10-Q/A 1 d10qa.txt FORM 10-Q/A ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-Q/A ---------------- [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended September 30, 2002 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 October 31, 2002, there were 24,975,943 shares of Class A Common Stock and 6,478,207 shares of Class B Common Stock of the Registrant outstanding. ================================================================================ For purposes of the Form 10Q/A, and in accordance with Rule 12b-15 under the Securities Exchange Act of 1934, as amended, the undersigned Registrant (the "Company") hereby amends its Quarterly Report on Form 10-Q for the six months ended September 30, 2002 to reflect the correction of an error made in the noncash compensation expense included therein, as follows: 1. Deleting in their entirety from Part I, Item 1, Financial Statement Schedules: a. "Condensed Consolidated Balance Sheets March 31, 2002 and September 30, 2002" and substituting in lieu thereof the "Condensed Consolidated Balance Sheets March 31, 2002 and September 30, 2002" set forth below. b. "Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Six Months Ended September 30, 2002" and substituting in lieu thereof the "Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Six Months Ended September 30, 2002" set forth below. c. "Condensed Consolidated Statements of Cash Flows for the Six Months Ended September 30, 2002" and substituting in lieu thereof the "Condensed Consolidated Statements of Cash Flows for the Six Months Ended September 30, 2002" set forth below. 2. Deleting in its entirety Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and substituting in lieu thereof "Management's Discussion and Analysis of Financial Condition and Results of Operations" set forth below. In order to preserve the nature and character of the disclosures provided in the Form 10-Q as they were originally filed, no attempt was made to modify or update any disclosure except those required to reflect the effects of the amendment. This correction does not impact previously reported revenue, total shareholders' equity, or cash balances. EXPLANATORY NOTE In May 2002, the Company offered employees (other than senior officers) a choice to surrender certain previously granted stock options in exchange for a future grant of new options to purchase the same class of shares. Employees who elected to participate in this program were required to make an election with respect to all covered options by May 14, 2002, and a total of 4.3 million stock options were surrendered as part of this plan. Certain of these options had intrinsic value at the original grant date, a portion of which had not been amortized to noncash compensation expense at the date the options were surrendered. At the time the offer was accepted, the Company reversed both the unamortized original intrinsic value included in the unearned compensation account and the previously recognized compensation expense associated with non-vested options, and wrote-off the related amounts against additional paid-in capital based upon its understanding of the accounting guidance regarding option forfeitures, including paragraph 15 of Accounting Principles Board Opinion No. 25. In the process of preparing the Company's financial statements for the quarter ended December 31, 2002, the Company learned that the accounting for the cancellation of the surrendered options was subject to the guidance under EITF 00-23, Issues Related to Accounting for Stock Compensation Under APB Opinion No. 25 and FASB Interpretation No. 44, Issue 37(a). This guidance provides that the total amount of compensation expense recognized over the life of a cancelled award cannot be less than the award's original intrinsic value, even when the award is voluntarily surrendered by the employee and cancelled prior to full vesting. The intrinsic value of compensatory stock option awards is charged to noncash compensation over the vesting period. At the date the options were cancelled, the remaining unamortized compensation expense of $8.6 million related to these surrendered options should have been recognized as a noncash charge to compensation expense during the three months ended June 30, 2002. The Company has therefore revised its consolidated financial statements for the quarter ended June 30, 2002, and the six-months ended September 30, 2002, to correct this $8.6 million error in the reporting of noncash compensation expense related to non-vested options that were cancelled in May 2002. Conforming changes reflecting this correction have been made in the Company's Management's Discussion and Analysis of Financial Condition and Results of Operations, and Consolidated Financial Statements. These corrections resulted in the following changes to earnings:
Six Months Ended September 30, 2002 (In 000's, except per share data) ---------------------------------- As Reported Revised --------------- --------------- Noncash compensation $ 24,824 $ 33,457 Total Operating Expenses 141,418 150,051 Loss from operations (52,933) (61,566) Loss before income taxes and cumulative effect of change in accounting Principle (53,308) (61,941) Loss before cumulative effect of change in accounting principle (44,016) (52,649) Net loss (184,880) (193,513) Comprehensive loss $(182,534) $(191,167) Basic and diluted loss per share of common stock: Loss before cumulative effect of change in accounting principle $ (1.40) $ (1.67) Cumulative effect of change in accounting principle (4.47) (4.47) --------- --------- Net loss $ (5.86) $ (6.14) ========= =========
The Company made changes to the condensed consolidated balance sheet to reflect the reversal of the write-off of additional paid-in capital related to the cancelled options and to reduce retained earnings (accumulated deficit) for the changes to earnings outlined above. The condensed consolidated balance sheet has been changed to reflect these corrections as follows:
September 30, 2002 (In 000's) -------------------------------------- As Reported Revised --------------- ------------------ Additional paid-in capital $ 653,261 $ 661,894 Retained earnings (accumulated deficit) (298,740) (307,373)
The Company also made changes to the condensed consolidated statements of cash flows to reflect these corrections as follows:
Six Months Ended September 30, 2002 (In 000's) -------------------------------------- As Reported Revised --------------- ------------------ Loss before cumulative effect of change in accounting principle $ (44,016) $ (52,649) Noncash compensation 24,824 33,457
DIAMONDCLUSTER INTERNATIONAL, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
March 31, September 30, ASSETS 2002 2002 ----------- -------------- (Unaudited) Current assets: Cash and cash equivalents $ 96,773 $ 92,186 Accounts receivable, net of allowance of $1,089 and $1,224 as of March 31, 2002 and September 30, 2002, respectively 22,131 21,805 Income taxes receivable 1,321 - Prepaid expenses and short-term deferred taxes 9,417 7,578 --------- --------- Total current assets 129,642 121,569 Computers, equipment, leasehold improvements and software, net 15,789 13,016 Lont-term deferred taxes 16,817 25,944 Other assets 3,749 3,100 Goodwill, net 235,179 94,315 --------- --------- Total assets $ 401,176 $ 257,944 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 6,277 $ 6,628 Income taxes payable - 1,909 Restructuring accrual, current portion 3,963 9,089 Other accrued liabilities 15,838 15,048 --------- --------- Total current liabilities 26,078 32,674 Restructuring accrual, less current portion - 9,315 --------- --------- Total liabilities 26,078 41,989 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, 27,497 issued as of March 31, 2002 and 28,027 issued as of September 30, 2002 27 28 Class B common stock, $.001 par value, 100,000 shares authorized, 6,562 issued as of March 31, 2002 and 6,622 issued as of September 30, 2002 7 7 Additional paid-in capital 659,844 661,894 Unearned compensation (121,340) (86,180) Notes receivable from sale of common stock (80) (80) Accumulated other comprehensive loss (2,810) (464) Accumulated deficit (113,860) (307,373) --------- --------- 421,788 267,832 Less: Common stock in treasury, at cost, 2,424 shares held at March 31, 2002 and 3,392 shares held at September 30, 2002 46,690 51,877 --------- --------- Total stockholders' equity 375,098 215,955 --------- --------- Total liabilities and stockholders' equity $ 401,176 $ 257,944 ========= =========
See accompanying notes to condensed consolidated financial statements. DIAMONDCLUSTER INTERNATIONAL, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (In thousands, except per share data)
For the Three Months For the Six Months ended September 30, ended September 30, -------------------- ------------------- 2001 2002 2001 2002 -------- -------- -------- --------- (Unaudited) (Unaudited) Revenue: Revenue before out-of-pocket expense reimbursements (net revenue) $ 50,756 $ 38,107 $108,941 $ 76,434 Out-of-pocket expense reimbursements 6,009 6,585 13,532 12,051 -------- -------- -------- --------- Total revenue 56,765 44,692 122,473 88,485 Operating expenses: Project personnel and related expenses before out-of-pocket reimbursable expenses 34,295 28,916 72,325 58,393 Out-of-pocket reimbursable expenses 6,009 6,585 13,532 12,051 -------- -------- -------- --------- Total project personnel and related expenses 40,304 35,501 85,857 70,444 Professional development and recruiting 3,564 962 7,226 2,152 Marketing and sales 1,871 1,125 4,512 2,840 Management and administrative support 11,934 9,828 25,681 20,301 Goodwill amortization 15,453 - 30,883 - Noncash compensation* 13,159 11,475 26,976 33,457 Restructuring charge - 20,857 - 20,857 -------- -------- -------- --------- Total operating expenses 86,285 79,748 181,135 150,051 -------- -------- -------- --------- Loss from operations (29,520) (35,056) (58,662) (61,566) Other expense, net (365) (76) (786) (375) -------- -------- -------- --------- Loss before income taxes and cumulative effect of change in accounting principle (29,885) (35,132) (59,448) (61,941) Income tax expense (benefit) (1,698) (7,377) (813) (9,292) -------- -------- -------- --------- Loss before cumulative effect of change in accounting principle (28,187) (27,755) (58,635) (52,649) Cumulative effect of change in accounting principle, net of income tax benefit of zero - - - (140,864) -------- -------- -------- --------- Net loss (28,187) (27,755) (58,635) (193,513) Unrealized gain from securities, net of income tax benefit of $150 for the three months ended September 30, 2001, and $57 for the six months ended September 30, 2001 (236) - (91) - Foreign currency translation adjustments 2,274 (337) (857) 2,346 -------- -------- -------- --------- Comprehensive loss $(26,149) $(28,092) $(59,583) $(191,167) ======== ======== ======== ========= Basic and diluted loss per share of common stock: Loss before cumulative effect of change in accounting principle $ (0.92) $ (0.89) $ (1.92) $ (1.67) Cumulative effect of change in accounting principle - - - (4.47) -------- -------- -------- --------- Net loss $ (0.92) $ (0.89) $ (1.92) $ (6.14) ======== ======== ======== ========= Shares used in computing basic and diluted net loss per share of common stock 30,775 31,227 30,553 31,525 -------- * Noncash compensation: Project personnel and related expenses $ 12,924 $ 11,306 $ 26,580 $ 32,571 Professional development and recruiting 34 19 48 123 Marketing and sales 29 20 38 205 Management and administrative support 172 130 310 558 -------- -------- -------- --------- Total noncash compensation $ 13,159 $ 11,475 $ 26,976 $ 33,457 ======== ======== ======== =========
See accompanying notes to condensed consolidated financial statements. DIAMONDCLUSTER INTERNATIONAL, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
For the Six Months Ended September 30, -------------------- 2001 2002 --------- --------- (Unaudited) Cash flows from operating activities: Loss before cumulative effect of change in accounting principle $ (58,635) $ (52,649) Adjustments to reconcile loss before cumulative effect of change in accounting principle to net cash used in operating activities: Restructuring charge - 20,857 Depreciation and amortization 4,113 3,145 Write-down of net book value of computers, equipment, leasehold improvements and software, net - 1,334 Goodwill amortization 30,883 - Noncash compensation 26,976 33,457 Deferred income taxes 2,058 (9,121) Tax benefits from employee stock plans 739 282 Write-down of equity investments 3,564 - Other (1,846) - Changes in assets and liabilities, net of effects of acquisition: Accounts receivable 2,883 1,721 Prepaid expenses and other 2,853 2,293 Accounts payable (350) 137 Restructuring accrual - (6,416) Other assets and liabilities (33,745) 819 -------------------- Net cash used in operating activities (20,507) (4,141) --------- --------- Cash flows from investing activities: Capital expenditures, net (5,171) (1,090) Acquisitions, net of cash acquired (1,468) - Other assets (3,353) 501 --------- --------- Net cash used in investing activities (9,992) (589) --------- --------- Cash flows from financing activities: Repayment of note (500) - Common stock issued 4,301 3,471 Purchase of treasury stock (6,171) (5,187) --------- --------- Net cash used in financing activities (2,370) (1,716) --------- --------- Effect of exchange rate changes on cash 3,679 1,859 --------- --------- Net decrease in cash and cash equivalents (29,190) (4,587) Cash and cash equivalents at beginning of period 151,358 96,773 --------- --------- Cash and cash equivalents at end of period $ 122,168 $ 92,186 ========= ========= Supplemental disclosure of cash flow information: Cash paid during the period for interest $ 51 $ 219 Cash paid during the period for income taxes 2,681 1,900
See accompanying notes to condensed consolidated financial statements. DIAMONDCLUSTER INTERNATIONAL, INC. 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 Condensed 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 premier global management-consulting firm. We help leading organizations worldwide develop and implement growth strategies, improve operations, and capitalize on technology. We work collaboratively with our clients, utilizing teams of consultants with skills in strategy, technology and program management. During the quarter ended September 30, 2002 we generated net revenues (before reimbursements of out-of-pocket expenses) of $38.1 million from 79 clients. We employed 674 client-serving professionals and had eleven offices in North America, Europe and Latin America as of September 30, 2002. Our revenues are comprised of professional fees for services rendered to our clients which are billed either monthly or semi-monthly in accordance with the terms of the client engagement. 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. If it becomes evident that costs are likely to be incurred subsequent to targeted project completion, a portion of the project revenue is 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. 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 are comprised 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 the 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, and that our overhead costs are balanced with our revenue level. In addition, we monitor the progress of client projects with client senior management. We manage the activities of our professionals by closely monitoring engagement schedules and staffing requirements for new engagements. However, a rapid decline in the demand for the professional services we provide could result in a lower utilization of our professionals than we planned. In addition, 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 retain underutilized employees. While the number of client serving professionals must be adjusted to reflect active engagements, we must also retain a sufficient number of senior professionals to oversee existing client engagements and participate in our sales efforts to secure new client assignments. Forward Looking Statements Statements contained anywhere in this report that are not historical facts contain forward-looking statements including DIAMONDCLUSTER INTERNATIONAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) such statements identified by the words "anticipate," "believe," "estimate," "expect" and similar terminology used with respect to the Company and its management. These forward looking statements are subject to risks and uncertainties which could cause the Company's 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 the Company undertakes 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 adversely affect the Company's operating or financial results, see Exhibit 99.1 to this Quarterly Report on Form 10-Q. Recently Adopted Accounting Pronouncements Goodwill and Other Intangible Assets On April 1, 2002 the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." With the adoption of SFAS No. 142, goodwill and other indefinite life intangible assets ("intangibles") are no longer subject to amortization, rather they are subject to an assessment for impairment whenever events or circumstances indicate that impairment may have occurred, but at least annually, by applying a fair value based test. Prior to April 1, 2002 the Company amortized goodwill and identifiable intangible assets on a straight-line basis over their estimated useful life not to exceed 40 years, and periodically reviewed the recoverability of these assets based on the expected future undiscounted cash flows. The Company completed its initial impairment test on goodwill using the methodology described in SFAS No. 142 in the first quarter of fiscal 2003, and will conduct an assessment of impairment based on fair value in accordance with the requirements of SFAS No. 142 on an annual basis in the future. In connection with the adoption of SFAS No. 142 on April 1, 2002, the Company recognized an impairment loss of $140.9 million as the cumulative effect of a change in accounting principle. Goodwill amortization was $61.9 million in fiscal 2002, or $2.01 per share on both a pre-tax and after-tax basis. Goodwill amortization for the three and six months ended September 30, 2001 was $15.5 million and $30.9 million, respectively. No goodwill amortization was recorded for the three and six months ended September 30, 2002. Goodwill, net, as of March 31, 2002 and September 30, 2002 was $235.2 million and $94.3 million, respectively. There were no indefinite life intangibles other than goodwill at September 30, 2002. The Company has two geographic operating segments - North America and Europe and Latin America. The majority of goodwill reflected in the Company's consolidated financial statements was recognized in connection with the November 2000 acquisition of Cluster. The acquired Cluster business comprises the majority of the activities of the Europe and Latin America operating segment. The carrying value of goodwill allocated to each of these operating segments was tested for impairment as of April 1, 2002, in connection with the initial adoption of SFAS No.142. The goodwill impairment loss of $140.9 million recognized in the first quarter of fiscal 2003 was necessary to write down the carrying amount of goodwill to its implied fair value. The fair value was estimated based on the income approach, using the present value of future estimated cash flows. Long-Lived Assets On April 1, 2002 the Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal 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." This Statement establishes a single accounting model, based on the framework established in SFAS No. 121, for long-lived assets to be disposed of by sale. The Statement retains most of the requirements of SFAS DIAMONDCLUSTER INTERNATIONAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (Continued) No. 121 related to the recognition of the impairment of long-lived assets to be held and used. There was no impact on the financial condition or operating results of the Company from adopting SFAS No. 144 in the six months ended September 30, 2002. Results of Operations The following table sets forth for the periods indicated, selected statements of operations data as a percentage of net revenues:
For the Three Months For the Six Months Ended September 30, Ended September 30, ----------------------- ---------------------- 2001 2002 2001 2002 ----------------------- ---------------------- Revenues: Revenue before out-of-pocket reimbursements (net revenue) ............... 100.0% 100.0% 100.0% 100.0% Out-of-pocket reimbursements ............................................ 11.8 17.3 2.4 15.8 --------------------- -------------------- Total revenue ....................................................... 111.8 117.3 112.4 115.8 Operating expenses: Project personnel and related expenses before out-of-pocket reimbursable expenses ..................................... 67.6 75.9 66.4 76.4 Out-of-pocket reimbursable expenses ..................................... 11.8 17.3 12.4 15.8 --------------------- -------------------- Total project personnel and related expenses ........................ 79.4 93.2 78.8 92.2 Professional development and recruiting ................................. 7.0 2.5 6.6 2.8 Marketing and sales ..................................................... 3.7 3.0 4.2 3.7 Management and administrative support ................................... 23.5 25.8 23.6 26.6 Goodwill amortization ................................................... 30.5 -- 28.3 -- Noncash compensation .................................................... 25.9 30.1 24.8 43.8 Restructuring charge .................................................... -- 54.7 -- 27.3 --------------------- -------------------- Total operating expenses ............................................ 170.0 209.3 166.3 196.4 --------------------- -------------------- Loss from operations ......................................................... (58.2) (92.0) (53.9) (80.6) Other expense, net ........................................................... (0.7) (0.2) (0.7) (0.5) --------------------- -------------------- Loss before taxes and cumulative effect of change in accounting principle .... (58.9) (92.2) (54.6) (81.1) Income tax benefit ........................................................... (3.4) (19.4) (0.8) (12.2) --------------------- -------------------- Loss before cumulative effect of change in accounting principle .............. (55.5) (72.8) (53.8) (68.9) Cumulative effect of change in accounting principle .......................... -- -- -- (184.3) --------------------- -------------------- Net loss .................................................................. (55.5)% (72.8)% (53.8)% (253.2)% ===================== ====================
Quarter Ended September 30, 2002 Compared to Quarter Ended September 30, 2001 Our net loss for the quarter ended September 30, 2002 was $27.8 million compared to a net loss of $28.2 million during the quarter ended September 30, 2001. The decrease in the loss of $0.4 million is primarily due to the decrease in operating expenses as a result of the cost reduction programs implemented throughout fiscal years 2002 and 2003, and the decrease in goodwill amortization upon the adoption of SFAS No. 142 effective April 1, 2002. These expense decreases were partially offset by the restructuring charge taken in the second quarter of fiscal year 2003 and a decrease in revenue before out-of-pocket reimbursements. The Company applies Accounting Principles Board (APB) Opinion 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for stock issued to employees. Effective April 1, 2003, the Company will apply Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock Based Compensation," in DIAMONDCLUSTER INTERNATIONAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) accounting for stock issued to employees for grants awarded subsequent to that date. Had compensation expense on options issued to employees during the quarter ended September 30, 2002 been determined based on the fair value at the grant date consistent with the methodology prescribed in SFAS No. 123, the Company's net loss and diluted earnings per share would have increased by $0.6 million to a net loss of $28.4 million for the three months ended September 30, 2002, or $(0.91) per share. Our revenues before out-of-pocket expense reimbursements decreased 24.9% to $38.1 million during the quarter ended September 30, 2002 as compared to the same period in the prior year. Total revenue including out-of-pocket expense reimbursements decreased 21.3% to $44.7 million for the quarter ended September 30, 2002 compared with $56.8 million reported for the same period of the prior year. The decrease in revenue can be principally attributed to the weakness in the global economy, resulting in a decline in current demand for the Company's services. The unstable economic conditions have also led to pricing pressures, a lengthening of the Company's sales cycle and reduction and/or deferrals of client expenditures for consulting services. Revenue from new clients accounted for 9% of the revenue during the three-month period ended September 30, 2002 compared to 13% during the same period in the prior year. We served 79 clients during the quarter ended September 30, 2002 as compared to 77 clients during the same period in the prior year. Project personnel and related expenses before out-of-pocket reimbursable expenses decreased $5.4 million to $28.9 million during the quarter ended September 30, 2002 as compared to the same period in the prior year. The decrease in project personnel and related expenses reflects savings resulting from cost reduction programs implemented throughout fiscal 2002 and 2003. Beginning 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 quarters ended December 31, 2001 and September 30, 2002 we further reduced personnel as part of the Company's restructuring plan. We reduced our client-serving professional staff from 1,095 at September 30, 2001 to 674 at September 30, 2002. As a percentage of net revenues, project personnel and related expenses before out-of-pocket expense reimbursements increased from 67.6% to 75.9% during the quarter ended September 30, 2002, as compared to the same period in the prior year, due primarily to increased client prospecting costs. Similarly, project personnel and related expenses including out-of-pocket reimbursable expenses decreased $4.8 million to $35.5 million during the quarter ended September 30, 2002 as compared to the same period of the prior year. Professional development and recruiting expenses decreased $2.6 million to $1.0 million during the quarter ended September 30, 2002 as compared to the same period in the prior year. This decrease primarily reflects decreases in our level of recruiting and decreased training conduct expenditures. As a percentage of net revenues, these expenses decreased to 2.5% as compared to 7.0% during the same period in the prior year. Marketing and sales expenses decreased from $1.9 million to $1.1 million during the quarter ended September 30, 2002 as compared to the same period in the prior year as a result of decreased marketing activities. As a percentage of net revenues, these expenses decreased to 3.0% as compared to 3.7% during the same period in the prior year. Management and administrative support expenses decreased from $11.9 million to $9.8 million, or 17.7%, during the quarter ended September 30, 2002 as compared to the same period in the prior year, principally as a result of our cost reduction programs, including the closing of the New York office and the downsizing of other offices globally. As a percentage of net revenues, these expenses increased from 23.5% to 25.8% during the quarter ended September 30, 2002 as compared to the same period in the prior year. Goodwill amortization decreased from $15.5 million to zero during the quarter ended September 30, 2002, as compared to the same period in the prior year, as a result of the Company's adoption of SFAS No. 142 on April 1, 2002. As a percentage of net revenues, these expenses decreased from 30.5% to 0.0% as compared to the same period in the prior year. DIAMONDCLUSTER INTERNATIONAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) Noncash compensation decreased from $13.2 million during the quarter ended September 30, 2001 to $11.5 million during the quarter ended September 30, 2002. This is primarily the amortization of unearned compensation resulting from the issuance of stock options at prices below fair market value to Cluster employees in connection with the Cluster acquisition. The unearned compensation will be earned over time contingent on the continued employment of these employees. As a percentage of net revenues, noncash compensation was 30.1% during the quarter ended September 30, 2002 as compared to 25.9% in the same period of the prior year. In the third quarter of fiscal 2003, the Company recorded a restructuring charge of $20.9 million as a result of management's plan to better align the Company's operating infrastructure with anticipated levels of business in fiscal 2003. 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 $12.1 million for contractual commitments related to office space reductions, $5.7 million for severance and related expenses, $2.7 million for the write-off of various depreciable assets and the termination of certain equipment leases and $0.4 million of additional expense recorded in connection with the restructuring plan implemented in December 2001 due primarily to a change in estimate related to the cost of terminating an equipment lease. The principal actions in the September 2002 restructuring plan involved office space reductions, which included further consolidation of office space in multiple offices globally. Estimated costs for the reduction in physical office space are comprised of contractual rental commitments for office space vacated, attorney fees and related costs to sublet the office space, offset by estimated sub-lease rental income. The restructuring plan also included workforce reductions, resulting in the termination of approximately 90 employees. Of the total employees severed, 60% were project personnel and 40% were operational personnel. The client-serving personnel consist of partners, principals, managers, associates and analysts. Also included in the restructuring plan were the costs associated with the termination of certain equipment leases and costs related to the write-down of other assets to their estimated net realizable value. The Company expects savings from the September 2002 restructuring plan to be about $15-$17 million on an annualized basis. The loss from operations increased from a loss of $29.5 million to a loss of $35.1 million during the quarter ended September 30, 2002 as compared to the same period in the prior year. This increase was due primarily to the decline in revenue and the restructuring charge taken in the second quarter of fiscal year 2003, partially offset by the decrease in operating expenses and goodwill amortization. EBITA, which consists of earnings from operations before amortization of goodwill, noncash compensation and restructuring charge increased from a loss of $0.9 million to a loss of $2.7 million during the quarter ended September 30, 2002 as compared to the same period in the prior year. EBITA is not a measure of financial performance under U.S. 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 U.S. 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. Other expense, net decreased from $0.4 million to $0.1 million during the quarter ended September 30, 2002 as compared to the same period in the prior year. As a percentage of net revenues, these expenses decreased to 0.2% as compared to 0.7% during the same period in the prior year. The Company has deferred tax assets which have arisen primarily as a result of operating losses incurred in fiscal year 2002 and the first six months of fiscal year 2003, as well as other temporary differences between book and tax accounting. Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Management judgment is required in determining the Company's provision for income taxes, its deferred tax assets and liabilities and any valuation DIAMONDCLUSTER INTERNATIONAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) allowance recorded against the gross deferred tax assets. The income tax benefit increased from a benefit of $1.7 million to a benefit of $7.4 million during the quarter ended September 30, 2002 as compared to the same period in the prior year, due principally to the increase in the pre-tax loss before nondeductible goodwill amortization incurred in the current quarter, partially offset by the additional income tax expense recorded during the second fiscal quarter of 2003 to provide a valuation allowance for deferred tax assets related to certain state net operating loss and credit carryforwards and certain foreign net operating loss carryforwards. The Company believes that the ultimate realization of the deferred tax assets for federal, state, and foreign income tax purposes is considered more likely than not, due to anticipated sufficient future taxable income. Six Months Ended September 30, 2002 Compared to Six Months Ended September 30, 2001 Our net loss for the six months ended September 30, 2002 of $193.5 million increased $134.9 million from $58.6 million during the six months ended September 30, 2001. This increase is due primarily to the noncash loss related to the impairment in the value of goodwill and an increase in noncash compensation, partially offset by a reduction in goodwill amortization upon the adoption of SFAS No. 142 on April 1, 2002, and the decrease in operating expenses resulting from the implementation of cost reduction programs throughout fiscal 2002 and 2003. The Company applies Accounting Principles Board (APB) Opinion 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for stock issued to employees. Effective April 1, 2003, the Company will apply Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock Based Compensation," in accounting for stock issued to employees for grants awarded subsequent to that date. Had compensation expense on options issued to employees during the six months ended September 30, 2002 been determined based on the fair value at the grant date consistent with the methodology prescribed in SFAS No. 123, the Company's net loss and diluted earnings per share would have been increased by $0.8 million to a net loss of $194.3 million for the six months ended September 30, 2002, or a loss of $(6.16) per share. Net revenue for the six months ended September 30, 2002 was $76.4 million, down 29.8% compared with $108.9 million reported for the same period in the prior year. The decrease in revenue can be principally attributed to the weakness in the global economy, resulting in a decline in current demand for the Company's services. The unstable economic conditions have also led to pricing pressures, a lengthening of the Company's sales cycle and reduction and/or deferrals of client expenditures for consulting services. Revenue from new clients accounted for 12% of the revenue during the six month period ended September 30, 2002, while revenue from existing clients accounted for 88% of revenue during the same period. We served 103 clients during the six months ended September 30, 2002, a decrease from the 111 clients served in the same period in the prior year. Project personnel and related expenses before out-of-pocket reimbursable expenses decreased $13.9 million to $58.4 million during the six months ended September 30, 2002 as compared to the same period in the prior year. The decrease in project personnel and related expenses reflects savings resulting from cost reduction programs implemented throughout fiscal 2002 and 2003. 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 quarters ended December 31, 2001, March 31, 2002, and September 30, 2002 we further reduced personnel as part of the Company's restructuring plan. We reduced our client-serving professional staff from 1,095 at September 30, 2001 to 674 at September 30, 2002. As a percentage of net revenues, project personnel and related expenses before out-of-pocket expense reimbursements increased from 66.4% to 76.4% during the six months ended September 30, 2002, as compared to the same period in the prior year, due primarily to increased client prospecting costs. Similarly, project personnel and related expenses including out-of-pocket reimbursable expenses decreased $15.4 million to $70.4 million during the six-month period ended September 30, 2002 as compared to the same period of the prior year. DIAMONDCLUSTER INTERNATIONAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) Professional development and recruiting expenses decreased $5.1 million to $2.2 million during the six months ended September 30, 2002 as compared to the same period in the prior year. This decrease primarily reflects decreases in our level of recruiting, a reduction in firmwide meetings, and decreased training conduct expenditures. As a percentage of net revenues, these expenses decreased to 2.8% as compared to 6.6% during the same period in the prior year. Marketing and sales expenses decreased from $4.5 million to $2.8 million during the six months ended September 30, 2002 as compared to the same period in the prior year as a result of decreased marketing activities and personnel reductions. As a percentage of net revenues, these expenses decreased to 3.7% as compared to 4.2% during the same period in the prior year. Management and administrative support expenses decreased from $25.7 million to $20.3 million, or 20.9%, during the six months ended September 30, 2002 as compared to the same period in the prior year, principally as a result of our cost reduction programs, including the closing of the New York office and the downsizing of other offices globally. As a percentage of net revenues, these expenses increased from 23.6% to 26.6% during the six-month period ended September 30, 2002 as compared to the same period in the prior year. Goodwill amortization decreased from $30.9 million to zero during the six months ended September 30, 2002 as compared to the same period in the prior year as a result of the Company's adoption of SFAS No. 142 on April 1, 2002. As a percentage of net revenues, these expenses decreased from 28.3% to 0% as compared to the same period in the prior year. Noncash compensation increased from $27.0 million during the six months ended September 30, 2001 to $33.5 million during the six months ended September 30, 2002. Noncash compensation expense is primarily due to the amortization of unearned compensation resulting from the issuance of stock options at prices below fair market value to Cluster employees in connection with the Cluster acquisition. The unearned compensation will be earned over time contingent on the continued employment of these employees. As a percentage of net revenues, noncash compensation was 43.8% during the six months ended September 30, 2002. The increase in noncash compensation expense during the six months ended September 30, 2002 is due principally to the recognition of additional expense related to the remaining unamortized original intrinsic value of certain non-vested stock options cancelled by the Company on May 14, 2002, pursuant to an offer to employees (other than senior officers) to surrender certain stock options previously granted to them in exchange for a future grant of new options to purchase the same class of shares. In the third quarter of fiscal 2003, the Company recorded a restructuring charge of $20.9 million as a result of management's plan to better align the Company's operating infrastructure with anticipated levels of business in fiscal 2003. 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 $12.1 million for contractual commitments related to office space reductions, $5.7 million for severance and related expenses, $2.7 million for the write-off of various depreciable assets and the termination of certain equipment leases and $0.4 million of additional expense recorded in connection with the restructuring plan implemented in December 2001 due primarily to a change in estimate related to the cost of terminating an equipment lease. The principal actions in the September 2002 restructuring plan involved office space reductions, which included further consolidation of office space in Barcelona, Boston, Chicago, Madrid, Munich, New York and Sao Paulo. Estimated costs for the reduction in physical office space are comprised of contractual rental commitments for office space vacated, attorney fees and related costs to sublet the office space, offset by estimated sub-lease rental income. The restructuring plan also included workforce reductions, resulting in the termination of approximately 90 employees. Of the total employees severed, 60% were project personnel and 40% were operational personnel. The client-serving personnel consist of partners, principals, managers, associates and analysts. Also included in the restructuring plan were the costs associated with the termination of certain equipment leases and costs related to the write-down of other assets to their DIAMONDCLUSTER INTERNATIONAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) estimated net realizable value. The Company expects savings from the September 2002 restructuring plan to be about $15 - $17 million on an annualized basis. The loss from operations increased from a loss of $58.7 million to a loss of $61.6 million during the six months ended September 30, 2002 as compared to the same period in the prior year. This increase was due primarily to a decline in revenue, the restructuring charge and an increase in noncash compensation expense, partially offset by the reduction in goodwill amortization and a decrease in operating expenses. EBITA, which consists of earnings from operations before amortization of goodwill, noncash compensation and restructuring charge, increased from a loss of $0.8 million to a loss of $7.3 million during the six months ended September 30, 2002 as compared to the same period in the prior year. EBITA is not a measure of financial performance under U.S. 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 U.S. 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. Other expense, net decreased from $0.8 million to $0.4 million during the six months ended September 30, 2002 as compared to the same period in the prior year. As a percentage of net revenues, these expenses remained approximately the same at 0.7% compared to the same period in the prior year. The Company has deferred tax assets which have arisen primarily as a result of operating losses incurred in fiscal year 2002 and the first six months of fiscal year 2003, as well as other temporary differences between book and tax accounting. Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Management judgment is required in determining the Company's provision for income taxes, its deferred tax assets and liabilities and any valuation allowance recorded against the gross deferred tax assets. For the six months ended September 30, 2002, the income tax benefit increased from $0.8 million to $9.3 million as compared to the same period in the prior year, due principally to the increase in the pre-tax loss before nondeductible goodwill amortization incurred in the period, partially offset by the additional income tax expense recorded during the second fiscal quarter of 2003 to provide a valuation allowance for deferred tax assets related to certain state net operating loss and credit carryforwards and certain foreign net operating loss carryforwards. The Company believes that the ultimate realization of the deferred tax assets for federal, state and foreign income tax purposes is considered more likely than not, due to anticipated sufficient future taxable income. Liquidity and Capital Resources We maintain a revolving line of credit pursuant to the terms of a secured credit agreement with 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 LIBOR plus 1.50%, at our discretion. The line of credit is secured by cash and certain accounts receivable of the Company's wholly-owned subsidiary DiamondCluster International North America, Inc. This line of credit is reduced, as necessary, to account for letters of credit outstanding. As of September 30, 2002, we had approximately $8.8 million available under this line of credit. During the six-month period ended September 30, 2002, net cash used in operating activities was $4.1 million, and included a net loss of $2.9 million after certain non-cash items and the restructuring charge (calculated by adding back the $20.9 million restructuring charge and $28.8 million of the following non-cash items to the loss before the cumulative effect of change in accounting principle of $52.6 million: depreciation and amortization, non-cash compensation, deferred income taxes and the write-down of the net book value of property, plant, and equipment), and $1.2 million used by working capital DIAMONDCLUSTER INTERNATIONAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) and other operating activities. Our billings for the three and six months ended September 30, 2002 totaled $46.4 million and $92.8 million, respectively. These amounts include VAT (which are not included in recognized revenue) and billings to clients for reimbursable expenses. Our gross accounts receivable balance of $23.0 million at September 30, 2002 represented 45 days of billings for the quarter ended September 30, 2002. Cash used in investing activities was $0.6 million for the six-month period ended September 30, 2002. Cash used in investing activities resulted primarily from capital expenditures, partially offset by an increase in other assets. Cash used in financing activities was $1.7 million for the six-month period ended September 30, 2002. Cash used in financing activities resulted primarily from the repurchase of DiamondCluster's Class A Common Stock totaling $5.2 million, which was offset by common stock issued during the quarter totaling $3.5 million. On June 24, 2002, the Company's Board of Directors increased the number of shares authorized to be repurchased under its existing stock repurchase program by three million shares. This authorization brought the total authorized shares for the stock repurchase program to six million shares. 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. Through September 30, 2002, the number of shares purchased under this authorization was 3.4 million shares at an aggregate cost of $51.9 million. On May 2, 2002, the Company offered employees (other than senior officers) a plan, approved by the Board of Directors, which gave employees a choice to surrender certain stock options previously granted to them in exchange for a future grant of a smaller number of new options to purchase the same class of shares, a majority of which would vest over a three-year period. The original options were granted under DiamondCluster's 2000 Plan and under DiamondCluster's 1998 Equity Incentive Plan. Employees who accepted this offer were required to make an election with respect to all covered options by May 14, 2002. In order to receive the new options, the employees are required to remain employed by DiamondCluster until November 15, 2002. The exchange offer was not available to the members of the Board of Directors or senior officers of DiamondCluster. A total of 4.3 million stock options were surrendered as a part of this plan. Certain of these options had intrinsic value at the original grant date, the unvested portion of which had not been amortized to noncash compensation expense at the date surrendered. The voluntary surrender of these options resulted in a noncash charge to compensation expense of $8.6 million during the quarter ended June 30, 2002 relating to the remaining unamortized compensation expense related to these surrendered options. On November 15, 2002, approximately 1.0 million new options are expected to be granted to employees who remain employed by DiamondCluster. The exercise price for a majority of the options to be granted on November 15, 2002 will be at 25% of fair market value on that date. As a result of various personnel and other expense management actions the Company plans to take in the third fiscal quarter, it expects to take a charge of approximately $8-10 million in the December 2002 quarter. The charge will consist of severance and related expenses, and other expenses related to operational restructuring, including the discontinuance of Context (R), a quarterly publication of the Company. The Company expects expense savings from these actions to be approximately $15 - $17 million on an annualized basis. We believe that our current cash balances, existing lines of credit, and cash flow from existing and future operations will be sufficient to fund our operating requirements at least through fiscal 2004. 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. However, there is no assurance that such financing would be available to us on acceptable terms. DIAMONDCLUSTER INTERNATIONAL, INC. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 99.2* CEO Certifications Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to sections 302 and 906 of the Sarbanes-Oxley Act of 2002 99.3* CFO Certifications Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to sections 302 and 906 of the Sarbanes-Oxley Act of 2002 99.4* Senior Vice President, Finance and Administration Certifications Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to sections 302 and 906 of the Sarbanes-Oxley Act of 2002 ------------- * filed herewith DIAMONDCLUSTER INTERNATIONAL, INC. 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: January 27, 2003 By: /s/ Melvyn E. Bergstein --------------------------- Melvyn E. Bergstein Chairman, Chief Executive Officer and Director Date: January 27, 2003 By: /s/ Karl E. Bupp -------------------- Karl E. Bupp Vice President, Chief Financial Officer and Treasurer