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Compuware's Y2 K Bug

The Corporation: Strategies

Compuware's Y2K Bug

After the millennium scare, the software outfit failed

When the clock struck midnight on Jan. 1, 2000, most of the computing world breathed a collective sigh of relief. Instead perts had predicted, the world's computers kept humming along nicely. But the same can't be said for Compuware Corp., a $2 billion purveyor of corporate testing software and services that helped companies prepare for Y2K.

At the start of the year, Compuware executives figured they'd shift the company's focus to the next big opportunity: e-commerce. But the strategy hasn't been going well for CEO Peter J. Karmanos Jr. and his company, based in Farmington Hills, Mich. For starters, efforts to retrain employees for e-commerce work are taking much longer than expected, hammering profit margins. Worse yet, some longtime customers, rejecting Compuware's demand for big price hikes, are defecting to lower-priced vendors. Says analyst Michael Egan, who tracks mainframe business for research outfit Meta Group Inc.: "Compuware is under attack."

Compuware executives declined to comment for this story. But the extent of their problems became clear on Apr. 12, when Compuware warned analysts in a conference call it would post a severe quarterly earnings shortfall. Two senior executives, one a 24-year veteran, were abruptly out of a job. The earnings news sparked a sell-off that sent Compuware shares down 40% in a single day, to around $11, their lowest level in two years.

It was hardly the kind of news shareholders have come to expect from Compuware. Since going public in 1992, the company has grown steadily with sales climbing 30% or more a year in the late 1990s and profits nearly doubling each year. And through the first three quarters of the fiscal year ended in March, that kind of growth continued.

Still, the past 12 months has been rough for Karmanos, 56, and the spectacularly successful company he co-founded in 1973. Last summer, Compuware was rocked by the disclosure of sexual harassment charges brought against Karmanos by two female employees, including a senior executive who was fired in the wake of the scandal (BW, July 5, 1999). Her case was later settled; the other is awaiting a trial date. Then, in January, Karmanos underwent double bypass surgery.

Karmanos, a popular figure in the Detroit area, has fully recovered. But Compuware is ailing. The company missed its targets for software sales for the fourth quarter, ending Mar. 31, by a mile. Compuware says software revenues will come in between $193 million to $198 million compared with the $300 million analysts had expected.SERIAL SNAFUS. So far, Compuware executives have few convincing explanations for why the software business did so poorly during the quarter. Executives have told analysts that the company had been working to close 14 major contracts, worth a total of $140 million, by the end of March. But many contracts didn't close in time. Among the reasons: Key customers were out of town or paperwork was missing, President Joseph A. Nathan told analysts.

Company officials have noted that Compuware has since locked up about $70 million to $80 million of the business it had expected during the March quarter. Officials said they will know more by May 1, when final results for the quarter are released. And during what should have been triumphant groundbreaking for Compuware's new corporate headquarters in downtown Detroit, Karmanos recently assured reporters that Compuware's setback was little more than a stumble. "We are still growing at an astonishing rate," he told local reporters. Still, he conceded to the reporters that the company had become complacent lately.

He's right. Compuware, a leader in providing trouble-shooting software for big mainframe computers, has opened itself up to increased pressure from competitors. Before Y2K, when companies were preoccupied with the need to reprogram their computers, many Compuware customers were reluctant to consider changing software vendors for fear of destabilizing their networks. Some analysts say Compuware used the opportunity to hike its software prices substantially. And some customers assert Compuware even became arrogant. "We were getting hit with huge upgrade bills," gripes an executive at one company that decided not to renew its Compuware contract. "Their culture was unwilling to negotiate."

Now that the Y2K threat is past, some of those customers are taking their business elsewhere. ABN Amro Information Technology Services Co. a subsidiary of Dutch banking giant ABN Amro, had been using various Compuware software products for years. But when Compuware recently sought a price hike well over 25%, the unit pulled its business--worth $6 million over three years.

Rivals, which include Computer Associates, Macro 4, and SERENA Software, are all too happy to pick up business from disgruntled Compuware customers. Tiny Macro 4 Inc., a $45 million software company based in Britain, says it has seen a surge in demand for its products, some of which compete with Compuware's. "Many customers have come looking to us for alternativesbecause they feel there's been price gouging" by Compuware, says Jim Sieger, a Macro 4 vice-president.

During the company's Apr. 12 conference call, Nathan insisted competition isn't to blame for the sales shortfall. "There is no evidenceto suggest competition was part of this," he said. "It was purely the mechanics of getting the business closed." Still, the shortfall in software revenues couldn't have come at a worse time. Compuware's financial results have already been hurt in recent months by problems in its professional services division. Once a big moneymaker, the unit says it has taken longer than expected to retrain employees for e-commerce work. With technicians tied up in classes and not enough emphasis on lining up new business, profits were reduced by $45 million in the fourth-quarter, executives told analysts.PINK SLIPS. That mistake cost two top executives their jobs. Phyllis Recca, executive vice-president of professional services and one of Compuware's earliest employees, left suddenly along with a top deputy in charge of the U.S. services business. Recca declined comment. But Nathan, who will run the unit for the time being, told analysts: "It became clear certain people in the services business didn't get it, and we have to fix that."

Analysts and investors have little doubt that Compuware will fix problems in its professional services unit within the next few months. They're far more worried about what Damian Rinaldi, an analyst for First Albany Corp.'s FAC/Equities, called the "horrendous mess" in Compuware's software division, which represents nearly 60% of revenues.

Amid what analysts believe is tougher competition, Compuware has recently shifted to larger, multi-year software license contracts. That lets Compuware lock in customers for a longer period of time, and book the entire value of the deal up front. It's risky, though, says analyst Tony Ursillo, whose investment firm, Loomis Sayles & Co. in Boston, recently sold a significant portion of its 1.18 million Compuware shares. "When it works, you sort of own that customer, and it makes your top line look pretty nice, too," says Ursillo. "But when [deals don't come through], then you'll suffer in big chunks, and that's what happened in this quarter."

No wonder analysts have been ratcheting back their forecasts for Compuware. Karmanos says Compuware revenue growth should slow to about 25%. For a $2 billion company, that still sounds like a pretty good clip. But shaken investors, long accustomed to better, are waiting to see if Pete Karmanos and Compuware can at least make good on those projections. If not, Y2K is likely to go down in Compuware history as the year of the dog.By Joann Muller in DetroitReturn to top

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