Micro Focus International plc
Q2 2019 Earnings Call Transcript

Published: 9 Jul 2019

[Operator:]

Hello and welcome to the earnings call for the Micro Focus International plc Interim Results for the six months ended 30th of April 2019 [Operator Instructions].I would now like to hand the call over to Mr. Ben Donnelly, Investor Relations Manager at Micro Focus. Please go ahead, sir.

[Ben Donnelly:]

Thank you, operator. This earnings call covers the six months period to the 30th of April 2019. I'm joined by Stephen Murdoch, CEO; Brian McArthur-Muscroft, CFO; and also Kevin Loosemore, Executive Chairman.In a moment, I will hand over to Stephen for some comments on our performance in the period. So those of you already accessing the webcast, accompanying this call, you will find a few slides in both Steve and Brian's commentary. For those participating only by phone, the webcast and the slides can be accessed through the front page of the Investor Relations section of the Micro Focus website. And the recording of this call, and those slides will be available shortly afterwards.I would now like to hand over to Stephen and then Brian for some introductory remarks before we open this up to Q&A.

[Stephen Murdoch:]

Thank you, Ben. Good morning and good afternoon everyone. Thank you very much for joining today's call. Our performance during the six month period was consistent with the guidance for the full year given at the time of the preliminary results on the 14th of February and that we reiterated in our mid-May trading update.This period can be characterized as one of making steady progress, moderating rates of revenue decline, improving adjusted EBITDA margins and generating significant levels of cash, in essence continued focus on delivering against our financial and operational commitments.The Group reported a revenue decline of 5.3% on a constant currency basis compared to the prior period, which is within our guidance range of minus 4% to minus 6%, and an improvement from the minus 8% decline in the same period last year. Within this, you can see the effects of running a broad portfolio where there's strength in some areas and weakness in others.Adjusted EBITDA increased by 2.8 percentage points, resulting in an adjusted EBITDA margin of 40%, which is a further step towards our 2020 plan to return to an adjusted EBITDA margin percent in the mid 40s. This progress was driven primarily by continued cost management actions related to our integration program.We're pleased to report adjusted earnings per share increase by 8.4% and that we continued to deliver strong free cash flow of $430 million in the six month period, and a cash conversion of 115%. The strength of the balance sheet is also evidenced by as already having headed to our mid-term target of adjusted net debt to adjusted EBITDA ratio of 2.7. Brian will talk more to the financial details in his section.During the period, we completed the sale of the SUSE business, and as a result of this and the related share buybacks, we returned more than $2.2 billion to shareholders in the period. As a recap, we acquired SUSE as part of the Attachmate Group acquisition in November 2014. The purchase price of Attachmate was $2.35 billion, and at that time, SUSE was 20% of the Attachmate revenues. We’ve now just sold SUSE for a total cash consideration of more than $2.5 billion just four years later at an accounting profit on disposal of more than $1.7 billion.The ability to carve out SUSE and create a fully operational standalone business in less than a year demonstrates the Group's ability to manage complex corporate actions in order to deliver exceptional shareholder returns. Today, we've also announced an interim dividend of $0.5833 again for the six month period.Moving now to operational highlights, we continued to make solid progress in terms of integrating HPE Software business and applying the Micro Focus model more consistently, more broadly across their operations. The key integration works streams are broadly on track, and I would highlight some notable examples of progress, particularly completion of the separation from the HPE shared infrastructure.To give an indication of the scale of this project, we effectively had to build from scratch the physical IT infrastructure for a very large global business. This involves migrating around 3,000 servers, around 150 applications to move and migrate 10,000 PCs and more than 25,000 end user email boxes. In addition we also upgraded other network, unified communications network infrastructure and consolidated five different security solutions onto our own security software products. As a side note, we now use more than 30 of our products in the day-to-day running of our business.More broadly, we continue to focus on delivering the key changes we need to reach our 2020 goals. These include delivering a single IT platform with a simplified and integrated systems architecture. We’ve completed the design stage of this and we’ll now move to build. And this will establish the future platform for the applications we need to run the core business processes, and also enable us to more easily integrate new businesses as we grow.Offering customers choice in who they partner with and how they deploy our software is a key part of this strategy. It’s also important that we have effective tools for our partners to engage with us. In March, we launched a new combined partner program and partner portal. This delivers more streamlined business systems and processes. For example, we made it easier for partners to sell across the entire portfolio and simplified the process for deal registration and how they access incentives. The work the team did here in building this received external recognition from the industry trade press.We continue to simplify the organization with a real focus on improving speed and the consistency of our execution. Examples of work being done, I would include the transformation of our finance organization, which includes moving from decentralized finance operations, which was spread across more than 40 locations around the world, to a global finance hub, and three regional delivery centers, with only the critical business partner support remaining in the country close to the business.Taking another example in HR, we’ve consolidated all of our employees and all of the associated HR data into a single instance implementation of workday. And having the single source of employee data, based on consistent job architectures allows us to simplify more of our operational processes as well as enabling greater efficiency over time, with managers and employees being able to self-serve.Earlier I commented on the financial aspects of the separation and sale of SUSE. But from an operational perspective, the 12-month project involves 17 work streams, resulted in changes to over 300 IT applications and 33 legal entities and associated structure. The ongoing relationship is now supported by a series of transitional services agreements, which will be completed and closed over time.I'm proud of the team's operational rigor to complete the transaction on time and on budget, and deliver the SUSE asset for its new owner, EQT Partners, as a fully carved out business. Additionally, in the period, we announced and completed the acquisition of Interset, a Canadian-based security software company. Interset has world class User and Entity Behavioral Analytics capabilities, which allow us to build this fundamental capability into our solutions across the portfolio, starting the security, but then pretty quickly thereafter broadening out.We continue to make progress in go-to-market effectiveness. But there's a lot more to do, particularly as we focus on driving speed and consistency of execution, both across portfolios and within geographies. This need for improved consistency is particularly evident in security where frankly our execution just wasn't good enough. Work to improve the operational effectiveness here is closely linked to instilling the right corporate culture of sharper and more consistent execution and building that on an unparalleled and accountable team.We’re making progress against this goal, but there remains a great deal to do on this front, including the ongoing simplification of the underlying end-to-end processes to make sure that this sustains. I'd like to take a few minutes and talk about some key product highlights. I'm particularly pleased with our progress against our goal of customer centric innovation. Product development is driven through customer engagement and feedback. And our unwavering focus is to help customers bridge both their existing investments and the emerging technologies and capabilities that they need to exploit to continue to evolve the business. And it's all about helping them find this balance of cost, risk and speed.There've been great examples of new capabilities delivered across and four key focus areas we have as a Group. So firstly, Enterprise DevOps, so that's about helping customers make a better software faster. So we’ve continued to improve and enhance our application modernization solutions, including the launch of our Micro Focus modernization maturity model, which really is the world's first maturity model designed to help customers build a robust and prioritize the end-to-end modernization strategy for the legacy applications.Our products enable customers to develop much more effectively from mainframe through to mobile, and deliver application capabilities faster, and new product capabilities into their business faster. And to help that even further into the future, we've also launched new robotic process automation capabilities within our products.Looking at Hybrid IT Management, we now have a cloud native and hybrid deployment options within service management tools and we've introduced new Artificial Intelligence within those tools to help analyze, for example, customer user support tickets, help more rapidly and automatically identify where they need help and get the problems resolved faster.In Security, I talked about the acquisition of Interset, which brings new capabilities to analyze user and entity, so the behavior of users and entities. This will enhance our security offerings initially, and then be broadened across all of our portfolios.More broadly, we've also expanded our application security capabilities, so again, enabling developers to build better security and service solutions from the ground up. And we've also improved our end-to-end solutions for data privacy in response to initiatives like GDPR or KVKK in Turkey or the emerging programs in both California and Canada.In Analytics, we've continued to extend the functionality and broaden the range of platforms that our solutions run this on. This allows for much easier integration into our core solutions and much more extensive enterprise, where just, again with cloud and hybrid deployment choices here, which materially reduce customers’ infrastructure costs. These are just a few examples that demonstrate the continued innovation we're driving within the product development organization.More broadly across that theme, we delivered more than 160 product releases during the period, ranging from small functional updates through to completely re-architected new solutions and new capabilities. We've underpinned that through the implementation of more of our own solutions in-house, including standardizing our own core development technologies, and standardizing our own DevOps processes through our own processes for both developing and then deploying to production and software. This has enabled much greater use of common technology across our portfolios, which allows us to leverage skills, and then obviously reduce duplicate costs.So, in terms of products, in summary, we continued to deliver innovation in both our existing technologies and enabled customers to embrace new and emerging capabilities. And increasingly, we're seeing customers rely on our software to help them solve real and complex issues today. That allows them to extend the life and improve further the return on investment of their current environment, but also position themselves to capture new opportunities as they drive their own transformation programs.I’d like to close up this section with a focus on our priorities looking forward. So the strategy and business model aren’t changing. Our goal is to deliver sustained customer value and strong consistent shareholder returns over the long-term. There are three key priorities that underpin this.Firstly, product and portfolio management, that is focused on delivering value over the long-term. Our relentless focus on delivering operational efficiency and this is really a combination of driving day-to-day continuous improvement, especially in our sales organization, and execution of our key integration programs through to completion.And finally, the third pillar is consistent and disciplined capital allocation. Our customer-centric and now increasingly cross portfolio approach to product management us to target and optimize the allocation of investment and development resources to deliver the most impact for customers. Taking a long-term view of more customers’ need allows us to work with them to extend their existing -- and maximize the return on their existing investments but also embrace that new innovation.So in essence we are focused on delivering solutions to complex challenges that they face today in a way that offers them maximum choice and flexibility. We remain singularly focused on driving more simplification and continuous improvement of our business operations, moderating the rate of revenue decline and continuing to improve EBITDA margins. We need to accelerate these efforts and improve our overall pace of execution.There really seems a great deal to do in driving these improvements within our go-to-market organization to increase the quality and consistency of our customer engagements. And through this drive better overall customer and partner alignment. The combination of our ongoing operational improvements, refining go-to-market and continued portfolio management will enable us to optimize cash flows over long-term. And again no change to our policy of surplus cash either be returned to shareholders or used on more value accretive opportunities.So with that, I'd like to hand over to Brian, who is going to take us through a little bit more detail on the financial performance. Brain?

[Brian McArthur-Muscroft:]

Thank you, Stephen. Hello, everyone, and thank you for joining the call. Just a bit of homework, all the numbers I refer to on this first slide will be on a constant currency basis, unless I say otherwise. And for information on the impact on the business of currency movements, please refer to the information included in the appendix to the presentation also.Firstly, let me give you an overview of our financial performance. During the first six months of the financial year, the businesses performed in line with our expectations. The revenue decline of 5.3% is within our guided range of minus 4% to minus 6% for the full year. This compares with a decline across the portfolio of 8% for H1 2018. We’ve provided portfolio analysis as an appendix to the presentation.License revenue declined by 11.1% in the six months ended 30 April. Within this the revenue decline in security was higher than expected due to the impact of the significant levels of sales force attrition experienced in the financial period 2018 and this rate of attrition impacts the sales execution further compounded by the corrective actions undertaken within the product portfolio roadmaps and these are taking time to flow through into pipeline and revenue. And Stephen I think has referred to our disappointment with this, but I think it's important that we call that out.Performance within ADM, AMC and IM&G demonstrates the portfolio effects of our business. Underlying performance in ITOM was stronger than the actual performance would indicate given the challenging prior period comparison. Maintenance revenue declined by 2% -- 2.6% in the period excluding the impact of the deferred revenue haircut and against the softer comparisons for H1 2018. Renewal rates will vary at a product level within periods, but across the portfolio, we continue to forecast a longer-term stabilization. After taking account of the revenue headcount, the maintenance revenue declined 1%.SaaS and other recurring revenue declined 10.4% and consulting revenue declined 19.1% in the period, excluding the impact of the deferred revenue haircut. The rate of decline in these two revenue streams is partially driven by deliberate management actions, which we referred to previously. After taking account of the revenue haircut, SaaS and other recurring revenue and consulting, revenue declined 8.3% and 18.3% respectively.These revenue streams contribute 2.5 percentage points to the overall revenue decline. The Group's revenue performance benefits from the impact of the IFRS15 revenue recognition standard and also year-on-year decline in the deferred revenue haircut. These two factors are offset by the disposal of Atalla and the change in approach to servicing U.S. Government contracts that we referred to at the full year. And the business is continuing to drive efficiencies and processes and remove complexity in costs from operations.Cost reduction programs are comprehensive and targeted to areas which do not impact the customer proposition. These cost reductions are in fact partially offset by investment in the front line sales organization. And even on a net basis, the business managed to reduce operating costs by 9.5% when compared to the same period last year. Alongside cost reductions, we continue to work on multiple transformation projects to simplify and standardize our systems including building a new IT stack to run more streamlined business processes.These projects remain on target for completion by the end of 2020. And as these projects complete, we anticipate incremental opportunities to realize efficiencies across our centralized functions and this will enable further cost reductions into 2021 in support of further margin expansion. The cost reductions achieved so far combined with the continued stabilization of the revenue decline results in adjusted EBITDA margin increase of 2.8 percentage points to 40% in the six months ended 30 April.In addition, diluted adjusted EPS for the period of $0.8553 represents an increase of 8.4% on the corresponding period. This increase is driven by the improvement in adjusted earnings and also the reduction in the number of shares in issue during the period for our buyback programs. In addition to this, on 29th April, the Group completed a further share consolidation, returning $1.8 billion to shareholders as part of the SUSE transaction. The impact of this consolidation will be further accretive to EPS in subsequent periods.We've announced an interim dividend of $0.5833 per share, which is the same as the interim dividend paid at this time last year. Our dividend policy remains unchanged at approximately 2 times covered by adjusted earnings. Again, as a small piece of housekeeping, the total interim dividend payment will amount to approximately $200 million, which represents 49.9% of our adjusted post-tax earnings for the period including predisposal earnings derived from SUSE.The dividend per share exceeds one-half of our adjusted earnings per share, because the latter is calculated with reference to our average shares in issue during the period, whereas the dividend will be paid on a reduced number of shares now in issue as a result of the share consolidation associated with the return of value. Thus, we expect to maintain this level of interim dividend per share with a progressive final dividend consistent with our policy. We'll return to our historical dividend phasing of paying approximately one-third by way of interim and two-thirds by way of final dividend over time.Moving now to some of our other key financial performance metrics. Firstly, HPE Software related exceptional items. As a result of the ongoing integration of the HPE Software business and development of our new IT platform, the business has incurred exceptional items of $163.2 million in the period. Within this amount, spend in relation to IT systems totaled $80.9 million. The overall exceptional spend through the end of April related to integration of the HPE Software business is $584.2 million of the $960 million total that we expect to spend overall and as we stand today I would expect to come in on or within that overall budget.Adjusted cash conversion in the six months ending 30 April 2019 has been particularly strong at 115.1%. This cash conversion is driven by a combination of the ongoing collection of aged receivables, combined with the business’ typical positive working capital profile in H1, where cash is collected from Q4 billings in the first half of the following financial year.Free cash flow has also increased to $429.9 million, compared to $213.7 million in the comparable period last year. And I’ll share further cash flow analysis on the next slide. The Group’s adjusted net debt at 30 April 2019 was $3.8 billion. The net debt figure has been adjusted to include the $1.8 billion we returned to shareholders in May 2019. The share consolidation is subsequent to shareholder return occurred on 29 April 2019. However, the cash did not leave the Group’s bank account until shortly after the period end. After adjusting for this payment, we were at our target adjusted EBITDA to debt ratio of 2.7 times.In the second half of the financial period, the net leverage will increase marginally as we made the one-off tax payment of approximately $300 million in relation to the SUSE transaction, as we previously disclosed. This will increase only to 2.8 times for a very short period, and then return to the Group's medium term net leverage target, which remains unchanged at 2.7 times net debt to adjusted EBITDA. And I'll give further detail on the profile of our debt facilities a little later.Turning to Slide 12, Micro Focus continues to be a highly cash generative business. The Group generated $622.6 million of cash from operations in the period, which represents an adjusted cash conversion rate of 115.1%. This result is higher than our typical conversion rate, driven by strong receivables collection, underpinning an overall working capital inflow of $70.3 million, including the net impact of provisions.Continued progress has been made against the collection of aged receivables, which has reduced from $342.2 million to $251.2 million. The business generated free cash flow of $429.9 million in the six months after spending $161.4 million on total exceptional costs. Free cash flow generation continues to be supported by the current low cash tax rate. And as this rate increases over time, we expect the cash effect of this to be offset by the reduction in exceptional costs.Moving to the final slides of the finance section, return to the Group's ability to maintain its medium term leverage target and the strength of the balance sheet generally, the chart on the left demonstrates how the business has delevered after both the Attachmate and HPE Software business transactions. The Group is able to achieve this because of the scale of cash generated and the continuing focus on maximizing cash flows for operating efficiencies, and overall strong capital discipline.At 30 April 2019, leverage remains at the medium term target of 2.75 when adjusted for the impact of the share consolidation related to the return of value. As I mentioned earlier, it should be noted that the net leverage will increase marginally when we made the tax payment, but it will return to 2.75 times shortly thereafter.In terms of gross debt, $2 million -- $200 million, sorry, of the proceeds from the SUSE disposal were used to reduce debt in the period. The next tranche of debt repayment is due in 2021. And there are no amortization payments during the meantime. It should be noted also that we have a $500 million RCF facility which remains undrawn and is not due until 2022.With that, I'll hand back to Stephen to sum up, before we move on to Q&A. Stephen?

[Stephen Murdoch:]

Thank you, Brian. So in summary, we're committed to the consistent execution of our strategy, and continuing to apply the Micro Focus business model robustly across the Group. By taking a long-term view of product management, whilst also continuing to drive simplification and continuous improvement of the business operations, we're confident that we are positioned to deliver sustained customer value and strong consistent shareholder returns.I have outlined our focus on moderating rates of revenue decline, improving our EBITDA margins, and optimizing our cash flows. We’ll achieve this by keeping customers front and center, driving continuous improvement in our sales execution, and delivering products that customers value and rely on at the core of the business operations.We believe the infrastructure software market is fragmented and consolidating and that Micro Focus is well placed to succeed within this market context. We’re reconfirming our guidance of constant currency revenue declines for the continuing operations of minus 4% to minus 6% for the 12 months to the 31st of October 2019.With that, I’ll now open up the call for Q&A. And over to you, Ben.

[Ben Donnelly:]

Thank you, Stephen. And with that, I will ask the operator to open the call up to Q&A. Can I please ask that you each ask one question initially to give everyone a chance to ask a question? Operator?

[Operator:]

[Operator instructions]. We'll now take our first question from James Goodman from Barclays. Please go ahead. Your line is open.

[James Goodman:]

If I could start with the revenue trajectory in the second half, so overall, it was largely as I'd expected, but the license performance was perhaps a bit weaker and conversely maintenance was a lot better than I'd expected and you mentioned some of the issues in security. But perhaps could you give us some more information on the other drivers, particularly how you manage to keep maintenance so solid? Because I thought there would have been an impact from lower license attachment last year. Thanks.

[Stephen Murdoch:]

Yes. Thanks, James. Basically, I would focus on the full year rather than any of the individual financial periods. So we’re reconfirming for the full year. We think the broad shape there and consensus is about right for those puts and takes on the compares on each individual line within the period that are impactful. What we're doing to drive continued improvement in license is really number of things that range from better product roadmap, so really sharper, more customer-oriented product roadmaps.We're driving improvements in the stability of the sales force, obviously unquestionably driving better discipline, got work to do on sales enablement. And we're also focused much more sharply on getting the right resources over the right customer opportunities. So an example of that would be the top accounts program that we developed in the U.S. this year and we’ll roll out more broadly as we go into the next fiscal. So much so to do. And I would focus on the year and not any of the individual lines in the period, James.

[James Goodman:]

That's helpful. Thank you. So I guess into the second half despite having I guess a tougher license cut, what you're saying is the underlying improvements in the business could well see a sequential improvement in terms of the year-on-year growth in licenses, especially at the bottom?

[Stephen Murdoch:]

We look at to improve the execution of licenses every day, for sure.

[Operator:]

We’ll take now take our question from John King from Bank of America. Please go ahead. Your line is open.

[John King:]

Can you just give a comment on the attrition rate currently seeing on the employee base, I guess the voluntary attrition from HPE in particular, I mean obviously you have had a lot of attrition at the start of that transaction and how under control is that now?

[Stephen Murdoch:]

Yes, John, it's trending to back to what we would consider pretty normal for a software company, so kind of mid-teens. Within there, there are still pockets and we're working hard to tie those pockets so we mentioned security. But on the whole it's moderating back to that mid-teens level that we've seen historically and it's pretty typical in the software industry.

[John King:]

Okay. And if I could sneak one on, on just on Interset, could you give us an idea of the revenue run rate for Interset?

[Stephen Murdoch:]

I would say that was a technology buy rather than a revenue buy. We need to get it integrated into the product and then drive pipeline. What it does do is it puts us in control of our destiny at the middle of a strategic asset called ArcSight rather than being relying on a third-party. And over time it will give us a platform to drive into other products. We've done this before with advanced authentication where we bought a piece of technology and then we've now managed to drive that technology into more than 30 of our products and it's now a sizable revenue stream and is in its own right, but it's embedded in the products.

[John King:]

Okay. So it’s more of a CapEx. Okay. So -- and then lastly on the stock compensation for the year. I mean I know that’s difficult line to forecast. But any idea as to, are live and are expected for the first half? So what you have planned with into that?

[Stephen Murdoch:]

Can we come back to you on that one John rather than try and give a reasonably detailed calculation on the call? So Ben will come back to you.

[Operator:]

We'll now take our next question from Gautam Pillai from Goldman Sachs. Please go ahead. Your line is open.

[Gautam Pillai:]

Just a follow-up on the maintenance comment that you made earlier, and it’s still very stable despite the significant drop in licenses. Can you comment if you see an increase in renewal rates in the last 12 months or so? And also if you could provide -- you could possibly provide number of renewal rate which you're seeing currently?

[Stephen Murdoch:]

Renewal rates have been consistent for some time. I can’t give you a renewal rate just now because the historical data that we're building from is different methodologies. So I can compare within an individual portfolio and look historically at that, but I can't compare cross portfolios and therefore an aggregate rate would be meaningless. What I would point to is, there’s five levers really to try and drive the maintenance performance. One is the level of license as you correctly pointed out.Secondly is just how much initial maintenance we attach to that license sale. Certainly you've got the renewal rates and win-backs and attrition. And some of those factors were not played through last year consistently through the course of the year. So you go a little bit compare dynamics first half, second half that are playing out. So it’s why I would suggest we just -- we look at the year as a whole. And then a lot of that variability washes through as we go into next year.

[Gautam Pillai:]

Okay. And if I can ask a quick one on the free cash flow as well. And can you comment, if there's more runways left in the working capital reversal, rental collections in the second half as well? And also what is the normalized level of cash conversion, you are targeting ones through the working capital impact?

[Brian McArthur-Muscroft:]

So this is Brian. I think to answer the last part first, our normalized cash conversion target is 95% to 100% on adjusted EBITDA. And I don't think that has changed or will change going forward. We have had a very strong period in H1 as you've noticed on the cash conversion. That's driven in terms of the working capital performance, particularly in relation to receivables. It comes in probably three parts. We have worked very hard on bringing down the core DSO calculation number. But as I said to you guys at the full year, the DSO in itself is slightly misleading, because the billing profile of the business isn't linear across a month in the year. So it can mislead, if it's not combined with the other parts to the calculation.In terms of the quality of the book, what we have had is a one-off benefit in the period by improving the closer of collections if you like in the middle of the aging on the receivables ledger, and we're now operating fairly close to best in class there I would suggest. And then the final piece is, is the target that we set ourselves to collect as much as we could as fast as we could of the residual old debt relating to the HPE deal going back as far as H1 last year. I'm really pleased to report that we've collected over $50 million in cash in the six month period for H1 in respect of those older balances and that has in turn added to the outperformance on cash conversion period which came through sort of 95% to 115%.In terms of your question about how much further runway do we have on that? We do have more to collect at the very old HPE balances but obviously the more we get into that, the harder it becomes. But I would still say we have 10s of millions that we can go after there over the next two periods, I’d suggest. And then I think that will pace throughout. I think in terms of underlying DSO, I think we will always go after a day or two each period, as we just try and become better and better at what we do. So there'll be a little bit there. But I’d suggest that we've got more to come but not as much as you saw in this period.

[Operator:]

We will now take our next question from Charlie Brennan of Credit Suisse. Please go ahead. Your line is open.

[Charlie Brennan:]

I just wanted to ask around the whole license trajectory. Over the last two years, you've lost about 30% of licenses. That seems to be considerably worse than the April growth rates in some of these categories that you’re addressing. Generally sense of what the underlying market is doing that you're trying to address. How much of the license shortfalls than internal execution problems? I'm just trying to get a sense of how you deal as to improve this trajectory? And then just as a secondary follow up, in some of these categories, I know you talked about the sales issues in security, but licenses and security have halved over the last two years. Do some of these categories just lose so much critical mass that they will fall back then? Thank you.

[Stephen Murdoch:]

Yes, thanks. Thanks, Charlie. If you look broadly at the portfolios here, we've always said that the proper execution we think we can get the AMC portfolio to be broadly stable. And I think you've seen that play out. It took us a few years to get it to that point. But you've seen that play out now. The underlying performance in ITOM is better than we're currently -- the headline numbers that we're showing. And I'm actually pretty pleased with the work done on the roadmap to modernize the core product portfolio, like flexibility deployment is such a broad category, though it’s kind of difficult to give you a market category for growth in there.But within sub-market categories, I'm pretty confident on the competitiveness of the portfolio. We do have some older legacy assets in there too which will run-off. So that one is really tough to kind of give you market segmentation. Securities, more straightforward, the market is growing and we're not. There were pieces of our portfolio. We're growing close to in some instances ahead of that. We’ve had a lot of work to do at the core of that portfolio with the core assets around ArcSight and Identity.We think we've done the work on that roadmap now, but we still have execution issues to solve there in what is a very hot market and candidly if your execution isn’t at the top of the game and then you won’t win in that market and we got to work to do in security. In IM&G which is again a very broad category, we're really pleased with the foundations we're building in big data and the technology and the opportunities that that presents for us. We're also pleased with the work that we're doing in the archive and retrieval space. We think we've got the right roadmaps and product opportunities there to stabilize that and drive improvement. And then the legacy pieces in there are really in terminal decline, and we're protecting customers’ investments and generating cash.So it's a mixed bag, in ADM, the testing space is growing, and we’ve got competitive products, and we got areas where we believe we're growing, the rest of this space has flat to declining revenues. Again it’s a little bit a mix in there. So long answer, Charlie, not giving you definitive pieces, but it’s pretty tough to do that across 300 products. What we have convinced obviously, we have a better product portfolio now than we had. We have more stability into the sales force. We got a lot to do to improve execution in there. And therefore a lot of opportunity in front of us, and we're confident that we can drive and improve trajectory in license.

[Operator:]

We’ll now take our next question from George O’Connor from Stifel. Please go ahead. Your line is open.

[George O’Connor:]

Stephen, have you done any work looking at what the optimal FTE population is for the Company?

[Stephen Murdoch:]

In aggregate, George, we do have target benchmarks by function that we're working our way towards. And then the rest is the perennial balance between what we think we can do on top-line, what we're trying to get done in EBITDA and how we're trying to manage the rest of the financial dynamics. So we don’t target benchmarks for the support infrastructure costs that we’re seeking. We've got firepower analysis that allows us to get a sense for where we're at in terms of the sales force and what we think we need by portfolio. But I think in aggregate resource level for the Company wouldn't really be a meaningful number.

[George O’Connor:]

In terms of the product strategies, that you've made 161 product intros, that’s off of a portfolio of 300. Does that mean you’re sort of half way through the customer-centric innovation roadmap process, or am I just getting that one wrong?

[Stephen Murdoch:]

I wouldn't really work out that way, it's just coincidental that there’s -- it’s kind of roughly half. We did over the course of the year last year, I can't remember the exact number what we did more than 200 over the course of the year. Obviously some periods of the year are quieter than others in terms of major release cycles. And some products you don't deliver a major release in the year because the customer doesn't consume the capability that quickly. We are having somebody delivering multiple versions over the course of the year.The customer-centric piece has multiple elements. One is you how we got the engagement mechanisms to get a direct and strong customer feedback. And those are now broadly in place across the organization. So things from dealers’ portals through to customer advisory boards and customer satisfaction data are all feeding into that. So the foundations of that are in place. The architectural work in the portfolios were advanced in terms of getting through that, it’s now the functional enhancements on the main and also cross portfolio capabilities.So the robotic process automation, new technologies I mentioned, we play out in ADM, at ITOM for example that we developed jointly. The Vertica product is now being put into our ITOM and our ADM suite. We're trying to code it in as well as customers are putting them alongside each other and doing some of those things. So that's really the emphasis going forward, now it’s more about use case driven leverage with the technology, George.

[Operator:]

[Operator Instructions]. We'll now take our next question Stacy Pollard from JP Morgan. Please go ahead. Your line is open.

[Stacy Pollard:]

Can you please talk around the timing or future M&A? Could you do something in fiscal '19 or '20? And perhaps color on the types of M&A? For example, is that more opportunistic around what's available? Or are you targeting certain solutions fitting in your product sets? And then a quick follow-up please.

[Stephen Murdoch:]

Okay. So, no change really, Stacy. We focus on three types of acquisition. One is the technology-oriented acquisition, which is putting us in control of our portfolio or accelerating the deployment of capabilities, so that's like Interset and some of the others that we did in the past 12 to 24 months. There's a second category, which is about either adjacency or consolidation of a space where we already have capability. And we're always looking at those two categories, always and we've never stopped.The third category is either transformational or taking us into a new market opportunity area. And those you're not really in control of the timing, they come up when they come up. So you have to assess them on the merits when they arrive in terms of, is it the right asset, at the right price? And therefore, where you are at your ability to execute? So we apply a risk adjusted premium on our ability to execute and then understand whether that has more accretion than cash returns, and we make the judgment on it on its merits.But again, you want to put yourself in a position where you can assess them on the merits and make the right decision for the business and not be constrained. And that's what we're working hard to do. But we're always actively scanning the market across all three categories. And we're very active in monitoring.

[Stacy Pollard:]

Okay. That’s useful, actually. And then last one, last question. Are you still targeting 15% to 20% total shareholder return going forward? And then how much of that would you say is, is that really driven by the core business? Or is that requiring a little bit of M&A as well?

[Stephen Murdoch:]

Yes, we are still targeting that and it's always required improvements in the core and value accretive opportunities elsewhere. So, there's always been multiple levers to getting that done, and you'll see us deploy those in a combination and a mix, depending on the circumstances.

[Operator:]

We'll now take the next question from Michael Briest with UBS. Please go ahead. Your line is open.

[Michael Briest:]

In terms of the exceptional items, can you talk about how they will hit the cash flow through the second half of the year and next? And what the timing is for switching over to the new IT system? And then secondly, just on EBITDA growth, it was 2% in the first half. I think the corporate bonus wide scheme plays out at 6% to 10%. Is that still the ambition that you have to achieve in the full year? Thank you.

[Brian McArthur-Muscroft:]

So taking the first one on the exceptionals, overall, we are still completely on target to the $960 million total budget across the three years and we're reiterating that we’ll have to come in on it or within it. And you'll notice that in H1 '19 we have come in at $163 million exceptional spend against the full year forecast that we gave last time of $420 million for this year. That is obviously light on a run rate basis it would appear.I think the likelihood is, if anything will probably come in a little bit under the $420 million but I think we will spend more than $160 million in the second half, because actually quite a lot of the program work is focused around Q3 and Q4 of this year, particularly in relation to some of the early data migration and cut over systems on the [stack C] work along with the continuation of everything else that we're doing.So I think naturally, you'll see an increase in activity towards the end of the year. I've reiterated that I think it's more likely that it will be a bit under $420 million then on $420 million at current run rate. The rest of that probably is us just being prudent in our cash forecasting.In terms of exceptionals in general, the target in terms of delivery of the project themselves, which is the important piece, there's nothing to impute by that apparent under spend in H1. All of the current projects are on target and on time table and we haven’t come across any difficulties since we last described those projects to you. I think your second question was on EBITDA?

[Stephen Murdoch:]

Yes. Just in terms of timing of the project, we’re still targeting the single system start during -- by the end of calendar 2020, Michael. There's been no change to the EBITDA -- sorry, to the bonus structure for anyone in the Company. It's still flat. EBITDA is zero percent bonus, 10% growth and EBITDA is a 100% bonus. The exec directors are capped, they are at the staff arm. So it's a straight line in between the two, no change.

[Operator:]

We'll now take our next question from James Goodman from Barclays. Please go ahead. Your line is open.

[James Goodman:]

Just a couple of quick follow-ups. Just in terms of understanding the shape of the performance in the half. I appreciate your commentary on not reading too much of any one data point. But just looking at the regional performance, the U.S. or North America was nearly flat on licenses, al the weakness within international. So just wondering is that because the security issues overlap with the international segments, or is that something else geographically that’s worth calling out there?

[Stephen Murdoch:]

Partly the issue this time last year was North America and EMEA was quite a bit stronger and so some of its flat, James. And candidly, our execution in EMEA wasn't as good as it has been in prior periods. So there's more work to do. But this time last year, we were talking about issues in North America and relative strength in EMEA. So that's why some things you hear me saying perhaps a little bit too often, the whole focus of the Company is trying to drive more consistency in more places more often. And there we think we can -- if we can crack that code, we really do have good runway ahead of us.

[James Goodman:]

That makes sense. I mean the other question I always get and I am sure you get the same one is, what is the sort of sustainable rate of top-line development in the outer years? The only reason I sort of raised it is, you've referenced the guidance that you put in place last year for FY '20. I think part of that guidance you talked to stabilized declines in revenue by which you meant a sort of no longer increasing rate of decline. Have you further clarified at all sort of exactly what you're thinking in terms of that guidance for FY '20 and beyond?

[Stephen Murdoch:]

No, we’re -- well, we're focused on delivering this year and then we'll give that guidance to you when we -- when we next talk to you with more detail then clearly we can do that.

[Ben Donnelly:]

So I think that’s what we’ve got time for now. And I don’t know if there’s anymore questions. So -- and Stephen?

[Stephen Murdoch:]

Yes, again just like to thank everyone for taking the time to be on the call today and for a pretty comprehensive set of questions. Myself and the team are available for follow-up, so it'd be a little tricky over the next few days as we go on a road trip. But after that -- of course, and again, thank you and hope you have a good day.