Open Text Corp Q2 FY2021 Earnings Call

Thank you for waiting. This is the conference operator. Welcome to the OpenText Corporation Second Quarter Fiscal 2021 Earnings Conference Call. Everyone is currently in listen-only mode and the conference is being recorded. After the presentation, there will be a chance to ask questions. I would like to turn the conference over to Harry Blount, Senior Vice President of Investor Relations. Please proceed.

Thank you, operator, and good afternoon, everyone. On the call today is OpenText’s Chief Executive Officer and Chief Technology Officer, Mark J. Barrenechea; and our Executive Vice President and Chief Financial Officer, Madhu Ranganathan. We have some prepared remarks, which will be followed by a question-and-answer session. This call will last approximately 60 minutes with a replay available shortly thereafter. I would like to take a moment and direct investors to the Investor Relations section of our website, investors.opentext.com, where we have posted our consolidated investor presentation that will supplement our prepared remarks today. The presentation includes information and financials specific to our quarterly results, notably our updated quarterly factors on Page 7 as well as a strategic overview. And now an update on Investor Day, I’m pleased to announce that OpenText executive team will be hosting a virtual Investor Day on Thursday, March 11. To register, please visit our Investor Relations website or contact our IR team directly. I would also like to announce that OpenText management will be participating at the Morgan Stanley Conference on March 1 and 4. We look forward to engaging with you in the coming weeks. I will now proceed with a reading of our Safe Harbor statement. Please note that during the course of this conference call, we may make statements relating to the future performance of OpenText that contain forward-looking information. While these forward-looking statements represent our current judgment, actual results could differ materially from a conclusion, forecast or projection in the forward-looking statements made today. Certain material factors and assumptions were applied in drawing any such statement.

Thank you, Harry. And good afternoon to everyone, and thank you for joining today’s call. I want to open the call with a note of optimism. Over the last year, the world has experienced health, financial, social, political, and environmental crises. Well, many of these crises continue and the effects are long-lasting and that forever changed the way we work live and love green shoots are emerging all around us. With an accelerating vaccine rollout, the prospects of a global economic recovery appear to be brightening. Today in the U.S., more people have received their first dose of a COVID-19 vaccine than cases reported. Economists are increasingly predicting a strong economic recovery in calendar 2021, due to a combination of rebounding demands, rising prices, and low inventory levels. We’re also so much better informed today than we were a year ago. The transformative nature of digital and extreme automation is clear. And we remain in the early stages of the fastest, deepest, and most consequential technology disruption in the history of the world. Businesses are accelerating their digital capabilities and are placing greater emphasis on trusted global partners, time to value, modern work, sustainable supply chains, tailored customer experiences, and cloud plus edge computing. What has become clear is that the cloud plus network plus edge are inextricably linked. Our new architecture and platform of Cloud Edition places OpenText information management demonstrably in the middle of important demand conversations for companies of all sizes - large, medium, and small. The previous four quarters at OpenText are reflective of the amazing strength and durability of our employees, our customers, our company, our business model, and the transformative aspects of our products. Over the last year, we have generated a record $3.3 billion and trailing 12-month revenues are a record $1.1 billion and trailing 12 months free cash flows and invested $400 million trailing 12 months in our products each approximately. We settled with the IRS. We increased our dividend by 15%. We announced the share repurchase program. We donated 4 million meals to help with food insecurity at the end of last year. We’ve achieved our highest employee engagement scores. We were named a Forbes top 150 employer. We delivered record fiscal 2021 Q2 revenues, which we’ll get to in a moment. We introduced our new platform Cloud Edition. And we’re on target to deliver adjusted EBITDA of 37% to 38% this fiscal year. And we are on target to deliver annual recurring revenues or ARR of 81% to 83% highlighting two key aspects of our business. First, the predictability of our business, and second, we are a cloud company. We made a statement. It was not just words that we would exit the pandemic stronger than we entered. The above results speak to our actions, our progress, amazing employees, and our culture. Humbly, these results provide OpenText with momentum and confidence as we entered the calendar year of 2021, and we are excited about the significant opportunities we can pursue with our Cloud Edition. Let me transition to our exceptional Q2. This quarter was highlighted by revenue growth, renewal rates, margin, cash flow, and positive organic ARR growth in reported currency. The team delivered an exceptional quarter. Many of our quarterly metrics are historic highs. Let me walk through the results on a year-over-year basis. Total revenue of $856 million, up 11%, the highest total revenue in our history. Cloud revenue of $250 million, up 41%, the highest cloud revenue in our history and the largest revenue contributor. Customer support revenue of $334 million, up 6%, the highest CS revenue in our history. ARR of $685 million, up 21% the highest ARR in our history and at 80% of total revenue. Adjusted EBITDA of $361 million or 42% adjusted EBITDA margin and the highest adjusted EBITDA dollars in our history and free cash flows of $275 million, up 46% best Q2 that CS in our history. Let me provide a few additional comments. The 41% growth in our cloud business was driven by our Carbonite acquisition, Cloud Editions, a rebound in our business network volumes, and continued momentum in SMBC and enterprise content services. The 6% growth in our support and update business was driven by our customer-centric 90-day release cycles and AI-informed engagement. We have over $2 billion in cash and committed liquidity at our disposal and our consolidated net leverage ratio has declined to 1.6 times this quarter, reflective of the disciplined operations post-acquisition of Carbonite. We continue to generate growth, cash, and returns in the right places. We had many notable customer expansions and wins in Q2. We have a full list in our investor deck. Please give the presentation a read, but let me highlight a few. MedPro Group, a Berkshire Hathaway company. It’s a national leader in customized insurance, clients, and patient safety and risk solutions. MedPro Group is expanding its OpenText extreme use to modernize enterprise-wide digital delivery processes. The Department of Work and Pensions in the UK, a governmental body responsible for welfare, pension, and child maintenance chose OpenText enterprise content solutions as an integral part of their end-to-end processing for shared, critical, and sensitive content. Froneri, one of the world’s largest global ice cream companies headquartered in the UK, expanded their commitment to OpenText B2B managed services and engaged with OpenText to build a service offering that allows them to dynamically flatten their supply chain. Revo Health, a Minneapolis-based provider of healthcare solutions for physician practices and ambulatory surgery centers expanded its investment in OpenText cloud using OT2 services to securely handle confidential communications. Before I turn to our approach of Total Growth in December, we announced that we closed all past, present, and future items related to a dispute with the IRS. As part of the resolution, OpenText will pay $299 million, first disputed amount of approximately $830 million. While we maintain that our long-standing position in this matter was right, we believe the settlement to be in the best interest of all stakeholders. Let me turn to growth. Walk through our Total Growth strategy, which has three fundamental elements: retain, grow, and acquire. On retain, we delivered another exceptional quarter, well customer support renewal rates at 94% and non-GAAP gross margins of 91.3%. Our cloud renewal rate excluding Carbonite was 96%. Our non-GAAP gross margins for total cloud of 66.7% and as margin was up 830 basis points year-over-year. We’re seeing the direct benefits of leveraging more automation and automation based on OpenText Magellan and the direct benefits of scaled operations. On growth, we continue to ramp up our investments in products and sales, continuing to grow our sales coverage of the global 10,000 customers. And we are expanding our relationships with global partners RMM and MSP. We’re on track to increase our R&D investment in fiscal 2021 to support advancing the most exciting product roadmap in our history with Cloud Editions. So the balance of fiscal 2021, our adjusted EBITDA margin will begin to reflect those increased investments. The principles behind our Cloud Editions include customer choice, cloud first, simplification, consumption, and innovation. Delivering our capabilities at APIs will enable developers to include OpenText and speed their time to market. In October, at OpenText world, we announced Cloud Editions 20.4, which featured our five clouds, Content Cloud, Business Network Cloud, Experience Cloud, Security and Protection Cloud, and our Developer Cloud based on our OT2 platform. In the weeks ahead, we’ll be turning on Cloud Editions 21.1, which will provide thousands of new facets, features, and enhancements. Our software development has always been deeply informed by customer feedback. And here are some highlights of upcoming Cloud Editions. In the Content Cloud, we now fully support all major hyperscalers. GCP is your AWS integration to SAP and Salesforce, embedded analytics. And by 21.4, the Content Cloud will be 100% recreated as a multi-tenant SaaS public shared environment running on OT2. With Cloud Editions 21.4, customers will never have to upgrade again. In the Business Network Cloud, we have added support for ethical supply chains, sustainability, and support for the circular economy, as well as country-specific support for invoicing tax and receiving. We now support invoicing tax and receiving in over 60 countries, enabling global supply chains that are sustainable and support the circular economy. In the Experience Cloud, we are providing superior omni-channel experiences through seamless integration, enabling full social commerce and personalization enabled by technology features and a long list of those features including notifications, messaging, document presentment, and CPass. OpenText Magellan is now integrated for machine learning into the Experience Cloud. And security – our Security and Protection Cloud within Bright Cloud service intelligence, we have now added cloud access security broker functionality. It’s also known as CASB to help enforce data-centric security policies and to prevent unwanted interactions. Our threat intelligence products are centered on behavioral analysis, not signatures and 21.2 we are excited about our unified management console for RMMs and MSPs to enable complete integration of Webroot and Carbonite. And the Developer Cloud, we now have over 25 live services, content service capture, signature, document presentment, and intelligent viewer - our workflow messaging for list goes on - identity and threat intelligence. Our Developer Cloud, check it out developer.opentext.com, is expected to continue to see organic growth in fiscal 2022. This new strategic long-term initiative for us is to embed our services in the next generation of cloud company and it will add a new channel to go-to-market. Our third Total Growth strategy on acquire. We remain patient, disciplined, value-based buyers with return-based metrics and cash flow as key criteria. Carbonite is a great example of a growth asset that met our disciplined value-based criteria while offering significant opportunities to create revenue growth and synergies through our cloud-based multichannel global platform. Our liquidity, cash flow, and balance sheet remains strong. The pipeline is also strong, and we will deploy capital when the right opportunity arises. Our total growth strategy of retain, grow, and acquire is unique, massively scalable, and delivering returns. Overall, we are a company that remains on offense with the intent of taking share, regardless of the economic environment. Let me move on to financial outlook. We enter calendar 2021 with earned confidence and an improving economy, coupled with the best top product portfolio in our history, positioned us to gain share by capitalizing on the present trends of digitalization, modern work, sustainable supply chains, security, and cloud. Madhu will cover the details of our financial outlook for Q3 and fiscal 2021. But let me highlight the core aspects. We're increasing the investment in our product sales and our people. We have an improved demand outlook, and we are raising our revenue growth outlook today for the remainder of the fiscal year. Cloud revenue growth is now expected to be in the high teens; total revenue growth is now expected to be in the mid-single digits, up from our prior guidance. OpenText believes strongly in returning value to shareholders. Today, I’m pleased to announce that the Board of Directors has approved our quarterly dividend of $0.2008 per share for holders of record of March 5, 2021, and a payment date of March 26, 2021. Let me conclude my remarks, where I began on a note of optimism. Today, we are playing offense with an improved outlook for fiscal 2021. We had an exceptional quarter with record revenue and adjusted EBITDA dollars with ARR growth of 21%, cloud growth of 41%, and support growth of 6%. We have a strong balance sheet with a net leverage ratio of 1.6 times, and we generated approximately $1.1 billion of trailing 12 months free cash flow. We settled with the IRS and put the matter behind us. Last year’s preemptive actions are replaced with energy and growth actions. Secular trends are strong, long-lasting, and OpenText is at the center of transformative discussions. We’re in the early innings of an important product cycle with Cloud Editions, and our pace of innovation has never been faster with 90-day release cycles and an aggressive product roadmap. On behalf of OpenText, I would like to thank our shareholders, our loyal customers, our partners, and our 14,000 dedicated employees for all contributing to the success. And I am so proud of the resilience and durability that continues to be demonstrated. We’re looking forward to seeing you at our virtual Investor Day on March 11, you can register on OpenText’s Investor Relations website or contact our Investor Relations team directly. Investor Day is a special opportunity for investors and analysts to gain a direct update from the OpenText leadership team on our strategic progress and future direction. The team is very excited to be with you. It’s my pleasure now to turn the call over to Madhu Ranganathan, OpenText’s Chief Financial Officer. Madhu, over to you?

Thank you, Mark. And thank you all for joining us today. We had a strong second quarter and a solid first half of this fiscal year 2021. Our preemptive responses at the onset of the global pandemic strengthened us as we continue to lead the way in modern work. Our disciplined financial management has allowed us to support key growth initiatives, maintain the resilience of our business model, and this is reflected in the expanded margins and solid cash simulation. I will speak to Q2, Q3 and our quarterly factors, our fiscal 2021 total growth strategy, our fiscal 2021 annual target model ranges, and our long-term aspirations, all outlined in our Q2 investor presentation that is posted on the IR website today. All references will be in the millions of USD unless noted otherwise and compared to the same period in the prior fiscal year. So let me start with revenues. Q2, total revenues for the quarter were $855.6 million, 10.9% or up 8.8% on a constant currency basis, including a strong contribution from Carbonite as we completed the one year market December 2020. There was a favorable effects impact to revenue of $16.2 million. The geographical split of total revenues in the quarter was Americas 60%, EMEA 32%, and Asia Pacific 8%. Year-to-date total revenues were $1.659 billion, up 13% or up 11.5% on a constant currency basis. Q2 annual recurring revenues were $684.9 million, up 21.5% or up 19.5% on a constant currency basis. As a percent of total revenues, ARR was 80% for the quarter, up from 73% of the second quarter of fiscal 2020. Here, I would like to highlight that we achieved positive organic ARR growth during the quarter on a reported basis. Year-to-date annual recurring revenues were $1.355 billion, up 21.7% or up 20.4% on a constant currency basis. As a percent of total revenues, year-to-date ARR was 82%, up from 76% of the first six months of fiscal 2020. Q2 cloud revenues are particularly strong at $350.5 million, up 41.1% or up 39.6% on a constant currency basis. Our cloud renewal rate excluding Carbonite’s approximately 96%. Year-to-date cloud revenues of $691.4 million, up 42.4% or up 41.5% on a constant currency basis. Q2 customer support revenues were $334.5 million, up 6% or up 3.6% on a constant currency basis. Our customer support renewal rate for Q2 was 94%. Across the business, our renewals performance remains strong. Year-to-date customer support revenues were $663.9 million, up 5.7% or up 4.2% on a constant currency basis. Q2 license revenues were $107.3 million, down 22.2% or down 24.6% on a constant currency basis. Year-to-date license revenues were $175.9 million, down 18.6% or down 20.7% on a constant currency basis. Q2 professional services revenues were $63.4 million, down 9% or down 11.4% on a constant currency basis. Year-to-date, professional services revenues were $128.5 million down 7.6% or down 10% on a constant currency basis. Tax update, before we speak to net income and other related metrics, I want to again call out the IRS Settlement we announced on December 22, 2020. The IRS Settlement provides finality to this longstanding matter, putting it behind us and we move forward and we believe it to be in the best interest of all stakeholders. The settlement resulted in a charge of approximately $299 million to the provision for income taxes. We expect to make payments to the IRS of approximately $287 million during the third quarter of fiscal 2021 and associated state tax and interest payments of approximately $12 million throughout calendar year 2021. All details are included in our Form 10-Q filed today. Q2 GAAP net loss was $65.5 million compared to net income of $107.5 million in the prior year, primarily driven by the tax provision relating to the IRS Settlement. Year-to-date GAAP net income was $37.9 million compared to net income of $181.9 million in the prior year. Q2 adjusted net income was $260.5 million, up 14.8% or up 11.1% on a constant currency basis. Year-to-date adjusted net income was $502.3 million, up 25.4% or up 22% on a constant currency basis. Q2 GAAP loss per share diluted was $0.24 down from earnings per share diluted of $0.40. Year-to-date GAAP earnings per share diluted was $0.14, down from $0.67. Q2 non-GAAP earnings per share diluted was $0.95, up $0.11 from $0.84 and up $0.08 on a constant currency basis. Year-to-date non-GAAP earnings per share diluted was $1.84, up $0.36 from $1.48 and up $0.31 on a constant currency basis. Turning to margins. GAAP gross margin for the quarter was 70.5% up 60 basis points. Year-to-date GAAP gross margin of 69.8%, up 120 basis points. Non-GAAP gross margin for the quarter was 77.1% up 160 basis points. Year-to-date non-GAAP gross margin was 76.8% up 240 basis points. From GAAP gross margins by revenue type, please refer to our Q2 fiscal 2021 10-Q report as I mentioned filed today. Also on a non-GAAP basis for the quarter, cloud margin was 66.7% up from 58.4% given by the continued improvement in our cloud service delivery and a strong contribution from Carbonite. Year-to-date cloud margin was 66.9%, up from 57.8%. For the quarter and year-to-date customer support margin was 91.2%, up from 90.7% and reflected continued strong renewal performance. For the quarter, license margin was 96%, down from 97.8% primarily due to higher third-party technology costs; similar trends on a year-to-date basis as well. For the quarter, professional services margin was 27.5%, up from 23.5% reflecting benefits we see from lower travel while effectively delivering our solutions on a digital and remote basis. Year-to-date professional services margin was 28.4% up from 22.8%. Please note that our total operating expenses for Q2 include the restoration of compensation and benefits effective December 1, 2020 for all employees. Adjusted EBITDA was $360.8 million this quarter, up 13.8% or up 10.7% on a constant currency basis. This represents 42.2% margin, up from 41.1% in the same quarter last year. Year-to-date adjusted EBITDA was $703.1 million, up 23.1% or up 20.2% on a constant currency basis. This represents 42.4% margin up from 38.9% during the first six months of fiscal 2020. Turning to cash flow, which was consistent and solid performance, with operating cash flows of $282.5 million for the quarter, up 36.3% and free cash flows of $274.8 million up 46.5%. On a year-to-date basis, operating cash flows are $516.4 million, up 49.8% and free cash flows of $493.4 million, up 61%. DSO was 47 days compared to 57 days in Q2 fiscal 2020. The year-over-year reduction of 10 days reflects continuous measures to drive operational efficiency in our working capital framework, particularly the code to collections as well as positive contributions to the integration of Carbonite. From a balance sheet perspective, we ended the quarter with approximately $1.5 billion in cash, given our strong cash flow performance. With a $600 million revolver repayment in October 2020, we now have $750 million undrawn and fully available, bringing our total liquidity to $2.25 billion. Our consolidated net leverage ratio is 1.6 times, an improvement from 1.82 times last quarter. This is a strong place to be solid execution of the quarter and a balance sheet that positions us well to execute our total growth strategy. Now turning to quality factors, total growth strategy, and annual target model all available on our investor website. So first and foremost, let me reiterate that we do view our business as annual and quarters will vary. Long-term value is created from sustained annual performance, and 90-day cycles are way too short to measure. On quality factors, for the third quarter fiscal 2021 and compared to the same period of the prior year, we expect the following inclusive of effects: an FX tailwind of revenues of $10 million to $15 million. Total revenues constant, annual recurring revenue, ARR constant to slightly up, adjusted EBITDA margin percentage up 100 to 200 basis points. For our full year fiscal 2021 total growth strategy, our first half of the fiscal year performance has been strong, particularly in the context of the global pandemic, and we’re very pleased to increase our outlook for the remainder of the fiscal year. We now expect the following for our fiscal year 2021 compared to fiscal year 2020: high teens growth on cloud revenue compared to a previous target of mid double digit, low single digit growth and customer support revenue is consistent with our prior target. High single to low double digit growth and annual recurring revenue compared to a previous target of high single digit, no changes in license and professional services revenue targets, which we see declining, and this is consistent with broader industry trends as cloud adoption accelerates. Total revenue moves from constant to low single digits to mid single digit growth in fiscal 2021. New M&A opportunities will remain additive to our model. Our fiscal 2021 annual target model with included operating ranges remains unchanged. However, I will highlight a few important points. Annual recurring revenue, ARR range for fiscal 2021 is expected to be 81% to 83% compared to 78.2% in fiscal 2020. Non-GAAP gross margin range in fiscal 2021 expected at 74% to 76% compared to 74.5% in fiscal 2020. Adjusted EBITDA margin range for fiscal 2021 expected at 37% to 38% compared to 36.9% in fiscal 2020. On long-term aspirations, our long-term aspirations remain unchanged, targeting adjusted EBITDA margin of 38% to 40% and free cash flow of $900 million to $1 billion for fiscal 2023 with a plan to reinvest any margin gains above 40% into additional growth initiatives. In summary, well done to the OpenText team for delivering solid Q2 and leading the way in digital working. On January 2021, the OpenText team got forward, tremendous learning and resilience as we look ahead to the second half of our fiscal year, a very special thank you for your amazing efforts. I thank you to our shareholders, whose trust and confidence we greatly value. We look forward to engaging with all of you as part of our investor outreach and conferences, and of course, at our March 11 Investor Day. I wish you all continued safety and health. I would now like to open the call to questions. Operator?

Thank you. We will now begin the question-and-answer session. Our first question comes from Raimo Lenschow of Barclays. Please go ahead.

Hey, congrats from me on a great quarter. Mark, you talked a little bit about the recovery or the green shoots of recovery you see everywhere. And it’s great to see the guidance decrease now, it’s fully organic what we see for next quarter. If you think about the next few quarters looking out and the guidance you’ve given there. Is there kind of the new normal, it’s an element of recovery in there, so that’s better than normal? Like, how do we have to think about it? What you see in there. And then had one follow-up.

Yes, thank you for the question. Look, if I wind back to a year ago, our energy was very much focused on our preemptive sort of decisions that ultimately strengthened us through the year. But if I look at the year ahead, certainly for the remainder of the fiscal year, which is through end of June, we see those green shoots. I mean, there are four things that come to mind. The first is, modern work is really accelerating, content management, workflow, e-signature, projects in collaboration. Second is we see this rebound of our business network volumes and industries that are seeing an increase, healthcare, automotive, retail - a lot of green shoots there for us on the business network. Security has come front of mind post SolarWinds, and our ability to really provide data protection and the next generation of threat intelligence based on behaviors or signatures. And then, Raimo, you have all the – I think the secular things around movement to cloud and the need to have that trusted partner on a global basis. So we feel like very sustained trends coming into the calendar year and we’ve had four quarters of experience through the pandemic, and each quarter has been getting sequentially stronger. So that’s part of the reason for a bit more visibility into the fiscal year as we come into the second half, and I welcome your second question.

Yes. Okay, perfect. And then on the cloud, so we know you’re talking 21.2 and 21.4, some things really exciting when it comes out. What do you see in terms of customer interest in terms of how they’re kind of migrating over to the cloud? Is that – do you see like new workloads going into the clouds and the existing stuff is still kind of staying on premise? Do you see the migration starting? What’s the momentum that you’re seeing there? Thank you.

Yes. Thank you for that. Look, at Investor Day, I plan to go much deeper on the kind of the status of Cloud Edition. Let me just give you a few examples. I look at our content cloud and support for modern work, we have new workloads and expanding work with organizations like the NIH in the U.S. and European Central Bank on the experience cloud. We have a new customer like PG&E and expanded workloads for social commerce at L’Oréal. On the business network side, we’re very excited about – we’re all very focused on a pandemic and rightfully so, but the greater challenge is really the environment and the circular economy. So our work is supporting very demonstrable features to support that circular economy with customers like Nestlé. Our protection cloud is doing work with Thomson Reuters on our security and protection cloud, and I’m really excited about how the developer cloud, everything as a public API is going to contribute to organic growth in fiscal 2022. So it’s all about the Cloud Editions. I think it’s a mixture of taking off cloud, current workloads to a private managed service. It’s about adding new workloads and our SaaS offerings. It’s attracting new customers and also a new market of our API services. And I plan to go into a lot more detail at Investor Day.

Okay. I’m looking forward to that. Okay. Thank you.

Our next question comes from Stephanie Price of CIBC. Please go ahead.

Good afternoon.

Hi, Stephanie.

Hi. Let’s talk a little bit about which pieces of the cloud drove that outperformance versus prior expectations. Did you see kind of outsize growth in Carbonite or CE or business networks? How do we think about that outperformance of cloud this quarter?

Yes, I would point to three pieces. On the content side and the content cloud, again for the reasons I just previously talked about support for modern work. Second is the business network, and the increase in volumes and nice new green shoots in a variety of industries. And Carbonite overall just had a strong quarter from the data protection Carbonite side, Webroot, threat intelligence, as well as Bright Cloud. So those are the three standouts, Stephanie, I’d point to the content cloud, business network, and Carbonite in general.

Okay, that’s helpful. And within Carbonite, I’m kind of thinking about the upside opportunities here and the cross-selling into the enterprise and extension of the partner network. Just curious, where we are in those initiatives or if the performance in Carbonite was really more a function of just the existing prosumer, consumer market kind of driving those sales.

Yes, there are three drivers. The first is just better running the existing business and it is a unique go-to-market. And this is where we sell to, we enable, we deploy to RMM and MSPs. We don’t really – we of course, sell to some SMBs directly, but the vast majority of our business is through RMMs and MSP. And it’s a very unique channel. I know others are claiming they invented it, they did and that’s okay. But our business is through this unique channel. So one growth is just better managing that. Two is increased innovation. I’m very excited about 21.2 and an integrated console that delivers on the promise of integrating Carbonite and Webroot to move through that channel of our RMM and MSP. The third is uplifting kind of upselling, upscaling the product into the enterprise. And we started to see some green shoots there. I mentioned a few names TD Securities, Hyatt, Thomson Reuters, Prudential, who are using a mixture of Carbonite data protection or Bright Cloud. So those are the three approaches, Stephanie, that we’re looking to grow. It’s just better managing the platform to RMMs and MSPs. It’s accelerating innovation, things like CASB, things like an integrated console, next generation of threat intelligence continuing to focus on behaviors for signatures. And then what I call it, upscaling the product into the enterprise, and we’ve begun to see some green shoots on the enterprise customers I just mentioned.

Great. Thank you very much.

Our next question comes from Paul Steep of Scotia Capital. Please go ahead.

Great, thanks. Mark, maybe you could talk just following up on the content cloud driving growth. Can you give us a sense of what that multi-year migration cycle might look like? I know that might be taking some of the excitement from the March day, but in any context of where we are and then I have one quick follow-up.

Yes. My team strongly encouraged me to save the gunpowder for Investor Day, if you will. But let me say it this way, Paul. We are in literally the earliest of innings truly are. We’re less than 10% migrated of our installed base into our five clouds. So it is still the earliest of innings to have our installed base fully on the Cloud Edition architecture and platform. And it’s not just a lift and shift of the platform. We can manage it better. We can manage it at a lower price, but we want to bring them to a modern environment. We want to manage the application stack. We want to be able to expand workloads. We want to be able to bring them to all of information management. So I would just summarize that we’re in the literally earliest of innings, we’re less than 10% migrated on cloud. Look, Cloud Edition has only been in the market just a little over a year. So it remains the single largest opportunity we have to drive growth is to migrate our installed base.

Great. And then risk of wearing out my welcome here. How should we think about longer term as we sort of move over from cloud? How should we think about that license line or maybe how are you managing that transition to make customers more or less agnostic about the purchase decision? Thanks folks.

Yes. Thank you, Paul. I think you’ll notice, I didn’t use the word license at all in my script. And the emphasis is all on cloud. Let me point to a few things. The first is our annual recurring revenue, ARR with 80%. It’s all about our business, but when you benchmark us to Oracle, Microsoft, IBM, SAP, we are ahead of every one of those in terms of our transition to ARR. We’re at 80%. Our target model is 81% to 83% for the year, but you look at established companies like IBM, Microsoft, Oracle, and SAP, we’re ahead of every single one of them in where we are as ARR as a percent of our business. Second, I’d point to our support business, which is a support and update business, the ability to get security updates, the ability to get rapid new features that are relevant and easy to consume, that business grew 6% as we noted. So our strategy is let customers decide as customer choice of how they want to consume. I said this many years ago, I am agnostic as to how they want to consume. We are opinionated on growing our margin, as you can see through the years that we’re not agnostic there. And we’ve – we’re just going to grow cloud faster than everything else as you’re seeing. So customers still have the choice, it is clearly cloud first, ARR is leading and dominating, and we’re ahead of our peers, and we’re simply going to grow faster in cloud than in ARR versus that transactional side of the business.

That helps. Thank you.

Paul, if I can maybe before we get to the last question, I just – we don’t philosophically believe that we should force it, because it’s still customer choice. And some companies are forcing it, but they’re also in a lot lower ARR than we are. And so it’s really the ARR piece that is really a standout at 80%, not just at OpenText, but when measured to our peers.

That helps. Thank you.

Our next question comes from Thanos Moschopoulos of BMO Capital Markets. Please go ahead.

Hi, good afternoon. Hey Mark, how would you characterize customer buying behavior in terms of sales cycles, decision processes, and deal sizes? Is it starting to look a lot more similar to pre-pandemic or are we still kind of in a weird environment in that regard?

I would say it’s returning; it’s not fully back to pre-pandemic, but it’s a lot less uncertain and bureaucratic than it was maybe in the first half of last year. There is no doubt a greater emphasis, and I think this is new. So it’s not pre-pandemic or during pandemic. I just think this is new. It is an emphasis on time to value. That there’s an immediacy, there’s a time to value, and it’s also a look to global trusted partners versus – so less risk adverse. So it’s a good question. Deal sizes, I think are slightly up. I think decision cycles are slightly down or slightly shrunk. It’s – I wouldn’t say it’s fully back to pre-pandemic, but it’s more there than not, and time to value is certainly emphasized in the majority of our transactions today.

Great. And then a question for Madhu, as I look at your guidance and your target model for the year that would seem to imply a fair bit of gross margin compression in the second half in professional services and cloud. Maybe just to clarify, would that be a function of comps being a restorative part of levels and expectation of travel expenses going up for maybe just conservative minor parks?

Thank you for that. So definitely as Mark was alluding, we are investing in the second half and we’re investing not just in putting medic and come back, but also in terms of hires and building up for the next year. And from a gross margin perspective, that also includes investment cloud services and customer support as well.

Presumably maybe to improve the capacity, right? Would that be fair?

Yes, and that’d be fair as well.

Yes, okay. Thanks for that one.

Thank you.

Our next question comes from Richard Tse of National Bank Financial. Please go ahead.

Yes. Thank you. With respect to the shift to the cloud, I’m just kind of curious, is there an opportunity to kind of create a step function up in terms of organic growth? What’s that transition here?

Richard, thanks for the question. As we noted in our script, we had in the quarter, organic ARR growth on reported currency. And I expect to have organic growth in the cloud in the second half of the year. In terms of a step up, we will maybe talk more about what that means, but I’m expecting cloud to grow organically, just to say it directly based on the factors we talked about.

Okay. Yes, I’m just asking because it was sort of looking at Slides 21 and 24, where you highlight your customers and the number of products that they’re signed up for, and it seems like they’re signing up for more. And I guess the line of questioning was around as these platforms become more uniform, the ability to sell on that basis I would think should be easier, which is why I’m asking a question, but...

Yes. Yes, and look, if I cannot point to the principles I talked a little bit about, and they’re important principles behind Cloud Editions. I think that’s partly of what you’re noting that once my graded into the OpenText Cloud, we have the ability to deploy the features for customers and they don’t have that friction in the system, right. The more integrated we get again, the less friction to more modules and as we get to more standardized product, the ease of both consumption and new modules. So it’s no doubt that Cloud Editions and running the cloud is going to give us the opportunity, because of the integration to deploy more capabilities and to have customers be able to consume more.

Okay. That makes sense. With respect to the acquisitions, I know you talked about us are one part of your growth strategy. What does that environment look like today? And I guess related to that, are you looking to sort of fortify the markets that you’re currently in, or would you kind of look at it expanding into new marks sort of like what you did with Carbonite and security?

Yes. Well, let me take it as an opportunity, I’ll answer the question directly, but I’m going to take it as an opportunity to highlight how we believe we create value. Number one, these are co-number one, number one, organic growth. And that’s top of the list. And as we look into the remainder of the second half of the fiscal year and the calendar year, we’re clearly emphasizing organic growth today and also the step up in our outlook. Second way – number two of number one is margin. And we’ve just been on a stellar track to continue to become more efficient, more productive as a company. And the third way, the third number one is capital, capital deployment and capital efficiency. We’re very focused on the capital we’ve deployed. Getting full value for Carbonite, getting full value for Liaison, Documentum wasn’t that long ago. And the Documentum puts us right in the middle of modern work for a lot of companies. And then there’s new capital deployment. On new capital deployment, which was I think part of the basis of your question is we’re going to remain a value buyer. We have the management and leadership bandwidth. We have a net debt ratio of 1.6 approaching sort of recent lows, if you will. And I’m very happy with the markets we’re in today. So I’m not looking to create a new market, Richard, but rather kind of gaining share in what we have.

Okay. And just one last one related to acquisitions, is your comfort level on leverage ratio? I think it was in the mid-3s if I don’t like, as I recall, but I’m not sure what it is today. Is it still around there?

Our net leverage ratio is 1.6 today. And as we’ve noted, we’ve chronicled historically that would be comfortable. Ideally, we’re at three, but we’ll go above three if we need to and then rapidly decrease that. And I’ll point again to Carbonite as well as Documentum where we rapidly deleveraged like we – three is where it’s just, I think of it simply that if the world goes really bad like they’re drop more than three years. That’s why – that’s what I thought of a 3x ratio, relatively conservative ratio. Our covenants allow us to go higher than that, but we like operating around three, we’re well below it. And if we need to go above three, we won’t be bashful or the right asset. But it will come with a rapid deleverage plan. And as we’ve demonstrated, we can do it and have done it with Carbonite and Documentum.

Okay. That was great. Thanks, Mark.

Our next question comes from Paul Treiber of RBC Capital Markets. Please go ahead.

Thanks very much, and good afternoon. Just want to hone into one product area in particular, which is e-signature, it seems like that is probably one of the products that would see some strong adoption in this environment. How do you see within the large enterprise deals, is it bundled in there or can you sell it as an incremental product offering? And the reason I bring it up with some of your competitors are doing quite well selling signatures, digital signatures? Should we expect similar growth, are you seeing similar growth with your own product there?

Yes. Paul, thank you for the question. We’re excited about it, and we sell it independently. We bought the source code to a company about a year ago, and we created a product about a year and a half ago, created a product and a service. And it’s now fully integrated into content services, and it’s now a standalone product. So we’re – we expect it is contributing, and we’re fully able to sell it as an independent module. And it is an important part of modern work, part of workflow, part of collaboration, project management, and ultimately signatures. I’ll highlight one customer fully live. We’re doing tens of thousands of signatures a month, the government of Ontario, and they are fully live on our e-signature product.

And you initially said the e-signatures, but with the market e-signature at least, it seems like a lot of the growth is coming from SMB. And it seems like there are other product categories. You look at like file sharing or whatnot where the growth has been driven by SMBs with the launch of your 21.4 products in the multi-tenant side into the cloud. Does that potentially open you up – open up in terms of going direct in terms of addressing the SMB market?

We still have – with all our progress, we still have much to learn. We bring e-signature to the enterprise. We’re – we haven’t brought e-signature to SMB. So our e-signature success is through our enterprise sales force. And this is one of the reasons we really love Carbonite, because we see a lot of these solutions that are built to scale up into the enterprise and scale laterally into SMB. And this part of our great long-term growth prospect is to be able to get that multi-channel way to market really humming. So we now have our product like e-signature for the enterprise, but we haven’t brought it into the SMB world yet. So I mean I appreciate your comment, but it just highlights why we brought on Carbonite and the opportunity for many of our key solutions. And it’s one of the things that as part of our strategic direction is able to bring product simultaneously to the enterprise and SMB. We have a lot of learning to do there and lots of opportunity.

Okay. Thanks for taking my questions.

This concludes the question-and-answer session. I will now hand the call back over to Mr. Barrenechea for closing remarks.

All right. Well, thank you very much. We’re obviously very excited about Q2 and playing offense and our improved outlook for fiscal 2021. I hope you’ll – well, we hope to see everyone at our virtual Investor Day on March 11. Please register on our website or contact Investor Relations. The team is very excited to spend time with you to talk to provide updates on our strategic progress and our future direction. Thank you for joining us today.

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