OpenText Corporation: Fiscal 2019 Second-Quarter 10-Q Summary
Business Context and Reporting Period
OpenText provides enterprise information management software and services through on-premises, cloud and hybrid delivery models. The filing covers the three and six months ended December 31, 2018, the second quarter and first half of Fiscal 2019. Results are presented in U.S. dollars under U.S. GAAP. OpenText employed approximately 12,800 people worldwide.
Effective July 1, 2018, the company adopted ASC Topic 606 using the cumulative-effect method. Accordingly, current-period revenue results are not fully comparable with prior periods reported under the former revenue standard.
Financial Performance and Key Metrics
| Metric | Three months ended Dec. 31, 2018 | Prior comparable period | Six months ended Dec. 31, 2018 | Prior comparable period |
|---|---|---|---|---|
| Total revenue | $735.2 million | $734.4 million | $1.402 billion | $1.375 billion |
| Recurring revenue | $529.6 million | $516.2 million | $1.049 billion | Not clearly provided |
| Gross profit | $507.2 million | $494.2 million | $948.1 million | $911.6 million |
| GAAP gross margin | 69.0% | 67.3% | 67.6% | 66.3% |
| Income from operations | $173.9 million | $166.9 million | $273.2 million | $254.6 million |
| GAAP net income attributable to OpenText | $104.4 million | $85.1 million | $140.8 million | $121.7 million |
| Diluted GAAP EPS | $0.39 | $0.32 | $0.52 | $0.46 |
| Adjusted EBITDA | $308.3 million | $290.5 million | $554.5 million | $510.9 million |
Second-quarter revenue was essentially flat year over year, or up 1.5% excluding approximately $10.3 million of unfavorable foreign-exchange effects. Recurring revenue increased 2.6%, or 3.9% excluding foreign exchange. Cloud services and subscriptions grew 5.3%, while license revenue declined 1.8% and professional services and other revenue declined 12.1%.
Second-quarter operating margin was approximately 23.7%, compared with 22.7% in the prior-year quarter. Net margin attributable to OpenText was approximately 14.2%, compared with 11.6%. The lower effective tax rate, including a $14.8 million reversal of accruals related to undistributed U.S. earnings, contributed materially to net-income growth.
- Six-month operating cash flow was $360.5 million, up 54.4% from $233.4 million.
- Cash, cash equivalents and restricted cash totaled $597.9 million at December 31, 2018; cash and cash equivalents alone totaled $595.1 million, down from $682.9 million at June 30, 2018.
- Operating cash flow was largely offset by $353.4 million of investing cash outflows, including the $311.3 million Liaison acquisition, and $87.3 million of financing cash outflows.
- Capital expenditures were $33.5 million for the first six months.
- Cash dividends paid were $81.2 million, or $0.3036 per share, during the first six months.
Debt, Liquidity and Balance Sheet
- Total debt principal was $2.643 billion, consisting of $850 million of 2026 Senior Notes, $800 million of 2023 Senior Notes and $992.5 million under Term Loan B. The carrying amount of debt was $2.618 billion.
- The $450 million revolving credit facility had no outstanding balance at December 31, 2018.
- Term Loan B carried an interest rate of approximately 4.09% and matures in May 2025; the Senior Notes mature in 2023 and 2026.
- The reported consolidated net leverage ratio was 1.9:1, below the 4:1 covenant maximum.
- Management stated that cash and available credit facilities should be sufficient for anticipated working capital, contractual commitments, capital expenditures, dividends and operating needs for the next twelve months, although additional acquisition activity could require financing.
- Contractual obligations totaled $3.827 billion, including $3.476 billion of debt obligations, $335.7 million of operating lease obligations and $15.7 million of purchase obligations.
Material Changes Versus the Prior Comparable Period
- Cloud services and subscriptions revenue increased $11.1 million in the quarter and $25.3 million year to date, supported by growth in the Americas and EMEA.
- Customer support revenue increased $2.3 million in the quarter and $18.4 million year to date; the customer-support renewal rate was approximately 91%, unchanged year over year.
- Professional services and other revenue declined $10.1 million in the quarter and $12.6 million year to date.
- Operating expenses increased $6.0 million in the quarter and $17.8 million year to date. Special charges increased to $9.4 million in the quarter and $32.7 million year to date, primarily because of the Fiscal 2019 restructuring plan.
- The Fiscal 2019 restructuring plan had recorded charges of $26.2 million by December 31, 2018, with total expected costs of approximately $29.0 million.
- Research and development expense declined 5.5% in the quarter, while management stated that it remained on target to spend 11% to 13% of fiscal-year revenue on R&D.
- Topic 606 increased reported second-quarter revenue by approximately $17 million and first-half revenue by approximately $21 million compared with pro forma results under the former Topic 605 standard. The standard also increased opening retained earnings by approximately $30 million.
- On December 17, 2018, OpenText acquired Liaison Technologies for approximately $311.3 million. The acquisition contributed no significant revenue or earnings during the reported periods because it closed near quarter-end.
Guidance, Outlook, Commentary and Risks
Management emphasized growth in earnings and cash flow, continued organic innovation and strategic acquisitions to expand the company’s enterprise information management portfolio. No specific numerical revenue or earnings guidance was provided in the filing. Management expects to continue pursuing acquisitions and stated that R&D spending remains targeted at 11% to 13% of fiscal-year revenue.
On January 31, 2019, after the reporting date, OpenText acquired Catalyst Repository Systems for approximately $75 million in cash. Catalyst’s results are expected to be consolidated beginning in the third quarter of Fiscal 2019.
- IRS tax examinations: Final Notices of Proposed Adjustment received January 7, 2019 proposed approximately $770 million of aggregate liability, including taxes, penalties and interest. OpenText strongly disputes the positions, has not recorded a material accrual and is considering appeals and litigation. Interest may continue to accrue.
- CRA transfer-pricing reassessments: Potential penalties and interest were estimated at approximately $23 million, assuming available tax attributes. The company has filed objections and is seeking competent-authority relief.
- Acquisition and integration risk: Future acquisitions may increase debt, amortization, restructuring charges and integration complexity.
- Market risks: A one-percentage-point increase in the Term Loan B interest rate would increase annual interest expense by approximately $9.9 million. Foreign-exchange movements affect reported results and cash balances.
- Operating risks: The filing identifies competition, customer demand and renewals, product-development execution, cybersecurity and network failures, intellectual-property claims, privacy regulation, foreign operations and retention of key personnel as continuing risks.
- Accounting and estimation risks: Revenue recognition, goodwill and intangible-asset valuation, income taxes, restructuring liabilities and acquisition accounting involve significant judgment.
Important Facts for Investors to Verify
- Reconcile reported growth under ASC 606 with comparable pro forma Topic 605 results, particularly for license revenue and recurring revenue.
- Monitor the resolution, accrual implications and potential cash exposure of the IRS and CRA tax matters.
- Assess leverage, floating-rate exposure and debt maturities against acquisition spending and shareholder distributions.
- Track whether the Fiscal 2019 restructuring plan remains near the estimated $29 million total cost.
- Evaluate the integration and financial contribution of Liaison and the subsequent Catalyst acquisition.
- Distinguish GAAP results from management’s non-GAAP measures, which exclude substantial amortization, share-based compensation, special charges and other items.