Interim results for the six months ended 31 Oct 17

8 January 2018

Micro Focus International plc

Interim results for the six months ended 31 October 2017

Micro Focus International plc ("the Company" or "the Group", LSE: MCRO.L, NYSE: MFGP), the international software product group, announces unaudited interim results for the six months ended 31 October 2017.

On 1 September 2017 the Company announced the completion of the merger of its wholly owned subsidiary with Seattle SpinCo, Inc., which holds the software business segment ("HPE Software") of Hewlett Packard Enterprise Company ("HPE"), in accordance with the terms of the previously announced Merger Agreement (the ''Transaction''). Trading results of HPE Software from completion are included in the results for the six months ended 31 October 2017 set out below.

The table below shows the reported results for the Group at actual exchange rates for the six months ended 31 October 2017 together with constant currency ("CCY") comparatives except where stated otherwise:

Reported revenues in the six months to 31 October 2017 were $1,234.5m, $549.8m (80.3%) higher than the prior period reported revenues ($684.7m), with HPE Software contributing $569.8m and $664.7m coming from existing Micro Focus and SUSE Product Portfolios ("existing Micro Focus") (2016: $684.7m), a decrease of 2.9%.

On a CCY basis existing Micro Focus declined by 2.7% (2016: CCY $683.0m), with the SUSE Product Portfolio growing by 13.1% to $164.4m (2016: CCY $145.3m) and the existing Micro Focus Product Portfolio declining by 7.0% to $500.3m (2016: CCY $537.7m).

Profit for the period increased by $16.0m to $106.6m (2016: $90.6m). EBITDA for the period increased by $146.8m to $434.9m (2016: $288.1m). Adjusted EBITDA* of $530.1m was 67.7% higher than that delivered in the comparable period at CCY ($316.1m).

Diluted EPS in the period decreased by 9.1% to 34.64 cents (2016: 38.12 cents). Adjusted Diluted EPS* in the period increased by 16.4% to 103.87 cents (2016: 89.20 cents).

Key highlights

· Completion of the HPE Software acquisition took place on 1 September 2017. American Depositary Shares representing 222,166,897 new ordinary shares were issued to HPE Shareholders, representing 50.1% of the fully diluted share capital of the Company at completion.

· Reported revenue growth of $549.8m (80.3%) driven by:

o Acquisition of HPE Software contributed $569.8m;

o SUSE Product Portfolio where reported revenues grew by 11.5% and CCY revenues grew in line with the market for Infrastructure Linux;

o Offset by anticipated declines in the existing Micro Focus Product Portfolio which declined by 6.9%.

· On a CCY basis:

o Total revenues of $1,234.5m (2016: CCY $683.0m), an increase of 80.7%.

o Adjusted EBITDA increased by 67.7% to $530.1m (2016: CCY $316.1m).

· Adjusted EBITDA margins decreased to 42.9% (2016: CCY 46.3%), reflecting the lower margins in the HPE Software business.

· Exceptional costs incurred in the period of $104.3m (2016: $41.0m) relate to integration costs, acquisition costs, pre-acquisition costs, property costs, severance and legal costs and net finance costs.

· Guidance for medium-term Adjusted Effective Tax Rate ("Adjusted ETR") revised to 25% from the previous guidance of 33%. Cash tax rate expected to be broadly in line with Adjusted Effective Tax Rate from FY20. Cash tax rate for FY18 and FY19 expected to be approximately 15%.

· Net debt and cash generation in the period:

o Cash generated from operations was $267.2m (2016: $201.9m) representing a cash conversion ratio of 61.9% (2016: 72.3%) of Adjusted EBITDA less exceptional costs. Impacted by the expected seasonal year-end increase in working capital balances ($253.0m versus $110.8m) due to timing of completion of HPE Software merger.

o Net debt* at 31 October 2017 was $4,151.7m (30 April 2017: $1,410.6m) increasing due to the acquisition of HPE Software with acquired bank borrowings of $2,600.0m, finance lease obligations and external debt drawn down.

o Adjusted net debt of $4,409.7m (30 April 2017: $1,410.6m) taking account of net closing balance sheet adjustments payable to HPE.

o Free cash flow* in the period of $28.5m (2016: $111.0m).

o Adjusted Net debt* to pro-forma Adjusted EBITDA for the 12-month period to 31 October 2017 is a multiple of 3.1 times; medium term target remains 2.7 times.

· Growth in Adjusted Diluted EPS of 16.4% to 103.87 cents (2016: 89.20 cents) and 9.1% decrease in Diluted EPS to 34.64 cents (2016: 38.12 cents).

· Interim dividend increased by 16.4% to 34.60 cents per share (2016: 29.73 cents per share) in line with dividend policy of full year dividend being twice covered by adjusted earnings.

Statutory results

· Operating profit of $220.0m (2016: $163.3m, +34.7%)

· Profit before tax of $145.7m (2016: $113.2m +28.7%)

· Basic earnings per share of 35.83 cents (2016: 39.57 cents) a decrease of 9.5%

 * The definition of Adjusted Revenue, Adjusted EBITDA, Adjusted EPS, Adjusted Diluted EPS, Net Debt, Adjusted Net Debt, Free Cash Flow, Constant Currency and Pro-forma are in the "Non IFRS measures" section of this Interim Statement. 

Kevin Loosemore, Executive Chairman of Micro Focus, commented:

"The period under review has seen the completion of the combination of Micro Focus with HPE Software to create one of the world's largest pure play software companies. This was a complex transaction with 12 months between announcement and completion. We are now fully engaged in the integration of the combined company.

The combination with HPE Software has clear business logic to extend Micro Focus' market presence in mature infrastructure software segments:

· to increase operational efficiency of the combined Group;

· to deliver effective product management focused on customer centered innovation; and

· to improve sales productivity.

Micro Focus sets out to deliver consistent long-term shareholder returns in the range of 15% to 20% per annum.

On a pro-forma basis, the Enlarged Group delivered revenue of $4,226.7m and Adjusted EBITDA of $1,401.1m at a margin of 33.1% for the 12 months ended 31 October 2017 which is consistent with the plans we built in summer 2016 when contemplating the merger. Our Adjusted Net Debt position at 31 October 2017 was $4,409.7m at pro-forma* Adjusted EBITDA multiple of 3.1 times.

Chris Hsu, our Chief Executive Officer, has been leading the HPE Software business since September 2016 and has managed the separation of the Software business from HPE by creating a standalone company, from a unit that was a small part of a large organization. Chris began a shift in HPE Software's business focus to customer centered innovation, a performance based culture around delivering on EBITDA targets and managing the cost base accordingly. As a result, there has already been a significant improvement in HPE Software's Adjusted EBITDA over the year, notwithstanding that the changes that have been made will take time to be embedded within the organization and that HPE Software's revenue for the 12 months ended 31 October 2017 was at the bottom of our guidance range.

For the existing Micro Focus business revenue was 2.7% lower in constant currency and Adjusted EBITDA 4.1% lower as we put operational improvement plans on hold while working on the completion of the HPE Software transaction.

The board is confident that medium-term low single digit revenue growth, industry leading margins and strong cash conversion will ensure that Micro Focus can deliver on its strategy. These returns can be further enhanced by appropriate deployment of capital in value enhancing acquisitions.

In line with our twice covered dividend policy and the transition to an October year end we are paying a dividend of 34.60 cents per share.

I am delighted to announce that we are further strengthening our management team in support of our strategy and the growth of the business. We have talked to our shareholders in the past year about how we scale our approach to M&A. I am pleased to announce that Mike Phillips, having been CFO since 2010, will take on the newly created role of Director of M&A.

Taking over from Mike as CFO with immediate effect will be Chris Kennedy, previously CFO at ARM and easyJet and well known to our investor base. We are also delighted to announce that Ian Fraser will join Micro Focus as Chief Human Resources Officer having held this same role at RELX Group and BHP Billiton.

Both Chris and Ian bring recent relevant experience in functional terms and also in dealing with listed businesses of scale in the UK and US and we welcome them to the team."

Enquiries:

About Micro Focus

Micro Focus (LSE: MCRO.L, NYSE: MFGP) is a global enterprise software Company supporting the technology needs and challenges of the Global 2000. Our solutions help organizations leverage existing IT investments, enterprise applications and emerging technologies to address complex, rapidly evolving business requirements while protecting corporate information at all times. Our product portfolios are Micro Focus (which included HPE Software from completion) and SUSE. Within Micro Focus our solution portfolios are COBOL Development and Mainframe Solutions, Host Connectivity, Identity and Access Security, IT Development and Operations Management Tools, and Collaboration and Networking. Within HPE Software our solution portfolios are IT Operation Management, Application Delivery Management, Enterprise Security Product, Platform, and Information Management Business. With effect from 1 November 2017 the Micro Focus solution portfolios are Security, IT Operations Management, Application Delivery Management, Information Management & Governance and Application Modernization & Connectivity. For more information, visit: www.microfocus.com. SUSE, a pioneer in Open Source software, provides reliable, interoperable Linux, Software Defined Infrastructure and Application Delivery platforms that give customers greater control and flexibility while reducing cost. For more information, visit: www.suse.com.

Forward-looking statements

Certain statements in this interim report are forward-looking. Although the Group believes that the expectations reflected in these forward-looking statements are reasonable, it can give no assurance that these expectations will prove to be correct. Because these statements involve risks and uncertainties, actual results may differ materially from those expressed or implied by these forward-looking statements. The Group undertakes no obligation to update any forward-looking statements whether as a result of new information, future events or otherwise.

Chief Executive Officer's Statement

Introduction

I was delighted to be appointed Chief Executive Officer of Micro Focus International plc with effect from the completion of the combination with HPE Software on 1 September 2017 and to present today my first set of interim results covering the six months ended 31 October 2017. These results include six months' trading of the existing Micro Focus and SUSE Product Portfolios and two months of the HPE Software business. We would like to thank our employees for their continued dedication, commitment and hard work in delivering the completion of the combination and the financial results for this period.

I have been asked many times since my appointment as Chief Executive Officer was announced what was going to change in the Micro Focus strategy that was put in place by Kevin Loosemore and his team back in 2011. This strategy and proven operating model has seen the company grow from revenues of $436.1m and Adjusted EBITDA of $160.9m in the year ended 30 April 2011 to pro-forma revenues $4,226.7m and Adjusted EBITDA of $1,401.1m in the 12 months ended 31 October 2017. As I explained at the Capital Markets Day in September, the Micro Focus strategy is a proven model and will remain consistent. From the first time Kevin and I discussed potentially combining the two companies I recognized the benefits of the Micro Focus operating model. By merging HPE Software together with Micro Focus, we create a global scale platform that leverages the Micro Focus proven operating model with a unique competency in efficiently managing a portfolio of scale assets. Our scale and proven model both enables us to create value through the merger and positions us well to benefit from ongoing industry consolidation. It is this model that allows us to deliver on our target of 15% to 20% shareholder returns per annum.

We place customers at the center of everything we do - how we innovate, build, sell and support our products. Our broad and deep portfolio that spans application development, hybrid infrastructure management, security, data analytics, information management & governance, etc., uniquely positions us to help our customers across their complex, Hybrid IT environments. We remain committed to delivering the value creation outlined at the announcement of the transaction, and our lean operating model preserves capital and maximizes shareholder returns on a sustainable basis.

Our merger combination was the culmination of interactions between HPE and Micro Focus that started in the middle of 2016 when I was Chief Operating Officer at HPE considering strategic options for HPE Software. For context, through the various Hewlett Packard spins, the Software business went from 3% of total revenues in 2014 prior to the HP-Hewlett Packard Enterprise split to approximately 8% post the HPE Enterprise Services-CSC spin-merge. The HPE Software business was a small division that did not move the company's overall performance and enjoyed the benefits of having the highest relative operating margins, thus revenue growth was the predominant focus. It was guided by the parent company's strategy and financial goals and often invested in projects to support the hardware centric business. This changed upon announcement of the merger on 7 September 2016 when I was appointed by HPE to lead the Software business. On a pro-forma basis for the Micro Focus Enlarged Group in the 12 months ended 31 October 2017, the heritage HPE Software represented approximately 68% of Group revenue. The substantial increase in relative scale and importance required the heritage HPE Software business to change its focus to delivering shareholder returns based on improved EBITDA and free cash flow.

Upon appointment by HPE and under its divestment governance, I started to apply the Micro Focus Four Box model that we learned in diligence, to prioritize innovation and R&D investments on projects with clear customer demand. This was a shift in approach from one that was often driven by pursuing Silicon Valley challengers or the desires of business unit managers that often did not result in increased customer demand and often pulled investment away from our core products. The Micro Focus customer centered innovation approach guides managers to build products that are more directly tied to our customer demands and adds innovative capabilities to our core products they have already invested in, increasing their ROI and, subsequently, our customer stickiness and longevity. This approach is more efficient and avoids higher risk, low probability of return investments. The clarity of being part of a scale, pure-play software company with a clear, focused strategy will unlock additional potential as the Micro Focus model is fully implemented.

Following completion and the issue of HPE's third quarter results we provided guidance on the revenue performance for HPE Software for the year ending 31 October 2017, adjusted for divestments and currency and before acquisition accounting adjustments relating to deferred revenue haircut under the Micro Focus accounting policies. We achieved the low end of the guidance range of $2,890.0m to $2,960.0m. We were disappointed with sales execution primarily in our Americas region. The Adjusted EBITDA for the HPE Software business for this period was $841.7m (before acquisition accounting adjustments relating to deferred revenue haircut and application of Micro Focus accounting policies) at a margin of 29.1% which is an 840 basis point improvement from the 20.7% margin for the 12 months ended 30 April 2016 included in the announcement of the transaction on 7 September 2016 (revenue: $3,172.0m, Adjusted EBITDA $658.0m), reinforcing the thesis of the transaction.

On a pro-forma basis, after taking account of the acquisition accounting adjustments relating to deferred revenue haircut and application of Micro Focus accounting policies, the Enlarged Group delivered revenue of $4,226.7m and Adjusted EBITDA of $1,401.1m for the 12 months ended 31 October 2017 at a margin of 33.1%. This is the base level against which we will be judging performance of the business as we move forward in the 12 months ending 31 October 2018. We will seek to fully implement the Micro Focus operating model in the Enlarged Group during this year and maintain our aim to provide investors with long term shareholder returns of between 15% and 20% per annum.

Following completion of the transaction we continued to run the HPE Software business separately within the Micro Focus Product Portfolio to avoid disruption through to the end of the fiscal year ended 31 October 2017. We brought the Enlarged Group together with effect from 1 November 2017 and from that date we operate two product portfolios, Micro Focus and SUSE, consistent with how the Company has operated since 1 May 2015. We have aligned our financial year end to 31 October and will initially report an 18-month financial period ending 31 October 2018, with interim results statements for the six month periods to 31 October 2017 and 30 April 2018.  

We set out a new four phase plan below for the combination of the Micro Focus and HPE Software businesses whilst continuing to deliver sustainable shareholder returns.

Everything we do is aimed at helping us deliver our commitment to our shareholders of consistent Adjusted EBITDA and free cash flow growth to deliver shareholder returns in the range of 15% to 20% per annum.

At the Capital Markets Day in September 2017, I outlined six focused strategic priorities which are consistent with this four phase plan. These are:

· Integrate the companies seamlessly

· Strengthen the go-to-market engine

· Drive customer-centred innovation in everything we do

· Capture value from the deal ($600m Adjusted EBITDA improvement)

· Build a combined company that employees want to be part of and that customers value as a strategic partner

· Execute value creating mergers and acquisitions

I also disclosed the Enlarged Group Mission Statement:

"We provide our customers with a best-in-class portfolio of enterprise-grade scalable software with analytics built in. We put customers at the centre of our innovation and build high quality products that our customers can rely on and our teams can be proud of."

By focusing on what our customers demand, we help them extend the life of the investments that they make with us. We prioritise our innovation and GTM activities around this customer promise which enables us to deliver more for them with a focused investment profile. Over time as this model takes hold and we build increased confidence with our customers, our revenue will stabilise and we will find additional opportunities to be relevant to our customers. Delivering on this mission will enable us to sustainably provide the shareholder returns that are core to our strategy.

Business strategy

The underlying premise behind our business strategy is that the Group should consistently and over the long-term deliver shareholder returns in the range of 15% to 20% per annum. To deliver this objective the Group has adopted an operational and financial strategy underpinned by consistent and effective management and reward systems. This strategy is capable of execution over the long-term. When considering investment priorities, both organic and inorganic, we evaluate our options against a set of characteristics enabling the categorization of our products into one of the following:

• New Models - Products or consumption models (cloud and subscription) that open new opportunities that could become growth drivers or represent emerging use cases that we need to be able to embrace;

• Growth Drivers - Products with consistent growth performance and market opportunity to build the future revenue foundations of the Group;

• Optimize - Products with declining revenue performance driven by the market or execution where the trajectory must be corrected to move back to the core category or investments focused to optimize long-term returns; and

• Core - Products that have maintained broadly flat revenue performance but represent the current foundations of the Group and must be protected and extended.

Within this overall portfolio we have some products that are growing significantly and others that are stable or in decline. Our business model means the way we manage the portfolio is analogous to a ''fund of funds'' with the objective of generating modest revenue growth over the medium-term, delivering high levels of profitability and strong cash generation and cash conversion ratio with a balanced portfolio approach. We will continue to focus investment in growth and core products and will not dispose of declining products unless we can achieve greater than the discounted cash flow they would generate in our ownership. Within the Enlarged Group we have also discovered areas in the portfolio with similar R&D efforts where a shared set of technologies and architectures (e.g. data ingestion, visualization, container platform, APIs) enable more innovation with less "duplicated" investment further contributing to our ability to drive higher efficiency without compromising innovation.

As outlined in the Annual Report for the year ended 30 April 2017, the combination with HPE Software may delay the return to revenue growth as the HPE Software products are integrated. We expect HPE Software's revenue trend to continue its historical decline until the transformation has been fully executed and the benefits take hold. This integration will be delivered by the four-year plan and the six key strategic priorities that will consolidate and strengthen the combined business, with the goal of delivering modest revenue growth in the medium-term as well as underpinning our margin improvement objectives.

The Enlarged Group is a strong platform and once we achieve our target cash conversion ratio of 90% to 95% we will generate significant free cash flows from which we can deliver returns of value to our shareholders and/or further highly accretive acquisitions.

Our performance in the period

Following completion of the transaction we have reviewed the Alternative Performance Measures ("APM") we use to track the business and upon which we will provide guidance to the market. Historically, Micro Focus has used several measures of EBITDA which have held consistency with measures used over time, however, at times this may have caused confusion with investors and analysts. Micro Focus has used Underlying Adjusted EBITDA as the key performance metric since 2011 for annual corporate bonus calculation on a constant currency basis. It makes sense for this to be the measure that is used going forward and is now renamed "Adjusted EBITDA". We use this term throughout the document. Our net leverage target has been a multiple of Facility EBITDA during this period. With the move to a single APM this target is equivalent to a multiple of 2.7 times Adjusted EBITDA.

The Group reported revenues of $1,234.5m (2016: $684.7m) and Operating Profit of $220.0m (2016: $163.3m). Excluding the HPE Software reported revenues of $569.8m, existing Micro Focus delivered $664.7m to reported revenues (2016: $684.7m), a decline of 2.9% and on a CCY basis this decline was 2.7% (2016: CCY $683m).

The SUSE Product Portfolio grew reported revenues by 11.5% to $164.4m (2016: $147.4m), 13.1% on a CCY basis (2016: CCY $145.3m) in line with the Infrastructure Linux market, whilst the existing Micro Focus Product Portfolio declined by 6.9% to $500.3m (2016: $537.3m), 7.0% on a CCY basis (2016: CCY $537.7m).

Adjusted EBITDA was $530.1m (2016: $320.3m) with HPE Software contributing $226.9m and existing Micro Focus delivering $303.2m. On a CCY basis the existing Micro Focus delivered a 4.1% decline in Adjusted EBITDA (2016: CCY $316.1m) as operational improvements were put on hold pending the completion of the HPE Software transaction.

Micro Focus Product Portfolio

The Micro Focus Product Portfolio, comprising the HPE Software business and the existing Micro Focus Product Portfolio, represents 86.7% of total Group revenue in the six-month period to 31 October 2017 (2016: 78.5%). On a pro-forma basis for the Enlarged Group it contributed 92% of pro-forma revenue in the 12 months ended 31 October 2017.

From within the Micro Focus Product Portfolio we will continue to manage, for the Group overall, the corporate support functions of HR, IT, Facilities, Finance, Legal and the Project Management Office ("PMO") for acquisitions and integration. In addition, we manage the delivery of a shared service for other elements of support to the SUSE portfolio enabling SUSE to directly control what they need to execute with speed and flexibility whilst leveraging the larger Group where effective as SUSE builds scale. Wherever practical the corporate support functions staff are dedicated to product portfolios, including SUSE, in order to provide the additional benefit of specialization whilst leveraging the scale of the shared function.

HPE Software

During the period from merger completion to 31 October 2017 we operated the HPE Software business separately from the rest of the Micro Focus Product Portfolio bringing the business together with effect from 1 November 2017. HPE Software completed its full year to 31 October 2017 which was the first full financial year since the announcement of the spin merge with Micro Focus. I was responsible for the HPE Software business with effect from 7 September 2016 and started to operate the business with a greater focus on delivery of improved profitability as opposed to targeting revenue growth.

The HPE Software business contributed revenues of $569.8m, after a deferred revenue haircut of $25.3m and Adjusted EBITDA of $226.8m. This revenue and Adjusted EBITDA contribution in the period reflects the period end weighting of software licence revenues.

As part of the provisional fair value adjustments relating to the acquisition accounting, Micro Focus applied its standard bad debt provisioning policy to the accounts receivable balance dependent on the aging of the accounts receivables. Prior to these adjustments, for the full year to 31 October 2017 the HPE Software business (under US GAAP and HPE legacy accounting policies, adjusted for divestitures, as derived from HPE Software management accounts) had revenue of $2,891.3m and Adjusted EBITDA of $841.7m. This revenue was at the bottom of the range of revenue guidance we gave after the completion of the transaction. When compared against the revenues of $3,172.0m and Adjusted EBITDA of $658.0m in the 12 months to 30 April 2016, this performance is an 8.9% reduction in revenue and 27.9% increase in Adjusted EBITDA, representing an 8.4% improvement in margin (29.1% v 20.7%).

Taking these provisional acquisition related adjustments into account pro-forma Revenue was $2,866.0m as a result of the deferred revenue haircut of $25.3m and pro-forma Adjusted EBITDA was $777.3m after the deferred revenue haircut, bad debt provision of $35.2m and incremental audit and insurance costs of $3.8m. At completion the bad debt provision amounted to $42.7m and by 31 October 2017 this had increased to $49.3m. It is estimated that approximately $35.2m of this bad debt provision would have arisen in the year to 31 October 2017 as the aging of the accounts receivable balances increased during the carve out process from HPE.

Existing Micro Focus Product Portfolio

During the six months ended 31 October 2017 within the existing Micro Focus Product Portfolio operational improvements were put on hold in anticipation of completion of the transaction. The combination with HPE Software would present operational efficiencies that would be counter-productive to long term value creation to seek within the existing business alone. In the period reported revenue was $500.3m (2016: CCY $537.7m) a decline of 7.0% and Adjusted EBITDA of $248.8m (2016: CCY $266.1m) a decline of 6.5%. The decline in revenue was primarily due to weakness in the Host Connectivity portfolio, particularly in North America, where there has been a continued impact of the loss of a sales team in this area in the second half of last year.

With effect from 1 November we combined the existing Micro Focus Product Portfolio with HPE Software in the Micro Focus product portfolio with a single Go-to-Market operation.

SUSE Product Portfolio

The SUSE product portfolio represented 13.3% of the total Group revenue in the six months ended 31 October 2017 (2016: CCY revenue 21.3%) and approximately 8% on a pro-forma basis for the 12 months ended on that date.

SUSE has continued with the mandate to deliver "sustainable and profitable revenue growth" and has continued to invest in the business to support this vision. The six months to 31 October 2017 has seen another period of growth with overall revenues up 13.1% on a CCY basis in line with the infrastructure Linux market. There have been challenges in the period with sales execution issues in North America resulting in the replacement of the sales leadership and management in that region. Growth of 35.5% was achieved in Asia Pacific & Japan, 11.4% in International, SUSE's largest region, and only 8.7% in North America.

SUSE continues with its growth mandate within the overall group structure and commands appropriate investment to make the growth mandate a reality.

Integration Update

The successful completion of the combination of Micro Focus with HPE Software on 1 September 2017 was described by each of our advisors at some stage as one of the most complicated transactions they have worked on. The cross border nature of the Reverse Morris Trust construct together with the carve out of HPE Software business created complexity which was compounded by the regulatory compliance required for dual listing of securities on the LSE and NYSE on 1 September 2017. However, the team of employees, consultants and advisors successfully delivered the completion of the transaction and it was marked by the ringing of the opening bell on the NYSE. This was followed by the first combined Capital Markets Day in London and then a sixteen city #DiscovertheNew customer and partner roadshow to illustrate the combined product portfolio of the Enlarged Group.

Leading up to the completion of the transaction the separate companies were restricted by competition laws as to what information could be shared on the respective businesses. We recognized this challenge but also the need for clarity for customers, partners and employees on the go forward organization structure. The need for clarity led to working within the restrictions but managing to plan effectively such that the new fiscal year could be launched from 1 November.

We brought the Go-to-Market organization of Micro Focus and the SUSE leadership team together for the Global Sales Kick Off in early November to launch the new company. This provided the opportunity to bring together teams from the heritage organization and re-inforce the clear messaging that had been provided to customers and partners on the roadshow.

In bringing the businesses together with effect from 1 November 2017 we have re-classified the products in the Micro Focus Product Portfolio into five sub-portfolios and continue to operate SUSE semi-independently. The sub-portfolios are Security, IT Operations Management, Application Delivery Management, Information Management & Governance and Application Modernization & Connectivity.

Future Architecture Software Transformation ("FAST") update

Micro Focus has always believed that as part of its acquisition strategy operating on a single set of systems and processes is the most efficient way of operating the business. The challenge of using its existing systems to scale for the Attachmate Group ("TAG") transaction in 2014 resulted in a plan to move to a more scalable platform. Once it became apparent that the HPE Software transaction was executable Micro Focus decided to utilize the FAST platform that was being implemented by HPE Software as the single platform for the Enlarged Group. We believe that once the FAST platform is fully implemented and operational that it will further reinforce enhance our ability to drive value from future software acquisitions.

FAST had been built on an ambitious timeline with an anticipated go-live date following completion of the full financial year to 31 October 2017. The decision was taken to go-live in November 2017 for the HPE Software business to accelerate the process of exiting the remaining dependency on HPE systems for operational execution. As with all complex systems implementations we knew this would require issue remediation and ongoing focus until our target standards of operation stability were achieved. Our current plan is to transfer the existing Micro Focus business to FAST from November 2018. The go-live process has been more challenging than anticipated due to issues related to migrated data that have taken time to resolve. The system is going through its second month end close and is being monitored closely through this key stage for the system.

The challenges associated with the carve out of the HPE Software business and the go-live on FAST have resulted in some delays to customer and partner invoicing and cash collection in the short term with an increase in DSO that is anticipated to continue for a period of time. As at 31 October 2017 HPE Software had DSO of 75 compared to the rest of the Group at 46 DSO resulting in an Enlarged Group DSO of 65.

Delivering value to shareholders

The board has adopted a very clear plan of value creation. We have believed for some time that there are significant segments of the enterprise software market that have matured. The response to this is consolidation. To be successful in this stage of a market both operational effectiveness and scale are critical. We believe that Micro Focus is now well positioned to lead in this space.

There is a clear customer requirement for a company that can innovate and extend the life of mature software assets.

Our priority is to improve the performance of the business in order to maximize the opportunity to generate modest revenue growth in the medium-term. At the same time, we have created flexibility to allow value creation to shareholders through cash distributions or acquisitions as appropriate. We deliver value to our customers through customer centered innovation. We will do nothing that will constrain our ability to achieve organic growth and we are currently investing significant amounts on activities designed to deliver value to customers that should provide a foundation to drive sustainable growth.

The HPE Software transaction is transformational in terms of the size of the Group from an operating point of view and follows on from the Attachmate Group transaction in 2014. These transactions involve the type of transformation that many companies would have said that they needed to go private to achieve out of the public eye. The board and management of Micro Focus believe that it is quite possible to do this on the public market and deliver the resulting increase in value to existing shareholders.

The HPE Software transaction was also transformational in terms of market capitalization. The day before the announcement of the transaction Micro Focus had a market capitalization of £4,480.7m which had increased to £9,849.1m by completion. At completion we issued 222.2m new ordinary shares and listed the same number of American Depositary Shares (ADS) on the New York Stock Exchange representing the underlying new ordinary shares. As anticipated there has been a reduction in the number of ADS listed on NYSE as HPE Shareholders either sold out of the stock or transferred their investment into the underlying ordinary shares. As a result of the work done with our brokers Numis Securities, Micro Focus had marketed extensively to the existing HPE shareholder base with the flow back of ADS to ordinary shares occurring without significant volatility in the share price. As at 31 December 2017 there were 148.0m ADS listed on the NYSE, a reduction of 34.3% compared with the number listed at completion 222.2m.

The board continues to target a modest level of gearing for a company with the cash generating qualities of Micro Focus with a target net debt to Adjusted EBITDA multiple of 2.7 times. We are confident that this level of debt will not reduce our ability to deliver our strategy, invest in products and/or make appropriate acquisitions. As the integration of the businesses continues the board will keep the appropriate level of debt under review.

In order to complete the acquisition of HPE Software the Company has extended its revolving credit facility from $375.0m to $500.0m, refinanced its term loan debt of $1,515.2m with an improved repayment profile and acquired or raised new term loan debt of $3,532.5m to complete the transaction and make the Return of Value.

At 31 October 2017, we had reported net debt of $4,151.7m representing a net debt to pro-forma Adjusted EBITDA ($1,401.1m) of 3.0 times. Adjusting the net debt for the provisional amounts due to and due from HPE as part of the agreement of the closing balance sheet increases the net debt to $4,409.7m at an adjusted net debt to pro-forma Adjusted EBITDA ($1,401.1m) of 3.1 times.

The board has adopted a dividend policy of being two times covered by the adjusted earnings of the Group. With the extension of the year end to 31 October, the company intends to pay two interim dividends and a final dividend for the 18-month period ended 31 October 2018. Applying this policy to the first interim dividend results a payment of 34.60 cents (2016: 29.73 cents).

The dividend will be paid in Sterling equivalent to 25.63 pence per share, based on an exchange rate of £1 = $1.35, the rate applicable on 5 January, 2018, the date on which the board resolved to pay the dividend. The dividend will be paid on 9 February 2018 to shareholders on the register as at 19 January 2018.

Board and Management Changes

During the period from 1 May 2017 to the date of this report we have seen a number of Board and Management changes arising out of the HPE Software transaction and the strengthening of the management team of the Enlarged Group.

Silke Scheiber and Darren Roos were appointed as independent Non-Executive Directors with effect from 15 May 2017 and a further independent Director, Lawton Fitt, was appointed with effect from 31 October 2017. John Schultz, who is a serving executive of HPE and is not independent joined the Board with effect from 1 September 2017. These appointments were all confirmed by the Micro Focus Nomination Committee and were in accordance with the terms of the Merger Agreement. On 1 September 2017 Stephen Murdoch stepped down from the Board and took up the role of Chief Operating Officer for the Enlarged Group.

On 20 December 2017 Micro Focus and HPE announced that they had decided to amend the terms of the Merger Agreement dated 7 September 2016 in respect of nominated directors. Following the recent promotion of John Schultz to Chief Legal and Administrative Officer of HPE, Micro Focus and HPE have agreed that HPE should nominate an independent non-executive to replace John Schultz on the Micro Focus Board. This will enable John to focus on his new responsibilities and enable Micro Focus to increase the mix of independent directors on the Board. John Schultz stepped down from the Board with immediate effect on 20 December 2017; a further announcement will be made when a candidate has been chosen.

Today we are delighted to announce two new members of the management team- Chris Kennedy as Chief Financial Officer and Ian Fraser as Chief Human Resources Officer.

Mike Phillips, our current CFO, is taking on a new and important role for Micro Focus as Director of M&A. Mike has been an invaluable member of the Micro Focus leadership team since September 2010. He played a key role in building the Micro Focus business model and driving the impressive track record of results.

We are excited to have Chris joining us. He's a world class CFO with FTSE experience. At ARM and previously easyJet he was responsible for driving detailed operating rigor at scale.

Ian joins us from RELX Group where he was the Group HR Director and played a key role in the company's transformation from a largely traditional publishing business to a world-leading provider of information and analytics for professional and business customers across industries. He will take over from Karen Geary, who was on our board as a non-executive director and then took on executive responsibilities to provide HR leadership during a critical time for our company. I would like to thank Karen for her commitment during this time of tremendous change.

I am thrilled to welcome Chris and Ian to the company. They both have deep expertise in their respective areas as well as experience dealing with listed businesses of scale in the UK and US. They will be great additions to an already strong management team.

I am pleased to welcome the new Board and management team members to Micro Focus.

Outlook

Micro Focus Product Portfolio

The period from announcement to completion of the HPE Software transaction is the longest of any of the Micro Focus mergers and acquisitions. This was a period of uncertainty for customers, partners, investors and employees which came to an end as we brought the two companies together at the beginning of November. We have achieved a great deal over the last 12 months and enter the new financial year with stronger foundations than a year ago.

We continue to focus on improving the way in which we operate to maximize the efficiency of the organization.

The Group has undergone huge change in FY16 and FY17 but the one constant has been clarity of strategy and the associated focus on aligning operational execution to the delivery of that strategy. Looking forward to the new FY18 this focus will continue with our key priorities being:

· Delivery of our financial plan;

· Continuing to operationalize the FOUR-BOX MODEL to better align resources to optimize the performance of each sub-portfolio; and

· Integration with HPE Software following Completion of the transaction.

SUSE Product Portfolio

For FY18 SUSE will focus on the successful execution of SUSE's mandate for sustainable, profitable revenue growth. The objective is to grow revenue ahead of growth rates for relevant markets.

Group Outlook

Our focus continues to be delivering annual returns to investors in the range of 15% to 20% per annum. We believe we have a strong operational and financial model that can continue to scale and provide excellent returns to our shareholders.

We anticipate revenues for the Group for the twelve months ending 31 October 2018 will decline by 2% to 4% when compared to the pro-forma revenues for the 12 months ended 31 October 2017 of $4,226.7m. As a result of the change in year-end we anticipate a shift in Licence revenue towards the new year-end of 31 October which will lead to second half revenues being higher than those in the six months to 30 April. We will seek to re-balance this revenue weighting in future years.

Chris Hsu

Chief Executive Officer

7 January 2018

Financial Review

The following discussion provides an analysis of our results of operations and should be read in conjunction with our unaudited consolidated financial statements included elsewhere in this report.

We include certain non-IFRS financial measures which assist management in comparing our performance on a consistent basis for purposes of business decision-making by removing the impact of certain items that management believes do not directly reflect our underlying operations. Included in the following discussion is Adjusted Operating Profit and Adjusted EBITDA, both of which are non-IFRS financial measures. For additional information on Adjusted Operating Profit and Adjusted EBITDA see "Non-IFRS Measures."

The Group operates two product portfolios (i) Micro Focus and (ii) SUSE. These are the operating segments and the cash generating units for the Group.

The Micro Focus Product Portfolio contains our mature infrastructure software products that are managed on a portfolio basis akin to a "fund of funds" investment portfolio. This portfolio is being managed through the 4 BOX Model underpinned by consistent end to end processes to make and maintain the software, whilst the software is sold and supported through a geographic Go-to-Market ("GTM") organization. Within the existing Micro Focus Product Portfolio, products are organised into five sub-portfolios based on industrial logic. During the period from completion to 31 October 2017 the HPE Software Products have also been managed under the Micro Focus Product Portfolio with its own set of five sub-portfolios of product.

SUSE's characteristics are different due to the Open Source nature and the growth profile of its offerings.

The portfolios have directly controlled costs and then an allocation of costs of the functions that are managed within the Micro Focus portfolio and provide services to both portfolios together with centrally managed support function costs. Set out in the table below are the profitability metrics for our two product portfolios including the breakdown of Adjusted Operating Profit and Adjusted EBITDA for the period:

HPE Software was acquired on 1 September 2017 and contributed $569.8m to revenue in the period. HPE Software is reported within the Micro Focus Product Portfolio for the period under review. With effect from 1 November the Micro Focus Product Portfolio will be managed as one with a consolidation of the sub-portfolios into five sub-portfolios based on industrial logic (as previously communicated at the Capital Markets Day).

The table below shows the reported revenue breakdown by type within the Micro Focus Product Portfolio and SUSE Product Portfolio for the six months to 31 October 2017, along with reported and CCY revenue for the six months to 31 October 2016 and the year ended 30 April 2017.

We are not providing renewal rate information for SUSE, existing Micro Focus or HPE Software within this set of results. Our methodology is still being refined in order to accommodate data from our multiple systems. We believe that until renewal information is provided, following the trends on the maintenance revenue for the Micro Focus sub-portfolios and subscription revenues for SUSE provides the best guidance on performance.

Micro Focus Product Portfolio

Revenue for the Micro Focus Product Portfolio grew by 99.0% on a CCY basis as a result of the inclusion of 2 months of HPE Software. The contribution of HPE Software to each of the revenue categories is shown in the table above for the period from completion to 31 October 2017. Without HPE Software, revenue declined by 7.0% on a CCY basis and the category movements are explained below.

Licence revenue

Licence revenue for the existing Micro Focus Product Portfolio declined by 17.0% on a CCY basis. There was year-on-year Licence revenue growth in Identity Access & Security, Development & IT Operations Management Tools and Collaboration & Networking offset by declines in CDMS and, primarily, Host Connectivity.

Maintenance revenue

Maintenance revenues for the existing Micro Focus Product Portfolio declined by only 2.5% on a CCY basis. Growth in CDMS was offset by declines in the other sub-portfolios.

Consultancy revenue

Consultancy revenues for the existing Micro Focus Product Portfolio declined by 11.7% on a CCY basis as we completed the implementation of the established Micro Focus policy of focusing only on consulting business that supports our licence business.

SUSE Product Portfolio

The SUSE Product Portfolio revenue increased by 13.1% to $164.4m compared with the CCY revenues for the comparative period of $145.3m, with the Subscription revenue increasing by 13.9% to $162.6m (2016: CCY $142.7m).

SUSE - Key Financial Metrics

SUSE provides technical support together with rights to updates, patches and security fixes for its Open Source solutions on a subscription basis with revenues being recognized rateably over the period of the contract. The key metrics are Revenue, Total Contract Value ("TCV") and Annual Contract Value ("ACV"). The ACV represents the value of the first 12 months of each contract reported as TCV.

TCV and ACV

TCV represents the gross billings for the six months ended 31 October 2017 of $151.9m, a decrease of 1.6% from the CCY for the six months ended 31 October 2016 of $154.3m. The weighted average contract duration reduced to 28 months in the six months ended 31 October 2017 from 32 months in the six months ended 31 October 2016.

The 'in period yield' from TCV to revenue remained broadly the same at 24.0% in the six months ended 31 October 2017 as it was in the year ended 30 April 2017. 'In period yield' represents the proportion of TCV generated in the period that can be recognized as Subscription Fee Revenue ("SFR") in the same period. Net new subscription TCV increased by 1.8% year-on-year and renewal subscriptions TCV decreased by 7.2% year-on-year.

Renewal subscription TCV will always be correlated to available renewal opportunity pool. As we are seeing a shift of SUSE on premise workloads to SUSE off premise workloads, expectation is for the renewal opportunity pool to decline. Another contributor to declining renewal TCV is SUSE customers consuming required renewal subscriptions through Independent Hardware Vendors, when the initial sale was direct or through a value added reseller. This is further corroborated by the significant increase we had in business derived through Public Cloud Service Providers as a route to market. Business through Independent Hardware Vendors also continues to grow as expected. Net new subscription contracts are derived from sale of subscriptions to new logo customers and existing customers expanding footprint of existing product portfolio or subscribing to new product solutions.

ACV measures the first 12-months duration equivalent of TCV. ACV grew to $101.6m, an increase of 2.5% from the CCY for FY17 of $99.1m. ACV removes the impact of multi-year TCV and is a cleaner KPI on the performance of the business. Where subscription term is less than 12 months, all of the subscription TCV billing is included in the ACV measure.

Regional TCV performance

Regional ACV performance

North America had below expected performance on TCV but showed growth in ACV, declining by 1.4% and growing by 8.5% respectively. Timing of some of the larger enterprise multi-year renewals together with deferral of some of the larger enterprise deals contributed to this TCV decline. Most of the slipped opportunities have subsequently been closed. Strong growth in ACV is influenced by good growth in shorter duration Public Cloud Service Provider business.

International had below expected performance in both TCV and ACV declining by 7.7% and 11.0% respectively. Comparison for International on TCV and ACV is influenced by a very strong comparative period, where we had a few very large enterprise transactions conclude in the prior period.

Asia Pacific & Japan continued to have very strong performance in TCV and ACV, growing by 19.4% and 24.0% respectively. We continue to have strong performance in China and some of the other emerging markets, and continue to win new accounts in some of the other key markets in the region.

The region continues to get good traction and growing revenue streams from local OEM relationships and also by leveraging the global agreements we have in place with key Independent Hardware Vendors and public cloud service providers.

ACV contribution by route to market

Direct represents customers that have a master licence agreement with SUSE and subscribe directly with SUSE or via authorized fulfillment partners.

Indirect represents customers that subscribe via the SUSE Value Added Reseller network and predominantly through a two tier distribution model.

Global Service Partners represents primarily Independent Hardware Vendors who sell SUSE subscriptions alongside the sale of their respective hardware and subscriptions generated from cloud service providers.

OEM (Embedded Systems) represents entities that embed SUSE subscriptions within the sale of their respective specialized appliance offerings.

We continue to see growth in Direct, Indirect and Global Service Partners routes to market, growing by 1.8%, 5.1% and 2.0% respectively.

We also see a trend of customers, who purchased subscriptions at the outset direct and through Value Added Resellers, subsequently subscribing through Global Service Partners. We continue to see strength in the Value Added Reseller network, where we have seen significant growth in ACV during the period. SUSE is focused on continuing to invest and strengthen its reach to customers through its mature extensive value add reseller, independent hardware vendor and cloud service provider routes to market.

OEM (Embedded Systems) transactions tend to be large, custom, specialized and binary in nature, and thus year on year fluctuations in ACV generated are to be expected.

We continued to extend SUSE's presence and contribution in key Open Source projects and relevant industry groups both in support of strengthening our contribution to Open Source innovation and development efforts as well as in support of our partner and enterprise customer relationships.

Deferred revenue

We continue to have year on year steady growth in the deferred revenue balance. At 31 October 2017 SUSE total deferred revenue balance was $366.1m (31 October 2016: $331.5m), an increase of $34.6m (10.4%) year-on-year. 75.5% of this increase in deferred revenue balance is recognizable revenue in the next 12 months and 84.4% recognizable in the next 24 months.

REGIONAL REVENUE

Regional revenue performance for the Group 

The table below shows Micro Focus regional revenue for the six months to 31 October 2017, six months to 31 October 2016 and the year ended 30 April 2017:

* The HPE Software acquisition has not been split by region here as the regions were not consistent with the existing Micro Focus regions. The HPE Software regions split is provided below.

Micro Focus Product Portfolio regional revenue performance

The Micro Focus Product Portfolio revenue by region and by revenue stream is shown in the table below:

North America had a disappointing performance in the period with licence revenue down 31.3% year on year. Growth in IAS, Collaboration & Networking and ITOM were more than offset by declines in CDMS and Host Connectivity. The latter continued to be impacted by the loss of an entire sales team to a competitor in the second half of 2017 and the subsequent disruption to customer project engagement and flow. Maintenance revenue declined as expected and overall revenues were down 10.8%

International's revenues were broadly flat year over year with growth in licence more than offsetting the decline in Maintenance and Consultancy. Licence growth in CDMS, IAS and ITOM more than offset the decline in IAS and Collaboration and Networking. Maintenance and Consultancy declines were in line with expectations.

Asia Pacific & Japan saw an 8.9% revenue decline in the six months to October 2017. Licence revenues were down in all portfolios except Collaboration and Networking whilst maintenance revenues declined in line with expectations.

HPE Software regional revenue performance

The table above provides the breakdown of the HPE Software revenue contribution for the period from completion to 31 October 2017. There is no comparative information for the acquisition and the delivered revenue in the two months brought the total revenue for the HPE Software business in the year to 31 October 2017 to the bottom of the range of guidance we gave after completion.

On a go forward basis, the Enlarged Group's revenue regions will be organized to the Americas (consisting of North America and Latin America), EMEA, and Asia Pacific and Japan.

SUSE Product Portfolio regional revenue performance

North America, International and Asia Pacific & Japan regions have shown growth on a CCY basis in revenue of 8.7%, 11.4% and 35.5% respectively. Growth in these regions was derived across all routes to market, coming into the period with a strong deferred income roll out together with securing new business with large enterprise accounts directly and through the various alliances and channel partners.

We are pleased to note that the change to specializing and aligning the field sales and marketing resources to SUSE in the Asia Pacific & Japan has continued to result in sustained recurring profitable revenue growth.

We made changes to the sales leadership in North America in the June to September timeframe and are rebuilding the sales team there. This contributed to the lower than expected revenue growth in North America in the period. 

Existing Micro Focus Product Portfolio revenue performance

Revenue for the existing Micro Focus products, net of the deferred revenue haircut, for the period at actual, constant currency exchange rates and reported comparatives are shown in the table below:

CDMS revenues were $126.1m; a decline of 6.0% on a CCY basis compared with the period to 31 October 2016. Maintenance revenues grew by 2.2% but this was more than offset by the decline in licence revenues, North America saw the largest decline in licence followed by APJ with growth in International slightly mitigating these declines. Licence revenues declined by 17.1% ($9.0m), Maintenance revenues grew by 2.2% ($1.7m) and Consulting revenues declined by 14.5% ($0.8m). CDMS revenues are typically cyclical to an extent and as such we continue to see this key area as delivering broadly stable revenues over the medium to long-term.

Host Connectivity revenues declined by 28.0% ($25.9m) in the period on a CCY basis. Licence revenues declined by 61.5% ($24.1m) with all regions impacted but particularly North America which was mostly as a result of the loss to a competitor of an entire sales team and management structure in the second half of FY2017 and the subsequent disruption to customer project engagement and flow. Maintenance revenues declined marginally by 3.1% ($1.6m) and there was a decline in Consulting revenues of 25.0% ($0.2m).

Identity, Access & Security revenues grew by 0.2% ($0.2m) in the period on a CCY basis. Licence revenues grew by 15.4% with this growth offset by anticipated declines in Maintenance and Consultancy revenues. We will continue to drive for growth in this area but expect that this will take time to be delivered.

Development & IT Operations Management Tools revenues in the period were $139.7m, a 1.4% decline on a CCY basis. $4.5m of the decline was in Maintenance revenues which declined by 4.1% in line with expectations. Licence revenues grew in the period by $2.7m or 10.9%. Consulting revenues declined by 2.7%.

Collaboration & Networking revenues which now include GWAVA were $67.8m, a decline of 2.3% ($1.6m) on a CCY basis. Licence revenue grew by 18.4% ($2.1m). Maintenance revenue declined by 5.4% ($3.0m) in the period compared with 13.4% in the prior year.

HPE Software Revenue by product portfolio

Revenue for the HPE Software Products, prior to the deferred revenue haircut, at actual exchange rates since the acquisition are shown in the table below:

The table above provides the breakdown of HPE Software revenue by product portfolio for the two months from completion to 31 October 2017. There are no comparatives available for the period.

On a go forward basis, the Micro Focus Product Portfolios will be organized into Security, IT Operations Management, Application Delivery Management, Information Management and Governance, and Application Modernization and Connectivity.

Group Operating costs

The operating costs (including exceptional costs of $98.5m) for the six months ended 31 October 2017 compared with six months to 31 October 2016 and the year ended 30 April 2017 are shown below:

*Re-classification of costs for Consolidated Statement of Comprehensive Income Presentation

As part of the HPE Software transaction the Company's shares and ADS were listed on the London Stock Exchange and New York Stock Exchange respectively. In the preparation of the Group's April 2017 Annual Report and Accounts and as part of the regulatory filing process in the USA the Group reviewed its consolidated statement of comprehensive income presentation and decided to re-classify both amortization of product development costs and amortization of acquired technology intangibles from research and development expenses to cost of sales. This presentation complies with IFRS and, in the view of the Company's Audit Committee, provides investors with a consolidated statement of comprehensive income presentation that is more comparable with other software companies listed on both markets.

On a reported basis, total operating costs increased by $493.1m to $1,014.5m (2016: $521.4m) for the six months ended 31 October 2017. On a CCY basis total operating costs for the period increased by $490.6m, or 93.6% to $1,014.5m in the six months ended 31 October 2017 (2016: CCY $523.9m). As described below in the individual cost categories, the increase is primarily in relation to the acquisition of HPE Software.

Cost of goods sold

Cost of sales increased by $150.5m, or 122.0% ($150.1m, or 121.2% on a CCY basis) to $273.9m in the six months ended 31 October 2017 as compared to $123.4m in the six months ended 31 October 2016.

On a reported basis, excluding HPE Software, costs of goods sold in the year decreased by $8.8m to $114.6m (2016: reported* $123.4m). There was a decrease in the amortization of purchased intangibles of $3.0m to $34.0m (2016: reported $37.0m). Cost of sales decreased primarily due to a reduction in staff related costs of $2.3m and a reduction in travel costs of $0.5m. Exceptional items are discussed later in this section.

On a CCY basis, excluding HPE Software, cost of goods sold for the year decreased by $9.2m to $114.6m (2017: CCY $123.8m) of which the exceptional costs were $3.1m (2016: CCY $1.3m). The costs in this category predominantly relate to our consulting and helpline support operations, amortization of product development costs and amortization of acquired technology intangibles. Excluding exceptional items, amortization of product development costs of $12.3m (2016: CCY $12.1m) and amortization of acquired technology intangibles of $34.0m (2016: CCY $37.0m) cost of goods sold decreased by $8.2m to $65.2m (2016: CCY $73.4m). The decrease is due primarily to a $2.7m reduction in staff related costs and a reduction in travel costs of $0.5m.

Selling and distribution costs

Selling and distribution costs increased by $180.1m, or 82.4% ($179.2m, or 81.7% on a CCY basis) to $398.6m in the six months ended 31 October 2017 as compared to $218.5m in the six months ended 31 October 2016.

On a reported basis, excluding HPE Software, selling and distribution costs in the year increased by $8.8m to $227.3m (2016: reported $218.5m). This increase in selling and distribution costs includes an increase in exceptional items of $6.6m to $8.6m (2016: reported $2.0m), and an increase in the amortization of purchased intangibles of $1.5m to $70.9m (2016: reported $69.4m). Exceptional items are discussed later in this section.

On a CCY basis, excluding HPE Software, selling and distribution costs increased by $7.9m to $227.3m (2016: CCY $219.4m). Excluding the amortization of purchased trade names and customer relationships intangible assets of $70.9m (2016: CCY $69.4m), selling and distribution costs were increased by $6.4m to $156.4m (2016: CCY $150.0m). Within these costs were exceptional costs of $8.6m (2016: CCY $2.0m), thus the underlying costs were $147.8m (2016: CCY $148.0m), a decrease of $0.2m (0.1%) on the prior year on a CCY basis.

Research and development expenses

Research and development expenses increased by $87.2m, or 100.9% ($86.2m, or 98.6% on a CCY basis) to $173.6m in the six months ended 31 October 2017 as compared to $86.4m in the six months ended 31 October 2016.

On a reported basis, excluding HPE Software, research and development expenses in the year increased by $16.9m to $103.3m (2016: reported $86.4m). This increase in research and development costs includes an increase in exceptional items of $5.2m to $7.4m (2016: reported $2.2m). The remaining increase relates to an increase in staff related costs of $14.2m. Exceptional items are discussed later in this section.

On a CCY basis, excluding HPE Software, research and development costs increased by $15.9m to $103.3m (2016: CCY $87.4m). Excluding exceptional costs of $7.4m (2016: CCY $2.2m), the resultant costs were $95.9m (2016: CCY $85.2m) an increase of $10.7m (12.6%). The increase is primarily down to increased staff related costs of $14.2m. Research and development costs, excluding HPE Software, are equivalent to approximately 15.5% of revenue (2016: CCY 12.8%).

At 31 October 2017 the net book value of capitalized product development costs on the consolidated statement of financial position was $54.1m (2016: $49.1m). The impact of net capitalization of internal product development costs was $4.5m (2016: net capitalization $2.9m).

Administrative expenses

Administrative expenses increased by $75.3m, or 80.9% ($75.1m, or 80.5% on a CCY basis) to $168.4m in the six months ended 31 October 2017 as compared to $93.1m in the six months ended 31 October 2016.

On a reported basis, excluding HPE Software, administrative expenses in the year increased by $18.5m to $111.6m (2016: reported $93.1m). Exceptional items included in administrative expenses increased $43.8m to $79.4m (2016: reported $35.6m), share-based payments increased by $2.8m to $18.3m (2016: reported $15.5m) and exchange gains increased by $1.9m to $9.0m (2016: reported $7.1m). Excluding acquisitions in the year, exceptional items, share-based payments and exchange gains, administrative expenses decreased by $5.5m to $43.5m (2016: reported $49.0m). The decrease relates primarily to a reduction in staff related costs of $13.5m. Exceptional items are discussed later in this section.

On a CCY basis, excluding HPE Software, administrative expenses increased by $18.3m to $111.6m (2016: CCY $93.3m). Excluding share based compensation of $18.3m (2016: CCY $15.5m), exceptional costs of $59.2m (2016: CCY $35.4m) and an exchange gain of $7.1m (2016: CCY gain of $9.0m), administrative expenses decreased by $10.1m (19.7%) to $41.2m (2016: CCY $51.3m). The decrease has arisen mostly from a reduction in staff related costs of $13.4m.

Share based compensation was $18.3m (2016: $15.5m).

Excluding HPE Software, amortization of intangibles for the year was $106.5m (2016: reported $106.3m).

Adjusted Operating Costs

Adjusted Operating Costs were $714.3m (2016: CCY $360.7m) an increase of $353.6m. The increase in Adjusted Operating Costs arose primarily from the acquisition of HPE Software ($356.6m), offset by a reduction of $3.0m in the existing Micro Focus business.

Total Operating costs were $1,014.5m (2016: CCY $523.9m) an increase of 93.6% ($490.6m).

Exceptional items

Exceptional items in the period were $104.3m (2016: reported $41.0m) including:

On a reported basis exceptional items increased by $63.3m, or 154.4% to $104.3m in the period ended 31 October 2017 (2016: reported $41.0m).

The increase in exceptional items in the six months to 31 October 2017 was as a result of an increase in pre-acquisition costs of $23.3m relating to the acquisition of HPE Software, an increase in integration costs of $6.6m in bringing acquired businesses together with the existing Micro Focus business, an increase in severance and legal costs of $5.8m (primarily relating to staff reductions in HPE Software), an increase in acquisition costs of $24.4m, and a reduction of property provisions of $2.6m.

The pre-acquisition costs relate to the acquisition of HPE Software which was announced in September 2016 and completed on 1 September 2017. These costs related to accounting, legal and commercial due diligence work, legal work on the various agreements, professional advisors' fees and pre-integration costs relating to activities in readiness for the HPE Software acquisition across all functions of the existing Micro Focus business.

Included within acquisition costs is $7.7m in respect of US excise tax payable on the award of Long Term Incentives and Additional Share Grants to four senior employees. 

Finance costs incurred in escrow period of $6.3m relates to interest charges on additional term loan facilities drawn down in relation to the acquisition, between the date the facilities were drawn into escrow and the acquisition date of HPE Software.

Finance income earned in escrow period of $0.6m relates to interest income earned on additional term loan facilities drawn down in relation to the acquisition, between the date the facilities were drawn into escrow and the acquisition date of HPE Software.

Currency impact

During the six months to 31 October 2017, 62.3% of our revenues were contracted in US dollars, 20.2% in Euros, 4.5% in Sterling, 2.8% in CAD dollars and 10.2% in other currencies. In comparison, 50.5% of our costs are US dollar denominated, 16.8% in Euros, 9.7% in Sterling, 1.6% in CAD dollars and 21.4% in other currencies.

This weighting of revenue and costs means that if the US$: Euro or US$: CAD exchange rates move during the period, the revenue impact is greater than the cost impact, whilst if US$: Sterling rate moves during the period the cost impact exceeds the revenue impact. Consequently, actual US$ EBITDA can be impacted by significant movements in US$ to Euro, CAD and Sterling exchange rates.

The currency movement for the US dollar against Sterling, Euro and CAD was a strengthening of 2.9% and a weakening of 3.3% and 1.5% respectively when looking at the average exchange rates in the six months to 31 October 2017 compared to those in the six months to 31 October 2016.

In order to provide CCY comparatives, we have restated the results of the Group for the six months ended 31 October 2016 at the same average exchange rates as those used in reported results for the six months ended 31 October 2017. Consequently, CCY revenues reduce to $683.0m from $684.7 reported, a reduction of 0.2%, and CCY Adjusted EBITDA reduces to $316.1m from $320.3m reported, a reduction of 1.3%.

Intercompany loan arrangements within the Group are typically denominated in the local currency of the overseas affiliate. Consequently, any movement in the respective local currency and US$ will have an impact on the converted US$ value of the loans. This foreign exchange movement is taken to the consolidated statement of comprehensive income. The Group's UK Corporation Tax liability is denominated in Sterling and any movement of the US$: Sterling rate will give rise to a foreign exchange gain or loss which is also taken to the consolidated statement of comprehensive income. The foreign exchange gain for the period is approximately $4.7m (2016: CCY gain of $9.1m).

Adjusted EBITDA

Adjusted EBITDA increased by $214.0m to $530.1m (2016: CCY $316.1m) with $226.9m of the increase coming from HPE Software. The remaining $12.9m decline in Adjusted EBITDA for the existing Micro Focus comprised a $4.4m increase from the SUSE Product Portfolio and a $17.3m decline from the Micro Focus Product Portfolio where operational efficiencies were put on hold pending the completion of the HPE Software transaction.

The table below summarises the Adjusted EBITDA and Adjusted EBITDA Margin for the Group.

Both revenue and Adjusted EBITDA in the current period have been reduced by the fair value deferred revenue haircut of $27.1m (2016: $6.4m) that was applied as part of the acquisitions. Of this $25.3m related to the acquisition of HPE Software.

Operating profit and Adjusted Operating Profit

Adjusted Operating Profit increased $193.9m, or 59.4% to $520.2m in the six months ended 31 October 2017 as compared to $326.3m in the six months ended 31 October 2016. On a constant currency basis, Adjusted Operating Profit increased $197.9m, or 61.4% to $520.2m in six months ended 31 October 2017 as compared to $322.3m in the six months ended 31 October 2016.

Micro Focus Product Portfolio - Adjusted Operating Profit and Adjusted EBITDA

The table below shows the Adjusted Operating Profit for the portfolio together with a comparison to 31 October 2016:

The Micro Focus Product Portfolio Adjusted Operating Profit was $470.4m in the six months ended 31 October 2017, delivering a margin of 44.0% which compares with the margin in the constant currency Adjusted Operating Profit for the six months ended 31 October 2016 of 50.6%. The decrease in margin arose mainly due to the effect of lower margins in the newly acquired HPE Software business.

The directly managed costs are those costs specifically managed by the Micro Focus Product Portfolio. All the Group central support costs are managed by the Micro Focus portfolio group and the allocation of these costs to SUSE is based on an appropriate methodology. SUSE directly manages all their own sales, consulting services and maintenance renewals activities.

The table below shows the reconciliation between Adjusted Operating Profit and Adjusted EBITDA for the Micro Focus Product Portfolio:

The Adjusted EBITDA improved by $209.6m in the period on a CCY basis primarily due to the acquisition of HPE Software contributing an increase of $226.9m offset by a reduction of existing Micro Focus of $17.3m.

SUSE Product Portfolio Adjusted Operating Profit and Adjusted EBITDA

The table below shows the Adjusted Operating Profit for the SUSE Product Portfolio and compares it against the CCY and as reported numbers for the six months to 31 October 2016:

The SUSE Product Portfolio Adjusted Operating Profit was $49.8m in the six months ended 31 October 2017 at a profit margin of 30.3%. Compared to the constant currency Adjusted Operating Profit for the six months ended 31 October 2016, this is a decrease of $0.6m (1.2%) and a profit margin decrease of 4.4%.

We have seen an increase in directly managed costs in the SUSE Product Portfolio that is consistent with the investment being made to deliver the SUSE growth charter.

The table below shows the reconciliation between Adjusted Operating Profit and Adjusted EBITDA for SUSE:

The Adjusted EBITDA improved by $4.4m in the year on a CCY basis primarily due to impact of foreign exchange in the period.

Group share of results of associates

Share of results of associates increased by $0.7m, or 63.6%, to a loss of $0.4m in the six months ended 31 October 2017 as compared to a loss of $1.1m in the six months ended 31 October 2016.

Net finance costs

Net finance costs were $73.8m (2016: $49.0m) including;

· loan interest and commitment fees of $59.5m (2016: $41.6m);

· the amortization of $13.4m of prepaid facility arrangement, original issue discounts and facility fees incurred on the Group's loan facilities (2016: $7.3m);

· finance lease interest $1.2m (2016: $nil);

· interest rate swaps, cash flow hedge, transfer from equity $0.5m (2016: $nil);

· interest on pension liability $0.6m (2016: $0.3m); and

· other interest costs of $0.3m (2016: $0.3m), offset by

· $1.7m (2016: $0.5m) of interest received.

Net finance costs have increased by $24.8m primarily due to loan interest and commitment fees ($17.9m) and the amortization of prepaid facility arrangements, original issue discounts and facility fees ($6.1m) as a result of the increase in Group borrowings resulting from the acquisition of HPE Software.

Profit before tax

Profit before tax was $145.7m (2016: reported $113.2m).

Adjusted profit before tax

Adjusted profit before tax was $451.8m (2016: reported $276.2m):

Taxation

The tax charge for the period was $39.1m (2016: $22.6m) with the Group's effective tax rate ("ETR") being 26.8% (2016: 20.0%). The tax charge on adjusted profit before tax for the period was $132.7m (2016: $64.1m), which represents an effective tax rate on adjusted profit before tax ("Adjusted ETR") of 29.4% (2016: 23.2%) as set out below:

In computing adjusted profit before tax, $306.1m of adjustments have been made in respect of which the associated tax is $93.6m. The Adjusted ETR for the six-month period ended 31 October 2017 of 29.4% is higher than 2016 (23.2%) due to the inclusion of HPE Software profits, which are subject to tax at a higher rate than existing Micro Focus profits, and restrictions on the deductibility of interest expenses under new UK tax rules.

The Group is forecasting an Adjusted ETR in the medium-term for the Enlarged Group, based on an initial estimate of the impact of recently enacted, complex US tax reforms (see further detail below), of 25%. The cash tax rate on "Cash Profits" (Adjusted EBITDA less exceptional items, capital expenditure and interest) is expected to be significantly lower than the Adjusted ETR in FY18 and FY19 (c.15% cash tax rate) due to the utilization of US tax attributes in the HPE Software Group and to be broadly aligned with the Adjusted ETR from FY20 onwards. These rates are significantly lower than previous medium-term guidance of 33% (Adjusted ETR) and 30% (cash tax rate).

The forecast Adjusted ETR is subject to various factors including:

· Further assessment of, and the issue of guidance by the US authorities in relation to, the detail of the recently enacted US tax reforms;

· Other changes in tax legislation in the main jurisdictions in which the Group operates;

· The geographical mix of profits;

· The risk of challenge from tax authorities to the allocation of profits across the Group in response to the OECD's Base Erosion and Profit Shifting project;

· Investigations and proposals of the European Commission;

· The tax consequences arising from the UK's exit from the European Union; and

· The resolution of open issues with tax authorities.

The Group's cash taxes paid in the period were $20.5m (2016: $18.2m), which represents a cash tax rate on "Cash Profits" of 6.6%. The low cash tax rate for the period is due to the utilization of favorable US tax attributes in the HPE Software group, the fact that no cash was repatriated from HPE Software foreign subsidiaries to the US in the period, and short-term benefits relating to the timing of instalment payments.

The forecast cash tax rate, when compared to the Adjusted ETR, is likely to fluctuate significantly year-on-year due to various factors, including the following:

· As a general matter, temporary differences often result in substantial shifts of cash tax payments from one period to another;

· In particular, the rate at which recognized deferred tax assets (brought forward tax losses and credits) are utilized is likely to vary significantly year-on-year;

· The final tax liability for a particular territory and year can often vary significantly from the estimates on which instalment payments have been made, resulting in under and over payments; and

· The timing of the settlement of open issues with tax authorities is uncertain and can lead to significant one-off increases in the cash tax rate.

Tax liabilities are recognized when it is considered probable that there will be a future outflow of funds to a taxing authority. Tax provisions are based on management's interpretation of country specific tax law and are measured using the single best estimate of likely outcome approach. Management uses in-house tax experts, professional advisors and previous experience when assessing tax risks. Within current tax liabilities is $54.1m (2016: $29.6m) in respect of provisions for uncertain tax positions, the majority of which relates to the risk of challenge from tax authorities to the geographic allocation of profits across the Group. The Group does not anticipate that there will be any material reversal of these provisions in the next 12 months. Due to the uncertainty associated with such tax items, it is possible that at a future date, on conclusion of open tax matters, the final outcome may vary significantly.

As a consequence of the HPE Software transaction, the Group is subject to potentially significant restrictions relating to tax issues that could limit the Group's ability to undertake certain corporate actions (such as the issuance of Micro Focus shares or Micro Focus ADSs or the undertaking of a merger or consolidation) that otherwise could be advantageous to the Group. The Group is obliged to indemnify HPE for tax liabilities relating to the separation of HPE Software from HPE if such liabilities are triggered by actions taken by the Group. The Group has robust procedures in place, including ongoing consultation with its tax advisors, to ensure no such triggering actions are taken.

On 22 December 2017, the US President signed the Tax Cuts and Jobs Act, which provides for significant and wide-ranging changes to the taxation of corporations. The reforms are complex, and it will take some time to assess the implications thoroughly, but broadly the implications are: a) a reduction in the Federal tax rate from 35% to 21%, with various measures to broaden the tax base including restrictions on interest deductibility and other anti-avoidance measures; and b) the introduction of an exemption for foreign dividends (currently such dividends are taxed at the US federal rate, with credit granted for foreign taxes suffered). In return for the latter benefit, a one-off transition tax (which can be spread over 8 years) is payable in respect of cumulative retained earnings of foreign subsidiaries at a rate of 15.5% for earnings represented by cash or cash equivalents and 8.0% for the balance of such earnings.

These US tax reforms will give rise to significant consequences, both immediately in terms of one-off impacts relating to the transition tax and the measurement of deferred tax assets and liabilities and going forward in terms of the Group's Adjusted ETR and cash tax rate. An initial review and estimate has been undertaken, which will be updated over the coming weeks and months as the Group works through the detail of these complex changes with its advisors and guidance is issued by the US authorities. Based on the Group's initial estimate, the transition tax and re-measurement of deferred tax balances are estimated to give rise to a one-off credit to the income statement in the period to 30 April 2018 of $600m to $700m.

Going forwards, in the medium-term, the reforms are estimated to reduce the Group's Adjusted ETR to 25%. The cash tax rate (including transition tax payments) is expected to be significantly lower than the Adjusted ETR in FY18 and FY19 (c.15% cash tax rate) due to the utilization of US tax attributes in the HPE Software group and to be broadly aligned with the Adjusted ETR from FY20 onwards. Due to being spread over 8 years, transition tax payments, do not have a significant impact on the cash tax rate.

Profit after tax

Profit after tax increased by 17.7% to $106.6m (2016: $90.6m reported).

Liquidity and Capital Resources

Our principal ongoing uses of cash are to meet working capital requirements to fund debt obligations and to finance our capital expenditures and acquisitions.

Capital structure of the Group

As at 31 October 2017 the market capitalization of the Group was £11,510.0m (30 April 2017: £5,944.0m), equivalent to $14,965.6m (30 April 2017: $7,667.8m) at an exchange rate of $1.30 to £1 (30 April 2017: $1.29 to £1). The net debt of the Group was $4,151.7m (30 April 2017: $1,410.6m), all denominated in US$, resulting in an Enterprise Value of $19,117.3m (30 April 2017: $9,078.4m). The board believes that this capital structure is appropriate for the Group's requirements.

Cash flow and net debt

The Group's cash generated from operations was $267.2m (2016: $201.9m). This represented a cash conversion ratio when compared to Adjusted EBITDA less exceptional items of 61.9% (2016: 72.3%).