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Open Text Corporation (NASDAQ:OTEX)

F2Q09 Earnings Call

January 28, 2009 5:00 pm ET

Executives

Greg Secord - Vice President, Investor Relations

John Shackleton – President, Chief Executive Officer

Paul J. McFeeters – Chief Financial Officer

Analysts

Mike Abramsky - RBC Capital Markets

Scott Penner - TD Newcrest

Tom Liston - Versant Partners

Paul Steep - Scotia Capital

Richard Tse - National Bank Financial

Blair Abernethy - Thomas Weisel Partners

Dushan Batrovic - Canaccord Adams

Lawrence Rhee - Blackmont Capital

Barbara Coffey - Kaufman Bros

Steven Li - Raymond James

Ralph Garcea - Haywood Securities

Gabriel Leung - Paradigm Capital

Mark Schappel - The Benchmark Company

Operator

Good afternoon, ladies and gentlemen. Welcome to the Open Text financial results for the second quarter of fiscal year 2009 conference call. (Operator Instructions) I would now like to turn the call over to Greg Secord, Vice President-Investor Relations. Please go ahead, sir.

Greg Secord

Thank you. Good afternoon, everybody. We’ll move ahead with the call. First, I am going to read our disclaimer.

During the course of this conference call, we may make projections or other future statements relating to the future performance of Open Text or its subsidiaries. These oral statements may contain forward-looking information and actual results could differ materially from the conclusions, forecasts or projections in the forward-looking information. Certain material factors or assumptions are implied or drawn as a conclusion while 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 conclusions, forecasts or projections in the forward-looking information and the material factors or assumptions that were implied 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, 2008 and of course, our press release that was issued today.

With that, I will turn the call over to Paul McFeeters, our Chief Financial Officer. Paul?

Paul J. McFeeters

Thank you, Greg.

Turning to the financial results for our second quarter in fiscal 2009, total revenue for the quarter was $207.7 million, up 14% compared to $182.5 million for the same period last year. In Q2, North America was responsible for 50% of our overall revenue, Europe, 25% and the remaining 5% coming from the rest of the world.

License revenue for the quarter was $64.9 million, up 18% compared to $55.2 million that we reported last year. Maintenance revenue for the quarter was $100.4 million, up 11% compared to $90.6 million last year. Professional services revenue in the quarter was $42.4 million, up 15% compared to $36.8 million in the same period last year.

We reported second quarter adjusted net income of $34 million or $0.64 per share on a diluted basis, up 30% compared to $26.2 million or $0.50 per share on a diluted basis for the same period a year ago.

Gross margins for the second quarter before amortization of acquired technology was 73.7% compared to 73.1% in the second quarter of last year. Customer support gross margin was 82.7% in Q2 FY09 compared to 84.3% in Q2 of the prior year. Professional services margin was 24.7% compared to 17.8% last year. The increase in professional services margins was comparable to federalization rates and the grouping of higher margins and higher revenues in this category.

Pre-tax adjusted operating margin before interest expense was 25.9% in the second quarter, compared to 24.7% last year. With respect to our adjusted earnings, the tax rate for the quarter is 30%. Actual cash taxes payable continued to be in the 15%-20% range.

Net income for the second quarter in accordance with GAAP was $0.8 million or $0.01 per share on a diluted basis compared to $10.7 million or $0.20 per share on a diluted basis in the same period a year ago. The fully diluted share count for the quarter was 53.2 million shares.

As of December 31, 2008, deferred revenue was $177 million compared to $180 million as of June 30, 2008. Accounts receivable as of December 31, 2008 was $127 million compared to $134 million as of June 30 of last year. Days sales outstanding was 53 days as of December 31 compared to 60 days as of June 30, 2008.

Operating cash flow in the quarter was $39.8 million compared to $39.3 million in the same period last year. The current year-over-year comparison is negatively affected by restructuring charges and timing differences in working capital.

Term loan balance as of December 31 was $219.5 million reduced from $399 million in October 2006 with scheduled repayments of $7.5 million and accelerated payments of $99 million.

Again this quarter, we have entered a chart in the press release to provide more visibility into the effective foreign exchange in our operations. It shows a percentage of revenues and expenses in U.S. and other major currencies. The net effect on operations due to EfEx was a positive $0.02 per share.

During the quarter, we acquired the remaining 3.6% of minority shares in IXOS for $12.4 million. On October 31, we used approximately $101 million of cash, net of cash acquired to purchase the shares of Captaris. We did not buy back any shares in the quarter. We will not be breaking out the financial effect from the Captaris acquisition in this quarter. It was accretive to the result in the quarter. We in fact will have the Captaris business on our operating model by the end of our fiscal year.

Last quarter, we stated that we will reduce worldwide employment by approximately 10% starting from a post-acquisition combined workforce of 3,600 reducing to 3,200. In addition, we will continue to rationalize facilities in both Open Text and Captaris. We also stated that Open Text’s restructuring charge would be approximately $20 million and this charge will be recorded in our statements of income. The breakdown of the charge is $11 million for workforce and $9 million for facilities. This quarter, we took a restructuring charge of $11.4 million but the remaining is expected to be in Q3 and Q4.

As part of our purchasing accounting for Captaris, we also indicated that the cost for reducing the workforce and facilities would be approximately $20 million. The breakdown of that charge is also $11 million for workforce and $9 million for facilities. In our purchase price adjustment on the balance sheet, we have charged $13.6 million as of December 31 with the remaining $6.4 million to be a further adjustment to the purchase price through fiscal ’09.

As of December 31, we have acted on 65% or approximately 260 employees. The remaining reductions for the most part will occur through the balance of the fiscal year. We continue to confirm that the cost-savings of our operations as a result of these actions will be approximately $20 million for this fiscal year with a run-rate savings of approximately $40 million for fiscal 2010. Approximately $3 million was achieved this quarter with the main savings in Q3 and Q4.

As part of acquisition carrying, we fair-valued the acquired deferred revenue of customer support contracts. The total adjustment for Captaris was $2 million and $0.5 million was written down in this quarter.

Now, I will turn to the company’s pre-tax adjusted operating margin model. We remain confident in our plan to maintain expenses in the 14%-16% range for development, 24%-26% for sales and marketing, 9%-10% for G&A, and 2% for depreciation. A copy of our business model is available on our website as part of the investor PowerPoint presentation.

If there are any questions, we will be presenting at several investor conferences in the coming weeks, the details of which are posted in the investor relations section of our website. Please contact the Investor Relations department for more information.

Now, I will turn the call over to John.

John Shackleton

Thank you, Paul. Hello, everyone. Thank you for joining us today.

We’re please with our Q2 results and as Paul mentioned, we generated $64.9 million in license revenue in the quarter, growing 18% over Q2 of last year. Of this license revenue, 25% came from new customers and 75% came from our install base.

In the quarter, we had good performance in all regions. Approximately 70% of all license sales were driven by demand for compliance-based solutions such as e-mail management, records management, and eDiscovery. In addition, we’re finding that CIOs are spending where they can achieve measurable ROIs within their fiscal year, particularly when streamlining and automating their business processes or meeting compliance needs.

In Q2, we saw license revenue broken down by vertical as 21% from government, 14% from financial services, 11% from high-tech manufacturing, 10% from energy, and 6% from pharmaceutical and life sciences. In the quarter, we saw more diversification both by vertical sector and geography than we have in past quarters.

Taking a look at the larger transactions in the quarter, we had five transactions that were $500,000 and an additional four transactions over $1 million. An average ECM transaction size was just over $240,000 essentially unchanged from the same quarter last year.

Examples of significant wins in the quarter include SBB-AG, Switzerland’s largest travel and transportation company. They purchased the Open Text Content Life Cycle Management Solution to improve process efficiencies in creating, storing, managing and controlling documents. The SBB also expects to reduce storage costs by using our solution. Supporting their web strategy, Getting Images, a leading creator and distributor of digital content purchased Open Text’s Digital Media Solutions as a platform to help drive revenues and reduce costs by providing central, organized and instant access to images from their website. The City of London Corporation which provides local government services selected Open Text to provide comprehensive, corporate records management and archiving solutions. The Open Text system will help the City of London eliminate the duplication of both electronic and physical files with the goal to deliver better services to the many residents, visitors, and businesses they interact with daily.

From a sales operations standpoint, we closed the quarter with a combined sales force of 320 core-to-kind sales execs. License revenues from partners were approximately 38% which is inline with our goals. On the product side, we’re pleased to have received the Department of Defense’s certification for our records management and content life cycle management solutions for Microsoft SharePoint.

We also announced in the quarter the new release of Open Text’s Fax Server Connector for Microsoft SharePoint, a comprehensive document capture and delivery solution for SharePoint. The products were previously marketed by Captaris under the RightFax name.

We also announced Open Text Recruiting Manager for Microsoft SharePoint, a solution to help simplify the recruiting process within organizations. This product is part of a continuing Open Text strategy to build applications that extend SharePoint based on the Open Text ECM suite.

We’ve moved into Captaris, as Paul mentioned. The integration is slightly ahead of schedule and was accreted the first quarter.

In November, we hosted Content World, our annual global user conference. This was our largest conference ever with over 1,600 attendees including over 1,200 customers and nearly 300 partners in attendance. At the conference, we presented the 2008 Global Star Award to customers for innovative and successful ECM deployments. Winners this year included Hasbro, Haliburton, Northup Grumman, the Supreme Court of the Netherlands, GM Europe, and Bruce Power.

We continue to see a strong pipeline and despite the global economy, we see demand for compliance-driven solutions as well as EPR integrated solutions that produce rapid ROIs that I mentioned earlier. I also want to remind everyone that our revenue seasonality trend should be similar to what we experienced in fiscal 2008 even with the addition of Captaris.

We’ve always been committed to meeting our profit margin goals and strong cash flow for our shareholders and will continue to manage the business accordingly.

While I will leave it to the industry analysts to predict the ECM growth rate, we believe that we will continue to perform at the top end of that range. On that note, we’re comfortable with our current first quarter consensus expectations for the fiscal year on both the top and bottom line.

With that, I’d like to open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mike Abramsky of RBC Capital Markets. Please go ahead.

Mike Abramsky - RBC Capital Markets

John, on that last point, you’re comfortable with the first call, top and bottom line. That seems to be actually a slight improvement to your visibility in terms of your comments last quarter where you said you were comfortable 90 days out.

John Shackleton

Right.

Mike Abramsky - RBC Capital Markets

Is that a fair interpretation and can you explain why that might be, what’s causing that?

John Shackleton

Basically, we have good comfort obviously on the 90 days out and from what we’re seeing in the extended pipeline, we feel comfort. It really is just looking at the pipeline, the amount of pipeline and calculating from that.

Mike Abramsky - RBC Capital Markets

How do you feel about your sales coverage in this environment and are you, in giving that kind of, I guess it’s not a forecast but an outlook or comfort statement with what’s going on and what is expected, how do you feel about the risk of revenue volatility or changes in visibility given the environment? Can you give us some sense of what’s giving you confidence given the volatility that’s going on out there?

John Shackleton

Everyone has seen volatility. They’ve seen concerns. Therefore, part of what we’ve done is discount even further on all of the pipeline. But what we are seeing is a pretty good mix as we said, both geographically and vertical, that the pipeline is adequate to meet the needs that we see. Obviously, if there was some major downturn, further downturn in the economy, we’d have to revisit. We do, and we have been for the last two quarters, instead of just the weekly review of the pipeline, it’s almost a daily review of the pipeline on a global basis. From what we’re seeing, as I said, we feel comfortable.

Mike Abramsky - RBC Capital Markets

The diversification by vertical and geography can you, more than usual, can you explain that a bit?

John Shackleton

As you may have seen from past quarters, usually the high-tech manufacturing is usually much larger than that as well as financial services would normally be lower. We have seen areas both in financial services and other areas that are looking at these areas and doing some significant deals in these areas. So it’s much broader than it seems as well as often you’ll see Europe being strong one quarter, North America being strong in another. They’re both being strong in this quarter and continue to both have strong pipelines as does Asia-Pac.

Mike Abramsky - RBC Capital Markets

Lastly, your proforma EBITDA margins look like they hit an all-time high. Can you talk a little bit about how you were able to achieve this? It looks like your G&A is at an all-time low as a percent of revenue. How do we think about the trend going forward in the future quarters?

Paul J. McFeeters

Hi, Mike, it’s Paul. I’ll take that. As I mentioned, we’re not changing our model but as we have been indicating each quarter as much as the operating range as you pointed out, it’s above that range. I think putting John’s comment out there, reminding everyone to look at historical seasonality going forward would mean that I wouldn’t think that we’d be pushing that any further up in Q3 and we will have to see how Q4 works out in terms of our restructuring charges, whether or not we need to adjust that. We are just continuing to confirm or we’re definitely at the operating range. We’re not changing our model and our forecasts going forward on that margin.

John Shackleton

At this time.

Paul J. McFeeters

At this time.

Operator

Your next question comes from Scott Penner, TD Newcrest. Please go ahead.

Scott Penner - TD Newcrest

Paul, just to quickly clarify that last comment. You said that you didn’t expect to push up against it in Q3 but in Q4, you’d revisit that given the pace of the restructuring, I guess. Is that to revisit your guidance on the operating model or the restructuring itself?

Paul J. McFeeters

No, I was commenting on the operating model, Scott.

John Shackleton

Particularly as it relates to seasonality, Scott, in Q3, a little down in Q2, then back up in Q4.

Scott Penner - TD Newcrest

Paul, again the support revenue, I assume just the marginal jump over Q1 is a function of the currency?

Paul J. McFeeters

It would be both the currency of course and EfEx.

Scott Penner - TD Newcrest

Okay, but there was some negative currency effects on support?

Paul J. McFeeters

Overall, as I mentioned, the EfEx actually positively affected the bottom line by $0.02. It wouldn’t have had a material negative effect on the revenue lines.

Scott Penner - TD Newcrest

Just the services margin, you made some comments about utilization and some higher margin hardware pass-throughs, is this a sustainable level going forward?

Paul J. McFeeters

For the professional services operations for Open Text, as we have been indicating over time, we’re expecting to get into the low-20s which we achieved. I was commenting that there was a further up-lift for adding the hardware margins that are gains from Captaris. So I would say yes, and now we would be in the, you would expect us to be in the low-20s going forward as we would expect to achieve.

Scott Penner - TD Newcrest

John, just for you, the split when you look at the pipeline, is it still maintained about that 70%-30% on the compliance versus the ROI-type projects? Are these projects again, last time you made reference to instances of things like payables optimization, SAP, are these still the kind of applications that are driving it?

John Shackleton

Exactly, Scott. While it has been 70%-30% for the last couple of quarters, my gut reaction, feeling is that we will see more of the back-office and front-office streamlining as long as you can prove those ROIs, I think we will see more of those.

Scott Penner - TD Newcrest

Lastly, John, one clarification. The four $1 million deals, are those all deals that were signed in the December quarter or are some of those, and if so can you give the number, are some of those just chunks of previously taken or signed deals?

John Shackleton

Those were all signed deals.

Paul J. McFeeters

All Q2.

John Shackleton

Yes, all brand-new deals in that quarter.

Operator

Your next question comes from Tom Liston, Versant Partners. Please go ahead.

Tom Liston - Versant Partners

Not to beat up the forecast too much here but a lot of the comments out there are partners and certainly some of your competitors that talk about it is really difficult to forecast anything, and one of the comments that we heard is it is a just-in-time, budgeting type environment and we have heard a lot about CFOs not finalizing budgets and having a hard time not pinning down numbers. Are you finding that they’re piecing out portions just because of the need of all of their solutions or what gives you confidence where you and your partners are not willing to put a number out there and CFOs don’t have a final number? Is it the CIOs talking, the CFOs and how do you reconcile that?

John Shackleton

I think there’s really two things, Tom. One, to remind everybody, if we look at 50% of our revenue is on maintenance; it’s been pretty steady at 92+% renewal. Even in this tough economy, we’ve seen those renewals pretty much holding. If we look at our professional services backlog, that’s about 25% of our revenues, we are seeing a strong backlog, no kind of downturn in that. Again, that’s fairly predictable. So really you are looking at that 25% of license revenue and two things on that. One is we have over the last two quarters been focused on our customer base, our install base where if I look at the big deals this past quarter, they were up to the majority, existing customers rolling out larger deployments. As we go forward, we will continue to focus on those and obviously feel comfortable that those will happen. The last point is, as I mentioned also, as we look and scrub our pipeline on almost a daily basis, we obviously are being more conservative than usual in that pipeline as well.

Tom Liston - Versant Partners

Just to confirm, and Paul might have given a number, was it about 92% renewals this quarter as well?

John Shackleton

It was 70%.

Paul J. McFeeters

No, on renewals.

John Shackleton

Yes, on maintenance renewals, yes, sorry.

Tom Liston - Versant Partners

How do you, when you look at your customer base and certainly you match them all up, there’s some decent-sized layoffs going on with I assume some folks that are using you, where do you feel that number sort of bottoms out here in the coming quarter, as those guys look to say okay, we don’t need those licenses or maintenance contracts anymore?

John Shackleton

We certainly haven’t seen any to-date and we haven’t seen much in past recessions. In fact, what we do see is where in more like mergers and acquisitions where they merge the seats in there. So even in the companies where obviously, our customers have significant lay-offs, we haven’t seen a drop in maintenance. Most of our products, in fact a good majority of the products are, obviously it’s not shelf-ware that is being used. From our customer base, we’ve seen them using more seats.

Tom Liston - Versant Partners

Two quick ones. License is basically in line with your previous guidance of being down probably 20%-30%?

John Shackleton

It’s 20%-30% for the year. Usually when you do an acquisition the first quarter, it’s not quite as dramatic as that but it’s pretty much in-line with what we’ve expected it would be. We do believe the trend will be there.

Tom Liston - Versant Partners

Finally, Paul, other income, I know some of the parts in there but that’s a big number this quarter, it’s worth going through some of the pieces there.

Paul J. McFeeters

Main reason for that, Tom, is again, CapEx adjustments, foreign exchange adjustments.

Tom Liston - Versant Partners

Is there anything else that’s material?

Paul J. McFeeters

No, nothing else material.

Operator

Your next question comes from Paul Steep, Scotia Capital. Please go ahead.

Paul Steep - Scotia Capital

John, maybe you can talk a little bit about strength within specific partners and how that played out this quarter.

John Shackleton

We’re seeing particular strengths with Microsoft and working very well with them. Deloitte is also doing extremely well and as well as we’ve seen with SAP. Good work particularly with the new solutions that we’ve built with them and the Captaris product.

Paul Steep - Scotia Capital

The only other one that I have would be are there any major compliance initiatives out there, like the last time, in Q1, we had SOX and we had some of the other compliance projects that were broadly being initiated. Is there anything else from a macro trend that would explain some of these strengths out there that you’ve seen in the quarter?

John Shackleton

On a global basis, initiated in Europe and there are different ones in Asia, the other thing along that is still compliance particularly around eDiscovery, so a lot of it is that as well. It seems to be on-going, there seems to be new ones cropping up every quarter.

Paul Steep - Scotia Capital

Last one, just for Paul. You’ve done a good job on the working cap. Anything we should think about on the DSOs, in terms of any reversals there? It looks like it has moved to sort of a new lower level. Any big change on that front or is this sort of the new norm?

Paul J. McFeeters

I wouldn’t go quite so far as calling it the new norm, Paul. I give credit to our team and collecting. Open Text is still very comfortable around the 60-day mark.

Operator

Your next question comes from Richard Tse, National Bank Financial. Please go ahead.

Richard Tse - National Bank Financial

Can you talk a bit about the competitive landscape? Some of your competitors are a bit soft this quarter. If you look at Interwoven, I would like your perspective on why they want to sell at this time and any color you would like to provide on that, which would be helpful.

John Shackleton

Two things I’d say, Richard, one is, we have clearly been taking advantage of the disruption that EMC and IBM have had in integrating, still even today, Document and File.Net. So we are seeing wins in that area. Some of that is because the companies are trying to force customers to do significant, costly upgrades in these areas. Customers are looking around and saying, I can probably do it cheaper and faster with Open Text or with Open Text-Microsoft. So we’re seeing some significant wins in that area.

The other thing with Interwoven, I would say, one of our areas as we look at our portfolio mix, one of the concern areas would be in the web content management where like most managers if someone came to me and said our website is looking a little old. We need to spend $1 million to clean it up. I wouldn’t see that as a must-have. So what we’re seeing is it’s not critical, people are putting off those decisions to upgrade their websites. I would see that Interwoven like our web content products is seeing some softness in the market.

Richard Tse - National Bank Financial

Just with respect to the deals today, is there sort of any change in how they’re getting done, meaning the timing of these things as well as the potential for increased discounting on licenses?

John Shackleton

On the discounting, we’re not seeing so much. We are obviously being careful as we did in previous downturns. It is to chunk the products to make them not so big so they don’t have to go for board approval or those kinds of things. We’re obviously doing that up-front. As we look at the pipeline, we’re being extra cautious and extra sensitive with each step of the sales cycle to make sure that we haven’t missed anything and the money is still there, etc. We’re being extra cautious in every step of the cycle. The good news is many of them being our customers, we’re very familiar, have good relationships, and so they’re being very cooperative in helping us navigate through their purchasing cycles. So we’re not seeing a significant delay even though we are being cautious in how we do it.

Operator

Your next question comes from Blair Abernethy, Thomas Weisel Partners. Please go ahead.

Blair Abernethy - Thomas Weisel Partners

Just a couple things, Paul. I was wondering if you could just walk us through the changes in your headcount from the September quarter, just given your core business, where it’s gone and then what the Captaris business did.

Paul J. McFeeters

Blair, I won’t break those out for a couple of reasons because they are two operating entities but I will tell you, as we stated, that when we acquired Captaris, our workforce was 3,600. We’ve taken about 240 people at this point out of the workforce. So we have about 160 further to go.

Blair Abernethy - Thomas Weisel Partners

So the 240 is basically out of your OpEx in the second quarter, right?

Paul J. McFeeters

That would be correct.

Blair Abernethy - Thomas Weisel Partners

Then the 160 is coming out over the next two quarters?

Paul J. McFeeters

Over the next two quarters.

Blair Abernethy - Thomas Weisel Partners

Again just on the restructuring expenses, the $11.5 million that you booked so far, how much of that was cash?

Paul J. McFeeters

Approximately $3 million of that was cash.

Blair Abernethy - Thomas Weisel Partners

Okay, and the income statement restructuring was purely the Open Text side of the restructuring?

Paul J. McFeeters

Yes, thanks for that clarification. It was purely Open Text. The other was in their purchase accounting and the balance sheet.

Blair Abernethy - Thomas Weisel Partners

The other income expense, or the other expense of $12.5 million, was that all ForEx?

Paul J. McFeeters

85% of it was ForEx. The majority of that is ForEx.

Blair Abernethy - Thomas Weisel Partners

What are your plans in terms of debt reduction?

Paul J. McFeeters

We didn’t repeat our use of cash in which debt reduction is always one of the options. Purchasing shares is also an option and of course, acquisitions. So we don’t specifically state which one of those three will be a priority for us as we go forward. At this time, as you know, our ongoing rate on that $300 million is approximately 4%. So based on today’s interest rates, we might hold on to it except for normal principal repayments for the short term.

Blair Abernethy - Thomas Weisel Partners

Just on your deal metrics, on the large deals, you said four deals over $1 million. Was there any sort of multi-million dollar deals in there, anything over $2-$3 million?

John Shackleton

There was one over $2 million. The rest were just over $1 million.

Blair Abernethy - Thomas Weisel Partners

Last question, John, I’m wondering if you could just expand a little bit on the government business, it seems to be a pretty big contributor in the quarter so where was that coming from and across the spectrum, Canada, U.K., Australia, that kind of thing.

John Shackleton

Actually, it was pretty mixed between Canada, Europe, Germany in particular, and Asia-Pac. So as I mentioned, it was fairly distributed across all regions.

Blair Abernethy - Thomas Weisel Partners

Any notable new customers in that?

John Shackleton

One of the German governments for tax, for the German equivalent of the IRS.

Operator

Your next question comes from Dushan Batrovic of Canaccord Adams. Please go ahead.

Dushan Batrovic - Canaccord Adams

The drop in the high-tech manufacturing vertical, is there anything besides some of the macro weakness or general quarterly lumpiness to make note of here? Is this a vertical that should come back to where it has been as far as being one of the dominant verticals that you participate in?

John Shackleton

I’m not sure that there was that much of a drop in it. It was more that there were higher revenues from other sectors. So it kind of evened it out a little more. Particularly, when we talk about high-tech manufacturing, we also include the telcos in there and we’re not seeing significant opportunities there. I wouldn’t see it as a decline in that sector.

Dushan Batrovic - Canaccord Adams

Any of the smaller deals, I mean the deals that you signed that were in between that $500,000 and $1 million, would you categorize any of those as being the type that could have been larger but were split up into smaller pieces because of a customer’s reluctance to putting more cash up front?

John Shackleton

I wouldn’t say so much as customer reluctance but we tried to structure it in such a way that it was easier for them to do the deals without long processes in getting board approval, etc. It’s usually, because again, the majority of our customers, that as we collaborate together, what’s the best way for them. We don’t want our customers having shelf-ware. We want them to be using these products.

Dushan Batrovic - Canaccord Adams

So it sounds like those deals don’t have an opportunity to grow.

John Shackleton

Another way to say it would be that’s exactly the point. These are not because the customers have been reluctant to spend more money. The part that is key though to the sales force is you‘ve got to prove return on investment fast. If you can do that, then they’re willing to buy.

Dushan Batrovic - Canaccord Adams

There’s been a lot of discussion around compliance. One of your competitors, or one of the other industry players, Autonomy coming after Interwoven, do you see them becoming a company that you would encounter more often based on compliance being a motivator in many of the deals that are being signed these days?

John Shackleton

We probably will. We haven’t seen them to-date. We rarely see Interwoven in the space. We could potentially see them in the future, but to-date we haven’t seen much of them.

Operator

Your next question comes from Lawrence Rhee, Blackmont Capital. Please go ahead.

Lawrence Rhee - Blackmont Capital

With respect to your compliance offerings, you talked about compliance driving growth for the better part of close to two years, I think, it’s obviously continued to drive growth in this current time period. When you look at your pipeline and opportunities, how much of a run do you think remains in terms of compliance driving growth?

John Shackleton

Again, two things on that one, Lawrence. One would be we are seeing this whole issue around streamlining business processes is growing and that would obviously have an effect on the ratio. On compliance, pretty much on a worldwide basis, there are new compliance rules coming out every quarter. I wouldn’t see a reduction in that for the foreseeable future, certainly for the next two or three years.

Lawrence Rhee - Blackmont Capital

With respect to various verticals, do you see any other verticals that may not have been a big contributor recently that could represent big opportunities with respect to compliance down the road?

John Shackleton

Not so much in compliance but its pretty much compliance across all industries. There’s no one that sticks out. You might argue that further down the road, you will certainly see more compliance around financial services. I would say that industries like government, construction, will obviously be areas that we think will grow.

Lawrence Rhee - Blackmont Capital

Just with respect to financial services, that is a nice spike up in terms of contribution for the quarter. Do you view that as a red flag or just as a big opportunity for you in this environment?

John Shackleton

Some of the financial service sales were related to merger-acquisition where they were using our software to help in that process. So I would see that opportunity continuing.

Operator

Your next question comes from Barbara Coffey of Kaufman Bros. Please go ahead.

Barbara Coffey - Kaufman Bros

In working with the system integrators which you’ve done more of recently, are they particularly good at certain verticals or are there certain compliance issues that they have packaged your products with, so I am wondering are your direct sales folks going after different opportunities than the system integrators and sort of how to look at that thing in an outlook?

John Shackleton

I would say two things about that Barbara, one would be that obviously, there are certain integrators that have a much bigger footprint in certain verticals, particularly things like government where some are stronger than others. We tend to work with them in that but we also do have, we are seeing like Deloitte and Accenture embracing this sector and doing a lot more work together in that space. We are seeing some significant opportunities with these system integrators, particularly Deloitte and Accenture.

Barbara Coffey - Kaufman Bros

Do they have any different kinds of sales cycles lifetime approach than what you’re doing with the other side of your businesses?

John Shackleton

Typically, they will have been working on the opportunity probably for a longer time at the time that they bring us in, the cycle is pretty much the same, the nine months, if it is a little bit larger, fifteen months, that kind of range. It’s certainly not shortening dramatically but they usually are larger deals when we work with them.

Operator

Your next question comes from Steven Li, Raymond James. Please go ahead.

Steven Li - Raymond James

John, back in November you had announced SAP would be reselling your product. Can you talk about the initial attraction you’re seeing and are there more potential aps coming for SAP?

John Shackleton

Yes to both. We saw some very good tracks, and sorry, Steven, I didn’t mention in my speech that we did release that product. They are reselling our VIM product. We have seen some traction. It was there year-end so we thought that maybe they would be busy closing out the business, etc. that they wouldn’t be focusing on it, but we did see significant traction and we think that will happen in the future. We are looking at a number of opportunities with them for building applications as we are with Microsoft.

Steven Li - Raymond James

Can you maybe talk about the areas that you’re looking at?

John Shackleton

At this point, I can’t but I can certainly get that information for you for next quarter.

Steven Li - Raymond James

John, can you also comment on just the overall deal with SAP given some of the challenges we’ve had?

John Shackleton

That they’ve had?

Steven Li - Raymond James

Yes, is it still strong or is it down with the market?

John Shackleton

What I would say is what we’re seeing is opportunities for the SAP salesmen to go back and sell additional licenses into their existing base which may be a little easier for them particularly with things like the VIM solution. So we’ve seen tremendous interest in that. As they go forward, we’re going to have to watch what goes on. Certainly this quarter has not been down. Obviously, this is their Q4. For Q1 is where we will see more. At this point in time, we’re seeing quite a bit with the other partners as well, people like Microsoft, where they haven’t seemed to have been hit as much.

Operator

Your next question comes from Ralph Garcea, Haywood Securities. Please go ahead.

Ralph Garcea - Haywood Securities

Just a couple quick questions. On the government side, you had another great quarter. You keep showing success at the federal level across most countries. Do you see an opportunity there at provincial, state levels, local levels, if you look at Australia, through Europe and where that market is probably 3-4X as large as the federal market that you have been successful in?

John Shackleton

Actually, one is we do see this as a tremendous opportunity. We have had some success as you may know, Open Text, before we acquired Hummingbird, didn’t really do much in this area at all where as Hummingbird did. We’ve been able to capitalize on that. We are seeing some interesting growth in that area across the board, Europe, Asia-Pac and North America.

Ralph Garcea - Haywood Securities

Are there different price points there when you go in a proceed level, or do you kind of strike an enterprise deal with the entity like you did with the Canadian deal and others?

John Shackleton

It’s actually more at the solution level where we’d be selling, for example, you know like tax collection or drivers’ licenses scanning, that kind of thing. It’s more of a solution problem level than an enterprise-wide site license. They’re typically not big enough to warrant having a massive site license but their key solutions have been very, the great thing about it is, often what you’ll find is that one province or one state is the leader and if you sell it in one state, it’s fairly easy to then get far-on with those other states with a relatively low cost of sale.

Ralph Garcea - Haywood Securities

A quick one for Paul. Given the price line on the services side, do you think the utilization rates from the Open Text perspective, do you think you will maintain those levels going into the second half of fiscal ’09 and the rest of the calendar year?

Paul J. McFeeters

You’re taking me out too far, Ralph. I can tell you that, certainly as John said in the other revenue lines, we can see good visibility out 90 days. I wouldn’t want to project past that.

John Shackleton

I would say, Ralph, that one our goal is to keep them in the low 20s and that Q2, this past quarter is usually a good one because we have a lot of additional training because of the user conference but even if you took that out, we do believe that we’ve made progress and we should be able to get to the low 20s going forward on a regular basis.

Ralph Garcea - Haywood Securities

Is that keeping the same rates within their perspective geographies or do you sort of have SWAT teams like U.S. guys that you would send into a European engagement or how are you managing those?

John Shackleton

We have a large team in Germany that does do SWAT in and around Europe, particularly things like Nordic. The U.K. will do SWAT teams in Benelux, things like that, but in America, it is pretty much a self-contained team. There’s not a lot of interchange between the teams.

Operator

Your next question comes from Gabriel Leung, Paradigm Capital. Please go ahead.

Gabriel Leung - Paradigm Capital

A couple of quick things for you, Paul. First, can you remind us again how much cash restructuring costs are to pay out?

Paul J. McFeeters

This quarter, they were paid out?

Gabriel Leung - Paradigm Capital

Yes, how much this quarter was paid out and how much remains.

Paul J. McFeeters

We paid out in total, for the total restructuring for Captaris and Open Text between $5-$6 million. Of the combined organizations, I would say half of it will be paid out in cash this fiscal year and the remaining throughout the following fiscal year or years, because about 50% or less than that is our restructuring of subsidy, so I am sure as we get sub-let, the cash goes out in an elongated fashion as we continue to pay rent.

Gabriel Leung - Paradigm Capital

Secondly, just given where LIBOR rates are now, should we expect to see that interest expense line start to come down a little bit or is the interest color you have in place going to offset some of the benefit that’s there at least until it expires later this year?

Paul J. McFeeters

Absolutely, the underlying face rate on the loan is coming down as I mentioned earlier. All in rates and existing color is around 4%. I would just like to point out the mark-to-market charge this quarter was $1.5 million so it negatively affected our EPS by $0.02. So that’s absorbed in that line already. Between now and the end of our cal year, this calendar year, we will have a net $3.6 million to put back into that line.

Gabriel Leung - Paradigm Capital

On the services line, any chance you can break out how much of the services revenues was associated with hardware resales?

Paul J. McFeeters

We’re doing that right now in our NDNA. For that question, I don’t have a definite answer for at this moment.

Gabriel Leung - Paradigm Capital

I’ll look in the 10-Q for that. Lastly, with you John, you might want to answer this or you might not want to, just on the pending Interwoven acquisition, given the lack of sizable independent ECM vendors less in space along with your stated desire to remain independent at least for the time being, do you think it’s worth it for you to pursue Interwoven to gain the real estate or do you think that there is no chance of that ever happening?

John Shackleton

There’s no chance of that happening, I don’t think.

Operator

Your next question comes from Mark Schappel of Benchmark Company. Please go ahead.

Mark Schappel - The Benchmark Company

Just one question. Paul, I was wondering if you could just to clarify one more time the $12.5 million charge on the other income line.

Paul J. McFeeters

Most of that 85%, Mark as I mentioned is adjustments to EfEx adjustments on repricing of company loans and various subsidiaries at the end of the quarter.

Operator

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

John Shackleton

Thank you everyone for your questions. Just to wrap up on the quarter’s highlights, Q2 was a good quarter. We believe that business remains steady for us. The Captaris integration was accretive and is tracking slightly ahead of schedule. While we face these uncertain economic times, we continue to focus on meeting our profit goals and we remain positive on the outlook for the fiscal year 2009 and I’m comfortable with the expectations on our first call for FY09. This concludes our call for today and thank you everyone for participating.

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Source: Open Text Corporation F2Q09 (Qtr End 12/31/08) Earnings Call Transcript
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