UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

FORM 10-K

 

 

Commission File Number 001-31451

 

BEARINGPOINT, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

(703) 747-3000

(Registrant’s telephone number, including area code)

 

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

 

Common Stock, $.01 Par Value

 

Series A Junior Participating Preferred Stock Purchase Rights

 

Securities registered pursuant to Section 12 (g) of the Act: None

 

 

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  YES o  NO þ

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  YES o  NO þ

 

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 o  NO þ

 

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.  o

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

     Large accelerated filer þ                 Accelerated filer o                 Non-accelerated filer o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES o  NO þ

 

As of June 30, 2006, the aggregate market value of the voting stock held by non-affiliates of the Registrant, based upon the closing price of such stock on the New York Stock Exchange on June 30, 2006, was approximately $1.7 billion.

 

The number of shares of common stock of the Registrant outstanding as of June 1, 2007 was 201,641,999.

 

 

TABLE OF CONTENTS

 

 

FORWARD-LOOKING STATEMENTS

 

Some of the statements in this Annual Report on Form 10-K constitute “forward-looking statements” within the meaning of the United States Private Securities Litigation Reform Act of 1995. These statements relate to our operations that are based on our current expectations, estimates and projections. Words such as “may,” “will,” “could,” “would,” “should,” “anticipate,” “predict,” “potential,” “continue,” “expects,” “intends,” “plans,” “projects,” “believes,” “estimates,” “goals,” “in our view” and similar expressions are used to identify these forward-looking statements. The forward-looking statements contained in this Annual Report include statements about our internal control over financial reporting, our results of operations and our financial condition. Forward-looking statements are only predictions and as such, are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Forward-looking statements are based upon assumptions as to future events or our future financial performance that may not prove to be accurate. Actual outcomes and results may differ materially from what is expressed or forecast in these forward-looking statements. The reasons for these differences include changes that occur in our continually changing business environment and the risk factors enumerated in Item 1A, “Risk Factors.” As a result, these statements speak only as of the date they were made, and we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

AVAILABLE INFORMATION

 

Our website address is www.bearingpoint.com. Copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as well as any amendments to those reports, are available free of charge through our website as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (the “SEC”). Information contained or referenced on our website is not incorporated by reference into and does not form a part of this Annual Report.

 

In this Annual Report on Form 10-K, we use the terms “BearingPoint,” “we,” “the Company,” “our Company,” “our” and “us” to refer to BearingPoint, Inc. and its subsidiaries. All references to “years,” unless otherwise noted, refer to our twelve-month fiscal year. Through June 30, 2003, our fiscal year ended on June 30. In February 2004, our Board of Directors approved a change in our fiscal year end to a twelve-month period ending December 31. As a requirement of this change, the results for the six-month period from July 1, 2003 to December 31, 2003 was reported as a six-month transition period.

 

General

 

BearingPoint, Inc. is one of the world’s largest management and technology consulting companies. We provide strategic consulting applications services, technology solutions and managed services to government organizations, Global 2000 companies and medium-sized businesses in the United States and internationally. Our services and focused solutions include implementing enterprise systems and business processes, improving supply chain efficiency, performing systems integration due to mergers and acquisitions, and designing and implementing customer management solutions. Our service offerings, which involve assisting our clients to capitalize on alternative business and systems strategies in the management and support of key information technology functions, are designed to help our clients generate revenue, increase cost-effectiveness, implement mergers and acquisitions strategies, manage regulatory compliance, and integrate information and transition clients to “next-generation” technology. In North America, we provide consulting services through our Public Services, Commercial Services and Financial Services industry groups in which we focus significant industry-specific knowledge and service offerings to our clients. Outside of North America, we are organized on a

geographic basis, with operations in Europe, the Middle East and Africa (“EMEA”), the Asia Pacific region and Latin America.

 

We have started the transition of our business to a more integrated, global delivery model. In 2007, we created a Global Account Management Program and a Global Solutions Council represented by all of our business units that will focus on identifying opportunities for globalized solutions suites. Our Global Delivery Centers continue to grow, both in terms of personnel and the percentage of work they provide to our business units.

 

For more information about our operating segments, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Segments” and Note 18, “Segment Information,” of the Notes to Consolidated Financial Statements.

 

Strategy

 

BearingPoint’s vision is to become recognized as the world’s leading management and technology consultancy, renowned for our passion and respected for our ability to help our clients solve their most pressing challenges. We operate in a highly competitive, global market. To drive profitable growth and gain market share, we are focused on doing the right work for the right clients. In 2006, we made significant strides in focusing our business activities, differentiating ourselves and our service offerings in the marketplace, and improving execution and management of our operations. Major strategic initiatives include:

 

 

 

North American Industry Groups

 

Our North American operations are managed on an industry basis, enabling us to capitalize on our significant industry-specific knowledge. This industry-specific focus enhances our ability to monitor global trends and observe best practice behavior, to design specialized service offerings relevant to the marketplaces in which our clients operate, and to build sustainable solutions. All of these industry groups provide traditional management consulting, managed services and systems integration services to their respective clients.

 

Our three North American industry groups are as follows:

 

 

We have established, diversified and recurring relationships with our clients, and our specific offerings for these client groups include process improvement, program management, resource planning, managed services and integration services. Our experience and the size and scale of our practice afford us the opportunity to compete for larger proposals in these markets.

 

 

International Operations

 

Currently, our operations outside of North America are organized on a geographic basis with alignment to our three North American industry groups, to enable consistency in our strategy and execution in the market. We presently have operations in the EMEA, Asia Pacific and Latin America regions. In 2006, we continued to experience solid growth in our systems integration business in France and continued expansion of our practice in the United Kingdom. In addition, we believe our Ireland practice is achieving increased acceptance in the marketplace. Furthermore, in Asia Pacific, we experienced an increase in systems integration work and engagements involving compliance with new local financial laws and regulations in our Japan practice as well as continued growth in Australia.

As previously reported, we are currently exploring the potential for creating an opportunity for significant increases in employee ownership of our EMEA business for managing directors of that business. We believe that monetizing a significant portion of our investment in our EMEA business unit through external investment and employee acquisitions could help to further our goals of increasing shareholder value, increasing employee ownership, strengthening our balance sheet and boosting customer confidence. At this time, however, we are still in the exploratory phase, and no specific plans or timetable for a final decision have been approved by our Board of Directors.

 

Global Development Centers

 

To supplement our industry groups, we have invested in creating Global Development Centers (“GDCs”) with highly skilled resources to enhance our information technology sourcing flexibility and provide our clients with more comprehensive services and solutions. The GDCs, located internationally in China and India and domestically in Hattiesburg, Mississippi, are extensions of our global off-shore solutions capabilities, providing facilities and world-class resources at a lower cost for application development and support. We currently have several hundred employees staffed in our India and China GDCs and plan to expand our Hattiesburg center, which opened in 2006, to approximately 200 by 2007. In 2006, we created an additional GDC in Bangalore, India to increase our Indian operations. The GDCs are designed to be an expandable model, which we believe will provide us with the flexibility to adjust our GDC resources as necessary to dynamically meet client demand. Our GDC strategy involves growing each of our centers in a manner calculated to provide focused expertise to deliver our uniquely differentiated service offerings at a lower cost to our clients. We are not positioned to engage in rapid expansion of these facilities. Consequently, we may be unable to keep pace with our clients’ demands for GDC resources, if these demands dramatically increase.

 

Our Joint Marketing Relationships

 

As of December 31, 2006, our alliance program had approximately 48 relationships with key technology providers that support and complement our service offerings. Through this program, we have created joint marketing relationships to enhance our ability to provide our clients with high value services. Those relationships typically entail some combination of commitments regarding joint marketing, sales collaboration, training and service offering development.

 

Our most significant joint marketing and product development technology relationships are with Oracle Corporation (which includes Hyperion, Siebel Systems and PeopleSoft, which were acquired by Oracle), Microsoft Corporation, SAP AG, Hewlett-Packard Company, and IBM Corporation. We work together to develop comprehensive solutions to common business issues, offer the expertise required to deliver those solutions, develop new products, build out talent capabilities, capitalize on joint marketing opportunities and remain at the forefront of technology advances.

 

Competition

 

We operate in a highly competitive and rapidly changing market and compete with a variety of organizations that offer services similar to those we offer. Our competitors include specialized consulting firms, systems consulting and implementation firms, former “Big 4” and other large accounting and consulting firms, application software firms providing implementation and modification services, service and consulting groups of computer equipment companies, outsourcing companies, systems integration companies, aerospace and defense contractors and general management consulting firms. We also compete with our clients’ internal resources.

 

Some of our competitors have significantly greater financial and marketing resources, name recognition, and market share than we do. The competitive landscape continues to experience rapid changes and large, well

capitalized competitors exist with the ability to attract and retain professionals and to serve large organizations with the high quality of services they require.

 

Winning larger, more complex projects generally requires more business development costs and time. Our pursuit of these larger, complex projects will increase the financial and marketing strength our competitors bring to bear against us. In the near term, pursuing longer, complex projects could also impact our utilization and selling, general and administrative expenses. To be successful under these challenging conditions, we must focus our skills and resources to best capitalize on our competitive advantages, selectively choosing only those offerings and markets where we feel we can uniquely differentiate ourselves from our competition. In 2006 and 2007, we continued to focus efforts on emerging technologies. For example, in 2007 we announced a global collaboration with Cassatt Corporation, aimed at helping companies and governments explore and deliver the benefits of utility computing solutions. We will continue this strategy beyond 2007 by focusing on particular outsourcing and managed services segments where we believe we can provide uniquely differentiated services for our clients.

 

We believe that the principal competitive factors in the markets in which we operate include scope of services, service delivery approach, technical and industry expertise, value added, availability of appropriate resources, global reach, pricing and relationships.

 

Our ability to compete also depends in part on several factors beyond our control, including our ability to hire, retain and motivate skilled professionals in the face of increasing competition for talent, and our ability to offer services at a level and price comparable or better than that of our competitors. There is a significant risk that changes in these dynamics could intensify competition and adversely affect our future financial results.

 

Intellectual Property

 

Our success has resulted in part from our methodologies and other proprietary intellectual property rights. We rely upon a combination of nondisclosure and other contractual arrangements, non-solicitation agreements, trade secrets, copyright and trademark laws to protect our proprietary rights and the rights of third parties from whom we license intellectual property. We also enter into confidentiality and intellectual property agreements with our employees that limit the distribution of proprietary information. We currently have only a limited ability to protect our important intellectual property rights. As of December 31, 2006, we had three issued patents in the United States and several patent applications pending to protect our products or methods of doing business.

 

We continue to expand our efforts to capture, protect and commercialize BearingPoint proprietary information. In 2006, we started focusing our efforts and investments to identify potentially reusable, proprietary intellectual property sooner in the design process and to take measures that will safeguard our intellectual property rights. We anticipate these initiatives will add value to particular client and market categories, and increase our earnings from proprietary assets.

 

Customer Dependence

 

During 2006 and 2005, our revenue from the U.S. Federal government, inclusive of government sponsored enterprises, was $983.1 million and $979.0 million, respectively, representing 28.5% and 28.9% of our total revenue, respectively. For 2006 and 2005, this included approximately $389.8 million and $381.3 million of revenue from the U.S. Department of Defense, respectively, representing approximately 11.3% and 11.3% of our total revenue for 2006 and 2005, respectively. A loss of all or a substantial portion of our contracts with the U.S. Federal government would have a material adverse effect on our business and results of operations. While most of our government agency clients have the ability to unilaterally terminate their contracts, our relationships are generally not with political appointees, and we have not historically experienced a loss of Federal government business with a change in administration. For more information regarding government

proceedings and risks associated with U.S. government contracts, see Item 1A, “Risk Factors,” Item 3, “Legal Proceedings,” and Note 11, “Commitments and Contingencies,” of the Notes to Consolidated Financial Statements.

 

Employees

 

As of March 31, 2007, we had approximately 17,500 full-time employees, including approximately 15,200 billable professionals.

 

Our future growth and success largely depends upon our ability to attract, retain and motivate qualified employees, particularly professionals with the advanced information technology skills necessary to perform the services we offer. Our professionals possess significant industry experience, understand the latest technology and build productive business relationships. We are committed to the long-term development of our employees and will continue to dedicate significant resources to improving our hiring, training and career advancement programs. We strive to reinforce our employees’ commitment to our clients, culture and values through a comprehensive performance review system and a competitive compensation philosophy that rewards individual performance and teamwork.

 

For 2006, our voluntary annualized attrition rate was 25.6%, compared to our 2005 voluntary attrition rate of approximately 25.3%. For the three months ended March 31, 2007, our voluntary annualized attrition rate was 23.9%, compared to our voluntary annualized attrition rate of 24.2% for the three months ended March 31, 2006.

 

Our continuing issues related to our North American financial reporting systems and our internal controls have made it particularly critical and challenging for us to attract and retain experienced personnel. Because we are not current in our SEC periodic filings, significant features of many of our employee equity plans remained suspended in 2006, which (1) precluded our employees from realizing the appreciation in their equity-based awards, (2) resulted in the delayed implementation of most components of our Managing Director Compensation Plan, approved by the Compensation Committee of the Board of Directors in January 2006 (the “MD Compensation Plan”), and (3) impacted our ability to use equity to attract, motivate and retain our professionals. In 2006 and 2007, we took the following steps to enhance our ability to attract and retain our employees:

 

 

 

Background

 

We were incorporated as a business corporation under the laws of the State of Delaware in 1999. We were part of KPMG LLP, now one of the “Big 4” accounting and tax firms. In January 2000, KPMG LLP transferred its consulting business to our Company. In February 2001, we completed our initial public offering, and on October 2, 2002, we changed our name to BearingPoint, Inc. from KPMG Consulting, Inc. Our principal offices are located at 1676 International Drive, McLean, Virginia 22102-4828. Our main telephone number is 703.747.3000.

 

In 2002, we significantly expanded our European presence with the purchase of KPMG Consulting AG (subsequently renamed BearingPoint GmbH), which included employees primarily in Germany, Switzerland and Austria. We continued to further our global expansion in 2002 by acquiring all or portions of the consulting practices of several global accounting firms in Brazil, Finland, France, Japan, Norway, Singapore, South Korea, Spain, Sweden, Switzerland and the United States.

 

Risks that Relate to our Failure to Timely File Periodic Reports with the SEC and our Internal Control over Financial Reporting

 

The process, training and systems issues related to financial accounting for our North American operations and the material weaknesses in our internal control over financial reporting continue to materially affect our financial condition and results of operations. So long as we are unable to resolve these issues and remediate these material weaknesses, we will be in jeopardy of being unable to timely file our periodic reports with the SEC as they come due, and it is likely that our financial condition and results of operations will

continue to be materially and adversely affected. Furthermore, the longer the period of time before we become current in our periodic filings with the SEC and/or the number of subsequent failures to timely file any future periodic reports with the SEC could increase the likelihood or frequency of occurrence and severity of the impact of any of the risks described below.

 

Our continuing failure to timely file certain periodic reports with the SEC poses significant risks to our business, each of which could materially and adversely affect our financial condition and results of operations.

 

We did not timely file with the SEC our Forms 10-K for 2004, 2005 and 2006, and we have not yet filed with the SEC our Forms 10-Q for the quarterly periods ended March 31, 2006, June 30, 2006, September 30, 2006 and March 31, 2007. Consequently, we are not compliant with the reporting requirements under the Securities Exchange Act of 1934 (the “Exchange Act”) or the listing rules of the New York Stock Exchange (the “NYSE”).

 

Our inability to timely file our periodic reports with the SEC involves a number of significant risks, including:

 

 

 

 

Any of these events could materially and adversely affect our financial condition and results of operations.

In 2004, we identified material weaknesses in our internal control over financial reporting, the remediation of which has materially and adversely affected our business and financial condition, and as of December 31, 2006, these material weaknesses remain.

 

As discussed in Item 9A, “Controls and Procedures,” of this Annual Report, our management has conducted an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 and has identified a number of material weaknesses in internal control over financial reporting as of December 31, 2006. A detailed description of each material weakness is described in Item 9A of this Annual Report. Due to these material weaknesses, management has concluded that we did not maintain effective internal control over financial reporting as of December 31, 2006. The existence of these material weaknesses continue to cause us to perform significant, substantial procedures to compensate for them. These material weaknesses, and other material weaknesses since remediated, also previously caused significant errors that led to the restatement of a number of our previously issued financial statements for certain fiscal periods prior to our year ended December 31, 2004.

 

Management’s conclusion as to the effectiveness of our internal control over financial reporting for 2006, as well as the material weaknesses that contributed to that conclusion, remain substantially the same as management’s conclusion, and the material weaknesses contributing to that conclusion, for 2005 and 2004. We were unsuccessful in our attempts to remediate significant numbers of material weaknesses by the end of 2006. We can currently give no assurances as to how many material weaknesses will be remediated by the end of 2007. We currently do not anticipate full remediation of all material weaknesses until 2008.

 

Moreover, we continue to experience difficulty in internally producing accurate and timely forecasted financial information due, in part, to issues related to the material control weaknesses and other deficiencies identified as part of management’s assessment of internal control over financial reporting and to the delays in filing our periodic reports with the SEC. While we continue to address many of the underlying issues that have affected our ability to produce accurate internal financial forecasts, there can be no assurance that our ability to produce such forecasts has sufficiently improved to enable us to accurately and timely predict and assess the ongoing cash demands or financial needs of our business. Moreover, our difficulties in producing accurate internal financial forecasts could continue to jeopardize the accuracy of any financial guidance we provide publicly.

 

We have engaged in, and continue to engage in, substantial efforts to address the material weaknesses in our internal control over financial reporting. We cannot be certain that any remedial measures we have taken or plan to take will ensure that we design, implement and maintain adequate controls over our financial processes and reporting in the future or will be sufficient to address and eliminate these material weaknesses. Our inability to remedy these identified material weaknesses or any additional deficiencies or material weaknesses that may be identified in the future, could, among other things, cause us to fail to file our periodic reports with the SEC in a timely manner, result in the need to restate financial results for prior periods, prevent us from providing reliable and accurate financial information and forecasts or from avoiding or detecting fraud, result in the loss of government contracts, or require us to incur further additional costs or divert management resources. Due to its inherent limitations, effective internal control over financial reporting can provide only reasonable assurances that transactions are properly recorded, or that the unauthorized acquisition, use or disposition of our assets, or inappropriate reimbursements and expenditures, will be detected. These limitations may not prevent or detect all misstatements or fraud, regardless of their effectiveness.

 

Furthermore, in order to sustain the timely production of our financial statements and SEC periodic reports, we must dramatically reduce the time required to prepare our financial statement accounts and balances. Until our material weaknesses have been remediated, we will not be able to fully minimize the time required to prepare our financial statement accounts and balances. Our ability to become timely and remain current in our SEC periodic filings will depend on, among other things, our ability to increase the focus of, and maximize the cooperation from, our client engagement teams and other corporate services in providing

financial information and updates into our financial closing process on a timely basis. If we are unable to achieve these efficiencies, we may be unable to become timely in our SEC periodic filings, or to sustain being timely once current.

 

We face risks related to securities litigation and regulatory actions that could adversely affect our financial condition and business.

 

We are subject to several securities class-action litigation suits. We are also subject to an enforcement investigation by the SEC. These lawsuits and the SEC investigation are described in Item 3, “Legal Proceedings,” and Note 11, “Commitments and Contingencies,” of the Notes to Consolidated Financial Statements.

 

Our senior management and Board of Directors devote significant time to these matters. These lawsuits and the SEC investigation may cause us to incur significant legal expenses, could have a disruptive effect upon the operations of our business, and could consume inordinate amounts of the time and attention of our senior management and Board of Directors.

 

Depending on the outcome of these lawsuits and the SEC investigation, we may be required to pay material damages and fines, consent to injunctions on future conduct, or suffer other penalties, remedies or sanctions. The ultimate resolution of these matters could have a material adverse impact on our financial results and condition and, consequently, negatively impact the trading price of our common stock.

 

Risks that Relate to Our Business

 

Our business may be adversely impacted as a result of changes in demand, both globally and in individual market segments, for our consulting and systems integration services.

 

Our business tends to lag behind economic cycles; consequently, we may experience rapid decreases in demand at the onset of significant economic downturns while the benefits of economic recovery may take longer to realize. Economic and political uncertainties adversely impact our clients’ demand for our services. During an economic downturn, our clients and potential clients often cancel, reduce or defer existing contracts and delay entering into new engagements, thereby reducing new contract bookings. In general, companies also reduce the amount of spending on information technology products and services during difficult economic times, resulting in limited implementations of new technology and smaller engagements.

 

Our contracts funded by U.S. Federal government agencies, inclusive of government sponsored enterprises, accounted for approximately 28.5% of our revenue in 2006. We depend particularly on contracts funded by clients within the Department of Defense, which accounted for approximately 11.3% of our revenue in 2006. We believe that our U.S. Federal government contracts will continue to be a source of a significant amount of our revenue for the foreseeable future. Our business could be materially harmed if the Federal government reduces its spending or reduces the budgets of its departments or agencies. Reduced budget and other political and regulatory factors may cause these departments and agencies to reduce their purchases under, or exercise their rights to terminate, existing contracts, or may result in fewer or smaller new contracts to be awarded to us.

 

Our operating results will suffer if we are not able to maintain our billing and utilization rates or control our costs.

 

Our operating results are largely a function of the rates we are able to charge for our services and the utilization rates, or chargeability, of our professionals. Accordingly, if we are not able to maintain the rates we charge for our services or an appropriate utilization rate for our professionals, or if we cannot manage our cost structure, our operating results will be negatively impacted, we will not be able to sustain our profit margin and our profitability will suffer.

Factors affecting the rates we are able to charge for our services include:

 

 

Factors affecting our utilization rates include:

 

 

Our operating results are also a function of our ability to control our costs. If we are unable to control these costs, such as costs associated with the production of financial statements, settlement of lawsuits or management of a significantly larger and more diverse workforce, our results of operations could be materially and adversely affected.

 

We continue to incur selling, general and administrative (“SG&A”) expenses at levels significantly higher than those of our competitors. If we are unable to significantly reduce SG&A expenses over the near term, our ability to achieve, and make significant improvements in, net income and profitability will remain in jeopardy.

 

In recent years we have experienced exceptionally high levels of SG&A expenses, primarily as a result of continuing issues related to our North American financial reporting systems and our internal controls, higher than average costs associated with hiring and retaining our employees and other assorted costs, including legal expenses associated with various disputes and litigation. During 2006, we incurred external costs related to the closing of our financial statements of approximately $128.2 million, compared to approximately $94.6 million in 2005. We currently expect our costs for 2007 related to these efforts to be approximately $68 million. In addition, we also currently expect to incur an additional $24.6 million in costs in 2007 related to preparation for the transition to our new North American financial reporting systems. Given our decision to defer implementation of our North American financial reporting systems until mid-2008, the level of these external and preparatory costs may vary significantly. It is likely that higher than normal SG&A costs will continue through 2007 and 2008 as we seek to achieve our objectives of timely preparing and filing our financial statements and SEC periodic reports, remediating material weaknesses in our internal control over financial reporting and completing the replacement of our North American financial reporting systems.

 

Our ability to reduce future SG&A expenses is dependent, among other things, on:

 

 

 

If we are unable to achieve these objectives, offset these costs through other expense reductions, or if we encounter additional difficulties or setbacks in achieving these objectives, our SG&A expenses could significantly exceed currently expected levels and, consequently, materially and adversely affect our competitive position, financial condition, results of operations and cash flows.

 

The systems integration consulting markets are highly competitive, and we may not be able to compete effectively if we are not able to maintain our billing rates or control our costs related to these engagements.

 

Systems integration consulting constitutes a significant part of our business. Historically, these markets have included a large number of participants and have been highly competitive. Recent increases in the number and availability of competing global delivery alternatives for systems integration work create ever increasing pricing pressures in these markets. We frequently compete with companies that have greater global delivery capabilities and alternatives, financial resources, name recognition and market share than we do. If we are unable to maintain our billing rates through delivering unique and differentiated systems integration solutions and control our costs through proper management of our workforce, global delivery centers and other available resources, we may lose the ability to compete effectively for this significant portion of our business.

 

Contracting with the Federal government is inherently risky and exposes us to risks that may materially and adversely affect our business.

 

We depend on contracts with U.S. Federal government agencies, particularly with the Department of Defense, for a significant portion of our revenue and consequently we are exposed to various risks inherent in the government contracting process, including the following:

 

 

 

 

 

The impact of any of these occurrences or conditions could affect not only our business with the agency or department involved, but also other agencies and departments within the Federal government. Depending on the size of the project or the magnitude of the budget reduction, potential costs, penalties or negative publicity involved, any of these occurrences or conditions could have a material adverse effect on our business or our results of operations.

 

Our ability to attract, retain and motivate our managing directors and other key employees is critical to the success of our business. We continue to experience sustained, higher-than-industry average levels of voluntary turnover among our workforce, which has impacted our ability to grow our business.

 

Our success depends largely on our general ability to attract, develop, motivate and retain highly skilled professionals. Competition for skilled personnel in the consulting and technology services business is intense. In light of our current issues related to our North American financial reporting systems and our internal controls, it is particularly critical that we continue to attract and retain experienced finance personnel. Recruiting, training and retention costs and benefits place significant demands on our resources. In addition, because we are not current in our SEC periodic filings, the near-term value of our equity incentives is uncertain, and our ability to use equity to attract, motivate and retain our professionals is in jeopardy. Significant features of many of our employee equity plans remain suspended. The continuing loss of significant numbers of our professionals or the inability to attract, hire, develop, train and retain additional skilled personnel could have a serious negative effect on us, including our ability to obtain and successfully complete important engagements and thus maintain or increase our revenue.

 

Our contracts can be terminated by our clients with short notice, or our clients may cancel or delay projects.

 

Our clients typically retain us on a non-exclusive, engagement-by-engagement basis, rather than under exclusive long-term contracts. Most of our consulting engagements are less than 12 months in duration. Most of our contracts can be terminated by our clients upon short notice and without significant penalty. Large client projects involve multiple engagements or stages, and there is a risk that a client may choose not to retain us for additional stages of a project or that a client will cancel or delay additional planned engagements. These terminations, cancellations or delays could result from factors unrelated to our work product or the progress of the project, but could be related to business or financial conditions of the client or the economy

generally. When contracts are terminated, cancelled or delayed, we lose the associated revenue, and we may not be able to eliminate associated costs in a timely manner. Consequently, our operating results in subsequent periods may be adversely impacted.

 

If we are not able to keep up with rapid changes in technology or maintain strong relationships with software providers, our business could suffer.

 

Our success depends, in part, on our ability to develop service offerings that keep pace with rapid and continuing changes in technology, evolving industry standards and changing client preferences. Our success also depends on our ability to develop and implement ideas for the successful application of existing and new technologies. We may not be successful in addressing these developments on a timely basis, or our ideas may not be successful in the marketplace. Also, products and technologies developed by our competitors may make our services or product offerings less competitive or obsolete. Any of these circumstances could have a material adverse effect on our ability to obtain and successfully complete client engagements.

 

In addition, we generate a significant portion of our revenue from projects to implement software developed by others. Our future success in the software implementation business depends, in part, on the continuing viability of these companies, their ability to maintain market leadership and our ability to maintain a good relationship with these companies.

 

Loss of our joint marketing relationships could reduce our revenue and growth prospects.

 

Our most significant joint marketing relationships are with Microsoft Corporation, Oracle Corporation and SAP AG. These relationships enable us to increase revenue by providing us additional marketing exposure, expanding our sales coverage, increasing the training of our professionals and developing and co-branding service offerings that respond to customer demand. The loss of one or more of these relationships could adversely affect our business by terminating current joint marketing and product development efforts or otherwise decreasing our revenue and growth prospects. Because most of our significant joint marketing relationships are nonexclusive, if our competitors are more successful in, among other things, building leading-edge products and services, these entities may form closer or preferred arrangements with other consulting organizations, which could materially reduce our revenue.

 

We are not likely to be able to significantly grow our business through mergers and acquisitions in the near term.

 

We have had limited success in valuing and integrating acquisitions into our business. Given past experiences, the current competing demands for our capital resources and limitations contained in our senior secured credit facility, we are unlikely to grow our business through significant acquisitions. Our inability to do so may competitively disadvantage us or jeopardize our independence.

 

There will not be a consistent pattern in our financial results from quarter to quarter, which may result in increased volatility of our stock price.

 

Our quarterly revenue and profitability have varied in the past and are likely to vary significantly from quarter to quarter, making them difficult to predict. This may lead to volatility in our stock price. Factors that could cause variations in our quarterly financial results include:

 

 

 

Our profitability may decline due to financial, regulatory and operational risks inherent in worldwide operations.

 

In 2006, approximately 33.3% of our revenue was attributable to activities outside North America. Our results of operations are affected by our ability to manage risks inherent in our doing business abroad. These risks include exchange rate fluctuation, regulatory concerns, terrorist activity, restrictions with respect to the movement of currency, access to highly skilled workers, political and economic stability, unauthorized and improper activities of employees and our ability to protect our intellectual property. Despite our best efforts, we may not be in compliance with all regulations around the world and may be subject to penalties and fines as a result. These penalties and fines may materially and adversely affect our profitability.

 

Some of our services are performed in high-risk locations, such as Iraq and Afghanistan, where the country or location is suffering from political, social or economic issues, or war or civil unrest. In those locations, we incur substantial costs to maintain the safety of our personnel. Despite these precautions, the safety of our personnel in these locations may continue to be at risk. Despite our best efforts, we may suffer the loss of our employees or those of our contractors. The risk of these losses and the costs of protecting against them may become prohibitive. If so, we may face taking a decision regarding removing our employees from one or more of these countries and ceasing to seek new work or complete the existing contracts that we have in those countries or regions. Such a decision could, directly or indirectly, materially and adversely affect our current and future revenue, as well as our profitability.

 

We may bear the risk of cost overruns relating to our services, thereby adversely affecting our profitability.

 

The effort and cost associated with the completion of our systems integration, software development and implementation or other services are difficult to estimate and, in some cases, may significantly exceed the estimates made at the time we commence the services. We often provide these services under level-of-effort and fixed-price contracts. The level-of-effort contracts are usually based on time and materials or direct costs plus a fee. Under these arrangements, we are able to bill our client based on the actual cost of completing the services, even if the ultimate cost of the services exceeds our initial estimates. However, if the ultimate cost exceeds our initial estimate by a significant amount, we may have difficulty collecting the full amount that we are due under the contract, depending upon many factors, including the reasons for the increase in cost, our communication with the client throughout the project, and the client’s satisfaction with the services. As a

result, we could incur losses with respect to these services even when they are priced on a level-of-effort basis. If we provide these services under a fixed-price contract, we bear the risk that the ultimate cost of the project will exceed the price to be charged to the client. If we fail to accurately estimate our costs or the time required to perform under a contract, the profitability of these contracts may be materially and adversely affected.

 

We may face legal liabilities and damage to our professional reputation from claims made against our work.

 

Many of our engagements involve projects that are critical to the operations of our clients’ businesses. If we fail to meet our contractual obligations, we could be subject to legal liability, which could adversely affect our business, operating results and financial condition. The provisions we typically include in our contracts that are designed to limit our exposure to legal claims relating to our services and the applications we develop may not protect us or may not be enforceable in all cases. Moreover, as a consulting firm, we depend to a large extent on our relationships with our clients and our reputation for high caliber professional services and integrity to retain and attract clients and employees. As a result, claims made against our work may be more damaging in our industry than in other businesses. Negative publicity related to our client relationships, regardless of its accuracy, may further damage our business by affecting our ability to compete for new engagements.

 

Our services may infringe upon the intellectual property rights of others.

 

We cannot be sure that our services do not infringe on the intellectual property rights of others, and we may have infringement claims asserted against us. These claims may harm our reputation, cost us money and prevent us from offering some services. In some contracts, we have agreed to indemnify our clients for certain expenses or liabilities resulting from claimed infringements of the intellectual property rights of third parties. In some instances, the amount of these indemnities may be greater than the revenue we receive from the client. Any claims or litigation in this area may be costly and result in large awards against us and, whether we ultimately win or lose, could be time-consuming, may injure our reputation, may result in costly delays or may require us to enter into royalty or licensing arrangements. If there is a successful claim of infringement or if we fail to develop non-infringing technology or license the proprietary rights we require on a timely basis, our ability to use certain technologies, products, services and brand names may be limited, and our business may be harmed.

 

We have only a limited ability to protect our intellectual property rights, which are important to our success.

 

Our success depends, in part, upon our plan to develop, capture and protect re-usable proprietary methodologies and other intellectual property. We rely upon a combination of trade secrets, confidentiality policies, nondisclosure and other contractual arrangements, and patent, copyright and trademark laws to protect our intellectual property rights. Our efforts in this regard may not be adequate to prevent or deter infringement or other misappropriation of our intellectual property, and we may not be able to detect the unauthorized use of, or take appropriate and timely action to enforce, our intellectual property rights.

 

Depending on the circumstances, we may be required to grant a specific client certain intellectual property rights in materials developed in connection with an engagement, in which case we would seek to cross-license the use of such rights. In limited situations, however, we forego certain intellectual property rights in materials we help create, which may limit our ability to re-use such materials for other clients. Any limitation on our ability to re-use such materials could cause us to lose revenue-generating opportunities and require us to incur additional cost to develop new or modified materials for future projects.

Risks that Relate to Our Liquidity

 

Our current cash resources might not be sufficient to meet our expected cash needs over time.

 

We have experienced recurring net losses. We have generated positive cash flow from operations in only three quarters since the beginning of our 2005 fiscal year. Historically, we have often failed, sometimes significantly, to achieve management’s periodic operating budgets and cash forecasts.

 

If we cannot consistently generate positive cash flow from operations, we will need to meet operating shortfalls with existing cash on hand, avail ourselves of the capital markets or implement or seek alternative strategies. These alternative strategies could include seeking improvements in working capital management, reducing or delaying capital expenditures, restructuring or refinancing our indebtedness, seeking additional debt or equity capital and selling assets. There can be no assurances that existing cash will be sufficient, we will have timely access to the capital markets or that any of these strategies can be implemented on satisfactory terms, on a timely basis, or at all.

 

We have been unable to issue shares of our common stock under our ESPP since February 1, 2005. The longer we are unable to issue shares of our common stock, the more likely our ESPP participants may elect to withdraw their accumulated cash contributions from the ESPP at rates higher than those we have historically experienced.

 

Under our ESPP, eligible employees may purchase shares of our common stock at a discount, through payroll deductions that accumulate over an offering period. Shares of common stock typically are purchased under the ESPP every six months. Because we are not current in our SEC periodic filings, we have been, and continue to be, unable to issue freely tradable shares of our common stock and have not issued any shares of common stock under the ESPP for our current offering period, which began on February 1, 2005. Employee ESPP contributions are currently included in our available cash balances on hand, amounting to approximately $22.4 million of accumulated contributions as of March 31, 2007. These contributions may be withdrawn by our employees on demand. If we experience withdrawal rates higher than those we have historically experienced, our cash flow could be materially and adversely affected.

 

Our 2007 Credit Facility imposes a number of restrictions on the way in which we operate our business and may negatively affect our ability to finance future needs, or do so on favorable terms. If we violate these restrictions, we will be in default under the 2007 Credit Facility, which may cross-default to our other indebtedness.

 

On May 18, 2007, we entered into a $400 million senior secured credit facility and on June 1, 2007, we amended and restated the credit facility to increase the aggregate commitments under the facility to $500 million (the “2007 Credit Facility”). The 2007 Credit Facility consists of term loans in an aggregate principal amount of $300 million and a letter of credit facility in an aggregate face amount at any time outstanding not to exceed $200 million. For more information on our 2007 Credit Facility, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.” Under the 2007 Credit Facility, certain of our corporate activities are restricted, which include, among other things, limitations on: disposition of assets; mergers and acquisitions; payment of dividends; stock repurchases and redemptions; incurrence of additional indebtedness; making of loans and investments; creation of liens; prepayment of other indebtedness; and engaging in certain transactions with affiliates. Any event of default under the 2007 Credit Facility or agreements governing our other significant indebtedness could lead to an acceleration of debt under the 2007 Credit Facility or other debt instruments that contain cross-default provisions. If the indebtedness under the 2007 Credit Facility were to be accelerated, our assets may not be sufficient to repay amounts due under the 2007 Credit Facility and the other debt securities then accelerated.

If we cannot generate positive cash flow from our operations, we eventually may not be able to service our indebtedness.

 

Our ability to make scheduled payments of principal and interest on, or to refinance, our indebtedness and to satisfy our other debt obligations will depend primarily upon our future ability to generate positive cash flow from operations. If we cannot generate positive cash flow from operations, there can be no assurance that future borrowings or equity financing will be available for the payment or refinancing of any indebtedness. If we are unable to service our indebtedness, whether in the ordinary course of business or upon acceleration of such indebtedness, our financial condition, cash flows and results of operations would be materially affected.

 

We may be unable to obtain new surety bonds, letters of credit or bank guarantees in support of client engagements on acceptable terms.

 

Some of our clients, primarily in the state and local market, require us to obtain surety bonds, letters of credit or bank guarantees in support of client engagements. We may be required to post additional collateral (cash or letters of credit) to support our obligations under our surety bonds upon the demand of our surety providers. If we cannot obtain or maintain surety bonds, letters of credit or bank guarantees on acceptable terms, we may be unable to maintain existing client engagements or to obtain additional client engagements that require them. In turn, our current and planned revenue, particularly from our Public Services business, could be materially and adversely affected.

 

Downgrades of our credit ratings may increase our borrowing costs and materially and adversely affect our financial condition.

 

On February 6, 2007, Standard & Poor’s Rating Services (“Standard & Poor’s”) withdrew our senior unsecured rating of B- and our subordinated debt rating of CCC+ and removed them from CreditWatch. Separately, on October 6, 2006, Moody’s downgraded our corporate family rating to B2 from B1 and the ratings for two of our subordinated convertible bonds series to B3 from B2, and placed our ratings on review for further downgrade.

 

Actions such as those by the rating agencies may affect our ability to obtain financing or the terms on which such financing may be obtained. Our inability to obtain additional financing, or obtain additional financing on terms favorable to us, could hinder our ability to fund general corporate requirements, affect our stock price, limit our ability to compete for new business, and increase our vulnerability to adverse economic and industry conditions.

 

Our leverage may adversely affect our business and financial performance and may restrict our operating flexibility.

 

The level of our indebtedness and our ongoing cash flow requirements for debt services could:

 

 

The holders of our debentures have the right, at their option, to require us to purchase some or all of their debentures upon certain dates or upon the occurrence of certain designated events, which could have a material adverse effect on our liquidity.

 

We have made two issuances of convertible subordinated debentures and two issuances of convertible senior subordinated debentures. For a description of these debentures, see Item 5, “Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities—Sales of Securities Not Registered Under the Securities Act.”

 

The holders of our debentures have the right to require us to repurchase any outstanding debentures upon certain dates and designated events. These events include certain change of control transactions and a termination of trading, which occurs if the Company’s common stock is no longer listed for trading on a U.S. national securities exchange. If we are unable to repurchase any of our debentures when due or otherwise breach any other debenture covenants, we may be in default under the related indentures, which could lead to an acceleration of unpaid principal and accrued interest under the indentures. Any such acceleration could lead to an acceleration of amounts outstanding under our 2007 Credit Facility. In the event of any acceleration of unpaid principal and accrued interest under our 2007 Credit Facility or under the debentures, we will not be permitted to make payments to the holders of the debentures until the unpaid principal and accrued interest under our 2007 Credit Facility have been fully paid.

 

Risks that Relate to Our Common Stock

 

The price of our common stock may decline due to the number of shares that may be available for sale in the future.

 

Sales of a substantial number of shares of our common stock, or the perception that such sales could occur, could adversely affect the market price of our common stock.

 

Upon conversion or exercise of our outstanding convertible debt and warrants, we will issue the following number of shares of our common stock, subject to anti-dilution protection and other adjustments, including upon certain change of control transactions:

 

 

 

 

As a result of our continuing delay in becoming current in our SEC periodic filings, we are not able to file a registration statement covering the shares issuable upon conversion of any of the debentures or exercise

of the July 2005 Warrants. Once such a registration statement is effective, more of the shares associated with such debentures and warrants may be sold. Any sales in the public market of such shares of common stock could adversely affect prevailing market prices of our common stock. In addition, under certain circumstances, the existence of the debentures may encourage short selling by market participants because the conversion of the debentures could depress the price of our stock.

 

As of March 31, 2007, our employees held stock options to purchase 34.7 million shares, representing approximately 17% of the 201,593,999 Company’s shares of common stock then outstanding and of which 31.6 million shares are currently vested. An additional number of stock options generally will become exercisable during the calendar years indicated below:

 

 

Since 2005 we have significantly increased the issuance of equity in the form of restricted stock units (“RSUs”) and PSUs (collectively, “stock units”) to managing directors and other key employees, as a means of better aligning the interests of these employees with our shareholders and to enhance the retention of current managing directors. As of March 31, 2007, an aggregate of 21.8 million RSUs and 21.9 million PSUs, net of forfeitures, were issued and outstanding, respectively. The following shares of common stock are expected to be delivered upon settlement of these stock units during the calendar years indicated below (assuming settlement of the PSUs at 100% vesting in 2009):

 

 

Because we are not current in our SEC periodic filings, we are unable to issue freely tradable shares of our common stock. Consequently, we have not issued shares under our ESPP or LTIP since January and April 2005, respectively, and significant features of many of our employee equity plans remain suspended. We expect that once we are current in our SEC periodic filings and we are able to issue freely tradable shares of our common stock, our employees may wish to sell a significant number of these shares of common stock, which could materially depress the price of our common stock. Based on the accumulated contributions and the closing price of our common stock as of March 31, 2007, approximately 3.4 million shares would have been purchased through our ESPP as of such date if we could have issued shares under the ESPP. We are considering exercising various rights that we have to stagger the settlement of outstanding, vested stock units once we become current in our SEC periodic filings; however, these alternatives may not be well received by our employees. We have no comparable right to defer settlement of shares due under our ESPP.

 

There are significant limitations on the ability of any person or company to acquire the Company without the approval of our Board of Directors.

 

We have adopted a stockholders’ rights plan. Under this plan, after the occurrence of specified events that may result in a change of control, our stockholders will be able to purchase stock from us or our successor at half the then current market price. This right will not extend, however, to persons participating in takeover attempts without the consent of our Board of Directors or to persons whom our Board of Directors determines to be adverse to the interests of the stockholders. Accordingly, this plan could deter takeover attempts.

In addition, our certificate of incorporation and bylaws each contains provisions that may make the acquisition of our company more difficult without the approval of our Board of Directors. These provisions include the following, among others:

 

 

None.

 

Our properties consist of leased office facilities for specific client contracts and for sales, support, research and development, consulting, administrative and other professional personnel. Our corporate headquarters consists of approximately 235,000 square feet in McLean, Virginia. As of December 31, 2006, we occupied approximately 90 additional offices in the United States and approximately 59 offices in Latin America, Canada, the Asia Pacific region and EMEA. All office space referred to above is leased pursuant to operating leases that expire over various periods during the next 10 years. Portions of our office space are sublet under operating lease agreements, which expire over various periods during the next 10 years and are also being marketed for sublease or disposition. Although we believe our facilities are adequate to meet our needs in the near future, our business requires that our lease holdings accommodate the dynamic needs of our various consulting engagements and, given business demands, the makeup of our leasehold portfolio may change within the next twelve-month period to address these demands.

 

In May 2007, in connection with the settlement of our dispute with KPMG LLP (“KPMG”) regarding the transition services agreement entered into with KPMG in connection with our initial public offering, we amended certain real estate documents relating to a number of properties that we currently sublet from KPMG to either allow us to further sublease these properties to third parties, or to return certain properties we no longer utilize to KPMG, in return for a reduction of the amount of our sublease obligations to KPMG for those properties.

 

Overview

 

We currently are a party to a number of disputes that involve or may involve litigation or other legal or regulatory proceedings. Generally, there are three types of legal proceedings to which we have been made a party:

 

 

We currently maintain insurance in types and amounts customary in our industry, including coverage for professional liability, general liability and management and director liability. Based on management’s current assessment and insurance coverages believed to be available, we believe that the Company’s financial statements include adequate provision for estimated losses that are likely to be incurred with regard to all matters of the types described above.

 

SEC Reporting Matters

 

2005 Class Action Suits. In and after April 2005, various separate complaints were filed in the U.S. District Court for the Eastern District of Virginia, alleging that the Company and certain of its current and former officers and directors violated Section 10(b) of the Exchange Act, Rule 10b-5 promulgated thereunder and Section 20(a) of the Exchange Act by, among other things, making materially misleading statements between August 14, 2003 and April 20, 2005 with respect to our financial results in our SEC filings and press releases. On January 17, 2006, the court certified a class, appointed class counsel and appointed a class representative. The plaintiffs filed an amended complaint on March 10, 2006 and the defendants, including the Company, subsequently filed a motion to dismiss that complaint, which was fully briefed and heard on May 5, 2006. We were awaiting a ruling when, on March 23, 2007, the court stayed the case, pending the U.S. Supreme Court’s decision in the case of Makor Issues & Rights, Ltd v. Tellabs, argued before the Supreme Court on March 28, 2007. On June 21, 2007, the Supreme Court issued its opinion in the Tellabs case, holding that to plead a strong inference of a defendant’s fraudulent intent under the applicable federal securities laws, a plaintiff must demonstrate that such an inference is not merely reasonable, but cogent and at least as compelling as any opposing inference of non-fraudulent intent. The Supreme Court decision is expected to significantly inform the court’s decision regarding the complaint and our motion to dismiss the complaint. It is not possible to predict with certainty whether or not we will ultimately be successful in this matter or, if not, what the impact might be.

 

2005 Shareholder’s Derivative Demand. On May 21, 2005, we received a letter from counsel representing one of our shareholders requesting that we initiate a lawsuit against our Board of Directors and certain present and former officers of the Company, alleging breaches of the officers’ and directors’ duties of care and loyalty to the Company relating to the events disclosed in our report filed on Form 8-K, dated April 20, 2005. On January 21, 2006, the shareholder filed a derivative complaint in the Circuit Court of Fairfax County, Virginia, that was not served on the Company until March 2006. The shareholder’s complaint alleged that his demand

was not acted upon and alleged the breach of fiduciary duty claims previously stated in his demand. The complaint also included a non-derivative claim seeking the scheduling of an annual meeting in 2006. On May 18, 2006, following an extensive audit committee investigation, our Board of Directors responded to the shareholder’s demand by declining at that time to file a suit alleging the claims asserted in the shareholder’s demand. The shareholder did not amend the complaint to reflect the refusal of his demand. We filed demurrers on August 11, 2006, which effectively sought to dismiss the matter related to the fiduciary duty claims. On November 3, 2006, the court granted the demurrers and dismissed the fiduciary claims, with leave to file amended claims. As a result of our annual meeting of stockholders held on December 14, 2006, the claim seeking the scheduling of an annual meeting became moot. On January 3, 2007, the plaintiff filed an amended derivative complaint re-asserting the previously dismissed derivative claims and alleging that the Board’s refusal of his demand was not in good faith. The Company’s renewed motion to dismiss all remaining claims was heard on March 23, 2007 and no ruling has yet been entered.

 

SEC Investigation. On April 13, 2005, pursuant to the same matter number as its inquiry concerning our restatement of certain financial statements issued in 2003, the staff of the SEC’s Division of Enforcement requested information and documents relating to our March 18, 2005 Form 8-K. On September 7, 2005, we announced that the staff had issued a formal order of investigation in this matter. We subsequently have received subpoenas from the staff seeking production of documents and information, including certain information and documents related to an investigation conducted by our Audit Committee. We continue to provide information and documents to the SEC as requested. The investigation is ongoing and the SEC is in the process of taking the testimony of a number of our current and former employees, as well as one of our former directors.

 

In connection with the investigation by our Audit Committee, we became aware of incidents of possible non-compliance with the Foreign Corrupt Practices Act and our internal controls in connection with certain of our operations in China and voluntarily reported these matters to the SEC and U.S. Department of Justice in November 2005. Both the SEC and the Department of Justice are investigating these matters in connection with the formal investigation described above. On March 27, 2006, we received a subpoena from the SEC regarding information related to these matters.

 

Government Contracting Matters

 

California Subpoenas. In December 2004, we were served with a subpoena by the Grand Jury for the United States District Court for the Central District of California. The subpoena sought records relating to twelve contracts between the Company and the U.S. Federal government, including two General Service Administration (“GSA”) schedules, as well as other documents and records relating to our U.S. Federal government work. We have produced documents in accordance with an agreement with the Assistant U.S. Attorney. The focus of the review is upon our billing and time/expense practices, as well as alliance agreements where referral or commission payments were permitted. In July 2005, we received a subpoena by the U.S. Army related to Department of Defense contracts. We subsequently were served with several subpoenas issued by the inspectors general of the GSA and the Department of Defense. These subpoenas are largely duplicative of the grand jury subpoena. In December 2006, the Company’s counsel was informally informed by the Assistant U.S. Attorney involved in this matter that the government has declined to pursue any criminal proceedings arising out of this matter. The government continues to pursue the investigation on the civil side. We continue to cooperate fully and have produced substantial amounts of documents and other information. At this time, we cannot predict the outcome of the investigation.

 

Core Financial Logistics System. There is an ongoing investigation of the Core Financial Logistics System (“CoreFLS”) project by the Inspector General’s Office of the Department of Veterans Affairs and by the Assistant U.S. Attorney for the Central District of Florida. To date, we have been issued three subpoenas, in June 2004, December 2004 and May 2006, seeking the production of documents relating to the CoreFLS project. We are cooperating with the investigation and have produced documents in response to the subpoenas. To date, there have been no specific allegations of criminal or fraudulent conduct on our part or any

contractual claims filed against us by the Veterans Administration in connection with the project. We continue to believe we have complied with all of our obligations under the CoreFLS contract. We cannot, however, predict the outcome of the inquiry.

 

Other Matters

 

Peregrine Litigation. We were named as a defendant in several civil lawsuits regarding certain software resale transactions with Peregrine Systems, Inc. during the period 1999 and 2001, in which purchasers and other individuals who acquired Peregrine stock alleged that we participated in or aided and abetted a fraudulent scheme by Peregrine to inflate Peregrine’s stock price, and we were also sued by a trustee succeeding the interests of Peregrine for the same conduct. In December 2005, we executed conditional settlement agreements whereby we were released from liability in these matters and in all claims for indemnity by KPMG, our former parent, in each of these cases. We issued settlement payments of approximately $36.9 million with respect to these matters in September 2006. In addition, on January 5, 2006, we finalized an agreement with KPMG, providing conditional mutual releases to each other from fee advancement and indemnification claims with respect to these matters, with no settlement payment or other exchange of monies between the parties.

 

We did not settle the In re Peregrine Systems, Inc. Securities Litigation and on January 19, 2005, the matter was dismissed by the trial court as it relates to us. The plaintiffs have appealed the dismissal and briefing of the appeal has been completed. To the extent that any judgment is entered in favor of the plaintiffs against KPMG, KPMG has notified us that it will seek indemnification for any such sums. The Company disputes KPMG’s entitlement to any such indemnification.

 

On November 16, 2004, Larry Rodda, a former employee, pled guilty to one count of criminal conspiracy in connection with the Peregrine software resale transactions that continue to be the subject of the government inquiries. Mr. Rodda also was named in a civil suit brought by the SEC. We were not named in the indictment or civil suit, and are cooperating with the government investigations.

 

Series B Debenture Suit. On September 8, 2005, certain holders of our 2.75% Series B Convertible Subordinated Debentures (the “Series B Debentures”) provided a purported Notice of Default to us based upon our failure to timely file certain of our SEC periodic reports due in 2005. Thereafter, these holders asserted that as a result, the principal amount of the Series B Debentures, accrued and unpaid interest and unpaid damages were due and payable immediately.

 

The indenture trustee for the Series B Debentures then brought suit against us and, on September 19, 2006, the Supreme Court of New York ruled on motion that we were in default under the indenture for the Series B Debentures and ordered that the amount of damages be determined subsequently at trial. We believed the ruling to be in error and on September 25, 2006, appealed the court’s ruling and moved for summary judgment on the matter of determination of damages.

 

After further negotiations, we and the relevant holders of our Series B Debentures entered into a First Supplemental Indenture (the “First Supplemental Indenture”) with The Bank of New York, as trustee, which amends the subordinated indenture governing our 2.50% Series A Convertible Subordinated Debentures due 2024 (the “Series A Debentures”) and the Series B Debentures. Concurrently, we and the relevant holders of our Series B Debentures lawsuit agreed to discontinue the lawsuit.

 

The First Supplemental Indenture modifies the debentures to include: (i) a waiver of our SEC reporting requirements under the subordinated indenture through October 31, 2008, (ii) the interest rate payable on all Series A Debentures from 3.00% per annum to 3.10% per annum until December 23, 2011, and (iii) adjustment of the interest rate payable on all Series B Debentures from 3.25% per annum to 4.10% per annum until December 23, 2014.

In order to address any possibility of a claim of cross-default, on November 2, 2006, we entered into a First Supplemental Indenture with The Bank of New York, as trustee, which amends the indenture governing our 5.0% Convertible Senior Subordinated Debentures due 2025. The supplemental indenture includes a waiver of our SEC reporting requirements through October 31, 2007 and provides for further extension through October 31, 2008 upon our payment of an additional fee of 0.25% of the principal amount of the debentures. We paid to certain consenting holders of these debentures a consent fee equal to 1.00% of the outstanding principal amount of the debentures. In addition, on November 9, 2006, we entered into an agreement with the holders of our 0.50% Convertible Senior Subordinated Debentures due July 2010, pursuant to which we paid a consent fee equal to 1.00% of the outstanding principal amount of the debentures, in accordance with the terms of the purchase agreement governing the issuance of these debentures.

 

On December 14, 2006, we held our 2006 Annual Meeting of Stockholders. Set forth below is information concerning each matter submitted to a vote at the meeting.

 

Election of Directors. Our stockholders elected the following persons as Class II directors, to hold office until the annual meeting of stockholders to be held in 2008 and their respective successors have been duly elected and qualified, and as Class III directors, to hold office until the annual meeting of stockholders to be held in 2009 and their respective successors have been duly elected and qualified, as applicable.

 

 

Approval of Amended and Restated BearingPoint, Inc. 2000 Long-Term Incentive Plan. Our stockholders approved the adoption of the Amended and Restated BearingPoint, Inc. 2000 Long-Term Incentive Plan.

 

 

Ratification of Appointment of PricewaterhouseCoopers LLP. Our stockholders ratified the appointment of PricewaterhouseCoopers LLP as our independent registered public accounting firm for our 2006 fiscal year.

 

Executive Officers of the Company

 

Information about our executive officers as of June 1, 2007, is provided below.

 

Judy A. Ethell, 48, has been Chief Financial Officer since October 2006 and Executive Vice President—Finance and Chief Accounting Officer since July 2005. Previously, she held various positions with PricewaterhouseCoopers LLP (“PwC”) between 1982 and 2005. From 2003 to 2005, Ms. Ethell was a Partner and Tax Site Leader of PwC, where her duties included managing client service, human resources, marketing, and management of the St. Louis, Missouri Tax office. From 2001 to 2003, Ms. Ethell was a National Tour Partner (Tax) of PwC.

 

F. Edwin Harbach, 53, has been President and Chief Operating Officer since January 2007. From 1976 until his retirement in 2004, Mr. Harbach held various positions with and served in leadership roles at Accenture Ltd, a global management consulting, technology services and outsourcing company, including chief information officer, Managing Partner of Japan and Managing Director of Quality and Client Satisfaction.

 

Laurent C. Lutz, 47, has been General Counsel and Secretary since March 2006. From 1999 to 2006, Mr. Lutz was Assistant General Counsel, Corporate Finance and Securities, of Accenture Ltd, a global management consulting, technology services and outsourcing company.

 

Roderick C. McGeary, 56, has been a member of our Board of Directors since August 1999 and Chairman of the Board of Directors since November 2004. Since March 2005, Mr. McGeary has served the Company in a full-time capacity, focusing on clients, employees and business partners. From 2004 until 2005, Mr. McGeary served as our Chief Executive Officer. From 2000 to 2002, Mr. McGeary was the Chief Executive Officer of Brience, Inc., a wireless and broadband company. Mr. McGeary is a director of Cisco Systems, Inc., a worldwide leader in networking for the Internet, and Dionex Corporation, a manufacturer and marketer of chromatography systems for chemical analysis.

 

Harry L. You, 48, has been a member of our Board of Directors and Chief Executive Officer since March 2005. Mr. You also served as the Company’s Interim Chief Financial Officer from July 2005 until October 2006. From 2004 to 2005, Mr. You was Executive Vice President and Chief Financial Officer of Oracle Corporation, a large enterprise software company. From 2001 to 2004, Mr. You was the Chief Financial Officer of Accenture Ltd, a global management consulting, technology services and outsourcing company. Mr. You is a director of Korn Ferry International, a leading provider of recruitment and leadership development services.

 

The term of office of each officer is until election and qualification of a successor or otherwise in the discretion of the Board of Directors.

 

There is no arrangement or understanding between any of the above-listed officers and any other person pursuant to which any such officer was elected as an officer.

 

None of the above-listed officers has any family relationship with any director or other executive officer. Please see “Certain Relationships and Related Transactions, and Director Independence—Judy Ethell/Robert Glatz” for information about Ms. Ethell’s relationship with Robert Glatz, a managing director and member of our management team.

 

Market Information

 

Our common stock is traded on the NYSE under the trading symbol “BE.” Until we are current in all of our periodic reporting requirements with the SEC, the NYSE will identify us as a late filer on its website and consolidated tape by affixing the letters “LF” to our common stock ticker symbol.

 

We did not file our annual reports on Form 10-K for 2005 and 2004 on a timely basis. We filed our 2004 Form 10-K on January 31, 2006 and our 2005 Form 10-K on November 22, 2006. We did not file this Annual Report on Form 10-K on a timely basis.

 

The following table sets forth the high and low sales prices for our common stock as reported on the NYSE for the quarterly periods indicated.

 

Price Range of Common Stock

 

Holders

 

At June 1, 2007, we had approximately 858 stockholders of record.

 

Dividends

 

We have never paid cash dividends on our common stock, and we do not anticipate paying any cash dividends on our common stock for at least the next 12 months. We intend to retain all of our earnings, if any, for general corporate purposes, and, if appropriate, to finance the expansion of our business. Our 2007 Credit Facility contains limitations on our payment of dividends. Our future dividend policy will also depend on our earnings, capital requirements, financial condition and other factors considered relevant by our Board of Directors.

 

Issuer Purchases of Equity Securities

 

In July 2001, our Board of Directors authorized us to repurchase up to $100.0 million of our common stock, and in April 2005, the Board of Directors authorized a stock repurchase program for an additional $100.0 million for common stock repurchases to be made over a twelve-month period beginning on April 11, 2005. We did not repurchase shares during this twelve-month period and the April 2005 authorization has now expired. Any shares repurchased under these stock repurchase programs are held as treasury shares.

 

We did not repurchase any of our common stock during 2006, and we do not intend to repurchase any shares of common stock until we are current in our periodic filings with the SEC. In addition, our 2007 Credit Facility contains limitations on our ability to repurchase shares of our common stock. At December 31, 2006 we were authorized to repurchase up to $64.3 million of our common stock.

 

Sales of Securities Not Registered Under the Securities Act

 

In 2006, we did not make any sales of securities not registered under the Securities Act. In 2004 and 2005, we completed the sale of the following convertible debt and warrants, all of which were sold pursuant to exemptions from registration provided by Section 4(2) or Regulation D under the Securities Act:

 

 

Equity Compensation Plan Information
(as of December 31, 2006)

 

 

 

 

Other Equity Plan Information

 

Effective as of September 14, 2006, the previously announced temporary blackout period pursuant to Regulation BTR ended because the Company’s 401(k) Plan was amended to permanently prohibit participant purchases and Company contributions of Company common stock under the 401(k) Plan.

COMPARATIVE STOCK PERFORMANCE

 

Our Peer Group (the “Peer Group”) consists of Accenture Ltd, Computer Sciences Corporation, Electronic Data Systems Corporation, and Cap Gemini Ernst & Young. We believe that the members of the Peer Group are most comparable to us in terms of client base, service offerings and size.

 

The following graph compares the total stockholder return on our common stock from 2002 through 2006 with the total return on the S&P 500 Index and the Peer Group. The graph assumes that $100 is invested initially and all dividends are reinvested.

 

 

Our selected financial data below are derived from our audited Consolidated Financial Statements and related Notes included elsewhere in this report as of and for the years ended December 31, 2006, 2005, and 2004. The selected data as of the six months ended December 31, 2003, and for the year ended June 30, 2003, are also derived from audited financial statements. The selected financial data for the year ended June 30, 2002 are derived from unaudited consolidated financial statements and, in the opinion of management, have been prepared in accordance with accounting principles generally accepted in the United States of America and reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of results for these periods. Selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and the related Notes thereto included herein.

Statements of Operations

 

Balance Sheet Data

 

 

 

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the Consolidated Financial Statements and the Notes to Consolidated Financial Statements included elsewhere in this Annual Report. This Annual Report contains forward-looking statements that involve risks and uncertainties. See “Forward-Looking Statements.”

 

Overview

 

We provide strategic consulting applications services, technology solutions and managed services to government organizations, Global 2000 companies and medium-sized businesses in the United States and internationally. In North America, we provide consulting services through our Public Services, Commercial Services and Financial Services industry groups in which we focus significant industry-specific knowledge and service offerings to our clients. Outside of North America, we are organized on a geographic basis, with operations in EMEA, the Asia Pacific region and Latin America.

 

We have started the transition of our business to a more integrated, global delivery model. In 2007, we created a Global Account Management Program and a Global Solutions Council represented by all of our industry groups that will focus on identifying opportunities for globalized solutions suites. Our Global Delivery Centers continue to grow, both in terms of personnel and the percentage of work they provide to our business units.

 

Economic and Industry Factors

 

We believe that our clients’ spending for consulting services is partially correlated to, among other factors, the performance of the domestic and global economy as measured by a variety of indicators such as gross domestic product, government policies, mergers and acquisitions activity, corporate earnings, U.S. Federal and state government budget levels, inflation and interest rates and client confidence levels, among others. As economic uncertainties increase, clients’ interests in business and technology consulting historically have turned more to improving existing processes and reducing costs rather than investing in new innovations. Demand for our services, as evidenced by new contract bookings, also does not uniformly follow changes in economic cycles. Consequently, we may experience rapid decreases in new contract bookings at the onset of significant economic downturns while the benefits of economic recovery may take longer to realize.

 

The markets in which we provide services are increasingly competitive and global in nature. While supply and demand in certain lines of business and geographies may support price increases for some of our standard service offerings from time to time, to maintain and improve our profitability we must constantly seek to improve and expand our unique service offerings and deliver our services at increasingly lower cost levels. Our Public Services industry group, which is our largest, also must operate within the U.S. Federal, state and local government markets where unique contracting, budgetary and regulatory regimes control how contracts are awarded, modified and terminated. Budgetary constraints or reductions in government funding may result in the modification or termination of long-term government contracts, which could dramatically affect the outlook of that business.

 

Revenue and Income Drivers

 

We derive substantially all of our revenue from professional services activities. Our revenue is driven by our ability to continuously generate new opportunities to serve clients, by the prices we obtain for our service offerings, and by the size and utilization of our professional workforce. Our ability to generate new business is directly influenced by the economic conditions in the industries and regions we serve, our anticipation and response to technological change, the type and level of technology spending by our clients and by our clients’

perception of the quality of our work. Our ability to generate new business is also indirectly and increasingly influenced by our clients’ perceptions of our ability to manage our ongoing issues surrounding our financial accounting, internal controls and SEC reporting capabilities.

 

Our gross profit consists of revenue less our costs of service. The primary components of our costs of service include professional compensation and other direct contract expenses. Professional compensation consists of payroll costs and related benefits associated with client service professional staff (including the vesting of various stock awards, tax equalization for employees on foreign and long-term domestic assignments and costs associated with reductions in workforce). Other direct contract expenses include costs directly attributable to client engagements. These costs include out-of-pocket costs such as travel and subsistence for client service professional staff, costs of hardware and software, and costs of subcontractors. If we are unable to adequately control or estimate these costs, or properly anticipate the sizes of our client service and support staff, our profitability will suffer.

 

Our operating profit reflects our revenue less costs of service and certain additional items that include, primarily, SG&A expenses, which include costs related to marketing, information systems, depreciation and amortization, finance and accounting, human resources, sales force, and other expenses related to managing and growing our business. Write-downs in the carrying value of goodwill and amortization of intangible assets have also reduced our operating profit.

 

Our operating cash flow is derived predominantly from gross operating profit and how we manage our receivables and payables.

 

Key Performance Indicators

 

In evaluating our operating performance and financial condition, we focus on the following key performance indicators: bookings, revenue growth, gross margin (gross profit as a percentage of revenue), utilization, days sales outstanding, free cash flow and attrition.

 

 

 

Readers should understand that each of the performance indicators identified above are utilized by many companies in our industry and by those who follow our industry. There are no uniform standards or requirements for computing these performance indicators, and, consequently, our computations of these amounts may not be comparable to those of our competitors.

 

2006 Highlights

 

In 2006, we were able to sustain our underlying operations and our core business continued to perform, despite the issues we continue to face with respect to our financial accounting systems and efforts to become timely in our SEC periodic reports. We began to see the benefits of restructuring efforts undertaken in previous years, particularly in our Asia Pacific and EMEA industry groups, as well as management actions aimed at improving our profitability. These benefits allowed us to show significant improvements in gross

profit and net income (loss) while maintaining relatively constant year-over-year levels of bookings and revenue. We were also successful in resolving and settling a number of long-running contractual disputes.

 

We were able to achieve these results despite increasing pricing pressures and competition for the retention of skilled personnel—two current industry-wide phenomena that affect us more acutely due to our continuing efforts to timely produce our financial statements and file our periodic reports with the SEC. We continue to be uniquely challenged in these regards and by persisting negative perceptions regarding our financial position that may have been, in our opinion, unjustifiably increased by our settlement of a vigorously contested lawsuit initiated by several holders of our Series B Debentures.

 

Of particular note in 2006 are the following:

 

 

 

 

 

Contributing to the net loss for 2006 were $48.2 million of losses related to the previously mentioned settlements with telecommunication clients, $57.4 million for bonuses payable to our employees, $53.4 million of non-cash compensation expense related to the vesting of stock-based awards, $29.6 million of lease and facilities restructuring charges and the previously mentioned $33.6 million year-over-year increase in external costs related to the closing of our financial statements.

 

 

 

 

 

 

Principal Business Priorities for 2007 and Beyond

 

In early 2007, our Board of Directors determined that our principal business priorities are: (1) enhance shareholder value, (2) become timely in our financial and SEC periodic reporting, (3) replace our North American financial reporting systems, (4) reduce employee attrition, (5) increase client awareness, confidence and satisfaction, and (6) strengthen our balance sheet. Identified below are management’s current and planned initiatives to achieve the priorities established by our Board of Directors.

 

Enhance Shareholder Value. We recognize that shareholder value is measured in bottom line results. We are also keenly aware that to improve shareholder value in the coming years we must focus not only on improving our business model, but also on becoming timely and economical in producing our financial statements and periodic reports. Our 2007 initiatives related to improving our business model include:

 

 

 

Become Timely in Our Financial and SEC Periodic Reporting. Becoming timely and more economical in producing accurate financial statements and SEC periodic reports is critical to our ability to enhance shareholder value in the coming years. While our objective is to complete our financial statements for the third quarter of 2007 and become current in our SEC periodic reporting with the filing of our quarterly report on Form 10-Q for that period with the SEC, in order to sustain accurate and timely production of our financial statements and timely file our SEC periodic reports, we must dramatically reduce the amount of time required to conduct our periodic financial closing process. Though we continue to incrementally improve on the amount of time required to conduct this process, we will not be able to fully minimize that amount of time until we have remediated the material weaknesses in our internal control over financial reporting and fully transitioned to our new North American financial reporting systems. We currently do not anticipate full remediation of all material weaknesses until 2008.

 

After significant analysis and debate, we have decided that we must prioritize our efforts to achieve and sustain timely financial and SEC periodic reporting in 2007 and early 2008, even as we continue to remediate our existing material weaknesses. The consequences of this decision are that we will need to continue to utilize our existing North American financial reporting systems longer than we previously planned and, during this time, we will need to rely heavily on our client engagement teams to fully accept and utilize the tools and resources we have provided them to build effective controls into the lifecycle of our contracts and assemble and review client contract accounting information on a timely basis as part of our daily operations, rather than subsequent to the end of the relevant financial reporting period.

 

While we remain confident with the proposed design for our new North American financial reporting systems, as well as our decision to transition to these systems as a longer-term improvement to our internal control environment, we are also very mindful of the risks associated with the transitioning to these new systems, particularly while we are striving to become timely and current in our financial and SEC periodic reporting. It is likely the transition to our new North American financial reporting systems will not begin before the last half of 2008.

 

Our 2007 initiatives related to becoming timely in our financial and SEC periodic reporting include:

 

 

 

Replace Our North American Financial Reporting Systems. We continue to prepare for the transformation of our North American financial reporting systems. During 2006, we spent approximately $28.0 million related to the maintenance of our existing North American financial reporting systems and the preparation of our transition to new North American financial reporting systems, and we currently expect to incur an additional $24.6 million and $33.4 million in 2007 and 2008, respectively, in these efforts. We will be transitioning from our existing North American financial reporting systems to two industry-standard applications. For our Public Services business in North America, we plan to implement an industry-standard platform for U.S. government contract accounting. We plan to implement the same financial system for our North American commercial operations that has worked successfully for our EMEA operations. Our planning and design phase is near complete. We believe that our existing North American financial reporting systems are currently performing at an operating level that will allow us, in the short-term, to prepare our financial statements and make our periodic filings with the SEC on a timely basis, assuming we can achieve our targets for shortening the financial closing process and obtaining timely and accurate financial information and updates from our client engagement teams and other corporate services.

 

Reduce Employee Attrition. We are seeking to reduce attrition by raising our levels of employee ownership to align the interests of our employees with those of our shareholders, providing improved training opportunities and seeking to better understand and manage employee career expectations.

 

 

 

 

 

Increase Client Awareness, Confidence and Satisfaction. Our 2007 initiatives related to enhancing our clients’ confidence and satisfaction include:

 

 

 

Strengthen Our Balance Sheet. Our 2007 efforts to strengthen our balance sheet include:

 

 

Segments

 

Our reportable segments for 2006 consist of our three North America industry groups (Public Services, Commercial Services, and Financial Services), our three international regions (EMEA, Asia Pacific and Latin America) and the Corporate/Other category (which consists primarily of infrastructure costs). Revenue and gross profit information about our segments are presented below, starting with each of our industry groups and then with each of our three international regions (in order of size).

 

Our chief operating decision maker, the Chief Executive Officer, evaluates performance and allocates resources among the segments. Accounting policies of our segments are the same as those described in Note 2, “Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements. Upon consolidation, all intercompany accounts and transactions are eliminated. Inter-segment revenue is not included in the measure of profit or loss for each reportable segment. Performance of the segments is evaluated on operating income excluding the costs of infrastructure functions (such as information systems, finance and accounting, human resources, legal and marketing) as described in Note 18, “Segment Information,” of the Notes to Consolidated Financial Statements. During 2005, we combined our Communications, Content and Utilities and Consumer, Industrial and Technology industry groups to form the Commercial Services industry group.

 

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

 

Revenue. Our revenue for 2006 was $3,444.0 million, an increase of $55.1 million, or 1.6%, over 2005 revenue of $3,388.9 million. The following tables present certain revenue information and performance metrics for each of our reportable segments during 2006 and 2005. Amounts are in thousands, except percentages. For additional geographical revenue information, please see Note 18, “Segment Information,” of the Notes to Consolidated Financial Statements.

 

 

n/m = not meaningful

 

 

Gross Profit. During 2006, our revenue increased $55.1 million and total costs of service decreased $137.4 million when compared to 2005, resulting in an increase in gross profit of $192.5 million, or 53.8%.

Gross profit as a percentage of revenue increased to 16.0% for 2006 from 10.6% for 2005. The change in gross profit for 2006 compared to 2005 resulted primarily from the following:

 

 

Gross Profit by Segment. The following tables present certain gross profit and margin information and performance metrics for each of our reportable segments for years 2006 and 2005. Amounts are in thousands, except percentages.

 

 

n/m = not meaningful

 

Changes in gross profit by segment were as follows:

 

 

Amortization of Purchased Intangible Assets. Amortization of purchased intangible assets decreased $0.7 million to $1.5 million in 2006 from $2.3 million for 2005.

 

Goodwill Impairment Charges. In 2006, there was no goodwill impairment charge. In 2005, a goodwill impairment loss of $166.4 million was recognized. For 2005, it was determined that the carrying amount of our EMEA and Commercial Services segments’ goodwill exceeded the implied fair value of that goodwill by $102.2 million and $64.2 million, respectively.

 

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $2.6 million, or 0.3%, to $748.3 million for 2006 from $750.9 million for 2005. Selling, general and administrative expenses as a percentage of gross revenue decreased to 21.7% for 2006 from 22.2% for 2005. The decrease was primarily due to costs savings from the reduction in the size of the Company’s sales force and reducing other business development expenses. Offsetting these decreases were increases in costs for finance and accounting, primarily for sub-contracted labor and other costs directly related to the 2005 financial statement close. In addition, the Company incurred additional SG&A expenses during 2006 related to an agreement with Yale University, as described above.

 

Interest Income. Interest income was $8.7 million and $9.0 million in 2006 and 2005, respectively. Interest income is earned primarily from cash and cash equivalents, including money-market investments. The slight decrease in interest income was due to lower levels of cash available to be invested in money markets during 2006 as compared to 2005.

 

Interest Expense. Interest expense was $37.2 million and $33.4 million in 2006 and 2005, respectively. Interest expense is attributable to our debt obligations, consisting of interest due along with amortization of loan costs and loan discounts. The increase in interest expense was due to higher average debt balances in 2006 as compared to 2005.

 

Insurance Settlement. During 2006, related to the Settlement Agreement with Hawaiian Telcom Communications, Inc., we recorded $38.0 million for an insurance settlement. See Note 11, “Commitments and Contingencies,” of the Notes to Consolidated Financial Statements for more information.

 

Other Income/Expense, net. Other income, net, was $8.7 million in 2006, and other expense, net, was $13.6 million in 2005. The balances in each period primarily consist of realized foreign currency exchange gains and losses.

 

Income Tax Expense. We incurred income tax expense of $32.4 million for the year ended December 31, 2006 and income tax expense of $122.1 million for the year ended December 31, 2005. The principal reasons for the difference between the effective income tax rate on loss from continuing operations of (17.9)% and (20.4)% for years ended December 31, 2006 and 2005, respectively, and the U.S. Federal statutory income tax rate are the nondeductible goodwill impairment charge of $0 million and $118.5 million; nondeductible meals and entertainment expense of $22.0 million and $19.6 million; increase to deferred tax asset valuation allowance of $76.8 million and $223.0 million; state and local income taxes of $(6.7) million and $(12.7) million; impact of foreign recapitalization of $5.4 million and $82.0 million; foreign taxes of $(3.8) million and $13.7 million; income tax reserves of $8.4 million and $18.6 million; non-deductible interest of $10.7 million and $7.7 million; foreign dividend income of $13.6 million and $9.3 million and other non-deductible items of $10.0 million and $3.7 million, respectively.

 

Net Loss. For 2006, we incurred a net loss of $213.4 million, or a loss of $1.01 per share. Contributing to the net loss for 2006 were $48.2 million of losses related to the previously mentioned settlements with telecommunication clients, $57.4 million accrued for bonuses payable to our employees, $53.4 million of non-cash compensation expense related to the vesting of stock-based awards, $29.6 million of lease and facilities restructuring charges and the previously mentioned $33.6 million year-over-year increase in external costs related to the closing of our financial statements. For 2005, we incurred a net loss of $721.6 million, or

a loss of $3.59 per share. Included in our results for 2005 were a $166.4 million goodwill impairment charge, $111.7 million of operating losses related to the HT Contract, $81.8 million of non-cash compensation expense related to the vesting of Retention RSUs, a $55.3 million increase in the valuation allowance primarily against our U.S. deferred tax assets, and $29.6 million of lease and facilities restructuring charges.

 

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

 

Revenue. Our revenue for 2005 was $3,388.9 million, an increase of $13.1 million, or 0.4%, over 2004 revenue of $3,375.8 million. The following tables present certain revenue information and performance metrics for each of our reportable segments during 2005 and 2004. Amounts are in thousands, except percentages. For additional geographical revenue information, please see Note 18, “Segment Information,” of the Notes to Consolidated Financial Statements.

 

 

 

n/m = not meaningful

 

 

 

Gross Profit. During 2005, our revenue increased $13.1 million and total costs of service increased $202.7 million when compared to 2004, resulting in a decrease in gross profit of $189.5 million, or 34.6%. Gross profit as a percentage of revenue decreased to 10.6% for 2005 from 16.2% for 2004. The change in gross profit for 2005 compared to 2004 resulted primarily from the following:

 

 

Gross Profit by Segment. The following tables present certain gross profit and margin information and performance metrics for each of our reportable segments for 2005 and 2004. Amounts are in thousands, except percentages.

 

 

 

n/m = not meaningful

 

Changes in gross profit by segment were as follows:

 

 

 

Amortization of Purchased Intangible Assets. Amortization of purchased intangible assets decreased $1.2 million to $2.3 million for 2005 from $3.5 million for 2004.

 

Goodwill Impairment Charges. In 2005 and 2004, goodwill impairment losses of $166.4 million and $397.1 million, respectively, were recognized. For 2005, it was determined that the carrying amount of our EMEA and Commercial Services segments’ goodwill exceeded the implied fair value of that goodwill by $102.2 million and $64.2 million, respectively. Similarly, in 2004, the EMEA segment’s carrying value of goodwill was adjusted downward by $397.1 million.

 

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $109.7 million, or 17.1%, to $750.9 million for 2005 from $641.2 million for 2004. Selling, general and administrative expenses as a percentage of gross revenue increased to 22.2% for 2005 from 19.0% for 2004. The increase was primarily due to significant costs for sub-contracted labor and other costs directly related to the financial closing process for 2005. We expect to incur expenses in years 2006 and 2007 relating to the preparation of our Consolidated Financial Statements for 2005 and 2006 to remain at this higher than historical level.

 

Interest Income. Interest income was $9.0 million and $1.4 million in 2005 and 2004, respectively. Interest income is earned primarily from cash and cash equivalents, including money-market investments. The increase in interest income was due to a higher level of cash available to be invested in money-markets during 2005 as compared to 2004.

 

Interest Expense. Interest expense was $33.4 million and $18.7 million in 2005 and 2004, respectively. Interest expense is attributable to our debt obligations, consisting of interest due along with amortization of loan costs and loan discounts. The increase in interest expense was due to higher average debt balances in 2005 as compared to 2004.

 

Loss on Early Extinguishment of Debt. We did not have a loss on early extinguishment of debt during 2005. In December 2004, we recorded a loss on early extinguishment of debt of $22.6 million related to the make whole premium, unamortized debt issuance costs and fees that were paid in connection with the early extinguishment of $220.0 million of our senior notes.

 

Other Expense, net. Other expense, net was $13.6 million and $0.4 million in 2005 and 2004, respectively. The balances in each period primarily consist of realized foreign currency exchanges losses.

 

Income Tax Expense. We incurred income tax expense of $122.1 million in 2005 and an income tax expense of $11.8 million in 2004. The principal reasons for the difference between the effective income tax rate on loss from continuing operations of (20.4)% and (2.2)% for 2005 and 2004, respectively, and the U.S. Federal statutory income tax rate are the nondeductible goodwill impairment charge of $118.5 million

and $385.9 million; nondeductible meals and entertainment expense of $19.6 million and $19.2 million; increase to deferred tax asset valuation allowance of $223.0 million and $24.8 million; state and local income taxes of $(12.7) million and $(8.2) million; impact of foreign recapitalization of $82.0 million and $54.8 million; foreign taxes of $13.7 million and $(1.0) million; income tax reserves of $18.6 million and $7.9 million and other nondeductible items of $8.2 million and $26.3 million, respectively.

 

Net Loss. For 2005, we incurred a net loss of $721.6 million, or a loss of $3.59 per share. Included in our results for 2005 were a $166.4 million goodwill impairment charge, $111.7 million of operating losses related to the HT Contract, $81.8 million of non-cash compensation expense related to the vesting of Retention RSUs, a $55.3 million increase in the valuation allowance primarily against our U.S. deferred tax assets, and $29.6 million of lease and facilities restructuring charges. For 2004, we incurred a net loss of $546.2 million, or a loss of $2.77 per share. Included in our results for 2004 are a $397.1 million goodwill impairment charge, $51.4 million for certain litigation settlement charges and $11.7 million of lease and facilities restructuring charges.

 

Obligations and Commitments

 

As of December 31, 2006, we had the following obligations and commitments to make future payments under contracts, contractual obligations and commercial commitments (amounts are in thousands):

 

 

 

 

Liquidity and Capital Resources

 

The following table summarizes the cash flow statements for 2006, 2005 and 2004 (amounts are in thousands):