**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

| **(Mark One)**                                                                                                                                                                                                                       |       |                                                                                          |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                 |       |                                                                                          |
| **x**                                                                                                                                                                                                                                | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|                                                                                                                                                                                                                                 |       |                                                                                          |
| **For the quarterly period ended September 28,  2007**                                                                                                                                                                               |
|                                                                                                                                                                                                                                 |       |                                                                                          |
| **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 of | ** ** | (I.R.S. Employer    |
| incorporation or organization)  | ** ** | Identification No.) |

 

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

(Address of principal executive offices, including zip code)

 

**(562) 624-5200**

(Registrant’s telephone number, including area code)

 

 

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

 

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 for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for the past90 days. Yes x  No o

 

**Indicate by check mark whether the registrant is a largeaccelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.**

** **
| **Large  accelerated filer **o | ** ** | **Accelerated  filer **x | ** ** | **Non-accelerated  filer **o |
|-------------------------------------|------------|-------------------------------|------------|-----------------------------------|

** **

**Indicate by check mark whether the registrant is a shellcompany (as defined in Rule 12b-2 of the Exchange Act).**Yes o  No x

** **

**Indicate the number of shares outstanding of each of the Registrant’sclasses of common stock, as of the latest practicable date.**

** **
| **Common Stock, $.001 par value** | ** ** | **27,149,761**                    |
|-------------------------------------------------------|------------|-----------------------------------|
| (Class)                                               |       | (Outstanding at October 26, 2007) |

 

 

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**First Consulting Group, Inc.**

**Table of Contents**

 
| COVER PAGE                                                                                          |   |   |
|-----------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                |   |   |
| TABLE  OF CONTENTS                                                                                  |   |   |
|                                                                                                |   |   |
| PART I. FINANCIAL INFORMATION                                                                  |   |   |
|                                                                                                |   |   |
| ITEM 1. FINANCIAL STATEMENTS                                                                        |   |   |
|                                                                                                |   |   |
| 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 RISK                                 |   |   |
|                                                                                                |   |   |
| ITEM 4. CONTROLS AND PROCEDURES                                                                     |   |   |
|                                                                                                |   |   |
| PART II. OTHER INFORMATION                                                                          |   |   |
|                                                                                                |   |   |
| ITEM 1. LEGAL PROCEEDINGS                                                                           |   |   |
|                                                                                                |   |   |
| ITEM 1A. RISK FACTORS                                                                               |   |   |
|                                                                                                |   |   |
| 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.  FINANCIALINFORMATION**

#  

## **Item 1. Financial Statements**

## ** **

**First Consulting Group, Inc. and Subsidiaries**

 

### **Consolidated Balance Sheets**

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

**(unaudited)**

** **
| ** **                                                                                                              | ** ** | **September 28,** | ** ** | **December 29,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                              | ** ** | **2007**               | ** ** | **2006**              | ** ** |
| **ASSETS**                                                                                                              | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current  assets:                                                                                                        | ** ** | ** **             | ** ** | ** **            | ** ** |
| Cash and  cash equivalents                                                                                              |       | $                      | 85,932     |                  | $          | 58,493 |   |
| Short-term  investments                                                                                                 |       | 10,000                 |       | 5,004                 |       |
| Accounts  receivable, less allowance of $1,285 and $1,648 as of September 28, 2007 and  December 29, 2006, respectively |       | 17,362                 |       | 20,485                |       |
| Unbilled  receivables                                                                                                   |       | 17,807                 |       | 12,124                |       |
| Prepaid  expenses and other current assets                                                                              |       | 4,289                  |       | 3,957                 |       |
| Current  assets of discontinued operations                                                                              |       | 1,871                  |       | 216                   |       |
| Total  current assets                                                                                                   |       | 137,261                |       | 100,279               |       |
|                                                                                                                    |       |                   |       |                  |       |
| Property and  equipment:                                                                                                |       |                   |       |                  |       |
| Furniture,  equipment, and leasehold improvements                                                                       |       | 7,617                  |       | 6,905                 |       |
| Information  systems equipment and software                                                                             |       | 28,329                 |       | 29,608                |       |
|                                                                                                                    |       | 35,946                 |       | 36,513                |       |
| Less  accumulated depreciation and amortization                                                                         |       | 26,965                 |       | 25,516                |       |
|                                                                                                                    |       | 8,981                  |       | 10,997                |       |
|                                                                                                                    |       |                   |       |                  |       |
| Other  assets:                                                                                                          |       |                   |       |                  |       |
| Executive  benefit trust                                                                                                |       | 11,961                 |       | 11,079                |       |
| Long-term  accounts receivable, net                                                                                     |       | 2,339                  |       | 2,413                 |       |
| Long-term  investments                                                                                                  |       | 2,758                  |       | 325                   |       |
| Deferred  contract costs                                                                                                |       | 8,733                  |       | 5,255                 |       |
| Deferred  income taxes                                                                                                  |       | 6,316                  |       | —                |       |
| Goodwill,  net                                                                                                          |       | 18,042                 |       | 17,820                |       |
| Intangibles,  net                                                                                                       |       | 170                    |       | 456                   |       |
| Other                                                                                                                   |       | 1,705                  |       | 2,437                 |       |
| Non-current  assets of discontinued operations                                                                          |       | —                 |       | 432                   |       |
|                                                                                                                    |       | 52,024                 |       | 40,217                |       |
| Total assets                                                                                                            |       | $                      | 198,266    |                  | $          | 151,493 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

3

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**First Consulting Group, Inc. and Subsidiaries**

 

**Consolidated Balance Sheets (Continued)**

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

**(unaudited)**

 
| ** **                                                                                                                                                                                       | ** ** | **September 28,** | ** ** | **December 29,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                       | ** ** | **2007**               | ** ** | **2006**              | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current  liabilities:                                                                                                                                                                            | ** ** | ** **             | ** ** | ** **            | ** ** |
| Accounts  payable                                                                                                                                                                                |       | $                      | 2,583      |                  | $          | 2,381 |   |
| Accrued  liabilities                                                                                                                                                                             |       | 3,097                  |       | 2,377                 |       |
| Accrued  payroll and payroll taxes                                                                                                                                                               |       | 3,974                  |       | 2,694                 |       |
| Accrued  vacation                                                                                                                                                                                |       | 6,237                  |       | 5,879                 |       |
| Accrued  employee benefits                                                                                                                                                                       |       | 3,038                  |       | 2,108                 |       |
| Accrued  incentive compensation                                                                                                                                                                  |       | 3,272                  |       | 937                   |       |
| Customer  advances                                                                                                                                                                               |       | 11,025                 |       | 10,086                |       |
| Taxes  payable                                                                                                                                                                                   |       | 12,143                 |       | 1,630                 |       |
| Current  liabilities of discontinued operations                                                                                                                                                  |       | 251                    |       | 1,866                 |       |
| Total  current liabilities                                                                                                                                                                       |       | 45,620                 |       | 29,958                |       |
| Non-current  liabilities:                                                                                                                                                                        |       |                   |       |                  |       |
| Supplemental  executive retirement plan                                                                                                                                                          |       | 8,601                  |       | 10,193                |       |
|                                                                                                                                                                                             |       |                   |       |                  |       |
| 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, 27,149,109 shares  issued and outstanding at September 28, 2007 and 26,253,061 shares issued and  outstanding at December 29, 2006 |       | 27                     |       | 26                    |       |
| Additional  paid-in capital                                                                                                                                                                      |       | 107,887                |       | 102,739               |       |
| Retained  earnings                                                                                                                                                                               |       | 35,360                 |       | 8,302                 |       |
| Accumulated  other comprehensive income                                                                                                                                                          |       | 771                    |       | 275                   |       |
| Total  stockholders’ equity                                                                                                                                                                 |       | 144,045                |       | 111,342               |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                 |       | $                      | 198,266    |                  | $          | 151,493 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

4

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**First Consulting Group, Inc. and Subsidiaries**

 

### **Consolidated Statements of Operations**

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

**(unaudited)**

 
| ** **                                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                               | ** ** | **September  28, 2007**     | ** ** | **September  29, 2006**    | ** ** | **September  28, 2007** | ** ** | **September  29, 2006** | ** ** |
| Revenues  before reimbursements                                          |       | $                                | 66,820     |                            | $          | 64,766 |   | $ | 200,019 |   | $ | 195,233 |   |
| Reimbursements                                                           |       | 3,817                            |       | 3,318                           |       | 10,656 |   | 10,557 |   |
| Total  revenues                                                          |       | 70,637                           |       | 68,084                          |       | 210,675 |   | 205,790 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Cost of  services before reimbursable expenses                           |       | 47,778                           |       | 46,406                          |       | 145,325 |   | 140,603 |   |
| Reimbursable  expenses                                                   |       | 3,817                            |       | 3,318                           |       | 10,656 |   | 10,557 |   |
| Total cost  of services                                                  |       | 51,595                           |       | 49,724                          |       | 155,981 |   | 151,160 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Gross profit                                                             |       | 19,042                           |       | 18,360                          |       | 54,694 |   | 54,630 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Selling  expenses                                                        |       | 3,813                            |       | 3,938                           |       | 11,746 |   | 12,119 |   |
| General and  administrative expenses                                     |       | 10,232                           |       | 8,775                           |       | 29,453 |   | 26,862 |   |
| Income from  operations                                                  |       | 4,997                            |       | 5,647                           |       | 13,495 |   | 15,649 |   |
| Other income  (expense):                                                 |       |                             |       |                            |       |   |   |   |   |
| Interest  income, net                                                    |       | 976                              |       | 646                             |       | 2,770 |   | 1,409 |   |
| Other income  (expense), net                                             |       | 22                               |       | (38                             | )          | 11 |   | (51 | ) |
| Income from  continuing operations before income tax provision (benefit) |       | 5,995                            |       | 6,255                           |       | 16,276 |   | 17,007 |   |
| Income tax  provision (benefit)                                          |       | (4,562                           | )          | 454                             |       | (1,759 | ) | 1,188 |   |
| Income from  continuing operations                                       |       | 10,557                           |       | 5,801                           |       | 18,035 |   | 15,819 |   |
| Income  (loss) on discontinued operations, net of tax                    |       | 10,024                           |       | 288                             |       | 9,375 |   | (47 | ) |
| Net income                                                               |       | $                                | 20,581     |                            | $          | 6,089 |   | $ | 27,410 |   | $ | 15,772 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Basic net  income per share:                                             |       |                             |       |                            |       |   |   |   |   |
| Income from  continuing operations                                       |       | $                                | 0.39       |                            | $          | 0.23 |   | $ | 0.67 |   | $ | 0.63 |   |
| Income on  discontinued operations, net of tax                           |       | 0.37                             |       | 0.01                            |       | 0.35 |   | — |   |
| Net income  per share                                                    |       | $                                | 0.76       |                            | $          | 0.24 |   | $ | 1.02 |   | $ | 0.63 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Diluted net  income per share:                                           |       |                             |       |                            |       |   |   |   |   |
| Income from  continuing operations                                       |       | $                                | 0.38       |                            | $          | 0.22 |   | $ | 0.66 |   | $ | 0.62 |   |
| Income on discontinued  operations, net of tax                           |       | 0.37                             |       | 0.01                            |       | 0.34 |   | — |   |
| Net income  per share                                                    |       | $                                | 0.75       |                            | $          | 0.23 |   | $ | 1.00 |   | $ | 0.62 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Weighted  average shares used in computing:                              |       |                             |       |                            |       |   |   |   |   |
| Basic net  income per share                                              |       | 27,108                           |       | 25,472                          |       | 26,848 |   | 25,074 |   |
| Diluted net  income per share                                            |       | 27,495                           |       | 26,229                          |       | 27,461 |   | 25,643 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

5

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**First Consulting Group, Inc. and Subsidiaries**

 

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

**(in thousands)**

**(unaudited)**

** **
| ** **                                                                         | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **September 28,  2007**    | ** ** | **September 29,  2006** | ** ** |
| Cash flows  from operating activities:                                             |       |                            |       |   |   |
| Net income                                                                         |       | $                               | 27,410     |   | $ | 15,772 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                            |       |   |   |
| Depreciation  and amortization                                                     |       | 4,488                           |       | 5,330 |   |
| Intangible  amortization                                                           |       | 466                             |       | 579 |   |
| Provision  for bad debts                                                           |       | (363                            | )          | (99 | ) |
| Benefit for  deferred income taxes                                                 |       | (6,316                          | )          | — |   |
| Loss on  sale/disposal of assets                                                   |       | 250                             |       | 473 |   |
| Stock-based  compensation                                                          |       | 1,003                           |       | 629 |   |
| In-process  research and development expenses acquired                             |       | 1,580                           |       | — |   |
| (Gain) loss  on operations of discontinued operations, net of tax                  |       | (9,375                          | )          | 47 |   |
| Change in  assets and liabilities:                                                 |       |                            |       |   |   |
| Accounts receivable                                                                |       | 3,486                           |       | 3,111 |   |
| Unbilled  receivables                                                              |       | (5,683                          | )          | (2,869 | ) |
| Prepaid  expenses and other current assets                                         |       | (318                            | )          | 60 |   |
| Long-term  accounts receivable                                                     |       | 74                              |       | (710 | ) |
| Deferred  contract costs                                                           |       | (3,478                          | )          | (1,102 | ) |
| Other assets                                                                       |       | 610                             |       | (397 | ) |
| Accounts  payable                                                                  |       | 202                             |       | 317 |   |
| Accrued  liabilities                                                               |       | 720                             |       | (1,951 | ) |
| Accrued  payroll and payroll taxes                                                 |       | 1,280                           |       | (564 | ) |
| Accrued  vacation                                                                  |       | 358                             |       | (999 | ) |
| Accrued  employee benefits                                                         |       | 930                             |       | 158 |   |
| Accrued  incentive compensation                                                    |       | 2,335                           |       | 761 |   |
| Customer  advances                                                                 |       | 939                             |       | 178 |   |
| Accrued  restructuring costs                                                       |       | —                          |       | (2,545 | ) |
| Taxes  payable                                                                     |       | 4,410                           |       | 657 |   |
| Supplemental  executive retirement plan                                            |       | (2,474                          | )          | (740 | ) |
| Other                                                                              |       | (128                            | )          | (97 | ) |
| Net cash  provided by operating activities of continuing operations                |       | 22,406                          |       | 15,999 |   |
| Net cash  provided by (used in) operating activities of discontinued operations    |       | (1,418                          | )          | 1,717 |   |
| Net cash  provided by operating activities                                         |       | 20,988                          |       | 17,716 |   |
| Cash flows  from investing activities:                                             |       |                            |       |   |   |
| Purchase of  investments, net                                                      |       | (7,429                          | )          | (3,009 | ) |
| Purchase of  property and equipment                                                |       | (2,519                          | )          | (4,358 | ) |
| Acquisition  of business, net of cash                                              |       | (2,061                          | )          | — |   |
| Net cash  used in investing activities of continuing operations                    |       | (12,009                         | )          | (7,367 | ) |
| Net cash  provided by investing activities of discontinued operations              |       | 13,762                          |       | — |   |
| Net cash  provided by (used in) investing activities                               |       | 1,753                           |       | (7,367 | ) |
| Cash flows  from financing activities:                                             |       |                            |       |   |   |
| Proceeds  from issuance of capital stock, net                                      |       | 4,166                           |       | 5,465 |   |
| Collections  of loan receivable                                                    |       | 102                             |       | 61 |   |
| Net cash  provided by financing activities                                         |       | 4,268                           |       | 5,526 |   |
| Effect of  exchange rate changes on cash and cash equivalents                      |       | 430                             |       | 215 |   |
| Net change  in cash and cash equivalents                                           |       | 27,439                          |       | 16,090 |   |
| Cash and  cash equivalents at beginning of period                                  |       | 58,493                          |       | 35,106 |   |
| Cash and  cash equivalents at end of period                                        |       | $                               | 85,932     |   | $ | 51,196 |   |
|                                                                               |       |                            |       |   |   |
| Supplemental  disclosure of cash flow information                                  |       |                            |       |   |   |
| Cash paid  during the period for interest                                          |       | $                               | 2          |   | $ | 5 |   |
| Cash paid  during the period for income taxes, net of refunds                      |       | $                               | 220        |   | $ | 530 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

6

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**First Consulting Group, Inc. and Subsidiaries**

** **

**Notes toConsolidated Financial Statements**

 

**September 28, 2007**

 

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

 

Basis of Presentation

 

The accompanyingconsolidated balance sheet of First Consulting Group, Inc. and subsidiaries (the“Company” or “FCG”) at September 28, 2007 and consolidated statements ofoperations and consolidated statements of cash flows for the three-month andnine-month periods ended September 28, 2007 and September 29, 2006 areunaudited. These interim financial statements reflect all adjustments,consisting of only normal recurring adjustments, which, in the opinion ofmanagement, are necessary to fairly present the financial position of theCompany at September 28, 2007 and the results of operations for the three-monthand nine-month periods ended September 28, 2007 and September 29, 2006. Theresults of operations and cash flows for the three-month and nine-month periodended September 28, 2007 are not necessarily indicative of the results to beexpected for the year ending December 28, 2007. For more complete financialinformation, these financial statements should be read in conjunction with theaudited financial statements for the year ended December 29, 2006 included inthe Company’s Annual Report on Form 10-K.

 

Principles of Consolidation

 

Theconsolidated financial statements include the accounts of the Company and itswholly owned subsidiaries. All material intercompany accounts and transactionshave been eliminated. The Company operates on a fiscal year consisting of a 52or 53 week period ending on the last Friday in December.

 

Stock-Based Compensation

 

*Restricted Stock*

 

A summary of restrictedstock activity for the nine months ended September 28, 2007 is as follows:

 
| ** **                     | ** ** | **Shares** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|--------------------------------|------------|------------|------------|-------------------------------------------------------------|------------|
| Balance at  December 29, 2006  |       | 130,000    |       | $                                                           | 8.49       |   |
| Grants                         |       | 290,800    |       | 12.87                                                       |       |
| Cancelled                      |       | (109,900   | )          | 11.30                                                       |       |
| Balance at  September 28, 2007 |       | 310,900    |       | 11.59                                                       |       |
|                                |            |            |            |                                                             |            |  |

 

During thenine months ended September 28, 2007, the Company issued 290,800 shares ofrestricted stock awards with a vesting period of three and four years to eightboard members and 50 vice presidents, respectively. For the three months endedSeptember 28, 2007, the Company recognized $4,000 of compensation costs relatedto these awards of which an expense reversal of $56,000 was a component of costof services, an expense of $2,000 was a component of selling expense, and anexpense of $58,000 was a component of general and administrative expense. Forthe nine months ended September 28, 2007, the Company recognized $410,000 ofcompensation costs related to these awards of which $140,000 was a component ofcost of services, $37,000 was a component of selling expense, and 

 

7

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$233,000 was a component of general andadministrative expense. At September 28, 2007, there was $3.1 million of totalunrecognized compensation costs related to unvested stock, which is expected tobe recognized over a weighted average period of 3.4 years. During the thirdquarter of 2007, the Company re-evaluated the estimated forfeiture rate on its2007 awards. The impact of this adjustment was a reduction in expense of$104,000.

 

In August2006, the Company issued 180,000 shares of restricted stock awards with avesting period of five years to seven vice presidents and recognized $51,000 ofcompensation costs during the three and nine months ended September 29, 2006.

 

*Accounting for Stock Options*

 

The Companyfollows the provisions of SFAS 123 (revised 2004),*“*Share-BasedPayment” (“SFAS 123R”) using the modified prospective transition method.Upon adoption of SFAS 123R, the Company changed its method of attributing thevalue of stock option-based compensation expense from the multiple-option(i.e., accelerated) approach to the single-option (i.e., straight-line) method.Compensation expense for share-based awards granted through December 30,2005 continues to be subject to the accelerated multiple-option method, whilecompensation expense for share-based awards granted on or afterDecember 31, 2005 is recognized using a straight-line, or single-optionmethod. The Company recognizes these compensation costs over the service periodof the award, which is generally the option vesting term of three to fouryears.

 

SFAS 123Rrequires forfeitures to be estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates in order to derive the Company’s best estimate of awards ultimatelyexpected to vest. Forfeitures have been estimated based on the Company’shistorical experience.

 

*Valuation and Expense Information under SFAS123R*

 

Expenseassociated with stock option-based compensation for the three and nine monthsended September 28, 2007 is $186,000 and $593,000, respectively, which had theeffect of reducing operating income and net income by this amount, and reducingbasic and diluted earnings per share by less than $0.01 for the three-monthperiod and $0.02 for the nine-month period. For the three and nine months endedSeptember 29, 2006, the stock option-based compensation was $230,000 and$578,000, respectively, which had the effect of reducing basic and dilutedearnings per share by $0.01 for the three-month period and $0.02 for thenine-month period.

 

The following represents thecost classification of the stock option-based compensation for the three andnine months ended September 28, 2007 and September 29, 2006 (in thousands):

 
| ** **                             | ** ** | **Three Months Ended** | ** ** | **Nine months Ended** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **September  28, 2007**     | ** ** | **September  29, 2006**    | ** ** | **September  28, 2007** | ** ** | **September  29, 2006** | ** ** |
| Cost of  services                      |       | $                                | 19         |                            | $          | 50 |   | $ | 72 |   | $ | 187 |   |
| Selling                                |       | 7                                |       | 30                              |       | 24 |   | 97 |   |
| General and  administrative            |       | 160                              |       | 150                             |       | 497 |   | 294 |   |
| Total stock  option-based compensation |       | $                                | 186        |                            | $          | 230 |   | $ | 593 |   | $ | 578 |   |

 

Tax benefitsresulting from tax deductions in excess of the compensation cost recognized forthose options are classified as financing cash flows. For the nine months endedSeptember 28, 2007, the Company recognized $60,000 of tax benefit related tostock option-based compensation. For the nine months ended September 29, 2006,the Company did not recognize any tax benefit related to stock 

 

8

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option-based compensation expense because theCompany maintained a full valuation allowance on its deferred tax assets at thetime.

 

The Companyuses the Black-Scholes option pricing model to value its options. There were nooptions granted during the nine months ended September 28, 2007. The fair valueof the options granted during the nine months ended September 29, 2006calculated using the Black-Scholes pricing model was $4.30 per share. Thefollowing assumptions were used in the Black-Scholes pricing model:

 
| ** **                            | ** ** | **Three Months Ended** | ** ** | **Nine months Ended**  | ** ** |
|---------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                            | ** ** | **September 29, 2006** | ** ** | **September 29, 2006** | ** ** |
| Dividend  yield                       |       | —                           |       | -                                |       |
| Expected  volatility                  |       | —                           |       | 0.46 - 0.59                      |       |
| Weighted  average expected volatility |       | —                           |       | 0.47                             |       |
| Risk-free  interest rate              |       | —                           |       | 4.28% - 5.02%                    |       |
| Expected  life                        |       | —                           |       | 5 to 6 years                     |       |

 

Expectedvolatilities are based on the Company’s historical volatility of its commonshares over a period of time equal to the expected term of the stock option.The risk-free interest rate assumption is based upon observed interest ratesappropriate for the term of the stock option. The expected dividend yield iszero as the Company does not expect to pay dividends in the future.

 

Stock optionactivity for the nine months ended September 28, 2007 is as follows:

 
| ** **                         | ** ** | **Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Weighted Average  Remaining  Contractual Life  (Years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------|------------|------------|------------|------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding  at December 29, 2006  |       | 2,915,960  |       | $                                              | 7.73       |                                                                 |       |                            |       |   |
| Exercised                          |       | (717,438   | )          | $                                              | 5.81       |                                                                 |       |                            |       |   |
| Cancelled                          |       | (167,569   | )          | $                                              | 10.03      |                                                                 |       |                            |       |   |
| Outstanding  at September 28, 2007 |       | 2,030,953  |       | $                                              | 8.21       |                                                                 | 5.30       |                            | $          | 5,344,688 |   |
|                               |       |       |       |                                           |       |                                                                 |       |                            |       |
| Exercisable  at September 28, 2007 |       | 1,583,120  |       | $                                              | 8.17       |                                                                 | 4.46       |                            | $          | 4,481,688 |   |

 

The aggregateintrinsic value in the table above represents the total pre-tax intrinsicvalue, based on the Company’s closing stock price of $10.30 on September 28,2007, which would have been received by the option holders had all optionholders exercised their options on September 28, 2007. This amount changesbased on the fair market value of the Company’s stock. Total intrinsic value ofoptions exercised for the nine months ended September 28, 2007 and September29, 2006 were $3.2 million and $1.9 million, respectively. As of September 28, 2007, there was $1.6million of total unrecognized compensation cost related to unvested stockoptions. This cost is expected to be recognized over a weighted average periodof approximately 2.3 years.

 

Basic and Diluted Net Income per Share

 

Basic netincome per share is computed using the weighted average number of common sharesoutstanding. Diluted net income per share is computed using the assumption thatstock 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.

 

9

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The following represents areconciliation of basic and diluted net income per share for the three and ninemonths ended September 28, 2007 and September 29, 2006 (in thousands, exceptper share data):

 
| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Nine months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **September  28, 2007**     | ** ** | **September  29, 2006**    | ** ** | **September  28, 2007** | ** ** | **September  29, 2006** | ** ** |
| Income  (loss) from continuing operations              |       | $                                | 10,557     |                            | $          | 5,801 |   | $ | 18,035 |   | $ | 15,819 |   |
| Gain (loss)  on discontinued operations, net of tax    |       | 10,024                           |       | 288                             |       | 9,375 |   | (47 | ) |
| Net income                                             |       | $                                | 20,581     |                            | $          | 6,089 |   | $ | 27,410 |   | $ | 15,772 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Basic  weighted average number of shares outstanding   |       | 27,108                           |       | 25,472                          |       | 26,848 |   | 25,074 |   |
| Effect of  dilutive options and contingent shares      |       | 387                              |       | 757                             |       | 613 |   | 569 |   |
| Diluted  weighted average number of shares outstanding |       | 27,495                           |       | 26,229                          |       | 27,461 |   | 25,643 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Basic net  income per share:                           |       |                             |       |                            |       |   |   |   |   |
| Income from  continuing operations                     |       | $                                | 0.39       |                            | $          | 0.23 |   | $ | 0.67 |   | $ | 0.63 |   |
| Income on  discontinued operations, net of tax         |       | 0.37                             |       | 0.01                            |       | 0.35 |   | — |   |
| Net income  per share                                  |       | $                                | 0.76       |                            | $          | 0.24 |   | $ | 1.02 |   | $ | 0.63 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Diluted net  income per share:                         |       |                             |       |                            |       |   |   |   |   |
| Income from  continuing operations                     |       | $                                | 0.38       |                            | $          | 0.22 |   | $ | 0.66 |   | $ | 0.62 |   |
| Income on  discontinued operations, net of tax         |       | 0.37                             |       | 0.01                            |       | 0.34 |   | — |   |
| Net income  per share                                  |       | $                                | 0.75       |                            | $          | 0.23 |   | $ | 1.00 |   | $ | 0.62 |   |

 

For the three months endedSeptember 28, 2007 and September 29, 2006, there were 856,635 and 1,288,392anti-dilutive outstanding stock options, respectively, excluded from thecalculation of diluted income per share. For the nine months ended September28, 2007 and September 29, 2006, there were 809,932 and 2,003,147 anti-dilutiveoutstanding stock options, respectively, excluded from the calculation ofdiluted income per share.

 

Use of Estimates

 

In preparingfinancial statements in conformity with accounting principles generallyaccepted in the United States of America, management is required to makeestimates and assumptions that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe financial statements, and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates. Onan ongoing basis, management evaluates its estimates, including those relatedto revenue recognition, valuation of goodwill, stock-based compensation,long-lived and intangible assets, accrued liabilities, income taxes includingthe amount of tax asset valuation allowance required, facility closure costs,litigation and disputes, and the allowance for doubtful accounts.

 

Managementbases its estimates on historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources. Suchestimates are subject to a number of assumptions, risks, and uncertainties,many of which are beyond the Company’s control. The Company’s actual resultsmay differ from its estimates.

 

10

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Cash and Cash Equivalents

 

For purposesof reporting, cash and cash equivalents include cash and interest-earningdeposits or securities purchased with original maturities of three months orless.

 

RecentAccounting Pronouncements

 

*Fair Value Measurements*

 

InSeptember 2006 and February 2007, respectively, the FASB issued SFAS 157, “FairValue Measurements” (“SFAS 157”), which provides guidance for using fair valueto measure assets and liabilities, and SFAS 159, “The FairValue Option for Financial Assets and Financial Liabilities” (“SFAS 159”),which allows the measurement of many financial instruments and certain otheritems at fair value. SFAS 157 will apply whenever another standard requiresor permits assets or liabilities to be measured at fair value. The standarddoes not expand the use of fair value to any new circumstances. SFAS 159 willpermit companies to use fair value measurements in certain circumstances. Bothstandards are effective for financial statements issued for fiscal yearsbeginning after November 15, 2007. The Company is currently evaluating theimpact of SFAS 157 and SFAS 159 on its consolidated financial position andresults of operations.

 

*Accounting for Uncertainty in Income Taxes*

 

In June 2006,the FASB issued FASB Interpretation 48, “Accounting for Uncertainty in IncomeTaxes” (“FIN 48”). FIN 48 clarifies the application of SFAS 109, “Accountingfor Income Taxes”, by establishing a threshold condition that a tax positionmust meet for any part of the benefit of that position to be recognized in thefinancial statements. In addition to recognition, FIN 48 provides guidanceconcerning measurement, de-recognition, classification, and disclosure of taxpositions. FIN 48 is effective for fiscal years beginning after December 15,2006. The Company adopted FIN 48 in the first quarter of 2007 and recorded acumulative effect adjustment of $352,000 which was accounted for as anadjustment to the beginning balance of retained earnings. See Note 9, “IncomeTaxes” for additional information regarding such adoption.

 

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

 

The Companyhad $10.0 million in short-term investments and $2.5 million in long-terminvestments at September 28, 2007 and $5.0 million in short-term investments atDecember 29, 2006. Such investments were held primarily in corporate notes andgovernment agency securities. Gross and net unrealized gains and losses oninvestments were immaterial at September 28, 2007. Additionally, the Companyhad $300,000 and $325,000 of non-marketable equity investments at September 28,2007 and December 29, 2006, respectively, valued at the lower of cost orestimated fair value, which were included within long-term investments.

 

**Note 3****                   ****Long-Term Accounts Receivable**

 

The Companyhad long-term accounts receivable at September 28, 2007 and December 29, 2006of $2.3 million and $2.4 million. Of the long-term account receivable of $2.3million at September 28, 2007, $1.3 million was created in August 2005 throughthe deferral until 2009 of the first month of fees of a new outsourcingcontract. In January 2006, an additional amount of approximately $800,000related to this contract was deferred until 2009. Both deferrals were inaccordance with the terms of the contract executed with this client in July2005. Imputed interest income at a rate of 7.0% of $119,000 was accrued duringthe first nine months of 2007 on this receivable. Unamortized discount of$398,000 remained at September 28, 2007.

 

11

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**Note 4****                   ****Business Acquisition**

 

On June 15,2007, the Company acquired 100% of the outstanding common stock of Zorch, Inc.(Zorch), a Salt Lake City, Utah-based company that has developed a proprietaryenterprise software solution to provide regulated content management andcollaboration for the life sciences industry using the Microsoft OfficeSharePoint Server 2007 platform. The Company paid $2.0 million in cash to theshareholders of Zorch. Additionally, the shareholders may earn up to $2.0million of additional consideration for the sale if the business achievescertain revenue targets during the period from acquisition through June 30,2008, and further consideration if operating income from the acquired businessexceeds 14% of revenues during an earnout period that commences in the secondhalf of 2008 and ends in the first quarter of 2011. The Company incurred aone-time charge of approximately $1.6 million during the second quarter offiscal year 2007 in recognition of acquired in-process software research anddevelopment expenses.

 

The following table summarizes the estimatedfair values of assets acquired as of June 15, 2007 in connection with the Zorchacquisition (in thousands):

 
| Other  current assets                |   | $     |  14    |   |
|--------------------------------------|--------|-------|-------------|--------|
| Property,  plant, and equipment      |   | 9     |        |
| Software                             |   | 180   |        |
| Goodwill                             |   | 278   |        |
| In-process  research and development |   | 1,580 |        |
| Cash  consideration                  |   | $     |  2,061 |   |

 

The results of operations of Zorch have beenincluded in the accompanying financial statements for the period from June 16,2007 through September 28, 2007. Pro forma information as if Zorch had beenacquired on January 1, 2006 has not been provided, since such pro forma resultsdo not differ materially from those reported in the accompanying financialstatements.

 

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

 

Under SFAS142, the Company completes an annual impairment testing which is performedduring the fourth quarter of each year.  The Company believes that theaccounting assumptions and estimates related to the annual goodwill impairmenttesting are critical because these can change from period to period. Various assumptions, such as discount rates, and comparable company analysisare used in performing these valuations. The impairment test requires theCompany to forecast future cash flows, which involves significantjudgment.   Accordingly, if expectations of future operating resultschange, or if there are changes to other assumptions, estimates of the fairvalue of reporting units could change significantly resulting in a goodwillimpairment charge, which could have a significant impact on the consolidatedfinancial statements.  The Company performed an impairment test on each ofits components of goodwill as of the fourth quarter of fiscal year 2006 anddetermined that none of its goodwill was impaired. As of September 28, 2007,the Company had $18.0 million of goodwill and $170,000 of amortizableintangible assets recorded on its balance sheet.

 

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The amounts of goodwill atSeptember 28, 2007 are as follows (in thousands):

 
| ** **                                       | ** ** | **Health  Delivery  Services** | ** ** | **Health  Delivery  Outsourcing** | ** ** | **Life  Sciences** | ** ** | **Software  Services** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|--------------------|------------|------------------------|------------|-----------|------------|
| Balance as  of December 29, 2006                 |       | $                              | 3,225      |                              | $          | 5,193              |       | $                      | 1,481      |      | $          | 7,921 | ** ** | **$** | **17,820** | ** ** |
| Acquired                                         |       | —                         |       | —                            |       | 278                |       | —                 | ** ** | **278**   | ** ** |
| Use of  acquired net operating loss carryforward |       | —                         |       | —                            |       | —             |       | (56                    | **)**      | **(56**   | **)**      |
| Balance as  of September 28, 2007                |       | $                              | 3,225      |                              | $          | 5,193              |       | $                      | 1,759      |      | $          | 7,865 | ** ** | **$** | **18,042** | ** ** |

 

As of September 28, 2007,the Company had the following acquired intangible assets (in thousands):

 
| ** **                        | ** ** | **Customer Related** | ** ** | **Software** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|---------------------------|------------|--------------|------------|-----------|------------|
| Balance as  of December 29, 2006  |       | $                         | 456        |         | $          | —    | ** ** | **$** | **456** | ** ** |
| Acquired                          |       | —                    |       | 180          | ** ** | **180**   | ** ** |
| Amortization                      |       | (456                      | )          | (10          | **)**      | **(466**  | **)**      |
| Balance as  of September 28, 2007 |       | $                         | —     |         | $          | 170       | ** ** | **$** | **170** | ** ** |
| Amortization  Period in Years     |       | 4                         |       | 5            |       |      |       |

 

The following tablesummarizes the estimated remaining annual pretax amortization expense for theseassets (in thousands):

 
| **Fiscal Year**           | ** ** | ** ** | ** ** |
|---------------------------|------------|------------|------------|
| 2007  (remainder of year) |       | $          |  9    |   |
| 2008                      |       | 36         |       |
| 2009                      |       | 36         |       |
| 2010                      |       | 36         |       |
| 2011                      |       | 36         |       |
| 2012                      |       | 17         |       |
| Total                     |       | $          |  170  |   |

 

**Note 6****                   ****Comprehensive Income**

 

Comprehensive income, net oftaxes, for the three and nine months ended September 28, 2007 and September 29,2006, is as follows (in thousands):

 
| ** **                               | ** ** | **Three Months Ended** | ** ** | **Nine months Ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | **September  28, 2007**     | ** ** | **September  29, 2006**    | ** ** | **September  28, 2007** | ** ** | **September  29, 2006** | ** ** |
| Net income                               |       | $                                | 20,581     |                            | $          | 6,089 |   | $ | 27,410 |   | $ | 15,772 |   |
|                                     |       |                             |       |                            |       |   |   |   |   |
| Foreign  currency translation adjustment |       | 212                              |       | 40                              |       | 493 |   | 50 |   |
| Unrealized  gain (loss) on investments   |       | 4                                |       | 5                               |       | 3 |   | (7 | ) |
| Other comprehensive  loss, net of tax    |       | 216                              |       | 45                              |       | 496 |   | 43 |   |
|                                     |       |                             |       |                            |       |   |   |   |   |
| Comprehensive  income                    |       | $                                | 20,797     |                            | $          | 6,134 |   | $ | 27,906 |   | $ | 15,815 |   |

 

The translation gain for thethree and nine months ended September 28, 2007 is due to the weakening of theU.S. dollar against currencies in European and Asian countries, where theCompany has assets.

 

13

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**Note 7****                   ****Discontinued Operations**

 

The Companycompleted the sale of its Software Products segment on September 12, 2007 and thedisposition has been accounted for as a discontinued operation in accordancewith SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”(“SFAS 144”).  The Company received $13.8million in cash from the sale, resulting in a pretax gain from the dispositionof discontinued operations of $17.1 million during the third quarter of 2007,which includes certain software subscription revenue that had been deferred asa customer advance, net of the related deferred costs.  Additionally, the Company may receive up to$3 million in additional sale proceeds if future revenues of the businessexceed certain targets.

 

Income fromdiscontinued operations was $10.0 million (net of $6.2 million of income tax)or $0.37 per share in the quarter ended September 28, 2007, compared to incomefrom discontinued operations of $288,000 or $0.01 per share in the quarterended September 29, 2006.  During thequarter ended September 28, 2007, the Company incurred an $824,000 operatingloss from this discontinued operation, compared to a $399,000 operating lossfor the quarter ended September 29, 2006. Income from discontinued operations was $9.4 million (net of $5.8million of income tax) or $0.35 per share, in the nine months ended September28, 2007, compared to a loss from discontinued operations of $47,000 or $0.00per share in the nine months ended September 29, 2006.  During the nine months ended September 28,2007, the Company incurred a $1.9 million operating loss from this discontinuedoperation, compared to a $739,000 operating loss for the nine months endedSeptember 29, 2006.  A 38.3% tax rate wasapplied to the discontinued operations in fiscal year 2007 compared to a 1.4%rate in fiscal year 2006.  Revenues forthe discontinued operation were $1.0 million and $2.2 million for the ninemonths ended September 28, 2007 and September 29, 2006, respectively.

 

On August 21,2006, the Company sold its Cyberview software product and related intellectualproperty and service contracts to Medisolv, Inc and recognized $691,000 ofpretax other income in the third quarter of fiscal year 2006, which is includedin discontinued operations, since Cyberview was part of the Software Productssegment.  

 

**Note 8****                   ****Disclosure of Segment Information**

 

For fiscalyear 2007, the Company has the following five reportable segments:

 

•                  HealthDelivery Services - the delivery of consulting and systems integration servicesto health delivery and government clients;

•                  HealthDelivery Outsourcing - the delivery of outsourcing services to health deliveryclients;

•                  LifeSciences - the sale of enterprise content management software and the deliveryof related consulting and systems integration services to pharmaceutical andother life sciences clients;

•                  HealthPlans - the delivery of consulting and systems integration services andoutsourcing services to health plan clients;

•                  SoftwareServices - the delivery of blended shore software development; and

 

Additionally,the Company has four shared service centers that provide services to multiplebusiness segments. These shared service centers include FCG India, FCG Vietnam,Integration Services, and Infrastructure Services. The costs of these servicesare internally billed and reported in the individual business segments as costof services at a standard transfer cost.

 

The Companyevaluates its segments’ performance based on revenues and operating income. Certainselling and general and administrative expenses (including corporate functions,occupancy related costs, depreciation, professional development, recruiting,and marketing) are managed at the corporate level and allocated to eachoperating segment based on either net revenues and/or actual usage. The Companydoes not manage or track most assets by segment. As a result, interest and othercharges are not included in the tables below.

 

14

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The followingsegment information is for the three months and nine months ended September 28,2007 and September 29, 2006 (in thousands):

 

**For the three months endedSeptember 28, 2007:**

** **
| **(in thousands)**                       | ** ** | **Health  Delivery  Services** | ** ** | **Health  Delivery  Outsourcing** | ** ** | **Life  Sciences** | ** ** | **Health  Plans** | ** ** | **Software  Services** | ** ** | **Other**  |   | **Totals** | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|--------------------|------------|-------------------|------------|------------------------|------------|------------|--------|------------|------------|
| ** **                                    | ** ** | ** **                     | ** ** | ** **                        | ** ** | ** **         | ** ** | ** **        | ** ** | ** **             | ** ** | ** ** |   | ** ** | ** ** |
| Revenues before reimbursements                |       | $                              | 15,120     |                              | $          | 27,580             |       | $                 | 8,617      |                   | $          | 9,407      |   | $          | 6,096      |   | $ | — |   | **$** | **66,820** | ** ** |
| Reimbursements                                |       | 2,329                          |       | 195                               |       | 106                |       | 1,097             |       | 90                     |       | —     |   | **3,817**  | ** ** |
| Total revenues                                |       | 17,449                         |       | 27,775                            |       | 8,723              |       | 10,504            |       | 6,186                  |       | —     |   | **70,637** | ** ** |
| Cost of services before reimbursable expenses |       | 9,692                          |       | 23,065                            |       | 4,069              |       | 6,259             |       | 4,197                  |       | 496        |   | **47,778** | ** ** |
| Reimbursable expenses                         |       | 2,329                          |       | 195                               |       | 106                |       | 1,097             |       | 90                     |       | —     |   | **3,817**  | ** ** |
| Total cost of services                        |       | 12,021                         |       | 23,260                            |       | 4,175              |       | 7,356             |       | 4,287                  |       | 496        |   | **51,595** | ** ** |
| Gross profit                                  |       | 5,428                          |       | 4,515                             |       | 4,548              |       | 3,148             |       | 1,899                  |       | (496       | )      | **19,042** | ** ** |
| Selling expenses                              |       | 1,556                          |       | 314                               |       | 948                |       | 757               |       | 386                    |       | (148       | )      | **3,813**  | ** ** |
| General & administrative expenses         |       | 2,109                          |       | 2,066                             |       | 2,839              |       | 1,348             |       | 910                    |       | 960        |   | **10,232** | ** ** |
| Income (loss) from operations                 |       | $                              | 1,763      |                              | $          | 2,135              |       | $                 | 761        |                   | $          | 1,043      |   | $          | 603        |   | $ | (1,308 | ) | **$** | **4,997** | ** ** |

 

**For the three months endedSeptember 29, 2006:**

** **
| **(in thousands)**                       | ** ** | **Health  Delivery  Services** | ** ** | **Health  Delivery  Outsourcing** | ** ** | **Life  Sciences** | ** ** | **Health  Plan** | ** ** | **Software  Services** | ** ** | **Other**  | ** ** | **Totals** | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|--------------------|------------|------------------|------------|------------------------|------------|------------|------------|------------|------------|
| ** **                                    | ** ** | ** **                     | ** ** | ** **                        | ** ** | ** **         | ** ** | ** **       | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues before reimbursements                |       | $                              | 14,171     |                              | $          | 26,900             |       | $                | 8,152      |                   | $          | 8,074      |       | $          | 7,170      |   | $ | 299 | ** ** | **$** | **64,766** | ** ** |
| Reimbursements                                |       | 2,078                          |       | 32                                |       | 129                |       | 916              |       | 162                    |       | 1          | ** ** | **3,318**  | ** ** |
| Total revenues                                |       | 16,249                         |       | 26,932                            |       | 8,281              |       | 8,990            |       | 7,332                  |       | 300        | ** ** | **68,084** | ** ** |
| Cost of services before reimbursable expenses |       | 8,299                          |       | 23,307                            |       | 4,121              |       | 6,087            |       | 4,579                  |       | 13         | ** ** | **46,406** | ** ** |
| Reimbursable expenses                         |       | 2,078                          |       | 32                                |       | 129                |       | 916              |       | 162                    |       | 1          | ** ** | **3,318**  | ** ** |
| Total cost of services                        |       | 10,377                         |       | 23,339                            |       | 4,250              |       | 7,003            |       | 4,741                  |       | 14         | ** ** | **49,724** | ** ** |
| Gross profit                                  |       | 5,872                          |       | 3,593                             |       | 4,031              |       | 1,987            |       | 2,591                  |       | 286        | ** ** | **18,360** | ** ** |
| Selling expenses                              |       | 1,642                          |       | 283                               |       | 990                |       | 562              |       | 501                    |       | (40        | )          | **3,938**  | ** ** |
| General & administrative expenses         |       | 2,602                          |       | 1,878                             |       | 1,815              |       | 994              |       | 886                    |       | 600        | ** ** | **8,775**  | ** ** |
| Income (loss) from operations                 |       | $                              | 1,628      |                              | $          | 1,432              |       | $                | 1,226      |                   | $          | 431        |       | $          | 1,204      |   | $ | (274 | ) | **$** | **5,647** | ** ** |

 

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**For the nine months endedSeptember 28, 2007:**

** **
| **(in thousands)**                       | ** ** | **Health  Delivery  Services** | ** ** | **Health  Delivery  Outsourcing** | ** ** | **Life  Sciences** | ** ** | **Health  Plans** | ** ** | **Software  Services** | ** ** | **Other**  |   | **Totals**  | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|--------------------|------------|-------------------|------------|------------------------|------------|------------|--------|-------------|------------|
| ** **                                    | ** ** | ** **                     | ** ** | ** **                        | ** ** | ** **         | ** ** | ** **        | ** ** | ** **             | ** ** | ** ** |   | ** **  | ** ** |
| Revenues before reimbursements                |       | $                              | 44,885     |                              | $          | 84,204             |       | $                 | 26,889     |                   | $          | 25,422     |   | $           | 18,619     |   | $ | — |   | **$** | **200,019** | ** ** |
| Reimbursements                                |       | 6,924                          |       | 424                               |       | 327                |       | 2,655             |       | 326                    |       | —     |   | **10,656**  | ** ** |
| Total revenues                                |       | 51,809                         |       | 84,628                            |       | 27,216             |       | 28,077            |       | 18,945                 |       | —     |   | **210,675** | ** ** |
| Cost of services before reimbursable expenses |       | 28,825                         |       | 72,836                            |       | 11,724             |       | 17,804            |       | 13,408                 |       | 728        |   | **145,325** | ** ** |
| Reimbursable expenses                         |       | 6,924                          |       | 424                               |       | 327                |       | 2,655             |       | 326                    |       | —     |   | **10,656**  | ** ** |
| Total cost of services                        |       | 35,749                         |       | 73,260                            |       | 12,051             |       | 20,459            |       | 13,734                 |       | 728        |   | **155,981** | ** ** |
| Gross profit                                  |       | 16,060                         |       | 11,368                            |       | 15,165             |       | 7,618             |       | 5,211                  |       | (728       | )      | **54,694**  | ** ** |
| Selling expenses                              |       | 4,697                          |       | 861                               |       | 3,012              |       | 1,978             |       | 1,514                  |       | (316       | )      | **11,746**  | ** ** |
| General & administrative expenses         |       | 6,190                          |       | 6,058                             |       | 8,812              |       | 3,525             |       | 2,423                  |       | 2,445      |   | **29,453**  | ** ** |
| Income (loss) from operations                 |       | $                              | 5,173      |                              | $          | 4,449              |       | $                 | 3,341      |                   | $          | 2,115      |   | $           | 1,274      |   | $ | (2,857 | ) | **$** | **13,495** | ** ** |

 

**For the nine months endedSeptember 29, 2006:**

 
| **(in thousands)**                        | ** ** | **Health  Delivery  Services** | ** ** | **Health  Delivery  Outsourcing** | ** ** | **Life  Sciences** | ** ** | **Health  Plan** | ** ** | **Software  Services** | ** ** | **Other**  | ** ** | **Totals**  | ** ** |
|------------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|--------------------|------------|------------------|------------|------------------------|------------|------------|------------|-------------|------------|
| ** **                                     | ** ** | ** **                     | ** ** | ** **                        | ** ** | ** **         | ** ** | ** **       | ** ** | ** **             | ** ** | ** ** | ** ** | ** **  | ** ** |
| Revenues  before reimbursements                |       | $                              | 45,725     |                              | $          | 81,113             |       | $                | 24,238     |                   | $          | 22,307     |       | $           | 20,511     |   | $ | 1,339 | ** ** | **$** | **195,233** | ** ** |
| Reimbursements                                 |       | 6,720                          |       | 101                               |       | 528                |       | 2,770            |       | 427                    |       | 11         | ** ** | **10,557**  | ** ** |
| Total  revenues                                |       | 52,445                         |       | 81,214                            |       | 24,766             |       | 25,077           |       | 20,938                 |       | 1,350      | ** ** | **205,790** | ** ** |
| Cost  of services before reimbursable expenses |       | 27,722                         |       | 70,397                            |       | 13,411             |       | 15,940           |       | 12,624                 |       | 509        | ** ** | **140,603** | ** ** |
| Reimbursable  expenses                         |       | 6,720                          |       | 101                               |       | 528                |       | 2,770            |       | 427                    |       | 11         | ** ** | **10,557**  | ** ** |
| Total  cost of services                        |       | 34,442                         |       | 70,498                            |       | 13,939             |       | 18,710           |       | 13,051                 |       | 520        | ** ** | **151,160** | ** ** |
| Gross  profit                                  |       | 18,003                         |       | 10,716                            |       | 10,827             |       | 6,367            |       | 7,887                  |       | 830        | ** ** | **54,630**  | ** ** |
| Selling  expenses                              |       | 5,571                          |       | 715                               |       | 2,719              |       | 1,599            |       | 1,476                  |       | 39         | ** ** | **12,119**  | ** ** |
| General  & administrative expenses         |       | 7,613                          |       | 5,711                             |       | 6,052              |       | 3,111            |       | 2,444                  |       | 1,931      | ** ** | **26,862**  | ** ** |
| Income  (loss) from operations                 |       | $                              | 4,819      |                              | $          | 4,290              |       | $                | 2,056      |                   | $          | 1,657      |       | $           | 3,967      |   | $ | (1,140 | **)** | **$** | **15,649** | ** ** |

 

The “other” column includes reclassifications related to the chargingout of the shared service centers described above, with the net loss in thatcolumn primarily consisting of under absorption of shared service centers orsupport costs into the segments.

 

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The Company’s Software Products segment, which previously deliveredsolutions involving the use of software to health delivery clients, has beenaccounted for as a discontinued operation due to the completion of its sale onSeptember 12, 2007 (seeNote 7 of Notes to Consolidated Financial Statements). Certain corporategeneral and administrative expenses previously allocated to the SoftwareProducts business have been included in “Other” as corporate general andadministrative expenses cannot be allocated to a discontinued operation inaccordance with SFAS 144.

 

**Note 9****                   ****Income Taxes**

 

The Company recorded a $4.6million and $1.8 million tax benefit for the three and nine months endedSeptember 28, 2007 versus a $454,000 and $1.2 million tax provision for thethree and nine months ended September 29, 2006.

 

The 7% tax provision for thenine months ended September 29, 2006 was only for current taxes payable forU.S. federal alternative minimum tax and certain state and foreign incometaxes, as the net operating loss carryforwards offset most of the federal andcertain state tax liabilities. Since these carryforwards have a full valuationallowance applied against them, their use reduces the income tax rate.

 

The estimated tax rate in fiscal year 2007 of28% on continuing operations has increased significantly from the rateexperienced in fiscal year 2006 as the Company has exhausted its remaining taxloss carryforwards over the course of this year. Management expects that itstax provision in 2008 and thereafter will return to levels consistent withstatutory federal and state tax rates.

 

The valuation allowance for deferred incometaxes has been a particularly volatile estimate over the past four years, asthe Company’s level of income and loss has fluctuated, requiring the Company toreassess the likelihood of realization of the tax assets. Due to cumulativelosses the Company had incurred over the previous several years, the Companyrecorded a full valuation allowance against the deferred tax assets in fiscalyear 2005. In the third quarter of fiscal year 2007, the Company reversed $6.3million of that valuation allowance, due to the significant income the Companyhas earned in the past two years, and the expectations of future taxable incomein 2008 being more likely than not sufficient to realize that amount of taxasset. Due to the inherent risk in estimates of future earnings, the amount ofthe valuation allowance continues to be subject to variability in the future,and may significantly affect the Company’s effective tax rate.

 

The Company adopted the provisions of FASBInterpretation 48 (“FIN 48”) “Accounting for Uncertainty in Income Taxes” onthe first day of fiscal year 2007. As a result of the implementation of FIN 48,the Company recognized a $352,000 increase to its liability for uncertain taxpositions, which was accounted for as an adjustment to the beginning balance ofretained earnings. Including the amount recognized upon adoption at December30, 2006, the Company had approximately $2.9 million of liabilities forunrecognized tax positions included in taxes payable in the accompanyingconsolidated balance sheet at September 28, 2007, all of which, if recognized,would favorably affect the Company’s effective income tax rate.

 

The Company recognizes interest related touncertain tax positions as part of interest expense, and penalties as acomponent of income tax expense. As of the first day of fiscal year 2007, theCompany had accrued interest and penalty of approximately $500,000 associatedwith its uncertain tax positions. During the three and nine months endedSeptember 28, 2007, the Company recorded an additional $91,000 and $192,000 ofinterest for uncertain tax positions within interest expense.

 

The Company files a consolidated federalincome tax return and income tax returns with various states and foreigncountries. The Company is currently not under examination by the InternalRevenue Service and is no longer subject to federal income tax examination foryears before 2003. However, the 

 

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Company is undergoing income tax audits with various states and the earliestopen tax year under examination in any such state is 1999.

 

**Note 10****                 ****Health Plans Outsourcing Contract**

 

In April 2006, the Company began a $12 million outsourcing contract inthe Health Plans segment. This contract requires the Company to complete a systemimplementation prior to beginning the operations phase of the contract. Sincethe fair value of the operations phase is difficult to objectively verify inorder to separately account for it under EITF 00-21, the Company is accountingfor the arrangement as a single outsourcing service arrangement. Theimplementation phase of this contract is being accounted for as deferred cost,and all revenue from the implementation will be recognized over the period of outsourcing operations. Asa result, the Company expects to receive approximately $8 million of cash whichis being accounted for as a customer advance prior to earning revenue on thecontract, and the Company’s deferred costs on the balance sheet are increasingaccordingly. Management estimates that the implementation will be completed inMay 2008. With respect to the implementation services, there has been anincrease in cost and hours to complete the project, and the parties arecurrently in discussions regarding a contract amendment, the result of which isexpected to be little to no profit on the contract. As of September 28, 2007, the Company had deferred $6.6 million of contractcosts and $4.4 million of customer advances under this contract.

 

**Note 11                 ****Subsequent Event - PendingAcquisition by Computer Sciences Corporation**

 

On October 30, 2007, First ConsultingGroup, Inc. and Computer Sciences Corporation (“CSC”), entered into anAgreement and Plan of Merger, pursuant to which CSC will acquire all of theoutstanding stock of First Consulting Group for a purchase price of $13.00 pershare in cash, without interest.  Completion of the merger is subject to customaryconditions, including the approval of First Consulting Group’s shareholders,the absence of any material adverse effect on its business and applicableregulatory approvals.  The merger isexpected to close in the first quarter of 2008.

 

## **Item 2.  Management’s Discussion andAnalysis 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-LOOKINGSTATEMENTS INVOLVE RISKS AND UNCERTAINTIES, INCLUDING THOSE SET FORTH IN ITEM1A OF PART II OF THIS REPORT UNDER THE CAPTION “RISK FACTORS,” AND OTHERREPORTS WE FILE WITH THE SECURITIES AND EXCHANGE COMMISSION. OUR ACTUAL RESULTSCOULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKINGSTATEMENTS.

 

**PendingAcquisition by Computer Sciences Corporation**

 

On October 30, 2007, First ConsultingGroup, Inc. and Computer Sciences Corporation (“CSC”), entered into anAgreement and Plan of Merger, pursuant to which CSC will acquire all of ouroutstanding stock for a purchase price of $13.00 per share in cash, withoutinterest.  Completion of the merger issubject to customary conditions, including the approval of our shareholders,the absence of any material adverse effect on our business and applicableregulatory approvals.  The merger isexpected to close in the first quarter of 2008.

 

**Overview**

 

We provideservices primarily to providers, payors, government agencies, pharmaceutical,biogenetic, and other healthcare organizations in North America, Europe, andAsia. We generate substantially all of our revenues from fees for informationtechnology outsourcing services and professional services.

 

We typically bill for our services on an hourly or fixed-fee basis asspecified by the agreement with a particular client. In our consulting andsystems integration (“CSI”) businesses, we often bill our services on an hourlybasis, by multiplying the amount of time expended on each assignment by theproject hourly rate for the staff members assigned to the engagement. Fixedfees, including outsourcing fees, are established on a per-assignment ormonthly basis and are based on several factors such as the size, scope,complexity and duration of an assignment, the number of our employees requiredto complete 

 

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the assignment, and the volume oftransactions or interactions. Revenues are generally recognized based on thelevel of services performed, the amount of cost incurred on the assignmentversus the estimated total cost to complete the assignment, or on astraight-line basis over the period of performance of service. Additionally, wehave been licensing a gradually increasing amount of our software products,generally in conjunction with the customization and implementation of suchsoftware products. Revenues from our software licensing and maintenance wereapproximately 4.2% and 3.7% of our net revenues during the first nine months of2007 and 2006, respectively. We expect our software licensing and relatedimplementation revenues to continue to grow incrementally in the near future.

 

Provisions aremade for estimated uncollectible amounts based on our historical experience. Wemay obtain payment in advance of providing services. These advances arerecorded as customer advances and reflected as a liability on our balance sheetuntil services are provided. Provisions for estimated losses on individualcontracts are made in the period in which the loss first becomes known.

 

Out-of-pocketexpenses billed and reimbursed by clients are included in total revenues, andthen deducted to determine revenues before reimbursements (“net revenues”). Forpurposes of analysis, all percentages of revenues in this discussion are statedas a percentage of net revenues, since we believe that this is the morerelevant measure of our business.

 

Cost ofservices primarily consists of the salaries, bonuses, and related benefits ofclient-serving staff, subcontractor expenses, and infrastructure costs relatedto services provided to clients and in our offshore shared service center. Sellingexpenses primarily consist of the salaries, benefits, travel, and other costsof our sales force, as well as marketing and market research expenses. Generaland administrative expenses primarily consist of costs to support our businesssuch as non-billable travel, internal information systems and infrastructure,salaries and expenses for executive management, financial accounting andadministrative personnel, and legal and other professional services. As staffrelated costs are relatively fixed in the short term, variations in ourrevenues and operating results in our CSI business can occur as a result ofvariations in billing margins and utilization rates of our billable associates.

 

Our most significant expenses are our humanresource and related salary and benefit expenses. As of September 28, 2007,approximately 1,554 of our 2,492 employees are billable consultants andsoftware developers. Another 588 employees are part of our outsourcing business.The salaries and benefits of such billable staff and outsourcing relatedemployees are recognized in our cost of services. Most non-billable employeesalaries and benefits are recognized as a component of either selling orgeneral and administrative expenses. Approximately 14.0% of our workforce, or350 employees, are classified as non-billable. Our cost of services as apercentage of net revenues is directly related to several factors, including,but not limited to:

 

•                  Our staffutilization, which is the ratio of total billable hours to available work hoursin a given period;

•                  The amount andtiming of costs incurred;

•                  Our ability tocontrol costs on our outsourcing projects;

•                  The billed rateon time and material contracts; and

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

 

In our outsourcing contracts, a significantportion of our revenues are fixed and allocated over the contract on astraight-line basis, as we are required to provide a specified level of ongoingservices. Also, certain revenues may fluctuate under the contracts based on thevolume of transactions we process or other measurements of service provided. Ifwe incur higher costs to provide the required services or receive less revenuedue to reduced transaction volumes or penalties associated with service levelfailures, our gross profit can be negatively impacted.

 

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In our CSIbusiness, we manage staff utilization by monitoring assignment requirements andtimetables, available and required skills, and available staff hours per weekand per month. Differences in personnel utilization rates can result fromvariations in the amount of non-billed time, which has historically consistedof training time, vacation time, time lost to illness and inclement weather,and unassigned time. Non-billed time also includes time devoted to othernecessary and productive activities such as sales support and interviewingprospective employees. Unassigned time results from differences in the timingof the completion of an existing assignment and the beginning of a newassignment. In order to reduce and limit unassigned time, we actively managepersonnel utilization by monitoring and projecting estimated engagement startand completion dates and matching staff availability with current and projectedclient requirements. The number of people staffed on an assignment will varyaccording to the size, complexity, duration, and demands of the assignment. Assignmentterminations, completions, inclement weather, and scheduling delays may resultin periods in which staff members are not optimally utilized. An unanticipatedtermination of a significant assignment or an overall lengthening of the salescycle could result in a higher than expected number of unassigned staff membersand could cause us to experience lower margins. In addition, entry into newmarket areas and the hiring of staff in advance of client assignments haveresulted and may continue to result in periods of lower staff utilization.

 

In response tocompetition and continued pricing and rate pressures, we have implemented aglobal sourcing strategy into our business operations, which includes thedeployment of offshore resources as well as resources that perform servicesremote from the client site. We also incorporate larger numbers of variablecost or per diem staff in some of our projects. We expect these strategies tocontinue to reduce 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 passthrough reduced costs to our clients related to offshore resources, the globalsourcing strategy may result in lower revenues on a per engagement basis.However, we expect to offset this potential revenue impact with improvedcompetitive positioning in our markets, which could result in an increasednumber of engagements to offset the potential revenue impact. Several of ourcompetitors employ both global sourcing and variable staffing strategies toprovide software development and other information technology services to theirclients, while at the same time reducing their cost structure and improving thequality of services they provide. If we are unable to realize the perceivedcost benefits of our strategies or if we are unable to deliver qualityservices, our business may be adversely impacted and we may not be able tocompete effectively.

 

**Results of Operations for the Three Months Ended September 28, 2007 andSeptember 29, 2006**

 

*Revenues.*Our net revenues were $66.8 million for thequarter ended September 28, 2007, an increase of 3.2% from $64.8 million forthe quarter ended September 29, 2006. Our total revenues were $70.6 million forthe quarter ended September 28, 2007, an increase of 3.7% from $68.1 millionfor the quarter ended September 29, 2006. The Health Plans segment had the mostsignificant increase in net revenues compared to the quarter ended September29, 2006, $1.3 million, or 16.5%, primarily due to market acceptance of ourglobal delivery model by mid-size and large health plans. Health DeliveryServices revenues increased by $949,000, or 6.7% from a relatively weak quarterin the prior year. Software Services declined by $1.1 million, or 15.0%, asseveral of our larger clients have been acquired by other entities or reducedtheir scope of operations utilizing our services over the past year.

 

One of our existing majoroutsourcing contracts, University of Pennsylvania Health System (UPHS), expiredon March 31, 2007, and UPHS informed us in April 2007 that the contract wouldnot be renewed. Under the terms of the contract, the engagement automaticallyconverted to a six-month period of post-expiration transition services, whichwere concluded at the end of September 2007, at which time most of the serviceswe were performing on an outsourced basis transitioned back to the client. Theexpiring contract accounted for $26.7 million of our revenues in fiscalyear 2006 and $7.5 million and

 

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$23.5 million of our revenues in the three and nine months of 2007, ofwhich $5.3 million, $1.2 million, and $3.4 million, respectively, werezero-margin, pass-through revenues to a major infrastructure subcontractor. Weexpect to retain only about $500,000 per quarter of revenues from UPHS under anew contract for ongoing services. As a result, we expect significantly lowerrevenues in our Health Delivery Outsourcing business unit starting in thefourth quarter of 2007.

 

Revenues in our otherbusiness units are not expected to change significantly from current levels inthe near future, with some growth expected in Life Sciences and Health Plans. Growthin Health Delivery Services and in Health Delivery Outsourcing (exclusive ofthe UPHS contract) is highly dependent on capturing market share through ourrestructured sales model and acceptance by the health delivery market of ourglobal delivery model and clinical advisory services. We expect that thecurrent lower level of Software Services revenues we have experienced so far inthis fiscal year to continue in the near future. The market for our services inthis business segment is extremely competitive and we are seeking new clientsand new markets (such as overseas markets) to grow revenues back to their previouslevels.

 

*Cost of Services.*Cost of services before reimbursable expenseswas $47.8 million for the quarter ended September 28, 2007, an increase of 3.0%from $46.4 million for the quarter ended September 29, 2006. The increase wasprimarily due to a $1.4 million increase in costs in the Health DeliveryServices segment for additional resources to serve the increase in revenues inthat segment, partly offset by a $382,000 decrease in costs in SoftwareServices as resources were reduced in response to the lower level of revenues. Additionally,“Other” cost of services grew by $483,000 due to lower absorption of sharedservice center costs. This was primarily due to currency appreciation of over15% of the Indian rupee versus the United States dollar, increasing the cost ofIndian resources when translated to dollars. If the rupee continues toappreciate in value against the dollar, our ability to provide cost competitiveservices from our Indian offshore development center could be negativelyaffected.

 

*GrossProfit.*Gross profitwas $19.0 million, or 28.5% of net revenues, for the quarter ended September28, 2007, an increase of 3.7% from $18.4 million, or 28.3% of net revenues, forthe quarter ended September 29, 2006. This increase was primarily due to $1.2million of increased gross profit in the Health Plan segment related to theincrease in revenues.

 

Weexpect to see significantly lower gross profit in Health Delivery Outsourcingin the fourth quarter of this year due to the completion of the UPHS contract,as described above. This contract had a higher than normal gross profit of $1.4million in the third quarter of 2007, due to transition activities related tocompletion of the project.

 

*Selling Expenses.*Selling expenses were $3.8 million for thequarter ended September 28, 2007, a decrease of 3.2% from $3.9 million for thequarter ended September 29, 2006. Selling expenses as a percentage of netrevenues decreased slightly to 5.7% for the quarter ended September 28, 2007from 6.1% for the quarter ended September 29, 2006.

 

*General and AdministrativeExpenses.*General andadministrative expenses were $10.2 million for the quarter ended September 28,2007, an increase of 16.6% from $8.8 million for the quarter ended September29, 2006. General and administrative expenses as a percentage of net revenuesincreased to 15.3% for the quarter ended September 28, 2007 from 13.5% for thequarter ended September 29, 2006. General and Administrative expenses grew $1.0million in Life Sciences, primarily related to spending on our FirstPointTMproduct subsequent to the acquisition of Zorch, Inc. in June 2007. Additionally,we spent approximately $600,000 during the third quarter of 2007 on legal costsassociated with the Company's process to enter into a merger agreement, whichwas signed on October 30, 2007. (see Note 11 of Notes to Consolidated FinancialStatements).

 

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*Interest Income, Net.*Interest income, net of interest expense, was$976,000 for the quarter ended September 28, 2007, an increase of 51.1% from$646,000 for the quarter ended September 29, 2006, primarily due to higherinterest rates earned on higher cash and investments balances. Interest income,net of interest expense, as a percentage of net revenues increased to 1.5% forthe quarter ended September 28, 2007 from 1.0% for the quarter ended September29, 2006.

 

*Other Income (Expense), Net*. Other income (expense) was negligible forthe quarters ended September 28, 2007 and September 29, 2006.

 

*Income Taxes.*We recorded a $4.6 million tax benefit forthe quarter ended September 28, 2007, compared to a $454,000 tax provision forthe quarter ended September 29, 2006. The benefit in the current quarter is dueto a $1.8 million provision (29.3% tax rate) on pretax income for the quarter,and a $6.3 million tax benefit due to the reversal of valuation allowance. Thisreversal is due to the realization of our remaining deferred tax assetsbecoming more likely than not based on the significant pretax income we are nowgenerating and management’s estimate of continuing profitability in 2008. The7.3% tax provision for the quarter ended September 29, 2006 was only forcurrent taxes payable for U.S. federal alternative minimum tax and certainstate and foreign income taxes, as our net operating loss carryforwards, whichwere fully reserved, offset most of the federal and certain state taxliabilities.

 

Our estimated tax rate in fiscal year 2007 of 28% on continuingoperations has increased significantly from the rate experienced in fiscal year2006 as we have exhausted our remaining tax loss carryforwards over the courseof this year. We expect that our tax provision in 2008 and thereafter willreturn to levels consistent with statutory federal and state tax rates. Duringthis 2007 transition, when our loss carryforwards cover only a part of ourexpected pretax income, our full year tax rate is subject to variation fromquarter to quarter, as changes in our estimated level of pretax income cansignificantly impact the tax rate.

 

*Income from Discontinued Operations.*We completed the sale of the SoftwareProducts business on September 12, 2007 and the disposition has been accountedfor as a discontinued operation. We had income from discontinued operations of$10.0 million in the quarter ended September 28, 2007, compared to income fromdiscontinued operations of $288,000 in the quarter ended September 29, 2006. Wereceived $13.8 million in cash from the sale resulting in a pretax gain fromthe disposition of discontinued operations of $17.1 million, which includes certainsoftware subscription revenue we had deferred as a customer advance, net of therelated deferred costs.

 

In August 2006, we sold the Cyberview software product and relatedintellectual property and service contracts to Medisolv, Inc and recognized$691,000 of pretax gain from the disposition of discontinued operation for thethree months ended September 29, 2006. During the quarter ended September 28,2007, we incurred an $824,000 pretax operating loss from this discontinuedoperation, compared to a $399,000 pretax operating loss for the quarter endedSeptember 29, 2006. We applied a 38.3% incremental tax rate to the discontinuedoperations in fiscal year 2007 compared to a 1.4% rate in fiscal year 2006 dueto the use of net operating loss carryforwards available in that year. We donot expect any significant future gain or loss related to the discontinuance ofthe Software Products segment of our business.

 

**Results of Operations for the Nine months Ended September 28, 2007 andSeptember 29, 2006**

 

*Revenues.*Our net revenues were $200.0 million for thenine months ended September 28, 2007, an increase of 2.5% from $195.2 millionfor the nine months ended September 29, 2006. Our total revenues were $210.7million for the nine months ended September 28, 2007, an increase of 2.4% from$205.8 million for the nine months ended September 29, 2006. The increases innet revenues were in Health Plans, Health Delivery Outsourcing, and LifeSciences, and offset by decreases in Software

 

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Services and Health Delivery Services. Health Plans revenues increasedby $3.1 million, or 14.0%, due to increased market acceptance of our globaldelivery model by mid-size and large health plans. Health Delivery Outsourcingrevenues grew by $3.1 million, or 3.8%, due to slightly higher revenues atexisting accounts and transition services on a terminated contract. LifeSciences net revenues increased by $2.7 million, or 10.9%, due to moreextensive implementation work being performed for our FirstDoc® softwareclients. Software Services revenues decreased by $1.9 million, or 9.2%, asseveral of our larger clients have been acquired by other entities or reducedtheir scope of operations utilizing our services over the past year.

 

*Cost of Services.*Cost of services before reimbursable expenseswas $145.3 million for the nine months ended September 28, 2007, an increase of3.4% from $140.6 million for the nine months ended September 29, 2006. Theincrease was primarily due to a $2.4 million increase in costs in the HealthDelivery Outsourcing segment, a $1.9 million increase in costs in the HealthPlans segment, and a $1.1 million increase in costs in the Health Deliverysegment, all directly related to the respective increases in revenues in thosesegments described above. Additionally, Software Services cost of servicesincreased by $784,000, because labor costs increased in the early part of thisyear due to the loss of higher margin projects and their replacement with lowermargin projects which require more resources to achieve the same revenues. Theseincreases are partially offset by a $1.7 million decrease in Life Scienceslabor and other costs due to improved efficiency in performing Life Sciencesimplementation projects.

 

*Gross Profit.*Gross profit was $54.7 million,or 27.3% of net revenues, for the nine months ended September 28, 2007, aslight increase of 0.1% from $54.6 million, or 28.0% of net revenues, for thenine months ended September 29, 2006. This was a result of increases in grossprofit in Life Sciences and Health Plans, offset by decreases in SoftwareServices and Health Delivery Services. Gross profit increased by $4.3 millionin Life Sciences due to increased revenues and decreased costs as describedabove. Health Plans gross profit increased by $1.3 million due to the increasein revenues. Software Services gross profit decreased by $2.7 million andHealth Delivery Services gross profit decreased by $1.9 million, in both casesdue to a combination of a revenue decline and a modest cost increase, asdescribed above.

 

*Selling Expenses.*Selling expenses were $11.7 million for thenine months ended September 28, 2007, a slight decrease of 3.1% from $12.1million for the nine months ended September 29, 2006. Selling expenses as apercentage of net revenues also decreased to 5.9% for the nine months endedSeptember 28, 2007 from 6.2% for the nine months ended September 29, 2006.

 

*General and AdministrativeExpenses.*General andadministrative expenses were $29.5 million compared to $26.9 million for thenine months ended September 29, 2006. This is primarily due to a $1.6 millioncharge in the second quarter of 2007 for acquired in-process research anddevelopment expense related to the Zorch acquisition (see Note 4 of Notes toConsolidated Financial Statements). Excluding this item, general andadministration expenses would have increased 3.8% to $27.9 million for the ninemonths ended September 28, 2007 from $26.9 million for the nine months endedSeptember 29, 2006. General and administrative expenses as a percentage of netrevenues were 14.7% of revenues for the nine months ended September 28, 2007,but would have increased slightly to 13.9% for the nine months ended September28, 2007 from 13.8% for the nine months ended September 29, 2006, exclusive ofthe in-process research and development charge from the Zorch acquisition.

 

*Interest Income, Net.*Interest income, net of interest expense, was$2.8 million for the nine months ended September 28, 2007, an increase of 96.6%from $1.4 million for the nine months ended September 29, 2006, due to higherinterest rates earned on higher cash and investments balances. Interest income,net of interest expense, as a percentage of net revenues increased to 1.4% forthe nine months ended September 28, 2007 from 0.7% for the nine months endedSeptember 29, 2006.

 

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*Other Income (Expense), Net*. Other income (expense) was negligible forthe nine months ended September 28, 2007 and September 29, 2006.

 

*Income Taxes.*We recorded a $1.8 million tax benefit forthe nine months ended September 28, 2007, compared to a $1.2 million taxprovision for the nine months ended September 29, 2006. The benefit in the ninemonths of 2007 is due to a $4.6 million provision (28.0% tax rate) on pretaxincome for the nine months, and a $6.3 million tax benefit due to the reversalof valuation allowance in the third quarter of the year. This reversal is due tothe realization of our remaining deferred tax assets becoming more likely thannot based on the significant pretax income we are now generating and management’sestimate of continuing profitability in 2008. The 7.0% tax provision for thenine months ended September 29, 2006 was only for current taxes payable forU.S. federal alternative minimum tax and certain state and foreign incometaxes, as our net operating loss carryforwards, which were fully reserved,offset most of the federal and certain state tax liabilities.

 

*Income from Discontinued Operations.*We completed the sale of the SoftwareProducts business on September 12, 2007 and the disposition has been accountedfor as a discontinued operation. We had income from discontinued operations of$9.4 million in the nine months ended September 28, 2007, compared to a lossfrom discontinued operations of $47,000 in the nine months ended September 29,2006. We received $13.8 million in cash from the sale resulting in a pretaxgain from the disposition of discontinued operations of $17.1 million, whichincludes certain software subscription revenue we had deferred as a customeradvance, net of the related deferred costs.

 

In August 2006, we sold the Cyberview software product and relatedintellectual property and service contracts to Medisolv, Inc and recognized$694,000 of pretax gain from the disposition of discontinued operation for thenine months ended September 29, 2006. During the nine months ended September28, 2007, we incurred a $1.9 million pretax operating loss from thisdiscontinued operation, compared to a $739,000 pretax operating loss for thenine months ended September 29, 2006. We applied a 38.3% incremental tax rateto the discontinued operations in fiscal year 2007 compared to a 1.4% rate infiscal year 2006 due to the use of net operating loss carryforwards availablein that year.

 

**Liquidity and Capital Resources**

 

At September 28, 2007, we had cash andinvestments available for sale of $98.4 million compared to $63.5 million atDecember 29, 2006. During the nine months ended September 28, 2007, wegenerated cash flow from operations of $21.0 million which primarily consistedof $18.0 million of net income from continuing operations. Additionally, ourcash flow benefited from $4.2 million of stock option exercises.

 

Our days sales outstanding (DSO) of accountsreceivable (including unbilled receivables and customer advances) increased to33 days for the third quarter of 2007 from 31 days for the fourth quarter of2006. We expect our DSO to increase in the fourth quarter of this year due tothe completion of the UPHS contract (see Results of Operations – Revenues),since that contract comprised over 10% of revenues, but very little accountsreceivable. We do not currently anticipate any other significant changes in DSO.During the fourth quarter, we expect to pay approximately $9 million of incometaxes, primarily related to the gain on the sale of discontinued operations,but also related to our pretax income from continuing operations as we haveexhausted our net operating loss carryforwards. We do not currently expect anyother significant cash flow changes related to the other elements of theworking capital cycle such as accounts payable and accrued liabilities;however, we are susceptible to ongoing routine fluctuations in these areas.

 

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We used $2.5 million of cash during the ninemonths ended September 28, 2007 to purchase property and equipment, primarilyinformation technology and related equipment, while incurring approximately$4.5 million of depreciation and amortization.

 

We used $2.0 million of cash in June 2007 forthe purchase of Zorch (see Note 4 of Notes to Consolidated FinancialStatements). Additionally, up to $2.0 million of additional payments may becomepayable to the previous shareholders of Zorch within the next year based on theachievement of certain revenue targets related to the acquired business, andadditional amounts may become payable in future years if operating income fromthe acquired business exceeds 14% of revenues during an earnout period thatcommences in the second half of 2008 and ends in the first quarter of 2011.

 

Our cash flow in fiscal year 2007 is highlydependent on our ability to continue to be profitable. Generally, we expect anynet profitability in fiscal year 2007 to contribute positively to cash flow.

 

As of September 28, 2007, the following tablesummarizes our contractual commitments (in thousands):

 
| ** **                          | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligation**     | ** ** | **Less than 1  Year**           | ** ** | **1 - 3  Years** | ** ** | **3 - 5  Years** | ** ** | **Total** | ** ** |
| Operating  leases, net of subleases |       | $                                         | 3,395      |   | $ | 3,870 |   | $ | 2,264 | ** ** | **$** | **9,529** | ** ** |
| Purchase  obligations               |       | 599                                       |       | 352 |   | — | ** ** | **951** | ** ** |
| Total                               |       | $                                         | 3,994      |   | $ | 4,222 |   | $ | 2,264 | ** ** | **$** | **10,480** | ** ** |

 

Additionally,as of September 28, 2007, we had $2.9 million of current liabilities in theconsolidated balance sheet for unrecognized tax positions. However, the periodsof cash settlement with the respective tax authorities cannot be reasonablyestimated.

 

Management believes that our existing cashand cash equivalents, together with funds generated from operations, will besufficient to meet operating requirements for at least the next twelve months. Ourcash and cash equivalents are available for capital expenditures (which are projectedat approximately $5 million for 2007), upfront setup costs and deferred fees onnew contracts, strategic investments, mergers and acquisitions (including theadditional payments related to the Zorch acquisition), and other potentiallarge-scale cash needs that may arise. In addition, we may consider incurringindebtedness or issuing debt or equity securities in the future to fundpotential acquisitions or investments, or for general corporate purposes.

 

**Off-Balance Sheet Arrangements**

 

None.

 

**Critical Accounting Policies and Estimates**

 

The foregoingdiscussion and analysis of our financial condition and results of operations isbased upon our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United States. Thepreparation of these financial statements requires us to make estimates andassumptions that affect the reported amounts of assets, liabilities, revenuesand expenses, and related disclosure of contingent assets and liabilities. Onan ongoing basis, we evaluate our estimates, including those related to revenuerecognition, cost to complete client engagements, valuation of goodwill andlong-lived and intangible assets, accrued liabilities, income taxes,restructuring costs, idle facilities, litigation and disputes, and theallowance for doubtful accounts. We base our estimates on historical experienceand on various other assumptions that we believe to be reasonable under the

 

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circumstances, the results of which form thebasis for making judgments about the carrying value of assets and liabilitiesthat are not readily apparent from other sources. Our actual results may differfrom our estimates and we do not assume any obligation to update anyforward-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, AccountsReceivable, and Unbilled Receivables***

 

Revenues arederived primarily from information technology outsourcing services, consulting,and systems integration. Revenues are recognized on a time-and-materials,level-of-effort, percentage-of-completion, or straight-line basis. Beforerevenues are recognized, the following four criteria must be met: (a)persuasive evidence of an arrangement exists; (b) delivery has occurred orservices rendered; (c) the fee is fixed and determinable; and (d)collectability is reasonably assured. We determine if the fee is fixed anddeterminable and collectability is reasonably assured based on our judgmentsregarding the nature of the fee charged for services rendered and productsdelivered. Arrangements vary in length from less than one year to seven years. Thelonger-term arrangements are generally level-of-effort or fixed pricearrangements.

 

Revenues fromtime-and-materials arrangements are generally recognized based upon contractedhourly billing rates as the work progresses. Revenues from level-of-effortarrangements are recognized based upon a fixed price for the level of resourcesprovided. Revenues from fixed fee arrangements for consulting and systemsintegration work are generally recognized on a rate per hour or percentage-of-completionbasis. 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 follow this method because reasonably dependableestimates of the revenues and costs applicable to various stages of a contractcan be made.

 

Revenuesrecognized on fixed price consulting and system integration contracts aresubject to revisions as the contract progresses to completion. If we do notaccurately estimate the resources required or the scope of the work to beperformed, do not complete our projects within the planned periods of time, ordo not satisfy our obligations under the contracts, then profit may besignificantly and negatively affected. 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. At September 28, 2007, we did not identify any contracts that requiredan accrual for losses. Some contracts include incentives for achieving eitherschedule targets, cost targets, or other defined goals. Revenues from incentivetype arrangements are recognized when it is probable they will be earned.

 

We account forcertain of our outsourcing contracts using EITF 00-21, “Accounting for RevenueArrangements with Multiple Deliverables,” which addresses how to account forarrangements that involve the delivery or performance of multiple products,services, and/or rights to use assets. Revenue arrangements with 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 is allocatedamong the separate units of accounting based on their relative fair values,with the amount allocated to the delivered

 

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item being limited to the amount that is notcontingent on the delivery of additional items or meeting other specifiedperformance conditions.

 

In ouroutsourcing contracts, a significant portion of our revenues are fixed andallocated over the contract on a straight-line basis, as we are required toprovide a specified level of services subject to certain performancemeasurements. Also, certain revenues may fluctuate under the contracts based onthe volume of transactions we process or other measurements of service provided.If we incur higher costs to provide the required services or receive lowerrevenues due to reduced transaction volumes or penalties associated withservice level failures, 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 costs are incurred and realization of thosecosts is either paid for upfront or guaranteed by the contract, those costs aredeferred and later expensed over the period of recognition of the relatedrevenue. At September 28, 2007 and December 29, 2006, we had deferred $8.7million and $5.3 million, respectively, of unamortized costs which are includedin non-current assets.

 

In April 2006,we began a $12 million outsourcing contract in the Health Plans segment. Thiscontract requires us to complete a system implementation prior to beginning theoperations phase of the contract. Since the fair value of the operations phaseis difficult to objectively verify in order to separately account for it underEITF 00-21, we are accounting for the arrangement as a single outsourcingservice arrangement. The implementation phase of this contract is beingaccounted for as deferred cost, and all revenue from the implementation will berecognized over the period of outsourcing operations. As a result, we expect toreceive approximately $7 million of cash which is being accounted for as acustomer advance prior to earning revenue on the contract, and our deferredcosts on the balance sheet are increasing accordingly. We estimate that theimplementation will be completed in May 2008. With respect to theimplementation services, there has been an increase in cost and hours tocomplete the project, and the parties are currently in discussions regarding acontract amendment, the result of which is expected to be little to no profiton the contract. As of September 28, 2007, we had deferred $6.6 million of contractcosts and $4.4 million of customer advances under this contract.

 

As part of ourongoing 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.

 

Softwarelicense and maintenance revenues comprised 4.2% of our net revenues for thenine months ended September 28, 2007. Additionally, we realized additionalrevenues from the implementation of our software. We recognize softwarerevenues in accordance with the provisions of the American Institute ofCertified Public Accountants Statement of Position (“SOP”) 97-2, “SoftwareRevenue Recognition”, as amended by SOP 98-9, “Modification of SOP 97-2,Software Revenue Recognition, With Respect to Certain Transactions”, and inaccordance with the Securities and Exchange Commission Staff AccountingBulletin (“SAB”) 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. Most of our software license fee revenues arefrom arrangements which include implementation services that are essential tothe functionality of our software products, and are recognized using contractaccounting, including the percentage-of-completion methodology, over the periodof the implementation.

 

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In those morelimited cases where our software arrangements do not include services essentialto the functionality of the product, license fee revenues are recognized whenthe software product has been shipped, provided a non-cancelable licenseagreement has been signed, there are no uncertainties surrounding productacceptance, the fees are fixed or determinable and collection of the relatedreceivable is considered probable. We do not generally offer rights of returnor acceptance clauses to our customers. In situations where we do providerights of return or acceptance clauses, revenue is deferred until the clauseexpires. Typically, our software license fees are due within a twelve-monthperiod from the date of shipment. If the fee due from the customer is not fixedor determinable, including payment terms greater than twelve months fromshipment, revenue is recognized as payments become due and all other conditionsfor revenue recognition have been satisfied. In software arrangements thatinclude rights to multiple software products, specified upgrades, maintenanceor services, we allocate the total arrangement fee among the deliverables usingthe fair value of each of the deliverables determined using vendor-specificobjective evidence. Vendor-specific objective evidence of fair value isdetermined using the price charged when that element is sold separately. Insoftware arrangements in which we have fair value of all undelivered elementsbut not of a delivered element, we use the residual method to record revenue.Under the residual method, the fair value of the undelivered elements isdeferred and the remaining portion of the arrangement fee is allocated to thedelivered element(s) and is recognized as revenue. In software arrangements inwhich we do not have vendor-specific objective evidence of fair value of allundelivered elements, revenue is deferred until fair value is determined or allelements have been delivered, or is spread over the term of an arrangement as asubscription.

 

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.

 

At September28, 2007 and December 29, 2006, we had unbilled receivables of $17.8 millionand $12.1 million, respectively, which represent revenues recognized forservices performed that were not billed at the balance sheet date. The majorityof these amounts are billed in the subsequent month; however, certainunbillable amounts arising from contracts occur when revenues recognized exceedallowable billings in accordance with the contractual agreements. Suchunbillable amounts most often become billable upon reaching certain projectmilestones stipulated per the contract, or in accordance with the percentage ofcompletion methodology. As of September 28, 2007, we had unbillable amounts ofapproximately $3.3 million, which are generally expected to be billed withinone year.

 

We hadlong-term accounts receivable at September 28, 2007 and December 29, 2006 of$2.3 million and $2.4 million. Of the long-term account receivable of $2.3million at September 28, 2007, $1.3 million was created in August 2005 throughthe deferral until 2009 of the first month of fees of a new outsourcingcontract. In January 2006, an additional amount of approximately $800,000related to this contract was deferred until 2009. Both deferrals were inaccordance with the terms of the contract executed with this client in July2005. Imputed interest income at a rate of 7.0% of $119,000 was accrued duringthe first nine months of 2007 on this receivable. Unamortized discount of$398,000 remained at September 28, 2007.

 

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.

 

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***Allowance for Doubtful Accounts***

 

We maintain an allowance for doubtfulaccounts for estimated losses resulting from the inability of our clients tomake required payments. This allowance is based on the amount and aging of ouraccounts receivable, creditworthiness of our clients, historical collectionexperience, current economic trends, and changes in client payment patterns. Ifthe financial condition of our clients was to deteriorate, resulting in animpairment of their ability to make payments, additional allowances would berequired. Our bad debt losses have generally been moderate due to the size andquality of our customers; however, we have recently incurred some bad debtlosses in our growing Software Services segment due to the lower credit qualityof our clients in that segment. Should one of our larger clients unexpectedlybecome unable to pay us, our allowance would have to increase significantly. Ourallowance for doubtful accounts at September 28, 2007 and December 29, 2006included specific reserves of approximately $537,000 and $899,000, respectivelyfor identified customer balances that are uncertain of collection, primarilytwo accounts in our Software Services segment, and a general reserve ofapproximately $750,000 for unknown losses.

 

***Deferred IncomeTaxes***

 

We account for income taxes in accordancewith SFAS 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 which differ fromour tax returns. We use significant estimates in determining what portion ofour deferred tax asset is more likely than not to be realized. We have alsorecorded a provision for uncertain tax positions in accordance with FIN 48, “Accountingfor Uncertainty in Income Taxes,” based on management’s estimate of potentialtax liabilities for open tax years.

 

Our valuation allowance for deferred incometaxes has been a particularly volatile estimate over the past four years, asour level of income and loss has fluctuated, requiring us to reassess thelikelihood of realization of our tax assets. Due to cumulative losses we hadincurred over the previous several years, we recorded a full valuationallowance against our deferred tax assets in fiscal year 2005. In the thirdquarter of fiscal year 2007, we reversed $6.3 million of that valuationallowance, due to the significant income we have earned in the past two years,and our expectations of future taxable income in 2008 being more likely thannot sufficient to realize that amount of tax asset. Due to the inherent risk inestimates of future earnings, the amount of our valuation allowance continuesto be subject to variability in the future, and may significantly affect oureffective tax rate.

 

***Goodwill andIntangible Assets***

 

Under SFAS142, we complete an annual impairment testing which is performed during thefourth 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.  Various assumptions, suchas discount rates, and comparable company analysis are used in performing thesevaluations. The impairment test requires us to forecast our future cash flows,which involves significant judgment.   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.  Weperformed an impairment test on each of our components of goodwill as of thefourth quarter of fiscal year 2006 and determined that none of our goodwill wasimpaired. As of September 28, 2007, we have $18.0 million of goodwill and$170,000 of amortizable intangible assets recorded on our balance sheet (seeNote 5 of the Notes to Consolidated Financial Statements included in thisreport).

 

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***Recent AccountingPronouncements***

 

InSeptember 2006 and February 2007, respectively, the FASB issued SFAS 157, “FairValue Measurements” and SFAS 159, “The Fair Value Option of Financial Assetsand Financial Liabilities (see Recent Accounting Pronouncements in Note 1 ofthe financial statements in Item 1 of this report).

 

In June 2006,the FASB issued FASB Interpretation 48, “Accounting for Uncertainty in IncomeTaxes” (see Recent Accounting Pronouncements in Note 1 of the financialstatements in Item 1 of this report).

 

## **Item 3. Quantitative and Qualitative Disclosuresabout Market Risk**

## ** **

Our financialinstruments include cash and cash equivalents, short-term and long-terminvestments, accounts receivable, unbilled receivables, and accounts payable. Onlythe cash and cash equivalents, and short-term and long-term investments whichtotaled $98.4 million at September 28, 2007 present us with market riskexposure resulting primarily from changes in interest rates.  Based onthis balance, a change of one percent in the interest rate would cause a changein interest income for the annual period of approximately $984,000.  Ourobjective in maintaining these investments is the flexibility obtained inhaving cash available for payment of accrued liabilities and acquisitions.

 

## **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 and procedures are designed to provide areasonable level of assurance of reaching our desired disclosure controlobjectives.

 

As required by SEC Rule 13a-15(b), we carried out anevaluation, under the supervision and with the participation of our management,including our Chief Executive Officer and our Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures as of December 29, 2006. Based on the foregoing, our Chief ExecutiveOfficer and Chief Financial Officer concluded that, except as indicated in theparagraph below, our disclosure controls and procedures were effective, andwere operating at the reasonable assurance level.

 

As previouslydisclosed in Item 9A to our Annual Report on Form 10-K for the fiscal yearended December 30, 2005, our Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were noteffective as of the end of that year because we did not maintain effectivecontrols over the determination and reporting of our provision for incometaxes, and we had a “material weakness” in internal controls as defined inAudit Standard No. 2 adopted by the Public Company Accounting Oversight Board. InAugust 2006, we hired a new tax director with experience in calculatingdeferred tax assets, and in applying SFAS 109, “Accounting for Income Taxes.”   The new tax director has improved theprocess and review controls over the calculation of our tax provision since herarrival. Because the tax provision is an annual process, and the new processand review controls were implemented during the course of fiscal year 2006,there has been insufficient time to validate that such controls and proceduresare operating at a level to have remediated the previous material weakness, andthat it therefore still existed as of December 29, 2006 and September 28, 2007.

 

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Other than as described above, there has been no changein our internal controls over financial reporting during our most recent fiscalnine months that has materially affected, or is reasonably likely to materiallyaffect, our internal controls over financial reporting.

 

# **PART II. OTHER INFORMATION**

#  

## **Item 1. Legal Proceedings**

## ** **

From time totime, we may be involved in claims or litigation that arise in the normalcourse of business. We are not currently a party to any legal proceedings,which, if decided adversely to us, would have a material adverse effect on ourbusiness, financial condition, or results of operations.

 

## **Item 1A. Risk Factors**

## ** **

Except as setforth below, there have been no material changes from risk factors aspreviously disclosed in response to Item 1A in Part I of our 2006 10-K.

 

*Failure tocomplete the merger with Computer Sciences Corporation could negatively impactour stock price and adversely affect our future financial condition,operations, and prospects.*

 

The proposedmerger with ComputerSciences Corporation ("CSC") is subject to the satisfaction ofclosing conditions, including the approval by the holders of a majority of our outstandingshares of common stock and other conditions described in the merger agreement. Wecannot be assured that these conditions will be satisfied or that the proposedmerger will be successfully completed. In the event that the proposed merger isnot completed:

 

•                  Management’sattention from our day-to-day business may be diverted;

 

•                  We may lose keyemployees;

 

•                  Ourrelationships with our customers and business partners may be disrupted as aresult of uncertainties with regard to our business and prospects;

 

•                  We may berequired to pay a termination fee of $10.9 million to CSC in specificcircumstances if the merger agreement is terminated;

 

•                  We will be requiredto pay significant transaction costs related to proposed merger, such as legal,accounting, and other fees; and

 

•                  The market priceof shares of our common stock may decline to the extent that the current marketprice of those shares reflects a market assumption that the proposed mergerwill be completed.

 

Any of these events couldadversely affect our stock price, business, cash flows, and operating results.

 

In addition, our current andprospective employees may experience uncertainty about their future role withCSC until CSC’s strategies with regard to us are announced or executed. Thismay adversely affect our ability to attract and retain key management,consulting associates, sales and marketing and other personnel.

 

We intend to comply with thesecurities and antitrust laws of the United States and any other jurisdictionin which the proposed transaction is subject to review. The reviewingauthorities may seek to

 

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impose conditions before giving theirapproval or consent to the transaction. A delay in obtaining the necessaryregulatory approvals will delay the completion of the transaction. We have notyet obtained any governmental or regulatory approvals required to complete thetransaction. We may be unable to obtain these approvals or to obtain themwithin the timeframe contemplated by the merger agreement.

 

If the merger agreement isterminated and our board of directors determines to seek another merger orbusiness combination, it may not be able to find a partner willing to pay anequivalent or more attractive price than that which would have been paid in themerger with CSC.

 

## **Item 2. Unregistered Sales of Equity Securitiesand Use of Proceeds**

## ** **

None.

 

## **Item 3. Defaults Upon Senior Securities**

## ** **

None.

 

## **Item 4. Submission of Matters to a Vote ofSecurity Holders**

## ** **

None.

 

## **Item 5. Other Information**

## ** **

None.

 

## **Item 6. Exhibits**

## ** **

| **Item**  | ** ** | **Description**                                                                                  |
|-----------|------------|--------------------------------------------------------------------------------------------------|
| 3.1 (1)   |       | Certificate of Incorporation of the Company                                                      |
| 3.1.1 (2) |       | Certificate of Amendment to Certificate of Incorporation of the  Company effective June 12, 2007 |
| 3.2 (3)   |       | Certificate of Designation of Series A Junior Participating Preferred  Stock                     |
| 3.3 (4)   |       | Bylaws of the Company                                                                            |
| 3.3.1 (5) |       | Amendment to the Bylaws of the Company effective June 12, 2007                                   |
| 4.1 (6)   |       | Specimen Common Stock Certificate                                                                |
| 11.1 (7)  |       | 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 3.1.1 to FCG’s Quarterly Report on Form 10-Q for thequarter ended June 29, 2007.

 

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

 

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(4)          Incorporated byreference to Exhibit 3.3 to FCG’s Form S-1.

 

(5)          Incorporated byreference to Exhibit 3.3.1 to FCG’s Quarterly Report on Form 10-Q for thequarter ended June 29, 2007.

 

(6)          Incorporated byreference to Exhibit 4.1 to FCG’s Form S-1.

 

(7)          See Note 1 of Notes toConsolidated Financial Statements, “Basic and Diluted Net Income Per Share.”

 

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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 on its behalf by the undersigned thereuntoduly authorized.

 
|                         | FIRST CONSULTING GROUP, INC.      |
|------------------------------|-----------------------------------|
|                         |                              |
|                         |                              |
| Date:  November 7, 2007 | /s/LARRY R. FERGUSON              |   |
|                         | Larry R. Ferguson                 |
|                         | Chief Executive Officer           |
|                         |                              |
|                         |                              |
| Date:  November 7, 2007 | /s/THOMAS A WATFORD               |   |
|                         | Thomas A. Watford                 |
|                         | Chief Operating Officer and Chief |
|                         | Financial Officer                 |
|                              |                                   |  |  |

 

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# **EXHIBIT INDEX**

** **
| **Item**  | ** ** | **Description**                                                                                  |
|-----------|------------|--------------------------------------------------------------------------------------------------|
| 3.1 (1)   |       | Certificate of Incorporation of the Company                                                      |
| 3.1.1 (2) |       | Certificate of Amendment to Certificate of Incorporation of the  Company effective June 12, 2007 |
| 3.2 (3)   |       | Certificate of Designation of Series A Junior Participating Preferred  Stock                     |
| 3.3 (4)   |       | Bylaws of the Company                                                                            |
| 3.3.1 (5) |       | Amendment to the Bylaws of the Company effective June 12, 2007                                   |
| 4.1 (6)   |       | Specimen Common Stock Certificate                                                                |
| 11.1 (7)  |       | 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 3.1.1 to FCG’s Quarterly Report on Form 10-Q for thequarter ended June 29, 2007.

 

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

 

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

 

(5)   Incorporatedby reference to Exhibit 3.3.1 to FCG’s Quarterly Report on Form 10-Q for thequarter ended June 29, 2007.

 

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

 

(7)   SeeNote 1 of Notes to Consolidated Financial Statements, “Basic and Diluted NetIncome Per Share.”

 

35

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