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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-K
 
 
     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended December 31, 2006
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 001-31451
 
BEARINGPOINT, INC.
(Exact name of Registrant as specified in its charter)
 
 
     
DELAWARE   22-3680505
(State or other jurisdiction of
incorporation or organization)
  (IRS Employer
Identification No.)
     
1676 International Drive, McLean, VA   22102
(Address of principal executive offices)   (Zip Code)
 
(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
 
                 
        Page
   
Description
  Number
 
PART I.
Item 1.
  Business   1
Item 1A.
  Risk Factors   7
Item 1B.
  Unresolved Staff Comments   21
Item 2.
  Properties   21
Item 3.
  Legal Proceedings   22
Item 4.
  Submission of Matters to a Vote of Security Holders   25
 
PART II.
Item 5.
  Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   27
Item 6.
  Selected Financial Data   30
Item 7.
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   33
Item 7A.
  Quantitative and Qualitative Disclosures About Market Risk   68
Item 8.
  Financial Statements and Supplementary Data   69
Item 9.
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   69
Item 9A.
  Controls and Procedures   70
Item 9A(T).
  Controls and Procedures   77
Item 9B.
  Other Information   77
 
PART III.
Item 10.
  Directors and Executive Officers of the Registrant   78
Item 11.
  Executive Compensation   81
Item 12.
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   101
Item 13.
  Certain Relationships and Related Transactions, and Director Independence   104
Item 14.
  Principal Accounting Fees and Services   105
 
PART IV.
Item 15.
  Exhibits, Financial Statement Schedules   106
       
Signatures
  112


 

 
PART I.
 
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.
 
ITEM 1.  BUSINESS
 
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


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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:
 
  •     Focusing on Key Segments, Clients, Solutions and Geographies. We intend to play only where we can win. In 2006, we made continued progress in realigning our business to focus on the areas that offer the greatest growth and opportunity. We are also focused on higher-margin, higher-growth solutions with low capital requirements. We seek to divert resources away from non-strategic accounts and segments to focus on increasing our market share in critical, high-growth areas.
 
  •     Improving our Delivery Capability. To provide premium, cost-effective, high-quality technology services and solutions to global clients, we will continue to invest strategically in building our global delivery network, thereby scaling our low-cost resources. The anchors of our global network are China and India, supported by onshore and near-shore centers as appropriate. In 2006, we opened new Global Development Centers in Bangalore, India and Hattiesburg, Mississippi. We also continue to increase our capabilities in Shanghai and Dalian, China, and Sao Paulo, Brazil. To deliver seamless solutions on a global basis, we are driving increased adoption of our global delivery methodology.
 
  •     Expanding our Managed Services Business. We selectively focus on applications management in strategically identified industry sectors that are complementary to our systems integration business. Our goal is to increase our managed services revenue by supporting our own solutions in addition to targeted non-BearingPoint developed applications. By building a strong alliance partner network with applications providers such as SAP, Oracle, PeopleSoft, Siebel and Hyperion, we are well-positioned to architect solutions tailored to a client’s specific needs with a single point of accountability.
 
  •     Improving our Cost Structure. To remain competitive, we strive to continually improve our operational discipline and streamline our cost base across all functions and business units. In 2006, for example, we reduced real estate costs by consolidating offices, including closing offices in four countries, without impacting our ability to serve clients. We continue to align our people “pyramid,” reducing the number of managing directors and senior managers, while increasing the number of analysts and consultants. We strive to manage risk in our portfolio, as well as the potential associated costs, through efforts such as a more stringent corporate deal review process and standardized contracting policies.
 
  •     Reducing Employee Attrition. As a professional services company, our employees are a key differentiator, and we must continue to focus on enhancing employee development, increasing employee ownership and taking other measures in order to reduce employee attrition. We are


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  committed to increasing training and development opportunities for our employees through programs such as our new partnership with the Yale School of Management for world-class training, by rolling out career paths and core competencies for all of our employees, and by building a pay-for-performance culture at all levels.
 
  •     Investing in our Business. We are seeking investment opportunities in key areas to drive future growth. For example, to remain on the leading edge of critical trends, issues and technologies that impact our clients, we are focused on developing horizontal and vertical end-to-end solutions that are based on repeatable innovation and delivered seamlessly to global clients. To increase awareness of the BearingPoint brand among clients and prospects, we launched a new brand strategy and more aggressive marketing efforts in late 2006.
 
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:
 
  •     Public Services serves a broad range of both public and private clients, including agencies of the U.S. Federal government such as the Departments of Defense, Homeland Security, Health and Human Services; provincial, state and local governments; public healthcare companies and private sector healthcare agencies; aerospace and defense companies; and higher education clients.
 
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.
 
  •     Commercial Services supports a highly diversified range of clients, including those in the technology, consumer markets, manufacturing, life sciences, transportation and communications sectors, as well as companies in the chemicals, oil and gas industries, and private and public utilities.
 
  •     Financial Services directs its solutions to many of the world’s leading banking, insurance, securities, real estate, hospitality and professional services institutions. We strive to anticipate global industry trends, opportunities and needs, and then deliver solutions that transform our clients. These service offerings are designed to allow customers to capitalize on existing application systems and e-business strategies and development. We believe we have differentiated ourselves from our competition by combining in-depth technical knowledge of our customers’ markets with focused offerings.
 
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.


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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


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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


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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:
 
  •     In December 2006, our shareholders approved amendments to our long-term incentive plan (“LTIP”) that, among other things, provided for a 25 million share increase in the number of shares authorized for equity awards made under the LTIP. The LTIP amendments enabled us to implement a new equity-based retention strategy, which we launched in February 2007 by awarding approximately 21.9 million performance share units (“PSUs”) to our managing directors and a limited number of key employees. The PSUs vest in three years if we are able to achieve certain performance metrics. The program was designed to enhance retention of our current managing directors and to incent these individuals to drive Company performance. For additional information on the PSUs, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Principal Business Priorities for 2007 and Beyond,” and Note 13, “Stock—Based Compensation,” of the Notes to Consolidated Financial Statements.
 
  •     In February 2007, we also granted performance cash awards providing for the payment of up to $50 million to a group of our managing directors and other high-performing senior-level employees. These cash retention awards generally are earned if we are able to achieve certain performance metrics, similar to those required under the PSU program. These performance cash awards were designed to retain our existing employees by diversifying their performance awards between cash and equity awards. For additional information on the performance cash awards, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Principal Business Priorities for 2007 and Beyond,” and Note 13, “Stock—Based Compensation,” of the Notes to Consolidated Financial Statements.


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  •     In November 2006, we began our partnership with Yale University to create the BearingPoint Leadership Program at the Yale School of Management, an innovative education and training program focusing on career and leadership development for our employees. We believe that our collaboration with Yale will offer our employees and new recruits with a unique learning experience that will help improve our ability to recruit and retain talented and motivated employees, enhance the quality of the services we deliver to our clients and cultivate a shared set of values, skills and culture that we hope will come to define a career with us.
 
  •     As part of our increased emphasis on a “pay for performance” compensation structure, we introduced performance-based cash bonus incentives in 2006. In 2006, we paid performance-based cash bonuses in an aggregate amount of $16 million to select staff-level employees, based on 2005 performance. Through June 2007, we have paid performance-based cash bonuses totaling approximately $50 million ($34 million to staff, $17 million to managing directors), based on 2006 performance. We believe the payment of a bonus for 2006 performance was appropriate, for retention purposes and because 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 filings.
 
  •     Under our “BE an Owner” program, eligible employees below the managing director level were intended to receive a stock grant equivalent to 3% of their annual salaries as of October 3, 2005. In January 2006, we paid the first half of the amount (1.5% of annual salary as of October 3, 2005) to our eligible employees in cash, in an aggregate amount of $18.4 million. After we have become current in our SEC periodic filings and we are able to issue freely tradable shares of our common stock, we intend to make a special contribution of approximately $14 million (the remaining 1.5% of annual salary as of October 3, 2005) under our Employee Stock Purchase Plan (the “ESPP”) on behalf of these eligible employees, which will be used to purchase shares of our common stock pursuant to the terms of the ESPP.
 
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.
 
ITEM 1A.  RISK FACTORS
 
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


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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:
 
  •     If we are not timely in filing our periodic reports by October 31, 2008, (i) a breach could be declared by our lenders under our senior secured credit facility, which may result in the lenders declaring our outstanding loans due and payable in whole or in part, and potentially resulting in a cross-default to one or more series of our convertible subordinated debentures and other indebtedness, and/or (ii) a breach could be claimed by holders of one or more series of our subordinated debentures resulting in a cross-default under our senior secured credit facility. See “—Risks that Relate to Our Liquidity.”
 
  •     If the NYSE ceases to grant us extensions to file our periodic reports with the NYSE, it has the right to begin proceedings to delist our common stock. A delisting of our common stock would have a material adverse effect on us by, among other things:
 
  •     reducing the liquidity and market price of our common stock;
 
  •     resulting in a possible event of default under and acceleration of our senior secured credit facility and triggering a right to the holders of our debentures to request us to repurchase all then outstanding debentures; and
 
  •     reducing the number of investors willing to hold or acquire our common stock, thereby restricting our ability to obtain equity financing.
 
  •     We may have difficulty retaining our clients and obtaining new clients.
 
  •     We are not eligible to use a registration statement to offer and sell freely tradable securities, which prevents us from accessing the public capital markets or delivering shares under our equity plans.
 
  •     Because we are not current in our SEC periodic filings, significant features of many of our employee equity plans remain suspended and our employees have effectively been precluded from realizing the appreciation in equity-based awards. The longer we are unable to deliver shares for purchase under our ESPP, the higher likelihood that we may experience increased rates of withdrawals by our employees of their accumulated contributions to our ESPP. For more information, see “—Risks that Relate to our Liquidity.”
 
Any of these events could materially and adversely affect our financial condition and results of operations.


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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


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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.


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Factors affecting the rates we are able to charge for our services include:
 
  •     our clients’ perception of our ability to add value through our services;
 
  •     our ability to access and use of lower-cost service delivery personnel, as compared to the ability of our competitors to do so;
 
  •     introduction of new services or products by us or our competitors;
 
  •     pricing policies of our competitors; and
 
  •     general economic conditions in the United States and abroad.
 
Factors affecting our utilization rates include:
 
  •     seasonal trends, primarily as a result of our hiring cycle and holiday and summer vacations;
 
  •     our ability to transition employees from completed projects to new engagements;
 
  •     our ability to forecast demand for our services and thereby maintain an appropriately balanced and sized workforce;
 
  •     our ability to manage attrition; and
 
  •     our ability to mobilize our workforce quickly or economically, especially outside the United States.
 
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:
 
  •     improving our controls around the financial closing process;
 
  •     remediating deficiencies in our internal controls;
 
  •     reducing the amount of time and effort spent to substantiate the accuracy and completeness of our financial results;
 
  •     reducing redundant systems and activities;
 
  •     streamlining the input and capture of data; and


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  •     hiring and retaining skilled finance and accounting personnel while decreasing the number of personnel required to support our financial close process, including reliance on contractors.
 
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:
 
  •     Our government contracts are subject to laws and regulations that provide government clients with rights and remedies not typically found in commercial contracts, which are unfavorable to us. These rights and remedies allow government clients, among other things, to:
 
  •     establish temporary holdbacks of funds due and owed to us under contracts for various reasons;
 
  •     terminate our facility security clearances and thereby prevent us from receiving classified contracts;
 
  •     cancel multi-year contracts and related orders if funds for contract performance for any subsequent year become unavailable;
 
  •     claim rights in products, systems and technology produced by us;
 
  •     prohibit future procurement awards with a particular agency if it is found that our prior relationship with that agency gives us an unfair advantage over competing contractors;
 
  •     subject the award of contracts to protest by competitors, which may require the suspension of our performance pending the outcome of the protest or our resubmission of a bid for the contract, or result in the termination, reduction or modification of the awarded contract; and
 
  •     prospectively reduce our pricing based upon achieving certain agreed service volumes or other metrics and reimburse any previously charged amounts subsequently found to have been improperly charged under the contract.
 
  •     Our failure to obtain and maintain necessary security clearances may limit our ability to perform classified work for government clients, which could cause us to lose business. In addition, security breaches in sensitive government systems that we have developed could damage our reputation and eligibility for additional work and expose us to significant losses.
 
  •     The Federal government audits and reviews our performance on contracts, pricing and cost allocation practices, cost structure, systems, and compliance with applicable laws, regulations and standards. If


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  the government finds that our costs are not reimbursable, have not been properly determined or are based on outdated estimates of our costs, we may not be allowed to bill for all or part of those costs, or we may have to refund cash that we have already collected, which may materially affect our operating margin and the expected timing of our cash flows.
 
  •     Government contracting officers have wide latitude in their ability to conclude as to the financial responsibility of companies that contract with agencies of the U.S. Federal government. Officers who conclude that a company is not financially responsible may withhold new engagements and terminate recently contracted engagements for which significant expenditures and outlays already may have been made.
 
  •     If the government uncovers improper or illegal activities in the course of audits or investigations, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or debarment from doing business with Federal government agencies. These consequences could materially and adversely affect our revenue and operating results. The inherent limitations of internal controls, even when adequate, may not prevent or detect all improper or illegal activities.
 
  •     Government contracts, and the proceedings surrounding them, are often subject to more extensive scrutiny and publicity than other commercial contracts. Negative publicity related to our government contracts, regardless of its accuracy, may further damage our business by affecting our ability to compete for new contracts.
 
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


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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:
 
  •     the business decisions of our clients regarding the use of our services;
 
  •     seasonality, including the number of work days and holidays and summer vacations;
 
  •     the stage of completion of existing projects or their termination;
 
  •     cost overruns or revenue write-offs resulting from unexpected delays or delivery issues on engagements;


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  •     periodic differences between our clients’ estimated and actual levels of business activity associated with ongoing engagements;
 
  •     our ability to transition employees quickly from completed projects to new engagements;
 
  •     the introduction of new products or services by us or our competitors;
 
  •     changes in our pricing policies or those of our competitors;
 
  •     our ability to manage costs, including personnel costs and support services costs, particularly outside the United States where local labor laws may significantly affect our ability to mobilize personnel quickly or economically;
 
  •     currency exchange fluctuations;
 
  •     ongoing costs associated with our efforts to remediate material weaknesses in our internal control over financial reporting, and to produce timely and accurate financial information despite the continuing existence of these material weaknesses;
 
  •     changes in, or the application of changes to, accounting principles generally accepted in the United States, particularly those related to revenue recognition; and
 
  •     global, regional and local economic and political conditions and related risks, including acts of terrorism.
 
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


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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.


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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.


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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:
 
  •     limit cash flow available for general corporate purposes, such as capital expenditures;
 
  •     limit our ability to obtain, or obtain on favorable terms, additional debt financing in the future for working capital or capital expenditures;
 
  •     limit our flexibility in reacting to competitive and other changes in our industry and economic conditions generally;
 
  •     expose us to a risk that a substantial decrease in net operating cash flows due to economic developments or adverse developments in our business could make it difficult to meet debt service requirements; and
 
  •     expose us to risks inherent in interest rate fluctuations because borrowings may be at variable rates of interest, which could result in high interest expense in the event of increases in interest rates.


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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:
 
                     
    Initial Per Share
        Total
 
    Conversion
    Initial
  Approximate
 
    Price/Exercise
    Conversion
  Number of
 
Convertible Debt and Warrants
  Price     Dates   Shares  
 
$250.0 million 2.50% Series A Convertible Subordinated Debentures due 2024
  $ 10.50     None (1)     23.8 million  
$200.0 million 2.75% Series B Convertible Subordinated Debentures due 2024
  $ 10.50     None (1)     19.0 million  
$200.0 million 5.0% Convertible Senior Subordinated Debentures due 2025
  $ 6.60     April 27, 2005     30.3 million  
$40.0 million 0.50% Convertible Senior Subordinated Debentures due 2010
  $ 6.75     July 15, 2006     5.9 million  
Warrants issued in connection with the July 2005 Senior Debentures
  $ 8.00     July 15, 2006     3.5 million  
                     
Total
                82.5 million  
                     
 
 
(1) The holders of the Series A Debentures and Series B Debentures have the right to convert the debentures into shares of common stock only upon the occurrence of certain triggering events.
 
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


19


 

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:
 
                             
    Exercise Price        
Number of Shares
  Range     Average     Calendar Year  
 
 1,470,000
  $ 5.72 — $10.00     $ 8.28       2007  (remainder of 2007)
961,000
    5.72 — 8.77       8.06       2008  
713,000
    7.20 — 8.70       7.85       2009  
 
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):
 
         
Number of Shares
 
Calendar Year
 
8,717,582
  2007
4,138,191
  2008
30,839,099
  2009 and thereafter
 
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.


20


 

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:
 
  •     our Board of Directors is classified into three classes, each of which will serve for staggered three-year terms;
 
  •     a director may be removed by our stockholders only for cause and then only by the affirmative vote of two-thirds of our voting stock;
 
  •     only our Board of Directors or the Chairman of our Board of Directors may call special meetings of our stockholders;
 
  •     our stockholders may not take action by written consent;
 
  •     our stockholders must comply with advance notice procedures in order to nominate candidates for election to our Board of Directors or to place stockholders’ proposals on the agenda for consideration at meetings of the stockholders;
 
  •     if stockholder approval is required by applicable law, any mergers, consolidations and sales of all or substantially all of our assets must be approved by the affirmative vote of at least two-thirds of our voting stock; and
 
  •     our stockholders may amend or repeal any of the foregoing provisions of our certificate of incorporation or our bylaws only by a vote of two-thirds of our voting stock.
 
ITEM 1B.  UNRESOLVED STAFF COMMENTS
 
None.
 
ITEM 2.  PROPERTIES
 
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.


21


 

 
ITEM 3.  LEGAL PROCEEDINGS
 
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:
 
  •     Claims and investigations arising from our continuing inability to timely file periodic reports under the Exchange Act, and the restatement of our financial statements for certain prior periods to correct accounting errors and departures from generally accepted accounting principles for those years (“SEC Reporting Matters”);
 
  •     Claims and investigations being conducted by agencies or officers of the U.S. Federal government and arising in connection with our provision of services under contracts with agencies of the U.S. Federal government (“Government Contracting Matters”); and
 
  •     Claims made in the ordinary course of business by clients seeking damages for alleged breaches of contract or failure of performance, by current or former employees seeking damages for alleged acts of wrongful termination or discrimination, and by creditors or other vendors alleging defaults in payment or performance (“Other Matters”).
 
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


22


 

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


23


 

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.


24


 

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.
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
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.
 
                 
Nominee
  For     Withhold  
 
Class II Directors:
               
Wolfgang Kemna
    146,986,049       15,119,408  
Albert L. Lord
    150,959,411       11,146,046  
J. Terry Strange
    147,088,156       15,017,301  
Class III Directors:
               
Roderick C. McGeary
    160,035,388       2,070,069  
Harry L. You
    160,822,084       1,283,373  
 
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.
 
                 
For
 
Against
   
Abstain
 
 
122,729,827
    37,623,511       1,752,079  
 
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.
 
                 
For
 
Against
   
Abstain
 
 
155,829,428
    5,636,361       68,896  


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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.


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PART II.
 
ITEM 5.  MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Market 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
 
                 
    Price Range of
 
    Common Stock  
    High     Low  
 
Fiscal Year 2007
               
Second Quarter (as of June 22)
  $ 8.00     $ 6.90  
First Quarter
    8.56       7.33  
Fiscal Year 2006
               
Fourth Quarter
    8.89       7.44  
Third Quarter
    9.00       7.36  
Second Quarter
    9.59       7.55  
First Quarter
    9.16       7.77  
Fiscal Year 2005
               
Fourth Quarter
    7.99       6.54  
Third Quarter
    8.50       7.27  
Second Quarter
    8.82       4.65  
First Quarter
    8.89       7.34  
Fiscal Year 2004
               
Fourth Quarter
    9.98       7.29  
Third Quarter
    9.25       7.22  
Second Quarter
    11.00       8.03  
First Quarter
    11.30       9.50  


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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:
 
  •     On December 22, 2004, we completed the sale of the $225.0 million aggregate principal amount of our 2.50% Series A Convertible Subordinated Debentures due 2024 (the “Series A Debentures”) and the $175.0 million aggregate principal amount of our 2.75% Series B Convertible Subordinated Debentures due 2024 (the “Series B Debentures”).
 
  •     On January 5, 2005, we completed the sale of an additional $25.0 million aggregate principal amount of our Series A Debentures and an additional $25.0 million of our Series B Debentures.
 
  •     On April 27, 2005, we completed the sale of the $200.0 million aggregate principal amount of our 5.00% Convertible Senior Subordinated Debentures due 2025 (the “April 2005 Senior Debentures”).
 
  •     On July 15, 2005, we completed the sale of the $40.0 million aggregate principal amount of our 0.50% Convertible Senior Subordinated Debentures due July 2010 (the “July 2005 Senior Debentures”) and common stock warrants (the “July 2005 Warrants”) to purchase up to 3.5 million shares of our common stock.


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Equity Compensation Plan Information
(as of December 31, 2006)
 
                         
    (a)     (b)     (c)  
                Number of securities
 
                remaining available
 
    Number of securities
    Weighted-average
    for future issuance
 
    to be issued upon
    exercise price of
    under equity
 
    exercise of
    outstanding
    compensation plans
 
    outstanding options,
    options, warrants
    (excluding securities
 
Plan Category
  warrants and rights     and rights     reflected in column (a))  
 
Equity Compensation Plans Approved by Security Holders
    53,844,732     $ 11.10       58,768,750 (1)(2)
Equity Compensation Plans Not Approved by Security Holders
                 
                         
Total
    53,844,732     $ 11.10       58,768,750  
                         
 
 
(1) Includes 35,019,474 shares of common stock available for grants of stock options, restricted stock, stock appreciation rights and other stock-based awards under our LTIP and 23,749,276 shares of common stock available for issuance under our ESPP.
 
(2) Under our LTIP, the number of shares of common stock authorized for grants or awards under the plan is 92,179,333. Under our ESPP, the number of shares of our common stock available for purchase is 3,766,096 shares, plus an annual increase on the first day of each of our fiscal years beginning on July 1, 2001 and ending on June 30, 2026 equal to the lesser of (i) 30 million shares, (ii) three percent of the shares outstanding on the last day of the immediately preceding fiscal year or (iii) a lesser number of shares as determined by our Board of Directors or the Compensation Committee of the Board.
 
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.


29


 

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.
 
(PERFORMANCE GRAPH)
 
ITEM 6.  SELECTED FINANCIAL DATA
 
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.


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Statements of Operations
 
                                                 
                      Six Months
             
    Year Ended     Ended
    Year Ended  
    December 31,
    December 31,
    December 31,
    December 31,
    June 30,
    June 30,
 
    2006     2005     2004     2003     2003     2002  
                                  (unaudited)  
    (in thousands, except per share amounts)  
 
Revenue
  $ 3,444,003     $ 3,388,900     $ 3,375,782     $ 1,522,503     $ 3,157,898     $ 2,383,099  
                                                 
Costs of service:
                                               
Costs of service
    2,863,856       3,001,327       2,816,559       1,221,249       2,436,864       1,761,444  
Lease and facilities restructuring charge
    29,621       29,581       11,699       61,436       17,283        
Impairment charges
                                  23,914  
                                                 
Total costs of service
    2,893,477       3,030,908       2,828,258       1,282,685       2,454,147       1,785,358  
Gross profit
    550,526       357,992       547,524       239,818       703,751       597,741  
Amortization of purchased intangible assets
    1,545       2,266       3,457       10,212       45,127       3,014  
Goodwill impairment charge (1)
          166,415       397,065       127,326              
Selling, general and administrative expenses
    748,250       750,867       641,176       272,250       550,098       477,230  
                                                 
Operating income (loss)
    (199,269 )     (561,556 )     (494,174 )     (169,970 )     108,526       117,497  
Insurance settlement
    38,000                                
Interest / other income (expense), net (2)
    (19,774 )     (37,966 )     (17,644 )     (1,773 )     (10,493 )     1,217  
Loss on early extinguishment of debt
                (22,617 )                  
                                                 
Income (loss) before taxes and cumulative effect of change in accounting principle
    (181,043 )     (599,522 )     (534,435 )     (171,743 )     98,033       118,714  
Income tax expense (3)
    32,397       122,121       11,791       4,872       65,342       80,263  
                                                 
Income (loss) before cumulative effect of change in accounting principle
    (213,440 )     (721,643 )     (546,226 )     (176,615 )     32,691       38,451  
Cumulative effect of change in accounting principle, net of tax (4)
                                  (79,960 )
                                                 
Net income (loss) applicable to common stockholders (5)
  $ (213,440 )   $ (721,643 )   $ (546,226 )   $ (176,615 )   $ 32,691     $ (41,509 )
                                                 
Earnings (loss) per share—basic and diluted:
                                               
Income (loss) before cumulative effect of change in accounting principle applicable to common stockholders
  $ (1.01 )   $ (3.59 )   $ (2.77 )   $ (0.91 )   $ 0.18     $ 0.24  
Cumulative effect of change in accounting principle
                                  (0.50 )
                                                 
Net income (loss) applicable to common stockholders
  $ (1.01 )   $ (3.59 )   $ (2.77 )   $ (0.91 )   $ 0.18     $ (0.26 )
                                                 


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Balance Sheet Data
 
                                                 
    December 31,
    December 31,
    December 31,
    December 31,
    June 30,
    June 30,
 
    2006     2005     2004     2003     2003     2002  
                                  (unaudited)  
    (in thousands)  
 
Cash, cash equivalents, and restricted cash (6)
  $ 392,668     $ 376,587     $ 265,863     $ 122,475     $ 121,790     $ 222,636  
Total assets
    1,939,240       1,972,426       2,182,707       2,211,613       2,150,210       948,029  
Long-term liabilities
    1,078,930       976,501       648,565       408,324       375,991       28,938  
Total debt
    671,850       674,760       423,226       248,228       277,176       1,846  
Total liabilities
    2,116,541       2,017,998       1,558,009       1,141,618       1,006,990       384,935  
Total stockholders’ equity (deficit)
    (177,301 )     (45,572 )     624,698       1,069,995       1,143,220       563,094  
 
 
(1) During the years ended December 31, 2005 and 2004 and the six months ended December 31, 2003, we recorded goodwill impairment charges of $166.4 million, $397.1 million and $127.3 million, respectively. For additional information regarding these goodwill impairment charges and international acquisitions, see Note 5, “Business Acquisitions, Goodwill and Other Intangible Assets,” of the Notes to Consolidated Financial Statements.
 
(2) During the year ended December 31, 2004, we recorded a change in accounting principle resulting in a charge of $0.5 million related to the elimination of a one-month lag in reporting for certain Asia Pacific subsidiaries, as well as a subsidiary within the EMEA region. While the elimination of the one-month lag is considered a change in accounting principle, the effect of the change is included in other income (expense) due to the immateriality of the change in relation to consolidated net loss.
 
(3) During the year ended December 31, 2005, we recorded a valuation allowance of $55.3 million, primarily against our U.S. deferred tax assets to reflect our conclusions that it is more likely than not that these tax benefits would not be realized. For additional information, see Note 14, “Income Taxes,” of the Notes to Consolidated Financial Statements.
 
(4) During the year ended June 30, 2002, we recognized a transitional impairment loss of $80.0 million as the cumulative effect of a change in accounting principle in connection with adopting Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.”
 
(5) During the fourth quarter of 2006, the one-month reporting lag in the remaining EMEA entities was eliminated. The elimination of one month of activity increased our 2006 consolidated net loss for the year ended December 31, 2006 by $1.2 million.
 
(6) Restricted cash amounts at December 31, 2006, 2005 and 2004 were $3.1 million, $121.2 million and $21.1 million, respectively. As of December 31, 2003, June 30, 2003 and June 30, 2002, there was no restricted cash.


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ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“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’


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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.
 
  •     Bookings. We believe that information regarding our new contract bookings provides useful trend information regarding how the volume of our new business changes over time. Comparing the amount of new contract bookings and revenue provides us with an additional measure of the short-term sustainability of revenue growth. Information regarding our new bookings should not be compared to, or substituted for, an analysis of our revenue over time. There are no third-party standards or requirements governing the calculation of bookings. New contract bookings are recorded using then existing currency exchange rates and are not subsequently adjusted for currency fluctuations. These amounts represent our estimate at contract signing of the net revenue expected over the term of that contract and involve estimates and judgments regarding new contracts as well as renewals, extensions and additions to existing contracts. Subsequent cancellations, extensions and other matters may affect the amount of bookings previously reported. Bookings do not include potential revenue that could be earned from a client relationship as a result of future expansion of service offerings to that client, nor does it reflect option years under contracts that are subject to client discretion. In addition, government contracts or work orders are not included in bookings until related appropriations spending has been properly approved and, then, only to the extent of the amount of spending approved. Consequently, there can be significant differences between the times of contract signing and new contract booking recognition. Although our level of bookings provides an indication of how our business is performing, we do not characterize our bookings, or our engagement contracts associated with new bookings, as backlog because our engagements generally can be cancelled or terminated on short notice or without notice.
 
  •     Revenue Growth. Unlike bookings, which provide only a general sense of future expectations, period-over-period comparisons of revenue provide a meaningful depiction of how successful we have been in growing our business over time.


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  •     Gross Margin (gross profit as a percentage of revenue). Gross margin is a meaningful tool for monitoring our ability to control our costs of services. Analysis of the various cost elements, including professional compensation expense, effects of foreign exchange rate changes and the use of subcontractors, as a percentage of revenue over time can provide additional information as to the key challenges we are facing in our business. The cost of subcontractors is generally more expensive than the cost of our own workforce and can negatively impact our gross profit. While the use of subcontractors can help us to win larger, more complex deals, and also may be mandated by our clients, we focus on limiting the use of subcontractors whenever possible in order to minimize our costs. We also utilize certain adjusted gross margin metrics in connection with the vesting and settlement of certain employee incentive awards. For a discussion of these metrics, see Item 11, “Executive Compensation—Compensation Discussion and Analysis.”
 
  •     Utilization. Utilization represents the percentage of time our consultants are performing work, and is defined as total hours charged to client engagement or to non-chargeable client-relationship projects divided by total available hours for any specific time period, net of holiday and paid vacation hours. In 2006, we changed how we define utilization to make this metric more consistent with how we believe our industry peer group measures this metric. Utilization percentages for 2005 set forth herein have been adjusted to conform to this new definition.
 
  •     Days Sales Outstanding (“DSO”). DSO is an operational metric that approximates the amount of earned revenue that remains unpaid by clients at a given time. DSOs are derived by dividing the sum of our outstanding accounts receivable and unbilled revenue, less deferred revenue, by our average net revenue per day. “Average net revenue per day” is determined by dividing total net revenue for the most recently ended trailing twelve-month period by 365.
 
  •     Free Cash Flow. Free cash flow is calculated by subtracting purchases of property and equipment from cash provided by operating activities. We believe free cash flow is a useful measure because it allows better understanding and assessment of our ability to meet debt service requirements and the amount of recurring cash generated from operations after expenditures for fixed assets. Free cash flow does not represent our residual cash flow available for discretionary expenditures as it excludes certain mandatory expenditures such as repayment of maturing debt. We use free cash flow as a measure of recurring operating cash flow. Free cash flow is a non-GAAP financial measure. The most directly comparable financial measure calculated in accordance with generally accepted accounting principles in the United States of America (“GAAP”) is net cash provided by operating activities.
 
  •     Attrition. Attrition, or voluntary total employee turnover, is calculated by dividing the number of our employees who have chosen to leave the Company within a certain period by the total average number of all employees during that same period. Our attrition statistic covers all of our employees, which we believe provides metrics that are more compatible with, and comparable to, those of our competitors.
 
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


35


 

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:
 
  •     New contract bookings for 2006 were $3,130.0 million, a slight decrease from new contract bookings of $3,130.7 million for 2005. We experienced strong bookings growth in all of our industry groups other than Commercial Services and Financial Services, with the most notable growth in our EMEA and Public Services industry groups. Commercial Services bookings were significantly lower when compared year-over-year, primarily due to 2005 bookings in excess of $100 million related to the signing of our contract with Hawaiian Telcom Communications, Inc. (the “HT Contract”), one of the largest contracts in our history. The short-term uncertainty and confusion precipitated by the dispute with certain holders of our Series B Debentures also appears to have had some temporary effect on bookings during the fourth quarter of 2006, particularly in our Financial Services business unit, which resulted in a year-over-year decrease in bookings for that business unit and can be expected to impact its revenue in early 2007. New contract bookings for the three months ended March 31, 2007 were approximately $709.5 million, compared with new contract bookings of $804.6 million for the three months ended March 31, 2006. Bookings growth in our international operations was not sufficient to offset contraction in our North American industry groups. In North America, Public Service bookings appear to have been impacted by increasing uncertainty surrounding the timing of approval of various Federal contract appropriations being precipitated by various factors, including ongoing congressional debates regarding military operations in Iraq and Afghanistan and the 2008 Federal budget. Year-over-year decreases in Public Services bookings for the three months ended March 31, 2007 are substantially attributable to growth in the first quarter of 2007 of the total contract value of new Federal contracts signed for which appropriations approval remained pending (“unfunded Federal contracts”) at March 31, 2007. We do not record unfunded Federal contracts as new contract bookings while appropriation approvals remain pending as there can be no assurances that these approvals will be forthcoming in the near future, if at all. Public Services bookings were also affected by one exceptionally large booking in our State, Local and Education (“SLED”) sector in the first quarter of 2005. Outside of our Public Services business unit, new contract bookings in North America were also negatively affected by commercial clients segregating larger projects into series of smaller work orders.
 
  •     Our revenue for 2006 was $3,444.0 million, representing an increase of $55.1 million, or 1.6%, over 2005 revenue of $3,388.9 million. Significant revenue increases in Asia Pacific, Public Services and EMEA were substantially offset by Commercial Services revenue declines and reversals attributable to the settlement of disputes with two significant telecommunications industry clients.
 
  •     Our gross profit for 2006 was $550.5 million, compared to $358.0 million for 2005. Gross profit as a percentage of revenue increased to 16.0% during 2006 from 10.6% during 2005. Revenue increases, as well as reductions in professional compensation expense and other direct contract expenses, were relatively equal contributors to this improvement.
 
  •     During 2006 and 2007, we worked with Hawaiian Telcom Communications, Inc., a telecommunications industry client (“HT”), to resolve issues relating to our delivery of services for the design, build and operation of various information technology systems. On February 8, 2007, we entered into a Settlement Agreement and Transition Agreement with HT. Pursuant to the Settlement Agreement, we paid $52 million, $38 million of which was paid by certain of our insurers. In


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  addition, we waived approximately $29.6 million of invoices and other amounts otherwise payable by HT to the Company. The Transition Agreement governed our transitioning of the remaining work under the HT Contract to a successor provider, which has been completed. In 2006 and 2005, we incurred losses of $28.2 million and $111.7 million, respectively, under the HT Contract.
 
  •     On June 18, 2007, we entered into a settlement with a telecommunications industry client resolving the client’s claims under a client-initiated “audit” of certain of the Company’s time and expense charges relating to an engagement that closed in 2003. In connection with the settlement, we will make six equal annual payments to the client in an aggregate amount of $24 million, with the first payment made on the signing date in return for a full release of the client’s claims. While this settlement provides us with the opportunity to perform services for this client in the future, the dispute has and will likely continue to negatively affect the level of new bookings anticipated from this client in 2007.
 
  •     On May 22, 2007, we settled certain disputes with KPMG that had arisen between our companies related to the February 2001 Transition Services Agreement. KPMG had asserted that we were liable to it for approximately $31 million under the Transition Services Agreement for certain technology service termination costs. While neither company admitted any liability under these claims, these claims were mutually released. In addition, we agreed to amend a number of real estate subleases between KPMG and BearingPoint, and consent to the further subletting of others. The settlement further involves cash payments by us to KPMG of $5 million over a three-year time frame.
 
  •     We incurred SG&A expenses of $748.3 million in 2006, representing a decrease of $2.6 million, or 0.3%, from SG&A expenses of $750.9 million in 2005. While we achieved costs savings by reducing the size of our sales force and other business development expenses, these cost savings were significantly offset by continuing increases in our finance and accounting costs, primarily for sub-contracted labor and other costs related to the closing of our 2005 financial statements, and charges related to our agreement with Yale University. 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 for 2005. We currently expect our costs for 2007 related to these efforts to be approximately $68 million.
 
  •     For 2006, we decided to allocate $17 million among our managing directors as a performance cash bonus because: (i) we had not previously paid performance-based bonuses to our managing directors and desired to begin implementing our “pay for performance” philosophy; (ii) 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; and (iii) we were unable to provide for bonuses under the MD Compensation Plan. Bonuses were not paid under the MD Compensation Plan because the plan has not yet been fully activated and the target levels of profitability set forth under the plan were not achieved due to our ongoing issues related to our financial accounting systems and internal controls and their related impact on our ability to become timely in our SEC periodic reports and deliver shares of common stock under equity-based awards. The amount of the bonus was determined by giving consideration to, and was partially covered by, the total base compensation we budgeted for payment to our managing directors for 2006. The total bonus exceeded the actual amount of compensation that would have been paid to our managing directors for 2006 by $10 million. Management believes the $192.5 million increase in 2006 gross profit across all industry groups justified payment of these amounts.
 
  •     For 2006, while all of our material weaknesses in our internal control over financial reporting cited for 2005 remain, we have remediated certain aspects of these material weaknesses, and improvements in our internal control over financial reporting continue. Over the course of 2006, we undertook significant remediation efforts, which reduced the total numbers of deficiencies and material weaknesses that continue to contribute to the material weaknesses in our internal control environment by 24% and 33%, respectively. Senior management implemented and caused to be sustained


37


 

  significant changes to personnel, including finance and accounting personnel in our corporate offices, processes and policies and have communicated the importance of our Standards of Business Conduct and ethics, and the importance of internal control over financial reporting. In addition, senior management caused to be implemented policies and processes and other mechanisms around the identification of our long-term assignment personnel in the United States and the accuracy and completeness of the related financial accounts.
 
  •     In 2006, we realized a net loss of $213.4 million, or a loss of $1.01 per share, compared to a net loss of $721.6 million, or a loss of $3.59 per share, in 2005. The decline in net loss in 2006 as compared to 2005 is attributable to several factors, including:
 
  •     Our gross profit across all industry groups in 2006 improved over our 2005 gross profit by $192.5 million;
 
  •     We did not have a goodwill impairment charge in 2006, compared to a $166.4 million goodwill impairment charge incurred in 2005;
 
  •     We recorded $38 million in 2006 for an insurance settlement in connection with our settlement with HT; and
 
  •     Our income tax provision for 2006 was lower than our income tax provision for 2005, as the 2005 amount included a $55.3 million increase to valuation allowance primarily against our U.S. deferred tax assets.
 
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.
 
  •     Utilization for 2006 was 76.2%, compared with 75.8% in 2005. Utilization for the three months ended March 31, 2007 was 76.6%.
 
  •     Free cash flow for 2006 and 2005 was $8.1 million and ($153.9) million, respectively. Net cash provided by and (used in) operating activities in 2006 and 2005 was $58.7 million and ($113.1) million, respectively. Purchases of property and equipment in 2006 and 2005 were $50.6 million and $40.8 million, respectively. The change in free cash flow for 2006 compared to 2005 resulted primarily from the following:
 
  •     We lowered our DSOs through enhancements in our cash collections efforts. At December 31, 2006, our DSOs stood at 82 days, representing a decrease of 12 days, or 13%, from our DSOs at December 31, 2005. Our continued focus on this metric during 2006 improved our free cash flow by $136.3 million as compared to 2005;
 
  •     We experienced higher operating profitability in our business, as evidenced by the sharp decline in operating loss for 2006 as compared to 2005; and
 
  •     We experienced greater cash outflows in 2006 due to payments made for professional services and related expenses accrued under the HT Contract during 2005, and in connection with our settlement with Peregrine Systems, Inc.
 
  •     In November 2006, we settled litigation with certain holders of our Series B Debentures who had alleged that we were in default under the applicable indenture as a result of our failure to timely provide certain SEC periodic reports to the trustee. Although we continue to believe we were not in default under the applicable indenture, and a subsequent court’s decision has provided support for our belief, this dispute exemplifies some of the recurring challenges presented to the growth of our business by the continuation of our inability to timely file our SEC periodic reports. We continue to be guardedly optimistic that achieving our goal of becoming current in our SEC periodic reports in


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  2007 and beginning to timely file our SEC periodic reports in 2008 will help alleviate some of the business pressures we have recently experienced in this regard.
 
  •     In 2006, we continued to focus on enhancing our global operations model. We launched an on-line, centrally managed Strategy and Operating Manual that standardizes and centralizes our operating processes and procedures, including legal and financial compliance procedures. We also created improved contracting procedures that will be implemented in the second half of 2007, which will provide additional references, resources and rigor around the contracting process. We also established a Global Account Management Program and governance structure that will focus on the identification and management of key global accounts and a Global Solutions Council represented by all of our industry groups that will focus on identifying opportunities for globalized solution suites.
 
  •     In 2006, we increased the use of lower cost resources, both offshore (China and India) and domestically (Hattiesburg, Mississippi). We focused our global delivery centers on developing specific skills and capabilities that would enhance our delivery capabilities. In 2006, we opened new facilities in Bangalore, India to expand our offshore footprint in an increasingly competitive market. In 2007, we will continue to optimize our global delivery model to improve our cost structure for our clients, and we expect to continue to aggressively increase the number of engagement hours delivered through our global delivery centers.
 
  •     In the first half of 2006, we hired a new General Counsel and Chief Compliance Officer, each with significant prior regulatory and compliance experience. We have strengthened our compliance programs by (1) restructuring and centralizing our compliance efforts under our Chief Compliance Officer, (2) developing and implementing in 2006 firm-wide enhanced compliance training with respect to the Foreign Corrupt Practices Act (the initial roll-out of which was completed by over 95% of our workforce), (3) adopting in 2007 a new Standards of Business Conduct based on best industry practices (to replace our prior Code of Business Conduct and Ethics) and (4) creating in 2007 a Compliance Committee comprised of members of our senior management whose focus will be to properly organize and allocate the necessary resources to address broader, Company-wide compliance efforts.
 
  •     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. We finalized decisions regarding the design of, and obtained licenses for the components needed to substantially replace, our North American financial reporting systems. For additional information regarding the transformation of our North American financial reporting systems, see “—Principal Business Priorities for 2007 and Beyond.”
 
  •     During 2006, we completed the deployment of our Program Control function, composed of approximately 200 accounting professionals, designed to support the completeness and accuracy of engagement accounting details in North America. This function is designed to build effective financial controls into the lifecycle of a contract by supporting the timely assembly and review of revenue recognition, engagement close-out and other contract cost elements as part of our daily operations. The success of this function will depend on a number of factors, including our ability to attract and retain qualified finance professionals, the implementation of an effective control environment over client contract accounting and the development of financial systems, and the acceptance and utilization of these systems by our managing directors, to support the function.
 
  •     As of December 31, 2006, we had approximately 17,500 full-time employees, including approximately 15,300 consulting professionals, which represented a decrease in billable headcount of approximately 0.6% from full-time employees and consulting professionals at December 31, 2005 of 17,600 and 15,400, respectively. As of March 31, 2007, we had approximately 17,500 full-time employees, including approximately 15,200 consulting professionals.
 
  •     Our voluntary, annualized attrition rate for 2006 was 25.6%, compared to 25.3% for 2005. The highly competitive industry in which we operate, and our continuing issues related to our North


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  American financial reporting systems and internal controls, have made it particularly critical and challenging for us to attract and retain experienced personnel. Our voluntary, annualized attrition rate for the three months ended March 31, 2007 was 23.9%, compared to our voluntary annualized attrition rate of 24.2% for the three months ended March 31, 2006.
 
  •     In November 2006, we began our partnership with Yale University to create the BearingPoint Leadership Program at Yale School of Management, an innovative education and training program focusing on career and leadership development for our employees. Participants are taught a curriculum jointly developed by a faculty composed of both Yale professors and BearingPoint specialists, including a consulting skills workshop for experienced professionals and management skills training for newly hired or promoted managers and managing directors. We believe that our collaboration with Yale will offer our employees and new recruits with a unique learning experience that will help improve our ability to recruit and retain talented and motivated employees, provide them with the skills and training that will enhance the delivery of services to our clients and cultivate a shared set of values, skills and culture that we hope will come to define a career with us. Furthermore, we believe that our relationship with a top-tier university will augment our brand and enhance our recruiting opportunities.
 
  •     In April 2007, the U.S. Defense Contract Audit Agency (“DCAA”) issued a report on its audit of our financial capability, which concluded that our financial condition is acceptable for performing government contracts. The DCAA examined our financial condition and capability to determine if we have adequate financial resources to perform government contracts in the current and near-term (up to one year). We expect that after the filing of this Annual Report on Form 10-K, the DCAA will begin a new audit of our financial capability, to re-assess our financial condition.
 
  •     As previously reported, in May 2006, the DCAA issued a report on its audit of our control environment and overall accounting systems controls, which audit began in 2005. The DCAA report concluded that our accounting system was “inadequate in part,” meaning that our system is adequate for government contracting. The DCAA report contained four condition statements, the most material of which relates to our failure to timely file our periodic reports with the SEC. The remaining three condition statements have been significantly or completely remediated.
 
  •     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 us from CreditWatch, in accordance with its policy of withdrawing ratings for companies that have not been current in their SEC filings for an extended period of time. 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.
 
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:
 
  •     Focus on Larger and More Profitable Clients and Projects. We must continue to focus our sales efforts on more profitable and growing client accounts and projects. Our long-term clients continue to predominate our revenue base, and we intend to prioritize our efforts around deepening these


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  relationships. With respect to smaller projects, we are standardizing our approach so as to either increase their profitability or avoid adding them to our portfolio. A key factor in returning to positive cash flow from operations will be our ability to significantly reduce our SG&A expenses associated with marginally profitable opportunities.
 
  •     Focus on Strengths and Specialization. We are seeking to improve the clarity of our business strategy by requiring our industry groups and managed services teams to further refine their respective areas of focus in terms of exclusively targeted segments, industries and offerings, and to more clearly differentiate their products and services.
 
  •     Increase Use of Offshore Services. We are continuing to increase the use of lower cost resources both offshore (China and India) and domestically (Hattiesburg, Mississippi) to support engagement work. Our EMEA practice is also exploring Central European near-shore capabilities. Our ability to counter the increasing success of offshore service providers in gaining market share in lower-margin, high volume market offerings will continue to depend on our ability to achieve our strategy of leveraging our comparatively limited network of global delivery centers and lower cost resources, with the goal of sustaining profitable growth in more sophisticated, strategic and transformational type engagements. While we had some success in this area in 2006, in order to continue to be able to combat increasing competition, we must continue to show improvements in both increasing the volume of our services delivered offshore and maintaining our margins on that work.
 
  •     Leverage Project Management and Reduce Cost of Delivery. We are leveraging our workforce more effectively by improving our managing director-to-staff ratio on projects from 1:17 as of March 31, 2005 to 1:24 as of December 31, 2006. We continue to seek to improve this ratio in 2007 and beyond. We also are implementing stricter criteria concerning the use of subcontractors to reduce our use of subcontractors and drive greater utilization of internal resources.
 
  •     Utilize Professional Services Staff More Efficiently. We are striving to become more efficient in recruiting, training and utilizing our professional services staff. Historically, we have faced challenges associated with transitioning employees from completed projects to new engagements, forecasting demand for our services, maintaining an appropriately balanced and sized workforce, and managing attrition. Our current staffing and, hence, recruiting efforts are managed on an industry group basis. We must continue to focus on improving both the processes and systems surrounding recruiting individuals with the right skill sets and staffing client engagements globally in a more efficient manner. We are actively seeking and soon hope to hire an experienced human resources executive to reinvigorate and redesign our human resources function.
 
  •     Manage By Standardized Metrics. Our new Chief Operating Officer is implementing a standardized key performance indicator scorecard for all industry groups and segments that will reinforce consistent management reporting.
 
  •     Improve Risk Management Processes. We have now implemented engagement risk management processes at both business unit and firm-wide levels to better evaluate prospective engagement and execution risks. Through these steps we intend to implement specific operations procedures to be utilized within our industry groups and deal review procedures to review significant proposals and contracts. Our legal team is completing a review of the terms of our larger, more risky engagements, the results of which will be used to conduct periodic deal assessments and reviews throughout the course of these engagements.
 
  •     Reduce Cost and Improve Quality of Corporate Services. We continue to aggressively explore cost reduction opportunities to move non-core administrative activities offshore. In 2007, we also plan to reduce our infrastructure costs by (1) eliminating costs associated with previous revenue recognition processes with the full deployment of our Program Control Function, (2) reducing employee attrition, thereby reducing related costs relating to hiring and exiting employees, (3) reducing our reliance on external consultants, and (4) consolidating our information technology hosting providers.


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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:
 
  •     Shorten the Financial Closing Process. To achieve and sustain timely financial and SEC periodic reporting, public companies with properly functioning internal controls prepare their financial statement accounts and balances (“the financial closing process”) on a monthly cycle within fifteen days of month’s end. Since we first identified a significant number of material weaknesses in our internal control over financial reporting in 2004, we have conducted only a quarterly financial closing process. The financial closing process for the first quarter of 2007 is not complete. We will be transitioning to a monthly financial closing process when we begin the preparation of our financial statement accounts and balances for the third quarter of 2007. We are targeting achievement of a monthly financial closing process 30 days after month’s end, beginning with the first quarter of 2008. Our ability to achieve this target on time will depend, in part, on (1) becoming timely and maintaining only one open monthly cycle at a time, (2) strengthening overall control processes to rely more on systems (rather than manual) processes, (3) gaining experience with new underlying tools and processes, (4) moving to a real-time quarterly review process by our auditors, (5) completing organizational build-outs in certain areas, (6) retaining an appropriate number of qualified Finance personnel, particularly in our international locations, and (7) full cooperation from our client engagement teams and other corporate services in timely providing financial information and updates into our financial closing process.
 
  •     Improve Disclosure Controls. Under the SEC’s reporting requirements, we must file our quarterly reports within forty days of the end of each fiscal quarter and our annual reports within sixty days of the end of each fiscal year. We are very proud of the significant improvements made by our Finance and Legal teams in 2006 in the preparation, review and completion of the content of our SEC periodic reports. However, our disclosure controls process must be further streamlined and coordinated across the Company for us to achieve timely filing of our SEC periodic reports, given


42


 

  that our monthly financial closing process is targeted to be reduced to no less than 30 days by early 2008.
 
  •     Remediate Material Weaknesses. We must remediate the material weaknesses in our financial reporting to remove the significant amounts of manual, time-consuming steps that currently exist in our financial closing process to be able to consistently file our SEC periodic reports on a timely basis. Resolving these material weaknesses is also crucial to being able to obtain timely and accurate standardized metrics with which to manage our business, increase cash collections and further reduce our DSOs, assuming we can achieve our targets for shortening the financial closing process. We were unsuccessful in our attempts to remediate all of our material weaknesses by the end of 2006 and can give no assurances as to how many material weaknesses we will be able to remediate by the end of 2007. We currently do not anticipate full remediation of all material weaknesses until 2008, however, we must make significant progress in our remediation during 2007, if we are to sustain timely financial and SEC periodic reporting in 2008.
 
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.
 
  •     PSU Program. In February 2007, the Compensation Committee approved the issuance of up to 25 million PSUs to our managing directors and other high-performing senior-level employees, including its executive officers. The PSU awards, each of which initially represents the right to receive at the time of settlement one share of the Company’s common stock, will vest on December 31, 2009. Generally, for any PSU award to vest, two performance-based metrics must be achieved for the performance period beginning on February 2, 2007 and ending on December 31, 2009: (1) the Company must first achieve a compounded average annual growth target in consolidated business unit contribution, and (2) total shareholder return for shares of the Company’s common stock must be at least equal to the 25th percentile of total shareholder return of the Standard & Poor’s 500 (“S&P 500”). For information, see Item 11, “Executive Compensation —Compensation Discussion and Analysis.” Depending on the Company’s total shareholder return relative to those companies that comprise the S&P 500, the PSU awards will vest on December 31, 2009 at percentages varying from 0% to 250% of the number of PSU awards originally awarded, and will settle on various dates in 2010 and 2011. We have no plans to make additional equity awards on a broad basis to our existing employees through 2009.
 
  •     Performance Cash Awards. In February 2007, the Compensation Committee also granted performance cash awards providing for the payment of up to $50 million to a group of our managing directors and other high-performing senior-level employees, including executive officers. Generally, 50% of these cash retention awards will be earned on December 31, 2007, and 50% will be earned


43


 

  on December 31, 2008, subject to the Company achieving the same compounded growth rate target in consolidated business unit contribution as required under the PSU program for the relevant period of time. If, however, the minimum compounded annual growth in consolidated business unit contribution has not been achieved at the end of each of those years, the awards may still be fully earned (up to the full remaining available amount of the award) if compounded average annual growth for the three-year period ended December 31, 2009 is achieved. Amounts earned will be paid by March 31, 2010 or, if the determination of amounts earned cannot be made by March 31, within 30 days of the date when the determination is made. Furthermore, we believe this cash award program provides retentive benefits for its participants, particularly when our equity based awards are illiquid, while further enhancing a pay-for-performance culture within the Company.
 
  •     Enhance Employee Training. To help our employees develop the skills they need to be successful with clients and advance their careers, we will further implement our training programs, including the joint training program with Yale University. In 2007, our curriculum includes consulting skills workshops for both our new analysts as well as our more experienced consultants, a management skills workshop for top performing managers focused on our company’s vision, direction, strategy and culture, and leadership workshops, both at the senior manager and new managing directors levels. We expect that in 2007, over 1,500 of our employees will participate in one of our programs at Yale.
 
  •     In 2007, we will be developing a new High-Performing Senior Manager Program focused on identifying and developing high-performing employees, which will be supported by a new curriculum and new promotion processes. This program will represent our investment in enhanced succession planning as well as our commitment to developing our next generation of leaders.
 
  •     In 2007, we are implementing two initiatives aimed at enhancing career development and performance management for our employees. The BearingPoint Core Competencies provide career guidance to our employees by defining a roadmap for career development and progression, setting forth a standardized set of behaviors that can be used to assess performance within each career level and identify areas for development. These core competencies are supplemented by our new Career Model, which sets forth three specialized career paths, applicable across our organization, for focused development and advancement for our staff. The Career Model encourages our employees to actively consider their long-term career goals within our organization, and to take actions that will help them achieve these goals. We believe that having a standardized framework for assessing our employees will enhance the structure of our cash and incentive compensation programs.
 
  •     Improve Employee Culture. We are continuing our efforts to enhance the attractiveness of career opportunities at BearingPoint. We intend to improve our corporate culture by, among other things, (1) implementing an integrated career and compensation framework, (2) initiating periodic employee satisfaction surveys, (3) utilizing employee satisfaction and attrition metrics by our industry groups, segments, client teams and individual managing directors, (4) increasing the time spent by management with our employees, and (5) enhancing our internal human resources functions.
 
Increase Client Awareness, Confidence and Satisfaction. Our 2007 initiatives related to enhancing our clients’ confidence and satisfaction include:
 
  •     Invest in Our Brand. In late 2006, we launched a new brand strategy and began a more aggressive marketing effort in late 2006. These programs are designed to increase awareness of BearingPoint as a leading global management and technology firm among clients and prospects in key markets. Developed through extensive internal and external research, our new brand strategy and messaging more clearly define who we are, what we do and how we are different from our competitors. We launched our new brand in February 2007 to our employees, to help improve communication,


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  increase employee morale and retention, and equip employees with enhanced sales and marketing materials to be more successful in the marketplace.
 
  •     Redirect Our Marketing Efforts. In connection with our new brand strategy, we initiated a fully integrated marketing program featuring our re-designed internet site, print and online advertising, events, sponsorships, thought leadership, public relations and client references. In the summer of 2007, we plan to launch a targeted marketing campaign to make an impact in the public services market, particularly in the Washington, D.C. area. This focused campaign will include strategic advertising in key business publications and targeted vertical publications in the government sector. We expect our brand re-positioning efforts will continue throughout 2007 and beyond.
 
  •     Develop Common Operating Model and Methodologies. We are implementing a common operating model across our geographic regions to provide clients with integrated global solutions. We are evaluating the effectiveness and acceptance within our businesses of our common service delivery methodologies. We expect to develop, enhance and standardize common methodologies and to enforce more rigorously their consistent use across the organization. From these efforts, we expect to realize increased efficiencies and improved client service quality.
 
  •     Client Satisfaction Surveys. Our Client Satisfaction Program has served as a valuable tool for gaining insight into our client relationships. The program helps us to understand how we are perceived in the market and identify differentiators that distinguish us from our competitors. In 2006, we redesigned our client satisfaction survey, translated the survey into nine languages, and expanded the program to increase the number of participating clients and translated to every business unit. In addition, we added a measure to gauge satisfaction at the engagement level, to augment the account-level reviews that were already in place. In 2007, we intend to continue to expand the scope and scale of the program, to gain a further understanding of our clients’ expectations and levels of satisfaction within all of our industry sectors.
 
Strengthen Our Balance Sheet. Our 2007 efforts to strengthen our balance sheet include:
 
  •     New Credit Facility. Our 2007 Credit Facility, consists of (1) term loans in the aggregate principal amount of $300 million and (2) a letter of credit facility in an aggregate face amount at any time outstanding not to exceed $200 million. The 2007 Credit Facility provides us with significantly greater financial resources than our 2005 Credit Facility did, and on terms that will allow us to focus on achieving and sustaining timely completion of our financial statements and filing of our SEC periodic filing without artificially imposed, interim financial reporting deadlines such as those that were imposed under the 2005 Credit Facility. For additional information regarding the 2007 Credit Facility, see “—Liquidity and Capital Resources.”
 
  •     Reduce our DSOs and Improve Operating Cash Flow. While we made significant strides in reducing DSOs in 2006, we have not yet achieved industry averages. To achieve further meaningful reductions in DSOs, we have focused on this metric at all leadership levels and are working to increase the functionality of, and training on, North American financial reporting systems to aid in the prompt generation of client invoices and account aging schedules. At December 31, 2006, our DSOs stood at 82 days, which we believe to be significantly above the current DSO average for information technology service companies.
 
  •     Improve Internal Cash Management. Through May 31, 2007, we have repatriated approximately $83.6 million from our international subsidiaries in 2007. In connection with this effort, we undertook a detailed review of our existing internal processes relating to cash management and have identified a series of steps that we can take to more efficiently utilize cash within our different geographic regions and more efficiently allocate firm-wide costs among all of our geographic regions.


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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.
 
                                 
    2006     2005     $ Change     % Change  
 
Revenue
                               
Public Services
  $ 1,339,358     $ 1,293,390     $ 45,968       3.6 %
Commercial Services
    554,806       663,797       (108,991 )     (16.4 %)
Financial Services
    399,331       379,592       19,739       5.2 %
EMEA
    703,083       662,020       41,063       6.2 %
Asia Pacific
    360,001       312,190       47,811       15.3 %
Latin America
    82,319       75,664       6,655       8.8 %
Corporate/Other
    5,105       2,247       2,858       n/m  
                                 
Total
  $ 3,444,003     $ 3,388,900     $ 55,103       1.6 %
                                 
 
                         
    Impact of
    Revenue growth
       
    currency
    (decline), net of
       
    fluctuations     currency impact     Total  
 
Revenue
                       
Public Services
    0.0 %     3.6 %     3.6 %
Commercial Services
    0.0 %     (16.4 )%     (16.4 %)
Financial Services
    0.0 %     5.2 %     5.2 %
EMEA
    0.9 %     5.3 %     6.2 %
Asia Pacific
    (3.2 )%     18.5 %     15.3 %
Latin America
    9.3 %     (0.5 )%     8.8 %
Corporate/Other
    n/m       n/m       n/m  
Total
    0.1 %     1.5 %     1.6 %


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n/m = not meaningful
 
  •     Public Services revenue increased in 2006, with strong revenue growth in certain sectors, particularly in the SLED and Emerging Markets sectors. SLED revenue increased due to significant increases in revenue from a number of our key clients. Emerging Markets revenue increased primarily from revenue increases on several large existing multi-year contracts and also from revenue associated with several new contracts signed in 2006. Revenue declined in our Civilian business sector due to reduced information technology spending and an increasingly competitive environment.
 
  •     Commercial Services revenue decreased in 2006, primarily due to a $57.5 million year-over-year decrease in revenue associated with the HT Contract and a reduction of $20.0 million in revenue related to the resolution of a billings dispute with another large telecommunications client regarding an engagement completed in 2003. Reduced customer demand for our services, particularly in the telecommunications industry, also affected our revenue. These decreases were partially offset by the recognition in 2006 of approximately $22.3 million in previously deferred revenue.
 
  •     Financial Services revenue increased in 2006, primarily due to revenue growth in our Insurance and Banking sectors, offset by declines in our Global Markets sector. Insurance sector revenue increased in response to industry-wide demand for major technology updates and upgrades to operational systems. Banking sector revenue increases were attributable to existing client engagements and the introduction of some new clients into our traditional client base. Global Markets sector revenue declined as we increased the proportion of work derived from lower rate per hour offshore resources in response to client demand, which affected our revenue.
 
  •     EMEA revenue increased in 2006, primarily due to strong revenue growth in the United Kingdom, France, Ireland and Switzerland. Revenue growth in the United Kingdom was driven by our continued expansion in that region, while France continued to benefit from an expanding systems integration practice and additional penetration into the French public sector market in 2006. Ireland and Switzerland revenue growth were generally attributable to increased demand for consulting services in local markets. Revenue in Germany declined due to a combination of the impact of adjustments in billable headcount precipitated by the restructuring of our German practice, increased pressure on pricing, and a reduction in the spending levels of German public sector clients.
 
  •     Asia Pacific revenue increased in 2006, primarily due to significant revenue growth in Australia and Japan. Australian revenue increased primarily due to a significant new client engagement in the telecommunications industry. Japanese revenue increased due to revenue growth from system implementation contracts and projects involving compliance with Japan’s Financial Instruments and Exchange Law, though a substantial portion of this revenue growth was derived from the use of subcontractors. Asia Pacific revenue was negatively affected in 2006 by the weakening of foreign currencies against the U.S. dollar, primarily the Japanese Yen.
 
  •     Latin America revenue increased in 2006, primarily as a function of the weakening of the U.S. dollar against local currencies in Latin America (particularly the Brazilian Real), along with local currency revenue growth and increasing engagement hours in Brazil, offset by deteriorating revenue in Mexico. Revenue in Brazil increased due to the addition of significant client engagements, while revenue in Mexico declined as they continue to restructure the business to position itself for future growth.
 
  •     Corporate/Other: Our Corporate/Other segment does not contribute significantly to our revenue.
 
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%.


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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:
 
  •     Professional compensation expense decreased as a percentage of revenue to 49.8% for 2006, compared to 52.2% for 2005. We experienced a net decrease in professional compensation expense of $53.8 million, or 3.0%, to $1,716.6 million for 2006 from $1,770.4 million for 2005. The decrease in 2006 from 2005 was primarily due to higher professional compensation expense recorded in 2005 (as compared to 2006) related to the loss accrual for the HT Contract. Stock compensation expense for 2006 was $41.0 million, as compared to $76.3 million for 2005. Cash bonuses earned in 2006 by our highest-performing employees were $49.0 million, as compared to $17.8 million earned in 2005.
 
  •     Other direct contract expenses decreased as a percentage of revenue to 26.0% for 2006 compared to 28.7% for 2005. We experienced a net decrease in other direct contract expenses of $75.8 million, or 7.8%, to $897.0 million for 2006 from $972.8 million for 2005. The decrease in 2006 from 2005 was primarily due to other direct contract expenses recorded in 2005 related to the loss accrual for the HT Contract. In addition, the decline was driven by reduced subcontractor expenses as a result of the increased use of internal resources and a decrease of resales of procured materials.
 
  •     Other costs of service as a percentage of revenue decreased to 7.3% for 2006 from 7.6% for 2005. We experienced a net decrease in other costs of service of $7.9 million, or 3.1%, to $250.2 million for 2006 from $258.1 million for 2005. The decrease in 2006 from 2005 was primarily attributable to a reduction in administrative support and related costs for our business units.
 
  •     In 2006 we recorded, within the Corporate/Other operating segment, a charge of $29.6 million for lease and facilities restructuring costs, compared to a $29.6 million charge for lease, facilities and other exit activities in 2005. These costs for 2006 related primarily to the fair value of future lease obligations associated with office space, primarily within the EMEA and North America regions, which we will no longer be using.
 
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.
 
                                 
    Year Ended December 31,              
    2006     2005     $ Change     % Change  
 
Gross Profit
                               
Public Services
  $ 263,841     $ 238,904     $ 24,937       10.4 %
Commercial Services
    81,419       (11,142 )     92,561       830.7 %
Financial Services
    135,187       110,602       24,585       22.2 %
EMEA
    129,523       87,702       41,821       47.7 %
Asia Pacific
    80,448       53,636       26,812       50.0 %
Latin America
    9,058       4,321       4,737       109.6 %
Corporate/Other
    (148,950 )     (126,031 )     (22,919 )     n/m    
                                 
Total
  $ 550,526     $ 357,992     $ 192,534       53.8 %
                                 


48


 

                 
    Year Ended December 31,  
    2006     2005  
 
Gross Profit as a % of revenue
               
Public Services
    19.7 %     18.5 %
Commercial Services
    14.7 %     (1.7 %)
Financial Services
    33.9 %     29.1 %
EMEA
    18.4 %     13.2 %
Asia Pacific
    22.3 %     17.2 %
Latin America
    11.0 %     5.7 %
Corporate/Other
    n/m       n/m  
Total
    16.0 %     10.6 %
 
n/m = not meaningful
 
Changes in gross profit by segment were as follows:
 
  •     Public Services gross profit increased in 2006 despite a substantial reduction in gross profits in our SLED practice and increases in professional compensation expense related to hiring needs related to demand for our services.
 
  •     Commercial Services gross profit increased in 2006, despite significantly lower revenue, primarily due to a $45.5 million year-over-year reduction in losses from the HT Contract. Other factors contributing to the increase in gross profit were the cost savings realized from 2005 workforce realignments and reduced subcontractor expenses as a result of the increased use of internal resources.
 
  •     Financial Services gross profit increased in 2006, due to higher revenue combined with a decline in compensation expenses. The decrease in compensation expenses is primarily due to more efficient utilization of Company shared staff in this segment and efficient use of offshore resources.
 
  •     EMEA gross profit increased in 2006, due primarily to higher revenue and improved profitability in France and Ireland along with significantly improved profitability in Spain as a result of higher utilization and lower costs. Slight declines in compensation expense and other direct contract expenses also contributed to the increase in gross profit, though compensation expense for 2006 continued to be affected by severance and other costs related to the internal restructuring of the Company’s German practice.
 
  •     Asia Pacific gross profit increased in 2006, primarily due to significant improvements in profitability and staff utilization in the Company’s Australian and Chinese businesses. Due to the high demand for resources in the Japanese market and limited availability of qualified personnel, increases in subcontractor expenses served to depress the growth of gross profit in the Company’s Japanese operations. Significant regional improvements in compensation expense derived from the 2005 workforce reductions in Japan and China were substantially offset by additional compensation expenses associated with the use of the Company’s personnel from outside the region in connection with a significant new telecommunications industry engagement in Australia.
 
  •     Latin America gross profit increased in 2006, due to higher revenue offset by an increase in compensation expenses, driven by higher billable headcount to meet the growth of our business in the region, predominantly Brazil.
 
  •     Corporate/Other consists primarily of rent expense and other facilities related charges.


49


 

 
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


50


 

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.
 
                                 
    Year Ended December 31,              
    2005     2004     $ Change     % Change  
 
Revenue
                               
Public Services
  $ 1,293,390     $ 1,343,670     $ (50,280 )     (3.7 %)
Commercial Services
    663,797       654,022       9,775       1.5 %
Financial Services
    379,592       326,452       53,140       16.3 %
EMEA
    662,020       642,686       19,334       3.0 %
Asia Pacific
    312,190       328,338       (16,148 )     (4.9 %)
Latin America
    75,664       79,302       (3,638 )     (4.6 %)
Corporate/Other
    2,247       1,312       935       n/m  
                                 
Total
  $ 3,388,900     $ 3,375,782     $ 13,118       0.4 %
                                 
 
                         
          Revenue
       
          growth
       
    Impact of
    (decline), net
       
    currency
    of currency
       
    fluctuations     impact     Total  
 
Revenue
                       
Public Services
    0.0 %     (3.7 )%     (3.7 %)
Commercial Services
    0.0 %     1.5 %     1.5 %
Financial Services
    0.0 %     16.3 %     16.3 %
EMEA
    0.1 %     2.9 %     3.0 %
Asia Pacific
    1.1 %     (6.0 )%     (4.9 %)
Latin America
    12.9 %     (17.5 )%     (4.6 %)
Corporate/Other
    n/m       n/m       n/m  
Total
    0.4 %     0.0 %     0.4 %
 
n/m = not meaningful
 
  •     Public Services revenue decreased in 2005, primarily attributable to expected reductions of $33.8 million in revenue derived from our subcontractors and resales of procured materials (which we must bill our clients, thereby increasing our revenue) and revenue reductions of $10.0 million associated with two loss contracts, both of which more than offset increases in headcount and chargeable hours resulting from our expanding use of employees at lower average bill rates.
 
  •     Commercial Services revenue increased in 2005, primarily driven by revenue growth with transportation clients and a significant contract with Hawaiian Telcom Communications, Inc., which was partially offset by revenue declines from certain of our clients in the manufacturing and high-tech industries.


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  •     Financial Services revenue increased in 2005, primarily due to revenue growth in all sectors, with especially strong growth in the Insurance and Global Market sectors. Revenue growth was principally due to an increase in demand for our services. Our average billing rates improved slightly year-over-year, as our ability to obtain higher rates per hour on certain of our market offerings offset the increasing use of lower-priced offshore personnel as a component of our overall pricing model.
 
  •     EMEA revenue increased in 2005, primarily due to combined revenue growth in France and the United Kingdom of $53.6 million, partially offset by a $29.8 million revenue decline in Germany. Our business in France experienced a significant shift into systems integration work, while revenue growth in the United Kingdom was driven by our continued expansion in that region. Revenue for Germany declined as a result of decreasing utilization caused by continued deterioration of market conditions in Germany which, consequently, led us to lower billable headcount.
 
  •     Asia Pacific revenue decreased in 2005, driven primarily by decreasing demand for services in Japan and China and the planned elimination of subcontractor usage in the region, which more than offset the improved billing rates achieved across the region in 2005 due to significantly lower revenue write-offs during the year. Limited opportunities in Japan and China led to significant staff reductions and lower utilization rates in those countries.
 
  •     Latin America revenue decreased in 2005, primarily as modest revenue growth in Brazil offset significant declines in revenue in all other countries in which we operate in the region. Revenue was also negative impacted by the weakening of the U.S. dollar against local currencies in Latin America (particularly the Brazilian Real).
 
  •     Corporate/Other: Our Corporate/Other segment does not contribute significantly to our revenue.
 
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:
 
  •     Professional compensation expense increased as a percentage of revenue to 52.2% for 2005, compared to 45.4% for 2004. We experienced a net increase in professional compensation expense of $238.0 million, or 15.5%, to $1,770.4 million for 2005 from $1,532.4 million for 2004. The increase in professional compensation expense was primarily the result of hiring additional billable employees in response to increased demand for our services. In addition, $74.9 million of this amount was related to the vesting of Retention RSUs.
 
  •     Other direct contract expenses decreased as a percentage of revenue to 28.7% for 2005 compared to 29.4% for 2004. We experienced a net decrease in other direct contract expenses of $18.7 million, or 1.9%, to $972.8 million for 2005 from $991.5 million for 2004. The change was driven primarily by reduced subcontractor expenses as a result of the increased use of internal resources.
 
  •     Other costs of service as a percentage of revenue decreased to 7.6% for 2005 from 8.7% for 2004. We experienced a net decrease in other costs of service of $34.5 million, or 11.8%, to $258.1 million for 2005 from $292.6 million for 2004. The decrease in 2005 from 2004 was primarily due to the settlement costs of $36.9 million involving or related to certain legal actions involving Peregrine Systems, Inc. (see Item 3, “Legal Proceedings,”) included in our 2004 results.
 
  •     In 2005 we recorded, within the Corporate/Other operating segment, a charge of $29.6 million for lease and facilities restructuring costs, compared to an $11.7 million charge for lease, facilities and other exist activities in 2004. These costs for 2005 related primarily to the fair value of future lease obligations associated with our previously announced reduction in office space, primarily within the North America, EMEA and Asia Pacific regions, which we no longer use.


52


 

 
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.
 
                                 
    Year Ended December 31,              
    2005     2004     $ Change     % Change  
 
Gross Profit
                               
Public Services
  $ 238,904     $ 290,582     $ (51,678 )     (17.8 %)
Commercial Services
    (11,142 )     129,784       (140,926 )     (108.6 %)
Financial Services
    110,602       101,075       9,527       9.4 %
EMEA
    87,702       96,236       (8,534 )     (8.9 %)
Asia Pacific
    53,636       31,063       22,573       72.7 %
Latin America
    4,321       13,454       (9,133 )     (67.9 %)
Corporate/Other
    (126,031 )     (114,670 )     (11,361 )     n/m  
                                 
Total
  $ 357,992     $ 547,524     $ (189,532 )     (34.6 %)
                                 
 
                 
    Year Ended December 31,  
    2005     2004  
 
Gross Profit as a % of revenue
               
Public Services
    18.5 %     21.6 %
Commercial Services
    (1.7 %)     19.8 %
Financial Services
    29.1 %     31.0 %
EMEA
    13.2 %     15.0 %
Asia Pacific
    17.2 %     9.5 %
Latin America
    5.7 %     17.0 %
Corporate/Other
    n/m       n/m  
Total
    10.6 %     16.2 %
 
n/m = not meaningful
 
Changes in gross profit by segment were as follows:
 
  •     Public Services gross profit decreased in 2005, in large measure due to a $97.9 million increase in compensation expense (including non-cash compensation expense of $25.5 million relating to the vesting of Retention RSUs) and the $50.3 million reduction in gross revenue, which on a combined basis, more than offset significant reductions of $65.7 million in other direct contract expenses and $30.8 million in other costs of services.
 
  •     Commercial Services gross profit decreased in 2005, as significantly higher gross revenue was eroded by significant cost overruns and loss accruals, most notably $111.7 million on the previously described HT Contract, which included increases in subcontractor expense accruals and hardware and software purchases that collectively increased our other direct contract expenses by $66.6 million which are substantially not recoverable. Significant increases in compensation expense, including non-cash compensation expense relating to the vesting of Retention RSUs, also contributed to the decrease in gross profit.
 
  •     Financial Services gross profit increased in 2005, as higher revenue across all sectors more than offset significant incremental increases in compensation expense related to a substantial increase in headcount, non-cash compensation expense relating to the vesting of Retention RSUs ($7.5 million) and additional cash bonuses ($3.0 million).


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  •     EMEA gross profit decreased in 2005, as incremental increases in compensation expense due to severance costs associated with workforce realignments in Germany, France and Spain ($27.0 million) and non-cash compensation expense related to the vesting of the Retention RSUs ($13.8 million) more than offset increases in revenue.
 
  •     Asia Pacific gross profit increased substantially in 2005, despite a decrease in revenue due, in large measure, to significant demonstrated improvements in cost management and realization of contract revenue.
 
  •     Latin America gross profit decreased in 2005, as increases in other direct contract expenses and compensation expense attributable to fringe benefits, non-cash compensation expense related to Retention RSUs and workforce realignments offset modest revenue growth in the region.
 
  •     Corporate/Other consists primarily of rent expense and other facilities related charges, which increased in 2005 primarily due to the lease and facilities restructuring charges discussed above.
 
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


54


 

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):
 
                                         
          Payment due by Period  
          Less than
                After
 
Contractual Obligations
  Total     1 year     1-3 years     3-5 years     5 years  
 
Long-term debt (1)
  $ 1,101,004     $ 27,110     $ 51,325     $ 72,732     $ 949,837  
Operating leases
    349,745       75,472       133,406       75,829       65,038  
Unconditional purchase obligations (2)
    99,594       51,278       36,126       9,190       3,000  
Obligations under the pension and postretirement medical plans
    47,558       3,808       7,869       8,433       27,448  
Microsoft Collaboration Agreement (3)
    4,689       4,689                    
                                         
Total
  $ 1,602,590     $ 162,357     $ 228,726     $ 166,184     $ 1,045,323  
                                         
 
 
(1) Long-term debt includes both principal and interest scheduled payment obligations. Certain of our long-term debt allows the holders the right to convert the debentures into shares of our common stock or cash (at the Company’s option) in earlier periods than presented above. For additional information, see Note 6, “Notes Payable,” of the Notes to Consolidated Financial Statements.
 
(2) Unconditional purchase obligations include material agreements to purchase goods or services, principally software and telecommunications services, that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Unconditional purchase obligations exclude agreements that are cancelable without penalty.
 
(3) For additional information, see Note 10, “Collaboration Agreement,” of the Notes to Consolidated Financial Statements.


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Liquidity and Capital Resources
 
The following table summarizes the cash flow statements for 2006, 2005 and 2004 (amounts are in thousands):
 
                                 
    Year Ended December 31,  
                      2006 to 2005
 
    2006     2005     2004     Change  
 
Net cash provided by (used in):
                               
Operating activities
  $ 58,680     $ (113,071 )   $ 48,265     $ 171,751  
Investing activities
    67,570       (141,043 )     (109,387 )     208,613  
Financing activities
    (7,316 )     274,152       176,538       (281,468 )
Effect of exchange rate changes on cash and cash equivalents
    15,297       (9,508 )     6,919       24,805  
                                 
Net increase in cash and cash equivalents
  $ 134,231     $ 10,530     $ 122,335     $ 123,701  
                                 
 
Operating Activities. Net cash provided by operating activities during 2006 increased $171.8 million over 2005. This increase was primarily attributable to improved profitability and a decrease in accounts receivable, as our DSOs decreased to 82 days at December 31, 2006 from 94 days at December 31, 2005, providing an additional $136.3 million. These items were partially offset by the cash outflow to support the professional services and related expenses required under the HT Contract, and, to a lesser extent, payments made for the Peregrine settlement of $36.9 million.
 
Net cash used in operating activities during 2005 increased $161.3 million over 2004. This increase was due to a net loss of $721.6 million adjusted by impairment of goodwill of $166.4 million and stock-based compensation expense of $85.8 million in 2005 as compared to a net loss of $546.2 million adjusted by impairment of goodwill of $397.1 million and stock-based compensation expense of $9.9 million in 2004. These items were partially offset by $127.5 million in cash generated from working capital, primarily due to a decrease in our DSOs to 94 days at December 31, 2005 from 103 days at December 31, 2004, largely due to more aggressive collections efforts, and $58.4 million and $3.2 million in income tax refunds received during 2005 and 2004, respectively.
 
Investing Activities. Net cash provided by investing activities during 2006 increased $208.6 million over 2005. This increase was predominantly due to the change in the amount of restricted cash posted as collateral for letters of credit and surety bonds. The requirement to deposit and maintain cash collateral terminated as part of the March 31, 2006 amendment to the 2005 Credit Facility, and such cash collateral was released to us. The increase was offset by an increase of $9.7 million in capital expenditures in 2006 over 2005.
 
Net cash used in investing activities during 2005 was $141.0 million, an increase of $31.7 million over 2004. This increase was due to an increase in restricted cash of $79.1 million for cash collateral posted in support of bank guarantees for letters of credit and surety bonds, which was partially offset by a decrease in capital expenditures of $47.5 million. The decline in capital expenditures was due primarily to higher hardware and software costs incurred during 2004 for the implementation of our North America financial reporting systems.
 
Financing Activities. Net cash used in financing activities during 2006 was $7.3 million, primarily due to repayments of our Japanese term loans. Net cash provided by financing activities for 2005 was $274.2 million, resulting primarily from the proceeds on the issuance of debentures with an aggregate principal amount of $290.0 million, as more fully described in “—Debt Obligations,” below.
 
In addition, issuances of common stock from our ESPP generated $0, $14.9 million and $26.9 million in cash during 2006, 2005 and 2004, respectively. Because we are not current in our SEC periodic filings, we are unable to issue freely tradable shares of our common stock. Consequently, we were unable to make any public


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offerings of our common stock in 2006 or 2005 and have not issued shares under the LTIP or ESPP since early 2005. These sources of financing will remain unavailable to us until we are again current in our SEC periodic filings.
 
Additional Cash Flow Information
 
2007. At March 31, 2007, we had global cash balances of approximately $249.0 million. Our 2007 Credit Facility consists of (1) term loans in the aggregate principal amount of $300 million and (2) a letter of credit facility in an aggregate face amount at any time outstanding not to exceed $200 million. Borrowings under the 2007 Credit Facility will be used for general corporate purposes, including the payment of obligations outstanding under our prior credit facility, and payment of the fees and expenses of the 2007 Credit Facility. For additional information regarding the 2007 Credit Facility, see “— 2007 Credit Facility.”
 
Our decision to obtain the 2007 Credit Facility was based, in part, on the fact that the North American cash balances have been negatively affected in the first quarter of 2007 by, among other things, cash collection levels not maintaining pace with the levels achieved in the fourth quarter of 2006 and payments made in connection with (1) the uninsured portion of the settlement of the dispute with HT, (2) ongoing costs relating to the design and implementation of the new North American financial reporting systems, (3) ongoing costs relating to production and completion of our financial statements, (4) other additional accrued expenses for 2006 paid in the first quarter of 2007, and (5) our current expectations that operations will not generate cash before the latter part of 2007.
 
Outlook. We currently expect that our operations will continue to use, rather than provide a source of cash through the latter part of 2007. Based on current internal estimates, we nonetheless believe that our cash balances, together with cash generated from operations and borrowings made under our 2007 Credit Facility, will be sufficient to provide adequate funds for our anticipated internal growth and operating needs. Our management may seek alternative strategies, intended to further improve our cash balances and their accessibility, if current internal estimates for cash uses for 2007 prove incorrect. These activities include: initiating further cost reduction efforts, seeking improvements in working capital management, reducing or delaying capital expenditures, seeking additional debt or equity capital and selling assets.
 
After consultation with a number of our external financial advisors and various credit sources, we continue to believe that our available receivables and expected earnings before interest, tax, depreciation and amortization are, notwithstanding our not being current in our SEC periodic filings, sufficient to provide us with access to the private equity and debt placement markets. However, there can be no assurance that the Company will be able to issue equity or debt with acceptable terms and the proceeds from any such issuances, subject to certain exceptions, must first be used to repay amounts owed under our 2007 Credit Facility.
 
Based on the foregoing and our current state of knowledge of the outlook for our business, we currently believe that cash provided from operations, existing cash balances and borrowings under our 2007 Credit Facility will be sufficient to meet our working capital needs through the end of 2007. However, actual results may differ from current expectations for many reasons, including losses of business that could result from our continuing failure to timely file periodic reports with the SEC, the occurrence of any event of default that could provide our lenders with a right of acceleration (e.g., non-payment), possible delisting from the NYSE, further downgrades of our credit ratings or unexpected demands on our current cash resources (e.g., to settle lawsuits). For additional information regarding various risk factors that could affect our outlook, see Item 1A, “Risk Factors.” If cash provided from operations is insufficient and/or our ability to access the capital markets is impeded, our business, operations, results and cash flow could be materially and adversely affected.


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Debt Obligations
 
The following tables present a summary of the activity in our debt obligations for 2006 and 2005:
 
                                         
    Balance
                      Balance
 
    December 31,
                      December 31,
 
    2005     Borrowings     Repayments     Other (b)     2006  
 
Convertible debentures
  $ 668,054     $      —     $     $ 3,436     $ 671,490  
Yen-denominated term loan (January 31, 2003)
    2,803             (2,802 )     (1 )      
Yen-denominated term loan (June 30, 2003)
    1,402             (1,442 )     40        
Other
    2,501             (2,262 )     121       360  
                                         
Total notes payable
  $ 674,760     $     $ (6,506 )   $ 3,596     $ 671,850  
                                         
 
 
                                                 
    Balance
          Discounts on
                Balance
 
    December 31,
          Senior
                December 31,
 
    2004     Borrowings     Debentures (a)     Repayments     Other (b)     2005  
 
Convertible debentures
  $ 400,000     $ 290,000     $ (23,361 )   $     $ 1,415     $ 668,054  
Yen-denominated term loan (January 31, 2003)
    9,724                   (6,089 )     (832 )     2,803  
Yen-denominated term loan (June 30, 2003)
    4,863                   (2,891 )     (570 )     1,402  
Yen-denominated line of credit(c)
    7,795                   (6,796 )     (999 )      
Other
    844       2,874             (1,209 )     (8 )     2,501  
                                                 
Total notes payable
  $ 423,226     $ 292,874     $ (23,361 )   $ (16,985 )   $ (994 )   $ 674,760  
                                                 
 
 
(a) Amount represents a discount to the $40,000 principal amount of the July 2005 Senior Debentures.
 
(b) Other changes in notes payable consist of amortization of notes payable discount and foreign currency translation adjustments.
 
(c) Yen-denominated line of credit was terminated on December 16, 2005.
 
At December 31, 2006, we had total outstanding debt of $671.9 million, compared to total outstanding debt of $674.8 million at December 31, 2005. The $2.9 million decrease in total outstanding debt was mainly attributable to the repayment of Yen-denominated term loans as well as other German debt offset by the amortization of notes payable discount related to the convertible debentures.
 
For information on the Series B Debenture litigation matter that we settled in late 2006, see Item 3, “Legal Proceedings—Other Matters.”
 
Debt Ratings
 
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.


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2007 Credit Facility
 
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 from $400.0 million to $500.0 million. The 2007 Credit Facility consists of (1) term loans in an aggregate principal amount of $300.0 million (the “Term Loans”) and (2) a letter of credit facility in an aggregate face amount at any time outstanding not to exceed $200.0 million (the “LC Facility”). Borrowings under the 2007 Credit Facility will be used for general corporate purposes, including the payment of obligations outstanding under the 2005 Credit Facility, and the payment of fees, commissions and expenses incurred by us in connection with the 2007 Credit Facility. Interest on the Term Loans is calculated, at the Company’s option, (1) at a rate equal to 3.5% plus the London Interbank Offered Rate, or LIBOR, or (2) at a rate equal to 2.5% plus the higher of (a) the federal funds rate plus 0.5% and (b) UBS AG, Stamford Branch’s prime commercial lending rate. As of June 1, 2007, we have borrowed $300.0 million under the Term Loans, and an aggregate of approximately $89.3 million of letters of credit previously outstanding under the 2005 Credit Facility has been assumed under the LC Facility.
 
Our obligations under the 2007 Credit Facility are secured by liens and security interests in substantially all of our assets and most of our material domestic subsidiaries, as guarantors of such obligations (including a pledge of 65% of the stock of certain of our foreign subsidiaries), subject to certain exceptions.
 
The 2007 Credit Facility requires us to make prepayments of outstanding Term Loans and cash collateralize outstanding Letters of Credit in an amount equal to (i) 100% of the net proceeds received from property or asset sales (subject to exceptions), (ii) 100% of the net proceeds received from the issuance or incurrence of additional debt (subject to exceptions), (iii) 100% of all casualty and condemnation proceeds (subject to exceptions), (iv) 50% of the net proceeds received from the issuance of equity (subject to exceptions) and (v) for each fiscal year ending on or after December 31, 2008 (and, at our election for the second half of the 2007 fiscal year), the difference between (a) 50% of the Excess Cash Flow (as defined in the 2007 Credit Facility) and (b) any voluntary prepayment of the Term Loan or the LC Facility (as defined in the 2007 Credit Facility) (subject to exceptions). If the Term Loan is prepaid or the LC Facility is reduced prior to May 18, 2008 with other indebtedness or another letter of credit facility, we may be required to pay a prepayment premium of 1% of the principal amount of the Term Loan so prepaid or LC Facility so reduced if the cost of such replacement indebtedness of letter of credit facility is lower than the cost of the 2007 Credit Facility. In addition, we are required to pay $750,000 in principal plus any accrued and unpaid interest at the end of each quarter, commencing on June 29, 2007 and ending on March 31, 2012.
 
The 2007 Credit Facility contains affirmative and negative covenants:
 
  •     The affirmative covenants include, among other things: the delivery of unaudited quarterly and audited annual financial statements, all in accordance with generally accepted accounting principles; certain monthly operating metrics and budgets; compliance with applicable laws and regulations (excluding, prior to October 31, 2008, compliance with certain filing requirements under the securities laws); maintenance of existence and insurance; after October 31, 2008, as requested by the Administrative Agent, maintenance of credit ratings; and maintenance of books and records (subject to the material weaknesses previously disclosed in our 2005 Form 10-K).
 
  •     The negative covenants, which (subject to exceptions) restrict certain of our corporate activities, 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.
 
Events of default under the 2007 Credit Facility include, among other things: defaults based on nonpayment, breach of representations, warranties and covenants, cross-defaults to other debt above $10 million, loss of lien on collateral, invalidity of certain guarantees, certain bankruptcy and insolvency


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events, certain ERISA events, judgments against us in an aggregate amount in excess of $20 million, and change of control events.
 
Under the terms of the 2007 Credit Facility, we are not required to become current in our SEC periodic filings until October 31, 2008. Until October 31, 2008, our failure to provide annual audited or quarterly unaudited financial statements, to keep our books and records in accordance with GAAP or to timely file our SEC periodic reports will not be considered an event of default under the 2007 Credit Facility. The timing of the requirement that we become current in our SEC periodic filings is aligned with the timing set forth in the waivers obtained under certain of our indentures. As previously disclosed, the indenture governing the Series A Debentures and Series B Debentures was amended to include a waiver of our SEC reporting requirements under the indenture through October 31, 2008. In addition, the indenture governing the April 2005 Debentures was amended to include a waiver of our SEC reporting requirements under such indenture through October 31, 2007, or through October 31, 2008 if we elect to pay an additional fee to certain holders of such debentures.
 
Discontinued 2005 Credit Facility
 
On July 19, 2005, we entered into a $150.0 million Senior Secured Credit Facility (the “2005 Credit Facility”). Our 2005 Credit Facility provided for up to $150.0 million in revolving credit and advances. Advances under the revolving credit line were limited by the available borrowing base, which was based upon a percentage of eligible accounts receivable. As of December 31, 2006, we had approximately $23.7 million available under the borrowing base.
 
In 2005 and 2006, we entered into five amendments to the 2005 Credit Facility. Among other things, these amendments revised certain covenants contained in the 2005 Credit Facility, including the extensions of the filing deadlines for our 2005, 2006 and 2007 SEC periodic reports and an increase in the amounts of civil litigation payments that we are permitted to pay and in the aggregate amount of investments and indebtedness that we are permitted to make and incur with respect to our foreign subsidiaries. In addition, in 2007 we obtained several limited waivers that, among other things, waived the delivery requirement of our periodic filings to the lenders under the facility.
 
The 2005 Credit Facility was terminated on May 18, 2007. On that date, all outstanding obligations under the 2005 Credit Facility were paid or assumed under the 2007 Credit Facility, and all liens and security interests under the 2005 Credit Facility were released.
 
Guarantees and Indemnification Obligations
 
In the normal course of business, we have indemnified third parties and have commitments and guarantees under which we may be required to make payments in certain circumstances. These indemnities, commitments and guarantees include: indemnities to third parties in connection with surety bonds; indemnities to various lessors in connection with facility leases; indemnities to customers related to intellectual property and performance of services subcontracted to other providers; and indemnities to directors and officers under the organizational documents and agreements with them. The duration of these indemnities, commitments and guarantees varies, and in certain cases, is indefinite. Certain of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments we could be obligated to make. We estimate that the fair value of these agreements was minimal. Accordingly, no liabilities have been recorded for these agreements as of December 31, 2006. Information regarding the amounts of our outstanding surety and surety-related bonds and letters of credit can be found above.
 
We are also required, in the course of business, particularly with certain of our Public Services clients, largely in the state and local markets, to obtain surety bonds, letters of credit or bank guarantees for client engagements. At December 31, 2006, we had $101.9 million in outstanding surety bonds and $89.3 million in letters of credit extended to secure certain of these bonds. The issuers of our outstanding surety bonds may, at any time, require that we post collateral (cash or letters of credit) to fully secure these obligations.


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Critical Accounting Policies and Estimates
 
The preparation of our Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States requires that management make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenue and expenses during the reporting period. Management’s estimates, assumptions and judgments are derived and continually evaluated based on available information, historical experience and various other assumptions that are believed to be reasonable under the circumstances. Because the use of estimates is inherent in the North American financial reporting systems, actual results could differ from those estimates. The areas that we believe are our most critical accounting policies include:
 
  •     revenue recognition,
 
  •     valuation of accounts receivable,
 
  •     valuation of goodwill,
 
  •     accounting for income taxes,
 
  •     valuation of long-lived assets,
 
  •     accounting for leases,
 
  •     restructuring charges,
 
  •     legal contingencies,
 
  •     retirement benefits,
 
  •     accounting for stock-based compensation, and
 
  •     accounting for intercompany loans.
 
A critical accounting policy is one that involves making difficult, subjective or complex accounting estimates that could have a material effect on our financial condition and results of operations. Critical accounting policies require us to make assumptions about matters that are highly uncertain at the time of the estimate, and different estimates that we could have used, or changes in the estimate that are reasonably likely to occur, may have a material impact on our financial condition or results of operations.
 
Revenue Recognition
 
We earn revenue from three primary sources: (1) technology integration services where we design, build and implement new or enhanced system applications and related processes, (2) services to provide general business consulting, such as system selection or assessment, feasibility studies, business valuations and corporate strategy services and (3) managed services in which we manage, staff, maintain, host or otherwise run solutions and systems provided to our customers. Contracts for these services have different terms based on the scope, deliverables and complexity of the engagement, which require us to make judgments and estimates in recognizing revenue. Fees for these contracts may be in the form of time-and-materials, cost-plus or fixed price.
 
Technology integration services represent a significant portion of our business and are generally accounted for under the percentage-of-completion method in accordance with the Statement of Position (“SOP”) 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”). Under the percentage-of-completion method, management estimates the percentage-of-completion based upon costs to the client incurred as a percentage of the total estimated costs to the client. When total cost estimates exceed estimated revenue, we accrue for the estimated losses immediately. The use of the percentage-of-completion method requires significant judgment relative to estimating total contract revenue and costs, including assumptions relative to the length of time to complete the project, the nature and complexity of the work to be performed, and anticipated changes in estimated salaries and other costs.


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Incentives and award payments are included in estimated revenue using the percentage-of-completion method when the realization of such amounts is deemed probable upon achievement of certain defined goals. Estimates of total contract revenue and costs are continuously monitored during the term of the contract and are subject to revision as the contract progresses. When revisions in estimated contract revenue and costs are determined, such adjustments are recorded in the period in which they are first identified.
 
Revenue for general business consulting services is recognized as work is performed and amounts are earned in accordance with the Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements,” as amended by SAB No. 104, “Revenue Recognition” (“SAB 104”). We consider amounts to be earned once evidence of an arrangement has been obtained, services are delivered, fees are fixed or determinable, and collectibility is reasonably assured. For contracts with fees based on time-and-materials or cost-plus, we recognize revenue over the period of performance. Depending on the specific contractual provisions and nature of the deliverable, revenue may be recognized on a proportional performance model based on level of effort, as milestones are achieved or when final deliverables have been provided.
 
For our managed service arrangements, we typically implement or build system applications for customers that we then manage or run for periods that may span several years. Such arrangements include the delivery of a combination of one or more of our service offerings and are governed by Emerging Issues Task Force (“EITF”) Issue 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” In managed service arrangements in which the system application implementation or build has standalone value to the customer, and we have evidence of fair value for the managed or run services, we bifurcate the total arrangement into two units of accounting: (i) the system application implementation or build, which is recognized as technology integration services using the percentage-of-completion method under SOP 81-1, and (ii) the managed or run services, which are recognized under SAB 104 ratably over the estimated life of the customer relationship. In instances where we are unable to bifurcate a managed service arrangement into separate units of accounting, the total contract is recognized as one unit of accounting under SAB 104. In such instances, total fees and costs related to the system application implementation or build are deferred and recognized together with managed or run services upon completion of the software application implementation or build ratably over the estimated life of the customer relationship. Certain managed service arrangements may also include transaction-based services in addition to the system application implementation or build and managed services. Fees from transaction-based services are recognized as earned if we have evidence of fair value for such transactions; otherwise, transaction fees are spread ratably over the remaining life of the customer relationship period as received. The determination of fair value requires us to use significant judgment. We determine the fair value of service revenue based upon our recent pricing for those services when sold separately and/or prevailing market rates for similar services.
 
Revenue includes reimbursements of travel and out-of-pocket expenses with equivalent amounts of expense recorded in other direct contract expenses. In addition, we generally enter into relationships with subcontractors where we maintain a principal relationship with the customer. In such instances, subcontractor costs are included in revenue with offsetting expenses recorded in other direct contract expenses.
 
Unbilled revenue consists of recognized recoverable costs and accrued profits on contracts for which billings had not been presented to clients as of the balance sheet date. Management anticipates that the collection of these amounts will occur within one year of the balance sheet date. Billings in excess of revenue recognized for which payments have been received are recorded as deferred revenue until the applicable revenue recognition criteria have been met.
 
Valuation of Accounts Receivable
 
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Assessing the collectibility of customer receivables requires management judgment. We determine our allowance for doubtful accounts by specifically analyzing individual accounts receivable, historical bad debts, customer concentrations, customer credit-worthiness, current


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economic and accounts receivable aging trends, and changes in our customer payment terms. Our valuation reserves are periodically re-evaluated and adjusted as more information about the ultimate collectibility of accounts receivable becomes available.
 
Valuation of Goodwill
 
Goodwill is the amount by which the cost of acquired net assets in a business acquisition exceeded the fair value of net identifiable assets on the date of purchase. We assess the impairment of goodwill and identifiable intangible assets on at least an annual basis on April 1 and whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable, as prescribed in the Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”).
 
An impairment review of the carrying amount of goodwill is conducted if events or changes in circumstances indicate that goodwill might be impaired. Factors we consider important that could trigger an impairment review include significant underperformance relative to historically or projected future operating results, identification of other impaired assets within a reporting unit, the more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold, significant adverse changes in business climate or regulations, significant changes in senior management, significant changes in the manner of our use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends, a significant decline in our stock price for a sustained period, or a significant unforeseen decline in our credit rating. Determining whether a triggering event has occurred includes significant judgment from management.
 
The goodwill impairment test prescribed by SFAS 142 requires us to identify reporting units and to determine estimates of the fair value of our reporting units as of the date we test for impairment unless an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. As of December 31, 2006, our reporting units consisted of our three North America industry groups and our three international regions. To identify impairment, the fair value of the reporting unit is first compared with its carrying value. If the reporting unit’s allocated carrying value exceeds its fair value, we undertake a second evaluation to assess the required impairment loss to the extent that the carrying value of the goodwill exceeds its implied fair value. The fair value of a reporting unit is the amount for which the unit as a whole could be bought or sold in a current transaction between willing parties. We estimate the fair values of our reporting units using a combination of the discounted cash flow valuation model and comparable market transaction models. Those models require estimates of future revenue, profits, capital expenditures and working capital for each unit as well as comparability with recent transactions in the industry. We estimate these amounts by evaluating historical trends, current budgets, operating plans and industry data. Determining the fair value of reporting units and goodwill includes significant judgment by management and different judgments could yield different results.
 
Accounting for Income Taxes
 
Provisions for federal, state and foreign income taxes are calculated on reported pre-tax earnings based on current tax law and also include, in the current period, the cumulative effect of any changes in tax rates from those used previously in determining deferred tax assets and liabilities. Such provisions differ from the amounts currently receivable or payable because certain items of income and expense are recognized in different time periods for financial reporting purposes than for income tax purposes. Significant judgment is required in determining income tax provisions and evaluating tax positions. We establish reserves for income tax when, despite the belief that our tax positions are fully supportable, there remain certain positions that are probable to be challenged and possibly disallowed by various authorities. The consolidated tax provision and related accruals include the impact of such reasonably estimable losses and related interest as deemed appropriate. To the extent that the probable tax outcome of these matters changes, such changes in estimate will impact the income tax provision in the period in which such determination is made.


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The majority of our deferred tax assets at December 31, 2006 consisted of federal, foreign and state net operating loss carryforwards that will expire between 2007 and 2026. During 2006, the valuation allowance against federal, state, and certain foreign net operating loss and foreign tax credit carryforwards increased $69.4 million over the year ended 2005, due to additional losses.
 
Since our inception, various foreign, state and local authorities have audited us in the area of income taxes. Those audits included examining the timing and amount of deductions, the allocation of income among various tax jurisdictions and compliance with foreign, state and local tax laws. In evaluating the exposure associated with various tax filing positions we accrue charges for exposures related to uncertain tax positions.
 
During 2005, the Internal Revenue Service commenced a federal income tax examination for the tax periods ended June 30, 2001, June 30, 2003, December 31, 2003, December 31, 2004 and December 31, 2005. We are unable to determine the ultimate outcome of these examinations, but we believe that we have established appropriate reserves related to apportionment of income between jurisdictions, the impact of the restatement items and certain filing positions. We are also under examination from time to time in foreign, state and local jurisdictions.
 
At December 31, 2006, we believe we have appropriately accrued for exposures related to uncertain tax positions. To the extent we were to prevail in matters for which accruals have been established or be required to pay amounts in excess of reserves, our effective tax rate in a given financial statement period may be materially impacted.
 
During 2006, 2005 and 2004, none of the established reserves expired based on the statute of limitations with respect to certain tax examination periods. In addition, an increase to the reserve for tax exposures of $13.8 million, $51.6 million, and $8.0 million, respectively, was recorded as an income tax expense for additional exposures, including interest and penalties.
 
The carrying value of our net deferred tax assets assumes that we will be able to generate sufficient future taxable income in certain tax jurisdictions to realize the value of these assets. If we are unable to generate sufficient future taxable income in these jurisdictions, a valuation allowance is recorded when it is more likely than not that the value of the deferred tax assets is not realizable. Management evaluates the realizability of the deferred tax assets and assesses the need for any valuation allowance. In 2006, we determined that it was more likely than not that a significant amount of our deferred tax assets primarily in the U.S. may not be realized, therefore we recorded a valuation allowance against those deferred assets.
 
Valuation of Long-Lived Assets
 
Long-lived assets primarily include property and equipment and intangible assets with finite lives (purchased software, internal capitalized software, and customer lists). In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we periodically review long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives are no longer appropriate. Each impairment test is based on a comparison of the undiscounted cash flows expected to result from the use and eventual disposition of the asset to the carrying amount of the asset. If an impairment is indicated, the asset is written down to its estimated fair value based on a discounted cash flow analysis. Determining the fair value of long-lived assets includes significant judgment by management, and different judgments could yield different results.
 
Accounting for Leases
 
We lease office facilities under non-cancelable operating leases that expire at various dates through 2017, along with options that permit renewals for additional periods. Rent abatements and escalations are considered in the determination of straight-line rent expense for operating leases. Leasehold improvements made at the inception of or during the lease are amortized over the shorter of the asset life or the lease term. We receive


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incentives to lease office facilities in certain areas which are recorded as a deferred credit and recognized as a reduction to rent expense on a straight-line basis over the lease term.
 
Restructuring Charges
 
We periodically record restructuring charges resulting from restructuring our operations (including consolidation and/or relocation of operations), changes in our strategic plan or management responses to increasing costs or declines in demand. The determination of restructuring charges requires management to utilize significant judgment and estimates related to expenses for employee benefits, such as costs of severance and termination benefits, and costs for future lease commitments on excess facilities, net of estimated future sublease income. In determining the amount of lease and facilities restructuring charges, we are required to estimate such factors as future vacancy rates, the time required to sublet excess facilities and sublease rates. These estimates are reviewed and potentially revised on a quarterly basis based on available information and known market conditions. If our assumptions prove to be inaccurate, we may need to make changes in these estimates that could impact our financial position and results of operations.
 
Legal Contingencies
 
We are currently involved in various claims and legal proceedings. We periodically review the status of each significant matter and assess our potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. We use significant judgment in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, accruals are based only on the best information at that time. As additional information becomes available, we reassess the potential liability related to our pending claims and litigation and may revise our estimates. Such revisions in the estimates of potential liabilities could have a material impact on our financial position and results of operations. We expense legal fees as incurred.
 
Retirement Benefits
 
Our pension plans and postretirement benefit plans are accounted for using actuarial valuations required by SFAS No. 87, “Employers’ Accounting for Pensions,” SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” and SFAS 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans.” The pension plans relate to our plans for employees in Germany and Switzerland. Accounting for retirement plans requires management to make significant subjective judgments about a number of actuarial assumptions, including discount rates, salary growth, long-term return on plan assets, retirement, turnover, health care cost trend rates and mortality rates. Depending on the assumptions and estimates used, the pension and postretirement benefit expense could vary within a range of outcomes and have a material effect on our financial position and results of operations. In addition, the assumptions can materially affect accumulated benefit obligations and future cash funding. For 2006, the discount rate to determine the benefit obligation for the pension plans was 4.2%. The discount rate reflects the rate at which the pension benefits could be effectively settled. The rate is based upon comparable high quality corporate bond yields with maturities consistent with expected pension payment periods. A 100 basis point increase in the discount rate would decrease the 2007 pension expense for the plans by approximately $1.9 million. A 100 basis point decrease in the discount rate would increase the 2007 pension expense for the plans by approximately $3.7 million. The expected long-term rate of return on assets for the 2006 was 4.5%. This rate represents the average of the long-term rates of return for the defined benefit plan weighted by the plans’ assets as of December 31, 2006. To develop this assumption, we considered historical asset returns, the current asset allocation and future expectations of asset returns. The actual long-term rate of return from July 1, 2003 until December 31, 2006 was 4.5%. A 100 basis point increase or decrease in the expected long-term rate of return on the plans’ assets would have approximately a $0.2 million impact on our 2007 pension expense. As of December 31, 2006, the pension plan had an $6.5 million unrecognized actuarial loss that will be expensed over the average future working lifetime of active participants.


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We also offer a postretirement medical plan to the majority of our full-time U.S. employees and managing directors who meet specific eligibility requirements. For 2006, the discount rate to determine the benefit obligation was 5.8%. The discount rate reflects the rate at which the benefits could be effectively settled. The rate is based upon comparable high quality corporate bond yields with maturities consistent with expected retiree medical payment periods. A 100 basis point increase or decrease in the discount rate would have approximately a $0.6 million impact on the 2006 retiree medical expense for the plan. As of December 31, 2006, the pension plan had $2.4 million in unrecognized actuarial losses that will be expensed over the average future working lifetime of active participants.
 
Accounting for Stock-Based Compensation
 
We have various stock-based compensation plans under which we have granted stock options, restricted stock awards and stock units to certain officers, employees and non-employee directors. We also have the ESPP and BE an Owner plans that allow for employees to purchase Company stock at a discount. We granted both service-based and performance-based stock units and stock options during 2006. For all awards, the fair value is fixed on the date of grant based on the number of stock units or stock options issued and the fair value of the Company’s stock on the date of grant. For the performance-based stock units and stock options, each quarter we compare the actual performance results with the performance conditions to determine the probability of the award fully vesting. The determination of successful compliance with the performance conditions requires significant judgment by management, as differing outcomes may have a significant impact on current and future stock compensation expense.
 
We adopted SFAS No. 123(R), “Share-Based Payment” (“SFAS 123(R)”) on January 1, 2006. This standard requires that all share-based payments to employees be recognized in the statements of operations based on their fair values. We have used the Black-Scholes model to determine the fair value of our stock option awards. Under the fair value recognition provisions of SFAS 123(R), share-based compensation is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating stock price volatility and employee stock option exercise behaviors. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted. As stock-based compensation expense recognized in the consolidated statements of operations is based on awards that ultimately are expected to vest, the amount of expense has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience. If factors change and we employ different assumptions in the application of SFAS 123(R), the compensation expense that we record in the future periods may differ significantly from what we have recorded in the current period.
 
We adopted the modified prospective transition method permitted under SFAS 123(R) and consequently have not adjusted results from prior years. Under the modified prospective transition method, the 2006 compensation cost includes expense relating to the remaining unvested awards granted prior to December 31, 2005 along with new grants made during 2006. For grants which vest based on certain specified performance criteria, the grant date fair value of the shares is recognized over the requisite period of performance once achievement of criteria is deemed probable. For grants that vest through the passage of time, the grant date fair value of the award is recognized over the vesting period.
 
We elected the alternative transition method as outlined in Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” (“FSP 123(R)-3”), to calculate the historical pool of excess tax benefits available to offset tax shortfalls in periods following the adoption of SFAS 123(R).
 
The after-tax stock-based compensation expense impact of adopting SFAS 123(R) for the year ended December 31, 2006 was $25.7 million with a $0.12 per share reduction to diluted earnings per share. Prior to the adoption of SFAS 123(R), we used the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” and related


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interpretations, including Financial Interpretation (“FIN”) 44, “Accounting for Certain Transactions Involving Stock Compensation”, for our plans. Under this accounting method, stock option compensation awards that are granted with an exercise price at the current fair value of our common stock as of the date of the award generally did not require compensation expense to be recognized in the consolidated statement of operations. Stock-based compensation expense recognized for our employee stock option plans, restricted stock units and restricted stock awards was $85.8 million in 2005, net of tax.
 
As of December 31, 2006, unrecognized compensation costs and related weighted-average lives over which the costs will be amortized were as follows:
 
                 
    Unrecognized
       
    Compensation
    Weighted-Average
 
    Costs     Life in Years  
 
Stock options
  $ 11,052       1.7  
Restricted stock and stock unit awards
    41,153       3.1  
ESPP
    4,713       1.0  
                 
Total
  $ 56,918       2.6  
                 
 
Accounting for Intercompany Loans
 
Intercompany loans are classified between long- and short-term based on management’s intent regarding repayment. Translation gains and losses on short-term loans are recorded in other income (expense), net, in our Consolidated Financial Statements and similar gains and losses on long-term loans are recorded as other comprehensive income in our Consolidated Statements of Changes in Stockholders’ Equity (Deficit). Accordingly, changes in management’s intent relative to the expected repayment of these intercompany loans will change the amount of translation gains and losses included in our Consolidated Financial Statements.
 
Accounting for Employee Global Mobility and Tax Equalization
 
We have a tax equalization policy designed to ensure that our employees on domestic long-term and foreign assignments will be subject to the same level of personal tax, regardless of the tax jurisdiction in which the employee works. We accrue for tax equalization expenses in the period incurred. If the estimated tax equalization liability, including related interest and penalties, is determined to be greater or less than amounts due upon final settlement, the difference is recorded in the current period.
 
Recently Issued Accounting Pronouncements
 
In June 2006, the FASB issued FIN No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”). This interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” It prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We will be required to adopt this interpretation in the first quarter of fiscal year 2007. We are currently evaluating the requirements of FIN 48 and have not yet determined the impact on our Consolidated Financial Statements.
 
In September 2006, the SEC staff issued SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. SAB 108 requires registrants to quantify the impact of correcting all misstatements using both the “rollover” method, which focuses primarily on the impact of a misstatement on the income statement and is the method we currently use, and the “iron curtain” method, which focuses primarily on the effect of correcting the period-end balance sheet. The use of both of these methods is referred to as the “dual


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approach” and should be combined with the evaluation of qualitative elements surrounding the errors in accordance with SAB No. 99, “Materiality” (“SAB 99”). The adoption of SAB 108 during 2006 did not have a material impact on our Consolidated Financial Statements.
 
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for the fiscal year beginning January 1, 2008. We are currently evaluating the impact of the provisions of SFAS 157.
 
In December 2006, the FASB issued FASB Staff Position No. EITF 00-19-2, “Accounting for Registration Payment Arrangements” (“FSP No. EITF 00-19-2”). FSP No. EITF 00-19-2 specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with SFAS No. 5, “Accounting for Contingencies.” FSP No. EITF 00-19-2 also requires additional disclosure regarding the nature of any registration payment arrangements, alternative settlement methods, the maximum potential amount of consideration and the current carrying amount of the liability, if any. FSP No. EITF 00-19-2 shall be effective immediately for registration payment arrangements and the financial instruments subject to those arrangements that are entered into or modified subsequent to the date of issuance of FSP No. EITF 00-19-2. For registration payment arrangements and financial instruments subject to those arrangements that were entered into prior to the issuance of FSP No. EITF 00-19-2, this guidance shall be effective for financial statements issued for fiscal years beginning after December 15, 2006, and interim periods within those fiscal years. We are currently evaluating the impact FSP No EITF 00-19-2 could have on our financial position, results of operations or cash flows.
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—including an amendment of FAS 115” (“SFAS 159”). The new statement allows entities to choose, at specific election dates, to measure eligible financial assets and liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of the provisions of SFAS 159.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
We are exposed to a number of market risks in the ordinary course of business. These risks, which include interest rate risk and foreign currency exchange risk, arise in the normal course of business rather than from trading activities.
 
Interest Rate Risk
 
Our exposure to potential losses due to changes in interest rates is minimal as our outstanding debt obligations have fixed interest rates. The fair value of our debt obligations may increase or decrease for


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various reasons, including fluctuations in the market price of our common stock, fluctuations in market interest rates and fluctuations in general economic conditions.
 
The table below presents principal cash flows (net of discounts) and related weighted average interest rates by scheduled maturity dates for our debt obligations as of December 31, 2006:
 
                                                         
    Expected Maturity Date
    Year ended December 31,
    (In thousands of U.S. Dollars, except interest rates)
    2007     2008   2009   2010     2011   Thereafter     Total     Fair Value
 
U.S. Dollar Functional Currency
                                                       
Series A Convertible Subordinated Debentures
                          $ 250,000     $ 250,000     $ 247,825
Average fixed interest rate
                            3.10 %     3.10 %      
U.S. Dollar Functional Currency
                                                       
Series B Convertible Subordinated Debentures
                          $ 200,000     $ 200,000     $ 206,260
Average fixed interest rate
                            4.10 %     4.10 %      
U.S. Dollar Functional Currency
                                                       
Series C Convertible Subordinated Debentures
                          $ 200,000     $ 200,000     $ 273,260
Average fixed interest rate
                            5.00 %     5.00 %      
U.S. Dollar Functional Currency
                                                       
Convertible Senior Subordinated Debentures
                $ 40,000               $ 40,000     $ 48,536
Average fixed interest rate
                  0.50 %               0.50 %      
U.S. Dollar Functional Currency
  $ 360                             $ 360     $ 360
Average fixed interest rate
    5.60 %                             5.60 %      
 
Foreign Currency Exchange Risk
 
We operate internationally and are exposed to potentially adverse movements in foreign currency rate changes. Any foreign currency transaction, defined as a transaction denominated in a currency other than the U.S. dollar, will be reported in U.S. dollars at the applicable exchange rate. Assets and liabilities are translated into U.S. dollars at exchange rates in effect at the balance sheet date and income and expense items are translated at average rates for the period.
 
We have foreign exchange exposures related primarily to short-term intercompany loans denominated in non-U.S. dollars to certain of our foreign subsidiaries. The potential gain or loss in the fair value of these intercompany loans that would result from a hypothetical change of 10% in exchange rates would be approximately $6.9 million and $9.2 million as of December 31, 2006 and 2005, respectively. For additional information refer to Note 2, “Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
See the index included on Page F-1, Index to Consolidated Financial Statements.
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
As previously reported, on February 5, 2007, the Chairman of the Audit Committee of the Board (the “Audit Committee”) was notified by our independent registered public accounting firm, PricewaterhouseCoopers LLP (“PwC”), that PwC was declining to stand for re-election and that the client-auditor relationship between the Company and PwC would cease upon PwC’s completion of services related to the audit of our annual financial statements for fiscal 2006 and related 2006 quarterly reviews.


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During the Company’s years ended December 31, 2005 and December 31, 2006, and through June 28, 2007, there were no disagreements between the Company and PwC on any matter of accounting principle or practice, financial statement disclosure, or auditing scope or procedure that, if not resolved to PwC’s satisfaction, would have caused it to make reference to the matter in connection with its report on the Company’s consolidated financial statements for the relevant year, and there were no reportable events as defined in Item 304(a)(1)(v) of Regulation S-K, except that the Company disclosed that material weaknesses existed in its internal control over financial reporting for 2006 and 2005. The material weaknesses identified are discussed in Item 9A of the Company’s Annual Reports on Form 10-K for the year ended December 31, 2006 and for the year ended December 31, 2005. The Company has authorized PwC to respond fully to any inquiries of its successor concerning the material weaknesses. PwC’s audit reports on the Company’s consolidated financial statements for the years ended December 31, 2006 and December 31, 2005 did not contain an adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope or accounting principles.
 
On February 9, 2007, the Audit Committee of the Board of Directors of the Company, as part of its periodic review and corporate governance practices, determined to engage Ernst & Young LLP (“Ernst & Young”) as the Company’s independent registered public accounting firm commencing with the audit for the year ending December 31, 2007. Ernst & Young also has been engaged as the independent registered public accounting firm for the Plan, commencing with the audit for the Plan’s year ending December 31, 2007. During the Company’s years ended December 31, 2005 and December 31, 2006, and through February 9, 2007, neither the Company, nor anyone on its behalf, consulted with Ernst & Young with respect to either (i) the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on the Company’s consolidated financial statements for 2006 or 2005, and no written report or oral advice was provided by Ernst & Young to the Company that Ernst & Young concluded was an important factor considered by the Company in reaching a decision as to the accounting, auditing, or financial reporting issue for 2006 or 2005 or (ii) any matter that was the subject of either a disagreement as defined in Item 304(a)(1)(iv) of Regulation S-K or a reportable event as described in Item 304(a)(1)(v) of Regulation S-K.
 
ITEM 9A. CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
 
As of the end of the period covered by this Annual Report, management performed, with the participation of our Chief Executive Officer and our Chief Financial Officer, an evaluation of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Our disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding required disclosures. Based on the evaluation and the identification of the material weaknesses in internal control over financial reporting described below, as well as our inability to file this Annual Report within the statutory time period, our Chief Executive Officer and our Chief Financial Officer concluded that, as of December 31, 2006, the Company’s disclosure controls and procedures were not effective.
 
Because of the material weaknesses identified in our evaluation of internal control over financial reporting, we performed additional procedures so that our consolidated financial statements as of and for the


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year ended December 31, 2006, including quarterly periods, are presented in accordance with GAAP. Our additional procedures included, but were not limited to:
 
i) recalculating North America revenue and related accounts, such as accounts receivable, unbilled revenue, deferred revenue and costs of service as of and for the year ended December 31, 2006 by validating data to independent source documentation;
 
ii) reviewing 100% of all contracts including contract modifications, accruals, and recognition of sub-contractor costs in 2006 in the United States;
 
iii) providing GAAP revenue recognition guidance on certain international contracts focusing on those contracts with a value in excess of $2 million and selected other contracts deemed to be of high risk;
 
iv) performing a comprehensive search for unrecorded liabilities at December 31, 2006;
 
v) performing a comprehensive global search to identify the complete population of employees deployed on expatriate assignments during 2006 and recalculating related compensation expense classified as costs of service, and employee income tax liabilities as of and for the year ended December 31, 2006;
 
vi) performing additional reconciliations of payroll expense to cash payments for payroll including salaries, bonuses, and other wages; as well as agreement of bonus accruals to supporting documentation and subsequent cash disbursements;
 
vii) performing additional review of lease and facility charges (performed by our GAAP Technical Accounting Policy Group) to ensure charges complied with GAAP and were complete and accurate;
 
viii) performing substantive procedures in areas related to our income taxes in order to provide reasonable assurance as to the related financial statement amounts and disclosures;
 
ix) verifying a significant sample of stock-based grants back to supporting documentation and manually agreeing certain assumptions used in the SFAS 123(R) calculations; and
 
x) performing additional closing procedures, including detailed reviews of journal entries, re-performance of account reconciliations and analyses of balance sheet accounts.
 
The completion of these and other procedures resulted in the identification of adjustments related to our consolidated financial statements as of and for the year ended December 31, 2006, which significantly delayed the filing of this Annual Report.
 
We believe that because we performed the substantial additional procedures described above and made appropriate adjustments, the consolidated financial statements for the periods included in this Annual Report are fairly stated in all material respects in accordance with GAAP.
 
Management’s Report on Internal Control over Financial Reporting
 
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projection of any evaluation of effectiveness to future periods is subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
Management has conducted, with the participation of our Chief Executive Officer and our Chief Financial Officer, an assessment, including testing of the effectiveness of our internal control over financial reporting as of December 31, 2006. Management’s assessment of internal control over financial reporting was conducted


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using the criteria in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
 
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. In connection with management’s assessment of our internal control over financial reporting, we identified the following material weaknesses in our internal control over financial reporting as of December 31, 2006.
 
1. We did not maintain an effective control environment over financial reporting. Specifically, we identified the following material weaknesses:
 
  •     We did not maintain a sufficient complement of personnel in our foreign locations with an appropriate level of knowledge, experience and training in the application of GAAP and in internal control over financial reporting commensurate with our financial reporting requirements.
 
  •     We did not maintain and communicate sufficient formalized and consistent finance and accounting policies and procedures. We also did not maintain effective controls designed to prevent or detect instances of non-compliance with established policies and procedures specifically with respect to the application of accounting policies at foreign locations.
 
  •     We did not enforce the consistent performance of manual controls designed to complement system controls over our North American financial accounting system. As a result, transactions and data were not completely and accurately recorded, processed and reported in the financial statements.
 
  •     We did not maintain adequate controls to ensure that employees could report actual or perceived violations of our policies and procedures. In addition, we did not have sufficient procedures to ensure the appropriate notification, investigation, resolution and remediation procedures were applied to reported violations.
 
The material weaknesses in our control environment described above contributed to the existence of the material weaknesses discussed in items 2 through 9 below. Additionally, these material weaknesses could result in a misstatement to substantially all our financial statement accounts and disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.
 
2. We did not maintain effective controls, including monitoring, over our financial close and reporting process. Specifically, we identified the following material weaknesses in the financial close and reporting process:
 
  •     We did not maintain formal, written policies and procedures governing the financial close and reporting process.
 
  •     We did not maintain effective controls to ensure that management oversight and review procedures were properly performed over the accounts and disclosures in our financial statements. In addition, we did not maintain effective controls to ensure adequate management reporting information was available to monitor financial statement accounts and disclosures.
 
  •     We did not maintain effective controls over the recording of recurring and non-recurring journal entries. Specifically, effective controls were not designed and in place to provide reasonable assurance that journal entries were prepared with sufficient supporting documentation and reviewed and approved to ensure the completeness and accuracy of the entries recorded.
 
  •     We did not maintain effective controls to provide reasonable assurance that accounts were complete and accurate and agreed to detailed support and that reconciliations of accounts were properly performed, reviewed and approved.


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  •     We did not maintain effective controls to provide reasonable assurance that foreign currency translation amounts resulting from intercompany loans were accurately recorded and reported in the consolidated financial statements.
 
These material weaknesses contributed to the material weaknesses identified in items 3 through 9 below and resulted in adjustments to our consolidated financial statements for the year ended December 31, 2006. Additionally, these material weaknesses could result in a misstatement to substantially all of our financial statement accounts and disclosures that would result in a material misstatement of our annual or interim consolidated financial statements that would not be prevented or detected.
 
3. We did not design and maintain effective controls over the completeness, accuracy, existence, valuation and disclosure of revenue, costs of service, accounts receivable, unbilled revenue, deferred contract costs, and deferred revenue. Specifically, we identified the following material weaknesses:
 
  •     We did not design and maintain effective controls to provide reasonable assurance over the initiation, recording, processing, and reporting of customer contracts, including the existence of and adherence to policies and procedures, adequate segregation of duties and adequate monitoring by management.
 
  •     We did not design and maintain effective controls to provide reasonable assurance that contract costs, such as engagement subcontractor costs, were completely and accurately accumulated.
 
  •     We did not design and maintain effective controls to provide reasonable assurance that we adequately evaluated customer contracts to identify and provide reasonable assurance regarding the proper application of the appropriate method of revenue recognition in accordance with GAAP.
 
  •     We did not design and maintain effective controls to provide reasonable assurance regarding the completeness of information recorded in the financial accounting system. Specifically, we did not design and have in place effective controls to provide reasonable assurance that invoices issued outside of the financial accounting system were appropriately recorded in the general ledger. As a result, we did not ensure that cash received was applied to the correct accounts in the appropriate accounting period.
 
4. We did not design and maintain effective controls over the completeness, accuracy, existence, valuation, and disclosure of our accounts payable, other current liabilities, other long-term liabilities and related expense accounts. Specifically, we did not design and maintain effective controls over the initiation, authorization, processing, recording, and reporting of purchase orders and invoices as well as authorizations for cash disbursement to provide reasonable assurance that liability balances and operating expenses were accurately recorded in the appropriate accounting period and to prevent or detect misappropriation of assets. In addition, we did not have effective controls to: i) provide reasonable assurance regarding the complete identification of subcontractors used in performing services to our customers; or ii) monitor subcontractor activities and accumulation of subcontractor invoices to provide reasonable assurance regarding the complete and accurate recording of contract-related subcontractor costs.
 
5. We did not design and maintain effective controls over the completeness and accuracy of costs related to expatriate compensation expense and related tax liabilities. Specifically, we did not maintain effective controls to identify and monitor employees working away from their home country for extended periods of time. In addition, we did not maintain effective controls to completely and properly calculate the related compensation expense and employee income tax liability attributable to each tax jurisdiction.
 
6. We did not design and maintain effective controls over the completeness, accuracy, valuation, and disclosure of our payroll, employee benefit and other compensation liabilities and related expense accounts. Specifically, we did not have effective controls designed and in place to provide reasonable assurance of the authorization, initiation, recording, processing, and reporting of employee related costs including bonus, health and welfare, severance, compensation expense, and stock-based compensation amounts in the accounting records. Additionally, we did not design and maintain effective controls over the administration of employee


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data or controls to provide reasonable assurance regarding the proper authorization of non-recurring payroll changes.
 
7. We did not design and maintain effective controls over the completeness, accuracy, existence, valuation and disclosure of property and equipment and related depreciation and amortization expense. Specifically, we did not design and maintain effective controls to provide reasonable assurance that asset additions and disposals were completely and accurately recorded; depreciation and amortization expense was accurately recorded based on appropriate useful lives assigned to the related assets; existence of assets was confirmed through periodic inventories; and the identification and determination of impairment losses were performed in accordance with GAAP. In addition, we did not design and maintain effective controls to provide reasonable assurance of the adherence to our capitalization policy, and we did not design and maintain effective controls to provide reasonable assurance that expenses for internally developed software were completely and accurately capitalized, amortized, and adjusted for impairment in accordance with GAAP.
 
8. We did not design and maintain effective controls over the completeness, accuracy, valuation, and disclosure of our prepaid lease and long-term lease obligation accounts and the related amortization and lease rental expenses. Specifically, we did not design and maintain effective controls to provide reasonable assurance that new, amended, and terminated leases, and the related assets, liabilities and expenses, including those associated with rent holidays, escalation clauses, landlord/tenant incentives and asset retirement obligations, were reviewed, approved, and accounted for in accordance with GAAP.
 
9. We did not design and maintain effective controls over the completeness, accuracy, existence, valuation and presentation and disclosure of our income tax payable, deferred income tax assets and liabilities, the related valuation allowance and income tax expense. Specifically, we identified the following material weaknesses:
 
  •     We did not design and maintain effective controls over the accuracy and completeness of the components of our income tax provision calculations and related reconciliation of our income tax payable and of differences between the tax and financial reporting basis of our assets and liabilities with our deferred income tax assets and liabilities. We also did not maintain effective controls to identify and determine permanent differences between our income for tax and financial reporting income purposes.
 
  •     We did not maintain effective controls, including monitoring, over the calculation and recording of foreign income taxes, including tax reserves, acquired tax contingencies associated with business combinations and the income tax impact of foreign debt recapitalization. In addition, we did not maintain effective controls over determining the correct foreign jurisdictions or tax treatment of certain foreign subsidiaries for United States tax purposes.
 
  •     We did not design and maintain effective controls over withholding taxes associated with interest payable on intercompany loans and intercompany trade payables between various tax jurisdictions.
 
Each of the control deficiencies discussed in items 3 through 9 above resulted in adjustments to our consolidated financial statements for the year ended December 31, 2006. Additionally, these control deficiencies could result in misstatements of the aforementioned financial statement accounts and disclosures that would result in a material misstatement of our annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, management has determined that each of the control deficiencies in items 3 through 9 above constitutes a material weakness.
 
Because of the material weaknesses described above, management has concluded that we did not maintain effective internal control over financial reporting as of December 31, 2006, based on the Internal Control—Integrated Framework issued by COSO.


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Our assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included in Item 8 of this Annual Report.
 
Remediation of Material Weaknesses in Internal Control over Financial Reporting
 
We have engaged in, and continue to engage in, substantial efforts to address the material weaknesses in our internal control over financial reporting and the ineffectiveness of our disclosure controls and procedures.
 
The Company has remediated its material weakness with respect to senior management setting the proper tone by placing importance on internal control over financial reporting and by placing importance on adherence to the code of business conduct and ethics through the following actions:
 
  •     Senior management made key hires in specific management positions.
 
  •     Senior management made strategic replacements of certain country and regional leadership.
 
  •     Senior management and regional and country leaders consistently communicated the proper tone as to internal control over financial reporting and adherence to the code of business conduct and ethics throughout their respective organizations.
 
  •     Senior management and regional and country leaders initiated specific efforts to design and implement improvements in internal controls over financial reporting whose primary objective was focused on the completeness and accuracy of financial accounts.
 
  •     Senior management instituted under the direction of its new Chief Compliance Officer comprehensive training on the Foreign Corrupt Practices Act, delivered in eight different languages, which was monitored to determine completion of the training. This resulted in over 95% of all employees world-wide completing the training and the required test.
 
We added significant skills and competencies to our corporate finance and accounting function by hiring individuals with strong technical skills and significant experience in areas deemed appropriate to their assigned responsibilities, including the creation of a GAAP Technical Accounting Policy Group, thereby remediating the material weakness with respect to a sufficient complement of personnel in our corporate offices.
 
The Company has remediated its material weakness with respect to the tracking of its long-term assignment employees (“LTA”) in the United States and the recording of the related expenses and tax liabilities by implementing the following mechanisms:
 
  •     A comprehensive LTA policy.
 
  •     Training and testing to measure the comprehension of the LTA policy including tracking of completion of the training and the related test. Completion rates were above 90%.
 
  •     A comprehensive tracking system that identifies potential LTA personnel and accumulates and records appropriate cost data and related liabilities.
 
In addition to the foregoing remediation activities, we continued to strengthen the control environment and the accuracy and completeness of the financial accounts. Except as noted above, the following remediation efforts, certain of which commenced in fiscal 2006 and continue in 2007, were insufficiently mature to fully remediate any additional material weaknesses in fiscal 2006:
 
  •     We established a global remediation project, under the direction of the Chief Financial Officer, in order to provide oversight and direction in an effort to establish an effective control environment.
 
  •     We strengthened our Internal Audit function by adding individuals with specialized skills where deemed appropriate.


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  •     We continued the implementation of our finance transformation program, the objective of which was to design and develop remediation strategies to address material weaknesses and improve internal controls.
 
  •     We designed and implemented a global closing process designed to identify and define close tasks for both financial and non-finance functional areas, due dates for close procedures, task completion and ownership, and process integration.
 
  •     We implemented a financial close management tool which allows us to track progress against approximately 1,500 closing tasks.
 
  •     We implemented a “Program Control” initiative, consisting in excess of 250 professionals with requisite skills, designed to support the completeness and accuracy of project accounting details in North America.
 
  •     We implemented improvements to our billing process, established policies and procedures limiting any invoicing outside of our financial system, and significantly reduced manual billing errors and unapplied cash balances.
 
  •     In the first quarter of 2007, we deployed a new contract set up process and application to guide the comprehensive review of contract and project set-up data within the accounting system.
 
  •     In the second quarter of 2007, we deployed and conducted extensive training on an application referred to as the “Project Control Workbench.” Combined with other process changes, enhanced controls and reporting, this application will improve the accuracy and timeliness of submission of project accounting data needed for accounting for subcontractor accruals, estimate-at-complete, estimate-to-complete, and revenue recognition in North America.
 
  •     We implemented improved processes to identify, monitor, track and account for employees working outside their home country for extended periods of time including account reconciliations, data reviews, and tax cost projection analyses.
 
  •     We implemented new processes designed to improve the completeness, accuracy and timing of accounting for expatriate assignments, including the development of a tracking application to assist in the compiling and reporting of employee-related costs.
 
  •     We deployed an automated tool to assist with the process of requesting time and expense adjustments.
 
  •     We performed in-depth access reviews in certain regions of the applicable payroll systems to ensure proper access restrictions.
 
  •     We created an oversight function within the Corporate Controller group to provide additional analyses, review and oversight for fixed assets.
 
  •     We implemented procedures to include a regular review of asset impairment.
 
  •     In the first quarter of 2007, we completed a fixed asset inventory in addition to our periodic “electronic” inventory of laptops and desktops, to validate asset existence.
 
  •     We centralized all lease administration, enabling us to capture all lease obligations and lease terms, and measure the completeness and accuracy of our lease records.
 
  •     We implemented a review of certain monthly leasing activity reports to identify lease-related commitments.
 
  •     We implemented a process to identify real-time lease activity or other lease term changes with respect to our leased facilities.
 
The foregoing initiatives have enabled us to significantly improve our control environment, the completeness and accuracy of underlying accounting data, and the timeliness with which we are able to close our books. Management is committed to continuing efforts aimed at fully achieving an operationally effective


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control environment and timely filing of regulatory required financial information. The remediation efforts noted above are subject to the Company’s internal control assessment, testing and evaluation processes. While these efforts continue, we will rely on additional substantive procedures and other measures as needed to assist us with meeting the objectives otherwise fulfilled by an effective control environment.
 
Changes in Internal Control over Financial Reporting
 
As noted above, senior management implemented and caused to be sustained significant changes to personnel, including finance and accounting personnel in our corporate offices, processes and policies and have communicated the importance of our Standards of Business Conduct and ethics, and the importance of internal control over financial reporting. In addition, senior management caused to be implemented policies and processes and other mechanisms around the identification of our long-term assignment personnel in the United States and the accuracy and completeness of the related financial accounts. These measures matured sufficiently such that in the fourth quarter of 2006, their sustainability and impact were considered sufficient. These changes represent material changes that have occurred in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected or are reasonably likely to materially affect, our internal control over financial reporting.
 
ITEM 9A(T). CONTROLS AND PROCEDURES
 
Not applicable.
 
ITEM 9B. OTHER INFORMATION
 
None.


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PART III.
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
Our Board of Directors (the “Board”) currently consists of nine directors. Our directors are divided into three classes serving staggered three-year terms. Information about our directors as of June 1, 2007, is provided below. For information about our executive officers, please see “Executive Officers” included in Part I of this Annual Report.
 
Class I Directors Whose Terms Expire in 2007
 
Douglas C. Allred, age 56, has been a member of our Board of Directors since January 2000. Mr. Allred is a private investor. Mr. Allred retired from his position as Senior Vice President, Office of the President, of Cisco Systems, Inc. in 2003. Mr. Allred was Senior Vice President, Customer Advocacy, Worldwide Consulting and Technical Services, Customer Services, and Cisco Information Technology of Cisco Systems, Inc. from 1991 to 2002. Mr. Allred is a Governor on the Washington State University Foundation Board of Governors.
 
Betsy J. Bernard, age 52, has been a member of our Board of Directors since March 2004. Ms. Bernard is a private investor. Ms. Bernard was President of AT&T Corporation from 2002 to 2003. From 2001 to 2002, Ms. Bernard was President and Chief Executive Officer of AT&T Consumer. Ms. Bernard is a director of The Principal Financial Group, a global financial institution.
 
Spencer C. Fleischer, age 53, has been a member of our Board of Directors since July 2005. Mr. Fleischer is a senior managing member and Vice Chairman of Friedman Fleischer & Lowe GP II, LLC, a company sponsoring and managing several investment funds that make investments in private and public companies, and has served in such capacity since 1998. Mr. Fleischer was appointed to the Board of Directors in accordance with the terms of the securities purchase agreement, dated July 15, 2005, relating to the July 2005 Senior Debentures among the Company and certain affiliates of Friedman Fleischer & Lowe, LLC. If Mr. Fleischer ceases to be affiliated with the purchasers or ceases to serve on our Board of Directors, so long as the purchasers collectively hold at least 40% of the original principal amount of the July 2005 Senior Debentures, the purchasers or their designee have the right to designate a replacement director to the Board of Directors.
 
Class II Directors Whose Terms Expire in 2008
 
Wolfgang Kemna, age 49, has been a member of our Board of Directors since April 2001. Mr. Kemna is Managing Director of Steeb Anwendungssysteme GmbH, a wholly owned subsidiary of SAP AG (“SAP”). Mr. Kemna was Executive Vice President of Global Initiatives of SAP from 2002 to 2004. He was also a member of SAP’s extended executive board from 2000 to 2004.
 
Albert L. Lord, age 61, has been a member of our Board of Directors since February 2003. Mr. Lord is Chairman of the board of directors of SLM Corporation, commonly known as “Sallie Mae,” and has served in this capacity since 2005. Mr. Lord was Vice Chairman and Chief Executive Officer of Sallie Mae from 1997 to 2005.
 
J. Terry Strange, age 63, has been a member of our Board of Directors since April 2003. Mr. Strange retired from KPMG where he served as Vice Chair and Managing Partner of the U.S. Audit Practice from 1996 to 2002. During this period, Mr. Strange also served as the Global Managing Partner of the Audit Practice of KPMG International and was a member of its International Executive Committee. Mr. Strange is a director of Compass BancShares, Inc., a financial services company, New Jersey Resources Corp., an energy services holding company, Group 1 Automotive, Inc., a holding company operating in the automotive retailing industry, and Newfield Exploration Company, an independent crude oil and natural gas exploration and production company.


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Class III Directors Whose Terms Expire in 2009
 
Roderick C. McGeary, age 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.
 
Jill S. Kanin-Lovers, age 55, has been a member of our Board of Directors since May 2007. Ms. Kanin-Lovers served as Senior Vice President of Human Resources & Workplace Management at Avon Products, Inc. from 1998 to 2004. Ms. Kanin-Lovers is a member of the Board of Directors of Dot Foods, Inc., one of the nation’s largest food redistributors, Heidrick & Struggles, a leading global search firm, and First Advantage Corporation, a leading provider of risk mitigation and business solutions. Ms. Kanin-Lovers also teaches Corporate Governance for the Rutgers University Mini-MBA program.
 
Harry L. You, age 48, has been a member of our Board of Directors since March 2005. Mr. You has served as Chief Executive Officer of the Company 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.
 
No family relationships exist between any of the directors or between any director and any executive officer of the Company.
 
Presiding Director of Executive Sessions of Non-Management Directors
 
Our non-management directors who are not employees of the Company meet separately on a periodic basis. The Board has designated Douglas C. Allred as the Presiding Director for all meetings of the executive sessions of non-management directors.
 
Audit Committee
 
Our Audit Committee is currently composed of Messrs. Strange (Chair), Kemna and Lord. The Board has affirmatively determined that each member of the Audit Committee has no material relationship with the Company (either directly or as a partner, stockholder or officer of the Company) and is independent of the Company and its management under the listing standards of the NYSE and the applicable regulations of the SEC. Mr. Strange serves on the audit committee of four other publicly registered companies. The Board has determined that such simultaneous service does not impair Mr. Strange’s ability to serve on the Company’s Audit Committee. In addition, the Board has determined that Mr. Strange is an Audit Committee Financial Expert.
 
Compensation Committee Interlocks and Insider Participation
 
The members of our Compensation Committee for 2006 were Messrs. Allred (Chair) and Strange and Ms. Bernard. On May 10, 2007, Ms. Kanin-Lovers was appointed to the Compensation Committee, and on June 18, 2007, Mr. Strange stepped down from the committee. No member of the Compensation Committee is a former or current officer or employee of the Company or any of the Company’s subsidiaries. To the Company’s knowledge, there were no other relationships involving members of the Compensation Committee requiring disclosure in this section of this Annual Report.


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Standards of Business Conduct
 
On May 10, 2007, the Board approved our Standards of Business Conduct (the “SBC”), which superseded our prior Code of Business Conduct and Ethics as of May 31, 2007. The SBC was developed as part of our commitment to enhancing our culture of integrity and our corporate governance policies. The SBC reflects changes in law and regulation, best practices and updates to the Company’s policies. In addition, the SBC contains new or enhanced policies and/or procedures relating to violations of the SBC, conflicts of interest (including those related to the giving and receiving of gifts and entertainment), financial disclosures, the importance of maintaining the confidentiality of Company, client and competitor information, data privacy and protection, Company property, investor and media relations, records management, and lobbying/political activities. The SBC applies to all of our directors and employees, including our principal executive officer, principal financial officer and principal accounting officer. The SBC is posted on our website, at www.bearingpoint.com, and is filed as an exhibit to this Annual Report. We intend to satisfy the disclosure requirement regarding any amendment to, or waiver of, a provision of the SBC for our Chief Executive Officer, Chief Financial Officer, Corporate Controller or persons performing similar functions, by posting such amendment or waiver on our within the applicable deadline that may be imposed by government regulation following the amendment or waiver.
 
Committee Charters
 
In addition, our Corporate Governance Guidelines, Audit Committee Charter, Compensation Committee Charter and Nominating and Corporate Governance Committee Charter are posted on the Company’s website, at www.bearingpoint.com. A printed copy of these documents, as well as our Standards of Business Conduct, will be made available upon request.
 
Annual Certifications
 
The certifications by our Chief Executive Officer and Chief Financial Officer regarding the quality of our public disclosures are filed as Exhibits 31.1 and 31.2, respectively, to this Annual Report. We have also submitted to the NYSE a certificate of our Chief Executive Officer certifying that he is not aware of any violation by the Company of the NYSE corporate governance listing standards.
 
Communications with Board of Directors
 
The Board welcomes your questions and comments. If you would like to communicate directly with our Board, our non-management directors of the Board as a group or Mr. Allred, as the Presiding Director, then you may submit your communication to our General Counsel and Corporate Secretary by writing to them at the following address:
 
BearingPoint, Inc.
c/o General Counsel and Corporate Secretary
8725 W. Higgins Road
Chicago, IL 60631
 
All communications and concerns will be forwarded to our Board, our non-management directors as a group or our Presiding Director, as applicable. We also have established a dedicated telephone number for communicating concerns or comments regarding compliance matters to the Company. The phone number is 1-800-206-4081 (or 240-864-0229 for international callers), and is available 24 hours a day, seven days a week. Our Standards of Business Conduct prohibits any retaliation or other adverse action against any person for raising a concern. If you wish to raise your concern in an anonymous manner, then you may do so.


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Section 16(a) Beneficial Ownership Reporting Compliance
 
Under the U.S. Federal securities laws, directors and executive officers, as well as persons who beneficially own more than ten percent of our outstanding common stock, must report their initial ownership of the common stock and any changes in that ownership to the SEC. The SEC has designated specific due dates for these reports, and we must identify in this Annual Report those persons who did not file these reports when due. Based solely on a review of copies of Forms 3, 4 or 5 filed by us on behalf of our directors and executive officers or otherwise provided to us and copies of Schedule 13Gs, we believe that all of our directors, executive officers and greater than ten percent stockholders complied with their applicable filing requirements for 2006. In 2005, however, Judy Ethell, our Chief Financial Officer, failed to report a Form 4 to report the issuance of RSUs to Robert Glatz, her spouse, in connection with his employment in August 2005. The issuance of RSUs to Mr. Glatz, which was previously described in our Annual Reports on Form 10-K for fiscal years 2004 and 2005 (filed with the SEC on January 31, 2006 and November 22, 2006, respectively), was reported on a Form 4 on June 28, 2007.
 
ITEM 11. EXECUTIVE COMPENSATION
 
Compensation Discussion and Analysis
 
The success of our business largely depends on 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 management and the Compensation Committee of our Board of Directors devote a significant amount of time and attention to addressing the compensation of our professionals. Our Compensation Committee has the authority to determine the compensation for our executive officers, including making individual compensation decisions, and reviewing and structuring the compensation programs applicable to our executive officers. Our executive officers are our Chairman of the Board, Chief Executive Officer, Chief Financial Officer, Chief Operating Officer and General Counsel and Secretary. This compensation discussion and analysis provides perspective on our compensation objectives and policies for our Chief Executive Officer, our Chief Financial Officer and our other executive officers. We believe that an understanding of our approach to managing director compensation generally is useful to an understanding of our business model and our particular compensation practices as it relates to our executive officers. For additional information, see Item 1, “Business—Employees,” Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Principal Business—Priorities for 2007 and Beyond,” and “—Managing Director Compensation Plan.”
 
Overall Compensation Philosophy and Objectives
 
Overall, our compensation philosophy is to enhance corporate performance and stockholder value by aligning the financial interests of our managing directors, including our executive officers, with those of our stockholders. We strive to implement this philosophy by tying a significant portion of our managing directors’ compensation to our financial performance.
 
We design our compensation programs to:
 
  •     attract and retain the best possible talent;
 
  •     motivate our people’s efforts to achieve long-term positive returns for our stockholders;
 
  •     increase the use of performance and equity-based awards;
 
  •     communicate metrics to influence employee performance and accountability;
 
  •     provide for cash and long-term incentive compensation at levels that are competitive with companies within our industry (targeting to remain around the 50th percentile); and
 
  •     recognize outstanding individual performance.


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How Compensation is Determined
 
Mix of Total Compensation. Our Compensation Committee and management collaborate to determine the mix of compensation for our employees, both among short and long-term compensation and cash and non-cash compensation. Our management team establishes and recommends cash compensation for all of our employees, including our executive officers. Our Compensation Committee reviews management’s recommendations of guidelines for salary and cash bonus increases for our employees, determines cash compensation for our executive officers, and establishes guidelines and structures for the issuance of equity-based compensation so as to establish the mix of total compensation for our employees.
 
In the past, our business model rewarded revenue growth and utilization; however, in 2006, management and our Compensation Committee changed this approach, to emphasize profitability and individual performance in establishing the mix of total compensation to be paid to our executive officers.
 
Market Benchmarking. The Compensation Committee reviews and considers peer benchmarking information in determining the mix or relationship of compensation elements for our executive officers.
 
We target total compensation for our executive officers to be consistent with peer companies performing at comparable levels. To evaluate the reasonableness and competitiveness of our compensation, we obtain information on market pay levels from various sources, including nationally recognized compensation surveys, SEC filings of selected, publicly-traded benchmark companies and first-hand experience obtained from the marketplace in hiring employees. In addition, we typically engage a consultant to gather information on pay levels and practices for a group of comparable management and technology consulting companies based in the United States. For each comparable company, the Compensation Committee’s consultant collects information regarding total compensation levels for executive officers (including base salary, annual bonus, long-term incentives and other compensation) and other related items. The Compensation Committee’s consultant summarizes and reviews this information, as well as information from leading published compensation surveys, with the Compensation Committee.
 
Role of Compensation Committee and Management in Executive Officer Compensation Decisions. The Compensation Committee evaluates the performance of our executive officers and approves their annual compensation, including salary, bonus, incentive and equity compensation. The Compensation Committee takes into consideration management’s recommendations for the total compensation of our executive officers. For our executive officers, the Compensation Committee generally considers the Company’s performance within our industry, the challenges we continue to face in improving our business operations, as well as each individual’s current contribution and expected future contribution to our performance. The Chief Executive Officer meets with the Compensation Committee to discuss the performance review for each executive officer (other than himself) and to make compensation recommendations. The Chairman of the Board participates in the review and discussion of the Chief Executive Officer’s compensation. The Compensation Committee considers these views when making its compensation determinations, as well as an analysis of short-term and long-term compensation prepared by its outside consultant that compares the individual’s compensation for the prior two years, evaluates the compensation recommendations made by management and provides a market analysis comparing these compensation amounts to a group of peer companies. In making compensation decisions, the Compensation Committee also considers the results of the “360 degree” performance review process we have implemented, which is intended to broaden the scope of our review process for managing directors and allows peers and direct and indirect reports to review and assess the performance of our managing directors, including our executive officers.
 
Management Team Employment Agreements. Since November 2004, there have been significant changes to our executive management team as a result of the issues related to our North American financial reporting systems, internal controls, various ongoing investigations and related litigation. During the past two years, the Compensation Committee and management have devoted a significant amount of time to attract highly motivated and experienced individuals to comprise our new executive management team and to provide leadership to the Company. In 2005 and 2006, the Board of Directors appointed a new Chief Executive


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Officer, Chief Financial Officer and General Counsel, and, in 2007, the Board appointed a new Chief Operating Officer. We entered into written employment agreements with Mr. You, our Chief Executive Officer, Ms. Ethell, our Chief Financial Officer, Mr. Lutz, our General Counsel and Secretary and Mr. Harbach, our Chief Operating Officer. Prior to agreeing upon the compensation terms of these employment agreements, the Compensation Committee took into consideration competitive market compensation information based upon peer group data and the data of companies with a similar market capitalization. Furthermore, it was necessary to compensate Mr. You, Ms. Ethell and Mr. Lutz with additional equity grants and other signing bonus payments to offset compensation that would have been earned or benefits that would have been received by such individuals had they remained with their previous employers.
 
Equity Compensation Programs
 
In connection with our 2006 Annual Meeting of Stockholders, our Board of Directors included a proposal to amend the LTIP to, among other things, provide for a 25 million share increase in the number of shares authorized for equity awards made under the LTIP. In soliciting proxies from our largest stockholders, we informed our stockholders that the increased share capacity would be used to implement a new equity-based retention strategy for 2007, under which awards would vest over several years and be subject to performance-based vesting criteria. Our management and the Compensation Committee made these recommendation because they realized that (1) approximately 70% of the RSUs we issued in 2005 would vest by January 1, 2007 and (2) the number of shares available under our LTIP would not allow us to issue substantial amounts of equity in the near future. Furthermore, because most of our outstanding stock option awards were granted before 2005, we believed those stock options had limited retentive value since they were granted with exercise prices that were still above our common stock’s current stock price. We believe that performance-based equity is viewed more favorably than RSUs by our stockholders because vesting is conditioned upon performance criteria that can be objectively measured rather than mere continuation of employment. Our stockholders approved the LTIP amendments on December 14, 2006.
 
Generally, we do not expect the Compensation Committee to make any additional grants of RSUs or PSUs to our executive officers through the end of 2009. Until that time, we expect that any bonus compensation earned by our executive officers will be paid in cash.
 
PSU Program. In February 2007, the Compensation Committee adopted a performance share unit (“PSU”) program for the Company’s highest-performing managing directors and senior managers, including our executive officers. The PSU program was implemented recognizing that: (i) we had achieved some important milestones in our efforts to become timely in our SEC periodic filings; (ii) we were beginning to achieve a level of operational stability under the direction and guidance of our new executive management team; and (iii) our managing directors had demonstrated their ability to maintain our core business under adverse conditions. As a result, management and the Compensation Committee determined that the PSUs should be structured with a view to promoting longer-term retention. The Compensation Committee concluded that the greatest retentive potential would be achieved if the PSUs were initially granted as large, three-year cliff vesting awards rather than in smaller increments with shorter vesting periods. To ensure that vesting of the PSUs was sufficiently tied to Company performance, the vesting of the PSUs was tied to achievement of performance targets of both minimum growth in consolidated business unit contribution (“CBUC”), defined as (i) consolidated net revenue less (ii) professional compensation, other costs of service and sales, general and administrative expense (excluding stock compensation expense, bonus expense, interest expense and infrastructure expense) and total shareholder return. CBUC was selected as a performance metric that we believe demonstrates the core growth of each of our industry groups. In addition, total shareholder return was selected as a “best practice” performance metric that we believe is a measure important to our stockholders. In determining the thresholds for these performance targets, the Compensation Committee selected target levels that, in its estimation, would require Company growth, yet also be reasonably achievable to encourage and incent our employees to perform. For additional information on the PSU Program, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Principal Business—Priorities for 2007 and Beyond.”


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Restricted Stock Units (“RSUs”). We will continue to grant RSUs for various purposes, including as awards granted in connection with promotions and, when we have become current in our SEC periodic reports, as part of developing attractive employment offers for new recruits. The vesting of these RSUs continues to be time-based, either with a three-year cliff vesting provision or vesting ratably over four years. By comparison, we expect that future RSUs granted to our executive officers, if any, will include performance-based vesting requirements. While we may incrementally increase the relative proportion of variable compensation of our executive officers through RSU grants, we currently expect that through 2009, the predominant source of equity awards held by our executive officers will be derived from PSUs.
 
While we have maintained parity with our major competitors on base cash compensation for our executive officers, relevant market data indicates that we continue to lag behind our competitors in the categories of cash incentive and long-term, equity incentive compensation. We believe the issuance of PSU awards help to balance the mix of fixed and variable compensation of our executive officers, aligning us more closely with the compensation structures offered by our competitors.
 
Principal Components of Executive Officer Compensation
 
The principal elements of our executive officer compensation program consist of base salary, annual incentive cash bonuses and, at appropriate intervals, long-term incentive compensation in the form of grants of stock-based awards. We also provide deferred compensation plans, health and welfare (including medical), retirement and other perquisites and benefits to our executive officers generally available to our other employees.
 
In determining 2006 compensation, we did not engage an outside consultant to assist the Compensation Committee. Compensation determinations, however, were based in part upon compensation information about executive officers at other systems integration and consulting firms gathered by Watson Wyatt Worldwide. In 2006 and 2007, we engaged Towers Perrin as our compensation consultant to prepare compensation analyses of our executive officers, provide market data information used to determine the payment of 2006 bonuses and 2007 compensation and provide guidance on our long-term compensation strategies, including the structuring of our PSU program.
 
Fixed Compensation
 
Base Salaries. Base salaries for our executive officers are determined by evaluating the responsibilities of the position held, the experience and performance of the individual and market information comparing such salaries to the competitive marketplace for executive talent, with emphasis on our primary competitors in the management and technology consulting industry. The Compensation Committee considers salary adjustments based upon the recommendation of the Chief Executive Officer (other than with respect to his salary), the Compensation Committee’s evaluation of Company performance and the performance of the executive officer, taking into account any additional or new responsibilities assumed by the individual executive officer in connection with promotions or organizational changes. Salary represents a smaller percentage of total compensation for our executive officers than for our less senior managing directors, with a greater percentage of the executive officers’ compensation being tied to performance and our share price.
 
Determination of 2006 Base Salaries. The employment agreements that we entered into with Mr. You, Ms. Ethell and Mr. Lutz provided for their respective base annual salaries during 2006, as reflected in the “Summary Compensation Table” on page 91. Pursuant to their employment agreements (entered into in 2005), base salary for each of Mr. You and Ms. Ethell was unchanged from 2005 to 2006. Mr. McGeary and Mr. Roberts do not have specific employment agreements with the Company.
 
For 2006, the Compensation Committee approved a base salary for Mr. McGeary in the range of $650,000 to $750,000, and delegated its authority to the Chief Executive Officer to make the final determination of his base salary. Our Chief Executive Officer determined that Mr. McGeary’s base salary for


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2006 should be $650,000, based on Mr. McGeary’s active involvement with the Board, his contributions as Chief Executive Officer of the Company in 2005, which included the hiring of the new executive management team and his participation in employee roadshows and other communications intended to maintain employee morale and address employee attrition.
 
In determining Mr. Robert’s base salary for 2006, the Compensation Committee considered various factors, such as Mr. Robert’s willingness to assume the role of Chief Operating Officer in 2005, the time and effort he spent assisting Mr. You in his new role as Chief Executive Officer, his efforts in addressing morale within the Finance team and helping to abate attrition and his contributions to our Managing Director Compensation Committee.
 
Variable Compensation
 
Annual Incentive Bonus. Generally, our executive officers would be eligible to receive annual incentive bonuses pursuant to our MD Compensation Plan, under the same terms and conditions applicable to the Company’s managing directors. However, currently, the Compensation Committee determines the target bonus amounts for Mr. You, Ms. Ethell and Mr. Lutz generally in accordance with the terms of their employment agreements. Any such bonuses paid to our executive officers are paid in lieu of MD Compensation Plan amounts. During 2006, we paid the annual bonuses set forth in the “Summary Compensation Table” on page 91. Bonuses earned for performance during one year are paid in the following year.
 
Determination of 2006 Annual Incentive Bonuses. In 2006, the Compensation Committee determined to award Mr. You, Mr. McGeary and Mr. Roberts cash bonuses equal to 7.8% of their base salaries, which was the percentage applied to determine cash bonuses for each managing director who achieved a “meets expectations” rating for 2006 performance. Although Mr. You was eligible to receive up to 100% of his bonus salary as set forth in his employment agreement, Mr. You and the Compensation Committee agreed that it was appropriate to alter the basis for determining his bonus compensation for 2006. In addition to the cash bonus, the Compensation Committee made conditional RSU awards to Mr. You and Mr. McGeary that would vest based on their achievement of certain performance targets. The stipulated performance targets were not achieved and these awards were not granted. However, for a discussion of a smaller, subsequent award that was made to Mr. You, see “2006 Long-Term Incentive Compensation” below. For 2006, the Compensation Committee determined to award Ms. Ethell and Mr. Lutz cash bonuses equal to 60% and 100%, respectively, of their base salaries (although Mr. Lutz was paid a pro rated amount, since his employment with the Company started in March 2006).
 
The Compensation Committee’s determinations of cash bonuses awarded to our executive officers in 2006, as well as determinations of 2007 compensation, were based in part on the following considerations:
 
     
Harry You
 
•    outstanding feedback in the “360 degree” peer review process
   
•    successful motivation of the Company’s managing directors to drive Company performance
   
•    progress made and left to be achieved with respect to the Company’s SEC filing status
   
•    evaluations by Board members


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Roderick McGeary
 
•    time dedicated to Board of the Directors and effectiveness in fulfilling Chairman role; liaison role between management and the Board
   
•    management roles and responsibilities, in addition to Board role
   
•    executive sponsor of the Company’s transition to new financial reporting systems
   
•    executive management role in addressing contractual or engagement relationship issues
     
Judy Ethell
 
•    development of Finance leadership team
   
•    responsibilities related to development of financial reporting systems
   
•    oversight of internal audit, internal controls and Sarbanes-Oxley efforts
   
•    progress achieved and remaining to be achieved with respect to the filing of the Company’s SEC periodic reports
   
•    expanded responsibilities as Chief Financial Officer
   
•    evaluations by the Audit Committee
     
Laurent Lutz
 
•    restructuring of the Legal department
   
•    stewardship of key external constituencies—e.g., SEC, New York Stock Exchange, insurers
   
•    creation and implementation of compliance function
   
•    success in managing and resolving various disputes and lawsuits
   
•    level of contribution in Board of Directors and committee meetings
   
•    implementation and oversight of improved disclosure controls
     
Rich Roberts
 
•    individual performance rating among managing directors
   
•    leadership role within the Public Services business unit
 
Long-Term Incentive Compensation
 
2006 Long-Term Incentive Compensation. In addition to their annual cash incentive bonuses, Mr. You and McGeary received grants of RSUs in connection with their 2006 performance. When the Compensation Committee determined Mr. You’s 2006 base compensation, the Compensation Committee also decided that to incent Mr. You’s performance, it would make a conditional grant of RSUs to Mr. You at the end of 2006 if Mr. You achieved certain performance milestones. Mr. You was eligible to receive a grant of 187,500 RSUs, to vest 25% on the grant date and 25% annually over the next three years, subject to the achievement of Company performance milestones for 2006. In early 2007, the Compensation Committee determined that these milestones had not been achieved, and as a result, these RSUs were not granted. The Compensation Committee did acknowledge, however, that Mr. You had made substantial contributions to the Company in 2006 (as set forth above) and, as a result, the Compensation Committee decided to make a smaller award of 72,992 RSUs to Mr. You, as bonus compensation for his performance.
 
In evaluating Mr. McGeary’s compensation for 2006, the Compensation Committee considered market data indicating that while Mr. McGeary’s cash compensation was commensurate for his position and responsibilities, his long-term incentive compensation was lower than market. Based on the factors set forth above, as well as an analysis of the mix of Mr. McGeary’s fixed and variable compensation, the Compensation Committee determined that it would increase Mr. McGeary’s long-term compensation. As a result, Mr. McGeary was granted 29,197 RSUs on February 12, 2007.

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None of our executive officers received equity grants in 2006 as part of their compensation for 2006. Several of our executive officers, however, received equity grants for reasons other than as part of their 2006 compensation. For an explanation of these grants, please see the “Summary Compensation Table” on page 91.
 
On April 20, 2005, pursuant to Regulation BTR, the Company announced there would be a blackout period under the Company’s 401(k) plan. Due to existence of the blackout period, the Company was unable to make issuances of equity awards to its executive officers prior to September 14, 2006. The Company’s 401(k) Plan was subsequently amended to permanently prohibit participant purchases and Company contributions of its common stock under the 401(k) Plan and as a result of this action, the blackout period under the 401(k) Plan ended, effective as of September 14, 2006 and the Company was again able to make equity-based awards to its executive officers.
 
To date, we have not instituted any equity ownership requirements for our executive officers. We did not consider any such policy in 2006 due to the BTR blackout mentioned above, as well as the complexities and risks associated with open-market purchases of our common stock by our executive officers while we are not current in our SEC periodic filings. We expect to consider an equity ownership policy once we have become current in our SEC periodic filings.
 
2007 Compensation
 
Base Salary. In determining 2007 compensation, management and the Compensation Committee agreed that the executive officers would receive the standard 4% increase in base compensation provided to all the Company’s other managing directors in 2007. The Compensation Committee approved the following 2007 salaries for our executive officers:
 
         
    Base Salary
 
Name
  for 2007  
 
Harry L. You
  $ 780,000  
Roderick C. McGeary
    676,000  
Judy A. Ethell
    520,000  
Laurent C. Lutz
    520,000  
 
In January 2007, Mr. Harbach was appointed as our Chief Operating Officer, replacing Mr. Roberts as an executive officer of the Company. Mr. Harbach’s base salary for 2007, set forth in his employment agreement with the Company, is $700,000.
 
PSU Awards. As part of our 2007 compensation program, the Compensation Committee approved in March 2007 the issuance of PSU awards to our executive officers. The Compensation Committee determined the amount of each PSU award granted to our executive officers by reviewing each executive officer’s individual performance and responsibilities and roles within the Company and by assessing and comparing the executive officer’s total compensation, including previously granted incentive awards and the balance of fixed and variable compensation, with competitive market data provided by Towers Perrin. PSU awards were granted to the following individuals:
 
         
    Total Number
 
    of
 
Name
  PSUs Granted (1)  
 
Harry L. You
    959,079  
Roderick C. McGeary
    255,754  
Judy A. Ethell
    306,905  
Laurent C. Lutz
    383,632  


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(1) The PSUs will vest on December 31, 2009 if two performance-based metrics are achieved for the performance period beginning on February 2, 2007 and ending on December 31, 2009. The Company must first achieve a compounded average annual growth target in consolidated business unit contribution. Then, depending on the Company’s total shareholder return relative to those companies that comprise the S&P 500, the percentage of PSU awards that vest will vary from 0% to 250%. The “Total Number of PSUs Granted” assumes that 100% of the PSU awards vest.
 
Mr. Harbach did not receive a PSU award since he received a grant of 888,325 RSUs on January 8, 2007 as part of his employment arrangement with the Company.
 
Other Compensation
 
Deferred Compensation Plans. We have a “Deferred Compensation Plan” and a “Managing Directors Deferred Compensation Plan.” The two plans are substantially identical and permit a select group of management and highly compensated employees to accumulate additional income for retirement and other personal financial goals by making elective deferrals of compensation to which they will become entitled to in the future. Our deferred compensation plans are nonqualified and unfunded, and participants are unsecured general creditors of the Company as to their accounts. Managing directors, including our executive officers, and other highly compensated executives selected by the plans’ administrative committee are eligible to participate in the plans. None of our executive officers have participated in our deferred compensation plans.
 
Other Benefits. We offer a variety of health and welfare and retirement programs to all eligible employees. Our executive officers are generally eligible for the same health and welfare programs on the same basis as our other employees. Our retirement program for U.S. employees consists of a 401(k) program, in which executive officers participate on the same terms and conditions as other eligible employees. We match the individual employee’s contribution to the program of 25% of the first 6% of pre-tax eligible compensation contributed to the plan, and, at our discretion, may make additional discretionary contributions of up to 25% of the first 6% of pre-tax eligible compensation contributed to the plan. Employee contributions to the 401(k) program for our executive officers, as well as other more highly compensated employees, are limited by federal law. We have not made up for the impact of these statutory limitations on named executives through any type of nonqualified deferred compensation or other program.
 
Perquisites and Other Compensation. In general, we have historically avoided the use of perquisites and other types of non-cash benefits for executive officers and expect this policy to continue. Certain of our executive officers have received perquisites such as reimbursements of moving expenses and legal fees and gross-up payments in connection with the same as set forth in their respective employment agreements.
 
Regulatory Considerations
 
The Internal Revenue Code contains a provision that limits the tax deductibility of certain compensation paid to our executive officers to the extent it is not considered performance-based compensation under the Internal Revenue Code. We have adopted policies and practices to facilitate compliance with Section 162(m) of the Internal Revenue Code. It is intended that awards granted under the LTIP to such persons will qualify as performance-based compensation within the meaning of Section 162(m) and regulations under that section.
 
In making decisions about executive compensation, we also consider the impact of other regulatory provisions, including the provisions of Section 409A of the Internal Revenue Code regarding non-qualified deferred compensation and the change-in-control provisions of Section 280G of the Internal Revenue Code. In accordance with recent IRS guidance interpreting Section 409A, the LTIP will be administered in a manner that is in good faith compliance with Section 409A. The Board intends that any awards under the LTIP satisfy the applicable requirements of Section 409A. Generally, Section 409A is inapplicable to incentive stock


88


 

options and restricted stock and also to nonqualified stock options so long as the exercise price for the nonqualified option may never be less than the fair market value of the common stock on the date of grant.
 
In making decisions about executive compensation, we also consider how various elements of compensation will impact our financial results including the impact of SFAS 123(R) which requires us to recognize the cost of employee services received in exchange for awards of equity instruments based upon the grant date fair value of those awards. SFAS 123(R) was a consideration in adopting restricted stock units as a long-term equity incentive.
 
REPORT OF THE COMPENSATION COMMITTEE
OF THE BOARD OF DIRECTORS ON EXECUTIVE COMPENSATION
 
The Compensation Committee of the Board of Directors has reviewed and discussed the Compensation Discussion and Analysis section of this Annual Report on Form 10-K with the Company’s management and, based on such review and discussion, recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K.
 
COMPENSATION COMMITTEE
 
Douglas C. Allred (Chair)
Betsy Bernard
Jill S. Kanin-Lovers*
J. Terry Strange**
 
*Member of the Compensation Committee since May 10, 2007
 
**Member of the Compensation Committee during 2006 and through June 18, 2007


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Summary of Cash and Certain Other Compensation
 
The Summary Compensation Table below sets forth information concerning all compensation for services in all capacities to the Company for 2006 of those persons who were the Chief Executive Officer, Chief Financial Officer and the three other most highly compensated executive officers of the Company for 2006 (“named executive officers”).
 
Summary Compensation Table
 
                                                                 
                                  Non-Equity
             
                                  Incentive
             
                      Stock
    Option
    Plan
    All Other
       
Name and
        Salary
    Bonus
    Awards
    Awards
    Compensation
    Compensation
    Total
 
Principal Position
  Year     ($) (1)     ($) (1)     ($) (2)     ($) (2)     ($)     ($)     ($)  
 
Harry L. You(3)
    2006       750,000       58,500       938,900       2,519,300             331,828       4,598,528  
Chief Executive Officer
                                                               
Roderick C. McGeary
    2006       662,640       50,712       250,000       263,732                   1,227,084  
Chairman of the Board
                                                               
Judy A. Ethell(4)
    2006       500,000       300,000       690,700       1,131,000             3,797       2,625,497  
Chief Financial Officer
                                                               
Laurent C. Lutz(5)
    2006       411,059       1,311,059                   525,000       78,431       2,325,549  
General Counsel and Secretary
                                                               
Richard J. Roberts(6)
    2006       650,000       50,700       855,400       332,160             3,977       1,892,237  
Chief Operating Officer
                                                               
 
 
(1) Unless otherwise noted, “Bonus” amounts consist of performance-based cash bonuses accrued in the fiscal year for which the bonus has been earned. We have entered into employment agreements with Mr. You, Ms. Ethell and Mr. Lutz that set forth the terms of their compensation.
 
(2) Unless otherwise noted, stock awards, which consist of RSUs, and stock options were granted in accordance with our LTIP. If dividends are declared on our common stock while any RSUs are outstanding, the number of shares to be granted upon settlement of the RSUs will be adjusted to reflect the payment of such dividends. Amounts reflected in the table as 2006 compensation reflect the dollar amount recognized for financial statement reporting purposes in 2006 in accordance with SFAS 123(R) for equity award expense. For additional information about 2006 awards of RSUs, stock options, and other non-equity incentive plan compensation, see “ — Grants of Plan-Based Awards.”
 
(3) Mr. You’s “All Other Compensation” includes reimbursements of $259,568 for costs related to the sale of his residences, $17,117 in commuting expenses, $51,532 in tax equalization payments with respect to the reimbursement of moving expenses and certain state taxes paid by Mr. You, $2,361 in personal travel expenses and $1,250 in Company matching contributions under our 401(k) Plan.
 
(4) On October 3, 2006, we entered into a letter agreement with Ms. Ethell relating to the rescission and replacement of certain grants of nonqualified stock options and RSUs made to her in July 2005 in connection with her employment with the Company. On July 1, 2005, Ms. Ethell received a grant for 292,000 RSUs and a stock option grant to purchase 600,000 shares of common stock (collectively, the “2005 Awards”). The 2005 Awards were intended to be of effect only after the Company had become current in its SEC periodic filings; however, we reconsidered the rationale behind this approach and as a result, we canceled the 2005 Awards and made subsequent replacement grants to Ms. Ethell, effective as of September 19, 2006 (the “2006 Awards”). The 2006 Awards consist of: (a) stock options to purchase up to 600,000 shares of our common stock, of which 25% vested upon grant, and, subject to achievement of certain performance criteria, 25% will vest on July 1 in each of 2007 through 2009, (b) 292,000 RSUs, of which 204,400 vested on date of grant, and, subject, to achievement of certain performance criteria, an additional 29,200 will vest on July 1 in each of 2007 through 2009, and (c) 94,000 RSUs, of which 25% vested on date of grant, and subject to achievement of certain performance criteria, 25% will vest on July 1 in each of 2007 through 2009.
 
(5) Mr. Lutz’s annual base salary for 2006 was $500,000. The amount reported as Mr. Lutz’s salary is the amount actually paid in 2006. Mr. Lutz’s 2006 bonus compensation consists of a $900,000 signing bonus and $411,059 of bonus compensation (pro rated, based on an annual performance bonus of $500,000). Mr. Lutz’s 2006 non-equity incentive plan compensation is more fully described under “ — Grants of Plan-Based Awards.” Mr. Lutz’s “All Other Compensation” consists of $41,857 in legal fees paid on Mr. Lutz’s behalf in connection with the negotiation of his employment arrangements with the Company, reimbursement of $36,574 in tax equalization payments with respect to the reimbursement of legal fees and certain state taxes paid by Mr. Lutz.
 
(6) Effective as of January 8, 2007, Mr. Roberts no longer serves as our Chief Operating Officer in connection with the appointment of F. Edwin Harbach as our President and Chief Operating Officer.


90


 

 
Grants of Plan-Based Awards
 
The following table provides information relating to equity awards made in 2006 to our named executive officers. All of the following awards that relate to our common stock were made pursuant to our LTIP.
 
                                                                         
                                                    Grant
 
                                              Exercise
    Date Fair
 
                                              Price of
    Value of
 
          Estimated Future Payouts Under
    Estimated Future Payouts Under
    Option
    Stock and
 
    Grant
    Non-Equity Incentive Plan Awards     Equity Incentive Plan Awards     Awards
    Option
 
Name
  Date     Threshold ($)     Target ($)     Maximum ($)     Threshold (#)     Target (#)     Maximum (#)     ($/Sh)     Awards  
 
Harry You
                                                     
Roderick C. McGeary (1)
    9/25/2006                                     29,411           $ 249,994  
Judy A. Ethell (2)
    9/19/2006                                     600,000     $ 8.70       2,883,600  
      9/19/2006                                     292,000             2,540,400  
      9/19/2006                                     94,000             817,800  
Laurent C. Lutz (3)
    2/27/2006                 $ 1,750,000 (3)                 (3)            
Richard J. Roberts (4)
    9/25/2006                                     77,343             657,416  
      9/25/2006                                     93,177             792,005  
 
 
(1) Mr. McGeary was granted 29,411 RSUs that vest 25% on January 1 in each of 2007 through 2010.
 
(2) Ms. Ethell was granted the following awards: (a) stock options to purchase up to 600,000 shares of our common stock, of which 25% vested upon grant, and, subject to achievement of certain performance criteria, 25% will vest on July 1 in each of 2007 through 2009, (b) 292,000 RSUs, of which 204,400 vested on date of grant, and, subject, to achievement of certain performance criteria, an additional 29,200 will vest on July 1 in each of 2007 through 2009, and (c) 94,000 RSUs, of which 25% vested on date of grant, and subject to achievement of certain performance criteria, 25% will vest on July 1 in each of 2007 through 2009. These grants were made pursuant to a letter agreement between the Company and Ms. Ethell, effective as of October 3, 2006, and replaced grants made to Ms. Ethell in 2005 in connection with her employment with the Company. The 2005 Awards were intended to be modified to be of effect only after the Company had become current on its SEC periodic filings, however, the rationale behind this approach was reconsidered by the Company. As a result, the 2005 Awards were canceled and the Compensation Committee approved these subsequent grants to Ms. Ethell, effective as of September 19, 2006.
 
(3) Mr. Lutz was granted the following: on the earlier of (i) the date an effective registration statement on Form S-8 is filed or is on file and (ii) the date, if any, we cease to be a reporting company under the Exchange Act, a grant of RSUs having an aggregate value of $1.75 million; provided, however, if RSUs have not yet been granted, subject to certain conditions, Mr. Lutz will receive cash payments (which will reduce the value of any RSUs to be granted) of $525,000 on July 1, 2006, $525,000 on June 30, 2007 and $175,000 on December 31 in each of 2007 through 2010.
 
(4) Mr. Roberts was granted the following awards: (a) 77,343 RSUs, all of which vested on September 25, 2006, and (b) 93,177 RSUs that vest 25% on January 1 in each of 2007 through 2010.


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Outstanding Equity Awards at Fiscal Year-End (December 31, 2006)
 
The following table provides information regarding the value of all unexercised options and unvested restricted stock units previously awarded to our named executives as of December 31, 2006.
 
                                                                         
    Option Awards     Stock Awards  
                                                    Equity
 
                                                    Incentive
 
                                                    Plan Awards:
 
                Equity
                            Equity
    Market
 
                Incentive
                            Incentive
    or Payout
 
                Plan Awards:
                      Market
    Plan Awards:
    Value of
 
    Number of
    Number of
    Number of
                Number of
    Value of
    Number of
    Unearned
 
    Securities
    Securities
    Securities
                Shares or
    Shares or
    Unearned Shares,
    Shares,
 
    Underlying
    Underlying
    Underlying
                Units of
    Units of
    Units or
    Units or
 
    Unexercised
    Unexercised
    Unexercised
    Option
    Option
    Stock That
    Stock That
    Other Rights
    Other Rights
 
    Options (#)
    Options (#)
    Unearned
    Exercise
    Expiration
    Have not
    Have not
    That Have
    That Have
 
Name
  Exercisable     Unexercisable     Options (#)     Price ($)     Date     Vested (#)     Vested ($)     not Vested (#)     not Vested (#)  
 
Harry L. You
    500,000 (1)     1,500,000 (1)         $ 7.55       3/18/2015       750,000 (2)   $ 5,902,500              
Roderick C. McGeary
    7,928                   55.50       6/30/2010       29,411 (3)     231,465              
      15,000                   16.38       4/24/2011                          
      450,000                   9.00       11/19/2014                          
Judy A. Ethell
    150,000 (4)     450,000 (4)           8.70       9/19/2016       87,600 (4)     689,412              
                                              70,500 (4)     554,835              
Laurent C. Lutz (5)
                                                     
Richard J. Roberts
    11,892                   18.00       7/31/2010       93,177 (6)     733,303              
      53,205                   18.00       2/8/2011                          
      50,000                   13.30       7/24/2011                          
      11,611                   11.01       9/3/2012                          
      70,000                   10.01       9/3/2012                          
      125,000                   8.19       8/28/2013                          
      40,000 (7)     20,000 (7)           9.15       10/4/2014                          
 
 
(1) Mr. You was granted stock options to purchase up to 2,000,000 shares of our common stock, which options vest 25% on March 18 in each of 2006 through 2009.
 
(2) Mr. You was granted 750,000 RSUs, of which 62,500 RSUs vested on March 21, 2007, 125,000 RSUs vest on March 21, 2008, 187,500 RSUs vest on March 21 in each of 2009 and 2010, 125,000 RSUs vest on March 21, 2011 and 62,500 RSUs vest on March 21, 2012.
 
(3) Mr. McGeary was granted 29,411 RSUs that vest 25% on January 1 in each of 2007 through 2010.
 
(4) Ms. Ethell was granted stock options to purchase up to 600,000 shares of our common stock, of which 25% vested upon grant (September 19, 2006), and, subject to achievement of certain performance criteria, 25% will vest on July 1 in each of 2007 through 2009. In addition, Ms. Ethell was granted (i) 292,000 RSUs, of which 204,400 vested on date of grant (September 19, 2006), and, subject to achievement of certain performance criteria, an additional 29,200 will vest on July 1 in each of 2007 through 2009; and (ii) 94,000 RSUs, of which 25% vested on date of grant (September 19, 2006), and subject to achievement of certain performance criteria, 25% will vest on July 1 in each of 2007 through 2009. These grants were made in connection with the rescission and replacement of the 2005 Awards. For additional information, see footnote 4 of the “Summary Compensation Table” on page 91.
 
(5) From April 20, 2005 through September 14, 2006, pursuant to Regulation BTR, we announced there would be a blackout period under our 401(k) plan. Due to existence of the blackout period, we were unable to make issuances of equity awards to its executive officers. In connection with his employment, Mr. Lutz was granted the following: on the earlier of (i) the date an effective registration statement on Form S-8 is filed or is on file and (ii) the date, if any, we cease to be a reporting company under the Exchange Act, a grant of RSUs having an aggregate value of $1.75 million; provided, however, if RSUs have not yet been granted, subject to certain conditions, Mr. Lutz will receive cash payments (which will reduce the value of any RSUs to be granted) of $525,000 on July 1, 2006, $525,000 on June 30, 2007 and $175,000 on December 31 in each of 2007 through 2010.
 
(6) Mr. Roberts was granted 93,177 RSUs that vest 25% on January 1 in each of 2007 through 2010.
 
(7) Mr. Roberts was granted stock options to purchase up to 60,000 shares of our common stock. The stock options vest as follows: 1/3 on October 4 in each of 2005, 2006, and 2007.


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Option Exercises and Stock Vested
 
The following table provides information with respect to restricted stock units and restricted stock that vested during 2006 with respect to our named executive officers. No options were exercised in 2006.
 
                                 
    Option Awards     Stock Awards  
    Number of Shares
          Number of Shares
       
    Acquired on
    Value Realized on
    Acquired on
    Value Realized on
 
Name
  Exercise (#)     Exercise ($)     Vesting (#)     Vesting ($)  
 
Harry L. You </