**UNITED STATES********SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 
| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES AND EXCHANGE ACT OF 1934**                              |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                    |
| ** ** | ** ** | **For  the quarterly period ended March 31, 2005**                                                                                 |
|       |       |                                                                                                                                    |
| **OR**     |
|       |       |                                                                                                                                    |
| **o**      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND  EXCHANGE ACT OF 1934**                            |
|       |       |                                                                                                                                    |
| ** ** | ** ** | **For  the transition period from                  to** |

 

**Commission file number 0-27444**

 

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**SOURCECORP, INCORPORATED**

(Exact name of registrant as specified in its charter)

 
| **DELAWARE**                                                                | ** ** | **75-2560895**                       |
|-----------------------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization)              |       | (I.R.S. Employer Identification No.) |
|                                                                        |       |                                 |
| **3232 MCKINNEY AVENUE, SUITE 1000  DALLAS, TEXAS**                         | ** ** | **75204**                            |
| (Address of principal executive offices)                                    |       | (Zip code)                           |
|                                                                        |       |                                 |
| REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: **(214) 740-6500** |

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes  ý  No  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inExchange Act Rule 12b-2). Yes  ý  No  o

 

Asof****April 29, 2005, 15,670,116 sharesof the registrant’s Common Stock, $.01 par value per share, were outstanding.

 

 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES**

**FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 2005**

 

**INDEX**

 
| **PART I. FINANCIAL INFORMATION** |                                                                                                                 |
|----------------------------------------|----------------------------------------------------------------------------------------------------------------------|
|                                   |                                                                                                                 |   |
| Item 1                                 | Financial Statements                                                                                                 |   |
|                                   |                                                                                                                 |   |
|                                   | Condensed  Consolidated Balance Sheets — December 31, 2004 and March 31, 2005  (unaudited)            |   |
|                                   |                                                                                                                 |   |
|                                   | Condensed  Consolidated Statements of Operations — Three months ended March 31,  2004 and 2005 (unaudited) |   |
|                                   |                                                                                                                 |   |
|                                   | Condensed  Consolidated Statements of Cash Flows — Three months ended March 31,  2004 and 2005 (unaudited) |   |
|                                   |                                                                                                                 |   |
|                                   | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                    |   |
|                                   |                                                                                                                 |   |
| Item 2                                 | Management’s Discussion  and Analysis of Financial Condition and Results of Operations                          |   |
|                                   |                                                                                                                 |   |
| Item 3                                 | Quantitative and Qualitative  Disclosures about Market Risk                                                          |   |
|                                   |                                                                                                                 |   |
| Item 4                                 | Controls and Procedures                                                                                              |   |
|                                   |                                                                                                                 |   |
| **PART II. OTHER  INFORMATION**   |                                                                                                                 |
|                                   |                                                                                                                 |   |
| Item 1                                 | Legal Proceedings                                                                                                    |   |
|                                   |                                                                                                                 |   |
| Item  2                                | Unregistered  Sales of Equity Securities and Use of Proceeds                                                         |   |
|                                   |                                                                                                                 |   |
| Item 6                                 | Exhibits                                                                                                             |   |
|                                   |                                                                                                                 |   |
| ** **                             | **SIGNATURES**                                                                                                       |   |
|                                   |                                                                                                                 |   |
| ** **                             | **Index to Exhibits**                                                                                                |   |

 

2

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**PART I.****FINANCIAL INFORMATION**

 

**Item 1.**      **Financial Statements**

 

**SOURCECORP, INCORPORATED AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(IN THOUSANDS, EXCEPT SHARE DATA)**

 
| ** **                                                                                                                                                                                                              | ** **                             | **December 31,  2004** | ** ** | **March 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------|-----------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                                                                              | ** **                             | **(Unaudited)**             | ** ** |
| **ASSETS**                                                                                                                                                                                                              |                                   |                        |       |                     |       |
| **CURRENT ASSETS:**                                                                                                                                                                                                     |                                   |                        |       |                     |       |
| Cash and cash equivalents                                                                                                                                                                                               |                                   | $                           | 3,722      |                     | $          | 244 |   |
| Accounts and notes receivable, less  allowance for doubtful accounts of $9,331 and $8,800, respectively                                                                                                                 |                                   | 65,315                      |       | 73,885                   |       |
| Inventories                                                                                                                                                                                                             |                                   | 875                         |       | 1,064                    |       |
| Deferred income taxes                                                                                                                                                                                                   |                                   | 5,272                       |       | 5,785                    |       |
| Income tax receivable                                                                                                                                                                                                   |                                   | 5,077                       |       | —                   |       |
| Prepaid expenses and other current assets                                                                                                                                                                               |                                   | 6,142                       |       | 7,285                    |       |
| Assets of discontinued operations                                                                                                                                                                                       |                                   | 842                         |       | —                   |       |
| Total current assets                                                                                                                                                                                                    |                                   | 87,245                      |       | 88,263                   |       |
| **PROPERTY, PLANT AND EQUIPMENT,**  net of accumulated depreciation of $45,166 and $48,409, respectively                                                                                                                |                                   | 39,603                      |       | 41,866                   |       |
| **GOODWILL**                                                                                                                                                                                                            |                                   | 326,139                     |       | 325,185                  |       |
| **INTANGIBLES**, net  of amortization of $1,700 and $1,906, respectively                                                                                                                                                |                                   | 4,904                       |       | 4,698                    |       |
| **OTHER NONCURRENT ASSETS**                                                                                                                                                                                             |                                   | 11,524                      |       | 11,225                   |       |
| Total assets                                                                                                                                                                                                            |                                   | $                           | 469,415    |                     | $          | 471,237 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                          |                                   |                        |       |                     |       |
| **CURRENT LIABILITIES:**                                                                                                                                                                                                |                                   |                        |       |                     |       |
| Accounts payable and accrued liabilities                                                                                                                                                                                |                                   | $                           | 52,549     |                     | $          | 44,954 |   |
| Current maturities of long-term obligations                                                                                                                                                                             |                                   | 258                         |       | 234                      |       |
| Income tax payable                                                                                                                                                                                                      |                                   | —                      |       | 1,371                    |       |
| Liabilities of discontinued operations                                                                                                                                                                                  |                                   | 326                         |       | —                   |       |
| Total current liabilities                                                                                                                                                                                               |                                   | 53,133                      |       | 46,559                   |       |
| **LONG-TERM OBLIGATIONS**,  net of current maturities                                                                                                                                                                   |                                   | 87,547                      |       | 94,225                   |       |
| **DEFERRED INCOME TAXES**                                                                                                                                                                                               |                                   | 13,210                      |       | 11,823                   |       |
| **LONG-TERM CUSTOMER LIABILITY**                                                                                                                                                                                        |                                   | 4,147                       |       | 1,305                    |       |
| **DEFERRED REVENUE**                                                                                                                                                                                                    |                                   | 8,010                       |       | 6,721                    |       |
| **OTHER LONG-TERM OBLIGATIONS**                                                                                                                                                                                         |                                   | 10,947                      |       | 10,418                   |       |
| Total liabilities                                                                                                                                                                                                       |                                   | 176,994                     |       | 171,051                  |       |
| **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, 15,703,586 and 15,706,786 shares issued and 15,666,916 and  15,670,116 shares outstanding at December 31, 2004 and March 31,  2005, respectively |                                   | 157                         |       | 157                      |       |
| Additional paid-in-capital                                                                                                                                                                                              |                                   | 193,925                     |       | 193,925                  |       |
| Retained earnings                                                                                                                                                                                                       |                                   | 103,136                     |       | 110,270                  |       |
|                                                                                                                                                                                                                    |                                   | 297,218                     |       | 304,352                  |       |
| Less—                                                                                                                                                                                                              | Treasury stock, at cost, 36,670 shares |                        | (501       | )                        | (501       | ) |
| Less—                                                                                                                                                                                                              | Deferred compensation                  |                        | (4,296     | )                        | (3,665     | ) |
| Total stockholders’ equity                                                                                                                                                                                         |                                   | 292,421                     |       | 300,186                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                         |                                   | $                           | 469,415    |                     | $          | 471,237 |   |

 

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

 

3

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(IN THOUSANDS, EXCEPT PER SHARE DATA)**

 
| ** **                                                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                  | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| ** **                                                  | ** ** | **(Unaudited)**                        | ** ** |
| **REVENUE**                                                 |       | $                                      | 95,816     |   | $ | 105,932 |   |
| **COST OF  SERVICES EXCLUSIVE OF DEPRECIATION**             |       | 56,393                                 |       | 58,536 |   |
| **DEPRECIATION**                                            |       | 3,200                                  |       | 3,423 |   |
| Gross profit                                                |       | 36,223                                 |       | 43,973 |   |
| **SELLING,  GENERAL AND ADMINISTRATIVE EXPENSES**           |       | 31,068                                 |       | 30,221 |   |
| **AMORTIZATION**                                            |       | 89                                     |       | 206 |   |
| Operating income                                            |       | 5,066                                  |       | 13,546 |   |
| **OTHER  (INCOME) EXPENSE:**                                |       |                                   |       |   |   |
| Interest expense                                            |       | 660                                    |       | 1,211 |   |
| Interest income                                             |       | (4                                     | )          | (45 | ) |
| Other (income) expense, net                                 |       | 119                                    |       | 315 |   |
| Income from continuing operations before  income taxes      |       | 4,291                                  |       | 12,065 |   |
| **PROVISION  FOR INCOME TAXES**                             |       | 1,716                                  |       | 4,710 |   |
| **INCOME  FROM CONTINUING OPERATIONS**                      |       | 2,575                                  |       | 7,355 |   |
| **INCOME  (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAX** |       | (510                                   | )          | (221 | ) |
| **NET  INCOME**                                             |       | $                                      | 2,065      |   | $ | 7,134 |   |
| **NET  INCOME PER COMMON SHARE**                            |       |                                   |       |   |   |
| **BASIC**                                                   |       |                                   |       |   |   |
| **Continuing  Operations**                                  |       | $                                      | 0.16       |   | $ | 0.47 |   |
| **Discontinued  Operations**                                |       | (0.03                                  | )          | (0.01 | ) |
| **Total**                                                   |       | $                                      | 0.13       |   | $ | 0.46 |   |
| **DILUTED**                                                 |       |                                   |       |   |   |
| **Continuing  Operations**                                  |       | $                                      | 0.16       |   | $ | 0.46 |   |
| **Discontinued  Operations**                                |       | (0.03                                  | )          | (0.01 | ) |
| **Total**                                                   |       | $                                      | 0.13       |   | $ | 0.45 |   |
| **WEIGHTED  AVERAGE COMMON SHARES OUTSTANDING**             |       |                                   |       |   |   |
| **BASIC**                                                   |       | 16,096                                 |       | 15,670 |   |
| **DILUTED**                                                 |       | 16,448                                 |       | 15,963 |   |

 

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

 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(IN THOUSANDS)**

 
| ** **                                                                                | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | **(Undaudited)**                       | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                                |       |                                   |       |   |   |
| Income from continuing operations                                                         |       | $                                      | 2,575      |   | $ | 7,355 |   |
| Adjustments to reconcile income to net cash  provided by (used in) operating activities:  |       |                                   |       |   |   |
| Depreciation and amortization                                                             |       | 3,289                                  |       | 3,629 |   |
| Deferred income tax provision (benefit)                                                   |       | 1,424                                  |       | (1,900 | ) |
| Compensation expense on restricted stock  grants                                          |       | 528                                    |       | 631 |   |
| Loss on sale of property, plant and  equipment                                            |       | —                                 |       | 15 |   |
| Change in operating assets and liabilities:                                               |       |                                   |       |   |   |
| Accounts and notes receivable                                                             |       | (2,523                                 | )          | (8,303 | ) |
| Inventories, prepaid expenses and other  assets                                           |       | (498                                   | )          | (1,441 | ) |
| Accounts payable and accrued liabilities                                                  |       | (4,650                                 | )          | (4,435 | ) |
| Net cash provided by (used in) operating  activities from continuing operations           |       | 145                                    |       | (4,449 | ) |
| Net cash provided by (used in) operating  activities from discontinued operations         |       | 565                                    |       | (171 | ) |
| Net cash provided by (used in) operating  activities                                      |       | 710                                    |       | (4,620 | ) |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                |       |                                   |       |   |   |
| Net proceeds received from divestitures                                                   |       | —                                 |       | 224 |   |
| Purchase of property, plant and equipment                                                 |       | (3,307                                 | )          | (5,705 | ) |
| Proceeds from disposition of property,  plant and equipment                               |       | 9                                      |       | 3 |   |
| Cash paid for acquisitions, net of cash  acquired                                         |       | (400                                   | )          | (34 | ) |
| Net cash used in investing activities from  continuing operations                         |       | (3,698                                 | )          | (5,512 | ) |
| Net cash used in investing activities from  discontinued operations                       |       | (100                                   | )          | — |   |
| Net cash used in investing activities                                                     |       | (3,798                                 | )          | (5,512 | ) |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                |       |                                   |       |   |   |
| Proceeds from exercise of common stock  options                                           |       | 94                                     |       | — |   |
| Proceeds from long-term obligations                                                       |       | 92,745                                 |       | 52,975 |   |
| Principal payments on long-term obligations                                               |       | (87,693                                | )          | (46,321 | ) |
| Net cash provided by financing activities  from continuing operations                     |       | 5,146                                  |       | 6,654 |   |
| ** **                                                                                |       |                                   |       |   |   |
| **NET  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS**                                 |       | 2,058                                  |       | (3,478 | ) |
| **CASH AND  CASH EQUIVALENTS,** beginning of period                                       |       | 2,097                                  |       | 3,722 |   |
| **CASH AND  CASH EQUIVALENTS,** end of period                                             |       | $                                      | 4,155      |   | $ | 244 |   |
| **SUPPLEMENTAL  DATA:**                                                                   |       |                                   |       |   |   |
| Cash paid for:                                                                            |       |                                   |       |   |   |
| Income taxes, net of income tax refunds                                                   |       | $                                      | 53         |   | $ | 11 |   |
| Interest                                                                                  |       | $                                      | 629        |   | $ | 1,209 |   |
| **NONCASH  FINANCING TRANSACTIONS:**                                                      |       |                                   |       |   |   |
| Assets acquired through financing and  capital lease arrangements                         |       | $                                      | 151        |   | $ | — |   |
| Restricted stock grant (132,000 and 0 shares,  respectively)                              |       | $                                      | 3,454      |   | $ | — |   |
| Common stock accrued related to business  acquisitions (9,623 and 0 shares, respectively) |       | $                                      | 261        |   | $ | — |   |

 

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

 

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1. Basis of Presentation**

 

Theaccompanying condensed consolidated financial statements and related notes tothe condensed consolidated financial statements include the accounts ofSOURCECORP, Incorporated and subsidiaries (collectively, the “Company”).  All significant intercompany accounts andtransactions have been eliminated in consolidation. These condensed consolidatedfinancial statements have been prepared by the Company, without audit, pursuantto the rules and regulations of the Securities and Exchange Commission(the “Commission”). Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America have beencondensed or omitted pursuant to such rules and regulations. However, theCompany believes that all disclosures are adequate to make the informationpresented not misleading.  Thesecondensed consolidated financial statements should be read in conjunction withthe Company’s consolidated financial statements and the related notes theretoin the Annual Report on Form 10-K filed with the Commission on March 31,2005.

 

Inthe opinion of management, all adjustments necessary to fairly present theCompany’s financial position at March 31, 2005, and results of operationsand cash flows for the three months ended March 31, 2005 and 2004 havebeen included. The results of operations for the three months ended March 31,2005 are not necessarily indicative of the results to be expected for the fullfiscal year or for any future periods.

 

TheCompany uses estimates and assumptions required for preparation of thefinancial statements. The estimates are primarily based on historicalexperience and business knowledge and are revised as circumstances change.However, actual results could differ from the estimates.

 

**2. Reserves and Other Loss Contingencies**

 

**Self-Insurance Liabilities and Reserves.**  TheCompany is self-insured for workmen’s compensation liabilities and asignificant portion of its employee medical costs. The Company accounts for itsself-insurance programs based on actuarial estimates of the amount of lossinherent in that period’s claims, including losses for which claims have notbeen reported. These loss estimates rely on actuarial observations of ultimateloss experience for similar historical events. The Company limits its risk bycarrying stop-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.  Forworkman’s compensation, the fixed dollar amount of stop-loss coverage is$500,000 per occurrence.  For medicalcosts, the fixed dollar amount of stop-loss coverage is $100,000 per coveredparticipant for the fiscal plan year, with a lifetime limit of liability percovered participant of $1,900,000.  TheCompany’s current stop-loss policy for medical costs is to expire on June 30,2005.  The Company is currently innegotiations to renew or replace the current stop-loss policy upon itsexpiration.

 

Accrual balances related to workmen’s compensationand medical costs, included in accured liabilities in the CondensedConsolidated Balance Sheets, are as follows (in thousands):

 

| ** **                  | ** ** | **December 31,  2004** | ** ** | **March 31,  2005** | ** ** |
|-----------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Workmen’s Compensation |       | $                           | 2,407      |                     | $          | 2,226 |   |
| Employee Medical Insurance  |       | 2,229                       |       | 2,323                    |       |
| Total                       |       | $                           | 4,636      |                     | $          | 4,549 |   |

 

**Other Loss Contingencies.**  TheCompany records liabilities when it is probable that a liability has beenincurred and the amount of the loss is reasonably estimable in accordance withStatement of Financial Accounting Standards (“SFAS”) No. 5, *Accounting for Contingencies*.  Disclosure is required when there is areasonable possibility that the ultimate loss will exceed the recordedprovision. Contingent liabilities are often resolved over long periods of time.Estimating probable losses requires analysis of multiple forecasts that oftendepend on judgments about potential actions by third parties such asregulators. The Company’s loss contingencies consist primarily of estimatesrelated to the probable outcome of pending litigation.  See Note 7.

 

6

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**3. Stockholders’ Equity and Stock-Based Compensation**

 

*Stock-Based Compensation*

 

In2002, the Board of Directors and Shareholders of the Company approved theSOURCECORP, Incorporated 2002 Long-Term Incentive Plan (the “2002 Plan”), whichreplaced the 1995 Stock Option Plan, as amended (the “1995 Plan”). The 2002Plan authorizes awards of options to purchase common stock and may includeincentive stock options (“ISOs”) and/or non-qualified stock options (“NQSOs”),stock appreciation rights, restricted stock, deferred stock, bonus stock andawards in lieu of cash obligations, dividend equivalents and other stock basedawards.

 

TheBoard of Directors has appointed a committee (the “Committee”), which is composedof independent, non-employee directors, to administer the 2002 Plan. Personseligible to receive awards under the plan include directors, officers,employees of the Company and its subsidiaries, and persons who provideconsulting services to the Company deemed by the Committee, or the Board as awhole, to be of substantial value to the Company, persons who have been offeredemployment by the Company or its subsidiaries, and persons employed by anentity that the Committee reasonably expects to become a subsidiary of theCompany. Awards granted under the 2002 Plan may, at the discretion of theCommittee, be granted either alone or in addition to, in tandem with or insubstitution for any other award granted under the 2002 Plan or any other planof the Company, any subsidiary or any business entity to be acquired by theCompany or one of its subsidiaries. The Committee determines vesting in awardsgranted under the 2002 Plan.

 

TheCompany applies Accounting Principles Board Opinion (“APB”) No. 25, *Accounting for Stock Issued to Employees*, and related interpretations inaccounting for stock-based compensation and awards. Stock option and warrantawards are granted at the market price of the common stock on the date ofgrant. Accordingly, no compensation expense has been recognized for stockoptions and warrants. Had compensation expense been determined based upon thefair value at grant dates for stock options and warrants consistent with themethod of SFAS No. 123, *Accounting forStock-Based Compensation,* the Company’s net income and earnings pershare would have been as follows (in thousands, except per share data):

 
| ** **                                                                                                                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                           | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| Net income as reported                                                                                                               |       | $                                      | 2,065      |   | $ | 7,134 |   |
| Add: Deferred compensation expense included  in reported net income, net of related tax effect                                       |       | 332                                    |       | 385 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of tax effect |       | (908                                   | )          | (768 | ) |
| Proforma net income                                                                                                                  |       | $                                      | 1,489      |   | $ | 6,751 |   |
|                                                                                                                                 |       |                                   |       |   |   |
| Earnings per share:                                                                                                                  |       |                                   |       |   |   |
| Reported basic earnings per share                                                                                                    |       | $                                      | 0.13       |   | $ | 0.46 |   |
| Proforma basic earnings per share                                                                                                    |       | $                                      | 0.09       |   | $ | 0.43 |   |
|                                                                                                                                 |       |                                   |       |   |   |
| Reported diluted earnings per share                                                                                                  |       | $                                      | 0.13       |   | $ | 0.45 |   |
| Proforma diluted earnings per share                                                                                                  |       | $                                      | 0.09       |   | $ | 0.42 |   |

 

Thefair value of stock options and warrants was estimated on the date of grantusing the Black-Scholes option pricing model using the following assumptions:

 
| ** **                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------|------------|----------------------------------------|------------|
| ** **                               | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| Weighted-average risk-free interest rate |       | 3.1                                    | %          | 0.0 | % |
| Weighted-average dividend yield          |       | 0.0                                    | %          | 0.0 | % |
| Weighted-average volatility              |       | 41.4                                   | %          | 0.0 | % |
| Weighted-average expected life           |       | 4.0 years                              |       | 0.0 years |   |

 

On December 18, 2004, the Compensation Committee of the Board ofDirectors approved, and the Board of Directors ratified, the acceleration ofthe vesting of certain options and warrants (specifically options and warrantsissued in 2002 or earlier, and only those options and warrants that by their termswould not vest before June 30, 2005), provided that the holders wereemployed by the Company as of December 31, 2004. The action was taken as amethod to provide a further incentive to option holders to maximize shareholdervalue without creating an immediate windfall (as substantially all of suchoptions and warrants had exercise prices above $30 per share). In taking suchaction, the Compensation Committee and the Board were mindful that theaccounting treatment of stock

 

7

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options and warrants was anticipated to change in the second half of2005 (which date has changed to the first quarter of 2006), requiring theexpensing of unvested stock options and warrants. As such, the CompensationCommittee and the Board were mindful that accelerating the vesting of suchoptions and warrants would avoid an expense in future periods that did notprovide any direct associated benefit to individuals and that could otherwisenegatively impact the Company’s reported results in future periods. This actionresulted in the acceleration of vesting of 364,100 stock options and warrantsat a weighted-average strike price of $30.38 during the fourth quarter of 2004.Although this action established a new measurement date for the stock optionsand warrants under the intrinsic value method, there was no compensationexpense associated with the vesting acceleration as the strike price related tothe accelerated stock options and warrants was above the fair market value ofthe Company’s common stock on December 17, 2004.  As a result of the acceleration, additionalexpense of approximately $2.1 million, net of tax, was included in thepro-forma disclosure during the three months ended December 31, 2004related to the acceleration.

 

During2003, the Company awarded 164,300 shares of restricted stock under the 2002Plan. The restricted shares were issued at no cost to the recipients;therefore, the Company recorded deferred compensation of approximately $2.9million based on the market value of the stock at the date of issuance.  Subsequent to the grant date, certainforfeitures of restricted stock have occurred resulting in a total award of155,000 shares and total deferred compensation of $2.8 million.  The deferred compensation charge is beingamortized to expense over the vesting period of the restricted stock. Therestricted shares vest over a three-year period ending July 1, 2006, withacceleration of the vesting period occurring if a certain stock price orperformance target is achieved. 

 

Duringthe three months ended March 31, 2004, the Company awarded 132,000 sharesof restricted stock under the 2002 Plan. The restricted shares were issued at no cost to the recipients;therefore, the Company recorded deferred compensation of approximately $3.5million based on the market value of the stock at the date of issuance.  Subsequent to the grant date, certainforfeitures of restricted stock have occurred resulting in a total award of126,750 shares and total deferred compensation of $3.3 million.  The deferred compensation charge is beingamortized to expense over the vesting period of the restricted stock.  The restricted shares vest at the end of athree-year period ending January 10, 2007, with acceleration of thevesting period occurring if certain performance targets are achieved.  

 

Duringthe three months ended June 30, 2004, the Company awarded 50,550 shares ofrestricted stock under the 2002 Plan. The restricted shares were issued at no cost to the recipients;therefore, the Company recorded deferred compensation of approximately $1.2million based on the market value of the stock at the date of issuance.  The deferred compensation charge is beingamortized to expense over 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.

 

Deferredcompensation amortized to expense, included in selling, general and administrativeexpenses in the Condensed Consolidated Statements of Operations, related to therestricted stock grants discussed above is as follows (in thousands):

 

| ** **              | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------|------------|----------------------------------------|------------|
| ** **              | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| May 2003 grant     |       | $                                      | 252        |   | $ | 238 |   |
| January 2004 grant |       | 276                                    |       | 276 |   |
| May 2004 grant     |       | —                                 |       | 117 |   |
| Total                   |       | $                                      | 528        |   | $ | 631 |   |

 

*Common Stock Repurchase Program*

 

During2003, the Company activated the $30.0 million stock repurchase programauthorized by the Board of Directors in April 2001 and purchased 1,306,979shares of its common stock at a cost of approximately $20.7 million.  During the three months ended June 30,2004, the Company purchased an additional 361,415 shares of its common stock ata cost of approximately $9.3 million completing the original repurchase program.

 

Duringthe third quarter of 2004, the Board of Directors authorized the purchase of anadditional $20.0 million of shares from time to time in the open market asconditions warrant.  During the threemonths ended September 30, 2004, the Company purchased 34,800 shares ofcommon stock at a cost of approximately $0.8 million.  During the three months ended December 31,2004, the Company purchased 82,724 shares of common stock at a cost ofapproximately $1.8 million.  

 

Therepurchased shares were recorded in the balance sheet as a reduction to commonstock, additional paid-in-capital, and retained earnings.  These shares have been retired and returnedto the status of authorized but unissued shares of the Company.

 

Noadditional shares were purchased during the three months ended March 31,2005.

 

8

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*Net Income Per Share*

 

Basicand diluted net income per common 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):

 
| ** **                                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                               | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| Basic weighted average common shares                     |       | 16,096                                 |       | 15,670 |   |
| Weighted average options, warrants and  restricted stock |       | 328                                    |       | 293 |   |
| Other contingent consideration                           |       | 24                                     |       | — |   |
| Diluted weighted average common shares                   |       | 16,448                                 |       | 15,963 |   |

 

AtMarch 31, 2004 and 2005, approximately 1.8 million and 3.0 million,respectively, of common shares were not included in the diluted earnings pershare calculation because they were anti-dilutive.  These common shares may be dilutive in futureearnings per share calculations.

 

**4. Discontinued Operations**

 

*2005 Divestiture*

* *

During the first quarter of 2005, the Company formally committed to aplan of divestiture for a non-strategic asset group related to its litigationservice operations reported in the Healthcare, Regulatory and Legal Compliancesegment in prior periods.  During 2004,the operation contributed approximately $3.7 million of revenue and loss beforeincome taxes of approximately $0.3 million. The Company has concluded the asset group meets the requirements fordiscontinued operations accounting treatment as outlined in SFAS No. 144, “*Accounting for the Impairment or Disposal ofLong-Lived Assets”* during the quarter ended March 31,2005.  As such, the operating assets andliabilities of this operation are presented in the condensed consolidatedbalance sheet as Assets and Liabilities of Discontinued Operations and theresults associated with this operation are presented in the condensedconsolidated statement of operations as Income (Loss) from DiscontinuedOperations, net of tax.

 

During the first quarter of 2005, the Company completed the sale ofthis non strategic asset group, resulting in the recognition of a pre-tax lossof approximately $0.2 million.  Inconnection with this transaction, the Company received approximately $0.2million of cash proceeds and a promissory note of approximately $0.1 million.

 

Summarizedselected financial information for the 2005 divestiture discussed above is asfollows (in thousands):

 
| ** **                                             | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                             | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | **(Unaudited)**                        | ** ** |
| **REVENUE**                                            |       | $                                      | 1,060      |   | $ | 260 |   |
| **COST OF  SERVICES**                                  |       | 748                                    |       | 194 |   |
| **DEPRECIATION**                                       |       | 21                                     |       | 6 |   |
| Gross profit                                           |       | 291                                    |       | 60 |   |
| **SELLING,  GENERAL AND ADMINISTRATIVE EXPENSES**      |       | 329                                    |       | 191 |   |
| Operating loss                                         |       | (38                                    | )          | (131 | ) |
| **OTHER  (INCOME) EXPENSE:**                           |       |                                   |       |   |   |
| Loss on sale of asset group                            |       | —                                 |       | 168 |   |
| Loss from discontinued operations before  income taxes |       | (38                                    | )          | (299 | ) |
| **PROVISION  (BENEFIT) FOR INCOME TAXES**              |       | (15                                    | )          | (117 | ) |
| **LOSS  FROM DISCONTINUED OPERATIONS**                 |       | $                                      | (23        | ) | $ | (182 | ) |

 

9

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Theassets and liabilities of the discontinued operation are stated separately onthe Condensed Consolidated Balance Sheets. The major asset and liability categories are as follows (in thousands):

 

| ** **                                                             | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                             |       | **(Unaudited)**             |       |
| **ASSETS OF DISCONTINUED OPERATION**                                   |       |                        |       |
| **CURRENT  ASSETS:**                                                   |       |                        |       |
| Accounts and notes receivable, net of  allowance for doubtful accounts |       | $                           | 731        |   |
| Prepaid expenses and other current assets                              |       | 17                          |       |
| Total current assets                                                   |       | 748                         |       |
| **PROPERTY,  PLANT AND EQUIPMENT,** net of accumulated depreciation    |       | 94                          |       |
| Total assets of discontinued operation                                 |       | $                           | 842        |   |
| **LIABILITIES OF DISCONTINUED OPERATION**                              |       |                        |       |
| **CURRENT  LIABILITIES:**                                              |       |                        |       |
| Accounts payable and accrued liabilities                               |       | $                           | 326        |   |
| Total liabilities of discontinued operation                            |       | $                           | 326        |   |

 

*2004 Divestitures*

* *

During the first quarterof 2004, the Company completed a strategic evaluation of its operations basedon certain criteria, such as strategic and financial fit, and future growthprospects. As a result, on May 6, 2004, the Company formally committed toa plan of divestiture for certain non-strategic asset groups related to itsDirect Mail operations reported in the Information Management and Distributionsegment in prior periods, and two medical records management operationsreported in the Healthcare, Regulatory and Legal Compliance segment in priorperiods. The Direct Mail operations and the two medical records managementoperations are accounted for as discontinued operations. As such, the resultsassociated with these operations are presented in the consolidated statement ofoperations as Income (Loss) from Discontinued Operations, net of tax.

 

During the secondquarter of 2004, the Company completed the sale of one of the medical recordsmanagement operations, which resulted in approximately $0.7 million of cashproceeds and a pre-tax gain on disposal of approximately $0.5 million.Additionally, the Company recognized a pre-tax loss on disposal related to theDirect Mail operations of approximately $2.2 million.

 

During the third quarterof 2004, the Company completed the sale of the Direct Mail operations and theremaining medical records management operation, resulting in the recognition ofa net pretax gain of $0.4 million. In connection with these transactions, theCompany received approximately $6.1 million of cash proceeds, net oftransaction costs, approximately $1.5 million of 12 percent securedsubordinated notes, which the Company fully reserved, related to the DirectMail operations, and $0.6 million of contingent consideration related to acontract renewal at the medical records management operation.

 

During the fourthquarter of 2004, the contingency surrounding the contract renewal at themedical records management operation was resolved. As such, the Companyrecognized additional consideration of $0.6 million offset by approximately$0.1 million of incremental loss related to finalizing the considerationrelated to the divestiture.

 

The collection of thereserved subordinated notes could result in a future reduction of the totalloss related to the disposition of the Direct Mail operations.

 

Summarizedselected financial information for the 2004 divestitures discussed above is asfollows (in thousands):

 
| ** **                                             | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                             | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | **(Unaudited)**                        | ** ** |
| **REVENUE**                                            |       | $                                      | 8,589      |   | $ | 7 |   |
| **COST OF  SERVICES**                                  |       | 6,400                                  |       | 49 |   |
| **DEPRECIATION**                                       |       | 401                                    |       | — |   |
| Gross profit                                           |       | 1,788                                  |       | (42 | ) |
| **SELLING,  GENERAL AND ADMINISTRATIVE EXPENSES**      |       | 2,611                                  |       | 4 |   |
| Operating loss                                         |       | (823                                   | )          | (46 | ) |
| **OTHER  (INCOME) EXPENSE:**                           |       |                                   |       |   |   |
| Interest and other expense (income), net               |       | (11                                    | )          | — |   |
| Loss on sale of asset group                            |       | —                                 |       | 17 |   |
| Loss from discontinued operations before  income taxes |       | (812                                   | )          | (63 | ) |
| **PROVISION  (BENEFIT) FOR INCOME TAXES**              |       | (325                                   | )          | (24 | ) |
| **LOSS  FROM DISCONTINUED OPERATIONS**                 |       | $                                      | (487       | ) | $ | (39 | ) |

 

10

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**5. Business Combinations**

 

*Goodwill and Intangibles*

 

Thechanges in the carrying value of goodwill and the components of intangibles areas follows (in thousands):

 

Goodwill:

 
| ** **                             | ** ** | **Information  Management and  Distribution** | ** ** | **Healthcare,  Regulatory  and Legal  Compliance** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------------|------------|-----------|------------|
| Net balance as of January 1, 2005 |       | $                                             | 167,660    |                                               | $          | 158,479   |       | $ | 326,139 |   |
| Adjusment related to past acquisition  |       | (935                                          | )          | —                                             |       | (935      | )          |
| Finalize purchas price allocation      |       | —                                        |       | (19                                                | )     | (19       | )     |
| Net balance as of March 31, 2005  |       | $                                             | 166,725    |                                               | $          | 158,460   |       | $ | 325,185 |   |

 

Intangibles:

 
| ** **             | ** ** | **December 31, 2004** | ** ** | **March 31, 2005**       | ** ** |
|------------------------|------------|----------------------------|------------|-------------------------------|------------|
| ** **             | ** ** | **Gross Carrying  Value**  | ** ** | **Accumulated  Amortization** | ** ** | **Gross Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** |
| Customer relationships |       | $                          | 4,283      |                          | $          | (1,084 | ) | $ | 4,283 |   | $ | (1,150 | ) |
| Non-compete agreements |       | 2,321                      |       | (616                          | )          | 2,321 |   | (756 | ) |
| Total                  |       | $                          | 6,604      |                          | $          | (1,700 | ) | $ | 6,604 |   | $ | (1,906 | ) |

 

Aggregateamortization expense related to intangibles for the three months ended March 31,2004 and 2005 was approximately $0.1 million and $0.2 million,respectively.  Estimated amortizationexpense for the periods ending December 31, 2005 through December 31,2016 is presented 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      |   |

*Contingent Consideration*

 

Certainof the Company’s acquisitions are subject to adjustments in overallconsideration and recorded goodwill based upon the achievement of specifiedrevenue and/or earnings targets generally over one to three year periods. In certainagreements, the Company reserves the right to change the payment mix to usecommon stock versus cash in satisfying contingent consideration liabilities. 

 

Management’sevaluation of the cumulative earnings of acquired companies through December 31,2004 indicated that an acquired company has met specified earnings targetsbeyond a reasonable doubt.  There were nochanges to management’s evaluation during the three months ended March 31,2005;  therefore, approximately $5.3million of additional consideration remains accrued and is expected to besettled in cash during 2005.  The accruedadditional consideration is included in accounts payable and accruedliabilities in the Condensed Consolidated Balance Sheets. 

 

Asof March 31, 2005, all periods applicable for earnout targets of pastacquisitions are completed.

 

# *Other Accrued Consideration*

#  

Duringthe three months ended March 31, 2005, no additional purchase proceedswere accrued.

 

**6. Segment Reporting**

 

TheCompany aggregates its service offerings and operations into two reportablesegments: (i) Information Management and

 

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Distribution,and (ii) Healthcare, Regulatory, and Legal Compliance. The Company’sreportable segments are organized around customer types and service offeringspossessing similar economic characteristics. Management evaluates segmentperformance based on revenue and income before income taxes. All centrallyincurred corporate costs are allocated to the segments based principally on operatingincome of the reportable segments.  Thereporting segments follow the same accounting policies used for the Company’sconsolidated financial statements.

 

Theidentified segments are as follows:

 

**Information Management and Distribution.**  Thissegment offers Business Process Outsourcing (“BPO”) solutions that help itscustomers manage the *Document In-flow*,*Workflow Processing* and *Statement Out-flow* of their missioncritical business document processes. This segment’s BPO solutions enablecustomers to automate their complex workflow processes by digitizing 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.

 

**Healthcare, Regulatory and Legal Compliance.**  Thissegment offers specialized knowledge-based processing and consulting servicesthat include medical records release, record management services for healthcareinstitutions, temporary staffing for healthcare institutions, providing managedcare compliance reviews, class action claims administration sevices, andprofessional economic research and litigation services.

 

TheCompany measures segment profit as income from continuing operations beforeincome taxes. Information on the segments follows (in thousands):

 
| ** **                                             | ** ** | **THREE MONTHS ENDED MARCH 31, 2005**     | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                             | ** ** | **Information  Management  and  Distribution** | ** ** | **Healthcare,  Regulatory  and Legal  Compliance** | ** ** | **Consolidated** | ** ** |
| Revenue                                                |       | $                                              | 56,295     |   | $ | 49,637 |   | $ | 105,932 |   |
| Income from continuing operations before  income taxes |       | 5,816                                          |       | 6,249 |   | 12,065 |   |
|                                                        |            |                                                |            |  |  |  |  |  |  |  |

 
| ** **                                                    | ** ** | **THREE MONTHS ENDED MARCH 31, 2004**     | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                    | ** ** | **Information  Management  and  Distribution** | ** ** | **Healthcare,  Regulatory  and Legal  Compliance** | ** ** | **Consolidated** | ** ** |
| Revenue                                                       |       | $                                              | 48,027     |   | $ | 47,789 |   | $ | 95,816 |   |
| Income (loss) from continuing operations  before income taxes |       | (1,629                                         | )          | 5,920 |   | 4,291 |   |
|                                                               |            |                                                |            |  |  |  |  |  |  |  |

 

**7.Litigation**

 

TheCompany is, from time to time, a party to litigation. The following is adescription of the most significant legal matters that the Company is involvedin.  In the event of an adverse outcomein one or more of the legal proceedings our business, financial condition,results of operations or cash flows could be materially adversely affected.

 

### ***Putative Securities Class Action***

### ** **

TheCompany, and the Company’s CEO and CFO individually, have been named asdefendants in several putative securities class actions, in response to theCompany’s press releases dated October 27, 2004, in which the Companydisclosed that its financial statements for certain prior periods should nolonger be relied upon, and also provided updated financial guidance. Thecomplaints (collectively, the “Actions”) were filed in the United StatesDistrict Court for the Northern District of Texas, Dallas Division, with thefirst action being filed November 1, 2004. The Actions are putative shareholderclass action lawsuits alleging violations of Federal Securities Laws, includingalleged violations of Sections 10(b) and 20(a), and Rule 10b-5 of theSecurities Exchange Act of 1934, as amended. The Actions are purportedly onbehalf 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 Actions have been transferred to asingle judge in the Northern District of Texas, Dallas Division and theseactions have been consolidated into a single action now styled *In re Sourcecorp, Inc. Securities Litigation,*and a lead plaintiff has been appointed.

 

#### ***Purported Derivative Action and Demand Letter***

#### ** **

Apurported stockholder derivative action was filed on December 28, 2004,against certain of the Company’s current and former officers and directors asindividual defendants and the Company as a nominal defendant in the 116thDistrict Court for Dallas County, Texas (the “Purported Derivative Action”).The Purported Derivative Action alleges breach of fiduciary duty, abuse ofcontrol, gross mismanagement, waste of assets, and unjust enrichment related tothe Company’s press release dated October 27, 2004, in which the Companydisclosed that its financial statements for certain prior periods should nolonger be relied upon. All of these claims are asserted derivatively on behalfof the Company and seek unspecified damages against those individuals.  Further, the

 

12

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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 DerivativeAction.  The Demand Letter requests theBoard to take certain action, but does not seek damages against theCompany.  The Company has formed aspecial committee of the Board of Directors to evaluate the claims made in thePurported Derivative Action and the Demand Letter.

 

*DigitalImaging Systems*

 

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 other things,that a portion of the Company’s process for scanning and indexing imagesviolates one of Digital Imaging Systems’ patents.  The Company has tendered this matter to oneof its software/hardware vendors for indemnification, which such vendor hasundertaken subject to pre-existing contractual conditions.  The suit demands unspecified damages.

 

*Various ROI Copy Charge Matters*

 

Fromtime to time, various subsidiaries of the Company that perform release ofinformation (“ROI”) services become defendants to putative class actionlawsuits generally alleging that the charge for reproducing certain medicalrecords is not in conformity with such plaintiffs’ reading of the applicableregulated charge. Such suits typically include multiple ROI companies andhospitals as defendants and demand reimbursement for prior charges as well asfor prospective pricing adjustments. The Company is currently a party toseveral such suits in various stages of development.  One such suit originally styled *McShane v. Recordex Acquisition Corp. &Sourcecorp, Incorporated* (andnow styled *Liss & Marion, PC v. RecordexAcquisition Corp., & Sourcecorp, Inc.*) filed February 10,2003, in the Court of Common Pleas Philadelphia County, Pennsylvania, allegesamong other things that the Company intentionally charges more for providingcopies of medical records than is permitted under Pennsylvania law.  The complaint does not specify the amount ofdamages sought.  Plaintiff's counsel hadat one time alleged damages were as high as $7 million without providing anyreal support for this amount; however, the Company believes that it willultimately prevail in this matter, or if any liability is found, that theamount of damages, if any, would be substantially less than such allegedamount.  In September 2004, thecourt entered its order certifying a class in this matter and both theplaintiffs and the defendants have filed motions for summary judgment.

 

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

 

InJune 2000, the Company filed an action styled *F.Y.I. Incorporated v. Spohr, et. al.* in Dallas, Texas, inwhich it asserted claims for breach of contract, fraud, and negligentmisrepresentation against the sellers of two related companies the Companyacquired in December 1998 (the “Texas Action”). The Texas Action was laterremoved to federal court and ultimately dismissed on jurisdictional grounds.The Company reasserted these claims in two actions that were laterconsolidated; one styled *F.Y.I. Incorporatedv. Spohr, et. al.* in Superior Court of the State of California inthe 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 the State ofCalifornia 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.

 

**8. Long-Term Customer Liability and Deferred Revenue**

** **

During October 2004,the Company, with the oversight and approval of the Audit Committee of itsBoard of Directors, initiated an investigation of the financial results of oneof its operating subsidiaries in the Information Management and Distributionreportable segment (the “Operating Subsidiary”). The findings of theinvestigation concluded that the Operating Subsidiary had incorrectlyrecognized revenue for certain customer arrangements and omitted certainoperating expenses from its financial results which in turn resulted inoverpayments and over accruals of contingent consideration amounts due underthe earn-out provisions of the acquisition agreement for the OperatingSubsidiary.  The overpayments and overaccruals of contingent consideration amounts had been originally recognized asadditional goodwill of the acquired business. 

 

As described in theCompany’s critical accounting policies, revenue is recognizable when each ofthe following conditions is met: persuasive evidence of an arrangementexists, the price is fixed or determinable, delivery has occurred or serviceshave been rendered and collection is reasonably assured. The investigationidentified 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 was reversed,resulting in a downward adjustment to certain asset accounts or the recognitionof a customer liability or deferred revenue. 

 

During the first quarter of 2005, the Company entered into an agreementwith one of its customers impacted by the facts relating to the subject of theinternal investigation.  As a result ofthe agreement, during the first quarter of 2005, the Company recognizedremediation revenue of $4.1 million related to revenue reversals; however, suchrevenue did not contribute to the Company’s operating cash flow in the currentyear.  

 

Additionally, during the first quarter of 2005, agreements from othercustomers impacted by the facts relating to the subject of the internalinvestigation were received and the customer agreed to apply certain balances,classified as long-term customer liability and/or deferred revenue, againstcurrent trade accounts receivable the Company has outstanding from suchcustomers.  The net amount appliedagainst trade accounts receivable during the first quarter of 2005 wasapproximately $0.6 million.  

 

13

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The balances classified as Long-Term Customer Liability and DeferredRevenue related to customers impacted by the facts relating to the subject ofthe internal investigation are as follows (in thousands):

 

| ** **                   | ** ** | **December 31,  2004** | ** ** | **March 31,  2005** | ** ** |
|------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Long-Term Customer Liability |       | $                           | 4,147      |                     | $          | 1,305 |   |
| Deferred Revenue             |       | 8,010                       |       | 6,155                    |       |
| Total                        |       | $                           | 12,157     |                     | $          | 7,460 |   |

 

The remaining balances at March 31, 2005, will be recognized whenfinalized and in accordance with agreements negotiated and finalized with eachapplicable customer.

 

14

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**Item 2.**      **Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

**Overview**

 

We were founded in September 1994, to create a national, singlesource provider of document and information outsourcing solutions to documentand information intensive industries, including healthcare insurance, financialservices, healthcare provider, transportation/logistics, federal and stategovernment, 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 and through March 31,2005, we have acquired 66 companies and divested 22 operating units by sales orclosures. We evaluate candidates for acquisition and periodically fordivestiture as a part of our strategic plan of providing customers a singlesolution for business process outsourcing and knowledge-based processing andconsulting services. The criteria for evaluation include geographic need,additional technology, market growth potential, industry expertise, serviceexpansion to broaden service offerings, expansion of our customer base, revenueand earnings growth potential, and expected sources and uses of capital.

 

On May 4, 2004, we announced theacquisition of KeyPoint Consulting, LLC (“KeyPoint”).  KeyPoint is an economic consulting firm withapproximately 26 principals and staff, and a network of academicaffiliates.  KeyPoint provides economic,financial, and forensic accounting services in matters involving complexlitigation and regulation.  KeyPoint’sclients include companies, law firms, and government and regulatoryagencies.  The acquisition of KeyPointsignificantly expands our expertise in new practice areas and helps usstrategically position for additional growth in our legal consulting area.  KeyPoint joined our legal consulting serviceoffering and is reported in the Healthcare, Regulatory and Legal Compliancesegment. Key Point contributed $5.6 million in revenue in 2004, orapproximately 2.9% of total segment revenue, and was moderately accretive to2004 earnings after consideration of related financing costs and amortizationof identified intangibles. 

 

Duringthe first quarter of 2004, we completed a strategic evaluation of ouroperations based on certain criteria, such as strategic and financial fit, andfuture growth prospects.  As a result, onMay 6, 2004, we formally committed to a plan of divestiture for certainnon-strategic asset groups.  The assetgroups to be divested included our Direct Mail operations, previously reportedin our Information Management and Distribution segment, and two medical recordsmanagement operations that were reported in our Healthcare, Regulatory andLegal Compliance segment. Collectively, these asset groups incurred losses, netof tax, of $0.8 million for 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 recordsmanagement operation and the Direct Mail operations were completed during thequarter ended September 30, 2004. See Note 4, Discontinued Operations, of Notes to Condensed ConsolidatedFinancial Statements, for a more detailed discussion.  

 

Duringthe first quarter of 2005, we completed the sale of an asset group thatprovides computer application software and services to the public sector.  This asset group was related to ourlitigation services operations and was previously reported in our Healthcare,Regulatory and Legal Compliance segment. This asset group incurred losses, net of tax, of $0.2 million for thefull year ended December 31, 2004. See Note 4, Discontinued Operations, of Notes to Condensed ConsolidatedFinancial Statements, for a more detailed discussion. 

 

**Basis for Management Discussion and Analysis**

 

Thefollowing discussion and analysis focuses on the results of operations andfinancial condition from the Company’s continuing operations; as such, inaccordance with Statement of Financial Accounting Standards No. 144,references and comparisons to prior periods exclude the impact of ourdiscontinued operations.

 

Ourrevenue possesses both project and recurring characteristics.  Project revenue includes one-time projects inwhich the customer relationship is not expected to continue after projectcompletion. Project revenue margins are usually higher than our average marginsand the workload can be highly volatile. Project revenue is typically based on time and material arrangements andpredominately occurs within the Healthcare, Regulatory and Legal Compliancesegment.  Recurring revenue ischaracterized by customer relationships that are generally for one year and maycontinue for longer.  Recurring revenueis typically based on transaction volumes sent to us by our customers at anagreed upon fixed rate per unit.  Ourcustomers’ volumes are generally not contractually or otherwiseguaranteed.  Recurring revenue typicallypossesses lower margins than project revenue but is usually more predictable.

 

Costof services consists primarily of compensation and benefits to employeesproviding goods and services to our clients; occupancy costs; equipment costsand supplies. Our cost of services also includes, to a limited extent, the costof products sold for micrographics supplies and equipment; computer hardwareand software; and business imaging supplies and equipment.

 

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Selling,general and administrative expenses (“SG&A”) consist primarily ofcompensation and related benefits to sales and marketing, executive management,accounting, human resources and other administrative employees; other sales andmarketing costs; communications costs; insurance costs; and legal andaccounting professional fees and expenses.

 

Inaddition, the condensed consolidated financial statements included in Item 1 “FinancialStatements”, should be read in conjunction with our consolidated financialstatements and the related notes thereto in the Annual Report on Form 10-Kfiled with the Securities and Exchange Commission on March 31, 2005.

 

**Business Segments**

 

Weaggregate our service offerings 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 the followingareas: economic characteristics, products and services, production processes,methods for distributing or delivering products, and type or class ofcustomers. We evaluate segment performance based on revenue and income beforeincome taxes. All centrally incurred corporate costs are allocated to thesegments based principally on operating income of the reportable segments. Thereporting segments follow the same accounting policies used for ourconsolidated financial statements as described in the summary of criticalaccounting policies.

 

Theidentified segments are as follows:

 

**Information Management and Distribution.**  Weoffer Business Process Outsourcing (“BPO”) solutions that help our customersmanage 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 information from the documents, hosting electronicdocuments on our Web-based repository, and preparing statements that customersmail or present electronically to their end users.  We offer our BPO solutions to businesses indocument intensive industries, such as healthcare insurance, financial services,healthcare provider, transportation/logistics, and federal and stategovernment.  For the three months ended March 31,2004 and 2005, revenue in the Information Management and Distribution segmentconsisted of approximately $43.1 million and $47.9 million of recurringrevenue, respectively, and $4.9 million and $8.4 million of project revenue,respectively.  

 

**Healthcare, Regulatory and Legal Compliance.**  Weoffer specialized knowledge-based processing and consulting services thatinclude medical records release, record management services for healthcareinstitutions, temporary staffing for healthcare institutions, temporarystaffing for healthcare institutions, providing managed care payment compliancereviews, class action claims administration services, professional economicresearch and litigation services, and tax benefit services. For the threemonths ended March 31, 2004 and 2005, revenue in the Healthcare,Regulatory and Legal Compliance segment consisted of approximately $18.2million and $18.7 million of recurring revenue, respectively, and $29.6 millionand $30.9 million of project revenue, respectively.  

 

**InternalInvestigation**

** **

During October 2004,the Company, with the oversight and approval of the Audit Committee of ourBoard of Directors, initiated an investigation of the financial results of oneof our operating subsidiaries in the Information Management and Distributionreportable segment (the “Operating Subsidiary”). The findings of theinvestigation concluded that the Operating Subsidiary had incorrectlyrecognized revenue for certain customer arrangements and omitted certainoperating expenses from its financial results which in turn resulted inoverpayments and over accruals of contingent consideration amounts due underthe earn-out provisions of the acquisition agreement for the OperatingSubsidiary.  The overpayments and overaccruals of contingent consideration amounts had been originally recognized asadditional goodwill of the acquired business. 

 

As described in ourcritical accounting policies, revenue is recognizable when each of thefollowing conditions is met: persuasive evidence of an arrangement exists,the price is fixed or determinable, delivery has occurred or services have beenrendered and collection is reasonably assured. Our investigation identifiedcertain instances where one or more of the aforementioned revenue recognitionconditions as applied to certain customer contracts were not met by theOperating Subsidiary. As a result, the revenue previously recognized that didnot meet all the mentioned revenue recognition conditions was reversed,resulting in a downward adjustment to certain asset accounts or the recognitionof a customer liability or deferred revenue. 

 

During thefirst quarter of 2005, we entered into an agreement with one of our customersimpacted by the facts relating to the subject of our internalinvestigation.  As a result of theagreement, during the first quarter of 2005, we recognized remediation revenue of$4.1 million related to revenue reversals; however, such revenue did notcontribute to the Company’s operating cash flow in the current year.  We expect to recognize additional remediationrevenue of approximately $3.0 million during the second quarter of 2005.  Although the exact timing is indeterminable,additional remediation revenue may be recognized in future periods inaccordance with agreements negotiated and finalized with each applicablecustomer.

 

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**THREE MONTHS ENDED MARCH 31, 2004 COMPARED TOTHREE MONTHS ENDED MARCH 31, 2005**

 
| ** **                                                 | ** ** | **Three  Months Ended March 31,** | ** ** |
|------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                 | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| ** **                                                 | ** ** | **($000’s)**                      | ** ** | **% of  Revenue** | ** ** | **($000’s)** | ** ** | **% of  Revenue** | ** ** |
| **Revenue**                                                |       | $                                      | 95,816     |   | 100.0 | % | $ | 105,932 |   | 100.0 | % |
| **Gross Profit**                                           |       | 36,223                                 |       | 37.8 | % | 43,973 |   | 41.5 | % |
| **SG&A**                                               |       | 31,068                                 |       | 32.4 | % | 30,221 |   | 28.5 | % |
| **Operating income**                                       |       | 5,066                                  |       | 5.3 | % | 13,546 |   | 12.8 | % |
| **Income from continuing  operations before income taxes** |       | 4,291                                  |       | 4.5 | % | 12,065 |   | 11.4 | % |
| **Income from continuing  operations**                     |       | 2,575                                  |       | 2.7 | % | 7,355 |   | 6.9 | % |
|                                                            |            |                                        |            |  |  |  |  |  |  |  |  |

 

**Revenue**

 

Ouroperations generated revenues of $105.9 million for the three months ended March 31,2005, an increase of 10.6% compared to the same period in 2004.  During the second quarter of 2004, weacquired KeyPoint Consulting, LLC (“KeyPoint”) as a part of our Healthcare,Regulatory and Legal Compliance segment. KeyPoint contributed approximately $1.9 million to the revenueincrease.  In addition, as previouslydiscussed, during the first quarter of 2005, we recognized remediation revenueof $4.1 million related to revenue reversals in previous years.  After considering the positive revenuevariance related to the KeyPoint acquisition and the remediation revenue, our remainingoperations achieved revenue growth of 4.4% during the first quarter of2005.  This revenue growth resulted primarilyfrom strong volumes in our information management service offering and in ourproject oriented class action claims administration service offering thatcontributed approximately $4.4 million and $2.1 million, respectively.  Including the KeyPoint acquisition, projectrevenue accounted for $39.3 million or 37.1% of revenue in the current yearquarter compared to $34.5 million or 36.1% of revenue in the prior yearquarter. (See “Management’s Discussion and Analysis of Financial Condition andResults of Operations—Basis for Management Discussion and Analysis.”)

 

Revenueswithin our Information Management and Distribution segment increased 17.2% from$48.0 million for the three months ended March 31, 2004, to $56.3 millionfor the three months ended March 31, 2005. The increase in segment revenues were primarily the result of: (i) 2004new business wins converted to revenue during 2005 contributing approximately$4.6 million, particularly in our healthcare payer, federal and stategovernment and mortgage vertical markets, and (ii) the previouslydiscussed remediation revenues of $4.1 million related to revenue reversals inprevious years.  Revenues in thestatement processing service offering were slightly down when compared to theprior year quarter.

 

Revenueswithin our Healthcare, Regulatory and Legal Compliance segment increased 3.9%from $47.8 million for the three months ended March 31, 2004, to $49.6million for the three months ended March 31, 2005. The acquisition ofKeyPoint contributed approximately $1.9 million to the increase.  Also contributing to the revenue increasewere higher volumes of small to medium size projects (i.e. projects with lessthan $500k of total revenue) in our class action claims administration serviceoffering, which increased approximately $2.1 million or 24%.  Offsetting increases in segment revenues werelower revenues of approximately $2.0 million in our healthserve serviceofferings principally due to lower demand for medical record coding staffingservices and customer attrition within our medical records release services.

 

**Gross profit**

 

Grossprofit increased 21.4% from $36.2 million, or 37.8% of revenue, for the threemonths ended March 31, 2004, to $44.0 million, or 41.5% of revenue, forthe three months ended March 31, 2005. Gross margin increased 370 basis points primarily due to: (i) thepreviously discussed remediation revenues of $4.1 million contributing 230basis points, and (ii) lower production personnel cost as a percentage ofrevenue contributing 170 basis points. Gross margin improvement resulting from personnel costs occurred in ourinformation management service offering due to productivity and qualityinitiatives which included:  introductionof Lean/Six Sigma quality initiatives, implementation of high speed scanningtechnology to replace labor intensive low speed scanners, implementation of payfor performance compensation strategies, and increased utilization of offshorelabor.

 

**Selling, general and administrative expenses**

 

SG&Adecreased 2.7% from $31.1 million, or 32.4% of revenue, for the three monthsended March 31, 2004, to $30.2 million, or 28.5% of revenue, for the threemonths ended March 31, 2005. The decrease in SG&A expense relatesprimarily to lower legal expense in the current year quarter.  During the first quarter of 2004, weexperienced $4.9 million of higher legal expense primarily due to thesettlement of a significant legal matter within our Information Management andDistribution segment.  Lower current yearlegal expense was partially offset by the following items: (i) $1.3million of investigation costs incurred during the current year quarter, (ii) $0.6million of incremental SG&A related to the Keypoint acquisition which wasacquired during the second quarter of 2004, and (iii) $2.5 million ofhigher personnel related cost.  We haveexperienced higher personnel related costs as a result of the

 

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following:(i) investment in management and sales resources within our class actionclaims administration service offering, (ii) investment in technology andsales resources within our information management service offering, and (iii) higherincentive compensation related to recent new business win successes andimproved year over year performance.  

 

**Income from continuing operations before income taxes**

 

Incomefrom continuing operations before income taxes increased from $4.3 million forthe three months ended March 31, 2004 to $12.1 million for the threemonths ended March 31, 2005.  The increasewas due to the factors impacting gross profit and SG&A discussedabove.  Offsetting the positive factorswas higher interest expense in the current year quarter of approximately $0.6million due to higher average debt balances and a higher interest rateenvironment.  Each 100 basis pointincrease in interest rates results in incremental interest expense ofapproximately $0.8 million at current debt levels.

 

**Provision for income taxes**

 

During the first quarter of2005, our effective tax rate decreased to 39% from the 40% tax rate in effectduring 2003 and in effect during 2004 prior to tax benefits received from thefavorable resolution of certain open tax issues and favorable resolution ofcertain strategic tax positions.  Thereduction in effective rate is due to acquisitions, divestures and changes inbusiness mix between various taxing jurisdictions.  We expect the lower effective tax rate of 39%to be sustainable throughout 2005.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

AtMarch 31, 2005, we had $41.7 million of working capital, including $0.2million of cash.  Working capital at December 31,2004 was $34.1 million, including $3.7 million of cash.  For the first three months of 2005, net cashused in operating activities from continuing operations was $4.4 millioncompared to cash provided by operating activities from continuing operations of$0.1 million for the same period in 2004. Key factors contributing to the net cash used by operating activitiesfrom continuing operations consist of: (i) increased accounts receivablebalances related to slower collections of approximately $1.6 million and higherrevenue in the current quarter, (ii) changes in compensation relatedaccruals of approximately $4.0 million due to annual incentive compensationpayments during the quarter and the timing of payroll fundings at the end ofthe current quarter, (iii) utilization of customer deposits ofapproximately $2.2 million related primarily to current projects within our class action claims administration serviceoffering and (iv) approximately$0.6 million of net payments related to the previously discussed internalinvestigation completed during the current year quarter.

 

Althoughworking capital fluctuations had a significant impact on operating cash flowduring the current year quarter, based on our current expectations of full yearoperating results and expectations regarding improvements in accountsreceivable collections, we expect to achieve an operating cash flow level for2005 within a range of $35 million to $50 million.  

 

Dayssales outstanding decreased two business days during the quarter to 43 businessdays at March 31, 2005, compared to 45 business days at December 31,2004.  Excluding the positive effects ofthe remediation revenue recognized during the quarter, days sales outstandingat March 31, 2005, were 45 business days.

 

Forthe three months ended March 31, 2005, investing activities fromcontinuing operations consisted of acquisitions of property, plant andequipment of $5.7 million, partially offset by divestiture proceeds of $0.2million, related to the divestiture of a non-strategic asset group related toour litigation services operations.  Somefuture quarters will include additional settlements of contingent considerationon past acquisitions.  Management’sevaluation of the cumulative earnings of acquired companies through December 31,2004 indicated that an acquired company has met specified earnings targetsbeyond a reasonable doubt.  Therefore,approximately $5.3 million of additional consideration remains accrued which isclassified as other current liabilities and is expected to be settled in cashduring 2005.

 

Netcash provided by financing activities from continuing operations was $6.7million for the three months ended March 31, 2005.  Borrowings from our line of credit of $53.0million were partially offset by payments on our line of credit of $46.3million.  We utilize our line of creditto fund general operating requirements of the Company as well as fundsignificant investments such as acquisitions or capital expenditures.

 

InApril 2001, we entered into a line of credit agreement with Bank ofAmerica, SunTrust Bank and Wells Fargo Bank, as co-agents (the “2001 CreditAgreement”). Under this agreement, we could from time to time borrow funds upto $297.5 million through April 2, 2004, subject to certain financialcovenants and ratios. Meeting these requirements is highly dependent uponmaintaining a minimum level of operating results and the continued demand forour services, among other factors.

 

EffectiveApril 3, 2002, we extended $220.0 million of the $297.5 millioncommitment for an additional year to April 2, 2005. In September 2002,additional extensions were granted by member banks, bringing the totalcommitment extended to April 2, 2005, to $290.0 million. Total feespaid in 2002 related to the extensions and amendments to the 2001 CreditAgreement were $0.3 million.

 

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EffectiveApril 3, 2003, we extended $230.0 million of the $297.5 millioncommitment to April 1, 2006. During the fourth quarter of 2003, aparticipating bank in the 2001 Credit Agreement assigned $7.5 million ofits commitment to another bank who, effective December 4, 2003, extendedthis commitment to April 1, 2006. Total fees paid in 2003 related to theextensions and amendments to the 2001 Credit Agreement were $0.3 million.

 

AtMarch 31, 2005, the remaining commitment under the 2001 Credit Agreementis $290.0 million 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      |                      |       |   |
|                    |            |                |            |                           |            |  |  |

 

Asof March 31, 2005, we are in compliance with loan covenants after givingeffect to the amendments and waivers discussed below, which among other thingsprovided for an amended definition of EBITDA. As of March 31, 2005, the availability under the 2001 CreditAgreement was approximately $24.5 million.

 

Ourability to borrow is contingent on certain leverage and fixed cost coverageratios. These ratios were scheduled to become more restrictive beginning in thequarter ended December 31, 2002 with the leverage ratio declining from 3.0times 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, we are subject to minimum net worthrequirements. Effective March 26, 2003, an amendment was approved thatallows 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 minimum networth requirement for an additional $30 million of share repurchases.

 

Asa result of our internal investigation, described above in “InternalInvestigation”, we were unable to file our September 30, 2004 QuarterlyReport on Form 10-Q within the timeframe prescribed by the SecuritiesExchange Act of 1934.  The failure totimely file the September 30, 2004 Quarterly Report on Form 10-Qresulted in a default under the 2001 Credit Agreement.  We entered into a waiver agreement on November 12,2004 with the lenders party to the 2001 Credit Agreement.  Pursuant to the terms of the waiveragreement, the lenders agreed, among other things, to waive any default underthe 2001 Credit Agreement that resulted from potential non-compliance with adesignated fixed charge coverage ratio, and our failure to timely file ourQuarterly Report on Form 10-Q for the September 30, 2004quarter.  The waiver agreement alsoprovides that during the period that the waiver agreement is in effect, theoutstanding principal amount of the loans under the 2001 Credit Agreement maynot exceed $112,000,000. The waiver agreement was to expire on March 15, 2005;  however, on March 15, 2005, we enteredinto on Extension and Modification of Waiver to Credit Agreement, whichextended such waiver through March 23, 2005.

 

Effective March 23,2005, we entered into an amendment to the 2001 Credit Agreement that allows forthe exclusion of certain contingent consideration overpayments to the formerowners of the Operating Subsidiary, as discussed above, from the definition ofEarnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”).Pursuant to 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 certain contingent consideration overpayments discussed above in “InternalInvestigation”.  As a result, the Companyclassified the debt under such Credit Agreement as a Current Maturity includedin the current liability section of its balance sheet at June 30 and September 30,2004. Upon entering the March 23, 2005 amendment, the Company cured thedefault under the 2001 Credit Agreement, as such, reclassifying debt under theCredit Agreement as Long-Term Obligations. In any event, as the maturity dateof the debt under the 2001 Credit Agreement is April 1, 2006, unless thematurity date of such debt is subsequently modified, such debt will beclassified as a Current Maturity on and after April 1, 2005

 

Management believes that it has sufficient liquidityfrom its cash flow and its revolving credit facility to meet ongoing businessneeds.  Additionally, depending on themix of stock and cash used in our strategic acquisition program, if any, we mayneed to seek further financing through the public or private sale of equity ordebt securities.  However, there can beno assurance we could secure such financing if and when it is needed or withterms we deem acceptable.

 

Managementfully expects to replace or refinance the 2001 Credit Agreement upon itsmaturity scheduled for April 1, 2006.

 

InJanuary 2000, we registered on Form S-4 (Registration No. 333-92981)3,012,217 shares of common stock for issuance in connection with ouracquisition program (the “Acquisition Shelf”), of which 1,359,852 shares wereavailable as of March 31, 2005; however, such registration statement mayrequire amendment prior to use.

 

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**Critical Accounting Policies**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations arebased on the related consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States of America. The preparation of the financial statements requiresthe use of estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses.

 

Wehave identified the following critical accounting policies that, as a result ofthe judgments, uncertainties, uniqueness and complexities of the underlyingaccounting standards and operations involved, could result in material changesto our financial condition or results of operations under different conditionsor using different assumptions. We apply a consistent methodology at the end ofeach quarter to determine our account balances that require judgmentalanalysis.

 

**Revenue Recognition.**  Revenue is recognized as it becomes realized or realizable and earnedaccording to the criteria provided by Staff Accounting Bulletin 104, *Revenue Recognition*. Revenue recognitionoccurs once persuasive evidence of an arrangement exists, delivery has occurredor services have been rendered, the sales price is fixed or otherwisedeterminable, and collection is reasonably assured. Our revenue-earningsactivities possess project and recurring customer relationships.

 

Project revenue includes one-time projects in which the customerrelationship is not expected to continue after project completion. Project revenueis typically based on time and material arrangements. Revenue recognitionoccurs at the contractual rates as the labor hours and direct expenses areincurred. Project revenue represents approximately 34% of total 2004 revenuesand typically occurs within our Healthcare, Regulatory, and Legal Compliancesegment.

 

Recurring revenue is characterized by customer relationships that aregenerally for one year and may continue for longer. Recurring revenue istypically based on the transaction volumes provided by our customers at anagreed upon fixed rate per unit. Our customer’s volumes are typically notcontractual or otherwise guaranteed. Revenue recognition occurs once work iscompleted and delivery has occurred or services have been rendered. Recurring revenuerepresents 66% of total 2004 revenues and typically occurs within ourInformation Management and Distribution segment.

 

Revenuerecognition policies related to offerings within 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 recognition policies within our Healthcare, Regulatory, andLegal Compliance segment are based upon objective criteria that do not requiresignificant estimates or uncertainties. For example, transaction volumes and time and costs under time andmaterial and cost reimbursable arrangements are based on specific, objectivecriteria under the contracts.  Thefollowing outlines specific revenue recognition policies related to certainofferings within this segment:

 

*Medical records release services* — revenue is recognized upon completion ofthe processing of the requested medical records.  Revenue recognition for this service is basedon an agreed upon and in some cases, a regulated rate applied to the number ofrecords processed.  When a fee is paid tothe 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 inthe arrangement is borne partially by both SOURCECORP and the hospital; (b) SOURCECORPhas no discretion 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* — revenue is recognized as storage servicesare provided based linear feet of documents stored times a monthly rate forshelf storage and based on a monthly per image rate for images storedelectronically.  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 and compliance services* — revenue is recognized for document and dataconversion services as the services are provided based upon an agreed upon rateper patient file applied to the number of files processed.  Storage and archiving fees are recognized asrevenue as the services are provided based upon an agreed upon monthly rate perfile stored or otherwise archived. Revenue related to coding and abstracting of medical records andstaffing services is recognized as the services are provided based on an agreedupon rate applied to the billable hours worked and eligible out-of-pocketexpenses defined by the service agreement. The out-of-pocket expense component is recognized as revenue and cost ofservices on a gross basis in accordance with EITF Issue 01-14, *Income Statement Characterization of ReimbursementsReceived for “Out-of-Pocket” Expenses Incurred. *Revenue related to compliance reviews is based primarily on anagreed upon percentage (or commission) of amounts identified and recovered fromthe third party payers as a fee for services provided.  Revenue is recognized upon successfulrecovery of underpayments to our clients by their managed care and commercial payersat the agreed upon percentage (or commission).

 

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*Class action claims administration services* — revenue is recognized as these services areprovided based on the agreed upon rate applied to the number of hours spentproviding services related to administering the legal settlements and expensesincurred.  The out-of-pocket expensecomponent is recognized as revenue and cost of services on a gross basis inaccordance with EITF Issue 01-14, *IncomeStatement Characterization of 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 of public delivery of the notificationthrough the various media outlets at the agreed upon percentage (orcommission).

 

*Professional economic research and litigation services* — revenue is recognized as these services areprovided based on consulting hours worked at agreed upon rates at the timeservices are rendered 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, *Income StatementCharacterization of Reimbursements Received for “Out-of-Pocket” ExpensesIncurred.*

 

Asa part of providing services to our customers, we incurs incidental expensescommonly referred to as “out-of-pocket” expenses. These expenses include itemssuch as airfare, hotels, mileage, etc. and are often reimbursable by ourcustomers. When reimbursable, we record both revenue and direct cost ofservices in accordance with the provisions of EITF Issue 01-14, *Income Statement Characterization of ReimbursementsReceived for “Out-of-Pocket’ Expenses Incurred.*

 

Unearnedincome, included in other current liabilities, represents payments from theCompany’s customers in advance of services being provided. Advanced paymentsare deferred as unearned income when received and recognized as revenue asservices 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 Asset and Other Intangible Asset Impairment.**  Asrequired by SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets,*managementcontinually evaluates whether events and circumstances indicate that thecarrying value of long-lived assets and intangible assets may not berecoverable. When events require, management performs the valuation bycomparing the estimated undiscounted future cash flows over the remaining lifeof the long-lived assets and intangible assets to the carrying amount of theasset being evaluated. An impairment loss is recognized if the carrying amountof assets being evaluated exceeds the expected future undiscounted cash flowbased on the difference between the carrying value and fair value..

 

**Goodwill Impairment.**  On January 1, 2002, weadopted SFAS No. 142, *Goodwill andOther Intangible Assets.* This statement states that goodwill andintangible assets that have indefinite useful lives will not be amortized butrather will be tested at least annually for impairment. Our annual impairmenttest is performed at October 31. The impairment test is based on fair value rather than undiscounted cashflows. Additionally, goodwill is tested at a reporting unit level rather thanthe individual operating unit level. A reporting unit is either at theoperating segment level or one reporting level below and could consist ofseveral service offerings aggregated into a single reporting unit. Serviceofferings are aggregated 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 similarpublicly 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 earning margins among other factors. Estimatesutilized in future calculations could differ from estimates used in the currentperiod. Future years’ estimates that are unfavorable compared to currentestimates could cause an impairment of goodwill and other intangible assets.Due to the fact that we are primarily a services company, our businessacquisitions typically result in significant amounts of goodwill and otherintangible assets. Therefore, an impairment charge resulting from goodwill orother intangible assets could result in a material adverse impact on ourfinancial statements during the period incurred.

 

**Self-Insurance Liabilities and Reserves.**  We areself-insured for workmen’s compensation liabilities and a significant portionof our employee medical costs. We account for our self-insurance programs basedon actuarial estimates of the amount of loss inherent in that period’s claims,including losses for which claims have not been reported. These loss estimatesrely on actuarial observations of ultimate loss experience for similarhistorical events. We limit our risk by carrying stop-loss policies forsignificant claims incurred for both workmen’s compensation liabilities andmedical costs. SOURCECORP’s exposure under the stop-loss policies for workmen’scompensation and medical costs is limited based on fixed dollar amounts.  For workman’s compensation, the fixed dollaramount 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.

 

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**Other Loss Contingencies.**  Werecord liabilities when it is probable that a liability has been incurred andthe amount of the loss is reasonably estimable in accordance with SFAS No. 5,*Accounting for Contingencies*.Disclosure is required when there is a reasonable possibility that the ultimateloss will exceed the recorded provision. Contingent liabilities are oftenresolved over long periods of time. Estimating probable losses requiresanalysis of multiple forecasts that often depend on judgments about potentialactions by third parties such as regulators. Our loss contingencies consistprimarily of estimates related to the probable outcome of current litigation.

 

**RISKS ASSOCIATED WITH FORWARD-LOOKING STATEMENTS**

 

ThisReport contains certain forward-looking statements such as our intentions,hopes, beliefs, expectations, strategies, predictions or any other variationthereof or comparable phraseology of our future activities or other futureevents or conditions within the meaning of Section 27A of the SecuritiesAct of 1933, as amended (the “Act”), and Section 21E of the SecuritiesExchange Act of 1934, as amended, which are intended to be covered by the safeharbors created thereby. Investors are cautioned that all forward-lookingstatements involve risks and uncertainty, including, without limitation, theactual final costs of our internal investigation, the Company’s ongoing SECinvestigation, the potential impairment of our ability to enter into governmentcontracts as a result of the conduct that was the subject of our investigation,remediation costs relating to our investigation, the potential customer impactof the results of our investigation, the effect of our investigation andfinancial statement restatement on the trading price of our stock, the risk of integrating our operatingcompanies, of managing our rapid growth, of the timing and magnitude oftechnological advances, of the occurrences of future events that could diminishour customers’ needs for our services, of a change in the degree to whichcompanies continue to outsource business processes, of an adverse outcome inany given legal proceeding or claim, of the denial of insurance on a particularclaim or of a party obligated to provide indemnification being financially unableto do so, as well as such other risks set forth under the heading Risk Factorsincluded in our most recent annual report on Form 10-K.

 

Althoughwe believe that the assumptions underlying the forward-looking statementscontained herein are reasonable, any of the assumptions could be inaccurate,and, therefore, there can be no assurance that the forward-looking statementsincluded in this Report will prove to be accurate. In light of the significantuncertainties inherent in the forward-looking statements included herein, theinclusion of such information should not be regarded as a representation by usor any other person that our objectives and plans will be achieved. Further, wedisclaim any obligation to update any such forward-looking statements, exceptas required by law.

 

**Item 3****.**     **Quantitative and QualitativeDisclosures about Market Risk**

 

Weare subject to interest rate risk on our term loans, revolving credit facilityand Industrial Revenue Bonds. A 100 basis point increase in short-term interestrates would result in approximately $0.8 million of additional expense in 2005based on our expected average balance outstanding under the credit facilityduring 2005. Interest rates are fixed on the capitalized lease obligations.

 

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**Item 4****.**    **Controls and Procedures**

 

*(a) Evaluation of disclosure controlsand procedures.*

 

The Company maintains disclosure controls and procedures, which it hasdesigned to ensure that material information related to the Company, includingits consolidated 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 rules andforms.  As of March 31, 2005, theCompany carried out an evaluation, under the supervision and with theparticipation of the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of the Company’s disclosure controls and procedurespursuant to Securities Exchange Act of 1934, as amended, Rule 13a-15 and15d-15. Based upon that evaluation, the Chief Executive Officer and ChiefFinancial Officer concluded that the Company’s disclosure controls andprocedures are effective in timely alerting them to material informationrelating to the Company (including its consolidated subsidiaries) required tobe included in the Company’s periodic SEC Filings.  Because of the inherent limitations ofdisclosure controls, including the possibility of collusion or impropermanagement override of controls, no matter how comprehensive or well designedsuch controls are, management may not in all cases be alerted to materialinformation relating to the Company (including its consolidated subsidiaries)required to be included in the Company’s periodic SEC filings.

 

*(b) Changes in internal controls.*

 

During the most recent fiscal quarter, there have been no changes tothe Company’s internal controls over financial reporting that occurred sincethe beginning of the Company’s first quarter of 2005 that have materiallyaffected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

However, during the first quarter of 2005, the following changes weremade to the Company's internal control environment as a result of its policy ofcontinuous control improvement:

 

•      The management reporting relationship waschanged for the accounting processing functions of three operatingsubsidiaries.  Formerly, the employeesresponsible for the accounting processing functions of these operatingsubsidiaries reported through the operational management structure.  These employees began reporting through theCompany’s corporate accounting department’s management structure during themost recent fiscal quarter.  As a result,all employees responsible for accounting processing functions at all of theCompany’s operating subsidiaries report through the Company’s corporateaccounting department’s management structure as of January 27, 2005.

 

•      In order to help ensure compliance withthe Company’s adopted internal controls, individual incentive compensationplans for designated senior managers were modified to include criteria relatedto the effectiveness in which the Company’s internal controls are applied.

 

**PART II.OTHER INFORMATION**

** **

**Item 1.**       **Legal Proceedings**

 

Weare, from time to time, a party to litigation. The following is a descriptionof the most significant legal matters that we are involved in.  In the event of an adverse outcome in one ormore of our legal proceedings our business, financial condition, results ofoperations or cash flows could be materially adversely affected.

 

### ***Putative Securities Class Action***

### ** **

TheCompany, and the Company’s CEO and CFO individually, have been named asdefendants in several putative securities class actions, in response to theCompany’s press releases dated October 27, 2004, in which the Companydisclosed that its financial statements for certain prior periods should nolonger be relied upon, and also provided updated financial guidance. Thecomplaints (collectively, the “Actions”) were filed in the United StatesDistrict Court for the Northern District of Texas, Dallas Division, with thefirst action being filed November 1, 2004. The Actions are putative shareholderclass action lawsuits alleging violations of Federal Securities Laws, includingalleged violations of Sections 10(b) and 20(a), and Rule 10b-5 of theSecurities Exchange Act of 1934, as amended. The Actions are purportedly onbehalf 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 Actions have been transferred to asingle judge in the Northern District of Texas, Dallas Division and theseactions have been consolidated into a single action now styled *In re Sourcecorp, Inc. Securities Litigation,*and a lead plaintiff has been appointed.

 

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#### ***Purported Derivative Action and Demand Letter***

#### ** **

Apurported stockholder derivative action was filed on December 28, 2004,against certain of the Company’s current and former officers and directors asindividual defendants and the Company as a nominal defendant in the 116thDistrict Court for Dallas County, Texas (the “Purported Derivative Action”).The Purported Derivative Action alleges breach of fiduciary duty, abuse ofcontrol, gross mismanagement, waste of assets, and unjust enrichment related tothe Company’s press release dated October 27, 2004, in which the Companydisclosed that its financial statements for certain prior periods should nolonger be relied upon, and also provided updated financial guidance. All ofthese claims are asserted derivatively on behalf of the Company and seeksunspecified damages against those individuals. Further, the Chairman of the Company’s Board of Directors received froma purported shareholder a demand letter (the “Demand Letter”) based on the sameset of facts as the Purported Derivative Action.  The Demand Letter requests the Board to takecertain action, but does not seek damages against the Company.  The Company has formed a special committee ofthe Board of Directors to evaluate the claims made in the Purported DerivativeAction and the Demand Letter.

 

*DigitalImaging Systems*

 

OnAugust 5, 2004, Digital Imaging Systems, Inc. filed suit against theCompany in the United States District Court-Southern District of New Yorkalleging, among other things, that a portion of the Company’s process forscanning and indexing images violates one of Digital Imaging Systems’patents.  The Company has tendered thismatter to one of its software/hardware vendors for indemnification, which suchvendor has undertaken subject to pre-existing contractual conditions.  The suit demands unspecified damages.

 

*Various ROI Copy Charge Matters*

 

Fromtime to time, various subsidiaries of the Company that perform release ofinformation (“ROI”) services become defendants to putative class actionlawsuits generally alleging that the charge for reproducing certain medicalrecords is not in conformity with such plaintiffs’ reading of the applicableregulated charge. Such suits typically include multiple ROI companies andhospitals as defendants and demand reimbursement for prior charges as well asfor prospective pricing adjustments. The Company is currently a party toseveral such suits in various stages of development.  One such suit originally styled*McShane v. Recordex Acquisition Corp. &**Sourcecorp, Incorporated* (and now styled *Liss & Marion, PC v. Recordex Acquisition Corp., & Sourcecorp,Inc.*) filed February 10, 2003, in the Court of Common PleasPhiladelphia County, Pennsylvania, alleges among other things that the Companyintentionally charges more for providing copies of medical records than ispermitted under Pennsylvania law.  Thecomplaint does not specify the amount of damages sought.  Plaintiff's counsel had at one time allegeddamages were as high as $7 million without providing any real support for thisamount; however, the Company believes that it will ultimately prevail in thismatter, or if any liability is found, that the amount of damages, if any, wouldbe substantially less than such alleged amount. In September 2004, the court entered its order certifying a class inthis matter and both the plaintiffs and the defendants have filed motions forsummary judgment.

* *

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

 

InJune 2000, the Company filed an action styled *F.Y.I. Incorporated v. Spohr, et. al.* in Dallas, Texas, inwhich we asserted claims for breach of contract, fraud, and negligentmisrepresentation against the sellers of two related companies that we acquiredin December 1998 (the “Texas Action”). The Texas Action was later removedto 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, theparties settled this matter on mutually acceptable terms.

 

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**Item 2.****   ****Unregistered Sales of EquitySecurities and Use of Proceeds**

 

Items2(a) and (b) are inapplicable.

 

(c) STOCKREPURCHASES

 
| **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** | ** ** |
|---------------------------------|------------|------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                            |       |                                           |       |                                        |       |                                                                                                   |       |                                                                                                                                        |       |
| Jan 1, 2005 – Jan 31, 2005 |       | —                                         |       | $                                           | —     |                                                                                                   | —     |                                                                                                                                        | $          | 17,415,551 |   |
| Feb 1, 2005 – Feb 28, 2005 |       | —                                         |       | $                                           | —     |                                                                                                   | —     |                                                                                                                                        | $          | 17,415,551 |   |
| Mar 1, 2005 – Mar 31, 2005 |       | —                                         |       | $                                           | —     |                                                                                                   | —     |                                                                                                                                        | $          | 17,415,551 |   |
|                                 |            |                                                |            |                                             |            |                                                                                                        |            |                                                                                                                                             |            |  |  |  |

 

**Item 6.**    **Exhibits**

 

(a) Exhibits

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                    |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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) |
|                |       |                                                                                                                                                                                                                                                               |
| 31.1                |       | Certification  Pursuant to section 302 of Sarbanes-Oxley Act.                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                               |
| 31.2                |       | Certification  Pursuant to section 302 of Sarbanes-Oxley Act.                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                               |
| 32.1                |       | Certification  Pursuant to section 906 of Sarbanes-Oxley Act.                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                               |
| 32.2                |       | Certification  Pursuant to section 906 of Sarbanes-Oxley Act.                                                                                                                                                                                                 |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this Report on Form 10-Q to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|                     | SOURCECORP,  INCORPORATED |
|--------------------------|---------------------------|
|                     |                      |   |
| Date:  May 12, 2005 | By:                       | /s/ ED H. BOWMAN, JR. |
|                     |                      | Ed H. Bowman, Jr. Chief Executive  Officer and President |
|                     |                      |   |
| Date:  May 12, 2005 | By:                       | /s/ BARRY L. EDWARDS |
|                     |                      | Barry L. Edwards Executive Vice  President and Chief Financial Officer  (Principal Financial and Accounting  Officer) |

 

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**INDEX TOEXHIBITS**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                    |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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) |
|                |       |                                                                                                                                                                                                                                                               |
| 31.1                |       | Certification  Pursuant to section 302 of Sarbanes-Oxley Act.                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                               |
| 31.2                |       | Certification  Pursuant to section 302 of Sarbanes-Oxley Act.                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                               |
| 32.1                |       | Certification  Pursuant to section 906 of Sarbanes-Oxley Act.                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                               |
| 32.2                |       | Certification  Pursuant to section 906 of Sarbanes-Oxley Act.                                                                                                                                                                                                 |

 

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