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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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COMMISSION FILE NUMBER 000-20900
COMPUWARE CORPORATION
---------------------
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2007430
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
ONE CAMPUS MARTIUS, DETROIT, MI 48226
(Address of principal executive offices including zip code)
31440 NORTHWESTERN HIGHWAY, FARMINGTON HILLS, MI 48334-2564
(Former name, former address and former fiscal
year, if changed since last report)
Registrant's telephone number including area code: (313) 227-7300
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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act): Yes X No
---- ----
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date:
As of August 4th, 2003, there were outstanding 382,682,061 shares of Common
Stock, par value $.01, of the registrant.
Page 1 of 27 pages
PART I. FINANCIAL INFORMATION Page
----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
June 30, 2003 and March 31, 2003 3
Condensed Consolidated Statements of Operations
for the three months ended June 30, 2003 and 2002 4
Condensed Consolidated Statements of Cash Flows
for the three months ended June 30, 2003 and 2002 5
Notes to Condensed Consolidated Financial
Statements 6
Independent Accountants' Report 11
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 21
Item 4. Controls and Procedures 21
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 22
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COMPUWARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
JUNE 30, MARCH 31,
ASSETS 2003 2003
------------- -------------
(UNAUDITED)
CURRENT ASSETS:
Cash and cash equivalents $ 361,646 $ 319,466
Investments 178,097 156,737
Accounts receivable, net 473,846 515,819
Deferred tax asset, net 29,894 30,605
Income taxes refundable, net 10,079 10,853
Prepaid expenses and other current assets 20,085 16,951
----------- -----------
Total current assets 1,073,647 1,050,431
----------- -----------
INVESTMENTS 74,642 95,095
----------- -----------
PROPERTY AND EQUIPMENT, LESS ACCUMULATED
DEPRECIATION AND AMORTIZATION 408,450 386,678
----------- -----------
CAPITALIZED SOFTWARE, LESS ACCUMULATED
AMORTIZATION 51,502 54,514
----------- -----------
OTHER:
Accounts receivable 273,939 260,735
Deferred tax asset, net 24,589 20,174
Goodwill, net 212,702 212,288
Other 28,518 42,770
----------- -----------
Total other assets 539,748 535,967
----------- -----------
TOTAL ASSETS $ 2,147,989 $ 2,122,685
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 29,132 $ 37,588
Accrued expenses 121,924 134,579
Deferred revenue 316,093 296,998
----------- -----------
Total current liabilities 467,149 469,165
DEFERRED REVENUE 315,242 299,079
ACCRUED EXPENSES 22,354 22,750
----------- -----------
Total liabilities 804,745 790,994
----------- -----------
SHAREHOLDERS' EQUITY:
Common stock 3,827 3,824
Additional paid-in capital 706,907 704,190
Retained earnings 634,509 631,906
Accumulated other comprehensive loss (1,999) (8,229)
----------- -----------
Total shareholders' equity 1,343,244 1,331,691
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,147,989 $ 2,122,685
=========== ===========
See notes to condensed consolidated financial statements.
3
COMPUWARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
JUNE 30,
---------------------------
2003 2002
--------- ---------
REVENUES:
Software license fees $ 55,325 $ 57,153
Maintenance fees 101,576 105,694
Professional services fees 149,111 183,752
--------- ---------
Total revenues 306,012 346,599
--------- ---------
OPERATING EXPENSES:
Cost of software license fees 7,386 7,627
Cost of professional services 139,480 167,369
Technology development and support 40,023 31,799
Sales and marketing 67,385 66,176
Administrative and general 53,232 44,768
--------- ---------
Total operating expenses 307,506 317,739
--------- ---------
INCOME (LOSS) FROM OPERATIONS (1,494) 28,860
OTHER INCOME 5,109 5,178
--------- ---------
INCOME BEFORE INCOME TAXES 3,615 34,038
INCOME TAX PROVISION 1,012 11,573
--------- ---------
NET INCOME $ 2,603 $ 22,465
========= =========
Basic earnings per share $ 0.01 $ 0.06
========= =========
Diluted earnings per share $ 0.01 $ 0.06
========= =========
See notes to condensed consolidated financial statements.
4
COMPUWARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
JUNE 30,
-------------------------
2003 2002
--------- ---------
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income $ 2,603 $ 22,465
Adjustments to reconcile net income to cash provided by
operations:
Depreciation and amortization 11,222 12,995
Tax benefit from exercise of stock options 91 62
Acquisition tax benefits 1,758 1,768
Deferred income taxes (3,704) 4,154
Other 5,979 6,295
Net change in assets and liabilities:
Accounts receivable 28,769 77,217
Prepaid expenses and other current assets (3,134) (1,312)
Other assets (1,167) (597)
Accounts payable and accrued expenses (23,838) (41,993)
Deferred revenue 35,258 9,964
Income taxes 774 5,045
--------- ---------
Net cash provided by operating activities 54,611 96,063
--------- ---------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of:
Property and equipment:
Headquarters facility (23,633) (42,911)
Other (2,616) (613)
Capitalized software (3,162) (3,012)
Investments:
Proceeds 111,708 40,885
Purchases (97,963) (56,899)
--------- ---------
Net cash used in investing activities (15,666) (62,550)
--------- ---------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Net proceeds from exercise of stock options 870 327
Contribution to stock purchase plans 2,365 3,325
--------- ---------
Net cash provided by financing activities 3,235 3,652
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 42,180 37,165
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 319,466 233,305
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 361,646 $ 270,470
========= =========
See notes to condensed consolidated financial statements.
5
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2003
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements include
the accounts of Compuware Corporation and its wholly owned subsidiaries
(collectively, the "Company"). All intercompany balances and transactions have
been eliminated in consolidation.
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("generally accepted accounting principles") for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. Generally accepted accounting principles require
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, contingencies and results of operations. While management
has based their assumptions and estimates on the facts and circumstances known
at June 30, 2003, final amounts may differ from estimates.
In the opinion of management of the Company, the accompanying unaudited
condensed consolidated financial statements reflect all adjustments, consisting
only of normal recurring adjustments, that are necessary for a fair presentation
of the results for the interim periods presented. These financial statements
should be read in conjunction with the Company's audited consolidated financial
statements and notes thereto for the year ended March 31, 2003 included in the
Company's Annual Report to Shareholders and the Company's Form 10-K filed with
the Securities and Exchange Commission. The consolidated balance sheet at March
31, 2003 has been derived from the audited financial statements at that date but
does not include all information and footnotes required by generally accepted
accounting principles for complete financial statements. The results of
operations for interim periods are not necessarily indicative of actual results
achieved for full fiscal years.
6
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2003
NOTE 2 - COMPUTATION OF EARNINGS PER COMMON SHARE
Earnings per common share ("EPS") data were computed as follows (in thousands,
except for per share data):
Three Months Ended
June 30,
---------------------------
2003 2002
---------- ----------
BASIC EPS:
Numerator: Net Income $ 2,603 $ 22,465
---------- ----------
Denominator:
Weighted-average common shares outstanding 382,521 375,883
---------- ----------
Basic EPS $ 0.01 $ 0.06
========== ==========
DILUTED EPS:
Numerator: Net Income $ 2,603 $ 22,465
---------- ----------
Denominator:
Weighted-average common shares outstanding 382,521 375,883
Dilutive effect of stock options 1,492 2,606
---------- ----------
Total shares 384,013 378,489
---------- ----------
Diluted EPS $ 0.01 $ 0.06
========== ==========
During the three months ended June 30, 2003 and 2002, stock options and a
warrant to purchase approximately 60,884,000 and 60,132,000 shares,
respectively, were excluded from the diluted EPS calculation because they were
anti-dilutive.
Through June 30, 2003, in accordance with SFAS No. 123, "Accounting for
Stock-Based Compensation", the Company applied APB Opinion No. 25 and related
Interpretations in accounting for its stock-based compensation plans. Stock
options are granted at current market prices at the date of grant, therefore, no
compensation cost has been recognized for its plans. If compensation cost for
the Company's plans had been determined based on the fair value at the grant
dates for the three months ended June 30, 2003 and 2002 consistent with the
method prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation",
net income and earnings per share would have been adjusted to the pro forma
amounts indicated below (in thousands, except for per share data):
Three Months Ended June 30,
-------------------------------
2003 2002
--------- ---------
Net income (loss):
As reported $ 2,603 $ 22,465
Compensation cost, net of tax (10,009) (11,927)
--------- ---------
Pro forma $ (7,406) $ 10,538
========= =========
Earnings (loss) per share:
As reported:
Basic earnings per share $ 0.01 $ 0.06
Diluted earnings per share 0.01 0.06
Pro forma:
Basic earnings (loss) per share (0.02) 0.03
Diluted earnings (loss) per share (0.02) 0.03
The pro forma amounts for compensation cost may not be indicative of the effects
on net income and earnings per share for future years.
7
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2003
NOTE 3 - COMPREHENSIVE INCOME
Other comprehensive income includes foreign currency translation gains and
losses that have been excluded from net income and reflected in equity. Total
comprehensive income is summarized as follows (in thousands):
Three Months Ended
June 30,
--------------------------
2003 2002
------------ ------------
Net income $ 2,603 $22,465
Foreign currency translation
adjustment, net of tax 6,230 6,323
------------ ------------
Total comprehensive income $ 8,833 $28,788
============ ============
NOTE 4 - SEGMENTS
Compuware operates in two business segments in the technology industry: products
and professional services. The Company provides software products and
professional services to IT organizations that help IT professionals efficiently
develop, implement and support the applications that run their businesses.
Financial information for the Company's business segments is as follows (in
thousands):
Three Months Ended
June 30,
-------------------------
2003 2002
----------- -----------
Revenues:
Products:
Mainframe $119,231 $128,063
Distributed systems 37,670 34,784
----------- -----------
Total products revenue 156,901 162,847
Professional services 149,111 183,752
----------- -----------
Total revenues $306,012 $346,599
=========== ===========
Operating expenses:
Products $114,794 $105,602
Professional services 139,480 167,369
Corporate staff 53,232 44,768
----------- -----------
Total operating expenses $307,506 $317,739
=========== ===========
Income (loss) from operations before other income:
Products $42,107 $ 57,245
Professional services 9,631 16,383
Corporate staff (53,232) (44,768)
----------- -----------
Income (loss) from operations before other income (1,494) 28,860
Other income 5,109 5,178
----------- -----------
Income before income taxes $ 3,615 $ 34,038
=========== ===========
8
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2003
Financial information regarding geographic operations are presented in the table
below (in thousands):
Three Months Ended
June 30,
-------------------------
2003 2002
----------- -----------
Revenues:
United States $220,888 $264,985
Europe and Africa 68,687 64,896
Other international operations 16,437 16,718
----------- -----------
Total revenues $306,012 $346,599
=========== ===========
NOTE 5 - RESTRUCTURING CHARGE
In the fourth quarter of fiscal 2002, the Company adopted a restructuring plan
to reorganize its operating divisions, primarily the professional services
segment. These changes were designed to increase profitability by better
aligning cost structures with current market conditions.
The restructuring plan included a reduction of professional services staff at
certain locations, the closing of entire professional services offices and a
reduction of sales support personnel, lab technicians and related administrative
and financial staff. Approximately 1,600 employees worldwide were terminated as
a result of the reorganization. Payments continue to be made to certain
terminated employees in accordance with their agreements.
The following table summarizes the restructuring charge as of March 31, 2003,
and charges against the accrual during the first quarter of fiscal 2004 (in
thousands):
Charges against
Balance at the accrual during Balance at
March 31, the quarter ended June 30,
2003 June 30, 2003 2003
---------- ------------------ ----------
Employee termination benefits $ 698 $ 346 $ 352
Facilities costs (primarily lease
abandonments) 19,088 1,636 17,452
Legal, consulting and
outplacement costs 15 4 11
---------- ------------------ ----------
Total restructuring accrual $ 19,801 $ 1,986 $ 17,815
========== ================== ==========
9
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2003
NOTE 6 - INVESTMENTS IN PARTIALLY OWNED COMPANIES
The Company holds a 33.3% interest in CareTech Solutions, Inc. (CareTech).
CareTech provides outsourcing for healthcare information technology
organizations including data, voice, applications and data center operations.
This investment is accounted for under the equity method. The Company records
its share of income or loss against its net investment in CareTech.
At June 30, 2003 and March 31, 2003, the Company's carrying value of its
investments in and advances to CareTech was $15,599,000 and $16,191,000,
respectively. Included in the net investment at June 30, 2003 is a note
receivable in the amount of $16,891,000 ($17,283,000 at March 31, 2003). The
note is payable in quarterly installments through January 2012 and bears
interest at 5.25%.
The Company has guaranteed lease obligations of CareTech up to $12,500,000. The
Company has not recorded any liability related to these guarantees since it
believes that CareTech will continue to meet its obligations.
CareTech's most significant customer is the Detroit Medical Center (DMC). The
DMC has publicly announced it is having financial difficulties. The Company
considered the financial situation of the DMC at June 30, 2003 (and at March 31,
2003) and concluded that no impairment reserve was warranted at that time.
The Company holds a 49% interest in ForeSee Results, Inc. (ForeSee). ForeSee was
incorporated in October 2001 to provide online customer satisfaction management.
At June 30, 2003 and March 31, 2003, the Company's carrying value of its
investments in and advances to ForeSee was $4,718,000 and $4,252,000,
respectively. Included in the net investment at June 30, 2003 are notes
receivable from ForeSee in the amount of $4,500,000 ($3,500,000 at March 31,
2003). The ForeSee notes bear interest at the prime rate (4.00% at June 30,
2003) and are due between June 2007 and June 2008. The Company has pledged
$1,500,000 in additional loans to ForeSee, if needed, subject to approval by the
ForeSee shareholders. The Company monitors the financial situation of ForeSee on
a regular basis and has concluded that no impairment reserve was warranted at
June 30, 2003 (or at March 31, 2003).
10
INDEPENDENT ACCOUNTANTS' REPORT
Compuware Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of
Compuware Corporation and subsidiaries (the "Company") as of June 30, 2003, and
the related condensed consolidated statements of operations and cash flows for
the three-month periods ended June 30, 2003 and 2002. These financial statements
are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures and
making inquiries of persons responsible for financial and accounting matters. It
is substantially less in scope than an audit conducted in accordance with
auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of the
Company and subsidiaries as of March 31, 2003, and the related consolidated
statements of operations, shareholders' equity, and cash flows for the year then
ended (not presented herein); and in our report dated May 6, 2003, we expressed
an unqualified opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of March 31, 2003 is fairly stated, in all material respects,
in relation to the consolidated balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Detroit, Michigan
July 21, 2003
11
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This discussion contains certain forward-looking statements within the meaning
of the federal securities laws which are identified by the use of the words
"believes," "expects," "anticipates," "will," "contemplates," "would" and
similar expressions that contemplate future events. Numerous important factors,
risks and uncertainties affect our operating results, including, without
limitation, those discussed below, contained elsewhere in this report and in our
2003 Form 10-K filed with the Securities and Exchange Commission, and could
cause actual results to differ materially from the results implied by these or
any other forward-looking statements made by us, or on our behalf. There can be
no assurance that future results will meet expectations. While we believe that
our forward-looking statements are reasonable, you should not place undue
reliance on any such forward-looking statements, which speak only as of the date
made. Except as required by applicable law, we do not undertake any obligation
to publicly release any revisions which may be made to any forward-looking
statements to reflect events or circumstances occurring after the date of this
report.
o In 2002, we filed a lawsuit against International Business Machines
Corporation (IBM) alleging, among other things, copyright infringement,
misappropriation of trade secrets, intentional interference with
contractual relations and economic expectancy, false advertising and
various violations of the Lanham Act, as well as various anti-trust law
violations. We claim that IBM has misappropriated portions of our software
tools, used our technology to develop competing products, used its monopoly
power to engage in unlawful tying arrangements and subverted competition on
the merits. IBM has filed a counterclaim against us alleging violation of
six of their patents. Pursuit of this litigation will be costly,
time-consuming and may divert management's time and attention. Our legal
expenses have increased substantially and our general and administrative
expenses could further increase as a result of these factors. In addition,
IBM may seek to influence our customers and potential customers to reduce
or eliminate the amount of our products and services that they purchase, or
our lawsuit against IBM may otherwise be viewed negatively by our customers
and potential customers and cause them to refrain from buying our products
and services. Any of the foregoing developments could adversely affect our
position in the marketplace and our results of operations.
o While we are expanding our focus on distributed software products, a
majority of our revenue from software products is dependent on our
customers' continued use of IBM and IBM-compatible mainframe products and
on the acceptance of our pricing structure for software licenses and
maintenance. The pricing of our software licenses and maintenance is under
constant pressure from customers and competitive vendors.
o Our operating margins may decline. We do not compile margin analysis other
than on a segment basis. However, we are aware that operating expenses
associated with our distributed systems products are higher than those
associated with our traditional mainframe products. Since we believe the
best opportunities for revenue growth are in the distributed systems
market, product operating margins could experience more pressure. In
addition, operating margins in the professional services business are
significantly impacted by small fluctuations in revenue since most costs
are fixed during any short term period.
o Our results could be adversely affected by increased competition and
pricing pressures. We consider over 40 firms to be directly competitive
with one or more of our products. These competitors include but are not
limited to BMC Software, Inc., Borland, Computer Associates International,
Inc., IBM and Mercury Interactive Corporation. Some of these competitors
have substantially greater financial, marketing, recruiting and training
resources than we do.
o In addition to the IBM claims discussed above, there can be no assurance
that other third parties will not assert infringement claims against us in
the future with respect to current and future products or that any such
assertion may not require us to enter into royalty arrangements or result
in costly litigation.
12
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
o The market for professional services is highly competitive, fragmented and
characterized by low barriers to entry. Our principal competitors in
professional services include but are not limited to Accenture, Computer
Sciences Corporation, Electronic Data Systems Corporation, IBM Global
Services, Analysts International Corporation, Keane, Inc. and numerous
other regional and local firms in the markets in which we have professional
services offices. Several of these competitors have substantially greater
financial, marketing, recruiting and training resources than we do.
o Our success depends in part on our ability to develop product enhancements
and new products which keep pace with continuing changes in technology and
customer preferences.
o Approximately 25% to 30% of our total revenue is derived from foreign
sources. This exposes us to exchange rate risks on foreign currencies and
to other international risks such as the need to comply with foreign and
U.S. export laws, and the uncertainty of certain foreign economies.
o We regard our software as proprietary and attempt to protect it with
copyrights, trademarks, trade secret laws and restrictions on disclosure,
copying and transferring title. Despite these precautions, it may be
possible for unauthorized third parties to copy certain portions of our
products or to obtain and use information that we regard as proprietary. In
addition, the laws of some foreign countries do not protect our proprietary
rights to the same extent as the laws of the United States.
o We depend on key employees and technical personnel. The loss of certain key
employees or our inability to attract and retain other qualified employees
could have a material adverse effect on our business.
o Our quarterly financial results vary and may be adversely affected by
certain relatively fixed costs. Our product revenues vary from quarter to
quarter. Net income may be disproportionately affected by a fluctuation in
revenues because only a small portion of our expenses varies with revenues.
o Historical seasonality in license revenue cannot be relied on as an
indicator of future performance due to the current economic conditions
affecting the IT industry.
o The slowdown in the world economy could continue for an extended period and
could cause customers to further delay or forego decisions to license new
products or upgrades to their existing environments or to reduce their
requirements for professional services, and this could adversely affect our
operating results.
o Acts of terrorism, acts of war and other unforeseen events may cause damage
or disruption to our properties, employees, suppliers, distributors,
resellers, and customers which could adversely affect our business and
operating results.
13
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
operational data from the consolidated statements of income as a percentage
of total revenues and the percentage change in such items compared to the
prior period:
Percentage of
Total Revenues
---------------------- ------------
Three Months Ended Period-
June 30, to-Period
---------------------- Change
2003 2002 ------------
-------- --------
REVENUE:
Software license fees 18.1% 16.5% (3.2)%
Maintenance fees 33.2 30.5 (3.9)
Professional services fees 48.7 53.0 (18.9)
-------- --------
Total revenues 100.0 100.0 (11.7)
-------- --------
OPERATING EXPENSES:
Cost of software license fees 2.4 2.2 (3.2)
Cost of professional services 45.6 48.3 (16.7)
Technology development and support 13.1 9.2 25.9
Sales and marketing 22.0 19.1 1.8
Administrative and general 17.4 12.9 18.9
-------- --------
Total operating expenses 100.5 91.7 (3.2)
-------- --------
Income (loss) from operations (0.5) 8.3 (105.2)
Other income 1.7 1.5 (1.3)
-------- --------
Income before income taxes 1.2 9.8 (89.4)
Income tax provision 0.3 3.3 (91.3)
-------- --------
Net income 0.9% 6.5% (88.4)%
======== ========
We operate in two business segments in the technology industry: products
and professional services. We evaluate segment performance based primarily
on segment contribution before corporate expenses. References to years are
to fiscal years ended March 31.
SOFTWARE PRODUCTS
REVENUE
Our products are designed to support four key activities within the
application development process: development and integration, quality
assurance, production readiness and performance management of the
application to optimize performance in production. Product revenue consists
of software license fees and maintenance fees and comprised 51.3% and 47.0%
of total revenue during the first quarter of 2004 and 2003, respectively.
OS/390 product revenue (mainframe revenue) decreased $8.9 million or 6.9%
during the first quarter of 2004 to $119.2 million from $128.1 million
during the first quarter of 2003. The decrease was partially offset by a
$2.9 million, or 8.3%, increase in revenue from distributed software
products during the first quarter of 2004 to $37.7 million from $34.8
million during the first quarter of 2003.
The overall decline in product revenue from the first quarter of 2003 to
2004 was primarily attributable to the overall decrease in technology
spending with extended closing cycles for
14
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
customer sales. License revenue decreased $1.9 million or 3.2% during the first
quarter of 2004 to $55.3 million from $57.2 million during the first quarter of
2003. This decrease is attributable to the overall economic weakness in the
technology market and to our inability to execute well within our sales
structure as we segregated the new sales teams from a group focused on customer
retention and relationship management. Maintenance fees decreased $4.1 million
or 3.9% to $101.6 million during the first quarter of 2004 from $105.7 million
during the first quarter of 2003. The decrease in maintenance fees was primarily
attributable to lower license fees during both 2004 and 2003 resulting in
minimal increases to the maintenance base and to market pressure on pricing.
We license software to customers using two types of software licenses, perpetual
and term. Generally, perpetual software licenses allow customers a perpetual
right to run our software on hardware up to a licensed aggregate MIPS (Millions
of Instructions Per Second) capacity. Term licenses allow customers a right to
run our software for a limited period of time on hardware up to a licensed
aggregate MIPS capacity. Also, our customers purchase maintenance services that
provide technical support and advice, including problem resolution services and
assistance in product installation, error corrections and any product
enhancements released during the maintenance period. Furthermore, based on
business needs, customers are allowed to license additional software and
purchase multiple years of maintenance in a single transaction (multi-year
transactions). In support of these multi-year transactions, we allow extended
payment terms to qualifying customers.
To recognize revenue for these multi-year transactions the contract price is
allocated between maintenance revenue and license revenue. All license revenue
associated with perpetual license agreements is recognized when the customer
commits unconditionally to the transaction, the software products and quantities
are fixed and the software has been shipped to the customer and collection is
reasonably probable. License revenue associated with term transactions or with
transactions that include an option to exchange or select products in the future
is deferred and recognized over the term of the agreement. When the license
portion is paid over a number of years, the license portion of the payment
stream is discounted to its net present value. Interest income is recognized
over the payment term. The maintenance revenue associated with all sales is
deferred and is recognized over the applicable maintenance period.
Product revenue by geographic location is presented in the table below (in
thousands):
Three Months Ended June 30,
--------------------------------
2003 2002
-------------- ---------------
United States $ 86,205 $ 98,185
Europe and Africa 54,955 48,596
Other international operations 15,741 16,066
-------------- ---------------
Total product revenue $ 156,901 $ 162,847
============== ===============
15
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
PRODUCT CONTRIBUTION AND EXPENSES
Financial information for the product segment is as follows (in thousands):
Three Months Ended June 30,
--------------------------------
2003 2002
--------------- ---------------
Revenue $ 156,901 $ 162,847
Expenses 114,794 105,602
--------------- ---------------
Product contribution $ 42,107 $ 57,245
=============== ===============
The product segment generated contribution margins of 26.8% and 35.2% during the
first quarter of 2004 and 2003, respectively. Product expenses include cost of
software license fees, technology development and support costs, and sales and
marketing expenses. These factors are discussed below.
Cost of software license fees includes amortization of capitalized software, the
cost of duplicating and disseminating products to customers and the cost of
author royalties. As a percentage of software license fees, cost of software
license fees were 13.4% and 13.3% in the first quarter of 2004 and 2003,
respectively.
Technology development and support includes, primarily, the costs of programming
personnel associated with product development and support less the amount of
software development costs capitalized during the period. Personnel costs
associated with developing and maintaining internal systems and
hardware/software costs required to support technology initiatives are also
included here. As a percentage of product revenue, costs of technology
development and support were 25.5% and 19.5% in the first quarter of 2004 and
2003, respectively.
Capitalization of internally developed software products begins when
technological feasibility of the product is established. Before the
capitalization of internally developed software products, total research and
development expenditures for the first quarter of 2004 increased $8.4 million,
or 24.1%, to $43.2 million from $34.8 million in the first quarter of 2003. The
increase in these costs in the first quarter of 2004 was primarily attributable
to an increase in salaries and bonuses associated with higher employee headcount
which increased by 98 people to 1,519 people as of June 30, 2003 from 1,421
people as of June 30, 2002.
Sales and marketing costs consist primarily of personnel related costs
associated with product direct sales and sales support, marketing for all our
offerings, and personnel costs associated with new sales initiatives. For the
first quarter of 2004, sales and marketing costs increased $1.2 million, or
1.8%, to $67.4 million from $66.2 million in the first quarter of 2003. The
increase was primarily attributable to increased salaries and benefits, offset
by decreased bonuses and commissions related to lower than anticipated license
fees revenue. As a percentage of product revenue, sales and marketing costs were
42.9% and 40.6% in the first quarter of 2004 and 2003, respectively.
16
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
PROFESSIONAL SERVICES
REVENUE
We offer a broad range of information technology professional services,
including business systems analysis, design and programming, software conversion
and system planning and consulting. Revenue from professional services decreased
$34.7 million or 18.9% during the first quarter of 2004 to $149.1 million
compared to $183.8 million in the first quarter of 2003. The decrease in revenue
for 2004 was due, primarily, to a reduction in customer demand for professional
services and to the wind down of contracts related to offices closed as a result
of the March 2002 restructuring.
Professional services revenue by geographic location is presented in the table
below (in thousands):
Three Months Ended June 30,
-----------------------------------
2003 2002
---------------- -----------------
United States $ 134,683 $ 166,800
Europe and Africa 13,732 16,300
Other international operations 696 652
---------------- -----------------
Total professional services revenue $ 149,111 $ 183,752
================ =================
PROFESSIONAL SERVICES CONTRIBUTION AND EXPENSES
Financial information for the professional services segment is as follows (in
thousands):
Three Months Ended June 30,
----------------------------------
2003 2002
--------------- -----------------
Revenue $ 149,111 $ 183,752
Expenses 139,480 167,369
--------------- -----------------
Professional services contribution $ 9,631 $ 16,383
=============== =================
During the first quarter of 2004, the professional services segment generated a
contribution margin of 6.5%, compared to 8.9% during the first quarter of 2003.
The decrease in professional services margin is primarily due to reduced
customer demand for our services associated with the decline of the economy as a
whole and the IT sector specifically.
Cost of professional services consists primarily of personnel-related costs of
providing services, including billable staff, subcontractors and sales
personnel. The decrease in these costs from the first quarter of 2003 to the
first quarter of 2004 is due, primarily, to reductions in staff, resulting in
lower salaries and benefits, and decreased use of subcontractors for special
services. The professional billable staff decreased 766 people to 5,011 people
as of June 30, 2003 from 5,777 people at June 30, 2002.
17
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
CORPORATE AND OTHER EXPENSES
Administrative and general expenses consist of costs associated with the
operations and administration of the Company. These costs include the corporate
executive, finance, human resources, legal and corporate communications
departments. In addition, administrative and general costs include all
facility-related costs, such as rent, maintenance, utilities, etc., associated
with our local sales and professional services offices. Administrative and
general expenses increased $8.5 million, or 18.9% during the first quarter of
2004 to $53.2 million from $44.8 million during the first quarter of 2003.
External legal fees for all litigation, including IBM and other matters were
$12.4 million and $3.1 million in the first quarter of 2004 and 2003,
respectively.
Other income consists primarily of interest income and expense. Other income for
the first quarter of 2004 was $5.1 million as compared to $5.2 million in the
first quarter of 2003.
Income taxes are accounted for using the asset and liability approach. Deferred
income taxes are provided for the differences between the tax bases of assets or
liabilities and their reported amounts in the financial statements. The income
tax provision was $1.0 million in the first quarter of 2004, which represents an
effective tax rate of 28%. This compares to an income tax provision of $11.6
million in the first quarter of 2003, which represents an effective tax rate of
34%. The decrease in the effective tax rate is primarily due to the greater
effect from certain tax benefit items with the decline in income and the
favorable settlements of certain tax issues.
RESTRUCTURING CHARGE
In the fourth quarter of 2002, we adopted a restructuring plan to reorganize our
operating divisions, primarily the professional services segment. These changes
were designed to increase profitability in the future by better aligning cost
structures with current market conditions.
The restructuring plan included a reduction of professional services staff at
certain locations, the closing of entire professional services offices and a
reduction of sales support personnel, lab technicians and related administrative
and financial staff. Approximately 1,600 employees worldwide were terminated as
a result of the reorganization. Payments continue to be made to certain
terminated employees in accordance with their agreements.
18
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
The following table summarizes the restructuring charge as of March 31, 2003,
and charges against the accrual during the first quarter of fiscal 2004 (in
thousands):
Charges against
Balance at the accrual during Balance at
March 31, the quarter ended June 30,
2003 June 30, 2003 2003
------------- --------------------- ------------
Employee termination benefits $ 698 $ 346 $ 352
Facilities costs (primarily lease
abandonments) 19,088 1,636 17,452
Legal, consulting and
outplacement costs 15 4 11
------------- --------------------- ------------
Total restructuring accrual $ 19,801 $ 1,986 $ 17,815
============= ===================== ============
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Assumptions and estimates
were based on the facts and circumstances known at June 30, 2003. However,
future events rarely develop exactly as forecast, and the best estimates
routinely require adjustment. The accounting policies discussed in Item 7 of our
Annual Report on Form 10-K are considered by management to be the most important
to an understanding of the financial statements, because their application
places the most significant demands on management's judgment and estimates about
the effect of matters that are inherently uncertain. These policies are also
discussed in Note 1 of the Notes to Consolidated Financial Statements included
in Item 8 of that report. There have been no material changes to that
information during the first quarter of 2004.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2003, cash and investments totaled approximately $614.4 million.
During the first quarter of 2004 and the first quarter of 2003, cash flow from
operations was $54.6 million and $96.1 million, respectively. The decrease was
primarily due to lower collections on customer receivables due to the general
decline in revenue over the last two years. During these periods, capital
expenditures including property and equipment, capitalized research and software
development, and purchased software totaled $29.4 million and $46.5 million,
respectively.
On May 2, 2003, we entered into a $100 million revolving credit facility
maturing in 364 days. If at any time the combined unencumbered liquid assets of
the Company (as defined in the credit facility) are less than $200 million, the
credit facility will be reduced to $50 million. Interest is payable at 1% over
the Eurodollar rate or at the prime rate, at the Company's option. No
19
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
borrowings have occurred or are planned under this facility. The terms of the
credit facility contain, among other provisions, a covenant to maintain a
minimum $1 billion consolidated net worth, and specific limitations on
additional indebtedness, liens and merger activity.
On May 6, 2003, the Board of Directors authorized the repurchase of up to $125
million of our common stock. Purchases of stock occur on the open market,
through negotiated or block transactions, periodically, based upon market and
business conditions. We regularly evaluate market conditions for an opportunity
to repurchase our stock. As of the filing date we have repurchased approximately
200,000 shares of our common stock under this program.
Although there were no acquisitions during the first quarter of 2004, management
continues to evaluate business acquisition opportunities that fit our strategic
plans.
We have relocated to our new corporate headquarters building. Final construction
is continuing with total estimated costs of $350 million for the building and
$50 million for furniture and fixtures. Annual depreciation expense will be
approximately $17 million. This will be partially offset by the savings realized
by the consolidation of our metro Detroit offices. Remaining cash outlays of
approximately $50 million are expected to continue through December 2003. The
remaining capital expenditures are intended to be funded using cash on hand and
cash flow from operations.
In July 2003 we entered into an option and purchase agreement for our recently
vacated building in Farmington Hills, Michigan. The option agreement allows the
holder to commit to purchase the building for one year after the execution of
this agreement. The option selling price of the building approximates the
current net book value of $20 million for the building. If exercised, the holder
would pay $5 million upon exercise and the remaining balance in five years with
interest being paid monthly at 7% of the unpaid balance.
As discussed in Note 6 to the condensed consolidated financial statements, we
regularly review the financial condition of our partially owned companies,
inclusive of considering the companies' relationships with their major
customers, to determine that the recorded amounts are appropriate and the
investments (inclusive of the debt obligations) are not impaired. CareTech's
most significant customer is the DMC. The DMC has publicly announced it is
having financial difficulties. After consideration of all relevant factors, we
concluded that no impairment reserve should be recorded at June 30, 2003.
We believe available cash resources together with cash flow from operations,
will be sufficient to meet cash needs for the foreseeable future.
20
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed primarily to market risks associated with movements in interest
rates and foreign currency exchange rates. There have been no material changes
to foreign exchange risk management strategy or marketable securities subsequent
to March 31, 2003, therefore the market risks remain substantially unchanged
since we filed the Annual Report on Form 10-K for the fiscal year ending March
31, 2003.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based
upon that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures are effective to cause the
material information we are required to disclose in the reports that we file or
submit under the Securities Exchange Act of 1934 to be recorded, processed,
summarized and reported within the time periods specified in the Commission's
rules and forms. There have been no significant changes in our internal controls
or in other factors which could significantly affect internal controls
subsequent to the date we carried out our evaluation.
21
COMPUWARE CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(b) On May 2, 2003, we entered into a $100 million revolving credit
facility maturing in 364 days. The terms of the credit facility
contain, among other provisions, a covenant to maintain a minimum
$1 billion consolidated net worth, which could limit our ability
to pay cash dividends.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exhibit
Number Description of Document
4.2 Revolving Credit Agreement dated as of May 2, 2003,
between Compuware Corporation and Comerica Bank
(incorporated by reference to the corresponding
exhibit to the Annual Report on Form 10-K for the
fiscal year ended March 31, 2003)
15 Independent Accountants' Awareness Letter
31.1 Certification of Chief Executive Officer pursuant to
Rule 13a-14(a) of the Securities Exchange Act.
31.2 Certification of Chief Financial Officer pursuant to
Rule 13a-14(a) of the Securities Exchange Act.
32 Certification pursuant to 18 U.S.C. Section 1350 and
Rule 13a-14(b) of the Securities Exchange Act.
(b) Reports on Form 8-K.
A Current Report on Form 8-K pursuant to Items 5 and 12 was
filed on May 9, 2003 reporting that on May 7, 2003 the Company
issued a press release announcing (i) its financial results for
the year ended March 31, 2003 and certain other information; and
(ii) the Company's Board of Directors authorized the repurchase
of up to $125 million in the Company's common stock.
22
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.
COMPUWARE CORPORATION
Date: August 12, 2003 By: /s/ Joseph A. Nathan
--------------- --------------------
Joseph A. Nathan
President
(duly authorized officer)
Date: August 12, 2003 By: /s/ Laura L. Fournier
--------------- ----------------------
Laura L. Fournier
Senior Vice President
Chief Financial Officer
23
10-Q EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
4.2 Revolving Credit Agreement dated as of May 2, 2003, between
Compuware Corporation and Comerica Bank (incorporated by
reference to the corresponding exhibit to the Annual Report on
Form 10-K for the fiscal year ended March 31, 2003)
15 Independent Accountants' Awareness Letter
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act.
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act.
32 Certification pursuant to 18 U.S.C. Section 1350 and Rule
13a-14(b) of the Securities Exchange Act.