OpenText Corporation — Q1 Fiscal 2017 Form 10-Q Summary
Reporting period: Three months ended September 30, 2016; filed November 3, 2016. Amounts are in U.S. dollars unless otherwise stated. OpenText provides enterprise information management software and services, including cloud, subscription, customer support, licensing, professional services and business-to-business information exchange. The company employed approximately 9,700 people worldwide.
Financial performance and liquidity
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Total revenue | $491.7 million | $434.5 million | +13.1% |
| Recurring revenue | $431.0 million | $383.1 million | +12.5% |
| Gross profit | $327.3 million | $294.5 million | +11.1% |
| GAAP gross margin | 66.6% | 67.8% | Down 120 bps |
| Income from operations | $74.1 million | $76.5 million | −3.2% |
| GAAP operating margin | 15.1% | 17.6% | Down 250 bps |
| Net income attributable to OpenText | $912.9 million | $41.3 million | Material increase |
| Diluted EPS | $7.46 | $0.34 | Material increase |
| Non-GAAP diluted EPS | $0.86 | $0.84 | +2.4% |
| Cash flow from operations | $73.5 million | $92.7 million | −20.8% |
Revenue growth was led by cloud services and subscriptions of $169.7 million, up 14.8%, customer support of $210.2 million, up 13.2%, and license revenue of $60.7 million, up 18.2%. Recurring revenue represented 87.7% of total revenue. Customer support renewal rates were approximately 90%, consistent with the prior-year quarter.
Operating expenses increased to $253.2 million from $218.0 million, reflecting higher research and development, sales and marketing, depreciation, acquired-intangible amortization and acquisition-related activity. Non-GAAP operating margin declined to 30.8% from 34.1%.
The quarter included an $876.1 million tax benefit from a July 2016 internal reorganization and recognition of a net deferred tax asset associated primarily with transferring intellectual property into Canada. Consequently, the reported 1,606.8% tax recovery rate and $7.46 diluted EPS are not representative of ongoing performance. Management reported a non-GAAP tax rate of approximately 15%.
Cash and cash equivalents declined to $834.9 million at September 30, 2016 from $1.284 billion at June 30, 2016. Investing cash outflows were $501.2 million, principally for the Recommind and HP customer communications management acquisitions. Accounts receivable increased to $297.5 million, and reported days sales outstanding increased to 52 days from 48 days in the prior-year quarter.
Debt, capital resources and other balance-sheet items
- Total debt principal was approximately $2.178 billion, with $2.145 billion recorded net of debt issuance costs.
- Debt consisted of $600 million of 5.875% Senior Notes due 2026, $800 million of 5.625% Senior Notes due 2023 and $778 million outstanding under Term Loan B.
- The $300 million revolving credit facility was undrawn. Term Loan B carried a 3.25% interest rate at September 30, 2016, and the reported consolidated net leverage ratio was 1.8:1.
- Management stated that cash, available credit facilities and operating resources were expected to fund anticipated needs for the next 12 months, excluding the financing requirements of the pending Dell-EMC transaction.
- The company declared and paid a quarterly dividend of $0.23 per share, totaling $27.8 million, and authorized a $200 million share repurchase plan, but made no repurchases during the quarter.
Material changes versus the prior comparable period
- Revenue increased 13.1%, but GAAP operating income decreased 3.2% as operating expenses grew faster than revenue.
- Gross, operating and product-level margins declined, partly reflecting higher cloud labor and network costs, professional-services costs, acquisition-related amortization and increased operating investment.
- Operating cash flow decreased $19.3 million, primarily because of working-capital effects and acquired receivables, including Recommind’s historically longer collection cycle.
- The company acquired Recommind for approximately $170.1 million and HP’s customer communications management business for approximately $315.0 million. These acquisitions added approximately $270.3 million of goodwill and increased acquired intangible assets.
- Acquisition-related and other special charges were $12.5 million versus $17.3 million in the prior-year quarter. The current quarter included $6.8 million of acquisition-related costs and $1.1 million for a new restructuring plan.
- Net interest and other related expense increased to $27.3 million from $19.0 million, primarily because of the Senior Notes 2026 issued in May 2016.
Guidance, outlook, risks and unusual items
Management’s stated Fiscal 2017 priorities were growth in earnings and cash flow, expansion of enterprise information management capabilities, continued cloud and recurring-revenue growth, organic investment and disciplined strategic acquisitions. Management targeted research and development spending of approximately 10% to 12% of revenue, with approximately $59 million spent in the quarter. The filing does not provide a specific full-year revenue or earnings guidance range.
On September 12, 2016, OpenText agreed to acquire assets and assume liabilities related to Dell-EMC’s enterprise content division for approximately $1.62 billion, subject to customary closing and regulatory conditions. The transaction was expected to close within 90 to 120 days of signing. The company obtained a financing commitment of up to $1.0 billion, while permanent financing could include cash, additional debt and equity issuance. The acquisition could increase leverage, interest expense, integration costs and dilution risk.
The most significant disclosed contingency is the ongoing IRS examination of fiscal 2010 through fiscal 2012 tax matters. Draft and anticipated proposed adjustments could result in an estimated aggregate liability of approximately $550 million, including federal and state taxes, penalties and interest. No material accrual was recorded, and the company intends to contest the IRS position. Other matters include a $2.7 million Brazilian tax dispute supported by a $4.0 million bank guarantee and $1.5 million accrued for an Indian transfer-pricing matter.
Key operating risks include acquisition completion and integration, realization of expected synergies, financing availability, foreign-exchange volatility, interest-rate exposure, customer purchasing delays, competition, cybersecurity and privacy obligations, intellectual-property claims, tax audits and the potential for additional restructuring costs. A one-percentage-point increase in Term Loan B’s interest rate would increase annual interest expense by approximately $7.8 million, based on the reported balance.
Investor verification checklist
- Separate the $876.1 million one-time tax benefit from sustainable earnings and cash generation; reconcile GAAP results with non-GAAP EPS of $0.86.
- Review the terms, financing mix, closing status and eventual accounting for the approximately $1.62 billion Dell-EMC acquisition.
- Assess post-acquisition integration, goodwill and intangible-asset valuation, amortization burden and restructuring requirements.
- Monitor operating cash flow, receivable collections and DSO, particularly as acquired businesses are integrated.
- Evaluate the company’s ability to maintain leverage and credit metrics after any Dell-EMC financing; existing debt principal was approximately $2.178 billion.
- Track the IRS examination and potential approximately $550 million tax exposure, which was not materially accrued.
- Confirm future margin trends, recurring-revenue growth, customer-support renewal rates and the effect of higher cloud and personnel costs.