Open Text Corporation — Fiscal 2013 Second-Quarter 10-Q Summary
Business context and reporting period
OpenText provides enterprise information management software, including enterprise content management, business process management, customer experience management, information exchange and discovery products. The filing covers the three and six months ended December 31, 2012, under U.S. GAAP. Results include EasyLink Services International Corporation from July 2, 2012.
Key financial metrics
| Metric | Three months ended Dec. 31, 2012 | Year-over-year change | Six months ended Dec. 31, 2012 | Year-over-year change |
|---|---|---|---|---|
| Total revenue | $352.2 million | Up 9.6% | $678.4 million | Up 11.3% |
| GAAP gross profit | $229.5 million | Up $13.7 million | $435.0 million | Up $32.6 million |
| GAAP gross margin | 65.2% | Down from 67.1% | 64.1% | Down from 66.0% |
| GAAP operating income | $67.2 million | Up $12.0 million | $107.3 million | Up $25.0 million |
| GAAP operating margin | 19.1% | Up from 17.2% | 15.8% | Up from 13.5% |
| Net income | $61.1 million | Up from $47.4 million | $80.5 million | Down from $82.4 million |
| Diluted EPS | $1.04 | Up from $0.81 | $1.37 | Down from $1.41 |
| Operating cash flow | Not separately stated in the financial statements | Management reported $74.7 million, up 67.1% | $136.5 million | Up from $90.0 million |
Non-GAAP diluted EPS was $1.58 for the quarter and $2.89 for the six-month period, compared with $1.39 and $2.42, respectively, in the prior-year periods. Non-GAAP operating margin was 32.1% for the quarter and 30.5% for the six months.
- Quarterly revenue mix: license $76.1 million, cloud services $46.2 million, customer support $164.7 million, and professional services and other $65.2 million.
- License revenue declined 15.1% in the quarter and 14.8% for the six months, primarily due to fewer large deals. Deals exceeding $0.5 million declined to 16 from 29 in the quarter and to 27 from 51 for the six months.
- Cloud services contributed $46.2 million in quarterly revenue and $91.0 million for the six months, primarily from EasyLink; there was no comparable prior-year line item.
- Customer support revenue was broadly stable, representing approximately half of total revenue, while professional services margins improved to 26.9% in the quarter from 23.8%.
- Cash and cash equivalents were $367.3 million at December 31, 2012, compared with $559.7 million at June 30, 2012.
- Total debt was $581.4 million, including a $570.0 million term loan and an $11.4 million mortgage. The $100 million revolving facility was undrawn.
- Current and long-term contractual obligations totaled $789.0 million, including $632.8 million of debt obligations, $150.7 million of operating leases and $5.5 million of purchase obligations.
Material changes versus prior comparable periods
- EasyLink was acquired for $342.3 million in cash on July 2, 2012. The acquisition added cloud services revenue, $172.2 million of goodwill and $197.1 million of acquired intangible assets, and increased amortization and integration costs.
- Cash used in investing activities was $326.2 million for the six months, including $315.3 million for the EasyLink acquisition.
- Cash declined by $192.5 million during the six months, compared with a $129.8 million increase in the prior-year period. Financing cash flow was negative $8.3 million versus positive $317.1 million in the prior year, when the company raised substantial term debt.
- Operating cash flow improved to $136.5 million, aided by higher noncash depreciation and amortization and more favorable working-capital changes.
- Research and development expense declined $3.9 million for the quarter and $7.5 million for the six months, while general and administrative expense increased $4.9 million and $7.3 million, respectively, largely reflecting EasyLink-related costs.
- Special charges were $2.3 million for the quarter and $11.8 million for the six months. The new Fiscal 2013 restructuring plan is expected to cost approximately $15.0 million in total, of which $8.3 million had been recorded by December 31, 2012.
- The six-month tax provision increased to $19.4 million from $5.5 million in the prior year, partly because the prior year included significant tax benefits from internal reorganizations and a U.S.-dollar functional-currency election.
Guidance, outlook, risks and unusual items
Management did not provide specific numerical revenue or earnings guidance. Management expects customer support to remain approximately 50% of revenue, views recurring support revenue and geographic diversification as stabilizing factors, and intends to continue pursuing strategic acquisitions to expand its enterprise information management portfolio.
- Liquidity: Management believes cash, available credit facilities and committed loan facilities are sufficient for the next 12 months, although material additional acquisitions could require additional financing.
- Debt risk: The term loan bears interest at LIBOR plus 2.50%; a 100-basis-point increase in LIBOR would increase annual interest expense by approximately $5.7 million based on the outstanding balance at period-end. The company was in compliance with its leverage and interest-coverage covenants.
- Tax contingencies: EasyLink faces a potential New York telecommunications excise and franchise tax assessment of approximately $10.5 million, plus a separate $0.5 million sales-tax assessment and related audits. The company has posted a bond for the $0.5 million assessment.
- Litigation: j2 Global and affiliates have asserted patent infringement claims concerning fax-related products. No liability was accrued, and management states that it believes the claims are without merit.
- Acquisition accounting: The EasyLink purchase price allocation remained subject to determining potential unrecorded liabilities involving legacy litigation, onerous contracts and sales-tax matters; finalization was expected by June 30, 2013.
- Foreign exchange: Approximately 46% of cash was held in non-U.S. currencies. The company uses Canadian-dollar foreign exchange forwards to hedge portions of Canadian payroll exposure.
- Internal controls: Management concluded that disclosure controls were effective and that no material changes affected internal control over financial reporting during the quarter.
Investor verification points
- Verify the sustainability of revenue growth after separating EasyLink-driven cloud services from underlying organic growth.
- Assess whether the decline in license revenue and large-deal activity is temporary or indicates weaker demand or sales execution.
- Reconcile GAAP results with non-GAAP results, particularly the substantial acquired-intangible amortization, restructuring charges and tax adjustments.
- Monitor cash conversion, acquisition spending and the reduction in cash balances following the EasyLink purchase.
- Review term-loan maturities, floating-rate exposure, covenant compliance and the scheduled mortgage maturity.
- Track EasyLink-related tax assessments, litigation, purchase-price-allocation adjustments and restructuring costs.
- Evaluate the effect of future acquisitions on goodwill, intangible amortization, leverage and reported margins.