OpenText Corporation: Q2 Fiscal 2020 Summary
Business context and reporting period
OpenText is a global information management software and services company offering on-premise, cloud and hybrid solutions. This Form 10-Q covers the three and six months ended December 31, 2019, the second quarter and first half of fiscal 2020. The company had approximately 14,600 employees worldwide and reported in U.S. dollars under U.S. GAAP.
Key financial metrics
| Metric | Three months ended Dec. 31, 2019 | Year-over-year change | Six months ended Dec. 31, 2019 | Year-over-year change |
|---|---|---|---|---|
| Total revenue | $771.6 million | 4.9% | $1.468 billion | 4.7% |
| Recurring revenue | $563.8 million | 6.5% | $1.113 billion | 6.1% |
| Cloud services and subscriptions | $248.3 million | 13.3% | $485.6 million | 13.6% |
| GAAP gross profit | $539.2 million | 6.3% | $1.008 billion | 6.3% |
| GAAP gross margin | 69.9% | Up from 69.0% | 68.6% | Up from 67.6% |
| Income from operations | $184.7 million | 6.2% | $317.3 million | 16.1% |
| Net income attributable to OpenText | $107.5 million | 2.9% | $181.9 million | 29.2% |
| Diluted GAAP EPS | $0.40 | From $0.39 | $0.67 | From $0.52 |
| Operating cash flow | Not separately provided | — | $344.7 million | Down 4.4% |
Second-quarter operating margin was approximately 24.0% and net margin was approximately 13.9%. Six-month operating margin was approximately 21.6% and net margin was approximately 12.4%.
Management also reported second-quarter non-GAAP diluted EPS of $0.84, non-GAAP net income of $227.0 million and Adjusted EBITDA of $317.0 million. These measures exclude, among other items, acquired-intangible amortization, share-based compensation and special charges.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $675.4 million at December 31, 2019, down from $941.0 million at June 30, 2019. Cash, cash equivalents and restricted cash totaled $680.2 million.
- Operating cash flow was $344.7 million for the first six months, while investing cash flow was negative $1.265 billion, primarily due to the $1.217 billion cash purchase of Carbonite.
- Total debt principal was $3.526 billion, including $750.0 million drawn under the revolving facility. Reported debt outstanding, net of issuance costs and premiums, was $3.514 billion.
- Current debt was $913.6 million, including the revolver, Carbonite convertible notes and scheduled Term Loan B payments. Long-term debt was $2.600 billion.
- The company reported a consolidated net leverage ratio of 2.3:1, compared with a 4.0:1 covenant limit. Management stated that cash and available credit facilities are expected to fund working capital, commitments, capital expenditures, dividends and operating needs for the next twelve months.
- Operating lease liabilities totaled $285.3 million following adoption of ASC Topic 842. Unfunded pension obligations totaled $75.9 million.
Material changes versus the prior comparable period
- Cloud services and subscriptions were the primary growth driver, increasing 13.3% in the quarter. Customer support increased 1.7%, license revenue increased 4.0%, and professional services and other revenue declined 4.5%.
- Recurring revenue represented approximately 73% of quarterly revenue and increased 7.8% excluding reported foreign-exchange effects, according to management.
- GAAP gross margin improved, but cloud gross margin declined to 58.3% from 59.5%, primarily because of higher labor and network costs associated with recent acquisitions.
- Operating income growth accelerated in the first half, aided in part by lower special charges and lower amortization of certain fully amortized acquired technology assets.
- Sales and marketing expense increased 8.8% in the quarter, while research and development expense increased 6.0%, reflecting higher headcount and acquisition-related costs.
- Operating cash flow declined despite higher net income, primarily because of less favorable working-capital changes.
- OpenText adopted the new lease standard on July 1, 2019, recording approximately $217.5 million of operating lease right-of-use assets and $253.5 million of operating lease liabilities. The adoption did not affect income or cash flow.
Acquisitions, outlook and unusual items
On December 24, 2019, OpenText acquired Carbonite for approximately $1.4 billion, including $1.3 billion paid in cash and approximately $0.1 billion held back under the purchase agreement. Carbonite contributed $9.5 million of revenue and a $3.7 million net loss for the seven days included in the quarter. The preliminary allocation included $885.5 million of goodwill and $840.0 million of acquired customer and technology intangible assets. OpenText also acquired The Fax Guys for approximately $5.3 million on December 2, 2019.
Management’s strategy remains focused on “Total Growth,” combining organic growth, cloud expansion, acquisitions, recurring revenue growth, margin improvement and cash generation. Fiscal-year-to-date research and development spending was approximately 11% of revenue, within the company’s stated target of 11% to 13% for fiscal 2020. No specific consolidated revenue or EPS guidance was provided in the filing text.
On January 29, 2020, the board approved a restructuring plan expected to cost approximately $26 million to $34 million through calendar 2020 and the first half of 2021, split approximately equally between workforce reductions and facility consolidations. The company also declared a quarterly dividend of $0.1746 per share, payable March 20, 2020.
Risks, contingencies and market exposures
- The IRS has proposed approximately $770 million of aggregate additional taxes, penalties and interest related to examinations of fiscal 2010 and fiscal 2012 reorganizations. OpenText disputes the proposed adjustments, has not recorded a material accrual, and warns that an adverse outcome could materially affect financial position and results.
- Canadian tax reassessments could result in approximately $25 million of penalties and interest, although management expects available tax attributes to offset the proposed additional taxable income. No accrual was recorded.
- Carbonite-related securities litigation and patent litigation remain unresolved; the company cannot estimate a possible loss range for these matters and has not accrued a loss contingency for them.
- Carbonite integration may require significant management resources and could cause additional expenses, restructuring charges, customer losses or delays in realizing expected synergies.
- Interest-rate exposure increased following the Carbonite acquisition. A one-percentage-point increase in rates would increase annual interest expense by approximately $9.8 million on Term Loan B and $7.5 million on the fully drawn revolver, assuming balances remained outstanding.
- Foreign-exchange movements, cybersecurity and network failures, competition, customer purchasing delays, intellectual-property claims, privacy regulation and the ability to expand in SMB and consumer markets remain material risks.
Important facts investors should verify
- Carbonite’s post-acquisition revenue growth, profitability, retention and integration costs in subsequent quarters.
- Progress in reducing the $750 million revolver balance and the company’s ability to maintain leverage within covenant limits.
- Whether cloud gross-margin pressure reverses as acquired operations are integrated.
- Operating cash-flow conversion relative to GAAP net income after acquisition-related working-capital effects.
- Updates to the IRS and CRA tax matters, including accrued liabilities, interest and potential cash requirements.
- Actual restructuring charges and savings compared with the announced $26 million to $34 million plan.
- The effects of acquired-intangible amortization, share-based compensation and special charges when evaluating non-GAAP results.