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FTI Consulting 10-K 2005
FORM 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-K

 


 

 

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

 

For the fiscal year ended December 31, 2004

 

OR

 

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

 

For the transition period from              to             

 

Commission file number 001-14875

 


 

FTI CONSULTING, INC.

(Exact Name of Registrant as Specified in its Charter)

 


 

Maryland   52-1261113
(State or Other Jurisdiction of Incorporation or Organization)   (I.R.S. Employer Identification No.)
900 Bestgate Road, Suite 100, Annapolis, Maryland   21401
(Address of Principal Executive Offices)   (Zip Code)
(410) 224-8770
(Registrant’s telephone number, including area code)

 

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

 

Title of Each Class   Name of Each Exchange on which Registered
Common Stock, $0.01 par value   New York Stock Exchange

 


 

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.  ¨

 

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

 

The aggregate market value of the voting and nonvoting common stock held by non-affiliates of the registrant was $696,989,000, based on the closing sales price of the registrant’s common stock on June 30, 2004.

 

The number of shares of registrant’s common stock outstanding on February 28, 2005 was 43,521,219.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of our definitive Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the end of our fiscal year are incorporated by reference into Part III of this Annual Report on Form 10-K.

 



Table of Contents

FTI CONSULTING, INC. AND SUBSIDIARIES

Annual Report on Form 10-K

Fiscal Year Ended December 31, 2004

 

INDEX

 

          Page

PART I          
Item 1.    Business    1
Item 2.    Properties    18
Item 3.    Legal Proceedings    18
Item 4.    Submission of Matters to a Vote of Security Holders    19
PART II          
Item 5.    Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    20
Item 6.    Selected Financial Data    21
Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    24
Item 7A.    Quantitative and Qualitative Disclosures About Market Risk    40
Item 8.    Financial Statements and Supplementary Data    42
Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    72
Item 9A.    Controls and Procedures    72
Item 9B.    Other Information    72
PART III          
Item 10.    Directors and Executive Officers of the Registrant    73
Item 11.    Executive Compensation    73
Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    73
Item 13.    Certain Relationships and Related Transactions    73
Item 14.    Principal Accountant Fees and Services    73
PART IV          
Item 15.    Exhibits and Financial Statement Schedules    74

 

 


Table of Contents

FTI CONSULTING, INC.

 

PART I

 

ITEM 1. BUSINESS

 

The following discussion of our business contains forward-looking statements relating to future events or our future financial performance within the meaning of Section 21E of the Securities Exchange Act of 1934, which involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements expressed or implied by such forward-looking statements not to be fully achieved. Our forward-looking statements include those discussed under “—Business Risks” in this Item 1, “Part II — Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the other documents we file with the Securities and Exchange Commission, or SEC, including, among others, our quarterly reports on Form 10-Q and amendments thereto. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue” or the negative of such terms or other comparable terminology. These statements are only predictions. We are under no duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results or events and do not intend to do so.

 

When we use the terms “FTI,” “we,” “us” and “our” we mean FTI Consulting, Inc., a Maryland corporation, and its consolidated subsidiaries.

 

Company Overview and Recent Developments

 

We began operations in 1982 as a consulting firm focused on providing forensic investigation, scientific and trial support services. We have evolved through internal growth and periodic strategic acquisitions. During 2004, we began operating our business in three practice segments:

 

    Forensic and Litigation Consulting and Technology Practice. Within our forensic and litigation consulting and technology practice, we help clients assess complex financial transactions and reconstruct events from incomplete and/or corrupt data, uncover vital evidence, identify potential claims and assist in the pursuit of economic recoveries. We also provide asset tracing investigative services and expert witness services. We provide litigation related services to clients in all phases of litigation, including pre-filing, discovery, jury selection, trial preparation, expert testimony and the actual trial. We assist with refining issues in litigation and venue selection, and provide fraud investigation and securities litigation assistance. Our trial graphics and technology and electronic evidence experts assist clients in preparing for and presenting their cases in court. Our repository services include secure extranet and web-hosting services for clients that are parties to multi-district litigation.

 

As of February 28, 2005, we acquired substantially all of the assets and certain of the liabilities of the Ringtail group. Established in 1997, Ringtail is a leading global developer of litigation support and knowledge management technologies for law firms, Fortune 500 corporate legal departments, government agencies and courts. Ringtail has developed a suite of integrated software modules to manage the information and workflow in complex legal cases. Specifically, Ringtail’s technologies are designed to ensure quality, reduce risk, increase productivity and improve cost effectiveness in the review, preparation and production of litigation data. In addition, Ringtail’s software has also been used in a transactional capacity to support “deal rooms” and merger and acquisition activity. We employ Ringtail’s products in the repository services, electronic evidence and document management services we perform for clients, and we accounted for approximately 30% of Ringtail’s prior year’s business.

 

In the fourth quarter of 2003, we completed two strategic acquisitions that fit within our forensic and litigation consulting and technology practice. We acquired specified assets and liabilities of the dispute advisory services, or DAS business, of KPMG LLP as of October 31, 2003, which assists clients in the analysis and resolution of all phases of complex claims and disputes. As of October 15, 2003, we

 

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acquired substantially all of the assets and certain liabilities of Ten Eyck Associates, P.C., which expanded our consulting services relating to investigations by the Securities and Exchange Commission, or SEC, and other regulatory authorities, securities law litigation, SEC accounting and enforcement, fraud investigations and The Sarbanes-Oxley Act of 2002.

 

    Corporate Finance/Restructuring Practice. Our corporate finance/restructuring practice provides turnaround, performance improvement, lending solutions, financial and operational restructuring, restructuring advisory, mergers and acquisitions, transaction advisory and interim management services. We assist under performing companies in making decisions to improve their financial and operational position given their current situation. We analyze, recommend and implement strategic alternatives for our corporate finance/restructuring clients, such as rightsizing infrastructure, improving working capital management, selling non-core assets or business units, restructuring capital and borrowings, and assessing long-term viability and business strategy. We also lead and manage the financial aspects of the in-court restructuring process, such as assessing the impact of a bankruptcy filing on the client’s financial and operational situation, planning for the smooth transition in and out of bankruptcy, facilitating the sale of assets and assisting to arrange debtor-in-possession financing. Through our corporate finance services, we can help financially distressed companies implement their plans by providing interim management teams. In January 2004, we experienced the unanticipated departure of approximately 60 professionals from our corporate finance/restructuring practice.

 

    Economic Consulting Practice. Within our economic consulting practice, we provide our clients with analyses of complex economic issues for use in legal and regulatory proceedings, strategic decision-making and public policy debates. In the fourth quarter of 2003, we diversified our service offerings by acquiring specified assets and certain liabilities of Lexecon, Inc, from Nextera Enterprises, Inc., to provide economic consulting services by the Lexecon professionals, who are among the leading providers of these services in the United States. Our services now include providing advice and testimony related to:

 

o   antitrust and competition issues that arise in the context of potential mergers and acquisitions;

 

o   other antitrust issues, including alleged price fixing, cartels and other forms of exclusionary behavior;

 

o   the application of modern finance theory to issues arising in securities litigation; and

 

o   public policy studies on behalf of companies, trade associations and governmental agencies.

 

All of our practices have experience providing testimony in the following areas: fraud, damages, lost profits, valuation, accountant’s liability and malpractice, contract disputes, patent infringement, price fixing, purchase price disputes, solvency and insolvency, fraudulent conveyance, preferences, disclosure statements, trademark and copyright infringement and the financial impact of government regulations. We have unique capabilities in several highly specialized areas, including telecommunications, transportation, railroad, utilities, oil and gas, chemicals, energy, banking and investment banking, pharmaceuticals, tobacco, retail and information technology.

 

Demand for our services is most often driven by non-discretionary engagements involving businesses facing critical situations that are often adverse. Our clients include companies, as well as creditors or other stakeholders, such as financial institutions and private equity firms, and the law firms that represent them. During 2004, our clients included 91 of the top 100 U.S. law firms, 181 corporate clients in the Fortune 500, and 21 of the 25 largest banks in the United States. During 2004, about 83% of our revenues came from repeat business from existing clients and referrals. Our revenues from continuing operations have grown from $122.3 million in 2001 to $427.0 million in 2004, at a compounded annual growth rate of 51.7%. During 2004, we continued to integrate the businesses we acquired during 2003 into our company. We believe demand for our services will continue to be strong, driven by a number of current and anticipated trends, including:

 

    increasingly complex interplay between competitive and regulatory forces faced by a wide range of businesses that encourages, and in some cases, requires the use of outside financial consultants;

 

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    the need for objective, independent expertise for critical, business processes; and

 

    debt levels that companies are continuing to use and carry.

 

We believe that our reputation, national scale and large staff of highly qualified professionals, position us well to capitalize on the trends driving the growth in our practices.

 

Trends Affecting Our Business

 

Escalating Public Scrutiny and Regulatory Complexity. We believe that factors driving our business include the increased awareness of the potential for corporate mismanagement or fraud, the heightened scrutiny that often uncovers alleged frauds and spawns investigations and litigation, the continuing trend in high-stakes litigation and the effect of increased regulation. For example, the Sarbanes-Oxley legislation has added a layer of complex regulatory requirements for public companies. Faced with recent enhanced scrutiny by investors and government agencies of financial reporting and corporate governance, in part as a result of this legislation, companies have begun to hire outside professionals to review and analyze their accounting records, internal controls and financial reporting. We believe that recent mandates arising from the Sarbanes-Oxley legislation, and the emerging trend toward hiring consulting firms unaffiliated with company auditors, represent a fundamental shift in corporate and governmental policy. We also anticipate that ever increasing litigation costs will require businesses to focus on better managing risks and the litigation process, particularly in large, complex, multi-jurisdiction cases and mass tort claims. These trends should directly benefit independent financial consulting service providers.

 

Increasing Need for Independent Expertise. We believe that businesses, their creditors and other institutional stakeholders are increasingly engaging consulting firms to provide objective, independent expertise for highly critical business processes, especially in those areas that are complex, unique and incident-driven. Businesses and financial institutions facing adverse circumstances have a need to access world-class expertise to assist them in implementing tactical operating plans to solve significant business dilemmas. This is particularly true in highly complex and sophisticated areas such as restructurings, bankruptcies, economic consulting, forensic accounting and high-stakes legal proceedings.

 

Trends in Continuing Use of Corporate Debt and Debt Default Rates. We believe that corporate debt levels and related default levels are important indicators of the potential need for restructuring, turnaround, bankruptcy and related consulting services. U.S. and international companies have increasingly relied on debt, including bank debt, to finance acquisitions, growth initiatives and working capital requirements, and therefore, we believe that debt levels will remain high. The size of the public and private debt market, as measured by the amount of aggregate U.S. corporate debt outstanding, has consistently expanded over the past 30 years, regardless of economic cycles. Although debt default rates tend to decline during periods of economic expansion, we believe that economic expansion also facilitates new issuances of speculative grade debt, as investors are generally willing to tolerate higher levels of risk during these periods. Notwithstanding increases in debt, in 2004, we have seen a decline of the mega bankruptcy cases, resulting in a greater portion of our business being comprised of engagements relating to bankruptcy and restructuring matters involving mid-size companies.

 

Business Strategy

 

We are one of the largest providers of forensic and litigation consulting and technology, corporate finance/restructuring and economic consulting services in the United States. We have a 22-year track record of performance and overall expertise. We provide high caliber consulting services through our staff of professionals who are able to quickly staff even the largest and most complex assignments. Our goal is to anticipate our clients’ needs and expand our expertise, professionals and the range of consulting services we offer in the United States and to expand internationally. Success in our marketplace depends primarily on having a reputation for

 

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providing consistently high-quality advice and services, on schedule and on budget. The following are key elements of our business strategy:

 

    Retain a Critical Mass of Highly Qualified Professionals. Our professionals are crucial to delivering our services to clients and generating new business. Through our substantial staff of highly qualified professionals, we can handle a number of large, complex assignments simultaneously. We offer each of our professionals significant compensation opportunities, including performance-based and other types of incentive and bonus compensation, along with a competitive benefits package and the chance to work on challenging engagements. Currently, we have written employment arrangements with most of our senior managing directors that include reasonable non-competition clauses. We strive to manage the renegotiation of written employment arrangements in advance of their expiration dates. We take a disciplined approach when recruiting additional professionals. We focus on hiring qualified individuals who meet our selective criteria.

 

    Leverage Our Relationships and Expertise. We work hard to maintain our existing client relationships and develop new ones. We believe that our existing client relationships and our reputation among other professionals, coupled with our recognized expertise, track record and size, are the most critical elements in a decision to retain us. We receive a significant amount of repeat business and referrals from our financial institution clients, from our clients in regulated industries, and from law firm clients. We strive to build client relationships on a company-wide basis, and to that end we enter into corporate as opposed to personal engagements. In this way, our goal is to develop client relationships that are not entirely dependent on the expertise of any particular professionals, although it is often difficult to decouple client and professional relationships. By successfully leveraging our reputation, experience and expanded client base, we believe we should obtain engagements from both existing and new clients.

 

    Expand the Range of Our Consulting Services. We believe that a number of factors driving demand for our services are non-cyclical in nature. These factors include general economic factors, the effects of regulation and competition on various industries, under-performing companies, ineffective business strategies, highly leveraged capital structures, failed acquisitions, corporate fraud and the increasing number of high-stakes lawsuits. One way to minimize cyclicality is to diversify our services. In the fourth quarter of 2003, we diversified our service offerings to expand our economic consulting practice through the acquisition of Lexecon, one of the leading providers of these services in the United States. The professionals, who joined us in the fourth quarter of 2003 from Ten Eyck, provide consulting services relating to SEC and other regulatory investigations, securities law litigation, SEC accounting and enforcement, fraud investigations and Sarbanes-Oxley. We have also increased our capacity to assist clients in the analysis and resolution of all phases of complex claims and disputes through the acquisition of the U.S. dispute advisory services business of KPMG LLP. Other business activities that contributed to diversification in 2004 include our investment banking and merger and acquisition services to middle market companies through our registered broker-dealer and National Association of Securities Dealers, or NASD, member, our transaction advisory and interim management services, and our corporate finance/restructuring services in the United Kingdom, that commenced in 2003. We believe diversification of our service offerings will better insulate our overall business from changing or fluctuating market conditions.

 

    Selectively Acquire Companies and Integrate Our New Professionals and Capabilities into Our Business. We have always followed a disciplined approach to acquisitions. Our selective approach has allowed us to acquire businesses on attractive terms. Since January 2000, we have completed seven significant acquisitions that have greatly enhanced our practices. We intend to selectively pursue strategic acquisitions that are complementary to our practices and expand our range of services and products. This should enable us to diversify and better perform the services we offer our existing client base, expand our staff of expert professionals and add new clients.

 

   

Manage Utilization of Our Professionals. We carefully monitor our utilization rates on a weekly, monthly and annual basis. Our goal is to manage growth to maintain utilization rates among all of our

 

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professionals rather than intermittently expanding our staff in anticipation of short-term demand. Our goal is to attain utilization rates that allow us to maintain our profitability, make us less vulnerable to fluctuations in our workload, and minimize seasonal factors affecting utilization.

 

Our Services

 

Forensic and Litigation Consulting and Technology Practice. Our forensic accounting specialists work with companies faced with fraud, financial disclosure and accounting investigations, misstatements and malpractice issues. As perpetrators of fraud become more ingenious, the expertise required to unravel their schemes increases. We have a team of forensic accountants, certified fraud examiners and computer technicians who are experts in discovering and analyzing the most sophisticated ways to circumvent internal financial controls. We routinely analyze complex transactions, reconstruct events from incomplete and/or corrupt data, uncover vital evidence, identify potential claims and assist in the pursuit of recoveries. We utilize sophisticated software tools to analyze and uncover important information from the computer systems used in the frauds. With our advanced search techniques and innovative methods, we are able to uncover valuable information that was considered lost, deleted or hidden. The acquisition of the U.S. dispute advisory business of KPMG LLP in 2003 greatly expanded our ability to provide those services.

 

We develop and deliver creative solutions to litigation problems. From the first computer animations used in court to the latest in digital graphic presentations, we have been one of the leaders in providing high-quality, cost-effective methods to prepare for and try cases. Our trial technology professionals have supported clients in the courtroom in some of the largest and most complex civil trials. Through the use of information technology and the Internet, we have demonstrated our ability to help control litigation costs, speed-up the trial process and provide litigants with superior access to data, a key competitive advantage. We prepare and enhance presentations and expert testimony on complex subjects, such as toxic torts, financial disputes and intellectual property resolutions. We have responded to the increasing demand for document management in cases involving thousands or even millions of pages of depositions, testimony and exhibits by developing document management and exhibit and trial preparation solutions that enable our clients to better focus on preparing for and trying cases. Our range of services for complex litigation matters include visual communication consulting services; graphic exhibit design and production; customized database development and distribution; video deposition capture and transcript linking; management of designated trial exhibits; courtroom survey, design and configuration; on-site technical trial support; trial-specific hardware procurement and tracking; and secure extranet storage and distribution of data, documents, transcripts, videos and exhibits. We have developed a number of technology-based tools to assist our clients in managing complex litigation. TrialMax ®, our comprehensive trial preparation software, enables a litigation team to easily store, annotate and display documents, computer graphics, video clips and digitized depositions in the courtroom. We employ an automated tool for handling trial data regardless of information source or data type.

 

Our repository services include secure extranet and web-hosting services for clients that are parties to multi-district litigation. We also intend to expand our web-hosting capabilities to teleconference and other Internet based applications. On February 28, 2005, we acquired substantially all of the assets and certain of the liabilities of the Ringtail group. Ringtail will be integrated into our repository services offerings within our forensic and litigation consulting and technology practice. Ringtail is a leading global developer of litigation support and knowledge management technologies for law firms, Fortune 500 corporate legal departments, government agencies and courts, with established offices in Williamsburg, Virginia; Melbourne, Australia and London, UK. Ringtail has developed a suite of integrated software modules to manage the information and workflow in complex legal cases. Specifically, Ringtail’s technologies are designed to ensure quality, reduce risk, increase productivity and improve cost effectiveness in the review, preparation and production of litigation data. In addition, Ringtail’s software has also been used in a transactional capacity to support “deal rooms” and merger and acquisition activity. Ringtail’s flagship product, Ringtail CaseBook provides knowledge management and case preparation through an Intranet repository for litigation document and information management and

 

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collaboration for legal cases. We accounted for approximately 30% of Ringtail’s prior year’s business. Historically, Ringtail has offered its products either through application service providers, or ASPs, or as direct client installations. The ASP model allows clients to outsource information technology and case management needs. The direct installation model allows clients to in-source Ringtail’s benefits within their existing infrastructure and accommodates particular data management or legacy requirements. With our financial and human capital resources behind Ringtail’s application technologies, we believe the Ringtail business can serve as a platform to:

 

    pursue content development in other areas already served by us, such as corporate finance/restructuring and economic consulting;

 

    expand our international presence; and

 

    diversify our client base.

 

We provide services relating to securities, regulatory and Sarbanes-Oxley investigations, and dispute advisory services. The acquisition of the Ten Eyck business in 2003 has greatly expanded our ability to provide those services.

 

Our experienced intellectual property professionals provide valuation, damage analysis and expert testimony services. They provide those services to a range of industries, including oil and gas, technology and consumer products. They perform financial analyses of intellectual property in licensing and royalty disputes, antitrust claims and other types of disputes. Our professionals employ industry research, statistical analysis, regression techniques, portfolio analysis and sophisticated financial modeling to support defensible, credible valuation and damage conclusions.

 

Our dispute settlement services help our clients mitigate the cost of, or avoid, litigation by evaluating claims and risks. These professionals coordinate business expertise with legal and technical analysis to develop cost-effective settlement strategies and implement mutually beneficial business resolutions.

 

We also provide asset tracing investigative services. We analyze corporate and personal records and electronic information, conduct interviews and evaluate related financial information to trace the flow of funds and locate assets that may have been misappropriated due to illegal or fraudulent activity. We use sophisticated software tools, advanced data mining and search techniques as well as databases to conduct asset searches for companies, government agencies and individuals. We have provided investigative services in diverse cases involving misdirected or stolen assets, embezzlements and bank, healthcare, insurance, energy, telecommunications and bankruptcy frauds.

 

Corporate Finance/Restructuring Practice. Our corporate finance/restructuring practice has regularly advised companies and creditors in some of the largest, most complex bankruptcy proceedings and out-of-court restructurings in the U.S. A number of factors affect demand for this practice’s services. These include:

 

    the level of lending activity and over-leveraging of companies;

 

    over-expansion by various businesses;

 

    increases in merger and acquisition activity;

 

    management problems; and

 

    the general economy in the U.S. and abroad.

 

When we represent companies, we work with our client’s management. We assess the client’s financial condition and viability, to structure and implement a business rehabilitation plan to manage the client’s cash flow to at least a break-even point. We help clients to identify any non-essential assets or business units that could be sold to generate cash for the client. We assist clients as they negotiate with their lenders to restructure their debt.

 

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If an out-of-court workout appears unlikely, we assess the impact of a bankruptcy filing on the client’s financial condition and operating performance and seek debtor-in-possession financing on the client’s behalf. If the client voluntarily files for bankruptcy or is involuntarily forced into bankruptcy, we have the expertise to manage the entire bankruptcy process, including structuring, negotiating with creditors and implementing the plan of reorganization. We also provide expert testimony in bankruptcy and restructuring proceedings on such issues as business unit valuation and economic loss. When we represent creditors, we seek to maximize amounts owed to them by the debtor, whether in an out-of-court workout or bankruptcy. In a workout engagement, we evaluate and monitor the quality and value of the collateral and any other assets available to the creditor, analyze the debtor’s business plan and underlying cash flow projections and assess the adequacy of the debtor’s financial reporting systems. Based on our analysis, we assess the debtor’s viability and develop and evaluate restructuring plans. If we conclude that an out-of-court workout is not feasible, we assist the creditors in deciding whether to provide debtor-in-possession financing, in working through the bankruptcy process, and in structuring and evaluating various reorganization plan alternatives. Demand for our corporate finance/restructuring services declined in 2004, primarily as a result of general economic conditions, including the strengthening of the economy, the availability of credit, low interest rates, fewer mergers and acquisitions and fewer large bankruptcy proceedings. We have been able to offset a portion of the effects of that decline by increasing our middle market bankruptcy, restructuring and workout engagements.

 

To better meet the needs of companies suffering a financial or operating crisis, we also offer interim management services, through our FTI Palladium Partners brand. FTI Palladium Partners’ professionals are able to assume interim senior management roles at companies in crisis. We can deploy our professionals to function as a chief executive officer, chief operating officer, chief financial officer or chief restructuring officer. We reevaluate business strategy and financial forecasts and implement plans to meet financial and operating challenges for our clients. Our creative approaches and innovative solutions can create short-term liquidity to stabilize the business and afford the distressed company time to explore its options. We are keenly aware of the sensitive nature of these arrangements and the need to build consensus around a realistic restructuring plan.

 

We have extensive experience in crisis management, negotiations of complex mergers, acquisitions and capital restructurings, as well as the liquidation of surplus assets. We have regularly provided our corporate financing, turnaround, restructuring, bankruptcy and related consulting services to the largest banks in the U.S., including Bank of America, N.A., Wachovia Bank, N.A. and JP Morgan Chase Bank. We have been involved in many of the largest bankruptcy proceedings and out-of-court restructurings in the U.S. We believe clients retain us because of our recognized expertise and capabilities in highly specialized areas, as well as our reputation for satisfying clients’ needs. In 2004, no single client accounted for more than 5% of our revenues from continuing operations. In January and February 2004, we experienced the unanticipated departure of about 60 professionals in our corporate finance/restructuring practice. We continue to employ and have hired additional professionals who have expertise in providing the same type and level of services.

 

Our mergers and acquisitions advisory specialists, through FTI Capital Advisors, a registered broker-dealer and NASD member, assist primarily middle-market clients in negotiating and structuring business combinations, acquisitions and dispositions of assets, business units or entire businesses.

 

Our lender and transactional support services assist lenders and other institutional clients in performing financial due diligence for loans, acquisitions and other transactions.

 

Economic Consulting. Our economic consulting practice provides sophisticated economic analysis of issues arising in merger, acquisition and other complex commercial and securities litigation, and modeling and analysis of the potential competitive effects and other financial advisory services. Our statistical and economic experts in our regulatory consulting practice use a range of tools to help companies evaluate issues such as the economic impact of deregulation on a particular industry, the amount of commercial damages suffered by a business as a result of a tort or a breach of contract or the value of a business or professional company. We also work with clients to develop business strategy and tactics on an ongoing basis to address these issues. We have deep

 

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industry experience in areas such as telecommunications, energy and transportation. Our professionals regularly provide expert testimony on damages, rates and prices, merger effects, intellectual property disputes in antitrust cases, regulatory proceedings, strategic planning, mergers, acquisitions and valuations. Our acquisition of the Lexecon business has greatly enhanced our ability to provide complex economic consulting services.

 

Related Expert Services. Our practices have experience providing testimony in the following areas: fraud, damages, lost profits, valuation, accountant’s liability and malpractice, contract disputes, patent infringement, price fixing, purchase price disputes, solvency and insolvency, fraudulent conveyance, preferences, disclosure statements, trademark and copyright infringement and the financial impact of government regulations.

 

Recent Acquisitions and Divestitures

 

Ringtail. On February 28, 2005, we completed the acquisition of substantially all of the assets and certain liabilities of the Ringtail group. The purchase price for Ringtail consisted of cash totaling $20.0 million plus 784,109 shares of common stock having a value of $15.0 million as of the close of trading on the New York Stock Exchange on February 15, 2005. The asset purchase agreement provides for an earn-out over the next three years based on future performance of up to an aggregate of $7.5 million, or $2.5 million per year, consisting, in our sole discretion, of all cash, restricted shares of our common stock, or a combination of cash and stock. The cash portion of the purchase price was financed from cash on hand and existing credit facilities. We have contractually agreed to pay additional consideration if the value of the shares issued as part of the purchase price and earnout is not at least 10% higher than their respective issuance prices on the date such shares or portion thereof first become eligible for resale under Rule 144 of the Securities Act of 1933, as amended. If the market value (as such value will be determined pursuant to the asset purchase agreement) of the stock issued as of February 28, 2005 is less than $16.5 million, and the earnout stock is less than up to $8.25 million, on their respective eligible resale dates, we will be obligated to pay the difference between the actual market value on such date and the protected share value, which will be paid in cash. We have substantial experience with the Ringtail products and the employees from Ringtail who have joined us as we use Ringtail’s software in the electronic evidence, repository services and document management services we provide to certain clients. Edward O’Brien and Christopher Priestley, Ringtail’s founders, and 22 other former Ringtail employees have joined us. Mr. O’Brien has entered into a written three year employment agreement, and Mr. Priestley has entered into a written four year employment agreement. The employment arrangements for the other employees range from one year to three years, which may be extended. Of the employees, 14 are resident in Australia, one is resident in the United Kingdom, and the rest are resident in the U.S. Messrs. O’Brien and Priestley split their time between Australia and U.S. The employment agreements contain non-competition and non-solicitation provisions, which in most cases have been designed to comply with Australian law.

 

Lexecon. As of November 28, 2003, we completed the acquisition of substantially all of the assets and certain liabilities of Lexecon from its parent company, Nextera. The purchase price for Lexecon consisted of cash totaling $129.2 million, which was financed from a combination of cash on hand and $104.1 million of borrowings under our senior bank term loan. The acquisition of Lexecon has enabled us to expand the type and sophistication of the economic consulting services that we offer our clients. In connection with the acquisition, Daniel Fischel and Dennis Carlton, two leading experts on economic consulting in the United States, joined the company. Mr. Fischel’s areas of expertise are securities, corporation law, regulation of financial markets and the application of economics of corporate finance to problems in those areas. Mr. Fischel has published widely and is the Lee and Brena Freeman Professor of Law and Business at the University of Chicago. Dr. Carlton, Professor of Economics at the Graduate School of Business at the University of Chicago, specializes in the economics of industrial organization, which is the study of individual markets and includes the study of anti-trust and regulatory issues. Joseph P. Kalt, a senior economist, also joined us as a senior managing director at that time. Messrs. Fischel, Carlton and Kalt have entered into employment agreements with us that expire December 31, 2008. In connection with the acquisition, we entered into a non-competition arrangement with Nextera. During the five-year non-competition period, Nextera has agreed not to, directly or indirectly, offer or provide services

 

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of the type offered by Lexecon, in the United States and Canada. Nextera also agreed not to hire as a partner, director, principal or employee, engage as an agent or contractor, or enter into a partnership, joint venture or other business association with, any person who was at any time an employee, representative, officer, director or manager of Nextera, for a period of 12 months after such person’s relationship with Nextera ended. Lexecon has offices in Chicago, Illinois and Cambridge, Massachusetts.

 

Dispute Advisory Business of KPMG. As of October 31, 2003, we completed the acquisition of specified assets and liabilities associated with the dispute advisory services business of KPMG. We acquired the DAS business for $89.1 million in cash, which we financed from our cash reserves. The DAS business compliments and expands our forensic and litigation consulting and technology practice in the analysis and resolution of all phases of complex claims and disputes. 28 former KPMG partners or managing directors have entered into written five-year employment agreements that expire October 31, 2008. In connection with the acquisition, we entered into a non-competition arrangement with KPMG LLP. During the four-year non-competition period, KPMG has agreed not to, directly or indirectly, offer or provide dispute advisory services of the type offered within 12 months prior to October 31, 2003, with specified exceptions, and market services using the terms “DAS” or “DAS Services,” in the United States. For a period of five years following the closing date of the acquisition, KPMG also agreed not to hire as a partner, director, principal or employee or engage as an agent or contractor, certain former employees that joined us in connection with the acquisition. We agreed not to solicit for hire or hire any employee employed by KPMG in its investigative and integrity advisory services business for a period of five years following the closing date, unless such person is a former employee who has not been employed by KPMG for a period of six consecutive months.

 

Ten Eyck. As of October 15, 2003, we completed the acquisition of substantially all of the assets and certain liabilities associated with Ten Eyck. Through that acquisition we expanded our consulting services to include SEC and similar regulatory investigations, securities law litigation, SEC accounting and enforcement, fraud investigations and Sarbanes-Oxley mandated requirements. We acquired the Ten Eyck business for $13.2 million in cash, which we financed from our cash reserves, and 175,536 restricted shares of our common stock that was then valued at approximately $2.4 million. Ten Eyck complements and expands our forensic and litigation consulting and technology practice. Five former Ten Eyck officers and stockholders have entered into written long-term employment agreements that expire on October 15, 2007.

 

U.S. Business Recovery Services, or BRS, Division of PricewaterhouseCoopers LLP. On August 30, 2002, we completed the acquisition of certain assets and liabilities of BRS. The purchase price for BRS consisted of $142.0 million in cash and 4.5 million shares of our common stock valued at $101.9 million. Each of the 49 BRS partners that joined us has entered into a four-year employment agreement with us that expire August 30, 2006. When they withdrew as partners of PricewaterhouseCoopers LLP, or PwC, 47 of them received shares of our common stock from PwC. As adjusted for the three-for-two stock split paid as a stock dividend on June 4, 2003 to stockholders of record on May 7, 2003, these partners received an aggregate of approximately 1.8 million shares of our common stock and then agreed with us to restrict the transfer of 40% of their shares. We granted the BRS partners contractual protection against a decline in the value of their restricted shares during the four-year restricted period if the market price for the shares falls below $18.89 per share (as adjusted for the three-for-two stock split during 2003). The contractual restrictions on transfer with respect to one-half of these shares expired in August 2004. The restrictions will expire with respect to the balance of the shares in August 2006, unless the applicable employee terminates his employment prior to that date, in which case the shares would continue to be subject to transfer and resale restrictions for eight years from the date of termination, and would lose their price protection. Nearly all of the BRS partners and selected other executives that joined us also received options to purchase a total of 903,000 shares of our common stock (as adjusted for the three-for-two stock split during 2003) at the fair market value of our common stock on August 30, 2002. These options vest in equal annual installments over three years beginning one year from the closing of the acquisition. In connection with the acquisition, we obtained a three-year agreement from PwC not to compete with us. On November 3, 2004, we settled an action filed on December 23, 2003, in the Supreme Court of the State of New York against PwC seeking enforcement of the non-competition covenants, damages, and injunctive and other equitable relief. See “—Item 3. Legal Proceedings.”

 

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Employment Terms. Our usual form of written long-term employment agreement that we use in connection with our acquisitions and new hires of senior professionals at the senior managing director level or higher, generally provides for fixed salary, incentive payments, which in some cases may be based on financial measures such as earnings before interest, income taxes, depreciation of property and equipment and amortization of other intangible assets, or EBITDA, and, in some cases, long-term equity incentives and other incentive bonus and incentive payments. Our employment agreements also typically provide for some form of equity incentive in the form of stock options or restricted stock. It also entitles the professional to participate in our benefit plans. In some cases, we extend forgivable loans to professionals below the executive officer level in lieu of paying cash signing bonuses. We believe that the loan arrangements (which require repayment in full if the employee’s employment terminates on certain events prior to his contract’s expiration date), enhance our ability to retain senior professionals. Employment agreements may provide for the payment of salary, accrued bonuses and other benefits beyond the termination date, if the professional leaves our employ for certain reasons prior to the agreement’s expiration date. The length and amount of payments to be paid by us following the termination or resignation of a professional varies depending on whether such person resigned or was terminated with cause or good reason, resigned or was terminated without cause or good reason, died or became disabled, or was terminated as a result of a change of control. Each agreement contains non-competition and non-solicitation covenants, which are in effect during the term of the agreement, and under various circumstances, extend beyond the expiration or termination date depending upon the reason for such termination. Under the non-competition agreement, the professional generally agrees not to offer or perform consulting services of the type performed during his employment, directly, or indirectly through another person or entity, in competition with us, within specified geographic areas, subject, in some cases, to certain exceptions. Generally, the professional also agrees not to solicit business regarding any case, matter or client upon which such professional worked on our behalf, or to solicit, hire, or influence the departure of, any FTI employee, consultant or independent contractor. Under the general terms of his or her employment agreement, the professional also agrees to maintain the confidentiality of our proprietary information and affirms that we are the owners of copyrights, trade marks, patents and inventions developed during the course of employment. As of December 31, 2004, all of the senior managing directors have entered into written employment agreements. Many of our employment agreements will expire between 2006 and 2008 because of the timing of our acquisitions and our 2004 initiative to enter into written agreements with our senior professionals. We monitor these expirations carefully to commence dialogues with professionals regarding their employment well in advance of the actual contract expiration dates. Our goal is to renew employment agreements when advisable and to stagger the expirations of the agreements if possible.

 

Clients

 

We have cultivated long-term relationships with many of the premier corporations, financial institutions, law firms, private equity firms and other institutions in the U.S. In 2004, we performed work for about 1,300 clients on about 3,200 matters, including:

 

    about 490 law firms, 91 of which were rated among the top 100 law firms (based on 2003 U.S. revenues as measured by American Lawyer magazine);

 

    181 corporate clients which were among the Fortune 500 in 2004; and

 

    21 of the 25 largest banks located in the U.S.

 

In 2004, we believe that about 83% of our business came from existing clients or referrals from existing clients. Our largest client represented less than 5% of our 2004 revenues from continuing operations.

 

Marketing and Sales

 

We rely primarily on referrals and our reputation to market our services to new and existing clients since most of our work is repeat work for existing clients or comes from referrals from existing clients or relationships with partners in major law firms or other professionals. Our professionals develop close working relationships

 

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with clients and often learn about new business opportunities from their frequent contacts with clients. In marketing our services, we emphasize our experience, the quality of our services and our professionals’ particular areas of expertise, as well as our ability to quickly staff a new engagement. While we aggressively seek new business opportunities, we maintain high professional standards and carefully evaluate potential new client relationships and engagements before accepting them. In the fourth quarter of 2004, we reorganized our marketing and sales divisions to employ 23 full-time people, who assist with the marketing of our consulting services.

 

Competition

 

Our business is highly competitive. Our competitors range from large organizations, such as the national accounting firms and the large management consulting companies that offer a broad range of consulting services, to small firms and independent contractors that provide one specialized service. Competitive factors affecting demand for our services include reputation, size, ability to immediately staff a substantial engagement, performance record, quality of work, range of services provided and existing client relationships. To a lesser extent, we also compete on price, but the critical nature of our services typically reduces price to a secondary consideration. Since our business depends in a large part on professional relationships, our business has low barriers of entry for professionals, including our professionals, wanting to start their own firms or to change employers.

 

Some national service providers are larger than we are and, on any given engagement, may have a competitive advantage over us with respect to one or more competitive factors. The smaller local or regional firms, while not offering the range of services we provide, often are able to provide the lowest price on a specific engagement because of their lower overhead costs and proximity to the engagement.

 

Patents, Licenses and Proprietary Information

 

We consider certain of our products and processes, including our TrialMax® comprehensive trial preparation software, proprietary and confidential. The Ringtail CaseBook software that we acquired from the Ringtail group on February 28, 2005 has been registered pursuant to U.S. federal copyright laws, and we consider the other technologies and software that we acquired in connection with the Ringtail transaction to be proprietary and confidential. We believe that our non-patented software and intellectual property, particularly some of our process software and intellectual property, is important to our forensic and litigation consulting and technology practice. We rely upon non-disclosure agreements and contractual agreements and a system of internal controls, including, without limitation, confidentiality and invention disclosure agreements with our employees and independent contractors, and license agreements with third parties, to protect our proprietary information. Despite these safeguards, there is a risk that competitors may obtain and use such information.

 

Human Resources

 

At December 31, 2004, we had 1,035 employees, of which 745 were billable professionals. We also engage independent contractors to supplement our professionals on client engagements as needed. Most of our professionals have many years of experience in their field of practice, and many are well recognized for their expertise and experience. None of our employees are subject to collective bargaining contracts or represented by a union. We believe our relationship with our employees is good.

 

Available Information

 

Our Internet website is www.fticonsulting.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, and our annual proxy statements, are available free of charge on our website, as soon as reasonably practicable after we electronically file with or furnish such materials to the SEC. We also make available on our website our Corporate Governance Guidelines,

 

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Policy on Ethics and Business Conduct, Categorical Standards of Director Independence, Policy on Inside Information and Insider Trading, Policy on Conflicts of Interest, Policy on Disclosure Controls and other policies (collectively, our “Corporate Governance Documents”), and Charters for the Audit, Compensation and Nominating and Corporate Governance Committees of our Board of Directors (collectively, the “Charters”). We make revised Corporate Governance Documents and Charters available on our website as they are adopted and become effective and will continue to do so. We have adopted the FTI Consulting, Inc. Policy on Ethics and Business Conduct (the “Code of Ethics”), which applies to our Chairman of the Board, President, Chief Executive Officer, Chief Financial Officer, Corporate Controller and other financial professionals, as well as our Chief Operating Officer and our other officers, directors, employees and independent contractors. The Code of Ethics is publicly available on our website at www.fticonsulting.com. If we make any substantive amendments to the Code of Ethics or grant any waiver, including any implicit waiver, from a provision of the Code of Ethics to our Chairman of the Board, President, Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, Corporate Controller or any director, we will disclose the nature of such amendment or waiver on that website or in a report on Form 8-K filed with the SEC. We will provide printed copies of our periodic reports and other materials filed with the SEC and our Corporate Governance Documents, including, without limitation, our Corporate Governance Guidelines, the Charters of the Committees of our Board and our Code of Ethics, to any person, without charge, upon request to Joanne F. Catanese, Associate General Counsel and Secretary, FTI Consulting, Inc., 900 Bestgate Road, Suite 100, Annapolis, Maryland 21401, telephone number (410) 224-8770.

 

Business Risks

 

Our failure to retain qualified professionals or hire additional qualified professionals would have a negative effect on our future growth and financial performance as well as client engagements, services and relationships.

 

Our business involves the delivery of professional forensic and litigation consulting and technology, corporate finance/restructuring and economic consulting services. In the consulting business, professional acumen, trust and relationships are critical elements of a company’s ability to deliver high quality professional services. Our professionals have highly specialized skills. They also develop strong bonds with the clients they service. Our continued success depends upon our ability to retain and expand our staff of professionals who have expertise, reputations and client relationships critical to maintaining and developing our business. We face intense competition in recruiting and retaining highly qualified professionals that we must have to continue our service offerings. As of December 31, 2004, substantially all of the senior managing directors have written employment agreements with the company. Many of our employment agreements will expire between 2006 and 2008 because of the timing of our acquisitions and our 2004 initiative to enter into written agreements with our senior professionals. We monitor these expirations carefully to commence dialogues with professionals regarding their employment well in advance of the actual contract expiration dates. Our goal is to renew employment agreements when advisable and to stagger the expirations of the agreements if possible. Because of the high concentration of contract expirations between 2006 and 2008, we may experience high turnover or other adverse consequences, such as higher costs, loss of clients and engagements, or difficulty staffing engagements, if we are unable to renegotiate employment arrangements or the costs of retaining qualified professionals become higher. We cannot assure you that we will be able to attract and retain enough qualified professionals to maintain or expand our business. Moreover, competition has been increasing our costs of retaining or hiring qualified professionals, a trend which could harm our operating margins and results of operations.

 

If our former professionals go into business in competition with us or join our competitors, our client engagements and relationships could decline, financial performance and growth could slow or decline, and employee morale could suffer, and we may not have legal recourse.

 

Typically, our professionals have a close relationship with the clients they serve, not only based on their expertise but also on bonds of personal trust and confidence. Although our clients generally contract for services with us as a company, and not with individual professionals, in the event that professionals leave, such clients would not be prohibited from hiring those professionals to perform future engagements. Clients could also decide

 

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to transfer active engagements to professionals who leave. The engagement letters that we typically enter into with clients do not obligate them to continue to use our services. Typically, our engagement letters permit clients to terminate our services at any time. Furthermore, while in some cases, the termination of an ongoing engagement by a client could constitute a breach of the client’s contract with us, we could decide that preserving the over-all client relationship is more important than seeking damages for the breach, and for that or other reasons that are not currently identifiable, decide not to pursue any legal remedies that might be available to us. We would make the determination whether to pursue any legal actions against a client on a case-by-case basis.

 

As of December 31, 2004, substantially all of the senior managing directors have written employment agreements with the company, which may include non-competition and non-solicitation arrangements. Where we have written non-competition agreements, they generally have been drafted to comply with state “reasonableness” standards. However, states generally interpret non-competition clauses narrowly. Therefore, a state may hold certain restrictions on competition to be unenforceable. In the case of former Ringtail employees residing in Australia, the non-competition provisions have been drafted to comply with Australian law. In the event an employee departs, we will consider any legal remedies we may have against such professional on a case-by-case basis. However, we may decide that preserving cooperation and a professional relationship, or other concerns, outweigh the benefits of any possible legal recovery. Therefore, we could determine not to pursue legal action, even if available.

 

In the first quarter of 2004, we experienced the unanticipated departures of about 60 professionals in our former FTI/Policano & Manzo restructuring practice. We have striven to build relationships and reassure our professionals and clients of our interest in them and our ability to provide services comparable to those provided by the departing professionals. Those departures had a negative impact on our financial results for 2004. In the fourth quarter of 2004, we entered into a monetary settlement of arbitration proceeds brought against those former employees and the company they formed to compete with us. See “—Item 3. Legal Proceedings.”

 

Our profitability will suffer if we are not able to manage utilization and pricing rates of our professional staff.

 

We calculate the utilization rate for our professional staff by dividing the number of hours that all of our professionals worked on client assignments during a period by the total available working hours for all of our professionals, assuming a 40-hour work week and a 52-week year. Available working hours include vacation and professional training days, but exclude holidays. The hourly rates we charge our clients for our services and the number of hours our professionals are able to charge our clients for our services are affected by the level of expertise and experience of the professionals working on a particular engagement and, to a lesser extent, the pricing and staffing policies of our competitors. If we fail to manage our utilization rates for our professionals or maintain or increase the hourly rates we charge our clients for our services, we may experience adverse consequences, such as non-revenue generating professionals, the loss of clients and engagements and the inability to appropriately staff engagements, and our profitability will suffer.

 

Demand for our corporate finance/restructuring professionals declined in 2004, which may continue, primarily as a result of general economic conditions, including the strengthening of the economy, the availability of credit, low interest rates, fewer mergers and acquisitions and fewer large bankruptcy proceedings. Our operating profit margins declined in 2004, which may continue, due to the slow down in our corporate finance/restructuring business and due to lower utilization rates in that practice and our recently acquired businesses relative to our historical experiences. We also experienced lower utilization in our forensic and litigation consulting and technology practice during late 2003 and the early part of 2004 resulting from the absorption of the professionals who joined us in connection with our acquisition of the dispute advisory services of KPMG LLP. Many of the billable professionals that resigned during the first quarter of 2004, were among our highest utilized and billing professionals, which also contributed to our lower utilization rates and operating profit margins in 2004.

 

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We rely heavily on our senior management team and practice leaders for the success of our business.

 

We rely heavily upon our senior management team and practice leaders to manage our forensic and litigation consulting and technology, corporate finance/restructuring and economic consulting practices. Given the highly specialized nature of our services and the scale of our operations, these people must have a thorough understanding of our service offerings as well as the skills and experience necessary to manage a large organization. If one or more members of our senior management team or our practice leaders leave and we cannot replace them with a suitable candidate quickly, we could experience difficulty in managing our business properly, and this could harm our business prospects, client relationships, employee morale and results of operations.

 

We face intense competition in our business. If we fail to compete effectively, we may miss new business opportunities or lose existing clients and our revenues and profitability may decline. Parties from whom we acquire assets may reenter the marketplace to compete with us in the future.

 

The market for our consulting services is highly competitive. Our competitors range from large organizations, such as the national accounting firms and the large management consulting companies that offer a broad range of consulting services, to small firms and independent contractors that provide one specialized service. Some of our competitors have significantly more financial resources, larger professional staffs and greater brand recognition than we do. Since our business depends in a large part on professional relationships, our business has low barriers of entry for professionals wanting to start their own firms. In addition, it is relatively easy for professionals to change employers. We cannot assure you that we will continue to compete successfully for new business opportunities or retain our existing clients or professional employees.

 

Although, in connection with our acquisitions, we obtain non-competition arrangements from the sellers, we cannot assure you that any one or more of them will not compete with us in the future. Also, the duration of those agreements are limited ranging from one to three years after the acquisition date. Certain activities may be carved out of, or otherwise may not be prohibited by those arrangements. Also, in some cases we may agree to restraints on our ability to compete with the sellers of those businesses with respect to certain practice areas or locations. Competition may harm our expected revenue growth and results of operations and cause the actual profitability of the business to differ materially from our expectations and the expectations of the investing public. A failure to meet these expectations could cause the price of our stock to decline. In connection with the BRS acquisition from PwC, we obtained a three-year agreement from PwC not to compete with us. On December 23, 2003, we filed an action in the Supreme Court of the State of New York against PwC seeking enforcement of the non-competition covenants, damages, and injunctive and other equitable relief. On November 3, 2004, we entered into a settlement and release in the action, which enforces the current non-compete until August 31, 2005. See “—Item 3. Legal Proceedings.”

 

Any claims involving the quality of our services could harm our overall professional reputation, which could harm our ability to compete for new business opportunities, retain and attract clients and engagements, and hire and retain qualified professionals.

 

Many of our engagements involve complex analysis and the exercise of professional judgment. Therefore, we are subject to the risk of professional liability. Often, our engagements involve matters that, if resolved unfavorably, may result in a severe impact on the client’s business, cause the client a substantial monetary loss or prevent the client from pursuing business opportunities. Since our ability to attract new clients and generate engagements depends upon our ability to maintain a high degree of client satisfaction as well as our reputation among industry professionals, any claims against us involving the quality of our services may be more damaging than similar claims against businesses in other industries.

 

We do not generally indemnify our clients; however, in certain cases, such as with clients who are governmental agencies or authorities, we may agree to indemnify them and their affiliates against third party liabilities. Indemnification provisions are negotiated on a contract-by-contract basis and in some cases may be reciprocal or may be coupled with limitations on the amount and type of damages that can be recovered.

 

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Any claim by a client or a third party against us could expose us to professional or other liabilities in excess of our insurance limits. We maintain a limited amount of liability insurance. The damages and/or expenses resulting from any successful claims against us, for indemnity or otherwise, in excess of our insurance limits would have to be borne directly by us and could seriously harm our profitability and financial resources.

 

Our clients may terminate our engagements with little or no notice, which may cause us to experience unexpected declines in our profitability and utilization.

 

Much of our business involves large client engagements that we staff with a substantial number of professionals. The engagement letters that we typically enter into with clients do not obligate them to continue to use our services. Typically, our engagement letters permit clients to terminate our services at any time. If our clients unexpectedly cancel engagements with us or curtail the scope of our engagements, we may be unable to replace the lost revenues from those engagements, may also be unable to quickly eliminate costs associated with those engagements, and we may not be able to quickly find other engagements to utilize our professionals. Any decrease in revenues without a corresponding reduction in our costs will likely harm our profitability.

 

We may have difficulty integrating our acquisitions, or convincing clients to allow assignment of their contracts to us, which may cause our client engagements to decline, with a consequent detrimental affect on our financial results.

 

The process of integrating our acquisitions into our existing operations may result in unforeseen operating difficulties and may require significant financial, operational and managerial resources that would otherwise be available for the operation, development and expansion of our existing business. To the extent that we have miscalculated our ability to integrate and properly manage any or all of our acquisitions, we may have difficulty in achieving our operating and strategic objectives.

 

A substantial amount of our growth has been due to acquisitions. During 2002, we acquired the BRS practice. During 2003, we completed three significant acquisitions, Lexecon, the former dispute advisory business of KPMG LLP and Ten Eyck, all of which occurred in the fourth quarter. Since year-end 2004, we have acquired the Ringtail business. The level of integration of these businesses at this time differs. Companies face significant challenges integrating acquisitions of personnel and assets. Some of the problems we face include differences in corporate cultures and management styles, additional or conflicting government regulation, disparate company polices and practices and client conflict issues. All of our acquisitions in 2003 and our Ringtail acquisition in 2005 were structured as asset transactions; therefore, a significant number of client engagements with those practices could not be assigned to us without client consent. All clients may not affirmatively consent to the assignment. In addition, in some cases there are no written client contracts memorializing an engagement. Such engagements will only continue at the pleasure of those clients. In certain cases, such as government contracts and bankruptcy engagements, the consents of clients cannot be solicited until after the acquisition has closed. Further such contracts may be subject to security clearance requirements or bidding provisions with which we might not be able to comply. There is no assurance that local, state and federal governments will agree to novate their contracts to us. In addition, in an engagement that involves a bankruptcy case, we must make a filing with the applicable U.S. Trustee, at which time such U.S. Trustee may find that we are no longer disinterested. In connection with such bankruptcy cases, we may be required to resign and to refund fees collected in connection with those engagements. We could be responsible for returning fees even if they were not paid to us, but were paid to the company from whom we acquired the business. In some cases, we may not have legal recourse to demand that the seller of the business reimburse us.

 

Our corporate finance/restructuring practice has an increased risk of fee nonpayment.

 

Many of our clients have engaged us because they are experiencing financial distress. We recognize that these clients may not have sufficient funds to continue operations or to pay for our services. We have not received retainers before we began performing services on the client’s behalf in connection with a significant amount of our restructuring business. In the cases that we have received retainers, we cannot assure you that the

 

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retainers will adequately cover our fees for the services we perform on behalf of these clients. We are not always able to obtain retainers from clients in bankruptcy as the bankruptcy court must approve our retainers for those clients. Even if a bankruptcy court approves our retainer or engagement, a bankruptcy court has the discretion to require us to return all, or a portion of, our fees. Therefore, we face the risk of nonpayment, which can result in write-offs. For the three years ended December 31, 2004, we wrote off a total of about $17.2 million of uncollectible fees in all practices. Our total write-offs exclude unbilled fee adjustments and amounts attributable to our applied sciences practice, which we sold in 2003. More write-offs than we expect in any period would have a negative impact on our results of operations.

 

If the size, complexity and number of debt defaults, bankruptcy or restructuring actions or other factors affecting demand for our corporate finance/restructuring services declines, our revenues and profitability could suffer.

 

Our corporate finance/restructuring practice provides various restructuring and restructuring-related services to companies in financial distress or their creditors or other stakeholders. A number of factors affect demand for this practice’s services. These include:

 

    the availability and level of lending activity, interest rates and over-leveraging of companies;

 

    over-expansion by various businesses;

 

    merger and acquisition activity;

 

    management problems; and

 

    the general economic factors resulting in the decline in the economy in the U.S.

 

Notwithstanding increases in debt, we have also seen a decline of the mega bankruptcy cases, resulting in a greater portion of our business being comprised of engagements relating to bankruptcy and restructuring matters involving mid-size companies primarily as a result of general economic conditions, including the strengthening of the economy, the availability of credit, low interest rates, fewer mergers and acquisitions and fewer large bankruptcy proceedings. In our experience, mid-size bankruptcy and restructuring engagements are more susceptible to cyclical factors such as holidays and vacations. The shift to mid-size engagements could result in lower utilization during the third and fourth quarters due to these factors. Declines in demand for our restructuring, turnaround, restructuring and bankruptcy services as well as smaller engagements could result in lower revenues and lower our overall profitability.

 

If we fail to find suitable acquisition candidates, or if we are unable to take advantage of opportunistic acquisition situations, our ability to expand may be curtailed.

 

The number of suitable acquisition candidates may decline if the competition for acquisition candidates increases. As a result, we may be unable to make acquisitions or be forced to pay more or agree to less advantageous acquisition terms for the companies that we are able to acquire. Alternatively, at the time an acquisition opportunity presents itself internal and external pressures (including, but not limited to, borrowing capacity under our credit facility or the availability of alternative financing), may cause us to be unable to pursue or complete an acquisition. Our ability to grow our business, particularly through acquisitions, may depend on our ability to raise capital by selling equity or debt securities or obtaining additional debt financing. We cannot assure you, however, that we will be able to obtain financing when we need it or on terms acceptable to us. In any case, we may be unable to grow our business or expand our service offerings, as quickly as we have in the past, and our profitability may decline.

 

We may not manage our growth effectively, and our profitability may suffer.

 

We have experienced rapid growth in recent years. This rapid expansion of our business may strain our management team, human resources and information systems. We cannot assure you that we can successfully manage the integration of any businesses we may acquire or that they will result in the financial, operational and

 

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other benefits that we anticipate. To manage our growth successfully, we may need to add qualified managers and employees and periodically update our operating, financial and other systems, as well as our internal procedures and controls. We also must effectively motivate, train and manage a larger professional staff. Such expansion may result in significant expenditures. If we fail to manage our growth effectively, our business, results of operations and financial condition may be harmed.

 

From time to time we operate with a substantial amount of debt, with variable interest rates.

 

Our total long-term debt at December 31, 2004, was $105.0 million. We have historically incurred debt to make acquisitions. We borrowed approximately $104.1 million to acquire the Lexecon practice in November 2003. Operating with a high amount of leverage could require us to redirect a substantial portion of our cash flow from operations to make payments on our debt. This would reduce the funds available for operations, future business opportunities, capital expenditures, acquisitions and other purposes. It will also limit our flexibility in planning for, or reacting to, changes in our business and our industry. The terms of our debt also require us to meet specified financial covenants. If we fail either to meet these financial requirements or our lenders do not waive them, we will be required to pay fees and penalties. Our lenders could also accelerate the maturity of our debt if we fail to meet these covenants, which would force us to seek alternative financing. If this were to happen, we cannot assure you that we would be able to obtain the additional financing we may need or that it would be on terms favorable to us.

 

Our debt accrues interest at a variable rate. Although currently we do not, we have in the past and may in the future, enter into interest rate swaps to reduce our exposure to rising interest rates. These hedge arrangements may result in us incurring higher interest expenses than we would have incurred without the hedges in place. If interest rates increase, we will need to dedicate more of our cash flow from operations to make payments on our debt.

 

Our revenues, operating income and cash flows are likely to fluctuate.

 

We have experienced fluctuating revenues, operating income and cash flow and expect that this will occur from time to time in the future. We may experience future fluctuations in our annual or quarterly revenues and operating income because of the timing of our client assignments, the types of assignments we are working on at different times, hiring trends and decreased productivity because of vacations taken by our professionals. This means our profitability will likely decline if we experience an unexpected variation in the number or timing of client assignments or during the third quarter when substantial numbers of professionals take vacations, which reduces their utilization rates. We may also experience future fluctuations in our cash flows because of the timing of the payment of incentive compensation to our professionals, which we generally pay during the first quarter of each year. Also, the timing of any future acquisitions and the cost of integrating them may cause fluctuations in our operating results.

 

A significant portion of Lexecon’s revenues result from relationships with clients and industry professionals maintained by Messrs. Fischel, Carlton and Kalt. The loss of one or more of them could decrease our revenues and our profitability.

 

The success of our acquisition of Lexecon will depend upon our retention of Messrs. Fischel, Carlton and Kalt. They have reputations in the field of economics for highly specialized expertise as well as important relationships with existing clients and industry professionals. Their reputations and relationships are critical to retaining and gaining new client engagements, particularly large, complex matters. We have written five-year employment agreements with Messrs. Fischel, Carlton and Kalt. The loss of Messrs. Fischel, Carlton or Kalt could harm the success of our acquisition of the Lexecon practice.

 

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We have a different system of governance and management from the companies from whom we made our acquisitions, which could cause senior professionals who joined us from the acquired companies to leave us.

 

Lexecon, the DAS and the BRS businesses shared many of the management practices and policies of their parent companies. We believe our management practices and policies differ from the practices and policies of those companies, including, but not limited to, the manner in which potential conflicts of interest were handled. In some cases, these different management practices and policies may lead to workplace dissatisfaction on the part of those professionals with our way of conducting business. The loss of one or more key professionals may harm our business and results of operations.

 

Our clients may preclude us from representing multiple clients in connection with the same engagement or competitive matter, our other practices may be precluded from accepting engagements from clients with respect to the same or competitive matter for which another practice has been engaged to provide services, and we may be required to agree to forego potential business prospects in order to win engagements, which could harm our revenues, results of operations and client relationships and engagements.

 

We follow internal practices to assess real and potential relationships between and among our clients, engagements, practices and professionals. For example, we generally will not represent parties adverse to each other in the same matter. Under bankruptcy rules we generally may not represent both a debtor and its creditors on the same engagement. Under federal bankruptcy laws, we are required to notify the U.S. Trustee of real or potential conflicts. The U.S. Trustee could find that we no longer meet the disinterestedness standard because of real or potential conflicts, and order us to resign and refund fees that have been paid. In some cases we could be ordered to refund fees that were not paid to us, but that were paid to the sellers of businesses that we acquired. We may not have recourse to recover any or all of any refunded fees from such sellers. Future relationships may require us to decline or resign from client engagements. New acquisitions may require us to resign from current client engagements because of relationship issues that are not currently identifiable. In addition, businesses that we acquire may not be free to accept engagements they could have accepted prior to our acquiring them because of relationship issues. Our inability to accept engagements from clients or prospective clients, represent multiple clients in connection with the same or competitive engagements, and any requirement that we resign from client engagements may negatively impact our revenues, revenue growth and results of operations.

 

ITEM 2. PROPERTIES

 

We lease about 33,300 square feet of office space for our principal corporate facilities located in Annapolis, Maryland, under various leases expiring through August 2009. We also lease offices in 23 other cities across the U.S., including such cities as New York, Chicago, Houston, Dallas, Los Angeles and Washington, D.C., as well as London, England, to support our operations.

 

ITEM 3. LEGAL PROCEEDINGS

 

From time to time in the ordinary course of business, we are subject to claims, asserted or unasserted, or named as a party to lawsuits or investigations. Litigation, in general, and intellectual property and securities litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings cannot be predicted with any certainty and in the case of more complex legal proceedings such as intellectual property and securities litigation, the results are difficult to predict at all. We are not aware of any asserted or unasserted legal proceedings or claims that we believe would have a material adverse effect on our financial condition or results of our operations.

 

On February 18, 2004, we filed suit in Superior Court, in North Bergen, New Jersey against a number of former employees and the new corporation they formed. In our complaint, we assert numerous claims, including that these former employees acted contrary to their obligations and breached their duties of loyalty by wrongfully soliciting numerous of our employees to leave the company and to join them in a competitive venture, wrongly

 

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solicited our clients and unlawfully used and disclosed our confidential, proprietary and trade secret information in the new business venture. Subsequently, the parties agreed to resolve the matter through arbitration and to protect the confidentiality of all records and proceedings. On December 31, 2004, before going to arbitration, the parties settled this action for an agreed upon amount and executed settlement and release agreements.

 

On December 23, 2003, we filed an action in the Supreme Court of the State of New York against PricewaterhouseCoopers LLP seeking damages, and injunctive and other equitable relief, and the enforcement of the non-competition covenants contained in our asset purchase agreement with PricewaterhouseCoopers relating to the acquisition of its domestic Business Recovery Services division. On February 10, 2004, the court granted in part and denied in part our motion for preliminary injunction. PricewaterhouseCoopers appealed the ruling and in June 2004, the Supreme Court of the State of New York upheld the preliminary injunction and affirmed our interpretation of the non-competition sections of the Asset Purchase Agreement. On November 3, 2004, the parties executed a settlement and release in the case pursuant to which:

 

    PricewaterhouseCoopers paid an agreed upon amount;

 

    the current injunction remains in place until August 31, 2005; and

 

    the action was dismissed with leave to refile, if there is a violation of the injunction.

 

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

 

No matters were submitted to our stockholders for consideration during the quarter ended December 31, 2004.

 

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PART II

 

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Price of and Dividends on Our Common Equity and Related Stockholder Matters

 

Market Information. Our common stock trades on the New York Stock Exchange under the symbol “FCN.” The following table lists the high and low sale prices per share for our common stock as reported on the New York Stock Exchange for the periods indicated. The prices for periods in 2003 have been adjusted to give effect to the three-for-two stock split that was paid as a stock dividend on June 4, 2003 to stockholders of record on May 7, 2003.

 

     Year Ended December 31,

     2004

   2003

     High

   Low

   High

   Low

Quarter Ended

                           

March 31

   $ 24.14    $ 13.55    $ 30.93    $ 25.53

June 30

     17.49      14.56      32.45      22.60

September 30

     19.65      15.37      27.60      17.00

December 31

     21.30      17.51      24.58      16.79

 

Number of Stockholders of Record. As of February 25, 2005, the number of record holders of our common stock was 162.

 

Dividends. We have not declared or paid any cash dividends on our common stock to date and we do not anticipate paying any cash dividends on our shares of common stock in the foreseeable future because we intend to retain our earnings, if any, to finance the expansion of our business, make acquisitions and for general corporate purposes. Our credit facility restricts our ability to a certain extent to pay dividends.

 

Securities Authorized for Issuance under Equity Compensation Plans

 

The following table lists information regarding outstanding options and shares reserved for future issuance under our equity compensation plans as of December 31, 2004. None of the plans have outstanding warrants or rights other than options, except for shares of restricted stock described in footnote (2) following the table. We have not issued any shares of our common stock to employees as compensation under plans that have not been approved by our security holders. The number of securities to be issued upon exercise of outstanding options, warrants and rights included in the table below excludes:

 

    shares of common stock issued as direct restricted and unrestricted stock awards under our 1997 Stock Option Plan, as amended;

 

    shares of common stock issued as direct restricted and unrestricted stock awards under our 2004 Long-Term Incentive Plan, as amended; and

 

    shares of common stock sold under our Employee Stock Purchase Plan, as amended.

 

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     (a)

    (b)

   (c)

 

Plan Category


   Number of Securities
to be Issued Upon
Exercise of
Outstanding Options,
Warrants and Rights


    Weighted-Average
Exercise Price of
Outstanding Options,
Warrants and Rights


  

Number of Securities
Remaining Available for
Future Issuance Under
Equity Compensation
Plans (Excluding
Securities Reflected in

Column (a)


 
     (in thousands)          (in thousands)  

Equity compensation plans approved by our security holders

   4,408 (1)   $ 19.17    3,201 (2)

Equity compensation plans not approved by our security holders

             
    

        

Total

   4,408 (1)   $ 19.17    3,201 (2)
    

        


(1) Includes 3,912,742 shares issuable upon vesting of outstanding stock options granted under our 1997 Stock Option Plan and 495,000 shares issuable upon vesting of outstanding stock options granted under our 2004 Long-Term Incentive Plan.

 

(2) Includes (a) 370,234 shares of common stock available for issuance under our 1997 Stock Option Plan, including 8,020 shares available for direct stock awards; (b) 2,250,628 shares of common stock available for issuance under our 2004 Long-Term Incentive Plan, including 345,628 shares available for direct stock awards; and (c) 580,125 shares available for issuance under our Employee Stock Purchase Plan.

 

Sales of Unregistered Securities

 

On February 28, 2005, we completed our acquisition of substantially all of the assets and certain liabilities of the Ringtail group pursuant to an asset purchase agreement dated February 16, 2005. Pursuant to that agreement, we issued 784,109 shares of our common stock as consideration, representing a portion of the purchase price to acquire the Ringtail group. The 784,109 shares of our common stock had an aggregate market value of $15.0 million based on the $19.13 per share closing price of a share of our common stock on the New York Stock Exchange on February 15, 2005 (the trading day immediately prior to the date of the asset purchase agreement.) We issued these shares of common stock in a transaction not involving a public offering pursuant to Section 4(2) of the Securities Act of 1933, as amended.

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

The following table provides information with respect to purchases we made of our common stock during the fourth quarter of 2004 (in thousands except per share amounts).

 

    

Total Number
of Shares

Purchased (1)


  

Average
Price Paid

per Share


  

Total Number of
Shares Purchased
as Part of Publicly
Announced

Program


  

Approximate Dollar
Value that May Yet
Be Purchased Under

the Program (2)


October 1 through October 31, 2004

              $ 36,639

November 1 through November 30, 2004

   78    $ 18.89    78    $ 35,158

December 1 through December 31, 2004

               
    
         
      

Total

   78    $ 18.89    78    $ 35,158
    
         
      

(1) We purchased all of these shares of our common stock through our publicly announced stock repurchase program.
(2) In October 2003, we announced that our board of directors approved a $50.0 million stock repurchase program. This program was extended in October 2004 for up to the remaining balance at that time of $36.6 million. Unless reauthorized or extended by the board of directors, this program will expire in October 31, 2005. These amounts represent gross purchase prices and include the transaction costs we may incur, such as commissions, on the related purchases.

 

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ITEM 6. SELECTED FINANCIAL DATA

 

The selected financial data presented below for the periods or dates indicated are derived from our consolidated financial statements. The consolidated financial statements for the years ended December 31, 2004, 2003, 2002, 2001 and 2000 were audited by Ernst & Young LLP. You should read the data below in conjunction with our consolidated financial statements, related notes and other financial information appearing in “—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “—Item 8. Financial Statements and Supplementary Data.”

 

Acquisitions

 

Our results of operations and financial position were impacted by our acquisition activities. We acquired the following businesses in transactions accounted for as purchase business combinations.

 

    As of November 28, 2003, we acquired Lexecon, Inc.

 

    As of October 31, 2003, we acquired the dispute advisory services business of KPMG LLP.

 

    As of October 15, 2003, we acquired Ten Eyck Associates.

 

    As of January 2, 2002, we acquired Technology & Financial Consulting, Inc.

 

    As of August 30, 2002, we acquired the U.S. Business Recovery Services division of PricewaterhouseCoopers, LLP.

 

Amortization

 

Effective January 1, 2002, we adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” Under Statement No. 142, we no longer amortize goodwill and intangible assets with indefinite useful lives, but we are required to test these assets for impairment at least annually.

 

Interest Expense, Net

 

For the year ended December 31, 2004, interest expense, net includes a $475,000 discount on a note receivable due from the owners of one of our former subsidiaries. We discounted this note by $475,000 in exchange for payment of the note ahead of its maturity in 2010. We received this prepayment in January 2005.

 

On January 1, 2003, we adopted Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” Among other changes, Statement No. 145 rescinds Statement No. 4, which required all gains and losses from extinguishments of debt to be aggregated and classified as an extraordinary item, net of the related tax effect. Statement No. 145 provides that gains and losses from extinguishments of debt should be classified as extraordinary items only if they are unusual or infrequent or they otherwise meet the criteria for classification as an extraordinary item, and observes that debt extinguishment transactions would seldom, if ever, result in extraordinary item classification of the resulting gains and losses. Accordingly, our losses on retirement of debt are included in interest expense for the years ended December 31, 2003 and 2000.

 

Discontinued Operations

 

In 2002, we committed to a plan to sell our applied sciences practice which we sold in 2003. Because we eliminated the operations and cash flows of the business components comprising the applied sciences practice from our ongoing operations as a result of the disposal transactions, and because we do not have any significant

 

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continuing involvement in the operations after the disposal transactions, we have presented the results of the applied sciences practice’s operations as a discontinued operation for all periods.

 

     Year Ended December 31,

 
     2004

    2003

    2002

    2001

    2000

 
     (in thousands, except per share data)  

INCOME STATEMENT DATA

        

Revenues

   $ 427,005     $ 375,695     $ 224,113     $ 122,317     $ 95,532  

Direct cost of revenues

     234,970       176,429       108,104       59,074       48,979  

Selling, general and administrative expense

     102,060       78,701       51,647       33,085       23,920  

Loss on abandoned facilities

     4,670                          

Special termination charges

           3,060                    

Amortization of other intangible assets

     6,836       3,680       1,033       4,235       3,942  
    


 


 


 


 


Operating income

     78,469       113,825       63,329       25,923       18,691  

Interest expense, net

     (6,086 )     (4,196 )     (4,717 )     (4,356 )     (19,242 )

Litigation settlement gains (losses), net

     1,672                          
    


 


 


 


 


Income (loss) from continuing operations, before income tax provision

     74,055       109,629       58,612       21,567       (551 )

Income tax provision

     31,177       44,838       23,704       8,621       184  
    


 


 


 


 


Income (loss) from continuing operations

     42,878       64,791       34,908       12,946       (735 )
    


 


 


 


 


Income from operations of discontinued operations, net of income tax provision (benefit)

           1,649       3,145       3,523       3,296  

Loss from sale of discontinued operations, net of income tax provision (benefit)

           (6,971 )     (891 )            
    


 


 


 


 


(Loss) income from discontinued operations

           (5,322 )     2,254       3,523       3,296  
    


 


 


 


 


Net income

   $ 42,878     $ 59,469     $ 37,162     $ 16,469     $ 2,561  
    


 


 


 


 


Earnings per common share - basic

                                        

Income (loss) from continuing operations

   $ 1.02     $ 1.58     $ 1.09     $ 0.48     $ (0.05 )
    


 


 


 


 


Net income

   $ 1.02     $ 1.45     $ 1.16     $ 0.61     $ 0.16  
    


 


 


 


 


Earnings per common share - diluted

                                        

Income (loss) from continuing operations

   $ 1.01     $ 1.54     $ 1.02     $ 0.44     $ (0.04 )
    


 


 


 


 


Net income

   $ 1.01     $ 1.41     $ 1.09     $ 0.56     $ 0.14  
    


 


 


 


 


Weighted average number of common shares outstanding

                                        

Basic

     42,099       40,925       32,031       26,762       15,918  
    


 


 


 


 


Diluted

     42,512       42,046       34,197       29,447       17,982  
    


 


 


 


 


 

     December 31,

     2004

   2003

   2002

   2001

   2000

     (in thousands)

BALANCE SHEET DATA

      

Cash and cash equivalents

   $ 25,704    $ 5,765    $ 9,906    $ 12,856    $ 3,235

Working capital

     60,241      14,933      13,778      28,766      20,163

Total assets

     708,525      660,565      430,531      159,098      149,246

Long-term debt, including current portion

     105,000      121,250      97,833      28,166      60,500

Stockholders’ equity

     496,154      455,156      267,975      105,136      68,624

 

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

 

Introduction and Overview

 

The following is a discussion and analysis of our consolidated financial condition and results of operations for each of the three years in the period ended December 31, 2004 and significant factors that could affect our prospective financial condition and results of operations. You should read this discussion together with our consolidated financial statements and notes included in “—Item 8. Financial Statements and Supplementary Data.” Historical results and any discussion of prospective results may not indicate our future performance. See “— Forward Looking Statements” included in this Item 7.

 

We are one of the largest providers of forensic and litigation consulting and technology, corporate finance/restructuring and economic consulting services in the United States. Within our forensic and litigation consulting and technology practice, we help clients assess complex financial transactions and reconstruct events from incomplete and/or corrupt data, uncover vital evidence, identify potential claims and assist in the pursuit of economic recoveries. We also provide asset tracing investigative services and expert witness services. Our litigation practice serves clients in all phases of litigation, including pre-filing, discovery, jury selection, trial preparation, expert testimony and the actual trial. We assist with refining issues in litigation and venue selection, and provide fraud investigation and securities litigation assistance. Our trial graphics and technology and electronic evidence experts assist clients in preparing for and presenting their cases in court.

 

Our corporate finance/restructuring practice provides turnaround, performance improvement, lending solutions, financial and operational restructuring, restructuring advisory, mergers and acquisitions, transaction advisory and interim management services. We assist under performing companies in making decisions to improve their financial and operational position given their current situation. We analyze, recommend and implement strategic alternatives for our corporate finance/restructuring clients, such as rightsizing infrastructure, improving working capital management, selling non-core assets or business units, restructuring capital and borrowings, and assessing long-term viability and business strategy. We also lead and manage the financial aspects of the in-court restructuring process, such as assessing the impact of a bankruptcy filing on the client’s financial and operational situation, planning for the smooth transition in and out of bankruptcy, facilitating the sale of assets and assisting to arrange debtor-in-possession financing. Through our corporate finance services, we can help financially distressed companies implement their plans by providing interim management teams. Our corporate finance/restructuring practice provides services throughout the United States and in the United Kingdom.

 

Within our economic consulting practice, we provide our clients with analyses of complex economic issues for use in legal and regulatory proceedings, strategic decision-making and public policy debates. Our services include providing advice and testimony related to:

 

    antitrust and competition issues that arise in the context of potential mergers and acquisitions;

 

    other antitrust issues, including alleged price fixing, cartels and other forms of exclusionary behavior;

 

    the application of modern finance theory to issues arising in securities litigation; and

 

    public policy studies on behalf of companies, trade associations and governmental agencies.

 

Our practices have experience providing testimony in the following areas: fraud, damages, lost profits, valuation, accountant’s liability and malpractice, contract disputes, patent infringement, price fixing, purchase price disputes, solvency and insolvency, fraudulent conveyance, preferences, disclosure statements, trademark and copyright infringement and the financial impact of government regulations.

 

Recent Events Affecting Our Operations. During the first quarter of 2004, we announced the unanticipated departure of a number of senior professionals in our corporate finance/restructuring practice. Some or all of those professionals have formed a company to compete with us. In addition, some of our clients with engagements on-

 

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going at that time transferred these engagements to those former employees and their company. See “Part I, Item 3. Legal Proceedings.” These clients requested refunds of their retainer balances, which negatively impacted our cash flows during the early part of 2004.

 

In July 2004, we entered into a new lease agreement for office space in New York City. The lease expires in November 2021. In accordance with the lease terms, we received a cash inducement of $8.1 million which we have classified as deferred rent in our balance sheet. We are amortizing the cash inducement over the life of the lease as a reduction to the cash rent expense. During the fourth quarter of 2004, we consolidated our New York City and Saddle Brook, New Jersey offices and relocated our employees into the new space. As a result of this decision, we vacated our leased office facilities prior to the lease termination dates. During the fourth quarter of 2004, we recorded a loss of $4.7 million related to the abandoned facilities.

 

Transactions and Developments after December 31, 2004. In February 2005, we acquired substantially all of the assets and assumed certain liabilities of the Ringtail group. Ringtail is a leading global developer of litigation support and knowledge management technologies for law firms. The assets we acquired include software products and technologies and intellectual property. Ringtail has developed a suite of integrated software modules to manage the information and workflow in complex legal cases. We paid $35.0 million for the acquisition, consisting of $20.0 million paid in cash and $15.0 million paid in shares of our common stock. We financed the cash portion of the purchase price with cash on hand and borrowings under our revolving credit facility. We may be required to pay the sellers additional annual consideration based upon post-acquisition revenues for the each of the years from 2005 through 2007. The earnout consideration may be up to $2.5 million per year and may be paid in cash, shares of our common stock or a combination of both. We granted the sellers contractual protection against a decline in the value of the purchase price and any earnout payment made in shares of our common stock. If on the first anniversary date of any issuance of purchase price or earnout shares, the market price of our common stock has not increased by at least 10%, we have agreed to make an additional cash payment to the sellers equal to the deficiency.

 

Financial and Operating Overview. We derive substantially all of our revenue from providing professional services to our clients in the United States. Over the past several years the growth in our revenues and profitability has resulted primarily from the acquisitions we have completed and also from our ability to attract new and recurring engagements.

 

Most of our services are rendered under time-and-expense arrangements that require the client to pay us a fee for the hours that we incur at agreed-upon rates. Under this arrangement we also bill our clients for reimbursable expenses which may include the cost of the production of our work products and other direct expenses that we incur on behalf of the client, such as travel costs and materials that we purchase to produce presentations for courtroom proceedings. We also have performance-based engagements in which we earn a success fee when and if certain predefined outcomes occur. This type of success fee may supplement a time-and-expense arrangement. Success fee revenues may cause significant variations in our revenues and operating results due to the timing of achieving the performance-based criteria.

 

During the year ended December 31, 2004, our revenues increased $51.3 million, or 13.7%, as compared to the year ended December 31, 2003. Revenues increased by 73.3% in our forensic and litigation and technology practice and by 397.5% in our economic consulting practice. This growth was almost entirely due to the acquisitions we completed during the fourth quarter of 2003 and to a lesser extent from internal growth. Although total revenues increased, the reduced volume of new business in the restructuring market and the unanticipated departure of a number of billable professional staff in our corporate finance/restructuring practice resulted in a 36.4% decrease in revenues from those services during 2004 as compared to 2003. In August 2002, we acquired the Business Recovery Services division of PricewaterhouseCoopers, LLP. This acquisition accounted for the majority of the increase in our revenues and profitability for 2003 as compared to 2002. See “—Results of Continuing Operations” for a more detailed discussion and analysis of our financial results.

 

Our financial results are primarily driven by:

 

    the utilization rates of the billable professionals we employ;

 

    the number of billable professionals we employ;

 

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    the rates per hour we charge our clients for service; and

 

    the number and size of engagements we secure.

 

Utilization Rates of Billable Professionals

 

     Year Ended December 31,

   

Percent

Change


 
     2004

    2003

   

Forensic and Litigation Consulting and Technology

   74 %   70 %   5.7 %

Corporate Finance/Restructuring

   82 %   91 %   (9.9 )%

Economic Consulting

   78 %   82 %   (4.9 )%

Total

   77 %   83 %   (7.2 )%

 

We calculate the utilization rate for our professional staff by dividing the number of hours that all of our professionals worked on client assignments during a period by the total available working hours for all of our professionals, assuming a 40-hour work week and a 52-week year. Available working hours include vacation and professional training days, but exclude holidays. Utilization of our professionals is affected by a number of factors, including:

 

    the number, size and timing of client engagements;

 

    the hiring of new professionals, which generally results in a temporary drop in our utilization rate during the transition period for new hires;

 

    our ability to forecast demand for our services and thereby maintain an appropriate level of professionals; and

 

    conditions affecting the industries in which we practice as well as general economic conditions.

 

During the year ended December 31, 2004, we experienced a decrease in our overall utilization rate as compared to the year ended December 31, 2003. This is primarily attributable to a change in economic conditions, the unanticipated departures of some of our professionals and the acquisitions we completed in 2003.

 

During the first half of 2003, utilization rates were high and our financial performance was strong across all practice areas. However, during the third quarter of 2003, demand for our corporate finance/restructuring services began to decline, primarily resulting from a strengthening economy coupled with a decline in the volume of new business in the restructuring market. As a result of economic conditions, utilization rates decreased in our corporate finance/restructuring practice during 2003. The unanticipated departures of professionals from this practice area during the first quarter of 2004 resulted in a further reduction to utilization rates beginning in 2004, since these professionals were highly utilized. Beginning in late 2003, we began to mitigate the impact of declining utilization rates by reassigning our corporate finance/restructuring professionals to other practice areas where demand was higher. We also began to more closely manage our professional staffing levels to optimize our utilization rates. We believe we successfully implemented our business strategy as evidenced by the stabilization of the utilization rates generated by this practice area.

 

During the year ended December 31, 2004, the utilization rate in our forensic and litigation consulting and technology practice was higher than for the same period of 2003. This is primarily attributable to the dispute advisory services business of KPMG that we acquired in the fourth quarter of 2003. The overall utilization rate of these professionals was much lower than we anticipated for the first few months after completion of the acquisition. This had a negative impact on the overall utilization rate of this practice late in 2003 and early in 2004. However, utilization rates improved beginning late in the first quarter of 2004, resulting in a higher utilization rate in 2004 as compared to 2003. The utilization rate in this practice is highly impacted by seasonal

 

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factors such as the vacation of our staff as well as client personnel. This typically results in lower utilization rates during the summer months of the third quarter and during the holiday season in the fourth quarter.

 

The economic consulting practice predominately reflects the results of the Lexecon business we acquired in the fourth quarter of 2003. Prior to the Lexecon acquisition, our economic consulting practice was relatively small and the utilization rates in 2003 primarily reflect the impact of several large engagements that were ongoing at that time.

 

Number of Billable Professionals

 

     December 31, 2004

    December 31, 2003

       
     Headcount

   % of Total

    Headcount

   % of Total

   

Percent

Change


 

Forensic and Litigation Consulting and Technology

   357    47.9 %   343    41.5 %   4.1 %

Corporate Finance/Restructuring

   243    32.6 %   305    36.9 %   (20.3 )%

Economic Consulting

   145    19.5 %   179    21.6 %   (19.0 )%
    
  

 
  

     

Total

   745    100.0 %   827    100.0 %   (9.9 )%
    
  

 
  

     

 

The number of billable employees decreased from December 31, 2003 to December 31, 2004 largely due to the decrease in demand for our corporate finance/restructuring services. In addition, during the first quarter of 2004, about 60 of our professionals departed from our former FTI/Policano & Manzo corporate finance/restructuring practice. During the first quarter of 2004, about 35 employees were reorganized from the economic consulting practice to the forensic and litigation and technology practice, resulting in a decrease in headcount in that practice area.

 

Average Billable Rate per Hour

 

     Year Ended December 31,

  

Percent

Change


 
     2004

   2003

  

Forensic and Litigation Consulting and Technology

   $ 284    $ 273    4.0 %

Corporate Finance/Restructuring

     441      408    8.1 %

Economic Consulting

     374      291    28.5 %

Total

     354      363    (2.5 )%

 

We calculate average billable rate per hour by dividing employee revenues for the period, excluding outside consultant and reimbursable revenues, by the number of hours worked on client assignments during the same period. Average hourly billable rates are affected by a number of factors, including:

 

    our clients’ perception of our ability to add value through the services we provide;

 

    the market demand for our services;

 

    introduction of new services by our competitors;

 

    the pricing policies of our competitors; and

 

    general economic conditions.

 

Our average billable rate per hour increased across all practice areas from December 31, 2003 to December 31, 2004. The improvement in average billable rates by practice area is the result of several factors, including:

 

    planned bill rate increases implemented throughout our corporate finance/restructuring practice during the second quarter of 2004, and as a result of promotions during the third quarter of 2004;

 

 

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    a change in the mix of billable professionals in our corporate finance/restructuring practice, which resulted in an increasing percentage of our professional employees being billable at higher rates; and

 

    an increase in the billable rates in our economic practice attributable to the Lexecon acquisition.

 

Although average billable rates increased across all of our practice areas during 2004 as compared to 2003, the total company average billable rate decreased. This decrease is due to a larger percentage of our business being generated in 2004 by the forensic and litigation consulting and technology practice which has lower billable rates than our corporate finance/restructuring practice. In 2003, our corporate finance/restructuring practice accounted for 68.0% of our consolidated revenues, while in 2004, our corporate finance/restructuring practice accounted for 38.1% of our consolidated revenues. At the same time, the percentage of consolidated revenues generated by our forensic and litigation consulting and technology practice increased from 27.4% during 2003 to 41.8% during 2004.

 

Segment Profits.

 

     Year Ended December 31,

       
     2004

    2003

       
    

Segment

Profits


   

% of

Segment
Revenues


   

Segment

Profits


   

% of

Segment
Revenues


   

Percent

Change


 
     (dollars in thousands)  

Forensic and Litigation Consulting and Technology

   $ 50,556     28.3 %     N/A     N/A     N/A  

Corporate Finance/Restructuring

     50,714     31.2 %     N/A     N/A     N/A  

Economic Consulting

     19,333     22.5 %     N/A     N/A     N/A  

Corporate

     (26,185 )   N/A     $ (18,720 )   N/A     39.9 %
    


       


           

Total

   $ 94,418     22.1 %   $ 123,537     32.9 %   (23.6 )%
    


       


           

N/A – Not available

 

In 2003, we did not operate our business practices as segments. Accordingly, we did not report results of operations by segment. The table above presents segment profits for the year ended December 31, 2004. We evaluate the performance of these segments based on operating income before depreciation, amortization and corporate general and administrative expenses. Segment profit consists of the revenues generated by that segment, less the direct costs of revenue and selling, general and administrative costs that are incurred directly by that segment as well as an allocation of some centrally managed costs, such as information technology services, marketing and facility costs. Unallocated corporate costs include costs related to other centrally managed administrative costs. These administrative costs include corporate office support costs, costs relating to accounting, human resources, legal, company-wide business development functions, as well as costs related to overall corporate management.

 

Total segment profits decreased during the year ended December 31, 2004 as compared to the comparable period of 2003. This decrease was driven by several factors, including the following:

 

    the decrease in demand for our corporate finance/restructuring related services, which began late in the third quarter of 2003;

 

    the unanticipated departure during the first quarter of 2004 of a number of billable professional staff in our corporate finance/restructuring practice that operated at high utilization rates;

 

    lower utilization rates generated by the businesses we acquired in late 2003 relative to our historical experience;

 

    lower gross profit margins generated by our recently acquired businesses, particularly Lexecon, an economic consulting business that operates in a competitive environment that typically generates lower gross margins than those experienced by our financial and litigation consulting and technology and our corporate finance/restructuring practices;

 

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    the increased investment in practice-area expansion, including sign-on and direct compensation for several senior-level professionals;

 

    a $4.7 million loss on abandoned facilities recorded in our corporate segment during 2004 related to the relocation and consolidation of our New York City and one of our Saddle Brook, New Jersey offices; and

 

    an increase in corporate overhead expenses driven largely by increased staffing and consulting costs to support our growing organization, to address the requirements of the Sarbanes-Oxley Act and to further strengthen our corporate governance activities.

 

During 2004, we addressed the decrease in demand for our services through the voluntary and involuntary turnover of our professionals as well as through reassignments of professionals to other practice areas. Our efforts were successful in neutralizing the impact of decreased demand for our services. Any decrease in revenues without a corresponding reduction in our costs would harm our profitability.

 

Critical Accounting Policies

 

General. Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which we have prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to bad debts, goodwill, income taxes and contingencies. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. These results form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

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

 

Revenue Recognition. Our services are primarily rendered under arrangements that require the client to pay us on a time-and-expense basis. We recognize revenues for our professional services rendered under time-and-expense engagements based on the hours incurred at agreed upon rates as work is performed. We recognize revenue from reimbursable expenses in the period in which the expense is incurred. The basis for our policy is the fact that we normally obtain engagement letters or other agreements from our clients prior to performing any services. In these letters and other agreements, the clients acknowledge that they will pay us based upon our time spent on the engagement and at our agreed-upon hourly rates. We are periodically engaged to provide services in connection with client matters where payment of our fees is deferred until the conclusion of the matter or upon the achievement of performance-based criteria. We recognize revenues for these arrangements when all the performance-based criteria are met and collection of the fee is reasonably assured.

 

Revenues recognized but not yet billed to clients are recorded at net realizable value as unbilled receivables in the accompanying consolidated balance sheets. Billings in excess of services provided represent amounts billed to clients, such as retainers, in advance of work being performed.

 

Some clients pay us retainers before we begin any work for them. We hold retainers on deposit until we have completed the work. We apply these retainers to final billings and refund any excess over the final amount billed to clients, as appropriate, upon our completion of the work. If the client is in bankruptcy, fees for our professional services may be subject to approval by the court. In some cases, a portion of the fees to be paid to us by a client is required by a court to be held until completion of our work. We make a determination whether to record all or a portion of such a holdback as revenue prior to collection on a case-by-case basis.

 

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Allowance for Doubtful Accounts and Unbilled Services. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our clients to pay our fees or for disputes that affect our ability to fully collect our billed accounts receivable as well as potential fee reductions or refunds imposed by bankruptcy courts. Even if a bankruptcy court approves of our services, it has the discretion to require us to refund all or a portion of our fees due to the outcome of the case or a variety of other factors. We estimate the allowance for these risks by reviewing the status of all accounts and recording reserves based on our experiences in these cases and historical bad debt expense. However, our actual experience may vary significantly from our estimates. If the financial condition of our clients were to deteriorate, resulting in their inability to pay our fees, or the bankruptcy courts require us to refund certain fees, we may need to record additional allowances or write-offs in future periods. This risk is mitigated to the extent that we receive retainers from some of our clients prior to performing significant services.

 

The provision for doubtful accounts and unbilled services is recorded as a reduction to revenues to the extent the provision relates to fee adjustments, estimates of refunds that may be imposed by bankruptcy courts and other discretionary pricing adjustments. To the extent the provision relates to a client’s inability to make required payments, the provision is recorded as bad debt expense which we classify within selling, general and administrative expense.

 

Goodwill and Other Intangible Assets. As of December 31, 2004, goodwill and the other intangible assets represented 73.2% of our total assets. The majority of our goodwill and other intangible assets were generated from acquisitions we completed during 2002 and the fourth quarter of 2003. Other intangible assets include tradenames, customer relationships, contract backlog, non-competition agreements and intellectual property. We make at least annual impairment assessments of our goodwill and intangible assets in accordance with our stated accounting policy. In making these impairment assessments, we must make subjective judgments regarding estimated future cash flows and other factors to determine the fair value of the reporting units of our business that are associated with these assets. It is possible that these judgments may change over time as market conditions or our strategies change, and these changes may cause us to record impairment charges to adjust our goodwill and other intangible assets to their estimated implied fair value or net realizable value.

 

Income Taxes. Our income tax provision consists principally of federal and state income taxes. Our estimated combined federal and state income tax rate for 2004 is 42.1%. We generate income in a significant number of states located throughout the United States. Our effective income tax rate may fluctuate due to a change in the mix of earnings between higher and lower state tax jurisdictions and the impact of non-deductible expenses. Additionally, we record deferred tax assets and liabilities using the liability method of accounting which requires us to measure these assets and liabilities using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. We have not recorded a valuation allowance on our deferred tax assets as we believe the recorded amounts are more likely than not to be realized. If the assumptions used in preparing our income tax provision differ from those used in the preparation of our income tax return, we may experience a change in our effective income tax rate for the year.

 

Significant New Accounting Pronouncement

 

As permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” we currently account for share-based payments to employees using the intrinsic value method under Accounting Principles Board, or APB, Opinion No. 25. As such, we generally do not recognize compensation cost related to employee stock options. In December 2004, the Financial Accounting Standards Board issued Statement No. 123(R), “Share-Based Payment,” which is a revision of Statement No. 123. Statement No. 123(R) requires all share-based payments to employees and directors to be recognized in the financial statements based on their fair values, using prescribed option-pricing models. Upon adoption of Statement 123(R) on July 1, 2005, pro forma disclosure will no longer be an alternative to financial statement recognition. Accordingly, the adoption of the fair-value method prescribed by Statement No. 123(R) will have a significant impact on our results of operations, although it will not have an impact on our overall financial

 

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position. The impact of adopting Statement No. 123(R) can not be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted Statement No. 123(R) in prior periods, the impact of that standard would have approximated the impact of Statement No. 123 as described in the notes to our consolidated financial statements. See “Item 8. Financial Statements and Supplementary Data—Note 1. Descriptions of Business and Significant Accounting Policies—Stock-based compensation.” Statement No. 123(R) also requires the benefit related to income tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current accounting principles. This requirement will reduce our net operating cash flows and increase our net financing cash flows in periods after adoption. Had we adopted this statement in prior periods using the valuation method and assumptions applied in our pro forma disclosures, we would have reduced our net operating cash flows and increased our net financing cash flows by $2.2 million during 2004, $11.6 million during 2003 and $12.8 million during 2002. When Statement No. 123(R) is adopted, we may elect to change our valuation method or assumptions. Such changes could have an impact on the amount of stock-based compensation we record.

 

Results of Continuing Operations

 

Year Ended December 31, 2004 vs. Year Ended December 31, 2003

 

Revenues.

 

     2004

    2003

   

Percent

Change


 
     Revenues

   % of Total

    Revenues

   % of Total

   
     (dollars in thousands)  

Forensic and Litigation Consulting and Technology

   $ 178,650    41.8 %   $ 103,101    27.4 %   73.3 %

Corporate Finance/Restructuring

     162,495    38.1 %     255,336    68.0 %   (36.4 )%

Economic Consulting

     85,860    20.1 %     17,258    4.6 %   397.5 %
    

  

 

  

     

Total

   $ 427,005    100.0 %   $ 375,695    100.0 %   13.7 %
    

  

 

  

     

 

Revenues from continuing operations increased during the year ended December 31, 2004 as compared to the comparable period of 2003. This increase is primarily attributable to the acquisitions we completed during the fourth quarter of 2003 offset by the decrease in demand for our corporate finance/restructuring services, which began during the third quarter of 2003, as well as the unanticipated departure of professionals from this practice during the first quarter of 2004. The acquisitions of Ten Eyck and the dispute advisory services business from KPMG accounted for about $67.8 million of the $75.5 million increase in revenues from our forensic and litigation consulting and technology group. The remainder of the increase in revenues from our forensic and litigation consulting and technology group is primarily attributable to growth in our trial consulting business.

 

The acquisition of Lexecon accounted for substantially all of the increase in revenues related to our economic consulting practice.

 

Our corporate finance/restructuring practice accounted for 68.0% of our revenues during year ended December 31, 2003 as compared to 38.1% during the year ended December 31, 2004. Late in the third quarter of 2003, we began to experience a decrease in demand for our corporate finance/restructuring related services, which has negatively impacted our revenues from that segment. The departure of a number of our billable professionals in the corporate finance/restructuring practice during the first quarter of 2004 also contributed to the decrease in revenues from that segment. Because this practice generates the highest billable rate per hour, the decrease in revenues attributable to this segment has largely impacted our overall revenue growth. Revenues attributable to this practice stabilized beginning in the second quarter of 2004 after decreasing significantly from the fourth quarter of 2003 to the first quarter of 2004.

 

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Direct Cost of Revenues.

 

     2004

    2003

       
     Cost of
Revenues


  

% of

Segment
Revenues


    Cost of
Revenues


  

% of

Segment
Revenues


   

Percent

Change


 
     (dollars in thousands)  

Forensic and Litigation Consulting and Technology

   $ 95,473    53.4 %   $ 57,256    55.5 %   66.7 %

Corporate Finance/Restructuring

     84,877    52.2 %     108,826    42.6 %   (22.0 )%

Economic Consulting

     54,620    63.6 %     10,347    60.0 %   427.9 %
    

        

            

Total

   $ 234,970    55.0 %   $ 176,429    47.0 %   33.2 %
    

        

            

 

Our direct cost of revenues consists primarily of employee compensation and related payroll benefits, including the amortization of signing bonuses given in the form of forgivable loans, the cost of outside consultants that we retain to supplement our professional staff, reimbursable expenses, including travel and out-of-pocket expenses incurred in connection with an engagement, and other related expenses billable to clients. Direct cost of revenues increased as a percentage of revenues in both our corporate finance/restructuring and economic consulting segments primarily due to lower utilization rates experienced by those practices during the year ended December 31, 2004 as compared to the same period in 2003. This resulted from revenues growing at a slower pace than direct costs. In addition:

 

    The number of billable professionals in our corporate finance/restructuring practice decreased by 20.3%, from 305 to 243, resulting in a decrease in direct costs in that practice. The unanticipated departure of some of our professionals in this practice during the first quarter of 2004 accounts for the majority of the decrease. This contributed to the increase in direct costs as a percentage of revenues in that practice, primarily because these professionals generally operated at higher utilization rates and higher billable rates than our other professionals.

 

    The acquisition of Lexecon, which operates at a lower gross margin than our other operating segments, contributed to the increase in our economic consulting practice.

 

    During 2004, we paid $10.6 million in signing bonuses to attract and retain highly-skilled professionals. These signing bonuses were granted in the form of forgivable loans that we are amortizing over periods of one to five years. These signing bonuses increased direct costs during 2004 as compared to 2003 by $0.8 million in the forensic and litigation consulting and technology, $1.4 million in the corporate finance practice and $0.4 million in the economic practice.

 

Direct cost of revenues as a percentage of revenues for the forensic and litigation consulting and technology practice decreased slightly during 2004 as compared to 2003. This is primarily due to an improvement in utilization rates which resulted in revenues growing at a faster pace than direct costs.

 

Selling, General and Administrative Expense.

 

     2004

    2003

       
     SG & A

  

% of

Segment
Revenues


    SG & A

  

% of

Segment
Revenues


   

Percent

Change


 
     (dollars in thousands)  

Forensic and Litigation Consulting and Technology

   $ 36,175    20.2 %     N/A    N/A     N/A  

Corporate Finance/Restructuring

     28,512    17.5 %     N/A    N/A     N/A  

Economic Consulting

     12,839    15.0 %     N/A    N/A     N/A  

Corporate

     24,534    N/A     $ 17,632    N/A     39.1 %
    

        

            

Total

   $ 102,060    23.9 %   $ 78,701    20.9 %   29.7 %
    

        

            
 

N/A – Not available

 

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Selling, general and administrative expenses consist primarily of salaries and benefits paid to sales and corporate office staff, rent, marketing, corporate overhead expenses, bad debt expense and depreciation and amortization of property and equipment. Segment selling, general and administrative costs includes those expenses that are incurred directly by that segment as well as an allocation of some centrally managed costs, such as information technology services, marketing and facility costs. Unallocated corporate selling, general and administrative costs include costs related to other centrally managed administrative costs. These administrative costs include corporate office support costs, costs relating to accounting, human resources, legal, company-wide business development functions, as well as costs related to overall corporate management. Selling, general and administrative expense increased as a percentage of our total revenues for the year ended December 31, 2004 as compared to the same period in 2003. This increase is largely attributable to increased personnel, facilities and general corporate expenses associated with the businesses we acquired in late 2003. The number of non-billable employees increased by 12.4%, from 258 at December 31, 2003 to 290 at December 31, 2004.

 

The increase in corporate overhead expenses is primarily related to increased back-office staffing and related costs to support our growing organization. In addition, corporate staffing and consulting costs have increased to address the requirements of the Sarbanes-Oxley Act and to further strengthen our corporate governance activities. In particular, beginning in late 2003 we began expanding our internal legal and audit departments and enhanced our regulatory reporting functions.

 

Bad debt expense increased as a percentage of revenues from 1.4% for the year ended December 31, 2003 to 1.7% for the year ended December 31, 2004. This increase accounted for $2.0 million of the increase in our total selling, general and administrative expenses. The majority of this increase, or $1.6 million, is attributable to our acquired operations. The remaining increase is primarily attributable to our corporate finance practice. The days sales outstanding related to our corporate finance practice more than doubled, from just under 30 days to just under 60 days. As a result of the unanticipated departure of professionals during the first quarter of 2004, we returned a large volume of retainers to clients we lost. This resulted in an increase in days sales outstanding, as the remaining part of this practice does not generally obtain large retainers in advance of performing work.

 

Depreciation and amortization of property and equipment classified within total selling, general and administrative expense increased by $3.1 million or 51.1% from the year ended December 31, 2003 as compared to the same period in 2004. This increase is a result of the increase in the furniture and equipment and office build-out necessary to support a larger organization which grew as a result of the acquisitions we completed during the fourth quarter of 2004.

 

Loss on Abandoned Facilities. During the fourth quarter of 2004, we consolidated our New York City and one of our Saddle Brook, New Jersey offices and relocated our employees into new office facilities in New York City. As a result of this decision, we vacated our leased office facilities prior to the lease termination dates. During the fourth quarter of 2004, we recorded a loss of $4.7 million related to the abandoned facilities.

 

Special Termination Charges. During the fourth quarter of 2003 we recorded $3.1 million of special termination charges. These charges relate to contractual benefits payable to specified employees as a result of the termination of their employment.

 

Amortization of Other Intangible Assets. The amortization expense related to other intangible assets increased by $3.2 million, or 85.8%, for the year ended December 31, 2004 as compared to the same period in 2003. This increase is related to the identifiable intangible assets recorded in connection with the acquisitions we completed during the fourth quarter of 2003.

 

Interest Expense. Interest expense consists primarily of interest on debt we incurred to purchase businesses over the past several years, including the amortization of deferred bank financing fees. Interest expense increased by $1.0 million, or 18.7% for the year ended December 31, 2004 as compared to the same period in 2003. This increase is primarily attributable to higher average borrowings outstanding during 2004 as compared to 2003. Average borrowings increased in the fourth quarter of 2003 and remained at this higher level throughout 2004 as

 

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a result of the three business combinations completed in late 2003. During the year ended December 31, 2003, we wrote-off about $768,000 of deferred bank financing fees as a result of the early extinguishment of long-term debt.

 

Discount on Note Receivable. In December 2004, we agreed to discount a note receivable due from the owners of one of our former subsidiaries. We discounted this note by $475,000 in exchange for payment of the note ahead of its maturity in 2010. We received this prepayment in January 2005.

 

Litigation Settlement gains (losses), net. During the fourth quarter of 2004, we reached settlement on various lawsuits. As a result, we recorded a gain of $1.7 million, net of legal costs.

 

Income Taxes. Our effective tax rate for continuing operations was 42.1% during 2004 and 40.9% during 2003. Our effective tax rate increased over the past year as a result of an increasing portion of our taxable income being generated in state and local jurisdictions with higher tax rates. See note 9 of Notes to Consolidated Financial Statements appearing elsewhere in this annual report for a reconciliation of the federal statutory rate to our effective tax rates during each of these years, and a summary of the components of our deferred tax assets and liabilities. We presently anticipate that our effective tax rate during 2005 will be similar to 2004.

 

Year Ended December 31, 2003 vs. Year Ended December 31, 2002

 

Revenues. Revenues from continuing operations increased 67.6% from $224.1 million for the year ended December 31, 2002 to $375.7 million for 2003. This increase is primarily attributable to the acquisition of BRS, which occurred as of August 30, 2002. Our corporate finance/restructuring practice accounted for about 68% of our revenues during 2003. About 27% of our revenues were attributable to our forensic and litigation consulting and technology practice, and less than 5% of our revenues were derived from our economic consulting practice.

 

During the third quarter of 2003, we began to experience a decrease in demand for our corporate finance/restructuring related services. Consequently, the decrease in the demand for those services resulted in a lower utilization of billable professionals during the second half of 2003 than we had experienced in earlier quarters and a decline in the growth of our revenues beginning in the third quarter of 2003. We began mitigating the impact of this decrease in demand by redeploying some of these professionals to work on transaction support, loan due diligence reviews and forensic accounting assignments where demand was higher. In addition, during the fourth quarter of 2003, we recorded a special termination charge totaling $3.1 million related to contractual benefits due to specified employees as a result of the termination of their employment.

 

Headcount Summary

 

As of December 31,


   Billable

    Non-billable

    Total

 

2003

   827     258     1,085  

2002 *

   610     159     769  
    

 

 

Increase

   217     99     316  
    

 

 

% Increase

   35.6 %   62.3 %   41.1 %
 
  * The headcount information for 2002 excludes 294 employees associated with our discontinued operations.

 

The number of billable employees increased from December 31, 2002 to December 31, 2003 largely due to the acquisitions of Lexecon and KPMG’s dispute advisory services business. We acquired about 290 billable employees as a result of these transactions in the fourth quarter of 2003. During the latter part of 2003, our corporate finance/restructuring practice experienced a decrease in billable employees related to the decreased demand for these services.

 

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Utilization of billable professionals was about 83% during 2003, compared to about 88% for the same period of 2002. We experienced a decrease in utilization rates across our largest practice areas in 2003, consisting of our corporate finance/restructuring practice and our forensic and litigation consulting and technology practice. During 2003, the volume of bankruptcy cases declined. As a result, utilization rates decreased in our corporate finance/restructuring practice primarily due to the decrease in demand for these services. The decrease in utilization rates in our forensic and litigation consulting and technology practice is primarily attributable to the DAS business that we acquired from KPMG in the fourth quarter of 2003. We acquired 151 billable employees from this transaction. The overall utilization rate of these professionals was lower than our existing practice. As a result, we actively repositioned our resources to focus on services where demand was higher.

 

Our average bill rate per hour for 2003 was $363, an increase from an average of $311 for 2002. The improvement in our bill rates was the result of several factors, including:

 

    an increase in our standard hourly bill rates during the year;

 

    an increased concentration of corporate finance/restructuring consulting services, beginning in August 2002, which typically have higher hourly bill rates than some of our other practice areas; and

 

    a decrease in billable employees in our corporate finance/restructuring practice primarily at the lower levels, which resulted in an increasing percentage of our professional employees being billable at higher rates.

 

Direct Cost of Revenues. Our direct cost of revenues consists primarily of employee compensation and related payroll benefits, the cost of outside consultants assigned to revenue-generating activities and other related expenses billable to clients. Direct cost of revenues from our continuing operations was 47.0% of our total revenues for the year ended December 31, 2003 as compared to 48.2% for the comparable period in 2002. The increases in our bill rates resulted in revenues increasing at a faster rate than direct costs.

 

Selling, General and Administrative Expense. Selling, general and administrative expense was 20.9% of our total revenues for 2003 and 23.0% for 2002. This improvement in 2003 was primarily due to the greater leverage of our corporate overhead costs in relation to our increased revenue base resulting primarily from the acquisition of BRS. Although selling, general and administrative expense did not increase as a percentage of revenues, it increased in absolute dollars by $27.1 million. This increase is largely attributable to increased personnel, facilities and general corporate expenses associated with the acquired operations of BRS and other business expansion.

 

Our corporate overhead expenses, included in selling, general and administrative expense, represented about 5.0% of total revenues for the year ended December 31, 2003 and 6.8% for 2002. Although corporate overhead expenses did not increase as a percentage of revenues, it increased in absolute dollars by $3.5 million or 23.1%. The increase in corporate overhead expenses is primarily related to increased staffing and consulting costs to address the requirements of the Sarbanes-Oxley Act and to further strengthen our corporate governance and control activities. In particular, we have created an internal legal department, expanded internal audit activities and enhanced our regulatory reporting functions. We also increased our back-office staffing during 2003 to support our growing organization. The decline in our corporate overhead costs relative to our revenues reflects the increased leverage of our overhead and corporate support services in relation to our increased revenue base.

 

Bad debt expense, included in selling, general and administrative expense, increased from 1.2% of revenues for the year ended December 31, 2002 to 1.4% of revenues for 2003. This increase represented $2.3 million of the increase in selling, general and administrative expense.

 

Depreciation and amortization of property and equipment has increased by $2.1 million from $4.9 million for the year ended December 31, 2002 to $7.0 million during 2003 as a result of the increase in the furniture and equipment necessary to support a larger organization. Depreciation and amortization decreased from 2.2% of revenues during 2002 to 1.9% of revenues during 2003.

 

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Amortization of Other Intangible Assets. In connection with the acquisition of BRS in August 2002, we recorded $5.1 million of other intangible assets, consisting primarily of client backlog. We began to amortize these other intangible assets in September 2002. Amortization expense of $1.0 million in 2002 is entirely attributable to the BRS acquisition. We recorded additional amortizable intangible assets in connection with our acquisition activities in the fourth quarter of 2003. Amortization expense increased by $2.7 million to $3.7 million during 2003 of which $3.1 million relates to the BRS acquisition and $0.6 million relates to the acquisitions completed in 2003.

 

Interest Income. Interest income increased $1.0 million from the year ended December 31, 2002 to $1.2 million during 2003. This increase is primarily due to income recognized on the investment of higher average cash balances during 2003, primarily resulting from the net proceeds received from the public offering of our common stock in February 2003 as well as increasing cash flows provided by operations.

 

Interest Expense. Interest expense consists primarily of interest on debt we incurred to purchase businesses over the past several years. Interest rates during 2003 have been lower than in 2002, although the additional borrowings in August 2002 to acquire BRS substantially increased the amount of our debt at the beginning of 2003 as compared to 2002. At December 31, 2002, we had $97.8 million of outstanding bank debt, and at December 31, 2003, we had $121.3 million of outstanding bank debt.

 

Interest expense increased from $4.9 million during the year ended December 31, 2002 to $5.4 million during 2003. Interest expense in 2003 includes $768,000 of deferred debt financing fees we wrote off in connection with the early debt extinguishments during the year. Interest expense increased during this period primarily due to the higher average borrowings outstanding during 2003 as a result of our additional borrowings in August 2002 to acquire BRS.

 

Income Taxes. Our effective tax rate for continuing operations in 2003 was 40.9% compared to 40.4% in 2002. Our effective tax rate increased from 2002 to 2003 as a result of an increasing portion of our taxable income being generated in state and local jurisdictions with high tax rates. See note 9 of Notes to Consolidated Financial Statements appearing elsewhere in this annual report for a reconciliation of the federal statutory rate to our effective tax rates during each of these years, and a summary of the components of our deferred tax assets and liabilities.

 

Liquidity and Capital Resources

 

Cash Flows.

 

     Year Ended December 31,

    Change from Previous Year

 
     2004

    2003

    Dollars

    Percent

 
     (dollars in thousands)  

Net cash provided by operating activities

   $ 58,443     $ 100,177     $ (41,734 )   (41.7 )%

Net cash used in investing activities

     (13,693 )     (231,741 )     218,048     94.1 %

Net cash (used in) provided by financing activities

     (24,811 )     127,423       (152,234 )   (119.5 )%

 

We have historically financed our operations and capital expenditures solely through cash flows from operations. However, during the early part of 2004, our operating income declined as compared to the same period of 2003. As a result we used borrowings under our revolving credit facility to finance some of our cash needs for operating activities and capital expenditures during 2004. We also used borrowings under our revolving credit facility to finance our share repurchase program, discussed in more detail below. As of December 31, 2004, we fully repaid all borrowings under our revolving credit facility. During 2004, our working capital requirements were higher than we have historically experienced primarily due to:

 

    increased requirements during the first quarter of 2004 to fund the working capital needs of the dispute advisory services business of KPMG that we acquired in October 2003;

 

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    increased quarterly incentive compensation payments attributable to the Lexecon business that we acquired in November 2003, as Lexecon has more frequent incentive compensation payments than our existing businesses;

 

    increased sign-on and retention compensation paid during 2004 to attract senior-level professionals and retain our strongest performers; and

 

    refunds of retainer balances associated with the loss of client engagements resulting from the departure of corporate finance/restructuring professionals.

 

Our operating assets and liabilities consist primarily of billed and unbilled accounts receivable, accounts payable and accrued expenses and accrued compensation expense. The timing of billings and collections of receivables as well as payments for compensation arrangements affect the changes in these balances. Our billed and unbilled accounts receivable, net of billings in excess of services provided has increased primarily due to the following:

 

    A decrease in retainers we collect from our clients prior to the performance of our service. Historically, our corporate finance/restructuring practice has generated the largest amount of retainers from our clients prior to beginning any billable work. This practice area also generates the lowest days sales outstanding rate in our company. The professionals that left us during the first quarter of 2004 transferred some of our clients and engagements to their new company. As a result, we were required to refund a large amount of retainer balances. Accordingly, the average days sales outstanding in this practice area more than doubled, from just under 30 days to just under 60 days. The corporate finance/restructuring practice continues to have the shortest collection period in our company.

 

    The acquisition of the dispute advisory services business of KPMG. We did not acquire any accounts receivable when we acquired the dispute advisory services business of KPMG during the fourth quarter of 2003. This business also did not begin to generate a substantial amount of revenues until late in the first quarter of 2004. Accordingly, the net accounts receivable attributable to the forensic and litigation consulting and technology practice has increased substantially more than our other practice areas during 2004 as compared to December 31, 2003.

 

    The acquisition of Lexecon. The average days sales outstanding for our economic practice area is the highest in our company and is attributable to the acquisition of Lexecon which occurred late in the fourth quarter of 2003. Lexecon has been engaged to provide services for a client where payment of our fees is deferred until the conclusion of the matter. At December 31, 2004, billed and unbilled receivables for this business included $7.3 million of fees for services rendered where payment will not be received until completion of the matter. This specific matter is the primary reason for days sales outstanding increasing in the economic practice.

 

Net cash used in investing activities during the year ended December 31, 2004 decreased $218.0 million as compared to the same period in 2003, primarily due to $234.1 million of cash used during 2003 to fund our acquisition activities offset by $12.2 million of cash received during 2003 from the sale of our applied sciences practice.

 

Due to the acquisitions we completed during the fourth quarter of 2003, our average employee headcount during 2004 was about 20% higher than during 2003. Accordingly, capital expenditures increased from $10.6 million during 2003 to $11.9 million during 2004 to support a larger organization during 2004 as compared to during 2003. This increase is primarily due to an increase in spending for leasehold improvements to modify and expand our office facilities, and to acquire additional furniture and information technology equipment. We had no material outstanding purchase commitments as of December 31, 2004.

 

Our financing activities have consisted principally of borrowings and repayments under long-term debt arrangements as well as issuances of common stock. Our long-term debt arrangements have principally been obtained to provide financing for our business acquisitions. During the first quarter of 2003, we completed the

 

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public offering of 4.0 million shares of our common stock, generating net cash proceeds of $99.2 million. We used about half of the net proceeds from the stock offering to repay our long-term debt. We also used all of the net cash proceeds from the sale of our applied sciences practice to repay debt. During the fourth quarter of 2003, we borrowed $104.1 million under our amended and restated bank credit facility in order to finance our acquisition of Lexecon. During the year ended December 31, 2004, our financing activities consisted principally of $16.3 million of principal payments on our term loans and $47.5 million of borrowings under our revolving credit facility that were repaid in full during the year.

 

In October 2003, our board of directors approved a share repurchase program under which we may purchase, from time to time, up to $50.0 million of our common stock over the next twelve months. In October 2004, our board of directors extended the share repurchase program through October 31, 2005. The shares of common stock may be purchased through open market or privately negotiated transactions and will be funded with a combination of cash on hand, existing bank credit facilities or new credit facilities. During 2003, we purchased and retired 194,200 shares of our common stock at a total cost of about $4.0 million. During 2004, we purchased and retired 657,300 shares of our common stock at a total cost of about $10.8 million. Since inception of the program, we have purchased and retired a total of 851,500 shares of our common stock for $14.8 million.

 

Capital Resources. Our amended and restated bank credit facility provides for up to $225.0 million of secured financing, consisting of a $100.0 million revolving loan and $125.0 million in term loans. The maturity date of the $100.0 million revolving credit facility is November 28, 2008. However, we may choose to repay outstanding borrowings under the revolving credit facility at any time before maturity without penalty. Principal payments on the term loans are payable quarterly through September 30, 2008. Debt under the credit facility bears interest at an annual rate equal to either the Eurodollar rate plus an applicable margin or an alternative base rate defined as the higher of (1) the lender’s announced prime rate or (2) the federal funds rate plus the sum of 50 basis points and an applicable margin. Under the credit facility, the lenders have a security interest in substantially all of our assets. As of December 31, 2004, we had outstanding aggregate debt under the credit facility of $105.0 million, bearing interest at rates ranging from 3.7% to 4.0%. We are not subject to any penalties for early payment of debt under the credit facility.

 

Our amended and restated bank credit facility contains covenants which limit our ability to incur additional indebtedness; create liens; pay dividends on, make distributions or repurchases of our capital stock or make specified other restricted payments; consolidate, merge or sell all or substantially all of our assets; guarantee obligations of other entities; enter into hedging agreements; enter into transactions with affiliates or related persons or engage in any business other than the consulting business. The credit facility requires compliance with financial ratios, including total indebtedness to earnings before interest, taxes, depreciation and amortization, or EBITDA; EBITDA to specified charges and the maintenance of a minimum net worth, each as defined under the amended credit facility. At December 31, 2004, we were in compliance with all covenants as stipulated in the credit facility agreements.

 

As of December 31, 2004, our capital resources included $25.7 million of cash and cash equivalents and a $100.0 million revolving loan commitment under our amended and restated bank credit facility. The availability of borrowings under our revolving credit facility is subject to specified borrowing conditions. We use letters of credit primarily as security deposits for our office facilities. Letters of credit reduce the availability under our revolving credit facility. As of December 31, 2004, we have $10.0 million of outstanding letters of credit, including an $8.0 million letter of credit used in place of a security deposit for the New York City lease we entered into in July 2004. As of December 31, 2004, we have $90.0 million of available borrowings under our revolving credit facility.

 

Future Capital Needs. We currently anticipate that our future capital needs will principally consist of funds required for:

 

    operating and general corporate expenses relating to the operation of our business;

 

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    capital expenditures, primarily for information technology equipment, office furniture and leasehold improvements;

 

    debt service requirements;

 

    up to $35.2 million of discretionary funding for our share repurchase program that has been extended through October 31, 2005;

 

    $20.0 million of cash to fund the acquisition of the Ringtail group, which we completed on February 28, 2005; and

 

    potential acquisitions of businesses that would allow us to diversify or expand our current service offerings.

 

We anticipate capital expenditures will be about $12.0 million during 2005. Our estimate takes into consideration the needs of our existing business as well as the needs of our recently completed acquisition of Ringtail. Our capital expenditure requirements may change if our staffing levels or technology needs change significantly from what we currently anticipate.

 

Off-Balance Sheet Arrangements. We have no off-balance sheet financing arrangements other than operating leases and we have not entered into any transactions involving unconsolidated subsidiaries or special purpose entities.

 

Future Contractual Obligations. The following table sets forth our estimates as to the amounts and timing of contractual payments for our most significant contractual obligations and commitments as of December 31, 2004. The information in the table reflects future unconditional payments and is based on the terms of the relevant agreements, appropriate classification of items under generally accepted accounting principles currently in effect and certain assumptions, such as interest rates. Future events could cause actual payments to differ from these amounts. See “—Forward-Looking Statements.”

 

Future contractual obligations related to our long-term debt include principal amortization and estimated interest payments based on interest rates in effect on January 1, 2005. The long-term debt obligations also assume that payments will be made based on the current payment schedule and excludes any drawdown under the revolving loan commitment.

 

 

Contractual Obligations   Total

  2005

  2006

  2007

  2008

  2009

  Thereafter

            (in thousands)        

Long-term debt

  $ 115,097   $ 25,509   $ 29,497   $ 33,268   $ 26,823   $ —     $ —  

Operating leases

    154,345     12,766     13,488     13,085     12,281     12,252     90,473

Capital lease obligations

    362     254     89     16     3     —       —  
   

 

 

 

 

 

 

Total obligations

  $ 269,804   $ 38,529   $ 43,074   $ 46,369   $ 39,107   $ 12,252   $ 90,473
   

 

 

 

 

 

 

 

Future Outlook. We believe that our anticipated operating cash flows and our $115.7 million in total liquidity, consisting of our cash on hand and the total borrowings available under our bank credit facility are sufficient to fund our capital and liquidity needs for at least the next twelve months. In making this assessment, we have considered:

 

    funds required for debt service payments;

 

    funds required for capital expenditures of about $12.0 million;

 

    $20.0 million of cash required to fund our acquisition of the Ringtail group completed in February 2005;

 

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    the discretionary funding of our share repurchase program; and

 

    other future contractual obligations.

 

For the last several years our cash flows from operations have exceeded our cash needs for capital expenditures and debt service requirements. We believe that our cash flows from operations, supplemented by short-term borrowings under our bank credit facility, as necessary, will provide adequate cash to fund our long-term cash needs from normal operations.

 

Our conclusion that we will be able to fund our cash requirements by using existing capital resources and cash generated from operations does not take into account the impact of any acquisition transactions, not currently contemplated, or any unexpected changes in significant numbers of billable professionals. The anticipated cash needs of our business could change significantly if we pursue and complete additional business acquisitions, if our business plans change, if economic conditions change from those currently prevailing or from those now anticipated, or if other unexpected circumstances arise that may have a material effect on the cash flow or profitability of our business. Any of these events or circumstances, including any new business opportunity, could involve significant additional funding needs in excess of the identified currently available sources and could require us to raise additional debt or equity funding to meet those needs. Our ability to raise additional capital, if necessary, is subject to a variety of factors that we cannot predict with certainty, including:

 

    our future profitability;

 

    the quality of our accounts receivable;

 

    our relative levels of debt and equity;

 

    the volatility and overall condition of the capital markets; and

 

    the market prices of our securities.

 

Any new debt funding, if available, may be on terms less favorable to us than our current credit facility. See “— Forward-Looking Statements.”

 

Effect of Inflation. Inflation is not generally a material factor affecting our business. General operating expenses such as salaries, employee benefits and lease costs are, however, subject to normal inflationary pressures.

 

Forward-Looking Statements

 

Some of the statements under “— Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These statements involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements expressed or implied by such forward-looking statements not to be fully achieved. These forward-looking statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue” or the negative of such terms or other comparable terminology. These statements are only predictions. We are under no duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results and do not intend to do so. Factors, which may cause the actual results of operations in future periods to differ materially from intended or expected results include, but are not limited to, the risk factors described in “Part I — Item 1. Business — Business Risks.”

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are subject to market risk associated with changes in interest rates on our variable rate debt. Our primary interest rate risk results from changes in the U.S. Prime and Eurodollar rates, which are used to determine the interest rates applicable to borrowings under our bank credit facility. Interest rate changes expose our variable rate long-term borrowings to changes in future cash flows. From time to time, we use derivative instruments primarily consisting of interest rate swap agreements to manage this interest rate exposure by achieving a desired proportion of fixed rate versus variable rate borrowings. These hedges reduce our exposure to rising interest rates, but also reduce the benefits from lower interest rates. As of December 31, 2004, we did not have any derivative instruments.

 

The table below provides information about our debt obligations and derivative financial instruments that are sensitive to changes in interest rates as of December 31, 2004. The table presents principal cash flows and related weighted average interest rates by year of maturity for our bank credit facility. We have estimated the fair value of our bank credit facility based on its carrying value, as interest rates are reset every 30 to 90 days. For the interest rate swap in effect as of December 31, 2003, the table presents the notional amount and average pay and receive rates. The fair value of our derivative financial instrument is based on estimates from bankers to settle the interest rate swap agreement.

 

    Year of Maturity

  2004

  2003

 
    2005

    2006

    2007

    2008

    2009

  Thereafter

  Total

   

Fair

Value


  Total

   

Fair

Value


 
                (in thousands)                          

Interest Rate Sensitivity:

                                                                         

Long-term debt

                                                                         

Variable rate

  $ 21,250     $ 26,250     $ 31,250     $ 26,250     $   —     $   —     $ 105,000     $ 105,000   $ 121,250     $ 121,250  

Average interest rate

    4 %     4 %     4 %     4 %                 4 %           3 %        

Interest rate swap

                                                                         

Variable to Fixed

  $ —       $ —       $ —       $ —       $ —     $ —     $ —       $ —     $ 8,670     $ 41  

Average pay rate

                                                                      7 %

Average receive rate

                                                                      1 %

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

FTI Consulting, Inc. and Subsidiaries

 

Consolidated Financial Statements

 

INDEX

 

     Page

Management’s Report on Internal Control over Financial Reporting

   43

Report of Independent Registered Public Accounting Firm — Internal Control over Financial Reporting

   44

Report of Independent Registered Public Accounting Firm — Consolidated Financial Statements

   45

Consolidated Balance Sheets — December 31, 2004 and 2003

   46

Consolidated Statements of Income — Years Ended December 31, 2004, 2003 and 2002

   47

Consolidated Statements of Stockholders’ Equity — Years Ended December 31, 2004, 2003 and 2002

   48

Consolidated Statements of Cash Flows — Years Ended December 31, 2004, 2003 and 2002

   49

Notes to Consolidated Financial Statements

   50

 

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Management’s Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2004. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with the authorization of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2004 based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2004.

 

Ernst & Young LLP, the independent registered public accounting firm that audited our financial statements, has issued an attestation report on management’s assessment of internal controls, which is included elsewhere in this annual report.

 

Date: March 9, 2005

 

/S/ JACK B. DUNN, IV

Jack B. Dunn, IV

President and Chief Executive Officer

(principal executive officer)

/S/ THEODORE I. PINCUS

Theodore I. Pincus

Executive Vice President and Chief Financial Officer

(principal financial officer)

 

 

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Report of Independent Registered Public Accounting Firm — Internal Control over Financial Reporting

 

Board of Directors and Stockholders

FTI Consulting, Inc.

 

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that FTI Consulting, Inc. maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). FTI Consulting, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, management’s assessment that FTI Consulting, Inc. maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, FTI Consulting, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of FTI Consulting, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004 and our report dated March 9, 2005 expressed an unqualified opinion thereon.

 

/s/ ERNST & YOUNG LLP

 

Baltimore, Maryland

March 9, 2005

 

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Report of Independent Registered Public Accounting Firm — Consolidated Financial Statements

 

Board of Directors and Stockholders

FTI Consulting, Inc.

 

We have audited the accompanying consolidated balance sheets of FTI Consulting, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 that 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 FTI Consulting, Inc. and subsidiaries at December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

We also have audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of FTI Consulting, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 9, 2005 expressed an unqualified opinion thereon.

 

/s/ ERNST & YOUNG LLP

 

Baltimore, Maryland

March 9, 2005

 

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FTI Consulting, Inc. and Subsidiaries

 

Consolidated Balance Sheets

(in thousands, except per share amounts)

 

     December 31,

 
     2004

    2003

 

Assets

                

Current assets

                

Cash and cash equivalents

   $ 25,704     $ 5,765  

Accounts receivable

                

Billed receivables

     89,536       68,906  

Unbilled receivables

     30,663       34,672  

Allowance for doubtful accounts and unbilled services

     (16,693 )     (20,045 )
    


 


       103,506       83,533  

Notes receivable

     9,031       109  

Prepaid expenses and other current assets

     6,041       4,998  

Deferred income taxes

     6,287       4,798  
    


 


Total current assets

     150,569       99,203  

Property and equipment, net

     23,342       21,921  

Goodwill

     507,656       514,544  

Other intangible assets, net

     10,978       10,137  

Other assets

     15,980       14,760  
    


 


Total assets

   $ 708,525     $ 660,565  
    


 


Liabilities and Stockholders’ Equity

                

Current liabilities

                

Accounts payable, accrued expenses and other

   $ 20,771     $ 18,869  

Accrued compensation

     39,383       32,815  

Current portion of long-term debt

     21,250       16,250  

Billings in excess of services provided

     8,924       16,336  
    


 


Total current liabilities

     90,328       84,270  

Long-term debt, net of current portion

     83,750       105,000  

Deferred rent, capital lease obligations and other, net of current portion

     12,745       1,822  

Deferred income taxes

     25,548       14,317  

Commitments and contingent liabilities (notes 6, 7, 8 and 14)

                

Stockholders’ equity

                

Preferred stock, $0.01 par value; 5,000 shares authorized; none outstanding

     —         —    

Common stock, $0.01 par value; 75,000 shares authorized; 42,487 shares issued and outstanding — 2004; and 42,253 shares issued and outstanding — 2003

     425       423  

Additional paid-in capital

     333,735       332,823  

Unearned compensation

     (8,551 )     (5,733 )

Retained earnings

     170,545       127,667  

Accumulated other comprehensive loss

     —         (24 )
    


 


Total stockholders’ equity

     496,154       455,156  
    


 


Total liabilities and stockholders’ equity

   $ 708,525     $ 660,565  
    


 


 

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

 

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FTI Consulting, Inc. and Subsidiaries

 

Consolidated Statements of Income

(in thousands, except per share amounts)

 

     Year Ended December 31,

 
     2004

    2003

    2002

 

Revenues

   $ 427,005     $ 375,695     $ 224,113  
    


 


 


Operating expenses

                        

Direct cost of revenues

     234,970       176,429       108,104  

Selling, general and administrative expense

     102,060       78,701       51,647  

Loss on abandoned facilities

     4,670       —         —    

Special termination charges

     —         3,060       —    

Amortization of other intangible assets

     6,836       3,680       1,033  
    


 


 


       348,536       261,870       160,784  
    


 


 


Operating income

     78,469       113,825       63,329  
    


 


 


Other income (expense)

                        

Interest income

     788       1,193       155  

Interest expense

     (6,399 )     (5,389 )     (4,872 )

Discount on note receivable

     (475 )     —         —    

Litigation settlement gains (losses), net

     1,672       —         —    
    


 


 


       (4,414 )     (4,196 )     (4,717 )
    


 


 


Income from continuing operations before income tax provision

     74,055       109,629       58,612  

Income tax provision

     31,177       44,838       23,704  
    


 


 


Income from continuing operations

     42,878       64,791       34,908  
    


 


 


Discontinued operations

                        

Income from operations of discontinued operations, net of income tax provision of $1,156 in 2003 and $2,198 in 2002

           1,649       3,145  

Loss from sale of discontinued operations, net of income tax provision (benefit) of $2,810 in 2003 and ($607) in 2002

           (6,971 )     (891 )
    


 


 


(Loss) income from discontinued operations

           (5,322 )     2,254  
    


 


 


Net income

   $ 42,878     $ 59,469     $ 37,162  
    


 


 


Earnings per common share — basic

                        

Income from continuing operations

   $ 1.02     $ 1.58     $ 1.09  
    


 


 


Net income

   $ 1.02     $ 1.45     $ 1.16  
    


 


 


Earnings per common share — diluted

                        

Income from continuing operations

   $ 1.01     $ 1.54     $ 1.02  
    


 


 


Net income

   $ 1.01     $ 1.41     $ 1.09  
    


 


 


 

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

 

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FTI Consulting, Inc. and Subsidiaries

 

Consolidated Statements of Stockholders’ Equity

(in thousands)

 

            
 
 

Additional
Paid-in
Capital

 
 
 

   
 

Unearned
Compensation

 
 

   
 

Retained
Earnings

   
 

 
 

Accumulated
Other

Comprehensive
(Loss) Income

 
 

 
 

   

Total

 

     Common Stock

 

         
     Shares

 

   

Amount

 

         

Balance, December 31, 2001

   29,387     $ 294     $ 75,318     $ (568 )   $ 31,036   $ (944 )   $ 105,136  

Issuance of common stock in connection with:

                                                    

Exercise of options, including income tax benefit of $12,754

   1,815       18       19,259                             19,277  

Employee stock purchase plan

   229       2       3,023                             3,025  

Restricted shares

   6       —         28                             28  

Business combinations

   4,569       46       102,844                             102,890  

Payment for fractional shares

   —         —         (16 )                           (16 )

Amortization of unearned compensation

                           222                     222  

Comprehensive income:

                                                    

Other comprehensive income—change in fair value of interest rate swaps, net of income tax provision of $185

                                         251       251  

Net income

                                   37,162             37,162  
                                                


Total comprehensive income

                                                 37,413  
    

 


 


 


 

 


 


Balance, December 31, 2002

   36,006       360       200,456       (346 )     68,198     (693 )     267,975  

Issuance of common stock in connection with:

                                                    

Public offering, net of offering costs of $1,386

   3,992       40       99,183                             99,223  

Exercise of options, including income tax benefit of $11,599

   1,798       18       24,478                             24,496  

Employee stock purchase plan

   196       2       4,041                             4,043  

Restricted shares, net of forfeitures

   282       3       5,807       (5,822 )                   (12 )

Business combinations

   176       2       2,372                             2,374  

Purchase and retirement of common stock

   (194 )     (2 )     (4,030 )                           (4,032 )

Payment for fractional shares

   (3 )     —         (2 )                           (2 )

Amortization of unearned compensation

                   518       435                     953  

Comprehensive income:

                                                    

Other comprehensive income—change in fair value of interest rate swaps, net of income tax provision of $228

                                         669       669  

Net income

                                   59,469             59,469  
                                                


Total comprehensive income

                                                 60,138  
    

 


 


 


 

 


 


Balance, December 31, 2003

   42,253       423       332,823       (5,733 )     127,667     (24 )     455,156  

Issuance of common stock in connection with:

                                                    

Exercise of options, including income tax benefit of $2,055

   462       5       4,920                             4,925  

Employee stock purchase plan

   202       2       2,837                             2,839  

Restricted shares, net of forfeitures

   227       2       4,140       (4,142 )                   —    

Purchase and retirement of common stock

   (657 )     (7 )     (10,803 )                           (10,810 )

Contingent payments to former owners of subsidiary, net of income tax benefit of $126

                   (182 )                           (182 )

Amortization of unearned compensation

                           1,324                     1,324  

Comprehensive income:

                                                    

Other comprehensive income—change in fair value of interest rate swaps, net of income tax provision of $17

                                         24       24  

Net income

                                   42,878             42,878  
                                                


Total comprehensive income

                                                 42,902  
    

 


 


 


 

 


 


Balance, December 31, 2004

   42,487     $ 425     $ 333,735     $ (8,551 )   $ 170,545   $ —       $ 496,154  
    

 


 


 


 

 


 


 

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

 

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Table of Contents

FTI Consulting, Inc. and Subsidiaries

 

Consolidated Statements of Cash Flows

(in thousands)

 

     Year Ended December 31,

 
     2004

    2003

    2002

 

Operating activities

                        

Net income

   $ 42,878     $ 59,469     $ 37,162  

Adjustments to reconcile net income to net cash provided by operating activities:

                        

Depreciation and other amortization

     9,113       7,003       4,947  

Amortization of other intangible assets

     6,836       3,680       1,033  

Income tax benefit from stock option exercises and other

     2,181       11,599       12,754  

Provision for doubtful accounts

     7,062       5,109       2,776  

Non-cash stock-based compensation

     1,324       941       307  

Loss from sale of discontinued operations

     —         6,971       1,209  

Loss on abandoned facilities

     4,670       —         —    

Non-cash interest expense and other

     1,949       1,873       542  

Changes in operating assets and liabilities, net of effects from acquisitions:

                        

Accounts receivable, billed and unbilled

     (27,860 )     179       551  

Prepaid expenses and other assets

     (10,328 )     (1,401 )     (985 )

Accounts payable, accrued expenses and other

     13,824       6,109       5,849  

Income taxes payable

     7,638       4,311       8,280  

Accrued compensation expense

     6,568       (1,841 )     11,581  

Billings in excess of services provided

     (7,412 )     (3,825 )     (5,349 )
    


 


 


Net cash provided by operating activities

     58,443       100,177       80,657  
    


 


 


Investing activities

                        

Purchases of property and equipment

     (11,939 )     (10,612 )     (8,777 )

Payments for acquisition of businesses, including contingent payments and acquisition costs

     (1,253 )     (234,117 )     (145,409 )

Cash received from sale of discontinued operations

     —         12,150       —    

Change in other assets

     (501 )     838       (2,200 )
    


 


 


Net cash used in investing activities

     (13,693 )     (231,741 )     (156,386 )
    


 


 


Financing activities

                        

Issuance of common stock, net of offering costs

     —         99,223       —    

Issuance of common stock under equity compensation plans

     2,870       12,897       6,523  

Purchase and retirement of common stock

     (10,810 )     (4,032 )     —    

Borrowings under long-term credit facility

     —         109,121       119,000  

Payments of long-term debt

     (16,250 )     (85,704 )     (49,333 )

Borrowings under revolving credit facility

     47,500       5,000       45,000  

Payments of revolving credit facility

     (47,500 )     (5,000 )     (45,000 )

Payments of capital lease obligations

     (571 )     (307 )     (214 )

Payments of debt financing fees and other

     (50 )     (3,775 )     (3,197 )
    


 


 


Net cash (used in) provided by financing activities

     (24,811 )     127,423       72,779  
    


 


 


Net increase (decrease) in cash and cash equivalents

     19,939       (4,141 )     (2,950 )

Cash and cash equivalents, beginning of year

     5,765       9,906       12,856  
    


 


 


Cash and cash equivalents, end of year

   $ 25,704     $ 5,765     $ 9,906  
    


 


 


 

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

 

 

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Table of Contents

FTI Consulting, Inc. and Subsidiaries

 

Notes to Consolidated Financial Statements

(dollar and share amounts in tables expressed in thousands, except per share data)

 

1. Description of Business and Significant Accounting Policies

 

Description of business. We are one of the largest providers of forensic and litigation consulting and technology, corporate finance/restructuring and economic consulting services in the United States. Within our forensic and litigation consulting and technology practice, we work with companies faced with fraud, financial disclosure and accounting investigations, misstatements and malpractice issues. We provide evaluation services, electronic evidence and repository hosting services and creative solutions to litigation and trial management problems, and help our clients mitigate the cost of or avoid litigation. Our corporate finance/restructuring practice assists under performing companies in making decisions to improve their financial and operational position given their current situation, as well as provides services in connection with bankruptcies, mergers and acquisitions and restructuring management. Within our economic consulting practice, we provide sophisticated economic, competition and anti-trust modeling and analysis, and merger, acquisition and financial advisory services.

 

We have a total workforce of over 1,000 employees who are strategically located in 24 cities in the United States, as well as in London, England and Melbourne, Australia. Our clients include companies, as well as creditors or other stakeholders, such as financial institutions, private equity firms and the law firms that represent them.

 

Principles of consolidation. The consolidated financial statements include the accounts of FTI Consulting, Inc. and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated.

 

Use of estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Due to the inherent uncertainty involved in making those assumptions, actual results could differ from those estimates.

 

We use estimates to determine the amount of the allowance for doubtful accounts necessary to reduce accounts receivable and unbilled receivables to their expected net realizable value and to account for any potential refunds that may be imposed by bankruptcy courts. We estimate the amount of the required allowance by reviewing the status of significant client matters and past-due receivables as well as by analyzing historical bad debt trends and realization adjustments to our revenues. Actual collection experience has not varied significantly from estimates, due primarily to credit policies, the controls and procedures designed to estimate realization adjustments to our revenues and a lack of concentrations of accounts receivable. Accounts receivable balances are not collateralized.

 

We also make estimates in determining self-insurance reserves for certain employee benefit plans and other ordinary accruals. These estimates are based upon historical trends, current experience and knowledge of relevant factors.

 

Cash equivalents. Cash equivalents consist of highly liquid short-term investments with maturities of three months or less at the time of purchase.

 

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Table of Contents

FTI Consulting, Inc. and Subsidiaries

 

Notes to Consolidated Financial Statements (continued)

(dollar and share amounts in tables expressed in thousands, except per share data)

 

Supplemental cash flow information.

 

     Year Ended December 31,

     2004

   2003

   2002

Cash paid for interest

   $ 4,962    $ 3,554    $ 4,100
    

  

  

Cash paid for income taxes, net of refunds

   $ 21,358    $ 28,705    $ 4,500
    

  

  

Other non-cash investing and financing activities

                    

Assets acquired under capital lease

   $    $ 41    $ 514

Issuance of common stock to acquire businesses

   $    $ 2,374    $ 102,890

 

Property and equipment. We record property and equipment, including improvements that extend useful lives, at cost, while maintenance and repairs are charged to operations as incurred. We calculate depreciation using the straight-line method based on estimated useful lives ranging from three to seven years for furniture, equipment and internal use software. We amortize leasehold improvements and assets under capital leases over the shorter of the estimated useful life of the asset or the lease term. The gross amount of assets recorded under capital lease obligations included in furniture, equipment and software is $1.3 million as of December 31, 2004 and $1.5 million as of December 31, 2003.

 

We capitalize costs incurred during the application development stage of computer software developed or obtained for internal use. Capitalized software is classified within furniture, equipment and software and is amortized over the estimated useful life of the software, which is generally three years.

 

Goodwill. Goodwill consists of the excess of the purchase price over the fair value of tangible and identifiable intangible net assets acquired in purchase business combinations. Upon adoption of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” on January 1, 2002, we ceased amortizing goodwill. We review goodwill for impairment as of October 1 of each year or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. The implied fair value of goodwill is the amount determined by deducting the estimated fair value of all tangible and identifiable intangible net assets of the reporting unit from the estimated fair value of the reporting unit. If the recorded value of goodwill exceeds its implied value, an impairment charge is recorded for the excess. For purposes of impairment testing, our reporting units are our operating segments which represent the lowest level for which discrete financial information is available and regularly reviewed by management. Components are combined when determining reporting units if they have similar economic characteristics.

 

Other intangible assets. We amortize our intangible assets that have finite lives over the estimated periods benefited using the straight-line method. See Note 5. “Goodwill and Other Intangible Assets.”

 

Valuation of long-lived assets excluding goodwill. We review long-lived assets, excluding goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or group of assets may not be fully recoverable. These events or changes in circumstances may include a significant deterioration of operating results, changes in business plans, or changes in anticipated future cash flows. If an impairment indicator is present, we evaluate recoverability by a comparison of the carrying amount of the assets to future undiscounted net cash flows we expect the assets to generate. We group assets at the lowest level for which there is identifiable cash flows that are largely independent of the cash flows generated by other asset groups. If the total of the expected undiscounted future cash flows is less than the carrying amount of the asset,

 

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Table of Contents

FTI Consulting, Inc. and Subsidiaries

 

Notes to Consolidated Financial Statements (continued)

(dollar and share amounts in tables expressed in thousands, except per share data)

 

an impairment loss, if any, is recognized for the difference between the fair value and carrying value of assets. Fair value is generally determined by estimates of discounted cash flows. The discount rate used in any estimate of discounted cash flows would be the rate required for a similar investment of like risk.

 

Assets to be disposed of are reported at the lower of carrying values or fair values, less estimated costs of disposal.

 

Interest rate swaps. We sometimes use derivative instruments consisting primarily of interest rate swap agreements to manage our exposure to changes in interest rates. We do not use derivative instruments for trading or other speculative purposes.

 

All derivative instruments are reported on the balance sheet at fair value and changes in a derivative’s fair value are recognized currently in earnings unless specified hedge criteria are met. If an interest rate swap is designated a cash flow hedge, the effective portions of the changes in the fair value of the swap are recorded in other comprehensive income. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings.

 

As part of managing the exposure to changes in the market interest rates on our variable rate debt, we may enter into interest rate swap transactions with financial institutions acting as the counter-party. To ensure both appropriate use as a hedge and hedge accounting treatment, all swaps entered into are designated according to the hedge objective against a specific debt issue. The notional amounts, rates and maturities of our interest rate swaps are closely matched to the related terms of hedged debt obligations. As of December 31, 2004, we are not a party to any interest rate swap agreements.

 

Debt financing fees. We amortize the costs we incur to obtain debt financing over the terms of the underlying obligations using the effective interest method. The amortization of debt financing costs is included in interest expense. Unamortized debt financing costs are classified within other assets in our consolidated balance sheets.

 

Billings in excess of services provided. Billings in excess of services provided represents amounts billed to clients, such as retainers, in advance of work being performed. Clients may make advance payments, which are held on deposit until completion of work. These amounts are either applied to final billings or refunded to clients upon completion of work. Retainers in excess of related accounts receivable and unbilled receivables are recorded as billings in excess of services provided in our consolidated balance sheets.

 

Revenue recognition. We derive most of our revenues from professional service activities. The vast majority of these activities are provided under time-and-expense billing arrangements, and revenues, consisting of billed fees and pass-through expenses, are recorded as work is performed and expenses are incurred. We normally obtain engagement letters or other agreements from our clients prior to performing any services. In these letters and other agreements, the clients acknowledge that they will pay us based upon our time spent on the engagement and at our agreed-upon hourly rates. We are periodically engaged to provide services in connection with client matters where payment of our fees is deferred until the conclusion of the matter or upon the achievement of performance-based criteria. We recognize revenues for these arrangements when all the performance-based criteria are met and collection of the fee is reasonably assured.

 

We record allowances for estimated realization adjustments to our professional services fees that are subject to review by bankruptcy courts. We record provisions for fee adjustments and discretionary pricing adjustments as a reduction of revenues. Revenues recognized, but not yet billed to clients, have been recorded as unbilled receivables in the accompanying consolidated balance sheets.

 

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Table of Contents

FTI Consulting, Inc. and Subsidiaries

 

Notes to Consolidated Financial Statements (continued)

(dollar and share amounts in tables expressed in thousands, except per share data)

 

Direct cost of revenues. Direct cost of revenues consists primarily of billable employee compensation and related payroll benefits, the cost of consultants assigned to revenue-generating activities and direct expenses billable to clients. Direct cost of revenues does not include an allocation of overhead costs.

 

Advertising costs. Costs related to advertising and other promotional expenditures are expensed as incurred. Advertising costs totaled $668,000 during 2004, $406,000 during 2003 and $480,000 during 2002.

 

Stock-based compensation. We record compensation expense for stock-based compensation for employees and non-employee members of our board of directors using the intrinsic value method prescribed by Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees.” Under APB Opinion No. 25, compensation expense is recorded over the vesting period to the extent that the fair value of the underlying stock on the grant date exceeds the exercise or acquisition price of the stock or stock-based award.

 

All options granted under our stock-based employee compensation plans had an exercise price greater than or equal to the market value of the underlying common stock on the date of grant. We also periodically issue restricted and unrestricted stock to employees in connection with new hires and performance evaluations. The fair market value on the date of issue of unrestricted stock is immediately charged to compensation expense, and the fair value on the date of issue of restricted stock is charged to compensation expense ratably over the restriction period.

 

Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” encourages companies to recognize expense for stock-based awards based on their estimated fair value on the date of grant. Statement No. 123 requires the disclosure of pro forma income and earnings per share data in the notes to the financial statements if the fair value method is not adopted. The following table illustrates the effect on net income and earnings per share if we had determined compensation costs by applying the fair value recognition provisions of Statement No. 123 to stock-based employee awards.

 

     Year Ended December 31,

 
     2004

    2003

    2002

 

Net income, as reported

   $ 42,878     $ 59,469     $ 37,162  

Add — Stock-based employee compensation cost included in reported net income, net of income taxes

     767       556       183  

Deduct — Total stock-based employee compensation expense determined under fair value based method for all awards, net of income taxes

     (7,391 )     (10,052 )     (8,059 )
    


 


 


Net income, pro forma

   $ 36,254     $ 49,973     $ 29,286  
    


 


 


Earnings per common share

                        

Basic, as reported

   $ 1.02     $ 1.45     $ 1.16  
    


 


 


Basic, pro forma

   $ 0.86     $ 1.22     $ 0.91  
    


 


 


Diluted, as reported

   $ 1.01     $ 1.41     $ 1.09  
    


 


 


Diluted, pro forma

   $ 0.86     $ 1.22     $ 0.87  
    


 


 


 

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Table of Contents

FTI Consulting, Inc. and Subsidiaries

 

Notes to Consolidated Financial Statements (continued)

(dollar and share amounts in tables expressed in thousands, except per share data)

 

The Black-Scholes option-pricing model and other models were developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of subjective assumptions, including the expected stock price volatility. Because our stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, we believe the existing models do not necessarily provide a reliable measure of the fair value of our stock-based awards. The fair value of our stock-based awards was estimated on the measurement date using the Black-Scholes option-pricing model using the following assumptions.

 

     Year Ended December 31,

     2004

   2003

   2002

Assumptions

              

Risk-free interest rate — option plan grants

   1.90% — 3.91%    1.86% — 2.59%    3.5%

Risk-free interest rate — purchase plan grants

   0.96% — 1.61%    1.02% — 1.16%    3.5%

Dividend yield

   0%    0%    0%

Expected life of option grants

   3 — 5 years    3 years    2.6 years

Expected life of stock purchase plan grants

   0.5 years    0.5 years    0.5 years

Stock price volatility — option plan grants

   54.6% — 59.6%    55.5% — 59.4%    63.4% — 68.5%

Stock price volatility — purchase plan grants

   56.9% — 71.6%    33.8% — 61.0%    54.6% — 57.3%

Weighted average fair value of grants

              

Stock options:

              

Grant price=fair market value

   $7.09    $8.98    $11.64

Grant price>fair market value

   $6.63    $9.17   

Employee stock purchase plan shares

   $6.62    $7.49    $5.53

Restricted shares

   $18.60    $20.53    $23.39

 

Income taxes. We use the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.

 

Stock splits. The board of directors approved a three-for-two split of our common stock payable in the form of a stock dividend to stockholders of record on May 7, 2003, which we paid on June 4, 2003. The board of directors also approved a three-for-two stock split payable in the form of a stock dividend which was distributed to stockholders of record on January 2, 2002. All share and per share data included in these consolidated financial statements have been restated to reflect these stock splits.

 

Earnings per common share. Basic earnings per common share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per common share

 

54