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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934 FOR THE
FISCAL YEAR ENDED AUGUST 31, 1998.

( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934 FOR THE
TRANSITION PERIOD FROM TO .

Commission file number 0-15295

NICHOLS RESEARCH CORPORATION
(Exact name of registrant as specified in its charter)

Delaware 63-0713665
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

4090 South Memorial Parkway
Huntsville, Alabama 35815-1502
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(Address of principal executive offices) (Zip Code)

The registrant's telephone number including area code: (256) 883-1140
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Securities registered pursuant to Section 12(b) of the Act:

Title of each class Name of each exchange
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None None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.01 per share
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(Title of Class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

As of November 3, 1998, there were 13,854,932 shares outstanding of
Nichols Research Corporation voting Common Stock, $.01 par value. The aggregate
market value of the voting stock held by non-affiliates of the registrant was
approximately $225,938,622 based on the closing price of such stock as reported
by the Nasdaq National Market on November 3, 1998, assuming that all shares
beneficially held by officers and members of the registrant's Board of Directors
are shares owned by "affiliates," a status which each of the officers and
directors individually disclaims.

DOCUMENTS INCORPORATED BY REFERENCE

Documents Form 10-K Reference
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Portions of the Proxy Statement for the January 14, 1999 Part III
Annual Shareholders' Meeting

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Except for historical information contained herein, this document contains
forward-looking statements as defined in Section 21E of the Securities Exchange
Act of 1934. Such forward-looking statements are subject to various risks and
uncertainties that could cause actual results to differ materially from those
projected in the forward-looking statements. These risks and uncertainties are
discussed in more detail in the Management's Discussion and Analysis of
Financial Condition and Results of Operations section of this Annual Report.
These forward-looking statements can be generally identified as such because the
content of the statements will usually contain such words as the Company or
management "believes," "anticipates," "expects," "plans," or words of similar
import. Similarly, statements that describe the Company's future plans,
objectives, goals, or strategies are forward-looking statements.

PART I

ITEM 1. BUSINESS

General

References herein to the "Company" mean Nichols Research Corporation
and its majority-owned subsidiaries and joint ventures.

The Company is a premier provider of high-performance technology-based
solutions and services where information access, movement, and evaluation are
mission critical to an organization's success. The Company provides these
services to a wide range of clients, in four markets: national security,
government information technology (IT), commercial IT, and healthcare IT. The
Company's substantial expertise and capabilities in a wide range of technologies
have been built over a 22-year period of providing advanced development,
scientific and application services to U.S. military programs, including air
defense systems, national and theater missile defense systems, and weapons
development programs. These activities have allowed the Company to build and
maintain a foundation of advanced skills in systems engineering; command,
control, communication, computers and intelligence (C4I) systems; virtual
reality-based training systems; test and evaluation; naval architecture; high
performance systems integration; information systems support; network and
computer facility outsourcing and management software and systems development;
data warehousing and mining; and systems security. The Company's advanced
technical capabilities gained while performing services for mission critical
federal projects provide the Company with a technological competence which the
Company is transferring to the commercial sector. The Company today addresses
the technology needs of a diverse customer base by applying its state-of-the-art
technical capabilities in commercial system integration, simulation, software
development and client-server architectures, including SAP(TM) consulting. As a
result, the Company has expanded the market for its services by offering
innovative technical solutions to customers' needs. Although the Company's
traditional military technology business has continued to grow and represented
approximately 55% of revenues in fiscal year 1998, other growing markets for the
Company's services represented approximately 45% of revenues in fiscal year
1998.

Some of the Company's federal government contracts contain options which
are exercisable at the discretion of the customer. An option may extend the
period of performance for one or more years for additional consideration on
terms and conditions similar to those contained in the original contract. An
option may also increase the level of effort and assign new tasks to the
Company. In the Company's experience, options are usually exercised. Therefore,
references herein to contract terms and values include options.

Business Strategy

The Company's business strategy consists of three key elements: (i)
maintain the Company's leadership in technology applications in its current
markets; (ii) apply the Company's technology base to create solutions for new
clients in chosen markets; and (iii) make strategic acquisitions and form
alliances to gain industry knowledge and thereby expand the business base of the
Company.

Maintain Technology Leadership. The Company's substantial expertise and
capabilities in a wide range of technologies have been built over a 22-year
period of providing advanced development, scientific, and application services
to U.S. military programs, including air defense systems, strategic and theater
missile defense systems, and weapons development programs. The Company believes
that, because of its expertise and capabilities with such a wide range of
technologies, it has an advantage over its competitors in providing information
technology and other technical business services based on these technologies.
The Company will seek to maintain this advantage by keeping pace with new
developments in technology and by continuing to compete for contracts which will
require the Company to provide high-quality, sophisticated technical solutions
to clients utilizing advanced technologies.

Apply Technology To Create Solutions For New Clients. The Company
believes that the creative use of its technology expertise and capabilities to
provide innovative, focused technical solutions for its clients has been largely
responsible for the Company's success. The Company intends to use its base of
technical expertise and capabilities in network design, systems integration,
software development, simulation technology, and Internet services to create
solutions for new clients in government, healthcare, insurance, and other
commercial markets.

Make Strategic Acquisitions And Form Alliances. The Company's
acquisition program is a key component of its overall business strategy. The
Company will seek to make strategic acquisitions and form alliances that will
allow the Company to (i) develop technical services which it does not currently
provide, (ii) target markets that it does not currently serve and gain industry
knowledge in such markets, (iii) develop strategic relationships with clients,
and (iv) spin-out high growth/high margin businesses.

In order to better execute its business strategy, the Company is
organized into the following four strategic business units reflecting the
particular market focus of each line of business:

Defense and Intelligence, formerly Nichols Federal, provides technical
services primarily to U.S. Government defense agencies. For the year ended
August 31, 1998, the Defense and Intelligence unit produced approximately 55% of
the Company's revenues.

Government Information Technology, formerly Nichols InfoFed, provides
information and technology solutions and services to a variety of federal, state
and local governmental agencies. For the year ended August 31, 1998, the
Government Information Technology unit produced approximately 24% of the
Company's revenues.

Commercial Information Technology, formerly Nichols InfoTec, provides
information and technology services to various commercial clients, other than
healthcare clients. For the year ended August 31, 1998, the Commercial
Information Technology unit produced approximately 10% of the Company's
revenues.

Healthcare Information Technology, formerly Nichols SELECT, provides
administrative and information services to clients in the healthcare and
insurance industries. For the year ended August 31, 1998, the Healthcare
Information Technology unit produced approximately 11% of the Company's
revenues.

Acquisitions and Alliances

Since September 1, 1994, the Company has successfully completed ten
strategic acquisitions and alliances to expand its business into other markets
and gain industry knowledge. The key acquisitions and alliances completed during
this period are:

Communications & Systems Specialists, Inc. (CSSi). In September 1994,
the Company acquired CSSi, which provides information systems development and
services primarily in client-server systems development for federal government
agencies. This acquisition enhanced the Company's ability to provide information
development services.

Conway Computer Group (CCG). In May 1995, the Company acquired CCG,
which provides information technology products and services to a variety of
commercial customers. As a result of the CCG acquisition, the Company expanded
its business to include computerized workers' compensation claims,
administration and risk management services. CCG also provides IT services to a
variety of commercial customers, including software development and consulting
services. CCG provides support services to customers with IBM business computer
systems.

Computer Services Corporation (CSC). In June 1995, the Company acquired
CSC, which provides transaction and practice management system services, a
computer-based medical management system, and a complete billing and accounts
receivable management service to physicians and other medical providers. This
acquisition expands the Company's commitment to IT services in the healthcare
industry by providing the Company with a core business base in computerized
transaction processing and related IT services. Effective September 23, 1996,
CSC was merged into Nichols SELECT Corporation which was subsequently renamed
Nichols TXEN Corporation.

HealthGate Data Corporation (HealthGate). In October 1995, the Company
acquired approximately 20% of HealthGate. HealthGate is a global Internet media
company which develops and provides branded, interactive health and wellness
information solutions to each of the four primary healthcare constituencies:
patients, providers, payors and suppliers.

Advanced Marine Enterprises, Inc. (AME). In May 1996, the Company acquired
AME, a leading naval architecture and marine technical services firm. AME also
develops simulation and virtual reality technology for naval and marine
applications and provides support in ship acquisition management, production
support, human systems integration and ship survivability and protection. AME
sells ship simulators and virtual reality trainers to the international
commercial ship building industry. Approximately 80% of AME's business is with
the U.S. Navy. The acquisition substantially expanded the Company's presence in
the Washington, D.C. area and provided an opportunity for the Company to expand
its business relationship with the U.S. Navy.

Intertech Management Group, Inc. (Intertech). During fiscal year 1997, the
Company acquired approximately 36% of the capital stock of Intertech. Intertech
provides software and data processing services to the telecommunications
industry.

NCCIM L.L.C (NCCIM). In fiscal year 1997, NCCIM, a joint venture equally
owned by the Company and Colsa Corporation, was formed and awarded a five year
contract having a value with options of $193 million. Under this contract, NCCIM
provides support services for automation, telecommunications, visual information
and records management for the U.S. Army Aviation and Missile Command and other
federal, state and local government agencies.

TXEN, Inc. (TXEN). In fiscal year 1995, the Company purchased 19.9% of
TXEN's capital stock with an option to purchase the remaining 80.1%. In August
1997, the Company exercised its option to purchase the remaining 80.1% of the
capital stock of TXEN. TXEN provides information technology products and
services to the managed healthcare industry, including computerized claims
processing and administration services. As a result of the acquisition of TXEN,
the Company enhanced its knowledge of the healthcare industry and acquired a
business base in a rapidly expanding segment of the healthcare information
services industry. TXEN was merged into Nichols SELECT Corporation, which after
the merger changed its name to Nichols TXEN Corporation.

Mnemonic Systems, Incorporated (MSI). In April 1998, the Company
acquired MSI, a systems integration company providing services primarily within
the U.S. Department of Justice. The acquisition supports the Company's
performance of information technology services for government agencies other
than the Department of Defense (DOD).

Welkin Associates, Ltd. (Welkin). In July 1998, the Company acquired
Welkin, a provider of systems engineering and acquisition management services to
the national intelligence community. The acquisition supports the Company's work
in the national intelligence community and increases the Company's presence in
the Washington D.C. area.

Defense and Intelligence

The Company's Defense and Intelligence unit provides technical services
to U.S. defense and intelligence agencies. For the year ended August 31, 1998,
the Company's Defense and Intelligence unit produced approximately 55% of the
Company's revenues.

The Company provides systems engineering, systems analysis, simulation
development, and systems integration for the defense and intelligence technical
services market. The Company's capabilities include optics, guidance and
control, software engineering, virtual reality trainers and simulations, naval
architecture, and C4I. These technical services are rendered primarily for the
U.S. Army, U.S. Navy, U.S. Air Force, and national agencies. Many of the
Company's contracts are not project specific, but require that the Company
provide technical services to a variety of weapons development and other
projects.

The Company has provided technical services related to missile defense
since 1983 when the Strategic Defense Initiative Organization (SDIO) was formed.
In 1993, SDIO changed its name to the Ballistic Missile Defense Organization
(BMDO). BMDO's mission continues to be Ballistic Missile Defense (BMD) with
emphasis on Theater Missile Defense (TMD) and National Missile Defense (NMD).
The Company's contract revenues from BMD programs were approximately $63.0
million in fiscal year 1996, $76.5 million in fiscal year 1997 and $71.7 million
in fiscal year 1998. Approximately 17% of the Company's revenues in fiscal year
1998 were from contracts related to BMD, compared to 20% of revenues in fiscal
year 1997, and 26% of revenues in fiscal year 1996. Ballistic Missile Defense
has existed for more than 29 years as a mission of the DOD through activities
such as the BMD program. If a decision were made to reduce substantially the
scope of current BMD programs or to eliminate the BMDO, management believes that
many national and theater missile defense programs, including some research and
development areas that existed prior to the creation of SDIO/BMDO, would
continue to be funded by the U.S. Army and U.S. Air Force, and other DOD
agencies.

Missile and Air Defense

For NMD and TMD programs, the Company's services include system
architecture definition, system analysis, system and element definition and
performance estimates, system engineering, lethality and vulnerability analysis,
test and evaluation, model and simulation development, radar and infrared sensor
and seeker definition and technology assessments, risk assessments, and program
and system acquisition documentation. Under a five year contract awarded in
fiscal year 1997 by the U.S. Army Space and Missile Defense Command with an
estimated value of $250 million, the Company is providing systems engineering
and technical support through studies, concept definition, independent analyses,
simulations, technological assessments, and related tasks in support of
ballistic and theater missile defense systems, experiments and technology
demonstrations. Under a five year contract awarded in fiscal year 1998 by the
BMDO with an estimated total value of $100 million, the Company provides system
engineering support for sensor systems.

Air Force Space Programs

Under a seven year contract awarded in fiscal year 1993 by the U.S. Air
Force Space and Missile Systems Center with an estimated total value of $100
million, the Company provides engineering, analysis, and design for satellite
and missile development programs. The Company anticipates that this contract
will be recompeted in late fiscal year 1999. Under several contracts with the
U.S. Air Force, the Company supports new materials research, provides software
quality assurance for testing and evaluation, supports research for infrared and
cryogenic technologies, provides sensor data reduction analysis, and develops
software for satellite tracking systems.

Military Systems and Simulations

The Company specializes in the application of information technology
for military systems and the simulation of those systems. The Company has
developed FlexTM, a modeling and simulation software product.The Company
develops user-friendly interface technologies that assist in applying
information technology for military applications.

Army Tactical Systems and Technology

The Company provides development services for U.S. Army tactical
systems and technologies, which support Army project offices and research and
development centers. The Company develops high-fidelity simulations for weapon
systems, which are used for cost-effective missile concept definition, design,
and analysis. Under a three year contract awarded in fiscal year 1997 with an
estimated total value of $104 million, the Company provides functional
engineering support to the U.S. Army Aviation and Missile Command's (AMCOM)
Research Development and Engineering Center for missile guidance and control.
The functional engineering support includes simulation-based analysis and
technical support. The Company anticipates that this contract will be recompeted
in fiscal year 1999.

Under a four year contract awarded in fiscal year 1996 by the U.S. Army
with an estimated contract value of $20 million, the Company is producing the
Avenger Institutional Conduct of Fire Trainer (ICOFT) and the Avenger Tabletop
Trainer. These two real-time training devices are being delivered to air defense
units of the U.S. Army, U.S. Marine Corps, and to U.S. allies under the Foreign
Military Sales Program.

Under a five year contract awarded in fiscal year 1998 by the Naval
Surface Warfare Center, Crane Division, with an estimated total value of $50
million, the Company is providing development, production, installation and
field support services for various air defense systems.

Army Simulation Programs

The Company provides engineering, analysis and development services for
U.S. Army tactical and strategic systems and advanced weapons system concepts,
which support Army project offices and research and development centers. The
Company develops high-fidelity digital, hardware-in-the-loop, and virtual
reality man-in-the-loop simulations for weapon systems, which are used for
cost-effective missile concept definition, design, and analysis. Under a four
year contract awarded in fiscal year 1996 with an estimated total value of $93
million, the Company provides systems analysis, design and fabrication,
simulation and software support, system, subsystem and component test and
evaluation support, and scientific computing support to the AMCOM Research
Development and Engineering Center for missile system simulation and analysis.
The Company anticipates that this contract will be recompeted during fiscal year
1999.

The Company has used the knowledge and capabilities that it gained from
creating computer simulations, performing computer and network integrations and
developing high resolution scene generations to establish an extensive business
base in Distributive Interactive Simulation (DIS), Virtual Prototype Simulation
(VPS) and Virtual Engagement (VE) simulations. DIS, which is migrating into the
High Level Architecture (HLA), is a simulation infrastructure that permits an
interactive exchange of information to facilitate multiple simulations across a
computer network. VPS is a virtual reality computer simulation that replicates
the sights, sounds, and functionality of a given system, simulating both the
operation of the weapon system and the environment surrounding the operator of
the system. VPS may be used to evaluate equipment designs, instruct users in the
operation of weapon systems, analyze the effectiveness of the system against
different threats, or test system effectiveness under various conditions. VPS
also provides the basis for the development of system trainers. VE simulations
support the integration and testing of weapons systems by engaging real or
virtual targets using a virtual missile interceptor. The Company has developed
virtual prototype simulators for several AMCOM systems, including Bradley
Linebacker, Line-Of-Sight-Anti-Tank (LOSAT) missile, Javelin, the Bradley
Fighting Vehicle (BFV) A2 and the Improved Target Acquisition System (ITAS). BFV
and ITAS include the Tube Launched Optically Guided Weapon (TOW) missile, Rapid
Force Projection Initiative (RFPI) Hunter Vehicle, Unmanned Ground Vehicle
(UGV), and Advanced Chaparral. The Company has developed a VE simulation for the
Patriot missile system which has been used in tests.

Defense Systems Integration

The Company provides system integration and development services for
the DOD, and supports DOD program managed activities as well as research and
development centers. The Company's capability to provide systems engineering and
integration solutions and services is broad based. The Company conducts analyses
of requirements, modernization of information technologies, process modeling,
design and rapid prototyping of designs and extensive simulation of the design
for operational application, training, testing and post deployment support and
analyses.

Digitization and C4I activities are a major force in the transformation
and modernization of the military in the next century. Tactical and strategic
digitization of the U.S. armed forces leverage the major IT advances in both the
commercial and government sectors of the U.S. economy. A major program supported
by the Company is the Rapid Forces Projection Initiative (RFPI) Advanced Concept
Technology Development (ACTD), for which the Company has acted as the systems
integration contractor since fiscal year 1994. The Company developed significant
solutions to the application of commercial-off-the-shelf components for military
needs including development of a Light Digital Tactical Operation Center
prototype and simulation center, and a distributed command and control computer
for the 101st Airborne Division of the U.S. Army. The Company has also assisted
in the development of the Institute of Electrical and Electronic Engineers
(IEEE) standards for information exchange by the military, such as the Sensor
Link Protocol for the Program Manager for Night Vision Devices. Under a five
year contract awarded in fiscal year 1997 with an estimated total value of $50
million, the Company supports the Office of the Secretary of Defense and joint
military services in the conduct of test planning, multi-service coordination,
and execution for joint testing and evaluations.

Advanced Tactical Systems

The Company performs basic research and provides engineering services
to the U.S. Air Force, U.S. Army, U.S. Navy, and Special Operations Command. The
Company supports the U.S. Air Force in the development of simulations and signal
processing algorithms for advanced guidance concepts for conventional weapon
systems. The Irma Multi-Sensor Signature Model, the U.S. Air Force's standard
air-to-surface target-in-background simulation, is an example of one such code.
Training concepts and course development are provided to the U.S. Army
Simulation, Training, and Instrumentation Command (STRICOM) and the Aviation
Center. Other areas of engineering support include special operations
technology, mine detection algorithms, avionics counter measures and formational
positioning systems, and special operations maritime electronics.

Naval Architecture

The Company provides naval architecture, marine engneering services,
services in ship acquisition management, production support, human systems
integration, and ship survivability and protection. The Company is also a leader
in the application of modeling and simulation technologies for naval solutions,
simulations development, training simulators, and virtual reality programs.

Under a five year contract awarded in fiscal year 1995 by the U.S.
Naval Sea Systems Command, with an estimated total value of $169 million, the
Company provides ship design services and technical support.

Under two five year contracts awarded in fiscal year 1998 for the Naval
Surface Warfare Center, Carderock Division, with an estimated total value of $23
million, the Company is performing marine scale model design, construction, and
testing services, and ship systems integration engineering.

Systems Engineering

The Company provides studies, analysis, acquisition management and
systems engineering services to elements of the intelligence community
sponsoring advanced technology systems essential to national security. The
Company delivers consulting services or direct support labor to augment the
capability of selected U.S. Government agencies to develop, acquire, and
integrate effectively complex systems or system components to achieve maximum
effectiveness in system operation.

Space Systems Applications

The Company provides integration and development support involving
satellite and other space applications. The Company performs contracts involving
the establishment of the architecture of future space surveillance and avionics
systems for the defense and intelligence community, and the development of
related prototype information processing systems. These contracts are based on
the Company's experience in optical sensor and geolocation technologies and its
ability to develop sophisticated computer simulations to evaluate the
performance of candidate architectures.

Intelligence Program Applications

The Company provides systems and software engineering services related
to the design, development, and support of real-time and embedded IT systems,
turnkey information systems, distributed client-server software systems,
object-oriented software solutions, and software applications to the various
U.S. Government intelligence agencies. The Company also provides engineering
services in the areas of network security, enterprise solutions, and
professional staff augmentation. The Company's information technology services
cover a broad spectrum of multi-vendor platforms and operating environments,
including client-server, scientific computing and digital signal processing.
Business practices employed by the Company are consistent with the Software
Engineering Institute Software and Systems Engineering Capability Maturity
Models.

Special Programs and Polarimetry Programs

The Company provides technical services related to scientific and
technical intelligence analysis, including hardware systems evaluation and
integration, hardware-in-the-loop testing and evaluation, analysis of foreign
weapons systems, foreign material exploitation, and system signature analysis
and prediction. Results of this work aid U.S. weapon system developers in
producing more effective products that give U.S. military forces greater combat
leverage.

The Company's 17-year record of such analysis and engineering support
has positioned the Company to develop polarization technology as an augmentation
to conventional optical sensor performance. The Company is continuing to develop
the fundamental technology, both independently and through integrated product
teams with government laboratories, while pursuing specific opportunities for
application of the technology under contracts from several government agencies.

Government Information Technology

The Company's Government Information Technology unit provides
information services and systems integration to federal, state and local
governmental agencies. For the year ended August 31, 1998, the Company's
Government Information Technology unit produced approximately 24% of the
Company's revenues.

The services offered by the Company include information technology
services, computer systems integration, staff augmentation, consulting services,
computer facility management and operations, Internet services, and customized
software system development for customers in the federal and state information
technology services market.

Computer Systems Integration

By building on its existing technical expertise and capabilities, the
Company has been awarded contracts in computer systems integration, including
large-scale projects. The Company's services include high performance computing,
enterprise networking, and office automation, including high-end supercomputer
architectures and applications; Internet services; high-speed, networking
technologies; advanced visualization systems; and on-line, high-integrity data
storage and archival systems. The Company is a systems integrator for many
manufacturers and suppliers of supercomputers, workstations, personal computers,
and networking equipment. The Company also offers a wide range of training
services utilizing innovative techniques and tools, such as computer-based
training aids to promote high productivity and efficient use of installed
systems. These training services include personal computer applications as well
as advanced supercomputing applications.

Under two three year contracts (excluding options) awarded in fiscal
year 1996 by the U.S. Army Information Systems Selection and Acquisition Agency,
the Company acts as the lead systems integrator for the DOD High Performance
Computing Modernization Program. Under these contracts, the Company supplies
computer hardware and software, provides maintenance and systems integration and
provides Internet services to DOD shared resource centers in Dayton, Ohio and
Vicksburg, Mississippi. The U.S. Government has awarded a total of only four
such contracts under a program to modernize its shared computer resources. These
shared resource centers offer government scientists and engineers access to
state-of-the-art high performance computing and communications capabilities. The
programs provide for periodic upgrades in systems to insure state-of-the-art
technology is installed in these centers. These awards established the Company
as a leader in systems integration of high performance computers. The Company
anticipates that these contracts will be recompeted in fiscal year 1999.

Other contracts include an eight year contract awarded in fiscal year
1994 with the State of Alabama, with an estimated total value of $53 million to
provide complete systems integration and facilities management services for the
statewide Alabama Research and Education Network and the Alabama Supercomputer
Center. The Company is providing Internet access to state government, industry,
college and secondary school clients within the State of Alabama. Under two
eight year contracts awarded in fiscal year 1992 by the Defense Intelligence
Agency's Missile and Space Intelligence Center with an estimated total value of
$34 million, the Company provides acquisition, installation, Intranet and
Internet services, and technical and management services for a high performance
scientific computer center.

In August 1998 the Company was awarded two eight year subcontracts
under the General Services Administration's Seat Management Program with an
estimated total value of $100 million. The Company has responsibility under
these subcontracts for high performance computing services and for delivery of
high-end scientific and engineering workstations.

Information Systems Support

The Company provides operating and support services for existing
information systems and assists in the development of enhancements that allow
these existing systems to meet evolving technical challenges. The Company
provides a wide range of services such as workflow management to enhance
operations data, training to improve the client's abilities to use existing IT
capabilities, support of video teleconferences, document imaging to reduce
paperwork, support of desktop computers, network design and development, and
software support for new and legacy computer systems.

The Company supports federal and state government clients in the use of
their information systems to ensure maximum potential and to keep such systems
up-to-date with evolving hardware and software technology. The Company is
performing its final option year under a $35 million contract awarded in fiscal
year 1995 by the Centers for Disease Control and Prevention and the Agency for
Toxic Substances and Disease Registry to upgrade, maintain, and manage their
microcomputer local and wide area networks for a primary facility in Atlanta,
Georgia, as well as offices in all 50 states and a number of locations around
the world.

In fiscal year 1998, the Company was awarded a seven year subcontract
for $16 million to support the Space and Missile Defense Center. The Company
will provide computer support and network administrative services and operate
and maintain software applications.

Other customers for which the Company provides information services
include the State of Alabama Department of Human Resources and the Office of
National Drug Control Policy.

Law Enforcement and Criminal Justice

The Company is a provider of proprietary and state-of-the-art innovative
technology and services to the investigative and law enforcement communities
both domestically and internationally. The Company's focus is to improve the
effectiveness of the criminal justice system. The Company provides software
development, maintenance and technical support to the Federal Bureau of
Investigation. The Company supports the Drug Enforcement Agency (DEA) by using
digital imaging techniques to populate databases used in DEA investigations. The
Company licenses a proprietary software product known as DRUGFIRETM which is a
forensic firearms examination and analysis system installed throughout the
United States and in six other countries. The Company also plans to introduce in
fiscal year 1999, another software product, ScenePro, which will be an
automated, multi-media crime scene toolkit.

Commercial Information Technology

The Company provides information technology and services to commercial
customers, state and local government agencies and judicial systems. The
services offered by the Company include systems integration and engineering,
application software development and deployment, data warehousing and mining,
information security, staff augmentation, and SAP R/3 consulting and
implementation. For the year ended August 31, 1998, the Company's Commercial
Information Technology unit generated approximately 10% of the Company's
revenues.

SAP (TM) Licensing and Implementation

Nichols ENTEC Systems, L.L.C. (ENTEC) is a joint venture presently owned
60% by the Company and 40% by DSM Copolymer, Inc., formed to license and
implement SAP (TM) software. This software is used to manage accounting, human
resources, production planning, materials management, and the sales and
distribution functions. According to SAP publications, this software has been
purchased by more than 9,000 customers worldwide. ENTEC is a National
Implementation Partner with SAP America, specializing in the implementation of
SAP R/3 enterprise-wide business software. In addition, ENTEC is both a SAP (TM)
Certified Business Solutions Partner and ASAP Partner. ENTEC sells SAP R/3
software to companies with annual revenues of less than $200 million in the
states of Arkansas, Louisiana, Mississippi, and Alabama. ENTEC provides a single
point of contact for the customer interested in purchasing software, hardware,
and services to implement a complete system. ENTEC was awarded a two year
contract in fiscal year 1998 by DynMcDermott Petroleum Operations Company, with
an estimated total value of $10 million, to deliver and implement SAP R/3
software for the Department of Energy's Strategic Petroleum Reserve. ENTEC
clients include DSM Copolymer, Aluma-Form/Dixie Electrical Manufacturing
Company, Tractor Supply Company, and Philips.

Consulting and Professional Services

The Company provides IT consulting and professional services such as
networking and system integration client server, custom business application
software development, contract programming, staff augmentation and training. The
Company provides these IT consulting services for clients with all types of
systems and networks. Programming and design capabilities range from traditional
software languages to modern graphical user interface development tools. The
Company's experience covers a broad spectrum of platforms and operating
environments. The Company's clients include the State of Alabama, MobileComm,
The Vanguard Group, Philips, the Virginia Courts System, and the University of
Mississippi Medical Center.

Healthcare Information Technology

The Company provides information technology-based administrative
services for the healthcare industry. For the year ended August 31, 1998, the
Company's Healthcare Information Technology unit produced approximately 11% of
the Company's revenues.

Nichols TXEN Corporation

The Company formed CSC Acquisition, Inc. ("Acquisition") as a
wholly-owned subsidiary on June 6, 1995. On June 30, 1995, the Company acquired
all of the assets and certain liabilities of Computer Services Corporation
(CSC). Since its incorporation in 1967, CSC performed administrative services
and information technology services for, and sold turnkey computer systems to,
physician practices. The Company formed Nichols SELECT Corporation (Nichols
SELECT) as a wholly-owned subsidiary on September 17, 1996. On September 23,
1996, Acquisition was merged into Nichols SELECT. On December 16, 1994, the
Company acquired 19.9% of the capital stock of TXEN, Inc. (TXEN) with an option
to acquire the remaining 80.1% of TXEN. Since its incorporation in 1989, TXEN
provided technology information outsourcing and administrative outsourcing
services for the managed health care industry. On August 29, 1997, the Company
acquired the remaining 80.1% of TXEN through a merger of TXEN into Nichols
SELECT, which after the merger continued to be wholly-owned by the Company.
After the TXEN acquisition, Nichols SELECT changed its name to Nichols TXEN
Corporation.

The Company, through its wholly-owned subsidiary, Nichols TXEN
Corporation, is a leading provider of outsourcing solutions for information
technology and administrative services in the managed care and physician
practice management segments of the health care industry. The Company's
outsourcing services improve quality and reduce costs by minimizing the time and
personnel needed to process health care transactions by offering customers a
broad range of medical billing and claims processing solutions. The Company
provides services under contracts and generates revenues primarily based on the
number of transactions processed or the number of enrolled health plan members
per month. As a result of the Company's fee structure and high customer
retention, approximately 72% and 77% of Nichols TXEN's revenues for fiscal years
1997 and 1998, respectively, were recurring.

The Company, through Nichols TXEN, offers a broad range of products and
services which allow customers the flexibility to perform administrative
functions with their own staff utilizing the Company's technology or to
outsource to the Company certain administrative and processing functions. Each
customer contracts with the Company for the level of outsourcing service needed.
The Company's outsourcing solutions provide customers with significant benefits,
including: (i) a variable rate operating cost structure for outsourced services;
(ii) speed of implementation; (iii) reduced capital expenditures for
administrative health care technologies; (iv) access to knowledgeable and
experienced personnel; (v) sophisticated application software and decision
support tools; and (vi) streamlined administrative functions. As a result, the
Company's services enable customers to concentrate on providing quality health
care by focusing on core competencies. The Company maintains a centralized
network data center to process transactions and provide technology services for
its customers. The Company believes that its ability to offer both technical
solutions and administrative services through a network data center
differentiates the Company from competitors that offer only turnkey software
solutions or only administrative services.

The Company, through Nichols TXEN, has organized its healthcare and
administrative services into two business divisions. The Managed Care Services
division provides the Company's technology and services to health maintenance
organizations (HMOs), physician-hospital organizations (PHOs), independent
practice associations (IPAs), integrated delivery systems (IDSs), provider
sponsored organizations (PSOs), Medicare and Medicaid HMOs, insurance carriers
and managed third-party administrators (Managed TPAs). The Practice Management
Services division provides the Company's technology and services to
hospital-based and other physician groups, hospital emergency departments and
physician networks. As of October 1, 1998, the Company had 90 managed care
services customers representing over 3.0 million lives nationwide and over 235
practice management services customers representing approximately 3,000
physicians primarily in the Southeast.

Workers' Compensation Services

The Company develops and supports two major packaged software products
which are used for property and casualty and workers' compensation insurance
systems. One of the products provides rating, underwriting, policy
administration, and premium accounting for insurance companies. The other
product provides full claims administration and risk management, as well as
electronic data transfer and managed care options, which may be used in
conjunction with the other products in an insurance company environment. The
Company also provides information technology consulting services, customized
software development, and packaged solutions for the property and casualty
insurance industry. Customers using the software include the State of Alaska,
The Kroger Company, Employers' Security Insurance Co., and American Federated
General Agency. The Company recently expanded its services by offering a
continuum of technology-based services built around a network data center. For
the fiscal year ended August 31, 1998, revenues from the Company's workers
compensation services were less than 1% of total revenues. Beginning in fiscal
year 1999, the Company's workers' compensation services became part of the
Company's Commercial IT unit.

HealthGate

The Company owns approximately 20% of HealthGate Data Corporation
(HealthGate). HealthGate is a global Internet media company which develops and
provides branded, interactive health and wellness information solutions to each
of the four primary healthcare constituencies: patients, providers, payors and
suppliers.

Competition

The Company competes against technical services companies in the defense
and aerospace industries, including TRW, Inc., GRC International, Inc., BTG,
Inc., and CACI International, Inc. The information services industry in which
the Company operates is highly fragmented with no single company or small group
of companies in a dominant position. The Company's competitors include large,
diversified firms with substantially greater financial resources and larger
technical staffs than the Company. Some of the larger competitors offer services
in a number of markets which overlap many of the same areas in which the Company
offers services, while certain companies are focused on only one or a few of
these markets. The firms which compete with the Company are consulting firms,
computer services firms, applications software companies and accounting firms,
as well as the computer service arms of computer manufacturing companies and
defense and aerospace firms. The primary factors of competition in the business
in which the Company is engaged include technical, management and marketing
competence, price, and past performance. The federal government market is highly
competitive with no single dominant company. Procurement reforms have increased
the importance of a contractor's past performance in deciding new bid awards.
Past performance can represent over half the criteria weighting on new awards.
The Company emphasizes client satisfaction, as evidenced by the Company's
ability to maintain clients for many years and winning all of its major contract
recompetes during the last five years. The Company believes that its low
overhead and cost structure give it an advantage in bidding on contracts.

Marketing

For the Defense and Intelligence and Government IT units, the Company's
marketing activities are generally directed by the strategic business unit
presidents. The strategic business unit presidents coordinate the marketing
activities of program development managers assigned to the executing business
units. The program development staff, as well as other Company managers,
engineers and scientists, attend new business briefings sponsored by government
agencies, review publications and learn of new business opportunities through
customer contacts. Potential new procurements are analyzed and evaluated within
the unit of the Company that would be principally responsible for performance of
the contract. The decision to submit a bid or proposal is made by the
responsible unit president for bids under $10 million. The decision to submit a
bid or proposal for bids greater than $10 million is made by the Chief Marketing
Officer through a formal bid review process.

For the Commercial IT and Healthcare IT units, the Company's marketing
services are directed by such units' vice presidents of commercial sales. The
marketing and sales staff receive a salary plus incentive compensation based on
sales. After identifying prospective sales opportunities, the sales and
marketing staff coordinates with the technical staff responsible for performing
the services to develop each customer proposal which, if accepted, results in a
contract award.

The corporate marketing staff focuses on selected large procurements and
activities associated with major new clients. Resources from across the Company
are available to the corporate marketing staff to address major marketing
issues. The corporate proposal staff and the corporate marketing staff report to
the Chief Marketing Officer.

Government Contracts

A substantial portion of the Company's revenues are derived from
contracts and subcontracts with the DOD and other federal government agencies. A
majority of the Company's contracts are competitively bid and awarded on the
basis of technical merit, personnel qualifications, experience, and price. The
Company also receives some contract awards involving special technical
capabilities on a negotiated, noncompetitive basis due to the Company's unique
technical capabilities in special areas. Future revenues and income of the
Company could be materially affected by changes in procurement policies, a
reduction in expenditures for the services provided by the Company, and other
risks generally associated with federal government contracts.

The Company performs its services under federal government contracts
that usually require performance over a period of one to five years. Long-term
contracts may be conditioned upon continued availability of Congressional
appropriations. Variances between anticipated budget and Congressional
appropriations may result in delay, reduction or termination of such contracts.
Contractors often experience revenue uncertainties with respect to available
contract funding during the first quarter of the government's fiscal year
beginning October 1, until differences between budget requests and
appropriations are resolved.

The Company's federal government contracts are performed under
cost-reimbursement contracts, time-and-materials contracts and fixed-price
contracts. Cost-reimbursement contracts provide for reimbursement of costs (to
the extent allowable under Federal Acquisition Regulations) and for payment of a
fee. The fee may be either fixed by the contract (cost-plus-fixed fee) or
variable, based upon cost, quality, delivery, and the customer's subjective
evaluation of the work (cost-plus-award fee). Under time-and-materials
contracts, the Company receives a fixed amount by labor category for services
performed and is reimbursed (without fee) for the cost of materials purchased to
perform the contract. Under a fixed-price contract, the Company agrees to
perform certain work for a fixed price and, accordingly, realizes the benefit or
detriment to the extent that the actual cost of performing the work differs from
the contract price. Contract revenues for the year ended August 31, 1998 were
approximately 43% from cost-reimbursement contracts, approximately 33% from
time-and-materials contracts and 24% from fixed-price contracts.

The Company's allowable federal government contract costs and fees are
subject to audit by the Defense Contract Audit Agency (DCAA). Audits may result
in non-reimbursement of some contract costs and fees. To date, the Company has
experienced no material adjustments as a result of audits by the DCAA. The DCAA
has not completed its audit of the Company's federal contracts for fiscal year
1998.

The Company's federal government contracts may be terminated, in whole
or in part, at the convenience of the government. If a termination for
convenience occurs, the government generally is obligated to pay the cost
incurred by the Company under the contract plus a pro rata fee based upon the
work completed. When the Company participates as a subcontractor, the Company is
at risk if the prime contractor does not perform its contract. Similarly, when
the Company as a prime contractor employs subcontractors, the Company is at risk
if a subcontractor does not perform its subcontract.

The Company's eligibility to perform under its federal government
contracts requires the Company to maintain adequate security measures. The
Company has implemented security procedures necessary to satisfy the
requirements of its federal government contracts.

Backlog

The Company had a backlog of approximately $1.3 billion, including
options of $954.1 million, at August 31, 1998. The Company had a backlog of $1.2
billion, including options of $928.0 million, at August 31, 1997, and a backlog
of $1.0 billion, including options of $501.8 million, at August 31, 1996.
Backlog represents the amount of revenues expected to be realized from awarded
contracts. Therefore, the amount in backlog is typically less than the face
amount of the contract. The amount includes estimates based on the Company's
experience with similar awards and customers, and estimates of revenues that
would be recognized from the performance of options, under existing contracts,
that may be exercised by the customer. These estimates are reviewed periodically
and are adjusted based on the latest available information. Historically, these
adjustments have not been significant. Because contracts in backlog are
typically multi-year contracts, an increase in backlog may not translate into
proportional revenue growth in any future period. Management believes that
approximately 20% to 25% of the Company's backlog at August 31, 1998 will result
in revenues for the year ending August 31, 1999.

The backlog amounts as presented are comprised of funded and unfunded
components. Funded backlog represents the sum of contract amounts for which
funds have been specifically obligated by customers to contracts. Unfunded
backlog represents future contract or option amounts that customers may obligate
over the specified contract performance periods. The Company's customers
allocate funds for expenditures on long-term contracts on a periodic basis. The
Company is committed to provide services under its contracts to the extent funds
are provided. The funded component of the Company's backlog at August 31, 1998
was approximately $214.6 million. The funded components of the Company's backlog
at August 31, 1997 and 1996, were $162.2 million and $99.5 million,
respectively. The ability of the Company to realize revenues from contracts in
backlog is dependent upon adequate funding for such contracts. Although funding
of its contracts is not within the Company's control, historical contract
fundings have been approximately equal to the aggregate amounts of the
contracts.

Intellectual Property Rights

The Company's success has resulted, in part, from its methodologies and
other proprietary intellectual property rights. The Company relies upon a
combination of trade secret, nondisclosure and other contractual arrangements
and technical measures to protect its proprietary rights. The Company generally
enters into confidentiality and nonsolicitation agreements with its clients and
potential clients and limits access to and distribution of its proprietary
information. There can be no assurance that the steps taken by the Company in
this regard will be adequate to deter misappropriation of its proprietary
information or that the Company will be able to detect unauthorized use and take
appropriate steps to enforce its intellectual property rights.

The Company's business does not depend on patents, copyrights, and
trademarks. Management believes that the Company's success depends on the
innovative skills and technical competence of its personnel rather than on the
ownership of patents, copyrights or trademarks. Technology developed by the
Company under its federal contracts is owned by the U.S. Government.

Employees

At August 31, 1998 the Company had approximately 3,000 full-time
employees. None of the Company's employees is covered by a collective bargaining
agreement. The Company considers its relationship with its employees to be good.

ITEM 2. PROPERTIES

The Company currently leases approximately 253,000 square feet of
office space in Huntsville, Alabama, and approximately 512,000 square feet of
office space in approximately 30 other locations throughout the United States.
The Company's leases expire at varying periods from 1998 to 2005, and currently
call for minimum annual lease payments of approximately $9.3 million. Certain of
the lessors under such leases are affiliated with the Company. See Note 8 to
Notes to the Company's Consolidated Financial Statements.

ITEM 3. LEGAL PROCEEDINGS

Pursuant to a purchase agreement dated April 15, 1998, the Company
purchased all of the capital stock of Mnemonic Systems, Inc. (MSI), from Artis
B. Isaac (Isaac). The purchase agreement contains an indemnity from Isaac in
favor of the Company against damages arising out of that certain litigation
pending in the United District Court for the District of Columbia captioned Otto
B. Isaac and Kathryn Isaac, Plaintiffs, v. Mnemonic Systems Inc. and Artis B.
Isaac, Defendants instituted on August 8, 1996, wherein the plaintiffs alleged,
among other matters, breach of contract, promissory estoppel, fraud, and
negligent misrepresentation in connection with the employment of Otto B. Isaac
by MSI and the subsequent termination of such employment relationship. MSI and
Isaac have denied the allegations and have counterclaimed for breach of contract
and fraud. In addition to the contractual indemnity, an escrow account funded by
the seller in the amount of approximately $800,000 exists to secure Isaac's
indemnity obligation to the Company, which the Company believes will be adequate
to cover the potential liability associated with this litigation.

On July 1, 1998, Forensic Technology WAI, Inc. (Forensic), filed suit
against MSI in United States District Court for the Eastern District of
Virginia, Alexandria Division, seeking injunctive relief, as well as monetary
damages. Forensic has alleged that the DRUGFIRE system offered by MSI and used
for the examination of fired cartridges infringes a United States patent issued
to Forensic on August 5, 1997. MSI believes that the DRUGFIRE system is
non-infringing, and that there are various grounds for invalidating the Forensic
patent. The Company has made a claim for indemnity against Isaac pursuant to the
contractual indemnity provisions of the purchase agreement.

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

None.

EXECUTIVE OFFICERS OF THE REGISTRANT

Information relating to the executive officers of the Company as of
August 31, 1998, is set forth below. Officers serve at the discretion of the
Board of Directors.

Officer
Name Age Position Since

Chris H. Horgen 52 Chairman 1976
Michael J. Mruz 53 Chief Executive Officer, President, Chief Operating 1994
Officer and Director
Roy J. Nichols 60 Senior Vice President and Vice Chairman 1976
Patsy L. Hattox 49 Corporate Vice President, Chief Administrative 1980
Officer, Secretary and Director
J. Michael Coward 55 Corporate Vice President and Chief Marketing Officer 1990
Allen E. Dillard 38 Corporate Vice President, Chief Financial Officer
and Treasurer 1992
Michael W. Solley 40 Executive Vice President 1992
John Rose 52 President, Army Business Operations 1998
James C. Moule 62 President, Navy and Air Force Business Operations 1988
Carl W. Monk, Jr. 51 President, National Programs Business Operations 1998
Thomas L. Patterson 56 Chairman, Healthcare IT and Director 1996
Paul D. Reaves 41 Chief Executive Officer, Healthcare IT 1998
H. Grey Wood 42 President, Healthcare IT 1998
Maurice Romine 57 President, Commercial IT 1996

Messrs. Horgen, Nichols, Coward, Dillard, Solley and Moule and Ms. Hattox
have been principally employed by the Company for over five years. Mr. Horgen
serves as a director of SouthTrust Bank of Alabama, N.A. Mr. Nichols serves as a
director of Adtran, Inc.

Michael J. Mruz became President of the Company in August 1994, its
Chief Operating Officer and a Director in September 1994, and its Chief
Executive Officer in September 1997. From 1989 to 1994, Mr. Mruz served as
Executive Vice President, Chief Financial and Administrative Officer, and a
member of the Board of Directors of BDM International, Inc. (BDM), a defense
contractor. While at BDM, Mr. Mruz held the positions of Corporate Vice
President from 1988 to 1989, Vice President/General Manager of BDM's Huntsville
Technology Center from 1983 to 1988, Vice President, Systems Design and Analysis
from 1979 to 1983, and various management and technical positions from 1974 to
1979. Mr. Mruz served in the U.S. Air Force from 1968 through 1974 in research
and development assignments involving communications systems.

John P. Rose became the President of the Company's Army Business
Operations on May 1, 1998. General Rose retired as a Brigadier General from the
U.S. Army in April, 1998. He served as the Director of Requirements on the Army
Staff from July 1995 to April 1998. From July 1992 to July 1995, General Rose
served as Director of North Atlantic Treaty Organization (NATO) Force Programs
at the Supreme Headquarters Allied Powers Europe (SHAPE), Belgium. In that
capacity he orchestrated military requirements for NATO nations in the post Cold
War environment.

Carl W. Monk, Jr. was named president of the Company's National
Programs Business Operations in September 1998. Mr. Monk joined the Company
in July 1998 with the acquisition of Welkin. Mr. Monk was the founder and
CEO of Welkin from its inception in 1988 through its merger with the Company
in 1998.

Thomas L. Patterson is Chairman of Nichols TXEN Corporation, a
wholly-owned subsidiary of the Company. He has been active in the healthcare,
managed care, and insurance markets since 1980. Mr. Patterson was co-founder and
President of TXEN, Inc., an information technology company for managed care
organizations, from 1989 to 1997. From 1980 to 1989, he was President of SEAKO,
Inc., an information technology company for practice management and managed care
systems.

Paul D. Reaves has been Chief Executive Officer of Nichols TXEN Corporation
since May 1998. Mr. Reaves was a co-founder of TXEN, Inc., and he served as
Executive Vice President of TXEN, Inc., from 1989 to 1997. From 1981 to 1989,
Mr. Reaves was employed by SEAKO, Inc. in programming, implementation, customer
support and sales and marketing. Mr. Reaves served as Vice President of SEAKO,
Inc. from 1985 to 1989.

H. Grey Wood has been President of Nichols TXEN Corporation since
January 1998 and was Vice President and General Manager of TXEN, Inc. from 1995
to 1998. From 1993 to 1995, he was Director and General Manger of the Physician
Practice Management Group of CSC Healthcare Systems, Inc., a vendor of turnkey
practice management and managed care software.

Maurice G. Romine became President of Nichols InfoTec Corporation, a
wholly-owned subsidiary of the Company, in May 1997. He served as Vice
President/General Manager of Nichols InfoTec Corporation from November 1996
until May 1997, and Vice President of the Company's Commercial Information
Technology Systems from February 1996 to November 1996. Prior to joining the
Company, Mr. Romine was employed by Intergraph Corporation, an interactive
computer graphics systems company, where he served as Executive Vice-President,
Corporate Marketing, from November 1989 to October 1992, and held various
management and technical positions from October 1976 to November 1989.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

Dividend Policy

The Company has never declared or paid cash dividends on its Common
Stock. The Company presently intends to retain its earnings for use in its
business, and therefore does not anticipate paying any cash dividends. Future
cash dividends, if any, will be determined by the Board of Directors in light of
Company's earnings, financial condition, capital requirements, and such other
factors as the Board may deem relevant. The Company's existing loan agreement
presently restricts the payment of cash dividends if the Company is in default.

Market and Stockholder Information

The Company's Common Stock is traded on the Nasdaq National Market
under the symbol NRES. The following table sets forth, for the periods
indicated, the high and low closing sale prices of the Company's Common Stock as
reported on the Nasdaq National Market.

1998 1997
High Low High Low

First Quarter 28 1/8 20 3/4 25 2/3 18 2/3
Second Quarter 26 5/8 20 3/8 29 3/4 21 1/2
Third Quarter 28 3/8 22 26 1/8 14 5/8
Fourth Quarter 28 3/4 20 1/8 25 3/4 17 3/4

On November 3, 1998, the per share closing sale price of the Common
Stock on the Nasdaq National Market was $19.875. On November 3, 1998, there were
approximately 1,607 holders of record of the Common Stock.

Recent Sales of Unregistered Securities

On July 28, 1998, the Company issued 415,671 shares of Common Stock to
shareholders of Welkin in connection with the merger of a wholly-owned
subsidiary of the Company with and into Welkin. The offering was exempt from
registration under Section 4(2) of the Securities Act of 1933 as a transaction
not involving any public offering.

ITEM 6. SELECTED FINANCIAL DATA

FIVE-YEAR FINANCIAL SUMMARY

Pro forma Pro forma
1998 1998 1997 1997 1996 1995 1994
---- ---- ---- ---- ---- ---- ----

Revenues $ 427,043,000 $427,043,000 $ 398,142,000 $ 398,142,000 $256,605,000 $ 180,698,000 $149,874,000

Net income $16,958,000*** $ 14,423,000 13,199,000** $ 1,199,000 $ 10,063,000 $ 7,651,000 $ 6,858,000

Earnings per
common share * $ 1.25 $ 1.06 $ 1.09 $ 0.10 $ 1.00 $ 0.80 $ 0.72

Earnings per
common share
assuming
dilution* $ 1.20 $ 1.02 $ 1.04 $ 0.09 $ 0.94 $ 0.77 $ 0.70

Stockholders'
equity $ 166,472,000 $166,472,000 $ 146,968,000 $ 146,968,000 $115,052,000 $ 69,358,000 $ 58,365,000

Long-term debt $ 2,948,000 $ 2,948,000 $ 4,025,000 $ 4,025,000 $ 4,784,000 $ 5,366,000 $ 4,328,000

Goodwill and
other intangibles,
net $ 54,214,000 $ 54,214,000 $ 48,130,000 $ 48,130,000 $21,004,000 $ 8,803,000 $ -

Total assets $ 224,061,000 $224,061,000 $ 210,132,000 $ 210,132,000 $165,321,000 $ 103,283,000 $82,318,000

* As adjusted for a three-for-two stock split effective October 21, 1996.

** Excludes a $12.0 million write off of purchased in-process research and
development.

*** Excludes $4.1 million of pretax special charges.

NOTE: All prior periods have been restated to reflect the fiscal year 1998
merger with Welkin, which was accounted for as a pooling of interests.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Except for historical information contained herein, this document contains
forward-looking statements as defined in Section 21E of the Securities Exchange
Act of 1934. Such forward-looking statements are subject to various risks and
uncertainties that could cause actual results to differ materially from those
projected in the forward-looking statements. These risks and uncertainties are
discussed in more detail below. These forward-looking statements can be
generally identified as such because the content of the statements will usually
contain such words as the Company or management "believes," "anticipates,"
"expects," "plans," or words of similar import. Similarly, statements that
describe the Company's future plans, objectives, goals, or strategies are
forward-looking statements.

Overview and Business Environment

The Company is a leading provider of technical and information
technology (IT) services, including information processing, systems development
and systems integration. The Company provides these services to a wide range of
clients, including the Department of Defense (DOD), other federal agencies,
state and local governments, healthcare and insurance organizations, and
commercial enterprises. The Company was founded in 1976 to develop specialized
optical sensing capabilities for military weapons and ballistic defense
programs. Until fiscal year 1991, virtually all of the Company's revenues were
derived under contracts with the federal government relating to high technology
weapons systems, strategic missile defense and other related aerospace
technologies. Areas of particular strength have included tactical technology,
smart sensing systems, simulations, data processing, systems engineering and
systems integration (including software development, networking, hardware
acquisition and installation, user training and system operation and
maintenance). Beginning in fiscal year 1991, in response to increasing budget
pressure on military procurements, the Company strategically began to develop
applications for its technical capabilities outside its traditional core
military business. Although the Company's core military business has continued
to grow, the Company has successfully entered the markets for other government
information technology solutions, as well as information technology solutions in
the healthcare industry and other commercial markets. The Company's business
strategy consists of three key elements: (i) maintain the Company's leadership
in technology; (ii) apply the Company's technology to create solutions for new
clients; and (iii) make strategic acquisitions and investments to expand the
business of the Company and gain industry knowledge.

The Company is organized into four strategic business units, reflecting
the particular market focus of each line of business. The Defense and
Intelligence unit, formerly Nichols Federal, provides technical services
primarily to U.S. Government defense agencies. The Government Information
Technology unit, formerly Nichols InfoFed, provides information and technology
solutions and services to a variety of governmental agencies. The Commercial
Information Technology unit, formerly Nichols InfoTec, provides information and
technology services to various commercial clients, other than healthcare
clients. The Healthcare Information Technology unit, formerly Nichols SELECT,
provides information and administrative services to clients in the healthcare
and insurance industries. For the year ended August 31, 1998, the percentage of
total revenues attributable to the four business units was approximately 55% for
Defense and Intelligence, 24% for Government IT, 10% for Commercial IT, and 11%
for Healthcare IT.

Risk Factors

The Company's business and financial performance are subject to risks
and uncertainties, including those discussed below.

Acquisition Strategy

Expansion through acquisitions is an important component of the
Company's overall business strategy. The Company has successfully completed ten
strategic acquisitions and alliances since September 1, 1994, most of which have
centered on IT and healthcare information services markets. Since the respective
dates of the acquisitions, the Company has integrated these acquired entities in
order to draw on the Company's base of technical expertise and capabilities in
designing solutions for government, commercial, and healthcare clients. The
Company's continued ability to grow by acquisitions is dependent upon, and may
be limited by, the availability of compatible acquisition candidates at
reasonable prices, the Company's ability to fund or finance acquisitions on
acceptable terms, and the Company's ability to maintain or enhance the
profitability of any acquired business.

Performance of Large Systems Integration Contracts

As part of the Company's business strategy to enter new markets, the
Company continues to pursue large systems integration contracts in both the
government and commercial markets, although competition for such contracts is
intense and many of the Company's competitors have greater resources than the
Company. While such contracts are working capital intensive, requiring large
equipment and software purchases to be funded by the Company before payment from
the customer, the Company believes such contracts offer attractive revenue
growth and margin expansion opportunities for the Company's range of technical
expertise and capabilities.

Variability of Quarterly Earnings or Operating Results

The Company's revenues and earnings may fluctuate from quarter to
quarter based on such factors as the number, size, and scope of projects in
which the Company is engaged, the contractual terms and degree of completion of
such projects, expenditures required by the Company in connection with such
projects, any delays incurred in connection with such projects, employee
utilization rates, the adequacy of provisions for losses, the accuracy of
estimates of resources required to complete ongoing projects, and general
economic conditions. Under certain contracts, the Company is required to
purchase, integrate and deliver to the customer large amounts of computer
processing systems and other equipment. Revenues are accrued as costs to deliver
these systems are incurred, and as a result, quarterly revenues will be impacted
by fluctuations related to equipment purchases which occur on a periodic basis
depending on contract terms and modifications.

Concentration of Revenues

Approximately 75%, 88%, and 76% of the Company's total revenues in
fiscal year 1998, fiscal year 1997 and fiscal year 1996, respectively, were
derived from contracts or subcontracts funded by the U.S. Government. These U.S.
Government contracts include military weapons systems contracts funded by the
DOD that accounted for approximately 55%, 53%, and 57% of the Company's total
revenues in such years, respectively. The Company believes that the success and
development of its business will continue to be dependent upon its ability to
participate in U.S. Government contract programs. Accordingly, the Company's
financial performance may be directly affected by changing U.S. Government
procurement practices and policies. Other factors that could materially and
adversely affect the Company's government contracting business and programs
include budgetary constraints, changes in fiscal policies or available funding,
changes in government programs or requirements (including proposals to abolish
certain government agencies or departments, curtailing the U.S. Government's use
of technology services firms, the adoption of new laws or regulations),
technological developments and general economic conditions. These factors could
cause U.S. Government agencies to exercise their rights to terminate existing
contracts for convenience or not to exercise options to renew such contracts.

Certain of the Company's contracts individually contribute a
significant percentage of the Company's revenues. The Company's seven largest
contracts (by revenues) are with the U.S. Government and generated approximately
43% of the Company's total revenues for the year ended August 31, 1998. The
Company expects revenues to continue to be concentrated in a relatively small
number of large U.S. Government contracts. Termination of such contracts, or the
Company's inability to renew or replace such contracts when they expire, could
materially and adversely affect the Company's revenues and income. During fiscal
year 1999, five of these seven contracts are expected to be recompeted.

Reductions or Changes in Military Weapons Expenditures

Historically, a majority of the Company's revenues (55% for the year
ended August 31, 1998) are related to U.S. military weapons systems. The U.S.
military weapons budget has been declining in real terms since the mid-1980s,
resulting in some cases in program delays, extensions, and cancellations. A
further significant decline in U.S. military expenditures for weapons systems,
or a reduction in the weapons systems portion of the defense budget, could
materially and adversely affect the Company. While not anticipated, the loss or
significant curtailment of the Company's U.S. military contracts would
materially and adversely affect the Company's revenues and income.

Approximately 17% of the Company's revenues in fiscal year 1998 were
from contracts related to Ballistic Missile Defense (BMD), compared to 20% of
revenues in fiscal year 1997 and 26% of revenues in fiscal year 1996 from such
contracts. Strategic defense has existed for more than 26 years as a mission of
DOD through activities such as the BMD program. If a decision were made to
reduce substantially the scope of current BMD programs, management believes that
many national and theater missile defense programs would continue to be funded
by the U.S. Army and U.S. Air Force, and other DOD agencies. While the Company
has expanded into other markets, a decision to reduce significantly or eliminate
missile defense funding would have an adverse effect on the Company's revenues
and income.

Uncertainties Associated with Government Contracts

The Company performs its services under U.S. Government contracts that
usually require performance over a period of one to five years. Long-term
contracts may be conditioned upon continued availability of Congressional
appropriations. Variances between anticipated budgets and Congressional
appropriations may result in delay, reduction, or termination of such contracts.
Contractors can experience revenue uncertainties with respect to available
contract funding during the first quarter of the government's fiscal year
beginning October 1, until differences between budget requests and
appropriations are resolved.

The Company's contracts with the U.S. Government and its prime
contractors are subject to termination, in whole or in part, either upon default
by the Company or at the convenience of the government. The termination for
convenience provisions generally entitle the Company to recover costs incurred,
settlement expenses, and profit on work completed prior to termination. Because
the Company contracts to supply goods and services to the U.S. Government, it is
also subject to other risks, including contract suspensions, audit adjustments,
protests by disappointed bidders of contract awards which can result in the
re-opening of the bidding process and changes in government policies or
regulations.

Contract Profit Exposure

The Company's services are provided primarily through three types of
contracts: fixed-price, time-and-materials and cost-reimbursement contracts.
Fixed-price contracts require the Company to perform services under a contract
at a stipulated price. Time-and-materials contracts reimburse the Company for
the number of labor hours expended at an established hourly rate negotiated in
the contract, plus the cost of materials incurred. Under cost-reimbursement
contracts, the Company is reimbursed for all actual costs incurred in performing
the contract to the extent that such costs are within the contract ceiling and
allowable under the terms of the contract, plus a fee or profit.

The Company assumes greater financial risk on fixed-price contracts
than on either time-and-materials or cost-reimbursement contracts. As the
Company increases its commercial business, it believes that an increasing
percentage of its contracts will be fixed-priced. Failure to anticipate
technical problems, estimate costs accurately, or control costs during
performance of a fixed-price contract, may reduce the Company's profit or cause
a loss. In addition, greater risks are involved under time-and-materials
contracts than under cost-reimbursement contracts because the Company assumes
the responsibility for the delivery of specified skills at a fixed hourly rate.
Although management believes that adequate provision for its fixed-price and
time-and-materials contracts is reflected in the Company's financial statements,
no assurance can be given that this provision is adequate or that losses on
fixed-price and time-and-materials contracts will not occur in the future.

To compete successfully for business, the Company must satisfy client
requirements at competitive rates. Although the Company continually attempts to
lower its costs, there are other information technology and technical services
companies that may provide the same or similar services at comparable or lower
rates than the Company. Additionally, certain of the Company's clients require
that their vendors reduce rates after services have commenced. The Company's
success will also depend upon its ability to attract, retain, train, and
motivate highly skilled employees, particularly in the areas of information
technology, where such employees are in great demand.

Year 2000

Many computer programs were designed and developed without considering
the upcoming change in the century, which could lead to failure in computer
applications or create erroneous results due to those computer programs not
recognizing the year 2000. This issue is referred to as the "Year 2000" problem.
Although the Company believes that its Year 2000 compliance program is
comprehensive, the Company may not be able to identify, successfully remedy or
assess all date-handling problems in its business systems or operations or those
of its customers and suppliers. As a result, the Year 2000 problem could have a
materially adverse affect on the Company's business, financial condition or
results of operations.

Amortization of Intangible Assets Related to TXEN Acquisition

In fiscal year 1995, the Company purchased 19.9% of the capital stock
of TXEN, Inc. (TXEN), for approximately $1.5 million. In August 1997, the
Company exercised its option to acquire the remaining 80.1% of the capital stock
of TXEN for aggregate consideration of approximately $43.8 million. The total
purchase price for the TXEN acquisition was allocated to the TXEN assets and
liabilities. The excess of the purchase price over the fair market value of the
tangible net assets acquired of approximately $42.1 million was allocated to the
following intangibles: $12.0 million to in-process research and development,
$15.6 million to goodwill, $12.7 million to other intangibles and $1.8 million
to capitalized software development. In-process research and development of
$12.0 million was expensed in the fourth quarter of 1997. Goodwill and other
intangibles of $27.6 million are being amortized using the straight-line method
over an estimated useful life of 20 years.

Of the total purchase price for the acquisition of TXEN, $12.0 million
was allocated to ten software programs and systems constituting in-process
technology. The fair value of the acquired in-process technology was determined
based on an analysis of the markets, projected cash flows and risks associated
with achieving such cash flows. At the date of acquisition, the technological
feasibility of the acquired technology had not been established and the acquired
technology has no alternative future uses. There can be no assurance that the
purchased in-process technology will be successfully developed. The acquired
in-process technology consisted of ten software and systems development projects
to reduce the time and personnel needed to perform managed care administrative
functions and provide enhanced information reports. At the date of acquisition,
the Company estimated that the cost to complete the projects was $1.75 million
of which $445,000 was spent in fiscal year 1998 and of which $1.3 million is
expected to be spent in fiscal year 1999. The Company expects to benefit from
such projects commencing in the second quarter of fiscal year 1999. The Company
expects the projects will be completed in the third quarter of fiscal 1999. To
the extent the in-process technology is not successfully developed, this could
have a material adverse impact on the Company's operating results and financial
condition.

In connection with the Company's filing of a Form S-3 registration
statement, the Company is engaged in discussions with the staff of the
Securities and Exchange Commission regarding the purchase price allocation
related to its August 1997 acquisition of TXEN. These discussions principally
relate to the amount allocated to in-process research and development and the
useful life of twenty years assigned to goodwill. The Company and its
independent auditors, Ernst & Young LLP, believe the purchase price allocation
recorded in connection with the TXEN acquisition, and related amortization
charges, are in accordance with widely recognized appraisal practices and
generally accepted accounting principles. However, the staff of the Securities
and Exchange Commission has recently expressed views concerning valuation of
in-process research and development in business combinations which, if
determined to be applicable, would probably result in a reduction in the amount
allocated to in-process research and development. If there are any significant
changes as a result of these discussions to the amounts allocated to purchased
in-process research and development or other intangible assets, or changes in
the lives over which such amounts are amortized, these could result in a
material reduction in the amount of the charge for in-process research and
development reflected in the Company's financial results for the year ended
August 31, 1997 and increased amortization expense in 1998 and subsequent
periods which could be material.

Results of Operations

The following table sets forth, for the periods indicated, the
percentages which certain items bear to consolidated revenues and the percentage
change of such items for the periods indicated. The amounts for fiscal years
1998 and 1997 include the impact of special charges to operating profit:

Percentage Increase
Percentage of Revenues (Decrease)
Years Ended August 31, Years Ended August 31,
1998 1997 1996 1998-1997 1997-1996

Revenues....................................... 100.0% 100.0% 100.0% 7.3% 55.2%
Cost and expenses:
Direct and allocable.................... 83.3 88.3 85.1 1.3 60.9
General and administrative.............. 9.2 6.3 8.4 56.9 16.4
Amortization of intangibles............. 1.0 0.5 0.5 121.3 53.0
Special charges......................... 1.0 3.0 __ (65.6) n/a
---------------------------------------------

Total cost and expenses............. 94.5 98.1 94.0 3.4 61.9

Operating profit............................. 5.5 1.9 6.0 202.0 (49.9)
Other income (expense), net.................. 0.1 0.3 0.2 (67.3) 167.5

Income before income taxes................... 5.6 2.2 6.2 168.2 (44.2)
Income taxes................................. 2.2 1.9 2.3 21.6 32.0
---------------------------------------------

Net income................................... 3.4% 0.3% 3.9% 1,102.9% (88.1)%
=============================================

The following table summarizes the percentage of revenues by contract
type for the periods indicated:

Years Ended August 31,
1998 1997 1996
---- ---- ----

Cost-reimbursement................................... 43% 49% 51%
Fixed-price.......................................... 33 35 22
Time-and-materials................................... 24 16 27

The table below presents contract award and backlog data for the
periods indicated:

Years Ended August 31,
1998 1997 1996
---- ---- ----
(in thousands)

Contract award amount................................$ 453,527 $ 679,174 $ 598,653
Backlog (with options)...............................$ 1,264,201 $ 1,228,362 $ 1,003,135
Backlog (without options)............................$ 310,071 $ 300,337 $ 501,373
Backlog percentage by contract type:
Cost-reimbursement.............................. 44% 45% 60%
Fixed-price..................................... 37% 30% 30%
Time-and-materials.............................. 19% 25% 10%

The backlog of contract awards is influenced by the number of new
contracts awarded and by the number of contracts awarded where the Company has
an existing contract that is recompeted. The Company performs under several
large multi-year contracts which, upon expiration, are recompeted. Historically,
the Company has been successful in winning recompeted contracts where it has
been the incumbent contractor. However, the Company cannot give assurance that
it will experience continued success with respect to future awards of recompeted
contracts. Of the $599 million in contract awards for fiscal year 1996, $355
million or 59% were with respect to the two high performance systems integration
contract awards. Of the $679 million in contract awards for fiscal year 1997,
$447 million or 65% were awards related to recompetition of contracts where the
Company was the incumbent. Of the $454 million of contract awards in fiscal year
1998, $77 million or 17% were awards related to recompetition of existing
contracts where the Company was the incumbent. The Company expects that in
fiscal year 1999, five of the Company's largest contracts by revenues will be
recompeted.

Comparison of Operating Results for Fiscal Year 1998 with Fiscal Year 1997

Revenues. Revenues increased $28.9 million (7.3%) for the year ended
August 31,1998. The Company's Defense and Intelligence unit, which represented
approximately 55% of consolidated revenues for the year, reported an increase of
$16 million (7%), primarily as a result of continued growth in existing contract
base. The Government IT unit, representing approximately 24% of consolidated
revenues for the year, reported a decrease of $30 million, primarily as a result
of reduced orders on two existing systems integration contracts. Commercial IT
revenues increased $15 million (58%) for the year, primarily as a result of SAP
software sales and integration services. Healthcare IT revenues increased $28
million (175%) for the year, primarily as a result of the acquisition of TXEN,
Inc. completed in August 1997.

Operating Profit. In the third quarter of fiscal year 1998 the Company
expensed $2 million of purchased in-process research and development activities
related to the acquisition of Mnemonic Systems, Incorporated (MSI). In the
fourth quarter of fiscal year 1998 the Company expensed $2.1 million in special
charges of which, $1.9 million related to the impairment of assets associated
with the insurance line of business (see Note 4 of the Notes to Consolidated
Financial Statements) and $0.2 million related to expenses incurred to
consummate the merger with Welkin Associates, Ltd. (Welkin), accounted for as a
pooling of interests. In the fourth quarter of fiscal year 1997 the Company
expensed $12 million of purchased in-process research and development activities
related to the acquisition of the remaining 80.1% of TXEN, Inc. (TXEN).
Operating profit including the write-offs of purchased in-process research and
development and special charges, increased $15.6 million (202%) for year ended
August 31, 1998 as compared to year ended August 31, 1997. Operating profit
excluding the write-offs of purchased in-process research and development and
special charges, increased $7.8 million (39.3%) for the year ended August 31,
1998 as compared to the year ended August 31, 1997. Direct and allocable costs
during fiscal year 1998 decreased as a percent of revenues compared to fiscal
year 1997 as a result of fewer hardware purchases for systems integration
contracts. General and administrative expense increased $14.2 million (56.9%)
for the year ended August 31, 1998 compared to the year ended August 31, 1997,
primarily as a result of the acquisition of TXEN completed in August 1997.
Amortization of intangibles increased $2.6 million (121.3%) for the year ended
August 31, 1998 as compared to the year ended August 31, 1997 primarily as a
result of the amortization of the intangibles recorded with the TXEN acquisition
completed in August 1997. The $4.1 million pre-tax special charges represents
1.0% of total costs and expenses for the year ended August 31, 1998. The $12.0
million pre-tax special charges represents 3.0% of total costs and expenses for
the year ended August 31, 1997. Total costs and expenses were 94.5% of revenues
for the year ended August 31, 1998 as compared to 98.1% of revenues for the year
ended August 31, 1997.

Operating Margin. Operating margin including the special charges was
5.5% of revenues for the year ended August 31, 1998 as compared to 1.9% of
revenues for the year ended August 31, 1997. Operating margin excluding the
special charges was 6.4% of revenues for the year ended August 31, 1998 as
compared to 5.0% of revenues for the year ended August 31, 1997. The Company's
Defense and Intelligence unit realized a 6.0% operating margin for the year
ended August 31, 1998 as compared to 4.2% for the year ended August 31, 1997.
The improved margins are primarily the result of improved margins on
time-and-material contracts. The Company's Government IT unit realized operating
margins, excluding the special charges, of 6.0% for the year ended August 31,
1998 as compared to 5.5% for the year ended August 31, 1997. The improved
margins are the result of increased margins on modifications awarded to existing
contracts during fiscal year 1998. The Company's Commercial IT unit realized
operating margins of 4.7% for the year ended August 31, 1998 as compared to 8.5%
for the year ended August 31, 1997. The decreased margins are a result of
increased costs related to infrastructure additions and client receivable
write-offs. The Company's Healthcare IT unit realized operating margins,
excluding special charges, of 12.3% for the year ended August 31, 1998 as
compared to 5.0% for the year ended August 31, 1997. The improved margins are
the result of the managed care operations acquired with the acquisition of TXEN
completed in August 1997.

Other Income (Expense). Other income (expense) decreased $.7 million for
the year ended August 31, 1998 as compared to the year ended August 31, 1997.
Other income includes equity in earnings of unconsolidated affiliates and
interest income. Other expense includes interest expense and minority interest.
Interest income is from the investment of the Company's cash reserves.
Substantially all available cash is invested in interest-bearing accounts or
fixed income instruments. Interest expense is primarily from the long-term
borrowings of the Company and the commitment fee on unused line of credit.

Equity in earnings of unconsolidated affiliates for the year ended
August 31, 1998 primarily represents the Company's share of the earnings of
NCCIM, L.L.C., a joint venture, 50% of which is owned by the Company; while the
comparable amount for the year ended August 31, 1997 primarily represents the
Company's share of earnings of TXEN. As of August 29, 1997, TXEN became a
wholly-owned subsidiary of the Company.

Minority interest primarily represents the minority partner's share of
earnings of Nichols ENTEC Systems, L.L.C., a joint venture, 60% of which is
owned by the Company. The increase in minority interest of $0.7 million for the
year ended August 31, 1998 as compared to the year ended August 31,1997 is
primarily the result of an increase in SAP software sales and integration
services in the Commercial IT unit.

Income Taxes. Income taxes as a percentage of income before taxes was
39.2% for the year ended August 31, 1998 as compared to 86.4% for the year ended
August 31, 1997. The decrease is primarily a result of the differences between
financial and taxable income related to the amortization of intangibles and
deductibility of special charges. In fiscal year 1997 the $12.0 million
write-off of purchased in-process research and development was not deductible
for tax purposes. In fiscal year 1998 the amortization expense of the intangible
assets acquired in the August 1997 acquisition of TXEN was not deductible for
tax purposes.

Net Income. Net income including the special charges increased $13.2
million (1,103%) for the year ended August 31, 1998, as compared to the year
ended August 31, 1997. Net income excluding the special charges increased $3.7
million (28.3%) for the year ended August 31, 1998 as compared to the year ended
August 31, 1997. The increases are a result of the items discussed above.

Earnings Per Common Share Assuming Dilution. Earnings per common share
assuming dilution including the special charges were $1.02 for the year ended
August 31, 1998 as compared to $0.09 for the year ended August 31, 1997.
Earnings per common share assuming dilution excluding the special charges were
$1.20 for the year ended August 31, 1998 compared to $1.04 for the year ended
August 31, 1997. Net income including the special charges increased $13.2
million (1,103%) for the year ended August 31, 1998 as compared to the year
ended August 31, 1997. Net income excluding special charges increased $3.7
million (28.3%) for the year ended August 31, 1998 as compared to the year ended
August 31, 1997. Weighted average common shares and common equivalent shares
increased 11.1% (1,412,291 shares) for the year ended August 31, 1998 as
compared to the year ended August 31, 1997.

Comparison of Operating Results for Fiscal Year 1997 with Fiscal Year 1996

Revenues. Revenues increased $141.5 million (55.2%) in fiscal year
1997. Approximately 70% of the increase was attributable to revenues from two
high performance system integration contracts awarded in 1996. During fiscal
year 1997, these two contracts generated approximately 30% of the Company's
total revenues. At August 31, 1997 a substantial portion of the two contract
values had been realized. These contracts generated less than 15% of the
Company's total revenues in fiscal year 1998.Approximately 20% of the increase
in revenues was attributable to acquisitions completed late in fiscal year 1996.
Approximately 10% of the increase in revenues was attributable to the existing
contract base.

Operating Profit. The Company expensed $12.0 million of costs in the
fourth quarter of fiscal year 1997 for research and development activities
in-process at the time of the acquisition of the remaining 80.1% of TXEN stock.
Including the $12.0 million write-off of purchased in-process research and
development associated with the acquisition of TXEN, operating profit decreased
$7.7 million (49.9%) in fiscal year 1997. Excluding the $12.0 million write-off
of purchased in-process research and development, operating profit increased
$4.3 million (27.8%) in fiscal year 1997. Including the write-off of purchased
in-process research and development, costs and expenses were 98.1% of revenues
for fiscal year 1997 compared to 94.0% of revenues for fiscal year 1996. The
write-off of purchased in-process research and development represents 3.0% of
total costs and expenses. Excluding the purchase of in-process research and
development, costs and expenses were 95.0% of revenues for fiscal year 1997.
Direct and allocable costs increased 60.9% ($133.0 million) in fiscal year 1997
as compared to fiscal year 1996. The increase is primarily the result of
increased purchases of hardware, software and subcontractor services in the
performance of certain government contracts. Direct and allocable costs as a
percent of revenues increased to 88.3% in fiscal year 1997 as compared to 85.1%
of revenues in fiscal year 1996 as a result of lower margins typically realized
on the purchased hardware, software, and subcontractor services. General and
administrative expenses increased 16.4% ($3.5 million) in fiscal year 1997 as
compared to fiscal year 1996. The increase is primarily a result of investments
in marketing and infrastructure resources made in fiscal year 1997 which are
expected to support future commercial revenues.

Other Income (Expense). Other income (expense) increased $0.7 million
in fiscal year 1997 as compared to fiscal year 1996. Other income includes
equity in earnings of unconsolidated affiliates and interest income. Other
expense includes interest expense and minority interest. Equity in earnings of
unconsolidated affiliates primarily represents the Company's share of earnings
of TXEN. As of August 29, 1997, TXEN became a wholly-owned subsidiary of the
Company. Interest income is from the investment of the Company's cash reserves.
Substantially all available cash is invested in interest-bearing accounts or
short-term fixed income instruments. Minority interest primarily represents the
minority partner's share of earnings of Holland Technology Group and Holland
Software Solutions, joint ventures, 60% of which are owned by the Company.

Income Taxes. Income taxes as a percentage of income before taxes was
86.4% in fiscal year 1997 and 36.5% in fiscal year 1996. The $12.0 million
write-off of purchased in-process research and development in the fourth quarter
of fiscal year 1997 is not deductible for tax purposes.

Net Income. Including the $12.0 million write-off of purchased
in-process research and development, net income decreased $8.9 million (88.1%)
for fiscal year 1997 as compared to fiscal year 1996. The decrease is the result
of the impact of the $12.0 million write-off of purchased in-process research
and development.

Earnings Per Share Assuming Dilution. Earnings per share assuming
dilution for fiscal year 1997 were $0.09 as compared to $0.94 for fiscal year
1996, a decrease of 90.0%. Excluding the $12.0 million write-off of purchased
in-process research and development, earnings per share assuming dilution were
$1.04 for fiscal year 1997 as compared to $0.94 for fiscal year 1996, a 10.2%
increase. Excluding the $12.0 million write-off of purchased in-process research
and development, net income increased 31.2% ($3.1 million), while weighted
average shares outstanding increased 19.0% (2,031,407 shares) for fiscal year
1997 as compared to fiscal year 1996.

Liquidity and Capital Resources

Historically, the Company's positive cash flow from operations and
available credit facilities have provided adequate liquidity and working capital
to fully fund the Company's operational needs and support the acquisition
program. Working capital was $78.0 million and $68.8 million at August 31, 1998
and 1997, respectively. Operating activities provided cash of $10.1 million and
$16.9 million for the years ended August 31, 1998 and 1997, respectively.
Investing activities used cash of $22.0 million and $29.2 million for the years
ended August 31, 1998 and 1997, respectively. Financing activities used cash of
$0.7 million for the year ended August 31, 1998 and provided cash of $14.1
million for the year ended August 31, 1997.

Cash provided by operating activities decreased $6.8 million for the
year ended August 31, 1998 as compared to the year ended August 31, 1997. The
decrease is the result of a decrease in the non-cash adjustments to reconcile
net income to net cash provided by operations ($3.9 million) and changes in
operating assets and liabilities, net of the effects of acquisitions ($16.1
million) offset by increased net income ($13.2 million).

Cash used for investing activities was $22.0 million for the year ended
August 31, 1998. The Company acquired all of the capital stock of MSI for
aggregate consideration of approximately $12.5 million. Purchases of property
and equipment were $9.3 million and $4.8 million for the years ended August 31,
1998 and 1997, respectively. The Company realized net proceeds of $2.3 million
from the maturity of long-term investments. An additional $1.0 million capital
investment was made for affiliates accounted for using the equity method.

Cash used for financing activities was $0.7 million for the year ended
August 31, 1998. The primary use of cash for financing activities was for the
net repayment of a $5.0 million indebtedness under the bank line of credit. The
Company realized proceeds from the sale of common stock of $5.6 million and $4.6
million for the years ended August 31, 1998 and 1997, respectively.

The Company renegotiated its bank line of credit in November 1997. The
agreement provides for unsecured borrowings up to $100,000,000. The credit
agreement provides for interest at London Interbank Offered Rate (LIBOR) plus a
margin ranging from 0.325% to 0.450% and a facility fee, payable quarterly, of
approximately 0.125% on the unused portion of the line of credit. The short-term
commitment agreement ($50,000,000) is renewable annually and the long-term
commitment agreement ($50,000,000) is renewable in November, 2000. There were
$5,000,000 outstanding borrowings on this line of credit at August 31, 1998.

The Company is regularly evaluating potential acquisition candidates and
expects to complete other transactions in fiscal year 1999. The purchase price
allocation for TXEN was finalized during the first fiscal quarter of 1998. The
$30.1 million, preliminarily classified as goodwill, was allocated as follows;
$15.6 million to goodwill, $12.7 million to other intangibles and $1.8 million
to capitalized software development. Goodwill and other intangibles of $27.6
million are being amortized using the straight-line method over an estimated
useful life of twenty years. Other intangibles of $0.7 million are being
amortized using the straight-line method over an estimated useful life of seven
years. The amount allocated to capitalized software development is being
amortized using the straight-line method over an estimated useful life of five
years. The acquisition of MSI was completed during the third fiscal quarter of
1998. The MSI acquisition resulted in the write-off of $2.0 million, pre-tax,
purchased in-process research and development and the recording of approximately
$10.0 million in goodwill which is being amortized using the straight-line
method over an estimated useful life of 15 years.

The Company has entered into preliminary negotiations with DSM Copolymer
to acquire an additional 35% interest in the ENTEC joint venture from DSM
Copolymer for $6.0 million plus an earn-out based on ENTEC revenues and profits.
If the negotiations are successful, the Company would own a 95% interest in the
joint venture. Closing is expected to occur during the second quarter of fiscal
year 1999.

The Company continues to actively pursue contracts for information
system development and computer system integration activities, which could
require the Company to acquire substantial amounts of computer hardware for
resale or lease to customers. The timing of payments to suppliers and payments
from customers under the Company's system integration contracts could cause cash
flows from operations to fluctuate from period to period.

The Company believes that, for the next four fiscal quarters, its
existing capital resources, together with available borrowing capacity, will be
sufficient to fund operating needs, finance acquisitions of property and
equipment, and make strategic acquisitions, if appropriate.

Recent Accounting Pronouncements

In February 1997, the Financial Accounting Standards Board (FASB)
issued Statement No. 128, Earnings Per Share. The overall objective of Statement
No. 128 is to simplify the calculation of earnings per share (EPS) and achieve
comparability with recently issued international accounting standards. The
Company first reported on the new EPS basis in the second quarter ended February
28, 1998. All prior period EPS amounts (including information regarding EPS in
interim financial statements, earnings summaries, and selected financial data)
have been restated to conform to the provisions of Statement No. 128.

In June 1997, the FASB issued Statement No. 130, Reporting Comprehensive
Income (SFAS 130). Statement No. 130 establishes new rules for the reporting and
display of comprehensive income and its components. Adoption of Statement No.
130 by the Company on September 1, 1998 will have no impact on the Company's
consolidated results of operations or stockholders' equity.

In June 1997, the FASB issued Statement No. 131, Disclosures About
Segments of an Enterprise and Related Information (SFAS 131). Statement No. 131
changes the method of determining segments from that currently required, and
requires the reporting of certain information about such segments. The Company
has not finalized how its segments will be reported or whether and to what
extent segment information will differ from that currently presented.

Effects of Inflation

Substantially all contracts awarded to the Company have been based on
proposals which reflect estimated cost increases due to inflation. Historically,
inflation has not had a significant impact on the Company.

Year 2000

Overview

Historically, certain computerized systems have had two digits rather
than four digits to define the applicable year, which could result in
recognizing a date using "00" as the year 1900 rather than the year 2000. This
could cause significant software failures or miscalculations and is generally
referred to as the "Year 2000" problem.

The Company recognizes that the impact of the Year 2000 problem extends
beyond its computer hardware and software and may affect utility and
telecommunication services, as well as the systems of customers and suppliers.

In response to the Year 2000 problem, the Company has developed a
compliance program to evaluate and address date related problems with the
Company's internal systems, services, products, and the systems and products of
the Company's vendors and suppliers. The compliance program is managed by the
Vice President of Corporate Information Systems and Services, and is patterned
after the United States General Accounting Office (GAO) and Office of Management
and Budget project management model.
The Company's Year 2000 compliance program includes five major phases:

Awareness Phase. The Year 2000 problem is defined and managers at the
executive level are educated about potential date related problems and the
potential impact to the Company and its customers from Year 2000 date handling
errors. A Year 2000 program team is established and an overall strategy is
developed.

Assessment Phase. The Year 2000 program team assesses the Year 2000
impact on the Company by: (i) identifying core business areas and processes;
(ii) performing an inventory and analysis of systems supporting the core
business areas; (iii)contacting third party service providers, and software and
hardware vendors to determine Year 2000 issues and their plans for becoming Year
2000 compliant; and (iv) prioritizing conversion or replacement of systems.

Renovation Phase. The Year 2000 program team corrects Year 2000
problems identified in the Assessment Phase by modifying program software,
updating databases, replacing systems or utilizing other appropriate methods.

Implementation Phase. The Year 2000 program team tests, verifies, and
validates converted or replaced systems, applications, databases and utilities
within a limited operational environment.

Validation Phase. The Year 2000 program team fully implements converted
or replaced systems, applications, databases and utilities. The Year 2000
program team also performs extensive testing of all system changes.

As part of the awareness phase the Company has reviewed

- Mission Essential Software Systems
- Mission Essential Computational Systems (hardware)
- Mission Essential Facilities Systems, including elevators, heating
and air conditioning systems, photocopying machines and utility services
- Mission Essential Network Systems
- Customer Software Services,provided by the Company's business units
- Mission Essential Vendor-Supplied Software and Services

The Company considers a system "mission essential" if a failure in that
system would materially disrupt the ability of the Company to perform
contractual services or to process business information in a timely manner. The
Company monitors the status of its Year 2000 compliance program and routinely
updates its Intranet to provide compliance data to its managers and employees.

The Company provides services and products to the U.S. Government pursuant
to specific contractual terms and exact specifications. The Company believes
that it will be responsible for upgrading only those services or products that
specify Year 2000 compliance and do not yet meet this requirement. The Company
is not currently aware of any such services or products.

Status and Timetable for Year 2000 Compliance

Nichols Research has developed a master timetable for its Year
2000 compliance program. The status of each major category of mission essential
systems is as follows:

SYSTEM CATEGORY PHASE ESTIMATED DATE
FOR COMPLIANCE
- --------------------------------------------------------------------------------

Mission Essential Software Systems Renovation December 1998
Mission Essential Computational Systems Renovation December 1998
Mission Essential Network Systems Renovation December 1998
Mission Essential Facilities Systems Assessment Unknown
Mission Essential Customer Systems Renovation December 1998
Mission Essential Vendor-Supplied Software
& Services Assessment Unknown

The phases listed above represent the status of the majority of
products within each category. There may be, within each "system," components at
a lower or higher phase in the Year 2000 assessment. For example, although
Mission Essential Vendor-Supplied Software and Services is rated in the
Assessment Phase, many of the Company's vendors have already been contacted and
have supplied letters or referenced web pages certifying their Year 2000
compliance. The Vice-President of Corporate Information Systems and Services
maintains compliance letters and referenced web page addresses.

While the Company estimates that its internal systems will be Year 2000
compliant by the end of calendar year 1998, there can be no assurance that the
third-party supplied software, hardware and services included in the Essential
Facilities and Vendor-Supplied Services categories will be Year 2000 compliant,
or that these third-parties will not suffer a Year 2000 business disruption that
may adversely affect the Company's business, financial condition or results of
operations.

Contingency Plans

Because the Company's Year 2000 conversions are expected to be
completed prior to any potential disruption to the Company's business, the
Company has not yet completed the development of a comprehensive Year 2000
contingency plan. However, the Company has minimized its exposure to Year 2000
failures of vendor supplied products by adding Year 2000 compliance as a
standard condition to its purchase orders. These contracts also reference
Federal Acquisition Regulation 39.106, which addresses Year 2000 compliance
issues. The Company is currently negotiating a Risk Management Insurance Policy
designed to protect the Company in the event that it is involved in litigation
arising from errors and omissions relating to Year 2000 issues. If the Company
determines that its business is at material risk of disruption due to the Year
2000 problem, or anticipates that its Year 2000 conversions will not be
completed in a timely fashion, the Company will work to develop a detailed
contingency plan.

Cost for Year 2000 Compliance

The Company believes that the total cost of its Year 2000 compliance
activity will not be material to the Company's operation, liquidity and capital
resources. The Company estimates that the total cost for its Year 2000
compliance will be $688,500 which represents 11,475 hours of analysis,
modification and testing, and $34,500 for new equipment purchases. To date, the
Company has completed 6,850 hours of Year 2000 compliance work, and purchased
new equipment valued at $27,000, for a total cost of $438,000.

Year 2000 Risks Faced by the Company

Although the Company believes that its Year 2000 compliance program is
comprehensive, the Company may not be able to identify, successfully remedy or
assess all date-handling problems in its business systems or operations or those
of its customers and suppliers. As a result, the Year 2000 problem could have a
materially adverse affect on the Company's business financial condition or
results of operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED BALANCE SHEETS

August 31, August 31, August 31,
1998 1997 1996
----------------------------------------------------
ASSETS (amounts in thousands)

Current assets:
Cash and temporary cash investments (Note 1)......... $ 11,275 $ 23,964 $ 22,151
Accounts receivable (net of allowance of $534,
$181, and $29) (Note 2)......................... 113,392 96,303 92,403
Deferred income taxes (Notes 1 and 5)................ 2,488 2,102 1,519
Other................................................ 3,939 3,162 2,438
----------------------------------------------------
Total current assets............................. 131,094 125,531 118,511

Long-term investments (Notes 1 and 3).................... 1,519 3,738 4,483

Property and equipment (Note 1):
Computers and related equipment...................... 29,465 22,409 17,455
Furniture, equipment and improvements................ 12,210 10,192 7,237
Equipment - contracts................................ 5,771 5,771 5,771
----------------------------------------------------
47,446 38,372 30,463
Less accumulated depreciation........................ 25,011 19,101 14,974
----------------------------------------------------
Net property and equipment....................... 22,435 19,271 15,489

Goodwill and other intangibles (net of accumulated
amortization of $5,857, $2,946, and $1,246) 54,214 48,130 21,004
(Notes 1, 4, and 11)...............................
Software development costs (net of accumulated
amortization of $840, $314, and $113) (Notes 1 and 4) 3,701 4,271 1,138
Investment in affiliates (Note 12)....................... 9,607 8,363 4,099
Other assets.............................................. 1,491 828 597
----------------------------------------------------

Total assets.............................................. $ 224,061 $ 210,132 $ 165,321
====================================================

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

CONSOLIDATED BALANCE SHEETS (CONTINUED)

August 31, August 31, August 31,
1998 1997 1996
-----------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (amounts in thousands)

Current liabilities:
Accounts payable..................................... $ 24,278 $ 28,679 $ 31,147
Accrued compensation and benefits (Note 9) ......... 18,317 11,854 9,382
Income taxes payable (Note 5)....................... 1,681 246 692
Current maturities of long-term debt (Note 6)....... 997 761 764
Borrowing on line of credit (Note 6)................ 5,000 10,500 __
Deferred revenue..................................... 1,797 3,114 230
Other................................................ 1,040 1,616 1,609
-----------------------------------------------------
Total current liabilities........................ 53,110 56,770 43,824

Deferred income taxes (Notes 1 and 5).................... 354 2,062 1,661

Long-term debt (Note 6):
Industrial development bonds......................... 1,335 1,558 1,777
Long-term notes...................................... 1,613 2,467 3,007
-----------------------------------------------------
Total long-term debt............................. 2,948 4,025 4,784

Minority interest in consolidated subsidiaries............ 1,177 307 __

Stockholders' equity (Notes 1 and 10):
Common stock, par value $.01 per share
Authorized - 30,000,000, 20,000,000 and
20,000,000 shares, respectively
Issued - 13,997,455, 13,553,346 and
12,076,463 shares, respectively.................. 140 135 121
Additional paid-in capital........................... 95,631 90,076 59,129
Retained earnings.................................... 71,989 58,045 57,090
Less cost of treasury stock - 168,500 shares......... (1,288) (1,288) (1,288)
-----------------------------------------------------
Total stockholders' equity....................... 166,472 146,968 115,052
-----------------------------------------------------

Total liabilities and stockholders' equity................ $ 224,061 $ 210,132 $ 165,321
=====================================================

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

CONSOLIDATED STATEMENTS OF INCOME

For the Years Ended August 31,
1998 1997 1996
----------------------------------------------------
(amounts in thousands except share data)

Revenues (Note 1) ...................................... $ 427,043 $ 398,142 $ 256,605

Costs and expenses:
Direct and allocable costs......................... 355,750 351,367 218,367
General and administrative expenses................ 39,099 24,913 21,408
Amortization of intangibles........................ 4,707 2,127 1,390
Special charges (Notes 4 and 11)................... 4,126 12,000 __
----------------------------------------------------
Total costs and expenses....................... 403,682 390,407 241,165
----------------------------------------------------

Operating profit........................................ 23,361 7,735 15,440

Other income (expense):
Interest expense (Note 6)......................... (467) (512) (629)
Other income, principally interest................. 1,176 1,095 1,044
Equity in earnings of unconsolidated
affiliates......................................... 524 656 __
Minority interest in consolidated
subsidiaries....................................... (870) (129) __
----------------------------------------------------
Income before income taxes.............................. 23,724 8,845 15,855
Income taxes (Note 5).................................. 9,301 7,646 5,792
----------------------------------------------------
Net income.............................................. $ 14,423 $ 1,199 $ 10,063
====================================================

Earnings per common share (Note 7)..................... $ 1.06 $ .10 $ 1.00
====================================================

Earnings per common share assuming
dilution (Note 7)................................ $ 1.02 $ .09 $ .94
====================================================

Weighted average common shares (Note 7)............... 13,607,145 12,090,377 10,090,684
====================================================

Weighted average common shares and
common equivalent shares (Note 7)................ 14,124,978 12,712,687 10,681,280
====================================================

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

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

Additional Total
Common Stock Paid-In Retained Treasury Stockholders'
Shares Amount Capital Earnings Stock Equity
------ ------ ------- -------- ----- ------
(in thousands except share data)

BALANCE, AUGUST 31, 1995........ 10,084,296 $101 $24,274 $47,125 $(2,143) $ 69,357
Sale of common stock............ 1,678,050 17 30,663 __ __ 30,680
Exercise of stock options....... 256,146 2 1,655 __ __ 1,657
Employee stock purchases........ 64,703 1 1,016 __ __ 1,017
Reissue of 108,066 shares of
treasury stock............... __ __ 1,523 __ 855 2,378
Repurchase of shares for retirement (6,732) __ (2) (98) __ (100)
Net income...................... __ __ __ 10,063 __ 10,063
----------------------------------------------------------------------------------------------

BALANCE, AUGUST 31, 1996........ 12,076,463 121 59,129 57,090 (1,288) 115,052
Exercise of stock options....... 326,656 3 3,047 __ __ 3,050
Employee stock purchases........ 79,816 __ 1,590 __ __ 1,590
Repurchase of shares for retirement (13,737) __ (4) (244) __ (248)
Issue of stock for acquisition.. 1,084,148 11 26,314 __ __ 26,325
Net income...................... __ __ __ 1,199 __ 1,199
----------------------------------------------------------------------------------------------

BALANCE, AUGUST 31, 1997........ 13,553,346 135 90,076 58,045 (1,288) 146,968
Exercise of stock options....... 332,312 4 3,351 __ __ 3,355
Employee stock purchases........ 111,797 1 2,204 __ __ 2,205
Net income...................... __ __ __ 14,423 __ 14,423
Adjustments for Welkin Associates,
Ltd. pooling of interests
(Note 11).................... __ __ __ (479) __ (479)
----------------------------------------------------------------------------------------------

BALANCE, AUGUST 31, 1998........ 13,997,455 $140 $95,631 $71,989 $(1,288) $166,472

==============================================================================================

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

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Years Ended August 31,
1998 1997 1996
---- ---- ----
(amounts in thousands)

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................................. $ 14,423 $ 1,199 $ 10,063
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Provision for doubtful accounts..................................... 353 27 23
Depreciation........................................................ 5,989 4,160 3,382
Amortization........................................................ 4,737 1,926 1,301
Equity in earnings of unconsolidated affiliates..................... (524) (656) __
Minority interest................................................... 870 307 __
Deferred income taxes............................................... (1,923) (389) (135)
Special charges..................................................... 3,977 12,000 __
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable.............................................. (17,919) 608 (30,554)
Other assets..................................................... (1,254) (307) (325)
Accounts payable................................................. (4,410) (3,776) 12,146
Accrued compensation and benefits................................ 6,331 2,151 1,118
Income taxes payable............................................. 944 (858) (335)
Other current liabilities........................................ (1,540) 487 (186)
-------------------------------------------
Total adjustments................................................ (4,369) 15,680 (13,565)
-------------------------------------------

Net cash provided (used) by operating
activities.................................................... 10,054 16,879 (3,502)

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment..................................... (9,273) (4,827) (5,339)
Purchase of long-term investments...................................... (100) (75) __
Purchase of capitalized software....................................... (722) (834) (935)
Payments for acquisitions, net of cash acquired........................ (13,178) (18,180) (15,503)
Payments for investment in affiliates.................................. (1,028) (6,054) (2,504)
Proceeds from long-term investments (Note 3)........................... 2,299 775 __
-------------------------------------------

Net cash used by investing activities......................... (22,002) (29,195) (24,281)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock................................. 5,560 4,640 33,354
Payments for retired shares............................................ __ (248) (100)
Payments of long-term debt............................................. (1,301) (763) (1,005)
Proceeds from borrowings on line of credit............................. 5,000 25,500 14,500
Payments on line of credit borrowings.................................. (10,000) (15,000) (14,500)
-------------------------------------------

Net cash provided (used) by financing activities....................... (741) 14,129 32,249

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

For the Years Ended August 31,
1998 1997 1996
---- ---- ----
(amounts in thousands)

Net increase (decrease) in cash and temporary cash investments......... (12,689) 1,813 4,466
Cash and temporary cash investments at beginning of year............... 23,964 22,151 17,685
-------------------------------------------

Cash and temporary cash investments at end of year..................... $ 11,275 $ 23,964 $ 22,151

===========================================

SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:
Issuance of stock as consideration in acquisitions..................... $ __ $ 26,325 $ 2,378
Adjustment to purchase price allocation................................ __ 200 __

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation. Nichols Research Corporation (Nichols) provides
information systems and technology services to agencies of the Department of
Defense (DOD), non-defense federal agencies, state governments and commercial
entities.

The consolidated financial statements include the accounts of Nichols
Research Corporation and its majority-owned subsidiaries and joint ventures (the
Company). Wholly-owned subsidiaries as of August 31, 1998 are Communications &
Systems Specialists, Inc. (CSSi), NRC Technical Services Corporation (NRCTSC),
Advanced Marine Enterprises, Inc. (AME), Nichols InfoTec Corporation, Nichols
TXEN Corporation, Mnemonic Systems, Incorporated. (MSI), and Welkin Associates,
Ltd. (Welkin). The majority-owned joint venture as of August 31, 1998 is Nichols
ENTEC. All significant intercompany balances and transactions have been
eliminated in consolidation. The Company's earnings in unconsolidated affiliates
and joint ventures are accounted for using the equity method.

Revenue Recognition. The major portion of the Company's revenues result
from services performed under U.S. Government contracts, either directly or
through subcontracts. Revenue on cost-plus-fee (including award fee) contracts
is recognized based on reimbursable costs incurred plus estimated fees earned
thereon. Revenue on fixed-price contracts is recognized using the percentage of
completion method based on costs incurred in relation to total estimated costs.
Revenue on time-and-materials contracts is recognized to the extent of fixed
billable rates for hours delivered plus reimbursable costs. Software license
fees are recognized upon delivery of the software product, unless the Company
has significant obligations remaining. If significant obligations remain
following delivery of the software, revenue is deferred and recognized as the
obligations are fulfilled. Provisions for losses on contracts are recognized in
the period in which the loss is first determinable. Unbilled accounts receivable
are stated at estimated realizable value.

Property and Equipment. Property and equipment are recorded at cost and
depreciated using the straight-line method over estimated useful lives of three
to ten years for equipment and furniture and over the terms of the related
leases for leasehold improvements.

In March 1995, the Financial Accounting Standards Board issued Statement
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of, which requires impairment losses to be recorded on
long-lived assets used in operations when indicators of impairment are present
and the undiscounted cash flows estimated to be generated by those assets are
less than the assets' carrying amount. Statement No. 121 also addresses the
accounting for long-lived assets that are expected to be disposed of. The
Company adopted Statement No. 121 in the first quarter of fiscal year 1997.

Income Taxes. Deferred income taxes are provided for temporary
differences between financial and taxable income, primarily related to accrued
liabilities, intangible assets and use of accelerated depreciation methods for
income tax purposes.

Cash and Temporary Cash Investments. The Company considers as cash
equivalents those securities that are available upon demand or have maturities
of three months or less at the time of purchase. At August 31, 1998, temporary
cash investments consisted of various money market accounts, primarily with an
Alabama bank.

Long-Term Investments. Investments are classified at the time of
purchase and are evaluated as of each balance sheet date. Debt securities, which
include municipal obligations and preferred stock, are classified as
held-to-maturity and are stated at amortized cost. Interest, dividends and
amortization of premiums are included in investment income.

Goodwill. Goodwill is amortized using the straight-line method over
periods ranging from ten to twenty years. The carrying amount of goodwill is
evaluated and if facts and circumstances suggest that it may not be recoverable
over the remaining amortization period, the carrying amount is reduced by the
amount estimated not to be recoverable. The Company assesses long-lived assets,
of which goodwill associated with assets acquired in a purchase business
combination is included, for impairment evaluations under Statement No. 121. As
discussed in Note 11 the Company is presently engaged in discussions with the
staff of the Securities and Exchange Commission concerning the basis for the
twenty year useful life being used to amortize certain of the Company's
goodwill.

Capitalized Software Development Costs. Certain costs of internally
developed software are capitalized and amortized over the estimated economic
useful life of the related software product. Amortization expense was $526,000,
$201,000 and $89,000 for years ended August 31, 1998, 1997, and 1996
respectively.

Stock Options. The Company grants stock options for a fixed number of
shares to employees with an exercise option price equal to the fair value of the
shares at the date of option grant. The Company accounts for stock option grants
in accordance with the Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and intends to continue to do so;
accordingly, the Company recognizes no compensation expense for stock option
grants in the financial statements.

Reclassification. Certain prior period amounts have been reclassified to
conform with the current year's presentation.

Use of Estimates. The preparation of the financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from the
estimates.

NOTE 2 - ACCOUNTS RECEIVABLE

Accounts receivable consist of the following as of August 31:

1998 1997 1996
------------- --------------- -------------
(in thousands)

Billed................................................................. $ 85,919 $ 50,901 $ 40,283
Unbilled............................................................... 27,473 45,402 52,120
------------- --------------- -------------
$ 113,392 $ 96,303 $ 92,403
============= =============== =============

Accounts receivable include $87,914,000, $82,702,000, and $74,357,000 due
from the U.S. Government at August 31, 1998, 1997, and 1996, respectively.

Unbilled accounts receivable include retainages of $1,652,000,
$4,094,000, and $3,534,000 at August 31, 1998, 1997 and 1996, respectively.
Unbilled amounts are classified as current assets since substantially all
amounts will be realized within one year.

Costs related to certain contracts are subject to adjustment from
negotiations and audit between the Company and its customers, including
representatives of the U.S. Government. Revenues for such contracts and the
related unbilled receivables have been recorded in amounts that are expected to
be realized.

NOTE 3 - LONG-TERM INVESTMENTS

The following is a summary of long-term investments as of the dates
stated:

Gross Gross Estimated Fair
Cost Unrealized Gains Unrealized Value
Losses
-------------------------------------------------------------------
(in thousands)

August 31, 1998 Held-to-maturity:
Municipal obligations..................... $ 1,019 $ 3 $ __ $ 1,022
Preferred stocks.......................... 500 1 __ 501
---------------- ----------------- --------------- ----------------
$ 1,519 $ 4 $ __ $ 1,523

August 31, 1997 Held-to-maturity:
Municipal obligations..................... $ 2,734 $ __ $ __ $ 2,734
Preferred stocks.......................... 1,004 9 __ 1,013
---------------- ----------------- --------------- ----------------
$ 3,738 $ 9 $ __ $ 3,747

August 31, 1996 Held-to-maturity:
Municipal obligations..................... $ 3,479 $ __ $ (20) $ 3,459
Preferred stocks.......................... 1,004 __ (26) 978
---------------- ----------------- --------------- ----------------
$ 4,483 $ __ $ (46) $ 4,437
================ ================= =============== ================

Contractual maturities of debt securities held to maturity occur ratably over
the next two years.

NOTE 4 - IMPAIRMENT OF LONG-LIVED ASSETS

During the fourth quarter of fiscal 1998, the Company reviewed the
insurance line of business. During the evaluation process it was determined that
expected future cash flows from this business would not be sufficient to recover
the recorded goodwill and capitalized software development costs related to this
business. The goodwill and capitalized software development costs were written
down to zero book value during the fourth quarter resulting in a pretax charge
of $1.9 million included in Special Charges on the Consolidated Statement of
Income for the year ended August 31, 1998.

NOTE 5 - INCOME TAXES

The provisions for income taxes for the years ended August 31, consist
of the following:

1998 1997 1996
---- ---- ----

(in thousands)
Current:
Federal....................... $ 9,766 $ 7,082 $ 5,203
State......................... 1,405 953 725
-----------------------------------
$ 11,171 $ 8,035 $ 5,928
Deferred:
Federal...................... $ (1,553) $ (343) $ (120)
State........................ (317) (46) (16)
-----------------------------------
$ (1,870) $ (389) $ (136)
-----------------------------------
$ 9,301 $ 7,646 $ 5,792
====================================

The significant components of deferred tax assets and liabilities as of
August 31:

1998 1997 1996
---- ---- ----
(in thousands)

Current deferred tax assets:
Accrued liabilities not currently deductible................... $ 2,488 $ 2,102 $ 1,519
Non-current deferred tax liabilities:
Basis difference for property and equipment................... (354) (2,062) (1,661)
----------------------------------------------

$ 2,134 $ 40 $ (142)
==============================================

Income tax expense as a percentage of income before income taxes for
the years ended August 31, varies from the federal statutory rate due to the
following:

1998 1997 1996
---- ---- ----
Statutory federal income
tax rate.................. 35.0% 35.0% 34.0%
State income taxes, net of
federal benefit........... 3.2 6.9 2.9
Non-deductible expenses
from acquisitions.......... 2.3 47.5 __
Equity earnings in
affiliates................. (0.8) (2.6) __
Other....................... (0.5) (0.4) (0.4)
------------------------------------------
39.2% 86.4% 36.5%
==========================================

The Company made income tax payments of approximately $9,189,000,
$8,480,000, and $6,262,000 in the years ended August 31,
1998, 1997, and 1996, respectively.

NOTE 6 - LINE OF CREDIT AND LONG-TERM DEBT

The Company has a bank line of credit which provides for unsecured
borrowings up to $100,000,000. The credit agreement provides for interest at
London Interbank Offered Rate (LIBOR) plus a margin ranging from 0.325% to
0.450% and a facility fee, payable quarterly, of approximately 0.125% on the
unused portion of the line of credit. The short-term commitment agreement
($50,000,000) expires November 1998 and is renewable annually and the long-term
commitment agreement ($50,000,000) is renewable in November, 2000. At August 31,
1998, there was $5,000,000 outstanding on this line of credit at an effective
interest rate of 6.0 percent.

In January 1995, the Company received $2,225,000 in bond proceeds from
the Alabama State Industrial Development Authority. The proceeds were restricted
for use in acquiring certain capital assets by July 1996. The bonds are payable
in equal annual principal installments of $222,500 through January 2005. The
bonds bear a variable rate of interest computed weekly but contain an option for
a fixed rate for a specified length of time. The bonds are secured by a letter
of credit. Interest payments of $132,000, $138,000, and $144,000, were made in
the years ended 1998, 1997, and 1996.

The Company borrowed $5,771,000 in fiscal year 1994 under a term loan
agreement. The proceeds were used to purchase computer hardware. The agreement
requires equal monthly principal installments of $64,537 until September 2001.
The loan bears interest at LIBOR plus 0.75% and is secured by the computer
hardware which has a carrying value of $2,388,000. Interest payments of
$182,000, $210,000, and $278,000 were made in the years ended August 31, 1998,
1997, and 1996, respectively. Interest expense is included in the consolidated
statements of income as a direct and allocable cost.

NOTE 7 - EARNINGS PER SHARE

In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings per Share. Statement 128
replaced the previously reported primary and fully diluted earnings per share
with earnings per common share and earnings per common share assuming dilution.
Unlike primary earnings per common share, earnings per common share excludes any
dilutive effects of options, warrants, and convertible securities. Earnings per
common share assuming dilution is very similar to the previously reported fully
diluted earnings per share. The Company adopted Statement 128 in the second
quarter of fiscal 1998. All earnings per share amounts for all periods have been
presented and, where necessary, restated to conform to the Statement 128
requirements.

The following table sets forth the computation of earnings per common
share and earnings per common share assuming dilution for the years ended August
31,:

1998 1997 1996

Numerator:
Net income and income available to
common stockholders and income
available to common stockholders $ 14,423,000 $ 1,199,000 $ 10,063,000
after assumed conversions...............
=================================================

Denominator:
Denominator for earnings per common
share - weighted average common
shares.................................. 13,607,145 12,090,377 10,090,684

Effect of dilutive securities:
Employee stock options....................... 517,833 622,310 590,596

-------------------------------------------------

Denominator for earnings per common
share assuming dilution - adjusted
weighted average common shares
and assumed conversions...................... 14,124,978 12,712,687 10,681,280
=================================================

Earnings per common share.......................... $ 1.06 $ 0.10 $ 1.00
=================================================
Earnings per common share assuming
dilution...................................... $ 1.02 $ 0.09 $ 0.94
=================================================

NOTE 8 - RELATED PARTY TRANSACTIONS AND COMMITMENTS

The Company leases office facilities under various operating leases,
including leases with companies in which certain officers and stockholders have
ownership interests. The leases generally have terms of one to ten years. Rent
expense for all operating leases for the years ended August 31, was as follows:

1998 1997 1996
-------------------------------------------------
(in thousands)

Total rent expense................................................ $ 8,520 $ 7,853 $ 5,047
Amounts to related parties........................................ 983 983 980

Future minimum lease payments under operating leases with remaining
terms of one year or more for the years ended August 31, are:

1999 2000 2001 2002 2003 thereafter
---- ---- ---- ---- ---- -----------
(in thousands)

Total.......................... $ 9,296 $ 8,391 $ 5,555 $ 3,626 $ 3,320 $ 10,275
Amounts to related parties..... 983 894 429 215 __ __

NOTE 9 - DEFINED CONTRIBUTION BENEFIT PLANS

Substantially all full-time employees are covered by one of several
defined contribution plans offered by the Company. Employees are permitted to
defer from 0% to 15% of their salary depending on the plan in which they
participate. A Company matching contribution is determined based on employee
deferral percentage and ranges from 0% to a maximum of 2.5%. Discretionary
contributions may also be made to plans as determined annually by the Board of
Directors. Total provisions for employee retirement plans were approximately
$8,112,000, $6,968,000, and $5,633,000 for the years ended August 31, 1998, 1997
and 1996, respectively.

NOTE 10 - EMPLOYEE STOCK OPTIONS AND STOCK PURCHASE PLANS

The Company has employee stock option plans that provide for the
issuance of incentive stock options (as defined by the Internal Revenue Code)
and nonstatutory stock options to key employees, including officers of the
Company and its subsidiaries. Options are nontransferable and exercisable only
during employment, with certain exceptions. Options are fully vested 48 months
from the date of grant. Options expire five or ten years from the date of grant.
At August 31, 1998, 1,629,955 shares were available for grant under these plans.

The Company also has a stock option plan for non-employee members of
the Board of Directors. Options are exercisable immediately and expire five
years from the date of grant. At August 31, 1998, 57,490 shares were available
for grant under this plan.

A summary of activity relating to stock options, including
reclassification of prior year share presentation, is as follows:

Employee Non-Employee
Stock Stock
Option Option Total
Plans Plans
----------------------------------------------------------

Outstanding at August 31, 1995
($8.58 per share)............................... 1,350,760 29,508 1,380,268
Granted ($14.20 per share)................ 299,468 9,000 308,468
Exercised ($6.47 per share).............. (250,644) (5,502) (256,146)
Canceled/Expired ($9.80 per share)........ (69,926) __ (69,926)
----------------------------------------------------------
Outstanding at August 31, 1996
($10.18 per share).............................. 1,329,658 33,006 1,362,664
Granted ($22.80 per share)................ 243,077 6,000 249,077
Exercised ($9.36 per share)............... (316,150) (10,506) (326,656)
Canceled/Expired ($12.45 per share)....... (36,474) (1,000) (37,474)
----------------------------------------------------------
Outstanding at August 31, 1997
($12.85 per share).............................. 1,220,111 27,500 1,247,611
Granted ($23.86 per share)................ 453,540 5,000 458,540
Exercised ($10.09 per share).............. (323,312) (9,000) (332,312)
Canceled/Expired ($17.09 per share)....... (106,676) __ (106,676)
----------------------------------------------------------

Outstanding at August 31, 1998.................. 1,243,663 23,500 1,267,163
Exercisable at August 31, 1998.................. 364,376 23,500 387,876

Weighted Weighted
Range of Contractual Average Average
Exercise Number Remaining Exercise Number Exercisable
Prices Outstanding Life Price Exercisable Price
------ ----------- ---- ----- ----------- -----

$ 0.72 - $ 8.14 235,807 3.5 years $ 7.11 216,988 $ 7.13
8.15 - 13.56 269,199 1.8 years 11.09 126,167 10.94
13.57 - 21.70 124,949 3.0 years 16.72 32,221 15.97
21.71 - 27.13 637,208 3.9 years 23.56 12,500 23.27
- -------------------------------------------------------------------------------------------------------------------
$ 0.72 - $ 27.13 1,267,163 3.3 years $17.51 387,876 $ 9.63

The Company has an employee stock purchase plan that allows eligible
employees to purchase common stock at less than fair market value. The purchase
price is 85% of fair market value on each quarterly purchase date. Purchases are
limited to the lesser of 10% of an employee's annual compensation or $25,000.
Shares of common stock issued under this plan were 111,797, 79,816, and 64,703
in the years ended August 31, 1998, 1997, and 1996, respectively.

In October 1995, the Financial Accounting Standards Board issued
Statement No. 123, Accounting for Stock-Based Compensation, which requires that
financial statements include certain disclosures about the stock-based employees
compensation and allows, but does not require, a fair value-based method of
accounting for such compensation. As allowed under the provisions of Statement
No. 123, the Company has elected to apply APB Opinion No. 25, Accounting for
Stock Issued to Employees, and related Interpretations in accounting for its
stock based plans. Accordingly, no compensation cost has been recognized for its
qualified stock option plans and its employee stock purchase plans. The effects
of applying Statement No. 123 on a pro forma basis are not likely to be
representative of the effects on reported pro forma net income (loss) for future
years as the estimated compensation cost reflects only options granted
subsequent to August 31, 1995. Had compensation cost for these programs been
determined based on the fair value at the grant dates for awards under these
programs consistent with the method prescribed under Statement No. 123, the
Company's net income and earnings per share would have been reduced to the pro
forma amounts indicated below for the years ended August 31:

1998 1997 1996
---- ---- ----
(in thousands except share data)

NET INCOME (LOSS):
As reported......................................................... $ 14,423 $ 1,199 $ 10,063
Pro forma........................................................... 12,179 (160) 9,525
EARNINGS (LOSS) PER COMMON SHARE ASSUMING DILUTION:
As reported......................................................... $ 1.06 $ 0.10 $ 1.00
Pro forma........................................................... 0.86 (0.01) 0.89
Weighted-average fair value of options granted
during the period...................................................... $ 9.52 $ 9.05 $ 6.38

The fair value of each option grant is estimated on the date of grant
using a type of Black-Scholes option-pricing model with the following
weighted-average assumptions used for option grants in fiscal 1998, 1997 and
1996, respectively: dividend yield of 0% for all years; expected volatility
factors of 0.391, 0.378 and 0.312; risk-free interest rates of 6.37%, 6.64% and
6.23%; and expected lives of 4 years for all years.

NOTE 11 - BUSINESS COMBINATIONS

On July 28, 1998, the Company exchanged 415,689 shares of its common
stock for all of the outstanding shares of Welkin. Welkin is a provider of
engineering and acquisition management services to the National Intelligence
community. The business combination was accounted for as a pooling of interests.
As a result of conforming Welkin's previous March 31 fiscal year end to the
Company's August 31 fiscal year end, seven months of operations are included in
both fiscal year ended August 31, 1998 and 1997. Revenue of $11,208,000 and net
income of $479,000 are included in both fiscal years. All periods presented have
been restated to include the accounts and operations of Welkin with those of the
Company as previously reported.

For the Years Ended August 31,
1997 1996
----------------------------------
(amounts in thousands)

Revenue:
Previously reported............................................. $ 379,695 $ 242,308
Welkin.......................................................... 18,447 14,297
-----------------------------------
Combined........................................................ $ 398,142 $ 256,605

Net Income:
Previously reported............................................. $ 474 $ 9,392
Welkin.......................................................... 725 671
-----------------------------------
Combined........................................................ $ 1,199 $ 10,063

Operations of the companies acquired which were accounted for as
purchases have been included in the accompanying consolidated financial
statements from their respective dates of acquisition. The excess of purchase
price over fair value of identifiable assets and liabilities acquired is
included as goodwill. Certain of the purchase agreements provide for contingent
payments based on certain operating results for periods ranging from one to five
years from date of acquisition.

On April 15, 1998 the Company acquired 100% of the outstanding stock of
MSI. MSI is a systems integration company serving clients primarily within the
U.S. Department of Justice. Aggregate consideration of approximately $12.5
million was paid at closing. Additional consideration of up to $6.0 million is
contingent upon achieving specified operating results during the twelve months
following acquisition as defined in the purchase agreement. The acquisition was
accounted for using the purchase method of accounting. The allocation of the
excess purchase price to intangible assets includes $2.0 million to in-process
research and development and $10.0 million to goodwill. The purchased in-process
research and development was expensed in the third quarter and is included in
the consolidated statements of income for the year ended August 31, 1998. The
goodwill amount is being amortized using the straight-line method over an
estimated useful life of fifteen years.

On August 29, 1997 the Company exercised its option to acquire the
remaining 80.1% of TXEN, Inc., an information systems and services company in
the managed care industry. Aggregate consideration of approximately $43.8
million was paid at closing, $17.5 million in cash and 1,084,148 shares of
stock, valued at approximately $26.3 million. Allocation of the excess purchase
price to intangible assets includes; $12.0 million to in-process research and
development which was expensed in the fourth quarter and is included in the
consolidated statement of income for the year ended August 31, 1997, $15.6
million to goodwill, $12.7 million to other intangibles and $1.8 million to
capitalized software development costs. Goodwill and other intangibles totaling
$27.6 million are being amortized using the straight-line method over an
estimated useful life of twenty years. The remaining $0.7 million of intangibles
is being amortized using the straight-line method over an estimated useful life
of seven years. The $1.8 million of capitalized software development costs is
being amortized using the straight-line method over an estimated useful life of
five years.

In connection with the Company's filing of a Form S-3 registration
statement, the Company is engaged in discussions with the staff of the
Securities and Exchange Commission regarding the purchase price allocation
related to its August 1997 acquisition of TXEN. These discussions principally
relate to the amount allocated to in-process research and development and the
useful life of twenty years assigned to goodwill. The Company and its
independent auditors, Ernst & Young LLP believe the purchase price allocation
recorded in connection with the TXEN acquisition, and related amortization
charges, are in accordance with widely recognized appraisal practices and
generally accepted accounting principles. However, the staff of the Securities
and Exchange Commission has recently expressed views concerning valuation of
in-process research and development in business combinations which, if
determined to be applicable, would probably result in a reduction in the amount
allocated to in-process research and development. If there are any significant
changes as a result of these discussions to the amounts allocated to purchased
in-process research and development or other intangible assets, or changes in
the lives over which such amounts are amortized, these could result in a
material reduction in the amount of the charge for in-process research and
development reflected in the Company's financial results for the year ended
August 31, 1997 and increased amortization expense in 1998 and subsequent
periods which could be material.

On May 31, 1996 the Company acquired all of the outstanding capital
stock of AME. AME provides naval architectural and marine engineering services
to primarily U.S. Government clients. The purchase price of approximately $17.5
million consisted of $15.1 million in cash and 108,066 shares of the Company's
stock valued at $2.4 million. The resulting goodwill of approximately $12.5
million is being amortized using the straight line method over fifteen years.

The following unaudited pro forma summary presents information as if
all the acquisitions had occurred at the beginning of each fiscal year
presented. The pretax charge of $14 million related to the write-off of
purchased in-process research and development has been included in the pro forma
results for the year ended August 31, 1997. The pro forma information is
presented for informational purposes only. It is based on historical information
and does not necessarily reflect the actual results that would have occurred nor
is it necessarily indicative of future results of operations of the combined
companies.

1998 1997
--------------------------------
(in thousands except share data)

Revenues...................................... $ 440,886 $ 435,949
Net income.................................... 16,341 1,608
Earnings per share assuming dilution.......... $ 1.16 $ 0.12

NOTE 12 - INVESTMENT IN AFFILIATES

The Company owns a 50% interest in a joint venture, NCCIM. NCCIM was
formed to perform work under a five year contract awarded in August 1997. The
Company's aggregate capital investment is $1,345,000 at August 31, 1998.
Undistributed equity earnings of $524,000 are included in the August 31, 1998
Retained Earnings balance reported in the Consolidated Balance Sheet.

In February 1997, the Company acquired approximately 30% of the
outstanding capital stock of Intertech Management Group, Inc. (Intertech).
Subsequently, the Company purchased an additional 4% interest. As of August 31,
1998, the Company holds approximately 34% of the outstanding capital stock at an
aggregate cost of approximately $5,663,000. Intertech provides software and data
processing services to the telecommunications industry.

In October 1995, the Company acquired the equivalent of approximately a
20% interest in HealthGate at an aggregate cost of approximately $2,069,000.
HealthGate provides a biomedical and health information system on the World Wide
Web.

NOTE 13 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

Earnings
(Loss)
Operating Per Share
Revenues Profit Net Income Assuming
(Loss) (Loss) Dilution
-------------------------------------------------------------------------------
(in thousands except share data)

Year ended August 31, 1998
First Quarter.................. $ 88,540 $ 5,682 $ 3,504 $ 0.25
Second Quarter.................. 92,509 5,963 3,819 0.27
Third Quarter................... 118,478 5,589 3,427 0.24
Fourth Quarter.................. 127,516 6,127 3,673 0.26

Year ended August 31, 1997
First Quarter................... $ 87,240 $ 4,776 $ 3,214 $ 0.25
Second Quarter.................. 96,379 4,615 3,154 0.25
Third Quarter................... 98,702 4,989 3,402 0.27
Fourth Quarter.................. 115,821 (6,645) (8,571) (0.67)

NOTE: All prior periods have been restated to reflect the merger with Welkin,
which was consummated on July 28, 1998 and accounted for as a pooling of
interests.

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board Of Directors
Nichols Research Corporation

We have audited the accompanying consolidated balance sheets of Nichols
Research Corporation as of August 31, 1998, 1997 and 1996, and the related
consolidated statements of income, stockholders' equity and cash flows for the
years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit 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 our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Nichols
Research Corporation at August 31, 1998, 1997 and 1996, and the consolidated
results of its operations and its cash flows for the years then ended in
conformity with generally accepted accounting principles.

ERNST & YOUNG LLP

BIRMINGHAM, ALABAMA
October 7, 1998

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information appearing under "Election of Directors" on pages 3
through 6 of the Nichols Research Corporation Proxy Statement relative to the
Annual Meeting of Shareholders to be held January 14, 1999, is incorporated by
reference in this Form 10-K Annual Report. Information regarding delinquent Form
3, 4 or 5 filers appearing under "Section 16(a) Beneficial Ownership Reporting
Compliance" on page 14 of the Nichols Research Corporation Proxy Statement
relative to the Annual Meeting of Shareholders to be held January 14, 1999, is
incorporated by reference in this Form 10-K Annual Report. Information relating
to the executive officers is set forth under "Executive Officers of the
Registrant" on page 12 of this Form 10-K Annual Report.

ITEM 11. EXECUTIVE COMPENSATION

The information appearing under "Executive Compensation" on pages 7
through 14 of the Nichols Research Corporation Proxy Statement relative to the
Annual Meeting of Shareholders to be held January 14, 1999, is incorporated by
reference in this Form 10-K Annual Report.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information appearing under "Common Stock Outstanding and Principal
Shareholders" on pages 1 through 3 of the Nichols Research Corporation Proxy
Statement relative to the Annual Meeting of Shareholders to be held January 14,
1999, is incorporated by reference in this Form 10-K Annual Report.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information appearing under "Certain Relationships and Related
Transactions" on page 14 of the Nichols Research Corporation Proxy Statement
relative to the Annual Meeting of Shareholders to be held January 14, 1999, is
incorporated by reference in this Form 10-K Annual Report.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) (1) The financial statements and other financial information of Nichols
Research Corporation set forth below and the Report of Independent Auditors
thereon are incorporated by reference from pages 24 through 37 of this Form 10-K
Annual Report:

Consolidated Balance Sheets at August 31, 1998, 1997, and 1996

Consolidated Statements of Income for the three years ended August 31, 1998

Consolidated Statements of Stockholders' Equity for the three years ended August
31, 1998

Consolidated Statements of Cash Flows for the three years ended August 31, 1998

Notes to Consolidated Financial Statements

Report of Ernst & Young LLP, Independent Auditors

Selected Quarterly Financial Data

(2) All financial statement schedules are omitted because they are not
applicable or the required information is shown in the financial statements or
notes thereto.

(3) Exhibits:

Exhibit Number
and Method of
Filing Reference Description

2.1 L Stock Purchase Agreement dated May 31, 1996, between Registrant and the shareholders of Advanced Marine
Enterprises, Inc.

2.2 T Agreement of Merger dated August 27, 1997, between Registrant, Nichols SELECT Corporation, TXEN, Inc.,
and the shareholders of TXEN, Inc.

2.3 O Stock Purchase Agreement dated April 15, 1998, between Registrant and Artis G. Isaac, the sole shareholder of
Mnemonic Systems, Incorporated.

2.4 A Agreement and Plan of Merger dated June 26, 1998, between Registrant, WAL Acquisition Company, Inc. and Welkin
Associates, Ltd.

3.1 M&C Certificate of Incorporation and Amendments thereto.

3.2 K By-laws and Amendments thereto.

4 D Specimen Stock Certificate.

10.1 B Performance Bonus Plan of Registrant dated July 1, 1986.*

10.2 D&F Non-Employee Officer and Director Stock Option Plan of Registrant.*

10.3 D&I 1988 Employees' Stock Purchase Plan of Registrant and Amendments Number One and Two thereto.*

10.4 J Lease dated February 18, 1992, between Parkway Properties II, as Lessor, and Registrant, as Lessee, for office
space located at 4035 Chris Drive, Huntsville, Alabama, together with exhibits.

10.5 N Lease dated January 25, 1996, between High Tech Properties, as Lessor, and Registrant, as Lessee, for office space
located at 1900 Golf Road, Huntsville, Alabama, together with exhibits.

10.6 E&Q Nichols Research Corporation 1989 Incentive Stock Option Plan.*

10.7 A Credit Agreement dated November 25, 1997 between the Registrant and Corestates Bank, N.A.relating to a $100
million revolving credit facility.

10.8 G&R Nichols Research Corporation 1991 Stock Option Plan.*

10.9 H Amendments Three and Four to the 1988 Employees' Stock Purchase Plan of Registrant.*

10.10 H Amendment to the Non-Employee Officer and Director Stock Option Plan of Registrant.*

10.11 H Amendment to the 1989 Incentive Stock Option Plan of Registrant.*

10.12 J Amendment Number Five to the 1988 Employees' Stock Purchase Plan of Registrant.*

10.13 J Amendment Number Two to the Non-Employee Officer and Director Stock Option Plan of Registrant.*

10.14 J Amendment Number One to the 1991 Stock Option Plan of Registrant.*

10.15 K Amendments Two and Three to the 1991 Stock Option Plan of Registrant.*

10.16 K Lease dated July 31, 1995, between Parkway Properties, as Lessor, and Registrant, as Lessee, for office
space located at 1910 Nichols Drive, Huntsville, Alabama.

10.17 K Restricted Stock Purchase Agreement dated September 1, 1994 between Registrant and Michael J. Mruz.*

10.18 P Amendment Six to the Nichols Research Corporation 1988 Employees' Stock Purchase Plan.*

10.19 Q Amendment Three to the Nichols Research Corporation 1989 Incentive Stock Option Plan.*

10.20 R Amendment Five to the Nichols Research Corporation 1991 Stock Option Plan.*

10.21 S Amendment Four to the Nichols Research Corporation Non-Employee Officer and Director Stock Option Plan.*

10.22 U Amendment Two to Employment Agreement dated September 1, 1997 between Nichols Research Corporation and
Michael J. Mruz.*

10.23 T Employment Agreement with Thomas L. Patterson, and Amendment to such Employment Agreement.*

10.24 C Nichols Research Corporation 1997 Stock Option Plan. *

10.25 C Nichols Research Corporation 1997 Stock Bonus Plan.*

10.26 C Nichols Research Corporation Supplemental Retirement Benefit Plan between Registrant and Michael J. Mruz.*

10.27 C Nichols Research Corporation Supplemental Retirement Benefit Plan between Registrant and Chris H. Horgen.*

10.28 A Employment Agreement dated July 28, 1998, between Welkin Associates, Ltd., the Registrant and Carl W.
Monk, Jr.*

10.29 A mendment Two dated June 1, 1998 to Employment Agreement between Nichols TXEN Corporation and Thomas L.
Patterson.*

10.30 A Employment Agreement dated December 16, 1994 between Nichols SELECT Corporation and Paul D. Reaves, and
amendment to such Employment Agreement.*

10.31 A Employment Agreement dated August 29, 1997 between Nichols SELECT Corporation and H. Grey Wood.*

21 A Subsidiaries of Registrant.

23 A Consent of Ernst & Young LLP, Independent Auditors.

24 A Power of Attorney. Reference is made to page 42 of this Form 10-K.

27 A Financial Data Schedule.

99 A Consent of Charles A. Leader.

- ----------------------

A Filed herewith.

B Incorporated by reference to exhibits filed with the Commission on November
21, 1986 with the Company's registration statement on Form S-1 under the
Securities Act of 1933, File No. 33-10323.

C Incorporated by reference to exhibits filed with the Commission on April 13,
1998 with the Company's Quarterly Report on Form 10-Q for the fiscal quarter
ended February 28, 1998, under the Securities Exchange Act of 1934.

D Incorporated by reference to exhibits filed with the Commission on November
28, 1989 with the Company's Annual Report on Form 10-K for the fiscal year ended
August 31, 1989, under the Securities Exchange Act of 1934.

E Incorporated by reference to exhibits filed with the Commission on November
16, 1990 with the Company's Annual Report on Form 10-K for the fiscal year ended
August 31, 1990, under the Securities Exchange Act of 1934.

F Incorporated by reference to exhibits filed with the Commission on January 18,
1991 with the Company's registration statement on Form S-8 under the Securities
Act of 1933, File No. 33-38568.

G Incorporated by reference to exhibits filed with the Commission on November
20, 1992 with the Company's Annual Report on Form 10-K for the fiscal year ended
August 31, 1992, under the Securities Exchange Act of 1934.

H Incorporated by reference to exhibits filed with the Commission on November
26, 1993 with the Company's Annual Report on Form 10-K for the fiscal year ended
August 31, 1993, under the Securities Exchange Act of 1934.

I Incorporated by reference to exhibits filed with the Commission on February 7,
1989 with the Company's registration statement on Form S-8 under the Securities
Act of 1933, File No. 33-13464.

J Incorporated by reference to exhibits filed with the Commission on November
28, 1994 with the Company's Annual Report on Form 10-K for the fiscal year ended
August 31, 1994, under the Securities Exchange Act of 1934.

K Incorporated by reference to exhibits filed with the Commission on November
29, 1995 with the Company's Annual Report on Form 10-K for the fiscal year ended
August 31, 1995, under the Securities Exchange Act of 1934.

L Incorporated by reference to exhibits filed with the Commission on June 17,
1996 with the Company's Current Report on Form 8-K dated May 31, 1996, as
amended, under the Securities Exchange Act of 1934.

M Incorporated by reference to exhibits filed with the Commission on July 25,
1996 with the Company's registration statement on Form S-3 under the Securities
Act of 1933, File No. 333-08787.

N Incorporated by reference to exhibits filed with the Commission on November
25, 1996 with the Company's Annual Report on Form 10-K for the fiscal year ended
August 31, 1996, under the Securities Exchange Act of 1934.

O Incorporated by reference to exhibits filed with the Commission on July 14,
1998 with the Company's Quarterly Report on Form 10-Q for the fiscal quarter
ended May 31, 1998, under the Securities Exchange Act of 1934.

P Incorporated by reference to exhibits filed with the Commission on June 13,
1997 with the Company's registration statement on Form S-8 under the Securities
Act of 1933, File No. 333-07164.

Q Incorporated by reference to exhibits filed on December 10, 1991 with the
Company's registration statement on Form S-8 under the Securities Act of 1933,
File No. 33-44409, as amended by Form S-8 filed with the Commission on June 13,
1997 (File No.
333-07160).

R Incorporated by reference to exhibits filed with the Commission on December 7,
1992 with the Company's registration statement on Form S-8 under the Securities
Act of 1933, File No. 33-55454, as amended by Form S-8 filed with the Commission
on June 13, 1997 (File No. 333-07162).

S Incorporated by reference to exhibits filed with the Commission on June 23,
1997 with the Company's registration statement on Form S-8 under the Securities
Act of 1933, File No. 333-29791.

T Incorporated by reference to exhibits filed with the Commission on September
11, 1997 with the Company's Current Report on Form 8-K dated August 31, 1997, as
amended under the Securities Exchange Act of 1934.

U Incorporated by reference to exhibits filed with the Commission on November
28, 1997, with the Company's Annual Report on Form 10-K for the fiscal year
ended August 31, 1997, under the Securities Exchange Act of 1934.

* Denotes management contract or compensatory plan or arrangement
required to be filed as an exhibit to this report.

(b) Reports on Form 8-K. No reports on Form 8-K were filed during the fourth
quarter of the fiscal year ended August 31, 1998.

(d) Financial Statement Schedules. The response to this portion of Item 14 is
submitted as a separate section of this report.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

NICHOLS RESEARCH CORPORATION

November 24, 1998 By Chris H. Horgen
----------------- ---------------
Chris H. Horgen
Chairman of the Board

POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below, hereby constitutes and appoints Michael J. Mruz and Allen E.
Dillard, and each or either of them, with full power of substitution, as
attorneys-in-fact in their names, place and stead to execute any and all
amendments to this Form 10-K, and to file the same, with exhibits thereto and
documents in connection therewith, and hereby ratify and confirm all that said
attorneys-in-fact and each of them or his substitutes may do by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.

Signature Title Date

Chris H. Horgen Chairman of the Board (Principal November 24, 1998
--------------- Executive Officer)
Chris H. Horgen

Michael J. Mruz Chief Exective Officer and Director November 24, 1998
---------------
Michael J. Mruz

Patsy L. Hattox Corporate Vice President, Chief Administrative November 25, 1998
--------------- Officer, Secretary and Director
Patsy L. Hattox

Roy J. Nichols Vice Chairman and Senior Vice President November 24, 1998
--------------
Roy J. Nichols

Roger P. Heinisch Director November 18, 1998
-----------------
Roger P. Heinisch

John R. Wynn Director November 25, 1998
------------
John R. Wynn

William E. Odom Director November 20, 1998
---------------
William E. Odom

James R. Thompson, Jr. Director November 20, 1998
----------------------
James R. Thompson, Jr.

Phil E. Depoy Director November 24, 1998
-------------
Phil E. Depoy

------------------- Chairman of Nichols TXEN Corporation and November ___, 1998
Thomas L. Patterson Director

Daniel W. McGlaughlin Director November 23, 1998
---------------------
Daniel W. McGlaughlin

David Friend Director November 18, 1998
------------
David Friend

Allen E. Dillard Corporate Vice President, Chief Financial Officer, November 25, 1998
---------------- and Corporate Treasurer (Principal Financial
Allen E. Dillard and Accounting Officer)