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Open Text Corporation (NASDAQ:OTEX)

Q3 2010 Earnings Call

April 29, 2010 5:00 PM ET

Executives

Greg Secord, Vice President, Investor Relations

Paul McFeeters – Chief Financial Officer

John Shackleton – President and CEO

Analysts

Mike Abramsky – RBC Capital Markets

Tom Liston – Versant Partners

Richard Tse – National Bank Financial

Scott Penner – TD Newcrest

Paul Lechem – CIBC World Markets

Paul Steep – Scotia Capital

Dushan Batrovic – Dundee Securities

Sera Kim – GMP Securities

Derrick Wood – Wedbush

Brian Freed – Morgan Keegan

Eyal Ofir – Canaccord Adams

Blair Abernethy - Thomas Weisel Partners

Operator

Good afternoon, ladies and gentlemen. Welcome to the Open Text Corporation Third Quarter Fiscal 2010 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, there will be a question-and-answer session. (Operator Instructions)

I would like to remind everyone that this conference is being recorded today, Thursday, April 29, 2010 at 5:00 PM Eastern. I would now like to turn the conference over to Mr. Greg Secord, Vice President, Investor Relations. Please go ahead.

Greg Secord

Yeah. Thank you for joining us. First, the disclaimer, during the course of the conference call we may make projections or other forward-looking statements relating to the future performance of Open Text or its subsidiaries. These all statements may 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 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 a conclusion, forecast or projection in the forward-looking information and the material factors or assumptions that were applied in drawing a conclusion while making a forecast or projection as reflected in the forward-looking information are contained in Form 10-K for Open Text for the fiscal year ended June 30, 2009, and Form 10-Q for our quarters ended September 30, 2009 and December 31, 2009, as well as in our press release that was issued earlier today.

And with that, I’d just like to comment on a few housekeeping items. Open Text will be having an informal analyst briefing at the Canada 3.0 Conference in Stratford, Ontario on Monday, May 10th. That will be at the Stratford, Ontario Rotary Complex. More information on that is available on our website.

As well, Open Text will have presence and be an active partner at the Users Conference for SAP. This SAPPHIRE conference is held in Orlando, Florida from May 16th to 19th and we will be having an informal analyst event there on Wednesday the 19th. Please reach to Investor Relations or email me directly, if you’re interested in attending or being part of that.

Now with that, I’ll turn the call over to Paul.

Paul McFeeters

Thank you, Greg. Starting with the financial results for third quarter of fiscal year 2010, total revenue was $212.8 million, compared to $192 million the same period last year. License revenue was $49.5 million, compared to $51.9 million reported last year.

Maintenance revenue was $124.4 million, up 22%, compared to $101.9 million last year. Services and other revenue remained stable at $38.8 million in the current quarter, compared to $38.2 million for the same period last year.

We reported third quarter adjusted net income of $40.3 million up 28%, compared to $31.4 million for the same period a year ago. Our adjusted EPS was $0.70 per share on a diluted basis, compared to $0.59 per share for the same period a year ago, an increase of 19%.

Gross margin for the third quarter before amortization of acquired technology was 73.7%, compared to 72.9% in the third quarter of last year.

Pre-tax adjusted operating margin before interest expense was 27.2% in the third quarter, compared to 24.4% in the same quarter last year. On a year-to-date basis, pre-tax adjusted operating margin before interest expense was 26.4% in the current quarter, compared to 24.7% for the comparable period last year.

Adjusted tax rate for the quarter remained at 27%, same as last quarter and slightly down from 28% last year. Within specialty charges, we recorded $5.1 million of restructuring charges and $0.6 million of acquisition-related costs.

Operating cash flow for the quarter was $78 million, compared to $72.9 million in the same period last year, an increase of $5.1 million. Absent the impact of cash paid, related to special charges, operating cash flow was $86.1 million, compared to $76.5 million in the same period last year, which equates to an increase of $9.6 million.

Net income for the third quarter in accordance with GAAP was $13.1 million, or $0.23 per share on a diluted basis, compared to $22 million or $0.41 per share on a diluted basis for the same period a year ago. There are approximately 57.7 million shares outstanding on a fully diluted basis.

In the third quarter, foreign exchange had a larger impact than normal. Regional currency movements hit our maintenance business the hardest. The combined effect of lower European currencies and a higher Canadian dollar also resulted in a larger than usual impacted operating income and decreased our adjusted earnings by approximately $0.03 per share.

Turning to the balance sheet at March 31, 2010, cash was $321.3 million, compared to $275.8 million at June 30, 2009. Accounts receivable was $122.6 million, up from $115.8 million at the end of our June quarter. Days sales outstanding were 52 days as of March 31, 2010, the same as for the previous quarter and at the end of Q3 of last year.

Deferred revenue was $223.8 million, compared to $197.3 million as of June 30, 2009. The Nstein acquisition closed on April 1st and therefore was not part of this quarter’s results.

Looking at the company’s pre-tax adjusted operating model, margin model, we are confident in our plan to maintain 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. Our annual operating net margin model is projected to be in the range of 22% to 27%. We still expect to close the fiscal year at the high end of that range.

Now, I’ll turn the call over to John.

John Shackleton

Thank you, Paul. Hello, everyone, and thank you for joining us today. While I’m pleased that we reached our margin targets, it’s clear that we’re seeing the effects of seasonality become more pronounced. While sales came in as expected in North America, Europe and Asia missed their targets. The manufacturing sector in Germany and Japan were particularly weak.

Overall, we’re seeing the economic impacts on IT spend still affecting certain regions around the globe. In Q3, North America was responsible for 53% of the revenue, Europe, 39% with the remaining 8% coming from Asia Pac.

In the quarter, we saw license revenue in key verticals with 20% from high-tech and manufacturing, 18% from financial services, 11% from government, 8% from consumer goods, 7% from utilities and 6% from healthcare and life sciences.

Of this license revenue, approximately 35% came from new customers and 65% from our install base. Most of the transactions in the quarter continue to come from follow-on sales to existing customers.

Taking a closer look at the transactions in the quarter, we had three transactions over $0.5 million, an additional five transactions over $1 million, with notable wins in high-tech and finance sectors.

The average transaction size was approximately $310,000, slightly up from last quarter’s $290,000. Examples of transactions closed in the quarter include RWD Technologies, a leading provider of performance improvement solutions. They signed a significant OEM contract extension with Open Text for use of our collaborative technology for multimedia learning.

MIT Lincoln Laboratory, a federally funded research and development center that applies advanced technology to problems of national security, purchased Open Text enterprise content management suite of products.

License revenue from partners and resellers was approximately 38%, in line with previous quarters and SAP continues to be our largest partner. They contributed approximately 10% of our license revenue in the quarter.

Also we announced the third major expansion of our reseller agreement with SAP to include Open Text Digital Asset Management. This solution enables marketing departments, media industry publishing houses and broadcasting to manage and distribute all types of rich media content.

Speaking of Digital Asset Management, we also announced Open Text Media Management 7, a major upgrade to our industry-leading Digital Asset Management solution. The upgrade includes a new user interface that makes finding, accessing and managing larger volumes of digital media fast and easy to use.

Microsoft also influenced transactions in the quarter and we continued to see demand for solutions in archiving, records management and compliance from Microsoft customers. In the quarter, we announced that we are working with Microsoft to showcase our ECM solutions, for SharePoint 2007 and 2010 platforms at selected Microsoft technology centers around the world.

In March, we unveiled Open Text Everywhere, a new application that allows the Open Text ECM Suite to be available via mobile devices. This will add many unique capabilities for our ECM customers helping organize and harness the power of their mobile workforce to increase productivity.

As for Vignette, we are pleased with how the integration has proceeded to date and expect to have the acquired business fully on our model by June 30th. Retention rates from Vignette customers are tracking ahead of plan and we’re now positioning to begin selling Open Text products and services to this customer base.

On April 1st, we completed the Nstein transaction. We announced our plan to integrate and expand Nstein’s content analytics capabilities into the Open Text ECM Suite to help customers create powerful new ways to manage governance and eDiscovery issues.

As a reminder, Nstein was generating approximately $5 million in revenues on a quarterly basis and keeping with prior acquisitions, we would expect a similar 20% to 30% first year decline in licensed revenue run rate for this business.

On Monday, we announced our offer to buy Burntsand Technologies, which will further expand our Professional Services group. As a reminder, the acquisition will take several weeks to close, so we’ll limit our comments to what was said in the issued press release and filings.

From a market perspective, the industry analysts continue to tell us that IT spend for FY ‘10 will still be challenging. But they continue to predict that the ECM market will grow in single-digit range. Our pipeline remains strong and we still believe we’ll be in range for Q4.

From a profitability standpoint, we’re clearly on track with our 22% to 27% adjusted operating margin and as Paul mentioned, expect to close the fiscal year in the upper end of that range.

In summary, our pipeline is tracking to plan. License revenue in the quarter has put us a little bit behind where we expected to be year-to-date but we believe we can make some of this up in Q4. And we are still comfortable with current first call consensus EPS estimates for the fiscal year and expect to see revenues within the -- for FY 2010 within range.

Now, I’d like to open the call to questions.

Question-and-Answer Session

Operator

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

Mike Abramsky – RBC Capital Markets

Yes. John, just on your comment, did you say you were comfortable with F ‘10 First Call EPS? And then you said something about we’re in range of Q4. Does that mean range of Q4 consensus and also does that include Nstein and Burntsand impacts?

John Shackleton

Good question. So, sorry, so the range we are talking about for First Call is the high of $958 million. The low is around $918 million for revenue and we feel comfortable in that range. And the Nstein would be included in that.

Mike Abramsky – RBC Capital Markets

Okay. And what was in Nstein, so that means that you feel that you are about basically about $5 million behind is what this quarter is setting you back in terms of license?

John Shackleton

Somewhere in that range, yes.

Mike Abramsky – RBC Capital Markets

Okay. And…

John Shackleton

And as said, we feel we can make some of that up.

Mike Abramsky – RBC Capital Markets

Okay. And what would -- and then on the EPS side, just to clarify what you’re comfortable with?

John Shackleton

On the EPS, the range is a high of 322 and low of 286. We feel very comfortable in the mean of that range.

Mike Abramsky – RBC Capital Markets

Okay. So normally you talk about, I think you had previously talked about FX being a natural hedge. And this time you’re talking about it having an EPS impact. I think you normally just have it on the topline. So what is the impact of FX to your topline and what is going on with regard to your hedge on EPS?

John Shackleton

I’ll let Paul answer that one.

Paul McFeeters

Yeah, Mike. No, we always report the net effect on our adjusted operating earnings with EPS. So that is typically what, not typically, that’s always what we have been doing. We’ve not broken it out from by revenue or expense line. What we do, as you know, is we give you the percentage of revenues and expenses in each major currency.

And the thing we’re pointing out this time is, so I did say that, we had a negative effect of $0.03 on our earnings per share because of the FX. And I think, we’re just trying to point out this time, of course is that, typically in the past or certainly in the last three or four years, most of the currency moved with or against the U.S. dollar and we always had a negligible plus or minus $0.01 or $0.02 maybe on the EPS.

This time, we’re just pointing out that we have a little different mix in terms of foreign exchange against the U.S. dollar with some of the euros or the euro currencies, pounds weakening, Canadian dollar strengthening.

And so, that was a different dynamic that we were sworn to make more clear this time. But we still only report and have in the past the EPS effect which is $0.03.

Mike Abramsky – RBC Capital Markets

So if you sort of take out the impact of Nstein and Burntsand, is the kind of shortfall to your prior, slight shortfall to your prior outlook? Is that largely on FX or is that some slowing in transaction momentum or stretch out of deals or what’s going on there?

John Shackleton

Yeah. Actually, one of the things we’re seeing Mike, is that some of the deals are getting bigger and they are obviously the larger deals and in some cases, significantly larger deals stretching out. But it’s really a combination. It is a combination of FX on particularly on things like customer support, areas of pipeline for the Professional services, which is a little hard to make up, it’s pretty much, how many resources have you got. But we feel very confident in our pipeline for licenses but we can make some of this up.

Mike Abramsky – RBC Capital Markets

Okay. Thank you.

John Shackleton

Thank you, Mike.

Operator

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

Tom Liston – Versant Partners

All right. Thank you. Good afternoon. Just on the license revenue. Could you talk a little bit more about whether the shortfall was more WCM or it’s probably not eDiscovery, but archiving or what have you? Obviously, Vignette last year did about $7 million and that’s probably down, but if you look at last year’s numbers in Vignette and look at some of your peers that are growing, what’s sort of the delta there between those two things?

John Shackleton

Yeah. Actually we, Tom, on the WCM, we did see on the red dot on the small, medium-sized companies particularly in Germany, as I said, where the manufacturing sector of small to medium-size companies did have an impact. On the larger WCM deals on the Vignette side, very positive, actually ahead of plan. The shortfall in Europe was really across the board.

Tom Liston – Versant Partners

Okay.

John Shackleton

It was kind of all products.

Tom Liston – Versant Partners

And I guess you’re kind of suggesting it anyway, but do you feel it’s more of a time issue where maybe December was a little ahead and then June will catch up a bit? Or does this make you start to rethink the acquisition strategy a little bit toward companies that might give you a bit of growth on the topline rather than trying to manage the cash flow, the revenue declines. Is that…

John Shackleton

I think what we’re seeing, Tom, is if you look at the traditional seasonality where Q1 would be down 10% to 20% on Q4, Q2 would be 20% to 30% up on Q1 and then Q3 would be 5%, 10% down, Q4 would be 20%, 30% up. We’re seeing bigger swings now. What we’ve seen is, if we look at this past year, Q1 was down 20% to 30%. Q2 was up 40% to 50% and then, this Q3 was down almost 30%. So, basically, we would see Q4 being a big upswing.

Tom Liston – Versant Partners

Why is that? Is it just budgeting at year end versus a new year and -- or…

John Shackleton

I think we are seeing again it is a combination of what is the absent of the acquisitions that we have made that have made our seasonality a little more pronounced. But I think it is also the, if you notice our government was down. And I think some of that is where they’re just delaying for budget reasons, et cetera. They delayed some of their sales.

Tom Liston – Versant Partners

Sure. Makes sense.

John Shackleton

A bit of a combination.

Tom Liston – Versant Partners

And just real quick for Paul, documented that the company is hiring fairly aggressively in Canada, some of that’s moving jobs from other parts in the Open Text organization back to Canada, but some of it is new.

Is there concern there with the Canadian dollar where it is or are you 25% of expenses in Canadian dollars, that increases with the Canadian dollar being strong, is that something you’re maybe perhaps rethinking?

Paul McFeeters

Tom, it’s a good question. We certainly are balancing between the pace of hiring, I’ll put it that way, against the cost restructuring that we’re near completion. So, I think the good news on that one is, that our cost restructuring is a little bit ahead of plan. And we’ve built a little bit of a margin in on that.

So I think in the long run, we’ll still track according to our hiring but the pace of that hiring certainly we would just slow it probably a little bit because of that point that you made. The Canadian dollar will strengthen right now.

Tom Liston – Versant Partners

Yeah. All right. Thank you very much.

John Shackleton

Thank you, Tom.

Operator

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

Richard Tse – National Bank Financial

Hello, Paul. Just a question on maintenance here. So your support went down from $130 million last quarter to $124 for this quarter. Was that all due to seasonality, sort of the FX?

Paul McFeeters

Not 100%, Richard. A little bit is due to actually a bit of a pickup in Q2 and that’s as a result of when we acquired Vignette. As you know, we had some unstable customers and we had enough time, I think we talked about this last quarter, where we were making some of them with the visibility on the Version 8 coming out. We were sort of able to pick up some, call it deferred maintenance that couldn’t be recognized before with customers now signing up. And it’s, we’ve been consistent in saying that we had better than expected outcome with Vignette.

So that is reflected in that number for Q2. So that was perhaps a little higher in Q2 than typical. So normally you would see the maintenance being picked up maybe 1% or so a quarter. So if you would normalize Q2, then, yeah, any difference on that would be an FX effect.

Richard Tse – National Bank Financial

So what was the number in terms of FX versus the impact on support?

Paul McFeeters

Yeah. We’re not, I apologize again, we’re not going to break out the FX by revenue, expense lines, we’re going to kind of stick with what we’ve done and that is give you EPS and the percentage of revenues and expenses in the major currencies.

Richard Tse – National Bank Financial

Okay. Well, what about the renewal rates, I guess for maintenance and…

John Shackleton

Renewal rates have stayed pretty much constant, Richard, around the 92%. We haven’t seen a drop or increase that.

Richard Tse – National Bank Financial

Okay. And with respect to the services, you sort of signaled interest in services with the Burntsand acquisition. Is that something that you’re thinking of pressing further on with bigger transactions in that area?

John Shackleton

As I mentioned before, we have a number of, particularly like the governments are also areas, Burntsands has some excellent Microsoft expertise as well as document management expertise that we will be able to utilize fully, both in the government space as well as oil and gas which they have some strong expertise in.

Richard Tse – National Bank Financial

And sorry, I don’t want to sort of belabor the point on maintenance, but if you circle back here and I understand that pickup you had last quarter. But to have it sort of decline subsequent to your sort of signing those maintenance contracts, that’s really don’t understand how that’s -- in terms of decline. And I think, it would certainly help if you would provide more color on the FX impact here?

John Shackleton

Yeah. I mean, I guess, if I go back to Q1 is 123 and….

Richard Tse – National Bank Financial

Yeah.

John Shackleton

… Q2 is 124, so if you sort of take, I’ll call it the blip out of Q2 and look at where the FX has been and look at our percentage of revenues, I think you can get that delta.

You know it is a little slower than normal growth and that is due to the FX. As I said the Q2 was more of a blip up. So if you draw the trend line between Q1 and Q2, and Q3 rather and then apply the FX, I think you’ll come up pretty close to the answer.

Richard Tse – National Bank Financial

Okay. All right. Thanks.

John Shackleton

I know you will.

Richard Tse – National Bank Financial

Okay. Thanks.

Operator

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

Scott Penner – TD Newcrest

Thanks. Just, John, first of all, just to make sure I’ve got this right. Last quarter, you mentioned the normal seasonality on the license side would be up 5% to 15% and in Q4 I think you just said you expect to be up 20% to 30%. Is that right?

John Shackleton

So what we are seeing is the new seasonality trends is that if you looked at Q2 to Q3, it would drop 20 to 30%. What used to be 5 to 10%, we are announcing it is almost 20, 30%. But Q4 which would be looking at just like Q2 would be in the 40 to 50% range.

Scott Penner – TD Newcrest

Sorry. Now I’m completely confused. The -- just so what is now the normal seasonality through the year for license revenue?

John Shackleton

Normal seasonality that we’ve seen this past year that I think we will see is Q1 would be down 20 to 30% off of Q4. Q2 was up in the 40 to 50% range. Q3 was down in the 20 to 30% range. And we believe Q4 will be up in the 40 to 50% range.

Scott Penner – TD Newcrest

And that’s on license revenue?

John Shackleton

That’s license. That’s exactly right.

Scott Penner – TD Newcrest

Okay. And on the -- just on the Vignette side, last quarter, I think you disclosed the revenue amount contribution. Is that available this quarter?

Paul McFeeters

Yes. Revenue is about the same, Scott. It is about $30 million and our contribution is approaching now closer to 10. And so as John said, we will be on model. We are pretty much tracking the model of Q4 now, so its contribution margin is matching but we have Open Text overall.

Scott Penner – TD Newcrest

Okay. And then just in terms of that big swing on seasonality, I mean that’s a pretty massive change from before. Is this just a -- I mean, it’s tough to really pinpoint what it’s a function of, but is it mainly the timing of these large deals? When do you think they are closure in the year?

John Shackleton

That’s the majority, yes. I would say that, but also in Europe was -- the economy in Europe was a factor.

Scott Penner – TD Newcrest

Okay. Paul, I think you may have gotten to the fact that there was about $8 million cash restructuring in the quarter. Is that right?

Paul McFeeters

Yes. That’s correct. It was in --. Yes, in cash, yes.

Scott Penner – TD Newcrest

Okay. And what is -- What is left to go as far as the workforce restructuring in Q4?

Paul McFeeters

In Q4, we will probably have further charge to the financials probably about $6 million. So of that, probably 75% of that is workforce. But I see a similar charge in Q4 as you saw in Q3.

Scott Penner – TD Newcrest

Okay. And then just lastly, you mentioned the $0.03 FX impact us this quarter on an adjusted EPS. Now on, just on the pretax operating line, I mean that would suggest that a relatively lousy quarter for license revenue. We were still comfortably above the 22 to 27% range. I am just trying to figure out what --? You know, are you waiting to potentially change that to target range in the next year? Is there any reason to think you should not be above that range next year?

Paul McFeeters

I think we will be more explicit about that part in Q4. But I think we have been both bullish about making sure that we will achieve the upper end of that range. But trend wise, I mean, I can understand your comment from a trend perspective.

John Shackleton

We are managing to the bottom-line, Scott, and we are ahead on some of those programs.

Scott Penner – TD Newcrest

Okay. I appreciate it. Thanks.

Operator

Your next question comes from Paul Lechem of CIBC World Markets. Please go ahead.

Paul Lechem – CIBC World Markets

Thank you. Good afternoon. Just on the seasonality again. Do you see the same type of seasonality out of your direct sale force as you do out of the channel?

John Shackleton

It is slightly different in that, obviously, SAP’s Q4 is the end of Q2. So their Q1 is -- I think that has impacted Q3 to some extent as well. That might have exaggerated a little bit, but in general, it is more direct sales, I would say.

Paul Lechem – CIBC World Markets

What can you do to smooth this out in the future? Is there anything you can do because it seems you are going in the wrong direction here and -- I’m also trying to figure out, so first of all what can you do to smooth it out? Secondly how much of this is related to the economic environment and how much will smooth out naturally when things get back on a more even keel?

John Shackleton

I think -- my gut feeling -- it is totally, gut feel is about, I would say, a third is about the economic uncertainty on a global basis. The other is, as we have been focusing on key government initiatives and government related, we are seeing bigger deals in the pipeline and as we said, they do take time particularly when governments are having a tough time with budgets. Over the long term, what are we doing about it is building the pipeline evens even stronger. From an internal performance standpoint, I am pretty happy with the sale force that we have got. They are performing well. And so it is not an internal operations issue at this point. We just need to build that pipeline over time. We also have a number of new products coming out throughout this year that we also think will help.

Paul Lechem – CIBC World Markets

How do you get comfort that Q4 will actually be where you are saying it is going to turn out? How do you actually get comfort of where the pipeline will actually hit in terms of quarters?

John Shackleton

Obviously it is -- in the software business it is always tough until the last two weeks of the quarter. But given the pipeline that we have and the breadth of the pipeline and what we have seen activity already this quarter, we feel bullish.

Paul Lechem – CIBC World Markets

What’s your coverage, your pipeline coverage at this point in time? Has that been moving around?

John Shackleton

In what sense, Paul?

Paul Lechem – CIBC World Markets

How much do you have in your pipeline versus your budgeted numbers for the year?

John Shackleton

It’s typically a four times.

Paul Lechem – CIBC World Markets

Has that remained stable?

John Shackleton

Yes. That’s -- in fact, it has been picking up.

Paul Lechem – CIBC World Markets

And is the seasonality as bad in North America as it is in Europe or is there any difference?

John Shackleton

Obviously it’s very different in Europe. One, Europe, did have an impact on this quarter and, obviously, they have a major impact in Q1 with the vacation periods that they have.

Paul Lechem – CIBC World Markets

Just one last question, go back onto Richard’s questions about the maintenance and I am trying to understand the FX impact. Because by my calculations, FX was a positive impact this quarter not a negative. So shouldn’t that have helped push things up a little bit more or am I getting it wrong?

John Shackleton

No. It was -- There was a -- we have calculations that are slightly negative. I said when I was commenting on it before, Paul, because you have to take out pretty much what I call kind of a Q2 pick up in Vignette, call it maintenance in arrears on that one, so. And from there it’s slightly negative on the FX.

Paul Lechem – CIBC World Markets

Negative year-over-year or negative versus Q1?

Paul McFeeters

Q2.

Paul Lechem – CIBC World Markets

Sequentially, okay.

Paul McFeeters

Sequentially, yeah.

Paul Lechem – CIBC World Markets

Okay. And in the quarter -- last question, sorry, I did have one more. In the quarter how much was the annualized -- I think you are looking at $40 million in annualized cost savings from Vignette. What kind of run rate are you at right now?

Paul McFeeters

It was close to eight for the quarter and as we indicated we would be on plan, X in Q4. I think we are a little bit ahead of that for Q4.

Paul Lechem – CIBC World Markets

Okay. Thank you very much.

Paul McFeeters

Thank you, Paul.

Operator

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

Paul Steep – Scotia Capital

Hey, guys. If we make it quick here and get beyond the quarter, John, maybe just talk a little bit about Share Point 2010 and how that looks on the competitive landscape long-term? How you think that sort of impacts the company and then maybe comment as well on the SAP side, the launch of the competing product from competitors here shortly on that platform, where you sort of see yourself in the market and one quick follow-up for Paul. Thanks.

John Shackleton

Yeah. If you look at the market, basically our positioning of being the Switzerland where most of these global large Fortune 1000 companies have multiple repositories of information from legacy competitors, etc. And while we see Share Point 10, the great thing about Share Point is anybody who uses office, it is easy to use. And it’s -- but beyond that for really heavy lifting and scaling as well as the ability to interface the structure data like SAP and Oracle, obviously, it can’t do that.

We see applications that we are building on Share Point will -- so the Share Point channel for us is a tremendous opportunity to expand our market. So we don’t see them as competition. We actually see them as strong partners. And the -- Sorry, what was the other question, Paul?

Paul Steep – Scotia Capital

Just around EMC launching the niche products in the next couple of weeks. What is your thought there with regard to SAP? I know it came up last call, but we might as well put it down this quarter.

John Shackleton

It is yet to be defined of what that product is and it certainly hasn’t been built.

Paul Steep – Scotia Capital

Fair enough. Why don’t we talk more importantly, Paul, the free cash? It’s going to build pretty dramatically here based on my numbers. Once we get beyond hedging and worrying about FX, what’s the redeployment plan there besides tuck-unders like Burntsand? Is there thought about it, where that cash goes and how it returns to shareholders? Thanks.

Paul McFeeters

Yeah. I think it’s consistent with what we’ve said in the past that in order of our uses of cash, acquisition probably remains number one. We are again not going to probably accelerate debt repayment at LIBOR plus 225 or repurchase stock, although we have that option to do so. So it will remain acquisition on a -- I will call it on an opportunistic basis.

Paul Steep – Scotia Capital

Right. Thanks, guys.

Paul McFeeters

Thank you, Paul.

Operator

Your next question comes from Dushan Batrovic of Dundee Securities. Please go ahead.

Dushan Batrovic – Dundee Securities

Hi. Thank you. I guess the question for me again is seasonality versus macroeconomic weakness out there. And maybe to ask the question a little bit differently is were there specific deals that you are tracking that might have slipped out of the quarter that you were counting on that should have closed in the quarter? Have any of them -- if that is the case, have any of them actually been closed?

And a second part of that is to what extent are you expecting a rebound in European -- in the European business thinking about what’s happening in Greece and et cetera? Are you banking on more comfort out of your enterprise accounts?

John Shackleton

Good questions. Let me start so, yes, a number of accounts in Europe did slip and, yes, we have since brought those in. Going forward on the Greece and Portugal, et cetera, we see little impact for us in that area. Our key areas are still U.K., Nordic, Germany and that -- I know, Italy, Spain. And we do actually see Q4 in Europe in looking to be pretty strong.

Long-term impact, we have got to obviously keep a close eye on that. We are seeing strength in the U.S. with they had a good quarter. And we see another good quarter coming up for them, as well as we have seen some interesting deals within out of Latin America as well. The bigger deals that as I said, are from governments and large corporations, so and global in nature, so we feel comfortable going forward that should continue.

Dushan Batrovic – Dundee Securities

Any other deals that have since closed, were they seven figure deals any of them?

John Shackleton

Yes.

Dushan Batrovic – Dundee Securities

Okay. Next question for me is your operating expenses were a bit lower than I was expecting. Did you accelerate any of the cost cutting based on what you are seeing in the quarter or were you basically to plan on the cost cutting side?

Paul McFeeters

Dushan, it’s -- we were just, as I mentioned it a little bit ahead of -- we were a little ahead of plan, so…

Dushan Batrovic – Dundee Securities

Was that in response to what you were seeing in terms of contract activity, though?

Paul McFeeters

I think this is again, at the beginning of the year. I mean we set this plan, as you know, in Q1 and we -- it was somewhat pointed and of course as we typically do with large acquisitions at the same time, we took a hard look at Open Text and with the -- I’ll say it a little more, the view around the economy felt that we would be more conservative on the cost side.

And so we were pretty ambitious right at the beginning of our fiscal year and now we are tracking a little ahead of what we said we would do in the expenses. So that is one reason and the other is certainly has some volume impact on the revenue. Those two items is probably, why we are a little ahead of expenses than maybe what you might have planned.

Dushan Batrovic – Dundee Securities

Okay. Last question for me is on the Burntsand acquisition. It’s a relatively small deal, but I’m curious whether it signals more of a bigger move into services side? Or is it just -- is it -- should we consider it more of a one-off?

John Shackleton

There’s a couple of things. One is the skill set that the Burntsand’s folks have are really valuable to the existing customers. And we do have a pent-up demand for that. So I think that’s really what that -- why that occurred.

Dushan Batrovic – Dundee Securities

So there’s not much risk of call it channel conflict? Some of the third-party service providers that you deal with?

John Shackleton

We think with their expertise in share point and others as well, as I mentioned earlier. There is many of our customers have multiple repositories. And as they try and aggregate their content, it’s a value to know multiple repositories. So we find that helpful as well.

We have also done recent studies that show when we help the customers install our products and train on our products et cetera, that revenue -- license revenue follows faster and more frequently than if we don’t do that. So we are a conscious effort to provide installation, training, handholding by Open Text employees.

Dushan Batrovic – Dundee Securities

Okay. Thank you so much.

John Shackleton

Thank you, Dushan.

Operator

Your next question comes from Sera Kim of GMP Securities. Please go ahead.

Sera Kim – GMP Securities

Hi. Good evening. Just one final clarification and I promise I won’t ask any more questions on this. But just to understand Q3, so there was typical seasonality but beyond the typical seasonality. There was some FX impact and then there were large government deals that took a little bit longer than what you were expecting. And then some orders in Europe got shipped. Is that kind of…

John Shackleton

So or another way to say that would be the seasonality was more exaggerated than usual. So what typically would be a Q3 would be in the 10% decline over Q2. We are seeing more of a 23% decline because of the couple of the issues you pointed out. One, economics in Germany, but also some delays in licenses in Europe.

Sera Kim – GMP Securities

Okay. But so it’s more exaggerated than if we look next to your same quarter then would you expect the similar, exaggerated seasonality?

John Shackleton

Obviously, we will do everything we can to smooth out the seasonality. But at this point in time, we would probably say, yes.

Sera Kim – GMP Securities

Okay. And just in terms of pipeline, you mentioned that it’s picked up. Would you be able provide us with any color in terms of your level of (inaudible) in terms of what your outlook is for next year? Would you say you are more -- you are feeling a little bit better about things today versus three months ago? Or would you say it’s still the same in terms of feelings?

John Shackleton

We will give the outlook for next year at the end of Q4 in our next one. But I would certainly say our pipeline has improved over the past six months.

Sera Kim – GMP Securities

Okay. And within the pipeline, is it for a similar type of product that have seen strengthened before? Or are you seeing increased demand in some of the other stuff? Like I think last quarter web content match had started to pickup?

John Shackleton

Yeah. So actually two -- one is, we are seeing the deals becoming larger and but we are seeing both web content management, social media and with that really part of web content is the rich media part of that. But we are also seeing significant in the archiving, SAP interfaces as well as we are seeing Oracle -- the Oracle interface as well.

Sera Kim – GMP Securities

Okay. And these large deals, are they coming from your SAP relationship or outside of the SAP?

John Shackleton

It’s actually -- it’s all. It’s we are seeing it from SAP, from Microsoft, from Oracle as well as from our own internal sales force.

Sera Kim – GMP Securities

Okay. Great. And the mobility solution that you officially launched last quarter, would you be able to give us any I guess feedback in terms of reception so far and…

John Shackleton

Reception we have seen from our customers who are beta testing it have been very positive. We will be demoing it at the Analyst Days that, Greg, mentioned both at the Canada 3 seminar as well as the SAPPHIRE. So anybody who would like to see it, we would love to show it to them. General feedback from customers has been very positive.

Sera Kim – GMP Securities

What -- do you have an idea in terms or are you built to share, what your targets are in terms of revenue take up for the first year?

John Shackleton

We will probably keep you some more color on that next -- as we announce next year, next quarter for FY ‘11.

Sera Kim – GMP Securities

Okay. And just last question on your professional services as far as other things that, it sounds like things are -- I mean, am I right in assuming that you have got pretty high capacity utilization of your consultants and are you feeling a little bit constrained on that front?

John Shackleton

The -- so our utilization for existing consultants is pretty good so far and that’s Burntsand. Obviously, we could use additional capacity for our customers.

Sera Kim – GMP Securities

Okay. Great. Thank you.

John Shackleton

Thank you.

Operator

Your next question comes from Derrick Wood of Wedbush. Please go ahead.

Derrick Wood – Wedbush

Hi. Thanks. Did you see anything different on the competitive front in the quarter that may have altered sale cycles?

Paul McFeeters

No. Not at all, no. Not really. It has been the same for probably two years now.

Derrick Wood – Wedbush

Okay. And aside from the greater seasonality happening in Q3 and what you are expecting in Q4, are there things in the pipeline that are telling you that overall spending conditions are improving in Europe? Or are you still cautious as you look forward?

John Shackleton

We are seeing, specifically as we talked about the big deals, we are seeing significant amounts being spent, but it does seem to be more of the larger corporations. It’s -- I would see in the small to medium-sized companies there is still a concern around the global economy.

Derrick Wood – Wedbush

Okay. Then lastly, any update around partnering activity with Oracle?

John Shackleton

I didn’t see much in Q3, but there are a number of things going on that we -- I think we will have some interesting stories to talk about in the coming quarter.

Derrick Wood – Wedbush

Okay. Thank you.

John Shackleton

Thank you.

Operator

Your next question comes from Brian Freed of Morgan Keegan. Please go ahead.

Brian Freed – Morgan Keegan

Good afternoon. Quick question. You guys talked about general weakness in Europe across the board. But if you look at the competitive landscape, EMC and IBM showed some improving trends in their ECM business. Given that you guys have been historically gaining share versus IBM and EMC, can you talk a little bit about what you saw that might have driven this trend in terms of product set or timing? That type of thing?

John Shackleton

You mean gaining market share over Documentum and FileNet?

Brian Freed – Morgan Keegan

Yeah. You guys have been gaining share versus them, but this quarter they seem to have reversed that trend a little bit.

John Shackleton

We didn’t, we haven’t seen that. I would say that in ECM -- in EMC’s case, they’re a storage company, they are very good at doing that. They are -- most of the software people that were originally in the Documentum organization, there are very few of those left. And so -- and there’s not -- the focus that they had is not there as being part of a much larger hardware company. And I would say that four on the IBM side, global services is doing -- they like to do large complex, highly customized deals. And so while they might be doing well in some of those very large, very complex but very customized, they are not almost engaging on a -- in the general market where it is more out of the box, easy to use, that kind of thing. And so as well as our partnerships with people like SAP and Microsoft, those two vendors have not been involved in that. And we have seen that has been an advantage as well for us.

Brian Freed – Morgan Keegan

Okay. And secondly, if you look at the rollout of SharePoint 2010, do you see any risk that customers would delay implementations of Open Text products as they evaluate that, given your [Multiple Speakers]?

John Shackleton

We see that they are users who use SharePoint see it as an easy to use user interface. Our major customers who use our products around archiving and are usually highly scalable, interfaces to SAP and other applications, that they can’t get that from Microsoft anyway. So we see it as much more of a joint, they are using SharePoint because it is easy to use. They are using us for the backend, heavy lifting, highly scalable as well as things like Document, Digital Asset Management and other web content management that SharePoint doesn’t provide.

Brian Freed – Morgan Keegan

Okay. Thanks.

John Shackleton

But we see coexisting in many of their accounts. And we don’t see customers talking about one or the other.

Operator

Your next question comes from Eyal Ofir of Canaccord Adams. Please go ahead.

Eyal Ofir – Canaccord Adams

Okay. Thanks. Just wanted to touch back on some of the questions you had on the OpEx levels, more specific to sales and marketing. Obviously you talked about seasonality coming into the fourth quarter, being a lot stronger. Should we anticipate sales and marketing expenses going up at similar -- a much higher seasonal effect as well?

Paul McFeeters

Yes. I would think more thinking about more Q2, relatively to revenues looking at the cost in that respect. Because there will be differently a volume impact there.

Eyal Ofir – Canaccord Adams

So is that in terms of just sequential growth or are you talking more in terms of a percentage of revenue?

Paul McFeeters

Percentage of revenue re-commissions.

Eyal Ofir – Canaccord Adams

Okay. Perfect. And then the other question I had was, did you guys specify in terms of how much indirect sales you guys had through the channel, through SAP, Oracle, Microsoft?

Paul McFeeters

It was 38%.

Eyal Ofir – Canaccord Adams

38%. And can you just talk about a little bit on the Oracle partnership, how that is going? I know you talked a little bit earlier about seeing some stuff in the next quarter, but anything you can give us that gives us an indication that that is moving along?

John Shackleton

We’ll -- let’s give you more next quarter on that. We do see relationships with them picking up and as I said we -- there will be some more concrete things for you next quarter.

Eyal Ofir - Canaccord Adams

Okay. And then one final question from me, on the license side, are you seeing any pricing pressure at all from potentially there are some incumbents or smaller players in the market?

John Shackleton

Not really. We haven’t seen much change over the past 18 months, two years.

Eyal Ofir - Canaccord Adams

Okay. Perfect. Thanks. I’ll pass the line.

John Shackleton

Thank you.

Operator

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

Blair Abernethy - Thomas Weisel Partners

Thanks. Just a question for you, Paul. On the -- in the past, you have been able to put through annual maintenance pricing increases. I’m just wondering where you stood on that this year and whether that was across the board, if you were able to do it or was it just specific on certain products?

Paul McFeeters

No. We are able to get it again. I think we’ve mentioned in the past that we are probably before the last couple of years of sort of economic downturn, we are likely in the three to five range and now we are more in the 1% to 3%, if you look at it across the board. I don’t think it’s categorized in any particular way from one product to the other. I think it is more company-specific.

Blair Abernethy - Thomas Weisel Partners

Okay. Great. And just on the question of Burntsand, given that might close here in the next 30 to 60 days, I guess, are you including that in your outlook for the balance of the year?

Paul McFeeters

No, not Burntsand.

Blair Abernethy - Thomas Weisel Partners

Okay. And then just turning over to some of the new license sales, John, you know 35% of the business coming out of new customers. I’m wondering if you could expand on that a bit and give us some sense of what products are working for you out there now? I haven’t -- we haven’t heard you talk about Social Media today at all and also sort of what verticals might be working for you?

John Shackleton

So on that, we are seeing for the new customers a lot of government, products pretty much the archiving, the obviously SAP interfaces, the web content management is strong. And with that obviously -- the Social Media will follow with that. So Social Media we just released this past quarter so that will begin to be having an effect. But the key verticals that we see strong, certainly for the coming year, would be in the government and government-related industries like utility, financial services and broadcasting, that kind of thing and we see those being strong. Obviously, our Digital Asset Management product for broadcasting is doing very well.

Blair Abernethy - Thomas Weisel Partners

Okay. Great. And did you -- I don’t think you updated us on the size of the sales force. Are there any sales force changes?

John Shackleton

It’s around 230 [accordingly], sorry, 330. Blair, I think last quarter, it was 350. So it’s down a little bit as we have done some -- as we are getting ready for the new year but not insignificant. We still have good capacity.

Blair Abernethy - Thomas Weisel Partners

Okay. Great. Thanks very much.

John Shackleton

Thank you, Blair.

Operator

(Operator Instructions) Mr. Shackleton, there are no further questions at this time. Please continue.

John Shackleton

Okay. So thank you for your questions and just a highlight on Q3. While we are pleased with our profitability for the quarter, we are not particularly happy with the revenue results but we are comfortable with EPS consensus and believe our revenue will be in range for fiscal 2010. That concludes our call for today and thank everyone for participating and for your questions.

Operator

Ladies and gentlemen, this concludes the conference call for today. Thank you for your participation and you may now disconnect your lines.

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Source: Open Text Corporation Q3 2010 Earnings Call Transcript
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