Open Text Corporation (OTEX) Earnings Call Transcript & Summary

Hey guys, thanks. Madhu, thanks for joining us.

Of course.

Let's start briefly. You're now like a much, much larger business, like 6 billion-dollar business. And talk a little bit about like how do you think about it, it's a lot of kind of parts to OpenText now like -- how do you think about competing like about the products you're going to bring out, where you're going to compete, how you want to compete, what's your guidepost there?

Yes. Sounds good. But first of all, thanks for having Open Text, and thanks for the time. And look, the best way to think about OpenText is we are singularly focused on information management. And with the new Micro Focus acquisition we did just about a year ago, we believe information management has come together really well, it's a $200 billion TAM. And it's very unique in what we do and the pillars in there, as you rightly pointed out, as it's come together is content management, is business network, is cybersecurity, IT operations management, application automation AI analytics. We call out AI analytics separately, but it's kind of spreads the fabric -- just spreads through all the other pillars. And if the pain point from a customer perspective are several, data sprawl, the complexities in information processing and where OpenText comes in, in terms of information and data at core where storing information, organizing information, securing information, processing information and of course, AI analytics insights information offering all of that in our cloud journey, we can talk more about it, offering all of that in the cloud and meeting the kind of like the customers need, which we believe we are very unique in what we do. And the $200 billion TAM, again, at a near $6 billion of revenue, right, the opportunity for us to keep growing within information management, having each one of the pillars that are today sizable but be really sizable. And say like several growth points within each of those pillars, and that's really where we're focused on. Yes.

Yes. And then how do you think -- and as part of that, how do you think about organic versus M&A? And what's your guidepost there and going forward?

Yes, it's actually a very important question. And in our last call, we came out with some statements about leaning into organic growth more than we do on M&A. And maybe let me just clarify, again, as a near $6 billion technology software company, M&A will always be part of our strategy, right? But the 30-plus-year history of OpenText has been built on a book of M&A. Again I come back to -- it just leaves us with a large addressable market, and there are plenty of opportunities to grow within this addressable market. We don't need more TAM, we need to grow into the TAM, and this is not an overnight question as you can appreciate. If you look at our R&D investments that are leading up to it, we are about 14% to 16%. We were about 11% just 5 years ago. And our go-to-market distribution engine is truly like none other at our scale. We probably have the strongest direct enterprise sales force, and we have a very strong unified partner network with the large names of SAP, et cetera. So when you combine the innovation capabilities and the go-to-market engine in this large addressable market, it absolutely make sense to unlock value in terms of growth rates of products and solutions within that. That's really the big message, right? As I said, M&A is never out of the realm for technology software companies but clearly going to lead with organic growth to unlock the value. And maybe the last comment I'd say is if you look to the ROI of R&D investments first and the best of that ROI is actually organic growth and maybe the last point is, we wouldn't be able to be here if we didn't build the framework in M&A, right?

Yes, yes, yes. Okay. Make sense. And you mentioned organic like it's obviously a big number out there for FY '26 and it's like the 7% to 9% organic growth on cloud like what's your framework to get to that number?

Yes, absolutely. So we have it in our investor deck, and I really urge us to think about OpenText of the future as it starts with a cloud, right? We said even 2 years ago that 80% of our R&D investment will be directed towards cloud and our cloud is the ultimate destination. So the starting point here is really the 15% cloud bookings growth that we've been talking about, and for fiscal '23, which is June, we did about 530 million of bookings. So the starting point is really that. And our cloud is a sort of a multi-cloud, it's very complex, integrated cloud, it's private cloud, it's public cloud and SaaS, right? So the next number to look to is organic growth of cloud revenue organic growth of 7% to 9%. Now we did 4% in fiscal '23 and you give us about 3 years and with a cloud bookings of 15% is the path that we're going to get to the 7% to 9% growth. Now within that, if we talk about which are the leading growth drivers, content is going to lead the growth, right? Absolutely. Content has been leading the bookings growth. It's just a testament of all the product innovation that has gone into the on-prem of document and content to where it's a very clear cloud platform solutions provider. And business network is a very close second. And the most important opportunity, we can talk about Micro Focus, we did not buy Micro Focus just for the license and customers support. We bought Micro Focus with the potential to be able to cloudify many of their products. So that's going to happen very systematically. About 5 to 7 of the products are in the official cloud road map, and are already showing results in cloud bookings. Those are really where the biggest strength is going to come from. The more SaaS we are able to get the products, so that's kind of the next phase that's going to add to the growth. And last but not least, I would say the AI opportunities are not factored into the numbers we're talking about and we will report them as we see it. But really, we're going to have the stand-alone AI opportunities. But keep in mind not all customers and enterprises are ready for AI, and there's going to be a fair amount of pull-in effect to cloud bookings that come from customers who want to get around structured data, ready to be automated and then for AI, and you'll see that sort of pull-in effect as well. So that's sort of the hierarchy of how we see this growth, Raimo.

Yes. Okay. Perfect. And then shifting gear a little bit. You had like corporate news last week. Like maybe update us on kind of what you're doing here and the rationale is for that.

Absolutely. So it is AMC. That stands for application modernization connectivity. It was a business unit within Micro Focus. So when we announced the deal of Micro Focus, we did not envision the divestiture. I want to be very clear on that. We intended to keep the company as a whole. AMC is also the cobalt, the mainframe aspect of their business. So we got an inbound call, and as we diligence the call, a few things really came to light. AMC is all off cloud. So in our product road map for the cloud, AMC in our own internal road map was the farthest in terms of when we would apply cloud investment I mean to the left are many products and solutions with a higher domain growth rate that we had clearly allocated the product investment in terms of cloudifying them. AMC is about a $500 million business and 55% adjusted EBITDA, about $275 million, so clearly very profitable. But also AMC is a flattish growth rate. And in our own internal models, we have models that are at low single digits. So with all of that, it made sense that this would afford us more bandwidth investment into cloud and AI. Now you check that box in a big way. But AMC is going to rocket software, and this is sort of their bread and butter, right? They have made investments into mainframe modernization, into hybrid and it will be a great home for an asset like AMC. We are experts in acquiring, and we do want to do the best job when we divest a company. So that criteria also played. And last but not least, I would say at $2.27 billion, and we get to delever almost $2 billion about 3 quarters earlier than we expected and at levels of delever also much higher than we anticipated. And that's going to give us capital allocation flexibility and certainly, that sort of closed out the decision to do this. But I would say the key driver is the off cloud nature of AMC, the flattish growth DNA of AMC and what it can do for cloud and AI opportunities for OpenText as we look in it.

In a way like it should help you because like the way investors [indiscernible] they want more cloud from you. But if you have something like AMC where it's going to be tough to get that on cloud, so it should help you in the overall mix in terms of being clicking this out and having more cloud in the total revenue, correct?

Yes. And very much so, the -- our CTO is focused, our engineering team is focused and all of that back into more cloud and AI. And AMC is a very meaningful -- about 750 people, right, and $500 million, so we -- that was, as I said, the first check box for us that, yes, this is going to allow us to focus more on cloud and AI. In terms of the mix itself, as you know, Raimo, I'm speaking about ARR, annual recurring revenue is a very important metric for us and divesting AMC will get it up to 78% to 80%.

Oh wow. Okay. Yes, yes. That helps a lot. Yes, yes. Okay. And then you mentioned proceeds already like what is it due to leverage ratios, et cetera? Because like you're deleveraging with that obviously much quicker than expected, yes.

We are in the high 3s right now and as we complete AMC divestiture, which will be about 90 days from close. We are expecting close to be in June 2024. It brings the leverage down below 3. And again, that will be about 3 quarters earlier than we'd anticipated.

Yes. Okay. Perfect. And then the good few things happened. You know like you know the market is so fluid at the moment with kind of new share price movements, et cetera. Like to maybe ground us for the next part of our conversation, just talk a little bit about like your kind of recently reported results to kind of get it on the same level and I have like a couple of follow-ups there.

Yes. Absolutely. So we had a very strong Q1, and cloud did very well. It was our 11th consecutive quarters of cloud organic growth rate in constant currency as well as ARR. And clearly, we announced from a strategy perspective, a more solidified AI strategy coming out of the initial vision in August and we had just completed in October, the OpenText World and a full-blown general availability of our Aviator solution, we can talk more about it, as I mean, as well as pricing, et cetera. And we also spoke about what we see in Q2, which is higher than our annualized rate for cloud bookings. We see Q2 cloud bookings at around 20%. And that's building up from the momentum of content in the cloud and business network in the cloud, and AI will have a contribution in there but certainly speaks to the overall momentum. And a couple of the very interesting points in the continued theme of Micro Focus we actually announced during the call, Paul Duggan, our Head of Customer Success, was on the call. And one of the key metrics for the Micro Focus integration is getting the renewal rates, which again was 65% of the book of business we acquired into the high 80s in this fiscal year, and we showed positive momentum there. And lastly, from a profitability perspective, we are able to get Micro Focus to a 36% to 38% adjusted EBITDA in this fiscal year. That's also about 6 months earlier than anticipated. And all of these really point to the return to organic growth for Micro Focus as definitely a very strong milestone we expect in fiscal '24.

Yes, yes. That's very encouraging. I mean on that note like what are you guys seeing on end demand? Like -- because like it's kind of uneven some vendors like having a good time, others like not so good. And where are you guys kind of coming out there?

Yes. So I'd say a couple of things, macro demand environment, and we read all the earnings of other companies as you do as well. It's a little uneven. I think for OpenText, I think a few things to keep in mind, the secular drivers of what creates demand for OpenText, it remains very strong, right? And we see that from our customers across. We did call out more driven -- the SMB side, we did call out, it's more related to Microsoft pricing and the resilience there. But broadly speaking, the macro environment has the drivers that are very positive to the OpenText products and solutions. And more importantly, keep in mind that the breadth of the portfolio has a built-in resilience. And what do I mean by that, right? I mean if there are slowdowns in supply chain or industrial or business network, content is doing very well. So we do have, given the breadth of the portfolio and the variety of optionalities we have in terms of the cloud offerings and the growth to the cloud, it has sort of some built-in resilience, we believe, from a macro perspective. And last but not the least, I would say that Micro Focus customers very eager to receive and adopt the cloud offerings that we would have that they have been waiting for, right? And that includes products like value additions. It includes products like the service management smacks. So I think, Raimo, the macro environment is uneven for other companies. We do have built-in resilience both from the breath of the portfolio and also from the initiatives that we are taking within the portfolio.

And then I wanted to shift gear. You mentioned AI already a few times. In theory, like if I think about it, like in a lot of the conversation we had here so far, what comes out is it that data is one of the core input factors into a good AI model, into the AI future. But you guys, you're distributors of a lot of corporate data like talk a little bit about your AI strategy, what you're doing with Aviator and how you see kind of your role here going forward?

Yes, absolutely. So here's where the 32-year young company of OpenText comes into play, where, yes, we are -- given our history, what we have done with respect to information and content, we are sitting on a lot of data for our customers. And for our customers looking for gen AI capabilities, OpenText is a logical place to go to, right? So I'll mention a few different points here. First of all, we do not need to partner with other companies for providing these solutions. What we call the OpenText Aviator is coming together of IDOL from Micro Focus; of Vertica, which is a vectorization database, Crucial, the second leg of the stool in AI solution, and OpenText had a proprietary AI analytics, Magellan tool as well. So with these 3 coming together, we call the OpenText Aviator, it is very much injected into all of our business clouds, right? So this Aviator can be applied to the content, can be applied to the business network, all of that. The second most important point is that we believe there's no AI without information management, information management is a prerequisite. It's not a self-serving statement. I think it's a statement that has been proven by everything that you're seeing there, information management is a prerequisite to AI. And in our slide deck, we have the comment about how it kind of flows, which is really very agnostic to the language model. And in the last 48 hours both Google and Amazon announced what we would say is that our strategy is taking a position to be agnostic to the language model. We're not in the language model business. Aviator is going to apply -- I mean, it's going to perform at the application. So you can keep Vertex or Gemini as strong as it needs to be. But Aviator is going to apply at the application layer. And more importantly, the customer's data is not our product, but we are building the Aviator with all of the security, the governance, the privacy and all of the requirements as the customers are going to kind of stream data into that. And but not least, we announced what we call to Get Your Wings program, and which is really, for $350,000, you have sort of 1 million documents in there and you can test. You, the customer, can test your hypothesis and if the hypothesis works, then, yes, you go ahead and do a full-blown ingestion optimization. So I would say that we are very strategic about it. Things are moving fast obviously, and we're very practical and methodical about it. And look, for Aviator in all of our business clouds and that's the approach we are taking. Yes. And I'm sorry pricing GA, many of what I'm talking about are being released in this month, in the month of December and there's more coming at the early part of next year.

So you're moving fast. Yes, yes, yes. Okay. Last couple of minutes I want to spend on margin profitability. So you mentioned already the one big part for Micro Focus to make them more profitable was around the support and maintenance situation. Can you talk a little bit about the cost takeout and like the synergy capture, I think is the right word, that -- where you are in that journey?

Yes. I think a few different aspects there. Ex AMC, we had 38% to 40%. With AMC, just a simple math, we are targeting at 36% to 38% for this fiscal year. Now with Micro focus, we had announced about $400 million of cost take out, but $260 million of them have already been actioned. And the rest would be completed in fiscal '24. When you think about workforce reduction, we're down with about 2 rounds and it's a good zone for us to take it forward. Now let's break the margin into a few different pieces, right? You talked about system support. OpenText runs at about 91% plus. As Micro Focus renewal rates improve, we will get Micro Focus also to our sort of gross margin standard of the customer support. We are absolutely investing in the cloud, but as you get to fiscal '25 and '26, we should see acceleration in cloud gross margin as well given many of the things we talked about in terms of the top line and some of the efficiencies that we are going to get. R&D at 14% to 16% is a good place to be. Sales and marketing at 16% to 18% is a good place to be. And R&D also, we should keep in mind that is so much driven by people, innovation and products. It's about 40% of our workforce. That's 10,000 people worldwide who are actually performing innovation. So more beyond the 36% to 38%, I would just say stay tuned for that as we actually wrap up this year. There's a lot of dialogues for us not yet mobilized, which is OpenText Aviator, how do you bring it in-house to our operating model. As we talk about developer productivity for our customers, how do you bring that in-house? So all of those discussions are in play and certainly, we will have some positives to the long-term operating margin.

And then last question because our time is almost up, cash flow -- the cash flow situation for Micro Focus, a lot of work that you could do there. Like where are you on that journey?

Yes. So we are calling out $800 million to $900 million for fiscal '24. And I would say that Micro Focus working capital is strong, fundamentally strong. It's just going to take some time for us as part of the integration to get them to the higher standards of OpenText. But for fiscal '26 with ex AMC, we're talking about $1.2 billion to $1.3 billion and again, low 20s to mid-20s in terms of FCF to revenue is really what our long-term target is.

Yes, yes, yes. Good. That's a good summary. Madhu, thanks. Thanks for joining us.

Well, thank you, Raimo. Thank you all as well.

Thank you.

It's a pleasure. Thank you.

Thank you.