| HEWITT ASSOCIATES INC Item 1A Risk Factors The outsourcing and consulting markets are highly competitive, and if we are not able to compete effectively our revenues and profit margins will be adversely affected |
| The outsourcing and consulting markets in which we operate include a large number of service providers and are highly competitive |
| Many of our competitors are expanding the services they offer in an attempt to gain additional business |
| Additionally, some competitors have established and are likely to continue to establish cooperative relationships among themselves or with third parties to increase their ability to address client needs |
| Some of our competitors have greater financial, technical and marketing resources, larger customer bases, greater name recognition, stronger international presence and more established relationships with their customers and suppliers than we have |
| Additional competitors have entered some of the marketplaces in which we compete |
| In addition, new competitors or alliances among competitors could emerge and gain significant market share and some of our competitors may have or may develop a lower cost structure, adopt more aggressive pricing policies or provide services that gain greater market acceptance than the services that we offer or develop |
| Large and well capitalized competitors may be able to respond to the need for technological changes faster, price their services more aggressively, compete for skilled professionals, finance acquisitions, fund internal growth and compete for market share more effectively than we do |
| In order to respond to increased competition and pricing pressure, we may have to lower our prices, which would have an adverse effect on our revenues and profit margin |
| 10 ______________________________________________________________________ [37]Table of Contents A significant or prolonged economic downturn could have a material adverse effect on our revenues and profit margin |
| Our results of operations are affected directly by the level of business activity of our clients, which in turn are affected by the level of economic activity in the industries and markets that they serve |
| Economic slowdowns in some markets, particularly in the United States, may cause reductions in technology and discretionary spending by our clients, which may result in reductions in the growth of new business as well as reductions in existing business |
| If our clients enter bankruptcy or liquidate their operations, our revenues could be adversely affected |
| Our revenues under many of our Outsourcing contracts depend upon the number of our clients’ employees or the number of participants in our clients’ employee benefit plans and could be adversely affected by layoffs |
| We may also experience decreased demand for our services as a result of postponed or terminated outsourcing of human resources functions or reductions in the size of our clients’ workforce |
| Reduced demand for our services could increase price competition |
| The profitability of our engagements with clients may not meet our expectations due to unexpected costs, cost overruns, early contract terminations, unrealized assumptions used in our contract bidding process and the inability to maintain our prices |
| Our profitability is a function of our ability to control our costs and improve our efficiency |
| As we adapt to change in our business, enter into new HR BPO engagements and take on new employees in new locations, we may not be able to manage our large, diverse and changing workforce, control our costs or improve our efficiency |
| Most new Outsourcing arrangements undergo an implementation process whereby our systems and processes are customized to match a client’s plans and programs |
| The cost of this process is estimated by us and often partially funded by our clients |
| If our actual implementation expense exceeds our estimate or if the ongoing service cost is greater than anticipated, the client contract may be less profitable than expected |
| Even though Outsourcing clients typically sign long-term contracts, these contracts may be terminated at any time, with or without cause, by our client upon 90 to 180 days written notice |
| Our Outsourcing clients are required to pay a termination fee; however, this amount may not be sufficient to fully compensate us for the profit we would have received if the contract had not been cancelled |
| Consulting contracts are typically on an engagement-by-engagement basis versus a long-term contract |
| A client may choose to delay or terminate a current or anticipated project as a result of factors unrelated to our work product or progress, such as the business or financial condition of the client or general economic conditions |
| When any of our engagements are terminated, we may not be able to eliminate associated costs or redeploy the affected employees in a timely manner to minimize the impact on profitability |
| Any increased or unexpected costs or unanticipated delays in connection with the performance of these engagements, including delays caused by factors outside our control, could have an adverse effect on our profit margin |
| Our profit margin, and therefore our profitability, is largely a function of the rates we are able to charge for our services and the staffing costs for our personnel |
| Accordingly, if we are not able to maintain the rates we charge for our services or appropriate staffing costs of our personnel, we will not be able to sustain our profit margin and our profitability will suffer |
| The prices we are able to charge for our services are affected by a number of factors, including competitive factors, cost of living adjustment provisions (COLA’s), the extent of ongoing clients’ perception of our ability to add value through our services and general economic conditions |
| Our profitability in providing HR BPO services is largely based on our ability to drive cost efficiencies during the term of our contracts for such services |
| If we cannot drive suitable cost efficiencies, our profit margins will suffer |
| We might not be able to achieve the cost savings required to sustain and increase our profit margins |
| Our Outsourcing business model inherently places ongoing pressure on our profit margins |
| We provide our Outsourcing services over long terms for variable or fixed fees that generally are less than our clients’ historical costs to provide for themselves the services we contract to deliver |
| Additionally, our HR BPO contracts generally provide cost savings to our clients, irrespective of our cost of providing these services |
| Also, clients’ demand for cost reductions may increase over the term of the agreement |
| As a result, we bear the risk of increases in the cost of delivering HR BPO services to our clients, and our margins associated with particular contracts will depend on our 11 ______________________________________________________________________ [38]Table of Contents ability to control our costs of performance under those contracts and meet our service commitments cost-effectively |
| Over time, some of our operating expenses will increase as we invest in additional infrastructure and implement new technologies to maintain our competitive position and meet our client service commitments |
| We must respond by continuously improving our service efficiency, unit costs and vendor management and continuing to grow our business so that our costs are spread over an increasing revenue base, or our ability to sustain and increase profitability will be jeopardized |
| Our accounting for our long-term contracts requires using estimates and projections that may change over time |
| Such changes may have a significant or adverse effect on our reported results of operations or consolidated balance sheet |
| Projecting contract profitability on our long-term Outsourcing contracts requires us to make assumptions and estimates of future contract results |
| All estimates are inherently uncertain and subject to change |
| In an effort to maintain appropriate estimates, we review each of our long-term Outsourcing contracts, the related contract reserves and intangible assets on a regular basis |
| If we determine that we need to change our estimates for a contract, we will change the estimates in the period in which the determination is made |
| These assumptions and estimates involve the exercise of judgment and discretion, which may also evolve over time in light of operational experience, regulatory direction, developments in accounting principles, and other factors |
| In particular, HR BPO is a relatively immature industry and we have limited experience in estimating implementation and ongoing costs compared to our more mature Benefits Outsourcing business |
| Further, initially foreseen effects could change over time as a result of changes in assumptions, estimates or developments in the business or the application of accounting principles related to long-term Outsourcing contracts |
| Application of, and changes in, assumptions, estimates and policies may adversely affect our financial results |
| The loss of a significantly large client or several clients could have a material adverse effect on our revenues and profitability |
| Although no one client comprised more than ten percent of our net revenues in any of the three years ended September 30, 2006, the loss of a significantly large client or several clients could adversely impact our revenues and profitability |
| Our largest clients employ us for Outsourcing services |
| As a result, given the amount of time needed to implement new Outsourcing clients, there is no assurance that we would be able to promptly replace the revenues or income lost if a significantly large client or several clients terminated our services or decided not to renew their contracts with us |
| We may have difficulty integrating or managing acquired businesses, which may harm our financial results or reputation in the marketplace |
| Our expansion and growth may be dependent in part on our ability to make acquisitions |
| The risks we face related to acquisitions include that we could overpay for acquired businesses, face integration challenges, have difficulty finding appropriate acquisition candidates, and any acquired business could significantly under-perform relative to our expectations |
| If acquisitions are not successfully integrated, our revenues and profitability could be adversely affected as well as adversely impact our reputation |
| We may pursue additional acquisitions in the future, which may subject us to a number of risks, including; • diversion of management attention; • inability to retain key personnel, other employees and clients of the acquired business; • potential dilutive effect on our earnings; • inability to establish uniform standards, controls, procedures and policies; • exposure to legal claims for activities of the acquired business prior to acquisition; and • inability to effectively integrate the acquired company and its employees |
| Any excess of the purchase price paid by Hewitt in an acquisition over the fair value of the net tangible and identifiable intangible assets acquired will be accounted for as goodwill |
| Hewitt is not required to amortize goodwill against income but goodwill will be subject to periodic reviews for impairment |
| If an impairment charge is required in the future, the charge would negatively impact reported earnings in the period of the charge |
| 12 ______________________________________________________________________ [39]Table of Contents Our business will be negatively affected if we are not able to anticipate and keep pace with rapid changes in government regulations or if government regulations decrease the need for our services or increase our costs |
| The areas in which we provide Outsourcing and Consulting services are the subject of government regulation which is constantly evolving |
| Changes in government regulations in the United States, our principal geographic market, affecting the value, use or delivery of benefits and human resources programs, including changes in regulations relating to health and welfare (such as medical) plans, defined contribution (such as 401(k)) plans, defined benefit (such as pension) plans or payroll delivery, may adversely affect the demand for or profitability of our services |
| In addition, our growth strategy includes a number of global expansion objectives which further subject us to applicable laws and regulations of countries outside the United States |
| If we are unable to adapt our services to applicable laws and regulations, our ability to grow our business or to provide effective Outsourcing and Consulting services in these areas will be negatively impacted |
| Recently, we have seen regulatory initiatives in both the United States and certain European countries result in companies either discontinuing their defined benefit programs or de-emphasizing the importance such programs play in the overall mix of their benefit programs with a trend toward increased use of defined contribution plans |
| If organizations shift to defined contribution plans more rapidly than we anticipate, our results of operation of our business could be adversely affected |
| If we are unable to satisfy regulatory requirements relating to internal controls over financial reporting, our business could suffer |
| Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud |
| If we cannot provide reliable financial reports or prevent fraud, both our reputation in the marketplace and our financial results could suffer |
| We have spent considerable resources reviewing and implementing improvements to our internal controls |
| Although we have received an unqualified audit opinion on our internal controls over financial reporting, we cannot be certain that our efforts will ensure that we implement and maintain adequate controls over our financial processes and reporting in the future |
| Any failure to implement required new or improved controls, or difficulties encountered in their implementation could harm our operating results or cause us to fail to meet our reporting obligations |
| Inadequate internal controls could also cause our clients or our investors to lose confidence in our services delivery or reported financial information, which could have a negative effect on the trading price of our common stock |
| Our business performance and growth plans will be negatively affected if we are not able to effectively apply technology in driving value for our clients through technology-based solutions or gain internal efficiencies through the effective application of technology and related tools |
| Our future success depends, in part, on our ability to develop and implement technology solutions that anticipate and keep pace with rapid and continuing changes in technology, industry standards and client preferences |
| We may not be successful in anticipating or responding to these developments on a timely and cost-effective basis, and our ideas may not be accepted in the marketplace |
| Additionally, the effort to gain technological expertise and develop new technologies in our business requires us to incur significant expenses |
| If we cannot offer new technologies as quickly as our competitors or if our competitors develop more cost-effective technologies, it could have a material adverse effect on our ability to obtain and complete client engagements |
| Our business is also dependent, in part, upon continued growth in the use of technology in business by our clients and prospective clients and their employees and our ability to deliver the efficiencies and convenience afforded by technology |
| If growth in the use of technology does not continue, demand for our services may decrease |
| Use of new technology for commerce generally requires understanding and acceptance of a new way of conducting business and exchanging information |
| Companies that have already invested substantial resources in traditional means of conducting commerce and exchanging information may be particularly reluctant or slow to adopt a new approach that would not utilize their existing personnel and infrastructure |
| 13 ______________________________________________________________________ [40]Table of Contents If our clients or third parties are not satisfied with our services, we may face damage to our professional reputation or legal liability |
| We depend to a large extent on our relationships with our clients and our reputation for high-quality outsourcing and consulting services |
| As a result, if a client is not satisfied with our services, it may be more damaging in our business than in other businesses |
| Moreover, if we fail to meet our contractual obligations, we could be subject to legal liability or loss of client relationships |
| The nature of our work, especially our actuarial services, involves assumptions and estimates concerning future events, the actual outcome of which we cannot know with certainty in advance |
| In addition, we could make computational, software programming or data management errors |
| Defending lawsuits arising out of any of our services could require substantial amounts of management attention, which could adversely affect our financial performance |
| Our exposure to liability on a particular engagement may be greater than the profit opportunity of the engagement |
| In addition to client liability, governmental authorities may impose penalties with respect to our errors or omissions and may preclude us from doing business in relevant jurisdictions |
| In addition to the risks of liability exposure and increased costs of defense and insurance premiums, claims arising from our professional services may produce publicity that could hurt our reputation and business |
| Improper disclosure of personal data could result in liability and harm our reputation |
| In addition, one of our significant responsibilities is to maintain the security and privacy of our clients’ confidential and proprietary information and the personal data of their employees and plan participants |
| We have established several policies and procedures to help protect the security and privacy of this information |
| Although we continue to review and improve our policies and procedures, it is possible that our security controls over personal data, our training of employees and vendors on data security, and other practices we follow may not prevent the improper access to or disclosure of personally identifiable information |
| Such disclosure could harm our reputation and subject us to liability under our contracts and laws that protect personal data, resulting in increased costs or loss of revenue |
| Further, data privacy is subject to frequently changing rules and regulations, which sometimes conflict among the various jurisdictions and countries in which we provide services |
| Our failure to adhere to or successfully implement processes in response to changing regulatory requirements in this area could result in legal liability or impairment to our reputation in the marketplace |
| We depend on our employees; the inability to attract new talent or the loss of key employees could damage or result in the loss of client relationships and adversely affect our business |
| Our success and ability to grow are dependent, in part, on our ability to hire and retain large numbers of talented people |
| In particular, our employees’ personal relationships with our clients are an important element of obtaining and maintaining client engagements |
| The inability to attract qualified employees in sufficient numbers to meet demand or losing employees who manage substantial client relationships or possess substantial experience or expertise could adversely affect our ability to secure and complete engagements, which would adversely affect our results of operations |
| In connection with our initial public offering and our transition to a corporate structure, we granted employees, including those employees who were owners of Hewitt Holdings LLC, the limited liability company that was the parent entity of Hewitt Associates LLC at the time of our initial public offering, shares of restricted stock or stock options to attract, retain and motivate such employees |
| Since our initial public offering, we have also made, and anticipate making in the future, other equity-based awards to many of our employees to serve in part as an incentive to remain employed with the Company |
| The incentives provided by these awards may not be effective in causing these employees to stay with our organization |
| All of the restricted stock granted at the time of our initial public offering as well as those shares issued in connection with our acquisitions of Bacon & Woodrow in June 2002 and Exult in October 2004 vested on or before June 2006 and transfer restrictions on those shares have lapsed, other than for certain minimum stock holding requirements imposed on all executives |
| Since these shares have vested and become freely transferable, we may not be successful at retaining the persons holding these shares, many of whom continue to be important to our success |
| 14 ______________________________________________________________________ [41]Table of Contents Our global operations and expansion strategy pose complex management, foreign currency, legal, tax and economic risks, which we may not adequately address |
| As of September 30, 2006, we had a total of 88 offices in 33 countries and 4 additional offices in 2 additional countries through joint ventures and minority investments |
| In fiscal 2006, approximately 78prca of our total revenues were attributable to activities in the United States and approximately 22prca of our revenues were attributable to our activities in Europe, Canada, the Asia-Pacific region and Latin America |
| Our ability to provide services from global locations having lower cost structures than the United States and continued penetration of markets beyond the United States are important components of the Company’s growth strategy |
| A number of risks may inhibit our international operations and global sourcing efforts, preventing us from realizing our global expansion objectives, including: • insufficient demand for our services in foreign jurisdictions, which may be due to applicable laws and regulations or benefit practices in such jurisdictions; • ability to execute effective and efficient cross-border sourcing of services on behalf of our clients; • the burdens of complying with a wide variety of foreign laws and regulations, including but not limited to regulations regarding the flow and transfer of data and other information between countries; • multiple and possibly overlapping and conflicting tax laws; • restrictions on the movement of cash; • political instability and international terrorism; • currency fluctuations; • longer payment cycles; • restrictions on the import and export of technologies; • price controls or restrictions on exchange of foreign currencies; and • trade barriers |
| The demand for our services may not grow at rates we anticipate |
| We have made and continue to make a significant investment and devote significant attention to our Human Resources Business Process Outsourcing services offering |
| Our Human Resources Business Process Outsourcing services offering may not be well received by our clients, or the demand for human resources business process outsourcing may not grow as rapidly as we anticipate, which could have an adverse impact on our revenues and profit margins |
| In addition, the growth for stand-alone Benefits Outsourcing services has slowed, particularly in the large plan market (over 20cmam000 participants), as some larger companies that have not previously outsourced some of their benefit programs consider whether they wish to outsource a larger portion of their human resources function or continue to administer such programs themselves |
| If a greater percentage of such organizations determine not to outsource such programs than we anticipate, it could also have an adverse impact on our revenues and profit margins |
| If we fail to establish and maintain alliances for developing, marketing and delivering our services, our ability to increase our revenues and profitability may suffer |
| Our growth depends, in part, on our ability to develop and maintain alliances with businesses such as brokerage firms, financial services companies, health care organizations, insurance companies, other business process outsourcing organizations and other companies in order to develop, market and deliver our services |
| If our strategic alliances are discontinued or we have difficulty developing new alliances, our ability to increase or maintain our client base may be substantially diminished |
| We rely on third parties to provide services and their failure to perform the service could do harm to our business |
| As part of providing services to clients, we rely on a number of third-party service providers |
| These providers include, but are not limited to, plan trustees and payroll service providers responsible for transferring funds to employees or on behalf of employees, and providers of data and information, such as software vendors, health plan 15 ______________________________________________________________________ [42]Table of Contents providers, investment managers and investment advisers, that we work with to provide information to clients’ employees |
| It also includes providers of human resource functions such as recruiters and trainers employed by us in connection with our human resources business processing services delivered to our clients |
| Failure of third party service providers to perform in a timely manner could result in contractual or regulatory penalties, liability claims from clients and/or employees, damage to our reputation and harm to our business |
| We have only a limited ability to protect the intellectual property rights that are important to our success, and we face the risk that our services or products may infringe upon the intellectual property rights of others |
| Our future success depends, in part, upon our ability to protect our proprietary methodologies and other intellectual property |
| Existing laws of some countries in which we provide or intend to provide services or products may offer only limited protection of our intellectual property rights |
| We rely upon a combination of trade secrets, confidentiality policies, non-disclosure and other contractual arrangements and copyright and trademark laws to protect our intellectual property rights |
| The steps we take 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 unauthorized use or take appropriate and timely steps to enforce our intellectual property rights |
| Protecting our intellectual property rights may also consume significant management time and resources |
| We cannot be sure that our services and products, or the products of others that we offer to our clients, do not infringe on the intellectual property rights of third parties, and we may have infringement claims asserted against us or against our clients |
| These claims may harm our reputation, result in financial liabilities and prevent us from offering some services or products |
| We have generally agreed in our Outsourcing contracts to indemnify our clients for any 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 revenues we receive from the client |
| Any claims or litigation in this area, whether we ultimately win or lose, could be time-consuming and costly, injure our reputation or require us to enter into royalty or licensing arrangements |
| We may not be able to enter into these royalty or licensing arrangements on acceptable terms |
| Any limitation on our ability to provide a service or product could cause us to lose revenue-generating opportunities and require us to incur additional expenses to develop new or modified solutions for future projects |
| We rely heavily on our computing and communications infrastructure and the integrity of these systems in the delivery of services for our clients, and our operational performance and revenue growth depends, in part, on the reliability and functionality of this infrastructure as a means of delivering human resources services |
| The internet is a key mechanism for delivering our services to our clients efficiently and cost effectively |
| Our clients may not be receptive to human resource services delivered over the internet due to concerns regarding transaction security, user privacy, the reliability and quality of internet service and other reasons |
| Our clients’ concerns may be heightened by the fact we use the internet to transmit extremely confidential information about our clients and their employees, such as compensation, medical information and other personally identifiable information |
| In addition, the internet has experienced, and is expected to continue to experience, significant growth in the number of users and volume of traffic |
| As a result, its performance and reliability may decline |
| In order to maintain the level of security, service and reliability that our clients require, we may be required to make significant investments in our on-line means of delivering human resources services |
| In addition, websites and proprietary on-line services have experienced service interruptions and other delays occurring throughout their infrastructure |
| If these outages or delays occur frequently in the future, internet usage as a medium of exchange of information could grow more slowly or decline and the internet might not adequately support our web-based tools |
| The adoption of additional laws or regulations with respect to the internet may impede the efficiency of the internet as a medium of exchange of information and decrease the demand for our services |
| If we cannot use the internet effectively to deliver our services, our revenue growth and results of operation may be impaired |
| We may lose client data as a result of major catastrophes and other similar problems that may materially adversely impact our operations |
| We have multiple processing centers around the globe which use various commercial methods for disaster recovery capabilities |
| Our main data processing center, located in Lincolnshire, Illinois is in a dual (separate) data center configuration to provide back-up capabilities |
| In the event of a disaster, we have developed business continuity plans; however, they may not be sufficient, and the data recovered may not be sufficient for the administration of our clients’ human resources programs and processes |
| 16 ______________________________________________________________________ [43]Table of Contents Our quarterly revenues, operating results and profitability will vary from quarter to quarter, which may result in volatility of our stock price |
| Our quarterly revenues, operating results and profitability have varied in the past and are likely to vary significantly from quarter to quarter |
| This may lead to volatility in our stock price |
| The factors that are likely to cause these variations are: • the rate at which we obtain new Outsourcing engagements since our Outsourcing engagements often require substantial implementation costs that are recovered over the term of the engagements; • seasonality of certain services, including annual benefit enrollment processes; • timing of Consulting projects and their termination; • timing of commencement of new Outsourcing engagements; • changes in estimates of profitability of Outsourcing engagements; • the introduction of new products or services by us or our competitors; • pricing pressure on new client services and renewals; • the timing, success and costs of sales, marketing and product development programs; • the success of strategic acquisitions, alliances or investments; • changes in estimates, accruals and payments of variable compensation to our employees; and • general economic factors |
| In addition, our operating results in future periods may be below the expectations of securities analysts and investors which may materially adversely affect the market price of our Class A common stock |
| There are significant limitations on the ability of any person or company to buy Hewitt without the approval of the Board of Directors, which may decrease the price of our Class A common stock |
| Our amended and restated certificate of incorporation and by-laws contain provisions that may make the acquisition of Hewitt more difficult without the approval of our Board of Directors, including the following: • our Board of Directors is classified into three classes, each of which serves for a staggered three-year term; • a Director may be removed by our stockholders only for cause and then only by the affirmative vote of two-thirds of the outstanding stock entitled to vote generally in the election of Directors; • only the Board of Directors or the Chairman of the Board may call special meetings of our stockholders; • our stockholders may take action only at a meeting of the stockholders and not by written consent; • our stockholders must comply with advance notice procedures in order to nominate candidates for election to the Board of Directors or to place stockholders’ proposals on the agenda for consideration at meetings of the stockholders; • the Board of Directors may consider the impact of any proposed change of control transaction on constituencies other than the stockholders in determining what is in the best interest of Hewitt; • business combinations involving one or more persons that own or intend to own at least 15prca of the voting stock must be approved by the affirmative vote of holders of at least 75prca of the voting stock, unless the consideration paid in the business combination is generally the highest price paid by these persons to acquire the voting stock or a majority of the directors unaffiliated with these persons who were directors prior to the time these persons acquired their shares approve the transaction; and • the stockholders may amend or repeal the provisions of the certificate of incorporation and the by-laws regarding change of control transactions and business combinations only by a vote of holders of two-thirds of the outstanding common stock at that time |
| 17 ______________________________________________________________________ [44]Table of Contents Section 203 of the Delaware General Corporation Law may delay, defer or prevent a change in control that our stockholders might consider to be in their best interest |
| We are subject to Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, prohibits certain “business combinations” between a Delaware corporation and an “interested stockholder” (generally defined as a stockholder who becomes a beneficial owner of 15prca or more of a Delaware corporation’s voting stock) for a three-year period following the date that such stockholder became an interested stockholder |
| Section 203 could have the effect of delaying, deferring or preventing a change in control that the stockholders might consider to be in their best interest |