Summary of COMPUWARE CORP - Yahoo! Finance

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

FORWARD-LOOKING STATEMENTS
The following discussion contains certain forward-looking statements within the meaning of the federal securities laws. When we use words such as "may", "might", "will", "should", "believe", "expect", "anticipate", "estimate", "continue", "predict", "forecast", "projected", "intend" or similar expressions, or make statements regarding our future plans, objectives or expectations, we are making forward-looking statements. Numerous important factors, risks and uncertainties affect our operating results and could cause actual results to differ materially from the results implied by these or any other forward-looking statements made by us, or on our behalf.
The material risks and uncertainties that we believe affect us are summarized below (see Item 1A Risk Factors in our 2008 Form 10-K and Part II Item 1A in our June 30, 2008 Form 10-Q). These risks and uncertainties are not the only ones we face. Additional risks and uncertainties discussed elsewhere in the reports we file with the Securities and Exchange Commission, as well as other risks and uncertainties that we are not aware of or focused on or that we currently deem immaterial, may also impair business operations. This report is qualified in its entirety by these risk factors and those listed below. If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and shareholders could lose all or part of their investment.
There can be no assurance that future results will meet expectations. While we believe that our forward-looking statements are reasonable, you should not place undue reliance on any such forward-looking statements, which speak only as of the date made. Except as required by applicable law, we do not undertake any obligation to publicly release any revisions which may be made to any forward-looking statements to reflect events or circumstances occurring after the date of this report.
• The majority of our software products revenue is dependent on our customers' continued use of International Business Machines Corp. ("IBM") and IBM-compatible products.

• Our software product revenue is dependent on the acceptance of our pricing structure for software licenses and maintenance.

• Our strategy to package products and services as a single offering may not be accepted by our customers, negatively impacting our revenue.

• The continuing uncertainty in the United States and global economies may reduce demand for our software products, professional services and application services, which may negatively affect our revenues and operating results.

• We may fail to achieve our forecasted financial results due to inaccurate sales forecasts or other factors.

• If we fail to achieve the results we expect from our expense reduction program, our results of operations and financial condition may be adversely affected.

• Our software and technology may infringe the proprietary rights of others, which may require us to enter into royalty arrangements or result in costly litigation.

• Our results could be adversely affected if our operating margin or operating margin percentage decline.

Table of Contents

COMPUWARE CORPORATION AND SUBSIDIARIES • Our results could be adversely affected by increased competition, pricing pressures and technological changes.

• The market for professional services is highly competitive, fragmented and characterized by low barriers to entry.

• The market for application services is in its early stages with emerging competitors. As the market matures, competition may increase and could have a negative impact on our results of operations.

• We must develop or acquire product enhancements and new products to succeed.

• Acquisitions may be difficult to integrate, disrupt our business or divert the attention of our management and may result in financial results that are different than expected.

• We are exposed to exchange rate risks on foreign currencies and to other international risks, which may adversely affect our business and results of operations.

• A further decline or consolidation in the U.S. domestic automotive manufacturing business could adversely affect our professional services and application services businesses.

• Current laws may not adequately protect our proprietary rights.

• The loss of certain key employees and technical personnel or our inability to hire additional qualified personnel could have a material adverse affect on our business.

• Our quarterly financial results vary and may be adversely affected by a number of unpredictable factors.

• Declines in our license commitments, increases in customer cancellations or currency fluctuations could lead to declines in our maintenance revenue.

• Unanticipated changes in our operating results or effective tax rates, or exposure to additional income tax liabilities, could affect our profitability.

• The continued suspension or the termination of our stock repurchase plan may result in a decrease in our stock price.

• If the fair value of our long-lived assets, including without limitation goodwill, deteriorated below their carrying value, recognition of an impairment loss would be required, which would adversely affect our financial results.

• Acts of terrorism, acts of war and other unforeseen events may cause damage or disruption to us or our customers which could adversely affect our business, financial condition and operating results.

• Our articles of incorporation, bylaws and rights agreement as well as certain provisions of Michigan law have anti-takeover effects that may deter hostile takeovers or delay or prevent changes in control or management, including transactions in which the stockholders of Compuware might otherwise receive a premium for their shares over the current market prices.

Table of Contents

COMPUWARE CORPORATION AND SUBSIDIARIES OVERVIEW
In this section, we discuss our results of operations on a segment basis for each of our three business segments in the technology industry: products, professional services and application services. We evaluate segment performance based primarily on segment contribution before corporate expenses. References to years are to fiscal years ended March 31. This discussion and analysis should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and notes included elsewhere in this report and our annual report on Form 10-K for the fiscal year ended March 31, 2008, particularly "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations".
We deliver value to businesses worldwide by providing software products, professional services and application services that improve the performance of IT organizations. Originally founded in 1973 as a professional services company, in the late 1970's we began to offer mainframe productivity tools for fault diagnosis, file and data management, and application debugging. In the 1990's, IT moved toward distributed and web-based platforms. Our solutions portfolio grew in response, and we now market a comprehensive portfolio of IT solutions across the full range of enterprise computing platforms that help:
• Develop and deliver high quality, high performance enterprise business applications in a timely and cost-effective manner.

• Measure, manage and communicate application service in business terms, and maintain consistent, high levels of service delivery.

• Provide executive visibility, decision support and process automation across the entire IT organization to enable all available resources to be harnessed in alignment with business priorities.

Additionally, to be competitive in today's global economy, enterprises must securely share applications, information and business processes. We address this market need through our application services, which are marketed under the brand name "Covisint". Our application services offerings provide a software-as-a-service platform that enables industries and business communities to securely integrate vital information and processes across users, business partners, customers, vendors and suppliers.
We earn revenue from licensing software products, providing maintenance and support for those products and rendering professional services. Our revenue recognition policies are in accordance with U.S. GAAP, including Statements of Position 97-2 "Software Revenue Recognition" and 98-9 "Modification of SOP 97-2, 'Software Revenue Recognition,' With Respect to Certain Transactions", Securities and Exchange Commission Staff Accounting Bulletin ("SAB") No. 104 and Emerging Issues Task Force Issue 00-21 "Revenue Arrangements with Multiple Deliverables". Accordingly, revenue is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the fee is fixed or determinable and collectibility is reasonably assured.
See Note 1 of the Condensed Consolidated Financial Statements for additional details regarding our revenue recognition policy, including our policy and methodology regarding certain bundled revenue arrangements where there is a lack of VSOE of fair value for any undelivered elements.

Table of Contents

COMPUWARE CORPORATION AND SUBSIDIARIES Quarterly Update
The following occurred during the third quarter of 2009:
• Realized an increase in product contribution margin to 47.5% in the third quarter of 2009 from 45.8% in the third quarter of 2008.

• Realized an increase in application services segment contribution margin to 0.6% in the third quarter of 2009 from a negative contribution margin of 7.4% in the third quarter of 2008.

• Experienced a decline in professional services segment contribution margin to 5.6% in the third quarter of 2009 from 6.7% in the third quarter of 2008.

• Experienced a decline in mainframe and distributed product revenue of 13.1% and 8.0%, respectively, compared to the third quarter of 2008.

• Restructuring actions to improve operating efficiencies resulted in a charge of $4 million.

• Released 1 mainframe and 10 distributed product updates designed to increase the productivity of the IT departments of our customers.

Our ability to achieve our strategies and objectives is subject to a number of risks and uncertainties, some of which we may not be able to control. See "Forward-Looking Statements".

Table of Contents

                     COMPUWARE CORPORATION AND SUBSIDIARIES
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain operational
data from the Condensed Consolidated Statements of Operations as a percentage of
total revenues and the percentage change in such items compared to the prior
period:

                                    Percentage of                                       Percentage of
                                   Total Revenues                                      Total Revenues
                                 Three Months Ended              Period-              Nine Months Ended              Period-
                                   December 31, *               to-Period              December 31, *               to-Period
                                2008             2007            Change             2008             2007            Change
REVENUE:
Software license fees            22.5 %           25.7 %          (23.8 )%           19.6 %           22.1 %          (16.5 )%
Maintenance fees                 43.4             38.8             (2.8 )            44.0             39.3              5.1
Professional services
segment revenue                  30.8             32.7            (18.3 )            33.3             35.5            (11.9 )
Application services
segment revenue                   3.3              2.8              2.2               3.1              3.1             (4.9 )

Total revenues                  100.0            100.0            (13.1 )           100.0            100.0             (6.0 )

OPERATING EXPENSES:
Cost of software
license fees                      2.3              2.2             (8.5 )             2.2              2.6            (22.0 )
Cost of maintenance
fees                              3.5              3.7            (17.1 )             3.9              3.7             (0.9 )
Professional services
segment expenses                 29.1             30.5            (17.3 )            31.2             31.7             (7.4 )
Application services
segment expenses                  3.3              3.0             (5.4 )             3.4              3.1              2.6
Technology development
and support                       8.3              7.6             (5.3 )             8.1              8.7            (12.0 )
Sales and marketing              20.5             21.5            (17.1 )            20.9             22.1            (11.1 )
Administrative and
general                          13.2             14.9            (23.0 )            14.3             15.1            (11.4 )
Restructuring cost                1.5              1.6            (18.1 )             0.8              4.4            (82.5 )

Total operating
expenses                         81.7             85.0            (16.5 )            84.8             91.4            (12.9 )

Income from operations           18.3             15.0              6.0              15.2              8.6             66.8
Other income, net                 0.9              1.5            (50.7 )             1.0              1.7            (45.6 )

Income before income
taxes                            19.2             16.5              0.9              16.2             10.3             47.6
Income tax provision              6.2              5.0              7.1               5.3              2.1            136.5

Net income                       13.0 %           11.5 %           (1.9 )%           10.9 %            8.2 %           24.6 %

* The professional services segment and the application services segment are combined and reported as professional services in the Condensed Consolidated Statement of Operations included within this report.

Table of Contents

                     COMPUWARE CORPORATION AND SUBSIDIARIES
PRODUCTS SEGMENT
Financial information for the products segment is as follows (in thousands):

                                   Three Months Ended           Nine Months Ended
                                      December 31,                December 31,
                                   2008          2007          2008          2007
          Revenue                $ 177,127     $ 199,451     $ 532,064     $ 546,775
          Expenses                  93,042       108,165       293,899       330,484

          Product contribution   $  84,085     $  91,286     $ 238,165     $ 216,291

The products segment generated contribution margins of 47.5% and 45.8% during the third quarter of 2009 and 2008, respectively, and 44.8% and 39.6% for the first nine months of 2009 and 2008, respectively. The increases in margin for the third quarter and first nine months of 2009 were due to declines in product expenses, primarily sales and marketing costs, outpacing the declines in product revenue for the reasons discussed below. Products Segment Revenue
Revenue for the products segment is as follows (in thousands):

                                      Three Months Ended                                 Nine Months Ended
                                         December 31,                                      December 31,
                             2008             2007           Change            2008             2007           Change
Software License Fees
Mainframe                  $  27,594        $  41,898          (34.1 )%      $  82,955        $  92,351          (10.2 )%
Distributed                   32,919           37,527          (12.3 )          81,251          104,361          (22.1 )

Total Software
License Fees                  60,513           79,425          (23.8 )         164,206          196,712          (16.5 )

Maintenance Fees
Mainframe                     81,702           83,812           (2.5 )         257,622          247,070            4.3
Distributed                   34,912           36,214           (3.6 )         110,236          102,993            7.0

Total Maintenance
Fees                         116,614          120,026           (2.8 )         367,858          350,063            5.1

Total Product Revenue
Mainframe                    109,296          125,710          (13.1 )         340,577          339,421            0.3
Distributed                   67,831           73,741           (8.0 )         191,487          207,354           (7.7 )

Total Product Revenue      $ 177,127        $ 199,451          (11.2 )%      $ 532,064        $ 546,775           (2.7 )%

Our software products are designed to enhance the effectiveness of key disciplines throughout the IT organization from application development and delivery to service management and IT portfolio management supporting all major enterprise computing platforms. Product revenue, which consists of software license fees and maintenance fees, comprised 65.9% and 64.5% of total revenue during the third quarter of 2009 and 2008, respectively, and 63.6% and 61.4% of total revenue during the first nine months of 2009 and 2008, respectively.

Table of Contents

COMPUWARE CORPORATION AND SUBSIDIARIES Software license fees
Software license fees ("license fees") decreased $18.9 million or 23.8%, which included a negative impact from foreign currency fluctuations of $5.1 million, during the third quarter of 2009 to $60.5 million from $79.4 million during the third quarter of 2008 and decreased $32.5 million or 16.5%, which included a negative impact from foreign currency fluctuations of $1.1 million, during the first nine months of 2009 to $164.2 million from $196.7 million during the first nine months of 2008.
Mainframe license fees for the third quarter and first nine months of 2009 declined $14.3 million and $9.4 million, respectively, and distributed license fees for the third quarter and first nine months of 2009 declined $4.6 million and $23.1 million, respectively, compared to the same periods from the prior year.
The declines in software license fees for the third quarter and first nine months of 2009 as compared to 2008 is a result of the economic slowdown experienced since the end of the second quarter of 2009 affecting the closure of license transaction deals across all product lines.
During the third quarter and first nine months of 2009, for software license transactions that are required to be recognized ratably, we deferred $21.4 million and $52.7 million, respectively, of license revenue relating to such transactions that closed during the respective periods, and recognized as revenue $20.4 million and $64.3 million of previously deferred license revenue relating to such transactions that closed and had been deferred prior to the beginning of the respective periods.
Maintenance fees
Maintenance fees decreased $3.4 million or 2.8%, which included a negative impact from foreign currency fluctuations of $7.6 million, during the third quarter of 2009 to $116.6 million from $120.0 million during the third quarter of 2008, and increased $17.8 million or 5.1%, which included a positive impact from foreign currency fluctuations of $2.7 million, during the first nine months of 2009 to $367.9 million from $350.1 million during the first nine months of 2008. The decrease in maintenance fees for the quarter was due to the negative impact of foreign currency fluctuations as the U.S. dollar generally strengthened against non-U.S. currencies during the third quarter of 2009. The increase in maintenance fees for the first nine months of 2009 relates primarily to maintaining a high rate of renewals.

Table of Contents

                     COMPUWARE CORPORATION AND SUBSIDIARIES
Products segment revenue by geographic location is presented in the table below
(in thousands):

                                        Three Months Ended           Nine Months Ended
                                           December 31,                December 31,
                                        2008          2007          2008          2007
     United States                    $  89,360     $  97,898     $ 274,135     $ 281,536
     Europe and Africa                   60,558        66,459       178,763       180,535
     Other international operations      27,209        35,094        79,166        84,704

     Total product revenue            $ 177,127     $ 199,451     $ 532,064     $ 546,775

Products Segment Expenses
Products segment expenses include cost of software license fees, cost of maintenance fees, technology development and support costs and sales and marketing expenses. These expenses are discussed below.
Cost of software license fees includes amortization of capitalized software, the cost of duplicating and disseminating products to customers, including associated hardware costs, and the cost of author royalties. Cost of software license fees decreased $600,000 or 8.5% during the third quarter of 2009 to $6.1 million from $6.7 million in the third quarter of 2008 and for the first nine months of 2009 decreased $5.2 million or 22.0% to $18.5 million from $23.7 million in the first nine months of 2008. The decreases in cost of software license fees were due to a decline in hardware costs associated with our Vantage product line. The decline in the first nine months of 2009 was further affected by a $3.9 million capitalized software impairment charge recorded during the first quarter of 2008 associated with the 2008 restructuring initiative.
As a percentage of software license fees, cost of software license fees were 10.1% and 8.4% in the third quarter of 2009 and 2008, respectively, and 11.2% and 12.0% (including 2.0% from the impairment charge) in the first nine months of 2009 and 2008, respectively. The increase in the percentage for the third quarter of 2009 was primarily due to the decline in software license fees. The decline in the percentage for the first nine months of 2009 was primarily due to the capitalized software impairment charge and decrease in hardware costs, as discussed above, offset in part by the decline in software license fees. Cost of maintenance fees consists of the direct costs allocated to maintenance and product support such as helpdesk and technical support. Customers who subscribe to maintenance are also eligible to receive the benefit of new releases as well as technical support. Cost of maintenance fees decreased $2.0 million or 17.1% during the third quarter of 2009 to $9.5 million from $11.5 million in the third quarter of 2008 and for the first nine months of 2009 decreased $300,000 or 0.9% to $32.8 million from $33.1 million in the first nine months of 2008. The decreases were primarily due to lower compensation and benefit costs resulting from employee headcount reductions as part of the restructuring actions taken during 2008 and 2009 (see Note 7 to the Condensed Consolidated Financial Statements). As a percentage of maintenance fees, cost of maintenance fees were 8.1% and 9.5% in the third quarter of 2009 and 2008, respectively, and 8.9% and 9.5% in the first nine months of 2009 and 2008, respectively.
Technology development and support includes, primarily, the costs of programming personnel associated with product development and support less the amount of software development

Table of Contents

COMPUWARE CORPORATION AND SUBSIDIARIES costs capitalized during the period. Also included are personnel costs associated with developing and maintaining internal systems and hardware/software costs required to support all technology initiatives. As a percentage of product revenue, costs of technology development and support were 12.6% and 11.9% in the third quarter of 2009 and 2008, respectively, and 12.8% and 14.1% in the first nine months of 2009 and 2008, respectively. Capitalization of internally developed software products begins when technological feasibility of the product is established. Total technology development and support costs incurred internally and capitalized in the third quarter and first nine months of 2009 and 2008 were as follows (in thousands):

                                                  Three Months Ended                Nine Months Ended
                                                     December 31,                     December 31,
                                                 2008             2007            2008            2007
Technology development and support costs
incurred                                      $   24,882        $ 26,393        $ 75,591        $  87,207
Capitalized technology development and
support costs                                     (2,487 )        (2,757 )        (7,688 )        (10,073 )


Technology development and support costs
expensed                                      $   22,395        $ 23,636        $ 67,903        $  77,134

Before the capitalization of internally developed software products, total technology development and support costs decreased $1.5 million or 5.7% during the third quarter of 2009 to $24.9 million from $26.4 million in the third quarter of 2008 and for the first nine months of 2009 decreased $11.6 million or 13.3% to $75.6 million from $87.2 million in the first nine months of 2008. The decreases in expense were primarily due to lower compensation and benefit costs resulting from employee headcount reductions as part of the restructuring actions taken during 2008 and 2009 (see Note 7 to the Condensed Consolidated Financial Statements).
Sales and marketing costs consist primarily of personnel related costs associated with product sales, sales support and marketing for all our product offerings. Sales and marketing costs decreased $11.4 million or 17.1% during the third quarter of 2009 to $55.0 million from $66.4 million in the third quarter of 2008 and for the first nine months of fiscal 2009 decreased $21.9 million or 11.1% to $174.7 million from $196.6 million in the first nine months of fiscal 2008. The decreases in sales and marketing costs for the third quarter and first nine months of 2009 were a result of the following: (1) lower compensation and . . .