| HUDSON HIGHLAND GROUP INC ITEM 1A RISK FACTORS The following risk factors and other information included in this Annual Report on Form 10-K should be carefully considered |
| The risks and uncertainties described below are not the only ones we face |
| Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations |
| If any of the following risks occur, our business, financial condition, operating results, and cash flows could be materially adversely affected |
| Since our spin-off in 2003, we have had a history of negative cash flows and operating losses that may continue for at least the next year |
| We have experienced negative cash flows and we have shown operating and net losses in the past |
| In 2005, we became modestly profitable |
| For the year ended December 31, 2005, we used cash in operating activities of dlra26dtta3 million and we recorded net income attributable to common stockholders of dlra5dtta3 million |
| We expect to continue to experience negative cash flows from operating activities for at least the next year |
| If our revenue grows more slowly than we anticipate or if operating expenses exceed our expectations, we may not be profitable in the next year |
| Our revenues can vary because our clients can terminate their relationship with us at any time with limited or no penalty |
| We provide executive search and mid-market professional staffing services on a temporary assignment-by-assignment basis, which clients can generally terminate at any time or reduce their level of use when compared to prior periods |
| Our executive search and professional staffing business is also significantly affected by our clients hiring needs and their views of their future prospects |
| Clients may, on very short notice, reduce or postpone their recruiting assignments with us and therefore, affect demand for our services |
| Our operations will be affected by global economic fluctuations |
| Demand for our services may fluctuate with changes in economic conditions, especially those resulting in slower or reduced employment growth |
| Because we operate from many small offices with fixed overhead, we have only limited flexibility to reduce expenses during economic downturns |
| Further, we may face increased pricing pressures during these times |
| For example, during 2001 and 2002, employers across the United States 5 ______________________________________________________________________ [33]Table of Contents reduced their overall workforce to reflect the slowing demand for their products and services |
| In turn, our revenue was significantly reduced in the United States |
| Economic conditions could continue in 2006, which could have a material adverse effect on our business, financial condition and operating results |
| Our credit facility restricts our operating flexibility |
| We have a dlra75dtta0 million senior secured credit facility |
| As of December 31, 2005, we had outstanding borrowings of dlra30dtta1 million and letters of credit issued and outstanding of dlra15dtta5 million under the credit facility |
| Available credit for use under the credit facility as of December 31, 2005 was dlra29dtta4 million |
| Our ability to borrow under the credit facility is tied to a borrowing base of our eligible accounts receivable |
| If the amount or quality of our accounts receivable deteriorates, our ability to borrow under the credit facility will be directly affected |
| In addition, our credit facility requires that we satisfy certain financial covenants, including complying with targeted levels of adjusted EBITDA As a result, we cannot assure you that we will be able to borrow under our credit agreement if we need money to fund working capital or other needs |
| In addition, our credit facility contains various restrictions and covenants that restrict our operating flexibility including: • prohibitions on payments of dividends and repurchases of stock; • restrictions on our ability to make additional borrowings, or to consolidate, merge or otherwise fundamentally change the ownership of the Company; and • limitations on investments, dispositions of assets and guarantees of indebtedness |
| These restrictions and covenants could have important consequences for investors, including the need to use a portion of our cash flow from operations for debt service rather than for our operations, an inability to incur additional debt financing for future working capital or capital expenditures, a lesser ability to take advantage of significant business opportunities, such as acquisition opportunities, or to react to market conditions; lesser ability to sell assets, grant or incur liens on our assets, or engage in mergers or consolidations |
| Our ability to comply with these financial requirements and other restrictions may be affected by events outside our control, in particular macroeconomic events |
| Our inability to comply with them could result in a default under our credit facility or other debt instruments |
| If a default occurs under our credit facility, the lenders under this facility could elect to declare all of the outstanding borrowings, as well as accrued interest and fees, to be due and payable and require us to apply all of our available cash to repay those borrowings |
| In addition, a default may result in higher rates of interest and the inability to obtain additional borrowings |
| Further, debt incurred under our credit facility bears interest at variable rates |
| Any increase in interest expense could reduce the funds available for operations |
| We face risks relating to our foreign operations |
| We conduct operations in over 20 foreign countries |
| For the years ended December 31, 2005, 2004 and 2003, approximately 66prca, 70prca and 71prca, respectively, of our revenue was earned outside of the United States |
| The financial results of our company could be materially affected by a number of factors particular to international operations |
| These include but are not limited to difficulties in staffing and managing foreign operations; operational issues such as longer customer payment cycles and greater difficulties in collecting accounts receivable; • changes in tax laws or other regulatory requirements; • issues relating to uncertainties of laws and enforcement relating to the regulation and protection of intellectual property; and currency fluctuation |
| If we are forced to discontinue any of our international operations, we could incur material costs to close down such operations |
| Regarding the foreign currency risk inherent in foreign operations, the results of our local operations are reported in the applicable foreign currencies and then translated into US dollars at the applicable foreign 6 ______________________________________________________________________ [34]Table of Contents currency exchange rates for inclusion in our financial statements |
| In addition, we generally pay operating expenses in the corresponding local currency |
| We had no hedging or similar foreign currency contracts outstanding at December 31, 2005 |
| Because of devaluations and fluctuations in currency exchange rates or the imposition of limitations on conversion of foreign currencies into US dollars, we are subject to currency translation exposure on the revenue and income of our operations in addition to economic exposure |
| This risk could have a material adverse effect on our business, financial condition and operating results |
| We face risks associated with acquisitions |
| From time to time, we make acquisitions |
| The success of these acquisitions is dependent upon our ability to integrate acquired personnel, operations, products and technologies into our organization effectively; and our ability to retain and motivate key personnel and to retain the clients of acquired firms |
| If we are not successful upon making an acquisition in the aspects of its integration into our operations, our financial results may be materially adversely affected |
| We rely on our information systems, and if we lose that technology or fail to further develop our technology, our business could be harmed |
| Our success depends in large part upon our ability to store, retrieve, process and manage substantial amounts of information, including our client and candidate databases |
| To achieve our strategic objectives and to remain competitive, we must continue to develop and enhance our information systems |
| This may require the acquisition of equipment and software and the development, either internally or through independent consultants, of new proprietary software |
| Our inability to design, develop, implement and utilize, in a cost-effective manner, information systems that provide the capabilities necessary for us to compete effectively, or any interruption or loss of our information processing capabilities, for any reason, could harm our business, results of operations or financial condition |
| Our markets are highly competitive |
| The markets for our services are highly competitive and those markets are characterized by pressures to reduce prices, incorporate new capabilities and technologies, accelerate job completion schedules and attract and retain highly skilled professionals who possess the skills and experience necessary to fulfill our clients’ employee search needs |
| Furthermore, we face competition from a number of sources |
| These sources include other executive search firms and professional search, staffing and consulting firms |
| Several of our competitors have greater financial and marketing resources than we do |
| Due to competition, we may experience reduced margins on our products and services, as well as loss of market share and our customers |
| If we are not able to compete effectively with current or future competitors as a result of these and other factors, our business, financial condition and results of operations could be materially adversely affected |
| We have no significant proprietary technology that would preclude or inhibit competitors from entering the mid-market professional staffing and temporary contracting and executive search markets |
| We cannot assure you that existing or future competitors will not develop or offer services and products that provide significant performance, price, creative or other advantages over our services |
| In addition, we believe that with continuing development and increased availability of information technology, the industries in which we compete may attract new competitors |
| Specifically, the advent and increased use of the Internet may attract technology-oriented companies to the executive search industry |
| We cannot assure you that we will be able to continue to compete effectively against existing or future competitors |
| 7 ______________________________________________________________________ [35]Table of Contents Our operating results fluctuate from quarter to quarter and therefore quarterly results cannot be used to predict future periods’ results |
| Our operating results fluctuate quarter to quarter in the past primarily due to the vacation periods of the first quarter in the Australasia region and the third quarter in the US and Europe regions |
| The success of our executive search business depends upon the ability of employees to develop and maintain strong, long-term relationships with clients |
| Usually, one or two employees have primary responsibility for a client relationship |
| When an employee leaves an executive search firm and joins another, clients that have established relationships with the departing employee may move their business to the employee’s new employer |
| The loss of one or more clients is more likely to occur if the departing employee enjoys widespread name recognition or has developed a reputation as a specialist in executing searches in a specific industry or management function |
| Historically, we have not experienced a significant number of departures of executive search partners |
| However, a failure to retain our most effective executive search partners or maintain the quality of service to which our clients are accustomed could have a material adverse effect on our business, financial condition and operating results |
| Also, the ability of a departing executive search partner to move business to his or her new employer could have a material adverse effect on our business, financial condition and operating results |
| Competition for highly skilled professionals is intense, and we compete with professional staffing and executive search agencies for qualified professionals |
| We and many of our competitors have experienced turnover of qualified professionals |
| We believe that we have been able to attract and retain highly qualified, effective professionals as a result of our reputation and our performance-based compensation system |
| These professionals have the potential to earn substantial bonuses based on the amount of revenue they generate by obtaining or executing executive search and permanent placement assignments or assisting other professionals to obtain or complete executive search and permanent placement assignments |
| Bonuses and commissions represent a significant proportion of these professionals’ total compensation |
| Any diminution of our reputation could impair our ability to retain existing or attract additional highly skilled professionals |
| Any inability to attract and retain highly skilled professionals could have a material adverse effect on our executive search business, financial condition and operating results |
| We face restrictions imposed by blocking arrangements in Highland Partners |
| Either by agreement with clients or for marketing or client relationship purposes, executive search firms frequently refrain, for a specified period of time, from recruiting certain employees of a client, and possibly other entities affiliated with such client, when conducting executive searches on behalf of other clients |
| This is known as a “blocking” or “off-limits” arrangement |
| Blocking arrangements generally remain in effect for one or two years following completion of an assignment |
| The actual duration and scope of any blocking arrangement, including whether it covers all operations of a client and its affiliates or only certain divisions of a client, generally depends on such factors as: • the length of the client relationship; • the frequency with which the executive search firm has been engaged to perform executive searches for the client; and • the number of assignments the executive search firm has generated or expects to generate from the client |
| Some of our executive search clients are recognized as industry leaders and/or employ a significant number of qualified executives who are potential candidates for other companies in that client’s industry |
| Blocking 8 ______________________________________________________________________ [36]Table of Contents arrangements with a client of this nature, or the awareness by a client’s competitors of such an arrangement, may make it difficult for us to obtain executive search assignments from, or to fulfill executive search assignments for, competitors while employees of that client may not be solicited |
| As our client base grows, particularly in our targeted business sectors, blocking arrangements increasingly may impede our growth or ability to attract and serve new clients |
| This could have an adverse effect on our business, results of operations and financial condition |
| We may be exposed to employment-related claims, legal liability and costs from both clients and employers that could adversely affect our business, financial condition and results of operations, and our insurance coverage may not cover all of our potential liability |
| We are in the business of employing people and placing them in the workplaces of other businesses |
| Risks relating to these activities include: • claims of misconduct or negligence on the part of our employees; • claims by our employees of discrimination or harassment directed at them, including claims relating to action of our clients; • claims related to the employment of illegal aliens or unlicensed personnel; • claims for payment of workers’ compensation claims and other similar claims; • claims for violations of wage and hour requirements; • claims for retroactive entitlement to employee benefits; • claims of errors and omissions of our temporary employees, particularly in the case of professionals; • claims by taxing authorities related to our employment of independent contractors and the risk that such contractors could be considered employees for tax purposes; • claims related to our non-compliance with data protection laws which require the consent of a candidate to transfer resumes and other data; and • claims by our clients relating to our employees’ misuse of client proprietary information, misappropriation of funds, other criminal activity or torts or other similar claims |
| We are exposed to potential claims with respect to the recruitment process |
| A client could assert a claim for matters such as breach of a blocking arrangement or recommending a candidate who subsequently proves to be unsuitable for the position filled |
| Similarly, a client could assert a claim for deceptive trade practices on the grounds that we failed to disclose certain referral information about the candidate or misrepresented material information about the candidate |
| Further, the current employer of a candidate whom we place could file a claim against us alleging interference with an employment contract |
| In addition, a candidate could assert an action against us for failure to maintain the confidentiality of the candidate’s employment search or for alleged discrimination or other violations of employment law by one of our clients |
| We may incur fines and other losses or negative publicity with respect to these problems |
| In addition, some or all of these claims may give rise to litigation, which could be time-consuming to our management team, costly and could have a negative impact on our business |
| In some cases, we have agreed to indemnify our clients against some or all of these types of liabilities |
| We cannot assure you that we will not experience these problems in the future, that our insurance will cover all claims or that our insurance coverage will continue to be available at economically feasible rates |
| We depend on our key management personnel |
| Our continued success will depend to a significant extent on our senior management, including Jon F Chait, our Chairman and CEO The loss of the services of Mr |
| Chait or one or more key employees could have a 9 ______________________________________________________________________ [37]Table of Contents material adverse effect on our business, financial condition and operating results |
| In addition, if one or more key employees join a competitor or form a competing company, the resulting loss of existing or potential clients could have a material adverse effect on our business, financial condition and operating results |
| There may be volatility in our stock price |
| The market price for our common stock has fluctuated in the past and could fluctuate substantially in the future |
| Factors such as the announcement of variations in our quarterly financial results or expected financial results could cause the market price of our common stock to fluctuate significantly |
| Further, due to the volatility of the stock market generally, the price of our common stock could fluctuate for reasons unrelated to our operating performance |
| Government regulations may result in the prohibition, regulation or restriction of certain types of employment services we offer or in the imposition of additional licensing or tax requirements that may reduce our future earnings |
| In many jurisdictions in which we operate, the temporary staffing industry is heavily regulated |
| For example, governmental regulations can restrict the length of contracts of temporary employees and the industries in which temporary employees may be used |
| In some countries, special taxes, fees or costs are imposed in connection with the use of temporary workers |
| For example, temporary workers in France are entitled to a 10prca allowance for the precarious nature of employment, which is eliminated if a full-time position is offered to them within three days |
| The countries in which we operate may: • create additional regulations that prohibit or restrict the types of employment services that we currently provide; • impose new or additional benefit requirements; • require us to obtain additional licensing to provide staffing services; or • increase taxes, such as sales or value-added taxes, payable by the providers of staffing services |
| Any future regulations that make it more difficult or expensive for us to continue to provide our staffing services may have a material adverse effect on our financial condition, results of operations and liquidity |
| Provisions in our organizational documents and Delaware law will make it more difficult for someone to acquire control of us |
| Our certificate of incorporation and by-laws and the Delaware General Corporation Law contain several provisions that make more difficult an acquisition of control of us in a transaction not approved by our board of directors, including transactions in which stockholders might otherwise receive a premium for their shares over then current prices, and that may limit the ability of stockholders to approve transactions that they may deem to be in their best interests |
| Our certificate of incorporation and by-laws include provisions: • dividing our board of directors into three classes to be elected on a staggered basis, one class each year; • authorizing our board of directors to issue shares of our preferred stock in one or more series without further authorization of our stockholders; • requiring that stockholders provide advance notice of any stockholder nomination of directors or any proposal of new business to be considered at any meeting of stockholders; • permitting removal of directors only for cause by a super-majority vote; • providing that vacancies on our board of directors will be filled by the remaining directors then in office; • requiring that a super-majority vote be obtained to amend or repeal specified provisions or our certificate of incorporation or by-laws; and 10 ______________________________________________________________________ [38]Table of Contents • eliminating the right of stockholders to call a special meeting of stockholders or take action by written consent without a meeting of stockholders |
| In addition, Section 203 of the Delaware General Corporation Law generally provides that a corporation may not engage in any business combination with any interested stockholder during the three-year period following the time that the stockholder becomes an interested stockholder, unless a majority of the directors then in office approve either the business combination or the transaction that results in the stockholder becoming an interested stockholder or specified stockholder approval requirements are met |
| In addition, our Board of Directors declared a dividend of one preferred share purchase right (a “Right”) for each outstanding share of common stock of the Company payable upon the close of business on February 28, 2005 to the stockholders of record on that date |
| Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, par value $ |
| 001 par value (“Preferred Shares”), of the Company at a price of dlra60 per one one-hundredth of a Preferred Share, subject to adjustment |
| These Rights may make the cost of acquiring the Company more expensive and, therefore, make an acquisition more difficult |