Open Text Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
February 1, 2024

There are 12 speakers on the call.

Operator

Thank you for standing by. This is the conference operator. Welcome to the OpenText Corp. Second Quarter Fiscal 20 24 Financial Results Conference Call. As a reminder, all participants I would now like to turn the conference over to Harry Blount, Senior Vice President, Investor Relations.

Operator

Please go ahead.

Speaker 1

Good afternoon, everyone, and welcome to OpenText's 2nd Quarter Fiscal 2024 Earnings Call. With me on the call today are OpenText Chief Executive Officer and Chief Technology Officer, Mark J. Barreneche and our Executive Vice President and Chief Financial Officer, Madhu Ranganathan. Today's call is being webcast live and recorded with a replay available shortly thereafter on the OpenText Investor Relations website. Earlier today, we posted our press release and investor presentation online.

Speaker 1

These materials will supplement our prepared remarks and can be accessed on the OpenText Investor Relations website investors. Opentext.com. I'm pleased to inform you that OpenText Management will be participating at the following upcoming conferences. Bernstein's Tech Media and Telecom 1 on 1 forum on February 28 in New York Morgan Stanley's Technology Media and Telecom Conference on March 4 in San Francisco and JMP Securities Technology Conference on March 5 in San Francisco. And now on to our Safe Harbor statement.

Speaker 1

Please note During the course of this conference call, we may make statements relating to the future performance of OpenText that contain forward looking information. While these forward looking statements represent our current judgment, actual results could differ materially from a conclusion, forecast or projection in the forward looking statements made today. Certain material factors and assumptions are applied in drawing any such statement. Additional information about the material factors that could cause actual results to differ materially from a conclusion, forecast or projection in the forward looking information as well as risk factors that may Project future performance results of OpenText are contained in OpenText's recent forms 10 ks and 10 Q as well as in our press release that was distributed earlier this afternoon, which may be found on our website. We undertake no obligation to update these forward looking statements unless required do so by law.

Speaker 1

In addition, our conference call may include discussions of certain non GAAP financial measures. Reconciliations of any non GAAP financial measures their most directly comparable GAAP measures may be found within our public filings and other materials, which are available on our website. And with that, I'm very pleased to hand the call to Mark.

Speaker 2

Thank you, Harry, and thank you to everyone joining today's call. Welcome to calendar 2024 in the second half of our fiscal year. OpenText is more relevant than ever as we enter the new era of business AI. We have significant momentum as we transform into a cloud growth company, as we expand our mission in information management and as we accelerate private and public cloud consumption. Artificial general intelligence is a once in a generational opportunity And OpenText is in a very strong position to lead the way in information management.

Speaker 2

We continue to accelerate our investments in product services and go to market and we are seeing the results. Q2 was a spectacular quarter and showcases our strategy and performance progress with the following: record revenues of $1,300,000,000 or 71 percent year over year growth strong organic growth, our 12th consecutive quarter of ARR growth in constant currency. Record enterprise cloud bookings of 236,000,000 63% year over year growth and we're just getting started. We are winning with cloud additions, our business clouds. We are winning with data security and trust requirements.

Speaker 2

SaaS and Micro Focus just coming online as well as business AI with OpenText Aviators. We had record adjusted EBITDA of 566,000,000 37% 66% year over year growth and strong free cash flows of $305,000,000 or 87 percent year over year growth. I'm so proud of our colleagues and partners. And this great success is enabled and powered by our innovation investments, strong customer momentum and operational excellence. Let me highlight a few amazing customer partnerships.

Speaker 2

Carl Zeiss is leveraging the OpenText Content Cloud for a global information management platform a single source of truth across the entire company, integrating business applications from SAP, Salesforce and Micro Focus Microsoft into the OpenText Cloud. Philips Healthcare is leveraging our OpenText Aviator platform Vertica for its mission critical medical imaging system for high availability and proactive field maintenance to ensure patients receive optimal clinical performance. BMW has selected the OpenText cybersecurity cloud, Fusion, for what is called Root of Trust Information Management and Data Governance. FedEx Express, the world's largest cargo airline, has been a strategic partner with OpenText for over a decade and that partnership expands now by leveraging the OpenText IT Operations Cloud for OpsBridge monitoring and autonomically responding to a very dynamic topology, ensuring the highest possible flexibility and resiliency in support of their mission. We had 48 cloud wins over 1,000,000 and new contract value in Q2 with many impressive customer stories just like these.

Speaker 2

Today marks our 1st full year of owning Micro Focus. And our focus is on cloud growth, AI, customer success and being number 1 in information management. Micro Focus contributed revenues of $601,000,000 in Q2 and we should end the fiscal year with renewal rates in the high 80s. The amazing work from our colleagues and partners and with the trust of our customers, we reshaped a shrinking business into a winning and growing innovator. We're doing exactly what we said we would do.

Speaker 2

Further, we're on track to complete the AMC divestiture by the end of the fiscal year, subject to standard regulatory approvals and customary closing conditions, which will allow us to go even faster in AI and the cloud. We intend to use the proceeds to reduce net leverage to less than 3x and ahead of schedule, providing us the flexibility to resume share buybacks and to pursue strategic M and A and to drive future cloud and ARR organic growth. We have all the ingredients we need for a fantastic 2024 and to achieve our F-twenty six aspiration of 7% to 9% cloud organic revenue growth. Now with our strong cloud bookings growth of 63% this quarter, your visibility into our cloud growth increases. And as a reminder, and as we like to say, we're an annual business.

Speaker 2

So let me turn to our fiscal 'twenty four outlook. We're maintaining our total cloud revenue outlook of $5,850,000,000 to $5,950,000,000 We are raising our cloud bookings growth target to 25% to 30% growth, up from 15% plus. We're within our adjusted EBITDA range, tightening the range to 36% to 37% given our investments in cloud and security and AI. We have both medium and long term opportunities to increase margin. But right now, our focus is driving bookings and cloud revenue growth.

Speaker 2

We're also raising the lower end of our free cash flow range and now expect stronger full year results of between 825,000,000 to $900,000,000 of free cash flow. And with our workforce optimization complete and the majority of the Micro Focus restructuring complete, Our attention and energy are focused now on customer transformations, innovation and growth. Information automation plus AI will be an essential part of our competitive advantage. OpenText will completely embed AI in all our products. I've received very positive customer feedback on our information management business clouds, AI, AKA Cloud Edition and our business AI, AKA Aviators.

Speaker 2

We are working with a major apparel company to apply AI's invoices, a major bank to detect fraud, a major manufacturer for complex compliance and a major food company to consolidate billions of supply chain transactions and documents to create the next generation of sustainable food. We are making strong and steady AI progress. We are differentiated in the market and we are winning business. Our differentiated advantages include managing active and large datasets. We believe in integrating automation and AI together, protecting data privacy, security and trust, focusing on AI assist and personas and being cost reasonable.

Speaker 2

We are clearly progressing from discussion to delivery and from vision to value. Aviators 23.4 and 24.1 are delivered and soon 24.2. We have 800 engineers working on AI we're delivering new capabilities now every 90 days. We have numerous customers in our Earn Your Wings program And our bookings growth is benefiting from customers consolidating and preparing for AI. We built a powerhouse services organization and we're ready to engage with customers for our talent to help them do AI transformations.

Speaker 2

And further, we are focused on enabling our engineers to go even faster with business AI. I'm announcing today that we've begun a significant internal AI transformation and how our engineers create OpenText software. We're creating a new platform called Platform Athena that will be our trusted platform to generate software and to assist our engineers in creating our products. Athena will significantly accelerate our innovation, accelerate time to market, attract the next generation of talent and raise our productivity and efficiency. Our first Athena generated products are expected to be in the market with Cloud Editions 25.2 and we'll keep you updated along the way.

Speaker 2

Our Q2 results tell our story. And let me conclude with saying how excited I am about the second half of the fiscal year our momentum in information management, cloud AI and information security and trust. There's so much runway ahead of OpenText for growth. Our investments are the fuel for that momentum. Our operational experience will help us realize higher profits and cash flows from those higher revenues and our accelerated path under 3x leverage will create stronger capital allocation and capital return opportunities.

Speaker 2

The OpenText Cloud is an information cloud and great information management is a key ingredient to business AI. Trust is an essential element in automation and AI and we're earning our customers' trust every day. This is why we were the 1st Canadian company to join Canada's voluntary code of conduct on the responsible development and management of advanced generative AI systems. And as I said last year and you heard it here first, our customers' data is not our product. A big thank you to my OpenText colleagues, customers and partners for this momentum.

Speaker 2

I also want to thank our shareholders for their support of the Micro Focus acquisition. It is your capital. We manage that It is your capital. We manage that responsibility with the utmost care and we are doing exactly what we said we would do, provides growth, cash flows and returns. Our top core value of OpenText has been deserving of trust We look forward to your feedback and continued support.

Speaker 2

Be the one that brings peace for all. Let me turn the call over to Madhu.

Speaker 3

Thank you, Mark, And thank you all for joining us today. So let me start with a few key points. In Q2, OpenText executed extremely well With record Q2 revenues and cloud bookings at an all time high, we have built an operations practice that strategically supports the foundation of a solid growing enterprise cloud business. During Q2, we also completed successfully our 1 year commitments and delivery on Micro Focus to drive integration. 1 year anniversary of Micro Focus is today.

Speaker 3

Our outlook fully reflects the opportunity in front of OpenText and the rapid progress we have made in growing Micro Focus revenue, profitability and free cash flows. Mark spoke to our Q2 results and let me share additional comments. Starting on Page 23 of the investor presentation posted on our IR website For the slides titled Q2 fiscal 2024 and trailing 12 months financial highlights, all references are in 1,000,000 of USD and compared to the same period in the prior fiscal year and are on a reported basis unless stated otherwise. On a year over year basis, With Q2 cloud revenue of $450,000,000 up 10.1% and 9.2% in constant currency. Q2 ARR annual recurring revenue of $1,150,000,000 up 58% and 55.6% in constant currency That represents approximately 75% of total revenue.

Speaker 3

This was our 11th consecutive quarter of enterprise cloud organic growth in constant currency and our 12th consecutive quarter of constant currency organic growth in ARR. Our license increased 168% year over year as reported and 163% in constant currency and this reflects the incremental contribution from Micro Focus and increase in the number of large deals and the granting of certain IP rights. And let me comment to the large deals. For cloud, we closed 48 deals greater than $1,000,000 in the quarter versus 23 in the earlier period. For license, we closed 35 contracts greater than $1,000,000 in the quarter versus 15 in the year earlier.

Speaker 3

The deep sizes reflect the strategic importance of OpenText and cloud booking strength as our customers prepare for AI. And moving to other financial metrics. GAAP net income was $38,000,000 primarily reflecting the increasing interest expense, amortization and special charges related to the acquisition of Micro Focus driving GAAP EPS of $0.14 GAAP gross margin of 73.6%, up from 70.8%, reflecting increased relative revenue contribution from our license business. Non GAAP gross margin of 78.6%, up from 76%, also reflecting Increased relative revenue contribution from license. Adjusted EBITDA of $566,000,000 an increase of 66.1 percent year over year and 61.2% in constant currency.

Speaker 3

Our adjusted EBITDA margin was 36.9%. As I mentioned earlier, we expect focus to be on our adjusted EBITDA model by the end of this fiscal year. Adjusted EPS of $1.24 continues to reflect this progress. Our DSOs are 47 days, flat from Q2 of the prior year and reflecting higher seasonal billings and consistent with our expectations. Our overall working capital performance remains strong and Micro Focus continues to systematically perform higher on all working capital metrics.

Speaker 3

We generated a stellar $350,700,000 in operating cash flows and $305,400,000 in free cash flows during the quarter. Turning to the balance sheet. Please see Page 25 of the investor presentation. We finished Q2 with $1,000,000,000 in cash. Our net leverage ratio was as expected at 3.7 times for Q2.

Speaker 3

After the quarter close, We made an additional January repayment of $175,000,000 on our acquisition term loan. After this payment, Our principal outstanding debt is $8,500,000,000 On Micro Focus integration, please refer to Page 34 of our investor presentation, We're delighted to share that OpenText is on or ahead of plan on every commitment relating to Micro Focus integration. I'm highlighting a few. Accelerate Micro Focus cloud growth, which includes product and sales investment as we saw strong cloud results in Q2 and return Micro Focus organic growth, Another strong quarter with $601,000,000 of revenues were able to accelerate return to organic growth in fiscal 2024. Improving Micro Focus Renewals is a key milestone for organic growth.

Speaker 3

We're on track for high 80s renewal rate in fiscal 2024. And lastly, my focus will be on our operating model, both adjusted EBITDA and free cash flows during fiscal 2024 making significant contributions. On Page 35 of our investor presentation, we are providing a final 1 year anniversary update to the financial integration framework. We have now actioned $370,000,000 of our $400,000,000 targeted savings initiatives. We're increasing our restructuring advisory and facility expense charges by $20,000,000 but reducing expected technology tax and legal entity simplification costs by $100,000,000 for a net reduction of 80,000,000 When combined with expected reduction in interest expense following the AMC divest, there is increased visibility on the improvement in free cash flow We expect to see between now and our fiscal 'twenty six aspirations.

Speaker 3

AMC update, let me spend a moment on application modernization and connectivity, AMC. The business continues to perform well and we're on track for a successful close in Q4 to divest AMC to Rocket Software. The net proceeds will reduce debt for a consolidated net leverage ratio of less than 3 times within 90 days of closing. Our dividend program. On February 1, our Board of Directors approved a quarterly cash dividend of $0.25 per common share.

Speaker 3

The record date for the next quarterly dividend is March 1, 2024 and the payment date is March 20, 2024. So let me turn to our targets and aspirations, starting with our Q3 fiscal 2024 quarterly factors On Page 32 of our investor presentation, on a year over year basis, we expect revenue of $1,400,000,000 to 1,450,000,000 ARR annual recurring revenue of $1,130,000,000 to $1,160,000,000 We expect FX to be constant. Adjusted EBITDA year over year margin between 32% 33% that reflects Micro Focus integration cost and FX adjusted EBITDA to also be constant. Our fiscal 2024 targets in constant currency are provided on Page 33 of our Investor Relations presentation. As I build on Mark's comments, I will also provide updates to the target model ranges To fully reflect our successful 1 year integration of Micro Focus, our cloud revenue is expected to be up 6% to 8% Customer support revenues up 43% to 45% year over year compared to our prior range of up 40% to 42% ARR up 25% to 27% compared to our prior range of up 24% to 26% Our license revenue up 68% to 70% compared to our prior range of up 71% to 73% and professional services revenue up 26% to 28% compared to our prior range of up 29% to 31%.

Speaker 3

Total revenue growth of 30% plus with organic growth in the range of 1% to 2% total operating expenses of 42% to 44% of revenues Non GAAP gross margin range of 77% to 79%. We are tightening our adjusted EBITDA margin range to 36% to 37% And that reflects higher investments in AI and cloud, sales and marketing and expenses related to the AMC divestiture and Micro Focus integration expense. At current exchange rates, we expect FX to be $20,000,000 to $40,000,000 a tailwind. Net interest expense for the year to be $550,000,000 to $570,000,000 and non GAAP effective tax rate of 14%. As noted earlier, our enterprise cloud business is doing extremely well with solid revenue growth and 63% year over year bookings growth in the quarter increasing our visibility.

Speaker 3

We are a key Microsoft partner and as noted in their recent call, the SMB market is facing short term challenges. This impacts our SMB business. We remain in a great position to continue to add products for SMB business and benefit as the environment improves. Turning to free cash flows. We expect free cash flow to grow year over year in both Q3 and Q4.

Speaker 3

We're raising the lower end of our FCF range and now expect stronger full year results between $825,000,000 to $900,000,000 Our fiscal 20 26 aspirations are included on Page 36 of presentation and remain unchanged from our materials we shared with you on November 28 when we announced the AMC divestiture. Our fiscal 'twenty six aspiration shows a highly predictable and growing business at scale led by cloud and ARR. So in summary, our OpenText team members have proudly delivered a solid Q2 and a strong first half of the fiscal year and we remain on track to meet our fiscal 2024 targets and fiscal 2020 6 aspirations. The Micro Focus integration is ahead of our commitments, And we expect Micro Focus to receive important milestones in fiscal 2024, a return to organic growth and renewal rates in the high 80s and Micro Focus business to be on OpenText operating model for adjusted EBITDA and free cash flows. The AMC divestiture reinforces and sharpens our focus, sharpens our capital allocation and over time will allow for more resources to be allocated to drive more growth.

Speaker 3

On behalf of OpenText, I would like to thank our shareholders, our loyal customers and partners. I would now request the operator to open the call for your questions.

Operator

Thank you. We'll now begin the question and answer Our first question is from Richard Tse with National Bank Financial. Please go ahead.

Speaker 4

Yes. Thank you. Madhu, I think you did Talk about the SMB market. I'm not sure if this is for Mark or Madhu, but wondering if you could sort of expand that and talk more broadly about the enterprise environment. It seems there's been some mixed messages out there as to whether it's kind of gone back to a normal pace or not.

Speaker 2

Yes, Richard, thanks for the question. Let me take a part of that. Look on the SMB part, SMB is a massive part of the U. S. Economy, dollars 370,000,000,000 in spend for companies with 1,000 employees or less.

Speaker 2

We believe information management is deeply relevant for this market. And as we know Microsoft is a key partner in this space. Microsoft's recently discussed some of their short term challenges in SMB, But they've also confirmed there are long term strategic drivers for growth in SMB as well. So I think we're in a great position to benefit from SMB, both in the medium and long term and it will be a strong contributor to our 7% to 9% organic cloud growth

Speaker 5

aspirations.

Speaker 2

As it relates to maybe a little more on the macro side, Look, I'm going to combine any of the comments and I hand over to Vadu. I'll combine a little bit of macro and competitors. We are benefiting From customer demand, as customers look to consolidate away from competitors that are stuck off cloud, they don't have a data security Our trust platform and have a weak AI vision and low capabilities to deliver. We're in the right place today. 60% of our business is in North America, public sector, energy, financial services, manufacturing, We're supporting CPG, apparel, retail.

Speaker 2

We got some fantastic ecosystem partners, Microsoft, SAP, Google and sales force. So we're in the right places right now and it's about delivering value for customers. And so we're we see a reasonable economy out there to go execute.

Speaker 3

Yes. Thank you, Mark. And Richard, I just wanted to highlight specific to fiscal 2024. Again, you saw the enterprise cloud bookings growth rate of 3% and we are also increasing the outlook for the year. For cloud revenues in fiscal 'twenty four, content revenue, analytics experience revenue and business network all doing very well, but we did want to call out the SMB as you look at the Q3 and the fiscal 'twenty four target for cloud revenue per se.

Speaker 4

Okay, great. And I just have a question on Aviator, No Debt, that's probably one of your more exciting products right now. I don't know if it's too early still, but do you have any sort of sense at this point in time what a reasonable attach rate would be within your existing customer base and that sort of potential incremental revenue opportunity. And I guess on the same note, I think you had some sort of I forgot what it was called, it was a trial at your annual user conference. Like I'm wondering if you could sharing stats in terms of the uptake on that trial?

Speaker 2

Yes, sure thing. Thank you again, Richard. We're making strong and steady progress. And I'll just start with what's differentiated in the market. And we have one business.

Speaker 2

Now we're differentiated, as I noted in my prepared remarks, on the data sets that our automation creates and we manage. We believe that our business cloud automation and AI are integrated. And I also said on my prepared remarks, We are embedding AI everywhere. It will be a capability AI will live right next to automation in the long term. You'll have your automation screen, but you'll have your AI Assist right next to it.

Speaker 2

And we're my best way to describe it is we're moving from vision to showing the value and discussion to delivery. We have numerous customers today in our burn your wings program. I discussed a few in my remarks in food, in apparel, manufacturing. And if you look at our bookings growth of 63% year over year growth, we have AI wins in that. And also note that we raised our outlook on our bookings growth from 15% to 25% to 30%.

Speaker 2

We're doing this the OpenText way. It is a strong vision, backed up by product. We're delivering every 90 days. We're moving from that vision to showing value. We're moving from discussion to delivery.

Speaker 2

We have now progressed to just a fantastic bookings quarter and raising our outlook for the year on bookings. So I'm and we've moved to the next step, which is creating really a breakthrough idea on platform Athena on how we're going to transform, how we write our own software using our own platform. So I'm pleased with our progress. We're going to keep making progress every 90 days. And I strongly believe that your visibility into our 7% to 9% cloud organic revenue growth significantly increases with the strong bookings outlook.

Speaker 4

Okay. Thank you. I'll pass the line.

Operator

Thank you. The next question is from Daniel Chan with TD Cowen. Please go ahead.

Speaker 6

Hi, thanks. Cash flow conversion took really took a step up in the quarter. Q2 seems to be seasonally stronger for conversion anyway, but considering the ongoing integration, this seemed pretty good. Is there anything to call out on that performance and should we expect that to continue?

Operator

Yes. Thank you, Dan.

Speaker 3

So what I would say is that as I've shared before, The OpenText cash conversion has remained very steady and strong. If you think about the elevation that we made with OpenText, We set out to do that with Micro Focus. What I would say is that in Q2, we saw Micro Focus also respond very positively and The cash conversion that you're seeing is sort of right in there. Keep in mind, they have different year ends and different quarters and we're actually very delighted how we were able to converge their operating performance to our quarters, etcetera. Do we expect it to continue?

Speaker 3

Yes, we absolutely expect it to continue.

Speaker 6

Thanks, Madhu. And then on the EBITDA margin guidance for the full year, tightened it up, but next quarter, I think it's looks like it's going to take a step down to 32% to 33%. Just wondering what's driving that?

Speaker 3

Yes. So, if you recall, Q3 for us is usually a seasonally lower EBITDA quarter. There are big factors, I'd say, for the remainder of the year, As Mark and I both called out, that includes investment in AI and cloud, just given the strong bookings we see. And we do have some AMC divestiture experience expenses and also some micro profit integration expense. But Q3, if I could just highlight, from an employee perspective, It's January 1, New Year.

Speaker 3

We have higher benefits expense. We have higher sort of vacation expense, etcetera. So that is more seasonal to Q2 and that also weighs down a bit the EBITDA margin. But for the year, the 36% to 37%, Q4 will remain a seasonally strong quarter.

Speaker 7

And Dan, I think it's fair to

Speaker 2

say, as Madhu noted, that Q3 is a Seasonally low quarter and Q4 is a seasonally stronger quarter.

Speaker 6

Okay. I appreciate that. The investments that you're making into cloud AI, like where are the areas of focus for this added investment? Thank you.

Speaker 2

Yes. Thank you, Dan. Well, you noted some of them. We continue to build out our private Cloud infrastructure, particularly around industry compliance, data security, trust, privacy. It's an investment in our SaaS offerings.

Speaker 2

As we talk about how to unlock our future value, We have established our private cloud platform as a standard globally. The next step is more public cloud SaaS consumption across our products and of course, aviator, our AI. So those are the areas where We're applying that investment and doing that within the range we talked at the beginning of the year, even though we tightened it a little bit, we're still within the range we've presented.

Speaker 6

That's good. Thank you.

Speaker 3

Thank you.

Operator

The next question is from Steve Enders with Citi. Please go ahead.

Speaker 8

Sure. Thanks for taking the question here. Maybe just to On the card bookings strength in the quarter, I mean, pretty impressive results there. I guess, What in particular kind of drove that side there? Was it customers converting over, meetings, cases?

Speaker 2

How

Speaker 8

big a contributor was AI? And then I guess secondarily, as you think about the step up in the growth, the growth outlook cloud bookings for the year, what's kind of the AI contribution that you're kind of embedding in that?

Speaker 2

Steve, thanks for the question. As I said in my prepared remarks on the cloud side, Clearly a very strong quarter at 63% year over year growth. And with our forward visibility, we see continued strength And we raised our outlook from 15% cloud bookings growth to 25% to 30% Cloud bookings growth for the year. What's driving that? First is, we see a lot of customers Continuing to move to our cloud and consolidating away from competitors who can't get to the cloud, can't provide the data security and trust, don't have a credible AI vision, let alone first products in the market.

Speaker 2

So just continued strength of our private cloud, customers consolidating, Compliance, data security, trust, privacy remain top of the list for the Global 10,000. That's a driver for us and AI. We've won AI Business. And it's showing up on our bookings. We're not breaking out AI or security and trust or content or BN bookings at this point, we don't get down to that level.

Speaker 2

But AI was a clear contributor in that 63% cloud bookings growth and a cadence and a factor in us raising our outlook, our growth outlook for the year.

Speaker 8

Okay. That's helpful. Maybe maybe taking some of the puts and takes of the drug outlook. It's good to see customer support step up. And Maybe just a little more, I guess, color on the license stepping down a little bit and pro services Stepping down a little bit from the expectations in last quarter?

Speaker 3

Yes. So Steve, I'll take that. License in the quarter actually was significantly higher from a year over year basis. And the contribution there really is bringing microfocus into the I mean, as you recall, Micro Focus cloud momentum is strong, but they're still smaller from a cloud perspective in terms of bookings and revenue relative Of course, OpenText and PS revenues also grew in the quarter comparatively. I want to make sure I heard your question right.

Speaker 3

Both license and PS Did grow in the quarter.

Speaker 8

Yes. I guess I want to just clarify just on the outlook. I think as you said that both of those were down

Speaker 7

the prior

Speaker 8

expectations from last quarter. So just trying to understand for the annual outlook why those 2 came down a little bit.

Speaker 3

Sure, sure. I missed that part in your earlier comment. So the adjustment of the ranges really reflects The strength of again micro focus from a customer support perspective, right, and we've adjusted that in the range. And keeping the overall fiscal 'twenty four target the same, from a license perspective, just consider that we have our Q3 seasonality in license and that applies to Micro Focus as well. But it's really the contributor there, I would say, is the better than the world for Micro Focus customer support.

Speaker 3

So we wanted to increase the range of the customer support and obviously account for some inherent volatility in the license business.

Speaker 8

Okay, perfect. Thanks for taking the questions there.

Speaker 3

Thank you.

Speaker 2

Yes. Thanks, Steve.

Operator

The next question is from Kevin Krishnaratne with Scotiabank. Please go ahead.

Speaker 7

Hey there. Just a couple of clarifications for me. So just on the cloud growth 6% to 8% that was maintained. So I just want to read is it just the fact that you've had the strong enterprise bookings, but they're still from SMB, is that sort of the reason why that range was maintained?

Speaker 3

Yes, I'll take it first and turn it over to Mark. Thanks for the question. So think about the cloud bookings as Mark mentioned, really increasing our visibility to the future, which would be Now fiscal 2025 and fiscal 2026, our cloud contracts are long, and we've talked about that before and the time to deployment and to revenue are also long, but we're very delighted at the performance in the quarter just giving us that future forward visibility. So take India for fiscal 'twenty four, we're keeping it at 6% to 8% and within that enterprise cloud revenue, analytics, Experian, BN, all doing well. And as we called out SMB, it's weighing down a bit.

Speaker 3

So we want to kind of balance that and keep the revenues at 6% to 8%. And that revenue is really benefiting from our cloud bookings from our prior quarters, right, and the cloud renewal rates, etcetera. So I just want to separate the strength of the cloud bookings here, which is really going to be positively impacting 202526 and just the factors outlining NOFIC for 2024.

Speaker 7

Got it. Thanks for that. And just a final other question here. On the bookings, I know sometimes you've announced the bookings and there can be a little bit of a delay, I guess, in the translation to revenue. Is The AI related bookings, do those look any different?

Speaker 7

Do you think that those are going to be translated from bookings to revenue at a faster pace, just given the sort of strong demand that your customers are seeing for the AI products?

Speaker 2

Yes, Kevin, thanks for that question. The bookings related to AI are following the same characteristics as an enterprise booking. And so in the SMB space, we tend to see 1 year contracts. In the enterprise space, we tend to see 2 to 4 year contracts. And so AI is following that enterprise pattern, if you will.

Speaker 2

And as we do notice, that bookings number will have a clear impact, positive impact in 2025 and 2026. But right now, it looks like our AI wins will follow our traditional enterprise pattern.

Speaker 7

Got it. Great. Thanks a lot. I'll pass

Speaker 8

the line.

Speaker 4

Thank you.

Operator

The next question is from Adir Khadze with 8 Capital. Please go ahead.

Speaker 5

Hi, good afternoon guys. Thanks for taking my questions. I wanted to talk a little bit about last quarter you saw some initial bookings in AI. This quarter you called out some strength there as well. I just want to ask how have customers really progressed in AI?

Speaker 5

Mark, you kind of mentioned that, a lot of customers are still dipping their feet with the Get Your Wings program. But are some of those early customers, are they progressing faster to maybe more larger scale deployments? Or are they kind of still in the Get Your Wings program, get their feet wet type of deployment phase?

Speaker 2

Yes. Thanks for the question. It's progressing and a couple wide statements here. We're going to embed AI and all our products. It's clear that there's a path where you have your automation and you have the learning from data.

Speaker 2

And our approach is to provide AI assist. If we automate a healthcare professional, there should be an AI persona right next to that. We automate A tech support specialist, there should be an AI assist next year. We automate a contract specialist or a loan specialist, There should be an AI assist right next to it. So we're going to embed AI everywhere.

Speaker 2

It's a discussion in every RFP. And some customers are In early stages of exploring, some are medium, a handful are more advanced. But it's in every single discussion. So it is certainly sort of separating out in the market Those competitors who have not necessarily even moved to the cloud or let alone have the resources to deliver a robust AI platform. So we're seeing benefit from our very strong first wave of products and our vision, Our skills now to be able to deploy, a data management platform and to be able to vectorize and install a Language model.

Speaker 2

So to be able to get customers and you earn your wings to actually be able to experiment either in the small or at Scale, very differentiated in the markets. I called out our services organization that we've been investing in for a decade in building that service organization. So we're making steady progress. We've gone from vision to first set of beta products to our first version, through our first delivery, 1st customers using and getting value, bringing Our services organization to higher capability to a very strong bookings growth, raising our booking outlook and seeing now how we can apply it internally on what we think is a breakthrough platform, co platform Athena. So I really like the progress that we're making.

Speaker 5

Okay, excellent. And then I just wanted to touch on one comment you made that The customers are getting value. What are some early learnings from that value that customers are getting? How is it helping their organization using these AI products?

Speaker 2

Yes, I did a few shout outs in the script. One is particularly using Our business network invoicing transactions to under and Some of the wider network metadata to understand next generation of food and sustainability, Going deep into contracts and understanding revenue opportunities and liabilities. But some of the early learnings are 1, you have to prepare. And you may need to consolidate systems. You may need to prepare your data a little bit.

Speaker 2

So preparation is important. Customers know what they want to do, right? There's not a lot of vagueness out there on what customers want to do, but they got to prepare. 2nd is do not separate your automation and your AI. You take data out of your automation, it immediately rocks like a cabbage because you get data.

Speaker 2

So I think that's another big learning. And customers want to do it economically. And with more open source language models, more skills, We're still staying on traditional processors, if you will, to manage cost. The customers want to do it reasonably. And this is just going to keep building on itself for OpenText.

Speaker 2

So those are some of our learnings.

Speaker 5

Excellent. Thanks a lot. I'll pass the line.

Operator

The next question is from Thanos Moskopoulos with BMO Capital Markets. Please go ahead.

Speaker 9

Hi, good afternoon. Regarding the AMC business, are you seeing any kind of impact in that business stemming from the fact that you've publicly announced your plans to dispose it or Nothing material out in that regard.

Speaker 2

Yes, Thanos, thanks for the question. No, it's steady as you go. These are products and customers who have been benefiting from decades of investment and understand the long term nature of the platform And it's steady as we go.

Speaker 9

Great. And just going back to the question regarding the slightly more conservative license outlook. Obviously, license is more volatile, it's pretty hard to forecast. But is there anything else you would point to? Is it a function maybe of clients preferring A cloud deployment model to a greater extent than you were initially expecting or anything else you would call out in that regard?

Speaker 3

And I'll take the first part, Thanos. In terms of the customer trends, we'll turn it over to Mark. Again, on the license, keep in mind, Q3 has also been seasonally lower from a license standpoint and that pattern also applies to Micro Focus in a licensed business. While Namunda, Micro Focus is doing very well. As I said, we are returning them to organic growth this year.

Speaker 3

So that's really the Q3 seasonality that we are that we're actually calling out. And also we're seeing, micro focus to you very well with the renewal rates, etcetera. So really we wanted to expand the customer support line, those ranges there and keeping our annual revenue within the range and accounting for more the license volatility is really what you see in the ranges. I'll also share that in my commentaries, we shared the number of over $1,000,000 deals both in the cloud side as well as in the license side and both remain very strong, right? It's more the Q3 seasonality that you're seeing into the annual ranges.

Speaker 3

And is there any other comments, Mark, you want to share?

Speaker 2

Yes, sure. License as a role. And we work In very secure environments, we work in deeply regulated environments and environments that have A very high bar on compliance. We want a fantastic nuclear platform That requires license in a private cloud. We want many customer Security, DoD and other community platforms that require licenses as well.

Speaker 2

But what's clear through time is that license has a role And it's going to have a role in certain types of regulatory and deeply compliant environments, environments that require the utmost trust And security has a role in the private cloud as well. And we've sort of found our natural level, right, in our license business. So, Thanos has a role. And it's also a place where we can integrate to our hybrid cloud strategy. And a hybrid cloud strategy also means SaaS and private cloud.

Speaker 2

So we're in the license business. It's got a role, But the role is clearer today than it was 5 years ago. All right. That's fine. Thanks.

Speaker 2

Thank you, Thanos.

Operator

The next question is from Raimo Lenschow with Barclays. Please go ahead.

Speaker 6

Great. Thank you. This is Jeremy on for Raimo. So just on micro focus, maybe focusing on the product side. Can you speak a bit to Which areas of the business are seeing most interest at the moment, whether it be, Idol, Vertica or maybe some of the security products?

Speaker 6

Thank you.

Speaker 2

Yes, I'd be happy to. Thank you, Jeremy. So, look, it's been a great year 1 And we're on to year 2. Today marks the 1st year anniversary. And if you'll just allow me, We reshaped a shrinking business and formed it into an innovative growing one.

Speaker 2

And it was a first it was fantastic first year. I want to thank everyone for their support. In terms of innovation and growth, let me provide a few shout outs. ITOM, our IT operations management. It's all about the next generation of products around observability and extending service management outside of the IT environment to corporate wide service management.

Speaker 2

That's our priority. In terms of security, about bringing it into SaaS, identity management and to edge computing. It's about ADM and having that end to end lifecycle. And our platform, Athena, has many components to from ADM, so getting, bringing AI, business AI and aviators into the developer experience. We introduced the new IoT platform based on core Vertica and something called the GPAS modules, you can find it on our website.

Speaker 2

And we're very excited to bring in Higher scale machine transaction data into our information cloud. And then of course all things cloud, Private Cloud, SaaS and AI Embedded across ITOM, security, ADM, IoT. I'll also note, in my comments of our 63% cloud bookings growth On our outlook for the year to 25% to 30% cloud bookings growth, Microsoft, I keep calling them Microsoft. We didn't buy Microsoft, we bought Micro Focus. I noted that Micro Focus cloud bookings contributed to that 63% growth as well and we'll begin to contribute more over time.

Speaker 6

Got it. Thank

Speaker 8

you. Thank

Speaker 2

you. I did not announce our acquisition of Microsoft today, so just to be clear. Yes. Thank you, Jeremy.

Operator

The next question is from Stephanie Price with CIBC. Please go ahead.

Speaker 10

Good afternoon. Mark, you mentioned M and A, so maybe I'll Not Microsoft, but you did mention strategic M and A in your prepared remarks. So how should we think about the balance between M and A and organic investments and shareholder capital We'll return here post the AMC divestiture.

Speaker 2

Yes, sounds great. Thanks, Stephanie. Well, look, we're excited to complete the divestiture. And as I noted, we're on track subject to closing additions and regulatory approvals. And we expect to close by the end of our fiscal year.

Speaker 2

And when we do so, our intent is to delever and bring our leverage under 3x and to return to a full stack capital allocator. As you'll see in the investor materials, we're looking to return 30% of our approximately 30% of our free cash flow via dividends and buyback. And that allows 70% of our available capital available for other purposes, including M and A. And you should expect us to return to M and A. That M and A will be strategic.

Speaker 2

It will be focused on ARR and cloud assets that drive future organic growth.

Speaker 10

Okay. Thank you. And then I also want to circle back on the investments in AI, Cloud and Security. Should we think assuming these investments continue post fiscal 2024 and how should we think about R and D as a percentage of revenue going forward from here?

Speaker 3

Yes, absolutely. I'll take that Stephanie. So today, we're actually looking at we actually called out R and D as a percentage of revenue at 14% to 16%. So at the largest scale, expect that to continue. In terms of It's both R and D and sales and marketing.

Speaker 3

And for fiscal 2024, it is 18% to 20%. So I would say expect us to Keep in that range, obviously, at the scale the dollars will be higher as well. And also the deployment of R and D, as Mark mentioned, 800 engineers deployed towards AI and related activities. So the teams are spending a lot of time, not just on the investments, But where the investments are going?

Speaker 10

Great. Thank you very much.

Speaker 2

Yes. Thank you, Stephanie. And just to amplify a point from Madhu, platform Athena, So let's go to significantly raise our productivity and output. And this I look through 2 decades 3 decades of leading engineering organizations and how they've evolved over time and how Organizations like OpenText have looked to balance our incredible talent globally and through automation and through systems, through open source wave, through better tools. There's another wave coming, which is called AI.

Speaker 2

And some companies will use it, well some may stumble along the way. For us, we have a very clear vision And we're going to be building our proprietary platform internally to manage roughly a 1,000,000,000 lines of software and how to auto generate cases, how to auto generate interfaces to APIs, how to accelerate learning. I think the talent we hire in the future in engineering is going to be radically different and radically elevated. Athena will be able to take descriptions and generate code. So that next wave of efficiency, And we'll talk more about that when we get to our F-twenty five plan.

Speaker 2

And the R and D expense percent, the nature of this in large scale tech companies But a change because there's a very interesting wave of AI coming and how we're going to be building software.

Operator

Yeah. And Stephanie, if I

Speaker 3

could just add one more. R and D is a very broad category just given our spectacular cloud bookings growth and we talked about visibility to 25 We are also investing in what we call information security, right, the CISO organization. We're also investing in cloud operations and cloud infrastructure and sort of hyperscale the cost. So I did want to mention in terms of investments, it's going sort of above the line and below the line as well.

Operator

Great. Thank you for the color.

Speaker 3

Thank you.

Operator

The next question is from Paul Treiber with RBC Capital Markets. Please go ahead.

Speaker 11

Thanks very much and good afternoon. Just your recent comments on Athena were very helpful to understanding what it is The and using AI to improve the productivity of your R and D teams,

Speaker 3

Do you expect or do

Speaker 11

you see improving productivity across the entire organization through AI over the next several years. Is that something that we could expect going forward?

Speaker 2

Yes. Paul, good to hear your voice and thanks for being on the call. Absolutely. And as I noted, we have room to improve our margin right Now we're focused on bookings and revenue growth. And I only decided on the call today going to one area, very large area for us, A transformative area for us, which is the core of the company.

Speaker 2

We're an engineering firm, right? And we create IP and products. But when we look across the entire company, we have other projects that we're working on and that will come to fruition in the coming years and increase productivity in the support organization, in the presales organization, in the renewals organization. So we can talk more about where we look to deploy them, but I wanted to be very grounded and kind of the first transformative area that we have our concrete plans are and it's sort of a multipliers, a force multiplier To be able to get our engineering team more productive, next generation of talent, accelerating product to market, we think that's the area that will have the nearest term and highest impact.

Speaker 11

Thanks. And then just Second question, just more specifically on the outlook for 2024. And when you look at Q4, if you can back into what implies your Q4 EBITDA margins, think the midpoint is at about 41.5 percent EBITDA margins, which is quite high and it's close to an all time high for the company. What is driving that seasonality to the upside. I think we talked a lot about Q3, but how do we think about Q4, the drivers there?

Speaker 3

Paul, thank you. It's Madhu here. It's a very important question. So a couple of things. One, I spoke about the Q3 seasonality, which is actually very typical.

Speaker 3

So again, at the Uber level, we are making investments, but Q3 has its own seasonality in terms of people spend, payroll spend, benefit, etcetera. So Q4 is our seasonally strong quarter from a revenue perspective and you will see that benefit the EBITDA margin as well. And some of the integration expenses we have For Micro Focus, for this fiscal year, some of the spend is focused in Q3, we look to optimize some of those in Q4. So I would say the big contributor to Q4 EBITDA margin is going to be our seasonally strong revenue quarter and tapering off of some of the expenses. And You're absolutely right for the second half of the year, Q4 EBITDA margin will be much stronger than Q3 to get to our annual range.

Speaker 11

All right. Thanks for taking the questions.

Speaker 2

Yes. Thanks, Paul.

Speaker 3

Thank you.

Operator

I'll now hand the call back over to Mr. Biren Shey for closing remarks.

Speaker 2

Very good. Thank you, everyone. Thanks for joining our call today. We're just delighted with our progress and our momentum. You heard us, we're investing for growth.

Speaker 2

We're Spending our competitive advantage, strong financial update and we're focused on capital return. In the room today as well is Greg Secorp would like to wish him a happy birthday. Thanks everyone for joining. And Madhu, myself, Harry and Greg, we look forward to engaging in the coming days weeks. That ends today's call.

Operator

This concludes today's conference call. You may disconnect your lines.

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Key Takeaways

  • Record Q2 performance: Revenue of $1.3 B (+71% YoY), enterprise cloud bookings of $236 M (+63%), adjusted EBITDA of $566 M (+66%), and free cash flow of $305 M (+87%).
  • Cloud & AI momentum: Achieved 12th consecutive quarter of ARR growth, closed 48 cloud contracts over $1 M, and embedded AI across products, winning business AI deals with OpenText Aviators.
  • Micro Focus integration ahead of plan: Micro Focus contributed $601 M in Q2, returned to organic growth with high-80s renewal rates, and has realized $370 M of $400 M targeted cost synergies.
  • AMC divestiture on track: Application Modernization & Connectivity sale expected by year-end to reduce net leverage below 3×, resume share buybacks, and fund strategic M and A.
  • Platform Athena unveiled: New AI-driven software development platform will assist engineers, accelerate time to market, and deliver new capabilities every 90 days.
AI Generated. May Contain Errors.
Earnings Conference Call
Open Text Q2 2024
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