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Compuware Corp (CPWR - Analyst Report) reported third-quarter fiscal 2014 earnings of 15 cents per share, which beat the Zacks Consensus Estimate by 3 cents.

Non-GAAP earnings (including stock based compensation) grew 25.0% from the year-ago quarter. The strong year-over-year growth was primarily driven by lower cost and improving margins. Moreover, in the third quarter, the company added more than 300 net new customers, which is a clear indicator of strong market share gains.

Revenues

Revenues decreased 2.9% from the year-ago quarter but increased 10.0% on a sequential basis to $250.5 million. However, revenues missed the Zacks Consensus Estimate of $257.0 million.

The year-over-year improvement was primarily driven by strong performance at segments like APM (up 11.2%), Covisint (up 1.1%), Professional services (up 4.3%) and Changepoint (up 4.2%), which offset tepid growth at the Uniface (down10.8%) and Mainframe (down 18.8%) segments.
 
Management stated that dynaTrace is continuously gaining market traction as an APM product. The product continues to provide significant competition to solutions from the likes of CA Technologies (CA - Analyst Report) and Hewlett-Packard (HPQ - Analyst Report).

Compuware’s top-line growth also gained from robust performance of other APM products, namely, Gomez Performance Network and Data Center Real-User Monitoring solution.

Although the Mainframe business reported a year-over-year decline in the third quarter, management believes it is stabilizing and has significant growth opportunities going forward.

Regarding Professional services, Compuware remains cautious due to macroeconomic headwinds in the market.

Margins

Operating expenses as a percentage of revenues declined 230 basis points (bps) from the year-ago quarter and 850 bps from the previous quarter. Operating expenses exclude restructuring expenses, amortization of purchased software, and amortization of acquired intangible assets but include stock-based compensation.

APM’s and Changepoint’s contribution margins were 20.0% and 3.3% respectively in the quarter. Mainframe’s contribution margin was a healthy 76.0% while Uniface’s contribution margin went down 720 bps from the year-ago quarter. Professional services contribution margin rose 300 bps from the year-ago quarter.

Non-GAAP operating margin improved 230 bps from the year-ago quarter to 17.7% due to lower-than-expected rise in operating expenses. Net income margin went up 440 bps from the year-earlier quarter to 13.7%.

Balance Sheet

At the end of the third quarter of fiscal 2014, cash and cash equivalents amounted to $108.9 million, up from $50.4 million in the previous quarter. There was no long-term debt at the end of the quarter.

Outlook

For fiscal 2014, Compuware expects revenues in the range of $915.0–$925.0 million. However, management reiterated its non-GAAP earnings outlook, which is expected to be in the 47–49 cents per share range. However, the Zacks Consensus estimate for fiscal 2014 stands at $0.38 per share, which happens to be lower than the mid-point of the management guidance range.

Management expects to increase the cost saving target to $110.0–$120.0 million from the previous target of $80.0–$100.0 million, to be achieved in fiscal 2015. Compuware expects APM to grow 9.0% in the fiscal year.

Recommendation

Compuware reported mixed third-quarter results. Management also slashed its revenue guidance primarily due to sluggish IT spending and challenges in Europe. Compuware operates in an intensely competitive landscape and competes with the likes of IBM Corp (IBM - Analyst Report) with respect to one or more offerings.

Nevertheless, we believe that Compuware’s innovative product pipeline, initiatives to reduce costs and new program wins will boost profitability going forward. Recently, Compuware is concentrating more on cost rationalization methods such as divesting some of its low profit churning businesses like Changepoint, Uniface and Professional Services segments in an attempt to enhance profitability.

Currently, Compuware carries a Zacks Rank #3 (Hold).

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