Compuware 10-Q 2011
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2010
o 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
(Exact name of registrant as specified in its charter)
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 o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer's class of common stock, as of the latest practicable date:
As of February 1, 2011, there were outstanding 218,760,115 shares of Common Stock, par value $.01, of the registrant.
See notes to condensed consolidated financial statements.
COMPUWARE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(In Thousands. Except Per Share Data)
See notes to condensed consolidated financial statements.
COMPUWARE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
See notes to condensed consolidated financial statements.
The accompanying unaudited condensed consolidated financial statements include the accounts of Compuware Corporation and its wholly owned subsidiaries (collectively, the "Company", “Compuware”, “we”, “our” and “us”). All inter-company 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. U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, contingencies and results of operations. While management has based their assumptions and estimates on the facts and circumstances existing at December 31, 2010, 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, 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, 2010 included in the Company's annual report on Form 10-K filed with the Securities and Exchange Commission (“SEC”). The condensed consolidated balance sheet at March 31, 2010 has been derived from the audited financial statements at that date but does not include all information and footnotes required by U.S. GAAP for complete financial statements. The results of operations for interim periods are not necessarily indicative of results expected to be achieved for the full fiscal year.
Basis for Revenue Recognition
The Company derives its revenue from licensing software products, providing maintenance and support for those products and rendering professional, application and web performance services. Revenue recognition begins once the following criteria have been 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.
When our web performance services are sold with software deliverables, an arrangement containing both software elements (i.e., software license with maintenance and product related services) and non-software elements (i.e., web performance and other hosting services) is created and referred to as a multiple-deliverable arrangement. The revenue associated with the arrangement is allocated to the software elements and non-software elements using our best estimate of selling price as we have been unable to establish vendor specific objective evidence of fair value (“VSOE”) or third party evidence for our software deliverables or non-software elements. Management’s best estimate of selling price for the non-software elements is based upon the price the hosting is sold for separately, which is consistent with the price stated in the contract as we have evidence that customers actually renew at this price. For the software deliverables, management’s best estimate of selling price is determined by using the prices of software deliverables sold separately taking into consideration geography, transaction size, and actual price charged. Once the revenue is allocated to the software elements and the non-software elements, revenue recognition occurs as described herein.
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 (time based licenses).
Perpetual license fee revenue is recognized using the residual method, under which the fair value, based on VSOE, of all undelivered elements of the agreement (i.e., maintenance and product related services) is deferred. VSOE is based on rates charged for maintenance and professional services when sold separately. The remaining portion of the fee is recognized as license fee revenue upon delivery of the products, provided that all revenue recognition criteria are met.
For revenue arrangements where there is a lack of VSOE for any undelivered elements, license fee revenue is deferred and recognized upon delivery of those elements or when VSOE can be established. When maintenance or product related services are the only undelivered elements, the license fee revenue is recognized on a ratable basis over the longer of the maintenance term or the period in which the product related services are expected to be performed. Such transactions include time based licenses as the Company does not sell maintenance for time based licenses separately and therefore cannot establish VSOE for the undelivered elements in these arrangements. In order to comply with SEC Regulation S-X, Rule 5-03(b), which requires product, services and other categories of revenue to be displayed separately on the income statement, the Company separates the license fee, maintenance fee and product related services fee (which is included in professional services fees) associated with time based licenses based on its determination of fair value. The Company applies its VSOE for maintenance related to perpetual license transactions and stand alone product related services arrangements as a reasonable and consistent approximation of fair value to separate license fee, maintenance fee and product related services fee revenue for income statement classification purposes.
The Company offers flexibility to customers purchasing licenses for its products and related maintenance. Terms of these transactions range from standard perpetual license sales that include one year of maintenance to large multi-year (generally two to five years), multi-product contracts. The Company allows deferred payment terms on 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 revenue as discussed above. In certain transactions where it cannot be concluded that the fee is fixed or determinable due to the nature of the deferred payment terms, the Company recognizes revenue as payments become due.
Maintenance and subscription fees
The Company’s maintenance agreements allow customers to receive technical support and advice, including problem resolution services and assistance in product installation, error corrections and any product enhancements released during the maintenance period. The first year of maintenance is generally included with all license agreements. Maintenance fees are recognized ratably over the term of the maintenance arrangements, which may range from one to five years.
The Company’s subscription fees relate to arrangements that permit our customers to access and utilize our web performance services. The subscription arrangements do not provide customers with the right to take possession of our software at any time and we do not make it feasible for the customer to run the software on its own hardware. Subscription fees are deferred upon contract execution and are recognized ratably over the term of the subscription.
Professional services fees
The Company provides the following professional services solutions: (1) IT portfolio management services; (2) application delivery management services; (3) application outsourcing services; and (4) enterprise legacy modernization services. The Company also offers implementation, consulting and training services in tandem with the Company’s product solutions offerings, which are referred to as product related services.
In addition, revenue associated with the Company’s application services segment is recorded as professional services fees and consists of fees for customers accessing its application services network and other services.
Professional services fees are generally based on hourly or daily rates. Revenues from professional services are recognized in the period the services are performed provided that collection of the related receivable is reasonably assured. For development services rendered under fixed-price contracts, revenues are recognized using the percentage of completion method and if it is 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 expected service period as the customer derives value from the services, consistent with the proportional performance method.
Deferred revenue consists primarily of billed and unbilled maintenance fees related to the future service period of maintenance agreements in effect at the reporting date. Deferred license, subscription and professional service fees are also included in deferred revenue for those arrangements that are being recognized on a ratable basis. Sales commission costs that directly relate to revenue transactions that are deferred are recorded as “Current” or “Non-current other assets”, as applicable, in the condensed consolidated balance sheets and recognized as “Sales and marketing” expenses in the condensed consolidated statements of operations over the revenue recognition period of the related customer contracts.
Research and development
Research and development (“R&D”) costs for the three months ended December 31, 2010 and 2009 were $16.2 million and $15.7 million, respectively, and for the nine months ended December 31, 2010 and 2009 were $51.8 million and $46.7 million, respectively. R&D costs related to our software products and web performance services network are reported as “Technology development and support” in the condensed consolidated statements of operations and for our application services network, the costs are reported as “Cost of professional services”.
The Company estimates its income taxes in each jurisdiction in which it operates. Deferred tax assets and liabilities are determined based on the differences between the financial statements and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the period that includes the enactment date.
The Company records net deferred tax assets to the extent it believes these assets will more likely than not be realized. These deferred tax assets are subject to periodic assessments as to recoverability and if it is determined that it is more likely than not that the benefits will not be realized, valuation allowances are recorded which would increase the provision for income taxes. In making such determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations.
Interest and penalties related to uncertain tax positions are included in the income tax provision.
Recently Issued Accounting Pronouncements
In July 2010, the FASB issued Accounting Standard Update (“ASU”) No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”. The ASU requires enhanced disclosures about the credit quality of financing receivables and the allowance for credit losses; including disclosures regarding credit quality indicators, past due information, and modifications of original terms. The requirements of this ASU were adopted during our quarter ending December 31, 2010. See Note 3 for additional information.
In December 2009, the FASB issued ASU No. 2009-17, “Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities.” ASU No. 2009-17 amends the guidance for consolidation of VIEs primarily related to the determination of the primary beneficiary of the VIE. This ASU became effective for us on April 1, 2010 and did not have an impact on our condensed consolidated financial statements.
Note 2 - Acquisitions
Effective December 21, 2010, the Company acquired certain assets and liabilities of BEZ Systems, Inc. (“BEZ”) for $2.5 million in cash. BEZ is a provider of predictive analytic solutions for IT departments that collects data continuously from the large number of systems the solutions monitor and then automatically aggregates the data to generate advice on how to allocate resources, tune applications and databases, and manage workloads to satisfy service level objectives for the most critical activities. BEZ solutions will be integrated into Gomez’s web performance solutions increasing our capabilities to provide predictive monitoring and business analytics to our customers. The assets and liabilities acquired have been recorded at their fair values as of the purchase date using the acquisition method. The purchase price exceeded the fair value of the acquired assets and liabilities by $1.9 million, which was recorded to goodwill within the web performance services segment. The fair value of intangible assets subject to amortization related to developed technology totaled $1.0 million with a useful life of five years.
Effective September 17, 2010, the Company acquired certain assets and liabilities of DocSite, LLC (“DocSite”), a provider of web-based solutions that give physicians and healthcare organizations the ability to accurately and timely manage, analyze and report healthcare performance and quality, for $15.9 million in cash. The assets and liabilities acquired have been recorded at their fair values as of the purchase date using the acquisition method. The purchase price exceeded the fair value of the acquired assets and liabilities by $13.9 million, which was recorded to goodwill within the application services segment. The fair value of intangible assets subject to amortization totaled $4.0 million, of which $1.9 million, $1.8 million and $260,000 related to developed technology, customer relationships and trademarks with a useful life of five, six and three years, respectively.
The arrangement included a contingent consideration component that increases the DocSite purchase price if pre-determined revenue targets for a specific product line are achieved by March 31, 2011. The contingent consideration arrangement could result in future payments of up to an additional $1.0 million. The fair value of the contingent consideration arrangement at the time of acquisition was $750,000 and was determined by applying the income approach which included significant inputs that are not observable in the market referred to as level 3 inputs (see Note 5 for additional information regarding level of inputs). The key assumptions used in the fair value measurement include the probability of attaining certain levels of revenue ranging from less than $3.5 million to greater than $4.5 million. A fair value assessment of the contingent consideration arrangement was performed as of December 31, 2010 and based on actual revenue results and revised revenue projections, the liability was reduced by $438,000 which was reflected in “cost of professional services” within the condensed consolidated statement of operations.
The factors that contribute to a purchase price that resulted in goodwill for our BEZ and DocSite acquisitions include, but are not limited to, the retention of research and development personnel with the skills to develop related technologies that will enhance our web performance and application service offerings, support personnel to provide maintenance services related to the technology acquired and a trained sales force capable of selling current and future acquired solutions. The goodwill resulting from these transactions is expected to be deductible for tax purposes.
BEZ’s financial results will be reported within our web performance services segment and DocSite’s will be reported within our application services segment.
The combined pre-acquisition results of operations and the combined post-acquisition revenues and earnings of DocSite and BEZ are considered immaterial for disclosure of supplemental pro forma information as of December 31, 2010.
Note 3 – Financing Receivables
The Company adopted ASU No. 2010-20 “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” during the third quarter of fiscal 2011. The disclosure requirements of this ASU are applicable to certain trade receivables with payment terms greater than one year and our loans receivables (see Note 5 within the consolidated financial statements included in our March 31, 2010 Form 10-K for a description of our loans receivables).
The Company allows deferred payment terms that exceed one year for customers purchasing licenses (perpetual or time-based) for our software products and the related maintenance services (“multi-year deferred payment arrangements”). A financing receivable exists when the license transfers to the customer or the related maintenance service has been provided (i.e. revenue recognition has occurred) prior to the due date of the related receivable. Our payment terms typically require payment before revenue recognition occurs, except for amounts associated with a perpetual license. As such, our products financing receivables primarily consist of the perpetual license portion of outstanding multi-year deferred payment arrangements.
The following is an aged analysis of our products and loans financing receivables based on invoice date as of December 31, 2010 (in thousands):
The Company performs a credit review of its financing receivables each reporting period to determine if an allowance for credit loss is required. The Company uses an internal risk rating system to determine the customer's credit risk. If there is no evidence of collection issues and the financing receivable is less than 90 days past due, the receivable is designated a pass rating, otherwise the receivable is designated a watch rating. This process considers the payment status of the receivable, collection and loss experience associated with other outstanding and previously paid account receivable balances, discussions with the customer, the risk environment of our geographic operations and review of public financial information if available.
As of December 31, 2010, all financing receivables were designated a pass rating and there was no allowance for credit losses on our financing receivables.
Note 4 - Foreign Currency Transactions and Derivatives
The Company is exposed to foreign exchange rate risks related to transactions that are denominated in non-local currency (“anticipated transactions”) and current inter-company balances due to and from the Company’s foreign subsidiaries (“inter-company balances”).
The Company enters into derivative contracts to sell or buy currencies with the intent of mitigating foreign exchange rate risks related to inter-company balances. The Company does not use foreign exchange contracts to hedge anticipated transactions and does not designate its foreign exchange derivatives as hedges. Accordingly, all foreign exchange derivatives are recognized on the condensed consolidated balance sheets at fair value (see Note 5 of the condensed consolidated financial statements).
The foreign currency net loss resulting from anticipated transactions and inter-company balances for the three months ended December 31, 2010 and 2009 was $464,000 and $564,000, respectively, and for the nine months ended December 31, 2010 and 2009 was $1.1 million and $1.2 million, respectively. The hedging transaction net gain (loss) from foreign exchange derivative contracts for the three months ended December 31, 2010 and 2009 was $2,500 and $141,000, respectively, and for the nine months ended December 31, 2010 and 2009 was $21,500 and $(558,000), respectively. These net gain (loss) amounts were recorded to “Administrative and general” in the condensed consolidated statements of operations.
At December 31, 2010, the Company had derivative contracts maturing through January 2011 to sell $8.8 million and purchase $5.0 million in foreign currencies. At March 31, 2010, the Company had derivative contracts maturing through April 2010 to sell $830,000 and purchase $4.1 million in foreign currencies.
Note 5 - Fair Value of Assets and Liabilities
The Company reports its money market funds, foreign exchange derivatives and the DocSite contingent consideration liability (see Note 2 for additional information) at fair value on a recurring basis using the following fair value hierarchy: level 1 - quoted prices in active markets for identical assets or liabilities; level 2 – inputs other than level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and level 3 - unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis (in thousands):
Non-financial assets such as goodwill and intangible assets are also subject to nonrecurring fair value measurements if they are deemed to be impaired. See Note 9 of the condensed consolidated financial statements for further information.
Note 6 - Computation of Earnings per Common Share
Earnings per common share data were computed as follows (in thousands, except per share amounts):
During the three months ended December 31, 2010 and 2009, stock awards to purchase a total of 5.2 million and 26.1 million shares, respectively, were excluded from the diluted earnings per share calculation because they were anti-dilutive and 17.6 million and 26.1 million shares, respectively, were excluded during the nine months ended December 31, 2010 and 2009.
Note 7 - Comprehensive Income
Other comprehensive income (loss) relates to foreign currency translation adjustments that have been excluded from net income and reflected in equity. Total comprehensive income is summarized as follows (in thousands):
Note 8 – Stock Benefit Plans and Stock-Based Compensation
The Company has the following stock benefit plans: (1) the 2007 Long Term Incentive Plan (“2007 LTIP”) allows the Company’s Compensation Committee to grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance-based cash or restricted stock unit awards and annual cash incentive awards to employees and directors of the Company; (2) the Employee Stock Purchase Plan allows participating U.S. and Canadian employees the right to have up to 10% of their compensation withheld to purchase Company common stock at a 5% discount; and (3) the Employee Stock Ownership Plan and Trust (“ESOP”) allows the Company to make contributions to the ESOP for the benefit of substantially all U.S. employees.
Covisint Corporation (“Covisint”), a subsidiary of the Company, maintains a stock benefit plan referred to as the 2009 Long-Term Incentive Plan (“2009 Covisint LTIP”) allowing the Board of Directors of Covisint to grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance-based cash or restricted stock unit awards and annual cash incentive awards to employees and directors of Covisint.
Stock award compensation expense was allocated as follows (in thousands):
As of December 31, 2010, $24.5 million of total unrecognized compensation cost, net of estimated forfeitures, related to unvested equity awards is expected to be recognized over a weighted-average period of approximately 2.69 years.
A summary of the Company’s option activity during the nine months ended December 31, 2010 is presented below (shares and intrinsic value in thousands):
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:
The fair value of stock options vested during the nine months ending December 31, 2010 was $4.64 per share.
A summary of the Company’s non-vested restricted stock units and performance-based restricted stock unit awards (collectively “Non-vested RSU”) activity during the nine months ended December 31, 2010 is summarized as follows (shares and intrinsic value in thousands):
As of December 31, 2010, there were 134,000 stock options outstanding from the 2009 Covisint LTIP. These options will vest only if, prior to August 26, 2015, Covisint completes an initial public offering (“IPO”) or if there is a change of control of Covisint.
The individuals who received stock options from the 2009 Covisint LTIP were also awarded performance-based restricted stock unit awards (“PSAs”) from the Company’s 2007 LTIP. There were 1.5 million PSAs outstanding as of December 31, 2010. These PSAs will vest only if Covisint does not complete an IPO or a change of control transaction by August 25, 2015, and the Covisint business meets a pre-defined revenue target for any four consecutive calendar quarters ending prior to August 26, 2015.
As of December 31, 2010, the Company has not recorded compensation expense for the Covisint stock options or the PSAs and these awards are not included in the Company’s diluted shares outstanding. Compensation expense will be accounted for in the period it becomes probable that the underlying conditions of the Covisint stock options or PSAs will be met and will be included in the diluted shares outstanding balance in the period the underlying performance conditions are met.
Note 9 – Goodwill, Capitalized Software and Other Intangible Assets
The change in the carrying amount of goodwill by reportable segment during the nine months ended December 31, 2010 is summarized as follows (in thousands):
The components of the Company’s capitalized software and other intangible assets are as follows (in thousands):
Capitalized software includes the costs of internally developed software technology and software technology purchased through acquisitions. Internally developed capitalized software costs and capitalized purchased software technology are amortized over periods up to five years.
Customer relationship agreements were acquired as part of recent acquisitions and are being amortized over periods up to ten years.
Other amortized intangible assets include amortizable trademarks and patents associated with recent acquisitions and are being amortized over periods up to three years.
Unamortized trademarks were acquired as part of the Covisint and Changepoint acquisitions in fiscal 2004 and fiscal 2005. These trademarks are deemed to have an indefinite life.
Amortization of intangible assets
Amortization expense of capitalized software, customer relationship and other intangible assets were as follows (in thousands):
Based on the capitalized software, customer relationship and other intangible assets recorded through December 31, 2010, the annual amortization expense over the next five fiscal years is expected to be as follows (in thousands):
Capitalized software is reviewed for impairment each balance sheet date or when events and changes in circumstances indicate that the carrying value may not be recoverable.
Goodwill and unamortized intangible assets are tested for impairment at least once a year or more frequently if management believes indicators of impairment exist. Impairment evaluations were performed on goodwill and unamortized intangible assets for all reporting segments as of March 31, 2010.
For all other intangible and long-lived assets, impairment evaluations are performed when events or changes in circumstances indicate that the carrying value may not be recoverable.
As of December 31, 2010, capitalized software, customer relationships, trademarks and other intangible assets are reported as "Capitalized software and other intangible assets, net" in the condensed consolidated balance sheets. In order to conform the March 31, 2010 balance sheet to the current presentation, the Company has reclassified certain intangible assets totaling $42.8 million (reported as non-current "Other assets" in the March 31, 2010 audited financial statements) to "Capitalized software and other intangible assets, net".
Note 10 – Segment Information
Compuware has four business segments in the technology industry: products, web performance services, professional services and application services. The Company’s products and services are offered worldwide to the largest IT organizations across a broad spectrum of technologies, including mainframe, distributed and Internet platforms and provide the following capabilities:
Financial information for the Company’s business segments is as follows (in thousands):
Financial information regarding geographic operations is presented in the table below (in thousands):
Note 11 - Restructuring Accrual
In recent years, the Company has incurred restructuring charges associated with the following initiatives: (1) aligning the professional services segment headcount and operating expenses after initiating a plan during the second half of fiscal 2009 to exit low-margin engagements and (2) management’s evaluation of the products segment and administrative and general business processes to identify operating efficiencies with the goal of reducing operating expenses.
The following table summarizes the restructuring accrual as of March 31, 2010, and changes to the accrual during the nine months ended December 31, 2010 (in thousands):
As of December 31, 2010, $450,000 of the restructuring accrual is recorded in current “accrued expenses”. The remaining balance of $156,000 is recorded to long-term “accrued expenses” in the condensed consolidated balance sheets and primarily relates to facility costs.
The accruals for facility costs at December 31, 2010 represent the remaining fair value of lease obligations for exited and demised 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 2014. Projected sublease income is based on management’s estimates, which are subject to change.
Note 12 - Debt
The Company had no long term debt at December 31, 2010 and March 31, 2010.
The Company has an unsecured revolving credit agreement (the “credit facility”) with Comerica Bank and other lenders. The 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 an additional $150 million subject to receiving further commitments from lenders and certain other conditions.
The credit facility contains various covenant requirements, including limitations on liens; indebtedness; mergers, consolidations and acquisitions; asset sales; dividends; investments, loans and advances from the Company; transactions with affiliates; and limits additional borrowing outside of the facility to $250 million. The credit facility is also subject to maximum total debt to EBITDA and minimum fixed charge coverage financial covenants. The Company was in compliance with the covenants under the credit facility at December 31, 2010.
Any borrowings under the credit facility bear interest at the prime rate 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 pays a quarterly facility fee on the credit facility based on the applicable margin grid.
Note 13 – Contingencies
The Company is subject to various legal actions and claims incidental to its business. Litigation is subject to many uncertainties and the outcome of individual litigated matters is not predictable with assurance. After discussion with counsel, it is the opinion of management that the outcome of such matters will not have a material adverse impact on the Company’s financial position, results of operations or cash flows.
To the Board of Directors and Shareholders of
We have reviewed the accompanying condensed consolidated balance sheet of Compuware Corporation and subsidiaries (the "Company") as of December 31, 2010, and the related condensed consolidated statements of operations for the three-month and nine-month periods ended December 31, 2010 and 2009, and of cash flows for the nine-month periods ended December 31, 2010 and 2009. 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.
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, 2010 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 27, 2010, 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, 2010 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ DELOITTE & TOUCHE LLP
February 8, 2011
COMPUWARE CORPORATION AND SUBSIDIARIES
In this section, we discuss our results of operations on a segment basis. We operate in four business segments in the technology industry: products, web performance services, professional services and application services. We evaluate segment performance based primarily on segment contribution before corporate expenses.
Our enterprise application management products, specifically Vantage, and our web performance services allow us to offer IT organizations comprehensive solutions that effectively monitor the performance of their enterprise and Internet application systems. Because of this relationship, we use the term “product software” to refer to both the products segment and web performance services segment. The revenue for the web performance services segment is referred to as subscription fees and reported with maintenance in the condensed consolidated statement of operations. Additionally, the research and development costs and sales and marketing costs for our products segment and web performance services segment are combined and reported as “Technology development and support” and “Sales and marketing”, respectively, in the condensed consolidated statements of operations. As a result, “Technology development and support”, “Sales and marketing” and contribution margins for the products segment and web performance services segment will be analyzed on a combined, product software basis within this section.
References to years are to fiscal years ended March 31. This discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes included elsewhere in this report and our annual report on Form 10-K for the fiscal year ended March 31, 2010, particularly “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations”.
The following discussion contains certain forward-looking statements within the meaning of the federal securities laws. When we use words such as “may”, “might”, “will”, “should”, “believe”, “expect”, “anticipate”, “estimate”, “continue”, “predict”, “forecast”, “projected”, “intend” or similar expressions, or make statements regarding our future plans, objectives or expectations, we are making forward-looking statements. Numerous important factors, risks and uncertainties affect our operating results and could cause actual results to differ materially from the results implied by these or any other forward-looking statements made by us, or on our behalf.
The material risks and uncertainties that we believe affect us are summarized below. These risks and uncertainties are not the only ones we face. Additional risks and uncertainties discussed elsewhere in the reports we file with the Securities and Exchange Commission (see Item 1A Risk Factors in our 2010 Form 10-K), as well as other risks and uncertainties that we are not aware of or focused on or that we currently deem immaterial, may also impair business operations. This report is qualified in its entirety by these risk factors and those listed below. If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and shareholders could lose all or part of their investment.
COMPUWARE CORPORATION AND SUBSIDIARIES
There can be no assurance that future results will meet expectations. While we believe that our forward-looking statements are reasonable, you should not place undue reliance on any such forward-looking statements, which speak only as of the date made. Except as required by applicable law, we do not undertake any obligation to publicly release any revisions which may be made to any forward-looking statements to reflect events or circumstances occurring after the date of this report.
Summary of Risk Factors
COMPUWARE CORPORATION AND SUBSIDIARIES
We deliver value to businesses by providing software and web performance solutions; professional services; and application services that improve the performance of information technology (“IT”) organizations.
Our primary source of profitability and cash flow is the sale of our mainframe productivity tools (“mainframe”) that are used within our customers’ mainframe computing environments for fault diagnosis, file and data management, and application debugging. We have experienced lower volumes of software license deals for our mainframe solutions causing our mainframe product revenue to decline. Changes in our current customer IT computing environments and spending habits have impacted their need for additional mainframe computing capacity. In addition, increased competition and pricing pressures have had an impact on revenues. Our customers utilize our products to reduce operating cost, increase programmer productivity and create a smooth labor force transition to the next generation of mainframe environment programmers. We will continue to make strategic enhancements to our mainframe solutions through research and development (“R&D”) investments with the goal of meeting these needs and maintaining a maintenance renewal rate in excess of 90%.
The cash flow generated from our mainframe solutions has allowed us to make significant investments in our application performance management (“APM”) solutions. This investment includes the addition of web performance services through the acquisition of Gomez, Inc. in November 2009 and research and development expenditures that enhance our Vantage and web performance services solutions.
COMPUWARE CORPORATION AND SUBSIDIARIES
We have identified the APM market as our primary target for revenue growth. Web applications and the complex distributed applications delivery chain supporting them have become increasingly critical to a company’s brand awareness, revenue growth and overall market share. Because of this, the market for APM solutions is large and is growing rapidly. Our web performance services, which are marketed under the brand name “Gomez” and provided on a software-as-a-service (“SaaS”) platform, and our Vantage solutions ensure the optimal performance of these applications across the enterprise, the Internet and the cloud.
To support the growth initiatives for our APM product line, we are developing solutions that combine the technology from our Vantage products with technology from our web performance services. During the third quarter of 2011, we released a controlled launch of our First Mile solution which integrates components of Vantage and our web performance services into a single solution that measures the performance of our customer’s web application delivery chain, including elements that reside both within the customer’s data center and on the Internet, displaying performance information through a single dashboard. We anticipate these combined solutions will add value to our customers and provide us opportunities to sell additional non-integrated Vantage products and web performance services driving future APM revenue growth.
We have also identified the secured collaboration service market as a growth market. Our application services, which are marketed under the brand name “Covisint” and provided on a SaaS platform, globally connect business communities, organizations and systems allowing the secure sharing of vital business information, applications and business processes across their internal and extended enterprise. The market for these services is growing, specifically in the healthcare industry as hospitals, physicians and the United States government move towards establishing electronic patient health and medical records which will require secure computerized databases and environments for storing and sharing of information. A significant amount of government funding for this conversion to electronic health and medical records is dependent on federal stimulus spending which has yet to be appropriated by Congress.
The professional services segment began a transformation during the second half of 2009 when management decided to exit low-margin engagements and focus resources on more profitable engagements. This significantly improved the segment’s contribution margin but resulted in a significant revenue decline. This transformation is complete and we anticipate modest revenue and contribution margin growth within the segment going forward as we focus on effectively demonstrating the value of our service offerings to customers.
COMPUWARE CORPORATION AND SUBSIDIARIES
The following occurred during the third quarter of 2011:
Our ability to execute our strategies and achieve our objectives is subject to a number of risks and uncertainties. See "Forward-Looking Statements".
COMPUWARE CORPORATION AND SUBSIDIARIES
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain operational data from the condensed consolidated statements of operations as a percentage of total revenues and the percentage change in such items compared to the prior period: