Open Text Corp (OTEX) 2008 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Open Text Q2 fiscal 2008 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. Instructions will be provided at that time for you to queue up for questions. (OPERATOR INSTRUCTIONS). I would like to remind everyone that this conference call is being recorded today, Thursday, February 7, 2008 at 5:00 p.m. Eastern time.

I would now like to turn the conference over to Mr. Greg Secord. One moment, please.

Thank you for joining us. Today we will be discussing our financial results for the second quarter of fiscal 2008 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 future performance of Open Text and its subsidiaries. These oral statements contain forward-looking information and 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 the 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, 2007 and in our press release that was issued earlier today.

I will turn the call over to John Shackleton.

Thank you, Greg. Good afternoon, everybody, and thank you for joining us. Today we're going to talk about our strong Q2 results which provide the first true year-over-year comparison since we acquired Hummingbird. We'll also update you on our partner strategy, discuss some significant customer wins, and review some of the highlights for the quarter. First, I'll hand the call to Paul for a detailed review of our Q2 results.

Thank you, John. Turning to the financial results for our second quarter of fiscal 2008. Total revenue for the quarter was $182.5 million, up 12% from $163.3 million in the same period last year, and up 11% from $164 million in our last quarter. License revenue for the quarter was $55.2 million, up 7% compared to the $51.4 million we reported last year, and up 25% compared to the $44.3 million in our last quarter.

Maintenance revenue for the quarter was $90.6 million, up 16% compared to $78 million last year, and up 5% from $86.3 million as reported last quarter. Professional services revenue in the quarter was $36.8 million, up 9% compared to $33.8 million last year, and up 10% from $33.4 million compared to last quarter.

We reported second quarter adjusted net income of $26.2 million or $0.50 per share on a diluted basis, up 46% compared to $18 million or $0.35 per share for the same period a year ago, and up 19% from $22.1 million or $0.43 per share last quarter.

Gross margin for the second quarter before amortization of acquired technology was 73% compared to 72% in the second quarter of fiscal '07. Professional services margins have improved to 18% compared to 14% in the second quarter of '07, reflecting the trailing off from profitable Hummingbird services contracts.

The pre-tax adjusted operating margin before interest expense was 24.7% in the second quarter, up from 20.7% last year and 24.1% last quarter.

With respect to our adjusted earnings, the overall tax rate for the quarter is 30%. Actual cash taxes payable continue to be in the 15% to 20% range. Net income for the second quarter in accordance with GAAP was $10.7 million or $0.20 per share compared to a net income of $2.3 million or $0.04 per share the same period a year ago, and up 37% from $7.8 million or $0.15 per share last quarter. The fully diluted share count for the quarter was approximately 52.7 million shares.

As of December 31, 2007, deferred revenue was $138 million compared to $147 million as of June 30, 2007. Accounts Receivable as of December 31 was $121 million compared to $129 million on June 30. Day sales outstanding was 60 days as of December 31, 2007 compared to 64 days for the previous quarter and 63 days for Q2 last year.

In the quarter, we did not purchase any shares under a share buyback program. We did make the $30 million accelerated debt repayment we previously announced on a term loan. The term loan balance of December 31, '07 is $296 million, which we reduced from $390 million a year ago. The mandatory repayments of $4 million and accelerated payments of $90 million.

As I mentioned over the past few quarters as part of purchase price accounting for Hummingbird, the deferred revenue liability acquired is subject to an adjustment, which will reduce the opening value to deferred revenue. This is a balance sheet entry that does not impact cash flow but does impact top line revenue. The impact this quarter was $300,000. This was the final quarter for this adjustment.

Two quarters ago, we updated our pre-tax adjusted operating margin model. We remain confident in our plans to manage expenses in the 14% to 16% range for development; 24% to 26% range for sales and marketing; 9% to 10% for G&A; and 2% for depreciation. This will generate a pre-tax adjusted operating margin of 20% to 25%. As previously indicated, we expect to continue in the upper end of that range. A copy of this updated business model is available on our website as part of the Investor PowerPoint presentation.

I would also like to comment on the foreign exchange movements that have occurred over the past few months. Due to our global operations mix, the Company has maintained somewhat of a natural currency hedge. As a result, the net impact due to foreign currency movements was close to 0 for the quarter and less than $0.01 EPS for the year-to-date results.

Over the next few months, Open Text will be participating in several investor conferences including the Credit Suisse Software Conference in Boston, and the Bear, Stearns Technology and Communication Conference in New York. Details of these and other investor events are available on the Investor Relations sections of our website.

Now I'll turn the call back to John.

Thank you, Paul. As I mentioned, we're very pleased with our Q2 results. Our efforts over the past year to integrate Hummingbird products, build a combined sales force and realize cost synergies have met or exceeded our expectations.

As Paul mentioned, revenue in the quarter was $182.5 million. Europe was responsible for 48% of revenues; North America was 46%, and the remaining 6% was from Asia-Pac. We saw particular strength in Europe but we're also happy with our sales performance in all regions and all verticals.

We generated $55.2 million in license revenue, growing 7% year-over-year. Of this license revenue, 37% came from new customers and 63% from our installed base. We had eight transactions over $500,000 and an additional five transactions over $1 million. The average transaction size was approximately $240,000, consistent with prior quarters.

In Q2, we saw license revenue broken down by vertical as 18% for high-tech manufacturing; 9% for government; 13% for financial services; 9% for pharmaceutical and life sciences; 15% for energy; and 8% for transportation. Examples of significant wins in the quarter are the Insurance Corporation of British Columbia, who purchased Livelink ECM for its advance workflow and SharePoint integration. ICBC purchased Livelink ECM to improve business processes, to ensure ongoing appliance with the Freedom of Information and Protection of Privacy Act and other legal and regulatory requirements.

Bruce Nuclear purchased Open Text solutions to assist in day-to-day power plant operations as well as meet their content security needs. By applying our DoD certification records management to all unstructured content, Open Text is able to apply life cycle management to everything from emails to CAT drawings from the shop floor.

UK-based Taylor Woodrow Construction selected Open Text affinity partner, Causeway Technologies, to deliver Livelink ECM document management, email management, and business process management capabilities to be their corporate platform for all unstructured information.

Macys.com selected Artesia DAM from Open Text Digital Media Group to improve the manageability of production photography and creative asset processes, and allows macys.com to manage the creative workflow in support of both macys.com and bloomingdales.com.

From a sales operation standpoint, we closed the quarter with a combined sales force of approximately 250 quota-carrying sales execs. Given the strong market, we will continue to invest in our sales and marketing efforts, adding salespeople to support our growth targets as our pipelines expand. License revenue from partners for the quarter was approximately 34%, and several of our biggest transactions were partner-influenced.

SAP, Accenture, Oracle and Microsoft all continue to report increasing partner demand for solutions in archiving, records management, and appliance. And we continue to target a goal of 40% partner-influenced license revenue mix in the coming 15 months.

Our joint selling efforts with the SAP sales force continues to expand our presence in existing SAP customers. This is a significant strategy for us in FY '08 as we enter new markets with SAP, as they resell Open Text branded archiving and document access products.

On the product front, in the quarter we announced our commitment to deliver solutions that meet Europe's new records management and software standards, [Morec II], which begins testing and certification this year. We have also updated the Hummingbird products and are now focusing on upgrading that customer base to the more robust DMX platform, which allows Hummingbird customers to access other Open Text products and functionalities, such as enhanced workflow.

As for our ECM market positioning, we're pleased to announce that in the quarter the industry analysts from Forrester named Open Text a leader in the Forrester Wave Enterprise Content Management suite, citing the strength of our core ECM functionality and breadth of ECM offerings. We said last quarter that ECM licenses should grow in the 8% to 13% range on an annual basis, and we are comfortable with this growth estimate. I am very confident in our pipeline going forward for the rest of the fiscal year.

Finally, I want to make a quick comment on our overall revenue seasonality for Q3. This has historically been flat, slightly down from our December quarter. While this is not meant to be a quarterly guidance, we expect this historical seasonality to be directionally correct.

Now I would like to open up the call for questions.

(OPERATOR INSTRUCTIONS). Tom Liston, Versant Partners.

Just on a same topic, John, given the Q1 to Q2 was up seasonally about 25% and the typical range is 10% to 15%, was there anything a bit abnormal where you might have had some deals or that came in ahead of time that suggest that the Q3 to Q3 might be maybe down perhaps a little bit more?

Not really, Tom. No, it's pretty much in line with what we thought it would be.

Was there a few highlights you could give us on the license revenue, why that was above the range that's typically seen from Q1 to Q2?

For Q2, we've had more large deals than normal for the past couple of years. And interestingly, it was across industries and across geographies. So, for example, we had about $4 million-plus deals in high-tech manufacturing, a couple in pharma, a couple in oil and gas, a couple in government, and as well as they were from Switzerland, Japan, Australia, and North America. So, a good geographic mix as well as good sector mix.

Okay. And Paul, just on the target margin model. When you said you expected to be at the other end of the range, was that on the operating margin? Because if we look through the Q2 quarter, the cost side of the equation, you're at the very low end or even below those ranges. Do you expect that to continue? Or do you see some investment in the second half?

No, I think we're expecting a fairly consistent model, to where you've seen it for six months. So you're correct; we're at the lower end of the range. And so I'm talking about the operating margin, as we have in the past, being at the upper end of that range that we've posted.

And, Tom, we will continue to invest in the sales force, growing that force.

Okay. And Paul, Q3's -- cash flow in Q2 was quite good but Q3's, again, typically the strongest with maintenance renewals and that's consistent when you enter Hummingbird into the fold?

Yes, that will be a consistent pattern.

Okay. And your maintenance renewals now as a blended corporate entity?

Yes. Still remains in the low 90% range.

Great. Okay, thanks. I'll pass (multiple speakers) --

We've been very happy, Tom, that that has been continuing.

Yes. Okay, great. Thanks. I'll pass the line.

Paul Steep, Scotia Capital.

Great. John, I guess the first one would be for you. You mentioned about the DMX upgrade cycle. Obviously, it's pretty early days, but maybe you can give us a little bit of feedback as to what you have seen there so far. And then I've got a quick follow-up for Paul.

Right. So we did begin releasing the product in November/December timeframe. And we have certainly seen some uptake, particularly in January/February, so this month. So we've been very positive regarding the renewal rates of customers on maintenance, but also the interest around upgrading to DMX.

Okay. And then maybe, I guess next quarter hopefully will be the time where we can maybe get some data since it's pretty early, but you'll have a sense at that point of how much of the base will have started to maybe move or contemplated it.

I think over the next two quarters we'll have a good sense of that, yes.

Quick follow-ups for Paul. First off, on the free cash usage. It looks like the cash continues to build at a great pace here. You didn't say anything about the debt repayment this time.

Yes, we're -- at this time, we're fairly comfortable with the debt position on our balance sheet, Paul. We're less than 2-to-1 now [at] EBITDA. And with the spreads increasing in the marketplace, we think the all-in rate is pretty effective. But we remain -- we repeat our three potential uses -- debt repayment, which we're not announcing at this point for this quarter, and of course, share repurchase and/or at this point, tuck-in acquisitions are other options for free cash flow.

Okay. Fair enough. Last quick one was just other income, since there wasn't any note there, it sort of popped up out of nowhere. Was there anything unusual there to read into it going forward? Or not?

No. No, there's no -- the majority of what happens in there is really FX affected.

That's what I thought. Okay, thanks.

Richard Tse, National Bank Financial.

John, just wanted to get a bit more color on the status of the partnerships. Could you, I guess, address SAP, Oracle or Microsoft individually in terms of what stage you're at in those partnerships? We're fairly early; when do you expect those to hit sort of a point of critical mass here?

Right. Obviously, the SAP one is the furthest along. Both of us have been extremely pleased with the results we've seen over the past couple of quarters and are looking at expanding that relationship.

Also with Microsoft, we have had some strong, particularly in North America, but also looking to expand that relationship further. And then also some of the large deals with Oracle; we've also seen that. So I would say the SAP is the furthest along. Microsoft is coming nicely. And we're going to be focusing more with Oracle to make sure that that's moving in the right direction.

Okay. And with respect to sort of the broad economy and all the undertones out there, you're sort of signaling here that things haven't really changed for you dramatically. In fact, you're sort of holding the course on your annual growth here. Has there been any resistance at all to any of your products from the point of view that the economy seems to be slowing down here a bit?

Seeing, looking at the pipeline certainly for the next two quarters out seems very healthy. In addition, as you may have seen, financial services is growing and we believe because of the user, for compliance issues, buying our software.

Okay. And then one final question. With respect to your sales force, where do you see that to be the optimal level at this point? Is 250 it? Or do you --?

I would like to -- based on what we see in the pipeline, we will cautiously look at increasing that sales force. For example, we have built a telesales group in Waterloo over the last few months. And that is now coming up to speed nicely and I think we will increase that. But I also see Europe, that we will probably increase our sales force in Europe as well.

(OPERATOR INSTRUCTIONS). Lawrence Rhee, Blackmont Capital.

Could you provides some color on the percentage bump, I guess, that you would receive on the maintenance revenue line there, Paul? Because of the accounting treatment for maintenance revenue back when the acquisition of Hummingbird occurred?

Sure. A year-ago, comparative quarter, that was an adjustment downward in the maintenance of $5.1 million, and this quarter, downward adjustment of $3 million. So the net will be 4.8, Lawrence.

Okay. That's great. And with respect to the competitive environment, has anything changed there? Are you hearing more? Obviously, the broad group generally did reasonably well for the December quarter. Is there anything you can comment from the competitive environment?

We're seeing -- it would appear to be some disarray with our main large competitors, particularly in Europe, where there seems a lot of turmoil and change going on within both of those -- the competitors. And a little bit here in the U.S. So we are seeing our win ratio is increasing.

Okay. That's great. Thanks, guys.

Scott Penner, TD Newcrest.

Thanks. John, last quarter, you talked a little bit about the possible tuck-in acquisitions, just some expertise on the SAP side and other solutions oriented. Is that still kind of what you're looking at? And are you any further along with doing something versus three months ago?

That's correct. And yes, we're further along.

Okay. And then on the partner side, just to follow along on Richard's question. Obviously, Accenture is a little bit different with how they approach the market. How would you characterize kind of where they are on the continuum there?

Probably they've come along this past year faster than what we had anticipated. And we're seeing some very strategic, large deals that we're optioned to that we're working together with them. And I've been very pleased with the progress we've made with Accenture.

Okay. And then Paul, just a quick question. The interest expense line didn't take down too much relative to what I would have expected after the debt repayments recently. Is there any other items in there? Or is that just pure?

Just -- Scott, just for clarification, we do have a little bit higher rate all-in because we had a fixed part, half of the debt was fixed, as you know, on a swap arrangement per the loan agreement. So that maintains a little higher rate than markets right now.

And just a quick reference to our notes in our financial statements, we talk about the costing of our hedge, which is a non-cash item. And you can reference there, and if you put that together, I think you'll be able to adjust your model to the interest rate that we're showing.

Paul Treiber, RBC Capital Markets.

Hi. This is Paul Treiber on behalf of Mike Abramsky. Could you provide FX impact to revenue in the constant currency growth in the quarter?

What we report on is our net effect. We don't report our gross for revenues and expenses. And so, as I said earlier, that our net effect on the EPS for FX was 0 this quarter; less than $0.01 EPS year-to-date.

Okay. And then how sustainable do you see that that 12% year-over-year organic growth going forward? And then how do you see your organic growth comparing against peers?

So, as we said, the market is -- they're looking at anywhere between 8% to 13%. I believe we can sustain and that's -- many of the analysts talked this through -- to 2011. I think it will go up, so it will be on the top of that range, more in the 11%, 12%, 13% range. And we feel very comfortable keeping pace with the market.

Blair Abernethy, Thomas Weisel Partners.

Just, Paul, I wanted to clarify, on the large deals, you said the deals north of $500,000, how many deals were those?

Of north of $500,000 were eight. And then an additional five over $1 million.

Okay. So, separate from the eight, an additional five.

Right. And what we say that's -- we're talking license amounts there. So licensed revenues were over $1 million or over $500,000. If you looked at PS and maintenance and others, they would be more.

John, were there any deals over $2 million?

Not this quarter.

Okay. And can you talk a little bit of these deals north of -- all these deals north of $500,000. What sort of solutions are getting the most traction out there in the big deal segment?

A lot of it is still email archiving, records management, looking at compliance, C-Discovery, those kind of things. And it really is across the verticals. It's financial services we're seeing growing, but it's also in high-tech manufacturing, et cetera. It's compliance that's driving the big deals.

Compliance. And how about the traditional Hummingbird legal vertical, how has that been performing for you?

It's doing okay. In fact, we have new products released this week. There is a big legal show in New York, as we speak. And we've released a couple of new products on that. And it's managing steadily. It's a smaller niche than what we're used to, but everybody -- it seems to be going well.

Steven Li, Raymond James.

Paul, just a quick one. Regarding the financial expense, the non-cash impact from the hedges in place you talk about, is that added back in your adjusted EPS calculation? Thanks.

No. Our -- just EPS we're doing is, as we state clearly, before interest. So that affect is in the interest line. So it's not in the adjusted. And it's a non-cash, just to clarify, that's a non-cash charge.

Paul Lechem, CIBC World Markets.

John, you've been talking about the email archiving, records management driver to your business for some time now. And it keeps on surprising me that it's still such a driver. How much more is there in that to play out before it starts to become saturated?

There is a tremendous amount, Paul. It never ceases to amaze me that very large, very sophisticated companies are still not addressing this issue. And so we see a long way to go in this market.

So we're talking still years to play out here?

I believe so, yes. Yes. Because a lot of it is while many customers or companies have some kind of storage technology, they don't have records management where they can easily access and recover that information. And that's where, when, if they have issues with compliance or government regulations, they need to have that to be able to find the materials in a timely fashion.

I guess that's what surprises me, if it is such a regulatory issue or a governments-driven issue or legal issue, that it might not happen faster and then the cycle is over. I mean, it just seems that we should be getting close to the end of this.

It's -- the other piece that I think is slowing down also is it impacts every piece of an organization. So that while you have to start looking at retention of records normally driven by legal counsel or the legal department, it impacts every function within an organization. And that takes time to agree upon the processes and business rules that are around them.

I see. Can you also now talk about the up grades? You spoke a little bit about DMX and you're starting to see that -- that [uptake] up there. You've also released a new version of Livelink. Can you talk about how long are these upgrade cycles going to play out? When should we start to see them really hit their stride and what should we expect out of that in terms of your license growth?

There is major focus on the Hummingbird side where many of their customers were looking at a costly and timely migration. What we've done this past year is pretty much pulled back the product, simplified the whole processes and to make it a simpler upgrade. And that's what we're now working with, particularly the large customers who are willing to move to get that extra functionality. And I think it will take a good year. We have a program in place to drive that. So, we have seen already some take-up. But I would see probably not so much next quarter but the quarter after is when we'll see that.

On the Open Text side, where we've -- providing closer interfaces to Microsoft and to SAP but also giving greater functionality and a totally integrated suite, and so we're beginning to see some of our large customers begin to look at that. And again, I think certainly looking at early next year, we will see uptake on that. Between the two (multiple speakers) --

Sorry. Are you saying that early next fiscal year or the next calendar year?

Early next fiscal year. So looking at the July/October timeframe. And we think between those two customer bases, we can sustain -- you know, look at the growth that the market is saying.

So, a good part of your 8% to 13% growth, you're expecting it to be driven around the product cycle?

Yes.

And getting the benefit of foreign exchange? Any foreign exchange lift?

The foreign exchange really is -- what we're seeing is neutral.

For the bottom line -- but I am assuming that it's helping you on the top line at this point in time?

When we look at the 8% to 13% growth, we'd be looking at FX neutral.

Okay. My last question is on the sales additions you're talking about. You've always talked about a 30% excess capacity in your sales organization so it surprises me a little bit that you want to be adding to sales at this point in time. Are you trying to look ahead at this point? Like why now are you adding salespeople?

The issue is -- good question -- what we're seeing is, is that, for example, as I mentioned, telesales in Waterloo, we're seeing it as a very efficient, lower cost way to service and support our customer base in helping them upgrade products. And so we can increase the sales force capacity much faster in these areas. So we're looking at doing that. And also there's certain places within Europe we're seeing significant growth and so -- as well as in the partner program, we need to provide salespeople and sales support to help our partners in areas that we're not in today.

So should we expect then you're going to be adding commensurate with your revenue growth, so really we're not going to see a huge increase in your margins on the sales fund?

So there shouldn't be -- what we'll do is we'll do this in phase. So as we get ahead of the curve, there should not be any additional -- significant additional costs in growing the sales force. So we should still be in the range that we've -- that Paul has discussed.

Yes, Paul, we're actually below that range, the lower end of that range right now. So if we invest there, we'll still be at the low end of the range.

Scott Penner, TD Newcrest.

Sorry, just a couple of things. The $5 million deals. Were they all driven by partners?

No, it was a mix, probably three by partner driver -- or influenced and driven by partners. And a couple were from the direct sales force.

Okay. And then in the past you -- and then, Paul, you touched on it -- the problem services businesses or service contracts at Hummingbird. Have those pretty much run their course?

Yes, for the most part. There's just maybe a few in the tail end, but we shouldn't see the impact it's had in the past.

And I think you will see the PS margins improving going forward.

Okay. And the 20% mark is still the kind of internal target?

Right.

Gabriel Leung, Paradigm Capital.

John, just wondering how things are going in the connectivity business. If I remember correctly, that side of the business is sensitive to hiring patterns. Just wondering if you were seeing any softness there, just given what's going on in the macroenvironment?

On the connectivity, it's gone pretty much to plan. In fact, Q2 was a very solid quarter. And as we'd mentioned before, we do see cross-sell opportunities into that base of other products. So, no, it's going well to plan.

Okay, great. And Paul, just a question on the R&D expense; had a bit of a sequential uptick. So, $26 million in the quarter, is that sort of the run rate you're looking for on a go-forward basis?

Yes, and again, Gabriel, as I mentioned, we don't -- it's in the low end of the range as a percentage. So I don't see it climbing up much over the 14%. Maybe, you know, some small -- call it absolute dollar fluctuations, but I think as our business grows, it will stay in the 14% range.

Okay. And sorry, I missed the quota-carrying rep headcount. What was that number this quarter?

It's around 250; same as it was last quarter.

Steven Li, Raymond James.

Just one little question. John, some of your operations of Hummingbird that you closed last year, can you quantify how much license revenues they would have represented, approximately?

If you remember when we talked about it, I believe that the licenses would decrease somewhere between 20% and 30%. And if you, say, took 25%, I think that's fairly reasonable. And part of it's obviously, as we said, was we held back a product, we haven't been selling the product until we've made it simpler for our customers to use. Now we should be able to stop building that back.

Oh, so, the whole of the 20% to 27% license decline was because of geographic regions that you had closed down?

It was a bit of both. So both geographic regions that we closed down, like southern Europe and Eastern Europe et cetera, but also because we intentionally stopped selling the product in North America and Northern European until we had fixed some of the issues and usability issues. And now that has been done.

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

Thank you, everybody, for coming on today's call. And just in summary, I'd like to wrap up. Again, we're very pleased with our performance for Q2. I'm positive on the outlook for the rest of the fiscal 2008. We have met or exceeded our expectations for revenue and profits while generating strong cash flow from operations. Our partner program is proving effective strategy. And we will continue to focus on growing our sales organization while concentrating on meeting our bottom-line objectives.

This concludes our call for today. Thank you for participating and your questions.

Ladies and gentlemen, this concludes our conference call for today. Thank you for participating. You may now disconnect your line.