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EDGEWATER TECHNOLOGY, INC. FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2004 INDEX

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

Commission file number: 0-20971

Edgewater Technology, Inc.
(Exact Name of Registrant as Specified in its Charter)

Registrant's telephone number including area code: (781) 246-3343

        Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes o    No ý

        The number of shares of Common Stock of the Registrant, par value $.01 per share, outstanding at October 27, 2004 was 11,207,899.

EDGEWATER TECHNOLOGY, INC.

FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2004

INDEX

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EDGEWATER TECHNOLOGY, INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Per Share Data)

¹

Includes related party amounts of $1,633 and $1,853 at September 30, 2004 and December 31, 2003, respectively.

See notes to the unaudited condensed consolidated financial statements.

3

EDGEWATER TECHNOLOGY, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Data)

¹

Includes related party amounts of $2,390 and $2,854 for the three months ended September 30, 2004 and 2003, respectively, and $7,379 and $8,865 for the nine months ended September 30, 2004 and 2003, respectively.

See notes to the unaudited condensed consolidated financial statements.

4

EDGEWATER TECHNOLOGY, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

See notes to the unaudited condensed consolidated financial statements.

5

EDGEWATER TECHNOLOGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.    ORGANIZATION:

        Edgewater Technology, Inc. ("Edgewater," "Edgewater Technology," "the Company," "our Company," "we," "us" or "our") is an award-winning strategic consulting firm that specializes in combining strategic consulting, technical knowledge, and industry domain expertise to develop technology solutions that assist primarily middle-market companies and divisions of Global 2000 companies to align their processes with their purposes. This approach not only promotes increased efficiency, but also supports increased effectiveness. By targeting strategic, mission critical applications, our consultants collaborate with customers to translate business goals into technical strategies. Headquartered in Wakefield, Massachusetts, our Company employs approximately 134 technical consulting professionals throughout our network of strategically positioned solutions centers.

        Our Company was incorporated in the State of Delaware in 1996. Our Company's business operations are conducted primarily through two subsidiaries: Edgewater Technology (Delaware), Inc., a Delaware corporation that was incorporated in 1992 and acquired by our Company on May 17, 1999, and Edgewater Technology (Virginia), Inc. (f/k/a Intelix, Inc.), a northern Virginia corporation that was incorporated in 1993 and was acquired by our Company on June 2, 2003.

2.    BASIS OF PRESENTATION:

        The accompanying unaudited condensed consolidated financial statements have been prepared by Edgewater Technology pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC") regarding interim financial reporting. Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to those rules and regulations, although we believe that the disclosures made are adequate to ensure the information presented is not misleading.

        The accompanying unaudited condensed consolidated financial statements reflect all adjustments (which were of a normal, recurring nature) that, in the opinion of management, are necessary to present fairly our financial position, results of operations and cash flows as of and for the interim periods presented. All intercompany transactions have been eliminated in the accompanying unaudited condensed consolidated financial statements. These financial statements should be read in conjunction with the audited financial statements and notes thereto included in our 2003 Annual Report on Form 10-K as filed with the SEC on March 30, 2004.

        The results of operations for the three and nine months ended September 30, 2004 are not necessarily indicative of the results to be expected for any future period or the full fiscal year. Our revenue and earnings may fluctuate from quarter to quarter based on factors within and outside our control, including variability in demand for information technology professional services, the length of the sales cycle associated with our service offerings, the number, size and scope of our projects and the efficiency with which we utilize our employees.

3.    REVENUE RECOGNITION:

        The Company recognizes revenue from three types of contracts: time and materials, subscription services, and fixed-price. A majority of the Company's contracts are billed on a time and materials basis. Time and materials contracts represented 75.1% and 71.5% of revenues for the three and nine months ended September 30, 2004, respectively. Time and materials contracts represented 74.1% and 71.2% of revenues for the three and nine months ended September 30, 2003, respectively. Revenues

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related to time and materials contracts are generally recognized as services are rendered and performed at contractually agreed upon rates.

        We also perform subscription services related to IT infrastructure. Subscription services represented 11.6% and 9.9% of revenues for the three and nine months ended September 30, 2004, respectively. Subscription services represented 9.4% and 10.6% of revenues for the three and nine months ended September 30, 2003, respectively. Revenue under subscription services contracts is generally recognized as monthly fixed amounts, for a specified period of time, as outlined within the respective contract.

        Revenue pursuant to fixed-price contracts is generally recognized under the proportional performance method of accounting. Over the course of a fixed-price contract, we routinely evaluate whether revenue and profitability should be recognized in the current period. To measure the performance and our ability to recognize revenue and profitability on fixed-price contracts, we compare actual direct costs incurred to the total estimated direct costs and determine the percentage of the contract that is complete. This percentage is multiplied by the estimated total contract value to determine the amount of net revenue recognized, subject to any warranty provisions and other holdbacks on revenue. Any warranty provisions included in fixed-price contracts are accounted for as a holdback of revenue until such provisions are satisfied. A formal project review process takes place monthly, although most projects are evaluated on an ongoing basis. Management reviews the estimated total direct costs on each contract to determine if the estimated amounts are reasonable and revisions to estimates are made as needed, in the period in which they become known. Fixed-price contracts represented 13.3% and 18.6% of revenues for the three and nine months ended September 30, 2004, respectively. Fixed-price contracts represented 16.5% and 18.2% of revenues for the three and nine months ended September 30, 2003, respectively.

        Revenues and earnings may fluctuate from quarter to quarter based on the number, size and scope of projects in which we are engaged, the contractual terms and degree of completion of such projects, any delays incurred in connection with a project, employee utilization rates, the adequacy of provisions for losses, the use of estimates of resources required to complete ongoing projects, general economic conditions and other factors. Certain significant estimates include estimates used for fixed-price contracts and the allowance for doubtful accounts. These items are frequently monitored and analyzed by management for changes in facts and circumstances, which could affect our estimates. Reimbursement of "out-of-pocket" expenses charged to customers is reflected as revenue.

        The agreements entered into in connection with a project, typically allow the Company's clients to terminate early due to breach or for convenience with approximately 30-120 days notice. In the event of termination, the client is contractually required to pay for all time, materials and expenses incurred by the Company through the effective date of the termination.

        For the three and nine months ended September 30, 2004, three customers and two customers each, respectively, including Synapse (a related party—See Note 9) accounted for more than 10% of revenues. For the three and nine months ended September 30, 2003, two customers each, including Synapse, accounted for more than 10% of revenues. For the three and nine months ended September 30, 2004, our five largest customers represented 80.0% and 77.1% of our revenues in the aggregate, respectively. For the three and nine months ended September 30, 2003, our five largest customers represented 80.4% and 83.7% of our revenues in the aggregate, respectively.

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4.    PROVISION FOR INCOME TAXES:

        The Company has deferred tax assets related to net operating loss carryforwards and tax credits, which expire at different times through and until 2021. Management evaluates the realizability of the deferred tax assets quarterly and may adjust the valuation allowance based on such analysis in the future. The Company has provided a valuation allowance against certain deferred tax assets aggregating approximately $14.1 million, which has remained unchanged since December 31, 2003. This valuation allowance is based on management estimates and represents tax credits and certain state net operating loss carryforwards and other assets that the Company concluded were not likely to be realized. The Company concluded the remaining assets, which consist primarily of the U.S. Federal net operating loss carryforward, is more likely than not to be realized through future taxable income. In addition, as a result of a change in the Internal Revenue Code, our 2002 tax loss will be carried back to 1997, resulting in a refund of previously paid taxes of $1.4 million, which amount has been recorded as Income Tax Receivable. The Company, due to an expected loss for 2004, has not recorded a tax provision for the nine months ended September 30, 2004. Accordingly, the Company has a remaining net deferred tax asset of approximately $22.2 million as of September 30, 2004.

5.    STOCKHOLDERS' EQUITY:

2003 Equity Incentive Plan:

        In May 2003, the Company's Board of Directors approved the "Edgewater Technology, Inc. 2003 Equity Incentive Plan" (the "2003 Plan") for the purpose of attracting and retaining employees and providing a vehicle to increase management's equity ownership in the Company. The 2003 Plan provides for restricted share awards and grants of nonqualified stock options in the aggregate of up to 500,000 shares of the Company's common stock. In May 2003, the Company's Compensation Committee authorized restricted share awards to certain executives of the Company under the 2003 Plan aggregating 140,000 shares of the Company's common stock (the "Restricted Share Awards"). The aggregate compensation expense associated with the Restricted Share Awards is approximately $0.7 million, which amount is being amortized straight-line over the vesting term (five years). Compensation expense related to the Restricted Share Awards during the three and nine months ended September 30, 2004 amounted to $0.03 million and $0.1 million, respectively. Compensation expense during the three and nine months ended September 30, 2003 amounted to $0.03 million.

General:

        In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation," to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method used on reported results.

        The Company records stock-based compensation awards issued to employees and directors using the intrinsic value method and stock-based compensation awards issued to non-employees using the fair value method of accounting. Stock-based compensation expense, if any, is recognized on awards of restricted shares or grants of stock options issued to employees and directors if the purchase price or

8

exercise price, as applicable, is less than the market price of the underlying stock on the measurement date, generally the date of grant. The differences between accounting for stock-based compensation under the intrinsic value method and the fair value method are shown below, with the fair value estimated on the grant date or award issue date, as applicable, using the Black-Scholes Option-Pricing Model:

        Assumptions included in Black-Scholes Option-Pricing Model:

6.    MARKETABLE SECURITIES:

        As of September 30, 2004, our marketable securities portfolio consisted of $24.9 million in commercial paper and $3.7 million in government obligations, including agencies, and amortized cost approximated fair value. As of December 31, 2003, our short-term investments consisted of $14.3 million in commercial paper and $2.1 million in government obligations, including agencies, and amortized cost approximated fair value.

7.    INTANGIBLE ASSETS:

        The Company has adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, goodwill and certain intangible assets are deemed to have indefinite lives and are no longer amortized, but are reviewed at least annually for impairment. Other identifiable intangible assets are amortized over their estimated useful lives. SFAS No. 142 requires that goodwill be tested for impairment at the reporting unit level at adoption and at least annually thereafter, utilizing the "fair

9

value" methodology. The Company evaluates the fair value of its reporting unit utilizing various valuation techniques and engages an outside valuation firm to provide valuation analysis each year on December 2, which is our selected annual measurement date.

        Our net goodwill as of September 30, 2004 and December 31, 2003 was $12.2 million and other net intangibles amounted to $0.6 million and $0.9 million as of September 30, 2004 and December 31, 2003, respectively.

        Intangible assets consisted of the following as of:

        Total amortization expense was $0.1 million and $0.3 million for the three and nine months ended September 30, 2004, respectively. Total amortization expense was $0.1 million and $0.3 million for the three and nine months ended September 30, 2003, respectively. This amortization expense relates to certain non-competition covenants and customer lists, which will expire from 2004 through 2010.

8.    EARNINGS PER SHARE:

        A reconciliation of net (loss) income and weighted average shares used in computing basic and diluted earnings per share is as follows:

10

        Stock options for which the exercise price exceeds the average market price over the period have an anti-dilutive effect on earnings per share, and accordingly, are excluded from the diluted computations for all periods presented. Had such shares been included, shares for the diluted computation would have increased by approximately 2.8 million and 2.7 million for the three and nine months ended September 30, 2004, respectively. For the three and nine months ended September 30, 2003, the diluted computations would have increased by approximately 2.7 million and 2.8 million shares, respectively. Options to purchase approximately 0.5 million and 0.7 million shares of common stock that were outstanding during the three and nine month period ended September 30, 2004, respectively, were not included in the computation of diluted net loss per share because the Company recorded a net loss for these periods. As of September 30, 2004 and 2003, there were approximately 4.5 million options outstanding.

9.    RELATED PARTIES:

        The Synapse Group, Inc. ("Synapse"), one of our significant customers, is considered a related party as its President and Chief Executive Officer is also a member of the Company's Board of Directors. During the three and nine months ended September 30, 2004, revenues from Synapse represented 49.8% and 42.9%, respectively, of total revenues. During the three and nine months ended September 30, 2003, revenues from Synapse represented 41.5% and 48.8%, respectively, of total revenues. Revenues, receivables and payments received from Synapse are disclosed in the accompanying unaudited condensed consolidated financial statements, which balances were within the Company's normal business terms.

        In 1999, the Company entered into a lease agreement with a stockholder, who was a former officer and director of the Company, to lease certain parcels of land and buildings in Fayetteville, Arkansas for its former corporate headquarters. Rent payments related to these facilities totaled approximately $0.06 million for the three months ended September 30, 2004 and 2003. Rent payments related to these facilities totaled approximately $0.2 million for the nine months ended September 30, 2004 and 2003. The Company's corporate headquarters moved to Wakefield, Massachusetts during 2001, and the Company subleased the Fayetteville facility to a third party in 2002. Sublease payments of $0.05 million were received during the three months ended September 30, 2004 and 2003. Sublease payments of $0.1 million were received during the nine months ended September 30, 2004 and 2003.

10.    COMMITMENTS AND CONTINGENCIES:

        We are sometimes a party to litigation incidental to our business. We believe that these routine legal proceedings will not have a material adverse effect on our financial position. We maintain insurance in amounts with coverages and deductibles that we believe are reasonable.

        During the second quarter of 2002, our Company was notified by the Internal Revenue Service (the "IRS") that it would be auditing our consolidated income tax returns for the 1998, 1999 and 2000 fiscal years. For the period of the fiscal years covered by the audit, we owned staffing-related businesses, which were sold during the 2000 and 2001 fiscal years. On August 2, 2004, our Company was notified by the IRS that no changes were recommended to the tax returns as previously filed. This notice formally documented the completion and closure of the audit of our company's consolidated income tax returns for the 1998, 1999 and 2000 fiscal years.

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        We have received and may continue to receive various tax notices and assessments from the IRS related to our former staffing businesses, which were sold in 2000 and 2001, and related civil penalties concerning the purported untimely filing of tax information. Between the filing of our quarterly report on Form 10-Q for the quarter ended September 30, 2003 and September of 2004, we have been successful in obtaining abatements of certain IRS notices. We also continue to work to resolve other outstanding IRS assessments, which presently are in a range of $0.8 million to $1.6 million. The Company recorded a reserve in 2003 of $1.0 million under discontinued operations, representing the low end of such estimate, plus related professional fees. The accrual is carried in the "other liabilities including discontinued operations" section in the September 30, 2004 balance sheet.

        The Company entered into employment agreements with certain executive officers and management personnel during the second quarter of 2003, which agreements provide for annual salaries, cost-of-living adjustments and additional compensation opportunities in the form of "performance-based" bonuses. Certain agreements include covenants against competition with our Company, which extend for a period of time after termination. These agreements extend for a four-year period through 2007.

11.    SUBSEQUENT EVENTS:

        On October 4, 2004, the Company entered into a definitive Asset Purchase Agreement (the "Purchase Agreement") among Edgewater Technology-Ranzal, Inc., a wholly owned subsidiary of the Company, Ranzal and Associates, Inc. ("Ranzal"), and certain stockholders of Ranzal providing for the acquisition of substantially all of the assets of Ranzal, its operations, and its business related to the development of business intelligence and business performance management solutions with an initial upfront payment at closing of approximately $5.2 million in cash. In addition to the initial cash consideration, the Purchase Agreement also includes language for specific earnout consideration which is scheduled, upon the attainment of certain performance measurements, to be paid out over the next twelve to eighteen months. The Company could pay an additional amount of approximately $3.0 million in potential earnout consideration.

        Results for Ranzal's operations will be included in the Company's results from the date of the acquisition. There is no impact to the Company's consolidated balance sheet as of September 30, 2004 or the consolidated statements of operations for the three and nine month period ended September 30, 2004.

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ITEM 2—MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Business Overview

        Edgewater Technology, Inc. is an award-winning consulting firm that specializes in combining strategic consulting, technical knowledge, and industry domain expertise to develop technology solutions that assist primarily middle-market companies and divisions of Global 2000 companies to align their processes with their purposes. This approach not only promotes increased efficiency, but also supports increased effectiveness. By targeting strategic, mission-critical applications, our consultants collaborate with our customers to translate business goals into technical strategies. Headquartered in Wakefield, Massachusetts, our Company employs approximately 134 technical consulting professionals throughout our network of strategically positioned solutions centers.

        Edgewater Technology offers a full spectrum of services and expertise to ensure the success of IT projects of any size and complexity, including:

•

Strategy—In a business environment where business is supported by an ever-increasing foundation of enabling technology, customer software, packaged software, networks, and technical infrastructure, Edgewater's strategy approach is more important than ever before. While this technology has been largely responsible for huge productivity gains and innovative new business models, the downside has also grown in terms of managing an ever increasing dependence on technology that is aging faster, becoming more complex, under increasing security scrutiny, and becoming ever more expensive. The choices have increased exponentially so a simple horizontal technology-only view will no longer suffice.

Edgewater's blend of vertical industry experts and technology specialists provides our clients with long and medium term technology strategies that deliver short-term value. This multi- disciplinary approach ensures that strategic plans not only serve the business need, but also are scalable, maintainable, and ultimately deliver the expected return on investment (ROI).

•

Design—Edgewater Technology believes by placing an emphasis in the design phase, organizations will be able to:



•

Reduce development costs



•

Integrate more effectively into their current IT infrastructure



•

Provide a flexible platform for more effective maintenance.

Design is critical in an ever more complex technology environment. In order to expedite the process of building of an application, businesses must evaluate all of their resources—determining what technologies and tools will integrate effectively within their current IT infrastructure. When design is done properly in the beginning, issues are addressed and rectified early which prevents cost overruns when code and systems are developed prematurely.

Within this critical phase, Edgewater's team identifies and documents the detailed design of the solution to be developed. Detailed decisions are made ranging from what technologies and tools will integrate with the client's current IT infrastructure to what creative resources will be required to maintain consistency with the client's current brand.

•

Build—Edgewater Technology focuses on top IT talent and its most effective application to any IT project build. Edgewater's team is multi-disciplinary in terms of technology, methodology, and project management, providing the ultimate in flexibility and risk management. The Company has achieved a better than 95% repeat business factor as a result of our extensive work in developing systems with our experienced consultants.

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With more choices existing today for the IT project build than any time in the past, it is central to have efficient and cost-effective IT talent, such as Edgewater's team of professionals, available as an option. Today, projects can be built in-house, outsourced off-shore or near-shore, contracted to project companies or ultimately utilize a blend of everything. Often the rush to build can end up being a costly decision, resulting in:

•

Inadequate functional design



•

Inadequate technical architecture



•

Inability to support the ever-changing needs of the organization.



•

Maintain—Edgewater Technology specializes in maintaining applications that require fast enhancement cycles, constant integration in changing environments and specialized quality assurance. The ability to cater to applications that support our customers' businesses, especially applications that are in the early stages of evolution, requires the necessary technology skills and business understanding. We assist our customers with the complete lifecycle of their custom applications. Application maintenance in today's environment can often be challenging and costly. Businesses are faced with uncovering the "hidden" costs of maintaining applications whether it includes testing, integration and/or ongoing support.



•

Operate—Edgewater Technology has the ability to provide clients with customized operations support ranging from remotely managing a customer's assets onsite at their location to facilities management of our customers' assets at Edgewater Technology's fully scalable operations facility. The need for a reliable, scalable and available IT infrastructure is critical to any organization's success.

        In addition to our ability to provide a full spectrum of services, Edgewater Technology also has the expertise to deliver systems integration services that maximize business results and performance improvements. We focus not only on deploying new systems, but also extending the longevity of existing systems for an ever-changing marketplace. This proven expertise enables us to bring complex technologies and systems together while minimizing risk, maximizing our clients' technology investments and delivering customized solutions that address an organizations' short and long-term business objectives.

        With more than twelve years of operating history, Edgewater Technology focuses on five core values that differentiate us from the competition:

(1)

Delivery Excellence—Our enviable delivery history is built upon more than twelve years of proven methodology and processes, and by continually delivering solutions that work. Our delivery excellence is a derivative of a well-defined business plan, highly trained professionals, strong technical expertise, and established implementation and support methodologies. Most importantly, we provide effective and continued communication with our customers throughout the entire process. Our delivery history has contributed to our ability to build long-term relationships with our customers.



(2)

Vertical Expertise/Horizontal Service Offerings—We combine vertical-industry knowledge with a broad base of key strategic technologies to serve our customers' technology needs and deliver award-winning tailored strategies and solutions. We bring vertical-industry knowledge together with a broad base of key strategic technologies. Edgewater Technology uses an iterative development methodology, with a focus on quality assurance and project management, to achieve rapid deployment capability and success in assisting organizations as they move through the barriers of technology transition. The primary vertical markets where we have developed core competencies to deliver our services include: Financial Services (Retail Banking, Portfolio/Asset Management); Health Care

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(Managed Care); Higher Education; Insurance; Life Sciences; Real Estate; Retail; Telecommunications; and various Emerging Markets that consist of untapped vertical markets which are just beginning to leverage the use of technology. We also focus on service offerings that cross each vertical such as Business Intelligence (BI), Business Activity Monitoring (BAM), Corporate Performance Management (CPM), Supply Chain, Customer Service and Web Services.

        The diagram below illustrates our vertical and horizontal service offerings:

(3)

Technology Excellence—We extend our services through proven key strategic technologies and through the focus of vertical business practices to build scalable custom solutions providing a solid ROI and thereby competitive advantage to our customers. Our team of professionals has the technology expertise, coupled with vertical knowledge, to offer comprehensive strategies and solutions. Our established partnerships with industry leaders enable us to deliver market-leading insights and innovative solutions that meet our customers' diverse business needs quickly. Our areas of technical expertise include: web-based solutions; architectural strategy; Web services; data management; transaction processing and legacy systems integration.



(4)

Middle-Market Focus—We are well positioned to serve the technology needs of the middle market through our solutions centers based where middle-market enterprises typically reside. The middle market is defined as companies and/or subsidiaries of Global 2000 corporations with $50 million to $1 billion in revenue. By leveraging our solutions centers, we are able to create a virtual development environment that allows for efficiencies in staff management, while servicing clearly defined markets to leverage technology and gain competitive advantage.



(5)

Strong Operational Metrics—Since our inception in 1992, Edgewater Technology's original management team has built an organization that is defined by a record of operational excellence, using electronic processes and systems to manage our consulting resources, company utilization and gross margin.

Critical Accounting Policies

        Our unaudited condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the

15

estimates, judgments and assumptions, upon which we rely, are reasonable based upon information available to us at the time that they are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the periods presented. To the extent there are differences between these estimates, judgments or assumptions and actual results, our financial statements may be affected. The accounting policies that we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

•

Revenue Recognition;



•

Accounting for Income Taxes; and



•

Valuation of Long-Lived and Intangible Assets.

        In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management's judgment in its application. There are also areas in which management's judgment in selecting among available alternatives would not produce a materially different result. See notes to unaudited condensed consolidated financial statements included elsewhere herein, which contain additional information regarding our accounting policies and other disclosures required by GAAP. We have identified the policies listed above as critical to our business operations and the understanding of our results of operations.

        Revenue Recognition.    Our revenues are derived from fees for services generated on a project-by-project basis. The Company recognizes revenue from three types of contracts: time and materials, subscription services, and fixed-price. A majority of the Company's contracts are billed on a time and materials basis. Time and materials contracts represented 75.1% and 71.5% of revenues for the three and nine months ended September 30, 2004, respectively. Time and materials contracts represented 74.1% and 71.2% of revenues for the three and nine months ended September 30, 2003, respectively. Revenues related to time and materials contracts are generally recognized as services are rendered and performed at contractually agreed upon rates.

        We also perform subscription services related to IT infrastructure. Subscription services represented 11.6% and 9.9% of revenues for the three and nine months ended September 30, 2004, respectively. Subscription services represented 9.4% and 10.6% of revenues for the three and nine months ended September 30, 2003, respectively. Revenue under subscription services contracts is generally recognized as monthly fixed amounts, for a specified period of time, as outlined within the respective contract.

        Revenue pursuant to fixed-price contracts is generally recognized under the proportional performance method of accounting. Over the course of a fixed-price contract, we routinely evaluate whether revenue and profitability should be recognized in the current period. To measure the performance and our ability to recognize revenue and profitability on fixed-price contracts, we compare actual direct costs incurred to the total estimated direct costs and determine the percentage of the contract that is complete. This percentage is multiplied by the estimated total contract value to determine the amount of net revenue recognized, subject to any warranty provisions and other holdbacks on revenue. Any warranty provisions included in fixed-price contracts are accounted for as a holdback of revenue until such provisions are satisfied. A formal project review process takes place monthly although most projects are evaluated on an ongoing basis. Management reviews the estimated total direct costs on each contract to determine if the estimated amounts are reasonable and revisions to estimates are made as needed, in the period in which they become known. Fixed-price contracts represented 13.3% and 18.6% of revenues for the three and nine months ended September 30, 2004, respectively. Fixed-price contracts represented 16.5% and 18.2% of revenues for the three and nine months ended September 30, 2003, respectively.

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        Revenues and earnings may fluctuate from year to year based on the number, size and scope of projects in which we are engaged, the contractual terms and degree of completion of such projects, any delays incurred in connection with a project, employee utilization rates, the adequacy of provisions for losses, the use of estimates of resources required to complete ongoing projects, general economic conditions and other factors. Certain significant estimates include estimates used for fixed-price contracts and the allowance for doubtful accounts. These items are frequently monitored and analyzed by management for changes in facts and circumstances, which could affect our estimates. Reimbursements of "out-of-pocket" expenses charged to customers are reflected as revenue.

        The agreements entered into in connection with a project, typically allow the Company's clients to terminate early due to breach or for convenience with approximately 30-120 days notice. In the event of termination, the client is contractually required to pay for all time, materials and expenses incurred by the Company through the effective date of the termination.

        Accounting for Income Taxes.    As part of the process of preparing our condensed consolidated financial statements, significant judgment is required in determining our provision for income taxes, the carrying value of deferred tax assets and liabilities and the valuation allowance recorded against certain deferred tax assets. We have recorded a $14.1 million valuation allowance against our net deferred tax assets as of September 30, 2004 and December 31, 2003, due to potential uncertainty related to our ability to utilize some of our deferred tax assets, primarily consisting of certain net operating losses carried forward and foreign tax credits, before they expire. We consider scheduled reversals of deferred tax liabilities, projected future taxable income, ongoing tax planning strategies and other matters, including the period over which our deferred tax assets will be recoverable in assessing the need for and the amount of the valuation allowance. In the event that actual results differ from these estimates or we adjust these estimates in future periods, adjustments to the deferred tax assets may be recorded, which could materially impact our financial position and net income (loss) in the period. The Company's net deferred tax asset was approximately $22.2 million as of September 30, 2004, which amount management believes will be realized in the future.

        Valuation of Long-Lived and Intangible Assets.    We assess the impairment of identifiable intangibles, long-lived assets and related goodwill annually through the use of a third-party appraiser, and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important, which could trigger an impairment review include: 1) significant negative industry or economic trends, 2) significant operating underperformance relative to expected historical or projected future results, 3) significant decline in our stock price or the stock price of our industry peers and/or 4) a decline in our market capitalization relative to our net book value. Our judgments regarding the existence of impairment indicators are based upon legal factors, market conditions and operational performance. Our Company adopted SFAS No. 142 in 2002 and in accordance therewith, recorded as a change in accounting principle, a non-cash impairment charge of $12.5 million upon adoption on January 1, 2002. On December 2, 2002, our selected annual measurement date, our Company recorded an additional non-cash charge of $7.4 million due to a further impairment of goodwill. The Company acquired Intelix on June 2, 2003 and recorded $1.4 million in goodwill and $0.5 million in identifiable intangibles.

        In accordance with the provisions of SFAS No. 142, the valuation of the recorded goodwill is evaluated for impairment on an annual basis, while the intangible assets are being amortized, on a straight-line basis, over four to eight years.

Financial Information

        The financial information that follows has been rounded in order to simplify its presentation. The amounts and percentages below have been calculated using the detailed financial information contained

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in the unaudited condensed consolidated financial statements, the notes thereto, and the other financial data included in this Quarterly Report on Form 10-Q.

Results for the three and nine months ended September 30, 2004, compared to results for the three and nine months ended September 30, 2003

        The following table sets forth the percentage of service revenues of items included in our unaudited condensed consolidated statements of operations:

        Service Revenues.    Revenues for the three months ended September 30, 2004 decreased by $2.0 million, or 29.4%, to $4.9 million compared to $6.9 million for the three months ended September 30, 2003. The quarter over quarter revenue decrease was primarily due to the delayed launch of IT initiatives during the quarter by new and existing clients, in addition to a reduction in billable project work stemming from the successful completion of two large projects. Revenues for the nine months ended September 30, 2004 decreased by $0.8 million, or 4.5%, to $17.5 million, compared to $18.3 million for the nine months ended September 30, 2003. This year-to-date revenue decrease is due to the third quarter 2004 developments described above which were partially offset by the full-year impact of the Intelix acquisition. For the three months ended September 30, 2004 and 2003, three and two customers, respectively, contributed more than 10% of revenues. For the nine months ended September 30, 2004 and 2003, two customers each contributed more than 10% of revenues. For the three months ended September 30, 2004 and 2003, our five largest customers represented 80.0% and 80.4% of our revenues in the aggregate, respectively. For the nine months ended September 30, 2004 and 2003, our five largest customers represented 77.1% and 83.7% of our revenues in the aggregate, respectively. Expenses reimbursed by our clients are also included in revenue. Expense reimbursements included in revenues amounted to $0.09 million and $0.06 million for the three months ended September 30, 2004 and 2003, respectively, while expense reimbursements included in revenues for the nine month period ended September 30, 2004 and 2003 amounted to $0.2 million and $0.1 million, respectively. Also see Note 9, Related Parties, to the unaudited condensed consolidated financial statements included elsewhere herein, for additional information.

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        Cost of Services.    Cost of services consists principally of salaries, payroll taxes, employee benefits and travel expenses for personnel dedicated to customer projects. These costs represent the most significant expense we incur in providing our services. Cost of services decreased $0.3 million, or 8.8%, to $3.4 million for the three months ended September 30, 2004, compared to $3.7 million for the three months ended September 30, 2003. The decrease is attributable to lower salaries and related fringe costs in the three month period ended September 30, 2004, as the number of billable consultants decreased to 134, compared to 155 in the same period in the prior year. Cost of services increased $1.2 million, or 11.8%, to $11.0 million for the nine months ended September 30, 2004, compared to $9.8 million for the nine months ended September 30, 2003. The increase is principally attributable to the full-year inclusion of Intelix related salaries and wages and also due to additional wage and salary increases related to our core business.

        Gross Profit.    Gross profit for the three months ended September 30, 2004 decreased by $1.7 million, or 53.4%, to $1.5 million, compared to $3.2 million for the three months ended September 30, 2003. Gross profit for the nine months ended September 30, 2004 decreased by $2.0 million, or 23.4%, to $6.5 million, compared to $8.5 million for the nine months ended September 30, 2003. The decrease in gross profit directly relates to the lower revenue and utilization during the period. Utilization rates were 66.0% for the three months ended September 30, 2004, compared to 80.0% for the three months ended September 30, 2003. Utilization rates were 73.4% for the nine months ended September 30, 2004, compared to 80.3% for the nine months ended September 30, 2003.

        Selling, General and Administrative Expense ("SG&A").    SG&A decreased $0.3 million, or 11.0%, to $2.5 million for the three months ended September 30, 2004, compared to $2.8 million for the three months ended September 30, 2003. SG&A decreased $0.2 million, or 2.7%, to $7.3 million for the nine months ended September 30, 2004, compared to $7.5 million for the nine months ended September 30, 2003. The decrease in the three month and nine month amounts is principally related to lower discretionary spending initiatives.

        Stock-Based Compensation Expense.    In May 2003, the Company's Compensation Committee authorized restricted share awards to certain executives of the Company, aggregating 140,000 shares of the Company's common stock. The aggregate compensation expense associated with these awards is approximately $0.7 million, which amount is being amortized straight-line over the vesting term (five years). Compensation expense related to these restricted share awards during the three months ended September 30, 2004 and 2003 was $0.03 million. Compensation expense for the nine months ended September 30, 2004 and 2003 amounted to $0.1 million and $0.03 million, respectively.

        Depreciation and Amortization Expense.    Depreciation and amortization expense decreased by $0.1 million to $0.2 million for the three months ended September 30, 2004, compared to $0.3 million for the three months ended September 30, 2003. Depreciation and amortization expense decreased $0.1 million to $0.6 million for the nine months ended September 30, 2004, compared to $0.7 million for the nine months ended September 30, 2003. This decrease reflects tighter spending controls on purchases of new fixed assets and a reduction in depreciation as older assets become fully depreciated, which were offset by additional amortization expense due to the Intelix acquisition.

        Operating (Loss) Income.    Operating income decreased $1.4 million to ($1.2) million for the three months ended September 30, 2004, compared to $0.2 million for the three months ended September 30, 2003. Operating income decreased $1.7 million to ($1.4) million for the nine months ended September 30, 2004, compared to $0.3 million for the nine months ended September 30, 2003. Operating income decreased from the prior year primarily due to lower revenue and decreased utilization rates in the periods presented.

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        Interest Income and Other, Net.    We earned net interest income of $0.2 million for the three months ended September 30, 2004, compared to net interest income of $0.1 million for the three months ended September 30, 2003. We earned net interest income of $0.4 million for the nine months ended September 30, 2004, compared to net interest income of $0.3 million for the nine months ended September 30, 2003. This increase reflects a recent shift of our available cash and cash equivalent balances into less liquid marketable securities, which have increased yields on our invested balances when compared to the yields achieved in the prior year.

        Tax (Benefit) Provision.    The Company provides for income taxes at the end of each interim period based on the estimated effective tax rates for the full fiscal year. Cumulative adjustments to the tax provision are recorded in the interim period in which a change in the estimated annual effective rate is determined. We recorded a tax (benefit) provision of ($0.01) million and $0.1 million for the three months ended September 30, 2004 and 2003, respectively. For the nine month period ended September 30, 2004 and 2003, the Company recorded no tax provision and a $0.3 million provision, respectively. Due to the currently available deferred tax assets and a projected loss for 2004, the Company has elected not to record a current year tax benefit for the three month and nine month periods ended September 30, 2004. During the three month and nine month periods ended September 30, 2003, the Company recorded a provision for income taxes based upon an estimated effective rate of 40%, which includes state and federal income tax rates.

        Net (Loss) Income.    Net (loss) income was ($1.0) million for the three months ended September 30, 2004, compared to $0.2 million for the three months ended September 30, 2003. Net (loss) income was ($1.0) million for the nine months ended September 30, 2004, compared to $0.4 million for the nine months ended September 30, 2003. Basic and diluted (loss) earnings per share was ($0.09) and $0.01 for the three months ended September 30, 2004 and 2003, respectively. Basic and diluted (loss) earnings per share was ($0.09) and $0.03 for the nine months ended September 30, 2004 and 2003, respectively.

Liquidity and Capital Resources

        The following table summarizes our cash flow activities for the periods indicated:

        As of September 30, 2004, we had cash, cash equivalents and marketable securities of $41.2 million, a 7.0% decrease from the December 31, 2003 balance of $44.3 million. Working capital, which is defined as current assets less current liabilities, decreased $3.3 million to $41.5 million as of September 30, 2004, compared to $44.8 million as of December 31, 2003. The decrease in working capital is primarily attributable to cash outflows related to repurchases of the Company's common stock, purchases of long-term marketable securities and the net loss from operations, which were partially offset by proceeds from stock option exercises during the nine month period ended September 30, 2004.

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        Our primary historical sources of funds are from operations and the proceeds from equity offerings. Our principal historical uses of cash have been to fund working capital requirements and capital expenditures. We generally pay our employees bi-weekly for their services, while receiving payments from customers 30 to 60 days from the date of the invoice.

        In December 2003, the Company's Board of Directors (the "Board") authorized management, subject to legal requirements, to use up to $20.0 million to repurchase our common stock over a period to expire February 25, 2005 (the "2003 Repurchase Plan"). The 2003 Repurchase Plan replaces the existing stock repurchase plan previously authorized by the Board in September 2002 (the "2002 Repurchase Plan"). Repurchases have been and will be made from time to time on the open market at prevailing market prices or in negotiated transactions off the market. Under the 2003 Repurchase Plan, during the three and nine months ended September 30, 2004, we repurchased 246,750 and 257,050 shares, respectively, of our common stock at an aggregated purchase price of $1.3 million and $1.4 million, respectively. Under the 2002 Repurchase Plan, during the three and nine months ended September 30, 2003, we repurchased 15,640 and 253,849 shares, respectively, of our common stock at an aggregated purchase price of $0.07 million and $1.1 million, respectively. As part of these repurchase plans, effective February 14, 2003, the Board authorized an SEC Rule 10b5-1 repurchase program with a broker that allows the Company to make more consistent repurchases of our common stock even during traditional blackout periods. As of September 30, 2004, the Company is authorized to repurchase up to $18.5 million of our common stock prior to February of 2005.

        Net cash provided by operating activities was $0.5 million and $0.7 million for the three months ended September 30, 2004 and 2003, respectively. Net cash (used in) provided by operating activities was ($1.5) million and $0.6 million for the nine months ended September 30, 2004 and 2003, respectively. The cash used during the nine months ended September 30, 2004 was primarily related to the payment of the 2003 bonus accrual, while the cash provided during the nine months ended September 30, 2003 was primarily attributable to an increase in prepaid expenses related to annual insurance renewals and the 2003 operating income, which were offset by an increase in the accounts receivable balance.

        Net cash (used in) investing activities was ($8.5) million and ($1.0) million for the three months ended September 30, 2004 and 2003, respectively. Cash (used in) provided by investing activities was ($12.5) million and $1.0 million for the nine months ended September 30, 2004 and 2003, respectively. Cash used in investing activities for the three and nine months ended September 30, 2004 was due primarily to purchases of marketable securities. Cash used in investing activities for the three months ended September 30, 2003 was primarily attributed to the purchase of marketable securities whereas net cash provided by investing activities for the nine months ended September 30, 2003 was primarily attributable to the redemption of marketable securities, net of the cash used for the purchase of Intelix, Inc. As of September 30, 2004, we have no long-term commitments for capital expenditures and all capital expenditures are discretionary.

        Net cash used in financing activities was $1.2 million and $0.05 million for the three months ended September 30, 2004 and 2003, respectively. Net cash used in financing activities was $0.9 million and $1.1 million for the nine months ended September 30, 2004 and 2003, respectively. Net cash used in financing activities for the three and nine months ended September 30, 2004 was primarily attributable to the repurchases of common stock, which were offset by the cash received from stock option exercises and proceeds from the employee stock purchase program. Net cash used in financing activities for the three and nine months ended September 30, 2003 was primarily related to repurchases of common stock.

        Net cash used in discontinued operations was $0.2 million for the three months ended September 30, 2004 and 2003. Net cash used in discontinued operations was $0.4 million and $1.5 million for the nine months ended September 30, 2004 and 2003, respectively. Net cash used in

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discontinued operations during the three months ended September 30, 2004 and 2003 related primarily to payments on tax matters and associated professional services. For the nine months ended September 30, 2004, net cash used in discontinued operations is primarily related to payments on tax matters and a reclassification of a tax payment, which had been accounted for as a reduction of cash as of December 31, 2003. Net cash used in discontinued operations during the nine months ended September 30, 2003 was primarily attributable to a $1.0 million settlement payment of a 2002 liability and the payment of other accrued discontinued operations charges.

        As a result of the above, our combined cash and cash equivalents decreased by $9.4 million and $0.6 million for the three months ended September 30, 2004 and 2003, respectively. Cash and cash equivalents decreased $15.3 million and $1.0 million for the nine months ended September 30, 2004 and 2003, respectively. The aggregate of cash, cash equivalents and the current portion of marketable securities was $39.4 million and $44.3 million, as of September 30, 2004 and December 31, 2003, respectively.

        We believe that our cash flows from operations and available cash will provide sufficient liquidity for our existing operations for the foreseeable future. We periodically reassess the adequacy of our liquidity position, taking into consideration current and anticipated operating cash flows, anticipated capital expenditures, business combinations, and public or private offerings of debt or equity securities.

Acquisition of Intelix, Inc.

        On June 2, 2003, the Company acquired all of the outstanding common stock of Intelix, Inc. ("Intelix"), a provider of systems integration and custom software development services located in Fairfax, Virginia. The results of Intelix's operations have been included in the Company's accompanying unaudited condensed consolidated statements of operations since the acquisition date. The acquisition was made to enhance Edgewater's geographical presence and will provide additional vertical expertise in the telecommunications and real estate industries.

Acquisition of Ranzal and Associates, Inc.

        On October 4, 2004, the Company entered into a definitive Asset Purchase Agreement (the "Purchase Agreement") among Edgewater Technology-Ranzal, Inc., a wholly owned subsidiary of the Company, Ranzal and Associates, Inc. ("Ranzal"), and certain stockholders of Ranzal providing for the acquisition of substantially all of the assets of Ranzal, its operations, and its business related to the development of business intelligence and business performance management solutions with an initial upfront payment at closing of approximately $5.2 million in cash. In addition to the initial cash consideration, the Purchase Agreement also includes language for specific earnout consideration which is scheduled, upon the attainment of certain performance measurements, to be paid out over the next twelve to eighteen months. The Company could pay an additional amount of approximately $3.0 million in potential earnout consideration.

        Results for Ranzal's operations will be included in the Company's results from the date of the acquisition. There is no impact to the Company's consolidated balance sheet as of September 30, 2004 or the consolidated statements of operations for the three and nine month period ended September 30, 2004.

Other Tax Matters

        During the second quarter of 2002, our Company was notified by the Internal Revenue Service (the "IRS") that it would be auditing our consolidated income tax returns for the 1998, 1999 and 2000 fiscal years. For the period of the fiscal years covered by the audit, we owned staffing-related businesses, which were sold during the 2000 and 2001 fiscal years. On August 2, 2004, our Company was notified by the IRS that no changes were recommended to the tax returns as previously filed. This

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notice formally documented the completion and closure of the audit of our company's consolidated income tax returns for the 1998, 1999 and 2000 fiscal years. Also see Note 10, Commitments and Contingencies, to the unaudited condensed consolidated financial statements included elsewhere herein, for additional information.

Off Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments

        We lease office space and certain equipment under noncancelable operating and capital lease arrangements through 2013. Rent expense, including amounts paid to related parties for discontinued operations, was approximately $0.3 million for the three months ended September 30, 2004 and 2003. Rent expense, including amounts paid to related parties for discontinued operations, was approximately $0.9 million and $0.5 million for the nine months ended September 30, 2004 and 2003, respectively.

        The Company entered into employment agreements with certain executive officers and management personnel during the second quarter of 2003, which agreements provide for annual salaries, cost-of-living adjustments and additional compensation opportunities in the form of "performance-based" bonuses. Certain agreements include covenants against competition with our Company, which extend for a period of time after termination. These agreements extend for a four-year period through 2007.

Special Note Regarding Forward Looking Statements

        Some of the statements in this Quarterly Report on Form 10-Q (this "10-Q") constitute forward-looking statements under Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements made with respect to significant customers, revenues, backlog, competitive and strategic initiatives, growth plans, potential stock repurchases, future results, tax consequences and liquidity needs. These statements involve known and unknown risks, uncertainties and other factors that may cause results, levels of activity, growth, performance, tax consequences or achievements to be materially different from any future results, levels of activity, growth, performance, tax consequences or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, those listed below, as well as those further set forth under the heading "Business—Factors Affecting Finances, Business Prospects and Stock Volatility" in our 2003 Annual Report on Form 10-K as filed with the SEC on March 30, 2004.

        The forward-looking statements included in this Form 10-Q relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may," "believe," "enable" "will," "provide," "anticipate," "future," "could," "growth," "increase," "modifying," "reacting," or the negative of such terms or comparable terminology. These forward-looking statements inherently involve certain risks and uncertainties, although they are based on our current plans or assessments which are believed to be reasonable as of the date of this 10-Q. Factors that may cause actual results, financial statement effects, disposition plans or proceeds, goals, targets, objectives or repurchases to differ materially from those contemplated, projected, forecast, estimated, anticipated, planned or budgeted in such forward-looking statements include, among others, the following possibilities: (1) inability to execute upon growth objectives; including growth in entities acquired by our Company; (2) changes in industry trends, such as a decline in the demand for solutions services or delays in industry-wide IT spending, whether on a temporary or permanent basis and/or delays by customers in initiating new projects or continuing new project milestones; (3) unanticipated events or the occurrence of fluctuations or variability in the matters identified under "Critical Accounting Policies;" (4) failure of our sales pipeline to be converted to billable work and recorded as revenue; (5) potential quarterly revenue variability that could arise under contracts where our customers have the flexibility to determine the level of services they may require of us; (6) adverse

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developments and volatility involving geopolitical or technology market conditions; (7) the occurrence of lawsuits or adverse results in tax matters; (8) loss of key executives; (9) failure of the middle market and the needs of middle-market enterprises for business services to develop as anticipated; (10) inability to recruit and retain professionals with the high level of information technology skills and experience needed to provide our services; (11) expanding outsourcing services to generate additional revenue; (12) any changes in ownership that would result in a limitation on the use of the net operating loss carry-forward under applicable tax laws, which is referred to as a net deferred tax asset of approximately $22.2 million as of September 30, 2004; and/or (13) the failure to obtain remaining predecessor entity tax records that are not in our control and/or successfully resolve remaining outstanding IRS matters relating to our former staffing businesses. In evaluating these statements, you should specifically consider various factors described above as well as the risks outlined under Item I "Business—Factors Affecting Finances, Business Prospects and Stock Volatility" in our 2003 Form 10-K filed with the SEC on March 30, 2004. These factors may cause our actual results to differ materially from those contemplated, projected, anticipated, planned or budgeted in any such forward-looking statements.

        Although we believe that the expectations in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, growth or achievements. However, neither we nor any other person assumes responsibility for the accuracy and completeness of such statements. We are under no duty to update any of the forward-looking statements after the date of this Form 10-Q to conform such statements to actual results.

ITEM 3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        Our primary financial instruments include investments in money market funds, short-term municipal bonds, commercial paper and U.S. government securities that are sensitive to market risks and interest rates. The investment portfolio is used to preserve our capital until it is required to fund operations, to fund strategic acquisitions, or other transactions which may be authorized by our Company's Board of Directors. None of our market-risk sensitive instruments are held for trading purposes. We do not purchase derivative financial instruments.

ITEM 4—CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

        General.    As of September 30, 2004 (the "Evaluation Date"), the Company evaluated the effectiveness of our "disclosure controls and procedures" ("Disclosure Controls") and the Company's "internal controls and procedures for financial reporting" ("Internal Controls"). This evaluation (the "Controls Evaluation") was carried out by the Company's disclosure controls and procedures committee under the supervision and with the participation of management, including our President and Chief Executive Officer ("the CEO") and Chief Financial Officer ("the CFO"). Rules adopted by the SEC require that in this section of this report, that the Company present the conclusions of the CEO and the CFO about the effectiveness of our Disclosure Controls and Internal Controls as of the Evaluation Date.

        CEO and CFO Certifications.    Appearing as exhibits 31.1 and 31.2 to this Quarterly Report, there are two separate forms of "Certifications" of the CEO and the CFO. These Certifications are required under Rule 13a-14(a) of the Exchange Act (the "13a-14 Certifications"). This section of this report, which you are currently reading, is the information concerning the Controls Evaluation referred to in the 13a-14 Certifications and this information should be read in conjunction with the 13a-14 Certifications for a more complete understanding of the topics presented. In addition to the 13a-14 Certifications, a certification of the CEO and the CFO under 18 USC § 1350 is included as Exhibit 32 of this Quarterly Report. The 1350 Certification requires the CEO and the CFO to certify to the best

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of their knowledge that this Quarterly Report complies with Section 13(a) or 15(d) of the Exchange Act (as defined below) and that such Quarterly Report fairly presents, in all material respects, the financial condition of the Company at the end of the period covered by this Quarterly Report. You are referenced to this certification for more information regarding the 1350 Certification.

        Disclosure Controls and Internal Controls.    Disclosure Controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), such as this report, is recorded, processed, summarized and reported within the time periods specified in the SEC rules. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the CEO and the CFO, as appropriate to allow timely decisions regarding required disclosure. Internal Controls are procedures which are designed with the objective of providing reasonable assurance that: (1) our transactions are properly authorized; (2) our assets are safeguarded against unauthorized or improper use; and (3) our transactions are properly recorded and reported, all to permit the preparation of our financial statements in conformity with generally accepted accounting principles. However, any control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.

        Scope of the Controls Evaluation.    The CEO's and the CFO's evaluation of our Disclosure Controls and our Internal Controls included a review of the controls' objectives and design, the controls' implementation by the Company and the effect of the controls on the information generated for use in this report. This type of evaluation will be done on a quarterly basis so that the conclusions concerning controls effectiveness can be reported in our Quarterly and Annual Reports. Our Internal Controls are also evaluated on an ongoing basis by other personnel in our finance and accounting department.

        Among other matters, the Company sought in our evaluation to determine whether there were any "significant deficiencies" or "material weaknesses" in our Internal Controls, or whether the Company had identified any acts of fraud involving personnel who have a significant role in our Internal Controls. This information was important both for the Controls Evaluation generally and because the 13a-14 Certifications require that the CEO and the CFO disclose that information to our Board's Audit Committee and to our independent auditors. In the professional auditing literature, "significant deficiencies" are control issues that could have a significant adverse effect on the ability to record, process, summarize and report financial data in the financial statements. A "material weakness" is defined in the auditing literature as a particularly serious reportable condition where the internal control does not reduce to a relatively low level the risk that misstatements caused by error or fraud may occur in amounts that would be material in relation to the financial statements and not be detected within a timely period by employees in the normal course of performing their assigned functions.

        Changes in Internal Controls.    There were no significant changes in our Internal Controls or in other factors that could significantly affect these controls subsequent to the date of the Evaluation Date, nor were there any significant deficiencies or material weaknesses in our Internal Controls. Accordingly, no corrective actions were required or undertaken.

        Conclusions.    Based on the Controls Evaluation, as described above, the CEO and the CFO have concluded that as of the Evaluation Date, the Company's Disclosure Controls and Internal Controls were adequate, effective and designed to ensure that material information relating to the Company and our consolidated subsidiaries was made known to them by others within those entities, particularly during the period when the Company's periodic reports are being prepared.

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PART II

ITEM 1—LEGAL PROCEEDINGS

        We are sometimes a party to litigation incidental to our business. We believe that these routine legal proceedings will not have a material adverse effect on our financial position. We maintain insurance in amounts, with coverage and deductibles that we believe are reasonable.

ITEM 2—UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

        In December 2003, the Company's Board of Directors (the "Board") authorized management, subject to legal requirements, to use up to $20.0 million to repurchase our common stock over a period to expire February 25, 2005 (the "2003 Repurchase Plan"). Repurchases have been and will be made from time to time on the open market at prevailing market prices or in negotiated transactions off the market. As part of this repurchase plan, effective February 14, 2003, the Board authorized an SEC Rule 10b5-1 repurchase program with a broker that allows the Company to make more consistent repurchases of our common stock even during traditional blackout periods. The following table represents repurchases that were made during the quarter ended September 30, 2004:

ITEM 3—DEFAULTS UPON SENIOR SECURITIES

        Not applicable as our Company does not have any senior securities issued or outstanding.

ITEM 4—SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        Not applicable as there were no matters submitted to our Company's stockholders during the quarterly period ended September 30, 2004.

ITEM 5—OTHER INFORMATION

        None.

ITEM 6—EXHIBITS

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SIGNATURES

        Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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