**UNITEDSTATES********SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

----

 

**FORM10-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, 2004**                                                                                                                                                                                                                                      |
|       |                                                                                                                                                                                                                                                                                        |
|       | **OR**                                                                                                                                                                                                                                                                                      |
|       |                                                                                                                                                                                                                                                                                        |
| **o**      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES AND EXCHANGE ACT OF 1934**                                                                                                                                                                                      |
|       |                                                                                                                                                                                                                                                                                        |
|       | **For the transition  period from                        to                      ** |

 

**Commission file number 0-27444**

 

----

 

**SOURCECORP, INCORPORATED**

(Exact name of registrant as specified in its charter)

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

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes ý  No o

 

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

 

Asof July 30, 2004, 15,773,405 shares of the registrant’s Common Stock, $.01par value per share, were outstanding.

 

 

----

 

**SOURCECORP,INCORPORATED AND SUBSIDIARIES**

**FORM 10-Q FOR THE PERIOD ENDED JUNE 30, 2004**

 

**INDEX**

 
| **PART  I.     FINANCIAL INFORMATION** |                                                                                                                        |
|-----------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------|
|                                                            |                                                                                                                        |   |
| Item 1                                                          | Condensed Financial  Statements                                                                                             |   |
|                                                            |                                                                                                                        |   |
|                                                            | Condensed Consolidated  Balance Sheets — December 31, 2003 and June 30, 2004 (unaudited)                     |   |
|                                                            |                                                                                                                        |   |
|                                                            | Condensed  Consolidated Statements of Operations — Three and six months ended  June 30, 2003 and 2004 (unaudited) |   |
|                                                            |                                                                                                                        |   |
|                                                            | Condensed  Consolidated Statements of Cash Flows — Six months ended June 30, 2003  and 2004 (unaudited)           |   |
|                                                            |                                                                                                                        |   |
|                                                            | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                           |   |
|                                                            |                                                                                                                        |   |
| Item  2                                                         | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                 |   |
|                                                            |                                                                                                                        |   |
| Item  3                                                         | Quantitative  and Qualitative Disclosures about Market Risk                                                                 |   |
|                                                            |                                                                                                                        |   |
| Item 4                                                          | Controls and Procedures                                                                                                     |   |
|                                                            |                                                                                                                        |   |
| **PART  II.     OTHER INFORMATION**    |                                                                                                                        |
|                                                            |                                                                                                                        |   |
| Item  1                                                         | Legal  Proceedings                                                                                                          |   |
|                                                            |                                                                                                                        |   |
| Item  2                                                         | Changes in Securities and Use of Proceeds                                                                                   |   |
|                                                            |                                                                                                                        |   |
| Item 6                                                          | Exhibits and  Reports on Form 8-K                                                                                           |   |
|                                                            |                                                                                                                        |   |
|                                                            | **SIGNATURES**                                                                                                              |   |
|                                                            |                                                                                                                        |   |
|                                                            | **Index to Exhibits**                                                                                                       |   |

 

2

----

 

**PART I.FINANCIAL INFORMATION**

 

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

 

**SOURCECORP, INCORPORATED AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

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

 
|                                                                                                                                                                                                            |   | **December 31,  2003** |    | **June 30,  2004** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|-------------------------|--------|
|                                                                                                                                                                                                            |   | **(Unaudited)**             |    |
| **ASSETS**                                                                                                                                                                                                      |   |                        |    |                    |   |
| **CURRENT ASSETS:**                                                                                                                                                                                             |   |                        |    |                    |   |
| Cash and cash equivalents                                                                                                                                                                                       |   | $                           | 2,097   |                    | $      | 5,436 |   |
| Accounts and notes receivable, less allowance for  doubtful accounts of $6,843 and $6,684, respectively                                                                                                         |   | 67,873                      |    | 82,385                  |   |
| Inventories                                                                                                                                                                                                     |   | 933                         |    | 796                     |   |
| Deferred income taxes                                                                                                                                                                                           |   | 6,072                       |    | 6,402                   |   |
| Prepaid expenses and other current assets                                                                                                                                                                       |   | 4,318                       |    | 5,281                   |   |
| Assets of discontinued operations                                                                                                                                                                               |   | 14,658                      |    | 9,718                   |   |
| Total current assets                                                                                                                                                                                            |   | 95,951                      |    | 110,018                 |   |
| **PROPERTY, PLANT AND EQUIPMENT,** net of accumulated depreciation of $53,393  and $54,509, respectively                                                                                                        |   | 35,902                      |    | 38,149                  |   |
| **GOODWILL**                                                                                                                                                                                                    |   | 324,305                     |    | 346,400                 |   |
| **INTANGIBLES,** net of amortization of $709 and $1,110, respectively                                                                                                                                           |   | 3,731                       |    | 5,494                   |   |
| **OTHER NONCURRENT ASSETS**                                                                                                                                                                                     |   | 10,384                      |    | 10,234                  |   |
| Total assets                                                                                                                                                                                                    |   | $                           | 470,273 |                    | $      | 510,295 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                  |   |                        |    |                    |   |
| **CURRENT LIABILITIES:**                                                                                                                                                                                        |   |                        |    |                    |   |
| Accounts payable and accrued liabilities                                                                                                                                                                        |   | $                           | 52,054  |                    | $      | 53,929 |   |
| Current maturities of long-term obligations                                                                                                                                                                     |   | 209                         |    | 232                     |   |
| Income tax payable                                                                                                                                                                                              |   | 2,186                       |    | 5,686                   |   |
| Liabilities of discontinued operations                                                                                                                                                                          |   | 5,423                       |    | 3,862                   |   |
| Total current liabilities                                                                                                                                                                                       |   | 59,872                      |    | 63,709                  |   |
| **LONG-TERM OBLIGATIONS,** net of current maturities                                                                                                                                                            |   | 73,390                      |    | 104,639                 |   |
| **DEFERRED INCOME TAXES**                                                                                                                                                                                       |   | 18,084                      |    | 20,625                  |   |
| **OTHER LONG-TERM OBLIGATIONS**                                                                                                                                                                                 |   | 7,839                       |    | 8,215                   |   |
| Total liabilities                                                                                                                                                                                               |   | 159,185                     |    | 197,188                 |   |
| **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, 16,150,184 and 15,806,244 shares issued and 16,094,156 and  15,750,216 outstanding at December 31, 2003 and June 30, 2004,  respectively |   | 162                         |    | 158                     |   |
| Additional paid-in-capital                                                                                                                                                                                      |   | 194,999                     |    | 195,528                 |   |
| Retained earnings                                                                                                                                                                                               |   | 119,236                     |    | 123,962                 |   |
|                                                                                                                                                                                                            |   | 314,397                     |    | 319,648                 |   |
| Less—Treasury stock, at cost, 56,028 shares                                                                                                                                                                |   | (982                        | )       | (982                    | )      |
| Less—Deferred compensation                                                                                                                                                                                 |   | (2,327                      | )       | (5,559                  | )      |
| Total stockholders’ equity                                                                                                                                                                                 |   | 311,088                     |    | 313,107                 |   |
| Total liabilities and stockholders’ equity                                                                                                                                                                 |   | $                           | 470,273 |                    | $      | 510,295 |   |

 

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

 

3

----

 

**SOURCECORP, INCORPORATED AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
|                                                   |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|--------------------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                                   |   | **2003**                               |   | **2004**                             |   | **2003** |   | **2004** |   |
|                                                   |   | **(Unaudited)**                        |   | **(Unaudited)**                      |   |
| **REVENUE**                                            |   | $                                      | 92,174 |                                 | $      | 97,450 |   | $ | 190,638 |   | $ | 199,209 |   |
| **COST OF SERVICES**                                   |   | 54,402                                 |   | 58,194                               |   | 111,241 |   | 115,335 |   |
| **DEPRECIATION**                                       |   | 3,044                                  |   | 2,983                                |   | 6,132 |   | 6,204 |   |
| Gross profit                                           |   | 34,728                                 |   | 36,273                               |   | 73,265 |   | 77,670 |   |
| **SELLING, GENERAL AND  ADMINISTRATIVE EXPENSES**      |   | 23,957                                 |   | 24,405                               |   | 47,750 |   | 55,793 |   |
| **AMORTIZATION**                                       |   | 88                                     |   | 312                                  |   | 177 |   | 401 |   |
| Operating income                                       |   | 10,683                                 |   | 11,556                               |   | 25,338 |   | 21,476 |   |
| **OTHER (INCOME) EXPENSE:**                            |   |                                   |   |                                 |   |   |   |   |   |
| Interest expense                                       |   | 1,005                                  |   | 698                                  |   | 2,415 |   | 1,357 |   |
| Interest income                                        |   | (4                                     | )      | (5                                   | )      | (257 | ) | (9 | ) |
| Other (income) expense, net                            |   | (325                                   | )      | 253                                  |   | (151 | ) | 373 |   |
| Income from continuing operations before income  taxes |   | 10,007                                 |   | 10,610                               |   | 23,331 |   | 19,755 |   |
| **PROVISION FOR INCOME TAXES**                         |   | 4,003                                  |   | 4,244                                |   | 9,332 |   | 7,902 |   |
| **NET INCOME FROM CONTINUING  OPERATIONS**             |   | 6,004                                  |   | 6,366                                |   | 13,999 |   | 11,853 |   |
| **LOSS FROM DISCONTINUED  OPERATIONS, NET OF TAX**     |   | (347                                   | )      | (1,813                               | )      | (163 | ) | (2,300 | ) |
| **NET INCOME**                                         |   | $                                      | 5,657  |                                 | $      | 4,553 |   | $ | 13,836 |   | $ | 9,553 |   |
| **NET INCOME PER COMMON SHARE**                        |   |                                   |   |                                 |   |   |   |   |   |
| **BASIC**                                              |   |                                   |   |                                 |   |   |   |   |   |
| **Continuing Operations**                              |   | $                                      | 0.37   |                                 | $      | 0.40 |   | $ | 0.84 |   | $ | 0.74 |   |
| **Discontinued Operations**                            |   | (0.02                                  | )      | (0.12                                | )      | (0.01 | ) | (0.14 | ) |
| **Total**                                              |   | $                                      | 0.35   |                                 | $      | 0.28 |   | $ | 0.83 |   | $ | 0.60 |   |
| **DILUTED**                                            |   |                                   |   |                                 |   |   |   |   |   |
| **Continuing Operations**                              |   | $                                      | 0.37   |                                 | $      | 0.39 |   | $ | 0.83 |   | $ | 0.72 |   |
| **Discontinued Operations**                            |   | (0.02                                  | )      | (0.11                                | )      | (0.01 | ) | (0.14 | ) |
| **Total**                                              |   | $                                      | 0.35   |                                 | $      | 0.28 |   | $ | 0.82 |   | $ | 0.58 |   |
| **WEIGHTED AVERAGE COMMON SHARES  OUTSTANDING**        |   |                                   |   |                                 |   |   |   |   |   |
| **BASIC**                                              |   | 16,319                                 |   | 16,014                               |   | 16,762 |   | 16,055 |   |
| **DILUTED**                                            |   | 16,381                                 |   | 16,374                               |   | 16,804 |   | 16,411 |   |

 

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

 

4

----

 

**SOURCECORP, INCORPORATED AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(IN THOUSANDS)**

 
|                                                                                      |   | **Six Months  Ended  June 30,** |   |
|-------------------------------------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                                      |   | **2003**                             |   | **2004** |   |
|                                                                                      |   | **(Unaudited)**                      |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                 |   |                                 |   |   |   |
| Net income from continuing operations                                                     |   | $                                    | 13,999 |   | $ | 11,853 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:        |   |                                 |   |   |   |
| Depreciation and amortization                                                             |   | 6,309                                |   | 6,605 |   |
| Deferred tax provision                                                                    |   | 4,023                                |   | 3,153 |   |
| Compensation expense on restricted stock grants                                           |   | 86                                   |   | 1,120 |   |
| (Gain) loss on sale of property, plant and  equipment                                     |   | (344                                 | )      | 125 |   |
| Change in operating assets and liabilities:                                               |   |                                 |   |   |   |
| Accounts and notes receivable                                                             |   | 5,435                                |   | (13,683 | ) |
| Inventories, prepaid expenses and other assets                                            |   | 173                                  |   | (332 | ) |
| Accounts payable and accrued liabilities                                                  |   | 8,331                                |   | (3,678 | ) |
| Net cash provided by operating activities from  continuing operations                     |   | 38,012                               |   | 5,163 |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                 |   |                                 |   |   |   |
| Purchase of property, plant and equipment                                                 |   | (6,454                               | )      | (8,339 | ) |
| Proceeds from disposition of property, plant and  equipment                               |   | 369                                  |   | 21 |   |
| Proceeds from divestitures                                                                |   | —                               |   | 750 |   |
| Cash paid for acquisitions, net of cash acquired                                          |   | (3,044                               | )      | (14,958 | ) |
| Net cash used for investing activities from  continuing operations                        |   | (9,129                               | )      | (22,526 | ) |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                 |   |                                 |   |   |   |
| Proceeds from exercise of common stock options                                            |   | 9                                    |   | 389 |   |
| Cash paid for common stock repurchased                                                    |   | (18,091                              | )      | (9,298 | ) |
| Proceeds from long-term obligations                                                       |   | 111,946                              |   | 174,634 |   |
| Principal payments on long-term obligations                                               |   | (125,101                             | )      | (143,510 | ) |
| Cash paid for debt issuance costs                                                         |   | (305                                 | )      | — |   |
| Net cash (used for) provided by financing  activities from continuing operations          |   | (31,542                              | )      | 22,215 |   |
|                                                                                      |   |                                 |   |   |   |
| Net cash provided (used) by discontinued  operations                                      |   | 2,164                                |   | (1,513 | ) |
|                                                                                      |   |                                 |   |   |   |
| **NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS**                                  |   | (495                                 | )      | 3,339 |   |
| **CASH AND CASH EQUIVALENTS,** beginning of period                                        |   | 3,217                                |   | 2,097 |   |
| **CASH AND CASH EQUIVALENTS,** end of period                                              |   | $                                    | 2,722  |   | $ | 5,436 |   |
| **SUPPLEMENTAL DATA:**                                                                    |   |                                 |   |   |   |
| Cash paid for:                                                                            |   |                                 |   |   |   |
| Income taxes, net of income tax refunds                                                   |   | $                                    | 1,115  |   | $ | 609 |   |
| Interest                                                                                  |   | $                                    | 2,229  |   | $ | 1,352 |   |
| **NONCASH FINANCING TRANSACTIONS:**                                                       |   |                                 |   |   |   |
| Assets acquired through financing and capital  lease arrangements                         |   | $                                    | 40     |   | $ | 147 |   |
| Restricted stock grants (164,300 and 177,300  shares, respectively)                       |   | $                                    | 2,949  |   | $ | 4,486 |   |
| Common stock issued related to business  acquisitions (20,268 and 0 shares, respectively) |   | $                                    | (94    | ) | $ | — |   |
| Common stock accrued related to business  acquisitions (0 and 9,623 shares, respectively) |   | $                                    | — |   | $ | 261 |   |

 

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

 

5

----

 

**SOURCECORP, INCORPORATED AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1. Basis of Presentation**

 

Theaccompanying condensed consolidated financial statements and related notes tothe condensed consolidated financial statements include the accounts ofSOURCECORP, Incorporated and subsidiaries (collectively, the “Company”).

 

Inthe opinion of management, the accompanying condensed consolidated financialstatements include all accounts and the adjustments necessary to present fairlythe Company’s financial position at June 30, 2004, results of operationsfor the three and six months ended June 30, 2003 and 2004, and cash flowsfor the six months ended June 30, 2003 and 2004. All significantintercompany transactions have been eliminated. Although management believesthat the disclosures are adequate to make the information presented notmisleading, certain information and footnote disclosures normally included inannual financial statements prepared in accordance with generally acceptedaccounting principles have been condensed or omitted pursuant to the rules andregulations of the Securities and Exchange Commission (the “Commission”). Thesecondensed consolidated financial statements should be read in conjunction withthe Company’s consolidated financial statements and the related notes theretoin the Annual Report on Form 10-K filed with the Commission on March 12,2004. The results of operations for the three and six months endedJune 30, 2003 and 2004 may not be indicative of the results for the fullyear.

 

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

 

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

 

*Stock-Based Compensation*

 

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

 

TheBoard of Directors has appointed a committee (the “Committee”) to administerthe 2002 Plan. Persons eligible to receive awards under the plan includedirectors, officers, employees of the Company and its subsidiaries, and personswho provide consulting services to the Company deemed by the Committee to be ofsubstantial value to the Company, persons who have been offered employment bythe Company or its subsidiaries, and persons employed by an entity that theCommittee reasonably expects to become a subsidiary of the Company. Awardsgranted under the 2002 Plan may, at the discretion of the Committee, be grantedeither alone or in addition to, in tandem with or in substitution for any otheraward granted under the 2002 Plan or any other plan of the Company, anysubsidiary or any business entity to be acquired by the Company or one of itssubsidiaries. The Committee determines vesting in awards granted under the 2002Plan.

 

6

----

 

TheCompany applies Accounting Principles Board Opinion (“APB”) No. 25, *Accounting for Stock Issued to Employees*and related interpretations in accounting for stock-based compensation andawards. Stock option and warrant awards are granted at the market price of thecommon stock on the date of grant. Accordingly, no compensation expense hasbeen recognized for stock options and warrants. Had compensation expense beendetermined based upon the fair value at grant dates for stock options andwarrants consistent with the method of Statement of Financial AccountingStandards (“SFAS”) No. 123, *Accounting forStock-Based Compensation,* the Company’s net income and earnings pershare would have been as follows (in thousands, except per share data):

 
|                                                                                                                                 |   | **Three  Months  Ended June 30,** |   | **Six Months  Ended  June 30,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                                                                                                                 |   | **2003**                               |   | **2004**                             |   | **2003** |   | **2004** |   |
| Net income as reported                                                                                                               |   | $                                      | 5,657  |                                 | $      | 4,553 |   | $ | 13,836 |   | $ | 9,553 |   |
| Add: Deferred compensation expense included in  reported net income, net of related tax effect                                       |   | 55                                     |   | 320                                  |   | 55 |   | 652 |   |
| Deduct: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of tax  effect |   | (909                                   | )      | (676                                 | )      | (1,738 | ) | (1,585 | ) |
| Proforma net income                                                                                                                  |   | $                                      | 4,803  |                                 | $      | 4,197 |   | $ | 12,153 |   | $ | 8,620 |   |
| Earnings per share:                                                                                                                  |   |                                   |   |                                 |   |   |   |   |   |
| Reported basic earnings per share                                                                                                    |   | $                                      | 0.35   |                                 | $      | 0.28 |   | $ | 0.83 |   | $ | 0.60 |   |
| Proforma basic earnings per share                                                                                                    |   | $                                      | 0.29   |                                 | $      | 0.26 |   | $ | 0.73 |   | $ | 0.54 |   |
| Reported diluted earnings per share                                                                                                  |   | $                                      | 0.35   |                                 | $      | 0.28 |   | $ | 0.82 |   | $ | 0.58 |   |
| Proforma diluted earnings per share                                                                                                  |   | $                                      | 0.29   |                                 | $      | 0.26 |   | $ | 0.72 |   | $ | 0.53 |   |

 

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

 
|                                     |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                     |   | **2003**                               |   | **2004**                             |   | **2003** |   | **2004** |   |
| Weighted-average risk-free interest rate |   | 2.4                                    | %      | 3.6                                  | %      | 2.4 | % | 3.3 | % |
| Weighted-average dividend yield          |   | 0.0                                    | %      | 0.0                                  | %      | 0.0 | % | 0.0 | % |
| Weighted-average volatility              |   | 44.3                                   | %      | 41.6                                 | %      | 44.3 | % | 41.5 | % |
| Weighted-average expected life           |   | 3.1 years                              |   | 4.0 years                            |   | 3.1 years |   | 4.0 years |   |

 

Duringthe three months ended June 30, 2003, the Company awarded 164,300 sharesof restricted stock under the 2002 Plan. The restricted shares were issued atno cost to the recipients; therefore, the Company recorded deferredcompensation of approximately $2.9 million based on the market value of thestock at the date of issuance. Subsequent to the grant date, certain forfeitures of restricted stockhave occurred resulting in a total award of 155,000 shares and total deferredcompensation of $2.8 million.  Thedeferred compensation charge is being amortized to expense over the vestingperiod of the restricted stock. The restricted shares vest over a three-yearperiod ending July 1, 2006, with acceleration of the vesting periodoccurring if a certain stock price or performance target is achieved. For thethree months ended June 30, 2003 and 2004, approximately $0.1 and $0.2million, respectively, of deferred compensation was amortized to expenserelated to this grant.  For the sixmonths ended June 30, 2003 and 2004, approximately $0.1 and $0.5 million,respectively, of deferred compensation was amortized to expense related to thisgrant.

 

Duringthe three months ended March 31, 2004, the Company awarded 132,000 sharesof restricted stock under the 2002 Plan. The restricted shares were issued at no cost to the recipients;therefore, the Company recorded deferred compensation of approximately $3.5million based on the market value of the stock at the date of issuance.  Subsequent to the grant date, certainforfeitures of restricted stock have occurred resulting in a total award of126,750 shares and total deferred compensation of $3.3 million.  The deferred compensation charge is beingamortized to expense over the vesting period of the restricted stock.  The restricted shares vest at the end of athree-year period ending January 10, 2007, with acceleration of thevesting period occurring if certain performance targets are achieved.  For the three and six months endedJune 30, 2004, approximately $0.2 million and $0.5 million of deferredcompensation was amortized to expense related to this grant.

 

Duringthe three months ended June 30, 2004, the Company awarded 50,550 shares ofrestricted stock under the 2002 Plan. The restricted shares were issued at no cost to the recipients;therefore, the Company recorded deferred compensation of approximately $1.2 millionbased on the market value of the stock at the date of issuance.  The deferred compensation charge is beingamortized to expense over the vesting period of the restricted stock.  The restricted shares vest on January 10,2007 and May 26, 2007, with acceleration of the vesting period for certainshares occurring if certain performance targets are achieved.  For the three months ended June 30,2004, approximately $0.1 million of deferred compensation was amortized toexpense related to this grant.

 

Totaldeferred compensation amortized to expense related to the restricted stockgrants was approximately $0.5 million and $1.1 million during the three and sixmonths ended June 30, 2004, respectively, and approximately $0.1 millionduring the three and six months ended June 30, 2003.

 

7

----

 

*Common Stock Repurchase Program*

 

During 2003, the Company activated the $30.0 million stock repurchaseprogram authorized by the Board of Directors in April 2001 and purchased1,306,979 shares of its common stock at a cost of approximately $20.7million.  During the three months endedJune 30, 2004, the Company purchased an additional 361,415 shares of itscommon stock at a cost of approximately $9.3 million completing the originalrepurchase program.  The repurchased shareswere recorded in the accompanying balance sheet as a reduction to common stock,additional paid-in-capital, and retained earnings.  These shares have been retired and returned to the status ofauthorized but unissued shares of the Company. During the third quarter of 2004, the Board of Directors authorized thepurchase of an additional $20 million of shares from time to time in the openmarket as conditions warrant.  TheCompany intends to repurchase additional shares through the new authorization ofthe Board of Directors although no shares have been repurchased through the newauthorization.

 

*Net Income Per Share:*

 

Basicand diluted net income per common share were computed in accordance with SFASNo. 128, *Earnings Per Share*. Thedifferences between basic weighted average common shares and diluted weightedaverage common shares and common stock equivalents are as follows (inthousands):

 
|                                                                               |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|------------------------------------------------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                                                               |   | **2003**                               |   | **2004**                             |   | **2003** |   | **2004** |   |
| Basic weighted average common shares                                               |   | 16,319                                 |   | 16,014                               |   | 16,762 |   | 16,055 |   |
| Weighted average options, warrants, restricted  stock and contingent consideration |   | 62                                     |   | 360                                  |   | 42 |   | 356 |   |
| Diluted weighted average common shares                                             |   | 16,381                                 |   | 16,374                               |   | 16,804 |   | 16,411 |   |

 

AtJune 30, 2003 and 2004, approximately 3.7 million and 2.0 million,respectively, of common stock equivalents were not included in the dilutedearnings per share calculation because they were anti-dilutive.  These common stock equivalents may bedilutive to future earnings per share calculations.

 

**3. Discontinued Operations**

 

During the first quarter of 2004, the Companycompleted a strategic evaluation of its operations based on certain criteria,such as strategic and financial fit, and future growth prospects.  As a result, on May 6, 2004, the Companyformally committed to a plan of divestiture for certain non-strategic assetgroups related to its Direct Mail operations reported in the InformationManagement and Distribution segment in prior periods, and two medical recordsmanagement operations reported in the Healthcare, Regulatory and LegalCompliance segment in prior periods.

 

During the second quarter of 2004, the Company completed the sale ofone of the medical records management operations, which resulted inapproximately $0.8 million of cash proceeds and a pre-tax gain on disposal ofapproximately $0.5 million.  Inaddition, the Company reclassified the operating assets and liabilities of theDirect Mail operations and the remaining medical records management operationas held-for-sale during the second quarter of 2004 and subsequently completedthe sale of these operations in the third quarter of 2004.  The Company recognized an estimated pre-taxloss on disposal related to the Direct Mail operations of approximately $2.2 millionin the second quarter of 2004.  Anyadjustments related to the loss on disposal of the Direct Mail operations willbe recorded through the date on which the transaction closed.  The sale of the remaining medical recordsmanagement operation is expected to yield a gain on disposal and will berecorded on the closing date.  The saleof the Direct Mail operations and the remaining medical records managementoperation yielded approximately $6.4 million of cash proceeds during the thirdquarter of 2004 and approximately $2.2 million of subordinated notes andcontingent consideration due over the next two years that could result in afuture reduction to the loss on disposal for these two transactions,collectively.

 

The Direct Mail operations and the two medical records managementoperations are accounted for as discontinued operations and as such, theirresults are presented in the Condensed Consolidated Statement of Operations asIncome (Loss) from Discontinued Operations, net of tax.

 

8

----

 

Summarized selected financial information for the discontinuedoperations is as follows:

 
|                                                   |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|--------------------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                                   |   | **2003**                               |   | **2004**                             |   | **2003** |   | **2004** |   |
|                                                   |   | **(Unaudited)**                        |   | **(Unaudited)**                      |   |
| **REVENUE**                                            |   | $                                      | 9,596  |                                 | $      | 6,937 |   | $ | 20,657 |   | $ | 15,526 |   |
| **COST OF SERVICES**                                   |   | 7,245                                  |   | 6,332                                |   | 14,918 |   | 12,732 |   |
| **DEPRECIATION**                                       |   | 423                                    |   | 128                                  |   | 871 |   | 529 |   |
| Gross profit                                           |   | 1,928                                  |   | 477                                  |   | 4,868 |   | 2,265 |   |
| **SELLING, GENERAL AND  ADMINISTRATIVE EXPENSES**      |   | 2,522                                  |   | 1,735                                |   | 5,162 |   | 4,346 |   |
| **AMORTIZATION**                                       |   | —                                 |   | —                               |   | — |   | — |   |
| Operating loss                                         |   | (594                                   | )      | (1,258                               | )      | (294 | ) | (2,081 | ) |
| **OTHER (INCOME) EXPENSE:**                            |   |                                   |   |                                 |   |   |   |   |   |
| Interest and other expense (income), net               |   | (15                                    | )      | 32                                   |   | (22 | ) | 21 |   |
| Loss on sale of asset groups                           |   | —                                 |   | 1,732                                |   | — |   | 1,732 |   |
| Loss from discontinued operations before income  taxes |   | (579                                   | )      | (3,022                               | )      | (272 | ) | (3,834 | ) |
| **PROVISION FOR INCOME TAXES**                         |   | (232                                   | )      | (1,209                               | )      | (109 | ) | (1,534 | ) |
| **NET LOSS FROM DISCONTINUED  OPERATIONS**             |   | $                                      | (347   | )                                    | $      | (1,813 | ) | $ | (163 | ) | $ | (2,300 | ) |
| **NET LOSS PER COMMON SHARE**                          |   |                                   |   |                                 |   |   |   |   |   |
| **BASIC**                                              |   |                                   |   |                                 |   |   |   |   |   |
| **Discontinued Operations**                            |   | $                                      | (0.02  | )                                    | $      | (0.12 | ) | $ | (0.01 | ) | $ | (0.14 | ) |
| **DILUTED**                                            |   |                                   |   |                                 |   |   |   |   |   |
| **Discontinued Operations**                            |   | $                                      | (0.02  | )                                    | $      | (0.11 | ) | $ | (0.01 | ) | $ | (0.14 | ) |
| **WEIGHTED AVERAGE COMMON SHARES  OUTSTANDING**        |   |                                   |   |                                 |   |   |   |   |   |
| **BASIC**                                              |   | 16,319                                 |   | 16,014                               |   | 16,762 |   | 16,055 |   |
| **DILUTED**                                            |   | 16,381                                 |   | 16,374                               |   | 16,804 |   | 16,411 |   |

 

The assets and liabilities of the discontinued operations are statedseparately on the Condensed Consolidated Balance Sheets.  The major asset and liability categories areas follows:

 
|                                                                   |   | **December 31,  2003** |   | **June 30,  2004** |   |
|------------------------------------------------------------------------|--------|-----------------------------|--------|-------------------------|--------|
|                                                                   |   | **(Unaudited)**             |   |
| **ASSETS OF  DISCONTINUED OPERATIONS**                                 |   |                        |   |                    |   |
| **CURRENT ASSETS:**                                                    |   |                        |   |                    |   |
| Accounts and notes receivable, net of allowance  for doubtful accounts |   | 5,693                       |   | 4,069                   |   |
| Inventories                                                            |   | 1,130                       |   | 820                     |   |
| Prepaid expenses and other current assets                              |   | 730                         |   | 503                     |   |
| Total current assets                                                   |   | 7,553                       |   | 5,392                   |   |
| **PROPERTY, PLANT AND EQUIPMENT,** net of accumulated depreciation     |   | 6,923                       |   | 4,168                   |   |
| **OTHER NONCURRENT ASSETS**                                            |   | 182                         |   | 158                     |   |
| Total assets of discontinued operations                                |   | $                           | 14,658 |                    | $      | 9,718 |   |
| **LIABILITIES  OF DISCONTINUED OPERATIONS**                            |   |                        |   |                    |   |
| **CURRENT LIABILITIES:**                                               |   |                        |   |                    |   |
| Accounts payable and accrued liabilities                               |   | $                           | 5,423  |                    | $      | 3,862 |   |
| Total liabilities of discontinued operations                           |   | $                           | 5,423  |                    | 3,862  |   |

 

9

----

 

**4. Business Combinations**

 

*2004 Acquisition*

 

On April 15, 2004, the Company acquired 100% of the membershipinterests of KeyPoint Consulting LLC (“KeyPoint”), located in Emeryvilleand Los Angeles, California.  Theaggregate consideration paid during the second quarter for KeyPoint consistedof $13.7 million in cash. In addition, the former members of KeyPoint areeligible to receive up to an additional $1.5 million in cash if there isno breach in representations and warranties of the acquisition agreement. Theallocation of the purchase price is set forth below (in thousands):

 
| Total consideration                                |   | $      | 15,020 |   |
|----------------------------------------------------|--------|--------|--------|--------|
| Less Estimated Fair Value of Identifiable  Assets: |   |   |   |
| Cash                                               |   | (1,427 | )      |
| Receivables                                        |   | (1,000 | )      |
| Prepaid expenses                                   |   | (21    | )      |
| Property, plant and equipment, net                 |   | (112   | )      |
| Total Assets                                       |   | (2,560 | )      |
| Plus Estimated Fair Value of Liabilities:          |   |   |   |
| Accounts payable and accrued expenses              |   | 1,393  |   |
| Accrued compensation                               |   | 233    |   |
| Deferred tax liability                             |   | 32     |   |
| Other liabilities                                  |   | 753    |   |
| Total Liabilities                                  |   | 2,411  |   |
| Goodwill and other intangibles                     |   | $      | 14,871 |   |

 

Of the $14.9 million of goodwill and other intangibles recordedfrom the acquisition, approximately $0.3 million was assigned to customerrelationships with a useful life of eight months and approximately $1.9 millionwas assigned to non-compete agreements with a useful life of four years.The remaining goodwill of $12.7 million will be tested annually forimpairment.  Approximately $4.6 millionof the goodwill is deductible for tax purposes.

 

*Goodwill and Intangibles*

 

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

 

Goodwill:

 
|                                   |   | **Information  Management and  Distribution** |    | **Healthcare,  Regulatory  and Legal  Compliance** |   | **Total** |   |
|----------------------------------------|--------|-----------------------------------------------|---------|----------------------------------------------------|--------|-----------|--------|
| Net balance as of January 1, 2004 |   | $                                             | 192,337 |                                               | $      | 131,968   |   | $ | 324,305 |   |
| Goodwill acquired                      |   | —                                        |    | 12,708                                             |   | 12,708    |   |
| Additional accrued consideration       |   | 8,881                                         |    | 506                                                |   | 9,387     |   |
| Net balance as of June 30, 2004   |   | $                                             | 201,218 |                                               | $      | 145,182   |   | $ | 346,400 |   |

 

Intangibles:

 
|                   |   | **June 30,  2004**   |   |
|------------------------|--------|---------------------------|--------|
|                   |   | **Gross  Carrying Value** |   | **Accumulated  Amortization** |   | **Net  Intangibles** |   |
| Customer Relationships |   | $                         | 4,283  |   | $ | (773 | ) | $ | 3,510 |   |
| Non Compete Agreements |   | 2,321                     |   | (337 | ) | 1,984 |   |
| Total                  |   | $                         | 6,604  |   | $ | (1,110 | ) | $ | 5,494 |   |

 

10

----

 

Aggregateamortization expense related to intangibles for the six months endedJune 30, 2004 was $0.4 million. Estimated amortization expense for theperiods ending December 31, 2004 through December 31, 2016 ispresented in the table below.

 
| **Years Ending December 31,** |   | **Estimated  Amortization  Expense** |   |
|------------------------------------|--------|--------------------------------------|--------|
|                               |   | **(in  thousands)**                  |   |
| 2004                               |   | $                                    | 991    |   |
| 2005                               |   | 825                                  |   |
| 2006                               |   | 825                                  |   |
| 2007                               |   | 737                                  |   |
| 2008                               |   | 384                                  |   |
| 2009 through 2016                  |   | 2,133                                |   |
| Total                              |   | $                                    | 5,895  |   |

 

*Contingent Consideration*

 

Certain of the Company’s acquisitions are subject to adjustments inoverall consideration and recorded goodwill based upon the achievement ofspecified revenue and/or earnings targets generally over one to three yearperiods. In certain agreements, the Company reserves the right to change thepayment mix to use common stock versus cash in satisfying contingentconsideration liabilities. In transactions where the Company acquired asubsidiary through a tax-free stock merger, the Company is required to pay aminimum amount of total consideration in common stock rather than cash, includingany contingent consideration payments.

 

As of June 30, 2004, approximately $10.6 million ofadditional consideration is accrued of which $9.8 million is classified asaccounts payable and accrued liabilities and is expected to be settled in cashand $0.8 million is classified as additional paid-in-capital and isexpected to be settled in common stock with final valuation determined at dateof issuance.

 

Not all of the periods applicable for earnout targets are completed andadditional amounts may be payable in future periods under the terms of theagreements.  If all earnout targetsunder the current agreements were achieved, the maximum contingentconsideration to be paid would be $17.8 million, including the $10.6million accrued at June 30, 2004, with approximately $12.5 million tobe paid in 2004 and approximately $5.3 million to be paid in 2005.  In accordance with the agreements, theCompany would be required to satisfy approximately $0.8 million of the$17.8 million potential liability in common stock related to a pasttax-free stock merger and has the option to satisfy $9.2 million of the$17.8 million potential liability in common stock with final valuation forthe number of shares to be determined at date of issuance.  The remaining potential liability would bepaid in cash, as specified in the agreements.

 

# *Other Accrued Consideration*

# * *

During the first quarter of 2004, the Company accrued additionalpurchase proceeds of approximately $0.4 million pursuant to the purchaseagreement of a past acquisition.  Thisamount is classified as accounts payable and accrued liabilities and isexpected to be paid in cash during 2004.

 

During the three months ended June 30, 2004, the Company accruedadditional purchase proceeds of approximately $1.5 million related to theKeyPoint acquisition.  This amount isclassified as accounts payable and accrued liabilities and, provided there isno breach of representations or warranties of the acquisition agreement, isexpected to be paid in cash during 2004.

 

## *Acquisition Related Payments*

##  

During the six months ended June 30, 2004, the Company paid netconsideration of approximately $2.7 million in cash related to contingentconsideration agreements of past acquisitions. In addition, the Company paid $12.3 million, net of cash acquired,related to the KeyPoint acquisition and the associated transaction costs.

 

**5. Segment Reporting**

 

The Company aggregates its service offerings and operations into tworeportable segments: (i) Information Management and Distribution, and(ii) Healthcare, Regulatory, and Legal Compliance. The Company’sreportable segments are organized around customer types and service offeringspossessing similar economic characteristics. Management evaluates segmentperformance based on revenue, operating income, and income before income taxes.All centrally incurred corporate costs are allocated to the segments basedprincipally on operating income. The reporting segments follow the sameaccounting policies used for the Company’s consolidated financial statements asdescribed in the summary of critical accounting policies.

 

11

----

 

The identified segments are as follows:

 

**Information Management and Distribution.**  This segment offers Business ProcessOutsourcing (“BPO”) solutions that help its customers manage the *Document In-flow*, *Workflow Processing* and *Statement Out-flow* of their missioncritical business document processes. This segment’s BPO solutions enablecustomers to automate their complex workflow processes by digitizing extremelylarge volumes of documents, capturing information from the documents, hostingelectronic documents on the Company’s Web-based repository, and preparingstatements that customers mail or present electronically to their end users.

 

**Healthcare, Regulatory and Legal Compliance.**  This segment offers specializedknowledge-based processing and consulting services that include medical recordsrelease, record management services for healthcare institutions, temporarystaffing for healthcare institutions, managed care compliance reviews, classaction claims administration, and professional economic research and litigationservices.

 

TheCompany measures segment profit as income before income taxes. Information onthe segments follows (in thousands):

 
|                       |   | **THREE  MONTHS ENDED JUNE 30, 2004**     |   |
|----------------------------|--------|------------------------------------------------|--------|
|                       |   | **Information  Management  and  Distribution** |   | **Healthcare,  Regulatory  and Legal  Compliance** |   | **Consolidated** |   |
| Revenue                    |   | $                                              | 53,884 |   | $ | 43,566 |   | $ | 97,450 |   |
| Income before income taxes |   | 4,761                                          |   | 5,849 |   | 10,610 |   |
|                            |        |                                                |        |  |  |  |  |  |  |  |

 
|                       |   | **THREE MONTHS ENDED JUNE 30, 2003**          |   |
|----------------------------|--------|----------------------------------------------------|--------|
|                       |   | **Information  Management**

**and  Distribution** |   | **Healthcare,  Regulatory  and Legal  Compliance** |   | **Consolidated** |   |
| Revenue                    |   | $                                                  | 52,890 |   | $ | 39,284 |   | $ | 92,174 |   |
| Income before income taxes |   | 5,657                                              |   | 4,350 |   | 10,007 |   |
|                            |        |                                                    |        |  |  |  |  |  |  |  |

 
|                       |   | **SIX MONTHS ENDED JUNE 30, 2004**        | ** ** |
|----------------------------|--------|------------------------------------------------|------------|
|                       |   | **Information  Management  and  Distribution** |       | **Healthcare,  Regulatory  and Legal  Compliance** |   | **Consolidated** |   |
| Revenue                    |   | $                                              | 111,175    |   | $ | 88,034 |   | $ | 199,209 |   |
| Income before income taxes |   | 7,621                                          |       | 12,134 |   | 19,755 |   |
|                            |        |                                                |            |  |  |  |  |  |  |  |

 
|                       |   | **SIX MONTHS ENDED JUNE 30, 2003**        |    |
|----------------------------|--------|------------------------------------------------|---------|
|                       |   | **Information  Management  and  Distribution** |    | **Healthcare,  Regulatory  and Legal  Compliance** |   | **Consolidated** |   |
| Revenue                    |   | $                                              | 108,017 |   | $ | 82,621 |   | $ | 190,638 |   |
| Income before income taxes |   | 13,007                                         |    | 10,324 |   | 23,331 |   |
|                            |        |                                                |         |  |  |  |  |  |  |  |

 

**6.****              Litigation**

 

The Company is, from time to time, a party to litigation arising in thenormal course of business. The following is a brief description of some of thelegal matters that the Company is involved in. Management believes that none of these actions, will have a materialadverse effect on its business or financial condition.  However, in the event of an adverse outcomein one or more of the legal proceedings, operating results for a given quartermay be negatively impacted.

 

*Healthcare Marketing Associates, Inc.vs. Managed Care Professionals, Inc.*

 

On February 9, 1995, prior to the acquisition by the Company,Managed Care Professionals, Inc. (one of the Company’s wholly-ownedsubsidiaries) (“MCP”) entered into an “Exclusive Marketing Agreement” withHealthcare Marketing Associates, Inc. (“HMA”) whereby MCP granted to HMAthe exclusive right to market, and HMA agreed to market exclusively for MCP,the MCP products and services to health care providers in the United States forwhich MCP agreed to pay HMA a percentage (30%) of gross revenues paid to MCP bythe provider (customer). The duration of the Agreement was for a period of five(5) years and expired on February 9, 2000 (“Termination Date”). OnApril 27, 2001, HMA filed a lawsuit against MCP in the Circuit Court ofthe County of St. Louis, State of Missouri, alleging entitlement to commissionson revenues generated after the Termination Date from providers who

 

12

----

 

were initially brought to MCP prior to the Termination Date. InMarch 2003, this lawsuit was tried before a judge and at the conclusion ofthe trial, the judge ruled in the plaintiff’s favor in the amount of$1.782 million plus prejudgment and post judgment interest, which equatedto approximately $2.4 million in total as of December 31, 2003. Thejudgment amount plus prejudgment interest costs were included in the Company’s2002 results. Post judgment interest accrues at a statutory 9% rate.  The Company has appealed this ruling andoral arguments for our appeal were heard on February 24, 2004.  On May 4, 2004, the Court of Appealsaffirmed the Circuit Court’s judgment. On July 23, 2004, the Company filed an application for transfer ofits appeal to the state’s Supreme Court.

 

*Various ROI Copy Charge Matters*

 

From time to time, various subsidiaries of the Company that performrelease of information (“ROI”) services become defendants to putative classaction lawsuits generally alleging that the charge for reproducing certainmedical records is not in conformity with such plaintiffs’ reading of the applicableregulated charge. Such suits typically include multiple ROI companies andhospitals as defendants and demand reimbursement for prior charges as well asfor prospective pricing adjustments. The Company is currently a party toseveral such suits in various stages of development. The Company believes ithas meritorious defenses and intends to continue to vigorously defend anyclaims made against it in these matters.

 

*Mattel v. SOURCECORP*

 

On February 18, 2003, Mattel, Inc. filed suit against theCompany in the Los Angeles County California Superior Court. In the suit, theplaintiff alleged that one of the Company’s subsidiaries is liable for the lossof various products, prototypes and paper documents allegedly stored at one ofthe subsidiary’s box storage facilities under theories of breach of contract,breach of fiduciary duty, negligence, breach of implied covenants of good faithand fair dealing and/or conversion. The plaintiff at various times allegeddamages ranging from “in excess of $2.5 million,” to approximately$20 million.  This matter wassettled prior to trial, the terms of which settlement are confidential. Thesettlement and related legal costs impacted the Company’s first quarter 2004pre-tax earnings by approximately $3.9 million with no future earnings impactexpected.  Furthermore, the impact ofthe settlement and related legal costs on the Company’s 2004 cash provided byoperating activities will be a net payment of approximately $5.7 million, beforeconsideration of taxes.

 

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

 

In June 2000, the Company filed an action styled *F.Y.I. Incorporated v. Spohr, et. al.* inDallas, Texas, in which it asserted claims for breach of contract, fraud, andnegligent misrepresentation against the sellers of two related companies theCompany acquired in December 1998 (the “Texas Action”). The Texas Actionwas later removed to federal court and ultimately dismissed on jurisdictionalgrounds. The Company reasserted these claims in two actions that were laterconsolidated; one styled *F.Y.I. Incorporatedv. Spohr, et. al.* in Superior Court of the State of California inthe County of Sacramento, Case No. 01-AS-00721 (the “Sacramento Action”)and one styled *Spohr, et. al. v. F.Y.I.Incorporated, et. al.* in the Superior Court of the State ofCalifornia in the County of San Francisco, Case No. 318703 (the “SanFrancisco Action”). In the consolidated action, the Company additionally filedclaims against the sellers’ accountants and the two sellers filed claims againstthe Company; however, in February 2004, the judge in the Sacramento Actiondismissed the Company’s claims against the sellers’ accountants. The sellersallege that the Company’s former subsidiary wrongfully failed and refused toexecute and deliver a requested estoppel certificate, and that the failure toprovide such estoppel certificate harmed the landlord in that they wereallegedly denied favorable terms on a refinancing of the property and wereallegedly prevented from completing a timely sale of the property. Sellersallege damages of approximately $1.5 million. The Company has asserteddamages in excess of $8 million. The Company believes it has meritoriousdefenses to sellers’ claims and intends to vigorously defend any claims madeagainst it in this matter.

 

13

----

 

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

 

Thefollowing discussion should be read in conjunction with our financial statements and the related notesthereto appearing elsewhere in this Report on Form 10-Q.

 

**Overview**

 

We were founded in September 1994, to create a national, singlesource provider of document and information outsourcing solutions to documentand information intensive industries, including healthcare, legal and tax,financial services, federal and state government, and other commercialservices.

 

We acquired the seven Founding Companies (the “Founding Companies”)simultaneously with the closing of our initial public offering (the “IPO”) onJanuary 26, 1996, and effectively began operations at that time. Theconsideration for the Founding Companies consisted of a combination of cash andcommon stock of our Company.  Since theIPO and through December 31, 2003, we acquired 65 companies and divested17 operating units by sales or closures. We evaluate candidates for acquisitionand periodically for divestiture as a part of our strategic plan of providingcustomers a single solution for business process outsourcing andknowledge-based processing and consulting services. The criteria for evaluationinclude geographic need, additional technology, market growth potential,industry expertise, service expansion to broaden service offerings, expansionof our customer base, revenue and earnings growth potential, and expectedsources and uses of capital.

 

On May 4, 2004, we announced the acquisition of KeyPoint Consulting,LLC (“KeyPoint”).  KeyPoint, located inEmeryville and Los Angeles, California, provides economic, financial, andforensic accounting services to law firms, corporations and governmentagencies.  KeyPoint merged with ourlegal consulting service offering and is reported in the Healthcare, Regulatoryand Legal Compliance segment.  Onceintegrated into the Company’s current legal consulting service offering,Keypoint is expected to contribute to earnings during 2005 after relatedintangible amortization and acquisition financing costs.

 

During the first quarter of 2004, we completed a strategic evaluationof our operations based on certain criteria, such as strategic and financialfit, and future growth prospects.  As aresult, on May 6, 2004, we formally committed to a plan of divestiture forcertain non-strategic asset groups.  Theasset groups to be divested include the Direct Mail operations, previouslyreported in our Information Management and Distribution segment, and twomedical records management operations that were reported in our Healthcare,Regulatory and Legal Compliance segment. Collectively, these asset groupsincurred losses, net of tax, of $0.8 million for the full year endedDecember 31, 2003.  During thequarter ended June 30, 2004, we completed the sale of one of the medicalrecords management operations.  Thedivestiture of the other medical records management operation and the DirectMail operations were completed during the quarter to end September 30,2004.  See Note 3, DiscontinuedOperations, of Notes to Condensed Consolidated Financial Statements, for a moredetailed discussion, including the adjustments that were recorded during thecurrent quarter.

 

**Basis for Management Discussion and Analysis**

 

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

 

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

 

Costof services consists primarily of compensation and benefits to employeesproviding goods and services to our clients; occupancy and facility costs;equipment costs and supplies. Our cost of services also includes the cost ofproducts sold for micrographics supplies and equipment; computer hardware andsoftware; and business imaging supplies and equipment.

 

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

 

14

----

 

**Business Segments**

 

We aggregate our service offerings and operations into two reportablesegments: (i) Information Management and Distribution, and(ii) Healthcare, Regulatory, and Legal Compliance. Service offerings areaggregated when they are similar in the following areas: economiccharacteristics, products and services, production processes, methods fordistributing or delivering products, and type or class of customers. Weevaluate segment performance based on revenue, operating income, and incomebefore income taxes. All centrally incurred corporate costs are allocated tothe segments based principally on operating income. The reporting segmentsfollow the same accounting policies used for our consolidated financialstatements as described in the summary of critical accounting policies.  The identified segments are as follows:

 

**Information Management and Distribution.**  We offer Business Process Outsourcing(“BPO”) solutions that help our customers manage the *Document In-flow*, *WorkflowProcessing* and *Statement Out-flow*of their mission critical document processes. Our BPO solutions enablecustomers to automate their complex workflow processes by digitizing extremelylarge volumes of documents, capturing information from the documents, hostingelectronic documents on our Web-based repository, and preparing statements thatcustomers mail or present electronically to their end users.  We offer our BPO solutions to businesses indocument intensive industries, such as healthcare, financial services, federaland state government, and other commercial services vertical industries.  For the three months ended June 30,2003 and 2004, revenue in the Information Management and Distribution segmentconsisted of approximately $46.4 million and $48.4 million of recurringrevenue, respectively, and $6.5 million and $5.5 million of project revenue,respectively.  For the six months ended June 30, 2003 and 2004, revenue in theInformation Management and Distribution segment consisted of approximately$93.9 million and $98.3 million of recurring revenue, respectively andapproximately $14.1 million and $12.9 million of project revenue, respectively.

 

**Healthcare, Regulatory and Legal Compliance.**  We offer specialized knowledge-basedprocessing and consulting services that include medical records release, recordmanagement services for healthcare institutions, temporary staffing forhealthcare institutions, managed care compliance reviews, class action claimsadministration, and professional economic research and litigation services. Forthe three months ended June 30, 2003 and 2004, revenue in the HealthcareRegulatory and Legal Compliance segment consisted of approximately $14.0million and $14.6 million of recurring revenue, respectively, and $25.3 millionand $29.0 million of project revenue, respectively.  For the six months endedJune 30, 2003 and 2004, revenue in the Healthcare, Regulatory and LegalCompliance segment consisted of approximately $28.4 million and $28.3 million ofrecurring revenue, respectively, and approximately $54.2 million and $59.7million of project revenue, respectively.

 

During 2003, our revenue consisted of the following mix by verticalmarket industry:

 

 

15

----

 

**THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREEMONTHS ENDED JUNE 30, 2004**

 
|                                              |   | **Three  Months Ended June 30,** |   |
|---------------------------------------------------|--------|---------------------------------------|--------|
|                                              |   | **2003**                              |   | **2004** |   |
|                                              |   | **($000’s)**                     |   | **% of  Revenue** |   | **($000’s)** |   | **% of  Revenue** |   |
| **Revenue**                                       |   | $                                     | 92,174 |   | 100.0 | % | $ | 97,450 |   | 100.0 | % |
| **Gross Profit**                                  |   | 34,728                                |   | 37.7 | % | 36,273 |   | 37.2 | % |
| **SG&A**                                      |   | 23,957                                |   | 26.0 | % | 24,405 |   | 25.0 | % |
| **Operating income**                              |   | 10,683                                |   | 11.6 | % | 11,556 |   | 11.9 | % |
| **Income from continuing operations  before tax** |   | 10,007                                |   | 10.9 | % | 10,610 |   | 10.9 | % |
| **Net income from continuing  operations**        |   | 6,004                                 |   | 6.5 | % | 6,366 |   | 6.5 | % |
|                                                   |        |                                       |        |  |  |  |  |  |  |  |  |

 

**Revenue**

 

Ouroperations generated revenues of $97.5 million for the three months endedJune 30, 2004, an increase of 5.7% compared to the same period in2003.  During the second quarter of2004, we acquired KeyPoint Consulting, LLC (“KeyPoint”) as a part of ourHealthcare, Regulatory and Legal Compliance segment.  KeyPointcontributed approximately $2.0 million to the revenue increase.  Additionally, strong volumes in our projectoriented Class Action Claims Administration service offering contributed approximately$2.4 million to the year-over-year increase. Project revenue accounted for $34.5 million or 35.4% of revenue in thecurrent quarter compared to $31.8 million or 34.5% of revenue in the prior yearquarter. (See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations—Basisfor Management Discussion and Analysis.”)

 

Revenuewithin our Information Management and Distribution segment increased 1.8% from$52.9 million for the three months ended June 30, 2003 to $53.9 millionfor the three months ended June 30, 2004. Project revenue accounted for 10.1% of segment revenue in the secondquarter of 2004 compared to 12.3% for the same period in 2003.  The increase in segment revenue wasprimarily the result of higher volumes in our Statement Processing serviceoffering, which were up approximately 8% or $0.6 million.  Revenue in the Information Managementservice offering increased slightly as higher volumes from our financial servicescustomers were partially offset by lower volumes from government servicescustomers.

 

Revenuewithin our Healthcare, Regulatory and Legal Compliance segment increased 10.9%from $39.3 million for the three months ended June 30, 2003 to $43.6million for the three months ended June 30, 2004. Project revenueaccounted for 66.7% of segment revenue in the second quarter of 2004 and 64.2%for the same period in 2003.  Theacquisition of KeyPoint contributed approximately $2.0 million to the increase.  Also contributing to the revenue increasewere higher project volumes in our Class Action Claims Administration serviceoffering, which increased approximately 51%, or $2.5 million, and slightlyhigher volumes in our Release of Medical Information service offering.

 

**Gross profit**

 

Grossprofit increased 4.4% from $34.7 million for the three months endedJune 30, 2003 to $36.3 million for the three months ended June 30,2004 driven primarily by higher revenue. Gross profit as a percentage of revenue decreased from 37.7% for thethree months ended June 30, 2003 to 37.2% for the three months endedJune 30, 2004.  The 50 basis pointdecline in gross profit as a percentage of revenue was primarily relatedto:  (i) a lower mix of federalgovernment project work, (ii) higher facilities costs related primarily to theopening of new facilities, mainly to support growth initiatives within ourInformation Management and Distribution segment, and (iii) higher bad debtexpense of approximately $0.9 million as the prior year quarter experienced anunusually large collection of accounts receivable outstanding greater thanninety days.  Personnel related costshelped offset the factors negatively impacting gross margin.  Personnel related costs, as a percentage ofrevenue, decreased from 46.8% in the prior year quarter to 44.3% in the currentquarter.  Key contributors to thedecline were: (i) an unusually large medical claims expense of approximately$1.1 million incurred in the prior year quarter, and (ii) our productivity andtechnology initiatives, such as high speed-scanners, offshore production andpay-for-performance compensation plans.

 

**Selling, general and administrative expenses**

 

SG&A increased 1.9% from $24.0 million, or 26.0% of revenue, forthe three months ended June 30, 2003 to $24.4 million, or 25.0% of revenue,for the three months ended June 30, 2004. The slight increase in SG&Aexpense relates primarily to higher travel expenses and marketing costs.

 

**Income from continuing operations before income taxes**

 

Incomefrom continuing operations before income taxes increased 6.0% from $10.0million, or 10.9% of revenue, for the three months ended June 30, 2003 to$10.6 million, or 10.9% of revenue, for the three months ended June 30,2004.   The increase in income fromcontinuing operations before income taxes was largely attributable to thefactors affecting gross profit and SG&A expense discussed above.  In addition, interest expense was lower byapproximately $0.3 million in the current year quarter due to a

 

16

----

 

morefavorable interest rate environment. The prior year quarter included a gain on sale of fixed assets ofapproximately $0.3 million compared to a loss in the current year quarter ofapproximately $0.1million.

 

**SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHSENDED JUNE 30, 2004**

 
|                                              |   | **Six Months  Ended June 30,** |    |
|---------------------------------------------------|--------|-------------------------------------|---------|
|                                              |   | **2003**                            |    | **2004** |   |
|                                              |   | **($000’s)**                   |    | **% of  Revenue** |   | **($000’s)** |   | **% of  Revenue** |   |
| **Revenue**                                       |   | $                                   | 190,638 |   | 100.0 | % | $ | 199,209 |   | 100.0 | % |
| **Gross Profit**                                  |   | 73,265                              |    | 38.4 | % | 77,670 |   | 39.0 | % |
| **SG&A**                                      |   | 47,750                              |    | 25.0 | % | 55,793 |   | 28.0 | % |
| **Operating income**                              |   | 25,338                              |    | 13.3 | % | 21,476 |   | 10.8 | % |
| **Income from continuing operations  before tax** |   | 23,331                              |    | 12.2 | % | 19,755 |   | 9.9 | % |
| **Net income from continuing  operations**        |   | 13,999                              |    | 7.3 | % | 11,853 |   | 6.0 | % |
|                                                   |        |                                     |         |  |  |  |  |  |  |  |  |

 

**Revenue**

 

Ouroperations generated revenues of $199.2 million for the six months endedJune 30, 2004, an increase of 4.5% compared to the same period in2003.  The acquisition of KeyPointduring the current year quarter contributed approximately $2.0 million to therevenue increase.  Also contributing to theyear-over-year increase in revenue were: (i) strong volumes in our projectoriented Class Action Claims Administration service offering which were up 44%or $4.9 million, and (ii) strong volumes in our Statement Processing serviceoffering which were up 9.7% or $1.6 million. Project revenue accounted for $72.6 million or 36.4% of revenue in thecurrent year compared to $68.3 million or 35.9% of revenue in the prior year.(See “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations—Basis for Management Discussion and Analysis.”)

 

Revenuewithin our Information Management and Distribution segment increased 2.9% from$108.0 million for the six months ended June 30, 2003 to $111.2 millionfor the six months ended June 30, 2004. Project revenue accounted for 11.5% of segment revenue in the currentyear compared to 13.1% for the same period in 2003.  The increase in segment revenue was primarily the result ofhigher volumes in our statement processing service offering, which were upapproximately 9.7%, or $1.6 million, and increased volumes from our financialservices customers in the information management service offering.  Partially offsetting this revenue growthwere lower volumes from our government services customers.

 

Revenuewithin our Healthcare, Regulatory and Legal Compliance segment increased 6.6%from $82.6 million for the six months ended June 30, 2003 to $88.0 millionfor the six months ended June 30, 2004. Project revenue accounted for67.8% of segment revenue in the second quarter of 2004 and 65.6% for the sameperiod in 2003.  The acquisition ofKeyPoint during the second quarter of 2004 contributed approximately $2.0million to the increase.  Alsocontributing to the revenue increase were higher project volumes in our ClassAction Claims Administration service offering, which increased approximately44%, or $4.9 million.  Partiallyoffsetting the growth in segment revenues were lower volumes within our legalconsulting service offering due to three significant projects in productionduring the first six months of 2003 and lower volumes in our medical codingservice offering

 

**Gross profit**

 

Gross profitincreased 6.0% from $73.3 million for the six months ended June 30, 2003to $77.7 million for the six months ended June 30, 2004 driven primarilyby higher revenue.  Gross profit as apercentage of revenue increased from 38.4% for the six months endedJune 30, 2003 to 39.0% for the six months ended June 30, 2004.  Personnel related costs, as a percentage ofrevenue, decreased from 45.7% in the prior year to 42.4% in the current yeardue primarily to our productivity and technology initiatives, such as highspeed scanners, offshore production and pay-for-performance compensation plansand $1.1 million incurred in the prior year for an unusually large medicalclaim.  Partially offsetting the lowerpersonnel related costs were higher facilities related expenses ofapproximately $1.8 million related to the opening of new production facilities,mainly to support growth initiatives within our Information Management andDistribution segment, and higher bad debt expense of approximately $1.2 millionas the prior year reflected unusually large collections of accounts receivablebalances outstanding greater than ninety days.

 

**Selling, general and administrative expenses**

 

SG&A increased 16.8% from $47.8 million, or 25.0% of revenue, forthe six months ended June 30, 2003 to $55.8 million, or 28.0% of revenue,for the six months ended June 30, 2004. The increase in SG&A expenseis largely attributable to: (i) the costs associated with the settlement of asignificant legal matter in the Information Management and Distribution segmentduring the first quarter of 2004 of approximately $3.9 million, (ii) anincrease in deferred compensation expense related to restricted stock ofapproximately $1.0 million and other personnel related expense of approximately$0.8 million, (iii) higher travel and marketing costs of approximately $1.0million, and (iv) other professional fees of approximately  $0.5 million.

 

17

----

 

**Income before income taxes**

 

Incomefrom continuing operations before income taxes decreased 15.3% from $23.3million, or 12.2% of revenue, for the six months ended June 30, 2003 to$19.8 million, or 9.9% of revenue, for the six months ended June 30,2004.   The decline in income fromcontinuing operations before income taxes was largely attributable to theincreased SG&A expenses discussed above, partially offset by theimprovement in gross profit and lower interest expense.  Interest expense was lower by approximately$1.1 million in the current year due to a more favorable interest rateenvironment and the expiration of the interest rate swap on March 31,2003.  Interest income in the prior yearincluded a one-time payment of $0.2 million related to a $2.3 million incometax receivable that was also collected during 2003.  Finally, during the six months ended June 30, 2003, a gainof approximately $0.3 million was realized related to the sale of property,plant and equipment compared to a loss in the current year of approximately$0.1 million.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

AtJune 30, 2004, we had $46.3 million of working capital, including $5.4million of cash. Working capital at December 31, 2003 was $36.1 million,including $2.1 million of cash. For the first six months of 2004, net cashprovided by operating activities from continuing operations was $5.2 millioncompared to $38.0 million for the same period in 2003.  Factors contributing to the decline inoperating cash flow from continuing operations consist of: (i) slower cashcollections during the current year resulting in $19.1 million of lower cashprovided by operating activities, (ii) the payment of a significant legal settlementduring the current year’s 2nd quarter of $9.2 million, (iii) higherannual incentive compensation payments compared to the prior year, and (iv) thereceipt of income tax refunds of $2.3 million in the prior year.

 

Slower2004 cash collections are driven primarily by two timing relatedvariables.  First, during the currentquarter we experienced payment delays from several sizable customers increasingour balance of accounts receivable greater than 90 days outstanding.  During July 2004, we collected a significantportion of these balances (approximately $10 million).  We expect the remaining customerscontributing to this variable to be current by September 30, 2004.  Secondly, we typically collect accountsreceivable related to year-end and first quarter federal government projectsduring the 2nd calendar quarter. For 2004, this will likely occur during the 3rd calendarquarter.  As a result, days salesoutstanding increased five business days during the quarter to 51 business daysat June 30, 2004 compared to 46 business days at March 31, 2004.

 

Aspreviously mentioned, we made payment of a significant legal settlement duringthe 2nd quarter of 2004 in the amount of $9.2 million.  During July 2004, we received aninsurance reimbursement of $4.1 million related to this settlement.  This amount will be included as a componentof our 3rd quarter cash from operating activities.

 

Asa result of the settlement of the significant legal matter and the timing ofexpected cash collections, our full year operating cash flow is expected to bein the range of $40 million to $45 million.

 

Forthe six months ended June 30, 2004, investing activities from continuingoperations consisted of acquisitions of property, plant and equipment of $8.3million and net acquisition related payments of $15.0 of which $12.3 millionrelates to the acquisition of KeyPoint Consulting LLC and $2.7 millionrepresents the settlement of contingent consideration.  Divestiture proceeds of $0.8 million offsetthe cash used by investing activities. Some future quarters will include additional settlements of contingentconsideration on past acquisitions. Not all of the periods applicablefor contingent consideration targets have been completed and additional amountsmay be payable in future periods under the terms of the agreements.  If all contingent consideration targetsunder the current agreements were achieved, the maximum amount of considerationto be paid would be $17.8 million, with approximately $12.5 millionto be paid in 2004 and approximately $5.3 million to be paid in 2005. Inaccordance with the agreements, the Company would be required to satisfyapproximately $0.8 million of the $17.8 million potential liability incommon stock related to a past tax-free stock merger and has the option tosatisfy $9.2 million of the $17.8 million potential liability incommon stock with final valuation determined at date of issuance.  The remaining potential liability would bepaid in cash, as specified in the agreements.

 

Netcash provided by financing activities from continuing operations was $22.2million for the six months ended June 30, 2004.  Payments of $143.5 million on our line of credit were more thanoffset by net proceeds borrowed from our line of credit of $174.6 million.  Additionally, net proceeds from common stockissuances of $0.4 million were more than offset by payments of $9.3 millionrelated to shares repurchased.  Weutilize our line of credit to fund general operating requirements of the Companyas well as fund significant investments such as acquisitions or capitalexpenditures.

 

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

 

Effective April 3, 2002, we extended $220.0 million of the$297.5 million commitment for an additional year to April 2, 2005. InSeptember 2002, additional extensions were granted by member banks,bringing the total commitment extended to April 2,

 

18

----

 

2005 to $290.0 million. Total fees paid in 2002 related to theextensions and amendments to the 2001 Credit Agreement were $0.3 million.

 

Effective April 3, 2003, we extended $230.0 million of the$297.5 million commitment to April 1, 2006. During the fourth quarterof 2003, a participating bank in the 2001 Credit Agreement assigned$7.5 million of its commitment to another bank who, effectiveDecember 4, 2003, extended this commitment to April 1, 2006. Totalfees paid in 2003 related to the extensions and amendments to the 2001 CreditAgreement were $0.3 million.

 

Management fully expects to replace or refinance the 2001 CreditAgreement upon its maturity scheduled for April 1, 2006. As a result ofthe extension agreements discussed in the previous two paragraphs, the$297.5 million commitment under the 2001 Credit Agreement is scheduled tomature as follows (in millions):

 
| **Maturity Date**  |   | **Commitment** |   | **Remaining  Commitment** |   |
|--------------------|--------|----------------|--------|---------------------------|--------|
| April 3, 2004 |   | $              | 7.5    |                      | $      | 290.0 |   |
| April 2, 2005 |   | 52.5           |   | $                         | 237.5  |   |
| April 1, 2006 |   | 237.5          |   |                      |   |
| Total              |   | $              | 297.5  |                      |   |   |

 

Our ability to borrow is contingent on certain leverage and fixed costcoverage ratios. These ratios were scheduled to become more restrictivebeginning in the quarter ended December 31, 2002 with the leverage ratiodeclining from 3.0 times to 2.5 times and the fixed charge coverage ratioincreasing from 1.25 times to 1.50 times. However, in September 2002, anamendment was approved that extended the fixed cost coverage ratio requirementof 1.25 until January 1, 2004 and will increase to 1.35 at all timesthereafter. In addition to the leverage and fixed cost coverage ratios, we aresubject to minimum net worth requirements. Effective March 26, 2003, anamendment was approved that allows for the reduction to the minimum net worthrequirement for up to $30 million of share repurchases. In addition,effective July 30, 2004, an amendment was approved that allows for thereduction to the minimum net worth requirement for an additional $30 million ofshare repurchases.  After application ofsuch ratios and our total commercial commitments of $12.3 million forstandby letters of credit, we have $22.6 million available to borrow underthe 2001 Credit Agreement as of June 30, 2004.  Management believes that it has sufficient liquidity from itscash flow and its revolving credit facility to meet ongoing businessneeds.  Additionally, depending on the mixof stock and cash used in our strategic acquisition program, if any, we may needto seek further financing through the public or private sale of equity or debtsecurities.  However, there can be noassurance we could secure such financing if and when it is needed or with termswe deem acceptable.

 

**Critical Accounting Policies**

 

Management’s Discussion and Analysis of Financial Condition and Resultsof Operations are based on the related consolidated financial statements, whichhave been prepared in accordance with accounting principles generally acceptedin the United States of America. The preparation of the financial statementsrequires the use of estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses.

 

We have identified the following critical accounting policies that, asa result of the judgments, uncertainties, uniqueness and complexities of theunderlying accounting standards and operations involved, could result inmaterial changes to our financial condition or results of operations underdifferent conditions or using different assumptions. We apply a consistentmethodology at the end of each quarter to determine our account balances thatrequire judgmental analysis.

 

**Revenue Recognition.**  We recognize our revenue as it becomesrealized or realizable and earned according to the criteria provided by StaffAccounting Bulletin 101, *RevenueRecognition in Financial Statements*. Revenue recognition occurs oncepersuasive evidence of an arrangement exists, delivery has occurred or serviceshave been rendered, the sales price is fixed or otherwise determinable, andcollection is reasonably assured. Our revenue-earning activities possess bothproject and recurring customer relationships.

 

Project revenue includes one-time projects in which the customerrelationship is not expected to continue after project completion. Projectrevenue is typically based on time and material arrangements. Revenuerecognition occurs at the contractual rates as the labor hours and directexpenses are incurred. Project revenue represented approximately 37% of total 2003revenues from continuing operations and typically occurs within our Healthcare,Regulatory, and Legal Compliance segment.

 

Recurring revenue is characterized by customer relationships that aregenerally for one year and may continue for longer. Recurring revenue istypically based on the transaction volumes provided by our customer at anagreed upon fixed rate per unit. Our customer’s volumes are typically notcontractual or otherwise guaranteed. Revenue recognition occurs once work iscompleted and delivery has occurred or services have been rendered. Recurringrevenue represented the remaining 63% of total 2003 revenues from continuingoperations and typically occurs within our Information Management andDistribution segment.

 

19

----

 

As a part of providing services to our customers, we incur incidentalexpenses commonly referred to as “out-of-pocket” expenses. These expensesinclude items such as airfare, hotels, and mileage and are often reimbursableby our customers. When reimbursable, we record both revenue and direct cost ofservices in accordance with the provisions of Emerging Issues Task Force(“EITF”) Issue 01-14, *Income StatementCharacterization of Reimbursements Received for “Out-of-Pocket” ExpensesIncurred.*

 

Unearned income, included in other current liabilities, representspayments from our customers in advance of services being provided. Advancedpayments are deferred as unearned income when received and recognized asrevenue as services are rendered.

 

**Allowance for Doubtful Accounts.**  The allowance for doubtful accounts isestablished and maintained based on our estimate of accounts receivablecollectibility. Management estimates collectibility by specifically analyzingaccounts receivable aging and other historical factors that affect collections.Such factors include the historical trends of write-offs and recovery ofpreviously written-off accounts, the financial strength of the customer andprojected economic and market conditions. The evaluation of these factorsinvolves subjective judgments and changes in these factors may significantlyimpact our consolidated financial statements.

 

**Long-Lived Asset Impairment.**  As required by SFAS No. 144, *Accounting for the Impairment or Disposal of Long-LivedAssets,*management continually evaluates whether events andcircumstances indicate that the carrying value of long-lived assets may not berecoverable. When events require, management performs the valuation bycomparing the estimated undiscounted future cash flows over the remaining lifeof the long-lived assets to the carrying amount of the asset being evaluated.An impairment loss is recognized to the extent the carrying amount of assetsbeing evaluated exceeds the expected future undiscounted cash flow. During thequarter ended June 30, 2004, a pre-tax impairment loss of approximately $1.7million was recognized related to the divestiture of our Print and Mailoperations.  See Note 3, DiscontinuedOperations, of Notes of Condensed Consolidated Financial Statements, for a moredetailed discussion.

 

**Goodwill Impairment.**  On January 1, 2002, we adopted SFASNo. 142, *Goodwill and Other IntangibleAssets.* This statement states that goodwill and intangible assetsthat have indefinite useful lives will not be amortized but rather will betested at least annually for impairment. Our annual impairment test isperformed at October 31.  Theimpairment test is based on fair value rather than undiscounted cash flows. Additionally,goodwill and other intangible assets are tested at a reporting unit levelrather than the individual operating unit level. A reporting unit is either atthe operating segment level or one reporting level below and could consist ofseveral service offerings aggregated into a single reporting unit. Serviceofferings are aggregated when they are similar in the following areas: economiccharacteristics, products and services, production processes, methods fordistributing or delivering products, and type or class of customers. Valuationmethods used in determining fair value include an analysis of the cash flowsthat the reporting units can be expected to generate in the future (IncomeApproach) and the fair value of a reporting unit as compared to similarpublicly traded companies (Market Approach). In preparing these valuationsmanagement utilizes estimates to determine fair value of the reporting units.These estimates include future cash flows, growth rates, capital needs, andprojected earning margins among other factors. Estimates utilized in futurecalculations could differ from estimates used in the current period. Futureyears’ estimates that are unfavorable compared to current estimates could causean impairment of goodwill and other intangible assets. Due to the fact that weare primarily a services company, our business acquisitions typically result insignificant amounts of goodwill and other intangible assets. Therefore, animpairment charge resulting from goodwill or other intangible assets couldresult in a material adverse impact on our financial statements during theperiod incurred.

 

**Self-Insurance Liabilities and Reserves.**  We are self-insured for workmen’scompensation liabilities and a significant portion of our employee medicalcosts. We account for our self-insurance programs based on actuarial estimatesof the amount of loss inherent in that period’s claims, including losses forwhich claims have not been reported. These loss estimates rely on actuarialobservations of ultimate loss experience for similar historical events. Welimit our risk by carrying stop-loss policies for significant claims incurredfor both workmen’s compensation liabilities 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 in accordance with SFAS No. 5, *Accountingfor Contingencies*. Disclosure is required when there is a reasonablepossibility that the ultimate loss will exceed the recorded provision.Contingent liabilities are often resolved over long periods of time. Estimatingprobable losses requires analysis of multiple forecasts that often depend onjudgments about potential actions by third parties such as regulators. Our losscontingencies consist primarily of estimates related to the probable outcome ofcurrent litigation.

 

**RISKS ASSOCIATED WITH FORWARD-LOOKING STATEMENTS**

 

ThisReport contains certain forward-looking statements such as our intentions,hopes, beliefs, expectations, strategies, predictions or any other variationthereof or comparable phraseology of our future activities or other futureevents or conditions within the meaning of Section 27A of the SecuritiesAct of 1933, as amended (the “Act”), and Section 21E of the SecuritiesExchange Act of 1934, as amended, which are intended to be covered by the safeharbors created thereby. Investors are cautioned that all forward-lookingstatements involve risks and uncertainty, including, without limitation, therisk of integrating our operating companies, of managing our rapid growth, ofthe timing and magnitude of technological advances, of the occurrences offuture events that could diminish our customers’ needs for our services, of achange in the degree to which companies continue to outsource businessprocesses, of an adverse outcome in any given legal proceeding or claim, of thedenial of insurance on a particular claim or of a party obligated to provideindemnification being financially unable to do so, as well as such other risksset forth under the heading Risk

 

20

----

 

Factorsincluded in our most recent annual report on Form 10-K.

 

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

 

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

 

Weare subject to interest rate risk on our term loans, revolving credit facilityand Industrial Revenue Bonds. A 100 basis point increase in short-term interestrates would result in approximately $0.5 million of additional expense in 2004based on our expected average balance outstanding under the credit facilityduring 2004. Interest rates are fixed on the capitalized lease obligations.

 

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

 

*(a) Evaluation of disclosure controls andprocedures.*

 

The Company maintains disclosure controls and procedures, which it hasdesigned to ensure that material information related to the Company, includingits consolidated subsidiaries, is made known to a group comprised of designatedmembers of the Company’s senior management, designated members of functionaldivisions of the Company, and/or the certifying officers (i.e. Chief ExecutiveOfficer and Chief Financial Officer) (collectively, the “DisclosureCommittee”), on a timely basis. In response to recent legislation and proposedregulations, the Company reviewed its internal control structure and itsdisclosure controls and procedures. Although the Company believes itspre-existing disclosure controls and procedures were adequate to enable theCompany to comply with its disclosure obligations, as a result of such review,the Company implemented minor changes, primarily to formalize and document theprocedures already in place. As of June 30, 2004, the Company carried out anevaluation, under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures pursuant to Securities Exchange Act of 1934,as amended, Rule 13a-15 and 15d-15. Based upon that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures are effective in timely alerting them tomaterial information relating to the Company (including its consolidatedsubsidiaries) required to be included in the Company’s periodic SEC Filings.

 

*(b) Changes in internal controls.*

 

There were no significant changes in our internal controls or in otherfactors, including any corrective actions with regard to significantdeficiencies and material weaknesses, that could significantly affect thesecontrols subsequent to the date of their evaluation.

 

21

----

 

**PART II.OTHER INFORMATION**

 

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

 

We are, from time to time, a party to litigation arising in the normalcourse of business. The following is a brief description of some of the legalmatters that we are involved in. We do not believe these actions, nor any ofthe actions that we are a party to, will have a material adverse effect on ourbusiness or financial condition; however, in the event of an adverse outcome inone or more of our legal proceedings, operating results for a given quarter maybe negatively impacted.

 

*Healthcare Marketing Associates, Inc.vs. Managed Care Professionals, Inc.*

 

On February 9, 1995, prior to the acquisition by the Company,Managed Care Professionals, Inc. (one of our wholly-owned subsidiaries)(“MCP”) entered into an “Exclusive Marketing Agreement” with HealthcareMarketing Associates, Inc. (“HMA”) whereby MCP granted to HMA theexclusive right to market, and HMA agreed to market exclusively for MCP, theMCP products and services to health care providers in the United States forwhich MCP agreed to pay HMA a percentage (30%) of gross revenues paid to MCP bythe provider (customer). The duration of the Agreement was for a period of five(5) years and expired on February 9, 2000 (“Termination Date”). OnApril 27, 2001, HMA filed a lawsuit against MCP in the Circuit Court ofthe County of St. Louis, State of Missouri, alleging entitlement to commissionson revenues generated after the Termination Date from providers who were initiallybrought to MCP prior to the Termination Date. In March 2003, this lawsuitwas tried before a judge and at the conclusion of the trial, the judge ruled inthe plaintiff’s favor in the amount of $1.782 million plus prejudgment andpost judgment interest, which equates to approximately $2.4 million intotal as of December 31, 2003. The judgment amount plus prejudgmentinterest costs were included in our 2002 results. Post judgment interestaccrues at a statutory 9% rate. We have appealed this ruling and oral argumentsfor our appeal were heard on February 24, 2004.  On May 4, 2004, the Court of Appeals affirmed the Circuit Court’sjudgment.  On July 23, 2004, wefiled an application for transfer of our appeal to the state’s Supreme Court.

 

*Various ROI Copy Charge Matters*

 

From time to time, various of our subsidiaries that perform release ofinformation (“ROI”) services become defendants to putative class actionlawsuits generally alleging that the charge for reproducing certain medicalrecords is not in conformity with such plaintiffs’ reading of the applicableregulated charge. Such suits typically include multiple ROI companies andhospitals as defendants and demand reimbursement for prior charges as well asfor prospective pricing adjustments. We are currently a party to several suchsuits in various stages of development. We believe we have meritorious defensesand intend to continue to vigorously defend any claims made against us in thesematters.

 

*Mattel v. SOURCECORP*

 

On February 18, 2003, Mattel, Inc. filed suit against theCompany in the Los Angeles County California Superior Court. In the suit, theplaintiff alleged that one of our subsidiaries is liable for the loss ofvarious products, prototypes and paper documents allegedly stored at one of oursubsidiary’s box storage facilities under theories of breach of contract,breach of fiduciary duty, negligence, breach of implied covenants of good faithand fair dealing and/or conversion. The plaintiff at various times allegeddamages ranging from “in excess of $2.5 million,” to approximately$20 million.  This matter wassettled prior to trial, the terms of which settlement are confidential.  The settlement and related legal costsimpacted our first quarter 2004 pre-tax earnings by approximately $3.9 millionwith no future earnings impact expected. Furthermore, the impact of the settlement and related legal costs on our2004 operating cash flow will be approximately $5.7 million, beforeconsideration of taxes.

 

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

 

In June 2000, the Company filed an action styled *F.Y.I. Incorporated v. Spohr, et. al.* inDallas, Texas, in which we asserted claims for breach of contract, fraud, andnegligent misrepresentation against the sellers of two related companies thatwe acquired in December 1998 (the “Texas Action”). The Texas Action waslater removed to federal court and ultimately dismissed on jurisdictionalgrounds. We reasserted these claims in two actions that were laterconsolidated; one styled *F.Y.I. Incorporatedv. Spohr, et. al.* in Superior Court of the State of California inthe County of Sacramento, Case No. 01-AS-00721 (the “Sacramento Action”)and one styled *Spohr, et. al. v. F.Y.I.Incorporated, et. al.* in the Superior Court of the State ofCalifornia in the County of San Francisco, Case No. 318703 (the “SanFrancisco Action”). In the consolidated action, we additionally filed claimsagainst the sellers’ accountants and the two sellers filed claims against us;however, in February 2004, the judge in the Sacramento Action dismissedour claims against the sellers’ accountants. The sellers allege that our formersubsidiary wrongfully failed and refused to execute and deliver a requestedestoppel certificate, and that the failure to provide such estoppel certificateharmed the landlord in that they were allegedly denied favorable terms on arefinancing of the property and were allegedly prevented from completing atimely sale of the property. Sellers allege damages of approximately$1.5 million. We have asserted damages in excess of $8 million. Webelieve we have meritorious defenses to sellers’ claims and intend tovigorously defend any claims made against us in this matter.

 

22

----

 

**Item2. Changes in Securities and Use of Proceeds**

 

Items 2(a) through (d) are inapplicable.

 

(e) STOCK REPURCHASES

 
| **Period**                 |   | **(a) Total  Number of  Shares Purchased** |   | **(b)  Average  Price Paid per  Share** |   | **(c) Total  Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs** |    | **(d)  Maximum Number of Shares (or  Approximate Dollar Value) of Shares  that May Yet Be Purchased Under  the Plans or Programs** |      |
|----------------------------|--------|--------------------------------------------|--------|-----------------------------------------|--------|-----------------------------------------------------------------------------------------------|---------|------------------------------------------------------------------------------------------------------------------------------------|-----------|
|                       |   |                                       |   |                                    |   |                                                                                          |    |                                                                                                                               |      |
| Apr. 1, 2004-Apr. 30, 2004 |   | —                                     |   | —                                  |   | —                                                                                        |    | $                                                                                                                                  | 9,299,190 |   |
| May 1, 2004-May 31, 2004   |   | 111,123                                    |   | $                                       | 24.42  |                                                                                          | 111,123 |                                                                                                                               | $         | 6,585,915 |   |
| Jun. 1, 2004-Jun. 30, 2004 |   | 250,292                                    |   | $                                       | 26.31  |                                                                                          | 250,292 |                                                                                                                               | $         | 1,500 |   |
| August 2004                |   |                                       |   |                                    |   |                                                                                          |    |                                                                                                                               | $         | 20,001,500 |   |

 

**Item 6.**           **Exhibits and Reports on Form8-K**

 

(a)Exhibits

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                     |
|---------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1*                |   | Asset  Purchase Agreement, dated as of June 4, 2004, among Premier Acquisition  Corp., as Seller, *SOURCECORP*,  Incorporated, as Parent of Seller and Secure Health Information Corp., as  Buyer                                              |
|                |   |                                                                                                                                                                                                                                                |
| 2.2*                |   | Asset  Purchase Agreement, dated as of July 8, 2004, by and among Creative  Mailing & Marketing, LLC, as Buyer and Global Direct, Inc. and Mailing  & Marketing, Inc., as Sellers and *SOURCECORP*,  Incorporated                      |
|                |   |                                                                                                                                                                                                                                                |
| 2.3*                |   | Asset  Purchase and Sale Agreement, dated as of July 21, 2004, among Iron  Mountain Information Management, Inc., as Buyer, Deliverex Acquisition Corp.,  as Seller and *SOURCECORP,*  Incorporated, as Limited Guarantor                      |
|                |   |                                                                                                                                                                                                                                                |
| 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*               |   | Fourth  Amendment to Credit Agreement, effective as of July 30, 2004, by and  among *SOURCECORP*, Incorporated,  Bank of America, N.A. and the other Lenders party thereto                                                                     |
|                |   |                                                                                                                                                                                                                                                |
| 31.1                |   | Certification  Pursuant to section 302 of Sarbanes-Oxley Act.                                                                                                                                                                                  |
|                |   |                                                                                                                                                                                                                                                |
| 31.2                |   | Certification  Pursuant to section 302 of Sarbanes-Oxley Act.                                                                                                                                                                                  |
|                |   |                                                                                                                                                                                                                                                |
| 32.1                |   | Certification  Pursuant to section 906 of Sarbanes-Oxley Act.                                                                                                                                                                                  |
|                |   |                                                                                                                                                                                                                                                |
| 32.2                |   | Certification  Pursuant to section 906 of Sarbanes-Oxley Act.                                                                                                                                                                                  |

 

----

* Schedules and similar attachments are omitted in accordance with Item601(b)(2) of Regulation SK and a brief description of such omitted schedulesand similar attachments is included in the agreement.  The Company undertakes to supplementally provide the Commissionwith a copy of any such omitted schedule or similar attachment uponrequest.

 

23

----

 

(b) Reports on Form 8-K

 

On April 23, 2004, the Company filed a Current Report on Form 8-Kwith the Commission dated April 23, 2004, reporting, under Item 7 and Item12 thereto, the filing of a press release announcing the settlement of apreviously disclosed pending legal matter and setting forth its anticipatedimpact on the Registrant’s results of operations for the first quarter offiscal 2004.

 

On May 6, 2004, the Company filed a Current Report on Form 8-K with theCommission dated May 6, 2004, reporting, under Item 7 and Item 12 thereto, thefiling of a press release to announce its financial results for the firstquarter ended March 31, 2004.

 

OnMay 21, 2004, the Company filed a Current Report on Form 8-K with theCommission dated May 21, 2004, reporting, under Item 5 and Item 7 thereto,condensed consolidated statements of operations for the years 2002, 2003 andthe first quarter of 2004 reflective of the anticipated presentation givingeffect to the required discontinued operations accounting treatment of certainasset groups to be divested.

 

24

----

 

**SIGNATURES**

 

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

 
|                      | SOURCECORP,  INCORPORATED |
|---------------------------|---------------------------|
|                      |                      |   |
| Date: August 9, 2004 | By:                       | /s/ ED H. BOWMAN, JR. |
|                      |                      | Ed H. Bowman, Jr. Chief Executive  Officer and President |
|                      |                      |   |
| Date: August 9, 2004 | By:                       | /s/ BARRY L. EDWARDS |
|                      |                      | Barry L. EdwardsExecutive  Vice  President and Chief Financial Officer  (Principal Financial and Accounting  Officer) |

 

25

----

 

**INDEX TO EXHIBITS**

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                    |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1*                |   | Asset  Purchase Agreement, dated as of June 4, 2004, among Premier Acquisition  Corp., as Seller, *SOURCECORP*,  Incorporated, as Parent of Seller and Secure Health Information Corp., as  Buyer                                             |
|                |   |                                                                                                                                                                                                                                               |
| 2.2*                |   | Asset  Purchase Agreement, dated as of July 8, 2004, by and among Creative  Mailing & Marketing, LLC, as Buyer and Global Direct, Inc. and Mailing  & Marketing, Inc., as Sellers and *SOURCECORP*,  Incorporated                     |
|                |   |                                                                                                                                                                                                                                               |
| 2.3*                |   | Asset  Purchase and Sale Agreement, dated as of July 21, 2004, among Iron  Mountain Information Management, Inc., as Buyer, Deliverex Acquisition Corp.,  as Seller and *SOURCECORP,*  Incorporated, as Limited Guarantor                     |
|                |   |                                                                                                                                                                                                                                               |
| 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*               |   | Fourth  Amendment to Credit Agreement, effective as of July 30, 2004, by and  among *SOURCECORP*, Incorporated,  Bank of America, N.A. and the other Lenders party thereto                                                                    |
|                |   |                                                                                                                                                                                                                                               |
| 31.1                |   | Certification  Pursuant to section 302 of Sarbanes-Oxley Act.                                                                                                                                                                                 |
|                |   |                                                                                                                                                                                                                                               |
| 31.2                |   | Certification  Pursuant to section 302 of Sarbanes-Oxley Act.                                                                                                                                                                                 |
|                |   |                                                                                                                                                                                                                                               |
| 32.1                |   | Certification  Pursuant to section 906 of Sarbanes-Oxley Act.                                                                                                                                                                                 |
|                |   |                                                                                                                                                                                                                                               |
| 32.2                |   | Certification  Pursuant to section 906 of Sarbanes-Oxley Act.                                                                                                                                                                                 |

 

----

* Schedules and similar attachments are omitted in accordance with Item601(b)(2) of Regulation SK and a brief description of such omitted schedulesand similar attachments is included in the agreement.  The Company undertakes to supplementally provide the Commissionwith a copy of any such omitted schedule or similar attachment uponrequest.

 

26

----