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Open Text Corporation (NASDAQ:OTEX)

F4Q08 Earnings Call

August 19, 2008 5:00 pm ET

Executives

Greg Secord – Vice President, Investor Relations

John Shackleton – President, Chief Executive Officer

Paul J. McFeeters – Chief Financial Officer

Analysts

Scott Penner - TD Newcrest

Paul Steep - Scotia Capital

Richard Tse - National Bank Financial

Michael Abramsky - RBC Capital Markets

Lawrence Rhee - Blackmont Capital

David Wright - BMO Capital Markets

Barbara Coffey - Kaufman Bros.

Blair Abernethy - Thomas Weisel Partners Canada

Dushan Batrovic - Canaccord Capital

Gabriel Leung - Paradigm Capital Inc.

Tom Liston - Versant Partners Inc.

Mark Schappel – The Benchmark Company

Operator

Welcome to the Open Text Corporation fiscal 2008 fourth quarter financial results conference call. (Operator Instructions) I will now turn the conference over to Greg Secord.

Greg Secord

Today we will be discussing our financial results for the fourth quarter in fiscal 2008 which was released earlier this afternoon. With me today are John Shackleton, our President and Chief Executive Officer, and Paul McFeeters, our Chief Financial Officer. As with previous calls, after our prepared comments, the operator will poll for questions.

We’ll get started in a moment, but first I will read our disclaimer. During the course of this conference call, we may make projections or other forward-looking 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 conclusion, forecast or projection in the forward-looking information. Certain material, factors or assumptions were implied in drawing a conclusion or making a forward forecast or projection as reflected in the forward-looking information.

Additional information about the material factors or assumptions that could cause actual results to differ materially from the conclusion, forecast or projection in the forward-looking information and the material factors or assumptions that were implied in drawing a conclusion or making a forecast or projection as reflected in the forward-looking information are contained in Open Text’s Form 10-K for the fiscal year ended June 30, 2007 and in the press release that was issued earlier today.

Now I will turn the call over to John Shackleton.

John Shackleton

Before we review the financials, I’d like to comment on our performance for the fiscal year. Clearly, Q4 was an excellent end to what was the most successful year in the company’s history. We beat our own internal goals, generating record revenues, profits and cash flow for the fiscal year.

Open Text’s employees worked very hard throughout the year to expand our global presence and we made great progress in development, sales and in our back-office systems. Congratulations are in order for all of our employees. I would also like to thank our customers and partners for their tremendous support throughout the year.

I will provide greater detail from the quarter in a few minutes but first I’ll hand the call to Paul for a detailed review of our financials.

Paul J. McFeeters

Turning to the financial results for the fourth quarter in fiscal year 2008, total revenue for the quarter was $200.3 million, up 14% compared to $175.2 million for the same period last year. License revenue for the quarter was $68.2 million, up 15% compared to $59.2 million for Q4 of last year.

Maintenance revenue for the quarter was $95.1 million, up 16% compared to $82.2 million last year. Professional services revenue in the quarter was $37.1 million, up 10% compared to $33.8 million in the same period last year.

We reported fourth quarter adjusted net income of $33.3 million or $0.63 per share on a diluted basis, up 25% compared to $26.7 million or $0.52 per share on a diluted basis for the same period a year ago.

Cash flow from operations for the quarter was $44.6 million, up 56% compared to $28.6 million in Q4 of last year. Gross margin for the fourth quarter before amortization of acquired technology was 73.9% compared to 73.3% in the fourth quarter last year.

Pre-tax adjusted operating margin before interest expenses was 24.1% in the fourth quarter compared to 25% in the same quarter last year. With respect to our adjusted earnings, the tax rate for the quarter is 30%. Actual cash taxes payable continue to be in the 15% to 20% range.

Net income for the fourth quarter in accordance with GAAP was $27.3 million or $0.51 per share on a diluted basis compared to $8.2 million or $0.16 per share on a diluted basis for the same period a year ago. The fully diluted share count for the quarter was approximately 53.1 million shares.

As of June 30, 2008, deferred revenue was $176.9 million compared to $181.9 million as of March 31, 2008. Accounts receivable as of June 30 was $134.4 million compared to $135.7 million as of March 31, 2008. Paid sales outstanding was 60 days as of June 30 compared to 68 days for the previous quarter and 66 days for Q4 of last year.

Term loan balance as of June 30, 2008 was $294 million which we reduced from $390 million in October 2006 through scheduled repayments of $6 million and accelerated payments of $90 million.

Turning now to our fiscal 2008 results, total annual revenue was $725 million, up 22% from $595.7 million in fiscal 2007. License revenue for the fiscal year was $219.1 million, up 20% compared to $182.5 million last year, while maintenance revenue was $363.6 million compared to $287.6 million last year. For the full fiscal year, product license and product maintenance revenues accounted for 80% of our annual revenues with the remaining 20% related to our professional services.

Adjusted net income for the fiscal year 2008 was $107 million, up 44% compared to $74.3 million for fiscal 2007. Adjusted earnings per share on a diluted basis of $2.03 was an increase of 39% over $1.36 per share on a diluted basis for fiscal 2007.

Gross margin of the fiscal year before amortization of acquired technology was 73.7% compared to 72.2% in the prior year. Pre-tax operating margin before interest and stock compensation was 24.3% for fiscal 2008 which is up from 21.8% last year. The overall tax rate for adjusted earnings was 30% compared to 32% in the prior year.

On a GAAP basis, we reported net income for the year of $53 million or $1.01 per share on a diluted basis compared to a net income of $21.7 million or $0.43 per share in fiscal 2007. Net cash flow from operations for the fiscal year was $166 million, up 50% compared to cash flow from operations of $111 million in fiscal 2007.

The effect of foreign currency on our net operating results was a positive $0.03 per share.

As we stated in the past, Open Text is very closely matched in income and expenses for euros, British pounds, Swiss francs, and other non-U.S. currencies. We are mismatched primarily in Canadian dollars which represent 7% of total revenues and 25% of total expenses.

Referencing our pre-tax adjusted operating margin model, we remain confident in our plans 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, 2% for depreciation. This will generate a pre-tax operating margin of 20% to 25% and as demonstrated in our results throughout the fiscal year, we expect to continue in the upper end of that range. A copy of our business model is available on our website as part of the investor PowerPoint presentation.

Now, I will turn the call back to John.

John Shackleton

As Paul mentioned earlier, we’re very pleased with our Q4 results and with our annual results. In Q4, Europe was responsible for 50% of the revenue, North America, 45%, and the remaining 5% coming from Asia-Pac. We saw particular strength in Europe driven by demand for compliance-based solutions but we’re also happy with our sales performance in all regions and all verticals.

As Paul mentioned, we generated $68.2 million in license revenue in the quarter growing 15% over last Q4. Of this license revenue, 23% came from new customers and 77% from our install base.

On an annual basis, our license revenue grew at 20%, exceeding the industry analysts’ forecast of 8% to 13%. As Paul mentioned, we had a little help from currency but still our normalized growth rate was roughly in the 13% to 15% range.

In Q4, we saw license revenue broken down by vertical, at 36% from high-tech manufacturing, 15% from government, 11% for financial services, 9% from energy, and 5% from pharmaceutical and life sciences.

Taking a closer look at the transactions in the quarter, we have eight transactions over $500,000 and an additional seven transactions over $1 million with notable wins in financial services and high-tech manufacturing. This influenced the average transaction size to approximately $300,000 which was slightly up from prior quarters.

Examples of significant wins in the quarter include Pacific Life Insurance who’s expanding its existing Livelink implementation with the addition of Livelink ECM content life cycle management, e-mail management, SharePoint integration, and file server archiving. The solutions provide Pacific Life Insurance with a comprehensive Enterprise-wide ECM suite.

Fender Musical Instruments, the world’s #1 maker of stringed instruments purchased Livelink ECM content life cycle management. The solution when combined with Livelink Document Access for SAP provides Fender with end-user access to structured and unstructured data to improve their business processes.

Lincoln Electric, a leading provider of advanced welding and cutting technologies, purchased Livelink ECM content life cycle management, e-mail management and monitoring file system archiving and Livelink Collection Server. Their immediate goals were to reduce costs and increase efficiency in the areas of e-Discovery, documents and records management.

From a sales operating standpoint, we closed the quarter with a combined sales force of over 259 quota-carrying sales execs. Given the strong market, we’ll continue to invest more in our sales and marketing efforts.

SAP, Oracle and Microsoft all contributed to report increasing partner demand for solutions in archiving, records management, and compliance. License revenue from partners was approximately 30% in the quarter and 35% for the full fiscal year which was in line with our targets. An example of these partner-influenced transactions include a multi-million dollar deal with Microsoft and an European telco to streamline its IT operations and reduce costs by archiving SAP documents and Exchange server public folders onto lower-cost storage devices using Open Text’s e-mailing archiving for Exchange and file system archiving for SAP.

Keeping in line with our corporate strategy, we recently made two small acquisitions. First, we acquired all of the assets of the Spicer Corporation division that specializes in file format viewer solutions for desktop applications, integrated business processes and repo-graphics. We acquired them for approximately $12 million. This transaction was affected July 1, 2008 and is not included in our Q4 results. Secondly, we acquired eMotion from Corbis Corporation for approximately $5 million. The eMotion division will become part of Open Text’s Digital Media Group extended Open Text’s digital media capabilities as part of its Enterprise 2.0 strategy. Again, this transaction occurred after we closed the fiscal year.

In the quarter, we announced that Open Text received the highest rating possible as a strong positive in analyst firm Gartner’s 2008 Market Scope for records management. Gartner recommends that customers consider companies with this rating as a strong choice for their strategic ECM investments.

Building on our growing relationship with Microsoft, we announced that our Enterprise Library Services offering has received the 35 Windows Server 2008 designation. The announcement demonstrates Open Text’s continued leadership as an early supporter of the latest Microsoft technologies.

Further on the partner side, with SAP, we announced Open Text Web Solutions for use with SAP solutions. Our web solutions complement the content management capabilities of the SAP NetWeaver portal helping organizations to easily apply business rules to their content, further align them to choose their audience and helping them to ensure the right person gets the right content at the right time.

We are also pleased to announce that Open Text received the SAP Pinnacle Award in the category of Software Solutions Field Engagement. SAP Pinnacle Awards are granted to the select few SAP partners that have excelled in developing their partnership with SAP by providing high-quality products, solutions and services to customers.

On the events side, we hosted Livelink-Up Europe which was a big success with almost 2,000 attendees in three cities. We established a new attendance with many key partners present, representing a good cross-section of industries. We showcased our ECM road map including specific vertical partner-based solutions.

As an illustration of the final stages of our product integration, we’ve announced the branding of our global user conference on Open Text Content World. This will be held in Orlando from November 17 - 21.

Turning now to our outlook for FY09, industry analysts are telling us that ECM should grow into the 10% to 13% range. As we look at fiscal 2009, I feel confident that we’ll be well within that range. Our revenues’ seasonality trends in the coming year should be similar to the seasonality that we experienced in fiscal 2008 and we feel very comfortable with the current street consensus for top and bottom line in Q1 as well as for the next fiscal year. We’re very well positioned for another successful year going forward.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Scott Penner from TD Newcrest.

Scott Penner - TD Newcrest

John, you mentioned last quarter, you highlighted some of the activities that you had in Web 2.0 technologies and one of the acquisitions was kind of based around that. Can you give us an update on that in general and then some of your revenue diversity and whether compliance-related solutions are still around 60% to 70% of the license revenue?

John Shackleton

That’s right, Scott. There is a lot of interest, we’re seeing in 2.0, both in Europe and North America. We see interest in that area. We’re seeing a lot from our existing customer base moving towards these solutions. From a market standpoint, we’re seeing about 60% of the revenue driven by compliance. We’ve also seen a slight change in the market in that a number of our customers are looking to expand their ROIs and their existing products. For example, interfacing to SAP or to Oracle or to Microsoft, where as they are getting a better return on investment from those products by linking them with the Open Text product suite. So we have seen a slight change in compliance but it’s still in the 60% range.

Scott Penner - TD Newcrest

Just as far as the million-dollar deals go, seven is the highest number in quite some time. Can you give a little bit more detail on how many of those were in connection with partners, whether there were any sizeable deals and of the million-dollar deals that were

not in connection with partners, what was driving it?

John Shackleton

I would say between the partner involvement and us, it was about 50/50 on the big deals. Probably the biggest was partner-related with Microsoft. Probably geographically, it was a 50/50 split. From an industry standpoint, the biggest were in high-tech manufacturing and then the second would actually be financial services.

Scott Penner - TD Newcrest

Lastly for me is, Paul, on the net interest expense, it looked quite a little bit lower than it has been in the past couple quarters. Can you shed some light on what’s in there?

Paul J. McFeeters

When we did our loan, we put in a hedge. For about 50% of the loan at one time, it was $190 million. It goes down over time. It is a three year hedge. Presently, it is $150 million, where we did floating to fixed. With the floating to fixed hedge we have to do a mark-to-market which is really a non-cash entry into our financials. So what’s been happening actually through the fiscal year is that we’ve been getting a mark-to-market charge for each of the previous three quarters, and now we have a mark-to-market positive. So we have a $2.4 million credit if you will in the interest expense line because of the adjustment in the obligation of the mark-to-market. This obligation of mark-to-market will never be cash and it will all zero out by the end of the three-year term but it has fallen from quarter to quarter. That’s a large reason. The interest income is up as well, about half a million dollars.

Scott Penner - TD Newcrest

So the $2.4 million is the hedge. So what was it for the year?

Paul J. McFeeters

For the year, we would have had a charge for the year generally of $2.8 million.

Operator

Your next question comes from Paul Steep from Scotia Capital.

Paul Steep - Scotia Capital

John, maybe we can talk a little bit on license growth, just to follow on there as to what’s really been the driver or the strength there throughout the year. Has a lot of it been through a combination of the existing upgrades cycle with DMX, the partner channel? Just trying to get a sense of the sustainability of the drive of that going into ’09.

John Shackleton

I would say, Paul, both of the things you mentioned. One is the partner program is obviously working. We’re seeing strong pipeline from our partners. In many cases, the partners are actually new customers. On our existing customer base, we’re seeing more towards, as I mentioned, we’re looking for allies on existing software where they’re getting better returns, interfacing to things like SAP, Oracle and Microsoft. So it’s probably 50/50 between those two.

Paul Steep - Scotia Capital

In terms of the upgrade cycle, we’re still, because last quarter you had some small comments about it, still early stages, do you see it running throughout ’09 into ’10 or where are we at on that?

John Shackleton

We certainly see a strong pipeline, certainly for the next six months we feel very confident. The general feeling is certainly throughout the rest for the fiscal year, the analysts are saying pretty much the same thing. It will be a little bit soft in North America but it is being made up in Europe and Asia, Asia-Pac.

Paul Steep - Scotia Capital

The final one for me for Paul. The other income of $11.3 million, it is a fairly material change over there. I just wanted to see what item sort of popped up there in the quarter. It’s sort of abnormal.

Paul J. McFeeters

That’s primarily due to foreign exchange. The effect of converting non-U.S. functional currencies to our various subsidiaries can kick up. Actually, it swings on gains or losses on foreign exchange and that’s what that is primarily.

Operator

Your next question comes from Richard Tse from National Bank Financial.

Richard Tse - National Bank Financial

John, just curious to see, what you’re charting this year in terms of the partner contribution to your revenue and I wanted to get a sense too on the partner side, would you say that’s all of your major partners that you’ve called on have hit their stride or are we still fairly early in terms of their gaining traction in their system?

John Shackleton

I would say, Richard, that SAP is ahead of the others. Obviously, we’ve had a longer relationship there but we’ve seen very positive strides from Microsoft and see a good pipeline with them, also with Oracle as well. They are all coming up but the last two are as not as mature as obviously our SAP relationship.

Richard Tse - National Bank Financial

So do you see your partner contribution moving up to 40+% this year?

John Shackleton

My goal would be to see it up 40%, in that range, yes.

Richard Tse - National Bank Financial

In terms of your cash flow, I guess you previously paid down some incremental debt here, I think you’re holding back on that. Can you enlighten us on why you continue to do that?

Paul J. McFeeters

Yes, Richard, this is Paul. As we said in the past, if we feel that we see potential opportunities in the future as we look at the same type of acquisitions, we think that’s one reason not to accelerate the repayment. Yet again, we are at a below 6% rate and today, to replace that debt would be somewhere between 7.5% to 8%. We think again in terms of balance sheet management, it’s not bad to have the debt there, particularly at that rate. Our low-color ratios are less than two times, coverage is at eight times. So there’s no cover risk to the company. Those are the three primary reasons for leaving the debt, just with the normal repayment terms.

Richard Tse - National Bank Financial

Just one final question here. When you look at Scott’s question on the Web 2.0 products and you suggested that you are getting some traction here now, would that be over and above what you’re forecasting as your fiscal ’09 internal numbers or is that baked in here already?

John Shackleton

I would say that’s baked in as we look at the total portfolio, that’s what we’d see. Around those areas, we have seen growth in the 20% range in this past year. So it’s going very well.

Operator

You next question comes from Mike Abramsky from RBC Capital Markets.

Michael Abramsky - RBC Capital Markets

Just in terms of the deals and momentum. Would you characterize this as an unusual quarter? Is this kind of a trend that you are seeing now because of the momentum you’re building on partnerships and the direct sales force execution? Is this something that we can expect to continue through the rest of the year as you talked about you are comfortable with the outlook?

John Shackleton

Mike, the execution on the sales force is going extremely well. I think there’s been some of the competition that has been disrupted this year and we’ve obviously benefitted from that. We just had our sales kick-offs and there is very positive outlook. We have some tremendous people. So I would see that progressing. We have invested in this past year in our partner programs so we have some great people supporting our partners as well. I feel pretty confident that this will continue.

Michael Abramsky - RBC Capital Markets

I’m sorry, I jumped on the call late but did you talk about if any of those specific deals were done in partnership with either Oracle, Microsoft or SAP?

John Shackleton

I mentioned, Mike, that the first deal, the large deal, the one on the 7th, was with Microsoft.

Michael Abramsky - RBC Capital Markets

Was that deal significantly over $1 million?

John Shackleton

Yes.

Michael Abramsky - RBC Capital Markets

I know you did a large deal with Microsoft two quarters ago so can you tell us a little bit about why, if it was two, you can correct me, can you tell us why you’re seeing that kind of traction and under what situations given that obviously SharePoint is at the given time a competitive product?

John Shackleton

It’s mainly where SharePoint is being used in an Enterprise-wide highly-scalable organization where we can enhance and help manage that product efficiently as well as in conjunction with SAP products.

Michael Abramsky - RBC Capital Markets

So are those existing Livelink clients or new clients?

John Shackleton

This was an existing client but almost a new division, if you will.

Michael Abramsky - RBC Capital Markets

Do you see SharePoint anytime soon changing to address the kind of Enterprise-wide scalability that you’re able to fill at this time?

John Shackleton

I believe, Mike, that while it will improve in certain areas, we’ve been working with Microsoft building joint product road maps that we can continue to work certainly for as I see it, 3, 5 years plus where we can enhance and help them with their products.

Michael Abramsky - RBC Capital Markets

I am going to ask this because I didn’t get to the elephant in the room. John, you can choose to comment or not, I suppose. The short position has obviously been a huge and constant factor. You’ve now executed strongly eight quarters of beating the street in a row, steady margins, Hummingbird’s kind of close successfully, is there any issues there that you are asked about that are related to that, that you continue to dog it? Is there any reason why the thing doesn’t go away?

John Shackleton

We cannot see a reason why. We talk to many people about it. At the end of the day, we believe keep performing, keep putting the numbers up. The answer there is there is nothing there that we know of.

Operator

Your next question comes from Lawrence Rhee of Blackmont Capital.

Lawrence Rhee - Blackmont Capital

Can you just add some color, Paul, on the cost side, on the sales and marketing side? It was just a little bit higher than what we were looking for. Were there any kinds of costs in there that you categorize as one-time in the operating expense side?

Paul J. McFeeters

Because of both the success of our license production and typically accelerations of year-end quarters, there would be a one-time commission charge that would normalize out again in Q1 next year. In closing large volumes of transactions, you have all of the related expenses such as travel that would be up. So I think that anything that you would identify as a blip up in sales will normalize going into the new fiscal year.

John Shackleton

I think you would see it in most cue points as you look back at last year. It’s not unusual. There’s nothing out of the ordinary for Q4.

Paul J. McFeeters

There’s not a run-rate increase. It’s just one-time items.

Lawrence Rhee - Blackmont Capital

Can you just add some color, obviously the economic market still remains shaky and just add some color, obviously you guys had some great deals fall in the quarter. Just some color on the sales cycle process. Is it improving for you or how has it transitioned over the past couple months?

John Shackleton

These past two quarters, I feel confident that our sales team are performing, being very productive, better than what I have seen in a long time. That has something to do with it. I think also, as I mentioned before, some of the competition are in disarray so that’s had something to do with it. But also we had, as we see for example, the U.S. government has been tough for quite a while. We’ve made up for that in other regions. So it’s kind of balanced itself out.

Operator

Your next question comes from David Wright from BMO Capital Markets.

David Wright - BMO Capital Markets

Can you talk about the large deal size? Did you have more than one over $2 million, or sorry, your number was seven over a million dollars? I’m just wondering how large some of those deals are.

John Shackleton

On average, they were just slightly over a million dollars for the most. There was one multi-million but the rest were just a million or slightly over.

David Wright - BMO Capital Markets

So I noticed that your average deal size is climbing. Is that because of the greater number of multi-million dollar deals or are you actually selling more even on the smaller deals? Is the average deal size rising?

John Shackleton

It was mainly skewed by the big deals.

David Wright - BMO Capital Markets

So we should see on a seasonality view as we go into Q1, we might expect fewer larger deals for the average deal size?

John Shackleton

I think you will be back to that $250,000 range.

David Wright - BMO Capital Markets

As your product becomes larger and more complicated, I’m just wondering if there is more of an opportunity for services revenue and revenue growth looking at the business model. Is that something that is an opportunity?

John Shackleton

Actually, David, the PS organizations, we’ve tried to keep it constant around this mark where our goal is basically to help the customer get the product up and running and using it as quickly and efficiently as possible. This past year we have been doing a lot of enablement to get our partners also providing the services for our customers. We don’t particularly want to grow, we could easily grow the revenues for professional services higher if we wanted to because there is a demand.

Operator

Your next question comes from Barbara Coffey from Kaufman.

Barbara Coffey - Kaufman Bros.

Taking a look at the sale cycles around the world in this past quarter, have you seen any additional thresholds in sign-offs or altering deal sizes to see if there are smaller chunks then and whether or not that has changed based on geography?

John Shackleton

It really hasn’t changed, Barbara, over the past two years. I would say that that’s been the case where as most sign-offs, more chunking. This has been across both North America and Europe. I have seen us be more efficient in our pipeline management and closing over the past six months as we’ve gotten a most seasoned sales force.

Barbara Coffey - Kaufman Bros.

Do you see any difference between the process whether or not it is a direct sale or whether or not it’s with partners and the timing or process it takes to get compensated?

John Shackleton

What I would say is that over the past six months, we’ve been able to see more visibility on the partner pipeline. Previously, as we’ve built relationships with partners, there’s much more sharing of what’s in the pipeline and what stage of the pipeline is. So we’ve seen more visibility in the partner pipeline than we have previously.

Operator

Your next question comes from Blair Abernethy from Thomas Weisel Partners.

Blair Abernethy - Thomas Weisel Partners Canada

Paul, I just wanted to ask you a little bit about the maintenance base. I wondered if you could just talk a little bit about how the renewal levels are there and so what’s the pricing environment looking like for maintenance renewals? Also what is your sense on the Hummingbird maintenance base?

Paul J. McFeeters

Environmental renewals are still about the 92% to 93% range. The team continues to get what I would call pretty effective increases on a year-over-year basis. So that’s helping good increases in the attrition of the range of 6% to 7%. We were very pleased with a continuance in the customer base in Hummingbird. So we’ve enjoyed that and it’s experiencing the same high level of renewals that we found at Open Text.

Blair Abernethy - Thomas Weisel Partners Canada

Just on the sales and marketing side again. Can you give us a sense of where you plan on taking that rep count in 2009, so what you have today, how much of the rep community is sort of seasoned versus people who are still ramping?

John Shackleton

We have hired a number of people in this past quarter as we ended the fourth quarter. So after our sales kick-offs, we got those people onboard. We have probably a 30% overage capacity in the sales force. At this point in time, we have certainly enough to feel comfortable with our numbers but we do see potential opportunities in places like Russia or China where we might be working with partners, we might expand those groups.

Blair Abernethy - Thomas Weisel Partners Canada

Any change in the competitive landscape this quarter for you guys?

John Shackleton

Not really, no.

Operator

The next question comes from Scott Penner from TD Newcrest.

Scott Penner - TD Newcrest

John, if you can get a little bit more into the acquisition strategy as it stands right now? There were a couple of very small deals in the quarter. You previously talked about looking at solutions providers in areas like SAP. Is that still an area that we should look for you to be active in and is there more material transactions, I guess, on the horizon?

John Shackleton

The strategy remains the same. We do see applications solutions particularly with our partners like SAP, Oracle, etc. that we will continue to look at. So there’s really no change in that. We see a lot of opportunities. We feel that the market is getting hotter if anything.

Scott Penner - TD Newcrest

So you still see the valuation as not being fertile in some of the deals that you are looking at?

John Shackleton

That’s correct.

Scott Penner - TD Newcrest

Paul, should we assume that the tax rate stays at this 30% level to last year?

Paul J. McFeeters

That’s correct.

Scott Penner - TD Newcrest

Lastly, John, just a little bit more on the status of the Hummingbird upgrade cycle. I think you started to get a little bit into this earlier. Do most of the Hummingbird base now have Enterprise connect capability and when do you expect some of the real upgrade license revenue to start producing?

John Shackleton

They have the upgrade capability now and we believe we will start seeing it, my guess is November that we should start to see pick-up in that area. After we have the conference is when things start to pick up.

Operator

Your next question comes from Dushan Batrovic from Canaccord Capital.

Dushan Batrovic - Canaccord Capital

Some of the big concerns out there are around softer IT spending across the board. I’m just wondering how well insulated you feel that the industry does not grow at the 10% to 13% that analysts predict but 5% to 6%. Can you beat that number given the focus on the compliance side given to the exposure of a broad-base of verticals that will not be as necessarily shaped as the broader IP markets?

John Shackleton

From the studies we’ve seen, we saw that IT spend for the coming year was supposed to be, I think in a worldwide basis, something like 3.5%. That study was kind of tempered a little bit. They did another follow-up study in the U.S. where they brought it down in the U.S. to about 3.25%, although it was still averaging close to 3.5%. The #1, #2 most spend was going to be in security and ECM. We were the second largest piece of software spend in that budget. We see particularly strong compliance in Europe and we are beginning to see in Asia as well. I feel very comfortable on the 10% to 13%, looking six months out, we are feeling very comfortable.

Dushan Batrovic - Canaccord Capital

Can you just remind us what the rest of the 40% of the business that isn’t tied to compliance, what that is driven by?

John Shackleton

It’s driven by existing customers basically linking their unstructured data to their structured data for things like web content management, management solutions, digital asset management solutions, those kinds of things. There is a lot around linking their structured information with their unstructured, archiving e-mails, etc.

Operator

Your next question comes from Gabriel Leung from Paradigm Capital.

Gabriel Leung - Paradigm Capital Inc.

The large deal in the quarter, can you comment on whether that was greater or less than 10% of total license revenues?

John Shackleton

Less. I don’t believe we have ever had a quarter where one deal was more than 10% of the revenue.

Gabriel Leung - Paradigm Capital Inc.

So between 5% to 10%?

John Shackleton

Less than that. We don’t want to go there.

Gabriel Leung - Paradigm Capital Inc.

As I look across the half million and million dollar plus deals, can you comment on what percentage of that was displacements, how much of that was existing customers and of the displacements, what was some of the common rationale from moving from a different platform over to you guys?

John Shackleton

I think I mentioned, on our existing customer base, it is close to 70%, something like that over existing customers. On the new displacements, a lot of it has to do again with the ability to interface tightly with structured information from people like SAP and Oracle, etc. So that would be a lot of the displacements.

Gabriel Leung - Paradigm Capital Inc.

Paul, the main margins, I think are down to around 81% for this quarter. Can you comment on that and what your expectations would be going into the next few quarters? Do you expect that to jump back to the 84% to 85% range again?

Paul J. McFeeters

Yes, I do. Basically, in Q4, just to go a long way for now, you can expect us getting back up into what you saw for the year in total, close to the 84% range.

Operator

Your next question comes from Tom Liston from Versant Partners.

Tom Liston - Versant Partners Inc.

John, just on the nice bead on the quarter with license revenue. In terms of the competition being distracted, the sales execution, etc., as much as aiding partners, that’s all true, do you think there might have been a little bit of focus in there saying that they’re pulling in some of the spending for this quarter because they are worried on the second half, that the budgets might get reduced given the amount of macroeconomic backdrop?

John Shackleton

I haven’t seen that. What I’ve tried to do, is visit 5-9 CIOs a quarter, and just talk in general about what they see going on. That’s not been one of the issues. In the U.S., there is a concern about the economy, but again, coming out of that study I mentioned, where there was 3.5% increase in spending, there was still spending going on. So they were being cautious but they certainly had the budgets to do what needed to be done. I haven’t

Tom Liston - Versant Partners Inc.

In Europe, you’re not seeing any weakness there, the economy is starting to turn as well.

John Shackleton

Not in the areas that we are in, no.

Tom Liston - Versant Partners Inc.

Finally, just a clarification, I believe you said that your growth in license was 13% to 15% of you normalized it. Does that mean in constant currency? Is that the comment that you made in your prepared remarks?

John Shackleton

That’s right.

Tom Liston - Versant Partners Inc.

That was for the year, right?

John Shackleton

That’s for the year, correct.

Operator

Your next question comes from Mark Schappel from Benchmark.

Mark Schappel – The Benchmark Company

Paul, why did the net interest expense essentially go away in the quarter?

Paul J. McFeeters

The significant portion of that, as I said earlier in the call, was that we do have an accounting adjustment mark-to-market for the hedge that we have in place for the debt. So when the debt originated, we put 50% in and in a floating to fixed hedge and since it is treated as fluctuated, we have to do a mark-to-market each quarter. It’s a known cash charge and mostly through the year, it’s been a charge that, mostly in this quarter, it has been a reversal of some of that. It is about a $2.4 million credit to that expense line. The other part comes out at about a half a million dollars.

Mark Schappel – The Benchmark Company

Going forward, is it wise to go back to just modeling a more normalized interest expense?

Paul J. McFeeters

It is, yes.

Mark Schappel – The Benchmark Company

On the $11.3 million other income benefit, can you just review one more time, I believe you said it was related to foreign exchange. It just seems like such a large change from prior quarters though. Can you give a little color on that?

Paul J. McFeeters

Some of the reasons that you would change from prior quarters is classifying certain foreign currency, inter-company loans. Sometimes you change the view of it from a permanent to a non-permanent so that can change the way you reflect things in the quarter.

Operator

Your next question comes from David Wright from BMO Capital Markets.

David Wright - BMO Capital Markets

Paul, looking at the balance sheet, there’s quite a change to the tax positions. I was wondering what was driving them, was it a reclassification that maybe had to do with the acquisitions you did and will this affect cash flow in the coming year at all?

Paul J. McFeeters

Well, let me deal with cash flow. It won’t affect cash flow. In comparing it year-over-year, yes, there was some reclassification due to the introduction of Fin 48 to the beginning of the fiscal year, so you would see that change in looking at year-over-year balance sheets. That would be what that would be about. In terms of cash flow and taxes, no, we would expect us to continue being in the 15% to 20% range.

David Wright - BMO Capital Markets

So no cash flow carried forward in those acquisitions, are they at all reflected in here?

Paul J. McFeeters

No, they wouldn’t be. One was just an assets purchase, the other wouldn’t be material. It wouldn’t be reflected there.

Operator

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

John Shackleton

Thank you all for your questions. Just to wrap-up on the quarter highlights, Q4 was an excellent end to a record year for Open Text. I’m very positive on our outlook for fiscal 2009. We’ve exceeded both our revenue and profit goals while generating strong cash flow from our operations. Our partnership programs are working very well and we continue to focus on selling in these areas. This concludes our call for today. Thanks everyone for participating and thank you for your questions.

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Source: Open Text Corporation F4Q08 (Qtr End 06/30/08) Earnings Call Transcript
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