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Compuware Corporation (NASDAQ:CPWR)

F2Q10 Earnings Call

October 22, 2009 5:00 pm ET

Executives

Lisa Elkin – Vice President of Communication & Investor Relations

Robert C. Paul – President & Chief Operating Officer

Laura Lawson Fournier – Chief Financial Officer & Executive Vice President

Analysts

Kirk Materne – Rafferty Capital Markets

[David Uda – Vibrant Financial]

Operator

Welcome to the Compuware Corporation second quarter results teleconference. At the request of Compuware this conference is being recorded for instant replay purposes. At this time I’d like to turn the conference over to Ms. Lisa Elkin, Vice President of Communication and Investor Relations for Compuware Corporation.

Lisa Elkin

With me this afternoon are Bob Paul, President and Chief Operating Officer and Laura Fournier, Executive Vice President and Chief Financial Officer. Certain statements made during this conference call that are non-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 because 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 & 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 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 Q2 earnings per share surged 50% year-over-year to $0.12. Income from operations grows 52% from Q2 last year to $41.4 million. Software license fees reached $50.1 million in Q2, market leadership drives year-over-year vantage in mainframe software license fee increases of 31% and 60% respectively. Professional services margins nearly triple from year ago period to 11%. Compuware Corporation today announced final financial results for its second quarter ended September 30, 2009.

Compuware reports second quarter revenues of $217.9 million compared to $269.8 million in Q2 last year. Second quarter earnings per share were $0.12 compared to $0.08 in Q2 last year based upon 236.1 million and 257.6 shares outstanding respectively. Second quarter net income was $28 million compared to $21.6 million in the same period last year. I would now like to turn the call over to Bob.

Robert C. Paul

Q2 represents an extremely positive step in delivering on our overall strategy. Driven by a nearly 52% increase in operating income the company produced a 50% year-over-year increase in earnings per share. At $0.12 per share Compuware exceeded Wall Street estimates for EPS by 33%. Software license revenues from core products line Compuware mainframe solutions and vantage are up and operating expenses are down.

The company has methodically divested itself of peripheral products and services, reducing unprofitable revenues and increasing margins. Compared to the year ago quarter we divested or intentionally forgotten nearly $60 million of revenue almost doubling the company’s operating margin from 10% to 19% and this is obviously good progress on our goal of 25% to 30% operating margin.

Maintenance contracts or renewals entered in to during the second quarter excluding divested products were up more than 11% from the year ago period. Compuware continues to successfully fight to expand our maintenance base. Through ongoing investment and delivering repeatable customer value we expect that you’ll see continued strength in this important revenue stream.

These positive results are no accident. For more than a year our Compuware 2.0 initiative has fundamentally restructure Compuware for ongoing success. The entire company is focused on achieving a definitive leadership position that is sustainable and we will create steady, accelerated growth and profitability. We’ve assembled an extremely strong executive line management and sales leadership team who have done a remarkable job. Having said that, the team also knows that a lot of work still lies ahead.

We’ve instituted targeted cost reductions and a cultural commitment to expense vigilance. We’ve positioned Compuware solutions for success in the near and long term insuring healthier more sustainable growth than at any time in the company’s history. Looking at the portfolio for our Compuware mainframe solutions they provide the cash, customer value and market creditability to launch and extend our other solutions. We continue to increase investments here.

As validated by Gartner, our market growth in the mainframe testing tool space is six times that of our nearest competitor. Our market share is more than twice that of our nearest competitor. We are executing progressively and protecting and looking to expand our footprint in this space. Compuware distributed product set is healthy and profitable. Application performance management is the company’s growth engine category and by combing vantage and Gomez we’ve delivered the global standard for optimizing application performance in an at least $18 billion category according to Forrester.

Our combined solution is the only one that can provide a unified view of application performance across the entire application delivery chain both enterprise and Internet with immediate problem isolation resolution. If you join the experts in believing that virtualization, cloud computing and mobile computing are growth markets, you should know that Compuware is the only company that can deliver performance monitoring and management over these increasingly complex environments.

This simply means that we are the early mover in a growth market that should feed the accelerated growth of the overall company. Furthermore, we are already working on building next generation application performance management capabilities so when competitors generate catch up hype in this category we will be another step or two ahead. That ultimately is the magic of operational focus. Also, we’ve just completed our most recent round of business planning for Gomez and it’s clear the acquisition will be operationally accretive this fiscal year.

I want to talk briefly about Covisint and its organizational maturity. For a couple of years we projected that the downturn in the automotive would offset some of the emerging growth in the healthcare practice yet despite a flat quarter-to-quarter revenues the year-over-year growth was 11.6% but here is what changed. This quarter we saw a 29% increase in automotive billings, a good proxy for revenue growth in a SaaS model and a 40% increase in healthcare revenue. This is significant because the auto practice is now back to growth and we have both existing and expecting healthcare contracts that will accelerate adoption in coming quarters.

On another front, our recently established partner organization is already producing incremental revenue including one of the largest vantage deals that we signed in Q2. With definitive partner agreements with industry leaders such as CISCO and Accenture and a growing strategic presence in both those organizations, we see great opportunity to expand market share. As more joint offerings gain traction, we expect to see further revenue growth as a result of these partnerships.

We continue to focus on fewer, better and more influential partners who understand and extend our business value around optimizing application performance across the enterprise and the Internet. Finally, our services business is much healthier than it has been in the past with a margin nearly triple that of a year ago period and doubled from last quarter, we have a foundation from which we can continue to improve this business. We will do so primarily by delivering higher margin differentiated services, growing the product related services business and continuing to improve operational discipline.

In summary, I ask how should you measure our progress? Well first, we committed on focusing on becoming best in the world and achieving a market leadership position in application performance management. I know that there’s a lot of execution work still to do ahead of us but our team and most analyst believe that that market is ours to lose. With a combined vantage and Gomez offering we have an unparallel solution and thought leadership position. The acquisition of Gomez when combined with our exciting Covisint bookings will give Compuware about $100 million in annual trailing bookings in the infrastructure as a service category.

This category is experiencing tremendous growth as companies look to speed time to value and reduce capital expenditures. We also committed to stop doing those things where we could not be best in the world. The divestitures and discontinuation of some point products has provided great focus and resource allocation toward those areas where we are best in class. We committed to incubate Covisint and position this group for breakout growth which we are more optimistic about than ever.

We committed to improve our services margin and although this was a difficult task we have obviously made substantial progress with more opportunity for improvement ahead. We committed to substantial expense reductions and improved operational agility. While we can visibly see the margin improvement, the powerful impact of the operational agility will be felt in the quarters and years to come.

Finally, we committed to set realistic expectations and then over achieve. As such, for the fiscal year we’re maintaining our previously stated guidance of $0.60 to $0.70 per share including the gain from the sale of our quality solutions. Moving in to the second half of the year, we will continue to operate aggressively with the focus, the confidence and the swagger that our employees have adopted to ensure we deliver on these expectations.

One last point, we’ve executed the business plan we believe with procession and some success. If you look at some of the parts and Compuware’s prospects for growth, our share price should be higher and our sales side analyst coverage should be broader. Starting immediately we will more formerly engage to communicate this powerful story with financial and industry analysts which we think will lead to great things ahead.

Laura Lawson Fournier

Our Q2 results clearly indicate that Compuware is headed in the right direction. We are making measurable progress on all fronts, strategy all the way through execution. Q2 was an excellent quarter, we beat license, maintenance, total revenue and EPS expectations and we saw an increase in our operating margin from 10% to 19% year-over-year and our balance sheet continues to be a reflection of our rock solid financial strength.

Our strategic focus is evident in terms of our license revenue when you consider last year’s number included revenue from the divested QA products. On an apples-to-apples comparison, if you eliminate the $6.5 million in QA revenue from last year’s license number, we actually exceeded last year’s Q2 license results by approximately $14.4 million or nearly 40%.

It is also important to do the same apples-to-apples comparison when looking at maintenance results and eliminating approximately $9 million in divested QA maintenance revenue from last year’s maintenance number and adjusting for the $3 million negative impact for currency, our maintenance performance this quarter is much more in line on a year-over-year comparable basis. The bottom line is that our maintenance business continues to perform extremely well, rising above economic and competitive pressures. This, is an excellent sign for the business going forward.

We continue to make tremendous progress regarding operating expense management. In the second quarter, every expense category was down on a year-over-year comparison for a net decrease in total operating expenses of 27% or $66.1 million. Even if we eliminate the directly allocable QA expenses in Q2 last year, total expenses are still down 22.6%. In terms of cash, we continue to expect operating cash to come in at $200 million for the year.

As expected, our second quarter operating cash flow was negative. As we discussed last quarter the primary reason centers around the classification of the estimated income tax payment on the $52 million gain on the QA divestiture as operating while the gain itself was classified as investing. Still, for the first six months, our operating cash flow was approximately $70 million and we are well positioned to reach our $200 million operating cash flow goals for the year particularly with our strongest cash collection period in front of us.

Given the strength of our current cash position, we anticipate a modest draw on our line of credit between $25 and $35 million when the Gomez acquisition closes. With regard to the stock buyback, in Q2 we repurchased approximately 7.3 million for about $53.5 million. Since May of 2003 we have repurchase nearly 180 million shares for approximately $1.5 billion. We will continue to evaluate business and economic conditions and continue to buy back stock when it is fiscally prudent to do so. And, given the current price of our stock we will be back in the market when the window opens on Monday.

This is a very exciting time for Compuware, our shareholders, employees and customers. We have a tremendous plan in place and it is working. Our operating results and our strategic actions such as our pending acquisition of Gomez and our divestiture of the QA business are a testament of that. But, it goes beyond all that, I’ve been at Compuware a long time and it’s been a while since I’ve seen such a shared sense of purpose, commitment and optimism among the team. I am convinced that we have the focus, the leadership, the direction and the expertise needed to capitalize on our tremendous potential and that is a very powerful dynamic.

Lisa Elkin

At this time ladies and gentlemen we will now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Kirk Materne – Rafferty Capital Markets.

Kirk Materne – Rafferty Capital Markets

Bob, maybe just to start it off can you talk a little bit about the change in the environment if you’ve seen much? Clearly, the results on a license basis in both distributed and mainframe are both a lot better sequentially and I was just trying to get some perspective on if the activity in the pipeline has picked up or if it was just better conversions on the opportunities within the pipeline for both distributed and mainframe?

Robert C. Paul

No easy answer there Kirk. I can give you a couple of variables and characteristics around the quarter. First off, typically when we’re looking at our sales commits in prior quarters last year we had a tough time holding on to the commit during the quarter and as the quarter came to an end obviously the commit came down a little bit. This is the first quarter where I’ve been here where the commit numbers actually went up at the end of the quarter.

I attribute that almost exclusively to sales operational discipline that we were implementing for about six months and now at the beginning of the fiscal year have in place around the training, around activity based management that we’re tracking globally real time and the leadership is following through and making sure it happens. I think there’s a much overall greater sense of discipline and thoughtfulness that’s going in to the sales process and execution itself.

Having said that, the tougher thing is whether the general macroeconomic conditions are changing or not. It’s tough to say because I think we’re also doing a much better job with a much sharper value proposition and a cleaner proof of concepts, cleaner implementations, those kinds of things. I would say that on the mainframe side there’s still tough battles and we’re still fighting hard and winning more than our fair share on ROI justification and so if you look at that purely on the mainframe side you’d start to think that maybe conditions were starting to change. But, it’s hard to say because it’s sort of clouded a little bit by the performance improvements that we’ve made.

Kirk Materne – Rafferty Capital Markets

Maybe just on Covisint you noted that the billings have started to trend back up on the auto side. Can you just give us some more color around that, what’s driving that? And, is that sustainable or is this a little bit of catch up? I guess just going forward on Covisint as a whole, I know you guys have been reluctant to give too much color on sort of where it is from a revenue perspective but just in terms of growth now that auto has stabilized a little bit what can we expect either from a billings perspective or a revenue perspective in terms of growth from that business or your expectations around it?

Robert C. Paul

A good way to look at the Covisint business is by industry sectors you just characterized. The automotive piece of the business actually has returned to growth and we do believe that the growth part of that is sustainable. We’re getting new contracts with customers that we’ve not had before. We’re getting new I would call them strategic opportunities that are driving – the primary revenue drives in Covisint is number of users and volume of data through the platform, that’s driving both of those key variables. That’s a good thing and I think that’s just a result of at least the automotive industry here stabilizing and turning somewhat back to a more normal market in a new environment.

On the healthcare side it’s very interesting, we have a couple of major contracts and partnerships and the bookings are obviously well in advance of revenues as we’ve talked about before on the SaaS offering. The climate for change in the healthcare industry to achieve a lot of the goals that are being talked about on a national level are starting to come in to play. By that I mean we’re starting to see major physician groups looking to adopt to be in a position to take advantage of the economic stimulus and obviously improve their practices.

Then, we’re also seeing a lot of state governments preparing for healthcare backbones if you will that will allow healthcare interoperability and healthcare information exchanges thrive. With that, the major contracts we have signed, it takes a while to build those out and a while to start implementing and adopting. We’re now in a phase of the business where the adoption has started.

Having said that, without getting in to trouble no too much color around the future, we’re expecting to see significant I would say anywhere from 20% to 45% to 50% increase in bookings in that sector next quarter and beyond. Obviously, that is an indicator of a very strong proxy for future revenue. We’re very excited about the business and as it’s an emerging category we also need to stay very, very vigilant around the solution, the value proposition and the repeatability of it moving forward. But, right now all things are solid.

Operator

Your next question comes from [David Uda – Vibrant Financial].

[David Uda – Vibrant Financial]

Bob, did you mention what Covisint revenues were in the quarter?

Robert C. Paul

I mentioned they were flat and I think we mentioned last quarter so that’s just under $9.6.

[David Uda – Vibrant Financial]

Any update on when you’re going to spin out and go public with that company?

Robert C. Paul

We’re not putting a timing on it. What we’re doing is we have an internal goal that once we get to $100 million of bookings then from all the data we have, from all the different analysts and groups and comparables, that feels like a good moment in time providing that the growth numbers are there, the profitability is there, the cash flow is there. We watch those indices very, very closely every quarter and so we’re actually very excited that if things progress the 12 to 24 month category. But, I would say stay tuned for that one and we’ll be able to give you a lot more information about it towards the end of this fiscal year.

[David Uda – Vibrant Financial]

What is the long term share count? I know Pete has said in the past that he wants to get below 200 million. Is that still the plan longer term?

Robert C. Paul

We haven’t changed the target of 200 million outstanding shares as a goal. Obviously, when we get there it will be something else that we reveal.

[David Uda – Vibrant Financial]

Given you’re going to be spending most the cash and then some on Gomez, granted you’ll be building that back up again, any other capital plans or will you just let the cash flow then build again and start buying back shares at some point in the future?

Laura Lawson Fournier

As I said, we will probably start buying back shares right away when the window opens on Monday. We’re going to continue doing that since our big cash flow quarter is ahead of us yet.

Robert C. Paul

On the capital side, nothing on the horizon right now if you’re talking about more acquisitions and things like that that make sense.

[David Uda – Vibrant Financial]

When does that deal close and how will you present that in the income statement for us?

Laura Lawson Fournier

The deal will close probably we’re hoping sometime around the first of November but no later than November 15th. As far as how we present it we still haven’t worked out all of that but it is going to be software as a service so it is a ratable model and could be a separate line. We still have to work on that.

[David Uda – Vibrant Financial]

Will you talk about bookings like you do for Covisint for them? I mean, how much detail will you plan on giving?

Laura Lawson Fournier

We will definitely talk about bookings because that will be a very relevant number for that company.

Robert C. Paul

The nice thing is David is they have already filed their S1. They are very use to tracking and monitoring those numbers so it shouldn’t be a challenge at all. The other thing, if I could, relative to the Gomez acquisition, we’ve actually been making great strides with joint customers and are looking to make some we think very exciting announcements towards the end of November around some solutions that we think are just going to be received very, very well by our target markets.

[David Uda – Vibrant Financial]

You won’t bulk both Covisint and Gomez on the same line would you and call it software as a service?

Laura Lawson Fournier

We won’t. We will definitely give the breakout of those two numbers.

[David Uda – Vibrant Financial]

The longer term operating margin of 25% to 30%, what level of revenues or is there a level of revenues that you need to be at to hit that number?

Robert C. Paul

That’s a great question and what I’ll ask is that you hold on with that one because the Gomez acquisition changes a lot of things and we’re going through the next level of planning right now for Q4 and beyond fiscal year ’11 that we’ve just kicked off. So, we have to build that plan and those assumptions in to this new model with this acquisition. So, anything that we give your right now would be wrong but I think we’ll be able to talk about it more definitively shortly.

[David Uda – Vibrant Financial]

To get to the midpoint of the guidance range on earnings, what level of operating margins should we assume?

Laura Lawson Fournier

It’s going to be a combination between certainly in Q3 and Q4 we should see some strong revenue growth and we will continue to work at expenses. It’s going to be a mix in these next two quarters given the Gomez acquisition.

Robert C. Paul

Obviously David the easy answer is we’re going to get to that 25% operating margin number as quickly as possible.

[David Uda – Vibrant Financial]

Is that multi years out or do you think when the economy turns you can get there in 2011?

Robert C. Paul

Here’s me being positive about things but I think that’s a very, very fair target.

[David Uda – Vibrant Financial]

Then on how does the federal vertical perform in the quarter? Can you talk about any of the big deals that you had?

Robert C. Paul

Well, you’ve got some insights. We’ve done very well with the federal government this past quarter. We had a large deal with the Social Security Administration and obviously we continue to have some very strong opportunities in other areas of federal government, actually expanding on the SSA deal as we speak. But, I don’t have the specifics of that breakdown in front of me but it was a large size deal. The other piece of good news is that I think the number of what we classify as large deals close to tripled over the same period last year. So, we’re definitely getting our fair share and becoming more strategic with the markets we’re going after.

[David Uda – Vibrant Financial]

Do you see the federal government becoming bigger and was the deal a mainframe or a combination of mainframe and distributed?

Robert C. Paul

It was primarily mainframe but a combination. We do see the federal government business becoming bigger. We’ve added some great new talent to the team, some additional resources and also some allocation of some development expenses to handle some very specific initiatives going on in the federal government. So, yes a nice opportunity for growth there.

Operator

Your next question comes from Kirk Materne – Rafferty Capital Markets.

Kirk Materne – Rafferty Capital Markets

I guess maybe Laura, just around Gomez, when we start looking at the potential revenue impact from that as that comes on board, is there any sort of purchase accounting that you have to write down revenue associated with that given that they are more of a ratable model or should that revenue as its been trending just sort of come on your income statement pretty directly? I’m just trying to get a sense on if there’s any write downs you have to do from a revenue perspective?

Laura Lawson Fournier

No the write down is relatively small on the deferred side. I think that we will continue to see their revenue track along. There won’t be any major differences. The only thing from a purchase accounting we will have obviously some amortization related to that part of the price that is required to be amortized and we just don’t have that number yet but as a worse case it will be about $5 million a quarter.

Kirk Materne – Rafferty Capital Markets

You guys have been pretty true to sticking to GAAP, I assume you’re talking $0.65 to $0.70 you’re excluding any amortization from Gomez as we think about it in our model.

Laura Lawson Fournier

No, we aren’t. We have included it.

Kirk Materne – Rafferty Capital Markets

So you’re going to have the $0.60 to $0.70 EPS includes sort of a $5 million or there about headwind, is that fair?

Laura Lawson Fournier

Yes, that’s fair.

Operator

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

Lisa Elkin

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

Operator

Ladies and gentlemen this conference will be available for replay after 7PM today until October 29, 2009 at Midnight. You may access the AT&T Executive playback service at any time by dialing 1-800-475-6701 and entering the access code 115199. International participants may dial 1-320-365-3844. Again those numbers are 1-800-475-6701, international participants may dial 1-320-365-3844 using the access code 115199. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.

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