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CPWR > SEC Filings for CPWR > Form 10-Q on 7-Nov-2011All Recent SEC Filings

Show all filings for COMPUWARE CORP

Form 10-Q for COMPUWARE CORP


7-Nov-2011

Quarterly Report


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

This "Management's Discussion and Analysis of Financial Condition and Results of Operations" ("MD&A") is intended to provide an understanding of our financial condition, changes in financial condition, cash flow, liquidity and results of operations. The MD&A 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, 2011, particularly "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations". References to years are to fiscal years ended March 31.

In this section, we first discuss our results of operations on a business unit and segment basis. We evaluate segment performance based primarily on operating profit before certain charges such as internal information system support, finance, human resources, legal, administration and other corporate charges. Following the segment discussion, we then provide a separate discussion of the material period-to-period changes in our operating expenses, other income and income taxes as reflected on our income statement.

In previous fiscal years, we operated in four business segments in the technology industry: products, web application performance management services, professional services and application services. Effective April 1, 2011, we realigned our business unit structure which had the following effect on our segments: (1) the former products segment split into four new segments:
Application Performance Management ("APM"), Mainframe, Changepoint and Uniface;
(2) the former web performance services segment ("Gomez SaaS" solution) and Gomez On-premises software (formerly Vantage) comprise the APM segment; and (3) the operating results of our software related professional services ("software related services") are reported within APM, Mainframe, Changepoint and Uniface, as applicable (previously reported in the Professional Services segment).

As a result of these changes, we now have six business segments: APM, Mainframe ("MF"), Changepoint ("CP"), Uniface ("UF"), Professional Services ("PS") and Application Services ("AS"). These segments are described in detail in Note 10 to the condensed consolidated financial statements.

This business unit structure gives us better visibility and control over the operations of our business and increases our market agility, enabling us to more effectively capitalize on market conditions and competitive advantages to maximize revenue growth and profitability. The segment presentation in the prior period has been revised to conform to the current presentation of our reportable segments. The change in reporting segments had no impact on previously reported consolidated financial results.

We collectively refer to the solutions offered within our APM, Mainframe, Changepoint and Uniface segments as "software solutions". In order to provide a supplementary view of this business, aggregated financial data for our software solutions is presented herein.


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COMPUWARE CORPORATION AND SUBSIDIARIES

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. These risks and uncertainties are not the only ones we face. Additional risks and uncertainties discussed elsewhere in this report and the other reports we file with the Securities and Exchange Commission (see for example Item 1A Risk Factors in our 2011 Form 10-K), 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.

Summary of Risk Factors

A substantial portion of our mainframe segment revenue is dependent on our customers' continued use of International Business Machines Corporation and IBM-compatible products.

Our software solutions revenue is dependent on the acceptance of our pricing structure for software licenses, maintenance services and web performance services.

Mainframe maintenance revenue could continue to decline.

The markets for web performance services (Gomez SaaS) are at an early stage of development with emerging competitors. If these markets do not develop or develop more slowly than we expect, or if there is an increase in competition, our revenue may decline or fail to grow.

The success of our APM solutions is dependent on customer acceptance of these offerings.

Changes to our organizational structure can be disruptive and may negatively impact our results of operations.


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

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

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

Economic uncertainties or slowdowns may reduce demand for our products and services, which may have a material negative effect on our revenues and operating results.

Defects or disruptions in our web performance services (Gomez SaaS) or application services (Covisint SaaS) networks or interruptions or delays in service would impair the delivery of our on-demand services and could diminish demand for our services and subject us to substantial liability.

Future changes in the U.S. domestic automotive manufacturing business could reduce demand for our professional services and application services, which may have a material negative effect on our revenues and operating results.

If the fair value of our long-lived assets, primarily goodwill, deteriorates below the carrying value of these assets, recognition of an impairment loss would be required, which could materially and adversely affect our financial results.

Our software technology may infringe upon the proprietary rights of others.

Our results could be materially and adversely affected by increased competition, pricing pressures and technological changes within the software solutions market.

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

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 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.

Unanticipated changes in our 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 materially and adversely affect our business, financial condition and operating results.


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COMPUWARE CORPORATION AND SUBSIDIARIES

Our articles of incorporation, bylaws and rights agreement as well as certain provisions of Michigan law may have an anti-takeover effect.

OVERVIEW

We deliver value to businesses by providing software products; web performance services and application services through software-as-a-service ("SaaS") platforms; and professional services that improve the performance of information technology organizations.

Our primary source of profitability and cash flow is the sale of our mainframe productivity tools ("mainframe") that are used within our customers' mainframe computing environments for fault diagnosis, file and data management, application performance monitoring and application debugging. Over the past few years, we have experienced lower volumes of software license transactions for our mainframe solutions causing an overall downward trend in our mainframe product revenues. Changes in our current customer IT computing environments and spending habits have impacted their need for additional mainframe computing capacity. In addition, increased competition and pricing pressures have had a negative impact on our revenues. Customers utilize our products to reduce operating costs, increase programmer productivity and create a smooth transition to the next generation of mainframe environment programmers. We will continue to make strategic enhancements to our mainframe solutions through research and development investments with the goal of meeting customer needs and maintaining a maintenance renewal rate in excess of 90%. The cash flow generated from our mainframe business supports our growth segments.

We have identified the APM market as a key source of future revenue growth. Web, mobile and cloud applications and the complex distributed applications delivery chain supporting them have become increasingly critical to a company's brand awareness, revenue growth and overall market share. Because of this, the market for APM solutions is significant and growing rapidly. Our APM solutions are marketed under the brand names "Gomez" and "dynaTrace". These solutions provide our customers with on-premises software ("Gomez On-premises" and "dynaTrace") and SaaS platform based web application performance services ("Gomez SaaS"). These solutions ensure the optimal performance of our customer's enterprise, web, streaming, mobile and cloud applications. We are investing in our APM solutions with the goal of providing solutions that are best-in-class within the APM market. Specifically, our investments include: (1) enhancements to our global web performance services network with specific focus on ease of use, time-to-value and data analytics in mobile application performance capabilities and in video streaming performance; (2) enhancements to our First Mile to Last Mile solution which combines our on-premises software and SaaS solution into a single platform that provides performance metrics for cloud, web and data center applications in a consolidated dashboard; and (3) the acquisition of dynaTrace software, Inc. ("dynaTrace") in July 2011. The dynaTrace software enables companies to continuously track business transactions and provides exact identification of performance problems, enhancing our Gomez software solutions.

We have also identified the secured collaboration services market as a key source of revenue growth. Technology has allowed business communities, organizations and systems to globally connect and share vital information, applications and processes across their internal and extended enterprises. Our application services, which are marketed under the brand name "Covisint" and provided on a SaaS platform, create an environment that simplifies and secures this collaboration atmosphere. Our Covisint services are utilized primarily in the automotive and healthcare industries. The need for these services is growing, particularly in the healthcare industry as hospitals, physicians and the United States government move towards establishing electronic patient health and medical records that will require secured computerized databases and environments for storing and sharing of information.


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We also continue to enhance our Changepoint and Uniface solutions primarily through research and development expenditures.

Our Changepoint solution provides a single automated solution for professional services organizations to forecast and plan, as well as, manage resources, projects and client engagements. In addition, for project-centric organizations, Changepoint provides a cohesive and consolidated view of projects, investments, resources and applications to help manage the entire business portfolio.

Our Uniface solution is mature with over 25 years on the market. Uniface is a rapid application development environment for building, renewing and integrating the latest complex enterprise applications. Our strategy with the Uniface solution is to enhance the product with additional features making it more effective for enterprise applications and to expand the capabilities of the product to other technology applications.

The professional services reporting segment recently went through a business transformation and is now focused on achieving modest revenue growth and high operating margins by delivering high quality solutions and resources to our customers that meet their application development through project management needs. Our goal is to provide the expertise, best practices and agility needed to meet our customers' critical technology challenges. Areas of growth that we have identified are cloud and mobile application development services. Enhancing our competencies in these areas will provide an opportunity to continue growing the segment's revenue and operating margin.


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COMPUWARE CORPORATION AND SUBSIDIARIES
Quarterly Update

The following occurred during the second quarter of 2012:

Acquired dynaTrace for $255.8 million in cash, plus approximately $300,000 of direct acquisition costs (see Note 2 of the condensed consolidated financial statements included in this report for additional information). We borrowed $129.5 million on our credit facility to partially fund this acquisition.

Realized an increase of $34.8 million or 15.4% in revenue during the second quarter of 2012 as compared to the prior year due to a $16.1 million increase in software license fees, a $6.2 million increase in maintenance and subscription fees and a $12.5 million increase in professional services fees (see "Business Segment Analysis" for additional information).

Experienced a decrease in operating margin to 14.6% during the second quarter of 2012 compared to 18.1% in the second quarter of 2011. The decrease was primarily due to our continued investments in the APM and application services businesses and was partially offset by operating margin improvement in our professional services and mainframe businesses (see "Business Segment Analysis" for additional information).

Realized an increase of $24.3 million or 13.6% in software solutions revenue during the second quarter of 2012 compared to the prior year led by the APM and Mainframe businesses.

Experienced a decrease in software solutions operating margin to 41.0% in the second quarter of 2012 compared to 46.1% during the second quarter of 2011 primarily due to increased investments within our APM business.

Realized an increase in professional services segment operating margin to 19.9% in the second quarter of 2012 from 16.2% during the second quarter of 2011.

Experienced a decrease in application services segment operating margin to negative 13.0% in the second quarter of 2012 from positive 9.9% during the second quarter of 2011 as a result of hiring additional personnel to prepare for anticipated growth in the market.

Repurchased 422,200 shares of our common stock at an average price of $7.84 per share as part of our discretionary stock repurchase plan.

Our ability to execute our strategies and achieve our objectives is subject to a number of risks and uncertainties. See "Forward-Looking Statements".


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                     COMPUWARE CORPORATION AND SUBSIDIARIES

BUSINESS SEGMENT ANALYSIS

The following table sets forth, for the periods indicated, certain business
segment operational data. We evaluate the performance of our segments based
primarily on operating profit before certain charges such as internal
information system support, finance, human resources, legal, administration and
other corporate charges ("unallocated expenses"). Comparisons are to the
comparable period of the prior year. Financial information for our business
segments was as follows (in thousands):

                                                       Software Solutions
                                                                                                                                Unallocated
Three Months Ended :                APM           MF            CP           UF          Total          PS           AS          Expenses          Total

September 30, 2011

Total revenues                   $  62,844     $ 118,044     $ 10,851     $ 11,881     $ 203,620     $ 39,528     $ 17,548     $           -     $ 260,696

Operating expenses                  79,932        24,129       10,944        5,151       120,156       31,662       19,835            50,883       222,536

Income (loss) from  operations   $ (17,088 )   $  93,915     $    (93 )   $  6,730     $  83,464     $  7,866     $ (2,287 )   $     (50,883 )   $  38,160

Operating margin %                  (27.2% )       79.6%        (0.9% )      56.6%         41.0%        19.9%       (13.0% )             N/A         14.6%

September 30, 2010

Total revenues                   $  56,739     $ 102,135     $  9,688     $ 10,740     $ 179,302     $ 34,405     $ 12,162     $           -     $ 225,869

Operating expenses                  57,282        23,420       11,402        4,612        96,716       28,836       10,963            48,493       185,008

Income (loss) from operations    $    (543 )   $  78,715     $ (1,714 )   $  6,128     $  82,586     $  5,569     $  1,199     $     (48,493 )   $  40,861

Operating margin %                   (1.0% )       77.1%       (17.7% )      57.1%         46.1%        16.2%         9.9%               N/A         18.1%



                                                      Software Solutions
                                                                                                                               Unallocated
Six Months Ended :                 APM           MF            CP           UF          Total          PS           AS          Expenses          Total

September 30, 2011

Total revenues                  $ 118,357     $ 215,550     $ 20,817     $ 22,806     $ 377,530     $ 79,425     $ 33,715     $           -     $ 490,670

Operating expenses                149,371        48,205       22,306       10,551       230,433       63,251       36,669           102,540       432,893

Income (loss) from operations   $ (31,014 )   $ 167,345     $ (1,489 )   $ 12,255     $ 147,097     $ 16,174     $ (2,954 )   $    (102,540 )   $  57,777

Operating margin %                 (26.2% )       77.6%        (7.2% )      53.7%         39.0%        20.4%        (8.8% )             N/A         11.8%

September 30, 2010

Total revenues                  $ 103,574     $ 196,230     $ 19,110     $ 20,780     $ 339,694     $ 69,259     $ 23,401     $           -     $ 432,354

Operating expenses                114,077        47,172       22,690        9,299       193,238       58,640       21,440            95,788       369,106

Income (loss) from operations   $ (10,503 )   $ 149,058     $ (3,580 )   $ 11,481     $ 146,456     $ 10,619     $  1,961     $     (95,788 )   $  63,248

Operating margin %                 (10.1% )       76.0%       (18.7% )      55.3%         43.1%        15.3%         8.4%               N/A         14.6%


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COMPUWARE CORPORATION AND SUBSIDIARIES

Software Solutions as a Group

Our software solutions are comprised of the following business segments: (1) Application Performance Management; (2) Mainframe; (3) Changepoint; and (4) Uniface.

Revenue associated with our software solutions consists of software license fees, maintenance fees, subscription fees and professional services fees (software related services). Software solutions revenues are presented in the table below (in thousands):

                          Three Months Ended                          Six Months Ended
                             September 30,              %               September 30,              %
                          2011          2010          Change         2011          2010          Change
Software license fees   $  61,711     $  45,613           35.3 %   $  95,837     $  78,943           21.4 %
Maintenance fees          109,080       104,351            4.5 %     216,065       207,838            4.0 %
Subscription fees          19,101        17,656            8.2 %      38,225        30,928           23.6 %
Professional services
fees                       13,728        11,682           17.5 %      27,403        21,985           24.6 %
Total software
solutions revenue       $ 203,620     $ 179,302           13.6 %   $ 377,530     $ 339,694           11.1 %

Software license fees ("license fees") increased $16.1 million during the second quarter of 2012, which included a positive impact of foreign currency fluctuations of $2.4 million, and increased $16.9 million during the first six months of 2012, which included a positive impact of foreign currency fluctuations of $4.8 million, as compared to the same periods of the prior year. Excluding the impact from foreign currency fluctuations, license fees increased $13.7 million for the second quarter of 2012 and increased $12.1 million for the first six months of 2012 as compared to the same periods of the prior year. The increases were due to additional mainframe license revenue (see the Mainframe discussion within "Software Solutions by Business Segment" for more details).

During the second quarter of 2012 and 2011, for software license transactions that were required to be recognized ratably, we deferred $2.5 million and $5.6 million, respectively, of license fees relating to such transactions that closed during the period. We recognized as license fees $12.3 million and $15.6 million of previously deferred license revenue during the second quarter of 2012 and 2011, respectively, relating to such transactions that closed and had been deferred prior to the beginning of the period.

During the first six months of 2012 and 2011, for software license transactions that were required to be recognized ratably, we deferred $5.4 million and $12.6 million, respectively, of license fees relating to such transactions that closed during the period. We recognized as license fees $25.9 million and $30.9 million of previously deferred license revenue during the first six months of 2012 and 2011, respectively, relating to such transactions that closed and had been deferred prior to the beginning of the period.

Maintenance fees increased $4.7 million during the second quarter of 2012, which included a positive impact from foreign currency fluctuations of $4.6 million, and increased $8.2 million during the first six months of 2012, which included a positive impact from foreign currency fluctuations of $10.8 million, as compared to the same periods of the prior year. Excluding the impact from foreign currency fluctuations, maintenance fees increased $100,000 for the second quarter of 2012 and decreased $2.6 million for the first six months of 2012 as compared to the same periods of the prior year. Although we continue to experience a high maintenance renewal rate with our current mainframe customers, the decline in mainframe license transactions during 2010 and 2011 is impacting mainframe maintenance revenue as new or growth customers are not entirely replacing the maintenance revenue loss from the non-renewed or reduced capacity mainframe maintenance arrangements. The decline was entirely offset for the second quarter of 2012 and partially offset for the first six months of 2012 by an increase in Gomez On-premises software maintenance fees as demand for APM solutions continues to increase and by additional maintenance revenue gained from the acquisition of dynaTrace.


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Subscription fees increased $1.4 million during the second quarter of 2012, which included a positive impact from foreign currency fluctuations of $259,000, and increased $7.3 million during the first six months of 2012, which included a positive impact from foreign currency fluctuations of $650,000, as compared to the same periods of the prior year. Excluding the impact from foreign currency fluctuations, subscription fees increased $1.1 million for the second quarter of 2012 and increased $6.6 million for the first six months of 2012 as compared to the same periods of the prior year. The improvement in subscription fees over the prior year is primarily a result of the on-going ratable recognition of fiscal 2011 Gomez SaaS sales.

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