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OPEN TEXT CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q, including this Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A), contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 21E of the U.S. Securities Exchange Act of 1934, as amended (the Exchange Act), and Section 27A of the U.S. Securities Act of 1933, as amended (the Securities Act), and is subject to the safe harbours created by those sections. All statements other than statements of historical facts are statements that could be deemed forward-looking statements. When used in this report, the words "anticipates", "expects", "intends", "plans", "believes", "seeks", "estimates", "may", "could", "would", and other similar language, as they relate to Open Text Corporation ("OpenText" or the "Company"), are intended to identify forward-looking statements under applicable securities laws. Specific forward-looking statements in this report include, but are not limited to: (i) statements about our focus in the fiscal year beginning July 1, 2014 and ending June 30, 2015 (Fiscal 2015) on growth in earnings and cash flows; (ii) creating value through investments in broader Enterprise Information Management (EIM) capabilities; (iii) our future business plans and business planning process; (iv) statements relating to business trends; (v) statements relating to distribution; (vi) the Company's presence in the cloud and in growth markets; (vii) product and solution developments, enhancements and releases and the timing thereof; (viii) the Company's financial conditions, results of operations and earnings; (ix) the basis for any future growth and for our financial performance; (x) declaration of quarterly dividends; (xi) the changing regulatory environment and its impact on our business; (xii) potential loss of recurring revenues; (xiii) research and development and related expenditures; (xiv) our building, development and consolidation of our network infrastructure; (xv) competition and changes in the competitive landscape; (xvi) our management and protection of intellectual property and other proprietary rights; (xvii) foreign sales and exchange rate fluctuations; (xviii) cyclical or seasonal aspects of our business; (xix) capital expenditures; (xx) potential legal and/or regulatory proceedings; and (xxi) other matters. In addition, any statements or information that refer to expectations, beliefs, plans, projections, objectives, performance or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking, and based on our current expectations, forecasts and projections about the operating environment, economies and markets in which we operate. Forward-looking statements reflect our current estimates, beliefs and assumptions, which are based on management's perception of historic trends, current conditions and expected future developments, as well as other factors it believes are appropriate in the circumstances. The forward-looking statements contained in this report are based on certain assumptions including the following: (i) countries continuing to implement and enforce existing and additional customs and security regulations relating to the provision of electronic information for imports and exports; (ii) our continued operation of a secure and reliable business network; (iii) the stability of general economic and market conditions, currency exchange rates, and interest rates; (iv) equity and debt markets continuing to provide us with access to capital; (v) our continued ability to identify and source attractive and executable business combination opportunities; and (vi) our continued compliance with third party intellectual property rights. Management's estimates, beliefs and assumptions are inherently subject to significant business, economic, competitive and other uncertainties and contingencies regarding future events and, as such, are subject to change. We can give no assurance that such estimates, beliefs and assumptions will prove to be correct. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to differ materially from the anticipated results, performance or achievements expressed or implied by such forward-looking statements. The risks and uncertainties that may affect forward-looking statements include, but are not limited to: (i) integration of acquisitions and related restructuring efforts, including the quantum of restructuring charges and the timing thereof; (ii) the possibility that the Company may be unable to meet its future reporting requirements under the Exchange Act, and the rules promulgated thereunder; (iii) the risks associated with bringing new products and services to market; (iv) fluctuations in currency exchange rates; (v) delays in the purchasing decisions of the Company's customers; (vi) the competition the Company faces in its industry and/or marketplace; (vii) the final determination of litigation, tax audits and other legal proceedings; (viii) potential exposure to greater than anticipated tax liabilities or expenses; (ix) the possibility of technical, logistical or planning issues in connection with the deployment of the Company's products or services; (x) the continuous commitment of the Company's customers; (xi) demand for the Company's products and services; (xii) increase in exposure to international business risks as we continue to increase our international operations; (xiii) inability to raise capital at all or on not unfavorable terms in the future; and (xiv) downward pressure on our share price and dilutive effect of future sales or issuances of equity securities. Other factors that may affect forward-looking statements include, but are not limited to: (i) the future performance, financial and otherwise, of the Company; (ii) the ability of the Company to bring new products and services to market and to increase sales; (iii) the strength of the Company's product development pipeline; (iv) failure to secure and protect patents, trademarks and other proprietary rights; (v) infringement of third-party proprietary rights triggering indemnification obligations and resulting in significant expenses or restrictions on our ability to provide our products or services; (vi) failure to comply with privacy laws and regulations that are extensive, open to various interpretations and complex to implement; (vii) the Company's growth and profitability prospects; (viii) the estimated size and growth prospects of the EIM market; (ix) the Company's competitive position in the EIM market and its ability to take advantage of future opportunities in this market; (x) the benefits of the Company's products and services to be realized by customers; (xi) the demand for the Company's products and services and 26 -------------------------------------------------------------------------------- the extent of deployment of the Company's products and services in the EIM marketplace; (xii) the Company's financial condition and capital requirements; (xiii) system or network failures or information security breaches in connection with our services and products; and (xiv) failure to attract and retain key personnel to develop and effectively manage our business. For additional information with respect to risks and other factors which could occur, see the Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q including Part I, Item 1A "Risk Factors" therein and in this Quarterly Report on Form 10-Q and other securities filings with the Securities and Exchange Commission (SEC) and other securities regulators. Readers are cautioned not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. Unless otherwise required by applicable securities laws, the Company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The following MD&A is intended to help readers understand our results of operations and financial condition, and is provided as a supplement to, and should be read in conjunction with, our Condensed Consolidated Financial Statements and the accompanying Notes to our Condensed Consolidated Financial Statements under Part I, Item 1 of this Quarterly Report on Form 10-Q. All dollar and percentage comparisons made herein generally refer to the three months ended September 30, 2014 compared with the three months ended September 30, 2013, unless otherwise noted. Where we say "we", "us", "our", "OpenText" or "the Company", we mean Open Text Corporation or Open Text Corporation and its subsidiaries, as applicable. EXECUTIVE OVERVIEW We are an independent company providing a comprehensive suite of software products and services that assist organizations in finding, utilizing, and sharing business information from any device in ways which are intuitive, efficient and productive. Our technologies and business solutions address one of the biggest problems encountered by enterprises today: the explosive growth of information volume and formats. Our software and services allow organizations to manage the information that flows into, out of, and throughout the enterprise as part of daily operations. Our solutions help to increase customer satisfaction, improve collaboration with partners, address the legal and business requirements associated with information governance, and aim to ensure that information remains secure and private, as demanded in today's highly regulated climate. Our products and services provide the benefits of organizing and managing business content, while leveraging it to operate more efficiently and effectively. Our solutions incorporate social and mobile technologies and are delivered for on-premises deployment as well as through cloud and managed hosted services models to provide the flexibility and cost efficiencies demanded by the market. In addition, we provide solutions that facilitate the exchange of transactions that occur between supply chain participants, such as manufacturers, retailers, distributors and financial institutions, and are central to a company's ability to effectively collaborate with its partners. Our initial public offering was on the NASDAQ in 1996 and we were subsequently listed on the Toronto Stock Exchange in 1998. We are a multinational company and as of September 30, 2014, employed approximately 8,000 people worldwide. We operate in a market known as Enterprise Information Management (EIM). This is a comprehensive market category that includes a rich set of capabilities that allow organizations to manage content by optimizing the value of business information while reducing the costs associated with capturing, storing, and managing information. At its core, EIM is about helping organizations get the most out of information. Our EIM offerings include Enterprise Content Management (ECM), Business Process Management (BPM), Customer Experience Management (CEM), Information Exchange (iX), and Discovery. Quarterly Summary: During the quarter we saw the following activity: • Total revenue was $453.8 million, up 39.9% over the same period in the prior fiscal year. • License revenue was $58.6 million, up 6.0% over the same period in the prior fiscal year. • GAAP-based EPS, diluted, was $0.53 compared to $0.26 in the same period of the prior fiscal year. • Non-GAAP-based EPS, diluted, was $0.97 compared to $0.69 in the same period of the prior fiscal year. • GAAP-based operating margin was 22.7% compared to 16.0% in the same period of the prior fiscal year. • Non-GAAP-based operating margin was 34.3% compared to 30.6% in the same period of the prior fiscal year. • Operating cash flow was $138.5 million, up 73.3% from the same period in the prior fiscal year. • Cash and cash equivalents was $492.5 million as of September 30, 2014, compared to $427.9 million as of June 30, 2014. 27-------------------------------------------------------------------------------- See "Use of Non-GAAP Financial Measures" below for a reconciliation of non-GAAP-based measures to GAAP-based measures. See "Acquisitions" below for the impact of acquisitions on the period-to-period comparability of results. Acquisitions Our competitive position in the marketplace requires us to maintain a complex and evolving array of technologies, products, services and capabilities. In light of the continually evolving marketplace in which we operate, we regularly evaluate various acquisition opportunities within the EIM market. We believe our acquisitions support our long-term strategic direction, strengthen our competitive position, expand our customer base, provide greater scale to accelerate innovation, grow our earnings and increase shareholder value. We expect to continue to strategically acquire companies, products, services and technologies to augment our existing business. Our acquisitions, particularly significant ones such as GXS Group, Inc. (GXS), acquired in January 2014, affect the period-to-period comparability of our results. See note 18 "Acquisitions" to our Condensed Consolidated Financial Statements for more details. Outlook for Fiscal 2015 We believe we have a strong position in the EIM market. Our goal is to strengthen our position in EIM by building on our leadership in ECM, BPM, CEM, and iX and expanding our position in Discovery. Customer support revenues are generally a recurring source of income for us and makes up a significant portion of our revenue mix. With the acquisition of GXS, our cloud services revenue has grown and we expect cloud services revenue to continue to be a recurring and growing stream of revenue in the future. We also believe that our diversified geographic profile helps strengthen our position and helps to reduce the impact of a downturn in the economy that may occur in any one specific region. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates, judgments and assumptions that affect the amounts reported in the Condensed Consolidated Financial Statements. These estimates, judgments and assumptions are evaluated on an ongoing basis. We base our estimates on historical experience and on various other assumptions that we believe are reasonable at that time, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from those estimates. The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following: (i) Revenue recognition, (ii) Capitalized software, (iii) Goodwill, (iv) Acquired intangibles, (v) Restructuring charges, (vi) Business combinations, (vii) Foreign currency, and (viii) Income taxes. During the first quarter of Fiscal 2015, there were no significant changes to our critical accounting policies and estimates. For a detailed discussion of our critical accounting policies and estimates, please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended June 30, 2014. RESULTS OF OPERATIONS The following tables provide a detailed analysis of our results of operations and financial condition. For each of the periods indicated below, we present our revenues by product, revenues by major geography, cost of revenues by product, total gross margin, total operating margin, gross margin by product, and their corresponding percentage of total revenue. In addition, we provide Non-GAAP measures for the periods discussed in order to provide additional information to investors that we believe will be useful as this presentation is in line with how our management assesses our Company's performance. See "Use of Non-GAAP Financial Measures" below for a reconciliation of Non-GAAP-based measures to GAAP-based measures. 28 --------------------------------------------------------------------------------Summary of Results of Operations Three Months Ended September 30, Change increase (In thousands) 2014 (decrease) 2013 Total Revenues by Product Type: License $ 58,615 $ 3,309 $ 55,306 Cloud services 150,006 108,359 41,647 Customer support 183,906 15,466 168,440 Professional service and other 61,260 2,193 59,067 Total revenues 453,787 129,327 324,460 Total Cost of Revenues 147,869 41,433 106,436 Total GAAP-based Gross Profit 305,918 87,894 218,024 Total GAAP-based Gross Margin % 67.4 % 67.2 % Total GAAP-based Operating Expenses 202,892 36,911 165,981 Total GAAP-based Income from Operations $ 103,026 $ 50,983 $ 52,043 % Revenues by Product Type: License 12.9 % 17.1 % Cloud services 33.1 % 12.8 % Customer support 40.5 % 51.9 % Professional service and other 13.5 % 18.2 % Total Cost of Revenues by Product Type: License $ 3,088 $ 52 3,036 Cloud services 57,996 43,731 14,265 Customer support 23,218 1,048 22,170 Professional service and other 45,361 (74 ) 45,435 Amortization of acquired technology-based intangible assets 18,206 (3,324 ) 21,530 Total cost of revenues $ 147,869 $ 41,433 $ 106,436 % GAAP-based Gross Margin by Product Type: License 94.7 % 94.5 % Cloud services 61.3 % 65.7 % Customer support 87.4 % 86.8 % Professional service and other 26.0 % 23.1 % Total Revenues by Geography: Americas (1) $ 246,254 $ 70,877 $ 175,377 EMEA (2) 162,173 42,562 119,611 Asia Pacific (3) 45,360 15,888 29,472 Total revenues $ 453,787 $ 129,327 $ 324,460 % Revenues by Geography: Americas (1) 54.3 % 54.0 % EMEA (2) 35.7 % 36.9 % Asia Pacific (3) 10.0 % 9.1 % 29-------------------------------------------------------------------------------- Three Months Ended September 30, (In thousands) 2014 2013 GAAP-based gross margin 67.4 % 67.2 % GAAP-based operating margin 22.7 % 16.0 % GAAP-based EPS, diluted $ 0.53 $ 0.26 Non-GAAP-based gross margin (4) 71.6 % 73.9 % Non-GAAP-based operating margin (4) 34.3 % 30.6 % Non-GAAP-based EPS, diluted (4) $ 0.97 $ 0.69 (1) Americas consists of countries in North, Central and South America. (2) EMEA primarily consists of countries in Europe, Africa and the United Arab Emirates. (3) Asia Pacific primarily consists of the countries Japan, Australia, Hong Kong, Korea, Philippines, Singapore and New Zealand. (4) See "Use of Non-GAAP Financial Measures" (discussed later in the MD&A) for a reconciliation of Non-GAAP-based measures to GAAP-based measures. Revenues, Cost of Revenues and Gross Margin by Product Type 1) License Revenues: License revenues consist of fees earned from the licensing of software products to customers. Our license revenues are impacted by the strength of general economic and industry conditions, the competitive strength of our software products, and our acquisitions. Cost of license revenues consists primarily of royalties payable to third parties. Three Months Ended September 30, Change increase (In thousands) 2014 (decrease) 2013 License Revenues: Americas $ 22,897 $ (6,018 ) $ 28,915 EMEA 28,749 6,742 22,007 Asia Pacific 6,969 2,585 4,384 Total License Revenues 58,615 3,309 55,306 Cost of License Revenues 3,088 52 3,036 GAAP-based License Gross Profit $ 55,527 $ 3,257 $ 52,270 GAAP-based License Gross Margin % 94.7 % 94.5 % % License Revenues by Geography: Americas 39.1 % 52.3 % EMEA 49.0 % 39.8 % Asia Pacific 11.9 % 7.9 % License revenues increased by $3.3 million, which was geographically attributable to an increase in EMEA of $6.7 million, and an increase in Asia Pacific of $2.6 million, offset by a decrease in Americas of $6.0 million. The number of license deals greater than $1.0 million that closed during the first quarter of Fiscal 2015 as compared to the same period in the prior fiscal year was 3 deals in Fiscal 2015, inclusive of a settlement of patent infringement claims against Alfresco Software, Ltd., compared to 5 deals in Fiscal 2014. Cost of license revenues were relatively stable, with gross margin percentage remaining at approximately 95%. 2) Cloud Services: Cloud services revenues consist of service arrangements that allow our customers to make use of OpenText software, services and content over Internet enabled networks supported by OpenText data centers. These web applications allow customers to transmit a variety of content between various mediums and to securely manage enterprise information without the commitment of investing in related hardware infrastructure. Revenues are generated on several transactional usage-based models, are typically billed monthly in arrears, and can therefore fluctuate from period to period. Certain service fees are 30 -------------------------------------------------------------------------------- occasionally charged to customize hosted software for some customers and are either amortized over the estimated customer life, in the case of setup fees, or recognized in the period they are provided. In addition, the acquisition of GXS combines GXS' portfolio of business-to-business (B2B) integration solutions, such as messaging services, and managed services, with offerings in OpenText's iX portfolio. Messaging services allow for the automated and reliable exchange of electronic transaction information, such as purchase orders, invoices, shipment notices and other business documents, among businesses worldwide. Managed services provide an end-to-end fully outsourced B2B integration solution to our customers, including program implementation, operational management, and customer support. These services enable customers to effectively manage the flow of electronic transaction information with their trading partners and reduce the complexity of disparate standards and communication protocols. Revenues are primarily generated through transaction processing. Transaction processing fees are recurring in nature and are recognized on a per transaction basis in the period in which the related transactions are processed. Revenues from contracts with monthly, quarterly or annual minimum transaction levels are recognized based on the greater of the actual transactions or the specified contract minimum amounts during the relevant period. Customers who are not committed to multi-year contracts generally are under contracts for transaction processing solutions that automatically renew every month or year, depending on the terms of the specific contracts. Cost of cloud services revenues is comprised primarily of third party network usage fees, maintenance of in-house data hardware centers, technical support personnel-related costs, amortization of customer set up and implementation costs, and some third party royalty costs. Three Months Ended September 30, Change increase (In thousands) 2014 (decrease) 2013 Cloud Services: Americas $ 96,359 $ 68,530 $ 27,829 EMEA 35,192 29,072 6,120 Asia Pacific 18,455 10,757 7,698 Total Cloud Services Revenues 150,006 108,359 41,647 Cost of Cloud Services Revenues 57,996 43,731 14,265 GAAP-based Cloud Services Gross Profit $ 92,010 $ 64,628 $ 27,382 GAAP-based Cloud Services Gross Margin % 61.3 % 65.7 % % Cloud Services Revenues by Geography: Americas 64.2 % 66.8 % EMEA 23.5 % 14.7 % Asia Pacific 12.3 % 18.5 % Cloud services revenues increased by $108.4 million, primarily due to the acquisition of GXS. Geographically, this was attributable to an increase in Americas of $68.5 million, an increase in EMEA of $29.1 million, and an increase in Asia Pacific of $10.8 million. Cost of cloud services revenues increased by $43.7 million primarily due to higher revenue attainment and the impact of certain adjustments made in the first quarter of Fiscal 2014 relating to the release of sales tax liabilities that did not reoccur in the first quarter of Fiscal 2015. As a result, the gross margin percentage on cloud services revenue decreased to approximately 61% from approximately 66%. 3) Customer Support Revenues: Customer support revenues consist of revenues from our customer support and maintenance agreements. These agreements allow our customers to receive technical support, enhancements and upgrades to new versions of our software products when and if available. Customer support revenues are generated from support and maintenance relating to current year sales of software products and from the renewal of existing maintenance agreements for software licenses sold in prior periods. Therefore, changes in customer support revenues do not always correlate directly to the changes in license revenues from period to period. The terms of support and maintenance agreements are typically twelve months, with customer renewal options. Cost of customer support revenues is comprised primarily of technical support personnel and related costs, as well as third party royalty costs. 31 -------------------------------------------------------------------------------- Three Months Ended September 30, Change increase (In thousands) 2014 (decrease) 2013 Customer Support Revenues: Americas $ 97,356 $ 7,798 $ 89,558 EMEA 71,517 5,121 66,396 Asia Pacific 15,033 2,547 12,486 Total Customer Support Revenues 183,906 15,466 168,440 Cost of Customer Support Revenues 23,218 1,048 22,170 GAAP-based Customer Support Gross Profit $ 160,688 $ 14,418 $ 146,270 GAAP-based Customer Support Gross Margin % 87.4 % 86.8 % % Customer Support Revenues by Geography: Americas 52.9 % 53.2 % EMEA 38.9 % 39.4 % Asia Pacific 8.2 % 7.4 % Customer support revenues increased by $15.5 million, which was geographically attributable to an increase in Americas of $7.8 million, an increase in EMEA of $5.1 million, and an increase in Asia Pacific of $2.5 million. Cost of customer support revenues were relatively stable, with gross margin percentage on customer support revenues remaining at approximately 87%. 4) Professional Service and Other Revenues: Professional service and other revenues consist of revenues from consulting contracts and contracts to provide implementation, training and integration services (professional services). "Other" revenues consist of hardware revenues. These revenues are grouped within the "Professional service and other" category because they are relatively immaterial to our service revenues. Professional services are typically performed after the purchase of new software licenses. Cost of professional service and other revenues consists primarily of the costs of providing integration, configuration and training with respect to our various software products. The most significant components of these costs are personnel-related expenses, travel costs and third party subcontracting. Three Months Ended September 30, Change increase (In thousands) 2014 (decrease) 2013 Professional Service and Other Revenues: Americas $ 29,642 $ 567 $ 29,075 EMEA 26,715 1,627 25,088 Asia Pacific 4,903 (1 ) 4,904 Total Professional Service and Other Revenues 61,260 2,193 59,067 Cost of Professional Service and Other Revenues 45,361 (74 ) 45,435 GAAP-based Professional Service and Other Gross Profit $ 15,899 $ 2,267 $ 13,632 GAAP-based Professional Service and Other Gross Margin % 26.0 % 23.1 % % Professional Service and Other Revenues by Geography: Americas 48.4 % 49.2 % EMEA 43.6 % 42.5 % Asia Pacific 8.0 % 8.3 % Professional service and other revenues increased by $2.2 million, which was geographically attributable to an increase in EMEA of $1.6 million and an increase in Americas of $0.6 million. Asia Pacific remained stable year over year. 32 -------------------------------------------------------------------------------- Cost of professional service and other revenues remained stable. However, as a result of reduced headcount costs and other efficiencies gained from the realignment of our Professional Services business, the gross margin percentage on professional service and other revenues has increased to 26% from approximately 23%. Amortization of Acquired Technology-based Intangible Assets Three Months Ended September 30, Change increase (In thousands) 2014 (decrease) 2013 Amortization of acquired technology-based intangible assets $ 18,206 $ (3,324 ) $ 21,530 Amortization of acquired technology-based intangible assets decreased by $3.3 million as compared to the same period in the prior fiscal year. This is due to the intangible assets pertaining to our acquisitions of Vignette Corporation (Vignette), Hummingbird Corporation (Hummingbird), IXOS Software AG (IXOS), and Captaris Inc. becoming fully amortized, offset in part by the addition of new acquired technology-based intangible assets from our acquisition of GXS. Operating Expenses Three Months Ended September 30, Change increase (In thousands) 2014 (decrease) 2013 Research and development $ 44,742 $ 4,526 $ 40,216 Sales and marketing 80,099 10,686 69,413 General and administrative 35,756 6,870 28,886 Depreciation 12,242 5,784 6,458 Amortization of acquired customer-based intangible assets 25,884 8,607 17,277 Special charges 4,169 438 3,731 Total operating expenses $ 202,892 $ 36,911 $ 165,981 % of Total Revenues: Research and development 9.9 % 12.4 % Sales and marketing 17.7 % 21.4 % General and administrative 7.9 % 8.9 % Depreciation 2.7 % 2.0 % Amortization of acquired customer-based intangible assets 5.7 % 5.3 % Special charges 0.9 % 1.1 % Research and development expenses consist primarily of payroll and payroll-related benefits expenses, contracted research and development expenses, and facility costs. Research and development assists with organic growth, improves product stability and functionality, and as such we dedicate extensive efforts to update and upgrade our product offerings. The primary driver is typically budgeted software upgrades and software development. Quarter-over-Quarter Change between Fiscal (In thousands) 2015 and 2014 Payroll and payroll-related benefits $ 4,456 Contract labour and consulting (1,206 ) Share based compensation (164 ) Travel and communication (334 ) Facilities 1,722 Other miscellaneous 52Total year-over-year change in research and development expenses $ 4,526 33-------------------------------------------------------------------------------- Research and development expenses increased by $4.5 million. Primarily as a result of our acquisition of GXS, our research and development labour resources increased by 379 employees, from 1,528 employees at September 30, 2013 to 1,907 employees at September 30, 2014. This increase in labour resources resulted in a $4.5 million increase in payroll and payroll-related benefits and a $1.7 million increase in the use of facility and related resources. This was partially offset by a $1.2 million decrease in contract labour and consulting, resulting from continued efforts to reduce the usage of external services and replace them with internal resources. Overall, our research and development expenses, as a percentage of total revenues, have decreased to 10% from 12%. Sales and marketing expenses consist primarily of personnel expenses and costs associated with advertising, marketing and trade shows. Quarter-over-Quarter Change between Fiscal (In thousands) 2015 and 2014 Payroll and payroll-related benefits $ 5,455 Commissions 2,667 Contract labour and consulting 142 Share based compensation (283 ) Travel and communication 39 Marketing expenses 1,077 Facilities 451 Other miscellaneous 1,138Total year-over-year change in sales and marketing expenses $ 10,686 Sales and marketing expenses increased by $10.7 million. This is due to a $5.5 million increase in payroll and payroll-related benefits, primarily attributed to our acquisition of GXS, and a $2.7 million increase in commission benefits resulting from the increase in total revenues. Our sales and marketing labour resources increased by 205 employees, from 1,181 employees at September 30, 2013 to 1,386 employees at September 30, 2014. In addition, marketing expenses increased by $1.1 million, primarily on account of a global "sales kick off" event held at the beginning of Fiscal 2015. Overall, our sales and marketing expenses, as a percentage of total revenues, have decreased to 18% from 21%. General and administrative expenses consist primarily of payroll and payroll related benefits expenses, related overhead, audit fees, other professional fees, consulting expenses and public company costs. Quarter-over-Quarter Change between Fiscal (In thousands) 2015 and 2014 Payroll and payroll-related benefits $ 3,981 Contract labour and consulting 191 Share based compensation (60 ) Travel and communication 989 Facilities (1,795 ) Other miscellaneous 3,564Total year-over-year change in general and administrative expenses $ 6,870 General and administrative expenses increased by $6.9 million. Payroll and payroll-related benefits increased by $4.0 million, primarily as a result of the acquisition of GXS. Our general and administrative labour resources increased by 205 employees, from 757 employees at September 30, 2013 to 962 employees at September 30, 2014. Additionally, other miscellaneous expenses increased by $3.6 million, which includes professional fees such as legal, audit, and tax related expenses. Legal fees have increased primarily on account of litigation that we are pursuing with respect to amounts potentially recoverable by us. Audit and tax fees have increased due to our increased acquisition-related activities. As a result, general and administrative expenses, as a percentage of total revenue, have increased to 9% from 8% in the same period in the prior fiscal year. 34 -------------------------------------------------------------------------------- Depreciation expenses: Three Months Ended September 30, (In thousands) 2014 Change increase (decrease) 2013 Depreciation $ 12,242 $ 5,784 $ 6,458 Depreciation expenses increased by $5.8 million. This is primarily due to an increase in capital expenditures and the acquisition of GXS. Amortization of acquired customer-based intangible assets: Three Months Ended September 30, Change increase (In thousands) 2014 (decrease) 2013 Amortization of acquired customer-based intangible assets $ 25,884 $ 8,607 $ 17,277 Acquired customer-based intangible assets amortization expense increased by $8.6 million. This is primarily due to the acquisition of GXS during the third quarter of Fiscal 2014, offset by the intangible assets pertaining to our acquisitions of Hummingbird, IXOS, and Vignette becoming fully amortized. Special charges: Special charges typically relate to amounts that we expect to pay in connection with restructuring plans relating to employee workforce reduction and abandonment of excess facilities, acquisition-related costs and other similar charges. Generally, we implement such plans in the context of integrating existing OpenText operations with that of acquired entities. Actions related to such restructuring plans are typically completed within a period of one year. In certain limited situations, if the planned activity does not need to be implemented, or an expense lower than anticipated is paid out, we record a recovery of the originally recorded expense to Special charges. Three Months Ended September 30, (In thousands) 2014 Change increase (decrease) 2013 Special charges $ 4,169 $ 438 $ 3,731 Special charges increased by $0.4 million. This was due to a $3.2 million increase in other miscellaneous charges, offset by a $1.9 million decrease on account of restructuring activities and a $0.9 million decrease in acquisition-related costs. For more details on Special charges, see note 17 "Special Charges" to our Condensed Consolidated Financial Statements. Net Other Income (Expense) Net other income (expense) relates to certain non-operational charges consisting primarily of transactional foreign exchange gains (losses). This income (expense) is dependent upon the change in foreign currency exchange rates vis-à-vis the functional currency of the legal entity. Three Months Ended September 30, (In thousands) 2014 Change increase (decrease) 2013 Other income (expense), net $ (9,873 ) $ (11,799 ) $ 1,926 35-------------------------------------------------------------------------------- Net Interest and other Related Expense Net interest and other related expense is primarily comprised of cash interest paid and accrued on our debt facilities, offset by interest income earned on our cash and cash equivalents. Three Months Ended September 30, Change increase (In thousands) 2014 (decrease) 2013Interest and other related expense, net $ 11,099 $ 6,714 $ 4,385 Net interest and other related expense increased by $6.7 million as a result of additional interest expense incurred relating to our Term Loan B. For more details see note 10 "Long-Term Debt" to our Condensed Consolidated Financial Statements. Provision for Income Taxes We initiated an internal reorganization of our international subsidiaries in our fiscal year which began on July 1, 2009 and ended June 30, 2010 and we continue to integrate acquisitions into this new organizational structure, where appropriate, for the following reasons: 1) to consolidate our intellectual property within certain jurisdictions, 2) to effect an operational reduction of our global subsidiaries with a view to, eventually, having a single operating legal entity in each jurisdiction, 3) to better safeguard our intellectual property in jurisdictions with well established legal regimes and protections and 4) to simplify the management of our intellectual property ownership. We operate in several tax jurisdictions and are exposed to various foreign tax rates. We also note that we are subject to tax rate discrepancies between our domestic tax rate and foreign tax rates that are significant and these discrepancies are primarily related to earnings in Luxembourg. Three Months Ended September 30, Change increase (In thousands) 2014 (decrease) 2013 Provision for income taxes $ 17,402 $ (1,552 ) $ 18,954 The effective GAAP tax rate (which is the provision for taxes expressed as a percentage of net income before taxes) decreased to 21.2% for the three months ended September 30, 2014 from 38.2% for the three months ended September 30, 2013, primarily due to a decrease in the net change in valuation allowance in the amount of $2.0 million, and a decrease in the net expense of unrecognized tax benefits with related interest and penalties in the amount of $1.2 million. The remainder of the differences are due to normal course movements and non-material items. For information with regards to certain potential tax contingencies, see note 13 "Guarantees and Contingencies" to our Condensed Consolidated Financial Statements. 36 -------------------------------------------------------------------------------- Use of Non-GAAP Financial Measures In addition to reporting financial results in accordance with U.S. GAAP, the Company provides certain financial measures that are not in accordance with U.S. GAAP (Non-GAAP).These Non-GAAP financial measures have certain limitations in that they do not have a standardized meaning and thus the Company's definition may be different from similar Non-GAAP financial measures used by other companies and/or analysts and may differ from period to period. Thus it may be more difficult to compare the Company's financial performance to that of other companies. However, the Company's management compensates for these limitations by providing the relevant disclosure of the items excluded in the calculation of these Non-GAAP financial measures both in its reconciliation to the U.S. GAAP financial measures and its Condensed Consolidated Financial Statements, all of which should be considered when evaluating the Company's results. The Company uses these Non-GAAP financial measures to supplement the information provided in its Condensed Consolidated Financial Statements, which are presented in accordance with U.S. GAAP. The presentation of Non-GAAP financial measures are not meant to be a substitute for financial measures presented in accordance with U.S. GAAP, but rather should be evaluated in conjunction with and as a supplement to such U.S. GAAP measures. OpenText strongly encourages investors to review its financial information in its entirety and not to rely on a single financial measure. The Company therefore believes that despite these limitations, it is appropriate to supplement the disclosure of the U.S. GAAP measures with certain Non-GAAP measures defined below. Non-GAAP-based net income and Non-GAAP-based EPS are calculated as net income or earnings per share on a diluted basis, excluding the amortization of acquired intangible assets, other income (expense), share-based compensation, and special charges, all net of tax. Non-GAAP-based gross profit is the arithmetical sum of GAAP-based gross profit and the amortization of acquired technology-based intangible assets. Non-GAAP-based gross margin is calculated as Non-GAAP-based gross profit expressed as a percentage of revenue. Non-GAAP-based income from operations is calculated as income from operations, excluding the amortization of acquired intangible assets, special charges, and share-based compensation expense. Non-GAAP-based operating margin is calculated as Non-GAAP-based income from operations expressed as a percentage of revenue. The Company's management believes that the presentation of the above defined Non-GAAP financial measures provides useful information to investors because they portray the financial results of the Company before the impact of certain non-operational charges. The use of the term "non-operational charge" is defined for this purpose as an expense that does not impact the ongoing operating decisions taken by the Company's management and is based upon the way the Company's management evaluates the performance of the Company's business for use in the Company's internal reports. In the course of such evaluation and for the purpose of making operating decisions, the Company's management excludes certain items from its analysis, including amortization of acquired intangible assets, special charges, share-based compensation, other income (expense), and the taxation impact of these items. These items are excluded based upon the manner in which management evaluates the business of the Company and are not excluded in the sense that they may be used under U.S. GAAP. The Company believes the provision of supplemental Non-GAAP measures allow investors to evaluate the operational and financial performance of the Company's core business using the same evaluation measures that management uses, and is therefore a useful indication of OpenText's performance or expected performance of future operations and facilitates period-to-period comparison of operating performance (although prior performance is not necessarily indicative of future performance). As a result, the Company considers it appropriate and reasonable to provide, in addition to U.S. GAAP measures, supplementary Non-GAAP financial measures that exclude certain items from the presentation of its financial results. The following charts provide unaudited reconciliations of U.S. GAAP-based financial measures to Non-GAAP-based financial measures for the following periods presented: 37 -------------------------------------------------------------------------------- Reconciliation of selected GAAP-based measures to Non-GAAP-based measures for the three months ended September 30, 2014 (in thousands except for per share data) Three Months Ended September 30, 2014 GAAP-based Non-GAAP-based GAAP-based Measures % Non-GAAP-based Measures % of Measures of Revenue Adjustments Note Measures Revenue Cost of revenues Cloud services $ 57,996 $ (213 ) (1) $ 57,783 Customer support 23,218 (174 ) (1) 23,044 Professional service and other 45,361 (263 ) (1) 45,098 Amortization of acquired technology-based intangible assets 18,206 (18,206 ) (2) - GAAP-based gross profit and gross margin (%) / Non-GAAP-based gross profit and gross margin (%) 305,918 67.4% 18,856 (3) 324,774 71.6% Operating expenses Research and development 44,742 (563 ) (1) 44,179 Sales and marketing 80,099 (2,074 ) (1) 78,025 General and administrative 35,756 (1,162 ) (1) 34,594 Amortization of acquired customer-based intangible assets 25,884 (25,884 ) (2) - Special charges 4,169 (4,169 ) (4) - GAAP-based income from operations and operating margin (%) / Non-GAAP-based income from operations and operating margin (%) 103,026 22.7% 52,708 (5) 155,734 34.3% Other income (expense), net (9,873 ) 9,873 (6) - Provision for (recovery of) income taxes 17,402 8,606 (7) 26,008 GAAP-based net income / Non-GAAP-based net income, attributable to OpenText 64,626 53,975 (8) 118,601 GAAP-based earnings per share / Non GAAP-based earnings per share-diluted, attributable to OpenText $ 0.53 $ 0.44 (8) $ 0.97 (1) Adjustment relates to the exclusion of share based compensation expense from our Non-GAAP-based operating expenses as this expense is excluded from our internal analysis of operating results. (2) Adjustment relates to the exclusion of amortization expense from our Non-GAAP-based operating expenses as the timing and frequency of amortization expense is dependent on our acquisitions and is hence excluded from our internal analysis of operating results. (3) GAAP-based and Non-GAAP-based gross profit stated in dollars and gross margin stated as a percentage of revenue. (4) Adjustment relates to the exclusion of Special charges from our Non-GAAP-based operating expenses as Special charges are generally incurred in the periods following the relevant acquisitions and are not indicative or related to continuing operations and are therefore excluded from our internal analysis of operating results. (5) GAAP-based and Non-GAAP-based income from operations stated in dollars and operating margin stated as a percentage of revenue. (6) Adjustment relates to the exclusion of Other income (expense) from our Non-GAAP-based operating expenses as Other income (expense) relates primarily to the transactional impact of foreign exchange and is generally not indicative or related to continuing operations and is therefore excluded from our internal analysis of operating results. (7) Adjustment relates to differences between the GAAP-based tax provision (recovery) and a Non-GAAP-based tax rate; these rate differences are due to the income tax effects of expenses that are excluded for the purpose of calculating Non-GAAP-based adjusted net income. (8) Reconciliation of Non-GAAP-based adjusted net income to GAAP-based net income: Three Months Ended September 30, 2014 Per share diluted Non-GAAP-based net income, attributable to OpenText $ 118,601 $ 0.97 Less: Amortization 44,090 0.36 Share-based compensation 4,449 0.04 Special charges 4,169 0.03 Other (income) expense, net 9,873 0.08 GAAP-based provision for (recovery of) income taxes 17,402 0.14 Non-GAAP based provision for income taxes (26,008 ) (0.21 ) GAAP-based net income, attributable to OpenText $ 64,626 $ 0.53 38 -------------------------------------------------------------------------------- Reconciliation of selected GAAP-based measures to Non-GAAP-based measures for the three months ended September 30, 2013 (in thousands except for per share data) Three Months Ended September 30, 2013 GAAP-based Non-GAAP-based GAAP-based Measures % Non-GAAP-based Measures % of Measures of Revenue Adjustments Note Measures Revenue Cost of revenues Cloud services $ 14,265 $ (38 ) (1) $ 14,227 Customer support 22,170 (97 ) (1) 22,073 Professional service and other 45,435 (170 ) (1) 45,265 Amortization of acquired technology-based intangible assets 21,530 (21,530 ) (2) - GAAP-based gross profit and gross margin (%) / Non-GAAP-based gross profit and gross margin (%) 218,024 67.2% 21,835 (3) 239,859 73.9% Operating expenses Research and development 40,216 (728 ) (1) 39,488 Sales and marketing 69,413 (2,353 ) (1) 67,060 General and administrative 28,886 (1,226 ) (1) 27,660 Amortization of acquired customer-based intangible assets 17,277 (17,277 ) (2) - Special charges 3,731 (3,731 ) (4) - GAAP-based income from operations and operating margin (%) / Non-GAAP-based income from operations and operating margin (%) 52,043 16.0% 47,150 (5) 99,193 30.6% Other income (expense), net 1,926 (1,926 ) (6) - Provision for (recovery of) income taxes 18,954 (5,681 ) (7) 13,273 GAAP-based net income / Non-GAAP-based net income, attributable to OpenText 30,630 50,905 (8) 81,535 GAAP-based earnings per share / Non GAAP-based earnings per share-diluted, attributable to OpenText $ 0.26 $ 0.43 (8) $ 0.69 (1) Adjustment relates to the exclusion of share based compensation expense from our Non-GAAP-based operating expenses as this expense is excluded from our internal analysis of operating results. (2) Adjustment relates to the exclusion of amortization expense from our Non-GAAP-based operating expenses as the timing and frequency of amortization expense is dependent on our acquisitions and is hence excluded from our internal analysis of operating results. (3) GAAP-based and Non-GAAP-based gross profit stated in dollars and gross margin stated as a percentage of revenue. (4) Adjustment relates to the exclusion of Special charges from our Non-GAAP-based operating expenses as Special charges are generally incurred in the periods following the relevant acquisitions and are not indicative or related to continuing operations and are therefore excluded from our internal analysis of operating results. (5) GAAP-based and Non-GAAP-based income from operations stated in dollars and operating margin stated as a percentage of revenue. (6) Adjustment relates to the exclusion of Other income (expense) from our Non-GAAP-based operating expenses as Other income (expense) relates primarily to the transactional impact of foreign exchange and is generally not indicative or related to continuing operations and is therefore excluded from our internal analysis of operating results. (7) Adjustment relates to differences between the GAAP-based tax provision (recovery) and a Non-GAAP-based tax rate; these rate differences are due to the income tax effects of expenses that are excluded for the purpose of calculating Non-GAAP-based adjusted net income. (8) Reconciliation of Non-GAAP-based adjusted net income to GAAP-based net income: Three Months Ended September 30, 2013 Per share diluted Non-GAAP-based net income, attributable to OpenText $ 81,535 $ 0.69 Less: Amortization 38,807 0.33 Share-based compensation 4,612 0.04 Special charges 3,731 0.03 Other (income) expense, net (1,926 ) (0.02 ) GAAP-based provision for (recovery of) income taxes 18,954 0.16 Non-GAAP based provision for income taxes (13,273 ) (0.11 ) GAAP-based net income, attributable to OpenText $ 30,630 $ 0.26 39 -------------------------------------------------------------------------------- LIQUIDITY AND CAPITAL RESOURCES The following tables set forth changes in cash flows from operating, investing and financing activities for the periods indicated: As of September 30, Change increase (In thousands) 2014 (decrease) As of June 30, 2014 Cash and cash equivalents $ 492,486 $ 64,596 $ 427,890 Three Months Ended September 30, (In thousands) 2014 Change 2013 Cash provided by operating activities $ 138,531 $ 58,607 $ 79,924 Cash used in investing activities $ (37,831 ) $ 2,794 $ (40,625 ) Cash used in financing activities $ (27,151 ) $ (3,658 ) $ (23,493 ) Cash and cash equivalents Cash and cash equivalents primarily consist of deposits held at major banks with original maturities of 90 days or less. In connection with our acquisition of GXS, we entered into Term Loan B (as defined below in "Long-term Debt and Credit Facilities") on January 16, 2014 to borrow $800 million. For further details on this borrowing, see "Long-term Debt and Credit Facilities" below as well as a copy of the agreement filed as an exhibit to the Company's Current Report on Form 8-K, as filed with the SEC on January 16, 2014. We anticipate that our cash and cash equivalents, as well as available credit facilities, will be sufficient to fund our anticipated cash requirements for working capital, contractual commitments, capital expenditures, dividends and operating needs for the next 12 months. However, any further material or acquisition-related activities may require additional sources of financing and would be subject to the financial covenants established under our credit facilities. For more details, see "Long-term Debt and Credit Facilities" below. We do not have any material restrictions on repatriation of cash from foreign subsidiaries nor do we expect taxes on repatriation of cash held in foreign subsidiaries to have a material effect on our overall liquidity, financial condition or results of operations. Cash flows provided by operating activities Cash flows from operating activities increased by $58.6 million due to an increase in net income before the impact of non-cash items of $46.1 million and an increase in changes from working capital of $12.5 million. Cash flows used in investing activities Our cash flows used in investing activities is primarily on account of acquisitions and additions of property and equipment. Cash flows used in investing activities decreased by $2.8 million. This is primarily due to the impact of the purchase consideration for our acquisition of Cordys Holding B.V. in the first quarter of Fiscal 2014, offset by incremental additions to property and equipment of $21.9 million, and a $5.9 million increase in other investing activities. Cash flows from financing activities Our cash flows from financing activities consist of long-term debt financing and amounts received from stock options exercised by our employees. These inflows are typically offset by scheduled and non-scheduled repayments of our long-term debt financing and, when applicable, the payment of dividends and/or the repurchases of our Common Shares. Cash flows used in financing activities increased by $3.7 million. This is primarily due to a $5.7 million increase in principal payments on our credit facilities, and an increase in dividend payments made to our shareholders of $3.3 million, offset by a $5.3 million increase in cash collected from the issuance of Common Shares. 40 -------------------------------------------------------------------------------- Cash Dividends In the first quarter of Fiscal 2015, we declared and paid cash dividends of $0.1725 per Common Share that totaled $21.0 million. Future declarations of dividends and the establishment of future record and payment dates are subject to the final determination and discretion of our Board of Directors. Long-term Debt and Credit Facilities Term Loan A and Revolver As of September 30, 2014, one of our credit facilities consists of a $600 million term loan facility (Term Loan A) and a $100 million committed revolving credit facility (the Revolver). Borrowings under Term Loan A are secured by a first charge over substantially all of our assets, and as of January 16, 2014, on a pari passu basis with Term Loan B (as defined below). We entered into this credit facility and borrowed the full amount under Term Loan A on November 9, 2011 and amended certain of its terms on December 16, 2013. Term Loan A has a five year term and repayments made under Term Loan A are equal to 1.25% of the original principal amount at each quarter for the first 2 years, approximately 1.88% for years 3 and 4 and 2.5% for year 5. Term Loan A bears interest at a floating rate of LIBOR plus a fixed amount, depending on the Company's consolidated leverage ratio. As of September 30, 2014, this fixed amount was 2.50%, and the combined interest rate was 2.7%. The Revolver has a five year term with no fixed repayment date prior to the end of the term. As of September 30, 2014, we have not drawn any amounts on the Revolver. Under Term Loan A we must maintain a "consolidated leverage" ratio of no more than 3:1 at the end of each financial quarter. Consolidated leverage ratio is defined for this purpose as the proportion of our total debt, including guarantees and letters of credit, over our trailing twelve months net income before interest, taxes, depreciation, amortization, restructuring, share-based compensation and other miscellaneous charges. As of September 30, 2014, our consolidated leverage ratio was 2.15:1. We must also maintain a "consolidated interest coverage" ratio of 3:1 or more at the end of each financial quarter. Consolidated interest coverage ratio is defined for this purpose as our trailing twelve months net income before interest, taxes, depreciation, amortization, restructuring, share-based compensation and other miscellaneous charges, over our consolidated interest expense. As of September 30, 2014, our consolidated interest coverage ratio was 14:1. We utilize our long-term credit facilities primarily for acquisition activities. Our current position with respect to our loan covenants provides us with additional ability to borrow for potential future acquisition activities. For more details relating to our Term Loan A, see note 10 "Long-Term Debt" to our Condensed Consolidated Financial Statements. Term Loan B In connection with the acquisition of GXS, on January 16, 2014, we entered into a second credit facility, which provides for a $800 million term loan facility with certain lenders named therein, Barclays Bank PLC (Barclays), as sole administrative agent and collateral agent, and with Barclays and RBC Capital Markets as lead arrangers and joint bookrunners (Term Loan B). Repayments made under Term Loan B are equal to 0.25% of the original principal amount in equal quarterly installments for the life of Term Loan B, with the remainder due at maturity. Borrowings under Term Loan B are secured by a first charge over substantially all of our assets on a pari passu basis with Term Loan A. We entered into Term Loan B and borrowed the full amount of $800 million on January 16, 2014. Term Loan B has a seven year term. Borrowings under Term Loan B bear interest at a rate per annum equal to an applicable margin plus, at the borrower's option, either (1) the eurodollar rate for the interest period relevant to such borrowing or (2) an ABR rate determined by reference to the greatest of (i) the prime rate of Barclays, (ii) the federal funds rate plus 0.50% per annum and (iii) the one month eurodollar rate plus 1.00% per annum. The applicable margin for borrowings under Term Loan B will be 2.5% with respect to LIBOR borrowings and 1.5% with respect to ABR rate borrowings. Currently we have chosen for our borrowings under Term Loan B to bear a floating rate of interest at a rate per annum equal to 2.5% plus the higher of LIBOR or 0.75%. As of September 30, 2014, the interest rate was 3.25%. Term Loan B has incremental facility capacity of (i) $250 million plus (ii) additional amounts, subject to meeting a "consolidated senior secured net leverage" ratio not exceeding 2.75:1.00, in each case subject to certain conditions. Consolidated senior secured net leverage ratio is defined for this purpose as the proportion of our total debt reduced by 41 -------------------------------------------------------------------------------- unrestricted cash, including guarantees and letters of credit, that is secured by our or any of our subsidiaries' assets, over our trailing twelve months net income before interest, taxes, depreciation, amortization, restructuring, share-based compensation and other miscellaneous charges. Under Term Loan B, we must maintain a "consolidated net leverage" ratio of no more than 4:1 at the end of each financial quarter. Consolidated net leverage ratio is defined for this purpose as the proportion of our total debt reduced by unrestricted cash, including guarantees and letters of credit, over our trailing twelve months net income before interest, taxes, depreciation, amortization, restructuring, share-based compensation and other miscellaneous charges. As of September 30, 2014, our consolidated net leverage ratio was 1.33:1. For further details relating to Term Loan B, please see note 10 "Long-Term Debt" to our Condensed Consolidated Financial Statements. Mortgage We currently have an "open" mortgage with a bank where we can pay all or a portion of the mortgage on or before August 1, 2015. The original principal amount of the mortgage was Canadian $15.0 million and interest accrues monthly at a variable rate of Canadian prime plus 0.50%. Principal and interest are payable in monthly installments of Canadian $0.1 million with a final lump sum principal payment due on maturity. The mortgage is secured by a lien on our headquarters in Waterloo, Ontario, Canada. We entered into this mortgage in December 2005. As of September 30, 2014, the carrying value of the mortgage was $9.1 million. As of September 30, 2014, the carrying value of the Waterloo building that secures the mortgage was $15.6 million. Shelf Registration Statement In response to the demand and piggyback registration requests we received pursuant to the registration rights agreement entered into in connection with the acquisition of GXS, we filed a universal shelf registration statement on Form S-3 (the Shelf Registration Statement) with the SEC, which became effective automatically. The Shelf Registration Statement allows for primary and secondary offering from time to time of equity, debt and other securities, including Common Shares, Preference Shares, debt securities, depositary shares, warrants, purchase contracts, units and subscription receipts. A base shelf prospectus qualifying the distribution of such securities was also filed with certain Canadian securities regulators. The type of securities and the specific terms thereof will be determined at the time of any offering and will be described in the applicable prospectus supplement to be filed separately with the SEC and such Canadian securities regulators. On May 5, 2014, we filed a prospectus supplement with the SEC and certain Canadian securities regulators to allow certain selling shareholders who requested demand and piggyback registration to resell up to 2,583,302 Common Shares. Pensions As of September 30, 2014, our total unfunded pension plan obligations were $63.2 million, of which $1.5 million is payable within the next 12 months. We expect to be able to make the long-term and short-term payments related to these obligations in the normal course of operations. Our anticipated payments under our most significant plans for the fiscal years indicated below are as follows: Fiscal years ending June 30, CDT GXS GER GXS PHP 2015 (nine months ended June 30) $ 446 $ 657 $ 9 2016 657 913 24 2017 729 984 35 2018 779 1,063 46 2019 871 1,108 94 2020 to 2024 5,869 6,038 1,107 Total $ 9,351 $ 10,763 $ 1,315 For a detailed discussion on all pensions, see note 11 "Pension Plans and Other Post Retirement Benefits" to our Condensed Consolidated Financial Statements. 42 -------------------------------------------------------------------------------- Commitments and Contractual Obligations As of September 30, 2014, we have entered into the following contractual obligations with minimum payments for the indicated fiscal periods as follows: Payments due between October 1, 2014- July 1, 2015- July 1, 2017- July 1, 2019 (In thousands) Total June 30, 2015 June 30, 2017 June 30, 2019 and beyond Long-term debt obligations $ 1,492,579 $ 70,162 $ 561,703 $ 66,417 $ 794,297 Operating lease obligations* 202,686 37,429 69,962 47,213 48,082 Purchase obligations 23,265 8,585 14,187 493 - $ 1,718,530 $ 116,176 $ 645,852 $ 114,123 $ 842,379 *Net of $3.7 million of sublease income to be received from properties which we have subleased to third parties. The long-term debt obligations are comprised of interest and principal payments on our term loans and a mortgage on our headquarters in Waterloo, Ontario, Canada. See note 10 "Long-Term Debt" to our Condensed Consolidated Financial Statements. Guarantees and Indemnifications We have entered into customer agreements which may include provisions to indemnify our customers against third party claims that our software products or services infringe certain third party intellectual property rights and for liabilities related to a breach of our confidentiality obligations. We have not made any material payments in relation to such indemnification provisions and have not accrued any liabilities related to these indemnification provisions in our Condensed Consolidated Financial Statements. Litigation We are currently involved in various claims and legal proceedings. Quarterly, we review the status of each significant legal matter and evaluate such matters to determine how they should be treated for accounting and disclosure purposes in accordance with the requirements of ASC Topic 450-20 "Loss Contingencies" (Topic 450-20). Specifically, this evaluation process includes the centralized tracking and itemization of the status of all our disputes and litigation items, discussing the nature of any litigation and claim, including any dispute or claim that is reasonably likely to result in litigation, with relevant internal and external counsel, and assessing the progress of each matter in light of its merits and our experience with similar proceedings under similar circumstances. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss in accordance with Topic 450-20. As of the date of this Quarterly Report on Form 10-Q, such aggregated losses were not material to our consolidated financial position or result of operations and we do not believe as of the date of this filing that it is reasonably possible that a loss exceeding the amounts already recognized will be incurred that would be material to our consolidated financial position or results of operations. Contingencies EasyLink Services International Corporation (EasyLink) and its United States subsidaries are currently being assessed by the New York State Department of Taxation and Finance (the Department) for the potential applicability of telecommunications excise and franchise taxes to its New York State revenues for certain pre-acquisition EasyLink revenue. The potential exposure under this assessment, based upon the notice issued by the Department, is approximately $10.5 million and has been accrued for by us. OpenText intends to vigorously defend against this assessment. As part of our acquisition of GXS, we have inherited a tax dispute in Brazil between the Company's subsidiary, GXS Tecnologia da Informação (Brasil) Ltda. (GXS Brazil), and the municipality of São Paulo, in connection with GXS Brazil's judicial appeal of a tax claim in the amount of $2.7 million as of September 30, 2014. We currently have in place a bank guarantee in the amount of $3.7 million in recognition of this dispute. However, we believe that the position of the São Paulo tax authorities is not consistent with the relevant facts and based on information available on the case and other similar matters provided by local counsel, we believe that we can defend our position and that no tax is owed. Although we believe that the facts support our position, the ultimate outcome of this matter could result in a loss of up to the claim amount discussed above, plus future interest or penalties that may accrue. Historically, prior to our acquisition of GXS, GXS would charge certain costs to its subsidiaries, including GXS Brazil, primarily based on historical transfer pricing studies that were intended to reflect the costs incurred by subsidiaries in relation to 43 -------------------------------------------------------------------------------- services provided by the parent company to the subject subsidiary. GXS recorded taxes on amounts billed, that were considered to be due based on the intercompany charges. GXS subsequently re-evaluated its intercompany charges to GXS Brazil and related taxes and, upon taking into consideration the current environment and judicial proceedings in Brazil, concluded that it was probable that certain indirect taxes would be assessable and payable based upon the accrual of such intercompany charges and accrued approximately $10.2 million for the probable amount of a settlement related to the indirect taxes, interest and penalties. Our Indian subsidiary, GXS India Technology Centre Private Limited (GXS India), is subject to potential assessments by Indian tax authorities in the city of Bangalore. GXS India has received assessment orders from the Indian tax authorities alleging that the transfer price applied to intercompany transactions was not appropriate. Based on advice from our tax advisors, we believe that the facts that the Indian tax authorities are using to support their assessment are incorrect. We have filed appeals and anticipate an eventual settlement with the Indian tax authorities. We have accrued $1.4 million to cover our anticipated financial exposure in this matter. The United States Internal Revenue Service (IRS) is examining certain of our tax returns for Fiscal 2010 through Fiscal 2012, and in connection with those examinations is reviewing our internal reorganization in Fiscal 2010 to consolidate certain intellectual property ownership in Luxembourg and Canada and our integration of certain acquisitions into the resulting structure. These examinations may lead to proposed adjustments to our taxes, which may be material, individually or in the aggregate. As of the date of this Quarterly Report on Form 10-Q, no adjustments have been proposed by the IRS, and we have not recorded any material accruals for any such potential adjustments in our Condensed Consolidated Financial Statements. Please also see "Risk Factors" in our Annual Report on Form 10-K to our fiscal year ended June 30, 2014. Off-Balance Sheet Arrangements We do not enter into off-balance sheet financing as a matter of practice except for the use of operating leases for office space, computer equipment, and vehicles. None of the operating leases described in the previous sentence has, and we currently do not believe that they potentially may have, a material effect on our financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources. In accordance with U.S. GAAP, neither the lease liability nor the underlying asset is carried on the balance sheet, as the terms of the leases do not meet the criteria for capitalization. 44 -------------------------------------------------------------------------------- |