Open Text Corporation — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended March 31, 2013, filed April 25, 2013. The filing is for fiscal 2013 Q3, although the request metadata identifies “2012 Q3.” Results are presented in U.S. dollars under U.S. GAAP.
Business Context
OpenText provides enterprise information management software and related cloud, hosted, support, consulting, and integration services. The company employed approximately 5,000 people worldwide. Fiscal 2013 results include EasyLink Services International Corporation from July 2, 2012 and Resonate KT Limited from March 5, 2013.
Financial Highlights
| Metric | Three months ended March 31, 2013 | Prior-year period | Nine months ended March 31, 2013 | Prior-year period |
|---|---|---|---|---|
| Total revenue | $337.7 million | $292.3 million | $1,016.1 million | $901.8 million |
| Gross profit | $216.9 million | $186.0 million | $651.9 million | $588.4 million |
| Gross margin | 64.2% | 63.6% | 64.2% | 65.2% |
| Operating income | $40.9 million | $27.3 million | $148.2 million | $109.7 million |
| Operating margin | 12.1% | 9.3% | 14.6% | 12.2% |
| Net income | $25.8 million | $34.8 million | $106.3 million | $117.2 million |
| Diluted EPS | $0.44 | $0.59 | $1.80 | $2.00 |
Revenue mix: Third-quarter license revenue was $69.0 million, cloud services revenue was $44.4 million, customer support revenue was $166.6 million, and professional services and other revenue was $57.7 million. Customer support represented 49.3% of quarterly revenue and remained a significant recurring revenue source.
Non-GAAP results: Management reported third-quarter diluted non-GAAP EPS of $1.26 versus $1.01 in the prior-year period, non-GAAP operating margin of 26.8% versus 25.2%, and non-GAAP gross margin of 71.2% versus 71.0%. These measures exclude, among other items, acquired-intangible amortization, share-based compensation, special charges, and certain tax effects.
Cash Flow, Liquidity, Debt, and Balance Sheet
- Cash provided by operating activities for the first nine months was $253.3 million, up from $186.6 million.
- Cash used in investing activities was $351.7 million, primarily reflecting $315.3 million for EasyLink and $19.4 million for RKT, net of cash acquired.
- Cash and cash equivalents were $446.9 million at March 31, 2013, compared with $559.7 million at June 30, 2012.
- Total debt was $573.5 million, consisting primarily of a $562.5 million term loan and an $11.0 million mortgage. The current portion was $48.5 million.
- The company had not drawn on its $100 million revolving credit facility and stated that cash and available credit were expected to fund operating needs, working capital, commitments, and capital expenditures for the next 12 months. Additional financing could be required for material acquisitions.
- The term loan bears interest at LIBOR plus 2.50%, is secured by substantially all company assets, and is subject to leverage and interest-coverage covenants. OpenText reported compliance with all covenants at March 31, 2013.
- Total contractual obligations were $781.8 million, including $620.7 million of debt obligations, $152.5 million of operating leases, and $8.5 million of purchase obligations.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue increased 15.5%, driven by the EasyLink-related cloud services contribution and higher license revenue. License revenue increased 13.3% in the quarter, partly due to 21 deals exceeding $0.5 million versus 12 in the prior-year quarter.
- Nine-month license revenue declined $14.9 million, or approximately 6.9%, with 48 deals exceeding $0.5 million versus 63 in the prior-year period.
- Professional services and other revenue declined $7.7 million in the quarter and $6.3 million year to date. Quarterly professional-services margin fell to 16.3% from 19.5%, while nine-month margin improved to 22.5% from 20.3%.
- Quarterly operating income increased 49.7% and operating margin expanded to 12.1%, despite higher sales and marketing, general and administrative, depreciation, and acquired-intangible amortization expenses.
- GAAP net income and EPS declined because the prior-year periods benefited from significant one-time tax recoveries. The nine-month tax provision changed from an $8.5 million recovery in 2012 to a $30.6 million expense in 2013.
- Goodwill increased to $1.242 billion from $1.040 billion at June 30, 2012, primarily from EasyLink and RKT. Acquired intangible assets increased to $397.2 million from $312.6 million.
Outlook, Commentary, Risks, and Unusual Items
- Management stated that it expected approximately 50% of revenue to continue to come from customer support and emphasized geographic diversification and expansion across enterprise content management, business process management, customer experience management, information exchange, and discovery.
- Management expected to continue strategically acquiring companies, products, services, and technologies. No specific quantitative revenue or earnings guidance was provided in the filing text.
- Fiscal 2013 restructuring charges totaled $11.3 million through March 31, 2013, with total expected costs of approximately $13.3 million. Remaining restructuring liabilities were $5.9 million.
- On April 23, 2013, OpenText agreed to pay j2 Global a one-time $27.0 million settlement fee for inherited patent litigation, or $16.4 million net of expected tax effects. The settlement dismissed the related lawsuits with prejudice and was treated as an acquisition-related matter in the EasyLink purchase accounting.
- EasyLink was subject to potential New York telecommunications excise and franchise tax exposure of approximately $10.5 million, plus a separate approximately $0.5 million sales-tax assessment and ongoing audits.
- Income tax examinations were open in Canada, the United States, France, Spain, and India. Management believed reserves were adequate, but noted that outcomes could not be predicted with certainty.
- Interest-rate risk is material: a 100-basis-point increase in LIBOR would increase annual interest expense on the term loan by approximately $5.6 million, assuming the March 31 balance remained outstanding.
- Approximately 40% of cash was held in currencies other than the U.S. dollar. Foreign exchange changes could materially affect reported results and cash balances.
- On April 24, 2013, the company adopted a non-cumulative quarterly dividend policy and declared an initial dividend of $0.30 per share payable June 21, 2013. Future dividends remain subject to board discretion and contractual restrictions.
Investor Verification Items
- Reconcile GAAP and non-GAAP performance, particularly the substantial effects of acquired-intangible amortization, restructuring, share-based compensation, and tax adjustments.
- Assess the sustainability and margins of EasyLink cloud services, including usage-based revenue volatility and integration costs.
- Monitor license-revenue trends, large-deal volumes, and the decline in year-to-date license revenue.
- Review acquisition accounting for EasyLink and RKT, including pending purchase-price-allocation matters, goodwill, intangible amortization, and inherited liabilities.
- Track the j2 settlement payment, New York tax exposures, litigation, and other acquisition-related contingencies.
- Evaluate leverage, floating-rate exposure, debt maturities, covenant compliance, and the effect of acquisitions and the new dividend on liquidity.
- Confirm the first dividend payment and the board’s future decisions, since dividends are not guaranteed or cumulative.