** **

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

| **ý** | **Quarterly report pursuant to Section 13 or  15(d) of the Securities and Exchange Act of 1934 for the quarterly period  ended  March 31, 2002, or** |
|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|

 

| **o** | **Transition report pursuant to Section 13 or  15(d) of the Securities and Exchange Act of 1934 for the transition period  from               to              ** |
|-------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

**Commission file number 0-27444**

 

**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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

Yes         ý            No  o

 

As of April 30, 2002, 17,423,658 shares of the registrant’s Common Stock,$.01 par value per share, were outstanding.

 

 

----

 

**SOURCECORP,INCORPORATED AND SUBSIDIARIES**

**FORM 10-Q FORTHE PERIOD ENDED MARCH 31, 2002**

 

**INDEX**

** **
|         |                                                                                                  |
|--------------|-------------------------------------------------------------------------------------------------------|
| **PART I.**  | **FINANCIAL INFORMATION**                                                                             |
|         |                                                                                                  |
| Item 1       | Financial Statements                                                                                  |
|         |                                                                                                  |
|         | Consolidated Balance  Sheets — December 31, 2001 and March 31, 2002 (unaudited)                  |
|         |                                                                                                  |
|         | Consolidated Statements  of Operations — Three months ended March 31, 2001 and 2002 (unaudited)  |
|         |                                                                                                  |
|         | Consolidated  Statements of Cash Flows — Three months ended March 31, 2001 and 2002  (unaudited) |
|         |                                                                                                  |
|         | Notes to  Consolidated Financial Statements                                                           |
|         |                                                                                                  |
| Item  2      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations           |
|         |                                                                                                  |
| Item  3      | Quantitative  and Qualitative Disclosures about Market Risk                                           |
|         |                                                                                                  |
| **PART II.** | **OTHER INFORMATION**                                                                                 |
|         |                                                                                                  |
| Item 6       | Exhibits  and Reports on Form 8-K                                                                     |
|         |                                                                                                  |
|         | **SIGNATURES**                                                                                        |
|         |                                                                                                  |
|         | **Index to  Exhibits**                                                                                |
|         |                                                                                                  |

 

2

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# **PART I.         FINANCIALINFORMATION**

 

**Item 1.            FinancialStatements**

 

3

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**SOURCECORP,INCORPORATED AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

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

** **
|                                                                                                                                                                        |   | **December 31,  2001** |    | **March 31,  2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|---------|---------------------|--------|
| **ASSETS**                                                                                                                                                                  |   |                   |    | **(Unaudited)**     |   |
| **CURRENT ASSETS:**                                                                                                                                                         |   |                   |    |                |   |
| Cash and cash equivalents                                                                                                                                                   |   | $                      | 7,182   |                | $      | 441 |   |
| Accounts and notes receivable,  less allowance for doubtful accounts of $19,888 and $16,316, respectively                                                                   |   | 88,547                 |    | 88,660              |   |
| Inventories                                                                                                                                                                 |   | 2,587                  |    | 3,312               |   |
| Deferred income taxes                                                                                                                                                       |   | 9,805                  |    | 10,754              |   |
| Prepaid expenses and other  current assets                                                                                                                                  |   | 6,412                  |    | 5,277               |   |
| Total current assets                                                                                                                                                        |   | 114,533                |    | 108,444             |   |
|                                                                                                                                                                        |   |                   |    |                |   |
| **PROPERTY,  PLANT AND EQUIPMENT**, net of accumulated depreciation $40,863  and $44,241, respectively                                                                      |   | 41,942                 |    | 42,276              |   |
| **GOODWILL AND OTHER INTANGIBLES,**net of amortization of $22,356 and $22,444,  respectively                                                                                |   | 298,519                |    | 320,427             |   |
| **OTHER NONCURRENT ASSETS**                                                                                                                                                 |   | 8,077                  |    | 9,132               |   |
|                                                                                                                                                                        |   |                   |    |                |   |
| Total assets                                                                                                                                                                |   | $                      | 463,071 |                | $      | 480,279 |   |
|                                                                                                                                                                        |   |                   |    |                |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                              |   |                   |    |                |   |
|                                                                                                                                                                        |   |                   |    |                |   |
| **CURRENT LIABILITIES:**                                                                                                                                                    |   |                   |    |                |   |
| Accounts payable and accrued  liabilities                                                                                                                                   |   | $                      | 51,087  |                | $      | 58,171 |   |
| Current maturities of  long-term obligations                                                                                                                                |   | 324                    |    | 290                 |   |
| Income tax payable                                                                                                                                                          |   | 4,588                  |    | 2,783               |   |
| Total current liabilities                                                                                                                                                   |   | 55,999                 |    | 61,244              |   |
|                                                                                                                                                                        |   |                   |    |                |   |
| **LONG-TERM OBLIGATIONS**, net of current maturities                                                                                                                        |   | 116,055                |    | 117,876             |   |
| **DEFERRED INCOME TAX**                                                                                                                                                     |   | 1,839                  |    | 4,829               |   |
| **OTHER  LONG-TERM OBLIGATIONS**                                                                                                                                            |   | 18,005                 |    | 18,346              |   |
| Total liabilities                                                                                                                                                           |   | 191,898                |    | 202,295             |   |
|                                                                                                                                                                        |   |                   |    |                |   |
| **COMMITMENTS  AND CONTINGENCIES**                                                                                                                                          |   |                   |    |                |   |
|                                                                                                                                                                        |   |                   |    |                |   |
| **STOCKHOLDERS’ EQUITY:**                                                                                                                                              |   |                   |    |                |   |
| Preferred stock, $.01 par  value, 1,000,000 shares authorized, no shares issued and outstanding                                                                             |   | —                 |    | —              |   |
| Common stock, $.01 par value,  26,000,000 shares authorized, 17,341,674 and 17,359,052 shares issued and  outstanding at December 31, 2001 and March 31, 2002, respectively |   | 174                    |    | 175                 |   |
| Additional paid-in-capital                                                                                                                                                  |   | 204,086                |    | 204,599             |   |
| Accumulated other  comprehensive loss                                                                                                                                       |   | (1,242                 | )       | (948                | )      |
| Retained earnings                                                                                                                                                           |   | 69,137                 |    | 75,140              |   |
|                                                                                                                                                                        |   | 272,155                |    | 278,966             |   |
| Less — Treasury stock, $.01  par value, 56,028 shares at December 31, 2001 and March 31, 2002                                                                          |   | (982                   | )       | (982                | )      |
| Total stockholders’ equity                                                                                                                                             |   | 271,173                |    | 277,984             |   |
|                                                                                                                                                                        |   |                   |    |                |   |
| Total liabilities and  stockholders’ equity                                                                                                                            |   | $                      | 463,071 |                | $      | 480,279 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

4

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**SOURCECORP,INCORPORATED AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

** **
|                                                 |   | **Three  Months Ended March 31,** |       |
|------------------------------------------------------|--------|-----------------------------------|------------|
|                                                 |   | **2001**                          | ** ** | **2002** | ** ** |
|                                                 |   | **(Unaudited)**                   | ** ** |
|                                                 |   |                              |       |   |   |
| **REVENUE**                                          |   | $                                 | 125,205    |   | $ | 103,284 |   |
|                                                 |   |                              |       |   |   |
| **COST  OF SERVICES**                                |   | 75,119                            |       | 62,201 |   |
| **DEPRECIATION**                                     |   | 3,913                             |       | 3,450 |   |
| Gross profit                                         |   | 46,173                            |       | 37,633 |   |
| **SELLING,  GENERAL AND ADMINISTRATIVE****EXPENSES** |   | 27,455                            |       | 26,274 |   |
| **AMORTIZATION**                                     |   | 2,492                             |       | 89 |   |
| Operating income                                     |   | 16,226                            |       | 11,270 |   |
|                                                 |   |                              |       |   |   |
| **OTHER (INCOME) EXPENSE:**                          |   |                              |       |   |   |
| Interest expense                                     |   | 2,341                             |       | 1,496 |   |
| Interest income                                      |   | (105                              | )          | (28 | ) |
| Other (income) expense, net                          |   | (34                               | )          | 119 |   |
| Income before income taxes                           |   | 14,024                            |       | 9,683 |   |
|                                                 |   |                              |       |   |   |
| **PROVISION  FOR INCOME TAXES**                      |   | 5,329                             |       | 3,680 |   |
| **NET  INCOME**                                      |   | $                                 | 8,695      |   | $ | 6,003 |   |
|                                                 |   |                              |       |   |   |
| **NET  INCOME PER COMMON SHARE**                     |   |                              |       |   |   |
| **BASIC**                                            |   | $                                 | 0.54       |   | $ | 0.35 |   |
| **DILUTED**                                          |   | $                                 | 0.52       |   | $ | 0.34 |   |
|                                                 |   |                              |       |   |   |
| **WEIGHTED AVERAGE COMMON SHARES OUTSTANDING**       |   |                              |       |   |   |
| **BASIC**                                            |   | 16,212                            |       | 17,296 |   |
| **DILUTED**                                          |   | 16,876                            |       | 17,817 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

5

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**SOURCECORP,INCORPORATED AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(IN THOUSANDS)**

 
|                                                                               |   | **Three Months  Ended  March 31,** |       |
|------------------------------------------------------------------------------------|--------|------------------------------------|------------|
|                                                                               |   | **2001**                           |       | **2002** | ** ** |
|                                                                               |   | **(Unaudited)**                    | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                          |   |                               |       |   |   |
| Net income                                                                         |   | $                                  | 8,695      |   | $ | 6,003 |   |
| Adjustments to reconcile net  income to net cash provided by operating activities: |   |                               |       |   |   |
| Depreciation and amortization                                                      |   | 6,405                              |       | 3,539 |   |
| Deferred tax provision  (benefit)                                                  |   | (1,228                             | )          | 2,040 |   |
| Change in operating assets and  liabilities:                                       |   |                               |       |   |   |
| Accounts and notes receivable                                                      |   | (6,714                             | )          | 538 |   |
| Prepaid expenses and other  assets                                                 |   | (2,593                             | )          | (121 | ) |
| Accounts payable and accrued  liabilities                                          |   | 10,400                             |       | (1,258 | ) |
| Net cash provided by operating  activities                                         |   | 14,965                             |       | 10,741 |   |
|                                                                               |   |                               |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                          |   |                               |       |   |   |
| Net proceeds received from  sale of operating units                                |   | —                             |       | 10 |   |
| Purchase of property, plant  and equipment                                         |   | (5,093                             | )          | (2,990 | ) |
| Cash paid for acquisitions,  net of cash acquired                                  |   | (7,848                             | )          | (11,115 | ) |
| Net cash used for investing  activities                                            |   | (12,941                            | )          | (14,095 | ) |
|                                                                               |   |                               |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                          |   |                               |       |   |   |
| Proceeds from exercise of  common stock options                                    |   | 1,103                              |       | 61 |   |
| Proceeds from long-term  obligations                                               |   | 10,993                             |       | 97,750 |   |
| Principal payments on  long-term obligations                                       |   | (18,220                            | )          | (101,198 | ) |
| Cash paid for debt issuance  costs                                                 |   | (200                               | )          | — |   |
| Net cash used for financing  activities                                            |   | (6,324                             | )          | (3,387 | ) |
|                                                                               |   |                               |       |   |   |
| **NET  DECREASE IN CASH AND CASH EQUIVALENTS**                                     |   | (4,300                             | )          | (6,741 | ) |
|                                                                               |   |                               |       |   |   |
| **CASH AND CASH EQUIVALENTS,**beginning of period                                  |   | 9,504                              |       | 7,182 |   |
|                                                                               |   |                               |       |   |   |
| **CASH AND CASH EQUIVALENTS,**end of period                                        |   | $                                  | 5,204      |   | $ | 441 |   |
|                                                                               |   |                               |       |   |   |
| **SUPPLEMENTAL DATA:**                                                             |   |                               |       |   |   |
| Cash  paid for:                                                                    |   |                               |       |   |   |
| Income  taxes                                                                      |   | $                                  | 676        |   | $ | 3,568 |   |
| Interest                                                                           |   | $                                  | 2,555      |   | $ | 1,485 |   |
|                                                                               |   |                               |       |   |   |   |   |
| **NONCASH FINANCING TRANSACTIONS:**                                                |   |                               |       |   |   |   |   |
| Common  stock issued for accrued earnouts and holdbacks                            |   | $                                  | 387        |   | $ | 445 |   |
| Short-term  obligations refinanced under line of credit                            |   | $                                  | —     |   | $ | 4,781 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

6

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**SOURCECORP*,* INCORPORATED AND SUBSIDIARIES**

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

** **

**1.  Basis of Presentation:**

 

The accompanyingconsolidated financial statements and related notes to consolidated financialstatements include the accounts of SOURCECORP,Incorporated and our subsidiaries (collectively, the “Company”).

 

In the opinion ofour management, the accompanying consolidated financial statements include allof our accounts and the adjustments necessary to present fairly our financialposition at March 31, 2002, our results of operations for the three monthsended March 31, 2001 and 2002, and our cash flows for the three months endedMarch 31, 2001 and 2002. All significant intercompany transactions have beeneliminated. Although we believe that the disclosures are adequate to make theinformation presented not misleading, certain information and footnotedisclosures normally included in annual financial statements prepared inaccordance with generally accepted accounting principles have been condensed oromitted pursuant to the rules and regulations of the Securities and ExchangeCommission (the “Commission”). These consolidated financial statements shouldbe read in conjunction with our consolidated financial statements and therelated notes thereto in our Annual Report on Form 10-K filed with the Commissionon April 1, 2002.  The results ofoperations for the three month periods ended March 31, 2001 and 2002 may not beindicative of the results for the full year.

 

**2.  New AccountingStandards:**

 

*Recent Accounting Pronouncements*

 

In June 2001, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards ("SFAS") No. 141, “Business Combinations”and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFASNo. 141 requires the use of the purchase method of accounting for allbusiness combinations initiated after June 30, 2001, thereby eliminatingthe pooling-of-interests method of accounting. SFAS No. 141 also addressesthe recognition and measurement of goodwill and other intangible assetsacquired in a business combination. The adoption of SFAS No. 141 by theCompany on July 1, 2001, did not have a significant effect on theCompany’s financial statements.

 

The Company adopted theprovisions of SFAS No. 142 on January 1, 2002. Upon the adoption ofSFAS No. 142, goodwill and intangible assets that have indefinite usefullives will not be amortized but rather will be tested at least annually forimpairment.  At January 1, 2002, theCompany compared the fair values of the reporting units to their carryingvalues.  In determining the fair valuesof the reporting units, the Company used the discounted cash flow method andthe market value approach method.  Sincethe fair values of all reporting units exceeded the carrying values, no impairmentwas recorded at January 1, 2002.

 

Other intangible assetswith definite lives will continue to be amortized over their useful lives.  These intangible with definite lives wereacquired in the 2002 acquisitions.  SeeNote 4.

 

7

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The following tablereflects the effect of SFAS No. 142 on net income and earnings per share as ifSFAS No. 142 had been in effect for all periods presented (in thousands):

 
|                                                  |   | **Three Months Ended  March 31,** |   |
|-------------------------------------------------------|--------|-----------------------------------|--------|
|                                                  |   | **2001**                          |   | **2002** | ** ** |
| Net  income                                           |   | $                                 | 8,695  |   | $ | 6,003 |   |
| Add  back goodwill amortization, net of tax provision |   | 2,040                             |   | — |   |
| Adjusted  net income                                  |   | $                                 | 10,735 |   | $ | 6,003 |   |
|                                                  |   |                              |   |   |   |
| Basic  earnings per share:                            |   |                              |   |   |   |
| Reported  basic earnings per share                    |   | $                                 | 0.54   |   | $ | 0.35 |   |
| Add  back goodwill amortization, net of tax provision |   | 0.12                              |   | — |   |
| Adjusted  basic earnings per share                    |   | $                                 | 0.66   |   | $ | 0.35 |   |
|                                                  |   |                              |   |   |   |
| Diluted  earnings per share:                          |   |                              |   |   |   |
| Reported  diluted earnings per share                  |   | $                                 | 0.52   |   | $ | 0.34 |   |
| Add  back goodwill amortization, net of tax provision |   | 0.12                              |   | — |   |
| Adjusted  diluted earnings per share                  |   | $                                 | 0.64   |   | $ | 0.34 |   |

 

In August 2001, theFASB issued SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets.” This statement supercedes SFAS No. 121, “Accountingfor the Impairment of Long-Lived Assets and for Long-Lived Assets to BeDisposed Of.” The statement retains the previously existing accountingrequirements related to the recognition and measurement of the impairment oflong-lived assets to be held and used while expanding the measurementrequirements of long-lived assets to be disposed of by sale to includediscontinued operations. It also expands the previously existing reportingrequirements for discontinued operations to include a component of an entitythat either has been disposed of or is classified as held for sale. The Companyimplemented SFAS No. 144 on January 1, 2002, and tested thelong-lived assets for impairment utilizing expected future undiscounted cashflows.  This evaluation indicated thatthere was not an asset impairment for long-lived assets upon adoption of SFASNo. 144.

 

FASB Staff Announcement,Topic No. D-103, “Income Statement Characterization of Reimbursements Receivedfor ‘Out-of-Pocket’ Expenses Incurred,” was adopted January 1, 2002.  This statement requires that reimbursementsfor out-of-pocket expenses such as, airfare, hotels, mileage, etc., should becharacterized as revenue in the income statement.  The effect of this reclassification on the three months endedMarch 31, 2001 was $3.8 million increase in revenues, $3.4 million increase incost of services and $0.4 million increase in selling, general andadministrative expenses. Prior quarter amounts have been reclassified toconform to the current quarter presentation.

 

**3.  Strategic Realignment Plan**

 

During the second and thirdquarters of 2001, the Company completed its strategic realignment plan, inwhich the Company identified certain non-strategic operating units fordivestiture or closure.  The Companyincurred a $68.3 million charge for the three months ended June 30, 2001 and a$5.7 million gain for the three months ended September 30, 2001 for a totalloss of $62.6 million due to realignment costs in 2001.

 

8

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During the three months endedMarch 31, 2002, the activity related to the realignment plan has beensettlements of legal claims, contract terminations and various sellingexpenses.  The following table reflectsthe realignment activity for the three months ended March 31, 2002 (inmillions):

 
|                |   | **Realignment  Costs Liability  December 31, 2001** |   | **Charges** |   | **Payments** |   | **Realignment  Costs Liability  March 31, 2002** |   |
|---------------------|--------|-----------------------------------------------------|--------|-------------|--------|--------------|--------|--------------------------------------------------|--------|
| Asset Sales         |   | $                                                   | 5.4    |        | $      | —       |   | $                                                | 0.7    |   | $ | 4.7 |   |
| Location Exit Costs |   | 0.4                                                 |   | —      |   | 0.2          |   | 0.2                                              |   |
|                |   | $                                                   | 5.8    |        | $      | —       |   | $                                                | 0.9    |   | $ | 4.9 |   |

 

The March 31, 2002 realignment costs liability balanceconsists of accrued litigation, contract termination costs, lease payments andvarious selling expenses.

 

**4.  Business Combinations**

 

*2002Acquisitions*

 

At January 1, 2002, the Companyacquired United Information Services, Inc. (“UIS”), which is located in Iowa andwill strengthen the Company’s statement solutions group that has existinglocations in Arizona and New York.  Theaggregate consideration paid for UIS consisted of $17.5 million in cash.  Also, the former shareholders of UIS areeligible to receive up to an additional $10.0 million in the Company's commonstock and cash if there is no breach in representations and warranties of theacquisition agreement, and certain future revenue and earnings targets areachieved.  The preliminary allocation ofthe purchase price is set forth below (in thousands):

 

| Consideration Paid                            |   | $      | 17,500 |   |
|-----------------------------------------------|--------|--------|--------|--------|
| Estimated Fair Value of  Identifiable Assets: |   |   |   |
| Cash                                          |   | 7,065  |   |
| Receivables                                   |   | 615    |   |
| Prepaid expenses                              |   | 157    |   |
| Property, plant and equipment,  net           |   | 359    |   |
| Other assets                                  |   | 379    |   |
| Total Assets                                  |   | 8,575  |   |
| Estimated Fair Value of  Liabilities:         |   |   |   |
| Accounts payable and accrued  expenses        |   | 6,605  |   |
| Accrued compensation                          |   | 524    |   |
| Deferred tax liability                        |   | 98     |   |
| Note payable                                  |   | 305    |   |
| Total Liabilities                             |   | 7,532  |   |
|                                          |   |   |   |
| Goodwill and other intangibles                |   | $      | 16,457 |   |

 

Of the $16.5 million of goodwilland other intangibles recorded from the acquisition, $4.0 million was assignedto customer relationships with a useful life of 15 years and $0.5 million wasassigned to non-compete agreements with a useful life of 5 years.  The remaining goodwill of $12.0 million hasan indefinite life and will be tested annually for impairment per therequirements of SFAS No. 142.

 

The estimated fair market valuesreflected above are based on preliminary estimates and assumptions and aresubject to revision. In management’s opinion, the preliminary allocations arenot expected to be materially different from the final allocations.

 

9

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*ContingentConsideration*

 

Certain of our acquisitions aresubject to adjustments in overall consideration and recorded goodwill basedupon the achievement of specified revenue and/or earnings targets over one tothree year periods. During the first three months of 2002, we paidconsideration of 12,630 shares of common stock at an average price of $31.67 inrelation to contingent consideration agreements that have been finalized. Basedupon the evaluation of cumulative earnings through March 31, 2002 against thespecified earnings targets, we have accrued aggregate contingent considerationof approximately $22.1 million, of which $15.0 million is classified asaccounts payable and accrued liabilities and will be settled in cash and $7.1million is classified as long-term obligations and will be settled in commonstock. Not all of the periods applicable for the earnout targets have beencompleted and additional amounts may be payable in future periods under theterms of the agreements.

 

**5.  Weighted Average Shares Outstanding**

 

Basic and diluted net income percommon share were computed in accordance with SFAS No. 128, “Earnings PerShare.” The differences between basic weighted average common shares anddiluted weighted average common shares and common stock equivalents are asfollows (in thousands):

 

|                                                                   |   | **Three Months Ended  March 31,** |   |
|------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                   |   | **2001**                          |   | **2002** | ** ** |
|                                                                   |   |                              |   |   |   |
| Basic weighted average common shares                                   |   | 16,212                            |   | 17,296 |   |
| Weighted average options,  warrants and other contingent consideration |   | 664                               |   | 521 |   |
| Diluted weighted average  common shares                                |   | 16,876                            |   | 17,817 |   |

 

**6.  Segment Reporting**

** **

**In connection with the 2001strategic realignment plan, the Company reduced the number of segments fromfour to two to reflect the go-forward segment focus.  At January 1, 2002, the Company transferred four operating unitsfrom the Healthcare, Regulatory and Legal Compliance segment to the InformationManagement and Distribution segment and one operating unit from the InformationManagement and Distribution segment to the Healthcare, Regulatory and LegalCompliance segment.  These transferswere completed in order to aggregate these transferred operating companyresults with companies of similar core competencies.  The net effect of transferring these companies on the 2001segment information is an increase in the Information Management andDistribution segment’s revenue and income before taxes of $7.0 million and $1.0million, respectively.  The identifiedsegments are as follows:**

** **

**Information Management and Distribution.**  Thissegment includes operations that provide the following services: electronicimaging; analog services; data capture and database management; internetrepository services; and print and mail services, including statementprocessing, direct mail and fulfillment services.

 

10

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**Healthcare, Regulatory and Legal Compliance.**  Thissegment includes operations that provide the following services: medicalrecords release; off-site active storage of a healthcare institutions’ medicalrecords; online delivery of images of selected medical records; temporarystaffing services; providing attending physicians’ statements for life andhealth insurance underwriting; managed care compliance reviews; legal claimsadministration; and professional services related to trial support services.

** **

**The Company measures segmentprofit as income before income taxes. The Company has reclassified the 2001amounts to be consistent with the new segment reporting.  Information on the revised segments follows(in thousands):**

# ** **

|                       |   | **THREE MONTHS  ENDED MARCH 31, 2002**     |       |
|----------------------------|--------|--------------------------------------------|------------|
|                       |   |                                       | ** ** |   | ** ** |   | ** ** |   | ** ** |
|                       |   | **Information**Managementand  Distribution |       | **Healthcare,  Regulatory  and  Legal Compliance** |   | **Divestitures  and  Closures** |   | **Consolidated** |   |
| Revenue                    |   | $                                          | 64,318     |   | $ | 38,966 |   | $ | — |   | $ | 103,284 |   |
| Income before income taxes |   | 6,945                                      |       | 2,738 |   | — |   | 9,683 |   |
|                            |        |                                            |            |  |  |  |  |  |  |  |  |  |  |

 
|                       |   | **THREE MONTHS  ENDED MARCH 31, 2001**       |       |
|----------------------------|--------|----------------------------------------------|------------|
|                       |   |                                         | ** ** |   | ** ** |   | ** ** |   | ** ** |
|                       |   | **Information**Management  and  Distribution |       | **Healthcare,  Regulatory  and  Legal Compliance** |   | **Divestitures  and  Closures** |   | **Consolidated** |   |
| Revenue                    |   | $                                            | 55,628     |   | $ | 48,307 |   | $ | 21,270 |   | $ | 125,205 |   |
| Income before income taxes |   | 6,537                                        |       | 8,362 |   | (875 | ) | 14,024 |   |
|                            |        |                                              |            |  |  |  |  |  |  |  |  |  |  |

 

**7. Derivatives and Other Comprehensive Loss**

** **

Effective January 1, 2001, theCompany adopted SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities.” This statement requires that all derivative financialinstruments be recognized as either assets or liabilities in the balance sheetand carried at fair value. Gains or losses on derivatives designated as cashflow hedges are initially reported as a component of other comprehensive incomeand later classified into earnings in the period in which the hedged item alsoaffects earnings.

 

The Company has entered into aninterest rate swap for a notional amount of $50 million to hedge, through March31, 2003, its exposure to fluctuations in interest rates on $50 million of itsdebt.  The swap has been designated bythe Company as a cash flow hedge.  As ofMarch 31, 2002, the fair value of the interest rate swap was a liability of$1.6 million ($0.9 million, net of tax), which was recorded in the accompanyingconsolidated balance sheet in other long-term obligations with an offsetrecorded in equity as other comprehensive loss.  This swap has the effect of fixing the interest rate on $50million of the Company’s debt at 5.775% plus the applicable floating spread.

 

11

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Comprehensive income (loss) isdefined as the change in equity during a period from transactions and otherevents, except those resulting from investments by and distributions tostockholders.  The components ofcomprehensive income (loss) for the three month periods ended March 31, 2001and 2002 are as follows:

 

|                                                                                           |   | **Three Months Ended  March 31,** |   |
|------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                           |   | **2001**                          |   | **2002** | ** ** |
|                                                                                           |   |                              |   |   |   |
| Net income                                                                                     |   | $                                 | 8,695  |   | $ | 6,003 |   |
| Other comprehensive income  (loss):                                                            |   |                              |   |   |   |
| Change in fair value of  interest rate swap, net of tax benefit of $406 and $129, respectively |   | (662                              | )      | (294 | ) |
| Total comprehensive income                                                                     |   | $                                 | 8,033  |   | $ | 5,709 |   |

 

SFAS No. 130 “ReportingComprehensive Income” establishes standards for reporting and display ofcomprehensive income and its components in the financial statements.  The objective of SFAS No. 130 is to report ameasure of all changes in equity of an enterprise that result from transactionsand other economic events of the period other than transactions withowners.  Comprehensive income is thetotal of net income and all other non-owner changes within a company’s equity.

** **

**12**

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**Item2.            Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

The following discussion shouldbe read in conjunction with our financial statements and the related notesthereto appearing elsewhere in this Report on Form 10-Q.

#### ** **

#### **Introduction**

 

We are a leading provider of business processoutsourcing solutions.  We offercustomers in information intensive industries — such as healthcare, law,banking, insurance, retailing, high tech manufacturing and government — thesolutions to manage their information and document intensive businessprocesses, enabling these organizations to concentrate on their corecompetencies.

 

Since ourinception, we have acquired 72 and divested 17 companies.  We evaluate candidates for acquisition andperiodically for divestiture as a part of our strategic plan of providing customersa single solution for business process outsourcing.  The criteria for evaluation include geographic need, additionaltechnology, market growth potential, industry expertise, service expansion tobroaden service offerings, expansion of our customer base, revenue and earningsgrowth potential, and expected sources and uses of capital.

 

#### **Business Segments**

 

Our revenue relates to the following segments:

 

**Information Management and Distribution.**  Thissegment includes operations that provide the following services: electronicimaging; analog services; data capture and database management; internetrepository services; and print and mail services, including statementprocessing, direct mail and fulfillment services.

 

**Healthcare, Regulatory and Legal Compliance.**  Thissegment includes operations that provide the following services: medicalrecords release; off-site active storage of a healthcare institutions’ medicalrecords; online delivery of images of selected medical records; temporarystaffing services; providing attending physicians’ statements for life andhealth insurance underwriting; managed care compliance reviews; legal claimsadministration; and professional services related to trial support services.

 

#### **Basis for ManagementDiscussion and Analysis**

 

Cost of servicesconsists primarily of compensation and benefits to employees providing goodsand services to our clients, occupancy costs, equipment costs and supplies. Ourcost of services also includes the cost of products sold for micrographics suppliesand equipment, computer hardware and software and business imaging supplies andequipment.

 

Selling, general and administrative expenses(“SG&A”) consist primarily of: compensation and related benefits to salesand marketing, executive management, accounting, human resources and otheradministrative employees; other sales and marketing costs; communicationscosts; insurance costs; and legal and accounting professional fees andexpenses.

 

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**THREE MONTHS ENDED MARCH31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001**

** **

**The results for the three monthsended March 31, 2001 include the operating units that were divested in thesecond and third quarters of 2001.**  To understand the ongoing company, the followingtable is provided to show the results of ongoing operations exclusive of proforma adjustments eliminating (i) the results from operations for the divestedcompanies and closed facilities, and (ii) the goodwill amortization and therelated income tax benefit from the three months ended March 31, 2001.

** **
|                  |   | **Three Months Ended March  31,** |        |
|-----------------------|--------|-----------------------------------|-------------|
|                  |   | **2001**                          |        | **2002** |   |
|                  |   | **Ongoing Segments**              |        | **Pro — forma Adjustments** |   | **Consolidated** |   | **Ongoing Segments** |   | **Pro — forma Adjustments** |   | **Consolidated** |   |
| **Revenue**           |   | **$**                             | **103,935** | ** ** | **$** | **21,270** | ** ** | **$** | **125,205** | ** ** | **$** | **103,284** | ** ** | **$** | **—** | ** ** | **$** | **103,284** | ** ** |
| **Gross profit**      |   | **40,734**                        | ** **  | **5,439** | ** ** | **46,173** | ** ** | **37,633** | ** ** | **—** | ** ** | **37,633** | ** ** |
| **SG&A**          |   | **21,544**                        | ** **  | **5,911** | ** ** | **27,455** | ** ** | **26,274** | ** ** | **—** | ** ** | **26,274** | ** ** |
| **Operating income**  |   | **19,190**                        | ** **  | **(2,964** | **)** | **16,226** | ** ** | **11,270** | ** ** | **—** | ** ** | **11,270** | ** ** |
| **Income before tax** |   | **16,934**                        | ** **  | **(2,910** | **)** | **14,024** | ** ** | **9,683** | ** ** | **—** | ** ** | **9,683** | ** ** |
| **Net income**        |   | **10,753**                        | ** **  | **(2,058** | **)** | **8,695** | ** ** | **6,003** | ** ** | **—** | ** ** | **6,003** | ** ** |
|                       |        |                                   |             |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

** **

**Revenue**

 

Revenuedecreased 0.6% from $103.9 million for the three months ended March 31, 2001 to$103.3 million for the three months ended March 31, 2002. This decrease wasprimarily due to lower revenues from our direct mail operations and lowerproject revenues from our class-action claims administration operations.  This decrease was partially offset byrevenue from the acquisitions completed subsequent to March 31, 2001 and higherrecurring revenues from our information management operations.

 

**Gross profit**

 

Gross profit decreased 7.6% from$40.7 million for the three months ended March 31, 2001 to $37.6 million forthe three months ended March 31, 2002, largely due to lower project revenuesfrom the class-action claims administration operations. Gross profit as apercentage of revenue decreased from 39.2% for the three months ended March 31,2001 to 36.4% for the three months ended March 31, 2002, primarily due to ashifting in the mix of revenues from high-margin project-based revenue tolower-margin recurring revenue.  Projectrevenues represented 31% of the revenues for the three months ended March 31,2002 and 37% of the revenues for the three months ended March 31, 2001.

 

**Selling, general and administrative expenses**

 

SG&A increased 22.0% from$21.5 million, or 20.7% of revenue, for the three months ended March 31, 2001to $26.3 million, or 25.4% of revenue, for the three months ended March 31,2002.  This increase was a result ofSG&A at companies acquired subsequent to March 31, 2001, investments tosupport the information management growth strategy, additional worker’scompensation and medical insurance costs related to our self-insured programs,and the corporate name change initiative completed during the first quarter of2002.

 

14

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**Operatingincome**

 

Operating income decreased 41.3%from $19.2 million, or 18.5% of revenue, for the three months ended March 31,2001 to $11.3 million, or 10.9% of revenue, for the three months ended March31, 2002, largely attributable to the change in revenue mix and the higherSG&A expenses discussed above.

 

**Income beforeincome taxes and net income**

 

Income before income taxes decreased 42.8% from$16.9 million for the three months ended March 31, 2001 to $9.7 million for thethree months ended March 31, 2002, and net income decreased 44.2% from $10.8million for the three months ended March 31, 2001 to $6.0 million for the threemonths ended March 31, 2002, largely attributable to the change in revenue mixand the higher SG&A expenses discussed above.

 

The effective tax rate of 38.0% for the threemonths ended March 31, 2001 and 2002 differs from the statutory federalrate of 35.0% principally due to state and local taxes.

 

### **LIQUIDITYAND CAPITAL RESOURCES**

 

At March 31, 2002, we had $47.2million of working capital and $0.4 million of cash. The Company has beenactive in managing its cash on hand to minimize its interest expense.  Cash flows provided by operating activitiesfor the three months ended March 31, 2002 were $10.7 million.  Net cash provided by operating activitiesfor the three months ended March 31, 2002 was primarily affected by anemphasis on receivables collections and from the recent businessacquisition.  Net cash used in investingactivities was $14.1 million for the three months ended March 31, 2002, as wepaid $11.1 million for acquisitions, net of cash acquired.  Net cash used by financing activities was$3.4 million for the three months ended March 31, 2002, primarily due topaydowns of $101.2 million on our line of credit, net of proceeds of $97.8million on long-term obligations.

 

In April 2001, we entered into our line ofcredit agreement with Bank of America, SunTrust Bank and Wells Fargo Bank, asco-agents (the “2001 Credit Agreement”). Under this agreement, we can from timeto time borrow up to $297.5 million over a three-year period, subject tocertain customary borrowing capacity requirements. Meeting these requirementsis highly dependent upon maintaining a minimum level of operating results andthe continued demand for our services among other factors. Additionally,depending on the mix of stock and cash used in acquisitions if any, we may needto seek further financing through the public or private sale of equity or debtsecurities. There can be no assurance we could secure such financing if andwhen it is needed or on terms we deem acceptable.

 

At March 31, 2002,we had $90.3 million available to borrow under our 2001 Credit Agreement.  Also, we have total commercial commitmentsfor $8.7 million for standby letters of credit at March 31, 2002.

 

Managementbelieves that it has sufficient liquidity from its cash flow and its revolvingcredit facility to meet ongoing business needs.

 

In January 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 1,510,188 shares wereavailable as of March 31, 2002.

 

15

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**Critical Accounting Policies**

 

TheCompany has identified the following critical accounting policies that, as aresult of the judgments, uncertainties, uniqueness and complexities of theunderlying accounting standards and operations involved, could result inmaterial changes to its financial condition or results of operations underdifferent conditions or using different assumptions.

 

**Allowance for Doubtful Accounts.**  The allowance for doubtful accounts isgenerally established during the period in which revenues are recognized and ismaintained at a level deemed appropriate by management based on historical andother factors that affect collectibility. 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 the Consolidated FinancialStatements. Different assumptions or changes in economic circumstances couldresult in additional changes to the allowance for doubtful accounts.

 

**Long-Lived Asset Impairment.**  Management continually evaluates whetherevents and circumstances indicate that the carrying value of long-lived assetsmay not be recoverable. To make this evaluation, management compares theestimated undiscounted future cash flows over the remaining life of thelong-lived assets to the carrying amount of the assets being evaluated. Animpairment loss is recognized to the extent the carrying amount of assets beingevaluated exceeds the expected future undiscounted cash flow. 

 

**Goodwill and Other Intangible Asset Impairment.**  At January 1, 2002, we adopted SFASNo. 142, “Goodwill and Other Intangible Assets.” This statement statesthat goodwill and intangible assets that have indefinite useful lives will notbe amortized but rather will be tested at least annually for impairment. The impairmenttest is based on fair value rather than undiscounted cash flows. Additionally,goodwill and intangible assets are tested at a reporting group level ratherthan the individual operating unit level. Management utilizes estimates to determine fair value of the reportingunits.  These estimates include futurecash flows, growth rates, capital needs, and projected earning margins amongother factors.  Estimates utilized infuture calculations could differ from estimates used in the currentperiod.  Future years' estimates thatare unfavorable compared to current estimates could cause an impairment ofintangible assets in the given year.

 

 

### **RISKS ASSOCIATED WITH FORWARD-LOOKING STATEMENTS**

 

**This Report contains certainforward-looking statements such as our intentions, hopes, beliefs,expectations, strategies, predictions or any other variation thereof orcomparable phraseology of our future activities or other future events orconditions within the meaning of Section 27A of the Securities Act of 1933, as amended(the “Act”), and Section 21E of the Securities Exchange Act of 1934, asamended, which are intended to be covered by the safe harbors created thereby.Investors are cautioned that all forward-looking statements involve risks anduncertainty, including, without limitation, the risk of integrating ouroperating companies, of managing our rapid growth, of the timing and magnitudeof technological advances, of the occurrences of future events that coulddiminish our customers' needs for our services, of a change in the degree towhich companies continue to outsource business processes, as well as such otherrisks set forth under the heading Risk Factors included in our most recentannual report on Form 10-K.**

 

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Although we believe that the assumptions underlying the forward-lookingstatements contained herein are reasonable, any of the assumptions could beinaccurate, and, therefore, there can be no assurance that the forward-lookingstatements included in this Report will prove to be accurate. In light of thesignificant uncertainties inherent in the forward-looking statements includedherein, the inclusion of such information should not be regarded as arepresentation by us or any other person that our objectives and plans will beachieved.  Further, we disclaim anyobligation to update any such forward-looking statements, except as required bylaw.

 

17

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**Item3.            Quantitative and QualitativeDisclosures about Market Risk**

 

The Company is subject to interest rate risk on its term loans andrevolving credit facility.  Interestrates are fixed on the indenture and capital lease obligations.  The Company has entered into an interestrate swap for a notional amount of $50 million to hedge, through March 31,2003, its exposure to fluctuations in interest rates on $50 million of itsdebt.  This swap has the effect offixing the interest rate on $50 million of the Company’s debt at 5.775% plusthe applicable floating spread.  Theswap has been designated by the Company as a cash flow hedge.  As of March 31, 2002, the fair value of theinterest rate swap was a liability of $1.6 million ($0.9 million, net of tax),which was recorded in the accompanying consolidated balance sheet in otherlong-term obligations with an offset recorded in equity as other comprehensiveloss.

 

18

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**PART II.        OTHERINFORMATION**

 

**Item 6.            Exhibits and Reports on Form 8-K**

 

(a)           Exhibits

 
| 10.1   |   | Employment Agreement, dated as of April 23, 2002 between  SOURCECORP, Incorporated, SOURCECORP Management, L.P. and Kerry D. Walbridge                                   |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                          |
| 10.2   |   | Amended and Restated Employment Agreement, dated as of April 24,  2002 between SOURCECORP, Incorporated, SOURCECORP Management, L.P. and  Charles S. Gilbert             |
|   |   |                                                                                                                                                                          |
| 10.3   |   | Amended and Restated Employment Agreement, dated as of April 8,  2002 between SOURCECORP, Incorporated, SOURCECORP Management, L.P. and Ed H.  Bowman, Jr.               |
|   |   |                                                                                                                                                                          |
| 10.4   |   | Amended and Restated Employment Agreement, dated as of May 10, 2002  between SOURCECORP, Incorporated, SOURCECORP Management, L.P. and Joe A. Rose                            |
|   |   |                                                                                                                                                                          |
| 10.5   |   | First Amendment to Amended and Restated Employment Agreement, dated as  of April 24, 2002 between SOURCECORP, Incorporated, SOURCECORP Management,  L.P. and Michael S. Rupe  |
|   |   |                                                                                                                                                                          |
| 10.6   |   | First Amendment to Amended and Restated Employment Agreement, dated as  of April 10, 2002 between SOURCECORP, Incorporated, SOURCECORP Management,  L.P. and Ronald Zazworsky |
|   |   |                                                                                                                                                                          |
| 10.7   |   | Amended and Restated Employment Agreement, dated as of April 8,  2002 between SOURCECORP, Incorporated, SOURCECORP Management, L.P. and Thomas  C. Walker                |
|   |   |                                                                                                                                                                          |
| 10.8   |   | Amended and Restated Employment Agreement, dated as of April 24,  2002 between SOURCECORP, Incorporated, SOURCECORP Management, L.P. and Barry  L. Edwards               |

 

(b)           Reports on Form 8-K

 

On January 7, 2002, the Company filed a Current Report on Form 8-K withthe Commission dated January 7, 2002, reporting under Item 5 thereto, thefiling of a press release relating to revised guidance for 2001 fourth quarterand 2002.

 

On February 15, 2002, theCompany filed a Current Report on Form 8-K with the Commission dated February14, 2002, reporting under Item 5 thereto, the change in the Company’s name to *SOURCECORP,* Incorporated.

 

19

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**SIGNATURES**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the Registrant has duly caused this Reporton Form 10-Q to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                     | SOURCECORP, Incorporated               |
|--------------------------|----------------------------------------|
|                     |                                   |
| Date:  May 15, 2002 | By:                                    |     /s/ Ed H. Bowman, Jr. |
|                     |                                   |
|                     | Ed H. Bowman, Jr.                      |
|                     | Chief Executive Officer and President  |
|                     |                                   |
| Date:  May 15, 2002 | By:                                    |     /s/ Barry L. Edwards |
|                     |                                   |
|                     | Barry L. Edwards                       |
|                     | Executive Vice President and Chief     |
|                     | Financial Officer (Principal Financial |
|                     | and Accounting Officer)                |
|                          |                                        |  |  |  |

 

20

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**INDEX TOEXHIBITS**

 
| **Exhibit   Number** |   | **Description**                                                                                                                                                               |
|----------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |   |                                                                                                                                                                          |
| 10.1                 |   | Employment Agreement, dated as  of April 23, 2002 between SOURCECORP, Incorporated, SOURCECORP  Management, L.P. and Kerry D. Walbridge                                  |
|                 |   |                                                                                                                                                                          |
| 10.2                 |   | Amended and Restated Employment  Agreement, dated as of April 24, 2002 between SOURCECORP, Incorporated,  SOURCECORP Management, L.P. and Charles S. Gilbert             |
|                 |   |                                                                                                                                                                          |
| 10.3                 |   | Amended and Restated Employment Agreement, dated as of April 8,  2002 between SOURCECORP, Incorporated, SOURCECORP Management, L.P. and Ed H.  Bowman, Jr.               |
|                 |   |                                                                                                                                                                          |
| 10.4                 |   | Amended and Restated Employment  Agreement, dated as of May 10, 2002 between SOURCECORP, Incorporated,  SOURCECORP Management, L.P. and Joe A. Rose                           |
|                 |   |                                                                                                                                                                          |
| 10.5                 |   | First Amendment to Amended and  Restated Employment Agreement, dated as of April 24, 2002 between SOURCECORP,  Incorporated, SOURCECORP Management, L.P. and Michael S. Rupe  |
|                 |   |                                                                                                                                                                          |
| 10.6                 |   | First Amendment to Amended and  Restated Employment Agreement, dated as of April 10, 2002 between SOURCECORP,  Incorporated, SOURCECORP Management, L.P. and Ronald Zazworsky |
|                 |   |                                                                                                                                                                          |
| 10.7                 |   | Amended and Restated Employment  Agreement, dated as of April 8, 2002 between SOURCECORP, Incorporated,  SOURCECORP Management, L.P. and Thomas C. Walker                |
|                 |   |                                                                                                                                                                          |
| 10.8                 |   | Amended and Restated Employment Agreement, dated as of April 24,  2002 between SOURCECORP, Incorporated, SOURCECORP Management, L.P. and Barry  L. Edwards               |
|                 |   |                                                                                                                                                                          |

 

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