UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

 

 

FORM 10-Q

(Mark One)

 

 

For the transition period from              to

 

Commission File Number 0-23651

 

 

First Consulting Group, Inc.

(Exact name of registrant as specified in its charter)

 

 

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 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 ý        No  o

 

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

 

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

 

Common Stock, $.001 par value	24,773,016
(Class)	(Outstanding at April 25, 2003)

 

 

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 March 28, 2003 and December 27, 2002
		Consolidated Statements of Operations for the three month periods ended March 28, 2003 and March 29, 2002
		Condensed Consolidated Statements of Cash Flows for the three months ended March 28, 2003 and March 29, 2002
		Notes to Consolidated Financial Statements
	ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
	ITEM 4.  CONTROLS AND PROCEDURES
PART II.  OTHER INFORMATION
	ITEM 1.  LEGAL PROCEEDINGS.
	ITEM 2.  CHANGES IN SECURITIES.
	ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.
	ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
	ITEM 5.  OTHER INFORMATION.
	ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K.
SIGNATURES
CERTIFICATIONS
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, except share and per share data)

 

		March 28, 2003			December 27, 2002
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	23,321		$	27,550
Short-term investments		34,873			38,796
Accounts receivable, less allowance of $1,769 and $1,899 in the periods ended March 28, 2003 and December 27, 2002, respectively		27,369			36,889
Unbilled receivables		15,620			13,264
Deferred income taxes		6,198			6,198
Prepaid expenses and other current assets		3,132			2,110
Total current assets		110,513			124,807
Notes receivable – stockholders		610			657
Long-term investments		2,200			2,200
Property and equipment:
Furniture, equipment, and leasehold improvements		7,597			7,505
Information systems equipment		21,176			21,123
		28,773			28,628
Less accumulated depreciation and amortization		18,935			20,104
		9,838			8,524
Other assets:
Executive benefit trust		5,988			6,059
Unbilled long-term receivables		7,015			8,059
Deferred income taxes		3,147			3,147
Goodwill, net		13,898			3,282
Intangibles, net		895			214
Other		878			360
		31,821			21,121
Total assets		$	154,982		$	157,309

 

See accompanying notes.

 

3

 

		March 28, 2003			December 27, 2002
		(unaudited)
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	3,112		$	1,652
Accrued liabilities		10,883			14,660
Accrued restructuring		6,284			7,578
Accrued vacation		7,458			6,868
Accrued incentive compensation		1,967			2,328
Customer advances		7,043			7,877
Total current liabilities		36,747			40,963
Non-current liabilities:
Supplemental executive retirement plan		6,179			6,351
Minority interest		712			2,023
Total non-current liabilities		6,891			8,374
Commitments and contingencies		—			—
Stockholders’ equity:
Preferred Stock, $.001 par value; 9,500,000 shares authorized, no shares issued and outstanding		—			—
Series A Junior Participating Preferred Stock, $.001 par value; 500,000 shares authorized, no shared issued and outstanding		—			—
Common Stock, $.001 par value; 50,000,000 shares authorized, 24,816,723 shares issued and outstanding at March 28, 2003 and 24,073,089 shares issued and outstanding at December 27, 2002		25			24
Additional paid-in capital		97,383			92,461
Retained earnings		15,937			17,853
Deferred compensation-stock incentive agreements		(507		)	(621		)
Notes receivable-stockholders		(820		)	(1,076		)
Accumulated other comprehensive loss		(674		)	(669		)
Total stockholders’ equity		111,344			107,972
Total liabilities and stockholders’ equity		$	154,982		$	157,309

 

See accompanying notes.

 

4

 

First Consulting Group, Inc. and Subsidiaries

 

Consolidated Statements of Operations

(in thousands, except per share data)

 

		Three Months Ended
		(unaudited)
		March 28, 2003			March 29, 2002
Revenues before reimbursements		$	70,130		$	63,277
Reimbursements		3,613			3,877
Total revenues		73,743			67,154
Cost of services before reimbursable expenses		47,587			40,073
Reimbursable expenses		3,613			3,877
Total cost of services		51,200			43,950
Gross profit		22,543			23,204
Selling expenses		7,269			6,894
General and administrative expenses		14,577			14,713
Income from operations		697			1,597
Other income (expense):
Interest income, net		276			208
Other income (expense), net		201			(57		)
Income before income taxes		1,174			1,748
Provision for income taxes		493			734
Income before cumulative effect of change in accounting principle, net of tax		681			1,014
Cumulative effect of change in accounting principle, net of tax of $1,881		(2,597		)	—
Net income (loss)		$	(1,916	)	$	1,014
Net income (loss)  per share:
Basic:
Income before cumulative effect of change in accounting principle, net of tax		0.03			0.04
Cumulative effect of change in accounting principle, net of tax		(0.11		)	—
Net income (loss) per share		$	(0.08	)	$	0.04
Diluted:
Income before cumulative effect of change in accounting principle, net of tax		0.03			0.04
Cumulative effect of change in accounting principle, net of tax		(0.11		)	—
Net income (loss) per share		$	(0.08	)	$	0.04
Weighted average shares used in computing:
Basic net income (loss) per share		24,495			23,897
Diluted net income (loss) per share		24,648			25,166

 

See accompanying notes.

 

5

 

First Consulting Group, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Cash Flows

(in thousands)

 

		Three Months Ended
		(unaudited)
		March 28, 2003			March 29, 2002
Cash flows from operating activities:
Net income (loss):		$	(1,916	)	$	1,014
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Cumulative effect of change in accounting principle, net of tax		2,597			—
Depreciation and amortization		1,221			1,364
Intangible amortization		55			—
Provision for bad debts, net of adjustments		(170		)	71
Loss on sale of assets		26			9
Minority interest in net income (loss)		(199		)	85
Compensation from stock issuances		33			20
Interest income on notes receivable – stockholders		(34		)	(27		)
Changes in assets and liabilities, excluding effect of acquisitions:
Accounts receivable		10,686			8,010
Unbilled receivables		(7,306		)	(6,330		)
Prepaid expenses and other		(1,022		)	(537		)
Unbilled long term receivable		404			388
Other assets		269			106
Accounts payable		1,448			1,388
Accrued liabilities		(3,109		)	(688		)
Accrued restructuring		(1,294		)	(1,693		)
Accrued vacation		590			639
Accrued incentive compensation		(361		)	(718		)
Customer advances		(866		)	(665		)
Supplemental executive retirement plan		(172		)	138
Other		305			(284		)
Net cash provided by operating activities:		1,185			2,290
Cash flows from investing activities:
Proceeds from sale/maturity of investments		3,923			(163		)
Purchase of property and equipment		(1,471		)	(833		)
Acquisition of businesses, net of cash acquired		(8,952		)	—
Net cash used in investing activities		(6,500		)	(996		)
Cash flows from financing activities:
Proceeds from issuance of capital stock, net		668			1,286
Proceeds from notes receivable and tax loan payments		418			120
Net cash provided by financing activities		1,086			1,406
Net change in cash and cash equivalents		(4,229		)	2,700
Cash and cash equivalents at beginning of period		27,550			32,499
Cash and cash equivalents at end of period		$	23,321		$	35,199
Cash paid during the period for:
Interest		$	9		$	2
Income taxes		$	155		$	189

 

See accompanying notes.

 

6

 

Notes to Consolidated Financial Statements

 

1.                                      Basis of Presentation

 

The consolidated balance sheets of First Consulting Group, Inc. (the “Company”) at March 28, 2003 and consolidated statements of operations and condensed consolidated statements of cash flows for the periods ended March 28, 2003 and March 29, 2002 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 March 28, 2003 and the results of operations and cash flows for the three-month periods ended March 28, 2003 and March 29, 2002.  The results of operations and cash flows for the three months ended March 28, 2003 are not necessarily indicative of the results to be expected for the year ending December 26, 2003.  For more complete financial information, these financial statements should be read in conjunction with the audited financial statements for the year ended December 27, 2002 included in the Company’s Annual Report on Form 10-K.

 

2.                                      Stock-Based Compensation

 

The Company accounts for stock-based employee compensation as prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and has adopted the disclosure provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), and Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and 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 based method of accounting for stock-based awards had been applied. Under the fair value based method, compensation cost is recorded based on the value of the award at the grant date and is recognized over the service period.

 

The following table presents pro forma net income (loss) had compensation costs been determined on the fair value at the date of grant for awards under the plan in accordance with SFAS No. 123 (in thousands, except per share data):

 

					Three Months Ended
					March 28, 2003			March 29, 2002
Net income (loss), as reported					$	(1,916	)	$	1,014
Deduct: Total stock based employee compensation expense determined under fair value method for all awards, net of tax					(643		)	(742		)
Pro forma net income (loss)					$	(2,559	)	$	272
Basic earnings (loss) per share			As reported		$	(0.08	)	$	0.04
			Pro forma		$	(0.10	)	$	0.01
Diluted earnings (loss) per share			As reported		$	(0.08	)	$	0.04
			Pro forma		$	(0.10	)	$	0.01

 

7

 

3.                                      Disclosure of Segment Information

 

The Company currently has three reportable operating segments:  healthcare (which is the delivery of consulting and systems integration (“CSI”) services to health delivery, health plan, and government clients), life sciences (which is the delivery of CSI services to pharmaceutical and other life sciences clients), and outsourcing (which is the delivery of information technology outsourcing services to clients).  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 amount of CSI revenues attributed to each segment is accounted for by splitting the revenues on each client engagement based upon the hourly rates charged to the client for the services of each segment.  Costs are not transferred across segments.

 

The Company evaluates its segments’ performance based on revenues and operating income.  Selling and general and administrative expense (including corporate functions, occupancy related costs, depreciation, professional development, recruiting, and marketing), to some extent, are managed at the corporate level and allocated to each operating segment based on either net revenues, actual usage, or other reasonable allocation methods.

 

The following segment information is for the quarters ended March 28, 2003 and March 29, 2002 (in thousands):

 

For the three months ended March 28, 2003:

 

		Healthcare			Life Sciences			Outsourcing			Other			Totals
Revenues before reimbursements		$	27,699		$	17,937		$	24,494		$	—		$	70,130
Reimbursements		2,813			456			344			—			3,613
Total revenues		30,512			18,393			24,838			—			73,743
Cost of services before reimbursable expenses		16,383			9,634			21,570			—			47,587
Reimbursable expenses		2,813			456			344			—			3,613
Total cost of services		19,196			10,090			21,914			—			51,200
Gross profit		11,316			8,303			2,924			—			22,543
Selling expenses		4,402			2,016			737			114			7,269
General & administrative expenses		6,046			5,320			2,934			277			14,577
Income (loss) from operations		$	868		$	967		$	(747	)	$	(391	)	$	697

 

8

 

For the three months ended March 29, 2002:

 

		Healthcare			Life Sciences			Outsourcing			Other			Totals
Revenues before reimbursements		$	28,843		$	17,521		$	16,913		$	—		$	63,277
Reimbursements		3,292			536			49			—			3,877
Total revenues		32,135			18,057			16,962			—			67,154
Cost of services before reimbursable expenses		16,398			10,626			13,049			—			40,073
Reimbursable expenses		3,292			536			49			—			3,877
Total cost of services		19,690			11,162			13,098			—			43,950
Gross profit		12,445			6,895			3,864			—			23,204
Selling expenses		3,226			2,226			1,073			369			6,894
General & administrative expenses		6,412			4,839			2,271			1,191			14,713
Income (loss) from operations		$	2,807		$	(170	)	$	520		$	(1,560	)	$	1,597

 

Detail of Outsourcing revenues:

 

Outsourcing revenues before reimbursements include revenues related to a major subcontractor on several projects.  The breakdown of revenue in outsourcing is as follows (in thousands):

 

 

4.                                      Net Income (Loss) Per Share

 

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

 

		Three Months Ended
		March 28, 2003			March 29, 2002
Income before cumulative effect, net of tax		$	681		$	1,014
Cumulative effect of change in accounting principle, net of tax		(2,597		)	—
Net income (loss)		$	(1,916	)	$	1,014
Basic weighted average number of shares outstanding		24,495			23,897
Effect of dilutive options and warrants		153			1,269
Diluted weighted average number of shares outstanding		24,648			25,166
Basic per share:
Income before cumulative effect, net of tax		$	0.03		$	0.04
Cumulative effect of change in accounting principle, net of tax		(0.11		)	—
Net income (loss) per share		$	(0.08	)	$	0.04
Diluted per share:
Income before cumulative effect, net of tax		$	0.03		$	0.04
Cumulative effect of change in accounting principle, net of tax		(0.11		)	—
Net income (loss) per share		$	(0.08	)	$	0.04

 

9

 

For the three months ended March 28, 2003 and March 29, 2002, there were 4,260,733 and 1,129,756 anti-dilutive outstanding stock options, respectively, excluded from the calculation of diluted earnings per share.

 

5.                                      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 $34.9 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 March 28, 2003.  Additionally, the Company has $1.2 million of non marketable equity investments, valued at the lower of cost or estimated fair value, which are included in long-term investments.

 

6.                                      Accounts Receivable

 

At March 28, 2003, the Company carried a long-term account receivable of approximately $7.0 million from a single client.  The receivable relates to a major outsourcing contract, and will be collected over a four-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.

 

10

 

7.                                      Business Acquisitions

 

Businesses acquired through March 28, 2003, were accounted for under the purchase method of accounting and are included in the consolidated financial statements from the date of acquisition.

 

Paragon Solutions, Inc.

 

On February 12, 2003, the Company acquired 100% of Paragon Solutions, Inc., a U.S. based provider of onshore and offshore software development services which is now part of the life sciences segment. The Company issued 600,500 unregistered shares of common stock and paid cash consideration of approximately $0.2 million to their shareholders that elected cash payment.  The Company also agreed to reserve an additional 49,540 shares of its common stock for issuance upon the exercise of options that were initially issued under Paragon’s stock incentive plans.  Based upon a preliminary purchase price allocation, goodwill of approximately $10.2 million has been recorded.  Due to the recent closing date, the purchase price allocations are tentative and subject to final purchase price valuation analysis.  In connection with the acquisition, the Company immediately repaid $7.7 million of debt assumed from Paragon.  Additionally, the Company acquired approximately $0.4 million of cash as part of the acquisition.

 

The following table summarizes the estimated fair values of assets acquired and liabilities assumed as of February 12, 2003 in connection with the Paragon acquisition (in thousands):

 

 

Phyve Corporation

 

On February 20, 2003, the Company acquired certain assets of Phyve Corporation, a provider of information security and connectivity software solutions, for $1.4 million in cash.  The following table summarizes the estimated fair values of assets acquired in connection with this acquisition (in thousands):

 

 

8.                                      Goodwill and Intangible Assets

 

Effective December 29, 2001, the Company adopted Statement of Financial Accounting Standards No. 142 (“SFAS No. 142”).  SFAS No. 142 requires that goodwill and certain intangibles no longer be amortized, but instead are to be reviewed at least annually for impairment or if an event occurs

 

11

 

or circumstances change that may reduce the fair value of the reporting unit below its book value. The impairment test is conducted at the reporting unit level by comparing the fair value of the reporting unit with its carrying value.  Prior to the adoption of SFAS No. 142, goodwill was amortized over the estimated useful life.

 

SFAS No. 142 requires the Company to evaluate its existing intangible assets and goodwill that are acquired in a prior purchase business combination and to make any necessary reclassifications for recognition apart from goodwill.  The Company evaluates goodwill and intangible assets for impairment, as well as the related amortization periods for intangibles with definite lives, to determine whether adjustments to these amounts or estimated useful lives are required based on current events and circumstances. The evaluation is based on the Company’s projection of the future operating cash flows of the underlying assets combined with market valuation approaches. Significant estimates and assumptions were used in assessing the fair value of reporting units.  These estimates and assumptions included future cash flows, growth rates, discount rates, weighted average cost of capital, and estimates of market valuation for each of the reporting units.

 

The changes in the net carrying amounts of goodwill for the three months ended March 28, 2003 are as follows (in thousands):

 

		Healthcare			Life Sciences			Outsourcing			Total
Balance as of December 27, 2002		$	827		$	1,468		$	987		$	3,282
Acquired		—			10,193			430			10,623
Currency translation adjustment		—			(7		)	—			(7		)
Balance as of March 28, 2003		$	827		$	11,654		$	1,417		$	13,898

 

As of March 28, 2003, the Company had the following acquired intangible assets recorded (in thousands):

 

Amortized Intangible Assets		Gross Carrying Amount			Accumulated Amortization			Net Carrying Amount
Software (Phyve)		$	736		$	(30	)	$	706
Customer based (FCGIS)		$	304		$	(115	)	$	189

 

The following table summarizes the future estimated amortization expense for these assets (in thousands):

 

 

9.                                      Restructuring, severance, and impairment costs

 

The company did not incur any restructuring, severance, and impairment costs in the first quarter of 2003 or 2002. However, there are still accrued liabilities primarily related to abandoned leases remaining from a restructuring in June, 2002.  Payments on lease obligations are scheduled to continue

 

12

 

until 2008.  Market conditions and the ability to sublease these properties may affect the ultimate charge related to the lease obligations.  Any potential recovery or additional charge may affect amounts reported in future periods.

 

The restructuring liability for the quarter ended March 28, 2003 is summarized as follows (in thousands):

 

		Employee Related Costs			Facilities/Other Related Costs			Total
Reserve balance at December 27, 2002		$	1,093		$	6,485		$	7,578
Amounts utilized, net		(252		)	(1,042		)	(1,294		)
Reserve balance at March 28, 2003		$	841		$	5,443		$	6,284

 

The remaining $0.8 million of employee-related costs primarily relate to approximately 30 employees planned to be severed in the second quarter of 2003 in the Company’s life science business unit upon the planned completion of a major project.

 

10.                               Comprehensive Income (Loss)

 

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

 

 

11.                             Cumulative Effect of Change in Accounting Principle

 

Effective December 28, 2002, the Company adopted Emerging Issues Task Force (EITF) Issue 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables,” which addresses how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets.  Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (1) the delivered item has value to the customer on a standalone basis; (2) there is objective and reliable evidence of the fair value of undelivered items; and (3) delivery of any undelivered item is probable.  Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values, with the amount allocated to the delivered item being limited to the amount that is not contingent on the delivery of additional items or meeting other specified performance conditions.  The new standard is required to be adopted for all new applicable revenue arrangements no later than the third quarter of 2003.  Early adoption is permitted and the Company has elected to adopt the new standard as of the beginning of the first quarter of 2003.  In addition, the Company has elected to apply the new standard to all existing outsourcing arrangements impacted by EITF 00-21 and record to earnings the resulting cumulative effect as a change in accounting principle.  The adoption of EITF Issue 00-21 resulted in a non-cash charge, net of tax, of $2.6 million, or $0.11 per share, in the first quarter of 2003.

 

13

 

The following table illustrates the effect on net income and earnings per share as if the change in accounting principle had been adopted in prior periods (in thousands, except per share data):

 

		Three Months Ended
		March 28, 2003			March 29, 2002
Income before cumulative effect– as reported		$	681		$	1,014
Pro forma effect of change in accounting principle, net of tax		—			(576		)
Pro forma net income		$	681		$	438
Net income (loss) per share:
Basic:
Income before cumulative effect– as reported		$	0.03		$	0.04
Pro forma effect of change in accounting principle, net of tax		—			(0.02		)
Pro forma net income per share		$	0.03		$	0.02
Diluted:
Income before cumulative effect– as reported		0.03			0.04
Pro forma effect of change in accounting principle, net of tax		—			(0.02		)
Pro forma net income per share		$	0.03		$	0.02

 

14

 

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 providers, payors, government agencies, pharmaceutical, biogenetic, and other healthcare organizations in North America, Europe, and Asia.  We generate substantially all of our revenues from fees for professional services and information technology outsourcing 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.  In our consulting and systems integration businesses (“CSI”), the healthcare and life sciences business units, 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, the number of our employees required to complete the assignment, and the volume of transactions or interactions.  Actual hourly or fixed fees for an assignment may vary from the standard, target, or historical rates that we have charged.  Revenues are generally recognized related to the level of services performed based upon the amount of time completed on each assignment versus the projected number of hours required to complete such assignment, or the amount of cost incurred on the assignment versus the estimated total cost to complete the assignment.  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 total revenues, and then deducted to determine net revenues.  For purposes of analysis, all percentages in this discussion are stated as a percentage of net revenues, 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 outsourcing associates, 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; information systems; salaries and expenses for executive management, financial accounting and administrative personnel; expenses for firm and business unit governance meetings; recruiting fees; professional development and training; and legal and other professional services.  As associate related costs are relatively fixed in the short term, variations in our revenues and operating results in our CSI business can occur as a result of variations in billing margins and utilization rates of our billable associates.

 

15

 

Our most significant expenses are our human resource and related salary and benefit expenses.  As of March 28, 2003, approximately 1,006 of our employees are billable consultants.  Another 659 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 18.6% of our workforce, or 381 employees, are classified as non-billable.  Our cost of services as a percentage of revenues is directly related to several factors, including, but not limited to, our consultant utilization, which is the ratio of total billable hours to available hours in a given period, the amount and timing of cost incurred, our ability to control costs on our outsourcing projects, the billed rate on time and material contracts, and the estimated cost to complete our non-outsourcing fixed price contracts.  We evaluate our non-outsourcing fixed price contracts on a monthly basis by estimating the cost to complete the assignment.  We then recognize revenues to achieve a constant margin over the remaining term of the engagement.  We have changed our accounting for outsourcing contracts with the adoption of EITF 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables,” in the first quarter of fiscal year 2003.  Under our outsourcing contracts, a significant portion of our revenues are fixed and allocated over the contract on a straight-line basis, and we are required to provide a specified level of services subject to certain performance measurements.  Also, certain revenues may fluctuate under the contracts based on the volume of transactions we process or other measurements of service provided.  If we incur higher costs to provide the required services or receive less revenue due to reduced transaction volumes, our gross margin can be negatively impacted.

 

In our CSI business, we manage consultant utilization by monitoring assignment requirements and timetables, available and required skills, and available consultant hours per week and per month.   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.  Finally, an unanticipated termination of a major outsourcing contract could result in a significant reduction in revenues.  In May 2003, we received a letter from our significant outsourcing client in Cleveland, Ohio alleging breach of the terms of our contract.  The letter alleges failure to meet certain service levels in consecutive months and delinquency of certain transition services deliverables.  The client has requested that we present a plan for remediation of the alleged failures and delinquencies and we expect to address the client's issues in an acceptable manner.  However, we cannot be certain that such plan will cure our alleged breaches or that such client will not terminate their agreement with us.

 

16

 

Results of Operations for the Three Months Ended March 28, 2003 and March 29, 2002

 

Revenues.  Our net revenues increased to $70.1 million for the quarter ended March 28, 2003, an increase of 10.8% from $63.3 million for the quarter ended March 29, 2002.  Our total revenues increased to $73.7 million for the quarter ended March 28, 2003, an increase of 9.8% from $67.2 million for the quarter ended March 29, 2002.  The increases were primarily due to new outsourcing engagements which began in mid-2002, and $2.7 million of revenue generated from our acquisition of Codigent Solutions Group, Inc. in May 2002, and Paragon Solutions, Inc., in mid-February 2003.  This increase was offset by a decline in healthcare and life sciences revenues, exclusive of the acquisitions, resulting from delays in key provider contracts and continued uncertain market conditions.  In addition, we began the roll-off from a significant client engagement in our life sciences business unit in March 2003.  If we do not obtain new engagements and/or follow-up work from this or other clients, we could see a further revenue decline in the life sciences business unit.

 

Cost of Services.  Cost of services before reimbursable expenses increased to $47.6 million for the quarter ended March 28, 2003, an increase of 18.8% from $40.1 million for the quarter ended March 29, 2002.  The increase was primarily due to the costs of services of our new outsourcing engagements,  additional costs of services of our recent acquisitions, and severance costs, partially offset by a reduction in staff in our life sciences business unit.

 

Gross Profit.  Gross profit decreased to $22.5 million for the quarter ended March 28, 2003, a decrease of 2.8% from $23.2 million for the quarter ended March 29, 2002.  The decrease was primarily due to a reduced gross margin in our outsourcing business unit, which resulted from two factors.  First, we had two outsourcing contracts which began in mid-2002 that are still in their early stages of operation.  Our outsourcing contracts tend to have higher costs in the early stages as compared to the later stages, and because revenue is recorded on a straight-line basis, the margins are lower.  Second, we had a cost overrun on another outsourcing contract.  We expect these reduced margins in outsourcing to continue, but to a decreasing degree over the next several quarters.  Gross profit as a percentage of net revenue decreased from 36.7% for the quarter ended March 29, 2002 to 32.1% for the quarter ended March 28, 2003, due to the factors discussed above and the significant shift in revenue mix from healthcare and life sciences to outsourcing, which is a lower margin business.

 

Selling Expenses.  Selling expenses increased to $7.3 million for the quarter ended March 28, 2003, an increase of 5.5% from $6.9 million for the quarter ended March 29, 2002 primarily due to an increase in the size of our sales force in the healthcare business unit.  We expected to better leverage these expenses for the quarter ended March 28, 2003, but had some large projects delayed from signing into the second quarter of 2003.  Selling expenses as a percentage of net revenue decreased from 10.9% for the quarter ended March 29, 2002 to 10.4% for the quarter ended March 28, 2003.

 

General and Administrative Expenses.  General and administrative expenses decreased to $14.6 million for the quarter ended March 28, 2003, a decrease of 0.9% from $14.7 million for the quarter ended March 29, 2002.  The decrease resulted from cost reductions, offset by $1.2 million of general and administrative expenses related to our recently acquired companies.  General and administrative expenses as a percentage of net revenues decreased from 23.3% for the quarter ended March 29, 2002 to 20.8% for the quarter ended March 28, 2003.

 

Interest Income, Net.  Interest income, net of interest expense, increased to $0.3 million for the quarter ended March 28, 2003 from $0.2 million for the quarter ended March 29, 2002.  Interest income net of interest expense as a percentage of net revenue increased to 0.4 % for the quarter ended March 28, 2003 from 0.3% for the quarter ended March 29, 2002.

 

17

 

Other Income (Expense), Net.  Other income increased to $0.2 million for the quarter ended March 28, 2003 compared to an expense of $0.1 million for the quarter ended March 29, 2002.  The income in the current quarter is due to the 19.9% minority interest in the loss incurred during the first quarter by the subsidiary which contains the majority of FCG’s outsourcing business.

 

Income Taxes.  The provision for income taxes of 42% in the quarter ended March 28, 2003 remained the same as in the quarter ended March 29, 2002.

 

Cumulative Effect of Change in Accounting Principle.  In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on Issue 00-21, titled “Accounting for Revenue Arrangements with Multiple Deliverables,”  which addresses how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets.  The new standard is required to be adopted for all new applicable revenue arrangements no later than the third quarter of 2003.  Early adoption is permitted and we have elected to adopt the new standard as of the beginning of the first quarter of 2003.  In addition, we have elected to apply the new standard to all existing outsourcing arrangements impacted by EITF 00-21 and record to earnings the resulting cumulative effect as a change in accounting principle.  We have recorded a non-cash charge, net of tax, of $2.6 million, or $0.11 per share, in the first quarter of 2003.

 

Liquidity and Capital Resources

 

During the three months ended March 28, 2003, we generated cash flow from operations of $1.2 million.  During the three months ended March 28, 2003, we used approximately $7.5 million of cash, net of cash acquired, to acquire Paragon Solutions, Inc. which included repayment of its debt obligations, approximately $1.4 million of cash to acquire certain assets of Phyve Corporation (see Note 7 of the Notes to Consolidated Financial Statements), and approximately $1.5 million of cash to purchase property and equipment, including computer and related equipment, and office furniture.  At March 28, 2003, we had cash and investments available for sale of $59.2 million compared to $67.3 million at December 27, 2002.

 

We have a revolving line of credit, under which we are allowed to borrow up to $7.0 million at an interest rate of the prevailing prime rate with an expiration of May 1, 2004.  There was no outstanding balance under the line of credit at March 28, 2003.

 

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 capital expenditures (which are budgeted at $7.5 million for 2003, $1.5 million of which was spent during the three months ended March 28, 2003), strategic investments, mergers and acquisitions, and other potential large-scale cash needs that may arise, including $2.4 million in cash that will be spent on or about January 2004 to purchase the remaining 47.65% minority interest in FCG Infrastructure Services (formerly Codigent Solutions Group, Inc.) that we do not already own.

 

18

 

Critical Accounting Policies and Estimates

 

The foregoing discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On an on-going basis, we evaluate our estimates, including those related to revenue recognition, cost to complete client engagements, valuation of goodwill and long-lived and intangible assets, accrued liabilities, income taxes, restructuring costs, idle facilities, litigation and disputes, and the allowance for doubtful accounts.  We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.  Our actual results may differ from our estimates and we do not assume any obligation to update any forward-looking information.

 

We believe the following critical accounting policies reflect our more significant assumptions and estimates used in the preparation of our consolidated financial statements.

 

Revenue Recognition and Unbilled Receivables

 

Revenues are derived from consulting, systems integration, and information technology outsourcing services.  Revenues are recognized on a time-and-materials, level-of-effort, or percentage-of-completion basis.  Before revenues are recognized, the following four criteria must be met: (a) persuasive evidence of an arrangement exists; (b) delivery has occurred or services rendered; (c) the fee is fixed and determinable; and (d) collectibility is reasonably assured.  We determine if the fee is fixed and determinable and collectibility is reasonably assured based on our judgments regarding the nature of the fee charged for services rendered and products delivered and the collectibility of those fees.  Arrangements range in length from less than one year to seven years.  The longer-term arrangements are generally level-of-effort or fixed price arrangements.

 

Revenues from time-and-materials arrangements are generally recognized based upon contracted hourly billing rates as the work progresses.  Revenues from level-of-effort arrangements are based upon a fixed price for the level or resources provided.  Revenues from fixed fee arrangements for consulting and systems integration work are generally recognized on a percentage-of-completion basis.  We maintain, for each of our fixed fee contracts, estimates of total revenue and cost over the contract term. For purposes of periodic financial reporting on the percentage of completion contracts, we accumulate total actual costs incurred to date under the contract. The ratio of those actual costs to our then-current estimate of total costs for the life of the contract is then applied to our then-current estimate of total revenues for the life of the contract to determine the portion of total estimated revenues that should be recognized. We follow this method because reasonably dependable estimates of the revenues and costs applicable to various stages of a contract can be made.

 

Revenues recognized on fixed price contracts are subject to revisions as the contract progresses to completion.  If we do not accurately estimate the resources required or the scope of the work to be performed, do not complete our projects within the planned periods of time, or do not satisfy our obligations under the contracts, then profit may be significantly and negatively affected or losses may need to be recognized.  Revisions in our contract estimates are reflected in the period in which the determination is made that facts and circumstances dictate a change of estimate. Favorable changes in estimates result in additional revenues recognized, and unfavorable changes in estimates result in a reduction of recognized revenues. Provisions for estimated losses on individual contracts are made in the

 

19

 

period in which the loss first becomes known.  Some contracts include incentives for achieving either schedule targets, cost targets, or other defined goals.  Revenues from incentive type arrangements are recognized when it is probable they will be earned.

 

As of the beginning of fiscal year 2003, we adopted EITF Issue 00-21, titled “Accounting for Revenue Arrangements with Multiple Deliverables,” which addresses how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets.  Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (1) the delivered item has value to the customer on a stand-alone basis; (2) there is objective and reliable evidence of the fair value of undelivered items; and (3) delivery of any undelivered item is probable.  Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values, with the amount allocated to the delivered item being limited to the amount that is not contingent on the delivery of additional items or meeting other specified performance conditions.  We have created separate units of accounting on our existing outsourcing contracts based on the above criteria and will do so on our future contracts.  Generally, we have separated certain elements of our initial contract stages, where processes are reengineered into a new operating environment, from the ongoing operations of the contract.  The primary impact of the adoption of this new standard will be that our ongoing contract operations, which constitute the vast majority of the revenues from outsourcing contracts, will be recorded on a straight-line basis over the life of the contract instead of on a percentage-of-completion basis in proportion to costs incurred.  In general, we will report lower margins on existing contracts in the early years of a contract and anticipate reporting increased margins in the later years of a contract; however, no assurances can be made in that regard.  The new method will no longer be based on a consistent margin over the life of a contract.  We will likely experience greater volatility of outsourcing earnings as contract revenues remain level and contract costs move up or down, or shift from one quarter to another.

 

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

 

Unbilled receivables represent revenues recognized for services performed that were not billed at the balance sheet date.  The majority of these amounts are billed in the subsequent month. Unbilled amounts arising from contracts occur when revenues recognized exceed allowable billings in accordance with the contractual agreements.  As of March 28, 2003, we had unbillable revenues included in current unbilled receivables of approximately $1.3 million, which were expected to be billed in the following quarter.  In addition, we had long-term unbilled receivables at March 28, 2003, and March 29, 2002 of $7.0 million and $9.9 million, respectively, on a single major outsourcing contract with a term of seven years.  The long-term receivable will be billed and collected over the remaining four years of the contract through contractual billings that will exceed the amounts to be earned as revenues.

 

Customer advances comprise payments from customers for which services have not yet been performed or prepayments against work in process. These unearned revenues are deferred and recognized as future contract costs are incurred and as contract services are rendered.

 

20

 

Allowance for Doubtful Accounts

 

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our clients to make required payments. If the financial condition of our clients were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.   Management specifically analyzes account receivables and historical bad debt, customer concentrations, credit worthiness, past collection experience, current economic trends, and changes in our customer payment terms when evaluating the adequacy of doubtful accounts.

 

Goodwill and Intangible Assets

 

Effective December 29, 2001, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets.”  Under SFAS No 142, we will no longer amortize our goodwill and will be required to complete an annual impairment test.  We believe that the accounting assumptions and estimates related to the annual goodwill impairment testing are critical because these can change from period to period.  The impairment test requires us to forecast our future cash flows, which requires significant judgment.  Our operating results have been negatively impacted by the worldwide economic conditions.   Accordingly, if our expectations of future operating results change, or if there are changes to other assumptions, our estimate of the fair value of our reporting units could change significantly resulting in a goodwill impairment charge, which could have a significant impact on our consolidated financial statements.  As of March 28, 2003, we have $13.7 million of goodwill and $0.9 million of intangible assets recorded on our balance sheet.  See Note 8 of the Notes to Consolidated Financial Statements.

 

Recent Accounting Pronouncements

 

In June 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.”  SFAS No. 146 addresses accounting and reporting costs associated with exit or disposal activities and nullifies EITF Issue 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.”  SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity shall be recognized and measured initially at its fair value in the period that the liability is incurred.  SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002.  SFAS No. 146 did not have a material impact on our consolidated financial statements.

 

In November 2002, the EITF reached a consensus on Issue 00-21, titled “Accounting for Revenue Arrangements with Multiple Deliverables,” which addresses how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets.  Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (1) the delivered item has value to the customer on a standalone basis; (2) there is objective and reliable evidence of the fair value of undelivered items; and (3) delivery of any undelivered item is probable.  Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values, with the amount allocated to the delivered item being limited to the amount that is not contingent on the delivery of additional items or meeting other specified performance conditions.  The new standard is required to be adopted for all new applicable revenue arrangements no later than the third quarter of 2003.  Early adoption is permitted and we have elected to adopt the new standard as of the beginning of the first quarter of 2003.  In addition, we have elected to apply the new standard to all existing outsourcing arrangements impacted by EITF 00-21 and record to earnings the resulting cumulative effect as a change in accounting principle.  We believe that this voluntary adoption for existing contracts provides greater transparency into the performance of our multiple deliverable arrangements. We have recorded a non-cash charge, net of tax, of $2.6 million,

 

21

 

or $0.11 per share, in the first quarter of 2003.

 

In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees and Indebtedness of Others.” FIN 45 elaborates on the disclosures to be made by the guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued.  It also requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002; while the provisions of the disclosure requirements are effective for financial statements of interim or annual reports ending after December 15, 2002.  At March 28, 2003, we had no guarantees outstanding.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation -Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123, “Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.  The disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002.  At this time, we intend to continue to account for stock-based compensation to our associates using the methods prescribed by Accounting Principles Bulletin (APB) Opinion No. 25, and related interpretations.  We have made certain disclosures required by SFAS No. 148 in our Notes to Consolidated Financial Statements.

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”) which changes the criteria by which one company includes another entity in its consolidated financial statements. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003, and apply in the first fiscal period beginning after June 15, 2003, for variable interest entities created prior to February 1, 2003.  We have not entered into any transactions or other arrangements which we believe would be considered variable interest entities.

 

22

 

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.  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 are realized, our business, financial condition or results of operations 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 and possibly decline.

 

Our net revenues, 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 and 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;

•      Return of fees for work deemed unsatisfactory by a client or claims or litigation resulting from the same;

•                  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;

•                  Ability to sublease vacant office space included in previous restructuring charges; 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 unexpectedly 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 receivables (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 receivables in a timely manner, our business and financial condition could also suffer.  In addition, we began the roll-off of our resources from a large client engagement in our life sciences business unit during the first quarter of 2003, and we expect the engagement to be substantially completed at the end of the second quarter of 2003.  During the quarter ended March 28, 2003, this client engagement accounted for approximately 7% of our net revenues, and approximately 26% of our net revenues from the life sciences business unit. Even if we are able to secure new client engagements in our life sciences business unit, our revenues will be negatively impacted by the

 

23

 

completion of this large client engagement.  If these or any other variables or unknowns were to cause a shortfall in revenues or earnings or otherwise cause a failure to meet public market expectations, our business could be adversely affected.

 

Further, we adopted Emerging Issues Task Force Issue 00-21, “EITF 00-21” in the first quarter of 2003, which affects the way we recognize revenue on long-term outsourcing agreements. The adoption of EITF 00-21 results in separating our outsourcing contracts into multiple elements and separately accounting for each element, rather than accounting for all elements together as a group.  As a result, we now recognize revenue from certain service elements of our outsourcing agreements on a straight-line basis over the life of the contract, rather than on a percentage of completion basis.  Since we typically incur greater costs and expenses during the early phase of the service elements (which will now have straight-line revenue) than we do in the later years of those elements, we believe our net income will be less during the early stages of our outsourcing engagements.  In addition, if we are unable to manage costs as planned in the later stages of an outsourcing engagement, our net income will likewise be negatively impacted.  We adopted this accounting principle on a cumulative catch-up basis, which resulted in a non-cash charge to our net income in the first fiscal quarter of 2003 of approximately $2.6 million, net of tax, or $0.11 per share.  In general, income from our outsourcing contracts will be less stable in the future, since it will be more susceptible to changes in the mix of newer versus older contracts, and to the impact of cost fluctuations from quarter to quarter without a compensating change in revenue.  If we fail to meet our public market expectations or otherwise experience a shortfall in our net income due to these fluctuations, our business could be adversely affected and the price of our stock may decline.

 

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.

 

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 provide improved service at a lower cost and 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 $7.0 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 six active outsourcing relationships. Net revenues from such outsourcing relationships, as of the quarter ended March 28, 2003, represented approximately 34% of our consolidated net revenues.  The substantial majority of these revenues are received from four large outsourcing accounts that have signed long term agreements with us.  However, the loss of any of our outsourcing relationships would have a material impact on our business and results of operations.  In each 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

 

24

 

meet these performance levels or standards, our clients may receive monetary service level credits from us or, if we experience persistent failures, our clients may have a right to terminate the outsourcing contract for cause and have no obligation to pay us any termination fees.  In May 2003, we received a letter from our significant outsourcing client in Cleveland, Ohio alleging breach of the terms of our contract.  The letter alleges failure to meet certain service levels in consecutive months and delinquency of certain transition services deliverables.  The client has requested that we present a plan for remediation of the alleged failures and delinquencies, but we cannot be certain that such plan will cure our alleged breaches or that such client will not terminate their agreement with us.  Our anticipated revenues 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.

 

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.

 

Finally, we have publicly announced our intentions to expand our outsourcing business and perform our information technology outsourcing services for other potential clients.  We anticipate expanding our outsourcing business to perform discrete information technology services for clients.  The amount of time and resources required to win client engagements for our outsourcing business is significant, and we may not win the number or type of client engagements that we anticipate.  If we fail to meet our objective to secure new outsourcing engagements, or fail to secure new outsourcing engagements on acceptable commercial terms, we will not experience the growth in this business unit that we have anticipated.  We have also publicly announced our intention to enter into the business process outsourcing market (BPO) through acquisition.  If we are unable to successfully identify, acquire, and integrate an acquisition in the BPO space on commercially reasonable terms, we may not be able to successfully execute our strategy in this market.  Further, all acquisitions involve risks that could materially and adversely affect our business and operating results.  Consequently, we may fail to meet public market expectations and the price of our common stock may decline.

 

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 difficult to predict 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.

 

25

 

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 our 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 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.

 

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

 

We intend to grow, in part, by acquiring complementary businesses that could enhance our capability to serve the healthcare and pharmaceutical industries.  For example, in May 2002, we acquired a majority interest in Codigent Solutions Group, Inc. (now known as FCG Infrastructure Services, Inc.) and in February 2003, we acquired Paragon Solutions, Inc. and certain assets of Phyve Corporation. All acquisitions involve risks that could materially and adversely affect our business and operating results.  These risks include:

 

•                  Distracting management from our business;

•                  Losing key personnel and other employees;

•                  Losing clients;

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

•                  The impairment of acquired assets and goodwill; and

•                  Acquiring the contingent and other liabilities of the businesses we acquire

 

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.

 

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

 

Our success depends, to a significant extent, on obtaining additional engagements from our existing clients.  A substantial portion of our revenues is derived from additional 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 fail to generate additional revenues from our existing clients it may materially adversely affect our business and financial condition.

 

26

 

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

 

Our services often involve assessing and/or implementing 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 professional liability insurance, such insurance may not provide adequate coverage for successful claims against us.

 

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 key client service employees and executive officers could negatively affect us

 

Our performance depends on the continued service of our executive officers, senior managers, and key employees.  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:

 

•                  Dependence on lateral hiring of consultants;

•                  Travel demands imposed on our consultants;

•                  Loss of employees to competitors and clients; and

•                  Reductions in force in our business units as certain areas of our business have seen less demand.

 

27

 

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 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 revenues.

 

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

 

Our business has historically grown rapidly, and though our overall revenues have remained flat for the past several years, 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 restructured our business units and hired persons with appropriate skills, including salespersons, and reduced our workforce in practice areas experiencing less demand.  These market conditions and restructuring efforts have placed new and increased demands on our 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, or growth or restructuring, our operating results will suffer.  To manage any future growth, we must extend our financial reporting and information management systems to our multiple and international office locations and traveling employees, and 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 senior managers to engage in business development activities and their other day-to-day responsibilities.  Further, the addition of new employees and offices to offset any 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 revenues 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 industry.  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:

 

•                  Continued adverse changes to the industry’s general economic environment;

•                  Continued consolidation of companies; or

 

28

 

•                  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.

 

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 or services we may provide through subcontractors or employees that are located outside of the U.S.   Further, in February 2003, we acquired Paragon Solutions, Inc., a U.S. based company with offshore software development centers in India and Vietnam.  As a result of this acquisition, we currently have business operations and employees located in India and Vietnam, as well as our existing employees throughout Europe and Japan.  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 affected.  Our international operations are also 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;

•                  Recruiting and hiring employees, and other employment issues unique to international operations;

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

•                  Terrorist attacks;

•                  Difficulties in enforcing contractual obligations and intellectual property rights;

•                  Adverse tax consequences;

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

•                  Government regulations and restrictions;

•                  Adverse changes in regulatory requirements; and

•                  Economic or political instability.

 

We have been performing services in Europe for international clients for several years. We ceased performing healthcare consulting services for European clients in 2000, but continue to provide our services in Europe to pharmaceutical clients.  We cannot assure you that we will be able to maintain profitability in our European pharmaceutical services, which may materially adversely affect our financial condition, results of operations, and price for our common stock.

 

We established our first life sciences branch office in Japan in January 2003.  We cannot assure you that our newly established office in Japan will grow successfully, if at all.  If we cannot grow our practice, we may not be able to recoup or realize a return on our initial investments in that market and our financial condition and results of operations may be adversely affected.

 

29

 

Our acquisition of Paragon Solutions, Inc. provided us a means to implement our global sourcing strategy to provide software development and other information technology services to our clients.  If we are unable to realize perceived cost benefits of such a strategy or if we are unable to receive high quality services from foreign employees or subcontractors, our business may be adversely impacted. Further, our recently acquired international operations in Vietnam and India subject our business to a variety of risks and uncertainties unique to operating businesses in these countries, including the risk factors discussed above.

 

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

 

If we do not compete effectively in the healthcare and pharmaceutical information services industries, our business will 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, regional, and specialty consulting firms such as Bearing Point (formerly KPMG Consulting), Cap Gemini Ernst & Young, IBM Global Consulting Services, Wipro Technologies, and Accenture.

 

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

 

•                  Information system vendors such as McKesson, 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.  We also compete with companies that provide software development, information technology consulting, and other integration and maintenance services, such as Wipro Technologies, Cognizant Technology Solutions Corporation, and Tata Technologies Limited.

 

Several of our competitors employ a global sourcing strategy to provide software development and other information technology services to their clients, while at the same time reducing their cost structure and improving the quality of services they provide.  If we are unable to realize the perceived cost benefits of our recently implemented global sourcing strategy or if we are unable to receive high quality services from foreign employees or subcontractors, our business may be adversely impacted and we may not be able to compete effectively.

 

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

 

30

 

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.  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 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.  In addition, the financial health and viability of major U.S. carriers has recently become very questionable.  If efficient and cost effective air travel becomes unavailable to our consultants and other employees, or if domestic or international air travel is significantly reduced or halted, 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

 

31

 

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.  Finally, government regulations, particularly HIPAA, may require our clients to impose additional contractual responsibilities on us, which may make it more costly to perform certain of our engagements and subject us to increased risk in the performance of these engagements, including immediate termination of an engagement.

 

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 and have business operations in Europe, Japan, India and Vietnam.  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 35% of our outstanding shares of common stock and approximately 47% on a fully diluted basis.  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:

 

32

 

•                  Our performance and prospects;

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

•                  An increase in the number of outstanding shares of our common stock due to issuances in connection with our recent acquisitions;

•                  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

•                  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.  Further, if research analysts stop covering our company or reduce their expectations of us, our stock price could decline or the liquidity of our common stock may be adversely impacted, which could create difficulty for investors to resell their shares of our common stock.

 

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 9,500,000 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.

 

33

 

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 up to 500,000 shares of our Series A Junior Participating 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.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risks

 

Our financial instruments include cash and cash equivalents (i.e., short-term and long-term cash 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 $59.2 million at March 28, 2003 present us with market risk exposure resulting primarily from changes in interest rates.  Based on this balance, a change of one percent in the interest rate would cause a change in interest income for the annual period of approximately $0.6 million.  Our objective in maintaining these investments is the flexibility obtained in having cash available for payment of accrued liabilities and acquisitions.

 

Our borrowings are primarily dependent upon the prevailing prime rate.  As of March 28, 2003, we had no borrowings under our revolving line of credit and an available borrowing capacity of $7.0 million.  See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations- Liquidity and Capital Resources.”  The estimated fair value of borrowings under the revolving line is expected to approximate its carrying value.

 

Item 4.  Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures (as defined in Securities Exchange Act 1934 (the “Exchange Act”) Rules 13a-14(c) and 15d-14(c)) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

Within 90 days prior to the date of this quarterly report, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.

 

34

 

Changes in Internal Controls

 

There have not been any significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. There were no significant deficiencies or material weaknesses, and therefore no corrective actions were taken.

 

35

 

Part II.  Other Information

 

Item 1.  Legal Proceedings.

 

On February 19, 2003, we filed a complaint against Siteworks, LLC for breach of contract.  The claim was filed in the United States District Court, Eastern District of Pennsylvania.  We sought to recover fees and expenses totaling approximately $2.8 million for software development services provided to Siteworks during 2000 through 2002.  Prior to our filing of the lawsuit, Siteworks had delivered correspondence to us, in January and February 2003, alleging various failures by us and concealment of such failures in the performance of the contract.  In its correspondence, Siteworks alleged that it believed it could recover compensatory, consequential, and punitive damages from us.  Effective April 11, 2003, we settled our lawsuit against Siteworks.  We entered into mutual release of claims with Siteworks and do not expect the settlement to have a material effect on our financial condition or results of operations.

 

Item 2.  Changes in Securities.

 

(c) Sales of Unregistered Securities. On February 12, 2003, we acquired Paragon Solutions, Inc. in a merger transaction for an aggregate purchase price of approximately $4.2 million.  We issued 600,500 unregistered shares of our common stock and approximately $0.2 million in cash in the merger to the Paragon stockholders.  The shares of common stock we issued 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.  We also agreed to reserve an additional 49,216 shares of our common stock for issuance upon the exercise of options that were initially issued under Paragon’s stock incentive plans and assumed by us in the acquisition, and we have filed a registration statement on Form S-8 to register for resale shares issued upon exercise of these stock options.  After the effect of the exchange ratio, the stock options that were assumed in connection with the acquisition remain subject to the terms and conditions of the original option grant.

 

Item 3.  Defaults Upon Senior Securities.

 

None.

 

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

 

None.

 

Item 5.  Other Information.

 

None.

 

Item 6.  Exhibits 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

 

36

 

4.1(4)		Specimen Common Stock Certificate
11.1(5)		Statement of computation of per share earnings
99.1		Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(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, 1999.

 

(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)          See Note 4 to Consolidated Financial Statements, “Net Income (Loss) Per Share.”

 

 

(b)         Reports on Form 8-K

 

(1)          Form 8-K filed on January 13, 2003 reporting Michael J. Puntoriero’s appointment as our  Executive Vice President and Chief Financial Officer (Items 5 and 7).

 

(2)          Form 8-K filed on January 30, 2003 announcing the execution of our merger agreement to acquire Paragon Solutions, Inc. (Item 5).

 

(3)          Form 8-K filed on February 13, 2003 reporting the completion of our acquisition of Paragon Solutions, Inc. and providing the press release announcing our fourth quarter and fiscal year 2002 financial results (Items 5 and 7).

 

(4)          Form 8-K filed on February 27, 2003 reporting the appointment of Michael P. Downey to our Board of Directors and Audit Committee, the appointment of Guy L. Scalzi as our Senior Vice President and General Manager of our Outsourcing business unit, and the adoption of a Rule 10b5-1 sales plan by Fatima J. Reep, one of our Directors (Items 5 and 7).

 

37

 

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:  May 12, 2003	/s/ LUTHER J. NUSSBAUM
	Luther J. Nussbaum
	Chairman and Chief Executive Officer
Date:  May 12, 2003	/s/ MICHAEL J. PUNTORIERO
	Michael J. Puntoriero
	Executive Vice President and Chief
	Financial Officer
	(Principal Financial Officer)

 

38

 

CERTIFICATIONS

 

I, Michael J. Puntoriero, certify that:

 

1.  I have reviewed this quarterly report on Form 10-Q of First Consulting Group, Inc.;

 

2.  Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.  Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.  The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.  The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

 

a)  all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6.  The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Date: May 12, 2003
/s/ Michael J. Puntoriero
Michael J. Puntoriero
Executive Vice President and Chief Financial Officer

 

39

 

I, Luther J. Nussbaum, certify that:

 

1.  I have reviewed this quarterly report on Form 10-Q of First Consulting Group, Inc.;

 

2.  Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.  Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.  The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.  The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

 

a)  all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6.  The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Date: May 12, 2003
/s/ Luther J. Nussbaum
Luther J. Nussbaum
Chairman and Chief Executive Officer

 

40

 

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
11.1(5)		Statement of computation of per share earnings
99.1		Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(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, 1999.

 

(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)          See Note 4 to Consolidated Financial Statements, “Net Income (Loss) Per Share.”

 

41