ITEM 1. BUSINESS
GENERAL
First Consulting Group, Inc. ("FCG" or the "Company") provides information-based consulting, integration, and management services primarily for the health related industries in North America and Europe. FCG's services are designed to increase its clients' operations effectiveness through reduced cost, improved customer service, enhanced quality of patient care and more rapid introduction of new pharmaceutical compounds. FCG is focused on transforming the health-related industries. FCG applies deep industry knowledge and operations improvement skills combined with advanced information technologies, including the Internet, to make substantial improvements in healthcare delivery, healthcare financing and administration, health maintenance and drug research and development. Through its services, FCG offers industry-specific expertise to objectively evaluate, select, develop, implement and manage information systems, networks and applications. The Company provides its services primarily to healthcare delivery organizations, health plans, government healthcare organizations, and pharmaceutical and life sciences organizations, with a growing presence in other industries via web and infrastructure services. FCG has over 1,800 professionals serving North America and Europe. FCG's consultants possess extensive expertise in financial, administrative and clinical processes, information technologies and applications. FCG provides this expertise to clients by assembling multi-disciplinary teams that provide comprehensive services across its principal services of consulting, integration, and management (including outsourcing). FCG's consulting professionals are supported by internal research and a centralized information system that provides real-time access to current industry information and project methodologies, experiences, models and tools. FCG believes that its success is attributable to its strong relationships with industry leading clients, its industry and technical expertise, its professional environment that fosters employee recruitment and retention, and the depth and breadth of its services.
CLIENTS AND SERVICES
In 2000, FCG provided services to clients primarily in the healthcare, pharmaceutical and life sciences industries in North America and Europe. FCG's clients include leading integrated delivery networks (IDNs), health plans, acute care centers, academic medical centers, physician organizations, governmental agencies, pharmaceutical companies, biotech companies and other organizations. The Company has worked for many of the largest and most prestigious clients in its target segments, including all of the leading pharmaceutical companies as listed in Fortune's Global 500, 15 of the top 20 managed care firms, 20 of the top 25 IDNs, and the 2 largest U.S government healthcare IDNs. The Company's revenue mix from its major clients in 2000 was:
o Health Delivery Organizations (hospitals, integrated delivery networks, academic medical centers, clinics, physician organizations, associations - 44% (includes outsourcing clients) o Pharmaceutical, Biotech and other life sciences related organizations - 27% o Health Plans (Blue Cross Blue Shield organizations, Insurance Companies, Specialty Physician Organizations, Regional and National HMOs) - 21% o U.S. Federal Government Healthcare Agencies (e.g. Department of Defense, Department of Health and Human Services, and Department of Veterans Affairs) - 3% o Other industries - 5%
During 2000, the Company increased its efforts to pursue business in industries outside of the health related industries, including financial services, aerospace, automotive, technology and others. The Company is pursuing engagements that utilize its particular strengths in Internet, infrastructure, system development and document management technologies. FCG believes that it can successfully apply these capabilities to other industries in order to help increase its overall growth and provide new opportunities for its associates.
Please see "Risks Relating to the Business of FCG" below for a discussion of risks associated with engaging and maintaining clients.
FCG's principal services consist of consulting, integration, and management (outsourcing). The Company believes that its clients' overall operations effectiveness is dependent upon solid business strategy and the implementation of improved business processes supported by information management. Further, the Company believes that these elements are interdependent and therefore must be integrated in order to be successful. FCG offers its clients an integrated approach through multi-disciplinary teams with expertise across these areas. FCG typically is engaged on a project basis and assembles client teams from one or more services to match the expertise and service offerings with the overall objectives required by each client and engagement. Many client engagements involve multiple assignments. FCG may assemble several client teams to serve the needs of a single client. FCG provides its services at the client site to senior-level management and other personnel within the client organization. The Company provides its services through four vertically focused business units -health delivery, health plans, government healthcare, and life sciences, and three horizontal units - advanced technology (infrastructure), FCG Doghouse (e-services), and FCG Management Services (outsourcing). The table below provides the business mix for FCG's principal services. Subsequent paragraphs provide a profile of each business unit.
LIFE SCIENCES
FCG defines the life sciences industry to include major pharmaceutical companies, biotechnology companies, clinical research organizations (CROs), medical device manufacturers and related companies. The major component of FCG's life sciences services involves the design and development of information systems used in the drug development life cycle of pharmaceutical companies. The Company's services encompass the analysis, design, development, implementation, and maintenance of information systems used in all aspects of the drug development and post approval processes. The Company possesses comprehensive, industry-specific project development methodology, rapid application development skills, and understanding of leading information technologies. FCG helps its life sciences clients streamline the drug development process and improve the effectiveness of their IT investments.
FCG's information management and strategy services support every aspect of the drug development life cycle, from discovery, clinical trials, and regulatory approval to manufacturing, marketing and medical affairs. FCG's services are organized around the major processes of pharmaceutical firms, including:
DRUG DISCOVERY - Genomics, Compound Registration, Sample and Reagent Inventory Management, high-throughput screening, Chemical Compound Library Management, and Laboratory Information Management Systems/Assay Systems
PRE-CLINICAL & CLINICAL - Pharmacology Systems, Toxicology, Clinical Data Management, Clinical Trials Management, Drug Safety/Adverse Events Reporting, Clinical Supplies, Remote Data Entry, Case Report Forms Imaging, and Clinical Manufacturing
REGULATORY - Regulatory Document Management, Electronic Submissions, Regulatory Affairs Tracking, and Dossier Publishing
MANUFACTURING AND POST MARKET - Standard Operating Procedures- Packaging and Labeling, Good Manufacturing Practices, Safety and Surveillance, Phase IV Clinical Trials, Quality Control/Quality Assurance, Disease Management, Sales Force Automation, Data Warehousing, and Disease Management
FCG provides clients with systems integration and custom development solutions through the use of advanced technologies, methodologies and skills. FCG will perform the complete range of software engineering and development tasks including technology assessment, architecture, requirements gathering, detailed design, construction, testing, benchmarking, implementation and support. FCG's services include the following:
SYSTEMS DEVELOPMENT FCG is a leader in the application and seamless integration of diverse technologies with a commitment to identify and adopt new technologies in support of our client's business needs. The Company offers Data Warehousing and Decision Support systems, Client Server Systems Integration, web technologies and quality assurance and testing, as well as training services. Through strong relationships with leading vendors, FCG accesses cutting edge tools to provide clients with many solution options.
CONTENT MANAGEMENT FCG is a global leader in content management, having led the successful design and implementation of over 120 content management systems in clinical, regulatory, and manufacturing within life sciences organizations. These solutions accelerate the creation and publication of regulatory submissions, improve quality, abide by regulatory guidelines, and ultimately reduce the time to market for new drugs. In addition to traditional strategy and implementation services, FCG offers several packaged solutions. The Company has combined the industry's best practices, state of the art technology, and consulting services to produce FirstDocs(TM), the only comprehensive, pre-packaged suite of electronic content management solutions designed specifically for the life sciences industry.
VALIDATION SERVICES This practice works as an independent organization within FCG. The practice provides clients with the expertise to evaluate, structure, implement, and maintain effective quality programs that ensure compliance with applicable regulations. FCG has diverse experience and knowledge and strategic planning for quality systems, process integration, clinical data systems, laboratory automation, content management and 21 CFR Part 11 compliance.
HEALTH PLANS
To remain competitive, health plans must reduce costs, provide responsive customer service, support new plan benefits, and build market share. At FCG, specialists provide expertise in a wide range of health plan operations, program management, and health plan information systems.
FCG improves health plan performance with integrated solutions that link client strategies, processes, and people to providers, consumers, and purchasers. FCG's services help clients achieve differentiation and cost savings through a variety of strategies and transformation services, including customer relationship management (CRM). FCG assists clients with e-health strategies and deployment, including digital strategies, Internet and portal development, core systems integration, databases and technology infrastructure services. FCG's Health Insurance Portability and Accountability Act (HIPAA) services range from readiness assessment to planning/requirements definition and implementation. The Company also addresses health management processes like access coordination, medical management, and delivery monitoring.
FCG helps optimize core health plan processes like claims administration, engaging/retaining members and accountability/reporting. FCG identifies and implements supporting information management solutions. The Company provides strategy, design, and implementation expertise in IT optimization and customer service call centers. FCG assists health plans in systems implementation across all these areas, while applying process redesign techniques to ensure that clients maximize their investments in information technology.
HEALTH DELIVERY
As the healthcare industry has experienced radical change, hospital, technology, drug, and physician-related cost increases have created new demands for cost management solutions that do not sacrifice quality of care. Consumers are acquiring knowledge about healthcare options through advertising and the Internet and are demanding more service and convenience. Healthcare organizations must respond by offering measurable quality and service improvements, while remaining competitive from a cost standpoint.
Since its inception in 1980, FCG has served hundreds of healthcare delivery clients, including hospitals, integrated delivery networks, health trusts, academic medical centers, clinics, physician organizations, home healthcare companies, skilled nursing facilities, and related providers. The Company's focus on developing integrated solutions enables clients to achieve market differentiation, improve customer service and quality, manage cost and supply chains more effectively, and optimize their information management processes.
FCG's expertise includes process improvement and information management to support access to care, care/disease management, clinical performance improvement, patient safety, Enterprise Resource Planning (ERP), revenue cycle management, and e-strategy. FCG also helps its clients with strategic systems planning and optimizing their information technology (IT) investments. This includes IT value management, systems selection, data management strategies, and system implementations interwoven with process improvement techniques. Key vendor relationships include Cerner, Digiterra, and Lawson. Additionally, FCG assists clients through a full range of HIPAA compliance services, including education, tracking legislative issues, compliance assessment, planning and implementation of necessary processes, security, EDI and information technologies. Finally, FCG provides IT outsourcing services, from assessment/due diligence, program management through discrete and full outsourcing.
From process improvement and information systems strategy to clinical systems solutions to custom application development and implementation services, FCG provides the depth and breadth of expertise to address clients' specific needs, bringing teams of experienced professionals who have solved similar problems many times before.
GOVERNMENT HEALTHCARE
Like private enterprises, government agencies need to reduce costs, improve patient access to care, refine administrative and financial processes, and enhance the quality and delivery of information. However, they are often hobbled by additional challenges like limited access to highly trained IT specialists and a chronic shortage of expertise.
FCG bridges those gaps, helping government healthcare solve some of the most complex health problems in the United States. FCG has supported the Department of Defense, the Department of Veterans Affairs, and the Department of Health and Human Services through our government-wide General Services Administration Information Technology Professional Services contract and our Management, Organizational and Business Improvement Services contract. From administrative and financial services to health delivery systems, FCG's services to government healthcare parallel those to the private sector. FCG guides public sector health agencies through redesign of core operating processes, financial management, managed care and call center implementations, information architecture, data quality management, data warehousing, security planning, informatics infrastructure, and WAN/LAN implementations. The rewards are sustained operational improvement and enhanced quality of service and care.
FCG MANAGEMENT SERVICES (IT OUTSOURCING)
FCG Management Services, LLC, a majority owned subsidiary, provides information technology (IT) outsourcing services whereby it hires the IT staff of clients and runs part or all of the IT operations at the client site. FCG Management Services provides long-term IT management expertise, tailoring its efforts specifically to the client's culture, strategy, and needs. The Company offers a wide range of management services including assessment/due diligence, program management, discrete outsourcing and full IT outsourcing. The Company's assessment/due diligence service provides clients with a strategic and economic assessment of the feasibility of outsourcing part or all of its IT function. This assessment enables senior management to determine the appropriateness of outsourcing part or all of their IT function, relative to their financial condition, strategic objectives, internal IT capabilities and overall direction.
FCG also provides its clients with program management services, which involve the provision of senior management resource(s) for some or all of an organization's IT projects and functions. This may include for example, the provision of a Chief Information Officer, Director of Information Systems, or Manager and Director of Networks or Telecommunications. The assigned resource is employed by FCG and resides at the client site. FCG typically provides its program management services on a long-term basis (e.g., three years or more), at a fixed monthly or annual fee.
FCG provides clients with discrete outsourcing which includes the outsourcing and management of a particular IT function, e.g., help desk or enterprise network management. Under this arrangement, the employees of the client's particular function become employees of FCG and continue to work at the client's site. FCG and the client generally create a service level agreement that defines its scope of work as part of an overall discrete outsourcing contract. The client typically retains ownership of its assets and contracts with FCG on a fixed monthly or annual fee basis.
Under full outsourcing, the Company and its client create a long-term, multi-year engagement where FCG hires all of the client's IT staff, with FCG providing complete management of the IT function. The staff continue to provide the outsourcing services from the client's site, and the client retains ownership of the related assets, e.g., data center, and all hardware and software. FCG and the client typically create service level agreements, with the overall outsourcing contract lasting for three or more years, on an annual fixed fee basis.
FCG has formed a non-exclusive alliance with Affiliated Computer Services (ACS), a Fortune 1000 information technology services firm, to enhance its ability to provide complete IT outsourcing, including data center and network management capabilities. Outsourcing is proving to be a highly effective strategy for focusing skills, meeting strategic goals and reducing information management costs. Together, FCG and ACS bring a clear value proposition supported by more than 20,000 associates, experience in thousands of healthcare engagements and demonstrated mastery of information technology. FCG and ACS will pursue opportunities for large-scale healthcare data center and infrastructure management outsourcing together.
FCG DOGHOUSE (E-SERVICES)
The Company's e-services are provided via its subsidiary, FCG Doghouse, a full-service Internet strategy and development company. FCG Doghouse provides web strategy, design, development, integration and web hosting services to both health related and other industries. FCG Doghouse was formed in May 2000, when FCG acquired the web development and design business of Doghouse Productions LLC and combined it with the existing web expertise from FCG. FCG Doghouse brings together the end-to-end services necessary to conceive, plan, execute, and manage highly effective Web sites and systems. Its e-business experts possess the creative, consultative, and technical resources to transform business strategies into e-solutions. The exceptional expertise and experience in assisting clients in selecting, implementing, and integrating packaged technology solutions allow its clients to use Internet technologies and software that are already developed. FCG Doghouse helps clients use the Internet to strengthen relationships, open new markets, improve service, and reduce costs.
FCG Doghouse's e-services include: o Healthcare Digital Strategy o Data Warehousing o Web Architecture o Web Design and Development o Web Integration o Online Marketing o Web Hosting and Management
INFRASTRUCTURE SERVICES
FCG's infrastructure services include application and network integration of voice, data, video, and imaging technologies and systems. The Company evaluates, designs, develops and implements comprehensive system architectures, infrastructures, interfaces, databases, applications and networks to address the need for information integration and dissemination throughout an organization. FCG also performs multi-network integration, desktop system installation and management, server management, capacity planning, and performance analysis. FCG provides its infrastructure services on a fixed fee, per-hour, or fixed-fee per month basis as negotiated in individual client contracts.
Infrastructure services include:
o Security o Digital Imaging including Picture Archival Communication Systems (PACS) o Information Accessibility - Mobile Computing, Wireless, Desktop, Remote Access o Telecommunications, Call Centers and Customer Relationship Management (CRM) o Data Management and Integration - Data Architecture, EDI, Interface Engines o e-Infrastructure - Local and Wide Area Network Strategy, Architecture, Design and Implementation o IT Operations - Data Center, Help Desk, Disaster Recovery, Interim IT Leadership
FCG has expertise in working with a wide range of technology vendors across these areas, such as Cisco Systems, Dell Computer, HIE Inc., Microsoft Corporation, Oracle Corporation, New Era of Networks (NEON), Nortel Baynetworks Inc., SeeBeyond, and Sybase Inc.
SERVICE DELIVERY
FCG's services are provided by over 1,122 consultants and 372 outsourcing associates who collectively have expertise in key healthcare, pharmaceutical, financial, administrative and clinical processes, information technologies and applications. FCG believes that its health-related industries focus, information technology expertise, experienced consultants, and research and practice support enable its clients to reduce cost, improve customer service, enhance the quality of patient care, and more rapidly introduce new drug compounds to market.
To ensure client satisfaction, FCG typically assigns a client service or account executive to its clients. The client service or account executive's primary responsibility is to establish and maintain long-term relationships with clients. This individual regularly communicates with the client to ensure client satisfaction and is also responsible for billing decisions on each assignment. For client engagements with multiple independent assignments, FCG assigns a delivery service executive or program manager to each assignment. A delivery service executive has specific technology, process or service line expertise and is responsible for supervising the daily functions of the client team and for ensuring that the team's progress is consistent with the client's objectives and schedule. FCG measures every client's satisfaction through a client satisfaction survey completed at six-month intervals during the engagement and again at the conclusion of each assignment.
FCG employs consultants whose individual expertise combines healthcare delivery, health plan, pharmaceutical, information technology and consulting skills. FCG's consultants collectively have developed healthcare and pharmaceutical-specific expertise in key areas such as financial, administrative and clinical processes, care management, clinical decision support, health plan operations, medical and utilization management, outcomes and performance management, physician practice management, ambulatory care, drug research and development, drug regulatory submission, and privacy and confidentiality protection. FCG's consultants also have expertise in implementing, integrating and developing a wide range of information technology and management systems. These systems include packaged software applications, client/server and object-oriented computing technologies, data repositories and data warehousing, electronic commerce and electronic data imaging, networking, web technologies, telemedicine, document management, security, and disaster recovery. FCG has expanded its recruiting efforts to attract and retain the breadth and depth of skills and expertise necessary to compete successfully in the healthcare and pharmaceutical consulting industries.
SALES AND MARKETING
FCG generates a substantial portion of its revenue from existing clients and client referrals and markets its services primarily through its vice presidents and account executives. FCG's vice presidents and account executives develop strong relationships with senior-level information management and other decision-making personnel at leading healthcare and pharmaceutical organizations. FCG maintains these relationships by successfully completing assignments and exceeding clients' expectations. In particular, FCG believes that by successfully completing strategic plans for new and existing clients, it will have significant opportunities to offer implementation and integration services to these clients. FCG has demonstrated that this strategy leads to expanded opportunities with its clients and referrals to new clients. In providing its services, FCG obtains an in-depth understanding of its client's processes and internal information technology and business strategies. Through this understanding, FCG plans to provide performance improvement services to a greater portion of its client base. Performance improvement services involve assessing, designing and improving financial, administrative, clinical, and drug development processes. FCG's vice presidents and practice directors allocate a significant portion of their time to business development and related activities. FCG also employs account executives and business development directors who are dedicated to business development with potential and existing clients.
FCG is frequently engaged to provide multiple services throughout several phases of a client's information technology system lifecycle, including strategy, planning, procurement and contracting, implementation, integration and management. As a result of this involvement, FCG's personnel often develop an in-depth understanding of the client's business systems and capabilities and develop strong relationships with personnel within the client organization. These relationships provide FCG with significant opportunities to undertake additional assignments for each client.
In addition to generating assignments from existing clients, FCG attracts new clients through its targeted marketing activities. FCG's marketing activities include web marketing, public presentations, press releases, publishing of books, articles and white papers, and trade show participation. FCG also maintains research reports and white papers on its web site, along with other company and industry information. FCG's marketing staff produces a number of sales support tools including presentations, brochures, article reprints, sales kits, descriptions of FCG's services and case studies. Please see "Risks Relating to the Business of FCG" below for a discussion of risks associated with FCG's sales and marketing efforts.
RESEARCH AND PRACTICE SUPPORT
FCG's services and consultants are supported by internal research, training and a centralized information system that provides real-time access to current industry and technology information and project methodologies, experiences, models and tools. FCG's principal research and practice support initiatives include the Emerging Practices Group, Professional Development Programs, the Scottsdale Informatics Institute, and Knowledge, Information, Technology Exchange (KITE(R)).
EMERGING PRACTICES GROUP. The Emerging Practices Group performs industry research and collects, packages and distributes knowledge regarding emerging trends in the healthcare and pharmaceutical industries. Examples of topics that the Emerging Practices Group has researched are HIPAA, information technology value management, clinical performance improvement and medical errors, e-health, and health related industry trends and the implications for IT. FCG documents research findings, conducts internal and client workshops on these topics, and makes the research available for use in its client engagements. The Emerging Practices Group also publishes a periodic news summary that appears on the Company's web site and is sent via email to several thousand subscribers.
PROFESSIONAL DEVELOPMENT AND INCENTIVE PROGRAMS. FCG has instituted several professional development and incentive programs to encourage employee retention and to provide support for the professional growth of all its employees. FCG provides training to its employees through an annual four-day educational retreat, as well as ongoing classroom education, computer-based training, distance learning and external seminars. FCG has programs to educate all new employees about the history, culture, and practices of FCG. All employees are required to establish an annual professional development plan for knowledge acquisition, skill development, leadership assessment and training, project management and relationship management.
SCOTTSDALE INSTITUTE. FCG provides program management, research and advisory support to the Scottsdale Informatics Institute. The Scottsdale Informatics Institute is a membership organization composed of approximately 30 healthcare organizations across the United States, typically represented by their Chief Executive Officers, Chief Operating Officers and Chief Information Officers. Membership is by invitation only. The Scottsdale Institute provides its members with a cost-sharing vehicle for information exchange, problem solving and learning related to improving performance through information management. This enables members to more efficiently utilize information technology for performance improvement. In turn, it helps FCG to develop practical, applied solutions to problems of leading healthcare organizations and to anticipate service needs of the broader market.
KNOWLEDGE, INFORMATION, TECHNOLOGY EXCHANGE (KITE(R)). FCG's personnel have access to FCG's internal research and to current industry and technology information and project methodologies, experiences, models and tools through KITE(R). KITE(R) currently houses over 26,000 documents that include industry information, service methodologies and tools, benchmarks and best practice information, and other documentation to support FCG's services and consultants. KITE(R) is updated on a continuous basis with information resulting from each engagement, and by the Emerging Practices Group. FCG believes that this resource allows its consultants to utilize engagement-specific information that improves the quality and content of services delivered to clients while reducing cost of delivery.
INTERNATIONAL OPERATIONS
FCG has provided its consulting, integration, and interim management services to clients in Canada, Germany, France, Austria, Switzerland, Republic of Ireland, Mexico and the United Kingdom, and maintains offices in Frankfurt, Germany, London and St. Asaph, United Kingdom. In the third quarter of 2000 the Company closed its European Healthcare operations in order to improve FCG's overall profitability and to allow management to focus on other parts of its business. In June of 1999, the Company opened a European life sciences operation to meet the needs of its multi-national pharmaceutical companies. In December 1999, FCG acquired Activa, a U.K. based niche company specializing in Documentum services. The Company will continue to explore ways to expand its capabilities in the provision of integration services for pharmaceutical and other life sciences organizations in Europe. Please see "Risks Relating to the Business of FCG" below for a discussion of risks associated with FCG's international operations.
COMPETITION
The market for healthcare consulting, integration, and management services is intensely competitive, rapidly evolving and highly fragmented. The Company has competitors that provide some or all of the services provided by the Company. The Company competes for consulting services with international consulting firms, regional and specialty consulting firms, and the consulting groups of international accounting firms such as KPMG LLP, Deloitte & Touche LLP, PricewaterhouseCoopers, LLP, and Arthur Andersen & Company. In its integration and management services, the Company competes with information system vendors such as McKesson/HBOC, Siemens Medical Solutions and Integrated
Systems Solution Corporation, a division of International Business Machines Corporation; 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; and other healthcare consulting firms. In e-health and e-commerce related services the Company competes with the traditional competitors outlined above, as well as newer Internet product and service companies such as iXL, Razorfish, Scient, TriZetto, and Viant. Many of the Company's competitors have significantly greater financial, human and marketing resources than the Company. 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 the Company. In addition, as healthcare organizations become larger and more complex, the Company's larger competitors may be better able to serve the needs of such organizations. The Company may not be able to attract and retain the personnel or to dedicate the financial resources necessary to serve these resulting organizations.
The Company believes that it competes primarily on the basis of its expertise, reputation and quality of its services; however, its clients may become increasingly price-sensitive as competitive pricing pressures increase. Large information technology companies have, in the past, offered consulting services at a substantial discount as an incentive to utilize their implementation services, and software and hardware vendors may provide discounted implementation services for their products. These competitors may in the future discount such services more frequently or offer such services at no charge. There can be no assurance that the Company will be able to compete for price-sensitive clients on the basis of its current pricing or cost structure, or that the Company will be able to lower its prices or costs in order to compete effectively. Furthermore, many of the Company's competitors have long-standing business relationships with key personnel at healthcare organizations, which could prevent or delay the Company from expanding its client base. The Company believes that it has been able to compete successfully on the basis of the quality and range of its services and the accumulated expertise of its consultants. However, the Company may not be able to compete effectively with current and future competitors or competitive pressures faced by the Company may cause the Company's revenue or operating margins to decline or otherwise materially adversely affect FCG's business, financial condition and results of operations. Please see "Risks Relating to the Business of FCG" below for a discussion of additional risks associated with FCG's ability to compete in its markets.
LIMITED PROTECTION OF PROPRIETARY INFORMATION AND PROCEDURES
The Company's ability to compete effectively depends on its ability to protect its proprietary information, including its proprietary methodologies, research, tools, software code and other information. The Company relies primarily on a combination of copyright and trade secret laws and confidentiality procedures to protect its intellectual property rights. The Company requests that its consultants and employees sign confidentiality agreements and generally limits access to and distribution of its research, methodologies and software codes. The steps taken by the Company to protect its proprietary information may not be adequate to prevent its misappropriation. 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. The unauthorized use of the Company's intellectual property could have a material adverse effect on the Company's business, financial condition or results of operations. The Company believes that its systems and procedures and other proprietary rights do not infringe upon the proprietary rights of third parties. However, third parties could assert infringement claims against the Company in the future, and such claims may result in protracted and costly litigation, regardless of the merits of such claims.
EMPLOYEES
As of December 31, 2000, FCG had 1,878 employees, 91 of whom were vice presidents with responsibility for service delivery, new business development, client relationships, staff development, and company leadership. FCG believes that its relationship with its employees is good. The Company uses a variety of techniques to identify and recruit qualified candidates to support its growth. The Company employs full time recruiters dedicated to the recruitment and hiring of personnel. One of the Company's most successful sources of new hires is the StarQuest, or internal employee referral program, which encourages employees to recommend or refer qualified candidates for employment with the Company, and rewards referring employees with referral bonuses. In 2000, 143 new hires came from the StarQuest program. The Company also places advertisements in various newspapers and uses professional search firms to identify candidates for hire. The Company participates in job fairs, and sponsors independent recruiting events, such as open houses and free technical seminars. Please see "Risks Relating to the Business of FCG" below for a discussion of risks associated with attracting and retaining qualified employees.
FIRST VENTURES
In 1999, the Company announced formation of its First Ventures Healthcare and Life Sciences venture capital fund. The purpose of First Ventures is to place up to $15 million in minority equity investments in growing private companies developing technologies and services serving the healthcare and life sciences marketplaces. First Ventures utilizes FCG's industry expertise, experience, and relationships to identify and evaluate potential investments. Once FCG makes an investment, it provides assistance and guidance to its portfolio companies on issues such as management, technology, consulting, planning, and growth. First Ventures portfolio companies may also be or become partners with, customers of, or vendors to, FCG. To date, First Ventures has made two investments of $1 million each.
VENDOR RELATIONSHIPS
FCG has established numerous vendor relationships through its vendor alliance program. The Company believes the formation of these relationships enables it to increase its knowledge of key vendor solutions, obtain appropriate training, education, and certification on key technologies and solutions, and gain advantages from joint marketing approaches where appropriate. In turn, FCG is able to more rapidly identify and deliver integrated solutions to its clients, based on leading technologies, applications and solutions.
The Company has established non-exclusive alliance agreements with software, hardware, and services vendors that market components and solutions to FCG's current and prospective clients. The vendor alliance programs of which FCG is a part have provided FCG with sales leads, marketing assistance revenues, increased publicity, discounted software, specialized training programs, participation in beta software programs and privileged information about vendors' technical and marketing strategies.
The Company's relationships range from obtaining education and product/service updates to product implementation training and certification to joint marketing programs. Joint marketing programs typically involve joint account development and marketing, trade shows, development of collateral, marketing
through each company's web site, and other marketing efforts. Clients generally contract directly with the vendor for purchase of the products. FCG currently maintains relationships with the vendors depicted below:
RISKS RELATING TO THE BUSINESS OF FCG
THERE ARE VARIOUS FACTORS, WHICH MAY CAUSE OUR NET REVENUES, OPERATING RESULTS AND CASH FLOWS TO FLUCTUATE. Our net revenue, operating results and cash flows may fluctuate significantly because of a number of factors, many of which are outside our control. These factors may include:
o Losing one or more significant clients
o Fluctuations in market demand for our services, consultant hiring and utilization
o Delays in securing and completing client engagements
o Timing and collection of payments and new client engagements
o Increased competition and pricing pressures
o Losing key personnel and other employees
o Changes in our, and our competitor's, business strategy, pricing and billing policies
o Timing of certain general and administrative expenses
o Consummating an acquisition and the costs of integrating acquired operations
o Variability in the number of billable days in each quarter
o Availability of foreign net operating losses and other credits against our earnings
o International currency fluctuations
o The fixed nature of a substantial portion of our expenses, particularly personnel and related costs, depreciation, office rent and occupancy costs
One or more of the foregoing factors may cause our operating expenses to be relatively high during any given period. In addition, we bill certain of our services on a fixed-price basis, and any assignment delays or expenditures of time beyond that projected for the assignment could result in write-offs of client billings. Significant write-offs could materially adversely effect our business, financial condition and results of operations. Based on the preceding factors, we may experience a shortfall in revenue or earnings or otherwise fail to meet public market expectations, which could materially adversely effect our business, financial condition and the market price of our common stock.
In particular, for the fiscal quarters ended December 31, 1999, March 31, 2000, June 30, 2000 September 30, 2000, and December 31, 2000, we reported net losses (including non-recurring items) of $354,000, $1,707,000, $3,864,000, $6,178,000, and $2,125,000 respectively. We cannot assure you that we will return to profitability in the future, which could materially adversely affect our business, financial condition and the market price of our common stock.
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 client engagements and service fulfillment is not predictable with any degree of accuracy. Prior engagement cycles are not necessarily an indication of the timing of future client engagements or revenues.
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. We may be required to hire new consultants before securing a client engagement. Clients may defer committing to new assignments for any length of time and for any reason. Such deferrals could require us to maintain a significant number of under-utilized consultants during any given period. In addition, failing to procure an engagement after spending such time and resources could materially adversely effect our business, financial condition and results of operations.
In particular, the outsourcing business which we conduct through our subsidiary, FCG Management Services, has very long lead times, requiring us to spend a substantial amount of time and resources in attempting to secure an 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.
The length of time required to complete an assignment often depends on factors outside our control, including:
o Existing information systems at the client site;
o Changes or the anticipation of changes in the regulatory environment affecting healthcare and pharmaceutical organizations;
o Changes in the management or ownership of the client;
o Budgetary cycles and constraints;
o Availability of personnel and other resources; and
o Consolidation in the healthcare and pharmaceutical industries.
IF WE ARE UNABLE TO GENERATE ADDITIONAL REVENUE FROM OUR EXISTING CLIENTS, OUR BUSINESS MAY BE NEGATIVELY AFFECTED. Our success depends on obtaining additional engagements from our existing clients. A substantial portion of our revenue is derived from services provided to our existing clients. The loss of a small number of clients may result in a material decline in revenues and cause us to fail to meet public market expectations of our financial performance and operating results. If we materially fail to generate additional revenues from our existing clients it may materially adversely effect our business, financial condition and results of operations.
IF WE FAIL TO MEET CLIENT EXPECTATIONS IN THE PERFORMANCE OF OUR SERVICES, OUR BUSINESS COULD SUFFER. Our services often involve complex information systems and software, which are critical to the clients' operations. Our failure to meet client expectations in the performance of our services, including the quality, cost and timeliness of our services, may damage our reputation in the healthcare and pharmaceutical industries and adversely affect our ability to attract and retain clients. If a client is not satisfied with our services, we will generally spend additional human and other resources at our own expense to ensure client satisfaction. Such expenditures will typically result in a lower margin on such engagements and could materially adversely effect our business, financial condition and results of operations.
In the course of providing our services, we will often recommend the use of other 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. 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, financial condition and results of operations. Although we maintain liability insurance, such insurance may not provide adequate coverage for successful claims against us.
OUR OUTSOURCING ACTIVITIES ENTAIL SIGNIFICANT ENGAGEMENTS IN WHICH WE WILL COMMIT TO SPECIFIC SERVICE LEVEL AGREEMENTS THAT DEFINE OUR RESPONSIBILITIES OVER THE CONTRACTED PERIOD. Any failure on the part of us to meet contracted service levels may result in financial penalty or default of the contract, and may have a material adverse effect on us. Our outsourcing engagements are typically performed on a fixed price basis where 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. Our ability to achieve profitability in our outsourcing activities is dependent upon the accuracy of our forecasting and our ability to deliver the contracted scope of services within the constraints of the fixed price contract. Any failure by us in these areas may have a material adverse effect on the profitability of our outsourcing business.
In addition, our outsourcing agreements require that we invest significant amounts of time and resources in order to win the engagement, transition the client's information technology department to our management and complete the initial transformation of our client's information technology functioning to meet agreed-upon service levels. Often, we recover this investment through payments over the life of the outsourcing agreement. If we are unable to achieve agreed-upon service levels or otherwise breach the terms of our outsourcing agreements, the clients may have rights to terminate the agreements and we may be unable to recover our investments. In the case of our outsourcing agreement with the New York & Presbyterian Hospital, this investment amounts to almost $10 million, which we will recover over the seven-year term of that agreement. Any failure by us to recover these investments may have a material adverse effect on our financial condition, results of operations and price of our common stock.
WE MAY BE UNABLE TO ATTRACT AND RETAIN A SUFFICIENT NUMBER OF QUALIFIED EMPLOYEES. Our business is labor-intensive and requires highly skilled employees. Most of our consultants possess extensive expertise in
healthcare, insurance, pharmaceutical, information technology and consulting fields. To serve a growing client base, we must continue to recruit and retain qualified personnel with expertise in each of these areas. Competition for such personnel is intense. 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. We may not be able to recruit and retain a sufficient number of qualified personnel to serve existing and new clients. If we fail to recruit and retain a sufficient number of qualified personnel, our ability to expand our client base or services could be impaired and our business, financial condition and results of operations could be adversely effected.
THE LOSS OF OUR VICE PRESIDENTS AND EXECUTIVE OFFICERS COULD NEGATIVELY AFFECT US. Our performance depends on the continued service of our vice presidents, executive officers and senior managers. In particular, we depend on such persons to secure new clients and engagements and to manage our business and affairs. The loss of such persons could result in disruption of our business and stock price volatility and could have a material adverse effect on our business, financial condition and results of operations. We have not entered into long-term employment contracts with any of our employees and do not maintain key employee life insurance.
CONTINUED OR INCREASED EMPLOYEE TURNOVER COULD NEGATIVELY AFFECT OUR BUSINESS. We have experienced employee turnover as a result of (1) dependence on lateral hiring of consultants, (2) travel demands imposed on our consultants, (3) loss of employees to competitors and clients, and (4) the growth in the number of internet-related companies. Continued or increased employee turnover could materially adversely affect our business, financial condition and results of operations. In addition, many of our consultants develop strong business relationships with our clients. We depend on these relationships to generate additional assignments and engagements. The loss of a substantial number of consultants could erode our client base and decrease our revenue.
IF WE ARE UNABLE TO MANAGE OUR GROWTH, OUR BUSINESS MAY BE NEGATIVELY IMPACTED. Our business has grown rapidly in recent years. This growth has placed new and increased demands on our vice presidents and other management personnel. This growth has also placed significant and increasing demands on our financial, technical and operational resources and on our information systems. To manage any future growth, we must (1) extend our financial reporting and information management systems to a growing number of offices and employees, and (2) develop and implement new procedures and controls to accommodate new operations, services and clients. Increasing operational and administrative demands may make it difficult for our vice presidents to engage in business development activities. Adding a significant number of new employees and offices may also 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 have a material adverse effect on our business, financial condition and results of operations. If we fail to effectively manage our growth, our business, financial condition and results of operations could be adversely affected.
WE COULD BE NEGATIVELY IMPACTED IF WE FAIL TO SUCCESSFULLY INTEGRATE THE BUSINESSES WE ACQUIRE. We intend to grow, in part, by acquiring complementary professional practices within the healthcare and pharmaceutical industries. In 1998, we completed three acquisitions; in 1999, we completed two more acquisitions; and in 2000 we completed one additional acquisition. Integrating acquired operations is a complex, time-consuming and expensive process. All acquisitions involve risks that could materially and adversely effect our business and operating results. These risks include (1) distracting management from our business, (2) losing key personnel and other employees, (3) losing clients, (4) costs, delays and
inefficiencies associated with integrating acquired operations and personnel, and (5) amortizing the cost of acquired assets and goodwill. Acquired businesses may not enhance our services, provide us with increased client opportunities or result in growth. 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 result in the loss of employees and clients. Failing to acquire and successfully integrate complementary practices could materially adversely effect our business, financial condition and results of operations.
OUR INTERNATIONAL OPERATIONS CREATE SPECIALIZED RISKS THAT CAN NEGATIVELY AFFECT US. We provide our services to international clients. Expanding into international markets will require us to (1) spend a significant amount of management, human and financial resources, (2) hire additional personnel, and (3) establish international offices.
We may be unable to recruit and retain a sufficient number of qualified consultants in each country in which we intend to conduct our business. If we fail to recruit and retain qualified employees, our ability to expand internationally may be impaired and our business, financial condition and results of operations could be adversely effected. Our international operations are subject to a variety of risks, including:
o Difficulties in creating international market demand for our services;
o Difficulties and costs of tailoring our services to each individual country's healthcare and pharmaceutical market needs;
o Unfavorable pricing and price competition;
o Currency fluctuations;
o Longer payment cycles in some countries and difficulties in collecting international accounts receivables;
o Difficulties in enforcing contractual obligations and intellectual property rights;
o Adverse tax consequences;
o Increased costs associated with maintaining international marketing efforts and offices;
o Adverse changes in regulatory requirements; and
o Economic instability.
We have been performing services in Europe for international clients for three years, and we have not yet been profitable in providing those services. We recently ceased performing healthcare consulting services in Europe, although we will continue to provide our services in Europe to our pharmaceutical clients. We cannot assure that we will be able to achieve profitability in our European pharmaceutical services, which may materially adversely effect our financial condition, results of operations and price for our common stock.
Any one or all of these factors may cause increased operating costs, lower than anticipated financial performance and may materially adversely effect our business, financial condition and results of operations.
IF WE DO NOT COMPETE EFFECTIVELY IN THE HEALTHCARE AND PHARMACEUTICAL INFORMATION SERVICES INDUSTRIES, THEN OUR BUSINESS MAY BE NEGATIVELY IMPACTED. The market for healthcare and pharmaceutical information technology consulting is very competitive. We have competitors that provide some or all of the services we provide. In strategic consulting services, we compete with international consulting firms, regional and
specialty consulting firms and the consulting groups of international accounting firms such as KPMG LLP, Ernst & Young LLP, Deloitte & Touche LLP, PricewaterhouseCoopers, LLP and Arthur Andersen & Company.
In integration and co-management services, we compete with:
o information system vendors such as McKesson/HBOC, Siemens Medical Solutions and Integrated Systems Solution Corporation, a division of International Business Machines Corporation,
o service groups of computer equipment companies,
o systems integration companies such as Electronic Data Systems Corporation, Perot Systems Corporation, SAIC, CAP Gemini America, Inc. and Computer Sciences Corporation,
o clients' internal information management departments,
o other healthcare consulting firms and
o other pharmaceutical consulting firms such as Accenture, Technology Solutions Corporation, 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 such as iXL, Razorfish, Scient, TriZetto, and Viant.
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 complete effectively. This could result in a reduction in our revenues, resulting in lower earnings or operating losses, and otherwise materially adversely effecting our business, financial condition and results of operations.
IF WE FAIL TO ESTABLISH AND MAINTAIN RELATIONSHIPS WITH VENDORS OF SOFTWARE AND HARDWARE PRODUCTS, IT COULD HAVE A NEGATIVE EFFECT ON OUR ABILITY TO SECURE ENGAGEMENTS. We have a number of relationships with vendors. For example, we have established a non-exclusive partnership arrangement with Documentum, Inc. Documentum markets document management software applications largely to the pharmaceutical industry. We believe that our relationships with this vendor and others are important to our sales, marketing, and support activities. We often are engaged by vendors or their customers to implement or integrate vendor products based on our relationship with that vendor. If we fail to maintain our relationships with Documentum and other vendors or fails to establish additional new relationships, our business could be materially adversely effected.
OUR RELATIONSHIPS WITH AND INVESTMENTS IN VENDORS OF SOFTWARE AND HARDWARE PRODUCTS COULD HAVE A NEGATIVE IMPACT ON OUR ABILITY TO SECURE CONSULTING ENGAGEMENTS. Our growing number of relationships with software and hardware vendors could result in clients perceiving that we are not independent from those software and hardware vendors. Our ability to secure assessment and other consulting engagements is often dependent, in part, on our being independent of software and hardware solutions that we may review, analyze or recommend to clients. If clients believe that we are not independent of those software
and hardware vendors, clients may not engage us for certain consulting engagements relating to those vendors, which could materially adversely effect our business, financial condition and results of operations.
This is particularly true since we announced the formation of our First Ventures venture capital fund. First Ventures has made initial investments for us in software vendors such as Confer Software, Inc., and Sentillion, Inc. First Ventures will invest in other companies. Any of First Ventures' investments may be in software or hardware vendors who sell and license products to healthcare, pharmaceutical and other companies that may be our clients. If clients believe that we are not independent of the companies that First Ventures invests in, clients may not engage us for certain consulting engagements relating to those companies, which could materially adversely effect our business, financial condition and results of operations.
WE MAY EXPERIENCE LOSSES IN OUR INVESTMENTS IN FIRST VENTURES. We have committed up to $15 million to invest through First Ventures, our venture capital fund formed in 1999. First Ventures has invested and may invest in early-stage companies with limited capitalization and no public market for their shares. Many of these companies have never earned profits or, in some cases, realized any revenues on sales of products or services. We have no assurances that these companies will be successful or that we will earn any returns on our investments, and we could suffer a loss of any or all funds invested through First Ventures. Even if the companies in which First Ventures invests are successful, we have no assurances that we will be able to sell our shares in those companies or otherwise realize any value in the investments, or that any sale will be on terms favorable to First Ventures and us. If we experience investment losses in First Ventures, this could materially adversely effect our business, financial condition and results of operations.
IF WE FAIL TO KEEP PACE WITH REGULATORY AND TECHNOLOGICAL CHANGES OUR BUSINESS COULD BE MATERIALLY ADVERSELY AFFECTED. The healthcare and pharmaceutical industries are subject to regulatory and technological changes that may affect the procurement practices and operations of healthcare and pharmaceutical organizations. During the past several years, the healthcare and pharmaceutical industries have been subject to an increase in governmental regulation and reform proposals. These reforms could increase governmental involvement in the healthcare and pharmaceutical industries, lower reimbursement rates or otherwise change the operating environment of our clients. Also, certain reforms that create potential work for us could be delayed or cancelled. Healthcare and pharmaceutical organizations may react to these situations by curtailing or deferring investments, including those for our services. We cannot predict with any certainty what impact, if any, such legislative reforms could have on our business.
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 effect our business, financial condition and results of operations.
CHANGES IN THE HEALTHCARE AND PHARMACEUTICAL INDUSTRIES COULD NEGATIVELY IMPACT OUR REVENUES. We derive a substantial portion of all of our revenue from clients in the healthcare industry. As a result, our business, financial condition and results of operations are influenced by conditions affecting this industry, particularly current trends towards consolidation among healthcare and pharmaceutical organizations. Such consolidation may reduce the number of existing and potential clients for our services. In addition, the resulting organizations could have greater bargaining power, which could erode the current pricing structure for our services. The reduction in the size of our target market or our failure to maintain our pricing strategies could have a material adverse effect on our business, financial condition and results of operations.
A substantial portion of our revenues has come from companies in the pharmaceutical business. Our revenues are, in part, linked to the pharmaceutical industry's research and development expenditures. Should any of the following events occur in the pharmaceutical industry, our business could be negatively affected in a material way:
o The industry's general economic environment changes adversely;
o Companies continue to consolidate; or
o Research and development expenditures or pharmaceutical companies' expenditures on technology in general decrease.
A trend in the pharmaceutical industry is for companies to "outsource" either large information technology-dependent projects or their information systems staffing requirements. Outsourcing means that, rather than utilize its own employees, a company contracts with a third party to undertake an entire project or to provide technical personnel to augment its own staff. We benefit when pharmaceutical companies outsource to us, but may lose significant future business when pharmaceutical companies outsource to our competitors. If this outsourcing trend slows down or stops, or if pharmaceutical companies direct their business away from us, our financial condition and results of operations could be impacted in a materially adverse way.
WE MAY BE UNABLE TO EFFECTIVELY PROTECT OUR PROPRIETARY INFORMATION AND PROCEDURES. We must protect our proprietary information, including our proprietary methodologies, research, tools, software code and other information. To do this, we rely on a combination of copyright and trade secret laws and confidentiality procedures to protect our intellectual property. These steps may not protect our proprietary information. In addition, the laws of certain countries do not protect or enforce proprietary rights to the same extent, as do the laws of the United States. We are currently providing our services to clients in international markets. Our proprietary information may not be protected to the same extent as provided under the laws of the United States, if at all. The unauthorized use of our intellectual property could have a material adverse effect on our business, financial condition or results of operations.
WE MAY INFRINGE THE INTELLECTUAL PROPERTY RIGHTS OF THIRD PARTIES. Our success depends, in part, on not infringing patents, copyrights and other intellectual property rights held by others. We do not know whether patents held or patent applications filed by third parties may force us to alter our methods of business and operation or require us to obtain licenses from third parties. If we attempt to obtain such licenses, we do not know whether we will be granted licenses or whether the terms of those licenses will be fair or acceptable to us. Third parties may assert infringement claims against us in the future. Such claims may result in protracted and costly litigation, penalties and fines, regardless of the merits of such claims.
OUR MANAGEMENT MAY BE ABLE TO EXERCISE CONTROL OVER MATTERS REQUIRING STOCKHOLDER APPROVAL. Our current officers, directors, and other affiliates beneficially own approximately 50% of our outstanding shares of common stock. As a result, our existing management, if acting together, may be able to exercise control over or significantly influence matters requiring stockholder approval, including the election of directors, mergers, consolidations, sales of all or substantially all of our assets, issuance of additional shares of stock and approval of new stock and option plans.
THE PRICE OF OUR COMMON STOCK MAY BE ADVERSELY AFFECTED BY MARKET VOLATILITY. The trading price of our common stock fluctuates significantly. Since our common stock began trading publicly in February
1998, the reported sale price of our common stock on the Nasdaq National Market has been as high as $29.13 and as low as $3.63 per share. This price may be influenced by many factors, including:
o our performance and prospects;
o the depth and liquidity of the market for our common stock;
o investor perception of us and the industries in which we operate;
o changes in earnings estimates or buy/sell recommendations by analysts;
o general financial and other market conditions; and
o domestic and international economic conditions.
In addition, public stock markets have experienced, and are currently experiencing, extreme price and trading volume volatility, particularly in high technology sectors of the market. This volatility has significantly affected the market prices of securities of many companies for reasons frequently unrelated to or disproportionately impacted by the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. As a result, we may be unable to raise capital or use our stock to acquire businesses on attractive terms and investors may be unable to resell their shares of our common stock at or above their purchase price.
IF OUR STOCK PRICE IS VOLATILE, WE MAY BECOME SUBJECT TO SECURITIES LITIGATION WHICH IS EXPENSIVE AND COULD RESULT IN A DIVERSION OF RESOURCES. If our stock price experiences periods of volatility, our security holders may initiate securities class action litigation against us. If we become involved in this type of litigation it could be very expensive and divert our management's attention and resources, which could materially and adversely affect our business and financial condition.
OUR CHARTER DOCUMENTS, DELAWARE LAW AND STOCKHOLDERS RIGHTS PLAN WILL MAKE IT MORE DIFFICULT TO ACQUIRE US AND MAY DISCOURAGE TAKE-OVER ATTEMPTS AND THUS DEPRESS THE MARKET PRICE OF OUR COMMON STOCK.
Our Board of Directors has the authority to issue up to 10,000,000 shares of undesignated preferred stock, to determine the powers, preferences and rights and the qualifications, limitations or restrictions granted to or imposed upon any unissued series of undesignated preferred stock and to fix the number of shares constituting any series and the designation of such series, without any further vote or action by our stockholders. The preferred stock could be issued with voting, liquidation, dividend and other rights superior to the rights of our common stock. Furthermore, any preferred stock may have other rights, including economic rights, senior to our common stock, and as a result, the issuance of any preferred stock could depress the market price of our common stock.
In addition, our certificate of incorporation eliminates the right of stockholders to act without a meeting and does not provide cumulative voting for the election of directors. Our certificate of incorporation also provides for a classified board of directors. The ability of our Board of Directors to issue preferred stock and these other provisions of our certificate of incorporation and bylaws may have the effect of deterring hostile takeovers or delaying changes in control or management.
We are 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 effect the market value of our common stock.
In 1999, our Board of Directors adopted a share purchase rights plan that is intended to protect our stockholders' interests in the event we are confronted with coercive takeover tactics. Pursuant to the stockholders rights plan, we distributed "rights" to purchase shares of a newly created series of preferred stock. Under some circumstances these rights become the rights to purchase shares of our common stock or securities of an acquiring entity at one-half the market value. The rights are not intended to prevent our takeover, rather they are designed to deal with the possibility of unilateral actions by hostile acquirers that could deprive our Board of Directors and stockholders of their ability to determine our destiny and obtain the highest price for our common stock.
ITEM 2.
ITEM 2. PROPERTIES
FCG's headquarters is located in approximately 28,000 square feet of leased office space in Long Beach, California. FCG leases approximately 98,000 square feet in Wayne, Pennsylvania, which houses the majority of FCG's software development services employees plus a portion of FCG's practice support staff. FCG also has an additional 23 leases for local offices throughout the United States, the United Kingdom, and Germany. Overall, FCG's properties are suitable and adequate for FCG's needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time, FCG may be involved in claims or litigation that arise in the normal course of business. FCG is not currently a party to any legal proceedings which, if decided adversely to FCG, would have a material adverse effect on FCG's business, financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2000, no matters were submitted to a vote of the stockholders.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Since February 13, 1998, FCG Common Stock has been quoted on Nasdaq under the symbol "FCGI." The table below sets forth, for the quarters indicated, the reported high and low sale prices of FCG Common Stock reported on the Nasdaq National Market.
As of March 1, 2001, there were approximately 407 record holders of FCG Common Stock. Other than dividends previously paid by an acquired company to its individual owner, FCG has never paid cash dividends on its Common Stock and presently intends to continue to retain its earnings for use in the businesses.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical consolidated financial information of FCG as of December 31, 1999 and 2000 and for each of the years ended December 31, 1998, 1999 and 2000, has been derived from and should be read in conjunction with the consolidated financial statements of FCG and related notes thereto included elsewhere in this Report. The selected historical consolidated financial information of FCG as of December 31, 1996, 1997 and 1998 and for the years ended December 31, 1996 and December 31, 1997, have been derived from the audited consolidated financial statements of FCG, which are not included in this Report.
On December 18, 1998, FCG completed its merger with Integrated Systems Consulting Group, Inc. ("ISCG"). In December 1998, FCG also completed a merger with Pareto Consulting Ltd. ("Pareto"). The mergers were accounted for as poolings of interests and all prior period consolidated financial data presented herein has been restated to include the combined results of the acquisitions as though they had always been part of FCG.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following discussion and analysis should be read in conjunction with "Selected Financial Data" and the consolidated financial statements and notes thereto contained elsewhere in this Report. Except for the historical information contained herein, the discussion in this Report contains certain forward-looking statements that involve risks and uncertainties, such as statements of FCG's plans, objectives, expectations and intentions. The cautionary statements made in this Report should be read as being applicable to all related forward-looking statements wherever they appear in this prospectus. FCG's actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include those discussed in this section and the section entitled "Risks Relating to the Business of FCG" as well as those discussed elsewhere in this Report.
OVERVIEW
FCG provides services primarily to payors, providers, government agencies, pharmaceutical, biogenetic, and life science companies, and other healthcare organizations in North America and Europe. FCG generates substantially all of its revenue from fees for professional services. FCG typically bills for its services on an hourly, fixed-fee or monthly fixed-fee basis as specified by the agreement with a particular client. FCG establishes either standard or target hourly rates for each level of consultant based on several factors including industry and assignment-related experience, technical expertise, skills and knowledge. For services billed on an hourly basis, fees are determined by multiplying the amount of time expended on each assignment by the project hourly rate for the consultant(s) assigned to the engagement. Fixed fees are established on a per-assignment or monthly basis and are based on several factors such as the size, scope, complexity and duration of an assignment and the number of consultants required to complete the assignment. Actual hourly or fixed fees for an assignment may vary from the standard, target, or historical rates charged by FCG. For services billed on an hourly basis, FCG recognizes revenue as services are performed. For services billed on a fixed fee basis, FCG recognizes revenue using the percentage of completion method based either on 1) the amount of time completed on each assignment versus the projected number of hours required to complete such assignment, or 2) the amount of cost incurred on the assignment versus the projected total cost to complete the assignment. Revenue is recorded as incurred at assignment rates net of unplanned adjustments for specific engagements. Unplanned adjustments to revenue are booked at the time they are known. Out-of-pocket expenses are billed to and reimbursed by clients and offset against expenses incurred and are not included in recognized revenues. Provisions are made for estimated uncollectible amounts based on the Company's experience. FCG may obtain payment in advance of providing services. These advances are recorded as deferred revenue and reflected as a liability on FCG's balance sheet.
Cost of services primarily consists of the salaries, bonuses and related benefits of client-serving consultants and subcontractor expenses. General and administrative expenses primarily consist of the costs attributable to the development of the business and the support of its client-serving professionals, such as: non-billable travel; office space occupancy; investments in FCG's information systems, research and practice support and quality initiatives; salaries and expenses for executive management, financial accounting and administrative personnel; expenses for firm and business unit governance meetings; recruiting fees and professional development and training; and marketing, legal and other professional services. As associate related costs are relatively fixed, variations in FCG's revenues and operating results can occur as a result of variations in billing margins and utilization rates of its billable associates.
The Company routinely reviews its fees for services, professional compensation and overhead costs to ensure that its services and compensation are competitive within the industry. In addition, FCG routinely monitors the progress of client projects with its clients' senior management. Quality of Service Questionnaires are sent to the client after each engagement with the results compiled and reported to FCG executive management.
In connection with shares issued to FCG's vice presidents in return for interest-free notes, FCG recognizes compensation expense on its consolidated statement of operations. The recurring portion of FCG's compensation expense relating to stock issuances and the amortization of deferred compensation is reflected in FCG's consolidated statements of operations as general and administrative expenses or cost of services based on the function of the employee to whom the charge relates. FCG matches employee 401(k) contributions with either cash or shares of FCG Common Stock based on the fair market value of the shares.
FCG's most significant expenses are its human resource and related salary and benefit expenses. As of December 31, 2000, approximately 60% or 1,122 of FCG's 1,878 employees are billable consultants. Another 372 employees form the firm's outsourcing business. The salaries and benefits of such billable consultants and outsourcing related employees are recognized in FCG's cost of services. Non-billable employee salaries and benefits are recognized as a component of general and administrative expenses. Approximately 20%, or 384 employees are classified as non-billable. FCG's cost of services as a percentage of revenue is directly related to its consultant utilization, which is the ratio of total billable hours to available hours in a given period, and the amount of cost recognized under percentage of completion accounting. FCG manages consultant utilization by monitoring assignment requirements and timetables, available and required skills, and available consultant hours per week and per month. FCG evaluates its fixed contracts on a monthly basis using percentage of completion accounting. Differences in personnel utilization rates can result from variations in the amount of non-billed time, which has historically consisted of training time, vacation time, time lost to illness and inclement weather and unassigned time. Non-billed time also includes time devoted to other necessary and productive activities such as sales support and interviewing prospective employees. Unassigned time results from differences in the timing of the completion of an existing assignment and the beginning of a new assignment. In order to reduce and limit unassigned time, FCG actively manages personnel utilization by monitoring and projecting estimated engagement start and completion dates and matching consultant availability with current and projected client requirements. The number of consultants staffed on an assignment will vary according to the size, complexity, duration and demands of the assignment. Assignment terminations, completions, inclement weather, and scheduling delays may result in periods in which consultants are not optimally utilized. An unanticipated termination of a significant assignment or an overall lengthening of the sales cycle could result in a higher than expected number of unassigned consultants and could cause FCG to experience lower margins. In addition, expansion into new markets and the hiring of consultants in advance of client assignments have resulted and may continue to result in periods of lower consultant utilization.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2000 AND 1999
NET REVENUE. FCG's net revenue increased to $248.9 million for the year ended December 31, 2000, an increase of 4.8% over the $237.6 million for the year ended December 31, 1999. This increase was primarily attributable to growth in the Company's life sciences, health plans, FCG Doghouse (e-services) and management services (outsourcing), offsetting significant declines in health delivery and infrastructure services (advanced technology and systems and networking). Excluding outsourcing, revenue from healthcare delivery clients declined from 42% of total revenue in the year ended December 31, 1999 to 25% of total revenue in the year ended December 31, 2000.
COST OF SERVICES. Cost of services increased to $187.2 million for the year ended December 31, 2000, an increase of 25.8% over the $148.8 million for the year ended December 31, 1999. The increase was primarily attributable to an increase in the number of outsourcing employees hired at the end of 1999 to handle the growth in that business. Cost of services as a percentage of revenue increased to 75.2% for the year ended December 31, 2000 from 62.6% for the year ended December 31, 1999. This increase was primarily attributable to decreased consultant utilization and pricing pressure due to the significant slowdown in work generated in the healthcare delivery market in the post-Y2K environment.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased to $77.0 million for the year ended December 31, 2000, an increase of 11.1% over the $69.3 million for the year ended December 31, 1999. General and administrative expenses as a percentage of revenue increased to 30.9% for the year ended December 31, 2000 from 29.2% for the year ended December 31, 1999. This increase was due to incremental general administrative costs to operate FCG's new Doghouse e-services business and FCG's significantly increased outsourcing business.
MERGER, RESTRUCTURING, AND SEVERANCE COSTS. Merger, restructuring, and severance costs increased to $9.2 million for the year ended December 31, 2000 from $3.6 million for the year ended December 31, 1999. The costs incurred in 2000 were primarily attributable to the shutdown of FCG's European healthcare operations, the separation of approximately 150 U.S. employees due to the contraction in the healthcare delivery market, and the related consolidation and resizing of selected offices. The costs incurred during 1999 were primarily attributable to restructuring and severance costs associated with rationalizing capacity requirements in Europe, and secondarily separation costs associated with the merger between FCG and ISCG in December 1998.
INTEREST INCOME, NET. Interest income, net of interest expense, decreased to $2.4 million for the year ended December 31, 2000 from $2.6 million for the year ended December 31, 1999 due to a decline in invested cash. Interest income net of interest expense as a percentage of revenue decreased to 0.9% for the year ended December 31, 2000 from 1.1% for the year ended December 31, 1999.
OTHER INCOME (EXPENSE). Other expense of $1.0 million for the year ended December 31, 2000 compared to other income of $3.9 million for the year ended December 31, 1999. This substantial other income in 1999 was primarily attributable to the receipt of net proceeds from a life insurance policy for former Co-founder, Chairman and CEO James A. Reep, who passed away in April 1999. Other expense in 2000 primarily related to the $0.7 million writedown of FCG's investment in a startup software company.
INCOME TAXES. Income taxes as a percentage of income before income taxes increased to 40.0% for the year ended December 31, 2000 from 34.0% for the year ended December 31, 1999 primarily due to the effect of the other income in the 1999 fiscal year from the life insurance proceeds noted above not being taxable income, thus lowering the effective tax rate for the year, while the fiscal year 2000 tax provision reflected a more typical rate.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1999 AND 1998
NET REVENUE. FCG's net revenue increased to $237.6 million for the year ended December 31, 1999, an increase of 21.0% over the $196.3 million for the year ended December 31, 1998. This increase was primarily attributable to an increase in revenue from FCG's business service lines including application development, integration services, implementation services, and outsourcing management services.
COST OF SERVICES. Cost of services increased to $148.8 million for the year ended December 31, 1999, an increase of 34.2% over the $110.8 million for the year ended December 31, 1998. The increase was primarily attributable to an increase in the number of client-serving consultants and outsourcing
employees hired during the period to respond to the Company's growth. Cost of services as a percentage of revenue increased to 62.6% for the year ended December 31, 1999 from 56.5% for the year ended December 31, 1998. This increase was primarily attributable to decreased consultant utilization and corresponding revenue shortfall experienced in the second half of 1999 caused primarily by industry uncertainties surrounding Y2K.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased to $69.3 million for the year ended December 31, 1999, an increase of 9.5% over the $63.3 million for the year ended December 31, 1998. General and administrative expenses as a percentage of revenue decreased to 29.2% for the year ended December 31, 1999 from 32.2% for the year ended December 31, 1998. This decrease was primarily attributable to the firm's conscious efforts to reduce certain non-client related expenses. General, and administrative expenses are principally expenses to support FCG's investment in attaining new client work, recruiting new employees, governing costs associated with the practice and firm, enhancing internal professional development and training, and supporting the firm's infrastructure.
MERGER, RESTRUCTURING, AND SEVERANCE COSTS. Merger, restructuring, and severance costs decreased to $3.6 million for the year ended December 31, 1999 from $6.0 million for the year ended December 31, 1998. The costs incurred during 1999 were primarily attributable to restructuring and severance costs associated with rationalizing capacity requirements in Europe, and secondarily separation costs associated with the merger between FCG and ISCG in December 1998. The costs incurred in 1998 were primarily attributable to the merger between FCG and ISCG, and secondarily, the costs as a result of the termination of a potential business combination contemplated by ISCG prior to the merger between FCG and ISCG.
INTEREST INCOME, NET. Interest income, net of interest expense, increased to $2.6 million for the year ended December 31, 1999 from $2.3 million for the year ended December 31, 1998. Interest income net of interest expense as a percentage of revenue slightly decreased to 1.1% for the year ended December 31, 1999 from 1.2% for the year ended December 31, 1998.
OTHER INCOME. Other income increased to $3.9 million for the year ended December 31, 1999 from $55,000 for the year ended December 31, 1998. This increase was primarily attributable to the receipt of net proceeds from a life insurance policy for former Co-founder, Chairman and CEO James A. Reep, who passed away in April 1999. Other income was negligible in the prior year.
INCOME TAXES. Income taxes as a percentage of income before income taxes decreased to 34.0% for the year ended December 31, 1999 from 55.4% for the year ended December 31, 1998 primarily due to the effect of the other income in the current year from the life insurance proceeds noted above not being taxable income, thus lowering the effective tax rate for the year, while there had been certain nondeductible expenses related to the European operations which had caused a higher rate in 1998.
QUARTERLY FINANCIAL RESULTS
The following table sets forth certain unaudited statements of operations data for the eight quarters ended December 31, 2000, as well as such data expressed as a percentage of the Company's net revenue for the periods indicated. This data has been derived from unaudited financial statements that, in the opinion of the Company's management, include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of such information when read in conjunction with the Company's annual audited consolidated financial statements and the notes thereto. The operating results for any quarter are not necessarily indicative of the results for any future period.
UNAUDITED QUARTERLY STATEMENTS OF OPERATIONS (In Thousands, Except Per Share Data)
PERCENTAGE OF NET REVENUE
A substantial portion of the Company's expenses, particularly depreciation, office rent and occupancy costs, and, in the short run, personnel and related costs are relatively fixed. Certain client-reimbursable costs are offset against expenses incurred, and are not included in recognized revenues. The Company's quarterly operating results may vary significantly in the future depending on a number of factors, many of which are outside the control of the Company. These factors may include: the reduction in size, delay in commencement, interruption or termination of one or more significant engagements or assignments; fluctuations in consultant hiring and utilization; the loss of personnel; the loss of one or more significant clients; the unpredictability of engaging new clients and additional assignments from existing clients; increased competition; write-offs of client billings; consolidation of, and subsequent reduction in the number of, healthcare providers; pricing pressure; the number, timing and contractual terms of significant client engagements; market demand for the Company's services; delays or increased expenses incurred in connection with existing assignments; changes in pricing policies by the Company or its competitors; changes in the Company's business strategies; variability in the number of business days within a quarter; and international currency fluctuations. Due to the foregoing factors, quarterly revenue and operating results are not predictable with any significant degree of accuracy. In particular, the timing between initial client contract and fulfillment of the criteria necessary for revenue recognition can be lengthy and unpredictable, and revenue in any given quarter can be materially adversely affected as a result of such
unpredictability. Business practices of clients, such as deferring commitments on new assignments until after the end of fiscal periods, could require the Company to maintain a significant number of under-utilized consultants, which could have a material adverse effect on the Company's business, financial condition, and results of operations.
The Company typically experiences a lower number of billable days in the second and fourth quarters of every year. The Company requires attendance at an annual meeting of nearly two-thirds of its employees in the second quarter of every year and encourages its employees to take vacation during the December holidays. Variability in the number of billable days may also result from other factors such as vacation days, sick time, paid and unpaid leave, inclement weather, and holidays, all of which could produce variability in the Company's revenue and costs. In the event of any downturn in potential clients' businesses or the economy in general, planned utilization of the Company's services may be deferred or canceled, which could have a material adverse effect on the Company's business, financial condition and results of operations. Based on the preceding factors, the Company may experience a shortfall in revenue or earnings from expected levels or otherwise fail to meet expectations of securities analysts or the market in general, which could have a material adverse effect on the market price of the Common Stock.
LIQUIDITY AND CAPITAL RESOURCES
During the year ended December 31, 2000, the Company used cash flow for operations of $12.8 million. During the year ended December 31, 2000, the Company used cash flow of approximately $5.0 million to purchase property and equipment, including computer and related equipment and office furniture. Depreciation and amortization expense for the year ended December 31, 2000 was approximately $6.4 million. During the year ended December 31, 2000, the Company generated cash flow of $2.1 million from financing activities. At December 31, 2000, the Company had working capital of $62.8 million and long-term investments of $4.5 million. At December 31, 1999, the Company had working capital of $72.0 million and long-term investments of $17.1 million. The primary reason for the decrease in working capital and long-term investments was cash spent to fund the company's operating losses and restructuring costs. At December 31, 2000, FCG had a total of approximately $30.0 million of cash and liquid investments.
The Company had a $9 million revolving line of credit available through May 1, 2000, at the bank's prevailing prime rate. This line of credit expired at that point, but was reinstituted at $10 million in early 2001 on similar terms. The Company has a note payable to the bank with a remaining balance of $131,000 at December 31, 2000. The note bears interest at the bank's prime rate plus 0.5% and is payable in monthly installments of $4,000 plus interest with the last installment due July 1, 2003. All borrowings under the Company's credit facilities are secured by the Company's accounts receivable and other rights to payment, general intangibles and equipment. The line of credit agreement provides that the Company must satisfy certain covenants and restrictions.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's annual consolidated financial statements are included in Item 14 of this Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information required by this item is incorporated by reference to material that will be filed with the Securities and Exchange Commission by May 1, 2001, either as part of FCG's Proxy Statement for its 2001 Annual Meeting or as an amendment to this Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to material that will be filed with the Securities and Exchange Commission by May 1, 2001, either as part of FCG's Proxy Statement for its 2001 Annual Meeting or as an amendment to this Form 10-K.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to material that will be filed with the Securities and Exchange Commission by May 1, 2001, either as part of FCG's Proxy Statement for its 2001 Annual Meeting or as an amendment to this Form 10-K.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to material that will be filed with the Securities and Exchange Commission by May 1, 2001, either as part of FCG's Proxy Statement for its 2001 Annual Meeting or as an amendment to this Form 10-K.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT, SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) The following financial statements are filed as part of this Annual Report on Form 10-K:
(3) The exhibits listed in the Index to Exhibits hereof are attached hereto or incorporated herein by reference and filed as apart of this Report.
(b) Reports on Form 8-K.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (In Thousands, Except Share Data)
- ------------------------------------------------------------------------------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Per Share Data)
- ------------------------------------------------------------------------------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY-- FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(In Thousands)
- ----------------------------------------------------------------------------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands)
- ------------------------------------------------------------------------------ THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (In Thousands)
- ------------------------------------------------------------------------------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
First Consulting Group, Inc. and its subsidiaries (the "Company") is a leading provider of information technology and other consulting services primarily for healthcare providers, payors, other healthcare organizations, and pharmaceutical/life science firms. The Company's services are designed to assist its clients in increasing operations effectiveness by reducing cost, improving customer service and enhancing the quality of patient care. The Company provides this expertise to clients by assembling multi-disciplinary teams that provide comprehensive services. The Company's services and consultants are supported by internal research and a centralized information system, which provides real-time access to current industry and technology information, project methodologies, experiences and tools.
1. PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of First Consulting Group, Inc. and its subsidiaries. All material intercompany accounts and transactions have been eliminated.
2. CASH AND CASH EQUIVALENTS
The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
3. PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization are provided on a straight-line basis in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives, which are three to five years for information systems equipment, and three to ten years for furniture and equipment. Leasehold improvements are amortized over the lives of the respective leases or the service lives of the improvements, whichever is shorter.
4. UNBILLED RECEIVABLES
Unbilled receivables represent the recognized net revenue for services performed that had not been billed to clients at the balance sheet date. Such amounts are billed as project requisites are met.
5. INCOME TAXES
The Company accounts for income taxes on the liability method under which deferred tax liabilities (assets) are determined based on the differences between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. Deferred tax expense (benefit) is equal to the change in the deferred tax liability (asset) from the beginning to the end of the year. A current tax asset or liability is recognized for the estimated taxes refundable or payable for the current year.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTA A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
6. OTHER INCOME/EXPENSE
Other income in 1999 primarily consists of the proceeds from a life insurance policy. Other expense in 2000 primarily consists of the reduction in the carrying value of an equity investment and the elimination of minority interests in consolidated companies.
7. REVENUE RECOGNITION
The Company generates substantially all of its revenue from fees for professional services. The Company typically bills for its services on an hourly, fixed-fee or fixed-fee per month basis. For services billed on an hourly basis, the Company recognizes revenue as services are performed. For services billed on a fixed-fee or fixed-fee per month basis, the Company recognizes revenue using the percentage of completion method. Revenue is recorded as hours are incurred at assignment rates net of any adjustments due to specific engagement situations.
8. 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 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS 123"). SFAS 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. See Note F below.
9. 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 convertible shares and stock options were converted or exercised. Convertible shares and stock options are not considered when computing net loss per share. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase Common Stock at the average market price during the period. ASOP shares that have not been committed to be released are not treated as outstanding when determining the weighted average number of shares for either basic or diluted net income per share. All share and per share data amounts have been adjusted to reflect a four-for-one stock split in January 1998.
10. CREDIT RISKS
Financial instruments that subject the Company to concentrations of credit risks consist primarily of billed and unbilled accounts receivable. The Company's clients are primarily involved in the healthcare and pharmaceutical industries. Concentrations of credit risk with respect to billed and unbilled accounts receivable are limited due to the Company's credit evaluation process and the nature of its clients. Historically, the Company has not incurred significant credit-related losses.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTA A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
Management believes the fair value of financial instruments approximates their carrying amounts. The carrying value of cash and cash equivalents approximate their estimated fair values due to the short-term nature of these instruments. Investments available for sale are carried at fair value. Management believes the fair values of notes payable and stockholders' notes receivable approximate their carrying values based on current rates for instruments with similar characteristics.
12. GOODWILL
Goodwill and other intangibles are amortized on a straight-line basis over periods estimated to be benefited, generally five to ten years. Accumulated amortization, at December 31, 2000 and 1999, was $2,319,000 and $1,361,000, respectively. The Company periodically assesses the recoverability of its goodwill based on a review of projected undiscounted cash flows of the related operating entities.
13. DEFERRED COMPENSATION -- STOCK INCENTIVE AGREEMENTS
In accordance with APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, with regard to certain stock issued prior to the initial public offering, the Company recorded a charge to deferred compensation when it granted options or sold stock to officers or employees at an exercise price which was less than the fair market value of such shares. Amounts recorded as deferred compensation are amortized over the appropriate service period based upon the vesting schedule for such grants (generally ten years).
14. USE OF ESTIMATES
In preparing financial statements in conformity with generally accepted accounting principles, 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.
15. FOREIGN CURRENCY TRANSLATION
Assets and liabilities of the Company's foreign affiliates are translated at current exchange rates, while revenue and expenses are translated at average rates prevailing during the year. Translation adjustments are reported as a component of other comprehensive income.
16. RECLASSIFICATIONS
Certain reclassifications have been made to the 1999 and 1998 financial statements to conform to the 2000 presentation.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTA A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
17. LONG-TERM UNBILLED RECEIVABLES
Long-term unbilled receivables of $11,008,000 represents revenue recognized using the percentage of completion accounting in excess of amounts currently billable on a major outsourcing contract. This contract has a duration of seven years. The long-term receivable will be billed and collected gradually over the remaining six years of the contract through contractual billings that will exceed the amounts to be earned as revenue.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B -- BUSINESS COMBINATIONS
In December 1998, FCG completed a merger with Integrated Systems Consulting Group, Inc. ("ISCG"), by exchanging approximately 6,240,000 shares of its Common Stock for all of the Common Stock of ISCG. Each share of ISCG was exchanged for .77 of one share of FCG Common Stock. In addition, outstanding ISCG employee stock options were converted at the same exchange factor into options to purchase approximately 633,000 shares of FCG Common Stock. In December 1998, FCG also completed a merger with Pareto Consulting Ltd. ("Pareto"), by exchanging 147,531 shares of FCG Common Stock for all of the shares of Pareto.
The mergers with ISCG and Pareto have been accounted for as poolings of interests. Accordingly, all prior period consolidated financial statements presented have been restated to include the combined results of operations, financial position and cash flows of ISCG and Pareto as though they had always been a part of FCG.
Prior to the merger, Pareto's fiscal year ended on April 30. In recording the business combination, Pareto's prior period financial statements have been restated to a year ended December 31, to conform to FCG's fiscal year-end. Certain immaterial adjustments and reclassifications were made to the ISCG and Pareto financial statements to conform to FCG's presentations. The results of operations for the separate companies and the combined amounts presented in the consolidated financial statements are as follows:
In connection with the mergers, the Company recorded in the fourth quarter of 1998 a charge to operating expenses of $5.6 million for direct and other merger-related costs. Merger-related costs consisted primarily of fees for investment bankers, attorneys, accountants, financial printing, other related transaction costs, and exit costs. At December 31, 1999, all of these costs had been paid.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B -- BUSINESS COMBINATIONS (CONTINUED)
ACTIVA
In December 1999, the Company acquired certain assets and the business of Activa Systems Limited (Activa) for $770,000 in cash. Activa is a provider of Documentum-based controlled document solutions serving the pharmaceutical industry based in Wales, which has 13 employees and reported approximately $800,000 in revenue in 1999. This acquisition was accounted for using the purchase method of accounting. The fair value of the identifiable assets acquired was $70,000. The remainder of the purchase price was allocated to goodwill.
SDC
In February 1999, the Company acquired the business of SDC Consulting (SDC) for $2,000,000 in cash. SDC is a healthcare management consulting firm located in Leeds, England. At the time of its acquisition by the Company, SDC had 11 employees and reported revenues of approximately $2,300,000 in 1998. The acquisition was accounted for using the purchase method of accounting. The fair value of the identifiable assets acquired was zero, so the entire purchase price was allocated to goodwill.
WAVEFRONT
In February 1998, the Company acquired all of the outstanding shares of capital stock of WaveFront Consulting, Inc. ("WaveFront") for an initial cash payment of $3,650,000, plus conditional payments based upon future operating income. WaveFront is an information technology consulting firm located in Vienna, Virginia, specializing in providing distributed computing solutions, including client/server and internet development, principally in the telecommunications industry. WaveFront had 30 employees and reported revenues of $2.8 million for the year ended December 31, 1997. This acquisition was accounted for using the purchase method of accounting. The fair value of the identifiable net assets acquired was approximately $300,000. The remainder of the purchase price including the conditional payments has been allocated to goodwill.
GREENHALGH
In January 1998, the Company acquired all of the outstanding shares of Greenhalgh and Company Limited for $220,000 in cash and 36,300 shares of FCG Common Stock valued at $287,000. Greenhalgh is an information systems consulting firm located in Macclesfield, England, which reported $1.4 million in revenue in 1997. This acquisition was accounted for using the purchase method of accounting. The fair value of the identifiable net liabilities acquired was approximately $100,000. The purchase price together with this acquired liability was allocated to goodwill.
DOGHOUSE
On May 24, 2000, the Company created a new e-services company composed of the newly acquired web development and design business of Doghouse Products, LLC and existing web expertise from FCG. Under the terms of the agreement, FCG acquired certain assets of Doghouse Productions, LLC for approximately $6.7 million including $3,000,000 of cash, $1,800,000 of FCG Stock, and a minority
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
equity stake in the new e-service company valued at $1,940,000. The acquisition was accounted for using the purchase method of accounting and the allocation of the purchase price is set forth below:
The accounts of Activa, SDC, WaveFront, Greenhalgh and Doghouse have been included in the accompanying financial statements for the period from their respective purchase dates through December 31, 2000. Pro forma information as if these acquisitions had occurred on January 1, 1998 have not been provided since such pro forma results do not differ materially from those reported in the accompanying financial statements.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE C -- NOTES PAYABLE
The Company had a $9,000,000 revolving line of credit which was available through May 1, 2000, at the bank's prevailing prime rate. This line of credit expired at that point, but was reinstated for $10,000,000 in early 2001 with an expiration date of September 1, 2001. The balance outstanding on this line of credit was zero at December 31, 2000, and 1999. Borrowings on the line are collaterized by all of the Company's deposit accounts, accounts receivable and equipment. Under the line of credit agreement, the Company is required to pay a fee equal to 0.25% per annum on the average daily-unused balance and maintain selected financial ratios.
Long-term debt is summarized as follows (in thousands):
The note payable to bank is collateralized by all deposit accounts, accounts receivable, and equipment of the Company. The note bears interest at the bank's prime rate (9.5% and 8.25% at December 31, 2000 and 1999, respectively) plus 0.5%. The note is payable in monthly installments of $4,000 plus interest with the last installment due July 1, 2003.
FIRST CONSOLIDATED GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE D -- INCOME TAXES
The provision for income taxes consists of the following (in thousands):
Temporary differences consist of the following (in thousands):
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE D - INCOME TAXES (CONTINUED)
As a result of the following items, the total provision for income taxes was different from the amount computed by applying the statutory U.S. federal income tax rate to earnings before income taxes:
The Company has state net operating loss carryforwards of approximately $6.6 million, expiring principally in years 2005 through 2010. These carryforwards are available to offset future state taxable income.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE E - NOTES RECEIVABLE - STOCKHOLDERS
Notes receivable from stockholders consist primarily of loans provided to corporate officers ("officers") at the level of vice president and above for the purchase of shares of Common Stock (see Note H). Notes received in exchange for Common Stock have been classified as a reduction of stockholders' equity. In addition, prior to the Company's initial public offering in February 1998, the Company provided such officers with notes to cover the exercise price and associated taxes related to the exercise of stock options. Notes are non-interest bearing and have been discounted using imputed annual interest rates from 4.94% to 6.36%. The notes are secured by each officer's holdings of FCG Common Stock. Prior to the initial public offering, the notes were issued on a non-recourse basis. For notes issued subsequent to the offering, any loan amounts in excess of the value of the stock securing the notes are either 70% or 100% recourse to the borrower.
All loans are due in ten years. In addition, the Company generally requires participants to pay, each year, the greater of 10% of the outstanding amounts or 50% of the after tax amount of any annual bonus received by them to repay outstanding amounts of the notes. Stockholders' notes receivable received in exchange for Common Stock were $8,628,000 and $20,657,000 as of December 31, 2000 and 1999, respectively. Discount for imputed interest on these notes receivable was $2,089,000 and $4,460,000 as of December 31, 2000 and 1999, respectively. Amortization of deferred compensation resulting from discounting the face value of non-interest bearing notes issued to the Company by its officers for the purchase of shares of Common Stock was $1,079,000 and $868,000 for the years ended December 31, 2000 and 1999, respectively. Stockholders' notes receivable related to advances to officers for payment of taxes associated with stock option exercises were $2,263,000 and $2,341,000 as of December 31, 2000 and 1999, respectively. Discount for imputed interest on these notes receivable was $372,000 and $453,000 as of December 31, 2000 and 1999, respectively.
In December 2000, FCG eliminated its requirement that all vice presidents purchase and hold shares of FCG stock, based on legal and other factors. In addition, FCG offered to rescind each stock loan transaction made to each current and former vice president. The rescissions which occurred in 2000 decreased the shares outstanding by approximately 1.3 million shares, along with an elimination of $15.3 million of stock purchases loans made by FCG. Additional rescissions are to be finalized in 2001. The rescissions have no material impact on FCG's cash position or balance sheet, nor does FCG recognize any operating or one-time charge from these rescissions.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE F -- STOCK OPTIONS
A summary of stock option transactions is as follows:
At December 31, 2000, 1999 and 1998, 1,365,886, 613,015 and 419,096 options were exercisable, respectively at weighted average exercise prices of $9.99, $8.72 and $5.37, respectively. The following table summarizes information about stock options outstanding at December 31, 2000:
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company applies Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations in accounting for the plan. Accordingly, no compensation expense has been recognized for options granted. Had compensation expense for the Company been consistent with the methodology prescribed under Statement of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, (SFAS 123), the Company's net income and net income per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share data):
The fair value of the options granted under the plan in 2000, 1999 and 1998 calculated using the Black-Scholes pricing model were $4.98, $8.30, and $6.94 per share, respectively. The following assumptions were used in the Black-Scholes pricing model: expected dividend yield 0%, risk-free interest rate ranging from 5.5% to 7.18%, expected volatility factor of 1.0 for 2000 and 1999, and 0.5 for 1998, and an expected life ranging from six to seven years. Pro forma net income reflects only options granted on or after January 1, 1995, and excludes the effect of a volatility assumption prior to the Company becoming publicly traded. Therefore, the full impact of calculating compensation expense for stock options under SFAS 123 is not reflected in the pro forma net income amounts presented above because compensation expense is reflected over the options' vesting period, and compensation expense for options granted prior to January 1, 1995 is not considered.
For the year ended December 31, 2000, 1999 and 1998, compensation expense recognized in income for stock-based employee compensation related to the grant of options was $187,000, $214,000 and $251,000 respectively.
NOTE G -- SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
On January 1, 1994 the Company adopted the Supplemental Executive Retirement Plan (the "SERP"). The SERP was amended on January 1, 1996 and on July 1, 1998. The SERP is administered by the Board of Directors or a committee appointed by the Board of Directors.
Participants in the SERP are those officers who are eligible to participate in the 1994 Plan and who are selected by the Board of Directors or a committee appointed by the Board of Directors to participate. The Board of Directors or a committee appointed by the Board of Directors may also designate other officers for participation in the compensation reduction portion of the SERP. Participation is conditioned on the submission of a completed enrollment form.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE G - SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN (CONTINUED)
Participants may make fully vested compensation reduction contributions to the SERP, subject to a maximum deferral of 10% of annual base salary. The Company may make a voluntary "FCG contribution" for any year in an amount determined by the Board to the account of SERP participants. FCG contributions vest 10% for each year of service (with up to five years service credit for participants who were vice presidents on January 1, 1994), provided that FCG contributions fully vest upon a change in control of the Company or upon a participant's death, disability or attainment of age 65. Company contributions to the SERP were $1,414,000, $1,198,000, and $726,000 for the years ended December 31, 2000, 1999, and 1998, respectively.
The contributions to the SERP are invested by the Company in variable life insurance contracts. Management believes that the participants' account balance, cash surrender value of life insurance and death benefits will be sufficient to satisfy the Company's obligations under the SERP.
NOTE H - STOCK INCENTIVE AGREEMENTS
1994 RESTRICTED STOCK PLAN AND AGREEMENTS
On December 15, 1997, the Board of Directors adopted an amendment to the 1994 Restricted Stock Plan (as amended the "1994 Plan") and Restricted Stock Agreement ("RSA"). The stockholders approved the 1994 Plan and RSAs on January 15, 1998. The 1994 Plan provides a mechanism for the purchase and sale of Common Stock by its vice presidents. The 1994 Plan is administered by the Company's Board of Directors or a committee appointed by the Board.
Under the 1994 Plan, the Company has entered into RSAs with each of its officers. The 1994 Plan and RSAs provide that each person, upon becoming an officer of the Company, must purchase and hold a specific minimum number of shares of Common Stock. Officers at Levels I and II have been required to purchase and hold that number of shares equal to one times the officer's base salary divided by the then-current fair value of the Common Stock. Officers at Levels III and IV have been required to purchase and hold that number of shares equal to two times the officer's base salary divided by the then-current fair value of the Common Stock, which, prior to the completion of the Company's initial public offering in February, 1998, was determined by reference to a report prepared for the Company by an independent valuation firm.
For RSAs executed prior to the IPO, shares purchased under such RSAs are subject to a 7-year vesting period beginning the date upon which an individual becomes an officer and vest annually upon the completion of each year of service. Automatic acceleration of vesting occurs upon death or permanent disability of an officer and upon certain changes in ownership of the Company. Acceleration of vesting also occurs once the officer attains the age of 59 and has held the shares for at least three years. Shares purchased after the IPO date are fully vested upon purchase.
Under the terms of the pre-IPO RSAs, the Company retains a repurchase right with respect to unvested shares, unless such termination is due to death, disability or changes in control of the Company. Pursuant to this right, the Company may repurchase unvested shares at the original issuance price plus a growth factor. The growth factor is equal to the average interest rate compounded quarterly which the Company pays to a commercial lending institution in a calendar quarter (the "Growth Factor"). In the event the Company has no borrowings for a particular quarter, then the growth factor shall be the prime rate on the
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - STOCK INCENTIVE AGREEMENTS (CONTINUED)
first day of the quarter, as announced in the Wall Street Journal or if the Wall Street Journal discontinues such announcements, then it shall be the prime rate as announced by Bank of America.
Shares acquired under RSAs are nontransferable, with the exception of transfers for certain estate planning and charitable gift purposes. The Company may also repurchase vested shares from a departing officer if he or she competes with the Company and/or profits from the sale of Common Stock within six months of such competition. An officer may also sell unencumbered shares of Common Stock on the public market, subject to continuing to satisfy the minimum shareholding requirements.
Pre-IPO officers paid the purchase price of the shares by means of non-recourse and non-interest bearing promissory notes, which notes are secured by the shares of stock held by such officers. For RSAs executed after IPO, the shares are paid for with a non-interest bearing promissory note secured by the shares of stock held by the officer, which has recourse against the officer's personal assets for either 70% or 100% of the outstanding balance in excess of the value of the security. The shares are fully vested upon their purchase, but are held by the Company as collateral against the associated loan.
In December 2000, FCG eliminated its requirement that all vice presidents purchase and hold shares of FCG stock, based on legal and other factors. In addition, FCG offered to rescind each stock loan transaction made to each current and former vice president. The rescissions which occurred in 2000 decreased the shares outstanding by approximately 1.3 million shares, along with an elimination of $15.3 million of stock purchases loans made by FCG. Additional rescissions are to be finalized in 2001. The rescissions have no material impact on FCG's cash position or balance sheet, nor does FCG recognize any operating or one-time charge from these rescissions.
All RSAs also contain non-competition and non-solicitation provisions which apply generally to the officer's employment with the Company and which continue to bind the officer even after repurchase of all shares by the Company; provided, however, that such provisions may be superseded by an employment agreement entered into between the Company and the officer.
NON-QUALIFIED STOCK OPTION AGREEMENT
Effective January 1, 1996, and restated January 1, 1997, the Company executed and adopted a non-qualified stock option agreement for certain officers. The principal terms of the agreement provided that for each share of stock purchased at fair market value, the stockholder was granted one exercisable stock option which allowed the stockholder to purchase additional shares at a price below the fair market value of the Common Stock. During 1997 and 1996, 215,176 and 366,168 shares, respectively, were granted under the provisions of the agreement and stockholders exercised options on 364,728 and 127,416 shares of Common Stock, respectively. Deferred compensation of $512,000 and $737,000 was recorded for the years ended December 31, 1997 and 1996, respectively, related to the granting of options under this agreement. Compensation expense related to the amortization of the deferred compensation on these options approximated $69,000, $95,000 and $125,000 for the years ended December 31, 2000, 1999 and 1998, respectively.
Effective December 19, 1995, the Company executed and adopted a non-qualified stock option agreement for certain vice presidents. The principal terms of the agreement provided that for each share of stock purchased at fair market value of the Common Stock, the stockholder was granted two exercisable stock
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - STOCK INCENTIVE AGREEMENTS (CONTINUED)
options which allow the stockholder to purchase additional shares at approximately 20% of the fair market value of the Common Stock. During 1995, 1,279,440 stock options were granted under the provisions of the agreement and vice presidents exercised options for 733,008 shares of Common Stock. Compensation expense related to these options approximated $118,000, $119,000 and $126,000 for the years ended December 31, 2000, 1999 and 1998, respectively. At December 31, 1997, all below market stock options had been exercised and no below market options have been issued since.
OTHER EQUITY PLANS
On August 22, 1997, the Board adopted the 1997 Equity Incentive Plan (the "1997 Equity Plan") and the 1997 Non-Employee Directors' Stock Option Plan (the "1997 Directors' Plan). On January 15, 1998, the stockholders approved the plans, authorizing issuance of up to 1,600,000 shares of FCG Common Stock under the 1997 Equity Plan and 200,000 shares of FCG Common Stock under the 1997 Directors' Plan. On February 26, 1999, the stockholders approved amendments to the plans to increase the authorized number of shares issuable under such plans to 3,500,000 shares for the 1997 Equity Plan and 300,000 shares for the 1997 Directors' Plan. In June 2000, the stockholders further increased the number of shares issuable under the 1997 Equity plan to 4,500,000 shares. Stock awards issued under the 1997 Equity Plan vest over a ten-year term from the date of grant. Under the 1997 Equity Plan, the Company granted employees 1,391,307, 1,844,233, and 532,217 options to purchase Common Stock at an exercise price equal to the market price of Common Stock on the date of grant in the years ended December 31, 2000, 1999, and 1998, respectively. As of December 31, 2000, and 1999, 932,420, and 486,323 of these options were exercisable, respectively. The Company had no stock appreciation rights issued or outstanding for the years ended December 31, 2000 and 1999.
The 1997 Directors' Plan provides for non-discretionary stock option grants to directors of the Company who are not employed by the Company or an affiliate. Each person who, on the date of adoption of the 1997 Directors' Plan, was then a non-employee director of the Company, automatically received an option to purchase 20,000 shares of Common Stock. Each person thereafter elected as a non-employee director receives an option to purchase 4,000 shares of common Stock when first elected. On January 1 of each year, each person who is a non-employee director is automatically granted an additional option to purchase 4,000 shares of Common Stock. All options issued under the 1997 Directors' Plan have an exercise price equal to market price of Common Stock on the date of grant and expire ten years after the date of grant. The initial 20,000 share grants vest over five years following the date of grant; all 4,000 share grants vest over the 12 months following the date of grant. Under the plan in the years ended December 2000, 1999, and 1998, respectively, the Company granted 32,000, 32,000, and 20,000 options to purchase Common Stock at an exercise price equal to the market price of the Common Stock on date of grant. These options vest over a ten-year term from date of grant. As of December 31, 2000, 129,860 of these shares are exercisable.
Under the Company's amended 1989 Stock Option Plan (a plan carried over from ISCG subsequent to the merger), the Company may grant incentive stock options to employees and nonqualified stock options to employees and directors. All options are granted at not less than fair market value at the date of grant and generally expire ten years from the date of grant. Options granted prior to July 25, 1996 generally vest at a rate of 20% per annum beginning on the second anniversary of the grant date. Options granted on or after July 25, 1996 generally vest ratably over a five-year period. In 1997, ISCG's Board of Directors amended this plan with subsequent stockholder approval, to increase the number of shares of Common Stock authorized for issuance under the plan from 962,500 to 1,270,500 shares. Under the plan, the
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - STOCK INCENTIVE AGREEMENTS (CONTINUED)
Company granted employees 43,496, 422,784, and 191,091 options to purchase Common Stock at an exercise price equal to the market price of the Common Stock on the date of grant in the years ended December 31, 2000, 1999, and 1998, respectively. As of December 31, 2000, 1999, and 1998, 261,860, 126,692, and 187,548 of the options were exercisable, respectively.
On August 4, 1999, the Company's Board of Directors adopted the 1999 Non-Officer Equity Incentive Plan (the "1999 Non-Officer Plan"). The Plan authorizes the issuance of up to 1,000,000 shares of Common Stock pursuant to nonstatutory stock options, stock bonuses, rights to purchase restricted stock and stock appreciation rights to employees who are not officers of the Company. Stock options granted under the Plan are granted at fair market value of FCG Common Stock as of the date of grant, and vest over five years and expire ten years following the date of grant. Under the Plan, the Company granted non-officer employees 902,200 and 271,650 options to purchase Common Stock at an exercise price equal to the market price of the Common Stock on the date of grant in the years ended December 31, 2000 and 1999 respectively. As of December 31, 2000, 41,732 of the options were exercisable.
In May 2000, the Board of FCG Doghouse ("FCGDH"), a 94% owned subsidiary of FCG, adopted the FCG Doghouse Equity Incentive Plan (the "FCGDH Equity Plan") and authorized the issuance of up to 7,500,000 shares. Stock awards issued under the FCGDH Equity Plan vest over a ten-year from the date of grant. Under the FCGDH Equity Plan, the Company granted employees 4,707,018 options to purchase Common Stock at an exercise price equal to the appraised value ($0.78 per share) of FCGDH common stock on the date of grant in the year ended December 31, 2000. As of December 31, 2000, none of these options were exercisable.
NOTE I -- ASSOCIATE 401(K) AND STOCK OWNERSHIP PLANS
Under FCG's 401(k) plan (or "ASOP"), participants may elect to reduce their current compensation by up to the lesser of 15% of such compensation or the statutorily prescribed annual limit ($10,500 in 2000, and $10,000 in 1999 and 1998) and have the amount of such reduction contributed to the ASOP. In addition, the Company may make contributions to the ASOP on behalf of participants. Company contributions may be matching contributions allocated based on each participant's compensation reduction contributions, discretionary profit sharing contributions allocated based on each participant's compensation, or allocated to some or all participants on a per capita basis.
The ASOP is intended to qualify under Section 401 of the Internal Revenue Code of 1986, as amended, so that contributions by employees or by the Company to the ASOP, and income earned thereon are not taxable until withdrawn and so that contributions by the Company, if any, will be deductible by the Company when made. Participants become vested in company contributions under two graded vesting schedules, so that matching and per capita contributions are fully vested after five years of service and profit sharing contributions are fully vested after seven years of service.
The ASOP was originally structured as a leveraged employee stock ownership plan. The ASOP borrowed $4.0 million from a third-party financial institution (the "ASOP loan") to purchase 1,429,848 shares of Common Stock in 1995. The shares of Common Stock so purchased were placed in a suspense account under the ASOP from which they were released and allocated to participants' accounts as the ASOP loan was repaid. The Company reported in its Statement of Financial Position the debt of the ASOP and unearned ASOP shares, which was the original cost basis of the ASOP shares pledged as collateral for the
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - ASSOCIATE 401(K) AND STOCK OWNERSHIP PLAN (CONTINUED)
debt. As shares were committed to be released, the Company credited unearned ASOP shares based on the cost of the shares to the ASOP. The Company recorded compensation expense based on the fair market value of the shares committed to be released. The difference between the fair value of shares committed to be released and the cost of those shares to the ASOP was either charged or credited to stockholders' equity accounts, as applicable.
The ASOP shares were as follows:
As of December 31, 1999, the Company had exhausted the original pool of ASOP shares. In order to make its matching contribution for the quarter ended December 31, 1999, as well as allocating the final 27,294 unreleased shares from the original pool, the Company contributed (and allocated) 67,096 newly-issued shares. In 2000, the Company allowed its employees to individually determine whether they wanted to receive future Company contributions in FCG stock or in cash. For those employees who chose to continue to receive stock, the Company made its matching contributions in cash, and the ASOP used the cash to purchase FCG stock on the open market.
Compensation expense for the 401(k) match and the ASOP was approximately $5.6 million, $3.3 million, and $1.6 million for the years ended December 31, 2000, 1999 and 1998, respectively. The Company's practice is to net unvested amounts forfeited by terminated employees against the current year 401(k) match. Had the Company not had these forfeitures, the compensation expense would have been approximately $6.3 million, $4.2 million and $2.7 million in 2000, 1999 and 1998, respectively.
In fiscal year 2000, the Board of Directors and the Company's shareholders approved the Associate Stock Purchase Plan (the "ASPP") under which 500,000 shares of the Company's Common Stock could be sold to employees. Under the Plan, employees can elect to have between 1% and 10% of their earnings withheld to be applied to the purchase of these shares. The purchase price under the Plan is generally a 15% discount from the lesser of the market price on the beginning or purchase date of the offering periods under such Plan. In fiscal year 2000, the Company issued 341,756 of the 500,000 authorized shares. The 2000 ASPP terminates on December 31, 2001.
NOTE J - CONCENTRATION OF CREDIT RISK
The Company maintains its cash balances in financial institutions located in Long Beach, California and Philadelphia, Pennsylvania. These balances are insured by the Federal Deposit Insurance Corporation up to $100,000. At December 31, 2000, the Company had balances in excess of the insured amount of
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
approximately $9.2 million and $1.0 million, respectively. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on its cash and cash equivalents.
At December 31, 2000, the Company carried a long-term account receivable of approximately $11 million on its balance sheet from a single client. The receivable relates to a major outsourcing client, and will be paid down over a 6 year period.
NOTE K -- COMMITMENTS AND CONTINGENCIES
The Company leases its office facilities, certain office space and living accommodations for consultants on short-term projects under operating leases that expire at various dates through 2012. At December 31, 2000, the Company was obligated under non-cancelable operating leases with future minimum rentals as follows (in thousands):
Rent expense aggregated $6,135,000, $5,244,000, and $4,276,000 for the years ended December 31, 2000, 1999, and 1998 respectively.
The Company is involved in various legal actions arising in the normal course of business. Management is of the opinion that the outcome of these matters will not have a material adverse effect on the Company's financial position or results of operation.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE L -- INVESTMENTS
Available-for-sale securities are measured at fair value, with net unrealized gains and losses reported in equity as a component of other comprehensive income. The net unrealized holding gain (loss) increased $150,000 in 2000. The amortized cost, unrealized gains and losses, and fair values of the Company's available-for-sale securities (all of which are debt securities) held at December 31, 2000 and 1999 are summarized as follows:
The following table lists the maturities of debt securities held at December 31, 2000:
Additionally, the Company has $1.3 million of equity investments, valued at the lower of cost or market, which are included in long-term investments.
NOTE M -- DISCLOSURE OF SEGMENT INFORMATION
The Company has the following four reportable segments: consulting, integration, management services and European healthcare. The consulting services consist of strategic planning, operations effectiveness, procurement and contracting, and general consulting. The integration services include implementation of packaged vendor software, design and development of comprehensive system architectures, infrastructures, interfaces, databases, applications and networks to address the need for information integration and dissemination throughout a client's organization. Management services comprise the FCG's information technology outsourcing business. European healthcare primarily represents services provided in the United Kingdom and parts of continental Europe and includes a blend of consulting and integration services. FCG discontinued providing European healthcare services at the end of fiscal year 2000.
The accounting policies used to develop segment information correspond to those described in the summary of significant accounting policies. The Company manages segment reporting at a gross margin level. Selling, general and administrative expenses (including corporate functions, occupancy related costs, depreciation, professional development, recruiting, and marketing), and fixed assets (primarily computer equipment, furniture, and leasehold improvements) are managed at the corporate level separately from the segments. The Company's segments are managed on an integrated basis in order to serve clients by assembling multi-disciplinary teams, which provide comprehensive services across its principal services.
The following information about the segments is for the years ended December 31, 2000, 1999 and 1998:
The amount of revenue attributed to each segment is accounted for by splitting the revenue on each client engagement based upon the hourly rates charged to the client for the services of each segment. Costs are not transferred across segments.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES
NOTE N -- NET INCOME (LOSS) PER SHARE
The following represents a reconciliation of basic and diluted net income (loss) per share (amounts rounded to thousands except per share data):
The effect of dilutive options and warrants excludes 5,014,527 antidilutive options with exercise prices ranging from $.082 to $27.75 per share in 2000, 1,224,000 antidilutive options with exercise prices ranging from $12.69 to $27.75 per share in 1999, and 112,000 antidilutive options with exercise prices ranging from $16.07 to $27.75 per share in 1998.
NOTE O -- MERGER, RESTRUCTURING, AND SEVERANCE COSTS
Merger, restructuring, and severance costs of $9,200,000, $3,550,000 and $6,041,000 were incurred in 2000, 1999 and 1998, respectively. The costs incurred in 2000 were primarily attributable to the shutdown of FCG's European healthcare operations, the separation of approximately 150 U.S. employees due to the contraction in the healthcare delivery market, and the related consolidation and resizing of selected offices. The costs incurred during 1999 were primarily attributable to restructuring and severance associated with rationalizing capacity requirements in Europe, and secondarily separation costs associated with the merger between FCG and ISCG in December 1998. The costs incurred in 1998 were primarily attributable to the definitive merger agreement between FCG and ISCG, and secondarily, the costs as a result of the termination of a potential business combination contemplated by ISCG prior to the definitive merger agreement between FCG and ISCG. At December 31, 2000, $3,927,000 of the restructuring costs remained to be paid. These primarily consisted of severance and the future costs of excess facilities.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE P -- SHARE PURCHASE RIGHTS PLAN
In November 1999, the Company adopted a Share Purchase Rights Plan (the "Plan"). Terms of the Plan provide for a dividend distribution of one preferred share purchase right (a "Right") for each outstanding share of Common Stock as of December 10, 1999. Each Right, when exercisable, entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, par value $.001 per share (the "Preferred Shares"), at a price of $50.00 per one one-hundredth of a Preferred Share.
Upon the occurrence of (i) a public announcement that a person, entity or affiliated group has acquired beneficial ownership of 15% or more of the outstanding Common Shares (an "Acquiring Person") or (ii) generally 10 business days following the commencement of, or announcement of an intention to commence, a tender offer or exchange offer the consummation of which would result in any person or entity becoming an Acquiring Person, the Rights become exercisable. At that time, each holder of a Right, other than Rights beneficially owned by the Acquiring Person (which are void), will for a 60-day period have the right to receive upon exercise that number of shares of Company Common Stock having a market value of two times the exercise price of the Right. If the Company is acquired in a merger or other business combination transaction or 50% or more of its consolidated assets or earning power are sold to an Acquiring Person, its associates or affiliates, each holder of a Right will thereafter have the right to receive, upon the exercise thereof at the then current exercise price of the Right, that number of shares of common stock of the acquiring company which at the time of such transaction will have a market value of two times the exercise price of the Right.
The rights generally may be redeemed by the Company at a price of $0.001 per Right, and the Rights expire on November 22, 2009. The terms of the Rights may be amended by the Board of Directors of the Company without the consent of the holders of the Rights, except that after the rights have been distributed, no such amendment may adversely affect the interest of the holders of the Rights excluding the interests of an Acquiring Person. Until a Right is exercised, the holder thereof, as such, will have no rights as a stockholder of the Company, including, without limitation, the right to vote or to receive dividends.
The Rights have certain anti-takeover effects. The Rights will cause substantial dilution to a person or group that attempts to acquire the Company on terms not approved by the Company's Board of Directors. The Rights should not interfere with any merger or other business combination approved by the Board of Directors since the Rights may be amended to permit such acquisition or redeemed by the Company at $0.001 per Right prior to the earliest of (i) the time that a person or group has acquired beneficial ownership of 15% or more of the Common Shares or (ii) the final expiration date of the Rights.
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE Q -- UNAUDITED QUARTERLY FINANCIAL DATA
FIRST CONSULTING GROUP, INC. AND SUBSIDIARIES REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors First Consulting Group, Inc.
We have audited the accompanying consolidated balance sheets of First Consulting Group, Inc. and its subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, comprehensive income (loss), stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying index. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Consulting Group, Inc. and subsidiaries as of December 31, 2000 and 1999, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.
/s/ GRANT THORNTON LLP
Irvine, California February 14, 2001
SCHEDULE II-- VALUATION AND QUALIFYING ACCOUNTS (In Thousands)
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, FCG has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
BY: /S/ LUTHER J. NUSSBAUM -------------------------- Luther J. Nussbaum, Chief Executive Officer
Date: March 30, 2001
Know all persons by these presents, that each of the persons whose signature appears below hereby constitutes and appoints Luther J. Nussbaum and Walter J. McBride, each of them acting individually, as his attorney-in-fact, each with the full power of substitution, for him in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming our signatures as they may be signed by our said attorney-in-fact and any and all amendments to this Annual Report on Form 10-K.
Pursuant to the requirement of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of FCG in the capacities and on the dates indicated.
INDEX TO EXHIBITS