OpenText Corporation — Form 10-Q Summary
Reporting period: Quarter and nine months ended March 31, 2018, representing the third quarter of Fiscal 2018. The request metadata states “2017 Q3,” but the filing is for Fiscal 2018 Q3. Financial statements are unaudited and presented in U.S. dollars under U.S. GAAP.
Business Context
OpenText provides enterprise information management software and services through on-premise, cloud and hybrid delivery models. The company had approximately 12,200 employees as of March 31, 2018. Fiscal 2018 acquisitions included Covisint, Guidance Software and Hightail, with aggregate consideration of approximately $363.8 million.
Key Financial Metrics
| Metric | Three months ended March 31, 2018 | Prior comparable period |
|---|---|---|
| Total revenue | $685.9 million | $593.1 million |
| Gross profit | $443.1 million | $382.6 million |
| GAAP gross margin | 64.6% | 64.5% |
| Income from operations | $102.3 million | $65.3 million |
| GAAP operating margin | 14.9% | 11.0% |
| Net income attributable to OpenText | $58.8 million | $21.6 million |
| Diluted GAAP EPS | $0.22 | $0.08 |
| Adjusted EBITDA | $227.2 million | $189.1 million |
| Non-GAAP diluted EPS | $0.54 | $0.45 |
- Quarterly revenue increased 15.6%; excluding $28.7 million of favorable foreign exchange impact, growth was 10.8%.
- Annual recurring revenue, defined as cloud services and subscriptions plus customer support, was $521.4 million, up 18.3%, or 13.9% excluding foreign exchange.
- Cloud services and subscriptions revenue increased 18.1% to $209.1 million; customer support revenue increased 18.5% to $312.3 million.
- License revenue declined 3.6% to $84.1 million, although nine-month license revenue increased 21.1% to $297.6 million.
- Non-GAAP operating margin improved to 29.8% from 29.1%, and non-GAAP gross margin improved to 71.6% from 71.2%.
Nine-Month Results
| Metric | Nine months ended March 31, 2018 | Prior comparable period |
|---|---|---|
| Total revenue | $2.061 billion | $1.628 billion |
| Income from operations | $356.1 million | $246.5 million |
| GAAP operating margin | 17.3% | 15.1% |
| Net income attributable to OpenText | $180.5 million | $979.5 million |
| Diluted GAAP EPS | $0.68 | $3.88 |
| Operating cash flow | $504.4 million | $336.8 million |
| Adjusted EBITDA | $737.3 million | $555.5 million |
The prior-year nine-month net income and EPS benefited from a one-time $876.1 million tax benefit related to an internal reorganization; therefore, year-over-year GAAP net income comparisons are not representative of recurring performance.
Cash Flow, Liquidity and Capital Structure
- Cash and cash equivalents were $605.5 million at March 31, 2018, compared with $443.4 million at June 30, 2017.
- Operating cash flow increased 49.8% year over year to $504.4 million.
- Investing cash outflows were $415.2 million, including $321.0 million for the Covisint, Guidance and Hightail acquisitions and $83.0 million for property and equipment.
- Financing cash inflows were $55.2 million, including $200.0 million of Revolver borrowings, partially offset by $105.8 million of debt repayments and $105.0 million of dividends.
- Total debt principal was $2.691 billion, consisting of $850.0 million of 2026 Senior Notes, $800.0 million of 2023 Senior Notes, $766.3 million under Term Loan B and $275.0 million under the Revolver.
- The Revolver had $175.0 million of remaining committed capacity under its $450.0 million facility. Management expected to repay the $275.0 million outstanding balance within 12 months.
- Reported consolidated net leverage was 2.0:1, below the Term Loan B covenant maximum of 4.0:1.
- Contractual obligations totaled $3.840 billion, including debt obligations, operating leases and purchase obligations.
- The company declared and paid quarterly dividends of $0.1320 per share during the period and subsequently declared a $0.1518 per-share dividend payable June 29, 2018.
Material Changes Versus Prior Comparable Period
- Revenue growth was driven primarily by customer support, cloud services and subscriptions, acquisitions and favorable foreign exchange.
- GAAP operating income rose despite higher research and development, sales and marketing, general and administrative and amortization expenses.
- Special charges declined to $2.6 million in the quarter from $20.6 million, and to $21.4 million for the nine months from $44.2 million.
- Cloud gross margin declined to 54.9% from 56.4% in the quarter and to 56.0% from 57.7% for the nine months, primarily because of higher labor and network costs associated partly with acquisitions.
- Customer support gross margin improved to 89.2% from 86.9%, while professional services gross margin improved to 20.1% from 15.0% in the quarter.
- Interest expense increased because of higher Revolver borrowings and the previously issued additional 2026 Senior Notes.
- Days sales outstanding increased to 67 days from 54 days, with management attributing the increase partly to integrating acquired businesses and aligning their payment terms.
Outlook, Commentary and Unusual Items
- Management continued to target research and development spending of approximately 11% to 13% of revenue; quarterly R&D spending was approximately $84 million, or 12% of revenue.
- Management described acquisitions as a principal growth driver and expects to continue pursuing strategic acquisitions, while also investing in organic innovation, including the OpenText Magellan artificial intelligence platform.
- The Fiscal 2018 restructuring plan was expected to cost approximately $12.0 million in total, with $8.9 million recorded through March 31, 2018. The Fiscal 2017 restructuring plan was expected to cost approximately $45.0 million in total, with $37.5 million recorded.
- The Tax Cuts and Jobs Act resulted in a provisional one-time tax expense of $20.0 million for the nine months, including $4.7 million in the quarter. The company expected to finalize the amount by December 22, 2018.
- The IRS examinations of Fiscal 2010 through Fiscal 2012 remain ongoing. The company estimated potential aggregate exposure of approximately $605 million, including taxes, penalties and interest, but had recorded no material accrual and strongly disputed the IRS position.
- The CRA disputed the company’s transfer-pricing methodology and proposed a Fiscal 2012 reassessment increasing taxable income by approximately $90 million plus a penalty. No accrual was recorded; available deductions could offset additional Fiscal 2012 cash tax, excluding potential penalties.
- The company reported no material litigation accruals beyond amounts recognized and stated that material additional losses were not reasonably possible based on information available at filing.
- Adoption of the new lease standard is expected to increase reported assets and liabilities when effective for the company’s fiscal year ending June 30, 2020. Adoption of ASC 606 revenue guidance was planned for Fiscal 2019 using the cumulative-effect method, with potential changes to the timing and classification of revenue.
Investor Verification Checklist
- Confirm that comparisons use Fiscal 2018 Q3, ended March 31, 2018, rather than the “2017 Q3” metadata label.
- Assess recurring revenue growth and the sustainability of cloud and customer-support margins as acquisitions are integrated.
- Reconcile GAAP results with non-GAAP EPS and EBITDA, particularly the substantial amortization, share-based compensation and restructuring adjustments.
- Monitor Revolver repayment, interest-rate exposure and total leverage; a one-percentage-point rate increase would add approximately $7.7 million of annual Term Loan B interest and $2.8 million of annual Revolver interest at period-end balances.
- Track the IRS and CRA tax matters, especially the estimated $605 million IRS exposure, which was not accrued.
- Verify final purchase-price allocations for the Fiscal 2018 acquisitions and their effect on goodwill, intangible assets and future amortization.
- Review the final effects of the Tax Cuts and Jobs Act and the eventual adoption impacts of ASC 606 and the lease standard.