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Compuware (NASDAQ:CPWR)

F2Q07 Earnings Call

October 26, 2006 5:00 pm ET

Executives:

Lisa Elkin, VP Communications and Investor Relations

Laura Fournier, SVP and CFO

Hank Jallos, President and COO, Products

Andy Trestrail, President and COO, Professional Services

Bob Paul, President and COO, Covisint

Tom Costello, SVP, Human Resources, General Counsel and Secretary

Analysts:

David Rudow, Piper Jaffray

Kirk Materne, Banc of America Securities

Aaron Schwartz, JP Morgan

William Banover, Planning Alternative

Operator

Ladies and gentlemen, thank you very much for standing by. We do appreciate your patience today while the conference assembles. Good afternoon. Welcome to the Compuware Corporation Second Quarter Earnings Release Conference Call. Now, at this point we do have all of your phone lines muted or in a listen-only mode; however, after the executive team’s presentation today there will be opportunities for your questions. Those instructions will be given at that time. If you should require any assistance during the call you may reach an operator by pressing * then 0. At the request Compuware, ladies and gentlemen, today’s conference is being recorded for instant replay purposes. That information will be announced at the conclusion of our call. So with that being said we’re going to get right to the second quarter agenda. Here with our opening remarks is Ms. Lisa Elkin, Vice President of Communications and Investor Relations for Compuware Corporation. Please go ahead Ms. Elkin.

Lisa Elkin, VP Communications and Investor Relations

Thank you very much Brent and good afternoon ladies and gentlemen. With me this afternoon are Laura Fournier, Senior Vice President and Chief Financial Officer; Hank Jallos, President and Chief Operating Officer of Products; Andy Trestrail, President and Chief Operating Officer of Professional Services; Bob Paul, President and Chief Operating Officer of Covisint; and Tom Costello, Senior Vice President of Human Resources, General Counsel and Secretary.

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. Laura, Hank, Andy, and Bob will then provide details about the quarter and other Compuware business activities. We will then open the call to your questions.

Compuware announces fiscal year 2007 second quarter results. Compuware earned $0.07 per share in the second quarter. Sales of distributor products increased 10.5% year-over-year. Compuware today announced financial results for the second quarter which ended September 30, 2006. The Company’s final results for the quarter are in line with preliminary financial results announced on October 12, 2006.

Compuware reports second quarter revenues of $288.5 million and second quarter net income of $24.8 million. Compuware earned $0.07 per share diluted computation in the quarter compared to $0.06 in the second quarter of fiscal 2006 based upon 364.5 million and 391.2 million shares outstanding respectively. During the Company’s second quarter, software license fees were $56.7 million, professional services fees were $116.7 million, and maintenance fees were $115.1 million.

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

Laura Fournier, SVP and CFO

Thank you, Lisa. As we anticipated, the second quarter proved to be challenging, although we are encouraged by our distributed products and maintenance results as both are very critical components of Compuware’s growth plans. Operating cash flow for the second quarter came in lower than expected at $8.5 million. This shortfall was due primarily to the timing of international tax and payment obligations that had been accrued previously. For the year we continue to forecast cash flow from operations coming in at around $200 million.

As of September 30th, our cash balance was approximately $762 million. The cash balance declined from the previous period as a result of a more aggressive stock buyback program executed during the quarter. During the second quarter we purchased approximately $157 million of Compuware stocks or 21.7 million shares. Year-to-date for fiscal year ’07 we have purchased approximately $190 million of Compuware stock or 26.3 million shares. We will continue to repurchase shares for the remainder of the fiscal year as market and business conditions dictate.

In a moment Hank, Andy, and Bob will provide additional details about the quarter and will touch on business operations going forward. First, however, I will provide an update on our overall guidance.

Based on our current forecast, we believe Mainframe license revenues for the third quarter and fourth quarter will be comparable with the results for the third quarter and fourth quarter of the prior fiscal year. Professional services revenue for the year will come in flat with margins expected to stay in the 11% to 12% range.

Distributed license revenue for the quarter was up more than 10% year-over-year. Going into the second half of the fiscal year we remain optimistic about the prospects for our distributed solutions, particularly those in our growth markets such as application service management and IT portfolio management.

Maintenance was up year-over-year and sequentially. We continue to expect maintenance to remain steady for the remainder of the year with a slight increase on a full year basis. In terms of earnings, we continue to expect EPS for the year to be in the range of our previously provided guidance.

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

Hank Jallos, President and COO, Products

Thanks Laura. As Laura mentioned, the second quarter proved to be a challenging quarter for the Company; however, we are encouraged by the performance of our distributed products and maintenance business. We remain extremely optimistic about the future of our distributed business, particularly our core distributor offerings such as Vantage and ChangePoint. For the year, we expect to see growth in distributed license sales between approximately 25% and 30%. We’re also pleased with the strength of our maintenance results, especially our growing distributor maintenance space. There’s no better indicator of the value our solutions provide in the stable ever growing maintenance annuity.

In today’s IT market customers only continue to pay maintenance for those solutions that provide immediate and quantifiable return on investments. As noticed in a preliminary earnings results announcement earlier this morning, a great deal of our license weakness for the quarter can be attributed to the substandard performance of our European business operation. We are working hard at correcting this performance and we are seeing improved pipelines for the second half of the year.

The license weakness for the quarter was concentrated primarily in the Mainframe sales, which were down by approximately 25% both year-over-year and sequentially. The shortfall was primarily due to the capacity transactions, which as you know are very difficult to forecast.

To conclude, I would like to provide a brief update on our channel partner program, which is progressing extremely well. During the quarter our partners contributed or influenced approximately 45% of the total distributed revenue with more than 151 partners having multiple transactions. This represents a 36% increase in partner activity year-over-year. We also signed up 38 new partners from around the world. Andy.

Andy Trestrail, President and COO, Professional Services

Thanks Hank. Compuware professional services business continues to be negatively impacted by the poor and deteriorating economic conditions in the Michigan region. Currently, more than 40% of our services business is conducted in Michigan. The environment seemingly continues to worsen, particularly in the domestic automobile industry, a traditionally important sector for our business.

Making matters more challenging, several State of Michigan IT contracts for which we have been in the running and feel good about our chances of winning have been delayed and will not be awarded until some unspecified point after the governmental elections slated for early next month. We had anticipated that these contracts would have been awarded during the second quarter.

Going forward, we are going to continue to work on improving the execution of our services unit from both a revenue and margin perspective. We are still optimistic about the third and fourth quarters. We are actively working with several long-term opportunities that will generate positive momentum in the remainder of FY07 and into the following year. Thank you. Bob.

Bob Paul, President and COO, Covisint

Thanks Andy. Compuware Covisint continues to successfully achieve its business plan by expanding its footprint in the automotive industry while entering new and promising vertical markets. This is evidenced by our second quarter achievement of 60% in revenue year over year. During the quarter highlights include Covisint’s agreement with Shanghai GM that will expand our messaging, integration services with GM and hundreds of its suppliers in North America, Asia, Europe, and Latin America.

Additionally, in the second quarter, Covisint formally introduced a collaborative exchange for healthcare, which reduces healthcare costs and increases healthcare quality for patients, payers, and business. We gained 17 new healthcare customers last quarter including Louisiana Medicaid and Michigan’s largest independent physician’s organization, United Physician’s Group. These types of contracts will ensure a solid growth in subscription revenue and secure Covisint’s position as the leading healthcare interoperability service. Lisa.

Lisa Elkin, VP Communications and Investor Relations

Thank you very much Bob. Ladies and gentlemen, we will now be happy to take your questions.

Question-and-Answer Session

Operator

Indeed and thank you very much everyone for your time and that overview today. We do appreciate that. Ladies and gentlemen, as you just heard then at this point we do invite any questions or comments that you may have. Please feel free to queue up on your phones simply by pressing * then 1 on your phone keypad. You do hear a tone indicating you’ve been placed in queue and should you wish to remove yourself from the queue simply press the # key. So once again, to ask a question please press * and 1 on your touchtone phone. Representing Piper Jaffray our first participant in queue is David Rudow, please go ahead sir.

David Rudow, Piper Jaffray

Good afternoon everyone. First question around the Mainframe, you said flat year-over-year for the third quarter and fourth quarter, is that based on total product revenues or license, how would break that out between the two, because based on the results for this quarter that’s a pretty large jump, even assuming you had some deals that could roll over?

Laura Fournier, SVP and CFO

When we said that we meant Mainframe license sales for the third and quarter and fourth quarter, should be comparable to one year ago.

David Rudow, Piper Jaffray

Okay and then maintenance probably flat if that’s the case as well?

Laura Fournier, SVP and CFO

Maintenance for Mainframe is basically flat with a slight uptick, but our distributed maintenance is doing very well. So, overall for the year we should see a slight uptick in maintenance in total.

David Rudow, Piper Jaffray

So, what was the problem in Europe then, was it a distributor problem or was it Mainframe related?

Hank Jallos, President and COO, Products

David this is Hank. It was really both. In North America we got most of those transactions in already. We didn’t get them in the quarter. In Europe we got some, but in Europe we were off on the forecast on distributed as well as Mainframe, which is very, very unusual.

David Rudow, Piper Jaffray

Is that due to the movement of the previous set of sales with Europe coming over and running all distributed?

Hank Jallos, President and COO, Products

Yeah…senior managers in those geographies, separating them probably caused some complexity that’s taken us a little bit longer.

David Rudow, Piper Jaffray

And is this something that fixes itself in a quarter or this is a two or three quarter problem?

Hank Jallos, President and COO, Products

I think you’re going to see a direct improvement this quarter. I think we’ll be back on track.

David Rudow, Piper Jaffray

So, it’s a minor kind of slippage coming at the end of the quarter and just closing, is it a sales problem or is it a management problem?

Hank Jallos, President and COO, Products

It’s a sales problem.

David Rudow, Piper Jaffray

Okay. Then Laura your comments on the guidance for the year, was the guidance $0.40 to $0.45 before?

Laura Fournier, SVP and CFO

That was the original guidance, yes.

David Rudow, Piper Jaffray

And you’re holding that?

Laura Fournier, SVP and CFO

We’re holding that.

David Rudow, Piper Jaffray

Any contribution from IBM either on the product or on the services side?

Laura Fournier, SVP and CFO

Very minimal, nothing of significance.

David Rudow, Piper Jaffray

Because you had, what I think it was $6 million last quarter for product on IBM and nothing in services?

Laura Fournier, SVP and CFO

Well, we continue to do services with IBM but it’s minimal and there are no big projects going on or anything of substance. We’re continuing to work with IBM on both the services and product side, but right now there’s nothing to report.

David Rudow, Piper Jaffray

Okay, and then the cash flow guidance, does that include the payment of $20 million or $30 million from IBM for the year?

Laura Fournier, SVP and CFO

We don’t necessarily separate that out. That stays on our forecast. So, it’s just in the overall results of the business.

David Rudow, Piper Jaffray

Okay, and then on the testing side, I am figuring out what the growth was in that business. Mercury reported just very good results last night, what do you see competitively? Mercury obviously is still able to close deals pretty aggressively, do you have any special plans in place around testing to try to grab some of those customers?

Hank Jallos, President and COO, Products

Yeah, we’re talking to a number of them. We also have am awful lot of car activity and I don’t want to comment on customer names, we have a lot of systems integrators testing car activities as well as midrange and clients that aren’t real happy with the transition. I think what you’re seeing is a lot of pointing out of the pipeline as they move to go back.

David Rudow, Piper Jaffray

Okay, and then how about on the partner side, any advancement with testing with some of the partners?

Hank Jallos, President and COO, Products

Absolutely.

David Rudow, Piper Jaffray

I think that’s everything I have, thank you very much.

Operator

And next in queue we go to the line of Kirk Materne representing Banc of America Securities, please go ahead sir.

Kirk Materne, Banc of America Securities

Yeah, thanks very much. Laura, just to clarify on the license guidance for the end of the year, do you have any IBM contribution and sort of the guidance to get back towards flat, and I guess how should we think about that contribution that you’ll sort of do this year, are you sort of assuming that’s going to come in below the line at this time given you’re a little bit behind on that. I just want to understand where the revenue is coming in either above or below the line or how that’s factoring into your guidance?

Laura Fournier, SVP and CFO

At this point Kirk there are some deals in the pipeline out there for IBM and we continue to work them, but it is a real difficult path we go down with them.

Kirk Materne, Banc of America Securities

Okay, so I should assume most of what you’ve given out in terms of license guidance is pure Compuware if you’re getting…anything from IBM is sort of gravy on top of that?

Laura Fournier, SVP and CFO

Exactly.

Kirk Materne, Banc of America Securities

Okay, that’s helpful. And then Bob can you talk about the State of Michigan Blue Cross Blue Shield and sort of where that stands in terms of getting that activated and starting to get paid on that a little bit?

Bob Paul, President and COO, Covisint

Yeah, right now at the State of Michigan there was a last second or this week change order, to change a little bit of the technology, so that Blue Cross Blue Shield project will be going live the week of November 11th, the scheduled date right now. So, everything is going great, the customer is confident, happy, and we’re looking forward to having a successful launch and really helping them to be much more proactive in their relationships with these external constituents. Relative to the State of the Michigan there are lot of things in the hopper that we’re working with them on that span general security, access management opportunities, as well as some pretty compelling healthcare opportunities, and we’re looking forward to talking about those in the coming months.

Kirk Materne, Banc of America Securities

Okay and then just finally, Hank, obviously tough quarter in Mainframe for you guys, can you talk qualitatively about what you see in the market for Mainframe right now because obviously BMC put up some decent numbers, so I’m just trying to get a sense of why you’re sort of capacity utilization is burning off slower or where you see the broader market going around that? Thanks.

Hank Jallos, President and COO, Products

I just think with a lot of the stuff in the pipeline people are being very conservative on the capacity. We’re seeing it much more granular than large capacity procurements that we have seen particularly in Europe.

Kirk Materne, Banc of America Securities

Okay, thanks very much.

Operator

And ladies and gentlemen, once again to ask a question please press * and 1 on your touchtone phone. Representing JP Morgan next we go to the line of Aaron Schwartz, please go ahead.

Aaron Schwartz, JP Morgan

Good afternoon. I had a follow question on the weakness in Europe, was there any sort of common denominator that you can point to in terms of some of the deals not closing there?

Hank Jallos, President and COO, Products

No, we didn’t see any.

Aaron Schwartz, JP Morgan

And you do assume your guidance that close rates would improve in the back half of the year?

Hank Jallos, President and COO, Products

Yes.

Aaron Schwartz, JP Morgan

And then shifting to IBM, they have sort of talked a little bit more about their investment in systems management software for the Mainframe, I’m just wondering what your thoughts were around that and if that is an area where you think you could partner with them or going forward, or is that going to be more competitive?

Hank Jallos, President and COO, Products

On the systems management stuff, we’re working with them on their internal operations for global services as well as a bunch of client engagements. It’s a different cell because they tend to think that they can solve all the customer’s problems where we can provide a lot of information even passing onto…etc., but we’ll have to wait and see. We’ll know a lot more in the next two quarters.

Aaron Schwartz, JP Morgan

Okay, great, and then in terms of their Mainframe business, they’ve talked a lot about the mid market and emerging markets for just actual Mainframe hardware growth and I’m just wondering where you think you are in terms of distribution and sales presence in those two areas?

Hank Jallos, President and COO, Products

In the Mainframe space?

Aaron Schwartz, JP Morgan

Yeah, in emerging markets and the mid market, do you think you’d have to invest more there to capitalize on that?

Hank Jallos, President and COO, Products

We continue to think we have best of breed in all those solution areas. With this recent announcement to make the Mainframe platform easier to use if you will over time, we still think regardless we will be the leader in all those areas, in fault management, file and data management, and we’ll have the premium offering and continue to make it easier to use.

Aaron Schwartz, JP Morgan

Okay, I guess was referring more to the sales side especially in terms of emerging markets, is that an area you’d like to capitalize on and do you have the sales presence here to do that?

Hank Jallos, President and COO, Products

Yes we do.

Aaron Schwartz, JP Morgan

Okay and the last question I have is on the services business. The billable head count is continuing to decline, I’m just wondering if that is in any particular verticals or regions and if that is natural attrition or not and what the plans are there for head count?

<Andy Trestrail, President and COO, Professional Services

You know, it’s not in any particular region, although Michigan has been our most challenged region. We have aggressive plans to continue to hire and add head count into our operation. We have needs that are there in our pipeline for candidates and we’re going to continue to aggressively pursue those candidates in the market and bring them on. That is part of our strategy in showing off the business and making sure that we could deliver more positive results.

Aaron Schwartz, JP Morgan

Okay, thanks for taking my questions.

Operator

Thank you Mr. Schwartz, and next representing Planning Alternative let’s go to the line of William Banover, please go ahead sir.

William Banover, Planning Alternative

Yes, can you identify where Covisint would appear on the income statement?

Laura Fournier, SVP and CFO

Covisint is included in revenue and services cost.

William Banover, Planning Alternative

Thank you.

Operator

And with that Ms. Elkin there are no further questions, I’ll turn the call back to you for any closing remarks.

Lisa Elkin, VP Communications and Investor Relations

Thank you very much. At this time, ladies and gentlemen we will adjourn this conference call. Thank you very much for your time and interest and we hope you have a wonderful evening. Thank you.

Operator

And ladies and gentlemen your host is making today’s conference available for digitized replay. It’s for one full week starting at 8:30 p.m. Easter Daylight time October 26th all the way through 11:59 Eastern Standard Time November the 2nd. To access AT&T Executive replay service, please dial 800-475-6701. At the voice prompt enter today’s conference ID, 840562. Internationally please dial 320-365-3844, again with the conference ID of 840562. And that does conclude our call for this quarter. Thank you very much for your participation as well as for using AT&T’s executive teleconference service, you may now disconnect.

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Source: Compuware F2Q07 (Qtr End 09/30/06) Earnings Call Transcript
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