OpenText Corporation — Fiscal 2014 Second-Quarter 10-Q Summary
Business context and reporting period
OpenText provides enterprise information management software and services, including enterprise content management, business process management, customer experience management, information exchange, cloud and managed services. The filing covers the three and six months ended December 31, 2013, with results presented in U.S. dollars under U.S. GAAP. Approximately 5,300 employees were reported before the subsequent GXS acquisition.
On August 15, 2013, OpenText acquired Cordys Holding B.V. for approximately $33.2 million in cash. Cordys results were consolidated from the acquisition date and had no significant impact on reported revenue or net earnings for the periods presented.
Financial performance and liquidity
| Metric | Three months ended Dec. 31, 2013 | Prior-year comparable | Six months ended Dec. 31, 2013 | Prior-year comparable |
|---|---|---|---|---|
| Total revenue | $363.5 million | $352.2 million | $688.0 million | $678.4 million |
| Gross profit | $255.6 million | $228.2 million | $473.6 million | $432.6 million |
| GAAP gross margin | 70.3% | 64.8% | 68.8% | 63.8% |
| Income from operations | $73.9 million | $67.2 million | $126.0 million | $107.3 million |
| GAAP operating margin | 20.3% | 19.1% | 18.3% | 15.8% |
| Net income | $53.5 million | $61.1 million | $84.1 million | $80.5 million |
| Diluted EPS | $0.90 | $1.04 | $1.41 | $1.37 |
| Operating cash flow | $60.9 million | Not clearly provided in the filing text | $140.8 million | $136.5 million |
Revenue increased 3.2% in the quarter and 1.4% for the six-month period. Quarterly revenue comprised license revenue of $81.2 million, cloud services of $42.1 million, customer support of $174.4 million and professional services and other revenue of $65.8 million. Customer support remained the largest revenue stream, representing 48.0% of quarterly revenue.
License revenue increased 6.6% in the quarter, supported by 21 deals exceeding $0.5 million versus 16 in the prior-year quarter. Customer support revenue increased 5.9%. These gains were partly offset by a 6.0% decline in cloud services and a 1.2% decline in professional services and other revenue. Professional services gross margin declined to 22.1% from 26.0%, primarily due to increased subcontractor usage.
Gross margin improvement primarily reflected lower amortization of acquired technology-based intangible assets, lower third-party technology costs and improved customer support margins. Quarterly non-GAAP operating margin was 30.9% versus 32.1% in the prior-year period, and non-GAAP diluted EPS was $1.58 in both periods. Non-GAAP measures exclude items including acquired-intangible amortization, share-based compensation, special charges and certain other income or expense.
Cash and cash equivalents were $515.4 million at December 31, 2013, compared with $470.4 million at June 30, 2013. Six-month operating cash flow was $140.8 million. Investing cash outflows were $52.4 million, including $30.6 million for Cordys and $20.2 million of property and equipment additions. Financing cash outflows were $48.3 million, including $35.5 million of dividends and $19.1 million of debt repayments.
At December 31, 2013, total debt was $546.2 million, consisting primarily of $536.3 million under Term Loan A and a $10.0 million mortgage. The company had not drawn on its $100 million revolving facility. Term Loan A bore interest at LIBOR plus 2.25%. The company reported covenant ratios of 1.32:1 consolidated leverage and 23.2:1 interest coverage, compared with required maximum leverage of 3:1 and minimum interest coverage of 3:1.
Material changes versus the prior comparable period
- Quarterly net income decreased 12.5% and diluted EPS decreased from $1.04 to $0.90, despite higher revenue and operating income, primarily because the effective tax rate increased to 23.7% from 4.9%.
- The tax-rate increase reflected an $11.6 million increase in the net expense of unrecognized tax benefits and a $2.1 million impact from tax-return adjustments in the United States, Germany and Australia. The six-month effective tax rate increased to 29.7% from 19.4%.
- Quarterly operating income increased 10.0%, while operating margin improved by 1.2 percentage points. Reduced acquired-intangible amortization contributed materially to the improvement.
- Sales and marketing expense increased 19.6% in the quarter and represented 22.4% of revenue versus 19.3%, reflecting increased sales-force capacity, commissions, marketing activity and Cordys-related costs.
- Quarterly special charges increased to $6.3 million from $2.3 million, mainly due to acquisition-related costs. Six-month special charges declined to $10.0 million from $11.8 million.
- Cloud services revenue declined for both the quarter and six-month period, although cloud gross margin improved to 62.1% and 63.9%, respectively.
- Deferred revenue declined to $259.8 million, including current and long-term balances, from $294.2 million at June 30, 2013.
Guidance, outlook, commentary, risks and unusual items
Management emphasized growth in earnings and cash flow, expansion of Enterprise Information Management capabilities, increased cloud presence and continued strategic acquisitions. Management expects customer support, which historically represented approximately half of revenue, to remain a recurring revenue source and expects cloud services to be an important future growth driver. No specific quantitative revenue or earnings guidance was provided in the filing text.
On January 16, 2014, after the reporting date, OpenText acquired GXS Group, Inc. for approximately $1.1 billion in cash and 1,297,521 OpenText common shares. The cash consideration was funded with $265 million of cash on hand and $800 million borrowed under a new seven-year Term Loan B. GXS results were expected to be consolidated beginning in the third quarter of Fiscal 2014, and purchase accounting was still being evaluated at the filing date.
The GXS transaction materially increased leverage and introduced integration, customer-retention, employee-retention, execution and potential liability risks. Management also initiated a GXS-related restructuring plan with estimated total costs of $29 million to $37 million, substantially completed by the end of Fiscal 2015. The company expected approximately $22 million to $27 million of these costs during the remainder of Fiscal 2014.
Other notable exposures include a potential approximately $10.5 million New York telecommunications excise and franchise tax assessment relating to pre-acquisition EasyLink revenue, ongoing tax examinations in multiple jurisdictions, floating-rate debt exposure and foreign-exchange exposure. A 100-basis-point increase in LIBOR was estimated to increase annual Term Loan A interest expense by approximately $5.4 million based on the December 31 balance.
The board approved a two-for-one stock split, with a February 18, 2014 payment date, and declared a post-split quarterly dividend of $0.15 per share, equivalent to $0.30 per share on a pre-split basis. Disclosure controls and procedures were assessed as effective, with no material changes to internal control over financial reporting.
Most important facts for investors to verify
- Reconcile the reported non-GAAP EPS and operating margin with the filing’s exclusions, particularly acquired-intangible amortization, share-based compensation, special charges and tax effects.
- Assess the effect of the GXS acquisition and the additional $800 million Term Loan B on post-closing leverage, interest expense, covenant compliance, cash flow and dilution.
- Monitor the integration of GXS, expected restructuring costs of $29 million to $37 million and any revisions to purchase accounting or acquired intangible values.
- Evaluate the sustainability of revenue growth given the decline in cloud and professional services revenue and the increased sales and marketing investment.
- Review the effective tax rate, unrecognized tax benefits, open tax examinations and the potential EasyLink tax assessment.
- Consider exposure to LIBOR, foreign-currency movements and the company’s $742.7 million of disclosed debt, lease and purchase obligations.
- Confirm the stock split, dividend amounts and share-count changes when comparing historical per-share results.