September 13, 2006
Mr. Brad Skinner
Accounting Branch Chief
Division of Corporation Finance
Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549
Re: Compuware Corporation
Form 10-K for the fiscal year ended March 31, 2006
File No. 000-20900
Dear Mr. Skinner:
On behalf of Compuware Corporation, a Michigan corporation (the "Company" or
"Compuware"), I am responding to the Staff's comment letter dated August 30,
2006 with respect to Compuware's Form 10-K for the fiscal year ended March 31,
2006. I have set forth below each question contained in the Staff's comment
letter, followed by our response thereto.
FORM 10-K FOR THE FISCAL YEAR ENDED MARCH 31, 2006
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS RESULTS OF OPERATIONS
CORPORATE AND OTHER EXPENSES, PAGE 30
1. WE NOTE YOUR DISCLOSURE ON PAGE 31 AND 32 OF YOUR EFFECTIVE TAX RATE
EXCLUDING THE EFFECT OF REDUCTIONS TO YOUR INCOME TAX RESERVES AND TAX
SETTLEMENTS. THIS APPEARS TO BE A NON-GAAP MEASURE. PLEASE TELL US HOW YOU
CONSIDERED THE REQUIREMENTS OF ITEM 10(E)(1) OF REGULATION S-K.
1
Item 10(e)(1)(A) of Regulation S-K requires a presentation, with equal or
greater prominence, of the most directly comparable financial measure
presented in accordance with GAAP. We believe that the GAAP effective
income tax rate for each of the years presented has been prominently
disclosed in the first paragraph of this section titled "Income taxes".
Item 10(e)(1)(B) requires a reconciliation by schedule or other clearly
understandable method of the GAAP to non-GAAP disclosures. We believe the
current presentation provides the reader with the reconciling items between
the GAAP effective rate and the adjusted effective rate. The first
paragraph of this section clearly discloses the GAAP effective rate. The
next paragraph identifies the impact of the items related to prior year
matters and indicates the effective tax rate excluding these items. In an
effort to make future filings more easily understood in light of the
Staff's comment, we will present the GAAP effective tax rate, the impact of
the items related to prior year matters, and the effective tax rate
excluding such items in a tabular format in future filings that include
such information.
Item 10(e)(1)(C&D) requires statements disclosing why management believes
the non-GAAP presentation to be useful information and, to the extent
material, how management uses this measure. We acknowledge that the current
disclosure could be improved to more clearly indicate that management
believes the presentation is useful to investors and analysts because it
allows them to quickly understand the impact on our effective tax rate of
the resolution of the tax matters discussed in the Form 10-K without having
to do the calculation themselves. Although it is possible that additional
adjustments of this nature could occur in the future, management believes
it is beneficial for the reader to have an understanding of our effective
income tax rate excluding such items.
CONSOLIDATED STATEMENT OF OPERATIONS, PAGE 41
2. WE NOTE THAT YOU DO NOT DISCLOSE COST OF MAINTENANCE FEES ON YOUR STATEMENT
OF OPERATIONS. PLEASE TELL US THE AMOUNT THAT REPRESENTS THE COST OF
PROVIDING MAINTENANCE REVENUE. ALSO, TELL US IN WHICH LINE ITEM THESE COSTS
ARE CURRENTLY INCLUDED. EXPLAIN HOW YOUR CURRENT DISCLOSURES COMPLY WITH
RULE 5-03.2 OF REGULATION S-X.
Customers who subscribe to our maintenance and support services are
entitled to receive technical support and advice including problem
resolution services, installation support, error corrections and any
product enhancements released by us during the maintenance period.
Maintenance and support services are provided to our customers primarily by
employees in the Technology Development and Support area of our
organization and are included in this expense line item in the statement of
operations. The same
2
employees are also responsible for research and development and provide
internal systems support to our organization. In many situations, the
efforts of our technology personnel benefit both new license sales and our
maintenance customers. Therefore, any presentation of the cost of
maintenance revenue would represent only an imprecise estimate.
Because an allocation of these costs is not performed for financial
statement or management reporting purposes and would require a great deal
of subjectivity, we believe such an allocation (if performed) would not
provide additional useful information to our investors. Therefore, we have
not allocated maintenance costs into a separate line item for financial
statement purposes.
NOTE 14. COMMITMENTS AND CONTINGENCIES, PAGE 64
3. WE NOTE THAT YOU ENTERED INTO A SETTLEMENT ARRANGEMENT WITH IBM WHERE IBM
WILL PURCHASE A MINIMUM AMOUNT OF SOFTWARE LICENSES AND MAINTENANCE AND
WILL OFFER TO PURCHASE A MINIMUM VALUE OF SERVICES OVER A FOUR-YEAR TIME
FRAME BEGINNING WITH FISCAL 2006. PLEASE EXPLAIN TO US HOW YOU WILL ACCOUNT
FOR THIS SETTLEMENT. EXPLAIN HOW YOU DETERMINED THE AMOUNT THAT WAS
ALLOCATED TO REVENUE AND THE AMOUNT ALLOCATED TO "SETTLEMENT" IN 2006 AND
EXPLAIN HOW YOU EXPECT TO ALLOCATE THE PROCEEDS YOU WILL RECEIVE IN FUTURE
PERIODS. ALSO, PLEASE TELL US HOW YOU CONSIDERED WHETHER A PORTION OF THE
SETTLEMENT REPRESENTED AN ASSET AT THE TIME OF THE SETTLEMENT. AS PART OF
YOUR RESPONSE, PROVIDE REFERENCE TO THE AUTHORITATIVE GUIDANCE THAT
SUPPORTS YOUR ACCOUNTING.
To better understand the settlement we are providing you with the following
background of the transaction.
BACKGROUND
Prior to the settlement arrangement discussed below, Compuware had entered
into agreements under which Compuware provided professional services to
IBM. IBM had also previously purchased Compuware's products for internal
use and for use in IBM's Global Services business. IBM's Global Services
business has utilized these licenses in its delivery of services to IBM's
Global Services customers. IBM's Global Services business licenses
Compuware's products for use with named customers or for the "exclusive use
and benefit" of a named customer. Compuware does not allow IBM to license
products for Global Services customers without having the customer named
(i.e. no "stock" licenses).
In 2002, Compuware filed a claim against IBM for infringement of
Compuware's copyrights and misappropriation of Compuware's trade secrets
with respect to Compuware's mainframe software tools, intentional
interference with contractual relations with Compuware's employees and
former employees, antitrust law violations, tortious interference with
Compuware's economic expectancy and various state law violations. Compuware
claimed that (i) IBM copied and misappropriated
3
portions of Compuware's mainframe software tools and had wrongfully used
the Company's technology to develop competing products; (ii) IBM made false
representations regarding Compuware's software products in violation of the
Lanham Act; and (iii) IBM used its monopoly power to engage in unlawful
tying arrangements and to subvert competition on the merits by denying
critical information to Compuware and others in an effort to undermine
Compuware's development efforts. IBM filed counterclaims against Compuware
asserting infringement of various patents held by IBM.
In an effort to reduce the disruption in each organization's business, as
well as obviate the need for further protracted and expensive litigation,
with no admission of liability by any party (which each party expressively
denies), Compuware and IBM executed a settlement agreement and patent
cross-licensing agreement on March 21, 2005 to settle and compromise all
disputes, claims and controversies between them, including all claims and
counterclaims that were asserted or that could have been asserted.
The relevant terms of the patent cross-licensing agreement are as follows:
Patent Cross-License
In a separate agreement, which is incorporated in the settlement agreement,
IBM and Compuware entered into a mutual patent cross-license. There was no
monetary consideration provided by either party. The purpose of the license
is to avoid current and future patent infringement litigation similar to
assertions made by Compuware and IBM against each other. The cross license
covers existing patents, as well as future unspecified patents to be issued
through March 21, 2009. All patents subject to the patent cross-licensing
agreement relate to, or would relate to, software products developed for
resale by IBM and Compuware.
The settlement agreement includes the following provisions:
Settlement Agreement
Software Licenses and Maintenance
IBM agrees that it will make minimum payments to Compuware for licenses to
Compuware's software products and related maintenance in the amount of $140
million. These minimum payments are due as follows:
March 21, 2005 - $20 million, for products to be purchased during the
period March 21, 2005 through March 31, 2006. After the $20 million
prepayment is utilized, payments are due upon delivery of the
products.
From April 1, 2006 through March 31, 2010 payments are due upon
delivery of software.
4
- March 31, 2007 - $30 million less payments during the year,
April 1, 2006 through March 31, 2007 for software delivered,
if any.
- March 31, 2008 - $30 million less payments during the year,
April 1, 2007 through March 31, 2008 for software delivered,
if any.
- March 31, 2009 - $30 million less payments during the year,
April 1, 2008 through March 31, 2009 for software delivered,
if any.
- March 31, 2010 - $30 million less payments during the year,
April 1, 2009 through March 31, 2010 for software delivered,
if any.
Purchases in excess of the annual minimum may be carried forward against
the following year's minimum commitment. If IBM purchases software and
maintenance in excess of the $140 million minimum payments, additional
payments will be required.
The above payments do not include, or relate to, payments for IBM's
obligations to Compuware for maintenance of previously purchased products.
Payments made by IBM to Compuware for software licenses and associated
maintenance under the agreement, including those made by IBM on behalf of
IBM's customers, will be taken into account for purposes of determining
whether IBM's annual software commitments have been satisfied.
IBM will purchase all future products from Compuware under terms similar to
an existing contract with pricing terms at a fixed percentage discount. The
prices offered are not considered to be at a "significant incremental
discount" as defined in AICPA Technical Practice Aid (TPA) 5100.50 because
the pricing offered to IBM is consistent with the pricing Compuware offers
to similar customers.
IBM will purchase Compuware's software to provide outsourcing services to
its customers and for use in it own internal business units. That is, IBM
will not resell any of Compuware's software but will use Compuware's
software to provide services to its customers. Compuware will license its
software to IBM in a manner that will limit IBM's use to specific customers
or data centers. Therefore, IBM will be required to purchase separate
licenses of Compuware's software for each of its end-customers. IBM is
prohibited from purchasing Compuware's licenses as inventory (that is,
prior to identifying a specific end-customer).
Professional Services
IBM agrees that it will offer to purchase from Compuware $260 million in
professional services. IBM's offers to purchase must occur during the
periods and in the amounts set forth below.
5
March 21, 2005 through September 30, 2006 - $40 million
October 1, 2006 through September 30, 2007 - $60 million
October 1, 2007 through September 30, 2008 - $80 million
October 1, 2008 through September 30, 2009 - $80 million
The terms and conditions of IBM's offers to purchase are subject to IBM's
pre-existing Core Supplier Agreements. $130 million of IBM's offer to
purchase will be "Value Add Rate Services" that are defined and have
defined rates that may be changed from time to time by IBM but will be
consistent with rates that IBM pays to other vendors that are part of its
Core Supplier Program.
IBM's remaining offers to purchase will be General Contract Rate Services
and will be based on price schedules then in effect under IBM's
pre-existing core supplier program. These prices will be consistent with
the pricing IBM pays to its other vendors under the core supplier program.
IBM merely needs to offer to purchase the services, regardless of whether
Compuware accepts any such offers, in order for IBM's obligation to be
fulfilled. If IBM's offers to purchase exceed the minimum amounts during
the periods described above, IBM will be deemed to have made offers to
purchase Compuware's services in the amounts of such excess in the
immediately following commitment period. Compuware is under no obligation
to accept IBM's offers under this provision of the settlement agreement.
Settlement and Mutual Releases
The settlement agreement resulted in the settlement of all pending claims
and mutual releases.
ACCOUNTING TREATMENT
As the settlement agreement and the patent cross-licensing agreement were
entered into contemporaneously and the settlement agreement explicitly
incorporates the patent cross-licensing agreement, Compuware deemed it
appropriate to account for the two agreements as a single arrangement in
accordance with TPA 5100.39.
Compuware analyzed the license it received for the rights to use IBM's
patents and right to join the Premier Partner Program to determine if these
rights should be recorded at fair value.
The Company considered whether the right that we received to use IBM
patents constituted an asset. While the settlement arrangement includes a
significant monetary component, and while generally nonmonetary assets
exchanged in a
6
monetary transaction (that is, a transaction in which the monetary
consideration constitutes more than 25 percent of the value of the entire
arrangement) are measured at fair value, fair value measurement is
dependent on the ability to satisfactorily measure fair value of the
nonmonetary assets. In this case, neither party has in the past sold
similar patent licensing agreements; therefore, it is not possible to
reliably determine the fair value of the patent cross-licensing agreement.
Therefore, the Company concluded that it would not be appropriate to
recognize its right to use IBM's technology at fair value. The Company
believes this conclusion is consistent with the guidance in Issue 8(a) of
EITF Issue No. 01-2, Interpretations of APB Opinion No. 29 (EITF 01-2),
which states, in part:
Issue 8(a)--What level of monetary consideration in a nonmonetary
exchange causes the transaction to be considered monetary in its
entirety and, therefore, outside the scope of Opinion 29.
19. The Task Force discussed an exchange of nonmonetary assets that
would otherwise be based on recorded amounts but that also involves
monetary consideration (boot). The Task Force reached a consensus that
that transaction should be considered monetary (rather than
nonmonetary) if the boot is significant, and agreed that "significant"
should be defined as at least 25 percent of the fair value of the
exchange. As a monetary transaction, both parties would record the
exchange at fair value (as discussed in Issue 8(b), below). If the
boot in a transaction is less than 25 percent, the pro rata gain
recognition guidance in paragraph 22 of Opinion 29 should be applied
by the receiver of boot, and the payer of boot would not recognize a
gain. The Task Force acknowledged that the ability to satisfactorily
measure fair value is a prerequisite to the use of fair value.
[Footnote reference omitted and emphasis added]
The Company also analyzed IBM's offer to purchase professional services
from us in order to determine whether it should be considered an
element/obligation to the arrangement.
As IBM is merely required to offer to purchase the professional services in
the future and such offer does not create an obligation for Compuware, the
Company determined that such offer should not be treated as an element to
the arrangement. Compuware is under no obligation to accept IBM's offer.
Accordingly, the decision to transact will be made in the future when IBM
makes the offer. Therefore, the transaction should be accounted for at the
time Compuware accepts the offer and not prior to that time because
Compuware is under no obligation prior to accepting IBM's offer. Paragraph
36 of FASB Statement of Financial Accounting Concept No. 6, Elements of
Financial Statements (CON 6), lists the following three characteristics of
liabilities:
(a) it embodies a present duty or responsibility to one or more other
entities that entails settlement by probable future transfer or
use of assets at a specified or determinable date, on occurrence
of a specified event, or on demand,
7
(b) the duty or responsibility obligates a particular entity, leaving
it little or no discretion to avoid the future sacrifice, and
(c) the transaction or other event obligating the entity has already
happened.
In the case of the professional services element of the settlement
agreement, Compuware has full discretion to avoid future sacrifice and the
obligating transaction does not occur until Compuware accepts IBM's offer.
Accordingly, no obligation or liability exists and therefore the
professional services component of the settlement agreement does not
constitute a deliverable in the current arrangement.
Compuware also performed an analysis to determine if it should account for
the settlement of the litigation as a unit of accounting separate from the
patent cross-licensing agreement and the sale of software.
The Company determined the elements or deliverables of the arrangement
should be evaluated under EITF Issue No. 00-21, Revenue Arrangements with
Multiple Deliverables (EITF 00-21) to determine whether the elements
qualify as separate units of accounting. The litigation settlement element
of the arrangement would be subject to FASB Statement No. 5, Accounting for
Contingencies (FASB 5) and the patent cross-licensing and software elements
are subject to SOP 97-2, Software Revenue Recognition (SOP 97-2). Paragraph
4(a)(iii) of EITF 00-21 states the following:
If higher-level literature provides no guidance regarding the
separation of the deliverables within the scope of higher-level
literature from those deliverables that are not or the allocation of
arrangement consideration to deliverables within the scope of the
higher-level literature and to those that are not, then the guidance
in this Issue should be followed for purposes of such separation and
allocation. In such circumstances, it is possible that a deliverable
subject to the guidance of higher-level literature does not meet the
criteria in paragraph 9 of this Issue to be considered a separate unit
of accounting. In that event, the arrangement consideration allocable
to such deliverable should be combined with the amount allocable to
the other applicable undelivered item(s) within the arrangement. The
appropriate recognition of revenue should then be determined for those
combined deliverables as a single unit of accounting. [Footnote
reference omitted]
Paragraph 9 of EITF 00-21 lists the following three criteria that are
required for an element to qualify as a separate unit of accounting:
a. The delivered item(s) has value to the customer on a standalone
basis. That item(s) has value on a standalone basis if it is sold
separately by any vendor or the customer could resell the
delivered item(s) on a standalone basis. In the context of a
customer's ability to resell the delivered item(s), the Task
Force observed that this criterion does not require the existence
of an observable market for that deliverable(s).
8
b. There is objective and reliable evidence of the fair value of the
undelivered item(s).
c. If the arrangement includes a general right of return relative to
the delivered item, delivery or performance of the undelivered
item(s) is considered probable and substantially in the control
of the vendor.
Since the Company does not have evidence of fair value of the patent
cross-licensing agreement or for the fair value of its software elements to
be delivered (i.e. collectively, the undelivered elements), the criterion
in paragraph 9(b) of EITF 00-21 has not been met. Accordingly the
litigation settlement should be combined with the patent cross-licensing
agreement and software elements of the arrangement and the combination of
those elements should be accounted for as a single unit of accounting.
Additionally, the Company would not be able to separate the patent
cross-licensing agreement from the software deliverables under the guidance
of SOP 97-2. SOP 97-2 requires allocation of arrangement consideration
based on vendor-specific objective evidence of fair value (VSOE). Compuware
has never sold similar patent licensing rights in the past and therefore
determined that it is not possible to establish VSOE of fair value of the
patent cross-licensing agreement.
Since Compuware is required to recognize the litigation settlement, the
patent cross-licensing agreement and the software sales as a combined unit
of accounting, the Company should determine the appropriate recognition
models for each deliverable/element in the combined unit of accounting and
follow the model that yields the lowest cumulative amount of revenue. This
conclusion is consistent with the guidance in Ernst & Young's publication
entitled Financial Reporting Developments - Revenue Arrangements with
Multiple Deliverables - EITF Issue No. 00-21, which states in part:
Determining the appropriate revenue recognition model to follow when
multiple deliverables do not meet the separation criteria pursuant to
Issue 00-21, and therefore should be treated as a combined unit of
accounting, requires the use of professional judgment and is dependent
on the relevant facts and circumstances.
However, we believe that there is a rebuttable presumption that the
revenue recognition model applicable to the final deliverable included
in the arrangement is the model that should be followed when
recognizing revenue for the combined unit of accounting. The final
deliverable model dictates that revenue is only recognized once the
last item has been delivered, or over a performance period if the last
deliverable is a service, assuming the other revenue recognition
criteria have been met.
Additionally, we understand that the SEC staff will generally object
to any revenue recognition model that results in revenue recognition
as products are delivered or services are preformed (that is, any
method other than the method applicable to the last deliverable
included in the arrangement) if deliverables
9
cannot be separated into multiple units of accounting due to a lack of
standalone value. The SEC staff believes that recognizing revenue on
the delivery of items that have no standalone value is contrary to the
principles contained in Issue 00-21.
Based on this guidance the Company determined the appropriate recognition
models for the software sales and the patent cross-licensing elements to
determine which model will yield the lowest cumulative amount of revenue.
The following section discusses the appropriate recognition models for the
patent cross-licensing element as well as the software sales element:
Patent Cross-Licensing Agreement
IBM is entitled to all new patents (associated with software products)
developed by us during the next four year period under the patent
cross-licensing agreement on a when-and-if available basis. That is, IBM is
entitled to unspecified additional software products as described in
paragraph 48 of SOP 97-2. Paragraph 49 of SOP 97-2 requires ratable
recognition over the contractual term for these types of arrangements:
Paragraph 49 of SOP 97-2 states:
The software elements of the kinds of arrangements discussed in
paragraph .48 should be accounted for as subscriptions. No allocation
of revenue should be made among any of the software products, and all
software product-related revenue from the arrangement should be
recognized ratably over the term of the arrangement beginning with
delivery of the first product.
In this arrangement the cash payment of $20 million due in year 1 is less
than the amount that would be recognized on a straight-line basis (i.e.,
$140 million / 4 years = $35 million). Therefore, the Company's revenue
recognition will be limited to $20 million in year 1 based on the guidance
in paragraph 14 of SOP 97-2 which states in part:
No portion of the fee (including amounts otherwise allocated to
delivered elements) meets the criterion of collectibility if the
portion of the fee allocable to delivered elements is subject to
forfeiture, refund, or other concession if any of the undelivered
elements are not delivered.
Therefore, in the absence of other elements in the arrangement, the Company
would recognize the lesser of the actual amount of cash due in each year of
the arrangement over that particular year of the arrangement or $140
million recognized on a straight-line basis over 4 years (i.e. $35
million). Application of this methodology would result in recognition of
$20 million ratably over the first year and $30 million ratably over each
of years 2 through 5.
$140 Million Software & Maintenance Sales
10
This arrangement, however, also provides IBM with the right to buy future
products at a predetermined price. However, the predetermined prices are
not at a discount as defined in TPA 5100.50 because the discounts are not
incremental to the discounts Compuware offers to other similar customers.
Therefore, the Company is not required to defer any amounts related to the
discount as required by footnote 3 of SOP 97-2.
If these were the only elements to the arrangement, the Company would use
the residual method to recognize the revenue related to the software sales
upon delivery of the software to IBM based on the per copy price stated in
the arrangement (the Company has been able to establish VSOE of fair value
of PCS through separate sales of PCS) and the PCS fee would be recognized
over the PCS term. This is consistent with the guidance in paragraphs 21
and 12 of SOP 97-2, which states in part:
.21 ... the licensing fee is a function of the number of copies
delivered to, made by, or deployed by the user or reseller. Delivery
occurs and revenue should be recognized as the copies are made by the
user or sold by the reseller if the other criteria in this SOP for
revenue recognition are met.
.12 Under the residual method, the arrangement fee is recognized as
follows: (a) the total fair value of the undelivered elements, as
indicated by vendor-specific objective evidence, is deferred and (b)
the difference between the total arrangement fee and the amount
deferred for the undelivered elements is recognized as revenue related
to the delivered elements.
In the event that Compuware receives minimum payments because IBM's actual
purchases fall short from the minimum annual commitments, such amounts
would be recognized over the contractual period. We believe the excess
payments are similar to nonrefundable upfront fees as described in SAB
Topic 13-A.3(f). SAB Topic 13-A states in part:
Unless the up-front fee is in exchange for products delivered or
services performed that represent the culmination of a separate
earnings process, the deferral of revenue is appropriate. [Footnote
omitted]
Additionally, based on this guidance, the Company would recognize such
minimum payments in excess of IBM's purchases annually at the end of each
contractual period.
Recognizing revenue based on the lowest cumulative amount yielded by the
two models described above effectively results in the Company recognizing
revenue limited to the lesser of the following:
a) The payment for each annual commitment period recognized on a
straight-line basis over such period, or
b) The amount of actual software sales to IBM.
11
At the end of each year, amounts that Compuware has received from IBM as
excess payments for which the Company did not deliver any software become
non-refundable and cannot be applied against future purchases of software
(i.e., against future deliverables). Rather, future payments, in amounts
equal to the fair value of future software to be delivered or the
undelivered portion of the patent cross-license agreement will be received
and therefore the portion of the fee that becomes non-refundable would
qualify for immediate recognition. However, these amounts were not earned
as revenue but rather are considered payments received in settlement of the
legal dispute. Accordingly, such amounts will be recognized as other income
and not as revenue (see discussion under CLASSIFICATION below).
In the event that IBM purchases software with a value greater than the
average minimum commitment per year revenue recognition will be limited to
the amount recognizable assuming the only deliverable is the patent
cross-license agreement.
We also considered whether it may be appropriate to recognize our right to
receive the $140 million as an asset but concluded that it would be
inappropriate to recognize such amount as an asset because IBM has the
contractual right to receive software and maintenance in exchange for such
payments. Therefore, it was not possible to determine the net cash inflows
to the Company. Accordingly, we concluded it would be inappropriate to
recognize the $140 million as a receivable.
CLASSIFICATION
The Company deemed it appropriate to classify payments from IBM as revenue
to the extent that such payments (1) are made to acquire software which IBM
will take delivery of and has demonstrated an objective and verifiable use
for, and (2) reflect pricing that is reasonable and consistent with the
prices that Compuware would generally charge similar customers for the same
software. Any amounts received by Compuware beyond these amounts should be
classified as a gain on the settlement of a legal dispute.
While the sale of software in this agreement is inherently bundled with a
legal settlement, and while the fair values of the two amounts are not
readily determinable, the Company believes that, for classification
purposes on the income statement, Compuware could consider other evidence
as a means of classifying the amounts received from IBM.
In the aforementioned agreement, Compuware will clearly be delivering
software to IBM. FASB Concepts Statement No. 6, paragraph 78 defines
revenues as:
...inflows or other enhancements of assets of an entity or settlements
of its liabilities (or a combination of both) from delivering or
producing goods, rendering services, or other activities that
constitute the entity's ongoing major or central operations.
12
Accordingly, to the extent Compuware can demonstrate that delivery of its
software product has occurred and will be put to an objective and
verifiable use by IBM, and will be at prices commensurate with those
charged to external parties, the Company believes that the Company would
have a basis for allocating the consideration between the legal settlement
and revenue components of the transaction.
The Company also noted the following excerpt from the E&Y publication that
provides support for allocating revenue for classification purposes even
though revenue is recognized as a combined unit of accounting:
Regulation S-X, Rule 5-03(b), requires that public registrants
separately present revenues from the sale of products and revenues
from providing services in the income statement. When products and
services included in an arrangement are not separable and are
accounted for as a combined unit of accounting, we believe that the
revenue, once recognized, should be allocated between the sales of
products and services using the fair values of the products and
services (although amounts can be combined if the revenue associated
with any category is less than 10 percent of the registrant's total
revenues). Revenue may be allocated using either the relative fair
value method or residual value method as described in paragraph 12 of
Issue 00-21, even though the deliverables did not qualify for
separation pursuant to paragraph 9.
For purposes of this allocation, we believe that a registrant can use
its best estimate of the fair values of the respective product and
service. That is, for the purposes of this allocation we do not
believe that an entity is limited to the use of vendor-specific
objective evidence or third-party evidence of fair value as it is when
allocating arrangement consideration among deliverables within the
scope of Issue 00-21.
NOTE 16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED), PAGE 68
4. PLEASE EXPLAIN TO US HOW YOUR DISCLOSURES COMPLY WITH ITEM 302(A)(1) OF
REGULATION S-K THAT REQUIRES YOU TO PRESENT GROSS PROFIT WITHIN SELECTED
QUARTERLY FINANCIAL DATA.
Direct costs associated with license and maintenance revenue are subject to
numerous allocations based on estimates as discussed above in our response
to comment 2 and, therefore, the calculation of gross profit (if performed)
would be imprecise. The Company uses operating profit rather than gross
profit to evaluate the business and believes this provides the most useful
information to management and to readers of the financial statements. The
Company has disclosed quarterly information in the Notes to the
Consolidated Financial Statements consistent with the information included
in the Company's quarterly filings and in compliance with Regulation S-X
Rule 5-03 which does not require a presentation of gross profit on the face
of the
13
statement of operations. The Company has reported operating income on a
quarterly basis in addition to net sales and net income to facilitate the
reader's understanding of the business.
We acknowledge that we are responsible for the adequacy and accuracy of the
disclosure in all Company filings. We understand that neither the staff's
comments nor changes we make to our disclosure in response to staff comments
foreclose the Commission from taking any action with respect to our filings and
that the Company may not assert staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal securities laws of
the United States.
Please feel free to call me at (313) 227-7372 or Jean Rauchholz at (313)
227-7559 with any questions or if we can be of any assistance.
Very truly yours,
/s/ Laura Fournier
- -------------------------------------
Laura Fournier
Senior Vice President, Treasurer and
Chief Financial Officer
14