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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 2002
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 000-31351
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KPMG CONSULTING, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other
jurisdiction of 22-3680505
incorporation or (IRS Employer
organization) Identification No.)
1676 International Drive,
McLean, VA
(Address of principal 22102
executive office) (Zip Code)
(703) 747-3000
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $.01 Par Value
Series A Junior Participating Preferred Stock Purchase Rights
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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, and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X]
As of August 31, 2002, the aggregate market value of the voting stock held
by nonaffiliates of the Registrant was $1.92 billion.
The number of shares of common stock of the Registrant outstanding as of
August 31, 2002 was 189,528,913.
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DOCUMENTS INCORPORATED BY REFERENCE
Pertinent extracts from Registrant's Proxy Statement for its 2002 Annual
Meeting of Stockholders to be filed with the Securities and Exchange Commission
are incorporated into Part III.
Such information incorporated by reference shall not be deemed to
specifically incorporate by reference the information referred to in Item
402(a)(8) of Regulation S-K.
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TABLE OF CONTENTS AND CROSS-REFERENCE INDEX
Page
Description Number
----------- ------
Part I.
Item 1. Business.................................................................... 3
Item 2. Properties.................................................................. 6
Item 3. Legal Proceedings........................................................... 7
Item 4. Submission of Matters to a Vote of Security Holders......................... 8
Executive Officers of the Company........................................... 8
Part II.
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.... 9
Item 6. Selected Financial Data..................................................... 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................ 11
Item 7A. Quantitative and Qualitative Disclosures about Market Risks................. 30
Item 8. Financial Statements and Supplementary Data................................. 31
Item 9. Changes in and Disagreements with Accountants on Accounting and Finance
Disclosure................................................................ 68
Part III.
Item 10. Directors and Executive Officers of the Registrant.......................... 68*
Item 11. Executive Compensation...................................................... 68*
Item 12. Security Ownership of Certain Beneficial Owners and Management.............. 68*
Item 13. Certain Relationship and Related Transactions............................... 68*
Part IV.
Item 14. Controls and Procedures..................................................... 68
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K............. 69
Signatures........................................................................... 73
Certifications....................................................................... 74
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* The information required by Items 10, 11, 12 and 13 (except for certain
information regarding executive officers that is called for by Item 10,
which information is contained in Part I and Equity Compensation Plan
information required by Item 12, which information is contained in Part III)
is incorporated herein by reference from the definitive proxy statement that
the Company intends to file pursuant to Regulation 14A on or before October
4, 2002.
2
PART I.
Item 1. Business
Item 1(a). General Development of Business.
KPMG Consulting, Inc. (generally referred to below as "we" or the "Company")
was incorporated as a business corporation under the laws of the State of
Delaware in 1999. Our principal offices are located at the KPMG Consulting
Tower, 1676 International Drive, McLean, Virginia 22102-4828. Our main
telephone number is 703-747-3000. Our Company previously was a part of KPMG
LLP, one of the former "Big 5" accounting and tax firms. In January 2000, KPMG
LLP transferred its consulting business to our Company. In February 2001 we
completed our initial public offering, and on February 8, 2001 our common stock
began to trade on the Nasdaq National Market. As part of our initial public
offering, KPMG LLP and its partners sold all of the shares of our common stock
that they owned at that time. In addition, we have a totally separate corporate
governance and management structure from KPMG LLP. We are, therefore, an
independent consulting company.
Item 1(b). Financial Information about Industry Segments.
Information required by Item 1(b) is incorporated herein by reference to
Note 22 of the "Notes to Financial Statements" included under Item 8 of this
Annual Report.
Item 1(c). Narrative Description of Business.
Overview
We are one of the world's largest business consulting and systems
integration firms with approximately 9,300 employees at June 30, 2002 (and
approximately 16,000 employees as of September 18, 2002), serving over 2,100
clients worldwide, including Global 2000 and Fortune 1000 companies, small and
medium-sized businesses, government agencies and other organizations. The
Company provides business and technology strategy, systems design and
architecture, applications implementation, network and systems integration, and
related services that enable our clients to leverage technology for stronger
return on investment and enhanced services to their customers, vendors and
employees.
Industry Groups
During fiscal year 2002, we provided consulting services through five
industry groups in which we have significant industry-specific knowledge. These
groups are:
. Public Services, which assists public services clients in process
improvement, enterprise resource planning and Internet integration
service offerings. This group is also a leading provider of financial and
economic advisory services to governments, corporations and financial
institutions around the world. Our public services clients include
federal government agencies, state and local governments, and private and
public higher education institutions. In addition, this group provides
services to public service healthcare agencies and private sector payor
and provider companies.
. Financial Services, which focuses on delivering strategic, operational
and technology services, including new, component-based business and
technical architectures that leverage existing application systems and
e-business strategies and development, delivered through consumer and
wholesale lines of business. Our clients in the financial services sector
include banking, insurance, securities, real estate, hospitality and
professional services institutions.
. Communications and Content, which provides financial, operational and
technical services to wireline and wireless communications carriers,
public and private utilities, cable system operators and media and
entertainment service providers. Our services assist clients with
business strategy development, business process flow optimization,
technology integration and asset preservation.
3
. High Technology, which focuses on the identification and delivery of
business process improvements. Areas of focus include: enterprise
systems; supply chain; product lifecycle and collaboration; sales,
marketing, customer care, and channel and human resource management. Our
services support both global market industry leaders and fast growing
businesses requiring a broad range of technology, integration,
infrastructure and managed services assistance. These solutions address
business challenges specific to our electronics industry clients, which
include contract manufacturers, and consumer electronics, semiconductor,
hardware and network equipment manufacturers; large and emerging software
companies; and life sciences clients consisting of pharmaceutical,
medical device and distribution companies.
. Consumer and Industrial Markets, which advises clients on capturing and
assessing customer needs and buying patterns to improve one-to-one
marketing and capture additional market share. In addition, we develop
and implement channel integration strategies, electronic storefronts,
sales automation and call center service offerings to help clients better
serve their customers. We focus on improving supply chain integration
through e-procurement, collaborative planning, fulfillment, product data
management and digital marketplace solutions. We assist companies in
increasing the productivity of their workforce through Internet-enabled
employee self-service and human resource applications, web-based training
and learning, front office/back office integration, shared services and
knowledge management. We work with both established brick-and-mortar
companies, including their related Internet operations, and newer
Internet companies that produce or distribute consumer and industrial
products and services. We focus on three market sectors--consumer,
industrial and automotive, and chemical and energy. We work with clients
in several vertical markets, including petroleum, industrial products,
food, retail and transportation, to create digital marketplaces and
trading exchanges that connect buyers and sellers within each market.
Our focus on specific industries provides us with the ability to tailor our
service offerings to reflect an understanding of the marketplaces in which our
clients operate and enables our clients to achieve their objectives more
quickly and efficiently.
In addition, during the latter half of fiscal year 2002, we determined to
expand our managed services offerings to provide services for many "non-core"
business activities, including order management, billing, customer care and
service assurance. With our managed services solutions, we offer business
process outsourcing, information technology outsourcing, applications
management, outsourcing consulting and delivery infrastructure.
Our Joint Marketing Relationships
As of June 30, 2002, we had approximately 50 joint marketing relationships
with key technology providers which support and complement our service
offerings. We have created joint marketing relationships to enhance our ability
to provide our clients with high value services. Our joint marketing
relationships typically entail some combination of commitments regarding joint
marketing, sales collaboration, training and service offering development.
Our most significant joint marketing and product development relationships
are with Cisco Systems, Inc., Oracle Corporation, PeopleSoft, Inc., Microsoft
Corporation, SAP America, Inc., and Siebel Systems, Inc., which we believe
strengthens our market approach. We work together to develop comprehensive
solutions to common business issues, offer the expertise required to deliver
those solutions, lead in the development of new products, capitalize on joint
marketing opportunities and remain at the forefront of technology advances.
These joint marketing agreements help us to generate revenues as they provide a
source of referrals and the ability to jointly target specific accounts.
4
International Operations
We have multi-national operations covering North America, Latin America and
the Asia Pacific regions, Israel and a number of countries in Europe. We
utilize this multi-national network to provide consistent integrated service to
clients throughout these regions. In other regions, we frequently provide our
clients with services directly and, in some instances, we serve our clients
through longstanding working relationships with other consulting providers.
On May 7, 2002, the Company executed a letter of intent with respect to
certain independent business consulting practices affiliated with Andersen
Societe Cooperative Worldwide ("Andersen BC Practices"). Since May 7, 2002, the
Company acquired all of or parts of the assets of the Andersen BC Practices
located in Australia, Hong Kong, China, Singapore, South Korea, Switzerland,
Peru, Japan, Norway, Finland, Sweden, France and Spain. The Company has also
hired professionals and staff members of Andersen BC Practices located in the
U.S. and Brazil. Further, the Company has acquired the Ernst & Young business
consulting practice in Brazil.
On August 22, 2002, pursuant to a share purchase agreement dated as of June
8, 2002, by and among KPMG Consulting, Inc., KPMG DTG, the majority shareholder
of KPMG Consulting AG ("KCA"), and minority shareholders of KCA as set forth in
the share purchase agreement, we acquired all of the outstanding shares of KCA.
KCA's operations consist primarily of the German, Swiss and Austrian consulting
practices of KPMG DTG.
For additional information regarding the international transactions, see
"Company Overview" in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" below.
For the year ended June 30, 2002, international operations represented 8% of
our business (measured in revenue dollars), and we estimate that international
operations after completion of the KCA acquisition and other transactions
referred to above will account for more than 20% of our business.
Competition
We operate in a highly competitive and rapidly changing market and compete
with a variety of organizations that offer services similar to those we offer.
The market in which we operate includes a variety of participants, including
specialized e-business consulting firms, systems consulting and implementation
firms, former "Big 5" and other large accounting and consulting firms,
application software firms providing implementation and modification services,
service groups of computer equipment companies, outsourcing companies, systems
integration companies, and general management consulting firms.
Some of our competitors have significantly greater financial, technical and
marketing resources, generate greater revenues and have greater name
recognition than we do. The competitive landscape is experiencing rapid
changes. For instance, over the past few years, some of the former "Big 5"
accounting and consulting firms have sold or entered into agreements to sell
their consulting businesses, another completed its initial public offering, and
others have indicated plans or proposals to divest their consulting businesses.
These changes in our marketplace may create potentially larger and better
capitalized competitors with enhanced abilities to attract and retain
professionals. We also compete with our clients' internal resources.
A majority of our revenue is derived from global market leaders, Fortune
1000 companies, medium-sized companies, governmental organizations and other
large enterprises. There are an increasing number of professional services
firms seeking consulting engagements with these companies. We believe that the
principal competitive factors in the consulting industry in which we operate
include scope of services, service delivery approach, technical and industry
expertise, perceived value added, objectivity of advice given, focus on
achieving results, availability of appropriate resources and global reach.
Our ability to compete also depends in part on several factors beyond our
control, including the ability of our competitors to hire, retain and motivate
skilled professionals, the price at which others offer comparable services and
our competitors' responsiveness. There is a significant risk that this
increased competition will adversely affect our financial results in the future.
5
Intellectual Property
Our success has resulted in part from our methodologies and other
proprietary intellectual property rights. We rely upon a combination of
nondisclosure and other contractual arrangements, trade secret, copyright and
trademark laws to protect our proprietary rights and rights of third parties
from whom we license intellectual property. We also enter into confidentiality
and intellectual property agreements with our employees that limit the
distribution of proprietary information. We currently have only a limited
ability to protect our important intellectual property rights.
Seasonality
Typically, client service hours, which translate into chargeable hours and
directly affect revenue, are reduced during the first half of our fiscal year
(i.e., July 1 through December 31) due to the larger number of holidays and
vacation time taken by our employees and their clients. As a result, the first
and second quarters of the fiscal year historically are the lowest
revenue-generating and income-producing quarters.
Customer Dependence
In fiscal years 2002, 2001 and 2000, our revenues from the United States
federal government were $606.1 million, $482.1 million and $302.3 million,
respectively, representing 25.6%, 16.9% and 12.8% of our total revenues. A loss
of all of our contracts with the United States federal government would have a
material adverse effect on our business. While most of our government agency
clients have the ability to unilaterally terminate their contracts, our
relationships are generally not with political appointees, and we have not
typically experienced a loss of federal government business with a change of
administration.
Backlog
Although our level of bookings is an indication of how our business is
performing, we do not characterize our bookings, or our engagement contracts
associated with new bookings, as backlog because our engagements can generally
be cancelled or terminated on short notice.
Compliance with Environmental Laws
Federal, state and local statutes and regulations relating to the protection
of the environment have had no material adverse effect on our operating results
or competitive position, and we anticipate that they will have no material
adverse effect on our future operating results or competitive position in the
industry.
Employees
As of June 30, 2002, we had approximately 9,300 full-time employees,
including approximately 7,900 professional consultants. As a result of the KCA
acquisition and the transactions involving the Andersen BC Practices, as of
September 18, 2002 we had approximately 16,000 full-time employees, including
approximately 14,300 professional consultants.
6
Item 2. Properties
Our corporate headquarters is located in McLean, Virginia. This facility has
approximately 229,000 square feet of office space. As of June 30, 2002, we used
approximately 1.6 million square feet of office space in approximately 93
locations throughout the United States. Some of the spaces we occupy are used
for specific client contracts or development activities while administrative
personnel and professional service personnel use other spaces. In addition, as
of June 30, 2002, we had approximately 40 locations in Latin America, Canada,
Ireland, Israel and the Asia Pacific region with approximately 250,000
additional square feet of office space.
As a result of the transactions involving the U.S. Andersen BC Practice, as
of September 18, 2002, we had approximately 1.7 million square feet of office
space in approximately 95 locations throughout the United States. Some of the
spaces we occupy are used for specific client contracts or development
activities while administrative personnel and professional service personnel
use other spaces. In addition, as a result of the KCA acquisition and the
transactions involving the Andersen BC practices, as of September 18, 2002, we
had approximately 85 locations in Latin America, Canada, Europe, the Middle
East, the Asia Pacific Region, and Australia with approximately 2 million
square feet of office space in such locations.
All office space referred to above is leased. We believe that our facilities
are adequate to meet our needs for approximately the next 12 months.
Item 3. 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 adverse effect on our financial condition or results of
operations. Additional information regarding legal proceedings of the Company
is incorporated by reference herein from Note 12, "Commitments and
Contingencies" of the "Notes to Financial Statements" included under Item 8 of
this Report.
7
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders in the fourth
quarter of fiscal 2002.
Executive Officers of the Company.
Our executive officers as of June 30, 2002 are:
Date of
election or
appointment Business or professional
Present office and position to present experience during the past
Executive Officer Age with the Company office five years
----------------- --- ------------------------------ ----------- ---------------------------------
Randolph C. Blazer. 52 Chairman of the Board, Chief 2/08/00 Chief Executive Officer and
Executive Officer and 4/27/00 President of the Company;
President 4/27/00 Co-President and Co-Chief
Executive Officer of the
Company; member of two-
person executive team that
directed the Consulting Practice
for KPMG LLP
David W. Black..... 40 Executive Vice President, 4/27/00 Executive Vice President, General
General Counsel and Counsel and Secretary for
Secretary Affiliated Computer Services,
Inc.
Michael J. Donahue. 43 Group Executive Vice 4/27/00 Managing Partner, Solutions, of
President and Chief KPMG LLP
Operating Officer
Robert C. Lamb, Jr. 47 Executive Vice President 6/26/00 Corporate Controller of Fleet
and Chief Financial Officer Boston Financial
Nathan H. Peck, Jr. 48 Executive Vice President and 4/27/00 Acting Chief Financial Officer of
Chief Administrative Officer the Company; Chief
Administrative Officer,
Consulting Practice of KPMG
LLP; Co-Practice Leader,
Financial Services Consulting
Practice of KPMG LLP
Bradley J. Schwartz 45 Group Executive Vice 4/27/00 Group Executive Vice President,
President, Worldwide 4/01/01 Worldwide Client Services,
Client Service Communications and Content
of the Company; Managing
Partner, Information,
Communication &
Entertainment Consulting of
KPMG LLP
The term of office of each officer is until election and qualification of a
successor or otherwise at the pleasure of the Board of Directors.
There is no arrangement or understanding between any of the above-listed
officers and any other person pursuant to which any such officer was elected as
an officer.
None of the above-listed officers has any family relationship with any
director or other executive officer.
8
PART II.
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters
Market Information
Our Common Stock is listed on the Nasdaq National Market under the symbol
KCIN. On September 17, 2002, the Company announced that it had filed an
application for its Common Stock to be listed on the New York Stock Exchange.
The Company expects that its Common Stock will be listed for trading on the New
York Stock Exchange during the first week of October 2002 and that its Common
Stock will cease trading on the Nasdaq National Market at the same time. For
information regarding high and low quarterly sales prices of our common stock,
see the "Quarterly Summarized Financial Information" table included under Item
7 of this Report, which is incorporated by reference herein.
Holders
At June 30, 2002, we had 935 stockholders of record.
Dividends
We have not paid cash dividends on our Common Stock, and we do not
anticipate paying any cash dividends on our Common Stock for at least the next
12 months. We intend to retain all of our earnings, if any, to finance the
expansion of our business and for general corporate purposes. Our existing
credit facilities contain financial covenants and restrictions, some of which
directly or indirectly may limit our ability to pay dividends. Our future
dividend policy will also depend on our earnings, capital requirements,
financial condition and other factors considered relevant by our Board of
Directors.
9
Item 6. Selected Financial Data
The selected financial data were derived from the consolidated/combined
financial statements of the Company which are included elsewhere in this Annual
Report on Form 10-K. Certain prior period amounts have been reclassified to
conform with current period presentation. The data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the financial statements and the related notes
thereto included herein.
Consolidated (Corporate Basis) Combined (Partnership Basis)(1)
---------------------------------------------- -----------------------------------
Year Ended Pro Forma Five Months Seven Months Year Ended
---------------------- Year Ended Ended Ended ----------------------
June 30, June 30, June 30, June 30, January 31, June 30, June 30,
2002 2001 2000(2) 2000 2000 1999 1998
---------- ---------- ---------- ----------- ------------ ---------- ----------
(in thousands, except per share amounts) (in thousands)
Revenues.............................. $2,367,627 $2,855,824 $2,369,984 $1,105,166 $1,264,818 $1,981,536 $1,428,891
Costs of service:
Impairment charge.................... 23,914 7,827 8,000 8,000 -- -- --
Other costs of service............... 1,742,861 2,133,250 1,805,611 817,800 897,173 1,381,518 1,062,326
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total costs of service............. 1,766,775 2,141,077 1,813,611 825,800 897,173 1,381,518 1,062,326
Gross margin.......................... 600,852 714,747 556,373 279,366 367,645 600,018 366,565
Selling, general and administrative
expenses............................. 467,162 493,818 400,788 206,930 235,668 345,745 251,483
Special payment to managing
directors(3)......................... -- -- -- 34,520 -- -- --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Operating income...................... 133,690 220,929 155,585 37,916 131,977 254,273 115,082
Interest income....................... 3,144 2,386 6,178 6,178 -- -- --
Interest expense...................... (2,248) (17,175) (43,645) (16,306) (27,339) (25,157) (16,810)
Equity in losses of affiliate and
loss on redemption of equity
interest in affiliate................ -- (76,019) (30,186) (15,812) (14,374) (622) --
Other, net............................ -- 6,727 (411) (439) 28 (111) 619
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income before partner distributions
and benefits(1)...................... $ 90,292 $ 228,383 $ 98,891
========== ========== ==========
Income before taxes................... 134,586 136,848 87,521 11,537
Income tax expense.................... 81,524 101,897 61,265 29,339
---------- ---------- ---------- ----------
Net income (loss) before cumulative
effect of change in accounting
principle............................ 53,062 34,951 26,256 (17,802)
Cumulative effect of change in
accounting principle................. (79,960) -- -- --
---------- ---------- ---------- ----------
Net income (loss)..................... (26,898) 34,951 26,256 (17,802)
Dividend on Series A Preferred Stock.. -- (31,672) (25,992) (25,992)
Preferred stock conversion discount... -- (131,250) -- --
---------- ---------- ---------- ----------
Net income (loss) applicable to
common stockholders.................. $ (26,898) $ (127,971) $ 264 $ (43,794)
========== ========== ========== ==========
Earnings (loss) per share:
Income before cumulative effect of
change in accounting principle per
share................................ $ 0.34 $ (1.19) $ -- $ (0.58)
Cumulative effect of change in
accounting principle per share....... (0.51) -- -- --
---------- ---------- ---------- ----------
Net income (loss) applicable to
common stockholders per share........ $ (0.17) $ (1.19) $ -- $ (0.58)
========== ========== ========== ==========
10
As of June 30,
--------------------------------------------------
Consolidated Combined
------------------------------ -------------------
2002 2001 2000 1999 1998
--------- --------- ---------- --------- ---------
(in thousands) (in thousands)
Balance Sheet Data
Total assets............................ $ 895,131 $ 999,635 $ 951,638 $ 492,191 $ 294,369
Long-term obligations................... 9,966 13,414 76,602 22,860 10,508
Series A mandatorily redeemable
convertible preferred stock........... -- -- 1,050,000 -- --
--------
(1) As a partnership, all of KPMG LLP's earnings were allocable to its
partners. Accordingly, distributions and benefits to partners have not been
reflected as an expense in our historical partnership basis 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. Likewise, as a corporation, we are
subject to corporate income taxes effective February 1, 2000.
(2) This pro forma data assumes our Separation from KPMG LLP occurred as of
July 1, 1999 and reflects adjustments including:
. compensation and benefit costs for the seven month period ended January
31, 2000 for former consulting partners of KPMG LLP who became employees
of our company on January 31, 2000;
. changes to employee pension and bonus plans for the seven month period
ended January 31, 2000;
. income taxes for the pro forma period at a pro forma effective tax rate
of 70%.
. changes in the amount we pay KPMG LLP for shared infrastructure services.
(3) For the period from January 31, 2000 through June 30, 2000, the profits of
KPMG LLP and our Company were allocated among the partners of KPMG LLP and
our managing directors as if the entities had been combined through June
30, 2000. Under this arrangement, our managing directors received a special
payment of $34.5 million by our Company for the five month period ended
June 30, 2000.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis should be read in conjunction with the
consolidated and combined financial statements and the notes to financial
statements included elsewhere in this Form 10-K. This Annual Report on Form
10-K contains forward-looking statements that involve risks and uncertainties.
See the "Disclosure Regarding Forward-Looking Statements." All references to
"years," unless otherwise noted, refer to our fiscal year, which ends on June
30. For example, a reference to "2002" or "fiscal 2002" means the 12-month
period that ended on June 30, 2002.
Historical Overview
On January 31, 2000, the Company completed its separation from KPMG LLP (the
"Separation"). 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 the historical financial statements through January
31, 2000. Additionally, as a partnership, KPMG LLP was not subject to income
taxes and, as a result, the historical financial statements through January 31,
2000 do not include a provision for income taxes. Effective February 1, 2000,
following the Separation from KPMG LLP and the Company's commencement of
operations in corporate form, the 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
years ended June 30, 2002 and 2001, which reflect a corporate basis of
presentation, and the summation of the five months ended June 30, 2000, which
reflect a corporate basis of presentation, and the seven months ended January
31, 2000, which reflect a partnership basis of presentation, are not directly
comparable. Accordingly, to enhance comparability, for purposes of this
11
discussion and analysis, the operating results for fiscal 2000 have been
presented on a pro forma basis assuming the Separation from KPMG LLP occurred
as of July 1, 1999 (at which time the Company would have commenced operations
in corporate form).
Company Overview
KPMG Consulting, Inc. is one of the world's largest business consulting and
systems integration firms with approximately 9,300 employees at June 30, 2002
(and approximately 16,000 employees as of September 18, 2002) serving over
2,100 clients worldwide, including Global 2000 and Fortune 1000 companies,
small and medium-sized businesses, government agencies and other organizations.
The Company provides business and technology strategy, systems design and
architecture, applications implementation, network and systems integration, and
related services that enable our clients to leverage technology for stronger
return on investment and enhanced services to their customers, vendors and
employees.
Commencing with our first acquisition of an international practice (Mexico)
in December 1999, the Company has been executing a strategy to develop a global
business platform primarily through acquisition. Through September 18, 2002, we
have completed 31 acquisitions, group hires or other transactions, and we have
substantial operations in the North America, Europe, Asia Pacific and Latin
America regions. These regional practices are organized along industry groups
in which we have specialized knowledge and expertise, including public
services, financial services, communications and content, consumer and
industrial markets, and high technology. For the year ended June 30, 2002,
international operations represented 8% of our business (measured in revenue
dollars), and we estimate that international operations after completion of the
KCA acquisition and other transactions referred to above will account for more
than 20% of our business.
The following chart provides a summary of our recent transactions:
Relevant Entity Transaction Date
--------------- ------------------
Studio Verso and WebVibe Corporation...................................................... July, 1999
KPMG Consulting Mexico, S. de R.L. de C.V. (the consulting business of the Mexican member
of KPMG International).................................................................. December 29, 1999
Consulting business of the Canadian member of KPMG International.......................... March 1, 2000
Consulting business of the Japanese member of KPMG International.......................... April 1, 2000
San Tong Consulting Corporation (the consulting business of the South Korean member firm
of KPMG International).................................................................. May 31, 2000
Consulting business of the Central American members of KPMG International................. June 20, 2000
Consulting business of the New Zealand member of KPMG International and Web Limited....... June 26, 2000
Consulting business of the Venezuelan member of KPMG International........................ June 27, 2000
Consulting business of the Argentine member of KPMG International......................... June 30, 2000
Consulting business of the Colombian member of KPMG International......................... July 28, 2000
Consulting business of the Irish member of KPMG International............................. September 15, 2000
Consulting business of the Peruvian member of KPMG International.......................... September 22, 2000
Consulting business of the Brazilian member of KPMG International......................... October 3, 2000
Consulting business of the Netherlands Antilles member of KPMG International.............. February 7, 2001
12
Relevant Entity Transaction Date
--------------- ------------------
Regional consulting business in Southeast Asia (including Hong Kong, Malaysia, Singapore
and Taiwan) of the respective members of KPMG International............................. August 2, 2001
Consulting business of the Australian member of KPMG International........................ October 3, 2001
Andersen Business Consulting, Hong Kong................................................... May 1, 2002
Andersen Business Consulting, China....................................................... May 1, 2002
Andersen Business Consulting, Australia................................................... June 4, 2002
Group hire of certain employees formerly associated with Andersen Business Consulting,
United States........................................................................... July 1, 2002
Andersen Business Consulting, Switzerland................................................. July 1, 2002
Andersen Business Consulting, Nordics (including Finland, Norway and Sweden).............. July 1, 2002
Andersen Business Consulting, Singapore................................................... July 1, 2002
Andersen Business Consulting, South Korea................................................. July 2, 2002
Andersen Business Consulting, Peru........................................................ August 1, 2002
Andersen Business Consulting, Spain....................................................... August 1, 2002
Andersen Business Consulting, Japan....................................................... August 1, 2002
KPMG Consulting AG (the Consulting business of the German member firm of KPMG
International).......................................................................... August 22, 2002
Group hire of certain employees formerly associated with Andersen Business Consulting,
Brazil.................................................................................. August 23, 2002
Andersen Business Consulting, France...................................................... September 11, 2002
Business consulting practice of Ernst & Young, Brazil..................................... September 18, 2002
Financial Statement Presentation
The consolidated/combined financial statements reflect the operations of the
Company and all of its majority-owned subsidiaries. Upon consolidation, all
significant intercompany accounts and transactions are eliminated. Certain
prior period amounts have been reclassified to conform with current period
presentation, including the following significant reclassifications to the
statements of operations:
. reclassification of costs from "Other costs of service" to "Professional
compensation" for compensation and fringe benefit expenses related to
certain billable consulting staff,
. reclassification of costs from "Other costs of service" to "Selling,
general and administrative expenses" related to an overhead cost
allocation,
. reclassification of amortization of goodwill and purchased intangibles
from "Costs of service" to "Selling, general and administrative expenses,"
. transfer of our health care business to our high technology and public
services groups, and
. formation of our North American region by reclassification of our
Canadian operations from International by combining it with U.S.
operations.
Through January 31, 2000, we were a division of KPMG LLP. Our combined
financial statements for the seven months ended January 31, 2000, which
includes all majority-owned subsidiaries of KPMG LLP that were deemed part of
our consulting business, have been prepared using KPMG LLP's historical basis
of accounting in conformity with generally accepted accounting principles
("GAAP") in the United States of America and includes the assets, liabilities,
revenues and expenses related to our business. Included in our expenses are
allocations of certain costs incurred by KPMG LLP on behalf of our business.
These allocations are discussed in greater detail in the notes to financial
statements located elsewhere in this Form 10-K.
13
Since we historically operated as part of the partnership of KPMG LLP, our
consulting partners shared in the annual profits of KPMG LLP rather than
receiving salaries. Therefore, our historical combined financial statements for
the seven months ended January 31, 2000 do not reflect any compensation or
benefit costs for services rendered by the consulting partners of KPMG LLP. In
connection with the Separation, the consulting partners of KPMG LLP resigned
from KPMG LLP and became our managing directors. Effective February 1, 2000,
our managing directors began to receive salaries and other benefits as their
compensation, and our Company began operating in corporate form and became
subject to income taxes.
Segments
During fiscal 2002, we provided consulting services through five major
industry groups including public services, financial services, communications
and content, high technology, and consumer and industrial markets. Commencing
July 1, 2001, our health care group was combined with our public services and
high technology groups and the business units in our Canadian practice were
transferred from International to the five industry groups, resulting in a
North America region. In addition, we have multinational regional operations in
Asia Pacific, Latin America, Israel and following the acquisition of KCA and
the other transactions described above, in Europe. The Company's chief
operating decision maker, the Chairman and Chief Executive Officer, evaluates
performance and allocates resources based upon the industry groups. Performance
of the segments is evaluated on operating income excluding the costs of
infrastructure functions (such as information systems, finance and accounting,
human resources, legal and marketing). Prior year information has been
reclassified to reflect current year changes. The discussion and analysis
related to critical accounting policies and to each operational expense
category applies to all segments, unless otherwise indicated.
Recent Trends in our Business
The level of economic activity in the industries and regions we serve is a
primary factor affecting our revenues. In addition, changes in business
requirements and practices of our clients have a significant impact on the
demand for technology consulting and systems integration services we provide.
The current economic downturn has negatively affected the operations of some of
our clients and their IT spending. During this time, competition for new
engagements and pricing pressure have remained strong. As a result, we have
seen a decline in our revenues in fiscal 2002. We do not expect that business
volumes will significantly improve before the end of calendar 2002. We have
responded to these business conditions by carefully balancing our resources
with engagement staffing requirements, eliminating excess capacity through
workforce reductions and aggressively reducing discretionary costs to lower the
cost of operations and maintain profit margins.
Critical Accounting Policies and Estimates
Accounting policies and estimates 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); valuation of accounts receivable; valuation of goodwill;
and intra-period estimates of discretionary compensation costs and effective
income tax rates. See Note 2, "Significant Accounting Policies", of the Notes
to the Financial Statements for descriptions of critical accounting policies.
Revenue Recognition and Valuation of Unbilled Revenues. Generally we
recognize revenues as we perform services for our clients on a
time-and-materials or percentage-of-completion basis, depending upon the
contract with the client. Periodically we review ongoing engagements to
reassess our estimates to complete and estimates of realizability. If we
determine that the estimated revenue has changed on a given engagement, we
record the cumulative effect of the change in the period in which it becomes
known. Circumstances that could cause our estimated revenue to change include
changes in estimates of time required to complete an engagement, changes in
engagement staffing mix, changes in client participation in the engagement, and
other factors. In addition, we have an insignificant number of engagements for
which revenue is not recognized as we perform services, but as transaction fees
are earned or contingencies, such as cost savings, are resolved.
14
Valuation of Accounts Receivable. Periodically we review accounts
receivable to reassess our estimates of collectibility. We provide valuation
reserves for bad debts based on specific identification of likely and probable
losses. In addition, we provide valuation reserves for estimates of aged
receivables that may be written off, based upon historical experience. These
valuation reserves are periodically re-evaluated and adjusted as more
information about the ultimate collectibility of accounts receivable becomes
available. Circumstances that could cause our valuation reserves to increase
include changes in our clients' liquidity and credit quality, other factors
negatively impacting our clients' ability to pay their obligations as they come
due, and the quality of our collection efforts.
Valuation of Goodwill. Effective July 1, 2001, the Company early-adopted
the new accounting principle related to goodwill, Statement of Financial
Accounting Standard ("SFAS") No. 142, "Goodwill and Other Intangible Assets."
As a consequence, we recognized a transitional impairment loss of $80.0
million, net of tax, ($0.51 per share) as the cumulative effect of a change in
accounting principle. This transitional impairment loss resulted from the
change in method of measuring impairments from undiscounted cash flows to
discounted cash flows. We review goodwill for impairment at least once annually
and whenever events or significant changes in circumstances indicate that the
carrying value may not be recoverable. An impairment would be indicated if the
carrying value exceeds the fair value of a reporting unit. Factors which we
consider in determining if an impairment may have incurred are significant
underperformance of the business relative to historical or forecasted results,
and other significant factors negatively affecting our client base, our staff,
significant engagements, or the industries and markets we serve.
Estimates of Discretionary Compensation Costs and Effective Income Tax
Rates. Discretionary compensation costs and income tax expense are two of the
more significant expense categories that are highly dependent upon management
estimates and judgments, particularly at each interim reporting date. In
arriving at the amount of expense to recognize, management believes it makes
reasonable estimates and judgments using all significant information available.
Discretionary compensation costs are determined once a year after the Company's
annual operating results are finalized; thus, estimates are subject to change.
Circumstances that could cause our estimates of effective income tax rates to
change include the impact of information that subsequently became available as
we prepared our corporate income tax returns; the level of actual pre-tax
income; revisions to tax positions taken as a result of further analysis and
consultation, and changes mandated as a result of audits by taxing authorities.
Components of Our Statements of Operations
Revenues. We derive substantially all of our revenues from professional
service activities. Revenues include all amounts that are billed or billable to
clients. Unbilled revenues represents revenues for services performed that have
not been billed. Maintenance contract revenues are recognized ratably over the
terms of the agreement. When our consulting engagements have multiple elements,
each element is separately evaluated and revenue is recognized when it is
realized or realizable and earned.
Generally we enter into contracts with our clients prior to the time work on
a project begins. These contracts contain varying terms and conditions. These
contracts generally provide that they can be terminated without significant
advance notice or penalty. Generally, in the event that a client terminates a
project, the client remains obligated to pay us for services performed and
expenses incurred by us through the date of termination.
Professional Compensation. Competition for consulting professionals,
particularly information technology professionals with the advanced technology
skills necessary to perform the services we offer, has caused wages to increase
at a rate greater than the general rate of inflation, a trend we expect to
diminish as a result of the current downturn in economic conditions. As with
other professional service firms, we must adequately anticipate wage increases.
Our success is largely dependent on our ability to keep our consultants highly
utilized on revenue-generating activities, and to hire and retain talented
people.
15
Other Direct Contract Expenses. Other direct contract expenses include
costs directly attributable to client engagements. These costs include items
such as computer hardware and software, travel expenses for professional
personnel, and costs associated with subcontractors.
Other Costs of Service. Other costs of service primarily consist of the
costs attributable to the support and maintenance of the professional staff,
bad debt expense relating to accounts receivables, as well as other indirect
costs attributable to serving our client base. These costs include occupancy
costs related to office space utilized by professional staff, the costs of
training and recruiting professional staff, and costs associated with
professional support personnel.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses include expenses such as sales and marketing, costs for
information systems, finance and accounting, human resources, sales
commissions, amortization of goodwill and other identifiable intangibles, and
other expenses related to managing and growing our business. Prior to the
Separation, most of these activities were provided to us by KPMG LLP. Our
historical financial statements reflect costs determined on a basis consistent
with the original outsourcing agreement entered into at the time of the
Separation. The Company and KPMG LLP entered into a transition services
agreement effective February 8, 2001, whereby we no longer receive and do not
incur the cost of services related to the coordination and management of a
multidisciplinary professional services organization, as such services are not
required for us to operate our business as an independent company. For fiscal
2000, these costs included allocations for international and U.S. partnership
level management structure in the amount of $36.4 million, international and
firmwide partnership meetings in the amount of $3.2 million and support of the
KPMG Foundation, in the amount of $2.2 million.
Special Payment to Managing Directors. The terms of our Separation from
KPMG LLP provided that, for the period from January 31, 2000 through June 30,
2000, during which period none of our outstanding common stock was held by
outside investors, the profits of KPMG LLP and our Company were allocated among
the partners of KPMG LLP and our managing directors on a basis as if the
entities had been combined through June 30, 2000. Subsequent to June 30, 2000,
there has been no further sharing of profits by KPMG LLP and our Company. Under
this arrangement, the special payment made to our managing directors, who were
formerly partners in KPMG LLP, were paid by our Company. The amount attributed
to the five-month period ended June 30, 2000 was $34.5 million and is reflected
as an expense in our consolidated statement of operations.
Interest Expense and Interest Income. Through June 30, 2000, interest
expense was allocated to us by KPMG LLP based on outstanding accounts
receivable and unbilled revenues. Effective July 1, 2000, we are no longer
allocated interest by KPMG LLP. Interest expense is also incurred in connection
with debt financing agreements entered into by our Company. Interest income is
earned on short-term investment of available cash balances.
Equity in Losses of Affiliate and Loss on Redemption of Equity Interest in
Affiliate. Equity in losses of affiliate and loss on redemption of equity
interest in affiliate related to Qwest Cyber.Solutions LLC ("QCS"), which was
established in June 1999 as a joint venture with Qwest Communications
International Inc. to provide comprehensive Internet-based application service
provider, application hosting and application management services. QCS incurred
cumulative losses in excess of $65 million from its inception to December 27,
2000 and periodically required additional capital to fund its operations and
acquire equipment to support the expansion of its business. We decided not to
make any additional capital contributions to QCS and on December 27, 2000, QCS
redeemed our 49% ownership interest in the joint venture in exchange for a
nominal amount. Accordingly, our 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.
16
Income Tax Expense. As part of a limited liability partnership, through
January 31, 2000, we were not subject to corporate income taxes. Thereafter, we
are operating in corporate form and are subject to income taxes. Due to our
high level of non-deductible travel-related and amortization expenses, and
unusable foreign tax losses and credits, our effective tax rate exceeds
statutory rates. In addition, the Company's effective tax rate is significantly
impacted by its level of pre-tax earnings. Accordingly, if our pre-tax earnings
grow and non-deductible expenses grow at a slower rate or decrease, our
effective tax rate will decrease in the future.
Conversion Discount on Series A Preferred Stock. On January 31, 2000, Cisco
Systems, Inc. ("Cisco") purchased 5 million shares of our Series A Preferred
Stock for $1.05 billion. On September 15, 2000, Cisco and KPMG LLP agreed that
immediately prior to the closing of our initial public offering, KPMG LLP would
purchase 2.5 million shares of Series A Preferred Stock from Cisco for $525
million. Our agreement with Cisco required us to repurchase that number of
shares of our Series A Preferred Stock that would result in Cisco owning 9.9%
of our common stock following the conversion and the initial public offering.
At the initial public offering price of $18.00 there was a 20%, or $262.5
million conversion discount, such that the Series A Preferred Stock would
convert into our common stock at $14.40 per share for an equivalent of 72.9
million shares. On November 29, 2000, KPMG LLP agreed to convert all of the
Series A Preferred Stock it agreed to acquire from Cisco 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 $131.3 million. The intrinsic value (i.e.,
the "beneficial conversion feature") ascribable to the Series A Preferred Stock
as a result of the discounted conversion price was reflected as a preferred
dividend and a reduction of net income available to common stockholders as of
the date of the initial public offering.
Results of Operations Overview
The year ended June 30, 2002 was a challenging year as many clients reduced
spending on technology consulting and systems integration services. As a
result, we have seen a decline in our revenues in fiscal 2002. We have
responded to these business conditions by carefully balancing our resources
with engagement staffing requirements, eliminating excess capacity through
workforce reductions and aggressively reducing discretionary costs to lower the
cost of operations and maintain profit margins. After deducting an $80.0
million after-tax ($0.51 per share) charge representing the cumulative effect
of a change in accounting principle, the Company realized a net loss applicable
to common stockholders of $26.9 million, or $0.17 per share for the year ended
June 30, 2002 compared to a net loss applicable to common stockholders of
$128.0 million, or $1.19 per share for the year ended June 30, 2001. Included
in results for fiscal 2001 were a $76.0 million ($71.2 million net of tax)
charge consisting of equity losses of affiliate and loss on redemption of
equity interest in affiliate related to the Company's investment in QCS; a
$131.3 million preferred stock conversion discount, and $31.7 million of
preferred stock dividends. Income before cumulative effect of change in
accounting principle for fiscal 2002 and 2001 were $53.1 million and $35.0
million, respectively.
Year Ended June 30, 2002 Compared to Year Ended June 30, 2001
Revenues. Revenues decreased $488.2 million, or 17.1%, from $2,855.8
million in the year ended June 30, 2001, to $2,367.6 million in the year ended
June 30, 2002. This overall decrease is primarily attributable to a slower
economy, which significantly impacted the financial services and high
technology businesses with year-over-year declines of 50.4% and 57.6%,
respectively. Public Services remained strong with growth of 10.9% and
International revenue also grew by 34.9%, 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 through calendar 2002, with the most significant impact being in
the high technology and communications and content groups. However, this is
expected to be more than offset by the addition of revenues from recent
acquisitions.
17
Gross Margin. Gross margin as a percentage of revenues improved slightly to
25.4% from 25.0% for the years ended June 30, 2002 and 2001, respectively.
Despite the decrease in revenue discussed above, the Company was able to
maintain its gross margin percentage as a result of its continued focus on
expense control.
In dollar terms, gross margin decreased by $113.9 million, or 15.9%, from
$714.7 million for the year ended June 30, 2001, to $600.9 million for the year
ended June 30, 2002. The decrease in gross margin was due to a decline in
revenue of $488.2 million described above, offset by:
. A net decrease in professional compensation of $143.9 million, or 13.3%,
to $940.8 million compared to $1,084.8 million in the prior year. This
decrease was predominantly due to the Company's reduction in workforce
actions, taken in the second and fourth quarters of fiscal 2002 and the
fourth quarter of fiscal 2001. Overall the Company's average billable
headcount has declined from approximately 8,900 in fiscal 2001 to 8,100
in fiscal 2002. Additionally, incentive compensation accruals were also
lower as a result of the decrease in Company earnings.
. A net decrease in other direct contract expenses of $159.3 million, or
21.2%, to $592.6 million, representing 25.0% of revenue, compared to
$752.0 million, or 26.3% of revenue in the prior year. The decline as a
percentage of revenues is a direct result of the Company's efforts to
limit the use of subcontractors whenever possible, utilizing existing
resources, and reduced travel-related expenses.
. During fiscal 2002, the Company recorded an impairment charge of
$23.9 million ($20.8 million after-tax) primarily to write down equity
investments by $16.0 million and software licenses held for sale by
$7.6 million. These charges eliminated the Company's exposure to loss
related to equity investments and software licenses held for sale. The
Company's impairment charge of $7.8 million ($4.6 million after-tax) in
fiscal 2001 related to software licenses held for sale.
. A net decrease in other costs of service of $87.2 million, or 29.4%, to
$209.4 million from $296.5 million, was primarily due to a decrease in
bad debts expense of $29.2 million, reduced training costs of
$23.0 million, tighter controls on discretionary expenses, and reduced
headcount.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $467.2 million for the year ended June 30, 2002.
This reflects a decrease of $26.7 million, or 5.4%, from $493.8 million, which
is primarily due to lower levels of practice development expenses and a
decrease in amortization of intangibles expense of $15.2 million as a result of
the Company electing to early-adopt SFAS No. 142, "Goodwill and Other
Intangible Assets", which eliminated goodwill amortization.
Interest Income. Interest income increased $0.8 million, or 31.8%, from
$2.4 million during fiscal 2001 to $3.1 million for fiscal 2002. This increase
is primarily due to the Company's increase in short term investments due to an
increase of $157.7 million in its cash and cash equivalents position to
$203.6 million at June 30, 2002 from $45.9 million at June 30, 2001.
Interest Expense. Interest expense decreased $14.9 million, or 86.9%, from
$17.2 million to $2.2 million for the year ended June 30, 2001 and 2002,
respectively. This decrease was due to a repayment of all outstanding
borrowings under our credit facility during fiscal 2001, resulting from the use
of proceeds from our initial public offering, and improvements made in our
management of client billings and collections. This improvement is evidenced by
the further reduction in our days sales outstanding from 68 days at June 30,
2001 to 55 days at June 30, 2002.
Loss on Redemption of Equity Interest in Affiliate, Equity in Losses of
Affiliate. For the year ended June 30, 2001, loss on redemption of equity
interest in affiliate and equity losses of affiliate of $76.0 million related
primarily to the redemption of our equity investment in QCS in December 2000.
18
Income Tax Expense. For the year ended June 30, 2002, the Company earned
income before taxes and cumulative effect of change in accounting principle of
$134.6 million and provided income taxes of $81.5 million, resulting in an
effective tax rate of 60.6%. This rate was impacted by the non-deductibility of
losses incurred by certain international operations as well as non-deductible
impairment losses relating to equity investments. For the year ended June 30,
2001, the Company earned income before taxes of $136.8 million and provided
income taxes of $101.9 million, resulting in an effective tax rate of 74.5%.
This rate was significantly impacted by the non-deductibility of the loss on
redemption of equity interest in affiliate coupled with non-deductible losses
in certain international operations.
Cumulative Effect of Change in Accounting Principle. The Company elected to
early-adopt SFAS No. 142 as of July 1, 2001. This standard eliminates goodwill
amortization upon adoption and requires an assessment for goodwill impairment
upon adoption and at least annually thereafter. As a result of adoption of this
standard, the Company did not amortize goodwill during the year ended June 30,
2002, and incurred a non-cash transitional impairment charge of $80.0 million,
net of tax. 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 year ended June 30, 2001. After December 31,
2000, the Company was no longer required to pay dividends on our Series A
Preferred Stock because it was redeemed and converted in connection with our
initial public offering.
Preferred Stock Conversion Discount. Our Series A Preferred Stock contained
a beneficial conversion feature whereby the preferred stock could convert into
common stock at a rate of between 75% and 80% of the initial public offering
price. Based upon an initial public offering price of $18 per share, the net
amount of this one-time non-cash beneficial conversion feature was $131.3
million.
Net Income (Loss) Applicable to Common Stockholders. For the year ended
June 30, 2002, the Company incurred a net loss applicable to common
stockholders of $26.9 million, or $0.17 per share. For the year ended June 30,
2001, the Company incurred a net loss applicable to common stockholders of
$128.0 million, or $1.19 per share. Both periods results were impacted by
significant one-time or nonrecurring charges, as described above.
19
Historical Year Ended June 30, 2001 Compared to Pro Forma Year Ended June 30,
2000
Prior to our Separation and incorporation, our income before partner
distributions and benefits was the best measure for assessing our historical
financial performance. Through January 31, 2000, we operated as part of a
partnership, and payments to our consulting partners were accounted for as
distributions of partners' capital rather than as compensation expense. As a
result, through January 31, 2000, our historical professional compensation
expense does not reflect the professional compensation costs we incurred for
partners, including payments for services rendered or benefits paid. In
addition, as a partnership, we were not subject to income taxes, as such taxes
were the responsibility of the individual partners.
The following table sets forth certain financial information on a historical
basis for the year ended June 30, 2001 and a pro forma basis for the year ended
June 30, 2000. The adjustments made to fiscal 2000 historical results are
reflected in the pro forma columns and include adjustments to managing
directors' compensation, income taxes, and other items as described in the
accompanying notes to the pro forma consolidated statements of operations, as
if the Separation transaction had occurred on July 1, 1999.
Fiscal 2000
---------------------------------------------------------
Historical
Historical Consolidated Pro Forma
Combined Five Months Consolidated Historical
Seven Months Ended Year Ended Consolidated
Ended June 30, Pro Forma June 30, Year Ended
January 31, 2000 2000 Adjustments(a) 2000 June 30, 2001
---------------- ------------ -------------- ------------ -------------
(in thousands) (in thousands, except share and per share amounts)
Revenues.......................................... $1,264,818 $ 1,105,166 $ -- $ 2,369,984 $ 2,855,824
Professional compensation......................... 472,679 469,827 103,992(1) 1,034,991 1,084,751
3,874(2)
(15,381)(3)
Other direct contract expenses.................... 263,106 259,801 -- 522,907 751,951
Impairment charge................................. -- 8,000 -- 8,000 7,827
Other costs of service............................ 161,388 88,172 (1,847)(3) 247,713 296,548
---------- ----------- -------- ----------- ------------
Gross margin...................................... 367,645 279,366 (90,638) 556,373 714,747
Selling, general and administrative expenses...... 235,668 206,930 (41,810)(4) 400,788 493,818
Special payment to managing directors............. -- 34,520 (34,520)(5) -- --
---------- ----------- -------- ----------- ------------
Operating income.................................. 131,977 37,916 (14,308) 155,585 220,929
Interest expense.................................. (27,339) (16,306) -- (43,645) (17,175)
Interest income................................... -- 6,178 -- 6,178 2,386
Gain on sale of assets............................ -- -- -- -- 6,867
Equity in losses of affiliate and loss on
redemption of equity interest in affiliate....... (14,374) (15,812) -- (30,186) (76,019)
Minority interests................................ 28 (439) -- (411) (140)
---------- ----------- -------- ----------- ------------
Income before partner distributions and benefits.. $ 90,292
==========
Income before taxes............................... 11,537 (14,308) 87,521 136,848
Income tax expense................................ 29,339 31,926(6) 61,265 101,897
----------- -------- ----------- ------------
Net income (loss)................................. (17,802) (46,234) 26,256 34,951
Dividend on Series A Preferred Stock.............. (25,992) -- (25,992) (31,672)
Preferred stock conversion discount............... -- -- -- (131,250)
----------- -------- ----------- ------------
Net Income applicable to common stockholders...... $ (43,794) $(46,234) $ 264 $ (127,971)
=========== ======== =========== ============
Per share net income (loss) applicable to common
stockholders..................................... $ (0.58) $ -- $ (1.19)
=========== =========== ============
Weighted average shares--basic and diluted........ 75,843,000 75,688,801(7) 107,884,143
=========== =========== ============
20
--------
(a) Notes to Pro Forma Financial Information for Fiscal 2000
For purposes of preparing the accompanying fiscal 2000 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 combined/consolidated condensed financial
statements. The pro forma financial information for fiscal 2000 does not
assume the completion of the Company's initial public offering, which closed
on February 13, 2001. These notes should be read in conjunction with the
consolidated/combined financial statements and notes thereto, included in
this Form 10-K.
(1) Adjustment to reflect partner compensation and benefit costs that the
Company would have incurred for our managing directors under the terms of
the new compensation plan, which was 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 pursuant
to the original outsourcing agreement 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 July 1, 2000. These costs
primarily relate to services provided by the executive management teams
previously responsible for the consulting business of KPMG LLP and KPMG
International. Since we operate in corporate form, our existing executive
management team will oversee our domestic and international operations.
The costs related to our executive management are reflected in the
historical financial statements for non-partner costs and are included in
pro forma adjustment (1) for managing directors.
The pro forma effect of the elimination of those costs for the year ended
June 30, 2000 pursuant to the transition services agreement is as follows
(in thousands):
Year Ended
June 30, 2000
-------------
International and U.S. partnership level management structure $36,373
International and firmwide partnership meetings.............. 3,202
Support of the KPMG Foundation............................... 2,235
-------
Total.................................................... $41,810
=======
(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 received 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.
21
(7) Pro forma weighted average shares outstanding for the year ended June 30,
2000--basic and diluted, are calculated based on:
Assumed
Outstanding Shares
Common Stock Issuances From Outstanding
---------------------- ----------- -----------
Separation transaction........................... 07/01/99 75,563,773
Stock awards, net of forfeitures................. 01/31/00 13,502
Stock awards, net of forfeitures................. 02/16/00 297,324
Acquisition of the consulting business of the
New Zealand member of KPMG International........ 06/26/00 6,243
Revenues. Revenues increased $485.8 million, or 20.5%, from $2,370.0
million for the year ended June 30, 2000 to $2,855.8 million for the year ended
June 30, 2001. This overall increase was primarily attributable to an 8.9%
increase in U.S. client service hours billed due to growth in several groups,
including public services 14%, high technology 42% and communications and
content 60%, as well as continued growth from international operations acquired
during fiscal 2001. This growth was partially due to joint marketing
relationships with alliance partners, growth in next generation operations
support systems / business support systems offerings, business-to-business
Internet-related services, and growth from key accounts. In addition,
international revenue grew to $142.3 million due to acquisitions and organic
growth within these operations.
Gross Margin. Gross margin as a percentage of revenues was 25.0% for the
year ended June 30, 2001, which increased from 23.5% (on a pro forma basis) for
the year ended June 30, 2000.
The increase in gross margin was primarily due to (i) costs attributable to
the support and maintenance related to professional staff (such as occupancy,
training, recruiting and professional support personnel costs) increased at a
slower rate than the overall growth in the business and (ii) the recording of
certain one-time non-cash charges relating to compensatory common stock
issuances and settlement of pension obligations to certain managing directors
during fiscal 2000.
In dollar terms, gross margin increased by $158.4 million, or 28.5%, from
$556.4 million (on a pro forma basis) for the year ended June 30, 2000 to
$714.7 million for the year ended June 30, 2001. The increase in dollar terms
was due to the $485.8 million increase in revenues described above, partially
offset by cost increases due to the following:
. A net increase in professional compensation of $49.8 million, or 4.8%,
from $1,035.0 million (on a pro forma basis) to $1,084.8 million,
primarily due to a $36.6 million increase in professional staff
compensation and benefits due to higher wages and benefits for new and
existing staff and an increase of $12.6 million in accruals for incentive
compensation. In April 2001, the Company recorded a $20.0 million charge
for severance and termination benefits related to a reduction in
workforce. The reduction in workforce affected approximately 575
employees and was the result of balancing the Company's workforce with
market demand for certain types of services. These increases were
partially offset by 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.
. An increase in other direct contract expenses of $229.0 million, or
43.8%, from $522.9 million (22.1% of revenue) to $752.0 million (26.3% of
revenue), due to increased use of subcontractors and higher travel and
lodging expenses incurred by professional staff to travel to client
sites. These costs increased due to the overall growth in business and
our increased use of subcontractors to enable us to service our client
engagements while limiting the hiring of new employees during the
economic uncertainty of the second half of fiscal 2001.
22
. An increase in other costs of service of $48.8 million, or 19.7%, from
$247.7 million (on a pro forma basis) to $296.5 million due to overall
growth in the business during fiscal 2001 and a $32.4 million increase in
provisions for doubtful accounts due to losses incurred and increased
reserves during the second half of fiscal 2001 as a result of the
downturn in economic conditions, particularly in the financial services
industry.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $493.8 million for the year ended June 30, 2001.
This reflects an increase of $93.0 million, or 23.2%, from $400.8 million (on a
pro forma basis) for the year ended June 30, 2000. The increase in selling,
general and administrative expenses was primarily due to an increase of
$29.7 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 higher marketing costs. In addition, there was an
increase of $38.6 million due to the acquisition of several international
consulting businesses, including $8.6 million of goodwill and other intangible
asset amortization, and an increase of $20.2 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.
Interest Expense. Interest expense decreased $26.5 million, or 60.6%, from
$43.6 million to $17.2 million for the years ended June 30, 2000 and 2001,
respectively. This decrease was due to decreased outstanding borrowings under
the Company's credit facility for the year ended June 30, 2001 resulting from
the use of proceeds from the Company's initial public offering and improvements
made in the management of client billings and collections, as evidenced by the
reduction in days sales outstanding, from 82 days at June 30, 2000 to 68 days
at June 30, 2001. Interest expense for the year ended June 30, 2000 consisted
primarily of interest incurred by KPMG LLP and allocated to the Company.
Interest Income. Interest income decreased $3.8 million, or 61.4%, from
$6.2 million to $2.4 million for the year ended June 30, 2000 and 2001,
respectively. Interest income decreased as the proceeds from the issuance of
the Company's Series A Preferred Stock on January 31, 2000 were used to fund
working capital requirements.
Gain on Sale of Assets. During fiscal 2001, the Company sold two small
Canadian practices: Career Consulting and KPMG-Versa Systems Inc., a software
development firm. The Company recognized $6.9 million in pre-tax gains on the
sale of these two businesses. These non-strategic business units generated
approximately $10 million of annual revenue and recently operated at a
breakeven level.
Equity in Losses of Affiliate and Loss on Redemption of Equity Interest in
Affiliate. Equity in losses of affiliate and loss on redemption of equity
interest in affiliate, which related to the Company's equity investment in QCS,
increased $45.8 million from $30.2 million to $76.0 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
non-cash charge to earnings in December 2000. (See Note 14, "Investment in
Affiliate," of the Notes to the Financial Statements.)
Income Tax Expense. For the year ended June 30, 2001, the Company earned
income before taxes of $136.8 million and provided for income taxes of $101.9
million, resulting in an effective tax rate of 74.5%. The tax rate was
significantly impacted by nondeductible losses associated with certain
international operations and with the redemption of the Company's investment in
QCS.
Net Income (Loss). Net income increased by $8.7 million, from $26.3 million
(on a pro forma basis) for the year ended June 30, 2000, to $35.0 million for
the year ended June 30, 2001. Improved profitability reflected favorable
impacts from growth in the Company's business during fiscal 2001, coupled with
favorable changes in cost structure, as discussed previously, partially offset
by the one-time loss on redemption of an equity interest in an affiliate (which
business was exited in December 2000).
23
Preferred Stock Dividends. Series A Preferred Stock dividends totaling
$31.7 million were recognized in fiscal 2001 compared to $26.0 million in
fiscal 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
into common stock in connection with the initial public offering.
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 the
initial public offering price of $18 per share, the net amount of the
beneficial conversion feature was $131.3 million.
Net Loss Applicable to Common Stockholders. After deducting the
aforementioned dividends and conversion discount on our Series A Preferred
Stock, net loss applicable to common stockholders for the year ended June 30,
2001, was $128.0 million or $1.19 per share. As indicated above, the entire net
loss arose from the non-cash charge of $131.3 million relating to the
conversion of the Series A Preferred Stock referred to above. For the
comparable period of the prior year, net income applicable to common
stockholders was $264,000, which was considerably less than $.01 per share (on
a pro forma basis). The per share amounts of the losses were further affected
by the increase in the number of common shares outstanding by 82 million (32
million on an average basis) as a result of the Company's initial public
offering on February 8, 2001.
Industry Results
During fiscal 2002, we provided consulting services through five major
industry groups. Commencing July 1, 2001, our health care group was combined
with our public services and high technology groups and Canadian operations
were transferred from International to the five industry groups, creating a
North America region. Prior year information has been reclassified to reflect
current year presentation.
Consolidated Combined
---------------------------------------- ----------------
Five Months Seven Months
Year Ended Year Ended Ended Ended
June 30, 2002 June 30, 2001 June 30, 2000 January 31, 2000
------------- ------------- ------------- ----------------
(in thousands) (in thousands)
Revenues:
Public Services................ $ 966,422 $ 871,597 $ 345,673 $ 420,111
Communications and Content..... 473,269 551,089 187,050 157,838
Financial Services............. 229,993 463,930 236,488 291,976
Consumer and Industrial Markets 311,144 367,433 163,160 200,637
High Technology................ 194,751 459,448 149,686 174,011
International/Corporate(2)..... 192,048 142,327 23,109 20,245
---------- ---------- ---------- ----------
$2,367,627 $2,855,824 $1,105,166 $1,264,818
========== ========== ========== ==========
Revenues %:
Public Services................ 41% 31% 31% 33%
Communications and Content..... 20% 19% 17% 12%
Financial Services............. 10% 16% 21% 23%
Consumer and Industrial Markets 13% 13% 15% 16%
High Technology................ 8% 16% 14% 14%
International/Corporate(2)..... 8% 5% 2% 2%
---------- ---------- ---------- ----------
100% 100% 100% 100%
========== ========== ========== ==========
24
Consolidated Combined
--------------------------------------- ----------------
Five Months Seven Months
Year Ended Year Ended Ended Ended
June 30, 2002 June 30, 2001 June 30, 2000 January 31, 2000
------------- ------------- ------------- ----------------
(in thousands) (in thousands)
Operating Income(1):
Public Services................ $ 311,149 $ 243,536 $ 59,036 $ 128,255
Communications and Content..... 121,091 132,252 28,872 29,794
Financial Services............. 31,520 59,391 44,770 84,202
Consumer and Industrial Markets 79,820 85,460 25,778 51,693
High Technology................ 38,938 126,607 20,908 46,423
--------- --------- --------- ---------
582,518 647,246 179,364 340,367
International/Corporate(2)..... (448,828) (426,317) (141,448) (208,390)
--------- --------- --------- ---------
$ 133,690 $ 220,929 $ 37,916 $ 131,977
========= ========= ========= =========
Operating Income %:
Public Services................ 53% 38% 33% 38%
Communications and Content..... 21% 20% 16% 9%
Financial Services............. 5% 9% 25% 25%
Consumer and Industrial Markets 14% 13% 14% 15%
High Technology................ 7% 20% 12% 13%
------------- ------------- ------------- ----------------
100% 100% 100% 100%
------------- ------------- ------------- ----------------
International/Corporate(2)..... (77)% (66)% (79)% (61)%
============= ============= ============= ================
--------
(1) The years ended June 30, 2002 and 2001 and the five months ended June 30,
2000 include managing directors' compensation and benefit expense. The
seven months ended January 31, 2000 excludes payments for partner
distributions and benefits (as we were operating in partnership form until
January 31, 2000).
(2) International/Corporate revenues are primarily attributable to
international operations. International/Corporate operating loss is
principally due to infrastructure and shared services costs, as well as
operating results of international operations.
25
Quarterly Summarized Financial Information
The following table presents unaudited quarterly financial information for
each of the last eight quarters on a historical basis. In management's opinion,
the quarterly information contains all adjustments, consisting only of normal
recurring adjustments, necessary to fairly present such information. As a
professional services organization, the Company anticipates and responds to
service demands from its clients. Accordingly, the Company has limited control
over the timing and circumstances under which its services are provided.
Typically, client service hours are adversely affected during the first half of
the fiscal year due to the larger number of vacation days and holidays during
this period. Therefore, the Company can experience variability in its operating
results from quarter to quarter. The operating results for any quarter are not
necessarily indicative of the results for any future period.
June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30,
2002 2002 2001 2001 2001 2001 2000 2000
-------- -------- -------- --------- -------- --------- -------- ---------
(in thousands, except per share amounts)
Revenues.............................. $583,213 $582,305 $593,218 $608,891 $722,871 $ 750,913 $702,604 $679,436
Costs of service:
Professional compensation.......... 223,791 224,206 247,746 245,086 252,557 273,426 276,208 282,560
Other direct contract expenses..... 149,644 143,254 155,543 144,193 204,912 200,478 196,589 149,972
Impairment charge.................. 21,414 -- 2,500 -- 7,827 -- -- --
Other costs of service............. 47,928 51,322 54,500 55,648 85,062 65,340 78,005 68,141
-------- -------- -------- -------- -------- --------- -------- --------
Total costs of service.......... 442,777 418,782 460,289 444,927 550,358 539,244 550,802 500,673
-------- -------- -------- -------- -------- --------- -------- --------
Gross margin.......................... 140,436 163,523 132,929 163,964 172,513 211,669 151,802 178,763
Selling, general and administrative
expenses............................. 118,089 114,326 114,815 119,932 135,481 129,445 111,086 117,806
-------- -------- -------- -------- -------- --------- -------- --------
Operating income...................... 22,347 49,197 18,114 44,032 37,032 82,224 40,716 60,957
Interest expense...................... (534) (601) (491) (623) (1,643) (4,571) (5,981) (4,980)
Interest income....................... 979 878 518 770 716 888 421 361
Gain on sale of assets................ -- -- -- -- 6,867 -- -- --
Equity in losses of affiliates........ -- -- -- -- 338 (337) (63,330) (12,690)
Minority interest..................... -- -- -- -- 157 (372) 20 55
-------- -------- -------- -------- -------- --------- -------- --------
Income (loss) before taxes............ 22,792 49,474 18,141 44,179 43,467 77,832 (28,154) 43,703
Income tax expense.................... 22,388 25,726 11,547 21,863 21,014 48,296 9,417 23,170
-------- -------- -------- -------- -------- --------- -------- --------
Income (loss) before cumulative effect
of change in accounting principle.... 404 23,748 6,594 22,316 22,453 29,536 (37,571) 20,533
Cumulative effect of change in
accounting principle................. -- -- -- (79,960) -- -- -- --
-------- -------- -------- -------- -------- --------- -------- --------
Net income (loss)..................... 404 23,748 6,594 (57,644) 22,453 29,536 (37,571) 20,533
Dividend on Series A Preferred
Stock................................ -- -- -- -- -- -- (15,836) (15,836)
Preferred stock conversion............ -- -- -- -- -- (131,250) -- --
-------- -------- -------- -------- -------- --------- -------- --------
Net income (loss) applicable to
common stockholders.................. $ 404 $ 23,748 $ 6,594 $(57,644) $ 22,453 $(101,714) $(53,407) $ 4,697
======== ======== ======== ======== ======== ========= ======== ========
Per share net income (loss) applicable
to common stockholders--basic and
diluted*............................. $ -- $ 0.15 $ 0.04 $ (0.36) $ 0.14 $ (0.83) $ (0.70) $ 0.06
======== ======== ======== ======== ======== ========= ======== ========
Stock Price
High............................... $ 21.17 $ 21.07 $ 18.40 $ 15.40 $ 19.19 $ 23.48
Low................................ $ 13.11 $ 15.84 $ 11.00 $ 9.41 $ 10.91 $ 12.31
--------
* Three months ended September 30, 2001 includes a $0.51 loss for the
cumulative effect of change in accounting principle.
26
Liquidity and Capital Resources
The Company has funded its operations through cash generated from
operations. While the Company expects the current economic downturn may
continue to impact revenue growth for at least another six months, we continue
to actively manage client billings and collections and maintain tight controls
over discretionary expenses. Additionally, the Company has borrowing
arrangements available including a revolving credit facility with no
outstanding balance at June 30, 2002 (not to exceed $250 million), as well as a
receivables purchase agreement with no outstanding balance at June 30, 2002
(not to exceed $150 million). The revolving credit facility expires on May 29,
2005 and includes affirmative, negative and financial covenants, including,
among others, covenants restricting the Company's ability to incur liens and
indebtedness, purchase the Company's securities, and pay dividends and
requiring the Company to maintain a minimum level of net worth ($482.2 million
as of June 30, 2002), maintain fixed charge coverage of at least 1.25 to 1.00
(as defined) and maintain a leverage ratio not to exceed 2.50 to 1.00 (as
defined). We are in compliance with the financial ratios, covenants and other
restrictions imposed by this credit facility. The credit facility contains
customary events of default and a default (i) upon the acquisition by a person
or group of beneficial ownership of 30% or more of the Company's common stock,
or (ii) if within a period of six calendar months, a majority of the officers
of the Company's executive committee cease to serve on its executive committee,
and their terminations or departures materially affect the Company's business.
The receivables purchase agreement contains covenants that are consistent with
the Company's revolving credit facility, cross defaults to the revolving credit
facility and permits "sales" of accounts receivable through May 23, 2003,
subject to annual renewal. The accounts receivable purchase agreement is
accounted for as a financing; accordingly, it is not an off-balance sheet
financing arrangement.
Interest on borrowings under the revolving credit facility is determined, at
the Company's option, based on the prime rate or the LIBOR rate plus a margin
ranging from 0.875% to 1.625%. There are also commitment fees ranging from
0.20% to 0.275% for the revolving credit. The commitment fees vary based on the
Company's leverage ratio at quarter-end. The credit facility agreement
restricts the Company's ability to pay dividends, incur additional indebtedness
and purchase capital equipment. The credit facility agreement also requires the
Company to maintain certain levels of fixed charge coverage and net worth,
while limiting its leverage ratio to certain levels.
The Company's cash and cash equivalents increased $157.7 million to $203.6
million at June 30, 2002 when compared with $45.9 million at June 30, 2001. The
increase in cash and cash equivalents was due to $266.8 million of cash
provided by operating activities offset by $86.0 million of cash used in
investing activities and by $23.1 million of cash used in financing activities.
Cash provided by operating activities during the year ended June 30, 2002
was $266.8 million, principally due to cash operating results of $120.9 million
and collections of accounts receivable and unbilled revenues of $132.1 million
and $53.0 million, respectively, primarily offset by decreases in accrued
payroll and related liabilities of $47.6 million.
Cash used in investing activities during the year ended June 30, 2002 was
$86.0 million, principally due to $23.3 million of property and equipment
purchases, $27.3 million of intangible assets purchased or developed
internally, and $33.2 million paid for businesses acquired.
Cash used in financing activities for the year ended June 30, 2002 was $23.1
million principally, due to the purchase of 2.8 million treasury shares for
$35.7 million in connection with the Company's share repurchase program and the
repayment of notes payable of $13.5 million offset by proceeds of $29.9 million
from the issuance of common stock, primarily relating to the Company's employee
stock purchase plan.
In connection with acquisitions and the hiring of professionals and staff
members of various Andersen Business Consulting practices, the Company has paid
$396.7 million in cash subsequent to June 30, 2002.
On August 21, 2002 the Company entered into an additional $220.0 million
revolving credit facility for the purpose of funding the acquisition of KPMG
Consulting AG. This facility matures on December 15, 2002.
27
Borrowings bear interest at either the prime rate, the LIBOR rate plus a margin
ranging from 0.875% to 1.625% or money market rates the option of which is
determinable by the Company. The facility contains affirmative, negative and
financial covenants that are consistent with the Company's other revolving
credit facility described above. On August 22, 2002 the Company borrowed $220.0
million under the new facility and $75.0 million under the existing receivables
purchase agreement to acquire KPMG Consulting AG. The Company intends to
replace the new facility with other financing prior to December 15, 2002. The
credit facility provides that, upon receipt of proceeds by the Company from
certain dispositions of assets or issuances of equity or debt securities, the
revolving credit commitments will automatically be reduced by certain amounts
in the case of such dispositions, or by the amount of proceeds received in the
case of an issuance of securities, and the Company is required to repay amounts
due that exceed the reduced credit commitments.
On August 30, 2002, the Company expanded its yen-denominated line of credit
facility to an aggregated principle balance not to exceed 2 billion Yen
(approximately $16,800). Borrowings under the facility accrue interest at TIBOR
plus 0.90% and are used to finance working capital for the Company's Japan
operations. There are no covenants under the facility and it matures on August
30, 2003.
The Company has future aggregate minimum lease payments under operating
leases for the years ending June 30 in amounts as follows: 2003-$50.9 million,
2004-$45.7 million, 2005-$44.4 million, 2006-$42.3 million, 2007-$39.0 million,
thereafter-$155.5 million. Additionally, the Company expects to spend $20.0
million to $40.0 million on one-time re-branding efforts during the first half
of fiscal 2003.
Under the transition services agreement with KPMG LLP (which terminates no
later than February 8, 2004 for non-technology services and February 8, 2005
for technology-related services), the Company contracted to receive certain
infrastructure support services from KPMG LLP until the Company completes the
build-out of its own infrastructure. If the Company terminates services prior
to the end of the term for such services, the Company may be obligated to pay
KPMG LLP termination costs, as defined in the transition services agreement,
incurred as a result of KPMG LLP winding down and terminating such services.
KPMG LLP and the Company have agreed that during the term of the transition
services agreement the parties will work together to minimize any termination
costs (including transitioning personnel and contracts from KPMG LLP to our
Company), and our Company will wind down its receipt of services from KPMG LLP
and develop its own internal infrastructure and support capabilities or seek
third party providers of such services. The Company continues to receive from
KPMG LLP services relating to information technology (such as
telecommunications and user services), financial systems, human resources
systems, occupancy and office support services in facilities used by both the
Company and KPMG LLP, and financing of capital assets used in the provisioning
of transition services. The Company has given notice to KPMG LLP of its intent
to terminate certain services in fiscal 2003 for which the amount of
termination costs have either not been determined by KPMG LLP or not agreed
upon by the parties. In July 2002, the Company paid KPMG LLP $30.8 million
representing the unamortized costs of leasehold improvements purchased by KPMG
LLP and used exclusively by the Company. Based on information currently
available, the Company anticipates paying KPMG LLP approximately $40 million to
$60 million for the sale and transfer of additional capital assets (such as
computer equipment, furniture and leasehold improvements) currently used by the
Company through the transition services agreement (for which usage charges are
included in the monthly costs under the agreement). Until the Company takes
ownership of these capital assets, the transition services agreement provides
an off-balance sheet financing arrangement. The amount of termination costs
that the Company will pay to KPMG LLP depends upon the timing of service
terminations, the ability of the parties to work together to minimize the
costs, and the amount of payments required under existing contracts with third
parties for services provided to the Company by KPMG LLP and which can continue
to be obtained directly by the Company thereafter. Accordingly, the amount of
termination costs that the Company will pay to KPMG LLP in the future cannot be
reasonably estimated at this time. The Company believes that the amount of
termination costs yet to be assessed will not have a material adverse effect on
the Company's consolidated financial position, cash flows, or liquidity.
Whether such amounts could have a material effect on the results of operations
in a particular quarter or fiscal year cannot be determined at this time.
28
The Company believes that the cash provided from operations, borrowings
available under the various existing credit facilities, and existing cash and
cash equivalents along with additional financing to be completed prior to
December 15, 2002 should be sufficient to meet working capital and capital
expenditure needs for at least the next 12 months.
Recently Issued Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which
addresses the financial accounting and reporting for the impairment of
long-lived assets. This statement supersedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
and the accounting and reporting provisions for the disposal of a segment of a
business of Accounting Principles Board Opinion ("APB") No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." The Company is required to adopt SFAS No. 144 no later than the
first quarter of fiscal 2003 and does not believe adoption of SFAS No. 144 will
have a material impact on its financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the requirement under SFAS No. 4 to
aggregate and classify all gains and losses from extinguishment of debt as an
extraordinary item, net of related income tax effect. This statement also
amends SFAS No. 13 to require that certain lease modifications with economic
effects similar to sale-leaseback transactions be accounted for in the same
manner as sale-leaseback transactions. In addition, SFAS No. 145 requires
reclassification of gains and losses in all prior periods presented in
comparative financial statements related to debt extinguishment that do not
meet the criteria for extraordinary item in APB No. 30. The statement is
effective for fiscal years beginning after May 15, 2002 with early adoption
encouraged. The Company will adopt SFAS No. 145 effective July 1, 2002, and we
do not believe it will impact our financial position or results of operations.
On July 30, 2002, The FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." The statement requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by the statement include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity. SFAS
No. 146 is to be applied prospectively to exit or disposal activities initiated
after December 31, 2002. The Company is currently evaluating the requirements
and impact of this statement on our consolidated results of operations and
financial position.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements in this report constitute "forward-looking
statements" within the meaning of the United States Private Securities
Litigation Reform Act of 1995. These statements relate to our operations that
are based on our current expectations, estimates and projections. Words such as
"may," "will," "could," "would," "should," "anticipate," "predict,"
"potential," "continue," "expects," "intends," "plans," "projects," "believes,"
"estimates" and similar expressions are used to identify these forward-looking
statements. These statements are only predictions and as such 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 or our future financial performance 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.
29
Our actual results may differ from the forward-looking statements for many
reasons, including:
. the business decisions of our clients regarding the use of our services;
. the timing of projects and their termination;
. the availability of talented professionals to provide our services;
. the pace of technological change;
. the strength of our joint marketing relationships;
. continuing limitations following our separation from KPMG LLP;
. the actions of our competitors; and
. unexpected difficulties associated with our recent acquisitions and group
hires of business consultants involving KCA and the former Andersen
Business Consulting Practices.
In addition, our results and forward-looking statements could be affected by
general domestic and international economic and political conditions, including
the current slowdown in the economy, uncertainty as to the future direction of
the economy and vulnerability of the economy to domestic or international
incidents, as well as market conditions in our industry. For a more detailed
discussion of certain of these factors, see Exhibit 99.1 to this Form 10-K. We
caution the reader that the factors we have identified above may not be
exhaustive. We operate in a continually changing business environment, and new
factors that may affect our forward-looking statements emerge from time to
time. Management cannot predict such new factors, nor can it assess the impact,
if any, of such new factors on our business or the extent to which any factor,
or combination of factors, may cause actual results to differ materially from
those implied by any forward-looking statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risks
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. Our exposure to changes in foreign currency rates primarily relates to
net investment exposure, arising from acquisitions in and working capital
advances provided to certain international operations, including risk from the
recent acquisitions in Europe, Asia Pacific and Latin America.
30
Item 8. Financial Statements and Supplementary Data
MANAGEMENT'S REPORT ON FINANCIAL STATEMENTS
The management of KPMG Consulting, Inc. is responsible for the preparation
and fair presentation of the financial statements and other related financial
information published in this Annual Report on Form 10-K. The financial
statements were prepared in accordance with accounting principles generally
accepted in the United States of America and were necessarily based in part on
reasonable estimates and judgments giving due consideration to materiality. To
the best of our knowledge and belief, the information contained in this Annual
Report on Form 10-K is true and accurate in all material respects.
The management of the Company is also responsible for maintaining an
effective system of internal accounting controls. This system is designed to
provide reasonable assurance that assets are adequately safeguarded and
financial records accurately reflect all transactions and can be relied upon in
all material respects in the preparation of financial statements.
Grant Thornton LLP, independent certified public accountants, audits the
financial statements of the Company in accordance with auditing standards
generally accepted in the United States of America. The independent auditors'
report expresses an informed judgment as to the fair presentation of the
Company's reported operating results, financial position and cash flows. Their
judgments are based on the results of auditing procedures and other tests that
they deemed necessary, including their consideration of our internal accounting
controls and the control environment. Grant Thornton LLP has full and free
access to management and to the Audit Committee.
The Audit Committee is responsible to the Board of Directors for reviewing
the financial controls and accounting and reporting practices, and for
recommending appointment of the independent auditors. The Audit Committee meets
periodically with representatives of the independent auditors with and without
the Company's management being present.
/s/ RANDOLPH C. BLAZER
-------------------------
Randolph C. Blazer
Chairman of the Board,
Chief Executive Officer
and President
/s/ ROBERT C. LAMB, JR.
-------------------------
Robert C. Lamb, Jr.
Executive Vice
President and
Chief Financial Officer
31
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
KPMG Consulting, Inc.
We have audited the accompanying consolidated balance sheets of KPMG
Consulting, Inc. (successor to the consulting business of KPMG LLP) as of June
30, 2002 and 2001, and the related consolidated statements of operations,
changes in stockholders' equity (deficit) and cash flows for the years ended
June 30, 2002 and 2001 and the five months ended June 30, 2000, and the related
combined statements of income before partner distributions and benefits,
changes in equity and cash flows for the seven months ended January 31, 2000.
These financial statements are the responsibility of the management of KPMG
Consulting, Inc. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of KPMG
Consulting, Inc. as of June 30, 2002 and 2001, and the consolidated results of
operations, changes in stockholders' equity (deficit) and cash flows for the
years ended June 30, 2002 and 2001 and the five months ended June 30, 2000, and
the combined income before partner distributions and benefits, changes in
equity and cash flows for the seven months ended January 31, 2000, in
conformity with accounting principles generally accepted in the United States
of America.
/s/ GRANT THORNTON LLP
New York, New York
August 6, 2002 except for
Note 23, as to which the
date is September 18, 2002
32
KPMG CONSULTING, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
June 30, 2002 June 30, 2001
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents........................... $203,597 $ 45,914
Accounts receivable, net of allowances of $28,645
at June 30, 2002 and $27,467 at June 30, 2001..... 246,792 377,476
Unbilled revenues, net.............................. 128,883 180,355
Other current assets................................ 67,941 101,014
-------- --------
Total current assets............................ 647,213 704,759
Property and equipment, net............................ 60,487 66,947
Goodwill, net.......................................... 87,663 135,777
Other intangible assets, net........................... 75,652 53,606
Other assets........................................... 24,116 38,546
-------- --------
Total assets.................................... $895,131 $999,635
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable.................... $ 1,846 $ 11,594
Accounts payable.................................... 62,810 65,632
Accrued payroll and related liabilities............. 130,554 174,884
Other current liabilities........................... 88,085 101,999
-------- --------
Total current liabilities....................... 283,295 354,109
Notes payable, less current portion.................... -- 1,846
Other liabilities...................................... 9,966 11,568
-------- --------
Total liabilities............................... 293,261 367,523
Commitments and contingencies
Stockholders' equity:
Preferred Stock, $.01 par value 10,000,000 shares
authorized........................................ -- --
Common Stock, $.01 par value 1,000,000,000 shares
authorized, 161,478,409 shares issued on June 30,
2002 and 158,568,922 shares issued on June 30,
2001 (including 999,006 shares reserved).......... 1,605 1,576
Additional paid-in capital.......................... 689,210 656,293
Accumulated deficit................................. (41,421) (14,523)
Notes receivable from stockholders.................. (10,151) (7,950)
Accumulated other comprehensive loss................ (1,646) (3,284)
Treasury stock, at cost (3,812,250 shares
on June 30, 2002)................................. (35,727) --
-------- --------
Total stockholders' equity...................... 601,870 632,112
-------- --------
Total liabilities and stockholders' equity...... $895,131 $999,635
======== ========
The accompanying notes are an integral part of these financial statements
33
KPMG CONSULTING, INC.
CONSOLIDATED/COMBINED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
Consolidated Combined*
--------------------------------------- ------------
Year Year Five Months Seven Months
Ended Ended Ended Ended
June 30, June 30, June 30, January 31,
2002 2001 2000 2000
------------ ------------ ----------- ------------
Revenues........................................ $ 2,367,627 $ 2,855,824 $ 1,105,166 $1,264,818
Costs of service:
Professional compensation*................... 940,829 1,084,751 469,827 472,679
Other direct contract expenses............... 592,634 751,951 259,801 263,106
Impairment charge............................ 23,914 7,827 8,000 --
Other costs of service....................... 209,398 296,548 88,172 161,388
------------ ------------ ----------- ----------
Total costs of service*.................. 1,766,775 2,141,077 825,800 897,173
------------ ------------ ----------- ----------
Gross margin*................................... 600,852 714,747 279,366 367,645
Selling, general and administrative expenses.... 467,162 493,818 206,930 235,668
Special payment to managing directors........... -- -- 34,520 --
------------ ------------ ----------- ----------
Operating income*............................... 133,690 220,929 37,916 131,977
Interest income................................. 3,144 2,386 6,178 --
Interest expense................................ (2,248) (17,175) (16,306) (27,339)
Gain on sale of assets.......................... -- 6,867 -- --
Equity in losses of affiliate and loss on
redemption of equity interest in affiliate.... -- (76,019) (15,812) (14,374)
Minority interests.............................. -- (140) (439) 28
------------ ------------ ----------- ----------
Income before taxes............................. 134,586 136,848 11,537
Income before partner distributions and
benefits*..................................... $ 90,292
==========
Income tax expense*............................. 81,524 101,897 29,339
------------ ------------ -----------
Income (loss) before cumulative effect of change
in accounting principle....................... 53,062 34,951 (17,802)
Cumulative effect of change in accounting
principle..................................... 79,960 -- --
------------ ------------ -----------
Net income (loss)............................... (26,898) 34,951 (17,802)
Dividend on Series A Preferred Stock............ -- (31,672) (25,992)
Preferred stock conversion discount............. -- (131,250) --
------------ ------------ -----------
Net loss applicable to common stockholders...... $ (26,898) $ (127,971) $ (43,794)
============ ============ ===========
Earnings (loss) per share--basic and diluted:
Income (loss) before cumulative effect of
change in accounting principle applicable
to common stockholders..................... $ 0.34 $ (1.19) $ (0.58)
Cumulative effect of change in accounting
principle.................................. (0.51) -- --
------------ ------------ -----------
Net loss applicable to common
stockholders............................... $ (0.17) $ (1.19) $ (0.58)
============ ============ ===========
Weighted average shares--basic............... 157,559,989 107,884,143 75,843,000
============ ============ ===========
Weighted average shares--diluted............. 159,583,786 107,884,143 75,843,000
============ ============ ===========
--------
* On a combined partnership basis, excludes payments for partner distributions
and benefits and income tax expense.
The accompanying notes are an integral part of these financial statements
34
KPMG CONSULTING, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands)
Additional Notes Accumulated Treasury
Common Stock Paid-in Receivable Other Stock
-------------------- Capital Accumulated from Comprehensive ----------------
Shares Issued Amount (Deficit) Deficit Stockholders Income/(Loss) Shares Amount Total
------------- ------ ---------- ----------- ------------ ------------- ------ -------- ---------
Balance at January 31,
2000..................... -- $ -- $ -- $ -- $ -- $ -- -- $ -- $ --
Issuance of stock to
KPMG LLP and the
partners of KPMG LLP..... 75,564 756 (756) -- -- -- -- -- --
Issuance of note to KPMG
LLP...................... -- -- (630,000) -- -- -- -- -- (630,000)
Employee stock awards..... 311 3 17,247 -- -- -- -- -- 17,250
Notes receivable from
stockholders............. -- -- -- -- (5,845) -- -- -- (5,845)
Issuance of stock for
acquisition.............. 6 -- 347 -- -- -- -- -- 347
Cash dividend on Series A
Preferred Stock.......... -- -- (25,992) -- -- -- -- -- (25,992)
Shares reserved in trust.. 999 -- -- -- -- -- -- -- --
Earnings of valuation
services practice
retained by KPMG LLP..... -- -- (4,261) -- -- -- -- -- (4,261)
Comprehensive loss:
Net loss............... -- -- -- (17,802) -- -- -- -- (17,802)
Foreign currency
translation
adjustment, net of
tax................... -- -- -- -- -- (1,272) -- -- (1,272)
---------
Total comprehensive loss.. (19,074)
------- ------ --------- -------- -------- ------- ------ -------- ---------
Balance at June 30, 2000.. 76,880 759 (643,415) (17,802) (5,845) (1,272) -- -- (667,575)
------- ------ --------- -------- -------- ------- ------ -------- ---------
Cash dividend on Series
A Preferred Stock........ -- -- -- (31,672) -- -- -- -- (31,672)
Issuance of stock in
exchange for KPMG LLP's
0.5% interest in our
operating subsidiary..... 433 4 (4) -- -- -- -- -- --
Initial public offering
proceeds, net of
transaction costs........ 34,244 342 563,150 -- -- -- -- -- 563,492
Conversion of preferred
stock to common stock.... 44,607 446 802,475 -- -- -- -- -- 802,921
Preferred stock
conversion discount...... -- -- (131,250) -- -- -- -- -- (131,250)
Conversion of
acquisition obligations.. 2,455 25 65,337 -- -- -- -- -- 65,362
Shares retired............ (50) -- -- -- -- -- -- -- --
Notes receivable from
stockholders, including
$517 in interest......... -- -- -- -- (2,105) -- -- -- (2,105)
Comprehensive income:
Net income............. -- -- -- 34,951 -- -- -- -- 34,951
Foreign currency
translation
adjustment, net of
tax................... -- -- -- -- -- (2,012) -- -- (2,012)
---------
Total comprehensive
income................... 32,939
------- ------ --------- -------- -------- ------- ------ -------- ---------
Balance at June 30, 2001.. 158,569 1,576 656,293 (14,523) (7,950) (3,284) -- -- 632,112
------- ------ --------- -------- -------- ------- ------ -------- ---------
Sale of common stock
under Employee Stock
Purchase Plan,
including tax benefit
of $995 and other........ 2,280 23 27,273 -- -- -- -- -- 27,296
Exercise of stock
options under Long-
Term Incentive Plan,
including tax benefit
of $181.................. 209 2 3,782 -- -- -- -- -- 3,784
Compensation recognized
under Long- Term
Incentive Plan for
restricted stock (net
of $3,724 unearned
compensation)............ 420 4 1,862 -- -- -- -- -- 1,866
Notes receivable from
stockholders, including
$529 in interest......... -- -- -- -- (2,201) -- -- -- (2,201)
Transfer of shares in
trust to treasury........ -- -- -- -- -- -- (999) -- --
Common stock repurchased.. -- -- -- -- -- -- (2,813) (35,727) (35,727)
Comprehensive loss:
Net loss............... -- -- -- (26,898) -- -- -- -- (26,898)
Foreign currency
translation
adjustment, net of
tax................... -- -- -- -- -- 1,638 -- -- 1,638
---------
Total comprehensive loss.. (25,260)
------- ------ --------- -------- -------- ------- ------ -------- ---------
Balance at June 30, 2002.. 161,478 $1,605 $ 689,210 $(41,421) $(10,151) $(1,646) (3,812) $(35,727) $ 601,870
======= ====== ========= ======== ======== ======= ====== ======== =========
The accompanying notes are an integral part of these financial statements
35
KPMG CONSULTING, INC.
(Successor to the Consulting Business of KPMG LLP)
COMBINED STATEMENT OF CHANGES IN EQUITY
(in thousands)
Investment by
KPMG LLP in
KPMG Consulting, Inc.
---------------------
Balance at June 30, 1999............................... $ 184,219
Income before partner distributions and benefits.... 90,292
Additions of capital, net........................... 107,854
Transfer of net assets for common stock by KPMG LLP. (382,365)
---------
Balance at January 31, 2000............................ $ --
=========
The accompanying notes are an integral part of these financial statements
36
KPMG CONSULTING, INC.
(Successor to the Consulting Business of KPMG LLP)
CONSOLIDATED/COMBINED STATEMENTS OF CASH FLOWS
(in thousands)
Consolidated Combined
------------------------------- ------------
Year Year Five Months Seven Months
Ended Ended Ended Ended
June 30, June 30, June 30, January 31,
2002 2001 2000 2000
-------- --------- ----------- ------------
Cash flows from operating activities:
Income before partner distributions and benefits.......... $ 90,292
Net income (loss)......................................... $(26,898) $ 34,951 $ (17,802) --
Adjustments to reconcile to net cash provided by (used
in) operating activities:
Cumulative effect of change in accounting
principle............................................. 79,960 -- -- --
Equity in losses of affiliate and loss on redemption of
equity interest in affiliate.......................... -- 76,019 15,812 14,374
Deferred income taxes................................... (7,286) (13,213) 12,930 (1,074)
Gain on sale of assets.................................. -- (6,867) -- --
Debt conversion discount................................ -- 1,698 -- --
Stock awards............................................ 1,862 -- 17,250 --
Depreciation............................................ 30,641 29,548 12,074 13,447
Amortization............................................ 18,679 31,474 8,575 8,957
Impairment charge....................................... 23,914 7,827 8,000 --
Minority interests...................................... -- 140 439 (28)
Changes in assets and liabilities:
Accounts receivable..................................... 132,054 (51,864) (214,122) (132,878)
Unbilled revenues....................................... 52,990 59,180 (204,365) (57,598)
Other current assets.................................... 35,795 (1,190) (14,636) (19,409)
Other assets............................................ 2,999 1,321 (15,480) (3,842)
Accrued payroll and related liabilities................. (47,561) 27,519 40,862 (39,264)
Accounts payable and other current liabilities.......... (29,914) (38,945) 8,001 56,917
Special payment to managing directors................... -- (73,230) 73,230 --
Other liabilities....................................... (416) -- (1,162) (1,368)
-------- --------- --------- ---------
Net cash provided by (used in) operating
activities: 266,819 84,368 (270,394) (71,474)
-------- --------- --------- ---------
Cash flows from investing activities:
Purchases of property and equipment....................... (23,302) (44,309) (18,220) (16,367)
Businesses acquired, net of cash acquired................. (33,203) (13,599) (43,168) (21,120)
Purchases of other intangible assets...................... (27,301) (30,579) (29,379) (3,031)
Notes receivable.......................................... -- -- (7,020) --
Investment in affiliate................................... -- (9,945) -- --
Purchases of equity investments........................... (2,234) (7,500) (6,821) --
-------- --------- --------- ---------
Net cash used in investing activities............... (86,040) (105,932) (104,608) (40,518)
-------- --------- --------- ---------
The accompanying notes are an integral part of these financial statements.
37
KPMG CONSULTING, INC.
(Successor to the Consulting Business of KPMG LLP)
CONSOLIDATED/COMBINED STATEMENTS OF CASH FLOWS--(Continued)
(in thousands)
Consolidated Combined
------------------------------- ------------
Year Year Five Months Seven Months
Ended Ended Ended Ended
June 30, June 30, June 30, January 31,
2002 2001 2000 2000
-------- --------- ----------- ------------
Cash flows from financing activities:
Proceeds from issuance of common stock................ 29,908 563,492 -- --
Proceeds from issuance of Series A Preferred
Stock............................................... -- -- 1,050,000 --
Repurchases of common stock........................... (35,727) -- -- --
Proceeds from notes payable........................... -- 283 124,590 18,573
Repayment of notes payable............................ (13,512) (54,670) (94,335) (3,200)
Repayment of acquisition obligations.................. -- (42,033) -- --
Repayment of Series A Preferred Stock................. -- (378,329) -- --
Repurchase of minority interest in subsidiary......... (2,093) (1,914) -- --
Notes receivable from stockholders.................... (1,672) (1,588) (5,845) --
Dividends paid on Series A Preferred Stock............ -- (44,754) (12,910) --
Business transfer from KPMG LLP....................... -- -- (4,261) --
Repayment of notes payable to KPMG LLP................ -- -- (680,809) --
Additions of capital by KPMG LLP, net................. -- -- -- 107,854
-------- --------- ---------- --------
Net cash provided by (used in) financing
activities...................................... (23,096) 40,487 376,430 123,227
-------- --------- ---------- --------
Net increase in cash and cash equivalents................ 157,683 18,923 1,428 11,235
Cash and cash equivalents--beginning of period........... 45,914 26,991 25,563 14,328
-------- --------- ---------- --------
Cash and cash equivalents--end of period................. $203,597 $ 45,914 $ 26,991 $ 25,563
======== ========= ========== ========
Supplementary cash flow information:
Interest paid......................................... $ 1,351 $ 20,900 $ 14,936 $ 25,077
======== ========= ========== ========
Taxes paid............................................ $ 62,975 $ 149,585 $ --
======== ========= ==========
Supplemental non-cash investing and financing activities:
Conversion of acquisition obligations to common
stock............................................... $ 65,362
Conversion of Series A Preferred Stock to common
stock............................................... $ 802,921
Series A Preferred Stock conversion discount.......... $(131,250)
Acquisition obligations from business
acquisitions........................................ $ 42,880 $ 17,200
Contribution of net assets from KPMG LLP.............. $ (382,365)
Accounts receivable retained by KPMG LLP.............. $ 298,231
Unbilled revenues retained by KPMG LLP................ $ 97,170
Note payable to KPMG LLP for separation
transaction......................................... $ 41,357
Note payable to KPMG LLP for business
acquisition......................................... $ 27,795
Deferred income taxes................................. $ (45,772)
Dividends payable on Series A Preferred Stock......... $ 13,082
The accompanying notes are an integral part of these financial statements
38
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS
(in thousands, except share and per share amounts)
1. Description of the Business and Basis of Presentation
We are one of the world's largest business consulting and systems
integration firms with approximately 9,300 employees at June 30, 2002 (and
approximately 16,000 employees as of September 18, 2002) serving over 2,100
clients worldwide, including Global 2000 and Fortune 1000 companies, small and
medium-sized businesses, government agencies and other organizations. The
Company provides business and technology strategy, systems design and
architecture, applications implementation, network and systems integration, and
related services that enable our clients to leverage technology for stronger
return on investment and enhanced services to their customers, vendors and
employees. We deliver consulting services through five industry groups
(segments) including public services, financial services, communications and
content, high technology, and consumer and industrial markets. In addition, we
have multinational operations covering North America, Latin America, Asia
Pacific, Europe and Israel.
Historically, KPMG LLP has been a provider of assurance, tax and consulting
services. As of January 31, 2000, KPMG LLP separated its management and
information technology consulting business ("Consulting Business") from its
remaining businesses, and transferred the Consulting Business, including
substantially all of the operating assets (other than accounts receivable and
unbilled revenues of $298,231 and $97,170, respectively, which were retained by
KPMG LLP) and liabilities relating to such business, into a newly-formed
corporate entity. We refer to this as the "Separation." For periods prior to
January 31, 2000, "Company" refers to KPMG LLP's Consulting Business which was
operated in partnership form as a part of KPMG LLP; for periods commencing
January 31, 2000, "Company" refers to KPMG Consulting, Inc. which is operating
in corporate form.
The Company was incorporated on August 17, 1999, however it did not formally
commence significant operations until January 31, 2000. KPMG LLP and the
Company entered into certain agreements relating to the Separation of KPMG
LLP's Consulting Business, the transfer of that business to the Company and the
distribution of the Company's common stock. In connection with these
transactions 51.0 million shares of the Company's common stock were issued to
KPMG LLP and 24.5 million shares were issued to partners of KPMG LLP, including
partners associated with KPMG LLP's Consulting Business. The Company also
issued demand notes to KPMG LLP in the principal amounts of $630,000 and
$41,357 in connection with the Separation. The $630,000 demand note was paid
immediately after issuance with a portion of the proceeds from the sale of the
Series A Mandatorily Redeemable Convertible Preferred Stock ("Series A
Preferred Stock") (see Note 13). The $41,357 demand note was repaid on June 30,
2000.
Our managing directors resigned from the KPMG LLP partnership as of January
31, 2000. The terms of our Separation from KPMG LLP provided that, for the
period from January 31, 2000 through June 30, 2000, during which period none of
our outstanding common stock was held by outside investors, the profits of KPMG
LLP and our Company were to be allocated among the partners of KPMG LLP and the
managing directors of our Company as if the entities had been combined through
June 30, 2000. Under this arrangement, the Company's managing directors were
paid by our Company. The amount attributed to this arrangement for the five
month period ended June 30, 2000 was $34,520. Subsequent to June 30, 2000, no
further payments were made to or received from KPMG LLP based on the combined
profitability of the two firms.
On June 30, 2000, KPMG LLP transferred its valuation services practice to
our Company. Our financial statements for all periods presented include the
assets, liabilities and operating results of this practice. A charge against
paid-in capital of $4,261 was recognized to reflect the retention by KPMG LLP
of accounts receivable equal to the net assets of this practice as of June 30,
2000.
39
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
On January 17, 2001, the Company's board of directors and stockholders
approved a reverse stock split of approximately one for 5.045 effective
immediately prior to its initial public offering. All share and per share
amounts reflect this reverse stock split.
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 29.2 million shares
of common stock that were issued in connection with the conversion of the
Series A Preferred Stock that was 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 for
$378,329 in cash, and the remaining shares of Series A Preferred Stock were
converted into 15.4 million shares of common stock. The Company's proceeds from
the initial public offering, net of underwriting discount of $24,655 and our
pro rata portion of other expenses of the offering of $28,239, were $563,492.
Of the net proceeds, $378,329 was used to repurchase 1.4 million shares of
Series A Preferred Stock, $112,000 was used to repay all the Company's
outstanding indebtedness to KPMG LLP, and $70,000 was used to repay bank loans.
The financial statements of the Company have been prepared in conformity
with accounting principles generally accepted in the United States of America.
Through January 31, 2000, the Company's financial statements reflect KPMG LLP's
historical cost of the assets and liabilities associated with its Consulting
Business and a partnership basis of presentation, consistent with the legal and
operating form of the business. As a partnership, all of KPMG LLP's earnings
were allocable to its partners. As a result, it is difficult to differentiate
the ownership or "entrepreneurial" component of distributions to partners from
the compensation component of such distributions. Accordingly, compensation and
benefits for services rendered by consulting partners have not been reflected
as an expense in the combined statements of operations and cash flows.
Additionally, KPMG LLP provided certain infrastructure services relating to its
assurance, tax and consulting businesses on a centralized basis. The cost of
these services was allocated among these businesses on a basis management
believed to be reasonable. However, it is not practicable to determine what the
cost of these services would have been had we operated as an independent entity
and either performed such services internally or obtained them from a third
party. Further, as a partnership, the Company was not subject to U.S. federal
and state income taxes. Such taxes were the responsibility of the individual
partners. As a result, the combined financial statements do not reflect the
results of operations that would have been reported had the Company operated as
a stand-alone entity for the periods indicated in the combined financial
statements. On January 31, 2000, the former partners of KPMG LLP who were
associated with KPMG LLP's Consulting Business resigned their partnerships and
became managing directors of the Company. From that date forward, all
compensation and benefits incurred by the Company relating to services provided
by managing directors have been reflected in the Company's consolidated
financial statements. On that same date, the Company commenced operations in
corporate form and became subject to income taxes in jurisdictions in which it
operates.
2. Summary of Significant Accounting Policies
Accounting policies and estimates 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); valuation of accounts receivable; valuation of goodwill,
and intra-period estimates of discretionary compensation costs and effective
income tax rates.
Principles of Consolidation/Combination
The consolidated/combined financial statements reflect the operations of the
Company and all of its majority-owned subsidiaries. Upon
consolidation/combination, all significant intercompany accounts and
40
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
transactions are eliminated. Assets and liabilities of the operations of the
Company denominated in foreign currencies are translated into U.S. dollars
using current exchange rates. Revenues and expenses are translated at an
average exchange rate during the periods. Foreign exchange gains and losses
have not been significant. The cumulative translation adjustment is reported as
a component of "accumulated other comprehensive loss" in stockholders' equity
on the consolidated balance sheet.
Certain prior period amounts have been reclassified to conform with current
period presentation, including the following significant reclassifications to
the statement of operations:
. reclassification of costs from "Other costs of service" to "Professional
compensation" for compensation and fringe benefit expenses related to
certain billable consulting staff,
. reclassification of costs from "Other costs of service" to "Selling,
general and administrative expenses" related to an overhead cost
allocation, and
. reclassification of amortization of goodwill and other intangible assets
from "Costs of service" to "Selling, general and administrative expenses."
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities, the disclosure of contingent assets and liabilities,
and the reported amounts of revenues and expenses. These estimates and
assumptions include, but are not limited to, estimates of collectibility of
accounts receivable and unbilled revenues, costs to complete engagements, the
realizability of goodwill and other intangible assets, accrued liabilities and
other reserves, income taxes and other factors. Management has exercised
reasonableness in deriving these estimates. However, actual results could
differ from these estimates.
Revenue Recognition
We earn revenues from a range of consulting services, including business and
technology strategy, process design and operations improvement, systems
integration, network integration and infrastructure, and managed services.
Revenue includes all amounts that are billed or billable to clients, including
out-of-pocket costs such as travel and subsistence, costs of hardware and
software, and costs of subcontractors (collectively referred to as "other
direct contract expenses"). Revenues for services rendered are recognized on a
time-and-materials or percentage-of-completion basis, depending upon the
contract with the client. Revenues related to time-and-material contracts are
recognized in the period in which the services are performed. Revenues related
to fixed-price contracts are recognized based upon professional costs incurred
as a percentage of estimated total professional costs of the respective
contracts. The cumulative impact of any revisions in estimated revenues and
direct contract costs are recognized in the period in which they become known.
Losses on contracts are recognized during the period in which the loss first
becomes probable and reasonably estimable. Contract losses are determined to be
the amount by which the estimated service costs of the contract exceed the
estimated revenues that will be generated by the contract. Unbilled revenues
represent revenues for services performed that have not been billed. Billings
in excess of revenue recognized are recorded as deferred revenue until the
applicable revenue recognition criteria are met.
Managed services and software maintenance contract revenues are generally
recognized ratably over the term of each agreement. Revenues for transactions
that include multiple elements are allocated to each element based on its fair
value and recognized when it is realized or realizable and earned.
41
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
Costs of Service
Professional compensation consists of payroll costs and related benefits
associated with professional staff (including costs associated with reductions
in workforce). Other direct contract expenses include travel and subsistence,
subcontracting and other contract expenses. Other costs of service include
expenses attributable to professional and support staff, bad debt expense
relating to accounts receivable, and impairment charges associated with
long-lived assets. Most of our research and development activities have been
incurred pursuant to specific client contracts and, accordingly, have been
expensed as costs of service as incurred.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include expenses such as sales
and marketing, amortization of identifiable intangible assets, and costs for
information systems, finance and accounting, human resources, and other
infrastructure functions related to managing and growing our business.
Advertising costs are expensed when advertisements are first placed or run.
Advertising expense totaled $12,215 for the year ended June 30, 2002, $8,979
for the year ended June 30, 2001, $6,287 for the five months ended June 30,
2000, and $5,703 for the seven months ended January 31, 2000.
Cash Equivalents
Cash equivalents consist of demand deposits and highly liquid investments
with insignificant interest rate risks and original maturities of three months
or less at the time of acquisition.
Investments in Equity Securities
Included in other assets at June 30, 2001, the Company had investments in
nonmarketable equity securities of $13,370. Nonmarketable equity securities
were carried at the Company's cost and were monitored for declines in value.
When those declines were considered to be other than temporary, the carrying
value was reduced through a charge to income (see Note 20).
Property and Equipment
Equipment, furniture and leasehold improvements are recorded at cost less
allowances for depreciation and amortization. Depreciation is provided for all
classes of assets for financial statement purposes using the straight-line
method over the estimated useful lives of the assets, and both the
straight-line and accelerated methods for income tax purposes. Equipment and
furniture are depreciated over three to seven years. Leasehold improvements are
amortized over the lesser of the remaining term of the respective lease or the
expected life of the asset.
Goodwill and Other Intangible Assets
Goodwill represents the cost of acquired companies in excess of the fair
value of the net assets acquired. At the date of acquisition, goodwill is
allocated to reporting units based on net assets assigned to that unit.
Effective July 1, 2001, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," which
established financial accounting and reporting for acquired goodwill and other
intangible assets and superseded Accounting Principles Board Opinion ("APB")
No. 17, "Intangible Assets." Under SFAS No. 142, goodwill and indefinite-lived
purchased intangible assets are no longer amortized but are reviewed at least
annually for impairment; the Company has elected to perform this review
annually as of April 1. Identifiable intangible assets that have finite lives,
continue to be amortized over their estimated useful lives.
42
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
Other intangible assets include purchased or internally developed software
and finite-lived purchased intangible assets, which primarily consist of market
rights, backlog and software license rights. Finite-lived purchased intangible
assets are amortized principally by the straight-line method over their
expected period of benefit. The cost of software purchased or developed for
internal use is capitalized and amortized to expense by the straight-line
method, in accordance with Statement of Position 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use," over an
estimated useful life ranging to six years. The cost of software purchased or
developed to be marketed, including software acquired through acquisitions of
businesses, is capitalized and amortized over its estimated economic life in
accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to
be Sold, Leased or Otherwise Marketed."
The Company reviews the carrying value of its long-lived assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount of such assets may not be fully recoverable. Recoverability of
long-lived assets is assessed by a comparison of the carrying amount of the
asset to the estimated future net cash flows expected to be generated by the
asset.
Fair Value of Financial Instruments
The financial statements include the following financial instruments that
require disclosures of fair values: cash and cash equivalents, acquisition
obligations and notes payable. Fair values are determined by the Company using
available market information and appropriate valuation methodologies. No
comparison of fair values to the carrying value of these financial instruments
is presented, as their fair values are not significantly different than their
carrying values.
Concentrations of Credit Risk
Financial instruments that subject the Company to credit risk consist
primarily of accounts receivable and unbilled revenues. Accounts receivable are
reviewed on a periodic basis and an allowance for bad debts is recorded where
such amounts are determined to be uncollectible.
The Company's public services industry group has a significant portion of
their engagements performed on a fixed-price or fixed-time basis and derives
revenues from departments and agencies of the U.S. government. While most of
our government agency clients have the ability to unilaterally terminate their
contracts, the Company's relationships are generally not with politicaly
appointees; and the Company has not typically experienced a loss of federal
government projects with a change of administration. U.S. government revenues
accounted for 25.6%, 16.9% and 12.8% of the Company's revenues for fiscal 2002,
2001, and 2000, respectively.
Income Taxes
The Company accounts for corporate income taxes under the asset and
liability method. Deferred income tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis, and to operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are separated into current and noncurrent
amounts based on the classification of the related assets and liabilities for
financial reporting purposes. A valuation allowance is provided when it is more
likely than not that some portion of all of the deferred income tax assets will
not be realized.
Stock-Based Compensation
The Company discloses information relating to stock-based compensation
awards in accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation," and has elected to apply the provisions of APB No. 25,
43
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
"Accounting for Stock Issued to Employees" to such compensation awards. The
Company grants employee stock options at an exercise price equal to the fair
market value at the date of grant. The Company also makes available to
employees an Employee Stock Purchase Plan ("ESPP"). Under the Company's ESPP
shares are purchased at 85% of the lesser of the fair market value at the
beginning of a twenty-four month offering period or the fair market value at
the end of each six-month purchase period. No compensation expense is recorded
with respect to such stock option grants or the ESPP. Compensation expense with
respect to restricted stock and other stock awards is measured based on the
fair value of such awards as of the grant date, and charged to expense ratably
over the vesting period.
Earnings (Loss) per Share of Common Stock
Basic earnings (loss) per share is computed based on the weighted average
number of common shares outstanding during the period. Diluted earnings (loss)
per share is computed using the weighted average number of common shares
outstanding during the period plus the dilutive effect of potential future
issues of common stock relating to the Company's stock option program and other
potentially dilutive securities. In calculating diluted earnings (loss) per
share, the dilutive effect of stock options is computed using the average
market price for the period.
Recently Issued Accounting Standards
In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which
addresses the financial accounting and reporting for the impairment of
long-lived assets. This statement supersedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
and the accounting and reporting provisions for the disposal of a segment of a
business of APB No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions." The Company is required to
adopt SFAS No. 144 no later than the first quarter of fiscal 2003 and does not
believe adoption of SFAS No. 144 will have a material impact on the Company's
financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the requirement under SFAS No. 4 to
aggregate and classify all gains and losses from extinguishment of debt as an
extraordinary item, net of related income tax effect. This statement also
amends SFAS No. 13 to require that certain lease modifications with economic
effects similar to sale-leaseback transactions be accounted for in the same
manner as sale-leaseback transactions. In addition, SFAS No. 145 requires
reclassification of gains and losses in all prior periods presented in
comparative financial statements related to debt extinguishment that do not
meet the criteria for extraordinary item in APB No. 30. The statement is
effective for fiscal years beginning after May 15, 2002 with early adoption
encouraged. The Company will adopt SFAS No. 145 effective July 1, 2002 and we
do not believe it will impact our financial position or results of operations.
On July 30, 2002, The FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." The statement requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by the statement include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity. SFAS
No. 146 is to be applied prospectively to exit or disposal activities initiated
after December 31, 2002. The Company is currently evaluating the requirements
and impact of this statement on our consolidated results of operations and
financial position.
44
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
3. Earnings (Loss) per Share
The following table sets forth the computation of basic and diluted earnings
per share:
Year Ended Year Ended Five Months Ended
June 30, June 30, June 30,
2002 2001 2000
------------ ------------ -----------------
Net income (loss) applicable to common shareholders before
cumulative effect of change in accounting principle--
basic................................................... $ 53,062 $ (127,971) $ (43,794)
Convertible debt adjustment............................... 513 -- --
------------ ------------ -----------
Adjusted net income (loss) applicable to common
stockholders before cumulative effect of change in
accounting principle--diluted........................... 53,575 (127,971) (43,794)
Cumulative effect of change in accounting principle....... (79,960) -- --
------------ ------------ -----------
Adjusted net income (loss) applicable to common
stockholders--diluted................................... $ (26,385) $ (127,971) $ (43,794)
============ ============ ===========
Weighted average shares outstanding--basic................ 157,559,989 107,884,143 75,843,000
Assumed exercise of stock options......................... 1,155,741 -- --
Assumed conversion of convertible debt.................... 868,056 -- --
------------ ------------ -----------
Weighted average shares outsanding--diluted............... 159,583,786 107,884,143 75,843,000
============ ============ ===========
Earnings (loss) per share--basic and diluted.............. $ (0.17) $ (1.19) $ (0.58)
============ ============ ===========
Common shares related to outstanding stock options and other potentially
dilutive securities that were excluded from the computation of diluted earnings
per share as the effect would have been anti-dilutive were 17,946,503 and
27,351,257 at June 30, 2002 and 2001, respectively, and 8,048,183 for the five
months ended June 30, 2000.
4. Other Current Assets
Other current assets consist of the following at June 30:
2002 2001
------- --------
Deferred income taxes.................................. $27,390 $ 30,411
Prepaid expenses....................................... 18,743 19,202
Prepaid income taxes................................... 2,416 20,437
Other.................................................. 19,392 30,964
------- --------
Total............................................... $67,941 $101,014
======= ========
45
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
5. Property and Equipment
Property and equipment, net consists of the following at June 30:
2002 2001
--------- ---------
Equipment.................................................. $ 154,452 $ 142,509
Furniture.................................................. 12,743 6,978
Leasehold improvements..................................... 29,516 23,873
Total accumulated depreciation............................. (136,224) (106,413)
--------- ---------
Property and equipment, net of accumulated depreciation. $ 60,487 $ 66,947
========= =========
6. Adoption of SFAS No. 142, "Goodwill and Other Intangible Assets"
In connection with adopting SFAS No. 142, "Goodwill and Other Intangible
Assets," as of July 1, 2001, the Company completed the required test for and
measurement of transitional impairment. Based on that analysis, a transitional
impairment loss of $79,960 (post tax), or $0.51 per basic diluted earnings per
share, was recognized as the cumulative effect of an accounting change. There
was no tax benefit recorded in connection with this charge. 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 years ended June 30, 2002 and June 30, 2001, and for the five months ended
June 30, 2000 and the seven months ended January 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 indefinite-lived purchased intangibles
(assembled workforce).
46
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
Reconciliation of Net Income (Loss) and Earnings (Loss) Per Share
Consolidated Combined
--------------------------------------- ------------
Five Months Seven Months
Year Ended Year Ended Ended Ended
June 30, June 30, June 30, January 31,
2002 2001 2000 2000
------------ ------------ ----------- ------------
Reported income before partner distributions and
benefits...................................... $90,292
Reported income (loss) before cumulative effect
of change in accounting principle............. $ 53,062 $ 34,951 $ (17,802)
Add back goodwill amortization, net of tax...... -- 14,759 4,325 3,746
------------ ------------ ----------- -------
Adjusted income before partner distributions and
benefits...................................... $94,038
=======
Adjusted income (loss) before cumulative effect
of change in accounting principle............. 53,062 49,710 (13,477)
Cumulative effect of change in accounting
principle..................................... 79,960 -- --
------------ ------------ -----------
Adjusted net income (loss)...................... (26,898) 49,710 (13,477)
Dividend on Series A Preferred Stock............ -- (31,672) (25,992)
Preferred Stock conversion discount............. -- (131,250) --
------------ ------------ -----------
Adjusted net income (loss) applicable to
common shareholders........................... $ (26,898) $ (113,212) $ (39,469)
============ ============ ===========
Earnings (loss) per share--basic and diluted:
Reported income (loss) before cumulative effect
of change in accounting principle applicable
to common shareholders........................ $ 0.34 $ (1.19) $ (0.58)
Add back goodwill amortization, net of tax...... -- 0.14 0.06
------------ ------------ -----------
Adjusted income (loss) before cumulative effect
of change in accounting principle applicable
to common shareholders........................ 0.34 (1.05) (0.52)
Cumulative effect of change in accounting
principle..................................... (0.51) -- --
------------ ------------ -----------
Adjusted net income (loss) applicable to
common stockholders........................... $ (0.17) $ (1.05) $ (0.52)
============ ============ ===========
Weighted average shares--basic.................. 157,559,989 107,884,143 75,843,000
============ ============ ===========
Weighted average shares--diluted................ 159,583,786 107,884,143 75,843,000
============ ============ ===========
47
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
The changes in the carrying amount of goodwill for the year ended June 30,
2002 are as follows:
Transitional
Balance Impairment Balance
June 30, 2001(a) Additions (b) Charge Other(c) June 30, 2002
---------------- ------------- ------------ -------- -------------
Public Services.............. $ 12,616 $ -- $ -- $ (681) $11,935
Financial Services........... 3,028 -- -- (142) 2,886
Communications & Content..... 9,349 -- -- (1,107) 8,242
High Technology.............. 2,488 -- -- (562) 1,926
Consumer & Industrial Markets 9,178 -- -- (908) 8,270
International/Corporate...... 99,118 37,373 (79,960) (2,127) 54,404
-------- ------- -------- ------- -------
Total (d)................. $135,777 $37,373 $(79,960) $(5,527) $87,663
======== ======= ======== ======= =======
--------
(a) At June 30, 2001 the Company had a net carrying value for assembled
workforce of $16,800. Under SFAS No. 142, assembled workforce is no longer
considered a separately identifiable intangible asset and was therefore
reclassified to goodwill.
(b) Additions related to the acquisition of the regional consulting practices
in Southeast Asia and Australia (see Note 18).
(c) Other relates primarily to the reversal of deferred taxes on assembled
workforce no longer required due to adoption of SFAS No. 142.
(d) 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.
7. Other Intangible Assets
Other intangible assets consists of the following at June 30:
2002 2001
-------- --------
Internal-use software............................. $ 77,033 $ 59,149
Marketed software................................. 16,915 7,021
Purchased intangibles............................. 13,225 --
Other............................................. 2,612 8,765
Total accumulated amortization.................... (34,133) (21,329)
-------- --------
Other intangible assets, net................... $ 75,652 $ 53,606
======== ========
Purchased intangible assets consist primarily of purchased market rights,
which are being amortized over a weighted average useful life of 4.4 years.
Amortization expense attributable to purchased intangible assets was $3,014 in
fiscal 2002. The remaining amortization expense for purchased intangibles is
estimated to be $2,633 in 2003, $2,633 in 2004, $2,203 in 2005, $2,060 in 2006,
and $512 in 2007.
48
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
8. Notes Payable
Notes payable consists of the following at June 30:
2002 2001
------- --------
Trade notes payable.................................... $ 1,846 $ 8,069
Other.................................................. -- 5,371
------- --------
1,846 13,440
Less: current portion.................................. (1,846) (11,594)
------- --------
Noncurrent portion..................................... $ -- $ 1,846
======= ========
Trade notes are payable in quarterly installments through 2003 and bear
interest at rates between 7.0% and 9.4%. Other debt primarily consisted of
short-term yen-denominated borrowings which bore interest at 1.7% as of June
30, 2001.
On May 29, 2002, the Company entered into a new credit agreement with a
commercial lender, which provides the Company with a revolving credit facility
in an aggregate principle balance not to exceed $250,000. This credit agreement
replaced the Company's prior revolving credit agreements, which had totaled
$200,000. The funds available under the credit arrangement may be used for
general corporate purposes, for working capital, and for acquisitions subject
to certain restrictions. The revolving credit facility expires on May 29, 2005.
There were no outstanding balances under the respective revolving credit
facilities at June 30, 2002 and June 30, 2001. Under the revolving credit
facility the Company granted liens with respect to our equity interests in
certain foreign subsidiaries. The credit agreement provides for the issuance of
letters of credit, in the aggregate amount not to exceed $30,000, with a
maximum maturity of twelve months from the date of issuance. The Company had
outstanding letters of credit under the respective credit agreements of $108 at
both June 30, 2002 and 2001.
The credit agreement restricts the Company's ability to pay dividends and
incur additional indebtedness. The credit agreement also requires the Company
to maintain certain levels of fixed charge coverage and net worth, while
limiting our leverage ratio to certain levels.
Interest on borrowings under the credit agreement are determined, at the
Company's option, based on the prime rate or the LIBOR rate plus a margin
ranging from 0.875% to 1.625%. There are commitment fees ranging from 0.20% to
0.275% for the revolving credit. The commitment fees vary based on the
Company's leverage ratio at quarter-end.
On May 29, 2002, the Company amended the May 22, 2000 receivables purchase
agreement with an issuer of receivables-backed commercial paper in an amount
not to exceed $150,000. The Company has the option to sell, on an ongoing basis
and without recourse, an undivided percentage interest in designated pools of
accounts receivable. In connection with the receivables purchase agreement, the
Company has granted a security interest in certain accounts receivable. To
maintain the balance in the designated pools of accounts receivable sold, the
Company is obligated to sell undivided interests in new receivables as existing
receivables are collected. The agreement permits the sale of up to $150,000 of
an undivided interest in accounts receivable through May 23, 2003, subject to
an annual renewal. There was no outstanding balance on the accounts receivable
financing at June 30, 2002 and June 30, 2001. Interest on borrowings under the
receivables purchase agreement is based on a variable commercial paper rate
plus 0.4%. There is a commitment fee of 0.225% on the unused balance.
Subsequent to June 30, 2002, the Company borrowed $220,000 under a new
revolving credit agreement and borrowed $75,000 on the accounts receivable
financing facility in connection with the acquisition of KPMG Consulting AG
(see Note 23).
49
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
9. Other Current Liabilities
Other current liabilities consist of the following at June 30:
2002 2001
------- --------
Deferred revenue.................... $19,072 $ 31,677
Acquisition obligation (see Note 10) 16,653 15,753
Due to KPMG LLP (see Note 17)....... 15,220 9,959
Other............................... 37,140 44,610
------- --------
Total............................ $88,085 $101,999
======= ========
10. Acquisition Obligations
On May 27, 1999, KPMG LLP acquired all of the voting common stock of
Softline Consulting & Integrators, Inc., a systems integration company, and
entered into an agreement to acquire all of the Softline nonvoting common stock
for not less than $65,000. The $65,000 acquisition obligation for the nonvoting
common stock of Softline accrues interest at 6% per annum, and was due by its
terms at the earlier of a demand by a majority vote of the nonvoting
shareholders, or May 8, 2000. In the event the Company had provided notice of
an IPO on or before May 8, 2000, the nonvoting shareholders would have had the
right to convert the acquisition obligation of $65,000, plus accrued interest,
into the Company's common shares at a conversion price equal to the IPO price
less the underwriter's per share discount. This obligation was not retired at
its maturity. The Company and the counterparties to this agreement entered into
an agreement in August 2000, pursuant to which $33,980 of this obligation was
repaid in cash, $7,020 was retired through the cancellation of short-term notes
due from the counterparties and $9,000 was settled in November 2000 ($3,000 in
cash and 326,024 shares of the Company's common stock). The remaining
obligation of $15,000 plus interest at 6% per annum, included in other current
liabilities, is payable upon the ultimate resolution of specific contingencies
relating to the Softline acquisition and will be paid through the issuance of
shares of the Company's common stock, valued for such settlement purposes at
the IPO price less the underwriting discount or, at the election of the
counterparties, through the issuance of cash equal to the current market price
of the Company's common stock for up to 30% of the shares otherwise issuable,
with the remainder payable in shares valued at the IPO price.
11. Other Liabilities
In August 1997, the Company entered into a collaboration agreement with
Microsoft Corporation. Under this agreement, the Company developed a broad
portfolio of services and solutions to enable the rapid deployment of Microsoft
products. Microsoft paid the Company $15,000. The agreement requires the
Company to train a specified number of consultants to be proficient in
Microsoft products, and to participate in joint marketing efforts with
Microsoft. Revenue for $5,000 was recognized as training and other costs
associated with the agreement were incurred. Revenue was not recognized for the
remaining $10,000 due to a minimum royalty liability of $10,000 associated with
the agreement. The agreement requires the Company to pay Microsoft royalties on
certain net revenues for business relating to Microsoft products. The royalty
period commenced in August 2000 and ends on the earlier of the date on which
the Company makes the maximum aggregate royalty payment of $10,000 or June 30,
2006. If aggregate payments on June 30, 2006 are less than $10,000, the Company
is obligated to make a final payment for the difference. The royalty for the
years ended June 30, 2002 and June 30, 2001 are $0 and $623, respectively.
12. Commitments and Contingencies
The Company is involved in legal proceedings, claims and litigation arising
in the ordinary course of business. Additionally, under its contracts with the
U.S. Government, the Company is subject to audit by the
50
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
Defense Contract Audit Agency, which could result in adjustments of amounts
previously billed. Based on its current assessment, management believes that
the Company's financial statements include adequate provision for estimated
costs and losses that may ultimately be incurred with regard to such matters.
In connection with the Separation, the Company indemnified KPMG LLP and its
partners for any liabilities or losses relating to the Company or otherwise
assigned to the Company. Similarly, KPMG LLP and its partners have indemnified
the Company for any liabilities or losses relating to or otherwise assigned to
KPMG LLP's assurance and tax businesses.
Transition Services Provided By KPMG LLP: As described in Note 17, when our
Company terminates infrastructure services provided by KPMG LLP under the
transition services agreement, we are potentially liable for the payment of
termination costs, as defined in the agreement, incurred by KPMG LLP in
connection with winding down and terminating such services. KPMG LLP and the
Company have agreed that during the term of the transition services agreement
(which terminates no later than February 8, 2004 for non-technology services
and February 8, 2005 for technology-related services), the parties will work
together to minimize any termination costs (including transitioning personnel
and contracts from KPMG LLP to our Company), and our Company will wind down its
receipt of services from KPMG LLP and develop its own internal infrastructure
and support capabilities or seek third party providers of such services. In
fiscal 2002, the Company terminated certain human resources, knowledge
management, office support services, purchasing and training services for which
$1,000 in termination costs was paid to KPMG LLP. The Company continues to
receive from KPMG LLP services relating to information technology (such as
telecommunications and user services), financial systems, human resources
systems, occupancy and office support services in facilities used by both the
Company and KPMG LLP, and financing of capital assets used in the provisioning
of transition services. The Company has given notice to KPMG LLP of its intent
to terminate certain services in fiscal 2003 for which the amount of
termination costs have either not been determined by KPMG LLP or not agreed
upon by the parties. In July 2002, the Company paid KPMG LLP $30,754
representing the unamortized costs of leasehold improvements purchased by KPMG
LLP and used exclusively by the Company. Based on information currently
available, the Company anticipates paying KPMG LLP approximately $40,000 to
$60,000 for the sale and transfer of additional capital assets (such as
computer equipment, furniture and leasehold improvements) currently used by the
Company through the transition services agreement (for which usage charges are
included in the monthly costs under the agreement). In August 2002, the Company
and KPMG LLP reached a settlement relating to a dispute about the determination
of costs under the transition services agreement, resulting in KPMG LLP paying
the Company $8,444. The amount of termination costs that the Company will pay
to KPMG LLP depends upon the timing of service terminations, the ability of the
parties to work together to minimize the costs, and the amount of payments
required under existing contracts with third parties for services provided to
the Company by KPMG LLP and which can continue to be obtained directly by the
Company thereafter. Accordingly, the amount of termination costs that the
Company will pay to KPMG LLP in the future cannot be reasonably estimated at
this time. The Company believes that the amount of termination costs yet to be
assessed will not have a material adverse effect on the Company's consolidated
financial position, cash flows, or liquidity. Whether such amounts could have a
material effect on the results of operations in a particular quarter or fiscal
year cannot be determined at this time.
Occupancy: The Company leases certain of its office facilities under
various operating leases, including subleases with KPMG LLP. Subleases with
KPMG LLP are for periods that coincide with the KPMG LLP lease periods which
run through 2014. The rental cost is based on square footage utilized by the
Company. Future aggregate minimum lease payments under operating leases for the
years ending June 30 are as follows: 2003-$50,900, 2004-$45,700, 2005-$44,400,
2006-$42,300, 2007-$39,000, thereafter-$155,500. Total rent expense related to
the operating leases was approximately $53,700 for the year ended June 30, 2002
and $48,000 for the year ended June 30, 2001. Prior to fiscal 2001, all rent
expense was allocated to the Company by KPMG LLP (see Note 17).
51
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
Financial Guarantees: In the ordinary course of business, the Company enters
into and is contingently liable to various insurance companies under bid and
performance bonds, totaling approximately $96,000 at June 30, 2002. These bonds
serve as collateral for performance under certain client contracts, as well as
guarantee bids in proposals to provide services to certain clients. Management
does not expect any material losses to result from the issuance of these
guarantees since payment is not likely to be required. If the Company were
required to obtain replacement bonds for those outstanding as of June 30, 2002,
we believe that the replacement costs would not vary significantly from the
actual fees paid which ranged from 0.5% to 1% of the face value of the bond.
13. Series A Mandatorily Redeemable Convertible Preferred Stock
On January 31, 2000, Cisco Systems, Inc. ("Cisco") purchased 5.0 million
shares of the Company's Series A Mandatorily Redeemable Convertible Preferred
Stock ("Series A Preferred Stock") for $1,050,000. The Series A Preferred Stock
had no voting rights except for the election of two directors and in connection
with certain fundamental events such as mergers, sale of substantially all
assets and charter amendments; carried a 6% annual dividend, payable quarterly;
and was convertible at the holder's option, upon the consummation of the
initial public offering, into the Company's common stock at a beneficial
conversion rate of 80% of the IPO price. The Company agreed not to enter into
an agreement relating to a merger, consolidation or other business combination
involving any of four specified companies during the five year period following
the issuance of the Series A Preferred Stock to Cisco. If the Company were to
enter into any such transaction, the Company could be obligated to repurchase
any outstanding securities of the Company held by Cisco and to make an
additional cash payment to Cisco equal to the Company's consolidated revenues
for the twelve months preceding the transaction.
On September 15, 2000, Cisco and KPMG LLP agreed that, immediately prior to
the closing of an IPO, KPMG LLP would purchase 2.5 million shares of Series A
Preferred Stock (half of such shares then outstanding and held by Cisco) from
Cisco for $525,000. Under this agreement, the Company agreed to repurchase that
number of shares of our Series A Preferred Stock resulting in Cisco owning 9.9%
of our common stock as of the date of our initial public offering. On November
29, 2000, KPMG LLP agreed to convert all of the preferred stock it acquired at
the initial public offering price without any conversion discount.
In February 2001, in connection with our IPO, the Company repurchased
approximately 1.4 million shares of Series A Preferred Stock from Cisco for
$378,329 in cash; Cisco and KPMG LLP converted the remaining 3.6 million shares
into 44.6 million shares of our common stock. The net amount of the beneficial
conversion feature, after deducting the $131,250 conversion discount foregone
by KPMG LLP, was $131,250 and reflected as a non-cash charge to net income
(loss) available to common stockholders in the fiscal 2001 Consolidated
Statement of Operations.
14. Investment in Affiliate
On June 3, 1999, the Company and Qwest Communications International Inc.
("Qwest") formed Qwest Cyber.Solutions, LLC ("QCS"), a company involved in
applications outsourcing. Through the contribution of net assets of Softline,
the Company acquired a 49% interest in QCS, with the remaining 51% interest
being held by Qwest. The Company's cost basis of its investment in QCS exceeded
its proportionate share of QCS's net assets by $39,244.
QCS periodically required additional capital to fund its operations and
acquire equipment to support the expansion of its business and 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 $63,330 ($58,482 on an after-tax basis) was
52
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
written off through a non-cash charge to earnings in December 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
marketing relationship with QCS. The Company's marketing relationship with QCS
extends through June 2, 2009 or through the date of an initial public offering
by QCS, if earlier.
The following is a summary of equity losses of affiliate and loss on
redemption of equity interest in affiliate:
Consolidated Combined
-------------------- ------------
Year Five Months Seven Months
Ended Ended Ended
June 30, June 30, January 31,
2001 2000 2000
-------- ----------- ------------
Interest in QCS's losses (49%)....................................... $(10,728) $(11,711) $ (9,277)
Amortization of excess investment in QCS............................. (1,961) (4,101) (5,097)
Loss on redemption of equity interest in QCS ($58,482 on an after-tax
basis)............................................................. (63,330) -- --
-------- -------- --------
Total............................................................. $(76,019) $(15,812) $(14,374)
======== ======== ========
15. Capital Stock and Option Awards
Long-Term Incentive Plan
On January 31, 2000, the Company adopted the 2000 Long-Term Incentive Plan
(the "Plan"), pursuant to which the Company is authorized to grant stock
options and other awards to its employees and directors. The number of shares
of common stock that are authorized for grants or awards under the Plan (the
"Authorized Shares") is equal to the greater of (i) 35,084,158 shares of common
stock and (ii) 25% of the sum of (x) the number of issued and outstanding
shares of common stock of the Company and (y) the Authorized Shares. Stock
options are granted with an exercise price equal to the common stock's fair
market value at the date of grant. Stock options granted have 10 year terms and
generally vest over four years from the date of grant.
In connection with our initial public offering, the Company granted 16.1
million stock options with an exercise price of $18 per share to employees.
These options vest over three and one-half years with 25% vesting on August 8,
2001 and an additional 25% vesting on August 8 in each of the years 2002
through 2004.
On February 1, 2002, the Company filed with the Securities and Exchange
Commission a tender offer relating to all stock options with an exercise price
of $55.50. Under the offering, holders of such options (other than executive
officers and directors of the Company) had the opportunity to surrender their
options as of March 1, 2002 and, in exchange, receive an equal number of
options to be issued in September 2002 with an exercise price equal to 110% of
the then fair market value of the Company's common stock. The replacement
options will vest ratably over three years. Approximately 4.7 million options
were tendered for cancellation and exchange under the offering (see Note 23).
53
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
Stock award and option activity during the periods indicated was as follows:
Options Outstanding
Shares -----------------------------
Available for Weighted Average
Grant Number Price per Option
------------- ----------- ----------------
Authorized at January 31, 2000... 35,084,158 -- --
Options granted............... (9,165,014) 9,165,014 $55.50
Options exercised............. -- -- --
Options forfeited............. 1,116,831 (1,116,831) $55.50
Options expired............... -- -- --
----------- ----------- ------
Balance at June 30, 2000......... 27,035,975 8,048,183 $55.50
Options granted............... (22,842,745) 22,842,745 $18.07
Options exercised............. -- -- --
Options forfeited............. 3,539,671 (3,539,671) $36.62
Options expired............... -- -- --
----------- ----------- ------
Balance at June 30, 2001......... 7,732,901 27,351,257 $27.31
Additional shares authorized.. 17,471,228 -- --
Options granted............... (14,270,171) 14,270,171 $13.63
Options exercised............. -- (209,146) $17.23
Options forfeited/tendered.... 10,620,348 (10,620,348) $38.49
Options expired............... -- -- --
Restricted stock awards....... (420,000) -- --
----------- ----------- ------
Balance at June 30, 2002......... 21,134,306 30,791,934 $17.17
=========== =========== ======
Information about stock options outstanding at June 30, 2002 is as follows:
Outstanding Options Options Exercisable
----------------------------------------------- ------------------------------
Weighted Average
Number Remaining Number
Outstanding Contractual Life Weighted Average Exercisable Weighted Average
Range of Exercise Price June 30, 2002 (Years) Exercise Price June 30, 2002 Exercise Price
----------------------- ------------- ---------------- ---------------- ------------- ----------------
$ 9.55-$11.09..... 39,618 9.1 $10.99 -- --
$11.10-$16.64..... 12,427,702 9.0 $13.36 180,660 $14.09
$16.65-$22.19..... 17,381,830 8.5 $18.03 4,396,750 $18.00
$22.20-$27.75..... 108,026 8.5 $22.63 28,123 $22.64
$55.50............ 834,758 7.2 $55.50 428,133 $55.50
---------- ---------
30,791,934 8.7 $17.17 5,033,666 $21.08
========== =========
Under the provisions of the 2000 Long-Term Incentive Plan, the Company may,
at its discretion, grant restricted stock awards to certain of its officers and
employees. In fiscal 2002, 420,000 restricted shares of common stock were
awarded. Holders of restricted stock have all the rights of other stockholders,
subject to certain restrictions and forfeiture provisions; such restricted
stock is considered to be issued and outstanding. Restrictions on the shares
will expire over three years. The market value of shares awarded was $5,586 and
was recorded as unearned compensation. Unearned compensation is being amortized
to expense over the three year vesting period and amounted to $1,862 in fiscal
2002.
On October 12, 2000, the Company adopted the ESPP that allows eligible
employees to purchase shares of the Company's common stock at a discount,
through accumulated payroll deductions of 1% to 15% of their
54
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
compensation, up to a maximum of $25. Under the ESPP, shares of the Company's
common stock are purchased at 85% of the lesser of the fair market value at the
beginning of the twenty-four month offering period or the fair market value at
the end of each six-month purchase period. The ESPP became effective on
February 1, 2001, and purchases were made at the end of the six-month purchase
periods, on July 31, 2001 and January 31, 2002. During these two purchase
periods, employees purchased a total of 2,280,341 shares for $26,674. At June
30, 2002, 6,212,852 common shares remained available for issue under the ESPP.
Pro Forma Fair Value Disclosures
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123 assuming the Company had accounted for its stock-based
awards to employees under the fair value method of SFAS No. 123, and amortized
as a charge to earnings the estimated fair value of options and other stock
awards over the awards' vesting period. The weighted average fair value of
stock options granted during the years ended June 30, 2002 and June 30, 2001,
and the five months ended June 30, 2000 were $8.64, $12.45 and $35.26,
respectively. The fair value of options granted was estimated using the
Black-Scholes option-pricing model with the following weighted average
assumptions:
Stock
Price Risk-Free Expected
Expected Interest Expected Dividend
Volatility Rate Life Yield
---------- --------- -------- --------
Year ended June 30, 2002................ 69.00% 4.37% 6 --
Year ended June 30, 2001................ 81.25% 5.31% 5 --
Five months ended June 30, 2000......... 70.00% 6.49% 5 --
The Company's pro forma information follows:
Year Year Five Months
Ended Ended Ended
June 30, June 30, June 30,
2002 2001 2000
-------- --------- -----------
As Reported:
Net loss applicable to common stockholders..... $(26,898) $(127,971) $(43,794)
Loss per share--diluted........................ $ (0.17) $ (1.19) $ (0.58)
Pro Forma Information:
Net loss applicable to common stockholders..... $(95,431) $(212,288) $(79,190)
Loss per share--diluted........................ $ (0.60) $ (1.97) $ (1.04)
On February 16, 2000, the Company issued stock awards of 297,324 shares to
certain employees as part of the Separation of KPMG LLP's Consulting
Businesses. In connection with these awards, the Company also provided loans of
$5,845 to the grantees for personal income taxes attributed to the awards. The
loans are secured by the shares of common stock issued to the employees, and
bear interest at 6.2% per annum. Principal and accrued interest on the loans
are due no later than February 16, 2005. These awards were fully vested at the
date of grant and, accordingly, the fair value of the awards of $16,500 was
recorded as compensation expense at the award date. Moreover, the Company
provided additional loans to employees of $1,588 at an interest rate of 4.63%
in April 2001, and $1,672 to executive officers at an interest rate of 4.5% in
October 2001. In the event the value of the Company's stock is less than the
aggregate principal and interest of the loans upon the maturity in August 2003
of the loans that were provided on February 16, 2000 and in April 2001, the
employees can elect to surrender their shares relating to the stock award and
the Company would take a charge to earnings for the excess value attributed to
the loans. The loans that were provided to the executive officers in October
2001 are full recourse loans.
55
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
Common Stock Repurchase
In August 2001, the Board of Directors authorized the Company to repurchase
up to $100,000 of its common stock. As of June 30, 2002, the Company had
repurchased 2.8 million shares of its common stock at an aggregated purchase
price of $35,727. The repurchased shares are held in treasury.
Preferred Stock
The Company has 10,000,000 authorized shares of $0.01 par value Preferred
Stock. An aggregate of 1,000,000 shares of Preferred Stock have been designated
as Series A Junior Participating Preferred Stock for issuance in connection
with the Company's Shareholder Rights Plan.
Shareholder Rights Plan
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 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 at a purchase price of $90,
subject to adjustment.
The Rights will trade automatically with the Common Stock and will not be
exercisable until a person or group has become an "acquiring person" by
acquiring 15% or more of the Company's outstanding Common Stock, or a person or
group commences a tender offer that will result in such a person or group
owning 15% or more of the Company's outstanding Common Stock. Upon announcement
that any person or group has become an acquiring person, each Right will
entitle all rightholders (other than the acquiring person) to purchase, for the
exercise price of $90, a number of shares of the Company's Common Stock having
a market value equal to twice the exercise price. Rightholders would also be
entitled to purchase Common Stock of the acquiring person having a value of
twice the exercise price if, after a person had become an acquiring person, the
Company were to enter into certain mergers or other transactions. If any person
becomes an acquiring person, the Board of Directors may, at its option and
subject to certain limitations, exchange one share of Common Stock for each
right.
The rights have certain anti-takeover effects, in that they would cause
substantial dilution to a person or group that attempts to acquire a
significant interest in the Company on terms not approved by the Board of
Directors. In the event that the Board of Directors determines a transaction to
be in the best interests of the Company and its stockholders, the Board of
Directors may redeem the Rights for $0.01 per share at any time prior to a
person or group becoming an acquiring person. The Rights will expire on October
2, 2011.
56
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
16. Income Taxes
The Company reported income before taxes and cumulative effect of change in
accounting principle of $134,586, $136,848 and $11,537, net of foreign losses
of approximately $10,365, $14,600 and $4,500, for the years ended June 30, 2002
and 2001, and for the five months ended June 30, 2000, respectively.
The components of income tax expense are as follows:
Year Year Five Months
Ended Ended Ended
June 30, June 30, June 30,
2002 2001 2000
-------- -------- -----------
Current:
Federal................................................ $ 65,175 $ 86,487 $10,869
State and local........................................ 18,584 24,446 3,071
Foreign................................................ 7,783 2,780 1,589
-------- -------- -------
Total current...................................... 91,542 113,713 15,529
-------- -------- -------
Deferred:
Federal................................................ (8,281) (8,635) 10,662
State and local........................................ (1,456) (2,440) 3,148
Foreign................................................ (281) (741) --
-------- -------- -------
Total deferred..................................... (10,018) (11,816) 13,810
-------- -------- -------
Total.............................................. $ 81,524 $101,897 $29,339
======== ======== =======
The following table presents the principal reasons for the difference
between the effective income tax rate from continuing operations and the U.S.
federal statutory income tax rate:
Year Year Five Months
Ended Ended Ended
June 30, June 30, June 30,
2002 2001 2000
-------- -------- -----------
U.S. federal statutory income tax rate...................... 35.0% 35.0% 35.0%
Change in valuation allowance............................... 10.0% 4.6% 34.0%
State taxes, net of federal benefit......................... 8.3% 10.5% 35.0%
Nondeductible meals and entertainment expense............... 4.3% 5.4% 31.4%
Foreign taxes............................................... 1.0% 1.1% 13.8%
Other, net.................................................. 2.0% 2.0% --
Nondeductible equity losses of affiliate and loss on
redemption of equity interest in affiliate................ -- 15.3% 35.5%
Nondeductible goodwill amortization......................... -- 0.6% 19.6%
Nonrecurring taxable gain on employee stock award........... -- -- 50.0%
---- ---- -----
Effective income tax rate................................... 60.6% 74.5% 254.3%
==== ==== =====
57
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
The temporary differences which give rise to a significant portion of
deferred income tax assets and liabilities are as follows:
Year Year
Ended Ended
June 30, June 30,
2002 2001
-------- --------
Deferred income tax assets:
Net operating loss carryforwards............... $ 30,400 $ 26,000
Accrued compensation........................... 18,800 23,600
Capital loss carryforward...................... 10,500 --
Allowance for doubtful accounts................ 10,900 11,400
Depreciation and amortization.................. 9,700 13,900
Accrued liabilities............................ 7,900 --
Goodwill....................................... 4,800 5,900
Foreign currency translation................... 1,100 2,300
Reserve for claims............................. 800 1,600
-------- --------
Total gross deferred income taxes.............. 94,900 84,700
Less valuation allowance.......................... (41,000) (29,100)
-------- --------
Total net deferred income tax assets.............. 53,900 55,600
-------- --------
Deferred income tax liabilities:
401(k) plan.................................... 8,500 8,200
Intangible assets.............................. 3,406 13,005
Accrued liabilities............................ -- 100
-------- --------
Total deferred income tax liabilities.......... 11,906 21,305
-------- --------
Net deferred income tax asset..................... $ 41,994 $ 34,295
======== ========
The Company has U.S. net operating loss carryforwards at June 30, 2002 of
approximately $47,000 which expire at various dates through 2020. The Company
also has foreign net operating loss carryforwards at June 30, 2002 of
approximately $32,000 which expire at various dates prescribed in foreign law.
A valuation allowance has been recorded due to the uncertainty of the
recognition of certain deferred income tax assets, primarily the net operating
losses of certain U.S. and foreign subsidiaries, as well as capital loss
carryforwards on certain U.S. entities. The net changes in the valuation
allowance for the years ended June 30, 2002 and 2001, and for the five months
ended June 30, 2000 were $11,900, $6,200 and $9,200, respectively.
No provision has been made for federal income taxes on unremitted earnings
of the Company's foreign subsidiaries (approximately $20 million of earnings as
of June 30, 2002), since the Company plans to permanently reinvest all such
earnings. It is not practicable to compute the estimated deferred tax liability
on these earnings.
17. Transactions with Related Parties
Cisco
We entered in to an alliance agreement with Cisco Systems, Inc. on December
29, 1999. At the same time we executed this alliance agreement, we also entered
into an agreement with Cisco pursuant to which Cisco purchased 5,000,000 shares
of our Series A Mandatorily Redeemable Convertible Preferred Stock (see Note
13). The term of the alliance agreement is five years, and may be extended as
mutually agreed by the Company and Cisco.
58
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
KPMG LLP
Infrastructure Services. Historically, certain infrastructure services
relating to KPMG LLP's assurance, tax and consulting businesses have been
provided by KPMG LLP on a centralized basis. These services include the
following: human resources, employee benefits, benefits administration, finance
and accounting, risk management, training, facilities management, legal,
marketing, technology, data processing, and other administrative and executive
functions. The financial statements for all historical periods include
allocations of these centralized costs based on the actual costs of such
services, on substantially the same basis as provided for in the original
outsourcing agreement, as discussed below.
The Company and KPMG LLP entered into an outsourcing agreement effective
January 31, 2000, whereby the Company received and was charged for services
performed by KPMG LLP. Certain services provided to us pursuant to this
original outsourcing agreement were not necessary for us to operate our
business as an independent company since they were duplicative or were
performed by us internally. In recognition of this fact and in anticipation of
consummation of our IPO, the Company and KPMG LLP entered into and amended and
restated outsourcing agreement effective July 1, 2000, eliminating the services
related costs that we did not require. Thereafter, on February 13, 2001, the
Company and KPMG LLP entered into a transition services agreement whereby we
receive and are charged for infrastructure services on substantially the same
basis as the amended and restated outsourcing agreement. The allocation of
costs to the Company for such services is based on actual costs incurred by
KPMG LLP and are allocated among KPMG LLP's assurance and tax businesses and
the Company primarily on the basis of full-time equivalent personnel and actual
usage (specific identification).
The transition services agreement expires on the fourth anniversary of our
February 8, 2001 initial public offering with regard to the technology
infrastructure costs, and on the third anniversary of the IPO with regard to
all other costs except for those relating to facilities costs. With regard to
facilities costs, the Company and KPMG LLP have entered into arrangements
pursuant to which our Company subleases from KPMG LLP office space that was
formally allocated to the Company under the outsourcing agreement. The terms of
the arrangements are substantially equivalent to those under the original
outsourcing agreement, and will extend over the remaining period covered by the
lease agreement between KPMG LLP and the lessor. If the Company terminates any
services under the transition services agreement prior to the end of the term
for such services, the Company is 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 KPMG LLP's shared infrastructure
and national support capabilities. It is the intent of the parties that, during
the term of the transition services 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 or by engaging
third party providers of such services (see Note 12).
During fiscal 2002, the Company began to wind down the services provided by
KPMG LLP. In July 2001, the Company and KPMG LLP agreed that the Company would
terminate certain services relating to human resources, training, purchasing,
facilities management and knowledge management. Termination costs associated
with these services paid by the Company to KPMG LLP in fiscal 2002 was $1,000.
Retirement and Benefit Plans. Historically, all of KPMG LLP's employees,
including those involved in KPMG LLP's Consulting Business, participated in
various KPMG LLP sponsored benefit and retirement plans. KPMG LLP's costs with
respect to these plans have been allocated among KPMG LLP's assurance, tax and
consulting businesses. KPMG LLP has retained the assets and liabilities under
these plans, other than those
59
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
relating to KPMG LLP's 401(k) plan, with respect to all current and former
employees of the Company. The assets related to the Company's employees who
participated in KPMG LLP's 401(k) plan were transferred into a new Company
sponsored 401(k) plan (see Note 19). From January 31, 2000, the date of the
Separation, no further benefits will accrue to the Company's employees under
KPMG LLP's retirement and benefit plans.
Interest Expense. Until January 31, 2000, cash management functions for
KPMG LLP's assurance, tax and consulting businesses were performed on a
centralized basis by KPMG LLP. Further, a substantial portion of KPMG LLP's
total cash requirements were obtained through utilization of partners'
available capital account balances. In return, the KPMG LLP partners were paid
interest on their total capital account balances at floating interest rates
based on the prime rate plus 1%. Total interest expense, net of interest
earned, incurred by KPMG LLP for all historical periods, including interest
paid to partners, has been allocated between KPMG LLP's assurance, tax and
consulting businesses based on relative average balances of accounts receivable
and unbilled revenues. Effective July 1, 2000, the Company was no longer
allocated interest by KPMG LLP.
Total expenses allocated to the Company with regard to occupancy costs,
retirement and benefit plans, interest expense and other infrastructure
services are as follows:
Consolidated Combined
----------------------------- ------------
Year Year Five Months Seven Months
Ended Ended Ended Ended
June 30, June 30, June 30, January 31,
2002 2001 2000 2000
-------- -------- ----------- ------------
Occupancy costs......................... $ 29,325 $ 55,502 $ 24,144 $ 32,570
Retirement and benefit plans............ -- -- 11,293 32,848
Interest expense........................ -- -- 13,680 23,504
Other infrastructure service costs...... 138,282 179,393 89,723 123,341
-------- -------- -------- --------
Total............................ $167,607 $234,895 $138,840 $212,263
======== ======== ======== ========
Amounts included in:
Other costs of service............... $ 29,325 $ 64,944 $ 27,400 $ 46,302
Selling, general and administrative
expenses........................... 138,282 169,951 97,760 142,457
Interest expense..................... -- -- 13,680 23,504
-------- -------- -------- --------
$167,607 $234,895 $138,840 $212,263
======== ======== ======== ========
Internal Use Software Costs. In September 2000, the Company purchased
$16,100 of internal use software from KPMG LLP at its net book value. This
purchase was made in connection with the Separation.
IPO Transaction Costs. In October 2000, KPMG LLP and the Company agreed to
pool all IPO transaction costs (such as legal, accounting and printing costs)
and apportion them to the companies based on the relative number of shares sold
in the initial public offering. Accordingly, the Company incurred transaction
costs of approximately $28,237, which were accounted for as a reduction in
proceeds from the transaction.
Related Party Revenues and Costs of Service. The Company has periodically
provided consulting services directly to KPMG LLP and other affiliates.
Additionally, KPMG LLP's assurance and tax businesses sometimes utilized the
Company's consultants in servicing their assurance and tax clients.
Correspondingly, the Company
60
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
sometimes utilized KPMG LLP assurance and tax professionals in servicing their
consulting clients. Management believes that the revenues earned and fees paid
between KPMG LLP's assurance and tax businesses, other affiliates and the
Company were determined on a basis substantially equivalent to what would have
been earned and paid in similar transactions with unrelated parties. The
revenues earned from, and costs paid to, KPMG LLP as a result of these services
are summarized as follows:
Year Year Five Months Seven Months
Ended Ended Ended Ended
June 30, June 30, June 30, January 31,
2002 2001 2000 2000
-------- -------- ----------- ------------
Total revenue................. $11,962 $53,554 $44,356 $55,378
======= ======= ======= =======
Total costs of service........ $ 6,961 $35,581 $ 5,651 $10,078
======= ======= ======= =======
Other Related Parties
Revenues earned from other related parties were as follows:
Year Year Five Months Seven Months
Ended Ended Ended Ended
June 30, June 30, June 30, January 31,
2002 2001 2000 2000
-------- -------- ----------- ------------
Qwest (see Note 14)........... $ -- $15,635(1) $12,980 $22,260
Cisco (see Note 13)........... 6,770 18,087 9,609 3,800
------ ------- ------- -------
$6,770 $33,722 $22,589 $26,060
====== ======= ======= =======
--------
(1) Represents revenues through December 27, 2000, as Qwest ceased to be a
related party as of that date (see Note 14).
Accounts receivable and unbilled revenues from other related parties were
$692 from Cisco at June 30, 2002 and $16,650 and $1,542 from Qwest and Cisco,
respectively, at June 30, 2001.
18. Acquisitions
All 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. Acquisitions completed after June 30, 2001 have been accounted for
in accordance with SFAS No. 141, "Business Combinations." During the three
years ended June 30, 2002, most acquisitions have been made to increase the
Company's multinational service delivery capabilities in the following regions
(amounts represent aggregate purchase prices in the region): North America
($52,765), Latin America ($36,070), Asia Pacific ($79,109), Europe ($35,880),
and other ($15,500).
Southeast Asia regional consulting businesses of KPMG International Member
Firms: On August 2, 2001, the Company acquired regional consulting practices
in Southeast Asia, consisting of businesses and marketing rights of KPMG
International member firms in Hong Kong, Malaysia, Singapore, Taiwan and China
for $16,931 ($6,795 cash was paid at closing). The allocation of the purchase
price to acquired assets and liabilities resulted in $15,259 of goodwill and
$2,302 of purchased intangibles. Goodwill is expected to be non-deductible for
foreign income tax purposes. However, the goodwill is expected to have U.S.
income tax basis that may have a beneficial impact on future foreign tax
credits upon possible repatriation of earnings.
61
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
Australian consulting business of KPMG International Member Firm: On
October 3, 2001, the Company acquired the consulting practice of the KPMG
International member firm in Australia for $28,900 (of which $26,211 was paid
in cash at closing). The allocation of the purchase price to acquired assets
and liabilities resulted in the allocation of $22,114 to goodwill and $10,754
to purchased intangibles. Goodwill is expected to be non-deductible for foreign
income tax purposes. However, the goodwill is expected to have U.S. income tax
basis that may have a beneficial impact on future foreign tax credits upon
possible repatriation of earnings.
Andersen Business Consulting, Hong Kong: On May 1, 2002, the Company
acquired certain assets of the consulting practice of Arthur Andersen & Co.,
Hong Kong for $373, which was allocated to unbilled revenues.
Andersen Business Consulting, China: On May 1, 2002, the Company acquired
certain assets of the consulting practice of Arthur Andersen (Shanghai)
Business Consulting Co., Ltd for $1,236, which was allocated to unbilled
revenues.
Andersen Business Consulting, Australia: On June 4, 2002, the Company
acquired certain assets of the consulting practice of Arthur Andersen & Co.,
Australia for nominal consideration. The allocation of the purchase price to
the acquired assets and liabilities assumed resulted in $169 of purchased
intangibles.
During the year ended June 30, 2001, the Company acquired numerous
businesses for an aggregate purchase price of $56,971, which resulted in $2,600
and $60,400 being allocated to assembled workforce and goodwill, respectively.
The businesses acquired were the Colombian, Irish, Peruvian, Brazilian and
Netherlands Antilles consulting practices of the respective KPMG International
member firms.
During the year ended June 30, 2000, the Company acquired numerous
businesses for an aggregate purchase price of $114,744, which resulted in
$20,300 and $73,300 being allocated to assembled workforce and goodwill,
respectively. The businesses acquired were as follows: Studio Verso and WebVibe
Corporation, and the Mexican, Canadian, Japanese, Korean, Central American, New
Zealand, Venezuelan and Argentinean consulting practices of the respective KPMG
International member firms.
The pro forma effects on operations of these acquisitions were not material
for the years ended June 30, 2002, 2001 and 2000. Refer to Note 23 for a
discussion of acquisitions made subsequent to June 30, 2002.
19. Employee Benefits
The Company sponsors a qualified 401(k) defined contribution plan (the
"Plan") covering substantially all of its employees. Participants are permitted
(subject to a maximum permissible contribution under the Internal Revenue Code
for calendar year 2002 of $11) to contribute up to 20% of their earnings to the
Plan. Matching contributions by the Company are discretionary and range between
0%-50% of the first 6% of employees' earnings contributions. Employees may
elect to invest their retirement funds in the Company's common stock, but no
provisions of the plan require them to do so. In addition, the Plan does not
restrict the ability of employees to dispose of any of the Company's common
stock that they hold in their retirement funds. Company contributions, net of
forfeitures, for the years ended June 30, 2002 and June 30, 2001 and for the
five months ended June 30, 2000 were $1,159, $13,640 and $1,966, respectively,
and were made in cash.
62
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
20. Reduction in Workforce and Impairment Charges
Reduction in Workforce
In June 2002, November 2001 and April 2001, the Company recorded $3,594,
$17,729 and $19,968, respectively, as charges for severance and termination
benefits related to reductions in workforce. The reduction in force affected
188 employees in June 2002, 325 employees in November 2001, and 575 employees
in April 2001. All reduction in force actions were the result of balancing the
Company's resources with market demand for services. All of the affected
employees have been terminated and are no longer employed by the Company.
Severance
Accrual
---------
Balance at June 30, 2001...................................... $ 4,236
Fiscal 2002 charges........................................... 21,323
Payments...................................................... (24,397)
--------
Balance at June 30, 2002 (to be disbursed by February 2003)... $ 1,162
========
Impairment Charges
The Company recorded the following impairment charges:
. Impairment charges related to software licenses held for resale due to
lower than anticipated sales in the amount of $7,600 and $7,827, during
fiscal 2002 and 2001, respectively ($5.1 million of the fiscal 2002
charge was recorded during the three months ended June 30, 2002), and
$4,000 during the five months ended June 30, 2000,
. Impairment charge of $4,000 during the five months ended June 30, 2000
related to goodwill, and
. During the three months ended June 30, 2002, $16,022 was recorded as an
impairment charge to write-off the value of the Company's portfolio of
equity investments at June 30, 2002.
21. Universal Shelf Registration Statement
On March 8, 2002, the Company filed a $1,000,000 universal shelf
registration statement with the Securities and Exchange Commission. This
registration statement, which became effective on March 18, 2002, allows the
Company to issue various types of securities, including debt, preferred stock,
common stock and warrants to purchase common stock. To date, the Company has
not issued any securities under this shelf registration statement.
22. Segment Information
The Company's segment information has been prepared in accordance with SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information."
Segments were determined based on the groups in which the Company has
industry-specific knowledge. 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, Canadian operations were transferred from
International to the five industry groups, resulting in a North America region.
The Company's chief operating decision maker, the Chairman and Chief Executive
Officer, evaluates performance and allocates resources based upon the industry
groups. Accounting policies of the segments are the same as those described in
the summary of significant accounting policies (see Note 2). Performance of the
63
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
segments is evaluated on operating income excluding the costs of infrastructure
functions (such as information systems, finance and accounting, human
resources, legal and marketing). Inter-segment sales were made at prices
approximating current market value. Prior year information has been
reclassified to reflect current year changes.
Consolidated Combined
---------------------------------- ------------
Five Months Seven Months
Year Ended Year Ended Ended Ended
June 30, June 30, June 30, January 31,
2002 2001 2000 2000
---------- ---------- ----------- ------------
Revenues
Public Services...................... $ 966,422 $ 871,597 $ 345,673 $ 420,111
Communications and Content........... 473,269 551,089 187,050 157,838
Financial Services................... 229,993 463,930 236,488 291,976
Consumer and Industrial Markets...... 311,144 367,433 163,160 200,637
High Technology...................... 194,751 459,448 149,686 174,011
International/Corporate(1)........... 192,048 142,327 23,109 20,245
---------- ---------- ---------- ----------
Total............................ $2,367,627 $2,855,824 $1,105,166 $1,264,818
========== ========== ========== ==========
Depreciation and Amortization
Public Services...................... $ 10,203 $ 8,469 $ 4,659 $ 3,710
Communications and Content........... 2,710 8,192 3,282 1,176
Financial Services................... 1,911 3,895 2,264 3,287
Consumer and Industrial Markets...... 1,118 4,877 2,325 3,625
High Technology...................... 1,186 7,916 4,473 5,093
International/Corporate(1)........... 32,192 27,673 3,646 5,513
---------- ---------- ---------- ----------
Total............................ $ 49,320 $ 61,022 $ 20,649 $ 22,404
========== ========== ========== ==========
Interest Expense(2)
Public Services...................... $ 17,596 $ 17,312 $ 9,595 $ 12,075
Communications and Content........... 8,898 12,662 3,449 2,552
Financial Services................... 3,202 9,124 3,804 3,906
Consumer and Industrial Markets...... 3,973 4,972 2,389 3,056
High Technology...................... 5,851 7,035 2,697 2,573
International/Corporate(1)........... (37,272) (33,930) (5,628) 3,177
---------- ---------- ---------- ----------
Total............................ $ 2,248 $ 17,175 $ 16,306 $ 27,339
========== ========== ========== ==========
Operating Income
Public Services...................... $ 311,149 $ 243,536 $ 59,036 $ 128,255
Communications and Content........... 121,091 132,252 28,872 29,794
Financial Services................... 31,520 59,391 44,770 84,202
Consumer and Industrial Markets...... 79,820 85,460 25,778 51,693
High Technology...................... 38,938 126,607 20,908 46,423
International/Corporate(1)........... (448,828) (426,317) (141,448) (208,390)
---------- ---------- ---------- ----------
Total............................ $ 133,690 $ 220,929 $ 37,916 $ 131,977
========== ========== ========== ==========
Assets(3)
Public Services...................... $ 189,860 $ 206,414 $ 233,174 $ 216,463
Communications and Content........... 75,494 145,152 136,640 97,796
Financial Services................... 29,399 61,616 83,409 80,421
Consumer and Industrial Markets...... 55,979 61,639 63,412 59,263
High Technology...................... 32,744 109,194 64,807 44,225
International/Corporate(1)........... 511,655 415,620 370,196 222,923
---------- ---------- ---------- ----------
Total............................ $ 895,131 $ 999,635 $ 951,638 $ 721,091
========== ========== ========== ==========
64
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
--------
(1) International/Corporate included our investment in QCS, which was not
specific to any individual segment, and includes our international
operations. It also includes infrastructure costs.
(2) Interest expense is allocated to the industry segments based on accounts
receivable and unbilled revenues.
(3) Industry segment assets include accounts receivable, unbilled revenues,
certain software and property and equipment directly attributed to the
industry segment, purchased intangible and goodwill. All other assets are
not allocated to industry segments and are deemed to be corporate assets.
International/Corporate revenues are primarily attributed to international
operations for all periods. Long-lived assets in international locations were
$8,347 at June 30, 2002, $9,019 at June 30, 2001, and $8,981 at June 30, 2000.
Included in consolidated operating income for fiscal 2002 is an impairment
charge of $23,914 which was recorded as follows: $2,500 in public services,
$10,245 in communications and content, $734 in high technology and $10,435 in
international/corporate. During fiscal 2001 an impairment charge of $7,827 was
recorded in public services and during the five months ended June 30, 2000,
$8,000 was recorded in high technology.
23. Subsequent Events
Acquisitions
Subsequent to June 30, 2002, the Company continued to expand its
international operations through the acquisition of KPMG Consulting AG ("KCA")
and transactions with various global Andersen Business Consulting practices.
The following chart provides a summary of these transactions:
Purchase
Relevant Entity Transaction Date Price
--------------- ------------------ --------
Group hire of certain employees formerly associated with Andersen Business
Consulting, United States............................................... July 1, 2002 $ 59,900
Andersen Business Consulting, Switzerland................................. July 1, 2002 6,500
Andersen Business Consulting, Nordics (including Finland, Norway and
Sweden)................................................................. July 1, 2002 5,880
Andersen Business Consulting, Singapore................................... July 1, 2002 220
Andersen Business Consulting, South Korea................................. July 2, 2002 280
Andersen Business Consulting, Peru........................................ August 1, 2002 150
Andersen Business Consulting, Spain....................................... August 1, 2002 27,070
Andersen Business Consulting, Japan....................................... August 1, 2002 19,700
KPMG Consulting AG (the consulting business of the German member of
KPMG International)..................................................... August 22, 2002 638,020
Group hire of certain employees formerly associated with Andersen Business
Consulting, Brazil...................................................... August 23, 2002 220
Andersen Business Consulting, France...................................... September 11, 2002 15,650
Business consulting practice of Ernst & Young, Brazil..................... September 18, 2002 nominal
65
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
The purchase of KCA was paid for through the issuance of 30,471,309 shares
of common stock to the sellers at $11.96 per share and $273,583 in cash. The
preliminary allocation of the purchase price to assets acquired and liabilities
assumed is as follows:
Preliminary
Allocation of
Purchase Price
--------------
Current assets.................... $ 134,000
Goodwill and purchased intangibles 647,000
Other long-lived assets........... 23,000
---------
Total assets................... 804,000
Current liabilities............... (116,000)
Long-term liabilities............. (50,000)
---------
Net assets acquired............... $ 638,000
=========
Purchased intangibles acquired include backlog, market rights and trade
names. Goodwill is expected to be non-deductible for foreign income tax
purposes. However, the goodwill is expected to have U.S. income tax basis that
may have a beneficial impact on future foreign tax credits upon possible
repatriation of earnings. The Company is currently in the process of
determining the allocation of the purchase price to assets acquired and
liabilities assumed in accordance with SFAS No. 141, "Business Combinations"
for all of the transactions noted above.
Financing Arrangements
On August 21, 2002, the Company entered into a $220,000 revolving credit
facility for the purpose of funding the acquisition of KCA. This credit
facility matures on December 15, 2002 and is in addition to the Company's other
credit facilities. The $220,000 revolving credit facility contains the same
financial covenants as the company's existing revolving credit facility (see
Note 8). Borrowings bear interest at either the prime rate, the LIBOR rate plus
a margin ranging from 0.875% to 1.625% or money market rates the option of
which is determinable by the Company. On August 22, 2002, in connection with
the closing of the KPMG Consulting AG acquisition, the Company borrowed
$220,000 under the new facility and $75,000 under the receivables purchase
facility. At August 31, 2002, these borrowings bore interest at 2.965% and
2.219%, respectively.
On August 30, 2002, the Company expanded its yen-denominated line of credit
facility to an aggregate principle balance not to exceed 2 billion Yen
(approximately $16,800). Borrowings under the facility accrue interest of TIBOR
plus 0.90% and are used to finance working capital for the Company's Japanese
operations. There are no covenants under the facility and it matures on August
30, 2003.
Purchase of Capital Assets
On July 18, 2002, the Company purchased $30,754 of capital assets, including
furniture and leasehold improvements, from KPMG LLP at its net book value.
These assets had been used by the Company under the transition services
agreement (for which usage charges had been included in the monthly costs under
the agreement) and will continue to be used in our business.
Issuance of Options Under Tender Offer
On September 3, 2002, in accordance with the February 1, 2002 tender offer
relating to stock options with an exercise price of $55.50, the Company issued
approximately 4,400,000 replacement options at an exercise price of $11.01,
which was 110% of the closing market price on that date (see Note 15).
66
KPMG CONSULTING, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share and per share amounts)
Stock Awards
In connection with the various Andersen Business Consulting Practice
transactions, the Company has committed to issuing approximately 4,000,000
shares of common stock to former partners of those practices as a retentive
measure and for no monetary consideration from such persons. The shares will be
issued in equal one-third increments over a three-year period on the
anniversary date of the respective transactions so long as the recipient
remains employed by the Company. Compensation expense will be recorded over the
three-year period.
Commitment to Re-Branding
On August 7, 2002, the Company announced its commitment to a re-branding
initiative, including changing its name, and expects to spend $20,000 to
$40,000 on this initiative in the first half of fiscal 2003.
67
Item 9. Changes in and Disagreements with Accountants on Accounting and
Finance Disclosure
There were no changes in or disagreements with accountants on accounting and
financial disclosure as defined by Item 304 of Regulation S-K.
PART III.
The information required by Items 10, 11, 12 and 13 (except for certain
information regarding executive officers that is called for by Item 10, which
information is contained in Part I and Equity Compensation Plan information
required by Item 12, which is included below) is incorporated herein by
reference from the definitive proxy statement that the Company intends to file
pursuant to Regulation 14A on or before October 4, 2002.
Item 12. Security Ownership of Certain Beneficial Owners and Management
EQUITY COMPENSATION PLAN INFORMATION
(as of June 30, 2002)
(c)
Number of
securities
remaining
available for
(a) (b) future issuance
Number of Weighted- under equity
securities to be average compensation
issued upon exercise price plans
exercise of of outstanding (excluding
outstanding options, securities
options, warrants warrants and reflected in
Plan Category and rights rights column (a))
------------- ----------------- -------------- ---------------
Equity Compensation Plans Approved by Security Holders 30,791,934 $17.17 27,347,158/(1)(2)/
Equity Compensation Plans Not Approved by Security
Holders............................................. -- -- --
---------- ------ ----------
Total.............................................. 30,791,934 $17.17 27,347,158
========== ====== ==========
--------
(1) Includes 21,134,306 shares of the Company's common stock available for
grants of stock options, stock appreciation rights and other stock-based
awards under the Company's 2000 Long-Term Incentive Plan and 6,212,852
shares of the Company's common stock available for issuance under the
Company's Employee Stock Purchase Plan.
(2) Under the Company's 2000 Long-Term Incentive Plan, the number of shares of
common stock authorized for grants or awards under the plan adjusts
automatically based upon the following formula: authorized shares is equal
to the greater of (i) 35,084,158 shares of common stock and (ii) 25% of the
sum of (x) the number of issued and outstanding shares of common stock and
(y) the number of authorized shares.
PART IV.
Item 14. Controls and Procedures
The management of the Company is responsible for maintaining an effective
system of internal controls. This system is designed to provide reasonable
assurance that assets are adequately safeguarded, and that financial records
accurately reflect all transactions and can be relied upon in all material
respects in the preparation of financial statements. There have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect these controls subsequent to June 30, 2002.
68
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1). The financial statements of the Company required in response to this Item are incorporated by
reference from Item 8 of this Report.
(a)(2). Not applicable.
(a)(3). See the exhibits listed below under Item 14 (c) and Financial Statement Schedule under Item 14(d).
(b). The Company filed no Current Reports on Form 8-K from April 1, 2002 through June 30, 2002.
(c). Exhibit Index
Exhibit
No. Description
--- -----------
2.1 Share Purchase Agreement dated June 8, 2002, among KPMG Consulting, Inc., KPMG DTG and the
minority shareholders, which is incorporated herein by reference to Exhibit 2.1 from the Company's
Form 8-K filed on September 6, 2002.
3.1 Amended and Restated Certificate of Incorporation of Registrant, dated as of February 7, 2001, which
is incorporated herein by reference to Exhibit 3.1 from the Company's Form 10-Q for the quarter
ending March 31, 2001.
3.2 Amended and Restated Bylaws of the Registrant, which is incorporated herein by reference to Exhibit
3.2 from the Company's Registration Statement on Form S-1 (Registration No. 333-36328, which is
contained in Commission File No. 000-31351) (referred to below as "the Company's Form S-1").
4.1 Rights Agreement, dated as of October 2, 2001, between KPMG Consulting and EquiServe Trust
Company, N.A., which is incorporated herein by reference to Exhibit 1.1 from the Company's
Registration Statement on Form 8-A dated October 3, 2001.
4.2 Certificate of Designation of Series A Junior Participating Preferred Stock, which is incorporated
herein by reference to Exhibit 1.2 from the Company's Registration Statement on Form 8-A dated
October 3, 2001.
4.3 Amendment No. 1 to the Rights Agreement between KPMG Consulting, Inc. and Equiserve Trust
Company, N.A., which is incorporated herein by reference to Exhibit 99.1 from the Company's Form
8-K filed on September 6, 2002.
10.1 Amended and Restated Separation Agreement, dated as of February 13, 2001, among KPMG LLP,
KPMG Consulting, LLC and the Registrant, which is incorporated herein by reference to Exhibit 10.1
from the Company's Form 10-Q for the quarter ending March 31, 2001.
10.2 Limited License Agreement between the Registrant and KPMG International, which is incorporated
herein by reference to Exhibit 10.2 from the Company's Form 10-Q for the quarter ending March 31,
2001.
10.3 Transition Services Agreement, dated as of February 13, 2001, among KPMG LLP, KPMG
Consulting, LLC and the Registrant, which is incorporated herein by reference to Exhibit 10.3 from
the Company's Form 10-Q for the quarter ending March 31, 2001.
10.4 Non-Competition Agreement, dated as of February 13, 2001, among KPMG LLP, KPMG Consulting,
LLC and the Registrant, which is incorporated herein by reference to Exhibit 10.4 from the
Company's Form 10-Q for the quarter ending March 31, 2001.
10.5 Form of Member Distribution Agreement for KPMG Consulting Qualified Employees, which is
incorporated herein by reference to Exhibit 10.6 from the Company's Form S-1.
10.6 Form of Member Distribution Agreement for KPMG Consulting Non-Qualified Employees, which is
incorporated herein by reference to Exhibit 10.7 from the Company's Form S-1.
69
Exhibit
No. Description
--- -----------
10.7 Form of Member Agreement for KPMG Consulting Non-Eligible Employees, which is incorporated
herein by reference to Exhibit 10.8 from the Company's Form S-1.
10.8 Form of Managing Director Agreement, which is incorporated herein by reference to Exhibit 10.9
from the Company's Form S-1.
10.9 Stock Purchase Agreement dated as of December 29, 1999 between Cisco Systems, Inc. and the
Registrant, which is incorporated herein by reference to Exhibit 10.11 from the Company's Form S-1.
10.10 Investor Rights Agreement dated as of January 31, 2000 among KPMG LLP, Cisco Systems, Inc. and
the Registrant, which is incorporated herein by reference to Exhibit 10.12 from the Company's Form
S-1.
10.11 Alliance Agreement, dated as of December 29, 1999, between Cisco Systems, Inc. and KPMG LLP
and related amendment, which is incorporated herein by reference to Exhibit 10.13 from the
Company's Form S-1.
10.12 Amendment No. 1 to Alliance Agreement, dated as of December 1, 2000, between Cisco Systems,
Inc. and the Registrant, which is incorporated herein by reference to Exhibit 10.12 from the
Company's Form 10-K for the year ended June 30, 2001.
10.13 Amendment No. 2 to Alliance Agreement, dated March 4, 2002 between Cisco Systems, Inc. and
KPMG Consulting, Inc., which is incorporated herein by reference to Exhibit 10.7 from the
Company's Form 10-Q for the quarter ended March 31, 2002.
10.14 Business Alliance Agreement, dated as of November 22, 1995, between KPMG LLP and Oracle
Corporation, which is incorporated herein by reference to Exhibit 10.16 from the Company's Form S-1.
10.15 National Partner Agreement, dated as of September 20, 1993, between KPMG LLP and SAP America,
Inc., which is incorporated herein by reference to Exhibit 10.17 from the Company's Form S-1.
10.16 Registrant's 2000 Long-Term Incentive Plan, amended as of March 30, 2001, which is incorporated
herein by reference to Exhibit 10.15 from the Company's Form 10-K for the year ended June 30, 2001.
10.17 Registrant's Employee Stock Purchase Plan, which is incorporated herein by reference to Exhibit 4.3
from the Company's Registration Statement on Form S-8 (Registration No. 333-55354, which is
contained in Commission File No. 000-31351).
10.18 Registrant's 401(k) Plan, which is incorporated herein by reference to Exhibit 10.20 from the
Company's Form S-1.
10.19 Amendment #1 to Registrant's 401(k) Plan, which is incorporated herein by reference to Exhibit 4.4
from the Company's Registration Statement on Form S-8 (Registration No. 333-55380, which is
contained in Commission File No. 000-31351).
10.20 Strategic Alliance Agreement dated as of December 27, 2000 among Qwest Communications
International Inc., KPMG Consulting, LLC, Softline Consulting & Integrators, Inc. and Qwest
Cyber.Solutions LLC, which is incorporated herein by reference to Exhibit 10.26 from the Company's
Form S-1.
10.21 Receivables Purchase Agreement, dated as of May 22, 2000, between KCI Funding Corporation,
KPMG Consulting, Inc., Market Street Funding Corporation and PNC Bank, National Association,
which is incorporated herein by reference to Exhibit 10.1 from the Company's Amendment No. 1 to
Form S-3 filed on March 15, 2002.
10.22 Amendment No.1 to Receivables Purchase Agreement, dated as of October 24, 2000, between KCI
Funding Corporation, KPMG Consulting, Inc., Market Street Funding Corporation and PNC Bank,
National Association, which is incorporated herein by reference to Exhibit 10.2 from the Company's
Amendment No. 1 to Form S-3 filed on March 15, 2002.
70
Exhibit
No. Description
--- -----------
10.23 Amendment No. 2 to Receivables Purchase Agreement, dated as of May 21, 2001, between KCI
Funding Corporation, KPMG Consulting, Inc., Market Street Funding Corporation and PNC Bank,
National Association, which is incorporated herein by reference to Exhibit 10.3 from the Company's
Amendment No. 1 to Form S-3 filed on March 15, 2002.
10.24 Amendment No. 3 to Receivables Purchase Agreement, dated as of August 1, 2001, between KCI
Funding Corporation, KPMG Consulting, Inc., Market Street Funding Corporation and PNC Bank,
National Association, which is incorporated herein by reference to Exhibit 10.4 from the Company's
Amendment No. 1 to Form S-3 filed on March 15, 2002.
10.25 Amendment No. 4 to Receivables Purchase Agreement, dated as of March 21, 2002, between KCI
Funding Corporation, KPMG Consulting, Inc., Market Street Funding Corporation and PNC Bank,
National Association.
10.26 Amendment No. 5 to Receivables Purchase Agreement, dated as of May 20, 2002, between KCI
Funding Corporation, KPMG Consulting, Inc., Market Street Funding Corporation and PNC Bank,
National Association.
10.27 Amendment No. 6 to Receivables Purchase Agreement, dated as of May 29, 2002, between KCI
Funding Corporation, KPMG Consulting, Inc., Market Street Funding Corporation and PNC Bank,
National Association.
10.28 Purchase and Sale Agreement, dated as of May 22, 2000, between KPMG Consulting, Inc. and KCI
Funding Corporation, which is incorporated herein by reference to Exhibit 10.5 from the Company's
Amendment No. 1 to Form S-3 filed on March 15, 2002.
10.29 Sale Agreement, dated as of May 22, 2000, between KPMG Consulting, LLP and KPMG Consulting,
Inc. which is incorporated herein by reference to Exhibit 10.6 from the Company's Amendment No. 1
to Form S-3 filed on March 15, 2002.
10.30 Revolving Credit Facility Agreement, dated May 29, 2002, between KPMG Consulting, Inc., the
guarantors referred to therein, the banks party thereto, PNC Bank National Association, as the
administrative agent, PNC Capital Markets, Inc. and JP Morgan Securities, Inc., as the arrangers,
Barclays Bank PLC, as the syndication agent, JP Morgan Chase Bank, Citibank N.A. and Bank of
America, N.A. as the documentation agents and SunTrust Bank, as the co-agent.
10.31 Revolving Credit Facility Agreement, dated August 21, 2002, between KPMG Consulting, Inc.,
KPMG Consulting, LLC, the guarantors referred to therein, the banks party thereto, JP Morgan Chase
Bank, as the administrative agent, and J.P. Morgan Securities, Inc., as the sole arranger and book
runner.
10.32 Promissory Note, dated as of October 1, 2001, executed by Randolph C. Blazer.
10.33 Promissory Note, dated as of October 1, 2001, executed by Michael J. Donahue.
10.34 Promissory Note, dated as of October 1, 2001, executed by Bradley J. Schwartz.
10.35 Promissory Note, dated as of October 1, 2001, executed by David W. Black.
10.36 Promissory Note, dated as of October 1, 2001, executed by Robert C. Lamb, Jr.
10.37 Form of Special Termination Agreement, made as of November 7, 2001, between KPMG Consulting,
Inc. and Certain Executive Officers, which is incorporated herein by reference to Exhibit 10.1 from
the Company's Form 10-Q for the quarter ended December 31, 2001.
10.38 Form of Special Termination Agreement, made as of November 7, 2001, between KPMG Consulting,
Inc. and Certain Executive Officers and Other Key Executives, which is incorporated herein by
reference to Exhibit 10.2 from the Company's Form 10-Q for the quarter ended December 31, 2001.
21.1 List of subsidiaries of the Registrant.
23.1 Consent of Grant Thornton LLP
99.1 Factors Affecting Future Financial Results
(d). Financial Statement Schedule
71
REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS ON SCHEDULE
Board of Directors and Stockholders
KPMG Consulting, Inc.
In connection with our audit of the financial statements of KPMG Consulting,
Inc. (successor to the consulting business of KPMG LLP) referred to in our
report dated August 6, 2002, except for Note 23, as to which the date is
September 18, 2002, which is included in this annual report on Form 10-K for
the year ended June 30, 2002, we have also audited Schedule II for the seven
months ended January 31, 2000, the five months ended June 30, 2000, and the
years ended June 30, 2001 and 2002. In our opinion, this schedule presents
fairly, in all material respects, the information required to be set forth
therein.
/s/ Grant Thornton LLP
New York, New York
August 6, 2002 except for Note 23, as to which the date is September 18, 2002
Schedule II
Valuation and Qualifying Accounts
Balance
at Charge to Balance at
Beginning Costs and Deductions- End
Allowance for Doubtful Accounts of Period Expenses(a) Write Offs of Period
------------------------------- --------- ----------- ----------- ----------
(in thousands)
Seven months ended January 31, 2000............... $ 3,500 $ 6,635 $ (5,235) $ 4,900
Five months ended June 30, 2000................... 4,900 12,881 (10,781) 7,000
Year ended June 30, 2001.......................... 7,000 63,157 (42,690) 27,467
Year ended June 30, 2002.......................... 27,467 22,510 (21,332) 28,645
--------
(a) Expense reflected in other costs of service in the Consolidated/Combined
Financial Statements
72
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By: /s/ RANDOLPH C. BLAZER
-----------------------------
Randolph C. Blazer
Chairman of the Board,
Chief Executive Officer
and President
Date: September 30, 2002
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
Signature Title Date
--------- ----- ----
Principal Executive Officer and Director:
By: /s/ RANDOLPH C. BLAZER Chairman of the Board, Chief September 30, 2002
----------------------------- Executive Officer and
Randolph C. Blazer President
Principal Financial and Accounting Officer:
By: /s/ ROBERT C. LAMB, JR. Executive Vice President and September 30, 2002
----------------------------- Chief Financial Officer
Robert C. Lamb, Jr.
Board of Directors:
By: /s/ DOUGLAS C. ALLRED Director September 30, 2002
-----------------------------
Douglas C. Allred
By: /s/ WOLFGANG KEMNA Director September 30, 2002
-----------------------------
Wolfgang Kemna
By: /s/ RODERICK C. MCGEARY Director September 30, 2002
-----------------------------
Roderick C. McGeary
By: /s/ AFSHIN MOHEBBI Director September 30, 2002
-----------------------------
Afshin Mohebbi
By: /s/ ALICE M. RIVLIN Director September 30, 2002
-----------------------------
Alice M. Rivlin
73
CERTIFICATIONS
I, Randolph C. Blazer, certify that:
1. I have reviewed this Annual Report on Form 10-K of KPMG Consulting,
Inc. (the "Registrant");
2. Based on my knowledge, this Annual Report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this Annual Report;
3. Based on my knowledge, the financial statements, and other financial
information included in this Annual Report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the Registrant as of, and for, the period presented in this Annual Report.
By: /S/ RANDOLPH C. BLAZER Date: September 30, 2002
----------------------------
Randolph C. Blazer
Chairman of the Board,
Chief Executive Officer and
President
I, Robert C. Lamb, Jr., certify that:
1. I have reviewed this Annual Report on Form 10-K of KPMG Consulting,
Inc. (the "Registrant");
2. Based on my knowledge, this Annual Report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this Annual Report;
3. Based on my knowledge, the financial statements, and other financial
information included in this Annual Report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the Registrant as of, and for, the period presented in this Annual Report.
By: /S/ ROBERT C. LAMB, JR. Date: September 30, 2002
----------------------------
Robert C. Lamb, Jr.
Executive Vice President and
Chief Financial Officer
74