**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,DC  20549**

 

----

 

**FORM 10-Q**

**(Mark One)**

 

| o                                                      | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|--------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                   |                                                                                          |   |
| **For the quarterly period ended September 30,  2005** |
|                                                   |                                                                                          |   |
| **OR**                                                 |
|                                                   |                                                                                          |   |
| o                                                      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                   |                                                                                          |   |

**For thetransition period from             to             **

 

**CommissionFile Number 0-23651**

 

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**First Consulting Group, Inc.**

(Exactname of registrant as specified in its charter)

 

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

 

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

(Addressof principal executive offices including zip code)

 

**(562)624-5200**

(Registrant’stelephone number, including area code)

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.  Yes ý               No o

 

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

** **

**Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).**   Yes o No ý

 

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

 

| **Common Stock, $.001 par value** | ** ** | **24,501,083**                     |
|-----------------------------------|------------|------------------------------------|
| (Class)                           |       | (Outstanding  at October 28, 2005) |

 

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**FirstConsulting Group, Inc.**

**Table ofContents**

 
| COVER PAGE                                                                                                     |                                       |
|----------------------------------------------------------------------------------------------------------------|--------------------------------------------|
|                                                                                                           |                                       |   |
| TABLE OF CONTENTS                                                                                              |                                       |
|                                                                                                           |                                       |   |
| PART I.                                                                                                        | FINANCIAL INFORMATION                      |   |
|                                                                                                           |                                       |   |
| Item  1.  Financial Statements and Notes (Unaudited)                                                 |                                       |
|                                                                                                           |                                       |
|                                                                                                           | Consolidated Balance  Sheets               |   |
|                                                                                                           |                                       |   |
|                                                                                                           | Consolidated Statements of Operations      |   |
|                                                                                                           |                                       |   |
|                                                                                                           | Consolidated Statements of Cash Flows      |   |
|                                                                                                           |                                       |   |
|                                                                                                           | Notes to Consolidated Financial Statements |   |
|                                                                                                           |                                       |   |
| Item 2.  Management’s  Discussion and Analysis of Financial Condition and Results of Operations |                                       |
|                                                                                                           |                                       |
| Item 3.  Quantitative and Qualitative  Disclosures about Market Risks                                |                                       |
|                                                                                                           |                                       |
| Item 4.  Controls and Procedures                                                                     |                                       |
|                                                                                                           |                                       |
| PART II.                                                                                                       | OTHER INFORMATION                          |   |
|                                                                                                           |                                       |   |
| Item  1.  Legal Proceedings                                                                          |                                       |
|                                                                                                           |                                       |
| Item 2.  Unregistered Sales of Equity  Securities and Use of Proceeds                                |                                       |
|                                                                                                           |                                       |
| Item 3.  Defaults Upon Senior Securities                                                             |                                       |
|                                                                                                           |                                       |
| Item 4.  Submission of Matters to a Vote of  Security Holders                                        |                                       |
|                                                                                                           |                                       |
| Item  5.  Other Information                                                                          |                                       |
|                                                                                                           |                                       |
| Item 6.  Exhibits                                                                                    |                                       |
|                                                                                                           |                                       |
| SIGNATURES                                                                                                     |                                       |
|                                                                                                           |                                       |
| EXHIBIT INDEX                                                                                                  |                                       |
|                                                                                                                |                                            |  |  |

 

2

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# **PART I. FINANCIAL INFORMATION**

 

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

 

**FirstConsulting Group, Inc. and Subsidiaries**

 

### **Consolidated Balance Sheets**

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

 

** **
| ** **                                                                                                             | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                             | ** ** | **(unaudited)**         | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                             | ** ** | ** **              | ** ** | ** **             | ** ** |
| Current assets:                                                                                                        | ** ** | ** **              | ** ** | ** **             | ** ** |
| Cash and cash equivalents                                                                                              |       | $                       | 25,383     |                   | $          | 15,012 |   |
| Short-term investments                                                                                                 |       | 7,870                   |       | 25,309                 |       |
| Accounts receivable, less allowance of $1,739 and $1,401 as of September 30, 2005 and December 31,  2004, respectively |       | 19,205                  |       | 26,266                 |       |
| Unbilled receivables                                                                                                   |       | 15,796                  |       | 11,005                 |       |
| Deferred income taxes                                                                                                  |       | 6,057                   |       | 7,869                  |       |
| Prepaid expenses and other current assets                                                                              |       | 3,781                   |       | 2,449                  |       |
| Other current receivable                                                                                               |       | 2,430                   |       | —                 |       |
| Current assets of discontinued operations                                                                              |       | —                  |       | 561                    |       |
| Total current assets                                                                                                   |       | 80,522                  |       | 88,471                 |       |
|                                                                                                                   |       |                    |       |                   |       |
| Property and equipment:                                                                                                |       |                    |       |                   |       |
| Furniture, equipment, and leasehold improvements                                                                       |       | 4,620                   |       | 4,144                  |       |
| Information systems equipment                                                                                          |       | 30,661                  |       | 27,016                 |       |
|                                                                                                                   |       | 35,281                  |       | 31,160                 |       |
| Less accumulated depreciation and amortization                                                                         |       | 21,807                  |       | 19,331                 |       |
|                                                                                                                   |       | 13,474                  |       | 11,829                 |       |
|                                                                                                                   |       |                    |       |                   |       |
| Other assets:                                                                                                          |       |                    |       |                   |       |
| Executive benefit trust                                                                                                |       | 9,346                   |       | 9,343                  |       |
| Long-term account receivable                                                                                           |       | 1,186                   |       | 3,806                  |       |
| Deferred contract costs                                                                                                |       | 2,779                   |       | 1,469                  |       |
| Deferred income taxes                                                                                                  |       | —                  |       | 3,220                  |       |
| Goodwill, net                                                                                                          |       | 18,159                  |       | 17,259                 |       |
| Intangibles, net                                                                                                       |       | 1,466                   |       | 2,437                  |       |
| Other                                                                                                                  |       | 2,571                   |       | 2,565                  |       |
|                                                                                                                   |       | 35,507                  |       | 40,099                 |       |
| Total assets                                                                                                           |       | $                       | 129,503    |                   | $          | 140,399 |   |

 

 

Theaccompanying notes are an integral part of these financial statements.

 

 

3

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**FirstConsulting Group, Inc. and Subsidiaries**

 

**ConsolidatedBalance Sheets (Continued)**

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

 

 

 
| ** **                                                                                                                                                                                      | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                      | ** ** | **(unaudited)**         | ** ** | ** **             | ** ** |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                   | ** ** | ** **              | ** ** | ** **             | ** ** |
| Current liabilities:                                                                                                                                                                            |       |                    |       |                   |       |
| Accounts payable                                                                                                                                                                                |       | $                       | 2,182      |                   | $          | 2,892 |   |
| Accrued liabilities                                                                                                                                                                             |       | 12,946                  |       | 11,104                 |       |
| Accrued restructuring                                                                                                                                                                           |       | 1,383                   |       | 1,800                  |       |
| Accrued vacation                                                                                                                                                                                |       | 7,250                   |       | 6,682                  |       |
| Accrued incentive compensation                                                                                                                                                                  |       | 1,374                   |       | 1,729                  |       |
| Customer advances                                                                                                                                                                               |       | 5,937                   |       | 7,458                  |       |
| Current liabilities of discontinued operations                                                                                                                                                  |       | 54                      |       | 105                    |       |
| Total current liabilities                                                                                                                                                                       |       | 31,126                  |       | 31,770                 |       |
| Non-current liabilities:                                                                                                                                                                        |       |                    |       |                   |       |
| Accrued restructuring                                                                                                                                                                           |       | 2,167                   |       | 3,220                  |       |
| Supplemental executive retirement plan                                                                                                                                                          |       | 9,516                   |       | 9,094                  |       |
| Total non-current liabilities                                                                                                                                                                   |       | 11,683                  |       | 12,314                 |       |
| Commitments and  contingencies                                                                                                                                                                  |       | —                  |       | —                 |       |
| Stockholders’ equity:                                                                                                                                                                      |       |                    |       |                   |       |
| Preferred Stock, $.001 par value; 9,500,000 shares authorized, no  shares issued and outstanding                                                                                                |       | —                  |       | —                 |       |
| Series A Junior Participating Preferred Stock, $.001 par value;  500,000 shares authorized, no shares issued and outstanding                                                                    |       | —                  |       | —                 |       |
| Common Stock, $.001 par value; 50,000,000 shares authorized,  24,475,306 shares issued and outstanding at September 30, 2005 and 24,862,547  shares issued and outstanding at December 31, 2004 |       | 24                      |       | 25                     |       |
| Additional paid-in capital                                                                                                                                                                      |       | 90,802                  |       | 91,636                 |       |
| Retained earnings (deficit)                                                                                                                                                                     |       | (3,728                  | )          | 4,727                  |       |
| Deferred compensation-stock incentive agreements                                                                                                                                                |       | (64                     | )          | (107                   | )          |
| Notes receivable-stockholders                                                                                                                                                                   |       | (249                    | )          | (286                   | )          |
| Accumulated other comprehensive income (loss)                                                                                                                                                   |       | (91                     | )          | 320                    |       |
| Total stockholders’ equity                                                                                                                                                                 |       | 86,694                  |       | 96,315                 |       |
| Total liabilities and stockholders’ equity                                                                                                                                                 |       | $                       | 129,503    |                   | $          | 140,399 |   |

 

 

Theaccompanying notes are an integral part of these financial statements.

 

 

4

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**FirstConsulting Group, Inc. and Subsidiaries**

 

### **Consolidated Statements ofOperations**

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

**(unaudited)**

 
| ** **                                                           | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|----------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                           | ** ** | **September 30,  2005** | ** ** | **September 24,  2004** | ** ** | **September 30,  2005** | ** ** | **September 24,  2004** | ** ** |
|                                                                 |       |                    |       |                    |       |   |   |   |   |
| Revenues before  reimbursements                                      |       | $                       | 72,717     |                    | $          | 65,302 |   | $ | 208,780 |   | $ | 197,892 |   |
| Reimbursements                                                       |       | 3,887                   |       | 4,430                   |       | 11,321 |   | 12,866 |   |
| Total revenues                                                       |       | 76,604                  |       | 69,732                  |       | 220,101 |   | 210,758 |   |
|                                                                 |       |                    |       |                    |       |   |   |   |   |
| Cost of services before  reimbursable expenses                       |       | 50,941                  |       | 43,681                  |       | 146,536 |   | 133,004 |   |
| Reimbursable expenses                                                |       | 3,887                   |       | 4,430                   |       | 11,321 |   | 12,866 |   |
| Total cost of services                                               |       | 54,828                  |       | 48,111                  |       | 157,857 |   | 145,870 |   |
|                                                                 |       |                    |       |                    |       |   |   |   |   |
| Gross profit                                                         |       | 21,776                  |       | 21,621                  |       | 62,244 |   | 64,888 |   |
|                                                                 |       |                    |       |                    |       |   |   |   |   |
| Selling expenses                                                     |       | 7,621                   |       | 6,520                   |       | 21,473 |   | 20,883 |   |
| General and administrative  expenses                                 |       | 14,591                  |       | 12,737                  |       | 43,931 |   | 37,741 |   |
| Income (loss) from operations                                        |       | (436                    | )          | 2,364                   |       | (3,160 | ) | 6,264 |   |
| Other income (expense):                                              |       |                    |       |                    |       |   |   |   |   |
| Interest income, net                                                 |       | 234                     |       | 185                     |       | 674 |   | 529 |   |
| Other income (expense), net                                          |       | (18                     | )          | 18                      |       | (51 | ) | (113 | ) |
| Expense for premium on repurchase of stock                           |       | —                  |       | —                  |       | — |   | (1,561 | ) |
| Income (loss) from continuing operations before income tax provision |       | (220                    | )          | 2,567                   |       | (2,537 | ) | 5,119 |   |
| Income tax provision                                                 |       | 20                      |       | 1,135                   |       | 5,381 |   | 2,945 |   |
| Income (loss) from continuing operations                             |       | (240                    | )          | 1,432                   |       | (7,918 | ) | 2,174 |   |
| Loss on discontinued  operations, net of tax benefit                 |       | —                  |       | (167                    | )          | (537 | ) | (512 | ) |
| Net income (loss)                                                    |       | $                       | (240       | )                       | $          | 1,265 |   | $ | (8,455 | ) | $ | 1,662 |   |
|                                                                 |       |                    |       |                    |       |   |   |   |   |
| Basic & diluted net  income (loss) per share:                    |       |                    |       |                    |       |   |   |   |   |
| Basic:                                                               |       |                    |       |                    |       |   |   |   |   |
| Income (loss) from  continuing operations                            |       | $                       | (0.01      | )                       | $          | 0.06 |   | $ | (0.33 | ) | $ | 0.09 |   |
| Loss on discontinued  operations, net of tax benefit                 |       | —                  |       | (0.01                   | )          | (0.02 | ) | (0.02 | ) |
| Net income (loss) per share                                          |       | $                       | (0.01      | )                       | $          | 0.05 |   | $ | (0.35 | ) | $ | 0.07 |   |
| Diluted:                                                             |       |                    |       |                    |       |   |   |   |   |
| Income (loss) from  continuing operations                            |       | $                       | (0.01      | )                       | $          | 0.06 |   | $ | (0.33 | ) | $ | 0.09 |   |
| Loss on discontinued  operations, net of tax benefit                 |       | —                  |       | (0.01                   | )          | (0.02 | ) | (0.02 | ) |
| Net income (loss) per share                                          |       | $                       | (0.01      | )                       | $          | 0.05 |   | $ | (0.35 | ) | $ | 0.07 |   |
| Weighted average shares  used in computing:                          |       |                    |       |                    |       |   |   |   |   |
| Basic net income (loss) per share                                    |       | 24,468                  |       | 24,339                  |       | 24,429 |   | 24,612 |   |
| Diluted net income (loss) per share                                  |       | 24,468                  |       | 24,405                  |       | 24,429 |   | 24,789 |   |

 

 

Theaccompanying notes are an integral part of these financial statements.

 

 

5

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**FirstConsulting Group, Inc. and Subsidiaries**

 

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

**(inthousands)**

**(unaudited)**

** **
| ** **                                                                                | ** ** | **Nine Months Ended**       | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                | ** ** | **September 30, 2005** | ** ** | **September 24, 2004** | ** ** |
| Cash flows from operating  activities:                                                    |       |                        |       |   |   |
| Net income (loss):                                                                        |       | $                           | (8,455     | ) | $ | 1,662 |   |
| Adjustments to reconcile net income (loss) to net cash provided by  operating activities: |       |                        |       |   |   |
| Depreciation and amortization                                                             |       | 4,765                       |       | 3,585 |   |
| Deferred income tax provision                                                             |       | 5,032                       |       | 2,253 |   |
| Premium on capital stock repurchase                                                       |       | —                      |       | 1,561 |   |
| Intangibles amortization                                                                  |       | 971                         |       | 1,281 |   |
| Writedown of investment                                                                   |       | —                      |       | 50 |   |
| Provision for bad debts, net of adjustments                                               |       | 336                         |       | 104 |   |
| Loss on sale of assets                                                                    |       | 44                          |       | 72 |   |
| Minority interest in net loss of subsidiaries                                             |       | —                      |       | (14 | ) |
| Compensation from stock issuances                                                         |       | 43                          |       | 105 |   |
| Interest income on notes receivable—stockholders                                     |       | (44                         | )          | (60 | ) |
| Changes in assets and liabilities, excluding effect of acquisitions:                      |       |                        |       |   |   |
| Accounts receivable                                                                       |       | 6,725                       |       | 3,854 |   |
| Unbilled receivables                                                                      |       | (4,791                      | )          | (2,940 | ) |
| Prepaid expenses and other                                                                |       | (1,332                      | )          | (759 | ) |
| Current assets of discontinued operations                                                 |       | 561                         |       | - |   |
| Other current receivable                                                                  |       | (2,430                      | )          | - |   |
| Long-term account receivable                                                              |       | 2,620                       |       | 1,489 |   |
| Deferred contract costs                                                                   |       | (1,310                      | )          | (1,288 | ) |
| Other assets                                                                              |       | (31                         | )          | (77 | ) |
| Accounts payable                                                                          |       | (710                        | )          | 1,310 |   |
| Accrued liabilities                                                                       |       | 1,842                       |       | 267 |   |
| Current liabilities of discontinued operations                                            |       | (51                         | )          | — |   |
| Accrued restructuring                                                                     |       | (1,470                      | )          | (3,812 | ) |
| Accrued vacation                                                                          |       | 568                         |       | (8 | ) |
| Accrued incentive compensation                                                            |       | (355                        | )          | 142 |   |
| Customer advances                                                                         |       | (1,521                      | )          | (2,646 | ) |
| Supplemental executive retirement plan                                                    |       | 419                         |       | (41 | ) |
| Other                                                                                     |       | (154                        | )          | (104 | ) |
| Net cash provided by operating activities:                                                |       | 1,272                       |       | 5,986 |   |
| Cash flows from investing  activities:                                                    |       |                        |       |   |   |
| Proceeds from sale/maturity of investments                                                |       | 17,439                      |       | 10,597 |   |
| Purchase of property and equipment                                                        |       | (6,502                      | )          | (5,851 | ) |
| Acquisition of businesses, net of cash acquired                                           |       | —                      |       | (2,383 | ) |
| Net cash provided by investing activities                                                 |       | 10,937                      |       | 2,363 |   |
| Cash flows from financing  activities:                                                    |       |                        |       |   |   |
| Proceeds from issuance of capital stock, net                                              |       | 862                         |       | 1,344 |   |
| Proceeds from notes receivable and tax loan payments                                      |       | 39                          |       | 78 |   |
| Capital stock repurchase                                                                  |       | (2,530                      | )          | (14,773 | ) |
| Net cash used in financing activities                                                     |       | (1,629                      | )          | (13,351 | ) |
| Effect of exchange rate  changes on cash and cash equivalents                             |       | (209                        | )          | 60 |   |
| Net change in cash and cash equivalents                                                   |       | 10,371                      |       | (4,942 | ) |
| Cash and cash equivalents  at beginning of period                                         |       | 15,012                      |       | 26,826 |   |
| Cash and cash equivalents  at end of period                                               |       | $                           | 25,383     |   | $ | 21,884 |   |
|                                                                                      |       |                        |       |   |   |
| Supplemental disclosure of  cash flow information                                         |       |                        |       |   |   |
| Cash paid during the period for interest                                                  |       | $                           | 57         |   | $ | 14 |   |
| Cash paid during the period for income taxes                                              |       | $                           | 470        |   | $ | 778 |   |
| Supplemental disclosure of  non-cash investing and financing activities                   |       |                        |       |   |   |
| Release from escrow of common stock to complete acquistion of  business                   |       | $                           | 900        |   | $ | 900 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

 

6

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### **Notes to Consolidated FinancialStatements**

 

 

**Note 1                    Accounting Policies**

 

*Basis of Presentation*

 

                Theaccompanying consolidated balance sheet of First Consulting Group, Inc. (the “Company”or “FCG”) at September 30, 2005 and consolidated statements of operations andconsolidated statements of cash flows for the periods ended September 30, 2005and September 24, 2004 are unaudited. These financial statements reflect all adjustments, consisting of onlynormal recurring adjustments, which, in the opinion of management, arenecessary to fairly present the financial position of the Company at September30, 2005 and the results of operations for the three-month and nine-monthperiods ended September 30, 2005 and September 24, 2004.  The results of operations and cash flows forthe nine-month period ended September 30, 2005 are not necessarily indicativeof the results to be expected for the year ending December 30, 2005.  For more complete financial information,these financial statements should be read in conjunction with the auditedfinancial statements for the year ended December 31, 2004 included in theCompany’s Annual Report on Form 10-K. Certain reclassifications have been made to the 2004 financialstatements to conform to the 2005 presentation.

 

*Principles of Consolidation*

 

*               *Theconsolidated financial statements include the accounts of the Company and itssubsidiaries.  All material intercompanyaccounts and transactions have been eliminated.

 

*Stock-Based Compensation*

 

The Company accounts for stock-based employee compensation using theintrinsic value method as prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees,”and has adopted the disclosure provisions of Statement of Financial AccountingStandards No. 123, “Accounting forStock-Based Compensation”**(“SFASNo. 123”), and Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation—Transitionand Disclosure—an amendment of SFAS No. 123”**(“SFAS No. 148”). SFAS No. 123 requires pro forma disclosures of net income (loss)and net income (loss) per share as if the fair value method of accounting forstock-based awards had been applied. Under the fair value method, compensationcost is recorded based on the value of the award at the grant date and is recognizedover the service period.

 

                InDecember 2004, the Financial Accounting Standards Board (“FASB”) enactedStatement of Financial Accounting Standards 123 (revised 2004) (“SFAS 123R”), “Share-Based Payment” which replaces Statement ofFinancial Accounting Standards No. 123 (“SFAS 123”), “Accounting forStock-Based Compensation” and supersedes APB Opinion No. 25 (“APB 25”), “Accountingfor Stock Issued to Employees.” SFAS 123R requires the measurement of allshare-based payments to employees, including grants of employee stock options,using a fair-value-based method and the recording of such expense in theconsolidated statements of income. The accounting provisions of SFAS 123R were originally planned to be effective for all quarterlyreporting periods beginning after June 15, 2005.  In April 2005, the Securities and ExchangeCommission adopted a revision to SFAS 123R to make the accounting provisionsapplicable to all fiscal year reporting periods commencing after June 15,2005.  As a result, the Company is nowrequired to adopt SFAS 123R commencing in the first quarter of 2006.

 

Uponthe adoption of SFAS 123R, the pro forma disclosures previously permitted underSFAS 123 no longer will be an alternative to financial statementrecognition. Although the Company has not yet determined the method of adoptionor whether the adoption of SFAS 123R will result in amounts that aresimilar to the current pro forma disclosures under SFAS 123, the Companyis evaluating the requirements under SFAS 123R and expects that the adoptionwill have an adverse impact on the reported earnings and net income per share.

 

7

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The following table presents the pro forma net income (loss) hadcompensation costs been determined using the fair value at the date of grantfor awards under the plan in accordance with SFAS No. 123 (in thousands, exceptper share data):

 
| ** **                                                                                                               | ** **  | ** ** | **Three Months Ended**           | ** ** | **Nine Months Ended**            | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|-------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                               | ** **  | ** ** | **September** **30,  2005** | ** ** | **September** **24,  2004** | ** ** | **September** **30,  2005** | ** ** | **September** **24,**

** 2004** | ** ** |
| Net income (loss), as  reported                                                                                          |        | $          | (240                             | )          | $                                | 1,265      |   | $ | (8,455 | ) | $ | 1,662 |   |
| Deduct:  Total  stock based employee                                                                           |        |       |                             |       |                             |       |   |   |   |
|    compensation  expense determined under     fair value method for all awards, net of tax |        | (147       | )                                | (425       | )                                | (827       | ) | (1,261 | ) |
| Add:       Amount of such  stock-based expense                                        |        |       |                             |       |                             |       |   |   |   |
|        included in net income  (loss)                                                 |        | —     |                             | —     |                             | —     |   | — |   |
| Pro forma net income  (loss)                                                                                             |        |       | $                                | (387       | )                                | $          | 840 |   | $ | (9,282 | ) | $ | 401 |   |
|                                                                                                                     |        |       |                             |       |                             |       |   |   |   |   |
| Basic income (loss) per  share                                                                                           | As reported |       | $                                | (0.01      | )                                | $          | 0.05 |   | $ | (0.35 | ) | $ | 0.07 |   |
|                                                                                                                     | Pro forma   |       | $                                | (0.02      | )                                | $          | 0.03 |   | $ | (0.38 | ) | $ | 0.02 |   |
|                                                                                                                     |        |       |                             |       |                             |       |   |   |   |   |
| Diluted income (loss) per  share                                                                                         | As reported |       | $                                | (0.01      | )                                | $          | 0.05 |   | $ | (0.35 | ) | $ | 0.07 |   |
|                                                                                                                     | Pro forma   |       | $                                | (0.02      | )                                | $          | 0.03 |   | $ | (0.38 | ) | $ | 0.02 |   |

 

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

 

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

 

8

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                Thefollowing represents a reconciliation of basic and diluted net loss per sharefor the three months and nine months ended September 30, 2005 and September 24,2004 (in thousands, except per share data):

 
| ** **                                            | ** ** | **Three Months Ended**           | ** ** | **Nine Months Ended**           | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                            | ** ** | **September** **30,  2005** | ** ** | **September** **24, 2004** | ** ** | **September** **30,  2005** | ** ** | **September** **24, 2004** | ** ** |
| Income (loss) from  continuing operations             |       | $                                | (240       | )                               | $          | 1,432 |   | $ | (7,918 | ) | $ | 2,174 |   |
| Loss on discontinued  operations, net of tax benefit  |       | —                           |       | (167                            | )          | (537 | ) | (512 | ) |
| Net income (loss)                                     |       | $                                | (240       | )                               | $          | 1,265 |   | $ | (8,455 | ) | $ | 1,662 |   |
|                                                  |       |                             |       |                            |       |   |   |   |   |
| Basic weighted average  number of shares outstanding  |       | 24,468                           |       | 24,339                          |       | 24,429 |   | 24,612 |   |
| Effect of dilutive options  and contingent shares     |       | —                           |       | 66                              |       | — |   | 177 |   |
| Diluted weighted average number of shares outstanding |       | 24,468                           |       | 24,405                          |       | 24,429 |   | 24,789 |   |
|                                                  |       |                             |       |                            |       |   |   |   |   |
| Basic per share:                                      |       |                             |       |                            |       |   |   |   |   |
| Income (loss) from  continuing operations             |       | $                                | (0.01      | )                               | $          | 0.06 |   | $ | (0.33 | ) | $ | 0.09 |   |
| Loss on discontinued  operations, net of tax benefit  |       | —                           |       | (0.01                           | )          | (0.02 | ) | (0.02 | ) |
| Net income (loss) per share                           |       | $                                | (0.01      | )                               | $          | 0.05 |   | $ | (0.35 | ) | $ | 0.07 |   |
|                                                  |       |                             |       |                            |       |   |   |   |   |
| Diluted per share:                                    |       |                             |       |                            |       |   |   |   |   |
| Income (loss) from  continuing operations             |       | $                                | (0.01      | )                               | $          | 0.06 |   | $ | (0.33 | ) | $ | 0.09 |   |
| Loss on discontinued  operations, net of tax benefit  |       | —                           |       | (0.01                           | )          | (0.02 | ) | (0.02 | ) |
| Net income (loss) per share                           |       | $                                | (0.01      | )                               | $          | 0.05 |   | $ | (0.35 | ) | $ | 0.07 |   |
|                                                       |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |  |  |

 

For the three months endedSeptember 30, 2005 and September 24, 2004, there were 5,075,785 and 4,657,173anti-dilutive outstanding stock options, respectively, excluded from thecalculation of diluted earnings (loss) per share.  For the nine months ended September 30, 2005and September 24, 2004, there were 5,179,378 and 4,772,401 anti-dilutiveoutstanding stock options, respectively, excluded from the calculation ofdiluted earnings (loss) per share.

 

*Use of Estimates*

 

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

 

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

 

                One particular significant estimate is the amount of realizability of the Company’s deferred tax assets, and the necessary amount of related valuation allowance.  Based on the Company’s recent historical performance and in accordance with SFAS 109, the Company increased its deferred tax asset valuation allowance by $6.0 million during the second quarter of fiscal year 2005.  This valuation allowance does not, in any way, limit the Company’s ability to use its deferred tax assets, primarily loss carryforwards, to offset income earned in the future.  As well as not being subject to taxation, a significant amount (approximately $20 million) of any future pretax income will not require a tax provision in the income statement.

 

9

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After application of the $6.0 millionvaluation allowance during the second quarter of 2005, the Company hasremaining net deferred tax assets at September 30, 2005 of approximately $6.0million.  Realization of the currentlyrecorded deferred tax assets is dependent on generating sufficient taxableincome in the foreseeable future. Although realization is not assured,management believes it is more likely than not that all of the remaining $6.0million net deferred tax asset will be realized.

 

*Cash and Cash Equivalents*

 

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

 

**Note 2                    Investments**

 

                AtSeptember 30, 2005, the Company had approximately $7.9 million in short-terminvestments.  Such investments were heldprimarily in commercial paper, money market investments, and tax-exemptgovernment securities.  Net unrealizedgains and losses on investments were immaterial at September 30, 2005.  Additionally, the Company had $325,000 ofnon-marketable equity investments, valued at the lower of cost or estimatedfair value, which were included within other assets.

 

**Note 3                    Other Current Receivable and Long-Term Receivable**

 

                AtSeptember 30, 2005, the Company carried an other current receivable ofapproximately $2.4 million from a single client.  The receivable is related to an outsourcingcontract and was originally scheduled to be collected over the next 15 months;however, due to the early termination of the contract for convenience by theclient, it is now scheduled to be received in full on December 31, 2005.

 

At September 30, 2005, theCompany carried a $1.2 million long-term account receivable.  This receivable represents the discountedvalue of the deferral of the first month’s receivable on a new outsourcingcontract which began in August 2005. This receivable has been deferred until the completion of the contractin five years, at which point it will be collected in the amount of $1.7million.  Additionally, the Company hasalso agreed to defer until 2010 one-half of the January 2006 monthly paymentdue from the same client.

 

**Note 4                    Business Acquisitions**

 

*FCG Infrastructure Services (“FCGIS”)*

 

On May 31, 2002, the Companyacquired a controlling interest of 52.35% in Codigent Solutions Group, Inc.,renamed FCG Infrastructure Services, Inc. (“FCGIS”), a provider of value addedinformation technology solutions to hospitals and other healthcare deliveryorganizations, for $2.6 million in cash.  On January 30, 2004, the Companypurchased the remaining 47.65% minority interest in FCGIS from five remainingindividual stockholders for approximately $2.4 million in cash.  Additionally,the Company deposited 591,328 shares of FCG common stock into an escrowaccount, with one-fourth of such shares to be released to those samestockholders in four separate increments upon successful fulfillment by FCGISof certain revenue and profitability targets for the six-month periods endedJune 25, 2004, December 31, 2004, July 1, 2005, and December 30, 2005.  Ifsuch targets were not fulfilled for any of the six-month periods, the shares inescrow for that period would revert to FCG.

 

10

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The acquisition wasaccounted for using the purchase method of accounting and the allocation of the$5.0 million non-contingent purchase price (net of cash acquired of $392,000)is as follows (in thousands):

 

| Accounts receivable       |   | $     | 784    |   |
|---------------------------|--------|-------|--------|--------|
| Fixed assets and software |   | 557   |   |
| Intangible assets         |   | 604   |   |
| Goodwill                  |   | 3,254 |   |
| Accrued liabilities       |   | (397  | )      |
| Assumed long-term debt    |   | (194  | )      |
| Net assets  acquired      |   | $     | 4,608  |   |

 

The $3.9 million of excessover book value was allocated between goodwill and intangible assets of $3.3million and $0.6 million, respectively.  Such amounts are non-deductiblefor tax purposes.

 

For the six-month periodsended June 25, 2004 and December 31, 2004, FCGIS met the revenue andprofitability targets, and 295,664 contingent shares were released to theformer FCGIS stockholders, thus adding $1.8 million to goodwill.  InFebruary 2005, the Company negotiated an early conclusion to its escrowagreement related to shares of common stock issued in the purchase of FCGIS,where half of the remaining 295,664 shares in escrow were released and theother half were forfeited back to the Company.  The shares released fromthe escrow further increased goodwill by $900,000 to a total of $6.1 million ofgoodwill related to the acquisition.

 

Additionally, on February23, 2005, the Company repurchased most of the stock which had been previouslyand currently released from escrow for its current fair market value.  Atotal of 422,018 shares were repurchased for approximately $2.5 million incash.  The repurchased shares weresubsequently cancelled.

 

**Note 5                    Goodwill and Intangible Assets**

 

Goodwill is evaluated forimpairment annually, pursuant to SFAS 142, or if an event occurs orcircumstances change that may reduce the fair value of the reporting unit belowits book value. The impairment test is conducted at the reporting unit level bycomparing the fair value of the reporting unit with its carrying value. Fairvalue is determined by using a market approach valuation model based on revenuemultiples or a discounted cash flow approach. The Company uses various assumptions in the valuation, such as discountrates, and comparable company analysis in performing these valuations.  If the carrying value exceeds the fair value,goodwill may be impaired. If this occurs, the fair value of the reporting unitis then allocated to its assets and liabilities in a manner similar to apurchase price allocation in order to determine the implied fair value of thereporting unit goodwill. This implied fair value is then compared with thecarrying amount of the reporting unit goodwill, and if it is less, the Companywould then recognize an impairment loss. In addition, the Company evaluates intangible assets with definite livespursuant to SFAS 142, to determine whether adjustment to these amounts orestimated useful lives are required based on current events and circumstances.

 

In the first quarter of2005, the Company reorganized its business segments.  In accordance with SFAS 142, the goodwillformerly attributed to the Meditech Service Center segment was divided betweenthe Health Delivery Services and Health Delivery Outsourcing segments based onthe relative fair values of parts of the previous Meditech Service Center beingreorganized into those business units, and is shown historically on thisrestated basis in the following schedule.

 

11

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The changes in the netcarrying amounts of goodwill for the nine months ended September 30, 2005 areas follows (in thousands):

 
| ** **                        | ** ** | **Health Delivery Services** | ** ** | **Health Delivery Outsourcing** | ** ** | **Life Sciences** | ** ** | **Government & Technology Services** | ** ** | **Other** | ** ** | **Total**  | ** ** |
|-----------------------------------|------------|------------------------------|------------|---------------------------------|------------|-------------------|------------|------------------------------------------|------------|-----------|------------|------------|------------|
| Balance as of December 26,  2003  |       | $                            | 1,051      |                            | $          | 3,228             |       | $                                        | 1,477      |      | $          | 8,260      |       | $ | 1,442 | ** ** | **$** | **15,458** | ** ** |
| Acquired                          |       | 1,701                        |       | 1,538                           |       | —            |       | —                                   |       | —    | ** ** | **3,239**  | ** ** |
| Impaired                          |       | —                       |       | —                          |       | —            |       | —                                   |       | (1,442    | **)**      | **(1,442** | **)**      |
| Currency translation adjustment   |       | —                       |       | —                          |       | 4                 |       | —                                   |       | —    | ** ** | **4**      | ** ** |
| Balance as of December 31,  2004  |       | 2,752                        |       | 4,766                           |       | 1,481             |       | 8,260                                    |       | —    | ** ** | **17,259** | ** ** |
| Acquired                          |       | 473                          |       | 427                             |       | —            |       | —                                   |       | —    | ** ** | **900**    | ** ** |
| Balance as of September  30, 2005 |       | $                            | 3,225      |                            | $          | 5,193             |       | $                                        | 1,481      |      | $          | 8,260      |       | $ | — | ** ** | **$** | **18,159** | ** ** |

 

The $900,000 of additionalgoodwill in the first quarter of 2005 relates to a final earn out payment tothe previous owners of a business which was the substantial portion of theMeditech Service Center segment (see Note 4 of Notes to Consolidated FinancialStatements).

 

As of September 30, 2005,the Company had the following acquired intangible assets recorded (inthousands):

 
| ** **                        | ** ** | **Software and Software Development** | ** ** | **Customer Related** | ** ** | **Non-Compete Agreements** | ** ** | **Total**  | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|----------------------|------------|----------------------------|------------|------------|------------|
| Balance as of December 26,  2003  |       | $                                     | 763        |                 | $          | 2,858                      |       | $          | 179        | ** ** | **$** | **3,800** | ** ** |
| Acquired                          |       | —                                |       | 300                  |       | —                     | ** ** | **300**    | ** ** |
| Amortization                      |       | (543                                  | )          | (981                 | )          | (139                       | **)**      | **(1,663** | **)**      |
| Balance as of December 31,  2004  |       | 220                                   |       | 2,177                |       | 40                         | ** ** | **2,437**  | ** ** |
| Amortization                      |       | (176                                  | )          | (755                 | )          | (40                        | **)**      | **(971**   | **)**      |
| Balance as of September  30, 2005 |       | $                                     | 44         |                 | $          | 1,422                      |       | $          | —     | ** ** | **$** | **1,466** | ** ** |
| Amortization Period in  Years     |       | 2  -3                                 |       | 2  -4                |       | 2  -3                      |       |       |       |
|                                   |            |                                       |            |                      |            |                            |            |            |            |  |  |  |  |  |  |  |

 

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

 

| **Fiscal Year**          | ** ** | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|------------|
| 2005 (remainder of year) |       | $          | 366        |       |
| 2006                     |       | 772        |       |
| 2007                     |       | 328        |       |
| Total                    |       | $          | 1,466      |       |

 

12

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**Note 6                    Accrued Restructuring**

 

**               **At September 30, 2005, the Company had approximately$3.6 million in restructuring accrual which related to restructuring,severance, and impairment costs incurred in the prior years, primarily in theLife Sciences segment.  The remainingaccrual entirely consists of costs related to vacated leases, net of estimatedsublease payments.

** **

**The restructuring liability activitythrough September 30, 2005 is summarized as follows (in thousands):**

** **

| ** **                                   | ** ** | **Facilities/Other  Related Costs** | ** ** |
|----------------------------------------------|------------|-------------------------------------|------------|
| Accrual balance at  December 31, 2004        |       | $                                   | 5,020      |   |
| Cash payments                                |       | (1,470                              | )          |
| Accrual balance at  September 30, 2005       |       | $                                   | 3,550      |   |
|                                         |       |                                |       |   |
| Current portion of accrued restructuring     |       | $                                   | 1,383      |   |
| Non-current portion of accrued restructuring |       | $                                   | 2,167      |   |

 

**Note 7                    Comprehensive Income (Loss)**

 

Comprehensive income (loss),net of taxes, for the three months and nine months ended September 30, 2005 andSeptember 24, 2004, is as follows (in thousands):

 
| ** **                               | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **September 30,  2005** | ** ** | **September 24,  2004** | ** ** | **September 30,  2005** | ** ** | **September 24,  2004** | ** ** |
| Net income (loss)                        |       | $                       | (240       | )                       | $          | 1,265 |   | $ | (8,455 | ) | $ | 1,662 |   |
|                                     |       |                    |       |                    |       |   |   |   |   |
| Foreign currency  translation adjustment |       | (34                     | )          | (162                    | )          | (424 | ) | (53 | ) |
| Unrealized gain on  investments          |       | 14                      |       | 7                       |       | 13 |   | 8 |   |
| Other comprehensive loss,  net of tax    |       | (20                     | )          | (155                    | )          | (411 | ) | (45 | ) |
|                                     |       |                    |       |                    |       |   |   |   |   |
| Comprehensive income  (loss)             |       | $                       | (260       | )                       | $          | 1,110 |   | $ | (8,866 | ) | $ | 1,617 |   |

** **

**Note 8                    Discontinued Operations**

 

OnDecember 7, 2004, the Company’s Board of Directors approved a plan to sell andexit its clinical and non-clinical Call Center Services (“CCS”) operation dueto recurring losses.  On February 2, 2005, the Company executed adefinitive agreement with the MPB Group, LLC, d/b/a The Beryl Companies. FCG is receiving 12 monthly payments of $12,500, totaling $150,000, forselected customer contracts. The disposal plan consisted primarily of thetermination of normal CCS activity, calculation of termination benefits for theexisting CCS employees, termination of a lease agreement, abandonment of propertyand equipment, collection of accounts receivable, and settlement ofliabilities.

 

Inaccordance with SFAS 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets,” this disposal represents a discontinued operation. Accordingly, the accompanying consolidated financial statements and notesreflect the results of operations and financial position of the CCS division asa discontinued operation for all periods presented.

 

13

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A summary of results for CCS for the nine months ended September 30,2005 included revenues of $631,000 and a pre-tax loss of $866,000 which relatedto the sales, operation, and wind-down of the business.  The pre-tax loss, net of a 38% tax benefit,resulted in a net loss of $537,000, compared to a loss of $512,000, net of a38% tax benefit for the nine months ended September 24, 2004.  The fiscal year 2005 net loss included$276,000 related to severance costs for the remaining staff of 37 people.  Further, in accordance with SFAS 146, “Accountingfor Costs Associated with Exit or Disposal Activities”, the Company recorded anaccrual for the remaining lease payments on the CCS leased property in theamount of $89,000.

 

**Note 9                    Disclosure of Segment Information**

 

In the first quarter of2005, the Company reorganized its previous segment reporting in accordance withSFAS 131 and had the following changes in its reporting:

 

•                  The Meditech Service Centersegment has been split between Health Delivery Services and Health Delivery Outsourcing.  An insignificant portion of the MeditechService Center has also been included in the Software Products segment;

•                  The Health Delivery Services(previously Health Delivery) and Health Delivery Outsourcing segments, whilestill reported separately, are now combined with a common sales group, HealthDelivery Sales into a total Health Delivery segment;

•                  The Government andTechnology Services (“GTS”) segment has been created by combining FCG SoftwareServices, formerly named Paragon Solutions, Inc. (our software developmentbusiness) and Technology Staffing Services groups, which used to be includedwithin Other Business, with the Government Healthcare business unit, which usedto be part of Health Delivery;

•                  Software Products (“SWP”)has been created by adding the Cyberview product that used to be in theMeditech Service Center segment to the existing SWP business line, which usedto be included within Other Business, and primarily involves the FirstGatewaysproduct.

 

For fiscal year 2005, the Companyhas the following six reportable operating segments:

 

•                  Health Delivery Services -the delivery of consulting and systems integration services to health deliveryclients;

•                  Health Delivery Outsourcing- the delivery of outsourcing services to health delivery clients;

•                  Life Sciences - the deliveryof consulting and systems integration services to pharmaceutical and other lifesciences clients;

•                  Health Plan - the deliveryof consulting and systems integration services and outsourcing services tohealth plan clients;

•                  Government and TechnologyServices - the delivery of consulting services to government clients, thedelivery of blended-shore software development, and the delivery of technologystaff augmentation services; and

•                  Software Products - the deliveryof solutions involving the use of software to health delivery clients.

 

Additionally, the Companyhas three shared service centers that provide services to multiple businesssegments.  These shared service centersinclude FCG India, Integration Services, and Infrastructure Services.   The costs of these services are internallybilled and reported in the individual business segments as cost of services ata standard transfer cost.

 

14

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The Company evaluates itssegments’ performance based on revenues and operating income.  Certain selling and general andadministrative expenses (including corporate functions, occupancy relatedcosts, depreciation, professional development, recruiting, and marketing), aremanaged at the corporate level and allocated to each operating segment based oneither net revenues and/or actual usage. The Company does not manage or track most assets by segment.  As a result, interest and other charges arenot included in the tables below.

 

The following segmentinformation is for the three months and nine months ended September 30, 2005and September 24, 2004 (in thousands):

 

**For the three months ended September 30, 2005:**

(in thousands)
| ** **                                    | ** ** | **Health  Delivery  Services** | ** ** | **Health  Delivery  Sales** | ** ** | **Health  Delivery  Outsourcing** | *** *** | ***Health  Delivery  Total*** | ** ** | **Life  Sciences** | ** ** | **Health  Plan** | ** ** | **Government  &  Technology  Services** | ** ** | **Software  Products** | ** ** | **Other** |   | **Totals** | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|-----------------------------------|--------------|-------------------------------|------------|--------------------|------------|------------------|------------|---------------------------------------------|------------|------------------------|------------|-----------|--------|------------|------------|
| Revenues before reimbursements                |       | $                              | 15,620     |                        | $          | —                            |         | $                             | 35,265     | * *           | *$*        | *50,885*         |       | $                                           | 7,272      |                   | $          | 4,938     |   | $          | 8,818      |   | $ | 823 |   | $ | (19 | ) | **$** | **72,717** | ** ** |
| Reimbursements                                |       | 2,469                          |       | —                      |       | 198                               | * *     | *2,667*                       |       | 318                |       | 701              |       | 192                                         |       | 9                      |       | —    |   | **3,887**  | ** ** |
| Total revenues                                |       | 18,089                         |       | —                      |       | 35,463                            | * *     | *53,552*                      |       | 7,590              |       | 5,639            |       | 9,010                                       |       | 832                    |       | (19       | )      | **76,604** | ** ** |
| Cost of services before reimbursable expenses |       | 10,216                         |       | —                      |       | 29,365                            | * *     | *39,581*                      |       | 4,149              |       | 3,338            |       | 5,106                                       |       | 898                    |       | (2,131    | )      | **50,941** | ** ** |
| Reimbursable expenses                         |       | 2,469                          |       | —                      |       | 198                               | * *     | *2,667*                       |       | 318                |       | 701              |       | 192                                         |       | 9                      |       | —    |   | **3,887**  | ** ** |
| Total cost of services                        |       | 12,685                         |       | —                      |       | 29,563                            | * *     | *42,248*                      |       | 4,467              |       | 4,039            |       | 5,298                                       |       | 907                    |       | (2,131    | )      | **54,828** | ** ** |
| Gross profit                                  |       | 5,404                          |       | —                      |       | 5,900                             | * *     | *11,304*                      |       | 3,123              |       | 1,600            |       | 3,712                                       |       | (75                    | )          | 2,112     |   | **21,776** | ** ** |
| Selling expenses                              |       | 1,226                          |       | 2,080                       |       | 1,057                             | * *     | *4,363*                       |       | 1,543              |       | 606              |       | 896                                         |       | 126                    |       | 87        |   | **7,621**  | ** ** |
| General & administrative expenses         |       | 2,602                          |       | —                      |       | 3,996                             | * *     | *6,598*                       |       | 2,339              |       | 698              |       | 1,980                                       |       | 308                    |       | 2,668     |   | **14,591** | ** ** |
| Income (loss) from operations                 |       | $                              | 1,576      |                        | $          | (2,080                            | )            | $                             | 847        | * *           | *$*        | *343*            |       | $                                           | (759       | )                      | $          | 296       |   | $          | 836        |   | $ | (509 | ) | $ | (643 | ) | **$** | **(436** | **)** |
|                                               |            |                                |            |                             |            |                                   |              |                               |            |                    |            |                  |            |                                             |            |                        |            |           |        |            |            |  |  |  |  |  |  |  |  |  |  |  |

 

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

(in thousands)
| ** **                                    | ** ** | **Health  Delivery  Services** | ** ** | **Health  Delivery  Sales** | ** ** | **Health  Delivery  Outsourcing** | *** *** | ***Health  Delivery  Total*** | ** ** | **Life  Sciences** | ** ** | **Health  Plan** | ** ** | **Government  &  Technology  Services** | ** ** | **Software  Products** | ** ** | **Other** | ** ** | **Totals** | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|-----------------------------------|--------------|-------------------------------|------------|--------------------|------------|------------------|------------|---------------------------------------------|------------|------------------------|------------|-----------|------------|------------|------------|
| Revenues before reimbursements                |       | $                              | 18,003     |                        | $          | —                            |         | $                             | 27,060     | * *           | *$*        | *45,063*         |       | $                                           | 8,812      |                   | $          | 3,770     |       | $          | 7,333      |   | $ | 330 |   | $ | (6 | **)** | **$** | **65,302** | ** ** |
| Reimbursements                                |       | 2,590                          |       | —                      |       | 171                               | * *     | *2,761*                       |       | 267                |       | 578              |       | 175                                         |       | 61                     |       | 588       | ** ** | **4,430**  | ** ** |
| Total revenues                                |       | 20,593                         |       | —                      |       | 27,231                            | * *     | *47,824*                      |       | 9,079              |       | 4,348            |       | 7,508                                       |       | 391                    |       | 582       | ** ** | **69,732** | ** ** |
| Cost of services before reimbursable expenses |       | 9,946                          |       | —                      |       | 22,528                            | * *     | *32,474*                      |       | 5,077              |       | 2,608            |       | 4,398                                       |       | 621                    |       | (1,497    | **)**      | **43,681** | ** ** |
| Reimbursable expenses                         |       | 2,590                          |       | —                      |       | 171                               | * *     | *2,761*                       |       | 267                |       | 578              |       | 175                                         |       | 61                     |       | 588       | ** ** | **4,430**  | ** ** |
| Total cost of services                        |       | 12,536                         |       | —                      |       | 22,699                            | * *     | *35,235*                      |       | 5,344              |       | 3,186            |       | 4,573                                       |       | 682                    |       | (909      | **)**      | **48,111** | ** ** |
| Gross profit                                  |       | 8,057                          |       | —                      |       | 4,532                             | * *     | *12,589*                      |       | 3,735              |       | 1,162            |       | 2,935                                       |       | (291                   | )          | 1,491     | ** ** | **21,621** | ** ** |
| Selling expenses                              |       | 1,045                          |       | 1,362                       |       | 474                               | * *     | *2,881*                       |       | 2,015              |       | 673              |       | 736                                         |       | 107                    |       | 108       | ** ** | **6,520**  | ** ** |
| General & administrative expenses         |       | 2,970                          |       | —                      |       | 2,595                             | * *     | *5,565*                       |       | 3,084              |       | 727              |       | 1,455                                       |       | 216                    |       | 1,690     | ** ** | **12,737** | ** ** |
| Income (loss) from operations                 |       | $                              | 4,042      |                        | $          | (1,362                            | )            | $                             | 1,463      | * *           | *$*        | *4,143*          |       | $                                           | (1,364     | )                      | $          | (238      | )          | $          | 744        |   | $ | (614 | ) | $ | (307 | **)** | **$** | **2,364** | ** ** |

 

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**For the nine months ended September 30, 2005:**

(in thousands)
| ** **                                    | ** ** | **Health  Delivery  Services** | ** ** | **Health  Delivery  Sales** | ** ** | **Health  Delivery  Outsourcing** | *** *** | ***Health  Delivery  Total*** | ** ** | **Life  Sciences** | ** ** | **Health  Plan** | ** ** | **Government &  Technology  Services** | ** ** | **Software  Products** | ** ** | **Other** | ** ** | **Totals**  | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|-----------------------------------|--------------|-------------------------------|------------|--------------------|------------|------------------|------------|-------------------------------------------------|------------|------------------------|------------|-----------|------------|-------------|------------|
| Revenues before reimbursements                |       | $                              | 48,760     |                        | $          | —                            |         | $                             | 94,686     | * *           | *$*        | *143,446*        |       | $                                               | 24,831     |                   | $          | 13,069    |       | $           | 25,500     |   | $ | 1,953 |   | $ | (19 | **)** | **$** | **208,780** | ** ** |
| Reimbursements                                |       | 7,518                          |       | —                      |       | 568                               | * *     | *8,086*                       |       | 739                |       | 1,828            |       | 606                                             |       | 62                     |       | —    | ** ** | **11,321**  | ** ** |
| Total revenues                                |       | 56,278                         |       | —                      |       | 95,254                            | * *     | *151,532*                     |       | 25,570             |       | 14,897           |       | 26,106                                          |       | 2,015                  |       | (19       | **)**      | **220,101** | ** ** |
| Cost of services before reimbursable expenses |       | 31,546                         |       | —                      |       | 79,675                            | * *     | *111,221*                     |       | 13,380             |       | 9,741            |       | 14,681                                          |       | 2,758                  |       | (5,245    | **)**      | **146,536** | ** ** |
| Reimbursable expenses                         |       | 7,518                          |       | —                      |       | 568                               | * *     | *8,086*                       |       | 739                |       | 1,828            |       | 606                                             |       | 62                     |       | —    | ** ** | **11,321**  | ** ** |
| Total cost of services                        |       | 39,064                         |       | —                      |       | 80,243                            | * *     | *119,307*                     |       | 14,119             |       | 11,569           |       | 15,287                                          |       | 2,820                  |       | (5,245    | **)**      | **157,857** | ** ** |
| Gross profit                                  |       | 17,214                         |       | —                      |       | 15,011                            | * *     | *32,225*                      |       | 11,451             |       | 3,328            |       | 10,819                                          |       | (805                   | )          | 5,226     | ** ** | **62,244**  | ** ** |
| Selling expenses                              |       | 3,542                          |       | 4,831                       |       | 2,039                             | * *     | *10,412*                      |       | 5,327              |       | 1,748            |       | 2,627                                           |       | 400                    |       | 959       | ** ** | **21,473**  | ** ** |
| General & administrative expenses         |       | 8,930                          |       | —                      |       | 10,389                            | * *     | *19,319*                      |       | 7,184              |       | 2,278            |       | 5,422                                           |       | 1,084                  |       | 8,644     | ** ** | **43,931**  | ** ** |
| Income (loss) from operations                 |       | $                              | 4,742      |                        | $          | (4,831                            | )            | $                             | 2,583      | * *           | *$*        | *2,494*          |       | $                                               | (1,060     | )                      | $          | (698      | )          | $           | 2,770      |   | $ | (2,289 | ) | $ | (4,377 | **)** | **$** | **(3,160** | **)** |
|                                               |            |                                |            |                             |            |                                   |              |                               |            |                    |            |                  |            |                                                 |            |                        |            |           |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

(in thousands)
| ** **                                    | ** ** | **Health  Delivery  Services** | ** ** | **Health  Delivery  Sales** | ** ** | **Health  Delivery  Outsourcing** | *** *** | ***Health  Delivery  Total*** | ** ** | **Life  Sciences** | ** ** | **Health  Plan** | ** ** | **Government  &   Technology  Services** | ** ** | **Software  Products** | ** ** | **Other** | ** ** | **Totals**  | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|-----------------------------------|--------------|-------------------------------|------------|--------------------|------------|------------------|------------|----------------------------------------------|------------|------------------------|------------|-----------|------------|-------------|------------|
| Revenues before reimbursements                |       | $                              | 54,043     |                        | $          | —                            |         | $                             | 81,759     | * *           | *$*        | *135,802*        |       | $                                            | 26,909     |                   | $          | 11,660    |       | $           | 22,528     |   | $ | 981 |   | $ | 12 | ** ** | **$** | **197,892** | ** ** |
| Reimbursements                                |       | 7,544                          |       | —                      |       | 415                               | * *     | *7,959*                       |       | 753                |       | 1,850            |       | 492                                          |       | 194                    |       | 1,618     | ** ** | **12,866**  | ** ** |
| Total revenues                                |       | 61,587                         |       | —                      |       | 82,174                            | * *     | *143,761*                     |       | 27,662             |       | 13,510           |       | 23,020                                       |       | 1,175                  |       | 1,630     | ** ** | **210,758** | ** ** |
| Cost of services before reimbursable expenses |       | 29,441                         |       | —                      |       | 67,702                            | * *     | *97,143*                      |       | 15,467             |       | 7,705            |       | 13,720                                       |       | 1,886                  |       | (2,917    | **)**      | **133,004** | ** ** |
| Reimbursable expenses                         |       | 7,544                          |       | —                      |       | 415                               | * *     | *7,959*                       |       | 753                |       | 1,850            |       | 492                                          |       | 194                    |       | 1,618     | ** ** | **12,866**  | ** ** |
| Total cost of services                        |       | 36,985                         |       | —                      |       | 68,117                            | * *     | *105,102*                     |       | 16,220             |       | 9,555            |       | 14,212                                       |       | 2,080                  |       | (1,299    | **)**      | **145,870** | ** ** |
| Gross profit                                  |       | 24,602                         |       | —                      |       | 14,057                            | * *     | *38,659*                      |       | 11,442             |       | 3,955            |       | 8,808                                        |       | (905                   | )          | 2,929     | ** ** | **64,888**  | ** ** |
| Selling expenses                              |       | 3,293                          |       | 3,966                       |       | 1,652                             | * *     | *8,911*                       |       | 7,030              |       | 2,406            |       | 2,137                                        |       | 251                    |       | 148       | ** ** | **20,883**  | ** ** |
| General & administrative expenses         |       | 8,228                          |       | —                      |       | 7,727                             | * *     | *15,955*                      |       | 9,008              |       | 2,015            |       | 4,489                                        |       | 548                    |       | 5,726     | ** ** | **37,741**  | ** ** |
| Income (loss) from operations                 |       | $                              | 13,081     |                        | $          | (3,966                            | )            | $                             | 4,678      | * *           | *$*        | *13,793*         |       | $                                            | (4,596     | )                      | $          | (466      | )          | $           | 2,182      |   | $ | (1,704 | ) | $ | (2,945 | **)** | **$** | **6,264** | ** ** |
|                                               |            |                                |            |                             |            |                                   |              |                               |            |                    |            |                  |            |                                              |            |                        |            |           |            |             |            |  |  |  |  |  |  |  |  |  |  |  |

 

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The“Other” column consists of unallocated shared service center and support costs.  For the three months and nine months endedSeptember 30, 2005 and September 24, 2004, there was a significant net loss inthis column due to under utilization of both the infrastructure and integrationshared service centers.

 

*Detail of Health DeliveryOutsourcing Revenues*

 

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

 
| ** **                     | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|--------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | **September 30,  2005** | ** ** | **September 24,  2004** | ** ** | **September 30,  2005** | ** ** | **September 24,  2004** | ** ** |
| Internally generated  revenues |       | $                       | 30,165     |                    | $          | 21,216 |   | $ | 78,753 |   | $ | 65,664 |   |
| Subcontractor revenues         |       | 5,100                   |       | 5,844                   |       | 15,933 |   | 16,095 |   |
| Revenues before reimbursements |       | $                       | 35,265     |                    | $          | 27,060 |   | $ | 94,686 |   | $ | 81,759 |   |
|                                |            |                         |            |                         |            |  |  |  |  |  |  |  |  |  |

 

**Note 10                  Line of Credit**

 

                    The Company has a revolvingline of credit expiring on May 1, 2006, under which it is allowed to borrow upto $7.0 million at the prevailing prime rate. There was no outstanding balance under the line of credit at September30, 2005.  Due to the Company’s thirdquarter loss, an amendment was required to certain of the Company’s loancovenants in order to maintain compliance. Terms of this amendment were approved subsequent to September 30, 2005,and the Company is in compliance with such amended terms.

 

**Note 11                  Capital Stock Repurchase**

 

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

TheCompany’s purchase of Mr. Lipson’s ownership interest included all of the1,962,400 outstanding shares of common stock of FCG held by Mr. Lipson,together with 32,000 in-the-money options to purchase shares of common stock ofFCG.  The aggregate purchase price forthe shares and the options represented a premium of approximately 11% over theclosing price of FCG’s common stock on February 26, 2004.

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

 

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Othermaterial terms of the transaction were as follows:

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

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

•          Mr. Lipson also granted tothe Board of Directors of the Company an irrevocable proxy for any of theCompany’s securities that he owns or acquires after the closing of the Company’spurchase in this transaction.

•          The Company and Mr. Lipsonexecuted a mutual release of claims.

## ** **

## **Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

                THEFOLLOWING MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OFTHE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.  SUCH FORWARD-LOOKING STATEMENTS INVOLVE RISKSAND UNCERTAINTIES, INCLUDING THOSE SET FORTH BELOW UNDER THE CAPTION “RISKSRELATING TO OUR BUSINESS,” AND CONTAINED IN OTHER REPORTS WE FILE WITH THESECURITIES AND EXCHANGE COMMISSION.  OURACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESEFORWARD-LOOKING STATEMENTS.

 

**Overview**

 

                Weprovide services primarily to providers, payors, government agencies,pharmaceutical, biogenetic, and other healthcare organizations in NorthAmerica, Europe, and Asia.  We generatesubstantially all of our revenues from fees for information technologyoutsourcing services and professional services.

 

We typically bill for ourservices on an hourly or fixed-fee basis as specified by the agreement with aparticular client.  For services billedon an hourly basis, in our consulting and systems integration businesses (“CSI”),fees are determined by multiplying the amount of time expended on eachassignment by the project hourly rate for the consultant(s) assigned to the engagement.  Fixed fees, including outsourcing fees, areestablished on a per-assignment or monthly basis and are based on severalfactors such as the size, scope, complexity, and duration of an assignment, thenumber of our employees required to complete the assignment, and the volume oftransactions or interactions.  Revenuesare generally recognized related to the level of services performed, the amountof cost incurred on the assignment versus the estimated total cost to completethe assignment, or on a straight-line basis over the period of performance ofservice.  Additionally, we have beenlicensing an increased amount of our software products, generally inconjunction with the customization and implementation of such softwareproducts.  Revenues from our softwarelicensing and maintenance were approximately 3% of our net revenues in thethird quarter of 2005, and we expect our software licensing revenues tocontinue to grow incrementally during our 2005 fiscal year.  We also expect our services revenuesassociated with the implementation of our software products to continue tobecome a more significant part of our overall services revenues.

 

Provisions are made forestimated uncollectible amounts based on our historical experience.  We may obtain payment in advance of providingservices.  These advances are recorded ascustomer advances and reflected as a liability on our balance sheet.

 

                Out-of-pocketexpenses billed and reimbursed by clients are included in total revenues, andthen deducted to determine revenues before reimbursements (“net revenues”).  For purposes of analysis, all percentages inthis discussion are stated as a percentage of net revenues, since we believethat this is the more relevant measure of our business.

 

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                Costof services primarily consists of the salaries, bonuses, and related benefitsof client-serving consultants and outsourcing associates, and subcontractorexpenses.  Selling expenses primarilyconsist of the salaries, benefits, travel, and other costs of our sales force,as well as marketing and market research expenses.  General and administrative expenses primarilyconsist of the costs attributable to the support of our client-servingprofessionals such as non-billable travel, office space occupancy, informationsystems and infrastructure, salaries and expenses for executive management,financial accounting and administrative personnel, expenses for firm andbusiness unit governance meetings, recruiting fees, professional developmentand training, and legal and other professional services.  As associate related costs are relativelyfixed in the short term, variations in our revenues and operating results inour CSI business can occur as a result of variations in billing margins andutilization rates of our billable associates.

 

Our most significantexpenses are our human resource and related salary and benefit expenses.  As of September 30, 2005, approximately 1,380of our 2,719 employees are billable consultants.  Another 1,012 employees are part of ouroutsourcing business.  The salaries andbenefits of such billable consultants and outsourcing related employees arerecognized in our cost of services.  Mostnon-billable employee salaries and benefits are recognized as a component ofeither selling or general and administrative expenses.  Approximately 12.0% of our workforce, or 327employees, are classified as non-billable. Our cost of services as a percentage of revenues is directly related toseveral factors, including, but not limited to:

 

•                  Our consultant utilization,which is the ratio of total billable hours to available hours in a givenperiod;

•                  The amount and timing ofcost incurred;

•                  Our ability to control costson our outsourcing projects;

•                  The billed rate on time andmaterial contracts; and

•                  The estimated cost tocomplete our non-outsourcing fixed price contracts.

 

In our outsourcingcontracts, a significant portion of our revenues are fixed and allocated overthe contract on a straight-line basis, as we are required to provide aspecified level of services subject to certain performance measurements.  Also, certain revenues may fluctuate underthe contracts based on the volume of transactions we process or othermeasurements of service provided.  If weincur higher costs to provide the required services or receive less revenuesdue to reduced transaction volumes or penalties associated with service levelfailures, our gross profit can be negatively impacted.  If any of our large outsourcing contracts areterminated by the client, or if we fail to secure renewals of any outsourcingcontracts, our results of operations could be adversely affected.

 

In our CSI business, wemanage consultant utilization by monitoring assignment requirements andtimetables, available and required skills, and available consultant hours perweek and per month.   Differences inpersonnel utilization rates can result from variations in the amount ofnon-billed time, which has historically consisted of training time, vacationtime, time lost to illness and inclement weather, and unassigned time.  Non-billed time also includes time devoted toother necessary and productive activities such as sales support andinterviewing prospective employees. Unassigned time results from differences in the timing of the completionof an existing assignment and the beginning of a new assignment.  In order to reduce and limit unassigned time,we actively manage personnel utilization by monitoring and projecting estimatedengagement start and completion dates and matching consultant availability withcurrent and projected client requirements. The number of consultants staffed on an assignment will vary accordingto the size, complexity, duration, and demands of the assignment.  Assignment terminations, completions,inclement weather, and scheduling delays may result in periods in whichconsultants are not optimally utilized. An unanticipated termination of a significant assignment or an overalllengthening of the sales cycle could result in a higher than expected number ofunassigned consultants and could cause us to experience lower margins.  In addition, entry into new market areas andthe hiring of consultants in advance of client assignments have resulted andmay continue to result in periods of lower consultant utilization.

 

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In response to competitionand continued pricing and rate pressures, we have implemented a global sourcingstrategy into our business operations, which includes the deployment ofoffshore resources as well as resources that perform services remote from theclient site.  We also incorporate largernumbers of variable cost or per diem staff in some of our projects.  We expect these strategies to result inimproved cost of services through a combination of lower cost attributable tooffshore resources and higher leverage of resources that perform servicesoffsite or on a variable cost basis.  Tothe extent we pass through reduced costs to our clients related to offshoreresources, the global sourcing strategy may result in lower revenues on a perengagement basis. However, we expect to offset this potential revenue impactwith improved competitive positioning in our markets, which could result in anincreased number of engagements to offset the potential revenue impact.  Several of our competitors employ both globalsourcing and variable staffing strategies to provide software development andother information technology services to their clients, while at the same timereducing their cost structure and improving the quality of services theyprovide.  If we are unable to realize theperceived cost benefits of our recently implemented strategies or if we areunable to receive high quality services from foreign employees, variable staffemployees or subcontractors, our business may be adversely impacted and we maynot be able to compete effectively.

 

**Results of Operations for theThree Months Ended September 30, 2005 and September 24, 2004**

 

*Revenues. *Our net revenues increasedto $72.7 million for the quarter ended September 30, 2005, an increase of 11.4%from $65.3 million for the quarter ended September 24, 2004.  Our total revenues increased to $76.6 millionfor the quarter ended September 30, 2005, an increase of 9.9% from $69.7million for the quarter ended September 24, 2004. The increases in net revenueswere in Health Delivery Outsourcing, Government and Technology Services, andHealth Plan, offset by a decrease in Health Delivery Services. The HealthDelivery Outsourcing segment had the most significant increase, $8.2 million,or 30.3%, primarily due to $4.0 million in revenues from two new outsourcingengagements, which began in the quarter ended September 30, 2005. Additionally,there was a one-time $1.0 million pass-through revenue item in Health DeliveryOutsourcing related to transitioning out subcontractor services at UniversityHospitals Health System (“UHHS”) in Cleveland, Ohio.  The remaining increase in revenues in thatsegment is due to additional contracts executed over the past year.  Government and Technology Services grew by$1.5 million, or 20.3%, primarily due to growth in FCG Software Services(formerly named Paragon Solutions, Inc.), which provides offshore softwaredevelopment services to clients.  Themost significant offsetting decrease was in Health Delivery Services, whichdeclined by $2.4 million, or 13.2%, due to market-based billing rate pressuresin our Revenue Cycle, Meditech, and ERP practices.

 

In August 2005, we began afive-year IT outsourcing agreement with one client, and a three-year agreementwith another client.  Annual revenuesfrom these two clients are expected to be approximately $29 million. In July2005, we announced the early termination for convenience by The New York andPresbyterian Hospital of our approximately $30 million per year outsourcingagreement, effective December 31, 2005 (the contract was executed in November1999 and was originally scheduled to expire in December 2006). Also, in October2005, we announced the mutually agreed termination of our outsourcing agreementwith UMass Memorial Health Care (“UMMHC”) effective November 1, 2005, withcertain transition services to be performed through December 31, 2005.  The expected net result of these recentdevelopments in our outsourcing business will be similar revenues in the fourthquarter of 2005 as compared to the third quarter of 2005, followed by asignificant decrease in revenues as of the beginning of 2006.  Additionally, we have an existing majoroutsourcing contract up for renewal in March 2006, the non-renewal of whichwould have a negative impact on our Health Delivery Outsourcing revenues.  Revenues in our business units other thanoutsourcing are not expected to change significantly as a whole in the nearterm.

 

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                *Cost of Services. *Costof services before reimbursable expenses increased to $50.9 million for thequarter ended September 30, 2005, an increase of 16.6% from $43.7 million forthe quarter ended September 24, 2004. The increase was primarily due to $6.8 million of additional costs inthe Health Delivery Outsourcing segment, of which $4.1 million was associatedwith the two new contracts and the $1.0 million pass-through item noted above,and the remainder was due to costs related to other contracts executed over thepast year and higher costs on the UMMHC contract.  We also increased costs in both the HealthPlan and the Government and Technology Services segments in order to deliverthe higher level of revenues in each segment. Life Sciences costs declined as we reduced costs in that area, primarilythrough staff attrition, to improve profitability.

 

*Gross Profit. *Gross profit increasedslightly to $21.8 million, or 29.9% of net revenues, for the quarter endedSeptember 30, 2005, an increase of 0.7% from $21.6 million, or 33.1% of netrevenues, for the quarter ended September 24, 2004.  This increase was due to increases in grossprofit in Health Delivery Outsourcing, Government and Technology Services, andHealth Plan related to the increases in revenues in those businesses describedabove, offset almost entirely by a decrease in gross profit in Health DeliveryServices, primarily due to the decrease in revenue described above. The grossprofit of Health Delivery Outsourcing, approximately 16.7% during the thirdquarter of 2005, is lower on a percentage basis than gross profit in our otherbusiness segments.  While the grossprofit percentage in this segment remained steady year over year for the thirdquarter, the significantly higher portion of our revenue mix coming from ourHealth Delivery Outsourcing segment was a major contributing factor to ouroverall gross profit percentage decline to 29.9% from 33.1% of net revenues,due to the lower gross profit nature of outsourcing business.

 

We expect that after thefourth quarter of 2005, due to the two contract completions described above,our mix of Health Delivery Outsourcing revenues should decline from close to50% of our net revenues in the third quarter of 2005 to approximately 40% ofour net revenues in the first quarter of 2006, which will have the effect ofincreasing our overall gross profit percentage. Further, since our gross margin percentage at the two completed projectswas lower than on our other outsourcing contracts, our gross profit percentagein Health Delivery Outsourcing is currently expected to increase nextyear.  Such percentage is also expectedto increase in the fourth quarter of 2005 due to a one-time termination fee onthe UMMHC contract.

 

Additionally, in March 2005,we extended our agreement with UHHS for an additional three-year period whichwill expire on July 31, 2010.  Thisagreement originally had a five-year term, with two years remaining.  As part of the extension, the client hasrequired that we replace Affiliated Computer Services (“ACS”) as theinfrastructure subcontractor.   As aresult, starting during the third quarter of 2005, we began to earn grossprofit on most of the ACS revenues, while it had previously been asubcontracted pass-through of costs with no profit for us.  On new or expanded outsourcing contracts,however, the first several quarters’ gross profit is typically reduced due tohigher costs incurred during the transition.

 

Despite the immediatedecline in outsourcing revenues that we expect to experience at the beginningof 2006, we expect outsourcing to contribute an increasing proportion of ourtotal revenues in the long term, which we expect will result in our grossprofit percentage declining incrementally.

 

In addition, a suddendownturn in demand in one or more of our segments, such as we experienced inHealth Delivery Services in the third quarter of 2005, or an inability tocontrol costs on our fixed price projects, could negatively affect our grossprofit percentage.

 

                *Selling Expenses. *Sellingexpenses increased to $7.6 million for the quarter ended September 30, 2005, anincrease of 16.9% from $6.5 million for the quarter ended September 24,2004.  This increase was primarily due tosales commissions on the new outsourcing contracts described above, as well asdue to higher marketing and advertising expenses and to severance costs.  Selling expenses are expected to declinestarting in the fourth quarter as a result of a reduced sales force.  Selling expenses as a percentage of netrevenues increased to 10.5% for the quarter ended September 30, 2005 from 10.0%for the quarter ended September 24, 2004 for the same reasons.

 

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                *General and Administrative Expenses. *General and administrative expenses increased to $14.6million for the quarter ended September 30, 2005, an increase of 14.6% from$12.7 million for the quarter ended September 24, 2004.  The increase was due to non-salary costs, asgeneral and administrative salaries and benefits declined by approximately$200,000.  The most significant increasewas in infrastructure costs of approximately $800,000 related to facilities andequipment needed to directly support our outsourcing business.  Such infrastructure costs now representapproximately $1.1 million per quarter of our general and administrativeexpenses.  Additionally, we incurredapproximately $500,000 in higher bad debt expenses, as we increased reservesfor the potential non-collectability of several accounts in the third quarterof 2005, while we had reversed certain such reserves in the third quarter of2004 upon the resolution of several accounts. Further, during the third quarter of 2005, we incurred $300,000 inhigher travel costs.  Finally, weexperienced higher costs in several other areas including rent in our growingoffshore shared service centers, and recruiting costs.  General andadministrative expenses as a percentage of net revenues increased to 20.1% forthe quarter ended September 30, 2005 from 19.5% for the quarter ended September24, 2004.  During the fourth quarter of2005, we expect general and administrative expenses to increase due to a chargeto accomplish a reduction of space utilized in our Life Sciences business unit.

 

*Interest Income, Net.** ***Interest income,net of interest expense, increased to $234,000 for the quarter ended September30, 2005, an increase of 26.5% from $185,000 for the quarter ended September24, 2004, due to higher interest rates earned on cash and investments.  Interest income, net of interest expense as apercentage of net revenues remained constant at 0.3% for the quarters endedSeptember 30, 2005 and September 24, 2004.

 

*Other Income (Expense),Net*.  Other income (expense) wasnegligible for the quarters ended September 30, 2005 and September 24, 2004.

 

                *Income Taxes. *Werecorded a $20,000 tax provision for the quarter ended September 30, 2005versus a $1.1 million tax provision for the quarter ended September 24,2004.  The tax provision for the quarterended September 30, 2005 reflects a minor adjustment to achieve an estimatedeffective annual tax benefit rate of 24.4% for 2005 (exclusive of a valuationallowance), compared to a normal tax provision rate of 44.2% for the quarterended September 24, 2004.  The effectivetax benefit rate for 2005 is lower than the 2004 provision rate due to theeffect of non-deductible expenses.

 

*Loss on DiscontinuedOperations*.  Thedisposition of our Coactive Call Center Service line in the first quarter offiscal year 2005 has been accounted for as a discontinued operation, and therewere no remaining activities in this business during the quarter endedSeptember 30, 2005.  For the quarterended September 24, 2004, we incurred a net loss from the operations of thisdiscontinued operation of $167,000.

 

**Results of Operations for theNine Months Ended September 30, 2005 and September 24, 2004**

 

*Revenues. *Our net revenues increasedto $208.8 million for the nine months ended September 30, 2005, an increase of5.5% from $197.9 million for the nine months ended September 24, 2004.  Our total revenues increased to $220.1million for the nine months ended September 30, 2005, an increase of 4.4% from$210.8 million for the nine months ended September 24, 2004.  The increases in net revenues were in HealthDelivery Outsourcing, Government and Technology Services, and Health Plan,offset by a decrease in Health Delivery Services.  The Health Delivery Outsourcing segment hadthe most significant increase, $12.9 million, or 15.8%, primarily due to theexecution of a new outsourcing engagement in late 2004, and two new engagementsin August 2005.  Government andTechnology Services grew by $3.0 million, or 13.2%, primarily due to growth inFCG Software Services, which provides offshore software development services toclients.  The most significant offsettingdecrease was in Health Delivery Services, which declined by $5.3 million, or9.8%, due to market-based billing rate pressures in our Revenue Cycle,Meditech, and ERP practices.

 

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                *Cost of Services. *Costof services before reimbursable expenses increased to $146.5 million for thenine months ended September 30, 2005, an increase of 10.2% from $133.0 millionfor the nine months ended September 24, 2004. The increase was primarily due to $12.0 million of additional costs inthe Health Delivery Outsourcing segment associated with the increased revenuesnoted above.  Additionally, we increasedcosts in Health Delivery Services in early 2005 to add staff in the clinicalpractice areas in order to meet increased demand in those areas.  We also increased Health Plan costs due toour higher volume of business, and to our investment in developing new businessofferings in both information technology and business process outsourcing inthat segment.  Life Sciences costsdeclined as we reduced costs in that area, primarily through staff attrition,to improve profitability.

 

*Gross Profit. *Gross profit decreased to$62.2 million, or 29.8% of net revenues, for the nine months ended September30, 2005, a decrease of 4.1% from $64.9 million, or 32.8% of net revenues, forthe nine months ended September 24, 2004. The decrease was primarily due to a reduction in the Health DeliveryServices segment gross profit, declining to 35.3% of net revenues for the ninemonths ended September 30, 2005 from 45.5% of net revenues for the nine monthsended September 24, 2004.  This decreasewas due to the decline in revenues in Health Delivery Services in the firstnine months of fiscal year 2005, while cost of services had increased.  In addition, gross profit decreased in HealthDelivery Outsourcing, declining to 15.9% of net revenues for the nine monthsended September 30, 2005 from 17.2% of net revenues for the nine months endedSeptember 24, 2004.  This decline was dueto costs incurred at several clients to attempt to achieve client satisfaction.

 

*Selling Expenses. *Selling expenses increasedslightly to $21.5 million for the nine months ended September 30, 2005, anincrease of 2.8% from $20.9 million for the nine months ended September 24,2004.  Selling expenses as a percentageof net revenues decreased slightly to 10.3% for the nine months ended September30, 2005 from 10.6% for the nine months ended September 24, 2004.

 

                *General and Administrative Expenses. *General and administrative expenses increased to $43.9million for the nine months ended September 30, 2005, an increase of 16.4% from$37.7 million for the nine months ended September 24, 2004.  The vast majority of the increase was due tonon-salary costs.  The most significantincrease was in infrastructure costs of approximately $2.4 million related tofacilities and equipment needed to directly support our outsourcing business.  Further, we incurred approximately $800,000of severance costs in the nine months ended September 30, 2005 compared toapproximately $100,000 in the nine months ended September 24, 2004.  Finally, we experienced higher costs in anumber of other areas including outside professional services such as audit, legal,and consulting costs, nonbillable travel, recruiting costs, and rent in ourgrowing offshore shared service centers.  General andadministrative expenses as a percentage of net revenues increased to 21.0% forthe nine months ended September 30, 2005 from 19.1% for the nine months endedSeptember 24, 2004.

 

*Interest Income, Net.** ***Interestincome, net of interest expense, increased to $674,000 for the nine monthsended September 30, 2005, an increase of 27.4% from $529,000 for the ninemonths ended September 24, 2004, due to higher interest rates earned on cashand investments.  Interest income, net ofinterest expense as a percentage of net revenues remained constant at 0.3% forthe nine months ended September 30, 2005 and September 24, 2004.

 

*Other Income (Expense),Net*.  Other expense decreased to$51,000 for the nine months ended September 30, 2005, a decrease of 54.9% from$113,000 for the nine months ended September 24, 2004.

 

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*Expense for Premium onRepurchase of Stock*.  In thefirst quarter of 2004, we repurchased 1.96 million shares of our common stockand certain options from a major stockholder at a premium to the then currentmarket price (see Note 11 of Notes to Consolidated Financial Statements).  The aggregate purchase price for the sharesand the options represented a premium of approximately 11% to market. As aresult, we recorded a pretax charge of approximately $1.6 million (without anytax benefit) for such premium included in the purchase consideration.

 

                *Income Taxes. *Werecorded a $5.4 million tax provision for the nine months ended September 30,2005 versus a $2.9 million tax provision for the nine months ended September24, 2004.  The tax provision for the ninemonths ended September 30, 2005 primarily consisted of a $6.0 million tax assetvaluation allowance recorded during the second quarter of 2005.  The valuation allowance was recorded as aresult of the recent historical losses we have incurred, creating additionalnegative evidence as to the uncertainty of our ability to realize certain ofour deferred tax assets, as assessed per the guidance of the applicable taxaccounting standard, SFAS 109. The high provision rate of 57.5% in 2004 is dueto the non-deductibility of the expense for premium on repurchase of stocknoted above.

 

*Loss on DiscontinuedOperations*.  Thedisposition of our Coactive Call Center Service line has been accounted for asa discontinued operation.  During thenine months ended September 30, 2005, we incurred $866,000 of costs related tothe operation and wind-down of the business. These costs, net of a 38% tax benefit, resulted in a net loss of$537,000, compared to a net loss from the operations of this discontinued operationof $512,000 for the nine months ended September 24, 2004.

 

**Liquidity and Capital Resources**

 

                During the ninemonths ended September 30, 2005, we generated cash flow from operations of $1.3million.  During the nine months endedSeptember 30, 2005, we used $2.5 million to repurchase shares of our commonstock from the previous owners of FCG InfrastructureServices, Inc. (formerly Codigent Solutions Group, Inc.).  Further, we used approximately $6.5 millionof cash to purchase property and equipment, primarily information technologyand related equipment, including infrastructure equipment for our data centerand help desk.  At September 30, 2005, wehad cash and investments available for sale of $33.3 million compared to $40.3million at December 31, 2004.  One of ournew outsourcing accounts, which began in August 2005, had a net negative impacton cash of over $2 million during the third quarter of 2005, primarily due toan agreed upon deferral of fees and transition costs, and will have anadditional negative impact of over $2 million over the next 2 quarters due tofurther agreed upon fee deferrals and to certain capital expenditures.  We expect cash to decrease in the fourthquarter of 2005 due to that contract, and to costs associated with our assumptionof work previously performed by a subcontractor at our UHHS outsourcingaccount; however, this decrease is expected to be offset by a payment of $2million due related to the termination of our New York Presbyterian outsourcingaccount, which is expected to be received by year end, or shortly thereafter.

 

                We have a revolving line ofcredit, under which we are allowed to borrow up to $7.0 million at an interestrate of the prevailing prime rate with an expiration of May 1, 2006.  There was no outstanding balance under theline of credit at September 30, 2005. Due to the third quarter loss, an amendment was required to certain ofthe loan covenants in order to maintain compliance.  Terms of this amendment were approvedsubsequent to September 30, 2005, and we are in compliance with such amendedterms.

 

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As of September 30, 2005,the following table summarizes our contractual and other commitments (inthousands):

 
| ** **                          | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------------|------------|----------------------------|------------|
| **Contractual Obligations**         | ** ** | **Less than 1  Year**      | ** ** | **1 -3  Years** | ** ** | **3-5  Years** | ** ** | **More Than  5 Years** | ** ** | **Total** | ** ** |
| Operating leases, net of  subleases |       | $                          | 4,635      |   | $ | 7,212 |   | $ | 1,059 |   | $ | 73 | ** ** | **$** | **12,979** | ** ** |
| Purchase obligations                |       | 155                        |       | — |   | — |   | — | ** ** | **155** | ** ** |
| Total                               |       | $                          | 4,790      |   | $ | 7,212 |   | $ | 1,059 |   | $ | 73 | ** ** | **$** | **13,134** | ** ** |

 

Management believes that ourexisting cash and investments, together with funds generated from operations,will be sufficient to meet operating requirements for at least the next twelvemonths.  Our cash and investments areavailable for capital expenditures (which are projected to total approximately$8.5 million for 2005), upfront setup costs and deferred fees on new contracts,strategic investments, mergers and acquisitions, and other potentiallarge-scale cash needs that may arise.

 

**Critical Accounting Policies andEstimates**

 

The foregoing discussion andanalysis of our financial condition and results of operations is based upon ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States.  The preparation of these financial statementsrequires us to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities.  On anon-going 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 baseour estimates on historical experience and on various other assumptions that webelieve to be reasonable under the 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 differ from ourestimates and we do not assume any obligation to update any forward-lookinginformation.

 

Webelieve the following critical accounting policies reflect our more significantassumptions and estimates used in the preparation of our consolidated financialstatements.

 

***RevenueRecognition and Unbilled Receivables***

 

Revenues are derivedprimarily from information technology outsourcing services, consulting, andsystems integration.  Revenues arerecognized on a time-and-materials, level-of-effort, percentage-of-completion,or straight-line basis.  Before revenuesare recognized, the following four criteria must be met: (a) persuasive evidenceof an arrangement exists; (b) delivery has occurred or services rendered; (c)the fee is fixed and determinable; and (d) collectability is reasonablyassured.  We determine if the fee isfixed and determinable and collectability is reasonably assured based on ourjudgments regarding the nature of the fee charged for services rendered andproducts delivered.  Arrangements vary inlength from less than one year to seven years. The longer-term arrangements are generally level-of-effort or fixedprice arrangements.

 

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

 

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Revenues recognized on fixedprice consulting and system integration contracts are subject to revisions asthe contract progresses to completion. If we do not accurately estimate the resources required or the scope ofthe work to be performed, do not complete our projects within the planned periodsof time, or do not satisfy our obligations under the contracts, then profit maybe significantly and negatively affected. Revisions in our contract estimates are reflected in the period in whichthe determination is made that facts and circumstances dictate a change ofestimate. Favorable changes in estimates result in additional revenuesrecognized, and unfavorable changes in estimates result in a reduction ofrecognized revenues. Provisions for estimated losses on individual contractsare made in the period in which the loss first becomes known.  Some contracts include incentives forachieving either schedule targets, cost targets, or other defined goals.  Revenues from incentive type arrangements arerecognized when it is probable they will be earned.

 

We account for certain ofour 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 multiple deliverables are divided intoseparate units of accounting if the deliverables in the arrangement meet thefollowing criteria: (1) the delivered item has value to the customer on astandalone basis; (2) there is objective and reliable evidence of the fairvalue of undelivered items; and (3) delivery of any undelivered item isprobable.  Arrangement consideration isallocated among the separate units of accounting based on their relative fairvalues, with the amount allocated to the delivered item being limited to theamount that is not contingent on the delivery of additional items or meetingother specified performance conditions.

 

                Inour outsourcing 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 mayfluctuate under the contracts based on the volume of transactions we process orother measurements of service provided. If we incur higher costs to provide the required services or receivelower revenues due to reduced transaction volumes or penalties associated withservice level failures, our gross profit can be negatively impacted.

 

On certain contracts, orelements of contracts, costs are incurred subsequent to the signing of thecontract, but prior to the rendering of service and associated recognition ofrevenue.  Where such costs are incurredand realization of those costs is either paid for upfront or guaranteed by thecontract, those costs are deferred and later expensed over the period ofrecognition of the related revenue.  AtSeptember 30, 2005, we had deferred $2.8 million of unamortized deferred costswhich are included in other non-current assets. Several of our recent contract awards include significant setup costs,so our deferred costs are expected to continue to increase in the fourthquarter of the year.

 

As part of our on-goingoperations to provide services to our customers, incidental expenses, which aregenerally reimbursable under the terms of the contracts, are billed tocustomers. 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.

 

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                Softwarelicense and maintenance revenues comprised approximately 3% of our net revenuesin the third quarter of 2005. Additionally, we realized substantial additional revenues from theimplementation of our software.  Werecognize software revenues in accordance with the provisions of the AmericanInstitute of Certified Public Accountants Statement of Position (“SOP”) 97-2, “SoftwareRevenue Recognition”, as amended by SOP 98-4, “Deferral of the Effective Dateof a Provision of SOP 97-2, Software Revenue Recognition” and SOP 98-9, “Modificationof SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions”,and in accordance with the Securities and Exchange Commission Staff AccountingBulletin (“SAB”) No. 104, “Revenue Recognition”. We license software undernon-cancelable license agreements and provide related professional services,including consulting, training, and implementation services, as well as ongoingcustomer support and maintenance.  Mostof our software license fee revenues are from arrangements which includeimplementation services that are essential to the functionality of our softwareproducts, and are recognized using contract accounting, including thepercentage-of-completion methodology, over the period of the implementation.

 

In those more limited caseswhere our software arrangements do not include services essential to thefunctionality of the product, license fee revenues are recognized when thesoftware product has been shipped, provided a non-cancelable license agreementhas been signed, there are no uncertainties surrounding product acceptance, thefees are fixed or determinable and collection of the related receivable isconsidered probable. We do not generally offer rights of return or acceptanceclauses to our customers. In situations where we do provide rights of return oracceptance clauses, revenue is deferred until the clause expires. Typically,our software license fees are due within a twelve-month period from the date ofshipment. If the fee due from the customer is not fixed or determinable,including payment terms greater than twelve months from shipment, revenue isrecognized as payments become due and all other conditions for revenuerecognition have been satisfied. In software arrangements that include rightsto multiple software products, specified upgrades, maintenance or services, weallocate the total arrangement fee among the deliverables using the fair valueof each of the deliverables determined using vendor-specific objectiveevidence. Vendor-specific objective evidence of fair value is determined usingthe price charged when that element is sold separately. In softwarearrangements in which we have fair value of all undelivered elements but not ofa delivered element, we use the residual method to record revenue. Under theresidual method, the fair value of the undelivered elements is deferred and theremaining portion of the arrangement fee is allocated to the deliveredelement(s) and is recognized as revenue. In software arrangements in which wedo not have vendor-specific objective evidence of fair value of all undeliveredelements, revenue is deferred until fair value is determined or all elementshave been delivered.

 

Revenues from training andconsulting services are recognized as services are provided to customers.Revenues from maintenance contracts are deferred and recognized ratably overthe term of the maintenance agreements. Revenues for customer support andmaintenance that are bundled with the initial license fee are deferred based onthe fair value of the bundled support services and recognized ratably over theterm of the agreement; fair value is based on the renewal rate for continuedsupport arrangements.

 

Unbilled receivablesrepresent revenues recognized for services performed that were not billed atthe balance sheet date.  The majority ofthese amounts are billed in the subsequent month. Unbillable amounts arisingfrom contracts occur when revenues recognized exceed allowable billings in accordancewith the contractual agreements.  Suchunbillable amounts most often become billable upon reaching certain projectmilestones stipulated per the contract, or in accordance with the percentagecompletion methodology.  As of September30, 2005, we had unbillable revenues included in current unbilled receivablesof approximately $2.8 million, which were generally expected to be billedwithin one year.  In addition, we had another current receivable of $2.4 million at September 30, 2005 and a long-termaccount receivable of $3.8 million at December 31, 2004, on a single majoroutsourcing contract with a term of seven years.  This receivable was originally scheduled tobe billed and collected over the remaining 15 months of the contract throughcontractual billings that will exceed the amounts to be earned as revenues;however, due to the early termination of the contract for convenience by theclient, it is now scheduled to be received in full on December 31, 2005.  Additionally, we had a long-term receivableof $1.2 million at September 30, 2005, which was created in August 2005 throughthe deferral until 2010 of the first month of fees at a new outsourcingcontract.

 

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Customeradvances are comprised of payments from customers for which services have notyet been performed or prepayments against work in process. These unearnedrevenues are deferred and recognized as future contract costs are incurred andas contract services are rendered.

 

***Allowance forDoubtful Accounts***

 

                Wemaintain an allowance for doubtful accounts for estimated losses resulting fromthe inability of our clients to make required payments. This allowance is basedon the amount and aging of our accounts receivable, creditworthiness of ourclients, historical collection experience, current economic trends, and changesin client payment patterns.  If thefinancial condition of our clients was to deteriorate, resulting in animpairment of their ability to make payments, additional allowances would berequired.

 

***Deferred Income Taxes***

 

We account for income taxesin accordance with SFAS No. 109, “Accounting for Income Taxes,” which requiresrecognition of deferred tax assets and liabilities for the expected future taxconsequences of events that have been included in the financial statementswhich differ from our tax returns.  Weuse significant estimates in determining what portion of our deferred tax assetis more likely than not to be realized. Our net deferred tax assets have historically consisted primarily of thetax benefit related to restructuring costs for facility closures, supplementalexecutive retirement plan contributions, and other accrued liabilities such asaccrued vacation pay, which are not deductible for tax purposes until paid.  During fiscal year 2003, we generatedadditional deferred tax assets for net operating loss carryforwards which werecreated by our pretax losses combined with the fact that we were outside theperiod it is allowable to carry back losses. Taking into account our then-recent history of cumulative losses, werecorded a valuation allowance of $5.5 million in the fourth quarter of fiscalyear 2003.  Together with a fullvaluation allowance of $5.5 million we had already taken against the net operatingloss carryforwards of companies we had previously acquired, we had a valuationallowance of $11.0 million against a total deferred tax asset of $21.6 millionat December 26, 2003.

 

During the fourth quarter offiscal year 2004, we re-evaluated our requirement for a valuation allowanceafter having completed a full year in which we recorded taxable income in eachquarter.  At that time, we determinedthat it was more likely than not we would realize an additional $3.0 million ofour deferred tax assets and recorded a tax benefit in this amount.  During the first quarter of 2005, we incurreda pretax loss; however, based on management’s expectation of pretax earningsfor 2005, no change in the valuation allowance was recorded.  During the first six months of 2005, weincurred a pretax loss from continuing operations of $2.3 million.  Based on such performance, we increased ourdeferred tax asset valuation allowance during the second quarter of 2005 by$6.0 million.  This does not, in any way,limit our ability to use our deferred tax assets, primarily loss carryforwards,to offset taxable income in the future. As well as not being subject to taxation, a significant amount(approximately $20 million) of any future pretax income will not require a taxprovision in the income statement.  Afterapplication of this additional valuation allowance, we have approximately $6.0million of deferred tax assets other than net operating losses unreserved onour balance sheet.  However, there is noguarantee that our taxable income will be sufficient to realize such remainingnet deferred tax assets, and we will continue to evaluate the recoverability ofdeferred tax assets for an additional valuation allowance on an ongoingbasis.  At the end of the third quarterof 2005, we performed such an evaluation, and determined that our valuationallowance is appropriate.  Additionally,if at some point in the future, the realization of a greater amount of ourdeferred tax assets is considered more likely than not, we will reverse all ora portion of the existing valuation allowance at that time.

 

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**Goodwill and Intangible Assets**

** **

Under SFAS No 142, we nolonger amortize our goodwill and are required to complete an annual impairmenttesting during the fourth quarter of each year. We believe that the accounting assumptions and estimates related to theannual goodwill impairment testing are critical because these can change fromperiod to period.  The impairment testrequires us to forecast our future cash flows, which involves significantjudgment.  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.  Due to the loss incurred in the Life Sciencessegment in the third quarter of 2005, we evaluated the $1.5 million of goodwillin that unit for impairment, and determined it was not impaired.  We will perform another more extensive suchreview in the fourth quarter of 2005.  Asof September 30, 2005, we had $18.2 million of goodwill and $1.5 million ofintangible assets recorded on our balance sheet (see Note 5 of the Notes toConsolidated Financial Statements).

 

***Recent Accounting Pronouncements***

 

                InDecember 2004, the Financial Accounting Standards Board (“FASB”) enactedStatement of Financial Accounting Standards 123 (revised 2004) (“SFAS 123R”), “Share-Based Payment” which replaces Statement ofFinancial Accounting Standards No. 123 (“SFAS 123”), “Accounting forStock-Based Compensation” and supersedes APB Opinion No. 25 (“APB 25”), “Accountingfor Stock Issued to Employees.” SFAS 123R requires the measurement of all share-basedpayments to employees, including grants of employee stock options, using afair-value-based method and the recording of such expense in the consolidatedstatements of income. The accounting provisions of SFAS 123R wereoriginally planned to be effective for all quarterly reporting periodsbeginning after June 15, 2005.  InApril 2005, the Securities and Exchange Commission adopted a revision to SFAS123R to make the accounting provisions applicable to all fiscal year reportingperiods commencing after June 15, 2005. As a result, we are now required to adopt SFAS 123R commencing in thefirst quarter of 2006.

 

Uponthe adoption of SFAS 123R, the pro forma disclosures previously permitted underSFAS 123 no longer will be an alternative to financial statementrecognition. Although we have not yet determined our method of adoption orwhether the adoption of SFAS 123R will result in amounts that aresimilar to the current pro forma disclosures under SFAS 123, we areevaluating the requirements under SFAS 123R and we expect that the adoptionwill have an adverse impact on our reported earnings and net income per share.

 

**Risks Relating to Our Business**

 

Before deciding to invest inus or to maintain or increase your investment, you should carefully considerthe risks described below, in addition to the other information contained inthis report.  The risks and uncertaintiesdescribed below are not the only ones facing our company.  Additional risks and uncertainties notpresently known to us or that we currently deem immaterial may also affect ourbusiness operations.  If any of theserisks are realized, our business, financial condition or results of operationscould be seriously harmed.  In thatevent, the market price for our common stock could decline and you may lose allor part of your investment.

 

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* *

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

 

                Ournet revenues, operating results, and cash flows may fluctuate significantlybecause of a number of factors, many of which are outside of our control.  These factors may include:

 

•                  Our ability to achieve andmaintain profitability in each of our business segments;

•                  The loss of one or moresignificant clients in any of our business segments, including any failure tosecure renewals for any of our large outsourcing contracts or any earlytermination of any significant contracts;

•                  Our ability to recruit andretain a new chief executive officer, and the ability of our current managementteam to effectively manage our operations through a transition in management;

•                  Our ability to realize ourdeferred tax assets through future pretax earnings;

•                  Use of offsite and offshoreresources on our engagements and adoption of a blended-shore delivery model inthe healthcare IT industry;

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

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

•                  Delays or increased expensesin securing and completing client engagements;

•                  Timing and collection offees and payments;

•                  The financial performanceand credit worthiness of our clients;

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

•                  Increased competition andpricing pressures;

•                  Budgeting and other capitalexpenditure decisions of our clients;

•                  Our ability to anticipatechanging customer demands and preferences;

•                  Our ability to incorporatethe use of variable labor staffing into our projects;

•                  The loss of key personneland other employees;

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

•                  The timing of certaingeneral and administrative expenses;

•                  Costs associated withintegrating acquired operations;

•                  Costs associated with thedisposition of certain assets;

•                  Impairment of goodwill fromour acquisitions;

•                  Variability in the number ofbillable days in each quarter;

•                  The write-off of clientbillings;

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

•                  Service level credits andpenalties associated with our outsourcing engagements;

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

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

•                  Impact on our business andclients relating to force majeure events, including recent hurricanes in the Southeastand potential pandemic or epidemic disease;

•                  International currencyfluctuations;

•                  Expenses related to theissuance of stock options to our employees; and

•                  The fixed nature of asubstantial portion of our expenses, particularly personnel and related costs,depreciation, office rent, and occupancy costs.

 

One or more of the foregoingfactors may cause our operating expenses to be unexpectedly high or result in adecrease in our revenues during any given period.  In addition, we bill certain of our serviceson a fixed-price basis, and any assignment delays or expenditures of timebeyond that projected for the assignment could result in write-offs of clientreceivables (both unbilled and billed). Significant write-offs could materially adversely affect our business,financial condition, and results of operations. Our business also has significant collection risks.  If we are unable to collect our receivablesin a timely manner, our business and financial condition could alsosuffer.  If these or any other variablesor unknowns were to cause a shortfall in revenues or earnings or otherwisecause a failure to meet public market expectations, our business could beadversely affected.

 

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                Weadopted EITF 00-21 in the first quarter of 2003, which affects the way werecognize revenue on long-term outsourcing agreements. The adoption of EITF00-21 results in separating our outsourcing contracts into multiple elementsand separately accounting for each element, rather than accounting for allelements together as a group.  As aresult, we recognize revenue from certain service elements of our outsourcingagreements on a straight-line basis over the life of the contract, rather thanon a percentage of completion basis. Since we typically incur greater costs and expenses during the earlyphase of the service elements (which now have straight-line revenuerecognition) than we do in the later years of those elements, we believe ournet income will be less during the early stages of our outsourcingengagements.  In addition, if we areunable to manage costs as planned in the later stages of an outsourcingengagement, our net income will likewise be negatively impacted.  In general, income from our outsourcingcontracts will be less stable in the future, since it will be more susceptibleto changes in the mix of newer versus older contracts, and to the impact ofcost fluctuations from quarter to quarter without a compensating change inrevenues.  If we fail to meet our publicmarket expectations or otherwise experience a shortfall in our net income dueto these fluctuations, our business could be adversely affected and the priceof our stock may decline.

 

                Finally,we reported a net loss for the nine months ended September 30, 2005.  As a result, we cannot assure you that wewill achieve or maintain positive earnings in the future.  If we are unable to achieve profitability ona quarterly or annual basis, the market price of our common stock could beadversely affected and our financial condition would suffer.

 

*We aredependent on our outsourcing engagements for a significant part of ourrevenues.*

 

                Netrevenues from our outsourcing relationships, for the nine months endedSeptember 30, 2005, represented approximately 45.4% of our consolidated netrevenues.  The substantial majority ofthese revenues are received from five large outsourcing accounts that signedlong-term agreements with us.  In June2005, we received a termination for convenience notice from The New York andPresbyterian Hospital, our largest client, and our outsourcing engagement withthem will terminate effective December 31, 2005.  In addition, we entered into a mutualtermination agreement with UMass Memorial Health Care on September 30, 2005 andwe expect all services under that agreement to be completed by December 31,2005.  The loss of any of our remainingthree large outsourcing relationships, including a failure to gain renewal ofany of these contracts (one of which, University of Pennsylvania HospitalSystem, is due to expire in March 2006), could have an adverse impact on ourbusiness and results of operations. Further, if we are unable to successfully close and implement the newoutsourcing relationships that we are pursuing (including the renewal of ourexisting outsourcing clients), our business and results of operations will beadversely impacted.

 

In many of our outsourcingengagements, the clients have fully outsourced their information technologystaff and functions to us.  In all of our outsourcingrelationships, we generally enter into detailed service level agreements, whichestablish performance levels and standards for our services.  If we fail to meet these performance levelsor standards, our clients may receive monetary service level credits from usor, if we experience persistent failures, our clients may have a right toterminate the outsourcing contract for cause and have no obligation to pay usany termination fees.  Our anticipatedrevenues and profitability from our outsourcing engagements could besignificantly reduced if we are unable to satisfy our performance levels orstandards, or if we are unable to improve our delivery costs as planned on suchengagements. Additionally, our outsourcing contracts can be terminated at the convenienceof our clients upon the payment of a termination fee.

 

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In addition, many of ouroutsourcing agreements require that we invest significant amounts of time andresources in order to win the engagement, transition the client’s informationtechnology department to our management, and complete the initialtransformation of our client’s information technology functioning to provideimproved service at a lower cost and meet agreed-upon service levels.  Often, we recover this investment throughpayments over the life of the outsourcing agreement.  If we are unable to achieve agreed-uponservice levels or otherwise breach the terms of our outsourcing agreements, theclients may have rights to terminate our agreements for cause and we may beunable to recover our investments.  Anyfailure by us to recover these investments could reduce our outsourcingrevenues, which would have a material adverse effect on our financialcondition, results of operations, and price of our common stock.

 

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

 

                Finally,we continue to pursue the outsourcing of discrete information technologyservices for clients.  The amount of timeand resources required to win client engagements for our outsourcing businessis significant, and we may not win the number or type of client engagementsthat we anticipate.  If we fail to meetour objective to secure new outsourcing engagements, or fail to secure newoutsourcing engagements on acceptable commercial terms, we will not experiencethe growth in this business that we have anticipated.

 

*The lengthof time required to engage a client and to complete an assignment may beunpredictable and could negatively impact our net revenues and operatingresults.*

 

The timing of securing ourclient engagements and service fulfillment is difficult to predict with anydegree of accuracy.  Prior engagementcycles are not necessarily an indication of the timing of future clientengagements or revenues.  The length oftime required to secure a new client engagement or complete an assignment oftendepends on factors outside our control, including:

 

•                  Existing information systemsat the client site;

•                  Changes or the anticipationof changes in the regulatory environment affecting healthcare andpharmaceutical organizations;

•                  Changes in the management orownership of the client;

•                  Budgetary cycles andconstraints;

•                  Changes in the anticipatedscope of engagements;

•                  Availability of personneland other resources; and

•                  Consolidation in thehealthcare and pharmaceutical industries.

 

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

 

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*We may be negatively impacted ifour investments in products and emerging service lines are unsuccessful.*

 

*               *We havepublicly announced our strategy to continue our investment in productdevelopment, including FirstDoc® and FirstGatewaysTM.  These investments are in addition tocontinuing our investments in other emerging service lines and products.  As a result, our financial results may beadversely impacted by product investment in the short term.  If such product development activities orinvestment in our emerging service lines do not result in relevant offeringsand sales, we will not achieve desired levels of return on theseinvestments.  As a result, our businessand results of operations could be adversely affected.

 

*If we are unable to generateadditional revenue from our existing clients, our business may be negativelyaffected.*

 

                Oursuccess depends, to a significant extent, on obtaining additional engagementsfrom our existing clients.  A substantialportion of our revenues is derived from additional services provided to ourexisting clients.  The loss of a smallnumber of clients, a reduction in the number of engagements with these clients,or the failure to secure renewals from any of our outsourcing clients mayresult in a material decline in revenues and cause us to fail to meet publicmarket expectations of our financial performance and operating results.  If we fail to generate additional revenuesfrom our existing clients, it may materially adversely affect our business, financialcondition, and results of operations.

 

*If we failto meet client expectations in the performance of our services, our businesscould suffer.*

 

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

 

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

 

*We may beunable to attract and retain a sufficient number of qualified employees.*

 

                Ourbusiness is labor-intensive and requires highly skilled employees.  Many of our associates possess extensiveexpertise in the healthcare, insurance, pharmaceutical, information technologyand consulting fields.  To serve agrowing client base, we must continue to recruit and retain qualified personnelwith expertise in each of these areas. We must also seek certain employees who are willing to

 

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work on a variable or per diem basis.  Competition for such personnel is intense andwe compete for such personnel with management consulting firms, healthcare andpharmaceutical organizations, software firms, and other businesses.  Many of these entities have substantiallygreater financial and other resources than we do, or can offer more attractivecompensation packages to candidates, including salary, bonuses, stock, andstock options.  If we are unable torecruit and retain a sufficient number of qualified personnel to serve existingand new clients, our ability to expand our client base or services and to offerour services at competitive rates could be impaired and our business wouldsuffer.

 

*The lossof our key client service employees and executive officers could negativelyaffect us.*

 

*               *Our performance depends onthe continued service of our executive officers, senior managers, and keyemployees.  In particular, we depend onsuch persons to secure new clients and engagements and to manage our businessand affairs.  The loss of such personscould result in the disruption of our business, longer or delayed sales cycles,and could have a material adverse effect on our business and results ofoperations.  Generally, we have notentered into long-term employment contracts with any of our employees and donot maintain key employee life insurance.

 

                OnNovember 3, 2005, Luther J. Nussbaum resigned from his position of Chairman ofthe Board, Chief Executive Officer and member of our Board of Directors.  Steven Heck, the Company’s President, hasbeen named as interim Chief Executive Officer, effective on the same date.  In addition, Douglas G. Bergeron, a currentindependent member of the Board of Directors, has been named Chairman of the Board.  The Board of Directors has initiated a searchfor a new chief executive officer.  If weare unable to recruit and retain a new chief executive officer, or if ourcurrent management team is unable to effectively manage and maintain ourbusiness through the transition in management, our business could be adverselyimpacted.

 

*We couldbe negatively impacted if we fail to successfully integrate the businesses weacquire.*

 

                Wehave grown, in part, by acquiring complementary businesses that could enhanceour capability to serve the healthcare and pharmaceutical industries.  All acquisitions involve risks that couldmaterially and adversely affect our business and operating results.  These risks include:

 

•                  Distracting management fromour business;

•                  Losing key personnel andother employees;

•                  Losing clients;

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

•                  The impairment of acquiredassets and goodwill;

•                  Acquiring the contingent andother liabilities of the businesses we acquire; and

•                  Not realizing the intendedor expected benefits of the acquisitions.

 

In addition, acquiredbusinesses may not enhance our services, provide us with increased clientopportunities, or result in the growth that we anticipate.  Furthermore, integrating acquired operationsis a complex, time-consuming, and expensive process.  Combining acquired operations with us mayresult in lower overall operating margins, greater stock price volatility, andquarterly earnings fluctuations. Cultural incompatibilities, career uncertainties, and other factorsassociated with such acquisitions may also result in the loss of employees andclients.  Failing to acquire andsuccessfully integrate complementary practices, or failing to achieve thebusiness synergies or other anticipated benefits, could materially adverselyaffect our business and results of operations.

 

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*Continuedor increased employee turnover could negatively affect our business.*

 

We have experienced employeeturnover as a result of:

 

•                  Dependence on lateral hiringof associates;

•                  Travel demands imposed onour associates;

•                  Loss of employees tocompetitors and clients; and

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

 

Continued or increasedemployee turnover could materially adversely affect our business, financialcondition, and results of operations.  Inaddition, many of our associates develop strong business relationships with ourclients.  We depend on these relationshipsto generate additional assignments and engagements.  The loss of a substantial number ofassociates could erode our client base and decrease our revenues, and couldadversely impact our ability to meet contractual obligations to clients.

 

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

 

                Ourbusiness has historically grown rapidly, and though our overall revenues haveremained flat for the past several years, we have experienced growth andincreased demand in certain areas of our business.  In response to shifts in market demand and inan effort to better align our business with our markets, we restructured ourorganization and hired persons with appropriate skills, including salespersons,and reduced our workforce in practice areas experiencing less demand.  We have also hired employees willing to workon a variable or per diem basis in order to better manage project costs andgeneral and administrative expenses associated with underutilizedresources.  These market conditions andrestructuring efforts have placed new and increased demands on our managementpersonnel.  They have also placedsignificant and increasing demands on our financial, technical and operationalresources, and on our information systems. If we are unable to manage growth effectively or if we experiencebusiness disruptions due to shifts in market demand, or growth orrestructuring, our operating results will suffer.  To manage any future growth, we must extendour financial reporting and information management systems to our multiple andinternational office locations and traveling employees, and develop andimplement new procedures and controls to accommodate new operations, servicesand clients.  Increasing operational andadministrative demands may make it difficult for our senior managers to engagein business development activities and their other day-to-dayresponsibilities.  Further, the additionof new employees and offices to offset any increasing demands may impair ourability to maintain our service delivery standards and corporate culture.  In addition, we have in the past changed, andmay in the future change, our organizational structure and business strategy.  Such changes may result in operationalinefficiencies and delays in delivering our services.  Such changes could also cause a disruption inour business and could cause a material adverse effect on our financialcondition and results of operations.

 

*Changes inthe healthcare and pharmaceutical industries or the economy in general couldnegatively impact our revenues.*

 

                Wederive a substantial portion of our revenues from clients in the healthcareindustry.  As a result, our business,financial condition, and results of operations are influenced by conditionsaffecting this industry, particularly any trends towards consolidation amonghealthcare and pharmaceutical organizations. Such consolidation may reduce the number of existing and potentialclients for our services.  In addition,the resulting organizations could have greater bargaining power, which coulderode the current pricing structure for our services and decrease ourrevenues.  The reduction in the size ofour target market or our failure to maintain our pricing goals could have a materialadverse effect on our business, financial condition, and results ofoperations.  Finally, each of the marketswe serve is highly 

 

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dependent upon the health of the overalleconomy.  Our clients in each of thesemarkets have experienced significant cost increases and pressures in recentyears.  Our services are targeted atrelieving these cost pressures; however, any continuation or acceleration ofcurrent market conditions could greatly impact our ability to secure or retainengagements, the loss of which could have a material adverse effect on ourbusiness and financial condition.

 

                Asubstantial portion of our revenues has also come from companies in thepharmaceutical industry.  Our revenuesare, in part, linked to the pharmaceutical industry’s research and developmentand technology expenditures.  Should anyof the following events occur in the pharmaceutical industry, our businesscould be negatively affected in a material way:

 

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

•                  Continued consolidation ofcompanies; or

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

 

A trend in thepharmaceutical industry is for companies to outsource either large informationtechnology-dependent projects or their information systems staff.  We benefit when pharmaceutical companiesoutsource to us, but may lose significant future business when pharmaceuticalcompanies outsource to our competitors. If this outsourcing trend slows down or stops, or if pharmaceuticalcompanies direct their business away from us, our financial condition andresults of operations could be impacted in a materially adverse way.

 

*Ourinternational operations create specialized risks that can negatively affectus.*

 

                Weare subject to many risks as a result of the services we provide to ourinternational clients or services we may provide through subcontractors oremployees that are located outside of the U.S. We have business operations and employees located in India, Vietnam, andthroughout Europe.  Our internationaloperations are subject to a variety of risks, including:

 

•                  Increasing and uncertainlabor costs and high turnover rates;

•                  Difficulties in creatingmarket demand for our offshore services based on perceived quality issues andpotential political risk;

•                  Difficulties in enforcingcontractual obligations and intellectual property rights;

•                  Difficulties in creatinginternational market demand for our other services;

•                  Unfavorable pricing andprice competition;

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

•                  Currency fluctuations;

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

•                  Changes in availability of,and requirements for, the types of work visas we may seek for our foreignemployees working in the U.S.;

•                  Restrictions on travel orother work conditions imposed by foreign governments;

•                  Additional costs, includingincome tax equalization, associated with foreign employees coming to work inthe U.S.;

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

•                  Terrorist attacks or armedhostilities;

•                  Adverse tax consequences;

•                  Increased costs associatedwith maintaining international marketing efforts and offices;

•                  Government regulations andrestrictions;

•                  Adverse changes inregulatory requirements; and

•                  Economic or politicalinstability.

 

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                Weperform services in Europe for our international pharmaceutical clients.  We cannot assure you that we will be able tobecome profitable in our European operations, which may materially adverselyaffect our financial condition, results of operations, and price for our commonstock.

 

Our acquisition of ParagonSolutions, Inc. (now FCG Software Services) in 2003 provided us a means toimplement our global sourcing strategy to provide software development andother information technology services to our clients.  If we are unable to realize perceived costbenefits of such a strategy or if we are unable to receive high qualityservices from foreign employees or subcontractors, our business may beadversely impacted. Further, our international operations in Vietnam and Indiasubject our business to a variety of risks and uncertainties unique tooperating businesses in these countries, including the risk factors discussedabove.

 

Any one or all of thesefactors may cause increased operating costs, lower than anticipated financialperformance, and may materially adversely affect our business, financialcondition, and results of operations.

 

*If we donot compete effectively in the healthcare and pharmaceutical informationservices industries, our business will be negatively impacted.*

 

                Themarket for healthcare and pharmaceutical information technology consulting isvery competitive.  We have competitorsthat provide some or all of the services we provide.  For example, in strategic consultingservices, we compete with international, regional, and specialty consultingfirms such as Bearing Point (formerly KPMG Consulting), IBM Global ConsultingServices, Wipro Technologies, and Accenture.

 

In integration andco-management services, we compete with:

 

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

•                  Service groups of computerequipment companies;

•                  Systems integrationcompanies such as Affiliated Computer Services (“ACS”), Electronic Data SystemsCorporation, Perot Systems Corporation, SAIC, and Computer SciencesCorporation;

•                  Clients’ internalinformation management departments;

•                  Other consulting firms suchas Accenture, Healthlink (a unit of IBM), and Computer Sciences Corporation’sconsulting division; and

•                  Other healthcare andpharmaceutical consulting and outsourcing firms.

 

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

 

                Severalof our competitors employ a global sourcing strategy to provide softwaredevelopment and other information technology services to their clients, whileat the same time reducing their cost structure and improving the quality ofservices they provide.  If we are unableto realize the perceived cost benefits of our recently implemented globalsourcing strategy or if we are unable to receive high quality services fromforeign employees or subcontractors, our business may be adversely impacted andwe may not be able to compete effectively.

 

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                Manyof our competitors have significantly greater financial, human, and marketingresources than us.  As a result, suchcompetitors may be able to respond more quickly to new or emerging technologiesand changes in customer demands, or to devote greater resources to the development,promotion, sale, and support of their products and services than we do.  In addition, as healthcare organizationsbecome larger and more complex, our larger competitors may be better able toserve the needs of such organizations. If we do not compete effectively with current and future competitors, wemay be unable to secure new and renewed client engagements, or we may berequired to reduce our rates in order to compete effectively.  This could result in a reduction in ourrevenues, resulting in lower earnings or operating losses, and otherwisematerially adversely affecting our business, financial condition, and resultsof operations.

 

*If we failto establish and maintain relationships with vendors of software and hardwareproducts, it could have a negative effect on our ability to secure engagements.*

 

                Wehave a number of relationships with software and hardware vendors.  For example, our Life Sciences business ishighly dependent upon a non-exclusive relationship with EMC Documentum, avendor of document management software applications with which we integrate ourFirstDoc® solution.    Weoften are engaged by vendors or their customers to implement or integratevendor products based on our relationship with a particular vendor.  In addition, our clients may request that wehost or operate a vendor application as part of a hosting or outsourcingrelationship, which may require the consent or cooperation of the vendor.  As a result, we believe that our relationshipswith vendors are important to our operations, including our sales, marketing,and support activities.  If we fail tomaintain our relationships with these vendors, or fail to establish additionalnew relationships, our business could be materially adversely affected.

 

*Ourrelationships with vendors of software and hardware products could have anegative impact on our ability to secure consulting engagements.*

 

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

 

*We mayinfringe the intellectual property rights of third parties.*

 

                Oursuccess depends, in part, on not infringing patents, copyrights, and otherintellectual property rights held by others. We do not know whether patents held or patent applications filed bythird parties may force us to alter our methods of business and operation orrequire us to obtain licenses from third parties.  If we attempt to obtain such licenses, we donot know whether we will be granted licenses or whether the terms of thoselicenses will be fair or acceptable to us. Third parties may assert infringement claims against us in thefuture.  Such claims may result inprotracted and costly litigation, penalties, judgments, and fines that couldadversely affect our business regardless of the merits of such claims.

 

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*If we failto keep pace with regulatory and technological changes, our business could bematerially adversely affected.*

 

                Thehealthcare and pharmaceutical industries are subject to regulatory andtechnological changes that may affect the procurement practices and operationsof healthcare and pharmaceutical organizations. During the past several years, the healthcare and pharmaceutical industrieshave been subject to an increase in governmental regulation and reformproposals.  These reforms could increasegovernmental involvement in the healthcare and pharmaceutical industries, lowerreimbursement rates or otherwise change the operating environment of ourclients.  Also, certain reforms thatcreate potential work for us could be delayed or cancelled.  Healthcare and pharmaceutical organizationsmay react to these situations by curtailing or deferring investments, includingthose for our services.  In addition, ifwe are unable to maintain our skill and expertise in light of regulatory ortechnological changes, our services may not be marketable to our clients and wecould lose existing clients or future engagements.  Finally, government regulations, particularlyHIPAA, may require our clients to impose additional contractualresponsibilities on us, which may make it more costly to perform certain of ourengagements and subject us to increased risk in the performance of theseengagements, including immediate termination of an engagement.

 

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

 

*We may beunable to effectively protect our proprietary information and procedures.*

 

                Wemust protect our proprietary information, including our proprietarymethodologies, research, tools, software code, and other information.  To do this, we rely on a combination ofcopyright and trade secret laws and confidentiality procedures to protect ourintellectual property.  These steps maynot protect our proprietary information. In addition, the laws of certain foreign countries do not protect orenforce proprietary rights to the same extent as do the laws of the UnitedStates.  We are currently providing ourservices to clients in international markets and have business operations inEurope, India and Vietnam.  Ourproprietary information may not be protected to the same extent as providedunder the laws of the United States, if at all. The unauthorized use of our intellectual property could have a materialadverse effect on our business, financial condition, or results of operations.

 

*The priceof our common stock may be adversely affected by market volatility.*

 

                Thetrading price of our common stock fluctuates significantly.  Since our common stock began trading publiclyin February 1998, the reported sale price of our common stock on the NasdaqNational Market has been as high as $29.13 and as low as $3.63 per share.  This price may be influenced by many factors,including:

 

•                  Our performance andprospects;

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

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

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

•                  General financial and othermarket conditions;

•                  Domestic and internationaleconomic conditions; and

•                  The other risks related toour business discussed above.

 

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

 

*If ourstock price is volatile, we may become subject to securities litigation, whichis expensive and could result in a diversion of resources.*

 

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

 

*Ourcharter documents, Delaware law and stockholders rights plan will make it moredifficult to acquire us and may discourage take-over attempts and thus depressthe market price of our common stock.*

 

                OurBoard of Directors has the authority to issue up to 9,500,000 shares ofundesignated preferred stock, to determine the powers, preferences, and rightsand the qualifications, limitations, or restrictions granted to or imposed uponany unissued series of undesignated preferred stock and to fix the number ofshares constituting any series and the designation of such series, without anyfurther vote or action by our stockholders. The preferred stock could be issued with voting, liquidation, dividend,and other rights superior to the rights of our common stock.  Furthermore, any preferred stock may haveother rights, including economic rights, senior to our common stock, and as aresult, the issuance of any preferred stock could depress the market price ofour common stock.

 

In addition, our certificateof incorporation eliminates the right of stockholders to act without a meetingand does not provide cumulative voting for the election of directors.  Our certificate of incorporation alsoprovides for a classified Board of Directors. The ability of our Board of Directors to issue preferred stock and theseother provisions of our certificate of incorporation and bylaws may have theeffect of deterring hostile takeovers or delaying changes in control ormanagement.

 

                Weare also subject to the provisions of Section 203 of the Delaware GeneralCorporation Law, which could delay or prevent a change in control of us, impedea merger, consolidation, or other business combination involving us ordiscourage a potential acquirer from making a tender offer or otherwiseattempting to obtain control.  Any ofthese provisions, which may have the effect of delaying or preventing a changein control, could adversely affect the market value of our common stock.

 

                In1999, our Board of Directors adopted a rights agreement that is intended toprotect our stockholders’ interests in the event we are confronted withcoercive takeover tactics.  Pursuant tothe stockholders rights plan, we distributed “rights” to purchase up to 500,000shares of our Series A Junior Participating Preferred Stock.  Under some circumstances, these rights becomethe rights to purchase shares of our common stock or securities of an acquiringentity at one-half the market value.  Therights are not intended to prevent our takeover, rather they are designed todeal with the possibility of unilateral actions by hostile acquirers that coulddeprive our Board of Directors and stockholders of their ability to determineour destiny and obtain the highest price for our common stock.

 

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

 

Our financial instrumentsinclude cash and cash equivalents, short-term investments, accounts receivable,unbilled receivables, accounts payable, and a revolving line of credit. Only the cash and cash equivalents and short-term investments, which totaled$33.3 million at September 30, 2005, present us with market risk exposureresulting primarily from changes in interest rates.  Based on thisbalance, a change of one percent in the interest rate would cause a change ininterest income for the annual period of approximately $333,000.  Ourobjective in maintaining these investments is the flexibility obtained inhaving cash available for payment of accrued liabilities and acquisitions.

 

Our borrowings are primarilydependent upon the prevailing prime rate.  As of September 30, 2005, wehad no borrowings under our revolving line of credit and an available borrowingcapacity of $7.0 million.  See “Item 2. Management’s Discussion andAnalysis of Financial Condition and Results of Operations - Liquidity andCapital Resources.”  The estimated fair value of borrowings under therevolving line is expected to approximate its carrying value.

 

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

 

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

 

As required by SEC Rule13a-15(b), we carried out an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer and ourChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures as of the end of the quarter covered bythis report. Based on the foregoing, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective, and were operating at the reasonable assurance level.

 

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

# ** **

 

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# **PART II. OTHER INFORMATION**

 

## **Item 1. Legal Proceedings**

 

From time to time, we may beinvolved in claims or litigation that arise in the normal course of business.We are not currently a party to any legal proceedings, which, if decidedadversely to us, would have a material adverse effect on our business,financial condition, or results of operations.

## ** **

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

 

None.

 

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

 

None.

 

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

 

None.

 

## **Item 5. Other Information**

 

None.

 

 

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## **Item 6. Exhibits**

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

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(1)          Incorporated byreference 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)          Incorporated byreference to Exhibit 99.1 to FCG’s Current Report on Form 8-K dated December 9,1999.

 

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

 

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

 

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

 

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# **SIGNATURES**

 

**               **Pursuant to the requirementsof the Securities and Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

|                   | FIRST CONSULTING GROUP,  INC.                                 |
|------------------------|---------------------------------------------------------------|
|                   |                                                          |
|                   |                                                          |
| Date: November 9, 2005 | /s/ STEVEN HECK                                               |
|                   | Steven Heck                                                   |
|                   | President and Interim  Chief Executive Officer                |
|                   |                                                          |
| Date: November 9, 2005 | /s/ THOMAS A WATFORD                                          |
|                   | Thomas A. Watford                                             |
|                   | Executive Vice President  and Interim Chief Financial Officer |
|                   |                                                          |

 

 

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# **EXHIBITINDEX**

 

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

----

(1)          Incorporated by reference toExhibit 3.1 to FCG’s Form S-1 Registration Statement (No. 333-41121) originallyfiled on November 26, 1997 (the “Form S-1”).

 

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

 

(3)          Incorporated by reference toExhibit 3.3 to FCG’s Form S-1.

 

(4)          Incorporated by reference toExhibit 4.1 to FCG’s Form S-1.

 

(5)          See Note 1 of Notes toConsolidated Financial Statements, “Basic and Diluted Net Income (Loss) PerShare.”

 

45

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