Open Text Corp (OTEX) 2007 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Open Text Corporation fiscal year 2007 Q2 financial results conference call. At this time all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). I would like to remind everyone that this conference call is being recorded on Thursday, February 8, 2007, at 5:00 PM Eastern time. I will now turn the conference over to Greg Secord, Director, Investor Relations. Please go ahead.

Good afternoon and thank you for joining us. Today we will be discussing our financial results for the second quarter of fiscal 2007 that were released earlier this afternoon. Joining me today are John Shackleton, our President and Chief Executive Officer; and Paul McFeeters, our Chief Financial Officer. After our prepared comments the operator will poll for questions.

During the course of this conference call we may make projections or other forward-looking statements relating to the future performance of Open Text and its subsidiaries. These oral statements contain forward-looking information. The actual results could differ materially from a conclusion, forecast or projection in the forward-looking information.

Certain material factors or assumptions were applied in drawing a conclusion or making a forecast or projection as reflected in the forward-looking information.

Additional information about the material factors or assumptions 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 a conclusion or making a forecast or projection as reflected in the forward-looking information are contained in Open Text's Form 10-K for the fiscal year ended June 30, 2006, and in our press release that was issued earlier today.

Now I will turn the call over to John Shackleton.

Good afternoon, everybody, and thank you for joining us. Today we're going to quickly go talk about our Q2 results, then go into the progress we have made on the Hummingbird integration.

So first I will hand the call to Paul McFeeters for a detailed review of our Q2 results.

Thank you, John. Turning to the financial results for our second quarter of fiscal 2007, total revenue for the quarter was $163.3 million, an increase of 47% from $110.8 million in the same period of last year. This number does not take into account the additional $5.1 million of Hummingbird deferred revenue excluded under purchase accounting rules for the first year after an acquisition.

License revenue for the quarter was $51.4 million compared to $37.1 million last year, up year over year 39%, while maintenance revenue in the quarter was $78 million, an increase of 68% compared to $46.5 million in the prior year.

While professional services revenue increased $6.6 million year over year, margins were impeded, resulting from a delay in restructuring of professional services headcount. Gross margin for the second quarter before amortization of acquired technology was 73%, which is consistent with previous quarters.

The pre-tax adjusted operating income margin in the second quarter before net interest expense was 20% compared to 21% the same quarter last year.

We reported second quarter adjusted net income of $18 million or $0.35 per share on a diluted basis compared to $15.4 million or $0.31 per share on a diluted basis in the same period a year ago. This represents growth of 17% on a year-over-year basis. Our overall effective tax rate for the quarter was 32%. Our cash taxes continue to be in the range of 10% to 15% annually.

Net income for the second quarter in accordance with GAAP was $2.3 million or $0.04 per share compared to $2.7 million or $0.05 per share in the same period a year ago. The fully diluted share count for the quarter was approximately [15.7] million shares. The GAAP net income for the second quarter also includes share-based compensation expense net of tax of $1.1 million or $0.02 per share on a diluted basis compared to $1.2 million or approximately $0.02 per share last year.

As of December 31st, deferred revenue was $117.7 million compared to $75.3 million as of September 30, 2006. Accounts receivable as of December 31st, 2006, was $114.1 million compared to $76.7 million as of September 30th, 2006, resulting in a DSO of 63 days compared to 58 days at the end of Open Text's September quarter end. We have been focused on managing the accounts receivable, and I'm very pleased with our collections progress to-date.

The cash position at quarter end was $124.4 million compared to $111.2 million at the end of our last quarter. This was achieved after paying out $25 million for acquisition-related and debt issuance costs. The net cash flow from operations was $31.4 million after cash paid for Open Text restructuring of $1.9 million and after net interest costs of $7.5 million. This compares with cash flow from operations of $9.6 million in Q1 and $15.4 million in the same period last year.

Now I will hand the call back over to John for a discussion on operations.

Thank you, Paul. We are happy with the results, meeting both our revenue and margin expectations. Our focus on the bottom line is paying off, and I'm very pleased with the cash flow from operations this quarter. From a revenue perspective, North America was responsible for 47% of revenue, Europe for 48% with the remaining 5% in the Middle East and Asia. The UK and high-tech manufacturing were particularly strong this quarter.

We generated 35% of license revenue from new customers and 65% from our installed base. The average transaction size of the combined company was approximately $200,000, down from the $250,000 last quarter but reflecting the broader product portfolio of the combined company. We had four transactions over $0.5 million and one transaction over $1 million.

Our customers continue to look for comprehensive ECM solutions that are fast and easy to deploy but highly scalable. Examples of significant wins in the quarter include Tronox, one of the world's largest producers of titanium dioxide pigment used in paints, plastics and other everyday products. Tronox is expanding its use of Livelink ECM with contract lifecycle management, which will help employees across the various departments work together to support all processes relating to a contract through its lifecycle.

Another example is Pacific Gas & Electric Company, which extended its existing Open Text solution-based infrastructure to include Livelink ECM document management for SAP solutions. The project will enable the Company to archive its SAP data and streamline relevant business processes.

In the quarter we saw revenue by vertical as 30% from high-tech manufacturing, 18% from government, 15% from energy, 8% from financial services and 8% from life sciences. We continue to see strengthen in areas like government and manufacturing.

From a sales operation standpoint we closed the quarter with a combined sales force of 210 quota carrying sales reps. This was up from 148 Open Text sales reps last quarter.

Regarding the Hummingbird integration, on the sales front, we have examined all regions of Hummingbird and identified geographies such as Spain, Portugal, Russia, South Africa and Latin America that would be better served by regional partners than by direct sales. We have also closed or consolidated offices in those areas. To date 19 facilities were impacted as part of this exercise, and with 21 global offices remaining in the plan. We expect to be completing these activities in the coming months.

On the product front, we have made great progress on the integrated product road map, where the combined products will provide rich user experience from the Hummingbird product line and stronger back-end functionality from the Open Text products. For Hummingbird customers specifically, the new DMX product will provide strong customer -- and easier to upgrade and save significant time and efforts and easy access to the Open Text modules.

I'm pleased with the progress we have made and the synergies we're realizing from our joint customer base as well as from our products, people and facilities. I'm particularly pleased with how the RedDot division is performing. RedDot brings us the capability to be competitive with both stand-alone Web content management but, more importantly, with Web content management as a strong, integral part of Livelink ECM 10. We have already begun leveraging opportunities by cross-selling into the Open Text and RedDot customer base.

In the quarter Reed Exhibitions, the world's leading organizer of trade and consumer events, began implementing the Web content management solution from RedDot, building a platform that will support both medium and long-term business goals, offering each of its business units the ability to create and manage their own content and digital assets.

On the product front, in November, we hosted LiveLink Up 2006, our 13th annual global user conference. The conference focused on helping customers leverage their Livelink ECM investment by demonstrating how to streamline information from their enterprise applications also to enhance operational efficiencies, reduce cost and improve performance. This was another successful conference for us with over 1200 attendees and over 30 customer presentations, more than in any previous year. We also had keynote addresses from our strategic partners, including Microsoft, Oracle, SAP and Accenture.

Customers recognized for their innovative ECM solutions included Philip Morris USA, Forest City Enterprises, Alabama Gas Corporation and ThyssenKrupp.

Other significant announcements in the quarter included the introduction of Livelink ECM 10, our latest major release to our ECM products. Then earlier today we also announced that Gartner has rated our records management products as a strong positive in the MarketScope of Records Management 2007 Report.

Our records management offerings continue to drive our strategic relationships, and tight integrations with Microsoft, Oracle and SAP. With these relationships customers can use our records management solutions to apply retention policies across content in a wide range of enterprise systems, including paper-based documents, e-mail, instant messages and file systems. These can be stored in repositories, for example, like Microsoft share point and in ERP applications.

We also announced a link-up that we received the latest US Department of Defense certification for our records management solutions. This certification includes chapter 4 management of classified records and has support for two additional records management solutions for use with Microsoft share point portal server 2003 and for SAP.

Next week at Summit, our Hummingbird user conference, which will be held in California, we will announce the foundation of the Hummingbird Open Text integrated roadmap. This presentation will be webcast live on Monday, February the 12. Full details and presentation materials will be available in the investor relations section of our Web site.

On the partner front we have continued to make significant progress, particularly with SAP, Oracle and Microsoft. Open Text revenue from partners more than doubled year over year, and partner revenue for the combined company was approximately 30%. So I'm pleased with the progress we are making in this area.

As I mentioned on our last investor call, there is usually some revenue falloff that occurs in any acquisition. We continue to expect a 20% overall reduction on Hummingbird's revenue rates going forward, and I should also remind you that the expected revenue reduction does not include the accounting treatment for deferred revenue that Paul pointed out.

Regarding Q3 guidance, we will continue to hold off providing specific revenue and earnings guidance while we get more comfortable with the combined pipeline. We have new salespeople, new support staff and we're actively continuing the process of reviewing and qualifying opportunities and making sure that they fit within the Open Text forecasting model.

I would also like to take this opportunity to remind the street of the seasonality in our business and the addition of Hummingbird does not change the seasonal buying patterns of our customers. Overall, there have been no surprises to our outlook. The consolidation has gone smoothly, and I feel that we're on track to meet our profitability goals. For the remainder of the fiscal year, our focus will continue on remaining on looking at the bottom line.

Now I would like to hand the call back to Paul to talk about accounting treatments for certain areas of the acquisition.

Before we discuss some of the accounting treatments that were a result of the Hummingbird transaction, I do want to address the delayed filing of the historical results.

Open Text acquired Hummingbird October 2nd, 2006. Hummingbird finished their fourth quarter on September 30, before they were acquired, and the 8-K filing of those historic results is still standing. Hummingbird had correspondence with the SEC regarding their revenue recognition policies. We are in the process of finishing our review and completing the 2006 audited statements. We're working with the Hummingbird auditors to file this information, but I want to make it very clear that the filing of these historical Hummingbird results has no bearing on the integration of the two companies, nor will it negatively impact the operating results of Open Text. It also does not impact the future filing schedule of Open Text quarterly reports. Our 10-Q will be filed tomorrow afternoon, on schedule.

As part of the purchase price accounting, the deferred revenue liability acquired is subject to an adjustment which will reduce the opening value of the deferred revenue. This is a balance sheet entry that does not impact cash flow but does impact top-line revenue, primarily through the first year of operations. We will continue to provide the amount of deferred revenue that was written down in this and future quarters. The impact this quarter was $5.1 million, which would have had a pretax effect of $0.10 and an after-tax effect of $0.07 on EPS.

In the second quarter Open Text accrued charges of $31 million for restructuring. Of this, approximately $5.1 million was classified as a restructuring or special charges to the statement of income. The balance is part of our acquisition cost as it is accrued for on the balance sheet.

We continue to see these actions resulting in savings of approximately $50 million for the current fiscal year and continue to project annualized savings from the restructuring could be in the $80 million range, starting with fiscal 2008.

I would like to close with a reminder. While there will be no investor or analyst event at the Summit, the Hummingbird user's conference, we will be Webcasting the main presentation on the morning of Monday, February 12. Full details, including dial-in numbers to listen to the presentation, as well as complete downloads of all the Company presentation materials, will be made available in the investor relations section of our Web site. Please contact our Investor Relations department for more information.

Now I will turn the call back to our operator to take questions.

(OPERATOR INSTRUCTIONS). Scott Penner, TD Newcrest.

Maybe I will just start off by asking you to split out, if you would, the connectivity revenue from the total number and where in the revenue lines it sits.

Open Text will continue to report statement reporting based on geography. So we will not be breaking that information out. Connectivity revenue is less than 10% of the Company's total revenue.

Maybe, then, I'll switch right away to just a discussion of the impact of the Hummingbird business in total on the licensure revenue. Are you going to give that out?

No. Again, we are integrating operations and sales forces, cross-selling. So we will not be tracking and reporting on what was formerly Hummingbird's operations or Open Text's operations. They are combined operations today.

As we cross-sell modules, in fact, which we have already started doing, it quickly becomes meaningless so that there really is no point in tracking both, particularly in the ECM space.

Yes, I'm just a little bit surprised you wouldn't separate out the connectivity revenue, seen how it is a -- you call it zero growth business, and it's a fairly material chunk of the revenue.

The issue is we have so many products in these areas that if we separate out one, to then separate out the others would be difficult knowing which ones to separate and which ones not to separate. So we will continue to continue with our reporting on a geographic basis, not product.

John, just let me just qualify some of the comments that you made on the partner revenue. Did you say that the Open Text partner revenue itself doubled year over year?

Yes, it did. The revenue previous year was around 8% of our revenues. This time it was pretty much double that. Together, they made up about 30% of the revenue.

And maybe I will come back on this connectivity side. Because I just -- if you could separate out the sales force, for instance, the number of reps that are actually selling the ECM?

Again, that's a division of the operations we will not be breaking out or reporting on.

Mike Abramsky, RBC Capital Markets.

Could you just talk about your decision not to provide or resume providing guidance? You have had several months to now scrub the pipeline, a quarter looks clean. When do you expect to resume it, and what are some of the issues that are preventing you from doing so at this point?

It really is, as we have been focusing on the bottom line, looking at areas, that, some of the remote areas that we feel are better served through partners. This is going to take a quarter, probably at least one more quarter to get ready so we feel comfortable as well as then they take on that revenue, it will be easy for us to forecast what we think they will do. So I would say at least one more quarter.

You mean you're expecting next quarter, or you think you're going to have another quarter where you still -- in other words, you are basically saying you need three full quarters before you can actually get comfort around that pipeline?

Hopefully, by the end of this quarter we will have much more comfort.

Your OpEx results are very positive. They are somewhat lower overall now than your prestated Open Text business model for 15% R&D, 30% sales and marketing and 10% G&A. Can you comment on how sustainable expenses are going to be at these levels as a percent of revenue?

Well, the percent of revenue -- we will be continuing to put that, I think, Mike, or perhaps in some cases maybe 1% or 2% less as we go forward and achieve the balance of the cost savings that I referred to.

So they are not temporary results of restructuring or other things; you see this as not only sustainable but perhaps more efficiencies to come into your OpEx as a percent of revenue?

Certainly sustainable and likely somewhat more positive.

Okay. The service margins -- I think you made a comment earlier on the delay in restructuring of professional services headcount. So do you expect those to recover, and how quickly do you expect -- obviously, you're seeing that you do, but how much do you expect them to recover and how quickly?

It will probably take a couple of quarters, as people finish up on projects, et cetera. So we can't just pull them up immediately. But we will be looking at this very closely over the next quarter and certainly the next two quarters. I would expect, certainly, by the end of the fiscal year that we should have this in shape.

Just a question maybe you can explain why your tax rate was much lower and how do we think about modeling a sustainable tax rate.

Just to be clear, I think we have been talking about tax rates, the effective tax rates in the low 30s. But I'm reporting and I have been reporting the cash tax that the Company pays in the 10% to 15%. I think that will be a continuing range as we go forward.

So now you are reporting actual cash taxes?

Cash taxes, yes. I believe I have in the last two quarters as well.

That's a departure from kind of historical procedure for Open Text?

Well, I'm not sure. But I think that, because of the -- I'll just call them anomalies of purchase accounting and taxes that you acquire in acquisitions, et cetera, we think it's more meaningful to report on cash taxes or report on that in addition to what we had reported. I just think it's more helpful for you and the investors.

But then doesn't that suggest you should report earnings on an apples-to-apples basis?

We still do. I'm just giving you information on cash taxes. We're still showing you proper accounting for effective tax rates on our income statement. -- this quarter, 32%.

Paul Steep, Scotia Capital.

Just since we are -- I understand your reluctance to provide the Hummingbird data. Quick back-of-the envelope math here shows flat year-over-year license numbers, depending on what you want to assume. If we sort of look inside that, you call that RedDot as a point of strength. We have seen competitors drive strong double-digit growth. Where are you at, and where do you sort of see yourselves at, post the next couple quarters as you work through the noise here on the acquisition?

As we said, as we work through the acquisition, we will be focusing on the bottom line. We will be giving up revenue in areas where we don't see that it's profitable to do that. Then coming out of that, I see us competing with the market, doing well. While some of the companies say that they are growing double digits, we're certainly not seeing -- losing market share from any of these folks.

Fair enough. The maintenance renewal cycle -- just to be clear, there have not been any glitches, no issues in terms of -- because I'm assuming the high cash balances are really going to reflect in in the March quarter as you basically have most of the clients on calendar year end renewals. Does it seem fair that there were no hitches on either the Open Text or the Hummingbird side?

I think you are right on both counts. We have not seen any hitches; and, as you point out, we do have a higher instance of renewals at the end of December, which will affect the cash flow, again, possibly in this quarter.

So that brings me to the next point, which is long-term debt repayment and where you see that target level at and how aggressive you are going to be in driving the debt down over the next few quarters.

Sure. Well, we're comfortable with maintaining about $100 million cash balance on our balance sheet. Cash in excess of that, of course, is, at least from our own operations standpoint, available for debt reduction. But again, that's subject to whether we are interested in certain tuck-in acquisitions and would use cash for those.

Can you sort of elaborate a little bit, I guess, as to what you see the acquisition environment versus paying down debt?

I'm responding only to the cash management side. It's my responsibility. I'm not going to be able to respond to any pending acquisitions and suggesting that there are any. I was just talking about how we are managing the cash balance and looking at that as we go forward as to whether we immediately pay down debt or leave it a bit higher than the stated balances I said we're comfortable with.

So we might keep a reserve for that, but the goal would be to pay down the balance as soon as we can.

You have done a bunch of facilities closure. I guess the only really meaningful one here would be, actually, a question on subletting. You had an excessive amount of space from IXOS in Germany. Any luck on placing that space?

The majority of it, not yet. We are breaking it down into smaller units because the market will address that, as opposed to the quantum. Again, in our accrual, we have not assumed any subletting until into 2008. So we will be re-reviewing that in the next quarter or two.

Tom Liston, Versant Partners.

Just on license revenue again, if you can answer, can give us either Hummingbird's last year license revenue in the quarter and/or at least some color on what the reduction might be, given that you have already said you're looking at a 20% overall reduction in overall Hummingbird revenue, and maintenance is obviously not going to drop as much. Is it at least fair to assume that there was a 25%-ish, 30% reduction in license revenue year over year in this quarter?

That's anticipation for the model, Tom, yes.

But can you comment on this December quarter? Give us some color on what Hummingbird would have been down on license revenue?

Again, we're not going to break out the Hummingbird and previous Hummingbird/Open Text business because we will then get into product breakouts. Since John mentioned, we don't do product breakouts, and we're cross-selling, we're using sales forces by geography, et cetera.

But I think your assumption of the model is right.

Back on Paul's maintenance renewal question, would I assume to date you're seeing plus 90% on both sides of the business in renewals?

Today, we are.

Can give us some further color on the Oracle/Microsoft partnerships and what type of influence they are having on some deals, in either the current quarter or what the pipeline looks like?

This past quarter, Microsoft -- we have had quite a bit of work, particularly in North America, working together on significant large deals. The Oracle is slightly behind because it's a newer relationship, but it's going very well, particularly in the medium-sized companies. Then SAP, we have also had some good success again in the U.S., with that program as well. We're seeing the pipelines building nicely with them.

With Oracle, was there any delays as people try to figure out what's going on with the Stellant or even internally there at Oracle, or what are the cause for some of the --?

Not really. In fact, we're working very closely with them. They still see us as their strategic ECM vendor. Obviously, we have a much wider portfolio than Stellant does. In fact, as late as last week we were working together closely with them and planning next steps. So we haven't seen any change because of the Stellant relationship.

Paul, I apologize if you've [re-entered] this. But the cash outlay before, for restructuring -- you said between Q2 and Q3 was $25 million to $27 million. It looks like there were $17.8 million or so out in Q2. Is there any update on that type of guidance for Q3? Does it look like just the net of that range?

Yes. Some of it, I think, will also go into Q4, but I would say the majority of the balance you see is cash paid in Q3.

So it would sort of be less than $10 million and above $6.5 million, $7 million?

Yes, I think it would be more in the $10 million range.

Lawrence Rhee, Genuity Capital Markets.

Could you just comment in terms of the percentage of revenue that came from the legal vertical, which I presume is still Hummingbird's strong suit?

If we look at the total legal areas, it was probably 2% or 3% total revenues as a vertical. Again, obviously, it's a mixture of products in those verticals from document management to solutions to Web content management. If you look at legal as part of the total entity, it's not a very large group.

So is that the 2% to 3% apples-to-apples with your other verticals that you highlighted earlier in your prepared remarks?

Correct.

Secondly, you probably heard on the Interwoven call they mentioned that 12 or 13 of their new customers were ex Hummingbird/Open Text customers. Is there a concern about some departures of customers to competitors, or what are you doing to kind of, hopefully, alleviate that?

I could show you a list of similar ones where RedDot has taken customers away from Interwoven. So most of the customers we see are not looking for point solutions, they are looking for full suites. So I don't think they could compete in that space.

Richard Tse, National Bank Financial.

Could you talk a bit about the spending environment generally for ECM? We have seen some decent numbers from the comps. What areas are hot, and has that environment changed in general? Or can you give us a sense of where that stands right now?

With our large customer base, we're seeing that -- for probably the first time in a couple of years, we're seeing that they are planning some fairly significant projects in ECM. We're also seeing, interestingly, for the first time in the medium-sized companies where they are coming in and doing pilots but pilots that are more enterprise-wide rather than with a large company, where they might start with a department-wide. They are really, because of their size, they are enterprise-wide deployments straight off the bat. So we're seeing some interesting pickup in business in that area.

With respect to the license environment, how should we view this going forward? I know you are not giving guidance, but is the mandate here to preserve or grow the earnings and you are wanting to sacrifice licenses to do that? Should we read it that way?

The goal is to establish and get our baseline with the two companies together, exactly that, getting the margins right, getting the right people, the right size of development groups and sales groups, et cetera. From that we will then look at moving from there.

One final question with respect to the connectivity business. Should we sort of just make this broad assumption here that if you look at Hummingbird when it was operating on its own, it really didn't change that much each quarter? Should we make that broad assumption here that you are following on that same path?

I would think you should, yes.

Steve [Koneg], Jefferies & Company.

A question on the Hummingbird deferred. Can you remind me why -- I think just a portion of it was written down. Can you tell us how much was written down? Then secondly, I just wanted to ask one more question about cost reduction opportunities as well.

Right now the deferred write-down is $13 million, and then the -- sorry, the amount to be written down is $13 million on the acquired deferred revenue balance. $5.1 million of that, now, has been attributed to this quarter.

So $5.1 million is already written down in the $13 million to go?

Yes, $5.1 million is -- so, really, it's a balance that is $13 million less than what it will be on the closing balance sheet of Hummingbird. So what we're referencing is the fact that if that write-down had not occurred, what would have been the amount that would have come into make this revenue. So it really doesn't reside anywhere on the balance sheet. But the reference I'm making is that, should we not have written down, which we are required to do, that amount, that would have affected this quarter's revenues by an additional $5.1 million.

Okay, and there's $13 million to go, if I understand correctly?

$13 million is gross, so then there would be the net of $8 million.

The net of $8 million to go. A question on cost reduction. I understand that there's more opportunity for cost reduction in services. Are there opportunities in other areas such as more offices, et cetera? Or do you believe that you've achieved the cost reduction or that you planned for those and now we are in a process of achieving those? Or are there more to come, potentially?

I think on facilities, we think we've got most of them. As we say, we do believe we can do better in professional services. I think there are other areas of, say, marketing, other places where I think we can be much more efficient.

Howard Lis, GMP Securities.

Most of my questions have been asked and answered, and maybe I missed this. But you had talked about a large charge of $32 million to $35 million expected in this quarter. I saw the $4.8 million on the income statement. Where is the rest of the charge?

The rest of the charge really is a part of the purchase accounting on the balance sheet, netted against goodwill. The restructuring charges on an acquisition go there as opposed to operating earnings. The Open Text part of the restructuring is what has gone to operating earnings.

Are there any further special charges anticipated?

No, there would not be any more special charges anticipated. We feel we've -- there could be some minor adjustments as we true-up our purchase accounting. But we've accrued primarily what we have already planned to accomplish.

David Wright, BMO Capital Markets.

RedDot -- I'm not sure if I remember this correctly, but is there something in February of the acquisition being finalized with -- the acquisition was finalized, but between Hummingbird and RedDot integration? Are there any integration issues coming up with RedDot in the near-term?

No. The RedDot -- when it was acquired by Hummingbird, there was not any integration going on; it was fairly stand-alone. We're doing integration with the whole Livelink product suite, and in fact, have done some initial integration with it. So that will be announced as part of the joint road plans on Monday.

So that's that product integration?

Right.

Because my understanding was it was being run as a separate entity, essentially. I thought that there was a date somewhere around now, February or March, where Hummingbird would be able to integrate other operations aside from just products. Is there a deadline like that coming up, that will give you an opportunity to cut out some more costs?

No, there was no date between the acquisition and now. We have been integrating particularly all-black office operations as well as some sales forces where it makes sense. So there has been no kind of unique data other than that, so the integration is already underway.

Is there a RedDot sales team, or marketing team or anything like that?

Yes, there is a RedDot sales team because the market that they are going after -- we see it as very different, so we're keeping that. But as a back office -- so there were no contractual issues that Hummingbird had that we would have had a problem integrating Hummingbird into the group. So basically what we're doing is this is a unique market that we are having a separate sales force going after that. But from any kind of marketing, PR, facilities, et cetera -- they would be just the same as any organization that we would look at maximizing and scalability.

I'm surprised you describe it as a unique market, considering your breadth. But I guess that's how you are running it.

When you look at the sales reps, so you had 148; now you have 210. I can understand that you would keep the connectivity people because that's a totally different market, and it sounds like you have kept some of the RedDot people. So I guess, of the Hummingbird salespeople in the DM front, would you have kept many of those at all?

That was an area that we felt that they had an overcapacity of salespeople, so that that was an area that we looked at very, very closely and in the restructuring focused on quite heavily, both from a sales standpoint and a management standpoint.

So in understanding how sales territories went together and the issues that could be around that, this was not a case where you took the top 20% of both organizations and then mixed the other ones? Did you essentially eliminate the Hummingbird side of things and kept the Open Text salespeople?

Well, we basically looked at the revenues being generated by those regions and then the sales force needed to support that. Also keep in mind that Hummingbird did have a much more of a partner sales channel so that we took that into consideration also.

You have answered my other questions. Thank you very much.

[Iell Efir], Canaccord Adams.

It's Iell Efir and [Hafalpina Misic]. A quick question for you around the deferred revenue write-down. You said that there was a net $8 million left. Could you just tell us how long you will be writing that piece off? Is it over the next two quarters, or is over the next three?

It will be over the next three quarters with a very small balance after that representing contracts that were beyond one year.

So that's the total, so the $13 million was only the contracts for the one year; is that correct?

No, it's the total contracts. The majority of it will have been put through by the end of one full year.

Can you guys make a comment if it's skewed towards more of the connectivity business versus the enterprise side on the Hummingbird?

No; its related to all of the deferred maintenance contracts, which would be all of the operations.

So it's all based on services, it would have been all services revenue?

Maintenance services, yes.

Steven Li, Raymond James.

Just a couple of clarifications. Would you highlighted the seasonality for the May quarter, historically it has been down 8% to 9% sequentially. That's about how much we should be expecting?

That's roughly what it has been for the last couple of years.

Then just on the tax rate, so we should be modeling 10% to 15% going forward?

You'll continue to see financial statements probably in the low 30%'s as far as the P&L rate. But I, again, like to emphasize what is happening from a cash standpoint. Because, as I said, there's a lot of acquisition losses that never run through the P&L; they stay on the balance sheet as part of the balance sheet of acquisition. So we think that reporting on both and particularly cash taxes, is informative. But from a pure P&L standpoint it will still remain in the low 30%'s.

Gabriel Leung, Paradigm Capital.

First, on the partner revenue contributions you talked about Open Text doubling that on a year-on-year basis. Was that mostly driven by your three key partnerships?

That's correct.

Can you talk a little bit about where your three partners are in terms of getting their sales force up and running and marketing the integrated message?

On the SAP, we have been doing this particularly in North America for this past year. We're now looking at expanding that to Europe. With Oracle they have done a significant amount of training already and have a dedicated team for that. And then with Microsoft we have been doing more joint selling, and this past quarter has picked up significantly again, mainly in North America.

Secondly, on the issues around the expected 20% revenue falloff from Hummingbird, can you talk about during Q2 whether or not you experienced any of that falloff?

Not as much as we would -- basically, we see the falloff in territories that we don't really see direct sales. So Asia-Pac, Middle East, Russia, et cetera, southern Europe, where we will not be as present in a direct sales force. So we believe we will see that fall off in the coming quarters.

But you did experience some falloff, but you just expected more of it to show up over the course of the next little while?

Yes, we saw some in this quarter.

Lastly, just helping me understand the maintenance, deferred maintenance write-off, there's $8 million more to be written off over the course of the next three quarters, it sounds like. So how should I be looking for this on a go-forward basis, then? In Q2 you reported $78 million in reported maintenance. All else being equal, if you had 100% maintenance renewal, should I look for that to drop by -- $8 million divided by three, say $2 million, so $76 million in revenues? Is that what I should be seeing?

Well, the effect for this quarter will be $5 million. So if we didn't have the purchase accounting and adjustment, it would have been $5 million higher, $5.1 million higher. In future quarters it comes in a declining balance, so you could look to have about $3 million to $4 million next quarter and $2 million to $3 million the following, and the remainder primarily in the last, in the fourth quarter.

Once the year runs out, we should see a healthy boost on the maintenance line just because this issue is gone now; right?

That's correct.

Blair Abernethy, Clarus Securities.

I'm just wondering if you can give us a little more detail on the larger deals, the deals over $500,000 and the $1 million deal, just in terms of verticals and what types of solutions were involved with these deals?

Right. On the deals -- I said a number of them were in this midmarket that we're seeing where we're selling an enterprise-wide solution, and it is typically a full suite of products. So it's not just one particular solution; it is looking at a whole suite of solutions. Most of them, the work that we're seeing is being driven by records management, so it has got something to do with compliance being driven, e-mail archiving, records management, document management, et cetera.

In terms of your progress in solution sales overall, can you just give us an update there and where you're getting the best traction?

Yes. The best traction is in areas like contract management, case management but also in the -- from the Hummingbird side, in the LegalKEY for the legal applications that they have, we're seeing nice traction there as well.

Paul, do you have headcount by function?

I do, generally. If I can just get back to you? I thought I had that handy, but I don't have it handy.

Can you just sort of walk through again the services margin issue, what's -- I'd missed that at the beginning of the call, and I just want to understand better what's going on there. What sort of corrective action were you doing to drive those margins higher?

What I was indicating -- John will speak to the actions going forward. But this quarter, clearly, we had not sort of [released] the restructured -- the number of PS individuals, professional service individuals, that will likely be the case at the end of the year, as we're continuing to work on accounts. But obviously, some of these were not as profitable as we had seen in previous quarters at the Company.

So basically, they did not run their professional services to be particularly a moneymaking or a breakeven organization; they were doing a lot of work, possibly fixed bids or free work, if you will. So one of the issues is -- as well as they might be in projects -- that it is taking us -- we can't just pull people immediately out of those projects. But we will be looking at their rates; we will be looking at the way -- we won't be doing any fixed bids as well as -- so, over time, we will bring their business practices to the same as ours to get those margins, I would say, to the low 20's as quickly as possible.

What kind of impact is that going to have on the average Hummingbird customer that has kind of been used to this? Are you going to see a falloff in revenue there as a result?

As a consulting group -- they have not generated a lot of revenues in PS, anyway. It's almost been that PS has played a role that -- while we have a pre-sales organization that does a lot of technical support and hand-holding for our customers. It's almost has been that their professional services have been doing that kind of thing. So I think, as a much larger organization, we can still provide the customers with the kind of technical support that they need. But we will certainly, going forward also with the customers, have them realize that we don't give away free consulting. So I would imagine that there will be some loss of revenue. But it will become profitable.

How many quarters do you think it's going to take for this to work through?

I think we'll certainly have our arms around it by the end of this quarter. It will probably take another quarter after that to completely clean up. As I said, given the organization -- it wasn't a large organization.

Just on your headcount question, so all sales and services were about 1750 people, development 750, G&A about 420.

Sorry? 750 in R&D?

750 in R&D, yes.

Scott Penner, TD Newcrest.

John, you presumably now have the position of kind of a go-to partner in this industry. You kind of called that out at the last investor and analyst day. Can you give us any anecdotal reports that that is happening?

Sorry; you broke up in the beginning. Could you just repeat that?

You mentioned that now, as the largest and kind of de facto ECM player that you have become a go-to partner for a lot of SI's. Can you just give us some of anecdotes that that is happening?

Yes. We are doing a lot more work with Accenture than we have, ever before. Also in Europe we have seen a lot of work with BearingPoint and where they are talking with us in accounts much earlier in the lifecycle of the accounts than we had before. We've probably seen two or three fairly significant deals this past quarter with the SI's.

Have you seen renegades from FileNet and what have you come over and really signed up with you guys?

From a partner standpoint?

Right.

Yes, yes.

I just wanted to talk again about the seasonality. You reminded us about the seasonality, presumably, that the March quarter is a little weaker. You mentioned that on a previous question. But just to be clear, that typical 8% to 9% is going to be magnified as you continue to kind of pair off on profitable revenue.

That's correct. We think it will be -- if you look over the past two years, it has been in that 5% to 8% range.

Okay, but you said that you are still getting out of -- you are still basically getting up to that 20% attrition of the Hummingbird revenue. So presumably, that's going to be higher this year?

That's correct.

When do you think you will have reached that kind of baseline revenue level that you're talking about?

Our goal would be to have done it, certainly, as we go into the new fiscal year, but I would think most of it would be this quarter.

What is the basis that we should use to, then, compare you to that 20% number? We have the June quarter for Hummingbird. Are you referring basically to the annualized Q4 numbers that we don't have?

I can take a look at previous combined Q2. Hummingbird ran fairly flat quarter over quarter.

Okay, no, I'm just talking about that 20% attrition number from the Hummingbird revenue. What is the basis for comparing you to that 20% number? Is it the --?

It would be the June quarters.

Paul Lechem, CIBC World Markets.

I just wanted to try and understand the sales outlook a little bit over the next few quarters because, just revisiting some of the questions that have been asked, clearly, you have laid off a lot of your sales headcounts over the last quarter -- by my calculation almost 40% of your combined sales reps. Plus you're closing down direct sales in a number of direct territories and moving those to partners.

I just don't understand, how are you going to avoid a lot of the turmoil that we saw with the IXOS acquisition on the sales front over the next two, three quarters? Who is actually going to be doing the sales, given you have actually made a lot of cuts on the sales force?

If you look at the cuts, it is cuts that are in the ECM space, where we obviously already have a strong sales force in the ECM space, as well as sales managers.

I'm not sure what you're referring to, the turmoil for IXOS, but IXOS selling into an SAP market is a very different sales force. So the other, obviously, thing that we have is a customer care program, where we are working closely with the Hummingbird customers, not only with our sales force but with our professional services, which is a very large group compared to what Hummingbird had, as well as with our customer support organization. So we have a large organization touching the Hummingbird customers on a regular basis.

Can you talk a little bit about what you're doing with the sales pipeline, how you're actually going down through the various sales opportunities to make sure that some of the volatility we saw following the IXOS acquisition might not recur this time?

So two things. One is they are on salesforce.com, same as ours as well as if you look at the different groups, people like RedDot, Connectivity -- if you look at the different regions, they fit fairly closely into our group. So this is not IXOS, which is a very different organization selling into a different company. These are very similar sales folks selling similar to our customers, maybe in smaller accounts. But this is very similar business to what our sales force is doing all the time.

Just in terms of the Hummingbird sales forecast or pipeline that you got when you acquired the company, can you describe what has happened in terms of your scrubbing that pipeline? Have you made major changes, or is pretty much as it was when you got it?

I would say that particularly in the ECM space, where, as you know, Hummingbird was basically up for sale probably six months before we acquired them, and so the sales force, I would say, to put it mildly, were distracted and their pipeline wasn't particularly strong.

Ed Maguire, Merrill Lynch.

This is actually Garrett Becker for Ed. Maybe, perhaps, you could talk a little bit about the cross selling. You mentioned earlier that you are focused on that. Maybe you could give us a little color and also maybe quantify that?

We have had a number of quick successes of selling the RedDot/WCM product into the Open Text accounts, particularly in North America, as well as we have looked at some add-on of the LegalKEY products into our major corporate accounts, again, in North America.

Any chance you could give us what the Hummingbird deferred balance was at the end of September? I may have missed that.

Deferred maintenance?

Yes.

I think it was around $60 million; I'd have to check it out. 60, 6-0.

6-0?

Yes.

We believe that's correct. We'll get back to you; we'll get back to Ed for you.

I wonder if you could talk a little bit about government. You mentioned that was pretty strong. We've seen some companies in other sectors have a little bit of troubles in the US, at least, with the continuing resolution and some of the budgetary changes going on there. I wonder if you could maybe talk a little bit about what you're seeing?

I believe some of the companies that had problems with the government were more in the state and local rather than the federal. For, certainly, the last two quarters we have not had a problem with the federal; in fact, it has been very strong. We are also seeing strong in UK and Australia for government.

Garrett, sorry, the specific number is 57, the deferred maintenance.

Sorry, Garrett's line is now closed. Your last question will come from David Wright of BMO Capital Markets.

When I look at the cost for Hummingbird, the number is a little higher than I expected. Is there anything you can comment there about why the number is as high as it is?

I'm sorry; could you clarify what you mean, cost for Hummingbird?

Yes. So the purchase price of Hummingbird is $384 million plus you have got another $18 million of acquisition costs. But what I had planned on was a number $50 million to $70 million lower.

The actual purchase price was around $500 million.

Yes, okay. (multiple speakers) So that's probably too detailed a question to go over on a call like this. I appreciate that, and I have netted things out. It's just that I'm surprised the number is where it is.

Sorry, David; maybe you can ask the question again, because I can probably answer it. But from the total purchase price of $500 million, I'm sorry, the question was --?

Well, the number that is netted out against your assets is $385 million, roughly, plus the acquisition costs of about $18 million. But when I had done the accounting from my standpoint I thought that number would be lower. So maybe I'll follow up with you afterwards to discuss why it is what it is. I just thought, if I asked, you might say, oh, yes, that's because of -- some, I don't know. Some extra charge or something. I'll leave it as it is. Thanks very much; I'll talk to you afterwards.

Thank you for your questions, everyone. Just to wrap up on the quarter's highlights, we met our goals; we had -- very happy with the strong cash flow from operations at $31.4 million. The Hummingbird integration is accretive and tracking to plan, and our partnership program with SAP, Oracle and Microsoft, particularly, is progressing well. For the remainder of the fiscal year we will continue to focus on the bottom line, and I believe we can do even better in the quarters to come.

That concludes our call for today. Thank you for your participation and questions.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your lines.