**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC  20549**

 

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**FORM10-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 September 24,  2004**                                                                                                                      |
| ** **                                                                                                                                                                  |
| **OR**                                                                                                                                                                      |
| ** **                                                                                                                                                                  |
| **o**                                                                                                                                                                       | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                        |                                                                                          |
| **For the transition period from            to             ** |
| ** **                                                                                                                                                                  |
| **Commission File Number 0-23651**                                                                                                                                          |

 

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**FirstConsulting Group, Inc.**

(Exact name of registrant as specified in its charter)

 

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

 

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

(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

 

**Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule12b-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** | ** ** | **24,777,072**                     |
|-----------------------------------|------------|------------------------------------|
| (Class)                           |       | (Outstanding  at October 22, 2004) |

 

 

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**First Consulting Group, Inc.**

**Table of Contents**

 
| COVER PAGE                                                                                           |   |
|------------------------------------------------------------------------------------------------------|--------|
|                                                                                                 |   |
| TABLE OF CONTENTS                                                                                    |   |
|                                                                                                 |   |
| PART I.FINANCIAL INFORMATION                                                                         |   |
|                                                                                                 |   |
| ITEM  1. FINANCIAL STATEMENTS AND NOTES (UNAUDITED)                                                  |   |
|                                                                                                 |   |
| Consolidated Balance Sheets                                                                          |   |
|                                                                                                 |   |
| Consolidated  Statements of Operations                                                               |   |
|                                                                                                 |   |
| 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. UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                 |   |
|                                                                                                 |   |
| ITEM 3.  DEFAULTS UPON SENIOR SECURITIES                                                             |   |
|                                                                                                 |   |
| ITEM  4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                         |   |
|                                                                                                 |   |
| ITEM 5. OTHER INFORMATION                                                                            |   |
|                                                                                                 |   |
| ITEM 6.  EXHIBITS                                                                                    |   |
|                                                                                                 |   |
| SIGNATURES                                                                                           |   |
|                                                                                                 |   |
| EXHIBIT INDEX                                                                                        |   |

 

2

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# ** **

# **PART I.  FINANCIAL INFORMATION**

 

## **Item1. Financial Statements and Notes (Unaudited)**

 

**FirstConsulting Group, Inc. and Subsidiaries**

 

### **ConsolidatedBalance Sheets**

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

** **
| ** **                                                                                                              | ** ** | **September 24,  2004** | ** ** | **December 26,  2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                              | ** ** | **(unaudited)**         | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                              | ** ** | ** **              | ** ** | ** **             | ** ** |
| Current assets:                                                                                                         | ** ** | ** **              | ** ** | ** **             | ** ** |
| Cash and cash equivalents                                                                                               |       | $                       | 21,884     |                   | $          | 26,826 |   |
| Short-term investments                                                                                                  |       | 25,222                  |       | 33,803                 |       |
| Accounts receivable, less allowance of  $1,392 and $1,974 as of September 24, 2004 and December 26, 2003,  respectively |       | 23,606                  |       | 27,564                 |       |
| Unbilled receivables                                                                                                    |       | 12,887                  |       | 9,947                  |       |
| Deferred income taxes                                                                                                   |       | 6,279                   |       | 6,279                  |       |
| Prepaid expenses and other current assets                                                                               |       | 2,144                   |       | 1,713                  |       |
| Total current assets                                                                                                    |       | 92,022                  |       | 106,132                |       |
|                                                                                                                    |       |                    |       |                   |       |
| Notes receivable – stockholders                                                                                    |       | 438                     |       | 432                    |       |
| Long-term  investments                                                                                                  |       | 1,150                   |       | 3,216                  |       |
| Property and  equipment:                                                                                                |       |                    |       |                   |       |
| Furniture, equipment, and leasehold  improvements                                                                       |       | 4,519                   |       | 4,053                  |       |
| Information systems equipment                                                                                           |       | 26,580                  |       | 23,663                 |       |
|                                                                                                                    |       | 31,099                  |       | 27,716                 |       |
| Less accumulated depreciation and  amortization                                                                         |       | 20,369                  |       | 19,177                 |       |
|                                                                                                                    |       | 10,730                  |       | 8,539                  |       |
|                                                                                                                    |       |                    |       |                   |       |
| Other assets:                                                                                                           |       |                    |       |                   |       |
| Executive benefit trust                                                                                                 |       | 8,611                   |       | 8,144                  |       |
| Long-term account receivable                                                                                            |       | 4,279                   |       | 5,768                  |       |
| Deferred income taxes                                                                                                   |       | 2,076                   |       | 4,329                  |       |
| Goodwill, net                                                                                                           |       | 17,800                  |       | 15,458                 |       |
| Intangibles, net                                                                                                        |       | 2,819                   |       | 3,800                  |       |
| Other                                                                                                                   |       | 2,948                   |       | 1,583                  |       |
|                                                                                                                    |       | 38,533                  |       | 39,082                 |       |
| Total assets                                                                                                            |       | $                       | 142,873    |                   | $          | 157,401 |   |

 

The accompanying notes are an integral part of these financial statements.

 

3

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| ** **                                                                                                                                                                                      | ** ** | **September 24,  2004** | ** ** | **December 26,  2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                      | ** ** | **(unaudited)**         | ** ** | ** **             | ** ** |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                   | ** ** | ** **              | ** ** | ** **             | ** ** |
| Current liabilities:                                                                                                                                                                            | ** ** | ** **              | ** ** | ** **             | ** ** |
| Accounts payable                                                                                                                                                                                |       | $                       | 3,116      |                   | $          | 1,806 |   |
| Accrued liabilities                                                                                                                                                                             |       | 12,088                  |       | 11,544                 |       |
| Accrued payroll and related taxes                                                                                                                                                               |       | 5,501                   |       | 5,778                  |       |
| Accrued restructuring                                                                                                                                                                           |       | 1,861                   |       | 4,613                  |       |
| Accrued vacation                                                                                                                                                                                |       | 7,025                   |       | 7,033                  |       |
| Accrued incentive compensation                                                                                                                                                                  |       | 2,100                   |       | 1,958                  |       |
| Customer advances                                                                                                                                                                               |       | 7,129                   |       | 9,775                  |       |
| Total current liabilities                                                                                                                                                                       |       | 38,820                  |       | 42,507                 |       |
| Non-current liabilities:                                                                                                                                                                        |       |                    |       |                   |       |
| Accrued restructuring                                                                                                                                                                           |       | 3,626                   |       | 4,686                  |       |
| Supplemental executive retirement plan                                                                                                                                                          |       | 8,167                   |       | 7,741                  |       |
| Minority interest                                                                                                                                                                               |       | —                  |       | 657                    |       |
| Total non-current liabilities                                                                                                                                                                   |       | 11,793                  |       | 13,084                 |       |
| Commitments and contingencies                                                                                                                                                                   |       | —                  |       | —                 |       |
| Stockholders’ equity:                                                                                                                                                                      |       |                    |       |                   |       |
| Preferred Stock, $.001 par value; 9,500,000  shares authorized, no shares issued and outstanding                                                                                                |       | —                  |       | —                 |       |
| Series A Junior Participating Preferred  Stock, $.001 par value; 500,000 shares authorized, no shares issued and  outstanding                                                                   |       | —                  |       | —                 |       |
| Common Stock, $.001 par value; 50,000,000  shares authorized, 24,777,072 shares issued and outstanding at September 24,  2004 and 25,902,574 shares issued and outstanding at December 26, 2003 |       | 25                      |       | 26                     |       |
| Additional paid-in capital                                                                                                                                                                      |       | 90,289                  |       | 101,706                |       |
| Retained earnings                                                                                                                                                                               |       | 2,562                   |       | 900                    |       |
| Deferred compensation-stock incentive  agreements                                                                                                                                               |       | (187                    | )          | (323                   | )          |
| Notes receivable-stockholders                                                                                                                                                                   |       | (373                    | )          | (488                   | )          |
| Accumulated other comprehensive loss                                                                                                                                                            |       | (56                     | )          | (11                    | )          |
| Total stockholders’ equity                                                                                                                                                                 |       | 92,260                  |       | 101,810                |       |
| Total liabilities and stockholders’ equity                                                                                                                                                 |       | $                       | 142,873    |                   | $          | 157,401 |   |
|                                                                                                                                                                                                 |            |                         |            |                        |            |  |  |  |

 

The accompanying notes are an integral part of these financialstatements.

 

4

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**FirstConsulting Group, Inc. and Subsidiaries**

 

### **ConsolidatedStatements of Operations**

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

 
| ** **                                                                                             | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                                             | ** ** | **(unaudited)**         | ** ** | **(unaudited)**         | ** ** |
| ** **                                                                                             | ** ** | **September 24,  2004** | ** ** | **September 26,  2003** | ** ** | **September 24,  2004** | ** ** | **September 26,  2003** | ** ** |
| Revenues before reimbursements                                                                         |       | $                       | 66,008     |                    | $          | 65,849 |   | $ | 200,028 |   | $ | 207,289 |   |
| Reimbursements                                                                                         |       | 4,430                   |       | 4,060                   |       | 12,866 |   | 11,725 |   |
| Total revenues                                                                                         |       | 70,438                  |       | 69,909                  |       | 212,894 |   | 219,014 |   |
|                                                                                                   |       |                    |       |                    |       |   |   |   |   |
| Cost of services before reimbursable  expenses                                                         |       | 44,227                  |       | 46,324                  |       | 134,621 |   | 141,916 |   |
| Reimbursable expenses                                                                                  |       | 4,430                   |       | 4,060                   |       | 12,866 |   | 11,725 |   |
| Total cost of services                                                                                 |       | 48,657                  |       | 50,384                  |       | 147,487 |   | 153,641 |   |
|                                                                                                   |       |                    |       |                    |       |   |   |   |   |
| Gross profit                                                                                           |       | 21,781                  |       | 19,525                  |       | 65,407 |   | 65,373 |   |
|                                                                                                   |       |                    |       |                    |       |   |   |   |   |
| Selling expenses                                                                                       |       | 6,616                   |       | 7,582                   |       | 21,144 |   | 24,234 |   |
| General and administrative expenses                                                                    |       | 13,068                  |       | 14,831                  |       | 38,819 |   | 45,020 |   |
| Restructuring, severance, and impairment  costs                                                        |       | —                  |       | 4,179                   |       | — |   | 8,093 |   |
| Income (loss) from operations                                                                          |       | 2,097                   |       | (7,067                  | )          | 5,444 |   | (11,974 | ) |
| Other income (expense):                                                                                |       |                    |       |                    |       |   |   |   |   |
| Interest income, net                                                                                   |       | 185                     |       | 232                     |       | 529 |   | 760 |   |
| Other income (expense), net                                                                            |       | 18                      |       | (160                    | )          | (113 | ) | (164 | ) |
| Expense for premium on repurchase of stock                                                             |       | —                  |       | —                  |       | (1,561 | ) | — |   |
| Income (loss) before income taxes and  cumulative effect of change in accounting principle, net of tax |       | 2,300                   |       | (6,995                  | )          | 4,299 |   | (11,378 | ) |
| Income tax provision (benefit)                                                                         |       | 1,035                   |       | (2,448                  | )          | 2,637 |   | (3,982 | ) |
| Income (loss) before cumulative effect of  change in accounting principle, net of tax                  |       | 1,265                   |       | (4,547                  | )          | 1,662 |   | (7,396 | ) |
| Cumulative effect of change in accounting  principle,                                                  |       |                    |       |                    |       |   |   |   |   |
| net of tax                                                                                             |       | —                  |       | —                  |       | — |   | (2,597 | ) |
| Net income (loss)                                                                                      |       | $                       | 1,265      |                    | $          | (4,547 | ) | $ | 1,662 |   | $ | (9,993 | ) |
|                                                                                                   |       |                    |       |                    |       |   |   |   |   |
| Basic & diluted net income (loss) per  share:                                                      |       |                    |       |                    |       |   |   |   |   |
| Basic:                                                                                                 |       |                    |       |                    |       |   |   |   |   |
| Income (loss) before cumulative effect of  change in accounting principle, net of tax                  |       | $                       | 0.05       |                    | $          | (0.18 | ) | $ | 0.07 |   | $ | (0.30 | ) |
| Cumulative effect of change in accounting  principle, net of tax                                       |       | —                  |       | —                  |       | — |   | (0.10 | ) |
| Net income (loss) per share                                                                            |       | $                       | 0.05       |                    | $          | (0.18 | ) | $ | 0.07 |   | $ | (0.40 | ) |
| Diluted:                                                                                               |       |                    |       |                    |       |   |   |   |   |
| Income (loss) before cumulative effect of  change in accounting principle, net of tax                  |       | $                       | 0.05       |                    | $          | (0.18 | ) | $ | 0.07 |   | $ | (0.30 | ) |
| Cumulative effect of change in accounting  principle, net of tax                                       |       | —                  |       | —                  |       | — |   | (0.10 | ) |
| Net income (loss) per share                                                                            |       | $                       | 0.05       |                    | $          | (0.18 | ) | $ | 0.07 |   | $ | (0.40 | ) |
| Weighted average shares used in computing:                                                             |       |                    |       |                    |       |   |   |   |   |
| Basic net income (loss) per share                                                                      |       | 24,339                  |       | 24,944                  |       | 24,612 |   | 24,752 |   |
| Diluted net income (loss) per share                                                                    |       | 24,405                  |       | 24,944                  |       | 24,789 |   | 24,752 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

5

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**FirstConsulting Group, Inc. and Subsidiaries**

 

### **ConsolidatedStatements of Cash Flows**

**(inthousands)**

** **
| ** **                                                                                | ** ** | **Nine Months Ended**   | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                | ** ** | **(unaudited)**         | ** ** |
| ** **                                                                                | ** ** | **September 24,  2004** | ** ** | **September 26,  2003** | ** ** |
| Cash flows from operating activities:                                                     |       |                    |       |   |   |
| Net income (loss):                                                                        |       | $                       | 1,662      |   | $ | (9,993 | ) |
| 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                                                             |       | 3,585                   |       | 3,646 |   |
| Intangibles amortization                                                                  |       | 1,281                   |       | 657 |   |
| Premium on capital stock repurchase                                                       |       | 1,561                   |       | — |   |
| Writedown of investment                                                                   |       | 50                      |       | — |   |
| Provision (credit) for bad debts, net of  adjustments                                     |       | 104                     |       | (20 | ) |
| (Gain) loss on sale of assets                                                             |       | 72                      |       | (15 | ) |
| Minority interest in net (income) loss of  subsidiaries                                   |       | (14                     | )          | 88 |   |
| Compensation from stock issuances                                                         |       | 105                     |       | 128 |   |
| Interest income on notes receivable –  stockholders                                  |       | (60                     | )          | (85 | ) |
| Changes in assets and liabilities,  excluding effect of acquisitions:                     |       |                    |       |   |   |
| Accounts receivable                                                                       |       | 3,854                   |       | 14,714 |   |
| Unbilled receivables                                                                      |       | (2,940                  | )          | (6,494 | ) |
| Prepaid expenses and other                                                                |       | (759                    | )          | 239 |   |
| Long-term account receivable                                                              |       | 1,489                   |       | 1,230 |   |
| Other assets                                                                              |       | (1,365                  | )          | (331 | ) |
| Accounts payable                                                                          |       | 1,310                   |       | 1,146 |   |
| Accrued liabilities                                                                       |       | 544                     |       | 1,747 |   |
| Accrued payroll and related taxes                                                         |       | (277                    | )          | 1,693 |   |
| Accrued restructuring                                                                     |       | (3,812                  | )          | 717 |   |
| Accrued vacation                                                                          |       | (8                      | )          | 268 |   |
| Accrued incentive compensation                                                            |       | 142                     |       | (247 | ) |
| Customer advances                                                                         |       | (2,646                  | )          | (1,223 | ) |
| Deferred income taxes                                                                     |       | 2,253                   |       | (5,836 | ) |
| Supplemental executive retirement plan                                                    |       | (41                     | )          | (414 | ) |
| Other                                                                                     |       | (44                     | )          | 335 |   |
| Net cash provided by operating activities:                                                |       | 6,046                   |       | 4,547 |   |
| Cash flows from investing activities:                                                     |       |                    |       |   |   |
| Proceeds from sale/maturity of investments                                                |       | 10,597                  |       | 4,035 |   |
| Purchase of property and equipment                                                        |       | (5,851                  | )          | (4,160 | ) |
| Acquisition of businesses, net of cash  acquired                                          |       | (2,383                  | )          | (11,155 | ) |
| Net cash provided by (used in) investing  activities                                      |       | 2,363                   |       | (11,280 | ) |
| Cash flows from financing activities:                                                     |       |                    |       |   |   |
| Proceeds from issuance of capital stock,  net                                             |       | 1,344                   |       | 1,375 |   |
| Proceeds from notes receivable and tax loan  payments                                     |       | 78                      |       | 533 |   |
| Capital stock repurchase                                                                  |       | (14,773                 | )          | — |   |
| Net cash (used in) provided by financing  activities                                      |       | (13,351                 | )          | 1,908 |   |
| Net change in cash and cash equivalents                                                   |       | (4,942                  | )          | (4,825 | ) |
| Cash and cash equivalents at beginning of  period                                         |       | 26,826                  |       | 27,550 |   |
| Cash and cash equivalents at end of period                                                |       | $                       | 21,884     |   | $ | 22,725 |   |
|                                                                                      |       |                    |       |   |   |
| Cash paid during the period for:                                                          |       |                    |       |   |   |
| Interest                                                                                  |       | $                       | 14         |   | $ | 27 |   |
| Income taxes                                                                              |       | $                       | 778        |   | $ | 311 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

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 September24, 2004 and consolidated statements of operations and condensed consolidatedstatements of cash flows for the periods ended September 24, 2004 and September26, 2003 are unaudited.  These financialstatements reflect all adjustments, consisting of only normal recurringadjustments, which, in the opinion of management, are necessary to fairly presentthe financial position of the Company at September 24, 2004 and the results ofoperations for the three-month and nine-month periods ended September 24, 2004and September 26, 2003.  The results ofoperations and cash flows for the nine-month period ended September 24, 2004are not necessarily indicative of the results to be expected for the yearending December 31, 2004.  For morecomplete financial information, these financial statements should be read inconjunction with the audited financial statements for the year ended December26, 2003 included in the Company’s Annual Report on Form 10-K.  Certain reclassifications have been made tothe 2003 financial statements to conform to the 2004 presentation.

 

*Principles of Consolidation*

 

The consolidated financialstatements include the accounts of the Company and its subsidiaries.  All material intercompany accounts andtransactions 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 pro formadisclosures of net income (loss) and net income (loss) per share as if the fairvalue based method of accounting for stock-based awards had been applied. Underthe fair value based method, compensation cost is recorded based on the valueof the award at the grant date and is recognized over the service period.

 

The following table presentspro forma net income (loss) had compensation costs been determined on the fairvalue at the date of grant for awards under the plan in accordance with SFASNo. 123 (in thousands, except per share data):

 

7

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| ** **                                                                                                            | ** **  | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|-------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                                                            | ** **  | **September 24,  2004** | ** ** | **September 26,  2003** | ** ** | **September  24, 2004** | ** ** | **September 26,  2003** | ** ** |
| ** **                                                                                                            | ** **  | ** **              | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss), as reported                                                                                        |        | $                       | 1,265      |                    | $          | (4,547 | ) | $ | 1,662 |   | $ | (9,993 | ) |
| Deduct:Total stock based employee compensation  expense determined under fair value method for all awards, net of tax |        | (425                    | )          | (274                    | )          | (1,261 | ) | (1,676 | ) |
| Pro forma net income (loss)                                                                                           |        |                    | $          |  840               |       | $ |  (4,821 | ) | $ |  401 |   | $ |  (11,669 | ) |
|                                                                                                                  |        |                    |       |                    |       |   |   |   |   |   |
| Basic income (loss) per share                                                                                         | As reported |                    | $          | 0.05                    |       | $ | (0.18 | ) | $ | 0.07 |   | $ | (0.40 | ) |
|                                                                                                                  | Pro forma   |                    | $          | 0.03                    |       | $ | (0.19 | ) | $ | 0.02 |   | $ | (0.47 | ) |
|                                                                                                                  |        |                    |       |                    |       |   |   |   |   |   |
| Diluted income (loss) per share                                                                                       | As reported |                    | $          | 0.05                    |       | $ | (0.18 | ) | $ | 0.07 |   | $ | (0.40 | ) |
|                                                                                                                  | Pro forma   |                    | $          | 0.03                    |       | $ | (0.19 | ) | $ | 0.02 |   | $ | (0.47 | ) |

 

*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 exercised.  Dilution is computed by applying the treasurystock method. Under this method, options are assumed to be exercised at thebeginning of the period (or at the time of issuance, if later), and as if fundsobtained by the Company from such exercise were used by the Company to purchasecommon stock at the average market price during the period. Stock options arenot considered when computing diluted net loss per share as they are consideredanti-dilutive.

 

The following represents areconciliation of basic and diluted net income (loss) per share for thethree-month and nine-month periods ended September 24, 2004 and September 26,2003 (in thousands, except per share data):

 
| ** **                                                       | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                       | ** ** | **September 24,  2004** | ** ** | **September 26,  2003** | ** ** | **September 24,  2004** | ** ** | **September 26,  2003** | ** ** |
| ** **                                                       | ** ** | ** **              | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income (loss) before cumulative effect, net  of tax              |       | $                       | 1,265      |                    | $          | (4,547 | ) | $ | 1,662 |   | $ | (7,396 | ) |
| Cumulative effect of change in accounting  principle, net of tax |       | —                  |       | —                  |       | — |   | (2,597 | ) |
| Net income (loss)                                                |       | $                       | 1,265      |                    | $          | (4,547 | ) | $ | 1,662 |   | $ | (9,993 | ) |
|                                                             |       |                    |       |                    |       |   |   |   |   |
| Basic weighted average number of shares  outstanding             |       | 24,339                  |       | 24,944                  |       | 24,612 |   | 24,752 |   |
| Effect of dilutive options and contingent  shares                |       | 66                      |       | —                  |       | 177 |   | — |   |
| Diluted weighted average number of shares  outstanding           |       | 24,405                  |       | 24,944                  |       | 24,789 |   | 24,752 |   |
|                                                             |       |                    |       |                    |       |   |   |   |   |
| Basic per share:                                                 |       |                    |       |                    |       |   |   |   |   |
| Income (loss) before cumulative effect, net  of tax              |       | $                       | 0.05       |                    | $          | (0.18 | ) | $ | 0.07 |   | $ | (0.30 | ) |
| Cumulative effect of change in accounting  principle, net of tax |       | —                  |       | —                  |       | — |   | (0.10 | ) |
| Net income (loss) per share                                      |       | $                       | 0.05       |                    | $          | (0.18 | ) | $ | 0.07 |   | $ | (0.40 | ) |
|                                                             |       |                    |       |                    |       |   |   |   |   |
| Diluted per share:                                               |       |                    |       |                    |       |   |   |   |   |
| Income (loss) before cumulative effect, net  of tax              |       | $                       | 0.05       |                    | $          | (0.18 | ) | $ | 0.07 |   | $ | (0.30 | ) |
| Cumulative effect of change in accounting  principle, net of tax |       | —                  |       | —                  |       | — |   | (0.10 | ) |
| Net income (loss) per share                                      |       | $                       | 0.05       |                    | $          | (0.18 | ) | $ | 0.07 |   | $ | (0.40 | ) |

 

8

----

 

For the three months endedSeptember 24, 2004 and September 26, 2003, there were 4,657,173 and 5,056,908anti-dilutive outstanding stock options, respectively, excluded from thecalculation of diluted earnings per share. Additionally, at September 24, 2004, there were 443,496 contingentshares related to the acquisition of the remaining minority interest in FCGInfrastructure Services, Inc. (FCGIS) excluded from the calculation of bothbasic and diluted earnings per share because they were not yet earned.

 

*Use of Estimates*

 

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

 

The Companyuses significant estimates in the calculation of its income tax provision 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 of whichform the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources.  The Company’s actual results may differ fromits estimates.

 

*Cash andCash Equivalents*

 

For purposes of reporting,cash and cash equivalents include cash and interest-earning deposits orsecurities with original maturities of three months or less.

** **

**Note 2                    Investments**

 

At September 24, 2004, theCompany had approximately $25.2 million in short-term investments.  Such investments were held primarily incommercial paper, money market investments, and tax-exempt governmentsecurities.  Net unrealized gains andlosses on investments were immaterial at September 24, 2004.  Additionally, the Company had $1.2 million ofnon-marketable equity investments, valued at the lower of cost or estimatedfair value, which were included in long-term investments.

 

**Note 3                    Long-Term Account Receivable**

 

At September 24, 2004, theCompany carried a long-term account receivable of approximately $4.3 millionfrom a single client.  The receivablerelated to a major outsourcing contract and will be collected over a two yearperiod.

 

9

----

 

**Note 4                    Business Acquisitions**

 

*FCGInfrastructure Services (FCGIS)*

 

On January 30, 2004, the Company purchased the remaining 47.65%minority interest in FCGIS (formerly Codigent Solutions Group, Inc.) from fiveremaining individual stockholders for approximately $2.4 million in cash.  Additionally, the Company deposited 591,328shares of FCG common stock into an escrow account, with one-fourth of suchshares to be released to those same stockholders in four separate incrementsupon successful fulfillment by FCGIS of certain revenue and profitabilitytargets for the six-month periods ended June 25, 2004, December 31, 2004, July1, 2005, and December 30, 2005.  If suchtargets are not fulfilled for any of the six-month periods, the shares inescrow for that period revert to FCG. For the six-month period ended June 25, 2004, FCGIS met the revenue andprofitability targets, and the first 147,832 contingent shares were released tothe former FCGIS stockholders in July 2004.

 

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

 

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

 

**Note 5                    Goodwill and IntangibleAssets**

 

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 the adoptionof SFAS 141, goodwill was amortized over the estimated useful life.

 

Goodwill isevaluated for impairment annually in the fourth quarter of the year, or soonerif an event occurs or circumstances change that may reduce the fair value of areporting unit, to which specific goodwill applies, below its book value. Theimpairment test is conducted at the reporting unit level by comparing the fairvalue of the reporting unit with its carrying value. Fair value is primarilydetermined by using a market approach valuation model based on multiples ofrevenue. If the carrying value exceeds the fair value, 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 intangibleassets with definite lives to determine whether adjustment to these amounts orestimated useful lives is required based on current events and circumstances.

 

10

----

 

The changes in the netcarrying amounts of goodwill for the nine months ended September 24, 2004 areas follows (in thousands):

 
| ** **                       | ** ** | **Life Sciences** | ** ** | **Health  Delivery  Outsourcing** | ** ** | **Meditech  Service  Center** | ** ** | **Other  Businesses** | ** ** | **Total**  | ** ** |
|----------------------------------|------------|-------------------|------------|-----------------------------------|------------|-------------------------------|------------|-----------------------|------------|------------|------------|
| ** **                       | ** ** | ** **        | ** ** | ** **                        | ** ** | ** **                    | ** ** | ** **            | ** ** | ** ** | ** ** |
| Balance as of December 26, 2003  |       | $                 | 1,477      |                              | $          | 2,278                         |       | $                     | 2,001      |       | $          | 9,702 |   | $ | 15,458 |   |
| Acquired                         |       | —            |       | —                            |       | 1,440                         |       | —                |       | 1,440      |       |
| Currency translation adjustment  |       | 4                 |       | —                            |       | —                        |       | —                |       | 4          |       |
| Balance as of March 26, 2004     |       | 1,481             |       | 2,278                             |       | 3,441                         |       | 9,702                 |       | 16,902     |       |
| Acquired                         |       | —            |       | —                            |       | —                        |       | —                |       | —     |       |
| Contingent shares released       |       | —            |       | —                            |       | 899                           |       | —                |       | 899        |       |
| Currency translation adjustment  |       | —            |       | —                            |       | —                        |       | —                |       | —     |       |
| Balance as of June 25, 2004      |       | 1,481             |       | 2,278                             |       | 4,340                         |       | 9,702                 |       | 17,801     |       |
| Acquired                         |       | —            |       | —                            |       | —                        |       | —                |       | —     |       |
| Contingent shares released       |       | —            |       | —                            |       | —                        |       | —                |       | —     |       |
| Currency translation adjustment  |       | (1                | )          | —                            |       | —                        |       | —                |       | (1         | )          |
| Balance as of September 24, 2004 |       | $                 | 1,480      |                              | $          | 2,278                         |       | $                     | 4,340      |       | $          | 9,702 |   | $ | 17,800 |   |

 

Asof September 24, 2004, the Company had the following acquired intangible assetsrecorded (in thousands):

 
| **Intangible Assets**             | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **Amortization  Period in  Years** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|-------------------------------|------------|---------------------------|------------|------------------------------------|------------|
| ** **                        | ** ** | ** **                  | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                         | ** ** |
| Software and software development |       | $                           | 1,177      |                          | $          | (822                      | )          | $                                  | 355        |   | 2 - 3 |   |
| Customer related                  |       | 3,694                       |       | (1,283                        | )          | 2,411                     |       | 2 - 4                              |       |
| Non-compete agreements            |       | 400                         |       | (347                          | )          | 53                        |       | 2 - 3                              |       |
| Total                             |       | $                           | 5,271      |                          | $          | (2,452                    | )          | $                                  | 2,819      |   |   |   |

 

Thefollowing table summarizes the estimated annual amortization expense for theseassets (in thousands):

 

| **Fiscal Year**          | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|
| ** **               | ** ** | ** ** | ** ** |
| 2004 (remainder of year) |       | $          | 441        |   |
| 2005                     |       | 1,150      |       |
| 2006                     |       | 773        |       |
| 2007                     |       | 455        |       |
| Total                    |       | $          | 2,819      |   |
|                          |            |            |            |  |  |

 

11

----

 

**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 infacility costs due to facility downsizing. This restructuring was accounted for in accordance with EITF 94-3 andSAB 100.

 

**Restructuring, severance, andimpairment costs of $11.7 million were incurred in fiscal year 2003.  These costs included severance costs of $6.5million for reduction in staff and $5.2 million for facility downsizing, bothprimarily related to the significant decline in the Company’s Life Sciencesbusiness unit based on the reduction in custom software development servicespurchased by pharmaceutical clients. Restructuring charges in 2003 have been accounted for in accordance withSFAS 146.**

** **

**At September 24, 2004, there was aremaining restructuring liability of $5.5 million, which entirely related tovacated leases and related costs from these restructurings.**

** **

**The restructuring liability as ofSeptember 24, 2004 is summarized as follows (in thousands):**

** **
| ** **                            | ** ** | **Employee  Related Costs** | ** ** | **Facilities/Other  Related Costs** | ** ** | **Total**  | ** ** |
|---------------------------------------|------------|-----------------------------|------------|-------------------------------------|------------|------------|------------|
| ** **                            | ** ** | ** **                  | ** ** | ** **                          | ** ** | ** ** | ** ** |
| Accrued balance at December 26, 2003  |       | $                           | 1,665      |                                | $          | 7,634      |       | $ | 9,299 |   |
| Cash payments                         |       | (1,665                      | )          | (2,147                              | )          | (3,812     | )          |
| Accrued balance at September 24, 2004 |       | $                           | —     |                                | $          | 5,487      |       | $ | 5,487 |   |

 

**Note 7                    Comprehensive Income (Loss)**

 

Comprehensive income (loss),net of taxes, for the three months and nine months ended September 24, 2004 andSeptember 26, 2003 is as follows (in thousands):

 
| ** **                                           | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                           | ** ** | **September 24,  2004** | ** ** | **September 26,  2003** | ** ** | **September 24,  2004** | ** ** | **September 26,  2003** | ** ** |
| ** **                                           | ** ** | ** **              | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss)                                    |       | $                       | 1,265      |                    | $          | (4,547 | ) | $ | 1,662 |   | $ | (9,993 | ) |
| Foreign currency translation adjustment, net  of tax |       | (162                    | )          | (82                     | )          | (53 | ) | 23 |   |
| Unrealized gain (loss) on investments                |       | 7                       |       | 6                       |       | 8 |   | 42 |   |
| Comprehensive income (loss)                          |       | $                       | 1,110      |                    | $          | (4,623 | ) | $ | 1,617 |   | $ | (9,928 | ) |

 

**Note 8                    Cumulative Effect of Changein 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

 

12

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of additional items or meetingother specified performance conditions. The new standard was required to be adopted for all new applicablerevenue arrangements no later than the third quarter of 2003.  Early adoption was permitted and the Companyelected to adopt the new standard as of the beginning of the first quarter of2003.  In addition, the Company electedto apply the new standard to all then existing outsourcing arrangementsimpacted by EITF 00-21 and record to earnings the resulting cumulative effectas a change in accounting principle.  Theadoption of EITF Issue 00-21 resulted in a non-cash charge, net of tax, of $2.6million, or $0.11 per share, in the first quarter of 2003.

 

**Note 9                    Disclosure of SegmentInformation**

 

Commencingwith the first quarter of 2004 and due to a reorganization of the Company thattook effect at the beginning of 2004, the Company 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 smallerbusinesses (Paragon Solutions, Inc., staffing services, call center services,and FirstGatewaysTM), which are not included in any of the above segments andare 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 each segment.  Costs are not transferred across segments.

 

Additionally,the Company created three shared service centers that provide services tomultiple business segments.  These sharedservice centers include FCG India, Integration Services, and Infrastructure Services.   The costs of these services are internallybilled and reported in the individual business segments as cost of services ata standard transfer cost.

 

In accordance with these changes, the Company reclassified some staffamong cost of services, selling expenses and general and administrativeexpenses.  The history shown in thetables below and in the Company’s consolidated statement of operations isconsistent 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 relatedcosts, depreciation, professional development, recruiting, and marketing), aremanaged at the corporate level and allocated to each operating segment based oneither net revenues and/or actual usage.

 

13

----

 

The followingsegment information is for the three months and nine months ended September 24,2004 and September 26, 2003 (in thousands):

 

**For the three months ended September 24, 2004:**

** **
| ** **                                     | ** ** | **Health  Delivery** | ** ** | **Life  Sciences** | ** ** | **Health  Delivery  Outsourcing** | ** ** | **Meditech  Service  Center** | ** ** | **Health  Plan** | ** ** | **Other  Business** | ** ** | **Other**  | ** ** | **Totals** | ** ** |
|------------------------------------------------|------------|----------------------|------------|--------------------|------------|-----------------------------------|------------|-------------------------------|------------|------------------|------------|---------------------|------------|------------|------------|------------|------------|
| ** **                                     | ** ** | ** **           | ** ** | ** **         | ** ** | ** **                        | ** ** | ** **                    | ** ** | ** **       | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues before reimbursements                 |       | $                    | 16,267     |               | $          | 8,812                             |       | $                             | 24,386     |             | $          | 6,368               |       | $          | 3,770      |       | $          | 6,411 |   | $ | (6 | ) | $ | 66,008 |   |
| Reimbursements                                 |       | 2,227                |       | 267                |       | 169                               |       | 414                           |       | 578              |       | 187                 |       | 588        |       | 4,430      |       |
| Total revenues                                 |       | 18,494               |       | 9,079              |       | 24,555                            |       | 6,782                         |       | 4,348            |       | 6,598               |       | 582        |       | 70,438     |       |
| Cost of services before  reimbursable expenses |       | 8,911                |       | 5,077              |       | 20,329                            |       | 4,310                         |       | 2,608            |       | 4,489               |       | (1,497     | )          | 44,227     |       |
| Reimbursable expenses                          |       | 2,227                |       | 267                |       | 169                               |       | 414                           |       | 578              |       | 187                 |       | 588        |       | 4,430      |       |
| Total cost of services                         |       | 11,138               |       | 5,344              |       | 20,498                            |       | 4,724                         |       | 3,186            |       | 4,676               |       | (909       | )          | 48,657     |       |
| Gross profit                                   |       | 7,356                |       | 3,735              |       | 4,057                             |       | 2,058                         |       | 1,162            |       | 1,922               |       | 1,491      |       | 21,781     |       |
| Selling expenses                               |       | 2,398                |       | 2,015              |       | 469                               |       | 165                           |       | 673              |       | 788                 |       | 108        |       | 6,616      |       |
| General & administrative  expenses         |       | 2,818                |       | 3,084              |       | 2,399                             |       | 814                           |       | 727              |       | 1,579               |       | 1,647      |       | 13,068     |       |
| Income (loss) from operations                  |       | $                    | 2,140      |               | $          | (1,364                            | )          | $                             | 1,189      |             | $          | 1,079               |       | $          | (238       | )          | $          | (445 | ) | $ | (264 | ) | $ | 2,097 |   |

 

**For the three months ended September 26, 2003:**

 
| ** **                                      | ** ** | **Health  Delivery** | ** ** | **Life  Sciences** | ** ** | **Health   Delivery  Outsourcing** | ** ** | **Meditech  Service  Center** | ** ** | **Health  Plan** | ** ** | **Other  Business** | ** ** | **Other**  | ** ** | **Totals** | ** ** |
|-------------------------------------------------|------------|----------------------|------------|--------------------|------------|------------------------------------|------------|-------------------------------|------------|------------------|------------|---------------------|------------|------------|------------|------------|------------|
| ** **                                      | ** ** | ** **           | ** ** | ** **         | ** ** | ** **                         | ** ** | ** **                    | ** ** | ** **       | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues before reimbursements                  |       | $                    | 16,157     |               | $          | 8,760                              |       | $                             | 23,206     |             | $          | 4,722               |       | $          | 6,208      |       | $          | 6,730 |   | $ | 66 |   | $ | 65,849 |   |
| Reimbursements                                  |       | 2,385                |       | 259                |       | 63                                 |       | 381                           |       | 810              |       | 146                 |       | 16         |       | 4,060      |       |
| Total revenues                                  |       | 18,542               |       | 9,019              |       | 23,269                             |       | 5,103                         |       | 7,018            |       | 6,876               |       | 82         |       | 69,909     |       |
| Cost of services before  reimbursable expenses  |       | 9,340                |       | 6,375              |       | 19,935                             |       | 3,114                         |       | 3,498            |       | 4,537               |       | (475       | )          | 46,324     |       |
| Reimbursable expenses                           |       | 2,385                |       | 259                |       | 63                                 |       | 381                           |       | 810              |       | 146                 |       | 16         |       | 4,060      |       |
| Total cost of services                          |       | 11,725               |       | 6,634              |       | 19,998                             |       | 3,495                         |       | 4,308            |       | 4,683               |       | (459       | )          | 50,384     |       |
| Gross profit                                    |       | 6,817                |       | 2,385              |       | 3,271                              |       | 1,608                         |       | 2,710            |       | 2,193               |       | 541        |       | 19,525     |       |
| Selling expenses                                |       | 2,513                |       | 2,322              |       | 419                                |       | 452                           |       | 1,166            |       | 678                 |       | 32         |       | 7,582      |       |
| General & administrative  expenses          |       | 2,975                |       | 3,925              |       | 2,492                              |       | 1,265                         |       | 894              |       | 1,959               |       | 1,321      |       | 14,831     |       |
| Restructuring, severance, and  impairment costs |       | 280                  |       | 2,302              |       | 415                                |       | 6                             |       | 204              |       | 132                 |       | 840        |       | 4,179      |       |
| Income (loss) from operations                   |       | $                    | 1,049      |               | $          | (6,164                             | )          | $                             | (55        | )                | $          | (115                | )          | $          | 446        |       | $          | (576 | ) | $ | (1,652 | ) | $ | (7,067 | ) |

 

14

----

 

 

**For the nine months ended September 24, 2004:**

** **
| ** **                                     | ** ** | **Health  Delivery** | ** ** | **Life  Sciences** | ** ** | **Health  Delivery  Outsourcing** | ** ** | **Meditech  Service  Center** | ** ** | **Health****Plan** | ** ** | **Other  Business** | ** ** | **Other**  | ** ** | **Totals** | ** ** |
|------------------------------------------------|------------|----------------------|------------|--------------------|------------|-----------------------------------|------------|-------------------------------|------------|--------------------|------------|---------------------|------------|------------|------------|------------|------------|
| ** **                                     | ** ** | ** **           | ** ** | ** **         | ** ** | ** **                        | ** ** | ** **                    | ** ** | ** **         | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues before reimbursements                 |       | $                    | 48,300     |               | $          | 26,909                            |       | $                             | 74,935     |               | $          | 18,012              |       | $          | 11,660     |       | $          | 20,200 |   | $ | 12 |   | $ | 200,028 |   |
| Reimbursements                                 |       | 6,431                |       | 753                |       | 411                               |       | 1,241                         |       | 1,850              |       | 562                 |       | 1,618      |       | 12,866     |       |
| Total revenues                                 |       | 54,731               |       | 27,662             |       | 75,346                            |       | 19,253                        |       | 13,510             |       | 20,762              |       | 1,630      |       | 212,894    |       |
| Cost of services before  reimbursable expenses |       | 25,995               |       | 15,467             |       | 62,127                            |       | 12,180                        |       | 7,705              |       | 14,064              |       | (2,917     | )          | 134,621    |       |
| Reimbursable expenses                          |       | 6,431                |       | 753                |       | 411                               |       | 1,241                         |       | 1,850              |       | 562                 |       | 1,618      |       | 12,866     |       |
| Total cost of services                         |       | 32,426               |       | 16,220             |       | 62,538                            |       | 13,421                        |       | 9,555              |       | 14,626              |       | (1,299     | )          | 147,487    |       |
| Gross profit                                   |       | 22,305               |       | 11,442             |       | 12,808                            |       | 5,832                         |       | 3,955              |       | 6,136               |       | 2,929      |       | 65,407     |       |
| Selling expenses                               |       | 7,288                |       | 7,030              |       | 1,645                             |       | 627                           |       | 2,406              |       | 2,000               |       | 148        |       | 21,144     |       |
| General & administrative  expenses         |       | 7,907                |       | 9,008              |       | 7,158                             |       | 2,415                         |       | 2,015              |       | 4,738               |       | 5,578      |       | 38,819     |       |
| Income (loss) from operations                  |       | $                    | 7,110      |               | $          | (4,596                            | )          | $                             | 4,005      |               | $          | 2,790               |       | $          | (466       | )          | $          | (602 | ) | $ | (2,797 | ) | $ | 5,444 |   |

 

**For the nine months ended September 26, 2003:**
| ** **                                      | ** ** | **Health  Delivery** | ** ** | **Life  Sciences** | ** ** | **Health  Delivery  Outsourcing** | ** ** | **Meditech  Service  Center** | ** ** | **Health****Plan** | ** ** | **Other  Business** | ** ** | **Other**  | ** ** | **Totals** | ** ** |
|-------------------------------------------------|------------|----------------------|------------|--------------------|------------|-----------------------------------|------------|-------------------------------|------------|--------------------|------------|---------------------|------------|------------|------------|------------|------------|
| ** **                                      | ** ** | ** **           | ** ** | ** **         | ** ** | ** **                        | ** ** | ** **                    | ** ** | ** **         | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues before reimbursements                  |       | $                    | 49,361     |               | $          | 35,575                            |       | $                             | 70,254     |               | $          | 13,720              |       | $          | 19,652     |       | $          | 18,476 |   | $ | 251 |   | $ | 207,289 |   |
| Reimbursements                                  |       | 6,730                |       | 952                |       | 209                               |       | 1,071                         |       | 2,252              |       | 466                 |       | 45         |       | 11,725     |       |
| Total revenues                                  |       | 56,091               |       | 36,527             |       | 70,463                            |       | 14,791                        |       | 21,904             |       | 18,942              |       | 296        |       | 219,014    |       |
| Cost of services before  reimbursable expenses  |       | 28,473               |       | 21,793             |       | 61,345                            |       | 8,524                         |       | 10,202             |       | 12,817              |       | (1,238     | )          | 141,916    |       |
| Reimbursable expenses                           |       | 6,730                |       | 952                |       | 209                               |       | 1,071                         |       | 2,252              |       | 466                 |       | 45         |       | 11,725     |       |
| Total cost of services                          |       | 35,203               |       | 22,745             |       | 61,554                            |       | 9,595                         |       | 12,454             |       | 13,283              |       | (1,193     | )          | 153,641    |       |
| Gross profit                                    |       | 20,888               |       | 13,782             |       | 8,909                             |       | 5,196                         |       | 9,450              |       | 5,659               |       | 1,489      |       | 65,373     |       |
| Selling expenses                                |       | 8,486                |       | 6,900              |       | 1,656                             |       | 1,225                         |       | 3,868              |       | 2,016               |       | 83         |       | 24,234     |       |
| General & administrative  expenses          |       | 9,119                |       | 12,924             |       | 7,776                             |       | 3,302                         |       | 2,803              |       | 5,059               |       | 4,037      |       | 45,020     |       |
| Restructuring, severance, and  impairment costs |       | 259                  |       | 6,433              |       | 415                               |       | 6                             |       | 194                |       | 128                 |       | 658        |       | 8,093      |       |
| Income (loss) from operations                   |       | $                    | 3,024      |               | $          | (12,475                           | )          | $                             | (938       | )                  | $          | 663                 |       | $          | 2,585      |       | $          | (1,544 | ) | $ | (3,289 | ) | $ | (11,974 | ) |

 

The“other” column includes reclassifications related to the charging out of theshared service centers described above, with the net loss in that columnprimarily consisting of under absorption of shared service center or supportcosts into the segments.

 

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*Detail ofHealth 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**  | ** ** | **Nine Months Ended**   | ** ** |
|--------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | **September 24,  2004** | ** ** | **September 26,  2003** | ** ** | **September 24,  2004** | ** ** | **September 26,  2003** | ** ** |
| Internally generated revenues  |       | $                       | 18,542     |                    | $          | 17,661 |   | $ | 58,840 |   | $ | 54,033 |   |
| Subcontractor revenues         |       | 5,844                   |       | 5,545                   |       | 16,095 |   | 16,221 |   |
| Revenues before reimbursements |       | $                       | 24,386     |                    | $          | 23,206 |   | $ | 74,935 |   | $ | 70,254 |   |

 

**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 September 24, 2004.

 

**Note 11                  CapitalStock Repurchase**

 

On February 27, 2004, FCG repurchased all outstandingshares of the Company held by David S. Lipson, one of FCG’s directors and theformer CEO 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. Lipsonresigned from the Company’s Board of Directors.

 

The purchaseby FCG of Mr. Lipson’s ownership interest included 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 were allocable to any of the restrictivecovenants agreed to by Mr. Lipson in the repurchase agreement.

 

Other materialterms of the transaction were as follows:

 

•          The purchase price wascomprised of cash, a portion of which Mr. Lipson used to repay in full indebtednessowed by Mr. Lipson to FCG of approximately $0.3 million.

•          In the event FCGannounces or consummates a change in control transaction prior to February 27,2005, or if the Company enters into negotiations regarding a change in controltransaction prior to February 27, 2005 and subsequently announces 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 remain outstanding and may only be exercised on orbefore the first anniversary of this repurchase transaction.  Upon receipt of Mr. Lipson’s

 

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notice of exercise, FCG will repurchase such options and pay to Mr. Lipsonthe difference between the exercise price and the then fair market value of theshares issuable.

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

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

•          FCG and Mr. Lipsonexecuted a mutual release of claims.

 

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**Item 2.  Management’s Discussionand Analysis of Financial 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 RISKSAND UNCERTAINTIES, INCLUDING THOSE SET FORTH HEREIN UNDER THE CAPTION “RISKSRELATING TO OUR BUSINESS,” AND OTHER REPORTS WE FILE WITH THE SECURITIES ANDEXCHANGE COMMISSION.  OUR ACTUAL RESULTSCOULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKINGSTATEMENTS.  EXCEPT AS REQUIRED BYAPPLICABLE LAW, WE DO NOT HAVE ANY INTENTION OR OBLIGATION TO UPDATE PUBLICYANY FORWARD LOOKING STATEMENTS AFTER THE DISTRIBUTION OF THIS REPORT, WHETHERAS A RESULT OF NEW INFORMATION, FUTURE EVENTS, CHANGES IN ASSUMPTIONS OROTHERWISE.

 

**Overview**

 

We 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, inour consulting and systems integration businesses (“CSI”), fees are determinedby multiplying the amount of time expended on each assignment by the projecthourly rate for the associate(s) assigned to the engagement.  Fixed fees, including outsourcing fees, areestablished on a per-assignment or monthly basis and are based on severalfactors such as the size, scope, complexity and duration of an assignment, thenumber of our employees required to complete the assignment, and the volume oftransactions or interactions.  Revenuesare generally recognized related to the level of services performed, the amountof cost incurred on the assignment versus the estimated total cost to completethe assignment, 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 have grown from greater than 1% of our net revenues in fiscal year2003 to almost 3% of our net revenues in the first nine months of fiscal year2004, and we expect our software licensing revenues to continue to grow. 

 

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 revenues before reimbursements (“net revenues”).  For purposes of analysis, all percentages inthis discussion are stated as a percentage of net revenues, since we believethat this is the more relevant measure 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

 

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and business unit governancemeetings, recruiting fees, professional development and training, and legal andother professional services.  Asassociate related costs are relatively fixed in the short term, variations inour revenues and operating results in our CSI business can occur as a result ofvariations in billing margins and utilization rates of our billable associates.

 

Our mostsignificant expenses are our human resource and related salary and benefitexpenses.  As of September 24, 2004,approximately 1,279 of our 2,409 employees (associates) are billableassociates.  Another 782 employees arepart of our outsourcing business.  Thesalaries and benefits of such billable associates and outsourcing relatedemployees are recognized in our cost of services.  Most non-billable employee salaries andbenefits are recognized as a component of either selling or general andadministrative expenses.  Approximately14.4% of our workforce, or 348 employees, are classified as non-billable.  Our cost of services as a percentage ofrevenues is directly related to several factors, including, but not limited to:

 

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

•         The amountand timing of costs incurred;

•         Our abilityto control costs on our outsourcing projects; 

•         The billedrate on time and material contracts; and 

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

 

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 includes timedevoted to other necessary and productive activities such as sales support andinterviewing 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 unassigned time,we actively manage personnel utilization by monitoring and projecting estimatedengagement start and completion dates and matching associate availability withcurrent and projected client requirements. The number of associates staffed on an assignment will vary according tothe size, complexity, duration, and demands of the assignment.  Assignment terminations, completions,inclement weather, and scheduling delays may result in periods in whichassociates are not optimally utilized. An unanticipated termination of a significant assignment or an overalllengthening of the sales cycle could result in a higher than expected number ofunassigned associates and could cause us to experience lower margins.  In addition, entry into new market areas andthe hiring of associates in advance of client assignments have resulted and maycontinue to result in periods of lower associate utilization.  

 

In response 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.  Wehave also begun to incorporate more variable cost or per diem staff in some ofour projects.  We expect these strategiesto result in improved cost of services through a combination of lower costattributable to offshore resources and higher leverage of resources thatperform services offsite or on a variable cost basis.  To the extent we pass through reduced coststo our clients related to offshore resources, the global sourcing strategy mayresult in lower revenues on a per engagement basis. However, we expect tooffset this potential revenue impact with improved competitive positioning inour markets.  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

 

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from foreign employees,variable staff employees or subcontractors, our business may be adversely impactedand we may not be able to compete effectively.

** **

**Results of Operations for theThree Months Ended September 24, 2004 and September 26, 2003**

 

*Revenues. *Our net revenues increased to $66.0 million for the quarter endedSeptember 24, 2004, an increase of 0.2% from $65.8 million for the quarterended September 26, 2003.  Our totalrevenues increased to $70.4 million for the quarter ended September 24, 2004,an increase of 0.8% from $69.9 million for the quarter ended September 26,2003.  The minor net increases were theresult of increases in our Meditech and Health Delivery Outsourcing businesses,offset by a decrease in Health Plan.  TheMeditech segment had the most significant net revenue increase ($1.6 million or34.9%) due to the award of a new Meditech outsourcing engagement and othergeneral increases in demand for Meditech services.   Additionally, the Health DeliveryOutsourcing segment net revenues increased $1.2 million or 5.1% from additionalwork on existing projects.  The HealthPlan segment net revenues decreased $2.4 million or 39.3% due to the completionof several significant projects during late 2003 and early 2004, without havingnew projects to replace them.  Overallbusiness trends are expected to be similar in the fourth quarter of fiscal year2004 compared to the third quarter. Since December 31, 2004 occurs on a Friday, thus adding a 53rdweek to the fiscal year and a 14th week to the fiscal fourth quarter,our revenues and costs for the fourth quarter are expected to be higher thanrecent history and trends would otherwise indicate, although much less than afull one-thirteenth higher, since the extra week encompasses much of the slowholiday period.  

 

*Cost of Services. *Cost of services before reimbursable expenses decreased to $44.2million for the quarter ended September 24, 2004, a decrease of 4.5% from $46.3million for the quarter ended September 26, 2003.  The most significant reason for the decreasewas a reduction in headcount in Life Sciences, exclusive of some offshoreassociates transferred in Life Sciences in the third quarter of 2004.  Additionally, headcount decreased in HealthPlan, related to the decline in revenues in that segment.  Because of the additional week in our fiscalfourth quarter of fiscal 2004 (see “Revenues” above), there will be an unusualincrease in cost of service in that quarter proportional to the extra revenuewe receive.

* *

*GrossProfit. *Grossprofit increased to $21.8 million for the quarter ended September 24, 2004, anincrease of 11.6% from $19.5 million for the quarter ended September 26,2003.  The increase was primarily due toincreased gross profit in Life Sciences which was attributable to the cost ofservices decrease noted above. Additionally, Health Delivery Outsourcing gross profit increased due toongoing cost efficiencies that were achieved on certain contracts, and Meditechgross margin increased in line with the revenue increase in that segment.  These increases were partially offset by a $1.5million decline in Health Plan margin due to the major decline in revenues inthat segment.  Gross profit as apercentage of net revenues increased to 33.0% for the quarter ended September24, 2004 from 29.7% for the quarter ended September 26, 2003 due to increasedmargin percentage in all segments other than Health Plan, Meditech, and OtherBusiness.  Given the current revenue mix,our gross profit percentage is not expected to change significantly in the nearfuture; however, a sudden downturn in demand in one or more of our segments oran inability to control costs on our fixed price projects could negativelyaffect our margin percentage.

 

*Selling Expenses. *Selling expenses decreased to $6.6 million for the quarter endedSeptember 24, 2004, a decrease of 12.7% from $7.6 million for the quarter endedSeptember 26, 2003.  This decrease isprimarily due to a reduction in our sales force.  Selling expenses as a percentage of netrevenues decreased to 10.0% for the quarter ended September 24, 2004 from 11.5%for the quarter ended September 26, 2003.

 

*General and AdministrativeExpenses. *General and administrative expenses decreasedto $13.1 million for the quarter ended September 24, 2004, a decrease of 11.9%from $14.8 million for the quarter

 

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ended September 26, 2003.  The decrease resulted from cost reductions inlate 2003, including the consolidation of the administrative operations ofseveral of our acquired companies. General and administrative expenses as a percentage of net revenuesdecreased to 19.8% for the quarter ended September 24, 2004 from 22.5% for thequarter ended September 26, 2003.  Weexpect to hold general and administrative expenses, measured in absolutedollars, at their current level in the near future.

 

*Restructuring, Severance, and ImpairmentCosts. *Restructuring,severance, and impairment costs were zero for the three months ended September24, 2004 compared to $4.2 million for the three months ended September 26,2003.  Restructuring, severance, andimpairment costs for the three months ended September 26, 2003 includedapproximately $3.6 million of severance costs related to staff reductions and$0.6 million for facility downsizing and fixed asset write-downs.  

 

*Interest Income, Net. *Interest income, net of interest expense, remained at approximately thesame $0.2 million level for the quarter ended September 24, 2004 as compared tothe quarter ended September 26, 2003. Interest income net of interest expense as a percentage of net revenuesdecreased to 0.3% for the quarter ended September 24, 2004 from 0.4% for thequarter ended September 26, 2003.

 

*Other Income (Expense),Net*.  Other income (expense) was negligible for thequarter ended September 24, 2004 compared to other income (expense) of $0.2million for the quarter ended September 26, 2003.  

 

*Income Taxes. *The provision for income taxes for the quarter ended September 24, 2004was $1.0 million.  The provision was 45%for the quarter ended September 24, 2004, compared to a tax benefit rate of 35%for the quarter ended September 26, 2003. The higher absolute rate in 2004 is due to income taxes we pay incertain states which do not allow for the use of our net operating losscarryforwards to offset income of certain of our subsidiaries, and to thenondeductibility of certain of our expenses.

 

**Results of Operations for the Nine Months Ended September 24, 2004 andSeptember 26, 2003**

 

*Revenues. *Our net revenues decreased to $200.0 million for the nine months endedSeptember 24, 2004, a decrease of 3.5% from $207.3 million for the nine monthsended September 26, 2003.  Our totalrevenues decreased to $212.9 million for the nine months ended September 24,2004, a decrease of 2.8% from $219.0 million for the nine months endedSeptember 26, 2003.  The decreases wereprimarily due to declines in our Life Sciences and Health Plan businesses,partly offset by increases in Health Delivery Outsourcing and the MeditechService Center.   The Life Sciencessegment had the most significant net revenue decline ($8.7 million or 24.4%),due to the general decline in the custom software business for pharmaceuticalclients, and also due to the completion of a major engagement midway through2003.  The Health Plan segment declinedby $8.0 million, or 40.7%, due to the completion of several significantprojects during 2003 and early 2004, without having new projects to replacethem.  Health Delivery Outsourcing netrevenues increased by $4.7 million, or 6.7%, due to additional work on existingprojects.  The Meditech Service Centernet revenues increased by $4.3 million, or 31.3%, due to the award of a newMeditech outsourcing engagement and other general increases in demand forMeditech services.  

 

*Cost of Services. *Cost of services before reimbursable expenses decreased to $134.6million for the nine months ended September 24, 2004, a decrease of 5.1% from$141.9 million for the nine months ended September 26, 2003.  The decrease was primarily due to costreductions, primarily reductions in headcount, made in response to the revenuedeclines noted above.  We reduced cost ofservices by $6.3 million in Life Sciences and by $2.5 million in Health Plan.We also reduced cost of services in Health Delivery, despite only a smallerdecline in revenues, as we gained efficiencies and improved utilization

 

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percentages in that segment.  These decreases in cost of services werepartially offset by increased costs in the Meditech Service Center related tothe increase in work in that segment.

* *

*GrossProfit. *Grossprofit remained the same for the nine months ended September 24, 2004 and forthe nine months ended September 26, 2003 at $65.4 million.  Gross profit as a percentage of net revenuesincreased to 32.7% for the nine months ended September 24, 2004 from 31.5% forthe nine months ended September 26, 2003. This increase was due to the increased margin percentage in most of oursegments other than Health Plan and Life Sciences, where the significantdeclines in revenues led to decreases in gross margin.  Given the current revenues mix, our grossprofit percentage is not expected to change significantly in the near future;however, a sudden downturn in demand in one or more of our segments or aninability to control costs on our fixed price projects could negatively affectour margin percentage.

 

*Selling Expenses. *Selling expenses decreased to $21.1 million for the nine months endedSeptember 24, 2004, a decrease of 12.8% from $24.2 million for the nine monthsended September 26, 2003.  This decreasewas primarily due to a reduction in our sales force.  Selling expenses as a percentage of netrevenues decreased to 10.6% for the nine months ended September 24, 2004 from11.7% for the nine months ended September 26, 2003.

 

*General and AdministrativeExpenses. *General and administrative expenses decreasedto $38.8 million for the nine months ended September 24, 2004, a decrease of13.8% from $45.0 million for the nine months ended September 26, 2003.  The decrease resulted from cost reductions inthe latter part of 2003, including the consolidation of the administrativeoperations of several of our acquired companies.  General and administrative expenses as apercentage of net revenues decreased to 19.4% for the nine months endedSeptember 24, 2004 from 21.7% for the nine months ended September 26, 2003.  We expect to hold these expenses at theircurrent level in the near future.

 

*Restructuring, Severance, and ImpairmentCosts. *Restructuring,severance, and impairment costs were zero for the nine months ended September24, 2004 compared to $8.1 million for the nine months ended September 26,2003.  Restructuring, severance andimpairment costs for the nine months ended September 26, 2003 includedapproximately $4.3 million of severance costs related to staff reductions andapproximately $3.8 million for facility downsizing and fixed asset write-downs.  

 

*Interest Income, Net. *Interest income, net of interest expense decreased to $0.5 million forthe nine months ended September 24, 2004, a decrease of 30.4% from $0.8 millionfor the nine months ended September 26, 2003. This decrease was due to lower interest rates on our cash and marketablesecurities investments, and to reduced invested cash levels resulting from therepurchase of approximately $15.1 million of our stock from a major stockholderin February 2004.  Interest income net ofinterest expense as a percentage of net revenues decreased to 0.3% for the ninemonths ended September 24, 2004 from 0.4% for the nine months ended September26, 2003.

 

*Other Income (Expense),Net*.  Other expense decreased to $0.1 million forthe nine months ended September 24, 2004 from $0.2 million for the nine monthsended September 26, 2003.  

 

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

 

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*Income Taxes. *The provision for income taxes for the nine months ended September 24,2004 was $2.6 million.  The provision was61.3% for the nine months ended September 24, 2004.  Excluding the nondeductible premium onrepurchase of stock described above, the provision was 45% for the nine monthsended September 24, 2004, compared to a tax benefit rate of 35% for the ninemonths ended September 26, 2003.  Thehigher absolute rate in 2004 is due to income taxes we pay in certain stateswhich do not allow the use of our net operating loss carryforwards to offsetincome of certain of our subsidiaries, and to the nondeductibility of certainof our expenses.

 

*CumulativeEffect of Change in Accounting 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 required tobe adopted for all new applicable revenue arrangements no later than the thirdquarter of 2003.  Early adoption waspermitted and we elected to adopt the new standard as of the beginning of thefirst quarter of 2003.  In addition, weelected 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 nine months endedSeptember 24, 2004, we generated cash flow from operations of $6.0million.  During the nine months endedSeptember 24, 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$5.9 million of cash to purchase property and equipment, primarily computer andrelated equipment.  At September 24,2004, we had cash and investments available for sale of $47.1 million comparedto $62.6 million at December 26, 2003.

 

On February 27, 2004, we repurchased all outstanding FCGshares and certain FCG options held by a major stockholder (see Note 11 ofNotes to Consolidated Financial Statements). The aggregate purchase price for such 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.  In addition,in the event we were to announce or consummate a change in control transactionprior to the first anniversary of this transaction, or if we were to enter intonegotiations regarding a change in control transaction prior to the firstanniversary and subsequently announce publicly a definitive agreement for orconsummate a change in control transaction within the 18 months following theclosing 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 $4.1 million ifour 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 loansunder this agreement until early 2005, if at all.  Since our loans are unsecured, we cannotguarantee that the hospital will repay our loans on a timely basis, if atall.  If our loans are not repaid orrepaid in a timely manner, our financial condition would be impactednegatively.

 

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 September 24, 2004.

 

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

 

Our cash maydecline slightly during the fourth quarter where it otherwise might not have,since the extra week added to the quarter due to our fiscal calendar (see “Revenues”above) will generate an additional full semi-monthly payroll payment which willbe paid on the last day of the fiscal year. Payroll is our largest cash expense in the firm.  

 

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

 

| ** **                         | ** ** | **Payments Due by Period** | ** ** |
|------------------------------------|------------|----------------------------|------------|
| **Contractual Obligations**        | ** ** | **Less than 1  Year**      | ** ** | **1 -3  Years** | ** ** | **3-5  Years** | ** ** | **More than  5 Years** | ** ** | **Total** | ** ** |
|                               |       |                       |       |   |   |   |   |   |   |   |   |
| Operating leases, net of subleases |       | $                          | 5,459      |   | $ | 9,596 |   | $ | 3,472 |   | $ | — |   | $ | 18,527 |   |
| Purchase obligations               |       | 310                        |       | 154 |   | — |   | — |   | 464 |   |
| Total                              |       | $                          | 5,769      |   | $ | 9,750 |   | $ | 3,472 |   | $ | — |   | $ | 18,991 |   |

** **

**CriticalAccounting 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 United Statesof America.  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 ourestimates, including those related to revenue recognition, cost to completeclient engagements, valuation of goodwill and long-lived and intangible assets,accrued liabilities, income taxes, restructuring costs, idle facilities,litigation and disputes, and the allowance for doubtful accounts.  We base our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying value of assets and liabilities that are notreadily apparent from other sources.  Ouractual results may differ from our estimates and we do not assume anyobligation 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 Recognition and 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.  The longer-termarrangements are generally level-of-effort or fixed price arrangements.  

 

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

 

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 include incentivesfor achieving either schedule targets, cost targets, or other definedgoals.  Revenues from incentive typearrangements are recognized when it is probable they will be earned. 

 

We evaluateour non-outsourcing fixed price contracts on an ongoing basis by estimating thecost to complete the assignment.  We thenrecognize revenues to achieve a constant margin over the remaining term of theengagement.  We changed our accountingfor outsourcing contracts with the adoption of EITF 00-21, “Accounting forRevenue Arrangements with Multiple Deliverables,” in the first quarter of2003.  Under our outsourcing contracts, asignificant portion of our revenues are fixed and allocated over the contracton a straight-line basis, as we are required to provide a specified level ofservices subject to certain performance measurements.  Also, certain revenues may fluctuate underthe contracts based on the volume of transactions we process or othermeasurements of service provided.  If weincur higher costs to provide the required services or receive less revenue dueto reduced transaction volumes or penalties associated with service levelfailures, our gross profit can be negatively impacted.

 

On 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 such costsare incurred and realization of those costs is either paid for upfront orguaranteed by the contract, those costs are deferred and later expensed overthe period of recognition of the related revenue.  At September 24, 2004, we had deferred $1.4million 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 comprised less than 3% of our revenues in the first ninemonths 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

 

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Position (“SOP”) 97-2, “SoftwareRevenue Recognition”, as amended by SOP 98-4, “Deferral of the Effective Dateof a Provision of SOP 97-2, Software Revenue Recognition” and SOP 98-9, “Modificationof SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions”,and in accordance with the Securities and Exchange Commission Staff AccountingBulletin (SAB) No. 104, “Revenue Recognition”. We license software undernon-cancelable license agreements and provide related professional services,including consulting, training, and implementation services, as well as ongoingcustomer support and maintenance.  Manyof our more significant software arrangements include implementation servicesthat are essential to the functionality of our software products, and arerecognized using contract accounting including the percentage-of-completionmethodology over the period of 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 deliverables using the fair valueof 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 occur when revenues recognized exceed billings in accordance with thecontractual terms.  Such unbillableamounts most often become billable upon reaching certain project milestonesstipulated per contract, or in accordance with the percentage of completionmethod.  As of September 24, 2004, we hadunbillable revenues included in current unbilled receivables of approximately$3.8 million, which were generally expected to be billed in the followingquarter.  In addition, we had a long-termaccount receivable at September 24, 2004 and December 26, 2003 of $4.3 millionand $5.8 million, respectively, on a single major outsourcing contract with aterm of seven years.  The long-termreceivable will be billed and collected over the remaining two and a half yearsof the contract through contractual billings that will exceed the amounts to beearned as revenues.

 

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Customeradvances are comprised of payments from customers for which services have notyet been performed or prepayments against work in process. These unearnedrevenues are deferred and recognized as future contract costs are incurred andas 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 have historicallyconsisted primarily of the tax benefit related to restructuring costs forfacility closures, supplemental executive retirement plan contributions, andother accrued liabilities such as accrued vacation pay, which are notdeductible for tax purposes until paid.  Duringfiscal year 2003, we generated additional deferred tax assets for net operatingloss carryforwards which were created by our pretax losses combined with thefact that we are outside the period it is allowable to carry back losses, andalso for additional deferred tax assets related to the cumulative effect of ourchange in revenue recognition method on our outsourcing contracts.  We use significant estimates in determiningwhat portion of our deferred tax asset is more likely than not to be realized.  Based on those estimates and taking intoaccount our recent history of cumulative losses, we recorded a valuationallowance of $5.5 million in the fourth quarter of fiscal year 2003.  Together with a full valuation allowance of$5.5 million we had already taken against the net operating loss carryforwardsof companies we had acquired earlier in the year, at December 26, 2003, we hada valuation allowance of $11.0 million against a total deferred tax asset of$21.1 million.  Based on our belief thatit is more likely than not that future taxable income will be sufficient torealize the remaining $8.4 million of deferred tax assets, we have not recordeda valuation allowance against those assets. However, there is no guarantee that our taxable income will be sufficientto realize such remaining net deferred tax assets, and we will continue toevaluate the potential need for an additional valuation allowance on an ongoingbasis.  Additionally, if the realizationof a greater amount of our deferred tax assets in the future is considered morelikely than not, we will reverse all or a portion of the existing valuationallowance 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 cash flows, whichinvolves significant judgment.  Ouroperating results have been negatively impacted by the worldwide economicconditions.   Accordingly, if ourexpectations 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 September 24, 2004, we have $17.8million of goodwill and $2.8 million of intangible assets recorded on ourbalance sheet (see Note 5 of the Notes to Consolidated Financial Statements).

 

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**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 ourcommon stock could decline and you may lose all or part of your investment.

* *

*Manyfactors may cause our net revenues, operating results and cash flows tofluctuate 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:

 

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

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

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

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

•                  Delaysor increased expenses in securing and completing client engagements;

•                  Timingand collection of fees and payments;

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

•                  Increasedcompetition and pricing pressures;

•                  Useof offsite and offshore resources on our engagements;

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

•                  Theloss of key personnel and other employees;

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

•                  Thetiming of certain general and administrative expenses;

•                  Completingacquisitions and the costs of integrating acquired operations;

•                  Impairmentof goodwill from our acquisitions;  

•                  Variability inthe number of billable days in each quarter;

•                  Thewrite-off of client billings;

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

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

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

•                  Internationalcurrency fluctuations; 

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

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

 

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

 

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revenues or earnings or otherwise cause afailure to meet public market expectations, our business could be adverselyaffected.

 

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.  Since wetypically incur greater costs and expenses during the early phase of theservice elements (which will now have straight-line revenue recognition) thanwe do in the later years of those elements, we believe our net income will beless during the early stages of our outsourcing engagements.  In addition, if we are unable to manage costsas planned in the later stages of an outsourcing engagement, our net incomewill likewise be negatively impacted.  Ingeneral, income from our outsourcing contracts will be less stable in thefuture, since it will be more susceptible to changes in the mix of newer versusolder contracts, and to the impact of cost fluctuations from quarter to quarterwithout 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 a net loss for thefirst quarter of 2004.  As a result, wecannot assure you that we will achieve positive earnings in the future.  If we are unable to achieve profitability ona quarterly or annual basis, the market price of our common stock could beadversely affected and our financial condition would suffer.

* *

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

 

Net revenuesfrom our outsourcing relationships, for the nine months ended September 24,2004, represented approximately 41% of our consolidated net revenues.  The substantial majority of these revenuesare received from four large outsourcing accounts that have signed long-termagreements with us.  However, the loss ofany of our outsourcing relationships could have an adverse impact on ourbusiness and results of operations.  Ineach of these engagements, the clients have fully outsourced their informationtechnology staff and functions to us. In all of our outsourcing relationships, we generally enter intodetailed service level agreements, which establish performance levels andstandards for our services.  If we failto meet these performance levels or standards, our clients may receive monetaryservice level credits from us or, if we experience persistent failures, ourclients may have a right to terminate the outsourcing contract for cause andhave no obligation to pay us any termination fees.  Our anticipated revenues and profitabilityfrom our outsourcing engagements could be significantly reduced if we areunable to satisfy our performance levels or standards, or if we are unable toimprove our delivery costs as planned on such engagements.  Additionally, our outsourcing contracts canbe terminated at the convenience of our clients upon the payment of atermination fee.

 

In addition,many of our outsourcing agreements require that we invest significant amountsof time and 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-uponservice levels or otherwise breach the terms of our outsourcing agreements, theclients may have rights to terminate our agreements for cause and we may beunable to recover our investments.  Anyfailure by us to recover these investments could reduce our outsourcingrevenue, which would have a material adverse effect on our financial condition,results of operations, and price of our common stock.

 

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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 haveanticipated.  

 

*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;

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

•                  Changesin the management or ownership of the client;

•                  Budgetarycycles and constraints;

•                  Changesin the anticipated scope of engagements;

•                  Availabilityof personnel and other resources; and

•                  Consolidationin the healthcare and pharmaceutical industries.

 

Prior 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 andresources could materially adversely affect our business, financial condition,and results of operations.  We may alsobe required to hire new associates before securing a client engagement.  If clients defer committing to 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.  Also, during thefirst

 

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half of 2003, we acquiredParagon Solutions, Inc., Coactive Systems Corporation, and certain assets ofPhyve Corporation. All acquisitions involve risks that could materially andadversely affect our business and operating results.  These risks include: 

 

•                  Distractingmanagement from our business; 

•                  Losingkey personnel and other employees; 

•                  Losingclients; 

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

•                  Theimpairment of acquired assets and goodwill;

•                  Acquiringthe contingent and other liabilities of the businesses we acquire; and

•                  Notrealizing the intended or expected benefits of the acquisitions.

 

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

 

*We may benegatively impacted if our investments in products and emerging service linesare unsuccessful.*

* *

We havepublicly announced our strategy to increase our investment in productdevelopment, including further investment in FirstDocTM as well asinvestment in FirstGatewaysTM. These investments are in addition to continuing our investments in otheremerging service lines and products.  Wetypically do not capitalize the cost of our product development activities anddo not anticipate capitalizing expected investments this year.  As a result, our financial results may beadversely impacted by such increased investment in the short term.  If such product development activities orinvestment in our emerging service lines do not result in relevant offerings,we will not achieve desired levels of return on these investments.  As a result, our business and results ofoperations could be adversely affected.

* *

*If we areunable to generate additional revenue from our existing clients, our businessmay 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, or a reduction in the number of engagements with these clients, mayresult in a material decline in revenues and cause us to fail to meet publicmarket expectations of our financial performance and operating results.  If we fail to generate additional revenuesfrom our existing clients it may materially adversely affect our business andfinancial 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 our services,we will generally spend additional human and other resources at our own expenseto ensure client satisfaction.  Suchexpenditures will typically result in

 

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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 orfinancial condition.  Although wemaintain professional liability insurance, such insurance may not provideadequate coverage for successful 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 consulting fields.  To serve agrowing client base, we must continue to recruit and retain qualified personnelwith expertise in each of these areas. We must also seek certain employees that are willing to work on avariable or per diem basis.  Competitionfor such personnel is intense and we compete for such personnel with managementconsulting firms, healthcare and pharmaceutical organizations, software firms,and other businesses.  Many of theseentities have substantially greater financial and other resources than we do,or can offer more attractive compensation packages to candidates, includingsalary, bonuses, stock, and stock options. If we are unable to recruit and retain a sufficient number of qualifiedpersonnel to serve existing and new clients, our ability to expand our clientbase or services and to offer our services at competitive rates could beimpaired and our business would suffer.

 

*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-term employmentcontracts with any of our employees and do not maintain key employee lifeinsurance.

 

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

 

We haveexperienced employee turnover as a result of: 

 

•                  Dependenceon lateral hiring of associates; 

•                  Traveldemands imposed on our associates; 

•                  Lossof employees to competitors and clients; and 

•                  Reductionsin force as certain areas of our business have seen less demand.

 

Continued orincreased employee turnover could materially adversely affect our business andresults of operations.  In addition, manyof 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.

 

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* *

*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 willingto work on a variable or per diem basis in order to better manage project costsand general and administrative expense associated with underutilizedresources.  These market conditions andrestructuring efforts have placed new and increased demands on our managementpersonnel.  It has also placedsignificant and increasing demands on our financial, technical and operationalresources, and on our information systems. If we are unable to manage growth effectively or if we experiencebusiness disruptions due to shifts in market demand, or growth orrestructuring, our operating results will suffer.  To manage any future growth, we must extendour financial reporting and information management systems to our multiple andinternational office locations and traveling employees, and develop andimplement new procedures and controls to accommodate new operations, services andclients.  Increasing operational andadministrative demands may make it difficult for our senior managers to engagein business development activities and their other day-to-day responsibilities.  Further, the addition of new employees andoffices to offset any increasing demands may impair our ability to maintain ourservice delivery standards and corporate culture.  In addition, we have in the past changed, andmay in the future change, our organizational structure and businessstrategy.  Such changes may result inoperational inefficiencies and delays in delivering our services.  Such changes could also cause a disruption inour business and could cause a material adverse effect on our financialcondition 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 at relievingthese cost pressures; however, any continuation or acceleration of currentmarket 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:

 

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

•                  Continuedconsolidation of companies; or

•                  Adecrease in pharmaceutical companies’ research and development or technologyexpenditures.

 

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

 

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companies outsource to ourcompetitors.  If this outsourcing trendslows down or stops, or if pharmaceutical companies direct their business awayfrom us, our financial condition and results of operations could be impacted ina materially adverse 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, inFebruary 2003, we acquired Paragon Solutions, Inc., a U.S. based company withoffshore software development centers in India and Vietnam.  As a result of this acquisition, we currentlyhave business operations and employees located in India and Vietnam, as well asour 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:

 

•                  Difficultiesin creating international market demand for our services;

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

•                  Increasingand uncertain labor costs and high turnover rates;

•                  Unfavorablepricing and price competition;

•                  Currencyfluctuations;

•                  Recruitingand hiring employees, and other employment issues unique to internationaloperations, including ability to secure work visas for foreign employees in theU.S.;

•                  Changesin availability of, and requirements for, the types of work visas we may seekfor our foreign employees working in the U.S.;

•                  Longerpayment cycles in some countries and difficulties in collecting internationalaccounts receivable;

•                  Terroristattacks;

•                  Difficultiesin enforcing contractual obligations and intellectual property rights;

•                  Adversetax consequences;

•                  Increasedcosts associated with maintaining international marketing efforts and offices;

•                  Governmentregulations and restrictions;

•                  Adversechanges in regulatory requirements; and 

•                  Economicor political instability.

 

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 operations, which may materially adverselyaffect our financial condition, results of operations, and price for our commonstock.

 

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 orsubcontractors, our business may be adversely impacted. Further, ourinternational 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.

 

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*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 thatprovide some 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:

 

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

•                  Servicegroups of computer equipment companies;

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

•                  Clients’internal information management departments;

•                  Otherhealthcare consulting and outsourcing firms; and 

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

 

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 realize theperceived cost benefits of our recently implemented global sourcing strategy orif we are unable to receive high quality services from foreign employees orsubcontractors, our business may be adversely impacted and we may not be ableto 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 thedevelopment, promotion, sale, and support of their products and services thanwe do.  In addition, as healthcareorganizations become larger and more complex, our larger competitors may bebetter able to serve the needs of such organizations.  If we do not compete effectively with currentand future competitors, we may be unable to secure new and renewed clientengagements, or we may be required to reduce our rates in order to compete effectively.  This could result in a reduction in ourrevenues, resulting in lower earnings or operating losses, and otherwisematerially adversely affecting our business, financial condition, and resultsof operations.

 

*If we fail to establish and 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 EMC Documentum, avendor of document management software applications with which we integrate ourFirstDoc TM solution.

 

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We often are engaged by vendorsor their customers to implement or integrate vendor products based on ourrelationship with a particular vendor. In addition, our clients may request that we host or operate a vendorapplication as part of a hosting or outsourcing relationship, which may requirethe consent or cooperation of the vendor. As a result, we believe that our relationship with vendors is importantto our operations, including our sales, marketing, and support activities.  If we fail to maintain our relationships withthese vendors, or fail to establish additional new relationships, our businesscould 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 ourmethods of business and operation or require us to obtain licenses from thirdparties.  If we attempt to obtain suchlicenses, we do not know whether we will be granted licenses or whether theterms of those licenses will be fair or acceptable to us.  Third parties may assert infringement claimsagainst us in the future.  Such claimsmay result in protracted and costly litigation, penalties, and fines that couldadversely affect our business regardless of the merits of such 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.  Duringthe past several years, the healthcare and pharmaceutical industries have beensubject to an increase in governmental regulation and reform proposals.  These reforms could increase governmentalinvolvement in the healthcare and pharmaceutical industries, lowerreimbursement rates or otherwise change the operating environment of ourclients.  Also, certain reforms thatcreate potential work for us could be delayed or cancelled.  Healthcare and pharmaceutical organizationsmay react to these situations

 

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by curtailing or deferring investments,including those for our services.  Inaddition, if we are unable to maintain our skill and expertise in light ofregulatory or technological changes, our services may not be marketable to ourclients and we could lose existing clients or future engagements.  Finally, government regulations, particularlyHIPAA, may require our clients to impose additional contractual responsibilitieson us, which may make it more costly to perform certain of our engagements andsubject us to increased risk in the performance of these engagements, includingimmediate termination of an engagement.

 

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

* *

*We may be unable to effectively protect 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 a materialadverse effect on our business, financial condition, or results of operations.

 

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

 

Our currentofficers, directors, and other affiliates beneficially own approximately 24.7%of our outstanding shares of common stock and approximately 37.2% on a fullydiluted basis.  As a result, our existingmanagement, if acting together, may be able to exercise control over orsignificantly influence matters requiring stockholder approval, including theelection of directors, mergers, consolidations, sales of all or substantiallyall of our assets, issuance of additional shares of stock, and approval of newstock 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 publiclyin February 1998, the reported sale price of our common stock on the NasdaqNational Market has been as high as $29.13 and as low as $3.63 per share.  This price may be influenced by many factors,including:

 

•                  Ourperformance and prospects;

•                  Thedepth and liquidity of the market for our common stock;

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

•                  Changesin earnings estimates or buy/sell recommendations by analysts;

•                  Generalfinancial and other market conditions;

•                  Domesticand international economic conditions; and

•                  Theother risks related to our business discussed above.

 

In addition,public stock markets have experienced extreme price and trading volumevolatility.  This volatility hassignificantly affected the market prices of securities of many companies forreasons frequently unrelated to or disproportionately impacted by the operatingperformance of these companies.  Thesebroad market fluctuations may adversely affect the market price of our commonstock.  As a result,

 

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we may be unable to raise capital or use ourstock to acquire businesses on attractive terms and investors may be unable toresell their shares of our common stock at or above their purchase price.  Further, if research analysts stop coveringour company or reduce their expectations of us, our stock price could declineor the liquidity of our common stock may be adversely impacted, which couldcreate difficulty for investors to resell their shares 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 haveother rights, including economic rights, senior to our common stock, and as aresult, the issuance of any preferred stock could depress the market price ofour common stock.

 

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 ofincorporation also provides for a classified Board of Directors.  The ability of our Board of Directors toissue preferred stock and these other provisions of our certificate ofincorporation and bylaws may have the effect of deterring hostile takeovers or delayingchanges in control or 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, couldadversely affect the market value of our common stock.

 

In 1999, ourBoard of Directors adopted a share purchase rights plan that is intended toprotect our stockholders’ interests in the event we are confronted withcoercive takeover tactics.  Pursuant tothe stockholders rights plan, we distributed “rights” to purchase up to 500,000shares of our Series A Junior Participating Preferred Stock.  Under some circumstances, these rights becomethe rights to purchase shares of our common stock or securities of an acquiringentity at one-half the market value.  Therights are not intended to prevent our takeover, rather they are designed todeal with the possibility of unilateral actions by hostile acquirers that coulddeprive our Board of Directors and stockholders of their ability to determineour destiny and obtain the highest price for our common stock.

 

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**Item 3.  Quantitative andQualitative Disclosures about 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.  Only thecash and cash equivalents and short-term investments which totaled $47.1million at September 24, 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$0.5 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 September 24, 2004, we had noborrowings under our revolving line of credit and an available borrowingcapacity of $7.0 million.  See “Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations- Liquidity and Capital Resources.” The estimated fair value of borrowings under the revolving line isexpected to approximate its carrying value.

 

**Item 4. Controls and Procedures**

 

We maintaindisclosure controls and procedures that are designed to ensure that informationrequired to be disclosed in our Exchange Act reports is recorded, processed,summarized, and reported within the time periods specified in the Securitiesand Exchange Commission’s rules and forms, and that such information isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow for timelydecisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, management is required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures.  Our disclosure controls andprocedures are designed to provide a reasonable level of assurance of reachingour desired disclosure control objectives.

 

As required bySEC Rule 13a-15(b), we carried out an evaluation, under the supervision andwith the participation of our management, including our Chief Executive Officerand our Chief Financial Officer, of the effectiveness of the design andoperation of our disclosure controls and procedures as of the end of thequarter covered by this report. Based on the foregoing, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures were effective, and were operating at the reasonable assurancelevel.

 

There has beenno change in our internal controls over financial reporting during our most recentfiscal quarter or fiscal year that has materially affected, or is reasonablylikely to materially affect, our internal controls over financial reporting.

 

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* *

**PART II.  OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

None.

 

**Item 2. Unregistered Sales of Equity Securities****and Use of Proceeds**

 

None. 

 

**Item 3. Defaults Upon Senior Securities**

 

None.

 

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

 

None.

 

**Item 5.  Other Information**

 

None.

 

**Item 6. Exhibits**

 

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

 

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

 

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

 

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

 

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

 

(5)   See Note 1 to Consolidated FinancialStatements, “Accounting Policies – Basic and Diluted Net Income (Loss) PerShare.”

 

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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:  November 3, 2004 | /s/LUTHER J.  NUSSBAUM              |   |
|                    | Luther J.  Nussbaum                 |
|                    | Chairman of  the Board and          |
|                    | Chief  Executive Officer            |
|                    |                                |
|                    |                                |
| Date:  November 3, 2004 | /s/WALTER J.  MCBRIDE               |   |
|                    | Walter J.  McBride                  |
|                    | Executive Vice  President and Chief |
|                    | Financial  Officer                  |
|                         |                                     |  |  |

 

41

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**EXHIBITINDEX**

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

 

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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)           SeeNote 1 to Consolidated Financial Statements, “Accounting Policies – Basic andDiluted Net Income (Loss) Per Share.”

 

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