**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

Washington, D.C. 20549

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**Form 10-K**

| **x**      | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(D) OF THE  SECURITIES EXCHANGE ACT OF 1934**     |
|------------|----------------------------------------------------------------------------------------------------------|
| ** ** | **FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005**                                                          |
| **o**      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(D) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission file number: 0-20971**

**EdgewaterTechnology, Inc.**(Exactname of registrant as specified in its charter)

| **Delaware**                              | **71-0788538**       |
|-------------------------------------------|----------------------|
| (State or other jurisdiction  of          | (I.R.S. Employer     |
| incorporation or  organization)           | Identification  No.) |
| **20 Harvard Mill Square**                |                 |
| **Wakefield,  Massachusetts**             | **01880**            |
| (Address of  principal executive offices) | (Zip Code)           |

 

Registrant’s telephonenumber including area code: **(781) 246-3343**

**Securitiesregistered pursuant to Section 12(b) of the Act: None**

**Securitiesregistered pursuant to Section 12(g) of the Act:**

**Common Stock, $0.01 parvalue(Title of class)**

Indicate by a check mark ifthe registrant is a well-known seasoned issuer (as defined in Rule 405 ofthe Securities Exchange Act of 1934). Yes o   No x

Indicate by a check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Securities Exchange Act of 1934). Yes o   No x

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

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§229.405 of this chapter) is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.Yes o   No x

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer” and “largeaccelerated filer” in Rule 12b-2 of the Securities Exchange Act of1934. (Check one): Large accelerated filer o   Accelerated filer o   Non-accelerated filer x

Indicate by a check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Securities and Exchange Act of 1934). Yes o   No x

As of June 30, 2005,there were 10,353,451 shares of Common Stock of the Registrant outstanding. Theaggregate market value of the Common Stock of the Registrant held by non-affiliates(assuming for these purposes, but not conceding, that all executive officersand directors are “affiliates” of the Registrant) as of June 30, 2005 wasapproximately $45.5 million, computed based upon the closing price of $4.39 pershare on June 30, 2005.

As of March 15, 2006,there were 11,000,132 shares of Common Stock of the Registrant outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

Part III ofthis Annual Report on Form 10-K incorporates by reference portionsof the Registrant’s definitive proxy statement, to be filed with the Securitiesand Exchange Commission no later than 120 days after the close of its fiscalyear; provided that if such proxy statement is not filed with the Commission insuch 120-day period, an amendment to this Form 10-K shall befiled no later than the end of the 120-day period.

 

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**SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS**

Some of the statements under “Business,” “RiskFactors,” “Legal Proceedings,” “Market for Registrant’s Common Stock andRelated Stockholder Matters” and “Management Discussion and Analysis ofFinancial Condition and Results of Operations” and elsewhere in this AnnualReport on Form 10-K (this “Form 10-K”) constituteforward-looking statements under Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934, asamended, including statements made with respect to future earnings per share,future revenues, future operating income, future cash flows, potential businesscombination transactions, competitive and strategic initiatives, potentialstock repurchases and future liquidity needs. These statements involve knownand unknown risks, uncertainties and other factors that may cause results,levels of activity, growth, performance, earnings per share or achievements tobe materially different from any future results, levels of activity, growth,performance, earnings per share or achievements expressed or implied by suchforward-looking statements. Such factors include, among other things, thoselisted under “Business—Factors Affecting Finances, Business Prospects and StockVolatility” and elsewhere in this Form 10-K.

The forward-looking statements included in this Form 10-Kand referred to elsewhere are related to future events or our strategies orfuture financial performance. In some cases, you can identify forward-lookingstatements by terminology such as “may,” “should,” “believe,” “anticipate,” “future,”“forward,” “potential,” “estimate,” “encourage,” “opportunity,” “goal,” “objective,”“quality,” “growth,” “leader,” “could”, “expect,” “intend,” “plan,” “planned” “expand,”“focus,” “build,” “through,” “strategy,” “expiration,” “provide,”  “offer,” “maximize,” “allow,” “allowed,” “represent,”“commitment,” “create,” “implement,” “result,” “seeking,” “increase,” “add,” “establish,”“pursue,” “feel,” “work,” “perform,” “make,” “continue,”  “can,” “will,” “ongoing,” “include” or thenegative of such terms or comparable terminology. These forward-lookingstatements inherently involve certain risks and uncertainties, although theyare based on our current plans or assessments which are believed to bereasonable as of the date of this Form 10-K. Factors that may causeactual results, goals, targets or objectives to differ materially from thosecontemplated, projected, forecasted, estimated, anticipated, planned or budgetedin such forward-looking statements include, among others, the followingpossibilities: (1) inability to execute upon growth objectives, includinggrowth in entities acquired by our Company; (2) failure to obtain newcustomers or retain significant existing customers; (3) the loss of one ormore key executives and/or employees; (4) changes in industry trends, suchas a decline in the demand for Business Intelligence (“BI”) and CorporatePerformance Management (“CPM”) solutions, custom development and systemintegration services and/or delays in industry-wide information technology (“IT”)spending, whether on a temporary or permanent basis and/or delays by customersin initiating new projects or existing project milestones; (5) adversedevelopments and volatility involving geopolitical or technology marketconditions; (6) unanticipated events or the occurrence of fluctuations orvariability in the matters identified under “Critical Accounting Policies”; (7) failureof our sales pipeline to be converted to billable work and recorded as revenue;(8) failure of the middle market and the needs of middle-marketenterprises for business services to develop as anticipated; (9) inabilityto recruit and retain professionals with the high level of informationtechnology skills and experience needed to provide our services; (10) failureto expand outsourcing services to generate additional revenue; (11) any changesin ownership of the Company or otherwise that would result in a limitation ofthe net operating loss carryforward under applicable tax laws; (12) the failureof the marketplace to embrace CPM or BI services; and/or (13) the failure toobtain remaining predecessor entity tax records that are not in our controland/or successfully resolve remaining outstanding IRS matters relating to ourformer staffing businesses. In evaluating these statements, you shouldspecifically consider various factors described above as well as the risksoutlined under Item 1A. “Risk Factors Affecting Finances, Business Prospectsand Stock Volatility.”  These factors maycause our actual results to differ materially from those contemplated,projected, anticipated, planned or budgeted in any such forward-lookingstatements.

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

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**EDGEWATERTECHNOLOGY, INC.**

**Form 10-K**AnnualReportFor the Year Ended December 31, 2005

**TABLEOF CONTENTS**

|            | ** ** | ** **                                                                                                         | ** ** | **Page**   | ** ** |
|------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** ** | ** ** | **PART I**                                                                                                    |       |       |       |   |   |
| Item 1.    |       | Business                                                                                                           |       |       | 3          |   |   |
| Item  1A.  |       | Risk  Factors                                                                                                      |       |       | 11         |   |   |
| Item 1B.   |       | Unresolved Staff Comments                                                                                          |       |       | 16         |   |   |
| Item 2.    |       | Properties                                                                                                         |       |       | 16         |   |   |
| Item  3.   |       | Legal  Proceedings                                                                                                 |       |       | 16         |   |   |
| Item 4.    |       | Submission of Matters to a Vote of Security Holders                                                                |       |       | 16         |   |   |
| ** ** | ** ** | **PART II**                                                                                                   |       |       |       |   |   |
| Item 5.    |       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       |       | 17         |   |   |
| Item  6.   |       | Selected  Financial Data                                                                                           |       |       | 18         |   |   |
| Item 7.    |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                   |       |       | 20         |   |   |
| Item 7A.   |       | Quantitative and Qualitative Disclosures About Market  Risk                                                        |       |       | 35         |   |   |
| Item 8.    |       | Financial Statements and Supplementary Data                                                                        |       |       | 36         |   |   |
| Item 9.    |       | Changes in and Disagreements with Accountants on Accounting  and Financial Disclosure                              |       |       | 66         |   |   |
| Item 9A.   |       | Controls and Procedures                                                                                            |       |       | 66         |   |   |
| Item  9B.  |       | Other  Information                                                                                                 |       |       | 66         |   |   |
|       |       | **PART III**                                                                                                  |       |       |       |   |   |
| Item 10.   |       | Directors and Executive Officers of the Registrant                                                                 |       |       | 67         |   |   |
| Item 11.   |       | Executive Compensation                                                                                             |       |       | 67         |   |   |
| Item 12.   |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                    |       |       | 67         |   |   |
| Item 13.   |       | Certain Relationships and Related Transactions                                                                     |       |       | 67         |   |   |
| Item 14.   |       | Principal Accounting Fees and Services                                                                             |       |       | 67         |   |   |
| ** ** | ** ** | **PART IV**                                                                                                   |       |       |       |   |   |
| Item 15.   |       | Exhibits                                                                                                           |       |       | 68         |   |   |
| ** ** | ** ** | **OTHER ITEMS**                                                                                                    |       |       |       |   |   |
| ** ** | ** ** | Signatures                                                                                                         |       | ** ** | 72         |   |   |
|       |       | Power of  Attorney                                                                                                 |       |       | 72         |   |   |

 

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**PART I**

**AVAILABLEINFORMATION; BACKGROUND**

Edgewater Technology, Inc., formerly known asStaffMark, Inc., maintains executive offices located at 20 Harvard MillSquare, Wakefield, MA 01880-3209. Our telephone number is (781) 246-3343.Our stock is traded on the NASDAQ National Market under the symbol “EDGW.” OurInternet address is *www.edgewater.com*.We make available, free of charge, on the Investor Relations section of ourwebsite, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K and all amendments to those reports assoon as reasonably practicable after such material is electronically filed withthe Securities and Exchange Commission (the “SEC”). Copies are also available,without charge, from Edgewater Technology, Attn: Investor Relations, 20 HarvardMill Square, Wakefield, MA  01880-3209or by emailing *ir@edgewater.com*. Alternatively,reports filed with the SEC may be viewed or obtained at the SEC PublicReference Room in Washington, D.C., or the SEC’s Internet site at *www.sec.gov*. We do not intend for information contained inour website to be part of this Annual Report on Form 10-K.

In this Annual Report on Form 10-K,we use the terms “Edgewater Technology,” “we,” “our Company,” “the Company,” “our,”and “us” to refer to Edgewater Technology, Inc. and its wholly-ownedsubsidiaries. Our wholly-owned subsidiaries include:  Edgewater Technology (Delaware), Inc. (“EdgewaterDelaware”), a Delaware corporation that was incorporated in 1992 and acquiredby our Company on May 17, 1999; Edgewater Technology (Virginia), Inc.(formerly known as Intelix, Inc. and referred to in this Form 10-Kas  “Intelix”), a northern Virginiacorporation that was incorporated in 1993 and acquired by our Company on June 2,2003; and Edgewater Technology-Ranzal, Inc. (formerly known as Ranzal andAssociates, Inc. and referred to in this Form 10-K as “Ranzal”),a Delaware corporation that was incorporated in 2004 and acquired by ourCompany on October 4, 2004. Also, on February 15, 2006, the Companyacquired all of the outstanding capital stock of National Decision Systems, Inc(“NDS”). Please refer to Note 14 of the notes to consolidated financialstatements for more information related to the NDS acquisition.

**ITEM 1.**                BUSINESS

**Overview**

EdgewaterTechnology, Inc. is an innovative technology management consulting firmproviding a unique blend of premium IT services. We provide our clients with arange of business and technology offerings designed to assist them in:

·       envisioningand realizing strategic business solutions;

·       implementingcorporate performance management solutions;

·       optimizingbusiness processes to improve the delivery of products and services;

·       providingprogram and project management;

·       maximizingand unlocking the value of corporate data assets;

·       accessingand leveraging our blend of industry and technology expertise; and

·       evaluatingand leveraging infrastructure services.

Our primary target is themiddle market whose needs span the full spectrum of our offerings. We alsoprovide specialized premium services to divisions of Global 2000 companies. Wego to market by vertical industry and currently serve clients in the followingindustries: Consumer Packaged Goods/Manufacturing; 

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FinancialServices (Retail Banking, Portfolio/Asset Management); Healthcare(Payor/Managed Care); Higher Education; Hospitality; Insurance; Life Sciences;Retail; and various Emerging Markets.

**Industry Dynamicsand Opportunity**

*IndustryDynamics.*   In today’s complex businessenvironment, organizations are seeking ways to optimize business processes andimprove the delivery of information to customers, suppliers, employees,shareholders, partners and other constituents by enhancing IT systems. Whilemany organizations support their IT needs and initiatives internally, many arefaced with the realization that they lack the resources or expertise to clearlyidentify where improvements can be made. Organizations are looking to build,integrate and implement change across their enterprise and finding the rightindustry and technical expertise to assist in this process is an importantdecision.

Companies turn toconsulting firms like Edgewater Technology for a number of reasons, includingthe need:

·        Fordeep industry and technical expertise;

·        Toprovide premium consulting services in an accelerated timeframe;

·        Tomitigate their business risk;

·        Toreceive an outside objective perspective; and/or

·        Toserve as an agent to plan, manage and implement change.

We believe a structural change is taking place in theconsulting industry. The change is two-fold: customer buying habits arebecoming more complex and industry dynamics are evolving.

Customers are looking for lower cost commodityprogramming services to reduce overall operational expenses. In addition, theyare seeking premium consulting services to facilitate and expedite themanagement of (1) smaller strategic projects and (2) geographically-dispersedcomplex projects. They are looking to local firms to build strategic componentsor systems that address a specialized business problem. Lastly, customers areinvesting in IT to improve business process and corporate performance in orderto comply with new regulatory guidelines and successfully compete in today’sbusiness climate.

Consulting industry dynamics are evolving with theacceptance of business process outsourcing (BPO). IT service firms areenhancing their business models to expand services and delivery offerings. Theseofferings are also being supported by the growing global acceptance of theoffshore outsourcing model, which offers a compelling economic alternativeprimarily for software development services. While the BPO and outsourcingmodels have their advantages, it also provides an opportunity for technologymanagement consultants to become providers of premium IT services, which thesefirms do not typically have strong expertise.

*Industry Opportunity.**  *Technology has become such an integral part ofbusiness that it requires skilled strategic management in its own right. Technologyhas become a key enabler to business change when the appropriate strategicsteps, a meld of business process change and technology, are well laid out andthoughtfully executed. Technology management consulting firms deliverinnovative strategic thinking and in-depth vertical industry expertise, alongwith the ability to implement business process transformation through thejudicious use of the appropriate technologies.  Edgewater Technology has steadily enhanced ourofferings to address the evolving need for premium IT services and plan tocontinue to grow our competencies in this arena.

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**CompetitiveStrengths**

Edgewater Technology offers a unique blend of premiumIT services designed to assist our clients in improving financial andoperational performance across their enterprise. We develop business strategiesand technology solutions that address their specific needs while providing themwith increased competitive advantage. We feel that five core valuesdifferentiate us from the competition.

These valuesinclude the following:

(1)         **DeliveryExcellence**—Our history is built upon more than thirteen years ofproven methodology and well-defined process, in addition to continuallydelivering business and technology solutions that work. Our delivery excellenceis a derivative of a well-defined business plan, highly-skilled consultants,strong technical expertise, and established implementation and supportmethodologies. Most importantly, we use an iterative business and technologyapproach, with an emphasis on quality assurance and project management, toachieve rapid and successful deployment of our solutions. Our delivery historyhas contributed to our ability to build long-term customer relationships.

(2)         **VerticalExpertise/Horizontal Service Offerings**—We combine vertical-industryknowledge with a broad base of key strategic technologies to serve ourcustomers’ needs and deliver tailored and innovative strategies and solutions. Theprimary vertical markets where we have developed core competencies include:Consumer Packaged Goods/Manufacturing; Financial Services (Retail Banking,Portfolio/Asset Management); Healthcare (Payor/Managed Care); Higher Education;Hospitality; Insurance; Life Sciences; Retail; and various Emerging Markets.Horizontal service offerings include: Business Intelligence/Business ActivityMonitoring/Corporate Performance Management; Data Services; EnterpriseArchitecture Services; and Program/Project Management.

Thediagram that follows illustrates our vertical and horizontal service offerings:

(3)         **TechnologyExcellence**—We deliver our services by blending proven strategictechnologies and business practices to build scalable custom solutionsproviding a solid return on the investment. Our team of professionals has thetechnology expertise to offer comprehensive strategies and solutions. Our areasof technical expertise include: business activity monitoring, architectural 

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services (assessment andbuilds), service-oriented architectures, data and infrastructure services,transactional processing and legacy integration.

(4)         **Middle-MarketFocus**—Edgewater Technology is well positioned to serve thetechnology needs of the middle market. Their needs span the full spectrum ofour offerings. In 2005 alone, 86% of Edgewater Technology’s business wasderived from the middle market.

(5)         **Strong Operational Metrics**—Since our inception in 1992,Edgewater Technology’s original management team has built an organization thatis defined by a record of operational excellence, tracking key performanceindicators and well-defined operating metrics to manage our consultingresources, company utilization and gross margin.

**Business Strategy**

Our businessstrategy is to position our Company as the leading provider of premiuminformation technology services for both the middle market and divisions ofGlobal 2000 companies. We believe we can attain this strategic objective bydelivering a range of business and technology offerings. This approach enablesEdgewater to progress up the IT value pyramid and provides a measure ofinfluence over the sourcing of integration and software builds. To attain ourbusiness strategy objective, we will maximize our ability to deliver thefollowing capabilities:

·       *Envision and realize strategic business solutions*.   Weplan to serve our clients by delivering industry-based process re-engineeringservices coupled with strategic technology management services. These strategicbusiness solutions will assist clients to align their specific business goalswith an enterprise-wide IT strategy. We initially conduct an overall ITassessment and business analysis. This involves a detailed evaluation ofpossible technology alternatives, including whether the solution should be apackage solution, a customized solution or a combination of both.

·       *Implement corporate performance management solutions*.   Theprimary goal of the solutions we develop is to improve financial performanceand operating metrics across a client’s enterprise. We develop these solutionsby leveraging a blend of technology and vertical expertise as well aspartnering with industry CPM leaders, such as Hyperion Solutions. With CPM,clients are able to improve their overall operational performance andproductivity. A client’s ability to extract data and alert management ofoperational issues can enhance near real-time decision making—otherwise knownas Business Activity Monitoring, a building block of CPM.

·       *Optimize business processes to improve the delivery of products andservices*.   We deliver solutions that integrate effectively intoour client’s existing infrastructure while improving business operations thatsupport the generation of revenue. We develop these solutions by conductingbusiness process analysis. The analysis enables us to map business process withtechnology.

·       *Provide program and project management*.   We have theability to develop programs that manage multiple projects including those thatare complex and could involve multiple local and global vendors. To build the beststrategic, customized solutions, we take all facets of our client’s businessinto consideration and make recommendations that include an approach ofintegrating packaged and customized solutions.

·       *Maximize and unlock the value of corporate data assets*.   EdgewaterTechnology provides its clients with the necessary knowledge and experience tosuccessfully integrate data from the most complex systems. With provenmethodologies, we deliver data integration solutions, including data warehousesand data marts, enabling organizations to access, integrate, transform, anddeliver enterprise data from any source.

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·       *Infrastructure services*.   We offer a complete range ofmanaged IT services that enable our middle-market clients to concentrate ontheir core business, while being assured their technical infrastructure willsupport them as they grow. We offer services including infrastructureassessment and remediation, technology consulting, IT due diligence, as well asmanaged solution care, which includes hosting solutions; remote monitoring andmaintenance; network and operating systems maintenance; and applicationmaintenance. These strategic services ensure that our clients’ technicalinfrastructure will properly support their short- and long-term businessrequirements, while aligning their business goals with their technicalcapabilities.

·       *Access andleverage our blend of industry and technology expertise*.   Acrossall of our service offerings, we provide a combination of vertical businessknowledge along with technology expertise in the areas of strategy, technologyand program management. This approach enables us to deliver powerful businesssolutions for our clients.

**Our Services**

EdgewaterTechnology offers a full spectrum of services and expertise to ensure the successof our engagements, including:

·       **Strategy—**We blendour vertical industry and technology expertise to provide our clients withtechnology strategies that deliver long-term value across their enterprise. Ourteams of consulting professionals compile and disseminate defined deliverablesthat not only support business process change, but strategically drive business.We take a multi-disciplinary approach which ensures that strategic plans notonly serve the business need, but also are scalable, maintainable, andultimately deliver the expected return on investment.

·       **Design****—**Within this phase, we identify and documentthe detailed design of the solution which could range from what technologiesand tools will integrate with the client’s current IT infrastructure to whatcreative resources will be required to maintain consistency with the client’scurrent brand. In addition, this phase is where a new business flow can bedesigned to streamline processes and enhance business performance. By investingin the design phase of a project, organizations can (1) reduce overalldevelopment costs; (2) reshape the quality of corporate data assets andthe effectiveness of business process; and (3) provide a flexible platformfor more effective maintenance.

·       **Build****—**Edgewater Technology’s team provides ablended approach of services to develop and implement IT systems, includingtechnology, methodology, and project management. We build strategic solutionsthat address our client’s specific needs, provide them inherent value andensure that their solution aligns to their business goals.

·       **Infrastructure Services****—**We offer a complete range of technicalsupport services, which enables our clients to concentrate on their business,while being assured their technical infrastructure will support their growth. Ourcomplete range of infrastructure services enables our middle-market clients toconcentrate on their core business, while being assured their technicalinfrastructure will support them as they grow. We provide our clients with servicesthat include:

**·****      ***Managed Services*(including Application Support; Database Administration; Disaster RecoveryHosting; Help Desk; Hosting; Remote/Onsite Support & Services).

**·****      ***Technical Consulting &Advisory Services* (including Disaster Recovery Strategy &Services; Information Security Strategy & Services; InfrastructureProject Management; Infrastructure Strategy & Architecture;Integration Services; IT Due Diligence; IT Operational Excellence; IT Planning;Migration Planning).

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**·****      ***Assessment of Information Technology (IT) Infrastructure***(**including****Consolidation of IT Equipment; Create Stability in ITEnvironment; Implement Disaster Avoidance Strategy; Formulate Backup and Recovery Strategy; Standardize Software Upgradesto Ensure Manufacturer Support).

**·****      ***Management, Maintenance andSupport of the IT Environment* (including Supervision of DataManagement and Improved Reporting; Rectify Production Problems; Facilitate Maintenance Issues; AdministerSystem Upgrades and System Migrations; Implement Processes based on IndustryBest Practices).

Edgewater Technology hasthe proven expertise to plan, deliver and manage integration services thatimprove performance and maximize business results. We focus on deploying newsystems and unlocking the value of the existing corporate data assets. Thisproven expertise enables us to bring complex technologies and systems togetherwhile minimizing risk, leveraging our clients’ technology investments anddelivering tailored solutions.

**Customers;Significant Customers**

We derive a significantportion of our revenues from large projects with a limited number of customers.In 2005, our five largest customers accounted for 47.5% of our revenues. In2004, our five largest customers accounted for 69.0% of our revenues. One ofthese large customers is considered a related party. For further details, see “Item7—Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Related Party Transactions: Synapse.” During 2005, we recordedrevenues from 66 new customers, as compared to 28 new customers in 2004.

**Marketing, Salesand Strategic Alliances**

*Marketing.*   Theprimary goal of all of our marketing efforts is to generate sales opportunitiesby increasing Edgewater Technology’s brand awareness and value proposition. Ourmarketing efforts continued to be closely aligned with our go-to-marketstrategy, while introducing specific offerings that address business and ITchallenges clients face within a particular vertical market. We have developedcore competencies in delivering our services in key markets to increase theefficiency of our marketing efforts, we target specific areas of content on amonthly basis for each of our vertical practice areas. Marketing buildscampaigns around each content area, which include: marketing collateral,webinars, sell sheets, tradeshow/conference participation, speaking engagements,direct mail and public relations activities.

*Sales.**  *Our sales approach is to combine traditional saleswith our strength in verticals and technology. Our traditional sales functionis comprised of direct sales professionals and inside sales professionals. Bothwork closely with our practice directors to identify potential opportunitieswithin each account. Using a consultative selling methodology, target prospectsare identified and a pursuit plan is developed for each key account. Whencontact with a target is established, we utilize a blended sales model todemonstrate our expertise, combining consultative selling with traditionalsales methods, which typically consists of a business development manager, anindustry consultant and a technology consultant. This team approach to sellingallows Edgewater Technology to demonstrate, from the initial contact point, itsexpertise in both the specific industry as well as technology. Once thecustomer has engaged Edgewater Technology, our sales professionals maintaintheir relationships with the customer by working collaboratively with theconsulting professionals who are assigned to the customer.

*Strategic Alliances.**  *As part of our sales and marketingeffort, we have established working relationships with a number of companies,including: The Affiliated Alan Gray Companies, American Student Assistance,1Answer Solutions, BEA Systems, Corda Technologies, Document SciencesCorporation,  Hyperion, IBM, LumenSoftCorporation, Microsoft, Nexaweb Technologies, NuGenesis TechnologiesCorporation, Optical Image Technology, Oracle, PaperThin, SeaTab, SunMicrosystems and 

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UpStream Software. Thesealliances generally entail sharing sales leads, joint marketing efforts, makingjoint customer presentations, negotiating discounts on license fees or othercharges and conducting similar activities. Our arrangements with many of thesecompanies are informal and are not subject to definitive written agreements. Forthose companies with whom we do have definitive written agreements, thoseagreements are either terminable at will by either party or are for terms ofone year or less. We believe we have been successful in establishing allianceswith a strong group of companies who are either industry leaders orwell-regarded new entrants.

**ProfessionalRecruitment, Retention and Development**

Our success depends in part upon our ability torecruit and retain business and technology professionals with the high level ofskills and experience needed to provide our premium services. We believe thatthe combination of professional support, intellectual challenge, corporateculture and compensation we offer will continue to be attractive to these highly-skilledprofessionals. Our working environment also fosters collaboration, creativityand innovation. We believe that our employees are one of our most valuableassets.

*Employees.*   Asof December 31, 2005, Edgewater Technology had 282 employees. Of theseemployees, 233 were billable consultants and 49 were management andadministrative personnel, comprising sales, marketing, human resources,finance, accounting, internal information systems, and administrative support. Theaverage tenure of our employee base is approximately 5 years and the average “yearsof experience” is approximately 12 years.Our employees are not represented by a collective bargaining agreement. Webelieve that our employee relations are strong.

*Culture.*   Webelieve that our business culture is critically important in hiring andretaining qualified professionals. Our ability to provide effectivemultidisciplinary teams is dependent upon our ability to develop and sustain abusiness culture that is common across all disciplines and vertical practicesthroughout our Company. Our employees are talented and energetic professionalsthat come from a multitude of professional backgrounds. Edgewater Technologybelieves that this creates an exciting, diverse, and creative work environmentfor our employees.

*Compensation.*   Wehave a competitive compensation program that has been structured to attract andretain highly-skilled professionals. Edgewater Technology’s cash, bonus andequity compensation plans are tied to the achievement of the Company’sfinancial performance along with individual and team performance goals.

*Recruiting.*   Webelieve that our long-term success will depend upon our ability to attract,retain and motivate highly-skilled employees. Our recruitment department hastraditionally conducted its own direct recruiting efforts and coordinatedinformal and search firm referrals. We believe that our business model, whichresults in an intellectually stimulating work environment, provides greateropportunities for professional development and a dynamic corporate culture,enhances our ability to attract and retain top professionals.

*Professional Development.*   Webelieve that providing our professionals with a wide variety of challengingprojects, the opportunity to demonstrate ability and achieve professionaladvancement are keys to their retention. We work with our professionals toassist them with their professional development by offering internal andexternal learning opportunities. We encourage them to attain industrycertifications which strengthen their expertise in both business andtechnology. In addition, we also believe that the working relationships theyform on various project teams foster valuable formal and informal mentoring andknowledge sharing.

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**Competition**

Our service offerings consist of a full spectrum ofservices and expertise to ensure the success of IT projects. Our competitorsinclude IT solutions providers, in-house technical staff, software productcompanies with extended service organizations, international outsourcers of ITdevelopment, application and Web hosting firms and specialized providers ofCPM/BAM/BI.

There is significant competition in the management andIT consulting services space. Mergers or consolidations in our market may createnew, larger or better-capitalized competitors with enhanced abilities toattract and retain professionals. We also believe that the principle criteriaconsidered by prospective clients when selecting a consulting firm includeskills and capabilities of consultants, scope of services, service modelapproach, global presence, industry and technical expertise, reputation andquality of past work, perceived value and a results orientation.

The following is arepresentative list of competitors in the IT and management consulting servicesspace:

·       Systemsintegrators: Accenture, EDS, IBM Global Services, Inforte, Keane Consulting,LogicaCMG, Perficient, and Sapient;

·       Offshoresoftware development firms: Aztec Software, Cognizant Technology Solutions,Infosys, Indus, Satyam, Tata, and Wipro;

·       Managementconsulting firms: Bain & Company, Booz-Allen & Hamilton,Boston Consulting Group, DiamondCluster, and McKinsey & Company;

·       CorporatePerformance Management (CPM) / Business Activity Monitoring (BAM) / BusinessIntelligence (BI) providers: AnswerThink/Beacon, Greenbrier & Russel, InformaticaCorporation, ISA, Knightsbridge Solutions, Longview Solutions, MicroStrategy,Oracle, Palladium Consulting; and

·       Computer hardware, softwareand service vendors: Hewlett-Packard, IBM, Oracle and SAP.

**IntellectualProperty**

We consider our intellectual property to be a valuableasset in a highly competitive industry. We also consider our intellectualproperty to be an important factor in building brand recognition for qualityservice and performance. Therefore, we have secured certain service marks for ‘‘Edgewater,”“Edgewater Technology,’’ and “Edgewater Technology-Ranzal.” We believe we havesecured all rights to trademarks and trade names related to our business.

We rely on a combinationof trade secret, copyright and trademark laws to protect our proprietaryrights. In particular, we require each of our employees to sign an inventionand non-disclosure agreement, which provides that they must maintain theconfidentiality of our intellectual property and that any intellectual propertythat they develop while employed by us is the property of Edgewater Technology.We have developed detailed tools, processes and methodologies which are used indeveloping software code, scripts, libraries, data models, applications,business processes, frameworks and other technology used within our Company andin customer engagements. See also “Item 1A. Risk Factors AffectingFinances, Business Prospects and Stock Volatility.”

**Potential FutureStrategies, Transactions and Changes**

Critical to our ability to create long-termstockholder value, the Company will continue to pursue internal growthinitiatives and appropriate business combination transaction alternatives toachieve 

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growth. From time to time,we have engaged and we may continue to engage in preliminary discussions withvarious persons regarding potential business combination transactions.

We believe that our current cash reserves and ouranticipated cash flow from our operations will be, taken together, adequate forour working capital needs for at least the next twelve months. However, ouractual experience may differ significantly from our expectation, particularlyif we pursue growth through business combination transactions, which wepresently believe will be advantageous to building long-term stockholder value.In addition, other future events may adversely or materially affect ourbusiness, expenses or prospects and could affect our available cash or theavailability or cost of external financial resources.

We may, in thefuture, purchase common stock in the open market, in private transactions orotherwise, pursuant to any future board approved repurchase program. Any futurepurchases by us will depend on many factors, including:

·       Themarket price of our common stock at that time;

·       Ourbusiness strategy;

·       Ourbusiness and financial position; and

·       General economic and marketconditions.

**ITEM 1A.**        RISKFACTORS

**Risk FactorsAffecting Finances, Business Prospects and Stock Volatility**

In addition to other information contained in this Form 10-K,the following risk factors should be carefully considered in evaluatingEdgewater Technology and its business because such factors could have asignificant impact on our business, operating results and financial condition. Theserisk factors could cause actual results to materially differ from thoseprojected in any forward-looking statements.

***Our success dependson a limited number of significant customers, and our results of operations andfinancial condition could be negatively affected by the loss of a majorcustomer or significant project or the failure to collect a large accountreceivable.***   We generate a significantportion of our service revenues from a limited number of customers. As a result,if we were to lose a major customer or large project, our service revenuescould be materially and adversely affected. In 2005, our five largest customersaccounted for 47.5% of our service revenues. In 2004, our five largestcustomers accounted for 69.0% of our service revenues. We perform varyingamounts of work for specific customers from year to year. A major customer inone year may not use our services in another year. In addition, we may deriverevenues from a major customer that constitutes a large portion of a particularquarter’s total revenues. If we lose any major customers or any of ourcustomers cancel or significantly reduce a large project’s scope, including butnot limited to Synapse, our results of operations and financial condition couldbe materially and adversely affected. Further, if we fail to collect a largeaccounts receivable balance, we could be subjected to a material financialexpense and a decrease in cash flow.

***Our lack oflong-term customer contracts reduces the predictability of our revenues becausethese contracts may be canceled on short notice and without penalty.***   Ourcustomers generally retain us on a project-by-project basis, rather than underlong-term contracts. As a result, a customer may not engage us for furtherservices once a project is complete. If a significant customer, or a number ofcustomers, terminate, significantly reduce, or modify their contracts with us,our results of operations would be materially and adversely affected.Consequently, future revenues should not be predicted or anticipated based onthe number of customers we have or the number and size of our existingprojects. If a customer were to postpone, modify, or cancel a project,including but not limited to Synapse, we would be required to shift ourconsultants to other projects to minimize the impact on our operating results.We cannot provide 

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assurance that we will besuccessful in efficiently and effectively shifting our consultants to newprojects in the event of project terminations, which could result in reducedservice revenues and lower gross margins. If we experience unexpected changesor variability in our revenue, we could experience variations in our quarterlyoperating results and our actual results may differ materially from the amountsplanned and our operating profitability may be reduced or eliminated.

***If we fail tosatisfy our customers’ expectations, our existing and continuing business couldbe adversely affected.******  ***Oursales and marketing strategy emphasizes our belief that we have highlyreferenceable accounts. Therefore, if we fail to satisfy the expectations ofour customers, we could damage our reputation and our ability to retainexisting customers and attract new customers. In addition, if we fail todeliver and perform on our engagements, we could be liable to our customers forbreach of contract. Although most of our contracts limit the amount of anydamages to the fees we receive, we could still incur substantial cost, negativepublicity, and diversion of management resources to defend a claim, and as aresult, our business results could suffer.

***We may have lowermargins, or lose money, on fixed-price contracts.*****  **As part of our strategy, we intend to continue togrow our business with time-and-materials contracts, fixed-price contracts, andfixed-fee contracts. In 2005, fixed-price contracts represented approximately11.5% of our service revenues. We assume greater financial risk on fixed-pricecontracts than on time-and-materials or fixed-fee engagements, and we cannotassure you that we will be able to successfully price our larger fixed-pricecontracts. If we fail to accurately estimate the resources and time requiredfor an engagement, fail to manage customer expectations effectively or fail tocomplete fixed-price engagements within planned budgets, on time and to ourcustomers’ satisfaction, we could be exposed to cost overruns, potentiallyleading to lower gross profit margins, or even losses on these engagements.

***Competition in theIT and management consulting services market is intense and, therefore, we maylose projects to, or face pricing pressure from, our competitors or prospectivecustomers’ internal IT departments or international outsourcing firms.***   Themarket for IT and management consulting providers is highly competitive. Inmany cases, we compete for premium IT services work with in-house technicalstaff, software product companies with extended service organizations and otherinternational IT and management consulting firms, including offshoreoutsourcing firms. In addition, there are many small, boutique technologymanagement consulting firms who have developed services similar to thoseoffered by us. We believe that competition will continue to be strong and mayincrease in the future, especially if our competitors continue to reduce theirprice for IT and management consulting services. Such pricing pressure couldhave a material impact on our revenues and margins and limit our ability toprovide competitive services.

Our target market is rapidly evolving and is subjectto continuous technological change. As a result, our competitors may be betterpositioned to address these developments or may react more favorably to thesechanges, which could have a material adverse effect on our business. We competeon the basis of a number of factors, many of which are beyond our control.Existing or future competitors may develop or offer IT and managementconsulting services that provide significant technological, creative,performance, price or other advantages over the services we offer.

See “Item 1—Business—Competition” for a representativelist of competitors in the IT and management consulting services space.

Some of our competitors have longer operatinghistories and significantly greater financial, technical, marketing andmanagerial resources than we do. There are relatively low barriers of entryinto our business. We have no patented or other proprietary technology thatwould preclude or inhibit competitors from entering the IT services market.Therefore, we must rely on the skill of our personnel and the quality of ourcustomer service. The costs to start an IT and management consulting servicesfirm are low. We expect that we will continue to face additional competitionfrom new entrants into the market in the 

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future, offshore providersand larger integrators and we are subject to the risk that our employees mayleave us and may start competing businesses. Any one or more of these factorscould have a material impact on our business.

***Because we rely onhighly-trained and experienced personnel to design and build complex systemsfor our customers, an inability to retain existing employees and attract newqualified employees would impair our ability to provide our services toexisting and new customers.***   Our futuresuccess depends in large part on our ability to attract new qualified employeesand retain existing highly-trained and experienced technical consultants,project management consultants, business analysts and sales and marketingprofessionals of various experience levels. If we fail to attract new employeesor retain our existing employees, we may be unable to complete existingprojects or bid for new projects of similar size, which could adversely affectour revenues. While attracting and retaining experienced employees is criticalto our business and growth strategy, maintaining our current employee base mayalso be particularly difficult. Even if we are able to grow and expand ouremployee base, the additional resources required to attract new employees andretain existing employees may adversely affect our operating margins.

***We depend on ourkey personnel, and the loss of their services may adversely affect our business.*****  **We believe that our success depends on the continuedemployment of the senior management team and other key personnel. Thisdependence is particularly important to our business because personalrelationships are a critical element in obtaining and maintaining customerengagements. If one or more members of the senior management team or other keypersonnel were unable or unwilling to continue in their present positions, ourbusiness could be seriously harmed. Furthermore, other companies seeking todevelop in-house business capabilities may hire away some of our key personnel.

***Past orFuture business combination transactions or other strategic alternatives coulddisrupt our ongoing business, distract our management and employees, increaseour expenses and adversely affect our business.*****  **We realized recent growth, in part, through acquisitions,and we anticipate that a portion of our future growth may be accomplishedthrough one or more business combination transactions or other strategicalternatives. The ultimate success of any such transactions will depend upon,among other things, our ability to integrate acquired personnel, operations,products and technologies into our organization effectively, to retain andmotivate key personnel of acquired businesses and to retain customers ofacquired businesses. We cannot assure you that we will be successful in thisregard or that we will be able to identify suitable opportunities, continue tosuccessfully grow acquired businesses, integrate acquired personnel andoperations successfully or utilize our cash or equity securities as acquisitioncurrency on acceptable terms to complete any such business combinationtransactions. These difficulties could disrupt our ongoing business, distractour management and employees, increase our expenses and materially andadversely affect our results of operations. Any such transactions would involvecertain other risks, including the reduction of cash and/or working capital,the assumption of additional liabilities, potentially dilutive issuances ofequity securities and diversion of management’s attention from operatingactivities.

***Volatility of ourstock price could result in expensive class action litigation.*****  **If our common stock suffers from volatility like thesecurities of other technology and consulting companies, we could be subject tosecurities class action litigation similar to that which has been broughtagainst other companies following periods of volatility in the market price oftheir common stock. The process of defending against these types of claims,regardless of their merit, is costly and often creates a considerabledistraction to senior management. Any future litigation could result in substantialadditional costs and could divert our resources and senior management’sattention. This could harm our productivity and profitability and potentiallyadversely affect our stock price.

***We may not be able to protect our intellectualproperty rights or we may infringe upon the intellectual property rights ofothers, which could adversely affect our business.***   Ourfuture success will depend, in part, upon our intellectual property rights andour ability to protect these rights. We do not have any patents or 

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patent applications pending. Existing trade secret andcopyright laws afford us only limited protection. Third parties may attempt todisclose, obtain or use our solutions or technologies. This is particularlytrue in foreign countries where laws or law enforcement practices may notprotect our proprietary rights as fully as in the United States. Others mayindependently develop and obtain patents or copyrights for technologies thatare similar or superior to our technologies. If that happens, we may need tolicense these technologies and we may not be able to obtain licenses onreasonable terms, if at all. If we are unsuccessful in any future intellectualproperty litigation, we may be forced to do one or more of the following:

·       Ceaseselling or using technology or services that incorporate the challengedintellectual property;

·       Obtaina license, which may not be available on reasonable terms or at all, to use therelevant technology;

·       Configureservices to avoid infringement; and

·       Refundlicense fees or other payments that we have previously received.

Generally, we developsoftware applications for specific customer engagements. Issues relating toownership of and rights to use software applications and frameworks can becomplicated. Also, we may have to pay economic damages in these disputes, whichcould adversely affect our results of operations and financial condition.

***Fluctuations in our quarterly revenues and operatingresults may lead to reduced prices for our stock.*****  **Our quarterly revenues and operating results cansometimes be volatile. We believe comparisons of prior period operating resultscannot be relied upon as indicators of future performance. If our revenues orour operating results in any future period fall below the expectations ofsecurities analysts and investors, the market price of our securities wouldlikely decline.

Factorsthat may cause our quarterly results to fluctuate in the future include thefollowing:

·       Variabilityin market demand for IT and management consulting services;

·       Lengthof the sales cycle associated with our service offerings;

·       Unanticipatedvariations in the size, budget, number or progress toward completion of ourengagements;

·       Unanticipatedtermination of a major engagement, a customer’s decision not to proceed with anengagement we anticipated or the completion or delay during a quarter ofseveral major customer engagements;

·       Efficiencywith which we utilize our employees, or utilization, including our ability totransition employees from completed engagements to new engagements;

·       Ourability to manage our operating costs, a large portion of which are fixed inadvance of any particular quarter;

·       Changesin pricing policies by us or our competitors;

·       Seasonalityand cyclicality, including the effects of lower utilization rates duringperiods with disproportionately high holiday and vacation usage experience;

·       Timingand cost of new office expansions;

·       Thetiming of customer year-end periods and the impact of spending relative to suchyear-end periods;

·       Ourability to manage future growth; and

·       Costsof attracting, retaining and training skilled personnel.

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Some of these factors arewithin our control, while others are outside of our control.

***Anti-takeoverprovisions in our charter documents, our stockholder rights plan and/orDelaware law could prevent or delay a change in control of our Company.***   OurBoard of Directors can issue preferred stock in one or more series withoutstockholder action. The existence of this “blank-check” preferred stockprovision could render more difficult or discourage an attempt to obtaincontrol by means of a tender offer, merger, proxy contest or otherwise. Inaddition, our Company has a stockholder rights plan, commonly referred to as a “poisonpill,” that may discourage an attempt to obtain control by means of a tenderoffer, merger, proxy contest or otherwise. If a person acquires 20% or more ofour outstanding shares of common stock, except for certain institutionalstockholders, who may acquire up to 25% of our outstanding shares of commonstock, then rights under this plan would be triggered, which wouldsignificantly dilute the voting rights of any such acquiring person. Certainprovisions of the Delaware General Corporation Law may also discourage someonefrom acquiring or merging with us.

***If clients viewoffshore development as a viable alternative to our service offerings, ourpricing, revenue, margins and profitability may be negatively affected.******  ****A trend has developed whereasinternational IT service firms have been founded in countries such as India andChina, which have well-educated and technically-trained workforces available atwage rates that are substantially lower than U.S. wage rates. Whiletraditionally we have not competed with offshore development, presently thisform of software development is experiencing rapid and increasing acceptance inthe market. To counteract this trend, we are focusing towards premium serviceofferings, including design and strategy consulting engagements, which are moredifficult for offshore development firms to replicate. If we are unable tocontinually evolve our service offerings or the rate of acceptance of offshoredevelopment advances even faster than we expect, then our pricing and revenuecould be adversely affected.*

***We may be requiredto record additional goodwill impairment charges in future quarters.****  *As of December 31, 2005, we had recordedgoodwill and related intangible assets with a net book value of $17.1 millionrelated to prior acquisitions. We test for impairment at least annually andwhenever evidence of impairment exists. We performed our annual goodwillimpairment test as of December 2, 2005 and 2004 and determined that thegoodwill and related intangible assets were not impaired. We have in the pastrecorded impairments to our goodwill, however. In January 2002, werecorded as a change in accounting principle, a non-cash impairment charge of$12.5 million related to our goodwill. We recorded an additional non-cashcharge of $7.4 million, related to a further impairment in December 2002. See“Item 8—Financial Statements and Supplementary Data—Note 2.” As goodwillvalues are measured using a variety of factors, including values of comparablecompanies and using overall stock market and economic data, in addition to ourown future financial performance, we may be required in the future to recordadditional impairment charges that could have a material adverse effect on ourreported results.

***We may not generateenough income this year or in future periods to maintain the current netcarrying value of our deferred tax asset.***   We have a deferred tax assetof approximately $21.5 million, net of an applicable valuation allowance, as ofDecember 31, 2005. If we are unable to generate enough income this year orin future periods, the valuation allowance relating to our deferred tax assetmay have to be revised upward, which would reduce the carrying value of thisasset on our balance sheet under generally accepted accounting principles. Anincrease in the valuation allowance and a related reduction in the carryingvalue of this asset would increase our provision for income taxes, therebyreducing net income or increasing net loss, and could reduce our total assets(depending on the amount of any such change or changes). An increase in thevaluation allowance could otherwise have a material adverse effect on ourresults of operations and/or our stockholders’ equity and financial position.

***Material changes toour strategic relationship with Hyperion.****  *The Ranzal business, which we acquired in October of2004, derives a substantial portion of its revenues from a channel relationshipwith Hyperion Solutions Corporation. This relationship involves Hyperionassisted lead generation support with respect 

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to the businessintelligence services provided by Ranzal. This relationship is governed by aConsulting Reseller Partner Agreement, which is subject to annual renewal andis scheduled to expire in October of 2006. A failure to renew thisrelationship, or a material modification or change in Hyperion’s partnerapproach or its contract terms, for any reason, could have a material adverseimpact on our results of operations.

***Our reliance upon Synapse.  ******The Synapse Group, Inc. (“Synapse”),***as more fully described in “Item 7—Management’sDiscussion and Analysis of Financial Condition and Results of Operations—Related-PartyTransactions,” is considered both a significant customer and a related party. Revenuesfrom Synapse amounted to $8.4 million, or 21.2% of service revenues, and $9.7million, or 39.0% of service revenues, for 2005 and 2004, respectively. Infiscal 2005, we experienced a planned decrease in revenues of approximately$1.3 million from Synapse due to anticipated reductions in Synapse’s demand forour services. The Company provides services to Synapse related toinfrastructure support, custom software development and systems integration. Servicesare provided on both a fixed-fee and time and materials basis. Our contractswith Synapse, including all terms and conditions, are consistent with those wehave with our other customers and are negotiated on an annual basis. Theexisting one-year services contract with Synapse, which was entered into in January of2005, has been automatically extended, as per the terms of the contract, for anadditional six-month period. The contract extension became effective on January 1,2006. The Company anticipates that it will enter into a new one-year services contractwith Synapse during the first quarter of fiscal 2006. It is also anticipatedthat Synapse will purchase professional services consistent with thosepurchased in fiscal 2005, which approximated $8.4 million. There is noguarantee that the Company will be able to successfully negotiate a newcontract with Synapse at the end of the current contract period. Additionally,there is no guarantee that revenues related to Synapse services will becomparable to those generated in the past.

**ITEM1B.**       UNRESOLVED STAFF COMMENTS

None.

**ITEM 2.**                PROPERTIES

We lease 30,004 squarefeet of office space for our principal executive offices currently located at20 Harvard Mill Square, Wakefield, Massachusetts 01880-3209. Thelease for our corporate headquarters was extended for a 10 year period on December 31,2003 and this lease expires on December 31, 2013. We also have officefacilities in Arkansas, New Hampshire, New York, and Virginia. Our corporateand satellite offices are all leased properties. We do not own any real estate.An office located in Fayetteville, Arkansas, which was the Company’s principalexecutive offices until the 2001 fiscal year, is a leased property, which wesublet to a third party on July 1, 2002 until June 30, 2007. TheFayetteville, Arkansas lease expires on June 30, 2009. Our existingproperties satisfy our current operating needs, however we will seek additionalspace in the event our existing properties are unable to meet our operatingrequirements.

**ITEM 3.**                LEGALPROCEEDINGS

We are sometimes a partyto litigation incidental to our business. We maintain insurance in amounts,with coverages and deductibles that we believe are reasonable. As of the dateof the filing of this Form 10-K, our Company is not a party to anyexisting material litigation matters.

**ITEM4.**                SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

**Nomatters were submitted to a vote of security holders during the fourth quarterof 2005.**

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

**Stock Price Information**

Ourcommon stock, which has a par value of $0.01 per share, trades on the NASDAQNational Market under the symbol “EDGW.” On March 15, 2006, there wereapproximately 2,081 holders of record of our common stock and 11,000,132million shares of our common stock were outstanding. The number of recordholders indicated above does not reflect persons or entities that hold theirshares of stock in nominee or “street” name through various bankers orbrokerage firms. Based on our Company’s solicitations of proxies in April 2005,we estimate that there are approximately 8,000 holders of our Company’s commonstock. The following table sets forth the range of high and low trading pricesfor our common stock as reported by the NASDAQ National Market for each quarterin 2004 and 2005 and the first quarter of 2006 through March 15, 2006.

| ** **                    | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------------------|------------|----------|------------|---------|------------|
| **FISCAL 2004:**              |       |     |       |    |       |
| First Quarter                 |       | $        | 8.50       |    | $          | 4.65 |   |
| Second Quarter                |       | 7.15     |       | 5.10    |       |
| Third Quarter                 |       | 6.19     |       | 4.50    |       |
| Fourth Quarter                |       | 5.15     |       | 3.80    |       |
| **FISCAL  2005:**             |       |     |       |    |       |
| First Quarter                 |       | $        | 5.66       |    | $          | 4.16 |   |
| Second Quarter                |       | 4.60     |       | 3.90    |       |
| Third Quarter                 |       | 5.75     |       | 4.00    |       |
| Fourth Quarter                |       | 6.26     |       | 4.59    |       |
| **FISCAL  2006:**             |       |     |       |    |       |
| First Quarter                 |       | $        | 6.66       |    | $          | 5.58 |   |
| (through March 15, 2006) |       |     |       |    |       |

 

**Other Stockholder Matters**

We have not paid dividends in the past and intend toretain any earnings to finance the expansion and operations of our business.Subject to the items discussed in “Item 1—Business—Potential Future Strategies,Transactions and Changes,” we do not anticipate paying any cash dividends withregard to cash generated through our normal operations in the foreseeablefuture.  The trading price of our commonstock is subject to wide fluctuations in response to quarterly variations inoperating results, announcements of acquisitions, performance by ourcompetitors, and other market events or factors. In addition, the stock markethas, from time to time, experienced price and volume fluctuations, which haveparticularly affected the market price of many professional service companiesand which often have been unrelated to the operating performance of thesecompanies. These broad market fluctuations may adversely affect the marketprice of our common stock.

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**ITEM 6.**                SELECTEDFINANCIAL DATA

The2005, 2004, 2003, 2002 and 2001 selected consolidated financial data presentedbelow has been derived from our audited consolidated financial statements. Ourformer operating businesses, consisting of the StaffMark commercial staffingdivision, Robert Walters, Strategic Legal, IntelliMark and ClinForce arepresented as discontinued operations. We believe that this information shouldbe read in conjunction with our audited consolidated financial statements andaccompanying notes and “Item 7—Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” included elsewhere in this Form 10-K.

| ** **                                                                                                                       | ** ** | **Year Ended December 31,**                         | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                                       | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                                                                       | ** ** | **(In thousands, except per share data)** | ** ** |
| **Consolidated Statements of Operations Data:**                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Total revenue                                                                                                                    |       | $                                                                  | 43,126     |   | $ | 25,322 |   | $ | 25,054 |   | $ | 18,666 |   | $ | 26,574 |   |
| Cost of revenue                                                                                                                  |       | 25,126                                                             |       | 15,659 |   | 13,540 |   | 11,905 |   | 15,733 |   |
| Gross profit                                                                                                                     |       | 18,000                                                             |       | 9,663 |   | 11,514 |   | 6,761 |   | 10,841 |   |
| Operating expenses:                                                                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Selling, general and  administrative                                                                                             |       | 15,883                                                             |       | 10,154 |   | 10,080 |   | 8,833 |   | 10,551 |   |
| Depreciation and  amortization                                                                                                   |       | 1,046                                                              |       | 896 |   | 948 |   | 1,003 |   | 5,465 |   |
| Impairment of goodwill(1)                                                                                                        |       | —                                                             |       | — |   | — |   | 7,411 |   | — |   |
| Restructuring(2)                                                                                                                 |       | —                                                             |       | — |   | — |   | 349 |   | — |   |
| Total operating expenses                                                                                                         |       | 16,929                                                             |       | 11,050 |   | 11,028 |   | 17,596 |   | 16,016 |   |
| Operating income (loss)                                                                                                          |       | 1,071                                                              |       | (1,387 | ) | 486 |   | (10,835 | ) | (5,175 | ) |
| Interest income, net                                                                                                             |       | 1,054                                                              |       | 556 |   | 455 |   | 777 |   | 2,090 |   |
| Income (loss) before  taxes, discontinued operations, extraordinary item and change in accounting  principle                     |       | 2,125                                                              |       | (831 | ) | 941 |   | (10,058 | ) | (3,085 | ) |
| Tax provision (benefit)                                                                                                          |       | 850                                                                |       | — |   | (1,053 | ) | — |   | 593 |   |
| Income (loss) from  continuing operations before discontinued operations, extraordinary item and  change in accounting principle |       | 1,275                                                              |       | (831 | ) | 1,994 |   | (10,058 | ) | (3,678 | ) |
| Discontinued operations:                                                                                                         |       |                                                               |       |   |   |   |   |   |   |   |   |
| Income (loss) from  operations of discontinued divisions, net of applicable taxes                                                |       | 325                                                                |       | 236 |   | (1,020 | ) | (950 | ) | (904 | ) |
| Gain on sale of  divisions, net of applicable taxes                                                                              |       | —                                                             |       | — |   | — |   | — |   | 6,514 |   |
| Income (loss) before  extraordinary item and change in accounting principle                                                      |       | 1,600                                                              |       | (595 | ) | 974 |   | (11,008 | ) | 1,932 |   |
| Extraordinary item, net  of applicable taxes                                                                                     |       | —                                                             |       | — |   | — |   | — |   | (27 | ) |
| Change in accounting  principle(1)                                                                                               |       | —                                                             |       | — |   | — |   | (12,451 | ) | — |   |
| Net income (loss)                                                                                                                |       | $                                                                  | 1,600      |   | $ | (595 | ) | $ | 974 |   | $ | (23,459 | ) | $ | 1,905 |   |
| Basic income (loss) per share:                                                                                                   |       |                                                               |       |   |   |   |   |   |   |   |   |
| Continuing operations                                                                                                            |       | $                                                                  | 0.13       |   | $ | (0.07 | ) | $ | 0.18 |   | $ | (0.87 | ) | $ | (0.29 | ) |
| Discontinued operations                                                                                                          |       | 0.03                                                               |       | 0.02 |   | (0.09 | ) | (0.08 | ) | 0.44 |   |
| Extraordinary item                                                                                                               |       | —                                                             |       | — |   | — |   | — |   | — |   |
| Change in accounting  principle                                                                                                  |       | —                                                             |       | — |   | — |   | (1.08 | ) | — |   |
| Net income (loss)                                                                                                                |       | $                                                                  | 0.16       |   | $ | (0.05 | ) | $ | 0.09 |   | $ | (2.03 | ) | $ | 0.15 |   |
| Weighted average shares,  basic                                                                                                  |       | 10,241                                                             |       | 11,283 |   | 11,381 |   | 11,575 |   | 12,858 |   |
| Diluted income (loss) per share:                                                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |
| Continuing operations                                                                                                            |       | $                                                                  | 0.12       |   | $ | (0.07 | ) | $ | 0.17 |   | $ | (0.87 | ) | $ | (0.28 | ) |
| Discontinued operations                                                                                                          |       | 0.03                                                               |       | 0.02 |   | (0.09 | ) | (0.08 | ) | 0.43 |   |
| Extraordinary item                                                                                                               |       | —                                                             |       | — |   | — |   | — |   | — |   |
| Change in accounting  principle                                                                                                  |       | —                                                             |       | — |   | — |   | (1.08 | ) | — |   |
| Net income (loss)                                                                                                                |       | $                                                                  | 0.15       |   | $ | (0.05 | ) | $ | 0.08 |   | $ | (2.03 | ) | $ | 0.15 |   |
| Weighted average shares, diluted                                                                                                 |       | 10,653                                                             |       | 11,283 |   | 11,694 |   | 11,575 |   | 12,935 |   |

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Referto footnotes on following page.

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(1)             The Company adopted Statement of Financial AccountingStandards (“SFAS”) No. 142 on January 1, 2002 and, in accordancetherewith, recorded as a change in accounting principle a non-cash charge of$12.5 million relating to an impairment of recorded goodwill. On December 2,2002, the selected annual measurement date, the Company recorded an additionalnon-cash charge of $7.4 million, relating to a further impairment of goodwill. See“Item 8—Financial Statements and Supplementary Data—Note 2” included elsewhereherein.

(2)             As a result of a workforce reduction on February 28,2002, the Company recorded approximately $0.3 million in associatedrestructuring charges related to severance costs.

| ** **                                                    | ** ** | **As of December 31,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                    | ** ** | **(In Thousands)**               | ** ** |
| **Consolidated Balance Sheet Data:**           |       |                                  |       |   |   |   |   |   |   |   |   |
| Cash equivalents, marketable securities and accrued  interest |       | $                                     | 33,763     |   | $ | 33,908 |   | $ | 44,259 |   | $ | 46,782 |   | $ | 51,501 |   |
| Accounts receivable, net                                      |       | 9,858                                 |       | 5,272 |   | 3,532 |   | 2,647 |   | 4,045 |   |
| Goodwill and intangibles                                      |       | 17,076                                |       | 16,628 |   | 13,135 |   | 11,614 |   | 31,807 |   |
| Deferred tax asset                                            |       | 21,491                                |       | 22,213 |   | 22,175 |   | 22,884 |   | 22,523 |   |
| Other assets                                                  |       | 2,401                                 |       | 3,681 |   | 3,430 |   | 2,566 |   | 2,971 |   |
| Total assets                                                  |       | $                                     | 84,589     |   | $ | 81,702 |   | $ | 86,531 |   | $ | 86,493 |   | $ | 112,847 |   |
| Total liabilities                                             |       | $                                     | 6,504      |   | $ | 5,106 |   | $ | 5,647 |   | $ | 5,456 |   | $ | 7,855 |   |
| Stockholders’ equity                                     |       | 78,085                                |       | 76,596 |   | 80,884 |   | 81,037 |   | 104,992 |   |
| Total liabilities and stockholders’ equity               |       | $                                     | 84,589     |   | $ | 81,702 |   | $ | 86,531 |   | $ | 86,493 |   | $ | 112,847 |   |
| Outstanding shares  of common stock                           |       | 10,683                                |       | 10,549 |   | 11,366 |   | 11,485 |   | 11,594 |   |

 

 

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussionshould be read in conjunction with the “Item 6—Selected Financial Data” and “Item8—Financial Statements and Supplementary Data” and the related notes thereto inthis Annual Report on Form 10-K.

**Overview**

Edgewater is an innovative technology managementconsulting firm providing a unique blend of premium IT services. Our primarytarget is the middle market whose needs span the full spectrum of our offerings.We also provide specialized premium services to divisions of Global 2000companies. During the fiscal year ended December 31, 2005, we generatedrevenues, including reimbursement of out-of-pocket expenses, of approximately$43.1 million from a total of 158 clients. Headquartered in Wakefield,Massachusetts, as of December 31, 2005, our Company employed approximately233 technical consulting professionals.

Our ability to generate revenue is affected by thelevel of business activity of our clients, which in turn is affected by thelevel of economic activity in the industries and markets that they serve. Adecline in the level of business activity of our clients could have a materialadverse effect on our revenue and profit margin.

The largest portion of our operating expenses consistsof project personnel and related expenses. Project personnel expenses consistof payroll costs and related benefits associated with professional staff. Otherrelated expenses include travel, subcontracting, third-party vendor paymentsand non-billable costs associated with the delivery of services to our clients.We consider the relationship between project personnel expenses and revenue tobe an important measure of our operating performance. The relationship betweenproject personnel expenses and revenue is driven largely by the chargeabilityof our consultant base, the prices we charge our clients and the non-billablecosts associated with securing new client engagements and developing newservice offerings. The remainder of our recurring operating expenses iscomprised of expenses associated with the development of our business and thesupport of our client-serving professionals, such as professional developmentand recruiting, marketing and sales, and management and administrative support.Professional development and recruiting expenses consist primarily ofrecruiting and training content development and delivery costs. Marketing andsales expenses consist primarily of the costs associated with the developmentand maintenance of our marketing materials and programs. Management andadministrative support expenses consist primarily of the costs associated withoperations including finance, information systems, human resources, facilities(including the rent of office space), and other administrative support forproject personnel.

We regularly review our fees for services,professional compensation and overhead costs to ensure that our services andcompensation are competitive within the industry, and that our overhead costsare balanced with our revenue level. In addition, we monitor the progress ofclient projects with client senior management. We manage the activities of ourprofessionals by closely monitoring engagement schedules and staffingrequirements for new engagements. However, a rapid decline in the demand forthe professional services that we provide could result in lower utilization ofour professionals than we planned. In addition, because most of our clientengagements are terminable by our clients without penalty, an unanticipatedtermination of a client project could require us to maintain underutilizedemployees. While professional staff levels must be adjusted to reflect activeengagements, we must also maintain a sufficient number of senior professionalsto oversee existing client engagements and participate in our sales efforts tosecure new client assignments.

The Company’s managementmonitors and assesses its operating performance by evaluating key metrics andindicators. For example, we review information related to annualized revenueper billable 

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consultant,periodic consultant utilization rates, gross profit margins and billableemployee headcount. The information, along with other operating performancemetrics is used in evaluating our overall performance. These metrics andindicators are discussed in more detail under “Results for the Year Ended December 31,2005 Compared to Results for the Year Ended December 31, 2004.”

**Critical AccountingPolicies**

Our consolidatedfinancial statements are prepared in accordance with accounting principlesgenerally accepted in the United States of America (“GAAP”). These accountingprinciples require us to make certain estimates, judgments and assumptions. Webelieve that the estimates, judgments and assumptions, upon which we rely, arereasonable based upon information available to us at the time that they aremade. These estimates, judgments and assumptions can affect the reportedamounts of assets and liabilities as of the date of the financial statements, aswell as the reported amounts of revenues and expenses during the periodspresented. To the extent there are differences between these estimates,judgments or assumptions and actual results, our financial statements may beaffected. The accounting policies that we believe are the most critical to aidin fully understanding and evaluating our reported financial results includethe following:

·       RevenueRecognition;

·       Valuationof Deferred Tax Assets; and

·       Valuationof Long-Lived and Intangible Assets.

In many cases, the accounting treatment of aparticular transaction is specifically dictated by GAAP and does not requiremanagement’s judgment in its application. There are also areas in whichmanagement’s judgment in selecting among available alternatives would notproduce a materially different result. Senior management has reviewed thesecritical accounting policies and related disclosures with our Audit Committee.See “Notes to Consolidated Financial Statements” included in “Item 8—FinancialStatements and Supplementary Data” included elsewhere herein, which containadditional information regarding our accounting policies and other disclosuresrequired by GAAP. We have identified the policies listed below as critical toour business operations and the understanding of our results of operations.

*Revenue Recognition.**  *The Companyrecognizes revenue from providing IT and management consulting services underwritten service contracts with our customers. The service contracts we enterinto generally fall into three specific categories: time and materials,fixed-price and fixed-fee. Our revenues are generated from sources such astechnical consulting, custom software development, integration services,business intelligence consulting, strategic business process consulting andinfrastructure services. Revenues from these services are recognized as theservices are performed and amounts are earned in accordance with SEC StaffAccounting Bulletin (“SAB”) No. 101 (“SAB 101”), “Revenue Recognition inFinancial Statements,” as amended by SAB No. 104, “Revenue Recognition” (“SAB104”). We consider amounts to be earned once evidence of an arrangement hasbeen obtained, services are delivered, fees are fixed or determinable andcollectibility is reasonably assured. For the years ended December 31,2005, 2004 and 2003, revenues from strategy engagements, technical consultingand custom software development and integration services, and infrastructureservices represented the following: 

| **For the Year Ended December 31,** | ** ** | ** ** | ** ** | **Strategy  Engagements** | ** ** | **Consulting and  Development and  Integration  Services** | ** ** | **Infrastructure  Services** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|---------------------------|------------|----------------------------------------------------------------------|------------|------------------------------|------------|
| 2005                                                         |       |       | 35.7       | %                         |       |                                                                 | 55.9       | %                            |       |   | 8.4 | % |   |
| 2004                                                         |       |       | 20.7       | %                         |       |                                                                 | 67.2       | %                            |       |   | 12.1 | % |   |
| 2003                                                         |       |       | 2.9        | %                         |       |                                                                 | 85.7       | %                            |       |   | 11.4 | % |   |

 

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The Company derives a significant portion of itsservice revenue from time and materials-based contracts. Time andmaterials-based contracts represented 82.5%, 75.0% and 70.9% of servicerevenues for the years ended December 31, 2005, 2004 and 2003,respectively. Revenue under time and materials contracts is recognized asservices are rendered and performed at contractually agreed upon rates.

From time to time, the Company may offer volumepurchase arrangements as part of its time and materials contracts to itscustomers. In accordance with Emerging Issues Task Force Abstract (“EITF”) No. 00-22,“Accounting for “Points” and Certain Other Time-Based or Volume-Based SalesIncentive Offers, and Offers for Free Products or Services to Be Delivered inthe Future,” the Company has deferred payment amounts based upon its currentestimates of the actual discounts expected to be earned by the customers. Therewere no deferred amounts as of December 31, 2005 related to volumepurchase arrangements. As of December 31, 2004, the Company had recordedas deferred revenue a liability in the amount of $0.2 million related to such arrangements.

Revenue pursuant to fixed-price contracts isrecognized under the proportional performance method of accounting. Fixed-pricecontracts represented 11.5%, 15.8% and 18.8% of service revenues for the yearsended December 31, 2005, 2004 and 2003, respectively. Over the course of afixed-price contract, we routinely evaluate whether revenue and profitabilityshould be recognized in the current period. To measure the performance and ourability to recognize revenue and profitability on fixed-price contracts, wecompare actual direct costs incurred to the total estimated direct costs anddetermine the percentage of the contract that is complete. This percentage ismultiplied by the estimated total contract value to determine the amount of netrevenue that should be recognized in accordance with our revenue recognitionpolicies and procedures, subject to any warranty provisions or other projectmanagement assessments as to the status of work performed. This method is usedbecause reasonably dependable estimates of the revenues and costs applicable tovarious stages of a contract can be made, based on historical experience andmilestones identified in any particular contract.

Typically, the Company provides warranty services onits fixed-price contracts related to providing customers with the ability tohave any “design flaws” remedied and/or have our Company “fix” routine softwaredesign defects.  The services, asoutlined in the respective contracts, are provided for a specific period oftime after a project is complete. The Company values the warranty servicesbased upon historical labor hours incurred for similar services at standardbilling rates. In accordance with SAB 101 and SAB 104, revenue related to thewarranty provisions within our fixed-price contracts is recognized as theservices are performed and the revenue is earned. The warranty term istypically short term or for a 30-60 day period after the project iscomplete.

In the event we are unable to accurately estimate theresources required or the scope of work to be performed on a fixed-pricecontract, or we do not manage the project properly within the planned timeperiod, then we may recognize a loss on a contract. Provisions for estimatedlosses on uncompleted projects are made on a contract-by-contract basis. Anyknown or probable losses on projects are charged to operations in the period inwhich such losses are determined. A formal project review process takes placequarterly, although most projects are evaluated on an ongoing basis. Managementreviews the estimated total direct costs on each contract to determine if theestimated amounts are accurate, and estimates are adjusted as needed in theperiod revised estimates are made. The Company recorded an insignificant lossrelated to one specific contract during fiscal 2005. There were no recordedlosses on contracts during fiscal 2004.

We also perform services on a fixed-fee basis under infrastructureservices contracts, which include monthly hosting and support services.  Fixed-fee contracts represented 6.0%, 9.2% and10.3% of service revenues for the years ended December 31, 2005, 2004 and2003, respectively. Revenue under fixed-fee contracts are recognized as fixedmonthly amounts, for a specified period of time, as outlined within therespective contract.

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When a customer enters into a time and materials,fixed-price contract or a fixed-fee contract, the related revenue is accountedfor under EITF 00-21, “Revenue Arrangement with Multiple Deliverables.”  For all arrangements, we evaluate thedeliverables in each contract to determine whether they represent separateunits of accounting. If the deliverables represent separate units ofaccounting, we then measure and allocate the consideration from the arrangementto the separate units, based on reliable evidence of the fair value of eachdeliverable.

Client prepayments, even if nonrefundable, aredeferred (classified as a liability) and recognized over future periods asservices are performed. As of December 31, 2005 and 2004, the Company hasrecorded a deferred liability of approximately $0.2 million and $0.1 million,respectively, which is included in the financial statement caption of “deferredrevenue and other liabilities” related to customer prepayments.

Revenues from software resale contracts were less than4.0% of total revenues for all periods presented. Revenue and related costs arerecognized and amounts are invoiced to our customers upon the customer receiptof the purchased software. All related warranty and maintenance arrangementsare performed by the primary vendor of the software and are not the obligationof the Company.

We recognize revenues for services where thecollection from the client is probable and our fees are fixed or determinable. Weestablish billing terms at the time at which the project deliverables andmilestones are agreed. Our standard payment terms are 30 days from invoice date.Reimbursement of “out-of-pocket” expenses charged to customers is reflected asrevenue.

Our revenues and earnings may fluctuate from year toyear 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 delaysincurred in connection with a project, employee utilization rates, the adequacyof provisions for losses, the use of estimates of resources required tocomplete ongoing projects, general economic conditions and other factors.Certain significant estimates include those used for fixed-price contracts, suchas deferrals related to our volume purchase agreements, warranty holdbacks, andallocations of fair value of elements under multiple element arrangements, andthe valuation of our allowance for doubtful accounts.

*Valuationof Deferred Income Taxes.***  **In determining our current income tax provision, weassess temporary differences resulting from differing treatments of items fortax and accounting purposes. These differences result in deferred tax assetsand liabilities, which are recorded in our consolidated balance sheets. Wemaintain deferred tax assets and we must assess the likelihood that theseassets will be recovered from future taxable income. To the extent we believerecovery is not likely, we establish a valuation allowance. We record anallowance to reduce the net deferred tax asset to a value we believe will berecoverable by future taxable income. We believe the accounting estimaterelated to the valuation allowance is a critical accounting estimate because itis highly susceptible to change from period to period as it requires managementto make assumptions about the Company’s future income over the life of thedeferred tax asset, and the impact of increasing or decreasing the valuationallowance is potentially material to our results of operations. Management’sassumptions about future income require significant judgment because actualincome has fluctuated in the past and may continue to do so.

As of December 31, 2005, the gross value of thedeferred tax asset recorded on the Company’s balance sheet was approximately$26.7 million. This amount was comprised of approximately $21.0 million infederal net operating loss (“NOL”) carryforwards, $1.0 million in state NOLcarryforwards, $4.0 million in available federal credits, and $0.7 million innet deferred temporary timing differences. These amounts were offset by avaluation reserve of approximately $5.2 million providing for a net deferredtax asset of $21.5 million. This net deferred tax asset is representative ofthe Company’s assessment of the expected future realization of recordeddeferred tax assets.

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When assessing the probabilityof the future realization of the recorded value of this asset, the Companyreviews its planned future income and profitability projections. In projectingfuture income, we use our internal operating budgets and long-range planningprojections. We develop our budgets and long-range projections based on recentresults and trends, our project pipeline, and other appropriate factors. Basedupon these analyses, the Company believes that it is more than likely that itwill be able to recover the currently recorded value of our net deferred taxassets by achieving a compounded annual revenue growth rate of approximately 6.7% and achieving annualprofitability in the range of 4.4% to 5.8% through fiscal 2020. However, if wedo not generate sufficient future income and profits, the realization of thesedeferred tax assets may be impaired, resulting in an additional income taxexpense, thereby reducing net income or increasing net loss, in the period inwhich it is determined that it is more likely than not that either a portion orall of the deferred tax asset is recoverable.

*Valuationof Long-Lived and Intangible Assets.**  *In 2002, theCompany adopted SFAS No. 142, “Goodwill and Other Intangible Assets.”With the adoption of SFAS No. 142, goodwill and other indefinitelived intangible assets (“intangibles”) are no longer subject to amortization,rather, they are subject to an assessment for impairment whenever events orcircumstances indicate that impairment may have occurred, but at leastannually, by applying a fair value based test. Under SFAS No. 142,goodwill impairment is assessed at the reporting unit level, using a discountedcash flow method. Prior to April 1, 2002, the Company amortized goodwilland identifiable intangible assets on a straight-line basis over theirestimated useful lives not to exceed 40 years, and periodically reviewedthe recoverability of these assets based on the expected future undiscountedcash flows.

Under SFAS No. 142, goodwill impairment isdetermined using a two-step process. The first step of the goodwill impairmenttest is used to identify potential impairment by comparing the fair value of areporting unit with its net book value (or carrying amount), includinggoodwill. If the fair value of a reporting unit exceeds its carrying amount,goodwill of the reporting unit is considered not to be impaired and the secondstep of the impairment test is unnecessary. If the carrying amount of areporting unit exceeds its fair value, the second step of the goodwillimpairment test is performed to measure the amount of impairment loss, if any.The second step of the goodwill impairment test compares the implied fair valueof the reporting unit’s goodwill with the carrying amount of that goodwill. Ifthe carrying amount of the reporting unit’s goodwill exceeds the implied fairvalue of that goodwill, an impairment loss is recognized in an amount equal tothat excess. The implied fair value of goodwill is determined in the samemanner as the amount of goodwill recognized in a business combination. That is,the fair value of the reporting unit is allocated to all of the assets andliabilities of that unit (including any unrecognized intangible assets) as ifthe reporting unit had been acquired in a business combination and the fairvalue of the reporting unit was the purchase price paid to acquire thereporting unit.

Determining the fair value of a reporting unit underthe first step of the goodwill impairment test and determining the fair valueof individual assets and liabilities of a reporting unit (includingunrecognized intangible assets) under the second step of the goodwillimpairment test requires our management to make significant judgments,assumptions and estimates. These estimates and assumptions could have asignificant impact on whether or not an impairment charge is recognized andalso the magnitude of any such charge. To assist in the process of determininggoodwill impairment, the Company obtains appraisals from independent valuationfirms. In addition to the use of independent valuation firms, the Companyperforms internal valuation analyses and considers other market informationthat is publicly available. Estimates of fair value are primarily determinedusing discounted cash flows. This approach requires the use of significantestimates and assumptions including projected future cash flows (includingtiming), discount rate reflecting the risk inherent in future cash flows andperpetual growth rate, among others.

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Upon adoption of SFAS 142 in fiscal 2002, the Companyrecorded as a change in accounting principle, a non-cash impairment charge of$12.5 million. On December 2, 2002, our selected annual measurement date,our Company recorded an additional non-cash charge of $7.4 million due to afurther impairment of the recorded goodwill. No other impairment has beenrecorded in the periods presented.

As further described inNote 3 to the consolidated financial statements included elsewhere herein, theCompany, on June 2, 2003, acquired Intelix, Inc. and recorded $1.4million in goodwill and $0.5 million in identifiable intangible assets, whichare being amortized over a period of four to eight years. On October 4,2004, the Company acquired Ranzal and initially recorded $2.4 million ingoodwill and $1.6 million in identified intangible assets, which are beingamortized over a period of two to five years. Subsequently, in the firstquarter of fiscal 2005, the Company recorded and paid additional purchase priceconsideration of $1.0 million to Ranzal’s former stockholders. The paymentrelated to additional earnout consideration based upon the successfulattainment of certain profitability thresholds achieved from the date of theacquisition through February 28, 2005. Ranzal is also eligible for asecond earnout payment, if certain profitability thresholds are met, during theperiod commencing on March 1, 2005 and ending on February 28, 2006.The Company currently estimates that amounts potentially payable to Ranzalstockholders for the second earnout will be $2.6 million.

**Results ofOperations**

Thefollowing table sets forth, for the periods indicated, selected statements ofoperations data as a percentage of total revenue:

| ** **                                                               | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                               | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue:                                                                 |       |                                       |       |   |   |   |   |
| Service revenue                                                          |       | 92.3                                       | %          | 97.7 | % | 99.3 | % |
| Software revenue                                                         |       | 3.5                                        | %          | 0.2 | % | — | % |
| Reimbursable expenses                                                    |       | 4.2                                        | %          | 2.1 | % | 0.7 | % |
| Total revenue                                                            |       | 100.0                                      | %          | 100.0 | % | 100.0 | % |
| Cost of revenue:                                                         |       |                                       |       |   |   |   |   |
| Project and personnel costs                                              |       | 50.7                                       | %          | 59.5 | % | 53.3 | % |
| Software costs                                                           |       | 3.4                                        | %          | 0.2 | % | — | % |
| Reimbursable expenses                                                    |       | 4.2                                        | %          | 2.1 | % | 0.7 | % |
| Total cost of revenue                                                    |       | 58.3                                       | %          | 61.8 | % | 54.0 | % |
| Gross profit                                                             |       | 41.7                                       | %          | 38.2 | % | 46.0 | % |
| Operating  expenses:                                                     |       |                                       |       |   |   |   |   |
| Selling, general and administrative                                      |       | 36.8                                       | %          | 40.1 | % | 40.2 | % |
| Depreciation and amortization                                            |       | 2.4                                        | %          | 3.5 | % | 3.8 | % |
| Total operating expenses                                                 |       | 39.2                                       | %          | 43.6 | % | 44.0 | % |
| Operating income  (loss)                                                 |       | 2.5                                        | %          | (5.4 | )% | 2.0 | % |
| Interest income, net                                                     |       | 2.4                                        | %          | 2.2 | % | 1.8 | % |
| Income (loss)  before taxes and discontinued operations                  |       | 4.9                                        | %          | (3.2 | )% | 3.8 | % |
| Tax provision  (benefit)                                                 |       | 2.0                                        | %          | — | % | (4.2 | )% |
| Income (loss)  from continuing operations before discontinued operations |       | 2.9                                        | %          | (3.2 | )% | 8.0 | % |
| Discontinued  operations:                                                |       |                                       |       |   |   |   |   |
| Income (loss)  from operations of discontinued divisions                 |       | 0.8                                        | %          | 0.9 | % | (4.1 | )% |
| Net income (loss)                                                        |       | 3.7                                        | %          | (2.3 | )% | 3.9 | % |

 

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**Results for the Year Ended December 31,2005 Compared to Results for the Year Ended December 31, 2004**

*Revenue.**  *Total revenue increased by $17.8 million, or 70.3%,to $43.1 million for the year ended December 31, 2005 from  $25.3 million for the year ended December 31,2004.

Of the $17.8 million increase in 2005 total revenue,service revenue, excluding software and reimbursable expense revenue, increasedby $15.1 million, or 60.9%, to $39.8 million, as compared to service revenue of$24.7 million in 2004.  The 2005 increasein service revenues was primarily attributable to two factors. Our servicerevenue was enhanced by the October 4, 2004 acquisition of Ranzal, whichcontributed service revenue of approximately $11.0 million in 2005 revenue, ascompared to $2.0 million in the fourth quarter of 2004. The incremental yearover year increase in service revenue was also affected by an increase ofapproximately $6.1 million in service revenue related to Edgewater Technology’score business in 2005. Current year growth was also impacted by improved marketdemand for premium IT services, as new and existing clients continued to demandon-shore technical management consulting expertise to help their businessesevolve and grow.

Software revenue, which is directly attributable toRanzal, increased to $1.5 million in 2005, as compared to $0.06 million in 2004.Software revenue is expected to fluctuate between quarters depending on ourcustomers’ demand for such third-party off-the-shelf software. Gross profitmargins are generally much lower on software sales than on consulting services.

Generally, we are reimbursed for our out-of-pocketexpenses incurred in connection with our customers’ consulting projects. Reimbursedexpense revenue increased approximately $1.3 million in 2005, to approximately$1.8 million, as compared to $0.5 million in 2004. The aggregate amount ofreimbursed expenses will fluctuate from quarter to quarter depending on thelocation of our customers, the general fluctuation of travel costs, such asairfare, and the number of our projects that require travel.

Our annualized revenue per billable consultant, adjustedfor utilization, increased 15.0%, to $261 thousand in 2005, as compared to$227 thousand in 2004. The improvement is due to incremental increases inconsultant billing rates, largely associated with our Ranzal business, and anoverall improvement in consultant utilization rates in our core business. During2005, the Company increased the number of customers it served to 158, ascompared to 102 customers in 2004. In 2005, service revenue from our fivelargest customers, including Synapse, decreased to 47.5% of our total servicerevenue, as compared to 69.0% in 2004.

*Costof Revenue.**  *Cost ofrevenue primarily consists of**projectpersonnel costs principally related to salaries, payroll taxes, employeebenefits and travel expenses for personnel dedicated to customer projects. Thesecosts represent the most significant expense we incur in providing our services.In total, cost of revenue increased by $9.4 million, or 60.5%, to $25.1 millionin 2005 as compared to $15.7 million in 2004. The 2005 increase in cost ofrevenue is partially attributable to the full year effect of the Ranzal acquisition,which increased cost of revenue by approximately $6.4 million in 2005. Additionally,there was an increase of $3.0 million, or 20.9%, in project and personnel costsrelated to Edgewater Technology’s core business, as we increased our totalnumber of billable consultants by 58, separate and apart from the RanzalAcquisition, to support our growth in projects and related revenue growth. Ranzalincreased its billable headcount by 16 in 2005.

As a percentage of service revenue, project personnelcosts, before software costs and out-of-pocket expense reimbursements,decreased from 61.0% during 2004 to 54.9% during 2005. The decrease in projectpersonnel costs, as a percentage of service revenue, reflects increases in theCompany’s billable consultant utilization rates, which increased to 81.1% in2005, as compared to 72.1% in 2004.

Software costs increased by $1.4 million, to $1.5million, in 2005, as compared to $0.05 million in 2004. Software costs areexpected to fluctuate from year to year depending on our customers demand forsoftware. Reimbursable expenses, which increased in 2005 by $1.3 million, to$1.8 million, as compared to 

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$0.5 million in 2004, werea direct result of the Company’s increased customer base and associatedtravel-related expenses incurred during the comparative fiscal periods.

*GrossProfit.**  *Grossprofit increased by $8.3 million, or 86.3%, to $18.0 million in 2005, ascompared to $9.7 million in 2004. Gross profit, as a percentage of totalrevenue, increased to 41.7% in 2005, as compared to 38.2% in 2004. Gross profitrelated to service revenue increased to 45.1% in 2005 from 39.0% in 2004. Theimprovement in gross profit in 2005 is directly related to the cumulativeeffects of growth within the core Edgewater business, which increased grossprofit by $3.3 million in 2005, representing 39.5% of the year over yearincrease in gross profit, combined with the incremental gross profit of $5.0 millionprovided by Ranzal in 2005, which represented 60.5% of the year over yearincrease in gross profit. Positive factors influencing this growth includeincreases in customer base, increases in billable headcount and improvedutilization rates, which are discussed above.

*Selling,General and Administrative Expense (“SG&A”).**  *SG&A expenses totaled $15.9 million, or 39.9% oftotal revenue in 2005, as compared to SG&A expenses of $10.2 million, or41.1% of total revenue, in 2004. As a percentage of total revenue, SG&Aexpenses in 2005 remained fairly consistent with 2004 expenditure levels. During2005, the full year effect of the Ranzal Acquisition, accounted for $4.1 million,or 71.1% of the current year SG&A increase, while Edgewater Technology’score business represented $1.6 million, or 28.9% of the current year SG&Aincrease. In total, the $5.7 million, or 56.4% increase in SG&A expenses isattributable to cumulative increases in sales-related salaries, recruitingexpenses, marketing expenses, travel expenses and performance-based bonusaccruals.

Sales-related salaries expense, inclusive of commissionexpense, increased by $2.2 million in 2005 as the Company increased its averagesales-related headcount from 15 employees in 2004 to 21 employees in 2005. Theincrease in sales-related headcount was primarily related to Ranzal, whichaccounted for $1.1 million of the total increase in sales-related salariesand wages. In 2005, the Company reported increased recruiting expense of $0.7million, as compared to 2004. The increase in recruiting expense is directlyrelated to the overall increase in the Company’s headcount from 205 at the endof 2004 to 282 at the end of 2005. In connection with the increase insales-related headcount and a concerted effort to penetrate key strategicmarkets, the Company reported an increase of $0.3 million in marketing andselling expenses in 2005, as compared to 2004. Directly related to the growthexperienced in 2005, travel-related expenses increased by $0.3 million, ascompared to 2004. Additionally, during the 2005, the Company recorded $1.3 millionin connection with its performance-based bonus plan, while only $0.1 million inrelated performance-based bonus accruals were recorded in 2004. Finally,SG&A expenses in 2005 increased by $0.9 million related to othermiscellaneous expense items, which are not described above.

*Depreciationand Amortization Expense.*   Depreciation andamortization expense increased $0.1 million, or 16.7%, to $1.0 million, ascompared to $0.9 million in 2004. Depreciation expense increased by $0.1million, to $0.5 million, as compared to $0.4 million in 2004. The increaseprimarily reflected the full year effect of depreciation expense related to theacquired Ranzal fixed assets. Additionally, amortization expense remainedconsistent at $0.5 million in both 2005 and 2004. In the current fiscal year,amortization expense was increased by the full year effect of amortizationexpense related to the identified Ranzal intangible assets. Amortization of theRanzal intangible assets amounted to $0.4 million in 2005, as compared to $0.1million in 2004. The increase in current year amortization expense related tothe Ranzal identified intangible assets was fully offset by a decrease incomparative amortization expense of $0.3 million related to other intangibleassets that became fully amortized in 2005.

*OperatingIncome (Loss).**  *TheCompany’s operating income increased $2.5 million, to $1.1 million, in 2005, ascompared to an operating loss of $(1.4) million in 2004. The increase inoperating income is attributable to comparatively higher utilization rates,directly tied to the $15.1 million increase in 2005 service revenue. Each ofthese items is explained in further detail above.

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*InterestIncome (Expense), Net.*   We earned net interestincome of $1.1 million in 2005, as compared to net interest income of $0.6million in 2004. The increase in interest income reflects a 2004 shift of ouravailable cash and cash equivalent balances into less liquid marketablesecurities, which have increased yields on our invested balances when comparedto the yields achieved in the prior year. Average maturity and yield rates forthe year ended December 31, 2005 were approximately 132 days and 4.1%,respectively, as compared to 94 days and 1.6%, respectively, as of December 31,2004.

*Provisionfor Income Taxes.*   The Company recorded an incometax provision of $0.9 million in 2005. The 2005 provision represented taxexpense based on an estimated effective income tax rate of 40.0% of operatingincome, which was inclusive of both state and federal income tax rates. Noincome tax provision was recorded in 2004 as a result of the reported netoperating loss.

*Income(Loss) from Continuing Operations.*   Income fromcontinuing operations increased $2.1 million, to $1.3 million in 2005, ascompared to a loss of $(0.8) million in 2004. The current year increase inincome from continuing operations is the cumulative result of increased servicerevenue, gross margin and other items discussed above.

*DiscontinuedOperations.**  *We havereceived in the past and may continue to receive various tax notices andassessments from the IRS and various State Departments of Revenue related toour former staffing businesses, which were sold in 2000 and 2001. During both2005 and 2004, our Company was able to successfully resolve several outstandingassessments. On a net basis, the Company reversed approximately $0.3 millionand $0.2 million in 2005 and 2004, respectively, from its discontinuedoperations accrual related to the successful resolution of certain taxassessments. In 2005, the accrual decrease attributable to the IRS noticestotaled approximately $0.3 million, offset by other minor adjustments toremaining discontinued operations accrual items. In 2004, the accrual decreaseattributable to the IRS notices totaled approximately $0.8 million. Thisdecrease was offset by an increase in the accrual of $0.6 million, which wasprimarily the result of an increase in a previously established reserve relatedto the Company’s expected lease payments on its former corporate headquartersin Fayetteville, Arkansas in the amount of $0.4 million. The increase in thelease accrual was deemed necessary after revising a previously preparedestimate with more current information. SeeNotes 4 and 12 of the consolidated financial statements included elsewhereherein.

*Net Income (Loss).**  *We reported net income of $1.6 million in 2005 ascompared to a net loss of $(0.6) million 2004. The increased in net income is acumulative result of increased service revenue, gross margin and other itemsdiscussed above.

**Results for the Year Ended December 31,2004 Compared to Results for the Year Ended December 31, 2003**

*ServiceRevenues.**  *Duringthe year ended December 31, 2004, total revenues increased by $0.2 million,or 1.1%, over 2003 revenues of $25.1 million to $25.3 million. Our annualizedrevenue per billable consultant, adjusted for utilization, increased to $227thousand during 2004 as compared to $224 thousand in 2003 primarily due tothe incremental benefits of improved billing and utilization rates during thefourth quarter of 2004. The Company increased the number of customers it servedto 102 clients during 2004 as compared to 52 clients during 2003, whichwas primarily the result of the Ranzal acquisition. While our overall revenueremained flat on a year-over-year basis, in 2004, revenue from our five largestcustomers, including Synapse, decreased as a percentage of total revenue to69.0% of our total revenues as compared to 81.7% in 2003 due to the Company’srevenue diversification efforts.

Revenues for the year ended December 31, 2004 wereprimarily affected by two factors. Our revenues were enhanced by the October 4,2004 acquisition of Ranzal, which added approximately $2.3 million in fourthquarter revenues. The incremental year-over-year increase from Ranzal revenueswas also mitigated by a decrease of approximately $2.0 million in revenuesrelated to Edgewater Technology’s core business.  The decrease in Edgewater Technology corerevenues is primarily attributable to a reduction in revenue 

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from Synapse, a relatedparty and our largest customer. Synapse revenue declined by approximately $2.1 million,or 17.7%, to $9.7 million as compared to 2003 revenues of $11.8 million.  The Company also experienced continued delaysand reductions in overall spending as the U.S. economic environment continuedto be sluggish during 2004.

*Costof Services.**  *Cost ofservices consists of**projectpersonnel costs principally related to salaries, payroll taxes, employeebenefits and travel expenses for personnel dedicated to customer projects. Thesecosts represent the most significant expense we incur in providing our services.In total, project personnel costs increased by $2.2 million, or 15.6%, to $15.7million in 2004, as compared to $13.5 million in 2003. The 2004 increase inproject personnel costs were partially attributable to the Ranzal acquisition,which added approximately 25 billable consultants and $1.3 million in relatedpersonnel costs, and the full year effect of the June 2003 Intelixacquisition, which added approximately 29 billable consultants in 2003 andincreased project personnel costs by an additional $0.7 million in 2004. As apercentage of revenue, project personnel costs before out-of-pocket expensereimbursements increased from 53.4% during 2003 to 60.2% during 2004. Theincrease in project personnel costs, as a percentage of revenues, reflectsdecreases in the Company’s billable consultant utilization rates, whichdecreased to 72.1% in 2004, as compared to 78.7% in 2003.

*GrossProfit.**  *Grossprofit decreased $1.8 million, or 16.1%, to $9.7 million in 2004 as compared to$11.5 million in 2003. Gross profit, as a percentage of revenues, decreased to38.2% in 2004, as compared to 46.0% in 2003. The 2004 decrease in gross profitwas partially related to a decrease in Edgewater Technology core revenuesduring the second half of 2004 as market conditions led to a reduced level ofIT spending and delayed IT spending decisions. The effect of these conditionscaused a decrease in our billable consultant utilization rates, which decreasedto 72.1% in 2004, as compared to 78.7% in 2003 on an overall basis. The 2004utilization rate decrease was in large part attributable to a decrease of $2.1million in revenues from the Company’s largest customer. These decreases inEdgewater’s core business were offset by the 2004 gross profit contribution ofRanzal, which added $1.0 million in gross profit during the fourth quarter. Additionally,in 2004, the Company experienced an increase in billable and unbilled expenses.Billable and unbilled expenses increased by approximately $0.4 million in 2004to $0.7 million, as compared to $0.3 million in 2003. This increase represented25.2% of the 2004 reduction in gross margin.

*Selling,General and Administrative Expense (“SG&A”).**  *SG&A expenses of $10.0 million, or 39.6% ofrevenues, in 2004 remained consistent with 2003 expenditure levels. SG&Aexpenses also totaled $10.0 million in 2003 and represented 40.2% ofrevenues. In 2003, SG&A expenses included a bonus accrual of $1.3 million,as compared to a bonus accrual of $0.1 million in 2004. Offsetting the currentyear reduction in bonus expense was an increase in sales and administrativesalaries expenses of $0.5 million, as the Company increased sales headcountfrom 10 average full-time-equivalents in 2003 to 14 averagefull-time-equivalents. In addition, 2004 SG&A expenses included additionalexpenses related to the operations of Ranzal in the amount of $0.5 million,included in the fourth quarter 2004 operating results.

*Depreciationand Amortization Expense.*   Depreciation andamortization expense remained consistent with the 2003 amount of $0.9 million.  Depreciation expense decreased by $0.2million, to $0.4 million, in 2004, as compared to $0.6 million in 2003. The decreasereflected continued spending controls on purchases of new fixed assets and anoverall reduction in depreciation as older assets fully depreciate. Thisdecrease was offset by an increase in amortization related to the full yearamortization of the Intelix intangible assets and the incremental amortizationrelated to the Ranzal intangible assets of $0.1 million in 2004.

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*Operating(Loss) Income.*   Operating income decreased $1.9million to $(1.4) million in 2004, as compared to operating income of $0.5million in 2003. The decrease in income was attributable to comparatively lowerutilization rates, directly tied to decreased spending in IT consulting marketsin 2004 and increased salaries and wages related to strategic personnelinvestments, which were offset by $0.5 million in fourth quarter operatingincome attributable to the recently acquired Ranzal operations. Each of theseitems is explained in further detail above.

*InterestIncome (Expense), Net.*   We earned net interestincome of $0.6 million in 2004, as compared to net interest income of $0.5million in 2003. The increase in interest income reflected a 2004 shift of ouravailable cash and cash equivalent balances into less liquid marketable securities,which increased yields on our invested balances when compared to the yieldsachieved in the prior year. Average maturity and yield rates for the year endedDecember 31, 2004 were approximately 94 days and 1.6%, respectively.

*Provisionfor Income Taxes.*   The Company, as a result ofits net operating loss position for the year ended December 31, 2004, hasnot recorded a tax provision. Conversely, in 2003, we recorded a tax benefit of$1.1 million, which represented a tax provision of $0.3 million, based on anestimated effective rate of 40.0% on operating income for state and federalincome tax rates, offset by a benefit related to a refund receivable of $1.4million related to a 2002 net operating tax loss carry back claim.

We have deferred tax assets which have arisenprimarily as a result of operating losses incurred in prior fiscal years, aswell as differences between the tax bases of assets and liabilities and theirrelated amounts in the financial statements. SFAS No. 109, “Accountingfor Income Taxes,” requires the establishment of a valuation allowance toreflect the likelihood of realization of deferred tax assets. Managementjudgment is required in determining any valuation allowance recorded againstthe gross deferred tax asset amounts. As of December 31, 2004, thevaluation allowance against deferred tax assets was approximately$14.7 million, providing for a net deferred tax asset of $22.2 million.

*Income(Loss) from Continuing Operations.*   Income fromcontinuing operations decreased $2.8 million, to $(0.8) million in 2004,as compared to income of $2.0 million in 2003. This decrease was primarily aresult of lower 2004 revenues and operating margins, for the reasons describedabove. In addition a carry back tax claim of $1.4 million was included inincome during the previous year as compared to no carry back claim amountsbeing recorded in 2004.

*DiscontinuedOperations.**  *We havereceived and may continue to receive various tax notices and assessments fromthe IRS and various State Departments of Revenue related to our former staffingbusinesses, which were sold in 2000 and 2001. During 2004, our Company was ableto successfully resolve several outstanding assessments. On a net basis, theCompany reversed approximately $0.2 million from its discontinued operationsaccrual related to the successful resolution of our tax assessments. Theaccrual decrease attributable to the IRS notices totaled approximately $0.8million. This decrease was offset by an increase in the accrual of $0.6million, which was primarily the result of an increase in a previouslyestablished reserve related to the Company’s expected lease payments on itsformer corporate headquarters in Fayetteville, Arkansas in the amount of $0.4million. The increase in the lease accrual was deemed necessary after revisinga previously prepared estimate with more current information.  In 2003, we recorded a reserve of $1.0 millionrepresenting the low end of potential payments to be made under certain IRSnotices, plus related professional fees.See Notes 4 and 12 of the consolidated financial statements included elsewhereherein.

*Net (Loss) Income.**  *We recognized a net loss of $(0.6) million in 2004,as compared to net income of $1.0 million in 2003. The net income decreased in2004 primarily as a result of decreased revenue, gross margin and the taxbenefit recorded in 2003.

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**Liquidity andCapital Resources**

Thefollowing table summarizes our cash flow activities for the periods indicated:

| ** **                                  | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                  | ** ** | **(In thousands)**                     | ** ** |
| Cash flows provided by  (used in):          |       |                                        |       |   |   |   |   |
| Operating activities                        |       | $                                           | 1,237      |   | $ | 10 |   | $ | 2,633 |   |
| Investing activities                        |       | (80                                         | )          | (17,959 | ) | (914 | ) |
| Financing activities                        |       | (340                                        | )          | (3,827 | ) | (1,252 | ) |
| Discontinued operating activities           |       | (156                                        | )          | (541 | ) | (1,745 | ) |
| Total cash provided  (used) during the year |       | $                                           | 661        |   | $ | (22,317 | ) | $ | (1,278 | ) |

 

As of December 31, 2005, we had cash, cashequivalents, marketable securities and accrued interest of $33.8 million, a $0.1million, or 0.3% decrease from the December 31, 2004 balance of $33.9million. Working capital, which is defined as current assets less currentliabilities, increased $2.4 million, to $39.4 million, as of December 31,2005, as compared to $37.0 million as of December 31, 2004. The $0.1 milliondecrease in cash, cash equivalents, marketable securities and accrued interestis primarily attributable to cash outflows related to the Company’s currentyear stock repurchases of $1.6 million and the payment of Ranzal’s firstcontingent earnout consideration of $1.0 million. These outflows of cash wereoffset by an inflow of cash of $1.4 million from the IRS related to the Company’s1997 refund claim and $1.3 million in proceeds from 2005 stock optionexercises.

Our primary historical sources of funds have been fromoperations and the proceeds from equity offerings, as well as sales ofbusinesses in fiscal years 2000 and 2001. Our principal historical uses of cashhave been to fund working capital requirements, capital expenditures andacquisitions. We generally pay our employees bi-weekly for their services,while receiving payments from customers 30 to 60 days from the date of theinvoice.

Historically, a significant portion of the Company’scash flows from operations have been derived from our largest customer,Synapse, which is considered a related party. Payments received by the Companyfor services rendered to Synapse totaled approximately $7.7 million, $10.9million and $11.8 million in 2005, 2004 and 2003, respectively. Allreceivable amounts were collected within our normal business terms and ourcontracts with Synapse are typically for a period of one year or more. In theevent there is a loss of revenue related to Synapse, it would be expected thatsuch a loss would have an adverse impact upon the Company’s operations and cashflows. However, we believe such an impact could be mitigated through themanagement of employee headcount and through the redeployment of existingSynapse related resources on to other consulting projects.

Net cash provided by operating activities was $1.2million in 2005.  Changes in operatingaccounts included the 2005 income from continuing operations of $1.3 million;depreciation and amortization of $1.0 million; the receipt of $1.4 millionrelated to the 1997 IRS refund claim; an increase in accrued payroll andrelated liabilities of $2.0 million primarily related to the 2005performance-based bonus plan accrual and $0.7 million related to the currentyear reduction of our deferred tax asset, which is representative of theestimated federal income taxes due on our current year income from continuingoperations. The cash flow provided by the above items was partially offset byan overall increase in accounts receivable of $4.8 million, which isdirectly related to our revenue growth in 2005.

In 2004, net cash provided by operating activities was$0.01 million.  Changes in operatingaccounts included depreciation and amortization of $0.9 million; increases inaccounts payable and accrued expenses of $0.8 million related to the acquiredRanzal operations. The cash flows presented above were offset by the 2004 lossfrom continuing operations of $0.8 million and a decrease in accrued payrolland 

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related liabilities of$1.1 million as a result of the 2004 payment of the Company’s 2003performance-based bonus accrual.

In 2003, net cash provided by operating activities was$2.6 million. This was a result of 2003 net income from continuing operationsof $2.0 million; $1.0 million in loss related to the Company’s discontinuedoperations as a result of various tax notices and assessments from the IRS;depreciation and amortization of $0.9 million; and an increase in accountspayable and accrued expenses related to the Company’s accrual of its expected2003 performance-based bonus payouts.

Net cash used in investing activities was $0.1 millionin 2005. Net outflows related to $30.6 million in purchases of marketablesecurities, which represented the systematic reinvestment of proceeds frommaturing investments, $1.0 million related to the payment of Ranzal’s firstcontingent earnout consideration, and capital expenditures of $0.5 million. Theseoutflows of cash were offset by $32.0 million in proceeds from the redemptionof marketable securities.  As of December 31,2005, we have no long-term commitments for capital expenditures and all capitalexpenditures are discretionary.

In 2004, net cash used in investing activities was$18.0 million. Net outflows related to $12.0 million in net purchases of marketablesecurities as the Company transitioned cash and cash equivalents intolonger-term and higher yield investments and $5.7 million in costs related tothe October 4, 2004 purchase of Ranzal.

In 2003, net cash used in investing activities was$0.9 million. This was a result of $1.2 million in net marketable securityredemptions, which were offset by $2.0 million in costs related to the June 2003acquisition of Intelix.

Net cash used in financing activities was $0.3million, $3.8 million, and $1.3 million for 2005, 2004, and 2003, respectively.Cash used in financing activities in each of these periods was primarilyattributable to the repurchase of the Company’s common stock, which totaled$1.6 million, $4.4 million, and $1.4 million in 2005, 2004 and 2003,respectively. These purchases were offset by net proceeds from our employeestock purchase program and exercises of stock options.

Net cash used in discontinued operations was $0.2million, $0.5 million, and $1.7 million for 2005, 2004, and 2003, respectively.These amounts represent payments made by the Company related to itsdiscontinued operations accrual. As described in Note 4 of the consolidatedfinancial statements and included elsewhere herein, the Company, in 2000-2001made a strategic decision to undergo a comprehensive restructuring program torefocus future growth initiatives in its systems integration and consultingbusiness and as a result, committed to divestures in each of its staffingbusinesses. Payments in each of the presented fiscal years represent paymentsrelated to the discontinuance of the operations, which were accrued for inprevious years.

As a result of the above, and as a result of cashflows from discontinued operations, our combined cash and cash equivalentsincreased by $0.7 million in 2005, decreased by $22.3 million in 2004 anddecreased by $1.3 million in 2003. The aggregate of our cash and cashequivalents, marketable securities and accrued interest was $33.8 million,$33.9 million and $44.3 million, as of December 31, 2005, 2004 and 2003,respectively.

During the first quarter of 2006, the Company acquiredall of the outstanding capital stock of National Decision Systems, Inc.,pursuant to the terms of a Stock Purchase Agreement. The Company paid to theshareholders of NDS total consideration of approximately $10.2 million,consisting of an initial upfront payment at closing of approximately $8.5million in cash and assumed liabilities, and 264,610 shares of Edgewater’scommon stock, $0.01 par value per share (“Common Stock”), which is subject to athree year lock-up agreement. In addition, an earnout agreement was enteredinto in connection with the Purchase Agreement, and it specifies additionalearnout consideration that could be payable to the former NDS stockholders. Earnoutpayments are conditioned upon the attainment of certain performance 

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measurements for the NDSbusiness over the next 12 to 24 months. Assuming all performance measurementsare met within predetermined performance ranges, additional earnout considerationof approximately $7.2 million would be payable, comprised of approximately $5.8million payable in cash and the remaining amount payable in Common Stock, whichwill be valued at the time of such issuance. See Note 14 of the consolidatedfinancial statements included elsewhere herein.

We believe that ourcurrent cash balances and cash flows from operations will be sufficient to fundour short-term operating and liquidity requirements, at least through 2006, andthe long-term operating and liquidity requirements for our existing operations.We periodically reassess the adequacy of our liquidity position, taking intoconsideration current and anticipated operating cash flow, anticipated capitalexpenditures, business combinations, possible stockholder distributions andpublic or private offerings of debt or equity securities. The pace at which wewill either generate or consume cash will be dependent upon future operationsand the level of demand for our services on an ongoing basis. See “Item 1—Business—PotentialFuture Strategies, Transactions and Changes.”

**Off Balance SheetArrangements, Contractual Obligations and Contingent Liabilities andCommitments**

We lease office space under noncancellable operatinglease arrangements through 2013. Rent expense, including amounts paid torelated parties for discontinued operations, was approximately $1.1 million,$1.2 million and $1.1 million for the years ended December 31, 2005, 2004and 2003, respectively. TheCompany entered into a sublease agreement on July 1, 2002 with a thirdparty to occupy our former corporate headquarters in Fayetteville, Arkansas. Thesublease commenced on July 15, 2002 and will end on June 30, 2007. Underthe sublease agreement, the sub-tenant shall pay base rent to Edgewater in theamount of $0.2 million in 2006 and will pay $0.1 million in 2007.

Annualfuture minimum payments required under operating leases that have an initial orremaining noncancellable lease term in excess of one year are as follows (theseamounts do not include expected sublease payments of approximately $0.2 millionin 2006 and $0.01 million in 2007):

| **Year Ending December 31,** | ** ** | ** **              | ** ** | **Lease  Obligations** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                  | ** ** | **(In thousands)** | ** ** |
| 2006                                        |       |                    | $          | 1,060                  |       |   |
| 2007                                        |       |                    | 916        |                   |       |
| 2008                                        |       |                    | 849        |                   |       |
| 2009                                        |       |                    | 653        |                   |       |
| 2010                                        |       |                    | 525        |                   |       |
| Thereafter                                  |       |                    | 1,575      |                   |       |
|                                        |       |                    | $5,578     |                   |       |

 

**RecentlyIssued Accounting Pronouncements**

In December 2004, FASB issued SFAS No. 123R,“Share-Based Payment.” This statement is a revision of SFAS No. 123and supersedes APB No. 25 and its related implementation guidance. SFAS No. 123Rfocuses primarily on accounting for transactions in which an entity obtainsemployee services in share-based payment transactions. The statement requiresentities to recognize compensation expense for awards of equity instruments toemployees based on the grant-date fair value of those awards (with limitedexceptions). SFAS No. 123R is effective for the first annualreporting period that begins after June 15, 2005, although earlieradoption is encouraged.

The Company will adopt SFAS No. 123R on January 1,2006, using the statement’s modified-prospective transition method. Adoption ofSFAS 123R will not affect the Company’s cash flows or financial position, butit will reduce periodically reported income and earnings per share as theCompany 

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currently uses the intrinsicvalue method as permitted by Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (“APB No. 25”). As permitted under APB No. 25,no compensation expense is currently recognized for share purchase rightsgranted under the Company’s stock option plans or employee stock purchase plan.

Upon adoption, the Companywill begin recording compensation expense for employee stock options andemployee share purchase rights. We currently estimate our 2006 pre-taxstock-based compensation expense to be in the range of $1.1 million to $1.3million, reducing diluted earnings per share by $0.10 to $0.12.

**Related-Party Transactions**

*Synapse.**  *Synapse, one of our largest customers, as discussedin Note 11 to the consolidated financial statements included elsewhere in Item8 herein, is considered a related party as its former President and ChiefExecutive Officer, Michael Loeb, is also a member of our Board of Directors.Mr. Loeb, who resigned as the President and Chief Executive Officer ofSynapse during 2005, remains a member of Synapse’s board of directors as of December 31,2005. Mr. Loeb joined the Company’s Board of Directors in April 2000.Synapse has been an Edgewater customer since 1996. Revenues from Synapseamounted to $8.4 million, $9.7 million and $11.8 million, for 2005, 2004 and2003, respectively. Accounts receivable balances for Synapse were $1.4 millionand $0.7 million as of December 31, 2005 and 2004, respectively, whichamounts were on customary business terms. The Company typically providesservices to Synapse related to infrastructure services, custom softwaredevelopment, and systems integration. Services are provided on both a fixed-feeand time and materials basis. Our contracts with Synapse, including all termsand conditions, have been negotiated on an arm’s length basis and on marketterms similar to those we have with our other customers. The existing one-yearservices contract with Synapse, which was entered into in January of 2005,has been automatically extended, as per the terms of the contract, for anadditional six-month period. The contract extension became effective on January 1,2006. The Company anticipates that it will enter into a new one-year servicescontract with Synapse during the first quarter of 2006. It is also anticipatedthat Synapse will purchase professional services consistent with thosepurchased in 2005, which approximated $8.4 million.

*DeferredBoard Fees.**  *As of December 31,2004, the Company had recorded a liability in the amount of approximately $0.2million related to deferred board fees earned and payable to one of our Company’sDirectors. Payment of the fees was being deferred until a future date. Thedeferred fees are recorded under the caption “accounts payable and accrued liabilities”in the Company’s consolidated financial statements included elsewhere herein. Thereare no deferred board fees as of December 31, 2005 as all previouslydeferred amounts were fully paid in 2005.

*LeaseAgreement.*   Our Company entered into a leaseagreement in 1999, which was modified in June 2000, with a stockholder whois a former officer and director. The lease pertains to certain parcels of landand buildings in Fayetteville, Arkansas for its former corporate headquartersthat were included in our Company’s discontinued operations. Rent paymentsrelated to these facilities totaled approximately $0.2 million for each theyears ended December 31, 2005, 2004 and 2003, respectively. Future relatedparty lease obligations relate to this lease agreement. As our Company’scorporate headquarters moved to Wakefield, Massachusetts during 2001, theCompany subleased the Fayetteville facility to a third party in 2002. See Note12 of the consolidated financial statements included elsewhere herein.

Included in the “CertainTransactions” section of our 2006 Proxy Statement for our June 6, 2006Annual Meeting of Stockholders’ is additional disclosure concerning ourrelated-party transactions. Our Proxy Statement will be filed with the SEC onor before April 30, 2006.

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**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our primary financial instruments include investmentsin money market funds, short-term municipal bonds, commercial paper and U.S.government securities that are sensitive to market risks and interest rates. Theinvestment portfolio is used to preserve our capital until it is required tofund operations, strategic acquisitions or distributions to stockholders. Noneof our market-risk sensitive instruments are held for trading purposes. We didnot purchase derivative financial instruments in 2005 and 2004. Should interestrates on the Company’s investments fluctuate by 10% the impact would not bematerial to the financial condition, results of operations or cash flows.

For the last three years, the impact of inflation andchanging prices has not been material on revenues or income (loss) from continuingoperations.

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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

(a)           *ConsolidatedFinancial Statements:*

Thefollowing consolidated financial statements are included in this Form 10-K:

|                                                                                                                 | ** ** | **Page** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm                                                        |       |     | 37         |   |   |
| Consolidated Balance Sheets at December 31, 2005  and 2004                                                 |       |     | 38         |   |   |
| Consolidated Statements of Operations for the Years  Ended December 31, 2005, 2004 and 2003                |       |     | 39         |   |   |
| Consolidated Statements of Stockholders’ Equity for  the Years Ended December 31, 2005, 2004 and 2003 |       |     | 40         |   |   |
| Consolidated Statements of Cash Flows for the Years  Ended December 31, 2005, 2004 and 2003                |       |     | 41         |   |   |
| Notes to Consolidated Financial Statements                                                                      |       |     | 42         |   |   |

 

(b)          *Not Covered by Above Report:*

| Unaudited Supplementary  Quarterly Financial Information |   | 65 |   |
|----------------------------------------------------------|--------|----|--------|

 

36

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directorsand Stockholders ofEdgewater Technology, Inc.Wakefield, Massachusetts:

We have audited the accompanying consolidated balancesheets of Edgewater Technology, Inc. and subsidiaries (the “Company”) asof December 31, 2005 and 2004, and the related consolidated statements ofoperations, stockholders’ equity, and cash flows for each of the three years inthe period ended December 31, 2005. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. An auditincludes consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of Edgewater Technology, Inc. and subsidiaries as of December 31,2005 and 2004, and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2005, inconformity with accounting principles generally accepted in the United Statesof America.

/s/ Deloitte & Touche LLPBoston, MassachusettsMarch 20, 2006

37

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**EDGEWATER TECHNOLOGY, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(In Thousands, Except Share and Per Share Data)**

| ** **                                                                                    | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                    | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                    |       |                  |       |   |   |
| Current assets:                                                                               |       |                  |       |   |   |
| Cash and cash equivalents                                                                     |       | $                     | 6,225      |   | $ | 5,564 |   |
| Marketable securities                                                                         |       | 27,156                |       | 28,344 |   |
| Accounts receivable, net(1) of allowance of $403 and  $205, respectively                      |       | 9,858                 |       | 5,272 |   |
| Deferred income taxes, net                                                                    |       | 1,323                 |       | 710 |   |
| Income tax refund receivable                                                                  |       | —                |       | 1,430 |   |
| Prepaid expenses and other current assets                                                     |       | 1,367                 |       | 822 |   |
| Total current assets                                                                          |       | 45,929                |       | 42,142 |   |
| Property and equipment, net                                                                   |       | 1,364                 |       | 1,364 |   |
| Intangible  assets, net                                                                       |       | 1,481                 |       | 1,996 |   |
| Goodwill, net                                                                                 |       | 15,595                |       | 14,632 |   |
| Deferred income  taxes, net                                                                   |       | 20,168                |       | 21,503 |   |
| Other assets                                                                                  |       | 52                    |       | 65 |   |
| Total assets                                                                                  |       | $                     | 84,589     |   | $ | 81,702 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                 |       |                  |       |   |   |
| Current  liabilities:                                                                         |       |                  |       |   |   |
| Accounts payable and accrued liabilities                                                      |       | $                     | 2,430      |   | $ | 2,440 |   |
| Accruals related to discontinued operations                                                   |       | 729                   |       | 1,210 |   |
| Accrued payroll and related liabilities                                                       |       | 3,085                 |       | 1,091 |   |
| Deferred revenue and other liabilities                                                        |       | 260                   |       | 365 |   |
| Total current liabilities                                                                     |       | 6,504                 |       | 5,106 |   |
| Commitments and  contingencies (Note 12)                                                      |       |                  |       |   |   |
| Stockholders’  equity:                                                                   |       |                  |       |   |   |
| Preferred stock, $0.01 par value; 2,000 shares  authorized,   no shares issued or outstanding |       | —                |       | — |   |
| Common stock,  $0.01 par value; 48,000 shares authorized,                                     |       |                  |       |   |   |
| 29,736 shares  issued, 10,683 and 10,549 shares outstanding                                   |       |                  |       |   |   |
| as of December 31, 2005 and 2004, respectively                                           |       | 297                   |       | 297 |   |
| Paid-in capital                                                                               |       | 216,512               |       | 217,526 |   |
| Treasury stock,  at cost, 19,053 and 19,187 shares at December 31, 2005                  |       |                  |       |   |   |
| and 2004, respectively                                                                        |       | (143,505              | )          | (144,852 | ) |
| Deferred stock-based compensation                                                             |       | (913                  | )          | (469 | ) |
| Retained earnings                                                                             |       | 5,694                 |       | 4,094 |   |
| Total stockholders’ equity                                                               |       | 78,085                |       | 76,596 |   |
| Total liabilities  and stockholders’ equity                                              |       | $                     | 84,589     |   | $ | 81,702 |   |

----

(1)          Includes related-partyamounts of $1,433 and $706 at December 31, 2005 and 2004, respectively.

See notes to consolidated financial statements.

38

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**EDGEWATER TECHNOLOGY, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(In Thousands, Except Per Share Data)**

| ** **                                                                                                                             | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                             | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue:                                                                                                                               |       |                                        |       |   |   |   |   |
| Service revenue(1)                                                                                                                     |       | $                                           | 39,788     |   | $ | 24,731 |   | $ | 24,876 |   |
| Software revenue                                                                                                                       |       | 1,528                                       |       | 60 |   | — |   |
| Reimbursable expenses                                                                                                                  |       | 1,810                                       |       | 531 |   | 178 |   |
| Total revenue                                                                                                                          |       | 43,126                                      |       | 25,322 |   | 25,054 |   |
| Cost of revenue:                                                                                                                       |       |                                        |       |   |   |   |   |
| Project and personnel  costs                                                                                                           |       | 21,841                                      |       | 15,079 |   | 13,362 |   |
| Software costs                                                                                                                         |       | 1,475                                       |       | 49 |   | — |   |
| Reimbursable expenses                                                                                                                  |       | 1,810                                       |       | 531 |   | 178 |   |
| Total cost of revenue                                                                                                                  |       | 25,126                                      |       | 15,659 |   | 13,540 |   |
| Gross profit                                                                                                                           |       | 18,000                                      |       | 9,663 |   | 11,514 |   |
| Operating expenses:                                                                                                                    |       |                                        |       |   |   |   |   |
| Selling, general and  administrative                                                                                                   |       | 15,883                                      |       | 10,154 |   | 10,080 |   |
| Depreciation and  amortization                                                                                                         |       | 1,046                                       |       | 896 |   | 948 |   |
| Total operating expenses                                                                                                               |       | 16,929                                      |       | 11,050 |   | 11,028 |   |
| Operating income (loss)                                                                                                                |       | 1,071                                       |       | (1,387 | ) | 486 |   |
| Interest income, net                                                                                                                   |       | 1,054                                       |       | 556 |   | 455 |   |
| Income (loss) before  taxes and discontinued operations                                                                                |       | 2,125                                       |       | (831 | ) | 941 |   |
| Tax provision (benefit)                                                                                                                |       | 850                                         |       | — |   | (1,053 | ) |
| Income (loss) from  continuing operations before discontinued operations                                                          |       | 1,275                                       |       | (831 | ) | 1,994 |   |
| Discontinued operations:                                                                                                               |       |                                        |       |   |   |   |   |
| Income (loss) from  operations of discontinued divisions, net of applicable taxes                                                      |       | 325                                         |       | 236 |   | (1,020 | ) |
| Net income (loss)                                                                                                                      |       | $                                           | 1,600      |   | $ | (595 | ) | $ | 974 |   |
| Basic income (loss) per share:                                                                                                         |       |                                        |       |   |   |   |   |
| Continuing operations                                                                                                                  |       | $                                           | 0.13       |   | $ | (0.07 | ) | $ | 0.18 |   |
| Discontinued operations                                                                                                                |       | 0.03                                        |       | 0.02 |   | (0.09 | ) |
| Net income (loss)                                                                                                                      |       | $                                           | 0.16       |   | $ | (0.05 | ) | $ | 0.09 |   |
| Weighted average shares,  basic                                                                                                        |       | 10,241                                      |       | 11,283 |   | 11,381 |   |
| Diluted income (loss) per share:                                                                                                       |       |                                        |       |   |   |   |   |
| Continuing operations                                                                                                                  |       | $                                           | 0.12       |   | $ | (0.07 | ) | $ | 0.17 |   |
| Discontinued operations                                                                                                                |       | 0.03                                        |       | 0.02 |   | (0.09 | ) |
| Net income (loss)                                                                                                                      |       | $                                           | 0.15       |   | $ | (0.05 | ) | $ | 0.08 |   |
| Weighted average shares,  diluted                                                                                                      |       | 10,653                                      |       | 11,283 |   | 11,694 |   |
| The following amounts of non-cash stock-based  compensation expense is included in selling, general and administrative expense  above: |       | $                                           | 229        |   | $ | 134 |   | $ | 65 |   |

----

(1)          Includes related-partyamounts of $8,441; $9,685; and $11,766 for the years ended December 31,2005, 2004 and 2003, respectively.

See notes to consolidated financial statements.

39

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**EDGEWATER TECHNOLOGY, INC.**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**(In Thousands)**

| ** **                        | ** ** | ** **            | ** ** | ** **  | ** ** | ** **              | ** ** | ** **      | ** ** | ** **   | ** ** | **Deferred**           | ** ** | ** **   | ** ** | **Total**  | ** ** |
|-----------------------------------|------------|-----------------------|------------|-------------|------------|-------------------------|------------|-----------------|------------|--------------|------------|------------------------|------------|--------------|------------|------------|------------|
| ** **                        | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Treasury Stock** | ** ** | **Stock-based** | ** ** | **Retained** | ** ** | **Stockholders’** | ** ** |
| ** **                        | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**             | ** ** | **Shares**      | ** ** | **Amount**   | ** ** | **Compensation**       | ** ** | **Earnings** | ** ** | **Equity** | ** ** |
| BALANCE, December 31, 2002   |       |                  | 29,596     |        |       |                    | $296       |            |       | $217,302     |       | (18,111                | )          | $(140,276    | )          |       | $          | — |   |   |   | $3,715 |   |   |   | $81,037 |   |   |
| Issuance  of common stock related |       |                  |       |        |       |                    |       |            |       |         |       |                   |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |
| to employee stock plans           |       |                  | —     |        |       |                    | —     |            |       | (65          | )          | 24                     |       | 153          |       |       | —     |   |   |   | — |   |   |   | 88 |   |   |
| Stock option exercises            |       |                  | —     |        |       |                    | —     |            |       | (80          | )          | 32                     |       | 208          |       |       | —     |   |   |   | — |   |   |   | 128 |   |   |
| Repurchase of common stock        |       |                  | —     |        |       |                    | —     |            |       | —       |       | (315                   | )          | (1,409       | )          |       | —     |   |   |   | — |   |   |   | (1,409 | ) |   |
| Deferred stock-based compensation |       |                  | 140        |        |       |                    | 1          |            |       | 668          |       | —                 |       | —       |       |       | (603       | ) |   |   | — |   |   |   | 66 |   |   |
| Net income                        |       |                  | —     |        |       |                    | —     |            |       | —       |       | —                 |       | —       |       |       | —     |   |   |   | 974 |   |   |   | 974 |   |   |
| BALANCE, December 31, 2003   |       |                  | 29,736     |        |       |                    | 297        |            |       | 217,825      |       | (18,370                | )          | (141,324     | )          |       | (603       | ) |   |   | 4,689 |   |   |   | 80,884 |   |   |
| Issuance  of common stock related |       |                  |       |        |       |                    |       |            |       |         |       |                   |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |
| to employee stock plans           |       |                  | —     |        |       |                    | —     |            |       | (57          | )          | 27                     |       | 177          |       |       | —     |   |   |   | — |   |   |   | 120 |   |   |
| Stock option exercises            |       |                  | —     |        |       |                    | —     |            |       | (242         | )          | 104                    |       | 680          |       |       | —     |   |   |   | — |   |   |   | 438 |   |   |
| Repurchase of common stock        |       |                  | —     |        |       |                    | —     |            |       | —       |       | (948                   | )          | (4,385       | )          |       | —     |   |   |   | — |   |   |   | (4,385 | ) |   |
| Deferred stock-based compensation |       |                  | —     |        |       |                    | —     |            |       | —       |       | —                 |       | —       |       |       | 134        |   |   |   | — |   |   |   | 134 |   |   |
| Net loss                          |       |                  | —     |        |       |                    | —     |            |       | —       |       | —                 |       | —       |       |       | —     |   |   |   | (595 | ) |   |   | (595 | ) |   |
| BALANCE, December 31, 2004   |       |                  | 29,736     |        |       |                    | 297        |            |       | 217,526      |       | (19,187                | )          | (144,852     | )          |       | (469       | ) |   |   | 4,094 |   |   |   | 76,596 |   |   |
| Issuance  of common stock related |       |                  |       |        |       |                    |       |            |       |         |       |                   |       |         |       |       |       |   |   |   |   |   |   |   |   |   |   |
| to employee stock plans           |       |                  | —     |        |       |                    | —     |            |       | (204         | )          | 68                     |       | 459          |       |       | —     |   |   |   | — |   |   |   | 255 |   |   |
| Stock option exercises            |       |                  | —     |        |       |                    | —     |            |       | (564         | )          | 248                    |       | 1,605        |       |       | —     |   |   |   | — |   |   |   | 1,041 |   |   |
| Repurchase of common stock        |       |                  | —     |        |       |                    | —     |            |       | —       |       | (321                   | )          | (1,636       | )          |       | —     |   |   |   | — |   |   |   | (1,636 | ) |   |
| Deferred stock-based compensation |       |                  | —     |        |       |                    | —     |            |       | (246         | )          | 139                    |       | 919          |       |       | (444       | ) |   |   | — |   |   |   | 229 |   |   |
| Net income                        |       |                  | —     |        |       |                    | —     |            |       | —       |       | —                 |       | —       |       |       | —     |   |   |   | 1,600 |   |   |   | 1,600 |   |   |
| BALANCE,  December 31, 2005  |       |                  | 29,736     |        |       |                    | $          | 297             |       |         | $          | 216,512                |       | (19,053      | )          | $          | (143,505   | ) |   | $ | (913 | ) |   |   | $ | 5,694 |   |   |   | $ | 78,085 |   |   |
|                                   |            |                       |            |             |            |                         |            |                 |            |              |            |                        |            |              |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See notes to consolidated financial statements.

40

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**EDGEWATER TECHNOLOGY, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In Thousands)**

| ** **                                                                                | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                                    |       |                                        |       |   |   |   |   |
| Net income (loss)                                                                         |       | $                                           | 1, 600     |   | $ | (595 | ) | $ | 974 |   |
| (Income) loss from operations of discontinued  divisions                                  |       | (325                                        | )          | (236 | ) | 1,020 |   |
| Net income (loss) from continuing operations                                              |       | 1,275                                       |       | (831 | ) | 1,994 |   |
| Adjustments  to reconcile net income (loss) to net cash provided by operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and amortization                                                             |       | 1,046                                       |       | 896 |   | 948 |   |
| Provision for bad debts                                                                   |       | 189                                         |       | — |   | 94 |   |
| Deferred income taxes                                                                     |       | 722                                         |       | (38 | ) | (1,053 | ) |
| Amortization of deferred stock-based compensation                                         |       | 229                                         |       | 134 |   | 65 |   |
| Amortization of marketable securities premiums, net                                       |       | (226                                        | )          | — |   | — |   |
| Change  in operating accounts:                                                            |       |                                        |       |   |   |   |   |
| Accounts receivable                                                                       |       | (4,775                                      | )          | (11 | ) | (225 | ) |
| Income tax refund receivable                                                              |       | 1,430                                       |       | — |   | — |   |
| Prepaid expenses and other current assets                                                 |       | (545                                        | )          | (140 | ) | 312 |   |
| Other assets                                                                              |       | 13                                          |       | — |   | 14 |   |
| Accounts payable and accrued liabilities                                                  |       | (10                                         | )          | 789 |   | (370 | ) |
| Accrued payroll and related liabilities                                                   |       | 1,994                                       |       | (1,070 | ) | 911 |   |
| Deferred revenues and other liabilities                                                   |       | (105                                        | )          | 281 |   | (57 | ) |
| Net cash provided by operating activities                                                 |       | 1,237                                       |       | 10 |   | 2,633 |   |
| Net cash used in discontinued operating activities                                        |       | (156                                        | )          | (541 | ) | (1,745 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                    |       |                                        |       |   |   |   |   |
| Redemptions of marketable securities                                                      |       | 31,983                                      |       | 44,072 |   | 32,042 |   |
| Purchases of marketable securities                                                        |       | (30,569                                     | )          | (56,038 | ) | (30,797 | ) |
| Purchase of Intelix, net of cash acquired                                                 |       | —                                      |       | — |   | (1,966 | ) |
| Purchase of Ranzal, net of cash acquired                                                  |       | (963                                        | )          | (5,684 | ) | — |   |
| Purchases of property and equipment                                                       |       | (531                                        | )          | (309 | ) | (193 | ) |
| Net cash used in investing activities                                                     |       | (80                                         | )          | (17,959 | ) | (914 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                    |       |                                        |       |   |   |   |   |
| Payments on capital leases                                                                |       | —                                      |       | — |   | (60 | ) |
| Proceeds from employee stock plans and stock option  exercises                            |       | 1,296                                       |       | 558 |   | 217 |   |
| Repurchases of common stock                                                               |       | (1,636                                      | )          | (4,385 | ) | (1,409 | ) |
| Net cash used in financing activities                                                     |       | (340                                        | )          | (3,827 | ) | (1,252 | ) |
| Net increase (decrease) in cash and cash equivalents                                      |       | 661                                         |       | (22,317 | ) | (1,278 | ) |
| CASH AND CASH EQUIVALENTS, beginning of year                                              |       | 5,564                                       |       | 27,881 |   | 29,159 |   |
| CASH AND CASH EQUIVALENTS, end of year                                                    |       | $                                           | 6,225      |   | $ | 5,564 |   | $ | 27,881 |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:                                       |       |                                        |       |   |   |   |   |
| Interest paid                                                                             |       | $                                           | —     |   | $ | — |   | $ | 2 |   |
| Income taxes paid, net of refunds                                                         |       | $                                           | 240        |   | $ | — |   | $ | — |   |
| Cash receipts from related parties                                                        |       | $                                           | 7,741      |   | $ | 10,872 |   | $ | 11,842 |   |
| Cash paid to related parties                                                              |       | $                                           | 216        |   | $ | 223 |   | $ | 223 |   |
| NON-CASH FINANCING  ACTIVITIES:                                                           |       |                                        |       |   |   |   |   |
| Issuance of  restricted stock awards                                                      |       | $                                           | 673        |   | $ | — |   | $ | 668 |   |

 

See notes to consolidated financial statements.

41

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.   NATUREOF BUSINESS AND BASIS OF PRESENTATION:**

Edgewater Technology, Inc. (“Edgewater Technology”or the “Company”) is an innovative technology management consulting firmproviding a unique blend of premium information technology (“IT”) services. Weprovide our clients with a range of business and technology offerings.Headquartered in Wakefield, Massachusetts, as of December 31, 2005, ourCompany employed approximately 233 technical consulting professionalsthroughout our network of strategically positioned satellite offices.

Theconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States of America.Certain prior period amounts, as they relate to the presentation of the Company’srevenue and related cost of revenue attributable to software sales, have beenreclassified to conform to current period presentation.

**2.   SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES:**

The accompanyingconsolidated financial statements reflect the application of certainsignificant accounting policies as described in this note and elsewhere in theaccompanying consolidated financial statements and notes.

*Principles ofConsolidation—*

The consolidated financialstatements include the accounts of Edgewater Technology and its wholly-ownedsubsidiaries. All intercompany transactions have been eliminated inconsolidation.

*Use of Estimates—*

Our consolidated financialstatements are prepared in accordance with accounting principles generallyaccepted in the United States of America. These accounting principles requiremanagement to make certain estimates, judgments and assumptions that affect thereported amounts of assets, liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amount ofrevenues and expenses during the reporting period. These estimates, judgmentsand assumptions used in preparing the accompanying consolidated financialstatements are based upon management’s evaluation of the relevant facts andcircumstances as of the date of the financial statements. Although the Companyregularly assesses these estimates, judgments and assumptions used in preparingthese consolidated financial statements, actual results could differ from thoseestimates. Changes in estimates are recorded in the period in which they becomeknown. Significant assets and liabilities with reported amounts based onestimates include deferred income tax assets, intangible assets, and otherliabilities including matters involving historical payroll tax assessmentsincluded in discontinued operations.

*Cash and CashEquivalents—*

All highly liquidinvestments with remaining maturities of three months or less at the date ofpurchase are considered cash equivalents. Cash and cash equivalent balancesconsist of deposits, investments in money market funds and repurchaseagreements with large U.S. commercial banks. The Company’s cash equivalentsconsisted of $2.3 million in money market funds and $1.0 million in commercialpaper as of December 31, 2005. Cash equivalents consisted of $3.3 millionin money market funds as of December 31, 2004.

42

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**2.**   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:(Continued)

*MarketableSecurities—*

Marketable securities areclassified as held-to-maturity securities, which are recorded at amortized costand consist of marketable instruments, which include but are not limited togovernment obligations, including agencies and commercial paper. All marketablesecurities have original maturities greater than three months but less than oneyear at the date of purchase.  As of December 31,2005, we had $27.2 million in commercial paper. As of December 31,2004, we had $26.3 million in commercial paper and $2.0 million in governmentobligations, including agencies, respectively. Amortized cost approximated fairvalue.

*Property andEquipment—*

Property and equipment arestated at cost, net of accumulated depreciation and amortization. Property andequipment are depreciated on a straight-line basis over the estimateduseful lives of the assets, which range from three to ten years (or life oflease, if less). Additions that extend the lives of the assets are capitalized,while repairs and maintenance costs are expensed as incurred.

*Costs Incurred toDevelop Software for Internal Use—*

We account for costsrelated to software developed for internal use in accordance with the AmericanInstitute of Certified Public Accountants Statement of Position (“SOP”) 98-1,“*Accounting for Costs of Computer Software Developedor Obtained for Internal Use*.” In accordance with SOP 98-1, the Company capitalizes certaininternal and external costs, which are comprised of employee salaries andthird-party consulting fees incurred during the application development stageof the project, to develop and implement the internal-use software. Such capitalizedcosts are allocated to expense over the estimated life of the software of threeyears using the straight-line method.

*Impairment ofLong-Lived Assets—*

We evaluate our long-livedassets for impairment whenever events or changes in circumstances indicate thatthe carrying amount of such assets may not be recoverable. Impairment isgenerally assessed by a comparison of cash flows expected to be generated by anasset to its carrying value, with the exception that goodwill impairment isassessed by use of a fair value model (see Note 7 of the notes to theconsolidated financial statements). If such assets are considered to beimpaired, the impairment to be recognized is measured by the amount by whichthe carrying amount of the asset exceeds its fair value.

*Goodwill andIntangible Assets—*

Intangible assets consist primarily of goodwill,customer relationships and amounts paid pursuant to non-compete agreements. Non-competeagreements are amortized using the straight-line method over the life ofthe respective agreements. Customer relationships are amortized using thestraight-line method over their estimated remaining life.

Goodwill is tested for impairment at the reportingunit level at least annually, utilizing the “fair value” methodology. TheCompany evaluates the fair value of its reporting unit utilizing variousvaluation techniques.

43

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**2.**   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)

Goodwill must be tested for impairment on an annualbasis and between annual tests in certain circumstances. The Company performedits annual impairment test on December 2, 2005, 2004 and 2003, ourselected annual measurement dates. Historically, we recorded a non-cashimpairment charge of $7.4 million in the fourth quarter of 2002, primarilyas a result of the decline in industry stock prices for our peer group andlower revenues and operating margins for our Company at that time. As of December 2,2005, 2004 and 2003, after receiving an independent third-party valuationappraisal, it was determined that there was no further impairment to theremaining goodwill asset. Our net unamortized goodwill as of December 31,2005 and 2004 was $15.6 million and $14.6 million, respectively. The increasein goodwill from December 31, 2004 was directly related to the successfulcompletion of Ranzal’s first earnout period, which ended on February 28,2005. In 2005, the Company recorded and paid additional purchase priceconsideration of $1.0 million directly related to the earnout considerationpayable to Ranzal’s former stockholders. Ranzal is also eligible for a secondearnout payment, if certain profitability thresholds are met, during the periodcommencing on March 1, 2005 and ending on February 28, 2006. TheCompany currently estimates that amounts potentially payable to Ranzalstockholders for the second earnout will be approximately $3.0 million.

Other net intangiblesamounted to $1.5 million and $2.0 million as of December 31, 2005 and2004, respectively. The identifiable intangible assets are being amortized overtwo to five years and are further described in Notes 3 and 8.

*Revenue Recognitionand Allowance for Doubtful Accounts—*

TheCompany recognizes revenue from providing IT and management consulting servicesunder written service contracts with our customers. The service contracts weenter into generally fall into three specific categories: time and materials,fixed-price and fixed-fee. Our revenues are generated from sources such astechnical consulting, custom software development, integration services,business intelligence consulting, strategic business process consulting, andinfrastructure services. Revenues from these services are recognized as theservices are performed and amounts are earned in accordance with SEC StaffAccounting Bulletin (“SAB”) No. 101 (“SAB 101”), “Revenue Recognition inFinancial Statements,” as amended by SAB No. 104, “Revenue Recognition (“SAB104”).” We consider amounts to be earned once evidence of an arrangement hasbeen obtained, services are delivered, fees are fixed or determinable andcollectibility is reasonably assured. For the years ended December 31,2005, 2004 and 2003, revenues from strategy engagements, technical consultingand custom software development and integration services, and infrastructureservices represented the following:

| **For the Year Ended December 31,** | ** ** | **Strategy Engagements** | ** ** | **Consulting and Development and   Integration Services** | ** ** | **Infrastructure  Services** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------|------------|------------------------------------------------------------------------------------|------------|------------------------------|------------|
| 2005                                                         |       |                          | 35.7       | %                                                                                  |       |                         | 55.9       | % |   |   | 8.4 | % |   |
| 2004                                                         |       |                          | 20.7       | %                                                                                  |       |                         | 67.2       | % |   |   | 12.1 | % |   |
| 2003                                                         |       |                          | 2.9        | %                                                                                  |       |                         | 85.7       | % |   |   | 11.4 | % |   |

 

The Company derives a significant portion of itsservice revenue from time and materials-based contracts. Time andmaterials-based contracts represented 82.5%, 75.0% and 70.9% of servicerevenues for the years ended December 31, 2005, 2004 and 2003,respectively. Revenue under time and materials contracts is recognized asservices are rendered and performed at contractually agreed upon rates.

44

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**2.**   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)

From time to time, the Company may offer volumepurchase arrangements as part of its time and materials contracts to itscustomers. In accordance with Emerging Issues Task Force Abstract (“EITF”) No. 00-22,“Accounting for “Points” and Certain Other Time-Based or Volume-Based SalesIncentive Offers, and Offers for Free Products or Services to Be Delivered inthe Future,” the Company has deferred payment amounts based upon its currentestimates of the actual discounts expected to be earned by the customers. Therewere no deferred amounts as of December 31, 2005 related to volumepurchase arrangements. As of December 31, 2004, the Company had recordedas deferred revenue a liability in the amount of $0.2 million related to sucharrangements.

Revenue pursuant to fixed-price contracts isrecognized under the proportional performance method of accounting. Fixed-pricecontracts represented 11.5%, 15.8% and 18.8% of service revenues for the yearsended December 31, 2005, 2004 and 2003, respectively. Over the course of afixed-price contract, we routinely evaluate whether revenue and profitabilityshould be recognized in the current period. To measure the performance and ourability to recognize revenue and profitability on fixed-price contracts, wecompare actual direct costs incurred to the total estimated direct costs anddetermine the percentage of the contract that is complete. This percentage ismultiplied by the estimated total contract value to determine the amount of netrevenue that should be recognized in accordance with our revenue recognitionpolicies and procedures, subject to any warranty provisions or other projectmanagement assessments as to the status of work performed. This method is usedbecause reasonably dependable estimates of the revenues and costs applicable tovarious stages of a contract can be made, based on historical experience andmilestones identified in any particular contract.

Typically, the Company provides warranty services onits fixed-price contracts related to providing customers with the ability tohave any “design flaws” remedied and/or have our Company “fix” routine softwaredesign defects.  The services, asoutlined in the respective contracts, are provided for a specific period oftime after a project is complete. The Company values the warranty servicesbased upon historical labor hours incurred for similar services at standardbilling rates. In accordance with SAB 101 and SAB 104, revenue related tothe warranty provisions within our fixed-price contracts is recognized as theservices are performed and the revenue is earned. The warranty term istypically short term or for a 30-60 day period after the project iscomplete.

In the event we are unable to accurately estimate theresources required or the scope of work to be performed on a fixed-pricecontract, or we do not manage the project properly within the planned timeperiod, then we may recognize a loss on a contract. Provisions for estimatedlosses on uncompleted projects are made on a contract-by-contract basis. Anyknown or probable losses on projects are charged to operations in the period inwhich such losses are determined. A formal project review process takes placequarterly, although most projects are evaluated on an ongoing basis. Managementreviews the estimated total direct costs on each contract to determine if theestimated amounts are accurate, and estimates are adjusted as needed in theperiod revised estimates are made. The Company recorded an insignificant lossrelated to one specific contract during 2005. There were no recorded losses oncontacts during 2004 or 2003.

We also perform services on a fixed-fee basis under infrastructureservices contracts, which include monthly hosting and support services.  Fixed-fee contracts represented 6.0%, 9.2% and10.3% of service revenues for the years ended December 31, 2005, 2004 and2003, respectively. Revenue under fixed-fee 

45

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**2.**   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)

contracts are recognizedas fixed monthly amounts, for a specified period of time, as outlined withinthe respective contract.

When a customer enters into a time and materials,fixed-price contract or a fixed-fee contract, the related revenue is accountedfor under EITF 00-21, “Revenue Arrangement with Multiple Deliverables.”  For all arrangements, we evaluate thedeliverables in each contract to determine whether they represent separateunits of accounting. If the deliverables represent separate units ofaccounting, we then measure and allocate the consideration from the arrangementto the separate units, based on reliable evidence of the fair value of eachdeliverable.

Client prepayments, even if nonrefundable, aredeferred (classified as a liability) and recognized over future periods asservices are performed. As of December 31, 2005 and 2004, the Company hasrecorded a deferred liability of approximately $0.2 million and $0.1 million,respectively, which is included in the financial statement caption of “deferredrevenue and other liabilities” related to customer prepayments.

Revenues from software resale contracts were less than4.0% of total revenues for all periods presented. Revenue and related costs arerecognized and amounts are invoiced to our customers upon the customer receiptof the purchased software. All related warranty and maintenance arrangementsare performed by the primary vendor of the software and are not the obligationof the Company.

We recognize revenues for services where thecollection from the client is probable and our fees are fixed or determinable. Weestablish billing terms at the time at which the project deliverables andmilestones are agreed. Our standard payment terms are 30 days from invoice date.Reimbursement of “out-of-pocket” expenses charged to customers is reflected asrevenue.

Our revenues and earnings may fluctuate from year toyear 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 delaysincurred in connection with a project, employee utilization rates, the adequacyof provisions for losses, the use of estimates of resources required tocomplete ongoing projects, general economic conditions and other factors.Certain significant estimates include those used for fixed-price contracts,such as deferrals related to our volume purchase agreements, warrantyholdbacks, and allocations of fair value of elements under multiple elementarrangements, and the valuation of our allowance for doubtful accounts.

We maintain allowances fordoubtful accounts in order to estimate losses attributable to the inability ofour clients to make required payments. We base our estimates on our historicalcollection and write-off experience, current trends, credit policy, detailedanalysis of specific client situations and percentage of our accountsreceivable by aging category. While such credit losses have historically beenwithin our expectations and the allowances we established, we cannot guaranteethat we will continue to experience the same credit loss rates that we have inthe past. If the financial condition of our customers were to deteriorate,resulting in an impairment of their ability to make payment, additionalallowances may be required. Our failure to accurately estimate the losses ondoubtful accounts and ensure that the payments are received on a timely basiscould have a material adverse effect on our business, financial condition,results of operation and cash flows.

46

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**2.**   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)

***Costof Services—***

Our cost of services arecomprised primarily of project personnel costs, including direct salaries,payroll taxes, employee benefits and travel expenses for personnel dedicated tocustomer projects. These costs represent the most significant expense we incurin providing our services.

***InterestIncome, Net—***

*Interestincome, net was $1.1 million, $0.6 million and $0.5 million, for the yearsended December 31, 2005, 2004 and 2003, respectively. The following tablerepresents the components of interest income, net:*

| ** **           | ** ** | **Year Ended December 31,** | ** ** |
|----------------------|------------|--------------------------------------------|------------|
| ** **           | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **           | ** ** | **(In Thousands)**                    | ** ** |
| Interest income      |       | $                                          | 1,054      |   | $ | 556 |   | $ | 457 |   |
| Interest expense     |       | —                                     |       | — |   | (2 | ) |
| Interest income, net |       | $                                          | 1,054      |   | $ | 556 |   | $ | 455 |   |

 

*Provision for Taxes—*

***In determining our current income taxprovision, we assess temporary differences resulting from different treatmentsof items for tax and accounting purposes. These differences result in deferredtax assets and liabilities, which are recorded in our consolidated balancesheets. A valuation allowance is provided to the extent tax assets are notlikely to be recovered. We have recorded a valuation allowance against our netdeferred tax assets of approximately $5.2 million and $14.7 million as of December 31,2005 and 2004, respectively. This valuation allowance was established due touncertainties related to the Company’s ability to utilize some of its deferredtax assets, primarily consisting of certain net operating losses carriedforward and foreign tax credits, before they expire. The current year decreasein the Company’s valuation allowance relates to the write down of deferred taxasset amounts related to certain state net operating loss carryforwards whichexpired in 2005. The state net operating loss carryforwards were fully reservedfor as part of the Company’s valuation allowance.***

***The Company considers scheduled reversalsof deferred tax liabilities, projected future taxable income, ongoing taxplanning strategies and other matters, including the period over which ourdeferred tax assets will be recoverable, in assessing the need for and theamount of the valuation allowance. In the event that actual results differ fromthese estimates or we adjust these estimates in future periods, an adjustmentto the valuation allowance may be recorded, which could materially impact ourfinancial position and net income (loss) in the period of the adjustment. Inaddition, as a result of a change in the Internal Revenue Code, our 2002 taxloss was carried back to 1997, resulting in a refund of previously paid taxesof $1.4 million. This amount was recorded as a benefit in the fourth quarter of2003 and is shown as a current asset at December 31, 2004.***The fullamount of the $1.4 million refund receivable balance, plus accrued interestthereon, was collected during 2005.  SeeNote 8 of the notes to the consolidated financial statements.

47

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**2.   SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES: (Continued)**

*Earnings (Loss) PerShare—*

Basicearnings (loss) per share reflect the weighted-average number of common sharesoutstanding during each period. Diluted earnings (loss) per share reflect theimpact, when dilutive, of the exercise of options using the treasury stockmethod. Following is a reconciliation of the shares used in computing basic anddiluted net (loss) earnings per share for the fiscal years ended December 31,2005, 2004 and 2003:

| ** **                                                                   | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                   | ** ** | **(In Thousands)**                    | ** ** |
| Shares used in  computing basic net earnings (loss) per share           |       | 10,241                                     |       | 11,283 |   | 11,381 |   |
| Dilutive effect  of stock options and unvested restricted stock awards       |       | 412                                        |       | — |   | 313 |   |
| Shares used in  computing diluted net earnings (loss) per share              |       | 10,653                                     |       | 11,283 |   | 11,694 |   |
| Dilutive securities not  included in net loss per share due to reported loss |       | —                                     |       | 658 |   | — |   |

 

Stock options for whichthe exercise price exceeds the average market price have an anti-dilutive effecton earnings per share, and accordingly, are excluded from the dilutedcomputations of earnings per share in each of the periods presented. Had suchshares been included, the presented number of shares for the dilutedcomputation would have increased by approximately 2.7 million, 2.7 million and2.8 million in the years ended December 31, 2005, 2004 and 2003,respectively.

***FairValue of Financial Instruments—***

Edgewater Technology’sfinancial instruments include cash and cash-equivalents, marketable securities,accounts receivable, and accounts payable. The carrying values of cash and cashequivalents, accounts receivable, and accounts payable approximate their fairvalue due to the relatively short-term nature of the accounts. Managementbelieves that the marketable securities have interest rates which approximateprevailing market rates for instruments with similar characteristics and,accordingly, that the carrying value for these instruments reasonably estimatesfair value.

*Concentrations***of Credit Risk—

Financial instruments thatpotentially subject the Company to significant concentration of market orcredit risk consist principally of cash equivalent instruments, investments andaccounts receivable. The Company places its cash balances with reputablefinancial institutions and investments are generally limited to 10% in any onefinancial instrument. Investments are carried at cost or fair value, asappropriate. Trade receivables potentially subject the Company to credit risk.The Company extends credit to its customers based upon an evaluation of thecustomer’s financial condition and credit history and generally does notrequire collateral. The Company has historically incurred minimal creditlosses. The Company had two customers with outstanding balances that accountedfor greater than 10% of the accounts receivable balance as of December 31,2005 and 2004, respectively.

48

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**2.**   SUMMARY OF SIGNIFICANTACCOUNTING POLICIES: (Continued)

| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Accounts receivable:                  |       |                  |       |   |   |
| Synapse (related  party—Note 11) |       | 14.3                  | %          | 13.4 | % |
| Customer A                            |       | 13.6                  | %          | 27.3 | % |

 

Forthe years ended December 31, 2005, 2004 and 2003, two customers, includingSynapse (a related party—See Note 11), each contributed more than 10% of theCompany’s service revenues. For the years ended December 31, 2005, 2004and 2003, our five largest customers represented 47.5%, 69.0% and 81.7% of ourservice revenues in the aggregate, respectively.
| ** **                       | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------------|------------|------------------------------------------|------------|
| ** **                       | ** ** | **2005**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                        |       |                                     |       |   |   |   |   |
| Synapse (related  party—11) |       | 21.2                                     | %          | 39.0 | % | 47.3 | % |
| Customer A                       |       | 15.3                                     | %          | 14.3 | % | 21.0 | % |

*ComprehensiveIncome (Loss)—*

There are no elements ofcomprehensive income (loss) other than net income (loss).

*Stock Options—*

TheCompany records stock-based compensation awards issued to employees anddirectors using the intrinsic value method and stock-based compensation awardsissued to non-employees using the fair value method of accounting. Stock-basedcompensation expense, if any, is recognized on awards of restricted shares orgrants of stock options issued to employees and directors if the purchase priceor exercise price, as applicable, is less than the market price of theunderlying stock on the measurement date, generally the date of grant. Thedifferences between accounting for stock-based compensation under the intrinsicvalue method and the fair value method are shown below, with the fair valueestimated on the grant date or award issue date as applicable. The assumptionsused are described in Note 10.

| ** **                                                                                                     | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                     | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                     | ** ** | **(In Thousands)**                    | ** ** |
| Net income (loss)                                                                                              |       |                                       |       |   |   |   |   |
| As reported                                                                                                    |       | $                                          | 1,600      |   | $ | (595 | ) | $ | 974 |   |
| Add: Stock-based  compensation expense included in reported net income (loss), net of tax                      |       | 137                                        |       | 80 |   | 39 |   |
| Deduct:  Stock-based compensation expense determined under fair value based method for  all awards, net of tax |       | (607                                       | )          | (917 | ) | (1,310 | ) |
| Pro forma net  income (loss)                                                                                   |       | $                                          | 1,130      |   | $ | (1,432 | ) | $ | (297 | ) |
| Basic and diluted  earnings (loss) per share                                                                   |       |                                       |       |   |   |   |   |
| As reported—basic                                                                                         |       | $                                          | 0.16       |   | $ | (0.05 | ) | $ | 0.09 |   |
| As  reported—diluted                                                                                      |       | $                                          | 0.15       |   | $ | (0.05 | ) | $ | 0.08 |   |
| Pro forma—basic                                                                                           |       | $                                          | 0.11       |   | $ | (0.13 | ) | $ | (0.03 | ) |
| Pro forma—diluted                                                                                         |       | $                                          | 0.11       |   | $ | (0.13 | ) | $ | (0.03 | ) |

 

49

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**2.**   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)

*Segment Information—*

The Company engages inbusiness activities under one operating segment, which combines strategicconsulting, technical knowledge, and industry domain expertise to developcustom technology and business process solutions.

*Recent AccountingPronouncements—*

In December 2004, FASB issued SFAS No. 123R,“Share-Based Payment.”  This statement isa revision of SFAS No. 123 and supersedes APB No. 25 and itsrelated implementation guidance. SFAS No. 123R focuses primarily onaccounting for transactions in which an entity obtains employee services inshare-based payment transactions. The statement requires entities to recognizecompensation expense for awards of equity instruments to employees based on thegrant-date fair value of those awards (with limited exceptions). SFAS No. 123Ris effective for the first annual reporting period that begins after June 15,2005, although earlier adoption is encouraged.

The Company willadopt SFAS No. 123R on January 1, 2006, using the statement’smodified-prospective transition method. Adoption of SFAS 123R will not affectthe Company’s cash flows or financial position, but it will reduce periodicallyreported income and earnings per share as the Company currently uses theintrinsic value method as permitted by Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees” (“APB No. 25”). As permittedunder APB No. 25, no compensation expense is currently recognized forshare purchase rights granted under the Company’s stock option plans oremployee stock purchase plan.

Uponadoption, the Company will begin recording compensation expense for employeestock options and employee share purchase rights. We currently estimate ourfiscal 2006 pre-tax stock-based compensation expense to be in the range of $1.1million to $1.3 million, reducing both basic and diluted earnings per share by$0.10 to $0.12.

**3.   BUSINESSCOMBINATIONS:**

*Acquisitionof Ranzal and Associates, Inc.:**  *On October 4, 2004, the Company acquiredsubstantially all of the assets, operations and business of Ranzal andAssociates, Inc. (“Ranzal”), a consulting firm specializing in thedevelopment of Business Intelligence and Business Performance Managementsolutions. The results of Ranzal’s operations have been included in the Company’saccompanying consolidated statement of operations since the October 4,2004 acquisition date. The acquisition was made to strengthen EdgewaterTechnology’s capabilities in strategy and design, solidify the Company’s eastcoast presence, and expand vertical expertise and service offerings to themiddle market, in particular in the high-growth area of Business PerformanceManagement. The initial aggregate purchase price was $5.7 million, includingcash paid to the Ranzal stockholders of $5.2 million and direct acquisitioncosts incurred of $0.5 million.

50

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**3.**   BUSINESS COMBINATIONS: (Continued)

The Company used anindependent third-party appraiser to calculate the amounts allocated to assets,liabilities and identified intangible assets. The allocation of the initialpurchase price was as follows:

| ** **                                                                     | ** ** | **Total**               | ** ** | **Life (in years)** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------------|------------|
| ** **                                                                     | ** ** | **(In Thousands)** | ** ** | ** **                    | ** ** |
| Net book value of  assets and liabilities acquired                             |       |                    | $          | 1,689                         |       |   |   |   |   |   |
| Acquired  intangible assets                                                    |       |                    | 1,600      |                          |       |   | 2 to 5 years |   |   |
| Goodwill  (deductible for tax purposes under Section 197 of the IRS Code) |       |                    | 2,395      |                          |       |   |   |   |   |
| Total purchase price                                                           |       |                    | $          | 5,684                         |       |   |   |   |   |   |

 

In addition to the initialcash consideration, the stockholders of Ranzal are eligible for additional cashpayments, based upon a formula applied to Earnings Before Interest, Taxes,Depreciation and Amortization of the Ranzal business over the six and eighteenmonth periods beginning on September 1, 2004 and ending February 28,2006. In fiscal 2005, the Company recorded and paid additional purchase priceconsideration of $1.0 million directly related to the earnout considerationpayable to Ranzal’s former stockholders. Ranzal is also eligible for a secondearnout payment, if certain profitability thresholds are met, during the periodcommencing on March 1, 2005 and ending on February 28, 2006. As of December 31,2005, the Company has not accrued any payment amounts related to the secondearnout as the underlying facts related to the potential contingencies have notbeen resolved and additional consideration is not currently distributable tothe shareholders of Ranzal. As of December 31, 2005, the Company believesthat it is likely the second earnout payment amount of approximately $2.6 millionwill be attained. Any additional amounts paid to the former stockholders ofRanzal will be recorded as additional goodwill.

The following table setsforth supplemental unaudited pro forma financial information that assumes theacquisition of Ranzal was completed at the beginning of fiscal 2003. Theinformation for the twelve month periods ended December 31, 2004 and 2003include the historical results of Ranzal.

Theunaudited pro forma results include estimates and assumptions regardingincreased amortization of intangible assets related to the acquisition, areduction in administrative wages and benefits related to the elimination ofpositions, reduced rent expense, reduced interest expense related to notepayable agreements and estimated state income taxes in states which Edgewaterdoes not have available net operating loss carryforwards to offset taxableincome. The pro forma results, as presented, are not necessarily indicative ofthe results that would have occurred if the acquisition had occurred on thedate indicated, or that may result in the future.

| ** **                            | ** ** | **For the Year Ending   December 31,** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                            | ** ** | **2004**                                                        | ** ** | **2003** | ** ** |
| ** **                            | ** ** | **(In Thousands)**                                         | ** ** |
| Pro forma  revenues                   |       | $                                                               | 31,743     |   | $ | 31,829 |   |
| Pro forma net  income                 |       | $                                                               | 1,099      |   | $ | 2,188 |   |
| Pro forma diluted  earnings per share |       | $                                                               | 0.09       |   | $ | 0.19 |   |

 

51

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**3.**   BUSINESS COMBINATIONS: (Continued)

*Acquisitionof Intelix, Inc.:**  *On June 2, 2003, the Company acquired all of theoutstanding common stock of Intelix, Inc. (“Intelix”), a provider ofsystems integration and custom software development services located inFairfax, Virginia. The results of Intelix’s operations have been included inthe Company’s accompanying consolidated statements of operations since the June 2,2003 acquisition date. The acquisition was made to enhance Edgewater Technology’sgeographical presence and to provide additional vertical expertise. Theaggregate purchase price was $2.7 million, including cash paid to the Intelixstockholders of $0.9 million, assumed liabilities with an estimated fair valuein the amount of $1.5 million, and direct costs incurred of $0.3 million.

TheCompany used an independent third-party appraiser to calculate the amountsallocated to assets, liabilities and identified intangible assets. Theallocation of the initial purchase price was as follows:

| ** **                                         | ** ** | **Total**               | ** ** | **Life (in years)** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|-------------------------------|------------|
| ** **                                         | ** ** | **(In Thousands)** | ** ** | ** **                    | ** ** |
| Net book value of  assets and liabilities acquired |       |                    | $          | 845                           |       |   |   |   |   |   |
| Acquired  intangible assets                        |       |                    | 530        |                          |       |   | 4 to 8 years |   |   |
| Goodwill (not  deductible for tax purposes)        |       |                    | 1,367      |                          |       |   |   |   |   |
| Total purchase price                               |       |                    | $          | 2,742                         |       |   |   |   |   |   |

 

The Intelix acquisitionwas accounted for as a purchase transaction, and accordingly, the results ofoperations, commencing from the acquisition date of June 2, 2003, areincluded in the Company’s consolidated statements of operations. Pro formafinancial information related to the Intelix acquisition is not presented asthe effect of this acquisition was not material to the Company.

**4.   DISCONTINUEDOPERATIONS:**

During the second quarter of 2000, the Company beganto divest itself from its staffing businesses. Between June of 2000 and March of2001, the Company disposed of several of its business divisions in either stockor equity transactions. As a result of the completion of these transactions,the operating results for the Company’s StaffMark, Robert Walters, StrategicLegal, IntelliMark and ClinForce business units have been included indiscontinued operations in the accompanying consolidated financial statements. Operatingincome from discontinued operations was $0.3 million and $0.2 million in 2005and 2004, respectively. These amounts reflect the reversal of a portion of theaccrual to reflect management’s current estimate of the remaining liabilitiesas of December 31, 2005 and 2004. The remaining accrual for discontinuedoperations as of December 31, 2005 provides for a loss on a lease and anestimate of additional professional fees. Operating loss from discontinuedoperations for 2003 was $1.0 million, which did not have any tax effect. TheCompany provided an accrual for certain tax assessments and professional feesrelated to the discontinued businesses in 2003. See Note 12.

52

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**4.**   DISCONTINUEDOPERATIONS: (Continued)

Related to the abovetransactions, the Company has received certain payroll tax assessments relatedto our former staffing businesses, which were sold in 2000 and 2001. We havebeen successful in obtaining abatements of certain IRS notices. In 2003, werecorded a reserve of $1.0 million representing the low end of our estimatedexposure related to the assessments, plus related professional fees. During both 2005 and 2004, ourCompany was able to successfully resolve several outstanding notices related tothese tax matters as the Company received formal notice from the IRS thatcertain assessments had been fully abated. In 2005, on a net basis, the Companyreversed approximately $0.3 million from its discontinued operations accrualdirectly related to the successful resolution of certain tax assessments. In2004, directly related to the abovenotices, which totaled approximately $0.8 million, we reversed approximately$0.2 million of our accrual for discontinued operations in 2004. Also in 2004,based upon currently available information, we increased our previouslyestablished accrual related to our exposure on estimated future lease paymentsexpected to be made on office space related to our former corporate headquartersby approximately $0.4 million. The increase in the lease accrualwas deemed necessary after revising a previously prepared estimate with morecurrent information. Wecontinue to dispute additional unresolved IRS assessments in the amount of$0.02 million as of December 31, 2005.

**5.**   ACCOUNTSRECEIVABLE:

Included in accounts receivable are unbilled amountstotaling approximately $2.5 million and $1.8 million at December 31,2005 and 2004, respectively, which relate to services performed during the yearand billed in the subsequent period. Edgewater Technology maintains allowancesfor potential losses which management believes are adequate to absorb anypossible losses to be incurred in realizing the accounts receivable amountsrecorded in the accompanying consolidated financial statements.

Thefollowing are the changes in the allowance for doubtful accounts:

| ** **                      | ** ** | **Years Ending  December 31,** | ** ** |
|---------------------------------|------------|------------------------------------------|------------|
| ** **                      | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In Thousands)**                  | ** ** |
| Balance at  beginning of year   |       | $                                        | 205        |   | $ | 220 |   |
| Provisions for  bad debts       |       | 198                                      |       | — |   |
| Charge-offs, net  of recoveries |       | —                                   |       | (15 | ) |
| Balance at end of year          |       | $                                        | 403        |   | $ | 205 |   |

 

**6.   PROPERTY ANDEQUIPMENT:**

Componentsof property and equipment consisted of the following as of December 31:

| ** **                                      | ** ** | **2005**                | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                      | ** ** | **(In Thousands)** | ** ** |
| Furniture,  fixtures and equipment              |       | $                       | 1,186      |     | $          | 1,121 |   |
| Computer  equipment and software                |       | 2,564                   |       | 2,156    |       |
| Leasehold  improvements                         |       | 1,381                   |       | 1,356    |       |
|                                            |       | 5,131                   |       | 4,633    |       |
| Less accumulated  depreciation and amortization |       | 3,767                   |       | 3,269    |       |
|                                            |       | $                       | 1,364      |     | $          | 1,364 |   |

 

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**6.**   PROPERTY AND EQUIPMENT: (Continued)

Depreciation expenserelated to property and equipment for the years ended December 31, 2005,2004 and 2003 totaled approximately $0.5 million, $0.4 million and $0.6million, respectively.

**7.   GOODWILL ANDINTANGIBLE ASSETS:**

**Intangible Assets withIndefinite Lives:**

Thechanges in the carrying amount of goodwill for the years ended December 31,are as follows: 

| ** **                                            | ** ** | **2005**                | ** ** | **2004** | ** ** |
|-------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| **Goodwill:**                                         | ** ** | **(In Thousands)** | ** ** |
| Balance at  beginning of year                         |       | $                       | 14,632     |     | $          | 12,237 |   |
| Acquisition  consummated during 2004 (see Note 3)     |       | —                  |       | 2,395    |       |
| Additional  consideration related to 2004 acquisition |       | 963                     |       | —   |       |
| Balance at end of year                                |       | $                       | 15,595     |     | $          | 14,632 |   |

 

**Intangible Assetswith Definite Lives:**

Followingis a summary of the Company’s identifiable intangible assets that are subjectto amortization as of December 31:

| ** **                         | ** ** | **2005**                    | ** ** | **2004**                      | ** ** |
|------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| **Identifiable intangibles:** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** |
| ** **                         | ** ** | **(In Thousands)**     | ** ** |
| Non-compete agreements             |       |                        | $          | 2,230                         |       |   |   | $ | 1,820 |   |   |   | $ | 410 |   |   |   | $ | 2,230 |   |   |   | $ | 1,612 |   |   |   | $ | 618 |   |   |
| Customer  relationships            |       |                        | 1,430      |                          |       |   | 397 |   |   |   | 1,033 |   |   |   | 1,430 |   |   |   | 140 |   |   |   | 1,290 |   |   |
| Trade name and  trademark          |       |                        | 100        |                          |       |   | 62 |   |   |   | 38 |   |   |   | 100 |   |   |   | 12 |   |   |   | 88 |   |   |
|                               |       |                        | $          | 3,760                         |       |   |   | $ | 2,279 |   |   |   | $ | 1,481 |   |   |   | $ | 3,760 |   |   |   | $ | 1,764 |   |   |   | $ | 1,996 |   |   |

 

Theintangible assets were identified and valued by an independent third-partyappraiser. The original estimated useful lives of the acquired identifiableintangible assets are as follows:

| Non-compete agreements   |   | 4—5 years   |
|--------------------------|--------|------------------|
| Customer relationships   |   | 5—7.5 years |
| Trade name and trademark |   | 2 years          |

 

As of December 31, 2005, the net carrying amountof intangible assets acquired in business combinations mainly relate to theRanzal and Intelix acquisitions, which were consummated in fiscal 2004 and2003, respectively. Each of these transactions is further described in Note 3. Amortizationexpense related to intangible assets for the years ended December 31,2005, 2004 and 2003 totaled approximately $0.5 million, $0.5 million and $0.4 million,respectively.

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**7.**   GOODWILL AND INTANGIBLE ASSETS: (Continued)

Estimated annualamortization expense for the next five years ended December 31, is asfollows:

| ** ** | ** ** | **Amortization**        | ** ** |
|------------|------------|-------------------------|------------|
| ** ** | ** ** | **Expense**             | ** ** |
| ** ** | ** ** | **(In Thousands)** | ** ** |
| 2006       |       |                    | $          | 419 |   |   |
| 2007       |       |                    | $          | 367 |   |   |
| 2008       |       |                    | $          | 357 |   |   |
| 2009       |       |                    | $          | 282 |   |   |
| 2010       |       |                    | $          | 56 |   |   |

 

**8.   INCOME TAXES:**

**Theprovision for income taxes consisted of the following for the years ended December 31:**

| ** **                                                       | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                                       | ** ** | **(In Thousands)** | ** ** |
| Current tax expense  benefit:                                    |       |                    |       |     |       |     |       |
| Federal                                                          |       | $                       | 66         |     | $          | —   |       | $ | (1,541 | ) |
| State                                                            |       | 63                      |       | —   |       | (27      | )          |
| Foreign                                                          |       | —                  |       | —   |       | —   |       |
|                                                             |       | 129                     |       | —   |       | (1,568   | )          |
| Deferred tax expense  (benefit):                                 |       |                    |       |     |       |     |       |
| Federal                                                          |       | 962                     |       | (566     | )          | 414      |       |
| State                                                            |       | 9,203                   |       | (50      | )          | 101      |       |
| Change in valuation allowance                                    |       | (9,444                  | )          | 616      |       | —   |       |
|                                                             |       | 721                     |       | —   |       | 515      |       |
| Income tax provision  (benefit) from continuing operations  |       | $                       | 850        |     | $          | —   |       | $ | (1,053 | ) |

 

Thecomponents of deferred income tax assets and liabilities as of December 31,2005 and 2004 were as follows:

| ** **                                   | ** ** | **2005**                | ** ** | **2004** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                   | ** ** | **(In Thousands)** | ** ** |
| Deferred income tax  assets:                 |       |                    |       |     |       |
| Net operating loss carryforwards and credits |       | $                       | 26,059     |     | $          | 36,145 |   |
| Nondeductible reserves and accruals          |       | 736                     |       | 724      |       |
| Depreciation and amortization                |       | 82                      |       | 64       |       |
| Total deferred income tax assets             |       | 26,877                  |       | 36,933   |       |
| Deferred income tax  liabilities:            |       |                    |       |     |       |
| Other                                        |       | (162                    | )          | (75      | )          |
| Total deferred income tax liabilities        |       | (162                    | )          | (75      | )          |
| Valuation  allowance                         |       | (5,224                  | )          | (14,645  | )          |
| Deferred income tax, net                     |       | $                       | 21,491     |     | $          | 22,213 |   |

 

55

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**8.**   INCOME TAXES: (Continued)

The current year decreases in the Company’s reportednet operating loss carryforward and credits and valuation allowance relates tothe current year write down deferred tax asset amounts related to certain statenet operating loss carryforwards which expired in 2005. The state net operatingloss carryforwards were fully reserved for as part of the Company’s valuationallowance.

Components of the netdeferred tax assets (liabilities) reported in the accompanying consolidatedbalance sheets were as follows as of December 31, 2005 and 2004:

| ** **  | ** ** | **2005**                | ** ** | **2004**      | ** ** |
|-------------|------------|-------------------------|------------|---------------|------------|
| ** **  | ** ** | **Current**             | ** ** | **Long-term** | ** ** | **Current** | ** ** | **Long-term** | ** ** |
| ** **  | ** ** | **(In Thousands)** | ** ** |
| Assets      |       |                    | $          | 1,361         |       |   |   | $ | 20,367 |   |   |   | $ | 748 |   |   |   | $ | 21,540 |   |   |
| Liabilities |       |                    | (38        | )             |       |   | (199 | ) |   |   | (38 | ) |   |   | (37 | ) |   |
|        |       |                    | $          | 1,323         |       |   |   | $ | 20,168 |   |   |   | $ | 710 |   |   |   | $ | 21,503 |   |   |

 

As of December 31, 2005, we have tax affected netoperating loss carryforwards for federal income tax purposes of approximately$21.1 million and tax credits of approximately $4.0 million, which expirethrough 2021. In addition, the Company has various tax affected net operatingloss carryforwards for state income tax purposes of approximately $1.0 million,which expire through 2014. The Internal Revenue Code contains provisions thatlimit the net operating loss and tax credit carryforwards available to be usedin any given year in the event of certain circumstances, including significantchanges in ownership interests.

Due to the uncertainty surrounding the realization andtiming of certain deferred tax assets, the Company recorded a valuationallowance of approximately $5.2 million and $14.7 million as of December 31,2005 and 2004, respectively, which reduces the net assets to amounts managementbelieves are more likely than not to be realized. Management regularlyevaluates the realizability of the deferred tax assets and may adjust thevaluation allowance based on such analysis in the future. The valuationallowance decreased by approximately $9.6 million in fiscal 2005 in connectionwith the write down of deferred tax asset amounts related to certain state netoperating loss carryforwards, which expired in the current year. The expiredstate net operating loss carryforwards were fully reserved for as part of theCompany’s valuation allowance. The valuation allowance increased byapproximately $0.6 million in fiscal 2004 primarily due to management’sestimate of the Company’s ability to realize certain recorded deferred taxassets.

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**8.**   INCOME TAXES: (Continued)

The differences in incometaxes determined by applying the statutory federal tax rate of 34% to incomefrom continuing operations before income taxes and the amounts recorded in theaccompanying consolidated statements of operations for the years ended December 31,2005, 2004 and 2003 result from the following:

| ** **                                                                                     | ** ** | **2005**                                         | ** ** | **2004** | ** ** | **2003**   | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|----------|------------|------------|------------|
| ** **                                                                                     | ** ** | **Amount**                                       | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** |
| ** **                                                                                     | ** ** | **(Dollar Amounts In Thousands)** | ** ** |
| Income tax  (benefit) at statutory rate                                                        |       |                                             | $          | 722      |       |       | 34.0       | % |   | $ | (282 | ) |   | (34.0 | )% | $ | 303 |   | 34.0 | % |
| Add (deduct):                                                                                  |       |                                             |       |     |       |       |       |   |   |   |   |   |   |   |   |   |   |
| State income taxes, net of federal tax benefit                                                 |       |                                             | 63         |     |       | 3.0        |       |   | (16 | ) |   | (2.0 | ) | 73 |   | 6.0 |   |
| Net operating loss carry back claim                                                            |       |                                             | —     |     |       | —     |       |   | — |   |   | — |   | (1,430 | ) | (152.0 | ) |
| Non-deductible intangible asset and goodwill  amortization charges                             |       |                                             | 48         |     |       | 2.2        |       |   | 141 |   |   | 16.9 |   | — |   | — |   |
| Provision of valuation allowance against currently  generated net operating loss carryforwards |       |                                             | —     |     |       | —     |       |   | 128 |   |   | 15.5 |   | — |   | — |   |
| Other, net                                                                                     |       |                                             | 17         |     |       | 0.8        |       |   | 29 |   |   | 3.6 |   | 1 |   | — |   |
|                                                                                           |       |                                             | $          | 850      |       |       | 40.0       | % |   | $ | — |   |   | — | % | $ | (1,053 | ) | (112.0 | )% |

 

**9.   EMPLOYEE BENEFITPLANS:**

The Company has a 401(k) taxdeferred savings plan that is available to all employees who satisfy certainminimum hour requirements each year (the “Plan”). The Company matches 30% ofeach participant’s annual contribution under the Plan, up to 6% of eachparticipant’s annual base salary. Contributions by the Company to the plan wereapproximately $0.3 million, $0.2 million and $0.2 million for the years ended December 31,2005, 2004 and 2003, respectively.

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**10.**   COMMONSTOCK,  STOCK OPTIONS AND EMPLOYEE STOCKPURCHASE PLAN:

*Common andPreferred Stock—*

The Company’s stockholdershad authorized 48.0 million shares of common stock available for issuance as ofDecember 31, 2005 and 2004, and had 2.0 million shares of preferred stockavailable for issuance as of December 31, 2005 and 2004.

*Stockholder RightsPlan—*

The Company has astockholder rights plan, commonly referred to as a “poison pill,” that maydiscourage an attempt to obtain control by means of a tender offer, merger,proxy contest or otherwise. Under this plan, our Board of Directors can issuepreferred stock in one or more series without stockholder action. If a personacquires 20% or more of our outstanding shares of common stock, except forcertain institutional stockholders, who may acquire up to 25% of ouroutstanding shares of common stock, then rights under this plan would betriggered, which would significantly dilute the voting rights of any suchacquiring person. Certain provisions of the General Corporation Law of Delawaremay also discourage someone from acquiring or merging with us. No preferredstock has been issued as of December 31, 2005.

*2003 EquityIncentive Plan—*

In May 2003, the Company’s Board of Directorsapproved the “Edgewater Technology, Inc. 2003 Equity Incentive Plan” (the“2003 Plan”) for the purpose of attracting and retaining employees andproviding a vehicle to increase management’s equity ownership in the Company.The 2003 Plan provides for restricted share awards and grants of nonqualifiedstock options in the aggregate of up to 500,000 shares of the Company’s commonstock. Restricted awards are made at prices determined by the CompensationCommittee of the Board of Directors (the “Compensation Committee”) and arecompensatory in nature. Employees granted restricted share awards are requiredto provide consideration for the shares at the share price set by theCompensation Committee. During fiscal 2005, awards of 138,750 restricted shareswere made to employees at a weighted average value at the grant date of $4.84 pershare.  No such restricted share awardswere granted to employees in fiscal 2004. As of December 31, 2005, restrictedshare awards made to employees under the 2003 Plan total 269,750 shares at aweighted average value at grant date of $4.80 per share. The value of thecompensation expense related to the awards of restricted shares is beingamortized on a straight-line basis over the vesting term (five years). Theaggregate deferred compensation expense associated with the restricted shareawards is $1.3 million, which compensation expense amount is being amortizedstraight-line over the vesting term (five years). Compensation expense relatingto the Restricted Share Awards during the years ended December 31, 2005,2004 and 2003 was approximately $0.2 million, $0.1 million and $0.07 million,respectively.

The restricted shareawards vest ratably over a five-year period, during which time the Company hasthe right to repurchase the unvested shares at the amount paid if therelationship between the employee and the Company ceases. The Company maintainsthe right to repurchase the unvested shares if an employee is terminatedwithout cause. As of December 31, 2005 and 2004, 213,750 and 112,000restricted share awards, respectively, were subject to repurchase by theCompany under these restricted stock agreements.

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**10.**   COMMON STOCK,  STOCK OPTIONSAND EMPLOYEE STOCK PURCHASE PLAN: (Continued)

*Stock Options—*

In October 1999, the Company’s Board of Directorsamended the Company’s 1996 Stock Option Plan (the “1996 Plan”) to increase themaximum number of shares of the Company’s common stock that may be issued underthe 1996 Plan from 12% to 15% of the total number of shares of the Company’scommon stock outstanding. Options granted under the 1996 Plan generally become33% vested after one year and then vest 33% in each of the next two years orbecome 40% vested after two years and then vest 20% in each of the next threeyears. Under the 1996 Plan, the exercise price of the option equals the marketvalue of the Company’s common stock on the date of the grant, and the maximumterm for each option is ten years.

In February 2000, the Company adopted asubsidiary stock option plan (the “Subsidiary Plan”) for employees andconsultants of Edgewater Technology (Delaware), Inc., a wholly-ownedsubsidiary of Edgewater Technology. The purpose of the Subsidiary Plan was toaid Edgewater Technology in attracting and retaining employees. The totalamount of subsidiary common stock for which stock options could be grantedunder the Subsidiary Plan could not exceed 5.0 million shares of subsidiarycommon stock. In August 2000, the Subsidiary Plan was terminated andoptions for 2.9 million shares of the Company’s subsidiary stock that had beengranted under this Subsidiary Plan were exchanged into options for 1.8 millionshares of the Company’s common stock under a newly created parent company stockoption plan, currently entitled the “Edgewater Technology, Inc., Amendedand Restated 2000 Stock Option Plan” (the “2000 Plan”) and into options for 1.1million shares under the 1996 Plan, for an aggregate of 2.9 million sharesunderlying options. The fair market value of the subsidiary’s stock did notchange for the period of granting of the options to the exchange date. TheSubsidiary Plan had no other activity other than the granting of theaforementioned options for 2.9 million shares of the subsidiary common stockand there were no exercises or forfeitures of options between grant andconversion in August 2000. Grants of stock options under the 2000 Plan maynot exceed 4.0 million shares of the Company’s common stock. As a result ofthis exchange, the Company recorded a one-time compensation charge of $0.2million. In 2002, the Company amended the 2000 Plan to include grants of stockoptions to directors and officers.

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**10.**   COMMON STOCK,  STOCK OPTIONSAND EMPLOYEE STOCK PURCHASE PLAN: (Continued)

A summary of stock optionactivity under the Company’s 1996 Plan, 2000 Plan and 2003 Plan is as follows:

| ** **                           | ** ** | **Shares Under  Option** | ** ** | **Weighted Average  Price Per Share** | ** ** |
|--------------------------------------|------------|-------------------------------|------------|------------------------------------------------------|------------|
| Outstanding, January 1,  2003   |       |                          | 3,828,510  |                                                 |       |   | $ | 6.09 |   |   |
| Granted                              |       |                          | 905,900    |                                                 |       |   | 3.76 |   |   |
| Exercised                            |       |                          | (32,119    | )                                                    |       |   | 4.01 |   |   |
| Forfeited                            |       |                          | (181,769   | )                                                    |       |   | 5.73 |   |   |
| Outstanding,  December 31, 2003 |       |                          | 4,520,522  |                                                 |       |   | $ | 5.77 |   |   |
| Granted                              |       |                          | 231,450    |                                                 |       |   | 5.48 |   |   |
| Exercised                            |       |                          | (104,667   | )                                                    |       |   | 4.19 |   |   |
| Forfeited                            |       |                          | (296,888   | )                                                    |       |   | 6.89 |   |   |
| Outstanding,  December 31, 2004 |       |                          | 4,350,417  |                                                 |       |   | $ | 5.73 |   |   |
| Granted                              |       |                          | 303,445    |                                                 |       |   | 4.82 |   |   |
| Exercised                            |       |                          | (247,728   | )                                                    |       |   | 4.20 |   |   |
| Forfeited                            |       |                          | (194,337   | )                                                    |       |   | 5.78 |   |   |
| Outstanding,  December 31, 2005 |       |                          | 4,211,797  |                                                 |       |   | $ | 5.76 |   |   |

 

Optionsexercisable were approximately 3.7 million, 3.5 million and 3.2 million as of December 31,2005, 2004 and 2003, respectively. The weighted average exercise price of theseoptions was $5.90, $6.07 and $6.46 per share as of December 31, 2005, 2004and 2003, respectively. The following is a summary of stock options outstandingand exercisable as of December 31, 2005:

| **Options Outstanding** | ** **      | **Options Exercisable** | ** ** |
|------------------------------|-----------------|------------------------------|------------|
| ** **                   | ** **      | ** **                   | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                   | ** **      | ** **                   | ** ** | **Weighted** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Number of**           | ** **      | **Range of**            | ** ** | **Average** | ** ** | **Exercise** | ** ** | **Number of** | ** ** | **Exercise** | ** ** |
| **Options**                  | ** **      | **Exercise**                 | ** ** | **Remaining** | ** ** | **Price** | ** ** | **Options** | ** ** | **Price** | ** ** |
| ** **                   | **Outstanding** | ** **                   | ** ** | **Prices** | ** ** | **Life in Years** | ** ** | **Per Share** | ** ** | **Exercisable** | ** ** | **Per Share** | ** ** |
|                         | 1,476,923       |                         |       | $3.72 – $4.95 |   |   | 6.5 |   |   |   | $ | 4.08 |   |   | 1,124,819 |   |   | $ | 3.99 |   |   |
|                         | 1,386,595       |                         |       | 5.00  – 6.08 |   |   | 5.0 |   |   |   | 5.96 |   |   | 1,253,075 |   |   | 6.02 |   |   |
|                         | 1,215,512       |                         |       | 6.25  – 8.63 |   |   | 4.6 |   |   |   | 6.43 |   |   | 1,208,413 |   |   | 6.42 |   |   |
|                         | 77,400          |                         |       | 9.81  – 12.88 |   |   | 1.8 |   |   |   | 11.33 |   |   | 77,400 |   |   | 11.33 |   |   |
|                         | 36,327          |                         |       | 18.25  – 18.84 |   |   | 1.9 |   |   |   | 18.71 |   |   | 36,327 |   |   | 18.71 |   |   |
|                         | 19,040          |                         |       | 30.46  – 33.61 |   |   | 2.4 |   |   |   | 31.81 |   |   | 19,040 |   |   | 31.81 |   |   |
|                         | 4,211,797       |                         |       |   |   |   | 5.3 |   |   |   | $ | 5.76 |   |   | 3,719,074 |   |   | $ | 5.90 |   |   |
|                              |                 |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As discussed in Note 2,the Company has elected to account for its stock options using the intrinsicmethod. Accordingly, compensation expense, if any, is recognized on awards ofrestricted shares or grants of stock options issued to employees and directorsif the purchase price or exercise price, as applicable, is less than the marketprice of the underlying stock on the measurement date, generally the date ofgrant. Note 2 includes disclosures to reflect the Company’s pro forma netincome (loss) for the years ended December 31, 2005, 2004 and 2003 as ifthe fair value method of accounting had been used. In preparing 

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**10.**   COMMON STOCK,  STOCK OPTIONSAND EMPLOYEE STOCK PURCHASE PLAN: (Continued)

the pro forma disclosures, the fair value wasestimated on the grant date using the Black-Scholes option-pricing model. Thesefair value calculations were based on the following assumptions:

| ** **                                | ** ** | **For the Year Ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| Weighted average  risk-free interest rate |       | 4.35                                                         | %          | 3.63 | % | 3.25 | % |
| Dividend yield                            |       | 0                                                            | %          | 0 | % | 0 | % |
| Weighted average  expected life           |       | 4 years                                                      |       | 4 years |   | 5 years |   |
| Expected volatility                       |       | 62                                                           | %          | 65 | % | 68 | % |

 

Using these assumptions,the fair value of the stock options granted during the years ended December 31,2005, 2004 and 2003 was approximately $0.7 million, $0.6 million and $2.5million, respectively. The weighted average fair value per share of optionsgranted during 2005, 2004 and 2003 was $2.26, $2.48 and $2.40, respectively.

*Employee StockPurchase Plan—*

The Company has anemployee stock purchase plan entitled the Edgewater Technology, Inc. 1999Employee Stock Purchase Plan (the “1999 ESPP”) that allows for employee stockpurchases of the Company’s common stock at the lower of 85% of the stock priceas of the first or last trading day of each quarter. Purchases under the 1999ESPP are limited to 10% of the respective employee’s annual compensation. The1999 ESPP authorizes purchases for up to 700,000 shares of the Company’s commonstock and continues in effect until October 1, 2009 or until earlierterminated. As of December 31, 2005, there were 270,717 shares of commonstock remaining for purchase under the 1999 ESPP. During 2005, 2004 and 2003,we issued 68,198, 27,184 and 23,537 shares, respectively, under the 1999 ESPP.

*Treasury StockRepurchase Program—*

In September 2002, our Board of Directorsauthorized a stock repurchase program for up to $20.0 million of commonstock through December 31, 2003, which was extended through and expired inFebruary 2005. Under this program, stock purchases have been made fromtime to time on the open market at prevailing market prices or in negotiatedtransactions off the market. As part of the most recently authorized stockrepurchase program, effective February 14, 2003, our Company entered intoa SEC Rule 10b5-1 repurchase program with a broker that allowedpurchases of our common stock through traditional blackout periods. Both thestock repurchase program and the 10b5-1 repurchase program expired on February 25,2005.

During the years ended December 31,2005, 2004 and 2003, the Company repurchased 321,029, 948,234 and 304,195shares of its outstanding common stock for an aggregate purchase price of $1.6 million,$4.4 million and $1.4 million, respectively. From the inception of our stockrepurchase program in 2000 through its February 25, 2005 expiration date,we repurchased 3.6 million shares of our common stock for an aggregate purchaseprice of approximately $17.9 million.

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**11.   RELATED PARTYTRANSACTIONS:**

*Synapse.**  *Synapse, one of our largest customers, is considereda related party as its former President and Chief Executive Officer, MichaelLoeb, is also a member of our Board of Directors. Mr. Loeb, who resignedas the President and Chief Executive Officer of Synapse during 2005, remains amember of Synapse’s board of directors as of December 31, 2005. Mr. Loebjoined the Company’s Board of Directors in April 2000. Synapse has been anEdgewater customer since 1996. Service revenues from Synapse amounted to $8.4million, $9.7 million and $11.8 million, for 2005, 2004 and 2003, respectively.Accounts receivable balances for Synapse were $1.4 million and $0.7 million asof December 31, 2005 and 2004, respectively, which amounts were oncustomary business terms. The Company typically provides services to Synapserelated to infrastructure services, custom software development, and systemsintegration. Services are provided on both a fixed-fee and time and materialsbasis. Our contracts with Synapse, including all terms and conditions, havebeen negotiated on an arm’s length basis and on market terms similar to thosewe have with our other customers. The existing one-year services contract withSynapse, which was entered into in January of 2005, has been automaticallyextended, as per the terms of the contract, for an additional six-month period.The contract extension became effective on January 1, 2006. The Companyanticipates that it will enter into a new one-year services contract withSynapse during the first quarter of 2006. It is also anticipated that Synapsewill purchase professional services consistent with those purchased in 2005,which approximated $8.4 million.

*DeferredBoard Fees.*   As of December 31, 2004, theCompany had recorded a liability in the amount of approximately $0.2 millionrelated to deferred board fees earned and payable to one of our Company’sDirectors. Payment of the fees was being deferred until a future date. Thedeferred fees are recorded under the caption “accounts payable and accruedliabilities” in the Company’s consolidated financial statements includedelsewhere herein. There are no deferred board fees as of December 31, 2005as all previously deferred amounts were fully paid in fiscal 2005.

*Lease Agreement.*   OurCompany entered into a lease agreement in 1999, which was modified in June 2000,with a stockholder who is a former officer and director. The lease pertains tocertain parcels of land and buildings in Fayetteville, Arkansas for its formercorporate headquarters that were included in our Company’s discontinuedoperations. Rent payments related to these facilities totaled approximately$0.2 million for each of the years ended December 31, 2005, 2004 and 2003,respectively. Future related party lease obligations relate to this leaseagreement. As our Company’s corporate headquarters moved to Wakefield,Massachusetts during 2001, the Company subleased the Fayetteville facility to athird party in 2002.

**12.   COMMITMENTS ANDCONTINGENCIES:**

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

On February 11, 2003, our Company entered into amutual Settlement and Release Agreement with the Stephens Group, Inc.,StaffMark Investment, LLC, a majority-owned subsidiary of Stephens Group, Inc.and its subsidiaries (collectively, the “Stephens Group”), to terminate,dismiss and retain intact our Company’s favorable summary judgment ruling withrespect to a litigation matter in Delaware Superior Court. In addition to themutual releases, the mutual Settlement and Release Agreement required ourCompany to pay $1.0 million to the Stephens Group. The parties agreed that theexistence of 

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**12.**   COMMITMENTS AND CONTINGENCIES: (Continued)

the settlement agreementand all of its terms, including any payment, were not evidence of anywrongdoing or liability related to the sale of our Company’s commercialstaffing business in June 2000. The settlement amount of $1.0 million wascharged to discontinued operations in the 2002 statement of operations and suchamount was subsequently paid in February 2003.

During the second quarter of 2002, our Company wasnotified by the IRS that it would be auditing our consolidated income taxreturns for the 1998, 1999 and 2000 fiscal years, and subsequently the 1997fiscal year. Our Company has responded to various IRS information requests bydelivering documents and answering questions. For the period of the fiscalyears covered by the audit, we owned staffing-related businesses, which weresold during the 2000 and 2001 fiscal years. During fiscal 2004, the Companyreceived notice from the IRS formally closing its examination of the filedcorporate income tax returns for the 1997, 1998, 1999 and 2000 fiscal years,without any additional income tax liability.

We have received and maycontinue to receive various tax notices and assessments from the IRS andvarious State Departments of Revenue related to our former staffing businesses,which were sold in 2000 and 2001. In fiscal 2003, we recorded a reserve of $1.0million representing the low end of our estimated exposure related to theassessments, plus related professional fees. During both 2005 and 2004, our Company was able tosuccessfully resolve several outstanding notices related to these tax mattersas the Company received formal notice from the IRS that certain assessments hadbeen fully abated. In fiscal 2005, on a net basis, the Company reversedapproximately $0.3 million from its discontinued operations accrual directlyrelated to the successful resolution of certain tax assessments. In fiscal2004, directly related to the abovenotices, which totaled approximately $0.8 million, we reversed approximately$0.2 million of our accrual for discontinued operations in 2004. Also infiscal 2004, based upon currently available information, we increased ourpreviously established accrual related to our exposure on estimated futurelease payments expected to be made on office space related to our formercorporate headquarters by approximately $0.4 million. The increase inthe lease accrual was deemed necessary after revising a previously preparedestimate with more current information.We continue to dispute additional unresolved IRS assessments in theamount of $20 thousand as of December 31, 2005. Also see Note 4 to the consolidated financial statements.

**13.   LEASECOMMITMENTS:**

EdgewaterTechnology leases office space and certain equipment under operating leasesthrough 2013. As discussed in Notes 4 and 11, certain of these facilities areleased from related parties. Annual future minimum payments required underoperating leases, excluding sublease rentals, that have an initial or remaininglease term in excess of one year are as follows:

| **Fiscal Years** | ** ** | ** ** | ** ** | **Amount  (In thousands)** | ** ** |
|-----------------------|------------|------------|------------|---------------------------------|------------|
| 2006                  |       |       | $          | 1,060                           |       |   |
| 2007                  |       |       | 916        |                            |       |
| 2008                  |       |       | 849        |                            |       |
| 2009                  |       |       | 653        |                            |       |
| 2010                  |       |       | 525        |                            |       |
| Thereafter            |       |       | 1,575      |                            |       |
|                  |       |       | $          | 5,578                           |       |   |

 

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**EDGEWATER TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**13.**   LEASE COMMITMENTS: (Continued)

Rent payments underoperating leases, including amounts paid to related parties for discontinuedoperations, was approximately $1.1 million, $1.3 million and $1.1 million forthe years ended December 31, 2005, 2004 and 2003, respectively. The Company entered into a sublease agreementon July 1, 2002 with a third party to occupy our Fayetteville officefacility. The sublease commenced on July 15, 2002 and will end on June 30,2007. Under the sublease agreement, the sub-tenant shall pay base rent toEdgewater Technology in the amount of $0.2 million in fiscal 2006 and will pay$0.1 million in fiscal 2007.

**14.   SUBSEQUENTEVENTS—ACQUISITION OF NATIONAL DECISION SYSTEMS, INC.:**

On February 15, 2006, we acquired all of theoutstanding capital stock of National Decision Systems, Inc. (“NDS”),pursuant to the terms of a Stock Purchase Agreement.

The Company paid to the shareholders of NDS totalconsideration of approximately $10.2 million, consisting of an initial upfrontpayment at closing of approximately $8.5 million in cash and assumedliabilities, and 264,610 shares of Edgewater’s common stock, $0.01 par valueper share (“Common Stock”), which is subject to a three year lock-up agreement.In addition, an earnout agreement was entered into in connection with thePurchase Agreement, and it specifies additional earnout consideration thatcould be payable to the former NDS stockholders. Earnout payments areconditioned upon the attainment of certain performance measurements for the NDSbusiness over the next 12 to 24 months. Assuming all performance measurementsare met within predetermined performance ranges, additional earnoutconsideration of approximately $7.2 million would be payable, comprised ofapproximately $5.8 million payable in cash and the remaining amount payable inCommon Stock, which will be valued at the time of such issuance. To the extentNDS business performance favorably exceeds performance ranges for suchmeasurement periods, additional earnout consideration would be payable inrelation to additive EBITDA contribution by the NDS business above suchperformance ranges.

The Company has engaged an independent third-partyvaluation firm to allocate the purchase price. The Company expects to record acquisition-relatedintangible assets and goodwill upon the completion of such valuation in thequarterly period ending March 31, 2006.

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**Unaudited Supplementary Quarterly FinancialInformation(In Thousands, Except Per Share Data)**

Thenet income (loss) and earnings (loss) per share amounts below include resultsfrom discontinued operations.

| ** **                                              | ** ** | **2005**             | ** ** |
|---------------------------------------------------------|------------|----------------------|------------|
| ** **                                              | ** ** | **1st Quarter** | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** | **Total** | ** ** |
| Total revenue                                           |       |                 | $          | 8,959 |   |   |   | $ | 10,559 |   |   |   | $ | 11,497 |   |   |   | $ | 12,111 |   |   | $ | 43,126 |   |
| Gross profit                                            |       |                 | 3,821      |   |   |   | 4,592 |   |   |   | 4,850 |   |   |   | 4,737 |   |   | 18,000 |   |
| Income before discontinued operations                   |       |                 | 188        |   |   |   | 392 |   |   |   | 414 |   |   |   | 281 |   |   | 1,275 |   |
| Net income                                              |       |                 | 188        |   |   |   | 392 |   |   |   | 739 |   |   |   | 281 |   |   | 1,600 |   |
| Basic income per share before discontinued operations   |       |                 | $          | 0.02 |   |   |   | $ | 0.04 |   |   |   | $ | 0.04 |   |   |   | $ | 0.03 |   |   | $ | 0.13 |   |
| Diluted income per share before discontinued operations |       |                 | $          | 0.02 |   |   |   | $ | 0.04 |   |   |   | $ | 0.04 |   |   |   | $ | 0.03 |   |   | $ | 0.12 |   |
| Basic income per share                                  |       |                 | $          | 0.02 |   |   |   | $ | 0.04 |   |   |   | $ | 0.07 |   |   |   | $ | 0.03 |   |   | $ | 0.16 |   |
| Diluted  income per share                               |       |                 | $          | 0.02 |   |   |   | $ | 0.04 |   |   |   | $ | 0.07 |   |   |   | $ | 0.03 |   |   | $ | 0.15 |   |

 

| ** **                                                                | ** ** | **2004**             | ** ** |
|---------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                | ** ** | **1st Quarter** | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** | **Total** | ** ** |
| Total revenue                                                             |       |                 | $          | 6,422 |   |   |   | $ | 6,138 |   |   |   | $ | 4,893 |   |   |   | $ | 7,869 |   |   | $ | 25,322 |   |
| Gross profit                                                              |       |                 | 2,581      |   |   |   | 2,408 |   |   |   | 1,492 |   |   |   | 3,182 |   |   | 9,663 |   |
| Income (loss) before discontinued  operations                        |       |                 | 65         |   |   |   | (43 | ) |   |   | (1,017 | ) |   |   | 164 |   |   | (831 | ) |
| Net income (loss)                                                         |       |                 | 65         |   |   |   | (43 | ) |   |   | (1,017 | ) |   |   | 400 |   |   | (595 | ) |
| Basic and diluted income (loss) per share before discontinued  operations |       |                 | $          | 0.01 |   |   |   | $ | 0.00 |   |   |   | $ | (0.09 | ) |   |   | $ | 0.03 |   |   | $ | (0.05 | ) |
| Basic  and diluted income (loss) per share                                |       |                 | $          | 0.01 |   |   |   | $ | 0.00 |   |   |   | $ | (0.09 | ) |   |   | $ | 0.03 |   |   | $ | (0.05 | ) |

 

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**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES

**Evaluationof Disclosure Controls and Procedures**

We maintain disclosurecontrols and procedures, which we have designed to ensure that materialinformation related to the Company, including our consolidated subsidiaries, isproperly identified and evaluated on a regular basis and disclosed inaccordance with all applicable laws and regulations. In response to recentlegislation and proposed regulations, we reviewed our disclosure controls andprocedures. We also established a disclosure committee which consists ofcertain members of our senior management. The President and Chief ExecutiveOfficer and the Chief Financial Officer of Edgewater Technology, Inc. (itsprincipal executive officer and principal financial officer, respectively) haveconcluded, based on their evaluations as of the end of the period covered bythis Report, that the Company’s disclosure controls and procedures areeffective to ensure that information required to be disclosed by the Company inthe reports filed or submitted by it under the Securities Exchange Act of 1934,as amended, is recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission rules andforms, and include controls and procedures designed to ensure that informationrequired to be disclosed by the Company in such reports is accumulated andcommunicated to the Company’s management as appropriate to allow timelydecisions regarding required disclosure.

**Changes in Controls and Procedures**

There were no significantchanges in the Company’s internal controls, or in other factors that couldsignificantly affect these internal controls, subsequent to the date of ourmost recent evaluation.

**ITEM 9B.**       OTHERINFORMATION

None.

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**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

Informationrequired by Part III of Form 10-K is omitted from this reportbecause we will file a definitive proxy statement in accordance with Regulation14A of the SEC’s rules on or before April 30, 2006. These itemsinclude:

(a)          The information calledfor by Item 10 of Form 10-K, involving Item 401 of Regulation S-K isincorporated herein by reference to the material under the caption “Election ofDirectors—Nominees for Election—Other Named Executive Officers” in our proxystatement for our Annual Meeting of Stockholders to be held on June 6,2006.

(b)         The information calledfor by Item 10 of Form 10-K involving Item 405 of Regulation S-K isincorporated by reference to the material under the caption “Stock Ownership—Section 16(a) Beneficial Ownership Reporting Compliance” in our proxy statement forour Annual Meeting of Stockholders to be held on June 6, 2006.

(c)          Theinformation called for by Item 10 of Form 10-K involving Item 406 ofRegulation S-K is incorporated by reference to the material under the caption “Codeof Ethics” in our proxy statement for our Annual Meeting of Stockholders to beheld on June 6, 2006.

**ITEM 11.**         EXECUTIVECOMPENSATION

The information called forby Item 11 of Form 10-K for management remuneration involving Item402 of Regulation S-K is incorporated herein by reference to the material underthe caption “Compensation of Outside Directors and the Named Executive Officers”in our proxy statement for our Annual Meeting of Stockholders to be held on June 6,2006.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

The information called forby Item 12 of Form 10-K involving Item 201 (d) of RegulationS-K and Item 403 of Regulation S-K for the securities authorized under equitycompensation plans and security ownership of certain beneficial owners andmanagement, respectively, is incorporated herein by reference to the materialunder the caption “Compensation of Outside Directors and the Named ExecutiveOfficers—Equity Compensation Plans” and “Stock Ownership—Beneficial Ownershipof Certain Stockholders, Directors and Executive Officers”, respectively, inour proxy statement for our Annual Meeting of Stockholders to be held on June 6,2006.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

The information called forby Item 13 of Form 10-K involving Item 404 of Regulation S-K isincorporated herein by reference to the material under the caption “CertainTransactions” in our proxy statement for our Annual Meeting of Stockholders tobe held on June 6, 2006.

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

The information called forby Item 9(e) of Regulation 14A is incorporated herein by reference to thematerial under the captions “Audit and Non-Audit Fees” and “Policy on AuditCommittee Pre-Approval of Audit and Permissible Non-Audit Services of theIndependent Auditor” in our proxy statement for our Annual Meeting ofStockholders to be held on June 6, 2006.

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**PART IV**

**ITEM 15.**         EXHIBITS,FINANCIAL STATEMENT SCHEDULES

(a) 1.                        FinancialStatements required by Item 14 are included and indexed in Part II, Item8.

(a) 2.                        FinancialStatement Schedules included in Part IV of this report. Schedule II isomitted because the information is included in the Notes to ConsolidatedFinancial Statements. All other schedules under the accounting regulations ofthe SEC are not required under the related instructions or are inapplicableand, thus have been omitted.

(a) 3.                      See“Exhibit Index” on the following pages.

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**(a) 3. Exhibits**

**EXHIBITINDEX**

| Exhibit   Number | ** ** | **Description** |
|------------------|------------|-----------------|
|             | 2          | .1              |   | Asset Purchase Agreement dated as of October 4,  2004, by and among Edgewater Technology-Ranzal, Inc., Ranzal and  Associates, Inc., Robin Ranzal-Knowles and Theodore Ranzal (Incorporated  by reference from Exhibit 99.1 to the Company’s Form 8-K  filed with the SEC on October 7, 2004). |
|             | 2          | .2              |   | Earnout Agreement dated  as of October 4, 2004 by and among Edgewater  Technology-Ranzal, Inc., Ranzal and Associates, Inc., Robin  Ranzal-Knowles and Theodore Ranzal (Incorporated by reference from  Exhibit 99.1 to the Company’s Form 8-K filed with the SEC on  October 7, 2004). |
|             | 2          | .3              |   | Stock Purchase Agreement  dated as of February 15, 2006, by and among Edgewater  Technology, Inc. and certain stockholders of National Decision  Systems, Inc. (Incorporated by reference from Exhibit 99.1 to the  Company’s Form 8-K filed with the SEC on February 15, 2006). |
|             | 2          | .4              |   | Earnout Agreement dated  as of February 15, 2006 by and among Edgewater Technology, Inc. and  certain stockholders of National Decision Systems, Inc. (Incorporated by  reference from Exhibit 99.2 to the Company’s Form 8-K filed  with the SEC on February 15, 2006). |
|             | 2          | .5              |   | Amended and Restated Earnout  Agreement dated as of February 15, 2006 by and among Edgewater  Technology, Inc. and certain stockholders of National Decision Systems, Inc.* |
|             | 3          | .1              |   | Certificate of  Incorporation of the Company (Incorporated by reference from Exhibit 3.1  to the Company’s Registration Statement on Form S-1 (File  No. 333-07513)). |
|             | 3          | .2              |   | Certificate of Amendment  of the Certificate of Incorporation (Incorporated by reference from  Exhibit 3.2 to the Company’s Registration Statement on Form S-1  (File No. 333-07513)). |
|             | 3          | .3              |   | Certificate of Amendment  of the Certificate of Incorporation dated May 8, 1998 (Incorporated by  reference from Exhibit 3.3 to the Company’s Form 10-K filed  with the SEC on March 16, 1999). |
|             | 3          | .4              |   | Amended and Restated By-Laws of the Company, as  amended to date (Incorporated by reference from Exhibit 3.3 to the  Company’s Registration Statement on Form S-1 (File No. 333-07513)). |
|             | 4          | .1              |   | Form of certificate evidencing ownership of  common stock of the Company (Incorporated by reference from Exhibit 4.1  to the Company’s Registration Statement on Form S-1 (File  No. 333-07513)). |
|             | 4          | .2              |   | Article Four of the  Certificate of Incorporation of the Company (included in Exhibit 3.1). |
|             | 10         | .1              |   | Form of Director  Indemnification Agreement between the Company and each of its directors and  executive officers (Incorporated by reference from Exhibit 10.3 to the  Company’s Registration Statement on Form S-1 (File No. 333-07513)). |
|             | 10         | .2              |   | The Company’s 1997  Employee Stock Purchase Plan adopted May 2, 1997 (Incorporated by  reference from the Company’s Registration Statement on Form S-8  (File No. 333-29689)), which has been terminated by approval and  adoption of the Edgewater Technology, Inc. 1999 Employee Stock Purchase  Plan referenced in Exhibit 10.52. |

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|        | 10 | .3  |   | The Company’s  Non-Qualified 401(K) Plan. (Incorporated by reference from  Exhibit 10.27 from the Company’s Quarterly Report on Form 10-Q  for the quarter ended March 31, 1998, as filed with the SEC on  May 7, 1998). (1)                                                                                                                                                                                                                                                                     |
|--------|----|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 10 | .4  |   | Edgewater Technology, Inc. Amended and Restated  1996 Stock Option Plan, most recently amended, effective March 20, 2002  (Incorporated by reference from Exhibit 10.48 to the Company’s  Form 10-K for the year ended December 31,2001, filed with the  SEC on March 27, 2002). (1)                                                                                                                                                                                                             |
|   | 10 | .5  |   | Edgewater  Technology, Inc. Amended and Restated 2000 Stock Option Plan, amended  and restated effective March 20, 2002. (Incorporated by reference from  Exhibit 10.49 to the Company’s Form 10-K for the year ended  December 31, 2001, filed with the SEC on March 27, 2002) which has  been amended and in its current state is reflected in Exhibit 10.51.(1)                                                                                                                          |
|   | 10 | .6  |   | Edgewater  Technology, Inc. Amended and Restated 2000 Stock Option Plan, as most  recently amended on May 22, 2002. (Incorporated by reference from  Exhibit 4.9 to Post Effective Amendment No. 1 to Form S-8,  File No. 333-50912 filed with the SEC on May 30, 2002).(1)                                                                                                                                                                                                                      |
|   | 10 | .7  |   | Edgewater  Technology, Inc. Amended and Restated 1999 Employee Stock Purchase Plan,  as amended on May 22, 2002. (Incorporated by reference from  Exhibit 4.9 to Post Effective Amendment No. 1 to Form S-8,  File No. 333-88313 filed with the SEC on May 30, 2002). (1)                                                                                                                                                                                                                        |
|   | 10 | .8  |   | Lease Agreement by and  between the Company and Brewer Investments II, LLC dated June 28, 2000  and effective as of July 1, 2000 for Edgewater Technology, Inc.’s  former corporate headquarters at 302 E. Millsap Rd., Fayetteville, Arkansas.  (Incorporated by reference from Exhibit 10.54 to the Company’s  Form 10-K for the year ended December 31, 2002, filed with  the SEC on March 28, 2003).                                                                               |
|   | 10 | .9  |   | Sublease Agreement dated  as of July 1, 2002 by and between the Company and Tyson Foods, Inc.  for the sublease of the property at 302 E. Millsap Rd., in Fayetteville,  Arkansas. (Incorporated by reference from Exhibit 10.55 to the Company’s  Form 10-K for the year ended December 31, 2002, filed with  the SEC on March 28, 2003).                                                                                                                                                       |
|   | 10 | .10 |   | Edgewater  Technology, Inc. 2003 Equity Incentive Plan, incorporated by reference  to Exhibit 4.10 of Form S-8, 333-106325 filed with the  SEC on June 20, 2003. (Incorporated by reference from Exhibit 10.56  to the Company’s Form 10-Q for the quarter ended June 30,  2003 filed with the SEC on August 14, 2003). (1)                                                                                                                                                            |
|   | 10 | .11 |   | Employment Agreement by and among the Company,  Edgewater Technology (Delaware), Inc. (“Edgewater Delaware”) and Shirley  Singleton dated as of June 12, 2003, which supersedes and terminates  that certain employment agreement dated as of April 14, 2000 by and  between Edgewater Delaware and Shirley Singleton. (Incorporated by reference  from Exhibit 10.57 to the Company’s Form 10-Q for the quarter  ended June 30, 2003 filed with the SEC on August 14, 2003). (1) |
|   | 10 | .12 |   | Employment Agreement by and among the Company,  Edgewater Delaware and Dave Clancey dated as of June 12, 2003, which  supersedes and terminates that certain employment agreement dated as of  April 14, 2000 by and between Edgewater Delaware and Dave Clancey.  (Incorporated by reference from Exhibit 10.58 to the Company’s  Form 10-Q for the quarter ended June 30, 2003 filed with the  SEC on August 14, 2003). (1)                                                                    |

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|        | 10 | .13    |   | Employment Agreement by and among the Company,  Edgewater Delaware and Dave Gallo dated as of June 12, 2003, which  supersedes and terminates that certain employment agreement dated as of  July 31, 2000 by and between Edgewater Delaware and Dave Gallo. (Incorporated  by reference from Exhibit 10.59 to the Company’s Form 10-Q  for the quarter ended June 30, 2003 filed with the SEC on  August 14, 2003). (1) |
|--------|----|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 10 | .14    |   | Employment Agreement by and among the Company,  Edgewater Delaware and Kevin Rhodes dated as of May 22, 2003, which  supersedes and terminates that certain employment agreement dated as of  July 19, 2002 by and between the Company and Kevin Rhodes. (Incorporated  by reference from Exhibit 10.60 to the Company’s Form 10-Q  for the quarter ended June 30, 2003 filed with the SEC on  August 14, 2003). (1)     |
|   | 16 | .1     |   | Letter from Arthur Andersen LLP to the SEC dated  June 28, 2002 regarding a change in the Company’s independent  accountants. (Incorporated by reference from Exhibit 16.1 to the  Company’s Form 8-K filed with the SEC on June 28, 2002).                                                                                                                                                                                   |
|   | 21 | .1     |   | Subsidiaries of Edgewater Technology, Inc. as  of December 31, 2005.*                                                                                                                                                                                                                                                                                                                                                                             |
|   | 23 | .1     |   | Consent of Independent Registered Public Accounting  Firm.*                                                                                                                                                                                                                                                                                                                                                                                                 |
|   | 24 | .1     |   | Power of Attorney (See Signature Page).*                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 31 | .1     |   | 13a-14 Certification—President and Chief  Executive Officer*                                                                                                                                                                                                                                                                                                                                                                                           |
|   | 31 | .2     |   | 13a-14 Certification—Chief Financial Officer*                                                                                                                                                                                                                                                                                                                                                                                                          |
|   | 32 |   |   | Section 1350  Certification*                                                                                                                                                                                                                                                                                                                                                                                                                           |

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(1)          This agreement is acompensatory plan or arrangement required to be filed as an exhibit to thisAnnual Report on Form 10-K pursuant to Item 15(c).

*                    Filed herein

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, in the Town of Wakefield,State of Massachusetts, on March 23, 2006.

|        |   | Edgewater Technology, Inc.       |
|--------|--------|---------------------------------------|
|   |   | /s/ SHIRLEY SINGLETON                 |
|   |   | Shirley Singleton                     |
|   |   | President and Chief Executive Officer |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

**POWER OF ATTORNEY**

KNOWALL PERSONS BY THESE PRESENTS, that each person whose signature appears belowappoints jointly and severally, Shirley Singleton and Kevin R. Rhodes and eachone of them, his or her attorneys-in-fact, each with the power of substitution,for him or her in any and all capacities, to sign any and all amendments tothis Annual Report on Form 10-K and to file the same, with exhibitsthereto and other documents in connection therewith, with the SEC, herebyratifying and confirming all that each said attorneys-in-fact, or hissubstitute or substitutes, may do or cause to be done by virtue hereof.

|                        | **Name** | ** **                                    | ** ** |                     | **Title** | ** ** | ** ** |  | **Date** | ** ** |
|------------------------|----------|-----------------------------------------------|------------|---------------------|-----------|------------|------------|--|----------|------------|
| /s/ SHIRLEY  SINGLETON |     | President, Chief  Executive Officer and       |       | March 23, 2006 |
| Shirley  Singleton     |     | Director                                      |       |                |
| /s/ KEVIN R.  RHODES   |     | Chief Financial  Officer & Treasurer |       | March 23, 2006 |
| Kevin  R. Rhodes       |     | (Principal Financial and  Accounting Officer) |       |                |
| /s/ WAYNE  WILSON      |     | Director                                      |       | March 23, 2006 |
| Wayne  Wilson          |     |                                          |       |                |
| /s/ CLETE T.  BREWER   |     | Director                                      |       | March 23, 2006 |
| Clete  T. Brewer       |     |                                          |       |                |
| /s/ PAUL E.  FLYNN     |     | Director                                      |       | March 23, 2006 |
| Paul  E. Flynn         |     |                                          |       |                |
| /s/ PAUL GUZZI         |     | Director                                      |       | March 23, 2006 |
| Paul  Guzzi            |     |                                          |       |                |
| /s/ NANCY L. LEAMING   |     | Director                                      |       | March 23, 2006 |
| Nancy  L. Leaming      |     |                                          |       |                |
| /s/ MICHAEL R.  LOEB   |     | Director                                      |       | March 23, 2006 |
| Michael  R. Loeb       |     |                                          |       |                |
| /s/ BARRY B. WHITE     |     | Director                                      |       | March 23, 2006 |
| Barry B. White         |     |                                          |       |                |

 

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