| INFOCROSSING INC ITEM 1A RISK FACTORS You should carefully consider the following risk factors and warnings before making an investment in our common stock or convertible debt |
| If any of the following risks actually occur, our business, financial condition, results of operations and prospects could be materially and adversely affected |
| In such case, you may lose all or part of your investment |
| You should also refer to the other information set forth or incorporated by reference in this Annual Report, including our consolidated financial statements and the related notes included in Item 15 of this Annual Report |
| RISKS RELATED TO OUR BUSINESS LOSS OF MAJOR CLIENTS COULD REDUCE OUR REVENUES AND CAUSE LOSSES FOR OUR BUSINESS Our customers include commercial enterprises, institutions, and government agencies |
| From time to time, some of our customers have accounted for more than 10prca of our consolidated revenue |
| For the year ended December 31, 2005, one client, the Missouri Department of Social Services, accounted for more than 10prca of our consolidated revenue |
| For the years ended December 31, 2004 and 2003, one client, ADT Security Services, Inc, accounted for more than 10prca of our consolidated revenues |
| Page 9 Our success depends substantially upon the retention of our major customers as clients |
| Generally, we may lose a client as a result of a contract expiration, merger or acquisition, business failure, or the selection of another provider of information technology services |
| We cannot be sure that we will be able to retain long-term relationships or secure renewals on favorable terms with our customers |
| OUR CONTRACTS CONTAIN TERMINATION PROVISIONS AND PRICING RISKS THAT COULD CAUSE US TO LOSE OUR IT OUTSOURCING CONTRACTS OR LOSE MONEY ON OUR REMAINING IT OUTSOURCING CONTRACTS Many of our IT outsourcing contracts with clients permit termination upon ninety days notice and payment of an early termination fee |
| The ability of our clients to terminate contracts creates an uncertain revenue stream |
| If clients are not satisfied with our level of performance, pricing or other attributes, our reputation in the IT outsourcing industry may suffer, which may also materially and adversely affect our business, financial condition and results of operations |
| Some of our contracts contain pricing provisions that require the payment of a set fee by the client for our services regardless of the costs we incur in performing these services and/or provide for penalties in the event we fail to achieve certain contract standards |
| These pricing provisions, particularly in the case of long-term outsourcing agreements, require us to make estimates and assumptions at the time we enter into the contracts that could differ from actual results |
| These estimates may not necessarily reflect the actual costs to provide the contracted services |
| Any increased or unexpected costs or unanticipated delays in the performance of these engagements, including delays caused by factors out of our control, could cause us to lose money on these fixed price contracts and the losses could be material |
| WE OPERATE IN HIGHLY COMPETITIVE MARKETS IN THE IT OUTSOURCING INDUSTRY THAT COULD CAUSE US TO LOSE EXISTING CUSTOMERS OR PREVENT US FROM OBTAINING NEW CUSTOMERS We operate in a highly competitive market |
| Our current and potential competitors include other independent computer service companies and divisions of diversified enterprises, as well as the internal IT departments of existing and potential customers |
| Among the most significant of our competitors are IBM Corporation; Electronic Data Systems Corporation; Affiliated Computer Services, Inc |
| ; Computer Sciences Corp |
| ; and SunGard Data Systems, Inc |
| In general, the IT outsourcing services industry is fragmented, with numerous companies offering services in limited geographic areas, vertical markets, or product categories |
| Many of our larger competitors have substantially greater financial and other resources than we do |
| We compete on the basis of a number of factors, including price, quality of service, technological innovation, breadth of services offered and responsiveness |
| Our contracts do not establish us as the exclusive provider of IT outsourcing services to each customer |
| Accordingly, our customers may select one of our competitors to provide services beyond the scope of our existing agreement or decide not to outsource certain portions of their IT operations with us |
| We cannot be sure that we will be able to compete successfully against our competitors in the future |
| If we fail to compete successfully against our current or future competitors with respect to these or other factors, our business, financial condition, and results of operations will be materially and adversely affected |
| CHANGES IN TECHNOLOGY IN THE IT OUTSOURCING INDUSTRY COULD CAUSE OUR BUSINESS TO LOSE MONEY OR COULD REQUIRE US TO INVEST ADDITIONAL CAPITAL IN NEW TECHNOLOGY The markets for our services change rapidly because of technological innovation, new product and service introductions, and changes in customer requirements, among other factors |
| New products and services and new technology often render existing information services or technology infrastructure obsolete, costly, or otherwise unmarketable |
| For example, the introduction of new software applications for a particular computer platform will make other computer platforms less attractive to companies desiring to use the new applications |
| As a result, our success depends on our ability to timely innovate and integrate new technologies into our service offerings |
| We cannot be sure that we will be successful at adopting and integrating new technologies into our service offerings in a timely manner |
| Page 10 Advances in technology also require us to expend substantial resources to acquire and utilize new technologies in our business |
| We must continue to commit resources to train our personnel in the use of these new technologies |
| We must also continue to train personnel to maintain the compatibility of existing hardware and software systems with these new technologies |
| We cannot be sure that we will be able to continue to commit the resources necessary to update our technology infrastructure at the rate demanded by our markets |
| OUR SYSTEMS AND PROCESSES ARE NOT PROTECTED BY PATENTS OR BY REGISTERED COPYRIGHTS, TRADEMARKS, TRADE NAMES OR SERVICE MARKS AND AS A RESULT, OUR COMPETITORS MAY BE ABLE TO USE OUR SYSTEMS AND PROCESSES TO COMPETE AGAINST US AND HURT OUR BUSINESS We believe that because of the rapid pace of technological change in the computer industry, copyright and other forms of intellectual property protection are of less significance than factors such as the knowledge and experience of management and other personnel, and our ability to develop, enhance, market, and acquire new systems and services |
| As a result, our systems and processes are not protected by patents or by registered copyrights, trademarks, trade names, or service marks |
| To protect our proprietary services and software from illegal reproduction, we rely on certain mechanical techniques in addition to trade secret laws, restrictions in certain of our customer agreements with respect to use of our services and disclosure to third parties, and internal non-disclosure safeguards, including confidentiality restrictions with certain employees |
| Despite these efforts, it may be possible for our competitors or clients to copy aspects of our trade secrets |
| This could have a material adverse effect on our business, financial condition, and results of operations |
| INTELLECTUAL PROPERTY LITIGATION COULD CAUSE US TO LOSE MONEY AND LOWER OUR STANDING IN THE IT OUTSOURCING INDUSTRY In recent years, there has been significant litigation in the United States involving patent and other intellectual property rights |
| We are not currently involved in any material intellectual property litigation |
| We may, however, be a party to intellectual property litigation in the future to protect our trade secrets or know-how |
| Our suppliers, customers, and competitors may have patents and other proprietary rights that cover technology employed by us |
| Such persons may also seek patents in the future |
| Due to the confidential nature of United States patent applications, we are not aware of all patents or other intellectual property rights of which our services may pose a risk of infringement |
| Others asserting rights against us could force us to defend ourselves against alleged infringement of intellectual property rights |
| We could incur substantial costs to prosecute or defend any such litigation, and intellectual property litigation could force us to do one or more of the following: o cease selling or using services that incorporate the challenged technology; o redesign those services that incorporate the challenged technology; and o obtain from the holder of the infringed intellectual property right a license to sell or use the relevant technology, which may require us to pay royalties, which could be substantial |
| In addition, we generally agree in our contracts to indemnify our clients for any expenses or liabilities they may incur 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 |
| Furthermore, any ongoing intellectual property litigation could cause us to lose customers and harm our reputation within the IT outsourcing industry |
| FAILURE TO PROPERLY MANAGE GROWTH COULD CAUSE OUR BUSINESS TO LOSE MONEY We have expanded our operations rapidly in recent years |
| We intend to expand our operations in the foreseeable future to pursue existing and potential market opportunities |
| This growth places a significant demand on management and operational resources |
| In order to manage growth effectively, we must implement and improve our operational systems and controls on a timely basis |
| If we fail to implement these systems and controls, our business, financial condition, and results of operations will be materially and adversely affected |
| Page 11 ACQUISITIONS WE MAKE MAY NOT PROVIDE EXPECTED BENEFITS AND COULD POSSIBLY RESULT IN A LOSS OF MONEY AND RESOURCES We recently purchased (i)Structure, LLC ( "e (i)Structure "e ) with the expectation that the acquisition will result in various benefits, including, among others, a strengthened position in the IT outsourcing market, additional capabilities in distributed systems and networking services, and sales and market synergies |
| Achieving the anticipated benefits of the acquisition is subject to a number of uncertainties, including whether we integrate (i)Structure in an efficient and effective manner, and general competitive factors in the marketplace |
| Failure to achieve these anticipated benefits could result in increased costs, decreases in the amount of expected revenues and diversion of managementapstas time and energy and could materially impact our business, financial condition and operating results |
| We intend to consider selective acquisition opportunities going forward such as our recent acquisitions of (i)Structure, LLC, Verizon Information Technologies, Inc |
| (now known as Infocrossing Healthcare Services, Inc |
| ) and ITO Acquisition Corporation d/b/a Systems Management Specialists (now known as Infocrossing West, Inc |
| Therefore, we may acquire businesses or technologies in the future that we believe are a strategic fit with our business |
| These acquisitions may result in unforeseen operating difficulties and expenditures and may absorb significant management attention that would otherwise be available for ongoing development of our business |
| In addition, the integration of businesses or technologies may prove to be more difficult than expected, and we may be unsuccessful in maintaining and developing relations with the employees, customers and business partners of acquisition targets |
| Since we will not be able to accurately predict these difficulties and expenditures, it is possible that these costs may outweigh the value we realize from the acquisitions |
| Future acquisitions could also result in issuances of equity securities that would reduce our stockholders &apos ownership interest, the incurrence of debt, contingent liabilities, deferred stock based compensation or expenses related to the valuation of goodwill or other intangible assets and the incurrence of large, immediate write-offs |
| LOSS OF KEY PERSONNEL COULD CAUSE OUR BUSINESS TO LOSE MONEY OR CAUSE US TO INVEST CAPITAL TO REPLACE SUCH PERSONNEL Our success depends largely on the skills, experience, and performance of some key members of our management, including our Chairman and Chief Executive Officer, Zach Lonstein |
| The loss of any key members of our management may materially and adversely affect our business, financial condition, and results of operations |
| In addition, loss of key members of management could require us to invest capital to search for a suitable replacement |
| Such a search could serve as a distraction to the remaining members of management preventing them from focusing on the ongoing development of our business, which, in turn, could cause us to lose money |
| OUR BUSINESS DEPENDS ON OUR ABILITY TO RECRUIT, TRAIN, AND RETAIN SKILLED PERSONNEL TO PERFORM IT OUTSOURCING SERVICES; OUR FAILURE TO DO SO COULD INCREASE OUR COSTS AND LIMIT OUR GROWTH We must continue to grow by hiring and training technically-skilled people in order to perform services under our existing contracts and new contracts that we will enter into |
| The people capable of filling these positions are in great demand and recruiting and training qualified personnel require substantial resources |
| Our business also experiences significant turnover of technically-skilled people |
| If we fail to attract, train, and retain sufficient numbers of these technically-skilled people, our business, financial condition, and results of operations will be materially and adversely affected |
| WE MAY HAVE DIFFICULTY ACHIEVING AND SUSTAINING PROFITABILITY AND MAY EXPERIENCE ADDITIONAL LOSSES IN THE FUTURE From the fourth quarter of 1999 through the third quarter of 2003, we incurred significant net losses |
| As of December 31, 2005, we had an accumulated deficit of approximately dlra53dtta5 million, although we had positive net worth of approximately dlra107 million |
| For the year ended December 31, 2005, we had net income of dlra2dtta6 million |
| There is no assurance that we will generate positive net income in the future |
| Page 12 WE MAY NOT BE ABLE TO RAISE ADDITIONAL CAPITAL ON TERMS THAT ARE ACCEPTABLE TO US, WHICH COULD LIMIT OUR GROWTH We may need to raise additional capital to develop or enhance our technologies, to fund expansion, or to acquire complementary products, businesses or technologies |
| Additional financing may not be available on terms that are acceptable to us |
| If we raise additional funds through the issuance of equity securities or securities convertible into or exercisable for equity securities, the percentage ownership of our other stockholders would be reduced |
| Additionally, these securities might have rights, preferences and privileges senior to those of our current stockholders |
| If adequate funds are not available on terms acceptable to us, our ability to develop and enhance our services, fund expansion, and otherwise take advantage of unanticipated opportunities would be significantly limited |
| OUR INDEBTEDNESS COULD LIMIT OUR AVAILABLE CASH FLOW, HARM OUR CREDIT RATING AND PREVENT US FROM FULFILLING OUR OBLIGATIONS UNDER OUR OUTSTANDING INDEBTEDNESS We have a significant amount of indebtedness |
| At December 31, 2005, we had total indebtedness of dlra139dtta3 million consisting of a dlra55dtta0 million senior secured term loan, dlra5 million outstanding of a dlra15 million senior secured revolving loan, convertible notes with a book value of dlra65dtta2 million and a face value of dlra72dtta0 million, and dlra14dtta1 million of capital leases |
| The convertible notes mature on July 15, 2024 and bear interest at a rate of 4prca, payable semi-annually in arrears each January 15th and July 15th |
| They are convertible, subject to certain conditions, at the option of the holder prior to maturity, into shares of our common stock at a specified conversion price, subject to certain adjustments |
| The conversion price must be adjusted to reflect stock dividends, stock splits, issuances of rights to purchase shares of common stock and other events |
| Upon conversion, we will have the right to deliver to the holders, at our option, cash, shares of our common stock, or a combination thereof |
| At the current conversion price, the dlra72 million of convertible notes are convertible into 5cmam673cmam759 common shares |
| We have a call option, pursuant to which we may redeem the convertible notes, in part or in whole, for cash at any time on or after July 15, 2007 at a price equal to 100prca of the principal amount of the convertible notes, plus accrued interest, plus a "e premium "e if the redemption is prior to July 15, 2009, provided, however, the convertible notes are only redeemable prior to July 15, 2009 if the market price of our common stock has been at least 150prca of the conversion price then in effect for at least 20 trading days during any 30 consecutive trading day period |
| The "e premium "e referred to in the preceding sentence shall be in an amount equal to dlra173dtta83 per dlra1cmam000 principal amount of convertible notes, less the amount of any interest actually paid on such convertible notes prior to the redemption date |
| The holders of the convertible notes may require that we purchase for cash all or a portion of the convertible notes on July 15, 2009, 2014, and 2019 at a repurchase price equal to 100prca of the principal amount of the convertible notes plus any accrued interest |
| There are no financial covenants, other than a limitation on incurring additional indebtedness, as defined in the indenture |
| We are not restricted from paying dividends, or issuing other securities, or repurchasing other securities issued by us under the terms of the indenture |
| The senior secured loans mature in April 2009 and all remaining balances must be paid at that time |
| The senior secured loans bear interest based on either the eurodollar rate or the base rate plus a margin that will vary depending on our consolidated senior secured leverage ratio |
| Default interest may also be payable in certain circumstances |
| All computations of interest based on the base rate when the base rate is determined by Bank of Americaapstas prime rate will be made on the basis of a year of 365 or 366 days |
| All other computations of interest will be made on the basis of a 360-day year |
| The senior secured loans and guarantees are our and our subsidiaries &apos senior secured obligations, secured by a first-priority interest on substantially all of our assets and the assets of our subsidiaries, including the capital stock of our subsidiaries |
| Beginning on September 30, 2006, we are required to make amortization payments on the senior secured term loan at the end of each quarter |
| The amounts of the required amortization payments are dlra2cmam500cmam000 from September 30, 2006 to June 30, 2007, dlra3cmam750cmam000 from September 30, 2007 through June 30, 2008 and dlra5cmam000cmam000 on September 30, 2008 and December 31, 2008 |
| Within five business days after financial statements for a fiscal year are delivered, we must make principal payments equal to 50prca of excess cash flow for such fiscal year |
| Page 13 We are also required to prepay the senior secured loans with: o 100prca of net proceeds from dispositions of assets if such dispositions are not permitted by our credit agreement; o 50prca of net proceeds from certain issuances of equity interests; o 100prca of net proceeds from issuances of debt if such issuances are not permitted by our credit agreement; and o 100prca of certain net insurance proceeds |
| The senior secured loan documents provide for customary negative covenants, including limitations with respect to: o incurring indebtedness; o incurring liens; o fundamental changes; o sales of assets; o amendments to organizational notes documents and convertible notes documents; o dividends and other restricted payments, except, among other things, a dlra500cmam000 basket for repurchase of stock from present or former officers and employees upon death, disability or termination of employment; o cash capital expenditures each fiscal year in excess of dlra10 million per fiscal year; o investments, loans and advances; o transactions with affiliates; o sales and leasebacks; o changes in fiscal year, and o lines of business |
| The senior secured credit agreement provides for customary financial covenants, including: o a maximum consolidated leverage ratio; o a maximum consolidated senior secured leverage ratio; o minimum consolidated EBITDA; and o a minimum fixed charge coverage ratio |
| Our failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our indebtedness |
| This could severely constrain our available cash flow and would require us to consider all of our financial and other alternatives including possible replacement financing, a negotiated workout or seeking protection from our creditors under chapter 11 of the US bankruptcy code |
| Our substantial indebtedness could have important consequences to you |
| For example, it could: o make it more difficult for us to satisfy our obligations with respect to our outstanding indebtedness; o increase our vulnerability to general adverse economic and industry conditions; o require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, research and development efforts and other general corporate purposes; o limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; o place us at a competitive disadvantage compared to our competitors that have less debt; and o limit our ability to borrow additional funds |
| VARIABILITY OF QUARTERLY OPERATING RESULTS We expect our revenues and operating results to vary from quarter to quarter |
| These variations are likely to be caused by many factors that are, to some extent, outside our control, including the addition or loss of customers and the time in the quarter that an addition or loss occurs; variability of fees and expenses with respect to contractual arrangements when our fees are not fixed; and an increase in depreciation or amortization because of the acquisition of new equipment or software licenses and unusual charges whether incurred in the ordinary course of business or not |
| Accordingly, we believe that quarter-to-quarter comparisons of operating results for preceding quarters are not necessarily meaningful |
| You should not rely on the results of one quarter as an indication of our future performance |
| Page 14 RISKS RELATED TO INVESTMENT IN OUR COMMON STOCK OUR STOCK PRICE IS VOLATILE AND COULD DECLINE The price of our common stock has been, and is likely to continue to be, volatile |
| For example, our stock price in the first quarter of 2005 was as high as dlra20dtta15 per share and as low as dlra6dtta35 per share in the fourth quarter of 2005 |
| The market price of our common stock may fluctuate significantly in response to a number of factors, some of which are beyond our control, including: o quarterly variations in our operating results; o announcements we make regarding significant contracts, acquisitions, strategic partnerships, or joint ventures; o additions or departures of key personnel; o changes in market valuations of information technology service companies; o changes in financial estimates by securities analysts; and o sales of our common stock |
| In addition, the stock market in general, and companies whose stock is listed on The Nasdaq National Market, have experienced extreme price and volume fluctuations that have often been disproportionate to the operating performance of these companies |
| Broad market and industry factors may negatively affect the market price of our common stock, regardless of our actual operating performance |
| AVAILABILITY OF SIGNIFICANT AMOUNTS OF OUR COMMON STOCK FOR SALE COULD CAUSE ITS MARKET PRICE TO DECLINE As of December 31, 2005, there were 20cmam547cmam063 shares of our common stock outstanding |
| If our stockholders sell substantial amounts of our common stock in the public market or the perception exists that such sales could occur, including shares issued upon exercise of outstanding common stock purchase warrants, the market price of our common stock could fall |
| As of December 31, 2005, Zach Lonstein, our Chairman and Chief Executive Officer, beneficially owned 2cmam727cmam296 shares of our common stock, including shares from options vesting over the succeeding sixty days |
| Substantially all of those shares are available for sale in the public market pursuant to Rule 144 under the Securities Act, subject to certain volume, manner of sale and other restrictions |
| Zach Lonstein may require us to register his shares for resale, under certain conditions, pursuant to a resale registration rights agreement that we entered into with him |
| CONVERSION OF OUR OUTSTANDING CONVERTIBLE NOTES WILL DILUTE THE OWNERSHIP INTEREST OF EXISTING STOCKHOLDERS AND FUTURE ISSUANCES OF OUR SECURITIES COULD DILUTE YOUR OWNERSHIP The Company has dlra72cmam000cmam000 outstanding of 4dtta0prca Convertible Senior Notes due July 15, 2024, which we refer to as the convertible notes |
| These notes are convertible, subject to certain conditions, at the option of the holder prior to maturity, into shares of our common stock at a specified conversion price, subject to certain adjustments |
| At the current conversion price, the dlra72cmam000cmam000 of convertible notes are convertible into 5cmam673cmam759 common shares |
| The conversion of some or all of the outstanding convertible notes will dilute the ownership interest of existing stockholders |
| Any sales in the public market of the common stock issuable upon such conversion could adversely affect prevailing market prices of our common stock |
| In addition, the existence of the convertible notes may encourage short selling by market participants because the conversion of the notes could depress the price of our common stock |
| Additionally, we may decide to raise additional funds through public or private debt or equity financing to fund our operations |
| If we raise funds by issuing equity securities, the percentage ownership of current stockholders will be reduced, and the new equity securities may have rights prior to those of our common stock |
| We cannot predict the effect, if any, that future sales of our common stock or notes, or the availability of shares of our common stock for future sale, will have on the market price of our common stock or notes |
| Sales of substantial amounts of our common stock (including shares issued upon the exercise of stock options or warrants or the conversion of the notes), or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock |
| Page 15 WE HAVE NOT PAID CASH DIVIDENDS ON OUR COMMON STOCK AND DO NOT EXPECT TO DO SO We have never declared or paid a cash dividend on our common stock |
| We do not anticipate paying any cash dividends on our common stock in the foreseeable future |
| Certain provisions of the credit agreement for our senior secured debt do not permit us to pay cash dividends on our common stock |
| PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND BYLAWS AND DELAWARE LAW COULD DETER TAKEOVER ATTEMPTS AND PREVENT STOCKHOLDERS FROM OBTAINING A PREMIUM FOR THEIR SHARES Some provisions of our certificate of incorporation and bylaws, and Delaware law could delay, prevent, or make more difficult a merger, tender offer, or proxy contest involving us |
| Among other things: o under our certificate of incorporation, our Board of Directors may issue up to 3cmam000cmam000 shares of our preferred stock and may determine the price, rights, preferences, privileges and restrictions, including voting and conversion rights, of these shares of preferred stock; o under our certificate of incorporation, our Board of Directors has three classes of directors, with each director serving for a term of three years; o under our certificate of incorporation, our stockholders may remove our directors at any time, but only for cause; and o Delaware law limits transactions between us and persons that acquire significant amounts of our stock without approval of our Board of Directors |