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Executives

Lisa Elkin – Vice President, Communications & Investor Relations

Robert C. Paul – President & Chief Operating Officer

Laura Lawson Fournier - Chief Financial Officer, Executive Vice President and Treasurer

Daniel Follis, Jr. – Vice President, General Counsel and Secretary

Analysts

Walter Pritchard – Cowen and Company

David Rudow – Thrivent Financial

Compuware Corporation (CPWR) F4Q09 Earnings Call May 14, 2009 5:00 PM ET

Operator

Welcome to the Compuware Corporation’s fourth quarter year-end results teleconference. At the request of Compuware this conference is available recorded for instant replay purposes. At this time I’d like to turn the conference over to Miss Lisa Elkin, Vice President of Communications and Investor Relations for Compuware Corporation. Ms. Elkin you may begin.

Lisa Elkin

Thank you very much and good afternoon ladies and gentlemen. With me this afternoon are Bob Paul, President and Chief Operating Officer; Laura Fournier, Executive Vice President and Chief Financial Officer and Dan Follis, Vice President, General Counsel and Secretary. Pete will not be joining us on the call this afternoon.

Certain statements made during this conference call that are not historical facts including those regarding the company’s future plans, objectives and expected performance are forward-looking statements within the meaning of the Federal Securities laws. These forward-looking statements represent our outlook only as of the date of this conference call.

While we believe any forward-looking statements we have made are reasonable actual results could differ materially since the statements are based on our current expectations and are subject to risks and uncertainties. These risks and uncertainties are discussed in the company’s reports filed with the Securities and Exchange Commission. You should refer to and consider these factors when relying on such forward-looking information.

The company does not undertake and expressly disclaims any obligation to update or alter its forward-looking statements whether as a result of new information, future events or otherwise except as required by applicable law. For those of you who do not have a copy I will begin by summarizing the press release. Bob and Laura will then provide details about the quarter and other Compuware business activities. We will then open the call to your questions.

Compuware increases year-over-year earnings per share 17% to $0.55. Business service delivery strategy positions company for further earnings growth. Compuware today announced financial results for its fourth quarter and fiscal year end March 31, 2009. During the fiscal year revenues were $1.09 billion compared to $1.23 billion in the previous fiscal year. Net income was $139.6 million up from $134.4 million in fiscal 2008. Earnings per share were $0.55, an increase of 17% from $0.47 in fiscal 2008 based upon 252.4 million and 287.6 million shares outstanding respectively.

During fiscal 2009 software license fees were $219.6 million. Maintenance revenue was $479.5 million. Professional services fees for fiscal 2009 were $391.4 million. During the fourth quarter revenues were $253.4 million. Net income was $48.4 million and earnings per share were $0.20.

During the company’s fourth quarter software license fees were $55.5 million and maintenance fees were $111.6 million. Fourth quarter revenue from professional services was $86.3 million.

I would now like to turn the call over to Bob.

Robert Paul

Thanks Lisa. Compuware produced a successful fiscal year in 2009 featuring a 17% year-over-year increase in earnings per share. We delivered this increase in earnings despite economic pressures that continued to extend some sales cycles. At the beginning of last fiscal year we announced we would transform the company, positioning Compuware to be best in the world in select categories, thereby creating a foundation for accelerated growth. Most of that work is now complete as we turn more of our focus towards execution. We have the right strategy, a highly focused operations leadership team and the processes and metrics to make a compelling difference in the markets where we participate.

We knew that short-term comp share would be slightly smaller in revenue but much healthier as a business. We have accomplished this by moving our professional services business to a leaner, higher margin practice and also de-focusing from our quality and testing business. Overall, I am extremely pleased with the amount of change that has been achieved over the last year without disruption to the performance of the business.

We are planning for fiscal year 2010’s selling environment about the same as this year so if the greater economic conditions improve our guidance could be conservative. We realize that customers will continue to scrutinize every purchase, a dynamic which we will be well prepared for as we have developed a comprehensive library of return on investment case studies and associated references.

Also with a greater focus on the business in end-to-end application performance, a movement towards a clear market leadership position at some point we expect to see a positive inflection point in the performance of that business which could have an impact on our guidance for the year.

That said, I expect Compuware to deliver EPS for fiscal year 2010 in the $0.60-0.70 per share range. I am confident in our ability to achieve or exceed this goal for two important reasons. The transformation we completed in fiscal year 2009 has positioned us for accelerated growth and our increased focus will allow us to operate with greater efficiencies in fiscal year 2010.

Our targeted cost cutting initiative has reduced Compuware’s expense run rate by more than $175 million this fiscal year alone. We are still investing in people and in our core solutions but our increased discipline around cost will pay big dividends. Our business service delivery approach provides a total perspective of technology portfolio both on the progress of new projects that will enable business growth and the health of existing operations.

Compuware’s business service delivery solutions gives CIO’s and business leaders the confidence that applications will work well and deliver the value whatever technology is in use. This value proposition increases the strategic relevance of our company, allowing us to sell higher and more broadly into our customer base. It also positions us in a high growth market where both Gartner and Forrest have stated that we have market share leadership positions in sub-categories such as end-user experience.

In order to maximize the impact of this strategy we have improved our sales operations and processes including structure, sales methodologies, measurements and compensation. We have also just completed one of the most ambitious projects ever, performing a six-day comprehensive sales boot camp at our Compuware headquarters for more than 1,100 members of our sales, pre-sales and service solutions delivery groups. Our sales organization now has everything they need to be best in class this year.

One of the key messages in this meeting was that each of our lines of businesses plays a key role in our long-term strategy. Our mainframe business remains best in class and we continue to invest in these solutions to increase our competitive advantage. Our schedule of mainframe renewals in fiscal year 2010 is weighted more towards the last three quarters as Q1 represents only 11% of this year’s renewals. I do expect a roughly single digit growth in the mainframe business as we help our customers optimize this still vital platform.

We will capitalize on the strength of our mainframe position to build market leadership in our distributed solutions like Vantage and Changepoint. I expect more than 50% license fee growth in distributed solutions this year. In particular, our focus on optimizing end-to-end application performance holds great promise. Here is why. Our customers face tremendous challenges in getting value from the investment they make in applications. When IT commits to delivering a service it is doing more than just implementing and managing technology. IT makes a promise. Bring more speed and agility and innovation to the business, cut costs by automating processes, improve the customer experience and foster greater satisfaction and loyalty.

There is a fundamental shift occurring in computing architectures and to uphold these promises many IT organizations adopt disruptive technologies like web services, virtualization and cloud computing. These technologies add complexity and tax already scarce IT resources. Overcoming these challenges requires an end-to-end perspective on application performance and Compuware is unmatched in this category. To further expand our reach in delivering these solutions we have also established a new strategic partners program.

This organization will establish global partnerships with systems integrators, consultants and IT solution providers to jointly meet the business needs of our customers. Through the efforts of this recently constructed group we are already looking forward to announcing two global partnerships around our [BST] solutions for optimizing end-to-end application performance. I expect these agreements and others like it to drive meaningful, incremental revenue and market opportunities for Compuware this fiscal year.

In the coming year I also expect the dramatic transformation of our professional services business to continue. We have introduced a practice model in the business which will provide repeatability and high margins across the organization. By focusing on a consistent set of offerings where we see high demand and differentiated competency; areas like QA, governance, requirements management, business intelligence, data management, architecture and development and operations management, we will increase the scalability and profitability of this organization. This should result in continued substantial improvements in margin in the professional services division.

Covisint continues to gain market share and has established a leadership position and secure healthcare collaboration. Our partnership with the American Medical Association represents an inflection point in Covisint’s growth curve. With healthcare stimulus spending and IT investments at an all-time high, Covisint’s ability to deliver access to critical yet dispersed healthcare information in a secure, single [sign] and collaboration environment will produce explosive growth in the years to come. Covisint is positioned well to help physicians and state governments get their fair share of the $19 billion of federal government healthcare stimulus package and I expect billings for Covisint to increase more than 40% next year alone.

I am extremely enthusiastic about the coming year. Working with Pete and with our entire executive management team we have built a platform for Compuware to deliver significant growth in earnings. We have focused and aligned our business through our soon to be completed divestiture of the quality solutions and we will further focus our management and our technology investment strategy around these categories where we can be best in the world.

Through our differentiated ability to optimize end to end application performance we have created a foundation for business service delivery that will drive break out growth in the years ahead to benefit our shareholders, customers and employees. Even in the face of a tough economy, over the last year Compuware has become healthier, more focused with a greater opportunity for growth.

Laura?

Laura Lawson Fournier

Thanks Bob. We are really pleased with our Q4 and year-end results highlighted by a 17% year-over-year increase in earnings per share. We are especially encouraged by our ability to grow EPS in this tough economic climate and with the negative effect of currency impacting our revenue in FY09. Much of this EPS growth can be attributed directly to prudent expense management.

Over the last year we have taken nearly $180 million in costs out of this business. While we believe we still have opportunity to enjoy additional expense savings through greater operational efficiencies and our divestiture of the quality solutions business, the bulk of our cost cutting activity has been completed.

Now that is not to say we will not continue to diligently manage our cost structure going forward. Effective expense management is core to our operations. However, it should be pointed out that the future EPS gains will come primarily through margin expansion and revenue growth which will be driven by the strategic direction Bob just discussed.

Before moving on I want to touch on the currency effect for a moment, particularly as how it relates to maintenance revenue. For the year maintenance revenue was essentially flat. However, for the quarter it was down 11.6%. The maintenance decline in the fourth quarter can be attributed directly to the negative effect of currency. Put it this way. If you applied fiscal year 2008 rates to fiscal 2009 results, maintenance for the year would have come in around $487 million, a 2.2% increase year-over-year.

The reason I call this out specifically is I don’t want anyone to read the Q4 decline in maintenance revenue as anything but being currency driven. Our maintenance base is as strong as it has ever been.

In addition to strong EPS growth and expense management, Compuware’s other key fundamental, cash flow, continues to be solid. For the quarter Compuware’s operating cash flow was $153.2 million and we finished the year with operating cash of approximately $232 million.

In fiscal year 2010 we expect operating cash to come in around $200 million excluding any effect of the sale of our QA business. In terms of cash usage, our position remains the same. We will continue to look for opportunities for the strategic use of our cash but will remain cautious until we believe the economy has turned the corner.

Regarding stock buy backs, as always we will evaluate business and economic conditions and buy stock when it makes sense. In Q4 we purchased 4.9 million shares bringing our total to 21.6 million shares for the year.

A quick note on the business before I conclude. On occasion we get questions about the impact our exposure to Chrysler and GM might have on our business. The answer to both is minimal. Both companies have stayed current on any amounts due to us and we are continuing to do business as usual. The majority of the work we do with both companies is strategic to their operations such as the innovative work we are doing on OnStar for GM. At Chrysler they continue to use the Covisint Portal as a primary means of communicating with their constituents.

Overall, we are convinced that we are taking the right steps to successfully navigate this current economic compass while positioning the company through laser focus, optimized company alignment and greater strategic relevance for significant growth to come.

Lisa?

Lisa Elkin

Thanks Laura. Ladies and gentlemen we would now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Walter Pritchard – Cowen and Company.

Walter Pritchard – Cowen and Company

Laura on the maintenance I’m wondering if you could give us a sense of Euro versus Pound exposure there? I guess that was a little bit more of a negative impact from FX than we were expecting. I know those currencies performed a little bit differently during the quarter year-over-year. I was wondering if you could give us a bit more granularity so we could help get to the numbers you are talking about.

Laura Lawson Fournier

I’m sorry, I don’t have a break down of each of the different currencies. I only have it in total. We have never really broken it down between Yen or Pound or Euro. I would have to pretty much stick with the total effect on the maintenance in Q4.

Walter Pritchard – Cowen and Company

As it relates to the services business, could you help us out as it relates to your guidance of the $0.60-0.70 in earnings and the $200 million in cash flow. What should we expect from a run rate perspective on the services revenue as we move throughout the year? Also, what sort of billable headcount do you think you will trend throughout the year and maybe ending fiscal 2010?

Robert Paul

We will continue to monitor the business very, very carefully. We have got the processes and the metrics that we talked about before to watch the conditions as we expect the overall conditions of that business to improve. However, the business is a lot smaller in the low $200 million range from a total from where it was this year. That is because we are as we talked about before we have moved out of the very low margin business. Some of the staff supplementation work we have been doing. We believe that we still have great IT professionals here that can deliver a differentiated value to companies all over the world and we are going to continue to build on those core competencies. Very much focused on only acceptable margins that we approve moving forward. I think that is about 60% of what the business looked like before from a total revenues but obviously driving much higher margins.

Walter Pritchard – Cowen and Company

As it relates to the license declines you saw year-over-year I know one issue here has been that you had some pretty tough compares based on some of the premium licenses you did a year ago in the March quarter. I wonder if maybe you could help us out with normalizing for that or what the business did if you ignore the impact of the premium licenses and I guess I am especially interested on the mainframe side because I don’t think premiums were as much of an issue on the distributed side.

Robert Paul

On the premium side obviously that becomes a very attractive business for companies that are growing in capacity. What we saw obviously this year was not as much demand for those. So we got more back towards our traditional mainframe renewal rates and with the investment we made in the customer care organization, highly focused on discussions well in front of mainframe renewals, with the delivery on return on investment case studies with those clients on our dime.

That proved a very effective mechanism for the mainframe renewals. So the other license declines sporadically, we obviously took less focus on the quality and testing business as we were preparing for the divestiture process and I think that had obviously an impact. We did experience, the only thing I can point towards, is a slow down in buying cycles because of the economic conditions.

Walter Pritchard – Cowen and Company

Around the divestitures that were announced a couple of weeks ago, can you help us understand you did say that the cost cuts are largely done but I do know you had some costs associated with those businesses that you still need to remove from your run rate there. I’m just wondering if you can help us understand the run rate for operating expenses as you peel those costs out over the next few months.

Robert Paul

There is approximately about $45 million in expense associated with that business that will obviously leave the company with the divestiture. There are obviously some efficiencies gained that we have already taken in moving some of the corporate support functions into additional support for other business lines. The direct expense was about the $45 million that goes with the divestiture.

Walter Pritchard – Cowen and Company

On the cash flow guidance for next year, I just want to make sure we are clear on what the impact is of IBM and payments that you may receive. I think next year is the last year you have those payments. I was wondering if you could just detail that for us.

Laura Lawson Fournier

You are right. Next year is the last year for the IBM settlement agreement. We start out the year with a $30 million number. For the last several years they have never reached that. In FY09 we recognized $17 million in other income. As far as our cash flow for next year we are anticipating somewhere around that same number.

Operator

The next question comes from David Rudow – Thrivent Financial.

David Rudow – Thrivent Financial

Do you get the sense based on what you are seeing in the pipeline and talking to the sales people seeing as they were there a couple of weeks ago have we seen the worst? Are we bottoming out at current levels? Anything giving you any reasonable level of comfort on pipeline for fiscal 2010?

Robert Paul

Here is what gives me the most comfort in Fiscal 2010. We just went through the most comprehensive education, messaging, roll model playing and a complete delivery of an understanding of a metrics and expectations that the organization has. Every single sales person, sales manager, VP, pre-sales person, etc.

I think we are already starting to see an impact in behavior. As you know, our sales cycles can be anywhere from 3 months to 9 months on average. It will start to have I think a more meaningful performance metric impact to us in the coming quarters. Certainly activity levels, being a lot smarter about what they are doing, being more efficient in what they are doing and being more differentiated in what they are doing. We are already starting to see that impact the pipeline globally.

So that is good news. As it relates to the general economic conditions it is really tough to say. We are hopeful, obviously as we move into the next couple of quarters that the budgets start to loosen up but we are even working very hard there because one of the models that we talked about and trained heavily on was provocation based selling and the ability to actually create budgets based upon the value that our solutions are providing.

We are hopeful. We actually know operationally we will improve substantially over this year and we are hoping that it leads to a performance impact in the coming quarters.

David Rudow – Thrivent Financial

On the sale of testing, that includes the partner correct?

Robert Paul

That is correct.

David Rudow – Thrivent Financial

And File Aid?

Robert Paul

No.

David Rudow – Thrivent Financial

So what is the total run rate then of the business that you are selling? The revenue trailing run rate?

Robert Paul

Between $71-75 million.

David Rudow – Thrivent Financial

If you take that $71-75 million out and take that license piece assuming it is maybe half, do you think net of that if you take it apples-to-apples that you can be flat in license revenues for fiscal 2010?

Robert Paul

No. We are actually expecting…I am doing the math real quick here in my head. We are expecting growth in distributed license revenues simply because the remaining assets that we have, number one there are fewer of them so we are more focused and a lot better at delivering value around them. Obviously our investments will be more focused in those areas. Number two, they are a much higher performing assets in the market places that we participate. So we expect the growth rate of the remaining assets to be strong relative to the quality and testing business. Overall I am thinking the distributed number does go up.

David Rudow – Thrivent Financial

On the assets that you are selling, license revenues out of that $71-75 million is probably about $30 million. Is that a reasonable assumption?

Laura Lawson Fournier

You are right on. It is about $25-27 million with R&D and goodwill.

David Rudow – Thrivent Financial

Covisint you said growth of I believe 50%. Is that bookings or revenue growth?

Robert Paul

48% bookings growth and I think the revenue equated to a little over 20%. As you know in that business the bookings are amortized almost entirely over five years regardless of the contract length and everything else just because it is a software as a service model. So we typically look at that business and value it based upon total product commitments and cash flow which were very strong by the way.

David Rudow – Thrivent Financial

Back to the services piece, given the low $200 million number for the year, what are you looking for on the gross margins for that business?

Robert Paul

We would expect gross margins around 15% for the year.

Laura Lawson Fournier

Keep in mind too the way this is going to work is Q1 we are still going through a lot of the changes that are happening here in the services business. So we expect the margin to ramp up.

Robert Paul

It will be obviously a linear growth. The reason for that is obviously all the changes we are making that we talked about before, some of these are longer term contractual issues and we are still working with some of our larger clients to get to resolution.

David Rudow – Thrivent Financial

But probably running gross margins from where we were at this quarter is reasonable and then slowly ramp it up to maybe 1% per quarter improvement as you work through some of these issues?

Robert Paul

That wouldn’t be unreasonable.

David Rudow – Thrivent Financial

Operating margin. Did you talk about operating margin for the year?

Robert Paul

We have a goal for operating margin of about 25%.

David Rudow – Thrivent Financial

Is that long-term?

Robert Paul

Well why don’t we answer that when we get closer in the year.

David Rudow – Thrivent Financial

On the balance sheet there was an item asset held for sale. What was that?

Laura Lawson Fournier

That was assets related to the QA divestiture. It is the capitalized R&D, goodwill, a little bit of prepaid that was related to the QA products.

David Rudow – Thrivent Financial

Why did that not show up in discontinued ops?

Laura Lawson Fournier

Because our QA business was part of the entire products segment, not a stand alone segment. The literature would require us to show it as assets held for sale as opposed to discontinued operations. I just want to clarify so there is no question later on and then we aren’t able to talk about it. The license fees for the QA product were right around $26 million. I will just give them to you $34 million for maintenance and about $11 million for professional services.

David Rudow – Thrivent Financial

Was that business as a whole profitable?

Laura Lawson Fournier

Absolutely.

David Rudow – Thrivent Financial

How much of the cash flow guidance is lost with this sale of the $200 million you guided to?

Laura Lawson Fournier

In the current year’s cash flow there was probably about $20 million. But we have to play out the whole story here with the QA line. It was on a declining basis. One of the reasons it was at $20 million in this current year is we had cut back on so many expenses for the past few years.

Robert Paul

So we made the business healthy this year through minimizing the investments in the solutions obviously and that is what made it right side up.

David Rudow – Thrivent Financial

But some of the down tick in the 232 this year in operating cash flow and the 200 guidance comes from getting rid of QA?

Laura Lawson Fournier

Yes it would obviously. There was some cash flow from it but we absolutely believe that will be made up through the activity in the current year.

Operator

The next question comes from Walter Pritchard – Cowen and Company.

Walter Pritchard – Cowen and Company

I just wanted to follow-up on the answer to David’s question there about distributed license revenue. Are you talking about growing what is remaining or growing and actually growing and basically replacing what is pretty much a hole in that business of $26 million as Laura mentioned with the testing business?

Robert Paul

I am talking about growing the existing solutions and that level of growth is anticipated. The distributed solutions we talked about the anticipated growth is over 50%. I don’t have the calculation as to whether that exceeds or makes up for…it will exceed the numbers associated with the quality and testing business.

Walter Pritchard – Cowen and Company

Can you talk about and just dive a little bit deeper into that in terms of a quota perspective you have obviously people going out the door that had quota assigned to that product. It sounds like you raised the quota enough on everybody who is left to be able to make up for that. Is that how we should think about that happening?

Robert Paul

Actually no. The quotas didn’t move at all. We are just expecting better sales performance because of all the things we have done operationally and all the support mechanisms we have put in place and the new release in Vantage 11 that is coming out that actually allows for a single dashboard across an entire end-to-end architecture from mainframe, distributed and on into the web environment.

So, we are just expecting better performance from our sales organization. We have had some significant leadership changes also. We have we think a much more aligned and comprehensive sales structure around the target selling that we have built into the model. It should drive greater performance overall. But the quotes in and of themselves have not moved.

Walter Pritchard – Cowen and Company

We had a discussion here about maintenance revenue and the impact of FX. I know the maintenance billing was down quite a bit. I know that business tends to be really lumpy and you have renewals that come and go by the quarter. I am just wondering if you can help us understand as you look out through fiscal 2010 do you think maintenance billings will grow during the year or should we expect them to decline again?

Laura Lawson Fournier

We definitely expect maintenance billings to grow on the distributed side. I would say on the mainframe side to be flat with a little up side.

Walter Pritchard – Cowen and Company

It sounds like overall if we combine growth in distributed with flattish on the mainframe side we will get growth in maintenance billings.

Laura Lawson Fournier

We should.

Walter Pritchard – Cowen and Company

Lastly, could you give us a headcount number post the divestitures and post any actions you took on the services side that were after the end of the quarter? Maybe like a headcount at current time as opposed to ending the quarter?

Laura Lawson Fournier

At the end of the quarter we were about 5,200 people and after the divestitures I would guess about 4,750.

Operator

Ladies and gentlemen we will now conclude the question-and-answer portion of today’s conference call. I would like to turn the call back Lisa Elkin.

Lisa Elkin

Thank you very much. At this time ladies and gentlemen at this time we will adjourn this conference call. Thank you very much for your time and interest in Compuware. We hope you have a pleasant evening.

Operator

Ladies and gentlemen this conference will be made available for replay after 7:00 p.m. today until May 21 at midnight. You may access the AT&T playback service any time by dialing 800-475-6701 and entering the access code 992681. International participants please dial 320-365-3844. That does then conclude our conference for today. We thank you for your participation. You may now disconnect.

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Source: Compuware Corporation F4Q09 (Qtr End 03/31/09) Earnings Call Transcript
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