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 September 30, 2011 | ||
OR | ||
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
COMPUWARE CORPORATION
(Exact name of registrant as specified in its charter)
Michigan | 38-2007430 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
One Campus Martius, Detroit, MI 48226-5099 | ||
(Address of principal executive offices including zip code) |
Registrant's telephone number, including area code: (313) 227-7300
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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): Large accelerated filer x Accelerated filer o Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes o No x
Indicate the number of shares outstanding of each of the issuer's class of common stock, as of the latest practicable date:
As of November 3, 2011, there were outstanding 218,395,433 shares of Common Stock, par value $.01, of the registrant.
PART I. | FINANCIAL INFORMATION | Page |
Item 1. | Financial Statements | |
3 | ||
4 | ||
5 | ||
6 | ||
Report of Independent Registered Public Accounting Firm | 28 | |
Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations | 29 |
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 55 |
Item 4. | Controls and Procedures | 55 |
PART II. | OTHER INFORMATION | |
Item 1A. | Risk Factors | 56 |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 56 |
Item 5. | Other Information | 57 |
Item 6. | Exhibits | 66 |
SIGNATURES | 68 |
COMPUWARE CORPORATION AND SUBSIDIARIES
(In Thousands)
(Unaudited)
September 30, | March 31, | |||||||
ASSETS | 2011 | 2011 | ||||||
CURRENT ASSETS: | ||||||||
Cash and cash equivalents | $ | 63,866 | $ | 180,244 | ||||
Accounts receivable, net | 433,506 | 474,479 | ||||||
Deferred tax asset, net | 44,173 | 40,756 | ||||||
Income taxes refundable | 5,540 | 6,815 | ||||||
Prepaid expenses and other current assets | 30,357 | 40,446 | ||||||
Total current assets | 577,442 | 742,740 | ||||||
PROPERTY AND EQUIPMENT, LESS ACCUMULATED DEPRECIATION AND AMORTIZATION | 330,079 | 333,166 | ||||||
CAPITALIZED SOFTWARE AND OTHER INTANGIBLE ASSETS, NET | 121,310 | 83,001 | ||||||
ACCOUNTS RECEIVABLE | 200,028 | 206,887 | ||||||
DEFERRED TAX ASSET, NET | 42,366 | 35,754 | ||||||
GOODWILL | 803,289 | 607,765 | ||||||
OTHER ASSETS | 37,430 | 29,064 | ||||||
TOTAL ASSETS | $ | 2,111,944 | $ | 2,038,377 | ||||
LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
CURRENT LIABILITIES: | ||||||||
Accounts payable | $ | 21,943 | $ | 18,931 | ||||
Accrued expenses | 92,937 | 105,242 | ||||||
Income taxes payable | 22,670 | 12,286 | ||||||
Deferred revenue | 421,897 | 462,376 | ||||||
Total current liabilities | 559,447 | 598,835 | ||||||
LONG TERM DEBT | 125,600 | - | ||||||
DEFERRED REVENUE | 329,212 | 393,780 | ||||||
ACCRUED EXPENSES | 27,715 | 28,016 | ||||||
DEFERRED TAX LIABILITY, NET | 78,639 | 65,134 | ||||||
Total liabilities | 1,120,613 | 1,085,765 | ||||||
SHAREHOLDERS' EQUITY: | ||||||||
Common stock | 2,184 | 2,177 | ||||||
Additional paid-in capital | 674,318 | 654,109 | ||||||
Retained earnings | 334,723 | 297,067 | ||||||
Accumulated other comprehensive loss | (19,894 | ) | (741 | ) | ||||
Total shareholders' equity | 991,331 | 952,612 | ||||||
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY | $ | 2,111,944 | $ | 2,038,377 |
See notes to condensed consolidated financial statements.
COMPUWARE CORPORATION AND SUBSIDIARIES
(In Thousands, Except Per Share Data)
(Unaudited)
Three Months Ended | Six Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
REVENUES: | ||||||||||||||||
Software license fees | $ | 61,711 | $ | 45,613 | $ | 95,837 | $ | 78,943 | ||||||||
Maintenance and subscription fees | 128,181 | 122,007 | 254,290 | 238,766 | ||||||||||||
Professional services fees | 70,804 | 58,249 | 140,543 | 114,645 | ||||||||||||
Total revenues | 260,696 | 225,869 | 490,670 | 432,354 | ||||||||||||
OPERATING EXPENSES: | ||||||||||||||||
Cost of software license fees | 4,770 | 3,267 | 8,306 | 6,683 | ||||||||||||
Cost of maintenance and subscription fees | 17,547 | 13,265 | 34,205 | 26,552 | ||||||||||||
Cost of professional services | 65,935 | 51,296 | 127,888 | 102,009 | ||||||||||||
Technology development and support | 26,740 | 21,893 | 51,441 | 43,434 | ||||||||||||
Sales and marketing | 65,577 | 56,507 | 127,572 | 114,211 | ||||||||||||
Administrative and general | 41,967 | 38,780 | 83,481 | 76,217 | ||||||||||||
Total operating expenses | 222,536 | 185,008 | 432,893 | 369,106 | ||||||||||||
INCOME FROM OPERATIONS | 38,160 | 40,861 | 57,777 | 63,248 | ||||||||||||
OTHER INCOME (EXPENSE), NET | (8 | ) | 862 | 990 | 1,727 | |||||||||||
INCOME BEFORE INCOME TAXES | 38,152 | 41,723 | 58,767 | 64,975 | ||||||||||||
INCOME TAX PROVISION | 15,473 | 15,731 | 19,103 | 26,338 | ||||||||||||
NET INCOME | $ | 22,679 | $ | 25,992 | $ | 39,664 | $ | 38,637 | ||||||||
Basic earnings per share | $ | 0.10 | $ | 0.12 | $ | 0.18 | $ | 0.17 | ||||||||
Diluted earnings per share | $ | 0.10 | $ | 0.12 | $ | 0.18 | $ | 0.17 |
See notes to condensed consolidated financial statements.
COMPUWARE CORPORATION AND SUBSIDIARIES
(In Thousands)
(Unaudited)
Six Months Ended | ||||||||
September 30, | ||||||||
2011 | 2010 | |||||||
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES: | ||||||||
Net income | $ | 39,664 | $ | 38,637 | ||||
Adjustments to reconcile net income to net cash provided by operations: | ||||||||
Depreciation and amortization | 28,770 | 24,505 | ||||||
Stock award compensation | 11,983 | 9,195 | ||||||
Deferred income taxes | 3,024 | (627 | ) | |||||
Other | 125 | 416 | ||||||
Net change in assets and liabilities, net of effects from currency fluctuations and acquisitions: | ||||||||
Accounts receivable | 41,669 | 49,767 | ||||||
Prepaid expenses and other current assets | 5,913 | 16,822 | ||||||
Other assets | (7,232 | ) | 745 | |||||
Accounts payable and accrued expenses | (10,048 | ) | (28,040 | ) | ||||
Deferred revenue | (95,571 | ) | (104,230 | ) | ||||
Income taxes | 13,461 | 6,171 | ||||||
Net cash provided by operating activities | 31,758 | 13,361 | ||||||
CASH FLOWS USED IN INVESTING ACTIVITIES: | ||||||||
Purchase of: | ||||||||
Business, net of cash acquired | (249,337 | ) | (15,715 | ) | ||||
Property and equipment | (12,189 | ) | (7,528 | ) | ||||
Capitalized software | (13,137 | ) | (9,826 | ) | ||||
Other | (500 | ) | - | |||||
Net cash used in investing activities | (275,163 | ) | (33,069 | ) | ||||
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES: | ||||||||
Proceeds from borrowings | 161,200 | - | ||||||
Payments on borrowings | (35,600 | ) | - | |||||
Net proceeds from exercise of stock options including excess tax benefits | 6,498 | 3,241 | ||||||
Employee contribution to stock purchase plans | 1,403 | 1,232 | ||||||
Repurchase of common stock | (3,308 | ) | (59,015 | ) | ||||
Net cash provided by (used in) financing activities | 130,193 | (54,542 | ) | |||||
EFFECT OF EXCHANGE RATE CHANGES ON CASH | (3,166 | ) | 1,621 | |||||
NET DECREASE IN CASH AND CASH EQUIVALENTS | (116,378 | ) | (72,629 | ) | ||||
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD | 180,244 | 149,897 | ||||||
CASH AND CASH EQUIVALENTS AT END OF PERIOD | 63,866 | 77,268 |
See notes to condensed consolidated financial statements.
The accompanying unaudited condensed consolidated financial statements (“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 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 September 30, 2011, final amounts may differ from these estimates.
In the opinion of management of the Company, the accompanying financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the interim periods presented. These financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto for the year ended March 31, 2011 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, 2011 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 services for those products; and rendering web performance, professional and application services.
We sometimes enter into arrangements that include both software related deliverables (licensed software products, maintenance services or software related professional services) and non-software deliverables (web performance services, professional services unrelated to our software products or application services). Our web performance services and application services do not qualify as software deliverables because our license grant does not allow the customer the right or capability to take possession of the software. For arrangements that contain both software and non-software deliverables (almost all of these arrangements combine software deliverables with web performance services), in accordance with ASC 605 “Revenue Recognition,” we allocate the arrangement consideration based on fair value using the following hierarchy: vendor specific objective evidence of fair value (“VSOE,” meaning price when sold separately) if available; third-party evidence if VSOE is not available; or best estimated selling price if neither VSOE nor third-party evidence is available. We currently are unable to establish VSOE or third-party evidence for our web performance services or software deliverables. Therefore, we create our best estimate of selling price by evaluating renewal amounts included in a contract, if any, and prices of deliverables sold separately, taking into consideration geography, volume discounts, and transaction size.
Once we have allocated the arrangement consideration between software deliverables and non-software deliverables, we recognize revenue as described in the respective software license fees, maintenance and subscription fees, and professional services fees sections.
In order for a transaction to be eligible for revenue recognition, the following revenue criteria must be met: persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is reasonably assured. We evaluate collectability based on past customer history, external credit ratings and payment terms within various customer agreements.
Software license fees
The Company's software license agreements provide our customers with a right to use our software perpetually (perpetual licenses) or during a defined term (time-based licenses).
Assuming all revenue recognition criteria are met, perpetual license fee revenue is recognized using the residual method, under which the fair value, based on VSOE, of all undelivered elements of the agreement (i.e., maintenance and software related professional services) is deferred. VSOE is based on rates charged for maintenance and professional services when sold separately. The remaining portion of the fee is recognized as license fee revenue upon delivery of the products.
For revenue arrangements where there is a lack of VSOE for any undelivered elements, license fee revenue is deferred and recognized upon delivery of those elements or when VSOE can be established. When maintenance or software related professional services are the only undelivered elements, the license fee revenue is recognized on a ratable basis over the longer of the maintenance term or the period the software related professional services are expected to be performed. Such transactions include time-based licenses and certain unlimited capacity licenses, as the Company does not sell maintenance for these 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 software related professional services fee (which is included in professional services fees) associated with these types of arrangements based on its determination of fair value. The Company applies VSOE for maintenance related to perpetual license transactions and stand alone software related professional services arrangements as a reasonable and consistent approximation of fair value to separate license fee, maintenance fee and software related professional services fee revenue for income statement classification purposes.
The Company offers flexibility to customers purchasing licenses for its products and related maintenance. Terms of these transactions range from standard perpetual license sales that include one year of maintenance to large multi-year (generally two to five years), multi-product contracts. The Company allows deferred payment terms 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 financing fees) are generally recognized as revenue as discussed above. In certain transactions where it cannot be concluded that the fee is fixed or determinable due to the nature of the deferred payment terms, the Company recognizes revenue as payments become due. Financing fees are recognized as interest income over the term of the related receivable.
Maintenance and subscription fees
The Company’s maintenance arrangements allow customers to receive technical support and advice, including problem resolution services and assistance in product installation, error corrections and any product enhancements released during the maintenance period. The first year of maintenance is generally included with all license agreements. Maintenance fees are recognized ratably over the term of the maintenance arrangements, which may range from one to five years.
Subscription fees relate to arrangements that permit our customers to access and utilize our web performance services. We evaluate collectability based on past customer history, external credit ratings and payment terms within various customer agreements. Subscription fees are deferred upon contract execution and are recognized ratably over the term of the subscription.
Professional services fees
The Company provides a broad range of IT services for mainframe, distributed, web and mobile environments, including mobile computing application development and integration, package software customization, cloud computing consulting, development and integration of legacy systems, IT portfolio management services, enterprise legacy modernization services and application performance management. The Company also offers implementation, consulting and training services in tandem with the Company’s software solutions offerings, which are referred to as software related professional services.
Professional services fees are generally based on hourly or daily rates. Revenues from professional services are recognized in the period the services are performed provided that collection of the related receivable is reasonably assured. For development services rendered under fixed-price contracts, revenues are recognized using the 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.
Our application services fees are combined with professional services fees in our consolidated statement of operations and consist of fees for our on-demand software and other services. The arrangements do not provide customers the right to take possession of the software at any time, nor do the arrangements contain rights of return. Many of our application services fee contracts include a project fee and ongoing software-as-a-service (“SaaS”) operations (recurring) fees. Projects that have stand-alone value (e.g. other vendors provide similar services), qualify as a separate element of accounting. Therefore, the project fee is recognized as delivered. For those projects that do not have stand-alone value, the revenue is deferred and recognized over the expected period the customer will receive benefit. The recurring fees are recognized over the applicable service period.
Deferred revenue
Deferred revenue consists primarily of billed and unbilled maintenance fees related to the future service period of maintenance arrangements in effect at the reporting date. Deferred license and subscription services 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 “prepaid expenses and other current assets” 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 include primarily the cost of programming personnel and amounted to $21.1 million and $18.1 million for the three months ended September 30, 2011 and 2010, respectively, and $39.6 million and $35.4 million for the six months ended September 30, 2011 and 2010, 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”.
Income Taxes
The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax bases of assets and liabilities and net operating loss and credit carryforwards using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the period that includes the enactment date.
The Company records net deferred tax assets to the extent it believes these assets will more likely than not be realized. These deferred tax assets are subject to periodic assessments as to recoverability and if it is determined that it is more likely than not that the benefits will not be realized, valuation allowances are recorded which would increase the provision for income taxes. In making such determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations.
Interest and penalties related to uncertain tax positions are included in the income tax provision.
The Company’s effective tax rate for the six months ended September 30, 2011 was 32.5% compared to 40.5% for the six months ended September 30, 2010. The decrease in the effective tax rate was primarily due to legislation enacted in the State of Michigan in May 2011 that amended the Income Tax Act to implement a comprehensive set of tax changes effective January 2012. One part of the legislation contains provisions that replaced the current Michigan Business Tax (“MBT”) with a new corporate income tax. Certain credits allowed under the MBT, including the Brownfield Redevelopment (“Brownfield”) tax credit, will continue to be effective under the revised Income Tax Act. This allows the Company to reduce its future tax liability for the duration of the credit carryforward period. The Brownfield tax credit was originally awarded to the Company in 2003 when it moved its headquarters to the City of Detroit. Upon enactment of the MBT in 2008, the Company established a deferred tax asset for the Brownfield tax credits, assessed the ability to utilize such credits prior to expiration and recorded a valuation allowance to reduce the carrying value of the Brownfield deferred tax asset to the more likely than not realizable value. As a result of the May 2011 legislation, the valuation allowance associated with the Brownfield deferred tax asset was reversed resulting in a $5.0 million reduction to the Company’s income tax provision for the six months ended September 30, 2011. The decrease was further impacted by a $2.2 million increase to the valuation allowance recorded during the six months ended September 30, 2010 to reduce the carrying value of the Brownfield deferred tax asset to the more likely than not realizable value based upon our analysis and the then existing tax laws.
Recently Issued Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2011-5, “Presentation of Comprehensive Income.” The ASU disallows the presentation of the components of other comprehensive income as part of the statement of changes in stockholders’ equity. Further, the ASU requires that the statement of net income and the statement of other comprehensive income be presented consecutively within the financial statements, and also that reclassification adjustments between net income and other comprehensive income be included on the face of the financial statements. For public companies, the ASU should be applied retrospectively for fiscal years and interim periods beginning after December 15, 2011. We will adopt the requirements of this ASU starting in the fourth quarter of fiscal 2012.
In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820).” The amendments in this ASU change the wording used to describe the requirements for measuring fair value and for disclosing information about fair value measurements. For public companies, the ASU should be applied prospectively for annual periods beginning after December 15, 2011. We are currently evaluating the impact of this standard on our consolidated financial statements and plan to adopt this ASU in fiscal 2013.
In September 2011, the FASB issued ASU No. 2011-08, “Intangibles – Goodwill and Other (Topic 350).” The amendments in this ASU allow an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount before performing the first step of the two-step impairment test. If it is determined that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity must perform additional impairment testing. Otherwise, performing the two-step impairment test is not necessary. This ASU is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. We are evaluating the impact this will have on our assessment of goodwill and considering whether we will early adopt this ASU. This ASU is required to be adopted in fiscal 2013.
Note 2 – Acquisition
On July 1, 2011, the Company acquired all of the outstanding capital stock of dynaTrace software, Inc. (“dynaTrace”), through a merger of dynaTrace with a wholly owned subsidiary of the Company, for $255.8 million in cash, plus approximately $300,000 of direct acquisition costs recorded to “Administrative and general” expense. dynaTrace was a privately-held company whose technology enables continuous tracking of business transactions and provides exact identification of performance problems, enhancing our Gomez On-premises software solutions. The assets and liabilities acquired have been recorded at their estimated fair values as of the purchase date. The purchase price exceeded the estimated fair value of the acquired assets and liabilities by $210.9 million, which was recorded to goodwill. The estimated fair value of intangible assets subject to amortization totaled $42.0 million, of which $28.5 million, $9.8 million and $3.7 million related to developed technology, trade names, and customer relationships with a useful life of five, three and ten years, respectively. The purchase price was funded with the Company’s existing cash resources and borrowings of $129.5 million under its credit facility described in Note 11.
Compuware acquired dynaTrace to obtain the technology described above. The acquisition price in excess of the identifiable assets (goodwill) is a result of our expected synergies from the acquisition which are primarily related to expansion of the dynaTrace sales channel. In addition, we plan to integrate this technology with our Gomez On-premises and SaaS offerings and expand the dynaTrace sales channel into all of our sales channels including our direct sales force, inside sales force and independent distributors and partners.
The operations of dynaTrace will be managed as part of our APM business unit going forward. Therefore, financial activity and goodwill are included in the APM segment and reporting unit, respectively.
This acquisition was considered immaterial for disclosure of supplemental pro forma information of the acquiree since the acquisition date.
Note 3 – Financing 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 software products financing receivables primarily consist of the perpetual license portion of outstanding multi-year deferred payment arrangements.
Our loans receivable consist of notes due from CareTech, Inc. and ForeSee Results, Inc. (“ForeSee”). During the first quarter of fiscal 2012, the ForeSee loan receivable was modified to extend the payment terms. The modified payment terms require quarterly payments of principal and interest be made through March 31, 2015 at an annual interest rate of 7.0%. The agreement also required ForeSee to make a $2.4 million payment on the related note during the first quarter of fiscal 2012, reducing the loan receivable balance to $5.6 million as of September 30, 2011.
The following is an analysis of our software products and loaned financing receivables aged based on invoice date as of September 30, 2011 and March 31, 2011 (in thousands):
As of September 30, 2011 | ||||||||||||||||||||
Greater than | ||||||||||||||||||||
0-29 days | 30-90 days | 90 days | Total | |||||||||||||||||
past | past | past | financing | |||||||||||||||||
invoice date | invoice date | invoice date | Unbilled | receivables | ||||||||||||||||
Pass rating | ||||||||||||||||||||
Software products | $ | 2,724 | $ | 941 | $ | 26 | $ | 38,198 | $ | 41,889 | ||||||||||
Loans | 6,378 | 6,378 | ||||||||||||||||||
Total | 2,724 | 941 | 26 | 44,576 | 48,267 | |||||||||||||||
Watch rating | ||||||||||||||||||||
Software products | - | - | 137 | 190 | 327 | |||||||||||||||
Total financing receivables | $ | 2,724 | $ | 941 | $ | 163 | $ | 44,766 | $ | 48,594 |
As of March 31, 2011 | ||||||||||||||||||||
Greater than | ||||||||||||||||||||
0-29 days | 30-90 days | 90 days | Total | |||||||||||||||||
past | past | past | financing | |||||||||||||||||
invoice date | invoice date | invoice date | Unbilled | receivables | ||||||||||||||||
Pass rating | ||||||||||||||||||||
Software products | $ | 6,439 | $ | 434 | $ | 179 | $ | 37,971 | $ | 45,023 | ||||||||||
Loans | 9,753 | 9,753 | ||||||||||||||||||
Total | 6,439 | 434 | 179 | 47,724 | 54,776 | |||||||||||||||
Watch rating | ||||||||||||||||||||
Software products | - | 69 | 40 | 280 | 389 | |||||||||||||||
Total financing receivables | $ | 6,439 | $ | 503 | $ | 219 | $ | 48,004 | $ | 55,165 |
As of September 30, 2011 and March 31, 2011, the allowance for credit losses on our financing receivables was $327,000 and $389,000, respectively.
Note 4 - Foreign Currency Transactions and Derivatives
The Company is exposed to foreign exchange rate risks related to assets and liabilities that are denominated in non-local currency and current inter-company balances due to and from the Company’s foreign subsidiaries. We enter into foreign currency forward contracts to sell or buy currencies with the intent of mitigating foreign exchange rate risks related to these balances. The Company does not hedge currency risk related to anticipated revenue or expenses denominated in foreign currency. All foreign exchange derivatives are recognized in the consolidated balance sheets at fair value. See Note 5 of the condensed consolidated financial statements for further information.
The foreign currency net gains or (losses) for the three months ended September 30, 2011 and 2010 were $1.5 million and $(1.2) million, respectively, and for the six months ended September 30, 2011 and 2010 were $569,000 and $(666,000), respectively. The hedging transaction net gain (loss) from foreign exchange derivative contracts for the three months ended September 30, 2011 and 2010 was $(332,000) and $106,000, respectively, and for the six months ended September 30, 2011 and 2010 was $(588,000) and $19,000, respectively. These amounts were recorded to “administrative and general” in the condensed consolidated statements of operations.
The Company had derivative contracts maturing through October 2011 to sell $1.7 million and purchase $10.3 million in foreign currencies at September 30, 2011 and had derivative contracts maturing through April 2011 to sell $3.3 million and purchase $5.7 million in foreign currencies at March 31, 2011.
Note 5 - Fair Value of Assets and Liabilities
The Company reports its money market funds and foreign exchange derivatives at fair value on a recurring basis using the following fair value hierarchy: (1) Level 1 - quoted prices in active markets for identical assets or liabilities; (2) Level 2 – inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and (3) Level 3 - unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis (in thousands):
As of September 30, 2011 | ||||||||||||||||
Quoted Prices in | Significant | Significant | ||||||||||||||
Active Markets for | Other Observable | Unobservable | ||||||||||||||
Estimated | Identical Assets | Inputs | Inputs | |||||||||||||
Fair Value | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Assets: | ||||||||||||||||
Cash equivalents - money market funds | $ | 3,100 | $ | 3,100 | - | - | ||||||||||
Liabilities: | ||||||||||||||||
Foreign exchange derivatives | $ | 33 | - | $ | 33 | - |
As of March 31, 2011 | ||||||||||||||||
Quoted Prices in | Significant | Significant | ||||||||||||||
Active Markets for | Other Observable | Unobservable | ||||||||||||||
Estimated | Identical Assets | Inputs | Inputs | |||||||||||||
Fair Value | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Assets: | ||||||||||||||||
Cash equivalents - money market funds | $ | 106,640 | $ | 106,640 | - | - | ||||||||||
Liabilities: | ||||||||||||||||
Foreign exchange derivatives | $ | 18 | - | $ | 18 | - |
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):
Three Months Ended | Six Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
Basic earnings per share: | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Numerator: | ||||||||||||||||
Net income | $ | 22,679 | $ | 25,992 | $ | 39,664 | $ | 38,637 | ||||||||
Denominator: | ||||||||||||||||
Weighted-average common shares outstanding | 218,521 | 221,280 | 218,373 | 222,900 | ||||||||||||
Basic earnings per share | $ | 0.10 | $ | 0.12 | $ | 0.18 | $ | 0.17 | ||||||||
Diluted earnings per share: | ||||||||||||||||
Numerator: | ||||||||||||||||
Net income | $ | 22,679 | $ | 25,992 | $ | 39,664 | $ | 38,637 | ||||||||
Denominator: | ||||||||||||||||
Weighted-average common shares outstanding | 218,521 | 221,280 | 218,373 | 222,900 | ||||||||||||
Dilutive effect of stock awards | 3,604 | 3,114 | 4,439 | 3,071 | ||||||||||||
Total shares | 222,125 | 224,394 | 222,812 | 225,971 | ||||||||||||
Diluted earnings per share | $ | 0.10 | $ | 0.12 | $ | 0.18 | $ | 0.17 |
During the three and six months ended September 30, 2011, stock awards to purchase a total of approximately 14.1 million and 8.4 million shares, respectively, were excluded from the diluted earnings per share calculation because they were anti-dilutive. During the three and six months ended September 30, 2010, stock awards to purchase a total of approximately 19.6 million and 19.9 million shares, respectively, were excluded from the diluted earnings per share calculation because they were anti-dilutive.
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):
Three Months Ended | Six Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net income | $ | 22,679 | $ | 25,992 | $ | 39,664 | $ | 38,637 | ||||||||
Foreign currency translation adjustment, net of tax | (18,327 | ) | (1,263 | ) | (19,153 | ) | 2,427 | |||||||||
Total comprehensive income | $ | 4,352 | $ | 24,729 | $ | 20,511 | $ | 41,064 |
Note 8 – Stock Benefit Plans and Stock-Based Compensation
Stock Benefit Plans
The Company has the following stock benefit plans: (1) the Amended and Restated 2007 Long Term Incentive Plan (“2007 LTIP”) allows the Company’s Compensation Committee to grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance-based cash or restricted stock unit awards and cash incentive awards to employees and directors of the Company; (2) the Employee Stock Purchase Plan allows participating U.S. and Canadian employees the right to have up to 10% of their compensation withheld to purchase Company common stock at a 5% discount; and (3) the Employee Stock Ownership Plan and Trust (“ESOP”) allows the Company to make contributions to the ESOP for the benefit of substantially all U.S. employees.
During the 2011 annual meeting of shareholders, 13.5 million additional common shares were authorized to be registered under the 2007 LTIP. These additional shares were registered during the second quarter of 2012, which increased the aggregate amount of common shares reserved by the Company for issuance under the 2007 LTIP to 41.5 million as of September 30, 2011 (less shares previously issued).
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 Option Activity
A summary of option activity under the Company’s stock-based compensation plans as of September 30, 2011, and changes during the six months then ended is presented below (shares and intrinsic value in thousands):
Six Months Ended | ||||||||||||||||
September 30, 2011 | ||||||||||||||||
Weighted | ||||||||||||||||
Weighted | Average | |||||||||||||||
Average | Remaining | Aggregate | ||||||||||||||
Number of | Exercise | Contractual | Intrinsic | |||||||||||||
Options | Price | Term in Years | Value | |||||||||||||
Options outstanding as of March 31, 2011 | 16,868 | $ | 8.18 | |||||||||||||
Granted | 7,796 | 8.05 | ||||||||||||||
Exercised | (684 | ) | 8.22 | $ | 1,624 | |||||||||||
Forfeited | (227 | ) | 8.84 | |||||||||||||
Cancelled/expired | (679 | ) | 12.19 | |||||||||||||
Options outstanding as of September 30, 2011 | 23,074 | $ | 8.00 | 7.10 | $ | 13,561 | ||||||||||
Options vested and expected to vest, net of estimated forfeitures, as of September 30, 2011 | 21,228 | $ | 7.95 | 6.93 | $ | 13,095 | ||||||||||
Options exercisable as of September 30, 2011 | 10,406 | $ | 7.63 | 4.90 | $ | 6,470 |
The weighted average fair value of stock options granted during the periods and the assumptions used to estimate those values using the Black-Scholes option pricing model were as follows:
Six Months Ended | ||||||||
September 30, | ||||||||
2011 | 2010 | |||||||
Expected volatility | 39.87 | % | 42.56 | % | ||||
Risk-free interest rate | 1.72 | % | 2.75 | % | ||||
Expected lives at date of grant (in years) | 5.8 | 6.0 | ||||||
Weighted-average fair value of the options granted | $ | 4.04 | $ | 3.71 |
The average fair value of stock options vested during the six months ending September 30, 2011 and 2010 was $4.58 and $4.42 per share, respectively.
Restricted Stock Units and Performance-Based Stock Awards Activity
A summary of non-vested restricted stock units and performance-based stock awards (collectively “Non-vested RSU”) activity under the Company’s 2007 LTIP as of September 30, 2011 and changes during the six months then ended is presented below (shares and intrinsic value in thousands):
Six Months Ended | ||||||||||||
September 30, 2011 | ||||||||||||
Weighted | ||||||||||||
Average | Aggregate | |||||||||||
Grant-Date | Intrinsic | |||||||||||
Shares | Fair Value | Value | ||||||||||
Non-vested RSU outstanding as of March 31, 2011 | 3,741 | |||||||||||
Granted | 1,286 | $ | 9.85 | |||||||||
Released | (313 | ) | $ | 3,210 | ||||||||
Forfeited | (7 | ) | ||||||||||
Non-vested RSU outstanding as of September 30, 2011 | 4,707 |
Covisint Corporation 2009 Long-Term Incentive Plan
As of September 30, 2011, there were 135,000 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 September 30, 2011. 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.
Stock Awards Compensation
Stock award compensation expense was allocated as follows (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Stock-based compensation classified as: | ||||||||||||||||
Cost of maintenance and subscription fees | $ | 306 | $ | 99 | $ | 462 | $ | 159 | ||||||||
Cost of professional services | 555 | 255 | 1,175 | 492 | ||||||||||||
Technology development and support | 750 | 348 | 1,080 | 515 | ||||||||||||
Sales and marketing | 1,767 | 1,152 | 3,053 | 2,930 | ||||||||||||
Administrative and general | 3,282 | 2,037 | 6,213 | 5,099 | ||||||||||||
Total stock-based compensation expense before income taxes | $ | 6,660 | $ | 3,891 | $ | 11,983 | $ | 9,195 |
As of September 30, 2011, total unrecognized compensation cost of $52.1 million, net of estimated forfeitures, related to nonvested equity awards is expected to be recognized over a weighted-average period of approximately 2.82 years.
Note 9 – Goodwill, Capitalized Software and Other Intangible Assets
Goodwill
In previous fiscal years, the Company operated in four business segments in the technology industry: products, web application performance management services, professional services and application services. Effective April 1, 2011, the Company realigned its business unit structure which resulted in a change in the Company’s segment reporting and reporting unit structure (see Note 10 for additional information). The following reporting units were created as a result of this change: Application Performance Management (“APM”), Mainframe (“MF”), Changepoint (“CP”), Uniface (“UF”), Professional Services (“PS”) and Application Services (“AS”).
As of April 1, 2011, the Company performed a valuation to determine the reallocation of the goodwill balance from the prior period reporting units (products, web performance services, professional services and application services) to the new reporting units based on our estimated relative fair value. This valuation and reallocation resulted in the following as of April 1, 2011:
· | The goodwill balance of $221.1 million related to the products reporting unit as of March 31, 2011 was proportionally allocated to APM, Mainframe, Changepoint and Uniface (collectively “software solutions”) using the estimated relative fair value of each respective reporting unit. |
· | The goodwill balance of $219.5 million related to the web performance services reporting unit is now included within the APM reporting unit. |
· | As of March 31, 2011, the professional services reporting unit consisted of traditional professional services and software related professional services. The fiscal 2012 business unit structure realignment transferred the software related professional services to APM, Mainframe, Changepoint and Uniface. As a result, the goodwill balance of $141.8 million related to the professional services reporting unit was allocated between traditional professional services, APM, Mainframe, Changepoint and Uniface based on the estimated relative fair value of each respective reporting unit. The portion of goodwill allocated to the traditional professional services is reported in the professional services reporting unit. |
· | The goodwill balance of $25.4 million related to the Covisint application services reporting unit continues to be reported in the application services reporting unit during fiscal 2012. |
Following the allocation of goodwill to the new reporting units, the Company performed impairment evaluations of each reporting unit’s goodwill as of April 1, 2011 which indicated the goodwill carrying values were not impaired. There has been no triggering event since April 1, 2011.
The change in the carrying amount of goodwill by reporting unit during the six months ended September 30, 2011 is summarized as follows (in thousands):
APM | MF | CP | UF | PS | AS | Total | ||||||||||||||||||||||
Goodwill as of April 1, 2011 | $ | 282,815 | $ | 141,020 | $ | 22,151 | $ | 21,350 | $ | 115,044 | $ | 25,385 | $ | 607,765 | ||||||||||||||
Acquisition (1) | 210,908 | - | - | - | - | - | 210,908 | |||||||||||||||||||||
Effect of foreign currency translation | (14,814 | ) | (106 | ) | (17 | ) | (16 | ) | (431 | ) | (15,384 | ) | ||||||||||||||||
Goodwill as of September 30, 2011 | $ | 478,909 | $ | 140,914 | $ | 22,134 | $ | 21,334 | $ | 114,613 | $ | 25,385 | $ | 803,289 |
(1)The Company acquired dynaTrace on July 1, 2011. See Note 2 for information related to the purchase accounting that resulted in the recording of goodwill.
Capitalized software and other intangible assets
The components of the Company’s capitalized software and other intangible assets are as follows (in thousands):
As of September 30, 2011 | ||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||||
Unamortized intangible assets: | ||||||||||||
Trademarks | $ | 4,403 | $ | 4,403 | ||||||||
Amortized intangible assets: | ||||||||||||
Capitalized software | ||||||||||||
Internally developed | $ | 203,745 | (167,835 | ) | $ | 35,910 | ||||||
Purchased (1) | 167,001 | (128,647 | ) | 38,354 | ||||||||
Customer relationship (2) | 52,064 | (18,797 | ) | 33,267 | ||||||||
Other (2) | 20,271 | (10,895 | ) | 9,376 | ||||||||
Total amortized intangible assets | $ | 443,081 | $ | (326,174 | ) | $ | 116,907 |
As of March 31, 2011 | ||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||||
Unamortized intangible assets: | ||||||||||||
Trademarks | $ | 4,467 | $ | 4,467 | ||||||||
Amortized intangible assets: | ||||||||||||
Capitalized software | ||||||||||||
Internally developed | $ | 194,770 | $ | (161,671 | ) | 33,099 | ||||||
Purchased | 136,469 | (125,118 | ) | 11,351 | ||||||||
Customer relationship | 48,813 | (16,729 | ) | 32,084 | ||||||||
Other | 11,162 | (9,162 | ) | 2,000 | ||||||||
Total amortized intangible assets | $ | 391,214 | $ | (312,680 | ) | $ | 78,534 |
(1) In July 2011, the Company acquired developed technology valued at $28.5 million as part of the dynaTrace acquisition (see Note 2 for additional information). Additionally, the Company acquired developed technology valued at $4.2 million during fiscal 2012. | ||||||
(2) In July 2011, the Company acquired customer relationship agreements valued at $3.7 million and trade names valued at $9.8 million as part of the dynaTrace acquisition (see Note 2 for additional information). |
Capitalized software includes the costs of internally developed software technology and software technology purchased through acquisitions. Internally developed capitalized software costs and capitalized purchased software technology are being amortized over periods up to five years.
Customer relationship agreements are related to acquisition activity and are being amortized over periods up to ten years.
Other amortized intangible assets include amortizable trademarks and patents relating to acquisition activity and are being amortized over periods up to three years.
Unamortized trademarks were acquired as part of the Covisint and Changepoint acquisitions 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):
Three Months Ended | Six Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Amortized intangible assets: | ||||||||||||||||
Capitalized software | ||||||||||||||||
Internally developed | $ | 3,185 | $ | 2,706 | $ | 6,160 | $ | 5,444 | ||||||||
Purchased | 2,545 | 1,119 | 3,727 | 2,335 | ||||||||||||
Customer relationship | 1,176 | 1,089 | 2,263 | 2,219 | ||||||||||||
Other | 1,287 | 469 | 1,775 | 935 | ||||||||||||
Total amortization expense | $ | 8,193 | $ | 5,383 | $ | 13,925 | $ | 10,933 |
Capitalized software amortization related to our product software is reported as “Cost of software license fees”, amortization related to our web performance services (Gomez SaaS) is reported as “Cost of maintenance and subscription” and amortization related to our application services (Covisint SaaS) is reported as “Cost of professional services” in the condensed consolidated statements of operations.
Customer relationship amortization related to our software solutions segments is reported as “Sales and marketing” and amortization related to our application services segment is reported as “Cost of professional services” in the condensed consolidated statements of operations.
Amortization expense associated with trademarks and trade names is reported as “Administrative and general” in the condensed consolidated statements of operations.
Based on the capitalized software, customer relationship and other intangible assets recorded through September 30, 2011, the annual amortization expense over the next four fiscal years and thereafter is expected to be as follows (in thousands):
Fiscal Year Ended March 31, | ||||||||||||||||||||
2012 | 2013 | 2014 | 2015 | Thereafter | ||||||||||||||||
Amortized intangible assets: | ||||||||||||||||||||
Capitalized software | $ | 22,035 | $ | 20,760 | $ | 17,248 | $ | 12,097 | $ | 12,011 | ||||||||||
Customer relationship | 4,477 | 4,179 | 4,132 | 4,132 | 18,610 | |||||||||||||||
Other | 3,790 | 3,524 | 3,078 | 759 | - | |||||||||||||||
Total amortization expense | $ | 30,302 | $ | 28,463 | $ | 24,458 | $ | 16,988 | $ | 30,621 |
Note 10 – Segment Information
In previous fiscal years, the Company operated in four business segments: products, web application performance management services, professional services and application services. Effective April 1, 2011, the Company realigned its business unit structure which had the following effect: (1) the former products segment split into four new segments: Application Performance Management, Mainframe, Changepoint and Uniface; (2) the former web performance services segment (Gomez SaaS solution) and Gomez On-premises software (formerly Vantage) comprise the APM segment; and (3) the operating results of our software related professional services are reported within APM, Mainframe, Changepoint and Uniface, as applicable (previously reported in the Professional Services segment).
As a result of these changes, Compuware now has six business segments: APM, Mainframe, Changepoint, Uniface, Professional Services and Application Services.
This business unit structure gives the Company better visibility and control over the operations of the business and increases its market agility, enabling it to more effectively capitalize on market conditions and competitive advantages to maximize revenue growth and profitability. The segment presentation in the prior period has been recast to conform to the current presentation of the business segments. This change did not have an impact on previously reported consolidated financial results.
The Company’s products and services are offered worldwide to the largest IT organizations across a broad spectrum of technologies, including mainframe, distributed, Internet and mobile platforms and provide the following capabilities:
· | APM includes Gomez SaaS and On-premises solutions. The SaaS solutions are designed to test and monitor the performance, availability and quality of companies’ web and mobile applications. The on-premises solutions provide detailed application insight that identifies and helps correct the causes of poor application performance within client workstations, network, server, Java and .NET environments. dynaTrace operations are included within our APM segment. The acquisition of dynaTrace provided additional technology which enables continuous tracking of business transactions and provides exact identification of performance problems, enhancing our Gomez On-premises software solutions. |
· | Mainframe solutions are designed to improve the productivity of development, maintenance and support teams in application analysis, testing, defect detection and remediation, fault management, file and data management, data compliance and application performance management specifically within IBM mainframe environments. |
· | Changepoint is a business portfolio management and professional services automation solution that addresses the needs of executives within technology companies, enterprise IT and professional services organizations, allowing for management of the entire customer lifecycle, as well as for improved process efficiency, planning and visibility across program, project and product portfolios. |
· | Uniface is a rapid application development environment for building, renewing and integrating the largest and most complex enterprise applications. Uniface enables enterprises to meet increasing demand for developing complex, secure and global Web 2.0 applications, deployable on any platform including the cloud. |
· | Professional services include a broad range of IT services for mainframe, distributed and mobile environments, including mobile computing application development and integration, package software customization, cloud computing consulting, and development and integration of legacy systems. |
· | Application services, marketed under the brand name “Covisint” and provided on a SaaS platform, use business-to-business applications to integrate vital business information and processes between partners, customers and suppliers. |
The Company evaluates the performance of its segments based primarily on operating profit before certain charges such as internal information system support, finance, human resources, legal, administration and other corporate charges (“unallocated expenses”). The allocation of income taxes is not evaluated at the segment level. Financial information for the Company’s business segments was as follows (in thousands):
Three Months Ended | ||||||||||||||||||||||||||||||||
September 30, 2011 | ||||||||||||||||||||||||||||||||
Unallocated | ||||||||||||||||||||||||||||||||
APM | MF | CP | UF | PS | AS | Expenses | Total | |||||||||||||||||||||||||
Software license fees | $ | 18,329 | $ | 38,456 | $ | 2,136 | $ | 2,790 | $ | - | $ | - | $ | - | $ | 61,711 | ||||||||||||||||
Maintenance and subscription fees | 37,728 | 78,019 | 4,415 | 8,019 | - | - | - | 128,181 | ||||||||||||||||||||||||
Professional services fees | 6,787 | 1,569 | 4,300 | 1,072 | 39,528 | 17,548 | - | 70,804 | ||||||||||||||||||||||||
Total revenues | 62,844 | 118,044 | 10,851 | 11,881 | 39,528 | 17,548 | - | 260,696 | ||||||||||||||||||||||||
Operating expenses | 79,932 | 24,129 | 10,944 | 5,151 | 31,662 | 19,835 | 50,883 | 222,536 | ||||||||||||||||||||||||
Income (loss) from operations | $ | (17,088 | ) | $ | 93,915 | $ | (93 | ) | $ | 6,730 | $ | 7,866 | $ | (2,287 | ) | $ | (50,883 | ) | $ | 38,160 |
Three Months Ended | ||||||||||||||||||||||||||||||||
September 30, 2010 | ||||||||||||||||||||||||||||||||
Unallocated | ||||||||||||||||||||||||||||||||
APM | MF | CP | UF | PS | AS | Expenses | Total | |||||||||||||||||||||||||
Software license fees | $ | 18,229 | $ | 22,761 | $ | 2,248 | $ | 2,375 | $ | - | $ | - | $ | - | $ | 45,613 | ||||||||||||||||
Maintenance and subscription fees | 33,201 | 77,886 | 3,611 | 7,309 | - | - | - | 122,007 | ||||||||||||||||||||||||
Professional services fees | 5,309 | 1,488 | 3,829 | 1,056 | 34,405 | 12,162 | - | 58,249 | ||||||||||||||||||||||||
Total revenues | 56,739 | 102,135 | 9,688 | 10,740 | 34,405 | 12,162 | - | 225,869 | ||||||||||||||||||||||||
Operating expenses | 57,282 | 23,420 | 11,402 | 4,612 | 28,836 | 10,963 | 48,493 | 185,008 | ||||||||||||||||||||||||
Income (loss) from operations | $ | (543 | ) | $ | 78,715 | $ | (1,714 | ) | $ | 6,128 | $ | 5,569 | $ | 1,199 | $ | (48,493 | ) | $ | 40,861 |
Six Months Ended | ||||||||||||||||||||||||||||||||
September 30, 2011 | ||||||||||||||||||||||||||||||||
Unallocated | ||||||||||||||||||||||||||||||||
APM | MF | CP | UF | PS | AS | Expenses | Total | |||||||||||||||||||||||||
Software license fees | $ | 29,782 | $ | 57,154 | $ | 4,130 | $ | 4,771 | $ | - | $ | - | $ | - | $ | 95,837 | ||||||||||||||||
Maintenance and subscription fees | 74,822 | 154,994 | 8,717 | 15,757 | - | - | - | 254,290 | ||||||||||||||||||||||||
Professional services fees | 13,753 | 3,402 | 7,970 | 2,278 | 79,425 | 33,715 | - | 140,543 | ||||||||||||||||||||||||
Total revenues | 118,357 | 215,550 | 20,817 | 22,806 | 79,425 | 33,715 | - | 490,670 | ||||||||||||||||||||||||
Operating expenses | 149,371 | 48,205 | 22,306 | 10,551 | 63,251 | 36,669 | 102,540 | 432,893 | ||||||||||||||||||||||||
Income (loss) from operations | $ | (31,014 | ) | $ | 167,345 | $ | (1,489 | ) | $ | 12,255 | $ | 16,174 | $ | (2,954 | ) | $ | (102,540 | ) | $ | 57,777 |
Six Months Ended | ||||||||||||||||||||||||||||||||
September 30, 2010 | ||||||||||||||||||||||||||||||||
Unallocated | ||||||||||||||||||||||||||||||||
APM | MF | CP | UF | PS | AS | Expenses | Total | |||||||||||||||||||||||||
Software license fees | $ | 32,461 | $ | 37,469 | $ | 4,600 | $ | 4,413 | $ | - | $ | - | $ | - | $ | 78,943 | ||||||||||||||||
Maintenance and subscription fees | 61,646 | 155,627 | 7,162 | 14,331 | - | - | - | 238,766 | ||||||||||||||||||||||||
Professional services fees | 9,467 | 3,134 | 7,348 | 2,036 | 69,259 | 23,401 | - | 114,645 | ||||||||||||||||||||||||
Total revenues | 103,574 | 196,230 | 19,110 | 20,780 | 69,259 | 23,401 | - | 432,354 | ||||||||||||||||||||||||
Operating expenses | 114,077 | 47,172 | 22,690 | 9,299 | 58,640 | 21,440 | 95,788 | 369,106 | ||||||||||||||||||||||||
Income (loss) from operations | $ | (10,503 | ) | $ | 149,058 | $ | (3,580 | ) | $ | 11,481 | $ | 10,619 | $ | 1,961 | $ | (95,788 | ) | $ | 63,248 |
The Company does not evaluate assets and capital expenditures on a segment basis, and accordingly such information is not provided.
Financial information regarding geographic operations is presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Revenues: | ||||||||||||||||
United States | $ | 171,097 | $ | 145,740 | $ | 320,336 | $ | 277,896 | ||||||||
Europe and Africa | 55,726 | 53,073 | 110,330 | 101,411 | ||||||||||||
Other international operations | 33,873 | 27,056 | 60,004 | 53,047 | ||||||||||||
Total revenues | $ | 260,696 | $ | 225,869 | $ | 490,670 | $ | 432,354 |
As of | As of | |||||||
September 30, | March 31, | |||||||
2011 | 2011 | |||||||
Long-lived assets | ||||||||
United States | $ | 948,363 | $ | 944,506 | ||||
Europe and Africa | 250,075 | 33,037 | ||||||
Other international operations | 9,194 | 7,838 | ||||||
Total long-lived assets | $ | 1,207,632 | $ | 985,381 |
Long-lived assets are comprised of property, plant and equipment, goodwill and capitalized software.
Note 11 - Debt
As of September 30, 2011, the Company’s long-term debt under its unsecured revolving credit agreement (the “credit facility”) was $125.6 million. The Company had no long term debt at March 31, 2011.
On June 30, 2011, the Company amended the credit facility with Comerica Bank and other lenders. Under the amendment, the Company exercised its right to increase the revolving line of credit from $150 million to $200 million. The amendment reduces the amount the Company can increase the revolving line of credit to an additional $100 million (previously $150 million) subject to receiving further commitments from lenders and certain other conditions. The credit facility expires on November 1, 2012.
On July 1, 2011, Compuware borrowed $129.5 million under the credit facility to partially fund the acquisition of dynaTrace (see note 2).
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 September 30, 2011.
Any borrowings under the credit facility bear interest at the base rate (the greatest of the prime rate, the federal funds effective rate plus one percent, or the daily LIBOR rate plus one percent) or the Eurodollar rate, at the Company’s option, plus the applicable margin (which is based on the level of maximum total debt to EBITDA ratio). As of September 30, 2011, interest rates on outstanding borrowings were at a weighted average interest rate of 1.8%. The Company pays a quarterly facility fee on the credit facility based on the applicable margin grid. Interest and fees related to the credit facility were $788,000 during the six months ended September 30, 2011.
Note 12 – 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. It is the opinion of management that the outcome of such matters will not have a material impact on the Company’s financial position, results of operations or cash flows as of September 30, 2011.
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 September 30, 2011, and the related condensed consolidated statements of operations for the three-month and six-month periods ended September 30, 2011 and 2010 and of cash flows for the six-month periods ended September 30, 2011 and 2010. 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, 2011, and the related consolidated statements of operations, shareholders’ equity and comprehensive income, and cash flows for the year then ended (not presented herein); and in our report dated May 27, 2011, 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, 2011 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ DELOITTE & TOUCHE LLP
Detroit, Michigan
November 7, 2011
COMPUWARE CORPORATION AND SUBSIDIARIES
This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”) is intended to provide an understanding of our financial condition, changes in financial condition, cash flow, liquidity and results of operations. The MD&A should be read in conjunction with the unaudited condensed consolidated financial statements and notes included elsewhere in this report and our annual report on Form 10-K for the fiscal year ended March 31, 2011, particularly “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations”. References to years are to fiscal years ended March 31.
In this section, we first discuss our results of operations on a business unit and segment basis. We evaluate segment performance based primarily on operating profit before certain charges such as internal information system support, finance, human resources, legal, administration and other corporate charges. Following the segment discussion, we then provide a separate discussion of the material period-to-period changes in our operating expenses, other income and income taxes as reflected on our income statement.
In previous fiscal years, we operated in four business segments in the technology industry: products, web application performance management services, professional services and application services. Effective April 1, 2011, we realigned our business unit structure which had the following effect on our segments: (1) the former products segment split into four new segments: Application Performance Management (“APM”), Mainframe, Changepoint and Uniface; (2) the former web performance services segment (“Gomez SaaS” solution) and Gomez On-premises software (formerly Vantage) comprise the APM segment; and (3) the operating results of our software related professional services (“software related services”) are reported within APM, Mainframe, Changepoint and Uniface, as applicable (previously reported in the Professional Services segment).
As a result of these changes, we now have six business segments: APM, Mainframe (“MF”), Changepoint (“CP”), Uniface (“UF”), Professional Services (“PS”) and Application Services (“AS”). These segments are described in detail in Note 10 to the condensed consolidated financial statements.
This business unit structure gives us better visibility and control over the operations of our business and increases our market agility, enabling us to more effectively capitalize on market conditions and competitive advantages to maximize revenue growth and profitability. The segment presentation in the prior period has been revised to conform to the current presentation of our reportable segments. The change in reporting segments had no impact on previously reported consolidated financial results.
We collectively refer to the solutions offered within our APM, Mainframe, Changepoint and Uniface segments as “software solutions”. In order to provide a supplementary view of this business, aggregated financial data for our software solutions is presented herein.
COMPUWARE CORPORATION AND SUBSIDIARIES
Forward-Looking Statements
The following discussion contains certain forward-looking statements within the meaning of the federal securities laws. When we use words such as “may”, “might”, “will”, “should”, “believe”, “expect”, “anticipate”, “estimate”, “continue”, “predict”, “forecast”, “projected”, “intend” or similar expressions, or make statements regarding our future plans, objectives or expectations, we are making forward-looking statements. Numerous important factors, risks and uncertainties affect our operating results and could cause actual results to differ materially from the results implied by these or any other forward-looking statements made by us, or on our behalf.
The material risks and uncertainties that we believe affect us are summarized below. These risks and uncertainties are not the only ones we face. Additional risks and uncertainties discussed elsewhere in this report and the other reports we file with the Securities and Exchange Commission (see for example Item 1A Risk Factors in our 2011 Form 10-K), as well as other risks and uncertainties that we are not aware of or focused on or that we currently deem immaterial, may also impair business operations. This report is qualified in its entirety by these risk factors and those listed below. If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and shareholders could lose all or part of their investment.
There can be no assurance that future results will meet expectations. While we believe that our forward-looking statements are reasonable, you should not place undue reliance on any such forward-looking statements, which speak only as of the date made. Except as required by applicable law, we do not undertake any obligation to publicly release any revisions which may be made to any forward-looking statements to reflect events or circumstances occurring after the date of this report.
Summary of Risk Factors
· | A substantial portion of our mainframe segment revenue is dependent on our customers’ continued use of International Business Machines Corporation and IBM-compatible products. |
· | Our software solutions revenue is dependent on the acceptance of our pricing structure for software licenses, maintenance services and web performance services. |
· | Mainframe maintenance revenue could continue to decline. |
· | The markets for web performance services (Gomez SaaS) are at an early stage of development with emerging competitors. If these markets do not develop or develop more slowly than we expect, or if there is an increase in competition, our revenue may decline or fail to grow. |
· | The success of our APM solutions is dependent on customer acceptance of these offerings. |
· | Changes to our organizational structure can be disruptive and may negatively impact our results of operations. |
COMPUWARE CORPORATION AND SUBSIDIARIES
· | The market for application services (Covisint SaaS) is in its early stages of development with emerging competitors. As the market matures, competition may increase and could have a material negative impact on our results of operations. |
· | If we are not successful in implementing our professional services strategy, our operating margins may decline materially. |
· | We may fail to achieve our forecasted financial results due to inaccurate sales forecasts or other unpredictable factors. If we fail to meet the expectations of analysts or investors, our stock price could decline substantially. |
· | Economic uncertainties or slowdowns may reduce demand for our products and services, which may have a material negative effect on our revenues and operating results. |
· | Defects or disruptions in our web performance services (Gomez SaaS) or application services (Covisint SaaS) networks or interruptions or delays in service would impair the delivery of our on-demand services and could diminish demand for our services and subject us to substantial liability. |
· | Future changes in the U.S. domestic automotive manufacturing business could reduce demand for our professional services and application services, which may have a material negative effect on our revenues and operating results. |
· | If the fair value of our long-lived assets, primarily goodwill, deteriorates below the carrying value of these assets, recognition of an impairment loss would be required, which could materially and adversely affect our financial results. |
· | Our software technology may infringe upon the proprietary rights of others. |
· | Our results could be materially and adversely affected by increased competition, pricing pressures and technological changes within the software solutions market. |
· | The market for professional services is highly competitive, fragmented and characterized by low barriers to entry. |
· | We must develop or acquire product enhancements and new products to succeed. |
· | Acquisitions may be difficult to integrate, disrupt our business or divert the attention of our management and may result in financial results that are different than expected. |
· | We are exposed to exchange rate risks on foreign currencies and to other international risks that may adversely affect our business and results of operations. |
· | Current laws may not adequately protect our proprietary rights. |
· | The loss of certain key employees and technical personnel or our inability to hire additional qualified personnel could have a material adverse effect on our business. |
· | Unanticipated changes in our effective tax rates, or exposure to additional income tax liabilities, could affect our profitability. |
· | Our stock repurchase plan may be suspended or terminated at any time, which may result in a decrease in our stock price. |
· | Acts of terrorism, acts of war and other unforeseen events may cause damage or disruption to us or our customers, which could materially and adversely affect our business, financial condition and operating results. |
COMPUWARE CORPORATION AND SUBSIDIARIES
· | Our articles of incorporation, bylaws and rights agreement as well as certain provisions of Michigan law may have an anti-takeover effect. |
OVERVIEW
We deliver value to businesses by providing software products; web performance services and application services through software-as-a-service (“SaaS”) platforms; and professional services that improve the performance of information technology organizations.
Our primary source of profitability and cash flow is the sale of our mainframe productivity tools (“mainframe”) that are used within our customers’ mainframe computing environments for fault diagnosis, file and data management, application performance monitoring and application debugging. Over the past few years, we have experienced lower volumes of software license transactions for our mainframe solutions causing an overall downward trend in our mainframe product revenues. Changes in our current customer IT computing environments and spending habits have impacted their need for additional mainframe computing capacity. In addition, increased competition and pricing pressures have had a negative impact on our revenues. Customers utilize our products to reduce operating costs, increase programmer productivity and create a smooth transition to the next generation of mainframe environment programmers. We will continue to make strategic enhancements to our mainframe solutions through research and development investments with the goal of meeting customer needs and maintaining a maintenance renewal rate in excess of 90%. The cash flow generated from our mainframe business supports our growth segments.
We have identified the APM market as a key source of future revenue growth. Web, mobile and cloud applications and the complex distributed applications delivery chain supporting them have become increasingly critical to a company’s brand awareness, revenue growth and overall market share. Because of this, the market for APM solutions is significant and growing rapidly. Our APM solutions are marketed under the brand names “Gomez” and “dynaTrace”. These solutions provide our customers with on-premises software (“Gomez On-premises” and “dynaTrace”) and SaaS platform based web application performance services (“Gomez SaaS”). These solutions ensure the optimal performance of our customer’s enterprise, web, streaming, mobile and cloud applications. We are investing in our APM solutions with the goal of providing solutions that are best-in-class within the APM market. Specifically, our investments include: (1) enhancements to our global web performance services network with specific focus on ease of use, time-to-value and data analytics in mobile application performance capabilities and in video streaming performance; (2) enhancements to our First Mile to Last Mile solution which combines our on-premises software and SaaS solution into a single platform that provides performance metrics for cloud, web and data center applications in a consolidated dashboard; and (3) the acquisition of dynaTrace software, Inc. (“dynaTrace”) in July 2011. The dynaTrace software enables companies to continuously track business transactions and provides exact identification of performance problems, enhancing our Gomez software solutions.
We have also identified the secured collaboration services market as a key source of revenue growth. Technology has allowed business communities, organizations and systems to globally connect and share vital information, applications and processes across their internal and extended enterprises. Our application services, which are marketed under the brand name “Covisint” and provided on a SaaS platform, create an environment that simplifies and secures this collaboration atmosphere. Our Covisint services are utilized primarily in the automotive and healthcare industries. The need for these services is growing, particularly in the healthcare industry as hospitals, physicians and the United States government move towards establishing electronic patient health and medical records that will require secured computerized databases and environments for storing and sharing of information.
COMPUWARE CORPORATION AND SUBSIDIARIES
We also continue to enhance our Changepoint and Uniface solutions primarily through research and development expenditures.
Our Changepoint solution provides a single automated solution for professional services organizations to forecast and plan, as well as, manage resources, projects and client engagements. In addition, for project-centric organizations, Changepoint provides a cohesive and consolidated view of projects, investments, resources and applications to help manage the entire business portfolio.
Our Uniface solution is mature with over 25 years on the market. Uniface is a rapid application development environment for building, renewing and integrating the latest complex enterprise applications. Our strategy with the Uniface solution is to enhance the product with additional features making it more effective for enterprise applications and to expand the capabilities of the product to other technology applications.
The professional services reporting segment recently went through a business transformation and is now focused on achieving modest revenue growth and high operating margins by delivering high quality solutions and resources to our customers that meet their application development through project management needs. Our goal is to provide the expertise, best practices and agility needed to meet our customers’ critical technology challenges. Areas of growth that we have identified are cloud and mobile application development services. Enhancing our competencies in these areas will provide an opportunity to continue growing the segment’s revenue and operating margin.
COMPUWARE CORPORATION AND SUBSIDIARIES
Quarterly Update
The following occurred during the second quarter of 2012:
· | Acquired dynaTrace for $255.8 million in cash, plus approximately $300,000 of direct acquisition costs (see Note 2 of the condensed consolidated financial statements included in this report for additional information). We borrowed $129.5 million on our credit facility to partially fund this acquisition. |
· | Realized an increase of $34.8 million or 15.4% in revenue during the second quarter of 2012 as compared to the prior year due to a $16.1 million increase in software license fees, a $6.2 million increase in maintenance and subscription fees and a $12.5 million increase in professional services fees (see “Business Segment Analysis” for additional information). |
· | Experienced a decrease in operating margin to 14.6% during the second quarter of 2012 compared to 18.1% in the second quarter of 2011. The decrease was primarily due to our continued investments in the APM and application services businesses and was partially offset by operating margin improvement in our professional services and mainframe businesses (see “Business Segment Analysis” for additional information). |
· | Realized an increase of $24.3 million or 13.6% in software solutions revenue during the second quarter of 2012 compared to the prior year led by the APM and Mainframe businesses. |
· | Experienced a decrease in software solutions operating margin to 41.0% in the second quarter of 2012 compared to 46.1% during the second quarter of 2011 primarily due to increased investments within our APM business. |
· | Realized an increase in professional services segment operating margin to 19.9% in the second quarter of 2012 from 16.2% during the second quarter of 2011. |
· | Experienced a decrease in application services segment operating margin to negative 13.0% in the second quarter of 2012 from positive 9.9% during the second quarter of 2011 as a result of hiring additional personnel to prepare for anticipated growth in the market. |
· | Repurchased 422,200 shares of our common stock at an average price of $7.84 per share as part of our discretionary stock repurchase plan. |
Our ability to execute our strategies and achieve our objectives is subject to a number of risks and uncertainties. See "Forward-Looking Statements".
COMPUWARE CORPORATION AND SUBSIDIARIES
BUSINESS SEGMENT ANALYSIS
The following table sets forth, for the periods indicated, certain business segment operational data. We evaluate the performance of our segments based primarily on operating profit before certain charges such as internal information system support, finance, human resources, legal, administration and other corporate charges (“unallocated expenses”). Comparisons are to the comparable period of the prior year. Financial information for our business segments was as follows (in thousands):
Software Solutions | ||||||||||||||||||||||||||||||||||||
Three Months Ended : | APM | MF | CP | UF | Total | PS | AS | Unallocated Expenses | Total | |||||||||||||||||||||||||||
September 30, 2011 | ||||||||||||||||||||||||||||||||||||
Total revenues | $ | 62,844 | $ | 118,044 | $ | 10,851 | $ | 11,881 | $ | 203,620 | $ | 39,528 | $ | 17,548 | $ | - | $ | 260,696 | ||||||||||||||||||
Operating expenses | 79,932 | 24,129 | 10,944 | 5,151 | 120,156 | 31,662 | 19,835 | 50,883 | 222,536 | |||||||||||||||||||||||||||
Income (loss) from operations | $ | (17,088 | ) | $ | 93,915 | $ | (93 | ) | $ | 6,730 | $ | 83,464 | $ | 7,866 | $ | (2,287 | ) | $ | (50,883 | ) | $ | 38,160 | ||||||||||||||
Operating margin % | (27.2% | ) | 79.6% | (0.9% | ) | 56.6% | 41.0% | 19.9% | (13.0% | ) | N/A | 14.6% | ||||||||||||||||||||||||
September 30, 2010 | ||||||||||||||||||||||||||||||||||||
Total revenues | $ | 56,739 | $ | 102,135 | $ | 9,688 | $ | 10,740 | $ | 179,302 | $ | 34,405 | $ | 12,162 | $ | - | $ | 225,869 | ||||||||||||||||||
Operating expenses | 57,282 | 23,420 | 11,402 | 4,612 | 96,716 | 28,836 | 10,963 | 48,493 | 185,008 | |||||||||||||||||||||||||||
Income (loss) from operations | $ | (543 | ) | $ | 78,715 | $ | (1,714 | ) | $ | 6,128 | $ | 82,586 | $ | 5,569 | $ | 1,199 | $ | (48,493 | ) | $ | 40,861 | |||||||||||||||
Operating margin % | (1.0% | ) | 77.1% | (17.7% | ) | 57.1% | 46.1% | 16.2% | 9.9% | N/A | 18.1% |
Software Solutions | ||||||||||||||||||||||||||||||||||||
Six Months Ended : | APM | MF | CP | UF | Total | PS | AS | Unallocated Expenses | Total | |||||||||||||||||||||||||||
September 30, 2011 | ||||||||||||||||||||||||||||||||||||
Total revenues | $ | 118,357 | $ | 215,550 | $ | 20,817 | $ | 22,806 | $ | 377,530 | $ | 79,425 | $ | 33,715 | $ | - | $ | 490,670 | ||||||||||||||||||
Operating expenses | 149,371 | 48,205 | 22,306 | 10,551 | 230,433 | 63,251 | 36,669 | 102,540 | 432,893 | |||||||||||||||||||||||||||
Income (loss) from operations | $ | (31,014 | ) | $ | 167,345 | $ | (1,489 | ) | $ | 12,255 | $ | 147,097 | $ | 16,174 | $ | (2,954 | ) | $ | (102,540 | ) | $ | 57,777 | ||||||||||||||
Operating margin % | (26.2% | ) | 77.6% | (7.2% | ) | 53.7% | 39.0% | 20.4% | (8.8% | ) | N/A | 11.8% | ||||||||||||||||||||||||
September 30, 2010 | ||||||||||||||||||||||||||||||||||||
Total revenues | $ | 103,574 | $ | 196,230 | $ | 19,110 | $ | 20,780 | $ | 339,694 | $ | 69,259 | $ | 23,401 | $ | - | $ | 432,354 | ||||||||||||||||||
Operating expenses | 114,077 | 47,172 | 22,690 | 9,299 | 193,238 | 58,640 | 21,440 | 95,788 | 369,106 | |||||||||||||||||||||||||||
Income (loss) from operations | $ | (10,503 | ) | $ | 149,058 | $ | (3,580 | ) | $ | 11,481 | $ | 146,456 | $ | 10,619 | $ | 1,961 | $ | (95,788 | ) | $ | 63,248 | |||||||||||||||
Operating margin % | (10.1% | ) | 76.0% | (18.7% | ) | 55.3% | 43.1% | 15.3% | 8.4% | N/A | 14.6% |
COMPUWARE CORPORATION AND SUBSIDIARIES
Software Solutions as a Group
Our software solutions are comprised of the following business segments: (1) Application Performance Management; (2) Mainframe; (3) Changepoint; and (4) Uniface.
Revenue associated with our software solutions consists of software license fees, maintenance fees, subscription fees and professional services fees (software related services). Software solutions revenues are presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Change | 2011 | 2010 | Change | |||||||||||||||||||
Software license fees | $ | 61,711 | $ | 45,613 | 35.3 | % | $ | 95,837 | $ | 78,943 | 21.4 | % | ||||||||||||
Maintenance fees | 109,080 | 104,351 | 4.5 | % | 216,065 | 207,838 | 4.0 | % | ||||||||||||||||
Subscription fees | 19,101 | 17,656 | 8.2 | % | 38,225 | 30,928 | 23.6 | % | ||||||||||||||||
Professional services fees | 13,728 | 11,682 | 17.5 | % | 27,403 | 21,985 | 24.6 | % | ||||||||||||||||
Total software solutions revenue | $ | 203,620 | $ | 179,302 | 13.6 | % | $ | 377,530 | $ | 339,694 | 11.1 | % |
Software license fees (“license fees”) increased $16.1 million during the second quarter of 2012, which included a positive impact of foreign currency fluctuations of $2.4 million, and increased $16.9 million during the first six months of 2012, which included a positive impact of foreign currency fluctuations of $4.8 million, as compared to the same periods of the prior year. Excluding the impact from foreign currency fluctuations, license fees increased $13.7 million for the second quarter of 2012 and increased $12.1 million for the first six months of 2012 as compared to the same periods of the prior year. The increases were due to additional mainframe license revenue (see the Mainframe discussion within “Software Solutions by Business Segment” for more details).
During the second quarter of 2012 and 2011, for software license transactions that were required to be recognized ratably, we deferred $2.5 million and $5.6 million, respectively, of license fees relating to such transactions that closed during the period. We recognized as license fees $12.3 million and $15.6 million of previously deferred license revenue during the second quarter of 2012 and 2011, respectively, relating to such transactions that closed and had been deferred prior to the beginning of the period.
During the first six months of 2012 and 2011, for software license transactions that were required to be recognized ratably, we deferred $5.4 million and $12.6 million, respectively, of license fees relating to such transactions that closed during the period. We recognized as license fees $25.9 million and $30.9 million of previously deferred license revenue during the first six months of 2012 and 2011, respectively, relating to such transactions that closed and had been deferred prior to the beginning of the period.
Maintenance fees increased $4.7 million during the second quarter of 2012, which included a positive impact from foreign currency fluctuations of $4.6 million, and increased $8.2 million during the first six months of 2012, which included a positive impact from foreign currency fluctuations of $10.8 million, as compared to the same periods of the prior year. Excluding the impact from foreign currency fluctuations, maintenance fees increased $100,000 for the second quarter of 2012 and decreased $2.6 million for the first six months of 2012 as compared to the same periods of the prior year. Although we continue to experience a high maintenance renewal rate with our current mainframe customers, the decline in mainframe license transactions during 2010 and 2011 is impacting mainframe maintenance revenue as new or growth customers are not entirely replacing the maintenance revenue loss from the non-renewed or reduced capacity mainframe maintenance arrangements. The decline was entirely offset for the second quarter of 2012 and partially offset for the first six months of 2012 by an increase in Gomez On-premises software maintenance fees as demand for APM solutions continues to increase and by additional maintenance revenue gained from the acquisition of dynaTrace.
COMPUWARE CORPORATION AND SUBSIDIARIES
Subscription fees increased $1.4 million during the second quarter of 2012, which included a positive impact from foreign currency fluctuations of $259,000, and increased $7.3 million during the first six months of 2012, which included a positive impact from foreign currency fluctuations of $650,000, as compared to the same periods of the prior year. Excluding the impact from foreign currency fluctuations, subscription fees increased $1.1 million for the second quarter of 2012 and increased $6.6 million for the first six months of 2012 as compared to the same periods of the prior year. The improvement in subscription fees over the prior year is primarily a result of the on-going ratable recognition of fiscal 2011 Gomez SaaS sales.
Professional services fees within our software solutions business segments increased $2.0 million during the second quarter of 2012 and increased $5.4 million during the first six months of 2012. The improvement in professional services fees over the prior year primarily occurred within our APM business unit as demand for our APM solutions continues to grow.
Software solutions revenue by geographic location is presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
United States | $ | 116,441 | $ | 102,002 | $ | 212,408 | $ | 190,007 | ||||||||
Europe and Africa | 54,539 | 51,302 | 107,550 | 98,680 | ||||||||||||
Other international operations | 32,640 | 25,998 | 57,572 | 51,007 | ||||||||||||
Total software solutions revenue | $ | 203,620 | $ | 179,302 | $ | 377,530 | $ | 339,694 |
COMPUWARE CORPORATION AND SUBSIDIARIES
Software Solutions by Business Segment
Application Performance Management
The financial results of operations for our APM segment were as follows (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Chg | 2011 | 2010 | Chg | |||||||||||||||||||
Revenue | ||||||||||||||||||||||||
Software license fees | $ | 18,329 | $ | 18,229 | 0.5 | % | $ | 29,782 | $ | 32,461 | (8.3 | %) | ||||||||||||
Maintenance fees | 19,129 | 15,545 | 23.1 | % | 37,562 | 30,718 | 22.3 | % | ||||||||||||||||
Subscription fees | 18,599 | 17,656 | 5.3 | % | 37,260 | 30,928 | 20.5 | % | ||||||||||||||||
Professional services fees | 6,787 | 5,309 | 27.8 | % | 13,753 | 9,467 | 45.3 | % | ||||||||||||||||
Total revenue | $ | 62,844 | $ | 56,739 | 10.8 | % | $ | 118,357 | $ | 103,574 | 14.3 | % | ||||||||||||
Operating expenses | 79,932 | 57,282 | 39.5 | % | 149,371 | 114,077 | 30.9 | % | ||||||||||||||||
Loss from operations | $ | (17,088 | ) | $ | (543 | ) | (3047.0 | %) | $ | (31,014 | ) | $ | (10,503 | ) | (195.3 | %) | ||||||||
Operating margin % | (27.2 | %) | (1.0 | %) | (26.2 | %) | (10.1 | %) |
APM segment revenue increased $6.1 million for the second quarter of 2012 as compared to the same period of the prior year. The increase can be attributed largely to revenue from dynaTrace and also to increased customer demand for previously existing APM solutions, offset in part, by sales force distractions resulting from our combination of the SaaS and On-premises sales organizations. Maintenance fees associated with Gomez On-premises software, subscription fees related to Gomez SaaS solutions and professional services fees related to APM solutions all improved during the second quarter of 2012.
APM segment revenue increased $14.8 million for the first six months of 2012 as compared to the same period of the prior year due, in part, to revenue from dynaTrace and to increased customer demand for APM solutions. In total, subscription fees, maintenance fees and professional services fees increased $17.5 million over the first six months of 2011. These increases were partially offset by a decline in Gomez On-premises license fees. In the prior year, we closed significant transactions with U.S. customers that resulted in the recognition of $5.0 million of license fees during the first six months of 2011.
Operating expenses increased $22.7 million during the second quarter of 2012 and $35.3 million during the first six months of 2012 as compared to the same periods of the prior year. These increases can be attributed to continued investment in our APM solutions. These investments included hiring developers and sales personnel, increasing the capacity of our web application services network and the acquisition of dynaTrace. We believe these investments will better position us to capitalize on the anticipated growth of the APM industry. The costs associated with these investments exceeded revenue growth, which had a negative impact on our operating margin.
COMPUWARE CORPORATION AND SUBSIDIARIES
Mainframe
The financial results of operations for our Mainframe segment were as follows (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Chg | 2011 | 2010 | Chg | |||||||||||||||||||
Revenue | ||||||||||||||||||||||||
Software license fees | $ | 38,456 | $ | 22,761 | 69.0 | % | $ | 57,154 | $ | 37,469 | 52.5 | % | ||||||||||||
Maintenance fees | 78,019 | 77,886 | 0.2 | % | 154,994 | 155,627 | (0.4 | %) | ||||||||||||||||
Professional services fees | 1,569 | 1,488 | 5.4 | % | 3,402 | 3,134 | 8.6 | % | ||||||||||||||||
Total revenue | $ | 118,044 | $ | 102,135 | 15.6 | % | $ | 215,550 | $ | 196,230 | 9.8 | % | ||||||||||||
Operating expenses | 24,129 | 23,420 | 3.0 | % | 48,205 | 47,172 | 2.2 | % | ||||||||||||||||
Income from operations | $ | 93,915 | $ | 78,715 | 19.3 | % | $ | 167,345 | $ | 149,058 | 12.3 | % | ||||||||||||
Operating margin % | 79.6 | % | 77.1 | % | 77.6 | % | 76.0 | % |
Mainframe segment revenue increased $15.9 million for the second quarter of 2012 as compared to the same period of the prior year due to significant license transactions with U.S. and Australian government entities that resulted in the recognition of $19.5 million in license fees part of which had been delayed from the fourth quarter of 2011. Additionally, a license contract with a financial services company closed during the second quarter of 2012, resulting in the recognition of $2.5 million in license fees. Significant license transactions during the second quarter of 2011 were approximately $6 million.
Mainframe segment revenue increased $19.3 million for the first six months of 2012 as compared to the same period of the prior year due primarily to significant license transactions with government entities that resulted in the recognition of $21.5 million in license fees. Additionally, two license contracts with financial services companies closed during the first six months of 2012, resulting in the recognition of $4.9 million in license fees. Significant license transactions during the first six months of 2011 were approximately $6 million.
The operating margin improvement for both the second quarter and the first six months of 2012 was due to the increase in software license fees.
COMPUWARE CORPORATION AND SUBSIDIARIES
Changepoint
The financial results of operations for our Changepoint segment were as follows (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Chg | 2011 | 2010 | Chg | |||||||||||||||||||
Revenue | ||||||||||||||||||||||||
Software license fees | $ | 2,136 | $ | 2,248 | (5.0 | %) | $ | 4,130 | $ | 4,600 | (10.2 | %) | ||||||||||||
Maintenance fees | 3,913 | 3,611 | 8.4 | % | 7,752 | 7,162 | 8.2 | % | ||||||||||||||||
Subscription fees | 502 | - | N/A | 965 | - | N/A | ||||||||||||||||||
Professional services fees | 4,300 | 3,829 | 12.3 | % | 7,970 | 7,348 | 8.5 | % | ||||||||||||||||
Total revenue | $ | 10,851 | $ | 9,688 | 12.0 | % | $ | 20,817 | $ | 19,110 | 8.9 | % | ||||||||||||
Operating expenses | 10,944 | 11,402 | (4.0 | %) | 22,306 | 22,690 | (1.7 | %) | ||||||||||||||||
Loss from operations | $ | (93 | ) | $ | (1,714 | ) | 94.6 | % | $ | (1,489 | ) | $ | (3,580 | ) | 58.4 | % | ||||||||
Operating margin % | (0.9 | %) | (17.7 | %) | (7.2 | %) | (18.7 | %) |
Changepoint segment revenue increased $1.2 million for the second quarter of 2012 and $1.7 million for the first six months of 2012 as compared to the same periods of the prior year due to growth in maintenance, subscription and professional services fees offset by a decline in software license fees. The improvement in operating margin relates primarily to the increase in revenue.
Uniface
The financial results of operations for our Uniface segment were as follows (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Chg | 2011 | 2010 | Chg | |||||||||||||||||||
Revenue | ||||||||||||||||||||||||
Software license fees | $ | 2,790 | $ | 2,375 | 17.5 | % | $ | 4,771 | $ | 4,413 | 8.1 | % | ||||||||||||
Maintenance fees | 8,019 | 7,309 | 9.7 | % | 15,757 | 14,331 | 10.0 | % | ||||||||||||||||
Professional services fees | 1,072 | 1,056 | 1.5 | % | 2,278 | 2,036 | 11.9 | % | ||||||||||||||||
Total revenue | $ | 11,881 | $ | 10,740 | 10.6 | % | $ | 22,806 | $ | 20,780 | 9.7 | % | ||||||||||||
Operating expenses | 5,151 | 4,612 | 11.7 | % | 10,551 | 9,299 | 13.5 | % | ||||||||||||||||
Income from operations | $ | 6,730 | $ | 6,128 | 9.8 | % | $ | 12,255 | $ | 11,481 | 6.7 | % | ||||||||||||
Operating margin % | 56.6 | % | 57.1 | % | 53.7 | % | 55.3 | % |
COMPUWARE CORPORATION AND SUBSIDIARIES
Uniface segment revenue increased $1.1 million for the second quarter of 2012 and $2.0 million for the first six months of 2012 as compared to the same periods of the prior year due primarily to positive foreign currency impact on revenue and higher maintenance billings throughout the previous year. Operating expenses for the second quarter of 2012 increased proportionately with revenue. We continue to make investments in our development and customer support groups to pursue the segment’s growth objectives which caused minor decreases in the operating margins during the first half of 2012.
Professional Services
The financial results of operations for our professional services segment were as follows (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Chg | 2011 | 2010 | Chg | |||||||||||||||||||
Professional services fees | $ | 39,528 | $ | 34,405 | 14.9 | % | $ | 79,425 | $ | 69,259 | 14.7 | % | ||||||||||||
Operating expenses | 31,662 | 28,836 | 9.8 | % | 63,251 | 58,640 | 7.9 | % | ||||||||||||||||
Income from operations | $ | 7,866 | $ | 5,569 | 41.2 | % | $ | 16,174 | $ | 10,619 | 52.3 | % | ||||||||||||
Operating margin % | 19.9 | % | 16.2 | % | 20.4 | % | 15.3 | % |
Professional services segment fees increased $5.1 million for the second quarter of 2012 and $10.2 million for the first six months of 2012 as compared to the same periods of the prior year primarily due to an increase in application development services for customers within the financial services industry.
Operating expenses increased $2.8 million for the second quarter of 2012 and $4.6 million for the first six months of 2012 as compared to the same periods of the prior year primarily due to increased staffing levels and increases in subcontractor costs to manage the growth of the business. The improvement in operating margin was due to increases in average billing rates and staff utilization.
Professional services segment revenue by geographic location is presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
United States | $ | 39,278 | $ | 33,270 | $ | 78,657 | $ | 67,605 | ||||||||
Europe and Africa | 249 | 895 | 766 | 1,177 | ||||||||||||
Other international operations | 1 | 240 | 2 | 477 | ||||||||||||
Total professional services segment revenue | $ | 39,528 | $ | 34,405 | $ | 79,425 | $ | 69,259 |
COMPUWARE CORPORATION AND SUBSIDIARIES
Application Services
The financial results of operations for our application services segment were as follows (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Chg | 2011 | 2010 | Chg | |||||||||||||||||||
Application services fees | $ | 17,548 | $ | 12,162 | 44.3 | % | $ | 33,715 | $ | 23,401 | 44.1 | % | ||||||||||||
Operating expenses | 19,835 | 10,963 | 80.9 | % | 36,669 | 21,440 | 71.0 | % | ||||||||||||||||
Income (loss) from operations | $ | (2,287 | ) | $ | 1,199 | (290.7 | %) | $ | (2,954 | ) | $ | 1,961 | (250.6 | %) | ||||||||||
Operating margin % | (13.0 | %) | 9.9 | % | (8.8 | %) | 8.4 | % |
Application services segment fees increased $5.4 million for the second quarter of 2012 and $10.3 million for the first six months of 2012 as compared to the same periods of the prior year primarily due to growth from automotive customers as the industry has stabilized from the recent economic downturn, and to continued expansion into the healthcare industry. We anticipate demand in the healthcare industry will continue to grow 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. Our application services are designed to meet this demand which we believe will be a factor in the future growth of the application services segment.
As of September 30, 2011, backlog for the application services segment was approximately $145 million and represents contractually committed arrangements for the next five years that have yet to be recognized, and up to three years of anticipated revenue associated with certain annual contracts that we believe are highly likely to be renewed.
Operating expenses increased $8.9 million during the second quarter of 2012 and $15.2 million during the first six months of 2012 as compared to the same periods of the prior year due to continued investment in our Covisint business. In anticipation of capitalizing on the growth of the secured collaboration services market, we have continued to hire developers, customer support and sales personnel, and we continue to increase the capacity of our global application services network.
As we continue to invest in order to manage the growth in this segment, our spending on these investments has proportionally exceeded revenue growth causing the decline in our operating margin.
COMPUWARE CORPORATION AND SUBSIDIARIES
Application services segment revenue by geographic location is presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
United States | $ | 15,378 | $ | 10,468 | $ | 29,271 | $ | 20,284 | ||||||||
Europe and Africa | 938 | 876 | 2,014 | 1,554 | ||||||||||||
Other international operations | 1,232 | 818 | 2,430 | 1,563 | ||||||||||||
Total application services segment revenue | $ | 17,548 | $ | 12,162 | $ | 33,715 | $ | 23,401 |
Unallocated Expenses
Costs related to internal information system support, finance, human resources, legal, administration and other corporate charges are not allocated to our business units when management analyzes business unit operating results.
Unallocated expenses are presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Change | 2011 | 2010 | Change | |||||||||||||||||||
Unallocated expenses | $ | 50,883 | $ | 48,493 | 4.9 | % | $ | 102,540 | $ | 95,788 | 7.0 | % |
Unallocated expenses increased $2.4 million for the second quarter of 2012 and $6.8 million for the first six months of 2012 as compared to the same periods of the prior year primarily due to increases in administrative and general expense and technology development and support expense. See “Administrative and General” and “Technology Development and Support” within the “Operating Expenses” section for additional information.
COMPUWARE CORPORATION AND SUBSIDIARIES
OPERATING EXPENSES
Our operating expenses include cost of software license fees; cost of maintenance and subscription fees; cost of professional services; technology development and support costs; sales and marketing expenses; and administrative and general expenses. These expenses are described below without regard to the relevant segment(s) to which they are allocated.
Cost of Software License Fees
Cost of software license fees includes amortization of capitalized software related to our licensed software products, the cost of duplicating and disseminating products to customers, including associated hardware costs, and the cost of author royalties.
Cost of software license fees is presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Change | 2011 | 2010 | Change | |||||||||||||||||||
Cost of software license fees | $ | 4,770 | $ | 3,267 | 46.0 | % | $ | 8,306 | $ | 6,683 | 24.3 | % | ||||||||||||
Percentage of software license fees | 7.7 | % | 7.2 | % | 8.7 | % | 8.5 | % |
Cost of software license fees increased $1.5 million during the second quarter of 2012 and $1.6 million during the first six months of 2012 due primarily to $1.4 million in additional amortization expense in the second quarter of 2012 related to the $28.5 million in purchased software obtained through the dynaTrace acquisition.
Cost of Maintenance and Subscription Fees
Cost of maintenance and subscription fees consists of the direct costs allocated to maintenance and product support such as helpdesk and technical support; amortization of capitalized software related to our web performance service offerings, depreciation and maintenance expense associated with our web performance services network related computer equipment; data center costs; and payments to individuals for tests conducted from their Internet-connected personal computers (“peer”).
Cost of maintenance and subscription fees is presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Change | 2011 | 2010 | Change | |||||||||||||||||||
Cost of maintenance and subscription fees | $ | 17,547 | $ | 13,265 | 32.3 | % | $ | 34,205 | $ | 26,552 | 28.8 | % | ||||||||||||
Percentage of maintenance and subscription fees | 13.7 | % | 10.9 | % | 13.5 | % | 11.1 | % |
COMPUWARE CORPORATION AND SUBSIDIARIES
Cost of maintenance and subscription fees increased $4.3 million during the second quarter of 2012 and $7.7 million during the first six months of 2012 as compared to the same periods of the prior year primarily as a result of increases in data center and peer costs as we continue to make investments in our Gomez SaaS global network, development costs related to maintenance for our mainframe products and customer support costs due to the hiring of additional employees to support the growth of the APM business segment. To a lesser extent, increases in research and development costs and depreciation of computer equipment also contributed to the increased costs.
The increase in the cost of maintenance and subscription fees as a percentage of maintenance and subscription fees was primarily due to incremental customer support and maintenance for our licensed software products and incremental data center and peer costs proportionally exceeding the increase in maintenance and subscription fees.
Cost of Professional Services
Cost of professional services consist primarily of personnel-related costs of providing professional and application services, including billable and technical staff, subcontractors and sales personnel.
Cost of professional services fees is presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Change | 2011 | 2010 | Change | |||||||||||||||||||
Total cost of professional services fees | $ | 65,935 | $ | 51,296 | 28.5 | % | $ | 127,888 | $ | 102,009 | 25.4 | % | ||||||||||||
Percentage of professional services fees | 93.1 | % | 88.1 | % | 91.0 | % | 89.0 | % |
Cost of professional services fees increased $14.6 million during the second quarter of 2012 as compared to the second quarter of 2011 primarily due to the following: (1) $10.6 million increase in salary and benefit costs of which $6.7 million primarily related to the hiring of additional developers, sales and customer support personnel to support the growth of the application services business segment and $3.9 million related primarily to the hiring of billable staff to support the growth of the professional services segment; and (2) $2.0 million increase in subcontractor costs to support the growth in our professional services segment.
Cost of professional services fees increased $25.9 million during the first six months of 2012 as compared to the first six months of 2011 primarily due to the following: (1) $18.9 million increase in salary and benefit costs of which $13.0 million primarily related to the hiring of additional developers, sales and customer support personnel to support the growth of the application services business segment and $5.9 million related primarily to the hiring of billable staff to support the growth of the professional services segment; and (2) $4.7 million increase in subcontractor costs to support the growth in our professional services business segment.
The increase in cost of professional services fees as a percentage of professional services fees was primarily due to increased salary and benefit costs for application services proportionally exceeding the increase in application services fees.
COMPUWARE CORPORATION AND SUBSIDIARIES
Technology Development and Support
Technology development and support includes, primarily, the costs of programming personnel associated with software technology development and support of our products and the web performance services network less the amount of capitalized internal software costs during the reporting period. Also included are personnel costs associated with developing and maintaining internal systems and hardware/software costs required to support all technology initiatives.
Technology development and support costs incurred internally and capitalized are presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Change | 2011 | 2010 | Change | |||||||||||||||||||
Technology development and support costs incurred | $ | 30,397 | $ | 26,401 | 15.1 | % | $ | 57,525 | $ | 51,793 | 11.1 | % | ||||||||||||
Capitalized internal software costs | (3,657 | ) | (4,508 | ) | (18.9 | %) | (6,084 | ) | (8,359 | ) | (27.2 | %) | ||||||||||||
Technology development and support costs expensed | $ | 26,740 | $ | 21,893 | 22.1 | % | $ | 51,441 | $ | 43,434 | 18.4 | % | ||||||||||||
Technology development and support costs expensed as a percentage of software solutions revenue | 13.1 | % | 12.2 | % | 13.6 | % | 12.8 | % |
Technology development and support increased $4.0 million before capitalized internal software costs during the second quarter of 2012 and $5.7 million before capitalized internal software costs during the first six months of 2012 as compared to the same periods of the prior year. These increases primarily relate to higher salary and benefit costs due to the hiring of developers and customer support personnel to support the growth of the APM business segment and, to a lesser extent, annual wage increases and a negative impact from currency fluctuations as the U.S. dollar weakened against non-U.S. currencies. Technology development and support as a percentage of software solutions revenues increased from the prior year as the additional investment in our products and technology proportionally exceeded the increase in software solutions revenue.
The $851,000 decrease in capitalized internal software costs during the second quarter of 2012 and the $2.3 million decrease in capitalized internal software costs during the first six months of 2012 as compared to the same periods in the prior year relates primarily to the timing of projects that are in the technological feasibility phase of development, primarily Gomez On-premises and Changepoint solutions.
COMPUWARE CORPORATION AND SUBSIDIARIES
Sales and Marketing
Sales and marketing costs consist primarily of personnel related costs associated with product sales, sales support and marketing for our product offerings.
Sales and marketing costs are presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Change | 2011 | 2010 | Change | |||||||||||||||||||
Sales and marketing costs | $ | 65,577 | $ | 56,507 | 16.1 | % | $ | 127,572 | $ | 114,211 | 11.7 | % | ||||||||||||
Percentage of software solutions revenue | 32.2 | % | 31.5 | % | 33.8 | % | 33.6 | % |
Sales and marketing costs increased $9.1 million during the second quarter of 2012 as compared to the second quarter of 2011 due to the following: (1) $4.6 million in additional compensation and benefits expense related to additional sales employees, salary increases and a negative impact from currency fluctuations as the U.S. Dollar weakened against non-U.S. currencies; (2) $1.2 million additional commission and bonus expense due to higher target attainment; (3) a $1.2 million increase in travel expense; and (4) $900,000 in additional severance expense related to severance charges for certain employee terminations within our European operations during the second quarter of 2012.
Sales and marketing costs increased $13.4 million during the first six months of 2012 as compared to the first six months of 2011 due to the following: (1) $6.6 million in additional compensation and benefits expense related to additional sales employees, salary increases and a negative impact from currency fluctuations as the U.S. Dollar weakened against non-U.S. currencies; (2) $3.0 million in additional severance expense related to severance charges for certain employee terminations within our European operations during the first six months of 2012; (3) $2.4 million increase in travel expense; and (4) $600,000 additional commission and bonus expense due to higher target attainment.
Administrative and General
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 our worldwide offices.
COMPUWARE CORPORATION AND SUBSIDIARIES
Administrative and general expenses are presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Change | 2011 | 2010 | Change | |||||||||||||||||||
Administrative and general expenses | $ | 41,967 | $ | 38,780 | 8.2 | % | $ | 83,481 | $ | 76,217 | 9.5 | % |
Administrative and general costs increased $3.2 million during the second quarter of 2012 as compared to the prior year due to a $3.0 million increase in salaries and benefits expense, an $800,000 increase in amortization expense associated with trade names obtained as a result of the dynaTrace acquisition, and to a lesser extent, increases in building rent and maintenance expense, legal, audit and investor relations fees. These increases were offset by a $2.3 million positive currency impact primarily related to assets and liabilities of a country that are denominated in non-local currency.
Administrative and general costs increased $7.3 million during the first six months of 2012 as compared to the prior year due to a $4.6 million increase in salaries and benefits expense, an $800,000 increase in amortization expense associated with intangible assets obtained as a result of the dynaTrace acquisition, and to a lesser extent, increases in building rent and maintenance expense, legal and audit fees. These increases were offset by a $630,000 positive currency impact primarily related to assets and liabilities of a country that are denominated in non-local currency.
OTHER INCOME (EXPENSE)
Other income (expense), net consists primarily of interest income realized from our cash and cash equivalents, interest earned on our financing receivables and income generated from our investment in a partially owned company offset by interest expense associated with our long-term debt.
Other income (expense) is presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Change | 2011 | 2010 | Change | |||||||||||||||||||
Other income (expense) | $ | (8 | ) | $ | 862 | (100.9 | %) | $ | 990 | $ | 1,727 | (42.7 | %) |
The decline in other income (expense) is due to interest expense on borrowings in the second quarter. Borrowings were incurred to partially fund the dynaTrace acquisition.
COMPUWARE CORPORATION AND SUBSIDIARIES
INCOME TAXES
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 and net operating loss and credit carryforwards.
The income tax provision and effective tax rate are presented in the table below (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
September 30, | % | September 30, | % | |||||||||||||||||||||
2011 | 2010 | Change | 2011 | 2010 | Change | |||||||||||||||||||
Income tax provision | $ | 15,473 | $ | 15,731 | (1.6 | %) | $ | 19,103 | $ | 26,338 | (27.5 | %) | ||||||||||||
Effective tax rate | 40.6 | % | 37.7 | % | 32.5 | % | 40.5 | % |
The decrease in the effective tax rate for the first six months of 2012 was primarily due to new legislation enacted in the State of Michigan in May 2011 that amended the Income Tax Act to implement a comprehensive set of tax changes effective January 2012. One part of the legislation contains provisions that replaced the current Michigan Business Tax (“MBT”) with a new corporate income tax. Certain credits allowed under the MBT, including the Brownfield Redevelopment (“Brownfield”) tax credit, will continue to be effective under the revised Income Tax Act. This allows the Company to reduce its future tax liability for the duration of the credit carryforward period. The Brownfield tax credit was originally awarded to the Company in 2003 when it moved its headquarters to the City of Detroit. Upon enactment of the MBT in 2008, the Company established a deferred tax asset for the Brownfield credits, assessed the ability to utilize such credits prior to expiration and recorded a valuation allowance to reduce the carrying value of the Brownfield deferred tax asset to the more likely than not realizable value. As a result of the May 2011 legislation, the valuation allowance associated with the Brownfield deferred tax asset was reversed resulting in a $5.0 million reduction to the Company’s income tax provision for the six months ended September 30, 2011. The decrease was further impacted by a $2.2 million increase to the valuation allowance recorded during the six months ended September 30, 2010 to reduce the carrying value of the Brownfield deferred tax asset to the more likely than not realizable value based upon our analysis and the then existing tax laws.
COMPUWARE CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our consolidated financial statements are prepared in accordance with U.S. GAAP. 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 September 30, 2011. 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, 2011 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 consolidated financial statements included in Item 8 of that report. There have been no material changes to that information since the end of fiscal 2011.
Goodwill Impairment Evaluation
Effective April 1, 2011, the Company realigned its business unit structure which resulted in a change in the Company’s segment reporting (see Note 10 of the condensed consolidated financial statements for additional information) and reporting unit structure. The following reporting units were created as a result of this change: Application Performance Management, Mainframe, Changepoint, Uniface, Professional Services and Application Services.
As of April 1, 2011, the Company performed a valuation to determine the reallocation of the goodwill balance from the prior period reporting units (products, web performance services, professional services and application services) to the new reporting units based on our estimated relative fair value. See Note 9 of the condensed consolidated financial statements for additional information.
COMPUWARE CORPORATION AND SUBSIDIARIES
The goodwill balance by reporting unit as of April 1, 2011 and September 30, 2011 is presented as follows (in thousands):
APM | MF | CP | UF | PS | AS | Total | ||||||||||||||||||||||
Goodwill as of April 1, 2011 | $ | 282,815 | $ | 141,020 | $ | 22,151 | $ | 21,350 | $ | 115,044 | $ | 25,385 | $ | 607,765 | ||||||||||||||
Acquisition (1) | 210,908 | - | - | - | - | - | 210,908 | |||||||||||||||||||||
Effect of foreign currency translation | (14,814 | ) | (106 | ) | (17 | ) | (16 | ) | (431 | ) | (15,384 | ) | ||||||||||||||||
Goodwill as of September 30, 2011 | $ | 478,909 | $ | 140,914 | $ | 22,134 | $ | 21,334 | $ | 114,613 | $ | 25,385 | $ | 803,289 |
(1) The Company acquired dynaTrace on July 1, 2011. See Note 2 of the condensed consolidated financial statements for information related to the purchase accounting that resulted in the recording of goodwill.
We evaluated our goodwill for impairment on a reporting unit basis at April 1, 2011. This evaluation indicated that none of our reporting units were at risk of failing step one of our goodwill impairment analysis. Our professional services reporting unit was the only reporting unit where the estimated fair value was not substantially in excess of the carrying value, as the estimated fair value exceeded the reporting unit’s carrying value by 15% at April 1, 2011.
We continue to believe the risk of future goodwill impairment for the professional services reporting unit, which has a goodwill balance of $114.6 million at September 30, 2011, is low due to the improvement in the reporting unit’s operating margin. There has been no triggering event since April 1, 2011. See “Professional Services” above for information on the segment’s results of operations.
We use a discounted cash flow analysis and a market comparable value analysis to estimate the fair value of our reporting units. The key assumptions in the discounted cash flow analysis are forecasts for revenue growth rate, profitability, capital investment and weighted average cost of capital. We determine revenue growth rate, profitability and capital investment from the historical operation and future plans management has for the business. These plans for the future are based on assumptions derived from market and specific business knowledge. Further, the weighted average cost of capital uses industry comparable betas as its key assumption. The key assumptions in the market comparable value analysis are peer group selection and application of this peer group to the respective reporting unit. Management research and knowledge of the market is used to make the peer group selection and application.
There is a high degree of uncertainty regarding management’s forecast for the reporting units as market developments for both customers and competitors can affect actual results. There can also be uncertainty regarding management’s selection of peer companies as an exact match of peer companies may not exist.
The events and circumstances that could negatively affect our key assumptions for the professional services reporting unit and the analysis of fair value include the following:
· | Our inability to achieve sales productivity at a level to achieve the profitability in the forecast period. |
COMPUWARE CORPORATION AND SUBSIDIARIES
· | Failure of our billable staff to meet their utilization or billable rate targets. |
· | Our inability to hire and retain sales, technical and management personnel. |
· | Negative changes in the United States and global economies. |
· | Increased competition and pricing pressures within the professional services market. |
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2011, cash and cash equivalents totaled $63.9 million, compared to $180.2 million at March 31, 2011.
Net cash provided by operating activities
Net cash provided by operating activities during the first six months of 2012 was $31.8 million, which represents an $18.4 million increase from the first six months of 2011. The increase was primarily due to a $17.1 million decrease in cash paid to taxing authorities. Cash received from customers increased $36.1 million due to revenue growth in all areas of the business, but was offset by an increase in cash paid to employees of $29.5 million and by an increase in cash paid to suppliers of $6.4 million primarily due to increases to support the growth of our APM and Covisint businesses.
The condensed consolidated statements of cash flows compute net cash from operating activities using the indirect cash flow method. Therefore non-cash adjustments and net changes in assets and liabilities (net of effects from currency fluctuations) are adjusted from net income to derive net cash from operating activities.
Changes in accounts receivable and deferred revenue have typically represented the most significant adjustments to net income to arrive at operating cash flow as we allow for deferred payment terms on multi-year products contracts. The decrease in cash from operating activities resulting from the net change in accounts receivable as compared to the prior year was $8.1 million and primarily related to the timing of billings from multi-year product arrangements during the first six months of 2012 as compared to the first six months of 2011. The increase from the net change in deferred revenue was $8.7 million and primarily related to the increase in mainframe maintenance contracts during the first six months of 2012 compared to the first six months of 2011.
The other significant changes in our reconciliation of net income to derive net cash from operating activities during the first six months of 2012 as compared to the same period of 2011 were as follows: (1) the decrease in the net change in prepaid expenses and other current assets of $10.9 million and (2) the increase in the net change in accounts payable and accrued expenses of $18.0 million. The change in prepaid expenses and other current assets was due to the final IBM settlement payment for $21 million received during the first quarter of 2011, partially offset by a $3.3 million increase in prepaid expenses during the second quarter of 2011 primarily related to an advertising arrangement and a $6.9 million reclassification between other current assets and other assets during the first six months of 2012 related to modification of terms on a loan receivable (see Note 3 in the condensed consolidated financial statements for more information). The increase in the net change in accounts payable and accrued expenses was due primarily to bonus payments made during the first six months of 2011 in excess of the payments made during the first six months of 2012.
COMPUWARE CORPORATION AND SUBSIDIARIES
We believe our existing cash resources and cash flow from operations will be sufficient to meet operating cash needs for the foreseeable future.
Net cash used in investing activities
Net cash used in investing activities during the first six months of 2012 was $275.2 million, which represents a $242.1 million increase in cash used from the first six months of 2011 due to the acquisition of dynaTrace (see Note 2 of the condensed consolidated financial statements included in this report for additional information). The transaction resulted in a $249.3 million use of cash during the second quarter of 2012. The increase was partially offset by the effect of the acquisition of DocSite during the second quarter of 2011 for $15.7 million in cash. The remaining change was due to additional purchases of property and equipment and capitalized software during the second quarter of 2012.
We will continue to evaluate business acquisition opportunities that fit our strategic plans. If the cash consideration for a future acquisition or combination of acquisitions were to exceed our operating cash balance resources, we would likely utilize our credit facility again and may need to seek additional financing.
Net cash provided by financing activities
Net cash provided by financing activities during the first six months of 2012 was $130.2 million. Net cash used in financing activities during the first six months of 2011 was $54.5 million, resulting in a net increase to cash of $184.7 million.
The increase was primarily due to the following: (1) during the second quarter, we borrowed $161.2 million under our revolving credit facility primarily related to financing for the dynaTrace acquisition, of which $35.6 million was repaid during the quarter; (2) we repurchased $3.3 million in stock during the first six months of 2012, as compared to $59.0 million during the first six months of 2011; and (3) $3.3 million additional cash was received from employees exercising stock options.
Since May 2003, the Board of Directors has authorized the Company to repurchase a total of $1.7 billion of our common stock under a discretionary stock repurchase plan (“Discretionary Plan”). Purchases of common stock under the Discretionary Plan may occur on the open market, or through negotiated or block transactions based upon market and business conditions, subject to applicable legal limitations.
As of September 30, 2011, approximately $239.4 million remains authorized for future purchases under the Discretionary Plan.
In anticipation of the acquisition of dynaTrace, we temporarily suspended repurchases under the Discretionary Plan during the first quarter of 2012, but resumed our repurchase program initiative during the second quarter of 2012. Our long-term goal is to reduce our outstanding common share count to approximately 200 million shares, though we may adjust our goals based on our cash position and market conditions. Share repurchases under the Discretionary Plan are funded primarily through our operating cash flow and, if needed, funds from our credit facility. We reserve the right to change the timing and volume of our repurchases at any time without notice. Our standard quarterly black-out period commences 10 business days prior to the end of each quarter and terminates one full market day following the public release of our operating results for the period.
COMPUWARE CORPORATION AND SUBSIDIARIES
The Company has an unsecured revolving credit agreement (the “credit facility”) with Comerica Bank and other lenders to provide leverage for the Company if needed. Refer to Note 11 of the condensed consolidated financial statements for additional information related to the credit facility. We anticipate repaying the majority of the outstanding borrowings under the credit facility during fiscal 2012.
Recently Issued Accounting Pronouncements
See Note 1 of the condensed consolidated financial statements included in this report for recently issued accounting pronouncements that may affect the Company.
COMPUWARE CORPORATION AND SUBSIDIARIES
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, 2011. Except as described 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 2011.
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, 2011. Therefore, the market risks remain substantially unchanged since we filed the annual report on Form 10-K for the fiscal year ending March 31, 2011.
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.
COMPUWARE CORPORATION AND SUBSIDIARIES
Changes in Internal Control over Financial Reporting
No change in our internal control over financial reporting occurred during the fiscal quarter ended September 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Part II OTHER INFORMATION
For information regarding risk factors affecting us, see “Item 1A Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011. There have been no material changes to the risk factors previously disclosed in our Form 10-K.
The following table sets forth the repurchases of common stock for the quarter ended September 30, 2011:
Period | Total number of shares purchased | Average price paid per share | Total number of shares purchased as part of publicly announced plans | Approximate dollar value of shares that may yet be purchased under the plan or program (1) | ||||||||||||
For the month ended July 31, 2011 | - | $ | - | - | $ | 242,710,000 | ||||||||||
For the month ended August 31, 2011 | 257,000 | 7.84 | 257,000 | 240,695,000 | ||||||||||||
For the month ended September 30, 2011 | 165,200 | 7.83 | 165,200 | 239,402,000 | ||||||||||||
Total | 422,200 | $ | 7.84 | 422,200 |
(1) | Our purchases of common stock may occur on the open market or in negotiated or block transactions based upon market and business conditions. Unless terminated earlier or extended by resolution of our Board of Directors, the discretionary share repurchase plan will expire when we have repurchased all shares authorized for repurchase thereunder. The maximum amount of repurchase activity under the discretionary program continues to be limited on a daily basis to 25% of the average trading volume of our common stock for the previous four week period. In addition, no purchases are made during our self-imposed trading black-out periods in which the Company and our insiders are prohibited from trading in our common shares. |
COMPUWARE CORPORATION AND SUBSIDIARIES
Karmanos Executive Employment Agreement
As previously disclosed in the Company’s proxy statement distributed in connection with its 2011 annual meeting of shareholders, the Company entered into the Executive Employment Agreement (“Executive Agreement”) with its Executive Chairman, Peter Karmanos, Jr. with an effective date of July 1, 2011 and a termination date of March 31, 2013, after which Mr. Karmanos’ previously disclosed post-retirement consulting agreement will become effective. The final terms of the Executive Agreement, as executed by the parties in September 2011, are summarized below.
For the term of the Executive Agreement, Mr. Karmanos will be entitled to: (i) receive a base salary at an annual rate of $1.2 million (payable in installments with the Company’s normal payroll); and (ii) participate in the Company’s Executive Incentive Plan with annual and long-term incentive targets set by the Compensation Committee of the Board. For fiscal 2012, these targets have been set at 100 percent and 175 percent of his base salary, respectively. In addition, his existing stock options and restricted stock units will continue to vest in accordance with their terms. During the term of the Executive Agreement, Mr. Karmanos is also eligible to continue to participate in the Company’s 401(k) plan, its group life, medical and other insurance benefit plans and similar benefits available to the Company’s senior executives generally.
The Executive Agreement also obligates Mr. Karmanos to abide by standard confidentiality, non-disparagement and cooperation terms, and, during the term of the Executive Agreement and through the first anniversary of the date on which Mr. Karmanos’ employment terminates, not to compete with the Company or solicit its employees or customers. The Company is obligated to maintain directors and officers liability insurance during the term of the Executive Agreement and for six years thereafter on terms no less favorable than currently in effect. The Executive Agreement may be terminated by the Company only for cause, which requires a determination by the Board of Directors that Mr. Karmanos has committed a material violation of the employee code of conduct. The Executive Agreement will also terminate upon Mr. Karmanos’ death or disability. Benefits payable upon termination of the Executive Agreement are as follows:
Termination Event | Benefits To Be Paid | |
By the Company with cause | · | Salary due through the date of termination |
· | Health insurance coverage to the extent eligible under COBRA and required by law | |
· | Post-retirement consulting agreement becomes void | |
Termination due to death or disability of Mr. Karmanos | · | Remaining salary payable over the remaining term, paid in a lump sum |
· | All outstanding EIP awards immediately vest and paid in a lump sum | |
● | Reimbursement for COBRA premiums related to participation in the Company’s medical, dental, vision and hospitalization plans for 24 months | |
● | Any other benefits that would otherwise have been provided under the Executive Agreement through the remaining term, provided that continuation is not restricted by law and does not jeopardize the tax status of the applicable benefit or the Company program |
COMPUWARE CORPORATION AND SUBSIDIARIES
The Executive Agreement provides for no additional benefits for termination due to a change in control. To the extent that benefits payable under the Executive Agreement would be subject to an excise tax under Internal Revenue Code Section 4999, then the amounts payable will be reduced to one dollar less than the amount that would subject Mr. Karmanos to the excise tax.
COMPUWARE CORPORATION AND SUBSIDIARIES
AMENDED AND RESTATED 2007 LONG TERM INCENTIVE PLAN
The Company’s Board of Directors adopted the amended and restated 2007 Long Term Incentive Plan (the “Amended and Restated LTIP”) on May 19, 2011, and its shareholders approved it at the annual meeting of shareholders on August 23, 2011. The original 2007 Long Term Incentive Plan (“Original LTIP”) was adopted by the Board of Directors and shareholders in 2007. Approval of the Amended and Restated LTIP extended the term of the Original LTIP an additional four years to May 18, 2021 and increased the number of shares available for issuance under the Original LTIP by 13,500,000. The Amended and Restated LTIP also includes various other changes to the Original LTIP.
The following is a summary of the material terms of the Amended and Restated LTIP, including the material changes to the Original LTIP. The summary is qualified in its entirety by reference to the full text of the Amended and Restated LTIP included as Attachment A to the Company’s proxy statement filed on July 14, 2011 with the Securities and Exchange Commission.
Shares Subject to the LTIP
The Company had reserved an aggregate of 28,000,000 common shares for awards under the Original LTIP. With the addition of the new shares, the total number of common shares subject to the Amended and Restated LTIP has increased to 41,500,000 common shares.
The shares underlying awards granted under the Amended and Restated LTIP will become available for future grants to the extent the awards are later forfeited, cancelled, expire or otherwise terminate before such shares are issued or are settled for cash. To prevent dilution or enlargement of the rights of participants under the Amended and Restated LTIP, appropriate adjustments will be made by the Compensation Committee if any change is made to our outstanding common shares by reason of any merger, reorganization, consolidation, recapitalization, dividend or distribution, stock split, reverse stock split, spin-off or similar transaction or other change in corporate structure affecting our common shares or its value.
Participants and Administration
Only our employees and directors are eligible to participate in the Amended and Restated LTIP. The Amended and Restated LTIP is administered by the Compensation Committee, or any other committee or sub-committee of the Board designated by the Board. The Compensation Committee has the power to select participants who will receive awards, to make awards under the Amended and Restated LTIP and to determine the terms and conditions of awards (subject to the terms and conditions of the Amended and Restated LTIP). The Compensation Committee also has broad power to, among other things, interpret the terms of the Amended and Restated LTIP and establish rules and regulations for the administration of the Amended and Restated LTIP. In the case of awards designated as awards under Section 162(m) of the Internal Revenue Code, the Committee’s power to take certain actions will be limited by Section 162(m). To the extent permitted by applicable law, the Committee may delegate its authority under the Amended and Restated LTIP to the Company’s Chief Executive Officer with respect to awards to be made to, or held by, persons who are not executive officers or directors of the Company.
Except in connection with a corporate transaction involving the Company (including, without limitation, any stock dividend, stock split, reverse stock split, extraordinary cash dividend, recapitalization, reorganization, merger, consolidation, split-up, spin-off, combination, statutory share exchange, acquisition of property or stock, or liquidation), the Compensation Committee and the Board are not permitted to cancel outstanding options or stock appreciation rights and grant new awards with a lower exercise price as substitutes under the Amended and Restated LTIP or amend outstanding options or stock appreciation rights to reduce the exercise price below the fair market value of the common shares on the original grant date without shareholder approval.
COMPUWARE CORPORATION AND SUBSIDIARIES
Types of Plan Awards and Limits
The Compensation Committee may grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance-based cash or stock awards and cash incentive awards under the Amended and Restated LTIP. The terms of each award will be set forth in a written agreement with the recipient. Grants of awards other than options or stock appreciation rights are limited to no more than 10,000,000 shares in the aggregate during the life of the Amended and Restated LTIP. Grants intended to comply with the performance-based compensation exception to Internal Revenue Code Section 162(m) are subject to additional limits described below.
Stock Options
Options granted under the Amended and Restated LTIP may be incentive stock options or nonqualified stock options. No option may be exercised after the tenth anniversary of the date the option was granted. The exercise price of any option granted under the Amended and Restated LTIP must not be less than the fair market value of our common shares on the grant date. Payment upon exercise may be made (1) by cash or check, (2) by delivery of our common shares that have a fair market value equal to the exercise price, (3) pursuant to a broker-assisted cashless exercise, (4) by delivery of other consideration approved by the Compensation Committee with a fair market value equal to the exercise price, or (5) by other means determined by the Compensation Committee. A payment method involving delivery or withholding of common shares may not be used if it would violate applicable law or would result in adverse accounting consequences for the Company. An option award will not be permitted to include rights to dividend equivalents or reload option grants.
Options constituting incentive stock options may be granted only to employees of the Company or its subsidiaries. The aggregate market value, determined on the grant date, of stock with respect to which incentive stock options may first become exercisable for a holder during a calendar year may not exceed $100,000. In addition, in the event that the recipient is a more than 10 percent shareholder of the Company, the exercise price of incentive stock options may not be less than 110 percent of the fair market value of the common shares on the grant date, and the options may not be exercised more than five years after the grant date. Incentive stock options may be granted for up to the total number of common shares available for grants.
Stock Appreciation Rights
The Compensation Committee may grant stock appreciation rights pursuant to such terms and conditions as the Compensation Committee determines. No stock appreciation right may be granted with a term of more than ten years from the grant date. The exercise price may not be less than the fair market value of the common shares on the grant date. Upon exercise of a stock appreciation right, the participant will have the right to receive the excess of the aggregate fair market value of the shares on the exercise date over the aggregate exercise price for the portion of the right being exercised. Payments may be made to the holder in cash or common shares as specified in the grant agreement. Dividend equivalents may not be paid on stock appreciation right awards.
COMPUWARE CORPORATION AND SUBSIDIARIES
Restricted Stock and Restricted Stock Units
The Compensation Committee may grant shares of restricted stock and restricted stock units pursuant to such terms and conditions as the Compensation Committee determines. The restricted stock and restricted stock units will be subject to restrictions on transferability and alienation and other restrictions as the Compensation Committee may impose. The Compensation Committee may require payment of consideration for restricted stock granted under the Amended and Restated LTIP, which may be payable in cash, stock or other property. Subject to applicable restrictions on transfer, recipients of restricted shares that are issued and outstanding have the same rights as other shareholders, including all voting and dividend rights, prior to vesting. Recipients of restricted stock units may receive dividend equivalent rights at the Compensation Committee’s discretion. Restricted stock units are payable in common shares or cash as of the vesting date. Any restricted stock unit, whether settled in common stock or cash, will be paid no later than two and a half months after the later of the end of the fiscal or calendar year in which the restricted stock unit vests.
Performance Awards
The Compensation Committee may grant performance awards on terms and conditions that the Compensation Committee determines. Performance awards consist of the right to receive cash or common shares if the specified goals are attained. The written agreement for each grant will specify the performance goal or goals, the period over which the goals are to be attained, the payment schedule if the goals are attained and other terms as the Compensation Committee determines. In the case of performance shares, the participant will have the right to receive legended stock certificates (or equivalent book entry shares) subject to restrictions on transferability. A participant will be entitled to vote shares that are issued and outstanding prior to satisfaction of the performance goals, and any dividends received will be reinvested in additional performance shares subject to the related performance goal(s). In the case of performance stock units, the participant will receive an agreement that specifies the performance goal or goals that must be satisfied prior to the Company issuing payment, which may be cash or common shares. Performance awards will be paid no later than two and a half months after the later of the end of the fiscal or calendar year in which the performance award is no longer subject to a substantial risk of forfeiture.
Incentive Awards
The Compensation Committee may grant incentive awards on terms and conditions that the Compensation Committee determines. The determination for granting incentive awards may be based on the attainment of performance levels of the Company as established by the Compensation Committee. Such incentive awards will be paid in cash and will equal a percentage of the participant’s base salary for the fiscal year, a fixed dollar amount or some other formula determined by the Compensation Committee. Payments will be made within two and a half months after the later of the end of the fiscal or calendar year in which the award is no longer subject to a substantial risk of forfeiture, but only after the Compensation Committee determines that the performance goals were attained.
COMPUWARE CORPORATION AND SUBSIDIARIES
Code Section 162(m) Performance Measure Awards
The Compensation Committee may designate that any award in the form of restricted stock, restricted stock units, performance shares, performance units or incentive awards be granted pursuant to Section 162(m) of the Internal Revenue Code. As a result, such grants will be subject to certain additional requirements intended to satisfy the exemption for performance-based compensation under Section 162(m). The performance criteria will be one or more of the following objective performance goals, either individually, alternatively, or in any combination, applied to either the Company as a whole or to a subsidiary or division, either individually, alternatively, or in any combination, and measured over a designated performance period, in each case as specified by the Compensation Committee in the award and calculated excluding the effect of certain items specified in the Amended and Restated LTIP:
· | earnings (as measured by net income, gross profit, operating income, operating income before interest, EBIT, EBITA, EBITDA, pre-tax income, or cash earnings, or earnings as adjusted by excluding one or more components of earnings, including each of the above on a per share and/or segment basis); |
· | sales/net sales or growth in sales/net sales, revenues/net revenues or growth in revenues/net revenues or total sales commitments or growth in total sales commitments (defined as the sum of software license, maintenance, subscription and professional services (including application services) arrangements closed during the fiscal year, which sum is calculated by taking US Generally Accepted Accounting Principles (“US GAAP”) software license fees, maintenance and subscription fees and professional services fees and adding or subtracting, as appropriate, the change in the balance of deferred license, deferred maintenance, deferred subscription and deferred professional services revenue during the fiscal year, excluding the impact from foreign currency translation); |
· | return on net sales or revenues (as measured by net income, gross profit, operating income, operating income before interest, EBIT, EBITA, EBITDA, pre-tax income, operating cash flow or cash earnings as a percentage of net sales); |
· | gross profit margins; |
· | cash flow, operating cash flow, free cash flow or discounted cash flow; |
· | working capital; |
· | market capitalization or total stock market capitalization; |
· | return on investment (in cash or otherwise); |
· | return on equity, assets, net assets, capital or cost of capital; |
· | shareholder value; |
· | total shareholder return; |
· | economic value added; |
COMPUWARE CORPORATION AND SUBSIDIARIES
· | stock trading multiples (as measured against investment, net income, gross profit, operating income, operating income before interest, EBIT, EBITA, EBITDA, pre-tax income, cash earnings or operating cash flow); |
· | stock price; and |
· | the closing of an offering and sale of shares of the common stock or other common equity security of a subsidiary to the public by the Company or such subsidiary pursuant to a registration statement under the Securities Act which has been declared effective by the Securities and Exchange Commission (other than a registration statement on Form S-4, Form S-8 or any other similar form), if, immediately following the closing of such sale, shares of the common stock or other common equity security of such subsidiary are registered under Section 12(b) or 12(g) of the Exchange Act or would be required to be so registered if the date immediately following the closing were the last day of such subsidiary’s fiscal year. |
Subject to the adjustment provisions described above, the Amended and Restated LTIP limits grants to any one employee participant in any one fiscal year to 3,000,000 options or stock appreciation rights, 500,000 restricted shares or restricted stock units and 500,000 performance awards, up from 500,000, 200,000 and 200,000, respectively, in the Original LTIP. The Amended and Restated LTIP further limits the dollar value payable to any one employee participant in any one fiscal year on restricted stock units, performance awards or incentive awards valued in cash to the lesser of $20 million or ten times the participant’s base salary as of the beginning of the fiscal year, up from $10 million and five times, respectively. These limitations are intended to comply with requirements of Section 162(m) of the Internal Revenue Code.
Termination of Employment or Services
Options and Stock Appreciation Rights
Unless otherwise provided in the related grant agreement, if a participant’s employment or services are terminated for any reason other than death prior to the date that an option or stock appreciation right becomes vested, the right to exercise the option or stock appreciation right terminates, and all rights thereunder cease. If a participant’s employment or services are terminated due to the participant’s death, the option or stock appreciation right immediately becomes fully vested and exercisable, unless otherwise provided in the grant agreement. If an option or stock appreciation right becomes vested prior to termination of employment or services for any reason other than death or disability, then the participant has the right to exercise the option or stock appreciation right to the extent it was exercisable upon termination before the earlier of three months after termination or the expiration of the option or stock appreciation right, unless otherwise provided in the related grant agreement. If termination is due to the participant’s death or disability, then the participant or his or her estate may exercise the option or stock appreciation right to the extent it was exercisable upon termination until its expiration date, subject to any limitations in the grant agreement. The Compensation Committee may, in its discretion, accelerate the participant’s right to exercise an option or extend the option term, subject to any other limitations.
COMPUWARE CORPORATION AND SUBSIDIARIES
Restricted Stock, Restricted Stock Units, Performance Awards and Incentive Awards
Under the Amended and Restated LTIP, if a participant’s employment or services are terminated for any reason other than death, any portion of restricted shares, restricted stock units, performance awards and incentive awards not yet vested are generally forfeited to the Company (subject to a refund by the Company of any purchase price paid by the participant). Unless otherwise provided in the related grant agreement, if termination is due to the participant’s death, the portion of any such award not then vested shall immediately vest. The Compensation Committee, however, may provide, in its sole discretion, in the participant’s agreement or otherwise that an award will continue after termination of employment or services. The Compensation Committee may also waive or change any restrictions in its sole discretion except for restrictions on a Internal Revenue Code Section 162(m) award. The Compensation Committee may, for Internal Revenue Code Section 162(m) awards, deem restrictions and performance goals satisfied if a participant’s employment or services terminate due to death or disability.
Limitations on Transfer of Awards
No award under the Amended and Restated LTIP may be transferable other than by will or the laws of descent and distribution. Stock options and stock appreciation rights may only be exercised by the participant during his or her lifetime. However, a participant may assign or transfer without consideration an award, other than an incentive stock option, with the consent of the Compensation Committee. All common shares subject to an award will contain a legend restricting the transferability of the shares pursuant to the terms of the Amended and Restated LTIP, which can be removed once the restrictions have terminated, lapsed or been satisfied.
Termination and Amendment
No new awards may be granted under the Amended and Restated LTIP on or after May 18, 2021. The Board may terminate the Amended and Restated LTIP or the granting of any awards under the Amended and Restated LTIP at any time. In addition, the Board may further amend the Amended and Restated LTIP and the Compensation Committee may amend the terms of outstanding awards, but shareholder approval will be required for any amendment that materially increases benefits under the Amended and Restated LTIP, increases the common shares available under the Amended and Restated LTIP (except under the adjustment provisions), changes the eligibility provisions or modifies the Amended and Restated LTIP in a manner requiring shareholder approval under any applicable stock exchange rule. An amendment to the Amended and Restated LTIP will not, without the consent of the participant, materially and adversely affect the participant’s outstanding awards except to qualify the awards for exemption under Section 409A of the Internal Revenue Code, bring the Amended and Restated LTIP into compliance with Section 409A of the Internal Revenue Code, or as provided in the grant agreement.
Change in Control of the Company
COMPUWARE CORPORATION AND SUBSIDIARIES
Awards under the Amended and Restated LTIP are generally subject to special provisions upon a change in control transaction of the kind described in the Amended and Restated LTIP. Under the Amended and Restated LTIP, the Compensation Committee may provide in a grant agreement or otherwise that upon a change in control transaction (i) all outstanding options or stock appreciation rights immediately become fully vested and exercisable; (ii) any restriction period on any common shares immediately lapse and the shares become freely transferable; (iii) all performance goals are deemed to have been satisfied and any restrictions on any performance award immediately lapse and the awards become immediately payable; or (iv) all performance measures are deemed to have been satisfied for any outstanding incentive award, which immediately become payable. The Compensation Committee may also determine, in its sole discretion and without the consent of any participant, that upon a change in control, any outstanding option or stock appreciation right be cancelled in exchange for payment in cash, stock or other property for each vested share in an amount equal to the excess of the fair market value of the consideration to be paid in the change in control transaction over the exercise price.
COMPUWARE CORPORATION AND SUBSIDIARIES
Exhibit
Number | Description of Document |
2.11 | Agreement and Plan of Merger by and among Compuware Corporation, Compuware Acquisition Corp., dynaTrace software, Inc. and the Stockholder Representative dated as of July 1, 2011 (Company’s second Form 8-K dated July 8, 2011). |
4.8 | Consent and First Amendment to Credit Agreement dated June 30, 2011 (Company’s Form 8-K dated July 11, 2011). |
10.130 | Compuware Executive Incentive Agreement – Corporate (Company’s first Form 8-K dated July 8, 2011). |
10.131 | Form of Stock Option Agreement (Company’s first Form 8-K dated July 8, 2011). |
10.135 | Amended and Restated 2007 Long Term Incentive Plan (approved August 2011) (Attachment A to the Company’s proxy statement filed on July 14, 2011) |
Executive Employment Agreement between the Company and Peter Karmanos, dated as of July 1, 2011 |
Independent Registered Public Accounting Firm’s Awareness Letter |
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act. |
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act. |
Certification pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) of the Securities Exchange Act. |
101.INS | XBRL Instance Document* |
101.SCH | XBRL Taxonomy Extension Schema Document* |
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document* |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document* |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document* |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document* |
COMPUWARE CORPORATION AND SUBSIDIARIES
* | XBRL (Extensible Business Reporting Language) information is furnished and not filed herewith, is not a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections. |
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.
Date: November 7, 2011 | By: | /s/ Robert C. Paul | ||
Robert C. Paul | ||||
Chief Executive Officer | ||||
(duly authorized officer) | ||||
Date: November 7, 2011 | By: | /s/ Laura L. Fournier | ||
Laura L. Fournier | ||||
Executive Vice President, | ||||
Chief Financial Officer and Treasurer | ||||
(principal financial officer and principal accounting officer) |
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