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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2013

OR

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 000-20900

(Exact name of registrant as specified in its charter)

Michigan		38-2007430
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

One Campus Martius, Detroit, MI 48226-5099

(Address of principal executive offices including zip code)

Registrant's telephone number, including area code:  (313) 227-7300

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yesx   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer  x Accelerated filer o Non-accelerated filer o   (Do not check if a smaller reporting company)  Smaller reporting company 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 x

Indicate the number of shares outstanding of each of the issuer's class of common stock, as of the latest practicable date:

As of February 5, 2014, there were outstanding 218,183,424 shares of Common Stock, par value $.01, of the registrant.

 

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PART I.	FINANCIAL INFORMATION	Page
Item 1.	Financial Statements (unaudited)
	Condensed Consolidated Balance Sheets as of December 31, 2013 and March 31, 2013	3
	Condensed Consolidated Statements of Operations for the three months and nine months ended December 31, 2013 and 2012	4
	Condensed Consolidated Statements of Comprehensive Income for the three months and nine months ended December 31, 2013 and 2012	5
	Condensed Consolidated Statement of Shareholders’ Equity for the nine months ended December 31, 2013 and 2012	6
	Condensed Consolidated Statements of Cash Flows for the nine months ended December 31, 2013 and 2012	7
	Notes to Condensed Consolidated Financial Statements	8
	Report of Independent Registered Public Accounting Firm	30
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	57
Item 4.	Controls and Procedures	57
PART II.	OTHER INFORMATION	58
Item 1A.	Risk Factors	58
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	58
Item 6.	Exhibits	59
SIGNATURES		60

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COMPUWARE CORPORATION AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(In Thousands)

(Unaudited)

ASSETS		December 31, 2013				March 31, 2013
CURRENT ASSETS:
Cash and cash equivalents		$	108,897			$	89,873
Accounts receivable, net			466,669				424,587
Deferred tax asset, net			42,859				37,618
Income taxes refundable			9,552				4,951
Prepaid expenses and other current assets			33,600				36,210
Total current assets			661,577				593,239
PROPERTY AND EQUIPMENT, LESS ACCUMULATED DEPRECIATION AND AMORTIZATION			292,872				302,492
CAPITALIZED SOFTWARE AND OTHER INTANGIBLE ASSETS, NET			109,648				116,663
ACCOUNTS RECEIVABLE			181,636				174,891
DEFERRED TAX ASSET, NET			29,289				31,754
GOODWILL			735,411				722,042
OTHER ASSETS			26,675				32,201
TOTAL ASSETS		$	2,037,108			$	1,973,282
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable		$	25,610			$	18,717
Accrued expenses			113,061				103,994
Income taxes payable			8,737				14,507
Deferred revenue			408,505				417,862
Total current liabilities			555,913				555,080
LONG TERM DEBT			-				18,000
DEFERRED REVENUE			304,721				310,453
ACCRUED EXPENSES			15,549				27,873
DEFERRED TAX LIABILITY, NET			64,666				63,650
Total liabilities			940,849				975,056
SHAREHOLDERS' EQUITY:
Common stock			2,178				2,132
Additional paid-in capital			812,342				713,580
Retained earnings			265,099				301,298
Accumulated other comprehensive loss			(4,213	)			(18,784	)
Total Compuware shareholders' equity			1,075,406				998,226
Non-controlling interest			20,853				-
Total shareholders' equity			1,096,259				998,226
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY		$	2,037,108			$	1,973,282

See notes to condensed consolidated financial statements.

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COMPUWARE CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(In Thousands, Except Per Share Data)

(Unaudited)

		Three Months Ended December 31,								Nine Months Ended December 31,
		2013				2012				2013				2012
REVENUES:
Software license fees		$	56,694			$	64,831			$	127,810			$	130,499
Maintenance fees			101,600				102,341				300,628				307,487
Subscription fees			21,733				20,793				63,169				61,503
Professional services fees			46,378				46,049				141,790				140,155
Application services fees			24,109				23,852				72,735				64,981
Total revenues			250,514				257,866				706,132				704,625
OPERATING EXPENSES:
Cost of software license fees			5,366				5,388				16,404				15,117
Cost of maintenance fees			7,670				8,639				23,615				26,653
Cost of subscription fees			8,430				7,603				25,233				22,823
Cost of professional services			38,278				39,694				116,237				122,080
Cost of application services			28,618				20,758				86,568				57,468
Technology development and support			22,516				25,629				73,176				79,675
Sales and marketing			65,670				65,773				178,613				184,604
Administrative and general			40,325				44,733				113,646				122,819
Restructuring costs			3,737								9,082
Total operating expenses			220,610				218,217				642,574				631,239
INCOME FROM OPERATIONS			29,904				39,649				63,558				73,386
OTHER INCOME (EXPENSE), NET			2,960				(55	)			3,347				(90	)
INCOME BEFORE INCOME TAX PROVISION			32,864				39,594				66,905				73,296
INCOME TAX PROVISION			8,874				14,254				17,762				26,894
NET INCOME INCLUDING NON-CONTROLLING INTEREST			23,990				25,340				49,143				46,402
Less: Net income (loss) attributable to the non-controlling interest in Covisint Corporation			(1,032	)							(2,186	)
NET INCOME ATTRIBUTABLE TO COMPUWARE CORPORATION		$	25,022			$	25,340			$	51,329			$	46,402
Basic earnings per share		$	0.12			$	0.12			$	0.24			$	0.22
Diluted earnings per share		$	0.11			$	0.12			$	0.23			$	0.21
Dividends declared per common share		$	0.125			$	-			$	0.375			$	-

See notes to condensed consolidated financial statements.

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COMPUWARE CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(In Thousands, Except Per Share Data)

(Unaudited)

		Three Months Ended December 31,								Nine Months Ended December 31,
		2013				2012				2013				2012
NET INCOME INCLUDING NON-CONTROLLING INTEREST		$	23,990			$	25,340			$	49,143			$	46,402
OTHER COMPREHENSIVE INCOME (LOSS), BEFORE TAX
Foreign currency translation adjustments			3,544				4,690				15,771				(3,322	)
TAX ATTRIBUTES OF ITEMS IN OTHER COMPREHENSIVE INCOME (LOSS)
Foreign currency translation adjustments			218				831				1,200				(1,265	)
OTHER COMPREHENSIVE INCOME (LOSS),NET OF TAX			3,326				3,859				14,571				(2,057	)
COMPREHENSIVE INCOME INCLUDING NON-CONTROLLING INTEREST			27,316				29,199				63,714				44,345
Less: Net income (loss) attributable to the non-controlling interest in Covisint Corp.			(1,032	)			-				(2,186	)			-
Less: Other comprehensive income attributable to the non-controlling interest in Covisint Corp.			5				-				5				-
COMPREHENSIVE INCOME ATTRIBUTABLE TO COMPUWARE CORPORATION		$	28,343			$	29,199			$	65,895			$	44,345

See notes to condensed consolidated financial statements.

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COMPUWARE CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statement of Shareholders’ Equity

(In Thousands, Except Per Share Data)

(Unaudited)

		Common Stock								Additional Paid-In				Retained				Accumulated Other Comprehensive				Total Compuware Shareholders'				Non-controlling				Total Shareholders’
		Shares				Amount				Capital				Earnings				Loss				Equity				Interest				Equity
BALANCE AT MARCH 31, 2013			213,218,048			$	2,132			$	713,580			$	301,298			$	(18,784	)		$	998,226			$	-			$	998,226
Net income (loss)															51,329								51,329				(2,186	)			49,143
Foreign currency translation, net of tax																			14,571				14,571				5				14,576
Dividends			14,059								819				(81,627	)							(80,808	)							(80,808	)
Impact of equity transactions of non-controlling interest											(9,903	)											(9,903	)			9,903				-
Issuance of Covisint common stock											53,191												53,191				13,131				66,322
Issuance of common stock			179,047				2				1,874												1,876								1,876
Repurchase of common stock			(300,000	)			(8	)			(2,619	)			(5,901	)							(8,528	)							(8,528	)
Exercise/release of employee stock awards and related tax benefit (Note 6)			4,660,970				52				28,714												28,766								28,766
Stock awards compensation, net											26,686												26,686								26,686
BALANCE AT DECEMBER 31, 2013			217,772,124			$	2,178			$	812,342			$	265,099			$	(4,213	)		$	1,075,406			$	20,853			$	1,096,259
		Common Stock								Additional Paid-In				Retained				Accumulated Other Comprehensive				Total Compuware Shareholders'				Non-controlling				Total Shareholders’
		Shares				Amount				Capital				Earnings				Loss				Equity				Interest				Equity
BALANCE AT MARCH 31, 2012			217,506,319			$	2,175			$	685,904			$	372,408			$	(10,550	)		$	1,049,937							$	1,049,937
Net income (loss)															46,402								46,402								46,402
Foreign currency translation, net of tax																			(2,057	)			(2,057	)							(2,057	)
Issuance of common stock			231,595				2				2,053												2,055								2,055
Repurchase of common stock			(8,321,587	)			(82	)			(26,732	)			(50,365	)							(77,179	)							(77,179	)
Exercise/release of employee stock awards and related tax benefit (Note 6)			2,646,128				26				10,245												10,271								10,271
Stock awards compensation											20,663												20,663								20,663
BALANCE AT DECEMBER 31, 2012			212,062,455			$	2,121			$	692,133			$	368,445			$	(12,607	)		$	1,050,092			$	-			$	1,050,092

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COMPUWARE CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(In Thousands)

(Unaudited)

		Nine Months Ended December 31,
		2013				2012
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income including non-controlling interest		$	49,143				46,402
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization			48,294				49,358
Stock award compensation			32,526				20,663
Deferred income taxes			(4,484	)			6,172
Other			(5,396	)			552
Net change in assets and liabilities, net of effects from currency fluctuations:
Accounts receivable			(40,679	)			17,140
Prepaid expenses and other assets			7,066				4,608
Accounts payable and accrued expenses			3,438				(24,868	)
Deferred revenue			(18,161	)			(91,181	)
Income taxes			(12,503	)			20,122
Net cash provided by operating activities			59,244				48,968
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of:
Property and equipment			(11,518	)			(18,241	)
Capitalized software			(18,879	)			(24,817	)
Other			(275	)			(1,400	)
Net cash used in investing activities			(30,672	)			(44,458	)
CASH FLOWS USED IN FINANCING ACTIVITIES:
Proceeds from borrowings			51,000				142,800
Payments on borrowings			(69,000	)			(117,800	)
Net proceeds from exercise of stock awards including excess tax benefits			30,285				11,965
Employee contribution to stock purchase plans			1,812				2,046
Repurchase of common stock			(8,903	)			(76,366	)
IPO proceeds			68,448
Dividends			(80,808	)
Other			(1,397	)
Net cash used in financing activities			(8,563	)			(37,355	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH			(985	)			(1,451	)
NET CHANGE IN CASH AND CASH EQUIVALENTS			19,024				(34,296	)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			89,873				99,180
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	108,897			$	64,884

See notes to condensed consolidated financial statements.

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Note 1 - Basis of Presentation

The accompanying unaudited condensed consolidated financial statements (“financial statements”) include the accounts of Compuware Corporation and its subsidiaries (collectively, the "Company", “Compuware”, “we”, “our” and “us”). All inter-company balances and transactions have been eliminated in consolidation.

The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, contingencies and results of operations. While management has based their assumptions and estimates on the facts and circumstances existing at December 31, 2013, final amounts may differ from these estimates.

In the opinion of management of the Company, the accompanying financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the interim periods presented. These financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto for the year ended March 31, 2013 included in the Company's annual report on Form 10-K filed with the Securities and Exchange Commission (“SEC”). The condensed consolidated balance sheet at March 31, 2013 has been derived from the audited financial statements at that date but does not include all information and footnotes required by U.S. GAAP for complete financial statements. The results of operations for interim periods are not necessarily indicative of results expected to be achieved for the full fiscal year.

On October 1, 2013, Covisint Corporation (“Covisint), previously a wholly owned subsidiary of Compuware Corporation, issued 7.36 million shares of its common stock (19.7 percent of shares outstanding after the issuance) in an Initial Public Offering (“IPO”) of its shares at a price to the public of $10 per share. Prior to completion of the Covisint IPO, the Company contributed the assets and liabilities of the Covisint segment to Covisint Corporation.

The non-controlling equity interest in Covisint is reflected as non-controlling interest in the accompanying condensed consolidated balance sheets and was $20.9 million as of December 31, 2013.

The Covisint IPO was accounted for as an equity transaction in accordance with ASC 810, “Consolidation” and no gain or loss has been recognized as the Company retained the controlling financial interest. The IPO and subsequent option exercises increased the Company’s equity attributable to non-controlling interest by $23.0 million, which represented the carrying value of the non-controlling interest and increased the Company’s additional paid in capital by $43.3 million.

Upon completion of the Covisint IPO and as of December 31, 2013, Compuware owned 80.3 percent and 80.03 percent, respectively, of the economic and voting interest in Covisint. The Company has announced its intention to effect a tax-free spin-off of all its Covisint shares following the March 2014 expiration of the lock-up period under the Covisint IPO underwriting agreement. The Company has requested a private letter ruling from the Internal Revenue Service (“IRS”) providing that, subject to certain conditions, the anticipated spin-off will be tax-free to Compuware and its stockholders for U.S. federal income tax purposes. The spin-off or other disposition is subject to various conditions, including Board approval, the receipt of any necessary regulatory or other approvals, the receipt of the private letter ruling from the IRS with confirmation of the tax-free nature of the proposed transaction, the receipt of an opinion of counsel and the existence of satisfactory market conditions.

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There can be no assurance as to when the proposed spin-off or any other disposition will be completed, if at all. Unless and until Compuware ceases to own a controlling financial interest in Covisint, the Company will consolidate Covisint for financial reporting purposes, with a non-controlling interest adjustment for the economic interest in Covisint that Compuware does not own.

In connection with the Covisint IPO, the Company entered into various agreements relating to the separation of the Covisint business from the rest of Compuware’s businesses, including a master separation agreement, an employee benefits agreement, a Compuware services agreement, an intellectual property agreement, a registration rights agreement, a shared services agreement and a tax sharing agreement.

The Company derives its revenue from licensing software products; providing maintenance and support services for those products; providing hosted software; and rendering professional and application services. Our software solutions are comprised of license fees, maintenance fees, subscription fees for hosted software and software related professional services fees.

We sometimes enter into arrangements that include both software related deliverables (licensed software products, maintenance services or software related professional services) and non-software deliverables (hosted software, professional services unrelated to our software products or application services). Our hosted software and application services do not qualify as software deliverables because our license grant does not allow the customer the right or capability to take possession of the software. For arrangements that contain both software and non-software deliverables, in accordance with ASC 605 “Revenue Recognition,” we allocate the arrangement consideration to the non-software deliverables as a group, and to the software deliverables as a group (the “Deliverable Groups”). We determine the selling price to allocate the arrangement consideration to the Deliverable Groups based on the following hierarchy of evidence: vendor specific objective evidence of selling price (“VSOE,” meaning price when sold separately) if available; third-party evidence of selling price if VSOE is not available; or best estimated selling price if neither VSOE nor third-party evidence is available. We currently are unable to establish VSOE or third-party evidence of selling price for either our software related deliverables or our non-software deliverables as a group. Therefore, the best estimate of selling price for each Deliverable Group is determined primarily by considering various factors, including, but not limited to stated renewal rates in a contract, if any, the historical selling price of these deliverables in similar stand-alone transactions and pricing practices. Total arrangement consideration is then allocated on the basis of the Deliverable Group’s relative selling price.

Once we have allocated the arrangement consideration between the Deliverable Groups, we recognize revenue as described in the respective software license fees, maintenance fees, subscription fees, professional services fees and application services fees sections below.

In order for a transaction to be eligible for revenue recognition, the following revenue criteria must be met: persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is reasonably assured. We evaluate collectability based on past customer history, external credit ratings and payment terms within customer agreements.

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Software license fees

The Company's software license agreements provide our customers with a right to use our software perpetually (perpetual licenses) or during a defined term (time-based licenses).

Assuming all revenue recognition criteria are met, perpetual license fee revenue is recognized using the residual method, under which the fair value, based on VSOE, of all undelivered elements of the agreement (i.e., maintenance and software related professional services) is deferred. VSOE is based on rates charged for maintenance and professional services when sold separately. The remaining portion of the fee is recognized as license fee revenue upon delivery of the products.

For revenue arrangements where there is a lack of VSOE for any undelivered elements, license fee revenue is deferred and recognized upon delivery of those elements or when VSOE can be established. However, when maintenance or software related professional services are the only undelivered elements, the license fee revenue is recognized on a ratable basis over the longer of the maintenance term or the period the software related professional services are expected to be performed. Such transactions include time-based licenses and certain unlimited capacity licenses, as the Company has not established VSOE for the undelivered elements in these arrangements. In order to comply with SEC Regulation S-X, Rule 5-03(b), which requires product, services and other categories of revenue to be displayed separately on the income statement, the Company separates the license fee, maintenance fee and software related professional services fee (which is included in professional services fees) associated with these types of arrangements based on its determination of fair value. The Company applies VSOE for maintenance related to perpetual license transactions and stand-alone software related professional services arrangements as a reasonable and consistent approximation of fair value to separate license fee, maintenance fee and software related professional services fee revenue for income statement classification purposes.

The Company offers flexibility to customers purchasing licenses for its products and related maintenance. Terms of these transactions range from standard perpetual license sales that include one year of maintenance to multi-year (generally two to five years), multi-product contracts. The Company allows deferred payment terms with installments collectable over the term of the contract. Based on the Company’s successful collection history for deferred payments, license fees (net of any financing fees) are generally recognized as revenue as discussed above. In certain transactions where it cannot be concluded that the fee is fixed or determinable due to the nature of the deferred payment terms, the Company recognizes revenue as payments become due. Financing fees are recognized as interest income over the term of the related receivable.

Maintenance fees

The Company’s maintenance arrangements allow customers to receive technical support and advice, including problem resolution services and assistance in product installation, error corrections and any product enhancements released during the maintenance period. The first year of maintenance is generally included with all license agreements. Maintenance fees are recognized ratably over the term of the maintenance arrangements, which generally range from one to five years.

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Subscription fees

Subscription fees relate to arrangements that permit our customers to access and utilize our hosted software delivered on a software-as-a-service (“SaaS”) basis. Subscription fees are deferred upon contract execution and are recognized ratably over the term of the subscription.

Professional services fees

The Company provides a broad range of IT services for mainframe, distributed, web and mobile environments, including mobile computing application development and integration, package software customization, cloud computing consulting, development and integration of legacy systems, IT portfolio management services, enterprise legacy modernization services and application performance management. The Company also offers implementation, consulting and training services in tandem with the Company’s software solutions offerings, which are referred to as software related professional services.

Professional services fees are generally based on hourly or daily rates. Revenues from professional services are recognized in the period the services are performed provided that collection of the related receivable is reasonably assured. For development services rendered under fixed-price contracts, revenues are recognized using the proportional performance method and if it is determined that costs will exceed revenue, the expected loss is recorded at the time the loss becomes apparent.

Application services fees

Our application services fees consist of fees related to our Covisint on-demand software including associated services. The arrangements do not provide customers the right to take possession of the software at any time, nor do the arrangements contain rights of return. Many of our application services contracts include a services project fee and a recurring fee for ongoing platform-as-a-service (“PaaS”) operations. Certain services related to these projects have stand-alone value (e.g., other vendors provide similar services) and qualify as a separate unit of accounting. Services that have stand-alone value are recognized as delivered. For those services that do not have stand-alone value, the revenue is deferred and recognized over the longer of the committed term of the subscription agreement (generally one to five years) or the expected period over which the customer will receive benefit (generally five years). The recurring fees are recognized ratably over the applicable service period.

Deferred revenue consists primarily of billed and unbilled maintenance and subscription fees related to the future service period of maintenance and subscription agreements in effect at the reporting date. Deferred license, software related services and application services fees are also included in deferred revenue for those arrangements that are being recognized over time. Sales commission costs that directly relate to revenue transactions that are deferred are recorded as “prepaid expenses and other current assets” or non-current “other assets”, as applicable, in the condensed consolidated balance sheets and recognized as "cost of application services" or “sales and marketing” expenses, as applicable, in the condensed consolidated statements of operations over the revenue recognition period of the related customer contracts.

Research and development (“R&D”) costs primarily include the cost of programming personnel and amounted to $23.6 million and $26.2 million for the three months ended December 31, 2013 and 2012, respectively, and $72.7 million and $77.7 million for the nine months ended December 31, 2013 and 2012, respectively. R&D costs related to our software solutions are reported as “technology development and support” and for our application services network, the costs are reported as “cost of application services” in the condensed consolidated statements of operations.

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The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax bases of assets and liabilities and net operating loss and credit carryforwards using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the period that includes the enactment date. The Company does not permanently reinvest any earnings in its foreign subsidiaries and recognizes all deferred tax liabilities that arise from outside basis differences in its investment in subsidiaries.

 

The Company records net deferred tax assets to the extent it believes these assets will more likely than not be realized. These deferred tax assets are subject to periodic assessments as to recoverability and if it is determined that it is more likely than not that the benefits will not be realized, valuation allowances are recorded which would increase the provision for income taxes. In making such determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations.

 

Interest and penalties related to uncertain tax positions are included in the income tax provision.

 

The Company’s effective tax rate for the nine months ended December 31, 2013 was 26.5% as compared to 36.7% for the nine months ended December 31, 2012. The decline in the effective rate was primarily due to the recording of a benefit related to (i) stock compensation as a result of a change in our expectation regarding the tax deductibility of compensation for a certain officer during the first quarter of 2014; and (ii) the enactment of new tax legislation in Mexico during the third quarter of 2014.  The tax deductibility of this officer’s compensation is no longer subject to the tax deduction threshold for officer compensation.  Accordingly, a deferred tax asset was recorded related to the stock compensation that was previously expected to be disallowed for tax purposes and the Mexico deferred tax assets were revalued to reflect the enacted tax method.

 

Cash paid for income taxes was $29.3 million and $3.7 million for the nine months ended December 31, 2013 and 2012, respectively.

In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” The amendments in this ASU provide guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. We plan to adopt this ASU in fiscal 2015 and do not expect it to have a significant impact on our financial statements.

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In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet (Topic 210)”. The amendments in this ASU require improved disclosure information about financial instruments and derivative instruments that are either offset or subject to an enforceable master netting arrangement or similar agreement. Subsequently in January 2013, the FASB issued ASU 2013-01, “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities”, which clarifies the types of instruments and transactions that are subject to the offsetting disclosure requirements established by ASU 2011-11. These ASUs should be applied retrospectively for all comparative periods presented for annual periods beginning on or after January 1, 2013 and interim periods within those annual periods. The requirements of these ASUs were adopted during our quarter ended June 30, 2013 and did not have a significant impact on our disclosures.

Note 2 – Financing Receivables

In accordance with ASU No. 2010-20 “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses,” the Company allows deferred payment terms that exceed one year for customers purchasing licenses (perpetual or time-based) for our software products and the related maintenance services (“multi-year deferred payment arrangements”). A financing receivable exists when the license transfers to the customer or the related maintenance service has been provided (i.e., revenue recognition has occurred) prior to the due date of the related receivable. Our products financing receivables primarily consist of the perpetual license portion of outstanding multi-year deferred payment arrangements.

The following is an aged analysis of our products and loans financing receivables based on invoice dates as of December 31, 2013 and March 31, 2013 (in thousands):

 

		As of December 31, 2013
		0-29 days past invoice date				30-90 days past invoice date				Greater than 90 days past invoice date				Unbilled				Total financing receivables
Pass rating
Software products		$	9,019			$	581			$	188			$	34,820			$	44,608

 

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		As of March 31, 2013
		0-29 days past invoice date				30-90 days past invoice date				Greater than 90 days past invoice date				Unbilled				Total financing receivables
Pass rating
Software products		$	3,311			$	679			$	1,324			$	42,659			$	47,973
Loans															3,771				3,771
Total			3,311				679				1,324				46,430				51,744
Watch rating
Software products											179								179
Total financing receivables		$	3,311			$	679			$	1,503			$	46,430			$	51,923

The loan receivable as of March 31, 2013 was fully collected as of December 31, 2013. As of December 31, 2013 the company had no financing receivables with a “watch” rating and no allowance for credit losses on our financing receivables.  At March 31, 2013, the allowance for credit losses on our financing receivables was $179,000.

Note 3 - Foreign Currency Transactions and Derivatives

The Company is exposed to foreign exchange rate risks related to assets and liabilities that are denominated in non-local currency and current inter-company balances due to and from the Company’s foreign subsidiaries. The Company enters into foreign currency forward contracts to sell or buy currencies with the intent of mitigating foreign exchange rate risks related to these balances. The Company does not hedge currency risk related to anticipated revenue or expenses denominated in foreign currency. All foreign exchange derivatives are recognized in the condensed consolidated balance sheets at fair value. See note 4 of the condensed consolidated financial statements for further information.

The foreign currency net gains or (losses) for the three months ended December 31, 2013 and 2012 were ($465,000) and ($323,000), respectively and for the nine months ended December 31, 2013 and 2012 were ($3.4 million) and ($1.4 million), respectively. The hedging transaction net gains or (losses) from foreign exchange derivative contracts for the three months ended December 31, 2013 and 2012 were $81,000 and $54,000, respectively and for the nine months ended December 31, 2013 and 2012 were $978,000 and $525,000, respectively. These amounts were recorded to “administrative and general” in the condensed consolidated statements of operations.

The Company has derivative contracts maturing through January 2014 to sell $3.0 million and purchase $12.0 million in foreign currencies at December 31, 2013 and had derivative contracts maturing through April 2013 to sell $1.8 million and purchase $15.5 million in foreign currencies at March 31, 2013.

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Note 4 - Fair Value of Assets and Liabilities

The Company reports its money market funds and foreign exchange derivatives at fair value on a recurring basis using the following fair value hierarchy: (1) Level 1 - quoted prices in active markets for identical assets or liabilities; (2) Level 2 – inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and (3) Level 3 - unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis (in thousands):

		As of December 31, 2013
		Estimated Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Cash equivalents - money market funds		$	5,282			$	5,282				-				-
Liabilities:
Foreign exchange derivatives		$	33				-			$	33				-
		As of March 31, 2013
		Estimated Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Cash equivalents - money market funds		$	11,525			$	11,525				-				-
Foreign exchange derivatives		$	31				-			$	31				-

Non-financial assets such as goodwill and intangible assets are also subject to nonrecurring fair value measurements if they are deemed to be impaired. See note 7 of the condensed consolidated financial statements for further information.

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Note 5 - Computation of Earnings per Common Share

Earnings per common share data were computed as follows (in thousands, except per share amounts):

		Three Months Ended December 31,								Nine Months Ended December 31,
Basic earnings per share:		2013				2012				2013				2012
Numerator:
Net income attributable to Compuware Corporation		$	25,022			$	25,340			$	51,329			$	46,402
Denominator:
Weighted-average common shares outstanding			216,856				212,836				215,146				215,318
Basic earnings per share		$	0.12			$	0.12			$	0.24			$	0.22
Diluted earnings per share:
Numerator:
Net income attributable to Compuware Corporation		$	25,022			$	25,340			$	51,329			$	46,402
Denominator:
Weighted-average common shares outstanding			216,856				212,836				215,146				215,318
Dilutive effect of stock awards			4,705				4,036				5,530				4,153
Total shares			221,561				216,872				220,676				219,471
Diluted earnings per share		$	0.11			$	0.12			$	0.23			$	0.21

During the three months ended December 31, 2013 and 2012, stock awards to purchase 3.3 million and 7.8 million shares, respectively, were excluded from the diluted earnings per share calculation because they were anti-dilutive and stock awards to purchase 2.9 million and 5.3 million shares, respectively, were excluded from the calculation because the performance conditions for vesting had not yet been met. During the nine months ended December 31, 2013 and 2012, stock awards to purchase 3.0 million and 11.8 million shares, respectively, were excluded from the diluted earnings per share calculation because they were anti-dilutive and stock awards to purchase 3.8 million and 2.8 million shares, respectively, were excluded from the calculation because the performance conditions for vesting had not yet been met. See note 6 of the condensed consolidated financial statements for a discussion of options with performance conditions and performance based stock awards.

Note 6 – Stock Benefit Plans and Stock-Based Compensation

The Company has the following stock benefit plans: (1) the Amended and Restated 2007 Long Term Incentive Plan (“2007 LTIP”) allows the Company’s Compensation Committee to grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance-based cash or restricted stock unit awards and cash incentive awards to employees and directors of the Company; (2) the Employee Stock Purchase Plan allows participating U.S. and Canadian employees the right to have up to 10% of their compensation withheld to purchase Company common stock at a 5% discount; and (3) the Employee Stock Ownership Plan and Trust/401(k) Plan (“ESOP/401(k)”), which includes a qualified cash or deferred arrangement as described under Section 401(k) of the Internal Revenue Code, allows the Company to make contributions to the ESOP/401(k) for the benefit of substantially all U.S. employees.

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Covisint Corporation (“Covisint”), a subsidiary of the Company, maintains a stock benefit plan referred to as the 2009 Long-Term Incentive Plan (“2009 Covisint LTIP”) allowing the board of directors of Covisint to grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance-based cash or restricted stock unit awards and cash incentive awards to employees and directors of Covisint and the Company.

The Company provides a matching program for the 401(k) component of the ESOP/401(k). The Company matches 33% of employees’ 401(k) contributions up to 2% of eligible earnings. Matching contributions by the Company vest 100% when an employee attains three years of service with the Company. During the three months ended December 31, 2013 and 2012, the Company expensed $944,000 and $900,000, respectively, and for both the nine months ended December 31, 2013 and 2012, the Company expensed $3.3 million related to this plan.

Options that Vest Based on Service Conditions Only

A summary of activity for options that vest based on service conditions only under the Company’s stock-based compensation plans as of December 31, 2013, and changes during the nine months then ended is presented below (shares and intrinsic value in thousands):

		Nine Months Ended December 31, 2013
		Number of Options				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term in Years				Aggregate Intrinsic Value
Options outstanding as of March 31, 2013			19,076			$	8.44
Granted			1,146				10.63
Exercised			(3,447	)			7.81							$	10,811
Forfeited			(376	)			10.18
Cancelled/expired			(1,424	)			8.22
Options outstanding as of December 31, 2013			14,975			$	8.73				6.57			$	38,076
Options vested and expected to vest, net of estimated forfeitures, as of December 31, 2013			14,465			$	8.68				6.49			$	37,378
Options exercisable as of December 31, 2013			9,628			$	8.32				5.64			$	28,385

The average fair value of stock options vested during the nine months ending December 31, 2013 and 2012 was $3.99 and $4.14 per share, respectively.

Options that Vest Based on both Performance and Service Conditions (“Performance Options”)

As of December 31, 2013, 2.7 million stock options that vest based on both service and performance conditions were outstanding. The performance vesting conditions for these options are based on company-wide revenue and earnings targets. As of December 31, 2013, it is deemed probable that the performance targets for approximately 190,000 of these options will be achieved. Expense totaling $394,000 and a reduction to expense of $21,000 were recorded in the condensed consolidated statement of operations related to these stock options during the nine months and three months ended December 31, 2013, respectively. The reduction to expense during the three months ended December 31, 2013 was related to a change in the expected attainment associated with certain performance conditions. No expense was recorded in the condensed consolidated statement of operations related to these stock options during the nine months ended December 31, 2012.

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A summary of activity for options that vest based on the achievement of both service and performance conditions under the Company’s stock-based compensation plans as of December 31, 2013, and changes during the nine months then ended is presented below (shares and intrinsic value in thousands):

		Nine Months Ended December 31, 2013
		Number of Options				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term in Years				Aggregate Intrinsic Value
Options outstanding as of March 31, 2013			3,648			$	9.79
Granted			594				11.30
Forfeited/Cancelled			(1,529	)			10.00
Options outstanding as of December 31, 2013			2,713			$	10.00				8.79			$	3,435
Options vested and expected to vest, net of estimated forfeitures, as of December 31, 2013			190			$	11.30				9.37			$	-
Options exercisable as of December 31, 2013			-			$	-				-			$	-

The weighted average fair value of stock options granted during the periods and the assumptions used to estimate those values using the Black-Scholes option pricing model were as follows:

		Nine Months Ended December 31,
		2013				2012
Expected volatility			39.52	%			40.83	%
Risk-free interest rate			1.59	%			0.95	%
Expected lives at date of grant (in years)			6.3				6.3
Weighted-average fair value of the options granted		$	2.69			$	4.02
Dividend yield assumption (1)			4.42	%			0.00	%

(1)	In January 2013, our Board of Directors announced its intention to begin paying cash dividends totaling $0.50 per share annually. Prior to that, the Company had never paid a dividend or announced any intentions to pay a dividend.

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A summary of non-vested restricted stock units (“RSUs”) and performance-based stock awards (“PSAs” and collectively “Non-vested RSUs”) activity under the Company’s LTIP as of December 31, 2013, and changes during the nine months then ended is presented below (shares and intrinsic value in thousands):

		Nine Months Ended December 31, 2013
		Shares				Weighted Average Grant-Date Fair Value				Aggregate Intrinsic Value
Non-vested RSUs outstanding as of March 31, 2013			4,850
Granted			518			$	11.26
Dividend equivalents issued			99				10.98
Released			(1,681	)						$	18,204
Forfeited			(1,362	)
Non-vested RSUs outstanding as of December 31, 2013			2,424

Approximately 31,000 PSAs with performance conditions based on company-wide revenue and earnings targets were outstanding as of December 31, 2013. It is not deemed probable that these targets will be achieved as of December 31, 2013.

During the first nine months of 2014, the Company paid three quarterly dividends of $0.125 per share. In connection with this, approximately 21,000 and 99,000 dividend equivalent shares were issued to participants holding non-vested RSUs in the form of additional non-vested RSUs with the same terms, as of the dividend record date during the three and nine months ended December 31, 2013, respectively.

In August 2009, Covisint established a 2009 Long-Term Incentive Plan (“2009 Covisint LTIP”) allowing the board of directors of Covisint to grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance-based cash or restricted stock unit awards and annual cash incentive awards to employees and directors of Covisint and its affiliates. The 2009 Covisint LTIP reserves 4.5 million common shares of Covisint for issuance under this plan. On December 30, 2013, the board of directors of Covisint adopted an amendment to the 2009 Covisint LTIP, subject to shareholder approval which increased the number of shares of Covisint’s common stock available for issuance pursuant to stock-based awards granted under the LTIP by 3.0 million shares to 7.5 million (less shares subject to previous grants). The amendment was approved by shareholders and became effective in January 2014.

As of December 31, 2013, there were 4.2 million stock options outstanding from the 2009 Covisint LTIP, which reflects the 30-for-1 stock split approved by the Covisint board of directors on May 23, 2013. These options include a performance condition requiring a change in control or IPO of Covisint prior to vesting.  Many of these options vested upon the October 1, 2013 closing of Covisint’s IPO.  Expense related to these options of $3.6 million and cumulative expense of $16.1 million was recorded to cost of application services during the three months and nine months ended December 31, 2013, respectively.

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Certain employees who received stock options from the 2009 Covisint LTIP were also awarded PSAs from the Company’s 2007 LTIP. Approximately 1.1 million of these PSAs were cancelled during the three months ended December 31, 2013 upon the closing of the Covisint IPO.

Stock award compensation expense was allocated as follows (in thousands):

		Three Months Ended December 31,								Nine Months Ended December 31,
		2013				2012				2013				2012
Stock-based compensation classified as:
Cost of maintenance fees		$	-			$	164			$	348			$	616
Cost of subscription fees			(54	)			(47	)			(24	)			6
Cost of professional services			67				65				244				225
Cost of application services			3,765				396				14,271				1,105
Technology development and support			(27	)			468				1,078				1,842
Sales and marketing			1,152				1,328				4,736				4,515
Administrative and general			1,861				3,110				9,632				12,354
Restructuring costs			450				-				2,241				-
Total stock-based compensation expense before income tax provision		$	7,214			$	5,484			$	32,526			$	20,663

As of December 31, 2013, it is expected that total unrecognized compensation cost of $29.6 million, net of estimated forfeitures, related to nonvested Compuware and Covisint equity awards that are expected to vest will be recognized over a weighted-average period of approximately 1.72 years.

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		APM				MF				CP				UF				PS				AS				Total
Goodwill as of March 31, 2013		$	469,947			$	140,557			$	22,079			$	21,280			$	42,794			$	25,385			$	722,042
Effect of foreign currency translation			13,369				-				-				-				-				-				13,369
Goodwill as of December 31, 2013		$	483,316			$	140,557			$	22,079			$	21,280			$	42,794			$	25,385			$	735,411

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		As of December 31, 2013
		Gross Carrying Amount				Accumulated Amortization				Net Carrying Amount
Unamortized intangible assets:
Trademarks		$	4,394							$	4,394
Amortized intangible assets:
Capitalized software
Internally developed			262,752			$	(199,872	)			62,880
Purchased			131,395				(114,425	)			16,970
Customer relationship			52,232				(28,387	)			23,845
Other			20,513				(18,954	)			1,559
Total amortized intangible assets		$	466,892			$	(361,638	)		$	105,254
		As of March 31, 2013
		Gross Carrying Amount				Accumulated Amortization				Net Carrying Amount
Unamortized intangible assets:
Trademarks		$	4,428							$	4,428
Amortized intangible assets:
Capitalized software
Internally developed			243,872			$	(184,732	)			59,140
Purchased			165,117				(142,453	)			22,664
Customer relationship			52,036				(25,281	)			26,755
Other			19,884				(16,208	)			3,676
Total amortized intangible assets		$	480,909			$	(368,674	)		$	112,235

 

Capitalized software includes the costs of internally developed software technology and software technology purchased through acquisitions. Internally developed capitalized software costs and capitalized purchased software technology are being amortized over periods up to five years.

Customer relationship agreements are related to acquisition activity and are being amortized over periods up to ten years.

Other amortized intangible assets include amortizable trademarks and patents relating to acquisition activity and are being amortized over periods up to three years.

Unamortized trademarks were acquired as part of the Covisint and Changepoint acquisitions. These trademarks are deemed to have an indefinite life.

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Amortization expense of capitalized software, customer relationship and other intangible assets was as follows (in thousands):

		Three Months Ended December 31,								Nine Months Ended December 31,
		2013				2012				2013				2012
Amortized intangible assets:
Capitalized software
Internally developed		$	5,219			$	3,965			$	15,141			$	11,228
Purchased			1,988				2,420				6,749				7,199
Customer relationship			1,034				1,045				3,097				3,130
Other			770				826				2,302				2,643
Total amortization expense		$	9,011			$	8,256			$	27,289			$	24,200

Capitalized software amortization related to our on-premises software is reported as “cost of software license fees”, amortization related to our hosted software is reported as “cost of subscription fees” and amortization related to our application services is reported as “cost of application services” in the condensed consolidated statements of operations.

Customer relationship amortization related to our software solutions segments is reported as “sales and marketing” and amortization related to our application services segment is reported as “cost of application services” in the condensed consolidated statements of operations.

Amortization expense associated with trademarks and trade names related to our software solutions segments is reported as “cost of license fees” and amortization related to our application services segment is reported as “cost of application services” in the condensed consolidated statements of operations.

Based on the capitalized software, customer relationship and other intangible assets recorded through December 31, 2013, the annual amortization expense over the next five fiscal years and thereafter is expected to be as follows (in thousands):

		Fiscal Year Ended March 31,
		2014				2015				2016				2017				2018				Thereafter
Amortized intangible assets:
Capitalized software		$	29,721			$	26,995			$	23,341			$	13,402			$	6,431			$	1,850
Customer relationship			4,133				4,142				4,142				3,977				3,833				6,715
Other			3,082				779				-				-				-				-
Total amortization expense		$	36,936			$	31,916			$	27,483			$	17,379			$	10,264			$	8,565

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Note 8 – Segment Information

The Company evaluates the performance of its segments based primarily on revenue growth and contribution margin which is operating profit before certain charges such as restructuring, internal information system support, finance, human resources, legal, administration and other corporate charges (“unallocated expenses”). Transactions between segments are eliminated.  The allocation of income taxes is not evaluated at the segment level. Financial information for the Company’s business segments was as follows (in thousands):

		Three Months Ended December 31, 2013
		APM				MF				CP				UF				PS				AS				Unallocated Expenses & Eliminations (1)				Total
Software license fees		$	39,761			$	11,436			$	3,019			$	2,478			$	-			$	-			$	-			$	56,694
Maintenance fees			26,094				63,616				4,139				7,751				-				-				-				101,600
Subscription fees			20,982				-				751				-				-				-				-				21,733
Professional services fees			7,767				41				3,165				1,061				34,644				-				(300	)			46,378
Application services fees			-				-				-				-				-				24,109				-				24,109
Total revenues			94,604				75,093				11,074				11,290				34,644				24,109				(300	)			250,514
Operating expenses			76,127				18,196				10,704				5,499				28,457				29,322				52,305				220,610
Contribution /operating margin		$	18,477			$	56,897			$	370			$	5,791			$	6,187			$	(5,213	)		$	(52,605	)		$	29,904