Half Year 2022 Micro Focus International PLC Earnings Call
Good afternoon, and good morning, everyone.
Today's earnings call covers the six months ended the first half of April 2022.
I am pleased to be joined today by Steve Murdock, our chief Executive a massage Lee our Chief Financial Officer.
The slides to this presentation will be presented as part of the webcast facility accompanying this call. So those causes pricing bus Titan 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 the call finishes.
After the presentation, we look forward to cover and 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.
Hello, everyone and welcome to our interim results presentation.
Summarizing progress in the half were in line with where we expect it to be and within not squarely to behind on revenue ahead on cost cash was strong and we delivered on our product innovation commitments.
We suspended operations in Russia in Q2, and this impacted revenue by just under half a point.
Looking beyond the headline figures there is clear evidence in the underlying portfolios that our efforts to grow in key areas and improved levels of high quality recurring SaaS and subscription revenue are gaining traction.
For example, we're now on track and three of our four sub portfolios in cyber and we delivered another period of double digit growth in mainframe modernization independent all of our strategic partnership with AWS.
The license performance was disappointing as we are not yet able to smooth the volatility that large transactions in our more mature portfolios can cause in any individual period.
Maintenance revenues remain a critical priority and whilst we still have much to do our actions are beginning to deliver results with the rate of decline improving by approximately two percentage points from the FY 'twenty one exit run rate.
There is also growing evidence of improving trends in the underlying metrics and a number of our key focus areas.
Overall, we're pleased with the progress on product, having delivered new solutions in every portfolio, including important SaaS capabilities in Idaho and in cyber.
Looking more broadly it feels like a whole new world to zoom out since we last spoke.
The geopolitical uncertainty created by Russia's inpatient of Ukraine.
The resulting impact on energy prices and global supply chains.
Combining to slow growth on spike inflation.
Not to mention the dramatic collapse in tech valuations have made the market backdrop, clearly more complex or even unprecedented.
Of course, not immune to macroeconomic factors, particularly relating to costs on investment cycles, but I do want to take a moment to draw it to a few important points.
We have proven products with a widespread of customers' sectors and geographies.
We have a highly cash generative operating model.
Our value proposition is focused on enabling customers to maximize the iron Oi from the investments to make in technology.
In essence, we help them get more value from what they already have and bridge from this to exploit new opportunities such as SaaS cloud and AI.
Executing well. This means we are an investment priority for customers even in a more constrained environment.
So against a much more challenging macro backdrop.
It's not immune we do have inherent strengths on which to focus.
Finally, we made progress on our strategic priorities in each one.
We're focused on continuing this through the remainder of this year and into next.
That let me hand over to Matt to take you through the numbers.
Thanks Steven.
Our financial performance is in line with our expectations.
Revenue of $1 3 billion, a constant currency decline of six 8% year on year, excluding digital sites adjusted EBITDA of $437 million.
Underpinned by our cost reduction program and perhaps most importantly, free cash flow generation of $190 million, representing a 36% increase on H $1 21.
We committed to reduce exceptional spend and we have done. This has led to an overall improvement in the quality of our earnings we completed the sale of digital safe and have used proceeds to pay down debt.
As a result, our net debt has reduced by over half a billion since October and Leverages, we choose to fund all three times.
We successfully refinanced $1 6 billion of debt in January of this year. There was a good chance. This transaction, we'll win our treasury team refi the year on the basis that it may prove to be just about any refi healthy year.
Finally, we are proposing an interim dividend of eight <unk>.
Financial performance.
Usual, we've presented our trading performance on a constant currency basis to present, the underlying trends in the business in the period. The U S. Dollar has strengthened against all major currencies. This has resulted in a 2% headwind as a revenue line on a 4% headwind will $20 million and adjusted EBITDA lines.
We match, our dollar and Euro earnings to a dollar and euro debt.
This hedging strategy works the headwinds in EBITDA are offset by the reduction in our debt, which was around $120 million in the period.
Our cost base reduced by five 3% on a net basis. This reduction reflects our cost saving program, which is being partially offset by inflation, which we budgeted for at circa 5% per annum.
The combination of the revenue and cost actions delivered an adjusted EBITDA of $437 million, that's a margin of 35%.
Cost actions combined with a material reduction in exceptional spend is leading to an improvement in the quality of our earnings.
We generated an exceptional credit of $42 million in the <unk>.
First half compared to a charge of $143 million in the first half last year.
The profit on disposal of digital safe of $63 million.
It was partially offset by the $21 million spent on our cost reduction program.
The silver lining to the docs out which is hot labor market is that we have been able to use attrition and redeployment to minimize the exceptional spend we now expect to spend around $50 million in total in the full year compared to the previous guidance of $100 million.
Turning now to revenue.
This waterfall reconciles half one 'twenty one to harmful in 'twenty two.
Excluding $56 million of revenue from digital safe and the $35 million FX headwind. The starting point is 1335 at constant currency.
During Q2, we suspended our Russia operations, we have not restated for this impact.
Which reduced revenue by 3% in the half for completeness, we generated $40 million of revenue last year from Russia.
License.
Whilst we are in line with our expectations overall outperformance in license revenues disappointing with a decline of seven 9% against what was strong growth in the previous period.
This decline is because we are still seeing more volatility within individual periods when we would like.
Initially our growth portfolios are not yet at a scale to fully offset the volatility of our more mature protocols and which new license deals are by nature lumpy.
Combination of these actions underpins our goal of delivering consistent and sustainable growth in license revenue we.
We have made progress in delivering this because we're not there yet.
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Maintenance revenue improved by two percentage points from the exit run rate in half two last year.
This is in line with our planned trajectory and is improving but it's still below our medium term ambitions.
Thanks.
Performance in the period is encouraging here revenue increased by eight 7% compared to the first half of 'twenty one.
This is the third period of sequential improvement. We now are in the position where SaaS revenue will deliver growth over the medium term, we expect it to accelerate to double digit growth.
Finally consulting consulting revenue declined by eight 5% and in line with license revenue.
We are on track to deliver our FY 'twenty to Casa.
Please standby one fabless D connection with your presenters. Thank you.
Cash generation.
Here you can see how we are beginning to turn more of our adjusted EBITDA into cash rather than invest it and exceptionals.
Micro focus remains a highly cash generative business.
Overall, we have delivered an increase in free cash flow of 36% to $119 million in the first half compared to the first half in 'twenty one.
In February I spoke of three drivers for this improvement one reduction in exceptional charges to improvement in working capital and three reduce tax spend.
Our exceptional spend in the period is entirely related to the cost reduction program and we will continue to seek to minimize exceptional spend going forwards.
Working capital.
The group had a working capsule implied a $56 million in the first half this.
This is down on the prior period in July of $79 million, but that included the provision for the wet legal settlements of 75, if you normalize for this the improved working capital position was $52 million.
Our adjusted cash conversion in the first half was 113%, which demonstrates the seasonality of our billings.
Finally tax.
In the current period cash tax payments have returned to normal levels and have reduced from $129 million to 78.
Half year includes a one off payments in respect of EU state aid a $47 million.
We expect cash tax payments of approximately $130 million for the full year.
So in summary, we've improved our free cash flow from 140 million to $190 million in the first half of.
This has been achieved by a reduction in exceptional spend and lower tax looking forward to the full year. We now expect exceptional costs to reduce from our previous guidance of $100 million to approximately $50 million, excluding the profit on disposal of digital safe.
And our cash tax is expected to be approximately $130 million, representing an improvement of around 120 million year on year.
Our adjusted cash conversion for the full year is expected to be approximately 95% to 100% an improvement of seven to 12 percentage points year on year.
We have reduced both gross debt and leverage.
The group's net debt to adjusted EBITDA ratio was four times at the year end.
At the end of the first half reduces to three seven times and reduce net debt by $545 million.
January we announced the $1 6 billion partial refinancing of our term loans and in doing so increase the average maturity of the group's debt by year.
Our next maturity date on our lines as June 2020 for two years from now.
This is part of our plan to alter our capital structure splitting the $3 3 billion term loan with the intention of creating smaller tranches of debt that we will refinance honestly the path.
We currently use a combination of hedging instruments on the Senate floor in our euro debt to protect ourselves against rising interest rates the structure of our financing does therefore allow for an element of protection against potential rate rises.
We have provided some analysis on this as an appendix plus a 1% increase in both euro and U S markets would result in $27 million of incremental interest expense.
Finally, with respect to debt and leverage I will reiterate the reduction in leverage over the medium term remains a key priority of the group and our ambition is to reduce our gearing to around three times.
Our guidance for 'twenty two remains unchanged, we are working to absorb the reduction in revenue due to Russia.
We are aiming for $200 million of annualized savings on Exceptionals, we have improved our guidance, reducing our spend from $100 million this year to 50.
For the full year, we expect our adjusted cash conversion to be between 95, and a 100% staying on cash there are no changes on capex of $200 million cash tax of $130 million in interest cost of $230 million.
I'll now hand back to Steven to provide an operational update and outline our priorities for the next two years.
Thank you Matt.
I know you want to cover the individual product groups focus specifically on the main drivers required to underpin the FY 'twenty three trajectory.
AMC is at the heart of mainframe modernization on the move to cloud based solutions, we delivered double digit growth in each one.
And Additionally, the AWS money service solution launched formally last month as planned.
And once this contract begins to ramp in FY 'twenty three the underlying improvements will become more evident at the product group level I.
I will cover more in this area in a moment.
And ADM SaaS performance is encouraging.
We're seeing a combination of new customers on the transition of some of their existing customers to either a SaaS solution or a hybrid SaaS and on premise solution.
Going forward. This will result in a remix of revenues to SaaS on longer term improvements in the quality of recurring revenues within this portfolio.
As you know I told him as a part of the portfolio, where we have had the most work to do to reposition product roadmaps.
We've accelerated progress over the past 12 months with the launch of multiple new SAS offerings and key capabilities such as AI.
These actions coupled with improved customer engagement are the key to stabilizing maintenance revenues and improving performance overall with an idle.
In cyber we're very much where we expect it to be if not a little bit ahead.
We're delivering growth in both license and SaaS overall and growth in total revenue in two of the four sub portfolios as planned.
The trajectory is improving and the remaining two portfolios and we're making progress in moderating the rate of decline in maintenance within oxide.
Our goal is to accelerate this such that we deliver growth overall ahead of plan.
I M G. Jessica was behind our expectations on headline numbers, but saw strong growth in annual recurring revenue.
The goal is to scale this to balance secular declines elsewhere, resulting in a stable highly cash generative portfolio.
There has been a great deal of interest in mainframe modernization and I thought it was timely to provide a fuller update given the formal launch of the AWS solution offering earlier this month.
This market is growing and we're incredibly well placed to continue our leadership position.
We've been delivering for customers in this area for decades and have completed studies of projects and order of magnitude more than any of the competition.
Since we enable customers to modernize the mainframe applications.
Exploit breakthrough improvements in technology, such as cloud.
The processes such as Dev ops.
We engage directly with customers.
With all of the main global services providers are now strategically with the major cloud providers.
On AWS, specifically the formally launched the managed services offering last month with our technology a core element of the solution.
We've been working together to grow the pipeline have begun services engagements with customers to evaluate the solution and expect subscription revenues to begin to ramp in FY 'twenty three as planned.
Through this combination we are building a suite of high quality solutions with Blue Chip partners and expect to see more announcements in H two.
Finally, two important customer examples firstly Santander, where technology is at the heart of digitizing the core banking applications.
And Ali owns going live in their latest step to becoming a cloud only company.
Early days, but encouraging useful.
Let me close by reminding you of our priorities for the second half of this year and into next.
Starting with customers, we deliver solutions that help solve some of the most complex challenges they face day to day.
To do this we need to make sure. They can leverage the innovation, we are delivering which in the past we were inconsistent in doing.
Our focus is on the installed base targeting the deployment of our latest products and the innovation and improving service delivery capability.
This is key to renewal rates improvements in both maintenance and SaaS.
Onto our competitiveness and winning new projects.
Operationally, our focus is on becoming a more agile company able to execute efficiently and adapt to the risks and opportunities we see.
Our cost efficiency programs are on track for FY 'twenty, two and we're now working to deliver the next phase with more focus on reengineering processes and simplifying structure.
Finally, moving to a product group structure is about two things.
<unk> alignment of talent and product end to end such that we're better able to support and win new customers.
The optimal way to do this differs by product portfolio.
This shift enables us to reflect that in how we run the business day to day.
The second objective builds on this by creating the flexibility to differentiate how we structure and report the group.
In closing motto laying the specifics for FY 'twenty to the earlier, so I won't repeat the detail, but I will reiterate the commitment to delivering what we said we would and that we are working to mitigate the full year impact of Russia.
This means continuing to grow and sauce working to reduce and ultimately removes the volatility in license and accelerating progress in maintenance <unk>.
The macroeconomic headwinds I mean, the truth is even more important that we continue to execute the operational and financial discipline shown in each one.
We will continue to be highly vigilant on nutrition cost inflation and customer decision making cycles.
More strategically we remain committed to stabilizing revenue generating strong cash flows reducing leverage and building a leaner more agile business that is flexible and better positioned to exploit market opportunities.
With that let's open up the call for questions.
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Our first question comes in from the line of Charles Brennan, calling from Jefferies. Charles Please go ahead.
Great. Thanks, guys just two questions from me actually.
Firstly, all openly admit I'm not particularly good at modeling the interest charge for Alphatec companies.
Very helpfully, given us the $230 million cash number for the year.
Just two questions around that what does that look like in terms of P&L charge.
If we assume the current yield curve remains as it is what does that imply for next year.
And then secondly on a separate topic related to inflation, we're seeing a number of software companies using that as a vehicle to push through some outsized price increases.
A lot of cases, it's leading to the pull forwards of of customer demands.
Obviously, we can't really see that in your license performance. So can you just give us some insights into what youre doing with pricing and if you are changing prices when does the price list kicking thank you.
Hi, Charlie Steven.
The second question and then I'll hand to Mark for the first question.
Our license business is typically project driven so it's typically business case oriented rather than list price oriented and each of those deals gets negotiated individually.
At the point in time directly with the customer so it's less about the list price in that environment and therefore less about.
Place leverage if you like and more about effectiveness of deal negotiation, where we do have.
Pricing opportunities and renewals both in SaaS and then on the maintenance and there we've been pursuing.
Increased fees at the time of renewal wherever it's appropriate for us to do so.
A little bit by portfolio in terms of how hot we can push that but in every renewal we look for the appropriate price.
This opportunity at that time, so it's different between the project business in the the renewals business Charlie.
Mark do you want to take.
The interest, yes, sorry, yes.
Yes, cash $230 million, the P&L is higher because.
We pay upfront fees on the refi that we did which are amortized over the period of the lines.
I guess, if you add on 20% to 25 million you wouldn't be far away.
Perfect and just.
To help me out if the yield curve stays where it is <unk> 23.
Say, where.
Looking at around $2 17 for the.
The.
Cash.
<unk>.
A similar increase after the P&L charge.
Perfect awesome. Thanks.
Keith.
Just as a reminder, before we move to the next question that if you would like to ask a question on today's call and to please press star one on your telephone keypad.
And our next question comes in from the line of will Wallis, calling from Numis. Please go ahead.
Afternoon. Thank you.
For me that in place, but they're related firstly just in terms of what the.
Current market conditions I was just wondering what you were seeing in terms of customer behavior. As you went into the end of the of the halls and whether you've seen detected any further.
Customer caution.
As you've moved into the beginning of the second half.
On a related question really in terms of your own costs.
What have you been seeing in terms of stops.
<unk> rates again have you seen any any signs of that improving in the most recent couple of months.
Yes, Thanks will.
That was at the end of the quarter.
And I suspect that will continue for the foreseeable future. There was much more scrutiny on individual projects sign off within within customers. So typically longer decision, making cycles higher levels of sign off more scrutiny on more scrutiny on business cases is pretty typical in a in a constrained.
Economic environment you.
Normally see that behavior.
Our goal here is that we tend not to be a discretionary spend a toll in terms of the software and the use of the software given its mission critical nature. There is some degree of discretion around the timing of when you initiate.
A big upgrade cycle for example, so our focus is on making sure that if and good things that customer could afford to drive 10 projects and in tight times. They can afford to try five projects. We are always number four on the list. So we just need to start earlier and.
Make sure we take into account longer decision, making cycles and higher.
Higher approval levels and how we can scale the business cases, but no question. There is if there is significantly more scrutiny on customer spend thats for sure.
In terms of.
At the current market costs Sun.
The nutrition.
It's been an incredibly hot labor market through the first well probably the last nine months.
A combination of things coming together and being talked to by the loss of times create resignation.
Countries coming out of Lockdown.
And we've not been immune to that we've had heightened attrition overall.
But pockets of really quite high attrition, where we've got highly skilled people one on a hot market and on demand.
We monitor it week.
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Hi.
Being stabilizing over the past month or so.
I would probably know you anticipated slowing and on going the other way.
And you've already seen.
Other major tech players talking about hiring freezes on some of the the.
Hearts are startups on the West coast bypass.
Pulling back and reading, but so I suspect, we'll see an element of moderation.
In the market, but we do have we do have highly talented people and we are often targeted to get those people into other companies were also an attractive place to Luckily we hired almost 1000 people in in the last seven or eight.
Well since we closed the year is about a thousand people. So it's it's a hotspot so watch out.
But I do think it will moderate from here.
It's actually been helpful. In some areas of our business you've seen that play through in our exceptional spend being being down because we've monies to redeploy.
People to openings and we've managed to exit people without.
With those severance costs, so puts and takes I would say I would say well.
Thank you.
Thank you. We currently have no further questions coming through so as another reminder, if you would like to ask a question on todays call. Please press star one on your telephone keypad now.
And we do have another question coming through from the line of will Wallis calling from UBS. Please go ahead will.
I thought I'd ask a second question.
That's less of the queue.
At this time on our maintenance and your retention rates and maintenance side, obviously, we've seen the rate of decline in revenue.
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To what extent have you actually seen retention rates, improving and maintenance is that consistent across the business as a whole or other sort of still hotspots of high maintenance, particularly high maintenance attrition, perhaps you could give us a little color there.
Sure thing.
We've seen rates either improve or moderate trading broadly across the across the portfolio. We still got work to do in those four sub portfolios that highlighted previously, but all four of them all four of them improved.
As part of the reason, we're moving to this product group structure as it allows us to get after the specifics of why we would have an issue in the sub portfolio much quicker.
Much more coherently end to end in terms of the lightning likening resources. So we do have we do have areas, where we're very pleased with the renewal rates. We do have areas, where we still got work to do overall, we've got opportunity and we think we're taking the right actions very specifically to those sub portfolios and overall to begin to.
Improved as soon a sustainable basis moving forward.
Thank you.
Thank you and that was the final question for today, So I will turn the call back across to yourselves Stephen for any concluding remarks.
Okay. Thank you.
We're confident in the actions that we're taking are the right actions to deliver the revenue trajectory commitments that we've made.
So gross sauce.
Assistant Lee and drive it to double digit.
Double down on the growth portfolios that we have and drive those consistently into double digit growth moderate.
Declines in maintenance systematically and sustainably.
Remove the volatility in license.
And in each one we improved free cash flow, we reduced leverage and we make progress against this against our strategic objectives Theres no change to expectations for revenue cost so cash for FY 'twenty. Two we are working hard to mitigate the increased risks arising from <unk>.
Tough microenvironment.
We remain absolutely focused on the strategic priorities, we have for the FY 'twenty three.
So with that I'd really like to thank you for your obtained today and I look forward to speaking to you more one to one thank you.
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