Thank you for joining us at BofA's 2023 Leveraged Finance Conference. I'm Ana Goshko. I cover high-yield technology and telecom credits, and we're thrilled to have OpenText Corporation with us. We have Harry Blount, the company's Senior Vice President of Investor Relations. Harry, thanks so much for being with us again. He is a font of information and, you know, continues to help us understand OpenText and its history and its outlook. So on that note, Harry, you know, OpenText has a history of being a leader in information management, but that can be very sort of intangible to the, you know, kind of observer.
So what's the best way to describe and think about your products and what they do for customers, and, you know, any other kind of primer-like information you want to set to help set, you know, set the stage with? We'd appreciate.
You bet. Well, first of all, thank you to Bank of America and Ana for hosting us again, and I have to also point to our safe harbor statement on our website, so please refer to that for all of my statements I'm about to make. And I'd also like to acknowledge my colleague, Greg Secord here, who's in the front row, who also is in IR with me. So, the two of us together answer almost all your questions. Look, our mission is to power and protect information. Well, now what does that mean? Think about all of the data that an enterprise generates every year, and think about who should have access to that information. There may be bank routing numbers on it. There may be credit card data on it.
The data may be generated in France and has to legally stay physically in France. The data needs to be accessible to many different systems, from mainframes to PCs. The data may be generated by humans or machines. It may be structured or unstructured. The data may be only on a mainframe and then need to be backed up to tape somewhere. And then there's all sorts of regulatory requirements so that maybe a tax record needs to be saved for seven years in one country, nine years in another. There may be, as goods move through countries, taxes and tariffs that need to be filed real time with the taxing authorities. That is the business of content management.
It's protecting that data, powering that data, and putting it all together in a form that it's consistent, regardless of all these sources coming together, making it consistent so that everything is defined normal. So you can protect that information for compliance, you can access it for analytics, and, and going forward, AI. If you take a look at it, we are the market leader in enterprise content management. Our biggest competitor is IBM's FileNet business. If you think about some, more cloud-based, smaller players, think of, Box as, a competitor, for instance, in the content management space. If you look at our business, a lot of people will first look at our business and say: "Oh, my goodness, you guys have six different businesses that you talk about.
How is this all related?" Well, the content management business started out with managing all that information within the confines of a firewall. Think of things like all of the customer data that comes together from websites and store visits, and chats, and emails, and phone calls. That's called experience data. That's also content management. Then there's all the data that goes back and forth between businesses. How do you keep track of all of that? That's our business network, also a content management problem. We have our cybersecurity business, which is about protecting the information and putting encryption, identity access embedded in that data so that only the right people can access it when they should be able to. We have our IT operations business.
Think of all of the technical support data an IT operations manager has to have running an airline, where every airplane has to be tracked from the minute it takes off to the minute it lands. How many hours was it in the air? What parts are in it? Any repaired parts? When do they need to be repaired? It's a content management problem. Then think of the development side. We have a development business. Same thing, you've got to develop new business applications, such as AI, to extract more value from the data. So our business is powering and protecting data. If you step back and think about all of the problems we solve for customers, it's a complex but very mission-critical application.
And if you look at our growth over time, one of the consistencies that you've seen with us in the macro environment, the steadiness you've typically seen with us over time, is 'cause information doesn't go away. You still need to—you're generating new data all the time, and then you have a long, long tail of protecting that data. So hopefully, that gives a little bit of about what OpenText does and where we play in the ecosystem.
Okay, great. So Micro Focus, you know, a recent acquisition, debt-funded. How is Micro Focus changing the company, and is the thesis or the, you know, kind of the industrial logic for the acquisition actually being validated?
Yeah, it's a great question, and we announced the acquisition in August of last year and then completed the acquisition in January. So here's the investment thesis behind it: anytime you do a digital transformation, think of a large SAP installation, for instance. It's typically a several-year process. What needs to happen during any digital transformation, whether it's SAP or something else, is you still need to be able to access that data throughout the entire transformation. So as a CEO of a company, where's the first place you're gonna go before you embark on a digital transformation journey? You're gonna go to your CTO to make sure all the existing applications are gonna stay up and running. Before Micro Focus, we did not have market-leading products for the CTO, for the enterprise.
You also need to go to your application developer, your head of DevOps, to say: "Hey, can you not only, we have to get from here to there with this digital transformation. Can we actually write the code to do it?" Before Micro Focus, we didn't have market-leading products for the head of DevOps. And before Micro Focus, we did not have market-leading products for enterprise cybersecurity for the CISO. So what Micro Focus brings us is, we had many of the exact same customers, but the buyers inside the enterprise were different. Micro Focus filled the gaps on those buying groups, the key sign-offs that we have. So now we touch basically every major buying group inside of an enterprise. So that's part one of it.
Part two of it is, one of our core competencies has been to acquire companies and cloudify them. So if you think of Documentum, when we acquired Documentum out of EMC, Dell EMC, five or six years ago, it was mostly an on-premise, i.e., off cloud, so piece of software, mission-critical. It took us about five years to cloudify it. But now we have a cloud-based architecture. We release everything every 90 days. We acquired Micro Focus. Over 90% of their revenue was in the enterprise off cloud. We're gonna cloudify it, but we're gonna do it in about two years. If I were to ask a rhetorical question, two identical companies, same software, but one is only selling off cloud and one's only selling cloud, which one's growing faster?
So by cloudifying it, like we did with Documentum, you start addressing faster-growing deployment options, and now content is one of our fastest-growing cloud-based products. We expect to have the same benefit from Micro Focus. So there's TAM, buyers, potential for increased growth, and then we also... It was a highly profitable business that we're gonna make even more profitable. So if you take a look at all of the benchmarks of when we acquired, announced the acquisition in August, all of the benchmarks we set out were on track or ahead of plan to get them onto our adjusted EBITDA model, to return them to organic growth. We're one year ahead of schedule.
We're gonna return them to organic growth in fiscal 2024 versus our original target in Fiscal 2025, and we're still on track to get to less than 3x net leverage by the end of fiscal 2025 or sooner.
Okay. Okay, great. So, you know, as you mentioned, you know, being on track. So I think, you know, the company has said it expects Micro Focus to achieve organic growth this fiscal year, and that you would actually break that out, I believe, right?
Yep.
To make it kind of clear, transparent, that... And as you just mentioned, that, it, you expect it to be on your target operating model of 36%-38% Adjusted EBITDA margin, right? And that's within the FY 2024, which is the, you know, the June end. So you've been executing on the turnaround.
Yep.
You know, the other thing embedded in that is really the historic renewal rate. So OpenText has historically, contract renewals have been in the mid-90% area retention, and that's, but, you know, Micro Focus, I think, it was at least kind of 10 percentage points below that when you acquired it. Where are you right now with the Micro Focus churn? And, you know, what concrete steps did you take to improve it? Is that an impact from the cloudifying, or are there other measures you've taken to help with the churn there?
Yeah, great question. Let me unpack a little bit. Our renewal rates have been running in the mid-90s for both our cloud and off-cloud business, and when we acquired them, closed the acquisition on January 31, they were running in the low 80s. So our intent is to bring their renewal rates up to our renewal rates over time. The target we set was to have them in the mid-80s by the end of our Fiscal 2023, which we did, to have them into the upper 80s by the end of fiscal 2024 and into the 90s in Fiscal 2025. Now, to put that into perspective, their maintenance business was, depending on what time frame you use, call it $1.6 billion run rate.
So if you get a 15-point uplift over time, that would add over $200 million, almost $240 million of incremental revenue to our top line from Micro Focus on what is roughly a $6 billion run rate business. So that's four points of organic growth over several years, in terms of improving. Now, how? Anna, you asked also about the how of how we did that. So there's several things there. One is their practices. They had outsourced some of their renewals to partners...
So that means you don't have that deep customer interactions on an ongoing basis to find out if the customer's happy, if they're using your products, if there are certain things you can do to fix the products or the problems way ahead of time, besides showing up at the renewals, and you're giving away margins to a third party. We centralized the renewal practice day one. It's one of the things we do. Our head of renewals used to run Oracle's renewals. Another thing is they used to have in other parts of their business, they used to have their salespeople also be responsible for renewals. So depending on the nature of the salesperson, they may or may not have been focused on the renewal as much as new business. That's part of it.
The bigger, sorry, as meaningful of that, though, is the product strategy. They did not have a head of engineering. They did not release their products every 90 days. So we did, day one, we said we were gonna announce a cloud product roadmap to them so that the customer had choice of deploying. When over 90% of your revenue is off cloud, that means the customer has to buy it, install it in their own data center, and hire the people to run it. Most customers don't want to do that anymore. So we acquired it in January. We announced in April a product roadmap to cloudify their products in two years.
So between giving them, the customers a roadmap and options, getting deeply engaged with the customers day one to find out what they're happy with and what they're not, both of those enabled us to have the confidence in lifting up the renewal rates over time. A couple other data points related to that. One is part of diligence. I said earlier that we were in many of the same customers, so we had deep knowledge already of what the customers liked and didn't like about their products, and cloud was one of those. The other thing is, we did say on our most recent earnings call that by December, we will have touched about 75% of the renewal contracts and 90% by January. So the renewal rates that we disclose of low 80s%, mid-80s%, upper 80s%, those are trailing 12-month numbers.
That means our in-quarter renewals have to be running much higher than that as those renewals come up, in order to have that kind of steady uplift in the business.
Okay, that's great. So, you know, I think more broadly for the company, on your recent earnings call, management said that the company is on track for its FY 2024, which is June end, internal plan, and you expect a stronger second half, so it'd be the calendar year first half of 2024 versus this kind of latter half of 2023. So, you know, first, if you could refresh us on the targets, but you know, given the volatile macro situation, how good is your visibility in that sort of second half strength? And you know, what provides the confidence in that outlook?
Yeah. Yeah, let me unpack that a little bit, and I realized when you were asking the question, I didn't finish your prior question about organic growth. So our baseline with Micro Focus, with all of the things we've done with the product roadmap and renewals, our baseline is about $2.3 billion run rate contribution from Micro Focus. So we do expect to be better than that $2.3 billion baseline. So it is returning Micro Focus to organic growth. So if you do the $2.3 billion divided by four, it's 575. In the first quarter, September, we did $563 million. So to your question-
Got it.
We do expect this ongoing uplift in the Micro Focus revenues as the year progresses. What's driving that is part of it's the renewal rate that we talked about, the uplift, 'cause day one, you get the uplift in place with the renewals. There might be annual price adjustments in there. There might be more premium support services you sell. So the kind of the recognition of that, the rev rec of that, tends to come in layered in over time. So that provides a lot of visibility. The product roadmap that we announced in April, if you think of your typical 6- to 18-month enterprise sales cycle, we would just be beginning to see kind of the benefits of new business from the new, newly launched Micro Focus products.
So in the most recent earnings call in November, even though our full year booking target for cloud bookings was 15%, we talked about having a 20% year-over-year cloud booking number this quarter, this December quarter that we're in. Part of that is, Micro Focus, and part of it is the new AI products that we launched in October. In terms of the, free cash flow, we talked about $800 million-$900 million of free cash flow in Fiscal 2024, and we expect that as we finish the integration of Micro Focus to ramp up to about over $1.5 billion by fiscal 2026, and that's on a 270 million share base.
So you're looking at an uplift in FY 2026, a free cash flow of over $5 per share, at that point in time. On the macro, data doesn't go away. You continue to generate new data. It still needs to be powered and protected. The tail on it can be five, seven, 10 years. So if you look at our history over time, we've historically not been meaningfully economically sensitive. We have very long sales cycles, plus we have some benefits of our content management platform being cloudified. Also, before you can do any AI, you have to organize and manage your content, so there may be some benefits inside of that.
The one area we did call out on the most recent earnings call that we did say was a little bit of a headwind was our small and medium business component of our business, which is less than 10% of our revenue. There, think of Carbonite Webroot, so a lot of PC software. With the global PC market being down year-over-year, nine consecutive quarters, we saw a little bit of a tailwind, $10 million-$15 million, very minor. But that is really the only macro item that we called out.
Okay, so you brought up AI. I will come back to that in a minute.
Okay.
on a much more, potentially more mundane topic. So on the earnings call, management encouraged analysts to better balance their quarterly models. I think you mentioned that more than once. It sounded like you guys maybe weren't happy with some of the models that were out there. So is there something about the seasonality of the business that you think the market's been missing or some other misunderstanding that kind of drove that comment?
Yeah, I think, if you took a look at how the analysts had modeled us, we give quarterly factors so that we give kind of our outlook in terms of what we expect the next quarter after earnings to look like, and then we give the full fiscal year picture. And coming into the November quarter, it looked to us like there was a lot of uncertainty from the analysts on how to model the Micro Focus contribution to OpenText because of all the conversions from IFRS to GAAP, from pound to dollar, from them being on a six-month cycle versus us on a quarterly, 90-day quarterly recycle.
So as we looked out beyond kind of the September quarter we reported, there was quite a bit of variability quarter to quarter within the fiscal 2024. Fiscal 2024 overall was directionally consistent with what our full year aspirations were, but the end quarter was all over the map. So in order to provide some insight to the analysts about how we expected the year to unfold without getting overly precise, we provided a little bit more detail on it, and... So that was literally what drove it, is quite a bit of wide ranges, especially as we got into the second half of Fiscal 2024.
Okay. So on the topic of AI, so, Mark and, you know, you and others in management have made the point that AI is not necessarily new to OpenText, because you are an information management company, so the kind of the whole kind of process and ethos of AI is sort of embedded in your products anyway. But you did just mention the recent release of some additional products. So can you just talk about the role of AI in your current product offerings and what the product roadmap looks like?
Yeah. So there's artificial intelligence and machine learning, and then there's generative AI. And if you take a look at what we've done is, we've had for years a product called Magellan, that has been part of our overall AI portfolio. And since many of you are either analysts or investors, this isn't gonna come as a surprise, but before you can really analyze any company, any markets, you got to take data from different sources, put it together, put it in the same common format, same common definitions, dollars versus pounds, anything like that. So you can't do analytics or AI until you bring all the different sources of information together, put the same metadata over the top of it. And so we've been helping customers do that for years.
But generative AI, it's a whole new level of it. And the products that we introduced... Well, let me make one other predicate statement on it, is with the acquisition of Micro Focus, we added two new products that were critical for generative AI. One is a product called Vertica, which is a very high capacity, trillions of rows, vector database. And we added IDOL, which is a taxonomy for defining any type of data. But in particular, what IDOL brought to us that we didn't have before was the ability to do video, images, social media, et cetera. We already had many of the hundreds - we have hundreds of connectors, but many already suited for the enterprise, but this brought us some new capability.
So between our Magellan, Vertica, and IDOL products that we got from Micro Focus, we now have a full suite to not only provide content management, but to vectorize a database, put new metadata over the top of it, and then you bring us the large language model that you wanna use based on the particular AI problem you're gonna solve. So what, what our CEO, Mark, says is, "No data, no AI, no information management, no AI, no automation, no AI." So the content management business that we're in is not only organizing all this data, putting the taxonomy on it, powering and protecting it, you still don't want the IR guy being able to see bank routing data, even in an AI environment.
So you still have to power and protect it with all those provisions on it, but you also then need to continue to feed that data as new content's generated, which is again, part of what content management is. So for us, what we're excited about with our AI products is it leverages all of the things we've already been doing in content management. We're not going to be building large language models, so you can bring whatever one you want from Google, Microsoft, Facebook, et cetera. Bring it in and apply it to your data, but do it within the same private framework that you can analyze in a sandbox within a content management platform. You're not contributing it out into a public domain. The last thing I'll say on it is, when we introduced our AI products...
Look, we're at the early stages of AI in the enterprise. Nobody's gonna spend $25 million, $40 million, $50 million on a hypothesis. So we introduced this full suite of AI products. We'll have some more coming in the new calendar year. But we introduced a product called Get Your Wings, and it's an AI product that allows you to test a hypothesis without spending a boatload of money. For $350,000, we're offering our customers the opportunity to bring to test our large language model on 1 million documents. So they put the order in with us, we'll ingest 1 million documents for them within two weeks, hand it back to them, fully vectorized and with the large language model of their choice, and then they can prove out their hypothesis on AI.
But then think of where that goes, and Mark talked about us having consumption as one of our growth drivers going forward, AI and consumption. Once they prove out a hypothesis, they're probably gonna want to ingest 25 million documents, 50 million documents, and then there's an opportunity for us to drive more consumption into our more commercial AI products at that point.
Okay, fascinating. So we've got just about four minutes left, so I definitely want to touch on the debt side. So the company has committed to pay down debt of at least $175 million a quarter, and then you've set a net leverage target, correct me if I'm wrong, but it's below 3x.
Yeah.
That's by the end of fiscal year 25, so it'll be June quarter 25.
Yeah.
So basically, like, 18 months from now.
Or sooner, yep.
Yeah.
Fiscal 2025 or sooner, we'll be under 3x net leverage.
Okay, so a couple questions. So one, where do you expect to repay that debt? Is that really sort of just the pre-payable term loan, or have you thought about buying back bonds in the market?
So we, with the $175 million a quarter minimum principal payment that we're making, we just finished off paying down the revolver, so that's completely paid off. That was a $100 million tranche, and then the remaining $75 million last quarter, we applied to the floating rate 2029 debt tower. So we have. If you look at our overall debt towers, we're 48% fixed, 52% variable. The variable pieces are a 25 term loan and a 29 term loan. One's at SOFR + 175, one's at SOFR + 275.
So now that we have paid off the revolver, our intent is to continue to pay the $175 million minimum principal, and based on covenant restrictions, it'll go either to the 25s or 29s, depending on the covenant calculations in any given time frame.
It's gonna go to the term loan? Yeah.
Yeah.
Okay. Once you get to your net leverage target, then, then what? What's your capital allocation policy then?
It's a great question. Look, if you take a look at our current capital allocation right now, the two priorities are to pay down our leverage to get to less than 3 times and continue to pay our 20% of trailing free cash flow dividend. We still have done an acquisition. We did a very tiny acquisition called KineMatik. Very tiny, but we still have done that. You know, I think as we get closer to less than 3 x net leverage, you'll look at us, maybe even buying ourselves, in Mark's words, reinstating potentially share buybacks as an option. So we'll look at the best use of capital as we get closer to that net less than 3 x net leverage.
I think the other thing that is important, Ana, that, with our capital allocation, we just announced it in our most recent earnings call, and this is a very important comment in terms of our strategy. Historically, Mark, OpenText was majoring in M&A and minoring in organic growth. With this most recent quarter, we flipped it. We've gotten asked a lot of questions. Is this a permanent change? The answer is yes. We are now majoring in organic growth and minoring in M&A. So we'll still do M&A, but we have called out, our total organic growth going from 1%-2% in 2024, up to 2%-4% in 2026. Our cloud organic growth in fiscal 2023 was just under 4%.
We're calling it to go up to 7%-9% in fiscal 2026, and it's not an overnight decision. If you look at our R&D investment as a percent of revenue over the last four years, from fiscal 2020, it was 12%. It'll be up to 16% in fiscal 2024. And the amount of R&D we're putting in is mostly for cloudifying our products, which is all faster growing.
Okay, great. That's a great place to end because we just ran out of time. So Harry, thank you so much for being with us.
Thank you, Ana.
Thanks.
I really appreciate it.