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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
_________________
FORM 10-Q
[X] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act
of 1934 for quarterly period ended March 31, 2002.
[_] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period _________ to __________
Commission File Number 000-31351
KPMG CONSULTING, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 22-3680505
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1676 International Drive, McLean, VA 22102
(Address of principal executive office) (Zip Code)
(703) 747-3000
(Registrant's telephone number, including area code)
(Former name, if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file reports), and (2) has been subject to such filing requirements
for the past 90 days.
YES ________X_________ NO _____________
The number of shares of common stock of the Registrant outstanding as of April
30, 2002 was 157,786,577.
1
KPMG CONSULTING, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2002
TABLE OF CONTENTS
PART I - FINANCIAL STATEMENTS
Item 1: Financial Statements (unaudited)
Consolidated Condensed Statements of Operations for the Three and Nine Months Ended March 31, 2002 and 2001 ..... 3
Consolidated Condensed Balance Sheets as of March 31, 2002 and June 30, 2001 .................................... 4
Consolidated Condensed Statements of Cash Flows for the Nine Months Ended March 31, 2002 and 2001 ............... 5
Notes to Consolidated Condensed Financial Statements ........................................................... 6
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations ................... 13
Item 3: Quantitative and Qualitative Disclosure about Market Risk ............................................... 20
PART II - OTHER INFORMATION:
Item 1: Legal Proceedings ....................................................................................... 20
Item 6: Exhibits ................................................................................................ 20
SIGNATURES ...................................................................................................... 21
2
PART I, ITEM 1. - FINANCIAL STATEMENTS
KPMG CONSULTING, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
March 31, March 31,
2002 2001 2002 2001
------------------- --------------- ---------------- --------------
Revenues $ 582,305 $ 750,913 $ 1,784,414 $ 2,132,953
Costs of service:
Professional compensation 224,206 273,426 717,038 832,194
Other direct contract expenses 143,254 200,478 442,990 547,039
Other costs of service 51,322 65,340 163,970 211,486
------------ ------------ ------------ ------------
Total 418,782 539,244 1,323,998 1,590,719
------------ ------------ ------------ ------------
Gross margin 163,523 211,669 460,416 542,234
Selling, general and administrative expenses 114,326 129,445 349,073 358,336
------------ ------------ ------------ ------------
Operating income 49,197 82,224 111,343 183,898
Interest (income) expense, net (277) 3,683 (451) 13,862
Loss on redemption of equity interest in affiliate,
equity in losses of affiliate and other -- 709 -- 76,654
------------ ------------ ------------ ------------
Income before taxes 49,474 77,832 111,794 93,382
Income tax expense 25,726 48,296 59,136 80,884
------------ ------------ ------------ ------------
Income before cumulative effect of change
in accounting principle 23,748 29,536 52,658 12,498
Cumulative effect of change in accounting principle -- -- (79,960) --
------------ ------------ ------------ ------------
Net income (loss) 23,748 29,536 (27,302) 12,498
Dividend on Series A Preferred Stock -- -- -- (31,672)
Preferred stock conversion discount -- (131,250) -- (131,250)
------------ ------------ ------------ ------------
Net income (loss) applicable to common stockholders $ 23,748 $ (101,714) $ (27,302) $ (150,424)
============ ============ ============ ============
Earnings (loss) per share - basic and diluted:
Income (loss) before cumulative effect of change in
accounting principle applicable to common stockholders $ 0.15 $ (0.83) $ 0.33 $ (1.65)
Cumulative effect of change in accounting principle -- -- (0.50) --
------------ ------------ ------------ ------------
Net income (loss) applicable to common stockholders $ 0.15 $ (0.83) $ (0.17) $ (1.65)
============ ============ ============ ============
Weighted average shares - basic 157,368,815 122,374,885 157,490,844 91,322,218
============ ============ ============ ============
Weighted average shares - diluted 160,488,066 122,374,885 159,378,355 91,322,218
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements.
3
KPMG CONSULTING, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands, except share and per share amounts)
March 31, June 30,
2002 2001
------------------- -------------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 160,929 $ 45,914
Accounts receivable, net 287,100 377,476
Unbilled revenues, net 142,262 180,355
Prepaid and other current assets 75,194 101,014
------------------- -------------------
Total current assets 665,485 704,759
Property and equipment, net 62,601 66,947
Goodwill and other intangible assets, net 162,034 189,383
Other assets 32,641 38,546
------------------- -------------------
Total assets $ 922,761 $ 999,635
=================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable $ 6,954 $ 11,594
Acquisition obligation 15,000 15,000
Accounts payable 62,282 65,632
Accrued payroll and related liabilities 118,067 174,884
Other current liabilities 105,598 86,999
------------------- -------------------
Total current liabilities 307,901 354,109
Notes payable, less current portion - 1,846
Other liabilities 10,105 11,568
------------------- -------------------
Total liabilities 318,006 367,523
Stockholders' equity:
Preferred Stock, $.01 par value 10,000,000 shares authorized - -
Common Stock, $.01 par value 1,000,000,000 shares authorized,
161,438,246 shares issued on March 31, 2002 and
158,568,922 shares issued on June 30, 2001 (including
999,006 shares reserved on March 31, 2002 and June 30, 2001,
and 2,430,000 treasury shares on March 31, 2002) 1,604 1,576
Additional paid-in capital 686,237 656,293
Accumulated deficit (41,825) (14,523)
Notes receivable from stockholders (10,011) (7,950)
Accumulated other comprehensive loss (2,075) (3,284)
Common stock held in treasury, at cost (29,175) -
------------------- -------------------
Total stockholders' equity 604,755 632,112
------------------- -------------------
Total liabilities and stockholders' equity $ 922,761 $ 999,635
=================== ===================
The accompanying notes are an integral part of these financial statements.
4
KPMG CONSULTING, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended
March 31,
2002 2001
---------- ----------
Cash flows from operating activities:
Net income (loss) $ (27,302) $ 12,498
Adjustments to reconcile to net cash provided by (used in) operating activities:
Cumulative effect of change in accounting principle 79,960 -
Loss on redemption of equity interest in affiliate and equity in losses of affiliate - 76,357
Depreciation and amortization 35,906 43,855
Deferred income taxes and other (3,402) (19,232)
Debt conversion discount - 1,698
Changes in assets and liabilities:
Accounts receivable 91,747 (132,291)
Unbilled revenues 38,316 69,855
Prepaid expenses and other current assets 30,414 (5,527)
Other assets 13,508 (22,707)
Accrued payroll and related liabilities (60,267) 48,733
Accounts payable and other current liabilities 2,849 (624)
Distribution payable to managing directors - (73,230)
---------- ----------
Net cash provided by (used in) operating activities 201,729 (615)
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment (17,408) (33,905)
Businesses acquired, net of cash acquired (33,716) (13,599)
Purchases of other intangible assets (21,984) (18,195)
Investment in affiliate - (9,945)
Purchases of equity investments (2,234) (7,500)
---------- ----------
Net cash used in investing activities (75,342) (83,144)
---------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock 29,972 591,729
Repurchases of common stock (29,175) -
Proceeds from notes payable - 499
Repayment of notes payable (8,404) (48,369)
Repayment of acquisition obligations - (38,433)
Repayment of Series A Preferred Stock - (378,329)
Repurchase of minority interest in subsidiary (2,092) -
Notes receivable from stockholders (1,673) -
Dividends paid on Series A Preferred Stock - (44,754)
---------- ----------
Net cash provided by (used in) financing activities (11,372) 82,343
---------- ----------
Net increase (decrease) in cash and cash equivalents 115,015 (1,416)
Cash and cash equivalents - beginning of period 45,914 26,991
---------- ----------
Cash and cash equivalents - end of period $ 160,929 $ 25,575
========== ==========
Supplementary cash flow information:
Interest paid $ 1,044 $ 16,480
Taxes paid $ 31,946 $ 91,274
The accompanying notes are an integral part of these financial statements.
5
KPMG Consulting, Inc.
Notes to Consolidated Condensed Financial Statements
(in thousands, except share and per share amounts)
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited interim consolidated condensed financial
statements of KPMG Consulting, Inc. (the "Company") have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission ("SEC")
for quarterly reports on Form 10-Q. These statements do not include all of the
information and note disclosures required by generally accepted accounting
principles, and should be read in conjunction with our consolidated financial
statements and notes thereto for the fiscal year ended June 30, 2001, included
in the Company's Annual Report on Form 10-K filed with the SEC. The accompanying
consolidated condensed financial statements have been prepared in accordance
with accounting principles generally accepted in the United States and reflect
adjustments (consisting solely of normal, recurring adjustments) which are, in
the opinion of management, necessary for a fair presentation of results for
these interim periods. The results of operations for the three and nine months
ended March 31, 2002 are not necessarily indicative of the results that may be
expected for the fiscal year ending June 30, 2002. Certain prior period amounts
have been reclassified to conform with the current period presentation.
On August 29, 2001, the Board of Directors of the Company adopted a
shareholder rights plan. Under the plan, a dividend of one preferred share
purchase right (a "Right") was declared for each outstanding share of common
stock of the Company that was outstanding on October 2, 2001. Each Right
entitles the holder to purchase from the Company one one-thousandth of a share
of a new series of Series A Junior Participating Preferred Stock (the "Preferred
Shares") at a price of $90 per one one-thousandth of a Preferred Share, subject
to adjustment. The Rights are traded with the common stock and are not
exercisable until the occurrence of certain specified events (relating to
certain actual or prospective changes in ownership interests in the Company's
common stock of 15 percent or more). Until such specified events occur, the
Board of Directors may redeem the Rights for $0.01 per Right. The Rights will
expire on October 2, 2011.
Note 2. Segment Reporting
The Company discloses business segments under Statement of Financial
Accounting Standard ("SFAS") No. 131, "Disclosures About Segments of an
Enterprise and Related Information." SFAS No. 131 established standards for the
way public business enterprises report information about operating segments in
annual financial statements and required those enterprises to report selected
information about operating segments in interim financial statements.
Through fiscal 2001 the Company provided consulting services through six
major industry groups in which it has significant industry-specific knowledge.
Effective July 1, 2001, the Company transferred the health care group's
businesses into high technology and public services; accordingly the Company now
provides services through five major industry groups. Additionally, Canada was
transferred from International to the five industry groups, resulting in a North
American region. Prior year information has been reclassified to reflect these
changes.
6
Industry Results
Three Months Ended
March 31,
2002 2001
------------------------ --------------------------
Operating Operating
Revenue Income Revenue Income
----------- ----------- ----------- ------------
Public Services $ 256,829 $ 83,682 $ 237,404 $ 70,420
Communications & Content 115,371 32,970 140,752 38,516
Financial Services 47,218 8,128 119,289 15,275
Consumer & Industrial Markets 69,041 19,839 94,384 21,825
High Tech 43,269 9,665 123,267 32,337
International / Corporate (1) 50,577 (105,087) 35,817 (96,149)
---------- ---------- ---------- -----------
Total $ 582,305 $ 49,197 $ 750,913 $ 82,224
========== ========== ========== ===========
Nine Months Ended
March 31,
2002 2001
----------------------- -------------------------
Operating Operating
Revenue Income Revenue Income
----------- ----------- ----------- -----------
Public Services $ 712,170 $ 230,712 $ 629,091 $ 174,683
Communications & Content 380,919 105,730 403,080 94,874
Financial Services 168,657 20,280 391,410 71,526
Consumer & Industrial Markets 227,369 55,561 274,088 60,574
High Tech 155,979 29,430 334,348 81,636
International / Corporate (1) 139,320 (330,370) 100,936 (299,395)
---------- ---------- ---------- ----------
Total $1,784,414 $ 111,343 $2,132,953 $ 183,898
========== ========== ========== ==========
(1) International/ Corporate revenues are primarily attributable to
international regions (Latin America, Asia Pacific and Ireland ) for all
periods. International/ Corporate operating loss is principally due to
infrastructure and shared services costs, as well as operating results of
international regions.
7
Note 3. Comprehensive Income
The Company accounts for comprehensive income under SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 established standards for
reporting and displaying comprehensive income and its components in a financial
statement that is displayed with the same prominence as other financial
statements. The components of comprehensive income are as follows:
Comprehensive Income
Three Months Ended Nine Months Ended
March 31, March 31,
2002 2001 2002 2001
--------------- -------------- -------------- --------------
Income before cumulative effect of change
in acccounting principle $ 23,748 $ 29,536 $ 52,658 $ 12,498
Cumulative effect of change in accounting
principle - - (79,960) -
--------------- -------------- -------------- --------------
Net income (loss) 23,748 29,536 (27,302) 12,498
Foreign currency translation adjustment,
net of tax 440 (293) 1,209 (1,420)
--------------- -------------- -------------- --------------
Comprehensive income (loss) $ 24,188 $ 29,243 $ (26,093) $ 11,078
=============== ============== ============== ==============
Note 4. Earnings Per Share of Common Stock
Basic earnings per share is computed based on the weighted average number
of common shares outstanding during the period. Diluted earnings per share is
computed using the weighted average number of common shares outstanding during
the period plus the dilutive effect of potential future issues of common stock
relating to the Company's stock option program and other potentially dilutive
securities. In calculating diluted earnings per share, the dilutive effect of
stock options is computed using the average market price for the period.
8
The following table sets forth the computation of basic and diluted earnings per
share:
Calculation of Earnings (Loss) Per Share
Three Months Ended Nine Months Ended
March 31, March 31,
2002 2001 2002 2001
--------------- --------------- -------------- --------------
Net Income (loss) applicable to common stockholders
before cumulative effect of change in accounting principle $ 23,748 $ (101,714) $ 52,658 $ (150,424)
Convertible Debt Adjustment 114 - 341 -
--------------- --------------- -------------- --------------
Adjusted income (loss) applicable to common stockholders before
cumulative effect of change in accounting principle - diluted 23,862 (101,714) 52,999 (150,424)
Cumulative effect of change in accounting principle - - (79,960) -
--------------- --------------- -------------- --------------
Adjusted income (loss) applicable to common
stockholders - diluted $ 23,862 (101,714) (26,961) (150,424)
=============== =============== ============== ==============
Weighted average shares outstanding - basic 157,368,815 122,374,885 157,490,844 91,322,218
Assumed exercise of stock options 2,251,195 - 1,019,455 -
Assumed conversion of convertible debt 868,056 - 868,056 -
--------------- --------------- -------------- --------------
Weighted average shares outstanding - diluted 160,488,066 122,374,885 159,378,355 91,322,218
=============== =============== ============== ==============
Earnings (loss) per share - basic and diluted $ 0.15 $ (0.83) $ (0.17) $ (1.65)
=============== =============== ============== ==============
The following table sets for the number of common shares related to outstanding
stock options and other potentially dilutive securities that were excluded from
the computation of diluted earnings per shares as the effect would have been
anti-dilutive:
2002 2001
---- ----
Three months ended March 31 29,413,426 29,795,530
=============== ===============
Nine months ended March 31 30,645,166 29,795,530
=============== ===============
Note 5. Business Combinations
On August 2, 2001, the Company acquired a regional consulting practice
in Southeast Asia, consisting of businesses and marketing rights of KPMG
International member firms in Hong Kong, Malaysia, Singapore and Taiwan for
$16.9 million ($6.8 million cash was paid at closing). The allocation of the
purchase price to acquired assets and liabilities, determined in accordance with
SFAS No. 141, "Business Combinations," resulted in the allocation of $14.8
million to goodwill and $2.3 million to finite-lived intangibles.
On October 3, 2001, the Company acquired the consulting practice of the
KPMG International member firm in Australia for approximately $29.0 million (of
which $26.2 million was paid in cash at closing). The allocation of the purchase
price to acquired assets and liabilities, determined in accordance with SFAS No.
141, resulted in the allocation of $19.4 million to goodwill and $10.8 million
to finite-lived intangibles.
9
These acquisitions have been accounted for as purchases, in accordance with
SFAS No. 141. Any adjustment to the allocation of the purchase price for these
acquisitions upon finalization of our valuation of assets acquired and
liabilities assumed is not expected to have a significant effect on our balance
sheet. The pro forma effects on operations were not material.
Note 6. Adoption of SFAS No. 142, "Goodwill and Other Intangible Assets"
Effective July 1, 2001, the Company elected to early-adopt SFAS No. 142,
"Goodwill and Other Intangible Assets," which establishes financial accounting
and reporting for acquired goodwill and other intangible assets, and superseded
Accounting Principles Board Opinion No. 17, "Intangible Assets." Under SFAS No.
142, goodwill and indefinite-lived intangible assets are no longer amortized but
are reviewed at least annually for impairment; the Company has elected to
perform this review annually as of April 1. Separable intangible assets that
have finite useful lives, will continue to be amortized over their useful lives.
In connection with adopting this standard as of July 1, 2001, during the
first quarter the Company completed the test for and measurement of transitional
impairment. Based on that analysis, a transitional impairment loss of $80.0
million, or $0.50 per basic and diluted earnings per share, was recognized as
the cumulative effect of an accounting change. The transitional impairment
charge resulted from a change in the criteria for the measurement of the
impairment loss from undiscounted cash flows, a method required by SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of," to discounted cash flows as required by SFAS No. 142.
Net income (loss), and basic and diluted net earnings (loss) per share for
the three and nine months ended March 31, 2001 are set forth below as if
accounting for goodwill and other intangible assets had been accounted for in
the same manner for all periods presented. The adjustment of previously reported
net income (loss) and earnings (loss) per share represents the recorded
amortization of goodwill and other purchased intangibles (assembled workforce).
10
Reconciliation of Net Income (Loss) and Earnings (Loss) Per Share
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------------------- -------------------------------
2002 2001 2002 2001
------------ ------------ ------------- -------------
Reported income before cumulative effect
of change in accounting principle $ 23,748 $ 29,536 $ 52,658 $ 12,498
Add back goodwill amortization, net of tax - 3,676 - 10,151
------------ ------------ ------------- -------------
Adjusted income before cumulative effect
of change in accounting principle 23,748 33,212 52,658 22,649
Cumulative effect of change in accounting principle - - (79,960) -
------------ ------------ ------------- -------------
Adjusted net income (loss) 23,748 33,212 (27,302) 22,649
Series A Preferred Stock dividends - - - (31,672)
Preferred Stock conversion discount - (131,250) - (131,250)
------------ ------------ ------------- -------------
Adjusted income (loss) applicable to common stockholders $ 23,748 $ (98,038) $ (27,302) $ (140,273)
============ ============ ============= =============
Earnings (loss) per share - basic and diluted:
Reported income (loss) before cumulative effect of change
in accounting principle applicable to common stockholders $ 0.15 $ (0.83) $ 0.33 $ (1.65)
Add back goodwill amortization, net of tax - 0.03 - 0.11
------------ ------------ ------------- -------------
Adjusted income (loss) before cumulative effect of change
in accounting principle applicable to common stockholders 0.15 (0.80) 0.33 (1.54)
Cumulative effect of change in accounting principle - - (0.50) -
------------ ------------ ------------- -------------
Adjusted income (loss) applicable to common stockholders $ 0.15 $ (0.80) $ (0.17) $ (1.54)
============ ============ ============= =============
Weighted average shares - basic
157,368,815 122,374,885 157,490,844 91,322,218
============ ============ ============= =============
Weighted average shares - diluted 160,488,066 122,374,885 $ 159,378,355 91,322,218
============ ============ ============= =============
At March 31, 2002, the Company has $11.1 million of finite-lived
intangible assets consisting primarily of purchased market rights, which are
being amortized over a weighted average useful life of 4.4 years. The cost and
accumulated amortization of these assets at March 31, 2002 are $13.1 million and
$2.0 million, respectively.
The changes in the carrying amount of goodwill for the nine months ended March
31, 2002 are as follows:
Changes in Carrying Amount of Goodwill
Balance Transitional Balance
June 30, Impairment March 31,
2001 Additions (a) Charge Other (b) 2002
----------- --------------- ------------ ---------- -----------
Public Services $ 12,616 $ - $ - $ (681) $ 11,935
Financial Services 3,028 - - (142) 2,886
Communications & Content 9,349 - - (1,107) 8,242
High Tech 2,488 - - (562) 1,926
Consumer & Industrial Markets 9,178 - - (908) 8,270
International / Corporate 99,118 34,192 (79,960) (703) 52,647
----------- --------- --------- ------- ---------
Total (c) $ 135,777 $ 34,192 $ (79,960) $(4,103) $ 85,906
=========== ========= ========= ======= =========
(a) Additions related to the acquisition of the regional consulting practices in
Southeast Asia and Australia (see Note 5).
(b) Other relates primarily to the reversal of deferred taxes no longer required
due to adoption of SFAS No. 142.
(c) After adopting SFAS No. 142, on July 1, 2001, goodwill had gross and net
carrying values of $89,166 and $52,417, respectively, all of which was no longer
subject to amortization.
11
Note 7. Reduction in Workforce
During the second quarter, the Company recorded a $17.7 million charge
for severance and termination benefits related to a reduction in workforce and a
$2.5 million charge related to the impairment of third-party software licenses.
The reduction in workforce affected 325 employees and was the result of aligning
the Company's workforce with market demand for services. All of the affected
employees have been terminated and are no longer employed by the Company.
The changes in the Company's accrual for severance and termination benefits from
June 30, 2001 to March 31, 2002 are as follows:
Severance
Accrual
----------
Balance at June 30, 2001(a) $ 4,236
November charge 17,729
Payments (19,178)
---------
Balance at March 31, 2002(b) $ 2,787
=========
(a) Balance relates to the Company's reduction in force in April 2001.
(b) The remaining payments will be made in cash by February 2003.
Note 8. Stock Option Tender Offer
On February 1, 2002, the Company filed with the SEC a tender offer
relating to all stock options with an exercise price of $55.50. Under the
offering, holders of such options (other than executive officers and directors
of the Company) had the opportunity to surrender their options as of March 1,
2002 and, in exchange, receive an equal number of options to be issued in
September 2002 with an exercise price equal to 110% of the then fair market
value of the Company's common stock. The replacement options will vest ratably
over three years. Approximately 4.7 million options were tendered for
cancellation and exchange under the offering.
Note 9. Universal Shelf Registration Statement
On March 7, 2002, the Company filed a $1 billion universal shelf
registration statement with the SEC. This registration statement, which became
effective on March 19, 2002, allows the Company to issue various types of
securities, including debt, preferred stock, common stock and warrants to
purchase common stock.
Note 10. Subsequent Events
On May 8, 2002, the Company announced that it signed a Letter of Intent
to acquire the Business Consulting units of member firms of Andersen Worldwide
Societe Cooperative, also known as Andersen Worldwide. The Letter of Intent
establishes a framework for acquiring up to 23 independent Andersen consulting
practices in Europe, the United States, Asia Pacific and Latin America at a
price of up to $284 million. Additionally, up to 6.5 million shares of the
Company's common stock will be issued over a three-year period to Andersen's
consulting partners who join the Company. The acquisitions are subject to the
execution of definitive binding agreements and satisfaction of customary closing
12
conditions with each Business Consulting unit. In addition, the acquisition by
the Company of the Business Consulting unit of Arthur Andersen LLP in the United
States is subject to satisfactory resolution of potential liability issues.
On May 7, 2002, the Company completed the purchase of the Andersen
Business Consulting units in Hong Kong and China for up to $5 million subject to
the resolution of certain contingencies.
* * * * *
PART I, ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following information should be read in conjunction with the
information contained in the Consolidated Condensed Financial Statements and
notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q. This
Quarterly Report on Form 10-Q contains forward-looking statements that involve
risks and uncertainties. See the discussion relating to "Forward-Looking
Statements" below.
Accounting policies that management believes are most critical to the
Company's financial condition and operating results pertain to revenue
recognition and valuation of unbilled revenues (including estimates of costs to
complete engagements); collectibility of accounts receivable; valuation of
goodwill; and judgments about discretionary compensation costs and effective
income tax rates. In deriving accounting estimates, management considered
available information and exercised reasonable judgment. However, actual results
could differ from these estimates.
Company Overview
We are one of the world's largest consulting firms with approximately
9,200 employees. We serve over 2,500 clients, including Global 2000 companies,
Fortune 1000 companies, small and medium-sized businesses, government agencies
and other organizations. We provide our clients with a range of service
offerings that combine industry specific business strategy and operational
improvements, technology selection and implementation. Our service offerings are
designed to help our clients generate revenues, improve efficiency and contain
costs.
These services include:
. business and technology strategy;
. process design and operations improvement;
. systems integration;
. network integration and infrastructure; and
. outsourcing.
Through June 30, 2001 we provided consulting services through six
industry groups in which we have specific industry knowledge. Effective July 1,
2001, we transferred the health care group's businesses into high technology and
public services; accordingly, we now provide our services through five industry
groups. These groups are public services, financial services, communications and
content, high technology, and consumer and industrial markets. These groups
comprise the North American region. In addition, we have multi-national
operations covering Latin America, Asia Pacific, Ireland and Israel.
13
HISTORICAL RESULTS OF OPERATIONS OVERVIEW
The Company realized net income applicable to common stockholders for the three
months ended March 31, 2002 of $23.7 million, or $0.15 per share, compared to a
net loss of $101.7 million, or $0.83 per share for the three months ended March
31, 2001. Net income for the quarters ended March 31, 2002 and 2001, were $23.7
million and $29.5 million, respectively. This decrease was driven by a decline
in revenue of $168.6 million, largely offset by lower levels of operating
expenses.
After deducting an $80.0 million after-tax charge representing the cumulative
effect of a change in accounting principle, the Company realized a net loss
applicable to common stockholders of $27.3 million, or $0.17 per share for the
nine months ended March 31, 2002, compared to a net loss of $150.4 million, or
$1.65 per share for the nine months ended March 31, 2001. Net income before
cumulative effect of change in accounting principle for the nine months ended
March 31, 2002 and 2001 was $52.7 million and $12.5 million, respectively.
Included in operating results for the nine months ended March 31, 2002, was a
$20.2 million charge ($12.8 million net of tax) predominantly related to the
Company's November 2001 reduction in force. Included in results for the nine
months ended March 31, 2001, was a $76.0 million charge representing loss on
redemption of equity interest in affiliate related to the Company's investment
in Qwest Cyber.Solutions ("QCS") ($71.2 million net of tax).
Three Months Ended March 31, 2002 Compared to Three Months Ended March 31, 2001
Revenues. Revenues decreased $168.6 million, or 22.5%, from $750.9 million in
the three months ended March 31, 2001, to $582.3 million in the three months
ended March 31, 2002.
This overall decrease is primarily attributable to a slower economy than that of
the same quarter last year. Public Services remained strong with growth of 8.2%,
however, this growth was more than offset by declines in Financial Services and
High Tech of 60.4% and 64.9%, respectively. International revenue also grew by
41.2%, which is largely due to the acquisitions of the Australia and Southeast
Asia consulting practices.
The Company expects this period of economic uncertainty may continue to impact
revenue growth for at least another quarter with the most significant impact
being in the High Tech and Communications and Content industries.
Gross Margin. Gross margin as a percentage of revenues was relatively unchanged
at 28.1% and 28.2% for the three months ended March 31, 2002 and 2001,
respectively. Despite the decrease in revenue discussed above, the Company was
able to maintain its gross margin percentage as a result of its continued focus
on expense control.
14
In dollar terms, gross margin decreased by $48.1 million, or 22.7%, from $211.7
million for the three months ended March 31, 2001, to $163.5 million for the
three months ended March 31, 2002. The decrease in gross margin was due to a
decline in revenue of $168.6 million described above, offset by:
. A net decrease in professional compensation of $49.2 million, or
18.0%, to $224.2 million compared to $273.4 million in the prior
year's quarter. This decrease was predominantly due to the Company's
reduction in workforce actions, taken in the second quarter of fiscal
2002 and the fourth quarter of fiscal 2001. Overall the Company's
average billable headcount has declined from approximately 9,200 in
the third quarter of Fiscal 2001 to 7,900 in the current quarter.
Additionally, incentive compensation accruals were also lower.
. A net decrease in other direct contract expenses of $57.2 million, or
28.5%, to $143.3 million, representing 24.6% of revenue, compared to
$200.5 million, or 26.7% of revenue in the prior year's quarter. The
decrease is attributable to lower revenue levels combined with a
decrease in subcontractor usage as a percentage of revenue due to the
Company's continued efforts to strategically utilize subcontractors to
supplement its workforce.
. A net decrease in other costs of service of $14.0 million, or 21.5%,
to $51.3 million from $65.3 million, was primarily due to tighter
controls on discretionary expenses and reduced headcount.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $114.3 million for the three months ended March 31,
2002. This reflects a decrease of $15.1 million, or 11.7%, from $129.4 million
for the three month period ended March 31, 2001. This decrease is due to the
Company's continued cost control initiatives and reduced discretionary spending
offset by its increased infrastructure costs as the Company continues its
infrastructure build-out in order to lessen its reliance on its former parent
company, KPMG LLP. Additionally, amortization expense decreased $3.5 million as
a result of the Company's adoption of SFAS No. 142.
Interest (Income) Expense, Net. Interest (income) expense, net, decreased $4.0
million, or 107.5%, to $0.3 million of net interest income from $3.7 million of
net interest expense for the three months ended March 31, 2002 and 2001,
respectively. Included in interest expense for the three months ended March 31,
2001 was $1.7 million representing a one-time noncash charge for a beneficial
conversion feature (discount) of certain acquisition obligations that converted
to common stock soon after the completion of our initial public offering. The
remaining decrease was due to a repayment of all outstanding borrowings under
our credit facility, resulting from the use of proceeds from our initial public
offering, and improvements made in our management of client billings and
collections. This improvement is evidenced by the reduction in our days sales
outstanding from 77 days at March 31, 2001, to 58 days at March 31, 2002.
Income Tax Expense. For the three month period ended March 31, 2002, the Company
earned income before taxes of $49.5 million and provided income taxes of $25.7
million resulting in an effective tax rate for the quarter of 52.0%. For the
three months ended March 31, 2001, the Company earned income before taxes of
$77.8 million and provided income taxes of $48.3 million resulting in an
effective tax rate for the quarter of 62.1%. The tax rates have been
significantly impacted by the non-deductibility of losses associated with
certain international operations and relating to the Company's redemption of
equity interest in affiliate in December 2000.
15
Preferred Stock Conversion Discount. Our Series A Preferred Stock, contained a
beneficial conversion feature whereby the preferred stock could convert into
common stock at a rate of between 75% and 80% of the initial public offering
price. Based upon an initial public offering price of $18 per share, the net
amount of the beneficial conversion feature was $131.3 million.
Net Income (Loss) Applicable to Common Stockholders. For the three months ended
March 31, 2002, the Company realized net income applicable to common
stockholders of $23.7 million, or $0.15 per share. For the three months ended
March 31, 2001, the Company realized a net loss applicable to common
stockholders of $101.7 million, or $0.83 per share, largely due to the February
2001 conversion of Series A Preferred Stock to common stock.
Nine Months Ended March 31, 2002 Compared to Nine Months Ended March 31, 2001
Revenues. Revenues decreased $348.5 million, or 16.3%, from $2,133.0 million in
the nine months ended March 31, 2001, to $1,784.4 million in the nine months
ended March 31, 2002.
This overall decrease is primarily attributable to a slower economy than that of
the same period last year. Public Services remained strong with growth of 13.2%,
however, this growth was more than offset by declines in Financial Services and
High Tech of 56.9% and 53.3%, respectively. These decreases are a result of soft
market demand in these industries coupled with the postponement and cancellation
of client projects. Additionally, International revenue grew by 38.0%, which is
largely due to the acquisitions of the Australia and Southeast Asia consulting
practices.
Gross Margin. Gross margin as a percentage of revenues was 25.8% for the nine
months ended March 31, 2002. This reflects an increase from 25.4% for the nine
months ended March 31, 2001. The increase in gross margin percentage was
primarily due to a reduction in the Company's expenses as a result of an
increased focus on expense control.
In dollar terms, gross margin decreased by $81.8 million, or 15.1%, from $542.2
million for the nine months ended March 31, 2001, to $460.4 million for the nine
months ended March 31, 2002. Included in gross margin for the nine months ended
March 31, 2002, was the previously-mentioned $20.2 million charge, of which
$17.7 million related to the Company's November 2001 reduction in workforce. The
decrease in gross margin was due to a decline in revenues of $348.5 million
described above, offset by:
. A net decrease in professional compensation of $115.2 million, or
13.8%, including the previously-mentioned $17.7 million charge. This
decrease was predominantly due to the reduction in workforce actions
taken in the second quarter of fiscal 2002 and the fourth quarter of
fiscal 2001. In addition, incentive compensation accruals were also
lower.
. A net decrease in other direct contract expense of $104.0 million, or
19.0%, to $443.0 million, representing 24.8% of revenue, compared to
$547.0 million, or 25.6% of revenue in the prior year's comparable
period. The $104.0 million decrease is attributable to lower revenue
levels combined with a decline in travel-related expenses resulting in
part from the events of September 11th. Subcontractor usage as a
percentage of revenue also declined as the Company continued its
efforts to strategically utilize subcontractors to supplement its
workforce.
. A net decrease in other costs of service of $47.5 million, or 22.5%,
from $211.5 million to $164.0 million, primarily due to tighter
controls on discretionary expenses including training
16
and recruiting costs as well as reduced headcount. Additionally, bad
debt expense decreased $9.3 million due to greater emphasis on credit
reviews and strengthened cash collections.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $349.1 million for the nine months ended March 31,
2002. This reflects a decrease of $9.3 million, or 2.6%, from $358.3 million,
which is primarily due to a decrease in amortization expense of $10.4 million as
a result of the Company electing to early-adopt SFAS No. 142, "Goodwill and
Other Intangible Assets". These decreases are offset by increases in costs as
the Company continues its infrastructure build-out in order to lessen its
reliance on its former parent company, KPMG LLP.
Interest (Income) Expense, Net. Interest (income) expense, net, decreased $14.3
million, or 103.3%, from $13.9 million of net interest expense to $0.5 million
of net interest income for the nine months ended March 31, 2001 and 2002,
respectively. This decrease was due to a repayment of all outstanding borrowings
under our credit facility during fiscal 2001, resulting from the use of proceeds
from our initial public offering, and improvements made in our management of
client billings and collections. This improvement is evidenced by the reduction
in our days sales outstanding from 77 days at March 31, 2001 to 58 days at March
31, 2002.
Loss on Redemption of Equity Interest in Affiliate, Equity in Losses of
Affiliate and Other. For the nine months ended March 31, 2001, loss on
redemption of equity interest in affiliate and equity losses of affiliate and
other of $76.7 million related primarily to the redemption of our equity
investment in QCS in December 2000.
Income Tax Expense. For the nine months ended March 31, 2002, the Company earned
income before taxes and cumulative effect of change in accounting principle of
$111.8 million and provided income taxes of $59.1 million, resulting in an
effective tax rate of 52.9%. This rate was impacted by the non-deductibility of
losses incurred by certain international operations. For the nine months ended
March 31, 2001, the Company earned income before taxes of $93.4 million and
provided income taxes of $80.9 million, resulting in an effective tax rate of
86.6%. This rate was significantly impacted by the non-deductibility of the loss
on redemption of equity interest in affiliate coupled by non-deductible losses
in certain international operations.
Cumulative Effect of Change in Accounting Principle. The Company elected to
early-adopt SFAS No. 142 as of July 1, 2001. This standard eliminates goodwill
amortization upon adoption and requires an assessment for goodwill impairment
upon adoption and at least annually thereafter. As a result of adoption of this
standard, the Company did not amortize goodwill during the nine months ended
March 31, 2002, and incurred a non-cash transitional impairment charge of $80.0
million. This transitional impairment charge is a result of the change in
accounting principles to measuring impairments on a discounted versus an
undiscounted cash flow basis.
Preferred Stock Dividends. Series A Preferred Stock dividends totaling $31.7
million were recorded in the nine months ended March 31, 2001. After December
31, 2000, the Company was no longer required to pay dividends on our Series A
Preferred Stock because it was redeemed and converted in connection with our
initial public offering.
Preferred Stock Conversion Discount. Our Series A Preferred Stock contained a
beneficial conversion feature whereby the preferred stock could convert into
common stock at a rate of between 75% and 80% of the initial public offering
price. Based upon an initial public offering price of $18 per share, the net
amount of the beneficial conversion feature was $131.3 million.
17
Net Income (Loss) Applicable to Common Stockholders. For the nine months ended
March 31, 2002, the Company realized a net loss applicable to common
stockholders of $27.3 million, or $0.17 per share. For the nine months ended
March 31, 2001, the Company realized a net loss applicable to common
stockholders of $150.4 million, or $1.65 per share. Both periods results were
impacted by significant one-time or nonrecurring charges. Losses per share were
further affected by the completion of our initial public offering on February 8,
2001, which increased the number of average common shares outstanding by 66
million.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations through cash generated from
operations. While the Company expects this period of economic uncertainty may
continue to impact revenue growth for at least another quarter, we continue to
actively manage client billings and collections and maintain tight controls over
discretionary expenses, and expect operations to continue to generate cash.
Additionally, the Company has borrowing arrangements available including a
revolving credit facility with no outstanding balance at March 31, 2002 (not to
exceed $100 million), a revolving line of credit facility with no outstanding
balance at March 31, 2002 (not to exceed $100 million), as well as a note
payable related to an accounts receivable financing facility with no outstanding
balance at March 31, 2002 (not to exceed $200 million). The revolving credit
facility and revolving line of credit facility expire on May 24, 2004 and May
20, 2002, respectively. The accounts receivable purchase agreement permits
"sales" of accounts receivable through May 21, 2003, subject to annual renewal.
The accounts receivable purchase agreement is accounted for as a financing
transaction; accordingly, it is not an off-balance sheet financing arrangement.
The credit facilities described above include covenants relating to the
maintenance of certain financial ratios and restrictions on the Company's
ability to pay dividends.
Under the transition services agreement with KPMG LLP, the Company
contracted to receive certain infrastructure support services from KPMG LLP
until the Company completes the build-out of its own infrastructure (for a
period not to exceed four years from the date of our initial public offering).
If the Company terminates any services prior to the end of the term for such
services, the Company may be obligated to pay to KPMG LLP any termination costs
incurred as a result of KPMG LLP having made investments in systems, personnel
and other assets that were used in provisioning of shared services. It is the
intent of the parties, that during the term of the agreement, the Company will
work with KPMG LLP to minimize any termination costs, and the Company will wind
down its receipt of services from KPMG LLP by developing its own infrastructure
and support capabilities. Based on information currently available, the Company
anticipates paying KPMG LLP approximately $40 to $60 million for the net book
value of capital assets (such as software licenses, computer equipment and
leasehold improvements) that will be transferred to our Company on or before the
termination of the agreement; upon transfer, such capital assets will continue
to be used in our business. Until the Company takes ownership of these capital
assets, the transition services agreement is an off-balance sheet financing
arrangement. The Company expects to take ownership of approximately $35 million
of these capital assets within the next 12 months.
Cash provided by operating activities during the nine months ended March
31, 2002 was $201.7 million, principally due to cash operating results of $85.2
million and collections of accounts receivable of $91.7 million.
Cash used in investing activities during the nine months ended March 31,
2002 was $75.3 million principally due to $17.4 million in purchases of property
and equipment, $33.7 million paid for acquisitions, and $22.0 million invested
in other intangible assets.
18
Cash used in financing activities for the nine months ended March 31, 2002
was $11.4 million, principally due to the purchase of 2.4 million treasury
shares for $29.2 million and repayment of notes payable of $8.4 million, offset
by proceeds of $30.0 million from the issuance of common stock primarily
relating to the Company's employee stock purchase plan.
The Company believes that the cash provided from operations, borrowings
available under the various facilities described above and existing cash and
cash equivalents should be sufficient to meet working capital and on going
capital expenditure needs.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board issued SFAS No.
144 "Accounting for the Impairment or Disposal of Long Lived Assets". This
statement is effective for fiscal years beginning after December 15, 2001 and
supersedes SFAS No. 121, while retaining many of the requirements of such
statement. The Company is currently evaluating the impact of the statement.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking Statements relating to our operations
that are based on our current expectations, estimates and projections. Words
such as "expects," "intends," "plans," "projects," "believes," "estimates," and
similar expressions are used to identify these forward-looking statements. These
statements are not guarantees of future performance and involve risks,
uncertainties and assumptions that are difficult to predict. Forward-looking
statements are based upon assumptions as to future events that may not prove to
be accurate. Actual outcomes and results may differ materially from what is
expressed or forecast in these forward-looking statements. As a result, these
statements speak only as of the date they were made, and we undertake no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise.
Our actual results may differ from the forward-looking statements for many
reasons, including:
. the business decisions of our clients regarding the use of our
services;
. the timing of projects and their termination;
. the availability of talented professionals to provide our services;
. the pace of technological change;
. the strength of our joint marketing relationships;
. continuing limitations following our separation from KPMG LLP; and
. the actions of our competitors.
In addition, these statements could be affected by general domestic and
international economic and political conditions including slowdowns in the
economy, uncertainty as to the future direction of the economy and vulnerability
of the economy to domestic or international incidents. (For a more detailed
discussion of certain of these factors, see Exhibit 99.1 to this Form 10-Q.)
19
PART I, ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to a number of market risks in the ordinary course of
business. These risks, which include interest rate risk and foreign currency
exchange risk, arise in the normal course of business, rather than from trading
activities. Our exposure to changes in interest rates is minimal and arises
primarily because our indebtedness under our bank credit facilities carries
variable interest rates. Our exposure to changes in foreign currency rates
arises primarily from our investments in and working capital advances provided
to certain international operations, as well as engaging in multinational client
engagements. However, foreign currency exposures are not concentrated in a
single foreign currency.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are from time to time the subject of lawsuits and other claims and
regulatory proceedings arising in the ordinary course of our business. We do not
expect that any of these matters, individually or in the aggregate, will have a
material impact on our financial condition or results of operations.
ITEMS 2-5. NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits -- Reference is made to the Exhibit Index.
(b) Not Applicable
Exhibit Index
-------------
10.1 Receivables Purchase Agreement, dated as of May 22, 2000, between KCI
Funding Corporation, KPMG Consulting, Market Street Funding
Corporation and PNC Bank, National Association, incorporated herein
by reference to Exhibit 10.1 to the Company's Registration Statement
on Form S-3 dated March 15, 2002.
10.2 Amendment No. 1 to Receivables Purchase Agreement, dated as of
October 24, 2000, between KCI Funding Corporation, KPMG Consulting,
Market Street Funding Corporation and PNC Bank, National Association,
incorporated herein by reference to Exhibit 10.2 to the Company's
Registration Statement on Form S-3 dated March 15, 2002.
10.3 Amendment No. 2 to Receivables Purchase Agreement, dated as of
May 21, 2001, between KCI Funding Corporation, KPMG Consulting,
Market Street Funding Corporation and PNC Bank, National Association,
incorporate herein by reference to Exhibit 10.3 to the Company's
Registration Statement on Form S-3 dated March 15, 2002.
10.4 Amendment No. 3 to Receivables Purchase Agreement, dated as of
August 1, 2001, between KCI Funding Corporation, KPMG Consulting,
Market Street Funding Corporation and PNC Bank, National Association,
incorporated herein by reference to Exhibit 10.4 to the Company's
Registration Statement on Form S-3 dated March 15, 2002.
10.5 Purchase and Sale Agreement, dated as of May 22, 2000, between KPMG
Consulting, Inc. and KCI Funding Corporation, incorporated herein by
reference to Exhibit 10.5 to the Company's Registration Statement of
Form S-3 dated March 15, 2002.
10.6 Sale Agreement, dated as of May 22, 2000, between KPMG LLP and KPMG
Consulting, Inc., incorporated herein by reference to Exhibit 10.6 to
the Company's Registration Statement of Form S-3 dated March 15,
2002.
10.7 Amendment No. 2 to Alliance Agreement, dated March 4, 2002 between
Cisco Systems, Inc. and KPMG Consulting, Inc.+
99.1 Factors Affecting Future Results.
+Confidential material appearing in this document has been omitted
and filed separately with the Securities and Exchange Commission in
accordance with Rule 24b-2(b) of the Exchange Act of 1934, as
amended. Omitted information has been replaced with asterisks.
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
KPMG Consulting, Inc.
DATE: May 13, 2002 By: /s/ Randolph C. Blazer
------------------------
Randolph C. Blazer,
Chairman of the Board, Chief Executive
Officer, and President
Principal Financial and Accounting Officer
DATE: May 13, 2002 By: /s/ Robert C. Lamb, Jr.
-------------------
Robert C. Lamb, Jr.,
Executive Vice President
and Chief Financial Officer
21