amendment  to Credit Agreement, dated as of June 27, 2001, by and among F.Y.I.  Incorporated, bank of America, N.A., and the other signatories thereto  (Incorporated by reference to Exhibit 10.92 on the Company’s  Form 10-Q filed August 14, 2001)                                                             |
| 10.94  |   | Second Amendment to  Credit Agreement, dated as of September 27, 2002 between SOURCECORP,  Incorporated, Bank of America, N.A. and the other signatories thereto  (Incorporated by reference to Exhibit 10.1 on the Company’s Form 10-Q  filed November 14, 2002)                                                        |
| 10.95  |   | Third Amendment to  Credit Agreement, dated as of March 26, 2003 by and among SOURCECORP,  Incorporated, Bank of America, N.A., and the other Agents and Lenders party  hereto (Incorporated by reference to Exhibit 10.1 to the Company’s  Form 10-Q filed May 13, 2003)                                                |
| 10.96  |   | Extension Agreement,  effective April 3, 2002 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A., and Banc of America Securities  LLC, executed on behalf of Bank of America, N.A. (Incorporated by reference  to Exhibit 10.86 to the Company’s Form 10-K filed  March 31, 2003) |
| 10.97  |   | Extension Agreement,  effective April 3, 2002 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A., and Banc of America Securities  LLC, executed on behalf of SunTrust Bank (Incorporated by reference to  Exhibit 10.87 to the Company’s Form 10-K filed March 31,  2003)         |

91

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| 10.98  |   | Extension Agreement,  effective April 3, 2002 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A., and Banc of America Securities  LLC, executed on behalf of BNP Paribas (Incorporated by reference to  Exhibit 10.88 to the Company’s Form 10-K filed March 31,  2003)                                                    |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.99  |   | Extension Agreement,  effective April 3, 2002 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A., and Banc of America Securities  LLC, executed on behalf of First Union National Bank (Incorporated by  reference to Exhibit 10.89 to the Company’s Form 10-K filed  March 31, 2003)                                      |
| 10.100 |   | Extension Agreement,  effective April 3, 2002 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A., and Banc of America Securities  LLC, executed on behalf of The Bank of Nova Scotia (Incorporated by reference  to Exhibit 10.90 to the Company’s Form 10-K filed  March 31, 2003)                                        |
| 10.101 |   | Extension Agreement,  effective April 3, 2002 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A., and Banc of America Securities  LLC, executed on behalf of JPMorgan Chase Bank formerly known as The Chase  Manhattan Bank (Incorporated by reference to Exhibit 10.91 to the  Company’s Form 10-K filed March 31, 2003) |
| 10.102 |   | Extension Agreement,  effective April 3, 2002 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A., and Banc of America Securities  LLC, executed on behalf of Wachovia Bank, N.A. (Incorporated by reference to  Exhibit 10.92 to the Company’s Form 10-K filed March 31,  2003)                                            |
| 10.103 |   | Extension Agreement,  effective April 3, 2002 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A., and Banc of America Securities  LLC, executed on behalf of Washington Mutual Bank (Incorporated by reference  to Exhibit 10.93 to the Company’s Form 10-K filed  March 31, 2003)                                         |
| 10.104 |   | Extension Agreement,  effective April 3, 2002 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A., and Banc of America Securities  LLC, executed on behalf of Wells Fargo Bank Texas, National Association  (Incorporated by reference to Exhibit 10.94 to the Company’s Form 10-K  filed March 31, 2003)                   |
| 10.105 |   | Extension Agreement,  effective April 3, 2002 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A., and Banc of America Securities  LLC, executed on behalf of Bank One, NA (Incorporated by reference to  Exhibit 10.95 to the Company’s Form 10-K filed March 31,  2003)                                                   |
| 10.106 |   | Extension Agreement,  effective April 3, 2002 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A., and Banc of America Securities  LLC, executed on behalf of Texas Capital Bank, National Association  (Incorporated by reference to Exhibit 10.96 to the Company’s  Form 10-K filed March 31, 2003)                       |
| 10.107 |   | Extension Agreement,  effective April 3, 2003 among SOURCECORP, Incorporated, each of the Lenders  party thereto, Bank of America, N.A. and Bank of America Securities LLC,  executed on behalf of Bank of America, N.A. (Incorporated by reference to  Exhibit 10.7 to the Company’s Form 10-Q filed May 13,  2003)                                              |
| 10.108 |   | Extension Agreement,  effective April 3, 2003 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A. and Bank of America Securities  LLC, executed on behalf of The Bank of Nova Scotia (Incorporated by reference  to Exhibit 10.8 to the Company’s Form 10-Q filed May 13,  2003)                                            |

92

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| 10.109 |   | Extension Agreement,  effective April 3, 2003 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A. and Bank of America Securities  LLC, executed on behalf of Bank One, N.A. (Incorporated by reference to  Exhibit 10.9 to the Company’s Form 10-Q filed May 13,  2003)                                    |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.110 |   | Extension Agreement,  effective April 3, 2003 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A. and Bank of America Securities  LLC, executed on behalf of BNP Paribas (Incorporated by reference to  Exhibit 10.10 to the Company’s Form 10-Q filed May 13,  2003)                                      |
| 10.111 |   | Extension Agreement,  effective April 3, 2003 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A. and Bank of America Securities  LLC, executed on behalf of JPMorgan Chase Bank (Incorporated by reference to  Exhibit 10.11 to the Company’s Form 10-Q filed May 13,  2003)                              |
| 10.112 |   | Extension Agreement,  effective April 3, 2003 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A. and Bank of America Securities  LLC, executed on behalf of Suntrust Bank (Incorporated by reference to  Exhibit 10.12 to the Company’s Form 10-Q filed May 13,  2003)                                    |
| 10.113 |   | Extension Agreement,  effective April 3, 2003 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A. and Bank of America Securities  LLC, executed on behalf of Washington Mutual Bank (Incorporated by reference  to Exhibit 10.13 to the Company’s Form 10-Q filed  May 13, 2003).                          |
| 10.114 |   | Extension Agreement,  effective April 3, 2003 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A. and Bank of America Securities  LLC, executed on behalf of Wells Fargo Bank, N.A. (Incorporated by reference  to Exhibit 10.14 to the Company’s Form 10-Q filed  May 13, 2003)                           |
| 10.115 |   | Extension Agreement,  effective December 4, 2003 among SOURCECORP, Incorporated, each of the  Lenders party thereto, Bank of America, N.A. and Bank of America Securities LLC,  executed on behalf of Hibernia National Bank (Incorporated by reference to  Exhibit 10.115 to the Registrant’s 2003 Annual Report on Form 10–K filed  March 12, 2004) |
| 10.116 |   | Letter Agreement, dated  August 10, 2001, by and among F.Y.I. Incorporated, Bank of America, N.A.  and the other signatories thereto (Incorporated by reference to  Exhibit 10.3 on the Company’s Form 10-Q filed  November 14, 2001)                                                                                                            |
| 10.117 |   | Master Guaranty  Agreement, dated April 3, 2001, by and among certain subsidiaries of  F.Y.I. Incorporated and Bank of America, N.A. (Incorporated by reference to  Exhibit 10.4 on the Company’s Form 10-Q filed  November 14, 2001)                                                                                                            |
| 10.118 |   | Pledge Agreement, dated  April 3, 2001, by and between F.Y.I. Incorporated and Bank of America,  N.A. (Incorporated by reference to Exhibit 10.5 on the Company’s  Form 10-Q filed November 14, 2001)                                                                                                                                            |
| 10.119 |   | Master Pledge Agreement,  dated April 3, 2001, by and among certain subsidiaries of F.Y.I.  Incorporated and Bank of America, N.A. (Incorporated by reference to  Exhibit 10.6 on the Company’s Form 10-Q filed  November 14, 2001)                                                                                                              |
| 10.120 |   | Assignment Agreement  dated October 24, 2003 by and between Wachovia Bank, National  Association and Hibernia National Bank accepted by Bank of America, N.A. and  consented to by SOURCECORP, Incorporated. (Incorporated by reference to  Exhibit 10.120 to the Registrant’s 2003 Annual Report on Form 10–K filed  March 12, 2004)                      |

93

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| 10.121  |   | Fourth Amendment to  Credit Agreement, effective as of July 30, 2004, by and among SOURCECORP, Incorporated, Bank of  America, N.A. and the other Lenders party thereto (Incorporated by reference  to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q  filed August 9, 2004)**                                                                                       |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.122  |   | Waiver to Credit  Agreement, effective as of November 12, 2004, by and among SOURCECORP,  Incorporated, Bank of America, N.A., as a Lender and as Administrative Agent  for Lenders and the other Agents and Lenders party thereto (Incorporated by  reference to Exhibit 99.1 to the Company’s Current Report on  Form 8-K filed November 17, 2004).                             |
| 10.123  |   | Extension and  Modification of Waiver to Credit Agreement, effective March 15, 2005, by  and among SOURCECORP, Incorporated, Bank of America, N.A. as a Lender and as  Administrative Agent for Lenders and the other Agents and Lenders party  thereto (Incorporated by reference to Exhibit 99.1 to the Company’s  Current Report on Form 8-K filed March 16, 2005)             |
| 10.124  |   | Fifth Amendment and  Waiver to Credit Agreement executed to be effective as of March 23,  2005, by and among SOURCECORP, Incorporated, Bank of America, N.A. as a  Lender and as Administrative Agent for Lenders and the other Agents and  Lenders party thereto (Incorporated by reference to Exhibit 99.1 to the  Company’s Current Report on Form 8-K filed March 25, 2005)** |
| 10.125  |   | ISDA Master Agreement  and Schedule to ISDA Master Agreement dated as of December 20, 2000,  between F.Y.I. Incorporated and SunTrust Bank. (Incorporated by reference to  Exhibit 10.7 on the Company’s Form 10-Q filed  November 14, 2001)                                                                                                                                      |
| 10.126  |   | Confirmation of Interest  Rate Transaction Letter Agreement dated December 21, 2000, between  F.Y.I. Incorporated and SunTrust Bank. (Incorporated by reference to  Exhibit 10.8 on the Company’s Form 10-Q filed  November 14, 2001)                                                                                                                                             |
| 10.127* |   | F.Y.I. Incorporated  Nonqualified Retirement Plan, Amended and Restated as of January 1, 2000  (Incorporated by reference to Exhibit 10.87 on the Company’s  Form 10 -K filed April 1, 2002)                                                                                                                                                                                      |
| 10.128* |   | Description of Non-Qualified  Retirement Plan Match                                                                                                                                                                                                                                                                                                                                                        |
| 10.129* |   | 2005 Executive Officer  and Director Compensation Summary                                                                                                                                                                                                                                                                                                                                                  |
| 10.130* |   | Consulting Agreement  Amended Addendum, entered into effective as of October 1, 2004, between  SOURCECORP, Incorporated and David Lowenstein.                                                                                                                                                                                                                                                              |
| 21      |   | List of subsidiaries of  SOURCECORP, Incorporated                                                                                                                                                                                                                                                                                                                                                          |
| 23.1    |   | Consent of  Deloitte & Touche LLP                                                                                                                                                                                                                                                                                                                                                                 |
| 24      |   | Power of Attorney  (included with the signature page hereof)                                                                                                                                                                                                                                                                                                                                          |
| 31.1    |   | Certification pursuant  to Rule 13a-14(a) or Rule 15d-14(a)                                                                                                                                                                                                                                                                                                                                 |
| 31.2    |   | Certification pursuant  to Rule 13a-14(a) or Rule 15d-14(a)                                                                                                                                                                                                                                                                                                                                 |
| 32.1    |   | Certification pursuant  to Section 906 of Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                                                          |
| 32.2    |   | Certification pursuant  to Section 906 of Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                                                          |

----

*                    Compensatoryplan or arrangement.

**             Schedules and similarattachments are omitted in accordance with Item 601(b)(2) of RegulationS-K and a brief description of such omitted schedules and similar attachmentsis included in the agreement. The Company undertakes to provide the Commissionwith a copy of any such omitted supplemental schedule or similarattachment upon request.

94

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this Report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|                           | SOURCECORP, INCORPORATED |
|---------------------------|--------------------------|
|                      | By:                      | /s/  ED H. BOWMAN, JR., |
| * *                  |                     | Ed H.  Bowman, Jr.,*President and Chief Executive Officer* |
| Date: March 31, 2005 |                     |   |

 

**POWER OF ATTORNEY**

Each person whose signature appears below herebyauthorizes and constitutes Ed H. Bowman, Jr. and Charles S. Gilbert, andeach of them singly, his true and lawful attorneys-in-fact with full power ofsubstitution and resubstitution, for him and in his name, place and stead, inany and all capacities to sign and file any and all amendments to this reportwith all exhibits thereto, and other documents in connection therewith, withthe Securities and Exchange Commission, and he hereby ratifies and confirms allthat said attorneys-in-fact or any of them, or their substitutes, may lawfullydo or cause to be done by virtue hereof.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below as of March 31, 2005 by the following persons on behalfof the Registrant and in the capacities indicated.
|                                    | **SIGNATURE** | ** **                                            | ** ** | ** ** | **CAPACITY IN WHICH SIGNED** | ** ** |
|------------------------------------|---------------|-------------------------------------------------------|------------|------------|---------------------------------------------|------------|
| /s/  THOMAS C. WALKER              |          | Chairman of the Board  and Chief Development Officer  |
| Thomas C. Walker                   |          |                                                  |
| /s/  ED H. BOWMAN, JR.        |          | Director, President and  Chief Executive Officer      |
| Ed H.  Bowman, Jr.            |          | (Principal Executive Officer)                         |
| /s/  DAVID LOWENSTEIN              |          | Director and Founder                                  |
| David Lowenstein                   |          |                                                  |
| /s/  BARRY L. EDWARDS              |          | Executive Vice President  and Chief Financial Officer |
| Barry L. Edwards                   |          | (Principal Financial Officer)                         |
| /s/  G. MICHAEL BELLENGHI          |          | Director                                              |
| G. Michael  Bellenghi              |          |                                                  |
| /s/ MICHAEL J. BRADLEY             |          | Director                                              |
| Michael J.  Bradley                |          |                                                  |
| /s/  DONALD F. MOOREHEAD, JR. |          | Director                                              |
| Donald F.  Moorehead, Jr.     |          |                                                  |
| /s/  HON. EDWARD M. ROWELL         |          | Director                                              |
| Hon. Edward M.  Rowell             |          |                                                  |

 

95

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