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 2009 Form 10-K). 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 of packaging distributed products and services as a single offering may not be accepted by our customers, negatively impacting our revenue.

• We may fail to achieve our forecasted financial results due to inaccurate sales forecasts or other factors. If we fail to meet the expectations of analysts or investors, our stock price could decline substantially.

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

• The continuing weakening 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.

• If we are not successful in implementing our professional services strategy, our operating margins may decline.

• The continuation of the decline in the U.S. domestic automotive manufacturing business could adversely affect our professional services and application services businesses.

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COMPUWARE CORPORATION AND SUBSIDIARIES • If the fair value of our long-lived assets deteriorated below their carrying value, recognition of an impairment loss would be required, which would adversely affect our financial results.

• Our software and technology may infringe the proprietary rights of others.

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

• 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.

• The divestiture of our Quality and DevPartner product lines may cause a reduction in customer satisfaction, which could adversely affect our revenues and results of operations.

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

• 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 effect on our business.

• Maintenance revenue could decline.

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

• Our stock repurchase plan may be suspended or terminated at any time, which may result in a decrease in our stock price.

• 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 may have an anti-takeover effect.

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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, 2009, 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.

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COMPUWARE CORPORATION AND SUBSIDIARIES Quarterly Update
The following occurred during the first quarter of 2010:
• Sold our Quality and DevPartner product lines to Micro Focus International PLC ("Micro Focus") realizing a gain of $52.4 million to operating income (see Note 2 of the Condensed Consolidated Financial Statements included in this report).

• Experienced an increase in product contribution margin to 76.8% in the first quarter of 2010 from 45.7% in the first quarter of 2009, largely as a result of the gain on the sale to Micro Focus.

• Experienced a decline in professional services segment contribution margin to 5.5% in the first quarter of 2010 from 8.2% in the first quarter of 2009.

• Realized an increase in application services segment contribution margin to 9.1% in the first quarter of 2010 from a negative contribution margin of 17.4% in the first quarter of 2009.

• Experienced a decline in mainframe and distributed product revenue of 18.7% and 20.5%, respectively, compared to the first quarter of 2009.

• Experienced a charge of $2.5 million from restructuring actions to improve operating efficiencies.

• Released 4 mainframe and 7 distributed product updates designed to increase the productivity of the IT departments of our customers, including Vantage 11.

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".

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                     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
                                                    Total Revenues
                                                  Three Months Ended        Period-
                                                      June 30, *           to-Period
                                                   2009         2008        Change
      Revenue:
      Software license fees                         18.9 %       20.6 %      (34.0 )%
      Maintenance fees                              51.8         42.4        (12.2 )
      Professional services segment revenue         24.8         34.1        (47.9 )
      Application services segment revenue           4.5          2.9         10.0

      Total revenues                               100.0        100.0        (28.2 )


      Operating expenses:
      Cost of software license fees                  1.8          2.0        (35.2 )
      Cost of maintenance fees                       4.2          4.0        (25.3 )
      Professional services segment expenses        23.4         31.3        (46.4 )
      Application services segment expenses          4.1          3.5        (14.8 )
      Technology development and support            10.0          7.6         (4.8 )
      Sales and marketing                           24.8         20.5        (13.3 )
      Administrative and general                    18.7         13.8         (2.5 )
      Restructuring costs                            1.2          0.2        265.1
      Gain on divestiture of product lines         (24.4 )                     n/a

      Total operating expenses                      63.8         82.9        (44.8 )

      Income from operations                        36.2         17.1         52.4
      Other income, net                              0.7          1.0        (55.9 )

      Income before income taxes                    36.9         18.1         46.0
      Income tax provision                          13.1          6.5         44.3

      Net income                                    23.8 %       11.6 %       47.0 %

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

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

                                                 Three Months Ended
                                                      June 30,
                                                 2009          2008
               Revenue                         $ 151,673     $ 187,969
               Expenses                           35,184       101,981

               Products segment contribution   $ 116,489     $  85,988

The products segment generated contribution margins of 76.8% and 45.7% during the first quarter of 2010 and 2009. The increase in margin for the first quarter of 2010 was primarily due to the $52.4 million gain on divestiture of our Quality and DevPartner product lines (see Note 2 of the Condensed Consolidated Financial Statements included in this report for more details). Products Segment Revenue
Revenue for the products segment is as follows (in thousands):

                                                  Three Months Ended
                                                       June 30,
                                            2009          2008        Change
            Software License Fees
            Mainframe                     $  19,193     $  33,934       (43.4 )%
            Distributed                      21,353        27,508       (22.4 )

            Total Software License Fees      40,546        61,442       (34.0 )

            Maintenance Fees
            Mainframe                        80,392        88,524        (9.2 )
            Distributed                      30,735        38,003       (19.1 )

            Total Maintenance Fees          111,127       126,527       (12.2 )

            Total Product Revenue
            Mainframe                        99,585       122,458       (18.7 )
            Distributed                      52,088        65,511       (20.5 )

            Total Product Revenue         $ 151,673     $ 187,969       (19.3 )%

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

                                                  Three Months Ended
                                                       June 30,
                                                  2009          2008
               United States                    $  80,608     $  99,328
               Europe and Africa                   49,077        61,654
               Other international operations      21,988        26,987

               Total products segment revenue   $ 151,673     $ 187,969

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COMPUWARE CORPORATION AND SUBSIDIARIES 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 70.7% and 63.0% of total revenue during the first quarter of 2010 and 2009, respectively. Software license fees
Software license fees ("license fees") decreased $20.9 million or 34.0%, which included a negative impact from foreign currency fluctuations of $4.0 million, during the first quarter of 2010 to $40.5 million from $61.4 million during the first quarter of 2009.
Mainframe license fees for the first quarter of 2010 declined $14.7 million and distributed license fees for the first quarter of 2010 declined $6.2 million compared to the same period from the prior year.
The decline in software license fees for the first quarter 2010 as compared to 2009 was a result of the economic slowdown experienced since the end of the first quarter of 2009 affecting the closure of license transactions across all product lines within mainframe and the Vantage and Changepoint distributed product lines.
During the first quarter of 2010, for software license transactions that are required to be recognized ratably, we deferred $10.7 million of license revenue relating to such transactions that closed during the period. We recognized as revenue $24.4 million of previously deferred license revenue relating to such transactions that closed and had been deferred prior to the beginning of the period, including $7.2 million related to our divested products. Maintenance fees
Maintenance fees decreased $15.4 million or 12.2%, which included a negative impact from foreign currency fluctuations of $8.1 million, during the first quarter of 2010 to $111.1 million from $126.5 million during the first quarter of 2009.
Mainframe maintenance fees for the first quarter of 2010 declined $8.1 million and distributed maintenance fees for the first quarter of 2010 declined $7.3 million compared to the same period from the prior year. The decrease in maintenance fees for the quarter was primarily due to the negative impact of foreign currency fluctuations of $8.1 million and having one less month of Quality and DevPartner maintenance of approximately $3.0 million as these product lines were divested at the end of May 2009 (see Note 2 of the Condensed Consolidated Financial Statements included in this report).

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COMPUWARE CORPORATION AND SUBSIDIARIES Products Segment Expenses
Products segment expenses include cost of software license fees, cost of maintenance fees, technology development and support costs, sales and marketing expenses and the gain on divestiture of our Quality and DevPartner product lines to Micro Focus. As part of this divestiture, approximately 250 personnel related to the sales, sales support, development, maintenance and delivery of the Quality and DevPartner product lines were transferred to Micro Focus as of June 1, 2009 which reduced the product segment's compensation and benefit costs for the first quarter of 2010 compared to 2009. Changes to product segment 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 $2.2 million or 35.2% during the first quarter of 2010 to $3.9 million from $6.1 million in the first quarter of 2009. The decrease was primarily due to a reduction in capitalized software amortization as $17.6 million of capitalized software was sold to Micro Focus as part of the Quality and DevPartner divestiture. This capitalized software was classified as held for sale at March 31, 2009, as a result, no amortization was recorded in the first quarter of 2010 (see Note 2 of the Condensed Consolidated Financial Statements included in this report).
As a percentage of software license fees, cost of software license fees were 9.7% and 9.9% in the first quarter of 2010 and 2009, respectively. 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 $3.0 million or 25.3% during the first quarter of 2010 to $9.0 million from $12.0 million in the first quarter of 2009. The decreases were primarily due to lower compensation and benefit costs resulting from employee headcount reductions as part of the restructuring actions taken during 2009 (see Note 8 of the Condensed Consolidated Financial Statements included in this report) and to a lesser extent the transfer of employees to Micro Focus as discussed above. As a percentage of maintenance fees, cost of maintenance fees were 8.1% and 9.5% in the first quarter of 2010 and 2009, respectively.
Technology development and support includes, primarily, the costs of programming personnel associated with product development and support less the amount of software development 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 14.2% and 12.0% in the first quarter of 2010 and 2009, respectively.

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                     COMPUWARE CORPORATION AND SUBSIDIARIES
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 first
quarter of 2010 and 2009 were as follows (in thousands):

                                                             Three months ended
                                                                  June 30,
                                                              2009          2008
    Technology development and support costs incurred      $   24,376     $ 25,059
    Capitalized technology development and support costs       (2,894 )     (2,489 )


    Technology development and support costs expensed      $   21,482     $ 22,570

Before the capitalization of internally developed software products, total technology development and support costs decreased $700,000 or 2.7% during the first quarter of 2010 to $24.4 million from $25.1 million in the first quarter of 2009. The decrease in expenses was primarily due to lower compensation and benefit costs resulting from employee headcount reductions as part of the restructuring actions taken during 2009 (see Note 8 of the Condensed Consolidated Financial Statements included in this report) and to a lesser extent the transfer of employees to Micro Focus as discussed above. Sales and marketing costs consist primarily of personnel related costs associated with product sales, sales support and marketing for our product offerings. Sales and marketing costs decreased $8.2 million or 13.3% during the first quarter of 2010 to $53.1 million from $61.3 million in the first quarter of 2009. The decrease in sales and marketing costs was primarily a result of the following: (1) a decrease in bonus and commission costs of $4.6 million due to the decline in software license sales in 2010 and (2) a decrease in compensation and benefit costs of $3.3 million resulting from employee headcount reductions as part of the restructuring actions taken during 2009 (see Note 8 of the Condensed Consolidated Financial Statements included in this report) and to a lesser extent the transfer of personnel to Micro Focus as discussed above. As a percentage of product revenue, sales and marketing costs were 35.0% and 32.6% in the first quarter of 2010 and 2009.
Gain on divestiture of product lines relates to the sale of our Quality and DevPartner product lines to Micro Focus that occurred in May 2009. We recognized a gain of $52.4 million during the first quarter of 2010 relating to this transaction. See Note 2 of the Condensed Consolidated Financial Statements included in this report for more details.

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                     COMPUWARE CORPORATION AND SUBSIDIARIES
PROFESSIONAL SERVICES SEGMENT
Financial information for the professional services segment is as follows (in
thousands):

                                                        Three Months Ended
                                                            June 30, *
                                                        2009          2008
         Revenue                                      $  53,045     $ 101,832
         Expenses                                        50,115        93,510

         Professional services segment contribution   $   2,930     $   8,322

Professional services segment revenue by geographic location is presented in the table below (in thousands):

                                                        Three Months Ended
                                                             June 30,
                                                        2009          2008
        United States                                 $  44,749     $  82,617
        Europe and Africa                                 6,194        16,762
        Other international operations                    2,102         2,453

        Total professional services segment revenue   $  53,045     $ 101,832

During the first quarter of 2010 and 2009, the professional services segment generated a contribution margin of 5.5% and 8.2%, respectively. The decrease in contribution margin was primarily due to lower employee utilization rates within our Solutions Delivery Group resulting from a decline in license sales during the last two quarters and higher costs associated with certain fixed price projects.
2009 and 2010 Restructuring
During the second half of 2009 and the first quarter of 2010, management focused on improving the professional services segment's margins by initiating a plan to exit engagements that were considered low-margin and by reducing headcount and operating costs resulting in restructuring charges.
As a result, professional services revenues are expected to decline by approximately 40% in 2010 compared to 2009 but we expect improvement in the operating margin percentage of the segment as we progress through 2010. Actions initiated to date have included exiting low margin accounts, including our largest professional services client in the automotive industry. We expect approximately 20% of our professional services segment revenue in 2010 to be concentrated in the automotive industry.
If these actions do not improve the operating profit percentage of the . . .