News Column

COMPUWARE CORP - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

May 30, 2014

In this section, we discuss our results of operations on a segment basis. We have two software segments, APM and Mainframe. We also have a platform-as-a-service ("PaaS") offering called Covisint or Application Services. These segments are described in detail in note 1 to the consolidated financial statements. Our business segment structure is intended to provide visibility and control over the operations of our business and to increase our market agility, enabling us to more effectively capitalize on market conditions and competitive advantages to maximize revenue growth and profitability. On January 31, 2014, we sold substantially all of the assets and transferred certain liabilities associated with our Changepoint, Professional Services and Uniface business segments. The results of operations of these segments during all periods presented have been included in discontinued operations in the statement of operations. The discussion in this report is focused on our continuing operations. See note 2 of the consolidated financial statements included in Item 8 of this report for additional information on the divestiture and the results of the divested business segments. We evaluate the performance of our segments based primarily on revenue growth and contribution margin which represents operating profit before certain charges such as internal information system support, finance, human resources, legal, administration and other corporate charges. References to years are to fiscal years ended March 31 unless otherwise specified. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and notes included in Item 8 of this report. 27 -------------------------------------------------------------------------------- Table of Contents FORWARD-LOOKING STATEMENTS The following discussion contains certain forward-looking statements within the meaning of the federal securities laws. When we use words such as "may", "might", "will", "should", "believe", "expect", "anticipate", "estimate", "continue", "predict", "forecast", "projected", "intend" or similar expressions, or make statements regarding our future plans, objectives or expectations, we are making forward-looking statements. Numerous important factors, risks and uncertainties affect our operating results, including, without limitation, those discussed in Item 1A Risk Factors and elsewhere in this report, could cause actual results to differ materially from the results implied by these or any other forward-looking statements made by us, or on our behalf. There can be no assurance that future results will meet expectations. While we believe that our forward-looking statements are reasonable, you should not place undue reliance on any such forward-looking statements, which speak only as of the date made. Except as required by applicable law, we do not undertake any obligation to publicly release any revisions which may be made to any forward-looking statements to reflect events or circumstances occurring after the date of this report. OVERVIEW



We deliver value to businesses by providing software solutions (both on-premises and SaaS models), software related services and application services that improve the performance of information technology organizations.

Our primary source of profitability and cash flow is the sale of our Mainframe productivity tools that are used within our customers' mainframe computing environments for fault diagnosis, file and data management, application performance monitoring and application debugging. We have generally experienced lower volumes of software license transactions for our Mainframe solutions in recent years causing an overall downward trend in our Mainframe product revenues which we expect to continue. Changes in our current customer IT computing environments and spending habits have impacted their need for additional mainframe computing capacity. In addition, increased competition and pricing pressures have had a negative impact on our revenues. Customers utilize our products to reduce operating costs, increase programmer productivity and create a smooth transition to the next generation of mainframe environment programmers. We will continue to make strategic enhancements to our Mainframe solutions through research and development investments with the goal of meeting customer needs and maintaining a high maintenance renewal rate. The cash flow generated from our Mainframe business supports our APM business segment. The APM market is a key source of future revenue growth. Web, mobile and cloud applications and the complex distributed applications delivery chain supporting them have become increasingly critical to a company's brand awareness, revenue growth and overall market share. Because of this development, the market for APM solutions is significant and growing rapidly. Our APM solutions provide our customers with on-premises software and SaaS platform based hosted software. These solutions ensure the optimal performance of each customer's enterprise, web, streaming, mobile and cloud applications. We are investing in our APM solutions with the goal of providing solutions that are best-in-class within the APM market. Specifically, our investments include: (1) enhancements to our global hosted software network with specific focus on ease of use, time-to-value and data analytics in mobile and cloud application performance capabilities and in video streaming performance; (2) enhancements to our solutions that are focused on optimizing application performance and accelerating time to market; and (3) enhancements which combine our on-premises software and SaaS solution into a single platform that provides performance metrics for web, non-web, mobile, streaming and cloud applications in a single solution. The secure collaboration services market, served by our Covisint application services, is also a key source of revenue. Technology has allowed business communities, organizations and systems to globally connect and share vital information, applications and processes across their internal and extended enterprises. Our Covisint services, which are provided on a PaaS basis to customers primarily in the automotive, healthcare and energy industries, create an environment that simplifies and secures this collaboration atmosphere. Our focus in the automotive and manufacturing industries is on enabling our cutomers to connect, engage and collaborate on mission critical business processes with their suppliers, customers and business partners. Our focus in the healthcare industry is on enabling hospitals, physicians and government entities to share electronic patient health and medical records. 28 -------------------------------------------------------------------------------- Table of Contents Annual Update



The following occurred during fiscal 2014:

APM segment revenue increased $26.8 million or 8.9% during FY14 as compared to

FY13. Contribution margin increased 761% from a negative $4.3 million to $28.4

million in the fiscal year ended March 31, 2014. See "Business Segment

Analysis" for additional information.

Covisint revenue increased $6.4 million or 7.1% during 2014 as compared to 2013

due to growth from recurring revenue of $9.7 million, partially offset by a

$3.3 million decrease in services revenue. Recurring revenue grew 17.1% while

services revenue declined 9.7%. Contribution margin declined to negative 23.8%

during 2014 from positive 5.1% during 2013 due to the increase in expense

primarily from stock compensation as a result of the Covisint initial public

offering ("Covisint IPO") and continued investment related to being a standalone public company.



Total Revenue declined $3.1 million during 2014 as compared to 2013 due to an

$8.0 million decrease in maintenance fees and a $2.7 million decrease in

service fees, partially offset by a $6.4 million increase in application

service fees and a $1.0 million increase in subscription fees.

Operating margin from continuing operations increased to 6.6% during 2014 as

compared to 5.9% during 2013 due primarily to a decrease of $19.0 million in

administrative and general expense, a $9.2 million decrease in technology

development and support expense, a $6.1 million decrease in cost of services

and a $4.6 million decrease in sales and marketing expense, partially offset by

a $33.9 million increase in cost of application services (see the "Business

Segment Analysis," section below for additional information).

Net income from continuing operations including non-controlling interest

increased to $38.2 million during 2014 as compared to $25.3 million during

2013.



On a GAAP basis, earnings per share from continuing operations increased 58%

from $0.12 to $0.19 in 2014 as compared to 2013.

On a non-GAAP basis, excluding stock compensation expense, amortization of

purchased software and other acquired intangibles, restructuring charges,

certain advisory fees, impairment of goodwill and the gain on the divestiture

of the Changepoint, Professional Services and Uniface business segments,

earnings per share increased 25 percent in 2014 as compared to 2013. See the

"GAAP to non-GAAP Reconciliation" section below for a complete reconciliation

of operating income.



Realized $56 million in corporate and shared services expense reductions - 25%

higher than the top end of our projection. These expense reductions are

reflected in our unallocated costs ($29 million) and in our business segment

operating expenses ($2.7 million).

Incurred $13.1 million in advisory fees associated with certain shareholder

actions and our business transformation initiative.

Incurred $12.0 million in restructuring costs related to continuing operations

as we move forward with our plans to eliminate a total of approximately $110

million to $120 million of administrative and general and non-core operational

costs as a result of this program. See note 9 of the consolidated financial

statements included in Item 8 of this report for more details regarding our

restructuring plan.



Declared and paid four quarterly dividends totaling $0.50 per share.

Divested substantially all of the assets and transferred certain liabilities

that primarily related to the Changepoint, Professional Services and Uniface

business segments for $112 million cash, which resulted in a gain of $9.5

million, net of tax.



Completed the initial public offering of 7.36 million shares of the common

stock of our subsidiary Covisint Corporation on October 1, 2013. The shares

began trading on the NASDAQ Global Select Market on September 26, 2013, under

the symbol "COVS". Compuware currently owns 80.03 percent of Covisint's outstanding shares. On May 22, 2014, we announced our intention to begin exploring the strategic separation of our APM and Mainframe business segments. We believe such a separation would allow the management teams of both segments to be fully focused on the operations of their specific segment, provide distinct investment opportunities to the investor community and provide appropriate incentives to assist in attracting and retaining talent for each business.



Our ability to execute our strategies and achieve our objectives is subject to a number of risks and uncertainties. See "Forward-Looking Statements".

29 -------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain operational data from the consolidated statements of operations as a percentage of total revenues and the percentage change in such items compared to the prior period: Percentage of Period-to-Period Total Revenues Change Fiscal Year Ended 2013 2012 March 31, (1) to to 2014 2013 2012 2014 2013 REVENUE: Software license fees 22.1 % 22.0 % 25.6 % 0.1 % (18.7 )% Maintenance fees 49.0 50.0 49.9 (2.2 ) (5.1 ) Subscription fees 11.2 11.0 10.0 1.2 4.7 Services fees 4.2 4.5 4.8 (8.2 ) (10.6 ) Application services fees 13.5 12.5 9.7 7.1 23.0 Total revenues 100.0 100.0 100.0 (0.4 ) (5.2 ) OPERATING EXPENSES: Cost of software license fees 2.8 2.6 2.2 7.0 15.8 Cost of maintenance fees 3.9 4.4 4.5 (10.2 ) (8.9 ) Cost of subscription fees 4.5 4.2 3.8 7.1 4.0 Cost of services 3.6 4.4 4.8 (19.2 ) (12.4 ) Cost of application services 16.3 11.5 9.5 40.6 15.1 Technology development and support 12.0 13.2 12.3 (9.6 ) 1.2 Sales and marketing 30.0 30.5 31.7 (2.1 ) (8.9 ) Administrative and general 18.6 21.1 20.2 (12.4 ) (0.4 ) Restructuring costs 1.7 2.2 (23.9 ) n/ a Total operating expenses 93.4 94.1 89.0 (1.3 ) 0.3 Income from continuing operations 6.6 5.9 11.0 12.9 (49.4 ) Other income (expense), net 0.5 (0.2 ) 0.2 381.0 (171.6 ) Income from continuing operations before income tax provision 7.1 5.7 11.2 24.0 (51.7 ) Income tax provision - continuing operations 1.8 2.2 2.9 (18.7 ) (27.7 ) Income from continuing operations, net of tax 5.3 3.5 8.3 50.9 (60.1 ) Income (loss) from discontinued operations, net of tax 4.2 (5.9 ) 3.3 170.3 (270.8 ) Net income (loss) including non-controlling interest 9.5 (2.4 ) 11.6 494.9 (119.5 ) Net loss attributable to the non-controlling interest in Covisint Corporation (0.5 ) 0.0 0.0 n/ a n/ a Net income (loss) attributable to Compuware Corporation 9.9 % (2.4 )% 11.6 %



514.9 % (119.5 )%

(1) As discussed in Note 2, we have treated the operations of certain business

segments as discontinued operations. The results for all periods have been

restated to reflect such treatment.

30 -------------------------------------------------------------------------------- Table of Contents BUSINESS SEGMENT ANALYSIS The following table sets forth, for the periods indicated, certain business segment operational data. We evaluate the performance of our segments based primarily on revenue growth and contribution margin which is operating profit before certain charges such as restructuring, internal information system support, finance, human resources, legal, administration and other corporate charges ("unallocated expenses"). The allocation of income taxes is not evaluated at the segment level. Comparisons are to the comparable period of the prior year. Financial information for our business segments was as follows (in thousands): Unallocated Total Expenses and Year Ended: APM MF Software AS Elimination (1) Total March 31, 2014



Total revenues $ 327,367$ 296,254$ 623,621$ 97,135 $

- $ 720,756



Operating

expenses 298,924 74,384 373,308 120,233



179,360 672,901

Contribution

/operating

margin $ 28,443$ 221,870$ 250,313$ (23,098 )$ (179,360 )$ 47,855 Operating margin % 8.7 % 74.9 % 40.1 % (23.8 %) N/ A 6.6 % March 31, 2013 Total revenues $ 300,533$ 332,677$ 633,210$ 90,694 $ - $ 723,904 Operating expenses 304,835 91,325 396,160 86,084



199,256 681,500

Contribution

/operating

margin $ (4,302 )$ 241,352$ 237,050$ 4,610$ (199,256 )$ 42,404 Operating margin % (1.4 %) 72.5 % 37.4 % 5.1 % N/ A 5.9 % March 31, 2012 Total revenues $ 270,443$ 419,317$ 689,760$ 73,731 $ - $ 763,491 Operating expenses 317,621 99,310 $ 416,931 72,717



190,030 679,678

Contribution

/operating

margin $ (47,178 )$ 320,007$ 272,829$ 1,014$ (190,030 )$ 83,813 Operating margin % (17.4 %) 76.3 % 39.6 % 1.4 % N/ A 11.0 %



(1) Unallocated expenses for fiscal 2014 and 2013 include $12.0 million and $15.8

million, respectively in restructuring expenses. See note 9 of the

consolidated financial statements included in this report for additional

information.



GAAP TO NON-GAAP RECONCILIATION

In an effort to provide investors with additional information regarding our results as determined by U.S. generally accepted accounting principles (GAAP), we have provided non-GAAP net income and non-GAAP diluted earnings per share. Each of these financial measures excludes the impact of certain items and, therefore, has not been calculated in accordance with GAAP. These non-GAAP financial measures exclude stock compensation expense; amortization of acquired software and intangible assets; restructuring charges; advisory fees associated with certain shareholder actions and business transformation; a goodwill impairment charge; the related tax impacts of these items; and the gain on divestiture of business segments, net of tax. Each of the non-GAAP adjustments is described in more detail below. The table below provides a reconciliation of each of these non-GAAP measures to its most comparable GAAP financial measure. We believe that inclusion of these non-GAAP financial measures provides better comparability with our historical financial results and with the results of many of our competitors. In addition, we believe these non-GAAP financial measures are useful to investors because they allow investors to review supplemental information used internally by management to evaluate our financial results. These non-GAAP measures also represent the means by which we communicate our earnings guidance to investors. 31 -------------------------------------------------------------------------------- Table of Contents While we believe that these non-GAAP financial measures provide useful supplemental information, there are limitations associated with the use of these non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with GAAP, are not audited, do not reflect a comprehensive system of accounting and may not be completely comparable to similarly titled measures of other companies due to potential differences in the exact method of calculation between companies. Items such as stock compensation expense; amortization of acquired software and intangible assets; restructuring charges; advisory fees associated with certain shareholder actions and business transformation; goodwill impairment; the related tax impacts of these items; and the gain on divestiture of business segments, net of tax that are excluded from our non-GAAP financial measures can have a material impact on net income. As a result, these non-GAAP financial measures have limitations and should not be considered in isolation from, or as a substitute for, net income or loss, cash flow from operations or other measures of performance prepared in accordance with GAAP. We compensate for these limitations by using these non-GAAP financial measures as supplements to GAAP financial measures and by reconciling the non-GAAP financial measures to their most comparable GAAP financial measure. We have procedures in place to ensure that these measures are calculated using the appropriate GAAP components in their entirety and to ensure that our performance is properly reflected to facilitate consistent period-to-period comparisons. Management reviews the non-GAAP adjustments on a net-of-tax basis when evaluating our performance. Therefore, we exclude the tax impact of these charges when presenting non-GAAP financial measures.



The following discusses the reconciling items from our non-GAAP financial measures to the most comparable GAAP financial measures:

Stock compensation expense. Our non-GAAP financial measures exclude the

compensation expenses required to be recorded by GAAP for equity awards to

employees and directors. Although this is a normal recurring expense for us,

we believe it is useful in evaluating corporate performance during a particular

time period to review the supplemental non-GAAP financial measures excluding

this expense because these costs are generally fixed at the time an award is

granted, are then expensed over several years and generally cannot be changed

or influenced by management in the current period.

Amortization of acquired software and intangible assets. Our non-GAAP

financial measures exclude costs associated with the amortization of acquired

software and intangible assets. Although this is a normal recurring expense

for us, we believe it is useful in evaluating corporate performance during a

particular time period to review the supplemental non-GAAP financial measures

excluding this expense because these costs are fixed at the time of

acquisition, are then amortized over a period of several years after the

acquisition and generally cannot be changed or influenced by management in the

current period.



Restructuring charges. Our non-GAAP financial measures exclude restructuring

charges, and any subsequent changes in estimates as they relate to our ongoing

corporate restructuring activities. We believe it is useful in evaluating

corporate performance during a particular time period to review the

supplemental non-GAAP financial measures excluding restructuring charges in

order to provide comparability and consistency with historical operating

results.

Goodwill impairment charge. Our non-GAAP financial measures exclude an

impairment charge associated with a decline in the estimated fair value of our

professional services business unit (included in discontinued operations).

Management and the Board of Directors believe it is useful in evaluating

corporate performance during a particular time period to review the

supplemental non-GAAP financial measures, excluding goodwill impairment to

provide comparability and consistency with historical operating results. This

impairment charge is included in "Income (loss) from discontinued operations,

net of tax" in the statements of operations.

Advisory fees associated with certain shareholder actions and our business

transformation initiative. During the fourth quarter of fiscal 2013, in

response to an unsolicited, nonbinding offer to purchase the outstanding shares

of the Company from a shareholder, the Board of Directors announced its

willingness to consider other viable offers. We continue to incur consultant

fees to analyze the business, review additional requests for information from

other interested parties and to implement business transformation plans.

We

believe it is useful in evaluating corporate performance during a particular

time period to review the supplemental non-GAAP financial measures excluding

such costs in order to provide comparability and consistency with historical

operating results. 32



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Table of Contents

Provision for income taxes on above pre-tax non-GAAP adjustments. Our non-GAAP

financial measures exclude the tax impact of the above pre-tax non-GAAP

adjustments. This amount is calculated using the tax rates of each country to

which these pre-tax non-GAAP adjustments relate. Management excludes the

non-GAAP adjustments on a net-of-tax basis in evaluating our performance.

Therefore, we exclude the tax impact of these charges when presenting non-GAAP

financial measures.



Gain on divestiture of business segments, net of tax. Our non-GAAP financial

measures exclude the gain from the divestiture of our Changepoint, Professional

Services and Uniface business segments, net of tax. This gain is included in

"Income (loss) from discontinued operations, net of tax" in the statements of

operations. This gain is not comparable to activity in the other periods

presented. We believe it is useful in evaluating corporate performance during a

particular time period to review the supplemental non-GAAP financial measures

excluding the effect of this gain in order to provide comparability and consistency with historical results.



Our reconciliation of GAAP to non-GAAP financial information is presented below (in thousands, except for per share data):

TWELVE MONTHS ENDED MARCH 31, 2014 2013 NET INCOME ATTRIBUTABLE TO COMPUWARE COPORATION $ 71,583 $



(17,251 ) ADJUSTMENTS EXCLUDING IMPACT OF NON-CONTROLLING INTEREST STOCK COMPENSATION (EXCL. RESTRUCTURING)

35,045



27,105

AMORTIZATION OF PURCHASED SOFTWARE 8,418



9,604

AMORTIZATION OF ACQUIRED INTANGIBLES 7,178 7,581 RESTRUCTURING EXPENSES 13,196 16,573 GOODWILL IMPAIRMENT - 71,840 ADVISORY FEES 13,096 2,797 INCOME TAX EFFECT OF ABOVE ADJUSTMENTS (27,978 ) (30,420 ) GAIN ON DIVESTITURE OF BUSINESS SEGMENTS, NET OF TAX (9,529 ) - TOTAL ADJUSTMENTS 39,426 105,080 NON-GAAP NET INCOME $ 111,009$ 87,829 DILUTED EARNINGS PER SHARE - GAAP $ 0.32 $



(0.08 )

RECALCULATED USING DILUTIVE SHARES $ 0.32 $



(0.08 ) ADJUSTMENTS EXCLUDING IMPACT OF NON-CONTROLLING INTEREST STOCK COMPENSATION (EXCL. RESTRUCTURING)

0.16



0.12

AMORTIZATION OF PURCHASED SOFTWARE 0.04



0.04

AMORTIZATION OF ACQUIRED INTANGIBLES 0.03 0.03 RESTRUCTURING EXPENSES 0.06 0.08 GOODWILL IMPAIRMENT - 0.33 ADVISORY FEES 0.06 0.01 INCOME TAX EFFECT OF ABOVE ADJUSTMENTS (0.13 ) (0.14 ) GAIN ON DIVESTITURE OF BUSINESS SEGMENTS, NET OF TAX (0.04 ) - TOTAL ADJUSTMENTS 0.18 0.48 NON-GAAP DILUTED EPS $ 0.50$ 0.40 DILUTED SHARES OUTSTANDING 221,180 219,580 33

-------------------------------------------------------------------------------- Table of Contents SOFTWARE SEGMENTS



Application Performance Management

The financial results of operations for our APM segment were as follows (in thousands): Year Ended March 31, Period-to-Period Change 2014 2013 2012 2013 to 2014 2012 to 2013 Revenue Software license fees $ 116,373$ 100,565$ 85,462 15.7 % 17.7 % Maintenance fees 100,243 89,535 77,329 12.0 15.8 Subscription fees 80,857 79,862 76,246 1.2 4.7 Services fees 29,894 30,571 31,406 (2.2 ) (2.7 ) Total revenue 327,367 300,533 270,443 8.9 11.1 Operating expenses 298,924 304,835 317,621 (1.9 ) (4.0 ) Contribution margin $ 28,443$ (4,302 )$ (47,178 ) 761.2 % 90.9 % Contribution margin % 8.7 % (1.4 %) (17.4 %) APM segment revenue increased $26.8 million during 2014 due primarily to increased license and maintenance fees related to the growth in our customer base. Service and subscription fees were consistent with prior year. We are focused on maintaining customer satisfaction and increasing demand for our Saas offerings through dedicated resources focused on customer renewals and through continued enhancement to our offerings. Responding to customer needs, we anticipate a greater percentage of our APM revenue will be booked ratably going forward which is expected to negatively impact revenue in 2015. APM segment revenue increased $30.1 million during 2013 due primarily to increased license and maintenance fees related to the acquisition of dynaTrace during the second quarter of 2012. Additionally, subscription fees increased $3.6 million due to new SaaS solution sales during the previous year. Operating expenses decreased $5.9 million during 2014 due to a decline in salary and benefits expense related to headcount reductions associated with our restructuring initiatives and a decrease in amortization of intangibles, partially offset by an increase in expenses related to stock compensation and amortization of capitalized software and increased bonus and commissions expense related to the increase in revenue. Revenue growth and cost reductions for 2014 had a positive impact on our contribution margin as compared to the prior year.



Operating expenses decreased $12.8 million during 2013 due to reductions in headcount and marketing expenses. Revenue growth and cost reductions for 2013 had a positive impact on our contribution margin as compared to the prior year.

Application performance management revenue by geographic location is presented in the table below (in thousands):

Year Ended March 31, 2014 2013 2012 United States $ 176,021$ 160,212$ 139,030 Europe and Africa 93,533 84,590 85,720



Other international operations 57,813 55,731 45,693 Total APM segment revenue $ 327,367$ 300,533$ 270,443

34 -------------------------------------------------------------------------------- Table of Contents Mainframe The financial results of operations for our Mainframe segment were as follows (in thousands): Year Ended March 31, Period-to-Period Change 2014 2013 2012 2013 to 2014 2012 to 2013 Revenue Software license fees $ 42,824$ 58,528$ 110,289 (26.8 )% (46.9 )% Maintenance fees 253,131 271,824 303,639 (6.9 ) (10.5 ) Services fees 299 2,325 5,389 (87.1 ) (56.9 ) Total revenue 296,254 332,677 419,317 (10.9 ) (20.7 ) Operating expenses 74,384 91,325 99,310 (18.6 ) (8.0 ) Contribution margin $ 221,870$ 241,352$ 320,007 (8.1 )% (24.6 )% Contribution margin % 74.9 % 72.5 % 76.3 % Mainframe segment revenue decreased $36.4 million during 2014 primarily due to pricing pressures on and cancellations of maintenance contracts. Furthermore, the reduction in revenue is consistent with the general downward trend in our Mainframe product revenues we have experienced throughout the past several years. This decline slowed during 2014, and while we expect Mainframe revenues to continue to decline, we expect the rate of decline to further slow. Changes in our current customers' IT computing environments and spending habits have reduced their demand for additional mainframe computing capacity. In addition, increased pricing pressures and competition have had a negative impact on our revenues. In 2014, the Mainframe segment transitioned its Solutions Delivery Group (software related services) to the professional services business segment. In 2015, we intend to continue to make strategic enhancements to modernize, simplify, and automate our Mainframe solutions through research and development investments to retain customers in longer term commitments, and to expand the footprint to new customers. Mainframe segment revenue decreased $86.6 million during 2013 primarily due to a $23.6 million decline in significant software license transactions (license fees over $2 million) and due to pricing pressures on and cancellations of maintenance contracts. Furthermore, the reduction in revenue is consistent with the general downward trend in our Mainframe product revenues we have experienced throughout the past several years. Changes in our current customers' IT computing environments and spending habits have reduced their demand for additional mainframe computing capacity. In addition, increased pricing pressures, competition and the effects of foreign exchange rate changes have had a negative impact on our revenues.



During 2013, we introduced APM for Mainframe. In 2015 we will transition this product to the APM business segment. APM for Mainframe revenues were approximately $6.4 million and $1.7 million in 2014 and 2013, respectively.

Mainframe costs declined due to lower headcount related to the restructuring and lower commissions and bonus due to the decline in sales in both 2014 and 2013. In 2014, the percentage decrease in costs exceeded the percentage decrease in sales resulting in an increase in the contribution margin percentage. Although Mainframe costs declined from 2012 to 2013, many of our costs are relatively fixed and the significant decline in Mainframe revenue during 2013 resulted in a decline in contribution margin as compared to the prior year. 35 -------------------------------------------------------------------------------- Table of Contents Mainframe revenue by geographic location is presented in the table below (in thousands): Year Ended March 31, 2014 2013 2012 United States $ 159,072$ 190,542$ 232,350 Europe and Africa 79,743 81,244 104,048



Other international operations 57,439 60,891 82,919 Total Mainframe segment revenue $ 296,254$ 332,677$ 419,317

Software Revenue Combined

Software revenue includes both APM and Mainframe.

Software revenue consists of software license fees, maintenance fees, subscription fees and software related services. Software solutions revenues are presented in the table below (in thousands):

Year Ended March 31,



Period-to-Period Change

2014 2013 2012 2013 to 2014 2012 to 2013 Software license fees $ 159,197$ 159,093$ 195,751 0.1 % (18.7 )% Maintenance fees 353,374 361,359 380,968 (2.2 ) (5.1 ) Subscription fees 80,857 79,862 76,246 1.2 4.7 Services fees 30,193 32,896 36,795 (8.2 ) (10.6 ) Total software revenue $ 623,621$ 633,210$ 689,760 (1.5 )% (8.2 )%



Changes in the various revenue line items are discussed previously in the "Application Performance Management" and "Mainframe" sections.

Software revenue by geographic location is presented in the table below (in thousands): Year Ended March 31, 2014 2013 2012 United States $ 335,093$ 350,754$ 371,380 Europe and Africa 173,276 165,834 189,768



Other international operations 115,252 116,622 128,612 Total software solutions revenue $ 623,621$ 633,210$ 689,760

36 -------------------------------------------------------------------------------- Table of Contents APPLICATION SERVICES



The financial results of operations for our Covisint application services segment were as follows (in thousands):

Year Ended March 31,



Period-to-Period Change

2014 2013 2012 2013



to 2014 2012 to 2013

Application services fees $ 97,135$ 90,694$ 73,731

7.1 % 23.0 % Operating expenses 120,234 86,084 72,717 39.7 18.4 Contribution margin $ (23,099 )$ 4,610$ 1,014 (601.1 )% 354.6 % Contribution margin % (23.8 %) 5.1 % 1.4 % Application services fees increased $6.4 million during 2014 due to an increase in Covisint recurring fees, which was partially offset by a decline in Covisint services revenue. The increase in recurring fees was primarily due to continued growth within the non-automotive verticals, offset in part, by a decline in revenue of $1.8 million from customers that terminated or elected not to renew their agreements. Application services segment fees increased $17.0 million during 2013 due to growth from both recurring and services fees across automotive and healthcare customers as well as customers in other industries. Services fees increased, in part, due to the establishment of stand-alone value for certain services during 2012, which allowed us to recognize the related revenue as the services were delivered rather than over the expected period during which the customer would receive benefit. We continue to recognize the deferred services revenue and related expenses recorded prior to establishment of stand-alone value over the expected period of benefit to the customer.



Our application services segment generated 47%, 56% and 58% of its revenue from the automotive industry during 2014, 2013 and 2012, respectively.

Operating expense increased $34.1 million during 2014 primarily due to expenses associated with the Covisint IPO which closed during 2014. This resulted in recognition of expense associated with certain options to purchase Covisint shares, including a cumulative catch up, and the reversal of expense associated with performance awards to receive Compuware shares which were terminated upon closing of the offering on October 1, 2013. Operating expenses for the year ended March 31, 2014 included $17.3 million of stock compensation expense including $1.3 million of stock compensation expense unrelated to the IPO. Operating expenses also increased due to higher salaries and benefits expense resulting from an increase in headcount to support the expected growth of the business, a reduction in capitalized research and development costs, increased use of subcontractors and an increase in amortization of capitalized research and development costs. Operating expenses increased $13.4 million during 2013 due to continued investment in our Covisint business. In anticipation of capitalizing on the growth of the secured collaboration services market, we hired additional developers, customer support and sales personnel, and we increased the capacity of our global application services network during 2013. Additionally, costs associated with services with stand-alone value were recognized in 2013 consistent with the associated revenue recognition. The additional investments in 2013 were partially offset by increases in capitalized software and development costs. In May 2014, Convisint announced numerous initiatives to be undertaken by its new leadership including additional leadership changes and reductions in workforce intended to better align costs with revenues in the future. Based upon the scope and importance of these initiatives, we anticipate that fiscal 2015 will be a year of transformation for our Covisint business segment and we expect continued losses from this business segment during fiscal 2015. 37 -------------------------------------------------------------------------------- Table of Contents Application services segment revenue by geographic location is presented in the table below (in thousands): Year Ended March 31, 2014 2013 2012 United States $ 83,309$ 77,944$ 64,555 Europe and Africa 8,101 4,859 3,827 Other international operations 5,725 7,891



5,349

Total application services segment revenue $ 97,135$ 90,694$ 73,731

UNALLOCATED EXPENSES Unallocated expenses include costs associated with internal technology and the corporate executive, finance, human resources, administrative, legal, communications and investor relations departments. In addition, unallocated expenses include all facility-related costs, such as rent, building depreciation, maintenance and utilities associated with our worldwide offices. Significant changes in these areas are discussed in "Operating Expenses" under "Technology Development and Support" and "Administrative and General". Fiscal year ended March 31, 2014 and 2013 unallocated expenses also included $12.0 million and $15.8 million, respectively in restructuring expenses and $13.1 million and $2.8 million, respectively, in advisory expenses related to shareholder activities and our transformation. These expenses are discussed in the "Restructuring Charge" and the "Administrative and General" sections respectively below.



OPERATING EXPENSES

Our operating expenses include costs from continuing operations for software license fees; cost of maintenance fees; cost of subscription fees; cost of services; cost of application services; technology development and support costs; sales and marketing expenses; administrative and general expenses; goodwill impairment; and restructuring. These expenses are described below without regard to the relevant segment(s) to which they are allocated.

Cost of Software License Fees

Cost of software license fees includes amortization of capitalized software related to our licensed software products, the cost of duplicating and disseminating products to customers, including associated hardware costs, and the cost of author royalties.

Cost of software license fees is presented in the table below (in thousands):

Year Ended March 31, Period-to-Period Change 2014 2013 2012 2013 to 2014 2012 to 2013



Cost of software license fees $ 20,310$ 18,986$ 16,391

7.0 % 15.8 %



Percentage of software license fees 12.8 % 11.9 % 8.4 %

Cost of software license fees increased $1.3 million during 2014 and increased $2.6 million during 2013. The increase in 2014 was due primarily to increased amortization of capitalized research and development costs. The increase in 2013 was due primarily to additional amortization expense on intangible assets acquired as part of the dynaTrace acquisition during the second quarter of 2012. As dynaTrace was acquired during the second quarter of 2012, only a partial year of amortization was recognized during 2012 as compared to a full year of amortization for 2013. These expense increases resulted in the increase in cost as a percentage of software license fees. 38 -------------------------------------------------------------------------------- Table of Contents Cost of Maintenance Fees



Cost of maintenance fees consists of the direct costs allocated to maintenance and product support such as helpdesk and technical support.

Cost of maintenance fees is presented in the table below (in thousands):

Year Ended March 31,



Period-to-Period Change

2014 2013 2012 2013 to 2014 2012 to 2013



Cost of maintenance fees $ 28,387$ 31,621$ 34,715

(10.2 )% (8.9 )%



Percentage of maintenance fees 8.0 % 8.8 % 9.1 %

Cost of maintenance fees declined $3.2 and $3.1 million during 2014 and 2013, respectively. The decrease in 2014 is a result of a reduction in customer support costs. The decrease for 2013 primarily resulted from a reduction in maintenance costs related to our APM and Mainframe products.

Cost of Subscription Fees

Cost of subscription fees consists of the amortization of capitalized software related to our APM hosted software, depreciation and maintenance expense associated with our hosted software network related computer equipment; data center costs; and payments to individuals for tests conducted from their Internet-connected personal computers ("peer").



Cost of subscription fees is presented in the table below (in thousands):

Year Ended March 31,



Period-to-Period Change

2014 2013 2012 2013 to 2014 2012 to 2013



Cost of subscription fees $ 32,406$ 30,264$ 29,102

7.1 % 4.0 %



Percentage of subscription fees 40.1 % 37.9 % 38.2 %

Cost of subscription fees increased $2.1 million during 2014, primarily due to increased amortization of capitalized research and development costs related to on-going product enhancements. Additionally, costs increased, to a lesser extent, due to continued investment in our mobile network. Cost of subscription fees from increased $1.2 million during 2013, primarily due to additional amortization of capitalized research and development costs. We continued to invest in research and development throughout 2012 and 2013 which increased the amortizable base. To a lesser extent, increased compensation and benefits costs from hiring additional employees to support future business growth also contributed to the increase in cost of subscription fees for 2013.



Cost of Services

Cost of services consists primarily of personnel-related costs of providing our software related services. Cost of services is presented in the table below (in thousands): Year Ended March 31,



Period-to-Period Change

2014 2013 2012 2013 to 2014 2012 to 2013 Cost of services $ 25,662$ 31,777$ 36,276 (19.2 )% (12.4 )% Percentage of services fees 85.0 % 96.6 % 98.6 % 39

-------------------------------------------------------------------------------- Table of Contents Cost of services decreased $6.1 million and $4.5 million during 2014 and 2013, respectively. The decreases during 2014 and 2013 were primarily due to a decline in salaries and benefits expense resulting from headcount reduction.



Cost of Application Services - Covisint

Cost of application services consists primarily of personnel-related costs of providing application services, including billable and technical staff, subcontractors and sales personnel net of the amounts capitalized for development of internal use software.

Cost of application services incurred and capitalized are presented in the table below (in thousands): Year Ended March 31, Period-to-Period Change 2014 2013 2012



2013 to 2014 2012 to 2013

Cost of application services incurred $ 122,835$ 95,619$ 80,250 28.5 % 19.2 % Capitalized internal software costs (5,680 ) (12,321 ) (7,866 ) 53.9 (56.6 ) Cost of application services expensed $ 117,155$ 83,298$ 72,384 40.6 % 15.1 % Percentage of application services fees 120.6 % 91.8 % 98.2 %



See "Application Services" for a discussion of the associated costs.

Capitalization of internally developed software costs decreased $6.6 million during 2014 and increased $4.4 million during 2013. The decrease in 2014 is a result of changes to the agile delivery methodology for our platform enhancements, which has resulted in significantly shorter development cycles thereby reducing our capitalized costs. Capitalized internal software costs increased during 2013, as we continued to invest in enhancements and additional functionality for the platform.



Technology Development and Support

Technology development and support includes, primarily, the costs of programming personnel associated with development and support of our products and our hosted software network less the amount of capitalized internal software costs during the reporting period. Also included are personnel costs associated with developing and maintaining internal systems and hardware/software costs required to support all technology initiatives.



Technology development and support costs incurred and capitalized are presented in the table below (in thousands):

Year Ended March 31,



Period-to-Period Change

2014 2013 2012



2013 to 2014 2012 to 2013

Technology development and support costs incurred $ 103,844$ 113,017$ 108,355 (8.1 )% 4.3 % Capitalized software costs (17,663 ) (17,661 ) (14,122 ) (0.0 ) (25.1 ) Technology development and support costs expensed $ 86,181$ 95,356$ 94,233 (9.6 )% 1.2 % Technology development and support costs expensed as a percentage of software revenue 13.8 % 15.1 % 15.7 % 40 -------------------------------------------------------------------------------- Table of Contents Technology development and support decreased $9.2 million before capitalized software costs during 2014 due primarily to a decrease in salary and benefits resulting from headcount reductions associated with our restructuring initiatives. Technology development and support increased $4.7 million before capitalized software costs during 2013 due primarily to higher compensation and benefits costs related to the hiring of developers and customer support personnel to support the growth of the APM segment, including those hired through the dynaTrace acquisition in the second quarter of 2012. To a lesser extent, higher software maintenance costs also contributed to the increase in technology development and support costs. The increase in costs was partially offset by a reduction in bonus expense resulting from lower company-wide bonus attainment. Technology development and support as a percentage of software revenue decreased for both 2014 and 2013. During 2014 the decrease was a result of reductions in internal information systems headcount which proportionately exceeded the decrease in software solutions revenue. During 2013 the increase was a result of additional investment in our products and technology which proportionately exceeded the increase in software revenue. The capitalized software cost remained consistent during 2014. The fluctuations in capitalized internal software costs during 2013 relate primarily to the timing of projects that were in the technological feasibility phase of development. The $3.5 million increase in capitalized software costs during 2013 was primarily related to additional capitalization of costs for APM SaaS and Mainframe projects during 2013.



Sales and Marketing

Sales and marketing costs consist primarily of personnel related costs associated with product sales, sales support and marketing for our product offerings.

Sales and marketing costs are presented in the table below (in thousands):

Year Ended March 31,



Period-to-Period Change

2014 2013 2012 2013 to 2014 2012 to 2013



Sales and marketing costs $ 216,115$ 220,714$ 242,211

(2.1 )% (8.9 )%



Percentage of software revenue 34.7 % 34.9 % 35.1 %

Sales and marketing costs decreased $4.6 million during 2014 due to decreased compensation and travel expenses associated with headcount reductions related to our restructuring initiatives. These decreases were partially offset by an increase in bonus expense due to our increase in earnings. Sales and marketing costs decreased $21.5 million during 2013 due to decreased compensation and travel expense related to lower bonus and commissions associated with the declines in revenue and earnings as well as headcount reductions, primarily in Europe. Additionally, advertising expense declined from the prior year due to lower costs related to a significant marketing agreement. Sales and marketing costs as a percentage of software revenue remained consistent with the prior year.



Administrative and General

Administrative and general expenses consist primarily of costs associated with the corporate executive, finance, human resources, administrative, legal, communications and investor relations departments. In addition, administrative and general expenses include all facility-related costs, such as rent, building depreciation, maintenance and utilities, associated with our worldwide offices. 41



--------------------------------------------------------------------------------

Table of Contents Administrative and general expenses are presented in the table below (in thousands):

Year Ended March 31, Period-to-Period Change 2014 2013 2012 2013 to 2014 2012 to 2013



Administrative and general expenses $ 134,695$ 153,733$ 154,366

(12.4 )% (0.4 )% Administrative and general costs decreased $19.0 million during 2014 due primarily to a decrease in salaries and benefits expense associated with our restructuring activities. Other decreases associated with our restructuring including decreases in rent, contributions, depreciation, travel and corporate advertising were offset by increases primarily associated with bonuses and consulting fees related to shareholder activities, our transformation, and the divestiture of the Changepoint, Professional Services and Uniface business segments. On May 22, 2014, we announced our intention to begin exploring the strategic separation of our APM and Mainframe business segments. This strategic exploration will require the use of outside consultants and advisors, the cost of which is not currently known. Administrative and general costs decreased $633,000 during 2013 due primarily to a decline in bonus expense resulting from lower company-wide bonus attainment. The decline was partially offset by increased salary and benefits expense related to a post-retirement consulting agreement executed during 2013, asset impairment charges and advisory fees related to certain shareholder activities.



Restructuring Charge

As part of our announced plan to increase shareholder value, we are implementing significant cost reduction actions with the intention to eliminate approximately $110 million to $120 million of administrative and general and non-core operational costs over the next two years. On January 23, 2014, the Company announced the final phase of this cost reduction plan which includes additional reductions in the global workforce across all general, administrative and shared services divisions of the Company, along with the early termination of certain operating leases and the closing or reductions in size of office facilities worldwide. These cost reduction efforts, which are expected to be substantially completed by the end of fiscal 2015, are expected to result in cumulative restructuring charges of $50 million to $60 million. Substantially all of the remaining estimated charges will result in future cash expenditures.



The Company recorded a restructuring charge in continuing operations of approximately $12.0 million and $15.8 million during 2014 and 2013, respectively, for the costs associated with these reductions. Of the total amount approximately $21.1 million was related to severance costs for 215 terminated employees and $4.7 million was related to lease abandonment costs.

There were no restructuring actions taken during 2012. See note 9 of the consolidated financial statements included in this report for more details regarding our restructuring plan.

42 -------------------------------------------------------------------------------- Table of Contents OTHER INCOME (EXPENSE) Other income (expense), net consists primarily of interest income realized from our cash and cash equivalents, interest earned on our financing receivables, our share of the income or loss from our investments in partially owned companies and interest expense primarily associated with our long-term debt.



Other income (expense) is presented in the table below (in thousands):

Year Ended March 31,



Period-to-Period Change

2014 2013 2012 2013 to 2014 2012 to 2013 Interest income $ 1,948$ 2,010$ 3,684 (3.1 )% (45.4 )% Interest expense (1,104 ) (1,856 ) (3,161 ) 40.5 41.3 Other 2,444 (1,324 ) 1,110 284.6 (219.3 ) Other income (expense) $ 3,288$ (1,170 )$ 1,633 381.0 % (171.6 )% Interest income remained consistent between 2014 and 2013. The decline in interest income for 2013 was primarily due to the reduction in cash and cash equivalents resulting from cash used to purchase dynaTrace in 2012, repayments on our outstanding debt, our share repurchases and, to a lesser extent, a decline in interest income related to our installment receivables. The decrease in interest expense for 2014 is related to the reduction in borrowings under the line of credit. The average outstanding debt balance during 2014 was approximately $6.9 million as compared to approximately $50 million during 2013. The decrease in interest expense for 2013 was related to interest on borrowings under the line of credit. Borrowings were incurred primarily to fund a portion of the dynaTrace acquisition during the second quarter of 2012 and to continue the share repurchase program. The average outstanding debt balance during 2013 was approximately $50 million as compared to approximately $84 million during 2012.



The increase in other income was the result of the reversal of previously expensed stock compensation related to the termination for "Cause" of a post-retirement consulting contract with a former executive of the Company, offset, in part, by expense accruals related to the pending dispute associated with this contract termination.

The decline in other for 2013 was primarily related to a $1.7 million loss recognized on our investments in start-up companies (see note 7 of the consolidated financial statements included in this report for additional information).

INCOME TAXES

Income taxes are accounted for using the asset and liability approach. Deferred income taxes are provided for the differences between the tax bases of assets or liabilities and their reported amounts in the financial statements and net operating loss and credit carryforwards.



The income tax provision and effective tax rate are presented in the table below (in thousands):

Year Ended March 31,



Period-to-Period Change

2014 2013 2012 2013 to 2014 2012 to 2013 Income tax provision $ 12,944$ 15,917$ 22,005 (18.7 )% (27.7 )% Effective tax rate 25.3 % 38.6 % 25.8 %



The Company's effective tax rate was 25.3%, 38.6% and 25.8% for fiscal 2014, fiscal 2013 and fiscal 2012, respectively.

43 -------------------------------------------------------------------------------- Table of Contents The effective tax rate for fiscal 2014 was impacted primarily by the following favorable items: (i) the U.S. Research & Experimentation tax credit; (ii) the domestic production deduction; (iii) the recording of a benefit related to stock compensation as a result of a change in our expectation regarding the tax deductibility of compensation for a certain officer; (iv) the enactment of new tax legislation in Mexico; and (v) cash repatriation from Brazil. These favorable items were partially offset by the increase in a valuation allowance related to the Brownfield Redevelopment tax credit. As a result of the divestiture of our Changepoint, Professional Services and Uniface business segments, the tax credits expected to be used prior to the divestiture have decreased primarily due to a reduction in projected taxable income sourced to the State of Michigan. This increase to the valuation allowance was required to be reported in continuing operations. The effective tax rate for fiscal 2012 was impacted primarily by the following favorable items: (1) New legislation was enacted that amended Michigan's Income Tax Act to implement a comprehensive set of tax changes. One part of the legislation contains provisions that replaced the Michigan Business Tax ("MBT") with a new corporate income tax. Certain credits allowed under the MBT, including the Brownfield Redevelopment tax credit, will continue to be effective, which allowed us to reduce our future tax liability for the duration of the carryforward period. Therefore, the valuation allowance associated with this deferred tax asset was reversed in fiscal 2012. (2) All remaining issues with the Internal Revenue Service were effectively settled related to the fiscal 2005 through fiscal 2009 tax periods. See note 14 of the consolidated financial statements included in this report for additional information regarding the difference between our effective tax rate and the statutory rate for 2014, 2013 and 2012.



MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Note 1 of the consolidated financial statements included in this report contains a summary of our significant accounting policies.

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities and shareholder's equity and the disclosure of contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Assumptions and estimates were based on facts and circumstances existing at March 31, 2014. However, future events rarely develop exactly as forecast, and the best estimates routinely require adjustment. The accounting policies discussed below are considered by management to be the most important to an understanding of our financial statements, because their application places the most significant demands on management's judgment and estimates about the effect of matters that are inherently uncertain.



Revenue Recognition - We generate revenue from licensing software products; providing maintenance and support services for those products; providing hosted software; and rendering software related and application services.

We sometimes enter into arrangements that include both software related deliverables (licensed software products, maintenance services or software related services) and non-software deliverables (hosted software or application services). Our hosted software and application services do not qualify as software deliverables because our license grant does not allow the customer the right or capability to take possession of the software. For arrangements that contain both software and non-software deliverables, in accordance with ASC 605 "Revenue Recognition," we allocate the arrangement consideration to the non-software deliverables as a group, and to the software deliverables as a group (the "Deliverable Groups"). We determine the selling price to allocate the arrangement consideration to the Deliverable Groups based on the following hierarchy of evidence: vendor specific objective evidence of selling price ("VSOE," meaning price when sold separately) if available; third-party evidence of selling price if VSOE is not available; or best estimated selling price if neither VSOE nor third-party evidence is available. We currently are unable to establish VSOE or third-party evidence of selling price for either our software related deliverables or our non-software deliverables as a group. Therefore, the best estimate of selling price for each Deliverable Group is determined primarily by considering various factors, including, but not limited to stated renewal rates in a contract, if any, the historical selling price of these deliverables in similar stand-alone transactions and pricing practices. Total arrangement consideration is then allocated on the basis of the Deliverable Group's relative selling price. 44 -------------------------------------------------------------------------------- Table of Contents Once we have allocated the arrangement consideration between the Deliverable Groups, we recognize revenue as described below in the respective software license fees, maintenance fees, subscription fees, services fees and application services fees sections. In order for a transaction to be eligible for revenue recognition, the following revenue criteria must be met: persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is reasonably assured. We evaluate collectability based on past customer history, external credit ratings and payment terms within various customer agreements. Software License Fees - We license software products using both perpetual and term (time-based) licenses and provide maintenance services and software related services. Our software related services do not require significant production, modification or customization of the licensed software product. Assuming all revenue recognition criteria are met, perpetual license fee revenue is recognized using the residual method, under which the fair value, based on VSOE, of all undelivered elements of the agreement (i.e., maintenance and software related services) is deferred. VSOE is based on rates charged for maintenance and services when sold separately. The remaining portion of the fee is recognized as license fee revenue upon delivery of the products. Based on market conditions, we periodically change pricing methodologies for license, maintenance and software related services. Changes in rates charged for stand-alone maintenance and software related services could have an impact on how bundled revenue agreements are characterized as license, maintenance or software related services or have an effect on the timing of revenue recognition in the future. Pricing modifications, if any, made during the years covered by this report have not had a significant impact on the timing or characterization of revenue recognized. For revenue arrangements where there is a lack of VSOE for any undelivered elements, license fee revenue is deferred and recognized upon delivery of those elements or when VSOE can be established. However, when maintenance or software related services are the only undelivered elements, the license fee revenue is recognized on a ratable basis over the longer of the maintenance term or the period the software related services are expected to be performed. Such transactions include time-based licenses and certain unlimited capacity licenses, as we have not established VSOE for the undelivered elements in these arrangements. In order to comply with SEC Regulation S-X, Rule 5-03(b), which requires product, services and other categories of revenue to be displayed separately on the income statement, we separate the license fee, maintenance fee and software related services fee associated with these types of arrangements based on its determination of fair value. We apply VSOE for maintenance related to perpetual license transactions and stand-alone software related services arrangements as a reasonable and consistent approximation of fair value to separate license fee, maintenance fee and software related services fee revenue for income statement classification purposes. We offer flexibility to our customers purchasing licenses for their products and related maintenance. Terms of these transactions range from standard perpetual license sales that include one year of maintenance to multi-year (generally two to five years), multi-product contracts. The Company allows deferred payment terms with installments collectable over the term of the contract. Based on our successful collection history for deferred payments, license fees (net of any financing fees) are generally recognized as revenue as discussed above. In certain transactions where it cannot be concluded that the fee is fixed or determinable due to the nature of the deferred payment terms, we recognize revenue as payments become due. Financing fees are recognized as interest income over the term of the related receivable. 45 -------------------------------------------------------------------------------- Table of Contents Subscription Fees - Our subscription fees relate to arrangements that permit our customers to access and utilize our hosted software and are delivered on a SaaS basis. The subscription arrangements do not provide customers the right to take possession of the software at any time, nor do the arrangements contain rights of return. Subscription fees are deferred upon contract execution and are recognized ratably over the term of the subscription. Services Fees - We offer implementation, consulting, and training services in tandem with our software solutions. Our services fees are generally based on hourly or daily rates. Revenues from services are recognized in the period the services are performed provided that collection of the related receivable is reasonably assured. For development services rendered under fixed-price contracts, revenues are recognized using the proportional performance method and if it is determined that costs will exceed revenue, the expected loss is recorded at the time the loss becomes apparent. Application Services Fees - Our application services fees consist of revenue related to our Covisint on-demand software including associated services. The arrangements do not provide customers the right to take possession of the software at any time, nor do the arrangements contain rights of return. Many of our application services fee contracts include a services project fee and a recurring fee for ongoing PaaS operations. Certain services related to these projects have stand-alone value (e.g., other vendors provide similar services) and qualify as a separate unit of accounting. Services that have stand-alone value are recognized as delivered. For those services that do not have stand-alone value, the revenue is deferred and recognized over the longer of the committed term of the subscription agreement (generally one to five years) or the expected period over which the customer will receive benefit (generally five years). For services projects rendered under fixed-price contracts, revenues are recognized using the proportional performance method and if it is determined that costs will exceed revenue, the expected loss is recorded at the time the loss becomes apparent. The recurring fees are recognized ratably over the applicable service period. Unforeseen events that result in additional time or costs being required to complete fixed-price projects associated with either software related services or application services could affect the timing of revenue recognition for the balance of the project as well as margins going forward, and could have a negative effect on our results of operations. Long-lived assets - We follow the guidance of ASC 360-10, "Property, Plant and Equipment" to assess potential impairment losses on long-lived assets used in operations. A long-lived asset, or group of assets, to be held and used in the business are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset group may not be recoverable. A long-lived asset group that is not held for sale is considered to be impaired when the asset group is not recoverable, that is when the undiscounted net cash flows expected to be generated by the asset group is less than its carrying amount and the carrying amount of the asset group exceeds its fair value. We review long-lived assets for impairment at the lowest level for which identifiable cash flows are largely independent of the cash flows of the other assets and liabilities. Certain long-lived assets do not have identifiable cash flows that are largely independent, and in those circumstances, the asset group for that long-lived asset includes all assets and liabilities of the company. As part of our announced transformation plan, during the fourth quarter of 2014, we began to consider various strategic alternatives for certain long-lived assets, which indicated their carrying amount may not be recoverable. We, therefore, performed a recoverability test for certain long-lived asset groups currently held and used. The recoverability test indicated that the associated long-lived asset group was not impaired. While we believe our judgments and assumptions are reasonable, a change in facts or assumptions underlying certain estimates and judgments made as part of our recoverability test, including the decision to sell certain assets within the asset group, could result in a substantial impairment and would have a negative effect on our results of operations. 46 -------------------------------------------------------------------------------- Table of Contents Capitalized Software - We follow the guidance of ASC 985-20 "Costs of Software to be Sold, Leased, or Marketed" when capitalizing development costs associated with our software products and ASC 350-40 "Internal Use Software" when capitalizing development costs associated with our hosted software and application services. The cost of purchased and internally developed software technology is capitalized and stated at the lower of unamortized cost or expected net realizable value. We compute annual amortization using the straight-line method over the remaining estimated economic life of the software technology which is generally three to five years. Software is subject to rapid technological obsolescence and future revenue estimates supporting the capitalized software cost can be negatively affected based upon competitive products, services and pricing. Such adverse developments could reduce the estimated net realizable value of our capitalized software and could result in impairment or a shorter estimated life. Such events would require us to take a charge in the period in which the event occurs or to increase the amortization expense in future periods and would have a negative effect on our results of operations. At a minimum, we review for impairments each balance sheet date.



Impairment of Goodwill and Other Intangible Assets - We are required to assess the impairment of goodwill and other intangible assets annually, or more frequently if events or changes in circumstances indicate that the carrying value may exceed the fair value.

The performance test involves a two-step process. Step 1 of the impairment test involves comparing the fair values of the applicable reporting units with their aggregate carrying values, including goodwill. We measure the fair value of our APM and Mainframe and other intangible assets using an estimate of the related discounted cash flow and market comparable valuations, where appropriate. We measure the fair value of our Covisint reporting unit based on the market value for the Covisint shares as of March 31, 2014. The discounted cash flow model uses significant assumptions, including projected future cash flows, the discount rate reflecting the risk inherent in future cash flows, and a terminal growth rate. The key assumptions in the market comparable value analysis are peer group and comparable transactions selection and application of this information to the respective reporting unit. If the carrying amount of a reporting unit exceeds the reporting unit's fair value, we perform Step 2 of the goodwill impairment test to determine the amount of impairment loss by comparing the implied fair value of the respective reporting unit's goodwill with the carrying amount of that goodwill. Under such evaluation, if the carrying amount of the reporting unit's goodwill exceeds the implied fair value of the goodwill, the impairment loss is recognized as an operating expense in an amount equal to that excess. There is a high degree of judgment regarding management's forecast for the reporting units as market developments for both customers and competitors can affect actual results. There can also be uncertainty regarding management's selection of peer companies and comparable transactions as an exact match of peer companies is unlikely to exist. Application of the goodwill and other intangibles impairment test requires judgment, including the assignment of assets and liabilities to reporting units and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated using a discounted cash flow model in combination with a market approach. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, estimation of market interest rates, determination of our weighted average cost of capital and selection and application of peer group information. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions and estimated future cash flows. While we believe that the assumptions and estimates used to determine the estimated fair values of each of our reporting units are reasonable, a change in assumptions underlying these estimates could materially affect the determination of fair value and goodwill impairment for each reporting unit.



The events and circumstances that could affect our key assumptions in the analysis of fair value in the future include the following:

Our ability to achieve sales productivity at a level to achieve the

profitability in the forecast period.

Our ability to hire and retain sales, technology and management personnel.

Future negative changes in the global economy.

Increased competition and pricing pressures.

The fair value of our APM, Mainframe and Covisint reporting units were substantially in excess of each unit's respective carrying value as of March 31, 2014.

Deferred Tax Assets Valuation Allowance and Tax Liabilities - Income tax expense, deferred tax assets and liabilities and reserves for uncertain tax positions reflect management's best assessment of estimated future taxes to be paid. We are subject to income taxes in both the U.S. and numerous foreign jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax expense. 47 -------------------------------------------------------------------------------- Table of Contents Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenue and expense. In evaluating our ability to recover our deferred tax assets we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income, we develop assumptions including the amount of future state, federal and foreign pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses. Changes in estimates of projected future operating results or in assumptions regarding our ability to generate future taxable income during the periods in which temporary differences are deductible could result in significant changes to these liabilities and, therefore, to our net income.



The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations.

We recognize tax benefits from an uncertain tax position when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits.

We recognize tax liabilities in accordance with ASC 740 "Income Taxes" and we adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined. Stock-Based Compensation - We measure compensation expense for stock awards in accordance with ASC 718-10 "Share-Based Payment." Stock award compensation costs, net of an estimated forfeiture rate, are recognized on a straight-line basis over the requisite service period of the award, which is generally the vesting term of three to five years. For stock awards which vest more quickly than a straight-line basis, additional expense is taken in the early year(s) to ensure the expense is commensurate with the vest schedule. During fiscal 2014, the weighted-average forfeiture rate for options and awards granted was 5.1%. The fair value of stock options was estimated at the grant date using a Black-Scholes option pricing model with the following average assumptions for fiscal 2014: risk-free interest rate - 1.67%, volatility factor - 39.11%, expected option life - 6.2 years and dividend yield - 4.46%. The weighted average grant date fair value of option shares granted in fiscal 2014 was $2.63 per option share. For more information related to these assumptions, see notes 1 and 18 to the consolidated financial statements included in this report. In addition to the assumptions above, we estimate the expected pre-vesting award forfeiture rate and assess the probability that performance conditions that affect the vesting of certain awards will be achieved and take expense only for the awards expected to vest. If future events impact either the assumptions included in the Black-Scholes option pricing model or our pre-vesting forfeiture rate, future stock-based compensation expense could be materially different from the expense we have recorded in the current period. Other - Other accounting policies, although not generally subject to the same level of estimation as those discussed above, are nonetheless important to an understanding of the financial statements. Many assets, liabilities, revenue and expenses require some degree of estimation or judgment in determining the appropriate accounting. 48 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources



As of March 31, 2014, 2013 and 2012, cash and cash equivalents and investments totaled approximately $300.1 million, $89.9 million and $99.2 million, respectively.

Fiscal 2014 compared to Fiscal 2013

Net cash provided by operating activities

Net cash provided by operating activities during 2014 was $161.5 million, an increase of $29.1 million from 2013. The increase was primarily due to a $19.5 million increase in cash collected from customers consistent with the decline in accounts receivable with revenue being primarily consistent with 2013, and a decline of $46.9 million in cash paid to employees due to the restructuring actions we took during 2014. The increase was partially offset by a $29.9 million increase in cash paid for income taxes and an increase of $6.7 million in cash paid to suppliers. The majority of the increase in cash collected from customers relates to runoff of the accounts receivable related to the divestiture of our Changepoint, Professional Services and Uniface business segments. We expect cash flows from operations to decline in 2015 due to the impact of this runoff as well as due to taxes that will be paid in 2015 associated with the gain on the divestiture. The consolidated statements of cash flows included in this report compute net cash from operating activities using the indirect cash flow method. Therefore, non-cash adjustments and net changes in assets and liabilities (net of effects from acquisitions and currency fluctuations) are adjusted from net income to derive net cash from operating activities. Additionally, the impact of the net decrease in accounts receivable as compared to the prior year was $39.2 million and primarily related to the reduction in revenue from large software license deals and the timing of billings from multi-year product arrangements for 2014 as compared to 2013. The impact of the net increase in deferred revenue was $94.7 million and primarily related to growth in the APM business segment during 2014 as compared to 2013. The impact of the net decrease in accounts payable and accrued expenses as compared to the prior year was $3.2 million and primarily related to the reduction in headcount attributable to our restructuring program for 2014 as compared to 2013. We believe our existing cash resources, including our line of credit and cash flow from operations, will be sufficient to meet our short-term and long-term liquidity requirements, including the liquidity needed to fund the planned quarterly dividends.



Net cash provided by (used in) investing activities

Net cash provided by investing activities totaled $76.4 million, which represents an increase of $131.7 million from 2013. The increase is primarily due to the $112.0 million in cash provided by the divestiture of the Changepoint, Professional Services and Uniface business segments, and to a lesser extent, a decrease of $17.1 million in cash used for property, equipment and capitalized software. We will continue to evaluate business acquisition opportunities that fit our strategic plans. If the cash consideration for a future acquisition or combination of acquisitions were to exceed our operating cash balance resources, we would likely utilize our credit facility again and may need to seek additional financing. 49 -------------------------------------------------------------------------------- Table of Contents Net cash used in financing activities



Net cash used in financing activities during 2014 was $27.4 million, which represents a decrease of $55.8 million from the cash used in financing activities in 2013.

The change was primarily due to the $68.4 million of net proceeds from the Covisint IPO, and the decline of $72.0 million in repurchases of common stock, offset in part, by dividend payments of $108.2 million and to a lesser extent by a decline in net payments on the credit facility and increased proceeds from the exercise of employee stock awards. Since May 2003, the Board of Directors has authorized the Company to repurchase a total of $1.7 billion of our common stock under a discretionary stock repurchase plan, and most recently on February 7, 2008 when it authorized the repurchase of up to $750.0 million of our common stock. As of March 31, 2014 approximately $139.5 million remains authorized for future purchases. Purchases of common stock may occur on the open market, or through negotiated or block transactions based upon market and business conditions, subject to applicable legal limitations. Typically, the maximum amount of repurchase activity under the repurchase plan is limited on a daily basis to 25% of the average trading volume of our common stock for the previous four week period. In addition, no purchases are made during our self-imposed trading black-out periods in which the Company and our insiders are prohibited from trading in our common shares. Our standard quarterly black-out period commences 10 business days prior to the end of each quarter and terminates one full market day following the public release of our operating results for the period. We reserve the right to change the timing and volume of our repurchases at any time without notice. During 2014, we repurchased approximately 300,000 shares of our common stock at an average price of $11.77 per share for a total cost of $3.5 million under the 10b5-1 program. In May 2014, we announced intentions to implement a significant capital return program after the Tax-Free Distribution of our remaining Covisint shares and optimization of our balance sheet. In preparation for this program, we expect to modify our existing credit facility or to enter into alternative financing arrangements as the terms of our current credit facility will not accommodate these actions. The form and timing of any capital return program, if it occurs at all, have not yet been determined, are solely within our Board's discretion and are subject to, among other factors, prevailing business conditions, applicable legal and contractual restrictions on repurchases, the availability of capital resources and our other investment opportunities. The Company has an unsecured revolving credit agreement (the "credit facility") with Comerica Bank and other lenders to provide leverage for the Company if needed. Refer to note 10 of the consolidated financial statements included in this report for additional information related to the credit facility.



Fiscal 2013 compared to Fiscal 2012

Net cash provided by operating activities

Net cash provided by operating activities during 2013 was $132.4 million, a decrease of $47.2 million from 2012. The decrease was primarily due to an $80.9 million decline in cash collected from customers consistent with the decline in revenue as compared to the prior year and was partially offset by a decline in cash paid for income taxes of $20.9 million, a decline in cash paid to employees of $9.3 million resulting from headcount reductions and a decline in cash paid to suppliers of $5.2 million primarily related to fewer subcontractors. The consolidated statements of cash flows included in this report compute net cash from operating activities using the indirect cash flow method. Therefore, non-cash adjustments and net changes in assets and liabilities (net of effects from acquisitions and currency fluctuations) are adjusted from net income to derive net cash from operating activities. The most significant change in our reconciliation of net income to derive net cash from operating activities during 2013 as compared to 2012 was a $105.6 million decline in net income, which was partially offset by a noncash goodwill impairment charge of $71.8 million. Additionally, the impact of the net decrease in accounts receivable as compared to the prior year was $31.3 million and primarily related to the reduction in revenue from large software license deals and the timing of billings from multi-year product arrangements for 2013 as compared to 2012. The impact of the net decrease in deferred revenue was $47.3 million and primarily related to the decline in deferred multi-year Mainframe maintenance as well as a decline in Mainframe maintenance renewals during 2013 as compared to 2012. The impact of the net decrease in accounts payable and accrued expenses as compared to the prior year was $24.2 million and primarily related to the reduction in the bonus accrual due to lower revenue and earnings attainment for 2013 as compared to 2012. 50 -------------------------------------------------------------------------------- Table of Contents Net cash provided by (used) in investing activities Net cash used in investing activities during 2013 was $55.3 million, which represents a decrease in cash used of $241.7 million from 2012. The decrease is due primarily to $249.3 million in cash that was used to acquire dynaTrace during the second quarter of 2012 partially offset by increases in purchases of property and equipment and capitalized software of $9.4 million.



Net cash used in financing activities

Net cash used in financing activities during 2013 was $83.2 million, which represents a decrease of $121.7 million from the $38.4 million of cash provided by financing activities in 2012.

The change was primarily due to a $61.2 million increase in repurchases of common stock, a $37.4 million reduction in proceeds from borrowings and a $34.6 million increase in payments on borrowings partially offset by a $12.3 million increase in net proceeds from exercise of stock awards during 2013. The proceeds from borrowings during 2012 were used to fund the dynaTrace acquisition. The proceeds from borrowings during 2013 were used to fund our repurchases of common stock.



Recently Issued Accounting Pronouncements

See note 1 of the consolidated financial statements included in this report for recently issued accounting pronouncements that could affect the Company.

Contractual Obligations

The following table summarizes our payments under contractual obligations as of March 31, 2014 (in thousands):

Payment Due by Period as of March 31, Total 2015 2016 2017 2018 2019 Thereafter Contractual obligations: Operating leases $ 244,213$ 14,186$ 10,742$ 9,570$ 8,251$ 6,917$ 194,547 Other 4,870 3,420 400 150 150 150 600 Total $ 249,083$ 17,606$ 11,142$ 9,720$ 8,401$ 7,067$ 195,147 "Other" includes commitments under various advertising and charitable contribution agreements totaling approximately $3.5 million and $1.4 million, respectively, at March 31, 2014. There are no long term debt obligations, long term capital lease obligations or purchase obligations. We anticipate tax settlements of $8.5 million with certain taxing authorities, none of which is expected to be settled in the upcoming twelve months (as discussed in note 14 of the consolidated financial statements included in this report). We are not able to reasonably estimate in which future periods the $8.5 million will ultimately be settled. These settlements are not included in the Contractual Obligations table above.



Off-Balance Sheet Arrangements

We currently do not have any off balance sheet or non-consolidated special purpose entity arrangements as defined by the applicable SEC rules.

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