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 JUNE 30, 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, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ]
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 July 31, 2007, there were outstanding 302,011,687 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
June 30, 2007 and March 31, 2007 3
Condensed Consolidated Statements of Operations
for the three months ended June 30, 2007 and 2006 4
Condensed Consolidated Statements of Cash Flows
for the three months ended June 30, 2007 and 2006 5
Notes to Condensed Consolidated Financial
Statements 6
Report of Independent Registered Public Accounting Firm 18
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk 31
Item 4. Controls and Procedures 31
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 32
Item 5. Other Information 32
Item 6. Exhibits 33
SIGNATURES 34
2
COMPUWARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
JUNE 30, MARCH 31,
2007 2007
---------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 339,482 $ 260,681
Investments 78,052 107,062
Accounts receivable, net 367,443 420,774
Deferred tax asset, net 37,536 33,392
Income taxes refundable, net 28,294 58,266
Prepaid expenses and other current assets 34,132 41,019
---------- ----------
Total current assets 884,939 921,194
---------- ----------
INVESTMENTS 57,150 71,391
---------- ----------
PROPERTY AND EQUIPMENT, LESS ACCUMULATED
DEPRECIATION AND AMORTIZATION 379,743 385,227
---------- ----------
CAPITALIZED SOFTWARE, LESS ACCUMULATED
AMORTIZATION 67,250 72,276
---------- ----------
OTHER:
Accounts receivable 175,326 172,255
Deferred tax asset, net 16,817 15,987
Goodwill 353,405 353,682
Other 36,140 37,400
---------- ----------
Total other assets 581,688 579,324
---------- ----------
TOTAL ASSETS $1,970,770 $2,029,412
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 16,607 $ 27,713
Accrued expenses 111,146 141,970
Deferred revenue 372,951 359,688
---------- ----------
Total current liabilities 500,704 529,371
DEFERRED REVENUE 296,278 321,881
ACCRUED EXPENSES 18,987 11,346
DEFERRED TAX LIABILITY, NET 4,076 34,666
---------- ----------
Total liabilities 820,045 897,264
---------- ----------
SHAREHOLDERS' EQUITY:
Common stock 3,046 3,030
Additional paid-in capital 727,208 673,660
Retained earnings 405,698 444,159
Accumulated other comprehensive income 14,773 11,299
---------- ----------
Total shareholders' equity 1,150,725 1,132,148
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,970,770 $2,029,412
========== ==========
See notes to condensed consolidated financial statements.
3
COMPUWARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
JUNE 30,
--------------------
2007 2006
--------- --------
REVENUES:
Software license fees $ 47,271 $ 67,465
Maintenance fees 113,741 110,317
Professional services fees 118,377 118,536
-------- --------
Total revenues 279,389 296,318
-------- --------
OPERATING EXPENSES:
Cost of software license fees 10,365 6,585
Cost of maintenance fees 11,453 10,126
Cost of professional services 104,077 107,615
Technology development and support 29,329 27,114
Sales and marketing 64,731 65,768
Administrative and general 45,380 46,228
Restructuring costs 16,020
-------- --------
Total operating expenses 281,355 263,436
-------- --------
INCOME (LOSS) FROM OPERATIONS (1,966) 32,882
OTHER INCOME, NET 5,659 10,881
-------- --------
INCOME BEFORE INCOME TAXES 3,693 43,763
INCOME TAX PROVISION 3,504 14,442
-------- --------
NET INCOME $ 189 $ 29,321
======== ========
Basic earnings per share $ 0.00 $ 0.08
======== ========
Diluted earnings per share $ 0.00 $ 0.08
======== ========
See notes to condensed consolidated financial statements.
4
COMPUWARE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
JUNE 30,
---------------------
2007 2006
--------- ---------
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income $ 189 $ 29,321
Adjustments to reconcile net income to net cash provided
by operations:
Depreciation and amortization 13,817 13,393
Property and equipment impairment associated with
restructuring 2,998
Capitalized software impairment associated with
restructuring 3,873
Acquisition tax benefits 1,311 1,309
Stock option compensation 1,573 2,797
Deferred income taxes (2,519) 4,700
Other 494 (136)
Net change in assets and liabilities, net of effects
from acquisitions and currency fluctuations:
Accounts receivable 56,869 56,772
Prepaid expenses and other current assets 8,648 (2,565)
Other assets 1,223 667
Accounts payable and accrued expenses (30,242) (32,393)
Deferred revenue (19,532) (14,614)
Income taxes (896) 4,626
--------- ---------
Net cash provided by operating activities 37,806 63,877
--------- ---------
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Purchase of:
Businesses, net of cash acquired (20,484)
Property and equipment (4,346) (2,663)
Capitalized software (4,173) (5,486)
Proceeds from sale of property 2,016
Investments:
Proceeds 42,885 125,816
Purchases (137,304)
--------- ---------
Net cash provided by (used in) investing activities 34,366 (38,105)
--------- ---------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Net proceeds from exercise of stock options including
excess tax benefits 58,364 597
Contribution to stock purchase plans 1,592 1,504
Repurchase of common stock (55,218) (32,839)
--------- ---------
Net cash provided by (used in) financing activities 4,738 (30,738)
--------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 1,891 3,794
--------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 78,801 (1,172)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 260,681 612,062
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 339,482 $ 610,890
========= =========
See notes to condensed consolidated financial statements.
5
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 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 ("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 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 June 30, 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 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 that are not separable among the elements because there
is a lack of VSOE of fair value for the various arrangement elements, the
Company recognizes the license fee revenue on a ratable basis over the
maintenance term or over the period in which the services are expected to be
performed. However, for income statement presentation purposes, we allocate
revenue between professional services fees, maintenance fees and
6
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2007
(UNAUDITED)
licenses fees based on our best estimate of the fair value of the undelivered
elements using the residual method.
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
recognized as discussed above. 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. Maintenance is included with all license
agreements for up to one year and is renewable thereafter for an annual fee.
Maintenance fees are deferred and recognized as revenue on a ratable basis over
the maintenance period.
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. 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 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 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/or 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.
7
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2007
(UNAUDITED)
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.
The income tax provision for the first quarter ended June 30, 2007 includes an
additional $2.1 million charge relating to the tax receivable previously
recorded in the fourth 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 and fiscal year ended March 31, 2008, and has
concluded that the effects on the financial statements are not material.
Effective April 1, 2007, the Company adopted Financial Accounting Standards
Board ("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. As a result of the implementation of
FIN 48, we 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 $16.7 million of gross
unrecognized tax benefits of which $12.7 million, net of federal benefit, would
favorably affect the Company's effective tax rate if recognized. In addition,
$9.9 million of the liability for unrecognized tax benefits was reclassified
from current to non-current since a payment of cash is not anticipated within
one year of the balance sheet date. These non-current income tax liabilities are
recorded in non-current "Accrued Expenses" in the Condensed Consolidated Balance
Sheet.
In accordance with our accounting policy, interest and penalties related to
income tax liabilities are included in income tax expense. The Company has a
$3.6 million reserve recorded for the payment of interest and penalties at April
1, 2007. This amount is included as a component of the gross unrecognized tax
benefits discussed above.
At April 1, 2007, the Company has open tax years, from tax periods 1996 and
forward, with various taxing jurisdictions, including the U.S., Brazil and the
United Kingdom. While it is expected that the amount of unrecognized tax
benefits will change in the next twelve months, the Company does not anticipate
the change to have a significant impact on the results of operations or the
financial position of the Company. There have been no material changes to the
liability for uncertain tax positions during the quarter ended June 30, 2007.
On July 12, 2007, the State of Michigan enacted the Michigan Business Tax (MBT)
as the replacement for the Michigan Single Business Tax, effective January 1,
2008. The new Act imposes two taxes - a modified gross receipts tax and an
income tax. Management is currently evaluating the impact the MBT will have on
our consolidated financial statements.
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)
8
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2007
(UNAUDITED)
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 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.
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
June 30,
-------------------
2007 2006
-------- --------
BASIC EARNINGS PER SHARE:
Numerator: Net income $ 189 $ 29,321
-------- --------
Denominator:
Weighted-average common shares outstanding 301,967 376,759
-------- --------
Basic earnings per share $ 0.00 $ 0.08
======== ========
DILUTED EARNINGS PER SHARE:
Numerator: Net income $ 189 $ 29,321
-------- --------
Denominator:
Weighted-average common shares outstanding 301,967 376,759
Dilutive effect of stock options 3,627 768
-------- --------
Total shares 305,594 377,527
-------- --------
Diluted earnings per share $ 0.00 $ 0.08
======== ========
During the three months ended June 30, 2007 and 2006, stock options to purchase
a total of approximately 13,834,000 and 50,112,000 shares, respectively, were
excluded from the diluted earnings per share calculation because they were
anti-dilutive.
9
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2007
(UNAUDITED)
NOTE 3 - COMPREHENSIVE INCOME
Other comprehensive income includes unrealized gain on marketable securities and
foreign currency translation gains that have been excluded from net income and
reflected in equity. Total comprehensive income is summarized as follows (in
thousands):
Three Months Ended
June 30,
------------------
2007 2006
------ -------
Net income $ 189 $29,321
Unrealized gain on marketable
securities, net of tax 58
Foreign currency translation
adjustment, net of tax 3,474 4,031
------ -------
Total comprehensive income $3,663 $33,410
====== =======
NOTE 4 - STOCK BENEFIT PLANS AND STOCK-BASED COMPENSATION
The Company has numerous stock option plans that have provided grants of options
to employees and directors of the Company. 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 last day's average high and low price for each three
month offering period.
The Company's stock-based compensation plan activity was as follows (shares and
intrinsic value in thousands):
Three Months Ended June 30, 2007
----------------------------------------------
Weighted
Weighted Average
Average Remaining Aggregate
Number of Exercise Contractual Intrinsic
Options Price Term Value (1)
--------- -------- ----------- ---------
Options outstanding as of April 1, 2007 43,710 $12.23
Granted 360 11.22
Exercised (6,239) 8.90
Forfeited (204) 7.14
Cancelled/expired (260) 14.12
------ ------
Options outstanding as of June 30, 2007 37,367 $12.79 3.68 $83,026
====== ======
Options vested and expected to vest, net of
estimated forfeitures, as of June 30, 2007 35,883 $13.00 3.49 $76,700
Options exercisable as of June 30, 2007 31,506 $13.78 2.86 $57,065
10
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2007
(UNAUDITED)
The total fair value of shares vested and the total intrinsic value of options
exercised were as follows (intrinsic values in thousands):
Three Months Ended
June 30,
------------------
2007 2006
------- -----
Fair value of shares vested $ 5.13 $5.70
Intrinsic value of options exercised 14,461 502
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 representative of prospective trends. The expected term of an
award is based on the simplified method as described in SAB 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:
Three Months Ended
June 30,
------------------
2007 2006
------ ------
Expected volatility 60.31% 69.77%
Risk-free interest rate 4.83% 5.16%
Expected lives at date of grant (in years) 6.9 6.9
Weighted-average fair value of the options granted $ 7.18 $ 5.28
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.
11
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2007
(UNAUDITED)
Stock-based compensation expense was allocated as follows (in thousands):
Three Months Ended
June 30,
------------------
2007 2006
------ ------
Stock-based compensation classified as:
Cost of software license fees $ 1
Cost of maintenance fees 68 $ 68
Cost of professional services 336 419
Technology development and support 174 183
Sales and marketing 442 1,378
Administrative and general 430 749
Restructuring costs 122
------ ------
Total stock-based compensation expense
before income taxes 1,573 2,797
Income tax benefit (536) (923)
------ ------
Total stock-based compensation expense
after income taxes $1,037 $1,874
====== ======
As of June 30, 2007, $15.6 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 3.10 years.
12
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2007
(UNAUDITED)
NOTE 5 - GOODWILL AND INTANGIBLE ASSETS
The components of the Company's intangible assets were as follows (in
thousands):
June 30, 2007
--------------------------------------------
Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
-------------- ------------ ------------
Unamortized intangible assets:
Trademarks (1) $ 5,945 $ 5,945
======== =======
Amortized intangible assets:
Capitalized software (2) $333,329 $(266,079) $67,250
Customer relationship agreements (3) 13,994 (6,335) 7,659
Non-compete agreements (3) 2,825 (2,420) 405
Other (4) 6,891 (6,045) 846
-------- --------- -------
Total amortized intangible assets $357,039 $(280,879) $76,160
======== ========= =======
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 in fiscal 2004 and 2005. 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.
13
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 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) (973) (973)
Effect of foreign currency translation 304 392 696
-------- -------- --------
Balance at June 30, 2007, net $211,278 $142,127 $353,405
======== ======== ========
(1) The adjustment to goodwill primarily relates to tax adjustments related to
prior acquisitions.
14
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2007
(UNAUDITED)
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
June 30,
-------------------
2007 2006
-------- --------
Revenues:
Products:
Mainframe $103,237 $119,741
Distributed systems 57,775 58,041
-------- --------
Total product revenue 161,012 177,782
Professional services 118,377 118,536
-------- --------
Total revenues $279,389 $296,318
======== ========
Operating expenses:
Products $115,878 $109,593
Professional services 104,077 107,615
Corporate expenses 45,380 46,228
Restructuring costs 16,020
-------- --------
Total operating expenses $281,355 $263,436
======== ========
Income (loss) from operations before
other income:
Products $ 45,134 $ 68,189
Professional services 14,300 10,921
Corporate expenses (45,380) (46,228)
Restructuring costs (16,020)
-------- --------
Total income (loss) from operations
before other income: (1,966) 32,882
Other income 5,659 10,881
-------- --------
Income before income taxes $ 3,693 $ 43,763
======== ========
Financial information regarding geographic operations is presented in the table
below (in thousands):
Three Months Ended
June 30,
-------------------
2007 2006
-------- --------
Revenues:
United States $185,136 $202,632
Europe and Africa 69,933 67,472
Other international operations 24,320 26,214
-------- --------
Total revenues $279,389 $296,318
======== ========
15
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2007
(UNAUDITED)
NOTE 7 - RESTRUCTURING ACCRUAL
In the first quarter of fiscal 2008, the Company initiated a restructuring plan
that realigned and centralized certain product development activities. The plan
related to this activity is expected to result in a total charge of
approximately $22.0 million ($14.3 million was expensed during the first quarter
of 2008) consisting of employee termination benefits, property and equipment
impairments and lease abandonment costs totaling $15.0 million, $3.5 million and
$3.5 million, respectively. The Company also initiated workforce reductions
across other functions resulting in an expense of $1.7 million during the first
quarter of 2008 that consisted primarily of employee termination benefits. These
restructuring costs primarily occurred within our products segment.
Development activities related to the DevPartner and OptimalJ products were
transitioned from the Merrimack, NH facility and the Amsterdam, The Netherlands
facility to the Detroit headquarters facility and ApplicationVantage product
development was transitioned from the San Diego, CA facility to the Gdansk,
Poland facility. These changes were designed to reduce the Company's costs and
improve operating efficiencies. The restructuring plan includes the termination
of employees, primarily programming personnel, and full or partial closing of
the aforementioned facilities. Approximately 230 employees worldwide will be
terminated as a result of this realignment. The Company anticipates this
restructuring activity to be completed in the second quarter of 2008. In
addition, the Company also terminated 70 employees from various other functions
and geographies of the organization during the first quarter in an effort to
reduce operating expenses.
The following table summarizes the restructuring accrual as of March 31, 2007,
and changes to the accrual during the first three months of fiscal 2008 (in
thousands):
Non-cash
Expensed Paid charges
Accrual during the during the during the Accrual
balance at quarter ended quarter ended quarter ended balance at
March 31, June 30, June 30, June 30, June 30,
2007 2007 2007 2007 2007
---------- ------------- ------------- ------------- ----------
Employee termination benefits $10,761 $(1,690) $ (122) $ 8,949
Facilities costs (primarily lease
abandonments and property
and equipment impairment) $2,419 4,935 (176) $(2,998) 4,180
Other 324 (139) 185
------ ------- ------- ------- -------
Restructuring cost $2,419 $16,020 $(2,005) $(3,120) $13,314
====== ======= ======= ======= =======
As of June 30, 2007, $11.1 million of the restructuring accrual is recorded in
current "accrued expenses" with the remaining balance of $2.2 million recorded
in long-term "accrued expenses" in the Condensed Consolidated Balance Sheet.
The accruals for employee termination benefits at June 30, 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. These
amounts are expected to be paid within fiscal 2008.
The accruals for facilities costs at June 30, 2007 represent the remaining fair
value of lease obligations for exited locations, as determined at the cease-use
dates of those facilities, net of
16
COMPUWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2007
(UNAUDITED)
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.
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.
On July 23, 2007, 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. 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 will receive the first six months of salary no earlier than January 10,
2008 after which Mr. Jallos 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
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 will record a charge of
approximately $5.5 million in the second quarter of fiscal 2008 related to
this matter.
NOTE 8 - DEBT
The Company has no long term debt.
As of June 30, 2007, the Company held a $100 million revolving credit facility
maturing on July 27, 2007. Interest is payable at 1% over the Eurodollar rate or
at the prime rate (8.25% at June 30, 2007), at the Company's option. No
borrowings have occurred under this facility.
On July 26, 2007, the Company amended its Amended and Restated Credit Agreement
extending the maturity to October 26, 2007.
17
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 June 30, 2007, and
the related condensed consolidated statements of operations and cash flows for
the three-month periods ended June 30, 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 1 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
August 6, 2007
18
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.
A summary of the material risks and uncertainties that we believe affect us are
highlighted below and have not materially changed since the end of fiscal 2007
(see Item 1A Risk Factors in our 2007 10-K for a more detailed explanation of
each risk). These risks and uncertainties are not the only ones we face.
Additional 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. If any of the
following risks actually occur, our financial condition and results of
operations could be materially and adversely affected. If this were to happen,
the value of our common stock could decline significantly, and shareholders
could lose all or part of their investment.
There can be no assurance that future results will meet expectations. While we
believe that our forward-looking statements are reasonable, you should not place
undue reliance on any such forward-looking statements, which speak only as of
the date made. Except as required by applicable law, we do not undertake any
obligation to publicly release any revisions which may be made to any
forward-looking statements to reflect events or circumstances occurring after
the date of this report.
- The majority of our software products revenue is dependent on our
customers' continued use of International Business Machines Corp.
("IBM") and IBM-compatible products, and on the acceptance of our
pricing structure for software licenses and maintenance.
- 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 expansion of our stock repurchase plans is subject to a number of
risks and uncertainties that may cause the anticipated expansion not
to occur. For example, there can be no assurance that the Board of
Directors will approve the expansion of our
19
COMPUWARE CORPORATION AND SUBSIDIARIES
repurchase plans and the necessary additional borrowing, as such
approval is subject to a number of factors outside our control, any
one of which may cause the Board to determine that such approval is
not in the best interests of the Company or its shareholders.
Moreover, adequate financing will be required for the expansion of the
stock repurchase plan. This financing may not be available at rates
and on other terms and conditions that the Board determines to be in
the best interests of the Company and its shareholders. If the
expansion of the repurchase plans is approved and acceptable financing
is obtained, repurchases of the Company's common stock could be
delayed indefinitely by market conditions, adverse business
conditions, the Company's need to conserve capital resources for use
in its operations or 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.
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".
20
COMPUWARE CORPORATION AND SUBSIDIARIES
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 offerings, which help manage the supply chain
through the integration of vital business information and processes between
partners, customers and suppliers.
We focus on growing revenue and profit margins by enhancing and promoting our
current product lines, expanding our product and service offerings through key
acquisitions, developing strategic partnerships in order to provide clients with
our product solutions and managing our costs.
The following occurred during the first quarter of 2008:
- Initiated a restructuring plan that resulted in a charge of $16.0
million that is expected to reduce costs by approximately $30.0
million on an annualized basis. Additional restructuring charges are
expected in the second quarter of 2008 relating to this plan as
discussed in Note 7 to the Condensed Consolidated Financial
Statements.
- Repurchased approximately 4.8 million shares of our common stock at an
average price of $9.99 per share.
- Experienced a decrease in products contribution margin to 28.0% in the
first quarter of 2008 from 38.4% in the first quarter of 2007 due to a
decline in license revenue and an increase in cost of software license
fees.
- Incurred a slight decrease in distributed product revenue compared to
the first quarter of 2007.
- Incurred a 13.8% decrease in mainframe product revenue compared to the
first quarter of 2007 primarily related to a decline in license
revenue.
- Released 4 mainframe and 9 distributed product updates designed to
increase the productivity of the IT departments of our customers.
- Achieved an increase in professional services contribution margin to
12.1% in the first quarter of 2008 from 9.2% in the first quarter of
2007. The improvement is primarily due to lower operating expenses.
Our ability to achieve our strategies and objectives is subject to a number of
factors some of which we may not be able to control. See "Forward-Looking
Statements".
21
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
Total Revenues
------------------
Three Months Ended
June 30, Period-
------------------ to-Period
2007 2006 Change
----- ----- ---------
REVENUE:
Software license fees 16.9% 22.8% (29.9)%
Maintenance fees 40.7 37.2 3.1
Professional services fees 42.4 40.0 (0.1)
----- ----
Total revenues 100.0 100.0 (5.7)
----- -----
OPERATING EXPENSES:
Cost of software license fees 3.7 2.2 57.4
Cost of maintenance fees 4.1 3.4 13.1
Cost of professional services 37.3 36.3 (3.3)
Technology development and support 10.5 9.2 8.2
Sales and marketing 23.2 22.2 (1.6)
Administrative and general 16.2 15.6 (1.8)
Restructuring costs 5.7
----- -----
Total operating expenses 100.7 88.9 6.8
----- -----
Income (loss) from operations (0.7) 11.1 (106.0)
Other income 2.0 3.7 (48.0)
----- -----
Income before income taxes 1.3 14.8 (91.6)
Income tax provision 1.3 4.9 (75.7)
----- -----
Net income 0.0% 9.9% (99.4)%
===== =====
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 57.6% and 60.0% of total revenue
during the first quarter of 2008 and 2007, respectively.
Distributed software product revenue decreased $200,000 or 0.5% during the first
quarter of 2008 to $57.8 million from $58.0 million during the first quarter of
2007. The decrease was primarily due to a $4.5 million decrease in license
revenue offset by a $4.3 million increase in maintenance revenue.
22
COMPUWARE CORPORATION AND SUBSIDIARIES
Mainframe software product revenue decreased $16.5 million or 13.8% during the
first quarter of 2008 to $103.2 million from $119.7 million during the first
quarter of 2007. The decline was primarily due to lower license revenue.
License revenue decreased $20.2 million or 29.9% during the first quarter of
2008 to $47.3 million from $67.5 million during the first quarter of 2007.
Fluctuations in foreign currencies positively impacted license fees by $1.3
million during the first quarter of 2008. Mainframe and distributed license
revenue decreased $15.6 million and $4.6 million, respectively. The decline in
mainframe license revenue was primarily a result of decreased demand for
capacity in our United States operations. The decline in distributed license
revenue was primarily a result of sales execution during the first quarter
of 2008 that did not meet our expectations.
Maintenance fees increased $3.4 million or 3.1% to $113.7 million during the
first quarter of 2008 from $110.3 million during the first quarter of 2007.
Fluctuations in foreign currencies positively impacted maintenance fees by $2.8
million during the first quarter of 2008. The remaining change was primarily due
to an increase in distributed maintenance revenue related to our Vantage,
QACenter and Changepoint product lines.
Product revenue by geographic location is presented in the table below (in
thousands):
Three Months Ended
June 30,
-------------------
2007 2006
-------- --------
United States $ 85,416 $100,426
Europe and Africa 53,164 52,672
Other international operations 22,432 24,684
-------- --------
Total product revenue $161,012 $177,782
======== ========
PRODUCT CONTRIBUTION AND EXPENSES
Financial information for the products segment is as follows (in thousands):
Three Months Ended
June 30,
-------------------
2007 2006
-------- --------
Revenue $161,012 $177,782
Expenses 115,878 109,593
-------- --------
Product contribution $ 45,134 $ 68,189
======== ========
The product segment generated contribution margins of 28.0% and 38.4% during the
first quarter of 2008 and 2007, respectively. The decline in contribution
margins was primarily due to the decline in license revenue and the increase in
cost of software license fees.
Product expenses include cost of software license 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
23
COMPUWARE CORPORATION AND SUBSIDIARIES
the cost of author royalties. For the first quarter of 2008, cost of software
license fees increased $3.8 million or 57.4% to $10.4 million from $6.6 million
in the first quarter of 2007. The increase in cost of software license fees was
primarily due to a $3.9 million capitalized software impairment charge
associated with the restructuring program initiated during the first quarter of
2008 (see Note 7 to the Condensed Consolidated Financial Statements). As a
percentage of software license fees, costs of software license fees were 21.9%
(includes 8.2% from the impairment charge) and 9.8% in the first quarter 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 support. New releases include significant research and
development costs and are available to be licensed to new customers as well as
maintenance customers. For the first quarter of 2008, cost of maintenance fees
increased $1.4 million or 13.1% to $11.5 million from $10.1 million in the first
quarter of 2007. The increase in expense was primarily due to higher
compensation and benefit costs resulting from increased employee headcount,
primarily programming personnel, which started to occur during the middle of
fiscal 2007 in order to meet product development and maintenance initiatives. We
anticipate cost of maintenance fees to decline due to the restructuring program
initiated during the first quarter of 2008 (see Note 7 to the Condensed
Consolidated Financial Statements). As a percentage of maintenance fees, cost of
maintenance fees were 10.1% and 9.2% in the first quarter 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 here 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
18.2% and 15.3% in the first quarter 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 first
quarter of 2008 and 2007 were as follows (in thousands):
Three months ended
June 30,
------------------
2007 2006
------- -------
Technology development and support costs incurred $33,048 $32,596
Capitalized technology development and support costs (3,719) (5,482)
------- -------
Technology development and support costs reported $29,329 $27,114
======= =======
Before the capitalization of internally developed software products, total
technology development and support expenditures for the first quarter of 2008
increased $400,000 or 1.4%, to $33.0 million from $32.6 million in the first
quarter of 2007. The increase in expense was primarily due to higher
compensation and benefit costs resulting from increased employee headcount,
primarily programming personnel, which started to occur during the middle of
fiscal 2007 in order to meet product development and maintenance initiatives. We
anticipate technology development and support costs to decline due to the
restructuring program initiated
24
COMPUWARE CORPORATION AND SUBSIDIARIES
during the first quarter of 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 first quarter of 2008, sales and marketing costs
decreased $1.1 million or 1.6% to $64.7 million from $65.8 million in the first
quarter of 2007. The decrease in sales and marketing costs was primarily
attributable to a decrease in compensation, primarily bonus and commissions, due
to the decline in license revenue.
As a percentage of product revenue, sales and marketing costs were 40.2% and
37.0% in the first quarter of 2008 and 2007, respectively.
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 $100,000 or 0.1% during the first
quarter of 2008 to $118.4 million compared to $118.5 million in the first
quarter of 2007. The decrease in revenue was primarily due to a general slow
down in customer spending on certain IT programs and on staff supplementation
services, partially offset by a $3.3 million increase in application services
revenue.
Professional services revenue by geographic location is presented in the table
below (in thousands):
Three Months Ended
June 30,
-------------------
2007 2006
-------- --------
United States $ 99,720 $102,206
Europe and Africa 16,769 14,800
Other international operations 1,888 1,530
-------- --------
Total professional services revenue $118,377 $118,536
======== ========
25
COMPUWARE CORPORATION AND SUBSIDIARIES
PROFESSIONAL SERVICES CONTRIBUTION AND EXPENSES
Financial information for the professional services segment is as follows (in
thousands):
Three Months Ended
June 30,
-------------------
2007 2006
-------- --------
Revenue $118,377 $118,536
Expenses 104,077 107,615
-------- --------
Professional services contribution $ 14,300 $ 10,921
======== ========
During the first quarter of 2008, the professional services segment generated a
contribution margin of 12.1%, compared to 9.2% during the first quarter of 2007.
The increase in contribution margin was primarily due to a decrease in cost of
professional services.
Cost of professional services consists primarily of personnel-related costs of
providing services, including billable staff, subcontractors and sales
personnel. Cost of professional services decreased $3.5 million or 3.3% during
the first quarter of 2008 to $104.1 million compared to $107.6 million in the
first quarter of 2007. The decrease in costs 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 $800,000 or 1.8% during the first quarter of 2008 to
$45.4 million from $46.2 million during the first quarter of 2007. The decrease
in cost was primarily attributable to a $1.5 million decrease in foreign
currency losses, partially offset by an increase in costs associated with the
Director Phantom Stock Plan that resulted from the increase in our stock price
from March 31, 2007 to June 30, 2007.
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 $5.2 million or 48.0% during the first quarter of 2008 to $5.7
million compared to $10.9 million in the first quarter of 2007. The decrease in
other income was primarily attributable to a decline in investment interest
income resulting from a lower average cash equivalent and investment balance
throughout first quarter of 2008 compared to first quarter of 2007. We expect
interest income to decline as a result of the use of cash and investments for
future stock repurchases.
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 $3.5 million in the first
26
COMPUWARE CORPORATION AND SUBSIDIARIES
quarter of 2008 and $14.4 million in the first quarter of 2007 representing an
effective tax rate of 95% and 33%, respectively.
The increase in the effective tax rate from 2007 to 2008 is primarily due to an
additional $2.1 million charge relating to the tax receivable previously
recorded in the fourth 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 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 first quarter of 2008, we initiated a restructuring plan that included a
realignment and centralization of certain product development activities. These
changes were designed to reduce the Company's costs and improve operating
efficiencies. We incurred a charge of $16.0 million during the first quarter of
2008 that is expected to result in approximately $35.0 million of annualized
cost savings. Results will begin to be seen in the second quarter of 2008.
Additional charges are expected in the second quarter of 2008 relating to this
restructuring plan as discussed in Note 7 to the Condensed Consolidated
Financial Statements. We continue to evaluate our business processes in order to
identify ways to reduce costs with the goal of reducing operating expenses by an
additional $55.0 million to $65.0 million in annualized costs during fiscal
2008. 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 June 30, 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.
27
COMPUWARE CORPORATION AND SUBSIDIARIES
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2007, cash and cash equivalents and investments totaled
approximately $474.7 million.
Net cash provided by operating activities:
Net cash from operating activities decreased $26.1 million during the first
quarter of 2008 as compared to 2007. The decrease was primarily a result of the
$29.1 million decrease in net income discussed under "Results of Operations" and
severance payments associated with the restructuring program initiated in 2008.
Depreciation and amortization of $13.8 million and $13.4 million, respectively,
in the first quarter of 2008 and 2007 added to net income to provide cash from
operating activities. Our cash provided by operating activities is also impacted
by changes in working capital accounts. Changes in accounts receivable and
deferred revenue have typically had the largest impact on our cash flows as we
allow for deferred payment terms on multi-year products contracts. Changes in
accounts payable and accrued expenses are usually higher during the first
quarter of a fiscal year as commissions and bonuses accrued for at March 31,
2007 are paid during the first quarter. 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 quarter of 2008. There were no fiscal 2006
IBM settlement proceeds paid during the first quarter of 2007.
In the first quarter of fiscal 2008, the Company adopted a restructuring plan
that realigned and centralized certain product development activities. The plan
is expected to result in an estimated total cash payout of approximately $18.5
million for employee termination benefits and lease abandonment costs of which
$2.1 million was paid as of June 30, 2007. We continue to review our business
processes for additional cost savings that could cause us to incur further
restructuring costs during 2008 (see Note 7 to the Condensed Consolidated
Financial Statements).
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 quarter of 2008 was
$34.4 million compared to net cash used for investing activities of $38.1
million during the first quarter of 2007.
Net cash from investing activities increased $72.5 million during the first
quarter of 2008 as compared to 2007. The increase was primarily due to the $54.4
million net reduction in our investments. The sale of our investments is
primarily being used to fund the stock repurchase initiative. The remaining
increase in net cash was primarily due to the fact that we had no acquisitions
during the first quarter of 2008. In the first quarter of 2007, we acquired
SteelTrace Limited for $20.7 million in cash.
During these periods, capital expenditures for property and equipment and
capitalized research and software development totaled $8.5 million and $8.1
million, respectively.
We also continue to evaluate business acquisition opportunities that fit our
strategic plans.
28
COMPUWARE CORPORATION AND SUBSIDIARIES
Net cash provided by (used in) financing activities:
Net cash provided by financing activities during the first quarter of 2008 was
$4.7 million compared to net cash used for financing activities of $30.7 million
during the first quarter of 2007.
Net cash from financing activities increased $35.5 million during the first
quarter of 2008 as compared to 2007. The increase was primarily due to a $57.8
million increase in net proceeds from exercise of stock options, partially
offset by a $22.4 million increase in cash used to repurchase our common stock.
The Board of Directors has authorized the repurchase of our common stock under
two plans, the "Discretionary Plan" and the "10b5-1 Plan". Under the
Discretionary Plan, the Board of Directors has authorized the repurchase of a
total of up to $750.0 million of our common stock. 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 first quarter of 2008, we repurchased 492,000
shares of our common stock under the Discretionary Plan at an average price of
$10.90 per share for a total of $5.4 million. As of June 30, 2007, approximately
$98.1 million remains authorized for future purchases under the Discretionary
Plan.
Under the 10b5-1 Plan, the Board of Directors originally authorized the
repurchase of up to 34.0 million shares of our common stock in December 2006
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. In May 2007, we
executed an amendment to the 10b5-1 Plan that, among other things, extended the
termination date from June 30, 2007 to September 30, 2007. In conjunction with
its approval of the amendment, the Board also authorized the repurchase of up to
an additional 16.0 million shares under the 10b5-1 Plan. The 10b5-1 Plan allows
the repurchase of our common stock at times when we might be prevented from
doing so under insider trading laws or because of self-imposed trading blackout
periods. A broker selected by us has the authority to repurchase shares on our
behalf under the terms and limitations specified in the plan. During the first
quarter of 2008, we repurchased 4.3 million shares for an aggregate $42.7
million and settled $7.2 million of trades that occurred during the fourth
quarter of 2007 under the 10b5-1 Plan. Approximately 27.7 million shares
remained authorized for future repurchases as of June 30, 2007. The actual
number of shares to be repurchased will depend on the terms of the 10b5-1 Plan
and prevailing market conditions. The Company may terminate the 10b5-1 Plan at
any time.
We intend to request approval from the Board of Directors during fiscal 2008 to
expand the amounts authorized for repurchase of our common stock under the
Discretionary and Rule 10b5-1 Plans on an as needed basis.
We hold a $100 million revolving credit facility that would have matured on July
27, 2007 (see Note 9 to the Consolidated Financial Statements included in our
Annual Report on Form 10-K for the year ended March 31, 2007 for a description
of the facility). On July 26, 2007, we amended the credit agreement extending
the maturity to October 26, 2007. No borrowings have occurred under this
facility since inception.
29
COMPUWARE CORPORATION AND SUBSIDIARIES
We are currently working to expand our credit facility and are reviewing other
forms of financing to insure funding of our stock repurchase program. We
anticipate borrowing up to $300.0 million in fiscal 2008 in order to meet our
stock repurchase initiatives.
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 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.
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.
At June 30, 2007, we had gross unrecognized tax benefits of $18.0 million. We
anticipate settlement of $1.8 million with the taxing authorities in the
upcoming twelve months. 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.
30
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 June 30, 2007 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
31
COMPUWARE CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
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 June 30, 2007:
Approximate dollar value or
Total number maximum number of shares
of shares that may yet be purchased
purchased as under the plans or programs
part of ---------------------------
Total number Average publicly Discretionary Rule 10b5-1
of shares price paid announced Plan (a) Plan (b)
Period purchased per share plans ($) (shares)
------ ------------ ---------- ------------ ------------- -----------
For the month ended April 30, 2007 3,125,000 $ 9.86 3,125,000 $103,510,000 12,878,000
For the month ended May 31, 2007 1,686,000 10.23 1,686,000 98,144,000 27,684,000
For the month ended June 30, 2007 98,144,000 27,684,000
For the quarter ended June 30, 2007 4,811,000 $ 9.99 4,811,000 $ 98,144,000 27,684,000
(a) In December 2006, we announced that the Board of Directors authorized the
discretionary repurchase of the Company's common stock for up to $200
million. 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 plans will expire when we have repurchased
all shares authorized for repurchase thereunder.
(b) In December 2006, the Board of Directors adopted a plan under Rule 10b5-1
of the Securities Exchange Act of 1934 to repurchase 34.0 million shares of
our common stock. A broker selected by us has the authority under the terms
and limitations specified in the plan to repurchase shares on our behalf in
accordance with the terms of the plan. In May 2007, we expanded the plan to
include an additional 16.0 million shares and we expect these purchases to
continue through September 30, 2007, although the Company may terminate the
plan at any time.
ITEM 5. OTHER INFORMATION
On July 26, 2007, we amended the Amended and Restated Credit Agreement, dated
May 2, 2003 as of July 27, 2006, extending the maturity to October 26, 2007. The
amendment is attached to this report as exhibit 4.9 and incorporated herein by
reference.
32
COMPUWARE CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS
Exhibit
Number Description of Document
------- -----------------------
4.9 Amendment No. 1, dated as of July 26, 2007, to Amended and Restated
Credit Agreement Dated May 2, 2003 as of July 27, 2006 (1)
10.103 Settlement Agreement, dated July 18, 2007, between Compuware
Corporation and Hank Jallos (1)
10.104 Amendment No. 1, dated as of August 9, 2007, to the Settlement
Agreement dated July 18, 2007, between Compuware Corporation and
Hank Jallos (1)
15 Independent Registered Public Accounting Firm's Awareness Letter (1)
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of
the Securities Exchange Act. (1)
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of
the Securities Exchange Act. (1)
32 Certification pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) of
the Securities Exchange Act. (1)
(1) Filed herewith.
33
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: August 6, 2007 By: /s/ Peter Karmanos, Jr.
------------------------------------
Peter Karmanos, Jr.
Chief Executive Officer
(duly authorized officer)
Date: August 6, 2007 By: /s/ Laura L. Fournier
------------------------------------
Laura L. Fournier
Senior Vice President
Chief Financial Officer Treasurer
(principal financial officer)
34
EXHIBIT INDEX
Exhibit
Number Description of Document
------- -----------------------
4.9 Amendment No. 1, dated as of July 26, 2007, to Amended and Restated
Credit Agreement Dated May 2, 2003 as of July 27, 2006 (1)
10.103 Settlement Agreement, dated July 18, 2007, between Compuware
Corporation and Hank Jallos (1)
10.104 Amendment No. 1, dated as of August 9, 2007, to the Settlement
Agreement, dated July 18, 2007, between Compuware Corporation and
Hank Jallos (1)
15 Independent Registered Public Accounting Firm's Awareness Letter (1)
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of
the Securities Exchange Act. (1)
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of
the Securities Exchange Act. (1)
32 Certification pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) of
the Securities Exchange Act. (1)
(1) Filed herewith.
35