**SECURITIES AND 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  June 30, 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**

(Exactname 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’STELEPHONE 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

 

Asof July 31, 2002, 17,360,502 shares of the registrant’s Common Stock, $.01 parvalue per share, were outstanding.

 

 

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**SOURCECORP,INCORPORATED AND SUBSIDIARIES**

**FORM 10-Q FORTHE PERIOD ENDED JUNE 30, 2002**

 

**INDEX**

 
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                    |
|--------------|--------------------------------------------------------------------------------------------------------------|
|         |                                                                                                         |
| Item 1       | Financial Statements                                                                                         |
|         |                                                                                                         |
|         | Consolidated Balance Sheets  — December 31, 2001 and June 30, 2002 (unaudited)                          |
|         |                                                                                                         |
|         | Consolidated  Statements of Operations — Three and six months ended June 30, 2001 and 2002  (unaudited) |
|         |                                                                                                         |
|         | Consolidated  Statements of Cash Flows — Three and six months ended June 30, 2001 and 2002  (unaudited) |
|         |                                                                                                         |
|         | Notes to  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                                                  |
|         |                                                                                                         |
| **PART II.** | **OTHER INFORMATION**                                                                                        |
|         |                                                                                                         |
| Item  1      | Legal  Proceedings                                                                                           |
|         |                                                                                                         |
| Item  4      | Submission  of Matters to a Vote of Security Holders                                                         |
|         |                                                                                                         |
| Item 6       | Exhibits and  Reports on Form 8-K                                                                            |
|         |                                                                                                         |
|         | **SIGNATURES**                                                                                               |
|         |                                                                                                         |
|         | **Index to  Exhibits**                                                                                       |

 

2

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**PART I.    FINANCIAL INFORMATION**

 

**Item 1.    FinancialStatements**

 

3

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**SOURCECORP,INCORPORATED AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

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

** **
|                                                                                                                                                                       |   | **December 31,  2001** |    | **June 30,  2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|---------|--------------------|--------|
|                                                                                                                                                                       |   | **(Unaudited)**        |    |
| **ASSETS**                                                                                                                                                                 |   |                   |    |               |   |
| **CURRENT ASSETS:**                                                                                                                                                        |   |                   |    |               |   |
| Cash and cash equivalents                                                                                                                                                  |   | $                      | 7,182   |               | $      | 3,789 |   |
| Accounts and notes receivable,  less allowance for doubtful accounts of $19,888 and $16,726, respectively                                                                  |   | 88,547                 |    | 92,234             |   |
| Inventories                                                                                                                                                                |   | 2,587                  |    | 3,156              |   |
| Deferred income taxes                                                                                                                                                      |   | 9,805                  |    | 10,841             |   |
| Prepaid expenses and other  current assets                                                                                                                                 |   | 6,412                  |    | 4,524              |   |
| Total current assets                                                                                                                                                       |   | 114,533                |    | 114,544            |   |
|                                                                                                                                                                       |   |                   |    |               |   |
| **PROPERTY,  PLANT AND EQUIPMENT**, net of accumulated depreciation  $40,863 and $46,444, respectively                                                                     |   | 41,942                 |    | 42,445             |   |
| **GOODWILL AND OTHER INTANGIBLES,**net of amortization of $22,356 and $22,532,  respectively                                                                               |   | 298,519                |    | 320,440            |   |
| **OTHER NONCURRENT ASSETS**                                                                                                                                                |   | 8,077                  |    | 9,034              |   |
|                                                                                                                                                                       |   |                   |    |               |   |
| Total assets                                                                                                                                                               |   | $                      | 463,071 |               | $      | 486,463 |   |
|                                                                                                                                                                       |   |                   |    |               |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                             |   |                   |    |               |   |
|                                                                                                                                                                       |   |                   |    |               |   |
| **CURRENT LIABILITIES:**                                                                                                                                                   |   |                   |    |               |   |
| Accounts payable and accrued  liabilities                                                                                                                                  |   | $                      | 51,087  |               | $      | 59,396 |   |
| Current maturities of  long-term obligations                                                                                                                               |   | 324                    |    | 247                |   |
| Income tax payable                                                                                                                                                         |   | 4,588                  |    | 3,399              |   |
| Total current liabilities                                                                                                                                                  |   | 55,999                 |    | 63,042             |   |
|                                                                                                                                                                       |   |                   |    |               |   |
| **LONG-TERM OBLIGATIONS**, net of current maturities                                                                                                                       |   | 116,055                |    | 112,641            |   |
| **DEFERRED INCOME TAX**                                                                                                                                                    |   | 1,839                  |    | 6,265              |   |
| **OTHER  LONG-TERM OBLIGATIONS**                                                                                                                                           |   | 18,005                 |    | 18,920             |   |
| Total liabilities                                                                                                                                                          |   | 191,898                |    | 200,868            |   |
|                                                                                                                                                                       |   |                   |    |               |   |
| **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 17,360,502 shares issued and  outstanding at December 31, 2001 and June 30, 2002, respectively |   | 174                    |    | 175                |   |
| Additional paid-in-capital                                                                                                                                                 |   | 204,086                |    | 204,639            |   |
| Accumulated other  comprehensive loss                                                                                                                                      |   | (1,242                 | )       | (882               | )      |
| Retained earnings                                                                                                                                                          |   | 69,137                 |    | 82,645             |   |
|                                                                                                                                                                       |   | 272,155                |    | 286,577            |   |
| Less — Treasury stock, at  cost, 56,028 shares at December 31, 2001 and   June 30, 2002                                                                     |   | (982                   | )       | (982               | )      |
| Total stockholders’ equity                                                                                                                                            |   | 271,173                |    | 285,595            |   |
|                                                                                                                                                                       |   |                   |    |               |   |
| Total liabilities and  stockholders’ equity                                                                                                                           |   | $                      | 463,071 |               | $      | 486,463 |   |

 

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 June 30,** |    | **Six Months Ended June 30,** |   |
|---------------------------------------------------|--------|----------------------------------|---------|-------------------------------|--------|
|                                              |   | **2001**                         |    | **2002**                      |   | **2001** |   | **2002** |   |
|                                              |   | **(Unaudited)**                  |    | **(Unaudited)**               |   |
| **REVENUE**                                       |   | $                                | 123,104 |                          | $      | 105,787 |   | $ | 248,309 |   | $ | 209,071 |   |
|                                              |   |                             |    |                          |   |   |   |   |   |
| **COST OF SERVICES**                              |   | 73,745                           |    | 63,332                        |   | 148,864 |   | 125,533 |   |
| **SPECIAL  CHARGES**                              |   | 417                              |    | —                        |   | 417 |   | — |   |
| **DEPRECIATION**                                  |   | 4,236                            |    | 3,644                         |   | 8,149 |   | 7,094 |   |
| Gross profit                                      |   | 44,706                           |    | 38,811                        |   | 90,879 |   | 76,444 |   |
| **SELLING,  GENERAL AND ADMINISTRATIVE EXPENSES** |   | 27,464                           |    | 24,754                        |   | 54,919 |   | 51,028 |   |
| **SPECIAL CHARGES**                               |   | 67,908                           |    | —                        |   | 67,908 |   | — |   |
| **AMORTIZATION**                                  |   | 2,560                            |    | 89                            |   | 5,052 |   | 178 |   |
| Operating income (loss)                           |   | (53,226                          | )       | 13,968                        |   | (37,000 | ) | 25,238 |   |
|                                              |   |                             |    |                          |   |   |   |   |   |
| **OTHER (INCOME) EXPENSE:**                       |   |                             |    |                          |   |   |   |   |   |
| Interest expense                                  |   | 3,120                            |    | 1,541                         |   | 5,461 |   | 3,037 |   |
| Interest income                                   |   | (27                              | )       | (23                           | )      | (132 | ) | (51 | ) |
| Other (income) expense, net                       |   | —                           |    | 345                           |   | (34 | ) | 464 |   |
| Income (loss) before income  taxes                |   | (56,319                          | )       | 12,105                        |   | (42,295 | ) | 21,788 |   |
|                                              |   |                             |    |                          |   |   |   |   |   |
| **PROVISION  (BENEFIT) FOR INCOME TAXES**         |   | (13,188                          | )       | 4,600                         |   | (7,859 | ) | 8,280 |   |
| **NET  INCOME (LOSS)**                            |   | $                                | (43,131 | )                             | $      | 7,505 |   | $ | (34,436 | ) | $ | 13,508 |   |
|                                              |   |                             |    |                          |   |   |   |   |   |
| **NET  INCOME (LOSS) PER COMMON SHARE**           |   |                             |    |                          |   |   |   |   |   |
| **BASIC**                                         |   | $                                | (2.60   | )                             | $      | 0.43 |   | $ | (2.10 | ) | $ | 0.78 |   |
| **DILUTED**                                       |   | $                                | (2.60   | )                             | $      | 0.42 |   | $ | (2.10 | ) | $ | 0.76 |   |
|                                              |   |                             |    |                          |   |   |   |   |   |
| **WEIGHTED AVERAGE COMMON SHARES OUTSTANDING**    |   |                             |    |                          |   |   |   |   |   |
| **BASIC**                                         |   | 16,575                           |    | 17,304                        |   | 16,379 |   | 17,300 |   |
| **DILUTED**                                       |   | 16,575                           |    | 17,887                        |   | 16,379 |   | 17,854 |   |

 

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)**

 
|                                                                               |   | **Six Months  Ended  June 30,** |    |
|------------------------------------------------------------------------------------|--------|---------------------------------|---------|
|                                                                               |   | **2001**                        |    | **2002** |   |
|                                                                               |   | **(Unaudited)**                 |    |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                          |   |                            |    |   |   |
| Net income (loss)                                                                  |   | $                               | (34,436 | ) | $ | 13,508 |   |
| Adjustments to reconcile net  income to net cash provided by operating activities: |   |                            |    |   |   |
| Special Charges                                                                    |   | 68,325                          |    | — |   |
| Depreciation and amortization                                                      |   | 13,201                          |    | 7,272 |   |
| Deferred tax provision  (benefit)                                                  |   | (4,654                          | )       | 3,390 |   |
| Loss on sale of property,  plant and equipment                                     |   | —                          |    | 125 |   |
| Change in operating assets and  liabilities:                                       |   |                            |    |   |   |
| Accounts and notes receivable                                                      |   | (11,602                         | )       | (3,034 | ) |
| Prepaid expenses and other  assets                                                 |   | (4,919                          | )       | 514 |   |
| Accounts payable and accrued  liabilities                                          |   | (993                            | )       | 1,701 |   |
| Net cash provided by operating  activities                                         |   | 24,922                          |    | 23,476 |   |
|                                                                               |   |                            |    |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                          |   |                            |    |   |   |
| Net proceeds received from  sale of operating units                                |   | —                          |    | 10 |   |
| Purchase of property, plant  and equipment                                         |   | (8,777                          | )       | (6,825 | ) |
| Proceeds from sale of  operating company assets                                    |   | 1,250                           |    | — |   |
| Cash paid for acquisitions,  net of cash acquired                                  |   | (44,924                         | )       | (16,311 | ) |
| Net cash used for investing  activities                                            |   | (52,451                         | )       | (23,126 | ) |
|                                                                               |   |                            |    |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                          |   |                            |    |   |   |
| Proceeds from exercise of  common stock options                                    |   | 12,573                          |    | 100 |   |
| Proceeds from long-term  obligations                                               |   | 88,932                          |    | 155,847 |   |
| Principal payments on  long-term obligations                                       |   | (73,815                         | )       | (159,421 | ) |
| Cash paid for debt issuance  costs                                                 |   | (1,460                          | )       | (269 | ) |
| Net cash provided by (used  for) financing activities                              |   | 26,230                          |    | (3,743 | ) |
|                                                                               |   |                            |    |   |   |
| **NET  DECREASE IN CASH AND CASH EQUIVALENTS**                                     |   | (1,299                          | )       | (3,393 | ) |
|                                                                               |   |                            |    |   |   |
| **CASH AND CASH EQUIVALENTS,**beginning of period                                  |   | 9,504                           |    | 7,182 |   |
|                                                                               |   |                            |    |   |   |
| **CASH AND CASH EQUIVALENTS,**end of period                                        |   | $                               | 8,205   |   | $ | 3,789 |   |
|                                                                               |   |                            |    |   |   |
| **SUPPLEMENTAL DATA:**                                                             |   |                            |    |   |   |
| Cash paid for:                                                                     |   |                            |    |   |   |
| Income taxes                                                                       |   | $                               | 4,873   |   | $ | 6,317 |   |
| Interest                                                                           |   | $                               | 5,228   |   | $ | 2,913 |   |
|                                                                               |   |                            |    |   |   |
| **NONCASH FINANCING TRANSACTIONS:**                                                |   |                            |    |   |   |
| Common stock issued for accrued  earnouts and holdbacks                            |   | $                               | 1,270   |   | $ | 445 |   |
| Assets acquired through capital  lease agreements                                  |   | $                               | —  |   | $ | 103 |   |

 

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

 

6

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**SOURCECORP*,*INCORPORATED AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1. Basis of Presentation:**

 

The accompanyingconsolidated financial statements and related notes to consolidated financialstatements include the accounts of SOURCECORP, Incorporated and oursubsidiaries (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 June 30, 2002, our results of operations for the three and sixmonths ended June 30, 2001 and 2002, and our cash flows for the six months endedJune 30, 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 theCommission on April 1, 2002, as amended by the Form 10-K/A filed with theCommission on April 10, 2002.  Theresults of operations for the six-month periods ended June 30, 2001 and 2002may not be indicative of the results for the full year.

 

**2.  New Accounting Standards:**

 

*RecentAccounting Pronouncements*

 

In June 2001, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards(“SFAS”) No. 141, “Business Combinations” and SFAS No. 142, “Goodwilland Other Intangible Assets.” SFAS No. 141 requires the use of thepurchase method of accounting for all business combinations initiated afterJune 30, 2001, thereby eliminating the pooling-of-interests method ofaccounting. SFAS No. 141 also addresses the recognition and measurement ofgoodwill and other intangible assets acquired in a business combination. Theadoption of SFAS No. 141 by the Company on July 1, 2001, did not havea significant effect on the Company’s financial statements.

 

As required by FASB, 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 carrying values.  In determining the fair values of thereporting units, the Company used the discounted cash flow method and themarket value approach method.  Since thefair values of all reporting units exceeded the carrying values, no impairmentwas recorded at January 1, 2002.

 

Other intangible assets with definite lives willcontinue to be amortized over their useful lives.  The intangible assets with definite lives were acquired in the2002 acquisitions.  See Note 4.

 

7

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

 
|                                                  |   | **Three Months Ended  June 30,** |    | **Six Months Ended  June 30,** |   |
|-------------------------------------------------------|--------|----------------------------------|---------|--------------------------------|--------|
|                                                  |   | **2001**                         |    | **2002**                       |   | **2001** |   | **2002** |   |
| Net income (loss)                                     |   | $                                | (43,131 | )                              | $      | 7,505 |   | $ | (34,436 | ) | $ | 13,508 |   |
| Add back goodwill amortization,  net of tax provision |   | 2,274                            |    | —                         |   | 4,314 |   | — |   |
| Adjusted net income (loss)                            |   | $                                | (40,857 | )                              | $      | 7,505 |   | $ | (30,122 | ) | $ | 13,508 |   |
|                                                  |   |                             |    |                           |   |   |   |   |   |
| Basic earnings per share:                             |   |                             |    |                           |   |   |   |   |   |
| Reported basic earnings per  share                    |   | $                                | (2.60   | )                              | $      | 0.43 |   | $ | (2.10 | ) | $ | 0.78 |   |
| Add back goodwill amortization,  net of tax provision |   | 0.14                             |    | —                         |   | 0.26 |   | — |   |
| Adjusted basic earnings per  share                    |   | $                                | (2.46   | )                              | $      | 0.43 |   | $ | (1.84 | ) | $ | 0.78 |   |
|                                                  |   |                             |    |                           |   |   |   |   |   |
| Diluted earnings per share:                           |   |                             |    |                           |   |   |   |   |   |
| Reported diluted earnings per  share                  |   | $                                | (2.60   | )                              | $      | 0.42 |   | $ | (2.10 | ) | $ | 0.76 |   |
| Add back goodwill amortization,  net of tax provision |   | 0.14                             |    | —                         |   | 0.26 |   | — |   |
| Adjusted diluted earnings per  share                  |   | $                                | (2.46   | )                              | $      | 0.42 |   | $ | (1.84 | ) | $ | 0.76 |   |

 

In August 2001, the FASB issued SFASNo. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”This statement supercedes SFAS No. 121, “Accounting for the Impairment ofLong-Lived Assets and for Long-Lived Assets to Be Disposed Of.” The Statementretains the previously existing accounting requirements related to therecognition and measurement of the impairment of long-lived assets to be heldand used while expanding the measurement requirements of long-lived assets tobe disposed of by sale to include discontinued operations. It also expands thepreviously existing reporting requirements for discontinued operations toinclude a component of an entity that either has been disposed of or isclassified as held for sale. As required by FASB, the Company adopted SFASNo. 144 on January 1, 2002, and tested the long-lived assets forimpairment utilizing expected future undiscounted cash flows.  This evaluation indicated that there was notan asset impairment for long-lived assets.

 

As required by FASB, the Company adopted FASBEmerging Issues Task Force (“EITF”) Issue 01-14, “Income StatementCharacterization of Reimbursements Received for ‘Out-of-Pocket’ ExpensesIncurred” on January 1, 2002.  ThisIssue requires that reimbursements for out-of-pocket expenses such as, airfare,hotels, mileage, etc., be characterized as revenue in the incomestatement.  The effect of thisreclassification on the three months ended June 30, 2001 was $3.3 millionincrease in revenue, $2.9 million increase in cost of services and $0.4 millionincrease in selling, general and administrative expenses and no effect on netincome.  The effect of thisreclassification on the six months ended June 30, 2001 was $7.1 millionincrease in revenue, $6.3 million increase in cost of services and $0.8 millionincrease in selling, general and administrative expenses and no effect on netincome.  Prior quarter amounts have beenreclassified to conform 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, included as special charges in the statementof operations, for the three months ended June 30, 2001 and a $5.7 million gainfor the three months ended September 30, 2001 for a total loss of $62.6 milliondue to realignment costs in 2001.

 

8

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During the six months ended June30, 2002, the activity related to the realignment plan has been settlements oflegal claims, contract terminations and various selling expenses.  The following table reflects the realignmentactivity for the six months ended  June 30, 2002 (in millions):

 
|                |   | **Realignment  Costs Liability  December 31, 2001** |   | **Charges** |   | **Payments** |   | **Realignment  Costs Liability  June 30, 2002** |   |
|---------------------|--------|-----------------------------------------------------|--------|-------------|--------|--------------|--------|-------------------------------------------------|--------|
| Asset Sales         |   | $                                                   | 5.4    |        | $      | —       |   | $                                               | 1.2    |   | $ | 4.2 |   |
| Location Exit Costs |   | 0.4                                                 |   | —      |   | 0.3          |   | 0.1                                             |   |
|                |   | $                                                   | 5.8    |        | $      | —       |   | $                                               | 1.5    |   | $ | 4.3 |   |

 

The June 30, 2002 realignment costs liability balanceconsists of accrued litigation, contract termination costs, lease payments andvarious disposal expenses.

 

**4.  Business Combinations**

 

*2002Acquisitions*

 

Effective January 1, 2002, theCompany acquired United Information Services, Inc. (“UIS”), which is located inIowa and expanded the Company’s statement solutions group, which had existinglocations in Arizona and New York.  Theaggregate consideration paid for UIS consisted of $17.2 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                            |   | $      | 17,160 |   |
|-----------------------------------------------|--------|--------|--------|--------|
| Estimated Fair Value of  Identifiable Assets: |   |   |   |
| Cash                                          |   | 1,944  |   |
| Receivables                                   |   | 615    |   |
| Prepaid expenses                              |   | 157    |   |
| Property, plant and equipment,  net           |   | 359    |   |
| Other assets                                  |   | 379    |   |
| Total Assets                                  |   | 3,454  |   |
| Estimated Fair Value of  Liabilities:         |   |   |   |
| Accounts payable and accrued  expenses        |   | (1,824 | )      |
| Accrued compensation                          |   | (524   | )      |
| Deferred tax liability                        |   | (98    | )      |
| Note payable                                  |   | (305   | )      |
| Total Liabilities                             |   | (2,751 | )      |
|                                          |   |   |   |
| 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, which willbe completed by December 31, 2002.

 

9

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*ContingentConsideration*

 

Certain of our acquisitions aresubject to adjustments in overall consideration and recorded goodwill based uponthe achievement of specified revenue and/or earnings targets over one to threeyear periods. During the first six months of 2002, we paid consideration of$0.3 million in cash and 12,630 shares of common stock at an average price of$31.67 in relation to contingent consideration agreements that have beenfinalized. Based upon the evaluation of cumulative earnings through June 30,2002 against the specified earnings targets, we have accrued aggregatecontingent consideration of approximately $21.8 million, of which $14.7 millionis classified as accounts payable and accrued liabilities and will be settledin cash and $7.1 million is classified as long-term obligations and will besettled in common stock. In certain agreements, the Company has the option ofchanging the payment mix to use more cash versus common stock in satisfying theliability. 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.  If all earnouttargets under the current agreements were achieved, the maximum contingentconsideration to be paid would be $55.1 million, which includes the $21.8million liability as of June 30, 2002. The earnout payments would be madeaccording to the agreements and would be paid over the next three years withthe final payment made in 2005.

 

**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  June 30,** |   | **Six Months Ended  June 30,** |   |
|------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                                   |   | **2001**                         |   | **2002**                       |   | **2001** |   | **2002** |   |
| Basic weighted average common shares                                   |   | 16,575                           |   | 17,304                         |   | 16,379 |   | 17,300 |   |
| Weighted average options,  warrants and other contingent consideration |   | —                           |   | 583                            |   | — |   | 554 |   |
| Diluted weighted average  common shares                                |   | 16,575                           |   | 17,887                         |   | 16,379 |   | 17,854 |   |

 

At June 30, 2001 and 2002, approximately 3.0 millionand 2.3 million, respectively, of common stock equivalents were not included inthe diluted earnings per share calculation because they were anti-dilutive.These common stock equivalents may be dilutive in future earnings per sharecalculations.

 

**6.  Segment Reporting**

 

In connection withthe 2001 strategic realignment plan, the Company reduced the number of segmentsfrom four to two to reflect the go-forward segment focus.  At January 1, 2002, the Company transferredfour operating units from the Healthcare, Regulatory and Legal Compliancesegment to the Information Management and Distribution segment and oneoperating unit from the Information Management and Distribution segment to theHealthcare, Regulatory and Legal Compliance segment.  These transfers were completed to better align these operatingunits' results with operating units of similar core competencies.  The net effect of transferring theseoperating units on the 2001 segment information is an increase in the InformationManagement and Distribution segment’s revenue and income before taxes of $7.6million and $1.2 million, respectively for the three months ended June 30,2001, and $14.6 million and $2.2 million, respectively for the six months endedJune 30, 2001.  The identified segmentsare 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.

 

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**Healthcare,Regulatory and Legal Compliance.**  This segment includes operations that provide the followingservices: medical records release; off-site active storage of a healthcareinstitutions’ medical records; online delivery of images of selected medicalrecords; temporary staffing services; providing attending physicians’statements for life and health insurance underwriting; managed care compliancereviews; legal claims administration; and professional services related totrial support services.

 

The Companymeasures segment profit as income before income taxes. The Company hasreclassified the 2001 amounts to be consistent with the new segmentreporting.  Information on the revisedsegments follows (in thousands):

 
|                       |   | **THREE  MONTHS ENDED JUNE 30, 2002**          |   |
|----------------------------|--------|------------------------------------------------|--------|
|                       |   | **Information  Management  and  Distribution** |   | **Healthcare,  Regulatory  and  Legal Compliance** |   | **Divestitures, Closures  and  Special Charges** |   | **Consolidated** |   |
| Revenue                    |   | $                                              | 64,342 |   | $ | 41,445 |   | $ | — |   | $ | 105,787 |   |
| Income before income taxes |   | 6,852                                          |   | 5,253 |   | — |   | 12,105 |   |
|                            |        |                                                |        |  |  |  |  |  |  |  |  |  |  |

 
|                       |   | **THREE MONTHS ENDED JUNE 30, 2001**           |   |
|----------------------------|--------|------------------------------------------------|--------|
|                       |   | **Information  Management  and  Distribution** |   | **Healthcare,  Regulatory  and  Legal Compliance** |   | **Divestitures, Closures  and  Special Charges** |   | **Consolidated** |   |
| Revenue                    |   | $                                              | 63,717 |   | $ | 45,451 |   | $ | 13,936 |   | $ | 123,104 |   |
| Income before income taxes |   | 8,138                                          |   | 5,961 |   | (70,418 | )  | (56,319 | ) |
|                            |        |                                                |        |  |  |  |  |  |  |  |  |  |  |

 

 
|                       |   | **SIX MONTHS ENDED JUNE 30, 2002**             |    |
|----------------------------|--------|------------------------------------------------|---------|
|                       |   | **Information  Management  and  Distribution** |    | **Healthcare,  Regulatory  and  Legal Compliance** |   | **Divestitures, Closures  and  Special Charges** |   | **Consolidated** |   |
| Revenue                    |   | $                                              | 128,660 |   | $ | 80,411 |   | $ | — |   | $ | 209,071 |   |
| Income before income taxes |   | 13,797                                         |    | 7,991 |   | — |   | 21,788 |   |
|                            |        |                                                |         |  |  |  |  |  |  |  |  |  |  |

 
|                       |   | **SIX MONTHS ENDED JUNE 30, 2001**             |    |
|----------------------------|--------|------------------------------------------------|---------|
|                       |   | **Information  Management  and  Distribution** |    | **Healthcare,  Regulatory  and  Legal Compliance** |   | **Divestitures, Closures  and  Special Charges** |   | **Consolidated** |   |
| Revenue                    |   | $                                              | 119,345 |   | $ | 93,758 |   | $ | 35,206 |   | $ | 248,309 |   |
| Income before income taxes |   | 14,675                                         |    | 14,323 |   | (71,293 | )  | (42,295 | ) |
|                            |        |                                                |         |  |  |  |  |  |  |  |  |  |  |

 

**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 ofJune 30, 2002 the fair value of the interest rate swap was a liability of $1.4million ($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(7.025% and 7.275% at December 31, 2001 and June 30, 2002, respectively).

 

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 and six month periods ended June 30,2001 and 2002 are as follows:

 
|                                                                                                             |   | **Three Months Ended  June 30,** |    | **Six Months Ended  June 30,** |   |
|------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|---------|--------------------------------|--------|
|                                                                                                             |   | **2001**                         |    | **2002**                       |   | **2001** |   | **2002** |   |
| Net income                                                                                                       |   | $                                | (43,131 | )                              | $      | 7,505 |   | $ | (34,436 | ) | $ | 13,508 |   |
| Other comprehensive income  (loss):                                                                              |   |                             |    |                           |   |   |   |   |   |
| Change in fair value of  interest rate swap, net of tax effect of $-, $(91), $406 and $(220),  respectively |   | —                           |    | 66                             |   | (662 | ) | 360 |   |
| Total comprehensive income                                                                                       |   | $                                | (43,131 | )                              | $      | 7,571 |   | $ | (35,098 | ) | $ | 13,868 |   |

 

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 with owners.  Comprehensive income is the total of netincome and all other non-owner changes within a company’s equity.

 

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**Item 2.     Management’s Discussion and Analysis of Financial Conditionand 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, legal,financial services and government — the solutions to manage their informationand document intensive business processes, enabling these organizations toconcentrate on their core competencies.

 

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 providingcustomers a single source solution for business process outsourcing.  The criteria for evaluation includegeographic need, additional technology, market growth potential, industryexpertise, service expansion to broaden service offerings, expansion of ourcustomer base, revenue and earnings growth potential, and expected sources anduses 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.**  This segment includes operations that provide the followingservices: medical records release; off-site active storage of a healthcareinstitutions’ medical records; online delivery of images of selected medicalrecords; temporary staffing services; providing attending physicians’statements for life and health insurance underwriting; managed care compliancereviews; legal claims administration; and professional services related totrial support services.

 

**Basis for Management Discussion andAnalysis**

 

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 micrographicssupplies and equipment; computer hardware and software and business imagingsupplies and equipment.

 

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 JUNE 30, 2002COMPARED TO THREE MONTHS ENDED JUNE 30, 2001**

 

The results for the three months ended June 30, 2001 include theoperating units that were divested in the second and third quarters of2001.  To understand the ongoingcompany, the following table is provided to show the results of ongoingoperations after pro forma adjustments eliminating (i) the results fromoperations for the divested companies and closed facilities, and the relatedspecial charges from the divestitures and closures, and (ii) the adoption ofSFAS No. 142.

 
|                   |   | **Three Months Ended June 30,** |    |
|------------------------|--------|---------------------------------|---------|
|                   |   | **2001**                        |    | **2002** |   |
|                   |   | **Ongoing Segments**            |    | **Pro-forma  Adjustments** |   | **Consolidated** |   | **Ongoing Segments** |   | **Pro-forma  Adjustments** |   | **Consolidated** |   |
| **Revenue**            |   | $                               | 109,168 |   | $ | 13,936 |   | $ | 123,104 |   | $ | 105,787 |   | $ | — |   | $ | 105,787 |   |
| **Gross profit**       |   | 42,916                          |    | 1,790 |   | 44,706 |   | 38,811 |   | — |   | 38,811 |   |
| **SG&A**           |   | 23,469                          |    | 3,995 |   | 27,464 |   | 24,754 |   | — |   | 24,754 |   |
| **Operating income**   |   | 19,447                          |    | (72,673 | ) | (53,226 | ) | 13,968 |   | — |   | 13,968 |   |
| **Income  before tax** |   | 16,354                          |    | (72,673 | ) | (56,319 | ) | 12,105 |   | — |   | 12,105 |   |
| **Net income**         |   | 10,385                          |    | (53,516 | ) | (43,131 | ) | 7,505 |   | — |   | 7,505 |   |
|                        |        |                                 |         |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Revenue**

 

Total revenue decreased 3.1% from $109.2 million for the three monthsended June 30, 2001 to $105.8 million for the three months ended June 30,2002.  Our revenue is based ontransaction volumes sent to us by our customers and these volumes are generallynot contractually guaranteed.  Projectrevenue declined $6.5 million during the quarter resulting in a revenue mixshift between our project and recurring revenue.  Project revenue accounted for 31.3% of total revenue compared to36.4% in the prior year's quarter. Project revenue consists of one-time projects in which the customerrelationship is not guaranteed to continue after project completion.  Project revenue margins are usually higherthan our average margins and the workload can be highly volatile.  Recurring revenue is characterized bycustomer relationships that are generally for one year and may continue forlonger.  Recurring revenue generally haslower margins than project revenue and is usually more predictable.  The difference between project and recurringrevenue is important to the discussion of profitability and margins.

 

Revenue within ourInformation Management and Distribution segment increased 1.0% from $63.7million for the three months ended June 30, 2001 to $64.3 million for the threemonths ended June 30, 2002.  Thisincrease was achieved despite the completion of a significant projectrepresenting 4.1% of the segment's revenue during the three months ended June30, 2001 and continued weakness within our direct mail units during the threemonths ended June 30, 2002.  The directmail volumes have declined primarily due to the decline in industry spending,especially since September 11, 2001, and to customers' reduced advertisingbudgets.  Factors contributing to therevenue increase include strong business volumes from our government andfinancial services customers and the strategic acquisition of UIS during thefirst quarter of 2002.

 

Revenue within ourHealthcare, Regulatory and Legal Compliance segment decreased 8.8% from $45.5million for the three months ended June 30, 2001 to $41.4 million for the threemonths ended June 30, 2002.  Thisdecrease was primarily due to a decline in project revenue, which was downapproximately $5.7 for the segment during the quarter.  The project revenue decline was due to thenumber of very large legal claims administration cases completed in the firsthalf of 2001.  The current year revenuedoes not include any very large projects but it does include several mediumsize projects.  The lower projectrevenue was partially offset by increased volumes in our healthcare medicalcoding units during the period ended June 30, 2002.

 

**Gross profit**

 

Gross profit decreased 9.6% from$42.9 million for the three months ended June 30, 2001 to $38.8 million for thethree months ended June 30, 2002.  Thedecline was largely due to lower project revenue, which historically produceshigher margins than our recurring business, pricing pressures and lower volumesin direct mail.  Consequently, grossprofit as a percentage of revenue decreased from 39.3% for the three monthsended June 30, 2001 to 36.7% for the three months ended June 30, 2002.

 

**Selling,general and administrative expenses**

 

SG&A increased 5.5% from$23.5 million, or 21.5% of revenue, for the three months ended June 30, 2001 to$24.8 million, or 23.4% of revenue, for the three months ended June 30,2002.  This increase was primarily theresult of increased national sales and marketing expenses, operational projectmanagement, and technology personnel to support the information growthstrategy.  Additionally, we haveexperienced increased personnel costs due to higher medical insurance expenseand performance based incentive compensation, offset by expense control andreduction initiatives implemented during the first quarter of 2002.

 

**Operatingincome**

 

Operating income decreased 28.2%from $19.4 million, or 17.8% of revenue, for the three months ended June 30,2001 to $14.0 million, or 13.2% of revenue, for the three months ended June 30,2002.  The decline was largelyattributable to the shift in revenue mix from higher margin project revenue tolower margin recurring revenue.  Thehighly competitive environment in direct mail and the higher SG&A expensesdiscussed above also contributed to the decline in operating income.

 

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**Income beforeincome taxes and net income**

 

Income before income taxesdecreased 26.0% from $16.4 million for the three months ended June 30, 2001 to$12.1 million for the three months ended June 30, 2002, and net incomedecreased 27.7% from $10.4 million for the three months ended June 30, 2001 to$7.5 million for the three months ended June 30, 2002, largely attributable tothe items discussed above.

 

The effective tax rate of 36.5% and 38.0% for thethree months ended June 30, 2001 and 2002, respectively, differs from thestatutory federal rate of 35.0% principally due to state and local taxes.  The effective tax rate has changed betweenthe years due to acquiring companies in high income tax states and the adoptionof SFAS No. 142, which eliminated the amortization of goodwill and intangibleassets with indefinite lives for financial reporting purposes.

 

**SIX MONTHS ENDED JUNE 30, 2002COMPARED TO SIX MONTHS ENDED JUNE 30, 2001**

 

The results for the sixmonths ended June 30, 2001 include the operating units that were divested inthe second and third quarters of 2001. To understand the ongoing company, the following table is provided toshow the results of ongoing operations after pro forma adjustments eliminating(i) the results from operations for the divested companies and closedfacilities, and the related special charges from the divestitures and closures,and (ii) the adoption of SFAS No. 142.

** **
|                  |   | **Six Months Ended June 30,** |        |
|-----------------------|--------|-------------------------------|-------------|
|                  |   | **2001**                      |        | **2002** |   |
|                  |   | **Ongoing Segments**          |        | **Pro-forma  Adjustments** |   | **Consolidated** |   | **Ongoing Segments** |   | **Pro-forma  Adjustments** |   | **Consolidated** |   |
| **Revenue**           |   | **$**                         | **213,103** | ** ** | **$** | **35,206** | ** ** | **$** | **248,309** | ** ** | **$** | **209,071** | ** ** | **$** | **—** | ** ** | **$** | **209,071** | ** ** |
| **Gross profit**      |   | **83,650**                    | ** **  | **7,229** | ** ** | **90,879** | ** ** | **76,444** | ** ** | **—** | ** ** | **76,444** | ** ** |
| **SG&A**          |   | **45,013**                    | ** **  | **9,906** | ** ** | **54,919** | ** ** | **51,028** | ** ** | **—** | ** ** | **51,028** | ** ** |
| **Operating income**  |   | **38,637**                    | ** **  | **(75,637** | **)** | **(37,000** | **)** | **25,238** | ** ** | **—** | ** ** | **25,238** | ** ** |
| **Income before tax** |   | **33,288**                    | ** **  | **(75,583** | **)** | **(42,295** | **)** | **21,788** | ** ** | **—** | ** ** | **21,788** | ** ** |
| **Net income**        |   | **21,138**                    | ** **  | **(55,574** | **)** | **(34,436** | **)** | **13,508** | ** ** | **—** | ** ** | **13,508** | ** ** |
|                       |        |                               |             |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Revenue**

 

Revenue decreased1.9% from $213.1 million for the six months ended June 30, 2001 to $209.1million for the six months ended June 30, 2002.  A decline in project revenue, which was down $13.2 million forthe six months ended June 30, 2002 compared to the prior year, and lowervolumes in direct mail were the primary drivers.  Project revenue was down primarily due the number of very largelegal claims administration cases completed in the first half of 2001 while thecurrent year consisted of medium size projects.  Project revenue accounted for 30.6% of total revenue for the sixmonths ended June 30, 2002 compared with 36.2% for the six months ended June30, 2001.  Revenue in direct mail isdown $4.1 million or 16.3% compared to the prior year primarily due to thedecline in industry spending, especially since September 11, 2001, and tocustomers' reduced advertising budgets. The weaknesses in project revenue and direct mail have been partiallyoffset by increased volumes in information management and the acquisition ofUIS in the first quarter of 2002.  Thehigher volumes in information management have mainly come from our governmentaland financial services customers.

 

**Gross Profit**

 

Gross profitdecreased 8.6% from $83.7 million for the six months ended June 30, 2001 to$76.4 million for the six months ended June 30, 2002. The decline was primarilydue to lower project revenue, which historically produces higher margins thanour recurring business, pricing pressures and lower volumes from directmail.  Higher costs related to employeebenefits, mainly workers’ compensation and medical insurance in the currentyear put additional pressure on margins. Consequently, gross profit as a percentage of revenue decreased from39.3% for the six months ended June 30, 2001 to 36.6% for the three monthsended June 30, 2002.

 

**Selling, general and administrativeexpenses**

 

SG&A increased13.4% from $45.0 million, or 21.1% of revenue, for the six months ended June30, 2001 to $51.0 million, or 24.4% of revenue, for the six months ended June30, 2002.  This increase was primarilythe result of increased national sales and marketing expenses, operationalproject management, and technology personnel to support the informationmanagement growth strategy.  Additionally,we experienced increased personnel costs due to higher medical insuranceexpense and performance based incentive compensation, offset by expense controland reduction initiatives implemented during the first quarter of 2002.

 

15

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**Operating income**

 

Operating incomedecreased 34.7% from $38.6 million, or 18.1% of revenue, for the six monthsended June 30, 2001 to $25.2 million, or 12.1% of revenue, for the six monthsended June 30, 2002. The decline was largely attributable to the shift inrevenue mix from higher margin project revenue to lower margin recurringrevenue.  Other factors contributing tothe decline were pricing pressures and a highly competitive market place indirect mail and the higher SG&A expenses discussed above.

 

**Income before income taxes and netincome**

 

Income beforeincome taxes decreased 34.5% from $33.3 million for the six months ended June30, 2001 to $21.8 million for the six months ended June 30, 2002, and netincome decreased 36.1% from $21.1 million for the six months ended June 30,2001 to $13.5 million for the six months ended June 30, 2002, largely due tothe items discussed above.

 

The effective tax rate of 36.5% and 38.0% for the six months ended June30, 2001 and 2002, respectively, differs from the statutory federal rate of35.0% principally due to state and local taxes.  The effective tax rate haschanged between the years due to acquiring companies in high income tax statesand the adoption of SFAS No. 142, which eliminated the amortization of goodwilland intangible assets with indefinite lives for financial reporting purposes.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

At June 30, 2002, we had $51.5million of working capital and $3.8 million of cash. The Company has been activelymanaging its cash on hand to minimize its interest expense.  Cash flows provided by operating activitiesfor the six months ended June 30, 2002 were $23.5 million.  Operating cash flow for the three monthsended June 30, 2002 was negatively impacted by a large receivable from agovernmental unit that was received in the third quarter.  Net cash used in investing activities was$23.1 million for the six months ended June 30, 2002, as we paid $16.3 millionfor acquisitions, net of cash acquired. This amount includes net cash paid for our 2002 acquisition of UIS andcertain cash payments related to the contingent consideration agreements ofpast acquisitions.  It is expected thatwe will pay an additional $14.7 million for contingent consideration agreementsduring the remainder of 2002.  Net cashused by financing activities was $3.7 million for the six months ended June 30,2002, primarily due to payments of $159.4 million on our line of credit, net ofproceeds of $155.8 million 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 up to April 2, 2004, 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. Effective April 3,2002, we extended $220.0 million of the $297.5 commitment for an additionalyear to April 2, 2005.  We paid fees of$0.2 million for extending the commitment.

 

Managementbelieves that it has sufficient liquidity from its cash flow and its revolvingcredit facility to meet ongoing business needs.  However, our ability to borrow is contingent on certain leverageand fixed cost coverage ratios.  Afterapplication of such ratios and our total commercial commitments of $8.7 millionfor standby letters of credit, we had $82.0 million available to borrow underour 2001 Credit Agreement as of June 30, 2002. In the fourth quarter of 2002, the leverage and fixed cost coverageratios will become more restrictive and will reduce the availability under thecredit agreement.  Therefore, we intendto renegotiate the credit agreement during the third and fourth quarters tomaintain borrowing availability under the credit agreement and remain incompliance when the ratios change in the fourth quarter.  Additionally, depending on the mix of stockand cash used in acquisitions, if any, we may need to seek further financingthrough the public or private sale of equity or debt securities.  There can be no assurance we could securesuch financing if and when it is needed or on terms we deem acceptable.

 

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 June 30, 2002.  Theshares available have not been reduced for any contingent considerationliabilities.

 

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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.  We apply a consistent methodology at the end of each quarter todetermine our account balances that require judgmental analysis.

** **

**Revenue Recognition.**  Our revenue is principally driven bytransaction volumes.  We generallyrecognize revenue as transactions are completed and accepted by customers.  In a few instances, due to contractual termsand billing cycle cutoffs, we are unable to bill for work completed in acertain period.  In these cases, werecognize the revenue in the month that the work is performed in order to matchthe revenue with the cost of services. The work is billed to the customer according to the terms of theagreement or during the following billing cycle.

 

**Allowance for Doubtful Accounts.**  The allowance for doubtful accounts isgenerally established during the period in which the loss is expected 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

 

**Long-Lived Asset Impairment.**  As required by SFAS No. 144, managementcontinually evaluates whether events and circumstances indicate that thecarrying value of long-lived assets may not be recoverable. To make thisevaluation, management compares the estimated undiscounted future cash flowsover the remaining life of the long-lived assets to the carrying amount of theassets being evaluated. An impairment loss is recognized to the extent the carryingamount of assets being evaluated exceeds the expected future undiscounted cashflow.

 

**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. Theimpairment test is based on fair value rather than undiscounted cash flows.Additionally, goodwill and intangible assets are tested at a reporting grouplevel rather than the individual operating unit level.  Management utilizes estimates to determinefair value of the reporting units. These estimates include future cash flows, growth rates, capital needs,and projected earning margins among other factors.  Estimates utilized in future calculations could differ fromestimates used in the current period. Future years’ estimates that are unfavorable compared to currentestimates could cause an impairment of intangible assets in the given year.

 

**Self-Insurance Liabilities andReserves. **We areself-insured for workman’s compensation liabilities and a significant portionof our employees’ medical costs.  Weaccount for our self-insurance programs based on actuarial estimates of theamount of loss inherent in that period’s claims, including losses for whichclaims have not been reported. These loss estimates rely on actuarialobservations of ultimate loss experience for similar historical events.  We limit our risk by carrying stop-losspolicies for significant claims incurred for both workman’s compensationliabilities and medical costs.

 

**Other Loss Contingencies.**  We record liabilities when it is probablethat a liability has been incurred and the amount of the loss is reasonablyestimable.  Disclosure is required whenthere is a reasonable possibility that the ultimate loss will exceed therecorded provision.  Contingentliabilities are often resolved over long time periods.  Estimating probable losses requires analysisof multiple forecasts that often depend on judgments about potential actions bythird parties such as regulators.

 

**RISKS ASSOCIATED WITH FORWARD-LOOKINGSTATEMENTS**

 

This Reportcontains certain forward-looking statements such as our intentions, hopes,beliefs, expectations, strategies, predictions or any other variation thereofor comparable phraseology of our future activities or other future events orconditions within the meaning of Section 27A of the Securities Act of 1933, asamended (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, of an adverse outcomein any given legal proceeding or claim, of the denial of insurance on aparticular claim or of a party obligated to provide indemnification beingfinancially unable to do so, as well as such other risks set forth under theheading Risk Factors included in our most recent annual report on Form 10-K.

 

Although webelieve 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, we disclaim any obligation toupdate any such forward-looking statements, except as required by law.

 

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**Item3.****                                   Quantitativeand Qualitative Disclosures 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 itsrevolving credit facility.  This swaphas the effect of fixing the interest rate on $50 million of the Company’s debtat 5.775% plus the applicable floating spread. The swap has been designated by the Company as a cash flow hedge.  As of June 30, 2002, the fair value of theinterest rate swap was a liability of $1.4 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.

 

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**PART II.****                        OTHER INFORMATION**

 

**Item 1.            Legal Proceedings**

 

We are, from time totime, a party to litigation arising in the normal course of business.  While we do not believe that we arecurrently a party to any litigation required to be disclosed under Item 103 ofRegulation S-K of the Securities Exchange Act of 1934, as amended, and theinstructions thereto, the following is a brief description of two of the legalmatters that we are involved in.  Webelieve that neither of these actions, nor any other actions that we are aparty to, will have a material adverse effect on our business or financialcondition, however in the event of an adverse outcome in one or more of ourlegal proceedings, operating results for a given quarter may be negativelyimpacted.

 

*DeBari Litigation*

 

In March 1999, wefiled a lawsuit styled *DeBari AssociatesAcquisition Corp. v. Robert Burnham, Mark Walch, Nortec, LLC, SpencerMcElhannon and Peng Lin*in the Supreme Court of the State of NewYork (“Nortec Action”). We are seeking a declaratory judgment that RobertBurnham, Mark Walch, Nortec, LLC, Spencer McElhannon and Peng Lin (the “NortecDefendants”) have no interest in Net Data, Inc., a subsidiary of a companyacquired by us in February 1998.  Wedivested the operating assets of Net Data, Inc. as part of our 2001 strategicrealignment plan.  The Nortec Defendantshave counterclaimed alleging breach of contract, fraud, breach of fiduciaryduty as a joint venturer and unjust enrichment.  In March 2002, our motion for summary judgment in this matter wasdenied.  A trial date for the NortecAction was recently set for September 2002. We believe we have meritorious defenses and intend to continue tovigorously pursue our remedies and defend any claims made against us in thismatter.

 

*Roy Weatherford, et al vs. FranklinBank and Franklin Bank vs. MAVRICC Management Systems, Inc.*

 

OnFebruary 24, 1992, MAVRICC Management Systems, Inc. (one of ourwholly-owned subsidiaries, the operating assets of which were divested by us aspart of our 2001 strategic realignment plan) entered into an agreement withFranklin Bank, N.A. whereby MAVRICC agreed to maintain records for individualIRAs and Keogh Plans and to perform certain activities (specifically describedin the contract) necessary to assist Franklin Bank, N.A. in serving as acustodian for specific IRAs.  OnAugust 6, 2001, Plaintiffs Roy Weatherford, Lois Weatherford,James L. Loper and Alma D. Owen initiated a class action lawsuitagainst Franklin Bank, N.A. in Tennessee’s Sumner County Circuit Court,Chancellory Division, alleging breach of fiduciary duty, breach of contract,negligence and violation of the Consumer Protection Act.  The Weatherford complaint seeks compensatoryand punitive damages from Franklin Bank, N.A. On September 28, 2001, Franklin Bank, N.A. filed its Third-PartyComplaint against MAVRICC for indemnification, alleging that MAVRICC breachedthe agreement.  Our motion forreconsideration of our motion for dismissal was denied in March 2002.  A hearing on whether a class should becertified is currently anticipated to take place sometime in or about October2002.  We believe we have meritrious defensesand intend to continue to vigorously defend any claims made against us in thismatter.

 

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**Item 4.            Submissionof Matters to a Vote of Security Holders**

 

On May 24, 2002, we held ourannual meeting of stockholders. The stockholders elected eight (8) directors.The director nominees received the following votes:

 
|                     |   | **Number of Votes** |   |
|--------------------------|--------|---------------------|--------|
|                     |   |                |   |   |   |   |   |   |   |
| **Nominee**              |   | **For**             |   | **Against/Withheld** |   | **Abstentions** |   | **Broker Non-Votes** |   |
| Ed H. Bowman, Jr.        |   | 14,701,634          |   | 1,126,778 |   | — |   | — |   |
| Michael J. Bradley       |   | 14,701,634          |   | 1,126,778 |   | — |   | — |   |
| David Lowenstein         |   | 14,701,634          |   | 1,126,778 |   | — |   | — |   |
| Donald F. Moorehead, Jr. |   | 14,715,553          |   | 1,112,859 |   | — |   | — |   |
| Joe A. Rose              |   | 14,692,630          |   | 1,135,782 |   | — |   | — |   |
| Hon. Edward M. Rowell    |   | 14,692,630          |   | 1,135,782 |   | — |   | — |   |
| Jonathan B. Shaw         |   | 14,701,634          |   | 1,126,778 |   | — |   | — |   |
| Thomas C. Walker         |   | 14,375,773          |   | 1,452,639 |   | — |   | — |   |

 

Additionally, the proposed Long-Term Incentive Plan was approved andadopted with the following votes:

 
| **Number of Votes** |   |
|---------------------|--------|
|                |   |   |   |   |   |   |   |
| **For**             |   | **Against/Withheld** |   | **Abstentions** |   | **Broker Non-Votes** |   |
|                |   |   |   |   |   |   |   |
| 10,589,424          |   | 5,233,651 |   | 5,337 | ** ** | **—** | ** ** |

 

**Item 6.****                                  ****Exhibits andReports on Form 8-K**

 
| (a)    | Exhibits |   |
|--------|----------|--------|
|   |     |   |   |
|   | 2.1      |   | Stock Purchase  Agreement dated as of March 31, 2001 by and among F.Y.I. Incorporated, Image  Entry Acquisition Corp. Image Entry Inc., Image Entry of Owsley County Inc.,  Image Entry of Indianapolis Inc., Image Entry Federal Systems Inc., Image  Entry of Arkansas Inc. and Image Entry of Alabama Inc. and the Shareholders  of Image Entry Inc., Image Entry of Owsley County Inc., Image Entry of  Indianapolis Inc., Image Entry Federal Systems Inc., Image Entry of Arkansas  Inc. and Image Entry of Alabama Inc. (Incorporated by reference to Exhibit  2.20 to the Company’s Current Report Form 8-K filed April 12, 2001) |
|   |     |   |   |
|   | 2.2      |   | Certificate of  Ownership and Merger filed with the Secretary of State of Delaware effective  February 14, 2002 merging SOURCECORP, Incorporated with and into the  Registrant and changing the name of the Registrant to SOURCECORP,  Incorporated (incorporated by reference to Exhibit 99.2 to the Registrant’s  Current Report on Form 8-K filed February 15, 2002) |
|   |     |   |   |
|   | 3.1      |   | Restated  Certificate of Incorporation of SOURCECORP, Incorporated (Incorporated by  reference to Exhibit 99.3 to Amendment No. 1 to the Company’s Registration  Statement on Form 8-A  filed on February  15, 2002) |
|   |     |   |   |
|   | 3.2      |   | Amended and  Restated By-Laws of SOURCECORP, Incorporated (Incorporated by reference to  Exhibit 99.4 to Amendment No. 1 to the Company’s Registration Statement on  Form 8-A filed on February 15, 2002) |
|   |     |   |   |
|   | 4        |   | Specimen  certificate for the Common Stock, par value $.01 per share, of the  Registrant. (Incorporated by reference to Exhibit 99.1 to Amendment No. 1 to  the Company’s Registration Statement on Form 8-A filed on February 15, 2002) |
|   |     |   |   |
|   | 10.1     |   | First Amendment to Amended and Restated Employment Agreement, dated as  of May 10, 2002 between SOURCECORP, Incorporated, SOURCECORP Management, L.P.  and Joe A. Rose |
|   |     |   |   |
|   | 10.2     |   | First Amendment to Amended and Restated Employment Agreement, dated as  of April 8, 2002 between SOURCECORP, Incorporated, SOURCECORP Management,  L.P. and Thomas C. Walker |
|   |     |   |   |
|   | 10.3     |   | First Amendment to Amended and Restated Employment Agreement, dated as  of May 8, 2002 between SOURCECORP, Incorporated, SOURCECORP Management, L.P.  and Ed H. Bowman, Jr. |
|   |     |   |   |
|   | 10.4     |   | SOURCECORP,  Incorporated 2002 Long-Term Incentive Plan |
|   |     |   |   |
|   | 99.1     |   | Certification  Pursuant to section 906 of Sarbanes-Oxley Act |

 

 

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(b)                                Reports on Form 8-K

 

On April 22, 2002 (amended April 24, 2002), the Company filed a CurrentReport on Form 8-K with the Commission dated April 17, 2002, reporting underItem 5 thereto, the change in the Company’s independent auditors from ArthurAndersen, LLP to Deloitte & Touche, LLP.

 

On May 9, 2002, the Company fileda Current Report on Form 8-K with the Commission dated January 1, 2002,reporting under Item 5 thereto, the effect of adopting Emerging Issues TaskForce Topic No. D-103, “Income Statement Characterization of ReimbursementsReceived for ‘Out-of-Pocket’ Expenses Incurred” on 2001 financial results.

 

On May 10, 2002, the companyfiled a Current Report on Form 8-K with the Commission dated May 9, 2002,reporting under Item 5 thereto, the filing of a press release relating to the2002 first quarter results.

 

 

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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 duly authorized.

 
|                        | SOURCECORP, Incorporated               |
|-----------------------------|----------------------------------------|
|                        |
| Date:  August 14, 2002 | By:                                    | /s/  Ed H. Bowman, Jr. |
|                        | Ed H. Bowman, Jr.                      |
|                        | Chief Executive Officer and President  |
|                        |                                   |
| Date:  August 14, 2002 | By:                                    | /s/  Barry L. Edwards |
|                        | Barry L. Edwards                       |
|                        | Executive Vice President and Chief     |
|                        | Financial Officer (Principal Financial |
|                        | and Accounting Officer)                |

 

 

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**INDEX TOEXHIBITS**

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |   |
|---------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 2.1                 |   | Stock Purchase  Agreement dated as of March 31, 2001 by and among F.Y.I. Incorporated, Image  Entry Acquisition Corp. Image Entry Inc., Image Entry of Owsley County Inc.,  Image Entry of Indianapolis Inc., Image Entry Federal Systems Inc., Image  Entry of Arkansas Inc. and Image Entry of Alabama Inc. and the Shareholders  of Image Entry Inc., Image Entry of Owsley County Inc., Image Entry of  Indianapolis Inc., Image Entry Federal Systems Inc., Image Entry of Arkansas  Inc. and Image Entry of Alabama Inc. (Incorporated by reference to Exhibit  2.20 to the Company’s Current Report Form 8-K filed April 12, 2001) |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 2.2                 |   | Certificate of  Ownership and Merger filed with the Secretary of State of Delaware effective  February 14, 2002 merging SOURCECORP, Incorporated with and into the  Registrant and changing the name of the Registrant to SOURCECORP,  Incorporated (incorporated by reference to Exhibit 99.2 to the Registrant’s  Current Report on Form 8-K filed February 15, 2002)                                                                                                                                                                                                                                                                   |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 3.1                 |   | Restated  Certificate of Incorporation of SOURCECORP, Incorporated (Incorporated by  reference to Exhibit 99.3 to Amendment No. 1 to the Company’s Registration  Statement on Form 8-A  filed on  February 15, 2002)                                                                                                                                                                                                                                                                                                                                                                                                                 |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 3.2                 |   | Amended and  Restated By-Laws of SOURCECORP, Incorporated (Incorporated by reference to  Exhibit 99.4 to Amendment No. 1 to the Company’s Registration Statement on  Form 8-A filed on February 15, 2002)                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 4                   |   | Specimen  certificate for the Common Stock, par value $.01 per share, of the  Registrant. (Incorporated by reference to Exhibit 99.1 to Amendment No. 1 to  the Company’s Registration Statement on Form 8-A filed on February 15, 2002)                                                                                                                                                                                                                                                                                                                                                                                                  |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.1                |   | First Amendment to Amended and Restated Employment Agreement, dated as  of May 10, 2002 between SOURCECORP, Incorporated, SOURCECORP Management, L.P.  and Joe A. Rose                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |   |
| 10.2                |   | First Amendment to Amended and Restated Employment Agreement, dated as  of April 8, 2002 between SOURCECORP, Incorporated, SOURCECORP Management,  L.P. and Thomas C. Walker                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |   |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |   |
| 10.3                |   | First Amendment to Amended and Restated Employment Agreement, dated as  of May 8, 2002 between SOURCECORP, Incorporated, SOURCECORP Management, L.P.  and Ed H. Bowman, Jr.                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |   |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |   |
| 10.4                |   | SOURCECORP,  Incorporated 2002 Long-Term Incentive Plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |   |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |   |
| 99.1                |   | Certification  Pursuant to section 906 of Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |   |

 

 

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