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Open Text Corporation (NASDAQ:OTEX) Q3 2024 Earnings Call Transcript

Open Text Corporation (NASDAQ:OTEX) Q3 2024 Earnings Call Transcript May 2, 2024

Open Text Corporation misses on earnings expectations. Reported EPS is $0.36 EPS, expectations were $0.94. Open Text Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by. This is the conference operator. Welcome to the Open Text Corporation Third Quarter Fiscal 2024 Financial Results Conference Call. As a reminder, all participants are in listen-only mode, and the conference is being recorded. After the presentation, there will be an analyst Q&A session. [Operator Instructions] I would like to turn the conference over to Harry Blount, Senior Vice President, Investor Relations. Please go ahead.

Harry Blount: Good afternoon, everyone, and welcome to OpenText's third quarter fiscal 2024 earnings call. With me on the call today are OpenText's Chief Executive Officer and Chief Technology Officer, Mark J. Barrenechea, and OpenText's President, Chief Financial Officer and Corporate Development, Madhu Ranganathan. Today's call is being webcast live and recorded with a replay, available shortly thereafter on the OpenText Investor Relations website. Earlier today, we posted our press release and investor presentation online. These materials will supplement our prepared remarks and can be accessed on the OpenText investor relations website, I'm pleased to inform you that OpenText management will be participating at the following upcoming conferences.


Needham Technology, Media & Consumer Conference on May 14th in New York. Barclays Leveraged Finance Conference on May 21st in Austin, CIBC Technology & Innovation Conference on May 22nd in Toronto. Jefferies Software Conference on May 30th in Newport Coast, and Bank of America Global Tech Conference on June 6 in San Francisco. And now on to our safe harbor statement. During this call, we will make forward-looking statements relating to the future performance of OpenText. These statements are based on current expectations, assumptions, and other material factors that are subject to risks and uncertainties and actual results could differ materially from the forward-looking statements made today. Additional information about the material factors that could cause actual results to differ materially from such forward-looking statements 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 in our press release that was distributed earlier this afternoon, which may be found on our website.

We undertake no obligation to update these forward-looking statements unless required to do so by law. In addition, our conference call may include discussions of certain non-GAAP financial measures. Reconciliations of any non-GAAP financial measures to their most direct, comparable GAAP measures may be found within our public filings and other materials which are available on our website. And with that, I'm pleased to hand the call over to Mark.

Mark J. Barrenechea: Thank you, Harry, and welcome to today's call. Let me kick off the call with a statement. The strategic value of OpenText to our customers has never been higher. We continue to build cloud momentum with our business clouds, business AI, and business technology. And we see proof points of this as evidenced by our continued strength with large multi-year cloud contracts and our upward revisions in future cloud bookings expectations. And with the AMC divestiture now complete, we have increased our capital flexibility to accelerate growth in the $200 billion information management addressable market. Long term, we expect our business to deliver mid-single-digit total revenue growth through a balanced approach of cloud-led organic growth plus M&A comprised of 20% plus enterprise cloud bookings growth, 7% to 9% organic cloud growth, 2% to 4% total organic growth, and 1% to 2% M&A growth, powerful cash flows at 20% plus of revenues, and a new return of capital framework comprised of 50% of trailing 12-month free cash flows returned to shareholders in the form of dividends and share buybacks and 50% for Cloud M&A.

And to jumpstart this new return of capital program, we are announcing today a $250 million share buyback over the next 12 months, and our intention to return $450 million to $500 million of capital to shareholders in fiscal ‘25. Let's get started. You'll see in our investor deck today our four point strategy to building shareholder value. Point one of the strategy is to continue to lead the OpenText business system with a relentless focus on execution. Simply said, an OpenTexter always puts customers first, innovates, cares about people, and strives for exceptional performance. Our culture sets us apart. Point two, accelerate cloud growth. Our strategy to accelerate cloud growth is working. We've increased our R&D investment to an annualized $900 million, or 16% of fiscal ‘24 revenue.

This helped drive enterprise cloud bookings growth of 63% in Q2 and 53% in Q3. We've increased our F ‘24 enterprise cloud bookings targets to 33% to 38%. And we're confidently projecting 20% plus cloud bookings growth in both F ‘25 and beyond, up from prior targets of 15%. We expect our cloud revenue organic growth to reach between 7% and 9% by fiscal ‘27. And the best part is we're just getting started in our AI and security journey. The OpenText Cloud opportunity continues to expand across our business clouds, business AI, and business technology. We are well aligned to Gartner and customer spending priorities in cyber, information security, data, cloud platforms, and AI. We're focused on winning more workloads for knowledge workers, business networks, customer experience, and digital operations.

We're helping customers build and own their own capabilities in the private and public cloud and to do so securely. We're unlocking new developer opportunities in large-scale software companies and let's understand it, we're all software companies today and we're rapidly adding IoT and AI capabilities. We see two huge opportunities in AI. First, to help our large install base of customers prepare their operations and data through systems consolidations to our Cloud Editions. And second, to grow our aviator and thrust offerings. We officially introduced Titanium X at OpenText World Europe a couple weeks ago, our next-generation autonomous cloud. We demonstrated our latest Aviator technology with Cloud Editions 24.2. We made business AI as easy as pressing a button.

And we made clear the step function and productivity a knowledge worker can gain with learning models applied to information management. Customer analyst feedback is extremely positive. And while many customers are still researching and piloting, Aviator is helping us win now. We have unique capabilities to move enterprises into actionable business AI use cases to securely exploit both unstructured and structured data and accelerate customer value through partnerships like SAP, Google, and Microsoft. Consider Pick n Pay, leveraging DevOps Aviator for scaling testing and quality. A leading global apparel company accelerating invoice intelligence with Content Aviator. Zurich Airport leveraging our SaaS service management and universal discovery in the cloud.

Please watch on the recap of our OpenText World Europe where I demonstrated OpenText’s Content Cloud 24.2 with Content and Search Aviator, running the United States National Transportation Security Board data archive. It shows the power of automation plus AI, providing clear and bankable productivity gains for any knowledge worker. You can also hear directly from our customers of Nationwide, Carl Zeiss, Juniper, [Framatome] (ph), and Criteo at the event. Point three of our four-point strategy, powerful free cash flow generation. We are targeting an F ‘24 free cash flow of $725 million to $800 million, and our medium-term aspiration by fiscal ‘27 of $1.2 billion to $1.3 billion, or 20%-plus of free cash flow as a percent of revenue.

We expect to achieve these higher free cash flow aspirations through a series of actions. Adjusted EBITDA margin expansion from a technology enabled business through leveraging our data, automation, and AI. We are just getting started in deploying AI internally, completing all micro-focused integration expense, lower special charges over time, lower interest charges, and potentially lower rates over time. It is a combination of margin expansion, more technology enablement, elimination of integration expense, and a reduction in interest burden that is the path to our free cash flow aspirations. Point four, disciplined capital allocation. We expect to pay down our debt on May 6th by $2 billion, and with our net leverage ratio now below 3x, we are increasing our return to capital to shareholders by introducing a $250 million buyback and re-entering the M&A market with a new framework that is future-oriented while leveraging the best parts of our operational disciplines.

You will see in our investor presentation today our capital allocation strategy comprised of two elements, primary and additional allocation. For the primary, we intend to allocate 50% of our trailing 12 months free cash flow to dividends and buybacks. We have a strong dividend track record, as you know, of returning $1.9 billion over the last decade. I'm now pleased to add a buyback program to that return strategy. As noted, our target is 50% of trailing 12-month free cash flow allocation. And we're going to start higher with a $250 million buyback, and we tend to return again between $450 million to $500 million to shareholders in fiscal ‘25. For the additional part, we intend to allocate the other 50% of trailing 12 months free cash flows to cloud-based M&A.

Further, we are excited about the M&A opportunity for information management in the cloud for higher recurring revenues. We intend to cast a wide net across information management for established technologies with proven customer value propositions. We're looking for small to medium-sized cloud companies that will benefit from our business system, general operations, benefit from our distribution, and benefit from our multi-billion dollar cloud foundation and cloud operations. We'll always seek value in organic growth. You can expect us to complete multiple M&A transactions in the coming year while growing organically. Let me turn to our financials and our medium term aspirations. For Q3, our results reflect strong execution and strong customer trust.

On cloud bookings, $165 million, up 53% year-over-year. We more than doubled our $1 million plus wins year over year from 13 to 28. Average cloud deal size is up 30%. Contract terms are longer. Customers are increasing their commitments for long-term durations with ramps to full value. Our investment is also up to fuel that growth, to get customers ramped, and to introduce new capabilities like AI and IoT. We have total revenues of $1.4 billion, up 16% year-over-year. We ended cash of $1.1 billion and free cash flow of $348 million, up 14% and just had fantastic wins at Akamai, Nestle, Shell, Tyson Foods, BAE Systems, and MAN. Recall, we're an annual business, and for full fiscal of ‘24, our targets include cloud bookings growth between 33% to 38%, 6% to 8% cloud growth, total revenues between $5.745 billion to $5.795 billion, and free cash flows between $725 million to $800 million, up from $655 million last year.

Today we're also presenting preliminary F ‘25 targets and subject to change. These preliminary targets are without the AMC business. We're expecting enterprise bookings of 20% plus, cloud revenues of up to $1.9 billion, total revenues between $5.3 billion and $5.4 billion, free cash flows between $575 million to $650 million, which includes -- really important, which includes a one-time $250 million tax payment for the AMC divestiture. Excluding our tax payment from divestiture, our free cash flow would be growing again year-over-year. And we do -- we'll talk more about this. And again, a return of capital between $450 million to $500 million. We're excited about our cloud business, cloud additions, Titanium X, our next-generational autonomous cloud, security, SAP, and Aviators.

Our cloud bookings are strong and growing faster than the market, and it's a leading indicator of our cloud momentum. We're also maintaining our medium-term aspirations, but moving them from ‘26 to ‘27. Why? Customers are trending more and more to sign larger contracts with longer-term commitments of four-plus years that also include ramps. This is driven by industry trends and our strong multi-year roadmap of capabilities. This is positive news. Customers are increasing their commitments to OpenText for longer durations. You also see this positive trend from other cloud providers such as SAP, Google, Microsoft, and AWS, our most important partners. Our F ‘27 aspirations include enterprise cloud bookings of 20% plus, total revenues of $5.7 billion to $5.9 billion, cloud organic growth of 7% to 9%, total organic growth 2% to 4%, adjusted EBITDA of 36% to 38%, and free cash flow between $1.2 billion and $1.3 billion, reflecting strong continuous growth.

A close-up of a cyber security hardware device used for protection.
A close-up of a cyber security hardware device used for protection.

And M&A will contribute to these aspirations. Well, let me wrap up and thank you for joining today. And let me conclude my remarks where I started. The strategic value of OpenText to our customers have never been higher. We're increasingly confident about our business, our ability to grow in the cloud and produce higher profits from these higher revenues. And that's reflected in our increased visibility today that we are providing. To recap, OpenText has a highly attractive financial model with a predictable, resilient, and growing revenue stream up per quartile adjusted EBITDA margins and growing free cash flows and a very strong balance sheet. Our four-point strategy is designed to build shareholder value and to create a long-term recurring revenue and highly profitable business model.

And we're excited to reduce our debt by $2 billion, execute to a $250 million buyback and a new return of capital strategy, return to M&A, and deliver a stellar F ‘24 of 6% to 8% cloud growth. I want to express my deepest appreciation to the entire OpenText executive team and my colleagues for always putting customers first, innovating, caring about people and for their exceptional performance. I'm delighted to welcome Todd Cione, President of Worldwide Sales, responsible for all new sales. Let me congratulate Paul Duggan, President and Chief Customer Officer, responsible for all renewals, professional services, and support. And to Madhu Ranganathan, President and CFO, responsible for finance, operations, and corporate development. Please visit to read about our exceptional leadership team, ready for the next growth chapter in our business clouds, business AI, and business technology.

May the one that brings peace bring peace for all. Let me turn the call over to Madhu, but before I do, I want to wish Madhu a very happy birthday today. Madhu?

Madhu Ranganathan: Great, Thank you, Mark. And we appreciate all of you joining us today. So let me start with a few key points. In Q3, we successfully achieved our operating goals while focusing on initiatives for growing our cloud business. This was our 13th quarter of organic cloud growth. We announced yesterday, May 1st, that we have successfully completed divesting the AMC assets. This transaction returns us to capital flexibility. Last quarter, I mentioned that Micro Focus will be on our operating model, both adjusted EBITDA and free cash flows, as well as returning to organic growth by the end of fiscal 2024, we are on track to achieving that. Our outlook, targets, and aspirations fully reflect the opportunity in front of OpenText with enterprise cloud bookings leading the way as our customers prepare for AI.

Mark spoke to our Q3 results and let me share some additional comments. During the call, I will refer to the investor presentation posted on our IR website. All references are in millions of USD and compared to the same period in the prior fiscal year and are on a reported basis unless stated otherwise. On a year-over-year basis, Q3 cloud revenue was $455 million, up 4.4% as well as 4.4% in constant currency. Our enterprise cloud business is doing extremely well with 53% year-over-year bookings growth in the quarter, increasing our visibility towards cloud revenue growth. Q3ARR, annual recurring revenue, of $1.146 billion up 13.3% and 13.1% in constant currency, that represents approximately 79.2% of total revenue. And now moving to other financial metrics.

GAAP net income was $98.3 million, reflecting increased interest expense amortization and special charges that relate to the broader acquisition of Micro Focus driving GAAP EPS of $0.36. GAAP gross margin of 73%, up from 70.3%, also reflecting a healthy revenue contribution from our customer support and licensed businesses. Non-GAAP gross margin of 76.7%, up from 75.8%, also reflecting increased relative contribution from a revenue standpoint from customer support and license. Adjusted EBITDA $463.7 million, an increase of 27% and 26.4% in constant currency. Our adjusted EBITDA margin was 32% as we continued to make solid progress bringing Micro Focus to our operating model. Adjusted EPS was $0.94, was up 28.8%, and the same in constant currency.

Our overall working capital performance remains strong with our DSOs at 45 days that was consistent with Q3 of the prior year. We generated $384.7 million in operating cash flows and $348.2 million free cash flows in the quarter. Turning to the balance sheet, we finished Q3 with $1.125 billion in cash. Our net leverage ratio on March 31st was 3.8 times. With the successful completion of AMC divestiture, we have provided notice of our intent to prepay $1.060 billion of the acquisition term loan as well as to prepay in full the $940 million outstanding principal balance of the Term Loan B. That is a total of $2 billion debt repayments that we expect to make on May 6, which will bring our net leverage ratio to less than three times. The repayment will reduce our debt from $8.5 billion to $6.5 billion, and our annual interest expense from $537 million to $383 million, a reduction of $150 million.

We're extremely satisfied with the outcome and well positioned to execute on our capital allocation program given this flexibility. Now regarding M&A, our capital allocation model leaves ample room to invest in strategic M&A to drive future cloud growth. In my expanded role as President, I'm excited to lead our corporate development function. As Mark noted, we expect to do multiple deals, targeting small to medium sized cloud businesses. We have fully outlined our cloud M&A strategy on Page 26 of our investor deck. Turning to the dividend program. On April 30th, our Board of Directors also approved a quarterly cash dividend of $0.25 per common share. The record date for the next quarterly dividend is May 31st, 2024, and the payment date is June 18th, 2024.

OpenText ex AMC. Yesterday, after we announced the divestiture completion of the AMC business, we also filed pro forma statements to provide a historic view of how our business looked from July to December 2023 without AMC. I'll walk through a few points to ensure your financial models and year-over-year comparisons are accurate. Please also refer to slide 32. For fiscal 2023 actuals, AMC revenue is approximately $225 million and primarily representing the five months of AMC business since original close of acquisition. For fiscal 2024, AMC business annualized is approximately $528 million of revenue. Given completion of divestiture on May 1st, earlier than our previous target of June 30th, 2024, we're reducing our fiscal 2024 target model by approximately $100 million, the expected AMC revenue contribution for the months of May and June, 2024.

There will be no AMC revenues in fiscal 2025 and beyond. And now let me turn to our outlook starting on Page 36. Starting with our Q4 fiscal ‘24 quarterly factors in our investor presentation, revenue on a year-over-year basis, we expect $1.39 billion to $1.44 billion. ARR of $1.08 billion to $1.12 billion, a slight FX headwind. Adjusted EBITDA margin between 32.5% and 33.5%. Our assumptions today include the following. AMC divestiture closed as of May 1st and removing two months of AMC business from Q4, including a reduction in Q4 and fiscal ‘24 revenue of approximately $100 million, as I mentioned earlier. AMC divestiture related expenses now included in Q4. And regarding our cloud business, we now have a second consecutive data point with strong cloud bookings of 53% growth in the third quarter and greater than 60% growth in our second quarter.

The longer term customer commitments and ramps we are seeing are now factored into the Q4 revenue projections. We have also now further increased our cloud investments in SaaS, in IoT and security. Last is our AI and customer investment, which are further increased in Q4 as we see continued benefit to cloud bookings. Our fiscal ‘24 target model in constant currency is provided on Page 38. So building on my prior comments, the target model ranges for fiscal ‘24 reflect only 10 months of contribution from AMC. Total revenues between $5.745 billion to $5.795 billion. Total revenue growth of 27% with organic growth in the range of 1% to 2%. Cloud revenue growth, 6% to 8%. Enterprise cloud bookings growing 33% to 38%. Annual recurring revenue up 23.5% to 25.5%.

Adjusted EBITDA margin in the range of 33.5% to 34.5%, again, reflecting higher investments in AI and cloud sales and marketing, expenses related to the AMC divestiture, and Micro Focus integration expenses. We expect full fiscal ‘24 free cash flows of $725 million to $800 million, again reflecting AMC divestiture close two months earlier than expected. This excludes two months cash flow we would have seen from AMC of approximately $50 million and divestiture related expenses of $40 million with a slight positive offset of lower interest. On Page 39, we have laid out our preliminary fiscal 2025 targets and fiscal 2027 aspirations. As Mark mentioned, we're maintaining our medium term aspirations but moving from fiscal ‘26 to ‘27 driven by the cloud acceleration of our business.

We now have increased our expected growth in cloud bookings to 20% plus annually. We continue to watch the markets closely on interest rates and currency, noting that our long term models today do not assume any interest rate benefit or improvements in the euro or the yen. Both will positively benefit our model should they materialize. We expect total revenue in fiscal ‘25 to be $5.3 to $5.4 billion in constant currency with cloud growing to $1.85 to $1.9 billion. Our adjusted EBITDA will be lower, in the 32% to 33% in fiscal ‘25, and that reflects spend on our cloud and AI growth programs, as well as some trailing expenses from the Micro Focus acquisition. Free cash flows in fiscal ‘25 will be in the $575 million to $650 million range and includes a one-time tax payment of $250 million relating to the gain of AMC divestiture.

Without the tax payment, FCF in fiscal ‘25 will grow year-over-year. The tax payment is expected to be made in Q1 of fiscal ‘25 and will be reflected in our Q1 and fiscal ‘25 free cash flows. The path to our fiscal 27 free cash flow aspirations of $1.2 billion to $1.3 billion is highlighted on Page 24 of our materials. Our goal to improve free cash flows to 20% of revenue is supported by greater scale and efficiencies including automation and AI. An example is Project Athena, utilizing our own AI technology to automate development. The following key improvements in fiscal ‘27 create a clear path in our planning towards reaching these 2027 aspirations. Adjusted EBITDA margin expansion of 36% to 38%. Interest expense post-deleveraging coming down approximately $150 million.

Special charges reduction down approximately $30 million. And a one-time $250 million AMC tax charge, that will be completed in fiscal ‘25. With all of this, we expect continuous future year-over-year growth and free cash flows. So in summary, when we talk about the OpenText financial profile, investors should think about a mid-single-digit growing software company led by cloud revenue growth plus small-to-mid cloud M&A. Shareholders can expect us to complete M&A transactions in a few years. We have established our return on capital framework to complement our dividends previously at 20% of trailing 12-month cash flows to 50% overall return on capital by leveraging a new share buyback program. We raised enterprise cloud bookings from 15% to 20% and have a clear path to growing free cash flows to 20% plus of revenues in fiscal ‘27.

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

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