Open Text Corporation (OTEX) Earnings Call Transcript & Summary

Thank you for standing by. This is the conference operator. Welcome to the OpenText Corporation Conference Call. [Operator Instructions] And the conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Harry Blount, Senior Vice President, Investor Relations. Please go ahead.

Thank you, operator. Hello, everyone. Welcome to today's call to discuss OpenText's divestiture of the Application Modernization and Connectivity business to Rocket Software. With me on today's call are OpenText's Chief Executive Officer and Chief Technology Officer, Mark J Barrenechea and our Executive Vice President and Chief Financial Officer, Madhu Ranganathan. Mark will kick us off with some prepared remarks, which will be followed by a question-and-answer session. Today's call will last up to 45 minutes and is being recorded with a replay available shortly thereafter. I'd like to take a moment and direct investors to the Investor Relations section of our website, investors.opentext.com, where we posted an investor presentation with more details on today's announcement. And now I'll proceed with the reading of our safe harbor statement. Please note that during the course of this conference call, we may make statements related to the proposed divestment and the future performance of OpenText that contain forward-looking information. While these forward-looking statements represent our current expectations and projections, actual results could differ materially from a conclusion, forecast or projection in the forward-looking statements made today. Certain material factors and assumptions were 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 impact future performance results of OpenText are contained in OpenText's recent Forms 10-K and 10-Q as well as our press release that was distributed earlier, which may be found on our website. We undertake no obligation to update these forward-looking statements unless required to do so by law. In addition, our conference call may include discussions of certain non-GAAP financial measures. Reconciliations of any of our non-GAAP financial measures to 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'll hand the call over to Mark.

Thank you, Harry, and thank you, everyone, for joining us today. My remarks will be brief, then we'll open the call so Madhu and I can take your questions. And we're very much looking forward to it. OpenText is focused on the singular powerful concept of information management in the cloud with AI at scale. We manifestly expanded our mission with the Micro Focus acquisition and offer the most comprehensive information management platform in the market today, content and experience, business network, service management, security, DevOps, digital operations and our new Aviator AI platform and Aviator AI business clouds. The growth prospects for information management have never been better. Customers are modernizing their information management platforms at an accelerated rate to enable modern work for GenZ and digital fabrics, supply chains that are both global and regional and sustainable, operations that are digital, hybrid and green, stellar experiences for both customers and employees, productive, fast-paced and high-quality developers, secure compliant and trusted data while preparing to unlock the next generation of opportunity with AI. At the core of these modernizations or information, processing, algorithms and learning. It is clear that information management is a prerequisite for AI and that great AI requires great information management. To date, we announced the intent to divest our mainframe business, our AMC business to Rocket Software, a Bain Capital portfolio company. We are confident that our AMC customers, employees and partners will thrive in their ecosystem, given Rocket's focus, track record and expertise in modernization and mainframe technologies. Further, expect continued AMC leadership from us as we have important innovations to deliver to our AMC customers such as architectural blueprints for hyperscalers, epic support, open telemetry enablement, GCP ally database support, AWS PostgresSQL database support as well as a whole new set of arm-chip support on our road map. This divestiture will better position us to move with more speed in higher-growth areas such as cloud and AI in each of our business pillars as we continue to capitalize on the information management opportunities. Let me walk you through the key aspects of today's announcement. It's an all-cash purchase of USD 2.275 billion net of taxes and transaction costs, we expect approximately USD 2 billion of net proceeds. We're divesting approximately $500 million of revenue, $275 million of adjusted EBITDA dollars and approximately 750 employees. The mainframe business, the AMC business is 100% off cloud and the revenues are relatively constant. We expect to close the transaction in our fourth quarter ending June 30, 2024, subject to regulatory approvals and customary closing conditions. Within 90 days of closing, we expect to use 100% of the net proceeds to reduce our debt and bring our net leverage to normalized levels firmly under 3x and return to capital flexibility. Further, we expect to return to allocating 30% of our trailing 12-month free cash flow to dividends and potential buybacks. We do not expect any material impact to our F '24 targets, given the long-term nature of the business, and the expected timing of the close. To recall, our F '24 targets remain $5.85 billion to $5.9 billion in revenues, 36% to 38% adjusted EBITDA, $800 million to $900 million of free cash flows, including 15% plus enterprise cloud bookings growth, total revenue organic growth and returning Micro Focus to organic growth. And today, we are presenting a preliminary look into our F '26 aspirations, simply reflecting our aspirations without the AMC business and the return to financial flexibility. Please see Slide 8 in our investor presentation. Those F '26 aspirations in constant currency include enterprise cloud bookings growth of 15% plus; cloud organic revenue growth of 7% to 9%, ARR organic growth of 2% to 4% and ARR near 80% and total organic revenue growth of 2% to 4% and total revenues between $5.7 billion to $5.9 billion, adjusted EBITDA margin between 36% to 38% and free cash flow is between $1.2 billion and $1.3 billion. Capital allocation of 30% of trailing 12-month free cash flows for dividends and potential buybacks and our non-GAAP effective tax rate in the mid-20s. We believe the divestiture represents compelling value for our shareholders given the financial profile of the transaction, the significant debt reduction and the return to capital flexibility, including potential future buybacks. Beyond the numbers, this divestiture will better position us to move with more speed in higher growth areas, such as cloud capabilities and AI as we continue to capitalize on the information management opportunities. and strength of our new total growth model led by product innovation and expanded go-to-market. We're excited about our core markets of content and experience, business network, service management, security, DevOps and digital operations and our Aviator AI platform technologies, including Aviator Search, Aviator IoT, Aviator Thrust services and our new Aviator Business Clouds. The divestiture reinforces and sharpen our focus, sharpens our capital allocation and over time, will allow for more resources to be allocated to drive more growth. Let me recap Micro Focus, after only 2 full quarters of results. We're on track to both grow Micro Focus organically and bring Micro Focus on to the OpenText operating model this fiscal year. The cloud and AI opportunity is significant. We more than doubled our addressable market to near $200 billion. And from fiscal '22, that is pre-Micro Focus to fiscal '26 without AMC, we expect to have increased revenue by greater than $2.2 billion, increased adjusted EBITDA by greater than $800 million and increased free cash flow by greater than $300 million, and we're just getting started in information management. In summary, we remain focused on building the information management platform of the future and delivering shareholder value through our 6 fundamentals, expanding our competitive advantage in information management, expanding our customer consumption, unlocking new value in cloud, SaaS and AI, expanding our go-to-market in the G10K through our partner network in mid-market, realizing higher profits and higher cash flows from higher revenues and returning value to shareholders via our capital allocation asset. May the one that brings, bring peace for all. And with that, Madhu and I would like to open the line for your questions. And operator, if you could please open the line. We'd be delighted to take any questions today.

Certainly. We'll now begin the question-and-answer session. [Operator Instructions] Our first question is from Stephanie Price with CIBC.

Good afternoon. Could you dig a little Bit more into why you're divesting the AMC business here? I mean, was it tougher to move to organic growth than expected? Were there surprises post the deal? Like how should we think about that AMC business?

No, this is about focus and opportunity, Stephanie. We did not initiate a process. We had an inbound inquiry. We pursued that process. And today is a successful outcome of that process. And this is going to allow us to focus, focus not on the mainframe, focus singularly on the significant opportunity in information management. It's going to help us unlock the opportunity in our cloud and AI business, and return to capital flexibility. And we think that's a fantastic set of benefits coming out of the conclusion of this process.

Great. And then maybe just on the margins. It looks like the fiscal '26 aspirations margins are down a little bit here. Maybe you could talk about the trade-off between organic growth and profitability and how you think about the longer-term profitability of the business given the opportunities that you have here?

Yes. I mean a couple of things and then Madhu, feel free to jump in. We think the focus on unlocking the potential of information management far outweighs anything. And our continued transition to cloud, unlocking the SaaS and API opportunity, unlocking the AI opportunity. Looking at our new total growth model that this is going to focus the company while returning us to immediate capital flexibility. So on our F '26 aspirations on Slide 8, which exclude AMC, we're simply just taking out the revenues and taking out the EBITDA dollars. And so this is just the math of taking it out. As we've talked about in our future models, we don't have AI built into our operations at this point. We have other strategies to continue to optimize on our margin lines. And you'll hear more from us on our forward model once we complete the year. But we still have a lot of opportunity to automate and improve the productivity of the business as we've talked about.

Great.

Yes, Mark. And Stephanie, I was just going to add that all AMC business is off cloud revenue. So as you can see, our ARR will have an opportunity to trend more into the 78% to 80% of total revenue.

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

Just can you speak to capital allocation priorities following the divestiture? I noted the increase in free cash flow to be deployed on acquisitions and buybacks. But how do we think about priorities for the remainder of the free cash flow that you generate? Would you continue to prioritize deleveraging? Or would you expect to pick up acquisitions?

Yes. Paul, thanks for the question. Yes, the [ pawn ] divestiture, we intend to use 100% of the proceeds to pay down our debt and to return to our kind of normalized levels under 3x leverage. Conjunctive with that, we're going to return to our capital allocation approach of returning 30% of our trailing 12-month free cash flows made up of our dividends and potential buybacks. And we like our total growth strategy that we've announced, and we're going to stay on our total growth strategy given the opportunity of cloud and AI and SaaS, Thrust services and other things. This is going to help the company focus on those information management opportunities. For excess cash beyond this, I'd look to -- continue to look at our dividend. And as we've said, if we feel that there's an opportunity to acquire, we're first going to look at our own company and our own stock.

Thanks. And then secondly for me. Can you speak to the operational integration of AMC into your business? And then how much work would be involved with divesting AMC? And do you anticipate a period where you provide shared services to the buyer? Or do you anticipate it will be a clean break once you divested?

Yes, for sure. Great question, and thank you for that. The AMC business is sort of the original start of Micro Focus. And it's always operated as a relatively stand-alone business unit, if you will, or business pillar. Through its history, post the HP merger, it still remained as its business. And even post our acquisition, the mainframe has always been kind of in its own ecosystem. So it's highly -- it kind of runs in its own ecosystem, if you will, Paul. So look, in any divestiture, you have transition services. We provided a whole set of transition services with Rocket and we'll work together on that divestiture. Now look, we're an experienced buyer. So when we acquired Dell, we had a set of transition services. When we acquired our 2 HP assets, we had transition services. So we know how to do this well and have that all memorialized into our agreement and working relationship with Rocket and expect to work through those transition services in the first few quarters after the close.

The next question is from Thanos Moschopoulos with BMO Capital Markets.

Mark, looking at the trailing EBITDA of the business. I think the takeaway here is that it was a well-oiled machine with very strong EBITDA margins. So does that imply that the work you've been focusing on the integration side to bring Micro Focus up to your target margins. Presumably, that's been a lot more concentrated on the other parts of Micro Focus? Is that the correct implication? Or is there some accounting dynamic we should think of?

So we've been focused across our portfolio. When we closed Micro Focus, we had -- again, we had no intent to divest the business. We had it in -- so we're optimizing our entire portfolio, and we'll continue to do so. I look at our profile in F '26 and we still have opportunity to improve. We have significant opportunities. We've discussed trading more growth for more EBITDA and our profile here is without AI and other optimizations to our business. So Thanos, we've been optimizing across our entire portfolio. This is a successful conclusion of the inbound inquiry and process. We're delighted to partner with Rocket and Bain to make this happen. And we're going to continue to optimize, get more efficient, automate more, complete the systems integration, and we should expect stronger margins in the future.

All right. And just to clarify on the revenue mix of the AMC business. So you do mentioned that there was no cloud, fair to say then that it was very heavily focused on maintenance, maybe with a bit of license in PS or anything to call out there?

Yes. It's 100% off cloud revenues.

[Operator Instructions] The next question is from Daniel Chan with TD Cowen.

I think AMC was one of Micro Focus' better performing segments at the time of the acquisition. So if you look at the other segments, is the expectation to grow organically without AMC as well?

We're returning Micro Focus to organic growth without AMC, unequivocally. And I wouldn't -- I would challenge this statement, it was one of the better performing. Again, we have significant opportunity in service management, as we've talked about, our icon product line for modernizing infrastructure. We've created a security business that rivals the scale and reputation of RSA. The developer tools and DevOp tools are so relevant today as every company is a software company. So we really like the definition of information management that we've created post the -- with this divestiture.

Yes, I appreciate the color, Mark. I think at the time when Micro Focus was stand-alone, I think it was one of the more stable businesses that they had I think AMC was also provided -- was also a way for customers to migrate from mainframe and what the opportunities was eventually migrate to the cloud. With your service agreements here, like are there any agreements in place to funnel some of these customers that want to migrate from mainframe to the cloud on to OpenText Clouds?

Our opportunity that if workloads are migrating that are content management oriented, we're still going to provide our content management. If the workloads are related to supply chain, we'll still have our opportunity in supply chain. So look, we're going to be delighted to work with Rocket Software, not just on the divestiture of the business but also potential market opportunities because it's not the workloads that do move but some of those workloads are directly in supply chain or directly in information management opportunities, and we'll continue to be there to compete for that business. And there's no overlap with the Rocket interference.

But there's nothing contractual there say that Rocket's customers will move to OpenText Clouds.

No.

And then one last one, if I may. Are you -- like just given that you're looking at divesting the AMC business, are you looking or considering any of the other assets? Like how are you thinking about those other pieces of Micro Focus?

Yes. Thank you, Dan. No, we're not looking at any other acquisitions. So we unequivocally like the definition of information management, as I walked through, content experience, business network, service management, security, DevOps, digital operations, conjunctive with all -- with Aviators and our new AI platform. So no, we're not looking to invest any other products.

[Operator Instructions] Now I will hand the call back over to Mr. Barrenechea for closing remarks.

All right. Well, thank you very, very much. Harry, Madhu and I are delighted to host the call today. And we look forward to continuing the conversation. We're excited about the divestiture with the partnership with Rocket and returning to capital flexibility. So thank you for the time today. That ends the call.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.