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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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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, 2001
[ ] 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
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The number of shares of common stock of the Registrant outstanding as of April
30, 2001 was 157,569,916.
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KPMG CONSULTING, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2001
TABLE OF CONTENTS
PART I - FINANCIAL STATEMENTS
Item 1: Financial Statements (unaudited)
Consolidated/Combined Condensed Statements of Operations for the Three and Nine
Months Ended March 31, 2001, the Two Months ended March 31, 2000 and the One and
Seven Months ended January 31, 2000.......................................................... 3
Consolidated Condensed Balance Sheets as of March 31, 2001 and June 30, 2000................. 5
Consolidated/Combined Condensed Statements of Cash Flows for the Nine Months
Ended March 31, 2001, the Two Months ended March 31, 2000 and Seven Months ended
January 31, 2000 ............................................................................ 6
Notes to Consolidated/Combined Condensed Financial Statements............................... 7
Item 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations ............................................................................... 13
Item 3: Quantitative and Qualitative Disclosure about Market Risk........................... 29
PART II - OTHER INFORMATION:
Item 1: Legal Proceedings................................................................... 30
Item 6: Exhibits............................................................................ 30
SIGNATURES................................................................................... 31
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PART I, ITEM 1. - FINANCIAL STATEMENTS
KPMG CONSULTING, INC.
CONSOLIDATED/COMBINED CONDENSED STATEMENTS OF OPERATIONS (1)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
CONSOLIDATED CONSOLIDATED COMBINED
THREE MONTHS TWO MONTHS ONE MONTH
ENDED ENDED ENDED
MARCH 31, MARCH 31, JANUARY 31,
2001 2000 2000
------------- ------------- -------------
Revenues $ 750,913 $ 432,695 $ 199,111
Costs of service:
Professional compensation 255,794 185,457 74,370
Other direct contract expenses 200,478 94,180 43,513
Amortization of goodwill and other intangible assets 7,588 3,199 1,236
Impairment charge - 8,000 -
Other costs of service 89,722 55,012 31,895
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Total costs of service 553,582 345,848 151,014
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Gross margin 197,331 86,847 48,097
Selling, general and administrative expenses 115,107 85,739 35,486
Special payment to managing directors - 25,000 -
------------- ------------- -------------
Operating income (loss) 82,224 (23,892) 12,611
Interest expense, net (3,683) (1,814) (5,239)
Equity in losses of affiliates (Note 5) (337) (6,135) (2,848)
Minority interests (372) (174) (77)
------------- ------------- -------------
Income before partner distributions and benefits $ 4,447
=============
Income (loss) before taxes 77,832 (32,015)
Income tax expense (benefit) 48,296 (2,182)
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Net income (loss) 29,536 (29,833)
Dividend on Series A preferred stock - (10,328)
Preferred stock conversion discount (131,250) -
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Net loss applicable to common stockholders $ (101,714) $ (40,161)
============= =============
Loss per share:
Net loss applicable to common stockholders -
basic and diluted $ (0.83) $ (0.53)
============= =============
Weighted average shares - basic and diluted 122,374,885 75,693,566
============= =============
The accompanying notes are an integral part of these financial statements.
(1) Through January 31, 2000, KPMG LLP's consulting business was operated in
partnership form and all of its earnings were allocable to its partners.
Accordingly, partner distributions and benefits have not been reflected in
our historical financial statements through January 31, 2000. As a
corporation, effective February 1, 2000, payments for services rendered by
our managing directors are included as professional compensation, and we
are subject to corporate income taxes.
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KPMG CONSULTING, INC.
CONSOLIDATED/COMBINED CONDENSED STATEMENTS OF OPERATIONS (1)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
CONSOLIDATED CONSOLIDATED COMBINED
NINE MONTHS TWO MONTHS SEVEN MONTHS
ENDED ENDED ENDED
MARCH 31, MARCH 31, JANUARY 31,
2001 2000 2000
------------ ------------ ------------
Revenues $ 2,132,953 $ 432,695 $ 1,264,818
Costs of service:
Professional compensation 788,560 185,457 436,214
Other direct contract expenses 547,039 94,180 263,106
Amortization of goodwill and other intangible assets 22,163 3,199 8,957
Impairment charge - 8,000 -
Other costs of service 263,221 55,012 203,821
------------ ------------ ------------
Total costs of service 1,620,983 345,848 912,098
------------ ------------ ------------
Gross margin 511,970 86,847 352,720
Selling, general and administrative expenses 328,072 85,739 220,743
Special payment to managing directors - 25,000 -
------------ ------------ ------------
Operating income (loss) 183,898 (23,892) 131,977
Interest expense, net (13,862) (1,814) (27,339)
Equity in losses of affiliates and loss on redemption
of equity interest in affiliate (Note 5) (76,357) (6,135) (14,374)
Minority interests (297) (174) 28
------------ ------------ ------------
Income before partner distributions and benefits $ 90,292
============
Income (loss) before taxes 93,382 (32,015)
Income tax expense (benefit) 80,884 (2,182)
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Net Income (loss) 12,498 (29,833)
Dividend on Series A preferred stock (31,672) (10,328)
Preferred stock conversion discount (131,250) -
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Net loss applicable to common stockholders $ (150,424) $ (40,161)
============ ============
Loss per share:
Net loss applicable to common stockholders -
basic and diluted $ (1.65) $ (0.53)
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Weighted average shares - basic and diluted 91,322,218 75,693,566
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The accompanying notes are an integral part of these financial statements.
(1) Through January 31, 2000, KPMG LLP's consulting business was operated in
partnership form and all of its earnings were allocable to its partners.
Accordingly, partner distributions and benefits have not been reflected in
our historical financial statements through January 31, 2000. As a
corporation, effective February 1, 2000, payments for services rendered by
our managing directors are included as professional compensation, and we
are subject to corporate income taxes.
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KPMG CONSULTING, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
MARCH 31, JUNE 30,
2001 2000
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(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents $ 25,575 $ 26,991
Accounts receivable, net 459,523 318,182
Unbilled revenues, net 168,502 238,128
Due from KPMG LLP 9,279 2,155
Prepaid and other current assets 96,470 82,144
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Total current assets 759,349 667,600
Investment in affiliate - 66,075
Property and equipment, net of depreciation 64,945 51,546
Goodwill and other intangible assets, net of amortization 188,919 131,287
Other assets 44,546 35,130
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Total assets $ 1,057,759 $ 951,638
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LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of notes payable $ 8,440 $ 24,924
Due to KPMG LLP - 18,343
Acquisition obligations 18,600 82,200
Accounts payable 53,764 32,011
Accrued payroll and related liabilities 196,188 144,288
Distribution payable to managing directors - 73,230
Other current liabilities 107,016 117,615
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Total current liabilities 384,008 492,611
Notes payable, less current portion 11,503 42,383
Other liabilities 29,444 34,219
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Total liabilities 424,955 569,213
Series A Mandatorily Redeemable Convertible
Preferred Stock - 1,050,000
Stockholders' Equity (Deficit) :
Preferred Stock, $.01 par value 10,000,000 shares authorized - -
Common Stock, $.01 par value 1,000,000,000 shares authorized,
157,497,490 shares outstanding on March 31, 2001 and
75,880,842 shares outstanding on June 30, 2000 1,575 759
Additional paid-in capital 677,496 (643,415)
Accumulated deficit (36,977) (17,802)
Notes receivable from stockholders (6,598) (5,845)
Accumulated other comprehensive loss (2,692) (1,272)
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Total stockholders' equity (deficit) 632,804 (667,575)
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Total liabilities and stockholders' equity (deficit) $ 1,057,759 $ 951,638
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The accompanying notes are an integral part of these financial statements.
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KPMG CONSULTING, INC.
CONSOLIDATED/COMBINED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
CONSOLIDATED CONSOLIDATED COMBINED
NINE MONTHS TWO MONTHS SEVEN MONTHS
ENDED ENDED ENDED
MARCH 31, MARCH 31, JANUARY 31,
2001 2000 2000
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Cash flows from operating activities:
Income before partner distributions and benefits $ 90,292
Net income (loss) $ 12,498 $ (29,833)
Adjustments to reconcile to net cash used in operating activities:
Equity in losses of affiliate and loss on redemption of equity
interest in affiliate 76,357 6,135 14,374
Depreciation and amortization 43,855 8,432 22,404
Deferred income taxes and other (19,232) (2,008) (1,102)
Debt conversion discount, stock award and impairment charge 1,698 25,250 -
Changes in assets and liabilities:
Accounts receivable (132,291) (192,458) (132,878)
Unbilled revenues 69,855 (146,046) (57,598)
Due from/to KPMG LLP, net (10,844) (10,697) -
Prepaid expenses and other current assets (5,527) (10,688) (19,409)
Other assets (22,707) (20,932) (3,842)
Accrued payroll and related liabilities 48,733 19,663 (39,264)
Accounts payable and other current liabilities 11,735 (1,097) 56,917
Distribution payable to managing directors (73,230) 25,000 -
Other liabilities (1,515) (569) (1,368)
----------- ----------- -----------
Net cash used in operating activities (615) (329,848) (71,474)
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Cash flows from investing activities:
Purchases of property and equipment (33,905) (10,852) (16,367)
Businesses acquired, net of cash acquired (13,599) (24,305) (21,120)
Purchases of other intangible assets (18,195) - (3,031)
Investment in affiliate (9,945) - -
Purchases of equity investments (7,500) - -
----------- ----------- -----------
Net cash used in investing activities (83,144) (35,157) (40,518)
----------- ----------- -----------
Cash flows from financing activities:
Net payments from KPMG LLP - - 107,854
Proceeds from issuance of common stock 591,729 -
Proceeds from issuance of Series A Preferred Stock - 1,050,000 -
Proceeds from notes payable 499 7,407 18,573
Repayment of notes payable (48,369) (642,574) (3,200)
Repayment of acquisition obligations (38,433) - -
Repurchase of Series A Preferred Stock (378,329) - -
Notes receivable from stockholders - (5,845) -
Dividends paid on Series A Preferred Stock (44,754) - -
----------- ----------- -----------
Net cash provided by financing activities 82,343 408,988 123,227
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents (1,416) 43,983 11,235
Cash and cash equivalents - beginning of period 26,991 25,563 14,328
----------- ----------- -----------
Cash and cash equivalents - end of period $ 25,575 $ 69,546 $ 25,563
=========== =========== ===========
Supplementary cash flow information:
Interest paid $ 16,480 $ 3,827 $ 25,077
=========== =========== ===========
Taxes paid $ 91,274 $ - $ -
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
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KPMG CONSULTING, INC.
NOTES TO CONSOLIDATED/COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited interim consolidated or combined 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 and 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/combined
financial statements and notes thereto for the fiscal year ended June 30, 2000,
included in the Company's Prospectus dated February 7, 2001 filed with the SEC
pursuant to rule 424 (b) under the Securities Act of 1933. The accompanying
consolidated/combined condensed financial statements have been prepared in
accordance with generally accepted accounting principles and reflect all
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, 2001 are not necessarily indicative of the results that may be
expected for the fiscal year ending June 30, 2001. Certain prior period amounts
have been reclassified to conform with the current period presentation.
We completed the separation of our Company from KPMG LLP on January 31,
2000. For periods preceding the separation of our business from KPMG LLP, the
Company refers to KPMG LLP's management and information technology consulting
business, which was operated in partnership form. As a partnership, all of KPMG
LLP's earnings were allocable to its partners. Accordingly, distributions and
benefits to partners were not reflected as an expense in our historical
financial statements through January 31, 2000. Additionally, as a partnership,
KPMG LLP was not subject to income taxes and, as a result, our historical
financial statements through January 31, 2000 do not include a provision for
income taxes. Effective February 1, 2000, following our separation from KPMG LLP
and our commencement of operations in corporate form, our historical financial
statements include payments for services rendered by our managing directors, who
were formerly consulting partners of KPMG LLP, in professional compensation and
a provision for income taxes. Consequently, the historical results of operations
for the three and nine months ended March 31, 2001, and the two months ended
March 31, 2000, which reflect a corporate basis of presentation, and the one
month and seven months ended January 31, 2000, which reflect a partnership basis
of presentation, are not directly comparable.
On January 17, 2001, our board of directors and stockholders approved a
reverse stock split of approximately one share for every 5.045 shares effective
immediately prior to our initial public offering. All share and per share
amounts reflect this reverse stock split.
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NOTE 2. INITIAL PUBLIC OFFERING
During February 2001, the Company sold 34.2 million shares of common stock
in an initial public offering, and a selling stockholder (KPMG LLP) sold an
additional 95.1 million shares of common stock (including a portion of the
shares of common stock that were issued in connection with the conversion of the
Series A Mandatorily Redeemable Convertible Preferred Stock (the "Series A
Preferred Stock")) that were purchased by KPMG LLP, for a total offering of
129.3 million shares. In connection with the initial public offering, the
Company also repurchased 1.4 million shares of the Series A Preferred Stock, and
the remaining shares of Series A Preferred Stock were converted into 44.6
million shares of common stock (including 29.2 million shares sold by KPMG LLP).
The Company's proceeds from the initial public offering, net of the
underwriting discount of $24.7 million and our pro rata portion of other
estimated expenses of the offering of $7.0 million, were $584.7 million. Of the
net proceeds, $378.3 million were used to repurchase 1.4 million shares of the
Series A Preferred Stock, $112.0 million were used to repay all of the Company's
outstanding indebtedness to KPMG LLP, $70.0 million were used to repay the
outstanding indebtedness under the Company's receivables purchase facility with
PNC Bank and $24.4 million were used for working capital purposes.
The terms of the Series A Mandatorily Redeemable Convertible Preferred
Stock, issued to Cisco Systems, Inc. ("Cisco") on January 31, 2000, contained a
beneficial conversion feature whereby the preferred shares that converted into
common stock would convert at a rate of 80% of the initial public offering price
(based upon the actual initial public offering price of $18 per share),
resulting in a conversion discount of $262.5 million. On September 15, 2000,
Cisco and KPMG LLP agreed that, immediately prior to the closing of an initial
public offering, KPMG LLP would repurchase half of the preferred shares held by
Cisco. However, on November 29, 2000, KPMG LLP then agreed to convert all of the
preferred stock it acquired at the initial public offering price without any
conversion discount. Thus, the net amount of the beneficial conversion feature
(after deducting the amount of the conversion discount foregone by KPMG LLP) was
$131.25 million.
In connection with the initial public offering, the Company granted
approximately 16.1 million stock options with an exercise price of $18 per share
to employees. These options vest over a three and one half year period with 25%
vesting on August 8, 2001 and an additional 25% vesting on August 8 in each of
the years 2002 through 2004. As of March 31, 2001, the Company has approximately
21.0 million options outstanding with an exercise price of $18 and approximately
7.3 million options outstanding with an exercise price of $55.50. Additionally,
the Company granted approximately 200,000 options with exercise prices ranging
from $13.00 to $23.06 during the period February 9, 2001 through March 31, 2001.
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NOTE 3. 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.
The Company provides consulting services through six major industry groups.
The following is a summary of certain financial information by reportable
segment:
CONSOLIDATED CONSOLIDATED COMBINED
Three Months Two Months One Month
Ended Ended Ended
March 31, 2001 (1) March 31, 2000 (1) January 31, 2000 (1)
Operating Operating Operating
(Dollars in thousands) REVENUE INCOME (LOSS) REVENUE INCOME (LOSS) REVENUE INCOME (LOSS)
----------- -------------- ----------- -------------- ---------- --------------
Public Services $ 218,010 $ 67,720 $ 127,885 $ 16,871 $ 62,386 $ 21,169
Financial Services 118,082 15,280 87,973 14,685 46,201 6,451
Communications & Content 134,678 37,627 68,644 7,748 26,911 6,215
High Tech 109,077 29,530 51,491 2,241 20,335 4,073
Consumer & Industrial Markets 87,952 20,774 58,736 6,621 26,909 8,438
Healthcare 23,811 4,698 15,700 620 8,754 1,867
Corporate / Other (2) 59,303 (93,405) 22,266 (72,678) 7,615 (35,602)
----------- -------------- ----------- -------------- ---------- --------------
Total $ 750,913 $ 82,224 $ 432,695 $ (23,892) $ 199,111 $ 12,611
=========== ============== =========== ============== ========== ==============
CONSOLIDATED CONSOLIDATED COMBINED
Nine Months Two Months Seven Months
Ended Ended Ended
March 31, 2001 (1) March 31, 2000 (1) January 31, 2000 (1)
Operating Operating Operating
(Dollars in thousands) REVENUE INCOME (LOSS) REVENUE INCOME (LOSS) REVENUE INCOME (LOSS)
----------- -------------- ----------- -------------- ---------- --------------
Public Services $ 576,705 $ 167,130 $ 127,885 $ 16,871 $ 398,435 $ 122,857
Financial Services 387,950 71,406 87,973 14,685 291,976 84,201
Communications & Content 383,803 91,719 68,644 7,748 157,839 29,794
High Tech 294,097 73,983 51,491 2,241 140,107 37,979
Consumer & Industrial Markets 254,300 56,052 58,736 6,621 200,637 51,693
Healthcare 66,738 13,770 15,700 620 55,579 13,842
Corporate / Other (2) 169,360 (290,162) 22,266 (72,678) 20,245 (208,389)
----------- -------------- ----------- -------------- ---------- --------------
Total $ 2,132,953 $ 183,898 $ 432,695 $ (23,892) $1,264,818 $ 131,977
=========== ============== =========== ============== ========== ==============
(1) The periods ended March 31, 2001 and March 31, 2000 include managing
directors' compensation and benefit expense in each segment. The periods
ended January 31, 2000 exclude payments for partner distributions and
benefits as the Company was operating in partnership form.
(2) Corporate / Other revenues are primarily attributable to international
operations for all periods. Corporate / Other operating loss is principally
due to infrastructure and shared services costs, as well as operating
results of international operations.
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NOTE 4. 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 (in
thousands):
THREE MONTHS NINE MONTHS
ENDED MARCH 31, ENDED MARCH 31,
2001 2001
--------------- --------------
Net Income $ 29,536 $ 12,498
Foreign currency translation adjustment
(net of tax) (293) (1,420)
-------- --------
Comprehensive income $ 29,243 $ 11,078
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NOTE 5. INVESTMENT IN AFFILIATE
In June 1999, the Company acquired a 49% joint venture interest in Qwest
Cyber.Solutions, LLC ("QCS"), with the remaining 51% interest being held by
Qwest Communications International Inc. QCS periodically required additional
capital to fund its operations and acquire equipment to support the expansion of
its business. The Company decided not to make any additional capital
contributions to QCS. On December 27, 2000, QCS redeemed the Company's 49%
ownership interest in the joint venture in exchange for a nominal amount.
Accordingly, the Company's investment in QCS of $63.3 million ($58.5 million on
an after tax basis) was written off through a noncash charge to earnings in the
quarter ended December 31, 2000.
Concurrent with the disposition of the Company's equity investment in QCS,
the Company entered into an agreement pursuant to which the Company continues to
have a significant marketing relationship with QCS. Under this arrangement, the
Company will continue to work with QCS to develop sales and marketing plans for
the distribution of QCS' products and services through the Company, and to
market QCS' products and services. The Company's marketing relationship with QCS
allows the Company to continue to offer its clients application service provider
services. The Company's marketing relationship with QCS extends through June 2,
2009 or the date of an initial public offering by QCS, if earlier.
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NOTE 6. BUSINESS COMBINATIONS
During the nine months ended March 31, 2001, the Company acquired the
consulting businesses of KPMG International member firms in Brazil, Colombia,
Ireland, Netherland Antilles, and Peru. In connection with these acquisitions,
the Company paid cash of $13.3 million and incurred obligations of $35.9 million
payable to former owners of the Irish consulting business, $7.0 million payable
to former owners of the Brazilian consulting business, and $0.8 million payable
to KPMG LLP. The preliminary allocation of the purchase price to acquired assets
resulted in the allocation of $2.2 million to assembled workforce and $58.9
million to goodwill. Any adjustments to the allocation of the purchase price for
these acquisitions upon finalization of our valuation of these assets acquired
and liabilities assumed is not expected to have a significant effect on our
balance sheet.
The acquisitions have been accounted for as purchases and, accordingly, the
purchase price of each acquisition was assigned to the assets acquired and
liabilities assumed based on their fair values at the respective dates of
acquisition.
NOTE 7. SUPPLEMENTAL DISCLOSURE FOR STATEMENTS OF CASH FLOWS
In the nine months ended March 31, 2001, the following noncash investing
and financing activities occurred (in thousands):
$ 671,671 Conversion of Series A Preferred Stock to common stock
=========== as of the date of our initial public offering, net of the
conversion discount of $131.25 million
$ 63,663 Conversion of acquisition obligations to common stock
=========== soon after our initial public offering, net of conversion
discounts of $1,698 thousand
In the two months ended March 31, 2000, the following noncash investing and
financing activities occurred (in thousands):
$ (382,365) Contribution of net assets from KPMG LLP as of the date
=========== of the separation transaction
$ 395,401 Accounts receivable and unbilled revenues retained by
=========== KPMG LLP as of the date of the separation transaction
$ 76,991 Demand notes payable to KPMG LLP relating to the
=========== separation transaction and business acquisition
$ (62,027) Net deferred income tax asset created as a result of our
=========== separation from KPMG LLP and commencement of operations
in corporate form
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NOTE 8. SUBSEQUENT EVENT
On April 19, 2001, the Company announced a reduction in workforce of
between 450 and 550 personnel in the United States and Canada in order to
balance workforce capacity with market demand for services. This action impacted
approximately five percent of the company's worldwide workforce. A pre-tax
charge in the range of $15.0 million to $20.0 million will be recorded in the
fourth quarter.
* * * * * *
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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/Combined 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.
HISTORICAL OVERVIEW
We completed the separation of our Company from KPMG LLP on January 31,
2000. As a partnership, all of KPMG LLP's earnings were allocable to its
partners. Accordingly, distributions and benefits to partners were not reflected
as an expense in our historical financial statements through January 31, 2000.
Additionally, as a partnership, KPMG LLP was not subject to income taxes and, as
a result, our historical financial statements through January 31, 2000 do not
include a provision for income taxes. Effective February 1, 2000, following our
separation from KPMG LLP and our commencement of operations in corporate form,
our historical financial statements include payments for services rendered by
our managing directors, who were formerly consulting partners of KPMG LLP, in
professional compensation and a provision for income taxes. Consequently, the
historical results of operations for the three and nine months ended March 31,
2001 and two months ended March 31, 2000, which reflect a corporate basis of
presentation, and the one month and seven months ended January 31, 2000, which
reflect a partnership basis of presentation, are not directly comparable. In
addition, results of operations for the three and nine months ended March 31,
2001 are not necessarily indicative of the results of operations for the fiscal
year ending June 30, 2001.
COMPANY OVERVIEW
We are one of the world's largest consulting firms with over 10,000
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.
We provide consulting services through six industry groups in which we have
significant industry-specific knowledge. These groups are public services,
financial services, communications and content, high tech, consumer and
industrial markets, and health care. In addition, we have multi-national
operations covering North America, Latin America, Ireland, Israel, and Asia
Pacific.
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HISTORICAL RESULTS OF OPERATIONS OVERVIEW
The Company realized net income of $29.5 million for the three months ended
March 31, 2001. After deducting the one-time noncash conversion discount on our
Series A Preferred Stock of $131.25 million, net loss applicable to common
stockholders for the three months ended March 31, 2001 was $101.7 million, or
$0.83 per share. Net income was $12.5 million for the nine months ended March
31, 2001. Additionally, after deducting the aforementioned conversion discount,
net loss applicable to common stockholders was $150.4 million, or $1.65 per
share. The $0.83 net loss per share for the three months ended March 31, 2001
was attributable to the preferred stock conversion discount, partially offset by
earnings from operations. The $1.65 net loss per share for the nine months ended
March 31, 2001 was attributable to the preferred stock conversion discount of
$131.25 million and the after-tax equity in losses of affiliate and loss on
redemption of equity interest in affiliate of $71.5 million, partially offset by
earnings from operations. As a result of the redemption of our equity interest
in QCS on December 27, 2000, we are no longer committed to making capital
contributions to support the expansion of its business, and there will be no
further losses associated with this investment.
HISTORICAL THREE MONTHS ENDED MARCH 31, 2001 COMPARED TO PRO FORMA THREE MONTHS
ENDED MARCH 31, 2000
The following table sets forth our historical consolidated statements of
operations for the three months ended March 31, 2001 and pro forma three months
ended March 31, 2000. As discussed in Note 1 of the Consolidated/Combined
Condensed Financial Statements, the historical results of operations for the
three months ended March 31, 2001, which reflect a corporate basis of
presentation, and the three months ended March 31, 2000, which reflect a
corporate basis of presentation for the two months ended March 31, 2000 and a
partnership basis of presentation for the one month ended January 31, 2000, are
not directly comparable. Pro forma adjustments have been made to reflect all
fiscal year 2000 periods as if we had been operating in corporate form
throughout the year.
14
15
FY00
----------------------------------------------------------------- FY01
HISTORICAL PRO FORMA HISTORICAL
----------------------------- -------------------------------- -------------
COMBINED CONSOLIDATED CONSOLIDATED CONSOLIDATED
ONE MONTH TWO MONTHS THREE MONTHS THREE MONTHS
ENDED ENDED ENDED ENDED
JANUARY 31, MARCH 31, PRO FORMA MARCH 31, MARCH 31,
(Dollars in thousands, except share and 2000 2000 ADJUSTMENTS 2000 2001
per share amounts) ------------- ------------- ------------- ------------- -------------
Revenues $ 199,111 $ 432,695 $ 631,806 $ 750,913
Costs of service:
Professional compensation 74,370 185,457 $ 13,308 (1) 270,583 255,794
- (2)
(2,552)(3)
Other direct contract expenses 43,513 94,180 137,693 200,478
Amortization of goodwill and
other intangible assets 1,236 3,199 4,435 7,588
Impairment charge 8,000 8,000
Other costs of service 31,895 55,012 (306)(3) 86,601 89,722
------------- ------------- ------------- ------------- -------------
Total costs of service 151,014 345,848 10,450 507,312 553,582
------------- ------------- ------------- ------------- -------------
Gross margin 48,097 86,847 (10,450) 124,494 197,331
Selling, general and administrative expenses 35,486 85,739 (11,349)(4) 109,876 115,107
Special payment to managing directors 25,000 (25,000)(5) -
------------- ------------- ------------- ------------- -------------
Operating income (loss) 12,611 (23,892) 25,899 14,618 82,224
Interest expense, net (5,239) (1,814) (7,053) (3,683)
Equity in losses of affiliate (2,848) (6,135) (8,983) (337)
Minority interest (77) (174) (251) (372)
------------- ------------- ------------- ------------- -------------
Income before partner distributions and
benefits $ 4,447
=============
Income (loss) before taxes (32,015) 25,899 (1,669) 77,832
Income tax expense (benefit) (2,182) 1,014 (6) (1,168) 48,296
------------- ------------- ------------- -------------
Net income (loss) (29,833) 24,885 (501) 29,536
Dividend on Series A Preferred Stock (10,328) (10,328)
Preferred stock conversion discount (131,250)
------------- ------------- ------------- -------------
Net loss applicable to common
stockholders $ (40,161) $ 24,885 $ (10,829) $ (101,714)
============= ============= ============= =============
Net loss applicable to common
stockholders per share - basic and diluted $ (0.53) $ (0.14) $ (0.83)
============= ============= =============
Weighted average shares - basic and diluted 75,693,566 (7) 75,693,566 122,374,885
============= ============= =============
The accompanying notes to the pro forma consolidated statements of operations
can be found on page 26.
15
16
Revenues. Revenues increased $119.1 million, or 18.9%, from $631.8 million in
the three months ended March 31, 2000 to $750.9 million in the three months
ended March 31, 2001. This overall increase is primarily attributable to a 4.3%
increase in US client service hours billed due to growth in several of our
operating segments, including public services, high tech and communications and
content, as well as continued growth from recently acquired international
operations.
Strong revenue growth was experienced in the communications and content and high
tech segments, which increased 41% and 52% respectively. This growth was
partially due to joint marketing relationships with our alliance partners,
growth in our next generation operations support systems / business support
systems offerings, business-to-business Internet-related services, and growth
from our key accounts. In addition, international revenue grew to $59.3 million
due to acquisitions and growth within these operations.
Gross Margin. Gross margin as a percentage of revenues was 26.3% for the three
months ended March 31, 2001. This reflects an increase from 19.7% (on a pro
forma basis) for the three months ended March 31, 2000. Pro forma adjustments
were made to fiscal 2000 amounts (i) to include partner compensation and benefit
costs that we would have incurred for our managing directors under the terms of
the new compensation plan which we adopted and implemented effective July 1,
2000, had the new plan been in place during the historical period, and (ii) to
eliminate the cost of the employee pension plan. Following our separation from
KPMG LLP on January 31, 2000, our employees no longer participated in the KPMG
LLP defined benefit pension plan; instead, our employees now participate in a
stock option award program.
The 33.5% increase in gross margin percentage was due to the following factors:
- Changes in our managing director compensation plan, whereby guaranteed
base compensation levels were decreased, and the percentage of total
compensation that varies based upon individual and company performance
increased.
- Costs attributable to the support and maintenance of our professional
staff (such as occupancy, training, recruiting and professional support
personnel costs) were leveraged and increased at a slower rate than the
overall growth in the business.
- In the two months ended March 31, 2000, we recorded a one-time noncash
charge relating to compensatory common stock issuances to certain managing
directors, an impairment charge relating to certain goodwill and other
intangible assets and a one-time charge relating to settlement of pension
obligations to certain managing directors. No such charges were required
in the comparable period of fiscal 2001.
- These factors that contributed to the net increase in the gross margin
percentage were partially offset by increases in costs directly
attributable to client engagements (including costs of subcontractors,
travel and lodging, and computer hardware and software). We recently
increased the use of subcontractors to manage through a period of economic
uncertainty.
16
17
In dollar terms, gross margin increased by $72.8 million, or 58.5%, from $124.5
million (on a pro forma basis) for the three months ended March 31, 2000 to
$197.3 million for the three months ended March 31, 2001. The increase in dollar
terms was due to the $119.1 million increase in revenues described above,
coupled with:
- a net decrease in professional compensation of $14.8 million, or 5.5%,
from $270.6 million (on a pro forma basis) to $255.8 million, primarily
due to a one-time charge of $19.4 million recorded in fiscal 2000 relating
to compensatory common stock issuances and settlement of pension
obligations to certain managing directors, coupled with a $1.1 million net
decrease in managing director guaranteed base compensation. These cost
reductions were partially offset by a $5.7 million increase in
professional staff compensation and benefits due to higher wages and
benefits for new and existing staff.
- an $8 million impairment charge taken in March 2000, as described above.
These cost reductions were partially offset by cost increases due to the
following:
- an increase in other direct contract expenses of $62.8 million, or 45.6%,
from $137.7 million to $200.5 million, due to increased use of
subcontractors and higher travel and lodging expenses incurred by our
professional staff to travel to client sites. These costs increased due to
the overall growth in our business and to manage the mix of permanent and
subcontracted resources.
- an increase of $3.2 million in the amortization of goodwill and other
intangible assets primarily due to recently completed acquisitions.
- an increase of $3.1 million in other costs of service due to overall
growth in the business.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $115.1 million for the three months ended March 31,
2001. This reflects an increase of $5.2 million, or 4.8%, from $109.9 million
(on a pro forma basis). A pro forma adjustment was made to fiscal 2000 amounts
to eliminate certain costs allocated to us by KPMG LLP pursuant to an
outsourcing agreement. These costs were incurred by KPMG LLP in the coordination
and management of a multidisciplinary professional services organization.
Certain services provided to us pursuant to the original outsourcing agreement
prior to July 1, 2000 were not necessary for us to operate our business as an
independent company since they were duplicative or were performed by us
internally. Consequently, these services are no longer charged to us effective
as of July 1, 2000 under the amended and restated outsourcing agreement.
The $5.2 million, or 4.8%, increase in selling, general and administrative
expenses was primarily due to an $11.8 million increase in new business
development costs as a result of higher levels of commissions earned on a higher
revenue base and additional sales personnel, as well as an increase of $10.5
million related to recently acquired international consulting businesses. These
increases were partially offset by a $6.9 million decrease in marketing expenses
due to lower levels of advertising, coupled with a $10.2 million decrease due to
a variety of factors, none of which was individually significant.
17
18
Interest Expense, Net. Interest expense, net, decreased $3.4 million, or 47.8%,
from $7.1 million to $3.7 million for the three months ended March 31, 2000 and
2001, respectively. This decrease was due to decreased outstanding borrowings
under our credit facility for the three months ended March 31, 2001 resulting
from the use of proceeds from our initial public offering and improvements made
in our management of client billings and collections, as evidenced by the
reduction in our days sales outstanding, on an operating basis, from 92 at March
31, 2000 to 77 at March 31, 2001. Included in interest expense for the three
months ended March 31, 2001 is $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. Interest expense for the three months ended March 31,
2000 consisted primarily of interest incurred by KPMG LLP and allocated to the
Company.
Equity in Losses of Affiliates. Equity in losses of affiliates, which relates to
our equity investment in Qwest Cyber.Solutions ("QCS") for the three months
ended March 31, 2000, and a small joint venture investment for the three months
ended March 31, 2001, decreased $8.6 million, or 96.2%, from $9.0 million to
$0.3 million. We incurred no losses relating to QCS in the three months ended
March 31, 2001, because we redeemed our equity interest in QCS on December 27,
2000. (See Note 5 of the Consolidated/Combined Condensed Financial Statements.)
Income Tax Expense. 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. For this period, the Company's effective tax rate was 62.1%. The tax
rate was significantly impacted by nonbenefitable losses associated with certain
international operations, incremental tax expense associated with the redemption
of our investment in QCS, and nondeductible interest expense representing
beneficial conversion features of convertible acquisition obligations that
converted to common stock soon after the completion of our initial public
offering.
For the year ending June 30, 2001, the Company expects to incur income tax
expense at an effective tax rate of approximately 75% of its consolidated pretax
earnings. This rate reflects the negative impact of the loss on the redemption
of our investment in QCS recognized in December 2000 and other nondeductible
losses and expenses. Generally accepted accounting principles require that the
Company apportion the expected annual income tax expense to each quarter based
on the quarter's contribution to the expected annual pretax income. Therefore,
the effective tax rate for the fourth quarter of fiscal 2001 also will be
negatively affected by these items.
Through January 31, 2000, the date of our separation from KPMG LLP, the Company
operated in partnership form. Effective February 1, 2000, we commenced
operations in corporate form. Thus, for the three months ended March 31, 2000, a
pro forma adjustment was made to include income taxes at the fiscal 2000 pro
forma annual effective tax rate of 70%. We expect that as our earnings grow, and
the rate of growth of our nondeductible expenses declines, our effective tax
rate will decrease.
Net Income (Loss). Net income increased by $30.0 million, from a loss of $0.5
million (on a pro forma basis) for the three months ended March 31, 2000, to
$29.5 million for the three months ended March 31, 2001. Improved profitability
reflects favorable impacts from growth in our business coupled with favorable
changes in our cost structure, as discussed above.
18
19
Preferred Stock Conversion Discount, Net. Our Series A Preferred Stock, issued
to Cisco in January 2000, 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, this discount equated to $262.5 million. In September
2000, KPMG LLP agreed to repurchase from Cisco one-half of the Series A
Preferred Stock. Then, in November 2000, KPMG LLP agreed to convert its Series A
Preferred Stock without any conversion discount. Thus, the net amount of the
beneficial conversion feature (after deducting the amount of the conversion
discount foregone by KPMG LLP) was $131.25 million.
Net Loss Applicable to Common Stockholders. After deducting the aforementioned
conversion discount on our Series A Preferred Stock, net loss applicable to
common stockholders for the three months ended March 31, 2001, was $101.7
million or $0.83 per share. For the comparable period of the prior year, after
deducting dividends on Series A Preferred Stock, net loss applicable to common
stockholders was $10.8 million or $0.14 per share (on a pro forma basis). After
December 31, 2000, we were 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. The per share amounts of the losses were further
affected by the completion of our initial public offering on February 8, 2001,
which increased the number of common shares outstanding by approximately 82
million (48 million on an average basis).
19
20
HISTORICAL NINE MONTHS ENDED MARCH 31, 2001 COMPARED TO PRO FORMA NINE MONTHS
ENDED MARCH 31, 2000
The following table sets forth our historical consolidated statements of
operations for the nine months ended March 31, 2001 and pro forma nine months
ended March 31, 2000. As discussed in Note 1 of the Consolidated/Combined
Condensed Financial Statements, the historical results of operations for the
nine months ended March 31, 2001, which reflect a corporate basis of
presentation, and the nine months ended March 31, 2000, which reflect a
corporate basis of presentation for the two months ended March 31, 2000 and a
partnership basis of presentation for the seven months ended January 31, 2000,
are not directly comparable. Pro forma adjustments have been made to reflect all
fiscal year 2000 periods as if we had been operating in corporate form
throughout the year.
20
21
FY00
----------------------------------------------------------------- FY01
HISTORICAL PRO FORMA HISTORICAL
----------------------------- -------------------------------- -------------
COMBINED CONSOLIDATED CONSOLIDATED CONSOLIDATED
SEVEN MONTHS TWO MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
JANUARY 31, MARCH 31, PRO FORMA MARCH 31, MARCH 31,
(Dollars in thousands, except share and 2000 2000 ADJUSTMENTS 2000 2001
per share amounts) ------------- ------------- ------------- ------------- -------------
Revenues $ 1,264,818 $ 432,695 $ 1,697,513 $ 2,132,953
Costs of service:
Professional compensation 436,214 185,457 $ 103,992 (1) 714,156 788,560
3,874 (2)
(15,381)(3)
Other direct contract expenses 263,106 94,180 357,286 547,039
Amortization of goodwill and
other intangible assets 8,957 3,199 12,156 22,163
Impairment charge 8,000 8,000
Other costs of service 203,821 55,012 (1,847)(3) 256,986 263,221
------------- ------------- ------------- ------------- -------------
Total costs of service 912,098 345,848 90,638 1,348,584 1,620,983
------------- ------------- ------------- ------------- -------------
Gross margin 352,720 86,847 (90,638) 348,929 511,970
Selling, general and administrative expenses 220,743 85,739 (30,629)(4) 275,853 328,072
Special payment to managing directors 25,000 (25,000)(5) -
------------- ------------- ------------- ------------- -------------
Operating income (loss) 131,977 (23,892) (35,009) 73,076 183,898
Interest expense, net (27,339) (1,814) (29,153) (13,862)
Equity in losses of affiliate and loss on redemption
of equity interest in affiliate (14,374) (6,135) (20,509) (76,357)
Minority interest 28 (174) (146) (297)
------------- ------------- ------------- ------------- -------------
Income before partner distributions and
benefits $ 90,292
=============
Income (loss) before taxes (32,015) (35,009) 23,268 93,382
Income tax expense (benefit) (2,182) 18,470 (6) 16,288 80,884
------------- ------------- ------------- -------------
Net income (loss) (29,833) (53,479) 6,980 12,498
Dividend on Series A Preferred Stock (10,328) (10,328) (31,672)
Preferred stock conversion discount (131,250)
------------- ------------- ------------- -------------
Net loss applicable to common
stockholders $ (40,161) $ (53,479) $ (3,348) $ (150,424)
============= ============= ============= =============
Net loss applicable to common
stockholders per share - basic and diluted $ (0.53) $ (0.04) $ (1.65)
============= ============= =============
Weighted average shares - basic and diluted 75,693,566 (7) 75,607,037 91,322,218
============= ============= =============
The accompanying notes to the pro forma consolidated statements of operations
can be found on page 26.
21
22
Revenues. Revenues increased $435.4 million, or 25.7%, from $1,698 million in
the nine months ended March 31, 2000 to $2,133 million in the nine months ended
March 31, 2001. This overall increase is primarily attributable to a 10.6%
increase in US client service hours billed due to growth in several of our
operating segments, including public services, high tech and communications and
content, as well as continued growth from our recently acquired international
operations.
Strong revenue growth was experienced in the communications and content and high
tech segments, which increased 70% and 54% respectively. This growth was
partially due to joint marketing relationships with our alliance partners,
growth in our next generation operations support systems/business support
systems offerings, business-to-business Internet-related services, and growth
from our key accounts. In addition, international revenue increased nearly
fourfold to $169 million when compared to the prior year nine month period.
Gross Margin. Gross margin as a percentage of revenues was 24.0% for the nine
months ended March 31, 2001. This reflects an increase from 20.6% (on a pro
forma basis) for the nine months ended March 31, 2000. Pro forma adjustments
were made to fiscal 2000 amounts (i) to include partner compensation and benefit
costs that we would have incurred for our managing directors under the terms of
the new compensation plan which we adopted and implemented effective July 1,
2000, had the new plan been in place during the historical period, (ii) to
include partner vacation costs, and (iii) to eliminate the cost of the employee
pension plan. Following our separation from KPMG LLP on January 31, 2000, our
employees no longer participated in the KPMG LLP defined benefit pension plan;
instead, our employees now participate in a stock option award program.
The 16.5% increase in gross margin percentage was due to the following factors:
- Changes in our managing director compensation plan, whereby guaranteed
base compensation levels were decreased, and the percentage of total
compensation that varies based upon individual and company performance
increased.
- Costs attributable to the support and maintenance of our professional
staff (such as occupancy, training, recruiting and professional support
personnel costs) were leveraged and increased at a slower rate than the
overall growth in the business.
- In the two months ended March 31, 2000, we recorded a one-time noncash
charge relating to compensatory common stock issuances to certain managing
directors, an impairment charge relating to certain goodwill and other
intangible assets and a one-time charge relating to settlement of pension
obligations to certain managing directors. No such charges were required
in the comparable period of fiscal 2001.
- These factors that contributed to the net increase in the gross margin
percentage were partially offset by increases in costs directly
attributable to client engagements (including costs of subcontractors,
travel and lodging, and computer hardware and software). We recently
increased the use of subcontractors to manage through a period of economic
uncertainty.
22
23
In dollar terms, gross margin increased by $163.0 million, or 46.7%, from $348.9
million (on a pro forma basis) for the nine months ended March 31, 2000 to
$512.0 million for the nine months ended March 31, 2001. The increase in dollar
terms was due to the $435.4 million increase in revenues described above,
coupled with a reduction in costs due to an $8 million impairment charge taken
in March 2000.
The increase in revenue was partially offset by cost increases due to the
following:
- An increase in professional compensation of $74.4 million, or 10.4%, from
$714.2 million (on a pro forma basis) to $788.6 million, primarily due to
a net increase in managing director compensation of $15.8 million due to a
lower fiscal 2000 allocation of partnership earnings to the first half of
the year offset by the impact of changes in our managing director
compensation plan; $34.7 million attributable to higher wages and benefits
for new and existing staff, and an increase of $43.3 million in accruals
for incentive compensation. These increases were partially offset by the
one-time charge of $19.4 million recorded in fiscal 2000 relating to
compensatory common stock issuances and settlement of pension obligations
of certain managing directors.
- an increase in other direct contract expenses of $189.8 million, or 53.1%,
from $357.3 million to $547.0 million, due to increased use of
subcontractors and higher travel and lodging expenses incurred by our
professional staff to travel to client sites. These costs increased due to
the overall growth in our business and to manage the mix of permanent and
subcontracted resources.
- an increase of $10.0 million in the amortization of goodwill and other
intangible assets primarily due to recently completed acquisitions.
- an increase of $6.2 million in other costs of service due to overall
growth in the business.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $328.1 million for the nine months ended March 31,
2001. This reflects an increase of $52.2 million, or 18.9%, from $275.9 million
(on a pro forma basis). A pro forma adjustment was made to fiscal 2000 amounts
to eliminate certain costs allocated to us by KPMG LLP pursuant to an
outsourcing agreement. These costs were incurred by KPMG LLP in the coordination
and management of a multidisciplinary professional services organization.
Certain services provided to us pursuant to the original outsourcing agreement
prior to July 1, 2000 were not necessary for us to operate our business as an
independent company since they were duplicative or were performed by us
internally. Consequently, these services are no longer charged to us effective
as of July 1, 2000 under the amended and restated outsourcing agreement.
The $52.2 million, or 18.9%, increase in selling, general and administrative
expenses was primarily due to an increase of $22.6 million related to new
business development costs as a result of higher levels of commissions earned on
a higher revenue base and additional sales personnel, as well as an increase of
$25.6 million due to recently acquired international consulting businesses. In
addition, there was an increase of $4.0 million of allocated and direct costs
incurred to support growth in the business primarily relating to office space,
support and operation services, and increased staffing in infrastructure
departments.
23
24
Interest Expense, Net. Increase expense, net, decreased $15.3 million, or 52.5%,
from $29.2 million to $13.9 million for the nine months ended March 31, 2000 and
2001 respectively. This decrease was due to decreased outstanding borrowings
under our credit facility for the nine months ended March 31, 2001 resulting
from the use of proceeds from our initial public offering and improvements made
in our management of client billings and collections, as evidenced by the
reduction in our days sales outstandings, on an operating basis, from 92 at
March 31, 2000 to 77 at March 31, 2001. Included in interest expense for the
nine months ended March 31, 2001 is $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. Interest expense for the nine months ended March 31,
2000 consisted primarily of interest incurred by KPMG LLP and allocated to the
Company.
Equity in Losses of Affiliates and Loss on Redemption of Equity Interest in
Affiliate. Equity in losses of affiliates and loss on redemption of equity
interest in affiliate, which relates to our equity investment in QCS for the
nine months ended March 31, 2000, and QCS as well as a small joint venture
investment for the nine months ended March 31, 2001, increased $55.8 million
from $20.5 million to $76.4 million. On December 27, 2000, QCS redeemed the
Company's 49% ownership interest in the joint venture in exchange for a nominal
amount. Accordingly, the Company's investment in QCS of $63.3 million ($58.5
million on an after tax basis), was written off through a noncash charge to
earnings in December 2000. (See Note 5 of the Consolidated/ Combined Condensed
Financial Statements.)
Income Tax Expense. 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.
For this period, the Company's effective tax rate was 86.6%. The tax rate was
significantly impacted by nonbenefitable losses associated with certain
international operations, tax expense associated with the redemption of our
investment in QCS, and nondeductible interest expense representing beneficial
conversion features of convertible acquisition obligations that converted to
common stock at the time of our initial public offering.
Through January 31, 2000, the date of our separation from KPMG LLP, the Company
operated in partnership form. Effective February 1, 2000, we commenced
operations as a corporation. Thus, for the nine months ended March 31, 2000, a
pro forma adjustment was made to include income taxes at the fiscal 2000 pro
forma annual effective tax rate of 70%. We expect that as our earnings grow, and
the rate of growth of our nondeductible expenses declines, our effective tax
rate will decrease.
Net Income. Net income increased by $5.5 million, from $7.0 million (on a pro
forma basis) for the nine months ended March 31, 2000, to $12.5 million for the
nine months ended March 31, 2001. Improved profitability reflects favorable
impacts from growth in our business coupled with favorable changes in our cost
structure, as discussed above, partially offset by equity in losses of
affiliates and loss on redemption of equity interest in affiliate.
24
25
Preferred Stock Conversion Discount, Net. Our Series A Preferred Stock, issued
to Cisco in January 2000, 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, this discount equated to $262.5 million. In September
2000, KPMG LLP agreed to repurchase from Cisco one-half of the Series A
Preferred Stock. Then, in November 2000, KPMG LLP agreed to convert its Series A
Preferred Stock without any conversion discount. Thus, the net amount of the
beneficial conversion feature (after deducting the amount of the conversion
discount foregone by KPMG LLP) was $131.25 million.
Preferred Stock Dividends. Series A Preferred Stock dividends totaling $31.7
million were recognized in the six months ended December 31, 2000 compared to
$10.3 million in the two months ended March 31, 2000. After December 31, 2000,
we were 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.
Net Loss Applicable to Common Stockholders. After deducting the aforementioned
conversion discount and dividends on our Series A Preferred Stock, net loss
applicable to common stockholders for the nine months ended March 31, 2001, was
$150.4 million or $1.65 per share. For the comparable period of the prior year,
net loss applicable to common stockholders was $3.3 million or $0.04 per share
(on a pro forma basis). The per share amounts of the losses were further
affected by the completion of our initial public offering on February 8, 2001,
which increased the number of common shares outstanding by 82 million (16
million on an average basis).
25
26
NOTES TO PRO FORMA FINANCIAL INFORMATION
For purposes of preparing the accompanying pro forma financial information,
we have assumed that the Company's separation from KPMG LLP, converting the
legal form of our business from a partnership to a corporation was completed on
July 1, 1999, and have made the following adjustments to the historical
consolidated and combined condensed financial statements. The pro forma
financial information does not assume the completion of our initial public
offering, which closed on February 13, 2001. These notes should be read in
conjunction with our consolidated/combined pro forma financial information and
notes thereto for the fiscal year ended June 30, 2000, included in the Company's
Prospectus dated February 7, 2001, filed with the SEC pursuant to rule 424(b)
under the Securities Act of 1933.
(1) Adjustment to reflect partner compensation and benefit costs that we
would have incurred for our managing directors under the terms of our new
compensation plan which we have adopted and implemented effective July 1, 2000,
had the new plan been in place during the historical periods.
(2) Adjustment to reflect the increase in partner accrued vacation pay for
the periods preceding our Company's separation from KPMG LLP.
(3) Adjustment to reflect changes to our employee (professional and
administrative) pension plan. Following the separation from KPMG LLP on January
31, 2000, our employees no longer participate in the KPMG LLP pension plan. The
adjustments to eliminate costs under the employee pension plan were based on the
actual amounts allocated to us by KPMG LLP during the pro forma periods.
(4) KPMG LLP historically allocated costs incurred in the coordination and
management of a multidisciplinary professional services organization to each of
its functional business units. For the period from January 31, 2000 until June
30, 2000, we received these services pursuant to the original outsourcing
agreement. Certain services provided to us pursuant to the original outsourcing
agreement prior to July 1, 2000 were not necessary for us to operate our
business as an independent company since they were duplicative or were performed
by us internally. Consequently, these services were no longer charged to us
effective as of July 1, 2000. These costs, which have been eliminated for the
periods ended March 31, 2000, primarily relate to executive management costs
incurred in relation to the management of a national and international
multidisciplinary services firm which we no longer require. Because we have
historically had a full executive management team responsible for the consulting
business of KPMG LLP, these allocated costs are no longer incurred. The costs
related to our executive management are reflected in our historical financial
statements for non-partner costs and are included in pro forma adjustment (1)
for managing directors. Additionally, we no longer are a member of KPMG
International since the initial public offering. KPMG International costs
previously allocated to us by KPMG LLP were for executive management costs and
headquarter support costs for KPMG International. KPMG International's
management was duplicative of our executive management costs. We will not incur
these costs incrementally since we will operate in corporate form and our
existing executive management team will oversee our international operations.
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The pro forma effect of the elimination of those costs for the three and
nine months ended March 31, 2000, pursuant to the transition services agreement
is as follows (in thousands):
THREE MONTHS NINE MONTHS
ENDED MARCH 31, ENDED MARCH 31,
2000 2000
-------------- ---------------
International and U.S. partnership level management structure $10,335 $26,064
International and firmwide partnership meetings 638 3,181
Support of the KPMG Foundation 376 1,384
------- -------
Total $11,349 $30,629
======= =======
(5) Reflects an adjustment to eliminate the special payment to managing
directors. The special payment represents a payment to our managing directors
that was determined based on an allocation of the profits of KPMG LLP and our
Company among the partners of KPMG LLP and our managing directors, as if the
entities had been combined through June 30, 2000. The amounts paid by us to our
managing directors in excess of the compensation they earned as managing
directors of our Company represents the amount classified as a special payment
in our statement of operations. Absent this arrangement with KPMG LLP, our
managing directors would not have been entitled to this additional payment.
(6) Reflects an adjustment for an estimated income tax provision as if we
had operated as a corporation, including tax benefits of certain losses, at a
pro forma effective tax rate of 70% for the year ended June 30, 2000. Due to our
non-deductible goodwill amortization and our high level of non-deductible travel
related expenses, our effective tax rate is impacted to a great extent by our
level of earnings. If our earnings grow and non-deductible expenses and goodwill
amortization grow at a lesser rate or decrease, our effective tax rate will
decrease in the future.
(7) Weighted average shares outstanding-basic and diluted, are calculated
based on:
ASSUMED
OUTSTANDING SHARES
COMMON STOCK ISSUANCES FROM OUTSTANDING
---------------------- ---- -----------
Separation transaction 7/1/99 75,563,773
Stock awards, net of forfeitures 1/31/00 194,690
* * * * *
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LIQUIDITY AND CAPITAL RESOURCES
The Company has primarily funded its operations through cash generated from
operations. Additionally, the Company has borrowing arrangements available
including a revolving credit facility with $5 million outstanding at March 31,
2001 (not to exceed $100 million), a revolving line of credit facility with no
outstanding balance at March 31, 2001 (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, 2001 (not to exceed $200 million). The
revolving credit facility and revolving line of credit facility expire on May
24, 2004 and May 23, 2001, respectively, while the accounts receivable financing
facility permits "sales" of accounts receivable through May 21, 2003, subject to
annual renewal. 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.
The Company's cash and cash equivalents declined $1.4 million to $25.6
million at March 31, 2001 when compared with June 30, 2000. The decline in cash
and cash equivalents was due to $83.1 million of cash used in investing
activities and $0.6 million of cash used in operating activities, offset by
$82.3 million of cash provided by financing activities.
Cash used in operating activities during the nine months ended March 31,
2001 was $0.6 million, principally due to net growth in accounts receivable from
clients of $62.4 million, distributions made to our managing directors relating
to fiscal 2000 of $73.2 million, and increases in other assets and prepaid
expenses of $28.2 million, offset by operating results of $115.2 million and a
net increase in liabilities of $48.0 million.
Cash used in investing activities during the nine months ended March 31,
2001 was $83.1 million principally due to $33.9 million of property and
equipment purchases, $13.6 million paid in acquisitions, $9.9 million of
additional capital invested in QCS through October 2000, as well as $7.5 million
of equity investments.
Cash provided by financing activities for the nine months ended March 31,
2001 was $82.3 million, principally due to the proceeds of $591.7 million from
issuance of common stock, offset by the payment of $378.3 million to repurchase
1.4 million shares of Series A Preferred Stock and a $47.9 million net decrease
in notes payable.
A discussion of the Company's initial public offering and use of proceeds
can be found in Note 2 of the Consolidated/Combined Condensed Financial
Statements.
The Company believes that the cash provided from operations, borrowings
available under the various facilities described above, existing cash and cash
equivalents and proceeds from the February 8, 2001 initial public offering
should be sufficient to meet working capital and capital expenditure needs.
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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;
- 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. For a more detailed discussion
of certain of these factors, see Exhibit 99.1 to this Form 10-Q.
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 arises because our
indebtedness primarily carries variable interest rates. Foreign currency
exchange risk is not significant as foreign currency transactions have not been
significant and are not concentrated in a single foreign currency.
In connection with our borrowings and as a result of continual monitoring
of interest rates, we may in the future enter into interest rate swap agreements
for purposes of managing our borrowing costs.
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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) Reports on Form 8-K
None
EXHIBIT INDEX
Exhibit Number Description
-------------- -----------
3.1 Amended and Restated Certificate of Incorporation of the
Company, dated as of February 7, 2001
10.1 Amended and Restated Separation Agreement, dated as of
February 13, 2001, among KPMG LLP, KPMG Consulting, LLC
and the Company
10.2 Limited License Agreement, dated as of October 31, 2000,
between the Company and KPMG International
10.3 Transition Services Agreement dated as of February 13,
2001, among KPMG LLP, KPMG Consulting, LLC and the
Company
10.4 Non-Competition Agreement, dated as of February 13,
2001, among KPMG LLP, KPMG Consulting, LLC and the
Company
10.5 Company's 2000 Long-Term Incentive Plan, amended as of
March 30, 2001
10.6 Subordinated Revolving Note and Guaranty, dated January
1, 2001, issued to KPMG LLP, which is incorporated
herein by reference from the Company's Registration
Statement on Form S-1 (Registration No. 333-36328),
which is contained in Commission File No. 000-31351
99.1 Factors Affecting Future Financial Results
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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 14, 2001 By: /s/ Randolph C. Blazer
----------------------
Randolph C. Blazer,
Chief Executive Officer,
President and Chairman of the Board of
Directors
PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER
DATE: May 14, 2001 /s/ Robert C. Lamb, Jr.
-----------------------
Robert C. Lamb, Jr.,
Executive Vice President
and Chief Financial Officer
31