Open Text Corporation 10-Q Summary
Business context and reporting period
OpenText provides enterprise information management software and services, including on-premises, cloud, subscription, managed-service and hybrid offerings. The filing covers the quarter and six months ended December 31, 2015, the second quarter of Fiscal 2016. Results are presented in U.S. dollars under U.S. GAAP. The company employed approximately 8,200 people worldwide and completed the acquisition of Daegis Inc. on November 23, 2015.
Financial highlights
| Metric | Three months ended December 31, 2015 | Year-over-year change | Six months ended December 31, 2015 | Year-over-year change |
|---|---|---|---|---|
| Total revenue | $465.3 million | Down 0.5% | $899.9 million | Down 2.4% |
| Gross profit | $325.6 million | Up 1.9% | $620.1 million | Down 1.0% |
| GAAP gross margin | 70.0% | Up from 68.3% | 68.9% | Up from 68.0% |
| Income from operations | $110.0 million | Down 0.5% | $186.5 million | Down 12.7% |
| GAAP operating margin | 23.6% | Flat | 20.7% | Down from 23.2% |
| Net income attributable to OpenText | $87.7 million | Up 18.0% | $129.0 million | Down 7.2% |
| Diluted GAAP EPS | $0.72 | Up from $0.60 | $1.06 | Down from $1.13 |
| Operating cash flow | Not separately provided in the statements | Management reported $123.9 million | $216.7 million | Down from $248.1 million |
Recurring revenue was $383.5 million in the second quarter, representing 82.4% of total revenue. It declined 2.3% year over year on a reported basis but increased 3.7% excluding a $23.6 million foreign-exchange impact. License revenue increased 8.6% in the quarter, while cloud services and subscriptions declined 3.7%, customer support increased 2.6% and professional services and other declined 13.7%.
Non-GAAP diluted EPS was $1.01 for the quarter versus $0.97 in the prior-year quarter, and $1.85 for the six-month period versus $1.93. Non-GAAP operating margin was 37.0% for the quarter and 35.6% year to date, compared with 32.8% and 33.5%, respectively, in the prior-year periods. These measures exclude items including acquired-intangible amortization, share-based compensation, special charges, other income or expense and related tax effects.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $726.0 million at December 31, 2015, up from $700.0 million at June 30, 2015. Short-term investments were $16.3 million.
- Total debt was $1.584 billion, consisting of $800.0 million of 5.625% Senior Notes due 2023 and $784.0 million outstanding under Term Loan B. The company had no borrowings under its $300.0 million revolving credit facility.
- Term Loan B bears interest at 2.5% plus the higher of LIBOR or 0.75%; its stated rate was 3.25% at December 31, 2015. A one-percentage-point rate increase would increase annual interest expense by approximately $7.8 million, assuming the balance remained outstanding.
- Management reported a consolidated net leverage ratio of 1.4:1, compared with a covenant maximum of 4:1.
- Six-month financing cash outflows included $65.5 million for share repurchases under the company’s repurchase plan, $10.6 million for treasury-share purchases, $47.5 million of dividends and $4.0 million of debt repayment.
- The board authorized up to $200.0 million of common-share repurchases; approximately $134.5 million remained available at December 31, 2015. A $0.20-per-share dividend was declared on February 8, 2016, payable March 31, 2016.
- Contractual obligations totaled approximately $2.266 billion, including $2.049 billion of long-term debt obligations, $204.9 million of operating lease obligations and $12.0 million of purchase obligations.
Material changes versus the prior comparable period
- Reported revenue was pressured by foreign exchange, particularly in cloud services, customer support and professional services. Management estimated that revenue would have increased 6.2% year over year excluding $31.6 million of foreign-exchange impact.
- Cloud-services gross margin declined to 60.5% from 62.2%, partly due to higher labor costs and the absence of certain prior-year sales-tax adjustments.
- Customer-support gross margin improved to 88.2% from 86.7%, aided by lower third-party product and labor costs.
- Operating expenses increased 3.2% for the quarter and 5.1% for the six-month period, primarily because of higher amortization and special charges. Sales and marketing and general and administrative expenses declined.
- Special charges were $9.1 million in the quarter and $26.4 million year to date, compared with a prior-year recovery of $5.8 million and a prior-year recovery of $1.6 million, respectively. The difference largely reflects the absence of prior-year tax-liability recoveries, Fiscal 2015 restructuring costs and ERP implementation spending.
- Net interest expense increased to $19.2 million for the quarter and $38.2 million year to date, primarily following the issuance of the $800.0 million Senior Notes in January 2015.
- The effective tax rate declined to 4.4% for the quarter and 10.6% year to date, versus 19.7% and 20.4%, respectively. The decrease primarily reflected jurisdictional income mix and lower expense associated with uncertain tax positions, interest and penalties.
- Six-month operating cash flow declined by $31.4 million, primarily due to lower net income before non-cash items and less favorable working-capital changes. Second-quarter days sales outstanding increased to 54 days from 50 days.
Guidance, outlook, risks and unusual items
Management stated that Fiscal 2016 priorities include growth in earnings and cash flow, expansion of cloud-based enterprise information management through acquisitions and innovation, and delivery through on-premises, cloud and hybrid models. Management expects the Fiscal 2015 Restructuring Plan to cost approximately $32 million to $35 million in total, of which $29.3 million had been recorded by December 31, 2015, with substantial completion expected by the end of Fiscal 2016. The ERP implementation project is expected to be completed within the fiscal year ending June 30, 2017; $4.8 million of related costs had been incurred in the first six months.
The most significant disclosed contingency is an ongoing IRS examination of Fiscal 2010 through Fiscal 2012 tax returns and related international reorganizations. A draft Notice of Proposed Adjustment proposed approximately $280 million of additional U.S. federal tax for Fiscal 2010, and management expected an additional proposal of approximately $80 million for Fiscal 2012, plus penalties, interest and potential state taxes. The company estimated potential aggregate exposure of approximately $550 million as of December 31, 2015, inclusive of taxes, penalties and interest, but had recorded no material accrual and intends to contest the matter. An adverse outcome could materially affect financial position and results of operations.
- Other tax matters include a Brazilian dispute with a claim of approximately $2.0 million, supported by a $3.0 million bank guarantee; $4.8 million accrued for certain Brazilian indirect taxes; and $1.5 million accrued for potential Indian transfer-pricing exposure.
- Foreign-exchange risk remains material. A uniform 10% weakening of foreign currencies against the U.S. dollar would reduce the reported U.S.-dollar value of foreign-currency cash by approximately $32.3 million.
- The company identifies acquisition integration, restructuring, competition, demand, product development, cybersecurity, privacy, intellectual-property claims, foreign exchange, interest rates and tax audits as key risks.
- Management concluded that disclosure controls were effective as of December 31, 2015 and that no material changes occurred in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Progress and final resolution of the IRS tax examinations, including whether formal notices are issued and whether any accrual becomes necessary.
- Reported versus constant-currency trends in recurring revenue, cloud services and subscriptions, customer support and professional services.
- Cash conversion and working-capital performance, particularly the increase in days sales outstanding and decline in year-to-date operating cash flow.
- Debt repayment schedule, floating-rate exposure under Term Loan B and compliance with leverage covenants.
- Execution and total cost of the Fiscal 2015 restructuring program and ERP implementation.
- Impact of future acquisitions, including integration costs, acquired-intangible amortization and resulting non-GAAP adjustments.
- Sustainability of the unusually low effective tax rate and the distinction between GAAP results and management’s non-GAAP measures.