OpenText Corporation — Form 10-Q Summary
Business context and reporting period
OpenText Corporation is a global enterprise information management software company offering on-premise, cloud and hybrid solutions. This filing covers the three and six months ended December 31, 2017, the second quarter and first six months of Fiscal 2018. Results include Covisint from July 26, 2017 and Guidance Software from September 14, 2017. The filing was signed January 31, 2018.
Key financial metrics
| Metric | Three months ended Dec. 31, 2017 | Prior comparable period | Six months ended Dec. 31, 2017 |
|---|---|---|---|
| Total revenue | $734.4 million | $542.7 million | $1.375 billion |
| GAAP gross profit | $494.1 million | $374.7 million | $911.3 million |
| GAAP gross margin | 67.3% | 69.0% | 66.3% |
| Income from operations | $166.6 million | $107.2 million | $253.7 million |
| GAAP operating margin | 22.7% | 19.7% | 18.5% |
| Net income attributable to OpenText | $85.1 million | $45.0 million | $121.7 million |
| Diluted GAAP EPS | $0.32 | $0.18 | $0.46 |
| Adjusted EBITDA | $290.1 million | $199.8 million | $510.1 million |
| Operating cash flow | Not separately provided | Not separately provided | $233.7 million |
Six-month revenue increased 32.9% year over year. Second-quarter annual recurring revenue, defined as cloud services and subscriptions plus customer support, was $516.2 million, up 30.8%. Second-quarter diluted non-GAAP EPS was $0.76 versus $0.54, non-GAAP operating margin was 36.5% versus 34.0%, and adjusted EBITDA increased 45.2%.
- Second-quarter revenue mix: customer support $308.1 million, cloud services and subscriptions $208.1 million, license $135.2 million, and professional services and other $83.0 million.
- Cash and cash equivalents were $476.0 million at December 31, 2017, compared with $443.4 million at June 30, 2017.
- Accounts receivable was $512.0 million, including $73.2 million of unbilled receivables. Management reported second-quarter DSO of 63 days versus 52 days in the prior-year quarter.
- Capital expenditures were $55.9 million for the first six months.
- Dividends declared and paid were $0.1320 per share for the quarter and $0.2640 per share for the six-month period.
Debt and liquidity
Total principal debt was $2.793 billion at December 31, 2017, with $2.768 billion reported after premiums and debt issuance costs. Debt consisted of $850 million of 2026 Senior Notes, $800 million of 2023 Senior Notes, $768.2 million under Term Loan B and $375.0 million under the revolving facility. The revolver has $75.0 million of remaining capacity under its $450 million commitment.
- Term Loan B bore interest at approximately 3.35%; the revolver bore interest at approximately 3.20%.
- The company drew $200 million on the revolver during the six-month period to finance the Guidance acquisition and expects to repay the $375 million outstanding revolver balance within 12 months.
- Management expects cash and available credit facilities to fund working capital, contractual commitments, capital expenditures, dividends and operating needs for the next 12 months, although additional acquisitions could require further financing.
- Consolidated net leverage was 2.3:1 at December 31, 2017, below the 4.0:1 covenant threshold disclosed for Term Loan B.
Material changes versus the prior comparable period
- Revenue growth was broad-based: license revenue rose 38.3%, cloud services and subscriptions rose 18.9%, customer support rose 40.3%, and professional services and other rose 65.2% in the second quarter.
- GAAP gross margin declined from 69.0% to 67.3%, primarily reflecting higher amortization of acquired technology-related intangibles and increased cloud and service delivery costs.
- GAAP operating margin improved from 19.7% to 22.7%, helped by revenue scale and lower special charges compared with the prior-year quarter.
- Interest expense increased to $34.1 million from $27.7 million in the quarter because of the additional Senior Notes 2026 and revolver borrowings.
- Operating cash flow increased 29.5% for the six-month period, but working-capital consumption increased, including a $49.5 million use of cash from accounts receivable and a $72.5 million use from accounts payable and accrued liabilities.
- Investing cash outflows included $229.3 million for Guidance Software and $71.3 million for Covisint. Net investing outflows were $364.6 million versus $515.9 million in the prior-year period.
- The prior-year six-month results included an $876.1 million tax benefit from an internal reorganization; consequently, six-month GAAP net income fell from $957.9 million to $121.6 million despite stronger operating performance.
Guidance, outlook, commentary and unusual items
- Management expects to continue pursuing strategic acquisitions and identifies acquisitions as a leading growth driver, supplemented by organic innovation.
- Research and development spending was approximately 11% of quarterly revenue; management targets 11% to 13% of revenue for Fiscal 2018.
- Management highlighted the OpenText Magellan artificial-intelligence platform, OpenText Release 16 and recent acquisitions as strategic components of its enterprise information management offering.
- The Fiscal 2018 restructuring plan, associated with the Covisint and Guidance acquisitions, is expected to cost approximately $12.0 million; $8.4 million had been recorded by December 31, 2017.
- The company recorded a provisional $15.3 million tax expense related to the U.S. Tax Cuts and Jobs Act. The amount remains subject to measurement-period adjustments and was expected to be finalized by December 22, 2018.
- The IRS examinations concerning Fiscal 2010–2012 reorganizations could result in an estimated aggregate liability of approximately $600 million, including taxes, penalties and interest. No material accrual has been recorded, and the company intends to contest the proposed adjustments.
- The Canada Revenue Agency is disputing transfer-pricing positions. A Fiscal 2012 reassessment would increase taxable income by approximately $90 million, with proposed penalties of approximately 10%; the company has recorded no accrual for this matter.
- Other disclosed tax matters include a $3.9 million accrual related to a GXS Brazil matter, a $1.3 million accrual for a GXS India matter and a $1.4 million payment to settle the Brazilian municipal dispute.
- The company expects to adopt ASC Topic 606 revenue recognition in Fiscal 2019 using the cumulative-effect method. Management expects changes primarily for cloud implementation services and on-premise subscription offerings, but had not quantified the full impact.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting.
Most important facts for investors to verify
- Whether the strong revenue and recurring-revenue growth persists after acquisition-related comparisons normalize.
- The ability to reduce the $375 million revolver balance within 12 months while continuing acquisitions and paying dividends.
- The ultimate cash and accounting impact of the IRS and CRA tax disputes, including the estimated IRS exposure of approximately $600 million.
- The final tax accounting effects of the U.S. Tax Cuts and Jobs Act and the provisional $15.3 million charge.
- Whether the lower GAAP gross margin continues as acquired intangible amortization and cloud delivery costs remain elevated.
- The quantified impact of adopting ASC Topic 606 and the effect on revenue timing, deferred revenue and operating cash flow.
- Changes in accounts receivable, unbilled receivables and DSO, which increased materially year over year.
- Integration progress, restructuring costs and operating performance of Guidance and Covisint.
- Exposure to floating-rate debt, foreign exchange movements and privacy, cybersecurity, intellectual-property and regulatory risks.