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Wonder About Earnings Quality?

A look at Open Text shows its earnings left a lot to be desired.

Just because a company's earnings beat Wall Street estimates doesn't mean the quality of those earnings is any good. Consider

Open Text

(OTEX) - Get Free Report

. The first time the Canadian software company was

mentioned here, back in April, the headline screamed, "Why Open Text's Fundamentals Suggest the Company May Be a Closed Book."

Back then, the company's market value had roughly doubled in a month, thanks to its investments in two online services. Strip away the Internet businesses, the shorts said at the time, and Open Text had a decent but not great business of providing software that corporations use to let employees view, retrieve and otherwise access documents on Intranets. It had lots of competition but, more importantly, its receivables were stretched out more than four months. That means Open Text's customers were paying their bills way slower than were customers at a competitor that had recently warned the Street of an earnings shortfall. It also had negative operating cash flow (not usually a good sign at a software company) and there was a rapidly revolving door in its executive suite.

The company never responded to issues raised in the column, and the stock has since skidded by 38%.

But the story doesn't end there: While I was away last week, the company reported yet another "record" quarter, by meeting or beating various analyst estimates. But a closer look shows that the quality of those earnings was lousy. As

Banc of America Securities

analyst Greg Vogel -- an Open Text bull -- wrote to his clients: "Open Text managed to exceed our net income forecast by not paying anticipated taxes and higher than anticipated interest income." A lower tax rate? Higher interest income?

Both have nothing to do with real operations, which brings us to operating income, which is before taxes and interest income: It was 25% below Vogel's forecasts. Put another way, if not for the lower tax rate or interest income, there's no way Open Text would've come close to meeting expectations.

A company spokeswoman couldn't be reached yesterday; then again, officials of the company didn't return calls last time around, either.

Herb Greenberg writes daily for In keeping with TSC's editorial policy, he doesn't own or short individual stocks, though he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at Greenberg also writes a monthly column for Fortune.

Mark Martinez assisted with the reporting of this column.