OpenText Corporation 10-Q Summary
Business Context and Reporting Period
OpenText provides enterprise information management software and services, including license, cloud and subscription, customer support, and professional services. This Form 10-Q covers the three and six months ended December 31, 2016, the second quarter and first half of Fiscal 2017. Results are presented in U.S. dollars under U.S. GAAP and include Recommind from July 20, 2016 and the HP customer communications management business from July 31, 2016.
Key Financial Metrics
| Metric | Q2 FY2017 | Q2 FY2016 | Six Months FY2017 | Six Months FY2016 |
|---|---|---|---|---|
| Total revenue | $542.7 million | $465.3 million | $1,034.4 million | $899.9 million |
| Gross profit | $374.7 million | $325.6 million | $702.0 million | $620.1 million |
| GAAP gross margin | 69.0% | 70.0% | 67.9% | 68.9% |
| Income from operations | $107.2 million | $110.0 million | $181.2 million | $186.5 million |
| GAAP operating margin | 19.7% | 23.6% | 17.5% | 20.7% |
| Net income attributable to OpenText | $45.0 million | $87.7 million | $957.9 million | $129.0 million |
| Diluted EPS | $0.18 | $0.36 | $3.89 | $0.53 |
| Operating cash flow | Not separately reported | Not separately reported | $180.5 million | $216.7 million |
Q2 revenue increased 16.6%, led by cloud services and subscriptions revenue of $175.1 million, up 17.4%; customer support revenue of $219.7 million, up 19.3%; and license revenue of $97.8 million, up 19.4%. Recurring revenue was $444.9 million, up 16.0%.
Non-GAAP diluted EPS was $0.54 versus $0.50 in the prior-year quarter. Non-GAAP operating margin was 34.0% versus 37.0%. Management excludes amortization of acquired intangibles, share-based compensation, special charges, other income or expense, and related tax effects from these measures.
Cash and cash equivalents were $1.722 billion at December 31, 2016, up from $1.284 billion at June 30, 2016. The increase primarily reflected approximately $584.6 million of net equity-offering proceeds and approximately $256.9 million of gross proceeds from additional 2026 Senior Notes. Short-term investments were $3.2 million.
Total debt principal was $2.426 billion, comprising $850 million of 5.875% Senior Notes due 2026, $800 million of 5.625% Senior Notes due 2023, and $776 million of Term Loan B. The balance-sheet carrying amount of debt was $2.398 billion. The Term Loan B carried a 3.25% interest rate at December 31, 2016, and the reported consolidated net leverage ratio was 1.0:1.
Material Changes Versus the Prior Comparable Period
- Revenue growth was broad-based, while professional services revenue was essentially flat in Q2. Cloud gross margin declined to 58.2% from 60.5%, and professional services gross margin declined to 19.8% from 23.6%.
- Operating income declined despite higher revenue because operating expenses increased, including research and development, sales and marketing, amortization of acquired intangibles, and acquisition-related costs.
- Q2 net income and GAAP EPS declined primarily because the prior-year comparison did not include the current period’s higher tax expense and because the current quarter had no comparable benefit. For the six-month period, net income included a one-time $876.1 million non-cash deferred tax benefit from an internal intellectual-property reorganization.
- Six-month operating cash flow declined 16.7%, to $180.5 million, while investing cash outflows increased to $515.9 million due primarily to the $315.0 million HP CCM acquisition and the $170.1 million Recommind acquisition.
- On December 19, 2016, OpenText issued 19.8 million post-split common shares for approximately $584.6 million of net proceeds. On December 20, it issued an additional $250 million principal amount of 2026 Senior Notes.
- A two-for-one share split was completed on January 24, 2017; current and historical share and per-share information in the filing is presented on a post-split basis.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management emphasized growth through strategic acquisitions and organic innovation in enterprise information management. It expects to continue pursuing acquisitions and generally targets research and development spending of approximately 10% to 12% of revenue. The filing does not provide formal revenue or earnings guidance.
On January 23, 2017, OpenText completed the approximately $1.62 billion acquisition of Dell-EMC’s enterprise content division. Results were expected to be consolidated beginning in the third quarter of Fiscal 2017. The company drew $225 million under its revolving facility after quarter-end and subsequently increased total revolver commitments from $300 million to $450 million.
In connection with the Dell-EMC acquisition, management expected approximately $50 million of restructuring costs, consisting of approximately $41 million for workforce reductions, $6 million for facility consolidations, and $3 million of other costs, with a substantial portion expected during the remainder of Fiscal 2017.
The most significant disclosed contingency is an ongoing IRS examination of Fiscal 2010 through Fiscal 2012 tax matters. Based on the draft and anticipated notices of proposed adjustment, the company estimated potential aggregate exposure of approximately $550 million, including taxes, penalties, and interest, but had not recorded a material accrual. An adverse outcome could materially affect financial position and results.
Other risks include acquisition integration and execution, increased leverage, interest-rate and foreign-exchange exposure, cybersecurity and system failures, competition, customer purchasing delays, intellectual-property claims, international tax audits, and the ability to realize expected acquisition synergies. The company reported that disclosure controls were effective and that no material changes had occurred in internal control over financial reporting.
Important Facts for Investors to Verify
- Reconcile GAAP performance with non-GAAP results, particularly the effects of amortization, acquisition costs, restructuring, share-based compensation, and taxes.
- Assess the recurring impact of the $876.1 million tax benefit and the company’s future effective tax rate after the IP reorganization.
- Evaluate the financial and operational effects of the Dell-EMC acquisition, including the approximately $1.62 billion purchase price, new revolver borrowings, integration risks, and expected $50 million restructuring program.
- Monitor the IRS tax examination and potential exposure of approximately $550 million, which was not materially accrued.
- Review debt maturities, floating-rate exposure, covenant compliance, and liquidity after the Dell-EMC transaction.
- Consider the decline in operating cash flow and margins despite double-digit revenue growth.
- Verify the final purchase-price allocations for the Recommind and HP CCM acquisitions, which remained preliminary at filing.