Compuware F3Q07 (Qtr End 12/31/06) Earnings Call Transcript

| About: Compuware Corporation (CPWR)
TRANSCRIPT SPONSOR
Better Than AdSense
Click to enlarge

Compuware Corporation (NASDAQ:CPWR)

F3Q07 Earnings Call

January 25, 2007 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

Analysts

Kirk Materne - Banc of America Securities

Aaron Schwartz - J.P. Morgan

Kevin Buttigieg - A.G. Edwards

Presentation

Operator

Hello and welcome to the Compuware Corporation Third Quarter Results Teleconference. At the request of Compuware, this conference is being recorded for instant replay purposes.

At this time, I would like to turn the conference over to Ms. Lisa Elkin, Vice President of Communications and Investor Relations for Compuware Corporation. Ms. Elkin, you may begin.

Lisa Elkin

Thank you very much, Doug, 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 earns $0.11 per share in Q3. Distributed products license fees increased 10.5% year-over-year.

Compuware today announced financial results for the third quarter, which ended December 31, 2006. Compuware reports third quarter revenues of $315.1 million compared to $305.9 million in the third quarter of the previous fiscal year. In the quarter, Compuware produced net income of $36.5 million. Compuware earned $0.11 per share diluted computation in Q3 compared $0.10 per share in Q3 of fiscal 2006 based upon 343.1 million and 388.3 million shares outstanding respectively.

During the company's third quarter, software license fees were $86 million compared to $83.3 million in the same quarter of fiscal 2006. Maintenance fees were $114.4 million compared to $107.6 million in Q3 of the previous fiscal year. Professional services fees were $114.7 million compared to $115 million in the third quarter last year.

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

TRANSCRIPT SPONSOR

Better Than AdSense

What if there was a way to promote your company to a perfectly targeted group of potential customers, partners, acquirers and investors? What if you could tailor your pitch to them at the moment of maximum interest? And what if you could do this for a no-brainer price?

This is exactly what Seeking Alpha is offering with transcript sponsorships.

Seven types of companies are sponsoring earnings transcripts on Seeking Alpha:

1. Company sponsors its own earnings call transcript (example).

2. Company sponsors partner's transcript (example).

3. Company sponsors competitor's transcript (example).

4. Issuer-sponsored research firm sponsors client's transcript (example).

5. Investment newsletter sponsors transcripts of successful stock picks (example).

6. IR firm sponsors transcript of micro-cap company (example).

7. Consulting company sponsors company's transcript in sector of interest (example).

Your company's name and promotion could have been on this transcript! Learn more, or email Zack Miller for details.

Click to enlarge

Laura Fournier

Thank you, Lisa. The third quarter saw strong results across Compuware's key lines of business. We are encouraged by the continued double-digit growth in distributed products license revenue and by the rebound in Mainframe license fees. Further emphasizing the quality of this increase in software license revenue Compuware deferred more license revenues than it recognized in the quarter. Maintenance revenue was also very strong this quarter. While professional services results were modestly lower year-over-year, we remain optimistic about the pipeline and about the long-term potential of that business.

The company's cash flow and balance sheet remained strong. Operating cash flow for the third quarter came in at $20.8 million. For the year, we continue to expect cash flow from operations to be around $200 million. As of December 31st, our cash and investments totaled approximately $590 million. As with last quarter, the reduction in the company's cash and investments is primarily related to Compuware's aggressive stock buyback program. During Q3, Compuware purchased approximately $250 million of Compuware stock or 25.5 million shares. Year-to-date for fiscal year '07, we have purchased approximately $405 million of Compuware stock or 51.8 million shares. We will continue to repurchase shares for the remainder of the fiscal year. You may notice an increase in the company's G&A expense line. The primary reason for this increase is a onetime contribution of $5 million from Compuware to the Detroit Riverfront Conservancy. We believe this donation will not only support a worthy cause, but also further strengthen Compuware's relationships and business partnership with key municipal and business organization based in Detroit.

In terms of guidance, we expect the company will generate EPS for the fiscal year just below the low-end of our previously provided range. Our distributed license numbers continue to show growth momentum. We expect the revenue growth percentage to trend towards the high-teens or low twenties for the fiscal year. Compuware's mainframe license revenue continues to track to our guidance, which was flat for Q3 and Q4, compared to the last six months of fiscal year '06. Please keep in mind that it has historically been the case, the mainframe software business remains somewhat unpredictable.

We continue to expect professional services revenue for the year to be relatively flat with margins in the 10% to 11% range. In terms of Compuware's, overall margin and expense structure, the company is taking a hard look at expenses across the board as we move forward with planning for fiscal year '08. We expect that you will start to see improvement in overall margins in the next fiscal year. I will now turn the call over to Hank.

Hank Jallos

Thanks Laura. Highlighted by year-over-year as well as significant sequential growth in distributed license sales, we are pleased with the overall performance of the products division in the third quarter. Even more encouraging is the fact that this growth led by Compuware's two primary distributed products both Vantage and Changepoint. Vantage continues to perform well and we see no reason why this trend should not continue going forward. In fact, we are confident that the Vantage growth will strengthen, particularly in light of the recent acquisition of Proxima Technology. With this acquisition, Compuware added business service management capabilities to our already powerful Vantage solution, opening up a new capability for a very large worldwide customer base. We are very excited that the Proxima Technology assets and the organization are now part of Compuware. This acquisition is very important as we grow and transition our products business to be more focused on higher value solutions. We are equally encouraged by the performance of the Changepoint solution which experienced strong sequential growth and outstanding year-over-year growth.

During the quarter, we added several new enterprise clients to our growing list of Changepoint customers and that pipeline remained strong. As you can see from the numbers, mainframe license performance was flat year-over-year at $47.9 million while growing nearly 71% sequentially. North America did well due in large part of strength our relationship with our customers and the renewals of our ALAs. Central Europe in our international business also performed very well. Competition in the mainframe market remains intense, but we continue to be successful by promoting the value of our solutions that we deliver. We've experienced success and are seeing a great deal of opportunity with our data privacy solution. And we are already seeing a significant interest in our recently announced application audit offering.

For the fourth quarter, we anticipate mainframe license sales coming in relatively flat year-over-year but as always we remain cautious in our forecast due to the inherit choppiness of this business. Maintenance renewals continue to be a source of strength for the company as our client regularly renew their maintenance contracts with both mainframe and distributed products. Our maintenance revenue increased 6.3% for the quarter.

Our third party channel partners also remained a very important part of the company's strategy. During the quarter, partners contributed or influenced approximately 34% of the total distributed revenue. During the quarter, we made significant progress with our test factory solution and closing a partnership agreement with Atos Origin. The agreement enables Atos Origin to execute their strategic initiatives to industrialize their QA delivery facilities by implementing the Compuware test factory. This multi-million, multi-year agreement enables Atos to deploy the test factory solution throughout their global organization with the first deployments beginning in UK and France.

And, now I would like to turn it over to Andy.

Andy Trestrail

Thanks, Hank. Compuware Professional Services revenue and contribution margin for the quarter were relatively flat, both sequentially and year-over-year as the business continues to stabilize. We remained focus on executing our growth strategy, both in terms of revenue and margin. As I've previously discussed, the strategy revolves around delivering higher margin value-added and product-related services, and we are making progress on this front. For example in Q3 we signed an agreement with a large airline in the Asia-Pacific region to deliver our cards offering which will instill visibility, traceability and process control into our clients application quality efforts. This win is a tremendous example of how Compuware can provide a complete solution which includes products, services and partner collaboration. I want to mention that we beat out two large providers both with this bid with the key QA competitor. We also are extremely optimistic about how our test management solution will help deliver our services growth strategy.

Hank already mentioned from a partner perspective that Atos Origin has invested in a Compuware test management solution, but there is a services side of the story as well. Compuware will also provide Atos with significant services support to help them implement the solution again another example of the complete solution Compuware can provide and the synergy of our products and services business. We are also seeing increasing interest in our data privacy and legacy modernization solutions which have the potential to become substantial growth drivers for us. Many customers are faced with significant risk from these fronts and our unique solutions ensure both quality and security while reducing their total cost of ownership. Finally across the spectrum of our services portfolio the sale pipeline is strong and growing and we fully expect to see stronger results from this progress.

Thank you. Bob.

Bob Paul

Thanks Andy. Compuware closed and achieved 83.8% year-over-year revenue growth this quarter. Its impressive results were supported by the accomplishments in major delivery milestone. These included completing the GM Global Supply Communication Systems, live on the GMAC Employee Portal System and successfully launching the Blue Cross Blue Shield of Michigan and Delphi Security platforms. Furthermore Covisint went live on the global JCI Supplier Portal Platform and successfully initiated the first phase of a strategic security program with the United States Department of Justice. All of these projects will drive future subscription revenue.

As for new customers, Covisint gained some additional strategic accounts in the automotive which is in logistics vertical market this quarter. These new customers included household names which is Volkswagen of America, [Penski] and Cooper Standard as well as a number of smaller suppliers. Covisint penetration of the healthcare vertical continues to increase and this market shows great promise for our business. On the heels of winning the Best Demonstration of Value and Return on Investment Award at the Gartner Healthcare Summit, we signed a number of new strategic customers. Among these are the largest physician practice in the State of Michigan. The biggest Health System in Houston, Memorial Hermann and the First Health Information Exchange in Minnesota which represents the largest payers and providers in Minneapolis. In addition to these substantial regional successes, Covisint signed a national contract with Cigna and also expanded a number of users with some existing customers such as Blue Cross Blue Shield at South Carolina, which now has more than 1000 registered users on the Covisint platform. All of these initiatives will continue to grow in scope and in revenue and profit contributions. I believe that Covisint is uniquely well positioned for what I expect to be a revolution in the flurry of healthcare over the next five to ten years. Given these successes and a strong pipeline of opportunities, I expect continued strong growth for Covisint in Q4. Lisa

Lisa Elkin

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question of the day comes from the line of Kirk Materne with Banc of America Securities, please go ahead.

Kirk Materne - Banc of America Securities

Yes thanks very much. Laura can you just give I know you probably can't give the exact timing but can you just give us some qualitative ideas about when you might be coming back to the street to discuss some of the expense structure, thoughts that you guys might be thinking about right now and any plans around that for fiscal '08 with the speed not until May or could it be before then I guess it would be my question?

Laura Fournier

We haven't considered any special conference call before them, but we could talk about it if I may we certainly will have our plan in place for next fiscal '08. We have a committee going right now that is working looking at processes across the company and where we can do some cost cutting both at a short and long-term and by that time once we get this plan in place so to be more defined then we can talk to you about them.

Kirk Materne - Banc of America Securities

Okay and maybe Andy you talked about getting the contribution margin out on the services side clearly I think behind where you guys would like it right now. I guess how far you from seeing that turn because I think previously you guys have been guiding or not guiding but hoping to get towards that 18% to 20% range I mean is there still a year out or do you expect to see some turn as we get sort of right into the beginning of '08?

Andy Trestrail

I think it’s a -- we will start to see some progress on this as you can expect again, it’s a large chunk of revenue and seeing the amount or the percentage of it changed significantly requires a lot of change in the revenue and the margin of the business, but we are confident that the types of business that we are pursuing and the types of transaction that our sales organizations are bringing in are all parts of indicators that will begin to make progress in this front.

Kirk Materne - Banc of America Securities

Okay. And then just finally, I don't know who would best answer this, either Bob or Laura I guess. But at what point of time does it makes sense for you guys to start showing some of the growth in Covisint on its own in terms of the revenue contribution, just because its seems that that versus say, I imagine still not profitably and Bob, you can correct me, but it seems as that might be also holding down a little bit. I'd imagine the profitability of Covisint in the professional services group should be looked at perhaps separately?

Bob Paul

Well, it's a discussion that we continue to have. And the issue is not the profitability one versus not profitable. The issue is, is it a substantial piece of the -- substantial not piece of the business where warrants are breaking out. I suspect that we'll have a very real look at this again as we start to enter the next fiscal year and it will be a discussion of the next planning session that we have at Compuware. So, no indications yet, but I’m hopeful that it's not far away.

Kirk Materne - Banc of America Securities

Okay. Thanks very much.

Laura Fournier

Thank you.

Operator

(Operator Instructions). Our next question is from the line of Aaron Schwartz representing J.P. Morgan.

Aaron Schwartz - J.P. Morgan

Good afternoon. Congratulations on the nice results.

Laura Fournier

Sure.

Aaron Schwartz - J.P. Morgan

Just a good question on the quarter. It seems like you had a lower tax rate, how should we look at that going forward? Do you expect that to rebound at the 31% level or should we sort of look at this lower rate going forward?

Laura Fournier

The primary reason for the lower rates this quarter was the reinstatement of the R&D tax credit. So, yes, next quarter the rate should go back up to the 31%, 32%.

Aaron Schwartz - J.P. Morgan

Okay, terrific. And then, on the maintenance side, can you talk about through the seasonality with renewals, it seems like December, a few years ago you saw a better performance in terms of the deferred revenue, it seems like now it's more or so to the March quarter and I'm just wondering if there is just a shift in how you see the renewals throughout your year?

Laura Fournier

Well, definitely the Q4 coming up as a high renewal quarter which show up in the Q1, and then Q3 was a high billing quarter which shows up in Q4. So, these are the higher bonds -- higher quarters for maintenance.

Aaron Schwartz - J.P. Morgan

Okay. And then, in terms of deferred, was there any currency impact on that in the quarter?

Laura Fournier

I don't -- there was some currency impact on the deferred license fees that was a couple of million dollars. I don't have it on the maintenance side of the total.

Aaron Schwartz - J.P. Morgan

Okay. On the Covisint set business, may be I could just follow-up on that. Now that you have a couple of initiatives live, should there -- should we look for any sort of change in the leverage you're getting out of that business in terms of the trajectory?

Bob Paul

Yeah. I believe that as soon as you get some referenceable -- strong referenceable, nationally recognizable accounts that can serve as a test bed for the value proposition that we're trying to demonstrate then things should turn. But there is another dynamic here too and that is, this is really an early market category for something new that's starting to -- just starting now to sweep the healthcare industry, and it has to do all of the national issue around security and interoperability. So, we think we've got two things going for us. Number one is, we're one of the early market leaders with some great national partners that we've got some referenced based accounts to point towards. And the second thing is, the category in the market itself is growing very, very rapidly. So, I would agree with your assessment that we should start to see some high trajectories in that business.

Aaron Schwartz - J.P. Morgan

Okay. And then, I had a question on Europe. It seems like from the results of [Professional] and the Mainframe side the sales execution improved in that region in the quarter. How much of that is attributable to may be seasonality relative to just a natural improvement in the sales execution? Did that sort of live up to your expectations?

Hank Jallos

It's improving, but not where we want. Central Europe did very well and our international business has some more good spots, but it improved. It had nothing to do with the seasonality, but there is lot of room for improvement.

Aaron Schwartz - J.P. Morgan

Okay. And the last question I have is on the repurchase activity in the quarter, can you help us out with how much was done on your discretionary plan relative to the 10b5-1 plan?

Laura Fournier

Under 10b5-1, we did 4.7 million approximately shares of $40.8 million. Under discretionary, we did 49 million shares of $381.6 million.

Aaron Schwartz - J.P. Morgan

Perfect, thanks for taking my questions.

Laura Fournier

Thank you.

Operator

Thank you. And our next question is from the line of [Ryan Cane] with A.G. Edwards. Please go ahead.

Kevin Buttigieg - A.G. Edwards

Hi, it's Kevin Buttigieg from A.G. Edwards. I was just wondering if you could talk a little bit about whether or not you received any contribution from the IBM settlement agreement in either of license revenues or in professional services revenues in this period?

Laura Fournier

We did some business with IBM in the normal course of business and with the Global Services Group I don’t recall the exact number. I would say it totals around $5 million, not more than that.

Kevin Buttigieg - A.G. Edwards

$5 million just on the services line?

Laura Fournier

No, that’s in the product side. And the same thing on the services side, we continue to do some normal services engagements there, but nothing new or significance on the services side.

Kevin Buttigieg - A.G. Edwards

And both of those would really fall under the preview of settlement agreement or is it different from that when describe this being in the normal course of business? I'm a little bit confused as to whether or not that’s distinct from the IBM settlement agreement or not?

Laura Fournier

On the products side, it's going to be included in the settlement agreement.

Kevin Buttigieg - A.G. Edwards

Okay.

Laura Fournier

On the services side, there is really nothing to include. I mean there is -- they offer us business on the services side and we choose whether or not to take it.

Kevin Buttigieg - A.G. Edwards

Right.

Laura Fournier

So it's just a normal course. There is no settlement amount to apply it to.

Kevin Buttigieg - A.G. Edwards

Okay, I understand. And I was wondering if you could breakout for me what the percentage of the services business and the percentage of the total business is attributable to the automotive industry?

Laura Fournier

I'm sorry, we don’t have that information right here and that’s not something we normally give out.

Kevin Buttigieg - A.G. Edwards

Okay. Finally, I don’t know if you can comment on this now, but is there anything that you can provide us an update as far as the succession planning that was talked about a year ago or so now. I believe that there are some dates coming up for that?

Laura Fournier

I think everything is going along as it has been for the last few quarters, Pete remains involved in the business. We -- as we look, the OC is still intact, we are pretty much going along as we had for the last few quarters.

Kevin Buttigieg - A.G. Edwards

Okay, and are there external candidates under consideration as well or is it still mostly in internal candidate pool?

Laura Fournier

There is no external candidate at this point.

Kevin Buttigieg - A.G. Edwards

Okay thank you very much.

Operator

And thank you, our next question is a follow up from the line of Kirk Materne with Banc of America Securities, please go ahead.

Kirk Materne - Banc of America Securities

Yeah. Just -- Laura, can you just remind me under the IBM sell amount the product side that figures $40 million was do you all this fiscal year, I guess could you just tell us where you guys are and what's left to be recognized in the fourth quarter?

Laura Fournier

Kirk actually when we did the amendment, it was extended a year. So, this year we have $30 million.

Kirk Materne - Banc of America Securities

Okay.

Laura Fournier

And we are at about 20 right now.

Kirk Materne - Banc of America Securities

Okay and that can come in either through the top-line or through the other income line, correct?

Laura Fournier

Exactly.

Kirk Materne - Banc of America Securities

Okay. Thanks.

Laura Fournier

Sure, thanks.

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 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 and interest in Compuware, and we hope you have a pleasant evening.

Operator

And ladies and gentlemen that does conclude our conference for this afternoon. Thank you for your participation, you may now disconnect.

TRANSCRIPT SPONSOR

Better Than AdSense

What if there was a way to promote your company to a perfectly targeted group of potential customers, partners, acquirers and investors? What if you could tailor your pitch to them at the moment of maximum interest? And what if you could do this for a no-brainer price?

This is exactly what Seeking Alpha is offering with transcript sponsorships.

Six types of companies are sponsoring earnings transcripts on Seeking Alpha:

1. Company sponsors its own earnings call transcript (example).

2. Company sponsors partner's transcript (example).

3. Company sponsors competitor's transcript (example).

4. Issuer-sponsored research firm sponsors client's transcript (example).

5. Investment newsletter sponsors transcripts of successful stock picks (example).

6. IR firm sponsors transcript of micro-cap company (example).

7. Consulting company sponsors company's transcript in sector of interest (example).

Your company's name and promotion could have been on this transcript! Learn more, or email Zack Miller for details.

Click to enlarge

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!