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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2004
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 (I.R.S. 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
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR
VALUE $.01 PER SHARE
PREFERRED STOCK
PURCHASE RIGHTS
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act): Yes [X] No [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of September 30, 2003, the last business day of the registrant's
most recently completed second fiscal quarter, was $1,619,244,996, based upon
the closing sales price of the common stock on that date of $5.36 as reported on
the NASDAQ Stock Market. For purposes of this computation, all executive
officers, directors and 10% beneficial owners of the registrant are assumed to
be affiliates. Such determination should not be deemed an admission that such
officers, directors and beneficial owners are, in fact, affiliates of the
registrant.
There were 386,179,270 shares of $.01 par value common stock outstanding as of
June 1, 2004.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Registrant's 2004 Annual
Meeting of Shareholders (the "Proxy Statement") filed pursuant to Regulation 14A
are incorporated by reference in Part III.
1
COMPUWARE CORPORATION AND SUBSIDIARIES
FORM 10-K
TABLE OF CONTENTS
Item
Number Page
- ------ ----
PART I
1. Business 3
Executive Officers of the Registrant 12
2. Properties 13
3. Legal Proceedings 14
4. Submission of Matters to a Vote of Security Holders 14
PART II
5. Market for the Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities 15
6. Selected Consolidated Financial Data 16
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 17
7A. Quantitative and Qualitative Disclosure about Market Risk 30
8. Consolidated Financial Statements and Supplementary Data 32
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 56
9A. Controls and Procedures 56
PART III
10. Directors and Executive Officers of the Registrant 57
11. Executive Compensation 57
12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 57
13. Certain Relationships and Related Transactions 57
14. Principal Accountant Fees and Services 57
PART IV
15. Exhibits, Financial Statement Schedule and Reports on Form 8-K 58
2
PART I
ITEM 1. BUSINESS
We provide software products and professional services designed to increase the
productivity of the information technology, or IT, departments of businesses
worldwide. In the early years of our company, we focused on offering
professional services and mainframe products in the testing and implementation
environment where we gained extensive experience and established long-term
customer relationships. Over the past several years, we have expanded our
presence into products and professional services in the application development
and integration, quality assurance, production readiness and production
availability areas of the application life cycle. We extended our offerings to
include application services by acquiring certain assets of Covisint LLC
(Covisint) effective March 1, 2004. Covisint provides business-to-business
applications and communication services that connect the global automotive
industry. Additionally, we acquired Changepoint Corporation in May 2004.
Changepoint offerings help IT organizations by providing critical insight into
IT spending, operations and management. Initial technology integration plans,
while still under development, suggest outstanding synergy between Compuware's
application development, testing and performance management tools and
Changepoint's IT governance solution. This combined solution will offer Chief
Information Officers unmatched insight and visibility into their people,
projects, resources and applications, helping technology leaders align IT
investments with business priorities.
We were incorporated in Michigan in 1973. Our executive offices are located at
One Campus Martius, Detroit, Michigan 48226-5099, and our telephone number is
(313) 227-7300.
We operate in two business segments in the software and technology services
industries: products and professional services. See Note 13 of Notes to
Consolidated Financial Statements.
The following discussion may contain certain forward-looking statements within
the meaning of the federal securities laws. Numerous important factors,
including those discussed under Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations under the caption Forward-Looking
Statements could cause actual results to differ materially from those indicated
by such forward-looking statements.
Our Internet address is www.compuware.com. We make available, free of charge on
the web site, copies of reports we file with the Securities and Exchange
Commission as soon as reasonably practicable after we electronically file such
reports. The information contained on our web site should not be considered part
of this report.
OUR BUSINESS STRATEGY
Our business strategy is to provide a broad range of software and professional
services offerings to the largest users of information technology in the world.
Our solutions are focused on providing a real return on investment to our
clients by increasing productivity, efficiency, and visibility into their IT
applications throughout the application lifecycle. Our solutions and
professional services are in the IT Governance, application development, quality
assurance, production management and application services environments. Our
strategy is to support the most widely used technologies and platforms
implemented by the largest users of information technology in the world
including mainframe, distributed, Java, .Net, Windows, Unix, Linux, Oracle, and
SAP.
Companies with IT departments invest substantial resources to build and maintain
large, complex, mission-critical applications. As a result, this target market
can benefit most from our products and professional services offerings.
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From our perspective, the application life cycle includes four primary phases:
1) the application development phase in which software source code is created,
integrated with existing applications and modified over time; 2) the testing
phase, in which application software is executed, debugged, tested and
maintained in a series of repetitive, ongoing cycles for the life of the
application; 3) the performance testing phase, when an application is tested
under simulated production conditions to ensure it will function well once
implemented; and 4) the production phase in which the performance and
availability of operating systems, databases, servers, applications and networks
is monitored and managed.
PRODUCTS
The following table sets forth, for the periods indicated, a breakdown of
license and maintenance revenue by product line and the percentage of total
revenues for each line (in thousands):
YEAR ENDED MARCH 31, PERCENTAGE OF TOTAL REVENUES
----------------------------------- ----------------------------
PRODUCT REVENUE 2004 2003 2002 2004 2003 2002
--------- --------- --------- ---- ---- ----
File-AID $ 169,063 $ 182,224 $ 230,820 13.4% 13.2% 13.3%
Abend-AID 138,943 155,769 186,827 11.0 11.3 10.7
XPEDITER 113,647 110,880 136,848 9.0 8.1 7.9
QA Center Mainframe 20,004 24,527 30,880 1.6 1.8 1.8
STROBE 85,653 80,080 101,911 6.8 5.8 5.8
--------- --------- --------- ---- ---- ----
Total Mainframe Revenue 527,310 553,480 687,286 41.8 40.2 39.5
--------- --------- --------- ---- ---- ----
UNIFACE and Optimal 45,420 42,283 43,353 3.6 3.1 2.5
DevPartner 27,557 24,290 26,722 2.2 1.8 1.5
QA Center & File-AID/Client Server 39,141 34,691 36,524 3.1 2.5 2.1
Vantage 65,390 53,152 57,497 5.1 3.9 3.3
--------- --------- --------- ---- ---- ----
Total Distributed Product Revenue 177,508 154,416 164,096 14.0 11.3 9.4
--------- --------- --------- ---- ---- ----
Total Product Revenue $ 704,818 $ 707,896 $ 851,382 55.8% 51.5% 48.9%
========= ========= ========= ==== ==== ====
COMPUWARE SOFTWARE PRODUCTS AND THE APPLICATION LIFE CYCLE
Our software products enhance every step in the application life cycle, from
application development and quality assurance to production readiness and
availability, for mainframe and distributed platforms.
APPLICATION DEVELOPMENT AND INTEGRATION--Customers use our Abend-AID,
DevPartner, File-AID, Optimal, QACenter, STROBE, UNIFACE, Vantage and XPEDITER
products to achieve productivity gains.
QUALITY ASSURANCE--The Abend-AID, DevPartner, File-AID, QACenter, STROBE and
XPEDITER tools are used to automate the multiple, complex steps of thorough
application testing.
PRODUCTION READINESS--The Abend-AID, DevPartner, File-AID, QACenter, STROBE and
Vantage product lines are used to ready applications for production.
PRODUCTION AVAILABILITY--The Abend-AID, File-AID, QACenter, STROBE, Vantage and
XPEDITER product lines are used to find and fix application, server and/or
network performance problems before they affect end users.
IT GOVERNANCE--IT Governance by Changepoint allows IT organizations to evaluate
all of these projects providing Chief Information Officers with critical insight
into IT spending, operations and management.
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MAINFRAME MARKET
We believe that the market for mainframe products is well defined, and that our
mainframe products will continue to be in demand as the drive to extend legacy
applications into distributed environments continues to emphasize the need for
reliable, high-volume servers.
We intend to remain focused on developing, marketing and supporting high quality
software tools both to support traditional uses of the mainframe and to enhance
the efforts of IT staff who are working to web-enable their legacy applications
portfolio. We believe that our longstanding customer relationships and brand
equity in this arena will help us continue to improve the benefits our customers
receive from our mainframe products. In addition, we continue to pursue product
integration opportunities to increase the value that our customers obtain from
the use of our products, to enhance the synergy among the functional groups
working on key application projects and to make the entire process more
streamlined, automated and repeatable.
MAINFRAME SOFTWARE PRODUCTS
Our mainframe products focus on improving the productivity of developers and
analysts in analysis, unit testing, functional testing, performance testing,
defect removal, fault management, file and data management and application
performance management in the OS/390 and z/OS series environments.
Our mainframe products are functionally rich, are focused on user needs and
require minimal user training. We strive to ensure a common look and feel across
our products and emphasize ease of use in all aspects of product design and
functionality. Most products can be used immediately without modification of
customer development practices and standards and can be quickly integrated into
day-to-day testing, debugging and maintenance activities.
Our mainframe products are grouped into the following five product lines:
FILE-AID PRODUCTS
File-AID products provide a consistent, familiar and secure method for IT
professionals to access, analyze, edit, compare, move and transform data across
all strategic environments. File-AID is used to quickly resolve production data
problems and manage ongoing changes to data and databases at any stage of the
application life cycle.
ABEND-AID PRODUCTS
Abend-AID products assist IT professionals to quickly diagnose and resolve
application and system failures. The products automatically collect program and
environmental information, analyze the information and present diagnostic and
supporting data in a way that can be easily understood by all levels of IT
staff.
XPEDITER PRODUCTS
XPEDITER interactive debugging products help developers integrate enterprise
applications, build new applications and web-enable legacy ones, satisfying
corporate scalability, reliability and security requirements. XPEDITER tools
deliver powerful analysis and testing capabilities across multiple environments,
helping developers test more accurately and reliably, in less time.
QACENTER MAINFRAME PRODUCTS
QACenter Mainframe products deliver complete testing functionality for
automating test creation and execution, test results analysis and documentation.
The products simulate the on-line systems environment, allowing programmers to
test these applications under production conditions without requiring actual
users at terminals. Its powerful functions and features enhance unit,
concurrency, integration, migration, capacity and stress testing.
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STROBE PRODUCTS
Our STROBE MVS Application Performance Management and iSTROBE Application
Performance Analysis System products work together to help clients locate and
eliminate sources of excessive resource demands during every phase of an
application's life cycle. Features in both products support an extensive array
of subsystems, databases and languages.
DISTRIBUTED SYSTEMS MARKET
In contrast to the mainframe market, the distributed systems market is
characterized by multiple hardware, software and network configurations.
Combined with the more recent push to web-enable applications, IT organizations
find themselves under increasing pressure to rapidly create reliable,
top-performing applications, despite an exponential increase in environment
complexity. We believe our distributed and web products address these challenges
and that we are well positioned to market distributed development, integration,
functional and performance testing and application management software to our
target markets.
DISTRIBUTED SOFTWARE PRODUCTS
Our distributed products focus on improving the productivity of the entire
development team, including architects, developers, testers and operating
analysts. These products support requirements management, application
development, unit and functional testing and application performance analysis.
Our distributed products also help the development team in application profiling
and rapid new application rollout, as well as in managing server and network
application availability on multiple platforms including Microsoft Windows and
Microsoft .NET, J2EE, AIX, Solaris and DC2000.
Our distributed systems software products are grouped into five product lines:
UNIFACE and Optimal, DevPartner, QACenter and File-AID/CS, Vantage and IT
Governance by Changepoint.
UNIFACE AND OPTIMAL PRODUCTS
UNIFACE, our distributed systems application development product, is designed to
assist software developers in the creation, integration, deployment and
maintenance of complex distributed applications. UNIFACE enables software
developers to create applications that are not tied to any specific hardware
platform, operating system, database management system or graphical user
interface. Application objects are captured in a central repository, which
permits their reuse in the development of technology-independent applications
and allows for easier management and maintenance of applications. In addition,
UNIFACE insulates application development and deployment from the individual
technical components that comprise a computing environment. This reduces
development and maintenance costs and allows applications to be developed
rapidly using existing, proven legacy code.
OptimalJ is our Java development product. OptimalJ accelerates application
delivery by simplifying Java development, allowing developers of varying
experience levels to rapidly produce reliable J2EE business applications.
OptimalJ generates complete, working applications directly from a visual model,
using sophisticated patterns to implement accepted best practices for coding to
J2EE specifications.
UnifaceView is our business integration portal product. As a packaged, web-based
portal application, UnifaceView enables customers to quickly implement an
integrating platform to help bring together the diverse array of custom-built
and packaged applications and web services that many companies have assembled
over a period of time. UnifaceView brings these applications together in a
single desktop portal with powerful integration and administrative functions,
making it possible for a customer's IT department to effectively manage the
"home-base" desktop of every employee in its organization.
UnifaceFlow is our business process automation and business process modeling
product that automates the execution of business tasks running within and across
an organization. UnifaceFlow helps solution architects model and automate
business processes and tasks by aligning and
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connecting the process to the application environment for improved workflow
execution. This creates a more efficient and effective organization that
benefits from faster process-cycle times, improved time-to-market, greater cost
effectiveness and better customer service through improved response times.
DEVPARTNER PRODUCTS
DevPartner Studio helps developers build reliable, high-performance applications
and components for Microsoft .NET and for native Windows by quickly solving
problems with .NET migration, legacy integration, locating errors in application
code and memory, tuning runtime performance across distributed applications, and
assuring thorough testing.
DevPartner Studio Enterprise Edition combines powerful error detection,
performance, memory, coverage and requirements management with comprehensive
project tracking, defect management, task management and workflow automation.
DevPartner Studio Enterprise Edition supports development of high-performing
applications and components for Microsoft .NET and for native Windows.
DevPartner Java Edition pinpoints runtime errors, memory problems and
performance bottlenecks and identifies code coverage/stability across all tiers
of a Java application environment. Using DevPartner Java Edition, developers and
testers can quickly prioritize and focus on solving the complexity, quality and
performance problems associated with Java development.
DriverStudio products help developers create code that enables operating systems
to communicate with peripheral devices such as printers, scanners and the
Internet. The DriverStudio product line includes DriverStudio and SoftICE Driver
Suite.
QACENTER DISTRIBUTED PRODUCTS
QACenter delivers a unique offering of automated testing products and solutions
designed to validate applications running in the full spectrum of environments,
isolate and correct problems and ensure that systems can handle anticipated load
before applications go live. QACenter products include:
QARun and TestPartner--Functional test automation tools that allow organizations
to validate business-critical applications whether distributed, e-commerce
(web/Java) or CRM/ERP.
QADirector--Provides the framework for managing the entire testing process from
design through execution to analysis.
TrackRecord--A defect management solution that serves as a central repository
and communication hub for all development-related activities and test-related
activities and data.
Reconcile--An enterprise-wide requirements management system. Reconcile allows
project teams to create, change, track, evaluate and report project
requirements.
QALoad--An automated load testing solution for distributed, ERP and e-commerce
applications.
Compuware Application Reliability Solution (CARS)--Combines Compuware software
products and professional services into a defined process used to instill
discipline, automate processes and ensure consistency and repeatability
throughout the testing life cycle. Results are reported to IT management through
the application quality workbench.
FILE-AID/CLIENT SERVER
File-AID/Client Server is a comprehensive test data management tool designed to
help developers, QA teams and DBAs work efficiently with data as they develop,
test and support distributed applications. With File-AID/CS application
developers can extract, load, copy, convert, transform, compare and edit all
their data without having to be an expert in each database environment. All data
related tasks are performed through an easy to use interface eliminating the
need to write programs or scripts, code SQL or use multiple utilities.
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VANTAGE PRODUCTS
Vantage products allow IT professionals to manage, analyze and improve the
performance of distributed applications in a variety of environments. The
Vantage suite also helps IT organizations plan for and manage new distributed
application rollout. Vantage products include:
ClientVantage--Monitors the performance and availability of critical business
applications at the point of delivery--the client user interface.
NetworkVantage--Shows how users and applications consume critical shared network
resources; provides the information necessary to troubleshoot problems related
to unplanned use, unauthorized use, or poor configuration of the network;
supports WAN bandwidth sizing decisions; and provides historical trending data
for use in network growth management.
ServerVantage--Provides monitoring, alerting, troubleshooting and automated
response throughout the server infrastructure.
VantageView--Performance dashboard that provides an overall enterprise view of
application performance and availability across the customers infrastructure as
well as access to the underlying performance metrics.
Application Vantage--Pinpoints the source of poor transaction performance.
Provides real-time application performance troubleshooting, analyzing the
interaction between the application, the network and the supporting server
infrastructure. Application Vantage is also integrated with the ClientVantage
product for 24-hour a day, seven days a week exception-based performance
analysis.
Application Expert--Helps ensure successful deployment of new applications.
Analyzes transactions before applications are deployed and predicts how they
will perform under production conditions--helping to diagnose where potential
problems will occur. The WAN provisioning module determines the aggregate
network loading from a defined population of users and application workloads to
permit the "rightsizing" of expensive WAN links.
Predictor--Predicts enterprise network behavior based on various scenarios such
as changes in application mix, transaction volume, device outages and deployment
of additional bandwidth.
IT GOVERNANCE
IT Governance by Changepoint--Helps IT organizations by providing critical
insight into IT spending, operations and management. Combined with our other
products, we offer Chief Information Officers insight and visibility into their
people, projects, resources and applications, helping technology leaders align
IT investments with business priorities.
PRODUCT MAINTENANCE AND CUSTOMER SUPPORT
We believe that effective support of our customers and products during both the
trial period and for the license term is a substantial factor in product
acceptance and subsequent new product sales. We believe our installed base is a
significant asset and intend to continue to provide high levels of customer
support and product upgrades to assure a continuing high level of customer
satisfaction. In fiscal year 2004, we continued to experience a high customer
maintenance renewal rate.
All customers who subscribe to our maintenance and support services are entitled
to receive technical support and advice, including problem resolution services
and support in product installation, error corrections and any product
enhancements released by us during the maintenance period. Maintenance and
support services are provided online, through our FrontLine technical support
web site, by telephone access to technical personnel located in our development
labs and by support personnel in the offices of our foreign subsidiaries and
distributors.
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Licensees have the option of renewing their maintenance agreements each year for
an annual fee based on the license or list price of the product. They also have
the option of committing to maintenance for longer terms, generally up to five
years, on a contractual basis. For fiscal years 2004, 2003 and 2002, maintenance
fees represented approximately 32.3%, 30.0%, and 24.9%, respectively, of our
total revenues.
TECHNOLOGY DEVELOPMENT AND SUPPORT
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.
We have been successful in developing acquired products and technologies into
marketable software for our distribution channels. We believe that our future
growth lies in part in continuing to identify promising technologies from all
potential sources, including independent software developers, customers, small
startup companies and internal research and development.
Product development is performed primarily at our headquarters in Detroit,
Michigan; and at our development labs in Amsterdam, The Netherlands; Toronto,
Canada; Cambridge, Massachusetts; La Jolla, California; and Nashua, New
Hampshire.
Total technology development and support costs were $175.0 million, $154.7
million and $177.6 million during fiscal 2004, 2003 and 2002, respectively, of
which $11.3 million, $11.4 million and $13.3 million, respectively, were
capitalized.
Our software products are distributed as object code on standard magnetic
cartridges, diskettes and CDs, together with printed documentation. We also
distribute product electronically. We purchase cartridges, diskettes, CDs and
documentation printing from outside vendors. The product duplication, packaging
and distribution to our customers is performed at our production center in West
Bloomfield, Michigan.
PROFESSIONAL SERVICES
We offer a broad range of IT services for distributed systems and mainframe
environments. Our offerings include IT technical staffing and project
assistance, e-business and wireless development, NearShore development services
and ERP implementation. We also provide application life cycle management
assistance for outsourcing customers' application development and maintenance
activities as well as services for Compuware-owned products that enhance their
value.
We believe that the demand for professional services will continue to be driven
by the need to control costs, the significant level of resources necessary to
support complex and rapidly changing hardware, software and communication
technologies and the need for a larger technical staff for ongoing maintenance.
Our business approach to professional services delivery emphasizes hiring
experienced staff, extensive ongoing training, high staff utilization and
immediate, productive deployment of new personnel at client accounts.
Our objective in the professional services division is to create long term
relationships with customers in which our professional staff joins with the
customer's IT organization to plan, design, program, implement and maintain
technology-based solutions that achieve customer business goals. Typically, the
professional services staff is integrated with the customer's development team
on a specific application or project. Professional services staff work primarily
at customer sites or at our professional services offices located throughout
North America and Europe. We also have professional services
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operations in other international locations. In addition, Compuware offers a
NearShore Development Center that serves customers looking for flexible,
cost-effective and high-quality application services delivered remotely from our
facility in Montreal.
APPLICATION SERVICES
Professional services includes our business-to-business applications and
communication services, called the Automotive Industry Operating System (AIOS).
The AIOS provides our customers with a common connection to their suppliers and
customers. We work with manufacturers, suppliers and industry trade groups
worldwide to define and implement effective common processes for the global
automotive industry. Once connected through our system, customers are able to
reduce costs, increase efficiency, enhance quality and improve time to market
using Covisint Communicate Portal Solutions and Covisint Connect data messaging.
Covisint Communicate
Communicate Portal Solutions enables industry participants to access Original
Equipment Manufacturers (OEM) applications, supplier applications and our
applications via one common infrastructure, built on specifications developed
with input from suppliers and OEM customers. This Communicate Portal serves as
the framework for OEM-to-Supplier and Supplier-to-Supplier communications.
Individual users gain the synergistic advantage of coming to the Communicate
Portal using one user I.D. and password to access an entire industry in a single
consistent user interface.
Covisint Connect
Connect is a data messaging service that provides a single connection for a
company's computers to exchange data with the computers of its partners that can
handle both EDI and XML technologies in one environment. The single connection
will permit transfer of data to customers and suppliers in the format that makes
the most sense for their company. This approach reduces the complexity of
managing multiple formats that have been dictated by customers and the multitude
of protocols and connection points that are required to conduct business. The
service integrates industry standard eBusiness applications and is built from
state-of-the-art technology designed for today's eBusiness. Connect gives our
customer the flexibility to rapidly deploy new business processes to solve
industry specific problems and can be used to exchange data between a company's
current enterprise applications and its suppliers' applications.
CUSTOMERS
Our products and professional services are used by the IT departments of a wide
variety of commercial and government organizations. Our application services are
used by global automotive industry OEMs and suppliers.
Ford Motor Company accounted for approximately 12% of total revenue during
fiscal 2003. This revenue was primarily associated with the professional
services segment of the business. No single customer accounted for greater than
10% of total revenue during fiscal 2004 and 2002 or greater than 10% of accounts
receivable at March 31, 2004 and 2003.
SALES AND MARKETING
We market software products primarily through a direct sales force in the United
States, Canada, Europe, Japan, Asia-Pacific, Brazil, Mexico and South Africa as
well as through independent distributors giving us a presence in 60 countries.
We market our professional services primarily through account managers located
in offices throughout North America, Europe, Asia-Pacific and Brazil. Senior
professional services executives support branch marketing efforts by identifying
new business opportunities and making joint sales calls. This marketing
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structure enables us to keep abreast of, and respond quickly to, the changing
needs of our clients and to call on the actual users of our professional
services on a regular basis.
COMPETITION
The markets for our software products are highly competitive and characterized
by continual change and improvement in technology. We consider more than 40
firms to be directly competitive with one or more of our products. These
competitors include BMC Software, Inc., Borland, Computer Associates
International, Inc., International Business Machines Corporation (IBM), Mercury
Interactive Corporation and Niku Corporation. Some of these competitors have
substantially greater financial, marketing, recruiting and training resources
than we do. The principal competitive factors affecting the market for our
software products include: responsiveness to customer needs, functionality,
performance, reliability, ease of use, quality of customer support, vendor
reputation and price.
The market for professional services is highly competitive, fragmented and
characterized by low barriers to entry. Our principal competitors in
professional services include 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. The principal competitive factors affecting the
market for our professional services include responsiveness to customer needs,
breadth and depth of technical skills offered, availability and productivity of
personnel and the ability to demonstrate achievement of results and price.
We believe, based on our current market position, that we have competed
effectively in the software products and professional services marketplaces.
Nevertheless, a variety of external and internal events and circumstances could
adversely affect our competitive capacity. Our ability to remain competitive
will depend, to a great extent, upon our performance in product development and
customer support. To be successful in the future, we must respond promptly and
effectively to the challenges of technological change and our competitors'
innovations by continually enhancing our own product and services offerings.
PROPRIETARY RIGHTS
We regard our products as proprietary trade secrets and confidential
information. We rely largely upon a combination of trade secret, copyright and
trademark laws together with our license agreements with customers and our
internal security systems, confidentiality procedures and employee agreements to
maintain the trade secrecy of our products. We typically provide our products to
users under nonexclusive, nontransferable, perpetual licenses. Under the general
terms and conditions of our standard product license agreement, the licensed
software may be used solely for the licensee's own internal operations. Under
certain limited circumstances, we may be required to make source code for our
products available to our customers under an escrow agreement, which restricts
access to and use of the source code. Although we take steps to protect our
trade secrets, there can be no assurance that misappropriation will not occur.
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.
In addition to trade secret protection, we seek to protect our software,
documentation and other written materials under copyright law, which affords
only limited protection. We also assert trademark rights in our product names.
We have been granted 26 patents and have numerous patent applications pending
for certain product technology and have plans to seek additional patents in the
future. However, because the industry is characterized by rapid technological
change, we believe that factors such as the technological and creative skills of
our personnel, new product developments, frequent product enhancements, name
recognition and reliable product maintenance are more important to establishing
and maintaining a technology leadership position than the various legal
protections of our technology.
11
There can be no assurance that third parties will not assert infringement claims
against us in the future with respect to current and future products or that any
such assertion may not require us to enter into royalty arrangements which could
require a partial payment to the third party upon sale of the product, or result
in costly litigation. See Item 3, Legal Proceedings, for a description of
certain pending litigation regarding proprietary rights.
EMPLOYEES
As of March 31, 2004, we employed 8,660 people worldwide, with 1,864 in products
sales, sales support and marketing; 1,563 in technology development and support;
4,452 in professional services and 781 in other general and administrative
functions. Only a small number of our international employees are represented by
labor unions. We have experienced no work stoppages and believe that our
relations with our employees are good. Our success will depend in part on our
continued ability to attract and retain highly qualified personnel in a
competitive market for experienced and talented software developers,
professional services staff and sales and marketing personnel.
EXECUTIVE OFFICERS OF THE REGISTRANT
Our current executive officers, who serve at the discretion of our Board of
Directors, are listed below:
Name Age Position
---- --- --------
Peter Karmanos, Jr. 61 Chairman of the Board and Chief Executive Officer
Tommi A. White 53 Chief Operating Officer
Henry A. Jallos 55 Executive Vice President, Global Account Management
Laura L. Fournier 51 Senior Vice President, Chief Financial Officer
(Chief Accounting Officer) and Treasurer
Thomas M. Costello, Jr. 50 Senior Vice President, Human Resources, General
Counsel and Secretary
Gerald W. Smith 39 Executive Vice President, IT Governance
Robert C. Paul 41 Chief Executive Officer and President of the Covisint
Division
Peter Karmanos, Jr., is a founder of the Company and has served as Chairman of
the Board since November 1978, as Chief Executive Officer since July 1987 and as
President from January 1992 through October 1994.
Tommi A. White has served as Chief Operating Officer since October 2001. Ms.
White joined Compuware in August 2001 as Executive Vice President. Before
joining Compuware, Ms. White was Executive Vice President, Chief Administration
and Technology Officer at Kelly Services, Inc. Ms. White was at Kelly Services,
Inc. for nearly nine years.
Henry A. Jallos has served as Executive Vice President, Global Account
Management since October 2001 and as Executive Vice President, Products Division
from September 1998 through October 2001. From August 1994 through August 1998,
Mr. Jallos served as Senior Vice President, Worldwide Sales.
12
Laura L. Fournier has served as Senior Vice President, Chief Financial Officer
and Treasurer since April 1998. Ms. Fournier was Corporate Controller from June
1995 through March 1998. From February 1990 through May 1995, Ms. Fournier was
Director of Internal Audit.
Thomas M. Costello, Jr., has served as General Counsel since January 1985, Vice
President from January 1995 to May 2003 and Secretary since May 1995. Mr.
Costello was appointed Senior Vice President of Human Resources in September
2003. Mr. Costello joined Compuware in June 1984 as Assistant General Counsel.
Gerald W. Smith was named Executive Vice President, IT Governance in May 2004.
Mr. Smith joined Compuware as part of the Changepoint acquisition in May 2004.
Mr. Smith co-founded Changepoint and served as its President and Chief Executive
Officer since 1994.
Robert C. Paul has served as Chief Executive Officer and President of Covisint
which was acquired in March 2004. Mr. Paul had spent nearly three years at
Covisint. Before joining Covisint, Mr. Paul spent one year as President of
SYNAPZ, a division of Future Three Corporation, and nearly two years as
President and Chief Operating Officer at Coherent Networks International.
SEGMENT INFORMATION; PAYMENT TERMS AND FOREIGN REVENUES
For a description of revenues and operating profit by segment for each of the
last three fiscal years, see Note 13 of Notes to Consolidated Financial
Statements, included in Item 8 of this report. For a description of extended
payment terms offered to some customers, see Item 7 Management's Discussion and
Analysis of Financial Condition and Results of Operations - Results of
Operations -Software Products - Revenue. The Company's foreign operations are
subject to risks related to foreign exchange rates. For a discussion of this
risk, see Item 7A Quantitative and Qualitative Disclosure about Market Risk. For
financial information regarding geographic operations, see Note 13 of Notes to
Consolidated Financial Statements, included in Item 8 of this report.
ITEM 2. PROPERTIES
In fiscal 2004, we completed the construction of our new corporate headquarters
office building (Detroit facility) in Detroit, Michigan, which consolidated our
corporate office functions and Detroit-area operations. We own the Detroit
facility which is approximately 1.1 million square feet, including approximately
60,000 square feet to be leased to third parties for retail and related
amenities. We also own a Farmington Hills, Michigan facility, which is
approximately 225,000 square feet and a building in nearby West Bloomfield,
which is approximately 40,000 square feet. In addition, we lease approximately
217,000 square feet of land on which the Detroit facility resides and
approximately 33,000 square feet in a Farmington Hills office park. The Detroit
facility houses our executive offices, primary research and development lab,
principal marketing department, a professional services office, customer service
and support teams. The West Bloomfield facility houses our production and
distribution facilities.
In July 2003 we entered into an option and purchase agreement for our Farmington
Hills, Michigan facility. The option agreement allows the holder to commit to
purchase the building for one year after the execution of the agreement. The
option selling price of the building approximates the current net book value of
$20 million for the building. If exercised, the holder would pay $5 million upon
exercise and the remaining balance in five years with interest being paid
monthly at 7% of the unpaid balance.
We lease approximately 100 professional services and sales offices in 28
countries, including five remote product research and development facilities.
13
ITEM 3. LEGAL PROCEEDINGS
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, among other things, infringement of our copyrights and
misappropriation of our trade secrets with respect to our mainframe software
tools, intentional interference with contractual relations with our employees
and former employees, antitrust law violations, tortious interference with our
economic expectancy and various state law violations. We claim that (i) IBM has
copied and misappropriated portions of our mainframe software tools and has
wrongfully used our technology to develop competing products; (ii) IBM made
false representations regarding our software products in violation of the Lanham
Act; and (iii) IBM is using its monopoly power to engage in unlawful tying
arrangements and is subverting competition on the merits by denying critical
information to us and others in an effort to undermine our development efforts.
The suit seeks injunctive relief and unspecified monetary damages, among other
things, from IBM. In December 2003, the Court denied Compuware's 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. Compuware's
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 liquidity,
financial position and results of operations are not determinable at the present
time. In addition, IBM has filed a counterclaim against Compuware alleging
violation of six IBM patents. The Compuware products accused of infringement are
File-AID CS, Abend-AID, and Xpediter. The Court bifurcated the patent
counterclaims from the other claims and fact discovery is proceeding. No trial
date has been set for the counterclaims. We believe we have valid defenses to
the counterclaims, and we will vigorously defend against those claims.
On January 15, 2004, IBM filed patent infringement claims against Compuware in
the United States District Court for the Southern District of New York alleging
additional infringements 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. Fact discovery is
proceeding. No trial date has been set for these claims. We believe we have
valid defenses to the claims, and intend to vigorously defend against the
lawsuit. The impact of this action on our liquidity, financial position and
results of operations are not determinable at the present time.
On January 21, 2003, the Company filed suit against Moody's Investors Services,
Inc. ("Moody's") in the United States District Court in the Eastern District of
Michigan alleging breach of contract, defamation, silent fraud, and violation of
the Investment Advisors Act. The Company claims, among other things, that
Moody's failed to deal fairly and did not operate in good faith when it lowered
the Company's credit rating two full levels on August 13, 2002. The suit seeks
$245,000 in compensatory damages (the total fees paid to Moody's during the
course of the business relationship), punitive damages, the costs related to the
litigation and reasonable attorney fees. The Court has dismissed two of
Compuware's four claims. Discovery on this matter is proceeding.
The Company is a party to a consolidated class action proceeding filed in the
United States District Court for the Eastern District of Michigan. The original
lawsuits were filed on September 20, 2002 and October 10, 2002 respectively. On
May 1, 2003, the cases were consolidated. The matter is now titled In re
Compuware Securities Litigation. The suit was brought on behalf of purchasers of
the Company's common stock from January 1, 1999 to April 3, 2002. The defendants
are the Company and Peter Karmanos, Jr. The plaintiffs allege that the Company
failed to disclose under the securities laws its problems with the
misappropriation of its software source code by IBM. The plaintiffs further
allege that the Company omitted and/or disseminated materially false and
misleading statements concerning its deteriorating relationship with IBM. The
plaintiffs request that the court award them monetary damages and expenses of
litigation, including reasonable attorneys fees. The Company strongly disagrees
with the allegations and intends to vigorously defend against the lawsuit. The
case is in a preliminary procedural stage at this time.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the fourth
quarter of the fiscal year covered by this report.
14
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded on the NASDAQ Stock Market's National Market under
the symbol CPWR. As of June 1, 2004, there were approximately 6,710 shareholders
of record of our common stock. We have not paid any cash dividends on our common
stock since fiscal 1986. Our revolving credit agreement contains a minimum
tangible net worth covenant that could limit our ability to pay dividends. The
following table sets forth the range of high and low trading sale prices for our
common stock for the periods indicated, all as reported by NASDAQ.
FISCAL YEAR ENDED MARCH 31, 2004 HIGH LOW
Fourth quarter $ 8.65 $ 5.90
Third quarter 6.25 5.08
Second quarter 6.49 4.74
First quarter 6.52 3.30
FISCAL YEAR ENDED MARCH 31, 2003 HIGH LOW
Fourth quarter $ 5.06 $ 3.22
Third quarter 5.78 2.75
Second quarter 5.73 2.35
First quarter 12.49 5.50
The Company has several stock option plans pursuant to which it grants
performance-based stock options to employees, officers, and directors, as well
as an Employee Stock Ownership Plan (ESOP), an Employee Stock Purchase Plan, and
a Replacement Stock Option Award Program. For more information about our equity
compensation plans, see Note 15 of Notes to Consolidated Financial Statements,
included in Item 8 of this report.
The following table sets forth certain information, with respect to our equity
compensation plans at March 31, 2004 (shares in thousands):
Number of securities
Number of securities remaining available
to be issued Weighted-average for future issuance
upon exercise of exercise price of under equity
outstanding options outstanding options compensation plans
-------------------- ------------------- --------------------
Equity compensation plans
approved by security holders 38,155 $ 13.51 7,286
Equity compensation plans not
approved by security holders 25,471 $ 8.78 23,989
15
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected statement of operations and balance sheet data presented below are
derived from our audited consolidated financial statements and should be read in
conjunction with our audited consolidated financial statements and notes thereto
and Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations included in this report.
YEAR ENDED MARCH 31,
-----------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
(In thousands, except earnings per share data)
STATEMENT OF OPERATIONS DATA:
Revenues:
Software license fees $ 296,627 $ 295,720 $ 417,631 $ 495,572 $ 819,247
Maintenance fees 408,191 412,176 433,751 456,534 432,707
Professional services fees 559,829 667,444 889,162 1,083,050 996,120
----------- ----------- ----------- ----------- -----------
Total revenues 1,264,647 1,375,340 1,740,544 2,035,156 2,248,074
----------- ----------- ----------- ----------- -----------
Operating expenses:
Cost of software license fees 31,579 30,740 34,102 37,885 28,835
Cost of professional services 513,621 611,644 840,149 973,854 877,453
Technology development and support 163,655 143,289 164,280 187,155 154,086
Sales and marketing 310,643 264,012 294,496 351,214 377,920
Administrative and general 209,797 191,131 207,166 250,324 214,961
Goodwill amortization and impairment (1 and 2) 426,344 42,092 25,586
Restructuring costs (2) 46,930
Purchased research and development 17,900
----------- ----------- ----------- ----------- -----------
Total operating expenses 1,229,295 1,240,816 2,013,467 1,842,524 1,696,741
----------- ----------- ----------- ----------- -----------
Income (loss) from operations 35,352 134,524 (272,923) 192,632 551,333
Other income (expense) 20,665 21,691 22,076 (563) 10,443
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes 56,017 156,215 (250,847) 192,069 561,776
Income tax provision (benefit) 6,185 53,113 (5,592) 72,986 209,800
----------- ----------- ----------- ----------- -----------
Net income (loss) $ 49,832 $ 103,102 $ (245,255) $ 119,083 $ 351,976
=========== =========== =========== =========== ===========
Basic earnings (loss) per share (3) $ 0.13 $ 0.27 $ (0.66) $ 0.33 $ 0.98
Diluted earnings (loss) per share (3) 0.13 0.27 (0.66) 0.32 0.91
Shares used in computing net income (loss) per
share:
Basic earnings computation 382,630 377,028 371,786 365,192 358,560
Diluted earnings computation 384,608 378,440 371,786 372,809 384,691
BALANCE SHEET DATA (AT PERIOD END):
Working capital $ 649,945 $ 581,266 $ 506,692 $ 434,902 $ 391,801
Total assets 2,234,081 2,122,685 1,993,938 2,279,374 2,415,907
Long term debt - - - 140,000 450,000
Total shareholders' equity (4) 1,413,591 1,331,691 1,189,851 1,377,372 1,203,872
(1) Effective April 1, 2002, in accordance with SFAS No. 142, the goodwill
balance is no longer being amortized on a monthly basis. Instead it is
tested at least annually for impairment. In fiscal 2002, 2001 and 2000,
net income (loss) and earnings (loss) per share (diluted computation),
exclusive of amortization of goodwill, would have been ($212.4 million)
and (57 cents), $153.9 million and 41 cents and $375.9 million and 98
cents, respectively.
(2) Amortization and impairment of goodwill during 2002 included impairment
charges of $342.9 million associated with restructuring, $35.2 million
associated with a change in technology related to distributed products and
$9.3 million associated with the transfer of the engineering business to
an unrelated third party discussed in the Professional Services Revenue
section in Item 7 of this report. Restructuring costs in 2002 represent
costs incurred with the reorganization of the operating divisions during
the fourth quarter. See Note 7 of Notes to Consolidated Financial
Statements for more details on these charges.
(3) See Notes 1 and 11 of Notes to Consolidated Financial Statements for the
basis of computing earnings per share.
(4) No dividends were paid during the periods presented.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This discussion contains certain forward-looking statements within the meaning
of the federal securities laws which are identified by the use of the words
"believes," "expects," "anticipates," "will," "contemplates," "would" and
similar expressions that contemplate future events. Numerous important factors,
risks and uncertainties affect our operating results, including, without
limitation, those discussed below, and contained elsewhere in this report, 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 in 2004 filed a separate
complaint against us alleging violation of seven different 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 lawsuit against IBM and IBM's lawsuit against us 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.
- - 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.
17
- - 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, Mercury Interactive Corporation and Niku 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 that 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.
- - Changes in world economies 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.
18
OVERVIEW
In this section, we discuss our results of operations on a segment basis for
each of our financial reporting segments. 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.
We provide software products and professional services designed to increase the
productivity of the IT departments of businesses worldwide. In the early years
of our company, we focused on offering professional services and mainframe
products in the testing and implementation environment where we gained extensive
experience and established long-term customer relationships. Over the past
several years, we have expanded our presence into products and professional
services in the application development and integration, quality assurance,
production readiness and production availability areas of the application life
cycle.
We focus on growing revenue and profit margins by enhancing and promoting our
current product lines, expanding our product and service offerings through key
acquisitions, developing strategic partnerships in order to provide clients with
our product solutions and managing our costs. We achieved the following since
the beginning of fiscal 2004:
- Acquired certain assets of Covisint effective March 1, 2004.
Covisint provides business-to-business applications and
communication services that connect the global automotive industry.
Revenue associated with the acquired business was approximately $11
million during Covisint's calendar year 2003. We do not expect
Covisint to have a material effect on earnings in fiscal 2005.
- Acquired Changepoint Corporation in May 2004. Changepoint offerings
provide Chief Information Officers with insight and visibility into
their people, projects, resources and applications, helping
technology leaders align IT investments with business priorities.
Revenue associated with the acquired business was approximately $20
million for the twelve months ending April 2004. We do not expect
Changepoint to have a material effect on earnings in fiscal 2005.
- Released 38 mainframe and 55 distributed products, during fiscal
2004, designed to increase the productivity of the IT departments of
our customers.
- Achieved increases in distributed product revenue which is a
reflection of our increased focus in fiscal 2004 on promoting our
distributed products.
- Began realigning our professional service segment to higher margin
offerings. This was evident in fiscal 2004 as we decreased our
revenue derived from low margin subcontract projects. We will
continue this trend in fiscal 2005 where we anticipate a first
quarter reduction in subcontract revenue and cost of approximately
$3.1 million and $3.0 million, respectively.
- 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 measures were intended to save a total of $10 million to $15
million each quarter, starting in the third quarter of 2004. Savings
in the third and fourth quarters of 2004 were in line with our
overall estimates. Due to the positive financial results reported
during the third and fourth quarters of 2004 and the outlook for
continued revenue and profitability growth, certain of the
cost-cutting measures that were put in place (primarily salary
reductions) were rescinded effective April 1, 2004.
Our ability to achieve our strategies and objectives is subject to a number of
factors some of which we may not be able to control. See "Forward-Looking
Statements".
19
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 Period-to-Period
Total Revenues Change
---------------------------- ------------------
Fiscal Year Ended
March 31, 2003 2002
---------------------------- to to
2004 2003 2002 2004 2003
---- ---- ---- ---- ----
REVENUE:
Software license fees 23.5% 21.5% 24.0% 0.3% (29.2)%
Maintenance fees 32.3 30.0 24.9 (1.0) (5.0)
Professional services fees 44.2 48.5 51.1 (16.1) (24.9)
----- ----- -----
Total revenues 100.0 100.0 100.0 (8.0) (21.0)
----- ----- -----
OPERATING EXPENSES:
Cost of software license fees 2.5 2.2 2.0 2.7 (9.9)
Cost of professional services 40.6 44.5 48.3 (16.0) (27.2)
Technology development and support 12.9 10.4 9.4 14.2 (12.8)
Sales and marketing 24.6 19.2 16.9 17.7 (10.4)
Administrative and general 16.6 13.9 11.9 9.8 (7.7)
Goodwill amortization and impairment 24.5 (100.0)
Restructuring cost 2.7 (100.0)
----- ----- -----
Total operating expenses 97.2 90.2 115.7 (0.9) (38.4)
----- ----- -----
Income (loss) from operations 2.8 9.8 (15.7) (73.7) 149.3
Other income 1.6 1.6 1.3 (4.7) (1.7)
----- ----- -----
Income (loss) before income taxes 4.4 11.4 (14.4) (64.1) 162.3
Income tax provision (benefit) 0.5 3.9 (0.3) (88.4) **
----- ----- -----
Net income (loss) 3.9% 7.5% (14.1)% (51.7)% 142.0%
===== ===== =====
** Not meaningful
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 55.8%, 51.5% and 48.9% of total revenue during 2004,
2003 and 2002, respectively. OS/390 product revenue (mainframe revenue)
decreased $26.2 million or 4.7% during 2004 and decreased $133.8 million or
19.5% during 2003. Revenue from distributed software products increased by $23.1
million, or 15.0% during 2004 and decreased $9.7 million, or 5.9% during 2003.
License revenue increased $0.9 million or 0.3% during 2004 to $296.6 million
from $295.7 million during 2003 and decreased $121.9 million or 29.2% during
2003 from $417.6 million during 2002. License revenue was positively impacted by
fluctuations in foreign currencies during 2004 compared to fiscal 2003.
Excluding the favorable effect of such foreign currency fluctuations, license
revenue would have been approximately $277.8 million during fiscal 2004,
compared to $295.7 million during fiscal 2003, a decrease of 6.1%.
20
Maintenance fees decreased $4.0 million or 1.0% to $408.2 million during 2004
from $412.2 million during 2003 and decreased $21.6 million or 5.0% during 2003
from $433.8 million during 2002. Maintenance fees were positively impacted by
fluctuations in foreign currencies during 2004 compared to fiscal 2003.
Excluding the effect of foreign currency fluctuations, maintenance fees would
have been approximately $387.9 million during 2004, compared to $412.2 million
during 2003, a decrease of 5.9%.
The overall declines in product revenue from 2003 to 2004 and from 2002 to 2003
were primarily attributable to decreases in mainframe license fees and
maintenance fees associated with an overall decrease in technology spending and
a decrease in customer demand for large enterprise license agreements which are
multi-year, and often multi-payment contracts.
We license software to customers using two types of software licenses, perpetual
and term. Generally, perpetual software licenses allow customers a perpetual
right to run our software on hardware up to a licensed aggregate MIPS (Millions
of Instructions Per Second) capacity 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 up to a licensed
aggregate MIPS capacity. Also, our customers purchase maintenance services that
provide technical support and advice, including problem resolution services and
assistance in product installation, error corrections and any product
enhancements released during the maintenance period. Furthermore, based on
customers' 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, 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):
Year Ended March 31,
----------------------------------------
2004 2003 2002
---------- ---------- ----------
United States $ 375,670 $ 409,441 $ 532,772
Europe and Africa 246,579 221,272 223,636
Other international operations 82,569 77,183 94,974
---------- ---------- ----------
Total product revenue $ 704,818 $ 707,896 $ 851,382
========== ========== ==========
21
PRODUCT CONTRIBUTION AND EXPENSES
Financial information for the product segment is as follows (in thousands):
Year Ended March 31,
----------------------------------------
2004 2003 2002
---------- ---------- ----------
Revenue $ 704,818 $ 707,896 $ 851,382
Expenses 505,877 438,041 492,878
---------- ---------- ----------
Product contribution $ 198,941 $ 269,855 $ 358,504
========== ========== ==========
The product segment generated contribution margins of 28.2%, 38.1% and 42.1%
during 2004, 2003 and 2002, respectively. Product expenses include cost of
software license fees, technology development and support costs, and sales and
marketing expenses. These factors are discussed below.
Cost of software license fees includes amortization of capitalized software, the
cost of duplicating and disseminating products to customers and the cost of
author royalties. As a percentage of software license fees, cost of software
license fees were 10.6%, 10.4% and 8.2% in 2004, 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. 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
23.2%, 20.2% and 19.3% in 2004, 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 during 2004 increased $20.3 million or 13.1%, to $175.0
million from $154.7 million in 2003 and decreased $22.9 million or 12.9% during
2003 from $177.6 million in 2002.
The increase in technology costs for 2004 was primarily attributable to higher
compensation, benefit and bonus costs of approximately $23.1 million offset by a
decrease in depreciation expense of approximately $2.6 million. Compensation,
benefit and bonus costs were higher due to scheduled salary increases during
2004 and higher employee headcount in this area which increased by 5.9% to an
average headcount of 1,529 people during 2004. Depreciation expense declined due
to approximately $18 million of computer equipment which became fully
depreciated in the first and second quarters of 2004. A portion of the increase
was offset by cost reduction strategies implemented in October 2003 that
resulted in a reduction of technology development and support costs totaling
$2.0 during the third and fourth quarters of 2004.
The decrease in technology costs for 2003 was primarily attributable to lower
bonus costs of approximately $9.7 million, decreases in computer equipment
depreciation and purchased software amortization totaling approximately $7.8
million and reduced travel and communication costs of approximately $3.2
million.
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. Sales and
marketing costs increased $46.6 million or 17.7%, during 2004 to $310.6 million
from $264.0 million in 2003 and decreased $30.5 million or 10.4% during 2003
from $294.5 million in 2002. As a percentage of product revenue, sales and
marketing costs were 44.1%, 37.3% and 34.6% in 2004, 2003 and 2002,
respectively.
22
The increase in sales and marketing costs for 2004 was primarily attributable to
higher salary and benefit costs of approximately $27.1 million, increased
commission and bonus costs of approximately $12.5 million and higher advertising
costs of approximately $5.8 million. Compensation, benefit, commission and bonus
costs were higher due to salary increases during 2004, higher employee headcount
in this area which increased by 4.6% to an average headcount of 1,852 people
during 2004 and the negative effect of foreign currency fluctuations on these
costs as the U.S. dollar continued to weaken throughout fiscal 2004.
Approximately 50% of total sales and marketing compensation, benefit, commission
and bonus costs were attributable to our non-U.S. sales force. The change in
advertising costs was a result of increases in the promotion of our products in
the distributed software marketplace during fiscal 2004. In late October 2003,
we implemented cost reduction strategies that resulted in a reduction of sales
and marketing costs totaling $1.9 million during the third and fourth quarters
of 2004.
The decrease in sales and marketing costs for 2003 was primarily attributable to
reduced headcount which decreased by 18.8% to an average headcount of 1,770
people during 2003 resulting in lower compensation and benefit costs of
approximately $16.3 million, decreased travel costs of approximately $4.6
million and lower bonus and commission costs of approximately $6.6 million.
PROFESSIONAL SERVICES
REVENUE
We offer a broad range of IT professional services, including business systems
analysis, design and programming, software conversion and system planning and
consulting. Revenue from professional services decreased $107.6 million or 16.1%
during 2004 and decreased $221.7 million or 24.9% during 2003.
The decrease in revenue for 2004 was due, primarily, to a reduction in demand
for professional services as customers continue to postpone large projects,
continued downward pressure on our billing rates due to the highly competitive
nature of the professional services market and an increased effort in fiscal
2004 to reduce our involvement with lower margin subcontract IT projects in
order to focus our resources on higher margin projects for the future.
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 (Caretech), and to a lesser extent, the transfer of our engineering
business to an unrelated third party in December 2001. Professional services
revenue was further negatively impacted by the closing of certain
underperforming branch offices associated with the restructuring discussed
below.
Professional services revenue by geographic location is presented in the table
below (in thousands):
Year Ended March 31,
----------------------------------------
2004 2003 2002
---------- ---------- ----------
United States $ 499,670 $ 599,913 $ 795,284
Europe and Africa 56,749 64,816 90,536
Other international operations 3,410 2,715 3,342
---------- ---------- ----------
Total professional services revenue $ 559,829 $ 667,444 $ 889,162
========== ========== ==========
23
PROFESSIONAL SERVICES CONTRIBUTION AND EXPENSES
Financial information for the professional services segment is as follows (in
thousands):
Year Ended March 31,
----------------------------------------
2004 2003 2002
---- ---- ----
Revenue $ 559,829 $ 667,444 $ 889,162
Expenses 513,621 611,644 840,149
---------- ---------- ----------
Professional services contribution $ 46,208 $ 55,800 $ 49,013
========== ========== ==========
During 2004, the professional services segment generated a contribution margin
of 8.3%, compared to 8.4% and 5.5% during 2003 and 2002, respectively.
Cost of professional services consists primarily of personnel-related costs of
providing services, including billable staff, subcontractors and sales
personnel. Cost of professional services decreased $98.0 million or 16.0% during
2004 and decreased $228.5 million or 27.2% during 2003.
The decrease in cost of professional services for 2004 was primarily
attributable to lower compensation, benefit, bonus and travel costs of
approximately $86.8 million and a decrease in subcontractor costs of
approximately $12.2 million. Compensation, benefit, bonus and travel costs were
lower due to a 12.4% reduction in average employee headcount in this area to
4,956 people during 2004. In late October 2003, we implemented cost reduction
strategies that resulted in a reduction of professional services costs totaling
$14.1 million during the third and fourth quarters of 2004. All professional
services salaries have been reviewed and adjusted effective April 1, 2004.
The decrease in cost of professional services for 2003 was primarily
attributable to reductions in staff associated with the restructuring discussed
below, resulting in lower salaries and benefits, and decreased use of
subcontractors for special services. The professional services billable staff
decreased 25.8% to an average headcount of 5,660 people during 2003.
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 all of our locations. Administrative and
general expenses increased $18.7 million or 9.8%, during 2004 to $209.8 million
from $191.1 million in 2003 and decreased $16.1 million or 7.7% during 2003 from
$207.2 million in 2002.
The increase in administrative and general expenses for 2004 was primarily
attributable to an increase in legal fees of approximately $10.4 million and
higher depreciation expense associated with the new Detroit headquarters
building of approximately $5.6 million. In late October 2003, we implemented
cost reduction strategies that resulted in a reduction to administrative and
general costs totaling $1.7 million during the third and fourth quarters of
2004.
The decrease in administrative and general expenses in 2003 was primarily
attributable to decreased building rent of approximately $19.7 million,
decreased utility costs of approximately $6.0 million and decreased
compensation, benefit and bonus costs of approximately $20.7 million resulting
from the restructuring discussed below offset, in part, by increased legal costs
of approximately $22.1 million.
External legal fees for all litigation, including IBM and other matters were
$45.0 million, $34.6 million and $12.5 million in 2004, 2003 and 2002.
Litigation expense has increased significantly over the past two years due
primarily to the IBM litigation. Because a majority of the costs in connection
with the IBM litigation have been incurred during the preparation of this case
for trial, we do not expect litigation expenses to increase. Barring any unknown
future litigation claims, these expenses should decline moderately.
24
Other income consists primarily of interest earnings on deferred customer
receivables and interest income realized from investments. Other income for 2004
was $20.7 million compared to $21.7 million in 2003 and $22.1 million in 2002.
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
third quarter of 2004, 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
2004 was 28% compared to 34% for 2003. 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 provision was $6.2 million for
2004, net of the $9.5 million income tax benefit in the third quarter. This
compares to an income tax provision of $53.1 million for 2003.
RESTRUCTURING CHARGE
In the fourth quarter of 2002, we adopted a restructuring plan to reorganize our
operating divisions, primarily the professional services segment. These changes
were designed to increase profitability in the future by better aligning cost
structures with current market conditions.
The restructuring plan included a reduction of professional services staff at
certain locations, the closing of entire professional services offices and a
reduction of sales support personnel, lab technicians and related administrative
and financial staff. Approximately 1,600 employees worldwide were terminated as
a result of the reorganization.
The following table summarizes the accrual for the restructuring and charges
against the accrual during 2002, 2003 and 2004 (in thousands):
Employee Facilities costs Legal, consulting Total
termination (primarily lease and outplacement restructuring
benefits abandonments)* costs Other charge
----------- ---------------- ----------------- ---------- -------------
Restructuring charge $ 19,012 $ 26,341 $ 1,299 $ 278 $ 46,930
Incurred during year ended
March 31, 2002 (553) (676) (1,229)
----------- ---------- ---------- ---------- -----------
Accrual at March 31, 2002 18,459 25,665 1,299 278 45,701
Incurred during year ended
March 31, 2003 (16,405) (8,589) (691) (215) (25,900)
Adjustment (1,356) 2,012 (593) (63)
----------- ---------- ---------- ---------- -----------
Accrual at March 31, 2003 $ 698 $ 19,088 $ 15 $ - $ 19,801
Incurred during year ended
March 31, 2004 (591) (5,600) (4) (6,195)
----------- ---------- ---------- ---------- -----------
Accrual at March 31, 2004 $ 107 $ 13,488 $ 11 $ - $ 13,606
=========== ========== ========== ========== ===========
*Lease obligations will end in March of 2009.
During the year ended March 31, 2003, the Company determined the accruals
associated with employee terminations, legal and outplacement were in excess of
actual costs incurred. These excess accruals have been reduced. The accrual for
facilities costs was increased, since the Company had not been as successful in
subleasing abandoned leased space as originally anticipated.
Approximately 70% of the accrual related to facilities costs is included in
"long term accrued expenses" in the consolidated balance sheet at March 31,
2004.
25
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Note 1 of the Consolidated Financial Statements contains a summary of our
significant accounting policies.
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States (U.S. GAAP). 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 facts and circumstances at March 31,
2004. However, future events rarely develop exactly as forecast, and the best
estimates routinely require adjustment. These accounting policies discussed
below 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.
Revenue Recognition - A basic criteria for revenue recognition is that
collectibility is reasonably assured. We evaluate collectibility based on past
customer history, external credit ratings and payment terms within various
customer agreements. Future events or inaccuracies in reported credit data that
result in a change to collectibility expectations could have a negative effect
on our operating results.
Perpetual license fee revenue is recognized using the residual method, under
which the fair value, based on Compuware-specific objective evidence (CSOE), of
all undelivered elements of the agreement (e.g. maintenance and professional
services) is deferred. CSOE is based on rates charged for maintenance and
professional services when sold separately. Changes in rates charged for stand
alone maintenance and professional services could have a significant impact on
how bundled revenue agreements are characterized as license, maintenance or
professional services and therefore, on the timing of revenue recognition in the
future.
Generally, revenues from license and maintenance transactions that include
installment payment terms are recognized in the same manner as those requiring
current payment. This is because we have an established business practice of
offering installment payment terms to customers and have a history of
successfully enforcing original payment terms without making concessions.
However, because a significant portion of our license fee revenue is earned in
connection with installment sales, changes in future economic conditions or
technological developments could adversely affect our ability to immediately
record license fees for these types of transactions and/or limit our ability to
collect these receivables.
Professional Services Fees - Professional services fees are generally based on
hourly or daily rates. However, for services rendered under fixed-price
contracts, revenue is recognized using the percentage of completion method.
Unforeseen events that result in additional time or costs being required to
complete such projects could affect the timing of revenue recognition for the
balance of the project as well as services margins going forward, and could have
a negative effect on our results of operations.
Based on our interpretation of US GAAP including SOP 97-2 and 98-9, Securities
and Exchange Commission SAB 104 and EITF 00-21, we believe our revenue has been
properly reported. New interpretations or pronouncements related to software
revenue recognition policies could result in changes to our method of revenue
recognition in the future.
Allowance for Doubtful Accounts - The collectibility of accounts receivable is
regularly evaluated and we believe our allowance for doubtful accounts is
appropriate for our accounts receivable balances. In evaluating the allowance,
we consider historical loss experience, including the need to adjust for current
conditions, and the aging of outstanding receivables. Larger accounts are
reviewed on a detail
26
basis, giving consideration to collection experience and any information on the
financial viability of the customer. The allowance is reviewed and adjusted each
quarter based on the best information available at the time. Unforeseen events
which negatively affect the ability of our customer's to meet their payment
obligations would negatively impact our ability to collect outstanding amounts
due from customers and may cause a material impact on our financial position and
results of operations due to a change in the assumptions and judgment on which
we base this estimate.
Capitalized Software - The cost of purchased and internally developed software
is capitalized and stated at the lower of unamortized cost or expected net
realizable value. We compute annual amortization using the straight-line method
over the remaining estimated economic life of the software product which is
generally five years. Software is subject to rapid technological obsolescence
and future product revenue estimates supporting the capitalized software cost
can be negatively affected based upon competitive products and pricing. Such
adverse developments could reduce the estimated net realizable value of our
capitalized software and could result in impairment or a shorter estimated life.
Such events would require us to take a charge in the period in which the event
occurred or to increase the amortization expense in future periods and would
have a negative effect on our results of operations.
Impairment of Goodwill - We are required to assess the impairment of goodwill
annually, or more frequently if events or changes in circumstances indicate that
the carrying value may exceed the fair value. To analyze goodwill, we measure
its fair value using an estimate of the related business's discounted cash flow.
The discounted cash flow approach uses significant assumptions, including
projected future cash flows, the discount rate reflecting the risk inherent in
future cash flows, and a terminal growth rate.
The fair value of the reporting unit including the goodwill is then compared to
the carrying value of each reporting unit (Products and Professional Services).
If the carrying amount of the reporting unit goodwill exceeds the implied fair
value of the goodwill, the impairment loss is recognized as an operating expense
in an amount equal to that excess. Changes in any of these estimates and
assumptions, and unknown future events or circumstances (e.g. economic
conditions or technological developments), could have a significant impact on
whether or not an impairment charge is recognized and the magnitude of any such
charge.
Investments in Partially Owned Companies - As discussed in Note 5 to the
Consolidated Financial Statements, we have minority investments in and advances
to certain privately held companies for strategic purposes. At March 31, 2004,
the net carrying value of our investments and advances to these entities totaled
$25.9 million. Additionally, we have guaranteed outstanding lease obligations of
$3.2 million at March 31, 2004. We regularly evaluate the financial condition of
these partially owned companies to assess potential impairment in the carrying
value of our investments in and advances to these entities. We consider their
current financial situation, including their ability to meet current cash
requirements, expected future cash flows and any other information known to us
in determining whether an impairment charge is appropriate. Unknown factors or
unforeseen events that impair their ability to pay their obligations or to
operate profitably could have an impact on our ability to recoup our investments
in and outstanding advances to these companies and could require us to expense
all or a portion of the outstanding investments and advances in that period.
Deferred Tax Assets Valuation Allowance and Tax Liabilities - We estimate income
taxes in each of the jurisdictions in which we operate, net deferred tax assets
based on expected future taxable benefits in such jurisdictions and our
valuation allowance for deferred tax assets. For additional information
regarding these estimates see Note 12 to the Consolidated Financial Statements.
Changes in estimates of projected future operating results or in assumptions
regarding our ability to generate future taxable income during the periods in
which temporary differences are deductible could result in significant changes
to these accruals and, therefore, to our net income.
27
In addition, we recognize contingent tax liabilities through tax expense for
estimated exposures related to our current tax positions. We evaluate the need
for contingent tax liabilities on a quarterly basis and any change in the amount
will be recorded in our results of operations, as appropriate. It could take
several years to resolve certain of these contingencies.
Other - Other accounting policies, although not generally subject to the same
level of estimation as those discussed above, are nonetheless important to an
understanding of the financial statements. Many assets, liabilities, revenue and
expenses require some degree of estimation or judgment in determining the
appropriate accounting.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2004, cash and investments totaled approximately $767.1 million.
During 2004 and 2003, cash flow from operations was $258.1 million and $370.4
million, respectively. A significant portion of operating cash flow is generated
from the collection of the current portion of prior years' receivables. The
decrease was primarily due to lower collections on customer receivables due to
the general decline in revenue from the prior year. During these periods,
capital expenditures for the Detroit Headquarters facility totaled $65.2 million
and $219.1 million, respectively, and capital expenditures for other property
and equipment and capitalized research and software development totaled $20.7
million and $17.6 million, respectively.
On May 2, 2003, we entered into a $100 million revolving credit facility
maturing on July 29, 2004. See Note 9 of Notes to Consolidated Financial
Statements for a discussion of this revolving credit facility. No borrowings
have occurred or are planned under this facility. We intend to renew this
facility upon expiration.
We have relocated to our new corporate headquarters building. The total
construction cost approximated $350 million for the building and $50 million for
furniture and fixtures. Annual depreciation expense is approximately $16
million. Future cash requirements to complete the construction will be minimal
in fiscal year 2005.
In July 2003 we entered into an option and purchase agreement for our Farmington
Hills, Michigan facility. The option agreement allows the holder to commit to
purchase the building for one year after the execution of the agreement. The
option selling price of the building approximates the current net book value of
$20 million for the building. If exercised, the holder would pay $5 million upon
exercise and the remaining balance in five years with interest being paid
monthly at 7% of the unpaid balance.
On May 6, 2003, the Board of Directors authorized the repurchase of up to $125
million of our common stock. Our purchases of stock may occur on the open
market, through negotiated or block transactions based upon market and business
conditions. We regularly evaluate market conditions for an opportunity to
repurchase our stock. During August 2003, we repurchased approximately 200,000
shares of our common stock under this program at an average price of $4.97 per
share. Approximately $124 million remains for future purchases under this
program.
As discussed in Note 5 to the 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 in our financial statements are appropriate
and the investments (inclusive of the debt obligations) are not impaired.
CareTech Solutions, Inc.'s (Caretech) 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 March 31,
2004. The DMC has requested, and CareTech has agreed, to provide the DMC with
extended payment terms up to 90 days. In turn, we have also agreed to extend 90
day payment terms to CareTech. During the third quarter of fiscal 2004, the
other shareholders of CareTech expressed an inability or unwillingness to
provide additional funding to
28
meet any short falls in CareTech's cash flow requirements. Therefore, we will
record 100 percent of any future losses incurred by CareTech as a reduction to
our outstanding advances to CareTech. At March 31, 2004, the carrying value of
investments in and advances to Caretech was $22.0 million.
On February 5, 2004, we entered into an asset purchase agreement with Covisint
LLC (Covisint) which became effective March 1, 2004. We acquired selected assets
and certain liabilities related to their Communicate Portal Solutions, Connect
and Problem Solver businesses (acquired business) for approximately $7 million
in cash plus certain lease obligations up to $2.1 million.
In May 2004, we acquired all outstanding shares of Changepoint Corporation, a
privately held market-leader of IT Governance application software for
approximately $100 million in cash. The acquisition will be accounted for as a
purchase during the first quarter of fiscal 2005, and, accordingly, assets and
liabilities acquired will be recorded at fair value as of the acquisition date.
We continue to evaluate business acquisition opportunities that fit our
strategic plans.
We believe available cash resources, together with cash flow from operations,
will be sufficient to meet cash needs for the foreseeable future.
Contractual Obligations
The following table summarizes our payments under contractual obligations and
our other commercial commitments as of March 31, 2004 (in thousands):
Payment Due by Period as of March 31,
----------------------------------------------------------------------------------------
2010 and
Total 2005 2006 2007 2008 2009 Thereafter
--------- --------- --------- --------- --------- --------- ----------
Contractual obligations:
Operating leases $ 325,153 $ 29,287 $ 23,320 $ 19,396 $ 15,885 $ 11,558 $ 225,707
Other(1) 8,280 4,605 2,075 200 200 200 1,000
--------- --------- --------- --------- --------- --------- ----------
Total $ 333,433 $ 33,892 $ 25,395 $ 19,596 $ 16,085 $ 11,758 $ 226,707
========= ========= ========= ========= ========= ========= ==========
(1) - Other includes a $4.0 million commitment to various City of Detroit
charities and a $4.3 million advertising agreement.
Off-Balance Sheet Arrangements
As discussed in Note 5 to the Consolidated Financial Statements, we have
guaranteed lease obligations of CareTech of up to $12.5 million. We have not
recorded any liability related to these guarantees since we believe that
CareTech will continue to meet its obligations. At March 31, 2004, CareTech's
outstanding lease obligations were approximately $3.2 million.
We currently do not have any non-consolidated special purpose entity
arrangements.
29
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed primarily to market risks associated with movements in interest
rates and foreign currency exchange rates. We believe that we take the necessary
steps to appropriately reduce the potential impact of interest rate and foreign
exchange exposures on our financial position and operating performance. We do
not use derivative financial instruments or forward foreign exchange contracts
for investment, speculative or trading purposes. Immediate changes in interest
rates and foreign currency rates discussed in the following paragraphs are
hypothetical rate scenarios used to calibrate risk and do not currently
represent management's view of future market developments. A discussion of our
accounting policies for derivative instruments is included in the Notes to
Consolidated Financial Statements in Item 8 of this report.
INTEREST RATE RISK
Exposure to market risk for changes in interest rates relates primarily to our
cash investments and installment receivables. Derivative financial instruments
are not a part of our investment strategy. Investments are placed with high
quality issuers to preserve invested funds by limiting default and market risk.
In addition, mar