Open Text Corporation
Q1 2013 Earnings Call Transcript

Published: 31 Oct 2012

[Operator:]

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the OpenText Corp. First Quarter Fiscal Year 2013 Financial Results Conference Call. [Operator Instructions] I'd like to remind everyone this conference call is being recorded. I will now turn the conference over to Mr. Greg Secord, VP of Investor Relations. Please go ahead, sir.

[Greg Secord:]

Thank you and good afternoon, everybody. I would like to start off the call with a reading of our Safe Harbor statement. Please note that during the course of this conference call, we may make statements relating to the future performance of OpenText that contain forward-looking information. While these forward-looking statements represent our current judgment, actual results could differ materially from a conclusion, forecast or projection in the forward-looking statements made today. Certain material factors or assumptions were applied in drawing any such conclusion or while making any such forecast or projections as reflected in the forward-looking information. Additional information about the material factors that could cause actual results to differ materially from the conclusion, forecast or projection in the forward-looking information, and the material factors or assumptions that were applied in drawing the conclusion while making the forecast or projection as reflected in the forward-looking information, as well as the risk factors that may affect the future performance and results of OpenText, are contained in OpenText's Form 10-K and Form 10-Q, as well as in our press release that was issued earlier today, each of which may be found on our website. We undertake no obligation to update these forward-looking statements unless required by law. In addition, our conference call will include discussion of certain non-GAAP financial measures. Reconciliations of all non-GAAP financial measures to their most directly comparable GAAP measures have been included in today's press release, which may be found on our website. With that, I'd like to welcome everybody to the call. With me today is OpenText President and CEO, Mark Barrenechea; as well as our CFO, Paul McFeeters. As with our previous calls, we'll read prepared remarks followed by a question-and-answer session. The call will last approximately an hour with a replay available shortly thereafter. I'd also like to direct investors to the Investor Relations section of our website where we've posted an updated PowerPoint that will be referred to in this call. We have also posted a summary table highlighting OpenText's historical trend and financial metrics. As a reminder, OpenText will be holding a financial analyst briefing on Wednesday, November 14, as part of Enterprise World, our annual users conference being held in Orlando, Florida. As part of the briefing, financial analysts who attend the conference will have a unique opportunity to openly integrate with partners and customers on site. Our lunch presentation will feature an update on our EIM and Cloud services offerings, as well as an overview of both our CS Customer Support and CS Professional Services businesses. All presentation materials will be made available on our website in advance of the meeting. Please contact our Investor Relations department for more details. Also, I'm pleased to announce that OpenText will be presenting at the following upcoming conferences

[Paul J. McFeeters:]

Thank you, Greg. Turning to the financial results, I will highlight our first quarter of fiscal year 2013. Total revenue for the quarter was $326 million, up 13% compared to $288 million for the same period last year. Regionally, the Americas contributed 55%, EMEA 35% and Asia-Pacific 10%. Our exposure to the euro, as a percentage of revenue, decreased by 5 percentage points this quarter as a result of the acquisition of EasyLink. License Revenue for the quarter was $56 million, down 14% compared to $65 million reported for the same period last year, a decrease of 8% on an exchange adjusted basis. We saw license revenue broken down by vertical of 18% for financial services, 18% from services, 17% from technology, 12% from basic materials, 12% from consumer packaged goods, 9% from public sector,7% from health care, 3% from utilities, 3% from industrial goods and 1% from conglomerates. Cloud services revenue, which we've broken out separately in our financial statement, was $45 million for the year compared to $1.4 million for the same period in the prior fiscal year. Customer Support revenue for the quarter was $162 million, no change compared to $162 million in the previous year, but on an FX adjusted basis, Customer Support revenue grew by approximately 6%. Professional Services and other revenue in the quarter was $64 million, up 4% compared to $61 million in the same period last year. Professional Services and other revenue grew 10% on an exchange adjusted basis. Gross margin for the quarter before amortization of acquired technology was approximately 70% compared to approximately 72% in the same period last year. The reduction was attributable to the addition of EasyLink whose margin for the quarter was 59%, in line with our target operating model. Pretax adjusted operating margin before interest expense and stock compensation was $93.8 million this quarter compared to $72.9 million in Q1 of last fiscal year, an increase of 29%. Adjusted net income increased 28% to $76.9 million this quarter, up from $60.3 million in Q1 of last fiscal year. Adjusted EPS was $1.31 per share on a diluted basis, up from $1.03 per share in Q1 of the prior fiscal year, an increase of 27%. Operating cash flow over the quarter was approximately $62 million compared to $45 million in the same period in the prior fiscal year. The sequential effect of foreign currency movement on adjusted EPS for Q1 was a negative $0.01. The adjusted tax rate for the quarter was 14%, the same as it was last fiscal year. On a GAAP basis, income from operations before interest and taxes for the quarter was $40.1 million, up 48% from $27.1 million in the first quarter last year. Our provision for income taxes on a GAAP basis, which is higher than usual this quarter primarily due to the impact of $4.2 million of both the tax return adjustment in the current quarter and tax realization benefits of $10 million that occurred in Q1 of last year and were not repeated in the current quarter. As a result, net income for the quarter in accordance with GAAP was approximately $19.4 million or $0.32 per share on a diluted basis compared to $35 million or $0.50 per share on a diluted basis for the same period a year ago. There are approximately 58.9 million shares outstanding on a fully diluted basis for the first quarter of fiscal 2013. On the balance sheet of September 30, 2012, deferred revenues were $270 million compared to $287 million as of June 30, 2012, and $261 million as of September 30, 2011. Accounts receivable was approximately $170 million compared to $164 million as of June 30, 2012, and $144 million as of September 30, 2011. Day sales outstanding was 47 days as of September 30 compared to 48 days at June 30, 2012, and 45 days at September 30, 2011. At September 30, 2012, our headcount was approximately 5,000 comprised of the following staff

[Mark J. Barrenechea:]

Paul, thank you for the overview, and welcome, everyone, to today's call. Before we get started, I would like to express our concern for all those that are affected by Hurricane Sandy. Our thoughts are with you and your families at this time. We are thankful that all OpenText facilities are operational and all OpenText employees have checked in and are safe. On today's call, there are 3 things I'd like to focus on before opening up the call for your questions

[Operator:]

[Operator Instructions] Your first question comes from the line of Scott Penner of TD Securities.

[Scott Penner:]

I'd like to kick it off with a quick 2-parter. Now that's just -- if you could flush out a little bit any commentary on the linearity in the quarter whether you saw any change in buyer behavior, really, at the end of the quarter? And then just looking at the numbers in a little bit more detail, relative to your comments last quarter on seasonality, it looks like there was about a -- an $11 million shortfall for license revenue. I'm just wondering if that -- if we can look at it and say that's $5 million to $6 million of that has since closed in Q2?

[Mark J. Barrenechea:]

Yes. Scott, I'll take the first part and Paul take the second part. In the first part, we were tracking across our 4 revenue streams extremely well going into the last 2 weeks of the quarter. PS performed well, CS was in line. We are obviously very pleased with Cloud services. And in the last week to 2 on the license side, it became much more difficult to close business both in Europe and across North American government. So we were tracking very well coming into the last 2 weeks on all 4 revenue streams. But unfortunately, it gotten more difficult to close license in the last 2 weeks. With that said, of those deals pushed from the end of the quarter, we've already closed approximately 50% of those deals pushed from Q1 into Q2. Paul, the second part?

[Paul J. McFeeters:]

Yes. So -- and based on that, Scott, we expect to see a sequential direction coming back in line. In fact, we'll expect to see it a bit higher now in the Q2 over Q1 than previously directed.

[Scott Penner:]

Just maybe just one more quick one. Just, Paul, the charge in the quarter of $9 million -- almost $10 million was higher than I think you'd indicated it would likely be in the first quarter when you commented last quarter. I was just wondering whether it's still aimed to be kind of $10 million to $15 million in total and how that should look over the next couple of quarters?

[Paul J. McFeeters:]

Yes, it's higher this quarter, first of all, because we probably did twice as much in EasyLink than originally planned, closer to the floor. In addition, we did some internal restructuring, I would call it one-time charge of about $3 million to $4 million this quarter. And so going forward, yes, for the EasyLink part, I still see it in is, really the $12 million to $15 million range.

[Operator:]

Your next question comes from the line of Tom Liston of Cantor Fitzgerald.

[Tom Liston:]

Mark, just a question on the role of R&D investment and how might that lead to increased license growth. And by way of example of reviewing the BPM market forecast or positioning by Gartner, and it certainly had you in the niche category and you had a lot of product offerings there and had IBM, certainly the leader -- leading category. It feels to me that given the comments that an R&D investment would be the easier path to a new license growth if you can get up towards that leader quadrant in that situation. And just maybe, broadly speaking. And then R&D was down most of many quarters, and then EasyLink was part of that. So just comment -- some commentary if you're just shifting R&D investment or if there's a role to play in driving license growth there?

[Mark J. Barrenechea:]

Sure thing. So I have found through a couple of decades enterprise software that the pendulum either rests with selling in distribution or with products. Right now, our path to license growth is more oriented towards distribution. And there's no doubt we're going to continuously innovate and there's more that we can do in innovation. But our first path is selling capacity and execution, versus the greater emphasis on products and innovation. With that said, yes, I certainly looked at the new quadrant that come up from Gartner. They've defined a new space, they basically split the space into 2 pieces, one is core BPM, the other is intelligent BPM. We haven't moved at all on our scoring on core BPM, but a new analytic side of BPM, we ranked lower, and we certainly have to work on it, but that's 5% to 10% of the overall market. The R&D spend is down due to some efficiency gains as we combined EasyLink with core OpenText and just some efficiency gains.

[Operator:]

Your next question comes from the line of Richard Tse of Cormark Securities.

[Richard Tse:]

So Mark, you explained the license side of the business. Can you help us give us a bit of confidence that, that the strategy's working here by talking about some other metrics? Perhaps talk about your pipeline today versus what it was last year before you came in, and started moving on some of these strategies. And I guess related to that, what gives you that confidence that, that Q2 is going to be better than Q1? And then, I guess in terms of Paul, you talked about unusual short-term savings. Can you give us a bit more color on that side as well?

[Mark J. Barrenechea:]

Yes, on confidence in Q2, again I'll, and I'll hand the second part to Paul. We give our targets on an annual basis, not a quarterly basis. But with that said, we certainly were not pleased with the slower start to the year on license, clearly not pleased. I can tell you that Greg and I work together, our regional leadership. We spent a multi-day summit, we're reviewing what we thought the issues were, any minor calibration that if we over-rotate here, under-rotate here and made some minor calibrations as we come into Q2. And our worldwide leadership walked away with a pipeline that was bigger, enthusiastic and great confidence coming into Q2. We're not going to talk about the size of pipeline, is it up x percent, et cetera. It has certainly grown quarter-over-quarter and year-over-year but against -- I can tell you that we've brought together our leadership after our slower-than-expected start to the fiscal year and we've all walked away very focused on executing in Q2.

[Paul J. McFeeters:]

Richard, as you would well know in Q1, we always are very careful with our cost, and we did some restructuring as I responded to Scott's question. So we took some cost out early. As we indicated in the past, we were going to fund sales growth through efficiencies and other cost reductions and overall really showed up quite early in the fiscal year. So I would look at sales cost as a percentage coming back in line. It was unusually low as I said because, mostly because of revenue and rates were lower than expected. And in the labor cost, we're building in the strategic areas that market is driving. So it took up some costs early, funding the growth. The growth and the expenses are going to come with the growth in revenue.

[Operator:]

Your next question comes from the line of Paul Steep with Scotiabank.

[Paul Steep:]

Mark, I guess one for you and then one, maybe clarification for Paul. On the cloud side, I think you've articulated a pretty strong vision here. Where do you see and how do you sort of see it progressing, I guess, maybe through just this fiscal year without going too far out in terms of exiting in either a target to revenue or total, and how you sort of originally go to that, to the existing original OpenText account base using some of the EasyLink tools? And then the clarification for Paul is just, it would be worthwhile, I think to remind at least me, and maybe others on deferred revenue, how that's going to build back in with lapping some of the acquisitions as well as maybe the impact on EasyLink as we think about 2014.

[Mark J. Barrenechea:]

Very good, Paul. Our -- we have a variety of milestones and metrics in front of us. We said a milestone is we're going to speak more deeply about these at our upcoming Enterprise World. But it's moving more and more products into managed hosting, and more and more products into the cloud. At the end of the day, we want to be able to offer every product, either on-premises or in the cloud. And give customers that choice, that option of deploy a third place or our place, and if deployed at our place, keep making it easier for them to deploy at our place, and making it easier and more efficient for us posting hundreds and dozens and thousands of customer deployment over time. We're moving Archive. Archive will be turned on this quarter in the cloud. Capture will be turned on inside the cloud. These are big platforms. Tempo Social and Tempo Box. Tempo Box and then Tempo Social. So I'd follow the roadmap and the progress that we make in moving our sort of tier A products and turning those services on in the cloud. And there are 2 big installed bases here. We have 21,000 active customers on the EasyLink side to introduce new services to, new customers that we're selling to and in our install base. I'm watching closely kind of a cross-sell opportunity within the OpenText install base and the cross-sell opportunity with inside the EasyLink install base. So I'd watch the -- clearly, our revenue metric, right, as we execute to our cloud services revenue, but I follow the products and a cross sell opportunity as well and I look forward to highlighting folks along the way on our progress.

[Paul J. McFeeters:]

On the deferred revenue side, it's going down in the normal course that it does for each of the quarters and rebuild in Q3. Rebuilding in Q3, just to remind everybody, is because we have a higher percentage of our contracts renewing on December 31. So we're not concerned at all about the balance. In fact, I commented on, this was for revenue year-over-year on an FX adjusted basis is actually up 6%. So the deferred revenue does step down from Q3 to Q4 into Q1 and then into Q2, and then it's back up in Q3 again just because of the timing of the contracts. There is no deferred revenue picked up in EasyLink.

[Operator:]

Your next question comes from the line of Paul Treiber of RBC Capital Markets.

[Paul Treiber:]

The margins this quarter were very surprising. And beyond R&D, which you touched on, the OpEx -- your OpEx this quarter is below even Q1 last year, despite the addition of EasyLink. Can you provide some more color on what drove the short-term savings and commissions and other costs? And is that related to the license -- the soft license, or is there something else in there?

[Paul J. McFeeters:]

Two things, Paul. It's absolutely related to license volumes so the sales costs, a big part of that would be a direct relation to the lower license revenue. And as I mentioned earlier, we had aimed to take some costs out of the organization early. We are always concerned on Q1, beginning every fiscal year, and we also said that we would self-fund growth initiatives that are underway in the markets we've been talking about. That's why said in my report that we would expect those costs to become a bit more in line with our annual operating models, beginning in Q2 and through Q3 and Q4.

[Paul Treiber:]

And one more. You've been in the market promoting your EIM vision for the last 6 months or so now. Can you provide some color on the feedback from customers on that strategy to date? And then are you finding that, that strategy is engaging more C-level executives than maybe you have done in the past?

[Mark J. Barrenechea:]

It's resonating well. I mean, from our employees, customers, analyst, partners. We're finding more entry points into customers, to have discussions, and we're finding entry points higher in the organization. This is going to be the first year at Enterprise World that we've added a CIO track. I think that's partly reflective of a more value-based message, more opportunities to engage with an organization and our ability to engage higher in that organization and it's probably reflective we now have a CIO track at Enterprise World.

[Operator:]

Your next question comes from the line of Blair Abernathy with Stifel, Nicolaus.

[Blair H. Abernethy:]

Paul, just a quick question for you. On the EasyLink revenues reported, just under $45 million, is that pure EasyLink or is there any legacy OpenText revenue in that line?

[Paul J. McFeeters:]

There's $1.4 million of legacy OpenText there.

[Blair H. Abernethy:]

Would that have been Captaris?

[Paul J. McFeeters:]

No, that would be -- right, OpenText would had already engaged in hosting some of our customer's software before, so we did have, and we have had that business here, it hasn't been a large part, indicated in New York that we had about just under $7 million all of last year in that part. So that's hosting some of our solutions for OpenText customers on the ECM.

[Blair H. Abernethy:]

So and that was $1.4 million, was it?

[Paul J. McFeeters:]

For the quarter, yes.

[Blair H. Abernethy:]

And what lines would that have come out of, Paul?

[Paul J. McFeeters:]

Customer support.

[Blair H. Abernethy:]

Customer support. Second question is actually for you, again. Just on -- can you give us some -- your thoughts on your debt position at this point and whether you are -- should we be starting to factor in, may be taking some of this down over the next couple of years from cash flow? Or what's your thoughts on your balance sheet?

[Paul J. McFeeters:]

On the new debt that we raised in November, we already have, because it's a term loan A, we already have a principal repayment schedule, at 5% each of the first 2 years, 7.5% following 2, and 10% for the 5th year. So we will have repaid our debt for the normal course by 4% for this 5-year period. I don't see us accelerating that at this time.

[Operator:]

Your next question comes from the line of Stephanie Price of CIBC World Markets.

[Stephanie Price:]

I was hoping that we could go back to the pipeline. Other software firms have also called out sort of a slow end of the quarter, given concerns around the U.S. election and the fiscal cliff. Are you seeing it now pick up in the U.S. or is the U.S. still a bit weak here?

[Mark J. Barrenechea:]

Well, we'll throw our hands into that bucket of companies. You saw on the license side, sort of a slower end to the quarter. Now the only data and we have a couple of data points of those deals pushed at the end of the quarter, a little over half of them are closed in our first month of Q2. And I look at the pipeline and the planning and the structure and the -- really the planning and structure and mood, I guess, from our regional leadership. And they're very focused here in Q2. So my data point is our planning and what has -- what was pushed that has closed are 2 encouraging signs for us.

[Operator:]

Your next question comes from the line of Brian Freed of Wunderlich Securities.

[Brian Freed:]

You guys talked about public sector a little bit. I think it was 9% in the quarter. I know you guys were part of an announcement for a very large deal for the U.S. interior. Was any revenue or material revenue associated with that in the quarter? And what do you see as kind of the timing and opportunity there?

[Mark J. Barrenechea:]

Yes, so Brian, this is Mark. Yes, this was the DOI, Department of Interior. It's a multiyear arrangement, and as they turn on users, our revenue stream will follow that. There was some revenue within the quarter but not significant revenue within this quarter. So the deployment is ongoing and as they turn on more users, we'll see more revenue.

[Operator:]

Your next question comes from the line of Thanos Moschopoulos of BMO Capital Markets.

[Thanos Moschopoulos:]

Mark, you recently brought James Mackey onboard into the organization. Can you provide some color on his role on the executive team and how the addition of James might shape your M&A strategy going forward?

[Mark J. Barrenechea:]

Sure thing. Yes, we're delighted to bring on board Jim. Jim's going to lead corporate development for us. Jim will report to me directly. And he'll help with product strategy and planning and M&A. And he's obviously a world-class executive and professional. He's seen a lot, spending near a decade at SAP, helping drive SuccessFactors, BusinessObjects, Sybase and as he likes to remind me, another 30 acquisitions. And we're delighted to have him join the team. I think he'll help us in our thinking on strategy. Good M&A starts very early around direction and strategy and situational awareness. In terms of our change of M&A strategy, as we build a well-organized, account-based sales operation, we'll have more opportunity to get to broader distribution of assets that we buy. But we remain a value buyer, we will look at growth assets, as I've said in the past, but we primarily remain value buyers today. As we get more confidence in our sales execution, we certainly could look at more value-based assets. That's how we think about it.

[Operator:]

And your next question comes from the line of Eyal Ofir of Canaccord Genuity.

[Eyal Ofir:]

Can I just ask about the SAP revenue in the quarter, how much there was of license? And then also, when you look at to Q2, you talked about, obviously the sequential growth should be higher than the traditional 40%. Is there a number you can give us, you guys can give us, as in the north of 50% or 60% in terms of sequential license revenue growth?

[Paul J. McFeeters:]

Paul. Well first of all, the SAP revenues were -- has been tracking as in the past, greater than 10%. I don't think we use any of these percentages you're just referring to. Well I think previously, we had given a directive, a direction, sorry, and now guidance of course, of around 10% and 20%. We did indicate we would expect to be higher than that, but we didn't give any percentages on a sequential basis.

[Operator:]

[Operator Instructions] Your next question is a follow-up question from the line of Blair Abernethy of Stifel, Nicolaus.

[Blair H. Abernethy:]

Mark, just wanted to ask you a little bit or more about your sales force changes you put in, in terms of both management and then also increasing the number of feet on the street. Can you give us a sense of where -- how far along are you at in that process? And when do you think or when do you feel this is going to be stabilized?

[Mark J. Barrenechea:]

Blair, so structurally, our changes -- so I'm going to start my comments on the direct side of what we're doing, okay? On the direct side, because we want to end up with 4 channels, 4 major onramps to growth

[Operator:]

Your next question comes from the line of Gabriel Leung of Paradigm Capital.

[Gabriel Leung:]

2 quick questions for Paul. First, just on the operating margins, I think the last time you had guided to or you think operating margins are going to come in for the current fiscal year, you had suggested perhaps flat year-over-year, just given the Q1 performance and some of the efficiencies you're seeing, do you think it's fair to say that it might be better than just flat year-over-year?

[Paul J. McFeeters:]

No, Gabriel, I wouldn't -- I won't say that at this point. As I did indicate, we are funding and we indicated we are funding certain growth running our sales organization and expenses and so we are, as we said, we would find that money inside our operations, some of that you can see happening in Q3. I'm still directing that. We would view the expenses to fall in line, more in line with our operating model as a percentage of revenues and that's I would say would be still making the same comment with respect to this operating margin for the fiscal year.

[Gabriel Leung:]

All right. And then secondly, I think in response a previous question, I just want to confirm something here. You're, in the past, I think your seasonal guidance, I guess, for the December quarter was, I believe, up 20% to 30% quarter-over-quarter, and I think you just said 10% to 20%. Can you just confirm your comments there?

[Paul J. McFeeters:]

Yes. Well so just to be clear, when we talked about the seasonal directions. We were saying this was something over the long term in the past and looking forward, it wasn't specific guidance. What I did say is that, based on Q1, we would expect the sequential number to be likely higher than the range we indicated, which was 20% to 30%.

[Operator:]

Your next question comes from the line of Scot Penner, TD Securities.

[Scott Penner:]

Mark, just a quick one relative to one of your comments in the prepared remarks. And that is, some of the effective, the more web-based applications over time into the cloud model. I think most people view your cloud model as essentially hosting, so I wanted to sort of clarify whether there's any thought at this point to more of a SaaS model, really, what you meant by that?

[Mark J. Barrenechea:]

No, it's primarily applications as a service, and hosting as a service, today. Our customers still buy a license, we want to host them in the cloud and get additional revenue streams from doing that. But it's primarily having our applications as a service and being able to manage that within the cloud-based environment. We are not talking about SaaS opportunity at this point.

[Operator:]

Gentlemen, there are no further questions at this time. Please continue.

[Greg Secord:]

Okay, thank you everybody, for the call, and we look forward to speaking with you next quarter.

[Operator:]

Ladies and gentlemen, this concludes the conference call for today. Thanks for participating. You may now disconnect your lines.