UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

 

 

FORM 10-Q

 

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 28, 2002,

 

or

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from             to           

 

Commission File Number 0-23651

 

First Consulting Group, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x     No ¨

 

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

 

 

 

First Consulting Group, Inc.

Table of Contents

 

COVER PAGE
TABLE OF CONTENTS
PART I.		FINANCIAL INFORMATION
		ITEM 1.	FINANCIAL STATEMENTS AND NOTES (UNAUDITED)
			Consolidated Balance Sheets as of June 28, 2002 and December 28, 2001
			Consolidated Statements of Operations for the three month periods ended June 28, 2002 and June 30, 2001 and for the six month periods ended June 28, 2002 and June 30, 2001
			Condensed Consolidated Statements of Cash Flows for the six month periods ended June 28, 2002 and June 30, 2001
			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
PART II.	OTHER INFORMATION
		ITEM 1.	LEGAL PROCEEDINGS
		ITEM 2.	CHANGES IN SECURITIES
		ITEM 3.	DEFAULTS UPON SENIOR SECURITIES
		ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
		ITEM 5.	OTHER INFORMATION
		ITEM 6.	EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
Exhibit Index

 

2

 

PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements and Notes (Unaudited).

 

First Consulting Group, Inc. and Subsidiaries

 

Consolidated Balance Sheets

(in thousands)

 

		June 28, 2002			December 28, 2001
		(unaudited)
ASSETS
Current assets
Cash and cash equivalents		$	38,354		$	32,499
Short-term investments		18,712			19,410
Accounts receivable, less allowance of $2,270 and $2,740 in the periods ended June 28, 2002 and December 28, 2001, respectively		29,586			34,657
Unbilled receivables		18,020			13,963
Deferred income taxes, net		7,664			7,834
Prepaid expenses and other current assets		3,358			1,571
Total current assets		115,694			109,934
Notes receivable-stockholders		771			753
Long-term investments		2,200			1,200
Property and equipment
Furniture, equipment, and leasehold improvements		7,656			8,033
Information systems equipment		22,114			26,838
		29,770			34,871
Less accumulated depreciation and amortization		20,159			24,237
		9,611			10,634
Other assets
Executive benefit trust		6,011			6,246
Unbilled long term receivables		9,207			10,250
Deferred income taxes		2,550			2,433
Goodwill, net		3,468			3,587
Other		371			392
		21,607			22,908
Total assets		$	149,883		$	145,429
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable		$	2,406		$		1,723
Accrued liabilities		10,580			11,284
Accrued restructuring		10,323			6,781
Accrued vacation		7,619			6,453
Accrued incentive compensation		1,645			4,280
Customer advances		6,753			5,259
Total current liabilities		39,326			35,780
Non-current liabilities
Supplemental executive retirement plan		6,842			6,510
Minority interest		1,561			863
Total non-current liabilities		8,403			7,373
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, 23,978,610 shares issued and outstanding at June 28, 2002 and 23,715,719 shares issued and outstanding at December 28, 2001		24			24
Additional paid-in capital		91,788			90,215
Retained earnings		14,046			15,895
Deferred compensation-stock incentive agreements		(1,015		)	(1,134			)
Notes receivable-stockholders		(1,730		)	(1,780			)
Accumulated other comprehensive loss		(959		)	(944			)
Total stockholders’ equity		102,154			102,276
Total liabilities and stockholders’ equity		$	149,883		$		145,429

 

See accompanying notes.

 

3

 

First Consulting Group, Inc. and Subsidiaries

 

Consolidated Statements of Operations (Unaudited)

(in thousands, except per share data)

 

		Three Months Ended						Six Months Ended
		June 28, 2002			June 30, 2001			June 28, 2002			June 30, 2001
Revenue before reimbursements		$	66,198		$	66,206		$	129,475		$	136,506
Out of pocket reimbursements		3,937			4,312			7,814			9,298
Total revenue		70,135			70,518			137,289			145,804
Cost of services before reimbursable expenses		41,809			42,094			81,882			85,947
Out of pocket reimbursable expenses		3,937			4,312			7,814			9,298
Total cost of services		45,746			46,406			89,696			95,245
Gross profit		24,389			24,112			47,593			50,559
Selling expenses		6,939			8,138			13,833			15,997
General and administrative expenses		14,769			16,884			29,482			34,286
Restructuring, severance and impairment costs		7,818			4,349			7,818			4,349
Loss from operations		(5,137		)	(5,259		)	(3,540		)	(4,073		)
Other income
Interest income, net		244			299			452			710
Other expense, net		(50		)	(179		)	(107		)	(240		)
Loss before income taxes		(4,943		)	(5,139		)	(3,195		)	(3,603		)
Benefit for income taxes		(2,080		)	(2,158		)	(1,346		)	(1,513		)
Net loss		$	(2,863	)	$	(2,981	)	$	(1,849	)	$	(2,090	)
Basic net loss per share		$	(0.12	)	$	(0.13	)	$	(0.08	)	$	(0.09	)
Diluted net loss per share		$	(0.12	)	$	(0.13	)	$	(0.08	)	$	(0.09	)
Shares used in computing basic net loss per share		23,957			23,397			23,927			23,485
Shares used in diluted net loss per share		23,957			23,397			23,927			23,485

 

See accompanying notes.

 

4

 

First Consulting Group, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

 

		Six Months Ended
		June 28, 2002			June 30, 2001
Cash flows from operating activities:
Net loss		$	(1,849	)	$	(2,090	)
Adjustments to reconcile net loss		2,435			4,571
Change in assets and liabilities		7,767			4,114
Net cash provided by operating activities		8,353			6,595
Cash flows from investing activities:
Net purchase of investments		(271		)	(427		)
Furniture, equipment, and leasehold improvements		(1,368		)	(1,776		)
Acquisition of business		(2,617		)	(114		)
Net cash used for investing activities		(4,256		)	(2,317		)
Cash flows from financing activities:
Principal payments of long-term debt		—			(145		)
Proceeds from stock/tax loan payments		185			524
Proceeds from issuance of stock		1,573			1,381
Net cash provided by financing activities		1,758			1,760
Net increase in cash and equivalents		5,855			6,038
Cash and equivalents at beginning of period		32,499			11,429
Cash and equivalents at end of period		$	38,354		$	17,467
Cash paid during the period for:
Interest		$	14		$	12
Income taxes		$	189		$	211

 

See accompanying notes.

 

5

 

Notes to Consolidated Financial Statements

 

 

1.             Basis of Presentation

 

The consolidated balance sheet of First Consulting Group, Inc. (the “Company”) at June 28, 2002 and consolidated statements of operations and condensed consolidated statements of cash flows for the periods ended June 28, 2002 and June 30, 2001 are unaudited.  These financial statements reflect all adjustments, consisting of only normal recurring adjustments, which, in the opinion of management, are necessary to fairly present the financial position of the Company at June 28, 2002 and the results of operations for the three month periods and six-month periods ended June 28, 2002 and June 30, 2001.  The results of operations for the six months ended June 28, 2002 are not necessarily indicative of the results to be expected for the year ending December 27, 2002.  For more complete financial information, these financial statements should be read in conjunction with the audited financial statements for the year ended December 28, 2001 included in the Company’s Annual Report on Form 10-K.

 

2.             Investments

 

For purposes of reporting cash flows, cash and cash equivalents include cash and interest-earning deposits or securities with original maturities of three months or less. The Company has approximately $18.7 million in short-term investments and $1.0 million of long-term investments classified as available for sale.  Such investments are currently held primarily in commercial paper, money market investments and tax-exempt government securities.  Net unrealized gains and losses on investments were not material at June 28, 2002.

 

3.             Net Loss Per Share

 

The following represents a reconciliation of basic and diluted net loss per share for the three month and six periods ended June 28, 2002 and June 30, 2001, respectively (amounts rounded to thousands, except per share data):

 

		For the Three Months Ended June 28, 2002								For the Three Months Ended June 30, 2001
		Net Loss			Weighted Average Shares		Per share amount			Net Loss			Weighted Average Shares		Per share amount
Basic EPS:
Net loss available to common stockholders		$	(2,863	)	23,957		$	(0.12	)	$	(2,981	)	23,397		$	(0.13	)
Effect of dilutive options and warrants:		—			—		—			—			—		—
Diluted EPS:
Net loss available to common stockholders and assumed conversions		$	(2,863	)	23,957		$	(0.12	)	$	(2,981	)	23,397		$	(0.13	)

 

6

 

 

		For the Six Months Ended June 28, 2002								For the Six Months Ended June 30, 2001
		Net Loss			Weighted Average Shares		Per share amount			Net Loss			Weighted Average Shares		Per share amount
Basic EPS:
Net loss available to common stockholders		$	(1,849	)	23,927		$	(0.08	)	$	(2,090	)	23,485		$	(0.09	)
Effect of dilutive options and warrants:		—			—		—			—			—		—
Diluted EPS:
Net loss available to common stockholders and assumed conversions		$	(1,849	)	23,927		$	(0.08	)	$	(2,090	)	23,485		$	(0.09	)

 

4.             Disclosure of Segment Information

 

The Company provides segment reporting at a gross margin level. Selling and general and administrative expense (including corporate functions, occupancy related costs, depreciation, professional development, recruiting, and marketing), and fixed assets (primarily computer equipment, furniture, and leasehold improvements) are managed at the corporate level.  The Company currently has three segments: Healthcare, Life Sciences and Outsourcing.  The Company’s segments are managed on an integrated basis in order to serve clients by assembling multi-disciplinary teams, which provide comprehensive services.

 

The following is a summary of certain financial information by segment (in thousands):

 

For the quarter ended June 28, 2002:

 

		Healthcare			Life Sciences			Outsourcing			Totals
Revenue before reimbursements		$	29,492		$	18,011		$	18,695		$	66,198
Out of pocket reimbursements		3,415			463			59			3,937
Total revenue		32,907			18,474			18,754			70,135
Cost of services before reimbursable expenses		16,976			9,905			14,928			41,809
Out of pocket reimbursable expenses		3,415			463			59			3,937
Total cost of services		20,391			10,368			14,987			45,746
Gross profit		12,516			8,106			3,767			24,389
Selling expenses											6,939
General & administrative expenses											14,769
Restructuring, severance and impairment costs											7,818
Loss from operations											$	(5,137	)

 

7

 

For the quarter ended June 30, 2001:

 

		Healthcare			Life Sciences			Outsourcing			Totals
Revenue before reimbursements		$	33,434		$	17,001		$	15,771		$	66,206
Out of pocket reimbursements		3,854			458			—			4,312
Total revenue		37,288			17,459			15,771			70,518
Cost of services before reimbursable expenses		17,928			11,207			12,959			42,094
Out of pocket reimbursable expenses		3,854			458			—			4,312
Total cost of services		21,782			11,665			12,959			46,406
Gross profit		15,506			5,794			2,812			24,112
Selling expenses											8,138
General & administrative expenses											16,884
Restructuring, severance and impairment costs											4,349
Loss from operations											$	(5,259	)

 

 

For the six months ended June 28, 2002:

 

		Healthcare			Life Sciences			Outsourcing			Totals
Revenue before reimbursements		$	58,335		$	35,532		$	35,608		$	129,475
Out of pocket reimbursements		6,708			998			108			7,814
Total revenue		65,043			36,530			35,716			137,289
Cost of services before reimbursable expenses		33,374			20,531			27,977			81,882
Out of pocket reimbursable expenses		6,708			998			108			7,814
Total cost of services		40,082			21,529			28,085			89,696
Gross profit		24,961			15,001			7,631			47,593
Selling expenses											13,833
General & administrative expenses											29,482
Restructuring, severance and impairment costs											7,818
Loss from operations											$	(3,540	)

 

8

 

For the six months ended June 30, 2001:

 

		Healthcare			Life Sciences			Outsourcing			Totals
Revenue before reimbursements		$	72,073		$	36,816		$	27,617		$	136,506
Out of pocket reimbursements		8,283			1,015			—			9,298
Total revenue		80,356			37,831			27,617			145,804
Cost of services before reimbursable expenses		39,307			24,509			22,131			85,947
Out of pocket reimbursable expenses		8,283			1,015			—			9,298
Total cost of services		47,590			25,524			22,131			95,245
Gross profit		32,766			12,307			5,486			50,559
Selling expenses											15,997
General & administrative expenses											34,286
Restructuring, severance and impairment costs											4,349
Loss from operations											$	(4,073	)

 

9

 

5.             Comprehensive Loss

 

Comprehensive loss, net of taxes is as follows (in thousands):

 

For the quarter ended June 28, 2002:

 

Net Loss			Currency Translation Gain			Unrealized (Loss) on Investments			Comprehensive Loss
$	(2,863	)	$	171		$	(12	)	$	(2,704	)

 

 

For the quarter ended June 30, 2001:

 

Net Loss			Currency Translation			Unrealized (Loss) on Investments			Comprehensive Loss
$	(2,981	)	$	—		$	(12	)	$	(2,993	)

 

 

For the six months ended June 28, 2002:

 

Net Loss			Currency Translation Gain			Unrealized (Loss) on Investments			Comprehensive Loss
$	(1,849	)	$	10		$	(25	)	$	(1,864	)

 

 

For the six months ended June 30, 2001:

 

Net Loss			Currency Translation (Loss)			Unrealized Gain on Investments			Comprehensive Loss
$	(2,090	)	$	(142	)	$	30		$	(2,202	)

 

6.             Accounts Receivable

 

At June 28, 2002, the Company carried a long-term account receivable of approximately $9.2 million from a single client.  The receivable relates to a major outsourcing contract, and will be paid over a five-year period.

 

The allowance for doubtful accounts is developed based upon several factors including clients’ credit quality, historical write-off experience and any known specific issues or disputes which exist as of the balance sheet date.

 

7.                                      Acquisition

 

On May 31, 2002, the Company acquired a controlling interest of 52.35% in Codigent Solution Group, Inc. (CSG), a base provider of value added information technology solutions to hospitals and other healthcare delivery organizations, for $2.6 million.  The CSG acquisition did not have a material effect on the Company’s results of operation for June 2002.    The acquisition was accounted for using the purchase method of accounting and the allocation of the price is as follows:

 

Consideration paid					$	2,617,000
Book value of equity		$	1,151,000
Interest purchased		52.35		%
Equity purchased					603,000
Goodwill					$	2,014,000

 

10

 

FCG has agreed to acquire the remaining shares on or about January 2004 for at least $2.4 million for a minimum purchase price of $5.0 million.  In addition, the remaining outstanding shareholders may receive up to an additional $5.0 million in restricted Company stock based on CSG satisfying revenue, operating and performance targets during the next 18 months.

 

8.                                   Intangible Assets

 

Effective December 29, 2001, the Company adopted SFAS 141 and SFAS 142. SFAS 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting. It also specifies the types of acquired intangible assets that are required to be recognized and reported separate from goodwill.  SFAS 142 requires that goodwill and certain intangibles no longer be amortized, but instead are to be reviewed at least annually for impairment.

 

Net loss and loss per share for the first quarter ended June 28, 2002 and June 30, 2001 adjusted to exclude amortization expense (net of taxes) are as follows (amounts rounded to thousands, except per share data):

 

		Three Months Ended						Six Months Ended
		June 28, 2002			June 30, 2001			June 28, 2002			June 30, 2001
Net loss:
Reported net loss		$	(2,863	)	$	(2,981	)	$	(1,849	)	$	(2,090	)
Goodwill amortization		—			366			—			744
Adjusted net loss		$	(2,863	)	$	(2,615	)	$	(1,849	)	$	(1,346	)
Basic loss per share:
Reported basic loss per share		$	(0.12	)	$	(0.13	)	$	(0.08	)	$	(0.09	)
Goodwill amortization		—			0.02			—			0.03
Adjusted basic loss per share		$	(0.12	)	$	(0.11	)	$	(0.08	)	$	(0.06	)
Diluted loss per share:
Reported diluted loss per share		$	(0.12	)	$	(0.13	)	$	(0.08	)	$	(0.09	)
Goodwill amortization		—			0.02			—			0.03
Adjusted diluted loss per share		$	(0.12	)	$	(0.11	)	$	(0.08	)	$	(0.06	)

 

11

 

		The Healthcare Group			Life Sciences			Outsourcing			Total
Costs:
Balance as of December 28, 2001		$	3,523		$	2,276		$	—		$	5,799
Acquired		1,088			10			926			2,024
Disposed		3,523			—			—			3,523
Balance as of June 28, 2002		$	1,088		$	2,286		$	926		$	4,300
Accumulated Amortization:
Balance as of December 28, 2001		$	1,380		$	832		$	—		$	2,212
Acquired		—			—			—			—
Disposed		1,380			—			—			1,380
Balance as of June 28, 2002		$	—		$	832		$	—		$	832
Net Balance as of June 28, 2002		$	1,088		$	1,454		$	926		$	3,468

 

9.                                   Restructuring, severance and impairment costs

 

During the quarter ended June 28, 2002, the Company incurred a restructuring charge of $7.8 million consisting of $4.0 million in severance for the reduction of staff and $3.8 million in facility costs for facility downsizing.  The reductions in staff consisted of approximately 150 associates.  As of June 28, 2002, the entire charge of $7.8 million and a prior year restructuring balance of $2.5 million, primarily for facility downsizing, had yet to be incurred in cash.   The Company plans to complete all of the planned staff reductions during the remainder of 2002, and the facility downsizing over the lives of the related leases, some of which extend over the next six years.   The Company cannot assure that the current estimates for restructuring, severance and impairment costs will not change during the implementation and future periods.

 

12

 

ITEM 2.                                                     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

THE FOLLOWING MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. SUCH FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, INCLUDING THOSE SET FORTH HEREIN UNDER THE CAPTION “RISKS RELATING TO OUR BUSINESS”, AND OTHER REPORTS WE FILE WITH THE SECURITIES AND EXCHANGE COMMISSION.  OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS.

 

Overview

 

We provide services primarily to payors, providers, government agencies, pharmaceutical, biogenetic, and life science companies, and other healthcare organizations in North America and Europe. We generate substantially all of our revenue from fees for professional services. We typically bill for our services on an hourly, fixed-fee or monthly fixed-fee basis as specified by the agreement with a particular client.  We establish either standard or target hourly rates for each level of consultant based on several factors including industry and assignment-related experience, technical expertise, skills and knowledge.  For services billed on an hourly basis, fees are determined by multiplying the amount of time expended on each assignment by the project hourly rate for the consultant(s) assigned to the engagement.  Fixed fees, including outsourcing fees, are established on a per-assignment or monthly basis and are based on several factors such as the size, scope, complexity and duration of an assignment and the number of our people required to complete the assignment.  Actual hourly or fixed fees for an assignment may vary from the standard, target, or historical rates that we have charged. For services billed on an hourly basis, we recognize revenue as services are performed. For services billed on a fixed fee basis, we recognize revenue using the percentage of completion method based either on 1) the amount of time completed on each assignment versus the projected number of hours required to complete such assignment, or 2) the amount of cost incurred on the assignment versus the estimated total cost to complete the assignment. Revenue is recorded as incurred at assignment rates net of unplanned adjustments for specific engagements. Unplanned adjustments to revenue are booked at the time they are known.  Provisions are made for estimated uncollectible amounts based on our experience. We may obtain payment in advance of providing services. These advances are recorded as customer advances and reflected as a liability on our balance sheet.

 

Out of pocket expenses billed and reimbursed by clients are included in gross revenue, and then deducted to determine net revenue.  For purposes of analysis, all percentages in this discussion are stated as a percentage of net revenue, since we believe that this is the more relevant measure of our business over time.

 

Cost of services primarily consists of the salaries, bonuses and related benefits of client-serving consultants and subcontractor expenses.  Selling expenses primarily consist of the salaries, benefits, travel and other costs of our sales force, as well as marketing and research expenses. General and administrative expenses primarily consist of the costs attributable to the support of our client-serving professionals, such as: non-billable travel; office space occupancy; investments in our information

 

13

 

systems, practice support and quality initiatives; salaries and expenses for executive management, financial accounting and administrative personnel; expenses for firm and business unit governance meetings; recruiting fees and professional development and training; and, legal and other professional services.  As associate related costs are relatively fixed, variations in our revenues and operating results can occur as a result of variations in billing margins and utilization rates of our billable associates.

 

We routinely review our fees for services, professional compensation and overhead costs to ensure that our services and compensation are competitive within the industry.  In addition, we routinely monitor the progress of client projects with our clients’ senior management. Quality of Service Questionnaires are sent to the client after each engagement with the results compiled and reported to our executive management.

 

In connection with shares issued to certain of our vice presidents in return for interest-free notes, we recognize compensation expense on our consolidated statement of operations.  The recurring portion of our compensation expense relating to stock issuances and the amortization of deferred compensation is reflected in our consolidated statements of operations as general and administrative expense, selling expenses, or cost of services based on the function of the employee to whom the charge relates.

 

Our most significant expenses are our human resource and related salary and benefit expenses. As of June 28, 2002, approximately 834 of our employees are billable consultants. Another 688 employees form our firm’s outsourcing business. The salaries and benefits of such billable consultants and outsourcing related employees are recognized in our cost of services.  Non-billable employee salaries and benefits are recognized as a component of either selling or general and administrative expenses.  Approximately 18.7%, or 353 employees are classified as non-billable. Our cost of services as a percentage of revenue is directly related to our consultant utilization, which is the ratio of total billable hours to available hours in a given period, and the amount of cost recognized under percentage of completion accounting. We manage consultant utilization by monitoring assignment requirements and timetables, available and required skills, and available consultant hours per week and per month. We evaluate our fixed contracts on a monthly basis using percentage of completion accounting.  Differences in personnel utilization rates can result from variations in the amount of non-billed time, which has historically consisted of training time, vacation time, time lost to illness and inclement weather and unassigned time. Non-billed time also includes time devoted to other necessary and productive activities such as sales support and interviewing prospective employees.  Unassigned time results from differences in the timing of the completion of 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 estimated engagement start and completion dates and matching consultant availability with current and projected client requirements. The number of consultants staffed on an assignment will vary according to the size, complexity, duration and demands of the assignment. Assignment terminations, completions, inclement weather, and scheduling delays may result in periods in which consultants are not optimally utilized. An unanticipated termination of a significant assignment or an overall lengthening of the sales cycle could result in a higher than expected number of unassigned consultants and could cause us to experience lower margins. In addition, expansion into new markets and the hiring of consultants in advance of client assignments have resulted and may continue to result in periods of lower consultant utilization.

 

 

Results of Operations for the Three Months Ended June 28, 2002 and June 30, 2001

 

Net Revenue.  Net revenue of $66.2 million for the quarter ended June 28, 2002 was consistent

 

14

 

with the quarter ended June 30, 2001.  This was due to a decline in billable hours and lower pricing resulting from increased competition and economical uncertainties in the healthcare and life science markets offset by new outsourcing engagements.

 

Total Revenue.  Total revenue decreased to $70.1 million for the quarter ended June 28, 2002, a decrease of 0.5% from $70.5 million for the quarter ended June 30, 2001.  The decrease is due to a decline in billable hours, lower pricing and a decline in healthcare revenue, which generally requires the most reimbursable travel expense, offset by new outsourcing revenue.

 

Gross Profit.  Gross profit increased to $24.4 million for the quarter ended June 28, 2002, an increase of 1.1% from $24.1 million for the quarter ended June 30, 2001.  This was due to increased utilization of staff resulting in better margins in life sciences, and higher margin on outsourcing contracts offset by a decline in healthcare pricing.  Gross profit as a percentage of net revenue increased to 36.8% for the quarter ended June 28, 2002 from 36.4% for the quarter ended June 30, 2001.

 

Selling Expenses.  Selling expenses decreased to $6.9 million for the quarter ended June 28, 2002, a decrease of 14.7% from $8.1 million for the quarter ended June 30, 2001 due to staff reductions.  Selling expenses as a percentage of net revenue decreased from 12.3% for the quarter ended June 30, 2001 to 10.5% for the quarter ended June 28, 2002.

 

General and Administrative Expenses.  General and administrative expenses decreased to $14.8 million for the quarter ended June 28, 2002, a decrease of 12.5% from $16.9 million for the quarter ended June 30, 2001.  The decrease resulted from cost reductions we made and the elimination of goodwill amortization (See Note 8 of the Notes to Consolidated Financial Statements).  General and administrative expenses as a percentage of net revenue decreased from 25.5% for the quarter ended June 30, 2001 to 22.3% for the quarter ended June 28, 2002.

 

Restructuring, Severance and Impairment Costs. Restructuring, severance and impairment costs were $7.8 million for the quarter ended June 28, 2002 compared to $4.3 million for the quarter ended June 30, 2001. Restructuring, severance and impairment costs for the quarter ended June 28, 2002 included approximately $4.0 million of severance costs related to staff reductions and approximately $3.8 million for facility downsizing.  Restructuring severance and impairment costs for the quarter ended June 30, 2001 consisted primarily of $3.7 million of severance costs and approximately $0.5 million for facility downsizing.

 

Interest Income, Net. Interest income, net of interest expense, decreased to $0.2 million for the quarter ended June 28, 2002 from $0.3 million for the quarter ended June 30, 2001, due to lower interest rates, despite a higher level of cash and investments.  Interest income net of interest expense as a percentage of net revenue decreased slightly to 0.4% for the quarter ended June 28, 2002 from 0.5% for the quarter ended June 30, 2001.

 

Other Expense, Net.  Other expense decreased to $0.1 million for the quarter ended June 28, 2002 from $0.2 million for the quarter ended June 30, 2001.

 

Income Taxes.  The benefit for income taxes of 42% in the quarter ended June 28, 2002 remained the same as in the quarter ended June 30, 2001.

 

15

 

Results of Operations for the Six Months Ended June 28, 2002 and June 30, 2001

 

Net Revenue.  Our net revenue decreased to $129.5 million for the six months ended June 28, 2002, a decrease of 5.2% from $136.5 million for the six months ended June 30, 2001.   This was due to a significant decline in billable hours and lower pricing resulting from increased competition and economic uncertainties primarily in the healthcare market partially offset by additional outsourcing engagements.

 

Total Revenue.  Total revenue decreased to $137.3 million for the six months ended June 28, 2002, a decrease of 5.8% from $145.8 million for the six months ended June 30, 2001.   This was due to a decline in billable hours and lower pricing resulting from increased competition and economic uncertainties primarily in the healthcare market partially offset by additional outsourcing engagements.

 

Gross Profit.  Gross profit decreased to $47.6 million for the six months ended June 28, 2002, a decrease of 5.9% from $50.6 million for the six months ended June 30, 2001.  The decrease was due to a significant decline in both billable hours and pricing caused by the economic uncertainty and competition in healthcare, partially offset by an increase in outsourcing revenues and margins and better life science utilization due to headcount reductions.  Gross profit as a percentage of net revenue decreased to 36.8% for the six months ended June 28, 2002 from 37.0% for the six months ended June 30, 2001.

 

Selling Expenses.  Selling expenses decreased to $13.8 million for the six months ended June 28, 2002, a decrease of 13.5% from $16.0 million for the six months ended June 30, 2001.  Selling expenses as a percentage of net revenue decreased from 11.7% for the six months ended June 30, 2001 to 10.7% for the six months ended June 28, 2002 due to cost reductions.

 

General and Administrative Expenses.  General and administrative expenses decreased to $29.5 million for the six months ended June 28, 2002, a decrease of 14.0% from $34.3 million for the six months ended June 30, 2001. General and administrative expenses as a percentage of net revenue decreased from 25.1% for the six months ended June 30, 2001 to 22.8% for the six months ended June 28, 2002, due to the reduction in costs.

 

Restructuring, Severance and Impairment Costs.  Restructuring, severance and impairment costs were $7.8 million for the six months ended June 28, 2002 compared to $4.3 million for the six months ended June 30, 2001.  Restructuring severance and impairment costs for the six months ended June 28, 2002 included approximately $4.0 million of severance costs related to staff reductions and approximately $3.8 million for facility downsizing.  Restructuring severance and impairment costs for the six months ended June 30, 2001 consisted primarily of $3.7 million of severance costs and approximately $0.5 million for facility downsizing.

 

Interest Income, Net.  Interest income, net of interest expense, decreased to $0.5 million for the six months ended June 28, 2002 from $0.7 million for the six months ended June 30, 2001, primarily due to lower interest rates on invested cash. Interest income net of interest expense as a percentage of net revenue decreased to 0.3% for the six months ended June 28, 2002 from 0.5% for the six months ended June 30, 2001.

 

Other Expense, Net.  Other expense decreased to $0.1 million for the six months ended June 28, 2002 from $0.2 million for the six months ended June 30, 2001.

 

Income Taxes.  The benefit for income taxes of 42% in the quarter ended June 28, 2002 remained the same as in the quarter ended June 30, 2001.

 

16

 

Liquidity and Capital Resources

 

During the six months ended June 28, 2002, we generated cash flow from operations of $8.4 million.  During the six months ended June 28, 2002, we used cash flow of approximately $2.6 million to acquire a controlling interest in Codigent Solutions Group, Inc. (See Note 7 of the Notes to Consolidated Financial Statements) and approximately $1.4 million to purchase property and equipment, including computer and related equipment and office furniture, while depreciation and amortization expense was approximately $2.6 million.  At June 28, 2002, we had cash and investments available for sale of $58.1 million compared to $51.9 million at December 28, 2001.

 

We have a revolving line of credit, under which we are allowed to borrow up to $10.0 million at an interest rate of the prevailing prime rate with an expiration date of May 1, 2003.  There was no outstanding balance under the line of credit at June 28, 2002.

 

Management believes that our existing cash and investments together with funds generated from operations will be sufficient to meet operating requirements for the next twelve months.  Our cash and investments are available for strategic investments, mergers and acquisitions, and other potential large-scale cash needs that may arise.

 

Risks Relating to Our Business

 

Before deciding to invest in us or to maintain or increase your investment, you should carefully consider the risks described below, in addition to the other information contained in this report and in our other filings with the SEC. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks actually occur, our business, financial condition or results of operation could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part of your investment.

 

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

 

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

 

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

•                  Fluctuations in market demand for our services, consultant hiring and utilization;

•                  Delays or increased expenses in securing and completing client engagements;

•                  Timing and collection of fees and payments;

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

•                  Increased competition and pricing pressures;

•                  The loss of key personnel or other employees;

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

•                  The timing of certain general and administrative expenses;

•                  Completing acquisitions and the costs of integrating acquired operations;

•                  Variability in the number of billable days in each quarter;

•                  The write-off of client billings;

 

17

 

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

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

•                  International currency fluctuations; and

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

 

One or more of the foregoing factors may cause our operating expenses to be relatively high during any given period.  In addition, we bill certain of our services on a fixed-price basis, and any assignment delays or expenditures of time beyond that projected for the assignment could result in write-offs of client billings.  Significant write-offs could materially adversely affect our business, financial condition and results of operations.  In addition, our business has significant collection risks.  If we are unable to collect our receivables in a timely manner, our business and financial condition could also suffer.  If this or any other variables or unknowns were to cause a shortfall in revenue or earnings or otherwise cause a failure to meet public market expectations, our business, could be adversely affected.

 

Finally, we have reported net losses in the past, and we cannot assure you that we will continue to achieve positive earnings in the future.  If we are unable to maintain our profitability on a quarterly or annual basis, the market price of our common stock could be adversely affected and our financial condition would suffer.

 

The length of time required to engage a client and to complete an assignment may be unpredictable and could negatively impact our net revenues and operating results.

 

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

 

•                  Existing information systems at the client site;

•                  Changes or the anticipation of changes in the regulatory environment affecting healthcare and pharmaceutical organizations;

•                  Changes in the management or ownership of the client;

•                  Budgetary cycles and constraints;

•                  Changes in the anticipated scope of engagements;

•                  Availability of personnel and other resources; and

•                  Consolidation in the healthcare and pharmaceutical industries.

 

Prior to client engagements, we typically spend a substantial amount of time and resources (1) identifying strategic or business issues facing the client, (2) defining engagement objectives, (3) gathering information, (4) preparing proposals, and (5) negotiating contracts.  Our failure to procure an engagement after spending such time and resources could materially adversely affect our business, financial condition and results of operations.  We may also be required to hire new consultants before securing a client engagement.  If clients defer committing to new assignments for any length of time or for any reason we could be required to maintain a significant number of under-utilized consultants which could adversely affect operating results and financial condition during any given period.  Further, our outsourcing business has very long sales and contract lead times, requiring us to spend a substantial amount of time and resources in attempting to secure each outsourcing engagement.  We cannot predict

 

18

 

whether the investment of time and resources will result in a new outsourcing engagement or, if the engagement is secured, that the engagement will be on terms favorable to us.

 

If we are unable to generate additional revenue from our existing clients, our business may be negatively affected.

 

Our success depends on obtaining additional engagements from our existing clients.  A substantial portion of our revenue is derived from services provided to our existing clients.  The loss of a small number of clients may result in a material decline in revenues and cause us to fail to meet public market expectations of our financial performance and operating results.  If we materially fail to generate additional revenues from our existing clients it may materially adversely affect our business and financial condition.

 

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

 

Our services often involve complex information systems and software, which are critical to our clients’ operations.  Our failure to meet client expectations in the performance of our services, including the quality, cost and timeliness of our services, may damage our reputation in the healthcare and pharmaceutical industries and adversely affect our ability to attract and retain clients.  If a client is not satisfied with our services, we will generally spend additional human and other resources at our own expense to ensure client satisfaction.  Such expenditures will typically result in a lower margin on such engagements and could materially adversely affect our business, financial condition and results of operations.

 

Further, in the course of providing our services, we will often recommend the use of software and hardware products.  These products may not perform as expected or contain defects.  If this occurs, our reputation could be damaged and we could be subject to liability.  We attempt contractually to limit our exposure to potential liability claims; however, such limitations may not be effective.  A successful liability claim brought against us may adversely affect our reputation in the healthcare and pharmaceutical industries and could have a material adverse effect on our business or financial condition.  Although we maintain liability insurance, such insurance may not provide adequate coverage for successful claims against us.

 

Our outsourcing engagements comprise a significant part of our revenues.

 

Our outsourcing agreements require that we invest significant amounts of time and resources in order to win the engagement, transition the client’s information technology department to our management and complete the initial transformation of our client’s information technology functioning to meet agreed-upon service levels.  Often, we recover this investment through payments over the life of the outsourcing agreement.  If we are unable to achieve agreed-upon service levels or otherwise breach the terms of our outsourcing agreements, the clients may have rights to terminate our agreements for cause and we may be unable to recover our investments.  In the case of our outsourcing agreement with the New York Presbyterian Hospital, this investment amounts to almost $10 million, which we will recover on a pro rata basis over the remaining term of that agreement.  The term of the New York Presbyterian Hospital contract is due to expire in December 2006.  Any failure by us to recover these investments may have a material adverse effect on our financial condition, results of operations and price of our common stock.

 

Currently, we have among our active accounts, outsourcing relationships with New York Presbyterian and the University of Pennsylvania Health System.  Our agreement with New York Presbyterian is a seven-year engagement due to expire in December 2006.  We received approximately

 

19

 

$31.5 million from this engagement in 2001, or 12% of our consolidated revenue.  Our agreement with the University of Pennsylvania Hospital System is a six-year engagement due to expire in December 2006.  We received approximately $19.4 million from this engagement in 2001, or 7% of our consolidated revenue. In both of these engagements, the clients have fully outsourced their Information Technology staff and functions to us.  In all of our outsourcing relationships, we generally enter into additional agreements, including detailed service level agreements, which establish performance levels and standards for our services.  If we fail to meet these performance levels or standards, our clients may receive monetary service level credits from us or, if we experience persistent failures, our client may have a right to terminate the outsourcing contract for cause and have no obligation to pay us any termination fees.  As a result, our anticipated revenue from our outsourcing engagements could be significantly reduced if we are unable to satisfy our performance levels or standards.  Additionally, our outsourcing contracts can be terminated at the convenience of our clients upon the payment of a termination fee.

Finally, our outsourcing engagements typically require that we hire part or all of a client’s information technology personnel.  We cannot assure you that we will be able to retain these individuals, and effectively hire additional personnel as needed to meet the obligations of our contract.  Any failure by us to retain these individuals or otherwise satisfy our contractual obligations could have a material adverse effect on the profitability of our outsourcing business and our reputation as an Information Technology services outsourcing provider.

 

We may be unable to attract and retain a sufficient number of qualified employees.

 

Our business is labor-intensive and requires highly skilled employees.  Most of our consultants possess extensive expertise in the healthcare, insurance, pharmaceutical, information technology and consulting fields.  To serve a growing client base, we must continue to recruit and retain qualified personnel with expertise in each of these areas.  Competition for such personnel is intense and we compete for such personnel with management consulting firms, healthcare and pharmaceutical organizations, software firms and other businesses.  Many of these entities have substantially greater financial and other resources than we do, or can offer more attractive compensation packages to candidates, including salary, bonuses, stock and stock options.  If we are unable to recruit and retain a sufficient number of qualified personnel to serve existing and new clients, our ability to expand our client base or services could be impaired and our business would suffer.

 

The loss of our vice presidents and executive officers could negatively affect us.

 

Our performance depends on the continued service of our vice presidents, executive officers and senior managers.  In particular, we depend on such persons to secure new clients and engagements and to manage our business and affairs.  The loss of such persons could result in the disruption of our business and could have a material adverse effect on our business and results of operations.  We have not entered into long-term employment contracts with any of our employees and do not maintain key employee life insurance.

 

Continued or increased employee turnover could negatively affect our business.

 

We have experienced employee turnover as a result of (1) dependence on lateral hiring of consultants, (2) travel demands imposed on our consultants, (3) loss of employees to competitors and clients; and (4) reductions in force in our business units as certain areas of our business have seen less demand.  Continued or increased employee turnover could materially adversely affect our business and results of operations.  In addition, many of our consultants develop strong business relationships with our

 

20

 

clients.  We depend on these relationships to generate additional assignments and engagements.  The loss of a substantial number of consultants could erode our client base and decrease our revenue.

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

 

Our business has historically grown rapidly, and though our overall revenues have remained flat for the past several quarters, we have experienced growth and increased demand in certain areas of our business.  In response to shifts in market demand and in an effort to better align our business with our markets, we have restructured our business units in recent quarters.  This restructuring has included hiring persons with appropriate skills and reductions in force in practice areas experiencing less demand.  These market conditions and restructuring efforts have placed new and increased demands on our vice presidents and other management personnel.  It has also placed significant and increasing demands on our financial, technical and operational resources and on our information systems.  If we are unable to manage growth effectively or if we experience business disruptions due to shifts in market demand, our growth or restructuring, our operating results will suffer.   To manage any future growth, we must (1) extend our financial reporting and information management systems to a growing number of offices and employees, and (2) develop and implement new procedures and controls to accommodate new operations, services and clients.  Increasing operational and administrative demands may make it difficult for our vice presidents to engage in business development activities and their other day-to-day responsibilities.  Further, the addition of new employees and offices to offset such increasing demands may impair our ability to maintain our service delivery standards and corporate culture.  In addition, we have in the past changed, and may in the future change, our organizational structure and business strategy.  Such changes may result in operational inefficiencies and delays in delivering our services.  Such changes could also cause a disruption in our business and could cause a material adverse effect on our financial condition and results of operations.

 

Changes in the healthcare and pharmaceutical industries could negatively impact our revenues.

 

We derive a substantial portion of our revenue from clients in the healthcare industry.  As a result, our business and results of operations are influenced by conditions affecting this industry, particularly current trends towards consolidation among healthcare and pharmaceutical organizations.  Such consolidation may reduce the number of existing and potential clients for our services.  In addition, the resulting organizations could have greater bargaining power, which could erode the current pricing structure for our services.  The reduction in the size of our target market or our failure to maintain our pricing goals could have a material adverse effect on our business and financial condition.  Finally, each of the markets we serve is highly dependent upon the health of the overall economy.  Our clients in each of these markets have experienced significant cost increases and pressures in recent years.  Our services are targeted at relieving these cost pressures; however, any continuation or acceleration of current market conditions could greatly impact our ability to secure or retain engagements, the loss of which could have a material adverse effect on our business and financial condition.

 

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

 

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

 

•                  Continued consolidation of companies; or

 

21

 

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

 

A trend in the pharmaceutical industry is for companies to “outsource” either large information technology-dependent projects or their information systems staffing requirements.  We benefit when pharmaceutical companies outsource to us, but may lose significant future business when pharmaceutical companies outsource to our competitors.  If this outsourcing trend slows down or stops, or if pharmaceutical companies direct their business away from us, our financial condition and results of operations could be impacted in a materially adverse way.

 

We could be negatively impacted if we fail to successfully integrate the businesses we acquire.

 

We intend to grow, in part, by acquiring complementary professional practices within the healthcare and pharmaceutical industries.  All acquisitions involve risks that could materially and adversely affect our business and operating results.  These risks include (1) distracting management from our business, (2) losing key personnel and other employees, (3) losing clients, (4) costs, delays and inefficiencies associated with integrating acquired operations and personnel, and (5) the impairment of acquired assets and goodwill.  In addition, acquired businesses may not enhance our services, provide us with increased client opportunities or result in the growth that we anticipate.  Furthermore, integrating acquired operations is a complex, time-consuming and expensive process.  Combining acquired operations with us may result in lower overall operating margins, greater stock price volatility and quarterly earnings fluctuations.  Cultural incompatibilities, career uncertainties and other factors associated with such acquisitions may also result in the loss of employees and clients.  Failing to acquire and successfully integrate complementary practices, or failing to achieve the business synergies that we anticipate, could materially adversely affect our business and results of operations.

 

Our international operations create specialized risks that can negatively affect us.

 

We are subject to many risks as a result of the services we provide to our international clients.  For example, if we fail to recruit and retain a sufficient number of qualified employees in each country where we conduct business, our ability to expand internationally or perform our existing services may be impaired and our business could be adversely effected.  Our international operations are subject to a variety of risks, including:

 

•                  Difficulties in creating international market demand for our services;

 

•                  Difficulties and costs of tailoring our services to each individual country’s healthcare and pharmaceutical market needs;

 

•                  Unfavorable pricing and price competition;

 

•                  Currency fluctuations;

 

•                  Longer payment cycles in some countries and difficulties in collecting international accounts receivables;

 

•                  Difficulties in enforcing contractual obligations and intellectual property rights;

 

•                  Adverse tax consequences;

 

•                  Increased costs associated with maintaining international marketing efforts and offices;

 

•                  Adverse changes in regulatory requirements; and

 

22

 

•                  Economic instability.

 

In addition, we have been performing services in Europe for international clients for several years, and we have not yet been profitable in providing those services.  We recently ceased performing healthcare consulting services in Europe, although we will continue to provide our services in Europe to our pharmaceutical clients.  We cannot assure you that we will be able to achieve profitability in our European pharmaceutical services, which may materially adversely affect our financial condition, results of operations and price for our common stock.

 

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

 

If we do not compete effectively in the healthcare and pharmaceutical information services industries, then our business may be negatively impacted.

 

The market for healthcare and pharmaceutical information technology consulting is very competitive.  We have competitors that provide some or all of the services we provide.  For example, in strategic consulting services, we compete with international consulting firms, regional and specialty consulting firms and the consulting groups of international accounting firms such as KPMG Consulting, Cap Gemini Ernst & Young, Deloitte & Touche LLP, and Pricewaterhouse Coopers.

 

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

 

•                  Information system vendors such as McKesson/HBOC, Siemens Medical Solutions and IBM Global Systems,

 

•                  Service groups of computer equipment companies,

 

•                  Systems integration companies such as Electronic Data Systems Corporation, Perot Systems Corporation, SAIC, Cap Gemini Ernst & Young and Computer Sciences Corporation,

 

•                  Clients’ internal information management departments,

 

•                  Other healthcare consulting firms, and

 

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

 

In e-health and e-commerce related services, we compete with the traditional competitors outlined above, as well as newer Internet product and service companies.

 

Many of our competitors have significantly greater financial, human and marketing resources than us.  As a result, such competitors may be able to respond more quickly to new or emerging technologies and 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 organizations become larger and more complex, our larger competitors may be better able to serve the needs of such organizations.  If we do not compete effectively with current and future competitors, we may be unable to secure new and renewed client engagements, or we may be required to reduce our rates in order to compete effectively.

 

23

 

This could result in a reduction in our revenues, resulting in lower earnings or operating losses, and otherwise materially adversely affecting our business, financial condition and results of operations.

 

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

 

We have a number of relationships with vendors.  For example, we have established a non-exclusive partnership arrangement with Documentum, Inc.  Documentum markets document management software applications largely to the pharmaceutical industry.  We believe that our relationship with this vendor and others are important to our sales, marketing, and support activities.  We often are engaged by vendors or their customers to implement or integrate vendor products based on our relationship with a particular vendor.  If we fail to maintain our relationships with Documentum and other vendors, or fail to establish additional new relationships, our business could be materially adversely affected.

 

Our relationships with and investments in vendors of software and hardware products could have a negative impact on our ability to secure consulting engagements.

 

Our growing number of relationships with software and hardware vendors could result in clients perceiving that we are not independent from those software and hardware vendors.  Our ability to secure assessment and other consulting engagements is often dependent, in part, on our being independent of software and hardware solutions that we may review, analyze or recommend to clients.  If clients believe that we are not independent of those software and hardware vendors, clients may not engage us for certain consulting engagements relating to those vendors, which could reduce our revenues and materially adversely affect our business.

 

Our business is highly dependent on the availability of business travel.

 

Our consultants and service providers often reside or work in cities or other locations that require them to travel to a client’s site to perform and execute the client’s project.  As a result of the September 11, 2001 terrorist attacks, air travel has become more time-consuming to business travelers due to increased security, flight delays, reduced flight schedules and other variables.  If efficient and cost effective air travel becomes unavailable to our consultants and other employees, or if air travel is halted in the United States, we may be unable to satisfactorily perform our client engagements on a timely basis, which could have a materially adverse impact on our business.  Further, if our consultants or other employees refuse to utilize air travel to perform their job functions for any reason, our business and reputation would be negatively affected.

 

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

 

The healthcare and pharmaceutical industries are subject to regulatory and technological changes that may affect the procurement practices and operations of healthcare and pharmaceutical organizations.  During the past several years, the healthcare and pharmaceutical industries have been subject to an increase in governmental regulation and reform proposals.  These reforms could increase governmental involvement in the healthcare and pharmaceutical industries, lower reimbursement rates or otherwise change the operating environment of our clients.  Also, certain reforms that create potential work for us could be delayed or cancelled. Healthcare and pharmaceutical organizations may react to these situations by curtailing or deferring investments, including those for our services.  In addition, if we are unable to maintain our skill and expertise in light of regulatory or technological changes, our services may not be marketable to our clients and we could lose existing clients or future engagements.

 

24

 

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

 

We may be unable to effectively protect our proprietary information and procedures.

 

We must protect our proprietary information, including our proprietary methodologies, research, tools, software code and other information.  To do this, we rely on a combination of copyright and trade secret laws and confidentiality procedures to protect our intellectual property.  These steps may not protect our proprietary information.  In addition, the laws of certain countries do not protect or enforce proprietary rights to the same extent, as do the laws of the United States.  We are currently providing our services to clients in international markets.  Our proprietary information may not be protected to the same extent as provided under the laws of the United States, if at all.  The unauthorized use of our intellectual property could have a material adverse effect on our business, financial condition or results of operations.

 

We may infringe the intellectual property rights of third parties.

 

Our success depends, in part, on not infringing patents, copyrights and other intellectual property rights held by others.  We do not know whether patents held or patent applications filed by third parties may force us to alter our methods of business and operation or require us to obtain licenses from third parties.  If we attempt to obtain such licenses, we do not know whether we will be granted licenses or whether the terms of those licenses will be fair or acceptable to us.  Third parties may assert infringement claims against us in the future.  Such claims may result in protracted and costly litigation, penalties and fines that could adversely affect our business regardless of the merits of such claims.

 

Our management may be able to exercise control over matters requiring stockholder approval.

 

Our current officers, directors, and other affiliates beneficially own approximately 49% of our outstanding shares of common stock.  As a result, our existing management, if acting together, may be able to exercise control over or significantly influence matters requiring stockholder approval, including the election of directors, mergers, consolidations, sales of all or substantially all of our assets, issuance of additional shares of stock and approval of new stock and option plans.

 

The price of our common stock may be adversely affected by market volatility.

 

The trading price of our common stock fluctuates significantly.  Since our common stock began trading publicly in February 1998, the reported sale price of our common stock on the Nasdaq National Market 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 and prospects;

 

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

 

•                  investor perception of us and the industries in which we operate;

 

•                  changes in earnings estimates or buy/sell recommendations by analysts;

 

•                  general financial and other market conditions; and

 

25

 

•                  domestic and international economic conditions.

 

In addition, public stock markets have experienced extreme price and trading volume volatility.  This volatility has significantly affected the market prices of securities of many companies for reasons frequently unrelated to or disproportionately impacted by the operating performance of these companies.  These broad market fluctuations may adversely affect the market price of our common stock.  As a result, we may be unable to raise capital or use our stock to acquire businesses on attractive terms and investors may be unable to resell their shares of our common stock at or above their purchase price.

 

If our stock price is volatile, we may become subject to securities litigation, which is expensive and could result in a diversion of resources.

 

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

 

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

 

Our board of directors has the authority to issue up to 10,000,000 shares of undesignated preferred stock, to determine the powers, preferences and rights and the qualifications, limitations or restrictions granted to or imposed upon any unissued series of undesignated preferred stock and to fix the number of shares constituting any series and the designation of such series, without any further 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 have other rights, including economic rights, senior to our common stock, and as a result, the issuance of any preferred stock could depress the market price of our common stock.

 

In addition, our certificate of incorporation eliminates the right of stockholders to act without a meeting and does not provide cumulative voting for the election of directors.  Our certificate of incorporation also provides for a classified board of directors.  The ability of our board of directors to issue preferred stock and these other provisions of our certificate of incorporation and bylaws may have the effect of deterring hostile takeovers or delaying changes in control or management.

 

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

 

In 1999, our board of directors adopted a share purchase rights plan that is intended to protect our stockholders’ interests in the event we are confronted with coercive takeover tactics.  Pursuant to the stockholders rights plan, we distributed “rights” to purchase shares of a newly created series of preferred stock.  Under some circumstances these rights become the rights to purchase shares of our common stock or securities of an acquiring entity at one-half the market value.  The rights are not intended to prevent our takeover, rather they are designed to deal with the possibility of unilateral actions by hostile acquirers that could deprive our board of directors and stockholders of their ability to determine our destiny and obtain the highest price for our common stock.

 

26

 

ITEM 3.                                                     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

 

  None.

 

27

 

PART II.  OTHER INFORMATION

 

Item 1.    Legal Proceedings.

 

None.

 

Item 2.   Changes in Securities.

 

(a)  On June 10, 2002, we granted to David S. Lipson, a director of the company, an extension on certain demand and piggyback registration rights he originally received in connection with our acquisition of ISCG in December 1999.  Mr. Lipson was the founder and chief executive officer of ISCG.  The original term of the registration rights was 18 months from December 1999 and we have subsequently granted extensions on the expiration date.  Mr. Lipson’s demand registration rights allow him to request that FCG, on not more than one occasion, file a registration statement to allow him to sell in an underwritten offering any or all of his shares of common stock.  Mr. Lipson’s piggyback registration rights allow him to include all or a portion of his shares in an underwritten public offering of shares by the company, subject to underwriter cutback if the underwriters determine that the marketing of the company’s offering of primary shares would be impacted by the participation of a secondary seller such as Mr. Lipson.  The terms of the registration rights agreement allow us to delay filing a registration upon exercise by Mr. Lipson of his demand registration rights if such filing would be detrimental to us or if such request is made in a closed window period under our insider trading policy.  Under this most recent extension, Mr. Lipson’s registration rights expire on June 18, 2003.  Mr. Lipson beneficially owns 2,088,402 shares of our common stock as of June 28, 2002.

 

(c)  Sales of Unregistered Securities.  On May 31, 2002, we acquired 52.35% of the outstanding shares of Codigent Solutions Group, Inc. for approximately $2.6 million in cash.  The acquisition agreements provided that we will purchase the remaining shares of Codigent Solutions Group, Inc. on or about January 30, 2004, for approximately $2.4 million in cash.  In addition, we may issue up to $5.0 million in restricted shares of our common stock at the subsequent closing if Codigent Solutions Group, Inc. satisfies certain revenue, operating and performance targets.  The number of shares of our restricted common stock to be issued in January 2004, if any, will be based on the average closing price of our common stock on the Nasdaq National Market for the ten days preceeding such subsequent closing.  The shares to be issued, if any, are exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(2) of such Act and Rule 506 promulgated thereunder.

 

Item 3.    Defaults Upon Senior Securities

 

None.

 

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

 

We held our 2002 Annual Meeting of Stockholders on June 25, 2002. The stockholders elected the Board’s nominees as directors to serve three-year terms expiring at the 2005 Annual Meeting of Stockholders by the votes indicated:

 

 

28

 

The stockholders also ratified our selection of Grant Thornton LLP as our independent auditors for the year ending December 27, 2002, with 18,182,230 votes cast in favor, 483,137 votes cast against and 97,594 votes abstaining from the proposal. There was also 1 broker non-vote.

 

Item 5.    Other Information

 

On May 31, 2002, we acquired 52.35% of the outstanding shares of Codigent Solutions Group, Inc., a base provider of value added information technology solutions to hospitals and other healthcare delivery organizations, for approximately $2.6 million in cash.  The acquisition agreements provided that we will purchase the remaining shares of Codigent Solutions Group, Inc. on or about January 30, 2004, for approximately $2.4 million in cash.  In addition, we may issue up to $5.0 million in restricted shares of our common stock at the subsequent closing if Codigent Solutions Group, Inc. satisfies certain revenue, operating and performance targets.  The number of shares of our restricted common stock to be issued in January 2004, if any, will be based on the average closing price of our common stock on the Nasdaq National Market for the ten days preceding such subsequent closing.  The acquisition was accounted for using the purchase method of accounting.

 

Item 6. Exhibits and Reports on Form 8-K

 

(a) Exhibits

 

Item		Description
3.1 (1)		Certificate of Incorporation of the Company.
3.2 (2)		Certificate of Designation of Series A Junior Participating Preferred Stock
3.3 (3)		Bylaws of the Company.
4.1 (4)		Specimen Common Stock Certificate.
10.1 (5)		First Consulting Group, Inc. Associate 401(k) and Stock Ownership Plan
10.2 (6)		Letter Agreement with David S. Lipson regarding extension of registration rights.
11.1 (7)		Statement of computation of per share earnings.

 

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

 

(2)                                  Incorporated by reference to Exhibit 99.1 to FCG’s Current Report on Form 8-K dated December 9, 2000.

 

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

 

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

 

(5)                                  Filed with this Form 10-Q as Exhibit 10.1.

 

(6)                                  Filed with this Form 10-Q as Exhibit 10.2.

 

29

 

(7)                                  See Note 3 to Consolidated Financial Statements, “Net Income Per Share.”

 

 

(b)           Reports on Form 8-K

 

None.

 

30

 

SIGNATURES

 

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

 

	FIRST CONSULTING GROUP, INC.
Date:  August 12, 2002	/s/ LUTHER J. NUSSBAUM
	Luther J. Nussbaum Chairman and Chief Executive Officer
Date:  August 12, 2002	/s/ WALTER J. McBRIDE
	Walter J. McBride Executive Vice President and Chief Financial Officer (Principal Financial Officer)

 

31

 

Exhibit Index

 

Item		Description
3.1 (1)		Certificate of Incorporation of the Company.
3.2 (2)		Certificate of Designation of Series A Junior Participating Preferred Stock
3.3 (3)		Bylaws of the Company.
4.1 (4)		Specimen Common Stock Certificate.
10.1 (5)		First Consulting Group, Inc. Associate 401(k) and Stock Ownership Plan.
10.2 (6)		Letter Agreement with David S. Lipson regarding extension of registration rights.
11.1 (7)		Statement of computation of per share earnings.

 

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

 

(2)                                  Incorporated by reference to Exhibit 99.1 to FCG’s Current Report on Form 8-K dated December 9, 2000.

 

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

 

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

 

(5)                                Filed with this Form 10-Q as Exhibit 10.1.

 

(6)                                  Filed with this Form 10-Q as Exhibit 10.2.

 

(7)                                  See Note 3 to Consolidated Financial Statements, “Net Income Per Share.”

 

32