**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30,2003**

 

**Commission File No. 0-20947**

 

| **ON-SITE SOURCING, INC.**                                                          |
|-------------------------------------------------------------------------------------|
| (Exact name of registrant as specified in  its charter)                             |
|                                                                                |
| **DELAWARE**                                                                        |   | **54 -1648470** |
| (State or other jurisdiction of  Incorporation or organization)                     |   | (I.R.S.   Employer Identification Number) |
|                                                                                |   |   |
| **832 North Henry Street, Alexandria, Virginia  22314**                             |
| (Address of principal executive offices)                                            |
|                                                                                |
| **(703) 276-1123**                                                                  |
| (Registrant’s telephone number)                                                |
|                                                                                |
| **NONE**                                                                            |
| (Former name, former address and former  fiscal year, if changed since last report) |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes ý  No o.

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the ExchangeAct).     Yes  o  No  ý

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of November 10, 2003:

 

| Common Stock, $.01 par value |   | 5,599,225 shares |
|------------------------------|--------|------------------|

 

 

----

 

ON-SITE SOURCING, INC.

INDEX

 
| **Part I.**  | **Financial  Information**                                                                                                   |   |
|--------------|------------------------------------------------------------------------------------------------------------------------------|--------|
|         |                                                                                                                         |   |
| Item 1.      | Financial Statements:                                                                                                        |   |
|         | Balance  Sheets as of September 30, 2003 (unaudited) and December 31, 2002                                                   |   |
|         |                                                                                                                         |   |
|         | Statements  of Operations for the Three and Nine Months Ended September 30, 2003  (unaudited) and 2002 (unaudited)           |   |
|         |                                                                                                                         |   |
|         | Condensed  Statements of Cash Flows for the Three and Nine Months Ended September 30,  2003 (unaudited) and 2002 (unaudited) |   |
|         |                                                                                                                         |   |
|         | Notes to  Financial Statements (unaudited)                                                                                   |   |
|         |                                                                                                                         |   |
| Item 2.      | Management’s Discussion and Analysis of  Financial Condition and Results of Operations and Liquidity                    |   |
|         |                                                                                                                         |   |
| 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 3.      | Defaults Upon Senior Securities                                                                                              |   |
|         |                                                                                                                         |   |
| Item 4.      | Submission of Matters to a Vote of Security  Holders                                                                         |   |
|         |                                                                                                                         |   |
| Item 5.      | Other Information                                                                                                            |   |
|         |                                                                                                                         |   |
| Item 6.      | Exhibits and Reports on Form 8-K                                                                                             |   |
|         |                                                                                                                         |   |
|         | Signatures                                                                                                                   |   |

 

2

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ON-SITE SOURCING, INC.

BALANCESHEETS

 
|                                                                                                                                                                                                    |   | **September 30,  2003** |       | **December 31,  2002** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|------------------------|--------|
|                                                                                                                                                                                                    |   | **(Unaudited)**         |       |                   |   |
| ASSETS                                                                                                                                                                                                  |   |                    |       |                   |   |
|                                                                                                                                                                                                    |   |                    |       |                   |   |
| CURRENT  ASSETS:                                                                                                                                                                                        |   |                    |       |                   |   |
| Cash                                                                                                                                                                                                    |   | $                       | 4,729      |                   | $      | 4,279 |   |
| Accounts  receivable, net                                                                                                                                                                               |   | 8,757,928               |       | 8,157,822              |   |
| Prepaid  supplies                                                                                                                                                                                       |   | 372,533                 |       | 503,693                |   |
| Prepaid  expenses                                                                                                                                                                                       |   | 269,064                 |       | 288,469                |   |
| Deferred  tax asset                                                                                                                                                                                     |   | 104,610                 |       | 104,608                |   |
| Notes  receivable                                                                                                                                                                                       |   | 12,748                  |       | 48,442                 |   |
| Total  current assets                                                                                                                                                                                   |   | 9,521,612               |       | 9,107,313              |   |
|                                                                                                                                                                                                    |   |                    |       |                   |   |
| Property  and equipment, net                                                                                                                                                                            |   | 11,220,462              |       | 14,894,103             |   |
|                                                                                                                                                                                                    |   |                    |       |                   |   |
| OTHER  ASSETS                                                                                                                                                                                           |   |                    |       |                   |   |
| Assets  held for sale                                                                                                                                                                                   |   | 1,425,000               |       | —                 |   |
| Goodwill                                                                                                                                                                                                |   | 648,443                 |       | 648,443                |   |
| Income  taxes refundable                                                                                                                                                                                |   | —                  |       | 606,134                |   |
| Deferred  tax asset, net of current portion                                                                                                                                                             |   | 257,825                 |       | —                 |   |
| Other  assets                                                                                                                                                                                           |   | 159,218                 |       | 152,767                |   |
| Total  assets                                                                                                                                                                                           |   | $                       | 23,232,560 |                   | $      | 25,408,760 |   |
|                                                                                                                                                                                                    |   |                    |       |                   |   |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                                                                                              |   |                    |       |                   |   |
|                                                                                                                                                                                                    |   |                    |       |                   |   |
| CURRENT  LIABILITIES:                                                                                                                                                                                   |   |                    |       |                   |   |
| Line  of credit                                                                                                                                                                                         |   | $                       | 2,129,828  |                   | $      | 2,861,414 |   |
| Current  portion of long-term debt                                                                                                                                                                      |   | 1,016,357               |       | 1,101,706              |   |
| Accounts  payable                                                                                                                                                                                       |   | 1,683,049               |       | 1,987,302              |   |
| Income  tax payable                                                                                                                                                                                     |   | 64,598                  |       | —                 |   |
| Accrued  and other liabilities                                                                                                                                                                          |   | 1,551,730               |       | 1,238,028              |   |
| Total  current liabilities                                                                                                                                                                              |   | 6,445,562               |       | 7,188,450              |   |
|                                                                                                                                                                                                    |   |                    |       |                   |   |
| NONCURRENT  LIABILITIES                                                                                                                                                                                 |   |                    |       |                   |   |
| Long-term  debt, net of current portion                                                                                                                                                                 |   | 5,770,502               |       | 6,897,100              |   |
| Deferred  rent                                                                                                                                                                                          |   | 256,613                 |       | 257,747                |   |
| Deferred  tax liability                                                                                                                                                                                 |   | —                  |       | 266,846                |   |
| Interest  rate swap contract liability                                                                                                                                                                  |   | 820,156                 |       | 913,306                |   |
| Total  liabilities                                                                                                                                                                                      |   | 13,292,833              |       | 15,523,449             |   |
|                                                                                                                                                                                                    |   |                    |       |                   |   |
| Commitments  and contingencies                                                                                                                                                                          |   |                    |       |                   |   |
|                                                                                                                                                                                                    |   |                    |       |                   |   |
| STOCKHOLDERS’  EQUITY:                                                                                                                                                                             |   |                    |       |                   |   |
| Common  stock, $0.01 par value, 20,000,000 shares authorized 5,712,815 and 5,589,240  shares issued and 5,599,225 and 5,475,650 outstanding, at September 30, 2003  and December 31, 2002, respectively |   | 57,128                  |       | 55,892                 |   |
| Additional  paid-in capital                                                                                                                                                                             |   | 8,071,992               |       | 7,882,313              |   |
| Other  comprehensive loss                                                                                                                                                                               |   | (495,293                | )          | (551,545               | )      |
| Treasury  stock (113,590 shares of common stock at cost)                                                                                                                                                |   | (396,152                | )          | (396,152               | )      |
| Retained  earnings                                                                                                                                                                                      |   | 2,702,052               |       | 2,894,803              |   |
| Total  stockholders’ equity                                                                                                                                                                        |   | 9,939,727               |       | 9,885,311              |   |
| Total  liabilities and stockholders’ equity                                                                                                                                                        |   | $                       | 23,232,560 |                   | $      | 25,408,760 |   |

 

The accompanying notes arean integral part of these financial statements.

 

3

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ON-SITESOURCING, INC.

STATEMENTSOF OPERATIONS

 
|                                                                      |   | **(Unaudited)**         |      | **(Unaudited)**         |   |
|---------------------------------------------------------------------------|--------|-------------------------|-----------|-------------------------|--------|
|                                                                      |   | **Three Months Ended**  |      | **Nine Months Ended**   |   |
|                                                                      |   | **September 30,  2003** |      | **September 30,  2002** |   | **September 30,  2003** |   | **September 30,  2002** |   |
|                                                                      |   |                    |      |                    |   |   |   |   |   |
| Revenue                                                                   |   | $                       | 8,927,188 |                    | $      | 8,041,715 |   | $ | 25,816,187 |   | $ | 26,073,964 |   |
|                                                                      |   |                    |      |                    |   |   |   |   |   |
| Costs  and expenses:                                                      |   |                    |      |                    |   |   |   |   |   |
| Cost  of sales                                                            |   | 5,631,429               |      | 5,265,760               |   | 16,658,403 |   | 15,442,342 |   |
|                                                                      |   | 3,295,759               |      | 2,775,955               |   | 9,157,784 |   | 10,631,622 |   |
|                                                                      |   |                    |      |                    |   |   |   |   |   |
| Sales  and marketing                                                      |   | 1,126,160               |      | 1,117,100               |   | 3,251,599 |   | 3,384,104 |   |
| General  and administrative                                               |   | 1,518,734               |      | 1,964,994               |   | 4,848,768 |   | 6,013,817 |   |
|                                                                      |   | 2,644,894               |      | 3,082,094               |   | 8,100,367 |   | 9,397,921 |   |
|                                                                      |   |                    |      |                    |   |   |   |   |   |
| Income  (loss) from operations                                            |   | 650,865                 |      | (306,139                | )      | 1,057,417 |   | 1,233,701 |   |
|                                                                      |   |                    |      |                    |   |   |   |   |   |
| Other  income (expense):                                                  |   |                    |      |                    |   |   |   |   |   |
| Other  income (expense)                                                   |   | 54,633                  |      | (19,985                 | )      | 94,516 |   | 11,869 |   |
| Interest  expense                                                         |   | (156,593                | )         | (183,139                | )      | (490,771 | ) | (569,958 | ) |
|                                                                      |   | (101,960                | )         | (203,124                | )      | (396,255 | ) | (558,089 | ) |
| Income  (loss) from continuing operations before taxes                    |   | 548,905                 |      | (509,263                | )      | 661,162 |   | 675,612 |   |
| Income  tax provision (benefit)                                           |   | 160,700                 |      | (180,796                | )      | 178,193 |   | 149,679 |   |
|                                                                      |   |                    |      |                    |   |   |   |   |   |
| Net  income (loss) from continuing operations                             |   | 388,205                 |      | (328,467                | )      | 482,969 |   | 525,933 |   |
|                                                                      |   |                    |      |                    |   |   |   |   |   |
| Discontinued  operation (Note 6):                                         |   |                    |      |                    |   |   |   |   |   |
| Loss  from operations of discontinued business, net of income tax benefit |   | (12,353                 | )         | (291,050                | )      | (179,643 | ) | (484,001 | ) |
| Loss  on disposal of discontinued business , net of income tax benefit    |   | (496,077                | )         | —                  |   | (496,077 | ) | — |   |
|                                                                      |   |                    |      |                    |   |   |   |   |   |
| Net  income (loss)                                                        |   | $                       | (120,225  | )                       | $      | (619,517 | ) | $ | (192,751 | ) | $ | 41,932 |   |
|                                                                      |   |                    |      |                    |   |   |   |   |   |
| Earnings  (loss) per share:                                               |   |                    |      |                    |   |   |   |   |   |
| Basic                                                                     |   | $                       | (0.02     | )                       | $      | (0.11 | ) | $ | (0.03 | ) | $ | 0.01 |   |
| Diluted                                                                   |   | $                       | (0.02     | )                       | $      | (0.11 | ) | $ | (0.03 | ) | $ | 0.01 |   |
|                                                                      |   |                    |      |                    |   |   |   |   |   |
| Weighted-average  shares outstanding:                                     |   |                    |      |                    |   |   |   |   |   |
| Basic                                                                     |   | 5,578,869               |      | 5,471,175               |   | 5,521,096 |   | 5,364,472 |   |
| Diluted                                                                   |   | 5,578,869               |      | 5,471,175               |   | 5,521,096 |   | 5,651,747 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

4

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ON-SITESOURCING, INC.

CONDENSEDSTATEMENTS OF CASH FLOWS

 
|                                                 |   | **(Unaudited)**                      |    | **(Unaudited)**                     |   |
|------------------------------------------------------|--------|--------------------------------------|---------|-------------------------------------|--------|
|                                                 |   | **Three Months Ended  September 30** |    | **Nine Months Ended  September 30** |   |
|                                                 |   | **2003**                             |    | **2002**                            |   | **2003** |   | **2002** |   |
| Cash  flows from operating activities:               |   |                                 |    |                                |   |   |   |   |   |
| Net  cash provided by operations                     |   | $                                    | 752,392 |                                | $      | 683,932 |   | $ | 1,839,669 |   | $ | 914,460 |   |
|                                                 |   |                                 |    |                                |   |   |   |   |   |
| Cash  flows from investing activities:               |   |                                 |    |                                |   |   |   |   |   |
| Acquisition  of property and equipment               |   | (142,941                             | )       | (925,872                            | )      | (308,369 | ) | (2,636,613 | ) |
| Receipt  of payments on notes receivable             |   | 11,923                               |    | 34,969                              |   | 35,694 |   | 91,725 |   |
| Proceeds  from disposal of equipment                 |   | 175,975                              |    | —                              |   | 186,074 |   | 15,777 |   |
|                                                 |   |                                 |    |                                |   |   |   |   |   |
| Net  cash provided by (used in) investing activities |   | 44,957                               |    | (890,903                            | )      | (86,601 | ) | (2,529,111 | ) |
|                                                 |   |                                 |    |                                |   |   |   |   |   |
| Cash  flows from financing activities:               |   |                                 |    |                                |   |   |   |   |   |
| Proceeds  from sale of common stock                  |   | 47,500                               |    | 15,963                              |   | 190,915 |   | 675,175 |   |
| Payments  of long-term debt                          |   | (653,270                             | )       | (499,413                            | )      | (1,211,947 | ) | (1,071,273 | ) |
| Long  term debt borrowing                            |   | —                               |    | 1,250,000                           |   | — |   | 1,250,000 |   |
| Borrowings  under line of credit                     |   | 4,791,408                            |    | 5,554,831                           |   | 13,868,611 |   | 15,401,613 |   |
| Payments  on line of credit                          |   | (4,982,987                           | )       | (6,113,910                          | )      | (14,600,197 | ) | (14,639,615 | ) |
|                                                 |   |                                 |    |                                |   |   |   |   |   |
| Net  cash used in financing activities               |   | (797,349                             | )       | 207,471                             |   | (1,752,618 | ) | 1,615,900 |   |
|                                                 |   |                                 |    |                                |   |   |   |   |   |
| Net  change in cash                                  |   | —                               |    | 500                                 |   | 450 |   | 1,249 |   |
| Cash,  beginning of period                           |   | 4,729                                |    | 4,031                               |   | 4,279 |   | 3,282 |   |
| Cash,  end of period                                 |   | $                                    | 4,729   |                                | $      | 4,531 |   | $ | 4,729 |   | $ | 4,531 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

5

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**ON-SITESOURCING, INC.**

**NOTES****TO FINANCIALSTATEMENTS**

**(unaudited)**

#### ***1. Nature of Business***

 

On-Site Sourcing, Inc. (the Company) was incorporatedin the Commonwealth of Virginia in December 1992 and changed its state ofincorporation to Delaware in January 1996. The Company provides digital imaging, reprographics, and digitalprinting to law firms and other organizations throughout the United States.Services are primarily performed in the metropolitan areas of Philadelphia,Pennsylvania, Washington, D.C., Atlanta, Georgia, New York, New York,Gaithersburg, Maryland (through September 30, 2003), and Tempe, Arizona(through October 15, 2002).  In August2002, the Company expanded its operations to Chicago, Illinois and Wilmington,Delaware.  Effective October 15, 2002,the Company ceased production at its facility in Tempe, Arizona, as result of astrategic decision to focus on larger geographic markets for growth.  On October 8, 2003 the Company divested theoffset printing operation located in Gaithersburg, MD (see Note 6).

 

#### ***2***. Basis ofPresentation

 

The accompanying unaudited financial statements and related footnoteshave been prepared in accordance with generally accepted accounting principlesfor interim financial information and Article 10 of Regulation S-X.  Accordingly, they do not include all theinformation and footnotes required by generally accepted accounting principlesfor annual reporting periods.  Theinterim financial information, in the opinion of management, reflects alladjustments of a normal recurring nature necessary for a fair statement of theresults for the interim periods.

 

The financial information presented should be read in conjunction withthe Company’s audited financial statements and the notes thereto for the yearended December 31, 2002, as filed with the Securities and Exchange Commissionon Form 10-K.  The results of operations for the three and nine-monthperiods ended September 30, 2003 and 2002 may not be indicative of the resultsfor the full year.

 

**3. Summary of SignificantAccounting Policies**

 

#### ***Revenue Recognition***

 

Revenue is primarily derived from providing reprographics, imaging, anddigital printing services.  The Companyrecognizes revenue from services rendered when the following four revenuerecognition criteria are met: persuasive evidence of an arrangement exists,services have been rendered or delivery has occurred, the selling price isfixed or determinable, and collectibility is reasonably assured.  Return and bad debt allowances are estimatedbased on specific identification and historical information.

 

For services that are completed but not delivered to the customers, norevenue is recognized and the associated costs are inventoriedaccordingly.  Such costs are included inresults of operation during the same period when the related services aredelivered and the revenue is recognized.

 

6

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Concentration of Credit Risks

 

Financial instruments that potentially subject theCompany to significant concentrations of credit risk consist principally ofaccounts receivable.  The Company generally sells its products to lawfirms and other commercial customers located in the United States.  TheCompany grants credit terms without collateral to its customers and has notexperienced any significant credit related losses.  Accounts receivableinclude allowances to record receivables at their estimated net realizablevalue.

 

Goodwill

 

The Company accounts for goodwill in accordance with Statement ofFinancial Accounting Standard (SFAS) No. 142, Goodwill and Other IntangibleAssets (SFAS No. 142).  SFAS No. 142 requires the Company to compare theestimated fair value of the reporting unit to the carrying amount of thereporting unit to determine if there is potential impairment on an annualbasis, unless measurement is required at interim periods.  If the estimatedfair value of the reporting unit is less than its carrying value, an impairmentloss is recorded to the extent that the fair value of the goodwill is less thanits carrying value.  The Companydetermined there was no impairment of goodwill during the periods reported.

 

Impairment of Long-Lived Assets 

 

Long-lived assets, primarily property and equipment, are reviewed forimpairment whenever events or changes in circumstances indicate that thecarrying amount of the assets might not be recoverable. The Company does notperform a periodic assessment of assets for impairment in the absence of suchinformation or indicators. Conditions that would necessitate an impairmentassessment include a significant decline in the observable market value of anasset, a significant change in the extent or manner in which an asset is used,or a significant adverse change that would indicate that the carrying amount ofan asset or group of assets is not recoverable. For long-lived assets to beheld and used, the Company recognizes an impairment loss only if its carryingamount is not recoverable through its undiscounted cash flows and measures theimpairment loss based on the difference between the carrying amount andestimated fair value.

 

Derivative Instrument and Hedging Activity

 

The Company uses an interest rate swap to convert its variable-rateinterest payments on its mortgage ($5,253,526 at September 30, 2003) tofixed-rate interest payments. This interest rate swap has been designated andqualifies as a cash-flow hedge.

 

The Company carries all derivative financial instruments on the balancesheet at fair value.  Changes in fairvalue of designated, qualified and effective cash flow hedges are estimated andrecorded as a component of Other Comprehensive Income (Loss) until the hedgedtransaction occurs, which at that time, is recognized in earnings (loss).  The Company has determined that its interestrate swap was highly effective upon adoption.

 

As of and for the nine months ended September 30, 2003, the Companyrecorded a non-current liability of $820,156, which represented the estimatedfair value of the interest rate swap, along with an unrealized after-tax lossof $495,293 in Other Comprehensive Loss, which is a component of Stockholders’Equity.

 

7

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Stock-Based Compensation

 

The Company uses the intrinsic-value method in accounting for itsemployee stock options rather than the alternative fair value accountingmethod. Companies that follow the intrinsic-value method must provide pro formadisclosure of the impact of applying the fair-value method.

 

The following table summarizes relevant information as to reportedresults under the Company’s intrinsic-value method of accounting for stockawards, with supplemental information as if the fair value recognitionprovisions had been applied:

 

 
|                                          |   | **(Unaudited)  Three Months Ended  September 30,** |     | **(Unaudited)  Nine Months Ended  September 30,** |   |
|-----------------------------------------------|--------|----------------------------------------------------|----------|---------------------------------------------------|--------|
|                                          |   | **2003**                                           |     | **2002**                                          |   | **2003** |   | **2002** |   |
| Net income  (loss), as reported               |   | $                                                  | (120,225 | )                                                 | $      | (619,517 | ) | $ | (192,751 | ) | $ | 41,932 |   |
| Less: stock-based compensation                |   | 70,209                                             |     | 100,723                                           |   | 233,829 |   | 295,383 |   |
| Adjusted net (loss) income                    |   | $                                                  | (190,434 | )                                                 | $      | (720,240 | ) | $ | (426,580 | ) | $ | (253,451 | ) |
|                                          |   |                                               |     |                                              |   |   |   |   |   |
| Basic earnings per share – as reported   |   | $                                                  | (0.02    | )                                                 | $      | (0.11 | ) | $ | (0.03 | ) | $ | 0.01 |   |
| Diluted earnings per share – as reported |   | $                                                  | (0.02    | )                                                 | $      | (0.11 | ) | $ | (0.03 | ) | $ | 0.01 |   |
| Basic earnings per share – as adjusted   |   | $                                                  | (0.03    | )                                                 | $      | (0.13 | ) | $ | (0.08 | ) | $ | (0.05 | ) |
| Diluted earnings per share – as adjusted |   | $                                                  | (0.03    | )                                                 | $      | (0.13 | ) | $ | (0.08 | ) | $ | (0.05 | ) |

 

The fair value for each option granted was estimated at the date ofgrant using the Black-Scholes option-pricing model, assuming no expecteddividends and the following weighted average assumptions:

 
|                             |   | **For Three  Months Ended  September 30,** |   | **For the  Nine Months Ended  September 30,** |   |
|----------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|
|                             |   | **2003**                                   |   | **2002**                                      |   | **2003** |   | **2002** |   |
| Average  risk-free interest rate |   | 4.21                                       | %      | 5.42                                          | %      | 4.94 | % | 5.44 | % |
| Average expected life (in years) |   | 5                                          |   | 5                                             |   | 5 |   | 5 |   |
| Volatility                       |   | 82                                         | %      | 74                                            | %      | 84 | % | 74 | % |

 

**4. Comprehensive Income**

 

SFAS No. 130, “Reporting Comprehensive Income”,requires that total comprehensive income (loss) be disclosed with equalprominence as net income (loss).  Comprehensive income (loss) is defined as changes in stockholders’equity exclusive of transactions with owners, such as capital contributions anddividends.  The Company’s totalcomprehensive income (loss) is comprised of net income (loss) and othercomprehensive loss, which consists of changes in the estimated fair value ofthe interest rate swap contract.   AtSeptember 30, 2003 and 2002, the components of comprehensive income (loss) wereas follows:

 

8

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|                        |   | **(Unaudited)  Three Months Ended  September 30,** |     | **(Unaudited)  Nine Months Ended  September 30,** |   |
|-----------------------------|--------|----------------------------------------------------|----------|---------------------------------------------------|--------|
|                        |   | **2003**                                           |     | **2002**                                          |   | **2003** |   | **2002** |   |
| Net (loss)  income          |   | $                                                  | (120,225 | )                                                 | $      | (619,517 | ) | $ | (192,751 | ) | $ | 41,932 |   |
| Other comprehensive loss:   |   |                                               |     |                                              |   |   |   |   |   |
| Interest rate swap contract |   | 77,370                                             |     | (180,954                                          | )      | (56,252 | ) | (559,064 | ) |
|                        |   |                                               |     |                                              |   |   |   |   |   |
| Comprehensive loss          |   | $                                                  | (42,855  | )                                                 | $      | (800,471 | ) | $ | (136,499 | ) | $ | (517,132 | ) |

 

**5. Earnings (Loss) Per Share**

 

Basic earnings (loss) per share excludes dilution andis computed by dividing the net income (loss) by the weighted-average number ofcommon shares outstanding.  Dilutedearnings per share is computed by additionally reflecting the potentialdilution that could occur, using the treasury stock method, if options toacquire common stock were exercised and resulted in the issuance of commonstock. Diluted loss per share excludes the effect of common stock optionsbecause their inclusion would have been anti-dilutive.  A reconciliation of the weighted-averagenumber of common shares outstanding assuming dilution is as follows:

 
|                                                           |   | **(Unaudited)  Three Months Ended  September 30** |     | **(Unaudited)  Nine Months Ended  September 30** |   |
|----------------------------------------------------------------|--------|---------------------------------------------------|----------|--------------------------------------------------|--------|
|                                                           |   | **2003**                                          |     | **2002**                                         |   | **2003** |   | **2002** |   |
|                                                           |   |                                              |     |                                             |   |   |   |   |   |
| Net income                                                     |   | $                                                 | (120,225 | )                                                | $      | (619,517 | ) | $ | (192,751 | ) | $ | 41,932 |   |
|                                                           |   |                                              |     |                                             |   |   |   |   |   |
| Weighted average common shares outstanding                     |   | 5,578,869                                         |     | 5,471,175                                        |   | 5,521,096 |   | 5,364,472 |   |
| Dilutive effect of outstanding stockoptions                    |   | —                                            |     | —                                           |   | — |   | 287,275 |   |
|                                                           |   |                                              |     |                                             |   |   |   |   |   |
| Weighted average common shares outstanding,  assuming dilution |   | 5,578,869                                         |     | 5,471,175                                        |   | 5,521,096 |   | 5,651,747 |   |
|                                                           |   |                                              |     |                                             |   |   |   |   |   |
| Net income per share:                                          |   |                                              |     |                                             |   |   |   |   |   |
| Basic                                                          |   | $                                                 | (0.02    | )                                                | $      | (0.11 | ) | $ | (0.03 | ) | $ | 0.01 |   |
| Diluted                                                        |   | $                                                 | (0.02    | )                                                | $      | (0.11 | ) | $ | (0.03 | ) | $ | 0.01 |   |

 

For the three months ended September 30, 2003 and2002, 674,291 and 246,500 options, respectively, were excluded from the abovereconciliation, as these options were anti-dilutive for these periods.  For the three months ended September 30,2003 and 2002 and the nine months ended September 30, 2003, as a result of anet loss, 15,924, 201,703, and 27,840 options, respectively, were excluded fromthe diluted loss per share calculation, as the shares were anti-dilutive.

 

9

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**6. Discontinued Operations**

 

During thequarter, the Company approved a plan to divest its offset printing operationlocated in Gaithersburg, MD.  Inconnection with the planned divestiture, the Company recorded a charge of$496,077, net of taxes, which consists primarily of an anticipated loss on thedisposition of property and equipment. During October 2003, the Company completed the disposition of thedivision.  Proceeds from the sale of thedivision were $1,425,000, of which $925,000 was received in cash and $500,000in a five-year note receivable.  AtSeptember 30, 2003, property and equipment held for sale was separatelypresented in the balance sheet at their estimated fair values, less costs ofsale.

 

Excluding theloss related to the disposal, the operating results of the offset printingdivision for the three and nine months ended September 30, 2003 and 2002 wereas follows:

 
|               |   | **(Unaudited)  Three Months Ended  September 30** |    | **(Unaudited)  Nine Months Ended  September 30** |   |
|--------------------|--------|---------------------------------------------------|---------|--------------------------------------------------|--------|
|               |   | **2003**                                          |    | **2002**                                         |   | **2003** |   | **2002** |   |
|               |   |                                              |    |                                             |   |   |   |   |   |
| Revenue            |   | $                                                 | 640,938 |                                             | $      | 553,283 |   | $ | 1,829,615 |   | $ | 1,685,461 |   |
|               |   |                                              |    |                                             |   |   |   |   |   |
| Operating loss     |   | (73,776                                           | )       | (451,251                                         | )      | (271,947 | ) | (621,746 | ) |
|               |   |                                              |    |                                             |   |   |   |   |   |
| Income tax benefit |   | 61,423                                            |    | 160,201                                          |   | 92,304 |   | 137,745 |   |
|               |   |                                              |    |                                             |   |   |   |   |   |
| Net loss           |   | (12,353                                           | )       | (291,050                                         | )      | (179,643 | ) | (484,001 | ) |
|                    |        |                                                   |         |                                                  |        |  |  |  |  |  |  |  |  |

 

Results of thedisposed offset printing division were previously reported under the DigitalPrinting segment.  All prior periodresults of the division have been reclassified to reflect the disposition.

 

**7. Segment Information**

 

The Company is organized and operates in threesignificant segments: reprographics, imaging, and digital printingservices.  Until December 31, 2001, theCompany also had a facility management services segment. As most of the servicecontracts were terminated by the Company, this segment was significantlyreduced during the first quarter of 2002. At September 30, 2003, the Company has one facilities managementcontract remaining.  Management does notview facility management services as a separate segment for the periodsreported.  In the summary of the resultsof the Company’s operating segments below, the results for the facilitymanagement contract are listed under the heading of other.

 

Reprographics involves the copying and management of large amounts ofdocuments extracted in their original format, from the offices and files ofcustomers.  Reprographic servicesinclude copying, binding, drilling, labeling, collating, assembling and qualityreview.  The Company’s reprographiccenters, currently located in Virginia, New York, Pennsylvania, Georgia,Illinois, Delaware, and Arizona (through October 15, 2002), are open 24 hours aday, seven days a week to handle the prompt turn-around time often requested bycustomers. A typical job ranges in size from single documents with a smallnumber of pages to multiple sets of documents, which can exceed a millionpages. A job is typically picked up by the Company’s in-house dispatch serviceand brought back to its production center. The jobs are then processed per thecustomer’s instructions and reviewed by the quality control staff. Documentsare returned to the client via the Company’s dispatch service. Reprographicjobs are generally billed on a job-by-job basis, based on the number of copiesand the level of difficulty in copying the original documents.

 

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Imaging services involves the conversion or transferof the traditional paper and electronic documents into electronic media orvice-versa. Services provided in the imaging services division primarily caterto law firms. A typical job involves a law firm that is representing a clientin a litigation matter. In order for the law firm to prepare for its case, itoften must review a large number of documents, emails, and email attachments.As a result, the law firms often have a need to search and retrieve appropriatedocuments in a timely and efficient manner. In order to help meet this need,the imaging services division offers case management consulting, electronicscanning of documents, converting email, attachments and other electronic filesto images, indexing/coding, optical character recognition, electronicdiscovery, blowback printing, training, technical support and electronicdocument search and retrieval services. Imaging services are typically billedon a job-by-job basis, based on the number of images and complexity of theretrieval applications.

 

Digital printing services include both black and white and colordigital production of catalogs, brochures, postcards, stationary, direct mail,newsletters, and exhibit materials. Typical customers include organizations requiring print media. Inaddition, ancillary services, which include graphic design, mailing, specialfinishing, storage, fulfillment, and delivery services are provided through thedigital printing segment. Printing jobs are typically billed on a job-by-jobbasis depending on several factors, including quantity, number of colors,quality of paper, and graphic design time. Effective October 1, 2003 as aresult of the Company’s divestiture of its offset printing operation, theCompany will no longer report digital printing as a segment.

 

The Company’s chief operating decision maker is the Chief ExecutiveOfficer.  The Chief Executive Officerevaluates segment performance based on revenue and income before allocation ofcorporate administrative expenses and taxes. A summary of the results of the Company’s operating segments is asfollows:

 
|                      |   | **(Unaudited)  Three Months Ended  September 30** |      | **(Unaudited)  Nine Months Ended  September 30** |   |
|---------------------------|--------|---------------------------------------------------|-----------|--------------------------------------------------|--------|
|                      |   | **2003**                                          |      | **2002**                                         |   | **2003** |   | **2002** |   |
| Revenue:                  |   |                                              |      |                                             |   |   |   |   |   |
| Reprographics             |   | $                                                 | 4,991,476 |                                             | $      | 4,249,314 |   | $ | 14,509,358 |   | $ | 13,880,331 |   |
| Imaging                   |   | 3,441,638                                         |      | 3,338,372                                        |   | 9,822,588 |   | 10,729,559 |   |
| Digital printing          |   | 242,647                                           |      | 228,733                                          |   | 757,105 |   | 781,340 |   |
| Other                     |   | 277,532                                           |      | 246,661                                          |   | 790,099 |   | 828,629 |   |
| Inter-segment elimination |   | (26,105                                           | )         | (21,365                                          | )      | (62,963 | ) | (145,895 | ) |
|                      |   |                                              |      |                                             |   |   |   |   |   |
| Total revenue             |   | $                                                 | 8,927,188 |                                             | $      | 8,041,715 |   | $ | 25,816,187 |   | $ | 26,073,964 |   |

 

11

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|                              |   | **(Unaudited)  Three Months Ended  September 30** |    | **(Unaudited)  Nine Months Ended  September 30** |   |
|-----------------------------------|--------|---------------------------------------------------|---------|--------------------------------------------------|--------|
|                              |   | **2003**                                          |    | **2002**                                         |   | **2003** |   | **2002** |   |
| Income  (loss) before taxes:      |   |                                              |    |                                             |   |   |   |   |   |
| Reprographics                     |   | $                                                 | 661,220 |                                             | $      | 264,082 |   | $ | 1,677,907 |   | $ | 2,172,610 |   |
| Imaging                           |   | 849,174                                           |    | 824,116                                          |   | 2,357,304 |   | 3,214,525 |   |
| Digital printing                  |   | (20,835                                           | )       | (78,453                                          | )      | 31,724 |   | 6,334 |   |
| Other                             |   | 50,969                                            |    | 42,005                                           |   | 88,492 |   | 164,878 |   |
| Corporate administrative expenses |   | (991,624                                          | )       | (1,561,013                                       | )      | (3,494,265 | ) | (4,882,735 | ) |
|                              |   |                                              |    |                                             |   |   |   |   |   |
| Total income (loss) before taxes  |   | $                                                 | 548,905 |                                             | $      | (509,263 | ) | $ | 661,162 |   | $ | 675,612 |   |

 

Results of operations of the offset printing division located inGaithersburg, Maryland were excluded from the table due to the disposition ofthis division during the quarter ended September 30, 2003 (See Note 6).

 

**8. Restructuring of Financial Covenants**

 

The Company has a working capital line of credit, amortgage note and a term note to a bank. The underlying agreements related to these debts provide cross-defaultprotection provisions to the lender, and require compliance with certainfinancial covenants.  Under the originalcovenant structure, a significant covenant required the Company to maintain anInterest Coverage Ratio, as defined, in excess of 2.0:1.  In May 2003, the Company obtained approvalfrom the bank to reduce the required Interest Coverage Ratio to 1.25:1 for thequarter ended June 30, 2003, after which the ratio would revert back to 2.0:1.

 

In July 2003 as a result of the Company not being incompliance with the Interest Coverage Ratio at June 30, 2003, the Companyrequested the bank to restructure the Company’s covenants and debtstructure.  The bank agreed to restructurethe terms of the covenants and debt as follows:

 

Under the modified loan agreements, the principalamount available to borrow under the line of credit agreement was reduced from$7.0 million to $5.0 million and the related interest rate was increased by0.15% to 30-day LIBOR plus 2.35% (3.47% at September 30, 2003).   The working capital line of credit iscollateralized by accounts receivable and certain equipment, and expires in May2004.  The Company has the capacity toborrow, at any given time, the lesser of the established line of credit oreligible accounts receivable, generally defined as 75% of accounts receivablethat are less than 120 days old.  AtSeptember 30, 2003, the Company had approximately $3.0 million available todraw against the credit line.

 

The definition of the Funds Flow Coverage Ratio wasmodified and the revised Funds Flow Coverage Ratio was initially measured onSeptember 30, 2003, and at each subsequent quarter-end.  The Company is required to maintain aminimum Funds Flow Coverage Ratio of 1.5:1.

 

The Interest Coverage Ratio was deleted in itsentirety.

 

The Tangible Net Worth Covenant was modified toincrease the minimum tangible net worth of the Company, at all times, to$8,500,000.

 

A Net Loss Covenant was added which states that theafter tax net loss for any fiscal quarter shall not exceed $200,000, and amaximum after tax net loss for fiscal year 2003 shall not exceed $350,000.

 

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The modified agreement also states that the Companyshall not make capital expenditures in excess of $125,000 in any fiscalquarter.  However, this amount may beincreased by $150,000 if the company receives an equivalent amount of cash as aresult of stock options exercised by option holders of the Company.

 

At September 30, 2003,the Company was in compliance with all bank convents.

 

**9. Subsequent Events**

 

On October 28, 2003 the Company signed a letter of intent withDocuforce, LLC, to be acquired in a cash transaction valued at approximately$16,000,000. Under the terms of the proposed transaction, stockholders ofOn-Site Sourcing are expected to receive $2.75 per share, subject todollar-for-dollar adjustment based on changes in total stockholders’ equityfrom September 30, 2003 to the closing of the transaction. In addition, thetransaction is subject to due diligence and financial review by Docuforce LLC,approval by On-Site Sourcing’s stockholders and Docuforce’s principals,negotiation and execution of a definitive merger agreement and certain othercustomary conditions including certain key executives entering into employmentagreements with the acquirer. The transaction is expected to close in lateFebruary or early March 2004.

 

On November 4, 2003 the Company entered into an agreement for the saleand subsequent leaseback of the Company’s land and headquarters office andproduction facility located in Alexandria, VA. The transaction is contingent on a customary 30-dayfeasibility study to be conducted by the buyer and is expected to close in lateDecember 2003.  The sale price isestimated to be $9,900,000, comprised of assignment to the buyer of themortgage of approximately $5,200,000 and the interest rate swap contractliability of approximately $850,000, and cash proceeds of approximately$3,850,000.

 

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

 

On-Site Sourcing, Inc. (On-Site, the Company, we, us,or our) provides document and information management services through itsfacilities in the greater Atlanta, Baltimore, New York City, Philadelphia,Washington, D.C., Chicago, and Wilmington metropolitan areas, and servedclients on the West Coast through its Tempe, Arizona facility (through October15, 2002).  We help clients in information-intensiveindustries manage large volumes of documents and information, allowing them toconcentrate on their core business operations. Our target clients typicallygenerate large volumes of documents and information that require specializedprocessing, distribution, storage, and retrieval.  Our typical clients include law firms, insurance companies,healthcare organizations, non-profit organizations, accounting, consulting andfinance firms and other organizations throughout the United States.  We also provide commercial printing servicesutilizing digital printing technology in our facilities in the Washington, D.C.area.  Effective October 15, 2002, theCompany ceased production at its facility in Tempe, Arizona as result of astrategic decision to focus on larger geographic markets for growth. Theproduction facility represented a component of the Imaging Services Segment. OnOctober 8, 2003 the Company divested the offset printing operation located inGaithersburg, MD (see Note 6).

 

On-Site was originallyincorporated in Virginia in December 1992, and changed its state ofincorporation to Delaware in March 1996.

 

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**Forward Looking Disclosure**

 

Certain information included herein contains forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of1995.  All statements other thanstatements of historical fact, including statements regarding industryprospects, plans for future expansion and other business development activitiesas well as future results of operations or financial position and the effectsof competition are forward looking. Such forward-looking information is subject to changes and variationswhich are not reasonably predictable and which could significantly affectfuture results.  Accordingly, suchresults may differ from those expressed in any forward-looking statements madeby or on behalf of the Company.  Therisks and uncertainties that could significantly affect future results include,but are not limited to, those relating to the adequacy of operating andmanagement controls, operating in a competitive environment and a changingenvironment, including new technology and processes, existing and future vendorrelationships, the Company’s ability to access capital and meet its debt servicerequirements, dependence on existing management, general economic conditions,terrorist attacks, and changes in federal or state laws or regulations.  These risks and uncertainties, along withthe following discussion, describe some, but not all, of the factors that couldcause actual results to differ significantly from management’s expectations.

 

**Critical Accounting Policies and Judgments**

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires estimates and assumptionsthat affect the reported amounts of assets and liabilities, revenue andexpenses, and related disclosures of contingent assets and liabilities in thefinancial statements and accompanying notes. The U.S. Securities and Exchange Commission has defined a company’s mostcritical accounting policies as the ones that are most important to theportrayal of the Company’s financial condition and results of operations, andwhich require the Company to make its most difficult and subjective judgments,often as a result of the need to make estimates of matters that are inherentlyuncertain.  Based on this definition, wehave identified the critical accounting policies and judgments addressedbelow.  Although we believe that ourestimates and assumptions are reasonable, they are based upon informationpresently available.  Actual results maydiffer significantly from these estimates under different assumptions orconditions.

 

**Revenue Recognition**

 

Revenue is primarily derived from providing imaging, reprographics anddigital printing services.   The Companyrecognizes revenue from services rendered when the following four revenuerecognition criteria are met: persuasive evidence of an arrangement exists,services have been rendered or delivery has occurred, the selling price isfixed or determinable, and collectibility is reasonably assured.  Return and bad debt allowances are estimatedbased on specific identification and historical information.

 

For services that are completed but not delivered to the customers, norevenue is recognized and the associated costs are inventoriedaccordingly.  Such costs are included inresults of operation during the same period when the related services aredelivered and the revenue is recognized.

 

Included in “Accounts receivable, net” on our Balance Sheets is anallowance for doubtful accounts.  Seniormanagement reviews the accounts receivable aging on a monthly basis todetermine if any receivables will potentially be uncollectable.  After all attempts to collect the receivablehave failed, the receivable is written off against the allowance.  Based on the information available to us, webelieve our allowance for doubtful accounts as of September 30, 2003 isadequate.  However, no assurances can begiven that actual write-offs will not exceed the recorded allowance.

 

14

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**Accounting for Goodwill**

 

The Company records impairment losses on goodwill when events andcircumstances indicate that such assets might be impaired and the estimatedfair value of the asset is less than its recorded amount. Conditions that wouldnecessitate an impairment assessment include material adverse changes inoperations, significant adverse differences in actual results in comparisonwith initial valuation forecasts prepared at the time of acquisition, adecision to abandon acquired products, services or technologies, or othersignificant adverse changes that would indicate the carrying amount of therecorded asset might not be recoverable. The fair value for goodwill is estimated using the discounted cash flowmodel, with the Company’s own assumptions. At September 30, 2003 the Company noted no conditions or change incircumstances that would render an impairment assessment.  Change in management’s judgment may lead tosignificantly different results.

 

**Accounting for Derivative Instrument andHedging Activity**

 

The Company uses an interest rate swap to convert its variable-rateinterest payments on its mortgage ($5,253,526 at September 30, 2003) tofixed-rate interest payments. This interest rate swap was designated as acash-flow hedge and qualified for the short-cut method of assessingeffectiveness.

 

The Company carries all derivative financial instruments on the balancesheet at fair value.  Fair value isobtained from the lending institution on a quarterly basis, and is based oninterest rates at the inception of the hedge, current interest rates, andremaining time period until maturity on the underlying debt. Changes in fairvalue of effective cash flow hedges are recorded as a component of OtherComprehensive Income (Loss) until the hedged transaction occurs, which at thattime is recognized in earnings (loss). The Company assumes the hedged transaction will occur during the term ofthe underlying agreement.  Results ofoperations may be materially affected if such transaction were not to occur.

 

**Long-lived Assets**

 

Long-lived assets (primarily property andequipment) are reviewed for impairment whenever events or changes incircumstances indicate the carrying amount of the assets might not berecoverable. The Company views the following as conditions that necessitateimpairment: a significant decline in the observable market value of an asset, asignificant change in the extent or manner in which an asset is used, or asignificant adverse change that would indicate that the carrying amount of anasset or group of assets is not recoverable. For long-lived assets to be heldand used, the Company measures fair value based on quoted market prices,discounted estimates of future cash flows or other methods. For the three andnine months ended September 30, 2003, the Company did not note any events orchanges in circumstances indicating the carrying amount of long-lived assetswere not recoverable.  The carryingamount of long-lived assets is based on management’s judgment as to estimatedfuture performance of the business. Changes in judgments regarding future performance may lead to adifferent result.

 

**Accountingfor Taxes**

 

The Company recognizes deferred tax assets and liabilities based ondifferences between the financial reporting and tax bases of assets andliabilities using the enacted tax rates and laws that are expected to be ineffect when the differences are expected to be reversed. The Company provides avaluation allowance for deferred tax assets for amounts it considersunrealizable.  As of September 30, 2003,the Company did not provide any valuation allowance for the deferred taxassets.  This assessment is based onmanagement’s best estimate of forecasted taxable income.   There can be no guarantee that the actualresults will not be materially different from forecasted results.

 

15

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**Contingencies**

 

In the normal course of business, the Companyis subject to certain claims and legal proceedings.  We record an accrued liability for these matters when an adverseoutcome is probable and the amount of the potential liability is reasonablyestimable.  We do not believe theresolution of these matters will have a material effect upon our financialcondition, results of operations or cash flows for an interim or annual period.

 

**Recent Accounting Pronouncements**

 

In April 2003,the FASB issued SFAS No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities.” SFAS No. 149 amends and clarifiesaccounting for derivative instruments, including certain derivative instrumentsembedded in other contracts, and for hedging activities under SFAS No. 133. Thestatement requires that contracts with comparable characteristics be accountedfor similarly and clarifies when a derivative contains a financing componentthat warrants special reporting

in thestatement of cash flows. SFAS No. 149 is effective for contracts entered intoor modified after June 30, 2003, except in certain circumstances, and forhedging relationships designated after June 30, 2003. The Company does notexpect that the adoption of this standard will have a material effect on its financialposition, results of operations or cash flows.

 

In May 2003,the FASB issued SFAS No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity.”  This Statement establishes standards for how an issuer classifiesand measures in its statement of financial position certain financialinstruments with characteristics of both liabilities and equity. It requiresthat an issuer classify a financial instrument that is within its scope as aliability (or an asset in some circumstances) because that financial instrumentembodies an obligation of the issuer. This Statement is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning after June 15,2003, except for mandatorily redeemable financial instruments of nonpublicentities. The Company does not expect that the adoption of this standard willhave a material effect on its

financialposition, results of operations or cash flows.

 

**Results of OperationsFor the Three and Nine Months Ended September 30, 2003 and 2002.**

 

**Revenue**

 

Revenuereported for the three months ended September 30, 2003 was $8.9 million, a $0.9million, or 11.0% increase from the $8.0 million reported in the comparableperiod in 2002.  Revenue reported forthe nine months ended September 30, 2003 was $25.8 million, a $0.3 million, or1.0% decrease from the $26.1 million reported in the comparable period in2002.  The increase in revenue for the threemonths ended September 30, 2003 compared to the three months ended September30, 2002 was due to an increased demand for our service and partially due torevenue generated by the Company’s newly opened offices in Chicago, IL andWilmington, DE.  The decrease for thenine months ended September 30, 2003 compared to the nine months endedSeptember 30, 2002 was due to a overall reduced general demand for our servicesrelated to large transactional matters and reduced pricing on services as aresult of competitive pricing pressures.

 

**Gross Profit**

 

Gross profit for the threemonths ended September 30, 2003 was $3.3 million, a $0.5 million, or 18.7%,increase from the $2.8 million reported in the comparable period in 2002.  Gross profit for the nine months endedSeptember 30, 2003 was $9.1 million, a $1.5 million, or 13.9%, decrease fromthe $10.6 million reported in the comparable period in 2002.  Gross profit as a percentage of sales was36.9% and

 

16

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34.5% for the three monthsended September 30, 2003 and 2002, respectively.  Gross profit as a percentage of sales was 35.5% and 40.8% for thenine months ended September 30, 2003 and 2002, respectively.  The increase in gross profit for the threemonths ended September 30, 2003 as compared to the three months ended September30, 2002 was attributable to increased revenue, increased higher margin serviceofferings, and the positive impact of cost cutting measures implemented by theCompany.  For the nine months endedSeptember 30, 2003 compared to the nine months ended September 30, 2002, thereduction in gross profit was mostly attributable to overall decreasedrevenues, increased price competition, and increased selling of labor-intensiveservices and less higher profit margin service offerings, such as electronicfile processing.

 

**Sales and MarketingExpenses**

 

Salesand marketing expense for the three months ended September 30, 2003 remainedunchanged at  $1.1 as compared to thethree months ended September 30, 2002. Sales and marketing expense as a percentage of sales was 12.6% and 13.9%for the three months ended September 30, 2003 and 2002, respectively.  Sales and marketing expense for the ninemonths ended September 30, 2003 was $3.3 million, a $0.1 million, or 3.9%,decrease from the $3.4 million reported in the comparable period in 2002.  Sales and marketing expense as a percentageof sales was 12.6% and 13.0% for the nine months ended September 30, 2003 and2002, respectively.

 

Salesand marketing expense consists primarily of salaries, sales commissions, andother related costs associated with the selling of the Company’s services, suchas travel and entertainment.  Salescommissions paid to the Company’s account executives are calculated on aper-job basis and fluctuate depending on the profitability of the particularjob.  Sales and marketing expensedecreased for the three and nine months ended September 30, 2003 compared tothe comparable period in 2002 due to the transition of several accountexecutives from base salary to commission only, and cost cutting measures  with regard to marketing and relatedexpenses.

 

**General andAdministrative Expenses**

 

Generaland administrative expenses for the three months ended September 30, 2003 was$1.5 million, a $0.5 million or 22.7%, decrease from the $2.0 million reportedin the comparable period in 2002. General and administrative expenses as a percentage of sales were 17.0%and 24.4% for the three months ended September 30, 2003 and 2002,respectively.  General andadministrative expenses for the nine months ended September 30, 2003 was $4.8million, a $1.2 million or 19.4%, decrease from the $6.0 million reported inthe comparable period in 2002.  Generaland administrative expenses as a percentage of sales were 18.8% and 23.1% forthe nine months ended September 30, 2003 and 2002, respectively.  Significant factors that contributed to thedecreased expense for the three and nine months ended September 30, 2003include the following:

 

Adecrease of approximately $128,000 and $94,600 for the three and nine monthsended September 30, 2003, respectively, is attributable to the reduction ofadministrative salaries.  This reductionis attributable to the elimination of several highly compensated administrativepositions along with the closing of the Arizona office.

 

Adecrease of approximately $4,300 and $309,000 for the three and nine monthsended September 30, 2003, respectively, is attributable to the reduction inbonus payments awarded to the divisional managers.  This reduction  is due toa majority of the divisional managers not meeting their performance goals setin their bonus plans for fiscal year 2003. Unlike prior years, the bonus plans for 2003 are based on theperformance of each segment.  Prior yearbonus plans were based on the performance of each location.

 

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Adecrease of approximately $36,300 and $144,900 for the three and nine monthsended September 30, 2003, respectively, is attributable to the decreased travelincurred by executive and management level employees visiting the Company’svarious production locations.

 

Adecrease of approximately $38,200 and $99,100 for the three and six monthsended September 30, 2003, respectively, is attributable to the Company’sdecrease in depreciation expense.  Overthe past nine months, the Company has made a significant effort to reduce theamount of capital expenditures.  As aresult, the company has experienced an insignificant increase in depreciationexpense arising from new capital expenditures. Furthermore, the Company’s depreciable base has been consistentlydecreasing as its existing assets have become fully depreciated and/or disposedof.  This, coupled with the Company’sdecreasing capital expenditures, has resulted in a reduction in depreciationexpense.

 

A decrease of approximately $73,600 and $155,300 for the three and ninemonths ended September 30, 2003, respectively, is attributable to the Company’sdecrease in office expense.  TheCompany’s office expenses include company-sponsored events, promotional items,building maintenance and payroll processing fees.  The closing of the Arizona office and the increased costreduction efforts have contributed to the Company’s decrease in office andgeneral and administrative expenses.

 

**Other Income**

 

Otherincome for the three months ended September 30, 2003 was approximately $55,000,a $75,000 increase from the amount reported in the comparable period in2002.  Other income for the nine monthsended September 30, 2003 was approximately $95,000, an $83,000 increase fromthe approximately $12,000 reported in the comparable period in 2002.  Other income consists primarily of rentalincome and the gain or loss from fixed asset dispositions.  The Company’s rental income is generatedfrom subletting a portion of the property owned at 832 North Henry Street,Alexandria, VA.  The Company currentlyhas one tenant who will begin a month-to-month lease beginning in November2003.  The increased income for thethree and nine-month periods ending September 30, 2003 was attributable to again on the sale of assets, whereas a loss was recognized from the sale ofassets in the comparable periods in 2002.

 

Interest expense for the three months ended September 30, 2003 wasapproximately $157,000, a $26,000 decrease from the approximate $183,000reported in the comparable period in 2002.  Interest expense for the ninemonths ended September 30, 2003 was approximately $491,000, a $79,000 decreasefrom the approximately $570,000 reported in the comparable period in 2002.  The reduction in interest expense is due tolower debt balances and overall lower interest rates related to borrowingsunder term notes and other similar debt arrangements. In addition, the Companyhas reduced its line of credit and term notes outstanding balances as comparedto 2002.  The Company’s line of creditbalance was $2,129,828 and $3,882,165 as of September 30, 2003 and 2002,respectively.

 

**Income Taxes**

 

TheCompany had income tax expense of $160,700 and an income tax benefit of$180,796 for the three months ended September 30, 2003 and 2002,respectively.  This increase isattributable to the Company’s increased income before tax for the respectiveperiods.  The Company had income taxexpense of $178,193 and $149,679 for the nine months ended September 30, 2003and 2002, respectively.

 

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##### **Liquidityand Capital Resources**

 

The Company has funded its expansion through utilizing internallygenerated cash flow, long term financing, and a short-term commercial line ofcredit.  The Company anticipates that the cash flow from operations andthe credit facilities will be sufficient to meet the expected cash requirementsfor the next twelve months. However, the Company may experience an inability tomeet its capital requirements should any of the following events occur:significant loss from operations, significant decrease in revenue, creditcovenant defaults, and/or account receivable defaults by customers, or groupsof customers, whose balances are significant to the Company’s operations. Inorder to meet these unforeseen capital requirements, the Company may seekadditional resources, which could include collateral-based loans, capitalleases, and operating leases.

 

As of September 30, 2003, the Company had approximately $4,700 in cash(primarily petty cash).  To ensure thatworking capital is available to fund the Company’s operations, the Company hasa $5.0 million working capital line of credit (Line of Credit) that expires May2004.  The Company has the capacity to borrow, at any given time, thelesser of 1) the established line of credit or 2) the eligible accountsreceivable - generally defined as 75% of accounts receivable less than 120 daysold.  As of September 30, 2003 the Company had approximately $3.0 millionavailable under the Line of Credit, bearing interest at the lesser of thebank’s prime interest rate or the 30-day LIBOR plus 2.35%.

 

As of September 30, 2003, the Company had an outstanding mortgage notepayable (Mortgage) of $5,253,526.  TheMortgage was entered to fund the purchase of property located at 832 NorthHenry Street,  Alexandria, Virginia.  In order to manage interest costs and hedgeexposure to changing interest rates, the Company also entered into an interestrate swap, whereby the interest rate is fixed at 9.48%.  Under the terms of the Mortgage and therelated interest rate swap agreement, the Company is required to make monthlyprincipal and interest payments of $60,495 for a period of seven years, and alump-sum payment of $4,155,254 at the Mortgage termination in October 2007.

 

As of September 30, 2003, the Company also had one term note (Note)with a remaining principal amount of $1,533,333. The note bears interest at afluctuating annual rate equal to the 1 – Month LIBOR plus 2.35% and matures onJuly 31, 2005.

 

The Credit, Mortgage, and Note were all obtained fromthe same bank.  As of September 30, 2003the total bank borrowings were $8,916,687. The underlying agreements related to these borrowings require certainfinancial covenants and include cross-default provisions to protect the lender.

 

In July 2003 as a result of the Company not being incompliance with the Interest Coverage Ratio at June 30, 2003, the Companyrequested the bank to restructure the Company’s covenants and debtstructure.  The bank agreed torestructure the terms of the covenants and debt as follows:

 

Under the modified loan agreements, the principalamount available to borrow under the line of credit agreement was reduced from$7.0 million to $5.0 million and the interest rate increased to the 30-dayLIBOR plus 2.35% (3.47% at September 30, 2003), an increase of 0.15%.  The working capital line of credit iscollateralized by accounts receivable and certain equipment, and expires in May2004.  The Company has the capacity toborrow, at any given time, the lesser of the established line of credit oreligible accounts receivable, generally defined as 75% of accounts receivablethat are less than 120 days old.  AtSeptember 30, 2003, the Company had approximately $3.0 million available todraw against the credit line.

 

The definition of the Funds Flow Coverage Ratio wasmodified and the revised Funds Flow Coverage Ratio was initially measured onSeptember 30, 2003, and at each subsequent quarter-end.  The Company is required to maintain aminimum Funds Flow Coverage Ratio of 1.5:1.

 

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The Interest Coverage Ratio was deleted in itsentirety.

 

The Tangible Net Worth Covenant was modified toincrease the minimum tangible net worth of the Company, at all times, to$8,500,000.

 

A Net Loss Covenant was added which states that theafter tax net loss for any fiscal quarter shall not exceed $200,000, and amaximum after tax net loss for fiscal year 2003 shall not exceed $350,000.

 

The modified agreement also states that the Companyshall not make capital expenditures in excess of $125,000 in any fiscalquarter.  However, this amount may beincreased by $150,000 if the company receives an equivalent amount of cash as aresult of stock options exercised by option holders of the Company.

 

At September 30, 2003 theCompany was in compliance with all bank covenants.

 

The following summarizes the Company’s payment (principal and interest)obligations and commitments under contract, including debt and leasearrangements, as of September 30, 2003. The Company expects to fund such obligations from cash generated fromthe operating activities and the line of credit.

 
|                               |   | **Payments Due by Period** |       |
|------------------------------------|--------|----------------------------|------------|
| **Contractual  Obligations**       |   | **Total**                  |       | **Less than  1 Year** |   | **1-3  Years** |   | **4-5  Years** |   | **After 5  Years** |   |
| Line of Credit                     |   | $                          | 2,129,828  |   | 2,129,828 |   | — |   | — |   | — |   |
| Building Mortgage                  |   | 7,119,510                  |       | 725,940 |   | 2,177,820 |   | 4,215,750 |   | — |   |
| Long-Term Debt                     |   | 1,522,468                  |       | 843,576 |   | 678,892 |   | — |   | — |   |
| Lease Commitments                  |   | 5,844,131                  |       | 1,925,206 |   | 3,418,537 |   | 339,526 |   | 160,862 |   |
| Total Contractual Cash Obligations |   | $                          | 16,615,937 |   | $ | 5,624,550 |   | $ | 6,275,249 |   | $ | 4,555,276 |   | $ | 160,862 |   |
|                                    |        |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

## ***Item 3.***** ****Quantitativeand Qualitative Disclosures about Market Risk**

 

The Company’s activities expose it to market risks that are related tothe effects of changes in interest rates. The Company does not have cash flow exposure due to interest ratechanges for its mortgage note ($5,253,526 at September 30, 2003) as the Companyuses an interest rate swap to fix the variable interest rate on the note (30day LIBOR plus 2.5%) at 9.48%.  Otherdebt arrangements, such as working capital line of credit and short-term notesare used to support general operation needs, including capital expenditures andworking capital needs.  The carryingamounts for cash and cash equivalents, accounts receivable and notes payablereported in the balance sheets approximate fair value.

 

The table below presents principal amounts and related average interestrates by year of maturity for our long-term obligations at September 30, 2003:

 

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|                                             |   | **2003** |   | **2004** |   | **2005** |   | **2006** |    | **2007** |   |
|--------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|---------|----------|--------|
| Mortgage note                                    |   | $        | 56,010 |     | $      | 235,119  |   | $        | 260,184 |     | $      | 286,307 |   | $ | 4,415,906 |   |
| Average interest rate                            |   | 9.48     | %      | 9.48     | %      | 9.48     | %      | 9.48     | %       | 9.48     | %      |
|                                             |   |     |   |     |   |     |   |     |    |     |   |
| Term note                                        |   | 200,001  |   | 800,004  |   | 466,669  |   |     |    |     |   |
| Average interest rate                            |   | 3.65     | %      | 3.95     | %      | 4.95     | %      |     |    |     |   |
|                                             |   |     |   |     |   |     |   |     |    |     |   |
| Interest rate swap (pay fixed/receive  variable) |   | $        | 56,010 |     | $      | 235,119  |   | $        | 260,184 |     | $      | 286,307 |   | $ | 4,415,906 |   |
| Average pay rate                                 |   | 9.48     | %      | 9.48     | %      | 9.48     | %      | 9.48     | %       | 9.48     | %      |
| Average receive rate                             |   | 3.15     | %      | 3.45     | %      | 4.45     | %      | 5.74     | %       | 6.27     | %      |

 

The carrying amounts and fair value of our financial instruments are asfollows:

 
|               |   | **September  30, 2003** |      | **September  30, 2002** |   |
|--------------------|--------|-------------------------|-----------|-------------------------|--------|
|               |   | **Carrying  Amount**    |      | **Fair Value**          |   | **Carrying  Amount** |   | **Fair Value** |   |
| Line of credit     |   | $                       | 2,129,828 |                    | $      | 2,129,828 |   | $ | 3,882,165 |   | $ | 3,882,165 |   |
| Term note          |   | 1,533,333               |      | 1,533,333               |   | 3,059,081 |   | 3,059,081 |   |
| Mortgage note      |   | 5,253,526               |      | 5,253,526               |   | 5,464,836 |   | 5,464,836 |   |
| Interest rate swap |   | (820,156                | )         | (820,156                | )      | (925,757 | ) | (925,757 | ) |
|                    |        |                         |           |                         |        |  |  |  |  |  |  |  |  |

 

Based upon the composition of the Company’s variable-rate debtoutstanding at September 30, 2003, which is primarily borrowings under theworking capital line of credit and term notes, we do not believe that ahypothetical increase in the bank’s prime rate of interest or the 30-day LIBORwould be material to net income.

 

**Item4. Controls and Procedures**

 

Within 90 days prior to the filing date of this report, we evaluatedthe effectiveness of the design and operation of our disclosure controls andprocedures, which are designed to ensure the timeliness and accuracy of ourdisclosures and financial statements. This evaluation was under the supervision and with the participation ofmanagement, including our Chief Executive Officer and Chief FinancialOfficer.  The Company and managementalso recognized that all disclosure controls and procedures have certainlimitations based on cost-benefit considerations, and can only providereasonable assurances of achieving the desired control objectives.  Based upon the evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures are effective in providing reasonable assurances thatthey are timely alerted to material information required to be included in ourperiod Securities and Exchange Commission filings.

 

There have been no significant changes in the Company’s internalcontrols or in other factors that could significantly affect these controlssubsequent to the date of their evaluation.

 

**Part II. Other Information**

 

**Item 1.****  LegalProceedings**

 

None.

 

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**Item 2.****  Changesin Securities and Use of Proceeds**

 

None.

 

**Item 3.****  DefaultsUpon Senior Securities**

 

None.

 

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

 

None.

 

**Item 5.****  OtherInformation**

 

On October 28, 2003 the Company signed a letter of intent withDocuforce, LLC, to be acquired in a cash transaction valued at approximately$16,000,000. Under the terms of the proposed transaction, stockholders ofOn-Site Sourcing are expected to receive $2.75 per share, subject todollar-for-dollar adjustment based on changes in total stockholders’ equityfrom September 30, 2003 to the closing of the transaction. In addition, thetransaction is subject to due diligence and financial review by Docuforce LLC,approval by On-Site Sourcing’s stockholders and Docuforce’s principals,negotiation and execution of a definitive merger agreement and certain othercustomary conditions including certain key executives entering into employmentagreements with the acquirer. The transaction is expected to close in lateFebruary or early March 2004.

 

On November 4, 2003 the Company entered into an agreement for the saleand subsequent leaseback of the Company’s land and headquarters office andproduction facility located in Alexandria, VA. The transaction is contingent on a customary 30-day feasibilitystudy to be conducted by the buyer and is expected to close in late December2003.  The sale price is estimated to be$9,900,000, comprised of assignment to the buyer of the mortgage ofapproximately $5,200,000 and the interest rate swap contract liability ofapproximately $850,000, and cash proceeds of approximately $3,850,000.

 

**Item 6.****  Exhibitsand Reports**

 

(A)      EXHIBITS

 

Exhibit10.30 Agreement for the Sale and Purchase of the Gaithersburg Business, datedOctober 8, 2003 with Colornet Printing and Graphics, Inc.

 

Exhibit31.1 Certification as Adopted Pursuant to Section 302(a) of the Sarbanes-OxleyAct of 2002 by Chief Executive Officer

 

Exhibit31.2 Certification as Adopted Pursuant to Section 302(a) of the Sarbanes-OxleyAct of 2002 by Chief Financial Officer

 

Exhibit32.1 Certication Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant toSection 906 of the Sarbanes-Oxley Act of 2002 by Chief Executive Officer

 

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Exhibit32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuantto Section 906 of the Sarbanes-Oxley Act of 2002 by Chief Financial Officer

 

(B)      REPORTS ON FORM 8-K

 

On October 8, 2003, the Company filed a Current Report on Form 8-K withthe Securities and Exchange Commission to report the sale of the Company’sOffset Printing Division.  The CurrentReport on Form 8-K attaches as an exhibit the press release regarding the sale.

 

On November 4, 2003, the Company filed a Current Report on Form 8-Kwith the Securities and Exchange Commission to report the signing of a letterof intent with Docuforce, LLC to be acquired in a cash transaction valued atapproximately $16,000,000.

 

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**SIGNATURE**

 

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                           |   | ON-SITE SOURCING, INC.                                                                            |
|--------------------------------|--------|---------------------------------------------------------------------------------------------------|
|                           |   | (Registrant)                                                                                      |
|                           |   |                                                                                              |
|                           |   |                                                                                              |
|                           |   |                                                                                              |
|                           |   | /s/ Jason Parikh                                                                                  |
| Date    November 14, 2003 |   | Jason Parikh  Chief Financial Officer  (Duly Authorized Officer and Principal Financial  Officer) |

 

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