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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549
 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2004  [  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the period from __________ to __________ Commission file number
   001-12665 AFFILIATED COMPUTER SERVICES, INC. 
  Delaware
    
    51-0310342(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer Identification No.)2828 North Haskell, Dallas, Texas
    
    75204(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone
number, including area code    (214) 841-6111 Not Applicable 
  Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.   YesX  No Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YesX  No Indicate the number of shares outstanding of each of the registrants classes
of common stock, as of the latest practicable date. Number of shares outstanding as ofTitle of each class
    
    May 13, 2004Class A Common Stock, $.01 par value
    
    
    122,798,508Class B Common Stock, $.01 par value
    
    
    6,599,372129,397,880




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AFFILIATED COMPUTER SERVICES, INC. AND SUBSIDIARIES INDEX PAGENUMBERPART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Consolidated Financial Statements:Consolidated Balance Sheets at March 31, 2004 and
June 30, 2003
    
    1Consolidated Statements of Income for the Three Months and Nine
Months Ended March 31, 2004 and 2003
    
    2Consolidated Statements of Cash Flows for the Nine Months Ended
March 31, 2004 and 2003
    
    3Notes to Consolidated Financial Statements
    
    4  12Item 2.
    
    Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    13  26Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    27Item 4.
    
    Controls and Procedures
    
    27PART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    28Item 2
    
    Changes in Securities and Use of Proceeds
    
    29Item 6.
    
    Exhibits and Reports on Form 8-K
    
    30Severance AgreementCertification of Chief Executive OfficerCertification of Chief Financial OfficerCertification of Chief Executive OfficerCertification of Chief Financial Officer




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PART I 
 ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
 AFFILIATED COMPUTER
SERVICES, INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
(in thousands)
 March 31,
    
    June 30,2004
    
    2003(Unaudited)
    
    (Audited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    39,023
    
    
    $
    51,170Accounts receivable, net
    
    
    841,158
    
    
    
    835,478Inventory
    
    
    5,641
    
    
    
    6,245Other current assets
    
    
    98,523
    
    
    
    86,605Total current assets
    
    
    984,345
    
    
    
    979,498Property, equipment and software, net
    
    
    506,428
    
    
    
    478,212Goodwill, net
    
    
    1,958,291
    
    
    
    1,905,878Intangibles, net
    
    
    286,261
    
    
    
    265,091Other long-term assets
    
    
    78,946
    
    
    
    70,026Total assets
    
    $
    3,814,271
    
    
    $
    3,698,705LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    51,570
    
    
    $
    58,376Accrued compensation and benefits
    
    
    102,904
    
    
    
    132,027Other accrued liabilities
    
    
    320,499
    
    
    
    272,578Income taxes payable
    
    
    40,913
    
    
    
    17,057Deferred taxes
    
    
    31,272
    
    
    
    26,054Current portion of long-term debt
    
    
    2,158
    
    
    
    1,764Current portion of unearned revenue
    
    
    50,215
    
    
    
    49,620Total current liabilities
    
    
    599,531
    
    
    
    557,476Convertible notes
    
    
    
    
    
    
    316,990Long-term debt
    
    
    146,200
    
    
    
    181,350Deferred taxes
    
    
    213,717
    
    
    
    176,484Other long-term liabilities
    
    
    54,968
    
    
    
    37,217Total liabilities
    
    
    1,014,416
    
    
    
    1,269,517Stockholders equity:Class A common stock
    
    
    1,351
    
    
    
    1,266Class B common stock
    
    
    66
    
    
    
    66Additional paid-in capital
    
    
    1,705,195
    
    
    
    1,358,418Accumulated other comprehensive income, net
    
    
    (2,306
    )
    
    
    (971
    )Retained earnings
    
    
    1,509,993
    
    
    
    1,070,409Treasury stock
    
    
    (414,444
    )
    
    
    Total stockholders equity
    
    
    2,799,855
    
    
    
    2,429,188Total liabilities and stockholders equity
    
    $
    3,814,271
    
    
    $
    3,698,705
 The accompanying notes are an integral part of these consolidated financial statements. 1




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AFFILIATED COMPUTER SERVICES, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share amounts)
 Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Revenues
    
    $
    1,009,432
    
    
    $
    981,633
    
    
    $
    3,043,946
    
    
    $
    2,773,028Expenses:Wages and benefits
    
    
    424,874
    
    
    
    437,677
    
    
    
    1,345,541
    
    
    
    1,244,456Services and supplies
    
    
    269,352
    
    
    
    266,751
    
    
    
    806,278
    
    
    
    737,437Rent, lease and maintenance
    
    
    107,780
    
    
    
    90,135
    
    
    
    300,630
    
    
    
    261,414Depreciation and amortization
    
    
    47,881
    
    
    
    37,899
    
    
    
    131,508
    
    
    
    109,758Gain on sale of business
    
    
    (493
    )
    
    
    
    
    
    
    (284,839
    )
    
    
    Other operating expenses
    
    
    6,218
    
    
    
    14,082
    
    
    
    44,098
    
    
    
    40,253Total operating expenses
    
    
    855,612
    
    
    
    846,544
    
    
    
    2,343,216
    
    
    
    2,393,318Operating income
    
    
    153,820
    
    
    
    135,089
    
    
    
    700,730
    
    
    
    379,710Interest expense
    
    
    3,714
    
    
    
    6,051
    
    
    
    14,259
    
    
    
    19,252Other non-operating (income)
expense, net
    
    
    (423
    )
    
    
    1,844
    
    
    
    (1,591
    )
    
    
    3,733Pretax profit
    
    
    150,529
    
    
    
    127,194
    
    
    
    688,062
    
    
    
    356,725Income tax expense
    
    
    50,783
    
    
    
    47,701
    
    
    
    248,478
    
    
    
    133,775Net income
    
    $
    99,746
    
    
    $
    79,493
    
    
    $
    439,584
    
    
    $
    222,950Earnings per common share:Basic
    
    $
    0.76
    
    
    $
    0.60
    
    
    $
    3.33
    
    
    $
    1.69Diluted
    
    $
    0.72
    
    
    $
    0.57
    
    
    $
    3.14
    
    
    $
    1.60Shares used in computing earnings
per common share:Basic
    
    
    131,503
    
    
    
    132,540
    
    
    
    131,894
    
    
    
    132,261Diluted
    
    
    139,348
    
    
    
    143,657
    
    
    
    141,717
    
    
    
    143,301
 The accompanying notes are an integral part of these consolidated financial statements. 2




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AFFILIATED COMPUTER SERVICES, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
 Nine Months EndedMarch 31,2004
    
    2003Cash flows from operating activities:Net income
    
    $
    439,584
    
    
    $
    222,950Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation and amortization
    
    
    131,508
    
    
    
    109,758Gain on sales of businesses
    
    
    (290,261
    )
    
    
    (310
    )Gain on long-term investments
    
    
    (461
    )
    
    
    Impairment of long-term investments
    
    
    
    
    
    
    2,400Tax benefit on stock options
    
    
    15,680
    
    
    
    10,068Deferred income tax expense
    
    
    51,367
    
    
    
    83,778Other non-cash activities
    
    
    15,052
    
    
    
    17,342Changes in assets and liabilities, net of effects from acquisitions:Increase in accounts receivable
    
    
    (126,902
    )
    
    
    (89,201
    )Decrease in inventory
    
    
    415
    
    
    
    868Increase in other current assets
    
    
    (12,089
    )
    
    
    (4,682
    )Increase in other long-term assets
    
    
    (14,731
    )
    
    
    (3,389
    )Increase (decrease) in accounts payable
    
    
    4,233
    
    
    
    (17,975
    )Decrease in accrued compensation and benefits
    
    
    (18,459
    )
    
    
    (24,664
    )Increase in other accrued liabilities
    
    
    34,166
    
    
    
    64,977Change in income taxes payable
    
    
    23,856
    
    
    
    (11,946
    )Increase in unearned revenue
    
    
    9,489
    
    
    
    7,394Increase in other long-term liabilities
    
    
    7,047
    
    
    
    2,934Total adjustments
    
    
    (170,090
    )
    
    
    147,352Net cash provided by operating activities
    
    
    269,494
    
    
    
    370,302Cash flows from investing activities:Purchases of property, equipment and software, net
    
    
    (166,171
    )
    
    
    (153,543
    )Payments for acquisitions, net of cash acquired
    
    
    (235,128
    )
    
    
    (53,002
    )Proceeds from divestitures, net of transaction costs
    
    
    583,370
    
    
    
    4,974Additions to other intangible assets
    
    
    (23,582
    )
    
    
    (35,744
    )Additions to notes receivable
    
    
    (2,790
    )
    
    
    (3,157
    )Proceeds received on notes receivable
    
    
    4,432
    
    
    
    8,267Other
    
    
    (3,556
    )
    
    
    426Net cash provided by (used in) investing activities
    
    
    156,575
    
    
    
    (231,779
    )Cash flows from financing activities:Proceeds from issuance of debt
    
    
    808,025
    
    
    
    690,362Repayments of debt
    
    
    (848,482
    )
    
    
    (831,063
    )Purchase of treasury shares
    
    
    (414,444
    )
    
    
    Proceeds from stock options exercised
    
    
    18,766
    
    
    
    6,365Other
    
    
    (2,081
    )
    
    
    (2,597
    )Net cash used in financing activities
    
    
    (438,216
    )
    
    
    (136,933
    )Net increase (decrease) in cash and cash equivalents
    
    
    (12,147
    )
    
    
    1,590Cash and cash equivalents at beginning of period
    
    
    51,170
    
    
    
    33,814Cash and cash equivalents at end of period
    
    $
    39,023
    
    
    $
    35,404Supplemental information of noncash financing activitiesConversion of 3.5% Convertible Notes to Class A Common Stock
    
    $
    316,725
    
    
    $
    
 The accompanying notes are an integral part of these consolidated financial statements. 3




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AFFILIATED COMPUTER SERVICES, INC. AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
  1.
    
    BASIS OF PRESENTATIONThe consolidated financial statements include the accounts of Affiliated
Computer Services, Inc. (ACS) and its majority-owned subsidiaries. All
material intercompany profits, transactions and balances have been
eliminated. We are a Fortune 500 company with more than 40,000 people
providing business process and technology outsourcing solutions to commercial
and government clients.The financial information presented should be read in conjunction with our
consolidated financial statements for the year ended June 30, 2003. Certain
reclassifications have been made to prior period financial statements to
conform to current presentation. The foregoing unaudited consolidated
financial statements reflect all adjustments (all of which are of a normal
recurring nature), which are, in the opinion of management, necessary for a
fair presentation of the results of the interim periods. The results for the
interim periods are not necessarily indicative of results to be expected for
the year.Based on the criteria set forth in Statement of Financial Accounting
Standards No. 131, Disclosure about Segments of an Enterprise and Related
Information (SFAS 131), we have two reportable segments: Commercial and
Government. The segments presented in prior periods differ from the current
presentation. The sale of a majority of our Federal business in the second
quarter of fiscal year 2004 necessitated an assessment of our reportable
segments under SFAS 131. As a result, we combined our former State and Local
Governments segment with the remainder of our Federal segment into our
Government segment. Prior period reporting has been restated to conform to
the new segment reporting.Significant accounting policies are detailed in our Annual Report on Form
10-K for the year ended June 30, 2003. For discussion of our critical
accounting policies, please refer to Managements Discussion and Analysis of
Financial Condition and Results of Operations.2.
    
    STOCK-BASED COMPENSATIONWe follow Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, (APB 25) in accounting for our stock-based
compensation plans. Under APB 25, no compensation expense is recognized for
our stock-based compensation plans since the exercise prices of awards under
our plans are at the current market price of our stock on the date of grant.
Had compensation cost for our stock-based compensation plans been determined
based on the fair value at the grant date under those plans consistent with
the fair value method of Statement of Financial Accounting Standards No. 123
Accounting for Stock-Based Compensation, our net income and earnings per
share would have been reduced to the pro forma amounts indicated below (in
thousands, except per share amounts): Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Net IncomeAs reported
    
    $
    99,746
    
    
    $
    79,493
    
    
    $
    439,584
    
    
    $
    222,950Less: Pro forma
employee compensation
cost of stock-based
compensation plans,
net of tax
    
    
    5,328
    
    
    
    4,427
    
    
    
    15,185
    
    
    
    12,680Pro forma
    
    $
    94,418
    
    
    $
    75,066
    
    
    $
    424,399
    
    
    $
    210,270Basic earnings per shareAs reported
    
    $
    0.76
    
    
    $
    0.60
    
    
    $
    3.33
    
    
    $
    1.69Pro forma
    
    $
    0.72
    
    
    $
    0.57
    
    
    $
    3.22
    
    
    $
    1.59Diluted earnings per shareAs reported
    
    $
    0.72
    
    
    $
    0.57
    
    
    $
    3.14
    
    
    $
    1.60Pro forma
    
    $
    0.69
    
    
    $
    0.54
    
    
    $
    3.10
    
    
    $
    1.52
 4




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AFFILIATED COMPUTER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)  3.
    
    SALE OF FEDERAL BUSINESSEffective November 1, 2003, we completed the sale of a majority of our
Federal government business to Lockheed Martin Corporation (the Divested
Federal Business) for approximately $651 million, which included a cash
payment of $588 million at closing and $70 million payable pursuant to a
five-year non-compete agreement, less a working capital settlement of $7
million paid in the third quarter of fiscal year 2004. Assets sold were
approximately $349.0 million and liabilities assumed by Lockheed Martin were
approximately $68.1 million, both of which were primarily in the Government
segment. We recognized a pretax gain of $284.3 million ($181.7 million, net
of income tax) in the second quarter of fiscal year 2004. We recognized an
additional pretax gain of $0.5 million ($0.3 million, net of income tax) in
the third quarter of fiscal year 2004 due to our final working capital
settlement with Lockheed Martin. The after tax proceeds from the divestiture
were generally used to pay down debt; fund the acquisitions of Lockheed
Martins commercial information technology outsourcing business, Patient
Accounting Services Center, LLC and Truckload Management Services, Inc. (see
Note 5); and fund our share repurchase program (see Note 6).Revenues from the Divested Federal Business, which are primarily included in
the Government segment, were approximately $173.8 million for the three
months ended March 31, 2003, and $237.7 million and $504.3 million for the
nine months ended March 31, 2004 and 2003, respectively. For fiscal year
2003, revenues from the Divested Federal Business were approximately $680
million. This divestiture excludes, among others, our Department of
Education relationship, which during fiscal year 2003 had revenues of
approximately $172 million. Additionally, our Commercial and Government
operations will continue to serve as a subcontractor on portions of the
Divested Federal Business.Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets requires that depreciation and
amortization of long-lived assets held for sale be suspended during the
holding period prior to sale. Accordingly, we suspended depreciation and
amortization in the amount of $4.3 million ($2.7 million, net of income tax)
and $1.9 million ($1.2 million, net of income tax) for the first and second
quarters of fiscal year 2004, respectively, related to those long-lived
assets sold.In February 2004, we sold the contracts associated with the Hanscom Air Force
Base relationship to ManTech International Corporation for $6.5 million in
cash. We recognized a pretax gain of $5.4 million ($3.4 million, net of
income tax) for this transaction. For the Hanscom Air Force Base contracts,
we reported revenue in our Government segment of approximately $3.7 million
and $5.4 million for the three months ended March 31, 2004 and 2003, and
$16.7 million and $18.1 million for the nine months ended March 31, 2004 and
2003, respectively. For fiscal year 2003, revenues from the Hanscom Air
Force Base relationship were approximately $25 million. We will indemnify
ManTech with respect to the Department of Justice (DOJ) subpoena dated
October 2002 related to purchasing activities at Hanscom during the period
1998-2000 (see Note 12).The sales of both the Divested Federal Business to Lockheed Martin and the
contracts associated with the Hanscom Air Force Base relationship now allow
us to focus on our business process and information technology outsourcing
service offerings in the commercial, state and local, and Federal education
markets.4.
    
    CONVERTIBLE DEBTOn February 27, 2004, we completed the redemption of our 3.5% Convertible
Subordinated Notes due February 15, 2006 (the Notes). Holders of 99.9% of
all the outstanding Notes converted their Notes to 23.0234 shares of our
Class A common stock per $1,000 per principal amount of Notes in accordance
with the procedures specified in the related indenture governing the Notes.
As the result of such conversions, 7,291,983 shares of our Class A common
stock were issued to such noteholders at the conversion price of $43.44 per
share. The remaining Notes were redeemed in cash at 101.4% of the principal
amount, resulting in a cash redemption of $269,000.5.
    
    ACQUISITIONSIn November 2003, we acquired Lockheed Martin Corporations commercial
information technology outsourcing business, with annual revenues of
approximately $240 million. The transaction was valued at $107 million less
a working capital settlement of $6.9 million plus related transaction costs,
with assets acquired of $151.4 million and liabilities assumed of $51.3
million. Included in the assets acquired are goodwill of $89.4 million,
which is deductible for income tax purposes, and $26.8 million in intangible
assets. The $26.8 million of intangible assets are attributable to customer
relationships and non-compete agreements with useful lives ranging from 1 to
8 years, with an average anticipated useful life of approximately 5 years.
The operating results of the acquired business are included in our financial
statements in the Commercial segment from the effective date of the 5




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AFFILIATED COMPUTER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)  acquisition, November 1, 2003. This acquisition is not considered material
to our results of operations; therefore, no pro forma information is
presented.In January 2004, we completed the acquisition of Patient Accounting Services
Center, LLC (PASC), a provider of revenue cycle management for healthcare
providers, including billing, accounts receivables, and collection services.
PASC generated revenues of approximately $68 million for the year ended
December 31, 2003. The transaction was valued at approximately $95 million,
excluding contingent consideration of a maximum of $25 million based on
future financial performance, plus related transaction costs. We
acquired assets of $104.3 million and assumed liabilities of $9.4 million. We
recorded goodwill of $71.9 million, which is deductible for income tax
purposes, and $9.3 million in intangible assets. The $9.3 million of
intangible assets are attributable to customer relationships and non-compete
agreements with useful lives of 5 years. The operating results of the
acquired business are included in our financial statements in the Commercial
segment from the effective date of the acquisition, January 3, 2004. This
acquisition is not considered material to our results of operations;
therefore, no pro forma information is presented.In February 2004, we completed the acquisition of Truckload Management
Services, Inc. (TMI), an expedited document processing and business process
improvement services provider for the trucking industry. TMI had revenues of
approximately $25 million for the year ended December 31, 2003. The
transaction was valued at approximately $28 million, excluding contingent
consideration of a maximum of $14 million based upon future financial
performance, plus related transaction costs. We acquired assets of $30.2
million and assumed liabilities of $2.4 million. We recorded goodwill of
$22.9 million, which is deductible for income tax purposes, and $2.5 million
in intangible assets attributable to customer relationships and non-compete
agreements with useful lives of 4 to 6 years, with an average anticipated
useful life of approximately 6 years. The operating results of the acquired
business are included in our financial statements in the Commercial segment
from the effective date of the acquisition, February 1, 2004. This
acquisition is not considered material to our results of operations;
therefore, no pro forma information is presented.6.
    
    EQUITYOur Board of Directors has authorized two share repurchase programs totaling
$1.25 billion of our Class A common stock. On September 2, 2003, we announced
that our Board of Directors authorized a share repurchase program of up to
$500 million of our Class A common stock and on April 29, 2004, we announced
that our Board of Directors authorized a new, incremental share repurchase
program of up to $750 million of our Class A common stock. The programs,
which are open-ended, will allow us to repurchase our shares on the open
market from time to time in accordance with SEC rules and regulations,
including shares that could be purchased pursuant to SEC Rule 10b5-1. The
number of shares to be purchased and the timing of purchases will be based on
the level of cash and debt balances, general business conditions and other
factors, including alternative investment opportunities. We intend to fund
the repurchase program from various sources, including, but not limited to,
cash on hand, cash flow from operations, and borrowings under our existing
revolving credit facility. As of March 31, 2004, we had repurchased 8.3
million shares at a total cost of approximately $414.4 million.
Through May 13, 2004, on a trade date basis, we have repurchased 12.6 million shares at a
total cost of approximately $625.4 million of the total Board of Directors
authorization.On February 27, 2004, we completed the redemption of our 3.5% Convertible
Subordinated Notes due February 15, 2006 (the Notes). Holders of 99.9% of
all the outstanding Notes converted their Notes to 23.0234 shares of our
Class A common stock per $1,000 per principal amount of Notes in accordance
with the procedures specified in the related indenture governing the Notes.
As the result of such conversions, 7,291,983 shares of our Class A common
stock were issued to such noteholders at the conversion price of $43.44 per
share. The remaining Notes were redeemed in cash at 101.4% of the principal
amount, resulting in a cash redemption of $269,000.7.
    
    GEORGIA CONTRACTIn 2001, we were awarded a contract by the Department of Community Health of
the State of Georgia (DCH) to develop, implement and operate a system to
administer health benefits to Georgia Medicaid recipients as well as state
government employees (the Georgia Contract). This system development
project is large and complex and anticipated the development of a system that
would process both Medicaid and state employee claims. The Medicaid phase of
this project was implemented on 6




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AFFILIATED COMPUTER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)  April 1, 2003. Certain delays and operational issues were encountered in this
phase. In January 2004, we agreed to a non-binding settlement in principle
with DCH to settle claims that DCH and ACS had made against each other with
respect to delays in the initial phase development. Under the tentative
settlement terms, DCH would pay us approximately $9 million of $13 million in
outstanding system development invoices, with the remaining $4 million to be
paid in stages as certain system functionality is delivered (approximately
$38.1 million of system development invoices were previously paid by DCH).
DCH would also escrow an additional $11.8 million pending final certification
of the payment system by the Center for Medicare/Medicaid Services, the
governing Federal regulatory agency. In turn, we would pay DCH $10 million to
compensate for system implementation delays and operational issues, which
resulted in increased costs to DCH. Finally, we agreed to cancel Phase II of
the contract, which called for integration of a health claims payment system
for state employees with the Medicaid payment system and the membership
enrollment management system. This tentative settlement is subject to
completion of a definitive settlement agreement, which is expected to be
finalized in the fourth quarter of fiscal year 2004. During the second
quarter of fiscal year 2004, in connection with this tentative settlement, we
recorded a $6.7 million reduction in revenue resulting from the change in our
percentage-of-completion estimates primarily as a result of the termination
of Phase II of the contract, a charge of $2.6 million to services and
supplies associated with the accrual of wind-down costs associated with the
termination of Phase II and an accrual of $10.0 million in other operating
expenses that will be paid to DCH pursuant to the settlement in principle.8.
    
    GOODWILL AND OTHER INTANGIBLE ASSETSThe changes in the carrying amount of goodwill for the nine months ended
March 31, 2004 are as follow (in thousands): Government
    
    Commercial
    
    TotalBalance as of June 30, 2003
    
    $
    1,215,591
    
    
    $
    690,287
    
    
    $
    1,905,878Divestiture activity
    
    
    (136,307
    )
    
    
    (6,434
    )
    
    
    (142,741
    )Acquisition activity
    
    
    3,363
    
    
    
    191,791
    
    
    
    195,154Balance as of March 31, 2004
    
    $
    1,082,647
    
    
    $
    875,644
    
    
    $
    1,958,291
  The sale of the Divested Federal Business necessitated an assessment of our
reportable segments under SFAS 131. As a
result, we combined our former State and Local Governments segment with the
remainder of our Federal segment into our Government segment. Prior period
reporting has been restated to conform to the new segment reporting.Goodwill activity for the nine months ended March 31, 2004 was primarily due
to the sale of the Divested Federal Business (see Note 3), fiscal year 2004
acquisitions (see Note 5) and contingent consideration due to former
shareholders of prior acquisitions. Approximately 87% of our goodwill balance
is deductible for tax purposes.The following information relates to our other intangible assets (in
thousands): March 31, 2004
    
    June 30, 2003Gross Carrying
    
    Accumulated
    
    Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    Amount
    
    AmortizationAmortized intangible assets:Acquired customer-related intangibles
    
    $
    190,876
    
    
    $
    (46,026
    )
    
    $
    154,771
    
    
    $
    (31,735
    )Customer-related intangibles
    
    
    134,909
    
    
    
    (45,764
    )
    
    
    139,667
    
    
    
    (50,129
    )All other
    
    
    3,108
    
    
    
    (1,642
    )
    
    
    4,031
    
    
    
    (2,314
    )Total
    
    $
    328,893
    
    
    $
    (93,432
    )
    
    $
    298,469
    
    
    $
    (84,178
    )Unamortized intangible asset:Title plant
    
    $
    50,800
    
    
    
    
    
    
    $
    50,800
 7




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AFFILIATED COMPUTER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) Aggregate Amortization:For the quarter ended March 31, 2004
    
    $
    12,052For the quarter ended March 31, 2003
    
    
    9,246For the nine months ended March 31, 2004
    
    
    32,149For the nine months ended March 31, 2003
    
    
    26,313Estimated amortization:For the year ended June 30, 2004
    
    $
    44,501For the year ended June 30, 2005
    
    
    44,084For the year ended June 30, 2006
    
    
    38,655For the year ended June 30, 2007
    
    
    34,417For the year ended June 30, 2008
    
    
    31,148
  Amortization includes amounts charged to amortization expense for
customer-related intangibles and other intangibles, other than contract
inducements. Amortization of contract inducements of $2.9 million and $2.2
million for the three months ended March 31, 2004 and 2003, respectively, and
$7.9 million and $5.0 million for the nine months ended March 31, 2004 and
2003, respectively, is recorded as a reduction of related contract revenue.
Amortization expense includes approximately $6.5 million and $4.2 million for
acquired customer-related intangibles for the three months ended March 31,
2004 and 2003, respectively, and $15.8 million and $12.0 million for the nine
months ended March 31, 2004 and 2003, respectively. Amortized intangible
assets are amortized over the related contract term. The amortization period
of customer-related intangible assets ranges from 1 to 11 years, with a
weighted average of approximately 8 years. The amortization period for all
other intangible assets, including trademarks, ranges from 4 to 21 years,
with a weighted average of 7 years.9.
    
    COMPREHENSIVE INCOMEStatement of Financial Accounting Standards No. 130, Reporting Comprehensive
Income (SFAS 130), establishes standards for reporting and display of
comprehensive income and its components in financial statements. The
objective of SFAS 130 is to report a measure of all changes in equity of an
enterprise that result from transactions and other economic events of the
period other than transactions with owners. Comprehensive income is the total
of net income and all other non-owner changes within a companys equity.The components of comprehensive income are as follows (in thousands): Three months ended
    
    Nine Months endedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    99,746
    
    
    $
    79,493
    
    
    $
    439,584
    
    
    $
    222,950Other comprehensive income (loss):Foreign currency translation
adjustment (net of tax effect of
$(880) and $(802), respectively)
    
    
    (1,467
    )
    
    
    
    
    
    
    (1,335
    )
    
    
    Comprehensive income
    
    $
    98,279
    
    
    $
    79,493
    
    
    $
    438,249
    
    
    $
    222,950
 8




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AFFILIATED COMPUTER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)  10.
    
    EARNINGS PER SHAREIn accordance with Statement of Financial Accounting Standard No. 128,
Earnings per Share, the following table (in thousands except per share
amounts) sets forth the computation of basic and diluted earnings per share: Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Numerator:Numerator for basic earnings per share -
Income available to common stockholders
    
    $
    99,746
    
    
    $
    79,493
    
    
    $
    439,584
    
    
    $
    222,950Effect of dilutive securities:Interest on 3.5% convertible debt, net of tax
    
    
    1,088
    
    
    
    2,054
    
    
    
    5,196
    
    
    
    6,163Numerator for diluted earnings per share -
Income available to common stockholders
    
    $
    100,834
    
    
    $
    81,547
    
    
    $
    444,780
    
    
    $
    229,113Denominator:Weighted average basic shares outstanding
    
    
    131,503
    
    
    
    132,540
    
    
    
    131,894
    
    
    
    132,261Effect of dilutive securities:3.5% convertible debt
    
    
    4,350
    
    
    
    7,298
    
    
    
    6,323
    
    
    
    7,298Stock options
    
    
    3,495
    
    
    
    3,819
    
    
    
    3,500
    
    
    
    3,742Total potential common shares
    
    
    7,845
    
    
    
    11,117
    
    
    
    9,823
    
    
    
    11,040Denominator for weighted average diluted shares
    
    
    139,348
    
    
    
    143,657
    
    
    
    141,717
    
    
    
    143,301Earnings per common share  basic
    
    $
    0.76
    
    
    $
    0.60
    
    
    $
    3.33
    
    
    $
    1.69Earnings per common share  diluted
    
    $
    0.72
    
    
    $
    0.57
    
    
    $
    3.14
    
    
    $
    1.60
 9




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AFFILIATED COMPUTER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)  11.
    
    SEGMENT INFORMATIONAs discussed in Note 1, the sale of the Divested Federal Business
necessitated an assessment of our reportable segments under SFAS 131. As a
result, we combined our former State and Local Governments segment with the
remainder of our Federal segment into our Government segment. Prior period
reporting has been restated to conform to the new segment reporting.The following is a summary of certain financial information by reportable
segment (in thousands): Government
    
    Commercial
    
    Corporate
    
    ConsolidatedThree
Months Ended March 31, 2004Revenues
    
    $
    548,213
    
    
    $
    461,219
    
    
    $
    
    
    
    $
    1,009,432Operating expenses (excluding
depreciation and amortization)
    
    
    435,040
    
    
    
    359,130
    
    
    
    14,054
    
    
    
    808,224Gain on sale of business
    
    
    (493
    )
    
    
    
    
    
    
    
    
    
    
    (493
    )Depreciation and amortization
    
    
    18,106
    
    
    
    29,257
    
    
    
    518
    
    
    
    47,881Operating income
    
    $
    95,560
    
    
    $
    72,832
    
    
    $
    (14,572
    )
    
    $
    153,820Three
Months Ended March 31, 2003Revenues
    
    $
    650,747
    
    
    $
    330,886
    
    
    $
    
    
    
    $
    981,633Operating expenses (excluding
depreciation and amortization)
    
    
    538,132
    
    
    
    262,323
    
    
    
    8,190
    
    
    
    808,645Depreciation and amortization
    
    
    17,412
    
    
    
    19,789
    
    
    
    698
    
    
    
    37,899Operating income
    
    $
    95,203
    
    
    $
    48,774
    
    
    $
    (8,888
    )
    
    $
    135,089Nine
Months Ended March 31, 2004Revenues
    
    $
    1,845,607
    
    
    $
    1,198,339
    
    
    $
    
    
    
    $
    3,043,946Operating expenses (excluding
depreciation and amortization)
    
    
    1,526,836
    
    
    
    930,558
    
    
    
    39,153
    
    
    
    2,496,547Gain on sale of business
    
    
    (284,839
    )
    
    
    
    
    
    
    
    
    
    
    (284,839
    )Depreciation and amortization
    
    
    53,696
    
    
    
    76,198
    
    
    
    1,614
    
    
    
    131,508Operating income
    
    $
    549,914
    
    
    $
    191,583
    
    
    $
    (40,767
    )
    
    $
    700,730Nine
Months Ended March 31, 2003Revenues
    
    $
    1,862,867
    
    
    $
    910,161
    
    
    $
    
    
    
    $
    2,773,028Operating expenses (excluding
depreciation and amortization)
    
    
    1,548,994
    
    
    
    704,420
    
    
    
    30,146
    
    
    
    2,283,560Depreciation and amortization
    
    
    51,119
    
    
    
    56,519
    
    
    
    2,120
    
    
    
    109,758Operating income
    
    $
    262,754
    
    
    $
    149,222
    
    
    $
    (32,266
    )
    
    $
    379,710
  12.
    
    COMMITMENTS AND CONTINGENCIESOur Education Services business, which is included in our Commercial segment,
performs third party student loan servicing in the Federal Family Education
Loan program (FFEL) on behalf of various financial institutions. At March
31, 2004, we serviced a FFEL portfolio of approximately 1.5 million loans
with an outstanding principal balance of approximately $17.8 billion. Some
servicing agreements contain provisions that, under certain circumstances,
require us to purchase the loans from the investor if the loan guaranty has
been permanently terminated as a result of a loan default caused by our
servicing error. If defaults caused by us are cured during an initial
period, any obligation we may have to purchase these loans expires. Loans
that we purchase may be subsequently cured, the guaranty reinstated
and then we
repackage the loans for sale to third parties. We evaluate our exposure under
our purchase obligations on defaulted loans and establish a reserve for
potential losses, or default liability reserve, through a charge to the
provision for loss on defaulted loans purchased. The reserve is evaluated
periodically and adjusted based upon managements analysis of the historical
performance of the defaulted loans. This reserve was approximately $3.8
million at March 31, 2004 and $4.2 million at June 30, 2003. 10




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AFFILIATED COMPUTER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)  On December 16, 1998, a state district court in Houston, Texas entered final
judgment against us in a lawsuit brought by 21 former employees of Gibraltar
Savings Association and/or First Texas Savings Association (collectively,
GSA/FTSA). The GSA/FTSA employees alleged that they were entitled to the
value of 803,082 shares of our stock (adjusted for February 2002 stock split)
pursuant to options issued to the GSA/FTSA employees in 1988 in connection
with a former technology outsourcing services agreement between GSA/FTSA and
us. The judgment against us was for approximately $17 million, which
included attorneys fees and pre-judgment interest. The judgment was appealed
by the plaintiffs and us and the appellate process has now been concluded.
As a result of the appeals, the trial courts judgment has been reversed and
the case has been remanded to the trial court for further proceedings, except
that the trial court judgment was affirmed in part as to one of the
plaintiffs and the trial courts dismissal of certain of our affirmative defenses
was upheld. The amount of the judgment the state district court should award
the one plaintiff, whose judgment was upheld, is in dispute because the
parties do not agree on the applicable pre-judgment interest rate to be
applied by the court. This judgment amount should not exceed approximately
$1.6 million and, as of March 31, 2004, we have accrued an amount we believe
is appropriate for this judgment. We continue to believe that we have a
meritorious defense to all or a substantial portion of the remaining
plaintiffs claims despite the dismissal of certain of our
affirmative defenses and, accordingly, have not accrued any amount on our
balance sheet related to the remaining claims.One of our subsidiaries, ACS Defense, Inc., and several other government
contractors received a grand jury document subpoena issued by the U.S.
District Court for the District of Massachusetts in October 2002. The
subpoena was issued in connection with an inquiry being conducted by the
Antitrust Division of the U.S. Department of Justice (DOJ). The inquiry
concerns certain IDIQ (Indefinite Delivery  Indefinite Quantity)
procurements and their related task orders, which occurred in the late 1990s
at Hanscom Air Force Base in Massachusetts. Our revenue from the contracts
that we believe to be the focus of the DOJs inquiry was approximately $25
million for the fiscal year ended June 30, 2003, and approximately $16.7
million for the nine months ended March 31, 2004, representing approximately
0.7% of our revenue for fiscal year 2003 and 0.5% for the nine months ended
March 31, 2004. In February 2004, we sold the contracts associated with the
Hanscom Air Force Base relationship to ManTech International Corporation,
however, we will indemnify ManTech with respect to this DOJ subpoena. We are
continuing our previously announced internal investigation of this matter
through outside legal counsel and we are continuing to cooperate with the DOJ
in producing documents in response to the subpoena. At this stage of this inquiry,
we are unable to express an opinion as to its likely outcome. See Note 3 for
a discussion of the sale of the contracts associated with the Hanscom Air
Force Base relationship.Another of our subsidiaries, ACS State & Local Solutions, Inc. (ACS SLS),
and a teaming partner of this subsidiary, Tier Technologies, Inc. (Tier),
received a grand jury document subpoena issued by the U.S. District Court for
the Southern District of New York in May 2003. The subpoena was issued in
connection with an inquiry being conducted by the Antitrust Division of the
DOJ. The inquiry concerns the teaming arrangement between ACS SLS and Tier on
child support payment processing contracts awarded to ACS SLS and Tier, as a
subcontractor to ACS SLS, in New York, Illinois and Ohio. Our annual revenue
from these three contracts will be approximately $70 million when the
services are fully implemented, representing approximately 1.8% of our annual
revenue. Our teaming arrangement also contemplated the California child
support payment processing request for proposals, which was issued in late
2003; however, we did not enter into a teaming agreement with Tier for the
California request for proposals. Based on Tiers recent filings with the
Securities and Exchange Commission, we understand that on November 20, 2003
the DOJ granted conditional amnesty to Tier in connection with this inquiry
pursuant to the DOJs Corporate Leniency Policy. The policy provides that
the DOJ will not bring any criminal charges against Tier as long as it
continues to fully cooperate in the inquiry (and makes restitution payments
if it is determined that parties were injured as a result of impermissible
anticompetitive conduct). We are continuing our previously announced
internal investigation of this matter through outside legal counsel and we
are continuing to cooperate with the DOJ in producing documents in response
to the subpoena. At this stage of this inquiry, we are unable to express an
opinion as to its likely outcome. 11




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AFFILIATED COMPUTER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)  On March 22, 2004, ACS SLS received a grand jury document subpoena issued by
the U.S. District Court for the Southern District of Florida. The subpoena
was issued in connection with an inquiry being conducted by the DOJ and the
Inspector Generals Office of the U.S. Department of Labor (DOL) into the
subsidiarys workforce contracts in Dade and Monroe counties in Florida,
which expired in June 2003. In a related matter, on January 30, 2004, the
Florida Agency for Workforce Innovation Office of Inspector General (OIG)
issued a report that reviewed 13 Florida workforce regions served by ACS SLS,
including Dade and Monroe counties, and noted concerns related to the
accuracy of customer case records maintained by our local staff. Our total
revenue generated from the Florida workforce services contracts amount to
approximately 1% of our total annual revenue. The OIG reviewed
approximately 4,000 data elements and identified a potential of 488 possible
data conflicts. In March 2004 we filed our response to the OIG report. With
the assistance of outside experts, we reviewed the report and each possible
data conflict and determined that two-thirds of the possible data conflicts
were, in fact, not errors, but one-third were confirmed errors resulting in
an error rate of 4%, a rate which is not unexpected given the
manual processes involved in these services and the fact that we must rely on
employers to report accurate data. We have not received a response from the
OIG to our March 2004 submission. We had previously identified problems in
the operation of our Miami-Dade workforce operation, which resulted in the
removal of three individuals from employment. As part of our response to the
OIG report, we submitted a comprehensive action plan with recommendations to
enhance our data integrity and operational controls on workforce contracts
and to prevent a reoccurrence of these problems. The Securities and Exchange
Commission (SEC) is conducting an informal investigation into the matters
covered by the OIGs report. We are continuing our previously announced
internal investigation of these matters through outside legal counsel and we
are continuing to cooperate with the government and regulatory agencies in
their investigations. At this stage of these investigations, we are unable
to express an opinion as to the likely outcome of the investigations.In addition to the foregoing, we are subject to certain other legal
proceedings, inquiries, claims and disputes, which arise in the ordinary
course of business. Although we cannot predict the outcomes of these other
proceedings, we do not believe these other actions, in the aggregate, will
have a material adverse effect on our financial position, results of
operations or liquidity.13.
    
    NEW ACCOUNTING STANDARDSIn December 2003, the SEC issued SEC Staff Accounting Bulletin 104 Revenue
Recognition (SAB 104). SAB 104 updates existing Staff Accounting Bulletin
Topic 13 Revenue Recognition to be consistent with recently issued
guidance, primarily Emerging Issues Task Force Issue No. 00-21, Revenue
Arrangements with Multiple Deliverables. We do not believe that SAB 104
will a material impact on our financial position or results of operations.14.
    
    SUBSEQUENT EVENTSIn April 2004, we acquired etravelexperts, LLC. etravelexperts had annual
revenue of approximately $15 million and provides electronic ticket
fulfillment and related customer care for the airline industry and travel
websites. The purchase price of approximately $17 million, excluding
contingent consideration of a maximum of $4 million based upon future
financial performance, was funded from our existing cash on hand. 12




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS All statements in this Managements Discussion and Analysis of Financial
Condition and Results of Operations that are not based on historical fact are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 and the provisions of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended (which Sections were adopted as part of Private
Securities Litigation Reform Act of 1995). While management has based any
forward-looking statements contained herein on its current expectations, the
information on which such expectations were based may change. These
forward-looking statements rely on a number of assumptions concerning future
events and are subject to a number of risks, uncertainties, and other factors,
many of which are outside of our control, that could cause actual results to
materially differ from such statements. Such risks, uncertainties, and other
factors include, but are not necessarily limited to, those set forth under the
caption Risks Related to our Business. In addition, we operate in a highly
competitive and rapidly changing environment, and new risks may arise.
Accordingly, investors should not place any reliance on forward-looking
statements as a prediction of actual results. We disclaim any intention to,
and undertake no obligation to, update or revise any forward-looking statement. We report our financial results in accordance with generally accepted
accounting principles in the United States (GAAP). However, we believe that
certain non-GAAP financial measures and ratios, used in managing our business,
may provide users of this financial information with additional meaningful
comparisons between current results and prior reported results. Certain of the
information set forth herein and certain of the information presented by us
from time to time (including free cash flow and internal revenue growth) may
constitute non-GAAP financial measures within the meaning of Regulation G
adopted by the Securities and Exchange Commission (SEC). We have presented
herein and we will present in other information we publish that contains any of
these non-GAAP financial measures a reconciliation of these measures to the
most directly comparable GAAP financial measure. The presentation of this
additional information is not meant to be considered in isolation or as a
substitute for comparable amounts determined in accordance with generally
accepted accounting principles. GENERAL We are a Fortune 500 company with more than 40,000 people providing business
process and technology outsourcing solutions to commercial and government
clients. Our clients have time-critical, transaction-intensive business and
information processing needs, and we typically service these needs through
long-term contracts. During the quarter ended March 31, 2004, we signed contracts with new clients
and incremental business with existing clients representing $145.7 million of
annualized recurring revenue. The Commercial segment contributed 79% of the new
contract signings and the Government segment contributed 21% of the new
contract signings. For the nine months ended March 31, 2004, we signed
contracts with new clients and incremental business with existing clients
representing $439.4 million of annualized recurring revenue, which includes
$25.2 million related to a majority of the Federal business sold in November
2003 (the Divested Federal Business). We define new business signings as
recurring revenue from new contracts, including the incremental portion of
renewals, signed during the period and represents the estimated annual
recurring revenues, as measured under GAAP, to be recorded under that contract
after full implementation of our services. In November 2003, we completed the sale of the Divested Federal Business to
Lockheed Martin Corporation for approximately $651 million, which included a
cash payment of $588 million at closing and $70 million payable pursuant to a
five-year non-compete agreement, less a working capital settlement of $7
million paid in the third quarter of fiscal year 2004. Assets sold were
approximately $349.0 million and liabilities assumed by Lockheed Martin were
approximately $68.1 million, both of which were primarily in the Government
segment. We recognized a pretax gain of $284.3 million ($181.7 million, net of
income tax) in the second quarter of fiscal year 2004. We recognized an
additional pretax gain of $0.5 million ($0.3 million, net of income tax) in the
third quarter of fiscal year 2004 due to our final working capital settlement
with Lockheed Martin. We incurred $9.8 million ($6.2 million, net of income
tax) for compensation costs associated with former Federal employees, which is
reflected in wages and benefits. The after tax proceeds from the divestiture
were generally used to pay down debt; fund the acquisitions of Lockheed
Martins commercial information technology outsourcing business, Patient
Accounting Services Center, LLC and Truckload Management Services, Inc.; and
fund our share repurchase program. Revenues from the Divested Federal Business,
which are primarily included in the Government segment, were approximately
$173.8 million for the three months ended March 31, 2003, and $237.7 million
and $504.3 million for the nine months ended March 31, 2004 and 2003,
respectively. For fiscal year 2003, revenues from the Divested Federal
Business were $680 million. This divestiture excludes, among others, our
Department of Education relationship, which during fiscal year 2003 had
revenues of approximately $172 million. Additionally, our Commercial and
Government operations will continue to serve as a subcontractor on portions of
the Divested Federal Business. In February 2004, we sold the contracts associated with the Hanscom Air Force
Base relationship to ManTech International Corporation for $6.5 million in
cash. We recognized a pretax gain of $5.4 million ($3.4 million, net of income
tax) for this transaction. For the Hanscom Air Force Base contracts, we
reported revenue in our Government segment of approximately $3.7 million and
$5.4 million for the three months ended March 31, 2004 and 2003, and $16.7
million and $18.1 million for the nine 13




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months ended March 31, 2004 and 2003, respectively. For fiscal year 2003,
revenues from the Hanscom Air Force Base relationship were approximately $25
million. We will indemnify ManTech with respect to the Department of Justice
(DOJ) subpoena dated October 2002 related to purchasing activities at Hanscom
during the period 1998-2000 (see Part II, Item 1. Legal Proceedings). The sales of the Divested Federal Business to Lockheed Martin and the contracts
associated with the Hanscom Air Force Base relationship now allow us to focus
on our business process and information technology outsourcing service
offerings in the commercial, state and local, and Federal education markets. In November 2003, we acquired Lockheed Martin Corporations commercial
information technology outsourcing business, with annual revenues of
approximately $240 million. With this acquisition, we acquired four U.S. data
centers, approximately 1,000 employees, and a diverse client base representing
the manufacturing, automotive, retail, financial services, and communications
industries. The transaction was valued at $107 million less a working capital
settlement of $6.9 million, plus related transaction costs, with assets
acquired of $151.4 million and liabilities assumed of $51.3 million. Included
in assets acquired are goodwill of $89.4 million, which is deductible for
income tax purposes, and $26.8 million in intangible assets. The $26.8 million
of intangible assets are attributable to customer relationships and non-compete
agreements with useful lives ranging from 1 to 8 years, with an
average anticipated useful life of approximately 5 years. The operating results of the
acquired business are included in our financial statements in the Commercial
segment from the effective date of the acquisition, November 1, 2003. This
acquisition is not considered material to our results of operations; therefore,
no pro forma information is presented. In November 2003, we were awarded by the U.S. Department of Education (the
Department) the Common Services for Borrowers contract. This contract
includes comprehensive loan servicing, loan consolidation, and portfolio
management services. The new, five-year base contract replaced our existing
contract with the Department and will integrate a number of services, which
will allow the Department to increase service quality while saving overall
program costs. The contract is estimated at more than $1 billion in revenue
over the five-year period and is effective January 1, 2004. The contract also
includes provisions for up to five, one-year extensions. In January 2004, we completed the acquisition of Patient Accounting Services
Center, LLC (PASC), a provider of revenue cycle management for healthcare
providers, including billing, accounts receivables, and collection services.
PASC generated revenues of approximately $68 million for the year ended
December 31, 2003. The transaction was valued at $95 million, excluding
contingent consideration of a maximum of $25 million based on future financial
performance, plus related transaction costs. We acquired assets of $104.3
million and assumed liabilities of $9.4 million. We recorded goodwill of $71.9
million, which is deductible for income tax purposes, and $9.3 million in
intangible assets. The $9.3 million intangible assets are attributable to
customer relationships and non-compete agreements with useful lives of 5 years.
The operating results of the acquired business are included in our financial
statements in the Commercial segment from the effective date of the
acquisition, January 3, 2004. This acquisition is not considered material to
our results of operations; therefore, no pro forma information is presented. In February 2004, we completed the acquisition of Truckload Management
Services, Inc. (TMI), an expedited document processing and business process
improvement services provider for the trucking industry. TMI had revenues of
approximately $25 million for the year ended December 31, 2003. The transaction
was valued at $28 million, excluding contingent consideration of a maximum of
$14 million based upon future financial performance, plus related transaction
costs. We acquired assets of $30.2 million and assumed liabilities of $2.4
million. We recorded goodwill of $22.9 million, which is deductible for income
tax purposes, and $2.5 million in intangible assets attributable to customer
relationships and non-compete agreements with useful lives of 4 to 6 years, with
an average anticipated useful life of approximately 6 years. The operating
results of the acquired business are included in our financial statements in
the Commercial segment from the effective date of the acquisition, February 1,
2004. This acquisition is not considered material to our results of
operations; therefore, no pro forma information is presented. On February 27, 2004, we completed the redemption of our 3.5% Convertible
Subordinated Notes due February 15, 2006 (the Notes). Holders of 99.9% of
all the outstanding Notes converted their Notes to 23.0234 shares of our Class
A common stock per $1,000 per principal amount of Notes in accordance with the
procedures specified in the related indenture governing the Notes. As the
result of such conversions, 7,291,983 shares of our Class A common stock were
issued to such noteholders at the conversion price of $43.44 per share. The
remaining Notes were redeemed in cash at 101.4% of the principal amount,
resulting in a cash redemption of $269,000. In 2001, we were awarded a contract by the Department of Community Health of
the State of Georgia (DCH) to develop, implement and operate a system to
administer health benefits to Georgia Medicaid recipients as well as state
government employees (the Georgia Contract). This system development project
is large and complex and anticipated the development of a system that would
process both Medicaid and state employee claims. The Medicaid phase of this
project was implemented on April 1, 2003. Certain delays and operational issues
were encountered in this phase. In January 2004, we agreed to a non-binding
settlement in principle with DCH to settle claims that DCH and ACS had made
against each other with respect to delays in the initial phase development.
Under the tentative settlement terms, DCH would pay us approximately $9 million
of $13 million in outstanding system development invoices, with the remaining
$4 million to be paid in stages as certain system functionality is delivered
(approximately $38.1 million 14




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##### Table of Contents



of system development invoices were previously paid by DCH). DCH would also
escrow an additional $11.8 million pending final certification of the payment
system by the Center for Medicare/Medicaid Services, the governing Federal
regulatory agency. In turn, we would pay DCH $10 million to compensate for
system implementation delays and operational issues, which resulted in
increased costs to DCH. Finally, we agreed to cancel Phase II of the contract,
which called for integration of a health claims payment system for state
employees with the Medicaid payment system and the membership enrollment
management system. This tentative settlement is subject to completion of a
definitive settlement agreement, which is expected to be finalized in the
fourth quarter of fiscal year 2004. During the second quarter of fiscal year
2004, in connection with this tentative settlement, we recorded a $6.7 million
reduction in revenue resulting from the change in our percentage-of-completion
estimates primarily as a result of the termination of Phase II of the contract,
a charge of $2.6 million to services and supplies associated with the accrual
of wind-down costs associated with the termination of Phase II and an accrual
of $10.0 million in other operating expenses that will be paid to DCH pursuant
to the settlement in principle. Our Board of Directors has authorized two share repurchase programs totaling
$1.25 billion of our Class A common stock. On September 2, 2003, we announced
that our Board of Directors authorized a share repurchase program of up to $500
million of our Class A common stock and on April 29, 2004, we announced that
our Board of Directors authorized a new, incremental share repurchase program
of up to $750 million of our Class A common stock. The programs, which are
open-ended, will allow us to repurchase our shares on the open market from time
to time in accordance with SEC rules and regulations, including shares that
could be purchased pursuant to SEC Rule 10b5-1. The number of shares to be
purchased and the timing of purchases will be based on the level of cash and
debt balances, general business conditions and other factors, including
alternative investment opportunities. We intend to fund the repurchase program
from various sources, including, but not limited to, cash on hand, cash flow
from operations, and borrowings under our existing revolving credit facility.
As of March 31, 2004, we had repurchased 8.3 million shares at a total cost of
approximately $414.4 million. Through May 13, 2004, on a trade date basis, we
have repurchased 12.6 million shares at a total cost of approximately $625.4
million of the total Board of Directors authorization. On May 17, 2004, we announced that our outsourcing agreement with Gateway,
Inc. is being terminated as a result of Gateways March 2004 acquisition of
eMachines, Inc., which significantly changed its business strategy. The
transition of the majority of the outsourcing operations back to Gateway
will occur in the next 90 days. The outsourcing agreement contributed
approximately $14 million and $22 million in revenue in the three and nine
months ended March 31, 2004, respectively. Concurrent with the termination
of our outsourcing relationship with Gateway, we will also be terminating
our obligation to purchase products and services from Gateway (see
Liquidity and Capital Resources  Disclosures About Contractual Obligations
and Commercial Commitments). 15




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##### Table of Contents



REVENUE GROWTH Consolidated internal revenue growth for the three and nine months ended March
31, 2004 was 14% and 16%, respectively. Internal revenue growth is measured as
total revenue growth less acquired revenue from acquisitions and revenues from
divested operations. Acquired revenue from acquisitions is based on
pre-acquisition normalized revenue of acquired companies. We use the
calculation of internal revenue growth to measure revenue growth excluding the
impact of acquired revenues and the revenue associated with divested operations
and believe these adjustments to historical reported results are necessary to
accurately reflect our internal revenue growth. The following table sets forth
the calculation of internal revenue growth (in thousands): Three months ended March 31,
    
    Nine months ended March 31,2004
    
    2003
    
    $ Growth
    
    Growth %
    
    2004
    
    2003
    
    $ Growth
    
    Growth %ConsolidatedTotal Revenues
    
    $
    1,009,432
    
    
    $
    981,633
    
    
    $
    27,799
    
    
    
    3
    %
    
    $
    3,043,946
    
    
    $
    2,773,028
    
    
    $
    270,918
    
    
    
    10
    %Less: Divestitures (1)
    
    
    (3,654
    )
    
    
    (179,135
    )
    
    
    175,481
    
    
    
    
    
    
    
    (254,471
    )
    
    
    (522,408
    )
    
    
    267,937Adjusted
    
    $
    1,005,778
    
    
    $
    802,498
    
    
    $
    203,280
    
    
    
    25
    %
    
    $
    2,789,475
    
    
    $
    2,250,620
    
    
    $
    538,855
    
    
    
    24
    %Acquired revenues (2)
    
    $
    87,615
    
    
    $
    
    
    
    $
    87,615
    
    
    
    11
    %
    
    $
    168,636
    
    
    $
    
    
    
    $
    168,636
    
    
    
    8
    %Internal revenues
    
    
    918,163
    
    
    
    802,498
    
    
    
    115,665
    
    
    
    14
    %
    
    
    2,620,839
    
    
    
    2,250,620
    
    
    
    370,219
    
    
    
    16
    %Total
    
    $
    1,005,778
    
    
    $
    802,498
    
    
    $
    203,280
    
    
    
    25
    %
    
    $
    2,789,475
    
    
    $
    2,250,620
    
    
    $
    538,855
    
    
    
    24
    %GovernmentTotal Revenues
    
    $
    548,213
    
    
    $
    650,747
    
    
    $
    (102,534
    )
    
    
    (16
    )%
    
    $
    1,845,607
    
    
    $
    1,862,867
    
    
    $
    (17,260
    )
    
    
    (1
    )%Less: Divestitures (1)
    
    
    (3,654
    )
    
    
    (168,456
    )
    
    
    164,802
    
    
    
    
    
    
    
    (247,556
    )
    
    
    (499,729
    )
    
    
    252,173Adjusted
    
    $
    544,559
    
    
    $
    482,291
    
    
    $
    62,268
    
    
    
    13
    %
    
    $
    1,598,051
    
    
    $
    1,363,138
    
    
    $
    234,913
    
    
    
    17
    %Acquired revenues (2)
    
    $
    11,531
    
    
    $
    
    
    
    $
    11,531
    
    
    
    2
    %
    
    $
    21,838
    
    
    $
    
    
    
    $
    21,838
    
    
    
    1
    %Internal revenues
    
    
    533,028
    
    
    
    482,291
    
    
    
    50,737
    
    
    
    11
    %
    
    
    1,576,213
    
    
    
    1,363,138
    
    
    
    213,075
    
    
    
    16
    %Total
    
    $
    544,559
    
    
    $
    482,291
    
    
    $
    62,268
    
    
    
    13
    %
    
    $
    1,598,051
    
    
    $
    1,363,138
    
    
    $
    234,913
    
    
    
    17
    %CommercialTotal Revenues
    
    $
    461,219
    
    
    $
    330,886
    
    
    $
    130,333
    
    
    
    39
    %
    
    $
    1,198,339
    
    
    $
    910,161
    
    
    $
    288,178
    
    
    
    32
    %Less: Divestitures (1)
    
    
    
    
    
    
    (10,679
    )
    
    
    10,679
    
    
    
    
    
    
    
    (6,915
    )
    
    
    (22,679
    )
    
    
    15,764Adjusted
    
    $
    461,219
    
    
    $
    320,207
    
    
    $
    141,012
    
    
    
    44
    %
    
    $
    1,191,424
    
    
    $
    887,482
    
    
    $
    303,942
    
    
    
    34
    %Acquired revenues (2)
    
    $
    76,084
    
    
    $
    
    
    
    $
    76,084
    
    
    
    24
    %
    
    $
    146,798
    
    
    $
    
    
    
    $
    146,798
    
    
    
    16
    %Internal revenues
    
    
    385,135
    
    
    
    320,207
    
    
    
    64,928
    
    
    
    20
    %
    
    
    1,044,626
    
    
    
    887,482
    
    
    
    157,144
    
    
    
    18
    %Total
    
    $
    461,219
    
    
    $
    320,207
    
    
    $
    141,012
    
    
    
    44
    %
    
    $
    1,191,424
    
    
    $
    887,482
    
    
    $
    303,942
    
    
    
    34
    %
  (1)
    
    Divested revenues are revenues of businesses divested as if the
divestiture had occurred at the beginning of the period. Amounts
presented are primarily related to the sale of the Divested Federal
Business and the Hanscom contracts.(2)
    
    Acquired revenues are based on pre-acquisition normalized revenues of
acquired companies. 16




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##### Table of Contents



RESULTS OF OPERATIONS The following table sets forth certain items from our consolidated statements
of income as a percentage of revenues: Three months ended
    
    Nine months endedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Revenues
    
    
    100%
    
    
    
    100%
    
    
    
    100%
    
    
    
    100%Expenses:Wages and benefits
    
    
    42.1
    
    
    
    44.6
    
    
    
    44.2
    
    
    
    44.9Services and supplies
    
    
    26.7
    
    
    
    27.2
    
    
    
    26.6
    
    
    
    26.6Rent, lease and maintenance
    
    
    10.7
    
    
    
    9.2
    
    
    
    9.9
    
    
    
    9.4Depreciation and amortization
    
    
    4.7
    
    
    
    3.8
    
    
    
    4.3
    
    
    
    4.0Gain on sale of business
    
    
    
    
    
    
    
    
    
    
    (9.4
    )
    
    
    Other operating expenses
    
    
    0.6
    
    
    
    1.4
    
    
    
    1.4
    
    
    
    1.4Total operating expenses
    
    
    84.8
    
    
    
    86.2
    
    
    
    77.0
    
    
    
    86.3Operating income
    
    
    15.2
    
    
    
    13.8
    
    
    
    23.0
    
    
    
    13.7Interest expense
    
    
    0.3
    
    
    
    0.6
    
    
    
    0.5
    
    
    
    0.7Other
non-operating (income) expense, net
    
    
    
    
    
    
    0.2
    
    
    
    (0.1
    )
    
    
    0.1Pretax profit
    
    
    14.9
    
    
    
    13.0
    
    
    
    22.6
    
    
    
    12.9Income tax expense
    
    
    5.0
    
    
    
    4.9
    
    
    
    8.2
    
    
    
    4.9Net income
    
    
    9.9%
    
    
    
    8.1%
    
    
    
    14.4%
    
    
    
    8.0%
 COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2004 TO THE THREE MONTHS ENDED
MARCH 31, 2003 Revenues In the third quarter of fiscal year 2004, our revenue increased $27.8 million,
or 3%, to $1.0 billion from $981.6 million in the third quarter of fiscal year
2003. Revenues related to the Divested Federal Business and the Hanscom
contracts were $3.7 million and $179.1 million in the quarters ended March 31,
2004 and 2003, respectively. Excluding the impact of the revenues related to
the Divested Federal Business and the Hanscom contracts, revenues increased
from $802.5 million in the third quarter of fiscal year 2003 to $1.0 billion in
the third quarter of fiscal year 2004, or 25%. Internal revenue growth,
excluding the impact of the revenues related to the Divested Federal Business
and the Hanscom contracts, for the third quarter of fiscal year 2004 was 14%.
The remainder of the growth was related to acquisitions. Revenue in our Government segment, which represents 54% of consolidated revenue
for the third quarter of fiscal year 2004, decreased $102.5 million, or 16%, to
$548.2 million in the third quarter of fiscal year 2004 compared to the same
period last year. Revenues related to the Divested Federal Business and the
Hanscom contracts included in the Government segment were $3.7 million and
$168.4 million for the quarters ended March 31, 2004 and 2003, respectively.
Excluding the impact of the revenues related to the Divested Federal Business
and the Hanscom contracts, total Government segment revenues grew 13% in the
third quarter of fiscal year 2004 to $544.6 million from $482.3 million in the
third quarter of fiscal year 2003. Internal revenue growth, excluding the
impact of the revenues related to the Divested Federal Business and the Hanscom
contracts, was 11% primarily due to increased revenues for our Texas Medicaid,
New Jersey EZPass, and Department of Education contracts. These contracts
collectively represent 71% of our internal growth for the period in this
segment. The remaining growth was from acquisitions. Revenue in our Commercial segment, which represents 46% of consolidated revenue
for the third quarter of fiscal year 2004, increased $130.3 million, or 39%, to
$461.2 million in the third quarter of fiscal year 2004 compared to the same
period last year. Revenues related to the Divested Federal Business included
in the Commercial segment were $10.7 million in the third quarter of fiscal
year 2003. Excluding the impact of the revenues related to the Divested Federal
Business, revenues grew 44% in the third quarter of fiscal year 2004 compared
to the same period in fiscal year 2003. Internal revenue growth, excluding
the impact of the revenues related to the Divested Federal Business, was 20%
due primarily to the ramp up of new business including, among others, the
General Motors, Miller Brewing, Trilegiant, Northwest Airlines, Gateway and
Motorola contracts. These contracts collectively represent 56% of the internal
growth for the period in this segment. The remaining growth was from
acquisitions. 17




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##### Table of Contents



Operating Expenses Wages and benefits decreased $12.8 million, or 2.9%, to $424.9 million. As a
percentage of revenue, wages and benefits decreased 2.5% to 42.1% in the third
quarter of fiscal year 2004 from 44.6% in the same quarter of fiscal year 2003.
With the sale of the Divested Federal Business and the acquisition of the
commercial information technology outsourcing business from Lockheed Martin our
mix of business changed. The Divested Federal Business, which provided
primarily system integration services to the Federal Government and its
agencies, had a high proportion of labor related expenses to its revenues. The
sale of the Divested Federal Business accounted for approximately one-half of
the decrease in labor costs as a percentage of revenue. The acquisition of the
commercial information technology outsourcing business from Lockheed Martin has a lower component of labor costs in its overall costs structure, accounting
for the remainder of the period over period change as a percentage of revenue. Services and supplies increased $2.6 million, or 1.0%, to $269.4 million. As a
percentage of revenue, services and supplies decreased to 26.7% in the third
quarter of fiscal year 2004 from 27.2% in the third quarter of fiscal year
2003. The Divested Federal Business utilized subcontractors in the
performance of some of its contracts, and therefore the sale of this business
was primarily responsible for the decrease as a percentage of revenue. Rent, lease and maintenance increased $17.6 million, or 19.6%, to $107.8
million. As a percentage of revenue, rent, lease and maintenance increased to
10.7% in the third quarter of fiscal year 2004 from 9.2% in the third quarter
of fiscal year 2003. This increase was primarily due to the sale of our
Divested Federal Business in fiscal year 2004, which provided primarily system
integration services to its clients. These services typically have a lower
percentage of rent, lease and maintenance than information technology services,
due to equipment costs incurred in our information technology services. Depreciation and amortization increased $10.0 million, or 26.3%, to $47.9
million. As a percentage of revenue, depreciation and amortization increased
0.9%, to 4.7% due to capital expenditures and intangible additions. Other operating expenses decreased $7.9 million, or 55.8%, to $6.2 million. As
a percentage of revenue, other operating expenses decreased 0.8% to 0.6%.
Included in other operating expenses in the third quarter of fiscal year 2004
is the $5.4 million gain recognized on the sale of the Hanscom contracts. Interest expense Interest expense decreased $2.3 million in the third quarter of fiscal year
2004 compared to the third quarter of fiscal year 2003, primarily as a result
of the conversion of our 3.5% Subordinated Convertible Notes to Class A common
stock in the third quarter of fiscal year 2004. Other non-operating (income) expense, net Other non-operating (income) expense, net decreased $2.3 million in the third
quarter of fiscal year 2004 compared to the third quarter of fiscal year 2003
due to increased investment income in fiscal year 2004 . Tax Expense Our effective tax rate was approximately 33.7% in the third quarter of fiscal
year 2004. In the third quarter of fiscal year 2004, we recognized $4.6 million
of income tax credits related to prior years research and development costs
and approximately $1.0 million of current year tax credits related to research
and development costs. Our effective tax rate is below the 35% statutory rate
due to these credits, offset by state income taxes. COMPARISON OF THE NINE MONTHS ENDED MARCH 31, 2004 TO THE NINE MONTHS ENDED
MARCH 31, 2003 Revenues In the first nine months of fiscal year 2004, our revenue increased $270.9
million, or 10%, to $3.04 billion from $2.77 billion in the first nine months
of fiscal year 2003. Revenues related to the Divested Federal Business and the
Hanscom contracts were $254.5 million and $522.4 million in the nine months
ended March 31, 2004 and 2003, respectively. Excluding the impact of the
revenues related to the Divested Federal Business and the Hanscom contracts,
revenues increased from $2.3 billion in the nine months ended March 31, 2003 to
$2.8 billion in the nine months ended March 31, 2004, or 24%. Revenue in the
nine months ended March 31, 2004 includes a $6.7 million reduction resulting
from the change in our percentage-of-completion estimates on the Georgia
Contract primarily as a result of the termination of Phase II of the contract,
which was recognized in the second quarter of fiscal year 2004. Internal
revenue growth, excluding the impact of the revenues related to the Divested
Federal Business and the Hanscom contracts, for the nine months ended March 31,
2004 was 16%. The remainder of the growth was related to acquisitions. Revenue in our Government segment, which represents 61% of consolidated revenue
for the first nine months of fiscal year 2004, decreased $17.3 million, or 1%,
to $1.8 billion in the first nine months of fiscal year 2004 compared to the
same period last year. Revenues related to the Divested Federal Business and
the Hanscom contracts included in the Government segment were $247.6 million
and $499.7 million for the nine months ended March 31, 2004 and 2003,
respectively. Excluding the impact of the revenues related to the Divested
Federal Business and the Hanscom contracts, revenues grew 17% in the nine
months ended March 31, 2004 to 18




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##### Table of Contents



$1.6 billion from $1.4 billion in the same period of fiscal year 2003. Revenue
in the nine months ended March 31, 2004 includes a $6.7 million reduction
resulting from the change in our percentage-of-completion estimates on the
Georgia Contract primarily as a result of the termination of Phase II of the
contract, which was recognized in the second quarter of fiscal year 2004.
Internal revenue growth, excluding the impact of the revenues related to the
Divested Federal Business and the Hanscom contracts, was 16%, due primarily to
increased revenue in our Texas Medicaid, Department of Education, New Jersey
EZPass, Florida Medicaid, Georgia Healthcare Partnership, and Ohio and Illinois
child support payment processing contracts. These contracts collectively
represent 73% of the internal growth for the period in this segment. The
remainder of the growth is from acquisitions. Revenue in our commercial segment, which represents 39% of consolidated revenue
for the first nine months of fiscal year 2004, increased $288.2 million, or
32%, to $1.2 billion in the first nine months of fiscal year 2004 compared to
the same period last year. Revenues related to the Divested Federal Business
included in the Commercial segment were $6.9 million and $22.7 million in the
nine months ended March 31, 2004 and 2003, respectively. Excluding the impact
of the revenues related to the Divested Federal Business, revenues grew 34% in
the nine months ended March 31, 2004 compared to the same period in fiscal year
2003. Internal revenue growth, excluding the impact of the revenues related
to the Divested Federal Business, was 18% primarily due to the ramp up of new
business including, among others, the Motorola, General Motors, Gateway, Ingram
Micro, Miller Brewing, Northwest Airlines, and Trilegiant contracts. These
contracts collectively represent 83% of the internal growth for the period in
this segment. The remaining growth was from acquisitions. Operating Expenses Wages and benefits increased $101.1 million, or 8.1%, to $1.3 billion. As a
percentage of revenue, wages and benefits decreased 0.7% to 44.2%. Included in
wages and benefits were compensation costs of $9.8 million associated with
former Federal employees, which were primarily stay bonuses and accelerated
option vesting due to the sale. Excluding these costs, wages and benefits
increased $91.3 million, or 7.3% in the nine months ended March 31, 2004 over
the same period in fiscal year 2003 (calculated as the $101.1 million increase
less $9.8 million compensation costs, divided by reported nine months ended
March 31, 2003 wages and benefits costs) and therefore decreased to 43.9% as a
percentage of revenue. The Divested Federal Business, which provided primarily
system integration services to the Federal Government and its agencies, had a
high proportion of labor related expenses to its revenues. The sale of the
Divested Federal Business was primarily responsible for the decrease in labor
costs as a percentage of revenue. Rent, lease and maintenance increased $39.2 million, or 15.0%, to $300.6
million. As a percentage of revenue, rent, lease and maintenance increased
0.5%, to 9.9%. This increase was primarily due to the sale of our Divested
Federal Business in fiscal year 2004, which provided primarily system
integration services to its clients. These services typically have a lower
percentage of rent, lease and maintenance than information technology services,
due to equipment costs in our information technology services. Depreciation and amortization increased $21.8 million, or 19.8%, to $131.5
million. Depreciation and amortization expense was positively impacted by
approximately $6.2 million in the nine months ended March 31, 2004 as a result
of the cessation of depreciation and amortization expense related to the assets
held for sale in our Divested Federal Business. As a percentage of revenue,
depreciation and amortization increased 0.3%, to 4.3% due to capital
expenditures and intangible additions, offset by the cessation of depreciation
and amortization discussed above. Other operating expenses increased $3.8 million, or 9.6%, to $44.1 million. As
a percentage of revenue, other operating expenses remained constant. Included
in other operating expenses is the accrual for the $10.0 million settlement
that will be paid to DCH pursuant to the agreement in principle discussed
earlier, offset by the $5.4 million gain on the sale of the
Hanscom contracts. Interest expense Interest expense decreased $5.0 million in the first nine months of fiscal year
2004 compared to the same period in fiscal year 2003, primarily as a result of
the paydown of our revolving credit facility with the proceeds from the sale of
the Divested Federal Business in fiscal year 2004 and the conversion of our
3.5% Subordinated Convertible Debt in the third quarter of fiscal year 2004. Other non-operating (income) expense, net Other non-operating (income) expense, net decreased $5.3 million in the first
nine months of fiscal year 2004 compared to fiscal year 2003 due to increased
investment income in fiscal year 2004 offset by $2.4 million of write-downs of
long-term investments in fiscal year 2003. Tax Expense Our effective tax rate was approximately 36.1% for the nine months ended March
31, 2004. In the third quarter of fiscal year 2004, we recognized $4.6 million
of income tax credits related to prior years research and development costs
and approximately $1.0 million of current year tax credits related to research
and development costs. In addition, the effective tax rate on the gain related
to the sale of the Divested Federal Business was 36.1%. Our effective tax rate
exceeds the 35% statutory rate due to state income taxes, offset by the items
above. 19




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LIQUIDITY AND CAPITAL RESOURCES We finance our ongoing business operations through cash flows from operations
and utilize excess cash flow combined with the issuance of debt and equity to
finance our acquisition strategy. One of our primary financial goals is to
maintain an adequate level of liquidity through active management of assets and
liabilities. During the nine months ended March 31, 2004, we generated approximately $269.5
million in cash flow from operations versus approximately $370.3 million in the
same period in fiscal year 2003, a decrease of 27%. Our decrease in cash flow
from operations was due primarily to the following factors: $88.1 million tax
payment related to the sale of the Divested Federal Business (gross proceeds
from the sale of the Divested Federal Business are reflected in cash flow from
investing activities, but the tax payment related to the sale is required to be
presented as a reduction in cash flows from operations); an increase in our
unbilled accounts receivable related to our information technology system
development and implementation services accounted for under the
percentage-of-completion method of accounting, including HIPAA remediation work
and Medicaid system implementations; and an increase in our billed accounts
receivable as the result of fiscal year 2004 revenue growth; offset by a
decrease in deferred tax expense primarily due to differences in timing of
deductibility of amortization of customer related intangible assets as well as
other tax and book differences. The payments received from customers on our billed accounts receivables and the
increase in such accounts receivable are reflected as a single component of our
cash flow from operations, and the timing of collections of these receivables
may have either a positive or negative impact on our liquidity. Therefore, we
actively seek current collections of amounts due from customers. Free cash flow was approximately $79.7 million for the first nine months of
fiscal year 2004 versus approximately $181.0 million for the first nine months
of fiscal year 2003. Free cash flow for the nine months ended March 31, 2004
was negatively impacted by the $88.1 million tax payment related to the sale of
the Divested Federal Business. Free cash flow is measured as operating cash
flows (net cash provided by operating activities, as reported in our
consolidated statements of cash flows) less capital expenditures (purchases of
property, equipment and software, net of sales, as reported in our consolidated
statements of cash flows) less additions to other intangible assets (as
reported in our consolidated statements of cash flows). We believe this free
cash flow metric provides an additional measure of available cash flow after we
have satisfied the capital expenditure requirements of our operations, and
should not be taken in isolation to be a measure of cash flow available for us
to satisfy all our obligations and execute our business strategies. We also
rely on cash flows from investing and financing activities, which together with
free cash flow, are expected to be sufficient for us to execute our business
strategies. Our measure of free cash flow may not be comparable to similarly
titled measures of other companies. The following table sets forth the
calculations of free cash flow (in thousands): Nine months endedMarch 31,2004
    
    2003Net cash provided by operating activities
    
    $
    269,494
    
    
    $
    370,302Purchases of property, equipment and software, net
    
    
    (166,171
    )
    
    
    (153,543
    )Additions to other intangible assets
    
    
    (23,582
    )
    
    
    (35,744
    )Free cash flow
    
    $
    79,741
    
    
    $
    181,015
 During the nine months ended March 31, 2004, cash provided by investing
activities was $156.6 million. This includes $583.4 million in the first nine
months of fiscal year 2004 related to divestitures, primarily the sale of the
Divested Federal Business, net of transaction costs. We used $235.1 million
for acquisitions during the period, primarily the purchase of Lockheed Martins
commercial information technology outsourcing business, PASC and TMI. Cash used
for the purchase of property, equipment and software was $166.2 million for the
first nine months of fiscal year 2004 versus $153.5 million in the same period
in fiscal year 2003. Our capital expenditures were approximately 5.5% of total
revenues for the nine months ended March 31, 2004 and 2003. We do not expect
that the sale of the Divested Federal Business will have a significant impact
on our capital expenditure needs in relation to new business signings and, as
of the date of this filing, we anticipate that capital expenditures
and additions to other intangible assets will be
approximately 6% to 6.5% of revenues for fiscal year 2004. During the first nine months of fiscal year 2004, cash used in financing
activities was $438.2 million. Such financing activities include $414.4
million to repurchase 8.3 million shares of our common stock pursuant to our
initial $500 million share repurchase program, and net repayments of debt of
$40.5 million, primarily on our $875 million revolving credit facility.
Proceeds generated by the sale of the Divested Federal Business were used to
partially fund such activities. At March 31, 2004, we had approximately $148.4 million of long-term debt
outstanding including $143.6 million outstanding on our revolving credit
facility. At March 31, 2004, we had approximately $580.6 million available on
our $875.0 million revolving credit facility after giving effect to $150.8
million of outstanding letters of credit that secure certain contractual
performance and other obligations. As of March 31, 2004, we were in compliance
with the debt covenants under our revolving credit facility. 20




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Certain contracts, primarily in our Government segment, require us to provide a
surety bond or a letter of credit as a guarantee of performance. As of March
31, 2004, $323.6 million of outstanding surety bonds and $110.0 million of
outstanding letters of credit secured our performance of these contractual
obligations with our clients. In addition, we had approximately $32.5 million
of letters of credit outstanding which serve as collateral for our surety bond
program and approximately $8.3 million of letters of credit which secure our
medical insurance programs. In general, we would only be liable for the amount
of these guarantees in the event of default in the performance of our
obligations under each contract, the probability of which we believe is remote.
We believe that we have sufficient capacity in the surety markets and liquidity
from our cash flow and revolving credit facility to respond to future requests
for proposals. On February 27, 2004, we completed the redemption of our 3.5% Convertible
Subordinated Notes due February 15, 2006 (the Notes). Holders of 99.9% of
all the outstanding Notes converted their Notes to 23.0234 shares of our Class
A common stock per $1,000 per principal amount of Notes in accordance with the
procedures specified in the related indenture governing the Notes. As the
result of such conversions, 7,291,983 shares of our Class A common stock were
issued to such noteholders at the conversion price of $43.44 per share. The
remaining Notes were redeemed in cash at 101.4% of the principal amount,
resulting in a cash redemption of $269,000. At March 31, 2004, we had cash and cash equivalents of $39.0 million compared
to $51.2 million at June 30, 2003. Our working capital (defined as current
assets less current liabilities) decreased $37.2 million to $384.8 million at
March 31, 2004 from $422.0 million at June 30, 2003. Our current ratio (defined
as total current assets divided by total current liabilities) was 1.6 and 1.8
at March 31, 2004 and June 30, 2003, respectively. Our debt to capitalization
ratio (defined as the sum of short-term and long-term debt divided by the sum
of short-term and long-term debt and equity) was 5.0% and 17.1% at March 31,
2004 and June 30, 2003, respectively. Our Board of Directors has authorized two share repurchase programs totaling
$1.25 billion of our Class A common stock. On September 2, 2003, we announced
that our Board of Directors authorized a share repurchase program of up to $500
million of our Class A common stock and on April 29, 2004, we announced that
our Board of Directors authorized a new, incremental share repurchase program
of up to $750 million of our Class A common stock. The programs, which are
open-ended, will allow us to repurchase our shares on the open market from time
to time in accordance with SEC rules and regulations, including shares that
could be purchased pursuant to SEC Rule 10b5-1. The number of shares to be
purchased and the timing of purchases will be based on the level of cash and
debt balances, general business conditions and other factors, including
alternative investment opportunities. We intend to fund the repurchase program
from various sources, including, but not limited to, cash on hand, cash flow
from operations, and borrowings under our existing revolving credit facility.
As of March 31, 2004, we had repurchased 8.3 million shares at a total cost of
approximately $414.4 million. Through May 13, 2004, on a trade date basis, we
have repurchased 12.6 million shares at a total cost of approximately $625.4
million of the total Board of Directors authorization. Management believes that available cash and cash equivalents, together with
cash generated from operations and available borrowings under our credit
facility, will provide adequate funds for our anticipated internal growth and
operating needs, including capital expenditures, and to meet the cash
requirements of our contractual obligations below. In addition, we intend to
continue our growth through acquisitions, which could require significant
commitments of capital. In order to pursue such opportunities we may be
required to incur debt or to issue additional potentially dilutive securities
in the future. No assurance can be given as to our future acquisitions and
expansion opportunities and how such opportunities will be financed. 21




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DISCLOSURES ABOUT CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
AS OF MARCH 31, 2004 (IN THOUSANDS): Payments Due by PeriodLess thanContractual Obligations
    
    Total
    
    1 Year
    
    1-3 Years
    
    4-5 Years
    
    After 5 YearsLong-term debt
    
    $
    143,600
    
    
    $
    
    
    
    $
    143,600
    
    
    $
    
    
    
    $
    Capital lease obligations
    
    
    4,758
    
    
    
    2,158
    
    
    
    2,003
    
    
    
    597
    
    
    
    Operating leases
    
    
    412,081
    
    
    
    139,339
    
    
    
    161,342
    
    
    
    70,593
    
    
    
    40,807Purchase obligations
    
    
    47,104
    
    
    
    2,104
    
    
    
    10,000
    
    
    
    10,000
    
    
    
    25,000Total Contractual Cash Obligations
    
    $
    607,543
    
    
    $
    143,601
    
    
    $
    316,945
    
    
    $
    81,190
    
    
    $
    65,807
 Amount of Commitment Expiration per PeriodTotal Amounts
    
    Less thanOther Commercial Commitments
    
    Committed
    
    1 Year
    
    1-3 Years
    
    4-5 Years
    
    After 5 YearsStandby letters of credit
    
    $
    150,795
    
    
    $
    150,795
    
    
    $
    
    
    
    $
    
    
    
    $
    Surety Bonds
    
    
    323,592
    
    
    
    301,037
    
    
    
    22,528
    
    
    
    27
    
    
    
    Total Commercial Commitments
    
    $
    474,387
    
    
    $
    451,832
    
    
    $
    22,528
    
    
    $
    27
    
    
    $
    
 During the first nine months of fiscal year 2004, we entered into an agreement
with a customer to purchase $50 million of products and services over a
seven-year term, with a minimum purchase of $5 million annually, at prices
consistent with the customers commercial pricing and discount guidelines.
The customer with whom we had contracted to purchase products and services was Gateway, Inc. As discussed
earlier, we have announced that our outsourcing agreement with Gateway is being terminated. Concurrent with
the termination of our outsourcing relationship with Gateway, we will also be terminating our obligation to purchase
products and services from Gateway. We are obligated to make certain contingent payments to former shareholders of
acquired entities upon satisfaction of certain contractual criteria. As of
March 31, 2004, the maximum aggregate amount of the outstanding contingent
payments to former shareholders of acquired entities is approximately $61.5
million. Upon satisfaction of the specified contractual criteria, a
corresponding increase in goodwill would be recorded. During the third quarter
of fiscal year 2004, we paid $8.2 million related to these obligations. Our Education Services business, which is included in our Commercial segment,
performs third party student loan servicing in the Federal Family Education
Loan program (FFEL) on behalf of various financial institutions. At March
31, 2004, we serviced a FFEL portfolio of approximately 1.5 million loans with
an outstanding principal balance of approximately $17.8 billion. Some
servicing agreements contain provisions that, under certain circumstances,
require us to purchase the loans from the investor if the loan guaranty has
been permanently terminated as a result of a loan default caused by our
servicing error. If defaults caused by us are cured during an initial period,
any obligation we may have to purchase these loans expires. Loans that we
purchase may be subsequently cured, the guaranty reinstated and then we repackage
the loans for sale to third parties. We evaluate our exposure under our
purchase obligations on defaulted loans and establish a reserve for potential
losses, or default liability reserve, through a charge to the provision for
loss on defaulted loans purchased. The reserve is evaluated periodically and
adjusted based upon managements analysis of the historical performance of the
defaulted loans. This reserve was approximately $3.8 million at March 31, 2004
and $4.2 million at June 30, 2003. CRITICAL ACCOUNTING POLICIES The preparation of our financial statements in conformity with generally
accepted accounting principles requires us to make estimates and assumptions
relating to the reporting of assets and liabilities, the disclosure of
contingent assets and liabilities, and the reported amounts of revenues and
expenses. We base our estimates on historical experience and on various other
assumptions or conditions that are believed to be reasonable under the
circumstances. Actual results could differ from those estimates under different
assumptions or conditions. Critical accounting policies are defined as those that are reflective of
significant judgments and uncertainties and may result in materially different
results under different assumptions and conditions. We believe that the
following critical accounting policies used in the preparation of our
consolidated financial statements involve significant judgments and estimates. Revenue recognition. A significant portion of our revenue is recognized based
on objective criteria that does not require significant estimates or
uncertainties. For example, transaction volumes and time and costs under time
and material and cost reimbursable arrangements are based on specific,
objective criteria under the contracts. Accordingly, revenues recognized under
these methods do 22




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not require the use of significant estimates that are
susceptible to change. Revenue recognized using the percentage-of-completion
accounting method does require the use of estimates and judgment as discussed
below. Our policy follows the guidance from SEC Staff Accounting Bulletin 104 Revenue
Recognition (SAB 104). SAB 104 provides guidance on the recognition,
presentation, and disclosure of revenue in financial statements and updates
existing Staff Accounting Bulletin Topic 13 to be consistent with recently
issued guidance, primarily Emerging Issues Task Force Issue No. 00-21, Revenue
Arrangements with Multiple Deliverables (EITF 00-21). We recognize revenues
when persuasive evidence of an arrangement exists, the services have been
provided to the client, the sales price is fixed or determinable, and
collectibility is reasonably assured. In fiscal year 2003, approximately 60% of our revenue was recognized based on
transaction volumes, approximately 12% was related to time and material
contracts, approximately 14% was related to cost reimbursable contracts,
approximately 7% of our revenues were recognized using percentage-of-completion
accounting and the remainder was fixed fee based, wherein our revenue is earned
as we fulfill our performance obligations under the arrangements. Revenues on cost reimbursable contracts are recognized by applying an estimated
factor to costs as incurred, such factor being determined by the contract
provisions and prior experience. Revenues on unit-price contracts are
recognized at the contractual selling prices of work completed and accepted by
the client. Revenues on time and material contracts are recognized at the
contractual rates as the labor hours and direct expenses are incurred. Revenues for business process outsourcing services are recognized as services
are rendered, generally on the basis of the number of accounts or transactions
processed. Information technology processing revenues are recognized as
services are provided to the client, generally at the contractual selling
prices of resources consumed or capacity utilized by our clients. Revenues from
annual maintenance contracts are deferred and recognized ratably over the
maintenance period. Revenues from hardware sales are recognized upon delivery
to the client and when uncertainties regarding customer acceptance have
expired. Revenues on certain fixed price contracts where we provide information
technology system development and implementation services are recognized over
the contract term based on the percentage of development and implementation
services that are provided during the period compared with the total estimated
development and implementation services to be provided over the entire contract
using Statement of Position 81-1, Accounting for Performance of
Construction-Type and Certain Production-Type Contracts (SOP 81-1). SOP 81-1
requires the use of percentage-of-completion accounting for long-term contracts
that are binding agreements between us and our customers in which we agree, for
compensation, to perform a service to the customers specifications. These
services require that we perform significant, extensive and complex design,
development, modification and implementation activities for our customers
systems. Performance will often extend over long periods, and our right to
receive future payment depends on our future performance in accordance with the
agreement. The percentage-of-completion methodology involves recognizing revenue using the
percentage of services completed, on a current cumulative cost to total cost
basis, using a reasonably consistent profit margin over the period. Due to the
longer term nature of these projects, developing the estimates of costs often
requires significant judgment. Factors that must be considered in estimating
the progress of work completed and ultimate cost of the projects include, but
are not limited to, the availability of labor and labor productivity, the
nature and complexity of the work to be performed, and the impact of delayed
performance. If changes occur in delivery, productivity or other factors used
in developing the estimates of costs or revenues, we revise our cost and
revenue estimates, which may result in increases or decreases in revenues and
costs, and such revisions are reflected in income in the period in which the
facts that give rise to that revision become known. EITF 00-21 addresses the accounting treatment for an arrangement to provide the
delivery or performance of multiple products and/or services where the delivery
of a product or system or performance of services may occur at different points
in time or over different periods of time. The Emerging Issues Task Force
reached a consensus regarding, among other issues, the applicability of the
provisions regarding separation of contract elements in EITF 00-21 to contracts
where one or more elements fall within the scope of other authoritative
literature, such as SOP 81-1. EITF 00-21 does not impact the use of SOP 81-1
for contract elements that fall within the scope of SOP 81-1, such as the
implementation or development of an information technology system to client
specifications under a long-term contract. Where an implementation or
development project is contracted with a client, and we will also provide
services or operate the system over a period of time, EITF 00-21 provides the
methodology for separating the contract elements and allocating total
arrangement consideration to the contract elements. We adopted the provisions
of EITF 00-21 on a prospective basis to transactions entered into after July 1,
2003. We believe that EITF 00-21 did not have a material impact on our
financial position or results of operations. Revenues earned in excess of related billings are accrued, whereas billings in
excess of revenues earned are deferred until the related services are provided.
Immediate recognition is made of any anticipated losses. Valuation of goodwill and intangibles. Due to the fact that we are primarily a
services company, our business acquisitions typically result in significant
amounts of goodwill and other intangible assets, which affect the amount of
future period amortization expense and possible 23




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expense we could incur as a
result of an impairment. In addition, in connection with our revenue
arrangements, we incur costs to originate contracts and to perform the
transition and setup activities necessary to enable us to perform under the
terms of the arrangement. We capitalize certain incremental direct costs in
connection with these activities and amortize them over the term of the
arrangement. From time to time, we also provide certain inducements to
customers in the form of various arrangements, including contractual credits,
which are capitalized and amortized as a reduction of revenue over the term of
the contract. The determination of the value of goodwill and other intangibles
requires us to make estimates and assumptions about future business trends and
growth. We continually evaluate whether events and circumstances have occurred
that indicate the balance of goodwill or intangible assets may not be
recoverable. In evaluating impairment, we estimate the sum of expected future
cash flows derived from the goodwill or intangible asset. Such evaluation is
significantly impacted by estimates and assumptions of future revenues, costs
and expenses and other factors. If an event occurs which would cause us to
revise our estimates and assumptions used in analyzing the value of our
goodwill or other intangibles, such revision could result in a non-cash
impairment charge that could have a material impact on our financial results. Allowance for doubtful accounts. We make estimates of the collectibility of our
accounts receivable. We specifically analyze accounts receivable and
historical bad debts, customer credit-worthiness, current economic trends, and
changes in our customer payment terms and collection trends when evaluating the
adequacy of our allowance for doubtful accounts. Any change in the assumptions
used in analyzing a specific account receivable may result in additional
allowance for doubtful accounts being recognized in the period in which the
change occurs. NEW ACCOUNTING PRONOUNCEMENTS In December 2003, the SEC issued SAB 104. SAB 104 updates existing Staff
Accounting Bulletin Topic 13 Revenue Recognition to be consistent with
recently issued guidance, primarily EITF 00-21. We do not believe that SAB 104
will have a material impact on our financial position or results of operations. RISKS RELATED TO OUR BUSINESS The risks described below should not be considered to be comprehensive and
all-inclusive. Additional risks that we do not yet know of or that we
currently think are immaterial may also impair our business operations. If any
events occur that give rise to the following risks, our business, financial
condition, cash flow or results of operations could be materially and adversely
affected, and as a result, the trading price of our Class A common stock could
be materially and adversely impacted. These risk factors should be read in
conjunction with other information set forth in this report, including our
Consolidated Financial Statements and the related notes. Loss of, or reduction of business from, clients. The loss of clients and/or the
reduction of volumes and services provided to our clients could materially
affect our revenues, profitability and cash flows. In addition, we incur a high
level of fixed costs related to our technology outsourcing and business process
outsourcing clients. Therefore the loss of any one of our significant clients
could leave us with a significantly higher level of fixed costs than is
necessary to serve our remaining clients, thereby reducing our revenues,
profitability and cash flow. Termination of all or a part of a contract by a client or deterioration of the
financial condition of a client. We may be required to make significant capital
investments in order to attract and retain large outsourcing agreements. The
termination of all or a part of a client contract or the deterioration of the
financial condition or prospects of a client has in the past, and may in the
future, result in an impairment of the net book value of the assets recorded,
including a portion of our intangible assets, and a reduction in our earnings
and cash flow. Competition. We expect to encounter additional competition as we address new
markets and new competitors enter our existing markets. If we are forced to
lower our pricing or if demand for our services decreases, our business,
financial condition, results of operations, and cash flow may be materially and
adversely affected. Some of our competitors have greater resources, and they
may be able to use their resources to adapt more quickly to new or emerging
technologies or to devote greater resources to the promotion and sale of their
products and services. In addition, we must frequently compete with a clients
own internal business process and information technology capabilities, which
may constitute a fixed cost for the client. Difficulties in executing our acquisition strategy. We intend to continue to
expand our business through the acquisition of complementary companies. We
cannot, however, make any assurances that we will be able to identify any
potential acquisition candidates or consummate any additional acquisitions or
that any future acquisitions will be successfully integrated or will be
advantageous to us. Without additional acquisitions, we are unlikely to
maintain historical total growth rates. Failure to properly manage our operations and our growth. We have rapidly
expanded our operations in recent years. We intend to continue expansion in the
foreseeable future to pursue existing and potential market opportunities. This
rapid growth places a significant demand on our management and operational
resources. In order to manage growth effectively, we must implement and improve
our operational systems, procedures, and controls on a timely basis. If we fail
to implement these systems, procedures and 24




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controls on a timely basis, we may
not be able to service our clients needs, hire and retain new employees,
pursue new business, complete future acquisitions or operate our businesses
effectively. We could also trigger contractual credits to clients. Failure to
properly transition new customers to our systems, properly budget transition
costs or accurately estimate new contract operational
costs could result in delays in our contract performance, trigger service level
penalties or result in contracts whose profit margins did not meet our
expectations or our historical profit margins. Failure to properly integrate
acquired operations could result in increased cost. As a result of any of these
problems associated with expansion, our business, financial condition, and
results of operations could be materially and adversely affected. Government clients - termination rights, audits and investigations. A
substantial portion of our revenues are derived from contracts with state and
local governments and from contracts with the Department of Education.
Governments and their agencies may terminate most of these contracts at any
time, without cause. Also, our Department of Education contracts are subject
to the approval of appropriations being made by the United States Congress to
fund the expenditures to be made by the Federal government under these
contracts. Additionally, government contracts are generally subject to audits
and investigations by government agencies. If the government finds that we
improperly charged any costs to a contract, the costs are not reimbursable or,
if already reimbursed, the cost must be refunded to the government. If the
government discovers improper or illegal activities in the course of audits or
investigations, the contractor may be subject to various civil and criminal
penalties and administrative sanctions, which may include termination of
contracts, forfeiture of profits, suspension of payments, fines and suspensions
or debarment from doing business with the government. Any resulting penalties
or sanctions could have a material adverse effect on our business, financial
condition, results of operations and cash flow. Further, the negative publicity
that arises from findings in such audits, investigations or the penalties or
sanctions therefore could have an adverse effect on our reputation in the
industry and reduce our ability to compete for new contracts and may also have
a material adverse effect on our business, financial condition, results of
operations and cash flow. Exercise of contract termination provisions and service level penalties. Most
of our contracts with our clients permit termination in the event our
performance is not consistent with service levels specified in those contracts,
or provide for credits to our clients for failure to meet service levels. In
addition, if clients are not satisfied with our level of performance, our
reputation in the industry may suffer, which could materially and adversely
affect our business, financial condition, results of operations, and cash flow. Pricing risks. Some of our contracts contain provisions requiring that our
services be priced based on a pre-established standard or benchmark regardless
of the costs we incur in performing these services. Some of our contracts
contain pricing provisions that require the client to pay a set fee for our
services regardless of whether our costs to perform these services exceed the
amount of the set fee. Some of our contracts contain re-pricing provisions
which can result in reductions of our fees for performing our services. In
such situations, we are exposed to the risk that we may be unable to price our
services to levels that will permit recovery of our costs, and may adversely
affect our operating results and cash flow. Loss of significant software vendor relationships. Our ability to service our
clients depends to a large extent on our use of various software programs that
we license from a small number of primary software vendors. If our significant
software vendors were to terminate or refuse to renew our contracts with them,
we might not be able to replace the related software programs and would be
unable to serve our clients, which could have a material adverse effect on our
business, revenues, profitability and cash flow. Intellectual property infringement claims. We rely heavily on the use of
intellectual property. We do not own the majority of the software that we use
to run our business; instead we license this software from a small number of
primary vendors. If these vendors assert claims that we or our clients are
infringing on their software or related intellectual property, we could incur
substantial costs to defend these claims, which could have a material effect on
our profitability and cash flow. In addition, if any of our vendors
infringement claims are ultimately successful, our vendors could require us (1)
to cease selling or using products or services that incorporate the challenged
software or technology, (2) to obtain a license or additional licenses from our
vendors, or (3) to redesign our products and services which rely on the
challenged software or technology. If we are unsuccessful in the defense of
an infringement claim and our vendors require us to initiate any of the above
actions, then such actions could have a material adverse effect on our
business, financial condition, results of operations and cash flow. Rapid technological changes. The markets for our information technology
services are subject to rapid technological changes and rapid changes in client
requirements. We may be unable to timely and successfully customize products
and services that incorporate new technology or to deliver the services and
products demanded by the marketplace. Federal and State laws relating to individually identifiable information. We
process and store information relating to identifiable individuals, both in our
role as a service provider and as an employer. As a result, we are subject to
numerous Federal and State laws and regulations designed to protect
individually identifiable information, including financial and health
information. For example, in 1996, Congress passed the Health Insurance
Portability and Accountability Act (HIPAA) and as required therein, the
Department of Health and Human Services (HHS) established regulations
governing, among other things, the privacy, security and electronic
transmission of individually identifiable health information. We have taken
measures to comply with each of those regulations on or before the required
dates. Other Federal and State laws apply to the processing of individually
identifiable information as well, and 25




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additional legislation may be enacted at
any time. Failure to comply with these types of laws may subject us to
liability for monetary damages, fines and/or criminal prosecution and may have
a material adverse effect on our profitability and cash flow. Budget deficits at, or fluctuations in the number of requests for proposals
issued by, state and local governments and their agencies. A substantial
portion of our revenues are derived from contracts with state and local
governments and their agencies. Currently, many state and local governments
that we have contracts with are facing potential budget deficits. Also, the
number of requests for proposals issued by state and local government agencies
is subject to fluctuation. While this has not had a material adverse impact on
our results of operations through the third quarter of fiscal year 2004, it is
unclear what impact, if any, these deficits may have on our future business,
revenues, results of operations and cash flow. International risks. Recently we have expanded our international operations
and have also contemplated the acquisition of companies formed and operating in
foreign countries. International operations and acquisitions are subject to a
number of risks including, but not limited to the following - fluctuations in
foreign currency exchange rates; licensing and labor counsel requirements;
staffing key managerial positions; cultural differences; integration of
companies, their management, and operations, which are located in distant
locations; data privacy laws adopted by various countries in which ACS does
business, including but not limited to member states of the European Union;
general economic conditions in foreign countries; additional expenses and risks
inherent in conducting operations in geographically distant locations; laws of
those foreign countries; political instability; trade restrictions such as
tariffs and duties or other controls affecting foreign operations, and other
factors that may adversely affect our business, financial condition and
operating results. Armed hostilities and
terrorist attacks. Terrorist attacks and further acts of
violence or war may cause major instability in the U.S. and other financial
markets in which we operate. In addition, armed hostilities and acts of
terrorism may directly impact our physical facilities and operations, which are
located in North America, Central America, South America, Europe, Africa,
Australia, Asia and the Middle East, or those of our clients. These
developments subject our worldwide operations to increased risks and, depending
on their magnitude, could have a material adverse effect on our business. Failure to attract and retain necessary technical personnel and skilled
management and qualified subcontractors. Our success depends to a significant
extent upon our ability to attract, retain and motivate highly skilled and
qualified personnel and to subcontract with qualified, competent
subcontractors. If we fail to attract, train, and retain, sufficient numbers
of these technically-skilled people or are unable to contract with qualified,
competent subcontractors, our business, financial condition, and results of
operations will be materially and adversely affected. Our success also depends
on the skills, experience, and performance of key members of our management
team and on qualified, competent subcontractors. The loss of any key employee
or the loss of a key subcontract relationship could have an adverse effect on
our business, financial condition, cash flow, results of operations and
prospects. Servicing Risks. We service (for various lenders and under various service
agreements) a portfolio of approximately $17.8 billion of loans made under the
Federal Family Education Loan Program, which loans are guaranteed by a Federal
government agency. If a loan is in default, then a claim is made upon the
guarantor. If the guarantor denies the claim because of a servicing error,
then under certain of the servicing agreements we may be required to purchase
the loan from the lender. Upon purchase of the loan, we attempt to cure the
servicing errors and either sell the loan back to the guarantor (which must
occur within a specified period of time) or sell the loan on the open market to
a third party. We are subject to the risk that we may be unable to cure the
servicing errors or sell the loan on the open market. Our reserves, which are
based on historical information, may be inadequate if our servicing performance
results in the requirement that we repurchase a substantial number of loans,
which repurchase could have a material adverse impact on our cash flow and
profitability. Disruption in Utility or
Network Services. Our services are dependent on the
companies providing electricity and other utilities to our operating
facilities, as well as network companies providing connectivity to our
facilities and clients. While there are backup systems in many of our
operating facilities, an extended outage of utility services may have a
material adverse effect on our operations, revenues, cash flow and
profitability. Indemnification Risk. Our contracts, including our agreements with respect to
divestitures, include various indemnification obligations. If we are required
to satisfy an indemnification obligation, that may have a material adverse
effect on our business, profitability and cash flow. Other Risks. We have attempted to identify material risk factors currently
affecting our business and company. However, additional risks that we do not
yet know of, or that we currently think are immaterial, may occur or become
material. These risks could impair our business operations or adversely affect
revenues, cash flow or profitability. 26




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We have fixed rate and variable rate debt instruments. Our variable rate debt
instruments are subject to market risk from changes in interest rates.
Sensitivity analysis is one technique used to measure the impact of changes in
the interest rates on the value of market-risk sensitive financial instruments.
A hypothetical 10% change in interest rates would not have a material impact
on our future earnings, fair value, or cash flows. 
 ITEM 4. CONTROLS AND PROCEDURES The management of the Company, including the Companys principal executive
officer and principal financial officer have evaluated the effectiveness of the
Companys disclosure controls and procedures (as defined in Rule 13a-15(e) of
the Securities Exchange Act of 1934) as of March 31, 2004. Based on such
evaluation, the Companys principal executive officer and principal financial
officer have concluded that as of March 31, 2004, such disclosure controls and
procedures are effective. There have not been any changes in the Companys
internal control over financial reporting (as defined in Exchange Act Rule
13a-15(f) of the Securities Exchange Act of 1934) during the quarter ended
March 31, 2004 that have materially affected or are reasonably likely to
materially affect the Companys internal control over financial reporting. 27




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PART II 
 ITEM 1. LEGAL PROCEEDINGS On December 16, 1998, a state district court in Houston, Texas entered final
judgment against us in a lawsuit brought by 21 former employees of Gibraltar
Savings Association and/or First Texas Savings Association (collectively,
GSA/FTSA). The GSA/FTSA employees alleged that they were entitled to the
value of 803,082 shares of our stock (adjusted for February 2002 stock split)
pursuant to options issued to the GSA/FTSA employees in 1988 in connection with
a former technology outsourcing services agreement between GSA/FTSA and us.
The judgment against us was for approximately $17 million, which included
attorneys fees and pre-judgment interest. The judgment was appealed by the
plaintiffs and us and the appellate process has now been concluded. As a
result of the appeals, the trial courts judgment has been reversed and the
case has been remanded to the trial court for further proceedings, except that
the trial court judgment was affirmed in part as to one of the plaintiffs and
the trial courts dismissal of certain of our affirmative defenses was upheld. The
amount of the judgment the state district court should award the one plaintiff,
whose judgment was upheld, is in dispute because the parties do not agree on
the applicable pre-judgment interest rate to be applied by the court. This
judgment amount should not exceed approximately $1.6 million and, as of March
31, 2004, we have accrued an amount we believe is appropriate for this
judgment. We continue to believe that we have a meritorious defense to all or
a substantial portion of the remaining plaintiffs claims
despite the dismissal of certain of our affirmative defenses and, accordingly,
have not accrued any amount on our balance sheet related to the remaining
claims. One of our subsidiaries, ACS Defense, Inc., and several other government
contractors received a grand jury document subpoena issued by the U.S. District
Court for the District of Massachusetts in October 2002. The subpoena was
issued in connection with an inquiry being conducted by the Antitrust Division
of the U.S. Department of Justice (DOJ). The inquiry concerns certain IDIQ
(Indefinite Delivery  Indefinite Quantity) procurements and their related task
orders, which occurred in the late 1990s at Hanscom Air Force Base in
Massachusetts. Our revenue from the contracts that we believe to be the focus
of the DOJs inquiry was approximately $25 million for the fiscal year ended
June 30, 2003, and approximately $16.7 million for the nine months ended March
31, 2004, representing approximately 0.7% of our revenue for fiscal year 2003
and 0.5% for the nine months ended March 31, 2004. In February 2004, we sold
the contracts associated with the Hanscom Air Force Base relationship to
ManTech International Corporation, however, we will indemnify ManTech with
respect to this DOJ subpoena. We are continuing our previously announced
internal investigation of this matter through outside legal counsel and we are
continuing to cooperate with the DOJ in producing documents in response to the
subpoena.
At this stage of this inquiry, we are unable to express an opinion as to its
likely outcome. See Managements Discussion and Analysis of Financial
Condition and Results of Operations  General for a discussion of the sale of
the contracts associated with the Hanscom Air Force Base relationship. Another of our subsidiaries, ACS State & Local Solutions, Inc. (ACS SLS), and
a teaming partner of this subsidiary, Tier Technologies, Inc. (Tier),
received a grand jury document subpoena issued by the U.S. District Court for
the Southern District of New York in May 2003. The subpoena was issued in
connection with an inquiry being conducted by the Antitrust Division of the
DOJ. The inquiry concerns the teaming arrangement between ACS SLS and Tier on
child support payment processing contracts awarded to ACS SLS and Tier, as a
subcontractor to ACS SLS, in New York, Illinois and Ohio. Our annual revenue
from these three contracts will be approximately $70 million when the services
are fully implemented, representing approximately 1.8% of our annual revenue.
Our teaming arrangement also contemplated the California child support payment
processing request for proposals, which was issued in late 2003; however, we
did not enter into a teaming agreement with Tier for the California request for
proposals. Based on Tiers recent filings with the Securities and Exchange
Commission, we understand that on November 20, 2003 the DOJ granted conditional
amnesty to Tier in connection with this inquiry pursuant to the DOJs Corporate
Leniency Policy. The policy provides that the DOJ will not bring any criminal
charges against Tier as long as it continues to fully cooperate in the inquiry
(and makes restitution payments if it is determined that parties were injured
as a result of impermissible anticompetitive conduct). We are continuing our
previously announced internal investigation of this matter through outside
legal counsel and we are continuing to cooperate with the DOJ in producing
documents in response to the subpoena. At this stage of this inquiry, we are
unable to express an opinion as to its likely outcome. On March 22, 2004, ACS SLS received a grand jury document subpoena issued by
the U.S. District Court for the Southern District of Florida. The subpoena was
issued in connection with an inquiry being conducted by the DOJ and the
Inspector Generals Office of the U.S. Department of Labor (DOL) into the
subsidiarys workforce contracts in Dade and Monroe counties in Florida, which
expired in June 2003. In a related matter, on January 30, 2004, the Florida
Agency for Workforce Innovation Office of Inspector General (OIG) issued a
report that reviewed 13 Florida workforce regions served by ACS SLS, including
Dade and Monroe counties, and noted concerns related to the accuracy of
customer case records maintained by our local staff. Our total revenue
generated from the Florida workforce services contracts amount to approximately
1% of our total annual revenue. The OIG reviewed approximately 4,000
data elements and identified a potential of 488 possible data conflicts. In
March 2004 we filed our response to the OIG report. With the assistance of
outside experts, we reviewed the report and each possible data conflict and
determined that two-thirds of the
possible data conflicts were, in fact, not
errors, but one-third were confirmed errors resulting in an error rate of
4%, a rate which is not unexpected given the manual processes
involved in these services and the fact that we must rely on employers to 28




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report accurate data. We have not received a response from the OIG to our
March 2004 submission. We had previously identified problems in the operation
of our Miami-Dade workforce operation, which resulted in the removal of three
individuals from employment. As part of our response to the OIG report, we
submitted a comprehensive action plan with recommendations to enhance our data
integrity and operational controls on workforce contracts and to prevent a
reoccurrence of these problems. The Securities and Exchange Commission (SEC)
is conducting an informal investigation into the matters covered by the OIGs
report. We are continuing our previously announced internal investigation of
these matters through outside legal counsel and we are continuing to cooperate
with the government and regulatory agencies in their investigations. At this
stage of these investigations, we are unable to express an opinion as to the
likely outcome of the investigations. In addition to the foregoing, we are subject to certain other legal
proceedings, inquiries, claims and disputes, which arise in the ordinary course
of business. Although we cannot predict the outcomes of these other
proceedings, we do not believe these other actions, in the aggregate, will have
a material adverse effect on our financial position, results of operations or
liquidity. 
 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On February 27, 2004, we completed the redemption of our 3.5% Convertible
Subordinated Notes due February 15, 2006 (the Notes). Holders of 99.9% of
all the outstanding Notes converted their Notes to 23.0234 shares of our Class
A common stock per $1,000 per principal amount of Notes in accordance with the
procedures specified in the related indenture governing the Notes. As the
result of such conversions, 7,291,983 shares of our Class A common stock were
issued to such noteholders at the conversion price of $43.44 per share. The
remaining Notes were redeemed in cash at 101.4% of the principal amount,
resulting in a cash redemption of $269,000. Our Board of Directors has authorized two share repurchase programs totaling
$1.25 billion of our Class A common stock. On September 2, 2003, we announced
that our Board of Directors authorized a share repurchase program of up to $500
million of our Class A common stock and on April 29, 2004, we announced that
our Board of Directors authorized a new, incremental share repurchase program
of up to $750 million of our Class A common stock. The programs, which are
open-ended, will allow us to repurchase our shares on the open market from time
to time in accordance with SEC rules and regulations, including shares that
could be purchased pursuant to SEC Rule 10b5-1. The number of shares to be
purchased and the timing of purchases will be based on the level of cash and
debt balances, general business conditions and other factors, including
alternative investment opportunities. We intend to fund the repurchase program
from various sources, including, but not limited to, cash on hand, cash flow
from operations, and borrowings under our existing revolving credit facility.
As of March 31, 2004, we had repurchased 8.3 million shares at a total cost of
approximately $414.4 million. Through May 13, 2004, on a trade date basis, we
have repurchased 12.6 million shares at a total cost of approximately $625.4
million of the total Board of Directors authorization. Repurchase activity for the quarter ended March 31, 2004 was as follows.
Please refer to the discussion above for the cumulative repurchases under our share
repurchase program. Maximum number (orTotal number of
    
    approximate dollarshares purchased as
    
    value) of sharespart of publicly
    
    that may yet beTotal number of
    
    Average price paid
    
    announced plans or
    
    purchased under thePeriod
    
    shares purchased
    
    per share
    
    programs
    
    plans or programsJanuary 1  January 31, 2004
    
    
    475,000
    
    
    $
    55.8064
    
    
    
    475,000
    
    
    $
    264,252,637February 1  February 29, 2004
    
    
    1,164,593
    
    
    
    50.8730
    
    
    
    1,164,593
    
    
    
    205,006,284March 1  March 31, 2004
    
    
    2,407,900
    
    
    
    49.6075
    
    
    
    2,407,900
    
    
    
    85,556,430Total  Quarter ended March 31, 2004
    
    
    4,047,493
    
    
    $
    50.6991
    
    
    
    4,047,493
    
    
    $
    85,556,430
 29




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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K  a.)
    
    ExhibitsReference is made to the Index to Exhibits beginning on page
32 for a list of all exhibits filed as part of this report.b.)
    
    Reports on Form 8-K  1.)
    
    On January 20, 2004, the Company filed a Current Report on Form
8-K (dated as of January 20, 2004) for the purpose of furnishing the
second quarter of fiscal year 2004 earnings press release, announcing
the conference call to be hosted on the Companys website to disclose
the Companys financial results and disclosing the location of the
Companys Supplementary Financial Information used during the
conference call for the quarter ended December 31, 2003.2.)
    
    On January 23, 2004, the Company filed a Current Report on Form
8-K (dated as of January 20, 2004) for the purpose of furnishing the
transcript of the Companys presentation during the conference call
hosted on the Companys website disclosing the Companys financial
results, the questions and answers following the presentation and
furnishing a copy of the slides presented during the conference call
hosted on the Companys website.3.)
    
    On January 28, 2004, the Company filed a Current Report on Form
8-K (dated as of January 27, 2004) to announce the redemption of the
Companys 3.5% Convertible Subordinated Notes due February 15, 2006
and to furnish a copy of the Companys press release regarding this
matter.4.)
    
    On February 3, 2004, the Company filed a Current Report on Form
8-K (dated as of February 3, 2004) to announce the Companys intent
to respond in a timely manner to a report issued by the OIG on
January 30, 2004 (the Report) and to furnish a copy of the
Companys press release regarding the Report.5.)
    
    On February 27, 2004, the Company filed a Current Report on
Form 8-K (dated as of February 27, 2004) to announce that 99.9% of
the holders of its 3.5% Convertible Subordinated Notes due February
15, 2006 (the Notes) had converted their Notes to shares of the
Companys Class A Common Stock and to furnish a copy of the press
release announcing the conclusion of the redemption of the Notes.6.)
    
    On March 23, 2004, the Company filed a Current Report on Form
8-K (dated as of March 22, 2004) to announce that its wholly owned
subsidiary, ACS State & Local Solutions, Inc., recently filed its
response to the OIGs Report regarding certain workforce contracts in
Florida, that it has received a grand jury document subpoena issued
by the U.S. District Court for the Southern District of Florida and
to furnish a copy of the Companys press release regarding these
matters.7.)
    
    On March 31, 2004, the Company filed a Current Report on Form
8-K (dated as of March 31, 2004) to announce that it had been awarded
a seven-year contract to provide information technology services to
McDonalds Corporation and to furnish a copy of the Companys press
release regarding this matter. 30




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized on the 17th day of May, 2004. AFFILIATED COMPUTER SERVICES, INC.By:
    /s/ Warren D. EdwardsWarren D. EdwardsExecutive Vice President and
Chief Financial Officer 31




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INDEX TO EXHIBITS ExhibitNumber
    
    Exhibit Name3.1
    
    Certificate of Incorporation of the Company (filed as
Exhibit 3.1 to our Registration Statement on Form S-3,
filed March 30, 2001, File No. 333-58038 and incorporated
herein by reference).3.2
    
    Certificate Of Correction to Certificate of Amendment of
the Company, dated August 30, 2001 (filed as Exhibit 3.2 to
our Annual Report on Form 10-K, filed September 17, 2003
and incorporated herein by reference).3.3
    
    Bylaws of the Company, as amended and in effect on
September 11, 2003 (filed as Exhibit 3.3 to our Quarterly
Report on Form 10-Q, filed February 17, 2004 and
incorporated herein by reference).4.1
    
    Form of New Class A Common Stock Certificate (filed as
Exhibit 4.3 to our Registration Statement on Form S-1,
filed May 26, 1994, File No. 33-79394 and incorporated
herein by reference).4.2
    
    Amended and Restated Rights Agreement, dated April 2, 1999,
between the Company and First City Transfer Company, as
Rights Agent (filed as Exhibit 4.1 to our Current Report on
Form 8-K, filed May 19, 1999 and incorporated herein by
reference).4.3
    
    Indenture, dated as of February 21, 2001, between the
Company, as Issuer, and U.S. Trust Company of Texas, N.A.,
as Trustee, relating to the Companys 3.5% Convertible
Subordinated Notes due February 15, 2006 (filed as Exhibit
4.1 to our Registration Statement on Form S-3, filed March
30, 2001, File No. 333-58038 and incorporated herein by
reference).4.4
    
    Registration Rights Agreement, dated February 21, 2001, by
and between the Company and Goldman, Sachs & Co., as
representative of the several purchasers named therein
relating to the Companys 3.5% Convertible Subordinated
Notes due February 15, 2006 (filed as Exhibit 4.4 to our
Registration Statement on Form S-3, filed March 30, 2001,
File No. 333-58038 and incorporated herein by reference).4.5
    
    Specimen Note for the Companys 3.5% Convertible
Subordinated Notes due February 15, 2006 (filed as Exhibit
4.2 to our Registration Statement on Form S-3, filed March
30, 2001, File No. 333-58038 and incorporated herein by
reference).4.6
    
    Amendment No. 1 to First Amended and Restated Rights
Agreement, dated as of February 5, 2002, by and between the
Company and First City Transfer Company (filed as Exhibit
4.1 to our Current Report on Form 8-K, filed February 6,
2002 and incorporated herein by reference).4.7
    
    Form of Rights Certificate (included as Exhibit A to the
Amended and Restated Rights Agreement (Exhibit 4.2)).10.1*
    
    Form of Severance Agreement, dated as of March 1, 2004, by
and between Affiliated Computer Services, Inc. and each of
Jeffrey A. Rich, Mark A. King, Warren D. Edwards, Lynn
Blodgett, John Brophy and William L. Deckelman, Jr.31.1*
    
    Certification of Chief Executive Officer of Affiliated
Computer Services, Inc. pursuant to Rule 13a-14(a)
promulgated under the Securities Exchange Act of 1934, as
amended.31.2*
    
    Certification of Chief Financial Officer of Affiliated
Computer Services, Inc. pursuant to Rule 13a-14(a)
promulgated under the Securities Exchange Act of 1934, as
amended.32.1*
    
    Certification of Chief Executive Officer of Affiliated
Computer Services, Inc. pursuant to Rule 13a-14(b)
promulgated under the Securities Exchange Act of 1934, as
amended and Section 1350 of Chapter 63 of Title 18 of the
United States Code. Pursuant to SEC Release 34-47551, this
Exhibit is furnished to the SEC and shall not be deemed to
be filed.32.2*
    
    Certification of Chief Financial Officer of Affiliated
Computer Services, Inc. pursuant to Rule 13a-14(b)
promulgated under the Securities Exchange Act of 1934, as
amended and Section 1350 of Chapter 63 of Title 18 of the
United States Code. Pursuant to SEC Release 34-47551, this
Exhibit is furnished to the SEC and shall not be deemed to
be filed.
 * Filed herewith 32