| ONLINE RESOURCES CORP Item 1A Risk Factors You should carefully consider the following risks before investing in our common stock |
| If any of the events referred to below occur, our business, financial condition, liquidity and results of operations could suffer |
| In that case, the trading price of our common stock could decline, and you may lose all or part of your investment |
| Risks Related to Our Business Prior to the third quarter of 2002, we had a history of net losses; we have achieved net income profitability for all, but two, fiscal quarters since the third quarter of 2002 and cannot be sure that we will be profitable in all future periods |
| Although we achieved profitability under generally accepted accounting principles, or GAAP, in all but two of the fiscal quarters since the third quarter of 2002, we cannot be certain that we can be profitable in future periods |
| As of December 31, 2005, we had an accumulated deficit of dlra57dtta0 million |
| Although we believe we have achieved economies of scale, if growth in our revenues does not significantly outpace the increase in our expenses, we may not be profitable in future periods |
| We are dependent on the financial services industry, and changes within that industry could reduce demand for our products and services |
| The large majority of our revenues are derived from banks, credit unions and credit card issuers |
| Unfavorable economic conditions adversely impacting those parts of the financial services industry we serve could have a material adverse effect on our business, financial condition and results of operations |
| For example, depository financial institutions have experienced, and may continue to experience, cyclical fluctuations in profitability as well as increasing challenges to improve their operating efficiencies |
| Due to the entrance of non-traditional competitors and the current environment of low interest rates, the profit margins of depository financial institutions have narrowed |
| As a result, some financial institutions have slowed, and may 15 _________________________________________________________________ [63]Table of Contents continue to slow, their capital spending, including spending on web-based products and solutions, which can negatively impact sales of our online payments, account presentation, marketing and support services to new and existing clients |
| Decreases in or reallocation of capital expenditures by our current and potential clients, unfavorable economic conditions and new or persisting competitive pressures could adversely affect our business, financial condition and results of operations |
| The failure to retain existing end-users or changes in their continued use of our services will adversely affect our operating results |
| There is no guarantee that the number of end-users using our services will continue to increase |
| Because our fee structure is designed to establish recurring revenues through monthly usage by end-users of our clients, our recurring revenues are dependent on the acceptance of our services by end-users and their continued use of account presentation, payments and other financial services we provide |
| Failing to retain the existing end-users and the change in spending patterns and budgetary resources of financial services providers and their end-users will adversely affect our operating results |
| Any failure of our clients to effectively market our services could have a material adverse effect on our business |
| We generally charge our clients fees based on the number of their end-users who have enrolled with our clients for the services we provide |
| Therefore, end-user enrollment affects our revenue and is important to us |
| Because our clients offer our services under their name, we must depend on those clients to get their end-users to use our services |
| Although we offer extensive marketing programs to our clients, our clients may decide not to participate in our programs or our clients may not effectively market our services to their end-users |
| Any failure of our clients to allow us to effectively market our services could have a material adverse effect on our business |
| Demand for low-cost or free online financial services and competition may place significant pressure on our pricing structure and revenues and may have an adverse effect on our financial condition |
| Account holders eligible to use many of the online services we offer, including account presentation, bill payments and relationship management, may demand that these services be offered for lower cost or free |
| Clients and prospects may therefore reject our services in favor of companies that can offer more competitive prices |
| Thus, demand and competition may place significant pressure on our pricing structure and revenues and may have an adverse effect on our financial condition |
| If we are unable to expand or adapt our services to support our end-users’ needs, our business may be materially adversely affected |
| We may not be able to expand or adapt our services and related products to meet the demands of our clients and their end-users quickly or at a reasonable cost |
| The number of end-users registered for our services has increased from 3dtta1 million as of December 31, 2004 to 4dtta3 million as of December 31, 2005 |
| This resulting growth has placed, and is expected to continue to place, significant demands on our personnel, management and other resources |
| We will need to continue to expand and adapt our infrastructure, services and related products to accommodate additional clients and their end-users, increased transaction volumes and changing end-user requirements |
| This will require substantial financial, operational and management resources |
| If we are unable to scale our system and processes to support the variety and number of transactions and end-users who ultimately use our services, our business may be materially adversely affected |
| If we lose a material client, our business may be adversely impacted |
| Loss of any material client contract could negatively impact our ability to increase our revenues and maintain profitability in the future |
| Additionally, the departure of a large client could impact our ability to attract and retain other clients |
| 16 _________________________________________________________________ [64]Table of Contents California Federal Bank, commonly known as Cal Fed, accounted for 9prca of our revenues, including a dlra2dtta2 million one-time termination fee, for the year ended December 31, 2003 |
| During 2002, Citigroup acquired Cal Fed and converted the Cal Fed end-users to the Citigroup banking and bill payment platform in the first quarter of 2003 |
| Additionally, BB&T Corporation acquired our second largest client, First Virginia Banks, Inc |
| (“First Virginia”), in the third quarter of 2003 |
| In the year ended December 31, 2003, First Virginia accounted for 5prca of our revenues |
| BB&T converted the First Virginia end-users to the BB&T banking and bill payment platform in the fourth quarter of 2003 |
| Finally, Sears sold its credit card portfolio to Citigroup in 2004 and Citigroup converted the Sears end-users to the Citigroup card services platform in the second quarter 2005 |
| We anticipated the loss of Sears as part of our acquisition of Incurrent |
| Currently, among our continuing client base, no one client accounts for more than 4prca of our revenues |
| Consolidation of the financial services industry could negatively impact our business |
| The continuing consolidation of the financial services industry could result in a smaller market for our services |
| Consolidation frequently results in a change in the systems of, and services offered by, the combined entity |
| This could result in the termination of our services and related products if the acquirer has its own in-house system or outsources to competitive vendors |
| This would also result in the loss of revenues from actual or potential retail end-users of the acquired financial services provider |
| Our failure to compete effectively in our markets would have a material adverse effect on our business |
| We may not be able to compete with current and potential competitors, many of whom have longer operating histories, greater name recognition, larger, more established end-user bases and significantly greater financial, technical and marketing resources |
| Further, some of our competitors provide or have the ability to provide the same range of services we offer |
| They could market to our client and prospective client base |
| Other competitors, such as core banking processors, have broad distribution channels that bundle competing products directly to financial services providers |
| Also, competitors may compete directly with us by adopting a similar business model or through the acquisition of companies, such as resellers, who provide complementary products or services |
| A significant number of companies offer portions of the services we provide and compete directly with us |
| For example, some companies compete with our web-based account presentation capabilities |
| Some software providers also offer some of the services we provide on an outsourced basis |
| These companies may use bill payers who integrate with their account presentation services |
| Also, certain services, such as Intuit’s Quicken |
| Finance, may be available to retail end-users independent of financial services providers |
| Many of our competitors may be able to afford more extensive marketing campaigns and more aggressive pricing policies in order to attract financial services providers |
| Our failure to compete effectively in our markets would have a material adverse effect on our business |
| We may have exposure to greater than anticipated tax liabilities |
| We are subject to income taxes and other taxes in a variety of jurisdictions |
| The determination of our provision for income taxes and other tax liabilities requires significant judgment |
| Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made |
| 17 _________________________________________________________________ [65]Table of Contents Our ability to utilize our net operating loss carryforwards in any given period may be limited |
| Our federal net operating loss carryforwards are subject to limitation on how much may be utilized on an annual basis |
| If our net operating loss carryforwards in a period are limited, and we have taxable income which exceeds the available net operating loss carryforwards for that period, we would incur an income tax liability even though net operating loss carryforwards may be available in future years |
| This could negatively impact our future cash flow, financial position and financial results |
| Our quarterly financial results are subject to fluctuations, which could have a material adverse effect on the price of our stock |
| Our quarterly revenues, expenses and operating results may vary from quarter to quarter in the future based upon a number of factors, many of which are not within our control |
| Our revenue model is based largely on recurring revenues derived from actual end-user counts |
| The number of our total end-users is affected by many factors, many of which are beyond our control, including the number of new user registrations, end-user turnover, loss of clients, and general consumer trends |
| Our results of operations for a particular period may be adversely affected if the revenues based on the number of end-users forecasted for that period are less than expected |
| As a result, our operating results may fall below market analysts’ expectations in some future quarters, which could have a material adverse effect on the market price of our stock |
| Our limited ability to protect our proprietary technology and other rights may adversely affect our ability to compete |
| We rely on a combination of patent, copyright, trademark and trade secret laws, as well as licensing agreements, third-party nondisclosure agreements and other contractual provisions and technical measures to protect our intellectual property rights |
| There can be no assurance that these protections will be adequate to prevent our competitors from copying or reverse-engineering our products, or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology |
| To protect our trade secrets and other proprietary information, we require employees, consultants, advisors and collaborators to enter into confidentiality agreements |
| We cannot assure that these agreements will provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information |
| Although we hold registered United States patents covering certain aspects of our technology, we cannot be sure of the level of protection that these patents will provide |
| We may have to resort to litigation to enforce our intellectual property rights, to protect trade secrets or know-how, or to determine their scope, validity or enforceability |
| Enforcing or defending our proprietary technology is expensive, could cause diversion of our resources and may not prove successful |
| Our failure to properly develop, market or sell new products could adversely affect our business |
| The expansion of our business is dependent, in part, on our developing, marketing and selling new financial products to financial services providers and their customers |
| If any new products we develop prove defective or if we fail to properly market these products to financial services providers or sell these products to these providers’ customers, the growth we envision for our company may not be achieved and our revenues and profits may be adversely affected |
| If we are found to infringe the proprietary rights of others, we could be required to redesign our products, pay royalties or enter into license agreements with third parties |
| There can be no assurance that a third party will not assert that our technology violates its intellectual property rights |
| As the number of products offered by our competitors increases and the functionality of these products further overlap, the provision of web-based financial services technology may become increasingly subject to infringement claims |
| Any claims, whether with or without merit, could: • be expensive and time consuming to defend; 18 _________________________________________________________________ [66]Table of Contents • cause us to cease making, licensing or using products that incorporate the challenged intellectual property; • require us to redesign our products, if feasible; • divert management’s attention and resources; and • require us to pay royalties or enter into licensing agreements in order to obtain the right to use necessary technologies |
| There can be no assurance that third parties will not assert infringement claims against us in the future with respect to our current or future products or that any such assertion will not require us to enter into royalty arrangements (if available) or litigation that could be costly to us |
| System failures could hurt our business and we could be liable for some types of failures the extent or amount of which cannot be predicted |
| Like other system operators, our operations are dependent on our ability to protect our system from interruption caused by damage from fire, earthquake, power loss, telecommunications failure, unauthorized entry or other events beyond our control |
| We maintain our own offsite disaster recovery facility for the Chantilly, Virginia data center |
| In the event of major disasters, both our primary and backup locations could be equally impacted |
| We do not currently have sufficient backup facilities to provide full Internet services, if our primary facility is not functioning |
| We could also experience system interruptions due to the failure of our systems to function as intended or the failure of the systems we rely upon to deliver our services such as ATM networks, the Internet, or the systems of financial institutions, processors that integrate with our systems and other networks and systems of third parties |
| We may be liable to our clients for breach of contract for interruptions in service |
| Due to the numerous variables surrounding system disruptions, we cannot predict the extent or amount of any potential liability |
| Security breaches could have a material adverse effect on our business |
| Like other system operators, our computer systems may be vulnerable to computer viruses, hackers, and other disruptive problems caused by unauthorized access to, or improper use of, our systems by third parties or employees |
| We store and transmit confidential financial information in providing our services |
| Although we intend to continue to implement state-of-the-art security measures, computer attacks or disruptions may jeopardize the security of information stored in and transmitted through our computer systems of those of our clients and their end-users |
| Actual or perceived concerns that our systems may be vulnerable to such attacks or disruptions may deter financial services providers and consumers from using our services |
| Additionally, California has adopted, and other states are adopting, laws and regulations requiring that in-state account holders of a financial services provider be notified if their personal confidential information is compromised |
| If the specific account holders whose information has been compromised cannot be identified, all in-state account holders of the provider must be notified |
| Data networks are also vulnerable to attacks, unauthorized access and disruptions |
| For example, in a number of public networks, hackers have bypassed firewalls and misappropriated confidential information |
| It is possible that, despite existing safeguards, an employee could divert end-user funds while these funds are in our control, exposing us to a risk of loss or litigation and possible liability |
| In dealing with numerous end-users, it is possible that some level of fraud or error will occur, which may result in erroneous external payments |
| Losses or liabilities that we incur as a result of any of the foregoing could have a material adverse effect on our business |
| 19 _________________________________________________________________ [67]Table of Contents The potential obsolescence of our technology or the offering of new, more efficient means of conducting account presentation and payments services could negatively impact our business |
| The industry for account presentation and payments services is relatively new and subject to rapid change |
| Our success will depend substantially upon our ability to enhance our existing products and to develop and introduce, on a timely and cost-effective basis, new products and features that meet the changing financial services provider and retail end-user requirements and incorporate technological advancements |
| If we are unable to develop new products and enhanced functionalities or technologies to adapt to these changes or, if we cannot offset a decline in revenues of existing products by sales of new products, our business would suffer |
| We rely on internally developed software and systems as well as third-party products, any of which may contain errors and bugs |
| Our products may contain undetected errors, defects or bugs |
| Although we have not suffered significant harm from any errors or defects to date, we may discover significant errors or defects in the future that we may or may not be able to correct |
| Our products involve integration with products and systems developed by third parties |
| Complex software programs of third parties may contain undetected errors or bugs when they are first introduced or as new versions are released |
| There can be no assurance that errors will not be found in our existing or future products or third-party products upon which our products are dependent, with the possible result of delays in or loss of market acceptance of our products, diversion of our resources, injury to our reputation and increased expenses and/or payment of damages |
| The failure to attract or retain our officers and skilled employees could have a material adverse effect on our business |
| If we fail to attract, assimilate or retain highly qualified managerial and technical personnel, our business could be materially adversely affected |
| Our performance is substantially dependent on the performance of our executive officers and key employees who must be knowledgeable and experienced in both financial services and technology |
| We are also dependent on our ability to retain and motivate high quality personnel, especially management and highly skilled technical teams |
| The loss of the services of any executive officers or key employees could have a material adverse effect on our business |
| Our future success also depends on the continuing ability to identify, hire, train and retain other highly qualified managerial and technical personnel |
| If our managerial and key personnel fail to effectively manage our business, our results of operations and reputation could be harmed |
| We could be sued for contract or product liability claims and lawsuits may disrupt our business, divert management’s attention or have an adverse effect on our financial results |
| Financial services providers use our products and services to provide web-based account presentation, bill payment, and other financial services to their end-users |
| Failures in a client’s system could result in an increase in service and warranty costs or a claim for substantial damages against us |
| There can be no assurance that the limitations of liability set forth in our contracts would be enforceable or would otherwise protect us from liability for damages |
| We maintain general liability insurance coverage, including coverage for errors and omissions in excess of the applicable deductible amount |
| There can be no assurance that this coverage will continue to be available on acceptable terms or will be available in sufficient amounts to cover one or more large claims, or that the insurer will not deny coverage as to any future claim |
| The successful assertion of one or more large claims against us that exceeds available insurance coverage, or the occurrence of changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could have a material adverse effect on our business, financial condition and results of operations |
| Furthermore, litigation, regardless of its outcome, could result in substantial cost to us and divert management’s attention from our operations |
| Any contract liability claim or litigation against us could, therefore, have a material adverse effect on our business, financial condition and results of operations |
| In addition, because many of our projects are business-critical projects for financial services providers, a failure 20 _________________________________________________________________ [68]Table of Contents or inability to meet a client’s expectations could seriously damage our reputation and affect our ability to attract new business |
| Government regulation could interfere with our business |
| The financial services industry is subject to extensive and complex federal and state regulation |
| Financial institutions such as commercial banks, savings and loan associations, savings banks, and credit unions operate under high levels of governmental supervision |
| Our end-users must ensure that our services and related products work within the extensive and evolving regulatory requirements applicable to them |
| We are not licensed by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, the National Credit Union Administration or other federal or state agencies that regulate or supervise depository institutions or other providers of financial services |
| Under the authority of the Bank Service Company Act, the Gramm Leach Bliley Act of 1999 and other federal laws that apply to depository financial institutions, federal depository institution regulators have taken the position that we are subject to examination resulting from the services we provide to the institutions they regulate |
| In order not to compromise our clients’ standing with the regulatory authorities, we have agreed to periodic examinations by these regulators, who have broad supervisory authority to remedy any shortcomings identified in any such examination |
| Federal, state or foreign authorities could also adopt laws, rules or regulations relating to the financial services industry that affect our business, such as requiring us or our end-users to comply with data, record keeping and processing and other requirements |
| It is possible that laws and regulations may be enacted or modified with respect to the Internet, covering issues such as end-user privacy, pricing, content, characteristics, taxation and quality of services and products |
| If enacted or deemed applicable to us, these laws, rules or regulations could be imposed on our activities or our business, thereby rendering our business or operations more costly, burdensome, less efficient or impossible and requiring us to modify our current or future products or services |
| If we cannot achieve and maintain a satisfactory rating from the federal depository institution regulators, we may lose existing clients and have difficulty attracting new clients |
| The examination reports of the federal agencies that examine us are distributed and made available to our depository clients |
| A less than satisfactory rating from any regulatory agency increases the obligation of our clients to monitor our capabilities and performance as a part of their own compliance process |
| It could also cause our clients and prospective clients to lose confidence in our ability to adequately provide services, thereby possibly causing them to seek alternate providers, which would have a corresponding detrimental impact on our revenues and profits |
| We are exposed to increased costs and risks associated with complying with increasing and new regulation of corporate governance and disclosure standards |
| We are spending an increased amount of management time and external resources to comply with changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq National Market rules |
| In particular, Section 404 of the Sarbanes-Oxley Act of 2002 requires management’s annual review and evaluation of our internal control systems, and attestations of the effectiveness of these systems by our independent registered public accounting firm |
| We document and test our internal control systems and procedures and consider improvements that may be necessary in order for us to comply with the requirements of Section 404 |
| This process requires us to hire outside advisory services and results in additional expenses for us |
| In addition, the evaluation and attestation processes required by Section 404 are new, and neither companies nor auditing firms have significant experience in testing or complying with these requirements |
| Although we believe we currently have adequate internal controls over financial reporting, in the event that our chief executive officer, chief financial officer or independent registered public accounting firm determines that our controls over financial reporting are not effective as defined under Section 404 in the future, investor 21 _________________________________________________________________ [69]Table of Contents perceptions of our company may be adversely affected and could cause a decline in the market price of our stock |
| Risks Related to Acquisitions We may face difficulties in integrating acquired businesses |
| We acquired Incurrent in December 2004 and IDS in June 2005 and may acquire additional businesses in the future |
| To achieve the anticipated benefits of these acquisitions, we need, and will need, to successfully integrate the acquired businesses with our operations, to consolidate certain functions and to integrate procedures, personnel, product lines and operations in an efficient and effective manner |
| The integration process may be disruptive to, and may cause an interruption of, or a loss of momentum in, our business as a result of a number of potential obstacles, such as: • the loss of key employees or end-users; • the need to coordinate diverse organizations; • difficulties in integrating administrative and other functions; • the loss of key members of management following the acquisition; and • the diversion of our management’s attention from our day-to-day operations |
| If we are not successful in integrating these businesses or if the integrations takes longer than expected, we could be subject to significant costs and our business could be adversely affected |
| Our acquisitions increase the size of our operations and the risks described in this annual report |
| Our acquisitions increase the size of our operations and may intensify some of the other risks described herein |
| There are also additional risks associated with managing a significantly larger company, including, among other things, the application of company-wide controls and procedures |
| We made our acquisitions and may make future acquisitions, on the basis of available information, and there may be liabilities or obligations that were not or will not be adequately disclosed |
| In connection with any acquisition, we conduct a review of information as provided by the management of that company |
| It may have incurred contractual, financial, regulatory or other obligations and liabilities that may impact us in the future, which are not adequately reflected in unaudited financial and other information upon which we based our evaluation of the acquisition |
| If the unaudited financial and other information on which we have relied in making our offer for that company proves to be materially incorrect or incomplete, it could have a material adverse effect on our consolidated businesses, financial condition and operations |
| Acquired companies give us limited warranties and indemnities in connection with their businesses, which may give rise to claims by us |
| We rely upon limited representations and warranties of the companies we acquire |
| Although we put in place contractual and other legal remedies and limited escrow protection for losses that we may incur as a result of breaches of agreements, representations and warranties pertaining to the acquisition, we cannot assure you that our remedies will adequately cover any losses that we incur |
| The market price of our common stock has been subject to significant fluctuations and may continue to be volatile in response to: • actual or anticipated variations in quarterly operating results; 22 _________________________________________________________________ [70]Table of Contents • announcements of technological innovations; • new products or services offered by us or our competitors; • changes in financial estimates or ratings by securities analysts; • conditions or trends in the Internet and online commerce industries; • changes in the economic performance and/or market valuations of other Internet, online service industries; • announcements by us of significant acquisitions, strategic partnerships, joint ventures or capital commitments; • additions or departures of key personnel; • future equity or debt offerings or acquisitions or our announcements of these transactions; and • other events or factors, many of which are beyond our control |
| The stock market in general and the Nasdaq National Market have experienced extreme price and volume fluctuations and volatility that has particularly affected the market prices of many technology, emerging growth and developmental stage companies |
| Such fluctuations and volatility have often been unrelated or disproportionate to the operating performance of such companies |
| In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against a company |
| Litigation, if instituted, whether or not successful, could result in substantial costs and a diversion of management’s attention and resources, which would have a material adverse effect on our business |
| We have a substantial number of shares of common stock, including shares that may be issued upon exercise of options under our equity compensation plan and issued in connection to certain acquisitions that, if sold, could affect the trading price of our common stock |
| We have approximately 4dtta8 million shares of common stock that may be issued upon the exercise of stock options, and 1dtta9 million shares reserved for the future issuance under our equity compensation plan and our employee stock purchase program |
| We have also issued shares of our common stock in connection with certain acquisitions and may issue additional shares of our common stock in connection to future acquisitions |
| We cannot predict the effect, if any, that future sales of shares of common stock or the availability of shares of common stock for future sale will have on the market price of our common stock |
| Sales of substantial amounts of common stock (including shares issued upon the exercise of stock options), or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock |