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FTI Consulting, Inc. 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2004, for FTI Consulting, Inc., a provider of forensic and litigation consulting, corporate finance/restructuring, and economic consulting services. The company operates as a single reporting unit but manages three distinct operating segments. The reporting period includes the integration of three major acquisitions completed in late 2003 (Lexecon, KPMG dispute advisory services, and Ten Eyck Associates).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 13.7% for the quarter and 11.1% for the six-month period compared to 2003. This growth was driven by acquisitions, offset by a decline in the corporate finance/restructuring segment.
• Profitability Decline: Despite revenue growth, operating income decreased 27.8% for the quarter and 32.2% for the six-month period. Net income for the six months dropped 23.2% year-over-year.
• Margin Compression: Gross margins declined across all segments. Direct costs of revenues increased as a percentage of revenue (from 45.7% to 55.2% for the six months) due to lower utilization rates and the integration of lower-margin acquired businesses.
• Cash Flow Deterioration: Net cash provided by operating activities plummeted from $56.9 million in the first half of 2003 to $0.5 million in the first half of 2004. This was caused by increased receivables, refunds of client retainers, and lower operating income.
• Segment Shifts: The Corporate Finance/Restructuring segment revenue share dropped from ~70% in 2003 to ~37% in 2004 due to market conditions and the departure of senior professionals. Conversely, Forensic and Litigation Consulting and Economic Consulting segments grew significantly due to acquisitions.

Outlook, Risks, and Unusual Items

• Staff Departures: In Q1 2004, approximately 60 senior professionals departed the corporate finance/restructuring practice to form a competing firm. This resulted in lost client engagements, refund requests, and reduced utilization rates.
• Legal Proceedings: The company has filed lawsuits against the former employees and their new venture for breach of duty and solicitation. Additionally, a dispute with PricewaterhouseCoopers regarding non-competition covenants is ongoing, with a trial expected in fall 2004.
• Real Estate Restructuring: The company entered a new long-term lease for New York City office space in July 2004, receiving an $8.1 million cash inducement. However, it expects to record a loss of approximately $3.2 million in the second half of 2004 related to vacating and subleasing previous facilities.
• Liquidity: Operating cash flow was insufficient to fund capital expenditures and working capital needs in the first half of 2004. The company utilized its revolving credit facility, borrowing a net $11.0 million. As of June 30, 2004, $79.0 million remained available under the credit facility.
• Guidance: Management expects total revenues for 2004 to be higher than 2003 but anticipates lower segment profits in the third quarter due to seasonal factors and the impact of staff departures.

Investor Verification Checklist

• Verify the extent of client attrition and revenue loss resulting from the departure of the corporate finance/restructuring team.
• Monitor the resolution of the legal disputes with former employees and PricewaterhouseCoopers, including potential damages or injunctions.
• Assess the impact of the $3.2 million expected lease loss and the integration costs of the new New York City office.
• Review the trend in accounts receivable days and the ability to collect retainers, given the sharp decline in operating cash flow.
• Track the utilization rates of the newly acquired businesses (Lexecon, KPMG, Ten Eyck) to determine if they are stabilizing at expected levels.