OpenText Corporation: Form 10-Q Summary
Reporting period: Three and nine months ended March 31, 2020, filed April 30, 2020. The request metadata identifies “2019 Q3,” but the filing is for Fiscal 2020 Q3. Amounts are in thousands of U.S. dollars unless otherwise stated.
Business context
OpenText is an information management company offering on-premises, cloud and hybrid software and services, including enterprise information management, business network, customer experience, data protection and endpoint security solutions. The company employed approximately 15,000 people at March 31, 2020.
Fiscal 2020 results include Carbonite from December 24, 2019, The Fax Guys from December 2, 2019 and XMedius from March 9, 2020. These acquisitions materially affect period-to-period comparability.
Financial performance and liquidity
| Metric | Q3 Fiscal 2020 | Q3 Fiscal 2019 | Nine months Fiscal 2020 | Nine months Fiscal 2019 |
|---|---|---|---|---|
| Total revenue | $814.7 million | $719.1 million | $2.283 billion | $2.122 billion |
| Recurring revenue | $662.3 million | $549.4 million | $1.776 billion | $1.599 billion |
| Gross profit | $532.5 million | $479.5 million | $1.540 billion | $1.428 billion |
| GAAP gross margin | 65.4% | 66.7% | 67.5% | 67.3% |
| Income from operations | $95.1 million | $135.9 million | $412.3 million | $409.0 million |
| Net income attributable to OpenText | $26.0 million | $72.8 million | $207.8 million | $213.5 million |
| Diluted GAAP EPS | $0.10 | $0.27 | $0.77 | $0.79 |
| Adjusted EBITDA | $259.5 million | $261.8 million | $830.7 million | $816.4 million |
| Operating cash flow | Not separately provided | Not separately provided | $674.3 million | $646.5 million |
Q3 revenue increased 13.3%, or 14.1% excluding foreign exchange. Recurring revenue increased 20.6%, cloud services and subscriptions increased 42.3%, and customer support increased 3.9%. License revenue declined 17.9%, reflecting fewer and smaller large license transactions.
Non-GAAP Q3 diluted EPS was $0.61 versus $0.64, non-GAAP gross margin was 73.3% versus 73.0%, and non-GAAP net income was $166.3 million versus $173.0 million. The GAAP-to-non-GAAP difference primarily reflects acquired-intangible amortization, share-based compensation, special charges and other income or expense.
Cash and cash equivalents were $1.453 billion at March 31, 2020, compared with $941.0 million at June 30, 2019. Cash, cash equivalents and restricted cash totaled $1.458 billion. Operating cash flow increased 4.3% year over year, while investing cash outflows increased substantially because of acquisitions.
Balance sheet, debt and capital allocation
- Total assets were $10.162 billion, including $4.679 billion of goodwill and $1.732 billion of acquired intangible assets.
- Total debt was $4.196 billion, consisting principally of $2.650 billion of senior notes, $980.0 million of Term Loan B and $600.0 million drawn under the Revolver.
- Debt increased from $2.615 billion at June 30, 2019, primarily due to acquisition financing and the March 2020 Revolver draw.
- OpenText issued $900 million of 3.875% Senior Notes due 2028 and $900 million of 4.125% Senior Notes due 2030. Proceeds were used in part to redeem the $800 million Senior Notes due 2023 and repay a prior $750 million Revolver draw.
- The company drew $600 million under its $750 million Revolver in March 2020 as a precautionary measure related to COVID-19; $150 million remained available.
- The consolidated net leverage ratio was 2.3:1 at March 31, 2020, below the 4:1 covenant limit.
- The company paid $141.4 million of dividends during the first nine months, or $0.5238 per share, and declared a further $0.1746 per-share dividend on April 29, 2020.
Material changes versus the prior comparable period
- Revenue growth was driven principally by acquisitions and cloud expansion, while license revenue declined.
- GAAP operating income declined 30.0% in Q3 despite higher revenue, as operating expenses increased 27.3%, including higher research and development, sales and marketing, general and administrative expense and acquired-intangible amortization.
- GAAP net income attributable to OpenText declined 64.3% in Q3. The decline included $17.9 million of loss on extinguishment of debt, higher interest expense and higher amortization.
- Recurring revenue represented approximately 81% of Q3 revenue, compared with approximately 76% in the prior-year quarter.
- Customer support renewal rates improved to approximately 94% from 91%.
- Goodwill increased by approximately $909 million, largely from the Carbonite and XMedius acquisitions.
- Operating lease right-of-use assets and lease liabilities were recognized following adoption of ASC Topic 842 on July 1, 2019.
Guidance, outlook, risks and unusual items
Management continues to emphasize “Total Growth,” combining organic growth, cloud expansion, recurring revenue, margin improvement and acquisitions. Fiscal year-to-date research and development investment was approximately $270 million, or 12% of revenue, within the stated target range of 11% to 13% of revenue. The filing does not provide specific consolidated revenue or earnings guidance for Fiscal 2020.
COVID-19 was identified as a significant emerging risk. As of March 31, 2020, the company had not recorded estimated COVID-19-related amounts in its financial statements. More than 95% of employees were working from home as of the filing date, and management reduced hiring and discretionary spending.
On April 29, 2020, the board approved a COVID-19 restructuring plan expected to generate total charges of $80 million to $100 million over six to twelve months, substantially all expected to result in cash expenditures. The plan includes reducing the global office footprint by more than 50%, affecting approximately 15% of employees, with estimated facility-related costs of $65 million to $80 million and severance costs of $15 million to $20 million.
Key contingencies include an IRS examination involving proposed additional taxes, penalties and interest of approximately $770 million, for which no material accrual has been recorded; Canadian tax reassessments with estimated potential penalties and interest of approximately $25 million; and litigation inherited through Carbonite for which potential losses cannot be reasonably estimated. The company has accrued $1.2 million for the GXS India tax matter.
Additional risks include acquisition integration, realization of Carbonite synergies, demand from SMB and consumer customers, foreign exchange, floating-rate debt, cybersecurity, intellectual property claims and the uncertain duration and severity of COVID-19.
Facts investors should verify
- Whether recurring revenue and cloud growth remain strong after the full-period integration of Carbonite and other acquisitions.
- The effect of COVID-19 on customer purchasing decisions, cloud operating costs, collections, margins and cash flow.
- The timing, cash cost and savings achieved from the $80 million to $100 million COVID-19 restructuring plan.
- Debt repayment plans, Revolver utilization, floating-rate exposure and compliance with the 4:1 leverage covenant.
- Whether goodwill and acquired intangible assets remain recoverable and whether acquisition synergies are realized.
- The ultimate resolution and financial exposure of the IRS and CRA tax matters.
- The reconciliation and limitations of non-GAAP metrics, particularly given the significant acquired-intangible amortization and special charges excluded from those measures.