**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

# **FORM 10-Q**

 

**(Markone)**

 
| **ý**                                             | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                   |       |                                                                                          |
| **For the quarterly period ended September 30,  2004** |
|                                                   |       |                                                                                          |
| **OR**                                                 |
|                                                   |       |                                                                                          |
| **o**                                                  | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from                                  to                                  **

 

**Commissionfile number 001-14049**

 

**IMS Health Incorporated**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                             | ** ** | **06-1506026**                       |
|------------------------------------------|------------|--------------------------------------|
| (State of Incorporation)                 |       | (I.R.S. Employer Identification No.) |
|                                     |       |                                 |
| **1499 Post Road, Fairfield, CT**        | ** ** | **06824**                            |
| (Address of principal executive offices) |       | (Zip Code)                           |

 

Registrant’s telephone number, including area code    **(203) 319-4700**

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Sections 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes  ý  No  o

 

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

 

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date:

 

| **Title  of Class**                    | ** ** | **Shares Outstanding  At September 30, 2004** |
|----------------------------------------|------------|-----------------------------------------------|
| Common Stock, par value $.01 per share |       | 231,952,786                                   |

 

 

----

 

**IMSHEALTH INCORPORATED**

 

**INDEXTO FORM 10-Q**

 
| ** **                                                                                              | **PAGE(S)** |
|---------------------------------------------------------------------------------------------------------|-------------|
| **PART  I. FINANCIAL INFORMATION**                                                                      |        |
|                                                                                                    |        |
| Item 1. Financial Statements (Unaudited)                                                                |        |
|                                                                                                    |        |
| Condensed  Consolidated Statements of Financial Position                                                |        |
| As of September 30, 2004 and December 31,  2003                                                         | 3           |
|                                                                                                    |        |
| Condensed  Consolidated Statements of Income                                                            |        |
| Three Months Ended September 30, 2004 and  2003                                                         | 4           |
|                                                                                                    |        |
| Condensed  Consolidated Statements of Income                                                            |        |
| Nine Months Ended September 30, 2004 and  2003                                                          | 5           |
|                                                                                                    |        |
| Condensed  Consolidated Statements of Cash Flows                                                        |        |
| Nine Months Ended September 30, 2004 and  2003                                                          | 6           |
|                                                                                                    |        |
| Notes  to Condensed Consolidated Financial Statements                                                   | 7-34        |
|                                                                                                    |        |
| **Item 2. Management’s Discussion and  Analysis of Financial Condition and Results of Operations** | 35-52       |
|                                                                                                    |        |
| **Item  3. Quantitative and Qualitative Disclosures About Market Risk**                                 | 53          |
|                                                                                                    |        |
| **Item 4. Controls and Procedures**                                                                     | 53          |
|                                                                                                    |        |
| **PART II. OTHER INFORMATION**                                                                          | ** **  |
|                                                                                                    | ** **  |
| **Item  1. Legal Proceedings**                                                                          | 54          |
|                                                                                                    | ** **  |
| **Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of  Equity Securities**           | 54          |
|                                                                                                    |        |
| **Item 6.  Exhibits**                                                                                   | 54          |
|                                                                                                    |        |
| **SIGNATURES**                                                                                          | 55          |
| ** **                                                                                              | ** **  |
| **EXHIBIT  INDEX**                                                                                      | 56          |

 

2

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**PARTI. FINANCIAL INFORMATION**

**Item I. FINANCIAL STATEMENTS**

 

**IMS HEALTH INCORPORATED**

**CONDENSED CONSOLIDATED STATEMENTSOF FINANCIAL POSITION****(Unaudited)**

*(Dollars and shares in thousands,except per share data)*

 
| ** **                                                                                                                                 | ** ** | **As of September 30,  2004** | ** **    | **As of December 31,  2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|---------------|------------------------------|------------|
| **Assets:**                                                                                                                                |       |                          |          |                         |       |
| **Current Assets:**                                                                                                                        |       |                          |          |                         |       |
| Cash and cash equivalents                                                                                                                  | ** ** | **$**                         | **403,633**   |                         | $          | 344,432 |   |
| Short-term marketable securities                                                                                                           | ** ** | **22,241**                    |          | 40,108                       |       |
| Accounts receivable, net of allowances of  $6,044 and $4,429 in 2004 and 2003, respectively                                                | ** ** | **256,929**                   |          | 271,268                      |       |
| Other current assets                                                                                                                       | ** ** | **141,678**                   |          | 123,121                      |       |
| **Total Current Assets**                                                                                                                   | ** ** | **824,481**                   |          | 778,929                      |       |
| Securities and other investments                                                                                                           | ** ** | **10,687**                    |          | 14,988                       |       |
| TriZetto equity investment (Note 8)                                                                                                        | ** ** | **41,682**                    |          | 42,742                       |       |
| Property, plant and equipment, net of  accumulated depreciation of $181,137 and $174,472 in 2004 and 2003, respectively                    | ** ** | **138,788**                   |          | 141,282                      |       |
| Computer software                                                                                                                          | ** ** | **210,153**                   |          | 198,558                      |       |
| Goodwill                                                                                                                                   | ** ** | **265,377**                   |          | 247,958                      |       |
| Other assets                                                                                                                               | ** ** | **228,598**                   |          | 219,881                      |       |
| **Total Assets**                                                                                                                           | ** ** | **$**                         | **1,719,766** |                         | $          | 1,644,338 |   |
|                                                                                                                                       |       |                          |          |                         |       |
| **Liabilities, Minority Interests and  Shareholders’ Equity:**                                                                        |       |                          |          |                         |       |
| **Current Liabilities:**                                                                                                                   |       |                          |          |                         |       |
| Accounts payable                                                                                                                           | ** ** | **$**                         | **47,036**    |                         | $          | 47,513 |   |
| Accrued and other current liabilities                                                                                                      | ** ** | **163,849**                   |          | 190,478                      |       |
| Short-term debt                                                                                                                            | ** ** | **241,477**                   |          | 409,941                      |       |
| Accrued income taxes                                                                                                                       | ** ** | **138,349**                   |          | 67,369                       |       |
| Short-term deferred tax liability                                                                                                          | ** ** | **9,472**                     |          | 9,248                        |       |
| Deferred revenues                                                                                                                          | ** ** | **101,215**                   |          | 112,076                      |       |
| **Total Current Liabilities**                                                                                                              | ** ** | **701,398**                   |          | 836,625                      |       |
| Postretirement and postemployment benefits                                                                                                 | ** ** | **92,359**                    |          | 86,920                       |       |
| Long-term debt (Note 10)                                                                                                                   | ** ** | **392,927**                   |          | 152,050                      |       |
| Other liabilities                                                                                                                          | ** ** | **234,292**                   |          | 277,313                      |       |
| **Total Liabilities**                                                                                                                      | ** ** | **$**                         | **1,420,976** |                         | $          | 1,352,908 |   |
|                                                                                                                                       |       |                          |          |                         |       |
| **Commitments and contingencies (Note 9)**                                                                                                 |       |                          |          |                         |       |
| **Minority Interests**                                                                                                                     | ** ** | **$**                         | **101,361**   |                         | $          | 101,853 |   |
| **Shareholders’ Equity:**                                                                                                             |       |                          |          |                         |       |
| Common Stock, par value $.01, authorized  800,000 shares; issued 335,045 shares at September 30, 2004 and December 31,  2003, respectively | ** ** | **$**                         | **3,350**     |                         | $          | 3,350 |   |
| Capital in excess of par                                                                                                                   | ** ** | **478,849**                   |          | 490,297                      |       |
| Retained earnings                                                                                                                          | ** ** | **1,987,130**                 |          | 1,789,503                    |       |
| Treasury stock, at cost, 103,093 and 96,706  shares at September 30, 2004 and December 31, 2003, respectively                              | ** ** | **(2,204,842**                | **)**         | (2,032,748                   | )          |
| Cumulative translation adjustment                                                                                                          | ** ** | **(45,241**                   | **)**         | (37,255                      | )          |
| Minimum pension liability adjustment, net  of taxes of $10,806 at September 30, 2004 and December 31, 2003                                 | ** ** | **(21,963**                   | **)**         | (21,963                      | )          |
| Unrealized loss on changes in fair value of  cash flow hedges, net of tax                                                                  | ** ** | **(940**                      | **)**         | (2,299                       | )          |
| Unrealized gains on investments, net of  taxes of $585 and $373 at September 30, 2004 and December 31, 2003,  respectively                 | ** ** | **1,086**                     |          | 692                          |       |
| **Total Shareholders’ Equity**                                                                                                        | ** ** | **$**                         | **197,429**   |                         | $          | 189,577 |   |
| **Total Liabilities, Minority Interests and  Shareholders’ Equity**                                                                   | ** ** | **$**                         | **1,719,766** |                         | $          | 1,644,338 |   |

 

## ***See accompanying Notes to theCondensed Consolidated Financial Statements (unaudited).***

 

3

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## **IMSHEALTH INCORPORATED**

**CONDENSED CONSOLIDATED STATEMENTSOF INCOME****(Unaudited)**

*(Dollarsand shares in thousands, except per share data)*

 
| ** **                                                                                              | ** ** | **Three Months Ended  September 30,** | ** **  |
|---------------------------------------------------------------------------------------------------------|------------|---------------------------------------|-------------|
| ** **                                                                                              | ** ** | **2004**                              | ** **  | **2003** | ** ** |
|                                                                                                    |       |                                  |        |   |   |
| **Operating Revenue**                                                                                   | ** ** | **$**                                 | **384,171** |   | $ | 345,978 |   |
|                                                                                                    |       |                                  |        |   |   |
| Operating costs                                                                                         | ** ** | **163,465**                           |        | 142,457 |   |
| Selling and administrative expenses                                                                     | ** ** | **94,460**                            |        | 77,181 |   |
| Depreciation and amortization                                                                           | ** ** | **23,355**                            |        | 18,398 |   |
| **Operating Income**                                                                                    | ** ** | **102,891**                           |        | 107,942 |   |
| Interest income                                                                                         | ** ** | **1,834**                             |        | 739 |   |
| Interest expense                                                                                        | ** ** | **(4,751**                            | **)**       | (3,688 | ) |
| Gains from investments, net                                                                             | ** ** | **2,188**                             |        | 1,964 |   |
| Gain (loss) on issuance of investees’  stock, net                                                  | ** ** | **31**                                |        | (143 | ) |
| Other expense, net                                                                                      | ** ** | **(3,342**                            | **)**       | (1,117 | ) |
| **Non-Operating Income (Loss), Net**                                                                    | ** ** | **(4,040**                            | **)**       | (2,245 | ) |
| Income before provision for income taxes                                                                | ** ** | **98,851**                            |        | 105,697 |   |
| Provision for income taxes (Note 12)                                                                    | ** ** | **(33,881**                           | **)**       | (36,702 | ) |
| TriZetto equity income, net of income taxes  of $(427) and $(141) for 2004 and 2003, respectively       | ** ** | **662**                               |        | 218 |   |
| **Net Income**                                                                                          | ** ** | **$**                                 | **65,632**  |   | $ | 69,213 |   |
|                                                                                                    |       |                                  |        |   |   |
| **Basic Earnings Per Share of Common Stock**                                                            | ** ** | **$**                                 | **0.28**    |   | $ | 0.29 |   |
|                                                                                                    |       |                                  |        |   |   |
| **Diluted Earnings Per Share of Common Stock**                                                          | ** ** | **$**                                 | **0.28**    |   | $ | 0.29 |   |
|                                                                                                    |       |                                  |        |   |   |
| Weighted average number of shares  outstanding – basic                                             | ** ** | **232,981**                           |        | 239,141 |   |
| Dilutive effect of shares issuable as of  period-end under stock option plans                           | ** ** | **4,048**                             |        | 2,593 |   |
| Adjustment of shares outstanding applicable  to exercised and cancelled stock options during the period | ** ** | **118**                               |        | 64 |   |
| **Weighted Average Number of Shares  Outstanding – Diluted**                                       | ** ** | **237,147**                           |        | 241,798 |   |

 

*See accompanying Notes to the CondensedConsolidated Financial Statements (unaudited).*

 

4

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## **IMSHEALTH INCORPORATED**

**CONDENSED CONSOLIDATED STATEMENTS****OF INCOME (Unaudited)**

*(Dollarsand shares in thousands, except per share data)*

* *
| ** **                                                                                              | ** ** | **Nine Months Ended  September 30,** | ** **    |
|---------------------------------------------------------------------------------------------------------|------------|--------------------------------------|---------------|
| ** **                                                                                              | ** ** | **2004**                             | ** **    | **2003** | ** ** |
|                                                                                                    |       |                                 |          |   |   |
| **Operating Revenue**                                                                                   | ** ** | **$**                                | **1,125,330** |   | $ | 997,671 |   |
|                                                                                                    |       |                                 |          |   |   |
| Operating costs                                                                                         | ** ** | **475,405**                          |          | 421,260 |   |
| Selling and administrative expenses                                                                     | ** ** | **280,956**                          |          | 237,773 |   |
| Depreciation and amortization                                                                           | ** ** | **67,378**                           |          | 55,027 |   |
| Severance, impairment and other charges                                                                 | ** ** | **—**                           |          | 37,220 |   |
| **Operating Income**                                                                                    | ** ** | **301,591**                          |          | 246,391 |   |
| Interest income                                                                                         | ** ** | **4,899**                            |          | 3,257 |   |
| Interest expense                                                                                        | ** ** | **(13,184**                          | **)**         | (11,662 | ) |
| Gains from investments, net                                                                             | ** ** | **10,715**                           |          | 1,120 |   |
| Loss on issuance of investees’ stock, net                                                          | ** ** | **(60**                              | **)**         | (404 | ) |
| Other expense, net                                                                                      | ** ** | **(2,169**                           | **)**         | (21,755 | ) |
| **Non-Operating Income (Loss), Net**                                                                    | ** ** | **201**                              |          | (29,444 | ) |
| Income before provision for income taxes                                                                | ** ** | **301,792**                          |          | 216,947 |   |
| Provision for income taxes (Note 12)                                                                    | ** ** | **(89,354**                          | **)**         | (130,514 | ) |
| TriZetto equity loss, net of income taxes  of $393 and $117 for 2004 and 2003, respectively             | ** ** | **(607**                             | **)**         | (181 | ) |
| TriZetto impairment charge, net of income  taxes of $9,565 for 2003                                     | ** ** | **—**                           |          | (14,842 | ) |
| **Income from continuing operations**                                                                   | ** ** | **211,831**                          |          | 71,410 |   |
| Income from discontinued operations, net of  income taxes of $1,237 for 2003 (Note 6)                   | ** ** | **—**                           |          | 2,779 |   |
| Gain on discontinued operations (Note 6)                                                                | ** ** | **—**                           |          | 495,053 |   |
| **Net Income**                                                                                          | ** ** | **$**                                | **211,831**   |   | $ | 569,242 |   |
|                                                                                                    |       |                                 |          |   |   |
| **Basic Earnings Per Share of Common Stock:**                                                           |       |                                 |          |   |   |
| Income from continuing operations                                                                       | ** ** | **$**                                | **0.90**      |   | $ | 0.29 |   |
| Income from discontinued operations                                                                     | ** ** | **—**                           |          | 2.02 |   |
| **Basic Earnings Per Share of Common Stock**                                                            | ** ** | **$**                                | **0.90**      |   | $ | 2.31 |   |
|                                                                                                    |       |                                 |          |   |   |
| **Diluted Earnings Per Share of Common Stock:**                                                         |       |                                 |          |   |   |
| Income from continuing operations                                                                       | ** ** | **$**                                | **0.89**      |   | $ | 0.29 |   |
| Income from discontinued operations                                                                     | ** ** | **—**                           |          | 2.01 |   |
| **Diluted Earnings Per Share of Common Stock**                                                          | ** ** | **$**                                | **0.89**      |   | $ | 2.30 |   |
|                                                                                                    |       |                                 |          |   |   |
| Weighted average number of shares  outstanding – basic                                             | ** ** | **234,369**                          |          | 246,776 |   |
| Dilutive effect of shares issuable as of  period-end under stock option plans                           | ** ** | **4,380**                            |          | 1,058 |   |
| Adjustment of shares outstanding applicable  to exercised and cancelled stock options during the period | ** ** | **464**                              |          | 83 |   |
| **Weighted Average Number of Shares  Outstanding – Diluted**                                       | ** ** | **239,213**                          |          | 247,917 |   |

 

*See accompanying Notes to the CondensedConsolidated Financial Statements (unaudited).*

 

5

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**IMSHEALTH INCORPORATED**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS****(Unaudited)**

*(Dollars and shares in thousands,except per share data)*

 
| ** **                                                                               | ** ** | **Nine Months Ended September 30,** | ** **  |
|------------------------------------------------------------------------------------------|------------|-------------------------------------|-------------|
| ** **                                                                               | ** ** | **2004**                            | ** **  | **2003** | ** ** |
| **Cash Flows from Operating Activities:**                                                |       |                                |        |   |   |
| Net income                                                                               | ** ** | **$**                               | **211,831** |   | $ | 569,242 |   |
| Less income from discontinued operations  and gain on disposal                           | ** ** | **—**                          |        | (497,832 | ) |
| Income from continuing operations                                                        | ** ** | **211,831**                         |        | 71,410 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:       |       |                                |        |   |   |
| Depreciation and amortization                                                            | ** ** | **67,378**                          |        | 55,027 |   |
| Bad debt expense                                                                         | ** ** | **1,000**                           |        | 864 |   |
| Deferred income taxes                                                                    | ** ** | **8,710**                           |        | 10,436 |   |
| Gains from investments, net                                                              | ** ** | **(10,715**                         | **)**       | (1,120 | ) |
| Loss on issuance of investees’ stock, net                                           | ** ** | **60**                              |        | 404 |   |
| TriZetto equity loss, net                                                                | ** ** | **607**                             |        | 181 |   |
| TriZetto impairment charge, net                                                          | ** ** | **—**                          |        | 14,842 |   |
| Minority interests in net income of  consolidated companies                              | ** ** | **4,397**                           |        | 6,189 |   |
| Non-cash stock compensation charges                                                      | ** ** | **2,345**                           |        | 2,303 |   |
| Non-cash portion of severance, impairment and  other charges                             | ** ** | **—**                          |        | 6,576 |   |
| Change in assets and liabilities, excluding  effects from acquisitions and dispositions: |       |                                |        |   |   |
| Net decrease in accounts receivable                                                      | ** ** | **19,207**                          |        | 298 |   |
| Net increase in inventory                                                                | ** ** | **(2,305**                          | **)**       | (377 | ) |
| Net increase in prepaid expenses and other  current assets                               | ** ** | **(15,704**                         | **)**       | (7,380 | ) |
| Net decrease in accounts payable                                                         | ** ** | **(1,769**                          | **)**       | (3,431 | ) |
| Net decrease in accrued and other current  liabilities                                   | ** ** | **(23,855**                         | **)**       | (224 | ) |
| Net (decrease) increase in accrued  severance, impairment and other charges              | ** ** | **(5,252**                          | **)**       | 10,219 |   |
| Net decrease in deferred revenues                                                        | ** ** | **(12,470**                         | **)**       | (10,234 | ) |
| Net increase in accrued income taxes                                                     | ** ** | **19,161**                          |        | 77,722 |   |
| Net decrease in pension assets, net of  liabilities                                      | ** ** | **1,162**                           |        | 435 |   |
| Net decrease in other long-term assets                                                   | ** ** | **2,269**                           |        | 3,061 |   |
| Net tax benefit on stock option exercises                                                | ** ** | **8,424**                           |        | 799 |   |
| Nielsen Media Research payment received in  respect of D&B Legacy Tax Matters        | ** ** | **—**                          |        | 37,025 |   |
| **Net Cash Provided by Operating Activities**                                            | ** ** | **274,481**                         |        | 275,025 |   |
| **Cash Flows Used in Investing Activities:**                                             |       |                                |        |   |   |
| Capital expenditures                                                                     | ** ** | **(14,271**                         | **)**       | (12,948 | ) |
| Additions to computer software                                                           | ** ** | **(58,259**                         | **)**       | (56,743 | ) |
| Investments in short-term marketable  securities                                         | ** ** | **17,867**                          |        | (9,783 | ) |
| Payments for acquisitions of businesses,  net of cash acquired                           | ** ** | **(23,078**                         | **)**       | (52,237 | ) |
| Funding of venture capital investments                                                   | ** ** | **(500**                            | **)**       | (1,200 | ) |
| Other investing activities, net                                                          | ** ** | **3,722**                           |        | 1,296 |   |
| **Net Cash Used in Investing Activities**                                                | ** ** | **(74,519**                         | **)**       | (131,615 | ) |
| **Cash Flows Used in Financing Activities:**                                             |       |                                |        |   |   |
| Net increase (decrease) in debt                                                          | ** ** | **70,801**                          |        | (156,380 | ) |
| Borrowings under private placement                                                       | ** ** | **—**                          |        | 150,000 |   |
| Payments for purchase of treasury stock                                                  | ** ** | **(277,075**                        | **)**       | (97,936 | ) |
| Proceeds from exercise of stock options                                                  | ** ** | **80,923**                          |        | 11,545 |   |
| Dividends paid                                                                           | ** ** | **(14,204**                         | **)**       | (14,575 | ) |
| Proceeds from employee stock purchase plan                                               | ** ** | **1,841**                           |        | 1,382 |   |
| Increase in cash overdrafts                                                              | ** ** | **2,932**                           |        | 1,246 |   |
| Payments to minority interests                                                           | ** ** | **(4,889**                          | **)**       | (6,953 | ) |
| Refund of cash portion of Synavant spin-off  dividend                                    | ** ** | **—**                          |        | 4,863 |   |
| **Net Cash Used in Financing Activities**                                                | ** ** | **(139,671**                        | **)**       | (106,808 | ) |
| Effect of Exchange Rate Changes                                                          | ** ** | **(1,090**                          | **)**       | 6,088 |   |
| **Increase in Cash and Cash Equivalents**                                                | ** ** | **59,201**                          |        | 42,690 |   |
| **Cash and Cash Equivalents, Beginning of  Period**                                      | ** ** | **344,432**                         |        | 264,732 |   |
| **Cash and Cash Equivalents, End of Period**                                             | ** ** | **$**                               | **403,633** |   | $ | 307,422 |   |

 

*See accompanying Notes to the CondensedConsolidated Financial Statements (unaudited).*

 

6

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**IMSHEALTH INCORPORATED**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS****(Unaudited)**

**(Dollarsand shares in thousands, except per share data)**

 

**Note 1.   InterimCondensed Consolidated Financial Statements (unaudited)**

 

The accompanying Condensed Consolidated FinancialStatements (unaudited) have been prepared in accordance with accountingprinciples generally accepted in the United States of America for interimfinancial information and Article 10 of Regulation S-X under the Securities andExchange Act of 1934, as amended.  TheCondensed Consolidated Financial Statements (unaudited) do not include all theinformation and notes required by accounting principles generally accepted inthe United States of America for complete financial statements.  In the opinion of management, alladjustments, all of which are of a normal recurring nature, considerednecessary for a fair presentation of financial position, results of operationsand cash flows for the periods presented have been included.  The results of operations for interim periodsare not necessarily indicative of the results expected for the full year.  The Condensed Consolidated FinancialStatements (unaudited) and related notes should be read in conjunction with theConsolidated Financial Statements and related notes of IMS Health Incorporated(the “Company” or “IMS”) included in its 2003 Annual Report on Form 10-K and inits previous filings on Form 10-Q. Certain prior year amounts have been reclassified to conform to the 2004presentation.  Amounts presented in theCondensed Consolidated Financial Statements (unaudited) may not add due torounding.

 

**Note 2.   Basisof Presentation**

 

TheCompany is a leading global provider of information solutions to thepharmaceutical and healthcare industries. The Company’s revenues are derived primarily from the sale of a broadline of market information, sales management and consulting services to thepharmaceutical and healthcare industries. The Company’s information products are developed to meet client needs byusing data secured from a worldwide network of suppliers in the markets whereoperations exist.  Key informationproducts include:

 

•      Sales Force Effectiveness to optimize salesforce productivity and territory management;

 

•      Portfolio Optimization to provide clientswith insights into market opportunity and business development assessment;

 

•      Brand and Launch Management and Other to supportclient needs relative to market segmentation and positioning and life cyclemanagement for prescription and over-the-counter pharmaceutical products; and

 

•      Consulting and Services that use in-housecapabilities and methodologies to assist pharmaceutical clients in analyzingand evaluating market trends, strategies and tactics, and to help in thedevelopment and implementation of customized software applications and datawarehouse tools.

 

TheCompany operates in more than 100 countries. The Company also owns a venture capital unit, Enterprise Associates, LLC(“Enterprises”), which is focused on investments in emerging businesses, and a25.7% equity interest in The TriZetto Group, Inc. (“TriZetto”), atSeptember 30, 2004.

 

7

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The Company is managed ona global business model with global leaders for the majority of its criticalbusiness processes and accordingly has one reportable segment.

 

Until February 6, 2003,the Company also included the Cognizant Technology Solutions CorporationSegment (“CTS”), which provides custom Information Technology (“IT”) design,development, integration and maintenance services.  CTS is a publicly traded corporation on theNasdaq national market system.  TheCompany owned 55.3% of the common shares outstanding of CTS (92.5% of theoutstanding voting power) as of December 31, 2002, and accounted for CTS as aconsolidated subsidiary.  On February 6,2003, the Company divested CTS through a split-off transaction, and as aresult, the Company’s share of CTS results are presented as discontinuedoperations for 2003 through the date of divestiture (see Note 6).

 

**Note 3.   Summaryof Recent Accounting Pronouncements**

 

In January 2003, theFinancial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidationof Variable Interest Entities, an Interpretation of ARB No. 51,” (“FIN 46”).  FIN 46 requires all Variable InterestEntities (“VIEs”) to be consolidated by the primary beneficiary.  The primary beneficiary is the entity thatholds the majority of the beneficial interests in the VIE.  In addition, FIN 46 expands disclosurerequirements for both VIEs that are consolidated as well as VIEs from which theentity is the holder of a significant amount of the beneficial interest, butnot the majority.  In December 2003, theFASB issued Interpretation 46R, “Consolidation of Variable Interest Entities”(revised December 2003), (“FIN 46R”) which further clarified the provisions ofFIN 46 and delayed the effective date for applying the provisions of FIN 46until the end of the first quarter of 2004 for interests held by publicentities in VIEs or potential VIEs created before February 1, 2003.  The adoption of FIN 46R did not have amaterial impact on the Company’s financial position, results of operations orcash flows for the three and nine months ended September 30, 2004.

 

In December 2003, theFASB issued Statement of Financial Accounting Standards (“SFAS”) No. 132(revised 2003), “Employer’s Disclosures about Pensions and Other PostretirementBenefits,” an amendment of SFAS Nos. 87, “Employers’ Accounting for Pensions”,88, “Employers’ Accounting for Settlements and Curtailments of Defined BenefitPension Plans and for Termination of Benefits,” and 106, *“***Employers’ Accounting for Postretirement BenefitsOther Than Pensions,”** and a revision of SFAS No.132.  SFAS No. 132 (revised 2003)requires additional disclosures about the assets, obligations, cash flows, andnet periodic benefit cost of defined benefit pension plans and otherpostretirement benefit plans, but does not change the measurement orrecognition of such plans.  The newdisclosure requirements contained in SFAS No. 132 (revised 2003) are effectivefor fiscal years ending after December 15, 2003, with a delayed effective datefor certain disclosures, for foreign plans, and for non-public entities.  The Company has adopted all aspects of SFASNo. 132 (revised 2003) for all foreign and non-foreign plans, with theexception of the estimated future benefit payment disclosure.  This requirement was first effective forfiscal years ending after June 15, 2004. Additionally the Company is required to disclose components of the netbenefit cost in the quarterly financial statements beginning with the firstquarter of 2004.  This interim disclosureinformation is included in Note 11.  Theadoption of SFAS No. 132 (revised 2003) did not have a material impact on theCompany’s financial position, results of operations or cash flows for the threeand nine months ended September 30, 2004.

 

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In December 2003, the Medicare Prescription Drug,Improvement and Modernization Act of 2003 (the “Act”) was signed into law inthe U.S.  The Act introduced aprescription drug benefit under Medicare Part D and a federal subsidy tosponsors of retirement health care plans that provide a benefit that is atleast actuarially equivalent to Medicare Part D.  In May 2004, the FASB issued Staff PositionNo. (“FSP”) FAS 106-2, “Accounting and Disclosure Requirements Related to theMedicare Prescription Drug, Improvement and Modernization Act of 2003.”  This statement requires entities to disclosethe effects of the Act and to assess the impact of the subsidy on theaccumulated postretirement benefit obligation and the net periodicpostretirement benefit cost in the first interim period beginning after June15, 2004.  FAS 106-2 was first effectivefor the quarter ended September 30, 2004. The adoption of FAS 106-2 did not have a material effect on the Company’sfinancial position, results of operations or cash flows for the three and ninemonths ended September 30, 2004.

 

**Note 4.   Summaryof Significant Accounting Policies**

 

*Stock-based compensation.*  SFAS No. 123, “Accounting for Stock-BasedCompensation”, as amended by SFAS No. 148, “Accounting for Stock-BasedCompensation – Transition and Disclosure – an amendment of FASB Statement No.123” requires that companies with stock-based compensation plans eitherrecognize compensation expense based on the fair value of options granted orcontinue to apply the existing accounting rules and disclose pro forma netincome and earnings per share assuming the fair value method had beenapplied.  The Company has chosen tocontinue applying Accounting Principles Board (“APB”) Opinion No. 25, andrelated interpretations in accounting for its plans.  If the compensation cost for the Company’sstock-based compensation plans was determined based on the fair value at thegrant dates for awards under those plans, consistent with the method of SFASNo. 123, the Company’s net income and earnings per share would have beenreduced to the pro forma amounts indicated below for the three and nine monthsended September 30:

 
| ** **          | ** **                                                                                                  | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------|-------------------------------------------------------------------------------------------------------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **          | ** **                                                                                                  | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net Income:         | As reported                                                                                                 |                                  | **$**      | **65,632**                           | ** ** | $ | 69,213 |   | **$** | **211,831** | ** ** | $ | 569,242 |   |
|                | Add: Stock-based employee compensation  expense included in reported net income, net of tax                 | ** **                            | **677**    |                                 | 586        | ** ** | **2,334** |   | 1,760 |   |
|                | Deduct: Total stock-based employee  compensation expense under fair value method for all awards, net of tax | ** **                            | **(6,818** | **)**                                | (5,136     | ) | **(19,888** | **)** | (16,011 | ) |
|                | Pro forma                                                                                                   | ** **                            | **$**      | **59,491**                           |       | $ | 64,663 | ** ** | **$** | **194,277** |   | $ | 554,991 |   |
| Earnings Per Share: |                                                                                                        |                                  |       |                                 |       |   |   |   |   |
| Basic:              | As reported                                                                                                 |                                  | **$**      | **0.28**                             | ** ** | $ | 0.29 |   | **$** | **0.90** | ** ** | $ | 2.31 |   |
|                | Pro forma                                                                                                   | ** **                            | **$**      | **0.26**                             |       | $ | 0.27 | ** ** | **$** | **0.83** |   | $ | 2.25 |   |
|                |                                                                                                        |                                  |       |                                 |       |   |   |   |   |   |
| Diluted:            | As reported                                                                                                 |                                  | **$**      | **0.28**                             | ** ** | $ | 0.29 |   | **$** | **0.89** | ** ** | $ | 2.30 |   |
|                | Pro forma                                                                                                   | ** **                            | **$**      | **0.25**                             |       | $ | 0.27 | ** ** | **$** | **0.81** |   | $ | 2.24 |   |

 

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For a description of theCompany’s other critical accounting policies, please refer to the Company’s2003 Annual Report on Form 10-K as filed with the Securities and ExchangeCommission.

 

**Note 5.   Acquisitions**

 

The Company makesacquisitions in order to expand its products, services and geographicreach.  During the nine months endedSeptember 30, 2004, the Company completed five acquisitions for an aggregatecost of $19,757.  The acquisitions were SourceBelgium S.A. (Belgium), H.E.D.M. Bvba (Belgium), SciCon WissenschaftlicheUnternehmensberatung GmbH (Germany), Groupe PR (France) and Institute forMedical Marketing Research (Sweden)****andwere accounted for under the purchase method of accounting.  As such, the aggregate purchase price hasbeen allocated on a preliminary basis to the assets and liabilities acquiredbased on estimated fair values as of the closing date.  The purchase price allocations will befinalized after completion of the valuation of certain assets and liabilities.  Any adjustments resulting from the finalizationof the purchase price allocations are not expected to have a material impact onthe Company’s results of operations.  TheCondensed Consolidated Financial Statements (unaudited) include the results ofthese acquired companies subsequent to the closing of the acquisitions.  Had each of these acquisitions occurred as ofJanuary 1, 2004 or 2003, the impact on the Company’s results of operationswould not have been significant. Goodwill of approximately $11,966 was recorded in connection with theseacquisitions, none of which is deductible for tax purposes.

 

During the nine monthsended September 30, 2003, the Company completed five acquisitions with anaggregate cost of $58,238.  Theseacquisitions were Data Niche Associates, Inc. (U.S.), Azyx Polska GeopharmaInformation Services, Sp.z.o.o. (Poland), Azyx Serviços de GeomarketingFarmacéutico, Ltda. (Portugal), Interpharma Asia Pacific’s healthcareconsulting business (China) and Rx Canada, Inc. (Canada).  These were accounted for under the purchasemethod of accounting.  As such, theaggregate purchase price was allocated on a preliminary basis to the assets andliabilities acquired based on estimated fair values as of the closing date.  The Condensed Consolidated FinancialStatements (unaudited) include the results of these acquired companiessubsequent to the closing of the acquisitions. Had these acquisitions occurred as of January 1, 2003, the impact on theCompany’s results of operations would not have been significant.  Goodwill of approximately $35,926****was recorded in connection with theseacquisitions, of which $26,990****isdeductible for tax purposes.

 

The Company made taxrelated and other acquisition related payments during the nine months endedSeptember 30, 2003.  Accordingly,additional goodwill of $4,509 was recorded. This included a reduction of $3,012 related to the deferred taxliabilities resulting from intangible assets which are not amortizable for taxpurposes.

 

Further, during October2004, the Company completed its sixth acquisition of 2004 for a cost of$23,500, including estimated costs of completing the acquisition.  This acquisition will be accounted for underthe purchase method of accounting and the purchase price will be allocated tothe assets and liabilities acquired based on estimated fair values as of theclosing date.  Had this acquisitionoccurred as of January 1, 2004 or 2003, the impact on the Company’s results ofoperations would not have been significant.

 

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**Note 6.   CTSSplit-Off**

 

On February 6, 2003, theCompany completed an exchange offer to distribute its majority interest inCTS.  The Company exchanged 0.309 sharesof CTS class B common shares for each share of the Company that was tendered.  Under terms of the offer, the Companyaccepted 36,540 IMS common shares tendered in exchange for all 11,291 CTScommon shares that the Companyowned.  As the offer was oversubscribed,the Company accepted tendered IMS shares on a pro-rata basis in proportion tothe number of shares tendered.  Theproration factor was 21.115717%.

 

As a result of thisexchange offer, during the three months ended March 31, 2003, the Companyrecorded a net gain from discontinued operations of $495,053.  This gain was based on the Company’s closing marketprice on February 6, 2003 multiplied by the 36,540 shares of IMS common sharesaccepted in the offer, net of theCompany’s carrying value of CTS and after deducting direct andincremental expenses related to the exchange offer.

 

During the first quarterof 2003, the Company recorded direct and incremental costs related to the CTSSplit-Off of approximately $17,300, consisting primarily of investment advisor,legal and accounting fees.  During thefourth quarter of 2003, the Company reversed $1,834 of expenses as a true up ofactual costs incurred.  This reversalresulted in an increase to the gain from discontinued operations of $1,834.

 

In accordance with theprovisions of SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets,” for the period from January 1, 2003 through the dispositiondate the Company recorded the results of CTS and the gain on disposal as incomefrom discontinued operations net of income taxes in the Condensed ConsolidatedStatements of Income (unaudited).

 

If, contrary toexpectations, the CTS distribution were not to qualify as tax free underSection 355 of the Internal Revenue Code, then, in general, a corporatetax would be payable by the Company based on the difference between (x) the fairmarket value of the CTS class B common stock at the time of the exchange offerand (y) the Company’sadjusted tax basis in such class B common stock.  Pursuant to the distribution agreemententered into between theCompany and CTS in connection with the distribution, CTS agreed to indemnifythe Company in theevent the transaction is taxable as a result of a breach of certainrepresentations made by CTS, subject to certain exceptions.  In the opinion of management and based on theopinion of tax counsel, McDermott, Will & Emery, it is not probable, butmay be reasonably possible, that the Company will incur liability for thismatter and as such the Company has not accrued for this potentialliability.  The Company estimates thatthe aggregate tax liability in this regard would not exceed $215,725.** **

 

**Note 7.   Goodwilland Intangible Assets**

 

During the first ninemonths of 2004, the Company recorded additional goodwill of $17,899 relatedprimarily to the preliminary allocation of purchase price for the fiveacquisitions completed in 2004 (see Note 5) and payments on earn-out agreementson certain acquisitions completed prior to 2004.  As of September 30, 2004, goodwill amountedto $265,377.

 

Allof the Company’s acquired intangibles are subject to amortization.  Intangibleasset amortization expense was $2,970 and $8,703, during the three and ninemonths ended September 30,

 

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2004, respectively.  At September 30,2004, intangible assets were primarily composed of Customer Relationships,Databases and Trade Names (principally included in Other assets) and Computersoftware.  The gross carrying amounts and related accumulated amortizationof these intangibles were $74,987 and $20,580, respectively, at September 30,2004 and $58,752 and $9,975, respectively, at September 30, 2003.  These intangibles are amortized over periodsranging from two to fifteen years with a weighted average life of 7.7years.  The weighted average amortizationperiods of the acquired intangibles by asset class are listed in the followingtable:

 
| **Intangible Asset Type**        | ** ** | **Weighted average  amortization (years) period** | ** ** |
|----------------------------------|------------|---------------------------------------------------|------------|
| Customer Relationships           |       | 8.4                                               |       |
| Computer Software and Algorithms |       | 9.8                                               |       |
| Databases                        |       | 4.9                                               |       |
| Trade Names                      |       | 3.7                                               |       |
| Other                            |       | 4.5                                               |       |
| Weighted average                 |       | 7.7                                               |       |

 

Customerrelationships accounted for the largest portion of the Company’s acquiredintangibles at September 30, 2004.** **In accordance with the principlesof SFAS No. 142, “Goodwill and Other Intangible Assets” and Statement ofFinancial Accounting Concepts No. 7, “**Using Cash Flow Information and Present Value inAccounting Measurements,”** when determining the value ofcustomer relationships for purposes of allocating the purchase price of anacquisition, the Company looks at existing customer contracts of the acquiredbusiness to determine if they represent a reliable future source of income andhence, a valuable intangible asset for the Company.  The Company determines the fair value of thecustomer relationships based on the estimated future benefits the Companyexpects from the acquired customer contracts. In performing its evaluation and estimation of the useful life ofcustomer relationships, the Company looks to the historical growth rate ofoperating revenue of the acquired company’s existing customers as well as thehistorical attrition rates.

 

Based on current estimated useful lives, amortizationexpense associated with intangible assets at September 30, 2004 is estimated tobe approximately $3,000****for thelast quarter of 2004.  Annual amortizationexpense associated with intangible assets is estimated to be as follows:

 

| **Year Ended  December 31,** | ** ** | **Amortization  expense** | ** ** |
|------------------------------|------------|---------------------------|------------|
| 2005                         |       | $                         | 11,602     |   |
| 2006                         |       | 10,260                    |       |
| 2007                         |       | 7,985                     |       |
| 2008                         |       | 5,613                     |       |
| 2009                         |       | 4,598                     |       |
| Thereafter                   |       | $                         | 11,390     |   |

 

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**Note 8.   Investmentsin Equity Investees**

 

The Company’s investmentin TriZetto is accounted for under the equity method of accounting.  The Company’s share of the adjusted operatingresults of TriZetto amounted to a gain of $662 and a loss of $607 for the threeand nine months ended September 30, 2004, respectively (net of incometaxes of $(427) and $393, respectively). The Company’s share of the adjusted operating results of TriZettoamounted to a gain of $218 and a loss of $181 for the three and nine monthsended September 30, 2003, respectively (net of income taxes of $(141) and $117,respectively).

 

The Company performs a periodic assessment in accordance with its policyto determine whether an other-than-temporary decline in fair value hasoccurred.  Based on this assessment, animpairment charge of $14,842, net of taxes of $9,565, was recorded in the firstquarter of 2003, to write down the Company’s investment in TriZetto followingthe continued significant decline in the market value of TriZetto shares belowthe Company’s carrying value.  TheCompany concluded that these declines were other-than-temporary in accordancewith Staff Accounting Bulletin (“SAB”) No. 59, “Views on Accounting forNoncurrent Marketable Equity Securities,” and the impairment charge recordedbrought the Company’s book value in TriZetto down to TriZetto’s March 31, 2003market value.  As of September 30, 2004,the market value of TriZetto exceeded the carrying value by approximately$29,111.

 

**Note 9.   Contingencies**

 

The Company and itssubsidiaries are involved in legal and tax proceedings, claims and litigationarising in the ordinary course of business. Management periodically assesses the Company’s liabilities andcontingencies in connection with these matters based upon the latestinformation available.  For those matterswhere management currently believes it is probable that the Company will incura loss and that the probable loss or range of loss can be reasonably estimated,the Company has recorded reserves in the consolidated financial statementsbased on its best estimates of such loss. In other instances, because of the uncertainties related to either theprobable outcome or the amount or range of loss, management is unable to make areasonable estimate of a liability, if any. However, even in many instances where the Company has recorded areserve, the Company is unable to predict with certainty the final outcome ofthe matter or whether resolution of the matter will materially affect the Company’sresults of operations, financial position or cash flows.  As additional information becomes available,the Company adjusts its assessment and estimates of such liabilitiesaccordingly.

 

The Company routinelyenters into agreements with its suppliers to acquire data and with itscustomers to sell data, all in the normal course of business.  In these agreements, the Company sometimesagrees to indemnify and hold harmless the other party for any damages suchother party may suffer as a result of potential intellectual propertyinfringement and other claims.  Theseindemnities typically have terms of approximately two years.  The Company has not accrued a liability withrespect to these matters, as the exposure is considered remote.

 

Based on its review of thelatest information available, in the opinion of management, the ultimateliability of the Company in connection with pending tax and legal proceedings,claims and litigation will not have a material effect on the Company’s resultsof operations, cash flows or financial position, with the possible exception ofthe matters described below.

 

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*Legacy and Related Matters*

 

In order to understandthe Company’s exposure to the potential liabilities described below, it isimportant to understand the relationship between the Company and itspredecessors and other parties that, through various corporate reorganizationsand contractual commitments, have assumed varying degrees of responsibilitywith respect to such matters.

 

In November 1996, thecompany then known as The Dun & Bradstreet Corporation (“D&B”)separated into three public companies by spinning-off ACNielsen Corporation (“ACNielsen”)and Cognizant Corporation (“Cognizant”) (the “1996 Spin-Off”).  Pursuant to the agreements effecting the 1996Spin-Off, among other things, certain liabilities, including contingentliabilities relating to the IRI Action (defined below) and tax liabilitiesarising out of certain prior business transactions (the “D&B Legacy TaxMatters”), described more fully below, were allocated among D&B, ACNielsenand Cognizant.

 

In June 1998, Cognizantseparated into two public companies by spinning off IMS (the “1998 Spin-Off”)and then changed its name to Nielsen Media Research, Inc. (“NMR”).  As a result of the 1998 Spin-Off, the Companyand NMR are jointly and severally liable for all liabilities of Cognizant underthe agreements effecting the 1996 Spin-Off. As between themselves, however, the Company and NMR agreed that IMS willassume 75%, and NMR will assume 25%, of any payments to be made in respect ofthe IRI Action, including any legal fees and expenses related thereto incurredin 1999 or thereafter (IMS agreed to be responsible for legal fees and expensesincurred during 1998).  In addition, theCompany and NMR agreed they would share equally Cognizant’s share of liabilityarising out of the D&B Legacy Tax Matters after the Company paid the first$130,000 of such liability.  NMR’saggregate liability for payments in respect of the IRI Action and the D&BLegacy Tax Matters shall not exceed $125,000.

 

Also during 1998, D&Bseparated into two public companies by spinning-off The Dun & BradstreetCorporation (“D&B I”) and then changed its name to R.H. Donnelley (“Donnelley”).  As a result of their separation in 1998,Donnelley and D&B I are each jointly and severally liable for allliabilities of D&B under the agreements effecting the 1996 Spin-Off.

 

During 2000, D&B Iseparated into two public companies by spinning off The Dun & BradstreetCorporation (“D&B II”) and then changed its name to Moody’s Corporation (“Moody’s).  Pursuant to their separation in 2000, Moody’sand D&B II are each jointly and severally liable for all of D&B’sliabilities under the agreements effecting the 1996 Spin-Off.

 

*IRI Litigation. *The followingis a description of an antitrust lawsuit filed in 1996 by InformationResources, Inc. (“IRI”).  As more fullydescribed below, VNU N.V., a publicly traded Dutch company (“VNU”), and itsU.S. subsidiaries VNU, Inc., ACNielsen, AC Nielsen (US), Inc. (“ACN (US)”), andNMR (collectively, the “VNU Parties”), have assumed exclusive joint and severalliability for any judgment or settlement of this antitrust lawsuit.  As a result of the indemnity obligation, theCompany does not have any exposure to a judgment or settlement of this lawsuitunless the VNU Parties default on their obligations.  In the event of such default, the Companycould be liable as a successor to one of the named parties in the IRI Action(as defined below).

 

InJuly 1996, IRI filed a complaint, subsequently amended in 1997, in the U.S.District Court for the Southern District of New York, naming as defendants acompany then known as The Dun & Bradstreet Corporation and now known asDonnelley, A.C. Nielsen Company (a subsidiary of

 

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ACNielsen) and I.M.S. International, Inc. (apredecessor of the Company) (the “IRI Action”). At the time of the filing of the complaint, each of the other defendantswas a wholly-owned subsidiary of Donnelley. The amended complaint alleges various violations of U.S. antitrust lawsunder Sections 1 and 2 of the Sherman Antitrust Act.  The amended complaint also alleges a claim oftortious interference with a contract and a claim of tortious interference witha prospective business relationship. These claims relate to the acquisition by defendants of Survey ResearchGroup Limited (“SRG”).  IRI alleged SRGviolated an alleged agreement with IRI when it agreed to be acquired by defendantsand that defendants induced SRG to breach that agreement.

 

IRI’santitrust claims allege that defendants developed and implemented a plan toundermine IRI’s ability to compete within the United States and foreign marketsin North America, Latin America, Asia, Europe and Australia/New Zealand througha series of anti-competitive practices, including: unlawfully tying/bundlingservices in the markets in which defendants allegedly had monopoly power withservices in markets in which ACNielsen competed with IRI; entering intoexclusionary contracts with retailers in certain countries to deny IRI’s accessto sales data necessary to provide retail tracking services or to artificiallyraise the cost of that data; predatory pricing; acquiring foreign market competitorswith the intent of impeding IRI’s efforts to expand; disparaging IRI tofinancial analysts and clients; and denying IRI access to capital necessary forit to compete.

 

IRI’samended complaint originally alleged damages in excess of $350,000, which IRIasked to be trebled under antitrust laws. IRI has since revised its allegation of damages to exceed $650,000,which IRI also asked to be trebled.  IRIhas filed with the court the report of its expert who has opined that IRIsuffered damages of between $581,600 and $651,700 from the defendants’ allegedpractices.  IRI also sought punitivedamages in an unspecified amount.

 

InApril 2003, the Court denied a motion for partial summary judgment bydefendants that sought to dismiss certain of IRI’s claims and granted in part amotion by IRI seeking reconsideration of certain summary judgment rulings theCourt had previously made in favor of defendants.  The motion granted by the Court concerns IRI’sclaims of injuries from defendants’ alleged conduct in certain foreign markets.

 

Pursuantto a scheduling order entered by the Court on April 8, 2004, discovery isscheduled to end on November 1, 2004, and trial is scheduled to begin April 18,2005.

 

OnJune 21, 2004, pursuant to a stipulation between IRI and defendants, the Courtordered that certain of IRI’s claims be dismissed with prejudice from thelawsuit, including the claim for tortious interference with the SRGacquisition.  ACNielsen has advised theCompany that based on discussions with its counsel ACNielsen believes that thedismissal of the tortious interference claims also precludes any claim forpunitive damages.

 

Inconnection with the 1996 Spin-Off, D&B (now Donnelley), Cognizant (now NMR)and ACNielsen entered into an Indemnity and Joint Defense Agreement (the “OriginalJDA”), pursuant to which they agreed to:

 

•                  allocate potential liabilities that mayrelate to, arise out of or result from the IRI Action (“IRI Liabilities”); and

 

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•                  conduct a joint defense of such action.

 

Inparticular, the Original JDA provided that:

 

•                  ACNielsen would assume exclusive liabilityfor IRI Liabilities up to a maximum amount to be calculated at such time assuch liabilities became payable as a result of a final non-appealable judgmentor any settlement permitted under the Original JDA (the “ACN Maximum Amount”);and

 

•                  D&B and Cognizant would share liabilityequally for any amounts in excess of the ACN Maximum Amount.

 

The Original JDA alsoprovided that if it became necessary to post any bond pending an appeal of anadverse judgment, then Cognizant and D&B would be required to obtain thebond required for the appeal, and each shall pay 50% of the costs of such bond,if any, which cost will be added to IRI Liabilities.

 

In2001, ACNielsen was acquired by VNU N.V., a publicly traded Dutch company (“VNU”).  VNU assumed ACNielsen’s obligations under theOriginal JDA, and pursuant to the Original JDA VNU was to be included withACNielsen for purposes of determining the ACN Maximum Amount.

 

OnJuly 30, 2004, the VNU Parties, Donnelley, D&B II, Moody’s and the Companyentered into an Amended and Restated Indemnity and Joint Defense Agreement (the“Amended JDA”).  Pursuant to the AmendedJDA, any and all IRI Liabilities incurred by Donnelley, D&B II, Moody’s orIMS relating to a judgment (even if not final) or any settlement being enteredinto in the IRI Action will be jointly and severally assumed and fullydischarged exclusively by the VNU Parties. Under the Amended JDA, the VNU Parties have agreed to, jointly andseverally, indemnify Donnelley, D&B II, Moody’s and IMS from and againstall IRI Liabilities to which they become subject.  As a result, the concept of the “ACN MaximumAmount,” which previously represented a cap on VNU’s liability for the IRILiabilities, no longer exists and all such liabilities are the responsibilityof the VNU Parties pursuant to the Amended JDA.

 

Inaddition, the Amended JDA provides that if it becomes necessary to post anybond pending an appeal of an adverse judgment, then the VNU Parties shallobtain the bond required for the appeal and shall pay the full cost of suchbond.

 

Inconnection with entering into the Amended JDA, Donnelley, D&B II, Moody’sand IMS agreed to amend certain covenants of the Original JDA to provideoperational flexibility for ACNielsen going forward.  In addition, the Amended JDA includes certainamendments to the covenants of ACNielsen (which, under the Amended JDA, are nowalso applicable to ACN (US), which we understand holds ACNielsen’s operatingassets) that are designed to preserve such parties’ claim-paying ability andprotect Donnelley, D&B II, Moody’s and IMS. Among other covenants, ACNielsen and ACN (US) agreed that neither theynor any of their respective subsidiaries will incur any indebtedness to anyaffiliated person, except indebtedness the payment of which will, after apayment obligation under the Amended JDA comes due, be conditioned on, andsubordinated to, the

 

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payment and performance of the obligations ofsuch parties under the Amended JDA.  VNUhas agreed to having a process agent in New York to receive on its behalfservice of any process concerning the Amended JDA.

 

Asdescribed above, the VNU Parties have assumed exclusive responsibility for thepayment of all IRI Liabilities.  Providedthat the VNU Parties are able to fulfill their obligations under the AmendedJDA, and that they ultimately do fulfill such obligations, the Company believesthat the resolution of the IRI Action should not have a material adverse effecton the Company’s financial position, results of operations or cash flows.  However, because liability for violations ofthe antitrust laws is joint and several and because the rights and obligationsrelating to the Amended JDA are based on contractual relationships, the failureof the VNU Parties to fulfill their obligations under the Amended JDA couldresult in the other parties bearing all or a share of the IRI Liabilities.  Joint and several liability for the IRIAction means that even where more than one defendant is determined to have beenresponsible for an alleged wrongdoing, the plaintiff can collect all or part ofthe judgment from just one of the defendants. This is true regardless of whatever contractual allocation ofresponsibility the defendants and any other indemnifying parties may have made,including the allocations described above between the VNU Parties, Donnelly,D&B II, Moody’s and IMS.

 

Accordingly,and as a result of the allocations of liability described above, in the eventthe VNU Parties default on their obligations under the Amended JDA, the Companywill be responsible for 75% of Cognizant’s share of any liabilities arising outof the IRI Action (which, under the application of joint and several liabilitydescribed above, could be all the IRI Liabilities since the Company is asuccessor to a named defendant) and NMR will be responsible for 25% of any suchliabilities; provided that NMR’s aggregate liability for payments in respect ofthe IRI Action and the D&B Legacy Tax Matters shall not exceed$125,000.  To date, NMR has made paymentsof approximately $41,000 relating to the D&B Legacy Tax Matters.  Further, if the VNU Parties default on theirobligations, NMR, one of the VNU Parties, may default on its obligation toshare any IRI Liabilities with the Company, or at the time the IRI Liabilitiesarise may have previously made sharing payments up to its $125,000 cap.  In either such event, the Company could be liablefor an amount up to all the IRI Liabilities.

 

TheCompany is unable to predict the outcome of the IRI Action, the financialcondition of any of the VNU Parties or the other defendants at the time of anysuch outcome or whether the VNU Parties or the other defendants will fulfilltheir obligations under the Amended JDA or other related contractualagreements.  Hence, the Company cannotestimate such parties’ ability to pay the IRI Liabilities pursuant to theAmended JDA or the amount of the judgment or settlement in the IRI Action.  Nonetheless,management presently believes that the risk that the Company will incur anymaterial liabilities with respect to the IRI Action is remote and, therefore no liability in respect of this matter has beenaccrued in the Company’s financial statements.  As discussed above, provided that the VNUParties ultimately fulfill their obligations under the Amended JDA, the Companybelieves that the resolution of the IRI Action should not have a materialadverse effect on the Company’s financial position, results of operations orcash flows.  If, however, IRI were toprevail in whole or in part in this action and if the Company is required topay a substantial portion of any significant settlement or judgment, theoutcome of this matter could have a material adverse effect on the Company’sfinancial position, results of operations and cash flows.

 

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*D&BLegacy and Related Tax Matters. *Duringthe second quarter of 2003, the IRS issued an agent’s final examination reportseeking to disallow certain royalty expense deductions claimed by D&B onits 1995 and 1996 tax returns in connection with a partnership established in1993.  In January of 2004, the IRS issuedan agent’s final examination report to the partnership seeking to reallocatecertain items of partnership income and expense as well as disallow certainitems of partnership expense on the partnership’s 1997 tax return during whichyear Cognizant was a partner in the partnership.  In January 2004, the IRS issued agent’s finalexamination reports to the partnership and the Company seeking to reverse itemsof partnership income and loss and disallow certain royalty expense deductionsclaimed by the Company on its 1998 and 1999 tax returns arising from theCompany’s participation in the partnership. If the IRS were to ultimately prevail in the foregoing positions, theCompany’s share of the total liability for 1995 and 1996 would be approximately$37,300, its liability for 1997 would be approximately $18,100, and itsaggregate liability for 1998 and 1999 would be approximately $27,400 (all netof income tax benefit).  If the IRS wereto take a comparable position with respect to all of the Company’s tax yearssubsequent to 1999 and ultimately prevail, the Company’s additional liabilitywould be approximately $44,000 (net of income tax benefit).

 

In addition, in thesecond quarter of 2003, the IRS issued an additional agent’s finalexamination report to the partnership described above seeking to reallocatecertain partnership income to D&B for 1996. D&B II and the Company believe that the positions taken by the IRSin this report are inconsistent with the IRS’s denial of the royalty expensedeductions described above.  If the IRSwere to ultimately prevail in this matter, the Company’s share of the liabilityfor 1996 would be approximately an additional $21,200 (net of income taxbenefit).

 

In addition, the IRS hasasserted penalties for the years described above based on its interpretation ofapplicable law.  If the IRS were toprevail in its assertion of penalties and interest thereon, the Companyestimates that its liability for such penalties and interest would beapproximately $7,900 for 1995 and 1996 and $8,800 for 1997 through 1999 (allnet of income tax benefit).  D&B IIand the Company dispute the IRS’s position.

 

D&B II, as agent forDonnelley in the D&B Legacy Tax Matters, has filed protests relating to theproposed assessments for 1995 and 1996 with the IRS Office of Appeals.  D&B II advised that it will attempt toresolve these matters in the administrative appeals process before proceedingto litigation if necessary.  During thefirst quarter of 2004, as a result of information from D&B II regarding aproposed mediation with the IRS to settle partnership items related to 1995 and1996, the Company reclassified its tax reserves related to 1995 and 1996 fromlong-term (Other liabilities) to short-term (Accrued income taxes).  In addition, the Company has filed protestsrelating to the proposed assessments for 1997, 1998 and 1999 with the IRSOffice of Appeals and will attempt to resolve these matters in theadministrative appeals process before proceeding to litigation if necessary.

 

In June 2004, the Companywas advised that D&B II believed that it had reached a basis for settlementwith the IRS regarding the 1995 and 1996 corporate and partnership proposedassessments (the “Preliminary Settlement Terms”).  The agreement to the Preliminary SettlementTerms was tentative and non-binding. Under the Preliminary Settlement Terms, the “inconsistent positions”described above were eliminated and the Company’s expected share of theliability was estimated to

 

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range from approximately $28,500 to $35,500 (tax,penalty and interest, net of associated tax benefits).

 

In September 2004,D&B II advised the Company that the IRS had withdrawn its agreement to thePreliminary Settlement Terms.  D&B IIcontinued to negotiate with the IRS and subsequently developed a revisedproposed settlement (the “Revised Proposed Settlement”).  In October, Donnelley and D&B IIpresented the Revised Proposed Settlement to NMR and IMS and requested theirconsent.

 

Under the 1996 Spin-Offagreements, to the extent relevant here, Donnelley has the right and obligationto manage certain tax controversies with the IRS to the extent thosecontroversies relate to tax liabilities for Donnelley’s tax years 1995 and 1996arising from a specified partnership organized by Donnelley prior to the 1996Spin-Off (the “DLA Matter”).  Donnelleyhas apparently assigned this right and obligation to D&B II.  However, under the 1996 Spin-Off agreements,Donnelley cannot agree to any final settlement with respect to the DLA Matterwithout NMR’s consent, which right of consent NMR shares with IMS pursuant tothe terms of the 1998 Spin-Off agreements. If NMR and the Company withhold consent, then NMR and the Company wouldhave the right and obligation to assume responsibility for management of theDLA Matter and indemnify Donnelley to the extent that the ultimate liabilityarising from the controversy exceeded the proposed settlement.  Such excess liability could approximate$46,000.

 

On October 28, 2004, theCompany responded to Donnelley’s and D&B II’s request for consent to theRevised Proposed Settlement by consenting to the settlement of tax liabilitieswith respect to the DLA Matter.  However,the Revised Proposed Settlement addressed matters beyond the DLA Matter andthese matters would have an adverse impact on the Company for tax yearssubsequent to the 1996 Spin-Off and with respect to which the Company believesneither Donnelley nor D&B II has the authority to negotiate or propose asettlement.  The Company advisedDonnelley that, to the extent the revised proposed settlement addressed issuesbeyond the DLA Matter, the negotiation and presentation of the Revised ProposedSettlement constituted a breach of the 1996 Spin-Off agreements.

 

On October 29, 2004,Donnelley advised NMR and the Company that it is treating the Company’sposition as a withholding of consent, and that therefore under the 1996Spin-Off agreements, NMR and the Company are obligated to assume management ofthe controversy and to indemnify Donnelley to the extent any ultimateresolution of the controversy is less favorable to Donnelley than thatcontained in the Revised Proposed Settlement. The Company does not agree with Donnelley’s assertions and believes thatDonnelley has breached and continues to breach the terms of the 1996 Spin-Offagreements by negotiating and requesting consent for matters beyond itsauthority.  If the parties cannot resolvethis disagreement as provided in the dispute resolution provisions of the 1996Spin-Off agreements, the Company will pursue legal action to remedy Donnelley’sbreach and believes that it will prevail.

 

On November 1, 2004,D&B II contacted the IRS to ask whether it would be willing to modify theRevised Proposed Settlement to delete certain matters beyond the DLA Matter.  On November 3, 2004, the IRS responded thatit was unwilling to modify the Revised Proposed Settlement and would pursuecollection of the disputed tax through applicable enforcement procedures.

 

In another D&B LegacyTax Matter, in June 2000, the IRS completed its review of Donnelley’sutilization of certain capital losses generated during 1989 and 1990 and issueda formal notice of adjustment. D&B I, as agent for Donnelley, advised theCompany that on May 12, 2000, it filed an amended tax return for the 1989and 1990 tax periods, which reflected $561,582 of additional tax andinterest due.  D&B I paid the IRS$349,291 of this amount on May 12, 2000, and the Company paid the IRS$212,291 on May 17, 2000.  D&B Iadvised the Company that,

 

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notwithstanding thefiling and payment, it intended to contest the assessment and would alsocontest the assessment of amounts, if any, in excess of the amounts paid.  D&B I filed the complaint for a refund inthe U.S. District Court on September 21, 2000.  In June 2004, D&B II advised the Companythat it has decided not to pursue the refund claim and believes it has reacheda basis for settlement with the IRS.  Theagreement is tentative and non-binding until a definitive settlement agreementis executed.  The pending settlementrequires Donnelley to withdraw its complaint for a refund.  The Company expects that its share of anyliability in excess of the amount already paid could range from approximately$5,800 to $11,900 (penalty and interest, net of associated tax benefits), andthat any such payment could be made in 2004.

 

During the first quarterof 2003, the Company increased its reserve to its anticipated share of theprobable liability in connection with all of the foregoing tax matters.  As of September 30, 2004, the Company hadreserves for these tax matters of approximately $136,400.  In the opinion of management, it is notprobable, but may be reasonably possible that the Company will have additionalliability of $16,700 in excess of the amount reserved for these mattersattributable to potential penalties (and net interest thereon) for the years1995 through 1999.  In the opinion ofmanagement, the Company’s reserves for the foregoing tax matters are adequate forthe probable exposure and, accordingly, based on information currentlyavailable, management does not believe that these matters will have a materialadverse effect on the Company’s consolidated financial position or results ofoperations but may have a material adverse effect on cash flows in the periodin which any such amounts are paid.

 

In addition to thesematters, the Company and its predecessors have entered, and the Companycontinues to enter, into global tax planning initiatives in the normal courseof their businesses.  These activitiesare subject to review by applicable tax authorities.  As a result of the review process,uncertainties exist and it is possible that some of these matters could beresolved adversely to the Company.

 

*Sharing Dispute. *In May 2000,the Company paid $212,291 to the IRS in connection with a D&B Legacy TaxMatter.  Pursuant to the terms of the1998 Spin-Off, NMR was liable for a portion of this amount but was notobligated to pay the Company for its share until January 2, 2001.  In December 2000, the Company requestedreimbursement from NMR in the amount of $41,136, which represented NMR’s shareof the liability according to the Company’s calculations.  On January 2, 2001, NMR made a paymentof $10,530 but refused to pay the remaining $30,606 based on its interpretationof the applicable agreements.  At March31, 2003, the Company had a receivable of $36,805, which included theoutstanding principal and accumulated accrued interest of $6,199.  These amounts were reflected in Otherreceivable in the Condensed Consolidated Statements of Financial Position(unaudited).  On April 29, 2003, a panelfrom the American Arbitration Association International Center for DisputeResolution issued an award in favor of the Company and ordered that NMR pay theCompany the entire principal balance plus 9% simple interest from January 2,2001, together with all legal fees and costs incurred by the Company inconnection with the arbitration.  On April30, 2003, the Company received $37,025 from NMR in satisfaction of theprincipal amount plus interest from January 2, 2001 through April 30,2003.  On May 16, 2003, the Companyreceived an additional $1,332 from NMR as reimbursement of the Company’s legalfees and costs in connection with the arbitration.

 

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*Matters Before the EuropeanCommission and Belgian Competition Service*

 

In December 2000,National Data Corporation (now NDCHealth Corporation, “NDC”) filed a complaintagainst the Company with the European Commission (the “Commission”), requestingthat the Commission initiate a proceeding against the Company for an allegedinfringement of Article 82 of the EC Treaty.  Article 82 of the EC Treaty relates toabuses of a dominant position that adversely affect competition.  The complaint concerned an IMS geographicmapping structure used for the reporting of regional sales data in Germany,which the German courts have ruled is copyright protected.  In addition to seeking a formal Commissionproceeding against the Company, the complaint requested that the Commissiongrant interim relief requiring the Company to grant NDC a compulsory license toenable NDC to use this structure in its competing regional sales data servicein Germany.

 

In March 2001, theCommission initiated formal proceedings against the Company in this matter andin July 2001, the Commission ordered interim measures against the Companypending a final decision (the “Interim Decision”).  Under the Interim Decision, the Company was orderedto grant a license of the geographic mapping structure on commerciallyreasonable terms without delay to NDC and to any other competitor then presentin the German regional sales data market that requested a license.

 

In August 2001, theCompany filed an appeal with the Court of First Instance (“CFI”) seeking thesuspension and annulment of the Interim Decision in its entirety (the “AnnulmentAppeal”).  In October 2001, the Presidentof the CFI suspended the Interim Decision pending a judgment on the AnnulmentAppeal.  In April 2002, the EuropeanCourt of Justice (“ECJ”) denied an appeal by NDC attempting to overturn the CFI’sOctober 2001 suspension.

 

In October 2002, the CFIpostponed further consideration of the Annulment Appeal until after the ECJdecided certain questions separately referred to it by a German court that ispresiding over certain litigation that the Company is maintaining against NDCin Germany.  In the German litigation,the Company is seeking an injunction and damages against NDC formisappropriation of the Company’s intellectual property rights (the “InfringementClaim”).

 

In August 2003, theCommission withdrew its Interim Decision and then subsequently (in October2003), the Commission applied to the CFI to have the Annulment Appeal declaredmoot in its entirety.  Most recently, inApril 2004, the ECJ rendered its decision in the case referred to it by theGerman court.  This will permit the CFIto move forward with its consideration of the Annulment Appeal and the Germancourt to move forward with its consideration of the Infringement Claim againstNDC.

 

The Company intends tocontinue to vigorously assert that its refusal to grant licenses for the use ofits copyright protected geographic mapping structure to its direct competitorsin Germany, which compete in the same market for which the copyright exists, isnot in contravention of Article 82 of the EC Treaty.  Management of the Company is unable topredict at this time the final outcome of this matter or whether the resolutionof this matter could materially affect the Company’s future results ofoperations, cash flows or financial position.

 

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Complaints were filed in1998 and 1999 against the Company with the Belgian Competition Service (“BCS”)by SmithKline Beecham Pharma S.A. (“SKB”) and Source Informatics Belgium S.A. (“Source”)alleging abuse of a dominant position on the Belgian market and requests weremade for the adoption of interim measures pending consideration of thecomplaints.  In October 1999 and 2000,the Chairman of the BCS adopted interim measures against the Company, withwhich the Company has complied.  In April2004, the Company acquired Source and in June 2004 the BCS sent informationrequests to the Company, Source and the successor to SKB.  The Company and Source have responded to therequests.  In October 2004, the BCSnotified IMS of its intention to investigate IMS’s acquisition of Source as apotential abuse of a dominant position in violation of Belgian and Europeanlaw.  The Company will vigorously contestany adverse determination (including the assertion of penalties) by theBCS.  Management of the Company is unableto predict at this time the final outcome of this matter or whether an adverseresolution thereof could materially affect the Company’s results of operations,cash flows or financial position in the period in which such adverse resolutionoccurs.

 

*Other Contingencies*

 

*ContingentConsideration.*  Underthe terms of the purchase agreements related to acquisitions made from 2001 to2004, the Company may be required to pay additional amounts as contingentconsideration based on the achievement of certain targets during 2003 to2007.  Substantially all of anyadditional payments will be recorded as goodwill in accordance with EITF No.95-8, “Accounting for Contingent Consideration Paid to the Shareholders of anAcquired Enterprise in a Purchase Business Combination.”  As of September 30, 2004, approximately$3,000 was earned and paid under these contingencies.  Based on current estimates, managementexpects the remaining additional contingent payments under these agreements tototal approximately $23,000.  It isexpected that these contingent payments will be resolved within a specifiedtime period after the end of each respective calendar year from 2004 through2007.

 

*SynavantSpin-Off. *In August2000, the Company spun off Synavant, Inc. Pursuant to the terms of that spin-off, Synavant undertook to be jointlyand severally liable to the other parties to the 1996 Spin-Off for any futureliabilities of Cognizant under the terms of that spin-off and to NMR for anyfuture liabilities of the Company under the 1998 Spin-Off.  However, as between the Company and Synavant,each agreed to bear 50% of the Company’s share of any future liability arisingout of the IRI Action or the D&B Legacy Tax Matters (net of the liabilityborne by NMR), up to a maximum liability of $9,000 for Synavant.  In connection with the acquisition ofSynavant by Dendrite International, Inc., on June 16, 2003, Synavant satisfiedits current and future liabilities to the Company in respect of the IRI Actionand the D&B Legacy Tax Matters by paying $8,345 to the Company of whichapproximately $4,900 represented an adjustment to the Synavant Spin dividend,approximately $2,200 represented the reimbursement of previously expensed legalfees and approximately $1,100 was a prepayment of Synavant’s future 50% shareof legal fees associated with the IRI Action.

 

If, contrary toexpectations, the spin-off of Synavant were not to qualify as tax free underSection 355 of the Internal Revenue Code, then, in general, a corporatetax would be payable by the consolidated group, of which the Company is acommon parent and Synavant is a member, based on the difference between(x) the fair market value of the Synavant common stock on the date of the

 

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spin-off and (y) the adjusted basis of suchSynavant common stock.  In addition,under the consolidated return rules, each member of the consolidated groupwould be severally liable for such tax liability.  Pursuant to the terms of the spin-off, theCompany would be liable for the resulting corporate tax, except in certaincircumstances.  In the opinion of managementand based on the opinion of tax counsel, McDermott, Will & Emery, it is notprobable, but may be reasonably possible, that the Company will incur liabilityfor this matter, therefore, the Company has not recorded reserves for thismatter.  The Company estimates that theaggregate tax liability in this regard would not exceed $100,000.

 

*CTSSplit-Off.*  The Companycompleted the CTS Split-Off exchange offer on February 6, 2003 (see Note6).  If, contrary to expectations, theCTS distribution were not to qualify as tax free under Section 355 of theInternal Revenue Code, then, in general, a corporate tax would be payable by the Company based on thedifference between (x) the fair market value of the CTS class B commonstock at the time of the exchange offer and (y) the Company’s adjusted tax basis in suchclass B common stock.  Pursuant to thedistribution agreement entered into between the Company and CTS in connection with the distribution, CTSagreed to indemnify theCompany in the event the transaction is taxable as a result of a breachof certain representations made by CTS, subject to certain exceptions.  In the opinion of management and based on theopinion of tax counsel, McDermott, Will & Emery, it is not probable, butmay be reasonably possible, that the Companywill incur liability for this matter, therefore, the Company has notrecorded reserves for this matter.  The Company estimates that the aggregate taxliability in this regard would not exceed $215,725.

 

*Other Tax Contingencies.*The Company has reservedapproximately $22,000 of income tax benefits related to a 1998 non-U.S. taxreorganization that gave rise to tax deductible amortization of non-U.S.intangible assets.  This represents theCompany’s best estimate of the probable liability in the event the relevant taxauthorities challenge such tax benefits. Accordingly, based on information currently available, management doesnot believe that this matter will have a material adverse effect on the Company’sconsolidated financial position or results of operations but may have amaterial adverse effect on cash flows in the period in which any such amountsare paid.

 

Inaddition to the tax items discussed above, the Company has tax reserves ofapproximately $27,500 that relate to various positions it has taken on taxreturns filed in numerous countries over the last several years.  These reserves represent the Company’s bestestimate of the probable liability should the tax return positions bechallenged by the relevant tax authorities. While the amount is material in the aggregate, no individual item ismaterial and no single event will have a material impact related to thesereserves.

 

*Other Litigation. *On January 17, 2003, the Company was served with a summons in a litigation matter (the “DouglasLitigation”).  Also named as defendantsin this litigation were approximately 60 software vendors from which the Company purchasedprescription data in the 1990’s (and, for many of these vendors, from which the Company continues topurchase data).  In this action, it wasalleged the Companymisappropriated the trade secrets (i.e., prescription data) of thousands ofpharmacies in the United States and used this information either withoutauthorization or outside the scope of any authorization.  This same conduct was alleged to breachcontracts between the Companyand the software vendors from which the Company had purchased this prescription data.

 

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The action was brought instate court in southern Illinois (Circuit Court of the 20th JudicialCircuit) by two pharmacies.  Plaintiffssought class action status, representing all pharmacies whose data was sold tothe Company by their pharmacy dispensary software vendors from 1990 to thepresent.  The pharmacies were seeking$100,000 in actual damages plus an unspecified amount of unjust enrichmentdamages (i.e., share of the Company profits) derived from use of theprescription data by the Company and the other defendants, or, in thealternative, a reasonable royalty paid for the use of the prescriptiondata.  However, the Company believed andcontinues to believe that its practices with respect to the acquisition and useof this prescription data are consistent with applicable law and industrypractices, and that the claims were without merit.

 

TheCompany was a defendant in another litigation brought in state court insouthern Illinois (Circuit Court of the 20th Judicial Circuit) (the “MayberryLitigation”).  This lawsuit wasoriginally brought in 1994 against Mayberry Systems, a small developer ofpharmacy dispensary software in the Midwest. Two pharmacy customers alleged Mayberry Systems was taking prescriptiondata from their systems without authorization, and selling it to others(including the Company).  The Company wassubsequently added to the lawsuit in 1996, alleging that the Company knew orshould have known that Mayberry Systems was taking the data and selling itwithout authorization (i.e., misappropriation of trade secrets).  The lawsuit was later certified as a classaction on behalf of all former and current customers of Mayberry Systems(approximately 350 pharmacies). Plaintiffs were demanding damages in the amount of $20,000 plus punitivedamages and attorney’s fees.

 

Although the Company believedthat the two actions described above were without merit, the Company pursued ajoint settlement of the cases.  Duringthe third quarter of 2003, the Company proposed a preliminary settlementagreement with the plaintiffs’ counsel on both the actions which was subject toseveral significant contingencies.  OnFebruary 17, 2004, the Illinois state court approved the proposedsettlement.  The period for the filing ofappeals and motions for rehearing expired on March 18, 2004.  As a result of the resolution of thesignificant contingencies related to the settlement, in the fourth quarter of2003, the Company recorded a pre-tax charge of $10,636, net of $5,500 to bereimbursed under the Company’s insurance coverage.  Under the settlement, the Company will makecertain cash payments, provide certain product credits and enter into certainagreements for the purchase of data originating from the independent pharmacyplaintiffs.  This will provide theCompany the opportunity to acquire new data for new offerings while eliminatingthe costs and risks of litigation. During the first nine months of 2004, the Company paid approximately$8,000 related to this settlement and received $5,500 from insurance coverage.

 

During the second quarterof 2003 and up to the date of this filing, the Company has been served with 66complaints filed with the Labor Court in Frankfurt, Germany.  The plaintiffs are part of a group ofapproximately 110 employees of GIC Global Information Technology and ConsultingGmbH (“GIC Global”) whose employment was terminated in the second quarter of2003 in connection with GIC Global’s insolvency proceedings.  GIC Global is owned by former senior managersof what was once the Company’s data processing center in Frankfurt,Germany.  GIC Global purchased the assetsand business of the Frankfurt data processing center from the Company inSeptember 2000 as part of a management buyout. Thereafter, the Company moved its data processing to its data center inthe United States.  The plaintiffs areseeking reemployment and/or severance from the Company.

 

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As of the date of thisfiling, a total of 25 of the complaints described above were dismissed by theLabor Court and two complaints were voluntarily withdrawn.  Five of the dismissal actions have beenappealed by the respective plaintiffs, one of which was voluntarily withdrawn,and proceedings with respect to the other four appeals remain pending.  On April 13, 2004 and May 11, 2004, judgmentson two of the complaints were rendered against the Company in the aggregateamount of approximately $240, which judgments the Company intends toappeal.  Actions on four additionalcomplaints remain pending.

 

Although the Companycontinues to believe that these claims are without merit and intends tovigorously defend the remaining actions, on April 13, 2004, the Company enteredinto settlements with 54 (which settlement superceded 18 of the 25 dismissalsdescribed above) of the GIC plaintiffs in the aggregate amount of approximately$200 in order to avoid the potential future costs of numerous appeals.  During the third quarter, the Company settledtwo additional claims for approximately $19. The Company has expensed approximately $460 with respect to thesesettlements and the two judgments which the Company intends to appeal, but hasnot accrued a liability with respect to the four remaining actions, becausemanagement currently believes that the Company’s exposure to any material losswith respect to those remaining actions is remote.

 

**Note 10.         Financial Instruments**

 

*Foreign ExchangeRisk Management*

 

The Companytransacts business in more than 100 countries and is subject to risksassociated with changing foreign exchange rates.  The Company’s objective is to reduce earningsand cash flow volatility associated with foreign exchange rate changes.  Accordingly, the Company enters into foreigncurrency forward contracts to minimize the impact of foreign exchange movementson net income and on the value of non-functional currency assets andliabilities.

 

It is the Company’spolicy to enter into foreign currency transactions only to the extent necessaryto meet its objectives as stated above. The Company does not enter into foreign currency transactions forinvestment or speculative purposes.  Theprincipal currencies hedged are the Euro, the Japanese Yen, the British Pound,the Swiss Franc and the Canadian Dollar.

 

The impact of foreignexchange risk management activities on pre-tax income in the three and ninemonths ended September 30, 2004 were net gains (losses) of $(502) and $5,089,respectively, and in the three and nine months ended September 30, 2003 werenet gains (losses) of $222 and $(16,762), respectively.  In addition, at September 30, 2004, theCompany had approximately $214,657 in foreign exchange forward contractsoutstanding with various expiration dates through December 2004 relating tonon-functional currency assets and liabilities. Foreign exchange forward contracts are recorded at estimated fair value.  The estimated fair values of the forwardcontracts are based on quoted market prices. Unrealized and realized gains and losses on these contracts are notdeferred and are included in the Condensed Consolidated Statements of Income(unaudited) in Other income (expense), net.

 

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*Fair Value of FinancialInstruments*

 

At September 30, 2004,the Company’s financial instruments included cash, cash equivalents, short-termmarketable securities, accounts receivables, accounts payable, short-tem debt,long-term debt and foreign currency forward contracts.  At September 30, 2004, the fair values ofcash, cash equivalents, accounts receivables, accounts payable and short-term debtapproximated carrying values due to the short-term nature of theseinstruments.  The contractual value ofthe Company’s foreign currency forward contracts was approximately $214,657 atSeptember 30, 2004, and all contracts mature in 2004.  The estimated fair values of the forwardcontracts were determined based on quoted market prices.  

 

*Credit Concentrations*

 

The Companycontinually monitors its positions with, and the credit quality of, thefinancial institutions that are counterparties to its financial instruments anddoes not anticipate non-performance by the counterparties.  The Company would not realize a material lossas of September 30, 2004 in the event of non-performance by any onecounterparty.  The Company enters intotransactions only with financial institution counterparties that have primarilycredit ratings of A or better.  Inaddition, the Company limits the amount of credit exposure with any oneinstitution.

 

The Company maintainsaccounts receivable balances ($256,929 and $271,268, net of allowances, atSeptember 30, 2004 and December 31, 2003, respectively), principally fromcustomers in the pharmaceutical industry. The Company’s trade receivables do not represent significantconcentrations of credit risk at September 30, 2004 due to the high quality ofits customers and their dispersion across many geographic areas.

 

*Lines of Credit and Liquidity*

 

The Company had borrowingarrangements with several domestic and international banks to provide lines ofcredit up to $700,000 at September 30, 2004. Total borrowings under these existing lines were $479,200 and $407,600at September 30, 2004 and December 31, 2003, respectively, of which $237,000and $407,600 were classified as short-term, and $242,200 and $0 were classifiedas long-term as of September 30, 2004 and December 31, 2003, respectively.

 

OnApril 5, 2004, the Company entered into a $700,000 revolving credit facilitywith a syndicate of 12 banks (the “Unsecured Facility”).  The Unsecured Facility replaced the Company’slines of credit with several domestic and international banks.  The Unsecured Facility is comprised of$430,000 of short-term lines that expire April 2005 and $270,000 of long-termlines expiring April 2007.  In general,rates for borrowing under both the short-term and long-term components areLIBOR plus 45 basis points and can vary based on the Company’s Debt to EBITDAratio.  The weighted average interestrates for the short-term lines were 2.28% and 1.61% at September 30, 2004 andDecember 31, 2003, respectively.  Theweighted average interest rates for the long-term lines were 2.28% and 1.84% atSeptember 30, 2004 and December 31, 2003, respectively.  In addition, the Company will pay acommitment fee on the unused portion of the short-term and long-term facilitiesof 0.08% and 0.10%, respectively.

 

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TheCompany defines long-term lines as those where the lines are non-cancelable formore than 365 days from the balance sheet date by the financial institutionsexcept for specified violations of the provisions of the agreement.  Borrowings under these three-year facilitiesare short-term in nature; however, the Company has the ability and the intentto refinance the short-term borrowings as they come due through April 2007.  At September 30, 2004, the Companyreclassified $242,200 of its debt outstanding as long-term debt in accordancewith the provisions of SFAS No. 6, “Classification of Short-Term ObligationsExpected to be Refinanced.”

 

Total debt of $634,404and $561,991 at September 30, 2004 and December 31, 2003, respectively,included $150,000 of private placement debt (as further discussed below), and$5,204 and $4,391 at September 30, 2004 and December 31, 2003, respectively,related primarily to cash overdrafts, certain capital leases, mortgages and anadjustment to the carrying amount of fair value hedged debt.  At September 30, 2004, the Company had$27,800 and $193,000 available under its long and short-term lines of credit,respectively.

 

Duringthe fourth quarter of 2001, the Company renegotiated with several banks andentered into three-year lines of credit for borrowings of up to $175,000.  Borrowings had maturity dates of up to 90days from their inception.  These linesof credit were due to mature in 2004 and as such $175,000 was reclassified toshort-term debt as of December 31, 2003.

 

InMarch and April 2002, the Company entered into interest rate swaps on a portionof its variable rate debt portfolio. These arrangements convert the variable interest rates to a fixedinterest rate on a notional amount of $75,000 and mature at various times fromMarch 2005 through April 2006.  The fixedrates range from 4.05% to 5.08%.  Theinterest rate swaps are accounted for as cash flow hedges and any changes infair value are recorded in Other Comprehensive Income, in the CondensedConsolidated Statements of Shareholders’ Equity (unaudited).  The fair values are determined based onestimated prices quoted by financial institutions.  The mark-to-market adjustment for the threeand nine months ended September 30, 2004 was an unrealized net loss of $383 and$1,359, respectively.

 

InJanuary 2003, the Company closed a private placement transaction pursuant towhich the Company issued $150,000 of five-year debt to several highly ratedinsurance companies at a fixed rate of 4.60%. The proceeds were used to pay down short-term debt.  The Company also swapped $100,000 of itsfixed rate debt to floating rate based on six-month LIBOR plus a margin ofapproximately 107 basis points.  Theseswaps have been accounted for as fair value hedges under the provisions of SFASNo. 133, “Accounting for Derivative Instruments and Hedging Activities.”  The fair values are determined based onestimated prices quoted by financial institutions.  The cumulative fair value adjustment to theswap as of September 30, 2004 was an increase of $727.

 

The Company’s financingarrangements provide for certain covenants and events of default customary forsimilar instruments, including in the case of its main bank arrangements andthe 2003 private placement transaction, covenants to maintain specific ratiosof consolidated total indebtedness to EBITDA and of EBITDA to certain fixedcharges.  At September 30, 2004, theCompany was in compliance with these financial debt covenants and anticipates thatit will remain in compliance with the covenants over the term of the borrowingarrangements.

 

27

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**Note 11.         Pension and Postretirement Benefits**

 
| **Components of Net Periodic  Benefit Cost for the  Three Months Ended September 30,** | ** ** | **Pension Benefits** | ** **   | **Other Benefits** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------|--------------|--------------------|------------|
| **2004**                                                                               | ** ** | **2003**             | **2004 (1)** | ** **         | **2003**   |
| Service cost                                                                           | ** ** | **$**                | **2,595**    |               | $          | 2,262 | ** ** | **$** | **17** |   | $ | 36 |   |
| Interest cost                                                                          | ** ** | **3,370**            |         | 2,749              | ** ** | **167** |   | 190 |   |
| Expected return on plan assets                                                         | ** ** | **(4,721**           | **)**        | (3,582             | )          | **0** |   | 0 |   |
| Amortization of prior service cost (credit)                                            | ** ** | **(57**              | **)**        | (34                | )          | **(247** | **)** | (247 | ) |
| Amortization of transition obligation                                                  | ** ** | **(23**              | **)**        | 10                 | ** ** | **0** |   | 0 |   |
| Amortization of net loss                                                               | ** ** | **648**              |         | 424                | ** ** | **60** |   | 113 |   |
| Net periodic benefit cost                                                              | ** ** | **$**                | **1,812**    |               | $          | 1,829 | ** ** | **$** | **(3** | **)** | $ | 92 |   |

 
| **Components of Net Periodic  Benefit Cost for the Nine  Months Ended September 30,** | ** ** | **Pension Benefits** | ** **   | **Other Benefits** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------|--------------|--------------------|------------|
| **2004**                                                                              | ** ** | **2003**             | **2004 (1)** | ** **         | **2003**   |
| Service cost                                                                          | ** ** | **$**                | **7,866**    |               | $          | 6,994 | ** ** | **$** | **100** |   | $ | 108 |   |
| Interest cost                                                                         | ** ** | **10,025**           |         | 8,682              | ** ** | **593** |   | 570 |   |
| Expected return on plan assets                                                        | ** ** | **(14,093**          | **)**        | (10,412            | )          | **0** |   | 0 |   |
| Amortization of prior service cost (credit)                                           | ** ** | **(170**             | **)**        | 78                 | ** ** | **(741** | **)** | (741 | ) |
| Amortization of transition obligation                                                 | ** ** | **(69**              | **)**        | 4                  | ** ** | **0** |   | 0 |   |
| Amortization of net loss                                                              | ** ** | **1,945**            |         | 1,591              | ** ** | **376** |   | 339 |   |
| Net periodic benefit cost                                                             | ** ** | **$**                | **5,504**    |               | $          | 6,937 | ** ** | **$** | **328** |   | $ | 276 |   |

 

*(1) Reflects accounting for theimpact of the Medicare Prescription Drug, Improvement and Modernization Act of2003 prospectively beginning in the third quarter of 2004. The Medicare Part Dsubsidy reduced the accumulated postretirement benefit obligation by$1,384.  The total reduction in the netperiodic benefit cost due to the Act was $169 for the three months endedSeptember 30, 2004 of which $67 related to the subsidy.*

 

*Plansaccounted for under APB Opinion No. 12, “Omnibus Opinion – 1967”.  *The Company provides certainexecutives with supplemental pension benefits in accordance with theirindividual employment arrangements.  Asindividual arrangements, these pension benefits are accounted for under APBOpinion No. 12 (which addresses accounting for deferred compensation contracts)and not SFAS No. 87, and as a result, the tables of this Note do not includethe Company’s expense associated with providing these benefits.

 

**Note 12.         Income Taxes**

 

The Company operates in morethan 100 countries around the world and its earnings are taxed at theapplicable income tax rate in each of these countries.

 

For the nine months endedSeptember 30, 2004, the Company’s effective tax rate was impacted byapproximately $15,100 primarily due to a favorable partial U.S. auditsettlement.  For the nine months endedSeptember 30, 2003, the Company’s effective tax rate was impacted byapproximately $69,600 due to the Company’s reassessment, based on informationreceived in April 2003, of its liability associated with certain D&B LegacyTax Matters and related subsequent transactions.  This is more fully described in Note 9.  Further, the 2003 effective tax rate wasaffected by the favorable settlement of a non-U.S. audit, which approximated$13,900.

 

28

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While the Company intends tocontinue to seek global tax planning initiatives, there can be no assurancethat the Company will be able to successfully implement such initiatives toreduce or maintain its overall tax rate.

 

The Company accrues for taxloss contingencies in the period in which they are probable and estimable inaccordance with SFAS No. 5, “Accounting for Contingencies.”  These reserves are included in current incometaxes payable to the extent the related amounts are expected to be paid withinthe next twelve-month period.  If theCompany expects the liability to be settled beyond one year, these amounts areclassified as a long-term liability.

 

**Note 13.         IMS Health Capital Stock**

 

On February 10, 2004, theBoard of Directors authorized a stock repurchase program to buy up to 10,000shares.  As of September 30, 2004,approximately 4,400 shares remained available for repurchase under the February2004 program.

 

On April 15, 2003, theBoard of Directors authorized a stock repurchase program to buy up to 10,000shares.  This program was completed inMay 2004 at a total cost of $243,520.

 

On July 19, 2000, theBoard of Directors authorized a stock repurchase program to buy up to 40,000shares.  This program was completed inJune 2003 at a total cost of $868,314.

 

During the nine monthsended September 30, 2004, the Company repurchased approximately 11,176 sharesof outstanding common stock under these programs, including the repurchase of4,600 shares on January 9, 2004 pursuant to an accelerated share repurchase program (“ASR”).  The ASR agreement provides for the finalsettlement of the contract in either cash or additional shares of the Company’scommon stock at the Company’s sole discretion. During the second quarter of 2004,****theCompany was required to pay an additional $942 as the final settlement amountbased on an increase in the Company’s share price over the settlementperiod.  The total cost of the sharesrepurchased during the nine months ended September 30, 2004 was $277,075.

 

Shares acquired throughthe Company’s repurchase programs described above are open-market purchases orprivately negotiated transactions in compliance with Securities and ExchangeCommission Rule 10b-18.

 

As discussed in Note 6,during the three months ended March 31, 2003, the Company completed the CTSSplit-Off exchange offer and accepted 36,540 IMS common shares tendered inexchange for all 11,291 CTS common shares that the Company owned.

 

TheCompany re-issued approximately 4,676 treasury shares under option exercisesfor proceeds of $80,923 during the nine months ended September 30, 2004.  In addition, the Company paid dividends of$0.02 per share for a total of $4,704 during the three months ended September30, 2004.  For the nine months endedSeptember 30, 2004, the Company paid dividends of $0.06 per share for a totalof $14,204.

 

**Note 14.         Comprehensive Income**

 

*The following table sets forth the components of comprehensive income,net of income tax expense:*

 

29

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| ** **                                          | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                          | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                |       |                                  |       |                                 |       |   |   |   |   |
| **Net Income**                                      | ** ** | **$**                                 | **65,632** |                                 | $          | 69,213 | ** ** | **$** | **211,831** |   | $ | 569,242 |   |
| Other comprehensive income, net of taxes:           |       |                                  |       |                                 |       |   |   |   |   |
| Unrealized gains (losses) on:                       |       |                                  |       |                                 |       |   |   |   |   |
| Available-for-sale equity securities                | ** ** | **(352**                              | **)**      | 2,742                                | ** ** | **75** |   | 3,460 |   |
| Reclassification adjustment                         | ** ** | **312**                               |       | (2,692                               | )          | **531** |   | (2,893 | ) |
| Tax benefit on above                                | ** ** | **14**                                |       | (18                                  | )          | **(212** | **)** | (199 | ) |
| Change in unrealized gains (losses) on  investments | ** ** | **(26**                               | **)**      | 32                                   | ** ** | **394** |   | 368 |   |
| Foreign currency translation gains (losses)         | ** ** | **(573**                              | **)**      | 7,664                                | ** ** | **(7,986** | **)** | 36,937 |   |
| Changes in fair value of cash flow hedges           | ** ** | **383**                               |       | 461                                  | ** ** | **1,359** |   | 332 |   |
| Total other comprehensive income (loss)             | ** ** | **(216**                              | **)**      | 8,157                                | ** ** | **(6,233** | **)** | 37,637 |   |
| **Comprehensive Income**                            | ** ** | **$**                                 | **65,416** |                                 | $          | 77,370 | ** ** | **$** | **205,598** |   | $ | 606,879 |   |

 

**Note 15.         Severance, Impairment and Other Charges**

 

During the three monthsended March 31, 2003, the Company recorded $37,220 of severance, impairment andother charges (the “first quarter charge”) as a component of operatingincome.  These charges were incurred dueto a number of business and strategic factors affecting the Company:

 

•                  severance-related charges of $9,958 wereincurred in an effort to streamline operations and increase productivitythrough a worldwide reduction in headcount of approximately 80 employees.  This reduction in headcount was primarily focusedon upgrading the skills and capabilities of our employee base as we transformthe business to provide new and enhanced analytical and consulting offerings toour customers.  The reduction inheadcount also led to charges for impaired leases in the U.S. and U.K. foroffice space no longer being used by the Company and for which the Company hasnot been able to obtain subleases at rates comparable to the terms of its leaseobligations.  These severance benefits werecalculated pursuant to the terms of established employee protection plans, inaccordance with local statutory minimum requirements or individual employeecontracts, as applicable;

 

•                  contract-related charges of $22,307 wereincurred for impaired data supply, data processing and impaired lease contractsin the Company’s U.S. and Japanese operations. An impairment for a data supply contract in the U.S. was realized due tothe fact that in the first quarter of 2003 we determined that expected revenuesunder a co-marketing agreement with a data supplier would not be generated, but

 

30

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theCompany was still required to make payments under the terms of thecontract.  The Company also realized animpairment for a data processing contract in Japan related to a weekly dataproduct in Japan that was discontinued at the end of the first quarter of 2003,due to the interruption in data supply; and

 

•                  asset write-downs of $4,955 wererecorded to write-down certain computer software primarily in the U.S. and Japanto its net realizable value.  In theU.S., a decision to change the underlying technology in a product required thewrite-down of a previous version.  InJapan, the termination of the weekly data product required the write-down ofthe software used for that product.

 
| ** **                    | ** ** | **Severance  related charges** | ** ** | **Contract related  charges** | ** ** | **Asset  write-downs** | ** ** | **Total** | ** ** |
|-------------------------------|------------|--------------------------------|------------|-------------------------------|------------|------------------------|------------|-----------|------------|
| Charge at March 31, 2003      |       | $                              | 9,958      |                          | $          | 22,307                 |       | $         | 4,955      |   | $ | 37,220 |   |
| 2003 Utilization              |       | (6,197                         | )          | (7,047                        | )          | (6,634                 | )          | (19,878   | )          |
| 2004 Utilization              |       | (1,447                         | )          | (2,727                        | )          | —                 |       | (4,174    | )          |
| Adjustments                   |       | (1,746                         | )          | 67                            |       | 1,679                  |       | —    |       |
| Balance at September 30, 2004 |       | $                              | 568        |                          | $          | 12,600                 |       | $         | 0          |   | $ | 13,168 |   |

 

Thecash portion of the first quarter charge amounted to $30,586, of which theCompany paid approximately $13,244 during 2003 and $4,174 during the ninemonths ended September 30, 2004, related primarily to employee terminationbenefits and contract-related charges. The remaining accrual of $13,168 at September 30, 2004 relates tocontract related obligations and continuing payments related to employeetermination benefits.

 

TheCompany expects that cash outlays will be applied against the $13,168 balance remaining as follows:

 

| **Year Ended  December 31,** | ** ** | **Cash Outlays** | ** ** |
|------------------------------|------------|------------------|------------|
| 2004                         |       | $                | 1,718      |   |
| 2005                         |       | 7,917            |       |
| 2006                         |       | 923              |       |
| 2007                         |       | 752              |       |
| 2008                         |       | 228              |       |
| Thereafter                   |       | 1,630            |       |
| Total                        |       | $                | 13,168     |   |

 

During2003, the Company reversed approximately $1,750 of severance related chargesoriginally included in the first quarter charge due to the Company’s refinementof estimates.  The Company also recordedadditional charges during 2003 of approximately $1,700 related primarily to asoftware impairment.

 

During the fourth quarterof 2001, the Company completed the assessment of its Competitive FitnessProgram (the “Program”).  This Programwas designed to streamline operations, increase productivity, and improveclient service.  In connection with thisProgram, the Company recorded $94,616 of Severance, impairment and othercharges during the fourth quarter of 2001 as a component of operating income.

 

31

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| ** **                    | ** ** | **Severance  related charges** | ** ** | **Contract  related charges** | ** ** | **Asset write-  downs** | ** ** | **Total** | ** ** |
|-------------------------------|------------|--------------------------------|------------|-------------------------------|------------|-------------------------|------------|-----------|------------|
| Charge at December 31, 2001   |       | $                              | 39,652     |                          | $          | 26,324                  |       | $         | 28,640     |   | $ | 94,616 |   |
| 2001 utilization              |       | (3,692                         | )          | (6,663                        | )          | (27,887                 | )          | (38,242   | )          |
| 2002 utilization              |       | (26,277                        | )          | (9,819                        | )          | (1,474                  | )          | (37,570   | )          |
| 2003 utilization              |       | (6,384                         | )          | (2,720                        | )          | (241                    | )          | (9,345    | )          |
| 2004 utilization              |       | (353                           | )          | (725                          | )          | —                  |       | (1,078    | )          |
| Adjustments                   |       | (688                           | )          | (274                          | )          | 962                     |       | —    |       |
| Balance at September 30, 2004 |       | $                              | 2,258      |                          | $          | 6,123                   |       | $         | 0          |   | $ | 8,381 |   |

 

Approximately $39,652 wascharged to expense in the fourth quarter of 2001 related to a worldwidereduction in headcount.  This included$33,376 of severance benefits that were calculated pursuant to the terms of establishedemployee protection plans in accordance with local statutory minimumrequirements or individual employee contracts, as applicable.  This also included $6,277 of severancebenefits for approximately 175 employees that were recorded as part of theProgram in accordance with EITF Statement No. 94-3, “Liability Recognition ofCertain Employee Termination Benefits and Other Costs to Exit an Activity(including Certain Costs Incurred in Restructuring).”

 

The Company recorded$15,827 in contract-related charges, including $7,493 in payments to exit datasupply and processing contracts and $8,334 related to onerous leaseobligations.  These costs are incrementaland either relate to existing contractual obligations that do not have anyfuture economic benefit or represent a contract cancellation penalty.  They relate, in part, to the decision in thefourth quarter of 2001 to close down or vacate leased facilities in order toconsolidate functions geographically as part of the Program.

 

Approximately $17,723 wascharged to expense in the fourth quarter of 2001 to write down deferredsoftware costs to their net realizable value. These write-downs resulted from the Company’s decision to abandoncertain products or introduce new regional or global platforms.  The Company also charged $4,243 of goodwillto expense in the fourth quarter of 2001 as a result of the decision to ceaseproduct offerings as well as increased competition in certain markets.

 

Approximately $17,170 ofthe 2001 charge relates to GIC and resulted from the Company’s decision to exitthe GIC relationship and accelerate the transition of certain data processingfunctions that were rendered by GIC to the IMS Global Data Center.  Of the total GIC charge, approximately$14,600 is for lease and other asset impairments with the remaining balance of$2,570 representing contract termination payments to be made to GIC.

 

As of September 30, 2004,the Company paid approximately $56,633 under the Program.  Total terminations under the Program were535.  Although the total number ofterminations from the

 

32

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Program was lower than the original plan byapproximately 18%, due to a change in the mix of actual employee terminations,the Company has experienced a higher level of severance costs per employee,thereby offsetting any cost savings from fewer actual terminations.  As expected, all actions under the Programwere completed by December 31, 2002.  Theremaining accrual of $8,381 at September 30, 2004 related primarily to afacility shutdown and employee termination payments.

 

The adjusted cash portionof the 2001 charge amounted to $65,014, primarily for severance payments andcontract terminations.  The non-cashportion amounted to $29,602 and is composed primarily of asset write-offs.  The Company expects that cash outlays will beapplied against the $8,381 balance remaining as follows:

 

| **Year Ended  December 31,** | ** ** | **Cash Outlays** | ** ** |
|------------------------------|------------|------------------|------------|
| 2004                         |       | $                | 2,724      |   |
| 2005                         |       | 1,754            |       |
| 2006                         |       | 1,754            |       |
| 2007                         |       | 2,149            |       |
| Total                        |       | $                | 8,381      |   |

 

TheCompany expects that future results will benefit from the Program and the firstquarter charge to the extent of the contract-related charges and assetwrite-downs primarily through 2007.  TheCompany’s severance actions related to a shifting of resources around theCompany and as such are not expected to generate material cost savings.  The income statement lines that will beimpacted in future periods are Operating costs for the contract-related chargesand Depreciation and amortization for the asset write-downs.  However, the Company does not expect amaterial impact on future cash flows due to the fact that the Company is stillcontractually obligated to continue to make payments under impaired contracts.

 

**Note 16.         Operations by Business Segment**

 

Operating segments aredefined as components of an enterprise about which financial information isavailable that is evaluated on a regular basis by the chief operating decisionmaker, or decision making groups, in deciding how to allocate resources to anindividual segment and in assessing performance of the segment.  The Company operates a globally consistentbusiness model, offering pharmaceutical business information, software andrelated services to its customers in more than 100 countries.  See Note 1.

 

The Company maintainsregional geographic management to facilitate local execution of its globalstrategies.  However, the Companymaintains global leaders for the majority of its critical business processes;and the most significant performance evaluations and resource allocations madeby the Company’s chief operating decision makers are made on a globalbasis.  As such, the Company hasconcluded that it maintains one operating and reportable segment.

 

**GeographicFinancial Information:**

 

The following representsselected geographic information for the regions in which the Company operatesas of and for the three and nine months September 30, 2004 and 2003:

 

33

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| ** **                                 | ** ** | **Americas  (1)** | ** ** | **Europe  (2)** | ** ** | **Asia Pacific  (3)** | ** ** | **Corporate &  Other** | ** ** | **Total  IMS** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-----------------|------------|-----------------------|------------|----------------------------|------------|----------------|------------|
| **Three Months Ended September 30, 2004:** |       |              |       |            |       |                  |       |                       |       |           |       |
| Operating  revenue (4)                     |       | $                 | 175,660    |            | $          | 156,643               |       | $                          | 51,868     |           | —     |   | $ | 384,171 |   |
| Operating income (5)                       |       | $                 | 78,756     |            | $          | 24,300                |       | $                          | 26,790     |           | $          | (26,955 | ) | $ | 102,891 |   |
| **Nine Months Ended September 30, 2004:**  | ** ** | ** **        | ** ** | ** **      | ** ** | ** **            | ** ** | ** **                 | ** ** | ** **     | ** ** |
| Operating revenue (4)                      |       | $                 | 515,063    |            | $          | 456,016               |       | $                          | 154,251    |           | —     |   | $ | 1,125,330 |   |
| Operating income (5)                       |       | $                 | 227,238    |            | $          | 80,500                |       | $                          | 80,838     |           | $          | (86,985 | ) | $ | 301,591 |   |
| **Three Months Ended September 30, 2003:** |       |              |       |            |       |                  |       |                       |       |           |       |
| Operating  revenue (4)                     |       | $                 | 168,747    |            | $          | 129,439               |       | $                          | 47,792     |           | —     |   | $ | 345,978 |   |
| Operating income (5)                       |       | $                 | 81,489     |            | $          | 22,648                |       | $                          | 28,288     |           | $          | (24,483 | ) | $ | 107,942 |   |
| **Nine Months Ended September 30, 2003:**  |       |              |       |            |       |                  |       |                       |       |           |       |
| Operating revenue (4)                      |       | $                 | 480,476    |            | $          | 377,375               |       | $                          | 139,820    |           | —     |   | $ | 997,671 |   |
| Operating income (5)                       |       | $                 | 221,313    |            | $          | 67,398                |       | $                          | 81,472     |           | $          | (123,792 | ) | $ | 246,391 |   |

 

**Notes to Geographic FinancialInformation:**

 

*(1)**       Americas includes theUnited States, Canada and Latin America.*

 

*(2)**       Europe includes countriesin Europe, the Middle East and Africa.*

 

*(3)**       Asia Pacific includesJapan, Australia and other countries in the Asia Pacific region.*

 

*(4)**       Operating revenue relatesto external customers and is primarily based on the location of thecustomer.  The operating revenue for thegeographic regions includes the impact of foreign exchange in convertingresults into U.S. Dollars.*

 

(5)          *Operating income for the three geographic regionsdoes not reflect the allocation of certain expenses that are maintained inCorporate and Other and as such, is not a true measure of the respectiveregions’ profitability.  For the threemonths ended March 31, 2003, Severance, impairment and other charges of$17,369, $5,040 and $11,081 for the Americas, Europe and Asia Pacific,respectively, are presented in Corporate and Other.  The operating income for the geographicsegments includes the impact of foreign exchange in converting results intoU.S. Dollars.*

 

A summary of theCompany’s operating revenue by product line, as of and for the three and ninemonths ended September 30, 2004 and 2003 is presented below:

 
| ** **                            | ** ** | **Three Months Ended  September 30,** | ** **  | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------|------------|---------------------------------------|-------------|--------------------------------------|------------|
| ** **                            | ** ** | **2004**                              | ** **  | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Sales Force Effectiveness             | ** ** | **$**                                 | **174,784** |                                 | $          | 163,847 | ** ** | **$** | **514,573** |   | $ | 475,822 |   |
| Portfolio Optimization                | ** ** | **$**                                 | **107,475** |                                 | $          | 104,852 | ** ** | **$** | **330,250** |   | $ | 304,784 |   |
| Brand and Launch Management and Other | ** ** | **$**                                 | **59,967**  |                                 | $          | 49,510 | ** ** | **$** | **161,153** |   | $ | 137,670 |   |
| Consulting and Services               | ** ** | **$**                                 | **41,945**  |                                 | $          | 27,769 | ** ** | **$** | **119,354** |   | $ | 79,395 |   |
| Total Operating revenue               | ** ** | **$**                                 | **384,171** |                                 | $          | 345,978 | ** ** | **$** | **1,125,330** |   | $ | 997,671 |   |

 

34

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**Item2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

**(Dollars and shares in thousands,except per share data)**

 

*Thisdiscussion and analysis should be read in conjunction with the accompanyingCondensed Consolidated Financial Statements (unaudited) and related notes.*

 

***OurBusiness***

 

IMSHealth Incorporated (“we”, “us” or “our”) is a leading global provider ofinformation solutions to the pharmaceutical and healthcare industries.  Our revenues are derived primarily from thesale of a broad line of market information, sales management and consultingservices to the pharmaceutical and healthcare industries.  Our information products are developed tomeet client needs by using data secured from a worldwide network of suppliersin the markets where operations exist. Key information products include:

 

•      Sales Force Effectiveness to optimize salesforce productivity and territory management;

 

•      Portfolio Optimization to provide clientswith insights into market opportunity and business development assessment;

 

•      Brand and Launch Management and Other tosupport client needs relative to market segmentation and positioning and lifecycle management for prescription and over-the-counter pharmaceutical products;and

 

•      Consulting and Services that use in-housecapabilities and methodologies to assist pharmaceutical clients in analyzingand evaluating market trends, strategies and tactics, and to help in thedevelopment and implementation of customized software applications and datawarehouse tools.

 

Weoperate in more than 100 countries.  Wealso own a venture capital unit, Enterprise Associates, LLC (“Enterprises”),which is focused on investments in emerging businesses, and a 25.7% equityinterest in The TriZetto Group, Inc. (“TriZetto”), at September 30, 2004.

 

Wemanage on a global business model with global leaders for the majority of ourcritical business processes and accordingly have one reportable segment.

 

We believe that importantmeasures of our financial condition and results of operations include operatingrevenue, constant dollar revenue growth, operating income, operating margin andcash flows.

 

**Split-Off of Cognizant Technology Solutions CorporationSegment (“CTS”)**

 

Until February 6, 2003,we also included CTS, which provides custom Information Technology (“IT”)design, development, integration and maintenance services.  CTS is a publicly traded corporation on theNasdaq national market system.  We owned55.3% of the common shares outstanding of CTS (92.5% of the outstanding votingpower) as of December 31, 2002, and accounted for CTS as a consolidatedsubsidiary.  On February 6, 2003, wedivested CTS through a split-off transaction, and as a result, during the firstquarter of 2003, we recorded a net gain from discontinued operations of$495,053.  Our share of CTS results arepresented as discontinued operations for 2003

 

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through the date ofdivestiture (see Note 6 to the unaudited Condensed Consolidated FinancialStatements).

 

**Operating Results**

 

*References to constant dollarresults. *We reportresults in U.S. Dollars but we do business on a global basis.  Exchange rate fluctuations affect the rate atwhich we translate foreign revenues and expenses into U.S. Dollars and haveimportant effects on our results.  Inorder to illustrate these effects, the discussion of our business in thisreport sometimes describes the magnitude of changes in constant dollar terms.  We believe this information facilitates acomparative view of business growth.  Inthe first nine months of 2004, the U.S. Dollar was generally weaker againstother currencies compared to the first nine months of 2003, so growth atconstant dollar exchange rates was lower than growth at actual currencyexchange rates.  See “How Exchange RatesAffect Our Results” below and the discussion of “Market Risk” in the ManagementDiscussion and Analysis in our annual report on Form 10-K for the year endedDecember 31, 2003 for a more complete discussion regarding the impact offoreign currency translation on our business.

 

**Summary of Operating Results**

 
| ** **                          | ** ** | ** **                           | ** **  | **% Variance**     | ** ** |
|-------------------------------------|------------|--------------------------------------|-------------|--------------------|------------|
| ** **                          | ** ** | **Three Months Ended September 30,** | ** **  | **2004  vs. 2003** | ** ** |
| **2004**                            | ** ** | **2003**                             |
| Operating revenue                   | ** ** | **$**                                | **384,171** |               | $          | 345,978 |   | 11.0 | % |
| Operating costs                     | ** ** | **163,465**                          |        | 142,457            |       | 14.7 | % |
| Selling and administrative expenses | ** ** | **94,460**                           |        | 77,181             |       | 22.4 | % |
| Depreciation and amortization       | ** ** | **23,355**                           |        | 18,398             |       | 26.9 | % |
| Operating income                    | ** ** | **$**                                | **102,891** |               | $          | 107,942 |   | (4.7 | )% |

 
| ** **                              | ** ** | ** **                          | ** **    | **% Variance**     | ** ** |
|-----------------------------------------|------------|-------------------------------------|---------------|--------------------|------------|
| ** **                              | ** ** | **Nine Months Ended September 30,** | ** **    | **2004  vs. 2003** | ** ** |
| **2004**                                | ** ** | **2003**                            |
| Operating revenue                       | ** ** | **$**                               | **1,125,330** |               | $          | 997,671 |   | 12.8 | % |
| Operating costs                         | ** ** | **475,405**                         |          | 421,260            |       | 12.9 | % |
| Selling and administrative expenses     | ** ** | **280,956**                         |          | 237,773            |       | 18.2 | % |
| Depreciation and amortization           | ** ** | **67,378**                          |          | 55,027             |       | 22.4 | % |
| Severance, impairment and other charges | ** ** | **—**                          |          | 37,220             |       | n/a |   |
| Operating income                        | ** ** | **$**                               | **301,591**   |               | $          | 246,391 |   | 22.4 | % |

 

***OperatingIncome***

 

Our operating income forthe third quarter of 2004 decreased 4.7% at reported exchange rates and 6.3% atconstant dollar terms to $102,891 from $107,942 in the third quarter of2003.  The change was primarily due tothe increase in our operating costs and selling and administrative expensesdriven primarily by investments in new products and consulting and servicescapabilities and increased cost of data. Operating income for the nine months ended September 30, 2004 grew 22.4%

 

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to $301,591 from $246,391 in the nine months endedSeptember 30, 2003.  The change waslargely the result of $37,220 in severance, impairment and other charges werecorded in the first quarter of 2003 and the increase in our operating revenuein the first nine months of 2004 compared to the same period of 2003.  Absent the impact of severance, impairmentand other charges, our operating income increased by 6.3% at reported exchangerates and 3.2% at constant dollar terms.

 

***OperatingRevenue***

 

Our operating revenue forthe third quarter of 2004 grew 11.0% to $384,171 from $345,978 in the thirdquarter of 2003.  On a constant dollarbasis our operating revenue growth was 6.9%. On a constant dollar basis, revenue from all product and servicecategories grew with the exception of portfolio optimization.  Operating revenue for the first nine monthsof 2004 grew 12.8% to $1,125,330 from $997,671 in the first nine months of2003.  On a constant dollar basis ouroperating revenue growth was 7.7%.  Theincrease in our operating revenue resulted from growth in revenue in all fourof our product and service categories, together with the effect of currencytranslation.

 

**Summary of Operating Revenue**

 
| ** **                            | ** ** | **Three Months Ended  September 30,** | ** **  | **% Variance  2004 vs 2003** | ** ** |
|---------------------------------------|------------|---------------------------------------|-------------|------------------------------|------------|
| ** **                            | ** ** | **2004**                              | ** **  | **2003**                     | ** ** | **Reported Rates** | ** ** | **Constant Dollar** | ** ** |
| Sales Force Effectiveness             | ** ** | **$**                                 | **174,784** |                         | $          | 163,847 |   | 7 | % | 3 | % |
| Portfolio Optimization                | ** ** | **$**                                 | **107,475** |                         | $          | 104,852 |   | 3 | % | (2 | )% |
| Brand and Launch Management and Other | ** ** | **$**                                 | **59,967**  |                         | $          | 49,510 |   | 21 | % | 16 | % |
| Consulting and Services               | ** ** | **$**                                 | **41,945**  |                         | $          | 27,769 |   | 51 | % | 46 | % |
| Operating Revenue                     | ** ** | **$**                                 | **384,171** |                         | $          | 345,978 |   | 11 | % | 7 | % |

 
| ** **                            | ** ** | **Nine Months Ended  September 30,** | ** **    | **% Variance  2004 vs 2003** | ** ** |
|---------------------------------------|------------|--------------------------------------|---------------|------------------------------|------------|
| ** **                            | ** ** | **2004**                             | ** **    | **2003**                     | ** ** | **Reported Rates** | ** ** | **Constant Dollar** | ** ** |
| Sales Force Effectiveness             | ** ** | **$**                                | **514,573**   |                         | $          | 475,822 |   | 8 | % | 3 | % |
| Portfolio Optimization                | ** ** | **$**                                | **330,250**   |                         | $          | 304,784 |   | 8 | % | 3 | % |
| Brand and Launch Management and Other | ** ** | **$**                                | **161,153**   |                         | $          | 137,670 |   | 17 | % | 11 | % |
| Consulting and Services               | ** ** | **$**                                | **119,354**   |                         | $          | 79,395 |   | 50 | % | 45 | % |
| Operating Revenue                     | ** ** | **$**                                | **1,125,330** |                         | $          | 997,671 |   | 13 | % | 8 | % |

 

•                  *Sales Force Effectiveness*revenue grew primarily due to core Xponent offerings in the United States,Canada and Europe, and growth in the Asia Pacific region (excluding Japan),Latin America, and acquisitions.  Therevenue decline in Japan is leveling off and we anticipate a gradual return togrowth in 2005 now that key contracts with data suppliers have been finalized.

 

•                  *Portfolio Optimization*revenue for the first nine months of 2004 grew primarily due to strong demandfor certain of our core products, including our next generation MIDAS offering,called MIDAS Quantum; KnowledgeLink, our proprietary search engine; and

 

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NPA Market-Dynamics, our premier longitudinal offeringin the United States.  The decrease inthird quarter constant dollar revenue is primarily due to quarterly fluctuationsin MIDAS revenue as clients migrate to the new MIDAS Quantum pricing structure.

 

•                  *Brand Management, LaunchManagement and other product lines* revenue grew primarily due toPrescriber Profiler and Market Prognosis in the United States and ConsumerHealth in Europe.

 

•                  *Consulting and Services*revenue grew strongly across all our service lines, especially in ourManagement Consulting service line.

 

***OperatingCosts***

 

Our operating costsinclude data processing costs, the costs of data collection and production, andcosts attributable to personnel involved in production, data management and theprocessing and delivery of our consulting and services offerings.  Our operating costs grew 14.7% to $163,465 inthe third quarter of 2004, from $142,457 in the third quarter of 2003, and forthe first nine months of 2004 grew 12.9% to $475,405 from $421,260 for thecomparable period in 2003.  The increasein our operating costs was primarily due to**foreigncurrency translation, increased cost of data, increases in costs related toconsulting and services, and operating costs of acquired businesses.  The effect of foreign currency translationincreased our operating costs by approximately $7,000 for the third quarter of2004 as compared to the third quarter of 2003 and $24,000 for the first ninemonths of 2004 as compared to the first nine months of 2003.  Excluding the effect of the change in foreigncurrency translation, our operating costs grew 9.7% in the third quarter of 2004as compared to the third quarter of 2003 and grew 7.2% in the first nine monthsof 2004 as compared to the first nine months of 2003.

 

Operating costs haveincreased at a rate approximately equal to the increase in revenue in the firstnine months of 2004 as compared to the first nine months of 2003.  Our operating costs generally have increasedat a rate greater than operating revenues in each of the last two full fiscalyears.  This increase has been due to theimpact of foreign currency translation, higher data costs to support revenue growth,and acquisitions.

 

***Sellingand Administrative Expenses***

 

Our selling andadministrative expenses consist primarily of the costs attributable to sales,marketing and administration, including human resources, legal, management andfinance.  Our selling and administrativeexpenses grew 22.4% in the third quarter of 2004, to $94,460 from $77,181 inthe third quarter of 2003 and grew 18.2% to $280,956 from $237,773 in the firstnine months of 2004 compared to the first nine months of 2003, primarily due tothe following factors:

 

•                  *Foreign CurrencyTranslation*: The effect of foreign currency translation increasedour selling and administrative expenses by approximately $5,000 for the thirdquarter of 2004 as compared to the third quarter of 2003 and $16,000 for thefirst nine months of 2004 compared to the first nine months of 2003.  Excluding the effect of the change in foreigncurrency translation, our selling and administrative expenses grew 16.2% in thethird

 

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quarter of 2004 as compared to the third quarter of2003 and 11.3% in the first nine months of 2004 as compared to the first ninemonths of 2003.

 

•                  *Sales and Marketing*:Sales and marketing expense increased by approximately $1,000 in the third quarterof 2004, compared to the third quarter of 2003 and increased by approximately$10,000 in the first nine months of 2004, compared to the first nine months of2003 to support operating revenue growth.

 

•                  *Consulting*:  Consulting and services expenses increased byapproximately $7,000 in the third quarter of 2004, compared to the thirdquarter of 2003 and increased by approximately $9,000 in the first nine monthsof 2004, compared to the first nine months of 2003 to support growth in thisproduct category.

 

***Depreciationand Amortization***

 

Our depreciation andamortization charges increased 26.9% to $23,355 in the third quarter of 2004,from $18,398 in the third quarter of 2003, primarily due to computer softwareamortization associated with new products, which increased by approximately$5,000 in the third quarter of 2004 compared to the third quarter of 2003.  Depreciation and amortization chargesincreased 22.4% to $67,378 in the first nine months of 2004, from $55,027 inthe first nine months of 2003, primarily due to computer software amortizationassociated with new products, which increased by approximately $11,000.

 

***Severance,Impairment and Other Charges***

 

During the first quarterof 2003, we recorded a $37,220 pretax charge for severance, impairment andother charges, consisting primarily of severance charges of approximately$9,958 for approximately 80 employees, charges to exit data supply andprocessing contracts of $16,500, lease obligations associated with abandonedproperties of $5,807, and approximately $4,955 to write down computer softwareto its net realizable value.  For moredetail concerning these changes see Note 8 to the Consolidated FinancialStatements and the discussion of “Severance, Impairment and Other Charges” inthe Management Discussion and Analysis, both in our Annual Report on Form 10-Kfor the year ended December 31, 2003.

 

***Trendsin our Operating Margins***

 

Our operating margin forboth the third quarter and first nine months of 2004 were 26.8%, as compared to31.2% and 24.7% in the third quarter of 2003 and first nine months of 2003,respectively.  The decrease in ouroperating margin for the third quarter is primarily due to continuinginvestments in new products and consulting and services capabilities andincreased cost of data.  The improvementin our operating margins for the first nine months of 2004 was primarily due tothe absence in 2004 of the Severance, impairment and other charges of $37,220recorded in the first quarter of 2003.

 

Operating marginsgenerally have declined over the past two years and may continue to decline infuture periods as we invest in acquisitions and new products and services todrive future revenue growth.

 

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Recent acquisitions havealso had an adverse effect on our operating margins due to the fact that someof our acquisitions of small, niche businesses have historically experiencedlower operating margins than ours, and the revenue and cost synergies that weincorporate into our business plans are not all immediately realized.  We also experience higher intangibleamortization in the first years after completing an acquisition and may incuradditional costs in integrating the acquired operations into ours, both ofwhich tend to increase our costs and thus decrease our operating margins in theinitial years of each completed acquisition.

 

***Non-OperatingIncome (Loss)***

 

Our non-operating lossincreased 80.0% to a net loss of $4,040 in the third quarter of 2004 from a netloss of $2,245 in the third quarter of 2003 and grew 100.7% to a net gain of$201 in the nine months ended September 30, 2004 from a net loss of $29,444 inthe nine months ended September 30, 2003. The increase in our non-operating income was primarily due to thefollowing factors:

 

•                  *Gains from Investments*:We had gains from investment of $2,188 during the third quarter of 2004,primarily as a result of the sale of investments in the Enterprisesportfolio.  Gains from investment in thethird quarter of 2003 were $1,964. We had gains from investment of $10,715during the first nine months of 2004, primarily as a result of the sale ofinvestments in the Enterprises portfolio. Gains from investment in the first nine months of 2003 were $1,120.

 

*Other Income*:Other income (expense), net, increased primarily due to net foreign exchangegains/(losses) of $(502) and $5,089 in the third quarter and first nine monthsof 2004, respectively, compared with net foreign exchange gains/(losses) of$222 and $(16,762) in the third quarter and first nine months of 2003,respectively.

 

***Taxes***

 

For the nine months endedSeptember 30, 2004, our effective tax rate was impacted by approximately$15,100, primarily due to a favorable partial U.S. audit settlement.  For the nine months ended September 30, 2003,our effective tax rate was impacted by approximately $69,600, due to ourreassessment, based on information received in April 2003, of our liabilityassociated with certain D&B Legacy Tax Matters and related subsequenttransactions.  This is more fully describedin Note 9 to the Condensed Consolidated Financial Statements (unaudited).  Further, our effective tax rate for the ninemonths ended September 30, 2003 was affected by the favorable settlement of anon-U.S. audit which approximated $13,900.

 

For all periodspresented, our effective tax rate was reduced as a result of global taxplanning initiatives.  While we intend tocontinue to seek global tax planning initiatives, there can be no assurancethat we will be able to successfully implement such initiatives to reduce ormaintain our overall tax rate.

 

***TriZetto***

 

In the first quarter of2003, we recorded an impairment charge of $14,842, net of taxes of $9,565, towrite down our investment in TriZetto following the continued significantdecline in the market

 

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value of TriZetto shares below our carryingvalue.  We concluded that this declinewas other-than-temporary in accordance with SAB No. 59, “Views on Accountingfor Noncurrent Marketable Equity Securities.” As of March 31, 2003, TriZetto shares closed at $4.13 compared to ourbook value per share of $6.14 prior to recording the impairment charge.  As of September 30, 2004, the market value ofTriZetto exceeded our carrying value by approximately $29,111.  There can be no assurance that TriZettoshares will continue to trade above our carrying value or that furtherimpairment charges will not be required.

 

TriZetto equity income,net, of $662 and $218 was recorded in the three months ended September 30, 2004and 2003, respectively.  A charge forTriZetto equity loss, net, of $607 and $181 was recorded in the nine monthsended September 30, 2004 and 2003, respectively.  We do not control TriZetto and our resultsmay be significantly affected by our share of its income or losses.

 

## **Operating Results by Geographic Region**

 

The following representsselected geographic information for the regions in which we operate for thethree and nine months ended September 30, 2004 and 2003:

 
| ** **                                 | ** ** | **Americas  (1)** | ** ** | **Europe  (2)** | ** ** | **Asia Pacific  (3)** | ** ** | **Corporate &  Other** | ** ** | **Total  IMS** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-----------------|------------|-----------------------|------------|----------------------------|------------|----------------|------------|
| **Three Months Ended September 30, 2004:** |       |              |       |            |       |                  |       |                       |       |           |       |
| Operating  revenue (4)                     |       | $                 | 175,660    |            | $          | 156,643               |       | $                          | 51,868     |           | —     |   | $ | 384,171 |   |
| Operating income (5)                       |       | $                 | 78,756     |            | $          | 24,300                |       | $                          | 26,790     |           | $          | (26,955 | ) | $ | 102,891 |   |
| **Nine Months Ended September 30, 2004:**  | ** ** | ** **        | ** ** | ** **      | ** ** | ** **            | ** ** | ** **                 | ** ** | ** **     | ** ** |
| Operating revenue (4)                      |       | $                 | 515,063    |            | $          | 456,016               |       | $                          | 154,251    |           | —     |   | $ | 1,125,330 |   |
| Operating income (5)                       |       | $                 | 227,238    |            | $          | 80,500                |       | $                          | 80,838     |           | $          | (86,985 | ) | $ | 301,591 |   |
| **Three Months Ended September 30, 2003:** |       |              |       |            |       |                  |       |                       |       |           |       |
| Operating  revenue (4)                     |       | $                 | 168,747    |            | $          | 129,439               |       | $                          | 47,792     |           | —     |   | $ | 345,978 |   |
| Operating income (5)                       |       | $                 | 81,489     |            | $          | 22,648                |       | $                          | 28,288     |           | $          | (24,483 | ) | $ | 107,942 |   |
| **Nine Months Ended September 30, 2003:**  |       |              |       |            |       |                  |       |                       |       |           |       |
| Operating revenue (4)                      |       | $                 | 480,476    |            | $          | 377,375               |       | $                          | 139,820    |           | —     |   | $ | 997,671 |   |
| Operating income (5)                       |       | $                 | 221,313    |            | $          | 67,398                |       | $                          | 81,472     |           | $          | (123,792 | ) | $ | 246,391 |   |

 

**Notes to Geographic FinancialInformation:**

 

*(1)**       Americasincludes the United States, Canada and Latin America.*

 

*(2)**       Europeincludes countries in Europe, the Middle East and Africa.*

 

*(3)**       AsiaPacific includes Japan, Australia and other countries in the Asia Pacificregion.*

 

*(4)**       Operatingrevenue relates to external customers and is primarily based on the location ofthe customer.  The operating revenue forthe geographic regions includes the impact of foreign exchange in convertingresults into U.S. Dollars.*

 

(5)          *Operating income for the three geographic regions does not reflect theallocation of certain expenses that are maintained in Corporate and Other andas such, is not a true measure of the respective regions’ profitability.  For the three months ended March 31, 2003,Severance, impairment and other charges of $17,369, $5,040 and*

 

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*$11,081 for the Americas, Europe and Asia Pacific,respectively, are presented in Corporate and Other.  The operating income for the geographicsegments includes the impact of foreign exchange in converting results intoU.S. Dollars.*

 

***Americas Region***

 

Operatingrevenue growth in the Americas region was 4.1% in the third quarter of 2004,compared to the third quarter of 2003, primarily due to strong performance inthe consulting and services business in the U.S. and Canada, and continuedstrength of the sales force effectiveness business line, particularly in LatinAmerica.  Operating revenue growth was7.2% in the first nine months of 2004, compared to the first nine months of2003, primarily due to increases in all areas of the region for our core salesforce effectiveness and portfolio optimization offerings.  Growth was also strong in our consulting andservices line in the United States and Canada.

 

Operatingincome in the Americas region declined 3.4% in the third quarter of 2004,compared to the third quarter of 2003. The operating income decline was due to investment in global consultingcapabilities and higher data collection costs and software development tosupport new products. Operating income growth was 2.7% in the first nine monthsof 2004, compared to the first nine months of 2003, primarily due to increasedrevenue offset by increased costs of data, investments in product developmentand acquisitions.

 

***Europe Region***

 

Operatingrevenue growth in the Europe region was 21.0% in the third quarter of 2004,compared to the third quarter of 2003, primarily due to growth in core salesforce effectiveness products, our next-generation MIDAS offering, strong growthin our services and consulting business as well as foreign exchange.  Operating revenue growth was 20.8% in thefirst nine months of 2004, compared to the first nine months of 2003, primarilydue to strong growth in the consulting and services business and the salesforce effectiveness business line, as well as foreign exchange.

 

Operatingincome in the Europe region increased by 7.3% in the third quarter of 2004,compared to the third quarter of 2003. The operating income growth in 2004 was primarily driven by operatingrevenue growth offset by investments in the consulting business andacquisitions. Operating income growth was 19.4% in the first nine months of2004, compared to the first nine months of 2003, primarily driven by operatingrevenue growth.

 

***Asia Pacific Region***

 

Operatingrevenue in the Asia Pacific region increased 8.5% in the third quarter of 2004,compared to the third quarter of 2003, due to foreign exchange and continuedstrong growth in the region, excluding Japan. Operating revenue growth was 10.3% in the first nine months of 2004,compared to the first nine months of 2003, primarily due to foreign exchangeand strong growth in the region outside of Japan.  Operating revenue growth in Japan wasadversely affected by a data supplier issue that had resulted in theinterruption of the data supply used in a weekly product.  We discontinued that product at the end ofthe first quarter of 2003 and it has not yet been replaced with a new product.

 

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Operating income in the Asia Pacific region decreased by5.3% in the third quarter of 2004, compared to the third quarter of 2003,primarily due to the operating revenue issues discussed above.  Operating income decreased 0.8% in the firstnine months of 2004, compared to the first nine months of 2003.  The decline in operating margin in the regionwas due to the impact of the revenue decline in Japan from the discontinuationof the weekly product; because costs are primarily fixed in nature, the revenuedecline produced an operating income decline. In addition, we are incurring expenses to develop new products andservices in Japan that are intended to replace and grow those revenues lostfrom the discontinuation of the weekly product.

 

### **How Exchange Rates Affect Our Results**

 

We operate globally,deriving a significant portion of our operating income from non-U.S.operations.  As a result, fluctuations inthe value of foreign currencies relative to the U.S. Dollar may increase thevolatility of our U.S. Dollar operating results.  We enter into forward foreign currencycontracts to partially offset the effect of currency fluctuations.  In 2004, foreign currency translationincreased our U.S. Dollar revenue growth by approximately 4.1 percentage pointsin the third quarter and 5.1 percentage points in the first nine months, whilethe impact on our operating income growth was an approximate increase of 1.6percentage points in the third quarter and 3.1 percentage points in the firstnine months.

 

Our non-U.S. monetaryassets are maintained in currencies other than the U.S. Dollar, principally theEuro, the Japanese Yen, the British Pound, the Swiss Franc and the CanadianDollar.  Where monetary assets are heldin the functional currency of the local entity, changes in the value of thesecurrencies relative to the U.S. Dollar are charged or credited to Cumulativetranslation adjustment in our Condensed Consolidated Statements ofShareholders’ Equity (unaudited).  Theeffect of exchange rate changes during 2004 decreased our U.S. Dollar amount ofCash and cash equivalents by $1,090.

 

***Liquidityand Capital Resources***

 

On February 6, 2003, wedivested CTS through a split-off transaction, and as a result, our share of CTSresults are presented as discontinued operations for 2003 through the date ofdivestiture (see Note 6 to our unaudited Condensed Consolidated FinancialStatements).

 

Our cash and cashequivalents increased $59,201during the first nine months of 2004 to $403,633at September 30, 2004 compared to $344,432 at December 31, 2003.  The increase primarily reflects cash wegenerated from operating activities of $274,481,offset by cash used in investing and financing activities of $74,519 and$139,671, respectively.  Including the change in short-term marketablesecurities, which is included in cash used in investing activities, our cash andcash equivalents and short-term marketable securities increased to $425,874 atSeptember 30, 2004 compared to $384,540 at December 31, 2003, an increase of$41,334.

 

We currently expect that we will use ourcash and cash equivalents primarily to fund:

 

•      development of software to be used in our newproducts and capital expenditures to expand and upgrade our informationtechnology capabilities and to build or acquire facilities to house

 

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our growing business (we currently expect to spend approximately$85,000 to $95,000 during 2004 for software development and capitalexpenditures);

 

•      acquisitions;

 

•      share repurchases;

 

•      dividends to our shareholders (we expect 2004dividends will be $0.08 per share or approximately $19,000);

 

•      payments for tax related matters, including theD&B Legacy Tax Matters discussed further in Note 9 to our CondensedConsolidated Financial Statements (unaudited). Payments for certain of the D&B Legacy Tax Matters could be up toapproximately $42,000 in the last quarter of 2004; and

 

•      pension plancontributions (we currently expect contributions to U.S. and non-U.S. pensionplans to total approximately $21,000 in 2004).

 

Netcash provided by operating activities amounted to $274,481 for the nine months ended September 30, 2004, a decreaseof $544 over the comparableperiod in 2003.  The decrease relatesprimarily to the funding of income taxes, accrued and other current liabilitiesduring the nine months ended September 30, 2004, and the payment from NielsenMedia Research in 2003, as discussed in Note 9 to the Condensed ConsolidatedFinancials Statements (unaudited), with no comparable payment in the sameperiod in 2004, offset by higher income from continuing operations in the firstnine months of 2004.

 

Netcash used in investing activities amounted to $74,519 for the nine months ended September 30, 2004, a decreasein cash used of $57,096 overthe comparable period in 2003.  The lowercash requirements during the first nine months of 2004 relate primarily to thefact that we made net payments of $23,078 for acquisitions during the firstnine months of 2004, compared to net payments of $52,237 made for acquisitionsduring the comparable period in 2003.  Wealso had a $27,650 reduction in funding requirements for short-term marketablesecurities for the first nine months****of2004 compared with 2003.

 

Netcash used in financing activities amounted to $139,671 for the nine months ended September 30, 2004, anincrease of $32,863 over thecomparable period in 2003.  This increasewas primarily due to an increase of $179,139 for payments to purchase our stockduring the first nine months of 2004 compared with the comparable period in2003, offset by a $69,378 increase in proceeds we received from the exercise ofstock options by our employees and a $77,181 net increase in our borrowingsduring the first nine months of 2004 compared with the comparable period in2003.

 

Our financing activitiesinclude cash dividends we paid of $0.02 per share quarterly, which amounted to$14,204 and $14,575 during the first nine months of 2004 and 2003,respectively.  The payments and level ofcash dividends made by us are reviewed quarterly and are subject to the discretionof our Board of Directors.  Any futuredividends, other than the $0.02 per share quarterly dividends for 2004, whichwere declared by our Board of Directors in February 2004, April 2004,

 

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July 2004 and October 2004, will be based on, andaffected by, a number of factors, including our operating results and financialrequirements.

 

**Tax and other Contingencies**

 

Weare exposed to certain known tax and other contingencies that are material toour investors.  The facts and circumstances surrounding thesecontingencies and a discussion of their effect on us are included in Note 9 toour Condensed Consolidated Financial Statements (unaudited) for the periodended September 30, 2004.  We do not knowof any material tax or other contingencies, other than those described in Note9 to our Condensed Consolidated Financial Statements (unaudited).

 

Thesecontingencies may have a material effect on our liquidity, capitalresources or results of operations.  Although we have established reservesfor D&B Legacy Tax Matters, a 1998 non-U.S. tax reorganization and certaintax return positions in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 5, “Accounting for Contingencies”, the actual liabilityfor these matters may exceed the amount of the reserve.  We have not established any reserves inrespect of the other contingencies described in Note 9 to the CondensedConsolidated Financial Statements (unaudited).  In addition, even whereour reserves are adequate, the incurrence of any of these liabilities may havea material effect on our liquidity and the amount of cash available to us forother purposes.

 

Managementbelieves that we have made appropriate arrangements in respect of the futureeffect on us of these known tax and other contingencies.  Managementalso believes that the amount of cash available to us from our operations,together with cash from financing, will be sufficient for us to pay any knowntax and other contingencies as they become due without materially affecting ourability to conduct our operations and invest in the growth of ourbusiness.

 

**Stock Repurchase Programs**

 

Our share repurchaseprogram has been developed to buy opportunistically, when we believe that ourshare price provides us with an attractive use of our cash flow and debtcapacity.

 

On February 10, 2004, ourBoard of Directors authorized a stock repurchase program to buy up to 10,000shares.  As of September 30, 2004,approximately 4,400 shares remained available for repurchase under the February2004 program.

 

On April 15, 2003, ourBoard of Directors authorized a stock repurchase program to buy up to 10,000shares.  We completed this program in May2004 at a total cost of $243,520.

 

On July 19, 2000, ourBoard of Directors authorized a stock repurchase program to buy up to 40,000shares.  We completed this program inJune 2003 at a total cost of $868,314.

 

During the nine monthsended September 30, 2004, we repurchased approximately 11,176 shares ofoutstanding common stock under these programs, including the repurchase of4,600 shares on January 9, 2004 pursuant to an accelerated share repurchase program (“ASR”).  The ASR agreement provides for the finalsettlement of the contract in either cash or additional shares of our commonstock at our sole discretion.** **We were required to pay anadditional $942 as the final settlement

 

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amountbased on an increase in our share price over the settlement period.  The total cost of the shares repurchasedduring the nine months ended September 30, 2004 was $277,075.

 

Shares acquired throughour repurchase programs described above are open-market purchases or privatelynegotiated transactions in compliance with Securities and Exchange CommissionRule 10b-18.

 

**Debt**

 

In recent years, we haveincreased debt levels to balance appropriately the objective of generating anattractive cost of capital with providing us a reasonable amount of financialflexibility.  At September 30, 2004, ourdebt totaled $634,604, and management does not believe that this level of debtposes a material risk to us due to the following factors:

 

•      in each of the last two years, we havegenerated strong net cash provided by operating activities in excess of$300,000;

 

•      at September 30, 2004, we had $425,874 inworldwide cash and cash equivalents and short-term marketable securities;

 

•      at September 30, 2004, we had $220,800 ofunused debt capacity under our existing bank credit facilities ($27,800 and$193,000 available under our long and short-term lines, respectively); and

 

•      we believe that we have the ability to obtainadditional debt capacity outside of our existing debt arrangements.

 

Wehad borrowing arrangements with several domestic and international banks toprovide lines of credit up to $700,000 at September 30, 2004.  Total borrowings under these existing lineswere $479,200 and $407,600 at September 30, 2004 and December 31, 2003,respectively, of which $237,000 and $407,600 were classified as short-term and$242,200 and $0 were classified as long-term as of September 30, 2004 andDecember 31, 2003, respectively.

 

OnApril 5, 2004, we entered into a $700,000 revolving credit facility with asyndicate of 12 banks (the “Unsecured Facility”).  The Unsecured Facility replaced our lines of creditwith several domestic and international banks. The Unsecured Facility is comprised of $430,000 of short-term lines thatexpire April 2005 and $270,000 of long-term lines expiring April 2007.  In general, rates for borrowing under boththe short-term and long-term components are LIBOR plus 45 basis points and canvary based on our Debt to EBITDA ratio. The weighted average interest rates for our short-term lines were 2.28%and 1.61% at September 30, 2004 and December 31, 2003, respectively.  The weighted average interest rates for ourlong-term lines were 2.28% and 1.84% at September 30, 2004 and December 31,2003, respectively.  In addition, we willpay a commitment fee on the unused portion of the short-term and long-termfacilities of 0.08% and 0.10%, respectively.

 

We define long-term linesas those where the lines are non-cancelable for more than 365 days from thebalance sheet date by the financial institutions except for specifiedviolations of the

 

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provisions of the agreement.  Borrowings under these three-year facilitiesare short-term in nature; however, we have the ability and the intent torefinance the short-term borrowings as they come due through April 2007.  At September 30, 2004, we reclassified$242,200 of our short-term debt outstanding as long-term debt in accordancewith the provisions of SFAS No. 6, “Classification of Short-Term ObligationsExpected to be Refinanced.”

 

Our total debt of$634,604 and $561,991 at September 30, 2004 and December 31, 2003,respectively, included $150,000 of private placement debt (as further discussedbelow), and $5,204 and $4,391 at September 30, 2004 and December 31, 2003,respectively, related primarily to cash overdrafts, certain capital leases, mortgagesand an adjustment to the carrying amount of fair value hedged debt.  At September 30, 2004, we had $27,800 and$193,000 available under our long and short-term lines of credit, respectively.

 

During the fourth quarterof 2001, we renegotiated with several banks and entered into three-year linesof credit for borrowings of up to $175,000. Borrowings had maturity dates of up to 90 days from theirinception.  These lines of credit weredue to mature in 2004 and as such $175,000 was reclassified to short-term as ofDecember 31, 2003.

 

In March and April 2002,we entered into interest rate swaps on a portion of our variable rate debtportfolio.  These arrangements convertthe variable interest rates to a fixed interest rate on a notional amount of $75,000and mature at various times from March 2005 through April 2006.  The fixed rates range from 4.05% to5.08%.  We accounted for the interestrate swaps as cash flow hedges and we recorded any changes in fair value inOther Comprehensive Income, in our Condensed Consolidated Statements ofShareholders’ Equity (unaudited).  Wedetermine the fair values based on estimated prices quoted by financialinstitutions.  The mark-to-market adjustmentfor the three and nine months ended September 30, 2004 was an unrealized netloss of 383 and $1,359, respectively.

 

InJanuary 2003, we closed a private placement transaction pursuant to which weissued $150,000 of five-year debt to several highly rated insurance companiesat a fixed rate of 4.60%.  We used theproceeds to pay down short-term debt.  Wealso swapped $100,000 of our fixed rate debt to floating rate based onsix-month LIBOR plus a margin of approximately 107 basis points.  We accounted for these swaps as fair valuehedges under the provisions of SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities.”  Wedetermined the fair values based on estimated prices quoted by financialinstitutions.  The cumulative fair valueadjustment to the swap as of September 30, 2004 was an increase of $727.

 

Ourfinancing arrangements provide for certain covenants and events of defaultcustomary for similar instruments, including in the case of our main bankarrangements and the 2003 private placement transaction, covenants to maintainspecific ratios of consolidated total indebtedness to EBITDA and of EBITDA tocertain fixed charges.  At September 30,2004, we were in compliance with these financial debt covenants and weanticipate that we will remain in compliance with the covenants over the termof the borrowing arrangements.

 

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**Severance, Impairment and Other Charges**

 

During the three monthsended March 31, 2003, we recorded $37,220 of severance, impairment and othercharges (the “first quarter charge”) as a component of operating income.  We incurred these charges due to a number ofbusiness and strategic factors affecting us:

 

•      severance-related charges of $9,958 wereincurred in an effort to streamline operations and increase productivitythrough a worldwide reduction in headcount of approximately 80 employees.  This reduction in headcount was primarilyfocused on upgrading the skills and capabilities of our employee base as wetransform the business to provide new and enhanced analytical and consulting offeringsto our customers.  The reduction inheadcount also led to charges for impaired leases in the U.S. and U.K. foroffice space no longer being used by us and for which we had not been able toobtain subleases at rates comparable to the terms of our leaseobligations.  These severance benefitswere calculated pursuant to the terms of established employee protection plans,in accordance with local statutory minimum requirements or individual employeecontracts, as applicable;

 

•      contract-related charges of $22,307 wereincurred for impaired data supply, data processing and impaired lease contractsin our U.S. and Japanese operations.  Animpairment for a data supply contract in the U.S. was realized due to the factthat in the first quarter of 2003 we determined that expected revenues under aco-marketing agreement with a data supplier would not be generated, but we arestill required to make payments under the terms of the contract.  We also realized an impairment for a dataprocessing contract in Japan related to a weekly data product in Japan that wasdiscontinued at the end of the first quarter of 2003, due to the interruptionin data supply; and

 

•      assetwrite-downs of $4,955 were recorded to write-down certain of our computersoftware primarily in the U.S. and Japan to its net realizable value.  In the U.S., our decision to change theunderlying technology in a product required the write-down of a previousversion.  In Japan, the termination ofour weekly data product required the write-down of our software used for thatproduct.

 
| ** **                    | ** ** | **Severance  related charges** | ** ** | **Contract  related charges** | ** ** | **Asset  write-downs** | ** ** | **Total** | ** ** |
|-------------------------------|------------|--------------------------------|------------|-------------------------------|------------|------------------------|------------|-----------|------------|
| Charge at March 31, 2003      |       | $                              | 9,958      |                          | $          | 22,307                 |       | $         | 4,955      |   | $ | 37,220 |   |
| 2003 Utilization              |       | (6,197                         | )          | (7,047                        | )          | (6,634                 | )          | (19,878   | )          |
| 2004 Utilization              |       | (1,447                         | )          | (2,727                        | )          | —                 |       | (4,174    | )          |
| Adjustments                   |       | (1,746                         | )          | 67                            |       | 1,679                  |       | —    |       |
| Balance at September 30, 2004 |       | $                              | 568        |                          | $          | 12,600                 |       | $         | 0          |   | $ | 13,168 |   |

 

Thecash portion of the first quarter charge amounted to $30,586, of which we paidapproximately $13,244 during 2003 and $4,174 during the nine months endedSeptember 30, 2004, related primarily to employee termination benefits andcontract-related charges.  The remainingaccrual of $13,168 at September 30, 2004 relates to contract relatedobligations and continuing payments related to employee termination benefits.

 

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We expect that cashoutlays will be applied against the $13,168 balance remaining as follows:

 

| **Year Ended  December 31,** | ** ** | **Cash Outlays** | ** ** |
|------------------------------|------------|------------------|------------|
| 2004                         |       | $                | 1,718      |   |
| 2005                         |       | 7,917            |       |
| 2006                         |       | 923              |       |
| 2007                         |       | 752              |       |
| 2008                         |       | 228              |       |
| Thereafter                   |       | 1,630            |       |
| Total                        |       | $                | 13,168     |   |

 

Duringthe nine months ended December 31, 2003, we reversed approximately $1,750 ofseverance related charges originally included in the first quarter charge due toour refinement of estimates.  We alsorecorded additional charges during 2003 of approximately $1,700 relatedprimarily to a software impairment.

 

Weexpect that future results will benefit from the first quarter charge to theextent of the contract-related charges and asset write-downs primarily through2007.  Our severance actions related to ashifting of resources and as such are not expected to generate material costsavings.  The income statement lines thatwill be impacted in future periods are Operating costs for the contract-relatedcharges and Depreciation and amortization for the asset write-downs.  However, we do not expect a material impacton future cash flows due to the fact that we are still contractually obligatedto continue to make payments under impaired contracts.

 

***RecentlyIssued Accounting Standards***

 

In January 2003, theFinancial Accounting Standards Board (“FASB”) issued Interpretation No. 46,“Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,”(“FIN 46”).  FIN 46 requires all VariableInterest Entities (“VIEs”) to be consolidated by the primary beneficiary.  The primary beneficiary is the entity thatholds the majority of the beneficial interests in the VIE.  In addition, FIN 46 expands disclosurerequirements for both VIEs that are consolidated as well as VIEs from which theentity is the holder of a significant amount of the beneficial interest, butnot the majority.  In December 2003, theFASB issued Interpretation 46R, “Consolidation of Variable Interest Entities”(revised December 2003), (“FIN 46R”) which further clarified the provisions ofFIN 46 and delayed the effective date for applying the provisions of FIN 46until the end of the first quarter of 2004 for interests held by publicentities in VIEs or potential VIEs created before February 1, 2003.  The adoption of FIN 46R did not have amaterial impact on our financial position, results of operations or cash flowsfor the three and nine months ended September 30, 2004.

 

In December 2003, theFASB issued SFAS No. 132 (revised 2003), “Employer’s Disclosures about Pensionsand Other Postretirement Benefits,” an amendment of SFAS Nos. 87, “Employers’Accounting for Pensions”, 88, “Employers’ Accounting for Settlements andCurtailments of Defined Benefit Pension Plans and for Termination of Benefits,”and 106, “**Employers’ Accountingfor Postretirement Benefits Other Than Pensions,”** and arevision of SFAS No. 132.  SFAS No. 132(revised 2003) requires additional disclosures about the assets, obligations, cashflows, and net periodic benefit cost of defined benefit pension plans and otherpostretirement benefit plans, but does not change the measurement orrecognition of such plans.  The newdisclosure requirements contained in SFAS No. 132 (revised 2003) are effectivefor fiscal years ending after December 15,

 

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2003, with a delayedeffective date for certain disclosures, for foreign plans, and for non-publicentities.  We have adopted all aspects ofSFAS No. 132 (revised 2003) for all foreign and non-foreign plans, with theexception of the estimated future benefit payment disclosure.  This requirement was first effective forfiscal years ending after June 15, 2004. Additionally, we are required to disclose components of the net benefitcost in quarterly financial statements beginning with the first quarter of2004.  This interim disclosureinformation is included in Note 11 to the Condensed Consolidated Financial Statements(unaudited).  The adoption of SFAS No.132 (revised 2003) did not have a material impact on our financial position,results of operations or cash flows for the three and nine months endedSeptember 30, 2004.

 

In December 2003,the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the“Act”) was signed into law in the U.S. The Act introduced a prescription drug benefit under Medicare Part D anda federal subsidy to sponsors of retirement health care plans that provide abenefit that is at least actuarially equivalent to Medicare Part D.  In May 2004, the FASB issued Staff PositionNo. (“FSP”) FAS 106-2, “Accounting and Disclosure Requirements Related to theMedicare Prescription Drug, Improvement and Modernization Act of 2003.”  This statement requires entities to disclosethe effects of the Act and to assess the impact of the subsidy on theaccumulated postretirement benefit obligation and the net periodicpostretirement benefit cost in the first interim period beginning after June15, 2004.  FAS 106-2 was first effectivefor the quarter ended September 30, 2004. The adoption of FAS 106-2 did not have a material effect on theCompany’s financial position, results of operations or cash flows for the threeand nine months ended September 30, 2004.

 

***Forward-Looking Statements***

 

This Quarterly Report onForm 10-Q, as well as information included in oral statements or other writtenstatements made or to be made by us, contain statements that, in our opinion,may constitute “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995. The words such as “believe,” “expect,” “anticipate,” “intend,” “plan,”“foresee,” “likely,” “project,” “estimate,” “will,” “may,” “should,” “future,”“predicts,” “potential,” “continue” and similar expressions identify theseforward-looking statements, which appear in a number of places in thisQuarterly Report and include, but are not limited to, all statements relatingto plans for future growth and other business development activities as well ascapital expenditures, financing sources, dividends and the effects ofregulation and competition, foreign currency conversion and all otherstatements regarding the intent, plans, beliefs or our expectations or ourdirectors or officers.  Investors arecautioned that such forward-looking statements are not assurances for futureperformance or events and involve risks and uncertainties that could causeactual results and developments to differ materially from those covered in suchforward-looking statements.  These risksand uncertainties include, but are not limited to:

 

•      risks associated with operating on a globalbasis, including fluctuations in the value of foreign currencies relative tothe U.S. Dollar, and the ability to successfully hedge such risks – we derivedapproximately 61% of our operating revenue in 2003 from non-U.S. operations;

 

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•      to the extent we seek growth throughacquisitions, alliances or joint ventures, the ability to identify, consummate andintegrate acquisitions, alliances and ventures on satisfactory terms;

 

•      our ability to develop new or advancedtechnologies, including sophisticated information systems, software and othertechnology used to deliver our products and services and to do so on a timelyand cost-effective basis, and the exposure to the risk of obsolescence orincompatibility of these technologies with those of our customers or suppliers;

 

•      our ability to maintain and defend ourintellectual property rights in jurisdictions around the world;

 

•      our ability to successfully maintain historiceffective tax rates;

 

•      competition, particularly in the markets forpharmaceutical information;

 

•      regulatory, legislative and enforcementinitiatives to which we are or may become subject, relating particularly to taxand to patient privacy and the collection and dissemination of data andspecifically, the use of anonymized patient-specific information, which weanticipate to be an increasingly important tool in the design, development andmarketing of pharmaceuticals;

 

•      regulatory, legislative and enforcementinitiatives to which our customers in the pharmaceutical industry are or maybecome subject restricting the prices that may be charged for subscription orother pharmaceutical products or the manner in which such products may bemarketed or sold;

 

•      deterioration in economic conditions,particularly in the pharmaceutical, healthcare, or other industries in whichour customers may operate;

 

•      consolidation in the pharmaceutical industry andthe other industries in which our customers operate;

 

•      the imposition of additional restrictions on ouruse of or access to data, or the refusal by data suppliers to provide data tous;

 

•      conditions in the securities markets that mayaffect the value or liquidity of portfolio investments, including theinvestment in TriZetto and management’s estimates of lives of assets,recoverability of assets, fair market value, estimates and liabilities andaccrued income tax benefits and liabilities;

 

•      to the extent unforeseen cash needs arise, theability to obtain financing on favorable terms; and

 

•      terrorist activity, the threat of such activity,and responses to and results of such activity and threats, including but notlimited to effects, domestically and/or internationally, on us, our

 

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personnel and facilities, our customers and suppliers,financial markets and general economic conditions.

 

Consequently, all theforward-looking statements contained in this Quarterly Report on Form 10-Q arequalified by the information contained herein, including, but not limited to,the information contained under this heading and our Condensed ConsolidatedFinancial Statements (unaudited) and notes thereto for the three and ninemonths ended September 30, 2004 and by the material set forth under theheadings “Business” and “Factors That May Affect Future Results” in our AnnualReport on Form 10-K for the year ended December 31, 2003.  We are under no obligation to publiclyrelease any revision to any forward-looking statement contained or incorporatedherein to reflect any future events or occurrences.

 

***Critical Accounting Policies***

 

*Income Taxes.*  In addition to the tax items discussed inNote 9 to the Condensed Consolidated Financial Statements (unaudited), we havetax reserves of approximately $27,500 that relate to various positions we havetaken on tax returns filed in numerous countries over the last severalyears.  These reserves represent our bestestimate of the probable liability should the tax return positions bechallenged by the relevant tax authorities. While the amount is material in the aggregate, no individual item ismaterial and no single event will have a material impact related to thesereserves.

 

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

 

Information in responseto this Item is set forth in “Note 10. Financial Instruments” in the Notes tothe Condensed Consolidated Financial Statements (unaudited) on pages 25 through27 hereof.

 

**Item4.  Controlsand Procedures**

 

(a)                                  Evaluation of Disclosure Controls andProcedures

 

The Company maintainsdisclosure controls and procedures that are designed to ensure that informationrequired to be disclosed in the reports that the Company files or submits tothe SEC under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms, and that such information isaccumulated and communicated to the Company’s management, including its ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures,management recognized that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, as the Company’s are designed to do, and managementnecessarily was required to apply its judgment in evaluating the cost-benefitrelationship of possible controls and procedures.

 

The Company’s Chief Executive Officer and****Chief Financial Officer have evaluated theeffectiveness of the Company’s disclosure controls and procedures (as such termis defined in Rules 13a-14c and 15d-14c under the Exchange Act) as of September30, 2004 (the “Evaluation Date”).  Basedon such evaluation, such officers have concluded that, as of the EvaluationDate, the Company’s disclosure controls and procedures are effective inalerting them on a timely basis to material information relating to the Company(including its consolidated subsidiaries) required to be included in theCompany’s periodic filings under the Exchange Act.

 

(b)                                 Changes in Internal Control over FinancialReporting

 

There have been nochanges in our internal control over financial reporting that occurred duringthe period covered by this report that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

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**PARTII.  OTHERINFORMATION**

 

**Item 1. Legal Proceedings**

 

Informationin response to this Item is incorporated by reference to the information setforth in “Note 9. Contingencies” in the Notes to the Condensed ConsolidatedFinancial Statements (unaudited) on pages 13 through 25 hereof.

 

**Item 2.  Changes in Securities, Use of Proceeds and IssuerPurchases of Equity Securities**

 

The following table provides information about the purchase by theCompany during the quarter ended September 30, 2004 of equity securities thatare registered by the Company pursuant to Section 12 of the Exchange Act. 

 
| **Period**           | ** ** | **Total Number  of Shares  Purchased(1)** | ** ** | **Average  Price Paid  per Share** | ** ** | **Total Number of Shares  Purchased Under  Publicly Announced  Programs** | ** ** | **Maximum Number of   Shares that May Yet Be  Purchased Under the   Programs(2)** | ** ** |
|----------------------|------------|-------------------------------------------|------------|------------------------------------|------------|---------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
|                 |       |                                      |       |                               |       |                                                                      |       |                                                                              |       |
| July 1-31, 2004      |       | 1,114,500                                 |       | 22.85                              |       | 1,114,500                                                                 |       | 6,415,100                                                                         |       |
|                 |       |                                      |       |                               |       |                                                                      |       |                                                                              |       |
| August 1-31, 2004    |       | 1,209,500                                 |       | 23.39                              |       | 1,209,500                                                                 |       | 5,205,600                                                                         |       |
|                 |       |                                      |       |                               |       |                                                                      |       |                                                                              |       |
| September 1-30, 2004 |       | 795,000                                   |       | 23.82                              |       | 795,000                                                                   |       | 4,410,600                                                                         |       |
| **Total**            |       | 3,119,000                                 |       | 23.31                              |       | 3,119,000                                                                 |       | 4,410,600                                                                         |       |

 

(1)          Allshares were repurchased through the Company’s publicly announced stockrepurchase programs.

 

(2)          OnApril 15, 2003, the Company announced a stock repurchase program to buy up to10,000,000 shares of the Company’s common stock.  The Company completed the April 2003 programduring the quarter ended June 30, 2004. On February 10, 2004, the Company announced a stock repurchase programto buy up to 10,000,000 shares of the Company’s common stock.  Unless terminated earlier by resolution ofthe Company’s Board of Directors, this program will expire when the Company hasrepurchased all shares authorized for repurchase thereunder.  As of September 30, 2004, 5,589,400 shareshad been purchased under the February 2004 program.

 

**Item 6.  Exhibits**

 
| ** ** | **Exhibit  Number** | ** ** | **Description of Exhibits**                                                               |
|------------|---------------------|------------|-------------------------------------------------------------------------------------------|
|       |                |       |                                                                                      |
|       | 10.1                |       | Form  of Non-Employee Directors’ Restricted Stock Unit Agreement                     |
|       |                |       |                                                                                      |
|       | 10.2                |       | Form  of Non-Employee Directors’ Stock Option Agreement                              |
|       |                |       |                                                                                      |
|       | 10.3                |       | Forms  A and B of Employees’ Restricted Stock Unit Agreements                        |
|       |                |       |                                                                                      |
|       | 10.4                |       | Forms  A, B and C of Employees’ Stock Option Agreements                              |
|       |                |       |                                                                                      |
|       | 31.1                |       | CEO  302 Certification pursuant to Rule 13a-14(a)/15d-14(a)                               |
|       |                |       |                                                                                      |
|       | 31.2                |       | CFO  302 Certification pursuant to Rule 13a-14(a)/15d-14(a)                               |
|       |                |       |                                                                                      |
|       | 32.1                |       | Joint CEO/CFO Certification Required Under Section  906 of the Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

 

 

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

 

 
|                    |   |   IMS  Health Incorporated        |
|-------------------------|--------|---------------------------------------------|
|                    |   |                                        |
|                    |   |                                        |
|                    | By:    |   /s/ Nancy E. Cooper             |   |
| Date:  November 5, 2004 |   |   Nancy E. Cooper                 |
|                    |   |   Senior Vice President and       |
|                    |   |   Chief Financial Officer         |
|                    |   |   (principal financial officer)   |
|                    |   |                                        |
|                    |   |                                        |
|                    |   |   /s/  Leslye G. Katz             |   |
| Date:  November 5, 2004 |   |   Leslye  G. Katz                 |
|                    |   |   Vice  President, Controller     |
|                    |   |   (principal  accounting officer) |

 

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# **EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Description of Exhibits**                                                                |
|---------------------|------------|--------------------------------------------------------------------------------------------|
|                |       |                                                                                       |
| 10.1                |       | Form  of Non-Employee Directors’ Restricted Stock Unit Agreement                      |
|                |       |                                                                                       |
| 10.2                |       | Form  of Non-Employee Directors’ Stock Option Agreement                               |
|                |       |                                                                                       |
| 10.3                |       | Forms  A and B of Employees’ Restricted Stock Unit Agreements                         |
|                |       |                                                                                       |
| 10.4                |       | Forms  A, B and C of Employees’ Stock Option Agreements                               |
|                |       |                                                                                       |
| 31.1                |       | CEO  302 Certification pursuant to Rule 13a-14(a)/15d-14(a)                                |
|                |       |                                                                                       |
| 31.2                |       | CFO  302 Certification pursuant to Rule 13a-14(a)/15d-14(a)                                |
|                |       |                                                                                       |
| 32.1                |       | Joint  CEO/CFO Certification Required Under Section 906 of the Sarbanes-Oxley Act of  2002 |

 

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