Open Text Corporation (OTEX) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm George Iwanyc, one of the technology analysts here at Oppenheimer. Today, I have the pleasure of hosting Harry Blount, Senior VP and Head of Global Investor Relations at OpenText. We're going to do a fireside chat, but I'd like to let Harry have the floor to start off and kind of give us a level setting of OpenText 3.0 and the recent results.

Yes. George, thank you so much, and thank you to you and Oppenheimer for hosting us. Before I get started, obligated to make sure everybody refers to the safe harbor statement in our most recent investor presentation so that any of the statements that I do make are covered by that safe harbor. With that, thank you very much, everyone. So OpenText 3.0, to share what OpenText 3.0 is, let me just level set for the audience. I know we may have different levels of knowledge about OpenText. But we're the leader in information management. And what does that mean? Basically, our software manages some of the largest content repositories in the world. If you think about all of the data that is generated from your office applications, if you think about all the data that's generated from global supply chain, whether it be for parts like an auto dealer or Nestlé is another big customer, all the food ingredients from all over the world, there's thousands and thousands of suppliers and associated paperwork and taxes and tariffs and compliance that has to be kept track of and retained. If you think about all the data generated by an SAP system, a lot of that will flow onto our content management repository. Your IT operation support, all the documentation that is associated with supporting your technology and operations is managed many times in our content management repository, even developer code. So the volume of data that a business generates, particularly the unstructured data needs to be managed for compliance reasons, for regulatory reasons, for taxes and tariff reasons, any number of reasons. So if you think about the business that OpenText is in of information management, it's about managing that data. It's about protecting that data. We have cybersecurity that helps protect the data. And we have an analytics and AI business that helps you extract more value from that data. If you then look at what that means for OpenText and OpenText 3.0 Information Reimagined, new use cases are emerging. And those use cases are going to require more cloud deployment, more security deployment and more AI deployment. So those are some of the 3 big initiatives that you'll see that will drive a lot of our growth under OpenText 3.0. I'll not get into a lot of the details at this moment, but with AI specifically, before you can really deploy these learning models onto your data, you have to have that data organized, protected, intellectual property protections, everything in place. And we have a meaningful role to play there. If you think about what that means for us for F '25 and some of the key metrics you'll be looking for us to continue to lead with cloud revenue growth, up to 5%. You'll look for us to continue to focus on improving our EBITDA margins on a journey from where we're at up to the 36% to 38% EBITDA by F '27, continuing to return capital to our shareholders. We announced 50% of our capital is being used for primary purposes, which is dividend and buyback, and the other 50% for the highest return of capital. This year, we think our stock is the biggest and highest return to capital. So up to 90% of our free cash will be used to buy back stock and grow dividends. So George, that's a quick overview on OpenText and what we do and kind of the very highest level priorities for us.

All right. Well, thank you, Harry. So I'll jump in with some questions. But if anyone in the audience has questions, feel free to either e-mail me, which would be [email protected] or send a comment through the chat. So Harry, maybe starting with the recent results. You had a few mix trends with respect to moving pieces in the business. Kind of unpack those and then put that in context with the overall environment and what you're seeing there.

Yes, you bet. Thank you. So what George is referring to is that our overall results -- on a line item basis, we're generally in line with expectations, except for our license business. And we called out a couple of factors for the difference in license. First of all, we did not attribute it to any macro factors or competitive factors. What we are seeing is the lighter results in license reflects two primary things. One, we're seeing customers increasingly choose to deploy our products using cloud than we've had historically. So that's one factor in driving the strong cloud bookings growth that we did see and the lighter license. Specifically on cloud, we raised our cloud booking estimate multiple times throughout '24 from the 15% to 20% range at the beginning of the year up to where we ended it 33%. So that's reason code number one, customers choosing to buy more cloud from us versus on-prem or license. The second reason is we had 2 big strategic activities in Q4, our June Q4 quarter. The first one is that we divested of our mainframe business. It's called our AMC business. And through that separation, we had some of our account executives go with the -- conveyed over to Rocket Software, the buyer of the AMC business. But we also involved some of the other account executives we kept. We're involved in now going to our existing customers and separating contracts to move those over to Rocket while still keeping our existing contracts in place on the OpenText side. So that had an impact on business as well. The second action, strategic action in the quarter was what we call our business optimization. And there, what we did is we did a tremendous amount of planning of moving more of our people into our centers of excellence, India, Romania, Philippines and Canada. We are going to hire back a portion of those people, the savings that we realized from that business optimization in the form of R&D and sales. But those two big strategic actions plus the increasing choice of customers to deploy in the cloud did impact our license business. The cloud transition, if you don't mind, let me take a moment on that. What we are seeing is we completed a project a little over 2 years ago called Project Titanium that cloudified a lot of our content products. And if you think of the normal enterprise sales cycle, now is the time you should start to see the cloud ramping. And that's exactly what we are expecting in '25 and beyond. And it does have an impact on our financial model. With license, we typically recognize all that license revenue upfront, and it has a high 90s percent gross margin. We also typically get a 1-year renewal -- sorry, first year maintenance out of that, customer support, revenue, and that also is in the 90% gross margin. Whereas when they choose to buy cloud from us, typically, our contract is now approaching 4 years, the midpoint. And we typically only recognize about 15% to 20% of that in year 1, and it does tend to have initially lower gross margins. So that's another factor that investors have been asking us a great deal of questions about, the impact of the cloud transition on our financial model, George.

Yes. So maybe kind of digging into that. When you look at the transition from your license business to cloud, if you gave us a baseball analogy of where we are in that transition, what inning are we in? How -- does it accelerate from here? Or do we kind of do it linearly?

Yes, it's a great question. There's still a tremendous opportunity ahead for us in the cloud. We do see growth opportunities in our private cloud business. We see significant growth opportunities in public cloud growing more consumption. AI, how quickly AI takes off will clearly be a factor in driving that. That being said, we do expect that we will always have a portion of our customer base that does want to keep items on prem or off-cloud. We talked about nuclear France, some government facilities, defense intelligence type of customers are still going to want to maintain off-cloud capabilities. The other thing with us that's interesting is that, in many cases, the data that we have is years old for compliance and regulatory reasons, sometimes 6, 7, 8 years or longer old. And in many cases, it's actually more cost effective and less risky for those customers to keep that portion of their products with us off-cloud. So this is a really critical nuance in understanding our business, but most of the cloud growth we see is for new workloads, new deployments, not for lifting and shifting their data from their off-cloud. So we expect to have a long tail on our customer support business, because most of the cloud growth is incremental in new workloads. But we think there's many years of opportunity ahead of us with the cloud business yet.

Now you mentioned Titanium. Why don't you give us some perspective on Titanium X and where you are with that deployment?

Yes. So the first instantiation was Titanium before Titanium X, and we completed that a few years ago. And really think about that as moving our products to the next generation of cloud architecture, cloud additions, essentially enabling our customers to deploy our software any way they wanted it, in the cloud, public cloud, in the private cloud or continue to keep it off cloud. With Titanium X, we announced that right after we acquired Micro Focus, when we acquired Micro Focus, the vast majority of their revenue was on-prem. They had a very small cloud business. So Titanium X covers a couple of things. One is to cloudify Micro Focus products; two is to increase AI, to embed AI throughout our entire portfolio of products, also to embed security throughout our entire portfolio. So if you think of autonomous clouds, autonomous computing, we'll be moving at the end of Titanium X to having all of our key products cloudified with AI, with cybersecurity. And we're targeting to have that Titanium X completed by the June quarter of next year. We think that helps us in a number of different ways, provides all the flexibility to the customers that they want, but also able to protect the data more securely, make it more valuable through the analytics and AI.

And maybe this is a good time to ask about Micro Focus and how should investors look at the overall company with the OpenText core value proposition on content management and then what Micro Focus added there. And once Titanium x is done, what should customers expect from a go-to-market perspective?

Yes, absolutely. And let me just kind of touch on that. We completed the acquisition in January of '23. At the time we acquired it, Micro Focus was a declining asset. As of June 30, we've now arrested that decline. We've hit basically all of the targets that we set out to hit. We said we would try to stabilize and grow the business from a $2.3 billion base. If you adjust for the AMC business, we did that. We said that we were going to try to take their renewal rates which were in the low 80s and get them into the '90s by fiscal '25. We exited fiscal '24 in the high 80s. So we're on a path to get the renewal rate into the '90s. We said we'd get their EBITDA on to corporate plan, and we did that. So the good news is that we have now operationally completed a lot of the products, the portfolio, the integration and arrested the decline of the asset. And it's really positioned for growth as we move forward. In terms of what does Micro Focus bring to the table for us? Well, it brought a couple of things important. First of all, it was a fantastic financial transaction. Secondly, it brought us new buying. It brought us critical mass of products for the Chief Security Officer. We didn't have that before. It brought us critical massive enterprise class products for the CTO. We didn't have that before. And it brought us a critical mass of products for the Head of DevOps. So we now are addressing almost all the major buying centers inside of a corporation. Many of the customers were the same but the buying units inside those corporations were different. So it helps us become more strategic to our customers. Another thing that Micro Focus brought to the table is large content repositories, the business that we're in. If you think about all of the technology documents to support your software, your technology, your operations, there's a tremendous amount of documentation that needs to be managed. It's a content management problem. Think of an airline, for instance. Every time an individual plane takes off and lands, you have to keep track of it, all the parts on that airplane, the number of hours it's been in the air. It's a big content management challenge. So that -- it brought us another large set of content repository. Same thing with DevOps, millions and millions of lines of code. So we -- it enhanced and strengthened our position strategically in the enterprise, more buying centers, good financial transaction, operationally -- profitability now on our model. And as we look to the future, what's left to complete with Micro Focus is our back office systems integration, legal entity rationalization and some tax optimization. So as we look forward, we're now one company. We no longer think of it as OpenText and Micro Focus. We are one company, and it gives us a very strong platform to move forward on.

Now when you look at those final pieces on the merging the companies, is there a gross margin lift that you can still see from that effort?

We see gross margin lift primarily in our cloud business, not so much on the line item by line item business. Where we do see the margin improvement is on the EBITDA line. We do think that we have an opportunity to lift our EBITDA margins from the low 30s where we acquired Micro Focus to the combined entity getting into the 36% to 38% range by fiscal '27. So part of that EBITDA margin improvement is coming through the cloud gross margin improvement and part of the EBITDA margin improvement is coming through the business optimization that we took. And part of it's going to be through mix. As we grow more of our public SaaS business, that will have higher gross margins as well versus our private cloud.

When you think about those levers, is there one that is a nearer-term driver? Or are they pretty balanced across all the ones you've highlighted?

Yes. I think they're relatively balanced across, George. I think if you take a look at timing-wise on it, the cloud gross margin, we saw a meaningful improvement sequentially in our cloud gross margins here in the most recent quarter. The business optimization, you'll see benefiting us as well as productivity efficiency from AI, et cetera, over the next several years. And then the SaaS growth will happen over the next several years as well. So that's kind of the high level on timing.

Right. So digging into that cloud opportunity that you have. From a growth perspective, it looks like you have some opportunities to accelerate your cloud growth. What are the main levers from an organic growth standpoint to get your cloud revenue up? And how quickly do you see getting from 5% to, let's say, 7% or 8%?

Yes. We finished fiscal '24 with cloud growth -- cloud organic growth in the 1% range. But in the fourth quarter, we did start to see an uptick to the 3% range. To back that up a little bit, the leading indicator that we've seen is cloud bookings growth. We raised our cloud booking growth several times in fiscal '24. We finished at 33% cloud booking growth in the enterprise for fiscal '24. We do expect a long duration ramp on it. So we're expecting some of that to ramp in '25. So the fiscal '25 cloud organic that we're looking for is up to 5%. As we look out to fiscal '27, we're expecting cloud organic to reach the high single digits, 7% to 9%. So we have the visibility with our cloud bookings and our deferred backlog that gives us the confidence to put those targets and aspirations out.

And when you look at that, are you building in a macro recovery? Or is this straightforward execution and product blocking and tackling?

Yes. For the most part, it is about blocking and tackling. And if we get some help on the macroeconomic front, then certainly it skews more towards the high end. But we can get there based on what we're executing through our product road map, the bookings, et cetera.

Maybe it's a good time to pivot to AI. That feels like it's a massive change throughout the industry. And a company like OpenText that has all the content stored within their platform and their systems, how much of a competitive advantage is that? And how do you go about talking to your customers and saying, "Hey, we can help this transition to maximize the value in that content?"

Yes. It's a great question. And it's a fantastic opportunity for us. Our customers have trusted us with their data for many years, and that trust really matters. And it's not only about trust but it's all of the business processes of keeping that data up to date, protecting that data so that only the right people can access it at the right time under the right conditions. So there's three specific opportunities for us in AI, two on the revenue side and one on the internal side. Bucket number one is helping customers get their data ready for AI; bucket two is the products that we sell that are AI products called our Aviator products; and then bucket three is some productivity and efficiency that we can use applying AI internally. Let me touch on each one briefly. The enterprise AI is very different than the AI that you'll hear about with a ChatGPT or OpenAI. The data that's in there tends to be highly protected, highly procured with specific use cases, specific users, specific business processes. And those business processes need to be protected so that you don't have any leakage for intellectual property reasons, you don't break any privacy or compliance rules and regulations. And those -- the data, the business processes that are feeding that data need to be kept up to date and they're very -- typically, from an SAP or an Oracle or a Salesforce or what have you. So the challenge with helping our customers -- the challenge our customers have with our data is they need to keep everything up to date. We already have those business processes in place. We already have the data repository in place, the protections. So we are a trusted partner to help the customers get their data ready for AI. On top of that, if those -- if that data resides in many different type of repositories, let's take a customer, for instance. Let's say you want to bring together different customer data, you may have some in your call center system. You may have some in your web system for like an Adobe. You may have some in your sales pipeline like a Salesforce. Bringing those all together so you can apply AI to it is a challenge that -- an opportunity that we're kind of uniquely qualified to provide and help our customers do. So that bucket one is getting the data ready for AI, and we're very well positioned there. The second opportunity for us is our Aviator product line. And here, we are already doing some large pilots. We're generating a little bit of revenue. You saw a press release from us today from a company called Pick n Pay that has helped them improve their efficiency by 95%. And we're working with one of the world's largest apparel manufacturers to help them with all things on the procurement side of the equation. And there's -- we're solving many of the very large problems, supply chain issues, et cetera. We have not provided any specifics on the revenue impact that we're generating from AI, but we feel very good about that. The way our CEO describes it is that it's going to be kind of steady, steady, steady. And then all of a sudden, you're going to see a nice big lift up with our AI revenue. The third opportunity for us is we announced publicly something called Project Athena. And there, think about leveraging the ability to test code more efficiently. We have a product called Fortify we sell commercially that's outstanding at testing, providing test cases on new software code and improving the rate at which we develop and automate that code. So Athena is an opportunity for us to internally improve the quality of the testing of our code, the speed and efficiency at which we develop code.

Yes. Maybe digging into each one of those points. On the first point with the enterprises, where are we with respect to enterprises wanting to go from testing generative AI type of applications and their own AI/ML development to actually operationalizing it and starting to ramp and use the content that they have?

Yes. We're very early days in that. Accenture in their recent call talked about the speed at which customers are using AI depends on the strength of their digital core. And the more ready their data is, the faster they're able to move. But there's still the second aspect of it, which is you need to make sure before you spend money that you're going to get a good ROI from it. And so it's very early days for us. We are pleased that we've announced some early wins on that front. The way our CEO describes it is we have documented over 100 use cases. Basically, every conversation that we have with customers includes AI, but in terms of actually spending money on AI, it's very early days.

And when you think about going to your customers with those use cases, how much of that is just an individual OpenText effort? And how much is a partner effort with channel partners and SIs and technology levers to make generative AI work?

Yes. A lot of the work we're doing right now is OpenText driven. We are the knowledge experts when it comes to the customers' data and content management and the business processes that keeps that data up to date, keeps it protected. So I wouldn't say it's -- there isn't any partners involved, but it's predominantly OpenText driven.

Yes. So kind of going to the Aviator product. When you talk to a customer with that product, is this -- I know you said that monetization may come later and kind of see a pretty good ramp. But do you have very specific product discussions with Aviator? Or is this a cross-platform, this makes everything within OpenText work better?

Yes. I would -- it's a good question. I think I would say it really is use case driven in terms of which products we lever. Will there be more cross-platform opportunities over time? Time will tell. I think we certainly think that there will be opportunities, for instance, to take security across many of our -- throughout our portfolio, take AI across our entire portfolio. But right now, I think it's -- people are more narrowly focused on proving out their use cases. For instance, we've demoed publicly Content Aviator. And there's a couple of things that I thought were quite unique about that. We took all of the FAA data and were able to integrate many different types of content, everything from video and audio feeds to paper documentation, PDFs, et cetera, and very quickly assemble and accelerate the use case of an investigator being able to identify root causes, where to focus, et cetera. So that, to me, is one example of where we're unique, being able to take the typical content you might see, the PDFs, the Word documents, et cetera, but then also being able to scan and search through video and audio files to bring it all together. And then there's kind of more of a broader Search Aviator use case, where it's not only our content but being able to search other types of content repositories that may or may not be within our overall portfolio. So those are two of the earlier ones that we've demonstrated and talked about publicly.

Okay. And then on the last element, internally using AI. You've also talked about having very strategic hiring objectives and putting people in new areas where they could help optimize your cost structure. One, what does AI allow you to do with optimizing the cost structure? And two, can you maybe dig into the hiring plans, where, when, what kind of priorities?

Yes. We -- let me address the last one first, is we've already started July 1 to start to hire into the sales and R&D arena. So we're already starting to deploy some of those savings into revenue or productivity-enhancing areas. In terms of -- actually, and let me touch on that in a moment as well on the sales side of the equation. We also announced a new Head of Sales, Todd Cione, a few months ago. He's now been on the job about 100 days. And one of the other things that we did from an optimization efficiency perspective with him coming onboard is we now have a unified global sales organization. Before Todd came onboard, we had 4 different groups reporting into our CEO. So now we've standardized that. And that allows a tremendous amount of efficiencies for go-to-market, segmentation efficiencies and cross-functional collaboration. So that's another important aspect that shouldn't go unmentioned. In terms of the cost efficiency, they're several fold. I touched briefly on using Aviator to enhance our development of our code, the testing of our code. But we see a tremendous opportunity for IT service management as well, supporting our customers more efficiently with our IT operations management products. And that's an area that we've only briefly mentioned publicly, but we think that there is a tremendous opportunity there as well.

All right. Digging into the sales opportunity here. One of the things that Todd has said is there's a doubling down on the business cloud specialization. What does that mean? And how are you executing with respect to that?

Yes, absolutely. So I think one of the areas that having a single unified sales organization allows is that you can start to create product specialist groups that can serve an entire sales organization. So you can have your cloud specialist pod, you can have your cybersecurity pod. And you can leverage that entire pod across your entire service organization. So that's one of the areas that Todd was mentioning in terms of having people that are really outstanding at cloud deployment, cloud support, cloud implementation, even some on the design side of the equation.

Yes. And can you unpack what you're doing with, let's say, the global 10,000 versus the mid-market and commercial and then SMB customers?

You bet. So at the very top of the pyramid, we have our global account management team. And think of your very, very largest customers, where there's a cross-functional team servicing that. So there's great -- it may involve many different contracts, let say, a Nestlé or a BMW or what have you. But to the customer, even though there's many different contracts that we have with them, we're still serving that customer in a holistic strategic way. So that's the very top of the pyramid. The next layer is our global 10,000 accounts. Think of this as the 10,000 largest organizations in the world. And here, you are -- think of more of like a named account rep who's dedicated to that account. And it may not have quite the infrastructure that our global account team has dedicated to a single customer. But that account manager, account AE has access to all of those areas of pods, specialties that we might need. And there clearly is what we call our L.O.V.E. model, starting with a particular individual product and continuing to expand into other products over time as well as expand the initial product. Below that then is the mid-market. Think of that as more covered by our inside sales group. And then the final piece of the puzzle is our small-medium business channel, and that is done predominantly through channel partners like managed service providers. And there, we partner closely with Microsoft on the small and medium business channel. So that's our high-level go-to-market.

Going back to something that you said at the very beginning with the AMC divestiture. You had to do some account executive realign and just digging into who is responsible for what. When you look at all the things that Todd has done, has the realignment of the sales group been completed at this point, especially with respect to one unit between Micro Focus and OpenText?

Yes. Todd has done a fantastic job. He's identified talent internally and moved them into roles where they can be more productive, more impactful. He's brought in some outside talent from his tenure at Microsoft and Oracle and Apple Enterprise, Teradata and many others that he's worked at. So he's brought some talent in. And he's aligned the structure organizationally now so that we're set and really focused on executing to an F '25 plan now.

Very good. Maybe pivoting to a few things about the operations side with respect to cash flow, your EBITDA targets and maybe putting that in context of the macro environment. One, where are you seeing the most fluid engagement with customers from a demand perspective? And then when you start to looking at maximizing the cash flow and the return to shareholders, what should we stay focused on?

Yes. I would say in the macro environment, we haven't really called out macro as a factor influencing our targets and aspirations. 80% of our business is recurring. We have a substantial deferred portfolio, about mid-40s as -- mid- to high 40s as the non and deferred settle is current. So we have tremendous visibility into our F '25 targets because of the bookings, the backlog and the deferrals. A macro environment that strengthens would certainly help us to the upside -- to the higher end of the range. But -- and then if you look at our overall business, as always, you'll see areas that may be a little stronger, a little lighter depending on where they're at in the cycle. Europe, for instance, if we get a little help with the dollar-euro exchange, there might be some opportunity to do a little bit better in the European market. But for us, a lot of it is based on our product cycles, our go-to-market capabilities and the newly-enabled cloud products that we brought to market.

And doubling down on what you said earlier about capital returns. So near term, it looks like you're very focused on the share buybacks. But how should we look at the strategic plan for buybacks, dividends and M&A?

Yes. We've announced a capital allocation plan a quarter ago, and it's 50-50. It's 50% primary, and that is focused on growing our dividend and growing our buyback. And then we call the other portion additional. And the additional piece is going to be dedicated to our -- to the highest return of capital, and that could be M&A. It could be deleveraging. It could be more buyback, additional buyback, could be dividend. If you look at F '25, we're intending to use 90% of our free cash flow for dividend and buyback. We think at current stock price, our stock is the best M&A we can do. That being said, and if you look at our capital allocation longer term, M&A still is a part of our overall core strategy, specifically the M&A that we would do going forward is going to be small or medium cloud M&A. We don't need to do any more transformative M&A. We have enough addressable market now. It's really about continuing to strengthen the businesses that we're in through small- and medium-sized cloud M&A.

You've already touched upon this in kind of multiple points, but maybe just digging into your cash flow target and how we progress from here to what you're expecting in FY '27.

You bet. So we're at -- in F '25, we're looking for $575 million to $625 million of free cash flow. Now that number includes an approximate $250 million tax payment for the gain on sale of the AMC divestiture. So if you kind of take and adjust for that tax payment, you'd see our free cash flow now is comfortably north of the $800 million range for '25. And then we're on our way to getting free cash flow of $1.2 billion to $1.3 billion in fiscal '27. Part of -- a significant chunk of that improvement in our free cash flow is coming through the EBITDA margin improvement that I mentioned earlier. We're in a -- looking for 33% to 34% EBITDA in '25, going up to 36% to 38% by '27. So if you kind of take the midpoint of that range on a $5.5 billion revenue business, that accounts for a substantial portion of the remaining gap between kind of the normalized F '25 and where we're going for F '27.

All right. Maybe one last question to wrap everything up. If you were going to point investors into the key metrics to watch over the next year, what would you highlight? And two, how do you think OpenText could change over the next 3 to 5 years?

Yes. Look, for F '25, it's about cloud revenue growth, it's about our EBITDA margin improvement and providing visibility into our improving free cash flow profile. And then the biggest capital allocation -- capital return in our history is kind of the four highlights I talked to in '25. If you look at where we're going over the next 3 to 5 years, clearly, cloud is going to be our leading growth driver. As you get out to '27, the 7% to 9% cloud growth. And obviously, we're not giving any targets beyond '27 at this point. But cloud is a big piece of where we're going, but we also are expecting fantastic contributions from security and AI as well. So more consumption coming in as part of our model as well.

Great. Well, Harry, thank you very much.

Thank you.