OpenText Corporation — Form 10-Q Summary
Reporting period: Quarter and nine months ended March 31, 2017, representing Fiscal 2017 Q3. The request metadata identifies “2016 Q3,” but the filing itself is for Fiscal 2017 Q3 and compares with the period ended March 31, 2016. Financial statements are unaudited, prepared under U.S. GAAP, and reported in U.S. dollars.
Business Context
OpenText provides enterprise information management software and services, including license, cloud and subscription, customer support, and professional services offerings. The company had approximately 11,200 employees worldwide as of March 31, 2017.
Fiscal 2017 included the acquisitions of Recommind, certain HP customer communications management assets, and the enterprise content division of Dell-EMC, acquired January 23, 2017 for approximately $1.62 billion.
Key Financial Metrics
| Metric | Q3 Fiscal 2017 | Q3 Fiscal 2016 | Change |
|---|---|---|---|
| Total revenue | $593.1 million | $440.5 million | Up 34.6% |
| Gross profit | $382.6 million | $299.1 million | Up 27.9% |
| GAAP gross margin | 64.5% | 67.9% | Down 3.4 points |
| Income from operations | $65.3 million | $88.6 million | Down 26.3% |
| GAAP operating margin | 11.0% | 20.1% | Down 9.1 points |
| Net income attributable to OpenText | $21.6 million | $69.1 million | Down 68.7% |
| Diluted GAAP EPS | $0.08 | $0.28 | Down $0.20 |
| Diluted non-GAAP EPS | $0.45 | $0.40 | Up $0.05 |
| Operating cash flow | $336.8 million for nine months ended March 31, 2017 | Down 17.2% |
Revenue mix: Q3 license revenue was $87.2 million, cloud services and subscriptions were $177.1 million, customer support was $263.4 million, and professional services and other revenue was $65.4 million. Total recurring revenue was $505.9 million, up 34.5% year over year.
Non-GAAP performance: Non-GAAP gross margin was 71.2%, compared with 72.0% in the prior-year quarter. Non-GAAP operating margin was 29.1%, compared with 31.4%.
Balance Sheet, Cash Flow, Debt and Liquidity
- Cash and cash equivalents were $449.0 million at March 31, 2017, compared with $1.284 billion at June 30, 2016. Short-term investments were $2.7 million.
- Total debt outstanding was $2.622 billion, including $850 million of 2026 Senior Notes, $800 million of 2023 Senior Notes, $774.1 million under Term Loan B, and $225 million drawn under the Revolver.
- Current debt was $232.8 million, primarily reflecting the Revolver balance. The Revolver commitment had been increased to $450 million.
- Operating cash flow for the nine months was $336.8 million. Investing cash flow was negative $2.159 billion, primarily due to acquisitions, including the $1.622 billion ECD Business acquisition.
- Financing cash flow was positive $992.5 million, supported by a public equity offering, additional Senior Notes 2026 issuance, and Revolver borrowings. Dividends paid totaled $86.0 million for the nine-month period.
- Management expects cash, operating cash flow, and available credit facilities to fund working capital, contractual obligations, capital expenditures, dividends, and operating needs for the next 12 months. Additional material acquisitions could require further financing.
- Term Loan B carried interest at LIBOR plus 2.0% after a February 2017 repricing. The consolidated net leverage ratio was 2.5:1.0 at March 31, 2017, below the 4.0:1.0 covenant limit.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven principally by acquisitions, customer support growth, license growth, and higher cloud and subscription revenue. Foreign exchange reduced reported Q3 revenue growth by approximately $6.8 million.
- Cloud and subscription gross margin declined to 56.4% from 58.4%, and customer support gross margin declined to 86.9% from 87.8%, primarily due to acquisition-related labor, network, and third-party product costs.
- Operating expenses increased by $106.8 million in Q3, including higher research and development, sales and marketing, amortization of acquired intangibles, and special charges.
- Acquired intangible amortization increased by $34.5 million in Q3 to $80.1 million, and special charges increased to $20.6 million from a $1.7 million recovery in the prior-year quarter.
- Interest expense increased to $31.7 million from $16.2 million, mainly because of the 2026 Senior Notes and additional debt used to finance acquisitions.
- Nine-month GAAP net income benefited from a one-time $876.1 million non-cash deferred tax benefit related to the July 2016 internal intellectual-property reorganization. This benefit reduced the nine-month effective tax rate to a 496.3% recovery rate and is not expected to recur.
- Shares outstanding increased, reflecting a public equity offering and the January 2017 two-for-one share split. All historical share and per-share data were presented on a post-split basis.
Guidance, Outlook, Risks and Unusual Items
- Management emphasized continued strategic acquisitions, organic product innovation, cloud expansion, and investment in enterprise information management capabilities. It targets research and development spending of approximately 10% to 12% of revenue annually.
- The company expects approximately $45.0 million of total Fiscal 2017 restructuring costs, of which $20.7 million had been recorded by March 31, 2017. The restructuring relates primarily to workforce reductions and facility consolidation following acquisitions.
- The ECD Business contributed $79.8 million of revenue and a $16.6 million net loss from January 23 through March 31, 2017. Its results included approximately $12.2 million of special charges and $22.8 million of acquired-intangible amortization.
- The IRS is examining Fiscal 2010 through Fiscal 2012 tax returns and has proposed adjustments related to prior intellectual-property reorganizations. OpenText estimated potential aggregate exposure of approximately $575 million, including taxes, penalties, and interest, and has recorded no material accrual for the matter. The company disputes the IRS position.
- Other tax matters include a Brazil dispute involving a $2.9 million claim, supported by a $4.4 million bank guarantee, and Indian transfer-pricing assessments for which $1.6 million has been accrued.
- Total contractual obligations were approximately $3.799 billion, including $3.483 billion of debt-related principal and interest, $293.3 million of operating leases, and $22.6 million of purchase obligations.
- Key risks include integration of the ECD Business and other acquisitions, realization of expected synergies, leverage and interest-rate exposure, foreign currency movements, tax audits, cybersecurity and system risks, competition, customer demand, and execution of the new ERP implementation.
- After quarter-end, on May 5, 2017, the Revolver maturity was extended from December 22, 2019 to May 5, 2022 and interest-rate margins were reduced by 50 basis points. A quarterly dividend of $0.132 per share was declared for payment in June 2017.
Important Facts for Investors to Verify
- Confirm the period designation: the filing is for Fiscal 2017 Q3, not Fiscal 2016 Q3.
- Assess underlying operating performance excluding the one-time $876.1 million tax benefit, acquisition-related amortization, restructuring, and other special charges.
- Review whether ECD Business integration achieves expected revenue, cost savings, and synergies, and whether additional restructuring or acquisition costs arise.
- Evaluate liquidity after the $1.62 billion ECD acquisition, the $225 million Revolver draw, and the decline in cash to $449.0 million.
- Monitor the IRS tax examinations and potential approximately $575 million exposure, which was not materially accrued.
- Review debt covenants, floating-rate exposure, refinancing requirements, and the planned repayment of Revolver borrowings.
- Reconcile GAAP and non-GAAP results, particularly the substantial gap between Q3 diluted GAAP EPS of $0.08 and non-GAAP EPS of $0.45.
- Track recurring revenue growth, cloud-service margins, customer support renewal rates, accounts receivable and deferred revenue trends, and cash conversion.