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

**Washington, DC  20549**

 

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**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 March 26, 2004,**                                           |
|       |                                                                                          |
|       | **OR**                                                                                        |
|       |                                                                                          |
| o          | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition periodfrom             to             **

 

**Commission File Number 0-23651**

 

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**First Consulting Group, Inc.**

(Exactname of registrant as specified in its charter)

 
| **Delaware**                                                     |   | **95-3539020**                         |
|------------------------------------------------------------------|--------|----------------------------------------|
| (State  or other jurisdiction of  incorporation or organization) |   | (I.R.S.  Employer  Identification No.) |

 

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

(Addressof principal executive offices including zip code)

 

**(562) 624-5200**

(Registrant’stelephone number, including area code)

 

(Formername, former address and former fiscal year, if changed since last report)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.  Yes ý       No o

 

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

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 

| **Common  Stock, $.001 par value** |   | **24,686,256**                   |
|------------------------------------|--------|----------------------------------|
| (Class)                            |   | (Outstanding  at April 23, 2004) |

 

 

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**First ConsultingGroup, 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

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# **PART I**.  FINANCIAL INFORMATION

 

## **Item 1**. FinancialStatements and Notes (Unaudited)

 

**First Consulting Group, Inc. andSubsidiaries**

 

### **Consolidated Balance Sheets**

**(in thousands, except share and pershare data)**

 
|                                                                                                               |   | **March 26,  2004** |    | **December  26,  2003** |   |
|--------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|-------------------------|--------|
|                                                                                                               |   | **(unaudited)**     |    |                    |   |
| **ASSETS**                                                                                                         |   |                |    |                    |   |
| Current assets:                                                                                                    |   |                |    |                    |   |
| Cash and cash equivalents                                                                                          |   | $                   | 15,740  |                    | $      | 26,826 |   |
| Short-term investments                                                                                             |   | 24,950              |    | 33,803                  |   |
| Accounts receivable, less allowance of  $1,514 and $1,974 as of March 26, 2004 and December 26, 2003, respectively |   | 24,445              |    | 27,564                  |   |
| Unbilled receivables                                                                                               |   | 13,088              |    | 9,947                   |   |
| Deferred income taxes, net                                                                                         |   | 6,279               |    | 6,279                   |   |
| Prepaid expenses and other                                                                                         |   | 2,419               |    | 1,713                   |   |
| Total current assets                                                                                               |   | 86,921              |    | 106,132                 |   |
| Notes receivable – stockholders                                                                               |   | 436                 |    | 432                     |   |
| Long-term investments                                                                                              |   | 3,303               |    | 3,216                   |   |
| Property and  equipment:                                                                                           |   |                |    |                    |   |
| Furniture, equipment, and leasehold  improvements                                                                  |   | 4,518               |    | 4,053                   |   |
| Information systems equipment and software                                                                         |   | 23,396              |    | 23,663                  |   |
|                                                                                                               |   | 27,914              |    | 27,716                  |   |
| Less accumulated depreciation and  amortization                                                                    |   | 18,492              |    | 19,177                  |   |
|                                                                                                               |   | 9,422               |    | 8,539                   |   |
|                                                                                                               |   |                |    |                    |   |
| Other assets:                                                                                                      |   |                |    |                    |   |
| Executive benefit trust                                                                                            |   | 8,145               |    | 8,144                   |   |
| Long-term account receivable                                                                                       |   | 5,155               |    | 5,768                   |   |
| Deferred income taxes, net                                                                                         |   | 3,821               |    | 4,329                   |   |
| Goodwill, net                                                                                                      |   | 16,902              |    | 15,458                  |   |
| Intangibles, net                                                                                                   |   | 3,702               |    | 3,800                   |   |
| Other                                                                                                              |   | 2,334               |    | 1,583                   |   |
|                                                                                                               |   | 40,059              |    | 39,082                  |   |
| Total assets                                                                                                       |   | $                   | 140,141 |                    | $      | 157,401 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

3

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|                                                                                                                                                                                        |   | **March 26,  2004** |    | **December  26,  2003** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|-------------------------|--------|
|                                                                                                                                                                                        |   | **(unaudited)**     |    |                    |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                               |   |                |    |                    |   |
| Current liabilities:                                                                                                                                                                        |   |                |    |                    |   |
| Accounts payable                                                                                                                                                                            |   | $                   | 2,557   |                    | $      | 1,806 |   |
| Accrued liabilities                                                                                                                                                                         |   | 11,404              |    | 11,544                  |   |
| Accrued payroll and related taxes                                                                                                                                                           |   | 5,057               |    | 5,778                   |   |
| Accrued restructuring                                                                                                                                                                       |   | 2,640               |    | 4,613                   |   |
| Accrued vacation                                                                                                                                                                            |   | 7,277               |    | 7,033                   |   |
| Accrued incentive compensation                                                                                                                                                              |   | 2,074               |    | 1,958                   |   |
| Customer advances                                                                                                                                                                           |   | 8,307               |    | 9,775                   |   |
| Total current liabilities                                                                                                                                                                   |   | 39,316              |    | 42,507                  |   |
| Non-current liabilities:                                                                                                                                                                    |   |                |    |                    |   |
| Accrued restructuring                                                                                                                                                                       |   | 4,356               |    | 4,686                   |   |
| Supplemental executive retirement plan                                                                                                                                                      |   | 7,969               |    | 7,741                   |   |
| Minority interest                                                                                                                                                                           |   | —              |    | 657                     |   |
| Total non-current liabilities                                                                                                                                                               |   | 12,325              |    | 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 shared issued and  outstanding                                                               |   | —              |    | —                  |   |
| Common Stock, $.001 par value; 50,000,000  shares authorized, 24,682,160 shares issued and outstanding at March 26, 2004  and 25,902,574 shares issued and outstanding at December 26, 2003 |   | 25                  |    | 26                      |   |
| Additional paid-in capital                                                                                                                                                                  |   | 88,896              |    | 101,706                 |   |
| Retained earnings                                                                                                                                                                           |   | 267                 |    | 900                     |   |
| Deferred compensation-stock incentive  agreements                                                                                                                                           |   | (297                | )       | (323                    | )      |
| Notes receivable-stockholders                                                                                                                                                               |   | (472                | )       | (488                    | )      |
| Accumulated other comprehensive income  (loss)                                                                                                                                              |   | 81                  |    | (11                     | )      |
| Total stockholders’ equity                                                                                                                                                             |   | 88,500              |    | 101,810                 |   |
| Total liabilities and stockholders’ equity                                                                                                                                             |   | $                   | 140,141 |                    | $      | 157,401 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

4

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**First Consulting Group, Inc. andSubsidiaries**

 

### **ConsolidatedStatements of Operations**

**(in thousands, exceptper share data)**

 
|                                                                                            |   | **Three  Months Ended** |   |
|-------------------------------------------------------------------------------------------------|--------|-------------------------|--------|
|                                                                                            |   | **(unaudited)**         |   |
|                                                                                            |   | **March 26,  2004**     |   | **March 28,  2003** |   |
|                                                                                            |   |                    |   |   |   |
| Revenues before reimbursements                                                                  |   | $                       | 66,104 |   | $ | 70,130 |   |
| Reimbursements                                                                                  |   | 3,980                   |   | 3,613 |   |
| Total revenues                                                                                  |   | 70,084                  |   | 73,743 |   |
|                                                                                            |   |                    |   |   |   |
| Cost of services before reimbursable  expenses                                                  |   | 45,071                  |   | 47,243 |   |
| Reimbursable expenses                                                                           |   | 3,980                   |   | 3,613 |   |
| Total cost of services                                                                          |   | 49,051                  |   | 50,856 |   |
|                                                                                            |   |                    |   |   |   |
| Gross profit                                                                                    |   | 21,033                  |   | 22,887 |   |
|                                                                                            |   |                    |   |   |   |
| Selling expenses                                                                                |   | 7,327                   |   | 8,105 |   |
| General and administrative expenses                                                             |   | 12,200                  |   | 14,085 |   |
| Income from operations                                                                          |   | 1,506                   |   | 697 |   |
| Other income (expense):                                                                         |   |                    |   |   |   |
| Interest income, net                                                                            |   | 202                     |   | 276 |   |
| Other income (expense), net                                                                     |   | (21                     | )      | 201 |   |
| Expense for premium on repurchase of stock                                                      |   | (1,561                  | )      | — |   |
| Income before income taxes and cumulative  effect of change in accounting principle, net of tax |   | 126                     |   | 1,174 |   |
| Income tax provision                                                                            |   | 759                     |   | 493 |   |
| Income (loss) before cumulative effect of  change in accounting principle, net of tax           |   | (633                    | )      | 681 |   |
| Cumulative effect of change in accounting  principle, net of tax                                |   | —                  |   | (2,597 | ) |
| Net loss                                                                                        |   | $                       | (633   | ) | $ | (1,916 | ) |
|                                                                                            |   |                    |   |   |   |
| Basic and diluted net loss per share:                                                           |   |                    |   |   |   |
| Basic:                                                                                          |   |                    |   |   |   |
| Income (loss) before cumulative effect of  change in accounting principle, net of tax           |   | $                       | (0.02  | ) | $ | 0.03 |   |
| Cumulative effect of change in accounting  principle, net of tax                                |   | —                  |   | (0.11 | ) |
| Net loss per share                                                                              |   | $                       | (0.02  | ) | $ | (0.08 | ) |
| Diluted:                                                                                        |   |                    |   |   |   |
| Income (loss) before cumulative effect of  change in accounting principle, net of tax           |   | $                       | (0.02  | ) | $ | 0.03 |   |
| Cumulative effect of change in accounting  principle, net of tax                                |   | —                  |   | (0.11 | ) |
| Net loss per share                                                                              |   | $                       | (0.02  | ) | $ | (0.08 | ) |
| Weighted average shares used in computing:                                                      |   |                    |   |   |   |
| Basic net loss per share                                                                        |   | 25,422                  |   | 24,495 |   |
| Diluted net loss per share                                                                      |   | 25,422                  |   | 24,648 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

5

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**First Consulting Group, Inc. andSubsidiaries**

 

### **CondensedConsolidated Statements of Cash Flows**

**(in thousands)**

 
|                                                                                      |   | **Three  Months Ended** |   |
|-------------------------------------------------------------------------------------------|--------|-------------------------|--------|
|                                                                                      |   | **(unaudited)**         |   |
|                                                                                      |   | **March 26,  2004**     |   | **March 28,  2003** |   |
| Cash flows from operating activities:                                                     |   |                    |   |   |   |
| Net income (loss):                                                                        |   | $                       | (633   | ) | $ | (1,916 | ) |
| 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                                                             |   | 1,109                   |   | 1,221 |   |
| Premium on capital stock repurchase                                                       |   | 1,561                   |   | — |   |
| Intangible amortization                                                                   |   | 398                     |   | 55 |   |
| Provision for bad debts, net of adjustments                                               |   | 116                     |   | (170 | ) |
| Loss on sale of assets                                                                    |   | —                  |   | 26 |   |
| Minority interest in net income (loss) of  subsidiaries                                   |   | (14                     | )      | (199 | ) |
| Compensation from stock issuances                                                         |   | 26                      |   | 33 |   |
| Interest income on notes receivable –  stockholders                                  |   | (14                     | )      | (34 | ) |
| Changes in assets and liabilities,  excluding effect of acquisitions:                     |   |                    |   |   |   |
| Accounts receivable                                                                       |   | 3,003                   |   | 10,686 |   |
| Unbilled receivables                                                                      |   | (3,141                  | )      | (7,306 | ) |
| Prepaid expenses and other                                                                |   | (1,034                  | )      | (1,022 | ) |
| Long term account receivable                                                              |   | 613                     |   | 404 |   |
| Other assets                                                                              |   | (751                    | )      | 269 |   |
| Accounts payable                                                                          |   | 751                     |   | 1,448 |   |
| Accrued liabilities                                                                       |   | (861                    | )      | (3,109 | ) |
| Accrued restructuring                                                                     |   | (2,303                  | )      | (1,294 | ) |
| Accrued vacation                                                                          |   | 244                     |   | 590 |   |
| Accrued incentive compensation                                                            |   | 116                     |   | (361 | ) |
| Customer advances                                                                         |   | (1,468                  | )      | (866 | ) |
| Deferred income taxes                                                                     |   | 508                     |   | — |   |
| Supplemental executive retirement plan                                                    |   | 227                     |   | (172 | ) |
| Other                                                                                     |   | 88                      |   | 305 |   |
| Net cash (used in) provided by operating  activities                                      |   | (1,459                  | )      | 1,185 |   |
| Cash flows from investing activities:                                                     |   |                    |   |   |   |
| Proceeds from sale/maturity of investments                                                |   | 8,766                   |   | 3,923 |   |
| Purchase of property and equipment                                                        |   | (1,992                  | )      | (1,471 | ) |
| Acquisition of businesses, net of cash acquired                                           |   | (2,383                  | )      | (8,952 | ) |
| Net cash provided by (used in) investing  activities                                      |   | 4,391                   |   | (6,500 | ) |
| Cash flows from financing activities:                                                     |   |                    |   |   |   |
| Proceeds from issuance of capital stock,  net                                             |   | 729                     |   | 668 |   |
| Proceeds from notes receivable and tax loan  payments                                     |   | 26                      |   | 418 |   |
| Capital stock repurchase                                                                  |   | (14,773                 | )      | — |   |
| Net cash (used in) provided by financing  activities                                      |   | (14,018                 | )      | 1,086 |   |
| Net change in cash and cash equivalents                                                   |   | (11,086                 | )      | (4,229 | ) |
| Cash and cash equivalents at beginning of  period                                         |   | 26,826                  |   | 27,550 |   |
| Cash and cash equivalents at end of period                                                |   | $                       | 15,740 |   | $ | 23,321 |   |
|                                                                                      |   |                    |   |   |   |
| Cash paid during the period for:                                                          |   |                    |   |   |   |
| Interest                                                                                  |   | $                       | 4      |   | $ | 9 |   |
| Income taxes                                                                              |   | $                       | 310    |   | $ | 155 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

6

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### **Notesto Consolidated Financial Statements**

### ** **

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

 

*Basis of Presentation*

 

The consolidated balancesheets of First Consulting Group, Inc. (the “Company” or “FCG”) at March 26,2004 and consolidated statements of operations and condensed consolidatedstatements of cash flows for the periods ended March 26, 2004 and March 28,2003 are unaudited.  These financialstatements reflect all adjustments, consisting of only normal recurringadjustments, which, in the opinion of management, are necessary to fairlypresent the financial position of the Company at March 26, 2004 and the resultsof operations and cash flows for the three-month periods ended March 26, 2004and March 28, 2003.  The results ofoperations and cash flows for the three months ended March 26, 2004 are notnecessarily indicative of the results to be expected for the year endingDecember 31, 2004.  For more completefinancial information, these financial statements should be read in conjunctionwith the audited financial statements for the year ended December 26, 2003included in the Company’s Annual Report on Form 10-K.  Certain reclassifications have been made to the 2003financial statements to conform to the 2004 presentation.

 

*Principles of Consolidation*

 

The consolidated financialstatements include the accounts of First Consulting Group, Inc. and itssubsidiaries.  All material intercompanyaccounts and transactions have been eliminated.

 

***Stock***-Based Compensation

 

The Company accounts for stock-based employee compensation asprescribed by APB Opinion No. 25, “Accountingfor Stock Issued to Employees,” and has adopted the disclosureprovisions 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 net loss had compensation costsbeen determined on the fair value at the date of grant for awards under theplan in accordance with SFAS No. 123 (in thousands, except per share data):

 
|                                                                                                                    |        | **Three  Months Ended** |   |
|-------------------------------------------------------------------------------------------------------------------------|-------------|-------------------------|--------|
|                                                                                                                    |        | **March 26,  2004**     |   | **March 28,  2003** |   |
| Net loss, as reported                                                                                                   |        | $                       | (633   | ) | $ | (1,916 | ) |
| Deduct: Total stock based employee  compensation expense determined under fair value method for all awards, net  of tax |        | (453                    | )      | (643 | ) |
| Pro forma net loss                                                                                                      |        | $                       | (1,086 | ) | $ | (2,559 | ) |
|                                                                                                                    |        |                    |   |   |   |
| Basic loss per share                                                                                                    | As reported |                    |   | $ | (0.02 | ) | $ | (0.08 | ) |
|                                                                                                                    | Pro forma   |                    |   | $ | (0.04 | ) | $ | (0.10 | ) |
|                                                                                                                    |        |                    |   |   |   |   |   |
| Diluted loss per share                                                                                                  | As reported |                    |   | $ | (0.02 | ) | $ | (0.08 | ) |
|                                                                                                                    | Pro forma   |                    |   | $ | (0.04 | ) | $ | (0.10 | ) |
|                                                                                                                         |             |                         |        |  |  |  |  |  |  |  |  |

 

7

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

 

Basic netincome (loss) per share is based upon the weighted average number of commonshares outstanding.  Diluted net incomeper share is based on the assumption that stock options were converted orexercised. Dilution is computed by applying the treasury stock method. Underthis method, options are assumed to be exercised at the beginning of the period(or at the time of issuance, if later), and as if funds obtained thereby were usedto purchase common stock at the average market price during the period. Stockoptions are not considered when computing diluted net loss per share as theyare considered anti-dilutive.

 

The following represents a reconciliation ofbasic and diluted net loss per share (in thousands, except per share data):

 
|                                                             |   | **Three  Months Ended** |   |
|------------------------------------------------------------------|--------|-------------------------|--------|
|                                                             |   | **March 26,  2004**     |   | **March 28,  2003** |   |
|                                                             |   |                    |   |   |   |
| Income (loss) before cumulative effect, net  of tax              |   | $                       | (633   | ) | $ | 681 |   |
| Cumulative effect of change in accounting  principle, net of tax |   | —                  |   | (2,597 | ) |
| Net loss                                                         |   | $                       | (633   | ) | $ | (1,916 | ) |
|                                                             |   |                    |   |   |   |
| Basic weighted average number of shares  outstanding             |   | 25,422                  |   | 24,495 |   |
| Effect of dilutive options and warrants                          |   | —                  |   | 153 |   |
| Diluted weighted average number of shares outstanding            |   | 25,422                  |   | 24,648 |   |

 
|                                                             |   | **Three Months Ended** |   |
|------------------------------------------------------------------|--------|------------------------|--------|
|                                                             |   | **March 26,  2004**    |   | **March 28,  2003** |   |
| Basic per share:                                                 |   |                   |   |   |   |
| Income (loss) before cumulative effect, net  of tax              |   | $                      | (0.02  | ) | $ | 0.03 |   |
| Cumulative effect of change in accounting  principle, net of tax |   | —                 |   | (0.11 | ) |
| Net loss per share                                               |   | $                      | (0.02  | ) | $ | (0.08 | ) |
|                                                             |   |                   |   |   |   |
| Diluted per share:                                               |   |                   |   |   |   |
| Income (loss) before cumulative effect, net  of tax              |   | $                      | (0.02  | ) | $ | 0.03 |   |
| Cumulative effect of change in accounting  principle, net of tax |   | —                 |   | (0.11 | ) |
| Net loss per share                                               |   | $                      | (0.02  | ) | $ | (0.08 | ) |

 

For the three months endedMarch 26, 2004 and March 28, 2003, there were 5,242,036 and 4,260,733anti-dilutive outstanding stock options, respectively, excluded from thecalculation of diluted earnings per share. Additionally, at March 26, 2004, there were 591,328 contingent sharesrelated to the acquisition of the remaining minority interest in FCGInfrastructure Services, Inc. excluded from the calculation of diluted earningsper share because they were anti-dilutive to the loss incurred.

 

*Use of Estimates*

 

In preparingfinancial statements in conformity with accounting principles generallyaccepted in the United States, management is required to make estimates andassumptions that affect the reported amounts of assets and liabilities, thedisclosure of contingent assets and liabilities at the date of the financialstatements, and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.  On an on-going basis, the Company evaluatesits

 

8

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estimates, including thoserelated to revenue recognition, valuation of goodwill and long-lived andintangible assets, accrued liabilities, income taxes including the amount oftax asset valuation allowance required, restructuring costs, litigation anddisputes, and the allowance for doubtful accounts.

 

The Companyuses significant estimates in the calculation of its income tax benefit byestimating whether it will have sufficient future taxable income to realize itsdeferred tax assets.  There can be noassurances that the Company’s taxable income will be sufficient to realize suchdeferred tax assets and the Company will continue to evaluate its valuationallowance on an ongoing basis.

 

The Companybases its estimates on historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources.  The Company’s actual results may differ fromits estimates.

 

**Note 2**                    **Investments**

 

For purposes of reporting,cash and cash equivalents include cash and interest-earning deposits orsecurities with original maturities of three months or less.  At March 26, 2004, the Company hasapproximately $25.0 million in short-term investments and $2.1 million oflong-term investments classified as available for sale.  Such investments are currently heldprimarily in commercial paper, money market investments, and tax-exemptgovernment securities.  Net unrealizedgains and losses on investments were not material at March 26, 2004.  Additionally, the Company has $1.2 million ofnon-marketable equity investments, valued at the lower of cost or estimated fairvalue, which are included in long-term investments.

 

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

 

At March 26, 2004, theCompany carried a long-term account receivable of approximately $5.2 millionfrom a single client.  The receivablerelates to a major outsourcing contract and will be collected over the nextthree years.

 

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

 

*FCG Infrastructure Services (FCGIS)*

 

On January 30,2004, the Company purchased the remaining 47.65% minority interest in FCGIS(formerly Codigent Solutions Group, Inc.) from five remaining individualstockholders for approximately $2.4 million in cash.  Additionally, the Company deposited 591,328 shares of FCG CommonStock to an escrow account, with one-fourth of such shares to be released tothose same stockholders in four separate increments upon successful fulfillmentby FCGIS of certain revenue and profitability targets for the six month periodsended June 26, 2004, December 31, 2004, July 1, 2005, and December 30,2005.  If such targets are not fulfilledfor any six-month period, the shares in escrow for that period will revert toFCG.

 

The followingtable summarizes the estimated fair values of assets acquired as of January 30,2004 in connection with the FCGIS purchase (in thousands):

 

| Goodwill                           |   | $     | 1,440  |   |
|------------------------------------|--------|-------|--------|--------|
| Intangible assets                  |   | 300   |   |
| Net assets acquired                |   | 1,740 |   |
| Minority interest on balance sheet |   | 643   |   |
| Cash consideration                 |   | $     | 2,383  |   |

 

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

 

EffectiveDecember 29, 2001, the Company adopted SFAS 141 and SFAS 142.  SFAS 142 requires that goodwill and certainintangibles no longer be amortized, but instead are to be reviewed at leastannually for impairment.  Prior to theadoption of SFAS 141, goodwill was amortized over the estimated useful life.

 

Goodwill isevaluated for impairment annually in the fourth quarter of the year, or if anevent occurs or circumstances change that may reduce the fair value of thereporting unit below its book value. The impairment test is conducted at thereporting unit level by comparing the fair value of the reporting unit with itscarrying value. Fair value is primarily determined by using a market approachvaluation model based on multiples of revenue. If the carrying value exceedsthe fair value, goodwill may be impaired. If this occurs, the fair value of thereporting unit is then allocated to its assets and liabilities in a mannersimilar to a purchase price allocation in order to determine the implied fairvalue of the reporting unit goodwill. This implied fair value is then comparedwith the carrying amount of the reporting unit goodwill, and if it is less, theCompany would then recognize an impairment loss.  In addition, the Company evaluates intangible assets withdefinite lives to determine whether adjustment to these amounts or estimateduseful lives is required based on current events and circumstances.

 

The changes in the netcarrying amounts of goodwill for the three months ended March 26, 2004 are asfollows (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 |   |

 

As of March 26, 2004, theCompany had the following acquired intangible assets recorded (in thousands):

 
| **Amortized Intangible Assets**   |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   | **Net  Carrying  Amount** |   | **Amortization  Period in  Years** |   |
|-----------------------------------|--------|-----------------------------|--------|-------------------------------|--------|---------------------------|--------|------------------------------------|--------|
| Software and software development |   | $                           | 1,177  |                          | $      | (550                      | )      | $                                  | 627    |   | 2 |   |
| Customer related                  |   | 3,694                       |   | (756                          | )      | 2,938                     |   | 3 - 4                              |   |
| Non-compete agreements            |   | 400                         |   | (263                          | )      | 137                       |   | 2 - 3                              |   |
| Total                             |   | $                           | 5,271  |                          | $      | (1,569                    | )      | $                                  | 3,702  |   |   |   |

 

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The following tablesummarizes the estimated annual pretax amortization expense for these assets(in thousands):

 

| **Fiscal Year** |   |   |   |
|-----------------|--------|--------|--------|
| 2004            |   | $      | 1,324  |   |
| 2005            |   | 1,150  |   |
| 2006            |   | 773    |   |
| 2007            |   | 455    |   |
| Total           |   | $      | 3,702  |   |

 

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

 

In fiscal year2002, the Company incurred a restructuring charge of $7.8 million consisting of$4.0 million in severance for the reduction of staff and $3.8 million in facilitycosts due to facility downsizing.  Thisrestructuring was accounted for in accordance 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 due to the reduction in custom softwaredevelopment services purchased by pharmaceutical clients.  Restructuring charges in 2003 have beenaccounted for in accordance with SFAS 146.**

** **

**At March 26, 2004, there was a remaining restructuringliability of $7.0 million, which primarily relates to vacated leases from theserestructurings.**

 

**The restructuring liability as of March 26, 2004 issummarized as follows (in thousands):**

 
|                                 |   | **Employee  Related Costs** |   | **Facilities/Other  Related Costs** |   | **Total** |   |
|--------------------------------------|--------|-----------------------------|--------|-------------------------------------|--------|-----------|--------|
| Reserve balance at December 26, 2003 |   | $                           | 1,665  |                                | $      | 7,634     |   | $ | 9,299 |   |
| Cash payments                        |   | (1,527                      | )      | (776                                | )      | (2,303    | )      |
| Reserve balance at March 26, 2004    |   | $                           | 138    |                                | $      | 6,858     |   | $ | 6,996 |   |

 

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

 

Comprehensive income (loss),net of taxes, for the three months ended March 26, 2004 and March 28, 2003, isas follows (in thousands):

 
|                                                 |   | **Three  Months Ended** |   |
|------------------------------------------------------|--------|-------------------------|--------|
|                                                 |   | **March 26,  2004**     |   | **March 28,  2003** |   |
| Net loss                                             |   | $                       | (633   | ) | $ | (1,916 | ) |
| Foreign currency translation adjustment,  net of tax |   | 82                      |   | 5 |   |
| Unrealized gain (loss) on investments                |   | 10                      |   | (10 | ) |
|                                                 |   |                    |   |   |   |
| Comprehensive loss                                   |   | $                       | (541   | ) | $ | (1,921 | ) |

 

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

 

EffectiveDecember 28, 2002, the Company adopted Emerging Issues Task Force (EITF) Issue00-21 “Accounting for Revenue Arrangements with Multiple Deliverables,” whichaddresses how to account for arrangements that involve the delivery orperformance of multiple products, services, and/or rights to use assets.  Revenue arrangements with multipledeliverables are divided into separate units of accounting if the deliverablesin the arrangement meet the following criteria: (1) the delivered item hasvalue to the customer on a standalone basis; (2) there is objective andreliable evidence of the fair value of undelivered items; and (3) deliveryof any undelivered item is probable. Arrangement consideration should be allocated among the separate unitsof accounting based on their relative fair values, with the amount allocated tothe delivered item being limited to the amount that is not contingent on thedelivery of additional items or meeting other specified performanceconditions.  The new standard wasrequired to be adopted for all new applicable revenue arrangements no laterthan the third quarter of 2003.  Earlyadoption was permitted and the Company elected to adopt the new standard as ofthe beginning of the first quarter of 2003. In addition, the Company elected to apply the new standard to allexisting outsourcing arrangements impacted by EITF 00-21 and record to earningsthe resulting cumulative 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.

 

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

 

Commencingwith the first quarter of 2004 and due to a reorganization of the Company thattook effect at the beginning of 2004, FCG has changed its previous segmentreporting in accordance with SFAS 131. The Company now has five reportable operating segments:  health delivery (the delivery of consultingand systems integration services to health delivery and government clients),health plan (the delivery of consulting and systems integration services tohealth plan clients), life sciences (the delivery of consulting and systemsintegration services to pharmaceutical and other life sciences clients), healthdelivery outsourcing (the delivery of outsourcing services to health deliveryclients), and Meditech Service Center (the delivery of solutions involving theuse of Meditech software to health delivery clients).  Additionally, the Company has several smaller businesses (ParagonSolutions, Inc., staffing services, call center services, and the PatientSafety Institute/FirstGatewaysTM), which are not included in any of the abovesegments and are reported as “other business.”

 

The Company’ssegments are managed on an integrated basis in order to serve clients byassembling multi-disciplinary teams, which provide comprehensive services.  The amount of revenues attributed to eachsegment is accounted for by splitting the revenues on each client engagementbased upon the amounts charged to the client for the services of eachsegment.  Costs are not transferredacross segments.

 

Additionally,the Company has created three shared service centers that provide services tomultiple business segments.  Theseshared service centers include FCG India, Integration Services andInfrastructure Services.   The costs ofthese services are internally billed and reported in the individual businesssegments at a standard transfer cost.

 

Consistent with thesechanges, FCG has reclassified some staff among cost of services, sellingexpenses and general and administrative expenses.  The history shown in the tables below and in FCG’s consolidatedstatement of operations is now consistent with all of these changes.

 

The Companyevaluates its segments’ performance based on revenues and operatingincome.  Certain selling and general andadministrative expenses (including corporate functions, occupancy related

 

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costs, depreciation,professional development, recruiting, and marketing), are managed at thecorporate level and allocated to each operating segment based on either netrevenues and/or actual usage.

 

The followingsegment information is for the quarters ended March 26, 2004 and March 28, 2003(in thousands):

 

**For the three months ended March 26,2004:**

 
|                                          |   | **Health  Delivery** |   | **Life  Sciences** |   | **Health  Delivery  Outsourcing** |   | **Meditech  Service  Center** |   | **Health****Plan** |   | **Other  Business** |   | **Other** |   | **Totals** |   |
|-----------------------------------------------|--------|----------------------|--------|--------------------|--------|-----------------------------------|--------|-------------------------------|--------|--------------------|--------|---------------------|--------|-----------|--------|------------|--------|
| Revenues before reimbursements                |   | $                    | 15,614 |               | $      | 8,867                             |   | $                             | 25,217 |               | $      | 5,451               |   | $         | 4,248  |       | $      | 6,691 |   | $ | 16 |   | **$** | **66,104** |   |
| Reimbursements                                |   | 1,993                |   | 226                |   | 100                               |   | 425                           |   | 580                |   | 181                 |   | 475       |   | **3,980**  |   |
| Total revenues                                |   | 17,607               |   | 9,093              |   | 25,317                            |   | 5,876                         |   | 4,828              |   | 6,872               |   | 491       |   | **70,084** |   |
| Cost of services before reimbursable expenses |   | 8,628                |   | 5,054              |   | 21,001                            |   | 3,764                         |   | 2,438              |   | 4,859               |   | (673      | )      | **45,071** |   |
| Reimbursable expenses                         |   | 1,993                |   | 226                |   | 100                               |   | 425                           |   | 580                |   | 181                 |   | 475       |   | **3,980**  |   |
| Total cost of services                        |   | 10,621               |   | 5,280              |   | 21,101                            |   | 4,189                         |   | 3,018              |   | 5,040               |   | (198      | )      | **49,051** |   |
| Gross profit                                  |   | 6,986                |   | 3,813              |   | 4,216                             |   | 1,687                         |   | 1,810              |   | 1,832               |   | 689       |   | **21,033** |   |
| Selling expenses                              |   | 2,524                |   | 2,488              |   | 583                               |   | 220                           |   | 876                |   | 544                 |   | 92        |   | **7,327**  |   |
| General & administrative expenses         |   | 2,510                |   | 2,984              |   | 2,354                             |   | 806                           |   | 644                |   | 1,396               |   | 1,506     |   | **12,200** |   |
| Income (loss) from operations                 |   | $                    | 1,952  |               | $      | (1,659                            | )      | $                             | 1,279  |               | $      | 661                 |   | $         | 290    |       | $      | (108 | ) | $ | (909 | ) | **$** | **1,506** |   |

 

**For the three months ended March 28,2003:**

 
|                                          |   | **Health  Delivery** |   | **Life  Sciences** |   | **Health  Delivery  Outsourcing** |   | **Meditech  Service  Center** |   | **Health  Plan** |   | **Other  Business** |   | **Other** |   | **Totals** |   |
|-----------------------------------------------|--------|----------------------|--------|--------------------|--------|-----------------------------------|--------|-------------------------------|--------|------------------|--------|---------------------|--------|-----------|--------|------------|--------|
| Revenues before reimbursements                |   | $                    | 16,055 |               | $      | 15,389                            |   | $                             | 22,976 |             | $      | 3,980               |   | $         | 6,351  |       | $      | 5,299 |   | $ | 80 |   | **$** | **70,130** |   |
| Reimbursements                                |   | 1,938                |   | 372                |   | 95                                |   | 283                           |   | 672              |   | 238                 |   | 15        |   | **3,613**  |   |
| Total revenues                                |   | 17,993               |   | 15,761             |   | 23,071                            |   | 4,263                         |   | 7,023            |   | 5,537               |   | 95        |   | **73,743** |   |
| Cost of services before reimbursable expenses |   | 9,620                |   | 7,919              |   | 20,723                            |   | 2,360                         |   | 3,160            |   | 3,896               |   | (435      | )      | **47,243** |   |
| Reimbursable expenses                         |   | 1,938                |   | 372                |   | 95                                |   | 283                           |   | 672              |   | 238                 |   | 15        |   | **3,613**  |   |
| Total cost of services                        |   | 11,558               |   | 8,291              |   | 20,818                            |   | 2,643                         |   | 3,832            |   | 4,134               |   | (420      | )      | **50,856** |   |
| Gross profit                                  |   | 6,435                |   | 7,470              |   | 2,253                             |   | 1,620                         |   | 3,191            |   | 1,403               |   | 515       |   | **22,887** |   |
| Selling expenses                              |   | 3,012                |   | 2,138              |   | 767                               |   | 354                           |   | 1,353            |   | 573                 |   | (92       | )      | **8,105**  |   |
| General & administrative expenses         |   | 2,802                |   | 4,541              |   | 2,755                             |   | 895                           |   | 947              |   | 1,137               |   | 1,008     |   | **14,085** |   |
| Income (loss) from operations                 |   | $                    | 621    |               | $      | 791                               |   | $                             | (1,269 | )                | $      | 371                 |   | $         | 891    |       | $      | (307 | ) | $ | (401 | ) | **$** | **697** |   |

 

The“other” column consists of reclassifications related to the shared servicecenters described above, and under absorption of shared service center orsupport costs into the segments.

 

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*Detail of Health Delivery Outsourcing Revenues*

 

Health Delivery Outsourcingrevenues before reimbursements include revenues related to a majorsubcontractor on several projects.  Thebreakdown of revenue in outsourcing is as follows (in thousands):

 
|                           |   | **Three  Months Ended** |   |
|--------------------------------|--------|-------------------------|--------|
|                           |   | **March 26,  2004**     |   | **March 28,  2003** |   |
| Internally generated revenues  |   | $                       | 19,754 |   | $ | 18,161 |   |
| Subcontractor revenues         |   | 5,463                   |   | 4,815 |   |
|                           |   |                    |   |   |   |
| Revenues before reimbursements |   | $                       | 25,217 |   | $ | 22,976 |   |

 

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

 

The Companyhas a revolving line of credit, under which it is allowed to borrow up to $7.0million at an interest rate of the prevailing prime rate with an expiration ofMay 1, 2005.  There was no outstandingbalance under the line of credit at March 26, 2004.

 

**Note 11**                  **Capital Stock Repurchase**

 

On February 27, 2004, FCG repurchased all outstanding sharesof the Company held by David S. Lipson, one of FCG’s directors and the formerCEO of Integrated Systems Consulting Group, Inc. (ISCG).  FCG acquired ISCG in December 1998.  The Company also purchased any in-the-moneyoptions to purchase FCG common stock held by Mr. Lipson.  The aggregate purchase price for the sharesand options held by Mr. Lipson was $15.1 million.  As a result of the transaction, Mr. Lipson resigned from theCompany’s Board of Directors.

 

The purchaseby FCG of Mr. Lipson’s ownership interest includes all of the 1,962,400outstanding shares of common stock of FCG held by Mr. Lipson, together with32,000 in-the-money options to purchase shares of common stock of FCG.  The aggregate purchase price for the sharesand the options represented a premium of approximately 11% over the closingprice of FCG’s common stock on February 26, 2004.

 

In the firstquarter of 2004, FCG recorded a charge of $1.6 million without any tax benefit,which charge is based on the premium included in the purchaseconsideration.  From a tax perspective,no amounts of the purchase price are allocable to any of the restrictivecovenants agreed to by Mr. Lipson in the repurchase agreement.

 

Other material terms of thetransaction are as follows:

 

•      The purchase price iscomprised of cash, a portion of which Mr. Lipson has used to repay in fullindebtedness owed by Mr. Lipson to FCG of approximately $0.3 million.

•      In the event FCG were toannounce or consummate a change in control transaction prior to February 27, 2005,or if the Company were to enter into negotiations regarding a change in controltransaction prior to February 27, 2005 and subsequently announce publicly adefinitive agreement for or consummate a change in control transaction prior toAugust 27, 2005, FCG would pay to Mr. Lipson, upon the closing of such changein control of FCG, an amount equal to the difference of $7.50 per share and thechange in control transaction price per share, if such change in control priceper share amount is higher.

•      12,000 out-of-the-moneyoptions held by Mr. Lipson will remain outstanding and may only be exercised onor before the first anniversary of this repurchase transaction.  Upon receipt of

 

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Mr.Lipson’s notice of exercise, FCG will repurchase such options and pay to Mr.Lipson the difference between the exercise price and the then fair market valueof the shares issuable.

•      Mr. Lipson will be subjectto a five year non-compete agreement, a mutual non-disparagement agreement, anon-solicitation agreement and a standstill agreement.  The parties have agreed that no amounts ofthe purchase price will be allocated to these covenants for tax purposes.

•      Mr. Lipson also granted tothe Board of Directors of FCG an irrevocable proxy for any of FCG’s securitiesthat he owns or acquires after the closing of FCG’s purchase in thistransaction.

•      FCG and Mr. Lipson executeda mutual release of claims.

 

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

 

THE FOLLOWINGMANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THEPRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.  SUCH FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES,INCLUDING THOSE SET FORTH BELOW UNDER THE CAPTION “RISKS RELATING TO OURBUSINESS,” AND OTHER REPORTS WE FILE WITH THE SECURITIES AND EXCHANGECOMMISSION.  OUR ACTUAL RESULTS COULDDIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS.

 

**Overview**

 

We provideservices primarily to providers, payors, government agencies, pharmaceutical,biogenetic, and other healthcare organizations in North America, Europe, andAsia.  We generate substantially all ofour revenues from fees for information technology outsourcing services, andprofessional services.

 

We typicallybill for our services on an hourly, fixed-fee, or monthly fixed-fee basis asspecified by the agreement with a particular client.  For services billed on an hourly basis, in our consulting andsystems integration businesses (“CSI”), fees are determined by multiplying theamount of time expended on each assignment by the project hourly rate for theassociate(s) assigned to the engagement. Fixed fees, including outsourcing fees, are established on aper-assignment or monthly basis and are based on several factors such as thesize, scope, complexity and duration of an assignment, the number of ouremployees required to complete the assignment, and the volume of transactionsor interactions.  Revenues are generallyrecognized related to the level of services performed, the amount of costincurred on the assignment versus the estimated total cost to complete theassignment, or on a straight-line basis over the period of performance ofservice.  Additionally, we have recentlybeen licensing an increased amount of our software products, generally inconjunction with the customization and implementation of such softwareproducts.  Revenues from our softwarelicensing were greater than 1% of our total revenues in fiscal year 2003, andwe expect our software licensing revenues to grow in absolute dollars duringour 2004 fiscal year.

 

Provisions aremade for estimated uncollectible amounts based on our historicalexperience.  We may obtain payment inadvance of providing services.  Theseadvances are recorded as customer advances and reflected as a liability on ourbalance sheet.

 

Out-of-pocketexpenses billed and reimbursed by clients are included in total revenues, andthen deducted to determine net revenues. For purposes of analysis, all percentages in this discussion are statedas a percentage of net revenues, since we believe that this is the more relevantmeasure of our business.

 

Cost ofservices primarily consists of the salaries, bonuses, and related benefits ofclient-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 and business unit governance meetings, recruitingfees, professional development and training, and legal and other professionalservices.  As associate related costsare relatively fixed in the short term, variations in our revenues andoperating results in our CSI business can occur as a result of variations inbilling margins and utilization rates of our billable associates.

 

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Our mostsignificant expenses are our human resource and related salary and benefitexpenses.  As of March 26, 2004,approximately 1,150 of our 2,226 employees (associates) are billable associates.  Another 749 employees are part of ouroutsourcing business.  The salaries andbenefits of such billable associates and outsourcing related employees arerecognized in our cost of services. Most non-billable employee salaries and benefits are recognized as acomponent of either selling or general and administrative expenses.  Approximately 15% of our workforce, or 327employees, are classified as non-billable. Our cost of services as a percentage of revenues is directly related toseveral factors, including, but not limited to:

 

•      Ourbillable associate utilization, which is the ratio of total billable hours toavailable hours in a given period;

•      Theamount and timing of cost incurred;

•      Ourability to control costs on our outsourcing projects;

•      Thebilled rate on time and material contracts; and

•      Theestimated cost to complete our non-outsourcing fixed price contracts.

 

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.

 

In our CSIbusiness, we manage billable associate utilization by monitoring assignmentrequirements and timetables, available and required skills, and availableassociate hours per week and per month.  Differences in personnel utilization rates can result from variations inthe amount of non-billed time, which has historically consisted of trainingtime, vacation time, time lost to illness and inclement weather, and unassignedtime.  Non-billed time also includestime devoted to other necessary and productive activities such as sales supportand interviewing prospective employees. Unassigned time results from differences in the timing of the completionof an existing assignment and the beginning of a new assignment.  In order to reduce and limit unassignedtime, we actively manage personnel utilization by monitoring and projectingestimated engagement start and completion dates and matching associateavailability 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.  Assignmentterminations, completions, inclement weather, and scheduling delays may resultin periods in which associates are not optimally utilized.  An unanticipated termination of asignificant assignment or an overall lengthening of the sales cycle couldresult in a higher than expected number of unassigned associates and couldcause us to experience lower margins. In addition, entry into new market areas and the hiring of associates inadvance of client assignments have resulted and may continue to result inperiods of lower associate utilization.

 

In response tocompetition and continued pricing and rate pressures, we have recentlyimplemented a global sourcing strategy into our business operations, whichincludes the deployment of offshore resources as well as resources that performservices remote from the client site. We have also begun to incorporate more variable cost or per diem staffin some of our projects.  We expectthese strategies to result in improved cost of services through a combinationof lower cost attributable to offshore resources and higher leverage ofresources that perform services offsite or on a variable cost basis.  To the extent we pass through reduced coststo our clients related to offshore resources, the global

 

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sourcing strategy may result inlower revenues on a per engagement basis. However, we expect to offset thispotential revenue impact with improved competitive positioning in ourmarkets.  Several of our competitors employboth global sourcing and variable staffing strategies to provide softwaredevelopment and other information technology services to their clients, whileat the same time reducing their cost structure and improving the quality ofservices they provide.  If we are unableto realize the perceived cost benefits of our recently implemented strategiesor if we are unable to receive high quality services from foreign employees,variable staff employees or subcontractors, our business may be adverselyimpacted and we may not be able to compete effectively.

 

**Results of Operations for the Three Months Ended March 26,2004 and March 28, 2003**

 

*Revenues. *Our net revenues decreased to $66.1 millionfor the quarter ended March 26, 2004, a decrease of 5.7% from $70.1 million forthe quarter ended March 28, 2003.  Ourtotal revenues decreased to $70.1 million for the quarter ended March 26, 2004,a decrease of 5.0% from $73.7 million for the quarter ended March 28,2003.  The decreases were primarily dueto declines in our Life Sciences and Health Plan businesses, offset byincreases in Health Delivery Outsourcing and the Meditech Service Center.   The Life Sciences segment had the mostsignificant decline ($6.5 million or 42.4%), due to the general decline in thecustom software business for pharmaceutical clients, and also due to thecompletion of a major engagement for one particular such client in the secondquarter of 2003.  The Health Plansegment declined by $2.1 million or 33.1% due to the completion of several significantprojects during 2003, without having new projects to replace them.  Health Delivery Outsourcing increased by$2.2 million or 9.8% due to additional work on existing projects.  The Meditech Service Center increased by$1.5 million or 37.0%, due to the award of a new outsourcing engagement andother general increases in demand for those services.  Overall, we anticipate that our revenues in the near future willremain at a similar level to those of the first quarter of 2004.

 

* Cost ofServices. *Cost of services before reimbursable expensesdecreased to $45.1 million for the quarter ended March 26, 2004, a decrease of4.6% from $47.2 million for the quarter ended March 28, 2003.  The decrease was primarily due to costreductions made in response to the revenue declines noted above.  We reduced cost of services by $2.9 millionin Life Sciences and $0.7 million in Health Plan.  Additionally, we reduced cost of services by $1.0 million inHealth Delivery, despite a much more modest decline in revenue, through thereduction of management and staff and greater utilization of the remainingstaff.  These decreases were partiallyoffset by increased costs in the Meditech Service Center related to theincrease in work in that segment.

 

*Gross Profit. *Gross profitdecreased to $21.0 million for the quarter ended March 26, 2004, a decrease of8.1% from $22.9 million for the quarter ended March 28, 2003.  The decrease was primarily due to reducedgross margins in Life Sciences and Health Plan due to the revenue declinesnoted above.  These were partly offsetby an increase in gross margin in Health Delivery Outsourcing due to costefficiencies that were achieved on certain contracts in mid-2003.  Gross profit as a percentage of net revenuesdecreased slightly to 31.8% for the quarter ended March 26, 2004 from 32.6% forthe quarter ended March 28, 2003, due to the factors discussed above and acontinuing shift in revenue mix from consulting and systems integration tooutsourcing, which is a lower margin business. Given the current revenue mix, our gross profit percentage is notexpected to change significantly in the near future; however, a sudden downturnin demand in one or more of our segments or an inability to control costs onour fixed price projects could negatively affect our margin percentage.

 

*Selling Expenses. *Sellingexpenses decreased to $7.3 million for the quarter ended March 26, 2004, adecrease of 9.6% from $8.1 million for the quarter ended March 28, 2003primarily due to a reduction in our sales force in mid-2003.  Selling expenses as a percentage of netrevenues decreased to 11.1% for the quarter ended March 26, 2004 from 11.6% forthe quarter ended March 28, 2003.

 

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*General and Administrative Expenses. *General and administrative expenses decreased to $12.2 million for thequarter ended March 26, 2004, a decrease of 13.4% from $14.1 million for thequarter ended March 28, 2003.  Thedecrease resulted from cost reductions in the latter part of 2003 in mostareas, including the consolidation of the administrative operations of ourrecently acquired companies.  Generaland administrative expenses as a percentage of net revenues decreased to 18.5%for the quarter ended March 26, 2004 from 20.1% for the quarter ended March 28,2003.  We expect to hold these expensesat their current level in the near future.

 

*Interest Income, Net. *Interestincome, net of interest expense, decreased to $0.2 million for the quarterended March 26, 2004, a decrease of 26.8% from $0.3 million for the quarterended March 28, 2003 due to lower interest rates on our cash and marketablesecurities investments.  Interest incomenet of interest expense as a percentage of net revenues decreased to 0.3% forthe quarter ended March 26, 2004 from 0.4% for the quarter ended March 28,2003.

 

*Other Income (Expense), Net*. Other expense was negligible for the quarter ended March 26, 2004compared to other income of $0.2 million for the quarter ended March 28, 2003.

 

*Expense for Premiumon Repurchase of Stock*.  In the first quarter of 2004, we repurchased 1.96 million sharesof our stock and certain options from a major stockholder at a premium to thethen current market price (see Note 11 of Notes to Consolidated FinancialStatements).  The aggregate purchaseprice for the shares and the options represented a premium of approximately 11%to market.  As a result, we recorded apretax charge of approximately $1.6 million (without any tax benefit) for suchpremium included in the purchase consideration.

 

*Income Taxes. *The provisionfor income taxes for the quarter ended March 26, 2004 was $0.8 million despitethe existence of a pretax loss, due to the nondeductibility of the premium onrepurchase of stock described above. Excluding that unusual item, the provision was 45% for the quarter endedMarch 26, 2004, compared to 42% in the quarter ended March 28, 2003.  This increase is due to income taxes we payin certain states which do not allow the use of our net operating losscarryforwards to offset income of certain of our subsidiaries.

 

*Cumulative Effect of Change inAccounting Principle*.  In November 2002, the Emerging Issues TaskForce (EITF) reached a consensus on Issue 00-21, titled “Accounting for RevenueArrangements 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 three monthsended March 26, 2004, we used cash flow for operations of $1.5 million.  During the three months ended March 26,2004, 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$2.0 million of cash to purchase property and equipment, primarily computer andrelated equipment.  At March 26, 2004,we had cash and investments available for sale of $42.8 million compared to$62.6 million at December 26, 2003.

 

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On February 27, 2004, we repurchased all outstandingshares and certain options of the Company from a major stockholder (see Note 11of Notes to Consolidated Financial Statements).  The aggregate purchase price for the shares and options was $14.8million in cash, and cancellation of a note owed to us by the stockholder inthe amount of $0.3 million.  Inaddition, in the event we were to announce or consummate a change in controltransaction prior to the first anniversary of this transaction, or if we were toenter into negotiations regarding a change in control transaction prior to thefirst anniversary and subsequently announce publicly a definitive agreement foror consummate a change in control transaction within the 18 months followingthe closing of this repurchase transaction, we would pay to this formerstockholder, upon the closing of such change in control of FCG, an amount equalto the difference between $7.50 per share and the change in control transactionprice per share, if such change in control price per share amount was higher.

 

On October 1,2003, we entered into an unsecured loan agreement with White Plains HospitalCenter requiring us to provide interest free financing of up to $4.08 millionif our system implementation at the hospital results in an increase in thehospital’s accounts receivable balance or days outstanding during a 150-dayperiod following the completion of the system implementation.  Any amounts borrowed during this 150-dayperiod are payable 90 days after the borrowing date.  We do not currently expect to make any loans under this agreementuntil early 2005, if at all.  Since ourloans are unsecured, we cannot guarantee that the hospital will repay our loanson a timely basis, if at all.  If ourloans are not repaid or repaid in a timely manner, our financial conditionwould be impacted negatively.

 

We have arevolving line of credit, under which we are allowed to borrow up to $7.0million at an interest rate of the prevailing prime rate with an expiration ofMay 1, 2005.  There was no outstandingbalance under the line of credit at March 26, 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 atapproximately $7.0 million for 2004), strategic investments, mergers andacquisitions, and other potential large-scale cash needs that may arise.

 

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** |   | **After 5  Years** |   | **Total** |   |
| Operating leases, net of subleases |   | $                           | 5,516  |   | $ | 9,986 |   | $ | 5,742 |   | $ | — |   | $ | 21,244 |   |
| Purchase obligations               |   | 310                         |   | 309 |   | — |   | — |   | 619 |   |
| Total                              |   | $                           | 5,826  |   | $ | 10,295 |   | $ | 5,742 |   | $ | — |   | $ | 21,863 |   |

 

**Critical Accounting Policies and Estimates**

 

The foregoingdiscussion and analysis of our financial condition and results of operations isbased upon our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the UnitedStates.  The preparation of thesefinancial statements requires us to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenues and expenses, and relateddisclosure of contingent assets and liabilities.  On an on-going basis, we evaluate our estimates, including thoserelated to revenue recognition, cost to complete client engagements, valuationof goodwill and long-lived and intangible assets, accrued liabilities, incometaxes, restructuring costs, idle facilities, litigation and disputes, and theallowance for doubtful accounts.  Webase our estimates on historical experience and on various other assumptionsthat we believe to be reasonable under the circumstances, the results of whichform the basis for making judgments about the carrying

 

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value of assets and liabilitiesthat are not readily apparent from other sources.  Our actual results may differ from our estimates and we do notassume any obligation to update any forward-looking information.

 

We believe thefollowing critical accounting policies reflect our more significant assumptionsand estimates used in the preparation of our consolidated financial statements.

 

***Revenue Recognitionand Unbilled Receivables***

 

Revenues arederived primarily from information technology outsourcing services, consulting,and systems integration.  Revenues arerecognized 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 servicesrendered; (c) the fee is fixed and determinable; and (d) collectibility isreasonably assured.  We determine if thefee is fixed and determinable and collectibility is reasonably assured based onour judgments 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 pricearrangements.

 

Revenues fromtime-and-materials arrangements are generally recognized based upon contractedhourly billing rates as the work progresses. Revenues from level-of-effort arrangements are recognized based upon afixed price for the level of resources provided.  Revenues from fixed fee arrangements for consulting and systemsintegration work are generally recognized on a rate per hour orpercentage-of-completion basis.  Wemaintain, for each of our fixed fee contracts, estimates of total revenue andcost over the contract term. For purposes of periodic financial reporting onthe fixed price consulting and system integration contracts, we accumulatetotal actual costs incurred to date under the contract. The ratio of thoseactual costs to our then-current estimate of total costs for the life of thecontract is then applied to our then-current estimate of total revenues for thelife of the contract to determine the portion of total estimated revenues thatshould be recognized.  We follow thismethod because reasonably dependable estimates of the revenues and costsapplicable to various stages of a contract can be made.

 

Revenuesrecognized on fixed price consulting and system integration contracts aresubject to revisions as the contract progresses to completion.  If we do not accurately estimate theresources required or the scope of the work to be performed, do not completeour projects within the planned periods of time, or do not satisfy ourobligations 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 includeincentives for achieving either schedule targets, cost targets, or otherdefined goals.  Revenues from incentivetype arrangements are recognized when it is probable they will be earned.

 

As of thebeginning of fiscal year 2003, we adopted EITF 00-21, “Accounting for RevenueArrangements with Multiple Deliverables,” which addresses how to account forarrangements that involve the delivery or performance of multiple products,services, and/or rights to use assets. Revenue arrangements with multiple deliverables are divided intoseparate units of accounting if the deliverables in the arrangement meet thefollowing criteria: (1) the delivered item has value to the customer on astand-alone basis; (2) there is objective and reliable evidence of the fairvalue of undelivered items; and (3) delivery of any undelivered item isprobable.  Arrangement consideration isallocated among the separate units of accounting based on their relative fair values,with the amount allocated to the delivered item being limited to the amountthat is not contingent on the delivery of additional items or meeting other 

 

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specified performanceconditions.  We have created separateunits of accounting on our existing outsourcing contracts based on the abovecriteria and will evaluate each future contract based on the samecriteria.  Generally, we have separatedcertain elements of our initial contract stages, where new systems areimplemented and/or processes are reengineered into a new operating environment,from the ongoing operations of the contract. The primary impact of the adoption of this standard is that our ongoingcontract operations, which constitute the vast majority of the revenues fromoutsourcing contracts, are now recorded on a straight-line basis over the lifeof the contract instead of on a percentage-of-completion basis in proportion tocosts incurred.  In general, we willreport lower margins on existing contracts in the early years of a contract andanticipate reporting increased margins in the later years of a contract;however, no assurances can be made in that regard.  The new method is no longer based on a consistent gross profitover the life of a contract.  We willlikely experience greater volatility of outsourcing earnings as contractrevenues remain level and contract costs move up or down, or shift from onequarter to another.

 

On certaincontracts, or elements of contracts, costs are incurred subsequent to thesigning of the contract, but prior to the rendering of service and associatedrecognition of revenue.  Where suchcosts are incurred and realization of those costs is either paid for upfront orguaranteed by the contract, those costs are deferred and later expensed over theperiod of recognition of the related revenue. At March 26, 2004, we had deferred $0.8 million of such deferred costs.

 

As part of ouron-going operations to provide services to our customers, incidental expenses,which are generally reimbursable under the terms of the contracts, are billedto customers. These expenses are recorded as both revenues and direct cost ofservices in accordance with the provisions of EITF 01-14, “Income StatementCharacterization of Reimbursements Received for ‘Out-of-Pocket’ ExpensesIncurred,” and include expenses such as airfare, mileage, hotel stays,out-of-town meals, and telecommunication charges.

 

Althoughsoftware revenues only comprised less than 3% of our revenues in the firstquarter of 2004, they are growing as a proportion of our total revenues.  We recognize software revenues in accordancewith the provisions of the American Institute of Certified Public AccountantsStatement of Position (“SOP”) 97-2, “Software Revenue Recognition”, as amendedby SOP 98-4, “Deferral of the Effective Date of a Provision of SOP 97-2,Software Revenue Recognition” and SOP 98-9, “Modification ofSOP 97-2, Software Revenue Recognition, With Respect to CertainTransactions”, and in accordance with the Securities and Exchange Commission StaffAccounting Bulletin (SAB) No. 104, “Revenue Recognition”. We licensesoftware 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 whereour software arrangements do not include services essential to thefunctionality of the product, license fee revenues are recognized when thesoftware product has been shipped, provided a non-cancelable license agreementhas been signed, there are no uncertainties surrounding product acceptance, thefees are fixed or determinable and collection of the related receivable isconsidered probable. We do not generally offer rights of return or acceptanceclauses to our customers. In situations where we do provide rights of return oracceptance clauses, revenue is deferred until the clause expires. Typically,our software license fees are due within a twelve-month period from the date ofshipment. If the fee due from the customer is not fixed or determinable,including payment terms greater than twelve months from shipment, revenue isrecognized as payments become due and all other conditions for revenuerecognition have been satisfied. In software arrangements that include rightsto multiple software products, specified upgrades, maintenance or services, weallocate the total arrangement fee among the

 

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deliverables using the fairvalue of each of the deliverables determined using vendor-specific objectiveevidence. Vendor-specific objective evidence of fair value is determined usingthe price charged when that element is sold separately. In softwarearrangements in which we have fair value of all undelivered elements but not ofa delivered element, we use the residual method to record revenue. Under theresidual method, the fair value of the undelivered elements is deferred and theremaining portion of the arrangement fee is allocated to the deliveredelement(s) and is recognized as revenue. In software arrangements in which wedo not have vendor-specific objective evidence of fair value of all undeliveredelements, revenue is deferred until fair value is determined or all elementshave been delivered.

 

Revenues fromtraining and consulting services are recognized as services are provided tocustomers. Revenues from maintenance contracts are deferred and recognizedratably over the term of the maintenance agreements. Revenues for customersupport and maintenance that are bundled with the initial license fee aredeferred based on the fair value of the bundled support services and recognizedratably over the term of the agreement; fair value is based on the renewal ratefor continued support arrangements.

 

Unbilledreceivables represent revenues recognized for services performed that were notbilled at the balance sheet date.  Themajority of these amounts are billed in the subsequent month. Unbillableamounts arising from contracts occur when revenues recognized exceed allowablebillings in accordance with the contractual agreements.  As of March 26, 2004, we had unbillablerevenues included in current unbilled receivables of approximately $2.1million, which were generally expected to be billed in the followingquarter.  In addition, we had along-term account receivable at March 26, 2004 and December 26, 2003 of $5.2million and $5.8 million, respectively, on a single major outsourcing contractwith a term of seven years.  Thelong-term receivable will be billed and collected over the remaining threeyears of the contract through contractual billings that will exceed the amountsto be earned as revenues.

 

Customer advances are comprised of paymentsfrom customers for which services have not yet been performed or prepaymentsagainst work in process. These unearned revenues are deferred and recognized asfuture contract costs are incurred and as contract services are rendered.

 

***Allowance forDoubtful Accounts***

 

We maintain anallowance for doubtful accounts for estimated losses resulting from theinability of our clients to make required payments. If the financial conditionof our clients were to deteriorate, resulting in an impairment of their abilityto make payments, additional allowances may be required.   Management analyzes account receivables andhistorical bad debt, customer concentrations, credit worthiness, pastcollection experience, current economic trends, and changes in our customerpayment terms when evaluating the adequacy of doubtful accounts.

 

***Deferred Income Taxes***

 

We account for income taxes in accordancewith SFAS No. 109, “Accounting for Income Taxes,” which requires recognition ofdeferred tax assets and liabilities for the expected future tax consequences ofevents that 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

 

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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, we have a valuation allowance of $11.0 million against atotal deferred tax asset of $21.1 million. Based on our belief that it is more likely than not that future taxableincome will be sufficient to realize the remaining $10.1 million of deferredtax assets, we have not recorded a valuation allowance against thoseassets.  However, there is no guaranteethat our taxable income will be sufficient to realize such remaining netdeferred tax assets, and we will continue to evaluate the potential need for anadditional valuation allowance on an ongoing basis.  Additionally, if the realization of a greater amount of ourdeferred tax assets in the future is considered more likely than not, we willreverse all or a portion of the existing valuation allowance at that time.

 

***Goodwill and Intangible Assets***

 

Under SFAS No142, we no longer amortize our goodwill and are required to complete an annualimpairment testing during the fourth quarter of each year.  We believe that the accounting assumptionsand estimates related to the annual goodwill impairment testing are criticalbecause these can change from period to period.  The impairment test requires us to forecast our future cashflows, which involves significant judgment. Our operating results have been negatively impacted by the worldwideeconomic conditions.   Accordingly, ifour expectations of future operating results change, or if there are changes toother assumptions, our estimate of the fair value of our reporting units couldchange significantly resulting in a goodwill impairment charge, which couldhave a significant impact on our consolidated financial statements.  As of March 26, 2004, we have $16.9 millionof goodwill and $3.7 million of intangible assets recorded on our balancesheet (see Note 5 of the Notes to Consolidated Financial Statements).

 

***Recent Accounting Pronouncements***

 

See Note 1 ofthe Notes to the Consolidated Financial Statements for a discussion on recentaccounting pronouncements.

 

**Risks Relating to Our Business**

 

Beforedeciding to invest in us or to maintain or increase your investment, you shouldcarefully consider the risks described below, in addition to the otherinformation contained in this report. The risks and uncertainties described below are not the only ones facingour company.  Additional risks anduncertainties not presently known to us or that we currently deem immaterialmay also affect our business operations. If any of these risks are realized, our business, financial condition orresults of operations could be seriously harmed.  In that event, the market price for our common stock coulddecline and you may lose all or part of your investment.

 

*Many factors may cause our net revenues,operating results and cash flows to fluctuate and possibly decline.*

 

Our netrevenues, operating results, and cash flows may fluctuate significantly becauseof a number of factors, many of which are outside of our control.  These factors may include:

 

•      The loss of one or moresignificant clients in any of our business segments;

•      The roll-off or completionof significant projects in any of our business segments;

•      Fluctuations in marketdemand for our services, associate hiring, and utilization;

•      Delays or increased expensesin securing and completing client engagements;

 

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•      Timing and collection offees and payments;

•      Timing of new clientengagements in any of our business segments;

•      Increased competition andpricing pressures;

•      Use of offsite and offshoreresources on our engagements;

•      Ability to incorporate useof variable labor staffing into our projects;

•      The loss of key personneland other employees;

•      Changes in our, and ourcompetitors’, business strategy, pricing and billing policies;

•      The timing of certaingeneral and administrative expenses;

•      Completing acquisitions andthe costs of integrating acquired operations;

•      Variability in the number of billable days ineach quarter;

•      The write-off of clientbillings;

•      Return of fees for workdeemed unsatisfactory by a client or claims or litigation resulting from thesame;

•      Entry into fixed priceengagements and engagements where some fees are contingent upon the clientrealizing a certain return on investment for a project;

•      Availability of foreign netoperating losses and other credits against our earnings;

•      International currencyfluctuations;

•      Ability to sublease vacantoffice space included in previous restructuring charges; and

•      The fixed nature of asubstantial portion of our expenses, particularly personnel and 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 materiallyadversely affect our business, financial condition, and results ofoperations.  Our business also hassignificant collection risks.  If we areunable to collect our receivables in a timely manner, our business andfinancial condition could also suffer. If these or any other variables or unknowns were to cause a shortfall inrevenues or earnings or otherwise cause a failure to meet public marketexpectations, our business could be adversely affected.

 

We adoptedEITF 00-21 in the first quarter of 2003, which affects the way we recognizerevenue on long-term outsourcing agreements. The adoption of EITF 00-21 resultsin separating our outsourcing contracts into multiple elements and separatelyaccounting for each element, rather than accounting for all elements togetheras a group.  As a result, we nowrecognize revenue from certain service elements of our outsourcing agreementson a straight-line basis over the life of the contract, rather than on apercentage of completion basis.  Sincewe typically incur greater costs and expenses during the early phase of the serviceelements (which will now have straight-line revenue recognition) than we do inthe later years of those elements, we believe our net income will be lessduring 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 otherwiseexperience a shortfall in our net income due to these fluctuations, ourbusiness could be adversely affected and the price of our stock may decline.

 

Finally, wereported net losses before the cumulative effect of change in accountingprinciple for the last three quarters of 2003 as well as net loss for the firstquarter of 2004.  As a result, we cannotassure you that we will achieve positive earnings in the future.  If we are unable to achieve profitability on

 

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a quarterly or annual basis,the market price of our common stock could be adversely affected and ourfinancial condition would suffer.

 

*We are dependent on our outsourcing engagements for a significant partof our revenues.*

 

Currently, wehave seven significant outsourcing relationships. Net revenues from ouroutsourcing relationships, as of the quarter ended March 26, 2004, representedapproximately 43% of our consolidated net revenues.  The substantial majority of these revenues are received from fourlarge outsourcing accounts that have signed long-term agreements with us.  However, the loss of any of our outsourcingrelationships would have a material impact on our business and results ofoperations.  In each of theseengagements, the clients have fully outsourced their information technologystaff and functions to us.  Inall of our outsourcing relationships, we generally enter into additionalagreements, including detailed service level agreements, which establishperformance levels and standards for our services.  If we fail to meet these performance levels or standards, ourclients may receive monetary service level credits from us or, if we experiencepersistent failures, our clients may have a right to terminate the outsourcingcontract for cause and have no obligation to pay us any termination fees.  Our anticipated revenues from ouroutsourcing engagements could be significantly reduced if we are unable tosatisfy our performance levels or standards. Additionally, our outsourcing contracts can be terminated at theconvenience of our clients upon the payment of a termination fee.

 

In addition,our outsourcing agreements require that we invest significant amounts of timeand resources in order to win the engagement, transition the client’sinformation technology department to our management, and complete the initialtransformation of our client’s information technology functioning to provideimproved service at a lower cost and meet agreed-upon service levels.  Often, we recover this investment throughpayments over the life of the outsourcing agreement.  If we are unable to achieve agreed-upon service levels orotherwise breach the terms of our outsourcing agreements, the clients may haverights to terminate our agreements for cause and we may be unable to recoverour investments.  Any failure by us torecover these investments could reduce our outsourcing revenue, which wouldhave a material adverse effect on our financial condition, results ofoperations, and price of our common stock.

 

Ouroutsourcing engagements may also require that we hire part or all of a client’sinformation technology personnel.  Wecannot assure you that we will be able to retain these individuals, andeffectively hire additional personnel as needed to meet the obligations of ourcontract.  Any failure by us to retainthese individuals or otherwise satisfy our contractual obligations could have amaterial adverse effect on the profitability of our outsourcing business andour reputation as an information technology services outsourcing 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.

 

In May 2003,we completed the acquisition of Coactive Systems Corporation, a provider ofinbound and outbound call center services to the hospital and payermarkets.  The acquisition represents ourentry into the business process outsourcing market (BPO).  If we are unable to successfully integrateand leverage this acquisition in the BPO market, we may not be able tosuccessfully execute our strategy in this area.  Further, all acquisitions involve risks that could materially andadversely affect our business and operating results.  Consequently, we may fail to meet public market expectations andthe price of our common stock may decline.

 

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*The length of time required to engage a client and to complete anassignment may be unpredictable and could negatively impact our net revenuesand operating results.*

 

The timing ofsecuring our client engagements and service fulfillment is difficult to predictwith any degree of accuracy.  Priorengagement cycles are not necessarily an indication of the timing of futureclient engagements or revenues.  Thelength of time required to secure a new client engagement or complete anassignment often depends on factors outside our control, including:

 

•       Existinginformation systems at the client site;

•       Changes orthe anticipation of changes in the regulatory environment affecting healthcareand pharmaceutical organizations;

•       Changes inthe management or ownership of the client;

•       Budgetarycycles and constraints;

•       Changes inthe anticipated scope of engagements;

•       Availabilityof personnel and other resources; and

•       Consolidationin the healthcare and pharmaceutical industries.

 

Prior toclient engagements, we typically spend a substantial amount of time andresources (1) identifying strategic or business issues facing the client, (2)defining engagement objectives, (3) gathering information, (4) preparingproposals, and (5) negotiating contracts. Our failure to procure an engagement after spending such time and resourcescould materially adversely affect our business, financial condition, andresults of operations.  We may also berequired to hire new associates before securing a client engagement.  If clients defer committing to newassignments for any length of time or for any reason we could be required tomaintain a significant number of under-utilized associates which couldadversely affect our operating results and financial condition during any givenperiod.  Further, our outsourcingbusiness has very long sales and contract lead times, requiring us to spend asubstantial amount of time and resources in attempting to secure eachoutsourcing engagement.  We cannotpredict whether the investment of time and resources will result in a newoutsourcing engagement or, if the engagement is secured, that the engagementwill be on terms favorable to us.

 

*We could be negatively impacted if we fail to successfully integratethe businesses we acquire.*

 

We have grown,in part, by acquiring complementary businesses that could enhance ourcapability to serve the healthcare and pharmaceutical industries.  For example, we acquired a majority interestin Codigent Solutions Group, Inc. (renamed FCG Infrastructure Services, Inc.)in 2002 and purchased the remaining minority interest in that entity in thefirst quarter of 2004, and during the first half of 2003, we acquired ParagonSolutions, Inc., Coactive Systems Corporation, and certain assets of PhyveCorporation. All acquisitions involve risks that could materially and adverselyaffect our business and operating results. These risks include:

 

•      Distracting management fromour business;

•      Losing key personnel andother employees;

•      Losing clients;

•      Costs, delays, andinefficiencies associated with integrating acquired operations and personnel;

•      The impairment of acquiredassets and goodwill; and

•      Acquiring the contingent andother liabilities of the businesses we acquire.

 

In addition,acquired businesses may not enhance our services, provide us with increasedclient opportunities, or result in the growth that we anticipate.  Furthermore, integrating acquired operationsis a complex, time-consuming, and expensive process.  Combining acquired operations with us may result in lower overalloperating margins, greater stock price volatility, and quarterly earningsfluctuations.

 

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Cultural incompatibilities,career uncertainties, and other factors associated with such acquisitions mayalso result in the loss of employees and clients.  Failing to acquire and successfully integrate complementarypractices, or failing to achieve the business synergies that we anticipate,could materially adversely affect our business and results of operations.

 

*We may be negatively impacted if ourinvestments in products and emerging service lines are unsuccessful.*

 

We havepublicly announced our strategy to increase our investment in productdevelopment, including further investment in FirstDocTM as well asinvestment 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 to generate additionalrevenue from our existing clients, our business may be negatively affected.*

 

Our successdepends, to a significant extent, on obtaining additional engagements from ourexisting clients.  A substantial portionof our revenues is derived from additional services provided to our existingclients.  The loss of a small number ofclients may result in a material decline in revenues and cause us to fail tomeet public market expectations of our financial performance and operatingresults.  If we fail to generateadditional revenues from our existing clients it may materially adverselyaffect our business and financial condition.

 

*If we fail to meet client expectations in the performance of ourservices, our business could suffer.*

 

Our servicesoften involve assessing and/or implementing complex information systems andsoftware, which are critical to our clients’ operations.  Our failure to meet client expectations inthe performance of our services, including the quality, cost and timeliness ofour services, may damage our reputation in the healthcare and pharmaceuticalindustries and adversely affect our ability to attract and retain clients.  If a client is not satisfied with ourservices, we will generally spend additional human and other resources at ourown expense to ensure client satisfaction. Such expenditures will typically result in a lower margin on suchengagements and could materially adversely affect our business, financialcondition, and results of operations.

 

Further, inthe course of providing our services, we will often recommend the use ofsoftware and hardware products.  Theseproducts may not perform as expected or contain defects.  If this occurs, our reputation could bedamaged and we could be subject to liability. We attempt contractually to limit our exposure to potential liabilityclaims; however, such limitations may not be effective.  A successful liability claim brought againstus may adversely affect our reputation in the healthcare and pharmaceuticalindustries and could have a material adverse effect on our business or financialcondition.  Although we maintain professionalliability insurance, such insurance may not provide adequate coverage forsuccessful claims against us.

 

*We may be unable to attract and retain a sufficient number of qualifiedemployees.*

 

Our businessis labor-intensive and requires highly skilled employees.  Many of our associates possess extensiveexpertise in the healthcare, insurance, pharmaceutical, information technologyand

 

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consulting fields.  To serve a growing client base, we must continueto recruit and retain qualified personnel with expertise in each of theseareas.  We must also seek certainemployees that are willing to work on a variable or per diem basis.  Competition for such personnel is intenseand we compete for such personnel with management consulting firms, healthcareand pharmaceutical organizations, software firms, and other businesses.  Many of these entities have substantiallygreater financial and other resources than we do, or can offer more attractivecompensation packages to candidates, including salary, bonuses, stock, andstock options.  If we are unable torecruit and retain a sufficient number of qualified personnel to serve existingand new clients, our ability to expand our client base or services and to offerour services at competitive rates could be impaired and our business wouldsuffer.

 

*The loss of our key client service employees and executive officerscould negatively affect us.*

 

Ourperformance depends on the continued service of our executive officers, seniormanagers, and key employees.  Inparticular, we depend on such persons to secure new clients and engagements andto manage our business and affairs.  Theloss of such persons could result in the disruption of our business and couldhave a material adverse effect on our business and results of operations.  We have not entered into long-termemployment contracts with any of our employees and do not maintain key employeelife insurance.

 

*Continued or increased employee turnover could negatively affect ourbusiness.*

 

We haveexperienced employee turnover as a result of:

 

•      Dependence on lateral hiringof associates;

•      Travel demands imposed onour associates;

•      Loss of employees tocompetitors and clients; and

•      Reductions in force ascertain areas of our business have seen less demand.

 

Continued orincreased employee turnover could materially adversely affect our business andresults of operations.  In addition,many of our associates develop strong business relationships with our clients.  We depend on these relationships to generateadditional assignments and engagements. The loss of a substantial number of associates could erode our clientbase and decrease our revenues.

 

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

 

Our businesshas historically grown rapidly, and though our overall revenues have remainedflat for the past several years, we have experienced growth and increaseddemand in certain areas of our business. In response to shifts in market demand and in an effort to better alignour business with our markets, we restructured our organization and hiredpersons with appropriate skills, including salespersons, and reduced ourworkforce in practice areas experiencing less demand.  We have also begun to hire employees willing to work on avariable or per diem basis in order to better manage project costs and generaland administrative expense associated with underutilized resources.  These market conditions and restructuringefforts have placed new and increased demands on our management personnel.  It has also placed significant andincreasing demands on our financial, technical and operational resources, andon our information systems.  If we areunable to manage growth effectively or if we experience business disruptionsdue to shifts in market demand, or growth or restructuring, our operatingresults will suffer.  To manage anyfuture growth, we must extend our financial reporting and informationmanagement 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

 

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employees and offices to offsetany increasing 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 pharmaceutical industries couldnegatively impact our revenues.*

 

We derive asubstantial portion of our revenues from clients in the healthcareindustry.  As a result, our business andresults of operations are influenced by conditions affecting this industry,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 tomaintain our pricing goals could have a material adverse effect on our businessand financial condition.  Finally, eachof the 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 substantialportion of our revenues has also come from companies in the pharmaceuticalindustry.  Our revenues are, in part,linked to the pharmaceutical industry’s research and development and technologyexpenditures.  Should any of thefollowing events occur in the pharmaceutical industry, our business could benegatively affected in a material way:

 

•      Continued adverse changes tothe industry’s general economic environment;

•      Continued consolidation ofcompanies; or

•      A decrease in pharmaceuticalcompanies’ research and development or technology expenditures.

 

A trend in thepharmaceutical industry is for companies to outsource either large informationtechnology-dependent projects or their information systems staffingrequirements.  We benefit whenpharmaceutical companies outsource to us, but may lose significant futurebusiness 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 create specialized risks that cannegatively affect us.*

 

We are subjectto many risks as a result of the services we provide to our internationalclients or services we may provide through subcontractors or employees that arelocated outside of the U.S.   Further,in February 2003, we acquired Paragon Solutions, Inc., a U.S. based companywith offshore software development centers in India and Vietnam.  As a result of this acquisition, wecurrently have business operations and employees located in India and Vietnam,as well as our existing employees throughout Europe.  If we fail to recruit and retain a sufficient number of qualifiedemployees in each country where we conduct business, our ability to perform ourexisting services may be impaired and our business could be adverselyaffected.  Our international operationsare also subject to a variety of risks, including:

 

•      Difficulties in creatinginternational market demand for our services;

•      Difficulties and costs oftailoring our services to each individual country’s healthcare andpharmaceutical market needs;

 

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•      Uncertainty of labor costsand high turnover rates;

•      Unfavorable pricing andprice competition;

•      Currency fluctuations;

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

•      Longer payment cycles insome countries and difficulties in collecting international accountsreceivable;

•      Terrorist attacks;

•      Difficulties in enforcingcontractual obligations and intellectual property rights;

•      Adverse tax consequences;

•      Increased costs associatedwith maintaining international marketing efforts and offices;

•      Government regulations andrestrictions;

•      Adverse changes inregulatory requirements; and

•       Economic or politicalinstability.

 

We have beenperforming services in Europe for international clients for several years. Weceased performing healthcare consulting services for European clients in 2000,but continue to provide our services in Europe to pharmaceutical clients.  We cannot assure you that we will be able tobecome profitable in our European pharmaceutical services, which may materiallyadversely affect our financial condition, results of operations, and price forour common stock.

 

Ouracquisition of Paragon Solutions, Inc. provided us a means to implement ourglobal sourcing strategy to provide software development and other informationtechnology services to our clients.  Ifwe are unable to realize perceived cost benefits of such a strategy or if weare unable to receive high quality services from foreign employees or subcontractors,our business may be adversely impacted. Further, our recently acquiredinternational operations in Vietnam and India subject our business to a varietyof risks and uncertainties unique to operating businesses in these countries,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 the healthcare and pharmaceuticalinformation services industries, our business will be negatively impacted.*

 

The market forhealthcare and pharmaceutical information technology consulting is verycompetitive.  We have competitors that providesome or all of the services we provide. For example, in strategic consulting services, we compete withinternational, regional, and specialty consulting firms such as Bearing Point(formerly KPMG Consulting), Cap Gemini Ernst & Young, IBM Global ConsultingServices, Wipro Technologies, and Accenture.

 

In integrationand co-management services, we compete with:

 

•      Information system vendorssuch as McKesson, Siemens Medical Solutions, Cerner Corporation, and IBM GlobalSystems;

•      Service groups of computerequipment companies;

•      Systems integrationcompanies such as Electronic Data Systems Corporation, Perot SystemsCorporation, SAIC, Cap Gemini Ernst & Young, and Computer SciencesCorporation;

•      Clients’ internalinformation management departments;

•      Other healthcare consultingfirms; and

•      Other pharmaceuticalconsulting firms such as Accenture, Cap Gemini Ernst & Young, and ComputerSciences Corporation’s consulting division.

 

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In e-healthand e-commerce related services, we compete with the traditional competitorsoutlined above, as well as newer internet product and service companies.  We also compete with companies that providesoftware development, information technology consulting and outsourcing, andother integration and maintenance services, such as Wipro Technologies,Cognizant Technology Solutions Corporation, and Tata Technologies Limited.

 

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 ourcompetitors have significantly greater financial, human, and marketingresources than us.  As a result, suchcompetitors may be able to respond more quickly to new or emerging technologiesand changes in customer demands, or to devote greater resources to the development,promotion, sale, and support of their products and services than we do.  In addition, as healthcare organizationsbecome larger and more complex, our larger competitors may be better able toserve the needs of such organizations. If we do not compete effectively with current and future competitors, wemay be unable to secure new and renewed client engagements, or we may berequired 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 maintain relationships with vendors ofsoftware and hardware products, it could have a negative effect on our abilityto secure engagements.*

 

We have anumber of relationships with software and hardware vendors.  For example, our life sciences business ishighly dependent upon a non-exclusive relationship with Documentum, Inc., avendor of document management software applications with which we integrate ourFirstDoc TM solution.  Webelieve 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 software and hardware products couldhave a negative impact on our ability to secure consulting engagements.*

 

Our growingnumber of relationships with software and hardware vendors could result inclients perceiving that we are not independent from those software and hardwarevendors.  Our ability to secureassessment and other consulting engagements is often dependent, in part, on ourbeing independent of software and hardware solutions that we may review,analyze or recommend to clients.  Ifclients believe that we are not independent of those software and hardwarevendors, clients may not engage us for certain consulting engagements relatingto those vendors, which could reduce our revenues and materially adverselyaffect our business.

 

*We may infringe the intellectual property rights of third parties.*

 

Our successdepends, in part, on not infringing patents, copyrights, and other intellectualproperty rights held by others.  We donot know whether patents held or patent applications filed by third parties (i.e.in the area of enterprise content management) may force us to alter our methodsof business and

 

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operation or require us toobtain licenses from third parties.  Ifwe attempt to obtain such licenses, we do not know whether we will be grantedlicenses or whether the terms of those licenses will be fair or acceptable tous.  Third parties may assertinfringement 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 the merits ofsuch claims.

 

*Our business is highly dependent on the availability of businesstravel.*

 

Our associatesand service providers often reside or work in cities or other locations thatrequire them to travel to a client’s site to perform and execute the client’sproject.  As a result of the September11, 2001 terrorist attacks, air travel has become more time-consuming tobusiness travelers due to increased security, flight delays, reduced flightschedules, and other variables.  Ifefficient and cost effective air travel becomes unavailable to our associates,or if domestic or international air travel is significantly reduced or halted,we may be unable to satisfactorily perform our client engagements on a timelybasis, which could have a materially adverse impact on our business.  Further, if our associates refuse to utilizeair travel to perform their job functions for any reason, our business andreputation would be negatively affected.

 

*If we fail to keep pace with regulatory and technological changes, ourbusiness 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.

 

Technologicalchange in the network and application markets has created high demand forconsulting, implementation, and integration services.  If the pace of technological change were to diminish, we couldexperience a decrease in demand for our services.  Any material decrease in demand would materially adversely affectour business, financial condition, and results of operations.

 

*We may be unable to effectively protect our proprietary information andprocedures.*

 

We mustprotect our proprietary information, including our proprietary methodologies,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 ourservices to clients in international markets and have business operations inEurope, India and Vietnam.  Ourproprietary information may not be protected to the same extent as providedunder the laws of the United States, if at all.  The unauthorized use of our intellectual property could have amaterial adverse effect on our business, financial condition, or results ofoperations.

 

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*Our management may be able to exercise control over matters requiringstockholder approval.*

 

Our currentofficers, directors, and other affiliates beneficially own approximately 24.2%of our outstanding shares of common stock and approximately 37.2% on a fullydiluted basis.  As a result, ourexisting management, if acting together, may be able to exercise control overor significantly influence matters requiring stockholder approval, includingthe 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 be adversely affected by marketvolatility.*

 

The tradingprice of our common stock fluctuates significantly.  Since our common stock began trading publicly in February 1998,the reported sale price of our common stock on the Nasdaq National Market hasbeen as high as $29.13 and as low as $3.63 per share.  This price may be influenced by many factors, including:

 

•      Our performance andprospects;

•      The depth and liquidity ofthe market for our common stock;

•      Investor perception of usand the industries in which we operate;

•      Changes in earningsestimates or buy/sell recommendations by analysts;

•      General financial and othermarket conditions; and

•      Domestic and internationaleconomic conditions.

 

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 become subject to securitieslitigation, which is expensive and could result in a diversion of resources.*

 

If our stockprice experiences periods of volatility, our security holders may initiatesecurities class action litigation against us. If we become involved in this type of litigation it could be veryexpensive and divert our management’s attention and resources, which couldmaterially and adversely affect our business and financial condition.

 

*Our charter documents, Delaware law and stockholders rights plan willmake it more difficult to acquire us and may discourage take-over attempts andthus depress the market price of our common stock.*

 

Our board ofdirectors has the authority to issue up to 9,500,000 shares of undesignatedpreferred stock, to determine the powers, preferences, and rights and thequalifications, limitations, or restrictions granted to or imposed upon anyunissued series of undesignated preferred stock and to fix the number of sharesconstituting any series and the designation of such series, without any furthervote or action by our stockholders.  Thepreferred stock could be issued with voting, liquidation, dividend, and otherrights superior 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.

 

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In addition,our certificate of incorporation eliminates the right of stockholders to actwithout a meeting and does not provide cumulative voting for the election ofdirectors.  Our certificate of incorporationalso provides for a classified board of directors.  The ability of our board of directors to issue preferred stockand these other provisions of our certificate of incorporation and bylaws mayhave the effect of deterring hostile takeovers or delaying changes in controlor management.

 

We are alsosubject to the provisions of Section 203 of the Delaware General CorporationLaw, which could delay or prevent a change in control of us, impede a merger,consolidation, or other business combination involving us or discourage apotential acquirer from making a tender offer or otherwise attempting to obtaincontrol.  Any of these provisions, whichmay have the effect of delaying or preventing a change in control, could adverselyaffect 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 Disclosuresabout Market Risks

 

Our financialinstruments include cash and cash equivalents (i.e., short-term and long-termcash investments), accounts receivable, unbilled receivables, accounts payable,and a revolving line of credit.  Onlythe cash and cash equivalents and short-term investments which totaled $42.8million at March 26, 2004 present us with market risk exposure resultingprimarily from changes in interest rates. Based on this balance, a change of one percent in the interest ratewould cause a change in interest income for the annual period of approximately$0.4 million.  Our objective inmaintaining these investments is the flexibility obtained in having cashavailable for payment of accrued liabilities and acquisitions.

 

Our borrowingsare primarily dependent upon the prevailing prime rate.  As of March 26, 2004, we had no borrowingsunder our revolving line of credit and an available borrowing capacity of $7.0million.  See “Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”  Theestimated fair value of borrowings under the revolving line is expected toapproximate its carrying value.

 

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

 

We maintain disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in our Exchange Act reports is recorded, processed, summarized,and reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms, and that such information is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow for timely decisions regardingrequired disclosure. In designing and evaluating the disclosure controls andprocedures, management is required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.  Our disclosure controls and procedures aredesigned to provide a reasonable level of assurance of reaching our desireddisclosure control objectives.

 

As required by SEC Rule13a-15(b), we carried out an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer and ourChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures as of

 

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the end of the quarter coveredby this report. Based on the foregoing, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective, and were operating at the reasonable assurance level.

 

There has been no change inour internal controls over financial reporting during our most recent fiscalquarter or fiscal year that has materially affected, or is reasonably likely tomaterially affect, our internal controls over financial reporting.

 

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# **PART II**.  OTHERINFORMATION

 

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

## ** **

None.

 

## **Item 2.  Changes in Securities**

## ** **

(c) Sales of UnregisteredSecurities. On January 30, 2004, we acquired the remaining 47.65% minorityinterest in FCG Infrastructure, Inc. in a stock purchase transaction for anaggregate purchase price of approximately $2.4 million in cash and $3.6 millionin FCG restricted common stock. We issued 591,328 unregistered shares of ourcommon stock to the five minority stockholders of FCG Infrastructure Services,Inc. The shares of common stock we issued are exempt from the registrationrequirements of the Securities Act of 1933, as amended, pursuant to Section4(2) of such Act and Rule 506 promulgated thereunder.

 

(e) Repurchase of Securities.On February 27, 2004, we purchased 1,962,400 shares of common stock and32,000 in-the-money options from David S. Lipson, a member of our board ofdirectors, for a total purchase price of $15.1 million.  In connection with the transaction, Mr.Lipson resigned from the board of directors and repaid indebtedness to us of$328,311.  The net cash payment to Mr.Lipson in the transaction was $14.8 million. Other terms of the transaction are disclosed in our Current Report onForm 8-K, including the exhibits to such report, filed with the SEC on February27, 2004.

 

## **Item3.  Defaults Upon Senior Securities**.

 

None.

 

## **Item4.  Submission of Matters to a Vote ofSecurity Holders**

 

None.

 

## **Item 5.  Other Information.**

 

None.

 

## **Item6.  Exhibits and Reports 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                                                                        |
| 10.1(5)  |   | Stock Repurchase Agreement  dated February 27, 2004 between the Company and David S. Lipson. |
| 10.2     |   | Employment Agreement dated  March 22, 2004 between the Company and Mary Franz.               |
| 11.1 (6) |   | 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.                                  |

 

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(1)   Incorporatedby reference to Exhibit 3.1 to FCG’s Form S-1 Registration Statement (No.333-41121) originally filed on November 26, 1997 (the “Form S-1”).

 

(2)   Incorporatedby reference to Exhibit 99.1 to FCG’s Current Report on Form 8-K dated December9, 1999.

 

(3)   Incorporatedby reference to Exhibit 3.3 to FCG’s Form S-1.

 

(4)   Incorporatedby reference to Exhibit 4.1 to FCG’s Form S-1.

 

(5)   Incorporatedby reference to Exhibit 99.2 to FCG’s Current Report on Form 8-K dated February27, 2004.

 

(6)   SeeNote 1 to Consolidated Financial Statements, “Basic and Diluted Net Income(Loss) Per Share.”

 

(b)   Reportson Form 8-K

 

(1)   Form 8-K filed on February 3, 2004 reporting acquisition of remaining47.35% interest in FCG Infrastructure Services (f/k/a Codigent Solutions Group)(Items 5 and 7).

 

(2)   Form 8-K filed on February 19, 2004 providing the press releaseannouncing our fourth quarter and fiscal year 2003 financial results (Item 12).

 

(3)   Form 8-K filed on February 27, 2004 reporting the purchase of equityholding of David S. Lipson (Items 5 and 7).

 

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# **SIGNATURES**

 

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

 
|                    | FIRST  CONSULTING GROUP, INC.                       |
|-------------------------|-----------------------------------------------------|
|                    |                                                |
|                    |                                                |
| Date:  May 5, 2004 | /s/ LUTHER  J. NUSSBAUM                             |   |
|                    | Luther J.  Nussbaum                                 |
|                    | Chairman of  the Board and  Chief Executive Officer |
|                    |                                                |
|                    |                                                |
| Date:  May 5, 2004 | /s/ WALTER  J. MCBRIDE                              |   |
|                    | Walter J.  McBride                                  |
|                    | Executive  Vice President and Chief                 |
|                    | Financial  Officer                                  |

 

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# **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                                                           |
| 10.1(5)  |   | Stock Repurchase Agreement  dated February 27, 2004 between the Company and David S. Lipson. |
| 10.2     |   | Employment Agreement dated  March 22, 2004 between the Company and Mary Franz.               |
| 11.1 (6) |   | 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.                                  |

 

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(1)   Incorporatedby reference to Exhibit 3.1 to FCG’s Form S-1 Registration Statement (No.333-41121) originally filed on November 26, 1997 (the “Form S-1”).

 

(2)   Incorporatedby reference to Exhibit 99.1 to FCG’s Current Report on Form 8-K dated December9, 1999.

 

(3)   Incorporatedby reference to Exhibit 3.3 to FCG’s Form S-1.

 

(4)   Incorporatedby reference to Exhibit 4.1 to FCG’s Form S-1.

 

(5)   Incorporatedby reference to Exhibit 99.2 to FCG’s Current Report on Form 8-K dated February27, 2004.

 

(6)   SeeNote 1 to Consolidated Financial Statements, “Basic and Diluted Net Income(Loss) Per Share.”

 

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