Open Text Corporation (NASDAQ:OTEX) Q2 2023 Earnings Call Transcript

Open Text Corporation (NASDAQ:OTEX) Q2 2023 Earnings Call Transcript February 2, 2023

Operator: Thank you for standing by. This is the conference operator. Welcome to the OpenText Corporation Second Quarter Fiscal 2023 Financial Results Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. I would like to turn the conference over to Harry Blount, Senior Vice President, Investor Relations. Please, go ahead, sir.

Harry Blount: Thank you, operator. Good afternoon, everyone, and welcome to OpenText’s second quarter fiscal 2023 earnings call. With me on the call today are OpenText’s Chief Executive Officer and Chief Technology Officer, Mark J. Barrenechea; and our Executive Vice President and Chief Financial Officer, Madhu Ranganathan. Today’s call is being webcast live and recorded with a replay available shortly thereafter on the OpenText Investor Relations website. Earlier today, we posted our press release and investor presentation online. These materials will supplement our prepared remarks and can be accessed on the OpenText Investor Relations website, at investors.opentext.com. I’m pleased to inform you that OpenText management will be participating in the following upcoming conferences: Bernstein’s Technology, Media, Telecom and consumer one-on-one forum on March 1 in New York and Scotiabank’s TMT Conference on March 7 in Toronto.

And now on to our Safe Harbor statement. Please note that during the course of this conference call, we may make statements relating to the future performance of OpenText that contain forward-looking information. While these forward-looking statements represent our current judgment, actual results could differ materially from a conclusion, forecast or projection in the forward-looking statements made today. Certain material factors and assumptions were applied in drawing any such statement. Additional information about the material factors that could cause actual results to differ materially from a conclusion, forecast or projection in the forward-looking information, as well as risk factors that may project future performance results of OpenText are contained in OpenText’s recent Forms 10-K and 10-Q, as well as in our press release that was distributed earlier this afternoon, which may be found on our website.

We undertake no obligation to update these forward-looking statements unless required to do so by law. In addition, our conference call may include discussions of certain non-GAAP financial measures. Reconciliations of any non-GAAP financial measures to their most current — most directly comparable GAAP measures may be found within our public filings and other materials, which are available on our website. And with that, I’ll hand the call over to Mark.

Mark Barrenechea: Thank you, Harry, and welcome, everyone, to our fiscal 2023 Q2 call. Madhu and I are delighted to be hosting today’s call from Ottawa. Tomorrow, we ring the opening bells to NASDAQ live from the nation’s capital. It is NASDAQ’s first opening from Canada and tomorrow is a recognition and celebration of Canada’s and OpenText’s leading role in global technology innovation. We’re a differentiated young company and we’re just getting started. Let me get right to the most important points today. OpenText had a truly superb Q2, achieving overall constant currency revenue growth of 7.8%, which reflects very strong cloud revenue growth of 16%, excellent renewals performance and continued focus on efficiency with 37.7% adjusted EBITDA margin, even as many of our team members also worked very hard to prepare for the close and integration of Micro Focus.

Many of the same secular factors that contributed to our growth have only increased our confidence and the potential that we see in the acquisition of Micro Focus. Specifically, in an increasingly connected and data-intensive world, our customers need actionable insights and information, strong security and continuing innovation and the tools that they need to accelerate, the digital evolution of their complex business environments, in order to securely deliver on their customers’ expectations and do so efficiently. We are on track to deliver on every commitment we made at the time of the Micro Focus acquisition announcement. I’ll elaborate later, but we are more confident than ever about the value we can create for our shareholders, customers and our employees and the performance we can realize by applying the OpenText business system at very experienced integrators.

We have a proven track record that has been refined through the course of integrating many large acquisitions over the last decade. In addition, you’ll hear today that we’re on a path to deliver $6 billion in annual revenues, a $2 billion cloud revenue business and over $2 billion in adjusted EBITDA dollars with upper quartile free cash flows based on the trust of our customers. There’s five specific topics I want to cover today. One, our vision, our differentiation and how we plan to win in our markets, two, delivering on our expanded information management mission and growth programs; third, multiyear financial milestones and aspirations, including our superb Q2 results, fiscal ’23 growth markets — we discussed today our preliminary F ’24 growth targets and even stronger F ’26 aspirations.

We’ll also talk about our strong capital allocation approach and plan and how we intend to create value with the OpenText business system. Let’s get into it. First, our vision, our differentiation and how we plan to win in our markets. Markets are never static. Through time, we’ve expanded information management, to include many types of content experiences and business networks. With a Micro Focus acquisition, OpenText Corporate Mission expands again, this time to help enterprise professionals secure their operations, gain more set into their information — more insight into their information and better manage increasingly hybrid and complex digital fabric with a new generation of tools that include cybersecurity, digital operations management, applications automation and AI and analytics.

Digital Life is life, and this is generation digital. We call this business 2030. Organizations can only achieve their strategic aspirations by becoming digital leaders and top economic performers are already investing disproportionately in digital capabilities. We’re on the cusp of a new world era, driven by digital, new productivity and harnessing the world assets, unlocking human potential, the reshaping of economies by the frictionless flow of goods, people, capital ideas and the new uses of technologies that will drive the next big arena of value and competition. Business 2030 will be achieved through 4 digital transformations. Total enterprise reinvention. €“ every industry totally transformed by digital, a new workforce led by Generation Y and Z and only a digital mindset, new digital paradigms and sustainability, climate, trust and social justice and new digital requirements and extended reality, voice and facial interfaces, diverse and AI.

Organizations will continue to be the process advantage, of course, which they receive from ERP and CRM vendors, but the process advantage requires data and actionable insights. Customers need the information advantage, which they receive from OpenText forged by digital. I speak with a lot of customers and their business operations are getting more complex as they operate across many countries, many regulatory authorities, platforms, endpoints and cloud, including the rocketing security and industry compliance requirements. Process and information for is increasing for business information and automation that spans commerce, supply chain, service management, asset management, payment systems, financial systems, communications and service management.

The more connected business becomes the more complex of business operations. At OpenText, we have the end-to-end software and cloud capability to help customers make this transformation rapidly and cost effectively. This is why I like to say we are the platform of platforms for information management. Customers need a single real-time view of information across these complex business infrastructure, that is intelligent, connected, secure and responsible, that is what we do, and it is unique. This is the OpenText Information Advantage. Specifically, we believe there are six-key markets required to enable the Information Advantage and deliver the high-impact digital transformation required for business 2030 and winning in this new digital era.

The six markets are these. Number one, content services, which include experiences; number two, business networks; third, cybersecurity; fourth, application automation, which includes ADM and AMC; fifth, digital operations management, formerly ITOM; and sixth, analytics and AI. We are organizing around this strategic and growing totally addressable market of $200 billion plus, and we’ll keep you updated on our progress in these six market areas. Second thing I want to talk about today is delivering on our expanded information management vision and growth programs. It’s been a great first week speaking with Micro Focus, employees and customers and we have already completed our leadership, structural and key people integration. There’s an enormous amount of energy and excitement.

Please recall the transactional financial highlights are as follows. We paid an enterprise value of $5.8 billion financed with cash and debt. This equates to a revenue multiple of approximately 2.3 times and an adjusted EBITDA multiple of 6.7 times, a very attractive multiple and the business is immediately accretive to adjusted EBITDA dollars. Moreover, we love the amazing talent, marquee customers and great products, including idle in the content space, Vertica and AI, Fortify, Voltage and Security, SMAX in digital operations and load runner and Value Edge and applications automation, including critical maintain technologies that power the Global 10,000 today and tomorrow. We also intend to fix the things that need fixing, accelerate to the cloud, reinvention of the customer engagement with the OpenText love model, centralizing renewals and implementing OT best practices and rightsizing the organization for speed, impact and growth.

On growth, let me summarize a few key programs. OpenText delivered a 95% renewal rate for off-cloud in Q2. We expect to make steady progress in transforming the customer experience with Micro Focus products and raising their low 80s renewal rates to ours by the end of fiscal 2025 or sooner. Rapid innovation, the highest correlation to high renewal rates as product value, and we are taking several actions to accelerate innovation to all our customers. Specifically, we are immediately engaging customers to migrate to the OpenText private cloud for all major Micro Focus offerings and transitioning Micro Focus to our 90-day release cycles to accelerate innovation. Within these Zix markets, customers will benefit from some fantastic new product value.

Our growth strategy is to win the Zix market and go deep in each space with select and strategic cross-market integrations that include cloud, AI and security. Let me highlight some of those growth areas in our Zix markets. In the content space, we intend four programs to help customers expand the areas of digital potential. We’re going to leverage our new idle capabilities to incorporate new business workloads that leverage voice, video, imaging and facial recognition. These are all new workloads we can bring content into. We’re going to offer the OpenText private cloud capabilities to all Micro Focus customers to accelerate innovation. We’re going to deliver the most secure content platform in the market with our new voltage. And with Titanium gain larger share in SaaS ECM market.

We’re on track with Titanium. In the business network space, integrate our new Vertica advanced analytics and machine learning capabilities and to the OpenText trading grid to provide massive data analytics to drive the next generation of supply chain transformations and leverage our new digital operations management capabilities to increase the speed of change, the rate of change within the supply chain. Security is job number one. In cyber security with the acquisitions of Carbonite, Zix and Micro Focus security products, OpenText is now one of the largest cyber security businesses in the world. We’ve created a single go-to-market motion covering enterprise, SMB and consumer, providing a complete cyber security stack in the marketplace from endpoint, forensic, identity, encryption and cloud-based application security.

We intend to invest in cybersecurity, gain share and ensure this is a top driver of customer value from OpenText. With our applications automation space, we’ve added significant new DevOps capabilities and performance, quality and application testing within our — with our cloud scale and experience, we will turn up the volume in helping customers use these new tools to migrate and modernize into the cloud even faster. And our new digital operations management space will help customers increase service levels and customer experiences by integrating extended ECM and digital operations. We ran this play very successfully with SAP applications, we’ll run it again with ECM and digital operations. And in Analytics & AI. We believe Vertica is a gem.

We have two per value plays. Integrate Magellan in our new Vertica for stand-alone AI and analytics and the two products already have their initial integration, and we demoed it live this week and embedded Vertica and all our major offerings from content, business network and security. Information management in the cloud, secured intelligence and at scale. Customers will benefit from some fantastic new product value. On our cost reduction programs, we confirm our approach to removing 400 million of combined company costs over the next 18 months, by reducing overlapping work, removing inefficiencies, eliminating redundant facilities and automating work. Madhu will speak more about this in a few moments. Earlier this week, we announced our plan to rightsize our combined workforce from 25,000 employees to 23,000 employees or an approximate reduction of 8% within fiscal 2023.

This reduction is solely driven by the acquisition and we still plan for strategic hiring of key roles in select geographies to help us drive growth and innovation. This is going to be a rapid value-accretive integration. Thirdly, I want to talk about today is our growth plans, financial milestones and aspirations. As I said at the start, we had a superb Q2, and we’re integrating Micro Focus from a position of strength. Let me walk through some of our Q2 highlights and year-over-year constant currency. It’s our eighth consecutive quarter of cloud and ARR organic growth. We delivered $945 million in total revenues or 7.8% growth, $423 million of cloud revenues or 16% growth, and with Micro Focus, our cloud revenues are going to approach $2 billion a year.

We reported enterprise cloud bookings growth of 12% and our adjusted EBITDA was 37.7%. On a reported basis, we delivered $163 million of free cash flow and adjusted EPS of $0.89 or $0.94 in constant currency. I couldn’t be more pleased about what we have accomplished with and for our customers this quarter. We have strong customer adoption of cloud additions within the quarter RR. Donnelley, Lear, Royal Bank of Canada, Los Alamos National Laboratory, AMD, The US Defense Health Agency and Transport of London. We’re excited to partner with these leaders as they accelerate their digital transformation and look to own their digital capabilities. In an uncertain environment, we continue — we see continuing high customer engagement and strong demand for our solutions.

Last quarter, I talked about the current and compounding challenges in the world, inclusive of currency, wage and goods inflation, fuel prices, Russia’s war in Ukraine, supply chain constraints, skill shortages and more. Many of these trends continue. The only answer is digitalization to deliver insights, improve efficiency and lower costs and our strong Q2 results reflect the corresponding increasing need of businesses to partner with OpenText. It is clear that technology is playing a significant role in boosting productivity in the face of these challenges and technology is a greater portion of GDP today. IDC’s research makes it clear that technology budgets are growing. They forecast IT spend will grow 5% in 2023 this year, software spend at 8% and Software-as-a-Service spend at 15%.

Transitioning to our financial outlook, we promised more visibility, and we are providing it today. In our investor presentation, we have provided our updated F2023 target, F2024 preliminary targets and our F2026 aspiration, each include Micro Focus. Let me summarize in year-over-year terms and in constant currency. Our F2023 targets include total revenues up 28% to 30% or $4.47 billion to $4.55 billion with Micro Focus contributing between $870 million to $920 million continued enterprise cloud bookings growth of 15% plus. The total company is expected to grow organically. Adjusted EBITDA dollars between $1.46 billion and $1.52 billion, or adjusted EBITDA margin of 32.5% to 33.5%. Reported cash flow of $500 million to $600 million impacted from integration spend.

It will be a year of cloud acceleration and onboarding Micro Focus. Let me provide our preliminary for F2024 targets. Total revenues, up 33% to 35% or $5.7 billion to $5.9 billion of total revenues. Enterprise cloud bookings growth of 15% plus. The total company is expected to grow organically. Adjusted EBITDA dollars between $2.1 billion to $2.24 billion or between 36% to 38%, approximately $800 million to $900 million of reported free cash flow. And let me spend a moment on Micro Focus and fiscal 2024. We are baselining Micro Focus revenues to our financial quarters in to our standards and expectations. We want to make this simple and clear for you. They ended their last fiscal year at approximately $2.5 billion in revenues and declining mid single-digits.

Our revenue baseline for fiscal 2024 is approximately $2.3 billion in annual revenues and that is what we’ve modeled into our F ’24 preliminary targets. The F ’24 baseline includes transitioning from IFRS to US GAAP, transitioning to our reporting periods, our seasonality and the complete exiting of Russia, their previous sale of Digital Safe and stopping some non-strategic items. To be clear, that is all history now. The baseline for fiscal 2024 is a stable $2.3 billion, from which we intend to grow organically in fiscal 2025. Now if you want to do the forward metrics on the purchase price, that is 2.5x forward revenues that the midpoint of adjusted EBITDA 6.8x. This is an outstanding value purchase. We are replacing our F ’25-year aspirations with our F ’26 aspirations.

Total company organic growth up 2% to 4%. Enterprise cloud bookings continue at 15% plus adjusted EBITDA margin expansion to 38% to 40% and reported free cash flows of $1.5 billion plus. Fourth thing I want to talk about today is our capital allocation approach and plan. We have a strong three-year plan, and we have the leadership, talent and tools to deliver. We’re on a clear path to build a $2 billion cloud revenue business and $2 billion plus in adjusted EBITDA dollars. Based on this, our capital allocation approach can be summarized as following: a rapid delevering program. Starting in fiscal Q4, we expect to pay down our debt by a minimum of $150 million a quarter in over eight quarters until we are under 3x leverage, continuance of our dividend program.

We intend to grow our dividend as our free cash flows grow. The OpenText Board approved a cash dividend of $ 0.24299 per share with a record date of March 3 and a payment date of March 23. Share count, our long-term plan is to hold our share count constant. Our business model is being designed to have a 20% plus conversion rate from revenue to free cash flow. This is upper quartile performance and we’re on that path. Before I wrap up, let me just speak to how we create value with the OpenText Business System. The company is focused on growth, profits and creating value. We see three key stakeholder groups in the OpenText Business System, customers, employees and shareholders. For 125,000 enterprise customers with 1 million SMB businesses and 8 million home users, it starts with world-class delivery, trust in our products in cloud and the OpenText love model, land, operate, value, expand and creating a customer for life.

For employees, we invest in three areas: performance, achievement and learning. And for our shareholders, total revenue growth that includes organic and acquired revenues like our superb Q2. A reinvestment strategy for growth with customer-informed R&D and sales and marketing, building a digital business that removes cost, improves productivity via higher automation, upper quartile adjusted EBITDA margins, strong free cash flow with a yield of 20% plus our capital allocation plan, as I previously noted, and continued acquisitions. We intend to acquire strategic assets that create value, leveraging the OpenText business system as we just did with Micro Focus. This is our virtuous cycle, how we create value using the OpenText Business System.

Let me express something beyond our numbers in our business system. I have strong confidence in our business, team and plan. And I’ll keep you updated in the coming quarters as to our progress. I’ve always liked the model from the great state of Missouri, the ShowmeState. Our results will speak for themselves. In summary, OpenText is a unique company as we understand the complexity of our customers, and we help them reliably manage that complexity. As a result, we have earned their trust every day, and we delivered the market value with the information advantage. I’ll end my prepared remarks by reviewing the comments we made at the time of the Micro Focus acquisition announcement. One, we are reaffirming returning Micro Focus products to organic growth.

The five months of fiscal 2024 will be on-boarding, F 2024 a year returning to constant and F 2025 organic growth. Accelerate cloud growth on a combined basis, expect enterprise cloud bookings growth of 15% plus. We expect to transform the Micro Focus customer engagement and renewal model, as previously noted. The acquisition is dollar accretive from Day 1, and contribute significantly more as we integrate, take cost out, improve renewal rates and return to organic growth. Upper quartile adjusted EBITDA margin of 36% to 38% in fiscal 2024 and 38% to 40% in fiscal 2026. Upper quartile free cash flows of $800 million to $900 million in fiscal 2024, $1.5 billion plus in fiscal 2026. Rapid de-levering, continuation of our dividend program and enhanced visibility as we’re doing today and we’ll continue to do so.

We’re on track to deliver on every commitment we made. Let me express my deepest gratitude to our customers that place their trust in OpenText every day. My deepest gratitude to our OpenText colleagues who €“ who did outstanding work over the last six months completing the acquisition, delivering an amazing Q2 and strong momentum into the second half of this fiscal year and doing the hard work to prepare for applying our proven integration playbook. And finally, a huge and warm welcome for 11,000 new colleagues from Micro Focus customers and value-added partners. We will grow and innovate as United OpenText. We the one that brings peace €“ bring peace for all. Let me turn the call over to Madhu Ranganathan, OpenText’s CFO and my business partner.

Madhu.

Madhu Ranganathan: Thank you, Mark, and thank you all for joining us today. All references are in millions of USD and compared to the same period in the prior fiscal year and are on a reported basis unless I state otherwise. During Q2, at OpenText, we redefined one more time what consistent and solid execution means. We delivered a superb quarter of results better than the expectations of our target growth strategy shared with you on the last earnings call and proceeded towards closing Micro Focus acquisition on the 31st in line with our planned timing. OpenText is entering an exciting new phase acquiring Micro Focus from a solid position of strength with momentum and confidence in our total growth and integration plan. On Q2 results, we are very pleased with our Q2 revenue performance.

On a year-over-year basis, Enterprise cloud bookings of $145 million, up 12% year-over-year. And foreign exchange in Q2 was a revenue headwind of $48 million, approximately 45% in customer support and 31% in cloud. Cloud revenue of $409 million, up 12% as reported and 15% in constant currency. Strong renewals was 94% Enterprise Cloud, and 95% in off-cloud. ARR, annual recurring revenue of $725 million up 3.6% as reported and 8.7% in constant currency and representing 81% of total revenue. Total revenue of $897 million, up 2.4% as reported and 7.8% in constant currency. Q2 was the eighth consecutive quarter of organic growth in constant currency for both Cloud and ARR. And moving to other financial metrics. GAAP net income of $259 million, up from $88 million due to a non-cash mark-to-market benefit are micro focus-related derivatives and lower debt extinguishment cost.

Note that the mark-to-market benefit in Q2 is a reversal of Q1 loss, partially reflective of the significant currency movements of euro and GBP to the US dollar. GAAP gross margin of 71% and versus 70%, led by improved cloud margins. Adjusted EBITDA of $341 million or 38% of revenue versus $344 million or 39.2% down 0.8% as reported up 3.7% in constant currency. Cost of sales and operating expenses were up $24 million on a non-GAAP basis, all related to revenue growth, integration of Zix and growth-related investments in R&D and sales and marketing. Our organic growth rate trends are a testament to the benefits of truing from continued investments in products and go-to-market. On operating cash flow, we generated $195 million in operating cash flows in Q2.

Free cash flows in the quarter of $163 million or 18% of revenue. DSOs were 47 days versus 44 days in the prior year. Q2 DSO is reflective of December quarter seasonality and with high annual billings relating to our renewal business. Our working capital performance remained strong. Year-over-year, FCF was also impacted by front-end loaded CapEx investments. On enterprise cloud bookings, our trailing 12-month cloud bookings were a strong $511 million, up 25%, the highest in our history. We continue to see steady demand in large cloud deals and average minimum cloud contract value increases. In content, we saw strength in insurance, engineering, construction and telecommunication. In business network, we saw strength in wholesale, retail and banking sectors, experience saw strength in telecommunications.

Regionally, our international markets such as Bill and APAC saw key cloud wins. Our full quarter cloud pipeline growth is trending strongly upwards with solid growth in key industries such as government, healthcare and banking. And moving to balance sheet and liquidity, please do refer to page 15 of our investor presentation. We ended the December quarter with $2.8 billion of cash, which includes $990 million in net proceeds from the senior notes offering completed on December 1, 2022. Our net leverage ratio was two times for Q2. Turning to outlook, targets and aspirations. We plan our business in constant currency and present our business on a constant currency basis for our quarterly factors, total growth strategy and medium-term aspirations.

The financial visibility that Mark provided earlier, it reflects our integration and business planning. First of all, the Micro Focus financial consolidation starts on February 1 and will be included for five months during our current fiscal year ending June 30, 2022. The means micro focused revenues are included for two months in our March quarter and three months of full quarter for the June quarter. In our outlook, we have fully aligned IFRS to GAAP and reporting periods. I will share more details. Given the partial year inclusion, we are providing insights for five months relating to Micro Focus, which we have provided on the slides 17 to 21 of our investor presentation. And looking at fiscal 2024 and beyond, we view OpenText in aggregate and will speak to entire company, as well as our products in the six markets that Mark outlined in his commentary.

So regarding Micro Focus’ adjusted EBITDA profile, we acquired a high EBITDA margin business. Converting from IFRS to US GAAP will burden Micro Focus adjusted EBITDA due to the following items; the revenue timing relating to license renewals, R&D capitalization and lease accounting. Our base line for Micro Focus commencing February 1 a financial consolidation, it fully includes the IFRS to US GAAP conversion. During our integration period and beyond, we expect to gain operational efficiencies in the combined company. As you can see, the margin target for the combined company are at 36% to 38% for fiscal 2024 and a solid $2 billion plus in adjusted EBITDA dollars. Next, let me provide details with respect to significant items in our outlook that relate to the overall expense structure, cost reduction, interest expense, integration expense and special charges.

First of all, on cost reductions. We remain confident to execute towards our $400 million cost reduction plan. Earlier this week, on January 31, we announced a restructuring plan that will impact our global workforce following the Micro Focus acquisition, in an effort to further streamline our operations. The total size of the plan is expected to result in a reduction of the combined workforce of approximately 8% or 2,000 employees, with an estimated cost of $70 million to $80 million. We expect to complete the plan by the end of our current fiscal 2023. We also expect to eliminate redundant global facilities with the acquisition of Micro Focus, and we will provide further details when they become available. Lastly, we have several programs to optimize the usual duplicative efforts, including automation and procurement vendor consolidation, all as part of our operational integration.

These savings span several quarters and are fully reflected in our outlook. Turning to interest expense, is based on our debt service arrangements, and are included in our free cash flow outlook. Our capital structure and initial mix between fixed and floating debt was very intentional to have the ability to make repayments, delever and reduce interest expense over time. Our integration expenses, approximately $80 million are included in the outlook for our non-GAAP or adjusted results of fiscal 2023 and 2024. Special charges and alignment of global entities for an organization and our scale, they require significant investments and ranging from $380 million to $420 million are also included in our outlook for fiscal 2023 and 2024. These estimates will continue to be refined as we start the integration efforts.

So let me draw your attention to the free cash flow, slide number 10, in our investor presentation. You will notice our targets of $500 million to $600 million for fiscal 2023 and $800 million to $900 million for fiscal 2024, and a rapid growth trajectory to $1.5 billion in fiscal 2026. The expenses and investments I just outlined play significant role during fiscal 2023 and 2024, while our cost reduction programs and continued working capital improvements will drive a highly efficient organization at scale with upper quartile adjusted EBITDA and free cash flows. So let me transition to our debt levels and delever plan. With the closing of the Micro Focus acquisition on January 31, we will finish March quarter with approximately $9.3 billion in debt, excluding cash.

This pro forma debt structure reflects the senior secured note financing, the acquisition terminal amendment completed December 1, 2022, and the subsequent drawdown from our revolver of $450 million during January. Our pro forma debt structure has a 5.9-year weighted average maturity and a 6.3% weighted average interest rate and a net leverage ratio of 2.8 times. Approximately half our debt is fixed. We are planning a debt repayment of a minimum of $175 million per quarter, a $175 million per quarter, commencing Q4 fiscal 2023 ending June 30, 2023, over eight quarters to bring the leverage to lower than three times. As shared, since the initial announcement of the Micro Focus acquisition, we remain committed to within eight full quarters to bring the net leverage ratio to less than three times.

We have a solid delever plan. I would also refer you to slide 15 and 23 in our investor presentation for details on our debt towers and our deleveraging program. So with respect to outlook targets and aspirations, let me amplify Mark’s commentaries on the same topics, and I will highlight on Q3 quarterly factors and Q3 fiscal 2023 target model. On Q3 quarterly factors in constant currency, page 18 of the investor presentation. We expect revenue of $1.18 billion to $1.22 billion, inclusive of $310 million to $325 million of Micro Focus revenues; ARR of $0.96 billion, to $1 billion, inclusive of $245 million to $260 million of Micro Focus revenues. Our exchange rates being forecasted, FX would be a headwind of $30 million to $35 million, adjusted EBITDA on a year-over-year basis, margin percentage down 600 to 700 basis points, reflecting Micro Focus integration costs.

Excluding Micro Focus, adjusted EBITDA dollars and margin would be constant. As shared in our communications, Micro Focus remains immediately accretive from an EBITDA dollar perspective. Expect FX to be an adjusted EBITDA headwind of less than $5 million. On Q3 fiscal 2023 target model, our target model ranges are usually provided for annual and fiscal years. For this quarter only, we are providing a Q3 fiscal 2023 target model to reflect and assist the Micro Focus onboarding. Please refer to page 19 of the investor presentation, all figures in constant currency and as a percent of total revenue. We expect cloud revenue to be 35% to 37% of total revenue, ARR to be 82% to 84%, our license revenue 9% to 11%, non-GAAP gross margin of 74% to 76%, R&D of 17% to 19%, and sales and marketing of 21% to 23%, G&A of 9% to 11%; total operating expenses 52% to 54%, interest expense of $115 million to $125 million.

With respect to preliminary fiscal 2024 financial targets, please refer to page 17 of the investor presentation and the commentary shared earlier by Mark. With respect to our fiscal 2026 medium-term aspirations, please refer to page 22 of our investor deck and the comments shared earlier by Mark. As you can surmise, our targets and aspirations are strong and at scale. The horsepower of the combined company to generate upper quartile cash flows is strong. Our fiscal 2026 aspirations of 38% to 40% adjusted EBITDA and free cash flow of $1.5 billion plus, they fully reflect continued OpenText growth, particularly cloud growth and return to organic growth by Micro Focus, completion of the cost reduction program and the integration program with its related investments.

In summary, consistent and solid execution are core to the OpenText business system and our operating DNA that came to life, as people and operations delivered a superb Q2 and achieve an unprecedented readiness to close the transformative acquisition of Micro Focus. During the last 48 hours since we announced the close, our teams have kicked off a highly successful onboarding of a global organization of 11,000 professionals to OpenText, another testament of the OpenText execution engine that is well poised to continue the momentum. On behalf of OpenText, I would like to thank our shareholders, our loyal customers, partners and team members as we embark on the exciting journey ahead. I will now open the call for your questions. Operator?

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. The first question comes from Paul Treiber of RBC. Please go ahead.

Paul Treiber: Hello. Thanks very much and good afternoon. Just a couple of open-ended questions. Just first, on the product road map, you sound very excited about the combined product road map. Among all the acquisitions that you — that OpenText has done, how would you rate the product fit in the potential revenue synergy opportunity just coming from products alone between these two companies?

Mark Barrenechea: Yes. Paul, thanks for the question. Great to hear your voice. The — well, this is the largest expansion of information management that we’ve done. Documentum effectively bought market share and some capabilities in a couple of industries. GXS certainly put us in business networks, and we’ve added to that over time, like Liaison. And our acquisition of Carbonite and Zix put us — gave us a footprint, a solid footprint in cybersecurity. So this is the largest expansion of our mission, large expansion of information management. As I noted in my remarks, this has created a cybersecurity business of scale that will rival our content business in terms of scale and resources. We’re entering a whole new application automation space, which we think is essential for the needs of digitalization, digital operations management.

And we’re bringing on Global 10,000 critical technologies. We’re the market leader in EDI. We’re going to be the market leader in Mainframe technologies and bringing those workloads distributed. So Paul, and then, of course, Vertica and some other tools. So it’s the large expansion, brings our TAM up to over 200 billion. And at this scale, I’ll bridge back to what I said on our fiscal 2024 plan. We’ll — on this growth rate, we’re looking to generate $2.1 billion to $2.24 billion in adjusted EBITDA. So it’s also the largest expansion of being able to generate profit and EBITDA. So it’s the largest step forward we’ve made.

Paul Treiber: The — that’s good to hear. The — there’s a lot of work, obviously, with the integration that you need to chew through over the next couple of quarters or maybe years. What are the most important factors that need to happen in your view for this acquisition to workout very well for shareholders here?

Mark Barrenechea: Yes. Again, thank you, Paul. We’re off to a great start. I mean the energy and excitement internally has — in week one has just been electric. And look, we wanted to put out there our F ’24 preliminary plan. And I asked — and look, it’s — I have confidence in what we’re doing and the results are going to speak for themselves. And in our F ’24 plan, we’re looking to deliver $5.75 billion to $5.8 billion in total revenues, $2.1 billion to $2.24 billion in adjusted EBITDA and up to $900 million of free cash flow. Supporting that are the beginning of the transformation of how they engage customers and getting their renewal rates are — and underneath that is an accelerated product road map every 90 days underneath that is long-term value, accelerating customers to the private cloud than more public cloud.

So it’s just as we outlined, Paul, of — the gameplay we outlined pre-closed is the same post close. And it’s relatively straightforward. Get the renewal rate up, how do you do that, high correlation, it’s product innovation. The piece where we feel that OpenText can add the most value is our private cloud, accelerate innovation and then more public cloud services. We know how to run this play. It’s the same preannouncement as it is today, and we have the confidence to present to you today our F ’24 plan of $2.2 billion to $2.24 billion in adjusted EBITDA, 15% Enterprise Cloud bookings growth and revenue is up to $5.8 billion.

Paul Treiber: Thank you. I’ll pass it on.

Operator: The next question comes from Steven Enders of Citi. Please go ahead.