Earnings Call Transcript - OTEX Q2 2024

Operator, Operator

Thank you for waiting. This is the conference operator. Welcome to the OpenText Corporation's Second Quarter Fiscal 2024 Financial Results Conference Call. All participants are in listen-only mode and the conference is being recorded. There will be an opportunity to ask questions after the presentation. I would like to turn the conference over to Harry Blount, Senior Vice President, Investor Relations. Please proceed.

Harry Blount, Senior Vice President, Investor Relations

Good afternoon, everyone, and welcome to OpenText's second quarter fiscal 2024 earnings call. With me on the call today are OpenText's Chief Executive Officer and Chief Technology Officer, Mark J. Barrenechea; our Executive Vice President and Chief Financial Officer, 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, investors.opentext.com. I'm pleased to inform you that OpenText management will be participating at the following upcoming conferences: Bernstein's Tech Media and Telecom One-on-One Forum on February 28 in New York; Morgan Stanley's Technology Media and Telecom Conference on March 4 in San Francisco; and JMP Security's Technology Conference on March 5 in San Francisco. And now on to 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 any conclusion, forecast or projection in the forward-looking statements made today. Certain material factors and assumptions were applied in drawing any such statements. Additional information about the material factors that could cause actual results to differ materially from any conclusion, forecast or projection in the forward-looking information, as well as risk factors that may project 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 directly comparable GAAP measures may be found within our public filings and other materials, which are available on our website. And with that, I’m very pleased to hand the call over to Mark.

Mark Barrenechea, CEO

Thank you, Harry. And thank you to everyone joining today's call. Welcome to calendar 2024 and the second half of our fiscal year. OpenText is more relevant than ever as we enter the new era of business AI. We have significant momentum as we transform into a cloud growth company, as we expand our mission in information management, and as we accelerate private and public cloud consumption. Artificial general intelligence is a once in a generational opportunity, and OpenText is in a very strong position to lead the way in information management. We continue to accelerate our investments in product, services, and go-to-market, and we are seeing the results. Q2 was a spectacular quarter and showcases our strategy and performance progress with the following: record revenues of $1.3 billion or 71% year-over-year growth; strong organic growth, our 12 consecutive quarter of ARR growth in constant currency; record enterprise cloud bookings of $236 million or 63% year-over-year growth; and we're just getting started. We are winning with cloud additions, our business clouds, and we are winning with data security and trust requirements, SaaS and Micro Focus just coming online, as well as Business AI with OpenText Aviators. We had record adjusted EBITDA of $566 million, or 37%, and 66% year-over-year growth, and strong free cash flows of $305 million or 87% year-over-year growth. I'm so proud of our colleagues and partners. And this great success is enabled and powered by our innovation investments, strong customer momentum, and operational excellence. Let me highlight a few amazing customer partnerships. Carl Zeiss is leveraging the OpenText content cloud for a global information management platform and a single source of truth across the entire company, integrating business applications from SAP, Salesforce, and Microsoft into the OpenText cloud. Philips Healthcare is leveraging our OpenText Aviator platform, Vertica, for its mission-critical medical imaging system for high availability and proactive field maintenance to ensure patients receive optimal clinical performance. BMW has selected the OpenText cybersecurity cloud, Fusion, for what is called root of trust information management and data governance. FedEx Express, the world's largest cargo airline, has been a strategic partner with OpenText for over a decade and that partnership expands now by leveraging the OpenText IT operations Cloud, or OpsBridge monitoring and autonomically responding to a very dynamic topology, ensuring the highest possible flexibility and resiliency and support of their mission. We had 48 cloud wins over 1 million in new contract value in Q2, with many impressive customer stories just like these. Today marks our first full-year of owning Microfocus. Our focus is on cloud growth, AI, customer success, and being number one in information management. Micro Focus contributed revenues of $601 million in Q2, and we should end the fiscal year with renewal rates in the high-80s. The amazing work from our colleagues and partners and with the trust of our customers, we have reshaped a shrinking business into a winning and growing innovator. We're doing exactly what we said we would do. Further, we're on track to complete the AMC divestiture by the end of the fiscal year, subject to standard regulatory approvals and customary closing conditions, which will allow us to go even faster in AI in the cloud. We intend to use the proceeds to reduce net leverage to less than 3 times and ahead of schedule, providing us the flexibility to resume share buybacks and pursue strategic M&A and to drive future cloud and AR organic growth. We have all the ingredients we need for a fantastic 2024 and to achieve our F26 aspirations of 7% to 9% cloud organic revenue growth. With our strong cloud bookings growth of 63% this quarter, your visibility into our cloud growth increases. As a reminder, and as we like to say, we're an annual business. So let me turn to our fiscal ‘24 outlook. We're maintaining a total cloud revenue outlook of $5.85 billion to $5.95 billion. We are raising our cloud bookings growth target to 25% to 30% growth, up from 15% plus. We're within our adjusted EBITDA range, but tightening it to 36% to 37%, given our investments in cloud and security and AI. We have both medium and long-term opportunities to increase margin. But right now, our focus is driving bookings and cloud revenue growth. We're also raising the lower end of our free cash flow range. We now expect stronger full-year results of between $825 million to $900 million of free cash flow. With our workforce optimization complete and the majority of the Micro Focus restructuring complete, our attention and energy are now focused on customer transformation, innovation, and growth. Information automation plus AI will be an essential part of our competitive advantage. OpenText will completely embed AI in all our products. I've received very positive customer feedback on our Information Management Business Cloud, AKA Cloud Edition, and our Business AI, AKA Aviators. We're working with a major apparel company to apply AI's invoices, a major bank to detect fraud, a major manufacturer for complex compliance, and a major food company to consolidate billions of supply chain transactions and documents to create the next generation of sustainable foods. We are making strong and steady AI progress. We are differentiated in the market and we are winning business. Our differentiated advantages include managing active and large data sets. We believe in integrating automation and AI together, protecting data privacy, security and trust, focusing on AI assist and personas, and being cost reasonable. We are clearly progressing from discussion to delivery and from vision to value. Aviators 23.4 and 24.1 are delivered and soon 24.2. We have 800 engineers working on AI, and we're delivering new capabilities now every 90 days. We have numerous customers in our Earn Your Wings program, and our bookings growth is benefiting from customers consolidating and preparing for AI. We built a powerhouse services organization, and we're ready to engage with customers for our talent to help them do AI transformations. Furthermore, we're focused on enabling our engineers to go even faster with business AI. I'm announcing today that we've begun a significant internal AI transformation in how our engineers create OpenText software. We're creating a new platform called Platform Athena that will be our trusted platform to generate software and assist our engineers in creating our products. Athena will significantly accelerate our innovation, accelerate time to market, attract the next generation of talent, and raise our productivity and efficiency. Our first Athena-generated products are expected to be in the market with Cloud Editions 25.2, and we'll keep you updated along the way. Our Q2 results tell our story. Now let me conclude with saying how excited I am about the second half of the fiscal year for our momentum in information management, cloud, AI, and information security and trust. There's so much runway ahead for OpenText for growth. Our investments are the fuel for that momentum. Our operational experience will help us realize higher profits and cash flows from those higher revenues, and our accelerated path to under 3 times leverage will create stronger capital allocation and capital return opportunities. The OpenText Cloud is an information cloud and great information management is a key ingredient to business AI. Trust is an essential element in automation and AI, and we're earning our customers' trust every day. This is why we were the first Canadian company to join Canada's voluntary code of conduct on the responsible development and management of advanced generative AI systems. As I said last year, and you heard it here first, our customer's data is not our product. A big thank you to my OpenText colleagues, customers, and partners for this momentum. I also want to thank our shareholders for their support of the Micro Focus acquisition. It is your capital, and we manage that responsibility with the utmost care, and we are doing exactly what we said we would do, provide growth, cash flows, and returns. Our top core value at OpenText is deserving of trust and we look forward to your feedback and continued support. May the one that brings peace bring peace for all. Let me turn the call over to Madhu.

Madhu Ranganathan, CFO

Thank you, Mark, and thank you all for joining us today. So let me start with a few key points. In Q2, OpenText executed extremely well, with record Q2 revenues and cloud bookings at an all-time high. We have built an operations practice that strategically supports the foundation of a solid growing enterprise cloud business. During Q2, we also completed successfully our one-year commitments and delivery on Micro Focus to drive a creative integration. One-year anniversary of Micro Focus is today. Our outlook fully reflects the opportunity in front of OpenText and the rapid progress we have made in growing Micro Focus revenue, profitability, and free cash flows. Mark spoke to our Q2 results and let me share additional comments. Starting on page 23 of the investor presentation posted on our IR website for the slides titled Q2 fiscal ‘24 and trailing-12 months financial highlights, 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, with Q2 cloud revenue of $450 million, up 10.1% and 9.2% in constant currency. Q2 ARR, annual recurring revenue of $1.15 billion, up 58% and 55.6% in constant currency, that represents approximately 75% of total revenue. This was our 11th consecutive quarter of enterprise cloud organic growth in constant currency and our 12th consecutive quarter of constant currency organic growth in ARR. Our license increased 168% year-over-year as reported and 163% in constant currency, which reflects the incremental contribution from Micro Focus and an increase in the number of large deals and the granting of certain IP rights. Let me comment on the large deals. For cloud, we closed 48 deals greater than $1 million in the quarter versus 23 in the earlier period. For license, we closed 35 contracts greater than $1 million in the quarter versus 15 in the year earlier. The deal sizes reflect the strategic importance of OpenText and cloud booking strength as our customers prepare for AR. Moving to other financial metrics, GAAP net income of $38 million, primarily reflecting the increasing interest expense, amortization, and special charges related to the acquisition of Micro Focus, driving GAAP EPS of $0.14. GAAP gross margin of 73.6%, up from 70.8%, reflecting increased relative revenue contribution from a licensed business. Non-GAAP gross margin of 78.6%, up from 76%, also reflecting increased relative revenue contribution from licenses. Adjusted EBITDA of $566 million, an increase of 66.1% year-over-year and 61.2% in constant currency. Our adjusted EBITDA margin was 36.9%. As I mentioned earlier, we expect Micro Focus to be on our adjusted EBITDA model by the end of the fiscal year. Adjusted EPS of $1.24 continues to reflect this progress. Our DSOs are 47 days, flat from Q2 of the prior year, and reflecting higher seasonal billings and consistent with our expectations. Our overall working capital performance remains strong, and Micro Focus continues to systematically perform higher on all working capital metrics. We generated a stellar $350.7 million in operating cash flows and $305.4 million in free cash flows during the quarter. Turning to the balance sheet, please see page 25 of the investor presentation. We finished Q2 with $1 billion in cash. Our net leverage ratio was, as expected, at 3.7 times for Q2. After the quarter closed, we made an additional January repayment of $175 million on our acquisition term loan. After this payment, our principal outstanding debt is $8.5 billion. On Micro Focus Integration, please refer to page 34 of our investor presentation, where we're delighted to share that OpenText is on or ahead of plan on every commitment relating to Micro Focus integration. I'm highlighting a few; accelerate Micro Focus cloud growth, which includes product and sales investment, as we saw strong cloud results in Q2; and return Micro Focus to organic growth. Another strong quarter with $601 million of revenues allowed us to return to organic growth in fiscal ’24; improving Micro Focus renewals is a key milestone for organic growth that is on track for a high-80s renewal rate in fiscal ’24. Lastly, Micro Focus will be on an operating model for both adjusted EBITDA and free cash flows during fiscal ’24, making significant contributions. On page 35 of our investor presentation, we are providing a final one-year anniversary update to the financial integration framework. We have now actioned $370 million of our $400 million targeted savings initiatives. We're increasing our restructuring advisory and facility expense special charges by $20 million, but reducing expected technology, tax, and legal entity simplification costs by $100 million for a net reduction of $80 million. When combined with expected reduction in interest expense following the AMC divestiture, there is increased visibility on the improvement in free cash flow we expect to see between now and our fiscal ‘26 aspirations. Regarding the AMC update, let me spend a moment on application modernization and connectivity (AMC). The business continues to perform well and we're on track for a successful close in Q4 to divest AMC to Rocket Software. The net proceeds will reduce debt for a consolidated net leverage ratio of less than 3 times within 90 days of closing. Our dividend program, on February 1, our Board of Directors approved a quarterly cash dividend of $0.25 per common share. The record date for the next quarterly dividend is March 1, 2024, and the payment date is March 20, 2024. Let me turn to our targets and aspirations, starting with our Q3 fiscal ‘24 quarterly factors on page 32 of our investor presentation. On a year-over-year basis, we expect revenue of $1.4 billion to $1.45 billion; ARR, annual recurring revenue of $1.13 billion to $1.16 billion. We expect FX to be constant. Adjusted EBITDA year-over-year margin between 32% and 33%, reflecting Micro Focus integration cost, and FX adjusted EBITDA is also expected to be constant. Our fiscal ‘24 targets and constant currency are provided on page 33 of our investor relations presentation. As I build on Mark’s comments, I will also provide updates to the target model ranges to fully reflect our successful one-year integration of Micro Focus. Our cloud revenue is expected to be up 6% to 8%. Customer support revenues are up 43% to 45% year-over-year, compared to our prior range of up 40% to 42%. ARR is expected to go up 25% to 27% compared to our prior range of up 24% to 26%. Our license revenue is expected to increase by 68% to 70%, compared to our prior range of up 71% to 73%. Professional services revenue is expected to be up 26% to 28%, compared to our prior range of about 29% to 31%. Total revenue growth is projected to be over 30% with organic growth in the range of 1% to 2%. Total operating expenses are expected to be 42% to 44% of revenues. The non-GAAP gross margin range is expected to be 77% to 79%. We are tightening our adjusted EBITDA margin range to 36% to 37%, which reflects higher investments in AI and cloud, sales and marketing, and expenses related to the AMC divestiture and Micro Focus integration expenses. At current exchange rates, we expect FX to provide a $20 million to $40 million tailwind. Net interest expense for the year is expected to be $550 million to $570 million, and the non-GAAP effective tax rate of 14%. As noted earlier, our enterprise cloud business is performing exceptionally well with solid revenue growth and 63% year-over-year bookings growth in the quarter, increasing our visibility. We are a key Microsoft partner, and as noted in their recent call, the SMB market is facing short-term challenges. This impacts our SMB business. However, we remain in a great position to continue to add products for the SMB business and benefit as the environment improves. Regarding free cash flows, we expect free cash flow to grow year-over-year in both the third and fourth quarters. We're raising the lower end of our FCF range and now expect stronger full-year results of between $825 million to $900 million. Our fiscal ‘26 aspirations are included on page 36 of the investor presentation and remain unchanged from our materials shared with you on November 28 when we announced the AMC divestiture. Our fiscal ‘26 aspirations show the highly predictable and growing business at scale led by cloud and ARR. In summary, our OpenText team members have proudly delivered a solid Q2 and a strong first half of the fiscal year, and we remain on track to meet our fiscal ‘24 targets and fiscal ‘26 aspirations. The Micro Focus integration is ahead of our commitments, and we expect important milestones in fiscal ‘24: a return to organic growth, renewal rates in the high-80s, and the Micro Focus business to be on OpenText operating models for adjusted EBITDA and free cash flows. The AMC divestiture reinforces and sharpens our focus, capital allocation, and over time will allow for more resources to drive more growth. On behalf of OpenText, I would like to thank our shareholders, loyal customers, and partners. I will now request the operator to open the call for your questions.

Operator, Operator

Thank you. We'll now begin the question-and-answer session. Our first question is from Richard Tse with National Bank Financial. Please go ahead.

Richard Tse, Analyst

Yes, thank you. Madhu, you talked about the SMB market. I'm not sure if this is for Mark or Madhu, but I'm wondering if you could sort of expand that and talk more broadly about the enterprise spending environment? It seems there's been some mixed messages out there as to whether it's kind of gone back to a normal pace or not?

Mark Barrenechea, CEO

Yes, Richard, thanks for the question. Let me address part of that. The small and medium-sized business sector is a significant component of the U.S. economy, totaling $370 billion in spending for companies with 1,000 employees or fewer. We believe information management is highly relevant for this market. Microsoft is a crucial partner in this area. While they recently mentioned some short-term challenges in the SMB market, they also affirmed their long-term strategic potential for growth in this sector. Therefore, I think we are well-positioned to benefit from SMB in both the medium and long term, which will significantly contribute to our organic cloud growth targets of 7% to 9%. Regarding the macroeconomic environment, I’ll touch on what I mentioned earlier to Madhu. We're seeing strong customer demand as clients seek to move away from competitors who are not adequately transitioning to the cloud, lack data security or trust platforms, and have weak AI strategies and limited capabilities. We are currently in a favorable position. Approximately 60% of our business is in North America, covering the public sector, energy, financial services, and manufacturing; we're also supporting consumer packaged goods, apparel, and retail. We have excellent ecosystem partnerships with Microsoft, SAP, Google, and Salesforce. Thus, we are well-positioned at this moment, and it is essential to deliver value to our customers. We perceive a stable economy that allows us to execute our plans effectively.

Madhu Ranganathan, CFO

Yes, thank you, Mark. And Richard, I just wanted to highlight, specific to fiscal ‘24, again, you saw the enterprise cloud bookings growth rate of 63%. We're also increasing the outlook for the year. For cloud revenues in fiscal ‘24, content revenue, analytics revenue, experience revenue, and business network are all doing very well. But we did want to call out the SMB as you look at the Q3 and the fiscal ‘24 targets for cloud revenue, per se.

Richard Tse, Analyst

Okay, great. I just have a question on Aviator. No doubt that's probably one of your more exciting products right now. I don't know if it's too early still, but do you have any sense at this point in time what a reasonable attach rate would be within your existing customer base and that sort of potential incremental revenue opportunity? And I guess on the same note, I think you had some sort of, I forgot what it was called, a trial at your annual user conference. I'm wondering if you could share any stats in terms of the uptake on that trial?

Mark Barrenechea, CEO

Yes, sure, thanks. Thank you again, Richard. We're making strong and steady progress. And I'll just start with what differentiates us in the market. We have one business. Now, we're differentiated, as I noted in my prepared remarks, on the data sets that our automation creates and we manage. We believe that our business cloud automation and AI are integrated. I also said in my prepared remarks, we are embedding AI everywhere. It will be a capability; AI will live right next to automation in the long term. You'll have your automation screen, but you'll have your AI assist right next to it. My best way to describe it is we're moving from vision to showing value and from discussion to delivery. We have numerous customers today in our Earn Your Wings program. I discussed a few in food, in apparel, and manufacturing. If you look at our bookings growth of 63% year-over-year growth, we have AI wins in that. Note that we raised our outlook on our bookings growth from 15% to 25% to 30%. We're doing this the OpenText way. It is a strong vision backed up by product. We're delivering every 90 days. We're making progress from that vision to showing value. We've now achieved a fantastic bookings quarter and raised our outlook for the year on bookings. We're moving to the next step, creating really a breakthrough idea on platform Athena on how we're going to transform how we write our software using our own platform. So I'm pleased with our progress. We're going to keep making progress every 90 days. I strongly believe that your visibility into our 7% to 9% cloud organic revenue growth significantly increases with this strong bookings outlook.

Richard Tse, Analyst

Okay, thank you, I'll pass the line.

Madhu Ranganathan, CFO

Thank you.

Operator, Operator

The next question is from Daniel Chan with TB Cowen. Please go ahead.

Daniel Chan, Analyst

Hi, thanks. Casual conversion really took a step up in the quarter. Q2 seems to be seemingly stronger for conversion anyway, but considering the ongoing integration, this seemed pretty good. Is there anything to call out on that performance and should we expect that to continue?

Madhu Ranganathan, CFO

Yes. Thank you, Dan. So what I would say is that, as I've shared before, the OpenText cash conversion has remained very steady and strong. Keep in mind they had different year ends and different quarters, and we're actually very delighted with how we were able to converge their operating performance to our quarters, etc. Do we expect it to continue? Yes, we absolutely expect it to continue.

Daniel Chan, Analyst

Thanks, Madhu. And then on the EBITDA margin guidance for the full year, you've tightened it up. But it looks like next quarter, you're going down to about 32% to 33%. Just wondering what's driving that?

Madhu Ranganathan, CFO

Yes, so if you recall, Q3 for us is usually a seasonally lower EBITDA quarter. There are big factors for the remainder of the year, as Mark and I both called out, that includes investment in AI and cloud, given the strong bookings we see, and we do have some AMC divestiture expenses, as well as some Micro Focus integration expenses. But Q3, if I could just highlight, from an employee perspective, it's the start of a new year, and we often see higher benefits costs and higher vacation expenses, etc. So that is more seasonal to Q2, which also weighs down the EBITDA margin. Q4 will be a seasonally strong quarter.

Mark Barrenechea, CEO

And Dan, I think it's fair to say, as Madhu noted, that Q3 is a seasonally low quarter and Q4 is a seasonally stronger quarter.

Daniel Chan, Analyst

Okay, I appreciate that. The investments that you're making into cloud AI, where are the areas of focus for this added investment? Thank you.

Mark Barrenechea, CEO

Yes, thank you, Dan. Well, you noted some of them. We continue to build out our private cloud infrastructure, particularly around industry compliance, data security, trust, and privacy. It's an investment in our SaaS offerings. As we talk about how to unlock our future value, we have established our private cloud platform as a standard globally. The next step is more public cloud consumption across our products, and, of course, Aviator, our AI. Those are the areas where we're applying that investment. We're doing that within the range we talked about at the beginning of the year, even though we tightened it a little bit, we're still within the range we presented.

Daniel Chan, Analyst

Sounds good, thank you.

Madhu Ranganathan, CFO

Thank you.

Operator, Operator

The next question is from Steve Enders with Citi. Please go ahead.

Steve Enders, Analyst

Sure. Thanks for taking the question here. Maybe to start on the cloud booking experience in the core, I mean, pretty impressive results there. What in particular drove the upside there? Was it customers converting over, new use cases, how big of a contributor was this AI? Secondly, do you think about the growth outlook and cloud bookings for the year, what kind of AI contribution are you embedding in that?

Mark Barrenechea, CEO

Steve, thanks for that question. As I said in my prepared remarks on the cloud side, clearly a very strong quarter, 63% year-over-year growth. With our forward visibility, we see continued strength, and we raised our outlook from 15% cloud bookings growth to 25% to 30% cloud bookings growth for the year. What's driving that? First, we see a lot of customers continuing to move to our cloud and consolidating away from competitors who can't get to the cloud, can't provide the data security and trust, don't have a credible AI vision, let alone first products in the market. The continuous strength of our private cloud, customers consolidating, compliance, data security, trust, privacy remain top of the list for the global 10,000, that's the driver for us. AI has been a contributor to our 63% cloud bookings growth, and it was a factor in us raising our growth outlook for the year.

Steve Enders, Analyst

Okay, that's helpful. Maybe taking some of the puts and takes of the growth outlook. It's good to see customer support step up, but I'm looking for a little more color on the license stepping down a bit and professional services revenue stepping down from the expectations from last quarter.

Madhu Ranganathan, CFO

Yes, so Steve, I'll take that. License in the quarter actually was significantly higher from a year-over-year basis. The contribution there really is bringing Micro Focus into the play. Micro Focus cloud momentum is strong, but they're still smaller with respect to bookings and revenue compared to OpenText. PS revenues also grew in the quarter comparatively. I want to ensure I understood your question right—both license and PS did grow in the quarter.

Steve Enders, Analyst

Yes, I just wanted to clarify on the outlook. I think you said that both of those were down from the prior expectations from last quarter. So, I'm trying to understand what led to those changes in the annual outlook.

Madhu Ranganathan, CFO

Sure, I missed that part in your earlier comment. The adjustment of the ranges reflects the strength of Micro Focus from a customer support perspective; we've adjusted that to the range. The overall fiscal ‘24 target remains focused on license, incorporating Q3 seasonality. It's really the seasonal nature and the better renewals for Micro Focus customer support that we wanted to expand. I shared the number of over a million dollar deals in both the cloud and license side, and both remain strong.

Steve Enders, Analyst

Okay, perfect. Thanks for taking the questions.

Madhu Ranganathan, CFO

Sure. Thank you.

Operator, Operator

The next question is from Kevin Krishnaratne with Scotiabank. Please go ahead.

Kevin Krishnaratne, Analyst

Hey there just a couple of clarifications for me. So just on the cloud growth of 6% to 8%, that was maintained. I just want to confirm, is it just the fact that you've had strong enterprise bookings, but those are offset from SMB? Is that the reason why that range was maintained?

Madhu Ranganathan, CFO

Yes, I'll take it first and turn it over to Mark. Thanks for the question. Think about the cloud bookings as Mark mentioned, really increasing our visibility to the future, which would be fiscal ‘25 and fiscal ‘26. Our cloud contracts are long, and we talked about that before. The time to deployment and revenue realization can take longer. We're delighted at the performance this quarter, giving us that future forward visibility. For fiscal ‘24, we're keeping it at 6% to 8%, and within that, enterprise cloud revenue, analytics experience, DN, are all doing well. The SMB aspect is weighing it down a bit, so we want to balance that and keep the revenues at 6%, to 8%. That revenue is benefiting from our cloud bookings from our prior quarters and the cloud renewal rates.

Kevin Krishnaratne, Analyst

Got it, thanks for that. Just a final other question here, just on the bookings—sometimes you've announced the bookings, and there can be a little delay in the translation to revenue. Do the AI-related bookings look any different? Will they translate to revenue at a faster pace, considering the strong demand your customers are seeing for the AI products?

Mark Barrenechea, CEO

Yes, Kevin, thanks for that question. No, the bookings related to AI are following the same characteristics as enterprise bookings. In the SMB space, we tend to see one-year contracts. In the enterprise space, we tend to see two to four-year contracts. So AI is following that enterprise pattern. We do notice that bookings number will have a clear positive impact in ‘25 and ‘26. Right now, it looks like our AI wins will follow our traditional enterprise pattern.

Kevin Krishnaratne, Analyst

Got it. Great, thanks for that.

Madhu Ranganathan, CFO

Thank you.

Operator, Operator

The next question is from Adhir Kadve with Eight Capital. Please go ahead.

Adhir Kadve, Analyst

Hi, good afternoon guys, thanks for taking my questions. I wanted to talk about, you know, last quarter you saw some initial bookings in AI, this quarter you called out some strengths there as well? I just want to ask how have customers really progressed in AI? Mark, you kind of mentioned that a lot of customers are still dipping their feet in the Get Your Wings program, but are some of those early customers progressing faster to more large-scale deployments or are they still in the Get Your Wings program, getting their feet wet type of deployment phase?

Mark Barrenechea, CEO

Yes, Adhir. Thanks for the question. It's progressing, and a couple of why statements here. We're embedding AI in all our products. It’s clear that there's a path where you have your automation and the learning from data. Our approach is to provide AI assistance. If we automate a healthcare professional, there should be an AI persona right next to that. We automate a tech support specialist; there should be an AI assist next to it. We automate a contract specialist or a loan specialist, there should be an AI assist next to it. We're embedding AI everywhere. It's in every single discussion. So it is certainly separating out in the market those competitors who have not necessarily even moved to the cloud. We're making steady progress. We've gone from a vision to a first set of beta products, to our first version, through our first delivery. We have our first customers using and realizing value. I'm pleased with our progress.

Adhir Kadve, Analyst

Excellent. Just one more thing. You mentioned that customers are getting value. What are some early learnings from that value that customers are seeing? How is it helping their organization using these AI products?

Mark Barrenechea, CEO

Yes, I've given a few shout-outs in the script. One is particularly using our business network invoicing transactions and some of the wider network metadata to understand the next generation of food and sustainability, going deep into contracts and understanding revenue opportunities and liabilities. Some of the early learnings are, one, you have to prepare, and you may need to consolidate systems. Preparation is crucial. Customers know what they want to do, and there's not a lot of vagueness out there. Second, do not separate your automation and your AI; taking data out of your automation can lead to complications. Customers are looking for cost-effective solutions, and more open-source language models are becoming available; they also want to be reasonable about costs. This will continue to enhance OpenText.

Adhir Kadve, Analyst

Excellent, thanks a lot. I'll pass it on.

Operator, Operator

The next question is from Thanos Moschopoulos with BMO Capital Markets. Please go ahead.

Thanos Moschopoulos, Analyst

Hi, good afternoon. Regarding the AMC business, are you seeing any kind of impact in that business stemming from the fact that you've publicly announced your plans to dispose of it, or are you seeing no impact in that regard?

Mark Barrenechea, CEO

Yes, Thanos, thanks for the question. No, it's steady as we go. These are products and customers who have benefited from decades of investment and understand the long-term nature of the platform, so it's steady as we go.

Thanos Moschopoulos, Analyst

Great, and going back to the slightly more conservative license outlook. License can be more volatile—hard to forecast, but is there anything else you would point to? Is it customers preferring a cloud deployment model to a greater extent than you were initially expecting?

Madhu Ranganathan, CFO

I'll take the first part, Thanos. Again, on the license, Q3 has been seasonally lower from a licensed standpoint, and that pattern also applies to Micro Focus in the licensed business. Micro Focus is doing very well, and we expect them to return to organic growth this year. So that’s part of the Q3 seasonality that we're highlighting. The renewals we see for Micro Focus support this trend.

Mark Barrenechea, CEO

Yes, license has an important role. We work in very secure, regulated environments that require compliance. We want a fantastic nuclear platform that requires licensing in a private cloud. Many customers' security needs mandate licensing as well. The role is clearer today than it was five years ago, and it fits well within our hybrid cloud strategy.

Thanos Moschopoulos, Analyst

Thanks.

Operator, Operator

The next question is from Raimo Lenschow with Barclays. Please go ahead.

Unidentified Analyst, Analyst

Great, thank you. This is Jeremy on Raimo. Can you speak a bit to which areas of the Micro Focus business are seeing most interest at the moment, whether it be idle, Vertica, or maybe some of the security products? Thank you.

Mark Barrenechea, CEO

Yes, we’re happy to. Thank you, Jeremy. It’s been a great year one, and we're on to year two with the first-year anniversary today. If you'll allow me a moment, we have reshaped a shrinking business into an innovative, growing one. It was a fantastic first year. Thank you all for your support. In terms of innovation and growth, I want to provide a few shout-outs. Our IT operations management (ITOM) is all about the next generation of products around observability and extending service management outside of the IT environment to corporate-wide service management. That’s our priority. In terms of security, it’s about integrating SaaS, identity management, and edge computing. It’s about Application Development Management (ADM) and having a complete lifecycle. Our platform, Athena, includes many components from ADM, bringing AI—our business AI and Aviators—into the developer experience. We introduced a new IoT platform based on core Vertica, and several new GPAC modules available on our website. We're excited to bring higher scale machine transaction data into our information cloud. All things cloud, private cloud, SaaS, and AI are embedded across ITOM, security, ADM, and IoT. I noted in my comments earlier that our cloud bookings have increased by 63%, and we raised our outlook for the year to 25% to 30% cloud bookings growth. Micro Focus cloud bookings contributed to the 63% growth as well and will contribute more over time.

Unidentified Analyst, Analyst

Got it. Thank you.

Mark Barrenechea, CEO

Just to clarify, I did not announce our acquisition of Microsoft today, so just to be clear.

Operator, Operator

The next question is from Stephanie Price with CIBC. Please go ahead.

Stephanie Price, Analyst

Good afternoon, Mark. You mentioned M&A; some people will go there. Not Microsoft, but you did mention strategic M&A in your prepared remarks. How should we think about the balance between M&A and organic investments in shareholder capital return here post the AMC divestiture?

Mark Barrenechea, CEO

Yes, sounds great. Thank you, Stephanie. We're excited to complete the divestiture. We expect to close by the end of our fiscal year. When we do so, our intent is to de-lever and bring our leverage under 3 times, and return to a full-stack capital allocation strategy. We’re looking to return about 30% of our, approximately, free cash flow via dividends and buyback. That allows 70% of our available capital for other purposes, including M&A. You should expect us to return to M&A through strategic focus on ARR and cloud assets that drive future organic growth.

Stephanie Price, Analyst

Okay, thank you. Should we assume these investments continue post fiscal ‘24? How should we think about R&D as a percentage of revenue going forward?

Madhu Ranganathan, CFO

Yes, absolutely. R&D as a percentage of revenue is expected to be in the 14% to 16% range. For AI, it is both R&D and sales and marketing, which is expected to be 18% to 20%. Expect us to remain in that range; at larger scales, these dollar amounts will be higher. 800 engineers are deployed towards AI and related activities, so teams are focused heavily on investments.

Stephanie Price, Analyst

Great, thank you very much.

Mark Barrenechea, CEO

Yes. And thank you, Stephanie, and just to amplify Madhu's point, Platform Athena will significantly raise our productivity and output. Looking over decades of leading engineering organizations, how they've evolved—you'll see how organizations like OpenText look to balance our incredible talent globally through automation and systems. An interesting wave of AI tech is coming, and how we will be building software.

Madhu Ranganathan, CFO

Yes, and I wanted to add that R&D encompasses a broad category. Given our strong cloud bookings growth, we mentioned investments in information security and also in cloud operations and cloud infrastructure and hyperscale costs.

Stephanie Price, Analyst

Great, thank you for the color.

Operator, Operator

The next question is from Paul Treiber with RBC Capital Markets. Please go ahead.

Paul Treiber, Analyst

Thanks very much and good afternoon. Your recent comments on Athena were very helpful to understanding what it is, and using AI to improve the productivity of your R&D teams; do you expect or see improving productivity across the entire organization through AI over the next several years? Is that something we could expect going forward?

Mark Barrenechea, CEO

Yes, Paul, good to hear your voice. Absolutely. We have room to improve our margin. We're focused on bookings and revenue growth. I wanted to specifically highlight this transformative area, but we’re working on additional areas across the company—support, pre-sales, renewals. I’ll talk more about where we look to deploy them in the coming years, but engineering is where we plan to see the first significant impact.

Paul Treiber, Analyst

Thanks. Just a second question, more specifically on the outlook for ‘24. Looking at Q4, you can back into what it implies for Q4 EBITDA margins. The midpoint is about 41.5%. What is driving that seasonality to the upside?

Madhu Ranganathan, CFO

It's a very important question. As I mentioned, Q3 is typically a seasonally lower EBITDA quarter. Q4 is our seasonally strong quarter from a revenue perspective, which will benefit EBITDA margin as well. Some of the integration expenses related to Micro Focus for this fiscal year will also be optimized in Q4. The strong Q4 revenue will be a significant contributor to the EBITDA margin.

Paul Treiber, Analyst

Alright, thanks for taking the questions.

Mark Barrenechea, CEO

Yes, thanks, Paul.

Madhu Ranganathan, CFO

Thank you.

Operator, Operator

I'll now hand the call back to Mr. Barrenechea for closing remarks.

Mark Barrenechea, CEO

Very good. Thank you, everyone. Thanks for joining our call today. We're delighted with our progress and momentum. You heard us; we're investing for growth and expanding our competitive advantage with a strong financial update—focusing on capital return. In the room today is Greg Secord, and we'd like to wish him a happy birthday, yes. Thanks, everyone, for joining. Madhu, myself, Harry, and Greg, we look forward to engaging in the coming days and weeks. That ends today's call.

Operator, Operator

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