OpenText Corporation — Form 10-Q Summary
Reporting period: Three and nine months ended March 31, 2019, representing Fiscal 2019 third quarter and year-to-date periods. The request metadata identifies “2018 Q3,” but the filing itself is for March 31, 2019. Amounts are in U.S. dollars unless otherwise stated; financial statements are unaudited and prepared under U.S. GAAP.
Business Context and Reporting Period
OpenText provides enterprise information management software and services through on-premises, cloud and hybrid delivery models. The company had approximately 13,000 employees at March 31, 2019. Fiscal 2019 includes Liaison Technologies from December 17, 2018 and Catalyst Repository Systems from January 31, 2019.
OpenText adopted ASC Topic 606, Revenue from Contracts with Customers, effective July 1, 2018, using the cumulative-effect method. Adoption increased opening retained earnings by approximately $30 million and changed the timing and classification of certain revenue, contract assets, deferred revenue and commission costs.
Key Financial Metrics
| Metric | Three months ended March 31, 2019 | Year-over-year change | Nine months ended March 31, 2019 | Year-over-year change |
|---|---|---|---|---|
| Total revenue | $719.1 million | Up 4.9% | $2.122 billion | Up 2.9% |
| Recurring revenue | $549.4 million | Up 5.4% | $1.599 billion | Not clearly stated as a percentage |
| Cloud services and subscriptions | $238.6 million | Up 14.1% | $665.9 million | Up 9.0% |
| License revenue | $98.7 million | Up 17.4% | $308.4 million | Up 3.6% |
| Customer support | $310.8 million | Down 0.5% | $932.7 million | Up 1.8% |
| Professional services and other | $71.1 million | Down 11.6% | $214.6 million | Down 9.3% |
| Gross profit | $479.5 million | Up $36.2 million | $1.428 billion | Up $72.6 million |
| GAAP gross margin | 66.7% | Up from 64.6% | 67.3% | Up from 65.7% |
| Income from operations | $135.9 million | Up $33.1 million | $409.0 million | Up $51.7 million |
| Net income attributable to OpenText | $72.8 million | Up from $58.8 million | $213.5 million | Up from $180.5 million |
| Diluted GAAP EPS | $0.27 | Up from $0.22 | $0.79 | Up from $0.68 |
| Operating cash flow | Not separately provided | — | $646.5 million | Up 28.3% |
| Adjusted EBITDA | $261.8 million | Up from $227.6 million | $816.4 million | Up from $738.5 million |
Foreign exchange affected reported growth. Management stated that third-quarter revenue growth was 7.7% on a constant-currency basis, compared with reported growth of 4.9%. Recurring revenue growth was 7.8% on a constant-currency basis.
Liquidity, Debt and Capital Resources
- Cash and cash equivalents were $765.2 million at March 31, 2019, compared with $682.9 million at June 30, 2018. Including restricted cash, total cash was $769.5 million.
- Net cash provided by operating activities was $646.5 million for the nine months, compared with $504.0 million in the prior-year period.
- Investing cash outflows were $442.4 million, including $381.4 million for the Liaison and Catalyst acquisitions and $50.4 million for property and equipment.
- Financing cash outflows were $114.7 million, including $121.9 million of dividends, $26.5 million of treasury-stock purchases and $7.5 million of debt repayment.
- Total debt principal was $2.640 billion, consisting of $850 million of 2026 Senior Notes, $800 million of 2023 Senior Notes and $990 million of Term Loan B. The carrying value of debt was $2.616 billion.
- The $450 million revolving credit facility had no outstanding balance. Term Loan B bore interest at approximately 4.24% and matures in May 2025. The company reported a consolidated net leverage ratio of 1.7:1, versus a covenant limit of 4:1.
- 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; significant acquisitions could require additional financing.
Material Changes Versus the Prior Comparable Period
- Cloud services and subscriptions remained the principal growth driver, increasing 14.1% in the quarter and 9.0% year to date.
- License revenue increased 17.4% in the quarter, aided by the adoption of ASC Topic 606, which recognized certain license revenue upfront. Third-quarter reported license revenue was $17.3 million higher than the comparable pro forma ASC Topic 605 amount.
- Professional services declined 11.6% in the quarter and 9.3% year to date, although management reported improved year-to-date gross margin from more selective engagement acceptance.
- GAAP gross margin expanded to 66.7% in the quarter from 64.6%, and operating income increased 32.2%.
- Income tax expense increased in the quarter, producing an effective tax rate of 30.9% versus 25.5% in the prior-year quarter. The company cited foreign-taxed income, the U.S. BEAT regime and internal reorganization impacts.
- Year-to-date special charges increased to $33.5 million from $21.4 million, primarily due to the Fiscal 2019 restructuring plan. Management expects approximately $30 million of total costs under that plan and had recorded $26.9 million through March 31, 2019.
- OpenText acquired Liaison for approximately $310.6 million and Catalyst for approximately $70.8 million in cash. Both purchase price allocations remained preliminary, and management stated that neither acquisition materially affected reported revenue or earnings for the period since acquisition.
- The company declared and paid quarterly dividends totaling $0.1518 per share during the quarter. On April 30, 2019, it declared a subsequent dividend of $0.1746 per share, payable June 21, 2019, subject to the stated record-date requirements.
Guidance, Outlook, Risks and Unusual Items
Management emphasized continued investment in cloud capabilities, organic innovation and strategic acquisitions. Research and development spending was approximately $85 million, or 11.8% of quarterly revenue; management expects Fiscal 2019 R&D spending to remain within 11% to 13% of revenue. No formal revenue or EPS guidance target was provided in the filing.
- IRS tax matter: Final Notices of Proposed Adjustment for Fiscal 2010 and Fiscal 2012 proposed approximately $770 million of aggregate potential liability, including approximately $455 million of federal and state taxes, $130 million of penalties and $185 million of interest. OpenText disputes the IRS positions, is pursuing available appeals and court remedies, and has recorded no material accrual. An adverse outcome could materially affect financial position and results.
- CRA tax matter: Potential exposure related to Canadian transfer-pricing reassessments was estimated at approximately $23 million of penalties and interest, assuming available tax attributes. The company has recorded no accrual and is contesting the reassessments.
- Restructuring: Workforce reductions and facility consolidations generated $26.9 million of Fiscal 2019 restructuring charges through March 31, 2019.
- Accounting changes: ASC Topic 606 materially affects reported revenue timing, contract assets, deferred revenue and sales commissions. Comparisons with prior periods should distinguish reported results from pro forma ASC Topic 605 amounts.
- Market risks: A one-percentage-point increase in the Term Loan B interest rate would increase annual interest expense by approximately $9.9 million. A 10% weakening of foreign currencies against the U.S. dollar would reduce the reported U.S.-dollar value of foreign-currency cash by approximately $33.8 million.
- Other risks: Acquisition integration, restructuring execution, competition, customer purchasing delays, cybersecurity and network failures, intellectual-property claims, privacy regulation, foreign exchange, Brexit-related uncertainty and future tax assessments could affect results.
Investor Verification Priorities
- Reconcile reported Fiscal 2019 revenue and EPS with pro forma ASC Topic 605 results to isolate accounting-timing effects from underlying growth.
- Assess the sustainability of cloud growth and recurring-revenue expansion, including customer-support renewal rates, which were approximately 91%.
- Monitor integration, contribution and final purchase-price allocations for Liaison and Catalyst, as well as the expected $30 million Fiscal 2019 restructuring program.
- Evaluate leverage, floating-rate exposure, debt maturities and the company’s ability to fund acquisitions while maintaining dividends.
- Track developments in the IRS and CRA tax matters, including accrued interest, penalties and the potential for material cash payments.
- Review the company’s non-GAAP reconciliations carefully: third-quarter non-GAAP diluted EPS was $0.64 versus GAAP diluted EPS of $0.27, with the difference primarily reflecting amortization, share-based compensation, special charges, other income and tax adjustments.