##### Table of Contents









UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




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FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934


For the Fiscal Year Ended December 31,
2005

Commission File Number 0-22141



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Covansys Corporation

(Exact name of registrant as specified in its
charter)


|                                                                                                      |  |                                  
|----------------------------------------------------------------------------------------------------- |  | ---------------------------------
|Michigan                                                                                              |  | 38-2606945                       
|(State or Other Jurisdiction of
    Incorporation or Organization)                                    |  | (IRS Employer Identification No.)
|                                                                                                     
|32605 West Twelve Mile Road
    Farmington Hills, Michigan(Address of principal executive
    office) |  | 48334-3339(Zip Code)             

Registrants telephone number, including
area code: (248) 488-2088

Securities registered pursuant to
Section 12(b) of the Act: None

Securities registered pursuant to
Section 12(g) of the Act: Common Stock

Indicate by check
mark if the registrant is well-known seasoned issuer, as defined
in Rule 405 of the Securities
Act.     Yes o          No þ

Indicate by check
mark if the registrant is not required to file reports pursuant
to Section 13 or Section 15(d) of the
Act.     Yes  o          No þ

Indicate by check
mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days.     Yes þ          No o

Indicate by check
mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (§ 229.405 of
this chapter) is not contained herein, and will not be
contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any
amendment to this
Form 10-K. þ

Indicate by check
mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated
filer o       Accelerated
filer þ       Non-accelerated
filer o

Indicate by check
mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange
Act).     Yes  o          No þ

The aggregate
market value of common stock held by non-affiliates of the
registrant as of June 30, 2005 was $226,082,630.

The number of
shares outstanding of the registrants common stock as of
February 15, 2006 was 37,431,625.

DOCUMENTS INCORPORATED BY REFERENCE

Portions
of the Proxy Statement of the Registrant for its 2006 Annual
Meeting of Shareholders to the extent expressly so stated, are
incorporated by reference into Part III of this Report.



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##### 



COVANSYS CORPORATION AND
SUBSIDIARIES

FORM 10-K

For the Fiscal Year Ended December 31,
2005

INDEX






|                                                 |  |                                                                                                                          |    |  |    | 
|------------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------------------ | -- |  | -- | 
|PART I                                          
|Item 1.                                          |  | Business                                                                                                                 |    |  | 2  | 
|Item 1A.                                         |  | Risk Factors                                                                                                             |    |  | 4  | 
|Item 1B.                                         |  | Unresolved Staff Comments                                                                                                |    |  | 7  | 
|Item 2.                                          |  | Properties                                                                                                               |    |  | 8  | 
|Item 3.                                          |  | Legal Proceedings                                                                                                        |    |  | 8  | 
|Item 4.                                          |  | Submission of Matters to a
    Vote of Security Holders                                                                  |    |  | 8  | 
|                                                
|PART II                                         
|Item 5.                                          |  | Market for the
    Registrants Common Equity, Related Stockholder Matters and
    Issuer Purchases of Equity Securities |    |  | 9  | 
|Item 6.                                          |  | Selected Financial Data                                                                                                  |    |  | 10 | 
|Item 7.                                          |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations                                |    |  | 11 | 
|Item 7A.                                         |  | Quantitative and Qualitative
    Disclosure About Market Risk                                                            |    |  | 22 | 
|Item 8.                                          |  | Financial Statements and
    Supplementary Data                                                                          |    |  | 24 | 
|Item 9.                                          |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure                                 |    |  | 52 | 
|Item 9A.                                         |  | Controls and Procedures                                                                                                  |    |  | 54 | 
|Item 9B.                                         |  | Other Information                                                                                                        |    |  | 60 | 
|                                                
|PART III                                        
|Item 10.                                         |  | Directors and Executive
    Officers of the Company                                                                      |    |  | 60 | 
|Item 11.                                         |  | Executive Compensation                                                                                                   |    |  | 60 | 
|Item 12.                                         |  | Security Ownership of
    Certain Beneficial Owners and Management                                                       |    |  | 60 | 
|Item 13.                                         |  | Certain Relationships and
    Related Transactions                                                                       |    |  | 60 | 
|Item 14.                                         |  | Principal Accountants Fees
    and Services                                                                              |    |  | 60 | 
|                                                
|PART IV                                         
|Item 15.                                         |  | Exhibits, Financial
    Statement Schedules                                                                              |    |  | 61 | 
|Signatures                                       |  |                                                                                                                          | 62 | 
|Subsidiaries of Registrant                      
|Consent of BDO Seidman, LLP                     
|Consent of PricewaterhouseCoopers LLP           
|Certification Pursuant to Section 302           
|Certification Pursuant to Section 302           
|Certification Pursuant to 18 U.S.C. Section 1350
|Certification Pursuant to 18 U.S.C. Section 1350



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PART I






|        |         
|------- | --------
|Item 1. | Business

Summary

Incorporated in 1985, Covansys Corporation is a
global technology services company with a focus on
industry-specific solutions, strategic outsourcing and
integration services. We address the most challenging technology
issues companies are facing through an onsite, offsite, offshore
delivery model that helps our clients achieve rapid deployment,
world-class quality and reduced costs.

Covansys offers flexible, cost-effective project
delivery capabilities by providing our clients a choice among
any combination of the following options: (1) onsite at the
client facility; (2) offsite at one of our development
facilities in North America; or (3) offshore at one of our
development facilities in India which have been successfully
operating since 1992. Our ability to deliver services globally
is enhanced by our local account management and recruiting
infrastructure, consisting of a geographically dispersed network
of worldwide offices and client executives. Our infrastructure
allows us to act as a local partner, becoming an integral member
of a clients technology team. This infrastructure and
local account management structure demonstrates our commitment
to each market and enhances our ability to attract locally based
clients and consultants.

Covansys broad range of technical skills,
commitment to delivery and industry-specific solutions have
attracted and retained hundreds of satisfied clients. Currently,
Covansys provides services to a broad spectrum of clients in a
variety of industries including financial services, retail and
distribution, manufacturing, healthcare, public sector, and
telco/ utilities/ transportation.

We apply our industry-specific knowledge to
deliver a wide range of systems integrations and outsourcing
services including:



| |   |                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Custom Application Development which may include
    the design, development and implementation of custom computer
    information systems.                                                                                                                                                        
|
| |  | Packaged Software Implementation, Upgrades and
    Enhancements including the configuration, customization,
    implementation and upgrade of packaged information system
    software products.                                                                                                   
|
| |  | Application Maintenance and Development
    Outsourcing (AMD/O) which may include the ongoing operations,
    enhancement and upgrade of custom or packaged information system
    software products.                                                                                              
|
| |  | Legacy Modernization which may include the
    migration of legacy applications to newer architecture platforms
    in order to reduce maintenance and operational costs, or
    extending customer legacy applications with new technology
    enhancements or components, such as web enablement.
|
| |  | Business Process Outsourcing including
    transaction processing services such as claims, invoices and
    document processing.                                                                                                                                                                   

Our standing in the financial services sector was
strengthened in 2004 through the Master Services Agreement the
Company entered with Fidelity Information Services, Inc.
(FIS), a subsidiary of Fidelity National Financial,
Inc. The relationship with FIS, a related party as noted below,
demonstrates Covansys commitment to the financial services
clients and has provided us with new opportunities for continued
growth in this area.

Covansys recognized early on that quality was a
critical priority and has had its quality assurance rated by the
top organizations through the years. Covansys India has earned
all three of the gold standards of quality assurance for
software development: Level 5 of the People Capability
Maturity Model
(SEI-PCMM®),
Level 5 of the
SEI-CMM®
and ISO 9001:2000.

In 2005 Covansys, through its wholly-owned
subsidiary Covansys India Limited, acquired 95% of the
outstanding voting shares of Fortune Infotech Limited. Fortune
Infotech Limited, with principal offices in Vadodara, India, is
an experienced provider of offshore outsourcing solutions. Also
in 2005, Covansys acquired

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all of the outstanding voting stock of Technology
Service Partners, Inc., an experienced technology staffing
organization located in Jacksonville, Florida.


In 2004, Covansys entered into a Stock Purchase
Agreement with FIS and a Recapitalization Agreement with a
private equity investment fund managed by Clayton,
Dubilier & Rice, Inc. (the CDR
Shareholder). The transactions are more fully discussed in
Note 2 of the Consolidated Financial Statements. The
Recapitalization Agreement with the CDR Shareholder restructured
the ownership interest in the Company that the CDR Shareholder
had acquired in 2000.

Covansys augmented its public sector practice,
particularly in the insurance area, in 2002 through the
acquisition of PDA Services, Inc. (PDA). PDA has
allowed Covansys to become a market leader in the development,
implementation and maintenance of systems for states required to
meet federal tracking and reporting mandates of the Women,
Infants & Children (WIC) Program, servicing agent
activities for the National Flood Insurance program administered
by the Federal Emergency Management Agency, and Business Process
Outsourcing.

In the first quarter of 2006, the Company entered
into an agreement to sell the net assets of its state and local
consulting practice, included in the Public Sector segment for
reporting purposes, in order to focus on serving clients in the
commercial sector. (See Note 22)

Segment Information

Information regarding our segments, including
geographic information, appears in Note 17 of the
Consolidated Financial Statements. In 2005, the chief operating
decision-maker realigned certain portions of the business and
the operating segments reducing the number of reported segments
in prior years from four operating segments and other to two
operating segments and other. The four operating segments
reported in prior years were Commercial, India/Asia, Public
Sector and Europe. These operating segments have been realigned
into two operating segments-Commercial and Public Sector.

Competition

We believe the primary competitive factors in our
business are price, quality and scope of service. We believe our
principal competitive advantage lies in our offshore development
centers in India. Our competitors consist primarily of medium to
large information system integrators. Depending on the nature of
the engagement, our competitors are located domestically and
offshore.

Strategy

Covansys strategy has been to focus on its
core competencies and to deliver high quality solutions to its
clients. The Company offers specific solutions designed for
targeted vertical markets which rely heavily upon systems
integration and/or outsourcing services. These solutions are
primarily offered in the financial services, retail and
distribution, manufacturing, healthcare, public sector, and
telco/utilities/transportation sectors.

Consistent with this strategy, Covansys has
developed proprietary software and solution frameworks to meet
its clients needs. In all industries  whether
or not an industry specific solution has been
developed  Covansys offers customizable outsourcing
and integration services. Covansys strategic outsourcing
offerings include application maintenance and development
outsourcing (AMD/O), full outsourcing, and business process
outsourcing/information technology enabled services (BPO/ITES).
Integration services include customer development, e-business
solutions, data warehousing, legacy modernization, packaged
software implementation, upgrades and enhancement and document
management. Expenditures to develop our proprietary software in
the last three years have not been material.

In the first quarter of 2006, the Company entered
into an agreement to sell the net assets of its state and local
consulting practice, included in the Public Sector segment for
reporting purposes, in order to focus on serving clients in the
commercial sector. (See Note 22)

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Core to Covansys strategy is its ability to
offer clients the flexibility of opting to have services
delivered onsite, offsite, or offshore to optimally manage
business needs with cost structures while mitigating risks.

A unique differentiator for Covansys is that it
is a U.S.-based consulting and technology services provider that
offers clients the comfort of contracting with a domestic
corporation while offering cost-effective, high-quality offsite
and offshore services. The global, flexible delivery
capabilities Covansys has mastered during the last decade allow
clients to achieve rapid deployment, world-class quality and
reduced costs. The Company is well positioned to take advantage
of the offshore trend that is expected to continue as more and
more companies see the value of offshore that Covansys has been
offering for many years.

Human Resources

Our success depends in large part on our ability
to attract, develop, motivate and retain highly skilled IT
professionals. Our strategy for achieving career-based
employment includes career planning, thorough initial and
ongoing training, allocation of assignments in accordance with
employee skills and career objectives and a comprehensive
benefits package. This package includes a company-matched
401(k) plan, health, dental and vision insurance,
preventative medical, short-term disability insurance, a
flexible spending account and tuition reimbursement. We also
grant stock options as part of our recruitment and retention
strategy.

Our rigorous recruiting process includes
track-specific screening interviews, standardized on-line
assessments targeted to the specific technical skills and level
of expertise required, technical interviews conducted by our
employees, management interviews, and a background investigation
process. Once employed, consultants are staffed on client
engagements and project teams based on business demand and as
appropriate to their skills and expertise.

Our consultants typically have Bachelors or
Masters degrees in Computer Science, Engineering or other
technical disciplines. As of December 31, 2005, we had
approximately 6,800 employees comprised of
6,400 Information Technology (IT) professionals
and approximately 400 general and administrative personnel.
As of December 31, 2005, we also had approximately
500 independent contractors working on client engagements.

We have employee training centers in a variety of
locations in the United States and in India. Between projects
and after business hours, our IT professionals may receive
training on a variety of technology platforms. We provide over
1,500 courses on our computer-based training system, which
is available 24 hours a day, 7 days a week. We have
access licenses to over 1,300 titles in technical
coursework. In addition to technical skills in a variety of
programming languages, we offer courses in methodology and
business skills. Approximately 300 of our project managers are
PMP (Project Management Professionals) certified as assessed by
the Project Management Institute.

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 1A. | Risk Factors

Listed below are certain risk factors associated
with Covansys. The impact of any risk factor listed below, or
combination of factors listed below, could materially and
adversely affect our future revenue and earnings which could in
turn adversely affect the quoted market price of the
Companys publicly-traded securities.

Changes in Estimates Could Effect the
Profitability of Our Fixed Price Projects

Covansys realized approximately 42% of its 2005
revenue from fixed price contracts (percentage of completion as
well as fixed price IT outsourcing and maintenance).
Approximately 14% of revenue was

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realized from fixed price contracts with respect
to which we recognize revenue on a percentage of completion
basis.


Changes in estimated costs to complete as a
result of the subjectivity inherent in estimating the costs to
complete could be unfavorable and change our estimates of the
ultimate profitability on these projects. These projects
generally contain payment terms that are tied to the successful
achievement of delivered milestones. These milestones frequently
require a substantial level of work and thus expose the Company
to large unbilled balances. The ultimate payment of these
balances is dependent on the acceptance of the deliverables
contractually agreed to relative to each milestone.

Internal Control Weaknesses Could Effect the
Reliability of Our Financial Statements

In our 2004 Form 10-K, management disclosed
various material weaknesses in our internal control environment.
We effectively remediated these weaknesses and details of the
remediation efforts are disclosed in Item 9A of this
Form 10-K. While our assessment, testing and evaluation of
the design and operating effectiveness of our internal control
over financial reporting resulted in our conclusion that as of
December 31, 2005, our internal control environment is
effective, we cannot predict the outcome of our testing in
future periods. If we conclude in future periods that our
internal control environment is not effective, we may be
required to change our internal controls to remediate
deficiencies, investors may lose confidence in the reliability
of our financial statements, and we may be subject to sanctions
by regulatory authorities. Also, if we identify areas of our
internal control environment that require improvement, we could
incur additional expenses to implement enhanced processes and
controls to address such issues. Any such events could adversely
effect our financial results and/or may result in a negative
reaction in the stock market.

Our Operating Results are Difficult to Predict
Because They Vary from Quarter to Quarter

Our revenue and operating results can vary from
quarter to quarter depending on a number of factors, including:



| |   |                                                                                       
| | - | --------------------------------------------------------------------------------------
| |  | The timing and number of client projects
    commenced and completed during a quarter;
|
| |  | Changes in the rates we charge clients for
    services;                              
|
| |  | Employee hiring, attrition, utilization and
    billing rates;                        
|
| |  | Progress on fixed-price projects during a
    quarter; and                            
|
| |  | Our ability to obtain a written contract prior to
    the end of a quarter.           

Because a high percentage of our expenses are
fixed, such as personnel and facilities costs, a variation in
revenue may cause a significant variation in our quarterly
operating results and could result in losses.

Failure to Recruit, Train and Retain Skilled
Resources Could Increase Costs or Limit Growth

Our continued success depends upon our ability to
attract, develop, motivate and retain highly skilled IT
professionals and project managers with the necessary technical
skills and experience who may be in high demand worldwide. We
cannot be certain that we will be able to attract or retain the
IT professionals that we seek.

Our Agreement to Sell the State and Local
practice of Our Public Sector Business May Not Close

The Companys agreement signed in
March 2006 to sell the state and local practice of our
public sector business is contingent on the Companys
ability to meet certain closing conditions, including the
assignment of contracts to the buyer. In the event that those
closing conditions are not met, the agreement will be terminated
and the transaction will not close. The failure to close this
transaction could adversely affect the Companys
relationships with its customers and its ability to sell work to
these and other public sector customers in the future. In
addition, the Company may encounter employee attrition in
connection with the transaction which may impact its ability to
complete existing projects.

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We are Exposed to Regulatory, Political and
General Economic Conditions in India and Asia that Differ from
Those in the United States

Revenue generated by our India and Asia
operations, as calculated on a full attribution basis, from both
direct services provided to clients in India and Asia as well as
services provided to customers in the United States and Europe
accounted for approximately 30% of our 2005 revenue. In
addition, over 67% of our workforce is located in India and
Asia. We benefit directly from certain incentives provided by
the Indian government to encourage foreign investment, including
tax holidays (temporary exemptions from taxation on operating
income) and liberalized import and export duties. If the Indian
government changes any of these incentives, it could negatively
impact the profitability of our Indian operations.

Changes in interest rates, inflation rates, tax
rates and policies, or other social, political, economic or
diplomatic developments affecting India in the future could have
an adverse effect on our business.

Our foreign operations are subject to currency
exchange rate fluctuations, foreign exchange restrictions and
related issues that may adversely impact our operating results.
In addition, if we fail to manage our geographically dispersed
operations we may not meet our financial objectives.

Our Contracts are Short-Term and Contain
Termination Provisions that Exposes Us to Greater Variability in
Revenue

Many of our contracts have terms of less than one
year. A client may choose not to renew its contract when it
terminates. Under some of our contracts, clients may
unilaterally reduce the use of our services with little or no
notice and without penalty. Many of our contracts have
termination provisions and contracts with our public sector
state and local clients typically allow for termination for
convenience which is required by law. If we are unable to retain
our existing clients, our business could be adversely affected.
An unanticipated termination of a major project could result in
a loss of revenues and could require us to pay a number of
unassigned IT professionals until new engagements can be
obtained.

We Operate in Highly Competitive Markets That
Could Effect Our Profitability

The IT services industry is highly competitive,
undergoing consolidation and is served by many national,
regional and local firms, all of which are either existing or
potential competitors. Many of our competitors have
substantially greater resources and greater name recognition
than we do. In addition, there are relatively few barriers to
entry into our markets. We have faced, and we expect to continue
to face, additional competition from new entrants into our
markets as well as intensive pricing pressures from that
competition. We cannot be certain that we will be able to
compete successfully with existing or new competitors.

Some of Our Clients May Experience Unique
Economic Conditions that are Specific to Their Particular
Industry

We provide services to clients in a wide variety
of industries. Many of the industries are subject to factors and
economic conditions that are unique to the particular industry
and may not be reflected in the overall health of the economy in
general. Our revenue growth and the realizability of our
accounts receivable could be adversely affected if our clients
in these particular industries encounter economic difficulties.
Such difficulties could include:



| |   |                                                                                           
| | - | ------------------------------------------------------------------------------------------
| |  | The inability of participants in the industry to
    access the capital or credit markets;
|
| |  | Business slowdowns due to excess inventory; and                                           
|
| |  | Shortfalls in demand for the product or service
    produced by a particular industry.    

We Frequently Need to Negotiate Contract
Renewals on Comparable Terms to Maintain Our
Profitability

Contracts continually expire and must be
renegotiated or rebid. Due to the competitive nature of our
industry and variable economic status of our clients, we may
experience difficulty in negotiating terms comparable to current
or recently expired contracts.

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Public Sector Budget Constraints Could Effect
Our Profitability

Contracts with state and local government clients
generated approximately 25% of our revenue during the year ended
December 31, 2005. Our public sector clients are
experiencing significant budget constraints which could result
in a decrease in the amount of business generated in the future
by these customers.

We Have Limited Protection of Our Intellectual
Property Rights

Our success depends in part upon certain of our
solutions and methodologies that we utilize in providing IT
services to our clients. We rely upon a combination of
nondisclosure and other contractual arrangements and trade
secret, copyright and trademark laws to protect our proprietary
rights and the proprietary rights of third parties from whom we
license intellectual property and/or perform services. However,
these may not be adequate to protect our rights or those of our
customers.

Our Services May Infringe Upon the
Intellectual Property Rights of Others

We cannot be sure that our services do not
infringe on the intellectual property rights of others, and we
may have infringement claims asserted against us. These claims
may harm our reputation, cost us money and prevent us from
offering some services. In some contracts, we have agreed to
indemnify, and may in the future agree to indemnify, our clients
for certain expenses or liabilities resulted from claimed
infringements of the intellectual property rights of third
parties. In some instances, the amount of these indemnities may
be greater than the revenue we receive from the customer. While
there are no current claims as of this date, any claims or
litigation in this area may be costly and result in large awards
against us and, whether we ultimately win or lose, could be
time-consuming, may injure our reputation, may result in costly
delays or may require us to enter into royalty or licensing
arrangements. If there is a successful claim of infringement or
if we fail to develop non-infringing technology or license the
proprietary rights we require on a timely basis, our ability to
use certain technologies, products and services may be limited,
and our business may be harmed.

We May Face Legal Liabilities and Damage to
our Professional Reputation From Claims Made Against Our
Work.

Many of our engagements involve projects that are
critical to the operations of our clients businesses. If
we fail to meet our contractual obligations, we could be subject
to legal liability, which could adversely affect our business,
operating results and financial condition. The provisions we
typically include in our contracts that are designed to limit
our exposure to legal claims relating to our services and the
applications we develop may not protect us or may not be
enforceable under some circumstances or the laws of some
jurisdictions. We have experienced liability claims in the past
that have resulted in litigation expenses and payments for
settlements. Because of the nature of our business, we may have
claims asserted against us in the future. Moreover, as a
consulting firm, we depend to a large extent on our
relationships with our clients and our reputation to attract and
retain clients and employees. As a result, claims alleged by
clients may be more damaging in our industry than in other
businesses.

We May Fail to Properly Manage Acquisitions
and Strategic Investments

We have expanded, and plan to continue to expand
our operations through acquisitions of additional businesses.

Acquisitions involve a number of special risks,
including:



| |   |                                                                          
| | - | -------------------------------------------------------------------------
| |  | Diversion of managements attention;                                     
|
| |  | Failure to retain key personnel of the acquired
    business:            
|
| |  | Assumption of unanticipated legal liabilities and
    other problems; and
|
| |  | Difficulties in integrating systems, operations
    and cultures         





|         |                          
|-------- | -------------------------
|Item 1B. | Unresolved Staff Comments

None.

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|        |           
|------- | ----------
|Item 2. | Properties

We lease office space throughout the world and
our headquarters is located in Farmington Hills, MI. Currently,
our facilities are adequate for our needs.

We have principal offices in the following
locations:

|              |                  |  |               |  |                   |               |  |  |                   |  |  |  |                      | 
|------------- | ---------------- |  | ------------- |  | ----------------- | ------------- |  |  | ----------------- |  |  |  | -------------------- | 
|              |                  |  |               | 
|Commercial    |                  |  | Public Sector |  |                   |              
|              |                  |  |               |  |                   |              
|North America |                  |  | International |  |                   | North America |  |  | Other             | 
|              |                  |  |               |  |                   |               |  |  |                   | 
|              |                  |  |               |  |                   |              
|              | Schaumburg, IL   |  |               |  | Bangalore, India  |               |  |  | Columbus, OH      |  |  |  | Farmington Hills, MI | 
|              | Jacksonville, FL |  |               |  | Brussels, Belgium |               |  |  | Lake Oswego, OR   |  |  |  |                      | 
|              | Montreal, Canada |  |               |  | Chennai, India    |               |  |  | Lenexa, KS        |  |  |  |                      | 
|              | Santa Clara, CA  |  |               |  | London, UK        |               |  |  | Marietta, GA      |  |  |  |                      | 
|              |                  |  |               |  | Madrid, Spain     |               |  |  | Overland Park, KS |  |  |  |                      | 
|              |                  |  |               |  | Mumbai, India     |               |  |  |                   |  |  |  |                      | 
|              |                  |  |               |  | Munich, Germany   |               |  |  |                   |  |  |  |                      | 
|              |                  |  |               |  | Rome, Italy       |               |  |  |                   |  |  |  |                      | 
|              |                  |  |               |  | Singapore         |               |  |  |                   |  |  |  |                      | 
|              |                  |  |               |  | Vadodara, India   |               |  |  |                   |  |  |  |                      | 





|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

We are, from time to time, involved in litigation
and various legal matters that arise in the ordinary course of
business. We do not believe that the ultimate resolution of any
of the pending matters will have a material adverse effect on
our financial condition, results of operations, or cash flows.
We believe that we have adequate defenses against the legal
allegations levied against us and intend to defend these matters
vigorously.

As previously disclosed, the Companys prior
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 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 investigation has involved the
production of various documents. The depositions of current and
former employees have been scheduled. The Company is cooperating
to the fullest extent possible in the investigation and at the
present time it is not possible to predict with any degree of
accuracy how this matter will develop, or how and when it will
be resolved.

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 was filed in the U.S. Southern
District court for the Southern District of New York case
no. 05CV3509 and sought 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. On February 2, 2006 the
District court dismissed the case with prejudice. The plaintiff
subsequently appealed this determination to the United States
Court of Appeals for the Second Circuit on February 15,
2006.






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

No matters were submitted to a vote of our
security holders during the fourth quarter of the year ended
December 31, 2005.

8



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##### Table of Contents






PART II






|        |                                                                                                                         
|------- | ------------------------------------------------------------------------------------------------------------------------
|Item 5. | Market for the Registrants Common
    Equity, Related Stockholder Matters and Issuer Purchases of
    Equity Securities

The following table sets forth, for the periods
indicated, the range of high and low bid prices for our common
stock as reported on the NASDAQ National Market at the close of
each quarter:

|                              |                |                |   |       |     |  |   |       | 
|----------------------------- | -------------- | -------------- | - | ----- | --- |  | - | ----- | 
|                              |                |               
|                              |                | Price Range of |  
|                              |                | Common Stock   |  
|                              |                |                |  
|                              |                | High           |   |       | Low | 
|                              |                |                |   |       |     | 
|Year Ended December 31, 2005: |                |                |   |       |     |  |   |      
|                              | First Quarter  |                | $ | 14.95 |     |  | $ | 11.31 | 
|                              | Second Quarter |                | $ | 15.70 |     |  | $ | 9.36  | 
|                              | Third Quarter  |                | $ | 16.88 |     |  | $ | 12.71 | 
|                              | Fourth Quarter |                | $ | 16.90 |     |  | $ | 13.51 | 
|Year Ended December 31, 2004: |                |                |   |       |     |  |   |      
|                              | First Quarter  |                | $ | 12.20 |     |  | $ | 9.82  | 
|                              | Second Quarter |                | $ | 16.01 |     |  | $ | 8.62  | 
|                              | Third Quarter  |                | $ | 11.75 |     |  | $ | 7.00  | 
|                              | Fourth Quarter |                | $ | 15.87 |     |  | $ | 10.66 | 

As of February 15, 2006, there were
509 shareholders of record of our common stock.

Since our initial public offering in March 1997,
we have not paid cash dividends on our common stock. We
currently anticipate that all of our earnings will be retained
for the continued development of our business and we do not
anticipate paying any cash dividends in the foreseeable future.

The Company did not repurchase any shares during
the fourth quarter of 2005.

9



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|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

The selected financial data presented below for
each of the five years in the period ended December 31,
2005, are derived from our Consolidated Financial Statements and
related Notes thereto. The selected financial data should be
read in conjunction with Managements Discussion and
Analysis of Financial Condition and Results of Operations
and the Consolidated Financial Statements and related Notes
thereto included in this Form 10-K.

|                              |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |   |         |      |   |   |         |      |  
|----------------------------- | ---------------------------------------------------------------- | ------------------------------------- | - | ------- | ------- |  | - | ------- | ---- | - | ---------- | ------- | --- | ------- | - | ------- | ---- | - | - | ------- | ---- | -
|                              |                                                                  |                                      
|                              |                                                                  | Years Ended December 31,              |  
|                              |                                                                  |                                       |  
|                              |                                                                  | 2005(a)                               |   |         | 2004(b) |  |   | 2003    |      |   | 2002(c)(d) |         |     | 2001(e) |  
|                              |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |  
|                              |                                                                  |                                      
|                              |                                                                  | (In thousands, except per share data) |  
|Statement of Operations Data: |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |   |         |      |   |   |        
|                              | Revenue                                                          |                                       | $ | 434,120 |         |  | $ | 374,373 |      |   | $          | 378,630 |     |         | $ | 383,053 |      |   | $ | 404,734 |     
|                              | Cost of revenue                                                  |                                       |   | 316,109 |         |  |   | 281,114 |      |   |            | 286,183 |     |         |   | 284,427 |      |   |   | 290,658 |     
|                              |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |  
|                              | Gross profit                                                     |                                       |   | 118,011 |         |  |   | 93,259  |      |   |            | 92,447  |     |         |   | 98,626  |      |   |   | 114,076 |     
|                              | Selling, general and administrative expenses                     |                                       |   | 72,097  |         |  |   | 72,342  |      |   |            | 82,731  |     |         |   | 97,957  |      |   |   | 115,774 |     
|                              | Restructuring, merger costs and other                            |                                       |   |        |         |  |   |        |      |   |            |        |     |         |   |        |      |   |   | 23,665  |     
|                              |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |  
|                              | Income (loss) from operations                                    |                                       |   | 45,914  |         |  |   | 20,917  |      |   |            | 9,716   |     |         |   | 669     |      |   |   | (25,363 | )   
|                              | Interest expense                                                 |                                       |   | 495     |         |  |   | 245     |      |   |            |        |     |         |   |        |      |   |   |        |     
|                              | Other income, net                                                |                                       |   | 3,507   |         |  |   | 1,317   |      |   |            | 1,781   |     |         |   | 4,110   |      |   |   | 5,531   |     
|                              |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |  
|                              | Income (loss) before provision (benefit) for
    income taxes    |                                       |   | 48,926  |         |  |   | 21,989  |      |   |            | 11,497  |     |         |   | 4,779   |      |   |   | (19,832 | )   
|                              | Provision (benefit) for income taxes                             |                                       |   | 11,388  |         |  |   | 4,485   |      |   |            | 1,378   |     |         |   | 886     |      |   |   | (7,211  | )   
|                              |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |  
|                              | Net income (loss)                                                |                                       |   | 37,538  |         |  |   | 17,504  |      |   |            | 10,119  |     |         |   | 3,893   |      |   |   | (12,621 | )   
|                              | Convertible redeemable preferred stock dividends                 |                                       |   |        |         |  |   | (3,221  | )    |   |            | (4,433  | )   |         |   | (4,298  | )    |   |   | (4,265  | )   
|                              | Loss on redemption of convertible redeemable
    preferred stock |                                       |   |        |         |  |   | 28,674  |      |   |            |        |     |         |   |        |      |   |   |        |     
|                              |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |  
|                              | Net income (loss) available for shareholders                     |                                       |   | 37,538  |         |  |   | (14,391 | )    |   |            | 5,686   |     |         |   | (405    | )    |   |   | (16,886 | )   
|                              | Amounts allocated to participating preferred
    shareholders    |                                       |   |        |         |  |   |        |      |   |            | (1,385  | )   |         |   |        |      |   |   |        |     
|                              |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |  
|                              | Net income (loss) available to common shareholders               |                                       | $ | 37,538  |         |  | $ | (14,391 | )    |   | $          | 4,301   |     |         | $ | (405    | )    |   | $ | (16,886 | )   
|                              |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |  
|                              | Earnings (loss) per share                                        |                                       |   |         |         |  |   |         |      |   |            |         |     |         |   |         |      |   |   |         |     
|                              |                                                                  | Basic                                 |   | $       | 1.00    |  |   | $       | (.48 | ) |            | $       | .16 |         |   | $       | (.01 | ) |   | $       | (.59 | )
|                              |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |  
|                              |                                                                  | Diluted                               |   | $       | .99     |  |   | $       | (.48 | ) |            | $       | .16 |         |   | $       | (.01 | ) |   | $       | (.59 | )
|                              |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |  
|                              | Basic weighted average shares                                    |                                       |   | 37,364  |         |  |   | 29,971  |      |   |            | 26,975  |     |         |   | 27,734  |      |   |   | 28,704  |     
|                              | Dilutive effect of options                                       |                                       |   | 596     |         |  |   | (A      | )    |   |            | 229     |     |         |   |        |      |   |   |        |     
|                              | Convertible redeemable preferred stock                           |                                       |   |        |         |  |   | (A      | )    |   |            | (A      | )   |         |   | (A      | )    |   |   | (A      | )   
|                              |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |  
|                              | Diluted weighted average shares                                  |                                       |   | 37,960  |         |  |   | 29,971  |      |   |            | 27,204  |     |         |   | 27,734  |      |   |   | 28,704  |     
|                              |                                                                  |                                       |   |         |         |  |   |         |      |   |            |         |     |         |  



|    |              
|--- | -------------
|(A) | Anti-dilutive

|                    |                                              |                    |   |         |      |  |   |         |  |  |      |         |  |      |   |         |  |  |   |         | 
|------------------- | -------------------------------------------- | ------------------ | - | ------- | ---- |  | - | ------- |  |  | ---- | ------- |  | ---- | - | ------- |  |  | - | ------- | 
|                    |                                              |                   
|                    |                                              | As of December 31, |  
|                    |                                              |                    |  
|                    |                                              | 2005               |   |         | 2004 |  |   | 2003    |  |  | 2002 |         |  | 2001 |  
|                    |                                              |                    |   |         |      |  |   |         |  |  |      |         |  |      |  
|                    |                                              |                   
|                    |                                              | (In thousands)     |  
|Balance Sheet Data: |                                              |                    |   |         |      |  |   |         |  |  |      |         |  |      |   |         |  |  |   |        
|                    | Cash and short term investments              |                    | $ | 81,362  |      |  | $ | 71,250  |  |  | $    | 127,475 |  |      | $ | 101,551 |  |  | $ | 123,794 | 
|                    | Working capital                              |                    |   | 144,910 |      |  |   | 112,433 |  |  |      | 187,528 |  |      |   | 163,110 |  |  |   | 185,858 | 
|                    | Total assets                                 |                    |   | 271,261 |      |  |   | 248,802 |  |  |      | 314,871 |  |      |   | 304,936 |  |  |   | 297,099 | 
|                    | Revolving credit facility and long-term debt |                    |   |        |      |  |   |        |  |  |      |        |  |      |   |        |  |  |   |        | 
|                    | Convertible redeemable preferred stock       |                    |   |        |      |  |   |        |  |  |      | 168,655 |  |      |   | 164,222 |  |  |   | 159,924 | 
|                    | Total shareholders equity                   |                    |   | 207,860 |      |  |   | 174,191 |  |  |      | 87,726  |  |      |   | 78,565  |  |  |   | 84,192  | 

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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | In September and December, 2005 we acquired 95%
    of the voting stock of Fortune Infotech Limited
    (Fortune), located in Vadodara, India, in two
    separate transactions. Also, in November, 2005 we acquired all
    of the voting stock of Technology Service Partners, Inc.
    (TSPI), located in Jacksonville, FL. Both
    acquisitions were accounted for by the purchase method of
    accounting and, accordingly, their operating results have been
    included in the consolidated financial statements since their
    dates of acquisition. See Note 6 to the Consolidated Financial
    Statements.



|    |                                                                                                                                                                                                                                                                                                                                                                                                          
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(b) | In April 2004, we entered into a Stock
    Purchase Agreement with Fidelity Information Services, Inc.
    (FIS), a subsidiary of Fidelity National Financial,
    Inc. and a Recapitalization Agreement with a private equity
    investment fund managed by Clayton, Dubilier & Rice, Inc.
    (CDR) to restructure CDRs stock ownership. See
    Note 2 to the Consolidated Financial Statements.



|    |                                                                                                                                                                                                                                                                                                                                   
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(c) | On May 31, 2002 we acquired all of the
    capital stock of PDA Software Services, Inc. (PDA).
    This acquisition was accounted for by the purchase method of
    accounting and, accordingly, the operating results of PDA have
    been included in the consolidated financial statements since the
    date of acquisition.



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(d) | The Company adopted SFAS 142 effective
    January 1, 2002 and ceased amortizing goodwill. The Company
    completed the transitional goodwill impairment testing as
    required by SFAS 142, during 2002. These evaluations
    indicated that goodwill was not impaired.                                                                                                                                                                                                                                                                                                          
|   
|(e) | Fiscal year 2001 restructuring, merger costs and
    other consists of approximately $14.7 million related
    primarily to the disposal of an equity investment and related
    note receivable based on managements determination that
    this investment no longer fit the strategic direction of the
    Company; approximately $7.3 million of costs associated
    with our organizational restructuring, including severances and
    lease terminations; and approximately $1.7 million in legal
    and advisory fees related to discontinued acquisition
    discussions.






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The following section should be read in
conjunction with our Consolidated Financial Statements and
related Notes appearing in Item 8 of this Form 10-K.
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 impact of
changes in estimates on fixed price projects, internal control
weaknesses, variability of operating results, failure to
recruit, train and retain skilled IT professionals, our
agreement to sell the state and local practice of our Public
Sector business may not close, 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, public sector budget
constraints, limited protection of intellectual property rights,
infringement by our services on the property rights of others,
legal liability and damage to our professional reputation from
claims made against our work, 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 an onsite,
offsite, offshore delivery model that helps clients achieve
rapid deployment and reduced costs. We offer high-level subject
matter expertise in retail, healthcare, distribution,
manufacturing, financial services, telecommunications, utilities
and public sector clients. We apply our industry-specific
knowledge to deliver a wide range of outsourcing and integration
services, including; 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.

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We generally assume responsibility for project
management and may bill the client on either a
time-and-materials or fixed-price basis. We recognize revenue on
time-and-materials engagements as the services are performed and
after we have a signed contract. On fixed-price engagements, we
recognize revenue under the percentage of completion method
except for fixed-price outsourcing contracts where we recognize
revenue ratably over the applicable period. For the years ended
December 31, 2005, 2004 and 2003 approximately 42%, 40%,
and 42%, respectively, of our total revenue was 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 global 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.

In 2004, Covansys entered into a Stock Purchase
Agreement with FIS and a Recapitalization Agreement with a
private equity investment fund managed by Clayton,
Dubilier & Rice, Inc. (the CDR
Shareholder). The transactions, which are more fully
discussed in Note 2 of the Consolidated Financial
Statements. The Recapitalization Agreement with the CDR
Shareholder restructured the ownership interest in the Company
that the CDR Shareholder had acquired in 2000.

In March 2006, the Company entered into an
agreement to sell the assets and certain liabilities of its
state and local consulting practice, which is included in the
Public Sector segment for reporting purposes, for up to
$40 million. The state and local consulting practice had
the following results for the years ended December 31, 2005
and 2004:

|                              |  |                |        |  |      |   |        |  
|----------------------------- |  | -------------- | ------ |  | ---- | - | ------ | -
|                              |  |               
|                              |  | Year Ended     |       
|                              |  | December 31,   |       
|                              |  |                |       
|                              |  | 2005           |        |  | 2004 |  
|                              |  |                |        |  |      |  
|                              |  |               
|                              |  | (in thousands) |       
|Revenue                       |  | $              | 75,741 |  |      | $ | 62,994 |  
|Gross profit                  |  |                | 10,212 |  |      |   | 3,389  |  
|Income (loss) from operations |  |                | 2,793  |  |      |   | (6,797 | )

The income (loss) from the state and local
practice includes costs directly attributable to the business.
Certain operating expenses which are indirectly attributable to
the business are centrally managed at the corporate level and
have not been allocated.

The agreement, which is contingent on the
Companys ability to meet certain closing conditions, also
requires the Company to provide a certain level of services to
the buyer from its operations in India at below market rates
through the end of 2007. Until such time as the transaction
closes, it is not possible for the Company to determine whether
the sale of the business will qualify for discontinued
operations reporting.

Critical Accounting Policies and
Estimates

The preparation of financial statements in
conformity with generally accepted accounting principles in the
United States of America 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

12



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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 Item 8 of
this Form 10-K.

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 and
after we have a signed contract. 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, maintenance contracts and transaction processing 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 costs 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.

Revenue is 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,
as required by Staff Accounting Bulletin No. 104, 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 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. 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

13



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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 cost of such
research is charged to expense when incurred. When the
technological feasibility of the product is established,
subsequent costs are capitalized in accordance with SFAS 86
Computer Software to be Sold, Leased or Otherwise
Marketed. 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
require 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 for the years ended December 31, 2005, 2004 and
2003.

Goodwill.Goodwill
represents the excess of purchase price over the net tangible
and identifiable intangible assets related to businesses
acquired. The Company continually evaluates whether events and
circumstances have occurred that indicate the recorded amount of
goodwill may warrant revision or that the remaining balance may
not be recoverable. The Company tests for impairment of its
reporting units by comparing fair value to carrying value. Fair
value is determined using a discounted cash flow methodology.
The results of the Companys annual impairment analysis
concluded that no impairment existed at December 31, 2005.

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 bases.
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.

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. The
Company utilized domestic net operating loss carryforwards
during 2005. The effective tax rate was 23.3% for the full year
2005. On a quarterly basis, management assesses whether it
remains more likely than not that the deferred tax assets will
be realized.

Liquidity and Capital Resources

As of December 31, 2005, we had cash and
short-term investments totaling $81.4 million. We generally
fund our operations and working capital needs through internally
generated funds. Cash provided by operating activities was
$51.7 million, $39.4 million, and $35.7 million
for the years ended December 31, 2005, 2004 and 2003,
respectively. The significant increase in cash flow was due to
an increase in earnings of $20.0 million offset partially
by $6.0 million increase in cash used for accounts
receivable and revenue earned in excess of billings.
Restructuring, merger and other related charges used
$1.5 million, $2.7 million and $4.7 million of
operating cash for the years ended December 31, 2005, 2004
and 2003, respectively.

The principal use of cash for investing
activities during the three years ended December 31, 2005
was for the purchase of property and equipment, primarily as
part of the development and enhancement of our offshore software
development centers and the purchase of short-term investments.
Additionally, we used approximately $7.0 million for two
business acquisitions in 2005.

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To facilitate future cash flow needs, the Company
has a credit agreement which provides for borrowings or standby
and commercial letters of credit up to $75.0 million
through December 28, 2010.

The credit agreement contains financial covenants
which require the Company to maintain a certain leverage ratio
and a minimum total capitalization. At December 31, 2005,
the Company was in compliance with these ratios. At
December 31, 2005, the Company had no borrowings and
$9.4 million in outstanding letters of credit under this
Credit Agreement.

Net cash used in financing activities was
$18.8 million, $86.3 million and $.6 million in
2005, 2004, and 2003, respectively. The primary use of cash in
2005 was $17.5 million for the redemption of subordinated
notes issued in 2004 in connection with the recapitalization. In
2004 the redemption of the convertible redeemable preferred
stock and warrants used $179.1 million of cash which was
partially funded from the proceeds from the issuance of common
stock, principally from FIS and proceeds from the exercise of
stock options of $95.3 million. See Note 2 to
Consolidated Financial Statements for further details concerning
the recapitalization. A significant use of cash in financing
activities was for the repurchase of our Common Stock. During
2005, 2004 and 2003, we repurchased 415,700, 253,100 and
557,200 shares, respectively, of our Common Stock, for
$4.8 million, $2.4 million and $1.5 million,
respectively.

Most of our revenue is billed in U.S. dollars. We
recognize transaction gains and losses in the period of
occurrence. In 2005, foreign currency translation and
transaction gains were $.4 million. There were no material
operating trends or effects on liquidity as a result of
fluctuations in the functional currency.

Inflation did not have a material impact on our
revenue or income from operations in fiscal years 2005, 2004 and
2003.

Covansys has no off-balance sheet transactions.

The following table presents a summary of
payments due for our contractual obligations for operating
leases as of December 31, 2005:

Period After December 31, 2005

|                 |  |                |        |        |        |   |       |              |  |   |              |  |  |               |       |  |  |   |        | 
|---------------- |  | -------------- | ------ | ------ | ------ | - | ----- | ------------ |  | - | ------------ |  |  | ------------- | ----- |  |  | - | ------ | 
|                 |  |                |        | Within |        |   |       |              |  |   |             
|                 |  | Total          |        |        | 1 Year |   |       | 1 to 3 Years |  |   | 3 to 5 Years |  |  | After 5 Years |      
|                 |  |                |        |        |        |   |       |              |  |   |              |  |  |               |      
|                 |  |               
|                 |  | (In thousands) |       
|Operating leases |  | $              | 41,328 |        |        | $ | 7,504 |              |  | $ | 11,290       |  |  | $             | 6,216 |  |  | $ | 16,318 | 
|                 |  |                |        |        |        |   |       |              |  |   |              |  |  |               |      

The Company anticipates that it will use cash on
hand to pay its contractual obligations in 2006.

Results of Operations

The following table sets forth, for the periods
indicated, selected statement of operations data as a percentage
of revenues:

|                                             |  |                          |       |   |      |  |       |      |  |  |       |  
|-------------------------------------------- |  | ------------------------ | ----- | - | ---- |  | ----- | ---- |  |  | ----- | -
|                                             |  |                         
|                                             |  | Years Ended December 31, |      
|                                             |  |                          |      
|                                             |  | 2005                     |       |   | 2004 |  |       | 2003 | 
|                                             |  |                          |       |   |      |  |       |      | 
|Revenue                                      |  |                          | 100.0 | % |      |  | 100.0 | %    |  |  | 100.0 | %
|Cost of revenue                              |  |                          | 72.8  |   |      |  | 75.1  |      |  |  | 75.6  |  
|                                             |  |                          |       |   |      |  |       |      | 
|Gross profit                                 |  |                          | 27.2  |   |      |  | 24.9  |      |  |  | 24.4  |  
|Selling, general and administrative expenses |  |                          | 16.6  |   |      |  | 19.3  |      |  |  | 21.8  |  
|                                             |  |                          |       |   |      |  |       |      | 
|Income from operations                       |  |                          | 10.6  | % |      |  | 5.6   | %    |  |  | 2.6   | %

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Revenue and gross profit by segment is as follows:

|               |               |                          |         |         |        |   |         |         |        |   |         |         |        |  
|-------------- | ------------- | ------------------------ | ------- | ------- | ------ | - | ------- | ------- | ------ | - | ------- | ------- | ------ | -
|               |               |                         
|               |               | Years Ended December 31, |        
|               |               |                          |        
|               |               | 2005                     |         |         | 2004   |   |         | 2003    |       
|               |               |                          |         |         |        |   |         |         |       
|Revenue       |               |                          |         |         |        |   |         |         |        |   |         |        
|               | Commercial    |                          | $       | 334,806 |        |   | $       | 287,574 |        |   | $       | 273,240 |       
|               |               | Less intersegment        |         |         | (6,949 | ) |         |         | (5,052 | ) |         |         | (7,246 | )
|               |               |                          |         |         |        |   |         |         |       
|               |               |                          | 327,857 |         |        |   | 282,522 |         |        |   | 265,994 |        
|               | Public Sector |                          |         | 106,263 |        |   |         | 91,199  |        |   |         | 112,913 |       
|               | Other         |                          |         |        |        |   |         | 652     |        |   |         | (277    | )     
|               |               |                          |         |         |        |   |         |         |       
|               |               | $                        | 434,120 |         |        | $ | 374,373 |         |        | $ | 378,630 |        
|               |               |                          |         |         |        |   |         |         |       
|Gross profit  |               |                          |         |         |        |   |         |         |        |   |         |        
|               | Commercial    |                          | $       | 101,735 |        |   | $       | 85,702  |        |   | $       | 74,707  |       
|               | Public Sector |                          |         | 19,288  |        |   |         | 10,718  |        |   |         | 21,666  |       
|               | Other         |                          |         | (3,012  | )      |   |         | (3,161  | )      |   |         | (3,926  | )     
|               |               |                          |         |         |        |   |         |         |       
|               |               | $                        | 118,011 |         |        | $ | 93,259  |         |        | $ | 92,447  |        
|               |               |                          |         |         |        |   |         |         |       



| |                        
| | -----------------------
| | 2005 Compared with 2004

Revenue.Revenue in
2005 was $434.1 million, an increase of $59.7 million
or 16.0% from $374.4 million in 2004. Both commercial and
public sector saw increases in revenue in 2005 over 2004
amounts. Commercial revenue in 2005 includes $3.5 million
from work performed in 2004 after the Company had reached the
authorized spending limit on a time and materials contract. The
Company received the contract which covered these services in
2005 and recognized the revenue in 2005. The Company also
benefited from a full year of revenue from work performed under
a Master Services Agreement with FIS as well as an increase in
the level of hardware and software sales.

Commercial revenue increased 16.0% to
$327.9 million in 2005 from $282.5 million in 2004.
The increase results from additional work performed under the
Companys Master Services Agreement with FIS of
approximately $12.2 million as well as the addition of
other new 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 cost
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 about
$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.

On May 3, 2005, Oracle announced that it had
exercised its purchase option to acquire PeopleSofts
development center in Bangalore, India operated by the Company.
The transfer of this center was completed in November 2005, upon
which the employees of the center (approximately 430) became
employees of Oracle. Revenue generated from this development
center for the Company was approximately $13.4 million and
$8.4 million for the years ended December 31, 2005 and
2004. Under terms of the agreement, Oracle is required to pay a
buyout fee of $1,000 and an amount which approximates the book
value of the net assets of the business. In accordance with the
terms of the agreement, Oracle has paid 80% of the amount owned
as of December 31, 2005. The Company anticipates receipt of
the remaining proceeds by the end of the first quarter of 2006.

Public sector revenue increased 16.5% to
$106.3 million in 2005 from $91.2 million in 2004.
Public sector revenue increased due to an increase in hardware
and software sales of approximately $6.5 million as well as
revenues from projects which commenced in 2005. During 2004,
revenue was negatively impacted by adjustments to fixed price
projects of $5.5 million related to our assessment of the
collectibility of outstanding billed and unbilled receivables
associated with two troubled projects. In accordance with the
applicable

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percentage of completion accounting, we reflected
the changes as a contract price adjustment, and accordingly, as
a reduction in revenue.


Subsequent to December 31, 2005, the Company
received a notification from two of its Public Sector customers
that they were terminating their contracts with the Company
prior to the completion of all of the deliverables under the
contracts. At December 31, 2005 the Company has recorded
receivables and revenue in excess of $2.2 million related
to these customers. The Company and the customers are currently
in negotiations concerning the resolution of these outstanding
receivables and the Company has recorded no reserves for such
amounts, if any, which may not be paid.

Gross Profit.Gross
profit for 2005 was $118.0 million or 27.2% of revenue
compared with $93.3 million or 24.9% of revenue for 2004.
Gross profit increased both in terms of dollars and as a percent
of revenue in 2005 due to the aforementioned revenue recognized
in 2005 for work performed in 2004, the reduction in adjustments
related to fixed price projects, the higher utilization of
domestic and offshore resources in 2005 partially offset by
lower pricing and other concessions to certain customers. Gross
profit in the fourth quarter of 2005 was negatively impacted by
$.9 million due to the accrual of previously unrecognized
employee benefits for certain employees of our Indian operations.

Commercial gross profit was $101.7 million
or 31.0% of revenue in 2005 compared with $85.7 million or
30.3% of revenue in 2004. The improvement in gross profit is due
to aforementioned revenue and related gross profit recognized in
2005 for work performed in 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 quarter of 2005, the Company received a contract
which covered these services and recognized the revenue in the
first quarter of 2005, with a corresponding impact in gross
profit. Gross profit also benefited from a higher utilization of
offshore resources as well as higher utilization rates,
partially offset by lower pricing and other concessions to
certain customers.

Public sector gross profit increased
$8.6 million in 2005 over 2004 amounts. Gross profit as a
percentage of revenue was 18.2% in 2005 as compared with 11.8%
in 2004. Gross profit in 2005 benefited from higher revenue from
projects which commenced in 2005 as well as higher revenue from
hardware and software sales. As a percentage of revenue,
however, hardware and software sales have a lower gross profit
percentage than traditional consulting revenue. Gross profit in
2005 was also impacted by adjustments to estimates to complete
for certain contracts. Management has implemented new procedures
and requirements with respect to this estimation process in 2005
to help minimize the impact of any such adjustments in the
future.

Gross profit in 2004 was negatively impacted from
negative gross profit on challenged projects as well as
competitive pricing pressures. Actions were taken to address the
remaining challenged project.

Selling, General and
Administrative.Selling, general and
administrative expenses (SGA) in 2005 were flat as compared with
2004 amounts. Included in 2004 amounts are approximately
$7.8 million in costs related to Sarbanes-Oxley,
professional fees related to the recapitalization transaction
and restatement of financial statements, lease termination
costs, severance, impairment charges and loss on disposal and
obsolescence of property and equipment.

SGA expenses in 2005 included costs related
to Sarbanes-Oxley, professional fees related to the restatement
of financial statements, costs related to remediation of
material weaknesses in internal control including increased
infrastructure costs, costs incurred in connection with the
SEC investigation as well as increases in personnel costs
to improve skill sets to support the revenue growth of the
Company.

Income from
Operations.Income from operations
increased from $20.9 million in 2004 to $45.9 million
in 2005.

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Commercial income from operations increased
$12.0 million to $74.8 million in 2005. The
improvement is due to higher revenue and gross profit driven by
a higher utilization of both domestic and offshore resources, as
well as the revenue adjustments previously discussed.

Public sector income from operations increased
from a loss of $2.1 million in 2004 to income of
$8.5 million in 2005. The improvement is due to higher
levels of revenue, partially offset by adjustments to estimates
to complete of certain fixed price projects. The loss in 2004
was driven by lower revenues due to the completion of projects
in addition to revenue adjustments of $5.5 million related
to troubled projects and negative gross profit in certain other
projects.

Interest Expense.Interest expense of $.5 million relates to interest on a
$17.5 million note issued in connection with the FIS/CDR
transaction (See Note 2 to Consolidated Financial
Statements) and fees in connection with a credit agreement (See
Note 11 to Consolidated Financial Statements). The notes
were repaid in July, 2005.

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 transactions and translation
gains and losses. Also included in 2005 amounts is
$1.0 million in buy out fees related to the Oracle
transaction (See Note 20 to the Consolidated Financial
Statements).

Provision for Income
Taxes.The provision for income taxes
was $11.4 million in 2005 as compared with
$4.5 million in 2004 or an effective rate of 23.3% compared
with 20.4%, respectively. The effective tax rate in 2005
includes a favorable tax adjustment of $3.2 million from
the reversal of previously recorded tax reserves due to the
expiration of the statute of limitations for the tax years the
reserves related to, a favorable adjustment of $.5 million
from the reduction in a valuation allowance, partially offset by
an unfavorable adjustment of $.3 million due to an enacted
law change in the State of Ohio which reduced the amount of net
operating losses that the Company will be able to utilize in
future periods. In addition, the Company also reduced tax
reserves by $.3 million based on an evaluation of estimated
tax exposures. The effective tax rate in 2004 included a
favorable tax adjustment of $2.2 million from a reduction
in a valuation allowance.



| |                        
| | -----------------------
| | 2004 Compared with 2003

Revenue.Revenue in
2004 was $374.4 million, down 1.1% from $378.6 million
in 2003. The decline is primarily due to a continued decline in
our Public Sector business from $106.3 million in 2003 to
$91.2 million in 2004. The decline was offset by increases
in revenue in our Commercial business, including an increase of
$1.2 million of revenue recorded in 2004 in connection with
an agreement signed with SIRVA related to services previously
provided and a decrease of approximately $3.5 million in
2004 related to the Companys determination not to
recognize revenue for services provided to a significant
customer after reaching the authorized spending limit on a
related time and material contract.

The Companys total hours worked in 2004
increased by 10% over hours worked in 2003. While the Company
continued to increase its hours worked in certain segments of
its US commercial business, the majority of the net increase in
hours are in the Companys India operations. The average
bill rates in India are considerably lower than the average US
bill rates. Despite the increase in hours, the combination of
lower average bill rates in India, the increase in the revenue
from India based work and the decline in Public Sector revenue
resulted in relatively flat revenue for 2004.

Commercial segment revenue increased 6.2% to
$282.5 million in 2004 from $266.0 million in 2003.
The increase resulted from the addition of new clients,
including the revenue from the Companys Master Services
Agreement with FIS signed in 2004, $1.2 million of revenue
recorded in connection with the agreement signed with SIRVA
related to services previously provided, and expansion of work
with existing clients offset by the completion of existing
projects. Additionally, the Company increased Indian staffing
and improved its utilization for existing customer relationships
and the transfer of certain commercial relationships into this
geographic region. The Company anticipates based on its current
strategic plan that the majority of its revenue growth in the
next few years will be 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

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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 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 of providing the services, but did not recognize any
revenue for these services in 2004. Gross profit in the
Commercial sector was negatively impacted in the fourth quarter
by approximately $3.5 million. In 2005, the Company
received a contract which covered these services and will
recognize the revenue in the first quarter of 2005, with a
corresponding increase in gross profit.


The Company had approximately $8.4 million
in revenue in 2004 from a customer that was in the process of a
merger. While the Company has not been informed of any intent to
do so, the customer or its acquirer have the right to terminate
the arrangement. The Company believes that should such a
termination occur, the customer would need to transition the
services either in-house or to another provider over some period
of time.

Public Sector revenue decreased 19.2% in 2004 as
compared with 2003. The decline in Public Sector revenue is due
to the completion of numerous projects in 2004, combined with a
slow down in the requests for proposal on new projects issued by
state governments, particularly in the first part of 2004. We
have recently seen some increase in the level of requests for
proposal and have been awarded new projects that started in the
fourth quarter of 2004 or that will start in early 2005. Revenue
was also negatively impacted by the adjustment to the fixed
price projects discussed below.

During 2004 we made adjustments to the estimated
cost to complete for certain fixed price contracts for which we
recognize revenue on the percentage of completion basis. Revenue
was negatively impacted by $5.5 million related to our
reassessment of the collectability of outstanding billed and
unbilled receivables associated with two troubled projects. In
accordance with the application of percentage of completion
accounting, we reflected the changes as a contract price
adjustment, and accordingly, as a reduction in revenue.

Gross Profit.Gross
profit for 2004 was $93.3 million or 24.9% of revenue as
compared with $92.4 million or 24.4% of revenue for 2003.
Gross profit increased both in dollars and as a percent of
revenue due to the full year effect of our aggressive cost
control and realignment activities in 2004 which commenced
during 2003 in addition to lower health care related cost due to
better experience and changes in plan design. Gross profit for
2004 was negatively impacted by reassessment of costs of a loss
contract, adjustments to estimates to complete for certain
Public Sector contracts, and the adjustment of certain unbilled
fixed price contract receivables in the Public Sector based on
perceived collection risk as previously discussed. These
adjustments had a negative impact of approximately
$11.2 million in 2004. Gross profit in 2003 was negatively
impacted by $6.2 million on four fixed price projects in
the Public Sector and $1.8 million in severance costs
resulting from our realignment.

Commercial segment gross profit improved to
$85.7 million in 2004 from $74.7 million in 2003 or
30.3% as compared with 28.1% of revenue, respectively. The gross
profit improvements resulted from additional offshore work
performed by resources in India, cost control, the addition of
new clients, and new work for existing clients with better
margins. The additional revenue from a customer previously
discussed increased gross profit by $1.2 million. 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 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 of providing the services, but did
not recognize any revenue for these services in 2004. Gross
profit in the Commercial sector was negatively impacted in the
fourth quarter by approximately $3.5 million. In 2005, the
Company received a contract which covered these services and
recognized the revenue in the first quarter of 2005, with a
corresponding impact in gross profit.

Public Sector gross profit decreased to
$10.7 million in 2004 from $21.7 million in 2003.
Gross profit as a percent of revenue also decreased to 11.8% of
revenue in 2004 as compared with 19.2% in 2003. The decrease in
2004 in Public Sector gross profit, both in dollars and as a
percent of revenue, was the result of negative

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gross profit on challenged projects and
competitive pricing pressures. Two of these challenged projects
have been completed and actions have been taken to address the
remaining challenged project.


Selling, General and
Administrative.Selling, general and
administrative expenses decreased by $10.4 million in 2004
to $72.3 million from $82.7 million in 2003. SGA as a
percentage of revenue improved to 19.3% in 2004, compared with
21.8% in 2003. This improvement represents the full year results
of our organizational realignment efforts completed in 2003 and
continued cost reduction activities in 2004 in addition to lower
health care related costs due to better experience and changes
in plan design. In 2004, the Company continued to aggressively
move pieces of its internal information systems support to India
based employees, eliminated much of its internal marketing staff
and hired lower cost employees to replace those employees that
resigned or eliminated the position. The decline in SGA was
achieved despite a number of charges in 2004, which are more
fully discussed in the notes to the consolidated financial
statements including:



| |   |                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $1.1 million in professional fees associated
    with consultation and external auditing for the implementation
    of Sarbanes-Oxley Section 404
|
| |  | $1.7 million in lease termination costs
    (compared with $.4 million in 2003) (See Note 19 to
    Consolidated Financial Statements)           
|
| |  | $1.3 million in severance (compared with
    $2.1 million in 2003) (See Note 19 to Consolidated
    Financial Statements)                        
|
| |  | $1.3 million in impairment charges for
    investments and internally developed software (See Note 1
    to Consolidated Financial Statements)   
|
| |  | $1.0 million in loss on disposal and
    obsolescence of property and equipment (See Note 9 to
    Consolidated Financial Statements)            
|
| |  | $.7 million in professional fees associated
    with the recapitalization (See Note 2 to Consolidated
    Financial Statements)                  
|
| |  | $.7 million in professional fees for the
    fixed asset analysis (See Note 9 to Consolidated Financial
    Statements)                          

We have presented these charges in order to
provide additional information to the reader of the financial
statements. We caution that while a number of these charges
could be viewed as non-recurring in nature, we can
give no assurances that these or other non-recurring
charges will not be incurred in the future.

Income from
Operations.Income from operations
increased by $11.2 million or 115.3% in 2004 to
$20.9 million from $9.7 million in 2003. The
significant improvement in 2004 results from the increase in the
percentage of work performed in India at more favorable margins,
addition of new customers and new work for existing clients, and
the improvements in SG&A offset by the revenue adjustments
previously discussed.

Commercial income from operations increased by
$18.7 million or 42.4% to $62.7 million in 2004 as
compared with $44.1 million in 2003. Of the increase,
approximately $10.9 million is due to margin on increased
sales and approximately $4.4 million is due to improved
margins with the remainder due to decreases in SGA.

Public Sector income from operations was a loss
of $2.1 million in 2004 as compared with income of
$4.4 million in 2003. The decrease is due to the completion
of projects and slow down in requests for proposal on new work
in addition to revenue adjustments of approximately
$5.5 million related to troubled projects and negative
gross profit on troubled projects.

Interest Expense.Interest expense of $.3 million recorded in 2004 relates to
interest on a $17.5 million note issued in connection with
the FIS/CDR transaction (Note 2) and fees in connection
with the Credit Agreement (Note 11).

Other Income Net.Other income net represents net earnings on investments offset
by foreign currency losses of approximately $1.0 million.
Other income net decreased by $0.5 million to
$1.3 million in 2004 as compared with $1.8 million in
2003 due to lower interest rates earned on investments and a
decrease in cash

20



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and short term investments in September due to
the FIS/CDR transaction as well as foreign currency translation
and transaction losses.


Provision for Income
Taxes.The provision for income taxes
was $4.5 million in 2004 as compared with $1.4 million
in 2003, an effective tax rate of 20.4% compared with 12.0%,
respectively. The effective tax rate increased due to the
completion of tax holidays for certain locations in India and a
$4.3 million favorable tax adjustment related to settlement
of income tax audits for the years 1998 through 2001 in 2003
offset by the inclusion of $2.2 million reduction in a
valuation allowance in 2004.

Restructuring and Other Related
Charges

In 2005 the Company recorded $.5 million of
lease termination costs. No additional severance costs related
to restructuring activities were recorded. Amounts related to
lease termination will be paid out through June, 2011.

In 2004, the Company recorded $1.7 million
of lease termination costs and $1.3 million related to
severance as the company continued to reduce costs in line with
overall revenue expectations. Amounts related to severance were
paid through 2005 and amounts related to lease terminations will
be paid out through June, 2011.

In 2003, the Company recorded costs of
$4.2 million related to various headcount reductions and
termination of lease obligations associated with the
consolidation of facilities and its organizational realignment.
Amounts related to lease terminations will be paid out through
2006. Amounts related to severance incurred in 2003 were paid
through 2004.

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 $95.7 million (See Note 2 to Consolidated
Financial Statements). In the second quarter of 2004, the
Company entered into a Master Services Agreement with FIS to
provide services over a five year period. In connection with the
recapitalization, the company reimbursed FIS $1.0 million
for certain out-of-pocket fees and expenses. Services provided
by the Company to FIS during 2005 and 2004 totaled approximately
$17.3 million and $5.1 million, respectively. The
balance owed to the Company by FIS at December 31, 2005 and
2004 was $3.4 million and $2.3 million, respectively.

Synova is an IT professional services
organization owned by the Companys Chief Executive
Officer. For the years ended December 31, 2005, 2004 and
2003, we provided services to Synova totaling approximately
$2.1 million, $2.5 million and $3.2 million,
respectively. In addition, Synova provided services to Covansys,
for the years ended December 31, 2005, 2004 and 2003,
totaling approximately $4.8 million, $2.1 million and
$1.6 million, respectively. The net balance due to Synova
by Covansys at December 31, 2005 and 2004 was
$.7 million and $.2 million, respectively. In
addition, under the terms of a note payable originated in 2000
(originally $8.0 million), Synova owed Covansys
$3.0 million at December 31, 2004 which was repaid
during 2005.

We paid approximately $.6 million and
$.8 million to Clayton, Dubilier and Rice, Inc. (CDR), a
shareholder, for financial, management advisory, and executive
management services for the years ended December 31, 2004
and 2003, respectively. No such services were provided by CDR in
2005. During 2004, the Company entered into a recapitalization
transaction (Note 2 to Consolidated Financial Statements)
in which CDRs ownership interest in Covansys, including
$168.7 million of Convertible Redeemable Preferred Stock,
was redeemed and exchanged for consideration valued at
$227.7 million, including $177.5 million of cash,
2,000,000 shares of Covansys common stock, $17.5 million of
subordinated notes and five-year warrants for 5,000,000 shares
of common stock at a strike price of $18 per share. In
connection with the recapitalization, the Company reimbursed CDR
$.5 million for certain out-of-pocket fees and expenses.
The $17.5 million subordinated notes were repaid by the
Company in July, 2005.

The Company provides IT outsourcing services to
SIRVA, Inc., a company related through common ownership by CDR.
During the years ended December 31, 2005, 2004 and 2003,
services provided by

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##### Table of Contents



Covansys to SIRVA, Inc. totaled approximately
$8.4 million, $10.0 million and $8.4 million,
respectively. In addition, SIRVA provided services to Covansys,
for the year ended December 31, 2003 totaling
$.1 million. No services were provided by SIRVA to the
Company during the years ended December 31, 2005 or 2004.
In the fourth quarter of 2004, the Company executed an agreement
with SIRVA regarding fees for services provided in prior
periods. In connection with the agreement, the Company
recognized revenue of $1.2 million.


We paid approximately $.3 and $.9 million
during the years ended December 31, 2005 and 2004,
respectively, for consultation and advisory services in
connection with the Fortune and TSPI acquisitions (see
Note 6 to the Consolidated Financial Statements) and the
recapitalization transaction (see Note 2 to the
Consolidated Financial Statements) provided by the Chesapeake
Group, Inc., a company owned by a director. Nothing was owed by
the Company to the Chesapeake Group, Inc. at December 31,
2005 or 2004.

The Company has loans of $1.1 million and
$1.2 million at December 31, 2005 and 2004,
respectively, to its employees in India to assist them with the
purchase of automobiles and houses. The loans, which bear
interest at below market rates, are collateralized by the
property and repaid through payroll deductions.

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. The Company is
required to adopt the provisions of FAS 123R effective
January 1, 2006 and intends to use the modified prospective
method. Under this method, awards that are granted, modified or
settled after the date of adoption or have not fully vested at
the date of adoption will be measured and accounted for under
FAS 123R. The Company estimates that the adoption of
FAS 123R will reduce 2006 operating results before taxes by
approximately $1.7 million.

In December 2004, the FASB issued FASB Staff
Position (FSP) 109-2 Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Program within
the American Job 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 did not avail itself to the one-time repatriation
opportunities provided by 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.






|         |                                                              
|-------- | -------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosure
    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 Item 7 of this
Form 10-K  Managements Discussion and
Analysis of Financial Condition and Results of
Operations  Liquidity and Capital Resources.

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##### Table of Contents



Foreign Exchange Risk

Most of our revenue is billed in
U.S. dollars. We recognize transaction gains and losses in
the period of occurrence. During 2005, the Company experience
foreign currency translation and transaction gains of
approximately $.4 million. The Company does not speculate
in foreign currency.

Revenue generated by our India and Asia
operations, including development centers, from both direct
services provided to clients in India and Asia as well as
services provided to customers in the United States, accounted
for approximately 30% of our total 2005 revenue on a full
attribution basis. In addition, services provided by our other
international operations, primarily in Europe, accounted for
approximately 5% of our total 2005 revenue.

Interest Rate Risk

Our exposure to market risk for changes in
interest rates relates primarily to our cash and short-term
investment portfolio which was $81.4 million as of
December 31, 2005. All of our short-term investments are
designated as available-for-sale and, accordingly, are presented
at fair value in the consolidated 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.

Derivative Risk

From time to time, the Company hedges certain of
its forecasted foreign currency exposure using forward contracts
with durations no greater than 3 months. We had no such
contracts outstanding at December 31, 2005 or 2004.

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|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

To the Board of Directors and Shareholders of
Covansys Corporation:

We have audited the accompanying consolidated
balance sheet of Covansys Corporation and subsidiaries as of
December 31, 2005, and the related consolidated statements
of operations, shareholders equity and comprehensive
income, and cash flows for the year then ended. These financial
statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these
financial statements based on our audit.

We conducted our audit in accordance with the
standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.

In our opinion, the consolidated financial
statements referred to above present fairly, in all material
respects, the financial position of Covansys Corporation and
subsidiaries at December 31, 2005, and the results of their
operations and their cash flows for the year then ended, in
conformity with accounting principles generally accepted in the
United States of America.

We also have audited, in accordance with the
standards of the Public Company Accounting Oversight Board
(United States), the effectiveness of Covansys Corporation and
subsidiaries internal control over financial reporting as
of December 31, 2005, based on criteria established in
Internal Control  Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission
(COSO) and our report dated March 8, 2006 expressed an
unqualified opinion thereon.

BDO Seidman, LLP

Grand Rapids, Michigan


March 8, 2006


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##### Table of Contents



Report of Independent Registered Public
Accounting Firm

To the Board of Directors and Shareholders of
Covansys Corporation:

In our opinion, the consolidated balance sheet as
of December 31, 2004 and the related consolidated
statements of operations, statements of shareholders
equity and comprehensive income, and statements of cash flows
present fairly, in all material respects, the financial position
of Covansys Corporation and its subsidiaries at
December 31, 2004, and the results of their operations and
their cash flows for each of the two years in the period ended
December 31, 2004, in conformity with accounting principles
generally accepted in the United States of America. These
financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits. We
conducted our audits of the statements in accordance with the
standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant
estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

PricewaterhouseCoopers LLP

Detroit, Michigan


March 11, 2005, except as to Note 17, for which
the date is March 8, 2006.


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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

|                                         |                                                                                                                                                                           |                                            |        |         |         |  |        |         |         | 
|---------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------- | ------- |  | ------ | ------- | ------- | 
|                                         |                                                                                                                                                                           |                                           
|                                         |                                                                                                                                                                           | December 31,                               |       
|                                         |                                                                                                                                                                           |                                            |       
|                                         |                                                                                                                                                                           | 2005                                       |        |         | 2004    | 
|                                         |                                                                                                                                                                           |                                            |        |         |         | 
|                                         |                                                                                                                                                                           |                                           
|                                         |                                                                                                                                                                           | (Dollars in thousands)                     |       
|ASSETS                                   |                                                                                                                                                                           |                                            |        |         |         |  |        |        
|Current assets:                          |                                                                                                                                                                           |                                            |        |         |         |  |        |        
|                                         | Cash and cash equivalents                                                                                                                                                 |                                            | $      | 58,030  |         |  | $      | 49,841  |        
|                                         | Short term investments                                                                                                                                                    |                                            |        | 23,332  |         |  |        | 21,409  |        
|                                         | Accounts receivable, net of allowance for
    doubtful accounts
    of $1,357 and $1,532 at December 31, 2005 and 2004                                                    |                                            |        | 82,526  |         |  |        | 75,388  |        
|                                         | Revenue earned in excess of billings                                                                                                                                      |                                            |        | 25,632  |         |  |        | 24,613  |        
|                                         | Deferred taxes                                                                                                                                                            |                                            |        | 6,275   |         |  |        | 5,105   |        
|                                         | Prepaid expenses and other                                                                                                                                                |                                            |        | 8,842   |         |  |        | 7,226   |        
|                                         |                                                                                                                                                                           |                                            |        |         |         | 
|                                         |                                                                                                                                                                           | Total current assets                       |        |         | 204,637 |  |        |         | 183,582 | 
|Property and equipment, net              |                                                                                                                                                                           |                                            | 34,506 |         |         |  | 29,762 |        
|Computer software, net                   |                                                                                                                                                                           |                                            | 2,150  |         |         |  | 3,706  |        
|Goodwill                                 |                                                                                                                                                                           |                                            | 21,893 |         |         |  | 19,148 |        
|Deferred taxes                           |                                                                                                                                                                           |                                            | 3,086  |         |         |  | 5,808  |        
|Other assets                             |                                                                                                                                                                           |                                            | 4,989  |         |         |  | 6,796  |        
|                                         |                                                                                                                                                                           |                                            |        |         |         | 
|                                         |                                                                                                                                                                           | Total assets                               |        | $       | 271,261 |  |        | $       | 248,802 | 
|                                         |                                                                                                                                                                           |                                            |        |         |         | 
|LIABILITIES AND SHAREHOLDERS
    EQUITY |                                                                                                                                                                           |                                            |        |         |         |  |        |        
|Current liabilities:                     |                                                                                                                                                                           |                                            |        |         |         |  |        |        
|                                         | Current portion of long-term debt                                                                                                                                         |                                            | $      |        |         |  | $      | 17,500  |        
|                                         | Accounts payable                                                                                                                                                          |                                            |        | 14,346  |         |  |        | 14,052  |        
|                                         | Accrued payroll and related costs                                                                                                                                         |                                            |        | 21,542  |         |  |        | 16,744  |        
|                                         | Taxes payable                                                                                                                                                             |                                            |        | 1,438   |         |  |        | 3,481   |        
|                                         | Other accrued liabilities                                                                                                                                                 |                                            |        | 19,618  |         |  |        | 18,331  |        
|                                         | Deferred revenue                                                                                                                                                          |                                            |        | 2,783   |         |  |        | 1,041   |        
|                                         |                                                                                                                                                                           |                                            |        |         |         | 
|                                         |                                                                                                                                                                           | Total current liabilities                  |        |         | 59,727  |  |        |         | 71,149  | 
|Other liabilities                        |                                                                                                                                                                           |                                            | 3,674  |         |         |  | 3,462  |        
|Commitment and contingencies             |                                                                                                                                                                           |                                            |        |         |         |  |        |        
|Shareholders equity:                    |                                                                                                                                                                           |                                            |        |         |         |  |        |        
|                                         | Preferred stock, no par value, 1,000,000 shares
    authorized, 0 shares issued as convertible redeemable
    preferred stock as of December 31, 2005 and 2004            |                                            |        |        |         |  |        |        |        
|                                         | Common stock, no par value, 200,000,000 shares
    authorized, 37,398,342 and 37,418,764 shares issued and
    outstanding as of December 31, 2005 and 2004, respectively |                                            |        |        |         |  |        |        |        
|                                         | Additional paid-in capital                                                                                                                                                |                                            |        | 165,496 |         |  |        | 165,983 |        
|                                         | Retained earnings                                                                                                                                                         |                                            |        | 43,971  |         |  |        | 6,433   |        
|                                         | Accumulated other comprehensive income (loss)                                                                                                                             |                                            |        | (1,607  | )       |  |        | 1,775   |        
|                                         |                                                                                                                                                                           |                                            |        |         |         | 
|                                         |                                                                                                                                                                           | Total shareholders equity                 |        |         | 207,860 |  |        |         | 174,191 | 
|                                         |                                                                                                                                                                           |                                            |        |         |         | 
|                                         |                                                                                                                                                                           | Total liabilities and shareholders equity |        | $       | 271,261 |  |        | $       | 248,802 | 
|                                         |                                                                                                                                                                           |                                            |        |         |         | 

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

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COVANSYS CORPORATION AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                                 |                                          |                                       |         |         |      |   |         |        |   |   |         |        | 
|---------------------------------------------------------------- | ---------------------------------------- | ------------------------------------- | ------- | ------- | ---- | - | ------- | ------ | - | - | ------- | ------ | 
|                                                                 |                                          |                                      
|                                                                 |                                          | Year Ended December 31,               |        
|                                                                 |                                          |                                       |        
|                                                                 |                                          | 2005                                  |         |         | 2004 |   |         | 2003   |  
|                                                                 |                                          |                                       |         |         |      |   |         |        |  
|                                                                 |                                          |                                      
|                                                                 |                                          | (In thousands, except per share data) |        
|Revenue                                                          |                                          | $                                     | 434,120 |         |      | $ | 374,373 |        |   | $ | 378,630 |       
|Cost of revenue                                                  |                                          |                                       | 316,109 |         |      |   | 281,114 |        |   |   | 286,183 |       
|                                                                 |                                          |                                       |         |         |      |   |         |        |  
|                                                                 | Gross profit                             |                                       |         | 118,011 |      |   |         | 93,259 |   |   |         | 92,447 | 
|Selling, general and administrative expenses                     |                                          |                                       | 72,097  |         |      |   | 72,342  |        |   |   | 82,731  |       
|                                                                 |                                          |                                       |         |         |      |   |         |        |  
|                                                                 | Income from operations                   |                                       |         | 45,914  |      |   |         | 20,917 |   |   |         | 9,716  | 
|Interest expense                                                 |                                          |                                       | 495     |         |      |   | 245     |        |   |   |        |       
|Other income, net                                                |                                          |                                       | (3,507  | )       |      |   | (1,317  | )      |   |   | (1,781  | )     
|                                                                 |                                          |                                       |         |         |      |   |         |        |  
|                                                                 | Income before provision for income taxes |                                       |         | 48,926  |      |   |         | 21,989 |   |   |         | 11,497 | 
|Provision for income taxes                                       |                                          |                                       | 11,388  |         |      |   | 4,485   |        |   |   | 1,378   |       
|                                                                 |                                          |                                       |         |         |      |   |         |        |  
|                                                                 | Net income                               |                                       |         | 37,538  |      |   |         | 17,504 |   |   |         | 10,119 | 
|Convertible redeemable preferred stock dividends                 |                                          |                                       |        |         |      |   | (3,221  | )      |   |   | (4,433  | )     
|Loss on redemption of convertible redeemable
    preferred stock |                                          |                                       |        |         |      |   | 28,674  |        |   |   |        |       
|                                                                 |                                          |                                       |         |         |      |   |         |        |  
|Net income (loss) available for shareholders                     |                                          |                                       | 37,538  |         |      |   | (14,391 | )      |   |   | 5,686   |       
|Amounts allocated to participating preferred
    shareholders    |                                          |                                       |        |         |      |   |        |        |   |   | (1,385  | )     
|                                                                 |                                          |                                       |         |         |      |   |         |        |  
|Net income (loss) available to common shareholders               |                                          | $                                     | 37,538  |         |      | $ | (14,391 | )      |   | $ | 4,301   |       
|                                                                 |                                          |                                       |         |         |      |   |         |        |  
|Earnings (loss) per share                                        |                                          |                                       |         |         |      |   |         |        |   |   |         |       
|                                                                 | Basic                                    |                                       | $       | 1.00    |      |   | $       | (.48   | ) |   | $       | .16    | 
|                                                                 |                                          |                                       |         |         |      |   |         |        |  
|                                                                 | Diluted                                  |                                       | $       | .99     |      |   | $       | (.48   | ) |   | $       | .16    | 
|                                                                 |                                          |                                       |         |         |      |   |         |        |  
|Basic weighted average shares                                    |                                          |                                       | 37,364  |         |      |   | 29,971  |        |   |   | 26,975  |       
|Dilutive effect of options                                       |                                          |                                       | 596     |         |      |   | (A      | )      |   |   | 229     |       
|Convertible redeemable preferred stock                           |                                          |                                       |        |         |      |   | (A      | )      |   |   | (A      | )     
|                                                                 |                                          |                                       |         |         |      |   |         |        |  
|Diluted weighted average shares                                  |                                          |                                       | 37,960  |         |      |   | 29,971  |        |   |   | 27,204  |       
|                                                                 |                                          |                                       |         |         |      |   |         |        |  



|    |              
|--- | -------------
|(A) | Anti-dilutive

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

27



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS
EQUITY

AND COMPREHENSIVE INCOME


|                            |                                                                                     |                        |            |           |            |   |         |           |   |             |               |        |   |               |        |       |               |   |        |        |   |   |         |         |  
|--------------------------- | ----------------------------------------------------------------------------------- | ---------------------- | ---------- | --------- | ---------- | - | ------- | --------- | - | ----------- | ------------- | ------ | - | ------------- | ------ | ----- | ------------- | - | ------ | ------ | - | - | ------- | ------- | -
|                            |                                                                                     |                        |            |           |            |   |         |           |   | Accumulated |               |        |  
|                            |                                                                                     | Common Stock           |            |           | Additional |   |         | Retained  |   |             | Stock         |        |   | Other         |        |       | Total         |  
|                            |                                                                                     | Shares                 |            |           | Paid-In    |   |         | Earnings  |   |             | Subscriptions |        |   | Comprehensive |        |       | Shareholders |  
|                            |                                                                                     | Outstanding            |            |           | Capital    |   |         | (Deficit) |   |             | Receivable    |        |   | Income (Loss) |        |       | Equity        |  
|                            |                                                                                     |                        |            |           |            |   |         |           |   |             |               |        |   |               |        |       |               |  
|                            |                                                                                     |                       
|                            |                                                                                     | (Dollars in thousands) |           
|Balance  December 31, 2002 |                                                                                     |                        | 27,221,049 |           |            | $ | 98,631  |           |   | $           | (11,950       | )      |   | $             | (2,218 | )     |               | $ | (5,898 | )      |   | $ | 78,565  |        
|                            | Net income                                                                          |                        |            |          |            |   |         |          |   |             |               | 10,119 |   |               |        |      |               |   |        |       |   |   |         | 10,119  |  
|                            | Currency translation adjustment                                                     |                        |            |          |            |   |         |          |   |             |               |       |   |               |        |      |               |   |        | 4,271  |   |   |         | 4,271   |  
|                            | Reclassification of unrealized gains on
    short-term investments                  |                        |            |          |            |   |         |          |   |             |               |       |   |               |        |      |               |   |        | (191   | ) |   |         | (191    | )
|                            |                                                                                     |                        |            |           |            |   |         |           |   |             |               |        |   |               |        |       |               |  
|                            | Comprehensive income                                                                |                        |            |          |            |   |         |          |   |             |               |       |   |               |        |      |               |   |        |       |   |   |         | 14,199  |  
|                            | Stock options exercised                                                             |                        |            | 30,021    |            |   |         | 83        |   |             |               |       |   |               |        |      |               |   |        |       |   |   |         | 83      |  
|                            | Repayment of stock subscriptions receivable                                         |                        |            |          |            |   |         |          |   |             |               |       |   |               |        | 428   |               |   |        |       |   |   |         | 428     |  
|                            | Issuances of common stock and other                                                 |                        |            | 98,677    |            |   |         | 369       |   |             |               |       |   |               |        |      |               |   |        |       |   |   |         | 369     |  
|                            | Convertible redeemable preferred stock dividend                                     |                        |            |          |            |   |         | (4,433    | ) |             |               |       |   |               |        |      |               |   |        |       |   |   |         | (4,433  | )
|                            | Repurchases of common stock                                                         |                        |            | (557,200  | )          |   |         | (1,485    | ) |             |               |       |   |               |        |      |               |   |        |       |   |   |         | (1,485  | )
|                            |                                                                                     |                        |            |           |            |   |         |           |   |             |               |        |   |               |        |       |               |  
|Balance  December 31, 2003 |                                                                                     |                        | 26,792,547 |           |            |   | 93,165  |           |   |             | (1,831        | )      |   |               | (1,790 | )     |               |   | (1,818 | )      |   |   | 87,726  |        
|                            | Net income                                                                          |                        |            |          |            |   |         |          |   |             |               | 17,504 |   |               |        |      |               |   |        |       |   |   |         | 17,504  |  
|                            | Currency translation adjustment                                                     |                        |            |          |            |   |         |          |   |             |               |       |   |               |        |      |               |   |        | 3,622  |   |   |         | 3,622   |  
|                            | Unrealized losses on short-term investments                                         |                        |            |          |            |   |         |          |   |             |               |       |   |               |        |      |               |   |        | (29    | ) |   |         | (29     | )
|                            |                                                                                     |                        |            |           |            |   |         |           |   |             |               |        |   |               |        |       |               |  
|                            | Comprehensive income                                                                |                        |            |          |            |   |         |          |   |             |               |       |   |               |        |      |               |   |        |       |   |   |         | 21,097  |  
|                            | Stock options exercised                                                             |                        |            | 170,942   |            |   |         | 1,385     |   |             |               |       |   |               |        |      |               |   |        |       |   |   |         | 1,385   |  
|                            | Repayment of stock subscriptions receivable                                         |                        |            | (56,534   | )          |   |         | (961      | ) |             |               |       |   |               |        | 1,790 |               |   |        |       |   |   |         | 829     |  
|                            | Issuances of common stock and other                                                 |                        |            | 64,909    |            |   |         | 712       |   |             |               |       |   |               |        |      |               |   |        |       |   |   |         | 712     |  
|                            | Repurchase of common stock                                                          |                        |            | (253,100  | )          |   |         | (2,408    | ) |             |               |       |   |               |        |      |               |   |        |       |   |   |         | (2,408  | )
|                            | Convertible redeemable preferred stock dividend                                     |                        |            |          |            |   |         | (2,268    | ) |             |               | (953   | ) |               |        |      |               |   |        |       |   |   |         | (3,221  | )
|                            | Net proceeds from issuance of common stock and
    warrants to FIS                  |                        |            | 8,700,000 |            |   |         | 92,832    |   |             |               |       |   |               |        |      |               |   |        |       |   |   |         | 92,832  |  
|                            | Net effect of redemption of convertible
    redeemable preferred stock and warrants |                        |            | 2,000,000 |            |   |         | (16,474   | ) |             |               | (8,287 | ) |               |        |      |               |   |        |       |   |   |         | (24,761 | )
|                            |                                                                                     |                        |            |           |            |   |         |           |   |             |               |        |   |               |        |       |               |  
|Balance  December 31, 2004 |                                                                                     |                        | 37,418,764 |           |            |   | 165,983 |           |   |             | 6,433         |        |   |               |       |       |               |   | 1,775  |        |   |   | 174,191 |        
|                            | Net income                                                                          |                        |            |          |            |   |         |          |   |             |               | 37,538 |   |               |        |      |               |   |        |       |   |   |         | 37,538  |  
|                            | Currency translation adjustment                                                     |                        |            |          |            |   |         |          |   |             |               |       |   |               |        |      |               |   |        | (3,378 | ) |   |         | (3,378  | )
|                            | Reclassification of unrealized losses on
    short-term investments                 |                        |            |          |            |   |         |          |   |             |               |       |   |               |        |      |               |   |        | 29     |   |   |         | 29      |  
|                            | Unrealized (loss) on short-term investments                                         |                        |            |          |            |   |         |          |   |             |               |       |   |               |        |      |               |   |        | (33    | ) |   |         | (33     | )
|                            |                                                                                     |                        |            |           |            |   |         |           |   |             |               |        |   |               |        |       |               |  
|                            | Comprehensive income                                                                |                        |            |          |            |   |         |          |   |             |               |       |   |               |        |      |               |   |        |       |   |   |         | 34,156  |  
|                            | Stock options exercised                                                             |                        |            | 395,278   |            |   |         | 4,316     |   |             |               |       |   |               |        |      |               |   |        |       |   |   |         | 4,316   |  
|                            | Repurchase of common stock                                                          |                        |            | (415,700  | )          |   |         | (4,803    | ) |             |               |       |   |               |        |      |               |   |        |       |   |   |         | (4,803  | )
|                            |                                                                                     |                        |            |           |            |   |         |           |   |             |               |        |   |               |        |       |               |  
|Balance  December 31, 2005 |                                                                                     |                        | 37,398,342 |           |            | $ | 165,496 |           |   | $           | 43,971        |        |   | $             |       |       |               | $ | (1,607 | )      |   | $ | 207,860 |        
|                            |                                                                                     |                        |            |           |            |   |         |           |   |             |               |        |   |               |        |       |               |  

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

28



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                                                |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |        |         |        |          |        |         |  
|----------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------- | ------------------------------------------------------- | -------- | ------ | ------- | ------- | -------- | ------ | ------- | ------ | -------- | ------ | ------- | -
|                                                                                                |                                                                                                      |                                                                              
|                                                                                                |                                                                                                      | Year Ended December 31,                                                       |                                                        
|                                                                                                |                                                                                                      |                                                                               |                                                        
|                                                                                                |                                                                                                      | 2005                                                                          |                                                         |          | 2004   |         |         | 2003     |       
|                                                                                                |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |       
|                                                                                                |                                                                                                      |                                                                              
|                                                                                                |                                                                                                      | (Dollars in thousands)                                                        |                                                        
|Cash flows provided by (used in) operating
    activities                                      |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |        |         |        |         
|Net income                                                                                      |                                                                                                      | $                                                                             | 37,538                                                  |          |        | $       | 17,504  |          |        | $       | 10,119 |         
|Adjustments to reconcile net income to net cash
    provided by (used in) operating activities: |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |        |         |        |         
|                                                                                                | Depreciation and amortization                                                                        |                                                                               |                                                         | 13,145   |        |         |         | 13,391   |        |         |        | 15,198   |       
|                                                                                                | Loss on disposal and obsolescence of property and
    equipment                                      |                                                                               |                                                         | 155      |        |         |         | 1,395    |        |         |        | 944      |       
|                                                                                                | Provision for doubtful accounts                                                                      |                                                                               |                                                         | 63       |        |         |         | 892      |        |         |        | 875      |       
|                                                                                                | Provision for deferred income taxes                                                                  |                                                                               |                                                         | 1,316    |        |         |         | 770      |        |         |        | 2,462    |       
|                                                                                                | Impairment of long-lived assets                                                                      |                                                                               |                                                         | 52       |        |         |         | 1,225    |        |         |        |         |       
|                                                                                                | Gain from sale of development center                                                                 |                                                                               |                                                         | (1,000   | )      |         |         |         |        |         |        |         |       
|                                                                                                | Loss (gain) from sale of short term investments                                                      |                                                                               |                                                         | 5        |        |         |         | (153     | )      |         |        | (1,008   | )     
|                                                                                                | Loss on sale of investment                                                                           |                                                                               |                                                         |         |        |         |         |         |        |         |        | 680      |       
|                                                                                                | Stock option modification expense and other                                                          |                                                                               |                                                         | (6       | )      |         |         | 271      |        |         |        |         |       
|                                                                                                | Change in assets and liabilities, net of
    acquisitions:                                           |                                                                               |                                                         |          |        |         |         |          |        |         |        |          |       
|                                                                                                |                                                                                                      | Accounts receivable and revenue earned in excess
    of billings              |                                                         |          | (5,230 | )       |         |          | 799    |         |        |          | 9,220  |        
|                                                                                                |                                                                                                      | Prepaid expenses and other assets                                             |                                                         |          | 69     |         |         |          | 5,073  |         |        |          | 1,531  |        
|                                                                                                |                                                                                                      | Accounts payable, accrued payroll and related
    costs and other liabilities |                                                         |          | 5,582  |         |         |          | (1,776 | )       |        |          | (4,311 | )      
|                                                                                                |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |       
|                                                                                                |                                                                                                      |                                                                               | Net cash provided by operating activities               |          |        | 51,689  |         |          |        | 39,391  |        |          |        | 35,710  |  
|Cash flows provided by (used in) investing
    activities                                      |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |        |         |        |         
|                                                                                                | Investment in property, equipment and other                                                          |                                                                               |                                                         | (16,991  | )      |         |         | (10,167  | )      |         |        | (10,015  | )     
|                                                                                                | Investment in computer software                                                                      |                                                                               |                                                         | (83      | )      |         |         | (208     | )      |         |        | (909     | )     
|                                                                                                | Proceeds from sale of development center                                                             |                                                                               |                                                         | 800      |        |         |         |         |        |         |        |         |       
|                                                                                                | Proceeds from sale of available for sale
    securities                                              |                                                                               |                                                         | 130,642  |        |         |         | 112,750  |        |         |        | 170,149  |       
|                                                                                                | Purchases of available for sale securities                                                           |                                                                               |                                                         | (131,833 | )      |         |         | (95,427  | )      |         |        | (192,948 | )     
|                                                                                                | Business acquisitions, net of cash acquired                                                          |                                                                               |                                                         | (7,022   | )      |         |         |         |        |         |        |         |       
|                                                                                                |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |       
|                                                                                                |                                                                                                      |                                                                               | Net cash provided by (used in) investing
    activities |          |        | (24,487 | )       |          |        | 6,948   |        |          |        | (33,723 | )
|Cash flows provided by (used in) financing
    activities                                      |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |        |         |        |         
|                                                                                                | Repayment of subordinated notes                                                                      |                                                                               |                                                         | (17,500  | )      |         |         |         |        |         |        |         |       
|                                                                                                | Net proceeds from issuances of common stock and
    other                                            |                                                                               |                                                         |         |        |         |         | 93,906   |        |         |        | 370      |       
|                                                                                                | Net proceeds from exercise of stock options and
    other                                            |                                                                               |                                                         | 3,509    |        |         |         | 1,385    |        |         |        | 511      |       
|                                                                                                | Repurchases of common stock                                                                          |                                                                               |                                                         | (4,803   | )      |         |         | (2,408   | )      |         |        | (1,485   | )     
|                                                                                                | Redemption of convertible redeemable preferred
    stock
    and warrants                            |                                                                               |                                                         |         |        |         |         | (179,139 | )      |         |        |         |       
|                                                                                                |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |       
|                                                                                                |                                                                                                      |                                                                               | Net cash used in financing activities                   |          |        | (18,794 | )       |          |        | (86,256 | )      |          |        | (604    | )
|Effect of exchange rate changes on cash                                                         |                                                                                                      |                                                                               | (219                                                    | )        |        |         | 87      |          |        |         |       |         
|                                                                                                |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |       
|Increase (decrease) in cash and cash
    equivalents                                            |                                                                                                      |                                                                               | 8,189                                                   |          |        |         | (39,830 | )        |        |         | 1,383  |         
|Cash and cash equivalents at beginning of year                                                  |                                                                                                      |                                                                               | 49,841                                                  |          |        |         | 89,671  |          |        |         | 88,288 |         
|                                                                                                |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |       
|Cash and cash equivalents at end of year                                                        |                                                                                                      | $                                                                             | 58,030                                                  |          |        | $       | 49,841  |          |        | $       | 89,671 |         
|                                                                                                |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |       
|Supplemental disclosure of cash flow information:                                               |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |        |         |        |         
|                                                                                                | Cash paid (received) during the year for:                                                            |                                                                               |                                                         |          |        |         |         |          |        |         |        |          |       
|                                                                                                |                                                                                                      | Income taxes                                                                  |                                                         | $        | 11,481 |         |         | $        | 5,604  |         |        | $        | 3,775  |        
|                                                                                                |                                                                                                      | Interest                                                                      |                                                         | $        | 664    |         |         | $        |       |         |        | $        |       |        
|Noncash financing activities                                                                  |                                                                                                      |                                                                               |                                                         |          |        |         |         |          |        |         |        |         
|                                                                                                | Debt issued in connection with redemption of
    convertible redeemable preferred stock and warrants |                                                                               | $                                                       |         |        |         | $       | 17,500   |        |         | $      |         |       

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

29



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

(Dollars in thousands, except per share
data)


1.     Organization
and Summary of Significant Accounting Policies



| |           
| | ----------
| | Operations

Covansys Corporation and its wholly-owned
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 industry-specific solutions, strategic
outsourcing and integration services. 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.



| |                                                 
| | ------------------------------------------------
| | Principles of Consolidation and
    Organization

The consolidated financial statements include the
accounts of the Company and all of its majority-owned
subsidiaries. All significant intercompany accounts and
transactions have been eliminated in the accompanying
consolidated financial statements.



| |                 
| | ----------------
| | Foreign Currency

For significant foreign operations, the local
currencies have been designated as the functional currencies.
The financial statements of these subsidiaries are translated
into U.S. dollars using exchange rates in effect at year end for
assets and liabilities and at the average exchange rate during
the year for revenue and expenses. The resulting foreign
currency translation adjustment is reflected as a separate
component of shareholders equity.

Transaction gains and losses, which were not
significant in the years presented, are reflected in the
consolidated statements of operations in other income, net.



| |                     
| | --------------------
| | Comprehensive Income

Accumulated other comprehensive income (loss) is
primarily comprised of foreign currency translation adjustments.



| |                          
| | -------------------------
| | Cash and Cash Equivalents

Cash and cash equivalents include investments
which have original maturities of 90 days or less at the time of
their purchase.



| |                       
| | ----------------------
| | Short Term Investments

Short term investments consist substantially of
mutual funds and also at December 31, 2004 government
issued securities. The Company classifies such securities as
available-for-sale. Securities classified as available-for-sale
are required to be reported at fair value with unrealized gains
and losses, net of taxes, excluded from earnings and shown
separately as a component of other comprehensive income within
shareholders equity.

The unrealized gains and losses on these
investments included in accumulated other comprehensive income
for December 31, 2005 and 2004 are as follows:

|                      |  |              |        |   |      |   |        |  
|--------------------- |  | ------------ | ------ | - | ---- | - | ------ | -
|                      |  |             
|                      |  | December 31, |       
|                      |  |              |       
|                      |  | 2005         |        |   | 2004 |  
|                      |  |              |        |   |      |  
|Fair value            |  | $            | 23,332 |   |      | $ | 21,409 |  
|Cost                  |  |              | 23,365 |   |      |   | 21,438 |  
|Gross unrealized loss |  |              | (33    | ) |      |   | (29    | )

30



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)




| |                      
| | ---------------------
| | Financial Instruments

The fair values and carrying amounts of the
Companys financial instruments and short term investments
are approximately equivalent due to the short term nature of the
instruments.



| |            
| | -----------
| | Investments

The Company accounts for certain investments in
equity instruments on the cost method. The Company continually
evaluates whether events and circumstances have occurred that
indicate a decline in the market value of the investments is
judged to be other than temporary. When factors indicate that
the decline in market value is other than temporary, the cost
basis is written down to fair market value. During 2004, the
Company fully reserved for its investment in JP Systems.
The impairment loss of $1,000 before tax is included in selling,
general and administrative expenses in the income statement and
is included in the other category for segment reporting.

The following table summarizes the Companys
investments which are carried at cost as of December 31,
2005 and 2004:

|             |             |              |   |     |      |  |   |     | 
|------------ | ----------- | ------------ | - | --- | ---- |  | - | --- | 
|             |             |             
|             |             | December 31, |  
|             |             |              |  
|             |             | 2005         |   |     | 2004 | 
|             |             |              |   |     |      | 
|Cost Method: |             |              |   |     |      |  |   |    
|             | Investcare* |              | $ | 654 |      |  | $ | 915 | 
|             |             |              |   |     |      | 

* Covansys ownership percentage is
less than 5% in this privately held entity. The Company accounts
for distributions from this investment as a return of capital.



| |         
| | --------
| | Goodwill

Goodwill represents the excess of purchase price
over the net tangible and identifiable intangible assets related
to businesses acquired. The Company continually evaluates
whether events and circumstances have occurred that indicate the
recorded amount of goodwill may warrant revision or that the
remaining balance may not be recoverable. The Company tests for
impairment of its reporting units by comparing fair value to
carrying value. Fair value is determined using a discounted cash
flow methodology. The results of the Companys annual
impairment analysis concluded that no impairment existed at
December 31, 2005.



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment are stated at cost.
Depreciation is provided using the straight-line method over the
estimated useful lives of the assets. Leasehold improvements are
amortized over the expected life of the asset or term of the
lease, whichever is shorter. Renewal periods of leases have been
included in the lease term if the renewals are reasonably
assured.

Internally developed computer software is
recorded at cost and includes purchased, internally developed
and externally developed software to be used in the
Companys operations.



| |                  
| | -----------------
| | Long-Lived Assets

We evaluate the recoverability of long-lived
assets (excluding goodwill) in accordance with SFAS 144
whenever events or changes in circumstances indicate that the
carrying amounts may be impaired. The impairment evaluation is
performed by comparing their carrying values to the undiscounted
cash flows expected to be derived from such long-lived assets.
If such evaluation indicated an impairment, we use

31



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


discounted cash flows to measure fair value in
determining the amount of the long-lived assets that should be
written-off.



| |                    
| | -------------------
| | 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
revenues 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, maintenance and transaction processing contracts,
we recognize revenue ratably over the applicable 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 revenues and costs are continuously
monitored during the term of the contract, and recorded revenues
and costs 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 (See Note 4).

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, as required by Staff Accounting Bulletin No. 104,
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 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.



| |                  
| | -----------------
| | 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 in accordance with SFAS 86 Computer
Software to be Sold, Leased or Otherwise Marketed.
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

32



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


adjusted as necessary at the end of the
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. Based on these analyses and evaluations, the
Company has identified and recorded an impairment loss of $52
and $225 for its Claims Connect software product in 2005 and
2004, respectively. As of December 31, 2005 the
Companys investment in its Claims Connect software has
been written down to zero. Amounts charged to expense for
research and development of computer software were not material
for the years ended December 31, 2005, 2004 and 2003.

Amounts capitalized were $83, $208 and $909 for
the years ended December 31, 2005, 2004 and 2003,
respectively.

The amortization of software development costs
was $1,549, $1,707 and $2,437 for the years ended
December 31, 2005, 2004 and 2003, respectively.

Accumulated amortization on computer software
amounted to $10,689 and $8,892 as of December 31, 2005 and
2004, respectively.



| |             
| | ------------
| | 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 bases.
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.



| |                  
| | -----------------
| | Other Income, Net

Other income, net, represents the gain on sale of
the development center (Note 20), interest earned and
realized gains and losses on cash and short term investments
determined on a specific identification basis, loss from sale of
investment carried at cost and foreign currency gains/losses.



| |                            
| | ---------------------------
| | 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.

|                                                                               |  |                         |           |  |      |  |           |      |  |  |           | 
|------------------------------------------------------------------------------ |  | ----------------------- | --------- |  | ---- |  | --------- | ---- |  |  | --------- | 
|                                                                               |  |                        
|                                                                               |  | Year Ended December 31, |          
|                                                                               |  |                         |          
|                                                                               |  | 2005                    |           |  | 2004 |  |           | 2003 | 
|                                                                               |  |                         |           |  |      |  |           |      | 
|Common stock equivalents related to convertible
    redeemable preferred stock |  |                         |          |  |      |  | 6,140,060 |      |  |  | 8,695,652 | 
|Warrants issued to CDR to purchase
    5,300,000 shares of common stock        |  |                         |          |  |      |  | 3,742,366 |      |  |  | 5,300,000 | 
|Warrants issued to CDR to purchase
    5,000,000 shares of common stock        |  |                         | 5,000,000 |  |      |  | 1,469,466 |      |  |  |          | 
|Warrants issued to FIS to purchase
    4,000,000 shares of common stock        |  |                         | 3,000,000 |  |      |  | 1,175,573 |      |  |  |          | 
|Average number of stock options outstanding                                    |  |                         | 650,562   |  |      |  | 3,056,541 |      |  |  | 2,199,299 | 

33



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


The Companys Series A Voting
Convertible Preferred Stock was a participating security as
defined in Issue 03-6. Issue 03-6 is effective for periods
beginning after March 31, 2004. The Company adopted
Issue 03-6 in the second quarter ended June 30, 2004
and restated EPS for all prior periods presented. 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).



| |                                                                
| | ---------------------------------------------------------------
| | Use of Estimates in the Preparation of
    Financial Statements

The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts
of revenue and expenses during the reporting period. Actual
results could differ from those estimates.

Estimates and assumptions which, in the opinion
of management, are significant to the underlying amounts
included in the financial statements and for which it would be
reasonably possible that future events or information could
change those estimates include: (1) revenue recognition
under the percentage-of-completion method, (2) impairment
assessments of goodwill and other long-lived assets,
(3) realization of deferred tax assets and assessment of
tax reserves recorded, (4) allowance for doubtful accounts
and (5) litigation-related contingencies. These estimates
are discussed further throughout the accompanying notes to the
consolidated financial statements. The Company has formal
variable compensation plans for sales, delivery and management
employees. These plans are structured to pay out quarterly,
semi-annually or annually depending on the plan. Amounts are
accrued on a monthly basis relative to actual performance
compared to performance targets.



| |              
| | -------------
| | Stock Options

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. As supplemental information, the
Company has elected to provide the pro forma disclosures, as
permitted under the provisions of Statement of Financial
Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS No. 123).
Accordingly, no compensation expense other than expense required
for changes to stock option grants has been recognized for the
Plan within the accompanying consolidated statements of
operations. Had compensation expense for the Plan been
determined based on the fair value at the grant date consistent
with the provisions of SFAS No. 123, the Companys pro
forma net

34



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


income (loss) and pro forma earnings (loss) per
common share would have been reduced to the amounts indicated
below:

|                                                         |                                                                                                                                     |                         |   |        |      |  |   |         |   |  |   |       |  
|-------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------- | ----------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ----- | -
|                                                         |                                                                                                                                     |                        
|                                                         |                                                                                                                                     | Year Ended December 31, |  
|                                                         |                                                                                                                                     |                         |  
|                                                         |                                                                                                                                     | 2005                    |   |        | 2004 |  |   | 2003    |  
|                                                         |                                                                                                                                     |                         |   |        |      |  |   |         |  
|Net income (loss) available for common
    shareholders: |                                                                                                                                     |                         |   |        |      |  |   |         |   |  |   |      
|                                                         | As reported                                                                                                                         |                         | $ | 37,538 |      |  | $ | (14,391 | ) |  | $ | 4,301 |  
|                                                         | Stock-based employee compensation cost included
    in the determination of net income (loss) available for common
    shareholders |                         |   |       |      |  |   | 243     |   |  |   |      |  
|                                                         | Stock-based employee compensation cost had the
    fair value method been used                                                      |                         |   | 2,750  |      |  |   | 1,698   |   |  |   | 4,422 |  
|                                                         |                                                                                                                                     |                         |   |        |      |  |   |         |  
|                                                         | SFAS No. 123 pro forma                                                                                                              |                         | $ | 34,788 |      |  | $ | (15,846 | ) |  | $ | (121  | )
|                                                         |                                                                                                                                     |                         |   |        |      |  |   |         |  
|Basic earnings (loss) per share:                         |                                                                                                                                     |                         |   |        |      |  |   |         |   |  |   |      
|                                                         | As reported                                                                                                                         |                         | $ | 1.00   |      |  | $ | (.48    | ) |  | $ | 0.16  |  
|                                                         |                                                                                                                                     |                         |   |        |      |  |   |         |  
|                                                         | SFAS No. 123 pro forma                                                                                                              |                         | $ | .93    |      |  | $ | (.53    | ) |  | $ |      |  
|                                                         |                                                                                                                                     |                         |   |        |      |  |   |         |  
|Diluted earnings (loss) per share:                       |                                                                                                                                     |                         |   |        |      |  |   |         |   |  |   |      
|                                                         | As reported                                                                                                                         |                         | $ | .99    |      |  | $ | (.48    | ) |  | $ | 0.16  |  
|                                                         |                                                                                                                                     |                         |   |        |      |  |   |         |  
|                                                         | SFAS No. 123 pro forma                                                                                                              |                         | $ | .92    |      |  | $ | (.53    | ) |  | $ |      |  
|                                                         |                                                                                                                                     |                         |   |        |      |  |   |         |  

During 2004, the Company made amendments to the
stock option grants of two employees upon their termination. In
connection with the amendments, the Company recorded a charge of
$243.

Recently Issued Financial Accounting
Standards

In December 2004 the FASB issued SFAS
No. 123(R), 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.
The Company is required to adopt the provisions of FAS 123R
effective January 1, 2006 and intends to use the modified
prospective method. Under this method, awards that are granted,
modified or settled after the date of adoption or have not fully
vested at the date of adoption will be measured and accounted
for under FAS 123R. The Company estimates that the adoption
of FAS 123R will reduce 2006 operating results before taxes
by approximately $1,700.

In December 2004, the FASB issued 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 did not avail
itself to the one-time repatriation opportunities provided by
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

35



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


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.



|   |                 
|-- | ----------------
|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.

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 of $15.00,
$17.50, $20.50 and $24.00 per share and are exercisable through
2010. 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. 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. | Shareholder Rights Plan

In October 2004, the Companys board of
directors adopted a shareholder rights plan which provided for
the declaration of a dividend of one preferred share purchase
right for each share of the Companys common stock
outstanding and any common shares issued thereafter. The rights
are not exercisable until ten days following either:

(1) a public announcement that



| |                                                                                                                                                                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (A) a person or group of affiliated persons
    (other than Rajendra B. Vattikuti and his affiliates and
    associates or Fidelity Information Services, Inc. and its
    affiliates and associates) has acquired beneficial ownership of
    15% or more of the outstanding Common Shares,

36



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)




| |                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (B) Rajendra B. Vattikuti and his affiliates
    have acquired beneficial ownership of 25% or more of the
    outstanding Common Shares or                                                                                                                                                              
|
| | (C) Fidelity Information Services, Inc. and
    its affiliates have acquired beneficial ownership of 40% or more
    of the outstanding Common Shares (each of the persons specified
    in clauses (A), (B) or (C), upon acquiring that level of
    beneficial ownership, is an Acquiring Person) or

(2) the commencement of, or announcement of
an intention to make, a tender offer or exchange offer, the
consummation of which results in the beneficial ownership



| |                                                                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (A) by a person or group (other than
    Rajendra B. Vattikuti and his affiliates and associates or
    Fidelity Information Services, Inc. and its affiliates) of 15%
    or more of the outstanding Common Shares, or
|
| | (B) by Rajendra B. Vattikuti and his
    affiliates of 25% or more of the outstanding Common Shares or                                                                                                                 
|
| | (C) by Fidelity Information Services, Inc.
    and its affiliates of 40% or more of the outstanding Common
    Shares.                                                                                                 

Each right, if exercisable, will entitle its
holder to purchase one one-thousandth of a share of the
Companys Series B Junior Participating Preferred
Stock at an exercise price of $11.00, subject to adjustment.

If a person or group becomes an Acquiring Person,
each holder of a Right will thereafter have the right to
receive, upon exercise, Common Shares (or, in certain
circumstances, Preferred Shares or other similar securities of
the Company) having a value equal to two times the exercise
price of the Right. Notwithstanding any of the foregoing,
following the existence of a Acquiring Person, all Rights that
are, or (under certain circumstances specified in the Rights
Agreement) were, beneficially owned by any Acquiring Person will
be null and void.

In the event that the Company is acquired in a
merger or other business combination transaction or 50% or more
of its consolidated assets or earning power are sold after a
person or group has become an Acquiring Person, proper provision
will be made so that each holder of a Right will thereafter have
the right to receive, upon the exercise thereof at the then
current exercise price of the Right, that number of shares of
common stock of the acquiring company which at the time of such
transaction will have a market value of two times the exercise
price of the Right. In the event that any person or group
becomes an Acquiring Person, proper provision shall be made so
that each holder of a Right, other than Rights beneficially
owned by the Acquiring Person (which will thereafter be void),
will thereafter have the right to receive upon exercise that
number of Common Shares having a market value of two times the
exercise price of the Right.

At any time after any person or group becomes an
Acquiring Person and prior to the acquisition by such person or
group of 50% or more of the outstanding Common Shares, the Board
of Directors of the Company may exchange the Rights (other than
Rights owned by such person or group which will have become
void), in whole or in part, at an exchange ratio of one Common
Share, or one one-thousandth of a Preferred Share (or of a share
of a class or series of the Companys preferred stock
having equivalent rights, preferences and privileges), per Right
(subject to adjustment).

The board of directors may redeem the Rights at
any time before they become exercisable for $.01 per Right
and, if not exercised or redeemed, the Rights will expire on
November 1, 2014.



|   |                      
|-- | ---------------------
|4. | Fixed Price Contracts

The Company realized approximately 42% of its
revenue during the year ended December 31, 2005, from fixed
price contracts (percentage of completion as well as fixed price
IT outsourcing and maintenance).

37



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


Approximately 14% of our revenue during the year
ended December 31, 2005 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 2004 financial results were
negatively impacted by approximately $11,192 due to four
significant fixed price contracts which it considers to be
challenged.

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 was informed that its services would no
longer be required to complete the project prior to its
implementation. As of December 31, 2004, the Company was
not performing work on either of these contracts. As a result,
the Company reduced the related receivables by $5,500 and $350
to their net realizable value in the first quarter and third
quarter of 2004, respectively. 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. In the fourth quarter of
2004, the Company reached a settlement with one of these
customers, resulting in the recovery of $350 of the previously
written-off receivable. This recovery was reflected as revenue
in the fourth quarter.

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 $5,700 in 2004.

At December 31, 2005, the Company has $2,226
in billed and unbilled receivables related to a challenged
contract for which the Company is still performing services and
which management believes are collectible.

Subsequent to December 31, 2005, the Company
received a notification from two of its Public Sector customers
that they were terminating their contracts with the Company
prior to the completion of all of the deliverables under the
contracts. At December 31, 2005 the Company has recorded
receivables and revenue in excess of $2,200 related to these
customers. The Company and the customers are currently in
negotiations concerning the resolution of these outstanding
receivables and the Company has recorded no reserves for such
amounts, if any, which may not be paid.



|   |                                
|-- | -------------------------------
|5. | 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. During the years ended
December 31, 2005, 2004 and 2003, the Company repurchased
415,700 shares, 253,100 shares and 557,200 shares
for cash, at a total cost of $4,803, $2,408 and $1,485,
respectively. Through December 31, 2005, the Company has
repurchased 11,838,176 shares of its common stock for cash
in the open market, at a total cost of $146,783. As of
December 31, 2005, 2,161,824 shares remain available
for repurchase under the board of directors authorization. The
Company has entered into a Credit Agreement which restricts the
Companys ability to repurchase shares of its common stock
in the event that a default exists under the Credit Agreement or
in the event there are borrowings outstanding under the Credit
Agreement.



|   |             
|-- | ------------
|6. | Acquisitions

In September 2005, the Companys wholly
owned subsidiary, Covansys India Limited acquired 75% of the
outstanding common shares of Fortune Infotech Limited. In
December 2005 Covansys India Limited acquired an additional 20%
of the shares of Fortune Infotech Limited, raising Covansys
India Limiteds ownership to 95%. In November 2005, the
Company acquired all of the outstanding common shares of
Technology Service Partners, Inc., located in Jacksonville, FL.
The acquisitions were funded with existing

38



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


cash and have been accounted for as a purchase
and, accordingly, the operating results of these businesses are
included in the consolidated financial statements since the date
of acquisition. Pro forma information related to these
acquisitions is not included because the impact is considered
immaterial.

Fortune, with its principal office located in
Vadodara, India is an experienced provider of offshore
outsourcing solutions. TSPI is an experienced information
technology staffing organization.

The aggregate purchase price net of cash acquired
for these acquisitions was approximately $7,022. The aggregate
purchase price was allocated to the acquired assets and
liabilities based upon their respective fair values as follows:

|                                  |  |   |       | 
|--------------------------------- |  | - | ----- | 
|Short-term investments            |  | $ | 1,317 | 
|Accounts receivable, net          |  |   | 1,321 | 
|Prepaids and other current assets |  |   | 41    | 
|Property and equipment, net       |  |   | 2,477 | 
|Other assets                      |  |   | 60    | 
|Goodwill                          |  |   | 3,262 | 
|Accounts payable                  |  |   | 12    | 
|Accrued payroll and other         |  |   | 1,444 | 



|   |         
|-- | --------
|7. | Goodwill

The following table summarizes the change in the
carrying amount of goodwill for the two years ended
December 31, 2005:

|                                        |  |   |        |  
|--------------------------------------- |  | - | ------ | -
|Goodwill balance at January 1, 2004     |  | $ | 18,441 |  
|Foreign currency translation adjustment |  |   | 707    |  
|                                        |  |   |       
|Goodwill balance at December 31, 2004   |  |   | 19,148 |  
|Acquisitions                            |  |   | 3,262  |  
|Foreign currency translation adjustment |  |   | (517   | )
|                                        |  |   |       
|Goodwill balance at December 31, 2005   |  | $ | 21,893 |  
|                                        |  |   |       

The following table summarizes the Companys
goodwill by reportable segment:

|              |  |              |        |  |      |   |        | 
|------------- |  | ------------ | ------ |  | ---- | - | ------ | 
|              |  |             
|              |  | December 31, |       
|              |  |              |       
|              |  | 2005         |        |  | 2004 |  
|              |  |              |        |  |      |  
|Commercial    |  | $            | 15,532 |  |      | $ | 12,787 | 
|Public Sector |  |              | 6,361  |  |      |   | 6,361  | 
|              |  |              |        |  |      |  
|              |  | $            | 21,893 |  |      | $ | 19,148 | 
|              |  |              |        |  |      |  

The Company tested for impairment of its
reporting units by comparing estimated fair value to carrying
value. Fair value was determined using a discounted cash flow
methodology. The Company performed this analysis as part of its
annual assessment as of December 31, 2005 and 2004. These
evaluations indicated that goodwill was not impaired. The
Companys goodwill is not deductible for income tax
purposes.

39



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)




|   |                                    
|-- | -----------------------------------
|8. | Accounts Receivable and Credit Risk

Accounts receivable, which includes both billed
and unbilled receivables, are recorded at the invoiced or
estimated amount and do not bear interest. The allowance for
doubtful accounts is our best estimate of the amount of probable
credit losses in our existing accounts receivable. We review our
allowance for doubtful accounts quarterly. Past due balances
over 90 days are reviewed individually for collectibility.
Account balances are charged off against the allowance when we
feel it is probable the receivable will not be recovered.

The activity in the allowance for doubtful
accounts is as follows:

|                              |  |      |       |   |      |   |        |      |  |   |       |  
|----------------------------- |  | ---- | ----- | - | ---- | - | ------ | ---- |  | - | ----- | -
|                              |  | 2005 |       |   | 2004 |   |        | 2003 | 
|                              |  |      |       |   |      |   |        |      | 
|Balance  beginning of period |  | $    | 1,532 |   |      | $ | 1,789  |      |  | $ | 1,353 |  
|Provision                     |  |      | 63    |   |      |   | 892    |      |  |   | 875   |  
|Charge-offs                   |  |      | (238  | ) |      |   | (1,149 | )    |  |   | (439  | )
|                              |  |      |       |   |      |   |        |      | 
|Balance  end of period       |  | $    | 1,357 |   |      | $ | 1,532  |      |  | $ | 1,789 |  
|                              |  |      |       |   |      |   |        |      | 

The Company grants credit to clients based upon
managements assessment of their creditworthiness.
Substantially all of the Companys receivables are from
large and mid-size companies, major systems integrators and
governmental agencies.



|   |                       
|-- | ----------------------
|9. | Property and Equipment

As of December 31, 2005 and 2004, property
and equipment consisted of the following:

|                                                             |  |              |         |   |           |   |         |       |  |  |           | 
|------------------------------------------------------------ |  | ------------ | ------- | - | --------- | - | ------- | ----- |  |  | --------- | 
|                                                             |  |              |         |  
|                                                             |  | December 31, |         |   | Estimated |  
|                                                             |  |              |         |   | Useful    |  
|                                                             |  | 2005         |         |   | 2004      |   |         | Lives | 
|                                                             |  |              |         |   |           |   |         |       | 
|Equipment and purchased software                             |  | $            | 52,297  |   |           | $ | 52,862  |       |  |  | 3-5 years | 
|Internally developed computer software and
    related costs |  |              | 10,455  |   |           |   | 10,480  |       |  |  | 5-9 years | 
|Furniture and fixtures                                       |  |              | 5,464   |   |           |   | 7,520   |       |  |  | 5-7 years | 
|Leasehold Improvements                                       |  |              | 11,010  |   |           |   | 8,519   |       |  |  | 5-7 years | 
|Buildings                                                    |  |              | 2,945   |   |           |   | 1,461   |       |  |  | 31 years  | 
|                                                             |  |              |         |   |           |   |         |       | 
|                                                             |  |              | 82,171  |   |           |   | 80,842  |       |  |  |           | 
|Accumulated depreciation                                     |  |              | (47,665 | ) |           |   | (51,080 | )     |  |  |           | 
|                                                             |  |              |         |   |           |   |         |       | 
|Property and equipment, net                                  |  | $            | 34,506  |   |           | $ | 29,762  |       |  |  |           | 
|                                                             |  |              |         |   |           |   |         |       | 

Depreciation expense totaled $11,596, $12,702,
and $12,761, for the years ended December 31, 2005, 2004
and 2003, respectively.



|    |                           
|--- | --------------------------
|10. | 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 2005 and
2004 totaled approximately $17,298 and $5,070, respectively. The
balance owed to the Company by FIS at December 31, 2005 and
2004 was $3,415 and $2,259, respectively. In connection with the
acquisition of 2,300,000 shares of the Companys
common stock from the Chief Executive Officer of the Company by
FIS (Note 2), the Company reimbursed the Chief Executive
Officer $100 for certain out-of-pocket fees and expenses.

40



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


In addition, the Company reimbursed FIS $1,000
for certain out-of-pocket fees and expenses related to the
recapitalization.

Synova, Inc. and subsidiaries (Synova) are an IT
professional services organization owned by the Companys
Chief Executive Officer. For the years ended December 31,
2005, 2004 and 2003, the Company provided services to Synova
totaling approximately $2,074, $2,520 and $3,175, respectively.
In addition, Synova provided services to the Company, for the
years ended December 31, 2005, 2004 and 2003, totaling
approximately $4,786, $2,051 and $1,609, respectively. The net
balance owed to Synova by Covansys at December 31, 2005 and
2004 was $689 and $206, respectively. The $3,000 Synova note
payable owed to the Company by Synova was paid in September,
2005.

The Company paid approximately $604, and $779 to
Clayton, Dubilier and Rice, Inc. (CDR), a shareholder, for
financial, management advisory, and executive management
services for the years ended December 31, 2004, and 2003
respectively. No such services were provided by CDR in 2005.
During 2004, the Company entered into a recapitalization
transaction (Note 2) in which CDRs ownership interest
in Covansys, including $168,655 of Convertible Redeemable
Preferred Stock, was redeemed and exchanged for consideration
valued at $227,700 including $177,500 of cash, 2,000,000 shares
of Covansys common stock, $17,500 of subordinated notes and
five-year warrants for 5,000,000 shares of common stock at a
strike price of $18 per share. In connection with the
recapitalization, the Company reimbursed CDR $500 for certain
out-of-pocket fees and expenses. The $17,500 subordinated notes
were repaid by the Company in July, 2005.

The Company provides IT outsourcing services to
SIRVA, Inc., a company related through common ownership by CDR.
During the years ended December 31, 2005, 2004 and 2003,
services provided by the Company to SIRVA, Inc. totaled
approximately $8,391, $9,974 and $8,386, respectively. In
addition, SIRVA provided services to Covansys for the year ended
December 31, 2003 totaling $71. No services were provided
by SIRVA to the Company during the years ended December 31,
2005 or 2004. In December 2004, the Company signed an agreement
with SIRVA under which SIRVA agreed to pay the Company an
additional $1,200 for services previously provided through
December 31, 2004. This agreement was reflected in 2004
revenue.

The Company paid approximately $321 and $903
during the years ended December 31, 2005 and 2004,
respectively, for consultation and advisory services in
connection with the Fortune and TSPI acquisitions (Note 6)
and the recapitalization transaction (Note 2) for services
provided by the Chesapeake Group, Inc., a company owned by a
director. Nothing was owed to the Chesapeake Group, Inc. at
December 31, 2005 or 2004.

The Company has loans to its employees in India
of $1,077 and $1,192 at December 31, 2005 and 2004,
respectively, to assist them with the purchase of automobiles
and houses. The loans, which bear interest at below market
rates, are collateralized by the property and repaid through
payroll deductions.



|    |                 
|--- | ----------------
|11. | Credit Agreement

On December 28, 2005, the Company entered
into a new Credit Agreement which provides for borrowings or
standby and commercial letters of credit up to $75,000. The
Credit Agreement expires on December 28, 2010. With the
prior consent of the lenders, the Company may request to
increase the availability under the Credit Agreement by up to
$25,000 (not to exceed an aggregate availability of $100,000).

Borrowings under the Credit Agreement bear
interest at LIBOR plus 0.4% to 1.0% 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

41



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


on the unused portion of the commitment and a
facility letter of credit fee of 0.125% per annum based on the
level of outstanding credit exposure as defined in the Credit
Agreement.

The Credit Agreement contains covenants,
including financial covenants, that require the Company to
maintain a certain leverage ratio and a minimum net worth. At
December 31, 2005, the Company was in compliance with these
ratios. At December 31, 2005, the Company had no borrowings
and $9,386 in outstanding letters of credit under this Credit
Agreement.



|    |               
|--- | --------------
|12. | Self-Insurance

The Company is self-insured in the U.S. for
health and dental benefits up to $100 per member annually.
Insurance coverage is carried for risks in excess of this
amount. The Company recognized health and dental benefits
expense in the U.S. of approximately $7,775, $8,305, and $12,678
for the years ended December 31, 2005, 2004 and 2003,
respectively. Estimated claims incurred but not reported were
$1,669 and $1,529 as of December 31, 2005 and 2004,
respectively, and are included in other accrued liabilities in
the accompanying consolidated balance sheets.



|    |       
|--- | ------
|13. | Leases

The Companys leases for its headquarters
and certain of its regional offices contain scheduled rent
increases. In accordance with the guidance set forth in FASB
Technical Bulletin 85-3, Accounting for Operating
Leases with Scheduled Rent Increases, the Company
recognizes the expense for these leases on a straight-line basis
over the life of the lease.

Rent expense for the years ended
December 31, 2005, 2004 and 2003 amounted to approximately
$9,379, $9,284, and $8,885, respectively. The future minimum
lease payments required under these operating leases, net of
sublease commitments of $666, for the years ending
December 31, are as follows:

|           |  |   |        | 
|---------- |  | - | ------ | 
|2006       |  | $ | 7,504  | 
|2007       |  |   | 6,129  | 
|2008       |  |   | 5,161  | 
|2009       |  |   | 4,713  | 
|2010       |  |   | 1,503  | 
|Thereafter |  |   | 16,318 | 



|    |              
|--- | -------------
|14. | Stock Options

The Company maintains a Stock Option Plan (the
Plan). Under the Plan, eligible employees and directors may be
granted either incentive stock options (ISOs) or non-incentive
stock options (NISOs) at the discretion of the Compensation
Committee of the Board of Directors. At December 31, 2005
there are 13,247,454 shares of Common Stock authorized for grant
under the Plan. Options under the Plan are granted with exercise
prices equal to the fair value of common stock on the date of
grant. The options vest over periods determined by the
Compensation Committee of the Board of Directors.

On July 1, 2003, the Company completed a
stock option exchange program under which certain option holders
were permitted to exchange existing stock options for a number
of stock options calculated using the Black-Scholes valuation
methodology. A total of 5,203,162 options were available for
cancellation under this program. 2,590,527 options were
cancelled effective December 13, 2002 and were replaced
with 686,407 options issued on July 1, 2003. The new stock
options were granted with an exercise price of $3.12 per share,
equal to the close price of the Companys common stock on
that date.

42



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


During 2004, the Company made amendments to the
stock option grants of two employees upon their termination. In
connection with the amendments, the Company recorded a charge of
$243.

A summary of option activity is as follows
(number of options in thousands):

|                                |  |                     |        |                  |                |   |                  |             |  |               |                 |  |  |   |      | 
|------------------------------- |  | ------------------- | ------ | ---------------- | -------------- | - | ---------------- | ----------- |  | ------------- | --------------- |  |  | - | ---- | 
|                                |  |                     |        |                  |                |  
|                                |  | Options Outstanding |        |                  |                |   |                 
|                                |  |                     |        |                  |                |   | Weighted Average |            
|                                |  |                     |        | Weighted Average |                |   | Options          |             |  | Fair Value of |                
|                                |  | Shares              |        |                  | Exercise Price |   |                  | Exercisable |  |               | Options Granted | 
|                                |  |                     |        |                  |                |   |                  |             |  |               |                 | 
|Balance, January 1, 2003        |  |                     | 3,003  |                  |                | $ | 15.22            |             |  |               | 1,621           |  |  |   |      | 
|                                |  |                     |        |                  |                |   |                  |             |  |               |                 | 
|Options granted                 |  |                     | 985    |                  |                |   | 3.51             |             |  |               |                 |  |  | $ | 2.02 | 
|                                |  |                     |        |                  |                |   |                  |             |  |               |                 | 
|Options exercised               |  |                     | (30    | )                |                |   | 6.26             |             |  |               |                 |  |  |   |      | 
|Options cancelled and forfeited |  |                     | (1,043 | )                |                |   | 14.95            |             |  |               |                 |  |  |   |      | 
|                                |  |                     |        |                  |                |   |                  |             |  |               |                 | 
|Balance, December 31, 2003      |  |                     | 2,915  |                  |                |   | 11.83            |             |  |               | 1,610           |  |  |   |      | 
|                                |  |                     |        |                  |                |   |                  |             |  |               |                 | 
|Options granted                 |  |                     | 1,179  |                  |                |   | 12.07            |             |  |               |                 |  |  | $ | 5.71 | 
|                                |  |                     |        |                  |                |   |                  |             |  |               |                 | 
|Options exercised               |  |                     | (171   | )                |                |   | 8.35             |             |  |               |                 |  |  |   |      | 
|Options cancelled and forfeited |  |                     | (725   | )                |                |   | 12.81            |             |  |               |                 |  |  |   |      | 
|                                |  |                     |        |                  |                |   |                  |             |  |               |                 | 
|Balance, December 31, 2004      |  |                     | 3,198  |                  |                |   | 11.88            |             |  |               | 1,547           |  |  |   |      | 
|                                |  |                     |        |                  |                |   |                  |             |  |               |                 | 
|Options granted                 |  |                     | 212    |                  |                |   | 14.34            |             |  |               |                 |  |  | $ | 5.61 | 
|                                |  |                     |        |                  |                |   |                  |             |  |               |                 | 
|Options exercised               |  |                     | (395   | )                |                |   | 8.51             |             |  |               |                 |  |  |   |      | 
|Options cancelled and forfeited |  |                     | (363   | )                |                |   | 15.50            |             |  |               |                 |  |  |   |      | 
|                                |  |                     |        |                  |                |   |                  |             |  |               |                 | 
|Balance, December 31, 2005      |  |                     | 2,652  |                  |                |   | 12.08            |             |  |               | 1,401           |  |  |   |      | 
|                                |  |                     |        |                  |                |   |                  |             |  |               |                 | 

The fair value of each option grant is estimated
on the date of grant using the Black-Scholes option-pricing
model with the following assumptions used for the 2005, 2004 and
2003 grants: risk-free rate of interest of 4.0%, 3.4% and 3.3%
in 2005, 2004 and 2003, respectively, dividend yield of 0%, and
expected lives of 4 to 5 years. A volatility factor of 44%,
58%, and 86% was used in 2005, 2004 and 2003, respectively.

A summary of options outstanding at
December 31, 2005, is as follows:

|                        |  |                     |           |  |                     |  |      |          |  |   |                |  |  |          |           |  |  |   |       | 
|----------------------- |  | ------------------- | --------- |  | ------------------- |  | ---- | -------- |  | - | -------------- |  |  | -------- | --------- |  |  | - | ----- | 
|                        |  |                     |           | 
|                        |  | Options Outstanding |           |  | Options Exercisable | 
|                        |  |                     |           |  |                     | 
|                        |  | Number              |           |  | Weighted            |  |      | Weighted |  |   | Number         |  |  | Weighted |          
|                        |  | Outstanding at      |           |  | Average             |  |      | Average  |  |   | Exercisable at |  |  | Average  |          
|                        |  | December 31,        |           |  | Remaining           |  |      | Exercise |  |   | December 31,   |  |  | Exercise |          
|Range of Exercise Price |  | 2005                |           |  | Contractual Life    |  |      | Price    |  |   | 2005           |  |  | Price    |          
|                        |  |                     |           |  |                     |  |      |          |  |   |                |  |  |          |          
|$ 0.01 - 6.00           |  |                     | 448,836   |  |                     |  | 7.06 |          |  | $ | 3.15           |  |  |          | 232,289   |  |  | $ | 3.00  | 
|$ 6.01 - 11.89          |  |                     | 1,056,488 |  |                     |  | 7.89 |          |  |   | 11.23          |  |  |          | 417,498   |  |  |   | 10.92 | 
|$11.90 - 14.83          |  |                     | 658,111   |  |                     |  | 6.37 |          |  |   | 13.41          |  |  |          | 358,736   |  |  |   | 13.52 | 
|$14.84 - 19.34          |  |                     | 185,604   |  |                     |  | 6.59 |          |  |   | 16.49          |  |  |          | 89,604    |  |  |   | 17.31 | 
|$19.35 - 22.75          |  |                     | 256,205   |  |                     |  | 3.97 |          |  |   | 21.38          |  |  |          | 256,205   |  |  |   | 21.38 | 
|$22.76 - 34.58          |  |                     | 46,702    |  |                     |  | 2.19 |          |  |   | 30.16          |  |  |          | 46,702    |  |  |   | 30.16 | 
|                        |  |                     |           |  |                     |  |      |          |  |   |                |  |  |          |          
|                        |  |                     | 2,651,946 |  |                     |  |      |          |  |   |                |  |  |          | 1,401,034 |  |  |   |       | 
|                        |  |                     |           |  |                     |  |      |          |  |   |                |  |  |          |          

43



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


15.     Benefit
Plans

Defined Contribution Plan

The Company maintains the Covansys Corporation
Incentive Savings Plan and Trust (the 401(k) plan). All U.S.
employees of the Company are eligible to participate in the
401(k) plan on their first day of service if they have attained
age 21. The 401(k) plan is a defined contribution plan,
qualified as a profit sharing plan under Section 401(k) of
the Internal Revenue Code and provides for eligible employees to
contribute up to 50% of their compensation. For the years ended
December 31, 2005, 2004 and 2003, the Company matched 40%
of the employees contribution up to a maximum of 2.4% of
the employees compensation.

Matching contributions made by the Company
amounted to approximately $2,165, $2,371 and $2,541 for the
years ended December 31, 2005, 2004 and 2003, respectively.
The Company may also make an additional contribution, at its
discretion, to the 401(k) plan. No such additional
contributions have been made to date.

Defined Benefit Plan

The Company has a defined benefit plan for its
employees in India. Under the plan, employees who have completed
five years of service are entitled to a lump sum payment upon
retirement equal to one-half month of salary for each year of
service. As of December 31, 2005 and 2004, the projected
benefit obligation and accumulated benefit obligation totaled
$1,600 and $972 and $1,350 and $819, respectively. For purposes
of computing its obligations, the Company assumed a weighted
average discount rate, return on plan assets and increase in
compensation of 7.5%, 7.5% and 10%, respectively in 2005 and 7%,
7% and 10%, respectively in 2004.

Plan assets, which are invested with the Life
Insurance Corporation of India, totaled $1,277 and $1,031 at
December 31, 2005 and 2004, respectively. Benefits expected
to be paid by the plan in each of the next five years are $96,
$110, $127, $146 and $167, respectively. The aggregate benefits
expected to be paid by the plan during the five years thereafter
is $545. The Companys best estimate of its contribution to
the plan in fiscal 2006 is approximately $439.

Net periodic benefit expense totaled $526, $427
and $464 for the years ended December 31, 2005, 2004 and
2003, respectively.

Other

The Company maintains various employee retention
programs. The expense related to these programs is recognized as
the compensation is earned.

16.     Income
Taxes

Covansys operates in numerous tax jurisdictions
throughout the world with primary operations in the U.S. and
India. The Company also has operations in Canada and throughout
Europe. Covansys India is an Indian corporation subject to
income taxes and receives certain exemptions from Indian income
taxes under free trade zone and software exporters provisions of
Indian tax law. The Company considers all undistributed earnings
of its foreign subsidiaries, which the Company estimates could
be as much as $77,700, to be permanently invested. Therefore, no
United States income taxes have been provided on these earnings.

44



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


The provision for income taxes consists of:

|           |                 |                         |                 |       |        |        |   |       |       |       |   |        |        |       | 
|---------- | --------------- | ----------------------- | --------------- | ----- | ------ | ------ | - | ----- | ----- | ----- | - | ------ | ------ | ----- | 
|           |                 |                        
|           |                 | Year Ended December 31, |                
|           |                 |                         |                
|           |                 | 2005                    |                 |       | 2004   |        |   | 2003  |      
|           |                 |                         |                 |       |        |        |   |       |      
|Current   |                 |                         |                 |       |        |        |   |       |       |       |   |       
|           | Federal         |                         | $               | 5,551 |        |        | $ | 1,173 |       |       | $ | (4,452 | )     
|           | State and local |                         |                 | 1,290 |        |        |   | 531   |       |       |   | 1,143  |       
|           | Foreign         |                         |                 | 3,231 |        |        |   | 2,011 |       |       |   | 2,225  |       
|           |                 |                         |                 |       |        |        |   |       |      
|           |                 | Total current           |                 |       | 10,072 |        |   |       | 3,715 |       |   |        | (1,084 | )    
|Deferred  |                 |                         |                 |       |        |        |   |       |       |       |   |       
|           | Federal         |                         |                 | 990   |        |        |   | 238   |       |       |   | 2,018  |       
|           | State and local |                         |                 | 543   |        |        |   | 414   |       |       |   | 568    |       
|           | Foreign         |                         |                 | (217  | )      |        |   | 118   |       |       |   | (124   | )     
|           |                 |                         |                 |       |        |        |   |       |      
|           |                 | Total deferred          |                 |       | 1,316  |        |   |       | 770   |       |   |        | 2,462  |      
|           |                 |                         |                 |       |        |        |   |       |      
|           |                 |                         | Total provision |       | $      | 11,388 |   |       | $     | 4,485 |   |        | $      | 1,378 | 
|           |                 |                         |                 |       |        |        |   |       |      

For 2005, 2004 and 2003, $29,007, $9,595 and
$3,395, respectively, of income from operations before income
taxes was from U.S. sources, and $19,919, $12,394 and $8,102,
respectively, was from non-U.S. sources.

The items accounting for the difference between
income taxes computed at the federal statutory rate and the
consolidated effective rate are as follows:

|                       |                                                            |                         |    |    |      |  |    |      |   |  |    |     |  
|---------------------- | ---------------------------------------------------------- | ----------------------- | -- | -- | ---- |  | -- | ---- | - |  | -- | --- | -
|                       |                                                            |                        
|                       |                                                            | Year Ended December 31, |   
|                       |                                                            |                         |   
|                       |                                                            | 2005                    |    |    | 2004 |  |    | 2003 |  
|                       |                                                            |                         |    |    |      |  |    |      |  
|Federal statutory rate |                                                            |                         | 35 | %  |      |  | 35 | %    |   |  | 35 | %  
|Effect of             |                                                            |                         |    |    |      |  |    |      |   |  |    |    
|                       | Tax effect on foreign earnings not subject to
    U.S. tax |                         |    | (8 | )    |  |    | (10  | ) |  |    | (6  | )
|                       | Reversal of valuation allowance                            |                         |    | (1 | )    |  |    | (10  | ) |  |    |    |  
|                       | Foreign tax credits                                        |                         |    |   |      |  |    |     |   |  |    | (1  | )
|                       | Nondeductible expenses                                     |                         |    |   |      |  |    | 1    |   |  |    | 2   |  
|                       | State taxes, net of federal tax effect                     |                         |    | 3  |      |  |    | 2    |   |  |    | 10  |  
|                       | Taxes on distributions from foreign subsidiaries           |                         |    | 1  |      |  |    | 2    |   |  |    | 5   |  
|                       | Adjustment of tax contingency reserves                     |                         |    | (6 | )    |  |    |     |   |  |    | (35 | )
|                       | Other, net                                                 |                         |    | (1 | )    |  |    |     |   |  |    | 2   |  
|                       |                                                            |                         |    |    |      |  |    |      |  
|                       |                                                            |                         | 23 | %  |      |  | 20 | %    |   |  | 12 | %  
|                       |                                                            |                         |    |    |      |  |    |      |  

45



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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


The tax effects of temporary differences that
give rise to significant portions of the deferred tax assets and
deferred tax liabilities are presented below:

|                           |                                                                       |                                 |        |        |        |  |        |        |        | 
|-------------------------- | --------------------------------------------------------------------- | ------------------------------- | ------ | ------ | ------ |  | ------ | ------ | ------ | 
|                           |                                                                       |                                
|                           |                                                                       | December 31,                    |       
|                           |                                                                       |                                 |       
|                           |                                                                       | 2005                            |        |        | 2004   | 
|                           |                                                                       |                                 |        |        |        | 
|Deferred tax assets       |                                                                       |                                 |        |        |        |  |        |       
|                           | Accrued expenses                                                      |                                 | $      | 4,817  |        |  | $      | 3,165  |       
|                           | Allowance for doubtful accounts                                       |                                 |        | 543    |        |  |        | 612    |       
|                           | Net operating loss carryforwards                                      |                                 |        | 4,891  |        |  |        | 7,195  |       
|                           | Restructuring reserves                                                |                                 |        | 331    |        |  |        | 870    |       
|                           | Other                                                                 |                                 |        | 1,330  |        |  |        | 3,411  |       
|                           |                                                                       |                                 |        |        |        | 
|                           |                                                                       | Total gross deferred tax assets |        |        | 11,912 |  |        |        | 15,253 | 
|Deferred tax liabilities  |                                                                       |                                 |        |        |        |  |        |       
|                           | Property and equipment and capitalized software
    development costs |                                 |        | (1,410 | )      |  |        | (2,375 | )     
|                           |                                                                       |                                 |        |        |        | 
|                           | Net deferred tax assets before valuation allowance                    |                                 |        | 10,502 |        |  |        | 12,878 |       
|Valuation allowance        |                                                                       |                                 | (1,141 | )      |        |  | (1,965 | )     
|                           |                                                                       |                                 |        |        |        | 
|                           | Net deferred tax assets                                               |                                 | $      | 9,361  |        |  | $      | 10,913 |       
|                           |                                                                       |                                 |        |        |        | 

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 net
deferred tax assets will be realized through future taxable
income. The Company utilized domestic net operating loss
carryforwards during 2005 and 2004. The effective tax rate was
23.3% for the full year 2005. On a quarterly basis, management
assesses whether it remains more likely than not that the net
deferred tax assets will be realized. The valuation allowance
recorded relates to state net operating losses that begin to
expire in 2005. During 2005, the Company reversed $539 of
valuation reserves related to state net operating losses and
wrote off $335 in deferred tax assets due to an enacted law
change in the State of Ohio which reduced the amount of net
operating losses that the Company will be able to utilize in
future periods. In addition, the Company reversed previously
recorded tax reserves of $3,200 due to the expiration of the
statute of limitations for the tax years the recorded reserves
relate to and also reduced tax reserves by $279 based on an
evaluation of estimated tax exposures. During 2004, the Company
reversed $2,236 of valuation reserves related to federal net
operating losses that were deemed to be no longer required based
on managements estimates of future profitability of the
Company.

The Company has six business units (four in 2003)
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. Once the tax holiday
period has expired, these business units are eligible to deduct
a portion of the profits attributable to export activities. The
deduction for export activities was 30% and expired during the
Indian tax year ended March 31, 2004.

The remaining business units are subject to the
tax holiday for various periods ranging from March 31, 2005
through March 31, 2009 and will not be able to avail
themselves of the deduction for export activities. As the tax
holiday expires, the Companys overall effective tax rate
will be negatively impacted. The tax benefit for this tax
holiday was approximately $4,727 for the year ended
December 31, 2005.

The Company had available U.S. Federal net
operating loss carryforwards of approximately $5,326 as of
December 31, 2005. The majority of the net operating loss
carryforward was acquired in an acquisition and its utilization
is limited to $688 per year. This net operating loss
carryforward will expire in 2013. In addition, the Company has
available state and local operating loss carryforwards of
approximately $45,506 that expire at various dates through 2020
at a blended effective tax rate of 5.9%.

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COVANSYS CORPORATION AND
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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


17.     Segment
Information

The Company is a provider of IT services, with
locations throughout North America, India and Asia, and other
international locations. The chief operating decision-maker
evaluates each segments performance based primarily on its
revenue and income (loss) from operations due to the similarity
of the nature of services provided to clients. The geographic
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. In 2005, the chief operating decision-maker
realigned certain portions of the business and the operating
segments reducing the number of reported segments in prior years
from four operating segments and other to two operating segments
and other. The four operating segments reported in prior years
were Commercial, India/Asia, Public Sector and Europe. These
operating segments have been realigned into two
segments-Commercial and Public Sector. Segment information for
2004 and 2003 has been reclassified to conform to the 2005
presentation.



| |   |                                                                                                                                                                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Commercial includes all global services provided
    to non public sector customers. 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.
|
| |  | Public Sector includes all services provided to
    domestic state and local municipalities.                                                                                                                                                                                                                                                                           
|
| |  | Other consists primarily of the labor and
    supporting expenses for the Corporate functions, depreciation
    and amortization expenses, 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 Note 1.

India/Asia geographic segment supplies
substantial resources to North American Customers. The rate
charged by India to U.S. has been developed utilizing a cost
plus transfer pricing methodology. This results in a large
component of the available gross profit accruing to North
America where the end customer is located.

Segment information is presented below. Revenue
and income (loss) from operations by segment is as follows:

|          |               |                         |         |         |        |   |         |         |        |   |         |         |        |  
|--------- | ------------- | ----------------------- | ------- | ------- | ------ | - | ------- | ------- | ------ | - | ------- | ------- | ------ | -
|          |               |                        
|          |               | Year Ended December 31, |        
|          |               |                         |        
|          |               |                         |         |        
|          |               | 2005                    |         |         | 2004   |   |         | 2003    |       
|          |               |                         |         |         |        |   |         |         |       
|Revenue  |               |                         |         |         |        |   |         |         |        |   |         |        
|          | Commercial    |                         | $       | 334,806 |        |   | $       | 287,574 |        |   | $       | 273,240 |       
|          |               | Less intersegment       |         |         | (6,949 | ) |         |         | (5,052 | ) |         |         | (7,246 | )
|          |               |                         |         |         |        |   |         |         |       
|          |               |                         | 327,857 |         |        |   | 282,522 |         |        |   | 265,994 |        
|          | Public Sector |                         |         | 106,263 |        |   |         | 91,199  |        |   |         | 112,913 |       
|          | Other         |                         |         |        |        |   |         | 652     |        |   |         | (277    | )     
|          |               |                         |         |         |        |   |         |         |       
|          |               | $                       | 434,120 |         |        | $ | 374,373 |         |        | $ | 378,630 |        
|          |               |                         |         |         |        |   |         |         |       

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


|                              |                                          |                         |        |         |      |  |        |         |   |  |       |         |  
|----------------------------- | ---------------------------------------- | ----------------------- | ------ | ------- | ---- |  | ------ | ------- | - |  | ----- | ------- | -
|                              |                                          |                        
|                              |                                          | Year Ended December 31, |       
|                              |                                          |                         |       
|                              |                                          |                         |        |        
|                              |                                          | 2005                    |        |         | 2004 |  |        | 2003    |  
|                              |                                          |                         |        |         |      |  |        |         |  
|Income (Loss) from Operations |                                          |                         |        |         |      |  |        |         |   |  |       |        
|                              | Commercial                               |                         | $      | 74,778  |      |  | $      | 62,736  |   |  | $     | 44,053  |  
|                              | Public Sector                            |                         |        | 8,495   |      |  |        | (2,090  | ) |  |       | 4,372   |  
|                              | Other                                    |                         |        | (37,359 | )    |  |        | (39,729 | ) |  |       | (38,709 | )
|                              |                                          |                         |        |         |      |  |        |         |  
|                              |                                          |                         | 45,914 |         |      |  | 20,917 |         |   |  | 9,716 |        
|Interest Expense              |                                          |                         | (495   | )       |      |  | (245   | )       |   |  |      |        
|Other Income, net             |                                          |                         | 3,507  |         |      |  | 1,317  |         |   |  | 1,781 |        
|                              |                                          |                         |        |         |      |  |        |         |  
|                              | Income Before Provision For Income Taxes |                         | $      | 48,926  |      |  | $      | 21,989  |   |  | $     | 11,497  |  
|                              |                                          |                         |        |         |      |  |        |         |  

The following table summarizes selected financial
information of the Companys operations by geographic
location. Revenue by geographic location represents local third
party business plus work performed on behalf of other segments
and charged at the full attribution rate.

Europe revenue and intersegment elimination
amounts for 2004 and 2003 have been revised from previously
reported amounts to correct an error in eliminating intrasegment
revenue.

|          |               |                         |         |         |         |   |         |         |         |   |         |         |         |  
|--------- | ------------- | ----------------------- | ------- | ------- | ------- | - | ------- | ------- | ------- | - | ------- | ------- | ------- | -
|          |               |                        
|          |               | Year Ended December 31, |        
|          |               |                         |        
|          |               | 2005                    |         |         | 2004    |   |         | 2003    |        
|          |               |                         |         |         |         |   |         |         |        
|Revenue  |               |                         |         |         |         |   |         |         |         |   |         |        
|          | North America |                         | $       | 371,200 |         |   | $       | 326,296 |         |   | $       | 348,005 |        
|         
|          | India/Asia    |                         |         | 131,818 |         |   |         | 106,140 |         |   |         | 51,431  |        
|          |               | Less intersegment       |         |         | (90,340 | ) |         |         | (77,765 | ) |         |         | (37,982 | )
|          |               |                         |         |         |         |   |         |         |        
|          |               |                         | 41,478  |         |         |   | 28,375  |         |         |   | 13,449  |        
|          | Europe        |                         |         | 21,446  |         |   |         | 21,644  |         |   |         | 20,738  |        
|          |               | Less intersegment       |         |         | (4      | ) |         |         | (1,942  | ) |         |         | (3,562  | )
|          |               |                         |         |         |         |   |         |         |        
|          |               |                         | 21,442  |         |         |   | 19,702  |         |         |   | 17,176  |        
|          |               |                         |         |         |         |   |         |         |        
|          |               | $                       | 434,120 |         |         | $ | 374,373 |         |         | $ | 378,630 |        
|          |               |                         |         |         |         |   |         |         |        

|                             |                     |              |        |        |      |   |        |        | 
|---------------------------- | ------------------- | ------------ | ------ | ------ | ---- | - | ------ | ------ | 
|                             |                     |             
|                             |                     | December 31, |       
|                             |                     |              |       
|                             |                     | 2005         |        |        | 2004 |  
|                             |                     |              |        |        |      |  
|Tangible Long-Lived Assets  |                     |              |        |        |      |   |        |       
|                             | North America       |              | $      | 16,464 |      |   | $      | 21,522 | 
|                             | India/Asia          |              |        | 25,022 |      |   |        | 16,167 | 
|                             | Other international |              |        | 159    |      |   |        | 173    | 
|                             |                     |              |        |        |      |  
|                             |                     | $            | 41,645 |        |      | $ | 37,862 |       
|                             |                     |              |        |        |      |  

18.     Commitments,
Contingencies and Potential Liability to Clients

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 liabilities accordingly. We do not believe

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


that the ultimate resolution of these matters
will have a material adverse effect on our financial condition,
results of operations, or cashflows. We believe that we have
adequate legal defenses and intend to defend these matters
vigorously.

We have certain contracts with our state and
local clients that require us to provide a surety bond as a
guarantee of performance. As of December 31, 2005, we had
13 performance bonds outstanding and posted with clients,
with an aggregate total value of approximately $35,167 to secure
performance of contractual obligations with our clients.
Additionally, 14 letters of credit totaling $9,386 were
outstanding at December 31, 2005. In general, we would only
be liable for the amount of these guarantees in the event of
default in the performance of our obligations under each
contract, the probability of which we believe is remote. We
believe that we have sufficient capacity in the surety markets
and liquidity from our cash flow and revolving credit facility
to meet ongoing business needs and to respond to future requests
for proposals from state and local governments.

19.     Restructuring,
Merger and Other Related Charges

In April 2003, the Company announced it would
realign the organization. The realignment which is complete,
aligned sales, subject matter expertise and delivery and
provided a strong foundation for the future growth and
profitability for the Company. As part of the realignment, the
Company reduced headcount in the second quarter of 2003 by over
200 net positions in North America or approximately 8.5% of
domestic headcount. The reduction in headcount was split with
over 80% of the eliminated positions (billable and delivery
employees) coming from cost of revenue with the remaining coming
from selling, general and administrative.

During 2005, the Company recorded $491 of lease
termination costs. During 2004, the Company recorded $1,696 of
lease termination costs and $1,252 related to severance. Amounts
related to lease terminations will be paid out through 2011.
During 2003, the Company recorded costs of $4,208, split $1,834
included in cost of revenue and $2,374 included in selling,
general and administrative expenses, related to various
headcount reductions, including the reductions implemented
during the second quarter as discussed above, and termination of
lease obligations associated with the consolidation of
facilities.

The following is a roll forward of the accrual
balance for restructuring, merger and other related charges:

|                             |  |           |        |       |              |   |        |       |  |   |       |   |  |   |        |  
|---------------------------- |  | --------- | ------ | ----- | ------------ | - | ------ | ----- |  | - | ----- | - |  | - | ------ | -
|                             |  |           |        | Lease |              |   |        |       | 
|                             |  | Severance |        |       | Terminations |   |        | Other |  |   | Total |  
|                             |  |           |        |       |              |   |        |       |  |   |       |  
|Balance January 1, 2003      |  | $         | 8      |       |              | $ | 2,527  |       |  | $ | 29    |   |  | $ | 2,564  |  
|Expense                      |  |           | 3,819  |       |              |   | 389    |       |  |   |      |   |  |   | 4,208  |  
|Payments and other           |  |           | (3,456 | )     |              |   | (1,248 | )     |  |   | (29   | ) |  |   | (4,733 | )
|                             |  |           |        |       |              |   |        |       |  |   |       |  
|Balance December 31, 2003    |  |           | 371    |       |              |   | 1,668  |       |  |   |      |   |  |   | 2,039  |  
|Expense                      |  |           | 1,252  |       |              |   | 1,696  |       |  |   |      |   |  |   | 2,948  |  
|Payments and other           |  |           | (1,556 | )     |              |   | (1,190 | )     |  |   |      |   |  |   | (2,746 | )
|                             |  |           |        |       |              |   |        |       |  |   |       |  
|Balance December 31, 2004    |  |           | 67     |       |              |   | 2,174  |       |  |   |      |   |  |   | 2,241  |  
|Expense                      |  |           |       |       |              |   | 491    |       |  |   |      |   |  |   | 491    |  
|Payments and other           |  |           | (67    | )     |              |   | (1,471 | )     |  |   |      |   |  |   | (1,538 | )
|                             |  |           |        |       |              |   |        |       |  |   |       |  
|Balance at December 31, 2005 |  | $         |       |       |              | $ | 1,194  |       |  | $ |      |   |  | $ | 1,194  |  
|                             |  |           |        |       |              |   |        |       |  |   |       |  

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COVANSYS CORPORATION AND
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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


20.     Other Income,
Net

In November 2005 Oracle exercised its purchase
option to acquire PeopleSofts development center in
Bangalore, India operated by the Company. Approximately
430 employees of the center became employees of Oracle.
Revenue generated from this development center for the Company
was $13,405 and $8,400 for the years ended December 31,
2005 and 2004 respectively. No revenue was recorded in 2003.
Under terms of the agreement, Oracle is required to pay a buyout
fee of $1,000 and an amount which approximates the book value of
the net assets of the business. In accordance with the terms of
the agreement, Oracle has paid 80% of the amount owned as of
December 31, 2005. The Company anticipates receipt of the
remaining proceeds by the end of the first quarter of 2006.

In August, 2003, the Company was notified that
the Board of Directors and majority shareholders of one of the
Companys investments carried at cost had agreed to merge
with another entity. The merger consummated in August, 2003 and
the Company recognized a loss of approximately $680 which is
included in other income, net.

21.     Other

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 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
of providing the services, but did not recognize any revenue for
these services in 2004. Gross profit in the Commercial segment
was negatively impacted in the fourth quarter by approximately
$3,500. In 2005, the Company received a contract which covered
these services and recognized the revenue in the first quarter
of 2005, with a corresponding increase in gross profit.



|    |                 
|--- | ----------------
|22. | Subsequent Event

In March 2006, the Company entered into an
agreement to sell the assets and certain liabilities of its
state and local consulting practice, which is included in the
Public Sector segment for reporting purposes, for up to $40,000.
The state and local consulting practice had the following
results for the years ended December 31, 2005 and 2004:

|                              |  |                |        |  |      |   |        |  
|----------------------------- |  | -------------- | ------ |  | ---- | - | ------ | -
|                              |  |               
|                              |  | Year Ended     |       
|                              |  | December 31,   |       
|                              |  |                |       
|                              |  | 2005           |        |  | 2004 |  
|                              |  |                |        |  |      |  
|                              |  |               
|                              |  | (In thousands) |       
|Revenue                       |  | $              | 75,741 |  |      | $ | 62,994 |  
|Gross profit                  |  |                | 10,212 |  |      |   | 3,389  |  
|Income (loss) from operations |  |                | 2,793  |  |      |   | (6,797 | )

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COVANSYS CORPORATION AND
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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


The income (loss) from the state and local
practice includes costs directly attributable to the business.
Certain operating expenses which are indirectly attributable to
the business are centrally managed at the corporate level and
have not been allocated.

The agreement, which is contingent on the
Companys ability to meet certain closing conditions, also
requires the Company to provide a certain level of services to
the buyer from its operations in India at below market rates
through the end of 2007. Until such time as the transaction
closes, it is not possible for the Company to determine whether
the sale of the business will qualify for discontinued
operations reporting.

23.     Supplemental
Quarterly Information (Unaudited)

|                                                              |  |               |         |   |         |   |         |              |  |   |             |   |  |   |         | 
|------------------------------------------------------------- |  | ------------- | ------- | - | ------- | - | ------- | ------------ |  | - | ----------- | - |  | - | ------- | 
|                                                              |  |              
|                                                              |  | Quarter Ended |        
|                                                              |  |               |        
|2005                                                          |  | March 31      |         |   | June 30 |   |         | September 30 |  |   | December 31 |  
|                                                              |  |               |         |   |         |   |         |              |  |   |             |  
|Revenue                                                       |  | $             | 104,273 |   |         | $ | 108,708 |              |  | $ | 111,178     |   |  | $ | 109,961 | 
|Gross profit                                                  |  |               | 30,323  |   |         |   | 30,407  |              |  |   | 28,996      |   |  |   | 28,285  | 
|Income from operations                                        |  |               | 11,462  |   |         |   | 12,267  |              |  |   | 11,346      |   |  |   | 10,839  | 
|Net income                                                    |  |               | 8,057   |   |         |   | 11,248  |              |  |   | 8,610       |   |  |   | 9,623   | 
|Basic net income per share                                    |  | $             | .22     |   |         | $ | .30     |              |  | $ | .23         |   |  | $ | .26     | 
|                                                              |  |               |         |   |         |   |         |              |  |   |             |  
|Diluted net income per share                                  |  | $             | .21     |   |         | $ | .30     |              |  | $ | .23         |   |  | $ | .25     | 
|                                                              |  |               |         |   |         |   |         |              |  |   |             |  
|2004                                                          |  |               |         |   |         |   |         |              |  |   |             |   |  |   |         | 
|Revenue                                                       |  | $             | 84,892  |   |         | $ | 94,109  |              |  | $ | 96,201      |   |  | $ | 99,171  | 
|Gross profit                                                  |  |               | 14,891  |   |         |   | 25,263  |              |  |   | 26,116      |   |  |   | 26,989  | 
|Income (loss) from operations                                 |  |               | (4,373  | ) |         |   | 5,678   |              |  |   | 9,185       |   |  |   | 10,427  | 
|Net income (loss)                                             |  |               | (2,890  | ) |         |   | 4,603   |              |  |   | 6,567       |   |  |   | 9,224   | 
|Convertible redeemable preferred dividends                    |  |               | 1,130   |   |         |   | 1,139   |              |  |   | 952         |   |  |   |        | 
|Redemption of convertible redeemable preferred
    stock      |  |               |        |   |         |   |        |              |  |   | 28,674      |   |  |   |        | 
|                                                              |  |               |         |   |         |   |         |              |  |   |             |  
|Net income (loss) available for shareholders                  |  |               | (4,020  | ) |         |   | 3,464   |              |  |   | (23,059     | ) |  |   | 9,224   | 
|Amounts allocated to participating preferred
    shareholders |  |               |        |   |         |   | (847    | )            |  |   |            |   |  |   |        | 
|                                                              |  |               |         |   |         |   |         |              |  |   |             |  
|Net income (loss) available to common shareholders            |  | $             | (4,020  | ) |         | $ | 2,617   |              |  | $ | (23,059     | ) |  | $ | 9,224   | 
|                                                              |  |               |         |   |         |   |         |              |  |   |             |  
|Basic net income (loss) per share                             |  | $             | (0.15   | ) |         | $ | 0.10    |              |  | $ | (0.81       | ) |  | $ | 0.25    | 
|Diluted net income (loss) per share                           |  | $             | (0.15   | ) |         | $ | 0.10    |              |  | $ | (0.81       | ) |  | $ | 0.24    | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Revenue for the quarter ended December 31,
    2004, includes $1,200 in connection with an agreement signed
    with SIRVA related to services previously provided. Gross profit
    for the quarter ended December 31, 2004, includes the cost
    associated with services performed for one of the Companys
    significant customers after it had reached the authorized
    spending limit on a time and material contract. In accordance
    with Staff Accounting Bulletin 104, the Company did not
    recognize the revenue for these services in 2004 and gross
    profit was negatively impacted by approximately $3,500. In 2005,
    the Company received a contract which covered these services and
    recognized the revenue in the first quarter of 2005, with a
    corresponding increase in gross profit.

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)




|    |                                                                                                                                                                                                                                                                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(b) | The tax provision for the quarter and year ended
    December 31, 2004 included a reversal of $2,236 of
    valuation allowances related to federal net operating losses
    that were deemed to be no longer required based on
    managements estimates of future profitability of the
    Company.                                                               
|   
|(c) | The tax provision for the quarter ended
    June 30, 2005 included 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
    and a charge of $500 from the reversal of deferred tax assets
    due to an enacted law change in the State of Ohio.
|   
|(d) | The tax provision for the quarter ended
    September 30, 2005 included the reversal of previously
    recorded valuation allowances of $369 that were no longer
    required.                                                                                                                                                                                       



|    |                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------
|(e) | Net income in the quarter ended December 31,
    2005 includes $812 related to the sale of the Companys
    development center in India.



|    |                                                                                                                                                                                                                         
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(f) | The tax provision for the quarter ended
    December 31, 2005 includes a net credit of $614 from the
    adjustment of recorded reserves and valuation allowances based
    on an evaluation of estimated tax exposures.



|    |                                                                                                                                                                                                          
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(g) | Gross profit for the quarter ended
    December 31, 2005 includes a charge of $900 due to the
    accrual of previously unrecognized employee benefits for certain
    employees of our Indian operation.



|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure

On March 25, 2005, Covansys Corporation
(Covansys or the Company) notified
PricewaterhouseCoopers LLP (PwC) that the Audit
Committee dismissed PwC as the Companys independent
registered public accounting firm.

PwCs reports on the Companys
financial statements for the years ended December 31, 2004
and 2003 did not contain an adverse opinion or disclaimer of
opinion, nor were they qualified or modified as to uncertainty,
audit scope or accounting principle.

During the years ended December 31, 2004 and
2003 and through March 25, 2005, there were no
disagreements with PwC on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or
procedure, which disagreements, if not resolved to the
satisfaction of PwC would have caused them to make reference
thereto in connection with their reports on the financial
statements for such years.

During the years ended December 31, 2004 and
2003 and through March 25, 2005, there were no reportable
events as described in Regulation S-K
Item 304(a)(1)(iv)(B) except as follows. In accordance with
section 404 of the Sarbanes-Oxley Act, Covansys completed
its assessment of the effectiveness of its internal control over
financial reporting and concluded that the Companys
internal control over financial reporting was not effective as
of December 31, 2004 due to material weaknesses in its
internal control in revenue contract accounting, percentage of
completion accounting, property and equipment, income taxes and
lease accounting. PwC issued an adverse opinion on the
effectiveness of internal control over financial reporting as of
December 31, 2004. More details on the material weaknesses
in internal control over financial reporting and
managements plans to remediate these weaknesses are
discussed in Item 9A of the Companys 2004
Form 10-K.

In connection with the 2003 Form 10-K/A as
filed on August 6, 2004, the Company noted material
weaknesses in property and equipment and percentage of
completion accounting. The material weakness in percentage of
completion accounting was first communicated by PwC to the
Company in November 2003. These items are further discussed in
Item 9A of the Companys 2004 Form 10-K.

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##### Table of Contents



COVANSYS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(Dollars in thousands, except per share
data)


Covansys provided PwC with a copy of the above
disclosures and requested that PwC furnish Covansys with a
letter addressed to the Securities and Exchange Commission
stating whether it agrees with the foregoing statements by
Covansys and, if not, stating the respects in which it does not
agree. A copy of the letter from PwC is filed as
Exhibit 16.1 to the Companys Form 8-K dated
March 25, 2005.

On March 25, 2005, Covansyss Audit
Committee appointed BDO Seidman LLP as Covansyss
independent registered public accounting firm.

During Covansyss two most recent fiscal
years and through March 25, 2005, Covansys did not consult
BDO Seidman LLP with respect to the application of accounting
principles to a specified transaction, either completed or
proposed, or the type of audit opinion that might be rendered on
the Companys financial statements, or any other matters or
events listed in Item 304(a)(2) of Regulation S-K.

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Item 9A.     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 on December 31, 2005 the Companys Chief
Executive Officer and Chief Financial Officer concluded that the
Companys disclosure controls and procedures were effective.

MANAGEMENTS REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING

The management of Covansys Corporation is
responsible for establishing and maintaining adequate internal
controls over financial reporting. The Companys internal
controls over financial reporting are designed to provide
reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for
external purposes in accordance with generally accepted
accounting principles. These controls include policies and
procedures that (i) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the Company
(ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the Company
are being made only in accordance with required authorization
levels of management and directors of the Company; and
(iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use or disposition
of the Companys assets that could have a material effect
on the financial statements.

The Companys management assessed the
effectiveness of its internal controls over financial reporting
as of December 31, 2005. In making this assessment, the
Companys management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission
(COSO) in Internal Control-Integrated Framework.

Managements assessment included evaluation
of such elements as the design and operating effectiveness of
key financial reporting controls, process documentation,
accounting policies and the overall control environment. This
assessment is supported by testing and monitoring performed by
the Internal Audit organization.

Based on this assessment, management determined
that, as of December 31, 2005, the Companys internal
controls over financial reporting were effective. The current
year assessment determined that the five material weaknesses
noted as of December 31, 2004 in the Companys 2004
Form 10-K have been effectively remediated. Management has,
therefore, concluded that, based on these remediation efforts
and the current years evaluation, the Company did maintain
effective internal control over financial reporting as of
December 31, 2005. A discussion of the previously noted
material weakness and respective remediation efforts is included
under Changes in Internal Controls over Financial Reporting
and Managements Remediation Initiatives.

Managements assessment of the effectiveness
of the Companys internal control over financial reporting
as of December 31, 2005 has been audited by BDO Seidman
LLP, an independent registered public accounting firm, as stated
in their report which appears herein.

Because of the inherent limitations of internal
control over financial reporting, including the possibility of
collusion or improper management override of controls,
management misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of
any evaluation of the effectiveness of the internal control over
financial reporting to future periods are subject to the risk
that the controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies
and procedures may deteriorate.

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CHANGES IN INTERNAL CONTROL OVER FINANCIAL
REPORTING

AND MANAGEMENTS REMEDIATION
INITIATIVES


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 the
Companys internal controls and increase the oversight of
other factors that could have significantly affected those
controls. Management has also taken corrective action with
regard to significant deficiencies and material weaknesses.

As a result of managements evaluation of
internal control over financial reporting, certain material
weaknesses were identified and reported in the December 31,
2004 assessment as set forth in the section entitled
Managements Report on Internal Control Over Financial
Reporting of the Companys 2004 Form 10-K.
Management has addressed these material weaknesses and
deficiencies through a number of initiatives including those
specifically set forth below:



| |                     
| | --------------------
| | Revenue Recognition:

In the Companys prior year assessment, it
was noted that the Company did not maintain effective controls
over the validity and accuracy of contract revenue and the
related billed and unbilled accounts receivable. Specifically,
the Company did not maintain effective controls over obtaining a
signed contract or determining that a contract amendment was
authorized at the time revenue was recognized and that all
original or amended contract terms (primarily customer
acceptance conditions and fee limitation clauses) were
accurately reflected within the consolidated financial
statements. This control deficiency contributed to the Company
recording a material adjustment to the fourth quarter 2004
financial statements. Additionally, this control deficiency
could have resulted in a misstatement to the revenue accounts
that would have resulted in a material misstatement to annual or
interim financial statements that would not be prevented or
detected.

The Company has performed the following
procedures to strengthen the control environment and accounting
for contracts:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In the first quarter of 2005, the Company engaged
    in a thorough process to organize and catalogue its customer
    contracts in order to integrate all of its contract information
    into a contracts module of its ERP system. This initiative
    confirmed that remediation 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
    contractual documentation for new engagements be presented to
    and confirmed by the Legal Department prior to recognition of
    revenue for that engagement;
|
| |  | Additionally, during the third quarter of 2005,
    the Company substantially enabled major features of the
    contracts module of its ERP system and reassigned ownership of
    entering all contract and related billing information to the
    Legal Department;                                                                                                                                                                                                                                                                                                                                                        
|
| |  | A Project Set-Up Review Committee was also
    established during the year to ensure information entered into
    the Companys contract module of its ERP system, by the
    Legal Department is complete and accurate. This Committee is
    comprised of Company personnel from the Project Management
    Office, Finance Department , Legal Department, and Operations;
    and                                                                                                                                                                                                                                         
|
| |  | In conjunction with the contract organization
    process and in preparation of the year-end financial statements,
    the Company reviewed substantially all of its contracts that
    contained a fee limitation cap to confirm that revenue
    recognized did not exceed the fee limitation cap.                                                                                                                                                                                                                                                                                                                         



| |              
| | -------------
| | Fixed Assets:

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. At that time the Company concluded
that it did not maintain effective controls over the
completeness and accuracy of net property and equipment balances
and the related depreciation expense. Specifically,
substantially all of the Companys property and equipment
records were maintained using databases and

55



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spreadsheets, which were not integrated with the
Companys underlying ERP system and did not have adequate
controls to ensure that assets, asset values, capitalization
dates and useful lives were complete, accurate and recorded on a
timely basis. Additionally, reconciliation controls over
inter-company fixed asset transactions were not operating
effectively. This control deficiency resulted in the restatement
of the Companys consolidated financial statements for
2003, 2002 and 2001 and for each of the quarters for the two
years in the period ended December 31, 2003. Additionally,
as part of the year-end closing process in December 2004,
management discovered that a consolidating entry to properly
record property and equipment on the balance sheet at
December 31, 2003 was classified as accumulated
comprehensive income in error. That item was corrected but the
discovery of the error precluded management from concluding that
the material weakness in its fixed assets accounting procedures
had been fully remediated in the prior year. Since June 2004,
the Company has successfully accomplished the following items to
strengthen the control environment and accounting for its fixed
assets:




| |   |                                                                                                                                                                                                                                                                                                                                                                                                   
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Development of a global policy and procedure
    manual regarding the recording, tracking and depreciation of
    fixed assets;                                                                                                                                                                                                                                                                   
|
| |  | Addition of a new resource in the information
    technology staff that is responsible for equipment tracking;                                                                                                                                                                                                                                                                                    
|
| |  | Periodic physical inventories of equipment since
    the third quarter of 2004 which have produced only minor
    adjustments and;                                                                                                                                                                                                                                                                
|
| |  | Implementation of the fixed asset module in the
    Companys ERP system in the third quarter of 2005 to
    facilitate in the tracking and accounting of fixed assets. This
    implementation eliminates the use of multiple spreadsheets and
    systems which significantly streamlines the process while
    injecting more preventative automated controls into the control
    environment.



| |                                         
| | ----------------------------------------
| | 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
disclosed that it did not maintain effective controls over the
completeness and accuracy of revenue accounted for under
percentage-of-completion method and the associated revenue in
excess of billings balance sheet account. Under the percentage
of completion accounting method, revenue to be recognized is
dependent on, among other things, managements ability to
produce reasonably dependable estimates to complete the
contract. The Companys percentage-of-completion accounting
control procedures were not designed to require the use of a
consistent risk-adjusted method to estimate the costs to
complete. Additionally, the Companys controls over cost to
complete estimates were not operating effectively because
project management and accounting personnel did not consistently
document manual adjustments to cost estimates and
percentage-of-completion accounting records and they did not, in
limited instances, provide written certifications attesting to
the accuracy of their cost to complete estimates. Since the
discovery of this material weakness, the Company has implemented
a multi-part plan to strengthen management of fixed price
contracts and to enhance the processes supporting application of
the percentage of completion method of accounting for its fixed
price contracts. Some of the more significant enhancements that
have been implemented are as follows:



| |   |                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Modification and communication of the
    Companys global revenue recognition policy;                                                                                                             
|
| |  | Standardization and continuous improvement of the
    use of three primary estimating tools;                                                                                                       
|
| |  | 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;
|
| |  | Monthly certification by individual project
    managers attesting to the appropriateness of their monthly
    estimate-to-complete submissions;                                                   

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| |   |                                                                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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
    period estimates of costs to complete;
|
| |  | Increased executive oversight of significant
    projects including periodic reviews by executive management of
    projects that include new or high risk technology
    implementations or of significant size and complexity;                                                 
|
| |  | Increased monitoring of projects by the Project
    Management Office (PMO);                                                                                                                                                                                                     
|
| |  | Creation of more detailed procedural
    documentation and additional training to assist the
    Companys employees in their reporting responsibilities;                                                                                                                        
|
| |  | Zero profit method of accounting for certain
    fixed price projects where it was not possible to make
    reasonably dependable estimates of future costs; and                                                                                                                 
|
| |  | Creation of a database which is comprised of
    historical project performance and trend analysis data which can
    be considered on current projects of a similar nature to
    facilitate more accurate estimates to complete.                                               



| |       
| | ------
| | 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. As a result, management concluded that the
Company did not maintain effective controls over the accuracy of
the Companys current tax payable account, the deferred tax
asset and liability balances, valuation allowance and income tax
expense. Specifically, the Company did not have controls in
place to ensure that the Company had sufficient supporting
documentation for these income tax balances and that its income
tax accounts were periodically reconciled to supporting
documentation. This control deficiency resulted in the
restatement of the Companys consolidated financial
statements for 2003, 2002 and 2001, for each of the quarters for
the two years in the period ended December 31, 2003 and for
the first, second and third quarters for 2004, and in the
Company recording and audit adjustment to the fourth quarter
2004 financial statements.

For the 2005 year, the Company partnered
with a tax consulting firm and adopted the use of tax software
to assist in insuring that there was sufficient documentation to
support the current tax payable, deferred tax asset, deferred
tax liability and income tax expense accounts. With the
assistance of the Companys tax consultants, the Company
has performed an extensive evaluation of the design of the
historical process and related controls surrounding taxes and
has formalized its policies and procedures related to accounting
for taxes. In particular, the Company has performed the
following:



| |   |                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------
| |  | Implemented standard tax reporting packages which
    are submitted quarterly by foreign entities to ensure
    completeness of information;
|
| |  | Provided FAS 109 training to key management
    personnel at all major business locations and subsidiaries;                                 
|
| |  | Formalized its procedures, including refined role
    definition for key management personnel; and                                          
|
| |  | Integrated tax professionals into the process to
    gain appropriate level of tax expertise with respect to FAS 109
    compliance.        



| |        
| | -------
| | Leases:

As part of its 2004 year end closing
process, management 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. Upon further examination, the Company concluded that
effective controls over the completeness and accuracy of its
accrued lease liability and related lease expense accounts were
not maintained. Specifically, the Company did not have controls
in place to ensure the accounting implications for new or
amended leases were consistently evaluated and reviewed by
management. Additionally, the Companys

57



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controls over its selection and monitoring of its
accounting policy for lease accounting were ineffective. The
Company incorrectly applied generally accepted accounting
principles to lease agreements with step increases in rental
payments resulting in an error in the accrued lease liability
and related lease expense. This control deficiency resulted in
the restatement of the Companys consolidated financial
statements for 2003, 2002 and 2001, for each of the quarters for
the two years in the period ended December 31, 2003 and for
the first, second and third quarters for 2004.


For the year 2005, the Company implemented
controls to reduce the risk of such errors in the future as
follows:



| |   |                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Implementation of a comprehensive lease review
    checklist which is completed by the Companys Finance
    Department in conjunction with a review of all new lease
    agreements to ensure proper accounting treatment;                                                     
|
| |  | Monthly reviews surrounding accounts related to
    step rent provisions, lease terminations and sublease income are
    conducted by the Companys Controller;                                                                                                                 
|
| |  | Quarterly procedures have been enhanced to
    facilitate communication from operations personnel to relevant
    financial personnel to ensure that events which occur throughout
    the year with respect to leased property is promptly addressed
    and accounted for; and
|
| |  | The lease policy has been revised to require that
    all property leases be executed by only the Companys Chief
    Financial Officer or authorized designee.                                                                                                                 

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REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

To the Board of Directors and Shareholders of
Covansys Corporation:

We have audited managements assessment,
included in the accompanying Managements Report on
Internal Control Over Financial Reporting, that Covansys
Corporation and subsidiaries maintained effective internal
control over financial reporting as of December 31, 2005,
based on criteria established in Internal Control 
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria).
Covansys Corporations management is responsible for
maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control
over financial reporting. Our responsibility is to express an
opinion on managements assessment and an opinion on the
effectiveness of the Companys internal control over
financial reporting based on our audit.

We conducted our audit in accordance with the
standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was
maintained in all material respects. Our audit included
obtaining an understanding of internal control over financial
reporting, evaluating managements assessment, testing and
evaluating the design and operating effectiveness of internal
control, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit
provides a reasonable basis for our opinion.

A companys internal control over financial
reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A
companys internal control over financial reporting
includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions
of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance
with authorizations of management and directors of the company;
and (3) provide reasonable assurance regarding prevention
or timely detection of unauthorized acquisition, use, or
disposition of the companys assets that could have a
material effect on the financial statements.

Because of its inherent limitation, internal
control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures
may deteriorate.

In our opinion, managements assessment that
Covansys Corporation and subsidiaries maintained effective
internal control over financial reporting as of
December 31, 2005, is fairly stated, in all material
respects, based on the COSO criteria. Also, in our opinion,
Covansys Corporation and subsidiaries, maintained, in all
material respects, effective internal control over financial
reporting as of December 31, 2005, based on the COSO
criteria.

We have also audited, in accordance with the
standards of the Public Company Accounting Oversight Board
(United States), the accompanying consolidated balance sheet of
Covansys Corporation and subsidiaries as of December 31,
2005, and the related consolidated statements of operations,
shareholders equity and comprehensive income, and cash
flows for the year then ended and our report dated March 8,
2006 expressed an unqualified opinion.

BDO Seidman, LLP

Grand Rapids, Michigan


March 8, 2006


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|         |                  
|-------- | -----------------
|Item 9B. | Other Information

None.




PART III





|         |                                                    
|-------- | ---------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Company

The information required by this item is included
in our Proxy Statement for our 2006 Annual Meeting of
Shareholders under the caption Directors and Executive Officers
and is incorporated herein by reference.

Audit Committee

Covansys has a separately designated standing
Audit Committee in accordance with Section 3(a)(58)(A) of
Regulation S-K of the Securities and Exchange Act of 1934,
as amended (Exchange Act). Each member of the Audit
Committee is independent within the meaning of
Item 7(d)(3)(iv) of Schedule 14A of the Exchange Act.
The members of the Audit Committee are William C. Brooks
(Chairman), David H. Wasserman and Ronald K. Machtley.

Audit Committee Financial Expert

The Board of Directors has determined that
William C. Brooks of the Audit Committee is an audit committee
financial expert as defined by Item 401(h) of
Regulation S-K of the Exchange Act.

Section 16(a) Beneficial Ownership
Reporting Compliance

The information required by this item is included
in our Proxy Statement for our 2006 Annual Meeting of
Shareholders under the caption Directors and Executive Officers
of the Company and is incorporated herein by reference.

Code of Ethical Conduct

Covansys has adopted a Code of Ethical Conduct
(Code) for all executive and financial officers. The
Code is available on our website at www.covansys.com.
Stockholders may request a free copy of the Code from: Covansys,
32605 West 12 Mile, Farmington Hills, MI 48334,
Attention Chief Financial Officer.

Covansys has not waived compliance with any
aspect of the Code.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information required by this item is included
in our Proxy Statement for our 2006 Annual Meeting of
Shareholders under the caption Executive Compensation and is
incorporated herein by reference.






|         |                                                                   
|-------- | ------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management

The information required by this item is included
in our Proxy Statement for our 2006 Annual Meeting of
Shareholders under the caption Director and Executive Officer
Ownership of Covansys Corporation Common Stock and is
incorporated herein by reference.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

The information required by this item is included
in our Proxy Statement for our 2006 Annual Meeting of
Shareholders under the caption Certain Relationships and Related
Transactions and is incorporated herein by reference.






|         |                                            
|-------- | -------------------------------------------
|Item 14. | Principal Accountants Fees and
    Services

The information required by this item is included
in our Proxy Statement for our 2006 Annual Meeting of
Shareholders under the caption Principal Accountants Fees and
Services and is incorporated herein by reference.

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PART IV





|         |                                            
|-------- | -------------------------------------------
|Item 15. | Exhibits, Financial Statement
    Schedules

(a) Documents filed as a part of the report:



| |                                     
| | ------------------------------------
| | 1. Consolidated Financial Statements



| |                                                                                                            
| | -----------------------------------------------------------------------------------------------------------
| | The following consolidated financial statements
    of the Company and its subsidiaries are filed herewith:

|                                                                                                                                              |  |      |    | 
|--------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                                                                                                                                              |  | Page |   
|                                                                                                                                              |  |      |   
|Reports of Independent Registered Public
    Accounting Firms                                                                                 |  |      | 24 | 
|Consolidated Balance Sheets as of
    December 31, 2005 and 2004                                                                              |  |      | 26 | 
|Consolidated Statements of Operations for each of
    the years ended December 31, 2005, 2004 and 2003                                        |  |      | 27 | 
|Consolidated Statements of Shareholders
    Equity and Comprehensive Income for each of the years ended
    December 31, 2005, 2004 and 2003 |  |      | 28 | 
|Consolidated Statements of Cash Flows for each of
    the years ended December 31, 2005, 2004 and 2003                                        |  |      | 29 | 
|Notes to Consolidated Financial Statements                                                                                                    |  |      | 30 | 

2.     Financial
Statement Schedules

None

3.(a) Exhibits

|        |    |       |             |                                                                                                                                                                                                    
|------- | -- | ----- | ----------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |       |            
|No.     |    |       | Description
|        |    |       |            
|        | 3  | .1(a) |             | Restated Articles of Incorporation of the
    Company, as amended.                                                                                                                                 
|        | 3  | .2(b) |             | Restated Bylaws.                                                                                                                                                                                   
|        | 4  | .1    |             | See Exhibits 3.1 and 3.2 for provisions of the
    Restated Articles of Incorporation and Restated Bylaws of the
    Company defining the rights of the holders of Common Stock of
    the Company.
|        | 4  | .2(c) |             | Specimen Stock Certificate.                                                                                                                                                                        
|        | 10 | .1(d) |             | Credit Agreement with JPMorgan Chase Bank, N.A.                                                                                                                                                    
|        | 10 | .2(b) |             | Shareholder Rights Plan.                                                                                                                                                                           
|        | 10 | .3(b) |             | Master Service Provider Agreement with Fidelity
    Information Services.                                                                                                                          
|        | 10 | .4(b) |             | Exhibits to Master Service Provider Agreement
    with Fidelity Information Services.                                                                                                              
|        | 21 | .1    |             | Subsidiaries of Registrant.                                                                                                                                                                        
|        | 23 | .1    |             | Consent of BDO Seidman, LLP.                                                                                                                                                                       
|        | 23 | .2    |             | Consent of PricewaterhouseCoopers LLP.                                                                                                                                                             
|        | 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 pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.                                                                    
|        | 32 | .2    |             | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.                                                                    



---



|    |                                                                                                                                                                                                            
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Incorporated herein by reference and filed with
    the Companys Form 10-Q for the period ended March 31,
    2004.                                                                                       
|   
|(b) | Incorporated herein by reference and filed with
    the Companys Form 10-Q for the period ended
    September 30, 2004.                                                                                   
|   
|(c) | Incorporated herein by reference to exhibit of
    the same number in the Form S-1 Registration Statement of
    the Registrant (Registration No. 333-18413) dated as of
    December 20, 1996, as amended.
|   
|(d) | Incorporated herein by reference to exhibit of
    the same number in the Form 8-K Current Report dated
    December 28, 2005.                                                                             

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SIGNATURES

Pursuant to the requirements of Sections 13
and 15(d) 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/ RAJENDRA B. VATTIKUTI

| |                                                   
| | --------------------------------------------------
| |                                                   
| | Rajendra B. Vattikuti                             
| | Chairman, Chief Executive Officer and
    Director

March 8, 2006

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed by the
following persons on behalf of the Registrant and in the
capacities and on the dates indicated:

|                                               |  |                                                                                                |  |               |  | 
|---------------------------------------------- |  | ---------------------------------------------------------------------------------------------- |  | ------------- |  | 
|                                              
|/s/ RAJENDRA B. VATTIKUTIRajendra B. Vattikuti |  | Chairman, Chief Executive Officer
    and Director                                             |  | March 8, 2006
|                                              
|/s/ JAMES S. TROUBAJames S. Trouba             |  | Vice President and
    Chief Financial Officer
    (Principal Financial Officer)               |  | March 8, 2006
|                                              
|/s/ THOMAS E. LINDSEYThomas E. Lindsey         |  | Vice President, Controller and
    Chief Accounting Officer
    (Principal Accounting Officer) |  | March 8, 2006
|                                              
|*William C. Brooks                             |  | Director                                                                                       |  | March 8, 2006
|                                              
|*Hugh R. Harris                                |  | Director                                                                                       |  | March 8, 2006
|                                              
|*Douglas S. Land                               |  | Director                                                                                       |  | March 8, 2006
|                                              
|*Ronald K. Machtley                            |  | Director                                                                                       |  | March 8, 2006
|                                              
|*Frank R. Sanchez                              |  | Director                                                                                       |  | March 8, 2006
|                                              
|*John A. Stanley                               |  | Director                                                                                       |  | March 8, 2006
|                                              
|*Frank D. Stella                               |  | Director                                                                                       |  | March 8, 2006

62



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##### Table of Contents



|                                                          |  |          |  |               |  | 
|--------------------------------------------------------- |  | -------- |  | ------------- |  | 
|                                                         
|*David H. Wasserman                                       |  | Director |  | March 8, 2006
|                                                         
|*Gary C. Wendt                                            |  | Director |  | March 8, 2006
|                                                         
|* /s/ JAMES S. TROUBAJames S. Trouba
    Attorney-in-fact |  |          |  |              

63



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##### Table of Contents



EXHIBIT INDEX

|        |    |       |             |                                                                                                                                                                                                    
|------- | -- | ----- | ----------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |       |            
|No.     |    |       | Description
|        |    |       |            
|        | 3  | .1(a) |             | Restated Articles of Incorporation of the
    Company, as amended.                                                                                                                                 
|        | 3  | .2(b) |             | Restated Bylaws.                                                                                                                                                                                   
|        | 4  | .1    |             | See Exhibits 3.1 and 3.2 for provisions of the
    Restated Articles of Incorporation and Restated Bylaws of the
    Company defining the rights of the holders of Common Stock of
    the Company.
|        | 4  | .2(c) |             | Specimen Stock Certificate.                                                                                                                                                                        
|        | 10 | .1(d) |             | Credit Agreement with JPMorgan Chase Bank, N.A.                                                                                                                                                    
|        | 10 | .2(b) |             | Shareholder Rights Plan.                                                                                                                                                                           
|        | 10 | .3(b) |             | Master Service Provider Agreement with Fidelity
    Information Services.                                                                                                                          
|        | 10 | .4(b) |             | Exhibits to Master Service Provider Agreement
    with Fidelity Information Services.                                                                                                              
|        | 21 | .1    |             | Subsidiaries of Registrant.                                                                                                                                                                        
|        | 23 | .1    |             | Consent of BDO Seidman, LLP.                                                                                                                                                                       
|        | 23 | .2    |             | Consent of PricewaterhouseCoopers LLP.                                                                                                                                                             
|        | 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 pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.                                                                    
|        | 32 | .2    |             | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.                                                                    



---



|    |                                                                                                                     
|--- | --------------------------------------------------------------------------------------------------------------------
|(a) | Incorporated herein by reference and filed with
    the Companys Form 10-Q for the period ended March 31,
    2004.



|    |                                                                                                                         
|--- | ------------------------------------------------------------------------------------------------------------------------
|(b) | Incorporated herein by reference and filed with
    the Companys Form 10-Q for the period ended
    September 30, 2004.



|    |                                                                                                                                                                                                            
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(c) | Incorporated herein by reference to exhibit of
    the same number in the Form S-1 Registration Statement of
    the Registrant (Registration No. 333-18413) dated as of
    December 20, 1996, as amended.
|   
|(d) | Incorporated herein by reference to exhibit of
    the same number in the Form 8-K Current Report dated
    December 28, 2005.