A tanking economy and crippled credit market posed a double blow for Bay Area-based Am Law 100 firms in 2008, causing slower revenue growth and declining profits. Firms battled rising costs and declining demand for legal services, which combined to deliver shrinking profit margins across the board.

Firms with the least exposure to New York’s financial sector, such as employment-heavy Littler Mendelson and Silicon Valley firms, fared better. Geographic and practice area diversity helped buoy revenue for wider-focused firms like Orrick, Herrington & Sutcliffe and Morrison & Foerster.

But rising costs, including associate salary increases and outlays for expansion, dragged down profits. Revenue growth slowed to single digits for most firms. Revenue per lawyer was pretty much flat across the board, with Littler posting the highest rise of the firms surveyed at 5 percent.

Securities and real estate work evaporated when credit markets froze, but litigation, intellectual property, bankruptcy and employment law picked up the slack in 2008, firms reported.

“The bottom line is the profession is not going out of business, it’s not going to fall apart,” said consultant Bradford Hildebrandt of Hildebrandt International. “We are suffering from two simultaneous issues, a downturn in demand and this cash flow crisis. And those two things together are a perfect storm. If we had just one of those, I don’t think the numbers would be quite as stark.”

Charting Rough Waters

Take a look at early results for Bay Area law firms:

The Recorder surveyed seven of the largest homegrown Bay Area firms (Wilson Sonsini Goodrich & Rosati, whose fiscal year ends Jan. 31, and Pillsbury Winthrop Shaw Pittman have not yet reported numbers). Most reported a drop in profits per equity partner, with Orrick posting the biggest decline, at 21 percent.

The lone exception was Littler, which grew head count 20 percent in 2008 and saw a slight rise, 3 percent, in profits per partner, to $435,000. Revenue rose 15 percent to $354 million.

Marko Mrkonich, president of Littler, said the numbers would be even better if they weren’t “distorted” by factors relating to Littler’s growth, including the cost of opening three new offices in St. Louis, Birmingham and Detroit.

Still, he’s not complaining.

“We don’t take anything for granted, nor do we take special delight in the challenges our friends and clients and other law firms are facing. We are fortunate to be in a space where there remains a high demand for our services,” Mrkonich said.

“It is an odd feeling though. Every time you read the paper, you kind of scratch your head a bit and wonder where it will end.”

MORRISON & FOERSTER

MoFo’s gross revenue grew 2 percent, to $911 million. Profits per partner declined 13 percent, to $1.1 million.

“We saw almost two different years,” said Chairman Keith Wetmore. “There was the first half of the year, and as things turned markedly south with Lehman, we saw a slower pace, not a declining pace, for the second half that affected some practices significantly and some not at all.”

In the face of the current economic crisis, Wetmore said, the double-digit decline in PPP isn’t so upsetting.

“In light of everything that is happening in so many financial markets, the fact that my partners are basically making what they made two years ago is not perceived as a huge hardship,” Wetmore said.

Wetmore said MoFo’s geographic diversity and strength in bankruptcy and intellectual property helped it weather the storm, despite costs rising across the board. He cited rising associate salaries and the firm’s growth in its Japan and Washington, D.C., offices as key reasons expenses rose faster than revenue.

Over a dozen firms nationwide have said they will freeze associate salaries, but Wetmore said MoFo has not yet made a decision on associate pay.

ORRICK

Orrick, Herrington & Sutcliffe racked up an 8 percent increase in gross revenue, to $835 million, half the percentage it grew the previous year. With expansion costs, including the acquisition of a German firm, profits per equity partner dipped 21 percent to $1.315 million.

Orrick has a large capital markets practice, which suffered when the credit crisis hit. The firm laid off 40 lawyers in structured finance and real estate in November, and said in late December that it would freeze associate salaries in 2009.

Revenue per lawyer, at $855,000, was flat, and 2008 was the first year in Ralph Baxter Jr.’s 18-year reign as chairman that Orrick’s profits are down, according to an Orrick spokesman.

“Our results for 2008 were disappointing but not surprising,” Baxter said. “The world financial crisis and the credit market crisis had a direct impact on many of our most important clients.”

Baxter is known for his aggressive growth plans for Orrick. In 2008, he said, the firm added more attorneys than any previous year.

The Recorder takes annual head counts as of Aug. 31 each year, so Orrick’s year-on-year increase of 74 full-time attorneys does not include at least 30 attorneys hired in October from defunct Heller Ehrman (nor the firm’s layoffs in November).

Adding a significant number of attorneys leaves a mark on a firm’s financials, Baxter said.

“Whenever you do that kind of thing, even in a very robust economic environment, expansion dampens your economic profitability,” Baxter said.

The results will not affect his long-term growth plans, Baxter said, but the firm will keep more of an eye on short-term economic circumstances when it makes decisions.

“2008 was a very challenging year. You saw the signs of it in the second half of 2007 and then the challenges in the financial markets continued and really picked up speed and sharply intensified,” Baxter said.

COOLEY GODWARD KRONISH

Cooley Godward Kronish posted a 14 percent increase in revenue, to $552 million, but profits per equity partner dipped 7 percent, to $1.32 million, partly the result of a larger equity class.

Cooley Chief Executive Joseph Conroy said corporate and litigation practices were strong in the first half of the year, while litigation was strong in the second half, when corporate work started to drop off. A 13 percent increase in head count and a 10 percent hike in billable rates at the beginning of the year also boosted revenue.

The firm’s practices weren’t at the center of the economic downturn, Conroy explained.

“Initially we weren’t exposed to the most hard-hit sectors,” Conroy said. “At the time the recession spread to the economy more broadly, we probably did a little better than other firms because of the balance we have.”

Historically a corporate powerhouse, half of the firm’s revenue now comes from litigation, he said.

A productivity decline in the second half of the year, combined with spending on lateral partners, drove profits down, Conroy said. Cooley brought on 15 partners and 20 associates a few months ago from Heller Ehrman. Those lawyers aren’t included in The Recorder ‘s head count.

“It was a significant investment because of the timing of it,” said Conroy. “It took us from being up slightly in profitability to slightly down.”

SEDGWICK, DETERT, MORAN & ARNOLD

At $197.5 million, revenue rose about 5 percent at litigation firm Sedgwick, Detert, Moran & Arnold, but expansion led profits per equity partner to dip 3 percent to $700,000.

Office upgrades and rising costs cut into profits, said firm Chairman Michael Tanenbaum. The firm moved its administrative group to new space in San Francisco in 2008. The move will save money in the long run, he said, but was an added cost. The firm took on additional floor space in New York and Los Angeles to accommodate growth in those offices, he said.

Then there were the salary increases. The firm boosted first-year associate pay to $130,000 in 2007 and has not laid off staff or attorneys, and does not expect to freeze salaries in 2009, Tanenbaum said.

Rate increases helped offset these costs, even though demand for legal services was flat throughout the year, Tanenbaum said.

Insurance defense, product liability and mass tort litigation drove revenue.

“We are primarily a litigation firm,” he said. “I think our corporate practice areas are in the 15 to 18 percent range of our business, so to the extent that there was a downturn, the impact on the firm was moderated.”

Sedgwick also isn’t focused on mergers and acquisitions, except for medium-sized companies, and doesn’t handle Wall Street-style securitization. This sheltered the firm’s corporate practice from the worst.

“It wasn’t a disaster by any stretch of the imagination,” he said.

Tanenbaum said he expects business to remain steady in the coming year. “Historically, we’ve seen an uptick in litigation in downturns,” he said. “I don’t know if that will be true this time around. Our expectation, and talking to our clients about their expectations, is that we don’t expect it to grow in any substantial way.”

FENWICK & WEST

Fenwick & West boosted its top line by 7 percent — to $196 million — with the help of a strong year from its IP litigation and tax practices. Its bread-and butter corporate practice, as with everyone else’s, didn’t do as well.

“Corporate and licensing were the ones that were impacted by the overall slowdown in business,” said Gordon Davidson, the firm’s chairman.

Davidson did note with a laugh that the firm had “100 percent market share in IPOs in Silicon Valley, having done one in January.”

It’s actually no joke: After ArcSight went public with the help of Fenwick, there wasn’t another IPO in Silicon Valley for the rest of the year. A year without as many IPOs — which bring in between $1 million and $2 million a piece — hurt Fenwick and other valley firms. Profits per equity partner were down 2 percent to $995,000, a result of the one-time cost of opening its new Seattle office, Davidson said.

Overall it was tough year for law firms, he said. Revenue per lawyer also dropped 2 percent to $795,000.

Methodology

The Recorder surveys law firm results as part of our sister publication The American Lawyer’s annual Am Law 200 project. The vast majority of firms supply us with official numbers. For some that do not, we determine financials from confidential nonmanagement sources, or construct estimates based on a variety of sources. We do not declare which firms cooperated and which did not.

“It was a sobering year for the legal industry,” he said. “We’ve all been accustomed to ever-increasing hours and dollars and profits.”

TOWNSEND AND TOWNSEND AND CREW

Revenue was up 13 percent, to $164.5 million, at IP boutique Townsend and Townsend and Crew, but profits per equity partner dipped 4 percent, to $705,000, a result of the one-time cost of outfitting the new D.C. office and higher associate salaries, according to Townsend Chairman James Gilliland.

“Patent litigation has not slowed down,” said Gilliland.

A 15 percent jump in head count due to additions in its year-old Washington, D.C., and Denver offices helped boost revenue. A 5 percent rate hike at the beginning of the year didn’t hurt, either.

Revenue per lawyer was down 2 percent to $755,000.

Gilliland said that was in part because hours were a little softer on the patent prosecution side, which usually makes up more than half of the firm’s revenue.

“Clients are being a little more selective in the types of applications they file and prosecute,” he said.

Also taking a bite out of RPL was a contingency case taken for inventor Frank Shum against Intel, which ended in a hung jury instead of the tens of millions in damages — and a sizable contingency fee — the firm had hoped to see.

Of course, two firms are missing from this year’s rankings. Heller Ehrman and Thelen, both founded over 100 years ago, closed shop this fall.

Staff writer Petra Pasternak contributed to this report. Reporter Amanda Royal’s e-mail address is amanda.royal@incisivemedia.com. Reporter Zusha Elinson’s email address is zusha.elinson@incisivemedia.com.