OpenText Leaves Investors Unsatisfied as Earnings Growth Slows

By Dan Caplinger Markets Fool.com

The challenge that every growth stock faces is managing investor expectations. Given the popularity of companies that have exposure to the cloud computing industry, OpenText (NASDAQ: OTEX)has inspired many of its shareholders to set very high expectations for the company, and sometimes it proves to be difficult to keep raising the bar quarter after quarter.

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Coming into Monday's fiscal third-quarter financial report, OpenText shareholders wanted to see extremely strong sales growth with accompanying gains in the bottom line as well. OpenText's numbers weren't quite as good as the targets its investors had set and that led to some concerns about the stock's future course. Let's take a closer look more closely at OpenText to see how it did and what's ahead for the company going forward.

Image source: OpenText.

OpenText falls off the pace

OpenText's fiscal third-quarter results were only poor compared to the outsized projections that its investors were expecting. Revenue came in at $593 million, up almost 35% from year-ago levels, but that was less than the roughly $601 million in sales that those following the stock had wanted to see. More concerning was that GAAP net income plunged by more than two-thirds from the third quarter of fiscal 2016, and even after making allowances for extraordinary items, adjusted earnings of $0.45 per share climbed at only half the rate that investors had hoped to see.

A closer examination of OpenText's numbers shows that the company's overall sales performance was still solid. Revenue from cloud services and subscriptions was up 20%, while licensing revenue gained ground at an even better 35% pace. The winner across the segments was customer support, which posted sales 43% growth to widen its stranglehold on OpenText's overall revenue. The small professional services unit had the best growth rate in the business, sending its top line higher by 45%.

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From a profitability standpoint, though, OpenText had to deal with different dynamics. Gross margin in the cloud services arena dropped about 2 percentage points to between 56% and 57%, and customer support also took a hit on its margin figures. Huge jumps in sales and marketing, research and development, and general overhead costs sent operating expenses up by more than half from year-ago levels, eating into profits.

Once again, OpenText brought in some big clients, with 19 transactions over $1 million. New customers included ag giant Cargill and utility company Exelon. Several areas of the economy had high demand for OpenText services, including the financial, services, technology, consumer goods, industrial goods, and public sector industry group.

CEO Mark Barrenechea was happy with how OpenText did. "Customers are responding favorably to our expanded portfolio of customer experience management, vertical content solutions, and dsiscovery offerings," Barrenechea said. He noted, however, that acquisitions haven't yet had the impact that OpenText had anticipated, noting that "while the financial benefits are evident in our quarterly results, they are yet to be fully realized."

Can OpenText keep heading skyward?

In particular, OpenText is looking to keep serving enterprise customers with the highest-quality offerings it can. Barrenechea pointed to enterprise information management and artificial intelligence as the next key areas for the industry, and OpenText is moving to take full advantage of opportunities in those areas.

OpenText also demonstrated its confidence in its future by implementing a dividend increase. The company said that it would pay $0.132 per share to shareholders beginning next month, and that payment is 15% higher than what it sent to investors previously.

Yet despite the higher dividend, OpenText shareholders weren't happy about the shortfalls in sales and earnings growth, and the stock dropped more than 9% in after-hours trading following the announcement. In order to keep its investors satisfied, OpenText will have to find ways to accelerate its growth even further and show the value of the investments it has made in its future.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Open Text. The Motley Fool has a disclosure policy.