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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, 2005
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. [ ]
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, 2004, the last business day of the registrant's
most recently completed second fiscal quarter, was $1,645,029,944, based upon
the closing sales price of the common stock on that date of $5.15 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 388,464,724 shares of $.01 par value common stock outstanding as of
June 1, 2005.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Registrant's 2005 Annual
Meeting of Shareholders (the "Proxy Statement") filed pursuant to Regulation 14A
are incorporated by reference in Part III.
COMPUWARE CORPORATION AND SUBSIDIARIES
FORM 10-K
TABLE OF CONTENTS
Item
Number Page
- ------ ----
PART I
1. Business 3
2. Properties 14
3. Legal Proceedings 14
4. Submission of Matters to a Vote of Security Holders 15
PART II
5. Market for the Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities 16
6. Selected Consolidated Financial Data 17
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 18
7A. Quantitative and Qualitative Disclosure about Market Risk 31
8. Consolidated Financial Statements and Supplementary Data 33
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 61
9A. Controls and Procedures 61
9B. Other Information 63
PART III
10. Directors and Executive Officers of the Registrant 64
11. Executive Compensation 64
12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 64
13. Certain Relationships and Related Transactions 64
14. Principal Accountant Fees and Services 64
PART IV
15. Exhibits and Financial Statement Schedule 65
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PART I
ITEM 1. BUSINESS
We deliver value to businesses worldwide by providing software products and
professional services that increase the productivity of information technology
(IT) departments. Originally founded as a professional services company, we in
the late 1970's began to offer mainframe productivity tools for fault management
and diagnosis, file and database management, and application debugging.
In the 1990's, IT moved toward distributed and web-based platforms. Our
solutions portfolio grew in response, and we now market a comprehensive
portfolio of IT solutions for both distributed and mainframe systems that help:
- Develop, test and deploy industrial-strength enterprise
applications.
- Proactively manage the availability and performance of key
applications and resolve problems before they impact the business.
- Govern, control and align the entire IT portfolio.
IT Governance was added to our solution portfolio in May 2004 with the
acquisition of Changepoint Corporation (Changepoint). Changepoint offerings help
IT organizations by providing critical insight into IT spending, operations and
management, helping technology leaders align IT investments with business
priorities.
Additionally, to be competitive in today's global economy, enterprises must
securely share applications, information and business processes. We address this
market need through our Covisint offerings, which help manage the supply chain
through the integration of vital business information and processes between
partners, customers and suppliers.
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 the Notes to
Consolidated Financial Statements, included in Item 8 of this report.
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.
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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 enterprise IT solutions are focused on providing a real return on investment
for our clients by increasing productivity, efficiency and visibility into their
IT applications throughout the application life cycle. We support the most
widely used technologies and platforms, including mainframe, distributed, Java,
..NET, Windows, UNIX, Linux, Oracle and SAP.
We offer software solutions and professional services in the four primary phases
of the application life cycle: 1) Application development, in which software
source code is created, integrated with existing applications and modified over
time; 2) Quality assurance, in which application software is executed, debugged,
tested and maintained in a series of repetitive, ongoing cycles to ensure it
will function well once implemented; 3) Application service management, in which
the performance and availability of operating systems, databases, servers,
applications and networks is monitored and managed; and 4) IT governance, which
provides IT executives with comprehensive capabilities to govern, control and
align the entire IT portfolio across development and operations.
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 (dollars in thousands):
YEAR ENDED MARCH 31, PERCENTAGE OF TOTAL REVENUES
------------------------------------- ----------------------------
Product Revenue 2005 2004 2003 2005 2004 2003
--------- --------- --------- ---- ---- ----
File-AID $ 172,438 $ 169,063 $ 182,224 14.0% 13.4% 13.2%
Abend-AID 138,592 138,943 155,769 11.3 11.0 11.3
XPEDITER 108,762 113,647 110,880 8.8 9.0 8.1
QACenter Mainframe 23,343 20,004 24,527 1.9 1.6 1.8
STROBE 83,608 85,653 80,080 6.8 6.8 5.8
--------- --------- --------- ---- ---- ----
Total Mainframe Revenue 526,743 527,310 553,480 42.8 41.8 40.2
--------- --------- --------- ---- ---- ----
UNIFACE and Optimal 47,403 45,420 42,283 3.8 3.6 3.1
DevPartner 28,078 27,557 24,290 2.3 2.2 1.8
QACenter & File-AID/Client Server 42,688 39,141 34,691 3.5 3.1 2.5
Vantage 70,642 65,390 53,152 5.7 5.1 3.9
Changepoint 14,945 1.2
--------- --------- --------- ---- ---- ----
Total Distributed Product Revenue 203,756 177,508 154,416 16.5 14.0 11.3
--------- --------- --------- ---- ---- ----
Total Product Revenue $ 730,499 $ 704,818 $ 707,896 59.3% 55.8% 51.5%
========= ========= ========= ==== ==== ====
COMPUWARE SOFTWARE PRODUCTS AND THE APPLICATION LIFE CYCLE
Our software products enhance every step in the application life cycle, from
application development and testing to performance management and overall IT
governance, for mainframe, distributed and web-based platforms.
APPLICATION DEVELOPMENT -- Customers use our DevPartner, Optimal and Uniface
products to achieve productivity gains by building applications faster and with
higher quality.
QUALITY ASSURANCE -- QACenter and Xpediter tools and the Compuware Application
Reliability Solution (CARS) automate the multiple, complex steps of thorough
application testing.
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APPLICATION SERVICE MANAGEMENT -- The Abend-AID, File-AID, Strobe and Vantage
product lines are used to find and fix application, server and/or network
performance problems before they affect end users.
IT GOVERNANCE -- Changepoint equips IT executives to manage the business of IT,
with visibility into IT operations down to the level of individual performance.
MAINFRAME MARKET
We believe that our mainframe products will remain among the industry leaders.
The market for mainframe products is well-defined, and the drive to extend
legacy applications into distributed environments continues to underscore 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 application
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
service 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. These products 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, including building test data environments to provide the
right data in the shortest time.
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. Automated failure notification helps speed problem resolution and reduce
downtime.
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
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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 applications under production conditions without requiring actual users at
terminals. Their powerful functions and features enhance unit, concurrency,
integration, migration, capacity and stress testing.
STROBE PRODUCTS
Our Strobe and iStrobe are Application Performance Management products that work
together to help clients locate and eliminate sources of excessive resource
demands during every phase of an application's life cycle. Strobe products
measure the activity of z/OS-based online and batch applications, providing
reports on where and how time is spent during execution. Strobe 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,
quality assurance and application service 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 operations
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
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 helps to reduce
development and maintenance costs and allows applications to be developed
rapidly using existing, proven legacy code.
Uniface View is our business integration portal product. As a packaged,
web-based portal application, Uniface View enables customers to quickly
implement an integrating platform to help bring together the
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diverse array of custom-built and packaged applications and web services that
many companies have assembled over a period of time. Uniface View 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.
Uniface Flow is our business process automation and business process modeling
product that automates the execution of business tasks running within and across
an organization. Uniface Flow helps solution architects model and automate
business processes and tasks by aligning and 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.
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.
OptimalAdvisor is a package and code analysis tool that delivers insight and
advice into the code structure and effectiveness of Java applications. This
helps developers to better understand code problems and solutions, assess and
monitor code quality, measure code properties and refactor code based on the
design analysis.
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 SecurityChecker is a security analysis tool that helps quickly scan,
locate and fix security vulnerabilities in ASP.NET applications written in
either C# or Visual Basic .NET.
DevPartner Fault Simulator uses error simulation to emulate real-world
application error conditions, allowing developers and testers to proactively
analyze and debug application error-handling code.
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 suites include:
QACenter Enterprise Edition -- Compuware's automated functional testing and test
management solution includes the following products:
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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 -- A test management solution for full life-cycle testing of
distributed large-scale applications. QADirector provides the framework
for managing the entire testing process, allowing users to measure and
analyze risk and improve efficiency with test management and analysis that
aligns quality assurance with business goals to maximize application
quality.
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
provides a method for keeping planning, development and testing activities
synchronized with the business goals for accurate assessment of project
status.
FileAID/Client Server -- A comprehensive test data management tool that
provides repeatable and consistent testing by allowing QA teams to easily
reuse test cases with different test data.
QACenter Performance Edition -- Our automated load testing and server
and network performance monitoring solution pinpoints problems and optimizes
system performance for distributed, ERP and e-commerce applications.
Compuware Application Reliability Solution (CARS) -- Combines our 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.
VANTAGE PRODUCTS
Vantage products enable IT organizations to deliver application service by
managing the performance of distributed applications from the end user's
perspective. Response-time metrics are integrated with deep performance
analytics, enabling IT organizations to proactively identify, resolve and
prevent performance problems. Working together to monitor performance at the
business, transaction and infrastructure level, Vantage products provide
enterprise-wide application service management.
ClientVantage -- Provides a complete measure of end-user experience for all
users, all the time, by tracking response times, resource usage, application
faults and availability. Now with additional capability provided by our May 2005
acquisition of Adlex, a leader in agentless performance monitoring of extremely
high-transaction web-based and enterprise applications, ClientVantage gives deep
insight into application performance.
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 -- Via agent-based or agentless technology, monitors the
availability and performance of applications, databases and servers, allowing
administrators to centrally manage events across all application components --
web servers, firewalls, application servers, file systems, databases, middleware
and operating systems.
VantageView -- Performance dashboard that provides an overall enterprise view of
application performance and availability across the customer's infrastructure,
as well as access to the underlying performance metrics.
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Vantage Analyzer for J2EE -- Directs users straight to the source of J2EE
performance problems, using visibility and detailed transaction analysis --
without draining production resources.
ApplicationVantage -- Pinpoints the source of poor performance and
infrastructure problems to the client, server or network in production and
pre-production environments, eliminating time-consuming guesswork. Predictive
analysis features enable IT organizations to ensure that new and modified
applications roll out successfully and provide crucial information for
establishing and meeting service requirements.
Predictor -- Delivers WAN provisioning and growth management information to help
IT organizations justify WAN and device upgrade expenditures and design network
layout for enhanced performance before response delays occur.
CHANGEPOINT PRODUCTS
Changepoint provides Chief Information Officers ("CIOs") and IT managers with
critical insight into IT spending, operations and management, helping them align
IT investments with business priorities. Changepoint automates core IT business
processes to reduce costs and increase efficiency and quality. Our IT governance
offering is an IT business management solution that enables integrated
management of all IT investments. It offers project, application and
infrastructure portfolio management with visibility, so that organizations can
select and prioritize the investments that best support business goals, even as
business conditions and market requirements change.
Changepoint Professional Services Application (PSA) provides total visibility
into the performance of an IT services organization from detailed analyses of
the performance of engagements, projects and customers to higher level views of
workgroups, the sales pipeline, engagements, project portfolios and financial
projections. A configurable Management Portal enables the consolidation of
business-critical information from Changepoint PSA, as well as other critical
business systems.
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 customer support and product
upgrades to assure a continuing high level of customer satisfaction. In fiscal
year 2005, 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.
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 2005, 2004 and 2003, maintenance
fees represented approximately 34.5%, 32.3%, and 30.0%, respectively, of our
total revenues.
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TECHNOLOGY DEVELOPMENT AND SUPPORT
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. In May 2005, we acquired Adlex, Incorporated with a development lab
in Gdansk, Poland.
Total technology development and support costs were $172.7 million, $175.0
million and $154.7 million during fiscal 2005, 2004 and 2003, respectively, of
which $19.3 million, $11.3 million and $11.4 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.
PROFESSIONAL SERVICES
We offer a broad range of IT services for distributed systems and mainframe
environments. Our offerings include technical staffing, application development,
quality assurance, project management and application maintenance. We also offer
professional services solutions that utilize Compuware's products for enhanced
efficiency, quality and performance.
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, 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 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, that are delivered via the Covisint Interoperability
Platform. This platform provides our customers with a comprehensive solution for
communicating real-time transactions and other vital information with their
suppliers, partners and customers. We work with our customers and industry trade
groups worldwide to define and implement effective common processes for sharing
business processes within an industry. Once connected through the Covisint
platform, customers are able to reduce costs, increase efficiency, enhance
quality and improve time to market.
Covisint Communicate portal solutions enable a company's business partners to
securely access the company's applications and vital information. Covisint
Communicate serves as the framework for web-based communications with a
business's extended enterprise. Individual users gain the synergistic advantage
of a single Covisint I.D. and password that can be used to access an entire
industry in a single consistent user interface.
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Covisint Connect data messaging service provides a single connection for a
company's computers to exchange data with the computers of its partners. The
proprietary, underlying technology can handle both traditional EDI and newer XML
communications in one environment. The single connection permits 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 unique, multiple
formats and connection types that are often required by customers to conduct
business.
We are currently focused on expanding these services beyond the automotive
market to include clients in healthcare, logistics, banking and government
operations.
CUSTOMERS
Our products and professional services are used by the IT departments of a wide
variety of commercial and government organizations.
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 other single customer accounted for greater
than 10% of total revenue during fiscal 2005, 2004 or 2003, or greater than 10%
of accounts receivable at March 31, 2005 and 2004.
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
sales executives support branch marketing efforts by identifying new business
opportunities and making joint sales calls. This marketing 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 products and 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 Software Corp., 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 Ltd., Computer Sciences Corporation,
Electronic Data Systems Corporation, IBM Global Services, Analysts International
Corporation, Keane, Inc., Infosys Technologies 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.
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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, effective sales execution and our ability to acquire and
integrate new technologies. 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 29 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.
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.
12
EMPLOYEES
As of March 31, 2005, we employed 7,908 people worldwide, with 1,770 in products
sales, sales support and marketing; 1,400 in technology development and support;
3,995 in professional services and 743 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. 62 Chairman of the Board, Chief Executive Officer and
President
Tommi A. White 54 Chief Operating Officer
Henry A. Jallos 56 Executive Vice President, Global Account Management
Laura L. Fournier 52 Senior Vice President, Chief Financial Officer
(Chief Accounting Officer) and Treasurer
Thomas M. Costello, Jr. 51 Senior Vice President, Human Resources, General
Counsel and Secretary
Robert C. Paul 42 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 and October 2003 to present.
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.
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.
13
Robert C. Paul has served as Chief Executive Officer and President of Covisint
since its acquisition in March 2004. Mr. Paul had spent nearly three years at
Covisint prior to the acquisition. 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 the 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 the Notes
to Consolidated Financial Statements, included in Item 8 of this report.
ITEM 2. PROPERTIES
Our executive offices, primary research and development lab, principal marketing
department, primary professional services office, customer service and support
teams are located in our corporate headquarters office building in Detroit,
Michigan. We own the facility, which is approximately 1.1 million square feet,
including approximately 60,000 square feet available for lease to third parties
for retail and related amenities. In addition, we lease approximately 217,000
square feet of land on which the facility resides.
We also own a Farmington Hills, Michigan facility, which is approximately
225,000 square feet. As discussed in Note 4 of the Notes to Consolidated
Financial Statements, included in Item 8 of this report, this facility is
classified in current assets as held for sale.
We lease approximately 93 professional services and sales offices in 29
countries, including six remote product research and development facilities.
ITEM 3. LEGAL PROCEEDINGS
On March 21, 2005, the Company entered into a definitive Settlement Agreement
with International Business Machines Corporation ("IBM") to settle all of the
outstanding litigation and related disputes among the parties in Michigan and
New York, which includes the following cases: Compuware Corp. v. Int'l Bus.
Mach. Corp., No. 02-70906 (E.D. Mich. filed March 12, 2002); Compuware Corp. v.
Int'l Bus. Mach. Corp., No. 02-72752 (E.D. Mich. filed July 3, 2002); and Int'l
Bus. Mach. Corp. v. Compuware Corp., No. 04-CV-000357 (CM)(LMS)(S.D.N.Y. filed
January 15, 2004).
Pursuant to the terms of the Settlement Agreement:
1) IBM will pay a minimum of $140 million over four years for licenses
and maintenance of Compuware software products, and will offer to
purchase a minimum of $260 million of Compuware services over four
years;
2) IBM and Compuware have entered into an irrevocable, perpetual patent
cross-licensing agreement, covering patents related to both
companies' businesses currently issued or to be issued on or prior
to March 21, 2009; and
3) The parties have agreed to dismiss all claims in the above
litigation with prejudice and have granted mutual releases.
14
Further information regarding this Settlement Agreement is included in the Form
8-K filed by the Company with the United States Securities and Exchange
Commission on March 22, 2005.
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. On May 26, 2005, the Court dismissed
Compuware's claims. The Company intends to appeal this ruling.
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 plaintiff alleges that the Company
failed to disclose under the securities laws its problems with the
misappropriation of its software source code by IBM. The plaintiff further
alleges that the Company omitted and/or disseminated materially false and
misleading statements concerning its deteriorating relationship with IBM. The
plaintiff requests that the court award them monetary damages and expenses of
litigation, including reasonable attorneys fees. The Company strongly disagrees
with the allegations and is vigorously defending against the lawsuit. On August
27, 2004, plaintiffs moved to certify a class. In January 2005, the Court ruled
in the Company's favor by denying plaintiff's motion for class certification.
The Company believes that the risk of loss resulting from these claims by the
plaintiff is remote. The lawsuit is currently in the discovery phase.
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.
15
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 May 31, 2005, there were approximately 6,039 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 $1 billion
minimum tangible net worth covenant that could limit our ability to pay
dividends. The following table sets forth the range of high and low sale prices
for our common stock for the periods indicated, all as reported by NASDAQ.
FISCAL YEAR ENDED MARCH 31, 2005 HIGH LOW
Fourth quarter $ 7.60 $ 5.51
Third quarter 6.58 5.01
Second quarter 6.77 4.35
First quarter 8.95 6.37
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
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 the 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, 2005 (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 36,425 $13.50 8,365
Equity compensation plans not
approved by security holders 25,725 $ 8.68 23,735
16
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,
--------------------------------------------------------------------------
2005 2004 2003 2002 2001
------------ ------------ ------------ ------------ ------------
(In thousands, except earnings per share data)
STATEMENT OF OPERATIONS DATA:
Revenues:
Software license fees $ 305,189 $ 296,627 $ 295,720 $ 417,631 $ 495,572
Maintenance fees 425,310 408,191 412,176 433,751 456,534
Professional services fees 501,340 559,829 667,444 889,162 1,083,050
------------ ------------ ------------ ------------ ------------
Total revenues 1,231,839 1,264,647 1,375,340 1,740,544 2,035,156
------------ ------------ ------------ ------------ ------------
Operating expenses:
Cost of software license fees 27,293 31,579 30,740 34,102 37,885
Cost of professional services 444,996 513,621 611,644 840,149 973,854
Technology development and support 153,386 163,655 143,289 164,280 187,155
Sales and marketing 319,940 310,643 264,012 294,496 351,214
Administrative and general (5) 199,628 207,613 188,814 206,347 228,631
Goodwill amortization and impairment 426,344 42,092
(1 and 2)
Restructuring costs (2) 46,930
------------ ------------ ------------ ------------ ------------
Total operating expenses 1,145,243 1,227,111 1,238,499 2,012,648 1,820,831
------------ ------------ ------------ ------------ ------------
Income (loss) from operations 86,596 37,536 136,841 (272,104) 214,325
Other income (expense) (5) 19,629 18,481 19,374 21,257 (22,256)
------------ ------------ ------------ ------------ ------------
Income (loss) before income taxes 106,225 56,017 156,215 (250,847) 192,069
Income tax provision (benefit) 29,743 6,185 53,113 (5,592) 72,986
------------ ------------ ------------ ------------ ------------
Net income (loss) $ 76,482 $ 49,832 $ 103,102 $ (245,255) $ 119,083
============ ============ ============ ============ ============
Basic earnings (loss) per share (3) $ 0.20 $ 0.13 $ 0.27 $ (0.66) $ 0.33
Diluted earnings (loss) per share (3) 0.20 0.13 0.27 (0.66) 0.32
Shares used in computing net income (loss)
per share:
Basic earnings computation 386,701 382,630 377,028 371,786 365,192
Diluted earnings computation 388,501 384,608 378,440 371,786 372,809
BALANCE SHEET DATA (AT PERIOD END):
Working capital (5) $ 780,223 $ 616,628 $ 541,153 $ 474,947 $ 412,264
Total assets (5) 2,478,218 2,262,709 2,162,798 2,025,683 2,281,211
Long term debt - - - - 140,000
Total shareholders' equity (4) 1,516,155 1,413,591 1,331,691 1,189,851 1,377,372
(1) Effective April 1, 2002, in accordance with SFAS No. 142, the goodwill
balance is no longer being amortized. Instead it is tested at least
annually for impairment. In fiscal 2002 and 2001, net income (loss) and
earnings (loss) per share (diluted computation), exclusive of amortization
of goodwill, would have been ($212.4 million) and (57 cents) and $153.9
million and 41 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. Restructuring costs in 2002 represent costs
incurred with the reorganization of the operating divisions during the
fourth quarter. See Note 7 of the Notes to Consolidated Financial
Statements, included in Item 8 of this report, for more details on these
charges.
(3) See Notes 1 and 11 of the Notes to Consolidated Financial Statements,
included in Item 8 of this report, for the basis of computing earnings per
share.
(4) No dividends were paid during the periods presented.
(5) Certain amounts in the fiscal 2004, 2003, 2002 and 2001 statement of
operations and balance sheet data have been reclassified to conform to the
fiscal 2005 presentation. Included in these reclassifications are income
tax reserves totaling $33.3 million, $40.1 million, $31.7 million and
$22.6 million at March 31, 2004, 2003, 2002 and 2001, respectively, that
have been reclassified from long term deferred taxes to accrued expenses
which thereby resulted in a corresponding increase in deferred tax assets.
These reclassifications do not have any impact on net income and are
immaterial to the financial statements overall.
17
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.
- - 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.
- - There can be no assurance that third parties will not assert infringement
claims against us in the future with respect to current and future
products or that any such assertion may not require us to enter into
royalty arrangements or result in costly litigation.
- - Our operating margins may decline. We are aware that operating expenses
associated with our distributed systems products are higher than those
associated with our traditional mainframe products. Since we believe the
best opportunities for revenue growth are in the distributed systems
market, product operating margins could experience more pressure. In
addition, operating margins in the professional services business are
significantly impacted by small fluctuations in revenue since most costs
are fixed during any short term period.
- - Our results could be adversely affected by increased competition and
pricing pressures. We consider over 40 firms to be directly competitive
with one or more of our products. These competitors include but are not
limited to BMC Software, Inc., Borland Software Corp., 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 Ltd.,
Computer Sciences Corporation, Electronic Data Systems Corporation, IBM
Global Services, Analysts International Corporation, Keane, Inc., Infosys
Technologies 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 or acquire 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.
18
- - 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 and to the varying structure of customer
arrangements and the associated revenue recognition requirements.
- - 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.
19
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. This discussion and
analysis should be read in conjunction with the audited consolidated financial
statements and notes included elsewhere in this report.
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 products and professional services offerings
to remain competitive in the IT market.
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.
The following occurred since the beginning of fiscal 2005:
- Entered into a software, services and technology relationship with
IBM and settled all outstanding litigation between the companies.
According to the agreement, IBM will enter into license and
maintenance arrangements for $140 million of our software over four
years and offer to purchase $260 million of our services over four
years.
- Acquired Changepoint in May 2004. Changepoint offerings provide CIOs
with insight and visibility into their people, projects, resources
and applications, helping CIOs align IT investments with business
priorities.
- Acquired Adlex, Incorporated ("Adlex") in May 2005. Adlex has
pioneered service delivery management technology that enables
Internet Service Providers and enterprise customers to diagnose and
then manage the quality of service that business-critical
applications deliver to end-users. This technology complements the
Compuware Vantage product line by providing extremely high-capacity,
agentless end-user experience monitoring and deep insight into
application performance.
- Acquired the technology assets of DevStream Corporation
("Devstream"), based in Colorado Springs, Colorado. The privately
owned software company developed an advanced J2EE performance
analysis product, which we recently introduced as Vantage Analyzer
for J2EE.
- Released 13 mainframe and 37 distributed products, during fiscal
2005, designed to increase the productivity of the IT departments of
our customers.
- Achieved a products contribution margin of 31.5% in fiscal 2005
compared to 28.2% in fiscal 2004.
- Achieved a distributed product revenue increase of 14.8% in fiscal
2005 compared to fiscal 2004. Approximately 43% of the increase was
a reflection of our continued focus on promoting our distributed
products with the remainder attributable to the Changepoint
acquisition in the first quarter of 2005.
- Improved the professional services margin to 11.2% in fiscal 2005
from 8.3% in fiscal 2004 through improved utilization of
professional services personnel and, to a lesser extent, a concerted
effort to reduce low margin subcontractor arrangements.
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".
20
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, 2004 2003
--------------------------- to to
2005 2004 2003 2005 2004
---- ----- ----- ----- ----
REVENUE:
Software license fees 24.8% 23.5% 21.5% 2.9% 0.3%
Maintenance fees 34.5 32.3 30.0 4.2 (1.0)
Professional services fees 40.7 44.2 48.5 (10.4) (16.1)
----- ----- -----
Total revenues 100.0 100.0 100.0 (2.6) (8.0)
----- ----- -----
OPERATING EXPENSES:
Cost of software license fees 2.2 2.5 2.2 (13.6) 2.7
Cost of professional services 36.1 40.6 44.5 (13.4) (16.0)
Technology development and support 12.5 12.9 10.4 (6.3) 14.2
Sales and marketing 26.0 24.6 19.2 3.0 17.7
Administrative and general 16.2 16.4 13.7 (3.8) 10.0
----- ----- -----
Total operating expenses 93.0 97.0 90.0 (6.7) (0.9)
----- ----- -----
Income from operations 7.0 3.0 10.0 130.7 (72.6)
Other income 1.6 1.4 1.4 6.2 (4.6)
----- ----- -----
Income before income taxes 8.6 4.4 11.4 89.6 (64.1)
Income tax provision 2.4 0.5 3.9 380.9 (88.4)
----- ----- -----
Net income 6.2% 3.9% 7.5% 53.5% (51.7)%
===== ===== =====
SOFTWARE PRODUCTS
Revenue
Our products are designed to support the complete application lifecycle:
development and integration, quality assurance, production readiness and
performance management of the application to optimize performance in production.
Our Changepoint application provides CIOs with oversight for spending,
operations and management. Product revenue which consists of software license
fees and maintenance fees, comprised 59.3%, 55.8% and 51.5% of total revenue
during 2005, 2004 and 2003, respectively.
Distributed software product revenue increased $26.3 million or 14.8% during
2005 to $203.8 million from $177.5 million in 2004 and increased $23.1 million
or 15.0% during 2004 from $154.4 million in 2003. The increased revenue during
2005 was primarily due to an increase of $13.2 million in maintenance revenue
related to our DevPartner and Vantage product lines and to the addition of $14.9
million related to Changepoint, which was acquired during the first quarter of
2005. The increased revenue during 2004 was primarily due to an increase in
license and maintenance revenue related to our Vantage product lines.
Mainframe software product revenue decreased $567,000 or 0.1% during 2005 to
$526.7 million from $527.3 million in 2004 and decreased $26.2 million or 4.7%
during 2004 from $553.5 million in 2003. The decreased revenue during 2004 was
primarily due to a decrease in license and maintenance revenue related to our
File-Aid and Abend-Aid product lines.
21
License revenue increased $8.6 million or 2.9% during 2005 to $305.2 million
from $296.6 million in 2004 and increased $907,000 or 0.3% during 2004 from
$295.7 million in 2003. License revenue increased $9.3 million compared to 2004
due to fluctuations in foreign currencies. Excluding the favorable effect of
foreign currency fluctuations, license revenue decreased 0.2% during 2005. The
decrease, net of currency fluctuations, was primarily due to a reduction in
DevPartner license revenue offset by the addition of Changepoint as discussed
above.
Maintenance fees increased $17.1 million or 4.2% to $425.3 million during 2005
from $408.2 million in 2004 and decreased $4.0 million or 1.0% during 2004 from
$412.2 million in 2003. Maintenance fees increased $11.9 million compared to
2004 due to fluctuations in foreign currencies. Excluding the favorable effect
of foreign currency fluctuations, maintenance fees increased 1.3% during 2005.
The increased maintenance revenue in 2005 was primarily a result of revenue
growth in our distributed product lines and to the addition of Changepoint as
discussed above.
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,
---------------------------------------
2005 2004 2003
--------- --------- ---------
United States $ 399,690 $ 375,670 $ 409,441
Europe and Africa 240,233 246,579 221,272
Other international operations 90,576 82,569 77,183
--------- --------- ---------
Total product revenue $ 730,499 $ 704,818 $ 707,896
========= ========= =========
22
PRODUCT CONTRIBUTION AND EXPENSES
Financial information for the product segment is as follows (in thousands):
Year Ended March 31,
------------------------------------------------
2005 2004 2003
--------- --------- ---------
Revenue $ 730,499 $ 704,818 $ 707,896
Expenses 500,619 505,877 438,041
--------- --------- ---------
Product contribution $ 229,880 $ 198,941 $ 269,855
========= ========= =========
The product segment generated contribution margins of 31.5%, 28.2% and 38.1%
during 2005, 2004 and 2003, respectively. Product expenses include cost of
software license fees, technology development and support costs, and sales and
marketing expenses. These factors are discussed below.
Cost of software license fees includes amortization of capitalized software, the
cost of duplicating and disseminating products to customers and the cost of
author royalties. As a percentage of software license fees, cost of software
license fees were 8.9%, 10.6% and 10.4% in 2005, 2004 and 2003, respectively.
The decrease in cost of software license fees for 2005 was primarily
attributable to a reduction in amortization expense related to capitalized
software acquired as a result of the Programart acquisition that became fully
amortized in September 2004.
Technology development and support includes, primarily, the costs of programming
personnel associated with product development and support excluding 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
21.0%, 23.2% and 20.2% in 2005, 2004 and 2003, respectively.
Capitalization of internally developed software products begins when
technological feasibility of the product is established. Before the
capitalization of internally developed software products, total technology
development and support expenditures during 2005 decreased $2.3 million or 1.3%,
to $172.7 million from $175.0 million in 2004 and increased $20.3 million or
13.1% during 2004 from $154.7 million in 2003.
The decrease in technology costs for 2005 was primarily attributable to lower
compensation and benefit costs of approximately $2.2 million due to reductions
in employee headcount in this area which occurred during the third and fourth
quarters of 2005.
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 becoming 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 million
during the third and fourth quarters of 2004.
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 $9.3 million or 3.0%, during 2005 to $319.9 million
from $310.6 million in 2004 and increased $46.6 million or 17.7% during 2004
from $264.0 million in
23
2003. As a percentage of product revenue, sales and marketing costs were 43.8%,
44.1% and 37.3% in 2005, 2004 and 2003, respectively.
The increase in sales and marketing costs for 2005 was primarily attributable to
higher compensation and benefit costs and an increase in marketing seminar costs
related to the OJX seminar that was held at our Detroit world headquarters in
September 2004 to promote our OptimalJ product line. Compensation and benefit
costs were higher due to scheduled salary increases during 2005 and the negative
effect of foreign currency fluctuations on these costs as the U.S. dollar
continued to weaken throughout 2005. Approximately 50% of total sales and
marketing compensation and benefits were attributable to our foreign operations.
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 2004. Approximately 50%
of total sales and marketing compensation, benefit, commission and bonus costs
were attributable to our foreign operations. The change in advertising costs was
a result of increases in the promotion of our products in the distributed
software marketplace during 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.
In April 2005, the Company realigned the sales organization and eliminated a
layer of management with the intention of improving communication channels in
deal strategy, execution, forecasting and closing. The realignment will reduce
headcount and is expected to lower salaries and benefits by approximately $12
million during 2006, offset by severance and other implementation costs
associated with the realignment totaling approximately $5 million during the
first two quarters of 2006.
PROFESSIONAL SERVICES
REVENUE
We offer a broad range of IT services to help businesses make the most of their
IT assets. Some of these services include outsourcing and co-sourcing,
application management, product solutions, project management, enterprise
resource planning and customer relationship management services, and our unique
Compuware Application Reliability Solution, a comprehensive approach to
application quality assurance. Revenue from professional services decreased
$58.5 million or 10.4% during 2005 to $501.3 million from $559.8 million in 2004
and decreased $107.6 million or 16.1% during 2004 from $667.4 million in 2003.
The decrease in revenue for 2005 and 2004 was primarily due 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 a reduction in
subcontractor arrangements, along with a strategic move away from non-core
professional services such as helpdesk, computer operations and non-technical
project management. As we move forward, we are focusing on higher margin project
development services and combined product and services solution arrangements.
24
Professional services revenue by geographic location is presented in the table
below (in thousands):
Year Ended March 31,
-------------------------------------
2005 2004 2003
--------- --------- ---------
United States $ 436,730 $ 499,670 $ 599,913
Europe and Africa 59,383 56,749 64,816
Other international operations 5,227 3,410 2,715
--------- --------- ---------
Total professional services revenue $ 501,340 $ 559,829 $ 667,444
========= ========= =========
Professional Services Contribution and Expenses
Financial information for the professional services segment is as follows (in
thousands):
Year Ended March 31,
-------------------------------------
2005 2004 2003
--------- --------- ---------
Revenue $ 501,340 $ 559,829 $ 667,444
Expenses 444,996 513,621 611,644
--------- --------- ---------
Professional services contribution $ 56,344 $ 46,208 $ 55,800
========= ========= =========
During 2005, the professional services segment generated a contribution margin
of 11.2%, compared to 8.3% and 8.4% during 2004 and 2003, respectively. The
increase from 2004 to 2005 was primarily due to improved utilization of
professional services personnel and, to a lesser extent, a concerted effort to
reduce low margin subcontractor projects.
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 $68.6 million or 13.4%,
during 2005 to $445.0 million from $513.6 million in 2004 and decreased $98.0
million or 16.0% during 2004 from $611.6 million in 2003.
The decrease in cost of professional services for 2005 was primarily
attributable to lower compensation, benefit, bonus and travel costs of
approximately $56.1 million and a decrease in subcontractor costs of
approximately $11.4 million. Compensation, benefit, bonus and travel costs were
lower due to an 18.7% reduction in average employee headcount in this area to
4,029 people during 2005.
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.
CORPORATE AND OTHER EXPENSES
Administrative and general expenses consist primarily of costs associated with
the corporate executive, finance, human resources, administrative, legal and
corporate communications departments. In addition, administrative and general
expenses include all facility-related costs, such as rent, building
depreciation, maintenance, utilities, etc., associated with all of our
locations. Administrative and general expenses decreased $8.0 million or 3.8%,
during 2005 to $199.6 million from $207.6 million in 2004 and increased $18.8
million or 10.0% during 2004 from $188.8 million in 2003.
The decrease in administrative and general expenses for 2005 was primarily
attributable to a decrease in legal fees of approximately $15.9 million due to
reduced legal costs associated with the IBM litigation offset by an increase in
charitable contributions of $3.1 million, increase in compensation and benefits
25
of $2.2 million due to scheduled salary increases and higher depreciation
expense associated with the Detroit headquarters building of approximately $2.1
million.
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 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.
External legal fees for all litigation, including IBM and other matters were
$29.1 million, $45.0 million and $34.6 million in 2005, 2004 and 2003.
Litigation expense was impacted significantly over the last three fiscal years
by the IBM litigation. In March 2005, we entered into a software, services and
technology relationship with IBM and settled all outstanding litigation between
the companies. With the settlement of the IBM litigation, we anticipate that
legal costs should decline significantly in 2006 compared to the last three
fiscal years, barring any unforeseen litigation claims against us.
Other income consists primarily of interest earnings on deferred customer
receivables, interest income realized from investments and income/losses
generated from our investments in partially owned companies. Other income for
2005 was $19.6 million compared to $18.5 million in 2004 and $19.4 million in
2003.
Income taxes are accounted for using the asset and liability approach. Deferred
income taxes are provided for the differences between the tax bases of assets or
liabilities and their reported amounts in the financial statements. The income
tax provision was $29.7 million, $6.2 million and $53.1 million, respectively,
in 2005, 2004 and 2003 which represents an effective tax rate of 28%, 11% and
34%, respectively.
During the quarter ended December 31, 2003, we adjusted our reserves related to
various tax matters. This adjustment resulted in an income tax benefit of $9.5
million relating primarily to favorable tax settlements with the U.S. Internal
Revenue Service (IRS) and developments in other tax matters both in the U.S. and
other taxing jurisdictions. We recorded a net benefit of $4.7 million related to
the completion of an IRS exam which challenged the deductibility of interest
paid on Corporate Owned Life Insurance (COLI) policies. We entered into a
Closing Agreement with the IRS on this matter in October 2003. All COLI policies
have been cancelled. The balance of the adjustment related to revisions in
estimates for reserves related to the U.S. Research and Experimentation tax
credit, an audit of our Australian operations for fiscal years 1996 through
2001, and other income tax reserves no longer deemed necessary. Excluding the
$9.5 million tax benefit, the effective tax rate for 2004 was 28%.
The effective income tax rates for 2005 and 2004 are below the statutory rate
due to the impact of certain tax benefits discussed in Note 12 of the Notes to
Consolidated Financial Statements, included in Item 8 of this report. We expect
changes in pre-tax net income and in the domestic/foreign composition of revenue
to change the relative effect of these tax benefits and to result in an increase
in the effective income tax rate for fiscal 2006.
The decrease in the effective tax rate from 2003 to 2004, excluding the $9.5
million income tax benefit, is primarily due to the higher percentage impact of
certain tax benefit items as a result of the decline in income.
26
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 by better aligning cost structures with
current market conditions. See Note 7 of the Notes to Consolidated Financial
Statements, included in Item 8 of this report, for changes in the restructuring
accrual for 2003, 2004 and 2005.
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Note 1 of the Notes to Consolidated Financial Statements, included in Item 8 of
this report, 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 existing at
March 31, 2005. However, future events rarely develop exactly as forecast, and
the best estimates routinely require adjustment. The 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 vendor specific objective evidence (VSOE) of all
undelivered elements of the agreement (e.g. maintenance and professional
services) is deferred. VSOE is based on rates charged for maintenance and
professional services when sold separately. Based on market conditions, we
periodically change pricing methodologies for license, maintenance and
professional services. Changes in rates charged for stand alone maintenance and
professional services could have an 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. Pricing modifications made
during the years covered by this report have not had a significant impact on the
timing or characterization of revenue recognized.
We have an increasing need for flexibility in licensing rights and offerings to
our customers. As our contractual arrangements evolve to meet the needs of our
customers, an increasing percentage of our license arrangements must be
recognized over the terms of the arrangement. While this ratable recognition has
no impact on our results over time, it may change the timing of forecasted
revenue and impact quarterly results.
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.
27
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 U.S. GAAP including Statement of Position 97-2
"Software Revenue Recognition" and 98-9 "Modifications of SOP 97-2, "Software
Revenue Recognition," With Respect to Certain Transactions", Securities and
Exchange Commission Staff Accounting Bulletin 104 and Emerging Issues Task Force
Issue 00-21 "Revenue Arrangements with Multiple Deliverables", 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 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 customers
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 of the Notes
of Consolidated Financial Statements, included in Item 8 of this report, we have
minority investments in and advances to certain privately held companies for
strategic purposes. At March 31, 2005, the net carrying value of
28
our investments and advances to these entities totaled $21.5 million.
Additionally, we have guaranteed outstanding lease obligations of $5.4 million
at March 31, 2005. 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 of the Notes to Consolidated Financial
Statements, included in Item 8 of this report. 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.
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, 2005, cash and cash equivalents and investments totaled
approximately $866.6 million. During 2005 and 2004, cash flow from operations
was $242.3 million and $258.1 million, respectively. During these periods,
capital expenditures for the Detroit Headquarters facility totaled $10.7 million
and $65.2 million, respectively, and capital expenditures for other property and
equipment and capitalized research and software development totaled $37.3
million and $20.7 million, respectively.
We hold a $100 million revolving credit facility maturing on July 28, 2005. See
Note 9 of the Notes to Consolidated Financial Statements, included in Item 8 of
this report, for a description of the facility. No borrowings have occurred
under this facility.
During fiscal 2005, we implemented a plan to market and sell the former
headquarters building in Farmington Hills, Michigan. The building is classified
in current assets as held for sale. We evaluated whether the current carrying
value of the building was impaired and, based on an independent appraisal of the
building, concluded that no impairment charge should be recorded at March 31,
2005.
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. There were no purchases under this program during 2005.
Approximately $124 million remains for future purchases under this program.
29
In May 2005, the Company acquired privately held Adlex, Incorporated, a
technology development company, for approximately $36 million in cash. The
acquisition will be accounted for as a purchase and, accordingly, assets and
liabilities acquired will be recorded at fair value as of the acquisition date.
During fiscal 2005, we acquired Changepoint and Devstream for approximately $108
million and estimated future payments of $1.9 million. During fiscal 2004, we
acquired certain assets of Covisint LLC for approximately $8.6 million in cash
and liabilities assumed. For more information about these acquisitions, see Note
2 of the Notes to Consolidated Financial Statements, included in Item 8 of this
report.
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, 2005 (in thousands):
Payment Due by Period as of March 31,
------------------------------------------------------------------------------
2011 and
Total 2006 2007 2008 2009 2010 Thereafter
-------- ------- ------- ------- ------- ------- ----------
Contractual obligations:
Operating leases $347,240 $34,038 $27,108 $23,138 $20,077 $11,572 $ 231,307
Other (1) 9,175 7,575 200 200 200 200 800
-------- ------- ------- ------- ------- ------- ---------
Total $356,415 $41,613 $27,308 $23,338 $20,277 $11,772 $ 232,107
======== ======= ======= ======= ======= ======= =========
(1) - Other includes $7.3 million of commitments to various Detroit area
charities and a $1.9 million advertising agreement.
Off-Balance Sheet Arrangements
As discussed in Note 5 of the Notes to Consolidated Financial Statements,
included in Item 8 of this report, 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, 2005, CareTech's outstanding lease obligations were
approximately $5.4 million.
We currently do not have any non-consolidated special purpose entity
arrangements.
30
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 Note 1 of the
Notes to Consolidated Financial Statements, included 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, marketable debt securities and long term debt investments are
classified as held-to-maturity or as available-for-sale which does not expose
the consolidated statements of operations to fluctuations in interest rates.
The table below provides information about our investment portfolio. For
investment securities, the table presents principal cash flows and related
weighted average interest rates by expected maturity dates (in thousands, except
interest rate):
Year Ended March 31, Fair Value at
-------------------------------
2006 2007 2008 Total March 31, 2005
-------- ------- ---- -------- --------------
Cash Equivalents $497,687 $497,687 $497,687
Average Interest Rate 2.35% 2.35%
Investments $299,715 $69,169 $368,884 $367,277
Average Interest Rate 1.89% 2.06% 1.92%
Average Interest Rate (tax equivalent) 2.46% 2.84% 2.53%
We offer financing arrangements with installment payment terms in connection
with our multi-year software sales. Installment accounts are generally
receivable over a two to five year period. As of March 31, 2005, non-current
accounts receivable amounted to $248.7 million, and are due approximately $144.6
million, $69.2 million, $27.2 million, $7.1 million and $573,000 in each of the
years ending March 31, 2007 through 2011, respectively. The fair value of
non-current accounts receivable is estimated by discounting the future cash
flows using the current rate at which the company would finance a similar
transaction. At March 31, 2005, the fair value of such receivables is
approximately $246.5 million. Each 25 basis point increase in interest rates
would have an associated $450,000 and $600,000 negative impact on the fair value
of non-current accounts receivable based on the balance of such receivables at
March 31, 2005 and 2004, respectively. A change in interest rates will have no
impact on cash flows or net income associated with non-current accounts
receivable.
FOREIGN CURRENCY RISK
We have entered into forward foreign exchange contracts primarily to hedge
amounts due to or from select subsidiaries denominated in foreign currencies
(mainly in Europe and Asia-Pacific) against fluctuations in exchange rates. Our
accounting policies for these contracts are based on our designation of the
contracts as hedging transactions. The criteria we use for designating a
contract as a hedge include the contract's effectiveness in risk reduction and
one-to-one matching of derivative instruments to underlying transactions. Gains
and losses on forward foreign exchange contracts are
31
recognized in income, offsetting foreign exchange gains or losses on the foreign
balances being hedged. If the underlying hedged transaction is terminated
earlier than initially anticipated, the offsetting gain or loss on the related
forward foreign exchange contract would be recognized in income in the same
period. In addition, since we enter into forward contracts only as a hedge, any
change in currency rates would not result in any material net gain or loss, as
any gain or loss on the underlying foreign currency denominated balance would be
offset by the gain or loss on the forward contract. We operate in certain
countries in Latin America and Asia-Pacific where there are limited forward
currency exchange markets and thus we have unhedged transaction exposures in
these currencies.
The table below provides information about our foreign exchange forward
contracts at March 31, 2005. The table presents the value of the contracts in
U.S. dollars at the contract maturity date and the fair value of the contracts
at March 31, 2005 (in thousands, except contract rates):
Contract Maturity Forward Fair
date in date in Contract Position in Value at
2005 2005 Rate U.S. Dollars March 31, 2005
-------- -------- -------- ------------ --------------
Forward Sales
Pounds Sterling March 31 April 30 0.5320 $ 6,109 $ 6,145
Forward Purchases
Danish Krone March 31 April 30 5.7597 434 435
Euro Dollar March 31 April 30 0.7705 15,536 15,515
Hong Kong Dollar March 31 April 30 7.7901 5,584 5,577
Japanese Yen March 31 April 30 106.5080 2,019 2,006
Singapore Dollar March 31 April 30 1.6475 971 969
-------- -------
$ 24,544 $24,502
======== =======
Approximately 30% of our revenue is derived from foreign sources. This exposes
us to exchange ra