OpenText Corporation — Q1 Fiscal 2020 Form 10-Q Summary
Reporting period: Three months ended September 30, 2019, compared with the three months ended September 30, 2018. OpenText provides enterprise information management software and services through on-premises, cloud and hybrid deployments. The company employed approximately 13,200 people worldwide at quarter-end.
Financial Performance and Position
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Total revenue | $696.9 million | $667.2 million | +4.5% |
| Recurring revenue | $549.6 million | $519.6 million | +5.8% |
| Cloud services and subscriptions | $237.3 million | $208.1 million | +14.0% |
| GAAP gross profit | $468.4 million | $440.8 million | +6.2% |
| GAAP gross margin | 67.2% | 66.1% | +110 bps |
| Income from operations | $132.5 million | $99.2 million | +33.5% |
| Net income attributable to OpenText | $74.4 million | $36.3 million | +104.9% |
| Diluted GAAP EPS | $0.27 | $0.13 | +107.7% |
| Adjusted EBITDA | $254.2 million | $246.3 million | +3.2% |
| Operating cash flow | $137.4 million | $171.4 million | -19.8% |
- License revenue increased 1.3% to $77.9 million; customer support revenue increased 0.2% to $312.3 million; professional services and other revenue declined 1.7% to $69.4 million.
- Non-GAAP diluted EPS was $0.64 versus $0.60, and non-GAAP gross margin was 73.1% versus 73.4%.
- Cash and cash equivalents were $999.3 million at September 30, 2019, compared with $941.0 million at June 30, 2019. Including restricted cash, total cash was $1.002 billion.
- Total debt principal was approximately $2.635 billion, consisting of $850 million of 2026 Senior Notes, $800 million of 2023 Senior Notes and $985 million under Term Loan B. The Revolver had no balance outstanding.
- Term Loan B bore interest at approximately 3.86% and matures in May 2025. The reported consolidated net leverage ratio was 1.5:1, compared with a 4:1 covenant limit.
- The company paid $47.0 million in quarterly dividends, or $0.1746 per common share, and repurchased 300,000 shares for $12.4 million for potential use under equity plans.
Material Changes Versus the Prior Comparable Period
- Revenue growth was led by cloud services and subscriptions, particularly in the Americas. Cloud revenue increased $29.2 million, while cloud gross margin declined to 56.9% from 57.9% because of higher labor and network costs associated partly with acquisitions.
- GAAP operating income improved by $33.3 million. The main driver was an $18.2 million reduction in special charges, including substantially lower restructuring costs, together with lower amortization of certain acquired technology assets.
- The effective tax rate declined to 23.7% from 45.1%, primarily because of lower reserves for unrecognized tax benefits, the absence of prior-year internal-reorganization tax effects and higher research and development tax credits. These benefits were partly offset by higher foreign-taxed income and BEAT expense.
- Operating cash flow decreased despite higher net income, primarily because of less favorable working-capital movements, including lower accounts payable and accrued liabilities, lower deferred revenue and changes in receivables and other current assets.
- Effective July 1, 2019, OpenText adopted the new lease standard, recognizing approximately $203.3 million of operating lease right-of-use assets and $238.3 million of operating lease liabilities at September 30, 2019. The adoption did not affect reported income or cash flow.
- Recent acquisitions of Liaison and Catalyst affected comparability and contributed to higher headcount, operating costs and acquired-intangible amortization.
Outlook, Commentary, Risks and Unusual Items
- Management stated that Fiscal 2020 priorities include growth in earnings and cash flow, increasing recurring revenue, expanding margins, improving productivity, investing in the OpenText Cloud and pursuing strategic acquisitions.
- Research and development spending was approximately $81 million, or 12% of revenue. Management’s stated fiscal-year target is approximately 11% to 13% of revenue.
- Management expects cash, cash equivalents and available credit facilities to fund working capital, capital expenditures, dividends and operating needs for at least the next twelve months. Material acquisitions could require additional financing.
- As a subsequent event, on October 31, 2019 the Revolver was increased from $450 million to $750 million and its maturity was extended from May 2022 to October 2024. No borrowings were outstanding at filing.
- The most significant disclosed contingency is the IRS examination of Fiscal 2010–Fiscal 2012 tax returns. Proposed adjustments, penalties and interest were estimated at approximately $770 million in aggregate, with no material accrual recorded. An adverse outcome could materially affect financial position and results.
- CRA transfer-pricing reassessments could result in approximately $25 million of penalties and interest, assuming available tax attributes; no accrual was recorded. The company is also subject to additional tax audits in multiple jurisdictions.
- OpenText identified foreign exchange, floating-rate debt, acquisition integration, restructuring, competition, customer demand, cybersecurity, intellectual-property claims, privacy regulation and international operations as principal risks.
- Special charges were $5.1 million, including $1.7 million of restructuring charges and $2.7 million of acquisition-related costs, compared with $23.3 million in the prior-year quarter.
Investor Verification Checklist
- Verify the sustainability of cloud and recurring-revenue growth and whether cloud gross-margin pressure moderates.
- Assess operating cash-flow conversion and the effect of deferred revenue and other working-capital movements.
- Review debt maturities, floating-rate exposure and the impact of the amended $750 million Revolver.
- Evaluate the potential financial exposure from the IRS and CRA tax matters, including continuing interest and penalties.
- Reconcile GAAP results with management’s non-GAAP measures, particularly the large adjustments for acquired-intangible amortization, share-based compensation and special charges.
- Monitor integration and performance of the Liaison and Catalyst acquisitions, future acquisition activity and related restructuring costs.
- Review lease obligations, pension obligations and other contractual commitments when assessing total fixed obligations.