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FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
For the quarterly period ended March 31, 2002
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
For the transition period from to
Commission file number: 0-22141
COVANSYS CORPORATION
| Michigan (State or Other Jurisdiction of Incorporation or Organization) | 38-2606945 (IRS Employer Identification No.) |
32605 West Twelve Mile Road
Registrant’s telephone number, including area code:(248) 488-2088
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx Noo
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
| No Par Value (Class of Common Stock) | 27,847,282 (Outstanding as of April 5, 2002) |
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COVANSYS CORPORATION
INDEX
| Page No. | ||||||
| PART I. FINANCIAL INFORMATION | ||||||
| Item 1. | Financial Statements | 3 | ||||
| Condensed Consolidated Balance Sheets | 3 | |||||
| Condensed Consolidated Statements of Operations | 4 | |||||
| Condensed Consolidated Statements of Cash Flows | 5 | |||||
| Notes to Condensed Consolidated Financial Statements | 6 | |||||
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 8 | ||||
| PART II. OTHER INFORMATION | ||||||
| Item 6. | Exhibits and Reports on Form 8-K | 11 | ||||
| SIGNATURES | 12 | |||||
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COVANSYS CORPORATION AND SUBSIDIARIES
| December 31, | March 31, | |||||||||
| 2001 | 2002 | |||||||||
| (Dollars in thousands) | ||||||||||
| (Unaudited) | ||||||||||
ASSETS | ||||||||||
| Current assets: | ||||||||||
| Cash and cash equivalents | $ | 123,755 | $ | 106,212 | ||||||
| Accounts receivable, net | 69,391 | 68,006 | ||||||||
| Revenue earned in excess of billings, net | 30,755 | 34,499 | ||||||||
| Deferred taxes | 7,824 | 7,824 | ||||||||
| Prepaid expenses and other | 5,101 | 5,826 | ||||||||
| Total current assets | 236,826 | 222,367 | ||||||||
| Property and equipment, net | 32,560 | 33,524 | ||||||||
| Computer software, net | 1,981 | 2,409 | ||||||||
| Goodwill, net | 10,691 | 10,691 | ||||||||
| Deferred taxes | 2,891 | 2,891 | ||||||||
| Other assets, net | 12,674 | 12,553 | ||||||||
| Total assets | $ | 297,623 | $ | 284,435 | ||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||||
| Current liabilities: | ||||||||||
| Accounts payable | $ | 10,127 | $ | 8,026 | ||||||
| Accrued payroll and related costs | 29,650 | 22,313 | ||||||||
| Other accrued liabilities | 9,495 | 7,119 | ||||||||
| Deferred revenue | 397 | 1,219 | ||||||||
| Total current liabilities | 49,669 | 38,677 | ||||||||
| Other liabilities | 225 | 225 | ||||||||
| Commitments and contingencies | ||||||||||
| Convertible redeemable preferred stock, no par value, 200,000 shares issued and outstanding as of December 31, 2001 and March 31, 2002, respectively | 159,924 | 161,011 | ||||||||
| Shareholders’ equity: | ||||||||||
| Preferred stock, no par value, 1,000,000 shares authorized, 200,000 issued as convertible redeemable preferred stock | — | — | ||||||||
| Common stock, no par value, 200,000,000 shares authorized, 28,254,850 and 27,846,080 shares issued and outstanding as of December 31, 2001 and March 31, 2002, respectively | — | — | ||||||||
| Additional paid-in capital | 108,946 | 105,601 | ||||||||
| Retained earnings (deficit) | (12,230 | ) | (11,799 | ) | ||||||
| Stock subscriptions receivable | (2,362 | ) | (2,340 | ) | ||||||
| Accumulated other comprehensive loss | (6,549 | ) | (6,940 | ) | ||||||
| Total shareholders’ equity | 87,805 | 84,522 | ||||||||
| Total liabilities and shareholders’ equity | $ | 297,623 | $ | 284,435 | ||||||
The accompanying notes are an integral part of these condensed consolidated balance sheets.
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COVANSYS CORPORATION AND SUBSIDIARIES
| Three Months Ended | ||||||||||
| March 31, | ||||||||||
| 2001 | 2002 | |||||||||
| (In thousands, except | ||||||||||
| per share data) | ||||||||||
| (Unaudited) | ||||||||||
| Revenues | $ | 104,671 | $ | 90,768 | ||||||
| Cost of revenues | 77,145 | 66,485 | ||||||||
| Gross profit | 27,526 | 24,283 | ||||||||
| Selling, general and administrative expenses | 29,068 | 24,200 | ||||||||
| Restructuring and other | 3,216 | — | ||||||||
| Income (loss) from operations | (4,758 | ) | 83 | |||||||
| Other expense (income) | (1,644 | ) | (1,073 | ) | ||||||
| Income (loss) from operations before benefit for income taxes | (3,114 | ) | 1,156 | |||||||
| Benefit for income taxes | (1,164 | ) | (361 | ) | ||||||
| Net income (loss) | (1,950 | ) | 1,517 | |||||||
| Convertible redeemable preferred stock dividends | 1,053 | 1,086 | ||||||||
| Net income (loss) available for common shareholders | $ | (3,003 | ) | $ | 431 | |||||
| Basic earnings (loss) per share — Weighted average shares outstanding | 29,233 | 28,101 | ||||||||
| Basic earnings (loss) per share | $ | (0.07 | ) | $ | 0.05 | |||||
| Basic loss per share from preferred stock dividends | (0.04 | ) | (0.04 | ) | ||||||
| Basic earnings (loss) per share | $ | (0.11 | ) | $ | 0.01 | |||||
| Diluted earnings (loss) per share — | ||||||||||
| Weighted average shares outstanding | 29,233 | 28,101 | ||||||||
| Dilutive effect of stock options | — | 8,741 | ||||||||
| Diluted weighted average shares outstanding | 29,233 | 36,842 | ||||||||
| Diluted earnings (loss) per share from operations | $ | (0.07 | ) | $ | 0.04 | |||||
| Diluted loss per share from preferred stock dividends | (0.04 | ) | (0.03 | ) | ||||||
| Diluted earnings (loss) per share | $ | (0.11 | ) | $ | 0.01 | |||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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COVANSYS CORPORATION AND SUBSIDIARIES
| Three Months Ended | |||||||||||
| March 31, | |||||||||||
| 2001 | 2002 | ||||||||||
| (Dollars in thousands) | |||||||||||
| (Unaudited) | |||||||||||
| Cash flows used in operating activities: | |||||||||||
| Net income (loss) | $ | (1,950 | ) | $ | 1,517 | ||||||
| Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities from operations: | |||||||||||
| Depreciation and amortization | 3,024 | 2,808 | |||||||||
| Provision for doubtful accounts | 276 | 237 | |||||||||
| Change in assets and liabilities — | |||||||||||
| Accounts receivable and revenue earned in excess of billings | (5,412 | ) | (2,596 | ) | |||||||
| Prepaid expenses and other assets | 372 | (993 | ) | ||||||||
| Accounts payable, accrued payroll and related costs and other liabilities | (2,087 | ) | (11,814 | ) | |||||||
| Deferred revenue | (1,610 | ) | 822 | ||||||||
| Net cash used in operating activities of operations | (7,387 | ) | (10,019 | ) | |||||||
| Cash flows from investing activities: | |||||||||||
| Investment in property, equipment and other | (2,249 | ) | (3,545 | ) | |||||||
| Investment in computer software | — | (655 | ) | ||||||||
| Net cash used in investing activities of operations | (2,249 | ) | (4,200 | ) | |||||||
| Cash flows from financing activities: | |||||||||||
| Net proceeds from issuance of common stock | 473 | 283 | |||||||||
| Net proceeds from exercise of stock options and other, net | 48 | 39 | |||||||||
| Repurchases of common stock | (10,786 | ) | (3,646 | ) | |||||||
| Net cash used in financing activities of operations | (10,265 | ) | (3,324 | ) | |||||||
| Decrease in cash and cash equivalents | (19,901 | ) | (17,543 | ) | |||||||
| Cash and cash equivalents at beginning of period | 140,123 | 123,755 | |||||||||
| Cash and cash equivalents at end of period | $ | 120,222 | $ | 106,212 | |||||||
| Supplemental disclosures of cash flow information: | |||||||||||
| Cash paid during the period for: | |||||||||||
| Income taxes | $ | 62 | $ | 6 | |||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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COVANSYS CORPORATION AND SUBSIDIARIES
1. Organization and Basis of Presentation
Complete Business Solutions, Inc. was founded in 1985. In June 2001, Complete Business Solutions, Inc. changed its name to Covansys Corporation. Covansys Corporation and its subsidiaries (the Company) provide information technology (IT) services worldwide to large and mid-size organizations. The Company offers its clients a focused range of IT services specializing in systems integration services and strategic outsourcing. The Company’s range of experience runs from advising clients on IT business strategy and strategic technology plans to developing and implementing appropriate IT applications solutions.
The accompanying condensed consolidated financial statements have been prepared by management, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting of normal recurring adjustments, necessary to present fairly the financial position of Covansys Corporation and subsidiaries as of March 31, 2002, the results of its operations for the three month periods ended March 31, 2001 and 2002, and cash flows for the three month periods ended March 31, 2001 and 2002. These financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s 2001 Form 10-K.
The results of operations for the three month period ended March 31, 2002 are not necessarily indicative of the results to be expected in future quarters or for the full fiscal year ending December 31, 2002.
2. Income Taxes
The Company has benefited federal and state income taxes in the condensed consolidated statements of operations based on the anticipated effective tax rate for fiscal years 2001 and 2002. During the three month periods ended March 31, 2001 and 2002, the Company incurred tax losses in excess of tax carrybacks in the United States. The Company benefited these tax losses and expects to realize these tax assets through future U.S. taxable income generated by operations.
3. Common Stock Repurchase Program
The Company’s board of directors has authorized the repurchase of up to 12,000,000 shares of the Company’s Common Stock.
Through December 31, 2001, the Company repurchased 9,500,300 shares of its Common Stock, for cash, at a total cost of $131,504. During the three month period ended March 31, 2002, the Company repurchased 446,000 shares of its Common Stock at a total cost of $3,646. As of March 31, 2002, 2,053,700 shares remain available for repurchase under the current board authorization.
4. Restructuring and Other Costs
During the three month period ended March 31, 2001, the Company incurred approximately $1,516 in costs for severance and certain non-recurring employee costs related to the Company’s organizational restructuring. The charge related to approximately 150 employees in the Company’s U.S. operations and management. In addition, the Company incurred approximately $1,700 in legal and advisory fees related to discontinued acquisition discussions.
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5. Accounting Changes
Effective January 1, 2002, the Company adopted SFAS No. 141 Business Combinations and SFAS No. 142 Goodwill and Other Intangible Assets. SFAS 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting. SFAS 142 requires that goodwill and certain intangibles no longer be amortized, but instead tested for impairment at least annually.
The following table summarizes the reconciliation of reported net loss available for common shareholders to adjusted net loss available for common shareholders for the three month period ended March 31, 2001, had SFAS 142 been applied.
| Three Months Ended | |||||
| March 31, 2001 | |||||
| Net loss available for common shareholders | $ | (3,003 | ) | ||
| Amortization of Goodwill | 145 | ||||
| Adjusted net loss available for common shareholders | $ | (2,858 | ) | ||
| Basic loss per share — | |||||
| Weighted average shares outstanding | 29,233 | ||||
| Basic loss per share | $ | (0.10 | ) | ||
| Diluted loss per share — | |||||
| Weighted average shares outstanding | 29,233 | ||||
| Diluted loss per share | $ | (0.10 | ) | ||
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The following section should be read in conjunction with our Consolidated Financial Statements and related Notes appearing in this Form 10-Q. With the exception of statements regarding historical matters and statements concerning our current status, certain matters discussed in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are forward-looking statements that involve substantial risks and uncertainties. Such forward-looking statements may be identified by the words “anticipate,” “believe,” “estimate,” “expect” or “intend” and similar expressions. Our actual results, performance or achievements could differ materially from these forward-looking statements. Factors that could cause or contribute to such material differences include our failure to recruit and retain IT professionals, risks related to our merger, acquisition and strategic investment strategy, variability of our operating results, government regulation of immigration, potential cost overruns on fixed-price projects, exposure to regulatory, political and economic conditions in India and Asia, competition in the IT services industry, short-term nature and termination provisions of contracts, economic conditions unique to clients in specific industries, and limited protection of intellectual property rights.
Overview
We provide IT services worldwide, offering clients flexible global delivery capabilities. Our strategy is to establish long-term client relationships and to secure additional engagements with existing clients by providing quality services and by being responsive to client needs. For each of the past five years, over 80% of our revenues were generated from existing clients from the previous fiscal year.
We offer our clients a focused range of IT services specializing in systems integration services and strategic outsourcing. Our range of experience runs from advising clients on IT business strategy and strategic plans to developing and implementing appropriate IT applications solutions.
We generally assume responsibility for project management and may bill the client on either a time-and-materials or fixed-price basis. We recognize revenues on time-and-materials engagements as the services are performed. On fixed-price engagements, we recognize revenues under the percentage of completion method. For the three months ended March 31, 2001 and 2002, approximately 28% and 39%, respectively, of our total revenues were generated from fixed-price engagements. Fixed-price engagements generally experience higher gross margins than time-and-materials engagements due to our project management experience and ability to control project variables.
Our most significant cost is project personnel cost, which consists primarily of salaries, wages and benefits for our IT professionals. We strive to maintain our gross profit margin by controlling project costs and offsetting increases in salaries and benefits with increases in billing rates. We use a human resource management team to ensure that IT professionals are quickly placed on assignments to minimize nonbillable time and are placed on assignments that use their technical skills and allow for maximum billing rates.
In an effort to sustain our growth and profitability, we have made and continue to make substantial investments in our infrastructure, including: (1) development centers in the United States and India; (2) system methodologies; (3) sales and marketing teams; and (4) internal systems.
For information regarding our significant accounting policies please refer to our discussion of our significant accounting policies provided in our Annual Report on Form 10-K for the year ended December 31, 2001.
Results of Operations
Revenues. Revenues decreased 13.3% to $90.8 million for the three month period ended March 31, 2002 from $104.7 million for the same period in 2001. The decrease was largely attributable to weak economic conditions, reduced billable headcount and lower bill rates.
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Gross Profit. Gross profit consists of revenues less cost of revenues. Cost of revenues consists primarily of salaries (including nonbillable and training time), benefits, travel and relocation for IT professionals. In addition, cost of revenues includes depreciation and amortization, direct facility costs and contractual services. Gross profit decreased approximately 11.8% to $24.3 million for the three month period ended March 31, 2002 from $27.5 million for the same period in 2001. This decrease in gross profit is primarily due to lower bill rates, project transition and changes in contract mix. Gross profit as a percentage of revenues increased to approximately 26.8% for the three month period ended March 31, 2002 from approximately 26.3% for the same period in 2001. This increase in gross profit as a percentage of revenues is primarily attributable to increases in domestic and offshore utilization rates.
Selling, General and Administrative. Selling, general and administrative expenses consist primarily of costs associated with our direct selling and marketing efforts, human resources and recruiting departments, administration and indirect facility costs. Selling, general and administrative expenses decreased approximately 16.7% to $24.2 million for the three months ended March 31, 2002 compared to $29.1 million for the same period in 2001. As a percentage of revenues, selling, general and administrative expenses decreased to 26.7% for the three month period ended March 31, 2002 from 27.8% for the same period in 2001. These decreases are primarily due to the higher level of public relations and advertising costs associated with the branding initiative in 2001 and the continued close management of spending through targeted actions in 2002 and the impact of adopting SFAS 142.
Other Expense (Income). Other expense (income) represents interest earned on cash and cash equivalents. Other income for the three month period ended March 31, 2002 was $1.1 million, as compared to $1.6 million for the same period in 2001. The decrease is primarily due to lower interest rates on investments.
Benefit for Income Taxes. We have benefited federal and state income taxes in the condensed consolidated statements of operations based on the anticipated effective tax rate for fiscal years 2001 and 2002. During the first quarter of 2002, the Company incurred tax losses in excess of tax carrybacks in the United States. The Company benefited these tax losses and expects to realize these tax assets through future U.S. taxable income generated by operations.
Liquidity and Capital Resources
We generally fund our operations and working capital needs through internally generated funds, periodically supplemented by borrowings under our revolving credit facilities with a commercial bank. Our cash used in operations was $10.0 million for the three month period ended March 31, 2002 compared to cash used in operations of $7.4 million for the same period in 2001. The increase of cash used in operations is primarily due to payments for accrued paid time off, previously accrued restructuring costs, sales commissions and project bonuses.
The principal use of cash for investing activities during the three month period ended March 31, 2002 was for the purchase of property and equipment.
In addition to our current cash balance of $106.2 million, we maintain an arrangement with a commercial bank to facilitate future cash flow requirements. Under this arrangement we may borrow an amount not to exceed $30.0 million with interest at the bank’s prime rate, or the LIBOR rate plus 1 1/4%. Borrowings under this facility are short-term, payable on demand and are secured by our trade accounts receivable and equipment.
Net cash used in financing activities of $3.3 million for the three month period ended March 31, 2002 was due primarily to the repurchase of 446,000 shares of our Common Stock, offset slightly by proceeds from stock option exercises and sales.
Our offshore development centers’ operations accounted for approximately 16% of our total revenues during the three month period ended March 31, 2002. These revenues were comprised of rates and hours charged in the direct billings to our customers. Most of our revenues are billed in U.S. dollars. We recognize transaction gains and losses in the period of occurrence. Foreign currency fluctuations during the three month period ended March 31, 2002 did not have a material impact on income from operations as currency fluctuations on revenue denominated in a foreign currency were offset by currency fluctuations on expenses
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Inflation did not have a material impact on our revenues or income from operations during the three month period ended March 31, 2002.
Recently Issued Financial Accounting Standards
In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) which addresses the financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 supercedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of” and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” for the disposal of a segment of a business (as previously defined in that Opinion). SFAS 144 is effective for the Company’s fiscal year beginning January 1, 2002. Accordingly, the Company adopted SFAS No. 144 in the first quarter of 2002.
On June 30, 2001, the FASB issued Statement 141, Business Combinations, and Statement 142, Goodwill and Other Intangible Assets. Statement 141 requires all business combinations initiated after June 30, 2001 to be accounted for under the purchase method of accounting. Under Statement 142, goodwill and intangible assets that have indefinite useful lives will no longer be subject to amortization. Rather, goodwill and intangible assets will continue to be subject to at least an annual assessment for impairment. Under Statement 142, this is achieved by applying a fair-value based test. In addition, other intangible assets with finite useful lives will continue to be amortized over their estimated useful lives. The Company adopted SFAS 142 in the first quarter of 2002. Management is in the process of performing the transitional goodwill impairment test. At this time there appears to be no material impairment of goodwill upon adoption of SFAS 142.
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(a) Exhibits
| Number | Exhibit | |||
| (11) | Computation of Earnings per share. | |||
| (99) | Additional Exhibit | |||
(b) Reports on Form 8-K.
On May 3, 2002, Covansys filed a Form 8-K with the Securities and Exchange Commission regarding the dismissal of Arthur Andersen LLP as its independent public accountants, and the appointment of PricewaterhouseCoopers LLP as its new independent auditors. The appointment of PricewaterhouseCoopers is subject to ratification of the Company’s shareholders.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| COVANSYS CORPORATION |
| By: | /s/ NED C. LAUTENBACH |
| Ned C. Lautenbach | |
| Chief Executive Officer, | |
| Co-Chairman and Director | |
| /s/ MICHAEL S. DUFFEY | |
| Michael S. Duffey | |
| Executive Vice President and | |
| Chief Financial Officer |
Dated: May 15, 2002
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| Exhibit No. | Description | |||
| 11 | Computation of Earnings per share. | |||
| 99 | Additional Exhibit. | |||