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, 2003
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 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 48226-5099
(Address of principal executive offices including zip code)
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 January 30, 2004, there were outstanding 384,397,953 shares of Common
Stock, par value $.01, of the registrant.
Page 1 of 31 pages
Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
December 31, 2003 and March 31, 2003 3
Condensed Consolidated Statements of Operations
for the three months and nine months ended
December 31, 2003 and 2002 4
Condensed Consolidated Statements of Cash Flows
for the nine months ended December 31, 2003 and 2002 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 23
Item 4. Controls and Procedures 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 26
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COMPUWARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31, MARCH 31,
2003 2003
------------ -----------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 367,199 $ 319,466
Investments 175,043 156,737
Accounts receivable, net 427,433 515,819
Deferred tax asset, net 33,450 30,605
Income taxes refundable, net 21,848 10,853
Prepaid expenses and other current assets 16,991 16,951
------------ -----------
Total current assets 1,041,964 1,050,431
------------ -----------
INVESTMENTS 117,386 95,095
------------ -----------
PROPERTY AND EQUIPMENT, LESS ACCUMULATED
DEPRECIATION AND AMORTIZATION 427,561 386,678
------------ -----------
CAPITALIZED SOFTWARE, LESS ACCUMULATED
AMORTIZATION 44,220 54,514
------------ -----------
OTHER:
Accounts receivable 244,228 260,735
Deferred tax asset, net 23,080 20,174
Goodwill, net 213,083 212,288
Other 25,718 42,770
------------ -----------
Total other assets 506,109 535,967
------------ -----------
TOTAL ASSETS $ 2,137,240 $ 2,122,685
============ ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 28,194 $ 37,588
Accrued expenses 162,470 134,579
Deferred revenue 263,589 296,998
------------ -----------
Total current liabilities 454,253 469,165
DEFERRED REVENUE 291,542 299,079
ACCRUED EXPENSES 18,798 22,750
------------ -----------
Total liabilities 764,593 790,994
------------ -----------
SHAREHOLDERS' EQUITY:
Common stock 3,842 3,824
Additional paid-in capital 715,071 704,190
Retained earnings 647,193 631,906
Foreign currency translation adjustment 6,541 (8,229)
------------ -----------
Total shareholders' equity 1,372,647 1,331,691
------------ -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,137,240 $ 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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
REVENUES:
Software license fees $ 80,678 $ 73,761 $ 195,361 $ 217,933
Maintenance fees 102,940 100,359 303,913 309,090
Professional services fees 134,567 159,019 427,676 510,709
--------- --------- --------- ---------
Total revenues 318,185 333,139 926,950 1,037,732
--------- --------- --------- ---------
OPERATING EXPENSES:
Cost of software license fees 8,285 7,777 23,328 23,080
Cost of professional services 123,767 145,167 399,814 464,901
Technology development and support 41,640 37,312 124,398 107,906
Sales and marketing 82,117 63,534 227,167 194,551
Administrative and general 50,245 47,318 158,074 139,005
--------- --------- --------- ---------
Total operating expenses 306,054 301,108 932,781 929,443
--------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS 12,131 32,031 (5,831) 108,289
OTHER INCOME 4,988 6,497 14,735 15,535
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 17,119 38,528 8,904 123,824
INCOME TAX (BENEFIT) PROVISION (4,706) 13,099 (7,006) 42,100
--------- --------- --------- ---------
NET INCOME $ 21,825 $ 25,429 $ 15,910 $ 81,724
========= ========= ========= =========
Basic earnings per share $ 0.06 $ 0.07 $ 0.04 $ 0.22
========= ========= ========= =========
Diluted earnings per share $ 0.06 $ 0.07 $ 0.04 $ 0.22
========= ========= ========= =========
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,
-----------------------
2003 2002
--------- ---------
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income $ 15,910 $ 81,724
Adjustments to reconcile net income to cash provided
by operations:
Depreciation and amortization 39,994 38,912
Tax benefit from exercise of stock options 175 275
Acquisition tax benefits 5,275 5,305
Deferred income taxes (5,751) 14,125
Other 15,198 11,033
Net change in assets and liabilities:
Accounts receivable 104,893 130,128
Prepaid expenses and other current assets (40) (669)
Other assets 1,468 1,284
Accounts payable and accrued expenses 8,072 (18,019)
Deferred revenue (40,946) (42,856)
Income taxes (10,995) 32,658
--------- ---------
Net cash provided by operating activities 133,253 253,900
--------- ---------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of:
Property and equipment:
Headquarters facility (50,497) (151,108)
Other (5,500) (3,948)
Capitalized software (9,165) (8,555)
Investments:
Proceeds 275,344 107,600
Purchases (302,353) (179,235)
--------- ---------
Net cash used in investing activities (92,171) (235,246)
--------- ---------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Net proceeds from exercise of stock options 1,179 860
Contribution to stock purchase plans 6,468 7,133
Repurchase of common stock (996)
--------- ---------
Net cash provided by financing activities 6,651 7,993
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 47,733 26,647
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 319,466 233,305
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 367,199 $ 259,952
========= =========
See notes to condensed consolidated financial statements.
5
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 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 December 31, 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 on 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
NINE MONTHS ENDED DECEMBER 31, 2003
NOTE 2 - COMPUTATION OF EARNINGS PER COMMON SHARE
Earnings per common share data were computed as follows (in thousands, except
for per share data):
Three Months Ended Nine Months Ended
December 31, December 31,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
BASIC EARNINGS PER SHARE:
Numerator: Net income $ 21,825 $ 25,429 $ 15,910 $ 81,724
--------- --------- --------- ---------
Denominator:
Weighted-average common shares outstanding 384,090 377,943 382,550 376,588
--------- --------- --------- ---------
Basic earnings per share $ 0.06 $ 0.07 $ 0.04 $ 0.22
========= ========= ========= =========
DILUTED EARNINGS PER SHARE:
Numerator: Net income $ 21,825 $ 25,429 $ 15,910 $ 81,724
--------- --------- --------- ---------
Denominator:
Weighted-average common shares outstanding 384,090 377,943 382,550 376,588
Dilutive effect of stock options 1,852 1,195 1,753 1,596
--------- --------- --------- ---------
Total shares 385,942 379,138 384,303 378,184
--------- --------- --------- ---------
Diluted earnings per share $ 0.06 $ 0.07 $ 0.04 $ 0.22
========= ========= ========= =========
During the three months ended December 31, 2003 and 2002, stock options and a
warrant to purchase a total of approximately 53,668,000 and 63,385,000 shares,
respectively, were excluded from the diluted earnings per share calculation
because they were anti-dilutive. During the nine months ended December 31, 2003
and 2002, stock options and a warrant to purchase a total of approximately
53,708,000 and 63,023,000 shares, respectively, were excluded from the diluted
earnings per share calculation because they were anti-dilutive.
Through December 31, 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 and nine months ended December 31, 2003 and 2002,
consistent with the method prescribed by SFAS No. 123, "Accounting for
Stock-Based Compensation", net income (loss) and earnings (loss) per share would
have been adjusted to the pro forma amounts indicated below (in thousands,
except for per share data):
Three Months Ended Nine Months Ended
December 31, December 31,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Net income (loss):
As reported $ 21,825 $ 25,429 $ 15,910 $ 81,724
Compensation cost, net of tax (8,501) (12,682) (25,490) (37,808)
--------- --------- --------- ---------
Pro forma $ 13,324 $ 12,747 $ (9,580) $ 43,916
========= ========= ========= =========
Earnings (loss) per share:
As reported:
Basic earnings per share $ 0.06 $ 0.07 $ 0.04 $ 0.22
Diluted earnings per share 0.06 0.07 0.04 0.22
Pro forma:
Basic earnings (loss) per share 0.03 0.03 (0.03) 0.12
Diluted earnings (loss) per share 0.03 0.03 (0.03) 0.12
7
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2003
The pro forma amounts for compensation cost may not be indicative of the effects
on net income (loss) and earnings (loss) per share for future years.
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 Nine Months Ended
December 31, December 31,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Net income $ 21,825 $ 25,429 $ 15,910 $ 81,724
Foreign currency translation
adjustment, net of tax 7,038 3,338 14,770 7,535
--------- --------- --------- ---------
Total comprehensive income $ 28,863 $ 28,767 $ 30,680 $ 89,259
========= ========= ========= =========
8
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2003
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 Nine Months Ended
December 31, December 31,
----------------------- -------------------------
2003 2002 2003 2002
--------- --------- --------- -----------
Revenues:
Products:
Mainframe $ 135,943 $ 133,097 $ 376,195 $ 415,243
Distributed systems 47,675 41,023 123,079 111,780
--------- --------- --------- -----------
Total product revenue 183,618 174,120 499,274 527,023
Professional services 134,567 159,019 427,676 510,709
--------- --------- --------- -----------
Total revenues $ 318,185 $ 333,139 $ 926,950 $ 1,037,732
========= ========= ========= ===========
Operating expenses:
Products $ 132,042 $ 108,623 $ 374,893 $ 325,537
Professional services 123,767 145,167 399,814 464,901
Corporate staff 50,245 47,318 158,074 139,005
--------- --------- --------- -----------
Total operating expenses $ 306,054 $ 301,108 $ 932,781 $ 929,443
========= ========= ========= ===========
Income (loss) from operations before other income:
Products $ 51,576 $ 65,497 $ 124,381 $ 201,486
Professional services 10,800 13,852 27,862 45,808
Corporate staff (50,245) (47,318) (158,074) (139,005)
--------- --------- --------- -----------
Income (loss) from operations before other income 12,131 32,031 (5,831) 108,289
Other income 4,988 6,497 14,735 15,535
--------- --------- --------- -----------
Income before income taxes $ 17,119 $ 38,528 $ 8,904 $ 123,824
========= ========= ========= ===========
Financial information regarding geographic operations is presented in the table
below (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
---------------------- -----------------------
2003 2002 2003 2002
--------- --------- --------- ----------
Revenues:
United States $ 216,393 $ 241,715 $ 654,839 $ 770,219
Europe and Africa 78,990 70,647 212,735 208,563
Other international operations 22,802 20,777 59,376 58,950
--------- --------- --------- ----------
Total revenues $ 318,185 $ 333,139 $ 926,950 $1,037,732
========= ========= ========= ==========
9
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2003
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 accrual as of March 31, 2003,
and charges against the accrual during the first nine months of fiscal 2004 (in
thousands):
Charges against Charges against
Balance at the accrual during the the accrual during Balance at
March 31, six months ended the quarter ended December 31,
2003 September 30, 2003 December 31, 2003 2003
---------- ---------------------- ------------------ ------------
Employee termination benefits $ 698 $ 419 $ 4 $ 275
Facilities costs (primarily lease
abandonments) 19,088 3,110 1,227 14,751
Legal, consulting and
outplacement costs 15 5 10
---------- ---------------------- ------------------ ------------
Total restructuring accrual $ 19,801 $ 3,534 $ 1,231 $ 15,036
========== ====================== ================== ============
10
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2003
NOTE 6 - INVESTMENTS IN PARTIALLY OWNED COMPANIES
The Company holds a 33.3% interest in CareTech Solutions, Inc. (CareTech).
CareTech provides information technology outsourcing for healthcare
organizations including data, voice, applications and data center operations.
This investment is accounted for under the equity method including consideration
of EITF 98-13, "Accounting by an Equity Method Investor for Investee Losses When
the Investor Has Loans to and Investments in Other Securities of an Investee."
At December 31, 2003 and March 31, 2003, the Company's carrying value of its
investments in and advances to CareTech was $20,838,000 and $16,191,000,
respectively. Included in the net investment at December 31, 2003 and March 31,
2003, are a note receivable with an adjusted basis of $14,841,000 and
$16,191,000, respectively, and accounts receivable due from CareTech of
$5,997,000 at December 31, 2003. The note is payable in quarterly installments
through January 2012 and bears interest at 5.25%. At December 31, 2003, CareTech
was current with the terms of the note.
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. At December 31,
2003, CareTech's outstanding lease obligations were approximately $3,573,000.
CareTech's most significant customer is the Detroit Medical Center and
Subsidiaries (DMC). The DMC has publicly announced that it is having financial
difficulties. The Company considered the financial situation of the DMC at
December 31, 2003 (and at March 31, 2003) and concluded that no impairment
charge or valuation allowance related to our investment in and receivables due
from CareTech was warranted at that time. The DMC has requested, and CareTech
has agreed, to provide the DMC with extended payment terms up to 90 days. As a
result, it is possible that CareTech will be unable to meet its cash flow needs.
During the third quarter, the other shareholders of CareTech expressed an
inability or unwillingness to provide additional funding to meet CareTech's cash
flow requirements. Therefore, the Company began recording 100 percent of any
losses incurred by CareTech as a reduction to the Company's outstanding advances
to CareTech.
The Company holds a 49% interest in ForeSee Results, Inc. (ForeSee). ForeSee was
incorporated in October 2001 to provide online customer satisfaction management.
This investment is also accounted for under the equity method including EITF
98-13.
At December 31, 2003 and March 31, 2003, the Company's carrying value of its
investments in and advances to ForeSee was $4,467,000 and $4,252,000,
respectively. Included in the net investment at December 31, 2003 and March 31,
2003, are notes receivable from ForeSee with an adjusted basis of $4,253,000 and
$3,500,000, respectively. The ForeSee notes bear interest at the prime rate
(4.00% at December 31, 2003) and are due between June 2007 and December 2008.
The Company has pledged $667,000 in additional loans to ForeSee, if needed,
subject to approval by the ForeSee shareholders. During the second quarter of
fiscal 2004, the Company's equity investment in ForeSee was reduced to zero. At
that point, the Company began recording 100 percent of the losses sustained by
ForeSee as a reduction to the Company's outstanding advances to ForeSee since
the Company is uncertain whether the other shareholders are willing or able to
sustain their share of the losses. The Company continues to monitor the
financial situation of ForeSee on a regular basis and has concluded that no
impairment reserve was warranted at December 31, 2003 (or at March 31, 2003).
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, 2003
and the related condensed consolidated statements of operations for the
three-month and nine-month periods ended December 31, 2003 and 2002, and of cash
flows for the nine-month periods ended December 31, 2003 and 2002. These interim
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 interim 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, stockholders' 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
February 9, 2004
12
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and the notes thereto included elsewhere in
this report and the Company's Annual Report on Form 10-K for the year ended
March 31, 2003.
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.
- In 2002, we filed a lawsuit against 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 and a separate complaint
against us alleging violation of seven additional IBM patents. Pursuing and
defending these matters will be costly, time-consuming and may divert
management's time and attention. Due to these matters, our legal expenses
have increased substantially and our administrative and general 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 lawsuits involving 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.
- 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.
- 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.
13
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
- Our operating margins may decline. We do not regularly 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.
- 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.
- 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.
- 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.
- Approximately 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.
- We regard our software as proprietary and attempt to protect it with
copyrights, trademarks, trade secret laws and/or 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.
- 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.
- 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.
- 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.
- 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.
14
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 operations 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
2003 2002 Change 2003 2002 Change
--------- --------- --------- --------- --------- ---------
REVENUE:
Software license fees 25.4% 22.2% 9.4% 21.1% 21.0% (10.4)%
Maintenance fees 32.3 30.1 2.6 32.8 29.8 (1.7)
Professional services fees 42.3 47.7 (15.4) 46.1 49.2 (16.3)
--------- --------- --------- ---------
Total revenues 100.0 100.0 (4.5) 100.0 100.0 (10.7)
--------- --------- --------- ---------
OPERATING EXPENSES:
Cost of software license fees 2.6 2.3 6.5 2.5 2.2 1.1
Cost of professional services 38.9 43.6 (14.7) 43.1 44.8 (14.0)
Technology development and support 13.1 11.2 11.6 13.4 10.4 15.3
Sales and marketing 25.8 19.1 29.2 24.5 18.8 16.8
Administrative and general 15.8 14.2 6.2 17.1 13.4 13.7
--------- --------- --------- ---------
Total operating expenses 96.2 90.4 1.6 100.6 89.6 0.4
--------- --------- --------- ---------
Income (loss) from operations 3.8 9.6 (62.1) (0.6) 10.4 (105.4)
Other income 1.6 2.0 (23.2) 1.6 1.5 (5.1)
--------- --------- --------- ---------
Income before income taxes 5.4 11.6 (55.6) 1.0 11.9 (92.8)
Income tax provision (benefit) (1.5) 4.0 (135.9) (0.7) 4.0 (116.6)
--------- --------- --------- ---------
Net income 6.9% 7.6% (14.2)% 1.7% 7.9% (80.5)%
========= ========= ========= =========
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.
In late October 2003, we implemented a cost reduction strategy that included
salary reductions for executive management and most employees, additional
employee contributions toward healthcare, elimination of Company sponsored
holiday events and a review of other expenses. These cost reductions were
enacted as a result of reductions in revenues and operating losses experienced
during the first and second quarters of 2004. These measures are intended to
save a total of $10 million to $15 million each quarter, starting in the third
quarter of 2004. We will reevaluate these changes at the end of the fourth
quarter. The effects on the third quarter and expected effects on the fourth
quarter are discussed throughout this report.
15
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
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, which consists of software license fees and
maintenance fees, comprised 57.7% and 52.3% of total revenue during the third
quarter of 2004 and 2003, respectively, and 53.9% and 50.8% of total revenue
during the first nine months of 2004 and 2003. OS/390 product revenue (mainframe
revenue) increased $2.8 million or 2.1% during the third quarter of 2004 to
$135.9 million from $133.1 million during the third quarter of 2003 and
decreased $39.0 million or 9.4% during the first nine months of 2004 to $376.2
million from $415.2 million during the first nine months of 2003. Revenue from
distributed software products increased by $6.7 million, or 16.2% during the
third quarter of 2004 to $47.7 million from $41.0 million during the third
quarter of 2003, and increased $11.3 million, or 10.1% during the first nine
months of 2004 to $123.1 million from $111.8 million during the first nine
months of 2003.
License revenue increased $6.9 million or 9.4% during the third quarter of 2004
to $80.7 million from $73.8 million during the third quarter of 2003 and
decreased $22.5 million or 10.4% during the first nine months of 2004 to $195.4
million from $217.9 million during the first nine months of 2003. License
revenue was positively impacted by fluctuations in foreign currencies compared
to the third quarter and to the first nine months of 2003. Excluding the
favorable effect of such foreign currency fluctuations, license revenue would
have been approximately $75.0 million during the third quarter of 2004, compared
to $73.8 million during the third quarter of 2003, an increase of 1.7%. During
the first nine months of 2004 license revenue would have been approximately
$183.8 million, compared to $217.9 million during the first nine months of 2003,
a decrease of 15.7% excluding the effect of foreign currency fluctuations. The
increase in license revenue for the quarterly period is primarily attributable
to sales growth in our distributed products resulting from the increased sales
and marketing focus within this segment of our business. The year to date
decrease is attributable to the overall economic weakness in the technology
market and continued downward pricing pressure. We have significantly less
revenue from licenses for additional capacity compared to prior years.
Maintenance fees increased $2.5 million or 2.6% to $102.9 million during the
third quarter of 2004 from $100.4 million during the third quarter of 2003 and
decreased $5.2 million or 1.7% during the first nine months of 2004 to $303.9
million from $309.1 million during the first nine months of 2003. Maintenance
fees were positively impacted by fluctuations in foreign currencies compared to
the third quarter and to the first nine months of 2003. Excluding the effect of
foreign currency fluctuations, maintenance fees would have been approximately
$97.2 million during the third quarter of 2004, compared to $100.4 million
during the third quarter of 2003, a decrease of 3.2%. During the first nine
months of 2004 maintenance fees would have been approximately $289.5 million,
compared to $309.1 million during the first nine months of 2003, a decrease of
6.3% excluding the effect of foreign currency fluctuations. The decreases in
maintenance fees on a comparable dollar basis were 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 mainframe software on hardware up to a licensed aggregate MIPS
(Millions of Instructions Per Second)
16
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
capacity or to run our distributed software for a specified number of users or
servers. Term licenses allow customers a right to run our software for a limited
period of time on hardware as licensed. 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 Nine Months Ended
December 31, December 31,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
United States $ 97,003 $ 99,603 $ 271,398 $ 310,515
Europe and Africa 64,961 54,595 171,078 159,661
Other international operations 21,654 19,922 56,798 56,847
--------- --------- --------- ---------
Total product revenue $ 183,618 $ 174,120 $ 499,274 $ 527,023
========= ========= ========= =========
PRODUCT CONTRIBUTION AND EXPENSES
Financial information for the product segment is as follows (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Revenue $ 183,618 $ 174,120 $ 499,274 $ 527,023
Expenses 132,042 108,623 374,893 325,537
--------- --------- --------- ---------
Product contribution $ 51,576 $ 65,497 $ 124,381 $ 201,486
========= ========= ========= =========
The product segment generated contribution margins of 28.1% and 37.6% during the
third quarter of 2004 and 2003, respectively, and 24.9% and 38.2% during the
first nine months 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.
17
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
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 10.3% and 10.5% in the third quarter of 2004 and 2003,
respectively, and 11.9% and 10.6% in the first nine months 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. Also included here are
personnel costs associated with developing and maintaining internal systems and
hardware/software costs required to support technology initiatives. As a
percentage of product revenue, costs of technology development and support were
22.7% and 21.4% in the third quarter of 2004 and 2003, respectively, and 24.9%
and 20.5% during the first nine months 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 third quarter of 2004 increased $5.1 million,
or 12.7%, to $45.4 million from $40.3 million in the third quarter of 2003, and
for the first nine months of 2004 increased $17.1 million, or 14.7%, to $133.6
million from $116.5 million in the first nine months of 2003. The increases in
these costs for 2004 were primarily attributable to an increase in compensation
and benefits associated with higher employee headcount in this area which
increased by 59 people to 1,517 people as of December 31, 2003 from 1,458 people
as of December 31, 2002. In late October 2003, we implemented cost reduction
strategies that resulted in a reduction of technology development and support
costs totaling $850,000 during the third quarter that offset a portion of the
increase. We expect these cost reductions to save approximately $1.2 million
during the fourth quarter.
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
third quarter of 2004, sales and marketing costs increased $18.6 million, or
29.2%, to $82.1 million from $63.5 million in the third quarter of 2003 and for
the first nine months of 2004 increased $32.6 million, or 16.8% to $227.2
million from $194.6 million in the first nine months of 2003. The increases in
these costs for 2004 were primarily attributable to higher marketing costs
related to the promotion of products in the distributed software marketplace and
increased salaries and bonuses associated with the increase in our direct sales
force. Employee headcount in this area increased by 137 people to 1,875 people
as of December 31, 2003 from 1,738 people as of December 31, 2002. As a
percentage of product revenue, sales and marketing costs were 44.7% and 36.5% in
the third quarter of 2004 and 2003, respectively, and 45.5% and 36.9% in the
first nine months of 2004 and 2003, respectively. In late October 2003, we
implemented cost reduction strategies that resulted in a reduction of sales and
marketing costs totaling $800,000 during the third quarter that offset a portion
of the increase. We expect these cost reductions to save approximately $1.6
million during the fourth quarter.
18
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
$24.4 million or 15.4% during the third quarter of 2004 to $134.6 million
compared to $159.0 million in the third quarter of 2003, and decreased $83.0
million or 16.3% during the first nine months of 2004 to $427.7 million from
$510.7 million during the first nine months of 2003. The decrease in revenue for
2004 was due, primarily, to a reduction in demand for professional services as
customers postpone large projects, and to the highly competitive nature of the
professional services market and the resulting downward pressure on our billing
rates. Included in professional services revenue was approximately $5.2 million
and $16.3 million for the third quarter and first nine months of 2004,
respectively, related to services provided as subcontractors to CareTech, an
affiliated entity.
Professional services revenue by geographic location is presented in the table
below (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
United States $ 119,390 $ 142,112 $ 383,441 $ 459,704
Europe and Africa 14,029 16,052 41,657 48,902
Other international operations 1,148 855 2,578 2,103
--------- --------- --------- ---------
Total professional services revenue $ 134,567 $ 159,019 $ 427,676 $ 510,709
========= ========= ========= =========
PROFESSIONAL SERVICES CONTRIBUTION AND EXPENSES
Financial information for the professional services segment is as follows (in
thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Revenue $ 134,567 $ 159,019 $ 427,676 $ 510,709
Expenses 123,767 145,167 399,814 464,901
--------- --------- --------- ---------
Professional services contribution $ 10,800 $ 13,852 $ 27,862 $ 45,808
========= ========= ========= =========
During the third quarter of 2004, the professional services segment generated a
contribution margin of 8.0%, compared to 8.7% during the third quarter of 2003.
The professional services contribution margin was 6.5% and 9.0% for the first
nine months of 2004 and 2003, respectively. 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 third quarter of 2003 to the
third 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 586 people to 4,707 people
as of December 31, 2003 from 5,293 people at December 31, 2002. In late October
2003, we implemented cost
19
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
reduction strategies that resulted in a reduction of professional services costs
totaling $6.7 million during the third quarter. We expect these cost reductions
to save approximately $11.2 million during the fourth quarter.
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, building depreciation, maintenance,
utilities, etc., associated with our local sales and professional services
offices. Administrative and general expenses increased $2.9 million, or 6.2%
during the third quarter of 2004 to $50.2 million from $47.3 million during the
third quarter of 2003, and increased $19.1 million or 13.7% during the first
nine months of 2004 to $158.1 million from $139.0 million in the first nine
months of 2003. External legal fees for all litigation, including IBM and other
matters, were $10.9 million and $9.3 million in the third quarter of 2004 and
2003, respectively, and $35.0 million and $16.3 million in the first nine months
of 2004 and 2003, respectively. In late October 2003, we implemented cost
reduction strategies that resulted in a reduction to administrative and general
costs totaling $1.3 million during the third quarter. We expect these cost
reductions to save approximately $2.2 million during the fourth quarter.
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. During
the quarter ended December 31 2003, we recorded an income tax benefit of $9.5
million relating primarily to favorable tax settlements with the U.S. Internal
Revenue Service and recent developments in other tax matters both in the US
and other taxing jurisdictions. Excluding this tax benefit, the effective tax
rate for the quarter and for the nine months ended December 31, 2003 was 28%
compared to 34% for the same periods a year ago. The decrease in the effective
tax rate is primarily due to the higher percentage impact of certain tax benefit
items as a result of the decline in income. The income tax benefit was $4.7
million in the third quarter of 2004 and $7.0 million for the first nine months
of 2004, including the $9.5 million income tax benefit in the third quarter.
This compares to an income tax provision of $13.1 million in the third quarter
of 2003 and $42.1 million for the first nine months of 2003.
20
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
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 December 31, 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 nine months of 2004.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2003, cash and investments totaled approximately $659.6
million. During the first nine months of 2004 and 2003, cash flow from
operations was $133.3 million and $253.9 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 and capitalized research and
software development totaled $65.2 million and $163.6 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 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.
Although there were no acquisitions during the third quarter of 2004, management
continues to evaluate business acquisition opportunities that fit our strategic
plans. On February 5, 2004, we entered into an asset purchase agreement with
Covisint LLC (Covisint). Under the agreement, we will acquire most assets and
certain liabilities related to their Portal, Messaging/Supplier Connect and
Problem Solver businesses (acquired business). The transfer of the acquired
business is expected to be effective March 1, 2004, pending finalization of all
terms and conditions. We expect to fund this purchase using cash on hand and do
not expect it to have a material effect on cash balances.
During fiscal 2004, we 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 is approximately $16 million. This is partially offset by the savings
realized by the consolidation of our metro Detroit offices. The remaining cash
outlays of approximately $20 million are expected to occur in the fourth quarter
of fiscal 2004 and are intended to be funded using cash on hand and cash flow
from operations.
21
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
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 Detroit Medical Center and Subsidiaries (DMC).
The DMC has publicly announced it is having financial difficulties. After
consideration of all relevant factors, we concluded that no impairment charge or
valuation allowance related to our investment in and receivables due from
CareTech should be recorded at December 31, 2003. The DMC has requested, and
CareTech has agreed, to provide the DMC with extended payment terms up to 90
days. As a result, it is possible that CareTech will be unable to meet its cash
flow needs. During the third quarter, the other shareholders of CareTech
expressed an inability or unwillingness to provide additional funding to meet
CareTech's cash flow requirements. Therefore, we began recording 100 percent of
any losses incurred by CareTech as a reduction to our outstanding advances to
CareTech. We may advance additional funds to CareTech to meet their working
capital needs, but we do not expect these advances to be significant.
We believe available cash resources together with cash flow from operations,
will be sufficient to meet cash needs for the foreseeable future.
22
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 our foreign exchange risk management strategy or our investment standards
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 was no change in our internal controls over financial
reporting during the quarter ended December 31, 2003 that materially affected,
or is reasonably likely to materially affect, our internal controls over
financial reporting.
23
COMPUWARE CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
As disclosed in our Annual Report on Form 10-K for the fiscal year ending March
31, 2003, on March 12, 2002, we filed suit in the United States District Court
for the Eastern District of Michigan against International Business Machines
Corporation ("IBM") alleging certain intellectual property claims. The suit
seeks injunctive relief and unspecified monetary damages, among other things,
from IBM. Please refer to our Annual Report on Form 10-K for the fiscal year
ending March 31, 2003 for a complete description of these proceedings.
In December 2003, the court denied our Motion for Preliminary Injunction on the
trade secret and false advertising claims, ruling that there were fact issues
that needed to be decided by a jury. The Motion did not address IBM's antitrust
violations or unfair competition. Those claims, as well as the trade secret
misappropriation claims are scheduled to be tried by a jury in September 2004.
While we currently believe we ultimately will benefit from this litigation, the
impact of this action on our business relationship with IBM and our liquidity,
financial position and results of operations are not determinable at the present
time.
On January 15, 2004, IBM filed patent infringement claims against us in the
United States District Court for the Southern District of New York alleging
infringement of seven IBM patents. The Compuware products accused of
infringement are Strobe, QA Center, DevPartner and Uniface. The suit seeks
injunctive relief and unspecified monetary damages. We believe we have valid
defenses to the claims, and intend to vigorously defend against the lawsuit. The
impact of this action on our business relationship with IBM and our liquidity,
financial position and results of operations are not determinable at the present
time.
24
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
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 9 and 12 was
filed on October 23, 2003 reporting that on October 21, 2003,
the Company issued a press release announcing financial results
for the fiscal quarter ended September 30, 2003 and certain
other information. The information was considered furnished,
rather than filed. No financial statements were filed with this
report.
A Current Report on Form 8-K pursuant to Items 9 and 12 was
filed on October 10, 2003 reporting that on October 10, 2003,
the Company issued a press release announcing preliminary
financial results for the fiscal quarter ended September 30,
2003 and certain other information. The information was
considered furnished, rather than filed. No financial statements
were filed with this report.
25
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 9, 2004 By: /s/ Peter Karmanos, Jr.
---------------------------
Peter Karmanos, Jr.
Chief Executive Officer
(duly authorized officer)
Date: February 9, 2004 By: /s/ Laura L. Fournier
---------------------------
Laura L. Fournier
Senior Vice President
Chief Financial Officer
Treasurer
26
EXHIBIT INDEX
Exhibit
Number Description of Document
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.