UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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 of (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 August 8, 2002, there were outstanding 375,904,601 shares of Common Stock, par value $.01, of the registrant. Page 1 of 22 pages PART I. FINANCIAL INFORMATION Page ---- Item 1. Financial Statements Condensed Consolidated Balance Sheets as of June 30, 2002 and March 31, 2002 3 Condensed Consolidated Statements of Operations for the three months ended June 30, 2002 and 2001 4 Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 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 20 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 21 SIGNATURES 22 2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS COMPUWARE CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) JUNE 30, MARCH 31, 2002 2002 ----------- ----------- (UNAUDITED) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 270,470 $ 233,305 Investments 139,372 133,503 Accounts receivable, net 540,316 609,579 Deferred tax asset, net 35,042 41,811 Income taxes refundable, net 22,642 27,687 Prepaid expenses and other current assets 18,266 16,954 ----------- ----------- Total current assets 1,026,108 1,062,839 ----------- ----------- INVESTMENTS 65,139 55,566 ----------- ----------- PROPERTY AND EQUIPMENT, LESS ACCUMULATED DEPRECIATION AND AMORTIZATION 226,600 199,365 ----------- ----------- CAPITALIZED SOFTWARE, LESS ACCUMULATED AMORTIZATION 65,794 68,998 ----------- ----------- OTHER: Accounts receivable 298,797 306,751 Deferred tax asset, net 47,499 44,884 Goodwill, net 212,141 211,792 Other 43,751 43,743 ----------- ----------- Total other assets 602,188 607,170 ----------- ----------- TOTAL ASSETS $ 1,985,829 $ 1,993,938 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 19,495 $ 28,646 Accrued expenses 148,453 186,477 Deferred revenue 338,070 341,024 ----------- ----------- Total current liabilities 506,018 556,147 DEFERRED REVENUE 231,542 218,624 ACCRUED EXPENSES 27,415 29,316 ----------- ----------- Total liabilities 764,975 804,087 ----------- ----------- SHAREHOLDERS' EQUITY: Common stock 3,759 3,758 Additional paid-in capital 678,831 676,617 Retained earnings 551,269 528,804 Accumulated other comprehensive loss (13,005) (19,328) ----------- ----------- Total shareholders' equity 1,220,854 1,189,851 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,985,829 $ 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 JUNE 30, ---------------------- 2002 2001 --------- --------- REVENUES: Software license fees $ 57,153 $ 95,585 Maintenance fees 105,694 110,827 Professional services fees 183,752 244,063 --------- --------- Total revenues 346,599 450,475 --------- --------- OPERATING EXPENSES: Cost of software license fees 7,627 8,663 Cost of professional services 167,369 216,086 Technology development and support 31,799 41,731 Sales and marketing 66,176 71,472 Administrative and general 44,768 51,693 Goodwill amortization 9,804 --------- --------- Total operating expenses 317,739 399,449 --------- --------- INCOME FROM OPERATIONS 28,860 51,026 --------- --------- OTHER INCOME (EXPENSE): Interest and investment income 6,694 6,924 Interest expense and other (1,516) (2,537) --------- --------- Total other income 5,178 4,387 --------- --------- INCOME BEFORE INCOME TAXES 34,038 55,413 INCOME TAX PROVISION 11,573 21,057 --------- --------- NET INCOME $ 22,465 $ 34,356 ========= ========= Basic earnings per share $ 0.06 $ 0.09 ========= ========= Diluted earnings per share $ 0.06 $ 0.09 ========= ========= See notes to condensed consolidated financial statements. 4 COMPUWARE CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) THREE MONTHS ENDED JUNE 30, ---------------------- 2002 2001 --------- --------- CASH FLOWS PROVIDED BY OPERATING ACTIVITIES: Net income $ 22,465 $ 34,356 Adjustments to reconcile net income to cash provided by operations: Depreciation and amortization 12,995 25,106 Tax benefit from exercise of stock options 62 1,463 Acquisition tax benefits 1,768 1,802 Deferred income taxes 4,154 (259) Other 6,295 1,145 Net change in assets and liabilities, net of effects from acquisitions: Accounts receivable 77,217 49,323 Prepaid expenses and other current assets (1,312) (136) Other assets (597) 1,305 Accounts payable and accrued expenses (41,993) (47,860) Deferred revenue 9,964 29,526 Income taxes 5,045 (10,122) --------- --------- Net cash provided by operating activities 96,063 85,649 --------- --------- CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES: Purchase of: Property and equipment: Headquarters building (42,911) (12,091) Other (613) (2,349) Capitalized software (3,012) (3,208) Investments: Proceeds from maturity 40,885 73,255 Purchases (56,899) (53,618) --------- --------- Net cash provided by (used in) investing activities (62,550) 1,989 --------- --------- CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES: Net proceeds from exercise of stock options 327 2,942 Contribution to stock purchase plans 3,325 22 Payments on long term debt (88,000) --------- --------- Net cash provided by (used in) financing activities 3,652 (85,036) --------- --------- NET INCREASE IN CASH AND CASH EQUIVALENTS 37,165 2,602 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 233,305 53,340 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 270,470 $ 55,942 ========= ========= See notes to condensed consolidated financial statements. 5 COMPUWARE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS THREE MONTHS ENDED JUNE 30, 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 June 30, 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 THREE MONTHS ENDED JUNE 30, 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 June 30, ------------------- 2002 2001 -------- -------- BASIC EPS: Numerator: Net Income $ 22,465 $ 34,356 -------- -------- Denominator: Weighted-average common shares outstanding 375,883 370,204 -------- -------- Basic EPS $ 0.06 $ 0.09 ======== ======== DILUTED EPS: Numerator: Net Income $ 22,465 $ 34,356 -------- -------- Denominator: Weighted-average common shares outstanding 375,883 370,204 Dilutive effect of stock options 2,606 12,041 -------- -------- Total shares 378,489 382,245 -------- -------- Diluted EPS $ 0.06 $ 0.09 ======== ======== 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 June 30, ------------------------------- 2002 2001 --------------- -------------- Net Income $ 22,465 $ 34,356 Foreign currency translation adjustment, net of tax 6,323 1,154 --------------- -------------- Total comprehensive income $ 28,788 $ 35,510 =============== ============== 7 COMPUWARE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS THREE MONTHS ENDED JUNE 30, 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 June 30, ---------------------- 2002 2001 --------- --------- Revenues: Products: Mainframe $ 128,063 $ 166,914 Distributed systems 34,784 39,498 --------- --------- Total products revenue 162,847 206,412 Services 183,752 244,063 --------- --------- Total revenues $ 346,599 $ 450,475 ========= ========= Operating Expenses: Products $ 105,602 $ 121,866 Services 167,369 216,086 Corporate staff 44,768 51,693 Goodwill amortization 9,804 --------- --------- Total operating expenses $ 317,739 $ 399,449 ========= ========= Income from operations before other income (expenses): Products $ 57,245 $ 84,546 Services 16,383 27,977 Corporate staff (44,768) (51,693) Goodwill amortization (9,804) --------- --------- Income from operations before other income 28,860 51,026 Other income 5,178 4,387 --------- --------- Income before income taxes $ 34,038 $ 55,413 ========= ========= Financial information regarding geographic operations are presented in the table below (in thousands): Three Months Ended June 30, ------------------- 2002 2001 -------- -------- Revenues: United States $264,985 $344,724 Europe and Africa 64,896 80,431 Other international operations 16,718 25,320 -------- -------- Total revenues $346,599 $450,475 ======== ======== 8 COMPUWARE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS THREE MONTHS ENDED JUNE 30, 2002 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 includes 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 will be terminated as a result of the reorganization. As of June 30, 2002, 1,282 of the affected employees had been terminated. The following table summarizes the restructuring charge taken in fiscal 2002, and charges against the accrual during the first quarter of fiscal 2003 (in thousands): Charges against Balance at the accrual during March 31, the quarter ended Balance at 2002 June 30, 2002 June 30, 2002 ---------- ------------------ ------------- Employee termination benefits $18,459 $11,259 $ 7,200 Facilities costs (primarily lease abandonments) 25,665 2,774 22,891 Legal, consulting and outplacement costs 1,299 521 778 Other 278 195 83 ---------- ------------------ ------------- Total restructuring accrual $45,701 $14,749 $30,952 ========== ================== ============= 9 COMPUWARE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS THREE MONTHS ENDED JUNE 30, 2002 NOTE 6 -- GOODWILL AND INTANGIBLE ASSETS The components of the Company's intangible assets were as follows (in thousands): At June 30, 2002 --------------------------------------------------------------- Gross Carrying Accumulated Net Carrying Amount Amortization Amount -------------- ------------ ------------ Amortized intangible assets: Capitalized software $ 213,246 $ (147,452) $ 65,794 Other (1) 6,200 (3,808) 2,392 -------------- ------------ ------------ Total $ 219,446 $ (151,260) $ 68,186 ============== ============ ============ At March 31, 2002 --------------------------------------------------------------- Gross Carrying Accumulated Net Carrying Amount Amortization Amount -------------- ------------ ------------ Amortized intangible assets: Capitalized software $ 209,017 $ (140,019) $ 68,998 Other (1) 6,200 (3,725) 2,475 -------------- ------------ ------------ Total $ 215,217 $ (143,744) $ 71,473 ============== ============ ============ (1) 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 $6,298,000 and $7,769,000 for the three months ended June 30, 2002 and 2001, respectively. Annual amortization expense, based on identified intangible assets recorded through June 30, 2002 is expected to be as follows (in thousands): Year Ended March 31, ------------------------------------------------------------------ 2003 2004 2005 2006 2007 -------- -------- -------- ------- ------- Capitalized software $ 24,644 $ 23,236 $ 14,959 $ 5,615 $ 2,761 Other 330 330 330 330 330 -------- -------- -------- ------- ------- Total $ 24,974 $ 23,566 $ 15,289 $ 5,945 $ 3,091 ======== ======== ======== ======= ======= 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 quarter ended June 30, 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 349 349 -------- --------- --------- Balance as of June 30, 2002, net $ 72,182 $ 139,959 $ 212,141 ======== ========= ========= 10 COMPUWARE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS THREE MONTHS ENDED JUNE 30, 2002 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 June 30, ------------------------------- 2002 2001 -------- -------- Reported net income $ 22,465 $ 34,356 Add goodwill amortization, net of tax 8,274 -------- -------- Adjusted net income $ 22,465 $ 42,630 ======== ======== Diluted earnings per share $ 0.06 $ 0.11 ======== ======== 11 INDEPENDENT ACCOUNTANTS' REPORT Compuware Corporation: We have reviewed the accompanying condensed consolidated balance sheet of Compuware Corporation and subsidiaries (the "Company") as of June 30, 2002, and the related condensed consolidated statements of operations and cash flows for the three-month periods ended June 30, 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 July 15, 2002 12 COMPUWARE CORPORATION AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 operating results, including, without limitation, those contained in this report 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, or on behalf of, the Company. There can be no assurance that future results will meet expectations. While the Company believes that its 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, the Company does 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. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain operational data from the consolidated statements of income, in thousands, and as a percentage of total revenues and the percentage change in such items compared to the prior period: Results of Percentage of Operations Total Revenues ---------------------- ------------------ Three Months Ended Three Months Ended ---------- June 30, June 30, Period- ---------------------- ------------------ to-Period 2002 2001* 2002 2001* Change --------- --------- -------- -------- ---------- REVENUE: Software license fees $ 57,153 $ 95,585 16.5% 21.2% (40.2)% Maintenance fees 105,694 110,827 30.5 24.6 (4.6) Professional services fees 183,752 244,063 53.0 54.2 (24.7) --------- --------- -------- -------- Total revenues 346,599 450,475 100.0 100.0 (23.1) --------- --------- -------- -------- OPERATING EXPENSES: Cost of software license fees 7,627 8,663 2.2 1.9 (12.0) Cost of professional services 167,369 216,086 48.3 48.0 (22.5) Technology development and support 31,799 41,731 9.2 9.3 (23.8) Sales and marketing 66,176 71,472 19.1 15.8 (7.4) Administrative and general 44,768 51,693 12.9 11.5 (13.4) Goodwill amortization 9,804 2.2 (100.0) --------- --------- -------- -------- Total operating expenses 317,739 399,449 91.7 88.7 (20.5) --------- --------- -------- -------- Income from operations 28,860 51,026 8.3 11.3 (43.4) --------- --------- -------- -------- Other income (expense): Interest and investment income 6,694 6,924 1.9 1.6 (3.3) Interest expense and other (1,516) (2,537) (0.4) (0.6) 40.2 --------- --------- -------- -------- Total other income 5,178 4,387 1.5 1.0 18.0 --------- --------- -------- -------- Income before income taxes 34,038 55,413 9.8 12.3 (38.6) Income tax provision 11,573 21,057 3.3 4.7 (45.0) --------- --------- -------- -------- Net income $ 22,465 $ 34,356 6.5% 7.6% (34.6)% ========= ========= ======== ======== * Reclassified to conform to the June 2002 presentation. 13 COMPUWARE CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) 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 in the first quarter of last year would have been $42.6 million, or 11 cents per diluted share. 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 -- no longer allocating costs associated with the facilities, finance and human resource departments to the various 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 or loss from operations. The following table sets forth for the periods indicated, certain operational data reclassified to conform to the current presentation (dollars in thousands): Three Months Ended --------------------------------------------------- March 31, December 31, September 30, June 30, 2002 2001 2001 2001 --------- ------------ ------------- --------- REVENUE: Software license fees $ 109,477 $ 125,731 $ 86,838 $ 95,585 Maintenance fees 106,401 106,816 109,707 110,827 Professional services fees 192,650 221,233 231,216 244,063 --------- ------------ ------------- --------- Total revenues 408,528 453,780 427,761 450,475 --------- ------------ ------------- --------- OPERATING EXPENSES: Cost of software license fees 8,621 8,380 8,438 8,663 Cost of professional services 203,750 207,794 212,519 216,086 Technology development and support 42,315 39,218 41,016 41,731 Sales and marketing 76,462 77,507 69,055 71,472 Administrative and general 45,699 59,805 49,969 51,693 Goodwill amortization and impairment 387,710 19,027 9,803 9,804 Restructuring costs 46,930 --------- ------------ ------------- --------- Total operating expenses 811,487 411,731 390,800 399,449 --------- ------------ ------------- --------- Income (loss) from operations (402,959) 42,049 36,961 51,026 --------- ------------ ------------- --------- Other income (expense): Interest and investment income 8,172 7,180 7,228 6,924 Interest expense and other (2,270) (1,182) (1,439) (2,537) --------- ------------ ------------- --------- Total other income 5,902 5,998 5,789 4,387 --------- ------------ ------------- --------- Income (loss) before income taxes (397,057) 48,047 42,750 55,413 Income tax provision (benefit) (61,152) 18,258 16,245 21,057 --------- ------------ ------------- --------- Net income (loss) $(335,905) $ 29,789 $ 26,505 $ 34,356 ========= ============ ============= ========= Products contribution margin 41.0% 46.2% 39.7% 41.0% Professional services contribution margin (5.8%) 6.1% 8.1% 11.5% 14 COMPUWARE CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) 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 47.0% and 45.8% of total Company revenue during the first quarter of 2003 and 2002, respectively. OS/390 product revenue (mainframe revenue) decreased $38.8 million or 23.3% during the first quarter of 2003 to $128.1 million from $166.9 million during the first quarter of 2002. Revenue from distributed software products decreased $4.7 million or 11.9% during the first quarter of 2003 to $34.8 million from $39.5 million during the first quarter of 2002. The overall decline in product revenue from the first quarter of 2002 to 2003 was primarily attributable to decreases in license fees and maintenance fees associated with decreased customer demand for our products due in part to the continued softness in the economy as a whole and the IT industry in particular. License revenue decreased $38.4 million or 40.2% during the first quarter of 2003 to $57.2 million from $95.6 million during the first quarter of 2002. Maintenance fees decreased $5.1 million or 4.6% to $105.7 million during the first quarter of 2003 from $110.8 million during the first quarter of 2002. The decrease in maintenance fees was primarily attributable to lower license fees during both 2003 and 2002 and to market pressure on pricing. We support clients with product transactions covering multiple years and allowing deferred payment terms. The contract price is allocated between maintenance for the term of the deal and license revenue. All license revenue associated with these 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. License revenue associated with transactions that include an option to exchange or select products in the future has been deferred and is recognized over the term of the deal. 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 associated with all sales has been 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 June 30, --------------------------------- 2002 2001* --------------- --------------- United States $ 98,185 $ 125,299 Europe and Africa 48,596 56,742 Other international operations 16,066 24,371 --------------- --------------- Total products revenue $ 162,847 $ 206,412 =============== =============== * Reclassified to conform to the June 2002 presentation. 15 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 June 30, --------------------------------- 2002 2001* --------------- --------------- Revenue $ 162,847 $ 206,412 Expenses 105,602 121,866 --------------- --------------- Products contribution $ 57,245 $ 84,546 =============== =============== * Reclassified to conform to the June 2002 presentation The products segment generated contribution margins of 35.2% and 41.0% during the first quarter 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 margin in the first quarter 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 disseminating products to customers and the cost of author royalties. The decrease in these costs in the first quarter of 2003 was due primarily to decreased amortization of purchased software, decreased cost of printing and materials, and decreased salary and benefits associated with lower employee headcount. As a percentage of software license fees, cost of software license fees were 13.3% and 9.1% in the first quarter 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 in the first quarter of 2003 was primarily attributable to a decrease in salaries and bonuses associated with lower employee headcount and to reduced travel costs. As a percentage of product revenue, costs of technology development and support were 19.5% and 20.2% in the first quarter 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 first quarter of 2003 decreased $10.0 million, or 22.3%, to $34.8 million from $44.8 million in the first quarter 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 costs associated with new sales initiatives. The decrease in sales and marketing costs from the first quarter of 2002 to the first quarter of 2003 was primarily attributable to decreased salaries and benefits, and decreased travel expenses, offset by increased bonuses and commissions. As a percentage of license fees, sales and marketing costs were 115.8% and 74.8% in the first quarter of 2003 and 2002, respectively. 16 COMPUWARE CORPORATION AND SUBSIDIARIES 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 $60.3 million or 24.7% during the first quarter of 2003 to $183.8 million compared to $244.1 million in the first quarter 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 by geographic location is presented in the table below (in thousands): Three Months Ended June 30, ------------------------------------------- 2002 2001* -------------------- -------------------- United States $ 166,800 $ 219,425 Europe and Africa 16,300 23,689 Other international operations 652 949 -------------------- -------------------- Total professional services revenue $ 183,752 $ 244,063 ==================== ==================== * Reclassified to conform to the June 2002 presentation. PROFESSIONAL SERVICES CONTRIBUTION AND EXPENSES Financial information for our professional services segment is as follows (in thousands): Three Months Ended June 30, -------------------------------------------- 2002 2001* -------------------- --------------------- Revenue $ 183,752 $ 244,063 Expenses 167,369 216,086 -------------------- --------------------- Professional services contribution $ 16,383 $ 27,977 ==================== ===================== * Reclassified to conform to the June 2002 presentation. During the first quarter of 2003, the professional services segment generated a contribution margin of 8.9%, compared to 11.5% during the first quarter of 2002. The decrease in professional services margin is primarily due to lower billing rates and reduced customer demand for our services associated with the decline of the economy as a whole and the IT sector specifically. Cost of professional services consists primarily of personnel-related costs of providing services, including billable staff, subcontractors and sales personnel. The decrease in these costs from the first quarter of 2002 to the first quarter of 2003 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 1,746 people to 5,777 people as of June 30, 2002 from 7,523 people at June 30, 2001. 17 COMPUWARE CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) CORPORATE AND OTHER EXPENSES Administration and general expenses consist of all 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 $6.9 million, or 13.4% during the first quarter of 2003 to $44.8 million from $51.7 million during the first quarter of 2002. The decrease in administrative and general expenses was primarily attributable to decreased building rent and decreased salaries resulting from the restructuring discussed below. Interest and investment income for the first quarter of 2003 was $6.7 million as compared to $6.9 million in the first quarter of 2002. This decrease was due to decreased interest related to customers' deferred installments. Interest expense for the first quarter of 2003 was $1.5 million as compared to $2.5 million in the first quarter of 2002. Interest expense includes amortization of the initial financing fees and fees associated with the unutilized balance of the Senior Credit Facility (the credit facility) discussed in the Liquidity and Capital Resources section below. The decrease in interest expense from 2002 to 2003 was primarily attributable to the payoff of debt previously outstanding under the credit facility. 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 $11.6 million in the first quarter of 2003, which represents an effective tax rate of 34%. This compares to an income tax provision of $21.1 million in the first quarter of 2002, which represents an effective tax rate of 38%. The decrease in the effective tax rate is a result of no longer amortizing goodwill for financial statement purposes. Much 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 will be terminated as a result of the reorganization. The restructuring is proceeding as planned. As of June 30, 2002 and July 15, 2002, 1,282 and 1,367 employees, respectively, had been terminated as a result of the reorganization. 18 COMPUWARE CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The following table summarizes the restructuring charge taken in 2002 (in thousands): Charges against Balance at the accrual during March 31, the quarter ended Balance at 2002 June 30, 2002 June 30, 2002 ---------- ------------------ ------------- Employee termination benefits $ 18,459 $ 11,259 $ 7,200 Facilities costs (primarily lease abandonments) 25,665 2,774 22,891 Legal, consulting and outplacement costs 1,299 521 778 Other 278 195 83 ---------- ------------------ ------------- Total restructuring accrual $ 45,701 $ 14,749 $ 30,952 ========== ================== ============= 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 June 30, 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 first quarter of 2003. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2002, cash and investments totaled approximately $475.0 million. During the first quarter of 2003 and the first quarter of 2002, we generated $96.1 million and $85.6 million, respectively, in operating cash flow. The increased operating cash flow is generated, in part, from the collection of the current portion of prior years' installment receivables as reflected in the decrease in total accounts receivable. During these periods, we had capital expenditures that included property and equipment, capitalized research and software development, and purchased software of $46.5 million and $17.6 million, respectively. As of June 30, 2002, there was no long-term debt, compared to $52.0 million as of June 30, 2001. This balance represented borrowings under the credit facility. There is currently $500 million available for borrowing under the credit facility. Interest may be determined on a Eurodollar or base rate (as defined in the credit facility) basis at our option. The credit agreement contains restrictive covenants and requires commitment fees in accordance with standard banking practice. 19 COMPUWARE CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) We believe available cash resources including the amount available under the credit facility, 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 quarter 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 calendar 2003, the depreciation will result in an annual expense of approximately $17 million. This will be partially offset by the savings realized by the consolidation of offices. Capital expenditures to date total $149.7 million. Cash outlays for the next twelve months are expected to be approximately $247.5 million. Currently, we intend to fund the building using cash on hand and cash flow from operations. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is 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 since the Company filed its Annual Report on Form 10-K for the fiscal year ending March 31, 2002. 20 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 June 30, 2002 99.2 Certification by the Chief Financial Officer of this form 10-Q of Compuware Corporation for the quarter ended June 30, 2002 99.3 Certification by the Chief Executive Officer of form 10-K for the year ended March 31, 2002 and Subsequent filings of Compuware Corporation 99.4 Certification by the Chief Financial Officer of form 10-K for the year ended March 31, 2002 and Subsequent filings of Compuware Corporation (b) Reports on Form 8-K. None 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMPUWARE CORPORATION Date: August 12, 2002 By: /s/ Joseph A. Nathan --------------- --------------------- Joseph A. Nathan President (duly authorized officer) Date: August 12, 2002 By: /s/ Laura L. Fournier --------------- ---------------------- Laura L. Fournier Senior Vice President Chief Financial Officer 22 EXHIBIT INDEX 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 June 30, 2002 99.2 Certification by the Chief Financial Officer of this form 10-Q of Compuware Corporation for the quarter ended June 30, 2002 99.3 Certification by the Chief Executive Officer of form 10-K for the year ended March 31, 2002 and Subsequent filings of Compuware Corporation 99.4 Certification by the Chief Financial Officer of form 10-K for the year ended March 31, 2002 and Subsequent filings of Compuware Corporation