| EDGEWATER TECHNOLOGY INC/DE/ ITEM 1A RISK FACTORS Risk Factors Affecting Finances, Business Prospects and Stock Volatility In addition to other information contained in this Form 10-K, the following risk factors should be carefully considered in evaluating Edgewater Technology and its business because such factors could have a significant impact on our business, operating results and financial condition |
| These risk factors could cause actual results to materially differ from those projected in any forward-looking statements |
| Our success depends on a limited number of significant customers, and our results of operations and financial condition could be negatively affected by the loss of a major customer or significant project or the failure to collect a large account receivable |
| We generate a significant portion of our service revenues from a limited number of customers |
| As a result, if we were to lose a major customer or large project, our service revenues could be materially and adversely affected |
| In 2005, our five largest customers accounted for 47dtta5prca of our service revenues |
| In 2004, our five largest customers accounted for 69dtta0prca of our service revenues |
| We perform varying amounts of work for specific customers from year to year |
| A major customer in one year may not use our services in another year |
| In addition, we may derive revenues from a major customer that constitutes a large portion of a particular quarter’s total revenues |
| If we lose any major customers or any of our customers cancel or significantly reduce a large project’s scope, including but not limited to Synapse, our results of operations and financial condition could be materially and adversely affected |
| Further, if we fail to collect a large accounts receivable balance, we could be subjected to a material financial expense and a decrease in cash flow |
| Our lack of long-term customer contracts reduces the predictability of our revenues because these contracts may be canceled on short notice and without penalty |
| Our customers generally retain us on a project-by-project basis, rather than under long-term contracts |
| If a significant customer, or a number of customers, terminate, significantly reduce, or modify their contracts with us, our results of operations would be materially and adversely affected |
| Consequently, future revenues should not be predicted or anticipated based on the number of customers we have or the number and size of our existing projects |
| If a customer were to postpone, modify, or cancel a project, including but not limited to Synapse, we would be required to shift our consultants to other projects to minimize the impact on our operating results |
| We cannot provide 11 ______________________________________________________________________ assurance that we will be successful in efficiently and effectively shifting our consultants to new projects in the event of project terminations, which could result in reduced service revenues and lower gross margins |
| If we experience unexpected changes or variability in our revenue, we could experience variations in our quarterly operating results and our actual results may differ materially from the amounts planned and our operating profitability may be reduced or eliminated |
| If we fail to satisfy our customers’ expectations, our existing and continuing business could be adversely affected |
| Our sales and marketing strategy emphasizes our belief that we have highly referenceable accounts |
| Therefore, if we fail to satisfy the expectations of our customers, we could damage our reputation and our ability to retain existing customers and attract new customers |
| In addition, if we fail to deliver and perform on our engagements, we could be liable to our customers for breach of contract |
| Although most of our contracts limit the amount of any damages to the fees we receive, we could still incur substantial cost, negative publicity, and diversion of management resources to defend a claim, and as a result, our business results could suffer |
| We may have lower margins, or lose money, on fixed-price contracts |
| In 2005, fixed-price contracts represented approximately 11dtta5prca of our service revenues |
| We assume greater financial risk on fixed-price contracts than on time-and-materials or fixed-fee engagements, and we cannot assure you that we will be able to successfully price our larger fixed-price contracts |
| If we fail to accurately estimate the resources and time required for an engagement, fail to manage customer expectations effectively or fail to complete fixed-price engagements within planned budgets, on time and to our customers’ satisfaction, we could be exposed to cost overruns, potentially leading to lower gross profit margins, or even losses on these engagements |
| Competition in the IT and management consulting services market is intense and, therefore, we may lose projects to, or face pricing pressure from, our competitors or prospective customers’ internal IT departments or international outsourcing firms |
| The market for IT and management consulting providers is highly competitive |
| In many cases, we compete for premium IT services work with in-house technical staff, software product companies with extended service organizations and other international IT and management consulting firms, including offshore outsourcing firms |
| In addition, there are many small, boutique technology management consulting firms who have developed services similar to those offered by us |
| We believe that competition will continue to be strong and may increase in the future, especially if our competitors continue to reduce their price for IT and management consulting services |
| Such pricing pressure could have a material impact on our revenues and margins and limit our ability to provide competitive services |
| Our target market is rapidly evolving and is subject to continuous technological change |
| As a result, our competitors may be better positioned to address these developments or may react more favorably to these changes, which could have a material adverse effect on our business |
| We compete on the basis of a number of factors, many of which are beyond our control |
| Existing or future competitors may develop or offer IT and management consulting services that provide significant technological, creative, performance, price or other advantages over the services we offer |
| See “Item 1—Business—Competition” for a representative list of competitors in the IT and management consulting services space |
| Some of our competitors have longer operating histories and significantly greater financial, technical, marketing and managerial resources than we do |
| There are relatively low barriers of entry into our business |
| We have no patented or other proprietary technology that would preclude or inhibit competitors from entering the IT services market |
| Therefore, we must rely on the skill of our personnel and the quality of our customer service |
| The costs to start an IT and management consulting services firm are low |
| We expect that we will continue to face additional competition from new entrants into the market in the 12 ______________________________________________________________________ future, offshore providers and larger integrators and we are subject to the risk that our employees may leave us and may start competing businesses |
| Any one or more of these factors could have a material impact on our business |
| Because we rely on highly-trained and experienced personnel to design and build complex systems for our customers, an inability to retain existing employees and attract new qualified employees would impair our ability to provide our services to existing and new customers |
| Our future success depends in large part on our ability to attract new qualified employees and retain existing highly-trained and experienced technical consultants, project management consultants, business analysts and sales and marketing professionals of various experience levels |
| If we fail to attract new employees or retain our existing employees, we may be unable to complete existing projects or bid for new projects of similar size, which could adversely affect our revenues |
| While attracting and retaining experienced employees is critical to our business and growth strategy, maintaining our current employee base may also be particularly difficult |
| Even if we are able to grow and expand our employee base, the additional resources required to attract new employees and retain existing employees may adversely affect our operating margins |
| We depend on our key personnel, and the loss of their services may adversely affect our business |
| We believe that our success depends on the continued employment of the senior management team and other key personnel |
| This dependence is particularly important to our business because personal relationships are a critical element in obtaining and maintaining customer engagements |
| If one or more members of the senior management team or other key personnel were unable or unwilling to continue in their present positions, our business could be seriously harmed |
| Furthermore, other companies seeking to develop in-house business capabilities may hire away some of our key personnel |
| Past or Future business combination transactions or other strategic alternatives could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our business |
| We realized recent growth, in part, through acquisitions, and we anticipate that a portion of our future growth may be accomplished through one or more business combination transactions or other strategic alternatives |
| The ultimate success of any such transactions will depend upon, among other things, our ability to integrate acquired personnel, operations, products and technologies into our organization effectively, to retain and motivate key personnel of acquired businesses and to retain customers of acquired businesses |
| We cannot assure you that we will be successful in this regard or that we will be able to identify suitable opportunities, continue to successfully grow acquired businesses, integrate acquired personnel and operations successfully or utilize our cash or equity securities as acquisition currency on acceptable terms to complete any such business combination transactions |
| These difficulties could disrupt our ongoing business, distract our management and employees, increase our expenses and materially and adversely affect our results of operations |
| Any such transactions would involve certain other risks, including the reduction of cash and/or working capital, the assumption of additional liabilities, potentially dilutive issuances of equity securities and diversion of management’s attention from operating activities |
| Volatility of our stock price could result in expensive class action litigation |
| If our common stock suffers from volatility like the securities of other technology and consulting companies, we could be subject to securities class action litigation similar to that which has been brought against other companies following periods of volatility in the market price of their common stock |
| The process of defending against these types of claims, regardless of their merit, is costly and often creates a considerable distraction to senior management |
| Any future litigation could result in substantial additional costs and could divert our resources and senior management’s attention |
| This could harm our productivity and profitability and potentially adversely affect our stock price |
| We may not be able to protect our intellectual property rights or we may infringe upon the intellectual property rights of others, which could adversely affect our business |
| Our future success will depend, in part, upon our intellectual property rights and our ability to protect these rights |
| We do not have any patents or 13 ______________________________________________________________________ patent applications pending |
| Existing trade secret and copyright laws afford us only limited protection |
| Third parties may attempt to disclose, obtain or use our solutions or technologies |
| This is particularly true in foreign countries where laws or law enforcement practices may not protect our proprietary rights as fully as in the United States |
| Others may independently develop and obtain patents or copyrights for technologies that are similar or superior to our technologies |
| If that happens, we may need to license these technologies and we may not be able to obtain licenses on reasonable terms, if at all |
| If we are unsuccessful in any future intellectual property litigation, we may be forced to do one or more of the following: · Cease selling or using technology or services that incorporate the challenged intellectual property; · Obtain a license, which may not be available on reasonable terms or at all, to use the relevant technology; · Configure services to avoid infringement; and · Refund license fees or other payments that we have previously received |
| Generally, we develop software applications for specific customer engagements |
| Issues relating to ownership of and rights to use software applications and frameworks can be complicated |
| Also, we may have to pay economic damages in these disputes, which could adversely affect our results of operations and financial condition |
| Fluctuations in our quarterly revenues and operating results may lead to reduced prices for our stock |
| Our quarterly revenues and operating results can sometimes be volatile |
| We believe comparisons of prior period operating results cannot be relied upon as indicators of future performance |
| If our revenues or our operating results in any future period fall below the expectations of securities analysts and investors, the market price of our securities would likely decline |
| Factors that may cause our quarterly results to fluctuate in the future include the following: · Variability in market demand for IT and management consulting services; · Length of the sales cycle associated with our service offerings; · Unanticipated variations in the size, budget, number or progress toward completion of our engagements; · Unanticipated termination of a major engagement, a customer’s decision not to proceed with an engagement we anticipated or the completion or delay during a quarter of several major customer engagements; · Efficiency with which we utilize our employees, or utilization, including our ability to transition employees from completed engagements to new engagements; · Our ability to manage our operating costs, a large portion of which are fixed in advance of any particular quarter; · Changes in pricing policies by us or our competitors; · Seasonality and cyclicality, including the effects of lower utilization rates during periods with disproportionately high holiday and vacation usage experience; · Timing and cost of new office expansions; · The timing of customer year-end periods and the impact of spending relative to such year-end periods; · Our ability to manage future growth; and · Costs of attracting, retaining and training skilled personnel |
| Anti-takeover provisions in our charter documents, our stockholder rights plan and/or Delaware law could prevent or delay a change in control of our Company |
| Our Board of Directors can issue preferred stock in one or more series without stockholder action |
| The existence of this “blank-check” preferred stock provision could render more difficult or discourage an attempt to obtain control by means of a tender offer, merger, proxy contest or otherwise |
| In addition, our Company has a stockholder rights plan, commonly referred to as a “poison pill,” that may discourage an attempt to obtain control by means of a tender offer, merger, proxy contest or otherwise |
| If a person acquires 20prca or more of our outstanding shares of common stock, except for certain institutional stockholders, who may acquire up to 25prca of our outstanding shares of common stock, then rights under this plan would be triggered, which would significantly dilute the voting rights of any such acquiring person |
| Certain provisions of the Delaware General Corporation Law may also discourage someone from acquiring or merging with us |
| If clients view offshore development as a viable alternative to our service offerings, our pricing, revenue, margins and profitability may be negatively affected |
| A trend has developed whereas international IT service firms have been founded in countries such as India and China, which have well-educated and technically-trained workforces available at wage rates that are substantially lower than US wage rates |
| While traditionally we have not competed with offshore development, presently this form of software development is experiencing rapid and increasing acceptance in the market |
| To counteract this trend, we are focusing towards premium service offerings, including design and strategy consulting engagements, which are more difficult for offshore development firms to replicate |
| If we are unable to continually evolve our service offerings or the rate of acceptance of offshore development advances even faster than we expect, then our pricing and revenue could be adversely affected |
| We may be required to record additional goodwill impairment charges in future quarters |
| As of December 31, 2005, we had recorded goodwill and related intangible assets with a net book value of dlra17dtta1 million related to prior acquisitions |
| We test for impairment at least annually and whenever evidence of impairment exists |
| We performed our annual goodwill impairment test as of December 2, 2005 and 2004 and determined that the goodwill and related intangible assets were not impaired |
| We have in the past recorded impairments to our goodwill, however |
| In January 2002, we recorded as a change in accounting principle, a non-cash impairment charge of dlra12dtta5 million related to our goodwill |
| We recorded an additional non-cash charge of dlra7dtta4 million, related to a further impairment in December 2002 |
| See “Item 8—Financial Statements and Supplementary Data—Note 2 |
| ” As goodwill values are measured using a variety of factors, including values of comparable companies and using overall stock market and economic data, in addition to our own future financial performance, we may be required in the future to record additional impairment charges that could have a material adverse effect on our reported results |
| We may not generate enough income this year or in future periods to maintain the current net carrying value of our deferred tax asset |
| We have a deferred tax asset of approximately dlra21dtta5 million, net of an applicable valuation allowance, as of December 31, 2005 |
| If we are unable to generate enough income this year or in future periods, the valuation allowance relating to our deferred tax asset may have to be revised upward, which would reduce the carrying value of this asset on our balance sheet under generally accepted accounting principles |
| An increase in the valuation allowance and a related reduction in the carrying value of this asset would increase our provision for income taxes, thereby reducing net income or increasing net loss, and could reduce our total assets (depending on the amount of any such change or changes) |
| An increase in the valuation allowance could otherwise have a material adverse effect on our results of operations and/or our stockholders’ equity and financial position |
| Material changes to our strategic relationship with Hyperion |
| The Ranzal business, which we acquired in October of 2004, derives a substantial portion of its revenues from a channel relationship with Hyperion Solutions Corporation |
| This relationship involves Hyperion assisted lead generation support with respect 15 ______________________________________________________________________ to the business intelligence services provided by Ranzal |
| This relationship is governed by a Consulting Reseller Partner Agreement, which is subject to annual renewal and is scheduled to expire in October of 2006 |
| A failure to renew this relationship, or a material modification or change in Hyperion’s partner approach or its contract terms, for any reason, could have a material adverse impact on our results of operations |
| Our reliance upon Synapse |
| The Synapse Group, Inc |
| (“Synapse”), as more fully described in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Related-Party Transactions,” is considered both a significant customer and a related party |
| Revenues from Synapse amounted to dlra8dtta4 million, or 21dtta2prca of service revenues, and dlra9dtta7 million, or 39dtta0prca of service revenues, for 2005 and 2004, respectively |
| In fiscal 2005, we experienced a planned decrease in revenues of approximately dlra1dtta3 million from Synapse due to anticipated reductions in Synapse’s demand for our services |
| The Company provides services to Synapse related to infrastructure support, custom software development and systems integration |
| Services are provided on both a fixed-fee and time and materials basis |
| Our contracts with Synapse, including all terms and conditions, are consistent with those we have with our other customers and are negotiated on an annual basis |
| The existing one-year services contract with Synapse, which was entered into in January of 2005, has been automatically extended, as per the terms of the contract, for an additional six-month period |
| The contract extension became effective on January 1, 2006 |
| The Company anticipates that it will enter into a new one-year services contract with Synapse during the first quarter of fiscal 2006 |
| It is also anticipated that Synapse will purchase professional services consistent with those purchased in fiscal 2005, which approximated dlra8dtta4 million |
| There is no guarantee that the Company will be able to successfully negotiate a new contract with Synapse at the end of the current contract period |
| Additionally, there is no guarantee that revenues related to Synapse services will be comparable to those generated in the past |