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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2010

OR

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

Commission File Number 000-50464

LECG CORPORATION

(Exact name of registrant as specified in its charter)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  o  No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

As of April 30, 2010, there were 36,901,253 shares of the registrant’s common stock outstanding.

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LECG CORPORATION AND SUBSIDIARIES
FORM 10-Q

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PART I FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

LECG CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)
(unaudited)

See notes to condensed consolidated financial statements

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LECG CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)
(unaudited)

See notes to condensed consolidated financial statements

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LECG CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)
(unaudited)

See notes to condensed consolidated financial statements

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LECG CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.             Basis of presentation and operations

The accompanying Condensed Consolidated Financial Statements include the accounts of LECG Corporation and its wholly owned subsidiaries (collectively, the “Company” or “LECG”). The Company provides expert services, including economic and financial analysis, expert testimony, litigation support and strategic management consulting to a broad range of public and private enterprises. Services are provided by academics, recognized industry leaders and former high-level government officials (collectively, “experts”) with the assistance of a professional support staff. The Company’s experts are comprised of employees of the Company as well as exclusive independent contractors. These services are provided primarily in the United States (U.S.). The Company also has international offices in Argentina, Australia, Belgium, France, Hong Kong, Italy, New Zealand, Spain and the United Kingdom. On March 10, 2010, the Company completed a merger (the “Merger”) with SMART Business Holdings, Inc. (“SMART”) which resulted in an expansion of services offered by the Company and in the number of its office locations from 19 to 25 offices across the country. SMART’s operating results have been included in the Company’s consolidated results from the acquisition date to the end of the reporting period. In connection with the closing of the Merger, the Company announced the relocation and consolidation of its corporate headquarters to Devon, Pennsylvania, which is scheduled to be completed by the end of the third quarter of 2010. See Note 2 for more information regarding the Merger with SMART.

The Condensed Consolidated Statements of Operations for the three months ended March 31, 2010 and 2009, the Condensed Consolidated Balance Sheets as of March 31, 2010 and the Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2010 and 2009 are unaudited. In the opinion of management, these Condensed Consolidated Financial Statements include all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of LECG’s consolidated financial position, results of operations and cash flows for the periods then ended. The December 31, 2009 Condensed Consolidated Balance Sheet is derived from LECG’s audited consolidated financial statements included in its Annual Report on Form 10-K for the year then ended. The results of operations for the three months ended March 31, 2010 are not necessarily indicative of the results that may be expected for the year. The Condensed Consolidated Financial Statements in this report should be read in conjunction with the consolidated financial statements and related notes contained in the Annual Report on Form 10-K for 2009.

The preparation of these Condensed Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the Condensed Consolidated Financial Statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.

The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate their estimated fair values because of the short maturity of these financial instruments.

2.             SMART merger

On March 10, 2010, the Company completed its Merger with SMART Business Holdings, Inc. (“SMART”), a privately held provider of business advisory services, and received a $25.0 million cash investment from SMART’s majority shareholder, Great Hill Equity Partners III, LP. In the Merger transaction, LECG acquired 100% of SMART’s outstanding stock, in exchange for which the Company issued 10,927,869 shares of LECG common stock, having a value of approximately $33.3 million based on the March 10, 2010 closing stock price of $3.05. The Company also assumed approximately $42.8 million of SMART debt. Simultaneously with the consummation of the Merger, SMART’s majority shareholder, Great Hill Equity Partners III, LP, made a $25.0 million cash investment into LECG in exchange for 6,313,131 shares of Series A Convertible Redeemable Preferred Stock. This stock is convertible share-for-share into LECG’s common stock and provides a 7.5% annual dividend payable in cash or Series A Convertible Redeemable Preferred Stock at the Company’s discretion. As a result of the issuance of the common stock and Series A Convertible Redeemable Preferred Stock, Great Hill Equity Partners III, LP owns approximately 40% of the Company’s outstanding voting shares. The Company completed the Merger with SMART primarily to expand its services offered, gain market share, increase its talent pool of business consultants, and expand its client base to include SMART’s Fortune 200 customers. The combined company is expected to generate improved financial performance, with incremental revenues from integrated service opportunities and SMART’s financial advisory and business consulting practices including technology, business process improvement, compensation and benefits, accounting, actuarial and tax, and cost reductions for synergies.

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Preliminary purchase price allocation

The Merger was accounted for under Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) 805, Business Combinations (“ASC 805”). The purchase price allocation is preliminary as the Company’s determination of the fair values of the assets acquired and liabilities assumed is still in progress. Assets acquired and liabilities assumed are recorded at their estimated fair values as of the closing date of March 10, 2010 and represents management’s best estimate based on currently available data. If information later becomes available which would indicate adjustments are required to the purchase price allocation, such adjustments will be included in the purchase price allocation retrospectively. The total estimated purchase price to be allocated is $76.2 million. Total acquisition-related transaction costs are estimated to be approximately $6.0 million, and include fees for legal, financial advisory, accounting, due diligence, tax, valuation, printing and other various services in connection with the transaction. The Company recognized a total of $2.0 million of acquisition-related costs in the three months ended March 31, 2010 and $4.0 million in prior quarters. The total estimated purchase price was preliminarily allocated to SMART’s net tangible assets acquired and liabilities assumed, and to identifiable intangible assets based on their estimated fair values. The excess of the purchase price over the net tangible assets acquired and liabilities assumed and identifiable intangible assets was recorded as goodwill (Note 8).

The following table summarizes the preliminary allocation of the purchase price as of the March 10, 2010 acquisition date (in thousands):

Of the total estimated purchase price, approximately $24.9 million has been allocated to the net tangible assets acquired, and $5.1 million has been allocated to the identifiable intangible assets acquired, which consist of the value assigned to SMART’s customer relationships of $4.9 million and trademarks of $0.2 million. Approximately $46.2 million has been allocated to goodwill, and primarily represents the value of the acquired workforce and the expected synergies from combining operations. The goodwill asset acquired in the SMART acquisition is not expected to be deductible for tax purposes.

The Company acquired SMART’s gross deferred tax assets of approximately $24.8 million ($5.8 million net deferred tax assets), which consisted mostly of U.S. and foreign net operating loss carryforwards and tax basis in intangibles. In addition, the Company recorded a deferred tax liability of $2.0 million related to amortizable intangible assets from the Merger.  A full valuation allowance was recorded against the net overall deferred tax assets for SMART, as a result of the Company’s current assessment of its recoverability.

The accounts receivable balance at March 10, 2010 consists of gross contractual amounts of $24.2 million. The contractual cash flows not expected to be collected totaled $1.7 million.

The value assigned to SMART’s customer relationships was established based on the excess earnings methodology of the income approach in order to capture the subject customers’ expected contribution to future earnings. In this method, value is estimated as the present value of the benefits anticipated from ownership of the subject intangible asset in excess of the returns required on the investment in the contributory assets necessary to realize those benefits. The forecast of revenue from existing customer relationships was based on the recent year’s sales and assumptions regarding future customer attrition and expected volume and price changes. Management expects an average attrition rate of approximately 15% per year. Costs associated with the acquired customer revenue were based on specific margins and adjusted for the lower marketing expenses associated with sales to established customers. The excess earnings attributable to SMART’s customer relationships were discounted to present value using an estimated required rate of return. The Company will amortize the value of SMART’s customer relationships ratably over its economic life which is estimated to be ten years. Amortization of these customer relationships is not expected to be deductible for tax purposes.

The value assigned to SMART’s trade name was determined based on an income approach which assumes that the acquirer will not pay royalties or license fees to use the trade name. The approach is known as the relief-from-royalty method and is applied to the appropriate levels of net revenues to calculate the royalty savings attributable to the ownership of the trade name. The present value of the after-tax cost savings at an appropriate discount rate indicates the value of the trade name. The Company amortizes the trade name on a straight-line basis over ten months. Amortization of this trade name is not expected to be deductible for tax purposes.

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Pro forma financial information

The following summary of pro forma consolidated revenues, net loss and earnings per share is presented as if the Merger with SMART had occurred on January 1, 2009 and 2010. The amount of SMART revenues and earnings included in LECG’s Condensed Consolidated Statement of Operations for the three months ended March 31, 2010 is also presented below. These unaudited pro forma results are not necessarily indicative of future earnings or earnings that would have been reported had the Merger been completed as presented (in thousands, except per share data):

3.             Restricted cash

The Company had $1.8 million and $0 of restricted cash as of March 31, 2010 and December 31, 2009, respectively. The restricted cash balances were comprised of pledged bank deposits to collateralize outstanding letters of credit and are included in Other long-term assets in the Condensed Consolidated Balance Sheets.

4.             Series A convertible redeemable preferred stock

As part of the Merger with SMART, the Company issued 6,313,131 shares of Series A Convertible Redeemable Preferred Stock in exchange for $25.0 million. This Series A Convertible Redeemable Preferred Stock is convertible share-for-share into LECG’s common stock and provides a cumulative 7.5% annual dividend. These dividends are payable in additional shares of Series A Convertible Redeemable Preferred Stock or, at LECG’s option, in cash so long as LECG has sufficient cash to make such distribution without breaching the terms of any contract for borrowed money indebtedness and such cash is legally available therefor. Dividends accrue from the date of issuance of the Series A Convertible Redeemable Preferred Stock and are payable quarterly, in arrears, on the last day of March, June, September and December. Any accrued but unpaid dividends shall compound quarterly. For the March 31, 2010 dividend, the Company recorded approximately $0.1 million.

The dividend rate will increase from 7.5% per annum to 16% per annum if:

·                                           LECG pays or declares any dividend or any other distribution on the common stock (other than dividends or distributions paid in additional shares of common stock) or, subject to limited exceptions, purchases, redeems or otherwise acquires any of LECG’s capital stock, unless and until full dividends on the Series A Convertible Redeemable Preferred Stock have been paid or declared and set apart;

·                                           LECG incurs or permits any subsidiary to incur, directly or indirectly, any indebtedness for borrowed money that would result in LECG having, as of immediately following the incurrence of such indebtedness, indebtedness in excess of the greater of: (A) $75.0 million or (B) 2.5 times the amount of LECG’s EBITDA for the most recently completed fiscal year for which audited financial statements are available; or

·                                           LECG does not make full payment of the redemption price, on any required redemption date, in connection with the election by any holder of shares of Series A Convertible Redeemable Preferred Stock to cause LECG to redeem any shares of Series A Convertible Redeemable Preferred Stock as described below.

The holders of a majority of the then outstanding shares of Series A Convertible Redeemable Preferred Stock are permitted to waive the increase in the dividend rate with respect to any event and any such waiver will be binding on all holders of shares of Series A Convertible Redeemable Preferred Stock.

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Liquidation preference

If LECG was to voluntarily or involuntarily dissolve or liquidate, the holders of its Series A Convertible Redeemable Preferred Stock would be entitled to receive, prior and in preference to any distribution of LECG’s assets to the holders of its common stock, an amount per share equal to the greater of:

·                                           $3.96 (as adjusted for any stock splits, stock dividends, combinations, recapitalizations or other similar transactions) plus all accrued and unpaid cumulative dividends on such share; or

·                                           the amount which such holder of the Series A Convertible Redeemable Preferred Stock would have received assuming all shares of Series A Convertible Redeemable Preferred Stock had been converted into common stock at the then applicable conversion price immediately prior to any such dissolution or liquidation.

If LECG has insufficient funds to distribute to the holders of its Series A Convertible Redeemable Preferred Stock, then all of the funds legally available for distribution by LECG shall be distributed pro rata among the holders of the Series A Convertible Redeemable Preferred Stock in proportion to the preferential amount each such holder is entitled to receive.

Deemed liquidations

Certain events will also be treated as a liquidation or dissolution of LECG, entitling the holders of Series A Convertible Redeemable Preferred Stock to receive the liquidation payment described above. These events include: (i) a reorganization, consolidation or merger in which the Company is not the surviving entity; (ii) any other transaction in which the holders of the Company’s outstanding capital stock entitled to vote for the election of members of the Company’s board of directors immediately prior to such transaction do not hold a majority of the outstanding capital stock of the surviving or resulting entity entitled to vote for the election of members of the board of directors of the surviving or resulting entity; and (iii) any sale, conveyance or transfer of all or substantially all of the Company’s assets or business.

Conversion

A holder of Series A Convertible Redeemable Preferred Stock has the option to convert each share of Series A Convertible Redeemable Preferred Stock at any time into shares of common stock, at an initial conversion price of $3.96 per share. The conversion price will be equitably adjusted in the event the Company’s common stock is subdivided, combined or consolidated or in the event the Company’s common stock is changed into the same or a different number of shares of any other class or classes of stock or other securities or property.

LECG may also require the conversion of the Series A Convertible Redeemable Preferred Stock, in whole or in part, by sending written notice to the holders of the Series A Convertible Redeemable Preferred Stock at any time after the second anniversary of the first date of issuance of shares of Series A Convertible Redeemable Preferred Stock, if (i) the trading volume of LECG common stock averages at least 100,000 shares per trading day over the immediately preceding 30 trading day period (as adjusted for stock dividends, combination or splits with respect to the common stock), and (ii) the daily volume-weighted average price per share of LECG common stock for at least 20 of the 30 trading days preceding the date that the Company sends its notice requesting conversion exceeds two times the then current conversion price of the Series A Convertible Redeemable Preferred Stock.

Voting

Except as otherwise required by law, the holders of Series A Convertible Redeemable Preferred Stock vote (on an as-if converted to common stock basis) on all matters voted on by the holders of common stock. In addition, the holders of Series A Convertible Redeemable Preferred Stock vote separately as a class in certain circumstances, as set forth in the certificate of designations.

5.             Earnings per common share

Basic earnings per common share is computed by dividing the net income (loss) attributable to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed by dividing the net income attributable to common stockholders for the period by the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares as determined by the treasury stock method are included in the diluted earnings per common share calculation to the extent these shares are dilutive. If the Company has a net loss for the period, common equivalent shares are excluded from the denominator because their effect on net loss would be antidilutive.

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The following is a reconciliation of net loss and the number of shares used in the basic and diluted earnings per share computations (in thousands, except per share data):

Approximately 3.7 million and 5.7 million of anti-dilutive securities for the three months ended March 31, 2010 and 2009, respectively, were excluded from the calculation of diluted earnings per share.

6.             Equity-based compensation

The following table summarizes equity-based compensation and its effect on direct costs, general and administrative expenses and earnings (in thousands):

7.             Comprehensive loss

Comprehensive (loss) income represents net (loss) income plus other comprehensive (loss) income resulting from changes in foreign currency translation. The reconciliation of LECG’s comprehensive loss is as follows (in thousands):

8.             Goodwill and other intangible assets

On March 10, 2010, the Company completed the Merger with SMART and accounted for the Merger in accordance with ASC 805. As a result, the Company recorded approximately $46.2 million of goodwill and $5.1 million of other identifiable intangible assets. The purchase price allocation is preliminary as the Company’s determination of the fair values of the assets acquired and liabilities assumed is still in progress. For impairment testing purposes, the Company preliminarily assigned all of the SMART goodwill to the new Consulting and Governance segment (Note 14), pending a final assessment of expected synergies and potential realignment between segments. This goodwill is not expected to be deductible for tax purposes.

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The changes in the carrying amount of consolidated goodwill during the period are as follows (in thousands):

Also as a result of the Merger with SMART, the Company acquired $4.9 million and $0.2 million of customer relationships and trade name intangible assets, respectively. The customer relationships will be amortized over an estimated ten year life and the trade name will be amortized over an estimated life of ten months. These values are reflected in the table below.

Other intangible assets related to the Company’s acquisitions were as follows (in thousands):

(1)                                  Fully amortized intangible assets are eliminated from the gross and accumulated amortization amounts in the period the intangible asset fully amortized.

The aggregate amortization expense for the period was $0.2 million. The estimated future amortization expense for other intangible assets as of March 31, 2010 is as follows (in thousands):

9.             Debt

Credit facility

At December 31, 2009, the Company had $12.0 million in outstanding borrowings under its revolving credit facility (the “Facility”) and $1.6 million in outstanding standby letters of credit. On March 10, 2010, the Company received a $25.0 million cash investment from Great Hill Partners in connection with the SMART Merger, used the proceeds to repay $19.0 million outstanding under the Facility, and used $1.8 million to collateralize the outstanding letters of credit. This collateral is reflected as restricted cash in Other long-term assets in the Condensed Consolidated Balance Sheet. The Facility was terminated, and the unamortized portion of capitalized loan fees, totaling approximately $1.6 million, was expensed during the quarter ended March 31, 2010. Also in connection with the SMART Merger, the Company assumed approximately $40.8 million of term debt and $2.1 million of subordinated promissory notes which are discussed below.

Term debt

Concurrent with the closing of the SMART Merger, the Company entered into the Sixth Amendment to Credit Agreement and Consent (the “Amendment”) and became a co-borrower with SMART Business Advisory and Consulting, LLC under a Credit Agreement with the Bank of Montreal (“BMO”) and the syndicate bank members. The Amendment provides for a $40.8 million term

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loan which is guaranteed by LECG Corporation and its domestic subsidiaries. The Amendment also allows the Company to seek up to an additional $10.0 million of subordinated debt, subject to certain repayment and maturity restrictions. The term loan matures on March 31, 2011. The Amendment required a $4.0 million principal payment at closing, and subsequent quarterly principal payments of $3.0 million beginning on June 30, 2010 through December 31, 2010. Also, cash balances in excess of certain amounts at each quarter-end must be used to make additional principal payments. The remaining outstanding principal is due in full on March 31, 2011.

Interest is payable quarterly at a rate consisting of the Base Rate plus 6.5%. The Base Rate is defined as the greater of (i) 3.0%, (ii) BMO’s prevailing prime commercial rate, (iii) the Federal Funds rate plus 0.5%, or (iv) LIBOR plus 1.5%. The interest rate in effect as of March 31, 2010 was 9.5%. The Company paid approximately $0.2 million in fees related to this Amendment.  The Amendment contains non-financial and financial covenants, including a total funded debt to EBITDA ratio, a minimum fixed charge ratio, maximum rental and capital expenditures, and minimum quarterly EBITDA and cash balance requirements. At March 31, 2010, the Company was in compliance with the covenants under the Agreement.

Maintaining compliance with the Company’s debt covenants is critical to the Company’s operations. The current economic downturn adds uncertainty to the Company’s anticipated revenue levels, as seen by sequential declines in the Company’s revenue during the first and third quarters of 2009. The Company has executed a number of restructuring actions in response to these revenue declines. Should revenue declines continue or other unforeseen adverse developments occur, the Company would seek to remain in compliance with the debt covenants through further restructuring actions. The outstanding balance of the term debt at March 31, 2010 was $36.0 million.

Subordinated Promissory Notes

Subordinated promissory notes are owed to certain active and former employees of SMART with an aggregate face amount of $2.1 million and a stated interest rate of 5.0%. These notes are payable on the earlier of the repayment of the BMO term facility or May 15, 2014.

10.          Accrued compensation

Accrued compensation consists of the following (in thousands):

11.          Commitments and contingencies

Legal proceedings

The Company is party to certain legal proceedings arising out of the ordinary course of business, including proceedings that involve claims of wrongful termination by experts and professional staff who formerly worked for the Company, and claims for payment of disputed amounts relating to agreements in which the Company has acquired businesses. The outcomes of these matters are uncertain, and the Company’s management is not able to estimate the amount or range of amounts that may become payable as a result of a judgment or settlement in such proceedings. However, in the opinion of the Company’s management, the outcomes of these proceedings, individually and in the aggregate, would not have a material adverse effect on the Company’s business, financial position, results of operations or cash flows.

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Business acquisitions and certain expert hires

The Company made commitments in connection with its historical business acquisitions that require the Company to pay additional purchase consideration to the sellers if specified performance targets are met over a number of years, as specified in the related purchase agreements. These amounts are generally calculated and payable at the end of a calendar or fiscal year or other interval. The maximum amount of additional purchase consideration that may be required to be paid (by no later than December 2010) is $1.5 million if and when future performance targets are met. See Note 3 of Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for 2009 for a description of the commitments and contingencies related to the acquisitions of Secura, Mack Barclay, and Neilson Elggren.

The accrued purchase price payable, and the total potential remaining purchase price payments at March 31, 2010, and the date of any final potential payment by acquisition are as follows (in thousands):

(1)                                 Included in “Payable for business acquisitions” on the Condensed Consolidated Balance Sheet.

(2)                                 Represents additional potential purchase price to be paid and goodwill to be recognized in the future if specified performance targets and conditions are met.

(3)                                 Represents final date of any payment or potential payment.

In connection with the hiring of certain experts and professional staff in March 2004, the Company will pay additional performance bonuses of $2.5 million if specified performance targets are achieved prior to March 2011. In connection with the hiring of certain experts and professional staff in August 2006, the Company will pay performance bonuses of $6.0 million if specified performance targets are achieved by December 2011. All such performance bonus payments are subject to amortization from the time the bonus is earned through July 2014.

Significant expert retention and performance bonus contingencies

In the second half of 2009 and the first quarter of 2010, the Company entered into amended employment agreements with several experts and has made or is committed to make the following retention payments or performance-related payments if certain criteria are achieved at various measurement periods from 2010 to 2013. All such retention and performance payments will only be made if the expert is an employee of the Company on the payment date. Also, these payments are subject to amortization and potential repayment if the expert voluntarily terminates or is terminated for cause, generally from the time the payment is made through 2017. The table below presents the potential payments due by the years ending December 31 (in thousands):

Tax contingencies

In 2007 the Argentine taxing authority (“AFIP”) completed its audit of LECG Buenos Aires’ (“LECG BA”) income tax returns for 2003 and 2004, and its 2005 withholding tax return and issued a notice to disallow certain deductions claimed for those years as well as a proposal to impose a withholding tax on certain payments made by LECG BA to LECG LLC, its U.S. parent company. The AFIP proposed to limit the deductibility of costs charged by LECG LLC to LECG BA for expert and staff services performed by LECG personnel outside of Argentina on client related matters, and to require withholding tax on certain payments by

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LECG BA for services rendered by LECG personnel outside of LECG BA. In 2008, the Company elected to pay to the Argentine government $2.0 million for potential tax deficiencies and $1.3 million of potential interest in order to avoid the accrual of additional interest, while reserving its right to defend its position in Argentine tax court. The Company has recorded $3.3 million of payments to the Argentine taxing authority as Other long-term assets in the Condensed Consolidated Balance Sheets at March 31, 2010 and December 31, 2009.

On April 8, 2009, the Company was notified that the AFIP had terminated the penalty procedures relating to amounts previously paid for the 2003 and 2004 income tax and 2005 withholding tax deficiencies due to the passage of Argentine National Law No. 26.476 (Tax Moratorium). However, the Company may still be subject to penalties and interest on a potential underpayment of taxes related to the 2005 withholding tax return. Also, based on the results of the completed audit discussed above, the Company may receive additional notices for assessments of additional income taxes, penalties, and interest related to the Company’s 2005 and 2006 income tax returns and withholding taxes, penalties, and interest on payments made to the U.S. parent company to settle intercompany balances from June 2005 to December 2007.

Amounts paid in connection with the potential income and withholding tax deficiency would qualify for a foreign tax credit on LECG’s U.S. tax return and would result in a deferred tax asset on LECG’s Condensed Consolidated Balance Sheets, the realization of which would be dependent upon the ability to utilize the foreign tax credit within the ten-year expiration period. The Company believes that it properly reported these transactions in its Argentine tax returns and has assessed that its position in this matter will be sustained. Accordingly, the Company has not recognized any additional tax liability in connection with this matter at March 31, 2010.

12.          Income taxes

As a result of the Company’s Merger with SMART, the Company acquired SMART’s gross deferred tax assets of approximately $24.8 million, which consisted mostly of U.S. and foreign net operating loss carryforwards and tax basis in intangible assets. In addition, the Company recorded a deferred tax liability of $2.0 million related to amortizable intangibles from the Merger.  A full valuation allowance was recorded against the net overall deferred tax assets for SMART, as a result of the Company’s current assessment of its recoverability.

The Company’s deferred tax assets are generally projected to reverse over the next one to thirty-three years. The extended reversal period is the result of significant income tax basis in intangible assets which were impaired for financial statement purposes during 2008. Tax amortization from these assets, if not offset with current taxable income, creates a net operating loss with a 20-year carryforward period for federal tax purposes. During the first quarter of 2010, the Company reviewed its deferred tax assets, as well as projected taxable income, for recovery using the “more likely than not” approach by assessing the available evidence surrounding its recoverability. The Company considered all available evidence, both positive and negative, including forecasts of future taxable income, tax planning strategies and past operating results which includes the net loss for the first quarter of 2010 and the years-ended 2009 and 2008. Even though the Company projects income in future years, based on the current economic environment and the difficulty of accurately projecting taxable income, the Company determined it was “more likely than not” that its net deferred tax assets may not be realized. Consequently, as of March 31, 2010, the Company has retained a full valuation allowance against its net overall deferred tax assets, including those acquired in the SMART Merger. In future years, if the Company begins to generate taxable income and management determines that the deferred tax asset is recoverable, the valuation allowance will be reversed. Any such reversal will result in a tax benefit in the period of reversal. The income tax expense for the first quarter of 2010 represents the amount of tax we expect to pay on taxable income generated in foreign jurisdictions during the period.

13.          Restructuring and other impairments charges

As a result of the Merger with SMART, the Company has identified and begun pursuing opportunities for cost savings through office consolidations and workforce reductions to improve operating efficiencies across the Company’s combined businesses. Part of the anticipated cost savings will include the consolidation and move of the combined company’s corporate headquarters to Devon, Pennsylvania, where SMART is currently based. The move, which is scheduled to be completed by the end of the third quarter of 2010, is intended to position the combined company for future growth by creating a unified platform from which to build common practices and capitalize on growth opportunities, while streamlining and leveraging its infrastructure. During the first quarter of 2010, the Company moved forward with several initiatives, including: (i) the planned consolidation of five office locations; (ii) the planned closure of two other offices; and (iii) a workforce reduction of 61 administrative staff in its Emeryville office, partly offset by approximately 35 planned replacement hires in Devon, Pennsylvania. Net restructuring charges in the first quarter of 2010 totaled $3.9 million, which consisted primarily of $3.3 million of lease termination costs and $0.6 million of one-time employee termination benefits. Total termination benefits related to the relocation of the Corporate office is estimated to be $2.8 million through the end of the third quarter in 2010. Of the total $3.9 million charge, $3.4 million require current and future cash outlays and $0.5 million were non-cash related. In

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addition, the Company assumed $1.2 million of pre-merger restructuring liabilities related to SMART’s office closures/consolidations. The operations in these locations were consolidated into LECG’s existing office space in those same cities.

The Company recognized other non-cash impairment charges totaling $3.5 million during the first quarter of 2010 related to the impairment of certain property, plant and equipment and non-trade receivables. The receivables had been recorded in Other assets in the Condensed Consolidated Balance Sheet. The Company determined that recovery of the non-trade receivables was not reasonably assured as of March 31, 2010.

The table below summarizes the liabilities incurred or assumed and the activity during the period related to these restructuring and other impairment actions (in thousands):

14.                               Segment reporting

Prior to 2010, the Company managed its business in two operating segments: Litigation, Forensics and Finance (formerly known as Finance and Accounting Services) and Economics and Dispute Resolution (formerly known as Economics Services). As a result of the Merger with SMART, the Company formed the Consulting and Governance segment composed of the historical SMART consulting, business advisory, governance, assurance and tax practices. Below is a description of the Company’s three operating segments and their components:

Litigation, Forensics and Finance segment is composed of electronic discovery, financial services, forensic accounting, healthcare, higher education, intellectual property, and international finance and accounting services sectors as follows:

·                  Electronic discovery—provides direct collaboration with outside counsel, general counsel, corporate executives, bank examiners, bankruptcy trustees, forensic accountants, fraud examiners, and damages experts to deliver objective advice and testimony in all phases of the electronic discovery process including litigation preparedness, computer forensics and data analytics.

·                  Financial services—provides banking advisory services to leading financial service firms worldwide, addressing regulatory compliance, tax, and dispute resolution, and provides representation before applicable regulatory authorities and assists clients in regulatory compliance and SEC investigations and litigation.

·                  Forensic accounting—provides a broad range of expertise in accounting, auditing, computer forensics, regulatory (SEC), valuation, tax, and securities litigation, and offers a comprehensive mix of forensic accounting services, including internal investigations, fraud investigations, and when necessary, expert witness testimony.

·                  Healthcare—provides analyses and insight to clients confronting the uncertain healthcare environment by advising clients in the development of strategies, designing and understanding policies, and responding to legal and regulatory challenges, and offers a broad range of litigation support, management advisory, compliance, and expert testimony services.

·                  Higher education—provides strategic advice and management consulting to companies, universities, governments, and non-profit organizations with a focus on research and development and higher education.

·                  Intellectual property—provides expertise in areas such as capturing value from technological innovation and knowledge assets, estimating damages due to infringement or misappropriation, definition of markets and

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analyses of non-infringing alternatives, transfer pricing valuation studies, and valuation of businesses, opportunities, and intangible assets.

·                  International finance and accounting services—provides expert finance and accounting services to clients outside the United States, with particular emphasis on investigations, damages analysis and expert testimony in international arbitrations.

Economics and Dispute Resolution segment is composed of energy and environment, global competition, labor and employment, regulated industries, and securities sectors as follows:

·                  Energy and environment—provides expertise in the regulated energy, environment and natural resources industries.

·                  Global competition—offers a complete range of services on antitrust matters, including mergers and acquisitions, before courts and regulatory authorities around the world. The services involve the use of economic and statistical techniques to develop independent and objective analyses concerning issues related to merger reviews, monopolization claims, cartels, and quantification of damages. Experts in this area frequently testify before courts and appear before competition authorities in many jurisdictions around the world.

·                  Labor and employment—provides litigation support, independent expert testimony, and business advisory services, including issues of statistical liability in discrimination, wrongful termination, and wage and hour claims.

·                  Regulated industries—provides expertise in a broad range of regulated industries, such as telecommunications, transportation and financial claims.

·                  Securities—specializes in the study of capital markets. These leading financial economists conduct independent analyses in disputes involving allegations of securities fraud, valuation of complex securities, and capital market transactions such as mergers and acquisitions.

Consulting and Governance segment is composed of consulting and business advisory sector, and governance, assurance, and tax sector as follows:

·                  Consulting and Business Advisory— provides financial, operational and technology solutions, which improve business processes, leverage enabling technology and addresses human capital issues for corporate clients and government agencies in a broad range of industries including commercial services, healthcare, higher education, life sciences, and manufacturing.

·                  Governance, Assurance and Tax—provides broad-based accounting services to a broad range of clients in many industries, with a focus on insurance and financial services, commercial services, healthcare, higher education, life sciences and manufacturing. Tax solutions include a full range of federal, state and local, sales and use, personal property, real estate and international tax services. Other services include internal and external audit, compliance advisory, compensation and benefits services and actuarial services.

All segment revenues are generated from external clients and there are no intersegment revenues or expenses. The Company does not allocate general and administrative operating expenses to its segments.

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Summarized financial information by segment for the three months ended March 31, 2010 and 2009 is as follows (in thousands, except percentages):

(1)                                 Results for the Consulting and Governance segment in the three months ended March 31, 2010 represent activity from March 11, 2010 to March 31, 2010. Also, since the Merger with SMART was completed on March 10, 2010, no prior period results are presented for this segment.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and other parts of this Quarterly Report on Form 10-Q concerning our future business, operating and financial condition and statements using the terms “believes”, “expects”, “will”, “could”, “plans”, “anticipates”, “estimates”, “predicts”, “intends”, “potential”, “continue”, “should”, “may”, or the negative of these terms or similar expressions are “forward-looking” statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are based upon our current expectations as of the date of this Report. There may be events in the future that we are not able to accurately predict or control that may cause actual results to differ materially from expectations. Information contained in these forward-looking statements is inherently uncertain, and actual performance is subject to a number of risks, including but not limited to, (1) our ability to successfully attract, integrate and retain our experts and professional staff, (2) dependence on key personnel, (3) successful management and utilization of professional staff, (4) dependence on growth of our service offerings, (5) our ability to maintain and attract new business, (6) our ability to maintain and comply with the covenants under our new credit facility, (7) the cost and contribution of additional hires and acquisitions, (8) risks relating to the recent closing of our Merger with SMART and our ability to successfully integrate the service offerings, professional staff, facilities and culture of the predecessor organizations, (9) successful administration of our business and financial reporting capabilities including maintaining effective internal control over financial reporting, (10) potential professional liability, (11) intense competition, (12) risks inherent in international operations, and,(13) risks inherent in successfully transitioning and managing our restructured business. Further information on these and other potential risk factors that could affect our financial results may be described from time to time in our periodic filings with the Securities and Exchange Commission and include those set forth in this Report under Item 1A. “Risk Factors.” We cannot guarantee any future results, levels of activity, performance or achievement. We undertake no obligation to update any of these forward-looking statements after the date of this Report.

Overview

We provide expert services through our highly credentialed experts and professional staff, whose skills and qualifications provide us the opportunity to address complex, unstructured business and public policy problems. We also provide business advisory, consulting, technology, accounting, compensation and benefits, tax, and transaction advisory services. We deliver independent expert testimony and original authoritative studies in both adversarial and non-adversarial situations. We conduct economic, financial, accounting and statistical analyses to provide objective opinions and strategic advice to legislative, judicial, regulatory and business decision makers. Our skills include electronic discovery, forensic accounting, data collection, econometric modeling and other types of statistical analyses, report preparation and oral presentation at depositions. Our experts are renowned academics, former senior government officials, experienced industry leaders, technical analysts and seasoned consultants. Our clients include Fortune Global 500 corporations, major law firms, and local, state and federal governments and agencies in the United States and other countries throughout the world. Many of consulting and advisory services professionals have either come from national or international consulting and accounting firms or industry, and have held senior-level executive or director positions prior to joining our firm.

Certain business developments

On March 10, 2010, we completed our merger (which we refer to as the “Merger”) with SMART Business Holdings, Inc. (“SMART”), a privately held provider of business advisory services, and we received a $25.0 million cash investment from SMART’s majority shareholder, Great Hill Equity Partners III, LP (which we refer to as the investment). In the Merger transaction, we acquired 100% of SMART’s outstanding stock, in exchange for 10,927,869 shares of LECG common stock, and we assumed approximately $42.8 million of SMART debt as of March 10, 2010. Simultaneously with the consummation of the Merger, SMART’s majority shareholder, Great Hill Equity Partners III, LP, made a $25.0 million cash investment into LECG in exchange for 6,313,131 shares of Series A Convertible Redeemable Preferred Stock. This stock is convertible share-for-share into LECG’s common stock (equivalent to a price of $3.96 per share), and provides a 7.5% annual dividend payable in cash or Series A Convertible Redeemable Preferred Stock at our discretion. As a result of the issuance of the common stock and Series A Convertible Redeemable Preferred Stock, Great Hill Equity Partners III, LP owns approximately 40% of our outstanding voting shares.

As a result of our Merger with SMART, we have increased our revenue base and expanded our areas of practice. We have also significantly increased our cost structure and we have assumed additional debt in the amount of $42.8 million. In conjunction with completing the Merger, we repaid and terminated our prior credit facility, and we became co-borrowers with SMART under a term loan. During the first quarter of 2010, we announced the move of our corporate headquarters to Devon, Pennsylvania and the consolidation or closure of six other offices as a result of the Merger. Further financial information regarding our Merger and restructuring charges is included in Note 2 and Note 13 of Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

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2010 Billable headcount

The following table summarizes the change in the period-end billable headcount since March 31, 2009 and December 31, 2009.