OpenText Corporation — Q1 Fiscal 2019 Summary
Reporting period: Three months ended September 30, 2018; unaudited condensed consolidated financial statements prepared under U.S. GAAP in U.S. dollars. OpenText operates in the enterprise information management software market, offering on-premises, cloud and hybrid solutions. The company employed approximately 12,300 people worldwide.
Financial performance
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|
| Total revenue | $667.2 million | $640.7 million | +4.1% |
| Cloud services and subscriptions | $208.1 million | $193.9 million | +7.3% |
| Customer support | $311.6 million | $295.4 million | +5.5% |
| License revenue | $76.9 million | $78.2 million | -1.7% |
| Professional services and other | $70.6 million | $73.2 million | -3.5% |
| Gross profit | $440.8 million | $417.4 million | +5.6% |
| GAAP gross margin | 66.1% | 65.2% | +0.9 points |
| Income from operations | $99.2 million | $87.6 million | +13.2% |
| Operating margin | 14.9% | 13.7% | +1.2 points |
| Net income attributable to OpenText | $36.3 million | $36.6 million | -0.7% |
| Diluted GAAP EPS | $0.13 | $0.14 | Down $0.01 |
| Adjusted EBITDA | $246.3 million | $220.4 million | +11.7% |
| Non-GAAP diluted EPS | $0.60 | $0.54 | +11.1% |
- Annual recurring revenue, defined as cloud services and subscriptions plus customer support, was $519.6 million, up 6.2%.
- Recurring revenue represented approximately 77.9% of total revenue.
- Non-GAAP gross margin increased to 73.4% from 72.2%.
- Customer support renewal rates were approximately 91%, unchanged from the prior-year quarter.
- Effective tax rate increased to 45.1% from 42.7%, primarily due to tax effects of internal reorganizations.
Cash flow, liquidity and capital structure
| Metric | September 30, 2018 | June 30, 2018 |
|---|
| Cash and cash equivalents | $787.9 million | $682.9 million |
| Total assets | $7.62 billion | $7.77 billion |
| Total debt outstanding | $2.62 billion | $2.62 billion |
| Shareholders’ equity | $3.73 billion | $3.72 billion |
- Operating cash flow was $171.4 million, compared with $67.2 million in the prior-year quarter, a 154.9% increase.
- Investing cash outflow was $27.8 million, versus $326.7 million previously, primarily because the prior-year period included the Guidance Software and Covisint acquisitions.
- Financing cash outflow was $37.5 million, including $40.5 million of dividends and $11.7 million of treasury-share purchases.
- The company had no borrowings under its $450 million revolving credit facility.
- Debt consisted principally of $850 million of 2026 Senior Notes, $800 million of 2023 Senior Notes and $995 million outstanding under a Term Loan B maturing in 2025. The Term Loan B carried an interest rate of approximately 3.83% at quarter-end.
- Reported consolidated net leverage was 1.7:1, compared with a covenant limit of 4:1.
Material changes versus the prior comparable period
- Growth was led by cloud services and subscriptions and customer support, while license and professional-services revenue declined.
- Gross and operating margins improved despite higher amortization, depreciation and restructuring charges.
- Special charges increased to $23.3 million from $18.0 million, primarily because of the new Fiscal 2019 restructuring plan. Management expects total Fiscal 2019 restructuring costs of approximately $29.0 million, with $20.3 million recorded through September 30.
- Interest expense increased modestly as the new Term Loan B replaced the prior term loan, partly offset by the absence of prior-year Revolver borrowings.
- Operating cash flow benefited from stronger working-capital movements and lower days sales outstanding of 56 days versus 61 days in the prior-year quarter.
- Foreign exchange reduced reported revenue by approximately $1.6 million; on a constant-currency basis, reported revenue growth was approximately 4.4%.
Accounting changes and unusual items
- Effective July 1, 2018, the company adopted ASC Topic 606 using the cumulative-effect method, increasing opening retained earnings by approximately $30 million. Topic 606 increased reported Q1 revenue by approximately $3.8 million versus a pro forma Topic 605 presentation and affected contract assets, deferred revenue and capitalized commissions.
- The company also adopted ASU 2016-16 for intra-entity asset transfers, reducing opening retained earnings by approximately $27 million. ASU 2016-18 for restricted cash and ASU 2017-07 for pension-cost presentation were also adopted.
- Acquired intangible amortization totaled $93.4 million and share-based compensation totaled $6.6 million, materially affecting GAAP earnings but excluded from management’s non-GAAP measures.
- The company signed an agreement on October 31, 2018 to acquire Liaison Technologies for approximately $310 million. Closing was expected within 90 days, subject to customary regulatory approvals and closing conditions.
Outlook, contingencies and risks
- Management stated that Fiscal 2019 priorities include growth in earnings and cash flow, organic innovation, cloud expansion and strategic acquisitions. No formal full-year revenue or EPS guidance is provided in the filing.
- Research and development spending was approximately $77 million, or 12% of revenue. Management targets R&D spending of approximately 11% to 13% of revenue for Fiscal 2019.
- The most significant disclosed contingency is an IRS examination of fiscal 2010–2012 tax matters. The company estimates potential aggregate exposure of approximately $735 million, including approximately $455 million of federal and state taxes, $105 million of penalties and $175 million of interest. No material accrual has been recorded, and the company intends to contest the proposed adjustments.
- Canadian tax reassessments could result in approximately $23 million of penalties and interest, assuming available tax attributes offset the underlying tax adjustments. No accrual has been recorded.
- Key operating risks include acquisition integration and restructuring, competition, customer demand and renewals, cybersecurity and system reliability, foreign exchange, interest-rate exposure, intellectual-property claims, international tax audits and access to capital.
- A one-percentage-point increase in the Term Loan B interest rate would increase annual interest expense by approximately $10 million, assuming the quarter-end balance remained outstanding.
- Operating lease commitments totaled $348.7 million, net of expected sublease income, and total contractual obligations were $3.86 billion.
Investor verification checklist
- Verify the sustainability of recurring-revenue growth and the 91% customer-support renewal rate.
- Reconcile GAAP results with management’s non-GAAP EPS, EBITDA and margin measures, including amortization, restructuring charges, share-based compensation and tax adjustments.
- Assess the cash-flow impact and financing terms of the proposed $310 million Liaison Technologies acquisition.
- Monitor the IRS and CRA tax proceedings, including potential penalties, interest and timing of resolution.
- Review Term Loan B floating-rate exposure, debt maturities and compliance with leverage covenants.
- Evaluate whether the Fiscal 2019 restructuring plan delivers expected savings and whether additional charges arise.
- Consider the effect of ASC Topic 606 adoption when comparing future results with prior periods.
