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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

 


 

FORM 10-Q

 

(Mark One)

 

ý

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

 

For the quarterly period ended September 24, 2004

 

OR

 

o

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

 

 

For the transition period from            to            

 

Commission File Number 0-23651

 


 

First Consulting Group, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

95-3539020

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

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

(Address of principal executive offices including zip code)

 

(562) 624-5200

(Registrant’s telephone number, including area code)

 

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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

 

24,777,072

(Class)

 

(Outstanding at October 22, 2004)

 

 



 

First Consulting Group, Inc.

Table of Contents

 

COVER PAGE

 

 

 

TABLE OF CONTENTS

 

 

 

PART I.FINANCIAL INFORMATION

 

 

 

ITEM 1. FINANCIAL STATEMENTS AND NOTES (UNAUDITED)

 

 

 

Consolidated Balance Sheets

 

 

 

Consolidated Statements of Operations

 

 

 

Consolidated Statements of Cash Flows

 

 

 

Notes to Consolidated Financial Statements

 

 

 

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

 

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

 

 

 

ITEM 4. CONTROLS AND PROCEDURES

 

 

 

PART II. OTHER INFORMATION

 

 

 

ITEM 1. LEGAL PROCEEDINGS

 

 

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

 

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

 

 

ITEM 5. OTHER INFORMATION

 

 

 

ITEM 6. EXHIBITS

 

 

 

SIGNATURES

 

 

 

EXHIBIT INDEX

 

 

2



 

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)

 

 

 

September 24,
2004

 

December 26,
2003

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

21,884

 

$

26,826

 

Short-term investments

 

25,222

 

33,803

 

Accounts receivable, less allowance of $1,392 and $1,974 as of September 24, 2004 and December 26, 2003, respectively

 

23,606

 

27,564

 

Unbilled receivables

 

12,887

 

9,947

 

Deferred income taxes

 

6,279

 

6,279

 

Prepaid expenses and other current assets

 

2,144

 

1,713

 

Total current assets

 

92,022

 

106,132

 

 

 

 

 

 

 

Notes receivable – stockholders

 

438

 

432

 

Long-term investments

 

1,150

 

3,216

 

Property and equipment:

 

 

 

 

 

Furniture, equipment, and leasehold improvements

 

4,519

 

4,053

 

Information systems equipment

 

26,580

 

23,663

 

 

 

31,099

 

27,716

 

Less accumulated depreciation and amortization

 

20,369

 

19,177

 

 

 

10,730

 

8,539

 

 

 

 

 

 

 

Other assets:

 

 

 

 

 

Executive benefit trust

 

8,611

 

8,144

 

Long-term account receivable

 

4,279

 

5,768

 

Deferred income taxes

 

2,076

 

4,329

 

Goodwill, net

 

17,800

 

15,458

 

Intangibles, net

 

2,819

 

3,800

 

Other

 

2,948

 

1,583

 

 

 

38,533

 

39,082

 

Total assets

 

$

142,873

 

$

157,401

 

 

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

 

3



 

 

 

September 24,
2004

 

December 26,
2003

 

 

 

(unaudited)

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

3,116

 

$

1,806

 

Accrued liabilities

 

12,088

 

11,544

 

Accrued payroll and related taxes

 

5,501

 

5,778

 

Accrued restructuring

 

1,861

 

4,613

 

Accrued vacation

 

7,025

 

7,033

 

Accrued incentive compensation

 

2,100

 

1,958

 

Customer advances

 

7,129

 

9,775

 

Total current liabilities

 

38,820

 

42,507

 

Non-current liabilities:

 

 

 

 

 

Accrued restructuring

 

3,626

 

4,686

 

Supplemental executive retirement plan

 

8,167

 

7,741

 

Minority interest

 

 

657

 

Total non-current liabilities

 

11,793

 

13,084

 

Commitments and contingencies

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred Stock, $.001 par value; 9,500,000 shares authorized, no shares issued and outstanding

 

 

 

Series A Junior Participating Preferred Stock, $.001 par value; 500,000 shares authorized, no shares issued and outstanding

 

 

 

Common Stock, $.001 par value; 50,000,000 shares authorized, 24,777,072 shares issued and outstanding at September 24, 2004 and 25,902,574 shares issued and outstanding at December 26, 2003

 

25

 

26

 

Additional paid-in capital

 

90,289

 

101,706

 

Retained earnings

 

2,562

 

900

 

Deferred compensation-stock incentive agreements

 

(187

)

(323

)

Notes receivable-stockholders

 

(373

)

(488

)

Accumulated other comprehensive loss

 

(56

)

(11

)

Total stockholders’ equity

 

92,260

 

101,810

 

Total liabilities and stockholders’ equity

 

$

142,873

 

$

157,401

 

 

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

 

4



 

First Consulting Group, Inc. and Subsidiaries

 

Consolidated Statements of Operations

(in thousands, except per share data)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

(unaudited)

 

(unaudited)

 

 

 

September 24,
2004

 

September 26,
2003

 

September 24,
2004

 

September 26,
2003

 

Revenues before reimbursements

 

$

66,008

 

$

65,849

 

$

200,028

 

$

207,289

 

Reimbursements

 

4,430

 

4,060

 

12,866

 

11,725

 

Total revenues

 

70,438

 

69,909

 

212,894

 

219,014

 

 

 

 

 

 

 

 

 

 

 

Cost of services before reimbursable expenses

 

44,227

 

46,324

 

134,621

 

141,916

 

Reimbursable expenses

 

4,430

 

4,060

 

12,866

 

11,725

 

Total cost of services

 

48,657

 

50,384

 

147,487

 

153,641

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

21,781

 

19,525

 

65,407

 

65,373

 

 

 

 

 

 

 

 

 

 

 

Selling expenses

 

6,616

 

7,582

 

21,144

 

24,234

 

General and administrative expenses

 

13,068

 

14,831

 

38,819

 

45,020

 

Restructuring, severance, and impairment costs

 

 

4,179

 

 

8,093

 

Income (loss) from operations

 

2,097

 

(7,067

)

5,444

 

(11,974

)

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income, net

 

185

 

232

 

529

 

760

 

Other income (expense), net

 

18

 

(160

)

(113

)

(164

)

Expense for premium on repurchase of stock

 

 

 

(1,561

)

 

Income (loss) before income taxes and cumulative effect of change in accounting principle, net of tax

 

2,300

 

(6,995

)

4,299

 

(11,378

)

Income tax provision (benefit)

 

1,035

 

(2,448

)

2,637

 

(3,982

)

Income (loss) before cumulative effect of change in accounting principle, net of tax

 

1,265

 

(4,547

)

1,662

 

(7,396

)

Cumulative effect of change in accounting principle,

 

 

 

 

 

 

 

 

 

net of tax

 

 

 

 

(2,597

)

Net income (loss)

 

$

1,265

 

$

(4,547

)

$

1,662

 

$

(9,993

)

 

 

 

 

 

 

 

 

 

 

Basic & diluted net income (loss) per share:

 

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

 

 

 

 

Income (loss) before cumulative effect of change in accounting principle, net of tax

 

$

0.05

 

$

(0.18

)

$

0.07

 

$

(0.30

)

Cumulative effect of change in accounting principle, net of tax

 

 

 

 

(0.10

)

Net income (loss) per share

 

$

0.05

 

$

(0.18

)

$

0.07

 

$

(0.40

)

Diluted:

 

 

 

 

 

 

 

 

 

Income (loss) before cumulative effect of change in accounting principle, net of tax

 

$

0.05

 

$

(0.18

)

$

0.07

 

$

(0.30

)

Cumulative effect of change in accounting principle, net of tax

 

 

 

 

(0.10

)

Net income (loss) per share

 

$

0.05

 

$

(0.18

)

$

0.07

 

$

(0.40

)

Weighted average shares used in computing:

 

 

 

 

 

 

 

 

 

Basic net income (loss) per share

 

24,339

 

24,944

 

24,612

 

24,752

 

Diluted net income (loss) per share

 

24,405

 

24,944

 

24,789

 

24,752

 

 

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

 

5



 

First Consulting Group, Inc. and Subsidiaries

 

Consolidated Statements of Cash Flows

(in thousands)

 

 

 

Nine Months Ended

 

 

 

(unaudited)

 

 

 

September 24,
2004

 

September 26,
2003

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss):

 

$

1,662

 

$

(9,993

)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Cumulative effect of change in accounting principle, net of tax

 

 

2,597

 

Depreciation and amortization

 

3,585

 

3,646

 

Intangibles amortization

 

1,281

 

657

 

Premium on capital stock repurchase

 

1,561

 

 

Writedown of investment

 

50

 

 

Provision (credit) for bad debts, net of adjustments

 

104

 

(20

)

(Gain) loss on sale of assets

 

72

 

(15

)

Minority interest in net (income) loss of subsidiaries

 

(14

)

88

 

Compensation from stock issuances

 

105

 

128

 

Interest income on notes receivable – stockholders

 

(60

)

(85

)

Changes in assets and liabilities, excluding effect of acquisitions:

 

 

 

 

 

Accounts receivable

 

3,854

 

14,714

 

Unbilled receivables

 

(2,940

)

(6,494

)

Prepaid expenses and other

 

(759

)

239

 

Long-term account receivable

 

1,489

 

1,230

 

Other assets

 

(1,365

)

(331

)

Accounts payable

 

1,310

 

1,146

 

Accrued liabilities

 

544

 

1,747

 

Accrued payroll and related taxes

 

(277

)

1,693

 

Accrued restructuring

 

(3,812

)

717

 

Accrued vacation

 

(8

)

268

 

Accrued incentive compensation

 

142

 

(247

)

Customer advances

 

(2,646

)

(1,223

)

Deferred income taxes

 

2,253

 

(5,836

)

Supplemental executive retirement plan

 

(41

)

(414

)

Other

 

(44

)

335

 

Net cash provided by operating activities:

 

6,046

 

4,547

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from sale/maturity of investments

 

10,597

 

4,035

 

Purchase of property and equipment

 

(5,851

)

(4,160

)

Acquisition of businesses, net of cash acquired

 

(2,383

)

(11,155

)

Net cash provided by (used in) investing activities

 

2,363

 

(11,280

)

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of capital stock, net

 

1,344

 

1,375

 

Proceeds from notes receivable and tax loan payments

 

78

 

533

 

Capital stock repurchase

 

(14,773

)

 

Net cash (used in) provided by financing activities

 

(13,351

)

1,908

 

Net change in cash and cash equivalents

 

(4,942

)

(4,825

)

Cash and cash equivalents at beginning of period

 

26,826

 

27,550

 

Cash and cash equivalents at end of period

 

$

21,884

 

$

22,725

 

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

14

 

$

27

 

Income taxes

 

$

778

 

$

311

 

 

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

 

6



 

Notes to Consolidated Financial Statements

 

Note 1                    Accounting Policies

 

Basis of Presentation

 

The consolidated balance sheets of First Consulting Group, Inc. (the “Company” or “FCG”) at September 24, 2004 and consolidated statements of operations and condensed consolidated statements of cash flows for the periods ended September 24, 2004 and September 26, 2003 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 September 24, 2004 and the results of operations for the three-month and nine-month periods ended September 24, 2004 and September 26, 2003.  The results of operations and cash flows for the nine-month period ended September 24, 2004 are not necessarily indicative of the results to be expected for the year ending December 31, 2004.  For more complete financial information, these financial statements should be read in conjunction with the audited financial statements for the year ended December 26, 2003 included in the Company’s Annual Report on Form 10-K.  Certain reclassifications have been made to the 2003 financial statements to conform to the 2004 presentation.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and its subsidiaries.  All material intercompany accounts and transactions have been eliminated.

 

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):

 

7



 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 24,
2004

 

September 26,
2003

 

September
24, 2004

 

September 26,
2003

 

 

 

 

 

 

 

 

 

 

 

Net income (loss), as reported

 

$

1,265

 

$

(4,547

)

$

1,662

 

$

(9,993

)

Deduct:Total stock based employee compensation expense determined under fair value method for all awards, net of tax

 

(425

)

(274

)

(1,261

)

(1,676

)

Pro forma net income (loss)

 

 

$

 840

 

$

 (4,821

)

$

 401

 

$

 (11,669

)

 

 

 

 

 

 

 

 

 

 

 

Basic income (loss) per share

As reported

 

$

0.05

 

$

(0.18

)

$

0.07

 

$

(0.40

)

 

Pro forma

 

$

0.03

 

$

(0.19

)

$

0.02

 

$

(0.47

)

 

 

 

 

 

 

 

 

 

 

 

Diluted income (loss) per share

As reported

 

$

0.05

 

$

(0.18

)

$

0.07

 

$

(0.40

)

 

Pro forma

 

$

0.03

 

$

(0.19

)

$

0.02

 

$

(0.47

)

 

Basic and Diluted Net Income (Loss) Per Share

 

Basic net income (loss) per share is based upon the weighted average number of common shares outstanding.  Diluted net income per share is based on the assumption that stock options were exercised.  Dilution is computed by applying the treasury stock method. Under this method, options are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained by the Company from such exercise were used by the Company to purchase common stock at the average market price during the period. Stock options are not considered when computing diluted net loss per share as they are considered anti-dilutive.

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 24,
2004

 

September 26,
2003

 

September 24,
2004

 

September 26,
2003

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before cumulative effect, net of tax

 

$

1,265

 

$

(4,547

)

$

1,662

 

$

(7,396

)

Cumulative effect of change in accounting principle, net of tax

 

 

 

 

(2,597

)

Net income (loss)

 

$

1,265

 

$

(4,547

)

$

1,662

 

$

(9,993

)

 

 

 

 

 

 

 

 

 

 

Basic weighted average number of shares outstanding

 

24,339

 

24,944

 

24,612

 

24,752

 

Effect of dilutive options and contingent shares

 

66

 

 

177

 

 

Diluted weighted average number of shares outstanding

 

24,405

 

24,944

 

24,789

 

24,752

 

 

 

 

 

 

 

 

 

 

 

Basic per share:

 

 

 

 

 

 

 

 

 

Income (loss) before cumulative effect, net of tax

 

$

0.05

 

$

(0.18

)

$

0.07

 

$

(0.30

)

Cumulative effect of change in accounting principle, net of tax

 

 

 

 

(0.10

)

Net income (loss) per share

 

$

0.05

 

$

(0.18

)

$

0.07

 

$

(0.40

)

 

 

 

 

 

 

 

 

 

 

Diluted per share:

 

 

 

 

 

 

 

 

 

Income (loss) before cumulative effect, net of tax

 

$

0.05

 

$

(0.18

)

$

0.07

 

$

(0.30

)

Cumulative effect of change in accounting principle, net of tax

 

 

 

 

(0.10

)

Net income (loss) per share

 

$

0.05

 

$

(0.18

)

$

0.07

 

$

(0.40

)

 

8



 

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

 

Use of Estimates

 

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

 

The Company uses significant estimates in the calculation of its income tax provision by estimating whether it will have sufficient future taxable income to realize its deferred tax assets.  There can be no assurances that the Company’s taxable income will be sufficient to realize such deferred tax assets and the Company will continue to evaluate its valuation allowance on an ongoing basis.

 

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

 

Cash and Cash Equivalents

 

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

 

Note 2                    Investments

 

At September 24, 2004, the Company had approximately $25.2 million in short-term investments.  Such investments were held primarily in commercial paper, money market investments, and tax-exempt government securities.  Net unrealized gains and losses on investments were immaterial at September 24, 2004.  Additionally, the Company had $1.2 million of non-marketable equity investments, valued at the lower of cost or estimated fair value, which were included in long-term investments.

 

Note 3                    Long-Term Account Receivable

 

At September 24, 2004, the Company carried a long-term account receivable of approximately $4.3 million from a single client.  The receivable related to a major outsourcing contract and will be collected over a two year period.

 

9



 

Note 4                    Business Acquisitions

 

FCG Infrastructure Services (FCGIS)

 

On January 30, 2004, the Company purchased the remaining 47.65% minority interest in FCGIS (formerly Codigent Solutions Group, Inc.) from five remaining individual stockholders for approximately $2.4 million in cash.  Additionally, the Company deposited 591,328 shares of FCG common stock into an escrow account, with one-fourth of such shares to be released to those same stockholders in four separate increments upon successful fulfillment by FCGIS of certain revenue and profitability targets for the six-month periods ended June 25, 2004, December 31, 2004, July 1, 2005, and December 30, 2005.  If such targets are not fulfilled for any of the six-month periods, the shares in escrow for that period revert to FCG.  For the six-month period ended June 25, 2004, FCGIS met the revenue and profitability targets, and the first 147,832 contingent shares were released to the former FCGIS stockholders in July 2004.

 

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

 

Goodwill

 

$

2,339

 

Intangible assets

 

300

 

Net assets acquired

 

2,639

 

Minority interest on balance sheet

 

643

 

Contingent shares released

 

(899

)

Cash consideration

 

$

2,383

 

 

Note 5                    Goodwill and Intangible Assets

 

Effective December 29, 2001, the Company adopted SFAS 141 and SFAS 142.  SFAS 142 requires that goodwill and certain intangibles no longer be amortized, but instead are to be reviewed at least annually for impairment.  Prior to the adoption of SFAS 141, goodwill was amortized over the estimated useful life.

 

Goodwill is evaluated for impairment annually in the fourth quarter of the year, or sooner if an event occurs or circumstances change that may reduce the fair value of a reporting unit, to which specific goodwill applies, 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. Fair value is primarily determined by using a market approach valuation model based on multiples of revenue. If the carrying value exceeds the fair value, the fair value of the reporting unit is then allocated to its assets and liabilities in a manner similar to a purchase price allocation in order to determine the implied fair value of the reporting unit goodwill. This implied fair value is then compared with the carrying amount of the reporting unit goodwill, and if it is less, the Company would then recognize an impairment loss.  In addition, the Company evaluates intangible assets with definite lives to determine whether adjustment to these amounts or estimated useful lives is required based on current events and circumstances.

 

10



 

The changes in the net carrying amounts of goodwill for the nine months ended September 24, 2004 are as follows (in thousands):

 

 

 

Life Sciences

 

Health
Delivery
Outsourcing

 

Meditech
Service
Center

 

Other
Businesses

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of December 26, 2003

 

$

1,477

 

$

2,278

 

$

2,001

 

$

9,702

 

$

15,458

 

Acquired

 

 

 

1,440

 

 

1,440

 

Currency translation adjustment

 

4

 

 

 

 

4

 

Balance as of March 26, 2004

 

1,481

 

2,278

 

3,441

 

9,702

 

16,902

 

Acquired

 

 

 

 

 

 

Contingent shares released

 

 

 

899

 

 

899

 

Currency translation adjustment

 

 

 

 

 

 

Balance as of June 25, 2004

 

1,481

 

2,278

 

4,340

 

9,702

 

17,801

 

Acquired

 

 

 

 

 

 

Contingent shares released

 

 

 

 

 

 

Currency translation adjustment

 

(1

)

 

 

 

(1

)

Balance as of September 24, 2004

 

$

1,480

 

$

2,278

 

$

4,340

 

$

9,702

 

$

17,800

 

 

As of September 24, 2004, the Company had the following acquired intangible assets recorded (in thousands):

 

Intangible Assets

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Amortization
Period in
Years

 

 

 

 

 

 

 

 

 

 

 

Software and software development

 

$

1,177

 

$

(822

)

$

355

 

2 - 3

 

Customer related

 

3,694

 

(1,283

)

2,411

 

2 - 4

 

Non-compete agreements

 

400

 

(347

)

53

 

2 - 3

 

Total

 

$

5,271

 

$

(2,452

)

$

2,819

 

 

 

 

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

 

Fiscal Year

 

 

 

 

 

 

 

2004 (remainder of year)

 

$

441

 

2005

 

1,150

 

2006

 

773

 

2007

 

455

 

Total

 

$

2,819

 

 

11



 

Note 6                    Restructuring, Severance, and Impairment Costs

 

In fiscal year 2002, the Company incurred a restructuring charge of $7.8 million consisting of $4.0 million in severance for the reduction of staff and $3.8 million in facility costs due to facility downsizing.  This restructuring was accounted for in accordance with EITF 94-3 and SAB 100.

 

Restructuring, severance, and impairment costs of $11.7 million were incurred in fiscal year 2003.  These costs included severance costs of $6.5 million for reduction in staff and $5.2 million for facility downsizing, both primarily related to the significant decline in the Company’s Life Sciences business unit based on the reduction in custom software development services purchased by pharmaceutical clients.  Restructuring charges in 2003 have been accounted for in accordance with SFAS 146.

 

At September 24, 2004, there was a remaining restructuring liability of $5.5 million, which entirely related to vacated leases and related costs from these restructurings.

 

The restructuring liability as of September 24, 2004 is summarized as follows (in thousands):

 

 

 

Employee
Related Costs

 

Facilities/Other
Related Costs

 

Total

 

 

 

 

 

 

 

 

 

Accrued balance at December 26, 2003

 

$

1,665

 

$

7,634

 

$

9,299

 

Cash payments

 

(1,665

)

(2,147

)

(3,812

)

Accrued balance at September 24, 2004

 

$

 

$

5,487

 

$

5,487

 

 

Note 7                    Comprehensive Income (Loss)

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 24,
2004

 

September 26,
2003

 

September 24,
2004

 

September 26,
2003

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

1,265

 

$

(4,547

)

$

1,662

 

$

(9,993

)

Foreign currency translation adjustment, net of tax

 

(162

)

(82

)

(53

)

23

 

Unrealized gain (loss) on investments

 

7

 

6

 

8

 

42

 

Comprehensive income (loss)

 

$

1,110

 

$

(4,623

)

$

1,617

 

$

(9,928

)

 

Note 8                    Cumulative Effect of 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

 

12



 

of additional items or meeting other specified performance conditions.  The new standard was required to be adopted for all new applicable revenue arrangements no later than the third quarter of 2003.  Early adoption was permitted and the Company elected to adopt the new standard as of the beginning of the first quarter of 2003.  In addition, the Company elected to apply the new standard to all then 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.

 

Note 9                    Disclosure of Segment Information

 

Commencing with the first quarter of 2004 and due to a reorganization of the Company that took effect at the beginning of 2004, the Company changed its previous segment reporting in accordance with SFAS 131.  The Company now has five reportable operating segments:  health delivery (the delivery of consulting and systems integration services to health delivery and government clients), health plan (the delivery of consulting and systems integration services to health plan clients), life sciences (the delivery of consulting and systems integration services to pharmaceutical and other life sciences clients), health delivery outsourcing (the delivery of outsourcing services to health delivery clients), and Meditech Service Center (the delivery of solutions involving the use of Meditech software to health delivery clients).  Additionally, the Company has several smaller businesses (Paragon Solutions, Inc., staffing services, call center services, and FirstGateways™), which are not included in any of the above segments and are reported as “other business.”

 

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 revenues attributed to each segment is accounted for by splitting the revenues on each client engagement based upon the amounts charged to the client for the services of each segment.  Costs are not transferred across segments.

 

Additionally, the Company created three shared service centers that provide services to multiple business segments.  These shared service centers include FCG India, Integration Services, and Infrastructure Services.   The costs of these services are internally billed and reported in the individual business segments as cost of services at a standard transfer cost.

 

In accordance with these changes, the Company reclassified some staff among cost of services, selling expenses and general and administrative expenses.  The history shown in the tables below and in the Company’s consolidated statement of operations is consistent with all of these changes.

 

The Company evaluates its segments’ performance based on revenues and operating income.  Certain selling and general and administrative expenses (including corporate functions, occupancy related costs, depreciation, professional development, recruiting, and marketing), are managed at the corporate level and allocated to each operating segment based on either net revenues and/or actual usage.

 

13



 

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

 

For the three months ended September 24, 2004:

 

 

 

Health
Delivery

 

Life
Sciences

 

Health
Delivery
Outsourcing

 

Meditech
Service
Center

 

Health
Plan

 

Other
Business

 

Other

 

Totals

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues before reimbursements

 

$

16,267

 

$

8,812

 

$

24,386

 

$

6,368

 

$

3,770

 

$

6,411

 

$

(6

)

$

66,008

 

Reimbursements

 

2,227

 

267

 

169

 

414

 

578

 

187

 

588

 

4,430

 

Total revenues

 

18,494

 

9,079

 

24,555

 

6,782

 

4,348

 

6,598

 

582

 

70,438

 

Cost of services before reimbursable expenses

 

8,911

 

5,077

 

20,329

 

4,310

 

2,608

 

4,489

 

(1,497

)

44,227

 

Reimbursable expenses

 

2,227

 

267

 

169

 

414

 

578

 

187

 

588

 

4,430

 

Total cost of services

 

11,138

 

5,344

 

20,498

 

4,724

 

3,186

 

4,676

 

(909

)

48,657

 

Gross profit

 

7,356

 

3,735

 

4,057

 

2,058

 

1,162

 

1,922

 

1,491

 

21,781

 

Selling expenses

 

2,398

 

2,015

 

469

 

165

 

673

 

788

 

108

 

6,616

 

General & administrative expenses

 

2,818

 

3,084

 

2,399

 

814

 

727

 

1,579

 

1,647

 

13,068

 

Income (loss) from operations

 

$

2,140

 

$

(1,364

)

$

1,189

 

$

1,079

 

$

(238

)

$

(445

)

$

(264

)

$

2,097

 

 

For the three months ended September 26, 2003:

 

 

 

Health
Delivery

 

Life
Sciences

 

Health
Delivery
Outsourcing

 

Meditech
Service
Center

 

Health
Plan

 

Other
Business

 

Other

 

Totals

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues before reimbursements

 

$

16,157

 

$

8,760

 

$

23,206

 

$

4,722

 

$

6,208

 

$

6,730

 

$

66

 

$

65,849

 

Reimbursements

 

2,385

 

259

 

63

 

381

 

810

 

146

 

16

 

4,060

 

Total revenues

 

18,542

 

9,019

 

23,269

 

5,103

 

7,018

 

6,876

 

82

 

69,909

 

Cost of services before reimbursable expenses

 

9,340

 

6,375

 

19,935

 

3,114

 

3,498

 

4,537

 

(475

)

46,324

 

Reimbursable expenses

 

2,385

 

259

 

63

 

381

 

810

 

146

 

16

 

4,060

 

Total cost of services

 

11,725

 

6,634

 

19,998

 

3,495

 

4,308

 

4,683

 

(459

)

50,384

 

Gross profit

 

6,817

 

2,385

 

3,271

 

1,608

 

2,710

 

2,193

 

541

 

19,525

 

Selling expenses

 

2,513

 

2,322

 

419

 

452

 

1,166

 

678

 

32

 

7,582

 

General & administrative expenses

 

2,975

 

3,925

 

2,492

 

1,265

 

894

 

1,959

 

1,321

 

14,831

 

Restructuring, severance, and impairment costs

 

280

 

2,302

 

415

 

6

 

204

 

132

 

840

 

4,179

 

Income (loss) from operations

 

$

1,049

 

$

(6,164

)

$

(55

)

$

(115

)

$

446

 

$

(576

)

$

(1,652

)

$

(7,067

)

 

14



 

 

For the nine months ended September 24, 2004:

 

 

 

Health
Delivery

 

Life
Sciences

 

Health
Delivery
Outsourcing

 

Meditech
Service
Center

 

Health
Plan

 

Other
Business

 

Other

 

Totals

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues before reimbursements

 

$

48,300

 

$

26,909

 

$

74,935

 

$

18,012

 

$

11,660

 

$

20,200

 

$

12

 

$

200,028

 

Reimbursements

 

6,431

 

753

 

411

 

1,241

 

1,850

 

562

 

1,618

 

12,866

 

Total revenues

 

54,731

 

27,662

 

75,346

 

19,253

 

13,510

 

20,762

 

1,630

 

212,894

 

Cost of services before reimbursable expenses

 

25,995

 

15,467

 

62,127

 

12,180

 

7,705

 

14,064

 

(2,917

)

134,621

 

Reimbursable expenses

 

6,431

 

753

 

411

 

1,241

 

1,850

 

562

 

1,618

 

12,866

 

Total cost of services

 

32,426

 

16,220

 

62,538

 

13,421

 

9,555

 

14,626

 

(1,299

)

147,487

 

Gross profit

 

22,305

 

11,442

 

12,808

 

5,832

 

3,955

 

6,136

 

2,929

 

65,407

 

Selling expenses

 

7,288

 

7,030

 

1,645

 

627

 

2,406

 

2,000

 

148

 

21,144

 

General & administrative expenses

 

7,907

 

9,008

 

7,158

 

2,415

 

2,015

 

4,738

 

5,578

 

38,819

 

Income (loss) from operations

 

$

7,110

 

$

(4,596

)

$

4,005

 

$

2,790

 

$

(466

)

$

(602

)

$

(2,797

)

$

5,444

 

 

For the nine months ended September 26, 2003:

 

 

Health
Delivery

 

Life
Sciences

 

Health
Delivery
Outsourcing

 

Meditech
Service
Center

 

Health
Plan

 

Other
Business

 

Other

 

Totals

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues before reimbursements

 

$

49,361

 

$

35,575

 

$

70,254

 

$

13,720

 

$

19,652

 

$

18,476

 

$

251

 

$

207,289

 

Reimbursements

 

6,730

 

952

 

209

 

1,071

 

2,252

 

466

 

45

 

11,725

 

Total revenues

 

56,091

 

36,527

 

70,463

 

14,791

 

21,904

 

18,942

 

296

 

219,014

 

Cost of services before reimbursable expenses

 

28,473

 

21,793

 

61,345

 

8,524

 

10,202

 

12,817

 

(1,238

)

141,916

 

Reimbursable expenses

 

6,730

 

952

 

209

 

1,071

 

2,252

 

466

 

45

 

11,725

 

Total cost of services

 

35,203

 

22,745

 

61,554

 

9,595

 

12,454

 

13,283

 

(1,193

)

153,641

 

Gross profit

 

20,888

 

13,782

 

8,909

 

5,196

 

9,450

 

5,659

 

1,489

 

65,373

 

Selling expenses

 

8,486

 

6,900

 

1,656

 

1,225

 

3,868

 

2,016

 

83

 

24,234

 

General & administrative expenses

 

9,119

 

12,924

 

7,776

 

3,302

 

2,803

 

5,059

 

4,037

 

45,020

 

Restructuring, severance, and impairment costs

 

259

 

6,433

 

415

 

6

 

194

 

128

 

658

 

8,093

 

Income (loss) from operations

 

$

3,024

 

$

(12,475

)

$

(938

)

$

663

 

$

2,585

 

$

(1,544

)

$

(3,289

)

$

(11,974

)

 

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

 

15



 

Detail of Health Delivery Outsourcing Revenues

 

Health Delivery 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):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 24,
2004

 

September 26,
2003

 

September 24,
2004

 

September 26,
2003

 

Internally generated revenues

 

$

18,542

 

$

17,661

 

$

58,840

 

$

54,033

 

Subcontractor revenues

 

5,844

 

5,545

 

16,095

 

16,221

 

Revenues before reimbursements

 

$

24,386

 

$

23,206

 

$

74,935

 

$

70,254

 

 

Note 10                  Line of Credit

 

The Company has a revolving line of credit, under which it is allowed to borrow up to $7.0 million at an interest rate of the prevailing prime rate with an expiration of May 1, 2005.  There was no outstanding balance under the line of credit at September 24, 2004.

 

Note 11                  Capital Stock Repurchase

 

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

 

The purchase by FCG of Mr. Lipson’s ownership interest included all of the 1,962,400 outstanding shares of common stock of FCG held by Mr. Lipson, together with 32,000 in-the-money options to purchase shares of common stock of FCG.  The aggregate purchase price for the shares and the options represented a premium of approximately 11% over the closing price of FCG’s common stock on February 26, 2004.

 

In the first quarter of 2004, FCG recorded a charge of $1.6 million without any tax benefit, which charge is based on the premium included in the purchase consideration.  From a tax perspective, no amounts of the purchase price were allocable to any of the restrictive covenants agreed to by Mr. Lipson in the repurchase agreement.

 

Other material terms of the transaction were as follows:

 

          The purchase price was comprised of cash, a portion of which Mr. Lipson used to repay in full indebtedness owed by Mr. Lipson to FCG of approximately $0.3 million.

          In the event FCG announces or consummates a change in control transaction prior to February 27, 2005, or if the Company enters into negotiations regarding a change in control transaction prior to February 27, 2005 and subsequently announces publicly a definitive agreement for or consummate a change in control transaction prior to August 27, 2005, FCG would pay to Mr. Lipson, upon the closing of such change in control of FCG, an amount equal to the difference of $7.50 per share and the change in control transaction price per share, if such change in control price per share amount is higher.

          12,000 out-of-the-money options held by Mr. Lipson remain outstanding and may only be exercised on or before the first anniversary of this repurchase transaction.  Upon receipt of Mr. Lipson’s

 

16



 

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

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

          Mr. Lipson also granted to the Board of Directors of FCG an irrevocable proxy for any of FCG’s securities that he owns or acquires after the closing of FCG’s purchase in this transaction.

          FCG and Mr. Lipson executed a mutual release of claims.

 

17



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.  EXCEPT AS REQUIRED BY APPLICABLE LAW, WE DO NOT HAVE ANY INTENTION OR OBLIGATION TO UPDATE PUBLICY ANY FORWARD LOOKING STATEMENTS AFTER THE DISTRIBUTION OF THIS REPORT, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS, CHANGES IN ASSUMPTIONS OR OTHERWISE.

 

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 information technology outsourcing services, and professional services. 

 

We typically bill for our services on an hourly, fixed-fee, or monthly fixed-fee basis as specified by the agreement with a particular client.  For services billed on an hourly basis, in our consulting and systems integration businesses (“CSI”), fees are determined by multiplying the amount of time expended on each assignment by the project hourly rate for the associate(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.  Revenues are generally recognized related to the level of services performed, the amount of cost incurred on the assignment versus the estimated total cost to complete the assignment, or on a straight-line basis over the period of performance of service.  Additionally, we have recently been licensing an increased amount of our software products, generally in conjunction with the customization and implementation of such software products.  Revenues from our software licensing have grown from greater than 1% of our net revenues in fiscal year 2003 to almost 3% of our net revenues in the first nine months of fiscal year 2004, and we expect our software licensing revenues to continue to grow.

 

Provisions are made for estimated uncollectible amounts based on our historical 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 revenues before reimbursements (“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.

 

Cost of services primarily consists of the salaries, bonuses, and related benefits of client-serving 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 market 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

 

18



 

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.

 

Our most significant expenses are our human resource and related salary and benefit expenses.  As of September 24, 2004, approximately 1,279 of our 2,409 employees (associates) are billable associates.  Another 782 employees are part of our outsourcing business.  The salaries and benefits of such billable associates and outsourcing related employees are recognized in our cost of services.  Most non-billable employee salaries and benefits are recognized as a component of either selling or general and administrative expenses.  Approximately 14.4% of our workforce, or 348 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 billable associate utilization, which is the ratio of total billable hours to available hours in a given period;

         The amount and timing of costs 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. 

 

In our CSI business, we manage billable associate utilization by monitoring assignment requirements and timetables, available and required skills, and available associate 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 associate availability with current and projected client requirements.  The number of associates 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 associates 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 associates and could cause us to experience lower margins.  In addition, entry into new market areas and the hiring of associates in advance of client assignments have resulted and may continue to result in periods of lower associate utilization. 

 

In response to competition and continued pricing and rate pressures, we have recently implemented a global sourcing strategy into our business operations, which includes the deployment of offshore resources as well as resources that perform services remote from the client site.  We have also begun to incorporate more variable cost or per diem staff in some of our projects.  We expect these strategies to result in improved cost of services through a combination of lower cost attributable to offshore resources and higher leverage of resources that perform services offsite or on a variable cost basis.  To the extent we pass through reduced costs to our clients related to offshore resources, the global sourcing strategy may result in lower revenues on a per engagement basis. However, we expect to offset this potential revenue impact with improved competitive positioning in our markets.  Several of our competitors employ both global sourcing and variable staffing strategies 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 strategies or if we are unable to receive high quality services

 

19



 

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

 

Results of Operations for the Three Months Ended September 24, 2004 and September 26, 2003

 

Revenues.  Our net revenues increased to $66.0 million for the quarter ended September 24, 2004, an increase of 0.2% from $65.8 million for the quarter ended September 26, 2003.  Our total revenues increased to $70.4 million for the quarter ended September 24, 2004, an increase of 0.8% from $69.9 million for the quarter ended September 26, 2003.  The minor net increases were the result of increases in our Meditech and Health Delivery Outsourcing businesses, offset by a decrease in Health Plan.  The Meditech segment had the most significant net revenue increase ($1.6 million or 34.9%) due to the award of a new Meditech outsourcing engagement and other general increases in demand for Meditech services.   Additionally, the Health Delivery Outsourcing segment net revenues increased $1.2 million or 5.1% from additional work on existing projects.  The Health Plan segment net revenues decreased $2.4 million or 39.3% due to the completion of several significant projects during late 2003 and early 2004, without having new projects to replace them.  Overall business trends are expected to be similar in the fourth quarter of fiscal year 2004 compared to the third quarter.  Since December 31, 2004 occurs on a Friday, thus adding a 53rd week to the fiscal year and a 14th week to the fiscal fourth quarter, our revenues and costs for the fourth quarter are expected to be higher than recent history and trends would otherwise indicate, although much less than a full one-thirteenth higher, since the extra week encompasses much of the slow holiday period. 

 

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

 

Gross Profit.  Gross profit increased to $21.8 million for the quarter ended September 24, 2004, an increase of 11.6% from $19.5 million for the quarter ended September 26, 2003.  The increase was primarily due to increased gross profit in Life Sciences which was attributable to the cost of services decrease noted above.  Additionally, Health Delivery Outsourcing gross profit increased due to ongoing cost efficiencies that were achieved on certain contracts, and Meditech gross margin increased in line with the revenue increase in that segment.  These increases were partially offset by a $1.5 million decline in Health Plan margin due to the major decline in revenues in that segment.  Gross profit as a percentage of net revenues increased to 33.0% for the quarter ended September 24, 2004 from 29.7% for the quarter ended September 26, 2003 due to increased margin percentage in all segments other than Health Plan, Meditech, and Other Business.  Given the current revenue mix, our gross profit percentage is not expected to change significantly in the near future; however, a sudden downturn in demand in one or more of our segments or an inability to control costs on our fixed price projects could negatively affect our margin percentage.

 

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

 

General and Administrative Expenses.  General and administrative expenses decreased to $13.1 million for the quarter ended September 24, 2004, a decrease of 11.9% from $14.8 million for the quarter

 

20



 

ended September 26, 2003.  The decrease resulted from cost reductions in late 2003, including the consolidation of the administrative operations of several of our acquired companies.  General and administrative expenses as a percentage of net revenues decreased to 19.8% for the quarter ended September 24, 2004 from 22.5% for the quarter ended September 26, 2003.  We expect to hold general and administrative expenses, measured in absolute dollars, at their current level in the near future.

 

Restructuring, Severance, and Impairment Costs.  Restructuring, severance, and impairment costs were zero for the three months ended September 24, 2004 compared to $4.2 million for the three months ended September 26, 2003.  Restructuring, severance, and impairment costs for the three months ended September 26, 2003 included approximately $3.6 million of severance costs related to staff reductions and $0.6 million for facility downsizing and fixed asset write-downs. 

 

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

 

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

 

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

 

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

 

Revenues.  Our net revenues decreased to $200.0 million for the nine months ended September 24, 2004, a decrease of 3.5% from $207.3 million for the nine months ended September 26, 2003.  Our total revenues decreased to $212.9 million for the nine months ended September 24, 2004, a decrease of 2.8% from $219.0 million for the nine months ended September 26, 2003.  The decreases were primarily due to declines in our Life Sciences and Health Plan businesses, partly offset by increases in Health Delivery Outsourcing and the Meditech Service Center.   The Life Sciences segment had the most significant net revenue decline ($8.7 million or 24.4%), due to the general decline in the custom software business for pharmaceutical clients, and also due to the completion of a major engagement midway through 2003.  The Health Plan segment declined by $8.0 million, or 40.7%, due to the completion of several significant projects during 2003 and early 2004, without having new projects to replace them.  Health Delivery Outsourcing net revenues increased by $4.7 million, or 6.7%, due to additional work on existing projects.  The Meditech Service Center net revenues increased by $4.3 million, or 31.3%, due to the award of a new Meditech outsourcing engagement and other general increases in demand for Meditech services. 

 

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

 

21



 

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

 

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

 

Selling Expenses.  Selling expenses decreased to $21.1 million for the nine months ended September 24, 2004, a decrease of 12.8% from $24.2 million for the nine months ended September 26, 2003.  This decrease was primarily due to a reduction in our sales force.  Selling expenses as a percentage of net revenues decreased to 10.6% for the nine months ended September 24, 2004 from 11.7% for the nine months ended September 26, 2003.

 

General and Administrative Expenses.  General and administrative expenses decreased to $38.8 million for the nine months ended September 24, 2004, a decrease of 13.8% from $45.0 million for the nine months ended September 26, 2003.  The decrease resulted from cost reductions in the latter part of 2003, including the consolidation of the administrative operations of several of our acquired companies.  General and administrative expenses as a percentage of net revenues decreased to 19.4% for the nine months ended September 24, 2004 from 21.7% for the nine months ended September 26, 2003.  We expect to hold these expenses at their current level in the near future.

 

Restructuring, Severance, and Impairment Costs.  Restructuring, severance, and impairment costs were zero for the nine months ended September 24, 2004 compared to $8.1 million for the nine months ended September 26, 2003.  Restructuring, severance and impairment costs for the nine months ended September 26, 2003 included approximately $4.3 million of severance costs related to staff reductions and approximately $3.8 million for facility downsizing and fixed asset write-downs. 

 

Interest Income, Net.  Interest income, net of interest expense decreased to $0.5 million for the nine months ended September 24, 2004, a decrease of 30.4% from $0.8 million for the nine months ended September 26, 2003.  This decrease was due to lower interest rates on our cash and marketable securities investments, and to reduced invested cash levels resulting from the repurchase of approximately $15.1 million of our stock from a major stockholder in February 2004.  Interest income net of interest expense as a percentage of net revenues decreased to 0.3% for the nine months ended September 24, 2004 from 0.4% for the nine months ended September 26, 2003.

 

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

 

Expense for Premium on Repurchase of Stock.  In the first quarter of 2004, we repurchased 1.96 million shares of our stock and certain options from a major stockholder at a premium to the then current market price (see Note 11 of Notes to Consolidated Financial Statements).  The aggregate purchase price for the shares and the options represented a premium of approximately 11% to the market price of our common stock on the date we repurchased such stock.  As a result, we recorded a pretax charge of approximately $1.6 million (without any tax benefit) for such premium included in the purchase consideration.

 

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Income Taxes.  The provision for income taxes for the nine months ended September 24, 2004 was $2.6 million.  The provision was 61.3% for the nine months ended September 24, 2004.  Excluding the nondeductible premium on repurchase of stock described above, the provision was 45% for the nine months ended September 24, 2004, compared to a tax benefit rate of 35% for the nine months ended September 26, 2003.  The higher absolute rate in 2004 is due to income taxes we pay in certain states which do not allow the use of our net operating loss carryforwards to offset income of certain of our subsidiaries, and to the nondeductibility of certain of our expenses.

 

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 was required to be adopted for all new applicable revenue arrangements no later than the third quarter of 2003.  Early adoption was permitted and we elected to adopt the new standard as of the beginning of the first quarter of 2003.  In addition, we 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 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 nine months ended September 24, 2004, we generated cash flow from operations of $6.0 million.  During the nine months ended September 24, 2004, we used $2.4 million in cash to purchase the remaining 47.65% minority interest in FCG Infrastructure Services, Inc. (formerly Codigent Solutions Group, Inc.), and approximately $5.9 million of cash to purchase property and equipment, primarily computer and related equipment.  At September 24, 2004, we had cash and investments available for sale of $47.1 million compared to $62.6 million at December 26, 2003.

 

On February 27, 2004, we repurchased all outstanding FCG shares and certain FCG options held by a major stockholder (see Note 11 of Notes to Consolidated Financial Statements).  The aggregate purchase price for such shares and options was $14.8 million in cash, and cancellation of a note owed to us by the stockholder in the amount of $0.3 million.  In addition, in the event we were to announce or consummate a change in control transaction prior to the first anniversary of this transaction, or if we were to enter into negotiations regarding a change in control transaction prior to the first anniversary and subsequently announce publicly a definitive agreement for or consummate a change in control transaction within the 18 months following the closing of this repurchase transaction, we would pay to this former stockholder, upon the closing of such change in control of FCG, an amount equal to the difference between $7.50 per share and the change in control transaction price per share, if such change in control price per share amount was higher.

 

On October 1, 2003, we entered into an unsecured loan agreement with White Plains Hospital Center requiring us to provide interest free financing of up to $4.1 million if our system implementation at the hospital results in an increase in the hospital’s accounts receivable balance or days outstanding during a 150-day period following the completion of the system implementation.  Any amounts borrowed during this 150-day period are payable 90 days after the borrowing date.  We do not currently expect to make any loans under this agreement until early 2005, if at all.  Since our loans are unsecured, we cannot guarantee that the hospital will repay our loans on a timely basis, if at all.  If our loans are not repaid or repaid in a timely manner, our financial condition would be impacted negatively.

 

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, 2005.  There was no outstanding balance under the line of credit at September 24, 2004.

 

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

 

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

 

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

 

 

 

Payments Due by Period

 

Contractual Obligations

 

Less than 1
Year

 

1 -3
Years

 

3-5
Years

 

More than
5 Years

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases, net of subleases

 

$

5,459

 

$

9,596

 

$

3,472

 

$

 

$

18,527

 

Purchase obligations

 

310

 

154

 

 

 

464

 

Total

 

$

5,769

 

$

9,750

 

$

3,472

 

$

 

$

18,991

 

 

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 primarily from information technology outsourcing services, consulting, and systems integration.  Revenues are recognized on a time-and-materials, level-of-effort, percentage-of-completion, or straight-line basis.  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. 

 

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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 recognized based upon a fixed price for the level of resources provided.  Revenues from fixed fee arrangements for consulting and systems integration work are generally recognized on a rate per hour or 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 fixed price consulting and system integration 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 consulting and system integration 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 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.

 

We evaluate our non-outsourcing fixed price contracts on an ongoing 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 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 2003.  Under our outsourcing contracts, a significant portion of our revenues are fixed and allocated over the contract on a straight-line basis, as 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 or penalties associated with service level failures, our gross profit can be negatively impacted.

 

On certain contracts, or elements of contracts, costs are incurred subsequent to the signing of the contract, but prior to the rendering of service and associated recognition of revenue.  Where such costs are incurred and realization of those costs is either paid for upfront or guaranteed by the contract, those costs are deferred and later expensed over the period of recognition of the related revenue.  At September 24, 2004, we had deferred $1.4 million of such deferred costs.

 

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.

 

Although software revenues comprised less than 3% of our revenues in the first nine months of 2004, they are growing as a proportion of our total revenues.  We recognize software revenues in accordance with the provisions of the American Institute of Certified Public Accountants Statement of

 

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Position (“SOP”) 97-2, “Software Revenue Recognition”, as amended by SOP 98-4, “Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue Recognition” and SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions”, and in accordance with the Securities and Exchange Commission Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition”. We license software under non-cancelable license agreements and provide related professional services, including consulting, training, and implementation services, as well as ongoing customer support and maintenance.  Many of our more significant software arrangements include implementation services that are essential to the functionality of our software products, and are recognized using contract accounting including the percentage-of-completion methodology over the period of the implementation.

 

In cases where our software arrangements do not include services essential to the functionality of the product, license fee revenues are recognized when the software product has been shipped, provided a non-cancelable license agreement has been signed, there are no uncertainties surrounding product acceptance, the fees are fixed or determinable and collection of the related receivable is considered probable. We do not generally offer rights of return or acceptance clauses to our customers. In situations where we do provide rights of return or acceptance clauses, revenue is deferred until the clause expires. Typically, our software license fees are due within a twelve-month period from the date of shipment. If the fee due from the customer is not fixed or determinable, including payment terms greater than twelve months from shipment, revenue is recognized as payments become due and all other conditions for revenue recognition have been satisfied. In software arrangements that include rights to multiple software products, specified upgrades, maintenance or services, we allocate the total arrangement fee among the deliverables using the fair value of each of the deliverables determined using vendor-specific objective evidence. Vendor-specific objective evidence of fair value is determined using the price charged when that element is sold separately. In software arrangements in which we have fair value of all undelivered elements but not of a delivered element, we use the residual method to record revenue. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is allocated to the delivered element(s) and is recognized as revenue. In software arrangements in which we do not have vendor-specific objective evidence of fair value of all undelivered elements, revenue is deferred until fair value is determined or all elements have been delivered.

 

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

 

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. Unbillable amounts occur when revenues recognized exceed billings in accordance with the contractual terms.  Such unbillable amounts most often become billable upon reaching certain project milestones stipulated per contract, or in accordance with the percentage of completion method.  As of September 24, 2004, we had unbillable revenues included in current unbilled receivables of approximately $3.8 million, which were generally expected to be billed in the following quarter.  In addition, we had a long-term account receivable at September 24, 2004 and December 26, 2003 of $4.3 million and $5.8 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 two and a half years of the contract through contractual billings that will exceed the amounts to be earned as revenues.

 

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Customer advances are comprised of 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.

 

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 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.

 

Deferred Income Taxes

 

We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes,” which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns.  Our net deferred tax assets have historically consisted primarily of the tax benefit related to restructuring costs for facility closures, supplemental executive retirement plan contributions, and other accrued liabilities such as accrued vacation pay, which are not deductible for tax purposes until paid.  During fiscal year 2003, we generated additional deferred tax assets for net operating loss carryforwards which were created by our pretax losses combined with the fact that we are outside the period it is allowable to carry back losses, and also for additional deferred tax assets related to the cumulative effect of our change in revenue recognition method on our outsourcing contracts.  We use significant estimates in determining what portion of our deferred tax asset is more likely than not to be realized.  Based on those estimates and taking into account our recent history of cumulative losses, we recorded a valuation allowance of $5.5 million in the fourth quarter of fiscal year 2003.  Together with a full valuation allowance of $5.5 million we had already taken against the net operating loss carryforwards of companies we had acquired earlier in the year, at December 26, 2003, we had a valuation allowance of $11.0 million against a total deferred tax asset of $21.1 million.  Based on our belief that it is more likely than not that future taxable income will be sufficient to realize the remaining $8.4 million of deferred tax assets, we have not recorded a valuation allowance against those assets.  However, there is no guarantee that our taxable income will be sufficient to realize such remaining net deferred tax assets, and we will continue to evaluate the potential need for an additional valuation allowance on an ongoing basis.  Additionally, if the realization of a greater amount of our deferred tax assets in the future is considered more likely than not, we will reverse all or a portion of the existing valuation allowance at that time.

 

Goodwill and Intangible Assets

 

Under SFAS No 142, we no longer amortize our goodwill and are required to complete an annual impairment testing during the fourth quarter of each year.  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 involves 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 September 24, 2004, we have $17.8 million of goodwill and $2.8 million of intangible assets recorded on our balance sheet (see Note 5 of the Notes to Consolidated Financial Statements).

 

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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:

 

                  Our ability to reduce our losses in our life sciences business;

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

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

                  Fluctuations in market demand for our services, associate 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;

                  Use of offsite and offshore resources on our engagements;

                  Our ability to incorporate the use of variable labor staffing into our projects;

                  The loss of key personnel and other employees;

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

                  The timing of certain general and administrative expenses;

                  Completing acquisitions and the costs of integrating acquired operations;

                  Impairment of goodwill from our acquisitions; 

                  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;

                  Our 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.  If these or any other variables or unknowns were to cause a shortfall in

 

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revenues or earnings or otherwise cause a failure to meet public market expectations, our business could be adversely affected.

 

We adopted 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 recognition) 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.  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 reported net losses before the cumulative effect of change in accounting principle for the last three quarters of 2003 as well as a net loss for the first quarter of 2004.  As a result, we cannot assure you that we will achieve positive earnings in the future.  If we are unable to achieve profitability on a quarterly or annual basis, the market price of our common stock could be adversely affected and our financial condition would suffer.

 

We are dependent on our outsourcing engagements for a significant part of our revenues.

 

Net revenues from our outsourcing relationships, for the nine months ended September 24, 2004, represented approximately 41% 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 could have an adverse 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 detailed service level agreements, which establish performance levels and standards for our services.  If we fail to meet these performance levels or standards, our clients may receive monetary service level credits from us or, if we experience persistent failures, our clients may have a right to terminate the outsourcing contract for cause and have no obligation to pay us any termination fees.  Our anticipated revenues and profitability from our outsourcing engagements could be significantly reduced if we are unable to satisfy our performance levels or standards, or if we are unable to improve our delivery costs as planned on such engagements.  Additionally, our outsourcing contracts can be terminated at the convenience of our clients upon the payment of a termination fee.

 

In addition, many of 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.  Any failure by us to recover these investments could reduce our outsourcing revenue, which would have a material adverse effect on our financial condition, results of operations, and price of our common stock.

 

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Our outsourcing engagements may also 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 are 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 that we have anticipated. 

 

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.

 

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 associates 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 associates 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 have grown, in part, by acquiring complementary businesses that could enhance our capability to serve the healthcare and pharmaceutical industries.  For example, we acquired a majority interest in Codigent Solutions Group, Inc. (renamed FCG Infrastructure Services, Inc.) in 2002 and purchased the remaining minority interest in that entity in the first quarter of 2004.  Also, during the first

 

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half of 2003, we acquired Paragon Solutions, Inc., Coactive Systems Corporation, 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;

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

                  Not realizing the intended or expected benefits of the acquisitions.

 

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.

 

We may be negatively impacted if our investments in products and emerging service lines are unsuccessful.

 

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

 

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, or a reduction in the number of engagements with these 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.

 

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

 

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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.  Many of our associates 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.  We must also seek certain employees that are willing to work on a variable or per diem basis.  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 and to offer our services at competitive rates 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 associates;

                  Travel demands imposed on our associates;

                  Loss of employees to competitors and clients; and

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

 

Continued or increased employee turnover could materially adversely affect our business and results of operations.  In addition, many of our associates 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 associates could erode our client base and decrease our revenues.

 

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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 organization and hired persons with appropriate skills, including salespersons, and reduced our workforce in practice areas experiencing less demand.  We have also begun to hire employees willing to work on a variable or per diem basis in order to better manage project costs and general and administrative expense associated with underutilized resources.  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 any 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 and technology 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

                  A decrease in pharmaceutical companies’ research and development or 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

 

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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.  If we fail to recruit and retain a sufficient number of qualified employees in each country where we conduct business, our ability to 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;

                  Increasing and uncertain labor costs and high turnover rates;

                  Unfavorable pricing and price competition;

                  Currency fluctuations;

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

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

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

                  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 become profitable in our European operations, which may materially adversely affect our financial condition, results of operations, and price for our common stock.

 

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 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.

 

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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, Cerner Corporation, 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 and outsourcing 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 outsourcing, 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 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 software and hardware vendors.  For example, our life sciences business is highly dependent upon a non-exclusive relationship with EMC Documentum, a vendor of document management software applications with which we integrate our FirstDoc TM solution.

 

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We often are engaged by vendors or their customers to implement or integrate vendor products based on our relationship with a particular vendor.  In addition, our clients may request that we host or operate a vendor application as part of a hosting or outsourcing relationship, which may require the consent or cooperation of the vendor.  As a result, we believe that our relationship with vendors is important to our operations, including our sales, marketing, and support activities.  If we fail to maintain our relationships with these 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.

 

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 (i.e., in the area of enterprise content management) 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 business is highly dependent on the availability of business travel.

 

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

 

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

 

The healthcare and pharmaceutical industries are subject to regulatory and technological changes that may affect the procurement practices and operations of healthcare and pharmaceutical organizations.  During the past several years, the healthcare and pharmaceutical industries have been subject to an increase in governmental regulation and reform proposals.  These reforms could increase governmental involvement in the healthcare and pharmaceutical industries, lower reimbursement rates or otherwise change the operating environment of our clients.  Also, certain reforms that create potential work for us could be delayed or cancelled.  Healthcare and pharmaceutical organizations may react to these situations

 

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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, 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.

 

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

 

Our current officers, directors, and other affiliates beneficially own approximately 24.7% of our outstanding shares of common stock and approximately 37.2% 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:

 

                  Our performance and prospects;

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

                  Investor perception of us and the industries in which we operate;

                  Changes in earnings estimates or buy/sell recommendations by analysts;

                  General financial and other market conditions;

                  Domestic and international economic conditions; and

                  The other risks related to our business discussed above.

 

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,

 

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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.

 

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.

 

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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 $47.1 million at September 24, 2004 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 $0.5 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 September 24, 2004, 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

 

We maintain disclosure controls and procedures 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 for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Our disclosure controls and procedures are designed to provide a reasonable level of assurance of reaching our desired disclosure control objectives.

 

As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective, and were operating at the reasonable assurance level.

 

There has been no change in our internal controls over financial reporting during our most recent fiscal quarter or fiscal year that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

 

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PART II.  OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

None.

 

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

 

None.

 

Item 3.  Defaults Upon Senior Securities

 

None.

 

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

 

None.

 

Item 5.  Other Information

 

None.

 

Item 6.  Exhibits

 

 

Item

 

Description

3.1 (1)

 

Certificate of Incorporation of the Company

3.2 (2)

 

Certificate of Designation of Series A Junior Participating Preferred Stock

3.3 (3)

 

Bylaws of the Company

4.1 (4)

 

Specimen Common Stock Certificate

11.1 (5)

 

Statement of computation of per share earnings

31.1

 

Rule 13a-14(a)/Rule 15d-14(a) Certification of the Chief Executive Officer.

31.2

 

Rule 13a-14(a)/Rule 15d-14(a) Certification of the Chief Financial Officer.

32.1

 

Section 1350 Certification of the Chief Executive Officer.

32.2

 

Section 1350 Certification of the Chief Financial Officer.

 


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

 

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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: November 3, 2004

/s/LUTHER J. NUSSBAUM

 

 

Luther J. Nussbaum

 

Chairman of the Board and

 

Chief Executive Officer

 

 

 

 

Date: November 3, 2004

/s/WALTER J. MCBRIDE

 

 

Walter J. McBride

 

Executive Vice President and Chief

 

Financial Officer

 

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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

31.1

 

Rule 13a-14(a)/Rule 15d-14(a) Certification of the Chief Executive Officer.

31.2

 

Rule 13a-14(a)/Rule 15d-14(a) Certification of the Chief Financial Officer.

32.1

 

Section 1350 Certification of the Chief Executive Officer.

32.2

 

Section 1350 Certification of the Chief Financial Officer.

 


(1)   Incorporated by reference 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 1 to Consolidated Financial Statements, “Accounting Policies – Basic and Diluted Net Income (Loss) Per Share.”

 

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