-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WeHvV282a0xBgdZd8B4LI8LzA3JpKq45z0eN5dEKSGtn/iYmCF6Hn6pBnWiqonQr IstHdu9hoiy686xdRmrYvw== 0000950131-02-000558.txt : 20020414 0000950131-02-000558.hdr.sgml : 20020414 ACCESSION NUMBER: 0000950131-02-000558 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020214 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIAMONDCLUSTER INTERNATIONAL INC CENTRAL INDEX KEY: 0000924940 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MANAGEMENT CONSULTING SERVICES [8742] IRS NUMBER: 364069408 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-22125 FILM NUMBER: 02549812 BUSINESS ADDRESS: STREET 1: 875 NORTH MICHIGAN AVE SUITE 3000 CITY: CHICAGO STATE: IL ZIP: 60611 BUSINESS PHONE: 3122555000 MAIL ADDRESS: STREET 1: 875 NORTH MICHIGAN AVE STE 3000 CITY: CHICAGO STATE: IL ZIP: 60611 FORMER COMPANY: FORMER CONFORMED NAME: DIAMOND TECHNOLOGY PARTNERS INC DATE OF NAME CHANGE: 19961212 10-Q 1 d10q.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------- FORM 10-Q ----------------- [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended December 31, 2001 or TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 000-22125 DIAMONDCLUSTER INTERNATIONAL, INC. (Exact name of registrant as specified in its charter)
Delaware 36-4069408 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 875 N. Michigan Avenue, Suite 3000, Chicago, Illinois 60611 (Address of principal executive offices) (Zip Code)
(312) 255-5000 Registrant's Telephone Number, Including Area Code Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: As of December 31, 2001, there were 24,639,906 shares of Class A Common Stock and 6,332,153 shares of Class B Common Stock of the Registrant outstanding. ================================================================================ DIAMONDCLUSTER INTERNATIONAL, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE FISCAL QUARTER ENDED DECEMBER 31, 2001 TABLE OF CONTENTS PART I--FINANCIAL INFORMATION: Item 1: Financial Statements Consolidated Balance Sheets as of March 31 and December 31, 2001................................... 3 Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Nine Months Ended December 31, 2000 and 2001.......................................................... 4 Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2000 and 2001......... 5 Notes to Consolidated Financial Statements......................................................... 6 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations............ 10 Item 3: Quantitative and Qualitative Disclosures about Market Risk....................................... 17 PART II--OTHER INFORMATION: Item 6: Exhibits and Reports on Form 8-K................................................................. 19 SIGNATURES................................................................................................ 20
2 DIAMONDCLUSTER INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except per share data)
March 31, December 31, 2001 2001 --------- ------------ (Unaudited) ASSETS ------ Current assets: Cash and cash equivalents...................................................... $ 151,358 $ 113,345 Accounts receivable, net of allowance of $2,028 and $2,204 as of March 31, 2001 and December 31, 2001, respectively..................................... 32,879 16,985 Prepaid expenses and deferred taxes............................................ 18,153 12,644 --------- --------- Total current assets....................................................... 202,390 142,974 Computers, equipment, and software, net........................................... 16,182 17,334 Other assets and deferred taxes................................................... 8,084 18,204 Goodwill, net..................................................................... 295,600 250,511 --------- --------- Total assets............................................................... $ 522,256 $ 429,023 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current liabilities: Accounts payable............................................................... $ 7,824 $ 8,268 Note payable................................................................... 500 -- Restructuring accrual.......................................................... -- 8,880 Other accrued liabilities...................................................... 61,565 21,340 --------- --------- Total current liabilities.................................................. 69,889 38,488 Stockholders' equity: Preferred Stock, $1.00 par value, 2,000 shares authorized, no shares issued.... -- -- Class A Common Stock, $.001 par value, 200,000 shares authorized, 23,659 issued as of March 31, 2001 and 26,752 issued as of December 31, 2001........ 24 27 Class B Common Stock, $.001 par value, 100,000 shares authorized, 8,752 issued as of March 31, 2001 and 6,645 issued as of December 31, 2001................ 9 7 Additional paid-in capital..................................................... 652,234 655,169 Unearned compensation.......................................................... (177,375) (133,096) Notes receivable from sale of common stock..................................... (332) (80) Accumulated other comprehensive income (loss).................................. (1,249) (2,871) Retained earnings (accumulated deficit)........................................ 19,812 (81,931) --------- --------- 493,123 437,225 Less Common Stock in treasury, at cost, 2,016 shares held at March 31, 2001 and 2,424 shares held at December 31, 2001.......................................... 40,756 46,690 --------- --------- Total stockholders' equity................................................. 452,367 390,535 --------- --------- Total liabilities and stockholders' equity................................. $ 522,256 $ 429,023 ========= =========
See accompanying notes to consolidated financial statements 3 DIAMONDCLUSTER INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (In thousands, except per share data) (Unaudited)
For the Three Months For the Nine Months ended December 31, ended December 31, ------------------- ------------------- 2000 2001 2000 2001 ------- -------- -------- --------- Revenue: Revenue before out-of-pocket reimbursements (net revenue).................................................. $75,439 $ 36,159 $191,672 $ 145,100 Out-of-pocket expense reimbursements........................ 8,729 4,237 29,567 17,769 ------- -------- -------- --------- Total revenue........................................... 84,168 40,396 221,239 162,869 Operating expenses: Project personnel and related expenses before out-of- pocket reimbursable expenses.............................. 38,731 30,881 102,386 103,206 Out-of-pocket reimbursable expenses......................... 8,729 4,237 29,567 17,769 ------- -------- -------- --------- Total project personnel and related expenses............ 47,460 35,118 131,953 120,975 Professional development and recruiting..................... 7,752 2,794 18,888 10,020 Marketing and sales......................................... 3,344 1,375 9,594 5,887 Management and administrative support....................... 12,137 11,142 27,099 36,823 Goodwill amortization....................................... 5,885 15,462 6,589 46,345 Noncash compensation*....................................... 4,951 13,004 4,951 39,980 Restructuring charge........................................ -- 15,542 -- 15,542 ------- -------- -------- --------- Total operating expenses................................ 81,529 94,437 199,074 275,572 ======= ======== ======== ========= Income (loss) from operations.................................. 2,639 (54,041) 22,165 (112,703) Other income, net.............................................. 2,480 1,353 8,485 567 Income (loss) before taxes..................................... 5,119 (52,688) 30,650 (112,136) Income tax expense (benefit)................................... 6,287 (9,580) 16,244 (10,393) ------- -------- -------- --------- Net income (loss).............................................. (1,168) (43,108) 14,406 (101,743) Unrealized gain (loss) from securities, net of income tax benefit of $689 and $92 for the three months ended December 31, 2000 and 2001, respectively, and $387 and $149 for the nine months ended December 31, 2000 and 2001, respectively.................................... (1,078) (143) (605) (234) Foreign currency translation adjustments.................... 1,470 (531) 1,409 (1,388) ------- -------- -------- --------- Comprehensive income (loss).................................... $ (776) $(43,782) $ 15,210 $(103,365) ======= ======== ======== ========= Basic net income (loss) per share of common stock.............. $ (0.04) $ (1.39) $ 0.57 $ (3.32) ======= ======== ======== ========= Diluted net income (loss) per share of common stock............ $ (0.04) $ (1.39) $ 0.47 $ (3.32) ======= ======== ======== ========= Shares used in computing basic net income (loss) per share of common stock................................................. 26,919 30,946 25,105 30,684 Shares used in computing diluted net income (loss) per share of common stock................................................. 26,919 30,946 30,623 30,684 - -------- * Noncash compensation:........................................
Project personnel and related expenses. 4,869 12,730 4,869 39,310 Professional development and recruiting 11 49 11 97 Marketing and sales.................... 6 40 6 78 Management and administrative support.. 65 185 65 495 ----- ------ ----- ------ Total noncash compensation....... 4,951 13,004 4,951 39,980 ===== ====== ===== ======
See accompanying notes to consolidated financial statements 4 DIAMONDCLUSTER INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
For the Nine Months Ended December 31, ------------------- 2000 2001 -------- --------- Cash flows from operating activities: Net income (loss)................................................................. $ 14,406 $(101,743) Adjustments to reconcile net income (loss) to net cash from operating activities: Depreciation and amortization................................................. 4,393 6,251 Goodwill amortization......................................................... 6,589 46,345 Noncash compensation.......................................................... 4,951 39,980 Deferred income taxes......................................................... (387) (7,923) Tax benefits from employee stock plans........................................ 6,438 907 Write-down of equity investments.............................................. -- 3,564 Other......................................................................... -- (1,846) Changes in assets and liabilities, net of effects of acquisition: Accounts receivable........................................................ (3,920) 15,734 Prepaid expenses and other................................................. 5,687 (745) Accounts payable........................................................... 6,249 1,429 Restructuring accrual...................................................... -- 8,880 Other assets and liabilities............................................... 10,670 (38,143) -------- --------- Net cash provided by (used in) operating activities.................................. 55,076 (27,310) -------- --------- Cash flows from investing activities: Capital expenditures, net......................................................... (6,983) (7,344) Acquisitions, net of cash acquired................................................ (45,814) (1,781) Other assets...................................................................... (2,352) (2,591) -------- --------- Net cash used in investing activities................................................ (55,149) (11,716) -------- --------- Cash flows from financing activities: Repayment of note................................................................. (12,484) (500) Common stock issued............................................................... 8,887 6,299 Purchase of treasury stock........................................................ (14,144) (5,934) -------- --------- Net cash used in financing activities................................................ (17,741) (135) -------- --------- Effect of exchange rate changes on cash.............................................. 286 1,148 -------- --------- Net decrease in cash and cash equivalents............................................ (17,528) (38,013) Cash and cash equivalents at beginning of period..................................... 182,945 151,358 -------- --------- Cash and cash equivalents at end of period........................................... $165,417 $ 113,345 ======== ========= Supplemental disclosure of cash flow information: Cash paid during the period for interest.......................................... $ 19 $ 68 Cash paid during the period for income taxes...................................... 246 6,823 Supplemental disclosure for noncash investing and financing activities: Issuance of common stock for notes................................................ $ 513 $ --
See accompanying notes to consolidated financial statements 5 DIAMONDCLUSTER INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) A. Basis of Reporting The accompanying consolidated financial statements of DiamondCluster International, Inc., formerly Diamond Technology Partners Incorporated (the ''Company''), include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to current period presentation. In the opinion of management, the consolidated financial statements reflect all adjustments that are necessary for a fair presentation of the Company's financial position, results of operations, and cash flows as of the dates and for the periods presented. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Consequently, these statements do not include all the disclosures normally required by accounting principles generally accepted in the United States of America for annual financial statements or those normally made in the Company's Annual Report on Form 10-K. Accordingly, reference should be made to the Company's Annual Report on Form 10-K for additional disclosures, including a summary of the Company's accounting policies, which have not changed except as indicated in footnote F in these Notes to Consolidated Financial Statements. The consolidated results of operations for the quarter ended December 31, 2001, are not necessarily indicative of results for the full year. B. Business Combinations On November 28, 2000, the Company acquired Cluster Telecom B.V. ("Cluster"), a pan-European management consulting firm specializing in wireless technology, internet and digital strategies. Under the terms of the agreement, the Company paid $494.2 million, consisting of $44 million in cash and an aggregate of 6.3 million shares of the Company's Class B Common Stock and 7.5 million options to purchase shares of the Company's Class B Common Stock. In connection with the acquisition, the Company changed its name from Diamond Technology Partners Incorporated to DiamondCluster International, Inc. The excess of net assets acquired ("Goodwill") recorded for the Cluster acquisition was approximately $301.4 million. Additionally, the Company recorded unearned compensation in connection with this acquisition. In May 2000, the Company acquired Momentus Group Limited ("Momentus"), a London-based e-business consulting company. Under the terms of the acquisition agreement, the Company paid $5.7 million, consisting of approximately $2.9 million in cash and 44,252 shares of the Company's Class A Common Stock. Additionally, Momentus shareholders were paid 13,798 shares of the Company's Class A Common Stock in May 2001 for achievement of certain performance measures, and may earn up to an additional 49,475 shares through March 31, 2003 upon further achievement of these performance measures. Goodwill recorded for the Momentus acquisition was approximately $5.7 million. In October 1999, the Company acquired Leverage Information Systems, Inc. (''Leverage''), a San Francisco based systems architecture and development company specializing in the building of complex web sites and intranets. Under the terms of the acquisition, the Company paid $3.4 million, consisting of $1.0 million in cash and 97,500 shares of the Company's Class A Common Stock. Goodwill recorded for the Leverage acquisition was approximately $3.3 million. In April 1999, the Company acquired OmniTech Consulting Group, Inc. (''Omnitech''), a Chicago-based change management firm specializing in web-based and other multimedia corporate learning. Under the terms of the acquisition agreement, the Company paid $9.0 million, consisting of $4.0 million in cash, a $1.0 million note (which has been fully paid), and 173,461 shares of the Company' Class A Common Stock. Goodwill recorded for the Omnitech acquisition was approximately $8.8 million. 6 DIAMONDCLUSTER INTERNATIONAL, INC. NOTES TO FINANCIAL CONSOLIDATED STATEMENTS--(Continued) (Unaudited) The acquisitions were accounted for under the purchase method of accounting and, accordingly, the operating results of OmniTech, Leverage, Momentus and Cluster have been included in the Company's consolidated financial statements since the dates of the acquisitions. The amount of goodwill recorded for OmniTech, Leverage, Momentus and Cluster approximated $319.2 million, and is being amortized on a straight-line basis over useful lives ranging between 5 and 25 years. The following summarized unaudited pro forma financial information for the three and nine months ended December 31, 2000 assumes the Momentus and Cluster acquisitions occurred as of April 1, 2000:
Three Months Ended Nine Months Ended December 31, 2000 December 31, 2000 ------------------ ----------------- (in thousands, except per share data) (Unaudited) ------------------------------------ Revenue before out-of-pocket reimbursements (net revenue) $ 92,126 $252,339 Total revenue (including out-of-pocket expense) reimbursements......................................... $103,326 $289,561 Net loss.............................................. (11,108) (27,126) Loss per share:....................................... Basic............................................. $ (0.36) $ (0.88) Diluted........................................... $ (0.36) $ (0.88)
These amounts are based upon certain assumptions and estimates, and do not necessarily represent results that would have occurred if the acquisitions had taken place on the date assumed above, nor are they indicative of the results of future combined operations. C. Net Income (Loss) Per Share Following is a reconciliation of the shares used in computing basic and diluted net income (loss) per share for the three and nine month periods ended December 31, 2000 and 2001:
Three Months Ended Nine Months Ended December 31, December 31, ------------------ ----------------- 2000 2001 2000 2001 ------ ------ ------ ------ (in thousands) (Unaudited) Shares used in computing basic net income (loss) per share.. 26,919 30,946 25,105 30,684 Dilutive effect of stock options and warrants............... -- -- 5,518 -- ------ ------ ------ ------ Shares used in computing diluted net income (loss) per share 26,919 30,946 30,623 30,684 ====== ====== ====== ======
The dilutive earnings per share calculation for the three months ended December 31, 2000 and 2001 and the nine months ended December 31, 2001 excludes 5.4 million, 2.0 million and 2.0 million common stock equivalents, respectively, related to stock options due to their anti-dilutive effect as a result of the Company's net loss during these periods. An additional 3.2 million and 12.7 million stock options for the three months ended December 31, 2000 and 2001, respectively, and 1.4 million and 12.4 million stock options for the nine months ended December 31, 2000 and 2001, respectively, are excluded due to their anti-dilutive effect as a result of the option's exercise price being greater than the average market price of the common shares for these periods. 7 DIAMONDCLUSTER INTERNATIONAL, INC. NOTES TO FINANCIAL CONSOLIDATED STATEMENTS--(Continued) (Unaudited) D. Foreign Exchange Risk Management The Company has entered into a transaction to mitigate the effect of fluctuations in the rates of exchange between the Euro and the U.S. dollar on the parent company's net investment in its foreign subsidiaries. This transaction involves the use of a forward foreign exchange contract in the Euro currency. This forward foreign exchange contract obligates the Company to exchange predetermined amounts of Euros at specified exchange rates on specified dates or to make an equivalent U.S. dollar payment equal to the value of such exchange. As a result, increases or decreases in the parent company's net investment in its European subsidiaries due to changes in foreign exchange rates are partially offset by gains and losses on the forward contracts, so as to mitigate the possibility of significant foreign currency translation gains and losses. The Company does not use foreign currency contracts for trading purposes. The Company does not currently hedge anticipated foreign currency-denominated revenues and expenses. This forward contract is marked-to-market on a monthly basis and any change in its fair value is recorded as a component of the foreign currency translation adjustment included in comprehensive income. E. New Accounting Pronouncements On July 20, 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, Business Combinations and No. 142, Goodwill and Other Intangible Assets. SFAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Business combinations accounted for as poolings-of-interests and initiated prior to June 30, 2001 are grandfathered. SFAS 142 replaces the requirement to amortize intangible assets with indefinite lives and goodwill with a requirement for an impairment test. SFAS 142 also requires an evaluation of intangible assets and their useful lives and a transitional impairment test for goodwill and certain intangible assets upon adoption. After transition, the impairment test will be performed annually. The Company adopted SFAS 141 effective July 1, 2001. SFAS 142 is effective for fiscal years beginning after December 15, 2001, and must be applied as of the beginning of the year. The Company is in the process of evaluating the impact that adoption of SFAS 142 will have on the Company's consolidated financial statements; however, such impact, if any, is not known or reasonably estimable at this time. In October, 2001, the FASB issued SFAS No. 144, Accounting for the Impairment and Disposal of Long-Lived Assets. While SFAS 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of that Statement. SFAS 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The Company is in the process of evaluating the impact that adoption of SFAS 144 will have on the Company's consolidated financial statements; however, such impact, if any, is not known or reasonably estimable at this time. F. Reclassifications In November 2001, the FASB issued a Staff Announcement regarding the income statement classification of reimbursements received for "out-of-pocket" expenses incurred. This announcement requires that out-of-pocket expenses incurred and the related reimbursements be reflected in the income statement on a gross basis as both revenue and expense. Accordingly, the Company adjusted revenue for all periods reported to include out-of-pocket expense reimbursements. In addition, the Company adjusted revenue for all periods reported to include administrative charges billed to clients. Previously, these out-of-pocket expense reimbursements and administrative charges were classified as a reduction of project personnel and related expenses. This change in classification had no effect on current or previously reported net income (loss) or earnings (loss) per share. 8 DIAMONDCLUSTER INTERNATINAL, INC. NOTES TO FINANCIAL CONSOLIDATED STATEMENTS--(Continued) (Unaudited) The following table sets forth details regarding the income statement reclassifications for the periods indicated (in thousands):
Quarter Ended - - ----------------------------------------------------------------------- 12/31/2001 9/30/2001 6/30/2001 3/31/2001 12/31/2000 9/30/2000 6/30/2000 ---------- --------- --------- --------- ---------- --------- --------- Net revenue (previously reported).......... $35,739 $50,128 $57,207 $73,709 $73,595 $59,878 $52,158 Revenue before out-of-pocket expense reimbursements............................ 36,159 50,756 58,185 74,864 75,439 61,958 54,275 Out-of-pocket expense reimbursements....... 4,237 6,009 7,523 11,297 8,729 9,744 11,094 ------- ------- ------- ------- ------- ------- ------- TOTAL REVENUE........................... 40,396 56,765 65,708 86,161 84,168 71,702 65,369 ======= ======= ======= ======= ======= ======= ======= Project personnel & related expenses (previously reported)..................... 30,461 33,667 37,052 38,439 36,887 31,758 27,700 ------- ------- ------- ------- ------- ------- ------- Project personnel & related expenses before out-of-pocket reimbursable expenses....... 30,881 34,295 38,030 39,594 38,731 33,838 29,817 Out-of-pocket reimbursable expenses........ 4,237 6,009 7,523 11,297 8,729 9,744 11,094 ------- ------- ------- ------- ------- ------- ------- TOTAL PROJECT PERSONNEL & RELATED EXPENSES....................... $35,118 $40,304 $45,553 $50,891 $47,460 $43,582 $40,911 ======= ======= ======= ======= ======= ======= =======
G. Restructuring Charge In the third quarter of 2001, the Company recorded a restructuring charge comprised of severance and other personnel-related costs, and costs associated with reductions in office space and the write-off of associated leasehold improvements. This charge was recorded based on an evaluation of competitive conditions in the global markets for business strategy and technology solutions services, and included an assessment of the infrastructure needed to support anticipated levels of business in fiscal 2003 and beyond. Based upon this review, the Company determined that a restructuring charge of $15.5 million ($9.5 million on an after tax basis), or $0.31 per share, was required to recognize the costs associated with planned reductions in personnel and facilities that were needed to adjust its operations to levels more appropriate for current business requirements. The principal actions in the restructuring plan involve workforce reductions, including the discontinuation of certain business activities within the Diamond Marketspace Solutions group. The restructuring plan includes the termination of approximately 300 employees, of which 90% were client-serving personnel and 10% were operations support personnel. The client-serving personnel consist of partners, principals, managers, associates and analysts, and include 100 personnel who were formerly participating in the Company's furlough program. In addition, the restructuring plan includes office space reductions in San Francisco, New York and Chicago. Estimated costs related to the reduction of office space comprise contractual rental commitments for office space being vacated, in addition to costs associated with the write-off of leasehold improvements and write-down of other assets and equipment leases to their estimated net realizable value. The total cash outlay for the restructuring announced in December 2001 is expected to be approximately $12.8 million. The remaining $2.7 million of restructuring costs consists of non-cash charges primarily for write-offs of leasehold improvements for the facilities being downsized and other related assets, as well as the write-off of sign-on bonuses previously paid to terminated employees. As of December 31, 2001, $3.9 million of cash had been expended for this initiative, primarily related to severance and related costs. The major components of the restructuring charge are as follows (in thousands):
Original Utilized Balance - - -------- --------------- -------- Description Charge Cash Non-Cash 12/31/01 ----------- -------- ------ -------- -------- Severance and related costs......................................... $10,847 $3,863 $1,393 $5,591 Contractual commitments and leasehold improvements related to office space reductions.................................................. 3,089 -- 1,326 1,763 Write-off of property, plant, equipment and equipment leases........ 1,606 80 -- 1,526 ------- ------ ------ ------ $15,542 $3,943 $2,719 $8,880 ======= ====== ====== ======
9 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following information should be read in conjunction with the information contained in the Consolidated Financial Statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. See "Forward-Looking Statements" below. Overview We are a global business strategy and technology solutions firm that delivers value to its leading national and multinational clients by developing and implementing innovative digital strategies that capitalize on the opportunities and cost savings presented by new technologies. Once conceived, we believe such strategies must be implemented rapidly in order to maximize competitive benefits. We have experienced substantial revenue growth since our inception, generating revenue before out-of-pocket expense reimbursements of $145.1 million from 129 clients during the nine months ended December 31, 2001. We employed 958 client-serving professionals as of December 31, 2001. Our revenues are comprised of professional fees for services rendered to our clients who are billed either monthly or semi-monthly in accordance with the terms of the client engagement, plus reimbursement of out-of-pocket expenses. Prior to the commencement of a client engagement, we and our client agree on fees for services based upon the scope of the project, our staffing requirements and the level of client involvement. We recognize revenue as services are performed in accordance with the terms of the client engagement. Provisions are made based on our experience for estimated uncollectible amounts. These provisions, net of write-offs of accounts receivable, are reflected in the allowance for doubtful accounts. Provisions are also made for costs incurred subsequent to targeted project completion. These provisions, net of actual costs incurred on completed projects, are reflected in deferred revenue. Although from time to time we have been required to make revisions to our clients' estimated deliverables, to date none of such revisions have had a material adverse effect on our operating results. In November 2001, the FASB issued a Staff Announcement regarding the income statement classification of reimbursements received for "out-of-pocket" expenses incurred. This announcement requires that out-of-pocket expenses incurred and the related reimbursements be reflected in the income statement on a gross basis as both revenue and expense. Accordingly, the Company adjusted revenue for all periods reported to include out-of-pocket expense reimbursements. In addition, the Company adjusted revenue for all periods reported to include administrative charges billed to clients. Previously, these out-of-pocket expense reimbursements and administrative charges were classified as a reduction of project personnel and related expenses. This change in classification had no effect on current or previously reported net income (loss) or earnings (loss) per share. The largest portion of our costs is comprised of employee-related expenses for our client-serving professionals and other direct costs, such as third-party vendor costs and unbillable costs associated with the delivery of services to our clients. The remainder of our costs consists of the expenses associated with the development of our business and the support of our client-serving professionals, such as professional development and recruiting, marketing and sales, and management and administrative support. Professional development and recruiting expenses consist primarily of recruiting and training content development and delivery costs. Marketing and sales expenses consist primarily of the costs associated with our development and maintenance of our marketing materials and programs. Management and administrative support expenses consist primarily of the costs associated with operations, finance, information systems, facilities (including the rent of office space) and other administrative support for project personnel. We regularly review our fees for services, professional compensation and overhead costs to ensure that our services and compensation are competitive within the industry. In addition, we monitor the progress of client 10 projects with client senior management. We manage activities of our professionals by closely monitoring engagement schedules and staffing requirements for new engagements. Because most of our client engagements are, and may be in the future, terminable by our clients without penalty, an unanticipated termination of a client project could require us to maintain underutilized employees. While the number of client serving professionals must be adjusted to reflect active engagements, we must also maintain a sufficient number of senior professionals to oversee existing client engagements and participate in our sales efforts to secure new client assignments. New Accounting Pronouncements On July 20, 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, Business Combinations and No. 142, Goodwill and Other Intangible Assets. SFAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Business combinations accounted for as poolings-of-interests and initiated prior to June 30, 2001 are grandfathered. SFAS 142 replaces the requirement to amortize intangible assets with indefinite lives and goodwill with a requirement for an impairment test. SFAS 142 also requires an evaluation of intangible assets and their useful lives and a transitional impairment test for goodwill and certain intangible assets upon adoption. After transition, the impairment test will be performed annually. The Company adopted SFAS 141 effective July 1, 2001. SFAS 142 is effective for fiscal years beginning after December 15, 2001, and must be applied as of the beginning of the year. The Company is in the process of evaluating the impact that adoption of SFAS 142 will have on the Company's consolidated financial statements; however, such impact, if any, is not known or reasonably estimable at this time. In October, 2001, the FASB issued SFAS No. 144, Accounting for the Impairment and Disposal of Long-Lived Assets. While SFAS 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of that Statement. SFAS 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The Company is in the process of evaluating the impact that adoption of SFAS 144 will have on the Company's consolidated financial statements; however, such impact, if any, is not known or reasonably estimable at this time. 11 Results of Operations The following table sets forth for the periods indicated, selected consolidated statements of operations data as a percentage of net revenues:
For the Quarter For the Nine Months Ended December 31, Ended December 31, ---------------- ----------------- 2000 2001 2000 2001 ----- ------ ----- ----- Revenue: Revenue before out-of-pocket reimbursements (net revenue)..... 100.0% 100.0% 100.0% 100.0% Out-of-pocket expense reimbursements.......................... 11.6 11.7 15.4 12.2 ----- ------ ----- ----- Total revenue............................................. 111.6 111.7 115.4 112.2 Operating expenses: Project personnel and related expenses before out-of-pocket reimbursable expenses....................................... 51.3 85.4 53.4 71.1 Out-of-pocket reimbursable expenses........................... 11.6 11.7 15.4 12.2 ----- ------ ----- ----- Total project personnel and related expenses.............. 62.9 97.1 68.8 83.3 Professional development and recruiting....................... 10.3 7.7 9.9 6.9 Marketing and sales........................................... 4.4 3.8 5.0 4.1 Management and administrative support......................... 16.1 30.8 14.1 25.4 Goodwill amortization......................................... 7.8 42.7 3.4 31.9 Noncash compensation.......................................... 6.6 36.0 2.6 27.6 Restructuring charge.......................................... -- 43.0 -- 10.7 ----- ------ ----- ----- Total operating expenses.................................. 108.1 261.1 103.8 189.9 ----- ------ ----- ----- Income (loss) from operations.................................... 3.5 (149.4) 11.6 (77.7) Other income (loss), net......................................... 3.3 3.7 4.4 0.4 ----- ------ ----- ----- Income (loss) before taxes....................................... 6.8 (145.7) 16.0 (77.3) Income tax expense (benefit)..................................... 8.3 (26.5) 8.5 (7.2) ----- ------ ----- ----- Net income (loss)................................................ (1.5%) (119.2%) 7.5% (70.1%) ===== ====== ===== =====
Quarter Ended December 31, 2001 Compared to Quarter Ended December 31, 2000 Our net loss of $1.2 million during the quarter ended December 31, 2000 increased by $41.9 million resulting in a net loss of $43.1 million during the quarter ended December 31, 2001, due to increased amortization of goodwill and noncash compensation costs associated with the Cluster acquisition that closed on November 28, 2000, a decline in revenue, and additional costs associated with the restructuring plan implemented in the quarter ended December 31, 2001. Revenue before out-of-pocket expense reimbursements ("net revenue") for the quarter ended December 31, 2001 was $36.2 million, down 52.1% compared with $75.4 million reported for the period in the prior year. Total revenue including out-of-pocket expense reimbursements was $40.4 million for the quarter ended December 31, 2001, down 52.0% compared with $84.2 million reported for the period in the prior year. Revenue from new clients accounted for 10% of the revenue during the three month period ended December 31, 2001, while revenue from existing clients accounted for 90% of revenue during the period. We served 63 clients during the quarter ended December 31, 2001, a decrease from the 95 served in the same period in the prior year. Project personnel and related expenses before out-of-pocket reimbursable expenses decreased $7.9 million to $30.9 million during the quarter ended December 31, 2001 as compared to the same period in the prior year. Project personnel and related expenses including out-of-pocket reimbursable expenses decreased $12.3 million to $35.1 million during the quarter ended December 31, 2001 as compared to the same period in the prior year. The decrease in project personnel and related expenses reflects the savings resulting from cost reduction programs implemented throughout fiscal 2002. We decreased our client-serving professional staff from 1,063 at 12 December 31, 2000 to 958 at December 31, 2001. Beginning in June 2001, we reduced salaries between 10% and 15% for most employees, and in August 2001, we reduced salaries 65% for approximately 200 furloughed employees. During the quarter ended December 31, 2001, we further reduced personnel as part of the Company's restructuring plan. As a percentage of net revenue, project personnel and related expenses before out-of-pocket reimbursable expenses increased from 51.3% to 85.4% during the quarter ended December 31, 2001, as compared to the same period in the prior year, due primarily to decreases in utilization of our client serving professionals. Similarly, project personnel and related expenses including out-of-pocket reimbursable expenses increased as a percentage of net revenue from 62.9% to 97.1% during the quarter ended December 31, 2001. Professional development and recruiting expenses decreased $5.0 million to $2.8 million during the quarter ended December 31, 2001 as compared to the same period in the prior year. This decrease primarily reflects decreases in our level of recruiting and the cancellation of several firm wide meetings. As a percentage of net revenue, these expenses decreased to 7.7% as compared to 10.3% during the same period in the prior year. Marketing and sales expenses decreased from $3.3 million to $1.4 million during the quarter ended December 31, 2001 as compared to the same period in the prior year as a result of decreased marketing activities. As a percentage of net revenue, these expenses decreased to 3.8% as compared to 4.4% during the same period in the prior year. Management and administrative support expenses decreased 8.2% from $12.1 million to $11.1 million during the quarter ended December 31, 2001 as compared to the same period in the prior year, principally as a result of our cost reduction programs. As a percentage of net revenue, these expenses increased from 16.1% to 30.8% during the quarter ended December 31, 2001 as compared to the same period in the prior year. Goodwill amortization increased $9.6 million from $5.9 million to $15.5 million during the quarter ended December 31, 2001 as compared to the same period in the prior year, primarily as a result of the Cluster acquisition that was completed in November 2000. As a percentage of net revenue, these expenses increased from 7.8% to 42.7% as compared to the same period in the prior year. Noncash compensation increased from $5.0 million during the quarter ended December 31, 2000 to $13.0 million during the quarter ended December 31, 2001. This is primarily the amortization of equity granted to employees as a result of the Cluster acquisition that will be earned over time contingent on their continued employment. As a percentage of net revenue, noncash compensation increased from 6.6% to 36.0% as compared to the same period in the prior year. In the third quarter of fiscal 2002, the Company recorded a restructuring charge of $15.5 million based on an evaluation of competitive conditions in the global markets for business strategy and technology solutions services. The Company completed an assessment of the infrastructure needed to support anticipated levels of business in fiscal 2003 and beyond, and developed and implemented a restructuring plan designed to better align its cost structure and areas of operation with current business requirements. The restructuring charge consists of $10.8 million for workforce reductions, $3.1 million for the reduction of office space, and $1.6 million for the write-down of other depreciable assets and equipment leases. The restructuring plan includes the termination of approximately 300 employees, of which 90% were client-serving personnel and 10% were operations support personnel. The client-serving personnel consist of partners, principals, managers, associates and analysts, and include 100 personnel who were formerly participating in the Company's furlough program. In addition, the restructuring plan includes office space reductions in San Francisco, New York and Chicago. Estimated costs related to the reduction of office space comprise contractual rental commitments for office space being vacated, in addition to costs associated with the write-off of leasehold improvements and write-down of other assets to their estimated net realizable value. EBITA, which consists of earnings from operations before amortization of goodwill and noncash compensation and the restructuring charge, decreased from earnings of $13.5 million to a loss of $10.0 million 13 during the quarter ended December 31, 2001 as compared to the same period in the prior year. EBITA is not a measure of financial performance under generally accepted accounting principles. You should not consider it in isolation from, or as a substitute for, net income or cash flow measures prepared in accordance with generally accepted accounting principles or as a measure of profitability or liquidity. Additionally our EBITA calculation may not be comparable to other similarly titled measures of other companies. We have included EBITA as a supplemental disclosure because it may provide useful information regarding our ability to generate cash for operating and other corporate purposes. Income from operations decreased from $2.6 million to a loss from operations of $54.0 million during the quarter ended December 31, 2001 as compared to the same period in the prior year due primarily to increased amortization of goodwill and noncash compensation, reduced revenue and the restructuring charge. Other income decreased from $2.5 million to $1.4 million during the quarter ended December 31, 2001 as compared to the same period in the prior year, primarily as a result of a decrease in interest rates and a decline in cash balances, which went from $165.4 million as of December 31, 2000 to $113.3 million as of December 31, 2001. As a percentage of net revenue, other income increased from 3.3% to 3.7%. Income taxes decreased from an expense of $6.3 million to a benefit of $9.6 million during the quarter ended December 31, 2001 as compared to the same period in the prior year, due principally to the loss incurred in the current year. The realization of this benefit is dependent upon the Company's ability to generate taxable income in the future. Nine Months Ended December 31, 2001 Compared to Nine Months Ended December 31, 2000 Our net income of $14.4 million during the nine months ended December 31, 2000 decreased $116.1 million resulting in a net loss of $101.7 million during the nine months ended December 31, 2001, due to increased amortization of goodwill and noncash compensation costs associated with the Cluster acquisition that closed on November 28, 2000, a decline in revenue, and additional costs associated with the restructuring plan implemented in the quarter ended December 31, 2001. Revenue before out-of-pocket expense reimbursements ("net revenue") for the nine months ended December 31, 2001 was $145.1 million, down 24.3% compared with $191.7 million reported for the period in the prior year. Total revenue including out-of-pocket expense reimbursements was $162.9 million, down 26.4% compared with $221.2 million reported for the period in the prior year. Revenue from new clients accounted for 13% of the revenue during the nine month period ended December 31, 2001, while revenue from existing clients accounted for 87% of revenue during the period. We served 129 clients during the nine months ended December 31, 2001, a decrease from the 139 served in the same period in the prior year. Project personnel and related expenses before out-of-pocket reimbursable expenses increased $0.8 million to $103.2 million during the nine months ended December 31, 2001 as compared to the same period in the prior year. Project personnel and related expenses including out-of-pocket reimbursable expenses decreased $11.0 million to $121.0 million during the nine months ended December 31, 2001 as compared to the same period in the prior year. Overall, project personnel and related expenses increased slightly year over year as a result of a full period of operations including Cluster during fiscal 2002, offset by the savings from our cost reduction programs implemented during fiscal 2002. We decreased our client-serving professional staff from 1,063 at December 31, 2000 to 958 at December 31, 2001. Beginning in June 2001, we reduced salaries between 10% and 15% for most employees, and in August 2001, we reduced salaries 65% for approximately 200 furloughed employees. During the quarter ended December 31, 2001, we further reduced personnel as part of the Company's restructuring plan. As a percentage of net revenue, project personnel and related expenses before out-of-pocket reimbursable expenses increased from 53.4% to 71.1% during the nine months ended December 31, 2001, as compared to the same period in the prior year, due primarily to decreases in utilization of our client serving professionals. Similarly, project personnel and related expenses including out-of-pocket reimbursable expenses increased as a percentage of net revenue from 68.8% to 83.3% during the nine months ended December 31, 2001. 14 Professional development and recruiting expenses decreased $8.9 million to $10.0 million during the nine months ended December 31, 2001 as compared to the same period in the prior year. This decrease primarily reflects decreases in our level of recruiting and the cancellation of several firm wide meetings. As a percentage of net revenue, these expenses decreased to 6.9% as compared to 9.9% during the same period in the prior year. Marketing and sales expenses decreased from $9.6 million to $5.9 million during the nine months ended December 31, 2001 as compared to the same period in the prior year as a result of decreased marketing activities. As a percentage of net revenue, these expenses decreased to 4.1% as compared to 5.0% during the same period in the prior year. Management and administrative support expenses increased 35.9% from $27.1 million to $36.8 million during the nine months ended December 31, 2001 as compared to the same period in the prior year, principally due to additional facilities resulting from the Cluster transaction, including offices in Barcelona, Boston, Dusseldorf, Lisbon, London, Madrid, Munich, Paris, and Sao Paolo, as well as additional equipment and personnel necessary to support our increased consulting capacity. As a percentage of net revenue, these expenses increased from 14.1% to 25.4% during the nine months ended December 31, 2001 as compared to the same period in the prior year. Goodwill amortization increased $39.8 million from $6.6 million to $46.3 million during the nine months ended December 31, 2001 as compared to the same period in the prior year due to the acquisitions of Momentus and Cluster which were completed in May and November 2000, respectively. As a percentage of net revenue, these expenses increased from 3.4% to 31.9% as compared to the same period in the prior year. Noncash compensation increased $35.0 million from $5.0 million to $40.0 million during the nine months ended December 31, 2001. This is primarily the amortization of equity granted to employees as a result of the Cluster acquisition that will be earned over time contingent on their continued employment. As a percentage of net revenue, noncash compensation increased from 2.6% to 27.6% as compared to the same period in the prior year. In the third quarter of fiscal 2002, the Company recorded a restructuring charge of $15.5 million based on an evaluation of competitive conditions in the global markets for business strategy and technology solutions services. The Company completed an assessment of the infrastructure needed to support anticipated levels of business in fiscal 2003 and beyond, and developed and implemented a restructuring plan designed to better align its cost structure and areas of operation with current business requirements. The restructuring charge consists of $10.8 million for workforce reductions, $3.1 million for the reduction of office space, and $1.6 million for the write-down of other depreciable assets and equipment leases. The restructuring plan includes the termination of approximately 300 employees, of which 90% were client-serving personnel and 10% were operations support personnel. The client-serving personnel consist of partners, principals, managers, associates and analysts, and include 100 personnel who were formerly participating in the Company's furlough program. In addition, the restructuring plan includes office space reductions in San Francisco, New York and Chicago. Estimated costs related to the reduction of office space comprise contractual rental commitments for office space being vacated, in addition to costs associated with the write-off of leasehold improvements and write-down of other assets to their estimated net realizable value. EBITA, which consists of earnings from operations before amortization of goodwill and noncash compensation and the restructuring charge, decreased from earnings of $33.7 million to a loss of $10.8 million during the nine months ended December 31, 2001 as compared to the same period in the prior year. EBITA is not a measure of financial performance under generally accepted accounting principles. You should not consider it in isolation from, or as a substitute for, net income or cash flow measures prepared in accordance with generally accepted accounting principles or as a measure of profitability or liquidity. Additionally our EBITA calculation may not be comparable to other similarly titled measures of other companies. We have included EBITA as a supplemental disclosure because it may provide useful information regarding our ability to generate cash for 15 operating and other corporate purposes. Income from operations decreased from $22.2 million to a loss from operations of $112.7 million during the nine months ended December 31, 2001 as compared to the same period in the prior year due primarily to increased amortization of goodwill and noncash compensation and a decline in revenue. Other income decreased from $8.5 million to $1.0 million during the nine months ended December 31, 2001 as compared to the same period in the prior year, primarily as a result of a decrease in interest rates, a decline in cash balances, which went from $165.4 million as of December 31, 2000 to $113.3 million as of December 31, 2001, and losses realized on equity investments of $3.6 million in the nine months ended December 31, 2001. As a percentage of net revenue, other income decreased from 4.4% to 0.4%. Income taxes decreased from an expense of $16.2 million to a benefit of $10.4 million during the nine months ended December 31, 2001 as compared to the same period in the prior year, due principally to the loss incurred in the current year. The realization of this benefit is dependent upon the Company's ability to generate taxable income in the future. Liquidity and Capital Resources We maintain a revolving line of credit pursuant to the terms of an unsecured credit agreement from a commercial bank under which we may borrow up to $10.0 million at an annual interest rate based on the prime rate or based on the LIBOR plus 1.75%, at our discretion. This line of credit has been reduced to account for letters of credit outstanding. As of December 31, 2001, we had approximately $9.2 million available under this line of credit. For the first nine months of fiscal 2002, net cash used in operating activities was $27.3 million and included a net loss after non-cash items of $5.6 million (after adding back $96.1 million of the following non-cash items to the consolidated net loss of $101.7 million: depreciation and amortization, goodwill amortization, noncash compensation, and the write-down of equity investments), and $12.8 million used for working capital and other activities. Net cash used for working capital and other activities consisted mainly of the fiscal year 2001 bonuses that were paid out during the nine months ended December 31, 2001 and an increase in deferred tax assets, offset by decreases in accounts receivable and prepaid expenses totaling $15.0 million. Our billings for the three and nine months ended December 31, 2001 totaled $41.0 million and $169.0 million, respectively. These amounts include VAT (which are not included in recognized revenues) and billings to clients for reimbursable expenses. Our gross accounts receivable balance of $19.2 million at December 31, 2001 represented 42.0 days of billings for the three months ended December 31, 2001. Cash used in investing activities was $11.7 million for the nine month period ended December 31, 2001. Cash used in investing activities resulted primarily from purchases of property and equipment of $7.3 million, cash used in acquisitions of $1.8 million and cash used for other assets of $2.6 million. Cash used in financing activities was $0.1 million for the nine month period ended December 31, 2001. Cash used in financing activities resulted primarily from the repurchase of DiamondCluster's Common Stock totaling $5.9 million and repayment of a note for $0.5 million, which was offset by the proceeds from common stock issued during the nine months totaling $6.3 million. During fiscal year 2001, our Board of Directors authorized the repurchase, from time to time, of an additional two million shares of our Class A Common Stock as part of our existing stock repurchase program. This authorization brought the total authorization for the stock repurchase program to three million shares, which commenced in October 1998. These repurchases were authorized to be made in the open market or in privately negotiated transactions with the timing and volume dependent upon market conditions. At December 31, 2001, the number of shares purchased under this authorization was 2.4 million shares at an aggregate cost of $46.7 million. On January 30, 2001, we offered our employees (other than senior officers) a plan, approved by the Board of Directors, which gave employees a choice to cancel certain stock options granted to them in exchange for a 16 future grant of new options to purchase the same class of shares, a majority of which would vest proportionately over a four year period. The original options were granted under DiamondCluster's 2000 Stock Option Plan and under DiamondCluster's 1998 Equity Incentive Plan. Employees who accepted the offer were required to make an election with respect to all covered options by February 8, 2001. In order to receive the new options, the employees were required to remain employed by DiamondCluster until August 9, 2001. The exchange offer was not available to the members of the Board of Directors or senior officers of DiamondCluster. A total of 2.3 million stock options were cancelled as part of this plan. On August 9, 2001, a total of 1.5 million of new options were granted as part of this plan, which represented between 75% and 100% of the original grant and had an exercise price that was set on the grant date. The exercise price for a majority of the options granted on August 9, 2001 was set at fair market value. The total cash outlay for the restructuring announced in December 2001 is expected to be approximately $12.8 million. The remaining $2.7 million of restructuring costs consists of non-cash charges primarily for write-offs of leasehold improvements for the facilities being downsized, as well as the write-off of sign-on bonuses previously paid to terminated employees. As of December 31, 2001, $3.9 million of cash had been expended for this initiative, primarily related to severance and related costs. The Company expects the restructuring will produce cost savings of $22 million on an annualized basis, of which approximately 68% relates to project personnel and related costs, and approximately 32% relates to other operating expenses. We believe that our current cash balances, amounts available under our existing lines of credit and cash flow from existing and future operations will be sufficient to fund our operating requirements at least through fiscal 2003. If necessary, we believe that additional bank credit would be available to fund any additional operating and capital requirements. In addition, we could consider seeking additional public or private debt or equity financing to fund future growth opportunities. Forward-Looking Statements Statements contained anywhere in this report that are not historical facts contain forward-looking statements including such statements identified by the words "anticipate", "believe", "estimate", "expect" or similar terminology used with respect to us and our management. These forward-looking statements are subject to risks and uncertainties that could cause our actual results, performance and prospects to differ materially from those expressed in, or implied by, the forward-looking statements. The forward-looking statements speak only as of the date hereof and we undertake no obligation to revise or update them to reflect events or circumstances that arise in the future. Readers are cautioned not to place undue reliance on forward-looking statements. For a statement of the Risk Factors that might cause our actual operating or financial results to differ materially, see Exhibit 99.1 to this Quarterly Report on Form 10-Q. Quantitative and Qualitative Disclosures About Market Risk Foreign Currency Risk: International revenues are made mostly from our sales in the respective countries by our foreign subsidiaries and are typically denominated in the local currency of each country, most of which are tied to the Euro. These subsidiaries also incur most of their expenses in the local currency. Accordingly, all foreign subsidiaries use the local currency as their functional currency. Our international business is subject to risks typical of an international business, including, but not limited to differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions and foreign exchange rate volatility. Our future results could be materially adversely impacted by changes in these or other factors. These financial statements are typically denominated in the foreign currency of the foreign subsidiary in order to centralize foreign exchange risk with the parent company in the United States. We are also exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation. As exchange rates 17 fluctuate, these results, when translated, may vary from expectations and adversely impact overall expected results and profitability. The Company has entered into transactions to reduce the effect of foreign exchange transaction gains and losses from recorded foreign currency denominated assets and liabilities, and to reduce the effect of foreign exchange translation gains and losses on the parent company's net investment in its foreign subsidiaries. These transactions involve the use of forward foreign exchange contracts in certain European currencies. A forward foreign exchange contract obligates the Company to exchange predetermined amounts of specified foreign currencies at specified exchange rates on specified dates or to make an equivalent U.S. dollar payment equal to the value of such exchange. As a result, increases or decreases in the Company's foreign currency transactions are partially offset by gains and losses on the forward contracts, so as to mitigate the possibility of significant foreign currency transaction and translation gains and losses. The Company does not use foreign currency contracts for trading purposes. The Company does not currently hedge anticipated foreign currency-denominated revenues and expenses not yet incurred. All foreign currency transactions and outstanding forward contracts are marked-to-market on a monthly basis. Interest Rate Risk: The Company invests its cash in highly liquid investments with original maturities of three months or less. The interest rate risk associated with our investing activities at December 31, 2001 is not material in relation to our consolidated financial position, results of operations or cash flows. We have not used derivative financial instruments to alter the interest rate characteristics of our investment holdings. 18 PART II. OTHER INFORMATION Item 1 -- 5 None Item 6 Exhibits and Reports on Form 8-K (a) Exhibits 3.1(a) Restated Certificate of Incorporation (filed as Exhibit 3.1 to the Registration Statement on Form S-1 (File No. 333-17785) and incorporated herein by reference) 3.1(b) Form of Certificate of Amendment to Restated Certificate of Incorporation of the Company (filed as Exhibit 3.1(b) to the Registration Statement on Form S-3 (File No. 333-30666) and incorporated herein by reference) 3.1(c) Form of Certificate of Amendment to Restated Certificate of Incorporation of the Company (filed as Exhibit 3.1(a) to the Form 10-Q for the Quarter ended June 30, 2001 and incorporated herein by reference) 3.2 By-Laws (filed as Exhibit 3.2 to the Registration Statement on Form S-1 (File No. 333-30666) and incorporated herein by reference) 99.1* Risk Factors
- -------- * filed herewith (b) Form 8-K dated October 24, 2001 None 19 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DIAMONDCLUSTER INTERNATIONAL, INC. Date: February 14 , 2001 By: /S/ MELVYN E.BERGSTEIN ---------------------------------- Melvyn E. Bergstein Chairman, Chief Executive Officer and Director Date: February 14 , 2001 By: /S/ Karl E. Bupp ---------------------------------- Karl E. Bupp Vice President, Chief Financial Officer and Treasurer 20 EX-99.1 3 dex991.txt RISK FACTORS EXHIBIT 99.1 RISK FACTORS You should carefully consider the risks described below. The risks described are not the only ones we face. Any of the following risks could have a material adverse effect on our business, financial condition and operating results. You should also refer to the other information contained in this report, including our financial statements and the related notes. We May Be Unable to Continue to Effectively Integrate Operations of Our Most Recent Acquisition Which Could Materially Adversely Affect Our Business, Financial Condition and Results of Operations In order to maintain and increase profitability and operating efficiencies in periods subsequent to our acquisition of Cluster Telecom. B. V. ("Cluster"), we will need to continue to integrate and coordinate certain key elements: . service offerings; . marketing and business development efforts; . management and other professional personnel; and . operational systems of the former Diamond and Cluster. We may not accomplish the integration smoothly, expeditiously or successfully. The difficulties of integrating operations include: . the necessity of coordinating a global organization; . integrating personnel who have diverse business and cultural backgrounds; and . combining different corporate cultures. The process of integrating operations could cause an interruption of, or loss of momentum in, the activities of DiamondCluster's businesses and the loss of key personnel. We will need to dedicate management resources which may distract attention from normal operations. Employee uncertainty and lack of focus during the integration may also disrupt our businesses. If we fail to effectively integrate our operations, there could be uncertainty in the marketplace or client concern regarding the impact of our acquisition of Cluster, which could materially adversely affect the business, financial conditions and results of operations of DiamondCluster. 1 We Must Build Recognition and Client Acceptance of Our New Name Diamond and Cluster have each invested significant efforts in building recognition and client acceptance of their names. We believe that market acceptance of the new name of DiamondCluster International, Inc. will be an important aspect of our efforts to retain and attract clients. Promoting and maintaining name recognition will depend largely on the success of DiamondCluster's marketing efforts and its ability to provide high quality, reliable and cost-effective services. These efforts will require significant expenses, which will affect our results of operations. In addition, although we intend to centralize our marketing efforts, a significant part of our client services will continue to be provided through individual consulting offices. Client dissatisfaction with the performance of a single office could diminish the value of our brand following the closing. Currency Exchange Rate Fluctuations Could Adversely Affect Our Results of Operations Approximately 45% of DiamondCluster's revenue for the nine months ended December 31, 2001 was derived from operations outside the United States. The results of operations for DiamondCluster in the future could be significantly affected by factors associated with international operations, such as changes in foreign currency 2 exchange rates and uncertainties relative to regional economic or political circumstances, as well as by other risks sometimes associated with international operations. Since the revenue and expenses of DiamondCluster's foreign operations will generally be denominated in local currencies, exchange rate fluctuations between such local currencies and the U.S. dollar subject us to currency translation risk with respect to the reported results of our foreign operations. Also, we may be subject to foreign currency translation risks when transactions are denominated in a currency other than the currency in which we incur expenses related to such transactions. There can be no assurance that we will not experience fluctuations in financial results from our operations outside the United States, and there can be no assurance that we will be able to reduce contractually or otherwise favorably the currency translation risk associated with our operations. Our Revenues Could Be Adversely Affected by the Loss of a Significant Client or the Failure to Collect a Large Account Receivable We have in the past derived, and may in the future derive, a significant portion of our revenues from a relatively limited number of major clients. During fiscal 2001, Diamond had one client that individually accounted for 12% of Diamond Cluster's net revenues. During the first nine months of fiscal 2002, Diamond had one client which individually accounted for approximately 10% of our net revenues. From quarter to quarter, revenues from one or more individual clients may exceed 10% of our revenues for the quarter. If we lose any major clients or any of our clients cancel or significantly reduce a large project's scope, we would lose a significant amount of revenue. In addition, if we fail to collect a large account receivable, we could be subjected to significant financial exposure. Variability of Quarterly Operating Results May Result in Reduced Prices for Our Common Stock We have experienced, and may in the future continue to experience, fluctuations in our quarterly operating results. These fluctuations could reduce the market price of our Common Stock. Factors that may cause our quarterly operating results to vary include: . the number of active client projects; . the requirements of client projects; . the termination of major client projects; . the loss of major clients; and . the timing of new client engagements and personnel cost increases. The timing of revenues is difficult to forecast because our sales cycle is relatively long and our services are affected by both the financial condition and management decisions of our clients and general economic conditions. A high percentage of our expenses are relatively fixed at the beginning of any period. Because our general policy is not to adjust our staffing levels based upon what we view as short-term circumstances, a variation in the timing, initiation or completion of client assignments, particularly at or near the end of any quarter, can cause significant variations in operating results from quarter to quarter and could result in losses for any particular period. 3 The Absence of Long-Term Contracts With Our Clients Reduces the Predictability of Our Revenues Our clients are generally able to reduce or cancel their use of our professional services without penalty and, in some circumstances, with little notice. As a result, we believe that the number of clients or the number and size of our existing projects are not reliable indicators or measures of future revenue. We have in the past provided, and are likely in the future to provide, services to clients without long-term agreements. When a client defers, modifies or cancels a project, there is no assurance that we will be able to deploy rapidly our professionals to other projects in order to minimize the underutilization of employees and the resulting adverse impact on operating results. We may not be able to replace cancelled or reduced contracts with new business with the result that our revenues may decline. Our Chief Executive Officer Controls a Significant Portion of the Voting Rights Which Limits Your Ability to Influence Corporate Matters Our Chief Executive Officer controls a significant portion of our voting stock. All of the holders of our Class B Common Stock have granted proxies to our Chief Executive Officer to vote these shares. As of December 31, 2001, our current Chief Executive Officer controls, individually or by proxy, approximately 57.4% of the voting rights of our outstanding Common Stock. As a result, he will have the voting power to significantly influence the election of our board of directors and to affect all matters requiring stockholder approval. In addition, an agreement among Diamond and our partners requires that our Chief Executive Officer be selected from our partners. This significantly limits the number of qualified persons that may be considered for that office. As a result, we may not be successful in attracting future persons who are qualified to serve as our Chief Executive Officer. If We Are Unable to Protect Our Intellectual Property Rights or If We Infringe Upon the Intellectual Property Rights of Others Our Business May Be Harmed Failure to secure or maintain protection of our intellectual property could adversely affect our ability to serve our clients and generate revenue. We rely on a combination of non-disclosure and other contractual agreements and copyright and trademark laws to protect our proprietary rights. We enter into confidentiality agreements with our employees, require that our clients enter into such agreements, and limit access to and distribution of our proprietary information. However, these efforts may be insufficient to prevent misappropriation of our proprietary information or detect unauthorized use of our intellectual property rights. Ownership of intellectual property developed during our client engagements is the subject of negotiation and is frequently assigned to the client. We generally retain the right to use any intellectual property that is developed during a client engagement that is of general applicability and is not specific to the client's project. Issues relating to the ownership of and rights to use intellectual property developed during the course of a client engagement can be complicated. Clients may demand assignment of ownership or restrictions on our use of the work product. In addition, disputes may arise that affect our ability to resell or reuse intellectual property. We may have to pay economic damages in these disputes which could adversely affect our business. 4 Failure to Meet Client Expectations Could Result in Losses and Negative Publicity A failure or inability by us or one of our subcontractors to meet a client's expectations could damage our reputation and adversely affect our ability to attract new business and result in delayed or lost revenues. Our client engagements involve the creation, implementation and maintenance of business systems and other applications that can be critical to our clients' businesses. We may be sued or unable to collect accounts receivable if a client is not satisfied with our service. Our client contracts may not protect us from liability for damages in the event that we are sued. In addition, our general liability insurance coverage may not continue to be available on reasonable terms or in sufficient amounts. The successful assertion of any large claim against us or the failure by us to collect a large account receivable could result in significant financial exposure to us. An Inability to Keep Pace with Rapidly Changing Technology May Impair Our Ability to Remain Competitive Our failure to develop e-commerce business services that keep pace with continuing changes in the Internet and other technology, evolving industry standards, information technology and client preferences will result in decreased demand for our services. Among our challenges in this area are the need to: . continue to develop our strategic and technical experience; . develop new services that meet changing client needs; and . use effectively leading technologies. We may not be able to meet these objectives on a timely or successful basis. Competition in Our Industry is Intense and Could Harm Our Business Increased competition in our industry could result in price reductions, reduced gross margins or loss of market share, any of which could seriously harm our business. The e-commerce business services market is relatively new, includes a large number of participants, is subject to rapid technological changes and is highly competitive. We compete with a number of companies that have significantly greater financial, technical and marketing resources, greater name recognition, and greater revenues than ours. We believe that the principal competitive factors in our industry include: . diagnostic capabilities; . effectiveness of strategic business models; . scope of services; . service delivery approach; . technical and industry expertise; . perceived value; and . results orientation. We believe that our ability to compete also depends in part on a number of competitive factors outside of our control, including the ability of our competitors to hire, retain and motivate senior consultants, the price at which others offer comparable services, and the extent of our competitors' responsiveness to client needs. We may not be able to compete successfully with our competitors in the future. In addition, there are relatively low barriers to entry in our industry. We do not own any patented technology that inhibits competitors from entering that market or providing services similar to ours. As a result, new and unknown market entrants could pose a threat to our business. 5 The Price for Our Common Stock Has Been Volatile and Unpredictable The price for our Class A Common Stock has been volatile. Our Class A Common Stock has been listed on the Nasdaq National Market since February 1997. The closing market price of the Class A Common Stock has experienced variations, and since January 1, 1999, our high and low sales price has ranged from a high of $106.00 to a low of $7.50. The market price of our Class A Common Stock may experience fluctuations in the future for a variety of reasons. These include: . negative news about other publicly traded companies in our industry; . general economic or stock market conditions unrelated to our operating performance; . quarterly variations in our operating results; . changes in earnings estimates by analysts; . announcements of new contracts or service offerings by or our competitors; and . other events or factors. In addition, the stock market in recent years has experienced significant price and volume fluctuations which have affected the market prices of technology related companies. These fluctuations may continue to occur and disproportionately impact our stock price. The Failure to Integrate or Negotiate Successfully Any Future Acquisitions Could Harm Our Business and Operating Results If we acquire businesses in the future and are unable to integrate successfully these businesses, it could harm our business and operating results. In order to remain competitive or to expand our business, we may find it necessary or desirable to acquire other businesses, products or technologies. We may be unable to identify appropriate acquisition candidates. If we identify an appropriate acquisition candidate, we may not be able to negotiate the terms of the acquisition successfully, to finance the acquisition or to integrate the acquired businesses, products or technologies into our existing business and operations. Further, completing a potential acquisition and integrating an acquired business may strain our resources and require significant management time. In addition, we may be required to amortize significant amounts of goodwill and other intangible assets in connection with future acquisitions which would harm our operating results. We May Need to Raise Additional Capital in the Future Which May Not Be Available We may not be able to raise capital in the future to meet our liquidity needs and finance our operations and future growth. We were not profitable in the most recently reported quarter and we may not continue to be profitable in the future. We believe that existing cash resources, the amounts available under our revolving line of credit and cash generated from operations will be sufficient to satisfy our operating cash needs at least through fiscal 2003. Any future decreases in our operating income, cash flow, or stockholders' equity may impair our future ability to raise additional funds to finance operations. As a result, we may not be able to maintain adequate liquidity to support our operations. Future Sales of Our Common Stock in the Public Market Could Cause the Price of Our Stock to Decline In the future, our stockholders could sell substantial amounts of our common stock in the public market which could cause our market price to decline. A substantial number of outstanding shares of common stock and shares of our common stock issuable upon exercise of outstanding stock options and warrants will become eligible for future sale in the public market at various times. An increase in the number of shares of our common stock in the public market could adversely affect prevailing market prices and could impair our future ability to raise capital through the sale of our equity securities. 6 Our Charter Documents and Delaware Law May Discourage an Acquisition of Diamond Provisions of our certificate of incorporation, by-laws, and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. We may issue shares of preferred stock in the future without stockholder approval and upon such terms as our board of directors may determine. Our issuance of this preferred stock could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from acquiring, a majority of our outstanding stock and potentially prevent the payment of a premium to stockholders in an acquisition. Our charter and by-laws also provide that special stockholders meetings may be called only by our Chairman of the board of directors, by our Secretary at the direction of our board of directors, or by stockholders holding at least 30% of the voting power of the issued and outstanding shares of outstanding common stock, with the result that any third-party takeover not supported by the board of directors could be subject to significant delays and difficulties. In addition, our board of directors is divided into three classes, each of which serves for a staggered three-year term, which may make it more difficult for a third party to gain control of our board of directors. We Do Not Intend to Pay Dividends We have never paid any cash dividends on our common stock and do not expect to declare or pay any cash or other dividends in the foreseeable future. 7 -----END PRIVACY-ENHANCED MESSAGE-----