Business Context and Reporting Period
OpenText Corporation, an information management software and services company, filed this unaudited Form 10-Q for the quarter ended September 30, 2022, the first quarter of Fiscal 2023. The company reported approximately 14,500 employees across 35 countries and operates through cloud, customer support, license, and professional services offerings.
Financial Performance and Position
| Metric | Q1 Fiscal 2023 | Q1 Fiscal 2022 | Change |
|---|---|---|---|
| Total revenue | $852.0 million | $832.3 million | 2.4% increase |
| Recurring revenue | $722.0 million | $691.8 million | 4.4% increase |
| Cloud services and subscriptions | $404.7 million | $356.6 million | 13.5% increase |
| Gross profit | $593.7 million | $574.2 million | 3.4% increase |
| GAAP gross margin | 69.7% | 69.0% | Up 0.7 percentage points |
| Income from operations | $146.4 million | $182.7 million | 19.9% decrease |
| Net income attributable to OpenText | $(116.9) million | $131.9 million | Loss versus profit |
| Diluted EPS | $(0.43) | $0.48 | Decline |
| Non-GAAP net income | $206.8 million | $227.8 million | 9.2% decrease |
| Adjusted EBITDA | $304.0 million | $323.4 million | 6.0% decrease |
| Operating cash flow | $132.0 million | $189.7 million | 30.4% decrease |
Cloud revenue growth was partly offset by declines in customer support revenue of 5.3% and license revenue of 14.9%. On a constant-currency basis, management reported total revenue growth of 7.1% and recurring revenue growth of 8.9%. Enterprise cloud bookings increased approximately 37% to $111.7 million, excluding Carbonite and Zix.
Operating expenses increased $55.8 million, led by higher sales and marketing, research and development, general and administrative, amortization, restructuring, and acquisition-related costs. Non-GAAP gross margin was 75.2%, compared with 75.7% in the prior-year quarter.
Cash and cash equivalents were $1.704 billion at September 30, 2022, compared with $1.694 billion at June 30, 2022. Total cash, cash equivalents, and restricted cash were $1.706 billion. Cash flow included $36.3 million of capital expenditures and $64.7 million of dividend payments.
Total debt principal was $4.255 billion, with carrying debt of $4.219 billion after issuance costs. The company had $955.0 million outstanding under Term Loan B, no Revolver borrowings, and no borrowings under the newly arranged Acquisition Term Loan or Bridge Loan. Term Loan B bears a floating rate and had an interest rate of 4.27% at quarter-end. The reported consolidated net leverage ratio was 2.1:1, against a 4:1 covenant under existing facilities.
Material Changes Versus the Prior Comparable Period
- Cloud services and subscriptions increased $48.1 million, primarily reflecting acquisitions and continued cloud expansion.
- Customer support declined $17.9 million, although the renewal rate improved to 95% from 94%.
- License revenue declined $11.0 million, while professional services revenue was broadly stable.
- Operating income fell $36.3 million as operating expenses increased faster than gross profit.
- GAAP results were materially affected by $181.5 million of unrealized losses on derivatives entered into for the proposed Micro Focus acquisition. These losses were recorded in other expense and were largely not deductible for tax purposes.
- Other income and expense shifted from $29.8 million of income to $189.2 million of expense, also reflecting lower results from equity-method investments.
- Operating cash flow decreased $57.7 million, primarily because of lower earnings after non-cash adjustments and changes in working capital.
- Share-based compensation increased to $23.2 million from $13.9 million, and special charges increased to $14.3 million from $0.3 million.
Guidance, Outlook, Risks, and Unusual Items
Management did not provide specific quantitative revenue or earnings guidance in the filing. It reiterated a “Total Growth” strategy focused on recurring revenue growth, margin expansion, cloud modernization, acquisitions, and cash flow generation. Research and development spending was 12.9% of revenue, within the stated Fiscal 2023 target range of 12% to 14%.
OpenText announced an approximately $6.0 billion all-cash offer for Micro Focus, inclusive of Micro Focus cash and debt. Micro Focus shareholders approved the transaction on October 18, 2022, and management expected closing in the first quarter of calendar 2023, subject to regulatory and other conditions. Financing arrangements include a $2.585 billion Acquisition Term Loan and commitments of up to $2.0 billion under a Bridge Loan. Management intends to refinance or reduce Bridge Loan commitments through debt capital markets transactions, but provided no assurance that it can do so.
Derivative mark-to-market losses are expected to continue until the Micro Focus transaction is completed and may remain volatile with foreign exchange movements. The acquisition also presents risks related to regulatory approvals, financing, increased leverage, integration, transaction costs, restructuring, and realization of expected synergies.
OpenText expects total costs under its Fiscal 2022 restructuring plan to be approximately $40 million to $45 million, of which $31.9 million had been recorded through September 30, 2022. The company also expects additional acquisition and integration costs.
Significant contingencies include Canada Revenue Agency transfer-pricing reassessments. Management estimates potential penalties, interest, and provincial taxes related to Fiscal 2012 through Fiscal 2016 at approximately $70 million, while approximately $32 million had been paid provisionally. A separate Fiscal 2017 matter could require an income tax expense of up to approximately $470 million through a reduction of deferred tax assets if the company is unsuccessful, although management strongly disputes the CRA’s position and has recorded no accrual.
Other disclosed risks include inflation, rising interest rates, foreign exchange volatility, COVID-19, the Russia-Ukraine conflict, cybersecurity and privacy requirements, litigation, intellectual-property claims, customer demand, and the potential discontinuation of LIBOR. The company stated that its disclosure controls and procedures and internal control over financial reporting were effective as of September 30, 2022.
Important Facts for Investors to Verify
- Whether the Micro Focus acquisition closed on the expected schedule and on the announced terms.
- The amount and terms of debt ultimately drawn to fund the acquisition, resulting leverage, interest expense, and covenant compliance.
- The magnitude and duration of further derivative mark-to-market losses or gains before transaction close.
- Whether cloud and recurring revenue growth offsets continued declines in customer support and license revenue.
- Trends in operating cash flow, free cash flow, capital expenditures, and dividend sustainability.
- Progress against the $40 million to $45 million restructuring cost estimate and the level of post-acquisition integration costs.
- The resolution and cash-tax implications of the CRA reassessments, including the potential deferred tax asset reduction of up to approximately $470 million.
- Whether the company realizes anticipated Micro Focus synergies without materially increasing integration costs, leverage, or operating risk.