Business Context and Reporting Period
Open Text Corporation, a Canadian enterprise software company operating in the Enterprise Information Management market, filed this unaudited Form 10-Q for the quarter ended September 30, 2017, the first quarter of Fiscal 2018. The company provides on-premise, cloud and hybrid software for information management, digital transformation, content, security and business-network transactions. OpenText employed approximately 11,600 people worldwide.
Key Financial Metrics
| Metric | Q1 Fiscal 2018 | Q1 Fiscal 2017 | Change |
|---|---|---|---|
| Total revenue | $640.7 million | $491.7 million | 30.3% increase |
| Annual recurring revenue | $489.3 million | $380.0 million | 28.8% increase |
| Cloud services and subscriptions revenue | $193.9 million | $169.7 million | 14.2% increase |
| License revenue | $78.2 million | $60.7 million | 29.0% increase |
| Customer support revenue | $295.4 million | $210.2 million | 40.5% increase |
| GAAP gross profit | $417.2 million | $327.3 million | 27.5% increase |
| GAAP gross margin | 65.1% | 66.6% | Down 150 basis points |
| GAAP operating income | $87.1 million | $74.1 million | 17.6% increase |
| GAAP operating margin | 13.6% | 15.1% | Down 150 basis points |
| Net income attributable to OpenText | $36.6 million | $912.9 million | Significant decrease |
| Diluted GAAP EPS | $0.14 | $3.73 | Significant decrease |
| Adjusted EBITDA | $219.9 million | $166.6 million | 32.0% increase |
| Operating cash flow | $67.1 million | $73.5 million | 8.6% decrease |
Non-GAAP diluted EPS was $0.54 versus $0.43, non-GAAP gross margin was 72.2% versus 71.5%, and non-GAAP operating margin was 31.4% versus 30.8%. Customer support renewal rates were approximately 90%, consistent with the prior-year quarter.
Cash and cash equivalents were $376.4 million at September 30, 2017, compared with $443.4 million at June 30, 2017. Total assets were $7.70 billion and shareholders’ equity was $3.56 billion. Debt principal totaled $2.80 billion, including $375.0 million outstanding under the revolving facility; carrying value of debt was $2.77 billion. The company reported a consolidated net leverage ratio of 2.6:1, below its 4.0:1 covenant limit.
- Cash provided by operating activities: $67.1 million.
- Cash used in investing activities: $326.7 million, including $220.8 million for Guidance Software and $71.3 million for Covisint.
- Cash provided by financing activities: $184.9 million, primarily from a $200.0 million revolver draw.
- Capital expenditures: $30.4 million.
- Dividends paid: $35.0 million, or $0.1320 per common share.
Material Changes Versus the Prior Comparable Period
- Revenue growth reflected contributions from prior acquisitions and continued expansion in support, cloud and subscription offerings. Foreign-exchange-adjusted revenue growth was 29.3%.
- Customer support revenue increased 40.5%, while cloud services and subscriptions increased 14.2%. Cloud gross margin declined to 56.5% from 58.6%, primarily due to higher labor-related costs associated with acquisitions.
- Operating expenses increased $76.8 million, including higher research and development, sales and marketing, general and administrative costs, amortization and restructuring expenses.
- Amortization of acquired intangibles increased by $31.0 million in aggregate, and special charges increased to $18.0 million from $12.5 million.
- GAAP earnings comparisons were distorted by a $876.1 million one-time tax benefit recognized in Q1 Fiscal 2017 from an internal intellectual-property reorganization. No comparable benefit recurred in Q1 Fiscal 2018.
- On July 26, 2017, OpenText acquired Covisint for approximately $102.8 million. On September 14, 2017, it acquired Guidance Software for approximately $240.5 million. Both purchase-price allocations remained preliminary.
- Goodwill increased to $3.58 billion from $3.42 billion at June 30, 2017, and acquired intangible assets increased to $1.56 billion from $1.47 billion.
- The company implemented a new ERP system during the quarter and modified certain internal control processes. Management concluded that disclosure controls were effective.
Guidance, Outlook, Commentary and Risks
Management stated that Fiscal 2018 priorities include growth in earnings and cash flow, strategic acquisitions, organic innovation and broader EIM capabilities. No formal revenue or EPS guidance was provided. The company targets research and development spending of approximately 11% to 13% of Fiscal 2018 revenue and expects to continue pursuing acquisitions. Management believes cash, operating cash flow and available credit facilities will be sufficient for anticipated working capital, contractual obligations, capital expenditures, dividends and operating needs over the next twelve months, although additional financing could be required for material acquisitions.
The Fiscal 2018 restructuring plan, initiated in connection with the Covisint and Guidance acquisitions, had incurred $6.4 million of costs by September 30, 2017, with total expected costs of approximately $12.0 million. The earlier Fiscal 2017 restructuring plan had incurred $38.0 million of approximately $45.0 million of expected costs.
The most significant disclosed contingency is an ongoing IRS examination of Fiscal 2010 through Fiscal 2012 tax returns. Based on the draft and anticipated notices of proposed adjustment, the company estimates potential aggregate exposure of approximately $590 million, including U.S. federal and state taxes, penalties and interest. OpenText strongly disputes the IRS position, has not accrued a material amount, and states that an adverse outcome could materially affect financial position and results of operations. A CRA reassessment would increase taxable income by approximately $90 million, but the company expects available tax attributes could offset any Fiscal 2012 cash tax.
- Risks include acquisition integration, restructuring execution, leverage and floating-rate debt exposure, foreign-exchange movements, tax audits, competition, customer purchasing delays, cybersecurity and network failures, intellectual-property claims, privacy regulation and retention of key personnel.
- A 1% adverse interest-rate movement would increase annual interest expense by approximately $7.7 million on the Term Loan B and $3.8 million on the revolver, assuming balances remained outstanding.
- The company expects to repay the $375.0 million revolver balance within twelve months.
- Operating lease, debt and purchase obligations totaled approximately $3.99 billion, including interest and principal payments where applicable.
- The company declared a subsequent quarterly dividend of $0.1320 per share on November 1, 2017.
Important Facts for Investors to Verify
- Whether recurring-revenue growth and customer support renewal rates remain sustainable after the Guidance and Covisint integrations.
- The final purchase-price allocations, acquired intangible amortization and restructuring costs for the 2017 acquisitions.
- Progress and ultimate resolution of the IRS and CRA tax matters, particularly the estimated $590 million IRS exposure.
- Repayment timing for the $375.0 million revolver balance and compliance with leverage covenants.
- Whether operating cash flow converts the reported revenue and adjusted EBITDA growth into sufficient cash to fund acquisitions, dividends and debt reduction.
- The impact of the pending revenue-recognition standard, Topic 606, including potentially earlier recognition for implementation services and on-premise subscription offerings.
- The distinction between GAAP results and management’s non-GAAP measures, which exclude amortization, share-based compensation, special charges, other income or expense and certain tax effects.