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 DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
-------- ---------
COMMISSION FILE NUMBER 0-20900
COMPUWARE CORPORATION
---------------------
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2007430
(State or other jurisdiction (IRS Employer
incorporation or organization) Identification No.)
31440 NORTHWESTERN HIGHWAY
FARMINGTON HILLS, MI 48334-2564
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (248) 737-7300
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
----- -----
As of February 7, 2003, there were outstanding 378,055,795 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
December 31, 2002 and March 31, 2002 3
Condensed Consolidated Statements of Operations
for the three months and nine months ended
December 31, 2002 and 2001 4
Condensed Consolidated Statements of Cash Flows
for the nine months ended December 31, 2002 and 2001 5
Notes to Condensed Consolidated Financial
Statements 6
Independent Accountants' Report 12
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 24
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings 25
Item 2. Changes in Securities and Use of Proceeds 25
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES 27
----------
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COMPUWARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31, MARCH 31,
ASSETS 2002 2002
------ ------------- -------------
(UNAUDITED)
CURRENT ASSETS:
Cash and cash equivalents $ 259,952 $ 233,305
Investments 164,800 133,503
Accounts receivable, net 502,734 609,579
Deferred tax asset, net 36,809 41,811
Income taxes refundable, net 27,687
Prepaid expenses and other current assets 15,514 16,954
----------- -----------
Total current assets 979,809 1,062,839
----------- -----------
INVESTMENTS 93,813 55,566
----------- -----------
PROPERTY AND EQUIPMENT, LESS ACCUMULATED
DEPRECIATION AND AMORTIZATION 324,110 199,365
----------- -----------
CAPITALIZED SOFTWARE, LESS ACCUMULATED
AMORTIZATION 58,484 68,998
----------- -----------
OTHER:
Accounts receivable 283,468 306,751
Deferred tax asset, net 35,761 44,884
Goodwill, net 212,156 211,792
Other 41,536 43,743
----------- -----------
Total other assets 572,921 607,170
----------- -----------
TOTAL ASSETS $ 2,029,137 $ 1,993,938
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 27,803 $ 28,646
Accrued expenses 164,981 186,477
Income taxes payable, net 4,971
Deferred revenue 244,016 341,024
----------- -----------
Total current liabilities 441,771 556,147
DEFERRED REVENUE 272,776 218,624
ACCRUED EXPENSES 23,911 29,316
----------- -----------
Total liabilities 738,458 804,087
----------- -----------
SHAREHOLDERS' EQUITY:
Common stock 3,780 3,758
Additional paid-in capital 688,164 676,617
Retained earnings 610,528 528,804
Accumulated other comprehensive loss (11,793) (19,328)
----------- -----------
Total shareholders' equity 1,290,679 1,189,851
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,029,137 $ 1,993,938
=========== ===========
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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------------ ------------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
REVENUES:
Software license fees $ 73,761 $ 125,731 $ 217,933 $ 308,154
Maintenance fees 100,359 106,816 309,090 327,350
Professional services fees 159,019 221,233 510,709 696,512
----------- ----------- ----------- -----------
Total revenues 333,139 453,780 1,037,732 1,332,016
----------- ----------- ----------- -----------
OPERATING EXPENSES:
Cost of software license fees 7,777 8,380 23,080 25,481
Cost of professional services 145,167 207,795 464,901 636,400
Technology development and support 37,312 39,218 107,906 121,965
Sales and marketing 63,534 77,507 194,551 218,034
Administrative and general 47,318 59,804 139,005 161,466
Goodwill amortization and impairment 19,027 38,634
----------- ----------- ----------- -----------
Total operating expenses 301,108 411,731 929,443 1,201,980
----------- ----------- ----------- -----------
INCOME FROM OPERATIONS 32,031 42,049 108,289 130,036
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE):
Interest and investment income 7,125 7,180 20,897 21,332
Interest and other expense (628) (1,182) (5,362) (5,158)
----------- ----------- ----------- -----------
Total other income 6,497 5,998 15,535 16,174
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 38,528 48,047 123,824 146,210
INCOME TAX PROVISION 13,099 18,258 42,100 55,560
----------- ----------- ----------- -----------
NET INCOME $ 25,429 $ 29,789 $ 81,724 $ 90,650
=========== =========== =========== ===========
Basic earnings per share $ 0.07 $ 0.08 $ 0.22 $ 0.24
=========== =========== =========== ===========
Diluted earnings per share $ 0.07 $ 0.08 $ 0.22 $ 0.24
=========== =========== =========== ===========
See notes to condensed consolidated financial statements.
4
COMPUWARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
DECEMBER 31,
--------------------------
2002 2001
--------- ---------
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income $ 81,724 $ 90,650
Adjustments to reconcile net income to cash provided by
operations:
Depreciation and amortization 38,912 45,097
Goodwill amortization and impairment 38,634
Tax benefit from exercise of stock options 275 6,613
Acquisition tax benefits 5,305 5,346
Deferred income taxes 14,125 (1,820)
Other 11,033 1,298
Net change in assets and liabilities
Accounts receivable 130,128 69,710
Prepaid expenses and other current assets (669) 2,238
Other assets 1,284 (1,613)
Accounts payable and accrued expenses (18,019) (16,668)
Deferred revenue (42,856) 4,424
Income taxes 32,658 12,063
--------- ---------
Net cash provided by operating activities 253,900 255,972
--------- ---------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of:
Property and equipment:
Headquarters facility (151,108) (51,467)
Other (3,948) (5,188)
Capitalized software (8,555) (9,932)
Investments:
Proceeds from maturity 107,600 211,824
Purchases (179,235) (168,022)
--------- ---------
Net cash used in investing activities (235,246) (22,785)
--------- ---------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Net proceeds from exercise of stock options 860 11,158
Contribution to stock purchase plans 7,133 3,632
Payments on long term debt (140,000)
--------- ---------
Net cash provided by (used in) financing activities 7,993 (125,210)
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 26,647 107,977
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 233,305 53,340
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 259,952 $ 161,317
========= =========
See notes to condensed consolidated financial statements.
5
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2002
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 December 31, 2002, 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, 2002 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, 2002 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.
Certain amounts in the fiscal 2002 financial statements have been reclassified
to conform to the fiscal 2003 presentation.
6
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2002
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 Nine Months Ended
December 31, December 31,
----------------------- -----------------------
2002 2001 2002 2001
-------- -------- -------- --------
BASIC EPS:
----------
Numerator: Net Income $ 25,429 $ 29,789 $ 81,724 $ 90,650
-------- -------- -------- --------
Denominator:
Weighted-average common shares outstanding 377,943 372,015 376,588 371,123
-------- -------- -------- --------
Basic EPS $ 0.07 $ 0.08 $ 0.22 $ 0.24
======== ======== ======== ========
DILUTED EPS:
------------
Numerator: Net Income $ 25,429 $ 29,789 $ 81,724 $ 90,650
-------- -------- -------- --------
Denominator:
Weighted-average common shares outstanding 377,943 372,015 376,588 371,123
Dilutive effect of stock options 1,195 10,576 1,596 12,304
-------- -------- -------- --------
Total shares 379,138 382,591 378,184 383,427
-------- -------- -------- --------
Diluted EPS $ 0.07 $ 0.08 $ 0.22 $ 0.24
======== ======== ======== ========
During the three months ended December 31, 2002 and 2001, stock options and a
warrant to purchase approximately 63,385,000 and 22,164,000 shares,
respectively, were excluded from the diluted EPS calculation because they were
anti-dilutive. During the nine months ended December 31, 2002 and 2001, stock
options and a warrant to purchase approximately 63,023,000 and 22,076,000
shares, respectively, were excluded from the diluted EPS calculation because
they were anti-dilutive.
NOTE 3 - COMPREHENSIVE INCOME
Other comprehensive income includes foreign currency translation gains and
losses that have been excluded from net income and reflected instead in equity.
Total comprehensive income is summarized as follows (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
----------------------- -----------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net Income $ 25,429 $ 29,789 $ 81,724 $ 90,650
Foreign currency translation
adjustment, net of tax 3,338 (34) 7,535 1,389
-------- -------- -------- --------
Total comprehensive income $ 28,767 $ 29,755 $ 89,259 $ 92,039
======== ======== ======== ========
7
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2002
NOTE 4 - SEGMENTS
Compuware operates in two business segments in the software industry: products
and 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 Nine Months Ended
December 31, December 31,
------------------------------ ------------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenues:
Products:
Mainframe $ 133,097 $ 190,195 $ 415,243 $ 512,845
Distributed systems 41,023 42,352 111,780 122,659
----------- ----------- ----------- -----------
Total products revenue 174,120 232,547 527,023 635,504
Services 159,019 221,233 510,709 696,512
----------- ----------- ----------- -----------
Total revenues $ 333,139 $ 453,780 $ 1,037,732 $ 1,332,016
=========== =========== =========== ===========
Operating Expenses:
Products $ 108,623 $ 125,105 $ 325,537 $ 365,480
Services 145,167 207,795 464,901 636,400
Corporate staff 47,318 59,804 139,005 161,466
Goodwill amortization and
impairment 19,027 38,634
----------- ----------- ----------- -----------
Total operating expenses $ 301,108 $ 411,731 $ 929,443 $ 1,201,980
=========== =========== =========== ===========
Income from operations before
other income (expenses):
Products $ 65,497 $ 107,442 $ 201,486 $ 270,024
Services 13,852 13,438 45,808 60,112
Corporate staff (47,318) (59,804) (139,005) (161,466)
Goodwill amortization and
impairment (19,027) (38,634)
----------- ----------- ----------- -----------
Income from operations before
other income 32,031 42,049 108,289 130,036
Other income 6,497 5,998 15,535 16,174
----------- ----------- ----------- -----------
Income before income taxes $ 38,528 $ 48,047 $ 123,824 $ 146,210
=========== =========== =========== ===========
8
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2002
Financial information regarding geographic operations are presented in the table
below (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
--------------------------- ---------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Revenues:
United States $ 241,715 $ 349,550 $ 770,219 $1,026,448
Europe and Africa 70,647 77,840 208,563 232,908
Other international operations 20,777 26,390 58,950 72,660
---------- ---------- ---------- ----------
Total revenues $ 333,139 $ 453,780 $1,037,732 $1,332,016
========== ========== ========== ==========
NOTE 5 - RESTRUCTURING CHARGE
In the fourth quarter of fiscal 2002, Compuware 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 scheduled for
termination as a result of the reorganization. As of December 31, 2002, fewer
than 50 employees remain to be terminated under the plan. Payments continue to
be made to certain terminated employees in accordance with their agreements.
The following table summarizes the accrual for the restructuring charge as of
March 31, 2002, and charges against the accrual during the first nine months of
fiscal 2003 (in thousands):
Charges against Charges against
Balance at the accrual during the accrual during Balance at
March 31, the six months ended the quarter ended December 31,
2002 September 30, 2002 December 31, 2002 2002
----------- -------------------- ------------------- -------------
Employee termination benefits $ 18,459 $ 15,136 $ 590 $ 2,733
Facilities costs (primarily
lease abandonments) 25,665 5,038 1,789 18,838
Legal, consulting and
outplacement costs 1,299 572 214 513
Other 278 215 63
----------- -------------------- ------------------- -------------
Total restructuring accrual $ 45,701 $ 20,961 $ 2,593 $ 22,147
----------- -------------------- ------------------- -------------
9
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2002
NOTE 6 - GOODWILL AND INTANGIBLE ASSETS
The components of the Company's intangible assets were as follows (in
thousands):
At December 31, 2002
-------------------------------------------------------------
Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
---------------- -------------- --------------
Amortized intangible assets:
Capitalized software (1) $ 218,789 $(160,305) $ 58,484
Other (2) 6,200 (3,972) 2,228
--------- --------- ---------
Total $ 224,989 $(164,277) $ 60,712
========= ========= =========
At March 31, 2002
-------------------------------------------------------------
Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
---------------- -------------- --------------
Amortized intangible assets:
Capitalized software (1) $ 209,017 $(140,019) $ 68,998
Other (2) 6,200 (3,725) 2,475
--------- --------- ---------
Total $ 215,217 $(143,744) $ 71,473
========= ========= =========
1) The amortization expense is reported in cost of software license fees
expense on the income statement.
2) Other amortized intangible assets include trademarks associated with past
product acquisitions. The amortization expense is reported in general and
administrative expense on the income statement.
Aggregate amortization expense on intangible assets was $6,531,000 and
$7,989,000 for the three months ended December 31, 2002 and 2001, respectively.
Amortization expense on intangible assets for the nine months ended December 31,
2002 and 2001 was $19,316,000 and $23,381,000, respectively. Annual amortization
expense, based on identified intangible assets recorded through December 31,
2002, is expected to be as follows (in thousands):
Year Ended March 31,
-----------------------------------------------------------------
2003 2004 2005 2006 Thereafter
------- ------- ------- ------- ----------
Capitalized software $25,363 $24,295 $16,072 $ 6,737 $ 5,086
Other 330 330 330 330 1,155
------- ------- ------- ------- -------
Total $25,693 $24,625 $16,402 $ 7,067 $ 6,241
======= ======= ======= ======= =======
10
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2002
Effective April 1, 2002, in accordance with FASB 142, the goodwill balance is no
longer being amortized on a monthly basis. Instead, it will be tested at least
annually for impairment. Changes in the carrying amounts of goodwill for the
nine months ended December 31, 2002 were as follows (in thousands):
Goodwill: Products Services Total
-------- -------- --------
Balance at March 31, 2002, net $ 72,182 $139,610 $211,792
Effect of foreign currency translation 364 364
-------- -------- --------
Balance as of December 31, 2002, net $ 72,182 $139,974 $212,156
======== ======== ========
The Company's reported net income and diluted earnings per share exclusive of
amortization of goodwill in the prior year on an after-tax basis were as follows
(in thousands except per share data):
Three Months Ended December 31, Nine Months Ended December 31,
------------------------------- ------------------------------
2002 2001 2002 2001
-------- -------- -------- --------
Reported net income $ 25,429 $ 29,789 $ 81,724 $ 90,650
Add goodwill amortization, net of tax 17,067 33,614
-------- -------- -------- --------
Adjusted net income $ 25,429 $ 46,856 $ 81,724 $124,264
======== ======== ======== ========
Diluted earnings per share $ 0.07 $ 0.12 $ 0.22 $ 0.32
======== ======== ======== ========
11
INDEPENDENT ACCOUNTANTS' REPORT
Compuware Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of
Compuware Corporation and subsidiaries (the "Company") as of December 31, 2002,
and the related condensed consolidated statements of operations for the
three-month and nine-month periods and cash flows for the nine-month periods
ended December 31, 2002 and 2001. 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 to
financial data 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 as of March 31, 2002, 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, 2002, 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, 2002 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
January 22, 2003
12
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This discussion contains statements regarding our intentions, plans and
expectations and other 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 operating results, including, without limitation, those
described below and in our 2002 Form 10-K filing 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. We can give 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.
Factors which may affect our operating results include, among others, the
following:
- 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.
- 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.
- Our success depends in part on our ability to develop product enhancements
and new products that keep pace with continuing changes in technology and
customer preferences.
- Approximately 25% of our 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.
- 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.
- 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.
- Although we have not received any material claims that our products
infringe on the proprietary rights of third parties, there can be no
assurance that 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.
- 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.
13
COMPUWARE CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
- 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, products 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.
- Our results could be adversely affected by increased competition and
pricing pressures. Although no company competes with us across our entire
product line, we consider over 40 firms to be directly competitive with one
or more of our products. Our competitors include BMC Software, Inc.,
Computer Associates International, Inc., International Business Machines
Corporation (IBM), Mercury Interactive Corporation, Oracle Corporation and
Rational Software Corporation. Some of these competitors have substantially
greater financial, marketing, recruiting and training resources than we do.
- 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.
14
COMPUWARE CORPORATION AND SUBSIDIARIES
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 Percentage of
Total Revenues Total Revenues
------------------------ ------------------------
Three Months Ended Nine Months Ended
December 31, Period- December 31, Period-
------------------------ to-Period ------------------------ to-Period
2002 2001* Change 2002 2001* Change
---------- ----------- --------- ----------- ----------- ---------
REVENUE:
Software license fees 22.2% 27.7% (41.3)% 21.0% 23.1% (29.3)%
Maintenance fees 30.1 23.5 (6.0) 29.8 24.6 (5.6)
Professional services fees 47.7 48.8 (28.1) 49.2 52.3 (26.7)
---------- ---------- ----------- -----------
Total revenues 100.0 100.0 (26.6) 100.0 100.0 (22.1)
---------- ---------- ----------- -----------
OPERATING EXPENSES:
Cost of software license fees 2.3 1.8 (7.2) 2.2 1.9 (9.4)
Cost of professional services 43.6 45.8 (30.1) 44.8 47.8 (26.9)
Technology development and support 11.2 8.6 (4.9) 10.4 9.1 (11.5)
Sales and marketing 19.1 17.1 (18.0) 18.8 16.4 (10.8)
Administrative and general 14.2 13.2 (20.9) 13.4 12.1 (13.9)
Goodwill amortization and impairment 4.2 (100.0) 2.9 (100.0)
---------- ---------- ----------- -----------
Total operating expenses 90.4 90.7 (26.9) 89.6 90.2 (22.7)
---------- ---------- ----------- -----------
Income from operations 9.6 9.3 (23.8) 10.4 9.8 (16.7)
---------- ---------- ----------- -----------
Other income (expense):
Interest and investment income 2.2 1.6 (0.8) 2.0 1.6 (2.0)
Interest and other expense (0.2) (0.3) 46.9 (0.5) (0.4) (4.0)
---------- ---------- ----------- -----------
Total other income 2.0 1.3 8.3 1.5 1.2 (4.0)
---------- ---------- ----------- -----------
Income before income taxes 11.6 10.6 (19.8) 11.9 11.0 (15.3)
Income tax provision 4.0 4.0 (28.3) 4.0 4.2 (24.2)
---------- ---------- ----------- -----------
Net income 7.6% 6.6% (14.6)% 7.9% 6.8% (9.8)%
========== ========== =========== ===========
* Reclassified to conform to the December 2002 presentation as explained below.
Effective April 1, 2002, in accordance with FASB 142, the goodwill balance is no
longer being amortized on a monthly basis. Instead, it will be tested at least
annually for impairment. If goodwill had not been amortized in fiscal 2002, net
income would have been $46.9 million, or 12 cents per diluted share in the third
quarter of last year and $124.3 million, or 32 cents per diluted share for the
first nine months of last year.
Effective April 1, 2002, we reorganized our operations to better allow the
products and professional services organizations to focus on meeting customer
needs. We have reclassified certain expense items to better reflect our new
operating structure and are no longer allocating costs associated with the
facilities, finance and human resource departments to the various
15
COMPUWARE CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
operating groups. Instead, these costs are now included in administrative and
general expenses. All technology costs, including costs associated with internal
systems, are included in the technology development and support expense line.
This reclassification did not change total operating expenses. In accordance
with EITF No. 01-14, "Income Statement Characterization of Reimbursements
Received for `Out-of-pocket' Expenses Incurred", we have also reclassified
travel expense reimbursements paid by customers as revenue rather than as a
reduction to the related expense. This reclassification has resulted in a slight
change to professional services fees and cost of professional services without
changing income from operations.
We operate in two business segments in the technology industry: products and
professional services. We evaluate the performance of our segments 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. Products revenue consists of software license fees and
maintenance fees and comprised 52.3% and 51.2% of total Company revenue during
the third quarter of 2003 and 2002, respectively, and 50.8% and 47.7% of total
Company revenue during the first nine months of 2003 and 2002, respectively.
OS/390 product revenue (mainframe revenue) decreased $57.1 million or 30.0%
during the third quarter of 2003 to $133.1 million from $190.2 million during
the third quarter of 2002 and decreased $97.6 million or 19.0% during the first
nine months of 2003 to $415.2 million from $512.8 million during the first nine
months of 2002. Revenue from distributed software products decreased $1.4
million or 3.1% during the third quarter of 2003 to $41.0 million from $42.4
million during the third quarter of 2002 and decreased $10.9 million or 8.9%
during the first nine months of 2003 to $111.8 million from $122.7 million
during the first nine months of 2002.
License revenue decreased $51.9 million or 41.3% during the third quarter of
2003 to $73.8 million from $125.7 million during the third quarter of 2002 and
decreased $90.3 million or 29.3% during the first nine months of 2003 to $217.9
million from $308.2 million during the first nine months of 2002. During the
third quarter of 2003, we had no multi-year contracts with license fees greater
than $5 million while these contracts accounted for 16% of license revenue
during the third quarter of 2002. During the first nine months of 2003, 6% of
license revenue was related to multi-year contracts with license fees greater
than $5 million compared to 9% during the first nine months of 2002. The
decrease in license revenue for the third quarter and the first nine months of
2003 was due to increased competition, particularly in the mainframe market, and
to market pressure on pricing attributed to the continued softness in the
economy as a whole and the IT industry in particular. Maintenance fees decreased
$6.4 million or 6.0% to $100.4 million during the third quarter of 2003 from
$106.8 million during the third quarter of 2002 and decreased $18.3 million or
5.6% during the first nine months of 2003 to $309.1 million from $327.4 million
during the first nine months of 2002. The decrease in maintenance fees was
primarily attributable to lower license fees during both 2003 and 2002 resulting
in only minimal increases to the maintenance base and to market pressure on
pricing.
16
COMPUWARE CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
We license our software to our customers using two types of software licenses,
perpetual and term. Generally, perpetual software licenses allow our 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 our
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, we allow our customers the option 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 there are no
known problems with respect to payment. 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.
Products revenue by geographic location is presented in the table below (in
thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
-------------------------------------- -------------------------------------
2002 2001* 2002 2001*
------------------ ----------------- ----------------- -----------------
United States $ 99,603 $ 151,237 $ 310,515 $ 401,527
Europe and Africa 54,595 55,739 159,661 163,883
Other international operations 19,922 25,571 56,847 70,094
------------------ ----------------- ----------------- -----------------
Total products revenue $ 174,120 $ 232,547 $ 527,023 $ 635,504
================== ================= ================= =================
* Reclassified to conform to the December 2002 presentation.
17
COMPUWARE CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
PRODUCTS CONTRIBUTION AND EXPENSES
Financial information for the products segment is as follows (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------------------------- -------------------------------------
2002 2001* 2002 2001*
------------------ ----------------- ----------------- -----------------
Revenue $ 174,120 $ 232,547 $ 527,023 $ 635,504
Expenses 108,623 125,105 325,537 365,480
------------------ ----------------- ----------------- -----------------
Products contribution $ 65,497 $ 107,442 $ 201,486 $ 270,024
================== ================= ================= =================
* Reclassified to conform to the December 2002 presentation as described above.
The products segment generated contribution margins of 37.6% and 46.2% during
the third quarter of 2003 and 2002, respectively, and 38.2% and 42.5% during the
first nine months of 2003 and 2002, respectively. Products expenses include cost
of software license fees, technology development and support costs, and sales
and marketing expenses. The decrease in contribution margin during the third
quarter and for the first nine months of 2003 was primarily a result of the
decrease in software license revenue.
Cost of license fees includes amortization of capitalized software, the cost of
preparing and distributing products to customers and the cost of author
royalties. The decrease in these costs in the third quarter and for the first
nine months of 2003 was primarily due to decreased amortization of purchased
software, and decreased printing and materials costs. As a percentage of
software license fees, cost of software license fees were 10.5% and 6.7% in the
third quarter of 2003 and 2002, respectively, and 10.6% and 8.3% in the first
nine months of 2003 and 2002, 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. The decrease in these costs was primarily attributable to
decreased salaries, reduced travel costs, and decreased communication costs. As
a percentage of product revenue, costs of technology development and support
were 21.4% and 16.9% in the third quarter of 2003 and 2002, respectively, and
20.5% and 19.2% in the first nine months of 2003 and 2002, 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 third quarter of 2003 decreased $2.8 million,
or 6.5%, to $40.3 million from $43.1 million in the third quarter of 2002 and
for the first nine months of 2003 decreased $15.4 million, or 11.7%, to $116.5
million from $131.9 million in the first nine months of 2002.
Though we continue to place significant emphasis on direct sales through our own
sales force, we also market our products through indirect channels. Sales and
marketing costs consist primarily of personnel related costs associated with
products direct sales and sales support, marketing for all Company offerings,
and personnel related costs associated with new sales
18
initiatives. The decrease in sales and marketing costs in the third quarter and
for the first nine months of 2003 was primarily attributable to decreased
salaries and benefits, and decreased travel expenses, offset, in part, by
increased advertising promotions. As a percentage of license fees, sales and
marketing costs were 86.1% and 61.6% in the third quarter of 2003 and 2002,
respectively, and 89.3% and 70.8% in the first nine months of 2003 and 2002,
respectively.
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
$62.2 million or 28.1% during the third quarter of 2003 to $159.0 million
compared to $221.2 million in the third quarter of 2002, and decreased $185.8
million or 26.7% during the first nine months of 2003 to $510.7 million from
$696.5 million in the first nine months of 2002. The decrease in revenue for
2003 was due, primarily, to a reduction in customer demand for professional
services, the January 2002 assignment of our prime contract with a client to a
company in which we have a minority equity investment, and to a lesser extent,
the transfer of our engineering business to an unrelated third party in December
2001. Professional services revenue was further negatively impacted by the
closing of certain underperforming branch offices associated with the
restructuring discussed below. In total, these changes reduced professional
services revenue $41.6 million during the third quarter of 2003 and $132.4
million during the first nine months of 2003 compared to the same periods in the
prior year.
Professional services revenue by geographic location is presented in the table
below (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
---------------------------------- ----------------------------------
2002 2001* 2002 2001*
---------------- ---------------- ---------------- ----------------
United States $ 142,112 $ 198,313 $ 459,704 $ 624,921
Europe and Africa 16,052 22,101 48,902 69,025
Other international operations 855 819 2,103 2,566
---------------- ---------------- ---------------- ----------------
Total professional services revenue $ 159,019 $ 221,233 $ 510,709 $ 696,512
================ ================ ================ ================
* Reclassified to conform to the December 2002 presentation as described above.
19
COMPUWARE CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
PROFESSIONAL SERVICES CONTRIBUTION AND EXPENSES
Financial information for our professional services segment is as follows (in
thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
---------------------------------- ---------------------------------
2002 2001* 2002 2001*
---------------- ---------------- --------------- ----------------
Revenue $ 159,019 $ 221,233 $ 510,709 $ 696,512
Expenses 145,167 207,795 464,901 636,400
---------------- ---------------- --------------- ----------------
Professional services contribution $ 13,852 $ 13,438 $ 45,808 $ 60,112
================ ================ =============== ================
* Reclassified to conform to the December 2002 presentation as described above.
During the third quarter of 2003, the professional services segment generated a
contribution margin of 8.7%, compared to 6.1% during the third quarter of 2002.
The professional services' contribution margin was 9.0% and 8.6% for the first
nine months of 2003 and 2002, respectively. The increase in professional
services margin in the third quarter and the first nine months of 2003 is
primarily a result of the branch closings and other changes discussed in the
revenue section above.
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 in the third quarter and first nine
months of 2003 is due, primarily, to reductions in staff associated with the
restructuring discussed below, resulting in lower salaries and benefits, and
decreased use of subcontractors for special services. The professional billable
staff decreased 1,680 people to 5,293 people as of December 31, 2002 from 6,973
people at December 31, 2001.
CORPORATE AND OTHER EXPENSES
Administrative and general expenses consist of all other 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 decreased $12.5 million, or 20.9% during the
third quarter of 2003 to $47.3 million from $59.8 million during the third
quarter of 2002, and decreased $22.5 million or 13.9% during the first nine
months of 2003 to $139.0 million from $161.5 million in the first nine months of
2002. The decrease in administrative and general expenses was primarily
attributable to decreased building rent, decreased telephone costs and decreased
salaries resulting from the restructuring discussed below, offset in part by
increased legal costs due to ongoing litigation.
Interest and investment income for the third quarter of 2003 was $7.1 million
compared to $7.2 million in the third quarter of 2002 and for the first nine
months of 2003 interest and investment income was $20.9 million compared to
$21.3 million in the first nine months of 2002. Interest and other expense in
2003 includes amortization of deferred interest associated with future lease
obligations related to facilities no longer used by the Company as well as
amortization of the initial financing fees and fees associated with the
unutilized balance of our credit facility, which is discussed in the Liquidity
and Capital Resources section below. Interest and other
20
COMPUWARE CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
expense was $0.6 million in the third quarter of 2003 compared to $1.2 million
in the third quarter of 2002, and for the first nine months of 2003 was $5.4
million compared to $5.2 million for the first nine months of 2002. The decrease
in interest and other expense for the third quarter of 2003 is due to the
decrease in amortization of initial financing fees and fees associated with the
unutilized balance of the credit facility offset, in part, by the amortization
of interest associated with lease obligations. The increase in interest and
other expense for the first nine months of 2003 is due, primarily, to the
amortization of interest associated with lease obligations and to the September
2002 accelerated amortization of the initial financing fees associated with the
cancellation of the credit facility discussed below.
We account for income taxes 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 $13.1 million in the third quarter of 2003 and $42.1 million
for the first nine months of 2003, which represents an effective tax rate of
34.0%. This compares to an income tax provision of $18.3 million in the third
quarter of 2002 and $55.6 million for the first nine months of 2002, which
represents an effective tax rate of 38.0%. The decrease in the effective tax
rate is a result of no longer amortizing goodwill for financial statement
purposes. The majority of the goodwill amortization in the prior year was not
deductible for income tax purposes.
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 scheduled for
termination as a result of the reorganization. The restructuring is proceeding
as planned. As of December 31, 2002, fewer than 50 employees remain to be
terminated under the plan. Payments continue to be made to certain terminated
employees in accordance with their agreements.
21
COMPUWARE CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
The following table summarizes the accrual for the restructuring charge as of
March 31, 2002, and charges against the accrual during the first nine months of
fiscal 2003 (in thousands):
Charges against Charges against
Balance at the accrual during the accrual during Balance at
March 31, the six months ended the quarter ended December 31,
2002 September 30, 2002 December 31, 2002 2002
---------- -------------------- ----------------- ------------
Employee termination benefits $18,459 $15,136 $ 590 $ 2,733
Facilities costs (primarily
lease abandonments) (1) 25,665 5,038 1,789 18,838
Legal, consulting and
outplacement costs 1,299 572 214 513
Other 278 215 63
---------- -------------------- ----------------- ------------
Total restructuring accrual $45,701 $20,961 $ 2,593 $22,147
========== ==================== ================= ============
1) Lease obligations will end in March of 2009.
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. Our assumptions and
estimates were based on the facts and circumstances known at December 31, 2002;
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 our 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 third quarter of 2003.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2002, cash and investments totaled approximately $518.6
million. During the first nine months of 2003 and 2002, we generated $253.9
million and $256.0 million, respectively, in operating cash flow. During these
periods, we had capital expenditures that included property and equipment,
capitalized research and software development, and purchased software of $163.6
million and $66.6 million, respectively.
As of December 31, 2002 and 2001, there was no long-term debt. Since we did not
anticipate utilizing the credit facility before its expiration in August 2003,
the agreement was terminated. The termination was effective November 4, 2002.
22
COMPUWARE CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
We believe available cash resources together with cash flow from operations,
will be sufficient to meet our cash needs for the foreseeable future.
Although there were no acquisitions during the first nine months of 2003, we
continue to evaluate business acquisition opportunities that fit our strategic
plans.
We are building a new corporate headquarters building with a current estimated
cost of $350 million for the building and an estimated $50 million for furniture
and fixtures. Cash outlays will have no impact on the results of operations
until the building is ready for occupancy. When fully occupied in fiscal 2004,
the depreciation will result in an annual expense of approximately $14 to $17
million. This will be partially offset by the savings realized by the
consolidation of offices. Capital expenditures to date total $257.9 million.
Cash outlays for the next twelve months are expected to be approximately $142.1
million including approximately $65 million in the fourth quarter of 2003.
Currently, we intend to fund the building using cash on hand and cash flow from
operations.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others. The
Interpretation elaborates on the existing disclosure requirements for most
guarantees, including loan guarantees such as standby letters of credit. It also
clarifies that at the time a company issues a guarantee, the company must
recognize an initial liability for the fair value, or market value, of the
obligations it assumes under the guarantee and must disclose that information in
its interim and annual financial statements. The provisions related to
recognizing a liability at inception of the guarantee for the fair value of the
guarantor's obligations does not apply to product warranties or to guarantees
accounted for as derivatives. The initial recognition and initial measurement
provisions apply on a prospective basis to guarantees issued or modified after
December 31, 2002. The Company is currently evaluating the provisions of the
Interpretation, but believes that adoption of the recognition and measurement
provisions of Interpretation 45 will not have a material impact on its financial
statements.
In December 2002, the Financial Accounting Standards Board issued SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure." This
statement amends SFAS No. 123, "Accounting for Stock Based Compensation" to
provide alternative methods of voluntarily transitioning to the fair value based
method of accounting for stock-based employee compensation. SFAS No. 148 also
amends the disclosure requirements to require disclosure of the method used to
account for stock-based employee compensation and the effect of the method on
reported results in both annual and interim financial statements. The Company is
required to adopt this statement for the quarter ending March 31, 2003 and has
not determined the impact, if any, that this statement will have on its
financial position or results of operations.
In January 2003, the FASB issued Interpretation 46, Consolidation of Variable
Interest Entities. In general, a variable interest entity is a corporation,
partnership, trust, or any other legal structure used for business purposes that
either (a) does not have equity investors with voting
23
COMPUWARE CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
rights or (b) has equity investors that do not provide sufficient financial
resources for the entity to support its activities. Interpretation 46 requires a
variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual returns or
both. The consolidation requirements of Interpretation 46 apply immediately to
variable interest entities created after January 31, 2003. The consolidation
requirements apply to older entities in the first fiscal year or interim period
beginning after June 15, 2003. Certain of the disclosure requirements apply in
all financial statements issued after January 31, 2003, regardless of when the
variable interest entity was established. The Company has disclosed all variable
interest entities in Note 5 of the Notes to Consolidated Financial Statements
included in Item 8 of our Annual Report on Form 10-K. The Company is currently
evaluating the provisions of the Interpretation, but believes its adoption will
not have a material impact on its financial statements.
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, 2002. Therefore, the market risks remain substantially unchanged
from those described in our Annual Report on Form 10-K for the fiscal year
ending March 31, 2002.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of 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.
24
COMPUWARE CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As previously disclosed in the Company's Form 10-Q for the quarter ended
September 30, 2002, the Company is a party to two class action proceedings filed
in the United States District Court in the Eastern District of Michigan. The
Dinallo lawsuit, case number 02-73793, was filed on September 20, 2002 and the
Rosen lawsuit, case number 02-74073, was filed on October 10, 2002. The suits
were brought on behalf of purchasers of the Company's common stock from January
1, 1999 to April 3, 2002. Principal defendants include the Company and Joseph A.
Nathan, Henry A. Jallos and Laura L. Fournier. The plaintiffs in both cases
allege that the Company failed to disclose under the securities laws its
problems with the misappropriation of its software source code by IBM, and that
its material omissions and the dissemination of materially false and misleading
statements concerning the Company's deteriorating relationship with IBM. The
plaintiffs in both cases request that the court award them monetary damages and
expenses of litigation, including reasonable attorney fees. The Company strongly
disagrees with the allegations and intends to vigorously defend the lawsuits. At
this time, the Company's legal counsel is preparing a responsive pleading to
each lawsuit.
On January 21, 2003, the Company filed suit against Moody's Investors Services,
Inc. in the United States District Court in the Eastern District of Michigan
(case number 03-70247) alleging breach of contract, defamation, silent fraud,
and violation of the Investment Advisor's Act. The Company claims, among other
things, that Moody's failed to deal fairly and did not operate in good faith
when it lowered the Company's credit rating two full levels on August 13, 2002.
The suit seeks $245,000 in compensatory damages (the total fees paid to Moody's
during the course of the business relationship), punitive damages, the costs
related to the litigation and reasonable attorney fees.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(b) On November 4, 2002, the Company terminated its credit facility, which
contained a minimum net worth covenant.
25
COMPUWARE CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exhibit
Number Description of Document
------ -----------------------
15 Independent Accountants' Awareness Letter
99.1 Certification by the Chief Executive Officer of this
Form 10-Q of Compuware Corporation for the quarter
ended December 31, 2002 pursuant to 18 U.S.C. Section
1350
99.2 Certification by the Chief Financial Officer of this
Form 10-Q of Compuware Corporation for the quarter
ended December 31, 2002 pursuant to 18 U.S.C. Section
1350
(b) Reports on Form 8-K.
None
26
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: February 12, 2003 By: /s/ Joseph A. Nathan
----------------- ---------------------
Joseph A. Nathan
President
(duly authorized officer)
Date: February 12, 2003 By: /s/ Laura L. Fournier
----------------- ----------------------
Laura L. Fournier
Senior Vice President
Chief Financial Officer
27
CERTIFICATION
I, Peter Karmanos, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Compuware
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: February 12, 2003
/s/ Peter Karmanos, Jr.
-----------------------
Peter Karmanos, Jr.
Chief Executive Officer
CERTIFICATION
I, Laura L. Fournier, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Compuware
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: February 12, 2003
/s/ Laura L. Fournier
---------------------
Laura L. Fournier
Chief Financial Officer
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -------------------------------------------------------------
15 Independent Accountants' Awareness Letter
99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002