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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 December 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 incorporation or organization) (IRS Employer Identification No.)
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 January
31, 2002 was 156,697,943.
1
KPMG CONSULTING, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2001
TABLE OF CONTENTS
PART I - FINANCIAL STATEMENTS
Item 1: Financial Statements (unaudited)
Consolidated Condensed Statements of Operations for the Three and Six Months Ended
December 31, 2001 and 2000 ........................................................................... 3
Consolidated Condensed Balance Sheets as of December 31, 2001 and June 30, 2001 ...................... 4
Consolidated Condensed Statements of Cash Flows for the Six Months Ended
December 31, 2001 and 2000 ........................................................................... 5
Notes to Consolidated Condensed Financial Statements ................................................ 6
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations ...... 11
Item 3: Quantitative and Qualitative Disclosure about Market Risk ................................... 18
PART II - OTHER INFORMATION:
Item 1: Legal Proceedings ........................................................................... 18
Item 6: Exhibits .................................................................................... 18
SIGNATURES ........................................................................................... 20
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 Six Months Ended
December 31, December 31,
2001 2000 2001 2000
------------ ----------- ------------- -----------
Revenues $ 593,218 $ 702,604 $ 1,202,109 $ 1,382,040
Costs of service:
Professional compensation 247,746 276,208 492,832 558,768
Other direct contract expenses 155,543 196,589 299,736 346,561
Other costs of service 57,000 78,005 112,648 146,146
------------ ----------- ------------- -----------
Total 460,289 550,802 905,216 1,051,475
------------ ----------- ------------- -----------
Gross margin 132,929 151,802 296,893 330,565
Selling, general and administrative expenses 114,815 111,086 234,748 228,891
------------ ----------- ------------- -----------
Operating income 18,114 40,716 62,145 101,674
Interest (income) expense, net (27) 5,560 (174) 10,178
Loss on redemption of equity interest in affiliate
and equity in losses of affiliate - 63,310 - 75,946
------------ ----------- ------------- -----------
Income (loss) before taxes 18,141 (28,154) 62,319 15,550
Income tax expense 11,547 9,417 33,410 32,588
------------ ----------- ------------- -----------
Income (loss) before cumulative effect of change
in accounting principle 6,594 (37,571) 28,909 (17,038)
Cumulative effect of change in accounting principle - - (79,960) -
------------ ----------- ------------- -----------
Net income (loss) 6,594 (37,571) (51,051) (17,038)
Dividend on Series A Preferred Stock - 15,836 - 31,672
------------ ----------- ------------- -----------
Net income (loss) applicable to common stockholders $ 6,594 $ (53,407) $ (51,051) $ (48,710)
============ =========== ============= ===========
Earnings (loss) per share - basic and diluted:
Income (loss) before cumulative effect of change in
accounting principle applicable to common stockholders $ 0.04 $ (0.70) $ 0.18 $ (0.64)
Cumulative effect of change in accounting principle - - (0.50) -
------------ ----------- ------------- -----------
Net income (loss) applicable to common stockholders $ 0.04 $ (0.70) $ (0.32) $ (0.64)
============ =========== ============= ===========
Weighted average shares-basic and diluted 158,340,791 75,760,067 158,823,499 75,795,884
============ =========== ============= ===========
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)
December 31, June 30,
2001 2001
------------ ----------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 101,008 $ 45,914
Accounts receivable, net 295,360 377,476
Unbilled revenues, net 144,451 180,355
Prepaid and other current assets 92,263 101,014
---------- ----------
Total current assets 633,082 704,759
Property and equipment, net 65,532 66,947
Goodwill and other intangible assets, net 159,203 189,383
Other assets 32,869 38,546
---------- ----------
Total assets $ 890,686 $ 999,635
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable $ 8,781 $ 11,594
Acquisition obligation 15,000 15,000
Accounts payable 53,528 65,632
Accrued payroll and related liabilities 139,881 174,884
Other current liabilities 97,709 86,999
---------- ----------
Total current liabilities 314,899 354,109
Notes payable, less current portion 629 1,846
Other liabilities 10,208 11,568
---------- ----------
Total liabilities 325,736 367,523
Stockholders' equity :
Preferred Stock, $.01 par value 10,000,000 shares authorized - -
Common Stock, $.01 par value 1,000,000,000 shares authorized,
160,018,728 shares issued on December 31, 2001 and
158,568,922 shares issued on June 30, 2001 (including
999,006 shares reserved on December 31, 2001 and June 30,
2001, and 2,330,000 treasury shares on December 31, 2001) 1,590 1,576
Additional paid-in capital 669,016 656,293
Accumulated deficit (65,574) (14,523)
Notes receivable from stockholders (10,094) (7,950)
Accumulated other comprehensive loss (2,515) (3,284)
Common stock held in treasury, at cost (27,473) -
---------- ----------
Total stockholders' equity 564,950 632,112
---------- ----------
Total liabilities and stockholders' equity $ 890,686 $ 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)
Six Months Ended
December 31,
2001 2000
---------- ---------
Cash flows from operating activities:
Net income (loss) $ (51,051) $ (17,038)
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 - 76,020
Depreciation and amortization 23,015 28,171
Deferred income taxes and other (2,507) (19,172)
Changes in assets and liabilities:
Accounts receivable 83,486 (127,332)
Unbilled revenues 36,127 86,963
Prepaid expenses and other current assets (7,677) (2,096)
Other assets 12,971 2,951
Accrued payroll and related liabilities (38,316) 28,060
Accounts payable and other current liabilities 6,305 55,606
Distribution payable to managing directors - (73,230)
--------- ---------
Net cash provided by operating activities 142,313 38,903
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (12,497) (17,195)
Businesses acquired, net of cash acquired (33,179) (2,536)
Purchases of other intangible assets (14,641) (443)
Investment in affiliate - (9,945)
Purchases of equity investments (2,234) (7,500)
--------- ---------
Net cash used in investing activities (62,551) (37,619)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock 12,737 -
Repurchases of common stock (27,473) -
Proceeds from notes payable - 386,360
Repayment of notes payable (5,947) (336,022)
Repayment of acquisition obligations - (34,380)
Repurchase of minority interest in subsidiary (2,092) -
Notes receivable from stockholders (1,893) -
Dividends paid on Series A Preferred Stock - (28,918)
--------- ---------
Net cash used in financing activities (24,668) (12,960)
--------- ---------
Net increase (decrease) in cash and cash equivalents 55,094 (11,676)
Cash and cash equivalents - beginning of period 45,914 26,991
--------- ---------
Cash and cash equivalents - end of period $ 101,008 $ 15,315
========= =========
Supplementary cash flow information:
Interest paid $ 737 $ 11,871
Taxes paid $ 29,295 $ 80,674
The accompanying notes are an integral part of these financial statements.
5
KPMG Consulting, Inc.
Notes to Consolidated Condensed Financial Statements
(in thousands, except shares 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
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 six months
ended December 31, 2001 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
December 31,
2001 2000
--------------------------------- ------------------------------
Operating Operating
Revenue Income Revenue Income
---------------- ------------- ------------- --------------
Public Services $ 236,621 $ 76,381 $ 193,639 $ 49,046
Financial Services 53,734 4,016 133,420 29,855
Communications & Content 132,201 31,473 142,561 26,293
High Tech 50,122 7,269 111,636 25,124
Consumer & Industrial Markets 73,973 13,572 88,380 18,732
International / Corporate (1) 46,567 (114,597) 32,968 (108,334)
---------------- ------------- ------------- ------------
Total $ 593,218 $ 18,114 $ 702,604 $ 40,716
================ ============= ============= ============
Six Months Ended
December 31,
2001 2000
--------------------------------- ------------------------------
Operating Operating
Revenue Income Revenue Income
---------------- ------------- ------------- --------------
Public Services $ 455,341 $ 147,030 $ 391,687 $ 104,263
Financial Services 121,439 12,152 272,121 56,251
Communications & Content 265,548 72,760 262,328 56,358
High Tech 112,710 19,765 211,081 49,299
Consumer & Industrial Markets 158,328 35,722 179,704 38,749
International / Corporate (1) 88,743 (225,284) 65,119 (203,246)
---------------- ------------- ------------- ------------
Total $ 1,202,109 $ 62,145 $ 1,382,040 $ 101,674
================ ============= ============= ============
(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.
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:
7
Comprehensive Income
Three Months Ended Six Months Ended
December 31, December 31,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Income (loss) before cumulative effect of change
in acccounting principle $ 6,594 $ (37,571) $ 28,909 $ (17,038)
Cumulative effect of change in accounting
principle - - (79,960) -
---------- ---------- ---------- ----------
Net income (loss) 6,594 (37,571) (51,051) (17,038)
Foreign currency translation adjustment,
net of tax 129 274 769 (1,127)
---------- ---------- ---------- ----------
Comprehensive income (loss) $ 6,723 $ (37,297) $ (50,282) $ (18,165)
========== ========== ========== ==========
Note 4. 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 $18.9 million to goodwill and $10.8
million to finite lived intangibles.
These acquisitions have been accounted for as purchases, in accordance
with SFAS No. 141. The pro forma effects on operations were not material.
Note 5. 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
supersedes 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. Separable
intangible assets that have finite useful lives, will continue to be amortized
over their useful lives.
SFAS No. 142 requires that goodwill be tested for impairment at the
reporting unit level at adoption and at least annually thereafter, utilizing a
two step methodology. The initial step requires the Company to determine the
fair value of each reporting unit and compare it to the carrying value,
including goodwill, of such unit. If the fair value exceeds the carrying value,
no impairment loss would be recognized. However, if the carrying value of the
reporting unit exceeds its fair value, the
8
goodwill of this unit may be impaired. The amount, if any, of the impairment
would then be measured in the second step.
In connection with adopting this standard as of July 1, 2001, during the
first quarter the Company completed step one of the test for impairment, which
indicated that the carrying values of certain reporting units exceeded their
estimated fair values, as determined utilizing various valuation techniques
including discounted cash flow and comparative market analysis. Thereafter,
given the indication of a potential impairment, the Company completed step two
of the test. 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 six months ended December 31, 2000 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).
Reconciliation of Net Income (Loss) and Earnings (Loss) Per Share
Three Months Ended Six Months Ended
December 31, December 31,
------------------------------ ------------------------------
2001 2000 2001 2000
------------- ------------- ------------- -------------
Reported income (loss) before cumulative effect
of change in accounting principle $ 6,594 $ (37,571) $ 28,909 $ (17,038)
Add back goodwill amortization, net of tax -- 3,614 -- 6,475
------------- ------------- ------------- -------------
Adjusted income (loss) before cumulative effect
of change in accounting principle 6,594 (33,957) 28,909 (10,563)
Cumulative effect of change in accounting principle -- -- (79,960) --
------------- ------------- ------------- -------------
Adjusted net income (loss) 6,594 (33,957) (51,051) (10,563)
Series A Preferred Stock dividends -- 15,836 -- 31,672
------------- ------------- ------------- -------------
Adjusted income (loss) applicable to common stockholders $ 6,594 $ (49,793) $ (51,051) $ (42,235)
============= ============= ============= =============
Earnings (loss) per share - basic and diluted:
Reported income (loss) before cumulative effect of change
in accounting principle applicable to common stockholders $ 0.04 $ (0.70) $ 0.18 $ (0.64)
Add back goodwill amortization, net of tax -- 0.05 -- 0.09
------------- ------------- ------------- --------------
Adjusted income (loss) before cumulative effect of change
in accounting principle applicable to common stockholders 0.04 (0.65) 0.18 (0.55)
Cumulative effect of change in accounting principle -- -- (0.50) --
------------- ------------- ------------- --------------
Adjusted income (loss) applicable to common stockholders $ 0.04 $ (0.65) $ (0.32) $ (0.55)
============= ============= ============= =============
Weighted average shares - basic and diluted 158,340,791 75,760,067 158,823,499 75,795,884
============= ============= ============= =============
9
At December 31, 2001 the Company has $12.1 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 December 31, 2001 are $13.1 million
and $1.0 million, respectively.
The changes in the carrying amount of goodwill for the six months ended December
31, 2001 are as follows:
Balance Transitional Balance
June 30, Impairment December 31,
2001 Additions (a) Charge Other (b) 2001
-------- ------------- ------------- ------------- --------------
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 33,668 (79,960) (518) 52,308
-------- ------------ ------------- ---------- ------------
Total (c) $135,777 $ 33,668 $ (79,960) $ (3,918) $ 85,567
======== ============ ============= ========== ============
(a) Additions related to the acquisition of the regional consulting practices
in Southeast Asia and Australia (see Note 4).
(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.
Note 6. Reduction in Workforce
In November 2001, the Company recorded a $17.7 million charge for severance
and termination benefits related to a worldwide reduction in workforce and a
$2.5 million charge related to the impairment of third-party software licenses.
The reduction in workforce affected approximately 325 employees and was the
result of aligning the Company's workforce with market demand for certain types
of services. All of the affected employees have been terminated and are no
longer employed by the Company.
A summary of the movements in the Company's accrual for severance and
termination benefits from June 30, 2001 to December 31, 2001 is as follows:
Severance
Accrual
-------------
Balance at June 30, 2001(a) $ 4,236
November charge 17,729
Payments (15,200)
-------------
Balance at December 31, 2001(b) $ 6,765
=============
(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.
10
Note 7. Subsequent Events
On February 1, 2002 the Company filed with the SEC a Schedule TO relating
to a self tender offer for employee 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) have 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 (or at a later date if the exchange offer is
extended) with an exercise price equal to 110% of the then fair market value of
the Company's common stock. The replacement options will vest equally over three
years. As of the date of the tender offer there were approximately 6 million
options outstanding with an exercise price of $55.50. Consummation of this offer
will result in additional compensation expense of approximately $1 million to be
recognized by the Company over the vesting period of the replacement options.
* * * * *
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 polices 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 nearly 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.
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
11
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.
HISTORICAL RESULTS OF OPERATIONS OVERVIEW
The Company realized net income applicable to common stockholders for the three
months ended December 31, 2001 of $6.6 million, or $0.04 per share, compared to
a net loss of $53.4 million, or $0.70 per share for the three months ended
December 31, 2000. Included in operating results for the quarter ended December
31, 2001, was a $20.2 million charge ($12.8 million net of tax) predominantly
related to a reduction in workforce. Included in operating results for the
quarter ended December 31, 2000, was a $63.3 million non-operating loss on
redemption of an equity interest in affiliate ($58.5 million net of tax).
Excluding the after-tax effects of the aforementioned charges, operating net
income for the three months ended December 31, 2001, was $19.4 million compared
to $20.9 million in the quarter ended December 31, 2000. The slight decrease in
profitability was driven by a decline in revenue of $109.4 million, partially
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 $51.0 million, or $0.32 per share for the
six months ended December 31, 2001, compared to a net loss of $48.7 million, or
$0.64 per share for the six months ended December 31, 2000. Included in
operating results for the six months ended December 31, 2001, was the $20.2
million charge referred to above. Included in results for the six months ended
December 31, 2000, was $76.0 million charge representing equity in losses of
affiliate and loss on redemption of equity interest in affiliate ($71.2 million
net of tax). Excluding the after-tax effects of the aforementioned charges,
operating net income for the six months ended December 31, 2001, was $41.7
million compared to $54.2 million for the six months ended December 31, 2000.
This decrease in profitability was driven by a decline in revenue of $179.9
million, partially offset by lower levels of operating expenses.
Three Months Ended December 31, 2001 Compared to Three Months Ended December 31,
2000
Revenues. Revenues decreased $109.4 million, or 15.6%, from $702.6 million in
the three months ended December 31, 2000, to $593.2 million in the three months
ended December 31, 2001.
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
22.2%, however, this growth was more than offset by declines in Financial
Services and High Tech of 59.7% and 55.1%, 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.
Gross Margin. Gross margin as a percentage of revenues was 22.4% for the three
months ended December 31, 2001. This reflects an increase from 21.6% for the
three months ended December 31, 2000. The increase in gross margin percentage
was primarily due to a reduction in the Company's expenses as a result of a
continued focus on expense control.
12
In dollar terms, gross margin decreased by $18.9 million, or 12.4%, from $151.8
million for the three months ended December 31, 2000, to $132.9 million for the
three months ended December 31, 2001. Included in gross margin for the quarter
ended December 31, 2001, was a $20.2 million charge primarily related to a
reduction in workforce. The decrease in gross margin was due to a decline in
revenue of $109.4 million described above, offset by:
. A net decrease in professional compensation of $46.2 million, or
16.7%, excluding the $17.7 million charge recorded in the current
quarter. This decrease was predominantly due to the Company's
reduction in workforce actions taken in the current quarter and the
fourth quarter of fiscal 2001. The $17.7 million charge taken in the
current quarter pertains to the reduction in workforce of
approximately 325 employees, primarily in North America and Latin
America, in order to balance workforce capacity with market demand for
services. In addition, incentive compensation accruals were also
lower.
. A net decrease in other direct contract expenses of $41.0 million, or
20.9%, to $155.5 million, representing 26.2% of revenue, compared to
$196.6 million, or 28.0% of revenue in the prior year's quarter. The
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 has
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 $21.0 million, or 26.9%,
from $78.0 million to $57.0 million, was primarily due to tighter
controls on discretionary expenses and reduced headcount, offset by a
$2.5 million charge related to the impairment of third-party software
licenses. Additionally, bad debt expense decreased $7.5 million due to
greater emphasis on credit reviews and strengthened cash collections.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $114.8 million for the three months ended December
31, 2001. This reflects an increase of $3.7 million, or 3.4%, from $111.1
million for the three month period ended December 31, 2000. This increase is
primarily due to increased infrastructure costs as the Company continues its
infrastructure build-out in order to lessen its reliance on its former parent
company, KPMG LLP, as well as an incremental $2.7 million of expenses for the
Australia and Southeast Asia consulting practices.
Interest (Income) Expense, Net. Interest (income) expense, net, decreased $5.6
million, or 100.5%, from $5.6 million of net interest expense to $0.03 million
of net interest income for the three months ended December 31, 2000 and 2001,
respectively. This decrease was due to a repayment of all outstanding borrowings
under our credit facility of $100 million at December 31, 2000, 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 76 days at December 31,
2000, to 56 days at December 31, 2001.
Loss on Redemption of Equity Interest in Affiliate and Equity in Losses of
Affiliate. On December 27, 2000, the Company redeemed its equity interest in
Qwest Cyber.Solutions ("QCS") for a nominal amount which resulted in a non-cash
charge to earnings of $63.3 million ($58.5 million net of tax) during the three
month period ended December 31, 2000.
Income Tax Expense. For the three month period ended December 31, 2001, the
Company earned income before taxes of $18.1 million and provided income taxes of
$11.5 million resulting in an effective tax rate for the quarter of 63.7%.
13
For the three months ended December 31, 2000, the Company incurred a loss before
taxes of $28.2 million and provided income taxes of $9.4 million. The tax rates
have been significantly impacted by the non-deductibility of losses incurred in
certain international operations and related to the loss on redemption of equity
interest in affiliate.
Preferred Stock Dividends. Series A Preferred Stock dividends totaling $15.8
million were recorded in the three months ended December 31, 2000. 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.
Net Income (Loss) Applicable to Common Stockholders. For the three months ended
December 31, 2001, the Company realized net income applicable to common
stockholders of $6.6 million, or $0.04 per share. For the three months ended
December 31, 2000, the Company realized a net loss applicable to common
stockholders of $53.4 million, or $0.70 per share. Improvement in net income
applicable to common stockholders is due to the December 2000 redemption of an
equity interest in affiliate (thereby eliminating further investment in this
start-up venture), the February 2001 conversion of Series A Preferred Stock to
common stock (thereby eliminating preferred stock dividends), partially offset
by the previously-mentioned $20.2 million charge recognized in the quarter ended
December 31, 2001. The per share amounts of the income (loss) 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 82 million.
Six Months Ended December 31, 2001 Compared to Six Months Ended December 31,
2000
Revenues. Revenues decreased $179.9 million, or 13.0%, from $1,382.0 million in
the six months ended December 31, 2000, to $1,202.1 million in the six months
ended December 31, 2001.
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 16.3%,
however, this growth was more than offset by declines in Financial Services and
High Tech of 55.4% and 46.6%, respectively. These decreases are a result of
weakening market demand in these industries coupled with the postponement and
cancellation of client projects. Additionally, International revenue grew by
36.3%, 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 24.7% for the six
months ended December 31, 2001. This reflects an increase from 23.9% for the six
months ended December 31, 2000. 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 $33.7 million, or 10.2%, from $330.6
million for the six months ended December 31, 2000, to $296.9 million for the
six months ended December 31, 2001. Included in gross margin for the quarter
ended December 31, 2001, was the $20.2 million charge primarily related to the
reduction in workforce. The decrease in gross margin was due to a decline in
revenues of $179.9 million described above, offset by:
. A net decrease in professional compensation of $83.7 million, or
15.0%, excluding the previously-mentioned $17.7 million charge
recorded in the six months ended December 31, 2001. This decrease was
predominantly due to the reduction in workforce actions taken in the
14
current quarter and the fourth quarter of fiscal 2001. In addition,
incentive compensation accruals were also lower.
. A net decrease in other direct contract expense of $46.8 million, or
13.5%, to $299.7 million, representing 24.9% of revenue, compared to
$346.6 million, or 25.1% of revenue in the prior year's comparable
period. The $46.8 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 $33.5 million, or 22.9%,
from $146.1 million to $112.6 million, primarily due to tighter
controls on discretionary expenses including training and recruiting
costs and reduced headcount, offset by a $2.5 million charge related
to the impairment of third-party software licenses. Additionally, bad
debt expense decreased $9.2 million due to greater emphasis on credit
reviews and strengthened cash collections.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $234.7 million for the six months ended December
31, 2001. This reflects an increase of $5.9 million, or 2.6%, from $228.9
million, which is primarily due to increased infrastructure costs of $15.7
million as a result of the Company's infrastructure build out in order to lessen
its reliance on its former parent company, KPMG LLP, as well as, an incremental
$2.8 million of expenses for the Australia and Southeast Asia consulting
practices. This increase is partially offset by a decrease in amortization
expense of $6.9 million as a result of the Company electing to early-adopt SFAS
No. 142, "Goodwill and Other Intangible Assets", and decreases in other expenses
reflecting tighter controls over discretionary spending.
Interest (Income) Expense, Net. Interest (income) expense, net, decreased $10.4
million, or 101.7%, from $10.2 million of net interest expense to $0.2 million
of net interest income for the six months ended December 31, 2000 and 2001,
respectively. This decrease was due to a repayment of all outstanding borrowings
under our credit facility of $100 million at December 31, 2000, 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 76 days at December 31, 2000
to 56 days at December 31, 2001.
Loss on Redemption of Equity Interest in Affiliate and Equity in Losses of
Affiliate. For the six months ended December 31, 2000 loss on redemption of
equity interest in affiliate and equity losses of affiliate of $76.0 million
related to our equity investment in Qwest Cyber.Solutions ("QCS"). On December
27, 2000, the Company redeemed its equity interest in QCS for a nominal amount
which resulted in a non-cash charge to earnings of $63.3 million ($58.5 million
net of tax) during the six month period ended December 31, 2000.
Income Tax Expense. For the six months ended December 31, 2001, the Company
earned income before taxes and cumulative effect of change in accounting
principle of $62.3 million and provided income taxes of $33.4 million, resulting
in an effective tax rate of 53.6%. This rate was impacted by the
non-deductibility of losses incurred by certain international operations. For
the six months ended December 31, 2000, the Company earned income before taxes
of $15.5 million and provided income taxes of $32.6 million, resulting in an
effective tax rate of 209.6%. 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.
15
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 six months ended
December 31, 2001, 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 six months ended December 31, 2000. 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.
Net Income (Loss) Applicable to Common Stockholders. For the six months ended
December 31, 2001, the Company realized a net loss applicable to common
stockholders of $51.0 million, or $0.32 per share. For the six months ended
December 31, 2000, the Company realized a net loss applicable to common
stockholders of $48.7 million, or $0.64 per share. Period over period, net
losses applicable to common stockholders increased primarily due to decreased
levels of revenue, partially offset by decreased levels of costs and expenses.
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 82 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 will 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 December 31, 2001 (not
to exceed $100 million), a revolving line of credit facility with no outstanding
balance at December 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 December 31, 2001 (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, while 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 IPO). 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 arising at the end of the term of the
agreement, and the Company will wind down its receipt of services from KPMG LLP
by developing its own infrastructure and support capabilities.
16
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 by the end of fiscal 2002.
Cash provided by operating activities during the six months ended
December 31, 2001 was $142.3 million, principally due to cash operating results
of $49.4 million and collections of accounts receivable of $83.5 million.
Cash used in investing activities during the six months ended December
31, 2001 was $62.5 million principally due to $12.5 million in purchases of
property and equipment, $33.2 million paid for acquisitions, and $14.6 million
paid for other intangible assets.
Cash used in financing activities for the six months ended December 31,
2001 was $24.7 million, principally due to the purchase of 2.3 million treasury
shares for $27.5 million and repayment of notes payable of $5.9 million, offset
by proceeds of $12.7 million from the issuance of common stock primarily from
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 ongoing
capital expenditure needs.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB 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;
17
. 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.)
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 primarily because
our indebtedness under our bank credit facilities 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.
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) The Company filed one report on Form 8-K during the period of July
1, 2001 through the date of this report. The Form 8-K was filed on
October 3, 2001 and related to the adoption of a shareholder rights
plan.
Exhibit Index
-------------
4.1 Rights Agreement, dated as of October 2, 2001, between KPMG
Consulting, Inc. and EquiServe Trust Company, N.A., incorporated
by reference from Exhibit 1.1 to the Company's Registration
Statement on Form 8-A dated October 3, 2001.
18
4.2 Certificate of Designation of Series A Junior Participating
Preferred Stock, incorporated by reference to Exhibit 1.2 to the
Company's Registration Statement on Form 8-A dated October 3, 2001.
10.1 Form of Special Termination Agreement, made as of November 7, 2001,
between KPMG Consulting, Inc. and Certain Executive Officers.
10.2 Form of Special Termination Agreement, made as of November 7, 2001,
between KPMG Consulting, Inc. and Certain Executive Officers and
Other Key Executives
99.1 Factors Affecting Future Financial Results
19
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: February 12, 2002 By: /s/ Randolph C. Blazer
----------------------
Randolph C. Blazer,
Chairman of the Board, Chief Executive Officer,
and President
Principal Financial and Accounting Officer
DATE: February 12, 2002 By: /s/ Robert C. Lamb, Jr.
-----------------------
Robert C. Lamb, Jr.,
Executive Vice President
and Chief Financial Officer
20