Covansys 10Q 2005 Q2 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2005

Commission file number: 0-22141

COVANSYS CORPORATION

(Exact Name of Registrant as Specified in its Charter)


Michigan (State or Other Jurisdiction of Incorporation or Organization)		38-2606945 (IRS Employer Identification No.)

32605 West Twelve Mile Road

Suite 250

Farmington Hills, Michigan 48334

(Address of Principal Executive Offices and Zip Code)

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 by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) 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)		37,229,771 (Outstanding as of July 22, 2005)

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		14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		20
Item 4.	Controls and Procedures		20
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings		23
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		23
Item 4.	Submission of Matters to a Vote of Security Holders		23
Item 6.	Exhibits		24

SIGNATURES			25
Certification Pursuant to Section 302
Certification Pursuant to Section 302
Certification of Rajendra B. Vattikuti to Section 906
Certification of James S Trouba to Section 906

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

COVANSYS CORPORATION AND SUBSIDIARIES

condensed consolidated balance sheets


			June 30,			December 31,
			2005			2004

			(Dollars in thousands)
			(Unaudited)
ASSETS
Current assets:
	Cash and cash equivalents		$	65,078		$	49,841
	Short-term investments			15,308			21,409
	Accounts receivable net of allowance for doubtful accounts of $1,877 and $1,532 at June 30, 2005 and December 31, 2004			84,359			75,388
	Revenue earned in excess of billings			23,426			24,613
	Deferred taxes			5,563			5,105
	Prepaid expenses and other			11,933			7,226

		Total current assets		205,667			183,582
Property and equipment, net				28,674			29,762
Computer software, net				2,920			3,706
Goodwill				18,318			19,148
Deferred taxes				5,308			5,808
Other assets, net				5,551			6,796

		Total assets	$	266,438		$	248,802

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
	Current portion of long-term debt		$	17,500		$	17,500
	Accounts payable			15,324			14,052
	Accrued payroll and related costs			19,317			16,744
	Taxes payable			921			3,481
	Other accrued liabilities			19,714			18,331
	Deferred revenue			1,161			1,041

		Total current liabilities		73,937			71,149
Other liabilities				3,427			3,462
Commitments and contingencies
Shareholders’ equity:
	Preferred stock, no par value, 1,000,000 shares authorized, none issued			—			—
	Common stock, no par value, 200,000,000 shares authorized, 37,220,032 and 37,418,764 shares issued and outstanding as of June 30, 2005 and December 31, 2004, respectively			—			—
	Additional paid-in capital			163,454			165,983
	Retained earnings			25,738			6,433
	Accumulated other comprehensive income (loss)			(118	)		1,775

		Total shareholders’ equity		189,074			174,191

		Total liabilities and shareholders’ equity	$	266,438		$	248,802

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

COVANSYS CORPORATION AND SUBSIDIARIES

condensed consolidated statements of operations


			Three Months Ended						Six Months Ended
			June 30,						June 30,

			2005			2004			2005			2004

			(In thousands, except per share data)
			(Unaudited)
Revenue			$	108,708		$	94,109		$	212,981		$	179,001
Cost of revenue				78,301			68,846			152,251			138,847

		Gross profit		30,407			25,263			60,730			40,154
Selling, general and administrative expenses				18,140			19,585			37,001			38,849

		Income from operations		12,267			5,678			23,729			1,305
Interest expense				266			—			469			—
Other income, net				(217	)		(1,303	)		(806	)		(1,309	)

		Income before provision for income taxes		12,218			6,981			24,066			2,614
Provision for income taxes				970			2,378			4,761			901

		Net income		11,248			4,603			19,305			1,713
Convertible redeemable preferred stock dividends				—			1,139			—			2,269

		Net income (loss) available for shareholders		11,248			3,464			19,305			(556	)
		Amounts allocated to participating preferred shareholders		—			(847	)		—			—

		Net income (loss) available to common shareholders	$	11,248		$	2,617		$	19,305		$	(556	)

Earnings (loss) per share
	Basic		$	0.30		$	0.10		$	0.52		$	(0.02	)

	Diluted		$	0.30		$	0.10		$	0.51		$	(0.02	)

Basic weighted average shares				37,359			26,882			37,394			26,866
Dilutive effect of options				468			610			536			(A)
Convertible redeemable preferred stock				—			(A)			—			(A)

Dilutive weighted average shares				37,827			27,492			37,930			26,866


(A)	Anti-dilutive

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

COVANSYS CORPORATION AND SUBSIDIARIES

condensed consolidated statements of cash flows


				Six Months Ended
				June 30,

				2005			2004

				(Dollars in thousands)
				(Unaudited)
Cash flows from operating activities:
	Net income			$	19,305		$	1,713
	Adjustments to reconcile net income to net cash provided from operating activities:
		Depreciation and amortization			6,641			6,658
		Loss on disposal and obsolescence of property and equipment			256			1,066
		Provision for and write-off of doubtful accounts			345			499
		Provision for deferred income taxes			86			—
		Gain from sale of short-term investments			(35	)		(109	)
	Change in assets and liabilities:
		Accounts receivable and revenue earned in excess of billings			(8,680	)		(2,055	)
		Prepaid expenses and other			(2,822	)		(4,001	)
		Accounts payable, accrued payroll and related costs and other liabilities			2,657			1,550

			Net cash provided from operating activities		17,753			5,321
Cash flows from investing activities:
	Investment in property, equipment and other				(5,061	)		(4,845	)
	Investment in computer software				(43	)		(127	)
	Proceeds from sale of available for sale securities				68,369			62,281
	Purchases of available for sale securities				(62,296	)		(43,903	)

			Net cash provided from investing activities		969			13,406
Cash flows from financing activities:
	Net proceeds from issuance of common stock				—			872
	Net proceeds from exercise of stock options and other				1,847			370
	Repurchases of common stock				(4,803	)		—

			Net cash provided from (used in) financing activities		(2,956	)		1,242
			Effect of exchange rate changes on cash		(529	)		26

Increase in cash and cash equivalents					15,237			19,995
Cash and cash equivalents at beginning of period					49,841			89,671

Cash and cash equivalents at end of period				$	65,078		$	109,666

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

COVANSYS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

1. Organization and Basis of Presentation

Covansys Corporation was founded in 1985. Covansys Corporation and its subsidiaries (the Company) is a global technology services company, with a focus on industry-specific solutions, strategic outsourcing and integration solutions. The Company addresses the most challenging technology issues companies are facing through a unique onsite, offsite, offshore delivery model that helps clients achieve rapid deployment and reduced costs. The Company offers high-level subject matter expertise in the public sector industry, as well as years of experience in retail, healthcare, distribution, manufacturing, financial services, telecommunications and utilities. The Company applies its industry-specific knowledge to deliver a wide range of outsourcing and integration services, including: application maintenance and development outsourcing (AMD/O); custom application development; e-business services; packaged software implementation, upgrades and enhancements; and other services.

The accompanying unaudited condensed consolidated financial statements have been prepared by management 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, including normal recurring adjustments, necessary to present fairly the financial position of Covansys Corporation and subsidiaries as of June 30, 2005, the results of its operations for the three and six month periods ended June 30, 2005 and 2004, and cash flows for the six month periods ended June 30, 2005 and 2004. These financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s 2004 Annual Report on Form 10-K for the year ended December 31, 2004.

The results of operations for the three and six month periods ended June 30, 2005 are not necessarily indicative of the results to be expected in future quarters or for the year ending December 31, 2005.

2. Recapitalization

On April 27, 2004, the Company announced that it had entered into a long-term Master Services Agreement and a Stock Purchase Agreement with Fidelity Information Services (“FIS”), Inc., a subsidiary of Fidelity National Financial, Inc. The Master Services Agreement is expected to generate an anticipated $150,000 in revenues to the Company through April, 2009.

Under the Stock Purchase Agreement, as amended, with FIS and approved by shareholders on September 15, 2004, the Company issued to FIS 8,700,000 shares of the Company’s common stock and warrants for $95,700. The four tranches of warrants, each for 1,000,000 shares of the Company’s common stock, have a strike price between $15 and $24 per share. FIS also acquired 2,300,000 shares of the Company’s common stock from Rajendra Vattikuti, founder and Chief Executive Officer of the Company.

In order to facilitate the transactions with FIS, the Company also entered into a Recapitalization Agreement, as amended, with a wholly-owned subsidiary of a private equity investment fund managed by Clayton, Dubilier & Rice, Inc. (the “CDR Stockholder”) to restructure the CDR Stockholder’s ownership interest in the Company and certain corresponding governance rights, in exchange for a combination of cash, stock, notes and warrants. The CDR Stockholder owned 200,000 shares of the Company’s Series A Voting Convertible Preferred Stock, or approximately 8,695,000 shares of common stock on an as converted basis, and 5,300,000 common stock warrants with a strike price ranging from $25 to $31 per share.

Under the terms of the Recapitalization Agreement approved by shareholders on September 15, 2004, the CDR Stockholder exchanged all of its existing holdings in the Company for consideration valued at

$227,700 consisting of $177,500 of cash, 2,000,000 shares of common stock of the Company, subordinated notes in the total amount of $17,500 due December 31, 2005, which bears interest at LIBOR plus 2.20%, and five-year warrants for 5,000,000 shares of common stock with a strike price of $18 per share. In accordance with EITF D-42, as amended by EITF 00-27, the Company recorded a reduction to income available to common shareholders of $28,674 in the third quarter of 2004. The Company financed the transaction with the CDR Stockholder with cash on hand as well as proceeds from the FIS investment. The $17,500 subordinated notes were repaid by the Company in July, 2005.

3. Acquisition

The Company’s wholly owned subsidiary, Covansys India Limited, announced on June 9, 2005 its intention to acquire up to 75 percent (up to 4.05 million shares) of Fortune Infotech Limited’s (Fortune) common stock for Rs.32.50 per share ($0.74 per share). The Company intends to fund the acquisition with cash from its India operations. Fortune’s current annual revenue is less than one percent of the Company’s revenue. The Company does not expect the acquisition to have a material impact on its results of operation in 2005.

Fortune, with its principal office located in Baroda, India, is an experienced provider of offshore outsourcing solutions. Fortune focuses on business process outsourcing (BPO) and provides back office services such as transaction processing, claim processing and accounts payable processing services. The transaction will enhance the Company’s BPO capabilities and increase its ability to meet the needs of existing and prospective clients in the commercial sector. The Company expects to complete the acquisition before year end 2005.

4. Income Taxes

The Company has provided federal, foreign and state income taxes in the condensed consolidated statements of operations based on the anticipated effective tax rate for fiscal years 2005 and 2004. The Company’s tax rate is impacted by permanent items such as Subpart F income and nondeductible travel and entertainment expenses as well as the mix between domestic and foreign earnings.

Realization of deferred tax assets associated with the Company’s future deductible temporary differences and net operating loss carryforwards is dependent upon generating sufficient taxable income prior to their expiration. Although realization of the deferred tax assets is not assured, management believes it is more likely than not that the deferred tax assets will be realized through future taxable income. On a quarterly basis, management assesses whether it remains more likely than not that the deferred tax assets will be realized.

The Company has six (five in 2004) business units in India which are entitled to a tax holiday for 10 consecutive years commencing with the year the business unit started producing computer software or until the Indian tax year ending March 31, 2009, whichever is earlier. The tax holiday period for two of the business units has expired. The remaining business units are subject to the tax holiday for various periods through March 31, 2009. As the tax holiday expires, the Company’s overall effective tax rate will be negatively impacted.

The Company’s tax rate in the three months and six months ended June 30, 2005 was impacted by the reversal of previously recorded tax reserves of $3,200 due to the expiration of the statute of limitations for the tax years the recorded reserves related to. In addition, the Company recorded a charge of $500 from the reversal of deferred tax assets due to an enacted law change in the State of Ohio which will reduce the amount of net operating losses that the Company will be able to utilize in future periods.

5. Fixed Price Contracts

The Company realized approximately 39%, 38%, 36% and 35% of its revenue during the three months and six months ended June 30, 2005 and 2004, respectively, from fixed price contracts (percentage of completion as well as fixed price IT outsourcing and maintenance). Approximately 13%, 16%, 12% and 11% of the Company’s revenue during the three months and six months ended June 30, 2005 and 2004, respectively, was

realized from fixed price contracts with respect to which we recognize revenue on a percentage of completion basis. These contracts expose the Company to collection risk on both billed and unbilled receivables in the event that contract milestones are not met or the client does not accept the product as delivered. In addition, the Company could incur unanticipated losses if it is necessary to increase its estimated cost to complete.

The Company’s first half 2004 financial results were negatively impacted by approximately $9,400 due to four significant fixed price contracts which it considered to be challenged. No such adjustment was required in 2005 for the remaining troubled project.

Communications with contracting parties during 2004 caused management to re-assess the collectibility of billed and unbilled receivables for two troubled projects. In both cases, the Company had been informed that its services would no longer be required to complete the project prior to its implementation. As a result, the Company reduced the related receivables by $5,500 to their net realizable value in the first half of 2004. In accordance with the application of percentage of completion accounting, the Company reflected the changes as a contract price adjustment, and accordingly, as a reduction in revenue.

The Company also determined it was necessary to increase its estimated cost to complete for three of these projects due to changes in 2004 in both scope and resource requirements. The revision in estimates had the effect of reducing gross margin by $3,900 in the first half of 2004.

The Company has $3,882 in billed and unbilled receivables related to the remaining active contract that is identified as troubled at June 30, 2005. Management believes this amount is collectible.

6. Segment Information

The Company is a provider of IT services, and is organized geographically throughout North America, India and Asia, and other international locations. The chief operating decision-maker evaluates each location’s performance based primarily on its revenues and income from operations due to the similarity of the nature of services provided to clients. Revenue for the India/ Asia operation is evaluated based on the full attribution of bill rates charged to the end customer. The segment revenue figures disclosed below are stated at full attribution. Full attribution revenue is calculated using the end customer invoice rate on intersegment engagements, as opposed to using the transfer price rate. The chief operating decision-maker does not evaluate segment performance based on assets. Assets, including the related depreciation and amortization expense, are managed primarily by corporate management. Under this organization, the operating segments have been aggregated into the following four operating segments and other.


	•	Public Sector includes all services provided to domestic state and local municipalities.

	•	Commercial includes all U.S. operations services provided to non-public sector customers exclusive of services provided to FIS. Commercial includes application services for maintenance and development outsourcing (AMD/O), retail, healthcare, distribution, manufacturing, financial services, telecommunications, utilities, e-business, packaged software implementation and other services. Commercial also includes telecommunication services provided in Europe.

	•	India/Asia includes all services performed in India or Asia, Canada as well as non telecommunication services provided in Europe and services provided to FIS.

	•	Other consists primarily of the labor and supporting expenses for the Corporate functions, depreciation and amortization expenses as well as lease expenses for corporate headquarters.

The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies in the Company’s 2004 Annual Report on Form 10-K.

India/Asia supplies substantial resources to U.S. operations customers. The rate charged by India to U.S. operations has been developed utilizing a cost plus transfer pricing methodology. This results in a large component of the available gross margin accruing to U.S. operations where the end customer is located.

Revenue and income from operations by segment is as follows:


			Three Months Ended						Six Months Ended
			June 30,						June 30,

			2005			2004			2005			2004

Revenue
	Commercial		$	62,977		$	58,543		$	125,809		$	117,646
		Less intersegment		(1,698	)		(205	)		(3,562	)		(365	)

				61,279			58,338			122,247			117,281
	Public Sector			29,540			26,765			55,438			45,560
	India/Asia			38,675			27,969			77,594			56,341
		Less intersegment		(20,786	)		(18,963	)		(42,298	)		(40,181	)

				17,889			9,006			35,296			16,160

			$	108,708		$	94,109		$	212,981		$	179,001

Income from Operations
	Commercial		$	14,008		$	11,653		$	30,516		$	21,739
	Public Sector			3,902			2,461			6,537			(3,597	)
	India/Asia			4,108			1,032			6,672			2,472
	Corporate and Other			(9,751	)		(9,468	)		(19,996	)		(19,309	)

				12,267			5,678			23,729			1,305
Interest expense				266			—			469			—
Other income, net				(217	)		(1,303	)		(806	)		(1,309	)

	Income before Provision for Income Taxes		$	12,218		$	6,981		$	24,066		$	2,614

7. Property and Equipment

Subsequent to the original issuance of its financial statements for the year ended December 31, 2003, the Company identified $2,561 of adjustments related to property and equipment, $1,495 of which related to prior periods requiring the Company to restate its previously filed financial statements for all periods affected by the charge. The remaining $1,066 was recorded in the first quarter of 2004, $742 of which relates to equipment that the Company has been unable to determine the period or periods during which the equipment left its possession and $324 of which relates to equipment that became obsolete in the first quarter of 2004.

Of the first quarter 2004 charge of $1,066, $39 was recorded in cost of revenue and $1,027 was recorded in selling, general and administrative expense.

8. Common Stock Repurchase Program

The Company’s board of directors has authorized the repurchase of up to 14,000,000 shares of the Company’s common stock. Through June 30, 2005, the Company has repurchased approximately 11,838,176 shares of its common stock for cash, at a total cost of $146,783. The Company repurchased 403,200 shares at a cost of $4,803 during the three and six month periods ended June 30, 2005. As of June 30, 2005, 2,161,824 shares remain available for repurchase under the board of directors authorization.

9. Net Income (Loss) Per Share

Basic and diluted net income (loss) per share is computed in accordance with SFAS No. 128, “Earnings Per Share, as amended by Emerging Issues Task Force (“EITF”) Issue 03-6 by dividing net income (loss) available for common shareholders by the weighted average number of shares of common stock outstanding. The calculation of dilutive net income (loss) per share excludes the following common stock equivalents for the respective periods because their impact was anti-dilutive.


	Three Months Ended				Six Months Ended
	June 30,				June 30,

	2005		2004		2005		2004

Common stock equivalents related to convertible redeemable preferred stock		—		8,695,652		—		8,695,652
Warrants issued to CDR to purchase 5,300,000 shares of common stock		—		5,300,000		—		5,300,000
Warrants issued to CDR to purchase 5,000,000 shares of common stock		5,000,000		—		5,000,000		—
Warrants issued to FIS to purchase 4,000,000 shares of common stock		4,000,000		—		4,000,000		—
Average number of stock options outstanding		845,833		1,420,157		870,622		1,506,180

The Company’s Series A Voting Convertible Preferred Stock was a participating security as defined in Issue 03-6. The Company adopted Issue 03-6 in 2004. The adoption of Issue 03-6 results in a reduction in EPS available for common shareholders in periods where the Company has income and has no impact in periods where the Company has a loss. The Company’s Series A Voting Convertible Preferred Stock was redeemed as part of the Recapitalization Agreement with the CDR Shareholder (see Note 2).

10. Stock Option Plans

The Company has elected to account for stock options using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, no additional compensation expense has been recognized for our stock option plan within the accompanying condensed consolidated statements of operations. Had compensation expense for our stock option plan been determined based on the fair value at the grant date consistent with the provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” the Company’s pro forma net income (loss) available for common shareholders and pro forma basic and diluted net income (loss) per common share would have been reduced to the amounts indicated below:


		Three Months Ended				Six Months Ended
		June 30,				June 30,

		2005		2004		2005		2004

Net income (loss) available for common shareholders:
	As reported	$	11,248	$	2,617	$	19,305	$	(556	)
	Stock-based employee compensation cost included in the determination of net income (loss) from operations as reported		—		—		—		—
	Stock-based employee compensation cost had the fair value method been used		740		538		1,482		1,191

	SFAS No. 123 pro forma	$	10,508	$	2,079	$	17,823	$	(1,747	)

Basic and diluted income (loss) per share:
	As reported-basic	$	.30	$	.10	$	.52	$	(.02	)
	As reported-diluted	$	.30	$	.10	$	.51	$	(.02	)
	SFAS No. 123 pro forma-basic	$	.28	$	.08	$	.48	$	(.07	)
	SFAS No. 123 pro forma-diluted	$	.28	$	.08	$	.47	$	(.07	)

In December 2004 the FASB issued FAS 123R, “Share-Based Payment,” that requires companies to expense the value of employee stock options and similar awards. The effective date for application by public companies is annual periods beginning after June 15, 2005. FAS 123R applies to all outstanding and unvested share-based payment awards at a company’s adoption date. FAS 123R allows alternative transition methods. The Company has not yet selected a transition method. Management is presently reviewing the impact on our results of operation and financial position from implementing FAS 123R.

11. Comprehensive Income

Total comprehensive income is summarized as follows:


		Three Months Ended						Six Months Ended
		June 30,						June 30,

		2005			2004			2005			2004

Net income		$	11,248		$	4,603		$	19,305		$	1,713
Currency translation adjustment			(879	)		(2,683	)		(1,923	)		(1,001	)
Unrealized gains on short-term investments upon sale			19			—			30			—

	Total comprehensive income	$	10,388		$	1,920		$	17,412		$	712

12. Related Party Transactions

On September 15, 2004 the Company issued 8,700,000 shares of common stock and 4,000,000 warrants to FIS for $95,700 (See Note 2). In the second quarter of 2004, the Company entered into a Master Services Agreement with FIS to provide services over a five year period. Services provided by the Company to FIS during the three and six months ended June 30, 2005 totaled approximately $4,260 and $7,434, respectively. The balance owed to the Company by FIS at June 30, 2005 was $1,439.

Synova, Inc. and subsidiaries (Synova) is an IT professional services organization owned by the Chairman of the Company’s Board of Directors. During the three month periods ended June 30, 2005 and 2004, the Company provided services to Synova totaling $506 and $655, respectively and $1,085 and $1,306 for the six month periods ended June 30, 2005 and 2004, respectively. In addition, during the three month periods ended June 30, 2005 and 2004 Synova provided services to the Company totaling $1,054 and $293, respectively and $1,691 and $494 for the six month periods ended June 30, 2005 and 2004, respectively. The net balance owed to Synova by the Company at June 30, 2005 was $367. In addition, under the terms of a note payable, Synova owes the Company $2,500. This note is due in September 2005, and interest is paid quarterly in accordance with its terms.

The Company paid approximately $214 to CDR, a shareholder, for financial, management advisory, and executive management services during the three month period ended June 30, 2004 and $394 for the six month period ended June 30, 2004. No such services were provided by CDR during the three and six months ended June 30, 2005. During the three and six months ended June 30, 2005 the Company paid $370 of interest to CDR in accordance with the terms of the $17,500 subordinated notes due December 31, 2005 which were issued in connection with the FIS/CDR transaction as further described in Note 2. Current interest owed by the Company to CDR at June 30, 2005 is $281. On July 5, 2005 the Company repaid the $17,500 subordinated notes and accrued interest of $294.

In the third quarter of fiscal 2002, the Company entered into a ten-year agreement, as amended, to provide outsourcing services to SIRVA, Inc. a company related through common ownership of CDR. During the three month and six month periods ended June 30, 2005 and 2004, services provided by the Company to SIRVA, Inc. totaled approximately $2,232, $2,177, $4,482 and $4,753, respectively. The net balance owed to the Company by SIRVA at June 30, 2005 was $547.

13. Restructuring and Other Related Charges

The following is a roll forward of the accrual balance for Restructuring and Other Related charges for the six month periods ended June 30, 2005 and 2004 respectively.


				Lease
	Severance			Terminations			Total

Balance January 1, 2005	$	67		$	2,174		$	2,241
Expense		—			325			325
Payments and other		(67	)		(756	)		(823	)

Balance June 30, 2005	$	—		$	1,743		$	1,743

Balance January 1, 2004	$	371		$	1,668		$	2,039
Expense		1,019			1,429			2,448
Payments and other		(745	)		(546	)		(1,291	)

Balance June 30, 2004	$	645		$	2,551		$	3,196

Amounts related to lease terminations will be paid out through June 2011.

14. Cost of Computer Software to be Sold, Leased or Marketed

SFAS No. 86 “Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed” requires capitalization of software development costs incurred subsequent to establishment of technological feasibility and prior to the availability of the product for general release to customers. During the six months ended June 30, 2005 the Company capitalized computer software of approximately $43. Amortization of capitalized costs begins when the product is available for general release to customers and is computed on a straight-line basis over each products estimated economic life — typically five years. Amortization costs were $416 and $421 for the three months ended June 30, 2005 and 2004, respectively and $833 and $843 for the six months ended June 30, 2005 and 2004, respectively.

15. Goodwill

Changes in the carrying amount of goodwill for the six months ended June 30, 2005 is as follows:


Balance January 1, 2005	$	19,148
Currency translation		(830	)

Balance June 30, 2005	$	18,318

16. Credit Agreement

On September 7, 2004, the Company entered into a new Credit Agreement, as amended, which provides for borrowings or standby and commercial letters of credit up to $30,000. The Credit Agreement expires on December 28, 2005 but may be extended in one-year increments at the request of the Company and the consent of the lenders. With the prior consent of the Agent, the Company may request to increase the availability under the Credit Agreement by up to $10,000 (not to exceed an aggregate availability of $40,000). Borrowings under the Credit Agreement are collateralized by all domestic assets of the Company.

Borrowings under the Credit Agreement bear interest at LIBOR plus 1.20% to 1.55% or prime minus .50%. The interest rate matrix is based on the Company’s level of outstanding credit exposure as defined in the Credit Agreement. Under the Credit Agreement, the Company pays a commitment fee of .125% per annum on the unused portion of the commitment and a facility letter of credit fee of .90% to 1.55% per annum based on the level of outstanding credit exposure as defined in the Credit Agreement.

The Credit Agreement contains covenants which include financial covenants which require the Company to maintain a certain interest coverage ratio, leverage ratio and a minimum total capitalization. At June 30, 2005, the Company had no borrowings and $9,172 in outstanding letters of credit under this Credit

Agreement. The Credit Agreement also includes a covenant which restricts the Company’s ability to repurchase shares of its common stock in 2005 in excess of $20.0 million absent approval from the lenders.

17. Recently Issued Financial Accounting Standards

In December 2004 the FASB issued FAS 123R, “Share-Based Payment”, that requires companies to expense the value of employee stock options and similar awards. The effective date for application by public companies is annual periods beginning after June 15, 2005. FAS 123R applies to all outstanding and unvested share-based payment awards at a Company’s adoption date. FAS 123R allows alternative transition methods. The Company has not yet selected a transition method. Management is presently reviewing the impact on our results of operations and financial position from implementing FAS 123R.

In December 2004, the FASB issued an FASB Staff Position (FSP) 109-2 “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004”, which provides accounting and disclosure guidance for the foreign earnings repatriation provision within the American Jobs Creation Act of 2004. The Act provides special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer. FSP FASB 109-2 provides for a period of time beyond the financial reporting period of enactment for a company to evaluate the effect of the Act on its plan for reinvestment or repatriation of foreign earnings. The Company is in the process of evaluating the effects of one-time repatriation opportunities provided by the Act. At the time of filing these statements, the Company cannot reasonably estimate the income tax effects of such repatriation under the Act.

In May 2005, the FASB issued FAS 154, “Accounting Changes and Error Corrections”, a replacement of APB Opinion No. 20 and FASB Statement No. 3. Previously, APB No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements” required the inclusion of the cumulative effect of changes in accounting principle in net income of the period of the change. FAS 154 requires companies to recognize changes in accounting principle, including changes required by a new accounting pronouncement when the pronouncement does not include specific transition provisions, retrospectively to prior periods’ financial statements, unless impracticable to determine the effects of the change. The effective date for application by public companies is annual periods beginning after December 15, 2005. The Company will assess the impact of a retrospective application of a change in accounting principle in accordance with FAS 154 if the need for such a change arises after the effective date.

18. Other Income, Net

Other income, net represents interest earned and realized gains and losses from the sale of short-term investments and cash equivalents and foreign currency transaction and translation gains and losses.

Foreign currency fluctuations during the six months ended June 30, 2005 and 2004 resulted in a foreign currency translation gain (loss) of approximately ($101) and $144, respectively, from the remeasurement of nonfunctional currency net asset positions into the functional currency of the respective foreign subsidiary.

19. Disposition of Development Center

On May 3, 2005, Oracle announced that it has exercised its purchase option to acquire PeopleSoft’s development center in Bangalore, India operated by the Company. The transfer of this center is expected to be completed by the end of October 2005, upon which the employees of the center (approximately 480 at June 30, 2005) will become employees of Oracle. Revenue generated from this development center for the Company was approximately $8,400, $4,000 and $8,100 for the year ended December 31, 2004 and the three and six months ended June 30, 2005, respectively.

Under terms of the agreement, Oracle will pay a buyout fee and an amount equal to the book value of the net assets related to this business. The Company does not believe that these payments will have a material effect on either the financial condition or results of operations of the Company in 2005. The Company is continuing to analyze the underlying agreement to determine the final financial impact of the transfer of these assets.

20. Contingencies

We are involved in tax and legal proceedings, claims and litigation arising in the ordinary course of business. We periodically assess our liabilities and contingencies in connection with these matters, based upon the latest information available. For those matters where it is probable that we have incurred a loss and the loss or range of loss can be reasonably estimated, we have recorded reserves in the consolidated financial statements. In other instances, because of the uncertainties related to both the probable outcome and amount or range of loss, we are unable to make a reasonable estimate of a liability, if any. As additional information becomes available, we adjust our assessment and estimates of such labilities accordingly.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following section should be read in conjunction with our Condensed 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 internal control weaknesses, impact of changes in estimates on fixed price projects, variability of operating results, failure to recruit, train and retain skilled Information Technology (“IT”) professionals, exposure to regulatory, political and general economic conditions in India and Asia, short term nature and termination provisions of contracts, competition in the IT services industry, economic conditions unique to clients in specific industries, the success of the company to negotiate contract renewals at comparable terms, decline in profitability of European operations, public sector budget constraints, limited protection of intellectual property rights, and risks related to merger, acquisition and strategic investment strategy.

Overview

We are a global technology services company, with a focus on industry-specific solutions, strategic outsourcing and integration solutions. We address the most challenging technology issues companies are facing through a unique onsite, offsite, offshore delivery model that helps clients achieve rapid deployment and reduced costs. We offer high-level subject matter expertise in the public sector industry, as well as years of experience in retail, healthcare, distribution, manufacturing, financial services, telecommunications and utilities. We apply our industry-specific knowledge to deliver a wide range of outsourcing and integration services, including: application maintenance and development outsourcing (AMD/O); custom application development; e-business services; packaged software implementation, upgrades and enhancements; and other services. 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.

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 except for fixed-price outsourcing contracts where we recognize revenues ratably over the applicable period. For the three month periods ended June 30, 2005 and 2004, approximately 39% and 38%, respectively, of our total revenue were generated from fixed-price engagements.

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 managing salaries and benefits relative to 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; and (3) internal systems.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures in the consolidated financial statements and accompanying notes. We regularly evaluate and discuss with our Audit Committee the accounting policies and estimates we use to prepare our consolidated financial statements. Estimates are used for, but not limited to, revenue recognition under the percentage-of-completion method, impairment assessments of goodwill and other long-lived assets, realization of deferred tax assets, allowance for doubtful accounts, and litigation related contingencies. These estimates are based on historical experience, project management, and various assumptions that we believe to be reasonable given the particular facts and circumstances. Although we believe that our estimates, assumptions and judgments are reasonable, they are based upon information presently available. Actual results could differ significantly from these estimates under different assumptions, judgments or conditions.

The Securities and Exchange Commission has defined “critical accounting policies” as those that are most important to the portrayal of a company’s financial condition and results of operations, and which require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates. Based on this definition, we have identified the critical accounting policies discussed below. We have other significant accounting policies, which also involve the use of estimates, judgments and assumptions that are integral to understanding our results of operations. For a complete discussion of all significant accounting policies, see Note 1 of our Notes to Consolidated Financial Statements included in our 2004 Form 10-K.

The following is an overview discussion of our critical accounting policies.

Revenue Recognition. We recognize revenue in accordance with Staff Accounting Bulletin No. 104, for our time-and-materials and fixed price outsourcing contracts. For those service contracts which are billed on a time and materials basis, we recognize revenue as the services are performed. In our time and materials contracts our effort, measured by our time incurred, represents the contractual milestones or output measure which is the contractual earnings pattern. For our fixed price IT outsourcing and maintenance contracts, we recognize revenue ratably over the applicable outsourcing or maintenance period as the services are performed continuously over the contract period.

For our contracts to design, develop or modify complex information systems based upon the client’s specifications, we recognize revenue on a percentage of completion basis in accordance with Statement of Position 81-1. The percentage of completion is determined by relating the actual cost of labor performed to date to the estimated total cost of labor for each contract. This method is followed where reasonably dependable estimates of revenue and cost can be made. Estimates of total contract revenue and cost are continuously monitored during the term of the contract, and recorded revenue and cost are subject to revision as the contract progresses. Such revisions, which may result in increases or decreases to revenue and income, are reflected in the financial statements in the period in which they are first identified. If the estimate indicates a loss on a particular contract, a provision is made for the entire estimated loss without reference to the percentage of completion.

Covansys periodically enters into contracts that include multiple-element arrangements, which may include any combination of services, software, support/maintenance, and the re-sale of hardware or software. Contracts entered into after June 30, 2003 containing multiple elements or deliverables are segmented into separate units of accounting where the separate elements represent separate earnings processes in accordance with EITF 00-21. Revenues are allocated among the elements based on the relative fair values of the elements and are recognized in accordance with our policies for the separate elements unless the undelivered elements are essential to the functionality of the delivered elements. In circumstances where an undelivered element is

essential to the functionality of the delivered element, no revenue is recognized for the delivered element until the undelivered element is delivered.

Retainages, which are not material for any of the periods presented, are included in revenue earned in excess of billings in the accompanying condensed consolidated balance sheets. Revenue earned in excess of billings is primarily comprised of revenue recognized on certain contracts in excess of contractual billings on such contracts.

Impairment of Long-Lived Assets.We review the recoverability of our long-lived assets, including property and equipment when events or changes in circumstances occur that indicate that the carrying value of the asset may not be recoverable and goodwill at least annually. The assessment of possible impairment is based on our ability to recover the carrying value of the asset from expected future pre-tax cash flows of the related asset group or operating segment. If these cash flows are less than the carrying value of such asset, an impairment loss is recognized for the difference between estimated fair value and carrying value. The measurement of impairment requires management to make estimates of these cash flows related to long-lived assets, as well as other fair value determinations.

Computer Software. We perform research to develop software for various business applications. The costs of such research are charged to expense when incurred. When the technological feasibility of the product is established, subsequent costs are capitalized. Capitalized software costs are amortized on a product-by-product basis. Amortization is recorded on the straight-line method over the estimated economic life of the product, generally five years, commencing when such product is available. The establishment of technological feasibility and the ongoing assessment of the recoverability of these costs requires considerable judgment by management with respect to certain external factors including, but not limited to, anticipated future gross product revenue, estimated economic product lives and changes in software and hardware technology. These assumptions are reevaluated and adjusted as necessary at the end of each accounting period. Management reviews the valuation and amortization of capitalized development costs. We periodically consider the value of future cash flows attributable to the capitalized development costs in evaluating potential impairment of the asset. Amounts charged to expense for research and development of computer software were not material in the periods indicated.

Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Liquidity and Capital Resources

As of June 30, 2005, the Company had cash and short-term investments of $80.4 million. The Company funds its operations and working capital needs through internally generated funds. Cash provided from operations in the first six months of 2005 was $17.8 million which included the use of cash for working capital of $8.8 million. On July 5, 2005 the Company used $17.8 million to retire the subordinated notes, including accrued interest, issued to CDR in the FIS/CDR transaction as further described in Note 2.

Investing activities provided $3.7 million in cash during the second quarter of 2005, principally from the liquidation of short-term investments that were reinvested in cash equivalents.

To facilitate future cash flow needs, the Company has a credit facility which provides for borrowings or standby and commercial letters of credit up to $30.0 million through December 28, 2005.

The Credit Agreement contains financial covenants which require the Company to maintain a certain interest coverage ratio, leverage ratio and a minimum total capitalization. At June 30, 2005, the Company was in compliance with these ratios. At June 30, 2005, the Company had no borrowings and $9.2 million in outstanding letters of credit under this Credit Agreement.

Financing activities used $4.8 million in cash for the repurchase of 403,200 shares of the Company’s common stock offset by proceeds from the exercise of stock options.

The Company has no off-balance sheet transactions.

Results of Operations

Revenue and gross profit by segment is as follows:


			Three Months Ended						Six Months Ended
			June 30,						June 30,

			2005			2004			2005			2004

Revenue
	Commercial		$	62,977		$	58,543		$	125,809		$	117,646
		Less intersegment		(1,698	)		(205	)		(3,562	)		(365	)

				61,279			58,338			122,247			117,281
	Public Sector			29,540			26,765			55,438			45,560
	India/Asia			38,675			27,969			77,594			56,341
		Less intersegment		(20,786	)		(18,963	)		(42,298	)		(40,181	)

				17,889			9,006			35,296			16,160

			$	108,708		$	94,109		$	212,981		$	179,001

	Gross profit (loss)
		Commercial	$	17,525		$	16,232		$	38,285		$	30,611
		Public Sector		6,975			6,264			12,208			3,860
		India/Asia		6,944			3,269			12,469			6,780
		Other		(1,037	)		(502	)		(2,232	)		(1,097	)

			$	30,407		$	25,263		$	60,730		$	40,154

Revenue. Revenue was $108.7 million and $94.1 million in the second quarter of 2005 and 2004 and $213.0 million and $179.0 million for the six months ended June 30, 2005 and 2004, respectively. Revenue from the commercial segment was $61.3 million in the second quarter of 2005, an increase of 5.0% from 2004 revenue of $58.3 million. For the six months ended June 30, 2005 commercial segment revenue was $122.2, a 4.2% increase over 2004 revenue of $117.3. Revenue increased in both periods as a result of additional work at existing clients. During the fourth quarter of 2004, the Company continued to perform services for one of its significant customers after it had reached the authorized spending limit on a time and material contract. While the Company believed it would be paid for these services, management concluded that it did not have a legally enforceable contractual right to the revenue at December 31, 2004. As a result, in accordance with the Company’s revenue recognition policies and Staff Accounting Bulletin 104, the Company recognized the costs for these services but did not recognize any revenue for these services in the fourth quarter of 2004, which negatively impacted fourth quarter 2004 revenue and gross profit by approximately $3.5 million. In the first quarter of 2005, the Company received the contract which covered these services and recognized the revenue with a corresponding increase in gross profit.

Public sector revenue increased $2.8 million from second quarter 2004 revenue of $26.8 million and increased $9.8 million from first half 2004 revenue of $45.6 million. Much of the increase in both periods is due to new projects, increased work for existing clients and the absence of any requirement for significant, negative adjustments for contracts in which the Company recognizes income on a percentage of completion

basis. Adjustments to the estimated cost to complete on certain fixed price contracts in the first six months of 2004 in respect of which the Company recognizes income on the percentage of completion basis resulted in the Company not recognizing approximately $3.7 million of revenue in the six months ended June 30, 2004 which would have been recognized had the estimates to complete not required adjustment. In addition, public sector revenue was also negatively impacted during 2004 by a $5.5 million adjustment related to management’s reassessment of the collectibility of outstanding billed and unbilled receivables associated with two troubled projects. In accordance with the application of percentage of completion accounting, the Company reflected the changes as a contract price adjustment, and accordingly, as a reduction in revenue.

Revenue from India/ Asia increased significantly in both periods over comparable periods in 2004, reflecting the shift to a higher utilization of Indian resources on existing customer relationships, transfer of certain commercial segment customer relationships with existing customers to the region and additional revenue from the Company’s Master Services Agreement with FIS commencing in the second quarter of 2004.

On May 3, 2005, Oracle announced that it has exercised its purchase option to acquire PeopleSoft’s development center in Bangalore, India operated by the Company. The transfer of this center is expected to be completed by the end of October 2005, upon which the employees of the center (approximately 480 at June 30, 2005) will become employees of Oracle. Revenue generated from this development center for the Company was approximately $8.4 million, $4.0 million and $8.1 million for the year ended December 31, 2004 and the three and six months ended June 30, 2005, respectively.

Gross Profit. Gross profit in the second quarter of 2005 was $30.4 million or 28.0% of revenue compared with $25.3 million or 26.8% of revenue in the comparable 2004 period. Gross profit for the first six months of 2005 was $60.7 million or 28.5% of revenue compared with $40.1 million or 22.4% of revenue for the first six months of 2004. Gross profit increased in total and as a percentage of sales for 2005 as compared to 2004 due to improved utilization for both quarterly and year-to-date periods. During the three months ended June 30, 2005 the Company adjusted intercompany transfer prices for services rendered by India. The result was to increase India/Asia segment gross profit by approximately $1.5 million, reduce commercial segment gross profit by approximately $1.3 million and reduce Public Sector gross profit by approximately $0.2 million.

Commercial segment gross profit was $17.5 and $38.3 million or 28.6% and 31.3% of revenue for the three and six months ended June 30, 2005 compared with $16.2 and $30.6 million or 27.8% and 26.1% of revenue for the three and six months ended June 30, 2004. The gross profit improvement is due in part to additional offshore work performed by resources in India. In addition, during the fourth quarter of 2004, the Company continued to perform services for one of its significant customers after it had reached the authorized spending limit on a time and material contract. While the Company believed it would be paid for its services, management concluded that it did not have a legally enforceable contractual right to the revenue as of December 31, 2004. As a result, in accordance with the Company’s revenue recognition policies and Staff Accounting Bulletin 104, the Company recognized the costs for these services in the fourth quarter of 2004, but did not recognize the related revenue. Gross profit was negatively impacted in the fourth quarter of 2004 by approximately $3.5 million. In the first half of 2005, the Company received a contract which covered these services and recognized the revenue in the first half of 2005, with a corresponding impact in gross profit.

Gross profit for the first six months of 2004 was negatively impacted by the reassessment of costs of a loss contract, adjustments to estimates to the costs to complete for certain public sector contracts, as well as the adjustment of certain unbilled fixed price contract receivables in the public sector segment based upon perceived collection risk. These adjustments had a negative effect of approximately $9.4 million in the first six months of 2004. In addition gross profit in the second quarter of 2004 was impacted due to costs associated

with project ramp up on new accounts in India/Asia resulting from increased headcount and lower utilization rates.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $18.1 million and $19.6 million in the second quarter of 2005 and 2004, respectively or 16.7% and 20.8% of revenue. For the six months ended June 30, 2005 and 2004, selling, general and administrative expenses were $37.0 million and $38.8 million respectively or 17.4% and 21.7% of revenue. Included in 2005 are higher costs for professional fees related to consultation and internal auditing for the implementation of Sarbanes-Oxley Section 404 and higher costs associated with the restatement of prior year financial statements. Also included in this period is a $0.3 charge for lease termination. See the Company’s 2004 Annual Report on Form 10-K for additional information surrounding the restatement. Included in selling, general and administrative costs in the second quarter of 2004 are lease termination costs of $1.2 million and $0.7 million in professional fees associated with the fixed asset analysis. In addition, the first six months of 2004 includes a charge of $1.0 million from the loss on disposal and obsolescence of property and equipment as further described in Note 7.

Interest Expense. Interest expense of $0.3 and $0.5 million was recorded in the three and six months ended June 30, 2005 respectively, on $17.5 million of notes issued in connection with the FIS/CDR transaction (Note 2) and fees in connection with the credit agreement (Note 16).

Other Income, Net. Other income, net represents interest earned and realized gains and losses from the sale of short-term investments and cash equivalents and foreign currency transaction and translation gains and losses. Foreign currency fluctuations during the three months and six ended June 30, 2005 resulted in a foreign currency translation (loss) of approximately $(0.3) and $(0.1) million, respectively, from the remeasurement of nonfunctional currency net asset positions into the functional currency of the respective foreign subsidiary.

Provision for Income Taxes. The effective tax rate in the second quarter and first six months was 7.9% and 19.8%, respectively. The tax rate in both periods was impacted by the reversal of previously recorded tax reserves of $3.2 million due to the expiration of the statute of limitations for the tax years the reserves related to as well as a charge of $.5 million from the reversal of deferred tax assets due to an enacted law change in the State of Ohio which will reduce the amount of net operating losses that the Company will be able to utilize in future periods.

Recently Issued Financial Accounting Standards

In December 2004, the FASB issued a FASB Staff Position (FSP) 109-2 “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Program within the American Jobs Creation Act of 2004”, which provides accounting and disclosure guidance for the foreign earnings repatriation provision within the American Jobs Creation Act of 2004. The Act provides special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer. FSP FASB 109-2 provides for a period of time beyond the financial reporting period of enactment for a company to evaluate the effect of the Act on its plan for reinvestment or repatriation of foreign earnings. The Company is in the process of evaluating the one-time repatriation opportunities provided by the Act. At the time of filing these statements, the Company cannot reasonably estimate the income tax effects of such repatriation under the Act.

requires companies to recognize changes in accounting principle, including changes required by a new accounting pronouncement when the pronouncement does not include specific transition provisions, retrospectively to prior periods’ financial statements, unless impracticable to determine the effects of the change. The effective date for application by public companies is annual periods beginning after December 15, 2005. The Company will assess the impact of a retrospective application of a change in accounting principle in accordance with FAS 154 if the need for such a change arises after the effective date.

Commitments, Contingencies and Potential Liability to Clients

The Company is, from time to time, party to ordinary, routine tax and legal proceedings, claims and litigation incidental to the Company’s business. After discussion with its legal counsel, the Company does not believe that the ultimate resolution of any existing matter will have a material adverse effect on its financial condition, results of operations or cash flows.

In addition, many of the Company’s engagements involve projects that are critical to the operations of its clients’ businesses and provide benefits that may be difficult to quantify. The Company attempts to contractually limit its liability for damages arising from errors, mistakes, omissions or negligent acts in rendering its services. The Company has undertaken engagements for which the Company guarantees its performance based upon defined client specifications on delivery dates. Certain engagements have required the Company to obtain a performance bond from a licensed surety, to guarantee performance, and to post the performance bond with the client. The Company intends to satisfy all of its performance obligations with its clients and does not anticipate defaulting on any of these performance bonds or letters of credit.

Available Information

Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those reports, are available free of charge on our internet website at http://www.covansys.com as soon as reasonably practicable after such reports are electronically filed with the Securities and Exchange Commission.


Item 3.	*Quantitative and Qualitative Disclosures About Market Risk*

We are exposed to market risk for the effect of foreign currency fluctuations and interest rate changes. Information relating to quantitative and qualitative disclosure about market risk is set forth below and in Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.


	*Foreign Exchange Risk*

Foreign currency fluctuations during the six months ended June 30, 2005 and 2004 resulted in a translation gain (loss) of approximately $(101) and $144, respectively, from the remeasurement of nonfunctional currency net asset positions into the functional currency of the respective foreign subsidiary. The Company may use derivatives from time to time to hedge against foreign currency fluctuations. The Company had no outstanding derivative position as of June 30, 2005 or December 31, 2004. The Company does not speculate in foreign currency.


	*Interest Rate Risk*

Our exposure to market risk for changes in interest rates relates primarily to our cash and short-term investment portfolio, a short term note receivable and debt (all due within one year), which were $80.4 million, $2.5 million and $17.5 million, respectively, as of June 30, 2005. All of our short-term investments are designated as available-for-sale and, accordingly, are presented at fair value in the consolidate balance sheet. A portion of our short term investments are in mutual funds. Mutual funds may have their fair market value adversely affected due to a rise in interest rates, and we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates. The note receivable and debt are priced with variable interest rates which approximate market.


Item 4.	Controls and Procedures

Disclosure Controls and Procedures

The Company maintains controls and procedures designed to ensure that it is able to collect the information that is required to be disclosed in the reports it files with the SEC, and to process, summarize and disclose this information within the time period specified by the rules of the SEC. The Company’s Chief Executive Officer and the Chief Financial Officer are responsible for establishing, maintaining and enhancing these controls and procedures. Based on their evaluation of the Company’s disclosure controls and procedures as of June 30, 2005 the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were not effective for the reasons discussed below.

Changes in Internal Controls

The Company’s internal control over financial reporting is the responsibility of the Chief Executive Officer and the Chief Financial Officer. To fulfill this responsibility, management has continued to enhance internal controls and increase the oversight over those affected controls. Management has also taken corrective action with regard to identified significant deficiencies and material weaknesses through a number of initiatives including those specifically set forth below.

Revenue Contract Accounting.In the first quarter of 2005, the Company engaged in a thorough process to organize and catalogue its customer contracts in preparation of the integration of its contract information into a module of its ERP system. This process confirmed that measures implemented by the Company at the end of the second quarter of 2004 had strengthened the Company’s revenue recognition processes by requiring that contract documentation for new engagements be presented to and/or confirmed by the Legal Department prior to recognition of revenue for that contract. There are still improvements required, however, to strengthen the design of the Company’s process to capture and validate the contractual terms which impact the Company’s recognition of revenue. In conjunction with the contract organization process and in preparation of the year-end consolidated financial statements, management reviewed substantially all of its contracts that contain a fee limitation cap to confirm that revenue recognized did not exceed the fee limitation cap. It was through this process that the revenue adjustment associated with the contract disclosed in Note 22 of the consolidated financial statements in the 2004 Form 10-K, was identified and recorded during the fourth quarter closing process. The Company is continuing to develop procedures to improve the flow of information between its legal, finance and field operations, which procedures will include:


	•	Quarterly verification that contractual documentation exists to support revenue recognized in the applicable reporting period;

	•	Integration of the Company’s contract repository into a module of the Company’s ERP system (anticipated to occur no later than the third quarter of 2005); and

	•	Enhancement of the Company’s ERP system to track fee limitation caps.

Percentage of Completion Accounting.In November 2003, the Company disclosed a material weakness in its internal controls related to the Company’s application of the percentage-of-completion method of accounting for its fixed price contracts. The Company has implemented a multi-part plan to strengthen controls of fixed price contracts and to enhance the processes supporting application of the percentage-of-completion method of accounting for its fixed price contracts. As of December 31, 2004, however, management concluded that the material weakness had not been adequately remediated. Specifically, management determined that the initiatives encompassed in that plan had not been fully implemented and were not yet operating effectively. Since the material weakness was identified in 2003, management has implemented the following:


	•	Standardization and continuous improvement of the use of three primary estimating tools;

	•	Periodic project reviews with executive management;

	•	Enhanced training addressing revenue recognition, contract management and project tracking and reporting. Migration of project plans and project reporting to a standard workbook;


	•	The addition of a fixed price specialist to assist the project management teams on use of the standard workbook along with being available to address project related reporting issues; and

	•	Monthly certification by individual project managers attesting to the appropriateness of their monthly estimate-to-complete submissions.

The Company believes the foregoing measures strengthened its accounting policies with regard to percentage-of-completion accounting, but that such measures did not include a consistent risk-adjusted methodology for project managers to use in their estimates of costs to complete on percentage of completion projects. The Company will continue to strengthen its processes in this area in 2005 through:


	•	Creation and consistent application of a risk-adjusted methodology to identify the appropriate level of contingency for percentage of completion projects and a framework for project managers to use in calculating their estimates of costs to complete;

	•	Continued executive oversight of significant projects including weekly reviews by executive management of projects that include new or high risk technology implementations or that have significantly deviated from the project plan;

	•	Increased monitoring of projects by the Project Management Office;

	•	Creation of more detailed procedural documentation and additional training to assist the Company’s employees in their reporting responsibilities; and

	•	Automation and integration of the Company’s various systems and spreadsheets to provide greater transparency and real time information about the various projects and contracts under which the Company operates.

Net Property and Equipment:At the conclusion of a physical inventory process undertaken by the Company in June 2004, the Company identified a charge of $2.6 million for assets that could not be located or were no longer in use. This process resulted in a restatement of previously issued financial statements for 2003, 2002, and 2001 and in the Company reporting a material weakness related to the Company’s recording and tracking of fixed assets in its Form 10-Q for the quarter ended March 31, 2004. Additionally, as part of the year-end closing process, management discovered that a consolidating entry to properly record inter-company property and equipment transactions on the balance sheet at December 31, 2003, and at quarterly balance sheets through September 30, 2004, was classified within accumulated comprehensive income in error. This balance sheet misclassification has been corrected in the financial statements for the prior period. Since June 2004, the Company has successfully accomplished the following items of its plan to strengthen accounting for its fixed assets:


	•	Development of a policy and procedure manual regarding the recording, tracking and depreciation of fixed assets;

	•	Addition of a new resource in the information technology staff who is responsible for equipment tracking; and

	•	Periodic physical inventories of fixed assets including one completed at year-end 2004 which resulted in no material subsequent adjustments. Management will continue the periodic physical inventory process in 2005.

The Company anticipates implementing a transaction level fixed asset module within the Company’s ERP system to integrate the tracking of its fixed assets no later than the third quarter 2005.

Income Taxes:As part of its 2004 year-end closing process, the Company identified errors when reconciling its cumulative temporary difference and contingent tax liabilities to recorded amounts. Management has strengthened controls over this area in 2005 by enlisting additional tax expertise through more effective use and oversight of a third party tax service provider.

Leases (Step-Rents):As part of its 2004 year-end closing process, it was concluded that straight-line rent expense for the Company’s headquarters had been incorrectly accrued and that the related lease expense for

prior periods was incorrect. This error was determined to be a material weakness in internal controls and resulted in a restatement of prior period financial statements. The Company has recently implemented controls to reduce the risk of such an error in the future through implementation of a comprehensive lease review checklist, review of each significant lease for proper accounting treatment by the Company’s Finance Department, and limiting execution of all property leases by the Company’s Chief Financial Officer or authorized designee.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

As previously disclosed, the Company’s previous independent registered public accounting firm has notified the Company that it received a letter from the Securities and Exchange Commission (“SEC”) dated October 22, 2004 requesting certain information about the Company relating to the period January 1, 2001 to the present. On April 14, 2005, the Company received a subpoena for the production of documents from the Midwest Regional Office of the SEC regarding an investigation the SEC has commenced captioned In the matter of Covansys Corp. (C-03825). The Company is cooperating to the fullest extent possible in the production of the requested documents.

On April 8, 2005, Covansys received service of a lawsuit captioned Leon S. Segen, derivatively on behalf of Covansys Corporation versus CDR-Cookie Acquisition, L.L.C., Clayton, Dubilier & Rice Fund VI Limited Partnership, CD&R Associates VI Limited Partnership, CD&R Investment Associates VI, Inc., and Covansys Corporation. The case is filed in the U.S. Southern District court for the Southern District of New York case no. 05CV3509. The derivative claim seeks recovery under Section 16(b) of the Securities and Exchange Act of 1934 to obtain disgorgement of profits of CD&R related to the recapitalization transaction consummated with the CD&R entities in September 2004. The Company is monitoring developments in the matter with legal counsel.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds


	(a)	The Company did not sell any unregistered securities during the quarter ended June 30, 2005.

	(c)	Repurchases of Company Stock

The Company has a previously disclosed stock repurchase plan. During the quarter ended June 30, 2005 the Company had the following activity:

(d)

Maximum Number

(c)

(or Approximate

Total Number of

Dollar Value) of

(a)

Shares (or Units)

Total Number of

(b)

Purchased as Part of

that May Yet Be

Shares (or Units)

Average Price Paid

Publicly Announced

Purchased Under the

Period

Purchased

per Share (or Unit)

Plans or Programs

April 2005

—

2,565,024

May 2005

218,100

11.69

218,100

2,346,924

June 2005

185,100

12.18

185,100

2,161,824

No shares were purchased during the three months ended March 31, 2005.

Item 4. Submission of Matters to a Vote of Security Holders

On June 14, 2005, the annual meeting of shareholders was held. The meeting was held for the following purposes:


	1. to elect four directors to the Board of Directors; and

	2. to ratify the appointment of BDO Seidman, LLP as the Company’s independent registered public accounting firm for the fiscal year 2005.

The shareholders re-elected Mr. Hugh R. Harris as a director. The vote was 29,447,366 for and 6,401,257 withheld.

The shareholders re-elected Mr. William C. Brooks as a director. The vote was 35,273,219 for and 575,404 withheld.

The shareholders re-elected Mr. John A. Stanley as a director. The vote was 35,035,682 for and 812,941 withheld.

The shareholders re-elected Mr. Gary C. Wendt as a director. The vote was 34,913,190 for and 935,433 withheld.

Mr. Rajendra B. Vattikuti and Mr. Frank Sanchez continue as directors with a term expiring in 2006. Mr. Douglas S. Land, Mr. Ronald K Machtley, Mr. Frank D. Stella and Mr. David H. Wasserman continue as directors with terms expiring in 2007.

The shareholders approved the appointment of BDO Seidman, LLP as independent registered public accounting firm for Covansys Corporation for the year ending December 31, 2005. The vote was 35,789,286 for, 55,901 against and 3,436 abstain.

Item 6. Exhibits

(a) Exhibits


Number		Exhibit

	31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of Rajendra B. Vattikuti pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	Certification of James S. Trouba pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	COVANSYS CORPORATION


	By:	/s/Thomas E. Lindsey



	Thomas E. Lindsey
	Vice President and Chief
	Accounting Officer
	(Principal Accounting Officer)

	/s/James S. Trouba

	James S. Trouba
	Vice President and
	Chief Financial Officer
	(Principal Financial Officer)

Dated: July 28, 2005

Exhibit Index


Exhibit No.		Description

	31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of Rajendra B. Vattikuti pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	Certification of James S. Trouba pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Avg

Covansys (CVNS) Inactive 10-Q2005 Q2 Quarterly report

Content analysis

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents