| SRA INTERNATIONAL INC Item 1A RISK FACTORS Risks Related To Our Business We depend on contracts with US federal government agencies for substantially all of our revenue, and if our relationships with these agencies were harmed, our business would be threatened |
| Revenue from contracts with US federal government agencies accounted for 99prca of our revenue for all periods presented herein |
| Revenue from contracts with clients in the Department of Defense and the National Guard accounted for 49prca, 53prca, and 59prca, of our revenue for the fiscal years ended June 30, 2006, 2005, and 2004, respectively |
| We believe that federal government contracts will continue to be the source of substantially all of our revenue for the foreseeable future |
| For this reason, any issue that compromises our relationship with agencies of the federal government in general, or within the Department of Defense and the National Guard in particular would cause serious harm to our business |
| Among the key factors in maintaining our relationships with federal government agencies and departments are our performance on individual contracts and delivery orders, the strength of our professional reputation, and the relationships of our senior management with client personnel |
| The relationships and reputation that many members of our senior management team have established and maintain with government personnel contribute to our ability to maintain good client relations and to identify new business opportunities |
| The loss of any member of our senior management could impair our ability to identify and secure new contracts, to maintain good client relations, and otherwise to manage our business |
| Additionally, to the extent that our performance does not meet client expectations, or our reputation with one or more key clients is impaired, our revenue and operating results could be materially harmed |
| We face intense competition from many competitors that have greater resources than we do, which could result in price reductions, reduced profitability, and loss of market share |
| We operate in highly competitive markets and generally encounter intense competition to win contracts |
| If we are unable to successfully compete for new business or win recompetitions of existing business, our revenue growth and operating margins may decline |
| Many of our competitors are larger and have greater financial, technical, marketing, and public relations resources, larger client bases, and greater brand or name recognition than we do |
| Larger competitors include federal systems integrators such as Computer Sciences Corporation and Science Applications International Corporation, divisions of large defense contractors such as General Dynamics Corporation, Lockheed Martin Corporation, and Northrop Grumman Corporation, and consulting firms such as Accenture Ltd |
| and BearingPoint, Inc |
| Our larger competitors may be able to compete more effectively for very large-scale government contracts |
| Our larger competitors also may be able to provide clients with different or greater capabilities or benefits than we can provide in areas such as technical qualifications, past performance on large-scale contracts, geographic presence, the ability to provide a broader range of services without creating conflicts of interest or intra-organizational conflicts of interest, price, and the availability of key professional personnel |
| Our competitors also have established or may establish relationships among themselves or with third parties, including through mergers and acquisitions, to increase their ability to address client needs |
| Accordingly, it is possible that new competitors or alliances among competitors may emerge |
| We derive significant revenue from contracts awarded through a competitive bidding process, which can impose substantial costs upon us, and we will lose revenue if we fail to compete effectively |
| We derive significant revenue from federal government contracts that are awarded through a competitive bidding process |
| We expect that most of the government business we seek in the foreseeable future will be awarded through competitive bidding |
| Competitive bidding imposes substantial costs and presents a number of risks, including: • the need to bid on engagements in advance of knowing the complete design or full requirements, which may result in unforeseen difficulties in executing the engagement and cost overruns; 20 ______________________________________________________________________ [44]Table of Contents • the substantial cost and managerial time and effort that we spend to prepare bids and proposals for contracts that may not be awarded to us; • the need to accurately estimate the resources and costs that will be required to service any contract we are awarded; • the possibility that difficult market conditions will cause our competitors to strive for growth by reducing their bid pricing and compel us to choose between bidding at unprofitable levels or losing contracts and foregoing revenue; • the expense and delay that may arise if our competitors protest or challenge contract awards made to us pursuant to competitive bidding, and the risk that any such protest or challenge could result in the resubmission of bids on modified specifications, or in termination, reduction, or modification of the awarded contract; and • the opportunity cost of not bidding on and winning other contracts we might otherwise pursue |
| To the extent we engage in competitive bidding and are unable to win particular contracts, we not only incur substantial costs in the bidding process that would negatively affect our operating results, but we may be precluded from operating in the market for services that are provided under those contracts for a number of years |
| Even if we win a particular contract through competitive bidding, our profit margins may be depressed as a result of the costs incurred through the bidding process |
| Loss of our General Services Administration, or GSA, schedule contracts or our position as a prime contractor on one or more of our government-wide acquisition contracts, or GWACs, or our other multiple-award contracts would impair our ability to win new business |
| We believe that one of the key elements of our success is our position as the holder of five GSA schedule contracts and as a prime contractor under three GWACs and more than 35 agency-specific ID/IQ contracts |
| For the fiscal years ended June 30, 2006, 2005, and 2004, revenue from GSA schedule contracts, GWACs, and other ID/IQ contracts accounted for approximately 76prca, 77prca, and 83prca, respectively, of our revenue from federal government clients |
| If we were to lose our position on one or more of these contracts, we could lose revenue and our operating results could suffer |
| The GSA intends to combine two of its large GWACs, Millennia and ANSWER, and other specialized contracts under a new Alliant contract to be competitively awarded |
| If we do not win a position as a prime contractor on the new Alliant contract, we could lose revenue and our operating results could suffer |
| The Department of Defense issued guidance providing that procurements of services that are not performance-based or that are to be procured using a contract vehicle outside of the Department of Defense must be approved in advance |
| This could result in the Department of Defense limiting its future use of GWACs and GSA schedule contracts |
| Initiatives taken by the Department of Defense or other government agencies and departments, or the impact of the ongoing reorganization by the GSA, could cause services we provide on existing contracts to migrate to contract vehicles on which we are not a prime contractor |
| Should this occur, our ability to compete for business from these organizations in the future may be harmed |
| Orders under GSA schedule contracts, GWACs, and other ID/IQ contracts typically have a one- or two-year initial term with multiple options that may be exercised by our government clients to extend the contract for successive periods of one or more years |
| We can provide no assurance that our clients will exercise these options |
| If subcontractors on our prime contracts are able to secure positions as prime contractors, we may lose revenue |
| For each of the past several years we have received substantial revenue from government clients relating to work performed by other information technology providers acting as subcontractors to us |
| In some cases, 21 ______________________________________________________________________ [45]Table of Contents companies that have not held GSA schedule contracts or secured positions as prime contractors on GWACs have approached us in our capacity as a prime contractor, seeking to perform services as our subcontractor for a government client |
| Some of these providers that are currently acting as subcontractors to us may in the future secure positions as prime contractors |
| If one or more of our current subcontractors are awarded prime contractor status in the future, it could reduce or eliminate our revenue for the work they were performing as subcontractors to us |
| Revenue derived from work performed by our subcontractors represented approximately 30prca, 32prca, and 30prca of our revenue for the fiscal years ended June 30, 2006, 2005, and 2004, respectively |
| If our subcontractors fail to perform their contractual obligations, our performance and reputation as a prime contractor and our ability to obtain future business could suffer |
| As a prime contractor, we often rely significantly upon other companies as subcontractors to perform work we are obligated to deliver to our clients |
| Revenue derived from work performed by our subcontractors represented approximately 30prca, 32prca, and 30prca of our revenue for the fiscal years ended June 30, 2006, 2005, and 2004, respectively |
| A failure by one or more of our subcontractors to satisfactorily perform the agreed-upon services on a timely basis may compromise our ability to perform our obligations as a prime contractor |
| In some cases, we have limited involvement in the work performed by the subcontractor and may have exposure as a result of problems caused by the subcontractor |
| In extreme cases, performance deficiencies on the part of our subcontractors could result in a government client terminating our contract for default |
| A default termination could expose us to liability for the agency’s costs of re-procurement, damage our reputation, and hurt our ability to compete for future contracts |
| Additionally, we may have disputes with our subcontractors that could impair our ability to execute our contracts as required |
| Our quarterly operating results may fluctuate significantly as a result of factors outside of our control, which could cause the market price of our class A common stock to decline |
| Our revenue and operating results could vary significantly from quarter to quarter |
| In addition, we cannot predict with certainty our future revenue or results of operations |
| As a consequence, our operating results may fall below the expectations of securities analysts and investors, which could cause the price of our class A common stock to decline |
| Factors that may affect our operating results include: • fluctuations in revenue earned on contracts; • commencement, completion, or termination of contracts during any particular quarter; • variable purchasing patterns under GSA schedule contracts, GWACs, and agency-specific indefinite delivery/indefinite quantity contracts; • providing services under a share-in-savings or performance-based contract; • additions and departures of key personnel; • strategic decisions by us or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures, strategic investments, or changes in business strategy; • timing of significant bid and proposal costs; • contract mix, the extent of use of subcontractors, and the level of third-party hardware and software purchases for customers; • changes in presidential administrations and senior federal government officials or their priorities that affect the timing of technology procurement; • changes in policy or budgetary measures that adversely affect government contracts in general; • interruption by events beyond our control such as earthquakes, power losses, telecommunications failures, hurricanes, and incidents of terrorism; and • the seasonality of our business |
| 22 ______________________________________________________________________ [46]Table of Contents Reductions in revenue in a particular quarter could lead to lower profitability in that quarter because a relatively large amount of our expenses are fixed in the short-term |
| We may incur significant operating expenses during the start-up and early stages of large contracts and may not receive corresponding payments or revenue in that same quarter |
| We may also incur significant or unanticipated expenses when contracts expire, when they are terminated, or when they are not renewed |
| In addition, payments due to us from government agencies may be delayed due to billing cycles or as a result of failures of governmental budgets to gain Congressional and administration approval in a timely manner |
| If we fail to attract and retain skilled employees, we might not be able to staff recently awarded engagements and sustain our profit margins and revenue growth |
| We must continue to hire significant numbers of highly qualified individuals who have advanced information technology and technical services skills and who work well with our clients in a government environment |
| In some cases, they are required to have security clearances issued by the Department of Defense or other government agencies |
| These employees are in great demand and are likely to remain a limited resource for the foreseeable future |
| If we are unable to recruit and retain a sufficient number of these employees, our ability to staff recently awarded engagements and to maintain and grow our business could be limited |
| We are operating in a tight labor market and, if it continues to tighten, we could be required to engage larger numbers of subcontractor personnel, which could cause our profit margins to suffer |
| In addition, some of our contracts contain provisions requiring us to commit to staff an engagement with personnel the client considers key to our successful performance under the contract |
| In the event we are unable to provide these key personnel or acceptable substitutions, the client may terminate the contract, and we may not be able to recover our costs |
| We may lose revenue and our cash flow and profitability could be negatively affected if expenditures are incurred prior to final receipt of a contract or contract funding modification |
| We provide professional services and sometimes procure materials on behalf of our government clients under various contract arrangements |
| From time to time, in order to ensure that we satisfy our clients’ delivery requirements and schedules, we may elect to initiate procurements or provide services in advance of receiving formal contractual authorization from the government client or a prime contractor |
| If our government or prime contractor requirements should change or the government directs the anticipated procurement to a contractor other than us, or if the materials become obsolete or require modification before we are under contract for the procurement, our investment might be at risk |
| If we do not receive the required funding, our cost of services incurred in excess of contractual funding may not be recoverable |
| This could reduce anticipated revenue or result in a loss, negatively affecting our cash flow and profitability |
| We may lose money on some contracts if we underestimate the resources we need to perform under the contract |
| We provide services to the federal government under three types of contracts: cost-plus-fee, time-and-materials, and fixed-price |
| For the year ended June 30, 2006, we derived 45prca, 40prca, and 15prca of our revenue from cost-plus-fee, time-and-materials, and fixed-price contracts, respectively |
| Each of these types of contracts, to differing degrees, involves the risk that we could underestimate our cost of fulfilling the contract, which may reduce the profit we earn or lead to a financial loss on the contract |
| • Under cost-plus-fee contracts, which are subject to a ceiling amount, we are reimbursed for allowable costs and paid a fee, which may be fixed or performance-based |
| However, if our costs exceed the ceiling or are not allowable under the terms of the contract or applicable regulations, we may not be able to recover those costs |
| • Under time-and-materials contracts, we are reimbursed for labor at negotiated hourly billing rates along with the cost of certain expenses, and we assume the risk that our costs of performance may exceed the negotiated hourly rates |
| 23 ______________________________________________________________________ [47]Table of Contents • Under fixed-price contracts, we perform specific tasks for a fixed price |
| Compared to cost-plus-fee contracts and time-and-materials contracts, fixed-price contracts involve greater financial risk due to the potential for cost overruns |
| For all three contract types, we bear varying degrees of risk associated with the assumptions we use to formulate our pricing for the work |
| To the extent our working assumptions prove inaccurate, we may lose money on the contract, which would adversely affect our operating results |
| We may lose money or incur financial penalties if we agree to provide services under a performance-based contract arrangement |
| Under certain performance-based contract arrangements, we are paid only to the extent our customer actually realizes savings or achieves some other performance-based improvements that result from our services |
| In addition, we may also incur certain penalties |
| Performance-based contracts could impose substantial costs and risks, including: • the need to accurately understand and estimate in advance the improved performance that might result from our services; • the lack of experience both we and our primary customers have in using this type of contract arrangement; and • the requirement that we incur significant expenses with no guarantee of recovering these expenses or realizing a profit in the future |
| Even if we successfully execute a performance-based contract, our interim operating results and cash flows may be negatively affected by the fact that we may be required to incur significant up-front expenses prior to realizing any related revenue |
| Contracts with state and local governments, other governments, international entities, or other organizations with special standing, could impose substantial additional liability and costs upon us |
| As organizations seek to enhance their security, particularly state and local governments, other governments, international entities, and other organizations with special standing, such as the World Bank, we have the opportunity to expand our services beyond our core federal government client base |
| Contracting with such entities involves additional risks that may result in additional costs to us, including: • the additional costs associated with evaluating, qualifying, and negotiating such opportunities; • a requirement to understand and comply with the specific procurement laws and/or regulations of each individual state, locality, other government, international entity, or other party with special standing; • the contractual acceptance of liability provisions that impose, for example, liquidated damages or other monetary damages in excess of the amount of services we provide, and in some cases are unlimited; • the unavailability of certain protections that would typically be available under federal or common law; and • an increased risk of additional costs associated with dispute resolution |
| We may not be successful in identifying acquisition candidates and, if we undertake acquisitions, they could be expensive, increase our costs or liabilities, or disrupt our business |
| Additionally, if we are unable to successfully integrate companies we acquire, our revenue and operating results may be impaired |
| One of our strategies is to augment our organic growth through acquisitions |
| We have completed seven acquisitions of complementary companies that provide services in one of our three target markets |
| We may not be able to identify suitable acquisition candidates at prices that we consider appropriate or to finance acquisitions 24 ______________________________________________________________________ [48]Table of Contents on terms that are satisfactory to us |
| Acquisitions of businesses or other material operations may require additional debt or equity financing, resulting in leverage or dilution of ownership |
| Additionally, negotiations of potential acquisitions and the integration of acquired business operations could disrupt our business by diverting management attention away from day-to-day operations |
| We also may not realize cost efficiencies or synergies that we anticipated when selecting our acquisition candidates |
| Acquired companies may have liabilities or adverse operating issues that we fail to discover through due diligence |
| Any costs, liabilities, or disruptions associated with future acquisitions could harm our operating results |
| In addition, following the integration of acquired companies, we may experience increased attrition, including but not limited to key employees of acquired companies, which could reduce our future revenue |
| Unfavorable government audit results could force us to adjust previously reported operating results and could subject us to a variety of penalties and sanctions |
| The federal government audits and reviews our performance on contracts, pricing practices, cost structure, and compliance with applicable laws, regulations, and standards |
| Like most large government contractors, our contracts are audited and reviewed on a continual basis by federal agencies, including the Defense Contract Management Agency, or DCMA and the Defense Contract Audit Agency, or DCAA An audit of our work, including an audit of work performed by companies we have acquired or may acquire or subcontractors we have hired or may hire, could result in a substantial adjustment to our previously reported operating results |
| DCAA issued audit guidance suggesting that a Federal Acquisition Regulation billing clause prohibits billing subcontractor or third-party consultant hours using the prime contract hourly rates under time-and-material contracts, stating that these hours must be billed at cost |
| This is contrary to previously issued instructions from many customers, and contrary to industry practice |
| If the DCAA were to prevail with this new interpretation, cash we have already collected may need to be refunded, which could materially reduce profits and revenue on time-and-material orders |
| In addition, non-audit reviews by the government may still be conducted on all our government contracts |
| If a government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines, and suspension or debarment from doing business with US federal government agencies |
| In addition, we could suffer serious harm to our reputation if allegations of impropriety were made against us, whether or not true |
| If we were suspended or debarred from contracting with the federal government generally, or any specific agency, if our reputation or relationship with government agencies were impaired, or if the government otherwise ceased doing business with us or significantly decreased the amount of business it does with us, our revenue and operating results would be materially harmed |
| If we experience systems, service, or product failure, our reputation could be harmed and our clients could assert claims against us for damages or refunds |
| We create, implement, and maintain information technology solutions, as well as sell products, that are often critical to our clients’ operations, including operations in war-zones and other hazardous environments |
| We have experienced and may in the future experience some systems and service failures, schedule or delivery delays, and other problems in connection with our work |
| If our solutions, services, products, including third party products we may resell to our clients, or other applications have significant defects or errors, are subject to delivery delays, or fail to meet our clients’ expectations, we may: • lose revenue due to adverse client reaction; • be required to provide additional services to a client at no charge; 25 ______________________________________________________________________ [49]Table of Contents • receive negative publicity, which could damage our reputation and adversely affect our ability to attract or retain clients; or • suffer claims for substantial damages against us |
| In addition to any costs resulting from product or service warranties, contract performance, or required corrective action, these failures may result in increased costs or loss of revenue if clients postpone subsequently scheduled work or cancel or fail to renew contracts |
| While many of our contracts limit our liability for consequential damages that may arise from negligence in rendering services to our clients, these contractual provisions may not be legally sufficient to protect us if we are sued |
| In addition, our errors and omissions and product liability insurance coverage may not continue to be available on reasonable terms or in sufficient amounts to cover one or more large claims, or the insurer may disclaim coverage as to some types of future claims |
| As we continue to grow and expand our business into new areas, our insurance coverage may not be adequate |
| The successful assertion of any large claim against us could seriously harm our business |
| Even if not successful, these claims could result in significant legal and other costs, may be a distraction to our management, and may harm our reputation |
| Our business commitments require our employees to travel to potentially dangerous places, which may result in injury to our employees |
| Our business involves providing services that require our employees to operate in various countries around the world, including Iraq |
| These countries may be experiencing political upheaval or unrest, and in some cases war or terrorism |
| Senior level employees or executives may, on occasion, be part of the teams deployed to provide services in these countries |
| As a result, it is possible that certain of our employees or executives will suffer injury or bodily harm in the course of these deployments |
| It is also possible that we will encounter unexpected costs in connection with additional risks inherent with sending our employees to dangerous locations, such as increased insurance costs, as well as the repatriation of our employees or executives for reasons beyond our control |
| Our employees may engage in misconduct or other improper activities, which could harm our business |
| We are exposed to the risk that employee fraud or other misconduct could occur |
| Misconduct by employees could include intentional failures to comply with federal government procurement regulations, engaging in unauthorized activities, seeking reimbursement for improper expenses or falsifying time records |
| Employee misconduct could also involve the improper use of our clients’ sensitive or classified information, which could result in regulatory sanctions against us and serious harm to our reputation |
| It is not always possible to deter employee misconduct, and the precautions we take to prevent and detect this activity may not be effective in controlling unknown or unmanaged risks or losses, which could harm our business |
| Our failure to obtain and maintain necessary security clearances may limit our ability to perform classified work for government clients, which could cause us to lose business |
| Some government contracts require us to maintain facility security clearances and require some of our employees to maintain individual security clearances |
| We have seen a recent increase in the number of clients requiring special security clearances and the types of clearances required |
| If our employees lose or are unable to timely obtain security clearances, or we lose a facility clearance, the government client can terminate the contract or decide not to renew it upon its expiration |
| As a result, to the extent we cannot obtain the required security clearances for our employees working on a particular contract, or we fail to obtain them on a timely basis, we may not derive the revenue anticipated from the contract, which could harm our operating results |
| Security breaches in sensitive government systems could result in loss of clients and negative publicity |
| Many of the systems we develop, install, and maintain involve managing and protecting information used in intelligence, national security, and other sensitive or classified government functions |
| A security breach in one of 26 ______________________________________________________________________ [50]Table of Contents these systems could cause serious harm to our business, damage our reputation, and prevent us from being eligible for further work on sensitive or classified systems for federal government clients |
| We could incur losses from such a security breach that could exceed the policy limits under our insurance |
| Damage to our reputation or limitations on our eligibility for additional work resulting from a security breach in one of our systems could materially reduce our revenue |
| We depend on our intellectual property and our failure to protect it could enable competitors to market products and services with similar features that may reduce demand for our products |
| Our success depends in part upon the internally developed technology, proprietary processes, and other intellectual property that we utilize to provide our services and incorporate in our products |
| If we are unable to protect our intellectual property, our competitors could market services or products similar to our services and products, which could reduce demand for our offerings |
| Federal government clients typically retain a perpetual, world-wide, royalty-free right to use the intellectual property we develop for them in any manner they deem appropriate, including providing it to our competitors in connection with their performance of other federal government contracts |
| We typically seek governmental authorization to re-use intellectual property developed for the federal government or to secure export authorization |
| Federal government clients typically grant contractors the right to commercialize software developed with federal funding |
| However, if we were to improperly use intellectual property even partially funded by the federal government, the federal government could seek damages or royalties from us, sanction us, or prevent us from working on future government contracts |
| We may be unable to prevent unauthorized parties from attempting to copy or otherwise obtain and use our technology |
| Policing unauthorized use of our technology is difficult, and we may not be able to prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our intellectual property as fully as those in the United States |
| Others, including our employees, may compromise the trade secrets and other intellectual property that we own |
| Although we require our employees to execute non-disclosure and intellectual property assignment agreements and comply with related policies and procedures, these agreements may not be legally or practically sufficient to protect our rights |
| Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets, and to determine the validity and scope of the proprietary rights of others |
| Any litigation could result in substantial costs and diversion of resources, with no assurance of success |
| We may be harmed by intellectual property infringement claims |
| We may become subject to claims from our employees or third parties who assert that software and other forms of intellectual property that we use in delivering services and business solutions to our clients infringe upon intellectual property rights of such employees or third parties |
| Our employees develop much of the software and other forms of intellectual property that we use to provide our services and business solutions to our clients, but we also license technology from other vendors |
| If our vendors, our employees, or third parties assert claims that we or our clients are infringing on their intellectual property, we could incur substantial costs to defend those claims |
| In addition, if any of these infringement claims are ultimately successful, we could be required to: • cease selling or using products or services that incorporate the challenged software or technology; • obtain a license or additional licenses from our vendors or other third parties; or • redesign our products and services that rely on the challenged software or technology |
| Activation of military and National Guard reserves could significantly reduce our revenue and profits |
| Activation of military reserves, in connection with international conflicts or otherwise, could result in some clients and client contracting staff being activated into the military services |
| This could delay contract awards that might be in the evaluation or award process, which could in turn reduce our revenue until such time as our clients are able to complete the evaluation and award process, or could even result in the loss of the potential contract award |
| 27 ______________________________________________________________________ [51]Table of Contents As of June 30, 2006 we had approximately 200 employees who serve as reserves for a branch of the military or the National Guard |
| In the event of a significant call-up we will pay these employees the differential between their military pay and their salary for up to six months |
| Our standard practice in the absence of a significant call-up is to provide for up to two weeks of differential pay for military leave |
| Additionally, our fringe benefit expenses would be increased by any differential payments, which could reduce our profits |
| Risks Related To Our Industry A reduction in the US defense budget could result in a substantial decrease in our revenue |
| Revenue from contracts with clients in the Department of Defense and the National Guard accounted for 49prca, 53prca, and 59prca of our revenue for the fiscal years ended June 30, 2006, 2005, and 2004, respectively |
| The growing federal deficit, among other factors, could result in a decline in overall US military expenditures, or in the portion of those expenditures allocated to information technology services and solutions, which could decrease our revenue and profitability |
| The reduction in the US defense budget during the early 1990s caused some defense-related government contractors to experience decreased sales, reduced operating margins and, in some cases, net losses |
| Defense spending levels may not continue at present levels, and future levels of expenditures and authorizations for existing programs may decline, remain constant, or shift to agencies or programs in areas where we do not currently have contracts |
| A significant decline in defense expenditures, or a shift in expenditures away from agencies or programs that we support, could cause a material decline in our revenue |
| A reduction in US civil government agency budgets, including a reduction caused by the diversion of funding to support the war against terrorism, the reconstruction of Iraq, or natural disaster recovery, could result in a substantial decrease in our revenue |
| Revenue from contracts with civil agency clients accounted for 50prca, 46prca, and 40prca of our revenue for the fiscal years ended June 30, 2006, 2005, and 2004, respectively |
| We expect civil agency clients will continue to represent a substantial portion of our future revenue |
| A decline in expenditures by civil agencies, or in the portion of those expenditures allocated to information technology services and solutions, could cause a material decrease in our revenue and profitability |
| In particular, a shift of funds away from civil agencies to pay for programs within other agencies, for example the Department of Defense, to reduce federal budget deficits, or to fund tax reductions, could cause a material decline in our revenue |
| In particular, it is possible that funding for civil agencies may be diverted to support the ongoing war against terrorism, the reconstruction of Iraq, natural disaster recovery, or other international conflicts |
| Changes in the spending policies or budget priorities of the federal government could cause us to lose revenue |
| We derived 99prca of our revenue for all periods presented herein, from contracts with federal government agencies |
| We believe that contracts with federal government agencies and departments will continue to be the primary source of our revenue for the foreseeable future |
| Accordingly, changes in federal government fiscal or spending policies could directly affect our financial performance |
| Among the factors that could harm our federal government contracting business are: • the curtailment of the federal government’s use of technology services firms; • a significant decline in spending by the federal government in general, or by specific departments or agencies in particular; • a reduction in spending or shift of expenditures from existing programs to pay for an international conflict or related reconstruction efforts; • a failure of Congress to pass adequate supplemental appropriations to pay for an international conflict, or to pay for the cost of related reconstruction efforts; 28 ______________________________________________________________________ [52]Table of Contents • reductions in federal government programs or requirements; • the adoption of new laws or regulations that affect companies that provide services to the federal government; • delays in the payment of our invoices by government payment offices; • new legislation, procurement regulations, or union pressure that cause federal agencies to adopt restrictive procurement practices regarding the use of outside information technology providers; • changes in policy and goals by the government providing set aside funds to small businesses, disadvantaged businesses, and other socio-economic requirements in the allocation of contracts; and • general economic and political conditions |
| These or other factors could cause federal government agencies and departments to reduce their purchases under contracts, to exercise their right to terminate contracts, or not to exercise options to renew contracts, any of which could cause us to lose revenue |
| We have substantial contracts in place with many federal departments and agencies, and our continued performance under these contracts, or award of additional contracts from these agencies, could be materially harmed by federal government spending reductions or budget cutbacks at these departments or agencies |
| The failure by Congress to approve budgets on a timely basis for the federal agencies we support could delay or reduce spending and cause us to lose revenue |
| On an annual basis, Congress must approve budgets that govern spending by each of the federal agencies we support |
| When Congress is unable to agree on budget priorities and is unable to pass the annual budget on a timely basis, Congress typically enacts a continuing resolution |
| A continuing resolution allows government agencies to operate at spending levels approved in the previous budget cycle |
| When government agencies must operate under a continuing resolution, it may delay funding we expect to receive from clients on work we are already performing and will likely result in any new initiatives being delayed, and potentially cancelled |
| The Office of Management and Budget process for ensuring government agencies properly support capital planning initiatives, including information technology investments, could reduce or delay federal information technology spending and cause us to lose revenue |
| The Office of Management and Budget, or OMB, supervises spending by federal agencies, including enforcement of the Government Performance Results Act |
| This Act requires, among other things, that federal agencies make an adequate business justification to support capital planning initiatives, including all information technology investments |
| The factors considered by the OMB include, among others, whether the proposed information technology investment is expected to achieve an appropriate return on investment, whether related processes are contemporaneously reviewed, whether inter-operability with existing systems and the capacity for these systems to share data across government has been considered, and whether existing off-the-shelf products are being utilized to the extent possible |
| If our clients do not adequately justify proposed information technology investments to the OMB, the OMB may refuse funding for their new or continuing information technology investments, and we may lose revenue as a result |
| Federal government contracts contain provisions giving government clients a variety of rights that are unfavorable to us, including the ability to terminate a contract at any time for convenience |
| Federal government contracts contain provisions and are subject to laws and regulations that provide government clients with rights and remedies not typically found in commercial contracts |
| These rights and remedies allow government clients, among other things, to: • terminate existing contracts, with short notice, for convenience, as well as for default; • reduce or modify contracts or subcontracts; • terminate our facility security clearances and thereby prevent us from receiving classified contracts; 29 ______________________________________________________________________ [53]Table of Contents • cancel multi-year contracts and related orders if funds for contract performance for any subsequent year become unavailable; • decline to exercise an option to renew a multi-year contract; • claim rights in products, systems, and technology produced by us; • prohibit future procurement awards with a particular agency due to a finding of organizational conflict of interest based upon prior related work performed for the agency that would give a contractor an unfair advantage over competing contractors; • subject the award of GSA schedule contracts, GWACs, and other ID/IQ contracts to protest by competitors, which may require the contracting federal agency or department to suspend our performance pending the outcome of the protest and may also result in a requirement to resubmit bids for the contract or in the termination, reduction, or modification of the awarded contract; and • suspend or debar us from doing business with the federal government or with a particular governmental agency |
| If a government client terminates one of our contracts for convenience, we may recover only our incurred or committed costs, settlement expenses, and profit on work completed prior to the termination |
| If a federal government client were to unexpectedly terminate, cancel, or decline to exercise an option to renew with respect to one or more of our significant contracts or suspend or debar us from doing business with government agencies, our revenue and operating results would be materially harmed |
| Some government procurement offices have recently issued requests for proposals, or RFPs, stating that fees will not be permitted on subcontractors that are used on time-and-material orders issued under those contracts |
| If this prohibition is included in these future contract awards, and we subcontract a significant component of time and material orders issued under these contracts, this could reduce our profitability on future work |
| Our failure to comply with complex procurement laws and regulations could cause us to lose business and subject us to a variety of penalties |
| We must comply with laws and regulations relating to the formation, administration, and performance of federal government contracts, which affect how we do business with our government clients and may impose added costs on our business |
| Among the most significant regulations are: • the Federal Acquisition Regulation, and agency regulations analogous or supplemental to the Federal Acquisition Regulation, which comprehensively regulate the formation, administration, and performance of government contracts, including provisions relating to the avoidance of conflicts of interest and intra-organizational conflicts of interest; • the Truth in Negotiations Act, which requires certification and disclosure of all cost and pricing data in connection with some contract negotiations; • the Procurement Integrity Act, which requires evaluation of ethical conflicts surrounding procurement activity and establishing certain employment restrictions for individuals who participate in the procurement process; • the Cost Accounting Standards, which impose accounting requirements that govern our right to reimbursement under some cost-based government contracts; • laws, regulations, and executive orders restricting the use and dissemination of information classified for national security purposes and the exportation of specified products, technologies, and technical data; • laws surrounding lobbying activities a corporation may engage in and operation of a Political Action Committee established to support corporate interests; and • compliance with antitrust laws |
| 30 ______________________________________________________________________ [54]Table of Contents If a government review or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, harm to our reputation, suspension of payments, fines, and suspension or debarment from doing business with federal government agencies |
| The government may in the future reform its procurement practices or adopt new contracting rules and regulations, including cost accounting standards, that could be costly to satisfy or that could impair our ability to obtain new contracts |
| Any failure to comply with applicable laws and regulations could result in contract termination, price or fee reductions, or suspension or debarment from contracting with the federal government, each of which could lead to a material reduction in our revenue |
| Other Risks Related To Our Stock A public market for our class A common stock has existed only for a limited period of time, and our stock price is volatile and could decline |
| Prior to May 24, 2002, there was no public market for any class of our common stock |
| An active trading market for our class A common stock may not be sustained, which could affect your ability to sell your shares and could depress the market price of your shares |
| The stock market in general, and the market for technology-related stocks in particular, has been highly volatile |
| As a result, the market price of our class A common stock is likely to be similarly volatile, and holders of our class A common stock may experience a decrease in the value of their stock, including decreases unrelated to our operating performance or prospects |
| The price of our class A common stock could be subject to wide fluctuations in response to a number of factors, including those listed in this “Risk Factors” section and others such as: • our operating performance and the performance of other similar companies or companies deemed to be similar; • actual or anticipated differences in our quarterly operating results; • changes in our revenue or earnings estimates or recommendations by securities analysts; • publication of research reports about us or our industry by securities analysts; • additions and departures of key personnel; • contract mix and the extent of use of subcontractors; • strategic decisions by us or our competitors, such as acquisitions, consolidations, divestments, spin-offs, joint ventures, strategic investments, or changes in business strategy; • federal government spending levels, both generally and by our particular government clients; • the passage of legislation or other regulatory developments that adversely affect us or our industry; • the failure by Congress to approve budgets on a timely basis; • speculation in the press or investment community; • changes in the government information technology services industry; • changes in accounting principles; • terrorist acts; • general market conditions, including economic factors unrelated to our performance; and • military action related to international conflicts, wars, or otherwise |
| In the past, securities class action litigation has often been instituted against companies following periods of volatility in their stock price |
| This type of litigation could result in substantial costs and divert our management’s attention and resources |
| 31 ______________________________________________________________________ [55]Table of Contents Our chairman, whose interests may not be aligned with yours, controls our company, which could result in actions of which you or other stockholders do not approve |
| As of August 18, 2006, Ernst Volgenau, our chairman, beneficially owned 274cmam316 shares of class A common stock and 12cmam050cmam736 shares of class B common stock, which represented approximately 64dtta9prca of the combined voting power of our outstanding common stock |
| As of August 18, 2006, our executive officers and directors as a group beneficially owned an aggregate of 2cmam551cmam220 shares of class A common stock and 14cmam459cmam828 shares of class B common stock, which represented approximately 78dtta4prca of the combined voting power of our outstanding common stock |
| As a result, these individuals acting together, or Dr |
| Volgenau acting alone, will be able to control the outcome of all matters that our stockholders vote upon, including the election of directors, amendments to our certificate of incorporation, and mergers or other business combinations |
| In addition, upon the death of Dr |
| Volgenau and the conversion of his class B common stock into class A common stock, William K Brehm, a current director and the former chairman of our board of directors, if he survives Dr |
| Volgenau, would beneficially own all of the outstanding class B common stock and could exercise significant influence over corporate matters requiring stockholder approval |
| This concentration of ownership and voting power may also have the effect of delaying or preventing a change in control of our company and could prevent stockholders from receiving a premium over the market price if a change in control is proposed |
| Provisions of our charter documents and Delaware law may inhibit potential acquisition bids that you and other stockholders may consider favorable, and the market price of our class A common stock may be lower as a result |
| There are provisions in our certificate of incorporation and by-laws that make it more difficult for a third party to acquire, or attempt to acquire, control of our company, even if a change in control was considered favorable by you and other stockholders |
| For example, our board of directors has the authority to issue up to 5cmam000cmam000 shares of preferred stock |
| The board of directors can fix the price, rights, preferences, privileges, and restrictions of the preferred stock without any further vote or action by our stockholders |
| The issuance of shares of preferred stock may delay or prevent a change in control transaction |
| As a result, the market price of our class A common stock and the voting and other rights of our stockholders may be adversely affected |
| This issuance of shares of preferred stock may result in the loss of voting control to other stockholders |
| Our charter documents contain other provisions that could have an anti-takeover effect, including: • the high-vote nature of our class B common stock; • only one of the three classes of directors is elected each year; • stockholders have limited ability to remove directors without cause; • stockholders cannot take actions by written consent; • stockholders cannot call a special meeting of stockholders; and • stockholders must give advance notice to nominate directors or submit proposals for consideration at stockholder meetings |
| In addition, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which regulates corporate acquisitions |
| These provisions could discourage potential acquisition proposals and could delay or prevent a change in control transaction |
| They could also have the effect of discouraging others from making tender offers for our class A common stock |
| These provisions may also prevent changes in our management |