Earnings Transcript for SOW.DE - Q1 Fiscal Year 2022

Operator: Ladies and gentlemen, thank you for standing by. Welcome and thank you for joining Q1 Results Call 2022 of Software AG. Throughout today’s recorded presentation, all participants will be in a listen-only mode. The presentation will be followed by a question-and-answer session. I would now like to turn the conference over to Mr. Robin Colman. Please go ahead.

Robin Colman: Thank you, Francesca and good morning, ladies and gentlemen. Welcome to Software AG's analyst call and webcast on its preliminary Q1 2022 results. This morning, Software AG has published preliminary results for the first quarter as well as the presentation used in the call. Today's call will start with the presentation from our CEO, Sanjay Brahmawar; followed by Scott Little, Software AG's CRO; and the CFO, Matthias Heiden. We will try to keep this call in the regular one hour time frame and cover as many questions as possible. Before we start, here are some housekeeping remarks. This conference call is also being broadcast via the web and you may access the webcast via our Investor Relations website. The webcast will display the presentation slides related to this call and the same slides are available for download on our website. The webcast including the full call with questions, answers and the names of questioners will be recorded and made available for replay later today. Finally, let me remind you of our disclaimer statement which is shown at the beginning of the slide presentation and is valid for the entire call. Thank you for your patience. Now over to Sanjay.

Sanjay Brahmawar: Thank you, Robin. Good morning, everyone. Thank you for joining us today. At the start of our transformation, our aim was to deliver sustained growth momentum and bring consistent revenue and profit growth to Software AG. As we step into our fourth transformation year, we have delivered first quarter product revenue growth of 10% and non-IFRS EBITA margin of 19.9%. In absolute terms, this represented a non-IFRS EBITA increase of 67% year-on-year. Our increasingly consistent progress is being driven by our digital business which grew bookings 15% during the quarter. Subscription and SaaS bookings made up 81% of its bookings total and pushed our distributable ARR forward to growth of 12%. This is helping us drive more recurring revenue which accounted for 89% of overall product revenue in Q1. Finally, digital business product revenue grew 8% year-on-year. And having closed our acquisition of StreamSets after the quarter end, we have started the process of accelerating our organic growth and addressing even more of our market opportunity over time. Next, in A&N, we saw good performance with strong execution that was supported by the early close of a large U.K. government deal, driving bookings and product revenue up 43% and 12%, respectively, in the quarter. The early close we saw was customer led and we did well to execute fast to meet their needs. Please note, with this deal brought forward from our Q2 plan, nothing changes in our view for ANN in the first half or in the rest of the year. So big picture, I'm pleased with where we are at this early stage in the year and I'm incredibly grateful to the team for their efforts. Our growth culture continues to evolve and I'm confident we're well set for the coming quarters. Before we move on, I'd now like to make a short comment on broader events. Everyone at Software AG continues to be shocked and saddened by the war in Ukraine. We stand behind the Ukrainian people and we are doing all we can to support refugees arriving here in Germany. We're also working hard to ensure the safety and well-being of our people in the region. From our own business perspective, annual revenue from Russian and Ukrainian customers is in the low single-digit million euro range and we stopped all new business direct sales efforts in Russia in early 2021, as part of our Helix focus on our Tier 1 countries. Our interest here is humanitarian and we continue to monitor the situation closely. Now turning back to a quarter in which we maintained the strong momentum we saw in Q4. From a customer sales and motion perspective, our growth continues to be generated by our three drivers

Scott Little: Thank you, Sanjay and good morning, everyone. Our sales execution was strong again in the quarter and we saw our digital business conversion rate improve by three percentage points over Q1 last year. In the past, we've spoken about the opportunity to cross-sell our digital business products into our A&N customer base. In the last quarter, we saw strong performance from A&N. And within this, we saw 8 of our Top 10 deals include an element of cross-sell into our digital business, mostly for hybrid integration. A nice example here came from Puerto Rico's Treasury department, a very long-standing A&N customer which is now using web methods to create an API architecture that integrates its business processes both within and beyond the boundaries of the department. With our products that's so well aligned to market needs, we feel now is the right time to be more strategic, more proactive on the specialization of our sales force. This is a key area of expertise for our strategic partner, Silver Lake. We are confident we can do it without the need for new headcount and we know it drives improved results. In terms of progress, we have now realigned existing sales resources to take on more specialized roles with greater emphasis on selling key growth products like iPaaS, Process Mining and Cumulocity. We are also bringing these teams together under global leadership to drive knowledge sharing and accountability. This model is much like the one we currently have in place with our TrendMiner product and with Alfabet which have already been specialized for some time. An early example of our success here in a Q1 new logo deal with MMG, the €3.4 billion paper and packaging manufacturer in DACH. Owing to a more targeted sales approach, we have convinced this large customer to deploy web methods in a hybrid fashion for their B2B integration layer across their entire business. This will allow MMG to more effectively connect its SAP technology with several other critical systems as well as improving its integration capabilities across its key partner environments. During Q1, we've also continued to build our top-of-funnel demand. There are two areas of focus here. First, marketing digitization and second is continuing to drive increased impact from our partner ecosystem. On the marketing side, we've been building on the digital methods we first deployed in North America last year. We're rolling out similar approaches in our Tier 1 markets worldwide. And in only three months, we've increased our inbound lead volume by 9%. The success of these top-of-funnel programs is allowing us to refocus our regional marketing teams on the middle of the front, improving our conversion and close rates with vertical-specific programs that align with customer buying personas. On the partner side, I'm very pleased to report that our ecosystem registered 278 new deals in Q1. This increased our partner-driven pipeline by $34 million sequentially on Q4 of last year. Our partners also continue to make a solid impact on our digital business bookings where, led by Microsoft and AWS, we saw incremental partner bookings as a portion of our total digital bookings reached 10% in Q1. This result was supported by a strong contribution from E&Y in the quarter which helped us close a six figure ARIS win in North America, with a Fortune 500 paint and coating supplier operating in 70 countries around the world. This company is now using ARIS to support a multiyear transition to SAP's S/4HANA, choosing us over Signavio to simplify, standardize and harmonize business processes across its global organization. Alongside these well-embedded cloud partners, we also continue to build skills and understanding across the rest of our partner base with GSI consultants of the likes of TCS and Cognizant acquiring close to 150 certifications on our products since the launch of our batching program in 2021. In terms of impact, both of these businesses featured in our Top 6 partners by bookings in Q1. Now looking ahead, I'm confident that we have the pipeline we need to progress from our solid start to the year. Our pace is up two percentage points year-on-year and as our digital business pipeline continues to build overall, I believe that our pace, conversion strength and coverage trend sets us up to deliver on our full year targets. So Matthias, over to you.

Matthias Heiden: Thank you, Scott. Now it's time to look at how all this activity has helped us push our financial performance forward. As the medium-term driver of our sustainable growth in revenue and profit, I'm going to start with our Digital Business. First, on bookings, our total of €79.7 million represented year-on-year growth of 15%. This performance against a tough year-on-year compare reflects the increasing power of our modernized and transformed product set which will gain further momentum with the addition of StreamSets. It's also worth noting the strong contribution of SaaS to our bookings mix this quarter, up 32% year-on-year, driven by excellent customer wins, like our new logo deal in APJ with SEKO Solutions, a network and ICT solutions provider. In this case, the customer will use the value-add services within Cumulocity IoT to develop and optimize its end-to-end IoT solutions before taking them to market more quickly and efficiently than before. We also continue to benefit from the focus Scott referenced on driving cross-sell of our digital business into our A&N customer base. During the quarter, we won a great deal with a large Austrian bank, a long-standing A&N customer, with whom we're now being a strategic partner to enable digital transformation. In total, our bookings dropped through to digital business product revenue at a ratio of 44%, more or less in line with our full year planning assumption of between 45% and 47% and led to product revenue of €110.9 million or 8% growth year-on-year. ARR within our digital business, a key factor in building the quality and predictability of our overall revenue stream, was €429.4 million at the end of Q1 and has grown 12% year-on-year. In A&N, we delivered Q1 bookings of €32.6 million and growth of 43% with a good trend developing around subscription, where bookings were up 241% in the quarter. Overall, as Sanjay mentioned, our outperformance was mainly influenced by a large deal which closed early. This wasn't part of our original plan but sometimes the needs of our customers change. In these circumstances, it often makes sense for us to support them in the interest of maintaining a strong relationship. We will see softer than expected second quarter A&N performance as a result but we still feel confident in our full year position. Lastly on A&N, our bookings to revenue ratio was 65% in Q1, compared to our full year planning assumption of around 75%. This was largely the result of subscription success I just mentioned and still led to strong product revenue of €56 million or growth of 12% year-on-year. Together, group bookings in Q1 were €112.3 million which represents 22% growth year-on-year. While group product revenue, the key metrics showing the progress of our business model transformation, grew to €166.9 million or 10% growth year-on-year, comfortably within our stated full year guidance range. Our recurring revenue stream also continued to grow strongly during Q1, reaching €147.9 million. This also represents 10% growth year-on-year and accounted for 89% of our product revenue total and 71% of our overall revenue as a group. On Professional Services, we saw consistent performance with growth of 2%, driven by particularly strong performance in EMEA and our PS margin was in line with our plan. When combined, our PS revenue and our product revenue gave us first quarter total group revenue of €206 million which represents strong growth of 8% year-on-year. Now turning to our cost base. In the first quarter, our total costs were €176 million. This represents an increase of around 5% year-on-year on a stated basis or 7% when adjusting for the positive offset from other income in the quarter. Even though this 7% is slightly above the 5% to 6% corridor, we are expecting for the full year around 1/3 of Q1's increase related to FX, specifically the impact of the strong U.S. dollar on our cost base. Please note, however, any U.S. dollar impact on costs is offset by the U.S. dollar tailwind benefit to group revenue which was 4% in the quarter. If we adjust for this FX impact, our incremental cost growth falls back within the expected range of 5% to 6%. And overall, we still feel very comfortable with the €35 million to €40 million expectation we set for 2022 at our CMD. Alongside the FX-related cost increase, we invested another 1/3 of our incremental spend in R&D and cloud hosting. The final 1/3 was invested across sales and marketing activities, including demand generation and increased travel to clients as well as investment in technology as we modernize our IT landscape. Please be aware, we're also monitoring the broader macro environment in terms of inflation and potential cost impact as a result. We're comfortable we have the levers we need to manage this situation, including the pricing power we gained from our business model shift to subscription and the increasing competitiveness of our employer brand which is helping improve our ability to attract and retain the best talent at Software AG. On profit, our continued focus on profitable growth means we are now seeing the inflection point in our Helix margin journey. During the quarter, we delivered a strong non-IFRS EBITA margin of 19.9% which in absolute terms represents an increase of non-IFRS EBITA of 67%. Our improving results are being supported by good profit performance in our Digital Business as well as the top line tailwind we're seeing from our business model transformation and the quarter's solid A&N performance. Turning now to our balance sheet. In the context of an uncertain macroeconomic environment, it's worth making the point that Software AG remains a financially stable and resilient business with net debt to EBITDA of 1.28x after accounting for the StreamSets' acquisition closure. We have a steadily increasing recurring revenue stream with growing visibility and predictability of cash flows and we have a diversified customer base across a number of geographies, verticals and sectors. The convertible bonds related to our Silver Lake investment closed on February 15 this year and has been deployed in its entirety on our acquisition of StreamSets. Going forward, we expect to see an interest of around €3.5 million per quarter related to the bond. Approximately half of this relates to our regular coupon payments and the other half relates to the accounting impact of the fair value adjustment around the transaction. On cash flow, we delivered €24.3 million of free cash flow in Q1, 39% lower year-on-year. If we adjust our prior year comparator for the cash we collected late as a result of our malware attack in Q4 2020, this quarter's cash flow would have been flattish year-on-year. This is in line with our expected progress in the shift to subscription as it relates to our cash development. I'll now make a few comments on outlook before I close and we move to Q&A. First, to reiterate what Sanjay said, our organic guidance for the full year 2022 remains unchanged today. All our ranges are as we left them when we announced our Q4 and full year results in January. In addition, I'll make a few comments on the impact of StreamSets. With the acquisition having closed last week, I can confirm that we will have the benefits of StreamSets in our accounts for around 8.5 months of this year. The headline implication here is that the impact from the transaction that we communicated at the time of announcement remains in place today. On top of our organic development, we anticipate the addition of StreamSets to main. The group will deliver non-IFRS product revenue growth of between 12% and 16%. And we will see an impact to non-IFRS EBITA of between minus €17 million and minus €13 million. Following the closure, we are now working through the consolidation of StreamSets' accounts into our own. This exercise involves translating the non-IFRS revenue and profit numbers I have just stated into IFRS. We're also continuing to work through any impact of the group's financials from purchase price allocation, including any deferred revenue adjustment. We will update on the impact of these post-closing topics by the time we issue our half year report, if not earlier. Please note, going forward, we will also provide a number for StreamSets bookings based on our own bookings methodology which will be a totally new metric for the StreamSets business. And as a result, we will not incorporate it into our guidance. We will provide it for the sake of transparency and to help you build your understanding of the business' strong progress in Software AG's language. Looking ahead to 2023, please be reminded that at some dimensions, our organic ambitions remain in place. And we expect the addition of StreamSets to take us even further ahead of our €1 billion ambition for the overall group. We will issue more specific guidance for 2023, including StreamSets in Q4 of this year as normal. And that's it from me. Thanks for your attention today. We have made a solid start to the year with plenty of opportunity for innovation-led growth ahead of us in the remainder of 2022. Robin, back to you for Q&A.

Robin Colman: Thank you, Matthias, Sanjay and Scott. Ladies and gentlemen, you may now ask your questions. Francesca, please can you repeat the instructions on how to proceed.

Operator: And the first question is from Varun Rajwanshi from JPMorgan.

Varun Rajwanshi: Hi, good morning team. Quick one on the overall demand environment. Sanjay, can you make a comment here? Obviously, you've made a comment on Russia and Ukraine but beyond that, based on your discussions with customers, has there been any change in the end markets that you operate in over the last three months? And also on commercial progress in the U.S. market, you've made a few comments there. But can you just remind us of the market opportunity that Software AG's penetration to date and your expectation on growth contribution from this region over the next two to three years?

Sanjay Brahmawar: Varun, thanks for the questions. So listen, on the first one, look, I think there are several factors that are playing right now. You have the pandemic, you have supply chain disruptions that are ongoing, there's Fed tightening up, obviously and then the Russia grinding war in Ukraine. So all of this is obviously relating to headwinds for economic growth and it's a challenging environment. Having said that, what I would say, in all our interactions and particularly my interaction with CEOs, there's a clear effort to separate between mission-critical and nice to have. And that's what's being applied to software when you think about tech spend. Now our technology which is Hybrid Integration, IoT, Process Mining, this falls into the mission-critical bucket which is helping the companies with this uncertainty, deal with these supply chain issues, help with more hybrid working, really enable their people with more data visibility. So as such, I don't see a dampening in the demand for our infrastructure software. In fact, in some places, we need to help companies to accelerate. So that's kind of sort of on the overall. Then, in particular, Varun, on the U.S. market, you know that U.S. is 50% of our TAM and we have special attention with Scott and Mike Haugen both really pushing that market. Today, it contributes about 37% of our bookings, maybe about 38% of our revenue. But clearly, for us, this is a market where we can accelerate this, we can push this further. There are two things that kind of we are working on, Varun which still hold us back. One is, our visibility in the U.S. is still not as strong. Now thanks to bringing Silver Lake on as a partner and that is already, in the last couple of months, we're getting a lot more pull, a lot more acknowledgment by many other companies and also talent who are very excited by the opportunities. And the second thing is, of course, the majority of our sales force -- and over a period, the productivity of our sales force has improved, the execution has improved. So those two factors combined are going to help us even further with obviously a very strong cloud native product set.

Matthias Heiden: If I may just add, as a reminder, for the audience, on the regional split, just so that you can be clear around where our bookings came from in Q1. The way to think about this is that around 35% come from the Americas, 60% combined from EMEA and DACH and the remaining 10% from APJ. I think it is fair to say that the growth opportunity in the Americas is such that we can go clearly beyond and above the 35% contribution from this region. Maybe these additional data points help.

Varun Rajwanshi: Okay, thanks.

Matthias Heiden: Sure.

Operator: The next question is from Alastair Nolan from Morgan Stanley.

Alastair Nolan: First one was just on employee attrition, kind of the war for talent and wage inflation. Can you just update us as to what you're seeing on this front? I know it had been a particular focus last year, so just any progression or update would be helpful. And then secondly, quickly for you, Matthias. Can you just explain in a little bit more detail how you are thinking about demonstrating the organic progression of the business versus StreamSets and how that might look and feel from a reporting point of view as we move forward. Just came to understand what that might look like?

Sanjay Brahmawar: Alastair, I'll take the first one and obviously, the second is clearly directed to Matthias. Look, on attrition and the war for talent, I think we're not alone in experiencing the increase in the challenge. We see it, it's not helped by the great resignation. And then obviously, the inflation -- the wage inflation. We are countering these points with a couple of things. One is, obviously, with the opportunity, the cultural environment, the kind of challenge that we offer with Software AG products in a smaller environment, big enough to matter, small enough to care. This way, we are attracting talent from the Microsofts, the Googles but also from smaller companies like ServiceNow or TIBCO, etcetera, etcetera. So that's one way we are countering it. And the other thing, of course, is, we do have some hotspots like India and the U.S., where we've had to put special actions in place to make sure that we can deal with the competitive pressures that we are seeing. So I don't see this kind of easing up in the near future. But I think we're working quite hard in terms of making sure that we can keep attracting but also retaining the good talent that we have on board. Matthias?

Matthias Heiden: Yes, I'll start by complementing Sanjay's answer on wage inflation from a more financial perspective, if you allow. And that is, there are two elements to this, if you like, because one is, I'd like to give you some insight as to how we treat this in our planning process, so that we're not necessarily taken by surprise through inflation. Having said that, of course, none of us truly anticipated the current level of inflation. But what we normally do in the budgeting process is that we budget salary increases in such a way that they are above historic averages of inflation, so that addresses the cost side early on in the planning process. The flip side of that, if you like, is a more business-related topic. That is a reminder of our CPI and price increase clauses as a standard feature in Software AG's contracts which does give us a certain pricing power above and beyond. And of course, if we take the two together and should that not suffice to address the inflation, then the company would need to prioritize investments, hirings, etcetera. On the reporting, Alastair, that you asked. I'll give you a short and hopefully, crispy enough answer. We will continue to show the organic impression -- sorry, progression for the remainder of 2022 at a minimum to give you an idea how we progress organically. Having said that, rest assured, we will also make sure that there is clarity in the market, whether we have reached the organic ambition that we have laid out for the end of 2023 or not when we come that bridge and when we're crossing that. So we will not dilute unnecessarily. We will provide the necessary clarity on the way forward. Hopefully, that's helpful.

Alastair Nolan: Great. Thank you very much.

Operator: The next question is from Hannes Leitner from UBS. Please go ahead.

Hannes Leitner: Yes, thanks for letting me on . Maybe you can talk a little bit about the M&A pipeline ahead, given the market dynamics around technology companies quite suffered a lot in the public markets. And then also given your leverage ratio, would you also consider some buybacks in the near term?

Sanjay Brahmawar: So Hannes, first of all, we continue to build our M&A pipeline, as I mentioned in my section. However, we are not in a rush to take action. We are looking at what is a strategic fit for us in terms of the markets that we are addressing and the portfolio that we have to serve our clients. So it really has to be a strong strategic fit. And we're also leveraging our relationship with our partner, Silver Lake, in terms of being able to explore the market and identifying more candidates. So robust pipeline but we're not really in a rush to make a move, unless there is a very strong strategic fit and it is very close to our adjacency to our market such as integration, IoT and obviously, businesses process management. On the leverage, I'll give it over to Matthias.

Matthias Heiden: Yes. On the leverage, I have commented on that in my script. Hopefully, it was clear that the number was not visible in the chart itself because the closing has taken place after the end of March. But on an overall level, we're perfectly comfortable with where we are. In fact, on the way forward, I would feel comfortable with the company hovering somewhere between two and three should the need arise as a consequence of additional M&A activity.

Hannes Leitner: Great. Thank you.

Matthias Heiden: Sure.

Operator: The next question is from Knut Woller from Baader Bank. Please go ahead.

Knut Woller: Yes, thank you. Just on StreamSets, two questions. The first one, can you share with us some historical growth rates of StreamSets? I understood that you will provide guidance for 2023, including StreamSets with Q4. But still maybe as a sneak preview, do you still feel confident including StreamSets with the low end of your margin targets in 2023.

Sanjay Brahmawar: Knut, thanks for the question. Look, on the growth rates, I think we had already mentioned StreamSets, the company that's been growing at 70% CAGR on their historical performance. However, bear in mind that's based on triple-digit growth in the past. And so that's the history. However, going forward, we are very confident about them continuing a very strong double-digit growth. And as I said, in the first two months since we announced the acquisition, they have made very good progress on continuing that kind of growth. So we see, first of all, their own stand-alone case being delivered very well. Over and above that, Scott and team have already initiated the actions to leverage the scale. We have many accounts in their installed base where already we have conversations with the customers going on in terms of how StreamSets can complement the hybrid integration landscape that we have for our clients. So that's kind of that. On the margin, I'll hand over to Matthias.

Matthias Heiden: Sure. On the margin, first of all, organically, again, we have reconfirmed that today we're confident to reach it organically. We have given you information on the non-IFRS EBITA expectation for StreamSets for 2022. And as a reminder, because we discussed that when we announced after signing, from then on this contribution is set to improve, meaning it starts by becoming less negative. Will turn into profit like 0/profit in 2024 and probably around year five will be margin accretive to the then margin level of Software AG. With that said, Knut, that does imply that it will be dilutive in the year 2023. Frankly, it is too early to comment right now. But honestly, I do not want to set myself up for that trap, right? Whether it means in or out of the overall diluted group margin at the end of 2023. But I hope that this reminder will help you on your way forward if you connect the dots between what Sanjay said and what I just said.

Knut Woller: Thank you.

Matthias Heiden: Sure.

Operator: There are no further questions at this time. I hand back to Mr. Robin Colman.

Robin Colman: Thank you, ladies and gentlemen. Considering the time, we appreciate your participation and we look forward to speaking to you next time. So thank you. Have a lovely day.

Sanjay Brahmawar: Thank you.

Matthias Heiden: Thank you.

Operator: Ladies and gentlemen, the conference has now concluded and you may disconnect your telephone. Thank you for joining and have a pleasant day. Goodbye.