Open Text Corporation (OTEX) Earnings Call Transcript & Summary

Okay. Good morning. Thank you all for joining us this morning. We're joined by OpenText today, and we have Madhu, the EVP and CFO. Madhu to kick things off, maybe for folks who have a less well-known understanding of the company, could you just give us a quick overview of the business, what are the customer pain points that you're addressing and kind of what that market looks like?

Yes, I'm happy to, and thank you again for having OpenText and thanks, everyone attending today. So I'll start off with information management in all markets and all environments and particularly today, we strongly believe it's time for investors to engage in information management as a space. And for OpenText, the market itself, information management is $92 billion, very large. It's high value, and it's a CAGR of 9%. We are the leader in information management. We have a tenure, a history of 30 years. And when you think about the cloud, the OpenText Cloud Edition is going to be a growth foundation that will continue in the quarters ahead. And we provide information management to businesses of all sizes that is also very unique and differentiated for OpenText Enterprise and SMB. When we talk about pain points of the customers, I will talk to you about how we go to market with our products that is the 4 clouds. To start off with, it is the Content Cloud. It enables customers to bring data together from applications, systems and devices of all types. And the key objective there is not just to extract business insight, but remain compliant with global privacy, whether GDPR and otherwise, and OpenText is very unique in bringing the holistic solution together. I'm starting in the order of seniority. Content Cloud is our most established. It's our longest tenured. And then we move into Business Network. In each one of these, you'll hear about the deep entrenchment we have and notwithstanding a pretty long runway for growth. Our Business Network, think about the 40 of the largest 50 supply chains on our Business Network. And what do we do for them? It enables them to securely transact with their suppliers, check the credit, ethical score, disseminate through a wide variety of networks, tariffs, all notwithstanding. The third one is the Customer Experience Cloud. We call it the digital experience to the Customer Experience Cloud. It enables companies to seamlessly manage through all customer interactions. And here, again, web, chat, phone, e-mail, all of that. Then we come to the Security and Protection Cloud. Here again, we have an enterprise component, but we have a very large and growing SMB component. You may have read, we acquired 2 companies, Carbonite and Zix Corporation. And together, and you'll hear more about this from us, we call it the SMB, mid-SMB powerhouse where we not only have a channel at scale, SMB is all about channel. We have about 23,000 MSPs, a significant partnership with Microsoft for e-mail security. Our provider, Zix is one of the top 5 providers for Microsoft. Again, think about backup endpoint security threat intelligence, e-mail security, all of that. And I would say, truly watch the space there. I think the other piece, 2 other pieces, and I'll turn it over to you, Brandon, is that there are different ways to consume and OpenText remains very committed to what we call the 4 ways to consume. You can be private, you can be in your own data center, you can be in our data center or managed services, we provide all the ancillary services or the public cloud, and we have partnership with all the 3, Google, Amazon and Microsoft as well. And the last point to keep in mind is our growth is total growth, it's acquisition and organic growth. We are just very experienced and versatile in doing M&A, the right M&A and bringing it home, integrating and growing our installed base. So keep in mind, our growth of CAGR in the last several years has been 12%, and that is acquisition plus organic growth. Every acquisition sets the foundation for us for further organic growth. So where we stand today, about $3.5 billion in recurring annualized revenue, 80% of that is, in fact, recurring, EBITDA margins in the high 30s and free cash flow as well in the mid- to high 20s of revenue.

And that's a fantastic overview. Thank you for all of that. I think we'll try and kind of double-click on a few of those just to tease out some more details here. But before we go into those details around the cloud, specifically given your overview there as it relates to content experience, business network security, and we're thinking about today's environment whereby there are macro factors, whether it'd be inflation or rising rates, there's a geopolitical uncertainty. How are you guys thinking about the business right now in this climate and especially how that has kind of affected your customers?

Yes. No, thank you for that. It must be very hard to evaluate a company in today's environment as to where we are resilient and where we might have opportunities. And your question really leads into all of those. I will start off by saying OpenText has continued to execute very well through the pandemic. And on all fronts, we had a much stronger, better company if we are coming out of the pandemic, which we are here in person. So thank you. We are coming out of it. When you think about the geopolitical volatility that's going on right now, our exposure to Russia to Ukraine and to Belarus is de minimis. And our business plan and opportunities are not directly impacted. We do have a strong presence in Europe when we think about the ancillary effects of the geopolitical matters, and we stay very close to it. But direct exposure is actually very minimal. So -- and let's talk about inflation. For our customers, what we do for them is information led in digital transformation, we actually help our customers with their cost structures, with their dissemination of data structures, all of that through this period of inflation. Through our offerings, we believe the companies can redefine their purpose, redirect their labor, which is very important, and you heard about the warfare talent everywhere through this information-led automation that we offer across our clouds. I'll go back to saying that over 80% is recurring business for us. So high predictability and visibility. Our installed base have remained very strong. When you take off cloud, which is the on-prem and the cloud, our renewal rates have gone from 91% to 94%. I talked about growth. We stay very well positioned to go from renewal to expansion. And from a balance sheet perspective, we did a couple of rounds of refinancing and restructuring. So we've really optimized our debt structures. We moved the towers out, we have fixed rates. And to your point, if you can control the volatility factors, and that's at least at fixed rates, and we've done that. So we are having a very strong balance sheet as well. And that is sort of the DNA of OpenText. For those of you who don't know us very well, we will remain preemptive to be resilient. But in the process, we are not going to forego growth opportunities. And given our profitability, we have a strong financial envelope to do that.

Got it. So you've certainly taken the proactive measures to push out debt maturities such that you've eliminated any near term uncertainty there. You -- one point you mentioned as it relates to I think your customer retention, you said it expanded.

Yes.

How was that -- kind of what was the key driver there getting those extra points, especially going over the last few years. So what was the key anchoring?

Yes, absolutely. So I said from 91% to 94% is our renewal rate. As we look ahead, the opportunities for our direct sales force for our partners remain very large. And the renewal team is also a very experienced team, and we're very keen for them to add value, which is sell more products at the lower end while you're on the phone with a customer or on the e-mail with a customer from a renewal perspective, and we are going to be investing in training for those renewal reps. And that is really where we get from sort of a mid-90s renewal in certain pockets without sort of overcommitting to numbers to getting to beyond 100% while you add value. And that's a very key focus. If you look at our Investor Day presentation, Paul Duggan, who is an ex Oracle and ran a $5 billion business there, is leading our $1.3 billion Renewal business, and we're very excited about it.

Excellent. So maybe shifting gears here and we can talk about the OpenText advantage assets and capabilities. I know you guys have talked about this in your Analyst Day last week, but can you just give us more of a detailed approach or more of a detailed overview of that approach, kind of what it anchors? And ultimately, what does that help you do as an organization?

Yes. So when you think about OpenText advantaged assets and capabilities at the core is our customers. And then it's our people. So we have 15,000 people around the globe in various capabilities and we're represented in over 70 countries. Then you go into the products and the platform, and you will see how we speak about the 4 clouds and we have an emerging cloud API services, which I'll get to it as we have this conversation. And then it's really about the speed and the scale and the ecosystems. Our ecosystems include our partners and what powers all of this is what we call the OpenText Digital Zone, and you'll hear more about us about investing within OpenText to make it frictionless to make it seamless and more self-service. And these are very advantaged assets and capabilities. I'll go back to our large TAM, how do we execute against it. So this is how our plan is to do from a short term, medium term and long term.

I got it. So maybe that's a natural segue into your strategy overall. So how is it that you are currently defining OpenText's strategic priorities?

Yes. So think about near term, medium term and long term, right? From a long-term perspective, again, I want to emphasize the total growth. We are very experienced in M&A and you will continue to see us deploying capital in a very disciplined manner with free cash flow returns at the core plus organic growth. Our longer-term aspirations, we do want to be #1 in every cloud, I spoke to you about. And it is possible, can we double the company with up to 4% organic growth plus M&A in the next few years, we believe we can with a large TAM where we can organically grow and acquire within our universe of cloud is definitely possible. And I would also say that OpenText did something earlier and better than many companies and particularly in the tech industry, which is focusing on profitability and cash flow. So when you look at the next few years, generating $6 million of free cash flow in cumulative basis is also a key strategic priority. Cloud will remain our largest growth driver. So continue to grow in the cloud, our future cloud platform, expanding our markets, all of it is priority. We also said, as part of our long-term strategic priorities, as you asked, is 80% plus of our R&D investments will be focused on cloud-based technologies as you look ahead. And we believe that is actually required. If I could just break down the TAM as I walk through, Content is about $24 billion, then Business Network is $22 billion and Experience is about $25 billion, and Security and Protection is about $20 billion plus. So again, as you will see, we're very focused on the size of the opportunity, the significance of the opportunity and certainly, the growth rate of inherent opportunity.

Okay. Wonderful. And maybe just double clicking on those clouds, the $90 billion-plus opportunity is quite material. And you said you lead with Content that's your oldest cloud. Just maybe helping us understand here, what's the competitive environment across these various cloud kind of businesses that you have in place? And where do you expect to see most of the growth coming from those business clouds? Is there an index or focus on one over the other? Or are you equally kind of invested in the long-term success of all of them?

Yes. So we'll speak to the competitive environment first. The cloud additions I spoke about earlier in the conversation is fundamental and a foundation for growth. While we have different ways to consume, it positions us very competitively for our customers as they think about their own digital and cloud journey. The partnership with our hyperscaler as we call them, Google, Microsoft and Amazon. We are farthest with Google is also going to really help for the customers to make their choice in the cloud. At the end of the day, what OpenText really cares about is 2 things. One is our own software and products and solutions to be in the enterprise ecosystem and environment. And secondarily, but equally very important is the partnership with the cloud providers and for that integration capabilities of the cloud edition becomes actually very important. So from a competitive standpoint, whether it's IBM or Veeva from a life science perspective, our point providers is Box, et cetera, we remain very well positioned. The conversations our teams have with the customer is about the customer's long-term digital journey. And typically, even if it is a point sale, it has to lead us to that long term. If you open the roller decks of OpenText customers, you will find several, several in terms of 7-year tenure, 5-year tenure, more than a decade, all of that, right? So putting that competitive landscape aside, we remain very well positioned. Our focus is going to be very -- we call it the product investment model, where we really look at the strength and the history of each of the cloud, right, scale. So I would say when you look at the tenure of the clouds, the growth opportunities of the cloud, the investments are going to sort of balance itself off. Could we invest more on Security and Protection Cloud? Absolutely. And could we invest more in digital experience, yes. And Business Network supply chain remains very high. I'll come back to the envelope, right? 12% to 14% of revenue is R&D products and innovation. So it gives us quite a bit of latitude in terms of investments. And one other aspect I'll share in terms of the competitive strength is we probably have the best in terms of size and balance of direct enterprise software sales professionals and partners. We actually call our partners a force multiplier, and we have over 3,000 members of the sales organization and over 1,000 field sales professionals all enterprise software cadre. That is also, we believe, a great competitive advantage.

Okay. Wonderful. Thank you. Just thinking about -- you mentioned earlier the developer API cloud. So I wanted to quickly touch on -- you have your 4 core clouds, which anchor OpenText historically. But then there are also other avenues by which you are exploring to unlock new end markets, new use cases and to be able to better serve those customers. So maybe help us understand a little bit more about the Developer API Cloud and really what that enables and what growth opportunities you see there for OpenText?

Yes. It's a great question, something we are being a visionary about as we have so much opportunities. So we have about 10,000 developers, right? Our Developer Cloud will give our customers the choice on how to leverage our APIs and services either a headless API, as we call it, or embed their products and services, but all through an app, right? And engage with our community, as I said, of 10,000 developers to build their next big application is going to be very important. We also have a pretty learning culture and a humble culture at OpenText. And we are actively learning from some of the experts in the market, including Amazon and Twilio. The API is a required direction for OpenText to take at this point, right? As we took the direction towards the cloud, and that's why we are publicly talking about it, developers and companies do want to pick up a series of APIs to run their business. I would say our API business is early and nascent, but it's very well poised for future growth.

Okay. I understand. And so as you think about people wanting to get applications done quicker, faster, better, you give them the APIs and the tools to enable more of the development.

Yes, 100%. Yes.

And if we think about then the investments you similarly made in cloud infrastructure, I think that's also been another leg of growth by which you've been positioning the company for the future. So maybe can you talk to us a little bit about those investments in cloud infrastructure? And then more importantly, kind of what that opportunity there allows you to mock?

Yes. So when you talk about the investments in the cloud infrastructure, again, we have close to 7,000 individuals around the globe that include like product engineers and network engineers and cloud operation folks, all of that. And we are very strategically distributed, I would say, U.S., Canada, in the Waterloo region, Germany, India. And dev ops and automation is going to be the next wave for our teams in engineering. The skill sets range across, for example, Southern California for us is AI and machine learning. Waterloo for us is data science and machine learning. We're also very product-focused in the respective geographies. Content and Business Network has deep expertise in India. So when we think about investments here, we are very strategically distributed. And plus, it will be supply chain expertise if you're talking Business Network. It will be life science expertise If you're talking about competitive landscape with Veeva, et cetera. And when we talk about the 80% plus, we've started the process. We've looked at our R&D investments and very systematically, we are moving investments into more and more cloud-based technologies. Case in point is our API and Developer Cloud that we are also investing in. We feel very confident and very excited about the distribution of our investments across these clouds.

Okay. Thank you. And maybe building on that point with the API Developer Cloud, your investments in infrastructure, clearly, you're pivoting the business for more of a kind of cloud-focused customer buying motion. I think today, keep me on is roughly 1/3 of your customers are using cloud products. Just maybe help us understand the path to converting more of them to the cloud and maybe said differently, I think it's Release 16 to your cloud additions. Kind of what's that transition look like for a typical customer?

Yes. So that's right. We have about 1/3 of our customers who have journeyed their way into the cloud. But also keep in mind, they move the workloads, but by no means have they fully sort of saturated, consumed what could move to the cloud. So the data point is important, but it's a breadth, and we are also working on the depth. And then you have the 2/3. So here, I probably will anchor towards what are our major growth vectors, right? So when you look at content services, it's a big shift to our clouds, content is very highly regulated, and the Content Clouds can integrate quite well. We talked about Business Network, and I cannot emphasize more just the nature of disruption going on in supply chain. And the OpenText product solutions offerings are squarely sort of in there. And when you combine Business Network with IoT, that's where the opportunity is really kind of unfold. Today, Business Network is all cloud. We have approximately 300 sales professionals in BN as we call it, that are completely focused on selling that enterprise, that sort of enterprise cloud, right? And when you talk about digital experience, for instance, it's accelerating the consumers, customers' willingness to consume in the cloud. I would say, internally, we speak about what's the space, it's actually going to grow faster than the other cloud. Just given the secular tailwinds as we actually talk about it, the extreme remote nature of how everything is operating. And you move to the international markets. We centralized it under James McGourlay, who is an OpenText veteran. We actually have an opportunity to double our growth in international markets over the next few years. So from an organization structure perspective as well as an investment in go-to-market, and really founded on the product and innovation, we actually believe we have 75,000 enterprise customers and to move them consistently towards the cloud. I will also say that it doesn't take away opportunities from new customers. 37% of our enterprise cloud bookings in the first 2 quarters were from new customers. So the opportunities are pretty large, and we are sort of systematically going after it.

Okay. Perfect. So we talked about the end markets. We talked about the products and maybe now let's talk a bit more about go-to-market. So really, can you just help us understand maybe where you're targeted, whether it's enterprise, mid-market, SMB and how do you sell to them. Your focus, maybe it's equal weight across those segments. We've also touched a lot on partners and how they kind of help you kind of unlock and kind of you mentioned a force multiplier. So maybe help us understand kind of that motion, where the partners play in and then really how those relationships have evolved over time, whether it's with SAP or the hyperscalers?

Yes. That sounds great. So -- and maybe I will sort of intersect that in 2 ways. One, let's go direct and the partners. From a direct perspective, feel confident enough to say that OpenText probably has one of the best direct sales force across the globe. And as I talked to you earlier, North America remains a very key market, but we have over 3,000 professionals here. They have practice experience, whether it's supply chain or life sciences. At the same time, these direct sales reps can equally sell off-cloud solutions or as everyone is raising to the cloud, they're very well equipped to sell cloud as well. So we don't need a separate sales force to do that. Now moving to the partner side. There are 2 aspects here. On the enterprise front, we've had a decade-long very fruitful partnership with SAP. As you hear about SAP rise to the cloud, we are positioned from a go-to-market perspective as well as the product and the foundational aspects to rise with the cloud with SAP. We're also one of the leading cloud providers of several of SAP's products, we are really specialists in that. Now we have the other global system integrators, GSI, as we call it, whether it's Deloitte or other consulting firms that we partner with very, very closely. The hyperscaler partnerships, I can't speak enough about them, which is Google, Microsoft and AWS. The product to the cloud addition, the capability was more important and we're there, and the future is only going to improvise that. From an SMB perspective, we have a couple of things going on, 23,000 MSPs we call them. We don't directly work with the dental office or the lawyers office, we work through the MSPs and the 23,000 is at scale. And the Microsoft partnership that Zix brought to us is going to entrench with the Microsoft partnership we already have, and that's also going to be very strong for us. So the strength of the enterprise, the strength of the SMB, we actually call it SMB powerhouse. And I would say watch that space. It is at scale. You see the public numbers for Carbonite and some for Zix. And it is definitely in the $700-ish million. And over a period of time, as I said, we want to be #1 in each cloud in this particular case in Zix being #1 in the Security and Protection Cloud and particularly from an SMB perspective. So whether it's direct or channel partners, right? Or is it by cloud? That's sort of how we approach the market.

Okay. That's very helpful. And then maybe just double clicking on that here. You said you wanted to be #1 in each of the clouds. And I know you've also said that over the next 5 years, there's going to be a $2 billion investment in R&D and I know that organization has already grown quite materially as it may be -- maybe where is that investment focus to kind of help you guys achieve the #1 in each cloud, then going to maybe more importantly, how does that then set up the short-, medium term and long-term views of the company, specifically it relates to the organic growth story?

Yes. So in the near term, for fiscal '22, we will be doing total growth of 3% to 4%. And when you look at cloud, it's going to be 8% to 10%. When you look at fiscal '24 aspirations, we're talking organic growth up to 4%. And from a market perspective, as I said in the last few years, we've done 12% CAGR, including M&A. M&A will remain a very key expertise for us, and I'm happy to expand on that we have an in-house M&A team, and we are looking at about 1,200-plus targets in our respective cloud. So when you think about the longer term, I would say, let's keep thinking about the low double-digit growth we've done from an overall CAGR perspective in the last few years, and that is every expectation to continue to do that. And that is what's going to contribute to doubling the company. And as you rightly asked, I will say that we're very unique in having the financial envelope to do so, right? While we didn't specifically talk about adjusted EBITDA, 38% to 40% is our fiscal '24 target. This year, the midpoint is around 36% adjusted EBITDA. Each time we do a large acquisition, it's very normal for us to absorb the acquisition. And then we are -- our 38% to 40% remains unchanged. But the most important aspect is, could we do above 40%, we guess we can. But do we want to do that at the cost of top line, no, we don't. So we've explicitly stated that we'll bring every percent above 40 back into investment in all the areas we talked about go-to-market and products and innovation.

Okay. Perfect. You referenced the doubling the company again. In order to do this, do you need to tap into new markets? And do you have the tools and people in place now? Or are there interim steps you need to take to achieve this?

Yes. So it's a great question. Our current market is large. At $92 billion, you've got a lot of optionalities, right? Having said that, each vector that came out for OpenText, whether it's Content or Business Network came from a transformative acquisition. The Security and Protection Cloud came from the transformative acquisitions of Carbonite and Zix. So while we would not rule that out, I would say we remain very focused in the markets we know and the markets we play in. And that is where we think it's important to go deeper and capitalize on from an M&A perspective as well.

Okay. So that kind of ties into capital allocation strategy as you think about dividends, repurchases and M&A. I think there's maybe a slight tweak recently as it relates to that strategy. So maybe what's impetus for that change? And kind of what is that new policy?

Yes. I would say that we became smarter and clear about our capital allocation strategy over the years, really trigger driven by the strength in the cash flows. So where we landed was 33% of trailing 12 months free cash flows for buyback and dividend. We've been a consistent dividend issuer. And as the cash flows grew, the dividends grew as well. And we said from a buyback perspective, from an anti-dilutive standpoint, keeping the share count constant, but that does not preclude us programmatically to do higher than that. We've left the 2/3 open for M&A as it remains our core expertise, but we do have the flexibility for the right level of returns from a capital allocation perspective to move between these percentages. But we did want to put out the clarity of 33%. We used to be at 20% of trailing 12-month free cash flow for dividends now with 33% including the buyback.

Got it. Okay. And maybe for the M&A, given that's a large chunk of it and your recent shift to more cloud focused acquisitions with Carbonite and Zix. Is that how we should think about the strategy going forward? And just kind of thinking about this through the lens of finding targets that are not overly expensive, but they can also be plug into your platform to realize the synergies that you typically look for?

Yes. It's a great question. And I will say that watch Carbonite and Zig, these are growth assets. We speak about total growth, we speak about organic growth, but we also have acquired assets that have inherent growth opportunities, right? Everything has to grow when they come into mothership or the OpenText parent. So that's point number one. And the valuation will be paid for both, very reasonable. So we are very sort of skilled at that intersection of growth and being a disciplined buyer, and we will continue to do that. When you ask about the type of assets, think ARR. Our long-term aspiration is also 85% of our revenues will be ARR. That's cloud and customer support, maintenance, et cetera. So that is the lens we would apply when we look at target companies within our large TAM, think ARR, and we also have consistently been able to bring it back to our operating model every single M&A within a period of 12 to 18 months. And that, again, feeds into the financial envelope as well. And that's how we're thinking about it.

Great. Thank you. And maybe in closing here to wrap up. What do you think is most misunderstood or undervalued from an investor standpoint as it relates to OpenText? And then thinking about the next 12 to 18 months, what are you most excited for as it relates to the company and its trajectory?

Yes. Thank you for that. It's a great and very important point. As I said at the beginning of the conversation, information management, given its size, high value and growth rate and OpenText being a leader, we strongly believe every investor community should be engaged in information management and, of course, engaged with OpenText as well. And with that, where are we undervalued under sort of understood is an advancement into the cloud, right? And I couldn't emphasize that enough, while we give options, optionalities for the customers, we have made huge advancements into the cloud, including 80% plus target of our R&D investment for cloud as we look ahead. We have 75,000 enterprise customers. We have 40 out of the top 50 supply chain also as our customers, right? And what are we excited about? I would just say growth, plenty of opportunities to grow. And none of us appreciate the extreme volatility today, but that is an opportunity for OpenText across all our clouds. And given the financial strength of the business, you have a very resilient, financially strong leader in information management with also tremendous opportunities for growth.

Perfect. Thank you, Madhu, for joining us. It's been a pleasure.

Yes, thank you as well. And thank you all.