Compuware Corporation F1Q08 (Qtr End 06/30/08) Earnings Call Transcript

| About: Compuware Corporation (CPWR)

Compuware Corporation (NASDAQ:CPWR)

F1Q08 Earnings Call

July 23, 2008 5:00 pm ET


Lisa Elkins – Vice President of Communications and Investor Relations

Robert C. Paul - President and Chief Operating Officer

Laura L. Fournier – Executive Vice President and Chief Financial Officer

Jason Vines – Senior Vice President, Chief Communications Officer


Kirk Materne – Banc of America Securities

Aaron M. Schwartz, CFA – JP Morgan


Welcome to the Compuware Corporation’s first quarter results teleconference. (Operator Instructions) At this time I’d like to turn the conference over to Lisa Elkins, Vice President of Communications and Investor Relations for Compuware Corporation.

Lisa Elkins

With me this afternoon at Compuware is Executive Vice President and Chief Financial Officer Laura Fournier. Joining us by phone from the Fortune Brain Storm Tech Conference is President and Chief Operating Officer, Bob Paul and Jason Vines, Chief Communications Officer. Compuware Chairman and CEO, Peter Karmanos, is recovering very well from a recent surgery and could not join us this evening.

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 Corporation posted year-over-year increases in revenue, earnings and operating cash flow. Compuware continues to roll as mainframe; Vantage and Change Point license revenues grow significantly. Compuware today announced final financial results for its first quarter ended June 30, 2008.

Compuware reports first quarter revenues of $298.6 million, up from $279.4 million in the same period last year. Net income was $34.7 million in Q1 up from $189,000 in the first quarter last year. Earnings per share diluted computation were $0.13 compared to break even in the same period last year based upon 261.1 million and 305.6 million outstanding respectively.

During the company’s first quarter software license fees were $61.5 million compared to $47.3 million in Q1 last year. Maintenance fees were $126.5 million in Q1 compared to $113.7 million in the first quarter last year. Revenue from professional services in the quarter was $110.6 million compared to $118.4 million in the same quarter last year.

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

Robert Paul

Compuware delivered a strong Q1. Nearly 7% increase in year-over-year revenue paired with disciplined expense management and focused sales and marketing efforts spurred dramatic increases in earnings and income from operations.

Q1 featured meaningful revenue increases at the core of Compuware’s growth engine, license fees for Vantage, Change Point and mainframe tools. These solutions, particularly when combined with our professional services helped businesses and IT leaders solve their most pressing business problems.

Our customers and target markets today face a powerful conversion of technology and business forces. Computing, while becoming more efficient, is forced to support both global operations and strategic web-based initiatives. As a result the IT landscape is vastly more complex and Compuware is best in class at delivering end-to-end performance.

These pressures on IT are creating more demand for both our mainframe and distributed solutions. We believe we will continue to see growth even in the down economy because solving these problems reduces operational costs and delivers substantial IT value for our customers. We are working to achieve future break out growth by doubling down on these key differentiated areas that will further separate us from our competition.

As a fellow Compuware shareholder I think you should be pleased not just by our strong Q1 but by the opportunity Compuware has to help IT organizations around the world optimize their performance and get the most value out of their IT operations. The fundamental difference between us and our competition is we believe the category in which we participate of Business Service Management should be about proactive monitoring of IT performance rather than about capturing and resolving IT issues after the problems have occurred and the damage has been inflicted.

We will make the current positioning of the Business Service Management category obsolete in the years to come. So our success this quarter came through some important operational improvements implemented by our Compuware 2.0 initiative but the best is yet to come.

We have strategic efforts underway to leverage these assets in these market opportunities to create greater consistency moving forward. In this regard mainframe software continues to provide a foundation for our success. We will continue to invest in robust product enhancements to keep these solutions the leaders in our markets. We are also enhancing the technical and market backbone advantage and change point while growing the respective sales forces.

I expect to see an ongoing up trend in the results of these important solutions especially in the last half of the fiscal year. As for Covisint, revenues came in at $8.8 million for the quarter whilst under contract backlog, a key indicator of future revenues grew 12% year-over-year. In terms of the verticals the automotive business is holding up during a significant transformation in that industry while the healthcare business continues to grow along with the public sector.

Customer wins for Covisint in Q1 included an important contract with Minnesota for a statewide healthcare information exchange, our second such statewide win. We expect to see revenue growth from both Tennessee and Minnesota in the coming quarters. Also in the quarter Covisint partnered with ATT and Microsoft to offer a secure health information exchange through ATT’s network services and Microsoft’s HealthVault. This is a great opportunity for us to more effectively scale this business model.

Finally, we have completed much of the work necessary to prepare for the Covisint IPO. We will continue to plan for the offering with Covisint’s healthcare and business matures and market conditions allow.

Our increased professional services focused on delivering full product offerings to our recently created Solutions Delivery Group. It is starting to have a positive impact. By focusing services around Compuware products the Solutions Delivery Group has substantially increased product related revenue in Q1 particularly in North America. Long-term I believe this strategy will allow Compuware to choose the work that will be of most value to our customers while increasing our margins and profitability. As Compuware continues to invest in these businesses where we can be best in the world we are also working on aligning our internal processes to drive greater efficiencies.

We are hiring sales and technical staff where we need them. We see no degradation of our revenue even in tough market conditions. I believe that reference-based customers with a demonstrable return on investment are the backbone of market share growth. To that end we will launch the Customer Care Organization to more effectively protect customer relationships and maintenance revenue.

This organization will also identify and leverage reference customers and deliver ROI cast studies. This activity will provide a powerful lever for additional sales. We continue to have a strong response from our customers around our premium license program. The program reduces the risk of capacity increases for some of our largest customers. It also removes conflict from negotiations and provides strong relationship points for which Compuware can discover additional up selling opportunities for Solutions such as data privacy and mix management offerings.

Obviously I am very pleased with our Q1 performance. Compuware successfully delivered a good quarter while continuing to establish Compuware 2.0 framework and strategy for much better quarters to come. Having said that we have a lot of work to do. But I know we have the people and technical assets we need to make Compuware a leader in a number of important and growing markets.

In the coming quarters we will continue to focus on consistently meeting our near-term revenue objectives while implementing the long-term strategies that will ensure Compuware takes advantage of its immense opportunities for revenue and market capitalization growth.

Laura Fournier

Compuware produced a strong financial start to the fiscal year. We increased software license fees by 30% and maintenance revenues by 11.2% year-over-year. Total product commitment, the sum of all software sales activity in the quarter, increased substantially to $167.4 million from $110.2 million in Q1 last year. Operating cash flow was $47.8 million up from $37.8 million in Q1 last year.

With an excellent Q1 behind us and a strong balance sheet in our arsenal, Compuware continues to expect robust earnings growth in the 20-30% range for the year. We anticipate overall revenue growth of 5-10% for the year with operating cash flow coming in at approximately $250 million. We will also continue to manage our costs in a responsible fashion and actively pursue further cost cutting opportunities.

One item to note is that the professional services revenue did decrease 6.6% compared to Q1 last year. In the short-term we expect services revenue to decline as the business continues its transition to a more product focused model. We will augment these expected operating results through an ongoing commitment to our buyback program.

During the first quarter Compuware purchased 6 million shares of the company’s stock for approximately $58.9 million. The company has approximately 670.5 million remaining under the current authorization for further buybacks.

As Bob noted, we have achieved some impressive short-term goals. Now we plan to continue increasing our focus and clarifying our strategy around those businesses where we have the technology and the people to stake a market leadership position and deliver breakout growth.

Lisa Elkins

We will now be happy to take your questions.

Question-And-Answer Session


(Operator Instructions) Your first question comes from Kirk Materne – Banc of America Securities.

Kirk Materne – Banc of America Securities

Bob can you talk a little bit about just the premium license? Any activity you had in that this quarter and was that a factor in some of the strong results or are you just really starting to scratch the surface of that opportunity with your customers on the mainframe side?

Robert Paul

I think the answer to both questions there is yes. We did have some good new contracts and new engagements with customers in premium licenses so it is clearly hitting its mark. I’ll defer to Laura on the exact numbers if you need those but they were a component of the Q1 success as we predicted. But we still are really touching the tip of the iceberg and relates to the total potential market for the premium license program in coming quarters. I think you’ll see a steady activity as we get very strong in positioning, the value creation and the delivery of the premium license programs with the rest of our existing customers.

Kirk Materne – Banc of America Securities

Maybe just a follow-up to Laura’s point on the drop in services. I assume the drop in service revenue is going to continue to be planned and that is really what you are swapping out a lower margin business for a higher margin business. Is that what we should be expecting going forward?

Robert Paul

That is exactly right. There are a couple forces at work here. Number one, obviously we are getting a lot more strict about adding services to the overall contracts to deliver the value with our software licenses. We think that is an important part of growing a successful, value based business with our customers and to unlock that value we need those services. So we will start to see a dramatic increase in what we call the Solutions Delivery Group which will make an increasing percentage of the overall professional services.

The other thing is that we are doing more training on project based work around our core competencies. So it is not like the professional services business is going to go away. We are still focused on delivering high value services but more in line with some competencies we have in the business so we can again be known as best in the world in those areas. Your assessment is correct. We are being a lot more judicious about what kinds of things we are getting involved with as it relates to type of work and margins expected.

Kirk Materne – Banc of America Securities

Lastly, I know you went through a change in the revenue recognition on that business. When do you see that starting to phase out and the revenue starting to up tick again? Will it start in the next couple of quarters with deals like Tennessee and Minnesota or is that something we should be thinking in the December or March quarter of 2009?

Robert Paul

Our expectations are you will start to see increase in revenue immediately. It is a very conservative and proper revenue recognition policy that is in place. Almost everything now is amortized over five years. The important thing about Covisint is we are building a long-term, value based business. There is no rush, no need on our part to go launch the IPO.

I think now with more stability around the revenue recognition that we understand. I think the business around the healthcare and public sector markets will start to aggressively grow as we start to get more and more reference ability around those markets and we will weather the storm in the automotive industry. None of our customers are going away because we provide mission critical services. I think you will start to see the up tick come back. It might not be as aggressive as we thought. In fact we are looking forward to making an announcement in the coming weeks about another statewide engagement and will hopefully see some revenue from this quarter.


Your next question comes from Aaron M. Schwartz, CFA – JP Morgan.

Aaron M. Schwartz, CFA – JP Morgan

I have a couple of follow-up’s around the premium licensing program. Can you just walk through what a typical deal cycle is like and I know you are very new at this program. You seem to be quasi-type deal agreements and I’m just wondering given the macro backdrop what the conversation or engagement is like with the customer.

Robert Paul

Typically we will engage now, in fact part of the Customer Care Organization is designed to make sure we are engaging 3-6 months ahead of any maintenance renewals. That group in conjunction with our existing sales force has a dialogue with our customers around protecting them from mix increases. Any customer that is looking to or believes that their capacity on their mainframe will grow over the next couple of years we are basically locking them into a long-term agreement and protecting them from increased prices with traditional mix capacity.

It drives great value for our customers. It takes away a contentious issue of them paying us typically more money just because they are increasing the computing part of the mainframes and probably most importantly it allows us to have a dialogue around other value-based solutions we are now offering in the mainframe environment.

Then finally as we talk about the solutions we are very uniquely differentiated in the ability to deliver both distributed and mainframe solutions in the same environment solving a much bigger problem.

So number one we are getting in there. Number two it is a value-based discussion with the customer that protects them. Number three it gives us an opportunity to have a much more strategic discussion with our customer base.

Aaron M. Schwartz, CFA – JP Morgan

In terms of just looking at that program and maybe the risk in seeing deal delays given the macro backdrop is it because it is more of a renewal it alleviates that risk a little bit to where the customer has to do something with you because they have an expiration on their prior contract or is there anything there that protects you from seeing deal delays on what could be potentially sizeable transactions?

Robert Paul

I don’t think there is a….before I would have said that would have been a concern, a deal delay. Two things that are coming into play now is number one we are getting out in front of it. We understand what our customer base looks like and where these contracts come in for renewal. Number two in the first quarter, which was last quarter, not Q1 but Q4 of last year and a little bit in Q3 we were really honing in on what the discussion needed to be to create the best impact for our customers.

So I think we are a lot better at the discussion than we were in the beginning and as long as we stay out in front of it and we have these very focused operational targets with our sales organization if there are delays they will be few and far between.

Aaron M. Schwartz, CFA – JP Morgan

A follow-up on the services line. Is that an area where you think you can take cost out as quickly as the revenue is coming out or is this really the cost structure we should be thinking about in the balance of the year?

Robert Paul

The cost structure is pretty plain. The cost structure will decline as some of the generic technical services we are engaged in starts to decline also. It does decline. Having said that we have this gray area between what do we mean by project work and technical support. So what I think will happen is that if there is an overall decline, which we are forecasting right now, it will be slow but we are also expecting our margins to increase during the same time period. That is because the new business that will make up for the old business will be better margin, more clearly defined and we think delivering higher value.

It is going to take some time globally to have an entire services organization aligned around the project work and core competencies we are talking about but it will be a steady transition that you will see moving forward.

Aaron M. Schwartz, CFA – JP Morgan

Just looking at the margin structure, the operating margin structure for the June quarter it seems like the 2-2.5% margin expansion goal for the year now looks on the conservative side. I don’t know if you have any comments around how we should be thinking about that for the balance of the year?

Robert Paul

We’re not really changing guidance. I think we are optimistic about it. One of the great things about the 2.0 initiative is by having a very clearly articulated business plan with a lot of work going on around alignment of key operations in the business plan we are finding opportunities to take cost out of the business and in some cases reinvesting that.

So, Laura I don’t know if you want to add any color to that, but I think we are optimistic about being able to improve on those numbers but we are not giving any additional guidance at this point.

Laura Fournier

The only thing I would add Aaron is that keep in mind Q1 and Q2 are our slowest quarters from a revenue perspective. So as momentum builds throughout the year a lot of that revenue is other than commissions and bonuses dropped straight to the bottom line. So I think you see the pick up on that in Q3 and Q4.

Aaron M. Schwartz, CFA – JP Morgan

Lastly, in terms of your receivables it looks like DSO’s maybe ticked up a little bit there. Was there anything that happened there in the quarter or would you expect receivables to pick up in Q2 and Q3?

Laura Fournier

There was a slight increase in some overnighted receivables in Q1. It was in Europe and we have already addressed it and most of it has been collected. So while you see a little up tick there it should go back to normal levels.


We will now conclude the question-and-answer portion of today’s conference call.

Lisa Elkins

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.

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