**UNITEDSTATES********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 September 30, 2005**

 

**OR**

 
| **o** | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934** |
|-------|------------|-------------------------------------------------------------------------------------------------------------|

 

**For the transition periodfrom                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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o  No ý

 

Asof****October 31, 2005, 15,590,778shares of 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 SEPTEMBER 30,2005**

 

**INDEX**

 
| ** ** | **PART I. FINANCIAL  INFORMATION**                                                                                          |   |
|------------|----------------------------------------------------------------------------------------------------------------------------------|--------|
|       |                                                                                                                             |   |
| Item 1     | Financial Statements                                                                                                             |   |
|       |                                                                                                                             |   |
|       | Condensed Consolidated Balance Sheets —  December 31, 2004 and September 30, 2005 (unaudited)                     |   |
|       |                                                                                                                             |   |
|       | Condensed Consolidated Statements of Operations —  Three and nine months ended September 30, 2004 and 2005 (unaudited) |   |
|       |                                                                                                                             |   |
|       | Condensed Consolidated Statements of Cash Flows — Nine  months ended September 30, 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**                                                                                                            |   |

 

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**PART I.FINANCIAL INFORMATION**

 

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

**SOURCECORP, INCORPORATED AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                                                  | ** ** | **December 31,  2004** | ** ** | **September 30,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                                                                  | ** ** | **(Unaudited)**             | ** ** |
| **ASSETS**                                                                                                                                                                                                                  |       |                        |       |                         |       |
| **CURRENT  ASSETS:**                                                                                                                                                                                                        |       |                        |       |                         |       |
| Cash and cash equivalents                                                                                                                                                                                                   |       | $                           | 3,722      |                         | $          | 4,880 |   |
| Accounts and notes receivable, less  allowance for doubtful accounts of $9,331 and $8,343, respectively                                                                                                                     |       | 65,315                      |       | 79,435                       |       |
| Inventories                                                                                                                                                                                                                 |       | 875                         |       | 974                          |       |
| Deferred income taxes                                                                                                                                                                                                       |       | 5,272                       |       | 9,912                        |       |
| Income tax receivable                                                                                                                                                                                                       |       | 5,077                       |       | —                       |       |
| Prepaid expenses and other current assets                                                                                                                                                                                   |       | 6,142                       |       | 5,813                        |       |
| Assets of discontinued operations                                                                                                                                                                                           |       | 842                         |       | —                       |       |
| Total current assets                                                                                                                                                                                                        |       | 87,245                      |       | 101,014                      |       |
| **PROPERTY, PLANT AND EQUIPMENT**,  net of accumulated depreciation of $45,166 and $52,688, respectively                                                                                                                    |       | 39,603                      |       | 39,573                       |       |
| **GOODWILL**                                                                                                                                                                                                                |       | 326,139                     |       | 324,396                      |       |
| **INTANGIBLES,**net of amortization of $1,700 and $2,319,  respectively                                                                                                                                                     |       | 4,904                       |       | 4,285                        |       |
| **NON  QUALIFIED RETIREMENT PLAN ASSETS**                                                                                                                                                                                   |       | 8,870                       |       | —                       |       |
| **OTHER NONCURRENT  ASSETS**                                                                                                                                                                                                |       | 2,654                       |       | 2,223                        |       |
| Total assets                                                                                                                                                                                                                |       | $                           | 469,415    |                         | $          | 471,491 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                               |       |                        |       |                         |       |
| **CURRENT  LIABILITIES:**                                                                                                                                                                                                   |       |                        |       |                         |       |
| Accounts payable and accrued liabilities                                                                                                                                                                                    |       | $                           | 52,549     |                         | $          | 50,056 |   |
| Current maturities of long-term obligations                                                                                                                                                                                 |       | 258                         |       | 208                          |       |
| Income tax payable                                                                                                                                                                                                          |       | —                      |       | 3,898                        |       |
| Liabilities of discontinued operations                                                                                                                                                                                      |       | 326                         |       | —                       |       |
| Total current liabilities                                                                                                                                                                                                   |       | 53,133                      |       | 54,162                       |       |
| **LONG-TERM  OBLIGATIONS, net of current maturities**                                                                                                                                                                       |       | 87,547                      |       | 60,496                       |       |
| **DEFERRED  INCOME TAXES**                                                                                                                                                                                                  |       | 13,210                      |       | 30,426                       |       |
| **LONG-TERM  CUSTOMER LIABILITY**                                                                                                                                                                                           |       | 4,147                       |       | —                       |       |
| **DEFERRED  REVENUE**                                                                                                                                                                                                       |       | 8,010                       |       | —                       |       |
| **NON  QUALIFIED RETIREMENT PLAN OBLIGATIONS**                                                                                                                                                                              |       | 8,870                       |       | —                       |       |
| **OTHER  LONG-TERM OBLIGATIONS**                                                                                                                                                                                            |       | 2,077                       |       | 478                          |       |
| Total liabilities                                                                                                                                                                                                           |       | 176,994                     |       | 145,562                      |       |
| **COMMITMENTS  AND CONTINGENCIES**                                                                                                                                                                                          |       |                        |       |                         |       |
| **STOCKHOLDERS’  EQUITY:**                                                                                                                                                                                             |       |                        |       |                         |       |
| Preferred stock, $.01 par value, 1,000,000  shares authorized, no shares issued or outstanding                                                                                                                              |       | —                      |       | —                       |       |
| Series A Cumulative Participating  Preferred stock, no par value, 50,000 shares authorized, no shares issued or  outstanding                                                                                           |       | —                      |       | —                       |       |
| Common stock, $.01 par value, 26,000,000  shares authorized, 15,703,586 and 15,627,098 shares issued and 15,666,916 and  15,590,428 shares outstanding at December 31, 2004 and  September 30, 2005, respectively |       | 157                         |       | 156                          |       |
| Additional paid-in-capital                                                                                                                                                                                                  |       | 193,925                     |       | 196,991                      |       |
| Retained earnings                                                                                                                                                                                                           |       | 103,136                     |       | 136,131                      |       |
|                                                                                                                                                                                                                        |       | 297,218                     |       | 333,278                      |       |
| Less—Treasury stock, at cost, 36,670 shares                                                                                                                                                                            |       | (501                        | )          | (501                         | )          |
| Less—Deferred compensation                                                                                                                                                                                             |       | (4,296                      | )          | (6,848                       | )          |
| Total stockholders’ equity                                                                                                                                                                                             |       | 292,421                     |       | 325,929                      |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                             |       | $                           | 469,415    |                         | $          | 471,491 |   |

 

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

 

1

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                    | ** ** | **(Unaudited)**                            | ** ** | **(Unaudited)**                           | ** ** |
| **REVENUE**                                                   |       | $                                          | 96,698     |                                      | $          | 105,530 |   | $ | 289,612 |   | $ | 317,915 |   |
| **COST OF SERVICES EXCLUSIVE OF DEPRECIATION**                |       | 59,263                                     |       | 58,289                                    |       | 173,246 |   | 176,643 |   |
| **DEPRECIATION**                                              |       | 3,241                                      |       | 3,600                                     |       | 9,404 |   | 10,568 |   |
| Gross profit                                                  |       | 34,194                                     |       | 43,641                                    |       | 106,962 |   | 130,704 |   |
| **SELLING, GENERAL AND ADMINISTRATIVE  EXPENSES**             |       | 24,890                                     |       | 32,012                                    |       | 80,066 |   | 92,053 |   |
| **CONTINGENT CONSIDERATION OVERPAYMENT AND  ADJUSTMENT**      |       | 10,165                                     |       | 789                                       |       | 10,165 |   | 789 |   |
| **AMORTIZATION**                                              |       | 313                                        |       | 207                                       |       | 714 |   | 619 |   |
| Operating income (loss)                                       |       | (1,174                                     | )          | 10,633                                    |       | 16,017 |   | 37,243 |   |
| **OTHER  (INCOME) EXPENSE:**                                  |       |                                       |       |                                      |       |   |   |   |   |
| Interest expense                                              |       | 822                                        |       | 1,134                                     |       | 2,180 |   | 3,585 |   |
| Interest income                                               |       | (51                                        | )          | (75                                       | )          | (58 | ) | (153 | ) |
| Net legal settlement                                          |       | —                                     |       | (22,739                                   | )          | — |   | (22,739 | ) |
| Other (income) expense, net                                   |       | 253                                        |       | 324                                       |       | 625 |   | 657 |   |
| Income (loss) from continuing operations  before income taxes |       | (2,198                                     | )          | 31,989                                    |       | 13,270 |   | 55,893 |   |
| **PROVISION  FOR INCOME TAXES**                               |       | (1,796                                     | )          | 12,390                                    |       | 4,391 |   | 22,905 |   |
| **INCOME (LOSS) FROM CONTINUING OPERATIONS**                  |       | (402                                       | )          | 19,599                                    |       | 8,879 |   | 32,988 |   |
| **INCOME (LOSS) FROM DISCONTINUED OPERATIONS,  NET OF TAX**   |       | (275                                       | )          | 888                                       |       | (2,645 | ) | 7 |   |
| **NET INCOME (LOSS)**                                         |       | $                                          | (677       | )                                         | $          | 20,487 |   | $ | 6,234 |   | $ | 32,995 |   |
| **NET INCOME (LOSS) PER COMMON SHARE**                        |       |                                       |       |                                      |       |   |   |   |   |
| **BASIC**                                                     |       |                                       |       |                                      |       |   |   |   |   |
| **Continuing Operations**                                     |       | $                                          | (0.02      | )                                         | $          | 1.25 |   | $ | 0.56 |   | $ | 2.11 |   |
| **Discontinued Operations**                                   |       | (0.02                                      | )          | 0.06                                      |       | (0.17 | ) | 0.00 |   |
| **Total**                                                     |       | $                                          | (0.04      | )                                         | $          | 1.31 |   | $ | 0.39 |   | $ | 2.11 |   |
| **DILUTED**                                                   |       |                                       |       |                                      |       |   |   |   |   |
| **Continuing Operations**                                     |       | $                                          | (0.02      | )                                         | $          | 1.21 |   | $ | 0.54 |   | $ | 2.05 |   |
| **Discontinued Operations**                                   |       | (0.02                                      | )          | 0.06                                      |       | (0.16 | ) | 0.00 |   |
| **Total**                                                     |       | $                                          | (0.04      | )                                         | $          | 1.27 |   | $ | 0.38 |   | $ | 2.05 |   |
| **WEIGHTED AVERAGE COMMON SHARES OUTSTANDING**                |       |                                       |       |                                      |       |   |   |   |   |
| **BASIC**                                                     |       | 15,781                                     |       | 15,672                                    |       | 15,964 |   | 15,672 |   |
| **DILUTED**                                                   |       | 15,781                                     |       | 16,151                                    |       | 16,300 |   | 16,066 |   |

 

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

 

2

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**SOURCECORP, INCORPORATED AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(IN THOUSANDS)**

 
| ** **                                                                                 | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2004**                                  | ** ** | **2005** | ** ** |
| ** **                                                                                 | ** ** | **(Unaudited)**                           | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                                 |       |                                      |       |   |   |
| Income from continuing operations                                                          |       | $                                         | 8,879      |   | $ | 32,988 |   |
| Adjustments to reconcile income to net cash  provided by operating activities:             |       |                                      |       |   |   |
| Depreciation and amortization                                                              |       | 10,118                                    |       | 11,187 |   |
| Deferred income tax provision                                                              |       | 168                                       |       | 11,982 |   |
| Stock based compensation expense                                                           |       | 1,751                                     |       | 2,247 |   |
| Loss on sale of property, plant and  equipment                                             |       | 265                                       |       | 382 |   |
| Contingent consideration adjustment                                                        |       | —                                    |       | 789 |   |
| Non-cash income related to common stock  component of settlement                           |       | —                                    |       | (1,806 | ) |
| Change in operating assets and liabilities:                                                |       |                                      |       |   |   |
| Accounts and notes receivable                                                              |       | (2,223                                    | )          | (14,468 | ) |
| Inventories, prepaid expenses and other  assets                                            |       | (638                                      | )          | 836 |   |
| Accounts payable and accrued liabilities                                                   |       | (2,658                                    | )          | (3,065 | ) |
| Net cash provided by operating activities  from continuing operations                      |       | 15,662                                    |       | 41,072 |   |
| Net cash used in operating activities from  discontinued operations                        |       | (1,357                                    | )          | (171 | ) |
| Net cash provided by operating activities                                                  |       | 14,305                                    |       | 40,901 |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                 |       |                                      |       |   |   |
| Net proceeds received from divestitures                                                    |       | 6,812                                     |       | 2,288 |   |
| Purchase of property, plant and equipment                                                  |       | (12,590                                   | )          | (10,412 | ) |
| Proceeds from disposition of property,  plant and equipment                                |       | 37                                        |       | 40 |   |
| Cash paid for acquisitions, net of cash  acquired                                          |       | (17,495                                   | )          | (4,367 | ) |
| Net cash used in investing activities from  continuing operations                          |       | (23,236                                   | )          | (12,451 | ) |
| Net cash used in investing activities from  discontinued operations                        |       | (191                                      | )          | — |   |
| Net cash used in investing activities                                                      |       | (23,427                                   | )          | (12,451 | ) |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                 |       |                                      |       |   |   |
| Proceeds from exercise of common stock  options                                            |       | 481                                       |       | 67 |   |
| Cash paid for common stock repurchased                                                     |       | (10,071                                   | )          | — |   |
| Cash paid for debt issuance costs                                                          |       | —                                    |       | (175 | ) |
| Proceeds from long-term obligations                                                        |       | 246,956                                   |       | 183,476 |   |
| Principal payments on long-term obligations                                                |       | (228,436                                  | )          | (210,660 | ) |
| Net cash provided by (used in) financing  activities from continuing operations            |       | 8,930                                     |       | (27,292 | ) |
|                                                                                       |       |                                      |       |   |   |
| **NET  (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS**                                  |       | (192                                      | )          | 1,158 |   |
| **CASH AND  CASH EQUIVALENTS, beginning of period**                                        |       | 2,097                                     |       | 3,722 |   |
| **CASH AND  CASH EQUIVALENTS, end of period**                                              |       | $                                         | 1,905      |   | $ | 4,880 |   |
| **SUPPLEMENTAL  DATA:**                                                                    |       |                                      |       |   |   |
| Cash paid for:                                                                             |       |                                      |       |   |   |
| Income taxes                                                                               |       | $                                         | 1,362      |   | $ | 2,406 |   |
| Interest                                                                                   |       | $                                         | 2,122      |   | $ | 3,684 |   |
| **NONCASH  FINANCING TRANSACTIONS:**                                                       |       |                                      |       |   |   |
| Assets acquired through financing and  capital lease arrangements                          |       | $                                         | 258        |   | $ | 83 |   |
| Accrued capital expenditures                                                               |       | $                                         | —     |   | $ | 468 |   |
| Restricted stock grant (182,550 and 251,959  shares, respectively)                         |       | $                                         | 4,623      |   | $ | 4,803 |   |
| Restricted stock forefeiture (5,250 and  1,000 shares, respectively)                       |       | $                                         | (137       | ) | $ | (18 | ) |
| Common stock accrued related to business  acquisitions (30,324 and 0 shares, respectively) |       | $                                         | 261        |   | $ | — |   |

 

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

 

3

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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 condensedconsolidated financial statements have been prepared by the Company, withoutaudit, pursuant to the rules and regulations of the Securities andExchange Commission (the “Commission”). Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of Americahave been condensed or omitted pursuant to such rules and regulations.However, the Company believes that all disclosures are adequate to make theinformation presented not misleading. These condensed consolidated financial statements should be read inconjunction with the Company’s consolidated financial statements and therelated notes thereto in the Annual Report on Form 10-K filed with theCommission on March 31, 2005.

 

Inthe opinion of management, all adjustments necessary to fairly present theCompany’s financial position at September 30, 2005, the results ofoperations for the three and nine months ended September 30, 2005 and 2004 andcash flows for the nine months ended September 30, 2005 and 2004 have beenincluded. The results of operations for the three and nine months ended September 30,2005 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 ended June 30, 2005, with a lifetimelimit of liability per covered participant of $1,900,000.  The Company’s stop-loss policy for medicalcosts expired on June 30, 2005.  Thestop-loss policy was renewed for one year, effective July 1, 2005.  The fixed dollar amount of stop-loss coverageunder the new policy is $200,000 per covered participant with a lifetime limitof liability per covered participant of $1,800,000.

 

Accrual balances related to workmen’s compensationand medical costs, included in accrued liabilities in the condensed consolidatedbalance sheets, are as follows (in thousands):

 

| ** **                   | ** ** | **December 31,  2004** | ** ** | **September 30,  2005** | ** ** |
|------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| Workmen’s  Compensation |       | $                           | 2,407      |                         | $          | 2,051 |   |
| Employee  Medical Insurance  |       | 2,229                       |       | 1,969                        |       |
| Total                        |       | $                           | 4,636      |                         | $          | 4,020 |   |

 

*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*.  Contingent liabilities are often resolvedover long periods of time. Estimating probable losses requires analysis ofmultiple forecasts that often depend on judgments about potential actions bythird parties such as regulators. The Company’s loss contingencies consistprimarily of estimates related to the probable outcome of pending litigation.  See Note 8.

 

4

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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 awards grantedunder 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 Company’s common stock on thedate of grant. Accordingly, no compensation expense has been recognized forstock options and warrants. Had compensation expense been determined based uponthe fair value at each grant date for stock options and warrants consistentwith the provisions of SFAS No. 123, *Accountingfor Stock-Based Compensation,* the Company’s net income and earningsper share would have been as follows (in thousands, except per share data):

 
| ** **                                                                                                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                           | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net income (loss) as reported                                                                                                        |       | $                                          | (677       | )                                         | $          | 20,487 |   | $ | 6,234 |   | $ | 32,995 |   |
| Add: Deferred compensation expense included  in reported net income (loss), net of related tax effect                                |       | 379                                        |       | 506                                       |       | 1,031 |   | 1,294 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of tax effect |       | (931                                       | )          | (631                                      | )          | (2,516 | ) | (1,897 | ) |
| Proforma net income (loss)                                                                                                           |       | $                                          | (1,229     | )                                         | $          | 20,362 |   | $ | 4,749 |   | $ | 32,392 |   |
| Earnings per share:                                                                                                                  |       |                                       |       |                                      |       |   |   |   |   |
| Reported basic earnings per share                                                                                                    |       | $                                          | (0.04      | )                                         | $          | 1.31 |   | $ | 0.39 |   | $ | 2.11 |   |
| Proforma basic earnings per share                                                                                                    |       | $                                          | (0.08      | )                                         | $          | 1.30 |   | $ | 0.30 |   | $ | 2.07 |   |
|                                                                                                                                 |       |                                       |       |                                      |       |   |   |   |   |
| Reported diluted earnings per share                                                                                                  |       | $                                          | (0.04      | )                                         | $          | 1.27 |   | $ | 0.38 |   | $ | 2.05 |   |
| Proforma diluted earnings per share                                                                                                  |       | $                                          | (0.08      | )                                         | $          | 1.26 |   | $ | 0.29 |   | $ | 2.02 |   |

 

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  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| Weighted-average  risk-free interest rate |       | N/A                                        |       | N/A                                       |       | 3.3 | % | N/A |   |
| Weighted-average  dividend yield          |       | N/A                                        |       | N/A                                       |       | 0.0 | % | N/A |   |
| Weighted-average  volatility              |       | N/A                                        |       | N/A                                       |       | 41.5 | % | N/A |   |
| Weighted-average  expected life           |       | N/A                                        |       | N/A                                       |       | 4.0 years | N/A |   |

 

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 theirterms would not vest before June 30, 2005), provided that the holders wereemployed by the

 

5

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Company as of December 31, 2004. The action was taken as a methodto provide a further incentive to option holders to maximize shareholder valuewithout creating an immediate windfall (as substantially all of such optionsand warrants had exercise prices above $30 per share). In taking such action,the Compensation Committee and the Board were mindful that the accountingtreatment of stock options and warrants was anticipated to change in the secondhalf of 2005 (which date has changed to the first quarter of 2006), requiringthe expensing 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, certain forfeituresof restricted stock have occurred resulting in a total award of 154,000 sharesand 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.

 

Duringthe three months ended June 30, 2005, the Company awarded 245,170 sharesof restricted stock under the 2002 Plan. The restricted shares were issued atno cost to the recipients; therefore, the Company recorded deferredcompensation of approximately $4.7 million based on the market value of thestock at the date of issuance.  Thedeferred compensation charge is being amortized to expense over the vestingperiod of the restricted stock.  Of therestricted shares granted, 10,170 restricted shares vest over a three yearperiod ending May 23, 2008, and 235,000 restricted shares vest on December 18,2009, with acceleration of the vesting period for certain shares occurring ifcertain performance targets are achieved.

 

Duringthe three months ended September 30, 2005, the Company awarded 6,789 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 $0.1million 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.  Of the restricted stock granted, 1,789restricted shares vest over a three year period ending August 2, 2008, and5,000 restricted shares vest on December 18, 2009, with acceleration of thevesting period for certain shares occurring if certain performance targets areachieved.

 

6

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Deferredcompensation amortized to expense, included in selling, general andadministrative expenses in the condensed consolidated statements of operations,related to the restricted stock grants discussed above is as follows (inthousands):

 
| ** **               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **               | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| May 2003  grant     |       | $                                          | 238        |                                      | $          | 261 |   | $ | 736 |   | $ | 732 |   |
| January 2004  grant |       | 276                                        |       | 219                                       |       | 829 |   | 772 |   |
| May 2004  grant     |       | 117                                        |       | 92                                        |       | 186 |   | 323 |   |
| May 2005  grant     |       | —                                     |       | 236                                       |       | — |   | 402 |   |
| August 2005  grant       |       | —                                     |       | 3                                         |       | — |   | 3 |   |
| September  2005 grant    |       | —                                     |       | 2                                         |       | — |   | 2 |   |
| Total                    |       | $                                          | 631        |                                      | $          | 813 |   | $ | 1,751 |   | $ | 2,234 |   |

 

*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 repurchaseprogram.

 

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 (with the last such repurchase occurring on October 26,2004).

 

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.

 

*LegalSettlement*

 

OnSeptember 23, 2005, the Company and certain of its subsidiaries, entered into asettlement agreement with the former owners of the operating subsidiary thatwas the subject of its internal investigation and financial restatement.  As a part of the settlement proceeds, theformer owners returned 89,888 shares of the Company’s common stock valued atapproximately $1.8 million.  The commonshares were retired and recorded in the balance sheet as a reduction of commonstock and additional paid-in-capital. See Note 9.

 

*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  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                               | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| Basic weighted average common shares                     |       | 15,781                                     |       | 15,672                                    |       | 15,964 |   | 15,672 |   |
| Weighted average options, warrants and  restricted stock |       | —                                     |       | 479                                       |       | 318 |   | 394 |   |
| Other contingent consideration                           |       | —                                     |       | —                                    |       | 18 |   | — |   |
| Diluted  weighted average common shares                  |       | 15,781                                     |       | 16,151                                    |       | 16,300 |   | 16,066 |   |

 

AtSeptember 30, 2004 and 2005, approximately 2.4 million and 2.9 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. Stockholders’ Rights Plan**

 

On June 24, 2005,the Company adopted a stockholders’ rights plan, (the Rights Plan). Under theRights Plan, each holder of the Company’s common stock, at the close ofbusiness on July 4, 2005, received a dividend distribution of one Rightfor each share of common stock held.  Exceptas provided below, each Right entitles stockholders to buy one one-thousandthof a share (“Share Fraction”) of Series A Cumulative ParticipatingPreferred Stock of the Company at an exercise price of $90.00, subject toadjustment

 

7

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in certain circumstances, e.g. for stock splits orstock dividends.  Each preferred ShareFraction is designed to be equivalent in voting and dividend rights to oneshare of common stock.

 

If any person or groupacquires 15% or more of the Company’s common stock (other than pursuant to atender or exchange offer for all common stock at a price and on terms approvedby the Board of Directors), each Right will entitle its holder to purchase, atthe Right’s exercise price, common stock of the Company having a market valueof twice the Right’s exercise price. This amounts to the right to buy theCompany common stock at half price. Rights owned by the party triggering theexercise of Rights will not be exercisable.

 

In addition, if after anyperson or group has become a 15%-or-more stockholder, the Company is involvedin a merger or other business combination transaction with another person inwhich its shares of common stock are changed or converted, or sells 50% or moreof its assets or earning power to another person, each Right will entitle itsholder to purchase, at the Right’s exercise price, shares of common stock ofsuch other person having a market value of twice the Right’s exercise price.

 

**The Rights will beexercisable and will trade separately from the shares of common stock only if aperson or group, with certain exceptions, acquires 15% or more the Company’scommon stock or commences a tender or exchange offer that would result in suchperson or group owning 15% or more of the Company’s common stock.  Prior to that, the Rights will not tradeseparately from the common stock. The Company may redeem the Rights for $0.001per Right prior to the time any person or group acquires 15% or more of theCompany’s common stock. All Rights expire on June 24, 2015.**

 

This summary description is qualified in its entirety by reference tothe Rights Agreement, which has been filed as an exhibit to the Company’sRegistration Statement on Form 8-A.

 

**5. 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 assetgroup meets the requirements for discontinued operations accounting treatmentas outlined in SFAS No. 144, “*Accountingfor the Impairment or Disposal of Long-Lived Assets”* during thequarter ended March 31, 2005.  Assuch, the operating assets and liabilities of this operation are presented inthe condensed consolidated balance sheet as Assets and Liabilities ofDiscontinued Operations and the results associated with this operation arepresented in the condensed consolidated statement of operations as Income(Loss) from Discontinued Operations, 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.

 

Due to unrealizable capital losses associatedwith this transaction for tax purposes, additional tax expense of approximately$0.7 million was recognized during the second quarter of 2005.

 

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

 
| ** **                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                             | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | **(Unaudited)**                            | ** ** | **(Unaudited)**                           | ** ** |
| **REVENUE**                                            |       | $                                          | 976        |                                      | $          | — |   | $ | 2,885 |   | $ | 260 |   |
| **COST OF  SERVICES**                                  |       | 697                                        |       | —                                    |       | 2,049 |   | 194 |   |
| **DEPRECIATION**                                       |       | 21                                         |       | —                                    |       | 62 |   | 6 |   |
| Gross profit                                           |       | 258                                        |       | —                                    |       | 774 |   | 60 |   |
| **SELLING, GENERAL AND ADMINISTRATIVE  EXPENSES**      |       | 281                                        |       | —                                    |       | 916 |   | 191 |   |
| Operating loss                                         |       | (23                                        | )          | —                                    |       | (142 | ) | (131 | ) |
| **OTHER  (INCOME) EXPENSE:**                           |       |                                       |       |                                      |       |   |   |   |   |
| Interest Income                                        |       | —                                     |       | —                                    |       | (2 | ) | — |   |
| Loss on sale of asset group                            |       | —                                     |       | —                                    |       | — |   | 168 |   |
| Loss from discontinued operations before  income taxes |       | (23                                        | )          | —                                    |       | (140 | ) | (299 | ) |
| **PROVISION  (BENEFIT) FOR INCOME TAXES**              |       | (9                                         | )          | —                                    |       | (56 | ) | 543 |   |
| **LOSS  FROM DISCONTINUED OPERATIONS**                 |       | $                                          | (14        | )                                         | $          | — |   | $ | (84 | ) | $ | (842 | ) |

 

8

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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*

 

Duringthe first quarter of 2004, the Company completed a strategic evaluation of itsoperations based on certain criteria, such as strategic and financial fit, andfuture growth prospects. As a result, on May 6, 2004, the Company formallycommitted to a plan of divestiture for certain non-strategic asset groupsrelated to its Direct Mail operations reported in the Information Managementand Distribution segment in prior periods, and two medical records managementoperations reported in the Healthcare, Regulatory and Legal Compliance segmentin prior periods. The Direct Mail operations and the two medical recordsmanagement operations are accounted for as discontinued operations. As such,the results associated with these operations are presented in the consolidatedstatement of operations as Income (Loss) from Discontinued Operations, net oftax.

 

Duringthe second quarter of 2004, the Company completed the sale of one of themedical records management operations, which resulted in approximately $0.7million of cash proceeds and a pre-tax gain on disposal of approximately $0.5million. Additionally, the Company recognized a pre-tax loss on disposalrelated to the Direct Mail operations of approximately $2.2 million.

 

Duringthe third quarter of 2004, the Company completed the sale of the Direct Mailoperations and the remaining medical records management operation, resulting inthe recognition of a net pretax gain of $0.4 million. In connection with thesetransactions, the Company received approximately $6.1 million of cash proceeds,net of transaction 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.

 

Duringthe fourth quarter of 2004, the contingency surrounding the contract renewal atthe medical 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.

 

Duringthe third quarter of 2005, the Company received approximately $1.5 million inproceeds related to the collection of the subordinated notes receivableassociated with the disposition of  theCompany’s Direct Mail operations.  Due tothe uncertaintly of collection, income associated with the notes receivable wasnot recorded at the time of the divestiture resulting in income from discontinuedoperations in the third quarter of 2005.

 

9

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

 
| ** **                                                      | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                      | ** ** | **2004**                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                      | ** ** | **(Unaudited)**                            | ** ** | **(Unaudited)**                           | ** ** |
| **REVENUE**                                                     |       | $                                          | 262        |                                      | $          | — |   | $ | 15,789 |   | $ | 7 |   |
| **COST OF  SERVICES**                                           |       | 750                                        |       | —                                    |       | 13,484 |   | 49 |   |
| **DEPRECIATION**                                                |       | —                                     |       | —                                    |       | 528 |   | — |   |
| Gross profit                                                    |       | (488                                       | )          | —                                    |       | 1,777 |   | (42 | ) |
| **SELLING, GENERAL AND ADMINISTRATIVE  EXPENSES**               |       | 347                                        |       | —                                    |       | 4,693 |   | 4 |   |
| Operating loss                                                  |       | (835                                       | )          | —                                    |       | (2,916 | ) | (46 | ) |
| **OTHER  (INCOME) EXPENSE:**                                    |       |                                       |       |                                      |       |   |   |   |   |
| Interest and other expense (income), net                        |       | (39                                        | )          | —                                    |       | (19 | ) | — |   |
| (Gain) loss on sale of asset group                              |       | (361                                       | )          | (1,450                                    | )          | 1,371 |   | (1,433 | ) |
| Income (loss) from discontinued operations  before income taxes |       | (435                                       | )          | 1,450                                     |       | (4,268 | ) | 1,387 |   |
| **PROVISION  (BENEFIT) FOR INCOME TAXES**                       |       | (174                                       | )          | 562                                       |       | (1,707 | ) | 538 |   |
| **INCOME (LOSS) FROM DISCONTINUED OPERATIONS**                  |       | $                                          | (261       | )                                         | $          | 888 |   | $ | (2,561 | ) | $ | 849 |   |

 

**6. 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 |   |
| Adjustments  related to past acquisition |       | (1,724                                        | )          | —                                             |       | (1,724    | )          |
| Finalize  purchase price allocation      |       | —                                        |       | (19                                                | )          | (19       | )          |
| Net balance  as of September 30, 2005    |       | $                                             | 165,936    |                                               | $          | 158,460   |       | $ | 324,396 |   |

 

During the third quarter of 2005, the Company recorded an adjustment topreviously reported contingent consideration overpayments of approximately $0.8million related to the operating subsidiary involved in the Company’s internalinvestigation.  The adjustment in thecurrent quarter had no impact on current year operating cash flow.

 

Intangibles:

 
| ** **              | ** ** | **December 31, 2004** | ** ** | **September 30, 2005**   | ** ** |
|-------------------------|------------|----------------------------|------------|-------------------------------|------------|
| ** **              | ** ** | **Gross Carrying  Value**  | ** ** | **Accumulated  Amortization** | ** ** | **Gross Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** |
| Customer  relationships |       | $                          | 4,283      |                          | $          | (1,084 | ) | $ | 4,283 |   | $ | (1,284 | ) |
| Non-compete  agreements |       | 2,321                      |       | (616                          | )          | 2,321 |   | (1,035 | ) |
| Total                   |       | $                          | 6,604      |                          | $          | (1,700 | ) | $ | 6,604 |   | $ | (2,319 | ) |

 

10

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Aggregateamortization expense related to intangibles for the nine months ended September 30,2004 and 2005 was approximately $0.7 million and $0.6 million,respectively.  Estimated amortizationexpense for the years 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*

 

Management’sevaluation of the cumulative earnings of acquired companies through December 31,2004 indicated that an acquired company had met specified earnings targetsbeyond a reasonable doubt.  As a result,at December 31, 2004, in connection with the 2002 purchase of UIS, approximately$5.3 million of additional consideration remained accrued and was classified asaccounts payable and accrued liabilities in the condensed consolidated balance sheets.  There were no changes to management’sevaluation during the nine months ended September 30, 2005.  Pursuant to the terms of the UIS purchaseagreement, approximately $4.3 million of contingent consideration was paid incash to the former shareholders during the three months ended June 30,2005 and approximately $1.0 million of additional contingent considerationremains accrued.  The Company reservesthe right to change the payment mix to use common stock versus cash insatisfying contingent consideration liabilities.  The accrued additional consideration isincluded in accounts payable and accrued liabilities in the condensedconsolidated balance sheets and is expected to be paid in cash by the firstquarter of 2006.

 

Asof December 31, 2004, all periods applicable for earnout targets of pastacquisitions were completed.

 

**7. Segment Reporting**

 

TheCompany aggregates its service offerings and operations into two reportablesegments: (i) Information Management and Distribution, and (ii) Healthcare,Regulatory, and Legal Compliance. The Company’s reportable segments areorganized around customer types and service offerings possessing similareconomic characteristics. Management evaluates segment performance based onrevenue and income before income taxes. All centrally incurred corporate costsare allocated to the segments based principally on operating income of thereportable segments measured before the inclusion of the expense related to thecontingent consideration overpayments discussed in Note 10.  The reporting segments follow the sameaccounting policies used for the Company’s consolidated 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.

 

11

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

 

| ** **                                             | ** ** | **THREE MONTHS ENDED SEPTEMBER 30, 2005** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                             | ** ** | **Information  Management  and  Distribution** | ** ** | **Healthcare,  Regulatory  and Legal  Compliance** | ** ** | **Consolidated** | ** ** |
| Revenue                                                |       | $                                              | 56,554     |   | $ | 48,976 |   | $ | 105,530 |   |
| Income from  continuing operations before income taxes |       | 26,869                                         |       | 5,120 |   | 31,989 |   |
|                                                        |            |                                                |            |  |  |  |  |  |  |  |

 

| ** **                                                    | ** ** | **THREE  MONTHS ENDED SEPTEMBER 30, 2004** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                    | ** ** | **Information  Management  and  Distribution**  | ** ** | **Healthcare,  Regulatory  and Legal  Compliance** | ** ** | **Consolidated** | ** ** |
| Revenue                                                       |       | $                                               | 48,138     |   | $ | 48,560 |   | $ | 96,698 |   |
| Income  (loss) from continuing operations before income taxes |       | (7,760                                          | )          | 5,562 |   | (2,198 | ) |
|                                                               |            |                                                 |            |  |  |  |  |  |  |  |

 

 

| ** **                                             | ** ** | **NINE  MONTHS ENDED SEPTEMBER 30, 2005** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                             | ** ** | **Information  Management  and  Distribution** | ** ** | **Healthcare,  Regulatory  and Legal  Compliance** | ** ** | **Consolidated** | ** ** |
| Revenue                                                |       | $                                              | 169,450    |   | $ | 148,465 |   | $ | 317,915 |   |
| Income from  continuing operations before income taxes |       | 37,976                                         |       | 17,917 |   | 55,893 |   |
|                                                        |            |                                                |            |  |  |  |  |  |  |  |

 

| ** **                                                    | ** ** | **NINE  MONTHS ENDED SEPTEMBER 30, 2004** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                    | ** ** | **Information  Management  and  Distribution** | ** ** | **Healthcare,  Regulatory  and Legal  Compliance** | ** ** | **Consolidated** | ** ** |
| Revenue                                                       |       | $                                              | 146,191    |   | $ | 143,421 |   | $ | 289,612 |   |
| Income  (loss) from continuing operations before income taxes |       | (4,833                                         | )          | 18,103 |   | 13,270 |   |
|                                                               |            |                                                |            |  |  |  |  |  |  |  |

 

Resultsfor the Information Management and Distribution segment include contingentconsideration overpayments and adjustments of approximately $10.2 million and$0.8 million for the three and nine months ended September 30, 2004 and 2005,respectively, and approximately $22.7 million related to the net legalsettlement for the three and nine months ended September 30, 2005.  See Note 9 and Note 10 for additional discussionregarding these items.

 

**8.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 as defendantsin several putative securities class actions, in response to the Company’spress releases dated October 27, 2004, in which the Company disclosed thatits financial statements for certain prior periods should no longer be reliedupon, and also provided updated financial guidance. The complaints(collectively, the “Actions”) were filed in the United States District Courtfor the Northern District of Texas, Dallas Division, with the first actionbeing filed November 1, 2004. The Actions are putative shareholder classaction lawsuits alleging violations of Federal Securities Laws, includingalleged violations of Sections 10(b) and 20(a), and Rule 10b-5 of theSecurities Exchange Act of 1934, as amended. The four Actions were transferredto a single judge in the Northern District of Texas, Dallas Division and consolidatedinto a single action now styled *In reSourcecorp, Inc. Securities Litigatio.,* A lead plaintiff hasbeen appointed for the consolidated Action. In addition to the Company and its CEO and CFO, one of the Company’ssubsidiaries and one of the former owners of that subsidiary are named asdefendants in the consolidated Action.  Theconsolidated Action is purportedly on behalf of all persons who purchased theCompany’s common stock during the period between May 3, 2001, and October 27,2004, and seeks unspecified damages.  TheCompany cannot currently estimate the ultimate resolution of this contingency;however, the Company intends to vigorously defend this matter.  

 

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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 “State Derivative Action”). The StateDerivative Action alleges breach of fiduciary duty, abuse of control, grossmismanagement, waste of assets, and unjust enrichment related to the Company’spress release described above dated October 27, 2004, the subsequentrestatement of financial results, and certain other events.  All of these claims are asserted derivativelyon behalf of the Company and seek unspecified damages against those individuals.

 

Further,the Chairman of the Company’s Board of Directors received from a purportedshareholder a demand letter (the “Demand Letter”) based on the same set offacts as the State Derivative Action.  TheDemand Letter requests the Board to take certain action, but does not seekdamages against the Company.  The Companyhas formed a special committee of the Board of Directors that is evaluating theclaims made in the State Derivative Action and the Demand Letter.

 

OnOctober 21, 2005, the purported shareholder who sent the Demand Letter filed aderivative and class action against certain of the Company’s officers anddirectors as individual defendants and the Company as a nominal defendant inthe United States District Court for the Northern District of Texas, DallasDivision (the “Federal Derivative and Class Action”).  The FederalDerivative and Class Action alleges similar facts as the securities Actions,the State Derivative Action, and the Demand Letter and also includesallegations relating to the Company’s October 5, 2005 press release regardingthe exploration of strategic alternatives, including the potential sale of theCompany.  The Federal Derivative and Class Action asserts claims undersection 304 of the Sarbanes-Oxley Act of 2002, for contribution under sections10(b) and 21D of the Securities Exchange Act of 1934, for breach of fiduciaryduty, and for abuse of control and seeks unspecified damages, injunctiverelief, and the imposition of a constructive trust against the individualdefendants.  The claims are asserted derivatively on behalf of the Companyand on behalf of putative classes of those who held the Company’s common stockon October 5, 2005 and those who exchange their shares in a potential sale, ifany, of the Company.

 

*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.

 

Onesuch 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 theCourt of Common Pleas Philadelphia County, Pennsylvania, alleges among otherthings that the Company intentionally charged more for providing copies ofmedical records than is permitted under Pennsylvania law.  The complaint does not specify the amount ofdamages sought.  On June 10, 2005,the Court in this matter granted judgment in favor of the plantiffs for anamount as yet to be determined.  OnNovember 3, 2005, a separate hearing on damages was held, but no order has yetbeen entered.  If and when a judgement isentered, the Company will assess its appellate options.  The Company believes it is adequatelyreserved for this legal contingency.

 

*SEC Investigation*

 

OnJanuary 14, 2005, the Company received written confirmation from the SECthat the SEC had converted its informal inquiry in connection with the Company’sinternal investigation and restatement into a formal investigation. The Companyis continuing to fully cooperate with the SEC in connection with theinvestigation. The Company initially had contacted the enforcement division ofthe SEC on a voluntary basis to notify the agency of the Company’sunderstanding of the events leading to its internal investigation. The Companyis unable to predict the outcome of the investigation, the scope of mattersthat the SEC may choose to investigate in the course of this investigation orin the future, the SEC’s views of the issues being investigated, or any actionthat the SEC might take, including the imposition of fines, penalties, or otheravailable remedies.

 

**9.   Legal Settlement**

 

On September 23, 2005, the Company and certain ofits subsidiaries, entered into a settlement agreement with the former owners ofthe operating subsidiary that was the subject of its internal investigation andfinancial restatement.  In the settlementagreement, the former owners agreed to pay the Company a total of $30 million,consisting of: (i) $20 million in cash, (ii) 89,888 shares of the Company’scommon stock valued at approximately $1.8 million, and (iii) an approximate $8.2million future payment obligation secured by parcels of real estate and payablewithin 90 days of such settlement.  TheCompany has perfected its mortgages on all but one such parcels of real estate.

 

During Septmber 2005, the Company received the $20million in cash and the 89,888 shares of the Company’s common stock from theformer owners.  The common shares wereretired and were recorded in the balance sheet as a reduction of common stockand additional paid-in-capital.  Inaddition, as a result of the settlement agreement, the Company was releasedfrom approximately $1.2 million of related liabilities identified and recordedin connection with the financial restatement.  These items were recorded, net of

 

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associated legal fees of $0.3 million,  in the condensed consolidated statements ofoperations as other (income) expense and are reported under the caption “Net legalsettlement”.

 

The future payment obligation was not recorded asincome during the third quarter of 2005 due to uncertainty regarding collectionand the value of the consideration that may be received.  Any subsequent collection of the futurepayment obligation will result in additional settlement income in the period thatcollection becomes probable and estimable.

 

**10. Customer Remediation Activities**

 

DuringOctober 2004, the Company, with the oversight and approval of the AuditCommittee of its Board of Directors, initiated an investigation of thefinancial results of one of its operating subsidiaries in the InformationManagement and Distribution reportable segment (the “Operating Subsidiary”).The findings of the investigation concluded that the Operating Subsidiary hadincorrectly recognized revenue for certain customer arrangements and omittedcertain operating 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.

 

Asdescribed in the Company’s critical accounting policies, revenue isrecognizable when each of the following conditions is met: persuasiveevidence of an arrangement exists, the price is fixed or determinable, deliveryhas occurred or services have been rendered and collection is reasonably assured.The investigation identified certain instances where one or more of theaforementioned revenue recognition conditions as applied to certain customercontracts were not met by the Operating Subsidiary. As a result, the revenuepreviously recognized that did not meet all the mentioned revenue recognitionconditions was reversed, resulting in a downward adjustment to certain assetaccounts or the recognition of 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 recognized remediationrevenue of $4.1 million related to revenue reversals; however, such revenue didnot contribute to the Company’s operating cash flow in the current year.

 

During the second quarter of 2005, the Company entered into agreementswith two of its customers impacted by the facts relating to the subject of theinternal investigation.  As a result ofthe agreements, during the second quarter of 2005, the Company recognizedremediation revenue of $2.7 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 had outstanding from suchcustomers.  The net amount appliedagainst trade accounts receivable during the three and six month periods endedJune 30, 2005 was approximately $1.0 million and $1.6 million,respectively.

 

During the third 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 third quarter of 2005, the Company recognizedremediation revenue of $1.4 million related to revenue reversals; however, suchrevenue did not contribute to the Company’s operating cash flow in the currentyear.  Additionally, the customer agreedto apply certain balances, classified as deferred revenue, against currenttrade accounts receivable the customer had outstanding with the Company ofapproximately $0.1 million and as of September 30, 2005 had a remaining creditdue from the Company of approximately $0.3 million.  The remaining credit may, at the discretionof the customer, be applied against future trade accounts receivable balancesand is reported in the condensed consolidated balance sheets as accountspayable and accrued liabilities.

 

At September 30, 2005, approximately $1.9 million remains accruedrelated to customers impacted by the facts relating to the subject of theinternal investigation.  These balanceswere previously reported as Long-Term Customer Liability and Deferred Revenue inprior periods but  were reclassified duringthe current quarter to accounts payable and accrued liabilities in thecondensed consolidated balance sheets as the Company expects the remainingbalances to be settled within the next twelve months.  These balances will be recognized inaccordance with the agreements negotiated and finalized with each applicablecustomer.

 

**11. Non-Qualified Retirement Plan**

 

In May 2005, the Board of Directors approved the termination of theNon-Qualified Retirement Plan (“Plan”), effective July 1, 2005.  Distributions to Plan participants werecompleted during the third quarter of 2005. At December 31, 2004, the balance sheet included a noncurrent asset and anoffsetting long-term obligation of approximately $8.9 million each, related tothe Plan.

 

14

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**Item 2.**      **Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

**Overview**

 

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

 

Since the IPO and through September 30,2005, 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, weannounced the acquisition 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 expanded 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 asset groupsto be divested included our Direct Mail operations, previously reported in ourInformation 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 5, 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.  SeeNote 5, Discontinued Operations, of notes to condensed consolidated financial 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 (“SFAS”)No. 144, *Accounting for the Impairmentor Disposal of Long-Lived Assets,* references and comparisons toprior periods exclude the impact of our discontinued 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 otherwise guaranteed.  Recurring revenue typically possesses lowermargins 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.

 

15

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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) Information Management and Distribution, and (ii) Healthcare,Regulatory, and Legal Compliance. Service offerings are aggregated when theyare similar in the following areas: economic characteristics, products andservices, production processes, methods for distributing or deliveringproducts, and type or class of customers. We evaluate segment performance basedon revenue and income before income taxes. All centrally incurred corporatecosts are allocated to the segments based principally on operating income ofthe reportable segments measured before the inclusion of the expense related tocontingent consideration overpayments. The reporting 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 mission critical business documentprocesses. Our BPO solutions enable customers to automate their complexworkflow processes by digitizing extremely large volumes of documents,capturing information from the documents, hosting electronic documents on ourWeb-based repository, and preparing statements that customers mail or presentelectronically to their end users.  Weoffer our BPO solutions to businesses in document intensive industries, such ashealthcare insurance, financial services, healthcare provider,transportation/logistics, and federal and state government.  For the three months ended September 30,2004 and 2005, revenue in the Information Management and Distribution segmentconsisted of approximately $42.7 million and $49.9 million of recurringrevenue, respectively, and $5.4 million and $6.7 million of project revenue,respectively.  For the nine months endedSeptember 30, 2004 and 2005, revenue in the Information Management andDistribution segment consisted of approximately $130.2 million and $147.2million of recurring revenue, respectively, and $16.0 million and $22.3 millionof 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, providing managedcare payment compliance reviews, class action claims administration services,professional economic research and litigation services, and tax benefitservices.  For the three months endedSeptember 30, 2004 and 2005, revenue in the Healthcare, Regulatory andLegal Compliance segment consisted of approximately $18.1 million and $15.8million of recurring revenue, respectively, and $30.5 million and $33.2 millionof project revenue, respectively.  Forthe nine months ended September 30, 2004 and 2005, revenue in theHealthcare, Regulatory and Legal Compliance segment consisted of approximately$55.1 million and $48.5 million of recurring revenue, respectively, and $88.3million and $100.0 million of project revenue, respectively.

 

**InternalInvestigation**

** **

DuringOctober 2004, the Company, with the oversight and approval of the AuditCommittee of our Board of Directors, initiated an investigation of thefinancial results of one of our operating subsidiaries in the InformationManagement and Distribution reportable segment (the “Operating Subsidiary”).The findings of the investigation concluded that the Operating Subsidiary hadincorrectly recognized revenue for certain customer arrangements and omittedcertain operating 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.

 

Asdescribed in our critical accounting policies, revenue is recognizable wheneach of the following conditions is met: persuasive evidence of anarrangement exists, the price is fixed or determinable, delivery has occurredor services have been rendered and collection is reasonably assured. Ourinvestigation identified certain instances where one or more of theaforementioned revenue recognition conditions as applied to certain customercontracts were not met by the Operating Subsidiary. As a result, the revenuepreviously recognized that did not meet all the mentioned revenue recognitionconditions was reversed, resulting in a downward adjustment to certain assetaccounts or the recognition of a customer liability or deferred revenue.

 

During 2005, we entered into agreements withfour of our customers impacted by the facts relating to the subject of ourinternal investigation.  As a result ofthe agreements, we recognized remediation revenue of $4.1 million during thefirst quarter of 2005, $2.7 million during the second quarter of 2005 and $1.4million during the third quarter of 2005, related to revenue reversals.  The revenue

 

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reversals did not contribute to the Company’soperating cash flow in the current year. Although the exact timing is indeterminable, additional remediationrevenue may be recognized in future periods in accordance with any agreementnegotiated and finalized with the remaining customer.

 

On September 23, 2005, the Company and certainof its subsidiaries, entered into a settlement agreement with the former ownersof the operating subsidiary that was subject of our internal investigation andfinancial restatement.  In the settlementagreement, the former owners agreed to pay the Company a total of $30 million,consisting of:  (i) $20 million in cash,(ii) 89,888 shares of the Company’s common stock valued at approximately $1.8million, and (iii) an approximate $8.2 million future payment obligationsecured by parcels of real estate and payable within 90 days of such settlement.  The Company has perfected its mortgages onall but one such parcels of real estate.

 

During September 2005, the Company receivedthe $20 million in cash and the 89,888 shares of the Company’s common stock fromthe former owners.  The common shareswere retired and were recorded in the balance sheet as a reduction of commonstock and additional paid-in-capital.  Inaddition, as a result of the settlement agreement, the Company was releasedfrom approximately $1.2 million of related liabilities identified and recordedin connection with the financial restatement. These items were recorded, net of associated legal fees of $0.3 million,in the condensed consolidated statements of operations as other (income) expenseand are reported under the caption “Net legal settlement”.

 

The future payment obligation was notrecorded as income during the third quarter of 2005 due to uncertaintyregarding collection and the value of consideration that may be received.  Any subsequent collection of the futurepayment obligation will result in additional settlement income in the periodthat collection becomes probable and estimable.

 

**THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TOTHREE MONTHS ENDED SEPTEMBER 30, 2005**

 
| ** **                                                        | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                        | ** ** | **2004**                                  | ** ** | **2005** | ** ** |
| ** **                                                        | ** ** | **($000’s)**                         | ** ** | **% of  Revenue** | ** ** | **($000’s)** | ** ** | **% of  Revenue** | ** ** |
| **Revenue**                                                       |       | $                                         | 96,698     |   | 100.0 | % | $ | 105,530 |   | 100.0 | % |
| **Gross  Profit**                                                 |       | 34,194                                    |       | 35.4 | % | 43,641 |   | 41.4 | % |
| **SG&A**                                                      |       | 24,890                                    |       | 25.7 | % | 32,012 |   | 30.3 | % |
| **Operating  income (loss)**                                      |       | (1,174                                    | )          | (1.2 | )% | 10,633 |   | 10.1 | % |
| **Income (loss) from continuing operations  before income taxes** |       | (2,198                                    | )          | (2.3 | )% | 31,989 |   | 30.3 | % |
| **Income  (loss) from continuing operations**                     |       | (402                                      | )          | (0.4 | )% | 19,599 |   | 18.6 | % |
|                                                                   |            |                                           |            |  |  |  |  |  |  |  |  |

 

**Revenue**

 

Ouroperations generated revenues of $105.5 million for the three months endedSeptember 30, 2005, an increase of $8.8 million or  9.1% compared to the same period in 2004.  As previously discussed, during the third quarterof 2005, we recognized remediation revenue of $1.4 million related to revenuereversals in previous years.  After excludingthe positive revenue variance related to the remediation revenue, we achievedrevenue growth of 7.7% during the third quarter of 2005.  This revenue growth resulted primarily fromstrong volumes in our project oriented class action claims administrationservice offering, legal consulting service offering and in our informationmanagement service offering that contributed approximately $1.2 million, $1.8 millionand $6.7 million, respectively.  Projectrevenue accounted for $39.9 million or 37.8% of revenue in the current yearquarter compared to $35.9 million or 37.1% 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 17.5% from$48.1 million for the three months ended September 30, 2004, to $56.6million for the three months ended September 30, 2005.  The increase in segment revenues was primarilythe result of: (i) 2004 new business wins converted to revenue during 2005and increased volumes from existing customers contributing approximately $6.7million, particularly within our mortgage and federal and state governmentvertical markets, and (ii) the previously discussed remediation revenuesof $1.4 million related to revenue reversals in previous years.  Revenues in the statement processing serviceoffering increased approximately $0.4 million versus the prior year quarter dueprimarily to growth in new business.

 

Revenueswithin our Healthcare, Regulatory and Legal Compliance segment increased 1.0%from $48.6 million for the three months ended September 30, 2004, to $49.0million for the three months ended September 30, 2005.  Contributing to the revenue increase werehigher volumes in our legal consulting service offering which increasedapproximately $1.8 million or 18.6% and higher volumes of medium to large sizeprojects (i.e. projects greater than $500k of total revenue) in our classaction claims administration service offering, which increased approximately$1.2 million or 11.5%.  Offsettingincreases in segment revenues were lower revenue of approximately $2.3 millionin our medical records release service offering attributable to lower volumesand revenue losses of approximately $0.5 million related to Hurricane Katrina.

 

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**Gross profit**

 

Grossprofit increased 27.6% from $34.2 million, or 35.4% of revenue, for the threemonths ended September 30, 2004, to $43.6 million, or 41.4% of revenue,for the three months ended September 30, 2005.  Gross margin increased 600 basis pointsprimarily due to: (i) the previously discussed remediation revenue of $1.4million contributing 80 basis points, (ii) lower production personnel costas a percentage of revenue contributing 580 basis points, (iii) increasedvolumes within our class action claims administration and legal consultingservice offerings, which typically produce higher margins and lower bad debtexpense due to improved collections in our legal service offerings.  Gross margin improvement resulting from productionpersonnel costs occurred in our information management service offering due toproductivity and quality initiatives which included:  introduction of Lean/Six Sigma qualityinitiatives, implementation of high speed scanning technology to replace laborintensive low speed scanners, implementation of pay for performancecompensation strategies, and increased utilization of offshore labor.  Partially offsetting these gross margin improvementswere higher facilities related expenses, increased outside services primarilyassociated with offshore production and higher depreciation expense.

 

**Selling, general and administrative expenses**

 

SG&Aincreased 28.6% from $24.9 million, or 25.7% of revenue, for the three monthsended September 30, 2004, to $32.0 million, or 30.3% of revenue, for thethree months ended September 30, 2005. The increase in SG&A expense relates primarily to thefollowing:  (i) higher compensationexpense of approximately $2.4 million primarily related to new management,sales and staffing hires within our information management, claims administrationand legal consulting service offerings where a significant portion of ourorganic growth is being generated, (ii) higher incentive compensation ofapproximately $3.3 million due to improved performance in the current year andprogress to date to achieve full year targets , (iii) higher professionalfees of approximately $0.4 million, (iv) higher accounting and relatedfees associated with ongoing Sarbanes Oxley compliance related activity ofapproximately $0.4 million, (v) higher legal fees of approximately $0.2 millionand (v) ongoing investigation related costs of $0.2 million.

 

**Income from continuing operations before income taxes**

 

Incomefrom continuing operations before income taxes increased from a loss of $2.2million for the three months ended September 30, 2004 to income of $31.2million for the three months ended September 30, 2005.  The increase was the result of: (i) netsettlement income of $22.7 million related to the agreement with the formerowners of the Company’s operating subsidiary that was the subject of theCompany’s internal investigation and financial restatement discussed above, (ii) contingentconsideration overpayments expensed in the prior year quarter of $10.2 millioncompared to $0.8 million in the current quarter, and (iii) the factorsimpacting gross profit and SG&A discussed above.  The contingent consideration expenseadjustment in the current quarter represents an adjustment to previouslyreported contingent consideration overpayments. This adjustment had no impacton current year operating cash flow.  Interestexpense increased $0.3 million compared to the prior year quarter due primarilyto a higher interest rate environment and higher average debt levels.  Each 100 basis point increase in interestrates results in incremental annual interest expense of approximately $0.6million at current debt levels.

 

**Provision for income taxes**

 

During thethird quarter of 2005, income tax expense related to continuing operations was$12.4 million consistent with our expected effective tax rate of 39%.  The net benefit from income taxes reported inthe prior year quarter resulted from the loss from continuing operations beforeincome taxes at the effective rate of 40% and an additional benefit in theamount of approximately $0.7 million related to the favorable resolution of certainopen tax issues as well as the expiration of statutes of limitations on certainstrategic tax positions and an additional benefit of $0.3 million related toincreased state tax credits.

 

**NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TONINE MONTHS ENDED SEPTEMBER 30, 2005**

 
| ** **                                                 | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                 | ** ** | **2004**                                 | ** ** | **2005** | ** ** |
| ** **                                                 | ** ** | **($000’s)**                        | ** ** | **% of  Revenue** | ** ** | **($000’s)** | ** ** | **% of  Revenue** | ** ** |
| **Revenue**                                                |       | $                                        | 289,612    |   | 100.0 | % | $ | 317,915 |   | 100.0 | % |
| **Gross  Profit**                                          |       | 106,962                                  |       | 36.9 | % | 130,704 |   | 41.1 | % |
| **SG&A**                                               |       | 80,066                                   |       | 27.6 | % | 92,053 |   | 29.0 | % |
| **Operating  income**                                      |       | 16,017                                   |       | 5.5 | % | 37,243 |   | 11.7 | % |
| **Income from continuing operations before  income taxes** |       | 13,270                                   |       | 4.6 | % | 55,893 |   | 17.6 | % |
| **Income  from continuing operations**                     |       | 8,879                                    |       | 3.1 | % | 32,988 |   | 10.4 | % |
|                                                            |            |                                          |            |  |  |  |  |  |  |  |  |

 

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**Revenue**

 

Ouroperations generated revenues of $317.9 million for the nine months endedSeptember 30, 2005, an increase of $28.3 million or 9.8% compared to thesame period in 2004.  During the secondquarter of 2004, we acquired KeyPoint Consulting, LLC (“KeyPoint”) as a part ofour Healthcare, Regulatory and Legal Compliance segment.  KeyPoint contributed approximately $3.1million to the year over year revenue increase. In addition, as previously discussed, during the first nine months of2005, we recognized remediation revenue of $8.1 million related to revenuereversals in previous years.  After excludingthe positive revenue variance related to the KeyPoint acquisition and theremediation revenue, our remaining operations achieved revenue growth of 6.0%during the first three quarters of 2005. This revenue growth resulted primarily from strong volumes in ourinformation management service offering and in our project oriented classaction claims administration service offering that contributed approximately$15.0 million and $7.7 million, respectively. Including the KeyPoint acquisition, project revenue accounted for $122.3million or 38.5% of revenue in the current year compared to $104.4 million or36.0% of revenue in the prior year. (See “Management’s Discussion and Analysisof Financial Condition and Results of Operations—Basis for ManagementDiscussion and Analysis.”)

 

Revenueswithin our Information Management and Distribution segment increased 15.9% from$146.2 million for the nine months ended September 30, 2004, to $169.5million for the nine months ended September 30, 2005.  The increase in segment revenues was primarilythe result of: (i) increased volumes from existing customers and 2004 newbusiness wins converted to revenue during 2005 of approximately $15.0 million,particularly in our healthcare payer, federal and state government and mortgagevertical markets, (ii) the previously discussed remediation revenues of$8.1 million related to revenue reversals in previous years, and (iii) slightlyhigher revenues in our statement processing service offering of $0.2 million.

 

Revenueswithin our Healthcare, Regulatory and Legal Compliance segment increased 3.5%from $143.4 million for the nine months ended September 30, 2004, to$148.5 million for the nine months ended September 30, 2005.  As mentioned previously, the acquisition ofKeyPoint contributed approximately $3.1 million to the year over yearincrease.  Also contributing to therevenue increase were higher volumes of medium to large size projects (i.e.projects with total revenue greater than $500k) in our class action claimsadministration service offering, which increased approximately $7.7 million or30.7%.  Offsetting increases in segmentrevenues were lower volumes of approximately $1.9 million related to ourmedical record coding staffing services and lower revenues of approximately$5.0 million in our medical records release services attributable to lowervolumes and certain collectibility issues and revenue losses related to HurricaneKatrina of approximately $0.5 million.

 

**Gross profit**

 

Grossprofit increased 22.2% from $107.0 million, or 36.9% of revenue, for the ninemonths ended September 30, 2004, to $130.7 million, or 41.1% of revenue,for the nine months ended September 30, 2005.  Gross margin increased 420 basis pointsprimarily due to: (i) the previously discussed remediation revenues of$8.1 million contributing 150 basis points, (ii) lower productionpersonnel cost as a percentage of revenue contributing 380 basis points, and(iii) increased volumes within our class action claims administration serviceoffering, which typically produces higher margins.  Gross margin improvement resulting frompersonnel costs occurred in our information management service offering due toproductivity and quality initiatives which included:  introduction of Lean/Six Sigma qualityinitiatives, implementation of high speed scanning technology to replace laborintensive low speed scanners, implementation of pay for performancecompensation strategies, and increased utilization of offshore labor.

 

Factorspartially offsetting the gross margin improvements were higher facilitiesrelated expenses (an increase of 40 basis points), increased outside servicesprimarily associated with offshore production (an increase of 80 basis points)and higher depreciation expense (an increase of 20 basis points).

 

**Selling, general and administrative expenses**

 

SG&Aincreased 15.0% from $80.1 million, or 27.6% of revenue, for the nine monthsended September 30, 2004, to $92.1 million, or 29.0% of revenue, for thenine months ended September 30, 2005. The increase in SG&A expenserelates primarily to: (i) $1.8 million of investigation related costsincurred during the current year, (ii) $1.6 million of incremental SG&Arelated to the Keypoint acquisition which was acquired during the secondquarter of 2004, (iii) $1.1 million of accounting and related feesassociated with ongoing Sarbanes Oxley compliance related activity and(iv) $11.9 million of higher personnel related cost.  We have experienced higher personnel relatedcosts as a result of the following: (i) investment in management and salesresources within our class action claims administration service offering, (ii) investmentin technology and sales resources within our information management serviceoffering, and (iii) higher incentive compensation related to recent newbusiness win successes and improved year over year performance at the operatinglevel.  Partially offsetting the increasein SG&A were lower legal expenses of $3.6 million related primarily to thesettlement of a significant legal matter in our Information Management andDistribution segment during the first quarter of 2004.

 

**Income from continuing operations before income taxes**

 

Incomefrom continuing operations before income taxes increased from $13.3 million forthe nine months ended September 30, 2004 to $55.9 million for the ninemonths ended September 30, 2005. The increase was the result of: (i) net settlement income of $22.7million related to the agreement with the former owners of the Company’soperating subsidiary that was the subject of the

 

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Company’s internal investigation and financial restatementdiscussed above, (ii) contingent consideration overpayments expensed in theprior year of $10.2 million compared to $0.8 million in the current year, and(iii) the factors impacting gross profit and SG&A discussed above.  The contingent consideration expenseadjustment in the current year represents an adjustment to previously reportedcontingent consideration overpayments. This adjustment had no impact on currentyear operating cash flow.  Interestexpense increased $1.4 million compared to the prior year quarter due primarilyto a higher interest rate environment and higher average debt levels.   Each 100 basis point increase in interestrates results in incremental annual interest expense of approximately $0.6million at current debt levels.

 

**Provision for income taxes**

 

Year to date income taxexpense related to continuing operations was $22.9 million resulting inan effective tax rate of 41%.  During thesecond quarter of 2005, an adjustment to correct previously recorded deferredtax accounts increased our effective tax rate for the quarter from 39% to49%.  Management determined that theimpact of this adjustment to the prior year’s reported financial statements wasimmaterial; consequently, the entire impact was reflected in the secondquarter.  Our average effective tax ratefor the full year is estimated to be approximately 41%.

 

Prior year to date tax expense related to continuing operations was$4.4 million and included a benefit during the third quarter of approximately$0.7 million related to the favorable resolution of certain open tax issues aswell as the expiration of statutes of limitations on certain strategic taxpositions and an additional benefit of $0.3 million related to increased statetax credits.  Collectively, theadditional benefits had the effect of lowering our effective tax rate for thenine months ended September 30, 2004 to approximately 33%.

 

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

AtSeptember 30, 2005, we had $46.9 million of working capital, including $4.9million of cash.  Working capital at December 31, 2004 was $34.1 million, including $3.7 million of cash.  For the first nine months of 2005, net cashprovided by operating activities from continuing operations was $41.1 millioncompared to $15.7 million for the same period in 2004.  Key factors contributing to the year overyear increase consist of:  (i) receipt of$20 million related to the settlement with the former owners of theCompany’s operating subsidiary that was the subject of the Company’s internalinvestigation and financial restatement, (ii) increase in the deferred income tax provision of $11.8 millionprimarily associated with the settlement, and (iii) the contingentconsideration overpayment in the prior year of $10.2 million.  Partially offsetting the factors discussedabove were slower collections during the current year and an increase inaccounts receivable related to year over year revenue growth, excludingremediation revenue, of approximately 7% resulting in $12.2 million of lowercash provided by operating activities.

 

Excludingthe positive effects of remediation revenue, days sales outstanding were 47business days consistent with 47 business days for the second quarter of 2005and an increase of two business days compared to December 31, 2004.

 

Basedon our current expectations of full year operating results and expectationsregarding improvements in accounts receivable collections, we expect to achievean operating cash flow level for 2005 within a range of $30 million to $35million, excluding the $20 million settlement payment received in the thirdquarter and any subsequent proceeds from collection of the future paymentobligation related to the settlement.

 

Forthe nine months ended September 30, 2005, net cash used in investing activitiesfrom continuing operations consisted of acquisitions of property, plant andequipment of $10.4 million and acquisition related payments of $4.4 million, partiallyoffset by divestiture proceeds of $2.3 million.  Divestiture proceeds consisted of: (i) $0.2million associated with the sale of a non-strategic asset group related to ourlitigation services operations during the first quarter of 2005, (ii) thecollection in the second quarter of $0.6 million of contingent purchaseproceeds related to the divestiture of a medical records management operation completedduring the third quarter of 2004, and (iii) the receipt of approximately $1.5million associated with the divestiture of the direct mail business in thethird quarter of 2004.  Additionally, pursuantto the terms of the UIS acquisition agreement, approximately $4.3 million ofcontingent consideration was paid in cash to the former shareholders during thethree months ended June 30, 2005 and approximately $1.0 million ofadditional contingent consideration remains accrued.  The accrued additional consideration isincluded in accounts payable and accrued liabilities in the condensed consolidatedbalance sheets and is expected to be paid in cash by the first quarter of 2006.

 

Netcash used in financing activities from continuing operations was $27.3 millionfor the nine months ended September 30, 2005.  Payments on our line of credit and other debtarrangements of $201.7 million were partially offset by borrowings from ourline of credit of $183.5 million and cash paid for debt issuance costs of $0.2million.  The settlement proceeds of $20million discussed above were used to pay down debt.  We utilize our line of credit to fund generaloperating requirements of the Company as well as fund significant investmentssuch as acquisitions or capital expenditures.

 

OnSeptember 29, 2005, we amended our revolving credit facility.  Under the new credit agreement (the “2005Credit

 

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Agreement”),with Bank of America as agent and  SunTrust Bank and JP Morgan Chase as co-agents,we can from time to time borrow funds up to $100.0 million through September29, 2008, subject to certain customary financial covenants and ratios.  Meeting these requirements is highly dependentupon maintaining a minimum level of operating results and the continued demandfor our services, among other factors. Additionally, the 2005 Credit Agreement contains an accordion provisionfor an additional $50 million and restricts the Company’s ability to paydividends.

 

Totalfees paid during the current quarter related to the new credita agreement were $0.2 million.

 

Management believes that it has sufficientliquidity from its cash flow and its new revolving credit facility to meetongoing business needs.  Additionally,depending on the mix of stock and cash used in our strategic acquisitionprogram, if any, we may need to seek further financing through the public orprivate sale of equity or debt securities. However, there can be no assurance we could secure such financing if andwhen it is needed or with terms we deem acceptable.

 

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 September 30, 2005; however, such registration statementmay require amendment prior to use.

 

**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. Projectrevenue is typically based on time and material arrangements. Revenuerecognition occurs at the contractual rates as the labor hours and directexpenses are incurred. Project revenue represents approximately 34% of total2004 revenues and typically occurs within our Healthcare, Regulatory, and LegalCompliance segment.

 

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 not contractualor otherwise guaranteed. Revenue recognition occurs once work is completed anddelivery 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.  Forexample, transaction volumes and time and costs under time and material andcost reimbursable arrangements are based on specific, objective criteria underthe contracts.  The following outlinesspecific revenue recognition policies related to certain offerings within thissegment:

 

*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 of recordsprocessed.  When a fee is paid to thehospital, 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 as anAgent,* due to the fact that: (a) the primary obligation in thearrangement is borne partially by both the Company and the hospital; (b) theCompany has no

 

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discretionwith respect to the supplier of the medical record; and (c) the Company isnot 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 onan agreed upon percentage (or commission) of amounts identified and recoveredfrom the third party payers as a fee for services provided.  Revenue is recognized upon successfulrecovery of underpayments to our clients by their managed care and commercialpayers at the agreed upon percentage (or commission).

 

*Class 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

 

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beexpected to generate in the future (Income Approach) and the fair value of areporting unit as compared to similar publicly traded companies (MarketApproach). In preparing these valuations, management utilizes estimates todetermine fair value of the reporting units. These estimates include futurecash flows, growth rates, capital needs, and projected earning margins amongother factors. Estimates utilized in future calculations could differ fromestimates used in the current period. Future years’ estimates that areunfavorable compared to current estimates could cause an impairment of goodwilland other intangible assets. Due to the fact that we are primarily a servicescompany, our business acquisitions typically result in significant amounts ofgoodwill and other intangible assets. Therefore, an impairment charge resultingfrom goodwill or other intangible assets could result in a material adverseimpact on our financial 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. Our 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 plan yearended June 30,2005, with a lifetime limit of liability per coveredparticipant of $1,900,000.  Our stop-losspolicy for medical costs expired on June 30, 2005.  The stop-loss policy was renewed for oneyear, effective July 1, 2005.  Thefixed dollar amount of stop-loss coverage under the new policy is $200,000 percovered participant with a lifetime limit of liability per covered participantof $1,800,000.

 

**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 potential actionsby third parties such as regulators. Our loss contingencies consist primarilyof 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 financiallyunable to do so, as well as such other risks set forth under the heading RiskFactors included 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 Qualitative Disclosures 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 $0.6 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 September 30, 2005,the Company 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.

 

 

**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 as defendantsin several putative securities class actions, in response to the Company’spress releases dated October 27, 2004, in which the Company disclosed thatits financial statements for certain prior periods should no longer be reliedupon, and also provided updated financial guidance. The complaints(collectively, the “Actions”) were filed in the United States District Courtfor the Northern District of Texas, Dallas Division, with the first actionbeing filed November 1, 2004. The Actions are putative shareholder classaction lawsuits alleging violations of Federal Securities Laws, includingalleged violations of Sections 10(b) and 20(a), and Rule 10b-5 of theSecurities Exchange Act of 1934, as amended.  The four Actions were transferred to a singlejudge in the Northern District of Texas, Dallas Division, and consolidated intoa single action now styled *In re Sourcecorp, Inc.Securities Litigation.*Alead plaintiff has been appointed for the consolidated Action.  In addition to the Company and its CEO and CFO,one of the Company’s subsidiaries and one of the former owners of thatsubsidiary are named as defendants in the consolidated Aciton.  The consolidated Action is purportedly onbehalf of all persons who purchased the Company’s common stock during the periodbetween May 3, 2001, and October 27, 2004, and seeks unspecifieddamages.  The Company cannot currentlyestimate the ultimate resolution of this contingency; however, the Companyintends to vigorously defend this matter.

 

#### ***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 “State Derivative Action”). The StateDerivative Action alleges breach of fiduciary duty, abuse of control, grossmismanagement, waste of assets, and unjust enrichment related to the Company’spress release described above dated October 27, 2004, the subsequentrestatement of financial results, and certain other events. All of these claimsare asserted derivatively on behalf of the Company and seeks unspecifieddamages against those individuals.

 

Further,the Chairman of the Company’s Board of Directors received from a purportedshareholder a demand letter (the

 

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“Demand Letter”) based on thesame set of facts as the State 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 that is evaluating the claims made in the State DerivativeAction and the Demand Letter.

 

OnOctober 21, 2005, the purported shareholder who sent the Demand Letter filed aderivative and class action against certain of the Company’s officers anddirectors as individual defendants and the Company as a nominal defendant inthe United States District Court for the Northern District of Texas, DallasDivision (the “Federal Derivative and Class Action”).  The FederalDerivative and Class Action alleges similar facts as the securities Action, theState Derivative Action, and the Demand Letter and also includes allegations relatingto the Company’s October 5, 2005 press release regarding the exploration ofstrategic alternatives, including the potential sale of the Company.  TheFederal Derivative and Class Action asserts claims under section 304 of theSarbanes-Oxley Act of 2002, for contribution under sections 10(b) and 21D ofthe Securities Exchange Act of 1934, for breach of fiduciary duty, and forabuse of control and seeks unspecified damages, injunctive relief, and theimposition of a constructive trust against the individual defendants.  Theclaims are asserted derivatively on behalf of the Company and on behalf ofputative classes of those who held the Company’s common stock on October 5,2005 and those who exchange their shares in a potential sale, if any, of theCompany.

 

*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.

 

Onesuch suit originally styled*McShane v. RecordexAcquisition Corp. &**Sourcecorp, Incorporated*(and now styled *Liss & Marion, PC v. Recordex AcquisitionCorp., & Sourcecorp, Inc.*) filed February 10,2003, in the Court of Common Pleas Philadelphia County, Pennsylvania, allegesamong other things that the Company intentionally charged more for providingcopies of medical records than is permitted under Pennsylvania law.  The complaint does not specify the amount ofdamages sought.  On June 10, 2005,the Court in this matter granted judgment in favor of the plantiffs for anamount as yet to be determined.  OnNovember 3, 2005, a separate hearing on damages was held,  but no order has yet been entered.  If and when a judgment is entered, theCompany will assess its appellate options. The Company believes it is adequately reserved for this legalcontingency.

 

 

*SEC Investigation*

 

OnJanuary 14, 2005, the Company received written confirmation from the SECthat the SEC had converted its informal inquiry in connection with the Company’sinternal investigation and restatement into a formal investigation. The Companyis continuing to fully cooperate with the SEC in connection with theinvestigation. The Company initially had contacted the enforcement division ofthe SEC on a voluntary basis to notify the agency of the Company’sunderstanding of the events leading to its internal investigation. The Companyis unable to predict the outcome of the investigation, the scope of mattersthat the SEC may choose to investigate in the course of this investigation orin the future, the SEC’s views of the issues being investigated, or any actionthat the SEC might take, including the imposition of fines, penalties, or otheravailable remedies.

 

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**Item 2.****   ****Unregistered Sales of Equity Securities 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** | ** ** |
|--------------------------------------------|------------|------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                       |       |                                           |       |                                        |       |                                                                                                   |       |                                                                                                                                        |       |
| Jul 1, 2005  — Jul 31, 2005           |       | —                                         |       | $                                           | —     |                                                                                                   | —     |                                                                                                                                        | $          | 17,415,551 |   |
| Aug 1,  2005 — Aug 31, 2005 |       | —                                         |       | $                                           | —     |                                                                                                   | —     |                                                                                                                                        | $          | 17,415,551 |   |
| Sept 1, 2005  — Sept 30, 2005         |       | —                                         |       | $                                           | —     |                                                                                                   | —     |                                                                                                                                        | $          | 17,415,551 |   |

 

*Legal**Settlement*

** **

On September 23, 2005, the Company and certain ofits subsidiaries, entered into a settlement agreement with the former owners ofthe operating subsidiary that was the subject of its internal investigation andfinancial restatement. As a part of the settlement proceeds, the former ownersreturned 89,888 shares of the Company's common stock with a deemed value underthe settlement agreement of $20.495 per share, being approximately $1.8 millionin the aggregate. The common shares were retired and recorded in the balancesheet as a reduction of common stock and additional paid-in-capital.

** **

**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 3.2  to the Company’s Current Report on Form 8-K filed on June 27, 2005)                                                                                                                                                                                                                                                                                                                                               |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.1                 |       | 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)                                                                                                                                                                                                                                                                               |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.2                 |       | Form of Rights Agreement,  dated as of June 24, 2005, between SOURCECORP, Incorporated and American  Stock Transfer & Trust Company which includes as Exhibit A the form of  Certificate of Designations of Series A Participating Preferred Stock, as  Exhibit B the form of Right Certificate and as Exhibit C the Summary of  Rights to Purchase Series A Participating Preferred Stock (incorporated by  reference to Exhibit 4.1 to the Company’s Registration Statement on Form 8-A  filed on June 27, 2005) |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.1                |       | Agreement Settling  Disputes and Releasing Claims, entered into as of September 23, 2005, by and  between the Company and other parties listed therein                                                                                                                                                                                                                                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                               |

 

----

* Compensatory plan or arrangement.

 

26

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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:  November 9, 2005      | By:                       | /s/ ED H. BOWMAN, JR. |
|                         |                      | Ed H. Bowman, Jr. Chief Executive Officer and President |
|                         |                      |   |
| Date:  November 9, 2005 | By:                       | /s/ BARRY L. EDWARDS |
|                         |                      | Barry L. Edwards Executive Vice President and Chief Financial Officer  (Principal Financial and Accounting Officer) |

 

27

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**INDEX TO 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 3.2  to the Company’s Current Report on Form 8-K filed on June 27, 2005)                                                                                                                                                                                                                                                                                                                                               |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.1                 |       | 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)                                                                                                                                                                                                                                                                               |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.2                 |       | Form of Rights Agreement,  dated as of June 24, 2005, between SOURCECORP, Incorporated and American  Stock Transfer & Trust Company which includes as Exhibit A the form of  Certificate of Designations of Series A Participating Preferred Stock, as  Exhibit B the form of Right Certificate and as Exhibit C the Summary of  Rights to Purchase Series A Participating Preferred Stock (incorporated by  reference to Exhibit 4.1 to the Company’s Registration Statement on Form 8-A  filed on June 27, 2005) |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.1                |       | Agreement Settling  Disputes and Releasing Claims, entered into as of September 23, 2005, by and  between the Company and other parties listed therein                                                                                                                                                                                                                                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                               |

 

----

* Compensatory plan or arrangement.

 

28

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