OpenText Corporation: Fiscal 2023 Second-Quarter 10-Q Summary
Business context and reporting period
OpenText provides information-management software and services, including cloud, content, business-network, experience, security and developer solutions. This Form 10-Q covers the three and six months ended December 31, 2022, the second quarter of fiscal 2023. Results are presented in U.S. dollars under U.S. GAAP.
The quarter preceded the January 31, 2023 completion of OpenText’s approximately $5.8 billion all-cash acquisition of Micro Focus International. Micro Focus results were not included in the reported quarter and are expected to be consolidated beginning in fiscal 2023’s third quarter.
Key financial metrics
| Metric | Three months ended Dec. 31, 2022 | Three months ended Dec. 31, 2021 | Six months ended Dec. 31, 2022 | Six months ended Dec. 31, 2021 |
|---|---|---|---|---|
| Total revenue | $897.4 million | $876.8 million | $1.749 billion | $1.709 billion |
| Recurring revenue | $725.2 million | $699.8 million | $1.447 billion | $1.392 billion |
| Cloud services and subscriptions | $408.7 million | $364.9 million | $813.3 million | $721.5 million |
| Gross profit | $635.7 million | $615.6 million | $1.229 billion | $1.190 billion |
| GAAP gross margin | 70.8% | 70.2% | 70.3% | 69.6% |
| Income from operations | $184.7 million | $192.9 million | $331.0 million | $375.6 million |
| Net income attributable to OpenText | $258.5 million | $88.3 million | $141.6 million | $220.2 million |
| Diluted EPS | $0.96 | $0.32 | $0.52 | $0.81 |
| Adjusted EBITDA | $340.9 million | $343.5 million | $645.0 million | $666.9 million |
Quarterly revenue increased 2.4%, or 7.8% excluding a $47.5 million unfavorable foreign-exchange impact. Recurring revenue increased 3.6%, or 8.7% on a constant-currency basis. Cloud revenue increased 12.0%, or 16.0% excluding foreign exchange. Enterprise cloud bookings increased approximately 12% to $144.7 million.
Quarterly operating margin was approximately 20.6%, compared with 22.0% in the prior-year quarter. Six-month operating margin was approximately 18.9%, compared with 22.0% previously. Non-GAAP gross margin was 76.0% for the quarter and 75.6% for the six-month period, compared with 76.4% and 76.1%, respectively.
Cash flow, liquidity and capital structure
- Six-month operating cash flow was $327.1 million, down from $406.3 million, primarily because of lower net income after non-cash adjustments and working-capital changes.
- Cash and cash equivalents were $2.821 billion at December 31, 2022, compared with $1.694 billion at June 30, 2022. Cash, cash equivalents and restricted cash totaled $2.823 billion.
- Capital expenditures were $68.5 million during the six-month period.
- Six-month financing cash flow was $869.6 million, including $1.0 billion of debt proceeds and $129.6 million of dividend payments.
- Total debt principal was $5.253 billion at December 31, 2022, including the newly issued $1.0 billion of 6.90% senior secured notes due 2027. Reported debt after issuance costs was $5.203 billion.
- Term Loan B outstanding was $952.5 million and carried an interest rate of 5.82%. The Revolver and Acquisition Term Loan had no borrowings at December 31, 2022.
- The reported consolidated net leverage ratio was 2.0:1, below the 4.0:1 Term Loan B covenant.
- Following quarter-end, OpenText drew the full Acquisition Term Loan commitment, net of discounts and fees, and $450 million under the Revolver to fund the Micro Focus transaction.
- Management stated that cash and available credit facilities were expected to fund working capital, contractual commitments, capital expenditures, dividends, operating needs and pending acquisitions for the next twelve months, subject to financing covenants and potential additional acquisition activity.
Material changes versus the prior comparable period
- Cloud growth and acquisitions increased revenue, while customer support revenue declined 5.5% in the quarter and 5.4% for the six-month period, principally reflecting foreign exchange and lower EMEA revenue.
- License revenue declined 1.4% for the quarter and 6.8% for the six-month period. Professional services revenue declined 4.8% and 2.0%, respectively.
- Operating expenses increased $28.4 million in the quarter and $84.2 million year to date. Sales and marketing, research and development, general and administrative costs, share-based compensation and special charges all increased.
- GAAP net income increased sharply in the quarter because of $171.6 million of unrealized gains on derivatives related to Micro Focus financing. This gain was non-operational and excluded from management’s non-GAAP measures.
- Non-GAAP net income declined slightly to $240.2 million from $242.1 million, while diluted non-GAAP EPS remained $0.89. Six-month non-GAAP net income declined to $447.1 million from $469.9 million.
- Share-based compensation increased to $28.8 million in the quarter and $52.0 million year to date, compared with $14.4 million and $28.3 million, respectively.
- Special charges increased to $10.3 million in the quarter and $24.6 million year to date, including restructuring and Micro Focus acquisition-related costs.
- The quarterly dividend increased to $0.24299 per share from $0.2209. No common-share repurchases were made during the current quarter or six-month period.
Guidance, outlook, risks and unusual items
- Management’s strategy emphasizes recurring revenue growth, cloud expansion, margin improvement, acquisitions and cash-flow generation. Research and development represented 12.6% of fiscal year-to-date revenue; following the Micro Focus acquisition, management expects R&D spending to represent 13% to 15% of revenue for the remainder of the fiscal year.
- OpenText announced a post-acquisition restructuring plan expected to reduce the combined workforce by approximately 8%, or 2,000 employees, at an estimated cost of $70 million to $80 million. The plan is intended to support previously announced cost synergies of $400 million and was expected to be completed by the end of fiscal 2023.
- The Micro Focus acquisition materially increases leverage, integration complexity, transaction and restructuring costs, and exposure to interest-rate and foreign-exchange movements. The filing states that Micro Focus accounting and purchase-price allocation were not complete at the filing date.
- Foreign-exchange derivatives associated with the acquisition generated significant quarter-to-quarter earnings volatility. A one-cent change in the British pound/U.S. dollar forward rate was estimated to change derivative fair value by approximately $18.0 million.
- The Canada Revenue Agency is disputing OpenText’s transfer-pricing positions for fiscal 2012 through 2016. The company estimated potential penalties, interest and provincial taxes of approximately $72 million, had provisionally paid approximately $32 million, and had not accrued the reassessments.
- A separate CRA matter involving fiscal 2017 could require an income-tax expense of up to approximately $470 million through a reduction in deferred tax assets if OpenText is unsuccessful, although management disputes the position and has recorded no accrual.
- OpenText disclosed ongoing Carbonite-related securities and patent litigation. The filing states that no material loss was accrued for these matters and that certain potential losses cannot currently be estimated.
- Other principal risks include macroeconomic weakness, inflation, higher interest rates, foreign-exchange volatility, cybersecurity and privacy obligations, customer demand, competition, intellectual-property claims, tax audits, acquisition integration and future access to capital.
Investor verification priorities
- Verify the post-acquisition debt balance, interest expense, covenant compliance and liquidity after the Acquisition Term Loan and Revolver were drawn in January 2023.
- Assess whether Micro Focus integration milestones, the $400 million synergy target and the $70 million to $80 million restructuring estimate remain achievable.
- Separate recurring operating performance from acquisition-related costs, amortization, share-based compensation and the $171.6 million derivative gain that materially affected GAAP quarterly earnings.
- Monitor cloud growth, renewal rates, enterprise cloud bookings, customer support trends and foreign-exchange-adjusted revenue growth.
- Evaluate operating cash-flow conversion and working-capital trends, including the increase in quarterly days sales outstanding to 47 days from 44 days.
- Track the CRA reassessments, the potential deferred-tax-asset reduction of up to approximately $470 million and other tax uncertainties.
- Review the final Micro Focus purchase-price allocation, pro forma information and subsequent financial statements once filed.