**UNI****TED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,DC  20549**

 

----

 

**FORM 10-Q**

 

**(Mark One)**

 

| **ý**                                                                                                                                                                                                                             |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**  |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                   |   |                                                                                               |
| **For the  quarterly period ended June 25, 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                ** |
|                                                                                                                                                                                                                                   |
| **Commission  File Number 0-23651**                                                                                                                                                                                                    |

 

----

 

**First Consulting Group, Inc.**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                                                  |   | **95-3539020**                      |
|---------------------------------------------------------------|--------|-------------------------------------|
| (State or other jurisdiction ofincorporation or organization) |   | (I.R.S. EmployerIdentification No.) |

 

**111 W.Ocean Blvd., 4th Floor, Long Beach, CA  90802**

(Address of principal executive offices including zip code)

 

**(562)624-5200**

(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed sincelast report)

 

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

 

**Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act).  **YesýNo o

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 
| **Common  Stock, $.001 par value** |   | **24,777,072**                      |
|------------------------------------|--------|-------------------------------------|
| (Class)                            |   | (Outstanding at July 23, 2004) |

 

 

----

 

**FirstConsulting Group, Inc.**

**Table of Contents**

 
| COVER PAGE                       |                                                                                                       |
|----------------------------------|------------------------------------------------------------------------------------------------------------|
|                             |                                                                                                       |
| TABLE OF CONTENTS                |                                                                                                       |
|                             |                                                                                                       |
| PART I.                          | FINANCIAL INFORMATION                                                                                      |   |
|                             |                                                                                                       |
|                             | ITEM 1. FINANCIAL STATEMENTS AND NOTES  (UNAUDITED)                                                        |   |
|                             |                                                                                                       |   |
|                             | Consolidated Balance Sheets                                                                                |   |
|                             |                                                                                                       |   |
|                             | Consolidated Statements of Operations                                                                      |   |
|                             |                                                                                                       |   |
|                             | Condensed Consolidated Statements of Cash  Flows                                                           |   |
|                             |                                                                                                       |   |
|                             | Notes to Consolidated Financial Statements                                                                 |   |
|                             |                                                                                                       |   |
|                             | ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND  RESULTS OF OPERATIONS |   |
|                             |                                                                                                       |   |
|                             | ITEM  3.  QUANTITATIVE AND QUALITATIVE  DISCLOSURES ABOUT MARKET RISKS                                |   |
|                             |                                                                                                       |   |
|                             | ITEM  4.  CONTROLS AND PROCEDURES                                                                     |   |
|                             |                                                                                                       |   |
| PART II.  OTHER INFORMATION |                                                                                                       |
|                             |                                                                                                       |   |
|                             | ITEM  1.  LEGAL PROCEEDINGS                                                                           |   |
|                             |                                                                                                       |   |
|                             | ITEM  2.  CHANGES IN SECURITIES                                                                       |   |
|                             |                                                                                                       |   |
|                             | ITEM  3.  DEFAULTS UPON SENIOR SECURITIES                                                             |   |
|                             |                                                                                                       |   |
|                             | ITEM 4.  SUBMISSION OF MATTERS  TO A VOTE OF SECURITY HOLDERS                                         |   |
|                             |                                                                                                       |   |
|                             | ITEM  5.  OTHER INFORMATION                                                                           |   |
|                             |                                                                                                       |   |
|                             | ITEM  6.  EXHIBITS AND REPORTS ON FORM 8-K                                                            |   |
|                             |                                                                                                       |
| SIGNATURES                       |                                                                                                       |
|                             |                                                                                                       |
| EXHIBIT INDEX                    |                                                                                                       |
|                                  |                                                                                                            |  |  |

 

2

----

 

# **PART I.  FINANCIALINFORMATION**

 

## **Item 1. Financial Statementsand Notes (Unaudited)**

 

**FirstConsulting Group, Inc. and Subsidiaries**

 

### **Consolidated Balance Sheets**

**(inthousands, except share and per share data)**

 
|                                                                                                                         |   | **June 25,  2004** |    | **December 26,  2003** |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                                                                                                                         |   | **(unaudited)**         |    |                        |   |
| **ASSETS**                                                                                                                   |   |                    |    |                        |   |
| Current assets:                                                                                                              |   |                    |    |                        |   |
| Cash and cash equivalents                                                                                                    |   | $                       | 20,051  |                        | $      | 26,826 |   |
| Short-term investments                                                                                                       |   | 25,083                  |    | 33,803                      |   |
| Accounts receivable, less allowance of  $2,081 and $1,974 as of June 25, 2004 and December 26, 2003,  respectively |   | 24,226                  |    | 27,564                      |   |
| Unbilled receivables                                                                                                         |   | 12,015                  |    | 9,947                       |   |
| Deferred income taxes                                                                                                        |   | 6,279                   |    | 6,279                       |   |
| Prepaid expenses and other current assets                                                                                    |   | 2,970                   |    | 1,713                       |   |
| Total current assets                                                                                                         |   | 90,624                  |    | 106,132                     |   |
|                                                                                                                         |   |                    |    |                        |   |
| Notes receivable – stockholders                                                                                         |   | 437                     |    | 432                         |   |
| Long-term investments                                                                                                        |   | 1,150                   |    | 3,216                       |   |
| Property and equipment:                                                                                                      |   |                    |    |                        |   |
| Furniture, equipment, and leasehold  improvements                                                                            |   | 4,470                   |    | 4,053                       |   |
| Information systems equipment                                                                                                |   | 24,847                  |    | 23,663                      |   |
|                                                                                                                         |   | 29,317                  |    | 27,716                      |   |
| Less accumulated depreciation and  amortization                                                                              |   | 19,240                  |    | 19,177                      |   |
|                                                                                                                         |   | 10,077                  |    | 8,539                       |   |
|                                                                                                                         |   |                    |    |                        |   |
| Other assets:                                                                                                                |   |                    |    |                        |   |
| Executive benefit trust                                                                                                      |   | 8,146                   |    | 8,144                       |   |
| Long-term account receivable                                                                                                 |   | 4,719                   |    | 5,768                       |   |
| Deferred income taxes                                                                                                        |   | 2,976                   |    | 4,329                       |   |
| Goodwill, net                                                                                                                |   | 17,801                  |    | 15,458                      |   |
| Intangibles, net                                                                                                             |   | 3,260                   |    | 3,800                       |   |
| Other                                                                                                                        |   | 2,641                   |    | 1,583                       |   |
|                                                                                                                         |   | 39,543                  |    | 39,082                      |   |
| Total assets                                                                                                                 |   | $                       | 141,831 |                        | $      | 157,401 |   |

 

The accompanying notes are an integral partof these financial statements.

 

3

----

 

**FirstConsulting Group, Inc. and Subsidiaries**

 

**ConsolidatedBalance Sheets**

**(inthousands, except share and per share data)**

 
|                                                                                                                                                                                                        |   | **June 25,  2004** |    | **December 26,  2003** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                                                                                                                                                                                                        |   | **(unaudited)**         |    |                        |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                               |   |                    |    |                        |   |
| Current liabilities:                                                                                                                                                                                        |   |                    |    |                        |   |
| Accounts payable                                                                                                                                                                                            |   | $                       | 2,106   |                        | $      | 1,806 |   |
| Accrued liabilities                                                                                                                                                                                         |   | 12,058                  |    | 11,544                      |   |
| Accrued payroll and related taxes                                                                                                                                                                           |   | 5,318                   |    | 5,778                       |   |
| Accrued restructuring                                                                                                                                                                                       |   | 2,114                   |    | 4,613                       |   |
| Accrued vacation                                                                                                                                                                                            |   | 7,411                   |    | 7,033                       |   |
| Accrued incentive compensation                                                                                                                                                                              |   | 2,252                   |    | 1,958                       |   |
| Customer advances                                                                                                                                                                                           |   | 7,814                   |    | 9,775                       |   |
| Total current liabilities                                                                                                                                                                                   |   | 39,073                  |    | 42,507                      |   |
| Non-current liabilities:                                                                                                                                                                                    |   |                    |    |                        |   |
| Accrued restructuring                                                                                                                                                                                       |   | 4,136                   |    | 4,686                       |   |
| Supplemental executive retirement plan                                                                                                                                                                      |   | 8,105                   |    | 7,741                       |   |
| Minority interest                                                                                                                                                                                           |   | —                  |    | 657                         |   |
| Total non-current liabilities                                                                                                                                                                               |   | 12,241                  |    | 13,084                      |   |
| Commitments and contingencies                                                                                                                                                                               |   | —                  |    | —                      |   |
| Stockholders’ equity:                                                                                                                                                                                  |   |                    |    |                        |   |
| Preferred Stock, $.001 par value; 9,500,000  shares authorized, no shares issued and outstanding                                                                                                            |   | —                  |    | —                      |   |
| Series A Junior Participating Preferred  Stock, $.001 par value; 500,000 shares authorized, no shares issued and  outstanding                                                                               |   | —                  |    | —                      |   |
| Common Stock, $.001 par value; 50,000,000  shares authorized,  24,656,364 shares  issued and outstanding at June 25, 2004 and 25,902,574 shares issued and  outstanding at December 26, 2003 |   | 25                      |    | 26                          |   |
| Additional paid-in capital                                                                                                                                                                                  |   | 89,705                  |    | 101,706                     |   |
| Retained earnings                                                                                                                                                                                           |   | 1,297                   |    | 900                         |   |
| Deferred compensation-stock incentive  agreements                                                                                                                                                           |   | (236                    | )       | (323                        | )      |
| Notes receivable-stockholders                                                                                                                                                                               |   | (373                    | )       | (488                        | )      |
| Accumulated other comprehensive income  (loss)                                                                                                                                                              |   | 99                      |    | (11                         | )      |
| Total stockholders’ equity                                                                                                                                                                             |   | 90,517                  |    | 101,810                     |   |
| Total liabilities and stockholders’ equity                                                                                                                                                             |   | $                       | 141,831 |                        | $      | 157,401 |   |

 

The accompanying notes are an integral partof these financial statements.

 

4

----

 

**FirstConsulting Group, Inc. and Subsidiaries**

 

### **Consolidated Statements of Operations**

**(inthousands, except per share data)**

 
|                                                                                                   |   | **Three  Months Ended** |   | **Six Months  Ended**   |   |
|--------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|-------------------------|--------|
|                                                                                                   |   | **(unaudited)**         |   | **(unaudited)**         |   |
|                                                                                                   |   | **June 25,  2004** |   | **June 27,  2003** |   | **June 25,  2004** |   | **June 27,  2003** |   |
| Revenues before reimbursements                                                                         |   | $                       | 67,916 |                    | $      | 71,310 |   | $ | 134,020 |   | $ | 141,440 |   |
| Reimbursements                                                                                         |   | 4,456                   |   | 4,052                   |   | 8,436 |   | 7,665 |   |
| Total revenues                                                                                         |   | 72,372                  |   | 75,362                  |   | 142,456 |   | 149,105 |   |
|                                                                                                   |   |                    |   |                    |   |   |   |   |   |
| Cost of services before reimbursable  expenses                                                         |   | 45,323                  |   | 48,349                  |   | 90,394 |   | 95,592 |   |
| Reimbursable expenses                                                                                  |   | 4,456                   |   | 4,052                   |   | 8,436 |   | 7,665 |   |
| Total cost of services                                                                                 |   | 49,779                  |   | 52,401                  |   | 98,830 |   | 103,257 |   |
|                                                                                                   |   |                    |   |                    |   |   |   |   |   |
| Gross profit                                                                                           |   | 22,593                  |   | 22,961                  |   | 43,626 |   | 45,848 |   |
|                                                                                                   |   |                    |   |                    |   |   |   |   |   |
| Selling expenses                                                                                       |   | 7,201                   |   | 8,547                   |   | 14,528 |   | 16,652 |   |
| General and administrative expenses                                                                    |   | 13,551                  |   | 16,104                  |   | 25,751 |   | 30,189 |   |
| Restructuring, severance, and impairment  costs                                                        |   | —                  |   | 3,914                   |   | — |   | 3,914 |   |
|                                                                                                   |   |                    |   |                    |   |   |   |   |   |
| Income (loss) from operations                                                                          |   | 1,841                   |   | (5,604                  | )      | 3,347 |   | (4,907 | ) |
| Other income (expense):                                                                                |   |                    |   |                    |   |   |   |   |   |
| Interest income, net                                                                                   |   | 142                     |   | 252                     |   | 344 |   | 528 |   |
| Other expense, net                                                                                     |   | (110                    | )      | (205                    | )      | (131 | ) | (4 | ) |
| Expense for premium on repurchase of stock                                                             |   | —                  |   | —                  |   | (1,561 | ) | — |   |
| Income (loss) before income taxes and  cumulative effect of change in accounting principle, net of tax |   | 1,873                   |   | (5,557                  | )      | 1,999 |   | (4,383 | ) |
| Income tax provision (benefit)                                                                         |   | 843                     |   | (2,027                  | )      | 1,602 |   | (1,534 | ) |
| Income (loss) before cumulative effect of  change in accounting principle, net of tax                  |   | 1,030                   |   | (3,530                  | )      | 397 |   | (2,849 | ) |
| Cumulative effect of change in accounting  principle, net of tax                                       |   | —                  |   | —                  |   | — |   | (2,597 | ) |
| Net income (loss)                                                                                      |   | $                       | 1,030  |                    | $      | (3,530 | ) | $ | 397 |   | $ | (5,446 | ) |
|                                                                                                   |   |                    |   |                    |   |   |   |   |   |
| Basic & diluted net income (loss) per  share:                                                      |   |                    |   |                    |   |   |   |   |   |
| Basic:                                                                                                 |   |                    |   |                    |   |   |   |   |   |
| Income (loss) before cumulative effect of  change in accounting principle, net of tax                  |   | $                       | 0.04   |                    | $      | (0.14 | ) | $ | 0.02 |   | $ | (0.11 | ) |
| Cumulative effect of change in accounting  principle, net of tax                                       |   | —                  |   | —                  |   | — |   | (0.11 | ) |
| Net income (loss) per share                                                                            |   | $                       | 0.04   |                    | $      | (0.14 | ) | $ | 0.02 |   | $ | (0.22 | ) |
| Diluted:                                                                                               |   |                    |   |                    |   |   |   |   |   |
| Income (loss) before cumulative effect of  change in accounting principle, net of tax                  |   | $                       | 0.04   |                    | $      | (0.14 | ) | $ | 0.02 |   | $ | (0.11 | ) |
| Cumulative effect of change in accounting  principle, net of tax                                       |   | —                  |   | —                  |   | — |   | (0.11 | ) |
| Net income (loss) per share                                                                            |   | $                       | 0.04   |                    | $      | (0.14 | ) | $ | 0.02 |   | $ | (0.22 | ) |
| Weighted average shares used in computing:                                                             |   |                    |   |                    |   |   |   |   |   |
| Basic net income (loss) per share                                                                      |   | 24,074                  |   | 24,817                  |   | 24,748 |   | 24,656 |   |
| Diluted net income (loss) per share                                                                    |   | 24,340                  |   | 24,817                  |   | 24,981 |   | 24,656 |   |

 

The accompanying notes are an integral partof these financial statements.

 

5

----

 

**FirstConsulting Group, Inc. and Subsidiaries**

 

### **Condensed Consolidated Statements of Cash Flows**

**(inthousands)**

 
|                                                                                      |   | **Six Months  Ended**   |   |
|-------------------------------------------------------------------------------------------|--------|-------------------------|--------|
|                                                                                      |   | **(unaudited)**         |   |
|                                                                                      |   | **June 25,  2004** |   | **June 27,  2003** |   |
| Cash flows from operating activities:                                                     |   |                    |   |   |   |
| Net income (loss):                                                                        |   | $                       | 397    |   | $ | (5,446 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |   |                    |   |   |   |
| Cumulative effect of change in accounting  principle, net of tax                          |   | —                  |   | 2,597 |   |
| Depreciation and amortization                                                             |   | 2,309                   |   | 2,485 |   |
| Premium on capital stock repurchase                                                       |   | 1,561                   |   | — |   |
| Intangibles amortization                                                                  |   | 840                     |   | 293 |   |
| Writedown of investment                                                                   |   | 50                      |   | — |   |
| Provision for bad debts, net of adjustments                                               |   | 16                      |   | (20 | ) |
| Loss on sale of assets                                                                    |   | 31                      |   | 17 |   |
| Minority interest in net loss of  subsidiaries                                            |   | (14                     | )      | (50 | ) |
| Compensation from stock issuances                                                         |   | 56                      |   | 71 |   |
| Interest income on notes receivable –  stockholders                                  |   | (31                     | )      | (61 | ) |
| Changes in assets and liabilities,  excluding effect of acquisitions:                     |   |                    |   |   |   |
| Accounts receivable                                                                       |   | 3,322                   |   | 11,180 |   |
| Unbilled receivables                                                                      |   | (2,068                  | )      | (5,667 | ) |
| Prepaid expenses and other                                                                |   | (1,585                  | )      | (709 | ) |
| Long-term account receivable                                                              |   | 1,049                   |   | 814 |   |
| Other assets                                                                              |   | (1,058                  | )      | (19 | ) |
| Accounts payable                                                                          |   | 300                     |   | 1,381 |   |
| Accrued liabilities                                                                       |   | 514                     |   | 1,802 |   |
| Accrued payroll and related taxes                                                         |   | (460                    | )      | (1,075 | ) |
| Accrued restructuring                                                                     |   | (3,049                  | )      | 270 |   |
| Accrued vacation                                                                          |   | 378                     |   | 872 |   |
| Accrued incentive compensation                                                            |   | 294                     |   | (155 | ) |
| Customer advances                                                                         |   | (1,961                  | )      | 141 |   |
| Deferred income taxes                                                                     |   | 1,353                   |   | (3,365 | ) |
| Supplemental executive retirement plan                                                    |   | 362                     |   | (228 | ) |
| Other                                                                                     |   | 107                     |   | 273 |   |
| Net cash provided by operating activities:                                                |   | 2,713                   |   | 5,401 |   |
| Cash flows from investing activities:                                                     |   |                    |   |   |   |
| Proceeds from sale/maturity of investments                                                |   | 10,736                  |   | 3,115 |   |
| Purchase of property and equipment                                                        |   | (3,878                  | )      | (2,672 | ) |
| Acquisition of businesses, net of cash  acquired                                          |   | (2,383                  | )      | (11,095 | ) |
| Net cash provided by (used in) investing  activities                                      |   | 4,475                   |   | (10,652 | ) |
| Cash flows from financing activities:                                                     |   |                    |   |   |   |
| Proceeds from issuance of capital stock,  net                                             |   | 760                     |   | 746 |   |
| Proceeds from notes receivable and tax loan  payments                                     |   | 50                      |   | 466 |   |
| Capital stock repurchase                                                                  |   | (14,773                 | )      | — |   |
| Net cash (used in) provided by financing  activities                                      |   | (13,963                 | )      | 1,212 |   |
| Net change in cash and cash equivalents                                                   |   | (6,775                  | )      | (4,039 | ) |
| Cash and cash equivalents at beginning of  period                                         |   | 26,826                  |   | 27,550 |   |
| Cash and cash equivalents at end of period                                                |   | $                       | 20,051 |   | $ | 23,511 |   |
|                                                                                      |   |                    |   |   |   |
| Cash paid during the period for:                                                          |   |                    |   |   |   |
| Interest                                                                                  |   | $                       | 11     |   | $ | 14 |   |
| Income taxes                                                                              |   | $                       | 636    |   | $ | 664 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

6

----

 

### **Notes to Consolidated Financial Statements**

 

**Note 1****                                    ****Accounting Policies**

 

*Basis of Presentation*

 

Theconsolidated balance sheets of First Consulting Group, Inc. (the “Company” or“FCG”) at June 25, 2004 and consolidated statements of operations andcondensed consolidated statements of cash flows for the periods endedJune 25, 2004 and June 27, 2003 are unaudited.  These financial statements reflect alladjustments, consisting of only normal recurring adjustments, which, in theopinion of management, are necessary to fairly present the financial positionof the Company at June 25, 2004 and the results of operations and cashflows for the three-month and six-month periods ended June 25, 2004 andJune 27, 2003.  The results ofoperations and cash flows for the six-month period ended June 25, 2004 arenot necessarily indicative of the results to be expected for the year endingDecember 31, 2004.  For morecomplete financial information, these financial statements should be read inconjunction with the audited financial statements for the year endedDecember 26, 2003 included in the Company’s Annual Report on Form 10-K.  Certain reclassifications have been made tothe 2003 financial statements to conform to the 2004 presentation.

 

*Principles of Consolidation*

 

Theconsolidated financial statements include the accounts of First ConsultingGroup, Inc. and its subsidiaries.  Allmaterial intercompany accounts and transactions have been eliminated.

 

*Stock-Based Compensation*

 

The Company accounts for stock-based employeecompensation as prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and has adopted thedisclosure provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation”**(“SFAS No. 123”), and Statement ofFinancial Accounting Standards No. 148, “Accountingfor Stock-Based Compensation – Transition and Disclosure – an amendment of SFASNo. 123”**(“SFAS No.148”).  SFAS No. 123 requires proforma disclosures of net income (loss) and net income (loss) per share as ifthe fair value based method of accounting for stock-based awards had beenapplied. Under the fair value based method, compensation cost is recorded basedon the value of the award at the grant date and is recognized over the serviceperiod.

 

The following table presents pro forma netincome (loss) had compensation costs been determined on the fair value at thedate of grant for awards under the plan in accordance with SFAS No. 123 (inthousands, except per share data):

 

7

----

 
|                                                                                                                        |        | **Three  Months Ended** |   | **Six Months  Ended**   |   |
|-----------------------------------------------------------------------------------------------------------------------------|-------------|-------------------------|--------|-------------------------|--------|
|                                                                                                                        |        | **June 25,  2004** |   | **June 27,  2003** |   | **June 25,  2004** |   | **June 27,  2003** |   |
| Net income (loss), as reported                                                                                              |        | $                       | 1,030  |                    | $      | (3,530 | ) | $ | 397 |   | $ | (5,446 | ) |
| Deduct:Total stock based employee  compensation expense determined under fair value method for all awards,  net of tax |        | (383                    | )      | (759                    | )      | (836 | ) | (1,402 | ) |
| Pro forma net income (loss)                                                                                                 |        | $                       | 647    |                    | $      | (4,289 | ) | $ | (439 | ) | $ | (6,848 | ) |
|                                                                                                                        |        |                    |   |                    |   |   |   |   |   |
| Basic income (loss) per share                                                                                               | As reported |                    | $      | 0.04                    |   | $ | (0.14 | ) | $ | 0.02 |   | $ | (0.22 | ) |
|                                                                                                                        | Pro forma   |                    | $      | 0.03                    |   | $ | (0.17 | ) | $ | (0.02 | ) | $ | (0.28 | ) |
|                                                                                                                        |        |                    |   |                    |   |   |   |   |   |
| Diluted income (loss) per share                                                                                             | As reported |                    | $      | 0.04                    |   | $ | (0.14 | ) | $ | 0.02 |   | $ | (0.22 | ) |
|                                                                                                                        | Pro forma   |                    | $      | 0.03                    |   | $ | (0.17 | ) | $ | (0.02 | ) | $ | (0.28 | ) |

 

*Basic and Diluted Net Income(Loss) Per Share*

 

Basic net income (loss) per share is based upon the weighted averagenumber of common shares outstanding. Diluted net income per share is based on the assumption that stockoptions were exercised.  Dilution iscomputed by applying the treasury stock method. Under this method, options areassumed to be exercised at the beginning of the period (or at the time ofissuance, if later), and as if funds obtained by the Company from such exercisewere used by the Company to purchase common stock at the average market priceduring the period. Stock options are not considered when computing diluted netloss per share as they are considered anti-dilutive.

 

Thefollowing represents a reconciliation of basic and diluted net income (loss)per share for the three-month and six-month periods ended June 25, 2004and June 27, 2003 (in thousands, except per share data):

 
|                                                             |   | **Three  Months Ended** |   | **Six Months  Ended**   |   |
|------------------------------------------------------------------|--------|-------------------------|--------|-------------------------|--------|
|                                                             |   | **June 25,  2004** |   | **June 27,  2003** |   | **June 25,  2004** |   | **June 27,  2003** |   |
| Income (loss) before cumulative effect, net  of tax              |   | $                       | 1,030  |                    | $      | (3,530 | ) | $ | 397 |   | $ | (2,849 | ) |
| Cumulative effect of change in accounting  principle, net of tax |   | —                  |   | —                  |   | — |   | (2,597 | ) |
| Net income (loss)                                                |   | $                       | 1,030  |                    | $      | (3,530 | ) | $ | 397 |   | $ | (5,446 | ) |
|                                                             |   |                    |   |                    |   |   |   |   |   |
| Basic weighted average number of shares  outstanding             |   | 24,074                  |   | 24,817                  |   | 24,748 |   | 24,656 |   |
| Effect of dilutive options and contingent  shares                |   | 266                     |   | —                  |   | 233 |   | — |   |
| Diluted weighted average number of shares  outstanding           |   | 24,340                  |   | 24,817                  |   | 24,981 |   | 24,656 |   |
|                                                             |   |                    |   |                    |   |   |   |   |   |
| Basic per share:                                                 |   |                    |   |                    |   |   |   |   |   |
| Income (loss) before cumulative effect, net  of tax              |   | $                       | 0.04   |                    | $      | (0.14 | ) | $ | 0.02 |   | $ | (0.11 | ) |
| Cumulative effect of change in accounting  principle, net of tax |   | —                  |   | —                  |   | — |   | (0.11 | ) |
| Net income (loss) per share                                      |   | $                       | 0.04   |                    | $      | (0.14 | ) | $ | 0.02 |   | $ | (0.22 | ) |
|                                                             |   |                    |   |                    |   |   |   |   |   |
| Diluted per share:                                               |   |                    |   |                    |   |   |   |   |   |
| Income (loss) before cumulative effect, net  of tax              |   | $                       | 0.04   |                    | $      | (0.14 | ) | $ | 0.02 |   | $ | (0.11 | ) |
| Cumulative effect of change in accounting  principle, net of tax |   | —                  |   | —                  |   | — |   | (0.11 | ) |
| Net income (loss) per share                                      |   | $                       | 0.04   |                    | $      | (0.14 | ) | $ | 0.02 |   | $ | (0.22 | ) |

 

Forthe three months ended June 25, 2004 and June 27, 2003, there were4,417,995 and 5,042,640 anti-dilutive outstanding stock options, respectively,excluded from the calculation of diluted earnings per

 

8

----

 

share.  Additionally, at June 25, 2004, therewere 443,496 contingent shares related to the acquisition of the remainingminority interest in FCG Infrastructure Services, Inc. (FCGIS) excluded fromthe calculation of both basic and diluted earnings per share because they werenot yet earned.

 

*Use of Estimates*

 

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.  On an on-going basis, the Company evaluates its estimates, including those related to revenue recognition, valuation of goodwill and long-lived and intangible assets, accrued liabilities, income taxes including the amount of tax asset valuation allowance required, restructuring costs, litigation and disputes, and the allowance for doubtful accounts.

 

The Company uses significant estimates in the calculation of its incometax provision by estimating whether it will have sufficient future taxableincome to realize its deferred tax assets. Therecan be no assurances that the Company’s taxable income will be sufficient torealize such deferred tax assets and the Company will continue to evaluate itsvaluation allowance on an ongoing basis.

 

The Company bases its estimates on historical experience and on variousother assumptions that are believed to be reasonable under the circumstances,the results of which form the basis for making judgments about the carryingvalues of assets and liabilities that are not readily apparent from othersources.  The Company’s actual resultsmay differ from its estimates.

 

*Cash and CashEquivalents*

 

Forpurposes of reporting, cash and cash equivalents include cash andinterest-earning deposits or securities with original maturities of threemonths or less.

 

**Note 2****                                    ****Investments**

 

AtJune 25, 2004, the Company had approximately $25.1 million in short-terminvestments.  Such investments were heldprimarily in commercial paper, money market investments, and tax-exemptgovernment securities.  Net unrealizedgains and losses on investments were not material at June 25, 2004.  Additionally, the Company had $1.2 millionof non-marketable equity investments, valued at the lower of cost or estimatedfair value, which were included in long-term investments.

 

**Note 3****                                    ****Long-Term Account Receivable**

 

AtJune 25, 2004, the Company carried a long-term account receivable ofapproximately $4.7 million from a single client.  The receivable related to a major outsourcing contract and willbe collected over a two and one-half year period.

 

9

----

 

**Note 4****                                    ****Business Acquisitions**

 

*FCG InfrastructureServices (FCGIS)*

 

On January 30, 2004, the Company purchased the remaining 47.65%minority interest in FCGIS (formerly Codigent Solutions Group, Inc.) from fiveremaining individual stockholders for approximately $2.4 million in cash.  Additionally, the Company deposited 591,328shares of FCG common stock into an escrow account, with one-fourth of suchshares to be released to those same stockholders in four separate incrementsupon successful fulfillment by FCGIS of certain revenue and profitabilitytargets for the six-month periods ended June 25, 2004, December 31,2004, July 1, 2005, and December 30, 2005.  If such targets are not fulfilled for any of the six-monthperiods, the shares in escrow for that period revert to FCG.  For the six-month period ended June 25,2004, FCGIS met the revenue and profitability targets, and the first 147,832contingent shares were released to the former FCGIS stockholders inJuly 2004.

 

The following table summarizes the estimated fair values of assetsacquired as of January 30, 2004 in connection with the FCGIS purchase (inthousands):

 

| Goodwill                           |   | $     | 2,339  |   |
|------------------------------------|--------|-------|--------|--------|
| Intangible assets                  |   | 300   |   |
| Net assets acquired                |   | 2,639 |   |
| Minority interest on balance sheet |   | 643   |   |
| Contingent shares released         |   | (899  | )      |
| Cash consideration                 |   | $     | 2,383  |   |

 

**Note 5****                                    ****Goodwill and Intangible Assets**

 

Effective December 29, 2001, the Company adopted SFAS 141 and SFAS142.  SFAS 142 requires that goodwilland certain intangibles no longer be amortized, but instead are to be reviewedat least annually for impairment.  Priorto the adoption of SFAS 141, goodwill was amortized over the estimated usefullife.

 

Goodwill is evaluated for impairment annually in the fourth quarter ofthe year, or if an event occurs or circumstances change that may reduce thefair value of a reporting unit, to which specific goodwill applies, below itsbook value. The impairment test is conducted at the reporting unit level bycomparing the fair value of the reporting unit with its carrying value. Fairvalue is primarily determined by using a market approach valuation model basedon multiples of revenue. If the carrying value exceeds the fair value, the fairvalue of the reporting unit is then allocated to its assets and liabilities ina manner similar to a purchase price allocation in order to determine theimplied fair value of the reporting unit goodwill. This implied fair value isthen compared with the carrying amount of the reporting unit goodwill, and ifit is less, the Company would then recognize an impairment loss.  In addition, the Company evaluatesintangible assets with definite lives to determine whether adjustment to theseamounts or estimated useful lives is required based on current events andcircumstances.

 

10

----

 

Thechanges in the net carrying amounts of goodwill for the six months endedJune 25, 2004 are as follows (in thousands):

 
|                                 |   | **Life  Sciences** |   | **Health  Delivery  Outsourcing** |   | **Meditech  Service  Center** |   | **Other  Businesses** |   | **Total** |   |
|--------------------------------------|--------|--------------------|--------|-----------------------------------|--------|-------------------------------|--------|-----------------------|--------|-----------|--------|
| Balance as of December 26, 2003 |   | $                  | 1,477  |                              | $      | 2,278                         |   | $                     | 2,001  |      | $      | 9,702 |   | $ | 15,458 |   |
| Acquired                             |   | —             |   | —                            |   | 1,440                         |   | —                |   | 1,440     |   |
| Currency translation adjustment      |   | 4                  |   | —                            |   | —                        |   | —                |   | 4         |   |
| Balance as of March 26, 2004    |   | 1,481              |   | 2,278                             |   | 3,441                         |   | 9,702                 |   | 16,902    |   |
| Acquired                             |   | —             |   | —                            |   | —                        |   | —                |   | —    |   |
| Contingent shares released           |   | —             |   | —                            |   | 899                           |   | —                |   | 899       |   |
| Currency translation adjustment      |   | —             |   | —                            |   | —                        |   | —                |   | —    |   |
| Balance as of June 25, 2004     |   | $                  | 1,481  |                              | $      | 2,278                         |   | $                     | 4,340  |      | $      | 9,702 |   | $ | 17,801 |   |

 

Asof June 25, 2004, the Company had the following acquired intangible assetsrecorded (in thousands):

 
| **Amortized Intangible Assets**   |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   | **Net  Carrying  Amount** |   | **Amortization  Period in  Years** |   |
|-----------------------------------|--------|-----------------------------|--------|-------------------------------|--------|---------------------------|--------|------------------------------------|--------|
| Software and software development |   | $                           | 1,177  |                          | $      | (686                      | )      | $                                  | 491    |   | 2 - 3 |   |
| Customer related                  |   | 3,694                       |   | (1,021                        | )      | 2,673                     |   | 2 - 4                              |   |
| Non-compete agreements            |   | 400                         |   | (304                          | )      | 96                        |   | 2 - 3                              |   |
| Total                             |   | $                           | 5,271  |                          | $      | (2,011                    | )      | $                                  | 3,260  |   |   |   |

 

Thefollowing table summarizes the estimated annual pretax amortization expense forthese assets (in thousands):

 

| **Fiscal Year**          |   |   |   |
|--------------------------|--------|--------|--------|
| 2004 (remainder of year) |   | $      | 882    |   |
| 2005                     |   | 1,150  |   |
| 2006                     |   | 773    |   |
| 2007                     |   | 455    |   |
| Total                    |   | $      | 3,260  |   |

 

**Note 6****                                    ****Restructuring, Severance, and Impairment Costs**

 

In fiscal year 2002, the Company incurred a restructuring charge of$7.8 million consisting of $4.0 million in severance for the reduction of staffand $3.8 million in facility costs due to facility downsizing.  This restructuring was accounted for inaccordance with EITF 94-3 and SAB 100.

 

**Restructuring,severance, and impairment costs of $11.7 million were incurred in fiscal year2003.  These costs included severancecosts of $6.5 million for a reduction in staff of 153 people and facilitydownsizing of $5.2 million primarily related to the significant decline in theCompany’s Life Science business unit due to the reduction in custom softwaredevelopment services purchased by**

 

11

----

 

**pharmaceutical clients.  Restructuring charges in 2003 have beenaccounted for in accordance with SFAS 146.**

 

**AtJune 25, 2004, there was a remaining restructuring liability of $6.3million, which entirely related to vacated leases and related costs from theserestructurings.**

 

**Therestructuring liability as of June 25, 2004 is summarized as follows (inthousands):**

** **
|                                      |   | **Employee  Related Costs** |   | **Facilities/Other  Related Costs** |   | **Total** |   |
|-------------------------------------------|--------|-----------------------------|--------|-------------------------------------|--------|-----------|--------|
| Reserve balance at December 26, 2003 |   | $                           | 1,665  |                                | $      | 7,634     |   | $ | 9,299 |   |
| Cash payments                             |   | (1,665                      | )      | (1,384                              | )      | (3,049    | )      |
| Reserve balance at June 25, 2004     |   | $                           | — |                                | $      | 6,250     |   | $ | 6,250 |   |

 

**Note 7****                                    ****Comprehensive Income (Loss)**

 

Comprehensiveincome (loss), net of taxes, for the three months and six months endedJune 25, 2004 and June 27, 2003 is as follows (in thousands):

 
|                                                 |   | **Three  Months Ended** |   | **Six Months  Ended**   |   |
|------------------------------------------------------|--------|-------------------------|--------|-------------------------|--------|
|                                                 |   | **June 25,  2004** |   | **June 27,  2003** |   | **June 25,  2004** |   | **June 27,  2003** |   |
| Net income (loss)                                    |   | $                       | 1,030  |                    | $      | (3,530 | ) | $ | 397 |   | $ | (5,446 | ) |
| Foreign currency translation adjustment,  net of tax |   | 29                      |   | 100                     |   | 111 |   | 105 |   |
| Unrealized gain (loss) on investments                |   | (11                     | )      | 46                      |   | (1 | ) | 36 |   |
| Comprehensive income (loss)                          |   | $                       | 1,048  |                    | $      | (3,384 | ) | $ | 507 |   | $ | (5,305 | ) |

 

**Note 8****                                    ****Cumulative Effect ofChange in Accounting Principle**

 

Effective December 28, 2002, the Company adopted Emerging IssuesTask Force (EITF) Issue 00-21 “Accounting for Revenue Arrangements withMultiple Deliverables,” which addresses how to account for arrangements thatinvolve the delivery or performance of multiple products, services, and/orrights to use assets.  Revenuearrangements with multiple deliverables are divided into separate units ofaccounting if the deliverables in the arrangement meet the following criteria:(1) the delivered item has value to the customer on a standalone basis;(2) there is objective and reliable evidence of the fair value ofundelivered items; and (3) delivery of any undelivered item isprobable.  Arrangement considerationshould be allocated among the separate units of accounting based on theirrelative fair values, with the amount allocated to the delivered item beinglimited to the amount that is not contingent on the delivery of additionalitems or meeting other specified performance conditions.  The new standard was required to be adoptedfor all new applicable revenue arrangements no later than the third quarter of2003.  Early adoption was permitted andthe Company elected to adopt the new standard as of the beginning of the firstquarter of 2003.  In addition, theCompany elected to apply the new standard to all then existing outsourcingarrangements impacted by EITF 00-21 and record to earnings the resultingcumulative effect as a change in accounting principle.  The adoption of EITF Issue 00-21 resulted ina non-cash charge, net of tax, of $2.6 million, or $0.11 per share, in thefirst quarter of 2003.

 

12

----

 

**Note 9****                                    ****Disclosure of Segment Information**

 

Commencing with the first quarter of 2004 and due to a reorganizationof the Company that took effect at the beginning of 2004, the Company haschanged its previous segment reporting in accordance with SFAS 131.  The Company now has five reportableoperating segments:  health delivery(the delivery of consulting and systems integration services to health deliveryand government clients), health plan (the delivery of consulting and systemsintegration services to health plan clients), life sciences (the delivery ofconsulting and systems integration services to pharmaceutical and other lifesciences clients), health delivery outsourcing (the delivery of outsourcingservices to health delivery clients), and Meditech Service Center (the deliveryof solutions involving the use of Meditech software to health deliveryclients).  Additionally, the Company hasseveral smaller businesses (Paragon Solutions, Inc., staffing services, callcenter services, and the Patient Safety Institute/FirstGatewaysTM), which arenot included in any of the above segments and are reported as “other business.”

 

The Company’s segments are managed on an integrated basis in order toserve clients by assembling multi-disciplinary teams, which providecomprehensive services.  The amount ofrevenues attributed to each segment is accounted for by splitting the revenueson each client engagement based upon the amounts charged to the client for theservices of each segment.  Costs are nottransferred across segments.

 

Additionally, the Company has created three shared service centers thatprovide services to multiple business segments.  These shared service centers include FCG India, IntegrationServices, and Infrastructure Services.  The costs of these services are internally billed and reported in theindividual business segments as cost of services at a standard transfer cost.

 

Inaccordance with these changes, the Company has reclassified some staff amongcost of services, selling expenses and general and administrative expenses.  The history shown in the tables below and inthe Company’s consolidated statement of operations is now consistent with allof these changes.

 

The Company evaluates its segments’ performance based on revenues andoperating income.  Certain selling andgeneral and administrative expenses (including corporate functions, occupancyrelated costs, depreciation, professional development, recruiting, andmarketing), are managed at the corporate level and allocated to each operatingsegment based on either net revenues and/or actual usage.

 

13

----

 

The following segment information is for the three months and sixmonths ended June 25, 2004 and June 27, 2003 (in thousands):

 

**For the threemonths ended June 25, 2004:**

 
|                                           |   | **Health  Delivery** |   | **Life  Sciences** |   | **Health  Delivery  Outsourcing** |   | **Meditech  Service  Center** |   | **Health****Plan** |   | **Other  Business** |   | **Other** |   | **Totals** |   |
|------------------------------------------------|--------|----------------------|--------|--------------------|--------|-----------------------------------|--------|-------------------------------|--------|--------------------|--------|---------------------|--------|-----------|--------|------------|--------|
| Revenues  before reimbursements                |   | $                    | 16,419 |               | $      | 9,230                             |   | $                             | 25,332 |               | $      | 6,193               |   | $         | 3,642  |       | $      | 7,098 |   | $ | 2 |   | $ | 67,916 |   |
| Reimbursements                                 |   | 2,211                |   | 260                |   | 142                               |   | 402                           |   | 692                |   | 194                 |   | 555       |   | 4,456      |   |
| Total revenues                                 |   | 18,630               |   | 9,490              |   | 25,474                            |   | 6,595                         |   | 4,334              |   | 7,292               |   | 557       |   | 72,372     |   |
| Cost of  services before reimbursable expenses |   | 8,456                |   | 5,336              |   | 20,797                            |   | 4,106                         |   | 2,659              |   | 4,716               |   | (747      | )      | 45,323     |   |
| Reimbursable  expenses                         |   | 2,211                |   | 260                |   | 142                               |   | 402                           |   | 692                |   | 194                 |   | 555       |   | 4,456      |   |
| Total cost of  services                        |   | 10,667               |   | 5,596              |   | 20,939                            |   | 4,508                         |   | 3,351              |   | 4,910               |   | (192      | )      | 49,779     |   |
| Gross profit                                   |   | 7,963                |   | 3,894              |   | 4,535                             |   | 2,087                         |   | 983                |   | 2,382               |   | 749       |   | 22,593     |   |
| Selling expenses                               |   | 2,366                |   | 2,527              |   | 593                               |   | 242                           |   | 857                |   | 668                 |   | (52       | )      | 7,201      |   |
| General &  administrative expenses         |   | 2,579                |   | 2,940              |   | 2,405                             |   | 795                           |   | 644                |   | 1,763               |   | 2,425     |   | 13,551     |   |
| Income (loss)  from operations                 |   | $                    | 3,018  |               | $      | (1,573                            | )      | $                             | 1,537  |               | $      | 1,050               |   | $         | (518   | )          | $      | (49 | ) | $ | (1,624 | ) | $ | 1,841 |   |

 

**For the threemonths ended June 27, 2003:**

 
|                                            |   | **Health  Delivery** |   | **Life  Sciences** |   | **Health  Delivery  Outsourcing** |   | **Meditech  Service  Center** |   | **Health****Plan** |   | **Other  Business** |   | **Other** |   | **Totals** |   |
|-------------------------------------------------|--------|----------------------|--------|--------------------|--------|-----------------------------------|--------|-------------------------------|--------|--------------------|--------|---------------------|--------|-----------|--------|------------|--------|
| Revenues  before reimbursements                 |   | $                    | 17,149 |               | $      | 11,426                            |   | $                             | 24,072 |               | $      | 5,018               |   | $         | 7,093  |       | $      | 6,447 |   | $ | 105 |   | $ | 71,310 |   |
| Reimbursements                                  |   | 2,407                |   | 321                |   | 51                                |   | 407                           |   | 770                |   | 82                  |   | 14        |   | 4,052      |   |
| Total revenues                                  |   | 19,556               |   | 11,747             |   | 24,123                            |   | 5,425                         |   | 7,863              |   | 6,529               |   | 119       |   | 75,362     |   |
| Cost of  services before reimbursable expenses  |   | 9,513                |   | 7,499              |   | 20,687                            |   | 3,050                         |   | 3,544              |   | 4,384               |   | (328      | )      | 48,349     |   |
| Reimbursable  expenses                          |   | 2,407                |   | 321                |   | 51                                |   | 407                           |   | 770                |   | 82                  |   | 14        |   | 4,052      |   |
| Total cost of  services                         |   | 11,920               |   | 7,820              |   | 20,738                            |   | 3,457                         |   | 4,314              |   | 4,466               |   | (314      | )      | 52,401     |   |
| Gross profit                                    |   | 7,636                |   | 3,927              |   | 3,385                             |   | 1,968                         |   | 3,549              |   | 2,063               |   | 433       |   | 22,961     |   |
| Selling  expenses                               |   | 2,961                |   | 2,440              |   | 470                               |   | 419                           |   | 1,349              |   | 765                 |   | 143       |   | 8,547      |   |
| General &  administrative expenses          |   | 3,342                |   | 4,458              |   | 2,529                             |   | 1,142                         |   | 962                |   | 1,963               |   | 1,708     |   | 16,104     |   |
| Restructuring,  severance, and impairment costs |   | (21                  | )      | 4,131              |   | —                            |   | —                        |   | (10                | )      | (4                  | )      | (182      | )      | 3,914      |   |
| Income (loss)  from operations                  |   | $                    | 1,354  |               | $      | (7,102                            | )      | $                             | 386    |               | $      | 407                 |   | $         | 1,248  |       | $      | (661 | ) | $ | (1,236 | ) | $ | (5,604 | ) |

 

14

----

 

**For the sixmonths ended June 25, 2004:**

 
|                                           |   | **Health  Delivery** |   | **Life  Sciences** |   | **Health  Delivery  Outsourcing** |   | **Meditech  Service  Center** |   | **Health****Plan** |   | **Other  Business** |   | **Other** |   | **Totals** |   |
|------------------------------------------------|--------|----------------------|--------|--------------------|--------|-----------------------------------|--------|-------------------------------|--------|--------------------|--------|---------------------|--------|-----------|--------|------------|--------|
| Revenues  before reimbursements                |   | $                    | 32,033 |               | $      | 18,097                            |   | $                             | 50,549 |               | $      | 11,644              |   | $         | 7,890  |       | $      | 13,789 |   | $ | 18 |   | $ | 134,020 |   |
| Reimbursements                                 |   | 4,204                |   | 486                |   | 242                               |   | 827                           |   | 1,272              |   | 375                 |   | 1,030     |   | 8,436      |   |
| Total revenues                                 |   | 36,237               |   | 18,583             |   | 50,791                            |   | 12,471                        |   | 9,162              |   | 14,164              |   | 1,048     |   | 142,456    |   |
| Cost of  services before reimbursable expenses |   | 17,084               |   | 10,390             |   | 41,798                            |   | 7,870                         |   | 5,097              |   | 9,575               |   | (1,420    | )      | 90,394     |   |
| Reimbursable  expenses                         |   | 4,204                |   | 486                |   | 242                               |   | 827                           |   | 1,272              |   | 375                 |   | 1,030     |   | 8,436      |   |
| Total cost of  services                        |   | 21,288               |   | 10,876             |   | 42,040                            |   | 8,697                         |   | 6,369              |   | 9,950               |   | (390      | )      | 98,830     |   |
| Gross profit                                   |   | 14,949               |   | 7,707              |   | 8,751                             |   | 3,774                         |   | 2,793              |   | 4,214               |   | 1,438     |   | 43,626     |   |
| Selling  expenses                              |   | 4,890                |   | 5,015              |   | 1,176                             |   | 462                           |   | 1,733              |   | 1,212               |   | 40        |   | 14,528     |   |
| General &  administrative expenses         |   | 5,089                |   | 5,924              |   | 4,759                             |   | 1,601                         |   | 1,288              |   | 3,159               |   | 3,931     |   | 25,751     |   |
| Income (loss)  from operations                 |   | $                    | 4,970  |               | $      | (3,232                            | )      | $                             | 2,816  |               | $      | 1,711               |   | $         | (228   | )          | $      | (157 | ) | $ | (2,533 | ) | $ | 3,347 |   |

 

**For the sixmonths ended June 27, 2003:**

 
|                                            |   | **Health  Delivery** |   | **Life  Sciences** |   | **Health  Delivery  Outsourcing** |   | **Meditech  Service  Center** |   | **Health****Plan** |   | **Other  Business** |   | **Other** |   | **Totals** |   |
|-------------------------------------------------|--------|----------------------|--------|--------------------|--------|-----------------------------------|--------|-------------------------------|--------|--------------------|--------|---------------------|--------|-----------|--------|------------|--------|
| Revenues  before reimbursements                 |   | $                    | 33,204 |               | $      | 26,815                            |   | $                             | 47,048 |               | $      | 8,998               |   | $         | 13,444 |       | $      | 11,746 |   | $ | 185 |   | $ | 141,440 |   |
| Reimbursements                                  |   | 4,345                |   | 693                |   | 146                               |   | 690                           |   | 1,442              |   | 320                 |   | 29        |   | 7,665      |   |
| Total revenues                                  |   | 37,549               |   | 27,508             |   | 47,194                            |   | 9,688                         |   | 14,886             |   | 12,066              |   | 214       |   | 149,105    |   |
| Cost of services  before reimbursable expenses  |   | 19,133               |   | 15,418             |   | 41,410                            |   | 5,410                         |   | 6,704              |   | 8,280               |   | (763      | )      | 95,592     |   |
| Reimbursable  expenses                          |   | 4,345                |   | 693                |   | 146                               |   | 690                           |   | 1,442              |   | 320                 |   | 29        |   | 7,665      |   |
| Total cost of  services                         |   | 23,478               |   | 16,111             |   | 41,556                            |   | 6,100                         |   | 8,146              |   | 8,600               |   | (734      | )      | 103,257    |   |
| Gross profit                                    |   | 14,071               |   | 11,397             |   | 5,638                             |   | 3,588                         |   | 6,740              |   | 3,466               |   | 948       |   | 45,848     |   |
| Selling  expenses                               |   | 5,973                |   | 4,578              |   | 1,237                             |   | 773                           |   | 2,702              |   | 1,338               |   | 51        |   | 16,652     |   |
| General &  administrative expenses          |   | 6,144                |   | 8,999              |   | 5,284                             |   | 2,037                         |   | 1,909              |   | 3,100               |   | 2,716     |   | 30,189     |   |
| Restructuring,  severance, and impairment costs |   | (21                  | )      | 4,131              |   | —                            |   | —                        |   | (10                | )      | (4                  | )      | (182      | )      | 3,914      |   |
| Income (loss)  from operations                  |   | $                    | 1,975  |               | $      | (6,311                            | )      | $                             | (883   | )                  | $      | 778                 |   | $         | 2,139  |       | $      | (968 | ) | $ | (1,637 | ) | $ | (4,907 | ) |

 

The “other” column includes reclassificationsrelated to the charging out of the shared service centers described above, withthe net loss in that column primarily consisting of under absorption of sharedservice center or support costs into the segments.

 

15

----

 

*Detail of Health DeliveryOutsourcing Revenues*

 

HealthDelivery Outsourcing revenues before reimbursements include revenues related toa major subcontractor on several projects. The breakdown of revenue in outsourcing is as follows (in thousands):

 
|                           |   | **Three  Months Ended** |   | **Six Months  Ended**   |   |
|--------------------------------|--------|-------------------------|--------|-------------------------|--------|
|                           |   | **June 25,  2004** |   | **June 27,  2003** |   | **June 25,  2004** |   | **June 27,  2003** |   |
| Internally generated revenues  |   | $                       | 20,544 |                    | $      | 18,211 |   | $ | 40,298 |   | $ | 36,371 |   |
| Subcontractor revenues         |   | 4,788                   |   | 5,861                   |   | 10,251 |   | 10,677 |   |
| Revenues before reimbursements |   | $                       | 25,332 |                    | $      | 24,072 |   | $ | 50,549 |   | $ | 47,048 |   |

 

**Note 10****                             ****Line of Credit**

 

The Company has a revolving line of credit, under which it is allowedto borrow up to $7.0 million at an interest rate of the prevailing prime ratewith an expiration of May 1, 2005. There was no outstanding balance under the line of credit atJune 25, 2004.

 

**Note 11****                              CapitalStock Repurchase**

 

On February 27, 2004, FCGrepurchased all outstanding shares of the Company held by David S. Lipson, oneof FCG’s directors and the former CEO of Integrated Systems Consulting Group,Inc. (ISCG).  FCG acquired ISCG inDecember 1998.  The Company alsopurchased any in-the-money options to purchase FCG common stock held by Mr.Lipson.  The aggregate purchase pricefor the shares and options held by Mr. Lipson was $15.1 million.  As a result of the transaction, Mr. Lipsonresigned from the Company’s Board of Directors.

 

The purchase by FCG of Mr. Lipson’s ownership interest included all ofthe 1,962,400 outstanding shares of common stock of FCG held by Mr. Lipson,together with 32,000 in-the-money options to purchase shares of common stock ofFCG.  The aggregate purchase price forthe shares and the options represented a premium of approximately 11% over theclosing price of FCG’s common stock on February 26, 2004.

 

In the first quarter of 2004, FCG recorded a charge of $1.6 millionwithout any tax benefit, which charge is based on the premium included in thepurchase consideration.  From a taxperspective, no amounts of the purchase price were allocable to any of therestrictive covenants agreed to by Mr. Lipson in the repurchase agreement.

 

Other material terms of the transaction were as follows:

 

•          The purchaseprice was comprised of cash, a portion of which Mr. Lipson used to repay infull indebtedness owed by Mr. Lipson to FCG of approximately $0.3 million.

•          In the eventFCG announces or consummates a change in control transaction prior toFebruary 27, 2005, or if the Company enters into negotiations regarding achange in control transaction prior to February 27, 2005 and subsequentlyannounces publicly a definitive agreement for or consummate a change in controltransaction prior to August 27, 2005, FCG would pay to Mr. Lipson, uponthe closing of such change in control of FCG, an amount equal to the differenceof $7.50 per share and the change in control transaction price per share, ifsuch change in control price per share amount is higher.

•          12,000out-of-the-money options held by Mr. Lipson remain outstanding and may only beexercised on or before the first anniversary of this repurchasetransaction.  Upon receipt of

 

16

----

 

Mr. Lipson’s notice of exercise, FCG will repurchase such options andpay to Mr. Lipson the difference between the exercise price and the then fairmarket value of the shares issuable.

•          Mr. Lipson issubject to a five year non-compete agreement, a mutual non-disparagementagreement, a non-solicitation agreement and a standstill agreement.  The parties agreed that no amounts of thepurchase price were allocable to these covenants for tax purposes.

•          Mr. Lipson alsogranted to the Board of Directors of FCG an irrevocable proxy for any of FCG’ssecurities that he owns or acquires after the closing of FCG’s purchase in thistransaction.

•          FCG and Mr.Lipson executed a mutual release of claims.

 

17

----

 

## **Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

THE FOLLOWING MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS WITHINTHE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.  SUCH FORWARD-LOOKING STATEMENTS INVOLVERISKS AND UNCERTAINTIES, INCLUDING THOSE SET FORTH HEREIN UNDER THE CAPTION“RISKS RELATING TO OUR BUSINESS,” AND OTHER REPORTS WE FILE WITH THE SECURITIESAND EXCHANGE COMMISSION.  OUR ACTUALRESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKINGSTATEMENTS.  EXCEPT AS REQUIRED BYAPPLICABLE LAW, WE DO NOT HAVE ANY INTENTION OR OBLIGATION TO UPDATE PUBLICYANY FORWARD LOOKING STATEMENTS AFTER THE DISTRIBUTION OF THIS REPORT, WHETHERAS A RESULT OF NEW INFORMATION, FUTURE EVENTS, CHANGES IN ASSUMPTIONS OROTHERWISE.

 

**Overview**

 

We provide services primarily to providers, payors, governmentagencies, pharmaceutical, biogenetic, and other healthcare organizations inNorth America, Europe, and Asia.  Wegenerate substantially all of our revenues from fees for information technologyoutsourcing services, and professional services.

 

We typically bill for our services on anhourly, fixed-fee, or monthly fixed-fee basis as specified by the agreementwith a particular client.  For servicesbilled on an hourly basis, in our consulting and systems integration businesses(“CSI”), fees are determined by multiplying the amount of time expended on eachassignment by the project hourly rate for the associate(s) assigned to theengagement.  Fixed fees, including outsourcingfees, are established on a per-assignment or monthly basis and are based onseveral factors such as the size, scope, complexity and duration of anassignment, the number of our employees required to complete the assignment,and the volume of transactions or interactions.  Revenues are generally recognized related to the level ofservices performed, the amount of cost incurred on the assignment versus theestimated total cost to complete the assignment, or on a straight-line basisover the period of performance of service. Additionally, we have recently been licensing an increased amount of oursoftware products, generally in conjunction with the customization andimplementation of such software products. Revenues from our software licensing have grown from greater than 1% ofour net revenues in fiscal year 2003 to greater than 2% of our net revenues inthe first six months of fiscal year 2004, and we expect our software licensingrevenues to continue to grow.

 

Provisions are made for estimated uncollectible amounts based on ourhistorical experience.  We may obtainpayment in advance of providing services. These advances are recorded as customer advances and reflected as aliability on our balance sheet.

 

Out-of-pocket expenses billed and reimbursed by clients are included intotal revenues, and then deducted to determine revenues before reimbursements(“net revenues”).  For purposes ofanalysis, all percentages in this discussion are stated as a percentage of netrevenues, since we believe that this is the more relevant measure of ourbusiness.

 

Cost of services primarily consists of the salaries, bonuses, andrelated benefits of client-serving associates, and subcontractor expenses.  Selling expenses primarily consist of thesalaries, benefits, travel, and other costs of our sales force, as well asmarketing and market research expenses. General and administrative expenses primarily consist of the costsattributable to the support of our client-serving professionals such asnon-billable travel, office space occupancy, information systems, salaries andexpenses for executive management, financial accounting and administrativepersonnel, expenses for firm

 

18

----

 

and business unit governance meetings, recruiting fees, professionaldevelopment and training, and legal and other professional services.  As associate related costs are relativelyfixed in the short term, variations in our revenues and operating results in ourCSI business can occur as a result of variations in billing margins andutilization rates of our billable associates.

 

Our mostsignificant expenses are our human resource and related salary and benefitexpenses.  As of June 25, 2004,approximately 1,187 of our 2,287 employees (associates) are billableassociates.  Another 766 employees arepart of our outsourcing business.  Thesalaries and benefits of such billable associates and outsourcing relatedemployees are recognized in our cost of services.  Most non-billable employee salaries and benefits are recognizedas a component of either selling or general and administrative expenses.  Approximately 14.6% of our workforce, or 334employees, are classified as non-billable. Our cost of services as a percentage of revenues is directly related toseveral factors, including, but not limited to:

 

•                  Our billableassociate utilization, which is the ratio of total billable hours to availablehours in a given period;

•                  The amount andtiming of costs incurred;

•                  Our ability tocontrol costs on our outsourcing projects;

•                  The billed rateon time and material contracts; and

•                  The estimatedcost to complete our non-outsourcing fixed price contracts.

 

In our CSI business, we manage billable associate utilization bymonitoring assignment requirements and timetables, available and requiredskills, and available associate hours per week and per month.   Differences in personnel utilization ratescan result from variations in the amount of non-billed time, which has historicallyconsisted of training time, vacation time, time lost to illness and inclementweather, and unassigned time. Non-billed time also includes time devoted to other necessary andproductive activities such as sales support and interviewing prospective employees.  Unassigned time results from differences inthe timing of the completion of an existing assignment and the beginning of anew assignment.  In order to reduce andlimit unassigned time, we actively manage personnel utilization by monitoringand projecting estimated engagement start and completion dates and matchingassociate availability with current and projected client requirements.  The number of associates staffed on anassignment will vary according to the size, complexity, duration, and demandsof the assignment.  Assignment terminations,completions, inclement weather, and scheduling delays may result in periods inwhich associates are not optimally utilized. An unanticipated termination of a significant assignment or an overalllengthening of the sales cycle could result in a higher than expected number ofunassigned associates and could cause us to experience lower margins.  In addition, entry into new market areas andthe hiring of associates in advance of client assignments have resulted and maycontinue to result in periods of lower associate utilization.

 

In response to competition and continued pricing and rate pressures, wehave recently implemented a global sourcing strategy into our businessoperations, which includes the deployment of offshore resources as well asresources that perform services remote from the client site.  We have also begun to incorporate morevariable cost or per diem staff in some of our projects.  We expect these strategies to result inimproved cost of services through a combination of lower cost attributable tooffshore resources and higher leverage of resources that perform servicesoffsite or on a variable cost basis.  Tothe extent we pass through reduced costs to our clients related to offshoreresources, the global sourcing strategy may result in lower revenues on a perengagement basis. However, we expect to offset this potential revenue impactwith improved competitive positioning in our markets.  Several of our competitors employ both global sourcing andvariable staffing strategies to provide software development and otherinformation technology services to their clients, while at the same timereducing their cost structure and improving the quality of services theyprovide.  If we are unable to realizethe perceived cost benefits of our recently implemented strategies or if we areunable to receive high quality services

 

19

----

 

from foreign employees, variable staff employees or subcontractors, ourbusiness may be adversely impacted and we may not be able to competeeffectively.

 

**Results of Operations for the ThreeMonths Ended June 25, 2004 and June 27, 2003**

 

*Revenues. *Our net revenues decreased to $67.9 million for the quarter endedJune 25, 2004, a decrease of 4.8% from $71.3 million for the quarter endedJune 25, 2003.  Our total revenuesdecreased to $72.4 million for the quarter ended June 25, 2004, a decreaseof 4.0% from $75.4 million for the quarter ended June 27, 2003.  The decreases were primarily due to declinesin our Health Plan and Life Sciences businesses, partially offset by increasesin Health Delivery Outsourcing and the Meditech Service Center.  The Health Plan segment had the mostsignificant revenue decline ($3.5 million or 44.9%) due to the completion ofseveral significant projects during 2003, without having new projects toreplace them.  Additionally, during thesecond quarter of 2004, we took a revenue writedown of over $0.8 million on asingle project in the Health Plan segment due to a miscommunication with theclient’s senior management regarding the scope of the project.  The Life Sciences segment revenues declinedby $2.3 million, or 19.2%, due to the general decline in the custom softwarebusiness for pharmaceutical clients, and also due to the completion of a majorengagement in the second quarter of 2003. Health Delivery Outsourcing revenues increased by $1.4 million, or 5.6%,due to additional work on existing projects. The Meditech Service Center revenues increased by $1.2 million, or21.6%, due to the award of a new outsourcing engagement and other generalincreases in demand for Meditech services. Overall, we anticipate that our revenues in the third quarter of 2004will remain at a similar level to those of the second quarter.  Revenues in the fourth quarter are expectedto increase, in large part due to an extra week during the fourth quarter sinceDecember 31, 2004 occurs on a Friday, thus adding a 53rd weekto the fiscal year and a 14th week to the fiscal fourth quarter.

 

* Cost of Services. *Cost ofservices before reimbursable expenses decreased to $45.3 million for thequarter ended June 25, 2004, a decrease of 6.3% from $48.3 million for thequarter ended June 27, 2003.  Thedecrease was primarily due to cost reductions, primarily reduction inheadcount, made in response to the revenue declines noted above.  We reduced cost of services by $0.9 millionin Health Plan and $2.2 million in Life Sciences.  Additionally, we reduced cost of services by $1.1 million inHealth Delivery.  These decreases werepartially offset by increased costs in the Meditech Service Center as a resultof the increase in work in that segment.

 

*Gross Profit. *Gross profitdecreased to $22.6 million for the quarter ended June 25, 2004, a decreaseof 1.6% from $23.0 million for the quarter ended June 27, 2003.  The decrease was primarily due to reducedgross profit in Health Plan due to the revenue decline noted above.  This decline was partially offset by anincrease in gross profit in the other segments, but primarily in HealthDelivery Outsourcing due to ongoing cost efficiencies that were achieved oncertain contracts beginning in mid-2003. Gross profit as a percentage of net revenues increased to 33.3% for thequarter ended June 25, 2004 from 32.2% for the quarter ended June 27,2003 due to increased margin percentage in all segments other than Health Planand Life Sciences.  Given the currentrevenue mix, our gross profit percentage is not expected to changesignificantly in the near future; however, a sudden downturn in demand in oneor more of our segments or an inability to control costs on our fixed priceprojects could negatively affect our margin percentage.

 

*SellingExpenses. *Selling expenses decreased to $7.2 millionfor the quarter ended June 25, 2004, a decrease of 15.7% from $8.5 millionfor the quarter ended June 27, 2003. This decrease is primarily due to a reduction in our sales force whichtook effect in mid-2003.  Sellingexpenses as a percentage of net revenues decreased to 10.6% for the quarterended June 25, 2004 from 12.0% for the quarter ended June 27, 2003.

 

20

----

 

*Generaland Administrative Expenses. *General and administrative expenses decreasedto $13.6 million for the quarter ended June 25, 2004, a decrease of 15.9%from $16.1 million for the quarter ended June 27, 2003.  The decrease resulted from cost reductionsin the latter part of 2003, including the consolidation of the administrativeoperations of our recently acquired companies. General and administrative expenses as a percentage of net revenuesdecreased to 20.0% for the quarter ended June 25, 2004 from 22.6% for thequarter ended June 27, 2003.  Weexpect to hold general and administrative expenses measured in absolute dollarsat their current level in the near future.

 

*InterestIncome, Net. *Interest income, net of interest expense,decreased to $0.1 million for the quarter ended June 25, 2004, a decreaseof 43.7% from $0.3 million for the quarter ended June 27, 2003.  This decrease is due to lower interest rateson our cash and marketable securities investments, and to reduced invested cashlevels resulting from the repurchase of approximately $15.1 million of ourstock from a major stockholder in February 2004.  Interest income net of interest expense as a percentage of netrevenues decreased to 0.2% for the quarter ended June 25, 2004 from 0.4%for the quarter ended June 27, 2003.

 

*OtherIncome (Expense), Net*.  Other expense decreased to $0.1 million forthe quarter ended June 25, 2004, a decrease of 46.3% from $0.2 million forthe quarter ended June 27, 2003.

 

*IncomeTaxes. *The provision for income taxes for thequarter ended June 25, 2004 was $0.8 million.  The provision was 45% for the quarter ended June 25, 2004,compared to a tax benefit rate of 36.5% for the quarter ended June 27,2003.  The higher absolute rate in 2004is due to income taxes we pay in certain states which do not allow for the useof our net operating loss carryforwards to offset income of certain of oursubsidiaries.

 

**Results of Operationsfor the Six Months Ended June 25, 2004 and June 27, 2003**

 

*Revenues. *Our net revenues decreased to $134.0 million for the six months endedJune 25, 2004, a decrease of 5.2% from $141.4 million for the six monthsended June 25, 2003.  Our totalrevenues decreased to $142.5 million for the six months ended June 25,2004, a decrease of 4.5% from $149.1 million for the six months endedJune 27, 2003.  The decreases wereprimarily due to declines in our Life Sciences and Health Plan businesses,offset by increases in Health Delivery Outsourcing and the Meditech ServiceCenter.   The Life Sciences segment hadthe most significant revenue decline ($8.9 million or 32.4%), due to thegeneral decline in the custom software business for pharmaceutical clients, andalso due to the completion of a major engagement in the second quarter of2003.  The Health Plan segment declinedby $5.7 million, or 38.5%, due to the completion of several significantprojects during 2003, without having new projects to replace them.  Additionally, during the second quarter of2004, we took a revenue writedown of over $0.8 million on a single project inthe Health Plan segment due to a miscommunication with the client’s seniormanagement regarding the scope of the project. Health Delivery Outsourcing revenues increased by $3.6 million, or 7.6%,due to additional work on existing projects. The Meditech Service Center revenues increased by $2.8 million, or28.7%, due to the award of a new outsourcing engagement and other generalincreases in demand for those services.

 

* Cost of Services. *Cost ofservices before reimbursable expenses decreased to $90.4 million for the sixmonths ended June 25, 2004, a decrease of 5.4% from $95.6 million for thesix months ended June 27, 2003. The decrease was primarily due to cost reductions, primarily reductionin headcount, made in response to the revenue declines noted above.  We reduced cost of services by $5.0 millionin Life Sciences and $1.6 million in Health Plan.  Additionally, we reduced cost of services by $2.0 million inHealth Delivery.  These decreases werepartially offset by increased costs in the Meditech Service Center related tothe increase in work in that segment.

 

21

----

 

*Gross Profit. *Gross profitdecreased to $43.6 million for the six months ended June 25, 2004, adecrease of 4.8% from $45.8 million for the six months ended June 27,2003.  The decrease was primarily due toreduced gross profits in Life Sciences and Health Plan as a result of therevenue declines noted above.  Thedecrease in our gross profit was partly offset by an increase in gross profitsin our other segments, but primarily Health Delivery Outsourcing due to ongoingcost efficiencies that were achieved on certain contracts beginning inmid-2003.  Gross profit as a percentageof net revenues increased slightly to 32.6% for the six months endedJune 25, 2004 from 32.4% for the six months ended June 27, 2003.  This increase was due to the increasedmargin percentage in most of our segments other than Health Plan.  Given the current revenue mix, our grossprofit percentage is not expected to change significantly in the near future;however, a sudden downturn in demand in one or more of our segments or aninability to control costs on our fixed price projects could negatively affectour margin percentage.

 

*SellingExpenses. *Selling expenses decreased to $14.5 millionfor the six months ended June 25, 2004, a decrease of 12.8% from $16.7million for the six months ended June 27, 2003.  This decrease was primarily due to a reduction in our sales forcewhich took effect in mid-2003.  Sellingexpenses as a percentage of net revenues decreased to 10.8% for the six monthsended June 25, 2004 from 11.8% for the six months ended June 27,2003.

 

*Generaland Administrative Expenses. *General and administrative expenses decreasedto $25.8 million for the six months ended June 25, 2004, a decrease of14.7% from $30.2 million for the six months ended June 27, 2003.  The decrease resulted from cost reductionsin the latter part of 2003, including the consolidation of the administrativeoperations of our recently acquired companies. General and administrative expenses as a percentage of net revenues decreasedto 19.2% for the six months ended June 25, 2004 from 21.3% for the sixmonths ended June 27, 2003.  Weexpect to hold these expenses at their current level in the near future.

 

*InterestIncome, Net. *Interest income, net of interest expensedecreased to $0.3 million for the six months ended June 25, 2004, adecrease of 34.8% from $0.5 million for the six months ended June 27,2003.  This decrease was due to lowerinterest rates on our cash and marketable securities investments, and to reducedinvested cash levels resulting from the repurchase of approximately $15.1million of our stock from a major stockholder in February 2004.  Interest income net of interest expense as apercentage of net revenues decreased to 0.3% for the six months ended June 25,2004 from 0.4% for the six months ended June 27, 2003.

 

*OtherIncome (Expense), Net*.  Other expense increased to $0.1 million forthe six months ended June 25, 2004 from a negligible amount for the sixmonths ended June 27, 2003.

 

*Expense for Premium on Repurchase of Stock*.  In the first quarter of 2004, we repurchased1.96 million shares of our stock and certain options from a major stockholderat a premium to the then current market price (see Note 11 of Notes toConsolidated Financial Statements).  Theaggregate purchase price for the shares and the options represented a premiumof approximately 11% to the market price of our common stock on the date werepurchased such stock.  As a result, werecorded a pretax charge of approximately $1.6 million (without any taxbenefit) for such premium included in the purchase consideration.

 

*IncomeTaxes. *The provision for income taxes for the sixmonths ended June 25, 2004 was $1.6 million.  The provision was 80.1% for the six months ended June 25,2004.  Excluding the nondeductiblepremium on repurchase of stock described above, the provision was 45% for thesix months ended June 25, 2004, compared to a tax benefit rate of 35.0%for the six months ended June 27, 2003. The higher absolute rate in 2004 is due to income taxes we pay incertain states which do not allow the use of our net operating losscarryforwards to offset income of certain of our subsidiaries.

 

22

----

 

*Cumulative Effect of Change in Accounting Principle*.  In November 2002, the Emerging IssuesTask Force (EITF) reached a consensus on Issue 00-21, titled “Accounting forRevenue Arrangements with Multiple Deliverables,”  which addresses how to account for arrangements that involve thedelivery or performance of multiple products, services, and/or rights to useassets.  The new standard was requiredto be adopted for all new applicable revenue arrangements no later than thethird quarter of 2003.  Early adoptionwas permitted and we elected to adopt the new standard as of the beginning ofthe first quarter of 2003.  In addition,we elected to apply the new standard to all existing outsourcing arrangementsimpacted by EITF 00-21 and record to earnings the resulting cumulative effectas a change in accounting principle.  Werecorded a non-cash charge, net of tax, of $2.6 million, or $0.11 per share, inthe first quarter of 2003.

 

**Liquidity and Capital Resources**

 

During the six months endedJune 25, 2004, we generated cash flow from operations of $2.7million.  During the six months endedJune 25, 2004, we used $2.4 million in cash to purchase the remaining 47.65%minority interest in FCG Infrastructure Services, Inc. (formerly CodigentSolutions Group, Inc.), and approximately$3.9 million of cash to purchase property and equipment, primarily computer andrelated equipment.  At June 25,2004, we had cash and investments available for sale of $45.1 million comparedto $62.6 million at December 26, 2003.

 

On February 27, 2004, werepurchased all outstanding FCG shares and certain FCG options held by a majorstockholder (see Note 11 of Notes to Consolidated Financial Statements).  The aggregate purchase price for such sharesand options was $14.8 million in cash, and cancellation of a note owed to us bythe stockholder in the amount of $0.3 million. In addition, in the event we were to announce or consummate a change incontrol transaction prior to the first anniversary of this transaction, or ifwe were to enter into negotiations regarding a change in control transactionprior to the first anniversary and subsequently announce publicly a definitiveagreement for or consummate a change in control transaction within the 18months following the closing of this repurchase transaction, we would pay tothis former stockholder, upon the closing of such change in control of FCG, anamount equal to the difference between $7.50 per share and the change incontrol transaction price per share, if such change in control price per shareamount was higher.

 

OnOctober 1, 2003, we entered into an unsecured loan agreement with WhitePlains Hospital Center requiring us to provide interest free financing of up to$4.1 million if our system implementation at the hospital results in anincrease in the hospital’s accounts receivable balance or days outstandingduring a 150-day period following the completion of the systemimplementation.  Any amounts borrowedduring this 150-day period are payable 90 days after the borrowing date.  We do not currently expect to make any loansunder this agreement until early 2005, if at all.  Since our loans are unsecured, we cannot guarantee that thehospital will repay our loans on a timely basis, if at all.  If our loans are not repaid or repaid in atimely manner, our financial condition would be impacted negatively.

 

We have a revolving line of credit, under which we are allowed toborrow up to $7.0 million at an interest rate of the prevailing prime rate withan expiration of May 1, 2005.  There wasno outstanding balance under the line of credit at June 25, 2004.

 

Managementbelieves that our existing cash and investments, together with funds generatedfrom operations, will be sufficient to meet operating requirements for at leastthe next twelve months.  Our cash andinvestments are available for capital expenditures (which are projected at approximately$7.0 million for 2004), strategic investments, mergers and acquisitions, andother potential large-scale cash needs that may arise.

 

23

----

 

The followingtable summarizes our contractual and other commitments (in thousands):

 
|                               |   | **Payments  Due by Period** |   |
|------------------------------------|--------|-----------------------------|--------|
| **Contractual Obligations**        |   | **Less than  1  Year**      |   | **1 -3  Years** |   | **3-5  Years** |   | **More than  5 Years** |   | **Total** |   |
| Operating leases, net of subleases |   | $                           | 5,487  |   | $ | 9,811 |   | $ | 4,568 |   | $ | — |   | $ | 19,866 |   |
| Purchase obligations               |   | 310                         |   | 232 |   | — |   | — |   | 542 |   |
| Total                              |   | $                           | 5,797  |   | $ | 10,043 |   | $ | 4,568 |   | $ | — |   | $ | 20,408 |   |

 

**Critical Accounting Policies andEstimates**

 

The foregoing discussion and analysis of our financial condition andresults of operations is based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States of America. The preparation of these financial statements requires us to makeestimates and assumptions that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities.  On an on-going basis,we evaluate our estimates, including those related to revenue recognition, costto complete client engagements, valuation of goodwill and long-lived andintangible assets, accrued liabilities, income taxes, restructuring costs, idlefacilities, litigation and disputes, and the allowance for doubtfulaccounts.  We base our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying value of assets and liabilities that are notreadily apparent from other sources. Our actual results may differ from our estimates and we do not assumeany obligation to update any forward-looking information.

 

We believe the following critical accounting policies reflect our moresignificant assumptions and estimates used in the preparation of ourconsolidated financial statements.

 

***RevenueRecognition and Unbilled Receivables***

 

Revenues are derived primarily from information technology outsourcingservices, consulting, and systems integration. Revenues are recognized on a time-and-materials, level-of-effort, percentage-of-completion,or straight-line basis.  Before revenuesare recognized, the following four criteria must be met: (a) persuasiveevidence of an arrangement exists; (b) delivery has occurred or services rendered;(c) the fee is fixed and determinable; and (d) collectibility is reasonablyassured.  We determine if the fee isfixed and determinable and collectibility is reasonably assured based on ourjudgments regarding the nature of the fee charged for services rendered andproducts delivered and the collectibility of those fees.  Arrangements range in length from less thanone year to seven years.  Thelonger-term arrangements are generally level-of-effort or fixed price arrangements.

 

Revenues from time-and-materials arrangements are generally recognizedbased upon contracted hourly billing rates as the work progresses.  Revenues from level-of-effort arrangementsare recognized based upon a fixed price for the level of resources provided.  Revenues from fixed fee arrangements forconsulting and systems integration work are generally recognized on a rate perhour or percentage-of-completion basis. We maintain, for each of our fixed fee contracts, estimates of totalrevenue and cost over the contract term. For purposes of periodic financialreporting on the fixed price consulting and system integration contracts, weaccumulate total actual costs incurred to date under the contract. The ratio ofthose actual costs to our then-current estimate of total costs for the life ofthe contract is then applied to our then-current estimate of total revenues forthe life of the contract to determine the portion of total estimated revenuesthat should be recognized.  We followthis method because reasonably dependable estimates of the revenues and costsapplicable to various stages of a contract can be made.

 

24

----

 

Revenues recognized on fixed price consulting and system integrationcontracts are subject to revisions as the contract progresses tocompletion.  If we do not accuratelyestimate the resources required or the scope of the work to be performed, donot complete our projects within the planned periods of time, or do not satisfyour obligations under the contracts, then profit may be significantly andnegatively affected or losses may need to be recognized.  Revisions in our contract estimates arereflected in the period in which the determination is made that facts andcircumstances dictate a change of estimate. Favorable changes in estimatesresult in additional revenues recognized, and unfavorable changes in estimatesresult in a reduction of recognized revenues. Provisions for estimated losseson individual contracts are made in the period in which the loss first becomesknown.  Some contracts include incentivesfor achieving either schedule targets, cost targets, or other definedgoals.  Revenues from incentive typearrangements are recognized when it is probable they will be earned.

 

We evaluateour non-outsourcing fixed price contracts on an ongoing basis by estimating thecost to complete the assignment.  Wethen recognize revenues to achieve a constant margin over the remaining term ofthe engagement.  We changed ouraccounting for outsourcing contracts with the adoption of EITF 00-21,“Accounting for Revenue Arrangements with Multiple Deliverables,” in the firstquarter of 2003.  Under our outsourcingcontracts, a significant portion of our revenues are fixed and allocated overthe contract on a straight-line basis, as we are required to provide aspecified level of services subject to certain performance measurements.  Also, certain revenues may fluctuate underthe contracts based on the volume of transactions we process or othermeasurements of service provided.  If weincur higher costs to provide the required services or receive less revenue dueto reduced transaction volumes or penalties associated with service levelfailures, our gross profit can be negatively impacted.

 

On certain contracts, or elements of contracts, costs are incurredsubsequent to the signing of the contract, but prior to the rendering ofservice and associated recognition of revenue. Where such costs are incurred and realization of those costs is eitherpaid for upfront or guaranteed by the contract, those costs are deferred andlater expensed over the period of recognition of the related revenue.  At June 25, 2004, we had deferred $1.1million of such deferred costs.

 

As part of our on-going operations to provide services to ourcustomers, incidental expenses, which are generally reimbursable under theterms of the contracts, are billed to customers. These expenses are recorded asboth revenues and direct cost of services in accordance with the provisions ofEITF 01-14, “Income Statement Characterization of Reimbursements Received for‘Out-of-Pocket’ Expenses Incurred,” and include expenses such as airfare,mileage, hotel stays, out-of-town meals, and telecommunication charges.

 

Although software revenues comprised less than 3% of our revenues inthe first six months of 2004, they are growing as a proportion of our totalrevenues.  We recognize softwarerevenues in accordance with the provisions of the American Institute ofCertified Public Accountants Statement of Position (“SOP”) 97-2, “SoftwareRevenue Recognition”, as amended by SOP 98-4, “Deferral of the Effective Dateof a Provision of SOP 97-2, Software Revenue Recognition” and SOP 98-9,“Modification of SOP 97-2, Software Revenue Recognition, With Respect toCertain Transactions”, and in accordance with the Securities and ExchangeCommission Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition”.We license software under non-cancelable license agreements and provide relatedprofessional services, including consulting, training, and implementationservices, as well as ongoing customer support and maintenance.  Many of our more significant softwarearrangements include implementation services that are essential to thefunctionality of our software products, and are recognized using contractaccounting including the percentage-of-completion methodology over the periodof the implementation.

 

In cases where our software arrangements do not include servicesessential to the functionality of the product, license fee revenues arerecognized when the software product has been shipped, provided a

 

25

----

 

non-cancelable license agreement has been signed, there are nouncertainties surrounding product acceptance, the fees are fixed ordeterminable and collection of the related receivable is considered probable.We do not generally offer rights of return or acceptance clauses to ourcustomers. In situations where we do provide rights of return or acceptanceclauses, revenue is deferred until the clause expires. Typically, our softwarelicense fees are due within a twelve-month period from the date of shipment. Ifthe fee due from the customer is not fixed or determinable, including paymentterms greater than twelve months from shipment, revenue is recognized aspayments become due and all other conditions for revenue recognition have beensatisfied. In software arrangements that include rights to multiple softwareproducts, specified upgrades, maintenance or services, we allocate the totalarrangement fee among the deliverables using the fair value of each of thedeliverables determined using vendor-specific objective evidence.Vendor-specific objective evidence of fair value is determined using the pricecharged when that element is sold separately. In software arrangements in whichwe have fair value of all undelivered elements but not of a delivered element,we use the residual method to record revenue. Under the residual method, thefair value of the undelivered elements is deferred and the remaining portion ofthe arrangement fee is allocated to the delivered element(s) and is recognizedas revenue. In software arrangements in which we do not have vendor-specificobjective evidence of fair value of all undelivered elements, revenue isdeferred until fair value is determined or all elements have been delivered.

 

Revenues from training and consulting services are recognized asservices are provided to customers. Revenues from maintenance contracts aredeferred and recognized ratably over the term of the maintenance agreements.Revenues for customer support and maintenance that are bundled with the initiallicense fee are deferred based on the fair value of the bundled supportservices and recognized ratably over the term of the agreement; fair value isbased on the renewal rate for continued support arrangements.

 

Unbilled receivables represent revenues recognized for servicesperformed that were not billed at the balance sheet date.  The majority of these amounts are billed inthe subsequent month. Unbillable amounts arising from contracts occur whenrevenues recognized exceed allowable billings in accordance with thecontractual agreements.  As ofJune 25, 2004, we had unbillable revenues included in current unbilledreceivables of approximately $1.0 million, which were generally expected to be billedin the following quarter.  In addition,we had a long-term account receivable at June 25, 2004 andDecember 26, 2003 of $4.7 million and $5.8 million, respectively, on asingle major outsourcing contract with a term of seven years.  The long-term receivable will be billed andcollected over the remaining two and a half years of the contract throughcontractual billings that will exceed the amounts to be earned as revenues.

 

Customer advancesare comprised of payments from customers for which services have not yet beenperformed or prepayments against work in process. These unearned revenues aredeferred and recognized as future contract costs are incurred and as contractservices are rendered.

 

***Allowance forDoubtful Accounts***

 

We maintain an allowance for doubtful accounts for estimated lossesresulting from the inability of our clients to make required payments. If thefinancial condition of our clients were to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired.   Management analyzes accountreceivables and historical bad debt, customer concentrations, creditworthiness, past collection experience, current economic trends, and changes inour customer payment terms when evaluating the adequacy of doubtful accounts.

 

***Deferred Income Taxes***

 

We accountfor income taxes in accordance with SFAS No. 109, “Accounting for IncomeTaxes,” which requires recognition of deferred tax assets and liabilities forthe expected future tax consequences

 

26

----

 

of eventsthat have been included in the financial statements or tax returns.  Our net deferred tax assets havehistorically consisted primarily of the tax benefit related to restructuringcosts for facility closures, supplemental executive retirement plancontributions, and other accrued liabilities such as accrued vacation pay,which are not deductible for tax purposes until paid.  During fiscal year 2003, we generated additionaldeferred tax assets for net operating loss carryforwards which were created byour pretax losses combined with the fact that we are outside the period it isallowable to carry back losses, and also for additional deferred tax assetsrelated to the cumulative effect of our change in revenue recognition method onour outsourcing contracts.  We usesignificant estimates in determining what portion of our deferred tax asset ismore likely than not to be realized. Based on those estimates and taking into account our recent history ofcumulative losses, we recorded a valuation allowance of $5.5 million in thefourth quarter of fiscal year 2003. Together with a full valuation allowance of $5.5 million we had alreadytaken against the net operating loss carryforwards of companies we had acquiredearlier in the year, at December 26, 2003, we had a valuation allowance of$11.0 million against a total deferred tax asset of $21.1 million.  Based on our belief that it is more likelythan not that future taxable income will be sufficient to realize the remaining$10.1 million of deferred tax assets, we have not recorded a valuationallowance against those assets. However, there is no guarantee that our taxable income will besufficient to realize such remaining net deferred tax assets, and we will continueto evaluate the potential need for an additional valuation allowance on anongoing basis.  Additionally, if therealization of a greater amount of our deferred tax assets in the future isconsidered more likely than not, we will reverse all or a portion of theexisting valuation allowance at that time.

 

***Goodwill and Intangible Assets***

 

Under SFAS No 142, we no longer amortize our goodwill and are requiredto complete an annual impairment testing during the fourth quarter of eachyear.  We believe that the accountingassumptions and estimates related to the annual goodwill impairment testing arecritical because these can change from period to period.  The impairment test requires us to forecastour future cash flows, which involves significant judgment.  Our operating results have been negativelyimpacted by the worldwide economic conditions.   Accordingly, if our expectations of future operating resultschange, or if there are changes to other assumptions, our estimate of the fairvalue of our reporting units could change significantly resulting in a goodwillimpairment charge, which could have a significant impact on our consolidatedfinancial statements.  As ofJune 25, 2004, we have $17.8 million of goodwill and $3.3 million ofintangible assets recorded on our balance sheet (see Note 5 of the Notes toConsolidated Financial Statements).

 

**Risks Relating to Our Business**

 

Before deciding to invest in us or to maintain or increase yourinvestment, you should carefully consider the risks described below, inaddition to the other information contained in this report.  The risks and uncertainties described beloware not the only ones facing our company. Additional risks and uncertainties not presently known to us or that wecurrently deem immaterial may also affect our business operations.  If any of these risks are realized, ourbusiness, financial condition or results of operations could be seriouslyharmed.  In that event, the market pricefor our common stock could decline and you may lose all or part of yourinvestment.

 

*Many factors maycause our net revenues, operating results and cash flows to fluctuate andpossibly decline.*

 

Our net revenues, operating results, and cash flows may fluctuatesignificantly because of a number of factors, many of which are outside of ourcontrol.  These factors may include:

 

27

----

 

•                  Ourability to reduce our losses in our life sciences business;

•                  Theloss of one or more significant clients in any of our business segments;

•                  Theroll-off or completion of significant projects in any of our business segments;

•                  Fluctuationsin market demand for our services, associate hiring, and utilization;

•                  Delaysor increased expenses in securing and completing client engagements;

•                  Timingand collection of fees and payments;

•                  Timingof new client engagements in any of our business segments;

•                  Increasedcompetition and pricing pressures;

•                  Useof offsite and offshore resources on our engagements;

•                  Ourability to incorporate the use of variable labor staffing into our projects;

•                  Theloss of key personnel and other employees;

•                  Changesin our, and our competitors’, business strategy, pricing and billing policies;

•                  Thetiming of certain general and administrative expenses;

•                  Completingacquisitions and the costs of integrating acquired operations;

•                  Impairmentof goodwill from our acquisitions;

•                  Variability in the number ofbillable days in each quarter;

•                  Thewrite-off of client billings;

•                  Returnof fees for work deemed unsatisfactory by a client or claims or litigationresulting from the same;

•                  Entryinto fixed price engagements and engagements where some fees are contingentupon the client realizing a certain return on investment for a project;

•                  Availabilityof foreign net operating losses and other credits against our earnings;

•                  Internationalcurrency fluctuations;

•                  Ourability to sublease vacant office space included in previous restructuringcharges; and

•                  Thefixed nature of a substantial portion of our expenses, particularly personneland related costs, depreciation, office rent, and occupancy costs.

 

One or more ofthe foregoing factors may cause our operating expenses to be unexpectedly highduring any given period.  In addition,we bill certain of our services on a fixed-price basis, and any assignmentdelays or expenditures of time beyond that projected for the assignment couldresult in write-offs of client receivables (both unbilled and billed).  Significant write-offs could materially adverselyaffect our business, financial condition, and results of operations.  Our business also has significant collectionrisks.  If we are unable to collect ourreceivables in a timely manner, our business and financial condition could alsosuffer.  If these or any other variablesor unknowns were to cause a shortfall in revenues or earnings or otherwisecause a failure to meet public market expectations, our business could beadversely affected.

 

We adopted EITF 00-21 in the first quarter of 2003, which affects theway we recognize revenue on long-term outsourcing agreements. The adoption ofEITF 00-21 results in separating our outsourcing contracts into multipleelements and separately accounting for each element, rather than accounting forall elements together as a group.  As aresult, we now recognize revenue from certain service elements of ouroutsourcing agreements on a straight-line basis over the life of the contract,rather than on a percentage of completion basis.  Since we typically incur greater costs and expenses during theearly phase of the service elements (which will now have straight-line revenuerecognition) than we do in the later years of those elements, we believe ournet income will be less during the early stages of our outsourcing engagements.  In addition, if we are unable to managecosts as planned in the later stages of an outsourcing engagement, our netincome will likewise be negatively impacted. In general, income from our outsourcing contracts will be less stable inthe future, since it will be more susceptible to changes in the mix of newerversus older contracts, and to the impact of cost fluctuations from quarter toquarter without a compensating change in revenue.  If we fail to meet our public market expectations or otherwise

 

28

----

 

experience a shortfall in our net income due to these fluctuations, ourbusiness could be adversely affected and the price of our stock may decline.

 

Finally, we reported net losses before the cumulative effect of changein accounting principle for the last three quarters of 2003 as well as a netloss for the first quarter of 2004.  Asa result, we cannot assure you that we will achieve positive earnings in thefuture.  If we are unable to achieveprofitability on a quarterly or annual basis, the market price of our commonstock could be adversely affected and our financial condition would suffer.

 

*We are dependent on our outsourcingengagements for a significant part of our revenues.*

 

Currently, we have eight significant outsourcing relationships. Netrevenues from our outsourcing relationships, for the six months endedJune 25, 2004, represented approximately 41% of our consolidated netrevenues.  The substantial majority ofthese revenues are received from four large outsourcing accounts that havesigned long-term agreements with us. However, the loss of any of our outsourcing relationships would have amaterial impact on our business and results of operations.  In each of these engagements, the clientshave fully outsourced their information technology staff and functions to us.  In all of our outsourcingrelationships, we generally enter into detailed service level agreements, whichestablish performance levels and standards for our services.  If we fail to meet these performance levelsor standards, our clients may receive monetary service level credits from usor, if we experience persistent failures, our clients may have a right toterminate the outsourcing contract for cause and have no obligation to pay usany termination fees.  Our anticipatedrevenues and profitability from our outsourcing engagements could besignificantly reduced if we are unable to satisfy our performance levels orstandards, or if we are unable to improve our delivery costs as planned on suchengagements.  Additionally, ouroutsourcing contracts can be terminated at the convenience of our clients uponthe payment of a termination fee.

 

In addition, our outsourcing agreements require that we investsignificant amounts of time and resources in order to win the engagement,transition the client’s information technology department to our management,and complete the initial transformation of our client’s information technologyfunctioning to provide improved service at a lower cost and meet agreed-uponservice levels.  Often, we recover thisinvestment through payments over the life of the outsourcing agreement.  If we are unable to achieve agreed-uponservice levels or otherwise breach the terms of our outsourcing agreements, theclients may have rights to terminate our agreements for cause and we may beunable to recover our investments.  Anyfailure by us to recover these investments could reduce our outsourcingrevenue, which would have a material adverse effect on our financial condition,results of operations, and price of our common stock.

 

Our outsourcing engagements may also require that we hire part or allof a client’s information technology personnel.  We cannot assure you that we will be able to retain theseindividuals, and effectively hire additional personnel as needed to meet theobligations of our contract.  Anyfailure by us to retain these individuals or otherwise satisfy our contractualobligations could have a material adverse effect on the profitability of ouroutsourcing business and our reputation as an information technology servicesoutsourcing provider.

 

Finally, weare expanding our outsourcing business to perform discrete informationtechnology services for clients.  Theamount of time and resources required to win client engagements for ouroutsourcing business is significant, and we may not win the number or type ofclient engagements that we anticipate. If we fail to meet our objective to secure new outsourcing engagements,or fail to secure new outsourcing engagements on acceptable commercial terms,we will not experience the growth in this business that we have anticipated.

 

29

----

 

*The length of time required to engage aclient and to complete an assignment may be unpredictable and could negativelyimpact our net revenues and operating results.*

 

The timing of securing our client engagements and service fulfillmentis difficult to predict with any degree of accuracy.  Prior engagement cycles are not necessarily an indication of thetiming of future client engagements or revenues.  The length of time required to secure a new client engagement orcomplete an assignment often depends on factors outside our control, including:

 

•                  Existinginformation systems at the client site;

•                  Changesor the anticipation of changes in the regulatory environment affectinghealthcare and pharmaceutical organizations;

•                  Changesin the management or ownership of the client;

•                  Budgetarycycles and constraints;

•                  Changesin the anticipated scope of engagements;

•                  Availabilityof personnel and other resources; and

•                  Consolidationin the healthcare and pharmaceutical industries.

 

Prior to client engagements, we typically spend a substantial amount oftime and resources (1) identifying strategic or business issues facing theclient, (2) defining engagement objectives, (3) gathering information, (4)preparing proposals, and (5) negotiating contracts.  Our failure to procure an engagement after spending such time andresources could materially adversely affect our business, financial condition,and results of operations.  We may alsobe required to hire new associates before securing a client engagement.  If clients defer committing to new assignmentsfor any length of time or for any reason we could be required to maintain a significantnumber of under-utilized associates which could adversely affect our operatingresults and financial condition during any given period.  Further, our outsourcing business has verylong sales and contract lead times, requiring us to spend a substantial amountof time and resources in attempting to secure each outsourcing engagement.  We cannot predict whether the investment oftime and resources will result in a new outsourcing engagement or, if theengagement is secured, that the engagement will be on terms favorable to us.

 

*We could be negatively impacted if we fail tosuccessfully integrate the businesses we acquire.*

 

We have grown, in part, by acquiring complementary businesses thatcould enhance our capability to serve the healthcare and pharmaceuticalindustries.  For example, we acquired amajority interest in Codigent Solutions Group, Inc. (renamed FCG InfrastructureServices, Inc.) in 2002 and purchased the remaining minority interest in thatentity in the first quarter of 2004. Also, during the first half of 2003, we acquired Paragon Solutions,Inc., Coactive Systems Corporation, and certain assets of Phyve Corporation.All acquisitions involve risks that could materially and adversely affect ourbusiness and operating results.  Theserisks include:

 

•                  Distractingmanagement from our business;

•                  Losing keypersonnel and other employees;

•                  Losing clients;

•                  Costs, delays,and inefficiencies associated with integrating acquired operations andpersonnel;

•                  The impairmentof acquired assets and goodwill;

•                  Acquiring thecontingent and other liabilities of the businesses we acquire; and

•                  Not realizingthe intended or expected benefits of the acquisitions.

 

In addition, acquired businesses may not enhance our services, provideus with increased client opportunities, or result in the growth that weanticipate.  Furthermore, integratingacquired operations is a complex, time-consuming, and expensive process.  Combining acquired operations with us mayresult in

 

30

----

 

lower overall operating margins, greater stock price volatility, andquarterly earnings fluctuations. Cultural incompatibilities, career uncertainties, and other factorsassociated with such acquisitions may also result in the loss of employees andclients.  Failing to acquire andsuccessfully integrate complementary practices, or failing to achieve thebusiness synergies that we anticipate, could materially adversely affect ourbusiness and results of operations.

 

*We may be negativelyimpacted if our investments in products and emerging service lines areunsuccessful.*

 

We have publicly announced our strategy to increase our investment inproduct development, including further investment in FirstDocTM aswell as investment in a physician portal product, FirstGatewaysTM.  These investments are in addition tocontinuing our investments in other emerging service lines and products.  We typically do not capitalize the cost ofour product development activities and do not anticipate capitalizing expectedinvestments this year.  As a result, ourfinancial results may be adversely impacted by such increased investment in theshort term.  If such product developmentactivities or investment in our emerging service lines do not result inrelevant offerings, we will not achieve desired levels of return on theseinvestments.  As a result, our businessand results of operations could be adversely affected.

 

*If we are unable togenerate additional revenue from our existing clients, our business may benegatively affected.*

 

Our success depends, to a significant extent, on obtaining additionalengagements from our existing clients. A substantial portion of our revenues is derived from additionalservices provided to our existing clients. The loss of a small number of clients, or a reduction in the number ofengagements with these clients, may result in a material decline in revenuesand cause us to fail to meet public market expectations of our financialperformance and operating results.  Ifwe fail to generate additional revenues from our existing clients it maymaterially adversely affect our business and financial condition.

 

*If we fail to meet client expectations in theperformance of our services, our business could suffer.*

 

Our services often involve assessing and/or implementing complexinformation systems and software, which are critical to our clients’operations.  Our failure to meet clientexpectations in the performance of our services, including the quality, costand timeliness of our services, may damage our reputation in the healthcare andpharmaceutical industries and adversely affect our ability to attract andretain clients.  If a client is notsatisfied with our services, we will generally spend additional human and otherresources at our own expense to ensure client satisfaction.  Such expenditures will typically result in alower margin on such engagements and could materially adversely affect ourbusiness, financial condition, and results of operations.

 

Further, in the course of providing our services, we will oftenrecommend the use of software and hardware products.  These products may not perform as expected or containdefects.  If this occurs, our reputationcould be damaged and we could be subject to liability.  We attempt contractually to limit ourexposure to potential liability claims; however, such limitations may not beeffective.  A successful liability claimbrought against us may adversely affect our reputation in the healthcare andpharmaceutical industries and could have a material adverse effect on ourbusiness or financial condition. Although we maintain professional liability insurance, such insurancemay not provide adequate coverage for successful claims against us.

 

31

----

 

*We may be unable to attract and retain asufficient number of qualified employees.*

 

Our business is labor-intensive and requires highly skilledemployees.  Many of our associatespossess extensive expertise in the healthcare, insurance, pharmaceutical,information technology and consulting fields. To serve a growing client base, we must continue to recruit and retainqualified personnel with expertise in each of these areas.  We must also seek certain employees that arewilling to work on a variable or per diem basis.  Competition for such personnel is intense and we compete for suchpersonnel with management consulting firms, healthcare and pharmaceuticalorganizations, software firms, and other businesses.  Many of these entities have substantially greater financial andother resources than we do, or can offer more attractive compensation packagesto candidates, including salary, bonuses, stock, and stock options.  If we are unable to recruit and retain asufficient number of qualified personnel to serve existing and new clients, ourability to expand our client base or services and to offer our services atcompetitive rates could be impaired and our business would suffer.

 

*The loss of our key client service employeesand executive officers could negatively affect us.*

 

Our performance depends on the continued service of our executiveofficers, senior managers, and key employees. In particular, we depend on such persons to secure new clients andengagements and to manage our business and affairs.  The loss of such persons could result in the disruption of ourbusiness and could have a material adverse effect on our business and resultsof operations.  We have not entered intolong-term employment contracts with any of our employees and do not maintainkey employee life insurance.

 

*Continued or increased employee turnovercould negatively affect our business.*

 

We have experienced employee turnover as a result of:

 

•                  Dependence onlateral hiring of associates;

•                  Travel demandsimposed on our associates;

•                  Loss of employeesto competitors and clients; and

•                  Reductions inforce as certain areas of our business have seen less demand.

 

Continued or increased employee turnover could materially adverselyaffect our business and results of operations. In addition, many of our associates develop strong businessrelationships with our clients.  Wedepend on these relationships to generate additional assignments andengagements.  The loss of a substantialnumber of associates could erode our client base and decrease our revenues.

 

*If we are unable to manage shifts in marketdemand or growth in our business, our business may be negatively impacted.*

 

Our business has historically grown rapidly, and though our overallrevenues have remained flat for the past several years, we have experiencedgrowth and increased demand in certain areas of our business.  In response to shifts in market demand andin an effort to better align our business with our markets, we restructured ourorganization and hired persons with appropriate skills, including salespersons,and reduced our workforce in practice areas experiencing less demand.  We have also begun to hire employees willingto work on a variable or per diem basis in order to better manage project costsand general and administrative expense associated with underutilizedresources.  These market conditions andrestructuring efforts have placed new and increased demands on our managementpersonnel.  It has also placedsignificant and increasing demands on our financial, technical and operationalresources, and on our information systems. If we are unable to manage growth effectively or if we experiencebusiness disruptions due to shifts in market demand, or growth orrestructuring, our operating results will suffer.  To manage any future growth, we must extend our financialreporting and information management

 

32

----

 

systems to our multiple and international office locations andtraveling employees, and develop and implement new procedures and controls toaccommodate new operations, services and clients.  Increasing operational and administrative demands may make itdifficult for our senior managers to engage in business development activitiesand their other day-to-day responsibilities. Further, the addition of new employees and offices to offset anyincreasing demands may impair our ability to maintain our service deliverystandards and corporate culture.  Inaddition, we have in the past changed, and may in the future change, ourorganizational structure and business strategy.  Such changes may result in operational inefficiencies and delaysin delivering our services.  Suchchanges could also cause a disruption in our business and could cause amaterial adverse effect on our financial condition and results of operations.

 

*Changes in the healthcare and pharmaceuticalindustries could negatively impact our revenues.*

 

We derive a substantial portion of our revenues from clients in thehealthcare industry.  As a result, ourbusiness and results of operations are influenced by conditions affecting thisindustry, particularly any trends towards consolidation among healthcare andpharmaceutical organizations.  Suchconsolidation may reduce the number of existing and potential clients for ourservices.  In addition, the resultingorganizations could have greater bargaining power, which could erode thecurrent pricing structure for our services. The reduction in the size of our target market or our failure to maintainour pricing goals could have a material adverse effect on our business andfinancial condition.  Finally, each ofthe markets we serve is highly dependent upon the health of the overalleconomy.  Our clients in each of thesemarkets have experienced significant cost increases and pressures in recentyears.  Our services are targeted atrelieving these cost pressures; however, any continuation or acceleration ofcurrent market conditions could greatly impact our ability to secure or retainengagements, the loss of which could have a material adverse effect on ourbusiness and financial condition.

 

A substantial portion of our revenues has also come from companies inthe pharmaceutical industry.  Ourrevenues are, in part, linked to the pharmaceutical industry’s research anddevelopment and technology expenditures. Should any of the following events occur in the pharmaceutical industry,our business could be negatively affected in a material way:

 

•                  Continuedadverse changes to the industry’s general economic environment;

•                  Continuedconsolidation of companies; or

•                  A decrease inpharmaceutical companies’ research and development or technology expenditures.

 

A trend in the pharmaceutical industry is for companies to outsourceeither large information technology-dependent projects or their informationsystems staffing requirements.  Webenefit when pharmaceutical companies outsource to us, but may lose significantfuture business when pharmaceutical companies outsource to our competitors.  If this outsourcing trend slows down orstops, or if pharmaceutical companies direct their business away from us, ourfinancial condition and results of operations could be impacted in a materiallyadverse way.

 

*Our international operations createspecialized risks that can negatively affect us.*

 

We are subject to many risks as a result of the services we provide toour international clients or services we may provide through subcontractors oremployees that are located outside of the U.S.   Further, in February 2003, we acquired Paragon Solutions,Inc., a U.S. based company with offshore software development centers in Indiaand Vietnam.  As a result of thisacquisition, we currently have business operations and employees located inIndia and Vietnam, as well as our existing employees throughout Europe.  If we fail to recruit and retain asufficient number of qualified employees in each country where we conductbusiness, our ability to perform our existing services may be impaired and ourbusiness could be adversely affected. Our international operations are also subject to a variety of risks,including:

 

33

----

 

•                  Difficulties increating international market demand for our services;

•                  Difficulties andcosts of tailoring our services to each individual country’s healthcare andpharmaceutical market needs;

•                  Increasing anduncertain labor costs and high turnover rates;

•                  Unfavorablepricing and price competition;

•                  Currencyfluctuations;

•                  Recruiting andhiring employees, and other employment issues unique to international operations,including ability to secure work visas for foreign employees in the U.S.;

•                  Longer paymentcycles in some countries and difficulties in collecting international accountsreceivable;

•                  Terroristattacks;

•                  Difficulties inenforcing contractual obligations and intellectual property rights;

•                  Adverse taxconsequences;

•                  Increased costsassociated with maintaining international marketing efforts and offices;

•                  Governmentregulations and restrictions;

•                  Adverse changesin regulatory requirements; and

•                  Economic orpolitical instability.

 

We have been performing services in Europe for international clientsfor several years. We ceased performing healthcare consulting services forEuropean clients in 2000, but continue to provide our services in Europe topharmaceutical clients.  We cannotassure you that we will be able to become profitable in our Europeanpharmaceutical services, which may materially adversely affect our financialcondition, results of operations, and price for our common stock.

 

Our acquisitionof Paragon Solutions, Inc. provided us a means to implement our global sourcingstrategy to provide software development and other information technologyservices to our clients.  If we areunable to realize perceived cost benefits of such a strategy or if we areunable to receive high quality services from foreign employees orsubcontractors, our business may be adversely impacted. Further, our recentlyacquired international operations in Vietnam and India subject our business toa variety of risks and uncertainties unique to operating businesses in thesecountries, including the risk factors discussed above.

 

Any one or allof these factors may cause increased operating costs, lower than anticipatedfinancial performance, and may materially adversely affect our business,financial condition, and results of operations.

 

*If we do not compete effectively in thehealthcare and pharmaceutical information services industries, our businesswill be negatively impacted.*

 

The market for healthcare and pharmaceutical information technologyconsulting is very competitive.  We havecompetitors that provide some or all of the services we provide.  For example, in strategic consultingservices, we compete with international, regional, and specialty consulting firmssuch as Bearing Point (formerly KPMG Consulting), Cap Gemini Ernst & Young,IBM Global Consulting Services, Wipro Technologies, and Accenture.

 

In integration and co-management services, we compete with:

 

•                  Informationsystem vendors such as McKesson, Siemens Medical Solutions, Cerner Corporation,and IBM Global Systems;

•                  Service groupsof computer equipment companies;

•                  Systemsintegration companies such as Electronic Data Systems Corporation, PerotSystems Corporation, SAIC, Cap Gemini Ernst & Young, and Computer SciencesCorporation;

 

34

----

 

•                  Clients’internal information management departments;

•                  Other healthcareconsulting firms; and

•                  Otherpharmaceutical consulting firms such as Accenture, Cap Gemini Ernst &Young, and Computer Sciences Corporation’s consulting division.

 

In e-health and e-commerce related services, we compete with thetraditional competitors outlined above, as well as newer internet product andservice companies.  We also compete withcompanies that provide software development, information technology consultingand outsourcing, and other integration and maintenance services, such as WiproTechnologies, Cognizant Technology Solutions Corporation, and Tata TechnologiesLimited.

 

Several of ourcompetitors employ a global sourcing strategy to provide software developmentand other information technology services to their clients, while at the sametime reducing their cost structure and improving the quality of services theyprovide.  If we are unable to realizethe perceived cost benefits of our recently implemented global sourcingstrategy or if we are unable to receive high quality services from foreignemployees or subcontractors, our business may be adversely impacted and we maynot be able to compete effectively.

 

Many of our competitors have significantly greater financial, human,and marketing resources than us.  As aresult, such competitors may be able to respond more quickly to new or emergingtechnologies and changes in customer demands, or to devote greater resources tothe development, promotion, sale, and support of their products and servicesthan we do.  In addition, as healthcareorganizations become larger and more complex, our larger competitors may bebetter able to serve the needs of such organizations.  If we do not compete effectively with current and futurecompetitors, we may be unable to secure new and renewed client engagements, orwe may be required to reduce our rates in order to compete effectively.  This could result in a reduction in ourrevenues, resulting in lower earnings or operating losses, and otherwisematerially adversely affecting our business, financial condition, and resultsof operations.

 

*If we fail to establish and maintainrelationships with vendors of software and hardware products, it could have anegative effect on our ability to secure engagements.*

 

We have a number of relationships with software and hardwarevendors.  For example, our life sciencesbusiness is highly dependent upon a non-exclusive relationship with Documentum,Inc., a vendor of document management software applications with which weintegrate our FirstDoc TM solution. We believe that our relationship with vendors is important to our sales,marketing, and support activities.  Weoften are engaged by vendors or their customers to implement or integratevendor products based on our relationship with a particular vendor.  If we fail to maintain our relationshipswith these vendors, or fail to establish additional new relationships, ourbusiness could be materially adversely affected.

 

*Our relationships with vendors of softwareand hardware products could have a negative impact on our ability to secureconsulting engagements.*

 

Our growing number of relationships with software and hardware vendorscould result in clients perceiving that we are not independent from thosesoftware and hardware vendors.  Ourability to secure assessment and other consulting engagements is oftendependent, in part, on our being independent of software and hardware solutionsthat we may review, analyze or recommend to clients.  If clients believe that we are not independent of those softwareand hardware vendors, clients may not engage us for certain consulting engagementsrelating to those vendors, which could reduce our revenues and materiallyadversely affect our business.

 

35

----

 

*We may infringe the intellectual propertyrights of third parties.*

 

Our success depends, in part, on not infringing patents, copyrights,and other intellectual property rights held by others.  We do not know whether patents held orpatent applications filed by third parties (i.e. in the area of enterprisecontent management) may force us to alter our methods of business and operationor require us to obtain licenses from third parties.  If we attempt to obtain such licenses, we do not know whether wewill be granted licenses or whether the terms of those licenses will be fair oracceptable to us.  Third parties mayassert infringement claims against us in the future.  Such claims may result in protracted and costly litigation,penalties, and fines that could adversely affect our business regardless of themerits of such claims.

 

*Our business is highly dependent on theavailability of business travel.*

 

Our associates and service providers often reside or work in cities orother locations that require them to travel to a client’s site to perform andexecute the client’s project.  As aresult of the September 11, 2001 terrorist attacks, air travel has becomemore time-consuming to business travelers due to increased security, flightdelays, reduced flight schedules, and other variables.  If efficient and cost effective air travelbecomes unavailable to our associates, or if domestic or international airtravel is significantly reduced or halted, we may be unable to satisfactorilyperform our client engagements on a timely basis, which could have a materiallyadverse impact on our business. Further, if our associates refuse to utilize air travel to perform theirjob functions for any reason, our business and reputation would be negativelyaffected.

 

*If we fail to keep pace with regulatory andtechnological changes, our business could be materially adversely affected.*

 

The healthcareand pharmaceutical industries are subject to regulatory and technologicalchanges that may affect the procurement practices and operations of healthcareand pharmaceutical organizations. During the past several years, the healthcare and pharmaceuticalindustries have been subject to an increase in governmental regulation andreform proposals.  These reforms couldincrease governmental involvement in the healthcare and pharmaceuticalindustries, lower reimbursement rates or otherwise change the operatingenvironment of our clients.  Also,certain reforms that create potential work for us could be delayed orcancelled.  Healthcare andpharmaceutical organizations may react to these situations by curtailing ordeferring investments, including those for our services.  In addition, if we are unable to maintainour skill and expertise in light of regulatory or technological changes, ourservices may not be marketable to our clients and we could lose existingclients or future engagements.  Finally,government regulations, particularly HIPAA, may require our clients to imposeadditional contractual responsibilities on us, which may make it more costly toperform certain of our engagements and subject us to increased risk in theperformance of these engagements, including immediate termination of anengagement.

 

Technological change in the network and application markets has createdhigh demand for consulting, implementation, and integration services.  If the pace of technological change were todiminish, we could experience a decrease in demand for our services.  Any material decrease in demand wouldmaterially adversely affect our business, financial condition, and results ofoperations.

 

*We may be unable to effectively protect ourproprietary information and procedures.*

 

We must protect our proprietary information, including our proprietarymethodologies, research, tools, software code, and other information.  To do this, we rely on a combination ofcopyright and trade secret laws and confidentiality procedures to protect ourintellectual property.  These steps maynot protect our proprietary information. In addition, the laws of certain countries do not protect or enforceproprietary rights to the same extent, as do the laws of the UnitedStates.  We are currently providing our

 

36

----

 

services to clients in international markets and have businessoperations in Europe, India and Vietnam. Our proprietary information may not be protected to the same extent asprovided under the laws of the United States, if at all.  The unauthorized use of our intellectualproperty could have a material adverse effect on our business, financialcondition, or results of operations.

 

*Our management may be able to exercisecontrol over matters requiring stockholder approval.*

 

Our current officers, directors, and other affiliates beneficially ownapproximately 23.8% of our outstanding shares of common stock and approximately36.5% on a fully diluted basis.  As aresult, our existing management, if acting together, may be able to exercisecontrol over or significantly influence matters requiring stockholder approval,including the election of directors, mergers, consolidations, sales of all orsubstantially all of our assets, issuance of additional shares of stock, andapproval of new stock and option plans.

 

*The price of our common stock may beadversely affected by market volatility.*

 

The trading price of our common stock fluctuates significantly.  Since our common stock began tradingpublicly in February 1998, the reported sale price of our common stock onthe Nasdaq National Market has been as high as $29.13 and as low as $3.63 pershare.  This price may be influenced bymany factors, including:

 

•                  Our performanceand prospects;

•                  The depth andliquidity of the market for our common stock;

•                  Investorperception of us and the industries in which we operate;

•                  Changes inearnings estimates or buy/sell recommendations by analysts;

•                  Generalfinancial and other market conditions;

•                  Domestic andinternational economic conditions; and

•                  The other risksrelated to our business discussed above.

 

In addition,public stock markets have experienced extreme price and trading volumevolatility.  This volatility hassignificantly affected the market prices of securities of many companies forreasons frequently unrelated to or disproportionately impacted by the operatingperformance of these companies.  Thesebroad market fluctuations may adversely affect the market price of our commonstock.  As a result, we may be unable toraise capital or use our stock to acquire businesses on attractive terms andinvestors may be unable to resell their shares of our common stock at or abovetheir purchase price.  Further, ifresearch analysts stop covering our company or reduce their expectations of us,our stock price could decline or the liquidity of our common stock may beadversely impacted, which could create difficulty for investors to resell theirshares of our common stock.

 

*If our stock price is volatile, we may becomesubject to securities litigation, which is expensive and could result in adiversion of resources.*

 

If our stock price experiences periods of volatility, our securityholders may initiate securities class action litigation against us.  If we become involved in this type oflitigation it could be very expensive and divert our management’s attention andresources, which could materially and adversely affect our business andfinancial condition.

 

*Our charter documents, Delaware law andstockholders rights plan will make it more difficult to acquire us and maydiscourage take-over attempts and thus depress the market price of our commonstock.*

 

Our Board of Directors has the authority to issue up to 9,500,000shares of undesignated preferred stock, to determine the powers, preferences,and rights and the qualifications, limitations, or

 

37

----

 

restrictions granted to or imposed upon any unissued series ofundesignated preferred stock and to fix the number of shares constituting anyseries and the designation of such series, without any further vote or actionby our stockholders.  The preferredstock could be issued with voting, liquidation, dividend, and other rightssuperior to the rights of our common stock. Furthermore, any preferred stock may have other rights, includingeconomic rights, senior to our common stock, and as a result, the issuance ofany preferred stock could depress the market price of our common stock.

 

In addition, our certificate of incorporation eliminates the right ofstockholders to act without a meeting and does not provide cumulative votingfor the election of directors.  Ourcertificate of incorporation also provides for a classified Board of Directors.  The ability of our Board of Directors toissue preferred stock and these other provisions of our certificate ofincorporation and bylaws may have the effect of deterring hostile takeovers ordelaying changes in control or management.

 

We are also subject to the provisions of Section 203 of the DelawareGeneral Corporation Law, which could delay or prevent a change in control ofus, impede a merger, consolidation, or other business combination involving usor discourage a potential acquirer from making a tender offer or otherwiseattempting to obtain control.  Any ofthese provisions, which may have the effect of delaying or preventing a changein control, could adversely affect the market value of our common stock.

 

In 1999, ourBoard of Directors adopted a share purchase rights plan that is intended toprotect our stockholders’ interests in the event we are confronted withcoercive takeover tactics.  Pursuant tothe stockholders rights plan, we distributed “rights” to purchase up to 500,000shares of our Series A Junior Participating Preferred Stock.  Under some circumstances, these rightsbecome the rights to purchase shares of our common stock or securities of anacquiring entity at one-half the market value. The rights are not intended to prevent our takeover, rather they aredesigned to deal with the possibility of unilateral actions by hostileacquirers that could deprive our Board of Directors and stockholders of theirability to determine our destiny and obtain the highest price for our commonstock.

 

## **Item 3**. Quantitative and Qualitative Disclosures about Market Risks

## ** **

Our financial instruments include cash and cash equivalents (i.e.,short-term and long-term cash investments), accounts receivable, unbilledreceivables, accounts payable, and a revolving line of credit.  Only the cash and cash equivalents andshort-term investments which totaled $45.1 million at June 25, 2004present us with market risk exposure resulting primarily from changes ininterest rates.  Based on this balance,a change of one percent in the interest rate would cause a change in interestincome for the annual period of approximately $0.5 million.  Our objective in maintaining theseinvestments is the flexibility obtained in having cash available for payment ofaccrued liabilities and acquisitions.

 

Our borrowings are primarily dependent upon the prevailing primerate.  As of June 25, 2004, we hadno borrowings under our revolving line of credit and an available borrowingcapacity of $7.0 million.  See “Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations- Liquidity and Capital Resources.” The estimated fair value of borrowings under the revolving line isexpected to approximate its carrying value.

 

## **Item 4.**  Controlsand Procedures

## ** **

Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in our Exchange Act reports is recorded,processed, summarized, and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms, and that such informationis accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow fortimely decisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, management is required to

 

38

----

 

apply its judgment inevaluating the cost-benefit relationship of possible controls andprocedures.  Our disclosure controls andprocedures are designed to provide a reasonable level of assurance of reachingour desired disclosure control objectives.

 

Asrequired by SEC Rule 13a-15(b), we carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and our Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures as of the end ofthe quarter covered by this report. Based on the foregoing, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures were effective, and were operating at the reasonable assurancelevel.

 

Therehas been no change in our internal controls over financial reporting during ourmost recent fiscal quarter or fiscal year that has materially affected, or isreasonably likely to materially affect, our internal controls over financialreporting.

 

39

----

 

# **PARTII.  OTHER INFORMATION**

 

## **Item1.  Legal Proceedings**

 

None.

 

## **Item2.  Changes inSecurities**

## ** **

None.

 

## **Item3.  Defaults UponSenior Securities**

 

None.

 

## **Item4.  Submission ofMatters to a Vote of Security Holders**

## ** **

Weheld our 2004 Annual Meeting of Stockholders on June 1, 2004. Thestockholders elected the Board’s nominees as directors to serve three-yearterms expiring at the 2007 Annual Meeting of Stockholders by the votesindicated:

 
| **Nominee**       |   | **Votes in  Favor** |   | **Votes  Against** |   | **Abstentions** |   |
|-------------------|--------|---------------------|--------|--------------------|--------|-----------------|--------|
| Michael P. Downey |   | 20,127,779          |   | 603,853            |   | 0               |   |
| Robert G. Funari  |   | 20,411,120          |   | 320,512            |   | 0               |   |
| Fatima J. Reep    |   | 20,370,133          |   | 361,499            |   | 0               |   |

 

Thestockholders also ratified our selection of Grant Thornton LLP as ourindependent auditors for the year ending December 31, 2004, with20,582,440 votes cast in favor, 64,862 votes cast against and 84,330 votesabstaining from the proposal.

 

## **Item5.  Other Information**

## ** **

In2003 and the first half of 2004, we paid each non-employee member of our Boardof Directors the following amounts for their services as a director: a $10,000per year retainer (paid in equal quarterly installments) plus $1,000 for eachmeeting of the Board of Directors and $500 for each Committee meetingattended.  Effective July 1, 2004, the cash compensation payable toeach non-employee member of our Board of Directors was modified as follows: a$20,000 per year retainer (paid in equal quarterly installments) plus $1,000for each Board meeting attended in person, or $500 for each Board meetingattended telephonically.   In addition, each non-employee member ofour Board that also serves as the Chairperson of a Board Committee will receivean additional retainer of $8,000 per year (paid in equal quarterlyinstallments), and each non-employee member that serves on a Board Committee ina non-chairperson capacity will receive an additional retainer of $6,000 peryear (paid in equal quarterly installments).  No “per meeting” fees willbe paid any longer for attendance at Board Committee meetings.  Directorswill continue to be reimbursed for certain expenses in connection withattendance at Board of Director and Committee meetings.  In establishing the new directorcompensation, the Compensation Committee of our Board of Directors retained athird party compensation consulting firm to provide relevant analysis andrecommendations.  The Compensation Committeealso referenced compensation surveys produced by independent organizations inarriving at the recommended compensation adopted by our Board of Directors.

 

40

----

 

## **Item6.  Exhibits andReports on Form 8-K**

 

(a)          Exhibits

 

 
| **Item**  |   | **Description**                                                              |
|-----------|--------|------------------------------------------------------------------------------|
| 3.1  (1)  |   | Certificate  of Incorporation of the Company                                 |
| 3.2  (2)  |   | Certificate  of Designation of Series A Junior Participating Preferred Stock |
| 3.3  (3)  |   | Bylaws  of the Company                                                       |
| 4.1  (4)  |   | Specimen  Common Stock Certificate                                           |
| 11.1  (5) |   | Statement  of computation of per share earnings                              |
| 31.1      |   | Rule  13a-14(a)/Rule 15d-14(a) Certification of the Chief Executive Officer. |
| 31.2      |   | Rule  13a-14(a)/Rule 15d-14(a) Certification of the Chief Financial Officer. |
| 32.1      |   | Section 1350  Certification of the Chief Executive Officer.             |
| 32.2      |   | Section 1350  Certification of the Chief Financial Officer.             |

 

----

(1)          Incorporated by reference to Exhibit 3.1 toFCG’s Form S-1 Registration Statement (No. 333-41121) originally filed onNovember 26, 1997 (the “Form S-1”).

 

(2)          Incorporated by reference to Exhibit 99.1 toFCG’s Current Report on Form 8-K dated December 9, 1999.

 

(3)          Incorporated by reference to Exhibit 3.3 toFCG’s Form S-1.

 

(4)          Incorporated by reference to Exhibit 4.1 toFCG’s Form S-1.

 

(5)          See Note 1 to Consolidated FinancialStatements, “Basic and Diluted Net Income (Loss) Per Share.”

 

(b)         Reports on Form 8-K

 

(1)          Form8-K filed on April 22, 2004 providing the press release announcing ourfirst quarter 2004 financial results (Item 12).

 

(2)          Form8-K filed on June 2, 2004 providing a press release announcing the resultsof our annual stockholder meeting and our expected financial results for thesecond quarter of 2004 (Items 5, 7 and 12).

 

41

----

 

# **SIGNATURES**

# ** **

Pursuant to the requirements of the Securities and Exchange Act of1934, the registrant has duly caused this report to be signed in its behalf bythe undersigned thereunto duly authorized.

 
|                            | FIRST CONSULTING GROUP, INC.       |
|---------------------------------|------------------------------------|
|                            |                               |
|                            |                               |
| Date:  August 4, 2004 | /s/LUTHER J. NUSSBAUM              |   |
|                            | Luther J. Nussbaum                 |
|                            | Chairman of the Board and          |
|                            | Chief Executive Officer            |
|                            |                               |
|                            |                               |
| Date:  August 4, 2004 | /s/WALTER J. MCBRIDE               |   |
|                            | Walter J. McBride                  |
|                            | Executive Vice President and Chief |
|                            | Financial Officer                  |

 

42

----

 

# **EXHIBIT INDEX**

 
| **Item**  |   | **Description**                                                              |
|-----------|--------|------------------------------------------------------------------------------|
| 3.1  (1)  |   | Certificate  of Incorporation of the Company                                 |
| 3.2  (2)  |   | Certificate  of Designation of Series A Junior Participating Preferred Stock |
| 3.3  (3)  |   | Bylaws  of the Company                                                       |
| 4.1  (4)  |   | Specimen  Common Stock Certificate                                           |
| 11.1  (5) |   | Statement  of computation of per share earnings                              |
| 31.1      |   | Rule  13a-14(a)/Rule 15d-14(a) Certification of the Chief Executive Officer. |
| 31.2      |   | Rule  13a-14(a)/Rule 15d-14(a) Certification of the Chief Financial Officer. |
| 32.1      |   | Section 1350  Certification of the Chief Executive Officer.             |
| 32.2      |   | Section 1350  Certification of the Chief Financial Officer.             |

 

----

(1)          Incorporated by reference to Exhibit 3.1 toFCG’s Form S-1 Registration Statement (No. 333-41121) originally filed onNovember 26, 1997 (the “Form S-1”).

 

(2)          Incorporated by reference to Exhibit 99.1 toFCG’s Current Report on Form 8-K dated December 9, 1999.

 

(3)          Incorporated by reference to Exhibit 3.3 toFCG’s Form S-1.

 

(4)          Incorporated by reference to Exhibit 4.1 toFCG’s Form S-1.

 

(5)          See Note 1 to Consolidated FinancialStatements, “Basic and Diluted Net Income (Loss) Per Share.”

 

43

----