Micro Focus International plc
Q4 2021 Earnings Call Transcript

Published: 8 Feb 2022

[Ben Donnelly:]

Good afternoon, and good morning, everyone. Today's earnings call covers the Year-Ended 31st of October, 2021. And I am pleased to be joined today by Stephen Murdoch, our Chief Executive Officer; and Matt Ashley, our Chief Financial Officer. In a moment, I will hand over to Stephen and Matt to provide a short presentation of our performance in the period. The slides for this presentation that we presented are part of the webcast facility accompanying this call. For those participating by phone, the webcast and the slides can be accessed on the Micro Focus Investor Relations website. A recording of this call and the slides will be made available on this website shortly after this call finishes. After the presentation, we look forward to covering as many of your questions as we have time for. I would now like to hand over to Stephen to provide an overview of the period.

[Stephen Murdoch:]

Thank you, Ben. I'm delighted to be able to talk to you again so soon after our strategy update. We will use today to highlight our priorities for this year and next. Talk to the progress made in the past 60 days and provide some additional color around last year's performance. Overall, we're pleased with the progress we made, specifically in respectful systems, product and our go-to-market strategy. We've now moved the business onto one set of systems and standard global processes. This is the key foundation from which to drive efficiencies, and improvements in productivity. In product, we've improved the propositions across our portfolio. The introduction of new artificial intelligence, analytics and cyber capabilities, together with SaaS and subscription solutions in every portfolio, improves our competitiveness and our ability to capture more of the market opportunity. We now have a global go-to-market organization delivering greater consistency in both performance and customer service. The combination of these actions provides a platform for continued improvement and the delivery of the objectives we set out on our strategy day. Overall, we're pleased with the progress made in terms of revenue performance. License revenue grew overall, and in four of our five portfolios. We saw continued development and progress in our SaaS offerings and how significant work both completed and ongoing to improve our performance and maintenance. In Q1 of FY '22, we continue to make good progress. We announced and have completed the disposal of Digital Safe. The financial outcome achieved demonstrates the value inherent in our portfolio and our willingness and increasing ability to realize this value where and when appropriate. We closed our sub financial period on the new systems smoothly and to plan. We also identified and acted upon additional opportunities to remove duplicate costs and inefficiencies. Our strategic partnership with AWS achieved another key milestone at the launch of their flagship re

[Matt Ashley:]

Thanks, Stephen. Good afternoon, and good morning, everyone. Firstly, I'm delighted to say our audited results are consistent with those we presented in November. The key financials are revenue of 2.9 billion, representing a halving in the rate of overall decline, adjusted EBITDA of 1 billion, within this cost discipline was good with overall cost reducing whilst we continue to invest in both people and products. Adjusted free cash of $300 million, one of the strengths of our company is our ability to generate strong levels of free cash flow. Performance in '21 was impacted by a number of one off items, which I will cover later. The important thing is these will roll off and we have confidence free cash flow will build from here on. We certainly have not been sitting on our hands since November, we have been busy taking costs out of the business to remain on track to deliver the cost savings we described at the strategy day. We have completed the sale of Digital Safe. We've received the cash and are using it to pay down our debt. Just to remind you, we sold Digital Safe for $375 million, equivalent to approximately 3.5 times revenue, and 12.5 times adjusted EBITDA less lease costs. In total, we transferred $40 million of lease obligations as part of the transaction. We also took the benefit of the loan market and refinanced $1.6 billion of debt. Finally, we are proposing a final dividend of 20.3 cents. So let's look at our overall financial performance. We generated revenues of $2.9 billion in '21. This represents a halving of the rate of constant currency declines from 10% reported in '20 to approximately 5% in '21. I will expand on our revenue performance by stream and product group shortly. Alongside the improved revenue trajectory, our cost base reduced by 0.9% on the net basis. In terms of the cost base, we have essentially used cost savings achieved in the year totaling approximately $120 million to fund the run rate impacts of investments made inside the risk, big data and other parts of the portfolio. A combination of revenue and cost actions delivered and adjusted EBITDA performance of $1,040 million, which represents an adjusted EBITDA margin of 36%. You will remember from our strategy day, we have set ourselves an ambitious plus achievable targets. Over the next two years of removing $300 million of recurring costs on a net basis from 1.9 billion seen on this page to 1.6 billion as we exit fiscal '23. This reduction is also assuming a 5% inflationary cost in both fiscal '22 and '23, i.e., we have to save around $500 million gross to save $300 million net. Clearly inflation is a hot topic at the moment, particularly in the labor market. But we believe the parameters we have set ourselves are achievable. As we progress with the cost program, we will give detail of the savings we have achieved, but for commercial reasons, which I'm sure you understand, we have not disclosed our internal targets. Exceptional spend in the period totaled $247 million, last year it was $3 billion, which included an impairment charge of $2.8 billion in relation to the Group's goodwill. Finally, we are proposing a final dividend of 20.3 cents, taking our total dividend for the year to 29.1 cents, consistent with our 5x covered policy. Revenue, on this slide, you will see revenue performance, both by stream and product group. We are pleased to return to growth in License with revenue growing by approximately 5% in the period. Clearly an initial step, but a significant and encouraging. Sales execution was strong in both halves and with key metrics such as sales conversion rates remaining above previous periods, with improvements being broad based across the portfolio. Maintenance revenue declined by 9%. This was below our expectations, and what we believe is attainable. Improvement here remains a critical priority for the company. We have been consistent in our view that this will take multiple periods to deliver. SaaS revenue declined by 4%, but with an improving underlying trajectory. Excluding Digital Safe, SaaS revenues grew by 0.2% year-on-year and growth is expected to accelerate over the next few reporting periods. Our work in reshaping our consulting practice is now complete. And this part of our business is now well-positioned to deliver the type of projects which add value to customers through supporting faster, more-effective deployment of our software. Now turning to product group performance. AMC. We had a strong close to the year delivering growth overall. AMC is typically cyclical in nature, and this trend is expected to continue until we begin to see revenue from the AWS partnership, which remains on-track for '23 and beyond. CyberRes, in aggregate, we are really pleased with the progress made in the period. Three of the four sub portfolios here delivered performance inline or ahead of our expectations. There remains one sub portfolio which is providing a headwind, particularly in terms of maintenance performance, and we are executing a comprehensive plan to actively improve this. IM&G, the big news here is obviously the disposal of Digital Safe, which we have already discussed. Excluding Digital Safe, IM&G declined 2.5%. The remainder of the portfolio performed as we expected. In Big Data, we see significant market opportunity here, and expect growth to accelerate. In ADM, we made substantial progress with the products offerings, improving maintenance performance and growth in SaaS are the key priorities. ITOM, encouragingly, full year performance saw a moderation in the rate of licensed revenue decline with several sub-portfolios growing. We continue to work to improve maintenance performance. In summary, our goal of exiting '23 with flat or better revenue is on-track. Exceptional items, we recorded a total of $247 million of exceptional items in '21. This compares to $3 billion in the previous period, which included a $2.8 billion goodwill impairment charge. In the year, the key charges in relation to exceptional spend were, $136 million in respects of Micro Focus and HPE integration charges. Majority of this relates to the implementation of the enterprise wide platform. As I stated at the strategy day, it is our intention that we will incur no further exceptional spend in relation to this platform with any future costs recorded within normalized operating costs. In addition, we also incurred $75 million in relation to the settlement of the Wapp legal claim. Going forward, I'm keen that exceptional spend is only recorded in relation to incremental M&A, and cost reduction programs. Excluding further M&A, '22 and '23 exceptional costs are expected to be approximately $100 million in each year, and relate to the cost of delivering the cost savings I outlined earlier. At the bottom of the slide, you will see the cash cost of exceptional spend in 2001 after the impact of tax. The cash cost of exceptional spend in total was $236 million in the period. In the next slide, I will present the impact this has had on our free cash flow. Now this is my favorite slide. Not only does it reconcile EBITDA to free cash flow, but it allows you to see how our position improves next year. This is all about the cash. Micro Focus is a highly cash generative business. In '21, our ability to generate free cash flow was impacted by three material items

[Stephen Murdoch:]

Thank you, Matt. Let me start with a high level recap of the progress made last year, to set the context for how we will build on this looking forward. The move to a single set of systems is a critical element of how we are simplifying the business to deliver much more flexibility and agility for our teams and ease of doing business for our customers. As I said earlier, we have now closed our third quarter on the platform smoothly, and continue to identify opportunities to remove unproductive cost. In product, we are really pleased with the progress made last year, particularly in SaaS, and how we repositioned to CyberResilience. We refocused our approach in both ITOM and ADM, consolidated progress in IM&G and built on our leadership position in AMC. And we have taken important first steps in establishing a more specialist global salesforce. Through the remainder of this year, and next, we will build on this through the execution of the following three strategic priorities. Number one, transition to a product group operating model. We have a broad portfolio, operating in markets with different challenges and opportunities. As a result, we need to continue to build deeper levels of specialist capability, that is aligned by product portfolio, coupled with increased agility, such that we compete more effectively and win more of the market opportunity available. In addition, this approach will create more optionality from value creation as was evidenced by the Digital Safe transaction. Secondly, continued focus on the install base. We delivered significant innovation and improvements across the portfolios last year and have clear plans to do so again this year. We see lots of opportunity for improvement in how we enable customers to exploit this innovation. Executing this comprehensively and consistently will ensure customers see more business value faster, with improved return on investment. This will translate into improved retention rates and additional revenue through new project deployments and product expansion. Thirdly, utilizing the enterprise-wide platform. After several years of duplication and inefficiencies, we now have the foundation to drive simplification in our business, and we intend to exploit this as fully as possible. Through a combination of these initiatives, we are building a business that is focused by product portfolio, and supported by operational hubs to drive efficiency and agility, so that we optimize the performance of each portfolio. Turning now to the product portfolios. But before covering the key points by individual portfolio, I want to underscore that across the board, we are executing plans to improve maintenance renewal rates and increase recurring revenue through our subscription and SaaS offerings. We are also tracking operational metrics around adoption of our latest product releases, as a key leading indicator of future performance in these areas. In CyberRes, our breadth and ability to execute at scale and in an integrated fashion differentiates us from point solution competitors. We're already growing in two of our four sub-portfolios, are on-track to do so in a third and our advanced interaction plans to reposition outside. On this point specifically, we have delivered very significant product improvements and have more planned. We are now focused on helping our customers exploit these new releases fully. In AMC, we are consolidating and strengthening our leadership position and helping some of the largest companies in the world to modernize their mainframe applications to the cloud, which we do both directly and through strategic partnerships, such as AWS. In ADM, we have a proven track record, deep capabilities and a large install base of customers, who depend on our solutions every day. So firstly, we're focused on helping them fully adopt the innovation we deliver in this area. Additionally, we'll continue to deliver on our SaaS roadmaps and help customers to transition to these offerings as appropriate. In ITOM, our priorities are to deliver AI ops at the core of our service assurance portfolio. Cloud native and hybrid capabilities in service management and accelerating the delivery of our SaaS roadmaps. We're on track with these initiatives and again this is core to our goal of improving maintenance performance. Finally, in IM&G this portfolio is performing broadly to expectations. Additionally, we see a huge opportunity in Big Data and are confident in our ability to deliver growth. In aggregate, at the group level, we're seeking to balance revenue, profits and cash generation from the overall portfolio and create strategic flexibility in how we pursue value creation for shareholders. One of the benefits of moving to this product group model is that we will be able to give you increased levels of disclosure at the product portfolio level. This will be in place for the start of FY '23. I would like to finish by reconfirming the financial outcomes we're targeting for the exit of FY '23. Firstly, revenue trajectory of flat or better driven by growth in Cyber, AMC and IM&G, and significantly improved performance in ADM an ITOM. Secondly, capturing efficiencies and productivity gains through the reshaping and simplification of our business, with the target of delivering overall gross cost reduction of between $400 million and $500 million. These actions will combine to deliver an exit run rates of free cash flow of $500 million per annum. In closing the foundations we committed to are now in place and we're 100% focused on the execution of our objectives through to FY '23. Thank you for your time today. And I'll now pass back to the operator to open up the call for Q&A.

[Operator:]

The first question is coming from the line of Charlie Brennan, coming from Jeffries.

[Charlie Brennan:]

Can I start with two, if that's possible? The first is just in listening to your comments, it sounds like there's probably slightly greater confidence on the outlook for '23 than there might be for '22. You've obviously got a range of indicators that you lock out that we don't see. And you've got some things that are in the pipeline like AWS that will benefit '23 that we don't have in '22. But can you give us a few other things beyond AWS that give you the confidence that '23 is going to be a much better year? And then secondly, you touched on the problems of staff retention in the prepared remarks. Can you just give us some insights into the sort of attrition levels you're seeing and whether you're seeing anything bad that’s giving you any cause for alarm? You've obviously highlighted the EBT, but does that fill enough in the current environment to keep the people you need?

[Stephen Murdoch:]

Okay, Charlie, let me do the second one first. Like everybody in the marketplace, and I'm sure all the commentators that you've heard yourself, no one's really seen the labor market like we have today. And clearly, we're not immune to that. We also have a really talented workforce that solve some of the most difficult challenges customers face every day and we've got really interesting work and enjoy that work. So we're not in any way disproportionately confound about the attrition more than anyone else would be in an industry-wide phenomenon that we're all seeing today. And what we're doing is working on sharpening our employee proposition for both retention and recruitment. As I said, providing those career development and expansion opportunities for the team and using the other levels or levers at our disposal like the stock options that we've touched on. We've got some areas of heightened attrition. We've got overall attrition that's clearly above pre-COVID levels, with some pockets that we're dealing with. But it's no more unique for us than it is for anyone else in the marketplace. And we've got pretty decent and robust plans to deal with it. In terms of the revenue outlooks, we're pleased with the progress we've made since we laid out 60 days ago, we laid out very detailed plans for what we're going to get done through the exit of FY '23. We're confident in those objectives, we're incrementally more confident every time we talk here. And we're seeing some of the leading indicators in terms of getting customers on discussion of our products, which gives us some additional confidence in the underlying maintenance performance beginning to moderate and improve over time. As I mentioned, we've got security on -- we got really good growth in two of our core portfolios, we're very, very close to getting the stocks into exactly where we wanted it to be. We've got work to do on the fourth one. And the extent that we can accelerate the improvement in maintenance there really gives us a strong proposition in security, and we're very pleased with the overall portfolio. The SaaS roadmaps that we've laid out in ITOM have been very well received by customers. And we're making good progress in the SaaS capabilities that we already have and accelerating those in ADM. So, there's a lot in here, Charlie, there's a lot of moving parts. And -- but we really do have increasing conviction every time we talk to you in our ability to deliver against what we've achieved and what we set out for '23. We haven't made any changes to what we said in November about '22. And since then you've all updated your models and we very much appreciate you doing that. As a result, we think that the revenue consensus for the full year is there about. And we stressed 2 points, progress is not going to be linear. But we really do have increasing conviction on our ability to deliver the objectives for ‘23 or later.

[Charlie Brennan:]

Can I just circle back on the attrition? Is it fair to say that the majority of the attractions in the sales side of the business and again, is up feeding into some of your revenue observations for '22?

[Stephen Murdoch:]

It's pockets in sales, certain countries, certain portfolio areas is pockets in development. We got some really talented development teams as well. So it's more pockets and an elevated overall, for all the dynamics that you've seen playing out in the industry. We're able to recruit, we're attractive employer, we're not worried about our ability to recruit talent. Obviously, you've got a ramp change when you recruit so we're balancing retention. We're also seeking to try and use it as an opportunity to remake, because we're changing the wake of where we're putting some of our resources, so we're trying to exploit that as an opportunity as well, Charlie.

[Operator:]

The next question is coming from the line of Michael Briest from UBS. Michael, you're now unmuted. Now go ahead.

[Michael Briest:]

Thanks. Good afternoon. Just on the cost side of things, I appreciate the relative performance measures showing us the underlying trend there, and R&D was up a percent. Can you talk of where the savings will be visible over the next couple of years? Should we assume that R&D will continue to grow in absolute term? And also on the gross margin, it like it came down just about under a percentage point, and I'm just curious to what extent, and this is despite consulting falling more than average. To what extent, this sounds the SaaS transition and buildup of more hosting costs and what we should expect from that over the next couple of years? And then, I've got a follow-up. Thanks.

[Stephen Murdoch:]

I think it was the strategy day. It may have been earlier than that. We talked about the fact we re-architected quite a number of our SaaS solutions to be able to be deployed through the public cloud, whether that's AWS or Azure or GCP. And that's taking on-premise data centers and shutting those down and decommissioning them and moving customers to that public cloud infrastructure. We're pretty much there in terms of all of our ADM business now is onto public cloud infrastructures. And we will systematically move the rest, where it makes sense. So that's really about quality of service and long-term flexibility, the offering might -- and on the whole, it's a very good thing. And it's in in the guidance that we've laid out. So, there's nothing, there is no incremental there that we haven't already talked to. In terms of costs, we will continue to deliver our innovation agenda. We are not going to compromise what we are doing in product development at all. We think we have got tremendous opportunities in pretty much every line of the P&L where we have had to live with a degree of inefficiency over a number of years that we can now get after. And we have on top of that, opportunities to get our teams now better tools, better data, a way of doing the job faster andin terms of a more revolving fashion. And so we see quite a lot of opportunities, have pretty granular plans for cost takeout this year, and the emerging plans for how we'll do the rest next year. So, pretty confident with the plan as it stands today.

[Michael Briest:]

Just to come back on the gross margin. I mean, I’ve seen you cutting data center costs and other things, there is some savings. But, I mean the cost of hosting, obviously more than offsetting that. So should we expect gross margins to continue to trend lower and the efficiency to further down the P&L or are they sort of set to improve?

[Matt Ashley:]

Yeah. I think Marcus, Matt here. I think you'll see a continuation, slight reduction in the margin next year, then I think our cost programs will get ahead of it, and we'll see the margin turn around. So clearly, we're going after, below the line savings first. But there are some things we can do above the line that we expect. So, the answer to the question is, we do see an improvement in margin coming certainly '23 onwards.

[Michael Briest:]

Okay. And then just to follow up, Stephen. On the M&A side of things, are there more opportunities for sales that are quite sort of tangible or near, and equally, what is your appetite for doing acquisitions to enhance the portfolio? You've obviously done a few in the past, but what sort of scale would you consider?

[Stephen Murdoch:]

We've done, three or four, actually in the past 14 months, small technology-oriented tuck-ins that accelerate a piece of roadmap or provide an adjacency that rounds out solutions. We did one in behavioral analytics, for example, in security, fantastic technology, really well received by customers. We've got a pipeline of those types of acquisitions that we're continually looking at. And we'll take that opportunistically whenever it presents itself. As we move to this new product portfolio approach might give us clarity on what we need to get done there much more decisively. So we'll do more of those. In terms of future disposals, the execution plans, the same execution plan, irrespective of whether we own an asset forever, or we decide that there's a better opportunity for customers and shareholders by combining the asset with someone else like we did with Digital Safe. So all we're doing now is creating additional flexibility by improving the performance of each of oue individual portfolios to create that flexibility as we look forward.

[Operator:]

And the next question in the queue is coming from the line of Will Wallace with Numis.

[Will Wallace:]

I wanted to ask about the timing of when we're going to see – when we should expect to see certain things that you're doing come into effect. So in particular, firstly, when do you think we will see the cost savings coming through in terms of the P&L? Is it what are we going to see in H1 in terms of cost savings or do we have to wait until H2 or whatever? And secondly, a similar sort of question in relation to maintenance, and improvement, potential improvements in your renewal rates. How quickly should over that two year journey that you've mapped out? Should we expect to see that coming through? And I've got a follow-up question.

[Stephen Murdoch:]

On the cost savings, so we've been busy taking out already, so we'll split out for you. The gross impacts of the costs are taken out, and then you'll see the net impact through the P&L. The maths of it are quite unsatisfactory, frankly. If I just illustrate it with a simple model. If we take out $100 million a year for the next three years, it's clearly the average, this year is 50, next year 150, the year after 250, having taken out 300. So, it's always a bit underwhelming when you see the first half results. And it's like worth of 50 million we've taken out. And, yet more disappointment around I'm sure, but we can demonstrate the reduction in the headcount, reduction in the cost savings. And what it's also allowed us to do, and I'm quite pleased with overall industry as we were pretty clear about 500 out gross, 300 out mix, because that's allowed us to maneuver in this hot market for labor and make sure we're giving appropriate salary increases. And I was quite pleased we got on the front with that.

[Matt Ashley:]

Yeah, we're really confident in the actions we're taking will result in stabilization and maintenance. And our goal really is getting to that point as quickly as possible. The rate of progress we're expecting is modeled in those FY '23 outcomes. To the extent we can get there faster is clearly a benefit. But we're expecting the material improvements to be evident in '23 with this foundations for that being in place through the coming months in the remainder of FY '22.

[Will Wallace:]

So, the other question was on pricing, obviously, in an inflationary environment. To what extent do you have contractually getting price increases to extend you choosing to increase prices or to what extent for you to invest by effectively not putting through price increases?

[Stephen Murdoch:]

Well most of the new business that we do is project oriented and that's a value return dynamic, it's not materially shifted one way or the other by the macro environment on inflationary pressures. So that's the bulk of the new work that we would do. In terms of the pre-contracted work, then obviously, we've got a lot of renewals that run for a year or longer, and those are already priced. And when a renewal comes up for, when it comes up for renewal, we look -- we always have done and will continue to look for what the appropriate additional price increase, that is right at that time. It varies by portfolio and it varies by country and it varies by circumstance. But it's not -- the macro inflationary pressures don't present a material upside for us.

[Operator:]

And there are no further questions in the queue. I'll now hand it back over to your host Stephen to conclude today's conference.

[Stephen Murdoch:]

Thanks everyone. We did a pre-close in November, and we're delighted to be able to reconfirm those numbers today. We also laid a detailed plan and objectives at the strategy day at the end of November. So roughly 60 days ago, again, we're reconfirming those goals today, and that we've made material progress since completing the sale of Digital Safe and separating the business, refinancing part of our debt to smoother profiles we committed to do, identified and began executing on cost and efficiency opportunities. And incrementally, we're really pleased with the product agenda, the reaction we're getting to that from customers, and we feel increasingly confident in our ability to deliver the exit trajectory that we've committed to for '23. And we'll just get back to the day job now and see how we can make progress faster. Thanks everyone.

[Operator:]

Thank you, everyone, for joining us on today's call. You may now disconnect your handset. Hosts, please stay connected.