ITEM 1.
BUSINESS
We deliver services, software and best practices that enable our customers’ most important technologies to perform at their peak. Originally founded in 1973 as a professional services company, we began to offer mainframe productivity tools that information technology organizations (“IT”) used for fault diagnosis, file and data management, and application debugging in the late 1970's.
In the 1990's and 2000’s, our customers moved toward distributed and web-based platforms and more recently hosted services via the Internet (“cloud computing”). Our solutions portfolio grew in response, and we now market a comprehensive portfolio of solutions across the full range of enterprise computing platforms that help:
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Optimize the user experience, performance, availability and quality of web, non-web and mobile applications.
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Securely share and integrate vital information and processes across users, business partners, customers, vendors and suppliers.
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Maximize the profitability and efficiency of professional services engagements.
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Provide executive visibility, decision support and process automation to align IT resources with business priorities.
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Develop and deliver high-quality, high-performance enterprise applications in a timely and cost-effective manner.
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Increase productivity and reduce operational costs on the mainframe platform.
Our software products are used via software that is installed and run on our customers’ owned hardware and applications (“on-premises”). Our web performance and applications solutions are accessed by our customers through our on-demand hosted networks (see Technology and Network Operations section).
We operate in four business segments in the software and technology services industries: products, web application performance management services, professional services and application services (see note 15 of the consolidated financial statements included in this report).
For a discussion of developments in our business during fiscal 2011, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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. Our Internet address is www.compuware.com. Our Codes of Conduct and our Board committee charters, as well as copies of reports we file with the Securities and Exchange Commission are available in the investor relations section of our external web site 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.
This report contains certain forward-looking statements within the meaning of the federal securities laws. When we use words such as “may”, “might”, “will”, “should”, “believe”, “expect”, “anticipate”, “estimate”, “continue”, “predict”, “forecast”, “projected”, “intend” or similar expressions, or make statements regarding our future plans, objectives or expectations, we are making forward-looking statements. Numerous important factors, risks and uncertainties affect our operating results, including, without limitation, those discussed in Item 1A.
ITEM 1A.
RISK FACTORS
An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that we believe may affect us are described below. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are not aware of or focused on or that we currently deem immaterial may also impair business operations. This report is qualified in its entirety by these risk factors. If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and shareholders could lose all or part of their investment.
A substantial portion of our products segment revenue is dependent on our customers’ continued use of International Business Machines Corporation and IBM-compatible products.
A substantial portion of our revenue from software products is generated from products designed for use with IBM and IBM-compatible mainframe operating systems. As a result, the majority of our revenue from software products is dependent on our customers’ continued use of these systems. In addition, because our products operate in conjunction with IBM operating systems software, changes to IBM’s mainframe operating systems may require us to adapt our products to these changes. IBM also provides competing products designed for use with their mainframe operating systems. A decline in our customers’ use of IBM and IBM-compatible mainframe operating systems, our inability to keep our products current with changes to IBM’s mainframe operating systems on a timely basis, or the loss of market share to IBM’s competing products could have a material adverse effect on our results of operations and cash flow.
Our product revenue is dependent on the acceptance of our pricing structure for software licenses, maintenance services and web performance services.
The pricing of our software licenses, maintenance services and web performance services is under constant pressure from customers and competitive vendors that can negatively impact our product revenue. These competitive pressures could have a material adverse effect on our results of operations and cash flow.
Maintenance revenue could continue to decline.
Our maintenance revenue has been negatively affected by reduced pricing for mainframe maintenance renewals and the decline in new mainframe maintenance arrangements. If we are unable to increase new product sales and maintenance contract renewals to outpace the combined impact of maintenance cancellations, reduced pricing for maintenance renewals and currency fluctuations, our maintenance revenues will continue to decline, which could have a material adverse effect on our results of operations and cash flow.
The markets for web performance services are at an early stage of development with emerging competitors. If these markets do not develop or develop more slowly than we expect, or if there is an increase in competition, our revenue may decline or fail to grow.
We derive revenue from providing on-demand web performance services. While web applications have become increasingly significant for a growing number of companies, the market for web performance services is in an early stage of development, and it is uncertain whether these services will achieve and sustain high levels of demand and market acceptance. Growth in revenue generated from these services will depend on the willingness of organizations to increase their use of web performance services. Some businesses may be reluctant or unwilling to use these services for a number of reasons, including failure to perceive the need for improved testing and monitoring of web applications and lack of knowledge about the potential benefits these services may provide. This market is also competitive and rapidly changing, and several of our competitors have greater financial and marketing resources than we do. As a result, our competitors may be more efficient and effective at achieving the following principal competitive factors affecting the market for web performance services: real-time availability of data and reporting, the proven performance, security, scalability, flexibility and reliability of services offered; the usability of services offered, including ease of implementation and use; number of measurement points; and pricing. If we are less successful at achieving one or more of these factors than our competitors or the demand for web performance services declines or does not grow, we may lose market share which could have a material adverse effect on our business, financial condition and operating results.
The success of our combined Vantage and web performance services solutions, including First Mile, is dependent on customer acceptance of these offerings.
Our Vantage and web performance services solutions are currently sold within the APM market. We have begun to market solutions that combine Vantage with our web performance services, such as First Mile, which integrates components of Vantage and our web performance services into a single solution that measures the performance of our customer’s web application delivery chain. The level of customer acceptance regarding First Mile and other combined solutions is difficult to estimate since we believe there are no comparable solutions in the APM market and because the APM market is relatively new and rapidly changing. The level of acceptance of our APM solutions as value added by current and potential customers will impact sales volume and pricing of the APM solutions and can be negatively impacted by competition, our customers’ ability to effectively implement the solutions and the perceived value customers receive from the performance information provided by the solutions. We consider our combined APM solutions to be an integral part of our revenue growth in the future. If these combined solutions are not perceived as value added by customers within the APM market, we may not meet our future revenue projections for our Vantage and web performance services and our results of operations could be negatively impacted.
Changes to our organizational structure can be disruptive and may negatively impact our results of operations.
We recently announced our Compuware 3.0 initiative under which we will reorganize our operations into solution business units for APM, Changepoint, Mainframe, Uniface, Professional Services and Application Services. As part of this reorganization we will combine the Vantage and Web performance solutions into one operating unit. Risks associated with reorganizations include the potential distraction of management, risk of decreased productivity of our sales force and turnover of key personnel, which could negatively impact our financial results.
The market for application services is in its early stages of development with emerging competitors. As the market matures, competition may increase and could have a material negative impact on our results of operations.
Several of our competitors in the application services market have substantially greater financial, marketing, recruiting and training resources than we do. As a result, our competitors may be more efficient and effective at achieving the following principal competitive factors affecting the market for application services: speed of implementation, reduced risk related to regulatory compliance and implementation problems, inclusion of state of the art technology features, solution performance, ability to meet customer service level requirements and price. If we are less successful at achieving one or more of these factors than our competitors, we may lose market share which could have a material adverse effect on our business, financial condition and operating results.
If we are not successful in implementing our professional services strategy, our operating margins may decline materially.
Our business strategy for the professional services segment is to sustain the segment’s operating margin by requiring certain margin thresholds for all new business and managing the segment operating expenses accordingly. If our customers will not accept the billing rates necessary to achieve these minimum thresholds, our revenues and operating margins may be negatively impacted which could have a material adverse effect on our results of operations and cash flow.
We may fail to achieve our forecasted financial results due to inaccurate sales forecasts or other unpredictable factors. If we fail to meet the expectations of analysts or investors, our stock price could decline substantially.
Our revenues, particularly our software license revenues, are difficult to forecast. Software license revenues in any quarter are substantially dependent on orders booked in the quarter. Our sales personnel monitor the status of all proposals and estimate when a customer will make a purchase decision and the dollar amount of the sale. These estimates are aggregated periodically to generate the sales forecast. Our sales forecast estimates could prove to be unreliable both in a particular quarter and over a longer period of time as a significant amount of our transactions are completed during the final weeks and days of the quarter. Therefore, we generally do not know whether revenues or earnings will have met expectations until after the end of the quarter. Also, the manner in which our customers license our products can cause revenues to be deferred or recognized ratably over time. These changes in the mix of customer agreements could adversely affect our revenues. As a result, our actual financial results can vary substantially from our forecasted results.
In addition, investors should not rely on the results of prior periods or on historical seasonality in license revenue as an indication of our future performance. Our operating expense levels are relatively fixed in the short-term and are based, in part, on our expectations of future revenue. If we have unanticipated lower sales in any given quarter, we will not be able to reduce our operating expenses for that quarter proportionately in response. Therefore, net income may be disproportionately affected by a fluctuation in revenue.
Any significant shortfall in revenues or earnings, or lowered expectations could cause our common stock price to decline.
Economic uncertainties or slowdowns may reduce demand for our products and services, which may have a material adverse effect on our revenues and operating results.
Our revenues and profitability depend on the overall demand for our software products, web performance services, professional services and application services. Economic uncertainties over the last few years have resulted in companies reassessing their spending for technology projects. If the economies within the United States and/or other geographic regions in which we operate experience a slowdown or recession, it could have a material adverse effect on our results of operations and cash flow.
Defects or disruptions in our web performance services or application services networks or interruptions or delays in service would impair the delivery of our on-demand service and could diminish demand for our services and subject us to substantial liability.
Defects in our web performance services or application services networks could result in service disruptions for our customers. Our network performance and service levels could be disrupted by numerous events, including natural disasters and power losses. We might inadvertently operate or misuse the system in ways that could cause a service disruption for some or all of our customers. We might have insufficient redundancy or server capacity to address any such disruption, which could result in interruptions in our services or degradations of our service levels. Our customers might use our web performance services in ways that cause a service disruption for other customers. These defects or disruptions could undermine confidence in our services and cause us to lose customers or make it more difficult to attract new ones, either of which could have a material adverse effect on our results of operations and cash flow.
Future changes in the U.S. domestic automotive manufacturing business could reduce demand for our professional services and application services, which may have a material negative effect on our revenues and operating results.
A substantial portion of our worldwide professional services revenue, which includes the professional services segment and the application services segment, has been generated from customers in the automotive industry, with General Motors Company currently our largest customer.
While economic conditions for the automotive sector have improved, many of our customers in the domestic automotive industry have been engaged in restructuring and other efforts to cut costs, including IT expenditures. Any new negative developments in this industry, including additional bankruptcies, could reduce the demand for our services and increase the collection risk of accounts receivable from these customers, which could have a material adverse effect on our professional and application services results of operations and operating margin in this business.
If the fair value of our long-lived assets deteriorated below the carrying value of these assets, recognition of an impairment loss would be required, which could materially and adversely affect our financial results.
We evaluate our long-lived assets, including property and equipment, goodwill, acquired product rights and other intangible assets, whenever events or circumstances occur that may indicate these assets are impaired or periodically as required by generally accepted accounting principles. In the continuing process of evaluating the recoverability of the carrying amount of our long-lived assets, there is the possibility that we could identify a substantial impairment, which could have a material adverse effect on our results of operations.
Our software technology may infringe the proprietary rights of others.
Our software technology is developed or enhanced internally or acquired through acquisitions.
All employees sign an agreement that states the employee was hired for his or her talent and skill rather than for any trade secrets or proprietary information of others of which he or she may have knowledge. Further, our employees execute an agreement stating that work developed for us or our clients belongs to us or our clients, respectively.
During the due diligence stage of any software technology acquisition, we research and investigate the title to the software technology we would be acquiring from the seller. This investigation generally includes without limitation, litigation searches, copyright and trademark searches, review of development documents and interviews with key employees of the seller regarding development, title and ownership of the software technology being acquired. The acquisition agreement itself generally contains representations, warranties and covenants concerning the title and ownership of the software technology as well as indemnification and remedy provisions in the event the representations, warranties and covenants are breached by the seller.
Although we use all reasonable efforts to ensure we do not infringe on third party intellectual property rights, there can be no assurance that third parties will not assert infringement claims against us with respect to our current and future software technology or that any such assertion will not require us to enter into royalty arrangements or result in costly litigation.
Our results could be adversely affected by increased competition, pricing pressures and technological changes within the software products market.
The markets for our software products are highly competitive. We consider over 40 firms to be directly competitive with one or more of our products and several of these have greater financial and marketing 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, sales channels, vendor reputation and price. 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 sales, product development and customer support. To be successful in the future, we must respond promptly and effectively to our customers’ purchasing methodologies, challenges of technological change and our competitors' innovations by continually enhancing our product offerings.
We operate in an industry characterized by rapid technological change, evolving industry standards, changes in customer requirements and frequent new product introductions and enhancements. If we fail to keep pace with technological change in our industry, such failure would have an adverse effect on our revenues. During the past several years, many new technological advancements and competing products entered the marketplace. To the extent that our current product portfolio does not meet such changing requirements, our revenues will suffer. Delays in new product introductions or less-than-anticipated market acceptance of these new products are possible and could have a material adverse effect on our revenues.
Developers of third party products, including operating systems, databases, systems software, applications, networks, servers and computer hardware, frequently introduce new or modified products. These new or modified third party products could incorporate features which perform functions currently performed by our products or could require substantial modification of our products to maintain compatibility with these companies’ hardware or software. While we have generally been able to adapt our products and our business to changes introduced by new or modified third party product offerings, there can be no assurance that we will be able to do so in the future. Failure to adapt our products in a timely manner to such changes or customer decisions to forego the use of our products in favor of those with comparable functionality contained either in the hardware or other software could have a material adverse effect on our results of operations and cash flow.
The market for professional services is highly competitive, fragmented and characterized by low barriers to entry.
We have numerous competitors in the professional services markets in which we operate. 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, ability to demonstrate achievement of results and price. There is no assurance that we will be able to compete successfully in the future.
We must develop or acquire product enhancements and new products to succeed.
Our success depends in part on our ability to develop product enhancements and new products that keep pace with continuing changes in technology and customer preferences. The majority of our products have been developed from acquired technology and products. We believe that our future growth lies, in part, in continuing to identify, acquire and then develop promising technologies and products. While we are continually searching for acquisition opportunities, there can be no assurance that we will continue to be successful in identifying, acquiring and developing products and technology. If any potential acquisition opportunities are identified, there can be no assurance that we will consummate and successfully integrate any such acquisitions and there can be no assurance as to the timing or effect on our business of any such acquisitions. Our failure to develop technological improvements or to adapt our products to technological change may, over time, have a material adverse effect on our business.
Acquisitions may be difficult to integrate, disrupt our business or divert the attention of our management and may result in financial results that are different than expected.
As part of our overall strategy, we have acquired or invested in, and plan to continue to acquire or invest in, complementary companies, products, and technologies and may enter into joint ventures and strategic alliances with other companies. Risks commonly encountered in such transactions include: the difficulty of assimilating the operations and personnel of the combined companies; the risk that we may not be able to integrate the acquired technologies or products with our current products and technologies; the potential disruption of our ongoing business; the inability to retain key technical, sales and managerial personnel; the inability of management to maximize our financial and strategic position through the successful integration of acquired businesses; the risk that revenues from acquired companies, products and technologies do not meet our expectations; and decreases in reported earnings as a result of charges for in-process research and development and amortization of acquired intangible assets.
For us to maximize the return on our investments in acquired companies, the products of these entities must be integrated with our existing products. These integrations can be difficult and unpredictable, especially given the complexity of software and that acquired technology is typically developed independently and designed with no regard to integration. The difficulties are compounded when the products involved are well-established because compatibility with the existing base of installed products must be preserved. Successful integration also requires coordination of different development and engineering teams. This too can be difficult and unpredictable because of possible cultural conflicts and different opinions on technical decisions and product roadmaps. There can be no assurance that we will be successful in our product integration efforts or that we will realize the expected benefits.
With each of our acquisitions, we have initiated efforts to integrate the disparate cultures, employees, systems and products of these companies. Retention of key employees is critical to ensure the continued development, support, sales and marketing efforts pertaining to the acquired products. We have implemented retention programs to keep many of the key technical and sales employees of acquired companies. Nonetheless, we have lost some key employees and may lose others in the future.
We are exposed to exchange rate risks on foreign currencies and to other international risks that may adversely affect our business and results of operations.
Over one-third of our total revenues are derived from foreign operations and we expect that foreign operations will continue to generate a significant percentage of our total revenues. Products and services are generally priced in the currency of the country in which they are sold. Changes in the exchange rates of foreign currencies or exchange controls may adversely affect our results of operations. The international business environment is also subject to other risks, including the need to comply with foreign and U.S. laws and the greater difficulty of managing business operations overseas. In addition, our foreign operations are affected by general economic conditions in the international markets in which we do business. A worsening of economic conditions in these markets could cause customers to delay or forego decisions to license new products or to reduce their requirements for professional and application services.
Current laws may not adequately protect our proprietary rights.
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. We have many patents and many patent applications pending. However, existing patent and copyright laws afford only limited practical protection. 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. Any claims against those who infringe on our proprietary rights can be time consuming and expensive to prosecute, and there can be no assurance that we would be successful in protecting our rights despite significant expenditures.
The loss of certain key employees and technical personnel or our inability to hire additional qualified personnel could have a material adverse effect on our business.
Our success depends in part upon the continued service of our key senior management and technical personnel. Such personnel are employed at-will and may leave Compuware at any time. Our success also depends on our continuing ability to attract and retain highly qualified technical, managerial and sales personnel. The market for professional services and software products personnel has historically been, and we expect that it will continue to be, intensely competitive. There can be no assurance that we will continue to be successful in attracting or retaining such 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.
Unanticipated changes in our effective tax rates, or exposure to additional income tax liabilities, could affect our profitability.
We are subject to income taxes in both the United States and numerous foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. One of the components that needs to be evaluated is the realization of our deferred tax assets. We must assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. Changes in estimates of projected future operating results or in assumptions regarding our ability to generate future taxable income could result in significant increases to our total valuation allowance and tax expense that would reduce net income.
In addition, we recognize reserves for uncertain tax positions through tax expense for estimated exposures related to our current and historical tax positions. We evaluate the need for reserves for uncertain tax positions 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 reserves for uncertain tax positions.
We are also subject to routine corporate income tax audits in the jurisdictions in which we operate. Our provision for income taxes includes amounts intended to satisfy income tax assessments that are likely to result from the examination of our corporate tax returns that have been filed in these jurisdictions. The amounts ultimately paid upon resolution of these examinations could be materially different from the amounts included in the provision for income taxes and result in increases to tax expense.
Our stock repurchase plan may be suspended or terminated at any time, which may result in a decrease in our stock price.
We have repurchased shares of our common stock in the market during the past several years and currently repurchase shares under an arrangement pursuant to which management is permitted to determine the amount and timing of repurchases in its discretion subject to an overall limit. Our ability and willingness to repurchase shares is subject to, among other things, the availability of cash resources and credit at rates and upon terms we believe are prudent. Stock market conditions, the market value of our common stock and other factors may also make it imprudent for us from time to time to engage in repurchase activity. There can be no assurance that we will continue to repurchase shares at historic levels or at all. If our repurchase program is curtailed, our stock price may be negatively affected.
Acts of terrorism, acts of war and other unforeseen events may cause damage or disruption to us or our customers, which could materially and adversely affect our business, financial condition and operating results.
Natural disasters, acts of war, terrorist attacks and the escalation of military activity in response to such attacks or otherwise may have negative and significant effects, such as imposition of increased security measures, changes in applicable laws, market disruptions and job losses. Such events may have an adverse effect on the economy in general. Moreover, the potential for future terrorist attacks and the national and international responses to such threats could affect the business in ways that cannot be predicted. The effect of any of these events or threats could have a material adverse effect on our business, financial condition and results of operations.
Our articles of incorporation, bylaws and rights agreement as well as certain provisions of Michigan law may have an anti-takeover effect.
Provisions of our articles of incorporation and bylaws, Michigan law and the Rights Agreement, dated October 25, 2000, as amended, between Compuware Corporation and Computershare Trust Company, N.A., as rights agent, could make it more difficult for a third party to acquire Compuware, even if doing so would be perceived to be beneficial to shareholders. The combination of these provisions inhibits a non-negotiated acquisition, merger or other business combination involving Compuware, which, in turn, could adversely affect the market price of our common stock.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None
ITEM 2.
ITEM 2.
PROPERTIES
Our executive offices, one of our research and development labs, principal marketing department, primary professional and application services office, customer service and support teams are located in our corporate headquarters building in Detroit, Michigan. We own the facility, which is approximately 1.1 million square feet, including approximately 289,000 square feet designated for lease to third parties for office, retail and related amenities and approximately 3,200 square feet donated for use by local not-for-profit organizations. In addition, we lease approximately 217,000 square feet of land on which the facility resides.
We lease approximately 93 sales and professional services offices in 29 countries, including 5 remote product research and development facilities.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
The Company is subject to various legal proceedings and claims that arise in the ordinary course of business. The Company does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company's consolidated financial position, results of operations and cash flows.
PART II
ITEM 5.
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 Global Select Market (“NASDAQ”) under the symbol CPWR. As of May 13, 2011, there were 3,865 shareholders of record of our common stock. We have not paid any cash dividends on our common stock since fiscal 1986 and have no current intention 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.
Issuance of Unregistered Shares
As disclosed in the Company's annual meeting proxy statement, Peter Karmanos, Jr., the Company's Chief Executive Officer, purchases common shares from the Company on the same terms and subject to the same conditions and limitations as provided in the Company's Employee Stock Purchase Plan (“ESPP”) with respect to all other employees of the Company, although he does not participate in the ESPP directly and is not entitled to the favorable tax treatment afforded to participants in the ESPP due to his beneficial ownership of more than 5% of the Company's outstanding shares. The description of the ESPP included in note 18 of the consolidated financial statements included in this report, is incorporated herein by reference. The Company has treated for administrative purposes the shares purchased by Mr. Karmanos as purchases pursuant to the ESPP. However, since he is not allowed to participate in the ESPP while he remains a 5% owner, the issuance of shares may be considered unregistered. On February 28, 2011, 2,427 shares were issued to Mr. Karmanos for $10.64 per share under this arrangement (a total of $25,823). Mr. Karmanos continues to hold all shares purchased under this arrangement. The sales of these securities to Mr. Karmanos were exempt from the registration requirements of the Securities Act of 1933 in reliance on Section 4(2) of the Securities Act as transactions by an issuer not involving a public offering. There were no underwriters involved in connection with the sale of the above securities.
Common Share Repurchases
The following table sets forth, the repurchases of common stock for the quarter ended March 31, 2011:
(1)
The month ended March 31, 2011 includes 263,380 shares withheld for taxes resulting from certain stock options that were exercised in March 2011.
(2)
Our purchases of common stock may occur on the open market or in negotiated or block transactions based upon market and business conditions. Unless terminated earlier by resolution of our Board of Directors, the discretionary share repurchase plan will expire when we have repurchased all shares authorized for repurchase thereunder. The maximum amount of repurchase activity under the repurchase plan continues to be limited on a daily basis to 25% of the average trading volume of our common stock for the previous four week period. In addition, no purchases are made during our self-imposed trading black-out periods in which the Company and our insiders are prohibited from trading in our common shares.
Comparison of Cumulative Five Year Total Return
The following line graph compares the yearly percentage change in the cumulative total shareholder return on our common shares with the cumulative total return of each of the following indices: the S&P 500 Index, the NASDAQ Market Index and the NASDAQ Computer and Data Processing Index for the period from April 1, 2006 through March 31, 2011. The graph includes a comparison to the S&P 500 Index in accordance with SEC rules, as the Company's common stock is part of such index. The graph assumes the investment of $100 in our common shares, the S&P 500 Index and each of the two NASDAQ indices on March 31, 2006 and the reinvestment of all dividends.
The comparisons in the graph are required by applicable SEC rules. You should be careful about drawing any conclusions from the data contained in the graph, because past results do not necessarily indicate future performance. The information contained in this graph shall not be deemed to be "soliciting material" or "filed" with the SEC or subject to the liabilities of Section 18 of the Exchange Act, except to the extent that we specifically incorporate it by reference into a document filed under the Securities Act or the Exchange Act.
The additional information required in this section is contained in Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters of this report and is incorporated herein by reference.
ITEM 6.
ITEM 6.
SELECTED 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
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this section, we discuss our results of operations on a segment basis. We operate in four business segments in the technology industry: products, web application performance management services, professional services and application services. We evaluate segment performance based primarily on segment contribution which represents operating profit before administrative and general expenses and other charges (“contribution margin”). References to years are to fiscal years ended March 31 unless otherwise specified. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and notes included in Item 8 of this report.
Our on-premises enterprise application management products, specifically Vantage, and our web application performance management services (“web performance services”) allow us to offer IT organizations comprehensive solutions that effectively monitor the performance of their enterprise and Internet application systems. Because of this relationship, we use the term “product software” to refer to both the products segment and web performance services segment. The revenue for the web performance services segment is referred to as subscription fees and reported with maintenance in the consolidated statement of operations. Additionally, the research and development costs and sales and marketing costs for our products segment and web performance services segment are combined and reported as “technology development and support” and “sales and marketing”, respectively, in the consolidated statements of operations. As a result, “technology development and support”, “sales and marketing” and contribution margins for the products segment and web performance services segment will be analyzed on a combined, product software basis within this section.
FORWARD-LOOKING STATEMENTS
The following discussion contains certain forward-looking statements within the meaning of the federal securities laws. When we use words such as “may”, “might”, “will”, “should”, “believe”, “expect”, “anticipate”, “estimate”, “continue”, “predict”, “forecast”, “projected”, “intend” or similar expressions, or make statements regarding our future plans, objectives or expectations, we are making forward-looking statements. Numerous important factors, risks and uncertainties affect our operating results, including, without limitation, those discussed in Item 1A. Risk Factors and elsewhere in this report, 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.
OVERVIEW
We deliver value to businesses by providing software products, web performance services, professional services, and application services that improve the performance of information technology organizations.
Our primary source of profitability and cash flow is the sale of our mainframe productivity tools (“mainframe”) that are used within our customers’ mainframe computing environments for fault diagnosis, file and data management, application performance monitoring and application debugging. We have experienced lower volumes of software license deals for our mainframe solutions causing our mainframe product revenue to decline. Changes in our current customer IT computing environments and spending habits have impacted their need for additional mainframe computing capacity. In addition, increased competition and pricing pressures have had an impact on revenues. Our customers utilize our products to reduce operating cost, increase programmer productivity and create a smooth labor force transition to the next generation of mainframe environment programmers. We will continue to make strategic enhancements to our mainframe solutions through research and development investments with the goal of meeting these needs and maintaining a maintenance renewal rate in excess of 90%.
The cash flow generated from our mainframe solutions has allowed us to make significant investments in our APM and application services solutions. This investment includes the addition of web performance services through the acquisition of Gomez in November 2009 and research and development expenditures that enhance our Vantage and web performance services solutions.
We have identified the APM market as one of our primary targets for revenue growth. Web applications and the complex distributed applications delivery chain supporting them have become increasingly critical to a company’s brand awareness, revenue growth and overall market share. Because of this, the market for APM solutions is large and is growing rapidly. Our web performance services, which are marketed under the brand name “Gomez” and provided on a SaaS platform, and our Vantage solutions ensure the optimal performance of these applications across the enterprise, the Internet and the cloud.
To support the growth initiatives for our APM product line, we are developing solutions that combine the technology from our Vantage products with technology from our web performance services. During the third quarter of 2011, we released a controlled launch of our First Mile solution which integrates components of Vantage and our web performance services into a single solution that measures the performance of our customer’s web application delivery chain, including elements that reside both within the customer’s data center and on the Internet, displaying performance information through a single dashboard. We anticipate these combined solutions will add value to our customers and provide us opportunities to sell additional non-integrated Vantage products and web performance services driving future APM revenue growth.
We have also identified the secured collaboration service market as a growth business. Our application services, which are marketed under the brand name “Covisint” and provided on a SaaS platform, globally connect business communities, organizations and systems allowing the secure sharing of vital business information, applications and business processes across their internal and extended enterprise. The market for these services is growing, particularly in the healthcare industry as hospitals, physicians and the United States government move towards establishing electronic patient health and medical records which will require secure computerized databases and environments for storing and sharing of information. A significant amount of government funding for this conversion to electronic health and medical records is dependent on the dispersal of federal stimulus funds.
We continue to enhance our Changepoint and Uniface solutions primarily through research and development expenditures.
Our Changepoint solution provides a single automated solution for professional services organizations to forecast and plan; and manage resources, projects and client engagements. In addition, for project-centric organizations, Changepoint provides a cohesive and consolidated view of projects, investments, resources and applications to help manage the entire business portfolio.
Our Uniface solution is mature with over 25 years on the market. Uniface is a rapid application development environment for building, renewing and integrating the latest complex enterprise applications. We continue to make investments in Uniface to make available the benefits of the Uniface development environment across an expanded range of technologies, and with additional features.
The professional services segment began a transformation during the second half of 2009 when management decided to exit low-margin engagements and focus resources on more profitable engagements. This significantly improved the segment’s contribution margin but resulted in a significant revenue decline. This transformation is complete and we experienced year-over-year quarterly growth in revenue during the fourth quarter of 2011. We anticipate modest revenue and contribution margin growth within the segment going forward as we focus on effectively demonstrating the value of our service offerings to customers.
In May 2009, we exited the Quality and Testing business by selling our Quality and DevPartner distributed product lines (“divested products”) to Micro Focus International PLC (“Micro Focus”).
In early fiscal 2012, Compuware announced its 3.0 initiative. The Compuware 3.0 organizational model features a business unit structure for our APM, Changepoint, Mainframe, Uniface, Covisint and Professional Services lines of business. We believe this structure will maximize our market agility and responsiveness, enabling us to capitalize on market conditions and competitive advantages for maximum growth and profitability. As a result of this organizational change we will modify our reporting units and segments in fiscal 2012 to be consistent with this business unit structure.
Annual Update
The following occurred during fiscal 2011:
·
Achieved an increase in distributed product revenue of 5.5% (13.2% excluding divested products) in fiscal 2011 as compared to fiscal 2010 and experienced a decline in mainframe product revenue of 7.1% during the same period.
·
Realized a decrease in product software (includes product and web performance services) contribution margin to 40.4% in fiscal 2011 compared to 50.9% in fiscal 2010, as reported, and 42.9% excluding the gain on divestiture of $52.4 million in fiscal 2010.
·
Experienced an increase in professional services segment contribution margin to 13.7% in fiscal 2011 from 10.9% in fiscal 2010.
·
Experienced an increase in application services segment contribution margin to 7.3% in fiscal 2011 from 6.3% in fiscal 2010 and achieved an increase in application services revenue of 36.0% in fiscal 2011 as compared to fiscal 2010.
·
Acquired certain assets and liabilities of DocSite, LLC and BEZ Systems, Inc., for $15.9 million and $2.5 million, respectively, in cash (see note 2 of the consolidated financial statements included in this report for additional information).
·
Received $75.4 million, net of excess tax benefits, in financing cash flow from employees exercising stock options.
·
Repurchased approximately 16.9 million shares of our common stock at an average price of $9.52 per share as part of our discretionary stock repurchase plan.
·
Released 12 distributed and 16 mainframe product updates designed to increase the productivity of the IT departments of our customers.
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:
*
Web performance services segment revenue is referred to as subscription fees and combined with maintenance in the consolidated statements of operations included in this report.
**
The professional services segment and the application services segment are combined and reported as professional services in the consolidated statements of operations included in this report.
PRODUCT SOFTWARE
Financial information for the product software business was as follows (in thousands):
The product software business generated a contribution margin of 40.4% during fiscal 2011 compared to 50.9% and 45.8% during fiscal 2010 and fiscal 2009, respectively.
The decrease in the contribution margin in fiscal 2011 compared to fiscal 2010 was primarily due to the gain on divestiture of $52.4 million recorded during fiscal 2010 due to the sale of our Quality and DevPartner product lines (“Quality Divestiture”). See note 3 of the consolidated financial statements included in this report. Excluding this gain, the contribution margin for fiscal 2010 would have been 42.9%. The remaining decrease in contribution margin was primarily due to investments in our web performance services business which increased expenses for the year and, to a lesser extent, the decline in mainframe software license and maintenance fees.
The increase in the contribution margin in fiscal 2010 compared to fiscal 2009 was primarily due to the $52.4 million gain recorded in the Quality Divestiture, partially offset by the effect of the decline in mainframe product revenue.
Product Software Revenue
Revenue for the products and web performance services segments was as follows (in thousands):
*
Divested products software license and maintenance fees relate to our Quality and DevPartner product lines that were sold during fiscal 2010. See note 3 of the consolidated financial statements included in this report. For comparison purposes, we are excluding divested products from our software license and maintenance fees.
**
The web performance services segment began when we acquired Gomez, Inc. in November 2009. See note 2 of the consolidated financial statements included in this report.
Product software revenue by geographic location is presented in the table below (in thousands):
Product software revenue, which consists of software license fees, maintenance fees and subscription fees, comprised 73.4%, 73.0% and 64.1% of total revenue during fiscal 2011, 2010 and 2009, respectively.
Software license fees
Software license fees (“license fees”) increased slightly during fiscal 2011 to $194.7 million, which included a positive impact from foreign currency fluctuations of $1.6 million, and decreased $25.1 million or 11.4% during fiscal 2010 to $194.5 million, which included a positive impact from foreign currency fluctuations of $3.1 million, from $219.6 million in fiscal 2009.
Excluding the $8.7 million impact from divested products, license fees increased $9.0 million or 4.8% during fiscal 2011 as compared to fiscal 2010. The increase was due to the growth in our distributed license fees primarily attributable to our Vantage product line which increased $18.8 million or 31.8% as industry demand for APM solutions continued to grow, and a $3.6 million increase with our Uniface product line. The increase in distributed license fees was partially offset by a $13.1 million decline in Mainframe license fees as two large transactions expected to close in fiscal 2011 were delayed and expected to close during the first half of fiscal 2012.
Excluding the $17.4 million impact from divested products, license fees decreased $7.7 million or 4.0% during fiscal 2010 as compared to fiscal 2009. Mainframe products accounted for $4.8 million of the decrease and our distributed products accounted for $2.9 million of the decrease. Our distributed product decline was primarily due to a $6.2 million decline in Uniface and Changepoint license fees, offset by a $3.4 million increase in Vantage license fees. The license fee decline occurred during our first quarter of fiscal 2010 as the global economic slowdown that began during the second quarter of fiscal 2009 continued to affect the closure of license transactions for all our product lines. The decline was partially offset by license growth during the remainder of fiscal 2010 as economic conditions began to improve causing customers to increase technology spending.
During fiscal 2011 and fiscal 2010, for software license transactions that were required to be recognized ratably, we deferred $29.9 million and $55.6 million, respectively, of license revenue relating to such transactions that closed during the period. We recognized as license fees $61.2 million and $80.2 million of previously deferred license revenue during fiscal 2011 and 2010, respectively, relating to such transactions that closed and had been deferred prior to the beginning of the period, including $7.2 million related to our divested products during the first quarter of fiscal 2010.
Maintenance fees
Maintenance fees decreased $20.3 million or 4.6% during fiscal 2011 to $419.2 million, which included a positive impact from foreign currency fluctuations of $230,000, and decreased $40.0 million or 8.3% to $439.5 million during fiscal 2010, which included a positive impact from foreign currency fluctuations of $450,000, from $479.5 million in fiscal 2009.
Excluding the $4.8 million impact from divested products, maintenance fees decreased $15.4 million or 3.5% during fiscal 2011 as compared to fiscal 2010. The decrease was due to a decline of $17.7 million or 5.4% in maintenance fees associated with our mainframe product lines. Although we continue to experience a high maintenance renewal rate with our current mainframe customers, the decline in mainframe license deals during 2010 and 2011 is impacting mainframe maintenance revenue as new or growth customers are not entirely replacing the maintenance revenue loss from the non-renewed or reduced capacity mainframe maintenance arrangements. The decline was partially offset by an increase in Vantage maintenance fees primarily due to sales growth in our Vantage product line.
Excluding the $29.2 million impact from divested products, maintenance fees decreased $10.8 million or 2.4% during fiscal 2010 as compared to fiscal 2009. The decrease was primarily the result of reductions in our mainframe product lines. The global economic slowdown that began during the second quarter of fiscal 2009 also impacted maintenance contracts for new mainframe arrangements and the pricing of existing arrangements being renewed.
Subscription fees
In November 2009, through the acquisition of Gomez, we began to offer web performance services on a subscription basis that are used to test and monitor web and mobile applications. Revenue recognized from these services is referred to as subscription fees and totaled $67.7 million during fiscal 2011 and $16.9 million for the five-month period after the acquisition in fiscal 2010. See note 2 of the consolidated financial statements included in this report for historical pro forma financial results of Compuware and Gomez.
Product Software Expenses
Product software expenses include cost of software license fees, cost of maintenance and subscription fees, technology development and support costs, sales and marketing expenses and the gain on divestiture of product lines.
Cost of software license fees includes amortization of capitalized software, the cost of duplicating and disseminating products to customers, including associated hardware costs, and the cost of author royalties. Cost of software license fees decreased $1.2 million or 7.9% during fiscal 2011 to $14.2 million from $15.4 million in fiscal 2010 and decreased $9.1 million or 37.0% during fiscal 2010 from $24.5 million in fiscal 2009.
The decrease in expense for fiscal 2011 as compared to fiscal 2010 was primarily due to lower capitalized software amortization as certain purchased software from past acquisitions became fully amortized and the decline in capitalized internally developed software technology costs (“capitalized internal software costs”) in previous years is reducing the amortizable base.
The decrease in expense for fiscal 2010 as compared to fiscal 2009 was primarily a result of lower capitalized software amortization due to (1) classifying the capitalized internal software costs associated with our divested products as held for sale at March 31, 2009, which eliminated the need to amortize these costs during fiscal 2010; and (2) certain purchased software from past acquisitions becoming fully amortized.
As a percentage of software license fees, cost of software license fees was 7.3%, 7.9% and 11.2% in fiscal 2011, 2010 and 2009, respectively. The declines in the percentages were primarily due to the decrease in capitalized software amortization during fiscal 2011 and 2010 as compared to the previous periods. The change in fiscal 2010 compared to fiscal 2009 was partially offset by the reduction in license fees.
Cost of maintenance and subscription fees consists of the direct costs allocated to maintenance and product support such as helpdesk and technical support; amortization of capitalized software, depreciation and maintenance expense associated with our web performance services network related computer equipment; data center costs; and payments to individuals for tests conducted from their Internet-connected personal computers. Cost of maintenance and subscription fees increased $15.3 million or 36.2% during fiscal 2011 to $57.9 million from $42.6 million in fiscal 2010 and increased $700,000 or 1.6% during fiscal 2010 from $41.9 million in fiscal 2009.
The increase in cost during fiscal 2011 as compared to fiscal 2010 was a $15.7 million increase in the cost to deliver web performance services. In fiscal 2011, we incurred a full year of costs compared to a partial year in fiscal 2010 due to the Gomez acquisition.
The increase in expense during fiscal 2010 as compared to fiscal 2009 was primarily due to incurring $9.3 million in expense to deliver web performance services since the Gomez acquisition. The increase was partially offset by lower compensation and employee benefit costs resulting from the transfer of 273 employees to Micro Focus in the first quarter of fiscal 2010, and headcount reductions resulting from our restructuring actions.
As a percentage of maintenance and subscription fees, cost of maintenance and subscription fees were 11.9%, 9.3% and 8.7% in fiscal 2011, 2010 and 2009, respectively. The increases in the percentages were primarily due to the addition of our Gomez web performance service business as the cost to deliver web performance services is proportionately greater than the cost to deliver maintenance services.
Technology development and support includes, primarily, the costs of programming personnel associated with software technology development and support of our products and the web performance services network less the amount of capitalized internal software costs during the reporting period. Also included are personnel costs associated with developing and maintaining internal systems and hardware/software costs required to support all technology initiatives.
Total technology development and support costs incurred internally and capitalized during fiscal 2011, 2010 and 2009 were as follows (in thousands):
*
See note 1 ("capitalized software" section) of the consolidated financial statements included in this report for our policy on capitalizing internally developed software technology costs.
Before capitalized internal software costs, total technology development and support expenditures increased $5.2 million or 5.3%, to $102.9 million during fiscal 2011 from $97.7 million in fiscal 2010 and deceased $1.1 million or 1.1% during fiscal 2010 from $98.8 million in fiscal 2009.
The increase in cost for fiscal 2011 compared to fiscal 2010 was primarily due to the timing of the Gomez acquisition. In fiscal 2011, we incurred a full year of compensation and employee benefit costs for developers to maintain the Gomez web performance network compared to a partial year in fiscal 2010.
The decrease in cost for fiscal 2010 compared to fiscal 2009 was primarily due to lower compensation and employee benefit costs resulting from headcount reductions that occurred from restructuring actions and the transfer of employees to Micro Focus. The headcount reduction was partially offset by the addition of developers from the Gomez acquisition.
Capitalized internal software costs increased $6.1 million or 94.7% to $12.6 million during fiscal 2011 and decreased $5.9 million or 47.6% to $6.5 million during fiscal 2010. The changes in capitalized costs relates primarily to the timing of product releases. Significant product releases associated with our Vantage product occurred during fiscal 2011 and fiscal 2009 causing the capitalized internal software costs to be higher during those periods. The fiscal 2011 increase was further impacted by the First Mile APM solution release in fiscal 2011.
As a percentage of product software revenue, costs of technology development and support were 13.3%, 14.0% and 12.4% in fiscal 2011, 2010 and 2009 respectively.
Sales and marketing costs consist primarily of personnel related costs associated with product sales, sales support and marketing for our product offerings. Sales and marketing costs increased $21.4 million or 9.6% during fiscal 2011 to $243.8 million from $222.4 million in fiscal 2010 and decreased $4.0 million or 1.7% during fiscal 2010 from $226.4 million in fiscal 2009.
The increase in cost for fiscal 2011 compared to fiscal 2010 was primarily due to the timing of the Gomez acquisition. In fiscal 2011, we incurred a full year of compensation and employee benefit costs for Gomez sales representatives; intangible asset amortization associated with Gomez customer relationships agreements; and marketing costs compared to a partial year in fiscal 2010. The increase in Gomez sales and marketing costs related to compensation and employee benefit costs was $17.5 million; intangible asset amortization was $2.1 million; and marketing costs were $1.8 million.
The decrease in costs for fiscal 2010 as compared to fiscal 2009 was primarily due to lower compensation, employee benefits and travel costs of $8.2 million, partially offset by an increase in advertising costs primarily associated with our Compuware 2.0 marketing campaign. The decrease in compensation, employee benefits and travel costs was a result of headcount reductions related to restructuring actions and the transfer of employees to Micro Focus in connection with the Quality Divestiture. The headcount reduction was partially offset by the addition of sales representatives from the Gomez acquisition.
As a percentage of product software revenue, sales and marketing costs were 35.8%, 34.2% and 32.4% in fiscal 2011, 2010 and 2009, respectively.
Gain on divestiture of product lines relates to the Quality Divestiture that occurred in May 2009 and resulted in a gain of $52.4 million that was recognized during the first quarter of fiscal 2010. See note 3 of the consolidated financial statements included in this report for additional information.
PROFESSIONAL SERVICES SEGMENT
Financial information for the professional services segment is as follows (in thousands):
*
The professional services segment and the application services segments are combined and reported as professional services on the consolidated statement of operations, included in Item 8 of this report.
Professional services segment revenue by geographic location is presented in the table below (in thousands):
During fiscal 2011, the professional services segment generated a contribution margin of 13.7%, compared to 10.9% and 7.1% during fiscal 2009 and fiscal 2008, respectively.
The increases in contribution margin during fiscal 2011 and fiscal 2010 as compared to the previous period were primarily due to our initiatives to exit low-margin engagements and the restructuring actions taken during fiscal 2010 and 2009. The increase in fiscal 2011 was further impacted by improvements in staff utilization and billing rates during the second half of fiscal 2011.
Professional Services Restructuring
Beginning in fiscal 2009, management focused on improving the professional services segment’s contribution margins by initiating a plan to exit engagements that were considered low-margin and implementing restructuring actions focused on reducing headcount and operating costs. See note 9 of the consolidated financial statements included in this report for additional details related to our restructuring initiative.
Professional Services Segment Revenue
Revenue from professional services decreased $8.7 million or 4.3%, which included a negative impact from foreign currency fluctuations of $120,000, during fiscal 2011 to $192.2 million from $200.9 million in fiscal 2010 and decreased $155.2 million or 43.6%, which included a positive impact from foreign currency fluctuations of $184,000, during fiscal 2010 from $356.1 million in fiscal 2009. The decreases in revenue were primarily a result of the actions taken to exit low-margin engagements with one customer in the automotive industry representing $52.0 million of the decline in fiscal 2010.
Professional Services Segment Expenses
Professional services segment expenses consist primarily of personnel-related costs of providing services, including billable staff, subcontractors and sales personnel. Professional services segment expense decreased $13.0 million or 7.3% during fiscal 2011 to $165.9 million from $178.9 million in fiscal 2010 and decreased $152.1 million or 45.9% during fiscal 2010 from $331.0 million in fiscal 2009.
The decreases in costs in fiscal 2011 and fiscal 2010 compared to the prior year were primarily attributable to lower compensation, employee benefit and travel costs due to reductions in employee headcount resulting from our restructuring programs implemented to align operating costs with the decline in revenue. The decrease in cost during fiscal 2010 was further impacted by reductions in subcontractor costs due to the decline in professional services projects after exiting low-margin engagements.
APPLICATION SERVICES SEGMENT
Financial information for the application services segment is as follows (in thousands):
*
The professional services segment and the application services segments are combined and reported as professional services on the consolidated statement of operations, included in Item 8 of this report.
Application services segment revenue by geographic location is presented in the table below (in thousands):
During fiscal 2011, the application services segment generated a contribution margin of 7.3% compared to a contribution margin of 6.3% in fiscal 2010 and a negative contribution margin of 5.1% during fiscal 2009.
The increases in contribution margin from fiscal 2011 and fiscal 2010 compared to the prior year were primarily due to economies of scale from our revenue growth as described in “Application Services Segment Revenue” within this section. The fiscal 2011 margin included the effects of a $1.9 million charge for performance stock award compensation and a $750,000 reduction of expense regarding a DocSite contingent consideration adjustment (see notes 2 and 18 of the consolidated financial statements included in this report).
During the second quarter of fiscal 2011, we acquired DocSite, a provider of web-based solutions that allow physicians and healthcare organizations to accurately and timely manage, analyze and report healthcare performance and quality. Demand for such solutions has increased as U.S. government agencies provide financial incentives for physicians and healthcare organizations to use information technology when reporting health and quality of care information. DocSite offerings combined with Covisint’s secure SaaS model will allow us to offer our customers solutions for exchanging and analyzing clinical and patient information in a secure environment across the healthcare delivery system that meet U.S. healthcare technology standards.
Application Services Segment Revenue
Revenue from application services increased $14.5 million or 36.0% during fiscal 2011 to $55.0 million from $40.5 million in fiscal 2010 and increased $5.3 million or 14.9% during fiscal 2010 from $35.2 million in fiscal 2009.
The increase in revenue during fiscal 2011 as compared to fiscal 2010 was primarily a result of growth from automotive customers as the industry stabilized from the recent economic downturn, continued expansion into the healthcare industry and revenue generated from DocSite. DocSite revenue was $4.3 million since the acquisition, of which $2.8 million related to DocSite’s Physicians Quality Reporting Initiative (“PQRI”) services. Revenue generated from PQRI services is recognized during the fourth quarter of our fiscal year as it relates to Medicare reporting that is submitted during the fourth quarter.
The increase in revenue during fiscal 2010 as compared to fiscal 2009 was primarily due to our continued expansion into the healthcare industry and, to a lesser extent, increased spending within the manufacturing industry.
We anticipate demand in the healthcare industry will continue to grow as hospitals, physicians and the United States government move towards establishing electronic patient health and medical records which will require secure computerized databases and environments for storing and sharing of information. Our application services are designed to meet this demand and will be a factor in the future growth of the application services segment.
Our application services segment generated 49%, 50% and 56%, respectively, of its revenue from the automotive industry during fiscal 2011, 2010 and 2009.
Application Services Segment Expenses
Application services segment expenses consist primarily of personnel-related costs of providing services, including technical staff, subcontractors and sales personnel. Application services segment expenses increased $13.1 million or 34.5% during fiscal 2011 to $51.0 million from $37.9 million in fiscal 2010 and increased $900,000 or 2.4% during fiscal 2010 from $37.0 million in fiscal 2009.
The increase in expenses for fiscal 2011 as compared to fiscal 2010 was primarily due to the following: (1) an increase of $10.6 million in compensation and employee benefit costs associated with staff level increases in developers and sales representatives in order to manage the growth of the business; (2) an increase of $2.5 million related to consulting and third-party hosting costs to support the growth of the business and the increased customer demand for our portal services; (3) a $1.9 million charge recorded during the fourth quarter of fiscal 2011 representing the accumulation of stock compensation expense (grant date through March 31, 2011) associated with performance-based stock awards for which the performance target became probable of being met during the quarter (see note 18 of the consolidated financial statements included in this report); and (4) an increase of $1.8 million in amortization expense associated with deferred customer portal implementation costs and capitalized internal software costs. The increase in expense was partially offset by (1) a $3.4 million increase in the deferral of costs related to customer portal implementations for which the associated revenue and expense will be recognized in the future; and (2) a $750,000 reduction of expense that was recorded during the third and fourth quarters of fiscal 2011 reducing the DocSite contingent payment liability (see note 2 of the consolidated financial statements included in this report).
The increase in expenses for fiscal 2010 as compared to fiscal 2009 was primarily due to a $3.7 million increase in compensation and employee benefits as the segment continued to increase employee staffing levels to support the growth in revenue, partially offset by an increase in the deferral of costs related to customer portal implementations for which the associated revenue and expense will be recognized in the future.
CORPORATE AND OTHER EXPENSES
Administrative and general expenses consist primarily of costs associated with the corporate executive, finance, human resources, administrative, legal, communications and investor relations departments. In addition, administrative and general expenses include all facility-related costs, such as rent, building depreciation, maintenance and utilities, associated with our worldwide offices. Administrative and general expenses decreased $9.2 million or 5.6% during fiscal 2011 to $155.4 million from $164.6 million in fiscal 2010 and increased $16.6 million or 11.2% during fiscal 2010 from $148.0 million in fiscal 2009.
The decrease in expenses for fiscal 2011 as compared to fiscal 2010 was primarily due to (1) an increase of $4.3 million in rental income as we entered into a five year agreement to lease approximately 249,000 square feet of our Detroit, Michigan headquarters effective April 2010; (2) a reduction of $4.3 million in bonus expense; and (3) a reduction of $3.0 million in facility costs resulting from office consolidations in fiscal 2010 and fiscal 2011. The decrease in expenses was partially offset by a $1.6 million increase in travel costs and a $1.0 million increase in charitable contributions during fiscal 2011.
The increase in expenses for fiscal 2010 as compared to fiscal 2009 was primarily due to the following: (1) an increase in annual bonuses of $10.3 million; (2) an increase in expense of $8.6 million as foreign currency and hedging transactions resulted in a net loss of $2.2 million during fiscal 2010 compared to a net gain of $6.4 million in fiscal 2009; and (3) the effect of a gain of $5.6 million that was recorded during the first quarter of fiscal 2009 associated with a transaction that transitioned the employment of 170 of our professional services staff to a customer. The increase in expenses for fiscal 2010 was partially offset by reductions in compensation, employee benefits, travel, and facility costs of $9.3 million primarily due to the headcount reductions and facility closures that took place as part of restructuring actions.
Other income, net (“other income”) consists primarily of interest income realized from our cash and cash equivalents, interest earned on our financing receivables, settlement income and income generated from our investment in a partially owned company.
Settlement income relates to our settlement with IBM in March 2005 whereby IBM was committed to purchase software licenses and maintenance from the Company totaling $140 million over five years ending in fiscal 2010 ($20 million in fiscal 2006, $30 million in each of the following four years). The amount of the annual commitment not used to purchase software licenses and maintenance was recorded to other income.
Other income decreased $21.2 million or 82.7% during fiscal 2011 to $4.5 million from $25.7 million in fiscal 2010 and decreased $1.9 million or 6.7% during fiscal 2010 from $27.6 million in fiscal 2009. The decrease in other income from fiscal 2011 as compared to fiscal 2010 was primarily attributable to the financial provisions of the IBM settlement agreement expiring on March 31, 2010, therefore no settlement gain was recorded in fiscal 2011. We recorded an IBM settlement gain of $20.7 million in fiscal 2010 (see note 17 of the consolidated financial statements included in this report).
The decrease in other income from fiscal 2010 as compared to fiscal 2009 was primarily attributable to a $5.0 million decline in investment interest income resulting from lower interest rates during fiscal 2010, partially offset by a $2.8 million increase in the IBM settlement gain.
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 and net operating loss and credit carryforwards. The income tax provision was $47.3 million, $68.3 million and $73.1 million, respectively, in fiscal 2011, 2010 and 2009 representing an effective tax rate of 31%, 33% and 34%, respectively.
The decrease in the effective tax rate for fiscal 2011 as compared to fiscal 2010 was primarily due to an increase in tax credits realized during fiscal 2011 related to (1) the U.S. Research and Experimentation tax credit (“R&D credit”) including the impact of retroactively reinstating the credit to January 1, 2010; and (2) settlement of R&D credits related to fiscal 2007 through fiscal 2009 tax periods with the Internal Revenue Service.
The decrease in the effective tax rate for fiscal 2010 as compared to fiscal 2009 was primarily due to the release of valuation allowances related to Brownfield Redevelopment tax credit carryforward deferred tax assets that resulted in a tax benefit of $4.1 million.
On May 25, 2011, new legislation was enacted that amends the Income Tax Act to implement a comprehensive set of tax changes. One part of the legislation contains provisions that replace the current Michigan Business Tax (“MBT”) with a new corporate income tax. Certain credits allowed under the MBT, including the Brownfield Redevelopment tax credit, will continue to be effective, which will allow us to reduce our future tax liability for the duration of the carryforward period. Therefore, the valuation allowance currently associated with this deferred tax asset will be reversed. We anticipate that a $5.0 million reduction to our income tax provision will be recorded in the first quarter of fiscal 2012. The effective date of the legislation is January 1, 2012.
See note 14 of the consolidated financial statements included in this report for additional information regarding the difference between our effective tax rate and the statutory rate for fiscal 2011, 2010 and 2009.
RESTRUCTURING CHARGE
There were no restructuring actions taken during fiscal 2011 and at this time, there are no initiatives that require us to incur restructuring charges. However, unanticipated future conditions or events may require us to reassess the need for new restructuring initiatives. See note 9 to the consolidated financial statements for payment activity related to our restructuring accrual.
During fiscal 2009 and fiscal 2010, the Company incurred restructuring charges of $10.0 million and $8.0 million, respectively, associated with the following initiatives: (1) aligning the professional services segment headcount and operating expenses after initiating a plan to exit low-margin engagements and (2) increasing the operating efficiency of our products segment and administrative and general business processes with the goal of reducing operating expenses.
During the second half of fiscal 2009, the professional services segment’s business model was realigned resulting in the Company exiting engagements considered low-margin or unprofitable. This change required the Company to undertake restructuring actions to reduce headcount and operating expenses resulting in restructuring charges of $6.3 million and $4.2 million, respectively, during fiscal 2009 and fiscal 2010. Employee termination costs were $5.4 million and $4.0 million, respectively, due to the Company eliminating 748 professional services personnel and management positions.
The second initiative, to increase the operating efficiency of the Company’s products segment and administrative and general business processes, resulted in the Company incurring restructuring charges of $3.7 million and $3.8 million, respectively, during fiscal 2009 and fiscal 2010. Employee termination costs accounted for $3.0 million and $3.6 million, respectively, of the charges due to the elimination of 194 positions within our products segment related to technology and sales and marketing personnel and 86 corporate administrative and general positions.
As part of these initiatives, full or partial closing of seven offices occurred during fiscal 2009, resulting in lease abandonment charges of $1.3 million. The remaining facilities charges for fiscal 2009 and fiscal 2010 primarily related to changes in sublease income assumptions associated with leased facilities that were abandoned in previous restructuring initiatives.
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Note 1 of the consolidated financial statements included in 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, 2011. 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 - We generate revenue from licensing software products, providing maintenance and support services for those products, rendering web performance, professional (including product related services) and application services.
We provide software deliverables that include licensed software products, maintenance and professional services related to our software (“product related services”). We also provide non-software deliverables, such as professional services unrelated to our software (“professional services”), and web performance and application services where we grant the customer a right to use software but they do not have the right or capability to take possession of the software. For arrangements that contain both software and non-software deliverables (almost all of these arrangements combine software deliverables with web performance services), in accordance with ASC 605 “Revenue Recognition,” we split the arrangements between software and non-software deliverables using the following hierarchy: vendor specific objective evidence of fair value (“VSOE,” meaning price when sold separately) if available; third-party evidence if VSOE is not available; or best estimated selling price if neither VSOE nor third-party evidence is available. We currently are unable to establish VSOE or third-party evidence for our web performance services or software deliverables taken as a group. Therefore, we create our best estimate of selling price by evaluating renewal amounts included in a contract, if any, and prices of deliverables sold separately, taking into consideration geography, volume discounts, and transaction size.
Once we have allocated the arrangement between software deliverables and non-software deliverables, we recognize revenue as described below in the respective Product Revenue Recognition, Web Performance Services Fees and Professional and Application Services Fees sections.
In order for a transaction to be eligible for revenue recognition, the following revenue criteria must be met: persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is reasonably assured. We evaluate collectibility based on past customer history, external credit ratings and payment terms within various customer agreements.
Product Revenue Recognition - We license software products using both perpetual and term (time-based) licenses, provide maintenance services and software related professional services. Our software related professional services do not require significant production, modification or customization of the licensed software product.
Assuming all revenue recognition criteria are met, perpetual license fee revenue is recognized upfront, using the residual method, under which the fair value of the undelivered elements (e.g., maintenance and software professional services) are deferred, based on VSOE of these elements. VSOE is based on rates charged for maintenance and software professional services when sold separately. Based on market conditions, we periodically change pricing methodologies for license, maintenance and software professional services. Changes in rates charged for stand-alone maintenance and software professional services could have an impact on how bundled revenue agreements are characterized as license, maintenance or software professional services or have an effect on the timing of revenue recognition in the future. Pricing modifications, if any, made during the years covered by this report have not had a significant impact on the timing or characterization of revenue recognized.
For revenue arrangements where there is a lack of VSOE for any undelivered elements, license fee revenue is deferred and recognized upon delivery of those elements or when VSOE can be established. When maintenance or services are the only undelivered elements, the license fee revenue is recognized on a ratable basis over the longer of the maintenance term or over the period in which the services are expected to be performed. Such transactions include time-based and unlimited capacity licenses as we do not sell maintenance separately and therefore cannot establish VSOE for these undelivered elements in these arrangements. These arrangements do not qualify for separate recognition of the software license fees, maintenance fees and as applicable, professional services fees under ASC 605. However, to comply with SEC Regulation S-X, Rule 5-03(b), which requires product, services and other categories of revenue to be displayed separately on the income statement, we separate the license fee, maintenance fee and professional services fee revenue based on its determination of fair value. We apply our VSOE for maintenance related to perpetual license transactions and stand alone services arrangements as a reasonable and consistent approximation of fair value to separate license fee, maintenance fee and professional services fee revenue for income statement classification purposes.
We allow customers to have installment payment terms in our arrangements and generally, revenues from these transactions 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 our customer collection experience, 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. 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.
Web Performance Services Fees - Our subscription fees relate to arrangements that permit our customers to access and utilize our web performance services. The subscription arrangements do not provide customers the right to take possession of the software at any time, nor do the arrangements contain rights of return. Subscription fees are deferred upon contract execution and are recognized ratably over the term of the subscription.
Professional and Application Services Fees - Professional services fees are generally based on hourly or daily rates; therefore, revenues from professional services are recognized in the period the services are performed, provided that collection of the related receivable is deemed probable. For development services rendered under a fixed-price contract, revenue is recognized using the percentage of completion method and if determined that costs will exceed revenue, the expected loss is recorded at the time the loss becomes apparent.
Our application services fees are combined with professional services fees in our consolidated statement of operations and consist of fees for our on-demand software and other services. The arrangements do not provide customers the right to take possession of the software at any time, nor do the arrangements contain rights of return. Many of our application service fee contracts include a one-time project (one-time) fee and then ongoing SaaS operations (recurring) fees for the project. The one time fees do not qualify as a separate element of accounting as we are the only vendor to provide these services. Therefore, revenue associated with the one-time fees is recognized over the expected service period as the customer derives value from the recurring fees, consistent with the proportional performance method. The recurring fees are deferred upon contract execution and are recognized ratably over the term of the software as a service contract.
Unforeseen events that result in additional time or costs being required to complete our fixed-price or customer’s structure setup 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.
Capitalized Software - We follow the guidance of ASC 985-20 “Costs of Software to be Sold, Leased, or Marketed” when capitalizing development costs associated with our software products and ASC 350-40 “Internal Use Software” when capitalizing development costs associated with our web performance services and application services networks. The cost of purchased and internally developed software technology 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 technology which is generally three to five years. Software is subject to rapid technological obsolescence and future revenue estimates supporting the capitalized software cost can be negatively affected based upon competitive products, services 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 occurs or to increase the amortization expense in future periods and would have a negative effect on our results of operations. At a minimum, we review for impairments each balance sheet date.
Impairment of Goodwill and Other Intangible Assets - We are required to assess the impairment of goodwill and other intangible assets annually, or more frequently if events or changes in circumstances indicate that the carrying value may exceed the fair value.
The performance test involves a two-step process. Step 1 of the impairment test involves comparing the fair values of the applicable reporting units with their aggregate carrying values, including goodwill. We measure the fair value of reporting units and other intangible assets using an estimate of the related discounted cash flow and market comparable valuations, where appropriate. 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 key assumptions in the market comparable value analysis are peer group selection and application of this peer group to the respective reporting unit. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, the Company performs Step 2 of the goodwill impairment test to determine the amount of impairment loss by comparing the implied fair value of the respective reporting unit’s goodwill with the carrying amount of that goodwill. Under such evaluation, if the carrying amount of the reporting unit’s 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. There is a high degree of judgment regarding management’s forecast for the reporting units as market developments for both customers and competitors can affect actual results. There can also be uncertainty regarding management’s selection of peer companies as an exact match of peer companies is unlikely to exist.
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.
At March 31, 2011, our software products, web performance services and application services reporting units did not fail Step 1 of our goodwill impairment analysis. Our professional services reporting unit, with a goodwill balance of $141.8 million, was the only reporting unit where the estimated fair value was not substantially in excess of the carrying value, as the fair value exceeded the carrying value by approximately 12% at March 31, 2011.
The events and circumstances that could affect our key assumptions for the professional services reporting unit and the analysis of fair value include the following:
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Our ability to achieve sales productivity at a level to achieve the profitability in the forecast period.
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Failure of our billable staff to meet their utilization or rate targets.
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Our ability to hire and retain sales, technology and management personnel.
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Future negative changes in the worldwide economies.
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Increased competition and pricing pressures within the professional services market.
Deferred Tax Assets Valuation Allowance and Tax Liabilities - Income tax expense, deferred tax assets and liabilities and reserves for uncertain tax positions reflect management’s best assessment of estimated future taxes to be paid. We are subject to income taxes in both the U.S. and numerous foreign jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax expense.
Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenue and expense. In evaluating our ability to recover our deferred tax assets we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income, we develop assumptions including the amount of future state, federal and foreign pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses.
For additional information regarding these matters see note 14 of the consolidated financial statements included in 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 liabilities and, therefore, to our net income.
The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations.
We recognize tax benefits from an uncertain tax position when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits.
We recognize tax liabilities in accordance with ASC 740 “Income Taxes” and we adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined.
Stock-Based Compensation - We measure compensation expense for stock awards in accordance with ASC 718-10 “Share-Based Payment.” Stock award compensation costs, net of an estimated forfeiture rate (approximately 10%), are recognized on a straight-line basis over the requisite service period of the award, which is generally the vesting term of five years.
The fair value of stock options was estimated at the grant date using a Black-Scholes option pricing model with the following assumptions for fiscal 2011: risk-free interest rate - 2.43%, volatility factor - 42.08% and expected option life - 6.1 years (dividend yield is not a factor as we have never issued cash dividends and do not anticipate issuing cash dividends in the future). The weighted average grant date fair value of option shares granted in fiscal 2011 was $4.16 per option share.
If we increase the assumptions for the risk-free interest rate and the volatility factor by 50 percent in order to create a maximum compensation expense scenario, the fair value of stock options granted in fiscal 2011 would increase 39 percent. If the Company decreased its assumptions for the risk-free interest rate and the volatility factor by 50 percent to create a minimum compensation expense scenario, the fair value of stock options granted in fiscal 2011 would decrease 47 percent.
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, 2011, 2010 and 2009, cash and cash equivalents and investments totaled approximately $180.2 million, $149.9 million and $278.1 million, respectively.
Fiscal 2011 compared to Fiscal 2010
Net cash provided by operating activities
Net cash provided by operating activities during fiscal 2011 was $160.0 million, a decrease of $66.3 million from fiscal 2010. The decrease was primarily due to a reduction in customer cash collections of $64 million as our strategy to exit low margin professional services engagements has reduced our cash collections related to professional services during 2010 and 2011, and the decline in our mainframe product revenue. The decrease in cash was further impacted by an increase in employee bonus and commission payments of approximately $31 million during fiscal 2011. The decrease was partially offset by a $28 million decline in income taxes paid to taxing authorities due to the decline in pre-tax net income in fiscal 2011 as compared to fiscal 2010 and an increase in rental income receipts and reductions in building rent payments during fiscal 2011.
The consolidated statements of cash flows included in this report compute net cash from operating activities using the indirect cash flow method. Therefore non-cash adjustments and net changes in assets and liabilities (net of effects from acquisitions, the divestiture and currency fluctuations) are adjusted from net income to derive net cash from operating activities.
Changes in accounts receivable and deferred revenue have typically had the largest impact on the reconciliation of net income to compute cash flows from operating activities as we allow for deferred payment terms on multi-year products contracts. The decrease in the net change of accounts receivable was $48.4 million and primarily relates to the timing of billings from multi-year product arrangements during fiscal 2011 compared to fiscal 2010. The decrease in the net change of deferred revenue was $54.0 million and primarily relates to the decline in mainframe license and maintenance contracts.
The other significant changes in our reconciliation of net income to derive net cash from operating activities during fiscal 2011 as compared to fiscal 2010 were as follows: (1) the adjustment to net income of $52.4 million resulting from the gain relating to the Quality Divestiture during the first quarter of 2010 (the proceeds from the sale were recorded to investing activities); (2) the change in accounts payable and accrued expense balances decreased cash flow from operating activities by $15.4 million, and was primarily a result of the increase in employee bonus payments during the first quarter of 2011 that were accrued for at March 31, 2010; and (3) the change in deferred income taxes which increased cash provided by operating activities by $10.7 million primarily due to timing differences resulting from increases in capitalized internal software costs and deferred portal customer implementation costs.
We believe our existing cash resources and cash flow from operations will be sufficient to meet operating cash needs for the foreseeable future.
Net cash used in investing activities
Net cash used in investing activities during fiscal 2011 was $52.8 million, a decrease of $186.0 million from fiscal 2010.
The primary reason for the decrease was the decline in cash used for acquisitions. We acquired Gomez in fiscal 2010 for $284.4 million compared to $18.2 million used for acquisitions during fiscal 2011. The decrease was partially offset by the receipt of $65.0 million from the Quality Divestiture during the first quarter of fiscal 2010.
During fiscal 2011 and fiscal 2010, capital expenditures for property and equipment and capitalized research and software development totaled $34.6 million and $19.4 million, respectively, with $9.5 million of the increase due primarily to computer and network equipment purchases and $5.8 million of the increase due to increases in capitalized internal software costs related to our software products and web performance services network. Capital expenditures were funded with cash flows from operations.
We will continue to evaluate business acquisition opportunities that fit our strategic plans. If the cash consideration for an acquisition or combination of acquisitions were to exceed our operating cash balance needs, we would likely utilize our credit facility and may need to seek additional financing.
Net cash used in financing activities
Net cash used in financing activities during fiscal 2011 was $81.6 million, a decrease of $43.6 million from fiscal 2010.
The decrease was primarily due to a $74.9 million increase in cash receipts from employees exercising stock options primarily related to a broad based stock option grant (“BBSO grant”) that expired in April 2011. During the second half of fiscal 2011, our stock price exceeded the exercise price of this BBSO grant causing an increase in stock option exercise activity. This decrease was partially offset by an increase in common stock repurchases of $31.6 million during fiscal 2011 as compared to fiscal 2010.
Since May 2003, the Board of Directors has authorized the Company to repurchase a total of $1.7 billion of our common stock under a discretionary stock repurchase plan (“Discretionary Plan”). Purchases of common stock under the Discretionary Plan may occur on the open market, or through negotiated or block transactions based upon market and business conditions, subject to applicable legal limitations.
During fiscal 2011, we repurchased under the Discretionary Plan approximately 16.9 million shares of our common stock at an average price of $9.52 per share for a total cost of $161.2 million. As of March 31, 2011, approximately $242.7 million remains authorized for future purchases under the Discretionary Plan.
We intend to continue repurchasing shares under the Discretionary Plan, funded primarily through our operating cash flow and, if needed, funds from our credit facility. Our long-term goal is to reduce our outstanding common share count to approximately 200 million shares, though we may adjust our goals based on our cash position and market conditions. We reserve the right to change the timing and volume of our repurchases at any time without notice (see Part II Item 5 for additional information regarding our Discretionary Plan). Our standard quarterly black-out period commences 10 business days prior to the end of each quarter and terminates one full market day following the public release of our operating results for the period.
The Company has a credit facility with Comerica Bank and other lenders to provide leverage for the Company if needed. The credit facility provides for a revolving line of credit in the amount of $150 million and expires on November 1, 2012. The credit facility also permits us to increase the facility by an additional $150 million, subject to receiving further commitments from lenders and certain other conditions. The credit facility also limits borrowing outside of the facility to $250 million. We did not borrow against our credit facility during fiscal 2011. See note 10 of the consolidated financial statements included in this report for further discussion of the credit facility.
Fiscal 2010 compared to Fiscal 2009
Net cash provided by operating activities
Net cash provided by operating activities during fiscal 2010 was $226.3 million, a decrease of $5.7 million from fiscal 2009. The cause of the decrease was primarily due to a reduction in customer collections of $131 million resulting from the decline in revenue, primarily professional services, and an increase in income taxes paid during fiscal 2010 compared to fiscal 2009 of $34 million. The decrease was partially offset by reductions in disbursements for employee payroll and benefits of $158 million primarily due to the cost savings achieved from our restructuring initiatives.
The increase in the net change of accounts receivable of $46.6 million was primarily due to the impact of the decrease in professional services fees throughout fiscal 2010 on the accounts receivable balance. The increase in the net change of deferred revenue of $13.4 million from fiscal 2010 as compared to fiscal 2009 was primarily attributable to the increase in deferred revenue associated with our web performance services since the Gomez acquisition.
The other significant changes in our reconciliation of net income to derive net cash from operating activities during fiscal 2010 as compared to fiscal 2009 were as follows: (1) the adjustment to net income of $52.4 million resulting from the gain on divestiture of our Quality and DevPartner product lines (the proceeds from the sale were recorded to investing activities); and (2) the change in accounts payable and accrued expense balances increasing cash flow from operating activities by $28.6 million primarily due to the changes in our bonus and commission accruals which increased from March 31, 2009 to March 31, 2010.
As of March 31, 2010, we had $2.8 million accrued for restructuring actions (see note 9 of the consolidated financial statements included in this report).
Net cash used in investing activities
Net cash used in investing activities during fiscal 2010 was $238.8 million, an increase of $276.0 million from fiscal 2009.
The increase in cash used was primarily due to the acquisition of Gomez in fiscal 2010 for $284.4 million in cash (net of cash acquired). The purchase was funded from our existing cash resources and borrowings of $15.0 million under the credit facility, which was subsequently repaid during fiscal 2010. The increase in cash used in investing activities was further impacted by a $70.2 million decline in the amount of investments liquidated as all our investments were sold in fiscal 2009. The increase in cash used in investing activities was partially offset by net proceeds of $65.0 million received from the Quality Divestiture during fiscal 2010.
During fiscal 2010 and fiscal 2009, capital expenditures for property and equipment and capitalized research and software development totaled $19.4 million and $33.0 million, respectively, and were funded with cash flows from operations. The decline in capital expenditures for fiscal 2010 as compared to fiscal 2009 was primarily due to a lower investment in equipment of $8.3 million and a decline in capitalized internal software costs of $5.3 million.
Net cash used in financing activities
Net cash used in financing activities during fiscal 2010 was $125.3 million, a decrease of $66.6 million from fiscal 2009.
The decrease in cash used in financing activities was primarily due to a $73.1 million reduction in the amount of common stock repurchased in fiscal 2010 as compared to fiscal 2009. The decrease in cash used in financing activities was partially offset by a $5.8 million reduction in cash received from employee exercises of stock options during fiscal 2010 compared to fiscal 2009.
During fiscal 2010, we repurchased approximately 17.9 million shares of our common stock at an average price of $7.41 per share for a total cost of $132.9 million.
Recently Issued Accounting Pronouncements
See note 1 of the consolidated financial statements included in this report for recently issued accounting pronouncements that could affect the Company.
Contractual Obligations
The following table summarizes our payments under contractual obligations as of March 31, 2011 (in thousands):
”Other” includes commitments under various advertising and charitable contribution agreements totaling $9.2 million and $600,000, respectively, at March 31, 2011. There are no long term debt obligations, capital lease obligations or purchase obligations.
We anticipate tax settlements of $16.0 million with certain taxing authorities of which $122,000 is expected to be settled in the upcoming twelve months (as discussed in note 14 of the consolidated financial statements included in this report). We are not able to reasonably estimate in which future periods the remaining amount of $15.9 million will ultimately be settled. These settlements are not included in the Contractual Obligations table above.
Off-Balance Sheet Arrangements
We currently do not have any off balance sheet or non-consolidated special purpose entity arrangements as defined by the applicable SEC rules.
ITEM 7A.
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 manage 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 consolidated financial statements included in 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. Cash investments are placed with high quality issuers to preserve invested funds by limiting default and market risk.
Our investment portfolio consists of cash investments that have a cost basis and fair value totaling $180.2 million as of March 31, 2011. The average interest rate and average tax equivalent interest rate were 0.30% as of March 31, 2011. These investments will mature within the next three months.
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, 2011, non-current accounts receivable amounted to $206.9 million, of which approximately $127.0 million, $54.6 million, $22.8 million, $2.2 million and $304,000 are due in fiscal 2013 through fiscal 2017, 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, 2011, the fair value of such receivables is approximately $206.8 million. Each 100 basis point increase in interest rates would have an associated $751,000 negative impact on the fair value of non-current accounts receivable based on the balance of such receivables at March 31, 2011. Each 100 basis point decrease in interest rates would have an associated $537,000 positive impact on the fair value of non-current accounts receivable based on the balance of such receivables at March 31, 2011. At March 31, 2010, the fair value of such receivables was approximately $222.8 million. Each 100 basis point increase in interest rates would have had an associated $200,000 negative impact on the fair value of non-current accounts receivable based on the balance of such receivables at March 31, 2010. Each 100 basis point decrease in interest rates would have an associated $1.0 million positive impact on the fair value of non-current accounts receivable based on the balance of such receivables at March 31, 2010. 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 are exposed to foreign exchange rate risks related to assets and liabilities that are denominated in non-local currency and current inter-company balances due to and from our foreign subsidiaries. We enter into foreign currency forward contracts to sell or buy currencies with the intent of mitigating foreign exchange rate risks related to these balances. We do not currently hedge currency risk related to anticipated revenue or expenses denominated in foreign currency. All foreign exchange derivatives are recognized on the consolidated balance sheets at fair value (see note 4 of the consolidated financial statements). Gains and losses on forward foreign exchange contracts are recognized in income, offsetting foreign exchange gains or losses on the foreign balances being hedged.
At March 31, 2011, we performed a sensitivity analysis to assess the potential loss that a 10% positive or negative change in foreign currency exchange rates would have on our income from operations. Based upon the analysis performed, we believe such a change would not materially affect our consolidated financial position, results of operations or cash flows.
The table below provides information about our foreign exchange forward contracts at March 31, 2011. 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, 2011 (dollars in thousands):
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Compuware Corporation
Detroit, Michigan
We have audited the accompanying consolidated balance sheets of Compuware Corporation and subsidiaries (the “Company”) as of March 31, 2011 and 2010, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended March 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Compuware Corporation and subsidiaries as of March 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2011, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of March 31, 2011, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated May 27, 2011, expressed an unqualified opinion on the Company’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Detroit, Michigan
May 27, 2011
COMPUWARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2011 AND 2010
(In Thousands, Except Share Data)
See notes to consolidated financial statements.
See notes to consolidated financial statements.
See notes to consolidated financial statements.
See notes to consolidated financial statements.
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 31, 2011, 2010 and 2009
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Compuware Corporation (the “Company”, “Compuware”, “we”, “our” and “us”) delivers services, software and best practices that enable organizations’ most important technologies to perform at their peak. The Company’s software products consist of four major families: Mainframe, Vantage, Changepoint and Uniface; all of which are primarily intended for use by IT organizations and IT service providers. In addition, the Company offers a broad range of web application performance management services, professional services and application services.
The Company’s web application performance management services (“web performance services”), which are marketed under the brand name “Gomez”, are used by enterprises to test and monitor the performance, availability and quality of their web and mobile applications, while in development and after deployment.
The Company’s professional services provide clients with a broad range of IT services for mainframe, distributed and mobile environments. Our professional services group also offers implementation, consulting and training services in tandem with the Company’s product offerings which are referred to as product related services.
The Company’s application services, which are marketed under the brand name “Covisint”, use business-to-business applications to integrate vital business information and processes between partners, customers and suppliers.
Application services and web performance services are delivered through SaaS platforms referred to as the application services network and the web performance services network. These networks are independent from each other and deliver their services to customers entirely through on-demand, hosted technology in which a single instance of the software serves all customers.
Our products and services are offered worldwide across a broad spectrum of technologies, including mainframe, distributed and Internet platforms.
Basis of Presentation
The consolidated financial statements include the accounts of Compuware and its wholly owned subsidiaries after elimination of all intercompany balances and transactions. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”), which require management to make estimates and assumptions that affect the reported amounts of assets, liabilities, shareholders’ equity and the disclosure of contingencies at March 31, 2011 and 2010 and the results of operations for the years ended March 31, 2011, 2010 and 2009. While management has based their assumptions and estimates on the facts and circumstances existing at March 31, 2011, final amounts may differ from estimates.
Revenue Recognition
The Company derives its revenue from licensing software products, providing maintenance and support services for those products and rendering web performance, professional (including product related professional), and application services.
We sometimes enter into arrangements that include both software related deliverables (licensed software products, maintenance services and software related professional services) and non-software deliverables (web performance services, application services or professional services unrelated to our software products). Our web performance services and application services do not qualify as software deliverables because our license grant does not allow the customer the right or capability to take possession of the software. For arrangements that contain both software and non-software deliverables (almost all of these arrangements combine software deliverables with web performance services), in accordance with ASC 605 “Revenue Recognition,” we split the arrangements using the following hierarchy: vendor specific objective evidence of fair value (“VSOE,” meaning price when sold separately) if available; third-party evidence if VSOE is not available; or best estimated selling price if neither VSOE nor third-party evidence is available. We currently are unable to establish VSOE or third-party evidence for our web performance services or software deliverables taken as a group. Therefore, we create our best estimate of selling price by evaluating renewal amounts included in a contract, if any, and prices of deliverables sold separately, taking into consideration geography, volume discounts, and transaction size.
Once we have allocated the arrangement between software deliverables and non-software deliverables, we recognize revenue as described in the respective software license fee, maintenance and subscription, and professional services fees sections.
In order for a transaction to be eligible for revenue recognition, the following revenue criteria must be met: persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is reasonably assured. We evaluate collectibility based on past customer history, external credit ratings and payment terms within various customer agreements.
Software license fees
The Company's software license agreements provide its customers with a right to use its software perpetually (perpetual licenses) or during a defined term (time-based licenses).
Assuming all revenue recognition criteria are met, perpetual license fee revenue is recognized using the residual method, under which the fair value, based on VSOE, of all undelivered elements of the agreement (i.e., maintenance and software related professional services) is deferred. VSOE is based on rates charged for maintenance and professional services when sold separately. The remaining portion of the fee is recognized as license fee revenue upon delivery of the products.
For revenue arrangements where there is a lack of VSOE for any undelivered elements, license fee revenue is deferred and recognized upon delivery of those elements or when VSOE can be established. When maintenance or software related professional services are the only undelivered elements, the license fee revenue is recognized on a ratable basis over the longer of the maintenance term or the period in which the software related professional services are expected to be performed. Such transactions include time-based licenses and certain unlimited capacity licenses as the Company does not sell maintenance for these separately and therefore cannot establish VSOE for the undelivered elements in these arrangements. In order to comply with SEC Regulation S-X, Rule 5-03(b), which requires product, services and other categories of revenue to be displayed separately on the income statement, the Company separates the license fee, maintenance fee and software related professional services fee (which is included in professional services fees) associated with these types of arrangements based on its determination of fair value. The Company applies its VSOE for maintenance related to perpetual license transactions and stand alone software related professional services arrangements as a reasonable and consistent approximation of fair value to separate license fee, maintenance fee and software related professional services fee revenue for income statement classification purposes.
The Company offers flexibility to customers purchasing licenses for its products and related maintenance. Terms of these transactions range from standard perpetual license sales that include one year of maintenance to large multi-year (generally two to five years), multi-product contracts. The Company allows deferred payment terms on contracts, with installments collectible over the term of the contract. Based on the Company’s successful collection history for deferred payments, license fees (net of any finance fees) are generally recognized as revenue as discussed above. In certain transactions where it cannot be concluded that the fee is fixed or determinable due to the nature of the deferred payment terms, the Company recognizes revenue as payments become due. Financing fees are recognized as interest income over the term of the receivable and amounted to $1.5 million, $2.0 million and $2.8 million for fiscal 2011, 2010 and 2009, respectively.
At March 31, 2011, current accounts receivable includes installments on multi-year contracts totaling $253.3 million due in fiscal 2012. Non-current accounts receivable at March 31, 2011 amounted to $206.9 million, of which approximately $127.0 million, $54.6 million, $22.8 million, $2.2 million and $304,000 are due in fiscal 2013 through fiscal 2017, respectively.
Maintenance and subscription fees
The Company’s maintenance agreements allow customers to receive technical support and advice, including problem resolution services and assistance in product installation, error corrections and any product enhancements released during the maintenance period. The first year of maintenance is generally included with all license agreements. Maintenance fees are recognized ratably over the term of the maintenance arrangements, which may range from one to five years.
Subscription fees relate to arrangements that permit our customers to access and utilize our web performance services. We evaluate collectibility based on past customer history, external credit ratings and payment terms within various customer agreements. Subscription fees are deferred upon contract execution and are recognized ratably over the term of the subscription.
Professional services fees
The Company provides a broad range of IT services for mainframe, distributed and mobile environments, including mobile computing application development and integration, package software customization, cloud computing consulting, development and integration of legacy systems, IT portfolio management services, enterprise legacy modernization services and application performance management. The Company also offers implementation, consulting and training services in tandem with the Company’s product solutions offerings, which are referred to as product related services.
Professional services fees are generally based on hourly or daily rates. Revenues from professional services are recognized in the period the services are performed provided that collection of the related receivable is reasonably assured. For development services rendered under fixed-price contracts, revenues are recognized using the percentage of completion method and if it is determined that costs will exceed revenue, the expected loss is recorded at the time the loss becomes apparent.
Our application services fees are combined with professional services fees in our consolidated statement of operations and consist of fees for our on-demand software and other services. The arrangements do not provide customers the right to take possession of the software at any time, nor do the arrangements contain rights of return. Many of our application service fee contracts include a project (one-time) fee and then ongoing SaaS operations (recurring) fees for the project. The one time fees do not qualify as a separate element of accounting as we are the only vendor to provide these services. Therefore, revenue associated the one-time fees is recognized over the expected service period as the customer derives value from the recurring fees, consistent with the proportional performance method. The recurring fees are deferred upon contract execution and are recognized ratably over the term of the software as a service contract.
Deferred revenue
Deferred revenue consists primarily of billed and unbilled maintenance fees related to the future service period of maintenance agreements in effect at the reporting date. Deferred license, subscription and professional service fees are also included in deferred revenue for those arrangements that are being recognized on a ratable basis. Sales commission costs that directly relate to revenue transactions that are deferred are recorded as “prepaid expenses and other current assets” or non-current “other assets”, as applicable, in the consolidated balance sheets and recognized as “Sales and marketing” expenses in the consolidated statements of operations over the revenue recognition period of the related customer contracts. Long term deferred revenue at March 31, 2011 amounted to $393.8 million, of which approximately $212.4 million, $109.7 million, $48.3 million, $19.7 million and $3.7 million are expected to be recognized during fiscal 2013 through fiscal 2017, respectively.
Collection and remittance of taxes
The Company records the collection of taxes from customers and the remittance of these taxes to governmental authorities on a net basis in its consolidated statements of operations.
Cash and Cash Equivalents
The Company considers all investments with an original maturity of three months or less to be cash equivalents.
Concentration of Credit Risk
The Company’s financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash and trade receivables. The Company has cash investment policies which, among other things, limit investments to investment-grade securities. The Company performs ongoing credit evaluations of its customers, and the risk with respect to trade receivables is further mitigated by the diversity, both by geography and by industry, of the customer base.
The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. We use an internal risk rating system to determine a customer's credit risk. This process considers the payment status of the receivable, collection and loss experience associated with other outstanding and previously paid account receivable balances, discussions with the customer, the risk environment of our geographic operations and review of public financial information if available. A receivable is designated a pass rating if no issues are identified during the process, otherwise a watch rating is designated. The allowance is reviewed and adjusted based on the Company’s best estimates.
Changes in the allowance for doubtful accounts balance for the years ended March 31, 2011, 2010 and 2009 were as follows (in thousands):
(1)
Write-offs related primarily to accounts deemed uncollectible and maintenance and subscription cancellations.
Property and Equipment
The Company states property and equipment at the lower of cost or fair value for impaired assets. Depreciation is recorded using the straight-line method over the estimated useful lives of the related assets, which are generally estimated to be 40 years for buildings and three to ten years for furniture and fixtures, computer equipment and software. Leasehold improvements are amortized over the term of the lease, or the estimated life of the improvement, whichever period is less.
Capitalized Software
The Company’s capitalized software includes the costs of internally developed software technology and software technology purchased through acquisitions and is stated at the lower of unamortized cost or net realizable value.
Our internally developed software technology consists of development costs associated with software products to be sold (“software products”) and internal use software associated with our web performance services and application services networks.
We begin capitalizing development costs associated with our software products when technological feasibility of the product is established. For our internal use software, capitalization begins during the application development stage. Capitalized costs associated with our software products and web performance services network are recorded within the consolidated statement of operations against “technology, development and support” expense and “cost of professional services” for the application services network.
The amortization of capitalized software technology is computed on a project-by-project basis. The annual amortization is the greater of the amount computed using (a) the ratio of current gross revenues compared with the total of current and anticipated future revenues for the software technology or (b) the straight-line method over the remaining estimated economic life of the software technology, including the period being reported on. Amortization begins when the software technology is available for general release to customers. The amortization period for capitalized software is generally three to five years. Amortization of capitalized software technology is recorded as follows in the consolidated statement of operations: (1) software product amortization is recorded to “cost of license fees”; (2) web performance services network amortization is recorded to “cost of maintenance and subscription fees”; and (3) application services network amortization is recorded to “cost of professional services”.
Capitalized software is reviewed for impairment each balance sheet date or when events and circumstances indicate an impairment. Asset impairment charges are recorded when estimated future undiscounted cash flows are not sufficient to recover the carrying value of the capitalized software. The impairment charge is the amount by which the present value of future cash flows is less than the carrying value of these assets.
Research and development
Research and development (“R&D”) costs include primarily the cost of programming personnel and amounted to $69.2 million, $65.8 million and $64.3 million, respectively, during fiscal 2011, 2010 and 2009 of which $15.5 million, $9.8 million and $15.1 million, respectively, was capitalized for internally developed software technology. R&D costs related to our software products and web performance services network in the consolidated statements of operations are reported as “technology development and support” and for our application services network, the costs are reported as “cost of professional services”.
Goodwill and Other Intangible Assets
Goodwill and intangible assets with indefinite lives are tested for impairment annually at March 31 or more frequently if management believes indicators of impairment exist. With respect to goodwill, carrying values are compared with fair values, and when the carrying value exceeds the fair value, the carrying value of the impaired goodwill is reduced to fair value. The impairment test involves a two-step process with Step 1 comparing the fair values of the applicable reporting units with their aggregate carrying values, including goodwill. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, the Company performs Step 2 of the goodwill impairment test to determine the amount of impairment loss by comparing the implied fair value of the respective reporting unit’s goodwill with the carrying amount of that goodwill.
Income Taxes
The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax bases of assets and liabilities and net operating loss and credit carryforwards using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the period that includes the enactment date.
The Company records net deferred tax assets to the extent it believes these assets will more likely than not be realized. These deferred tax assets are subject to periodic assessments as to recoverability and if it is determined that it is more likely than not that the benefits will not be realized, valuation allowances are recorded which would increase the provision for income taxes. In making such determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations.
Interest and penalties related to uncertain tax positions are included in the income tax provision.
Foreign Currency Translation
The Company's foreign subsidiaries use their respective local currency as their functional currency. Accordingly, assets and liabilities in the consolidated balance sheets have been translated at the rate of exchange at the respective balance sheet dates, and revenues and expenses have been translated at average exchange rates prevailing during the period the transactions occurred. Translation adjustments have been excluded from the results of operations and are reported as accumulated other comprehensive income (loss) within our consolidated statements of shareholders’ equity and comprehensive income.
Stock-Based Compensation
Stock award compensation expense is recognized, net of an estimated forfeiture rate, on a straight-line basis over the requisite service period of the award, which is the vesting term.
The Company calculates the fair value of stock option awards using the Black-Scholes option pricing model, which incorporates various assumptions including volatility, expected term, risk-free interest rates and dividend yields. The expected volatility assumption is based on historical volatility of the Company’s common stock over the most recent period commensurate with the expected life of the stock option granted. The Company uses historical volatility because management believes such volatility is representative of prospective trends. The risk-free interest rate assumption is based upon observed interest rates appropriate for the expected life of the stock option awarded. The expected life of the stock option is based on either historical exercise data if available or the simplified method as described in SAB Topic 14, “Share-Based Payment”. Dividend yields have not been a factor in determining fair value of stock options granted as the Company has never issued cash dividends and does not anticipate issuing cash dividends in the future.
The following is the average fair value per share estimated on the date of grant and the assumptions used for each option granted during fiscal 2011, 2010 and 2009:
The Company measures the grant date fair value of restricted stock units using the Company’s closing common stock price on the trading date immediately preceding the grant date.
See note 18 for additional information regarding our stock-based compensation including the impact on net income during the reported periods.
Recently Issued Accounting Pronouncements
In July 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”. The ASU requires enhanced disclosures about the credit quality of financing receivables and the allowance for credit losses; including disclosures regarding credit quality indicators, past due information, and modifications of original terms. The requirements of this ASU were adopted during our quarter ended December 31, 2010. See note 5 for the related disclosure.
In October 2009, the FASB issued ASU No. 2009-13, “Multiple-Deliverable Revenue Arrangements,” which amends Accounting Standards Codification (“ASC”) Topic 605, “Revenue Recognition.” ASU 2009-13 amends the ASC to eliminate the residual method of allocation for multiple-deliverable revenue arrangements, and requires that arrangement consideration be allocated at the inception of an arrangement to all deliverables using the relative selling price method. The ASU also establishes a selling price hierarchy for determining the selling price of a deliverable, which includes: (1) vendor-specific objective evidence if available; (2) third-party evidence if vendor-specific objective evidence is not available; and (3) estimated selling price if neither vendor-specific nor third-party evidence is available. Additionally, ASU 2009-13 expands the disclosure requirements related to a vendor’s multiple-deliverable revenue arrangements. The Company early adopted ASU 2009-13 during the quarter ended December 31, 2009 and retrospectively applied the guidance as of April 1, 2009 which did not result in adjustments to previously presented periods.
2. ACQUISITIONS
Acquisitions are accounted for using the purchase method in accordance with ASC No. 805, “Business Combinations” and, accordingly, the assets and liabilities acquired are recorded at fair value as of the acquisition date.
BEZ Systems, Inc.
On December 21, 2010, the Company acquired certain assets and liabilities of BEZ Systems, Inc. (“BEZ”) for $2.5 million in cash. The purchase price was funded with the Company’s existing cash resources. BEZ is a provider of predictive analytic solutions for IT departments that collects data continuously from the large number of systems the solutions monitor and then automatically aggregates the data to generate advice on how to allocate resources, tune applications and databases, and manage workloads to satisfy service level objectives for the most critical activities. BEZ solutions will be integrated into our web performance services increasing our capabilities to provide predictive monitoring and business analytics to our customers. The assets and liabilities acquired have been recorded at their fair values as of the purchase date using the acquisition method. The purchase price exceeded the fair value of the acquired assets and liabilities by $1.9 million, which was recorded to goodwill within the web performance services segment. The fair value of intangible assets subject to amortization related to developed technology totaled $1.0 million with a useful life of five years.
DocSite, LLC
On September 17, 2010, the Company acquired certain assets and liabilities of DocSite, LLC (“DocSite”), a provider of web-based solutions that give physicians and healthcare organizations the ability to accurately and timely manage, analyze and report healthcare performance and quality, for $15.9 million in cash. The purchase price was funded with the Company’s existing cash resources. The assets and liabilities acquired have been recorded at their fair values as of the purchase date using the acquisition method. The purchase price exceeded the fair value of the acquired assets and liabilities by $13.9 million, which was recorded to goodwill within the application services segment. The fair value of intangible assets subject to amortization totaled $4.0 million, of which $1.9 million, $1.8 million and $260,000 related to developed technology, customer relationships and trademarks with a useful life of five, six and three years, respectively.
The arrangement included a contingent consideration component that would increase the DocSite purchase price up to an additional $1.0 million if pre-determined revenue targets for a specific product line were achieved by March 31, 2011. The fair value of the contingent consideration arrangement at the time of acquisition was $750,000 and was determined by applying the income approach which included significant inputs that are not observable in the market referred to as level 3 inputs (see note 4 for additional information regarding level of inputs). The key assumptions used in the fair value measurement include the probability of attaining certain levels of revenue ranging from less than $3.5 million to greater than $4.5 million. The minimum revenue target required for payment was not achieved and the full amount of the liability was reversed and reflected as a reduction to “cost of professional services” within the consolidated statement of operations.
Gomez, Inc.
On November 6, 2009, the Company acquired all of the outstanding capital stock of Gomez, Inc. (“Gomez”), through a merger of Gomez with a wholly owned subsidiary of the Company, for $295 million in cash, plus approximately $1.6 million of direct acquisition costs recorded to “administrative and general” in the consolidated statements of operations. The purchase price was funded with the Company’s existing cash resources and borrowings of $15 million under its credit facility, which was repaid during fiscal 2010.
Gomez is a provider of web performance services, which companies use to test and monitor the performance, availability and quality of their web and mobile applications and is reported in the web performance services segment.
Assets acquired and liabilities assumed are recorded in the consolidated balance sheet at their fair values as of November 6, 2009. An allocation of the purchase price at the date of acquisition is as follows (in thousands):
The Company believes this acquisition will improve its results of operations as Gomez’s web performance services complement our enterprise application management products, specifically Vantage, and allow us to offer IT organizations comprehensive solutions that effectively monitor the performance of their enterprise and Internet application systems and provide opportunities to cross-sell Gomez and Vantage solutions. As a result, the Company assigned $218.5 million of goodwill to the web performance services segment and the remaining $32.7 million to the products segment as of the acquisition date.
A summary of the identifiable intangible assets acquired, useful life and amortization method is as follows (in thousands):
Pro forma information
The following unaudited pro forma financial information presents the combined results of operations of Compuware and Gomez as if the acquisition had occurred as of the beginning of each of the fiscal periods presented and includes relevant pro forma adjustments, including amortization charges for the acquired intangible assets. The pro forma financial information is presented for informational purposes and is not indicative of the results of operations that would have been achieved if the acquisition and related borrowings had taken place at the beginning of each of the fiscal periods presented (in thousands):
The combined pre-acquisition results of operations and the combined post-acquisition revenues and earnings of DocSite and BEZ are considered immaterial for disclosure of supplemental pro forma information.
For financial results related to our web performance services segment since the date of acquisition see note 15 to the consolidated financial statements.
Goodwill
The significant factors that contributed to the Company recording goodwill associated with all three acquisitions include, but are not limited to, (1) the retention of research and development personnel with the skills to develop future web performance and application service offerings; (2) support personnel to provide maintenance services related to the technology acquired; (3) trained sales personnel capable of selling current and future acquired solutions; and (4) in the case of the Gomez acquisition, the opportunity to sell our enterprise application management products to Gomez’s existing customers.
The goodwill resulting from the BEZ and DocSite transactions is deductible for tax purposes, but is not deductible for the Gomez transaction.
3. DIVESTITURES
Quality and DevPartner divestiture
In May 2009, the Company sold its Quality and DevPartner distributed product lines to Micro Focus International PLC (“Micro Focus”) for $80 million, less certain adjustments relating to cash collected or invoiced for future maintenance and professional services obligations assumed by Micro Focus as discussed below.
The sale included the following assets: (1) all rights to the proprietary software products and other technologies associated with the Quality and DevPartner distributed product lines, including trade names, trade secrets, copyrights, patents, related client relationships and contracts, software and documentation; (2) the right to offer employment to approximately 290 personnel related to the sales, sales support, development, maintenance and delivery of the Quality and DevPartner product lines; and (3) personal property associated with the job requirements of the Company’s personnel that were hired by Micro Focus and other assets primarily used in connection with the products sold.
Effective upon the closing date of the sale, Micro Focus assumed the obligation to perform future maintenance and professional services related to the Quality and DevPartner product lines.
The Company recorded a gain on divestiture of $52.4 million to operating expenses during the first quarter of fiscal 2010 (in thousands):
(1)
As of the transaction date, deferred revenue associated with Quality and DevPartner products was $25.5 million related to future maintenance and professional services that became the obligation of Micro Focus. The Company issued a $15.0 million credit (net of an administrative fee) to Micro Focus for the previously collected or invoiced portion of deferred revenue at the date of close. The remaining $9.1 million in unbilled accounts receivable will be either collected by the Company and remitted to Micro Focus, net of an administrative fee, or assigned to Micro Focus. A liability for this $9.1 million was recorded to accounts payable upon the closing date of the sale. As of March 31, 2011 and 2010, the uncollected accounts receivable and related payable balance was $1.1 million and $1.7 million, respectively.
(2)
The goodwill adjustment of $9.7 million represents the fair value of the Quality and DevPartner product lines in relation to the fair value of the products segment at the time of divestiture.
The Quality and DevPartner product lines represent a portion of the products segment. Because the Company’s products segment does not account for operating expenses on a product-by-product basis, operating expenses cannot be directly associated with specific product lines. Therefore, the Quality and DevPartner product lines were not reported as a discontinued operation in the consolidated financial statements.
Employee transition agreement
In the first quarter of fiscal 2009, the Company transitioned the employment of 170 of its professional services staff to a customer which resulted in the Company recording a $5.6 million gain against “administrative and general” in the consolidated statements of operations.
4. FAIR VALUE OF ASSETS AND LIABILITIES
The carrying value of cash equivalents, current accounts receivable and accounts payable approximate their fair value due to the short-term maturities of these instruments.
At March 31, 2011, the fair value and carrying amount of non-current receivables was $206.8 million and $206.9 million, respectively, and $222.8 million and $222.3 million, respectively as of March 31, 2010. Fair value is estimated by discounting the future cash flows using the current rate at which the Company would finance a similar transaction.
We report our money market funds and foreign exchange derivatives at fair value on a recurring basis using the following fair value hierarchy: (1) Level 1 - quoted prices in active markets for identical assets or liabilities; (2) Level 2 - inputs other than level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and (3) Level 3 - unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis (in thousands):
Non-financial assets such as goodwill and intangible assets are also subject to nonrecurring fair value measurements if they are deemed to be impaired (see note 8).
5. FINANCING RECEIVABLES
The Company adopted ASU No. 2010-20 “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” during the third quarter of fiscal 2011. The disclosure requirements of this ASU are applicable to certain trade receivables with payment terms greater than one year and our loans receivable.
The Company allows deferred payment terms that exceed one year for customers purchasing licenses (perpetual or time-based) for our software products and the related maintenance services (“multi-year deferred payment arrangements”). A financing receivable exists when the license transfers to the customer or the related maintenance service has been provided (i.e., revenue recognition has occurred) prior to the due date of the related receivable. Our products financing receivables primarily consist of the perpetual license portion of outstanding multi-year deferred payment arrangements.
Our loans receivables consist of a note due from CareTech, Inc. (see note 7 for additional information) and ForeSee Results, Inc. (“ForeSee”). As of March 31, 2011, the ForeSee note receivable, including interest (fixed rate of 10.25%), was $8.0 million and will become due on March 30, 2012.
The following is an aged analysis of our products and loans financing receivables based on invoice date as of March 31, 2011 (in thousands):
The Company performs a credit review of its financing receivables each reporting period to determine if an allowance for credit loss is required. As of March 31, 2011, the allowance for credit losses on our financing receivables is $389,000. See the “concentration of credit risk” section within note 1 for additional information on our credit risk evaluation process and changes to the total accounts receivable allowance for doubtful accounts balance.
6. PROPERTY AND EQUIPMENT
Property and equipment, summarized by major classification, was as follows (in thousands):
Depreciation and amortization of property and equipment totaled $27.9 million, $26.5 million and $27.0 million for the years ended March 31, 2011, 2010 and 2009, respectively.
7. INVESTMENT IN A PARTIALLY OWNED COMPANY
The Company holds a 33.3% interest in CareTech Solutions, Inc. (“CareTech”), which provides information technology outsourcing for healthcare organizations including data, voice, applications and data center operations. This investment is accounted for under the equity method.
At March 31, 2011 and 2010, the Company’s carrying value of its investments in and advances to CareTech was $9.9 million and $12.2 million, respectively. Included in the net investment at March 31, 2011 and 2010, was a note receivable with a basis of $1.8 million and $4.1 million, respectively, and accounts receivable due from CareTech of $4.7 million and $5.4 million, respectively. The note is payable in quarterly installments through January 2012 and bears interest at 5.25%.
The Company reviewed CareTech’s financial condition at March 31, 2011 and 2010 and concluded that no impairment charge or valuation allowance related to its investment in CareTech was warranted. For the years ended March 31, 2011, 2010 and 2009, the Company recognized income of $685,000, $618,000 and $468,000, respectively, from its investment in CareTech.
Professional services revenue for the years ended March 31, 2011, 2010 and 2009 included $24.7 million, $23.8 million and $26.0 million, respectively, from services provided for CareTech customers on a subcontractor basis.
8. GOODWILL, CAPITALIZED SOFTWARE AND OTHER INTANGIBLE ASSETS
Changes in the carrying amounts of goodwill for the years ended March 31, 2011 and 2010 were as follows (in thousands):
The components of the Company’s capitalized software and other intangible assets were as follows (in thousands):
Unamortized trademarks were acquired as part of the Covisint and Changepoint acquisitions in fiscal 2004 and fiscal 2005. These trademarks are deemed to have an indefinite life and therefore are not being amortized.
Capitalized software includes the costs of internally developed software technology (“capitalized internal software cost”) and software technology purchased through acquisitions (“purchased software”).
Customer relationship agreements were acquired as part of recent acquisitions. The customer relationship agreements are being amortized over periods of up to ten years.
Other amortizable intangible assets include amortizable trademarks and patents associated with recent acquisitions and are being amortized over periods of up to three years.
Amortization of intangible assets
Amortization expense of intangible assets for the years ended March 31, 2011, 2010 and 2009 was $22.4 million, $18.5 million and $26.1 million, respectively, of which $11.2 million, $11.0 million and $15.9 million, respectively, relates to capitalized internal software cost amortization and was primarily reported as “cost of software license fees” in the consolidated statements of operations.
Estimated future amortization expense, based on identified intangible assets at March 31, 2011, is expected to be as follows (in thousands):
Impairment evaluation
The Company evaluated its goodwill and other intangible assets for all reporting units as of March 31, 2011 and 2010. There were no impairments recorded during fiscal 2011. The March 31, 2010 evaluation resulted in a $1.6 million charge to reduce the book value of our Changepoint trademark to its fair value of $4.1 million as of March 31, 2010 (fair value as of March 31, 2011 was $10.0 million). The $1.6 million impairment was recorded to “administrative and general” in the consolidated statements of operations. The Company used the “relief from royalty” income approach in determining the fair value of the trademark which estimates the portion of a company's earnings attributable to a trademark based upon the royalty rate the company would have paid for the use of the trademark if it did not own it. This measurement is considered a level 3 input under the fair value hierarchy (see note 4).
When performing the goodwill impairment evaluation, the Company determined the fair value of each reporting unit using a discounted cash flow analysis supported by market multiples of revenue. The evaluation resulted in a fair value that exceeded each reporting unit’s carrying value as of March 31, 2011 and 2010.
Reclassification
As of March 31, 2011, capitalized software, customer relationships, trademarks and other intangible assets are reported as "capitalized software and other intangible assets, net" in the consolidated balance sheets. In order to conform the March 31, 2010 balance sheet to the current presentation, the Company has reclassified certain intangible assets totaling $42.8 million (reported as non-current "other assets" in the March 31, 2010 consolidated balance sheets) to "capitalized software and other intangible assets, net".
9. RESTRUCTURING CHARGES
The following table summarizes the restructuring activity during fiscal 2011, 2010 and 2009 (in thousands):
During fiscal 2009 and fiscal 2010, the Company incurred restructuring charges of $10.0 million and $8.0 million, respectively, associated with the following initiatives: (1) aligning the professional services segment headcount and operating expenses after initiating a plan to exit low-margin engagements and (2) increasing the operating efficiency of our products segment and administrative and general business processes with the goal of reducing operating expenses.
The first initiative reduced headcount and operating expenses resulting in restructuring charges of $6.3 million and $4.2 million, respectively, during fiscal 2009 and fiscal 2010. Employee termination costs were $5.4 million and $4.0 million, respectively, due to the Company eliminating 748 professional services personnel and management positions.
The second initiative resulted in the Company incurring restructuring charges of $3.7 million and $3.8 million, respectively, during fiscal 2009 and fiscal 2010. Employee termination costs accounted for $3.0 million and $3.6 million, respectively, of the charges due to the elimination of 194 positions within our products segment related to technology and sales and marketing personnel and 86 corporate administrative and general positions.
As part of these initiatives, full or partial closing of seven offices occurred during fiscal 2009, resulting in lease abandonment charges of $1.3 million. The remaining facilities charges for fiscal 2009 and fiscal 2010 primarily related to changes in sublease income assumptions associated with leased facilities that were abandoned in previous restructuring initiatives.
At this time, there are no initiatives that will require the Company to incur restructuring charges. However, unanticipated future conditions or events may require the Company to reassess the need for further restructuring initiatives.
10. DEBT
The Company had no long term debt at March 31, 2011 and 2010.
The Company has an unsecured revolving credit agreement (the “credit facility”) with Comerica Bank and other lenders. The credit facility provides for a revolving line of credit in the amount of $150 million and expires on November 1, 2012. The credit facility also permits the Company to increase the revolving line of credit by up to an additional $150 million subject to receiving further commitments from lenders and certain other conditions.
The credit facility contains various covenant requirements, including limitations on liens; indebtedness; mergers, consolidations and acquisitions; asset sales; dividends; investments, loans and advances from the Company; transactions with affiliates; and limits additional borrowing outside of the facility to $250 million. The credit facility is also subject to maximum total debt to EBITDA and minimum fixed charge coverage financial covenants. The Company was in compliance with the covenants under the credit facility at March 31, 2011.
Any borrowings under the credit facility bear interest at the prime rate or the Eurodollar rate plus the applicable margin (based on the level of maximum total debt to EBITDA ratio), at the Company’s option. The Company pays a quarterly facility fee on the credit facility based on the applicable margin grid.
The Company incurs interest expense primarily related to the accrual for certain abandoned leases. Cash paid for interest totaled approximately $1.4 million, $1.2 million and $1.6 million during fiscal 2011, 2010 and 2009, respectively.
11. CAPITAL STOCK
Preferred Stock Purchase Rights
The Company entered into a Rights Agreement with Computershare Trust Company, N.A., as Rights Agent, in October 2000 (as subsequently amended, the “rights plan”). The rights plan was adopted to discourage abusive, undervalued and other undesirable attempts to acquire control of the Company by making acquisitions of control, that are not approved by the Company's Board of Directors, economically undesirable for the acquirer. Pursuant to the rights plan, each share of the Company’s common stock has attached to it one right, which initially represents the right to purchase one two-thousandth of a share of Series A Junior Participating Preferred Stock (a right) for $40. The rights are not exercisable until (1) the first public announcement that a person or group has acquired, or obtained the right to acquire, except under limited circumstances, beneficial ownership of 20% or more of the outstanding common stock; or (2) the close of business on the tenth business day (or such later date as the Company’s Board of Directors may determine) after the commencement of a tender or exchange offer the consummation of which would result in a person or group becoming the beneficial owner of 20% or more of the outstanding common stock. If a person or group becomes a beneficial owner of 20% or more of the outstanding common stock, each right converts into a right to purchase multiple shares of common stock of the Company, or in certain circumstances securities of the acquirer, at a 50% discount from the then current market value. In connection with the rights plan, the Company has designated 800,000 shares of its 5,000,000 shares of authorized but unissued Preferred Stock as “Series A Junior Participating Preferred Stock.” The rights are redeemable for a specified period at a price of $0.001 per right and expire on May 9, 2012, unless extended or earlier redeemed by the Board of Directors.
Stock Repurchase Plans
In fiscal 2008, the Board of Directors approved a plan allowing the repurchase of up to $750.0 million of Company common stock. Management has been authorized to regularly evaluate market conditions for an opportunity to repurchase common stock at its discretion within the parameters established by the Board (“Discretionary Plan”). During fiscal 2011, 2010 and 2009, the Company repurchased 16.9 million, 17.9 million and 20.3 million common shares, respectively, under the Discretionary Plan. As of March 31, 2011, the remaining balance for future purchases is $242.7 million. In addition, we repurchased 302,402 shares withheld for taxes upon the exercise or release of certain stock options and restricted stock units in fiscal 2011.
In fiscal 2009, the Board of Directors approved a 10b5-1 Plan which provided for the repurchase of the Company’s common stock based upon predetermined price, volume and timing conditions set forth in the plan in accordance with Rule 10b5-1(c) of the Securities Exchange Act of 1934. The Company repurchased 1.3 million common shares under the plan during fiscal 2009 before the plan was terminated in that fiscal year.
12. FOREIGN CURRENCY TRANSACTIONS AND DERIVATIVES
The Company is exposed to foreign exchange rate risks related to assets and liabilities that are denominated in non-local currency and current inter-company balances due to and from the Company’s foreign subsidiaries. We enter into foreign currency forward contracts to sell or buy currencies with the intent of mitigating foreign exchange rate risks related to these balances. The Company did not hedge currency risk related to anticipated revenue or expenses denominated in foreign currency. All foreign exchange derivatives are recognized on the consolidated balance sheets at fair value (see note 4).
The foreign currency net gains or (losses) for the years ended March 31, 2011, 2010 and 2009 were $(1.9) million, $(1.8) million and $19.3 million, respectively. The hedging transaction net (losses) from foreign exchange derivative contracts were $(169,000), $(411,000) and $(13.0) million, respectively. These amounts were recorded to “administrative and general” in the consolidated statements of operations.
At March 31, 2011, the Company had derivative contracts maturing through April 2011 to sell $3.3 million and purchase $5.7 million in foreign currencies and had derivative contracts maturing through April 2010 to sell $830,000 and purchase $4.1 million in foreign currencies at March 31, 2010.
13. EARNINGS PER COMMON SHARE
Basic EPS is computed by dividing earnings available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS assumes the issuance of common stock for all potentially dilutive equivalent shares outstanding using the treasury method.
Earnings per common share (“EPS”) data were computed as follows (in thousands, except for per share data):
During the years ended March 31, 2011, 2010 and 2009, stock awards to purchase approximately 7.6 million, 26.2 million and 19.3 million shares, respectively, were excluded from the diluted EPS calculation because they were anti-dilutive.
14. INCOME TAXES
Income tax provision
Income before income taxes and the income tax provision include the following (in thousands):
The Company's income tax expense differed from the amount computed on pre-tax income at the U.S. federal income tax rate of 35% for the following reasons (in thousands):
(1)
During fiscal 2011, our tax credits primarily relate to (1) the U.S. Research and Experimentation tax credit (“R&D credit”) including the impact of retroactively reinstating the credit to January 1, 2010; and (2) settlement of R&D credits related to fiscal 2007 through fiscal 2009 tax periods with the Internal Revenue Service.
(2)
A deferred tax benefit of $32.3 million was recorded in fiscal 2010 due to capital loss carryforwards generated from a foreign tax reorganization that occurred during fiscal 2010. These capital loss carryforwards can only be offset by capital gains within the foreign jurisdiction, which the Company believes is less than more likely than not to occur. Therefore, the Company recorded a valuation allowance equal to the deferred tax benefit.
(3)
During fiscal 2010, the Company recorded a $32.3 million valuation allowance against the capital gains carryforward deferred tax asset that was created from the tax reorganization as noted above; partially offset by the release of valuation allowances related to Brownfield Redevelopment tax credit carryforward deferred tax assets (“Brownfield tax credit carryforward asset”) in the amount of $4.1 million. Due to certain events and circumstances that occurred during these periods, including the acquisition of Gomez, the Company adjusted the carrying value of the Brownfield tax credit carryforward asset to its more likely than not realizable value.
During fiscal 2009, the Company recorded a $6.0 million valuation allowance against its Brownfield tax credit carryforward asset. On January 9, 2009, the State of Michigan amended the MBT with an effective date of January 1, 2008. The amendment impacts future taxable income under the MBT, therefore the Company evaluated its ability to realize the Brownfield tax credit carryforward asset before the expiration date and adjusted the carrying value of the asset to its more likely than not realizable value.
(4)
During the fourth quarter of fiscal 2010, the Company identified a carryforward component of an income tax receivable that existed at March 31, 2009 resulting in a $3.0 million benefit which was corrected during the fourth quarter of fiscal 2010. The Company has considered both the qualitative and quantitative effects of this error on the financial statements for the fiscal year ended March 31, 2009, as well as the qualitative and quantitative effects of including the error correction in the fourth quarter of fiscal 2010 and fiscal year ended March 31, 2010 and has concluded that the effects on the financial statements are not material.
Deferred tax assets and liabilities
Temporary differences and carryforwards that give rise to a significant portion of deferred tax assets and liabilities were as follows (in thousands):
At March 31, 2011, the Company had net operating losses, capital losses and tax credit carryforwards for income tax purposes of $64.1 million that expire in the tax years as follows (in thousands):
Uncertain tax positions
The amount of gross unrecognized tax benefits was $21.1 million, $22.1 million and $16.1 million as of March 31, 2011, 2010 and 2009, respectively, of which $16.1 million, $17.3 million and $12.4 million, respectively, net of federal benefit, would favorably affect the Company’s effective tax rate if recognized in future periods.
The following is a tabular reconciliation of the total amounts of unrecognized tax benefits for the years ended March 31, 2011, 2010 and 2009 (in thousands):
Our interest payable associated with uncertain tax positions that were unfavorable to the Company as of March 31, 2011, 2010 and 2009 was $1.8 million, $8.9 million and $9.3 million, respectively. Our interest receivable associated with uncertain tax positions that were favorable to the Company was $2.1 million, $7.1 million and $7.8 million, respectively. The March 31, 2009 balances include a $6.4 million balance sheet reclassification that increased the interest receivable and payable. The Company recognized $1.3 million of net interest income during fiscal 2011 and net interest expense of $248,000 and $313,000, respectively, during fiscal 2010 and 2009.
The Company has open tax years from 1999 and forward, with various taxing jurisdictions, including the U.S., Brazil and Canada. These open years contain matters that could be subject to differing interpretations of applicable tax laws and regulations due to the amount, timing or inclusion of revenue and expenses or the sustainability of income tax credits for a given audit cycle. During fiscal 2012, it is reasonably possible that the Company will settle income tax examinations in the amount of approximately $122,000.
Cash paid for income taxes
Cash paid for income taxes was $38.1 million, $66.1 million and $31.7 million during fiscal 2011, 2010 and 2009, respectively.
15. SEGMENT INFORMATION
Compuware operates in the software industry and has four business segments: products, web performance services, professional services and application services. The Company’s products and services are offered worldwide to the largest IT organizations across a broad spectrum of technologies, including mainframe, distributed and Internet platforms and provide the following capabilities:
·
Our products and web performance services are designed to enhance the effectiveness of key disciplines throughout IT organizations including application development and delivery, service management and IT portfolio management and the availability and quality of web applications.
·
Our IT professional services include a broad range of IT services for mainframe, distributed and mobile environments, including mobile computing application development and integration, package software customization, cloud computing consulting, development and integration of legacy systems, IT portfolio management services, enterprise legacy modernization services, and application performance management. Our professional services segment also provides implementation, consulting and training services in tandem with the Company’s product offerings which are referred to as product related services.
·
Our application services use business-to-business applications to integrate vital business information and processes between partners, customers and suppliers.
The Company evaluates the performance of its segments based primarily on operating profit before administrative and general expenses and other charges. The allocation of income taxes is not evaluated at the segment level. Financial information for the Company’s business segments was as follows (in thousands):
(1)
For the year ended March 31, 2010, income from the products segment includes a $52.4 million gain on divestiture of the Quality and DevPartner product lines (see Note 3 to the consolidated financial statements for additional information).
No single customer accounted for greater than 10% of total revenue during the years ended March 31, 2011, 2010 or 2009, or greater than 10% of accounts receivable at March 31, 2011 or 2010.
The Company does not evaluate assets and capital expenditures on a segment basis, and accordingly such information is not provided.
Financial information regarding geographic operations is presented in the table below (in thousands):
Long-lived assets are comprised of property, plant and equipment, goodwill and capitalized software.
16. RELATED PARTY TRANSACTIONS
The Company sells and purchases products and services to and from companies associated with certain officers or directors of the Company including the following:
Peter Karmanos, Jr., Chairman of the Board, is a shareholder of Compuware Sports Corporation (“CSC”). CSC operates an amateur hockey program in Southeastern Michigan. On September 8, 1992, the Company entered into a Promotion Agreement with CSC to promote the Company’s business. The promotion agreement automatically renews each year, unless terminated with 60 days prior notice by either party. Advertising costs related to this agreement were approximately $1.0 million, $974,000 and $840,000 for the years ended March 31, 2011, 2010 and 2009, respectively. These costs are included in “sales and marketing” in the consolidated statements of operations.
Peter Karmanos, Jr. has a significant ownership interest in entities that own and/or manage various sports arenas. The Company entered into an advertising agreement with one arena to promote the Company’s business, including the right to name the arena “Compuware Arena”. The Company also rents suites and places advertising at the arenas. Total costs related to these agreements were approximately $671,000, $707,000 and $590,000 for the years ended March 31, 2011, 2010 and 2009, respectively. These costs are included in “sales and marketing” in the consolidated statements of operations.
17. COMMITMENTS AND CONTINGENCIES
Contractual obligations
The Company’s contractual obligations primarily relate to various operating lease agreements for office space, equipment and land for various periods that extend through as late as fiscal 2100. Total rent payments under these agreements were approximately $24.3 million, $26.0 million and $30.9 million, respectively, for fiscal 2011, 2010 and 2009. Certain of these lease agreements contain provisions for renewal options and escalation clauses.
The Company also has commitments under various advertising and charitable contribution agreements totaling $9.2 million and $600,000, respectively, at March 31, 2011. Total expense related to these agreements was approximately $7.8 million, $7.6 million and $3.7 million, respectively, for fiscal 2011, 2010 and 2009.
The following table summarizes our payments under contractual obligations as of March 31, 2011 (in thousands):
The Company also leases space within the Company’s headquarters facility to business tenants. Total cash receipts relating to these lease spaces totaled $2.2 million, $870,000 and $1.1 million, respectively, for fiscal 2011, 2010 and 2009.
The following is a schedule of future minimum lease rental commitments (in thousands):
Settlement
In March 2005, the Company settled all of its outstanding litigation with International Business Machines Corporation (“IBM”). Under the settlement agreement and subsequent clarifications, IBM and the Company entered into a business arrangement whereby IBM was committed to purchase software licenses and maintenance from the Company totaling $140 million over five years ending in fiscal 2010 ($20 million in fiscal 2006, $30 million in each of the following four years).
During fiscal 2010 and 2009, IBM utilized $9.3 million and $12.1 million, respectively, of their license and maintenance commitment, resulting in an unused commitment balance of $20.7 million and $17.9 million, respectively, for fiscal 2010 and 2009. The unused commitment amounts are reported as “settlement” in the consolidated statements of operations and recognized as income in the fourth quarter of each respective fiscal year. There were no payment or purchase commitment requirements under this agreement during fiscal 2011 as these provisions expired on March 31, 2010.
Legal Matters
From time to time, the Company is subject to legal proceedings, claims, investigations and proceedings in the ordinary course of business. In accordance with U.S. GAAP, the Company makes a provision for a liability when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Litigation is inherently unpredictable. However, the Company believes it has valid defenses with respect to the legal matters pending against the Company. It is possible, nevertheless, that our consolidated financial position, cash flows or results of operations could be materially affected by the resolution of one or more of such contingencies.
18. BENEFIT PLANS
Employee Stock Ownership Plan
In July 1986, the Company established an Employee Stock Ownership Plan (“ESOP”). Under the terms of the ESOP, the Company may elect to make annual contributions to the Plan for the benefit of substantially all U.S. employees. The contribution may be in the form of cash or Company common stock. The Board of Directors authorizes contributions between a maximum of 25% of eligible annual compensation and a minimum sufficient to cover current obligations of the Plan. There have been no contributions to the ESOP plan in the past three fiscal years. This is a non-leveraged ESOP plan.
Employee Stock Purchase Plan
During fiscal 2002, the shareholders approved international and domestic employee common stock purchase plans under which the Company was authorized to issue up to 15 million shares of common stock to eligible employees. Under the terms of the plan, employees can elect to have up to 10% of their compensation withheld to purchase Company common stock at the close of the offering period. The value of the common stock purchased in any calendar year cannot exceed $25,000 per employee. The purchase price is 95% of the closing market sales price on the market date immediately preceding the last day of the offering period. Effective December 1, 2007, the Company discontinued the plan for employees outside the U.S. and Canada. During fiscal 2011, 2010 and 2009, the Company sold approximately 292,000, 316,000 and 405,000 shares, respectively, to eligible employees under the plan.
Director Phantom Stock Plan
Effective April 1, 2002, the Board of Directors approved the 2002 Directors Phantom Stock Plan (the “Phantom Plan”) for non-employee directors to provide increased incentive to make contributions to the long term growth of the Company, to align the interests of directors with the interests of shareholders, and to facilitate attracting and retaining directors of exceptional ability. The Phantom Plan provided for issuance of rights to receive the value of a share of the Company’s common stock in cash upon vesting which occurs upon the retirement of the director from the Board. Phantom shares were granted automatically at the beginning of each fiscal year and at the discretion of the Board.
In May 2005, the Board of Directors authorized non-employee directors to defer receipt of all or a portion of their director’s fees via a deferred compensation plan. As an alternative to a cash deferral, the plan allows non-employee directors to defer their cash compensation into deferred compensation stock units, which are based upon the price of Compuware’s common stock.
Effective January 1, 2009, the Board of Directors approved the issuance of restricted share units from the Company’s Long Term Incentive Plan to replace the phantom shares and the deferred compensation stock units outstanding as of December 31, 2008, eliminating the need for liability accounting treatment associated with the Phantom Plan and deferred compensation plan. The Company recorded income of $304,000 in fiscal 2009 related to the phantom share program which was recorded to “administrative and general” in the consolidated statements of operations.
Employee Equity Incentive Plans
In June 2007, the Company’s Board of Directors adopted the 2007 Long Term Incentive Plan (the “LTIP”) that was approved by the Company’s shareholders in August 2007. As of March 31, 2011, the Company has reserved an aggregate of 28.0 million common shares to be awarded under the LTIP. The Compensation Committee may grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance-based cash or stock awards and annual cash incentive awards under the LTIP.
Prior to the LTIP, the Company had seven stock option plans (“Plans”) dating back to 1991. All but one of the plans, the 2001 Broad Based Stock Option Plan (“BBSO”), were approved by the Company’s shareholders. The BBSO was approved by the Board of Directors in March 2001, but was not submitted to the shareholders for approval, as shareholder approval was not required at the time. These Plans have been terminated as to future grants.
In August 2009, Covisint Corporation (“Covisint”), a subsidiary of the Company, established a 2009 Long-Term Incentive Plan (“2009 Covisint LTIP”) allowing the Board of Directors of Covisint to grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance-based cash or restricted stock unit awards and annual cash incentive awards to employees and directors of Covisint. The 2009 Covisint LTIP reserves 150,000 common shares of Covisint for issuance under this plan.
Stock Options Activity
A summary of option activity under the Company’s stock-based compensation plans as of March 31, 2011, and changes during the year then ended is presented below (shares and intrinsic value in thousands):
During fiscal 2011, a stock option holder of approximately 3.4 million stock options elected to make a cashless stock option exercise and received 647,000 shares of common stock.
The vesting schedule of options has varied over the years with the following vesting terms being the most common: (1) 50% of shares vest on the anniversary date of the third year and 25% on the fourth and fifth year; (2) 30% of shares vest on the anniversary date of the first and second year and 40% on the third year; (3) 20% of shares vest on each annual anniversary date over five years; or (4) 25% of shares vest on each annual anniversary date over four years.
All options were granted at fair market value and expire ten years from the date of grant.
The average fair value of option shares vested during fiscal 2011, 2010 and 2009 was $4.55, $4.33 and $3.90 per share, respectively, and the total intrinsic value of options exercised were $24.7 million, $799,000 and $3.9 million, respectively.
Restricted Stock Units and Performance-Based Stock Awards Activity
A summary of non-vested restricted stock units and performance-based stock awards (collectively “Non-vested RSU”) activity under the Company’s LTIP as of March 31, 2011, and changes during the year then ended is presented below (shares and intrinsic value in thousands):
Restricted stock units typically vest 25% on each annual anniversary date over four years.
During fiscal 2011, the Company issued 133,000 performance-based stock awards (“PSAs”) under the Company’s LTIP to various employees associated with our Covisint business. See “Covisint Corporation 2009 Long-Term Incentive Plan” section within this footnote for additional information.
The units and PSAs are settled by the issuance of one common share for each unit upon vesting and vesting accelerates upon death, disability or a change in control.
Covisint Corporation 2009 Long-Term Incentive Plan
As of March 31, 2011, there were 135,000 stock options outstanding from the 2009 Covisint LTIP. These options will vest only if, prior to August 26, 2015, Covisint completes an initial public offering (“IPO”) or if there is a change of control of Covisint.
The individuals who received stock options from the 2009 Covisint LTIP were also awarded PSAs from the Company’s 2007 LTIP. There were 1.5 million PSAs outstanding as of March 31, 2011. These PSAs will vest only if Covisint does not complete an IPO or a change of control transaction by August 25, 2015, and the Covisint business meets a pre-defined revenue target for any four consecutive calendar quarters ending prior to August 26, 2015.
During the fourth quarter of fiscal 2011, we determined that Covisint’s ability to meet the pre-defined revenue targets prior to August 26, 2015 was probable based on Covisint’s revenue and billing growth in fiscal 2011 and Covisint’s projected future revenue growth estimates. Prior to the quarter, we considered the revenue targets improbable of being met. As a result, we recorded a charge of $1.9 million to “cost of professional services” in the consolidated statement of operations during the fourth quarter of fiscal 2011. This charge represents the compensation cost that has accumulated from grant date through March 31, 2011 based on the straight-line method. The PSAs’ unrecognized compensation cost as of March 31, 2011 will be recognized on a straight-line basis over the remaining vesting period.
Stock Awards Compensation
For the years ended March 31, 2011, 2010 and 2009, stock awards compensation expense was allocated as follows (dollars in thousands):
As of March 31, 2011, total unrecognized compensation cost of $27.0 million, net of estimated forfeitures, related to nonvested equity awards is expected to be recognized over a weighted-average period of approximately 2.89 years.
19. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial information for the years ended March 31, 2011 and 2010 was as follows (in thousands, except for per share data):
(1)
During the first quarter of fiscal 2010, the Company divested the Quality and DevPartner product lines resulting in a gain on divestiture of $52.4 million which was reported within operating expenses in the consolidated statements of operations.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to ensure information required to be disclosed in the Company’s reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required financial disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, with a company have been detected.
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective, at the reasonable assurance level, to cause information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act to be recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required financial disclosure.
Management’s Report on Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is defined under applicable Securities and Exchange Commission rules as a process designed under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer and effected by the Company’s Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that:
·
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
·
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U. S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
·
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective because of changes in conditions and that the degree of compliance with the policies or procedures may deteriorate.
As of March 31, 2011, management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting based on the criteria for effective internal control over financial reporting established in “Internal Control - Integrated Framework,” issued by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission. Based on the assessment, management determined that the Company’s internal control over financial reporting was effective, as of March 31, 2011, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
Deloitte & Touche LLP, the independent registered public accounting firm that audited the consolidated financial statements of the Company included in this Annual Report on Form 10-K, has issued an attestation report on the Company’s internal control over financial reporting as of March 31, 2011. The report, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of March 31, 2011, is included in this Item under the heading “Report of Independent Registered Public Accounting Firm.”
Changes in Internal Control Over Financial Reporting
No changes in the Company’s internal control over financial reporting occurred during the quarter ended March 31, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Compuware Corporation
Detroit, Michigan
We have audited the internal control over financial reporting of Compuware Corporation and subsidiaries (the “Company”) as of March 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2011, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended March 31, 2011, of the Company and our report dated May 27, 2011 expressed an unqualified opinion on those financial statements.
/s/ DELOITTE & TOUCHE LLP
Detroit, Michigan
May 27, 2011
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item is contained in the Proxy Statement under the captions “Corporate Governance” (excluding the Report of the Audit Committee), “Election of Directors” and “Other Matters - Section 16(a) Beneficial Ownership Reporting Compliance” and is incorporated herein by reference.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information required by this Item is contained in the Proxy Statement under the caption “Compensation of Executive Officers” and “Corporate Governance” and is incorporated herein by reference.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is contained in the Proxy Statement under the caption “Security Ownership of Management and Major Shareholders” and is incorporated herein by reference.
The Company’s Board of Directors adopted the 2007 Long Term Incentive Plan (“LTIP”) in June 2007 and the Company’s shareholders approved the LTIP in August 2007. The Compensation Committee may grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance-based cash or stock awards and annual cash incentive awards under the LTIP. Prior to the LTIP, the Company had seven stock option plans (“Prior Plans”) dating back to 1991. All but one of the Prior Plans, the 2001 Broad Based Stock Option Plan (“BBSO”), were approved by the Company’s shareholders. The BBSO was approved by the Board of Directors in March 2001, but was not submitted to the shareholders for approval, as shareholder approval was not required at the time. Under the terms of the BBSO, the Company was authorized to grant nonqualified stock options with a maximum term of ten years to any employee or director of the Company at an exercise price and with vesting and other terms determined by the Compensation Committee of the Company’s Board. Options granted under the BBSO either vested every six months over a four year period or 50% of the option became vested on the third year anniversary of the date of grant, and 25% of the option vested on each of the fourth year and fifth year anniversaries of the date of grant. All options were granted at fair market value and expired ten years from the date of grant.
As a result of the LTIP adoption, the Prior Plans have been terminated as to future grants.
The Company also has an Employee Stock Ownership Plan (“ESOP”) and an Employee Stock Purchase Plan (“ESPP”). The information about our equity compensation plans in note 18 of the consolidated financial statements included in this report is incorporated herein by reference.
The following table sets forth certain information with respect to our equity compensation plans at March 31, 2011 (shares in thousands):
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is contained in the Proxy Statement under the caption “Other Matters - Related Party Transactions,” “Corporate Governance” and “Compensation of Executive Officers - Compensation Committee Interlocks and Insider Participation” and is incorporated herein by reference.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is contained in the Proxy Statement under the caption “Item No.2 - Ratification of Appointment of the Independent Registered Public Accounting Firm” and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
Documents filed as part of this report.
1.
Consolidated Financial Statements
2.
Financial Statement Schedules
All financial statement schedules are omitted as the required information is not applicable or the information is presented in the consolidated financial statements or related notes.
3.
Exhibits
The exhibits filed in response to Item 601 of Regulation S-K are listed in the Exhibit Index attached to this report. The Exhibit Index is incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Detroit, State of Michigan on May 27, 2011.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signature
Title
Date
/S/ PETER KARMANOS, JR.
Chairman of the Board, Chief Executive Officer
May 25, 2011
Peter Karmanos, Jr.
And Director (Principal Executive Officer)
/S/ LAURA L. FOURNIER
Executive Vice President, Chief Financial Officer
May 25, 2011
Laura L. Fournier
and Treasurer (Principal Financial Officer and Principal Accounting Officer)
/S/ ROBERT C. PAUL
Director, President and Chief Operating Officer
May 25, 2011
Robert C. Paul
/S/ DENNIS W. ARCHER
Director
May 23, 2011
Dennis W. Archer
/S/ GURMINDER S. BEDI
Director
May 19, 2011
Gurminder S. Bedi
/S/ WILLIAM O. GRABE
Director
May 20, 2011
William O. Grabe
/S/ FREDERICK A. HENDERSON
Director
May 19, 2011
Frederick A. Henderson
/S/ FAYE A. NELSON
Director
May 27, 2011
Faye A. Nelson
/S/ GLENDA D. PRICE
Director
May 19, 2011
Glenda D. Price
/S/ W. JAMES PROWSE
Director
May 23, 2011
W. James Prowse
/S/ G. SCOTT ROMNEY
Director
May 27, 2011
G. Scott Romney
/S/ RALPH J. SZYGENDA
Director
May 27, 2011
Ralph J. Szygenda
EXHIBITS
The following exhibits are filed herewith or incorporated by reference to the filing indicated with which it was previously filed. Each management contract or compensatory plan or arrangement filed as an exhibit to this report is identified below with an asterisk before the exhibit number. The Company’s SEC file number is 000-20900.
**
XBRL (Extensible Business Reporting Language) information is furnished and not filed herewith, is not a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.