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, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
--------- ---------
COMMISSION FILE NUMBER 000-20900
COMPUWARE CORPORATION
---------------------
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2007430
(State or other jurisdiction of (IRS Employer
incorporation or organization) 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. Yes [X] No [ ]
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 [ ] Non-accelerated filer [ ]
Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] 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 January 31, 2008, there were outstanding 274,214,258 shares of Common
Stock, par value $.01, of the registrant.
Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
December 31, 2007 and March 31, 2007 3
Condensed Consolidated Statements of Operations
for the three and nine months ended December 31, 2007 and 2006 4
Condensed Consolidated Statements of Cash Flows
for the nine months ended December 31, 2007 and 2006 5
Notes to Condensed Consolidated Financial
Statements 6
Report of Independent Registered Public Accounting Firm 19
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures about Market Risk 35
Item 4. Controls and Procedures 35
PART II. OTHER INFORMATION
Item 1A. Risk Factors 36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 36
Item 6. Exhibits 37
SIGNATURES 38
2
COMPUWARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
DECEMBER 31, MARCH 31,
2007 2007
------------ ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 178,620 $ 260,681
Investments 87,171 107,062
Accounts receivable, net 413,203 420,774
Deferred tax asset, net 42,622 33,392
Income taxes refundable, net 58,266
Prepaid expenses and other current assets 31,569 41,019
----------- ----------
Total current assets 753,185 921,194
----------- ----------
INVESTMENTS 71,391
----------- ----------
PROPERTY AND EQUIPMENT, LESS ACCUMULATED
DEPRECIATION AND AMORTIZATION 370,641 385,227
----------- ----------
CAPITALIZED SOFTWARE, LESS ACCUMULATED
AMORTIZATION 63,165 72,276
----------- ----------
OTHER:
Accounts receivable 200,506 172,255
Deferred tax asset, net 37,541 15,987
Goodwill 353,104 353,682
Other 35,131 37,400
----------- ----------
Total other assets 626,282 579,324
----------- ----------
TOTAL ASSETS $1,813,273 $2,029,412
=========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 19,069 $ 27,713
Accrued expenses 132,391 141,970
Income taxes payable, net 5,004
Deferred revenue 329,460 359,688
----------- ----------
Total current liabilities 485,924 529,371
DEFERRED REVENUE 328,814 321,881
ACCRUED EXPENSES 18,639 11,346
DEFERRED TAX LIABILITY, NET 16,463 34,666
----------- ----------
Total liabilities 849,840 897,264
----------- ----------
SHAREHOLDERS' EQUITY:
Common stock 2,742 3,030
Additional paid-in capital 669,344 673,660
Retained earnings 272,430 444,159
Accumulated other comprehensive income 18,917 11,299
----------- ----------
Total shareholders' equity 963,433 1,132,148
----------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,813,273 $2,029,412
=========== ==========
See notes to unaudited condensed consolidated financial statements.
3
COMPUWARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------- ------------------
2007 2006 2007 2006
-------- -------- -------- --------
REVENUES:
Software license fees $ 79,425 $ 86,013 196,712 $210,187
Maintenance fees 120,026 114,432 350,063 339,881
Professional services fees 109,884 114,703 343,920 349,905
-------- -------- -------- --------
Total revenues 309,335 315,148 890,695 899,973
-------- -------- -------- --------
OPERATING EXPENSES:
Cost of software license fees 6,685 7,529 23,660 21,124
Cost of maintenance fees 11,452 10,157 33,110 30,079
Cost of professional services 103,705 102,189 309,752 313,449
Technology development and support 23,636 27,047 77,134 83,904
Sales and marketing 66,392 73,346 196,580 206,825
Administrative and general 46,158 52,139 134,412 143,523
Restructuring costs 4,894 39,645
-------- -------- -------- --------
Total operating expenses 262,922 272,407 814,293 798,904
-------- -------- -------- --------
INCOME FROM OPERATIONS 46,413 42,741 76,402 101,069
OTHER INCOME, NET 4,650 9,012 15,736 30,506
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES 51,063 51,753 92,138 131,575
INCOME TAX PROVISION 15,449 15,267 18,919 40,959
-------- -------- -------- --------
NET INCOME $ 35,614 $ 36,486 $ 73,219 $ 90,616
======== ======== ======== ========
Basic earnings per share $ 0.13 $ 0.11 $ 0.25 $ 0.25
======== ======== ======== ========
Diluted earnings per share $ 0.13 $ 0.11 $ 0.25 $ 0.25
======== ======== ======== ========
See notes to unaudited condensed consolidated financial statements.
4
COMPUWARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
DECEMBER 31,
---------------------
2007 2006
--------- ---------
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income $ 73,219 $ 90,616
Adjustments to reconcile net income to
net cash provided by operations:
Depreciation and amortization 41,364 40,547
Property and equipment impairment
associated with restructuring 3,079
Capitalized software impairment associated
with restructuring 3,873
Acquisition tax benefits 3,932 3,860
Stock option compensation 8,773 7,211
Deferred income taxes (14,039) 9,864
Other 1,072 (183)
Net change in assets and liabilities,
net of effects from acquisitions
and currency fluctuations:
Accounts receivable 1,387 36,782
Prepaid expenses and other current assets 10,422 (2,689)
Other assets 1,201 (166)
Accounts payable and accrued expenses (10,758) (18,155)
Deferred revenue (47,848) (76,125)
Income taxes 32,355 1,704
--------- ---------
Net cash provided by operating activities 108,032 93,266
--------- ---------
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Purchase of:
Businesses, net of cash acquired (20,484)
Property and equipment (8,828) (15,317)
Capitalized software (11,263) (16,003)
Proceeds from sale of property 15,466
Investments:
Proceeds 90,255 368,120
Purchases (376,387)
--------- ---------
Net cash provided by (used in)
investing activities 70,164 (44,605)
--------- ---------
CASH FLOWS USED IN FINANCING ACTIVITIES:
Net proceeds from exercise of stock options
including excess tax benefits 66,531 11,899
Contribution to stock purchase plans 3,184 3,688
Repurchase of common stock (337,785) (398,741)
--------- ---------
Net cash used in financing activities (268,070) (383,154)
--------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 7,813 6,482
--------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS (82,061) (328,011)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 260,681 612,062
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 178,620 $ 284,051
========= =========
See notes to unaudited condensed consolidated financial statements.
5
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2007
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements include
the accounts of Compuware Corporation and its wholly owned subsidiaries
(collectively, the "Company"). All intercompany balances and transactions have
been eliminated in consolidation.
The accompanying unaudited condensed consolidated 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. Generally accepted accounting
principles require 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, 2007, final amounts may differ
from these estimates.
In the opinion of management of the Company, the accompanying unaudited
condensed consolidated financial statements reflect all adjustments, consisting
only of normal recurring adjustments, that are 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, 2007 included in the
Company's Annual Report to Shareholders on Form 10-K filed with the Securities
and Exchange Commission ("SEC"). The condensed consolidated balance sheet at
March 31, 2007 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 actual results achieved for full fiscal years.
Revenue Recognition - The Company earns revenue from licensing software
products, providing maintenance and support for those products and rendering
professional services. The Company's revenue recognition policies are in
accordance with U.S. GAAP, including Statements of Position 97-2 "Software
Revenue Recognition" and 98-9 "Modification of SOP 97-2, 'Software Revenue
Recognition,' With Respect to Certain Transactions", Securities and Exchange
Commission Staff Accounting Bulletin 104 and Emerging Issues Task Force Issue
00-21 "Revenue Arrangements with Multiple Deliverables". Accordingly, the
Company recognizes revenue when all of the following criteria are met:
persuasive evidence of an arrangement exists, delivery has occurred or services
have been rendered, the fee is fixed or determinable, and collectibility is
reasonably assured.
Software license fees - The Company's software license agreements provide its
customers with a right to use its software perpetually (perpetual licenses) or
during a defined term (term licenses).
Perpetual license fee revenue is recognized using the residual method, under
which the fair value, based on vendor specific objective evidence ("VSOE"), of
all undelivered elements of the agreement (i.e., maintenance and professional
services) is deferred. VSOE is based on rates charged for maintenance and
professional services when sold separately. The remaining portion of the fee,
net of discretionary discounts (the residual), is recognized as license fee
revenue upon delivery of the products, provided that no significant obligations
remain and collection of the related receivable is deemed probable.
For revenue arrangements where there is a lack of VSOE of fair value for any
undelivered elements, license fee revenue is deferred and recognized upon
delivery of those elements or when VSOE of fair value can be established. When
maintenance or services are the only
6
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2007
(UNAUDITED)
undelivered elements, the license fee revenue is recognized on a ratable basis
over the longer of the maintenance term or over the period in which the services
are expected to be performed. Such transactions include term licenses as the
Company does not sell maintenance for term licenses separately and therefore
cannot establish VSOE for the undelivered elements in these arrangements. These
arrangements do not qualify for separate recognition of the software license
fees, maintenance fees and as applicable, professional services fees under SOP
97-2 as amended. However, 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 professional services fee revenue based on its determination
of fair value. The Company applies its VSOE of fair value for maintenance
related to perpetual license transactions and stand alone services arrangements
as a reasonable and consistent approximation of fair value to separate license
fee, maintenance fee and professional services fee revenue for income statement
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 large multi-year
(generally two to five years), multi-product contracts. The Company allows
deferred payment terms on multi-year contracts, with installments collectible
over the term of the contract. Based on the Company's successful collection
history for deferred payments, license fees (net of any finance fees) are
generally recognized as discussed above. In certain transactions where it cannot
be concluded that the fee is fixed or determinable at the time of the
arrangement due to the nature of the deferred payment terms, the Company
recognizes revenue as payments become due. The finance fee is recognized as
interest income over the term of the receivable.
Maintenance fees - The Company's maintenance agreements provide for 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 included with
all license agreements. Maintenance revenue is recognized ratably over the term
of the maintenance arrangements, which primarily range from one to five years.
Professional services fees - Professional services fees are generally based on
hourly or daily rates; therefore, revenues from professional services are
recognized in the period the services are performed provided that collection of
the related receivable is deemed probable. For development services rendered
under fixed-price contracts, revenue is recognized using the percentage of
completion method and if determined that costs will exceed revenue, the expected
loss is recorded at the time the loss becomes apparent. Certain professional
services contracts include a project and on-going operations for the project.
Revenue associated with these contracts is recognized over the service period as
the customer derives value from the services, consistent with the proportional
performance method.
Capitalized Software - Capitalized software includes the costs of purchased and
internally developed software products and is stated at the lower of unamortized
cost or net realizable value in accordance with Statement of Financial
Accounting Standards No. 86, "Accounting for the Costs of Computer Software to
be Sold, Leased, or Otherwise Marketed". Capitalization of internally developed
software products begins when technological feasibility of the product is
established. Technology development and support includes primarily the costs of
programming personnel associated with product development and support net of
amounts capitalized.
The amortization for both internally developed and purchased software products
is computed on a product-by-product basis. Capitalized software is reviewed for
impairment on each balance sheet date. The annual amortization is the greater of
the amount computed using (a) the ratio of current gross revenues compared with
the total of current and anticipated future revenues for that product, or (b)
the straight-line method over the remaining estimated economic life of the
7
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2007
(UNAUDITED)
product, including the period being reported on. Amortization begins when the
product is available for general release to customers. The amortization period
for capitalized software is generally five years.
Goodwill and Other Intangibles - Goodwill for each operating segment and
intangible assets with indefinite lives are tested for impairment annually and
when events or circumstances indicate that their fair value may have been
reduced below carrying value. The Company evaluated its goodwill and indefinite
lived intangibles as of March 31, 2007 and determined there was no impairment.
Income Taxes - The Company accounts for income taxes using the asset and
liability approach. Deferred income taxes are provided for the differences
between the tax bases of assets or liabilities and their reported amounts in the
financial statements.
Recently Issued Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 157 "Fair Value Measurements"
("SFAS 157"), which defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles and expands disclosures
about fair value measurements. SFAS 157 applies whenever other standards require
(or permit) assets or liabilities to be measured at fair value, and therefore,
does not expand the use of fair value in any new circumstances. This Statement
is effective for fiscal years beginning after November 15, 2007 except for in
the case of non-financial assets and liabilities measured on a non-recurring
basis. For these types of transactions, the application of SFAS 157 becomes
effective for fiscal years beginning after November 15, 2008. Management is
currently evaluating the impact this Statement will have on the Company's
financial statements.
In February 2007, the FASB issued Statement of Financial Accounting Standards
No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities,
Including an Amendment of FASB Statement No. 115," which permits entities to
measure eligible financial assets, financial liabilities and firm commitments at
fair value, on an instrument-by-instrument basis, that are otherwise not
permitted to be accounted for at fair value under other generally accepted
accounting principles. The fair value measurement election is irrevocable and
subsequent changes in fair value must be recorded in earnings. This Statement is
effective for fiscal years beginning after November 15, 2007. Management is
currently evaluating if it will elect the fair value option for any of the
Company's eligible financial instruments.
In December 2007, the FASB issued Statement of Financial Accounting Standards
No. 141 (revised 2007), "Business Combinations", which replaces Statement of
Financial Accounting Standards No. 141, "Business Combinations". This Statement
requires assets and liabilities acquired in a business combination, contingent
consideration and certain acquired contingencies, to be measured at their fair
value as of the date of acquisition. This Statement also requires that
acquisition-related costs and restructuring costs be recognized separately from
the business combination. This Statement is effective for fiscal years beginning
after December 15, 2008 and will be effective for business combinations entered
into after January 1, 2009. Management is currently evaluating the impact this
Statement will have on the Company's financial statements.
In December 2007, the FASB issued Statement of Financial Accounting Standards
No. 160, "Non-controlling Interests in Consolidated Financial Statements, an
Amendment of ARB No. 51". This Statement clarifies the accounting for
non-controlling interests and establishes
8
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2007
(UNAUDITED)
accounting and reporting standards for the non-controlling interest in a
subsidiary, including classification as a component of equity. This Statement is
effective for fiscal years beginning after December 15, 2008. Management is
currently evaluating the impact this Statement will have on the Company's
financial statements.
NOTE 2 - COMPUTATION OF EARNINGS PER COMMON SHARE
Earnings per common share data were computed as follows (in thousands, except
for per share data):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------- -------------------
2007 2006 2007 2006
-------- -------- -------- --------
BASIC EARNINGS PER SHARE:
Numerator: Net income $ 35,614 $ 36,486 $ 73,219 $ 90,616
-------- -------- -------- --------
Denominator:
Weighted-average common shares outstanding 281,359 342,078 292,514 360,833
-------- -------- -------- --------
Basic earnings per share $ 0.13 $ 0.11 $ 0.25 $ 0.25
======== ======== ======== ========
DILUTED EARNINGS PER SHARE:
Numerator: Net income $ 35,614 $ 36,486 $ 73,219 $ 90,616
-------- -------- -------- --------
Denominator:
Weighted-average common shares outstanding 281,359 342,078 292,514 360,833
Dilutive effect of stock options 1,123 1,021 1,757 510
-------- -------- -------- --------
Total shares 282,482 343,099 294,271 361,343
-------- -------- -------- --------
Diluted earnings per share $ 0.13 $ 0.11 $ 0.25 $ 0.25
======== ======== ======== ========
During the three and nine months ended December 31, 2007, stock options to
purchase a total of approximately 26,369,000 and 11,714,000 shares,
respectively, were excluded from the diluted earnings per share calculation
because they were anti-dilutive. During the three and nine months ended December
31, 2006, stock options to purchase a total of approximately 36,019,000 and
44,215,000 shares, respectively, were excluded from the diluted earnings per
share calculation because they were anti-dilutive.
NOTE 3 - COMPREHENSIVE INCOME
Other comprehensive income includes unrealized gain on marketable securities and
foreign currency translation gain and loss that have been excluded from net
income and reflected in equity. Total comprehensive income is summarized as
follows (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------ -----------------
2007 2006 2007 2006
------- ------- ------- -------
Net income $35,614 $36,486 $73,219 $90,616
Unrealized gain on marketable
securities, net of tax 71
Foreign currency translation
adjustment, net of tax (1,580) 1,770 7,618 4,982
------- ------- ------- -------
Total comprehensive income $34,034 $38,256 $80,837 $95,669
======= ======= ======= =======
9
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2007
(UNAUDITED)
NOTE 4 - STOCK BENEFIT PLANS AND STOCK-BASED COMPENSATION
The Company's Board of Directors adopted the 2007 Long Term Incentive Plan (the
"LTIP") in June 2007 and it was approved by the Company's shareholders in August
2007. The Company has reserved an aggregate of 28,000,000 common shares to be
awarded under the LTIP. The Compensation Committee may grant stock options,
stock appreciation rights, restricted stock, restricted stock units,
performance-based cash or stock awards and annual cash incentive awards under
the LTIP. All of the Company's other stock option plans have been terminated as
to future grants.
The Company also has an employee stock purchase plan under which rights to
purchase the Company's common stock are granted at 95% of the closing market
sales price on the market date immediately preceding the last day of the
offering period. Effective December 1, 2007, the Company discontinued the plan
for employees outside the U.S. and Canada. During the first nine months of
fiscal 2008, the Company sold approximately 362,000 shares pursuant to the plan.
The Company's stock-based compensation plan activity was as follows (shares and
intrinsic value in thousands):
Nine Months Ended December 31, 2007
----------------------------------------------
Weighted
Weighted Average
Average Remaining Aggregate
Number of Exercise Contractual Intrinsic
Options Price Term Value
--------- -------- ----------- ---------
Options outstanding as of April 1, 2007 43,710 $12.23
Granted 1,818 9.75
Exercised (6,999) 8.80
Forfeited (676) 7.29
Cancelled/expired (2,965) 14.87
------- ------
Options outstanding as of December 31, 2007 34,888 $12.66 3.58 $16,242
======= ======
Options vested and expected to vest, net of
estimated forfeitures,
as of December 31, 2007 33,075 $12.91 3.32 $14,257
Options exercisable as of December 31, 2007 28,125 $13.81 2.50 $ 7,729
The total fair value of shares vested and the total intrinsic value of options
exercised were as follows (intrinsic values in thousands):
Nine Months Ended
December 31,
-----------------
2007 2006
------- ------
Fair value of shares vested $ 5.12 $ 5.55
Intrinsic value of options exercised 16,588 1,928
Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based
Payment" requires the use of a valuation model to calculate the fair value of
stock option awards. The Company has elected to use the Black-Scholes option
pricing model, which incorporates various assumptions including volatility,
expected term, risk-free interest rates and dividend yields. The volatility is
based on historical volatility of the Company's common stock over the most
recent period commensurate with the estimated expected term of the stock option
granted. The Company uses historical volatility because management believes such
volatility is
10
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2007
(UNAUDITED)
representative of prospective trends. The expected term of an award is based on
the simplified method as described in Staff Accounting Bulletin 107. The
risk-free interest rate assumption is based upon observed interest rates
appropriate for the expected term of our awards. The dividend yield assumption
is based on the Company's history and expectation regarding dividend payouts.
The weighted average fair value of stock options granted during the periods and
the assumptions used to estimate those values using a Black-Scholes option
pricing model were as follows:
Nine Months Ended
December 31,
-----------------
2007 2006
------ -----
Expected volatility 59.35% 68.87%
Risk-free interest rate 4.15% 4.82%
Expected lives at date of grant (in years) 6.8 6.9
Weighted-average fair value of the options granted $ 6.07 $ 5.04
Dividend yields were not a factor in determining fair value of stock options
granted as the Company has never issued cash dividends and does not anticipate
issuing cash dividends in the future.
Stock-based compensation expense was allocated as follows (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------ -----------------
2007 2006 2007 2006
------ ------ ------- -------
Stock-based compensation classified as:
Cost of software license fees $ 1 $ 1 $ 2
Cost of maintenance fees $ 78 80 217 206
Cost of professional services 360 415 1,032 1,202
Technology development and support 164 213 506 574
Sales and marketing 552 866 1,684 3,036
Administrative and general 436 774 1,216 2,191
Restructuring costs (see Note 7) 4,117
------ ------ ------- -------
Total stock-based compensation expense
before income taxes 1,590 2,349 8,773 7,211
Income tax benefit (542) (799) (3,031) (2,452)
------ ------ ------- -------
Total stock-based compensation expense
after income taxes $1,048 $1,550 $ 5,742 $ 4,759
====== ====== ======= =======
As of December 31, 2007, $17.3 million of total unrecognized compensation cost,
net of estimated forfeitures, related to unvested stock options is expected to
be recognized over a weighted-average period of approximately 3.07 years.
11
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2007
(UNAUDITED)
NOTE 5 - GOODWILL AND INTANGIBLE ASSETS
The components of the Company's intangible assets were as follows (in
thousands):
December 31, 2007
--------------------------------------------
Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
-------------- ------------ ------------
Unamortized intangible assets:
Trademarks (1) $ 6,020 $ 6,020
======== =======
Amortized intangible assets:
Capitalized software (2) $336,898 $(273,733) $63,165
Customer relationship agreements (3) 14,050 (7,797) 6,253
Non-compete agreements (3) 2,848 (2,614) 234
Other (4) 6,891 (6,279) 612
-------- --------- -------
Total amortized intangible assets $360,687 $(290,423) $70,264
======== ========= =======
March 31, 2007
--------------------------------------------
Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
-------------- ------------ ------------
Unamortized intangible assets:
Trademarks (1) $ 5,865 $ 5,865
======== =======
Amortized intangible assets:
Capitalized software (2) $328,957 $(256,681) $72,276
Customer relationship agreements (3) 13,827 (5,571) 8,256
Non-compete agreements (3) 2,794 (2,222) 572
Other (4) 6,883 (5,900) 983
-------- --------- -------
Total amortized intangible assets $352,461 $(270,374) $82,087
======== ========= =======
(1) Certain trademarks were acquired as part of the Covisint, LLC and
Changepoint Corporation acquisitions. These trademarks are deemed to have
an indefinite life and therefore are not being amortized.
(2) Amortization and impairments of capitalized software are primarily included
in "Cost of software license fees" in the Condensed Consolidated Statements
of Operations. Capitalized software is generally amortized over five years
(see Note 7 to the Condensed Consolidated Financial Statements).
(3) Customer relationship agreements and non-compete agreements were acquired
as part of recent acquisitions. The customer relationship agreements are
being amortized over periods up to five years. The non-compete agreements
are being amortized over periods up to three years.
(4) Other amortized intangible assets include trademarks associated with
product acquisitions and are being amortized over periods up to ten years.
12
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2007
(UNAUDITED)
Changes in the carrying amounts of goodwill are summarized as follows (in
thousands):
Goodwill Products Services Total
-------- -------- --------
Balance at March 31, 2007, net $211,947 $141,735 $353,682
Adjustments to previously recorded purchase price (1) (1,285) 57 (1,228)
Effect of foreign currency translation 5 645 650
-------- -------- --------
Balance at December 30, 2007, net $210,667 $142,437 $353,104
======== ======== ========
(1) The adjustment to goodwill primarily relates to tax adjustments related to
prior acquisitions.
NOTE 6 - SEGMENTS
The Company operates in two business segments in the technology industry:
products and professional services. The Company provides software products and
professional services to IT organizations that help IT professionals efficiently
develop, implement and support the applications that run their businesses.
Financial information for the Company's business segments is as follows (in
thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------- -------------------
2007 2006 2007 2006
-------- -------- -------- --------
Revenues:
Products:
Mainframe $125,710 $132,194 $339,421 $365,881
Distributed systems 73,741 68,251 207,354 184,187
-------- -------- -------- --------
Total product revenue 199,451 200,445 546,775 550,068
Professional services 109,884 114,703 343,920 349,905
-------- -------- -------- --------
Total revenues $309,335 $315,148 $890,695 $899,973
======== ======== ======== ========
Operating expenses:
Products $108,165 $118,079 $330,484 $341,932
Professional services 103,705 102,189 309,752 313,449
Corporate expenses 46,158 52,139 134,412 143,523
Restructuring costs 4,894 39,645
-------- -------- -------- --------
Total operating expenses $262,922 $272,407 $814,293 $798,904
======== ======== ======== ========
Income from operations
before other income:
Products $ 91,286 $ 82,366 $216,291 $208,136
Professional services 6,179 12,514 34,168 36,456
Corporate expenses (46,158) (52,139) (134,412) (143,523)
Restructuring costs (4,894) (39,645)
-------- -------- -------- --------
Income from operations
before other income 46,413 42,741 76,402 101,069
Other income, net 4,650 9,012 15,736 30,506
-------- -------- -------- --------
Income before income taxes $ 51,063 $ 51,753 $ 92,138 $131,575
======== ======== ======== ========
13
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2007
(UNAUDITED)
Financial information regarding geographic operations is presented in the table
below (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------- -------------------
2007 2006 2007 2006
-------- -------- -------- --------
Revenues:
United States $186,436 $203,470 $566,200 $598,748
Europe and Africa 85,072 80,975 232,755 217,948
Other international operations 37,827 30,703 91,740 83,277
-------- -------- -------- --------
Total revenues $309,335 $315,148 $890,695 $899,973
======== ======== ======== ========
NOTE 7 - RESTRUCTURING ACCRUAL
During the first nine months of fiscal 2008 the Company has undertaken various
restructuring activities to improve the effectiveness and efficiency of a number
of the Company's critical business processes. These activities resulted in a
restructuring charge of $39.6 million for the nine months ended December 31,
2007. As a result of these initiatives the Company has terminated approximately
540 employees. In addition, the Company has exited certain locations or reduced
the square footage required to operate existing facilities.
In the first and second quarters of fiscal 2008, the Company initiated a
restructuring plan that realigned and centralized certain product development
activities. Development activities were transitioned from Merrimack, New
Hampshire, Amsterdam, The Netherlands, Sydney, Australia, Dublin, Ireland and
Cambridge, Massachusetts to the Detroit headquarters facility and Application
Vantage product development was transitioned from the San Diego, California
facility to the Gdansk, Poland facility. The restructuring plan resulted in the
termination of approximately 330 employees, primarily programming personnel, and
full or partial closing of the aforementioned facilities.
The Company also terminated approximately 150 employees during the first and
second quarter of fiscal 2008 from various other functions of the organization.
As part of this reorganization, senior sales management positions were
eliminated and the distributed and mainframe sales teams were aligned under one
management structure. In addition, the Application Delivery Management and
Changepoint sales teams were combined.
As part of these restructuring activities, the Company entered into a separation
agreement with Henry (Hank) Jallos, its former President and Chief Operating
Officer of Products, whose employment with the Company ended on July 10, 2007,
stipulating that Mr. Jallos will receive his salary in effect on his retirement
date ($600,000 per year) through June 30, 2009. In accordance with Section 409A
of the Internal Revenue Code, Mr. Jallos received the first six months of salary
on January 15, 2008 and going forward Mr. Jallos has or will receive his
remaining salary paid in semi-monthly installments through June 30, 2009. Mr.
Jallos will also receive bonuses earned under the Company's executive incentive
plan for fiscal 2006 in the amount of $345,000, which is payable in April 2008,
and for fiscal 2007 in the amount of $240,000, which is payable in April 2009.
Unvested stock options held by Mr. Jallos will continue to vest and all options
may be exercised by Mr. Jallos pursuant to the terms and conditions set forth in
the applicable stock option agreements as if his employment with the Company
continued. Mr. Jallos must refrain from making disparaging statements regarding
the Company and its directors and employees, and will remain obligated through
June 30, 2009 to
14
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2007
(UNAUDITED)
continue to comply with the provisions of our standard employee agreement, which
requires that he keep the Company's confidential information confidential and
that he comply with the Company's employee code of conduct. Under the standard
employee agreement, he will also be prohibited until June 30, 2010 from
competing with the Company, soliciting the Company's clients and soliciting or
recruiting the Company's employees. The Company recorded a charge of
approximately $5.4 million in the second quarter of fiscal 2008 related to this
matter, including a non-cash charge of $4.0 million related to the continued
vesting of outstanding stock options.
During the third quarter of fiscal 2008, the Company terminated approximately 60
employees primarily within the sales and marketing group. In addition, the
transition of development activities from Cambridge, Massachusetts to the
Detroit headquarters facility was completed resulting in the abandonment of the
aforementioned facility.
Substantially all costs related to the above actions have been expensed as of
December 31, 2007.
The following table summarizes the restructuring accrual as of March 31, 2007,
and changes to the accrual during the first nine months of fiscal 2008 (in
thousands):
Non-cash
Expensed Paid charges
Accrual during the nine during the nine during the nine Accrual
balance at months ended months ended months ended balance at
March 31, December 31, December 31, December 31, December 31,
2007 2007 2007 2007 2007
---------- --------------- --------------- --------------- ------------
Employee termination benefits $30,569 $(22,235) $(4,117) $ 4,217
Facilities costs (primarily lease
abandonments and property
and equipment impairment) $2,419 8,119 (1,729) (3,034) 5,775
Other 957 (901) 56
------ ------- -------- ------- -------
Total $2,419 $39,645 $(24,865) $(7,151) $10,048
====== ======= ======== ======= =======
As of December 31, 2007, $7.6 million of the restructuring accrual is recorded
in current "accrued expenses" with the remaining balance of $2.4 million
recorded in long-term "accrued expenses" in the Condensed Consolidated Balance
Sheet.
The accruals for employee termination benefits at December 31, 2007 primarily
represent the amounts to be paid to employees that have been terminated or
identified for termination as a result of initiatives described above.
15
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2007
(UNAUDITED)
The accruals for facilities costs at December 31, 2007 represent the remaining
fair value of lease obligations for exited locations, as determined at the
cease-use dates of those facilities, net of estimated sublease income that could
be reasonably obtained in the future, and will be paid out over the remaining
lease terms, the last of which ends in fiscal 2012. Projected sublease income is
based on management's estimates, which are subject to change.
In the first quarter of 2008, the Company also recorded a capitalized software
impairment charge of $3.9 million associated with our DevPartner and OptimalJ
products that was recorded to "Cost of software license fees" in our Condensed
Consolidated Statements of Operations.
NOTE 8 - DEBT
The Company has no long term debt.
On November 1, 2007, the Company entered into a new, unsecured revolving credit
agreement (the "new credit facility") with Comerica Bank and other lenders. The
new credit facility provides for a revolving line of credit in the amount of
$150 million and expires on November 1, 2012. The credit facility also permits
the Company to increase the revolving line of credit by up to $150 million
subject to receiving additional commitments from lenders and certain other
conditions.
The new credit facility contains various negative covenants, including
limitations on liens, investments, loans and advances, indebtedness, mergers,
consolidations and acquisitions, asset sales, dividends and transactions with
affiliates. The new credit facility is also subject to maximum total debt to
EBITDA and minimum fixed charge coverage financial covenants. The Company is in
compliance with the covenants under the new credit facility.
Any borrowings under the new credit facility bear interest at the greater of the
prime rate or the Federal Funds rate plus one hundred basis points; or the
Eurodollar rate plus the applicable margin (based on the level of maximum total
debt to EBITDA ratio), at the Company's option. The Company will also pay a
quarterly facility fee on the new credit facility based on the applicable margin
grid. The Company has not borrowed under the new credit facility.
Previously, the Company held a $100 million revolving credit facility which
matured on October 26, 2007. No borrowings occurred under this prior facility.
16
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2007
(UNAUDITED)
NOTE 9 - INCOME TAXES
On July 12, 2007, the State of Michigan enacted the Michigan Business Tax (MBT)
as a replacement for the Single Business Tax (SBT), which expired at December
31, 2007. The MBT took effect on January 1, 2008 and is comprised of two
components: an income tax and a modified gross receipts tax. The two components
of the MBT are considered income taxes subject to the accounting provisions of
FASB Statement No. 109, "Accounting for Income Taxes".
As a result of the MBT enactment, the Company recorded an income tax benefit of
approximately $12.0 million in the quarter ended September 30, 2007. This
benefit related primarily to the recognition of a deferred tax asset for
Brownfield Redevelopment credits that are available to offset MBT liabilities
through the Company's fiscal year 2022. The Brownfield Redevelopment credits
were previously available to reduce the Company's SBT liabilities. These credits
were not historically recorded as a deferred tax asset since the Company did not
account for the SBT as an income tax. As with all deferred tax assets, the
Company assessed the ability to utilize these credits prior to expiration and
recorded a valuation allowance for the amount that was not more likely than not
to be realized.
On December 1, 2007, an amendment to the MBT was enacted that imposes a
surcharge of 21.99% on each taxpayer's MBT liabilities. The amendment also
limits the types of credits that are available to offset the surcharge. As a
result of the amendment, the Company increased the estimated utilization of its
previously recorded Brownfield Redevelopment credits since these credits are
available to offset the surcharge. During the quarter ended December 31, 2007, a
benefit of approximately $3.0 million was recorded to adjust deferred taxes to
the amount that is more likely than not to be realized.
The income tax provision for the quarter ended June 30, 2007 includes an
additional $2.1 million charge relating to the tax receivable previously
recorded in the quarter ended March 31, 2007. The previously recorded receivable
had included an interest income component which was subject to income taxes, but
for which the Company had not recorded a tax provision. The Company has
considered both the qualitative and quantitative effects of this error on the
financial statements for the fiscal year ended March 31, 2007, as well as the
qualitative and quantitative effects of including the error correction in the
quarter ended June 30, 2007, the nine months ended December 31, 2007 and fiscal
year ended March 31, 2008, and has concluded that the effects on the financial
statements are not material.
During the quarter ended June 30, 2007, the Company adopted FASB Interpretation
No. 48, "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
Statement No. 109" ("FIN 48"). This Interpretation prescribes a recognition
threshold and a measurement attribute for the financial statement recognition
and measurement of tax positions taken or expected to be taken in a tax return.
Upon adoption of FIN 48, the Company recorded a $1.4 million increase in the
liability for unrecognized tax benefits, which was accounted for as a
cumulative-effect adjustment to retained earnings. At April 1, 2007, the Company
had $12.8 million of gross unrecognized tax benefits of which $9.9 million, net
of federal benefit, would favorably affect the Company's effective tax rate if
recognized. At December 31, 2007, the amount of gross unrecognized tax benefits
and the amount that would favorably affect the Company's effective income tax
rate in future periods were $13.2 million and $10.7 million, respectively. At
December 31, 2007, $1.6 million of the liability for uncertain tax positions is
netted against deferred tax assets relating to the same jurisdiction, and $4.2
million and $6.6 million are recorded as current and non-current accrued
expenses, respectively. The decrease in gross
17
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED DECEMBER 31, 2007
(UNAUDITED)
unrecognized tax benefits during the quarter ended December 31, 2007 was
primarily due to the settlement of a United Kingdom income tax audit.
In accordance with the Company's accounting policy, interest and penalties
related to income tax liabilities are included in income tax expense. At April
1, 2007, the Company had a $3.3 million reserve for the payment of interest and
penalties; and a $5.8 million receivable for interest. At December 31, 2007, the
Company has a $3.8 million reserve for the payment of interest and penalties;
and a $0.9 million receivable for interest. The Company recorded $0.2 million to
income tax expense for net interest and penalties for the current fiscal year
through December 31, 2007.
At December 31, 2007, the Company has open tax years, from tax periods 1999 and
forward, with various taxing jurisdictions, including the U.S., Brazil and
Canada. During the quarter ended December 31, 2007, the IRS and the Company
agreed on the audit plan for the Company's 2005 and 2006 tax periods. It is now
anticipated that the audit for these tax periods will be completed within the
next twelve months. The Company anticipates a decrease in net unrecognized tax
benefits of $4.2 million with the taxing authorities in the upcoming twelve
months.
NOTE 10 -- SUBSEQUENT EVENT
On February 7, 2008, the Company's Board of Directors authorized the repurchase
of up to $750.0 million of additional shares of the Company's Common Stock on
the open market under the Company's discretionary program from time-to-time
based upon market and business conditions.
18
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Compuware Corporation
Detroit, Michigan
We have reviewed the accompanying condensed consolidated balance sheet of
Compuware Corporation and subsidiaries (the "Company") as of December 31, 2007,
and the related condensed consolidated statements of operations for the
three-month and nine-month periods ended December 31, 2007 and 2006, and of cash
flows for the nine-month periods ended December 31, 2007 and 2006. These interim
financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to such condensed consolidated interim financial statements for them to
be in conformity with accounting principles generally accepted in the United
States of America.
As discussed in Note 9 to the condensed consolidated financial statements,
effective April 1, 2007, the Company adopted Financial Accounting Standards
Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes.
We have previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheet of Compuware Corporation and subsidiaries as of March 31, 2007, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for the year then ended (not presented herein); and in our report dated
May 24, 2007, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying condensed consolidated balance sheet as of March 31, 2007, is
fairly stated, in all material respects, in relation to the consolidated balance
sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Detroit, Michigan
February 7, 2008
19
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This 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 and, other than the risk factor relating to our stock repurchase plans,
have not materially changed since the end of fiscal 2007 (see Item 1A Risk
Factors in our 2007 Form 10-K), except as disclosed in Part II Item 1A of this
Form 10-Q. These risks and uncertainties are not the only ones we face.
Additional risks and uncertainties discussed elsewhere in the reports we file
with the Securities and Exchange Commission, as well as other risks and
uncertainties that we are not aware of or focused on or that we currently deem
immaterial, may also impair business operations. This report is qualified in its
entirety by these risk factors and those listed below. If any of the following
risks actually occur, our financial condition and results of operations could be
materially and adversely affected. If this were to happen, the value of our
common stock could decline significantly, and shareholders could lose all or
part of their investment.
There can be no assurance that future results will meet expectations. While we
believe that our forward-looking statements are reasonable, you should not place
undue reliance on any such forward-looking statements, which speak only as of
the date made. Except as required by applicable law, we do not undertake any
obligation to publicly release any revisions which may be made to any
forward-looking statements to reflect events or circumstances occurring after
the date of this report.
- Our mainframe product 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 license and maintenance.
- We may fail to achieve our forecasted financial results due to
inaccurate sales forecasts or other factors.
- If we fail to achieve the results we expect from our restructuring
programs, our results of operations and financial condition may be
adversely affected.
- Our software and technology may infringe the proprietary rights of
others.
- Our results could be adversely affected if our operating margins
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 continuation of our stock repurchase plans is subject to various
risks and uncertainties that may cause us to suspend or terminate our
market repurchase activity. For example, repurchases of the Company's
common stock could be delayed indefinitely
20
COMPUWARE CORPORATION AND SUBSIDIARIES
by conditions in the stock or debt markets, adverse business
conditions, the Company's need to conserve capital resources for use
in its operations, the Company's inability or unwillingness to borrow
funds, and other factors beyond our control.
- We must develop or acquire product enhancements and new products to
succeed.
- Acquisitions may be difficult to integrate, disrupt our business or
divert the attention of our management and may result in financial
results that are different than expected.
- We are exposed to exchange rate risks on foreign currencies and to
other international risks which may adversely affect our business and
results of operations.
- A further decline in the U.S. domestic automotive manufacturing
business could adversely affect our professional services business.
- 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.
- Our quarterly financial results vary and may be adversely affected by
a number of unpredictable factors.
- 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.
- Acts of terrorism, acts of war and other unforeseen events may cause
damage or disruption to us or our customers which could adversely
affect our business, financial condition and operating results.
- Our articles of incorporation, bylaws and rights agreement as well as
certain provisions of Michigan law have anti-takeover effects that may
deter hostile takeovers or delay or prevent changes in control or
management, including transactions in which the stockholders of
Compuware might otherwise receive a premium for their shares over the
current market prices.
21
COMPUWARE CORPORATION AND SUBSIDIARIES
OVERVIEW
In this section, we discuss our results of operations on a segment basis for
each of our financial reporting segments. We operate in two business segments in
the technology industry: products and professional 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 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, 2007, 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 and
professional 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 Covisint services offerings, which help manage the
supply chain through the integration of vital business information and processes
between partners, customers and suppliers.
We earn revenue from licensing software products, providing maintenance and
support for those products and rendering professional services. Our revenue
recognition policies are in accordance with U.S. GAAP, including Statements of
Position 97-2 "Software Revenue Recognition" and 98-9 "Modification of SOP 97-2,
'Software Revenue Recognition,' With Respect to Certain Transactions",
Securities and Exchange Commission Staff Accounting Bulletin 104 and Emerging
Issues Task Force Issue 00-21 "Revenue Arrangements with Multiple Deliverables".
Accordingly, we recognize revenue when all of the following criteria are met:
persuasive evidence of an arrangement exists, delivery has occurred or services
have been rendered, the fee is fixed or determinable, and collectibility is
reasonably assured.
Software license fees - our software license agreements provide our customers
with a right to use our software perpetually (perpetual licenses) or during a
defined term (term licenses).
Perpetual license fee revenue is recognized using the residual method, under
which the fair value, based on vendor specific objective evidence ("VSOE"), of
all undelivered elements of the agreement (i.e., maintenance and professional
services) is deferred. VSOE is based on rates charged for maintenance and
professional services when sold separately. The remaining portion of the fee,
net of discretionary discounts (the residual), is recognized as license fee
revenue upon delivery of the products, provided that no significant obligations
remain and collection of the related receivable is deemed probable.
22
COMPUWARE CORPORATION AND SUBSIDIARIES
For revenue arrangements where there is a lack of VSOE of fair value for any
undelivered elements, license fee revenue is deferred and recognized upon
delivery of those elements or when VSOE of fair value can be established. When
maintenance or services are the only undelivered elements, the license fee
revenue is recognized on a ratable basis over the longer of the maintenance term
or over the period in which the services are expected to be performed. Such
transactions include term licenses as we do not sell maintenance for term
licenses separately and therefore cannot establish VSOE for the undelivered
elements in these arrangements. These arrangements do not qualify for separate
recognition of the software license fees, maintenance fees and as applicable,
professional services fees under SOP 97-2 as amended. However, 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, we
separate the license fee, maintenance fee and professional services fee revenue
based on our determination of fair value. We apply our VSOE of fair value for
maintenance related to perpetual license transactions and stand alone services
arrangements as a reasonable and consistent approximation of fair value to
separate license fee, maintenance fee and professional services fee revenue for
income statement purposes.
We offer flexibility to customers purchasing licenses for our products and
related maintenance. Terms of these transactions range from standard perpetual
license sales that include one year of maintenance to large multi-year
(generally two to five years), multi-product contracts. We allow deferred
payment terms on multi-year contracts, with installments collectible over the
term of the contract. Based on our successful collection history for deferred
payments, license fees (net of any finance fees) are generally recognized as
discussed above. In certain transactions where it cannot be concluded that the
fee is fixed or determinable at the time of the arrangement due to the nature of
the deferred payment terms, we recognize revenue as payments become due. The
finance fee is recognized as interest income over the term of the receivable.
Maintenance fees - our maintenance agreements provide for 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 included with all license
agreements. Maintenance revenue is recognized ratably over the term of the
maintenance arrangements, which primarily range from one to five years.
Professional services fees - Professional services fees are generally based on
hourly or daily rates; therefore, revenues from professional services are
recognized in the period the services are performed provided that collection of
the related receivable is deemed probable. For development services rendered
under fixed-price contracts, revenue is recognized using the percentage of
completion method and if determined that costs will exceed revenue, the expected
loss is recorded at the time the loss becomes apparent. Certain professional
services contracts include a project and on-going operations for the project.
Revenue associated with these contracts is recognized over the service period as
the customer derives value from the services, consistent with the proportional
performance method.
23
COMPUWARE CORPORATION AND SUBSIDIARIES
QUARTERLY UPDATE
We focus on growing revenue and profit margins by enhancing and promoting our
current product lines and solutions, expanding our product and service offerings
through key acquisitions, developing strategic partnerships and managing our
costs.
The following occurred during the third quarter of 2008:
- Entered into a new revolving credit facility with Comerica Bank and
other lenders. The new credit facility expanded our revolving line of
credit availability from $100 million to $150 million and expires on
November 1, 2012.
- Restructuring actions resulted in a charge of $4.9 million. Cost
saving actions initiated during the first nine months of 2008 are
expected to reduce costs by approximately $90.0 million on an
annualized basis.
- Repurchased approximately 12.3 million shares of our common stock at
an average price of $8.97 per share.
- Experienced an 8.0% increase in distributed product revenue compared
to the third quarter of 2007 due to an increase in maintenance
revenue.
- Realized a 4.9% decrease in mainframe product revenue compared to the
third quarter of 2007 primarily due to a decline in license revenue.
- Experienced an increase in products contribution margin to 45.8% in
the third quarter of 2008 from 41.1% in the third quarter of 2007 due
to a decrease in product costs, primarily technology development and
support and sales and marketing costs.
- Released 2 mainframe and 12 distributed product updates designed to
increase the productivity of the IT departments of our customers.
Our ability to achieve our strategies and objectives is subject to a number of
risks and uncertainties some of which we may not be able to control. See
"Forward-Looking Statements".
24
COMPUWARE CORPORATION AND SUBSIDIARIES
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain operational
data from the consolidated statements of operations as a percentage of total
revenues and the percentage change in such items compared to the prior period:
Percentage of Percentage of
Total Revenues Total Revenues
------------------ -----------------
Three Months Ended Nine Months Ended
December 31, Period- December 31, Period-
------------------ to-Period ----------------- to-Period
2007 2006 Change 2007 2006 Change
----- ----- --------- ----- ----- ---------
REVENUE:
Software license fees 25.7% 27.3% (7.7)% 22.1% 23.3% (6.4)%
Maintenance fees 38.8 36.3 4.9 39.3 37.8 3.0
Professional services fees 35.5 36.4 (4.2) 38.6 38.9 (1.7)
----- ----- ----- -----
Total revenues 100.0 100.0 (1.8) 100.0 100.0 (1.0)
----- ----- ----- -----
OPERATING EXPENSES:
Cost of software license fees 2.2 2.4 (11.2) 2.6 2.4 12.0
Cost of maintenance fees 3.7 3.2 12.7 3.7 3.3 10.1
Cost of professional services 33.5 32.4 1.5 34.8 34.8 (1.2)
Technology development and support 7.6 8.6 (12.6) 8.7 9.3 (8.1)
Sales and marketing 21.5 23.3 (9.5) 22.1 23.0 (5.0)
Administrative and general 14.9 16.5 (11.5) 15.1 16.0 (6.3)
Restructuring cost 1.6 n/a 4.4 n/a
----- ----- ----- -----
Total operating expenses 85.0 86.4 (3.5) 91.4 88.8 1.9
----- ----- ----- -----
Income from operations 15.0 13.6 8.6 8.6 11.2 (24.4)
Other income 1.5 2.8 (48.4) 1.7 3.4 (48.4)
----- ----- ----- -----
Income before income taxes 16.5 16.4 (1.3) 10.3 14.6 (30.0)
Income tax provision 5.0 4.8 1.2 2.1 4.5 (53.8)
----- ----- ----- -----
Net income 11.5% 11.6% (2.4)% 8.2% 10.1% (19.2)%
===== ===== ===== =====
SOFTWARE PRODUCTS
Financial information for the products segment is as follows (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------- -------------------
2007 2006 2007 2006
-------- -------- -------- --------
Revenue $199,451 $200,445 $546,775 $550,068
Expenses 108,165 118,079 330,484 341,932
-------- -------- -------- --------
Product contribution $ 91,286 $ 82,366 $216,291 $208,136
======== ======== ======== ========
The products segment generated contribution margins of 45.8% and 41.1% during
the third quarter of 2008 and 2007, respectively, and 39.6% and 37.8% for the
first nine months of both 2008 and 2007, respectively. Product expenses include
cost of software license fees, cost of maintenance fees, technology development
and support, and sales and marketing costs. The increase in margins for the
third quarter and first nine months of 2008 was due to a decrease in product
costs, primarily technology development and support and sales and marketing
costs, partially offset by lower product revenue during the first nine months of
2008.
25
COMPUWARE CORPORATION AND SUBSIDIARIES
SOFTWARE PRODUCTS REVENUE
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 64.5% and 63.6% of total revenue
during the third quarter of 2008 and 2007, respectively, and 61.4% and 61.1% of
total revenue during the first nine months of 2008 and 2007, respectively.
Distributed software product revenue increased $5.6 million or 8.0% during the
third quarter of 2008 to $73.8 million from $68.2 million during the third
quarter of 2007 and increased $23.2 million or 12.6% during the first nine
months of 2008 to $207.4 million from $184.2 million during the first nine
months of 2007. The increase during the third quarter was due to higher
maintenance fees while the increase in the first nine months of 2008 was due to
higher license and maintenance fees as discussed below.
Mainframe software product revenue decreased $6.5 million or 4.9% during the
third quarter of 2008 to $125.7 million from $132.2 million during the third
quarter of 2007 and decreased $26.5 million or 7.2% during the nine months of
2008 to $339.4 million from $365.9 million during the first nine months of 2007.
The decline during the third quarter was due to lower license fees while the
decline in the first nine months of 2008 was due to decreased license and
maintenance fees as discussed below.
License revenue decreased $6.6 million or 7.7% during the third quarter of 2008
to $79.4 million from $86.0 million during the third quarter of 2007 and
decreased $13.5 million or 6.4% during the first nine months of 2008 to $196.7
million from $210.2 million in the first nine months of 2007. The decreases were
primarily a result of lower capacity mainframe license revenue in our United
States operations. The decline in the first nine months of 2008 was partially
offset by a $7.9 million increase in our distributed license revenue, primarily
within the Vantage and Changepoint product lines. Fluctuations in foreign
currencies positively impacted license fees by $4.2 million and $7.5 million
during the third quarter and first nine months of 2008, respectively.
Maintenance fees increased $5.7 million or 4.9% to $120.1 million during the
third quarter of 2008 from $114.4 million during the third quarter of 2007 and
increased $10.2 million or 3.0% during the first nine months of 2008 to $350.1
million from $339.9 million in the first nine months of 2007. The changes were
due to distributed maintenance fees, primarily the Vantage and Changepoint
product lines, increasing by $6.1 million and $15.3 million during the third
quarter and first nine months of 2008, respectively, as we continue to
experience increased demand for these product lines, partially offset by
declines in mainframe maintenance fees. Fluctuations in foreign currencies
positively impacted maintenance fees by $5.1 million and $11.6 million during
the third quarter and first nine months of 2008, respectively.
26
COMPUWARE CORPORATION AND SUBSIDIARIES
Product revenue by geographic location is presented in the table below (in
thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------- -------------------
2007 2006 2007 2006
-------- -------- -------- --------
United States $ 97,898 $108,103 $281,536 $302,849
Europe and Africa 66,459 63,937 180,535 169,872
Other international operations 35,094 28,405 84,704 77,347
-------- -------- -------- --------
Total product revenue $199,451 $200,445 $546,775 $550,068
======== ======== ======== ========
PRODUCT EXPENSES
Product expenses include cost of software license fees, cost of maintenance
fees, technology development and support costs and sales and marketing expenses.
These expenses are discussed below.
Cost of software license fees includes amortization of capitalized software, the
cost of duplicating and disseminating products to customers (including
associated hardware costs) and the cost of author royalties. For the third
quarter of 2008, cost of software license fees decreased $0.8 million or 11.2%
to $6.7 million from $7.5 million in the third quarter of 2007 and for the first
nine months of 2008 increased $2.6 million or 12.0% to $23.7 million from $21.1
million in the first nine months of 2007.
The decrease in cost for the third quarter of 2008 was due to a decline in
hardware costs associated with one of our products in the Vantage product line.
Although Vantage software sales have increased, customers are no longer required
to purchase the hardware from us as was the case in the previous year.
The increase in cost of software license fees for the first nine months was
primarily due to us incurring a $3.9 million capitalized software impairment
charge when our restructuring program was initiated during the first quarter of
2008 (see Note 7 to the Condensed Consolidated Financial Statements) offset in
part by a decline in hardware costs and lower capitalized software amortization
costs incurred subsequent to the impairment charge.
As a percentage of software license fees, costs of software license fees were
8.4% and 8.8% in the third quarter of 2008 and 2007, respectively, and 12.0%
(including 2.0% from the impairment charge) and 10.1% in the first nine months
of 2008 and 2007, 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. For the third quarter of 2008, cost of
maintenance fees increased $1.3 million or 12.7% to $11.5 million from $10.2
million in the third quarter of 2007 and for the first nine months of 2008
increased $3.0 million or 10.1% to $33.1 million from $30.1 million in the first
nine months of 2007. The increases in expense were primarily due to higher
compensation and benefit costs associated with the transfer of technical
personnel from sales support to customer support in order to meet product
development and maintenance initiatives and to provide increased customer
support in our international operations consistent with the revenue growth in
those markets.
27
COMPUWARE CORPORATION AND SUBSIDIARIES
As a percentage of maintenance fees, cost of maintenance fees were 9.5% and 8.9%
in the third quarter of 2008 and 2007, respectively and 9.5% and 8.8% in the
first nine months of 2008 and 2007, 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
11.9% and 13.5% in the third quarter of 2008 and 2007, respectively and 14.1%
and 15.3% in the first nine months of 2008 and 2007, respectively.
Capitalization of internally developed software products begins when
technological feasibility of the product is established. Total technology
development and support costs incurred internally and capitalized in the third
quarter and first nine months of 2008 and 2007 were as follows (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------ -------------------
2007 2006 2007 2006
------- -------- -------- --------
Technology development and support costs incurred $26,393 $33,575 $ 87,207 $ 99,909
Capitalized technology development and support costs (2,757) (6,528) (10,073) (16,005)
------- ------- -------- --------
Technology development and support costs reported $23,636 $27,047 $ 77,134 $ 83,904
======= ======= ======== ========
Before the capitalization of internally developed software products, total
technology development and support expenditures for the third quarter of 2008
decreased $7.2 million or 21.4% to $26.4 million from $33.6 million in the third
quarter of 2007 and for the first nine months of 2008 decreased $12.7 million or
12.7% to $87.2 million from $99.9 million in the first nine months of fiscal
2007. The decreases were primarily attributable to lower compensation costs due
to headcount reductions as a result of the restructuring program initiated
during the first quarter of fiscal 2008 (see Note 7 to the Condensed
Consolidated Financial Statements).
Sales and marketing costs consist primarily of personnel related costs
associated with product sales and sales support and marketing for all our
product offerings. For the third quarter of 2008, sales and marketing costs
decreased $6.9 million or 9.5% to $66.4 million from $73.3 million in the third
quarter of 2007 and for the first nine months of fiscal 2008 decreased $10.2
million or 5.0% to $196.6 million from $206.8 million in the first nine months
of fiscal 2007. The decreases in sales and marketing costs were primarily
attributable to lower compensation costs due to headcount reductions as a result
of the sales reorganization (see Note 7 to the Condensed Consolidated Financial
Statements) and lower costs associated with marketing and promotional programs,
partially offset by higher commissions expense primarily resulting from special
commission rate programs offered during the second and third quarters of 2008.
As a percentage of product revenue, sales and marketing costs were 33.3% and
36.6% in the third quarter of 2008 and 2007, respectively, and 36.0% and 37.6%
in the first nine months of 2008 and 2007, respectively.
28
COMPUWARE CORPORATION AND SUBSIDIARIES
PROFESSIONAL SERVICES
Financial information for the professional services segment is as follows (in
thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------- -------------------
2007 2006 2007 2006
-------- -------- -------- --------
Revenue $109,884 $114,703 $343,920 $349,905
Expenses 103,705 102,189 309,752 313,449
-------- -------- -------- --------
Professional services contribution $ 6,179 $ 12,514 $ 34,168 $ 36,456
======== ======== ======== ========
During the third quarter of 2008, the professional services segment generated a
contribution margin of 5.6%, compared to 10.9% during the third quarter of 2007
and 9.9% and 10.4% during the first nine months of 2008 and 2007, respectively.
The third quarter decline in contribution margin was due to lower revenue and
increased costs resulting from annual salary increases effective October 2007
and higher costs associated with certain fixed price projects.
PROFESSIONAL SERVICES REVENUE
We offer a broad range of IT services to help businesses make the most of their
IT assets. Some of these services include outsourcing and co-sourcing,
application services and management, product solutions, project management,
enterprise resource planning and customer relationship management services.
Revenue from professional services decreased $4.8 million or 4.2% during the
third quarter of 2008 to $109.9 million compared to $114.7 million in the third
quarter of 2007 and decreased $6.0 million or 1.7% for the first nine months of
2008 to $343.9 million from $349.9 million in the first nine months of 2007. The
decreases in revenue were primarily due to a general slow down in customer
spending on certain IT programs and on staff supplementation services within our
U.S. operations, partially offset by a $1.8 million and $8.0 million increase in
application services revenue during the third quarter and first nine months of
2008, respectively.
Professional services revenue by geographic location is presented in the table
below (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------- -------------------
2007 2006 2007 2006
-------- -------- -------- --------
United States $ 88,538 $ 95,367 $284,664 $295,899
Europe and Africa 18,613 17,038 52,220 48,076
Other international operations 2,733 2,298 7,036 5,930
-------- -------- -------- --------
Total professional services revenue $109,884 $114,703 $343,920 $349,905
======== ======== ======== ========
PROFESSIONAL SERVICES EXPENSES
Cost of professional services consists primarily of personnel-related costs of
providing services, including billable staff, subcontractors and sales
personnel. Cost of professional services increased $1.5 million or 1.5% during
the third quarter of 2008 to $103.7 million compared to
29
COMPUWARE CORPORATION AND SUBSIDIARIES
$102.2 million in the third quarter of 2007 and decreased $3.6 million or 1.2%
during the first nine months of 2008 to $309.8 million from $313.4 million
during the first nine months of 2007. The increase in cost for the third quarter
was due to annual salary increases effective October 2007 and higher costs
associated with certain fixed price projects within our U.S. operations. The
decrease in cost for the nine month period was primarily attributable to lower
compensation and benefit costs due to a reduction in employee headcount as
management continues to align headcount with customer demand for our services.
CORPORATE AND OTHER EXPENSES
Administrative and general expenses consist primarily of costs associated with
the corporate executive, finance, human resources, administrative, legal,
communications and investor relations departments. In addition, administrative
and general expenses include all facility-related costs, such as rent, building
depreciation, maintenance and utilities, associated with worldwide sales,
professional services and software development offices. Administrative and
general expenses decreased $5.9 million or 11.5% during the third quarter of
2008 to $46.2 million from $52.1 million during the third quarter of 2007 and
decreased $9.1 million or 6.3% during the first nine months of 2008 to $134.4
million from $143.5 million in the first nine months of 2007. The decreases were
primarily attributable to a $5.0 million donation to a local charity that we
incurred in the prior year and lower third party recruiting fees and consulting
fees.
Other income, net ("other income") consists primarily of interest income
realized from investments, interest earned on deferred customer receivables and
income/losses generated from our investments in partially owned companies. Other
income decreased $4.3 million or 48.4% during the third quarter of 2008 to $4.7
million compared to $9.0 million in the third quarter of 2007 and decreased
$14.8 million or 48.4% during the first nine months of 2008 to $15.7 million
from $30.5 million during the first nine months of 2007. The decreases in other
income were primarily attributable to a decline in investment interest income
resulting from a lower average cash equivalent and investment balance during the
respective periods of 2008 compared to 2007 as we continue to use funds to
repurchase our common shares.
Under our 2005 settlement agreement with International Business Machines
Corporation ("IBM"), IBM is committed to make payments related to the purchase
of software licenses and maintenance of $30.0 million in fiscal 2008. Payments
of $13.2 million are expected to be collected during fiscal 2008 related to
transactions closed prior to December 31, 2007. The unused commitment balance,
if any, at March 31, 2008 will be recorded to other income.
Income taxes are accounted for using the asset and liability approach. Deferred
income taxes are provided for the differences between the tax bases of assets or
liabilities and their reported amounts in the financial statements. The income
tax provision was $15.4 million in the third quarter of 2008 compared to $15.3
million in the third quarter of 2007, representing an effective tax rate of
30.3% and 29.5%, respectively. The income tax provision was $18.9 million for
the first nine months of 2008 compared to $41.0 million for the first nine
months of 2007, representing an effective rate of 20.5% and 31.1%, respectively.
The decrease in the effective tax rate for the nine month period is primarily a
result of recording $15.0 million of tax benefits during 2008 relating to the
recognition of a deferred tax asset for Brownfield Redevelopment credits which
are available to offset Michigan Business Tax ("MBT") liabilities through fiscal
2022 (see Note 9 to the Condensed Consolidated Financial Statements).
30
COMPUWARE CORPORATION AND SUBSIDIARIES
For the first nine months of 2008, the MBT benefit was partially offset by an
additional $2.1 million charge relating to the tax receivable previously
recorded in the quarter ended March 31, 2007. The previously recorded receivable
had included an interest income component which was subject to income taxes, but
for which the Company had not recorded a tax provision. The Company has
considered both the qualitative and quantitative effects of this error on the
financial statements for the fiscal year ended March 31, 2007, as well as the
qualitative and quantitative effects of including the error correction in the
quarter ended June 30, 2007, the nine months ended December 31, 2007 and fiscal
year ended March 31, 2008, and has concluded that the effects on the financial
statements are not material.
RESTRUCTURING COSTS AND ACCRUAL
In the third quarter of 2008, we continued with our initiative to improve
operating efficiencies and reduce costs (as discussed in Note 7 to the Condensed
Consolidated Financial Statements). We incurred charges of $4.9 million and
$39.6 million during the third quarter and first nine months of 2008,
respectively. Actions initiated during the first nine months of 2008 are
expected to result in approximately $90.0 million of annualized cost reductions,
primarily in technology development and support and sales and marketing. We
continue to evaluate our business processes to identify ways to reduce costs.
Further expense reductions are likely to result in additional restructuring
charges.
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Assumptions and estimates
were based on the facts and circumstances known at December 31, 2007. However,
future events rarely develop exactly as forecast, and the best estimates
routinely require adjustment. The accounting policies discussed in Item 7 of our
Annual Report on Form 10-K for the year ended March 31, 2007 are considered by
management to be the most important to an understanding of the financial
statements, because their application places the most significant demands on
management's judgment and estimates about the effect of matters that are
inherently uncertain. These policies are also discussed in Note 1 of the Notes
to Consolidated Financial Statements included in Item 8 of that report. There
have been no material changes to that information since the end of fiscal 2007.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2007, cash and cash equivalents and investments totaled
approximately $265.8 million.
Net cash provided by operating activities:
Net cash from operating activities increased $14.8 million during the first nine
months of 2008 as compared to the first nine months of 2007. The increase was
primarily a result of receiving a $14.0 million income tax refund during the
third quarter of 2008 related to IRS adjustments for 1996-1998 tax years
compared to $20.0 million of income tax payments made during the first
31
COMPUWARE CORPORATION AND SUBSIDIARIES
nine months of 2007. This increase was reduced in part by the $24.9 million of
severance and other payments associated with the restructuring program initiated
in 2008.
Changes in accounts receivable and deferred revenue have typically had the
largest impact on our operating cash flows as we allow for deferred payment
terms on multi-year products contracts. This net change was $7.1 million lower
in the first nine months of 2008 compared to the comparable period in 2007
primarily due to a decline in multi-year products deals. Changes in accounts
payable and accrued expenses were lower during the first nine months of 2008
compared to the comparable period in 2007 due to a $6.8 million increase in the
accrual for restructuring costs. The change in prepaid expenses and other
current assets was a result of collecting $10.0 million of fiscal 2007 IBM
settlement proceeds during the first nine months of 2008.
As of December 31, 2007, $10.0 million was accrued related to restructuring
actions (see Note 7 to the Condensed Consolidated Financial Statements). We
continue to review our business processes for additional cost reductions that
could cause us to incur further restructuring costs during 2008.
We believe cash flow from operations will be sufficient to meet operating cash
needs for the foreseeable future.
Net cash provided by (used in) investing activities:
Net cash provided by investing activities during the first nine months of 2008
was $70.2 million compared to net cash used for investing activities of $44.6
million during the first nine months of 2007, an increase of $114.8 million. The
increase was primarily due to the $90.3 million net reduction in our
investments. The proceeds were primarily used to fund the stock repurchase
initiative. The remaining increase in net cash was primarily due to no
acquisitions during the first nine months of 2008. In the first nine months of
2007, we acquired SteelTrace Limited for $20.7 million in cash.
For the nine months ended December 31, 2007 and 2006, capital expenditures for
property and equipment, net of proceeds received for the sale of the former
headquarters and distribution center in 2007, and capitalized research and
software development totaled $20.1 million and $15.9 million, respectively.
We also continue to evaluate business acquisition opportunities that fit our
strategic plans.
Net cash used in financing activities:
Net cash used by financing activities during the first nine months of 2008 was
$268.1 million compared to $383.2 million during the first nine months of 2007,
a decrease of $115.1 million. Of this amount, $61.0 million of the decrease was
due to lower repurchases of our common stock in 2008 compared to 2007 and $54.6
million was due to an increase in net proceeds from the exercise of stock
options.
The Company has repurchased common stock under two plans, the "Discretionary
Plan" and the "10b5-1 Plan". Under the Discretionary Plan, the Board of
Directors has authorized, from May 2003 to December 2007, the repurchase of a
total of up to $950.0 million of our common stock, including an additional
$200.0 million authorized in August 2007. Our purchases of stock under the
Discretionary Plan may occur on the open market, through negotiated or block
transactions based upon market and business conditions subject to applicable
legal limitations. During the
32
COMPUWARE CORPORATION AND SUBSIDIARIES
first nine months of 2008, we repurchased 24.9 million shares of our common
stock under the Discretionary Plan at an average price of $8.88 per share for a
total of $220.9 million. As of December 31, 2007, approximately $82.6 million
remains authorized for future purchases under the Discretionary Plan. On
February 7, 2008, the Board of Directors authorized an additional repurchase of
up to $750.0 million of our common stock under our discretionary repurchase
program. The additional authorization will be used toward our long-term goal of
reducing our outstanding common share count to approximately 200 million shares.
We do not anticipate any significant changes in our approach to the repurchase
program. The maximum amount of repurchase activity under the discretionary
program continues to be limited on a daily basis to 25% of the average trading
volume of our common stock for the previous four week period. In addition, no
purchases are made during our self-imposed trading black-out periods in which
the Company and our insiders are prohibited from trading in our common shares.
Our standard quarterly black-out period commences fifteen days prior to the end
of each quarter and terminates following the public release of our earnings.
Under the 10b5-1 Plan, the Board of Directors authorized the repurchase of up to
a total of 50.0 million shares of our common stock, subject to price, volume and
timing constraints set forth in the plan pursuant to Rule 10b5-1(c) of the
Securities Exchange Act of 1934 through September 30, 2007. A broker selected by
us had the authority to repurchase shares on our behalf under the terms and
limitations specified in the plan without our discretion, allowing repurchase
activity to continue at times when we might otherwise be prevented from
repurchasing shares under insider trading laws or because of self-imposed
trading blackout periods. During the first nine months of 2008, we repurchased
11.3 million shares for an aggregate $109.7 million and settled an additional
$7.2 million of trades that occurred during the fourth quarter of 2007 under the
10b5-1 Plan. In August 2007 the 10b5-1 Plan was terminated.
We intend to continue repurchasing shares under the Discretionary Plan, funded
primarily through our operating cash flow and, if needed, funds from our new
credit facility.
On November 1, 2007, the Company entered into a new credit facility with
Comerica Bank and other lenders to provide additional leverage for the Company.
The new credit facility provides for a revolving line of credit in the amount of
$150 million and expires on November 1, 2012. The new credit facility also
permits us to increase the facility by $150 million, subject to receiving
additional commitments from lenders and certain other conditions. The new
facility also limits additional borrowing outside of the facility to $250
million. See Note 8 to the Condensed Consolidated Financial Statements for a
description of the material terms of the new credit facility.
The new credit facility replaces a $100 million revolving credit facility that
matured on October 26, 2007. No borrowings have occurred under the new credit
facility or the previous facility since inception.
Recently Issued Accounting Pronouncements
In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157 "Fair Value Measurements" ("SFAS 157"), which defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles and expands disclosures about fair value measurements.
SFAS 157 applies whenever other standards require (or permit) assets or
liabilities to be measured at fair value, and therefore, does not expand the use
of fair value in any new circumstances. This Statement is effective for fiscal
years beginning after November 15, 2007. Management is currently evaluating the
impact this Statement will have on our financial statements.
In February 2007, the FASB issued Statement of Financial Accounting Standards
No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities,
Including an Amendment of FASB Statement No. 115," which permits entities to
measure eligible financial assets, financial liabilities and firm commitments at
fair value, on an instrument-by-instrument basis, that are otherwise not
permitted to be accounted for at fair value under other generally accepted
accounting principles. The fair value measurement election is irrevocable and
subsequent
33
COMPUWARE CORPORATION AND SUBSIDIARIES
changes in fair value must be recorded in earnings. This Statement is effective
for fiscal years beginning after November 15, 2007. Management is currently
evaluating if it will elect the fair value option for any of our eligible
financial instruments.
In December 2007, the FASB issued Statement of Financial Accounting Standards
No. 141 (revised 2007), "Business Combinations", which replaces Statement of
Financial Accounting Standards No. 141, "Business Combinations". This Statement
requires assets and liabilities acquired in a business combination, contingent
consideration and certain acquired contingencies, to be measured at their fair
value as of the date of acquisition. This Statement also requires that
acquisition-related costs and restructuring costs be recognized separately from
the business combination. This Statement is effective for fiscal years beginning
after December 15, 2008 and will be effective for business combinations entered
into after January 1, 2009. Management is currently evaluating the impact this
Statement will have on our financial statements.
In December 2007, the FASB issued Statement of Financial Accounting Standards
No. 160, "Non-controlling Interests in Consolidated Financial Statements, an
Amendment of ARB No. 51". This Statement clarifies the accounting for
non-controlling interests and establishes accounting and reporting standards for
the non-controlling interest in a subsidiary, including classification as a
component of equity. This Statement is effective for fiscal years beginning
after December 15, 2008. Management is currently evaluating the impact this
Statement will have on our financial statements.
CONTRACTUAL OBLIGATIONS
Our contractual obligations are described in "Item 7 - Management's Discussion
and Analysis of Financial Condition and Results of Operations" contained in our
Annual Report on Form 10-K for the year ended March 31, 2007.
We anticipate settlement of $4.2 million to the taxing authorities in the
upcoming twelve months (as discussed in Note 9 to the Condensed Consolidated
Financial Statements). We are not able to reasonably estimate in which future
periods the remaining amounts will ultimately be settled.
Except as described above or elsewhere in this report on Form 10-Q, there have
been no material changes to those obligations or arrangements outside of the
ordinary course of business since the end of fiscal 2007.
34
COMPUWARE CORPORATION AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed primarily to market risks associated with movements in interest
rates and foreign currency exchange rates. There have been no material changes
to our foreign exchange risk management strategy or our investment standards
subsequent to March 31, 2007, therefore the market risks remain substantially
unchanged since we filed the Annual Report on Form 10-K for the fiscal year
ending March 31, 2007.
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure
material information required to be disclosed in our reports that we file or
submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized, and reported within the time periods specified in the SEC's rules
and forms, and that such information is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required financial
disclosure. In designing and evaluating the disclosure controls and procedures,
management recognized that a control system, no matter how well designed and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Because of the inherent limitations in
all control systems, no evaluation of controls can provide absolute assurance
that all control issues and instances of fraud, if any, with a company have been
detected.
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934 (the
"Exchange Act"). Based upon that evaluation, our Chief Executive Officer and
Chief Financial Officer concluded that our disclosure controls and procedures
are effective, at the reasonable assurance level, to cause information required
to be disclosed in the reports that we file or submit under the Exchange Act to
be recorded, processed, summarized and reported within the time periods
specified in the Commission's rules and forms and that such information is
accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, to allow timely decisions regarding
required financial disclosure.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
No changes in our internal control over financial reporting occurred during the
quarter ended December 31, 2007 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
35
COMPUWARE CORPORATION AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 1A. RISK FACTORS
Other than the risk that our stock repurchase plans may be suspended or
terminated at any time that was added in our Form 10-Q for the quarter ended
September 30, 2007, there have been no material changes to the Risk Factors as
previously disclosed in our Form 10-K for the fiscal year ended March 31, 2007.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table sets forth, the repurchases of common stock for the quarter
ended December 31, 2007:
Total number Approximate dollar
of shares value of shares
Total Average purchased as that may yet be
number price part of purchased under
of shares paid per publicly the plans or
Period purchased share announced plans program(a)
------ ---------- -------- --------------- ------------------
For the month ended October 31, 2007 $192,725,000
For the month ended November 30, 2007 8,375,000 $8.93 8,375,000 117,954,000
For the month ended December 31, 2007 3,894,000 9.07 3,894,000 82,636,000
---------- ----------
Total 12,269,000 $8.97 12,269,000
========== ==========
(a) Our purchases of stock may occur on the open market or in negotiated or
block transactions based upon market and business conditions. Unless
terminated earlier by resolution of our Board of Directors, the
discretionary share repurchase plan will expire when we have repurchased
all shares authorized for repurchase thereunder. All purchases occurred
under our discretionary plan, as our 10b5-1 plan was terminated in August
2007. On February 7, 2008, the Board of Directors authorized an additional
repurchase of up to $750.0 million of our common stock under our
discretionary share repurchase program. We do not anticipate any
significant changes in our approach to the repurchase program. The maximum
amount of repurchase activity under the discretionary program continues to
be limited on a daily basis to 25% of the average trading volume of our
common stock for the previous four week period. In addition, no purchases
are made during our self-imposed trading black-out periods in which the
Company and our insiders are prohibited from trading in our common shares.
36
COMPUWARE CORPORATION AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
Exhibit
Number Description of Document
------- -----------------------
4.10 Compuware Corporation Revolving Credit Agreement dated as of November
1, 2007 (filed as an exhibit to the Company's Form 10-Q for the
quarter ended September 30, 2007 and incorporated herein by
reference).
15 Independent Registered Public Accounting Firm's Awareness Letter.
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of
the Securities Exchange Act.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of
the Securities Exchange Act.
32 Certification pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) of
the Securities Exchange Act.
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COMPUWARE CORPORATION
Date: February 7, 2008 By: /s/ Peter Karmanos, Jr.
------------------------------------
Peter Karmanos, Jr.
Chief Executive Officer
(duly authorized officer)
By: /s/ Laura L. Fournier
------------------------------------
Laura L. Fournier
Date: February 7, 2008 Senior Vice President
Chief Financial Officer
Treasurer
(principal financial officer)
38