Earnings Transcript for SOW.DE - Q1 Fiscal Year 2023

Operator: Good morning, ladies and gentlemen. Welcome to Software AG's Analyst Call and Webcast on its Preliminary Q1 2023 Results. This morning, Software AG published preliminary results for the reported quarter as well as the presentation used in this call. We will start with the presentation from our CEO, Sanjay Brahmawar; followed by our CFO, Daniela Bunger, before opening the line for taking your questions. Before we start, here are some housekeeping remarks. The conference call is also being broadcasted via the web. 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 and the names of the 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 is valid for the entire call. Sanjay, over to you.

Sanjay Brahmawar: Thank you, Robert. Good morning, everyone. Thank you for joining this presentation for our Q1 2023 results. As you all know, on Monday, we held a separate call to discuss the investment agreement we have signed with Silver Lake, our current strategic partner. Silver Lake intends to acquire all outstanding shares in Software AG. We're very excited about the opportunity to deepen our strategic relationship with Silver Lake. Alongside our largest investor, the Software AG Foundation, we believe the offer represents a very attractive proposition for our stakeholders. I would like to start this call by reiterating some of the key details and why we think the deal is in the best interest of all our stakeholders. The price represents a 53% premium to our closing share price on 20th April last week and a 48% premium to the three-month VWAP implying an equity value of around €2.2 billion. The offer is, of course, subject to a number of conditions, including a shareholder acceptance threshold of 50% plus one share. As you know, the Software AG Foundation recognizes the attractive nature of the offer and have signed a share purchase agreement to sell 25.1% of all shares as a result of the transaction. If the offer is successful, Silver Lake intends to delist the Company. Finally, it is important to note that this transaction is fully funded, Silver Lake does not require a domination in profit and loss transfer agreement to finance the offer and does not intend to enter into one. This offer follows a thorough evaluation by the Management Board and the independent Takeover Committee on behalf of the Supervisory Board. The evaluation concluded that the offer is in the best interest of Software AG shareholders and all stakeholders. Therefore, the Management Board and I intend to recommend the offer to shareholders. We expect the transaction to close in the fourth quarter of 2023. Turning to Slide 5 and why we are supporting this transaction. We believe there is a strong rationale across all our key stakeholder groups for deepening our relationship with Silver Lake. Silver Lake clearly shares our strategic vision and our values for driving successful outcomes for both our employees and our customers. Their relevant expertise has helped to inform the next phase of our strategic plan. Building on the four years of transformation progress we have already made through Helix. This shared vision means we are closely aligned on our strategic objectives, but both those we have set out for 2023 and over the medium term. As we outlined at our full year results in January, we have already made significant progress in aligning our business to our market opportunity. Our core focus areas are doubling down on innovation and integration for customers and further accelerating our journey to cloud first. In a competitive talent market, we will invest behind attracting, developing and retaining the best talent in our sector, whilst maintaining and building on our focus on culture. We know that increasing our specialization to drive efficiency and effectiveness is fundamental to our success. And finally, this transaction is highly attractive for our shareholders with Premier significantly higher than comparable public takeovers in Germany over the last decade. These terms enable the upfront realization of significant value for our shareholders. Silver Lake has highly relevant capabilities and proven experience in the core focus areas of our strategy. That is why we believe firmly that they are the right partner to support Software AG's long-term growth. With that, I would like now to turn to our Q1 results, which are the focus of today's call. This year, we have entered the final year of our Helix transformation. During Q1, we demonstrated our ability to deliver on our operating plan amidst the challenging macroeconomic environment. However, during Q1, customers remained cautious on IT expenditure overall. As a result, we continue to see extended sales cycles, mainly driven by ongoing macroeconomic uncertainty. Let me start with our headline numbers. Please be aware that from this year on, all numbers disclosed include the contribution from StreamSets. Digital business ARR showed significant growth of 21% year-on-year. Looking at the sequential growth, we saw a slight increase. This development is in line with market expectations. Given our normal seasonality and means we are on track versus our full year guidance target. ARR coming from SaaS licenses saw strong growth again, both year-over-year and sequentially. This development follows the trend we've seen since Q1 last year and reaffirms our decision to make SaaS and cloud offerings, our strategic priority going forward. In A&N, our ARR grew 7% year-on-year and 2% sequentially, in line with our full year guidance. This performance was as expected, given our strong Q4 driven by the early closing of significant deals. As a result, we also saw lower A&N revenue, which led to total product revenue growth of 1% year-on-year, in line with our expectations. With the combination of higher costs from the impact of StreamSets not present in Q1 last year as well as higher costs coming from inflation and cloud hosting, our operating margin landed at 11.2%, in line with our expectation for the quarter. While this result is outside of our full year guidance range, our normal weighting towards the year's remaining quarters means we remain fully confident of delivering on our 2023 margin guidance. Before I hand over to Daniela for further details on the financials, I would like to give you an update on the evolution of our strategy for the next medium term. As we complete our current program and look forward, our clear view is that the key create value for our stakeholders is a more balanced and less complex product portfolio. As a result, we have chosen to double down on innovation and integration and accelerate our journey to cloud first. Integration is the area we have the optimal combination of product leadership as well as current and future growth opportunities. Additionally, our increasing focus on cloud is offering us attractive unit economics as we scale through acceleration of customer demand. We have started to drive innovation to support our evolution already, particularly with our mission-critical integration products, webMethods [indiscernible] and StreamSets. Our mainframe collector, for example, is the first joint solution combining complementary StreamSets and Software AG products to solve today's data challenges. Another great innovation and achievement is the integration of ChatGPT. In January, we became the first independent iPaaS platform provider to introduce a ChatGPT API connector enabling seamless interaction with this innovative language model. Innovation like this continues to increase the impact we can deliver for customers. For example, we recently secured an outstanding win with Lufthansa Technik. Our data integration solution web methods has enabled them to reduce manual processes on 45,000 transactions per day from 27% to 8%. This has helped not only lower costs and increase operational performance but also enhance the technological competitive advantage. Currently, we are in discussions on Lufthansa's long-term journey to webMethods cloud. We also will continue to stay laser-focused on driving financial discipline throughout the entire organization. We will do this by managing costs tightly in order to drive margin expansion and mitigate the continuing impact of our transformation activities on cash flows. So far, we have made great progress with our optimization program, which will yield a margin benefit of between 30 million and 35 million in 2023 and further benefits thereafter. Now I'll hand over to Daniela to run through the quarterly financials. Daniela, over to you.

Daniela Bunger: Thank you, Sanjay. Our Q1 results represent a solid start to the year amidst a challenging macroeconomic environment. Let me start with ARR. In our digital business, our ARR grew 21% year-on-year. As a reminder, last year's comparator had no contribution from StreamSets. Looking at the sequential growth, we have seen a slight increase on a constant currency basis. As Sanjay already mentioned, this seasonality was anticipated in our full year guidance. Looking at the licenses mix. Sales grew 68% year-on-year, showing a solid sequential growth of 4% and reaching a portion of total digital business ARR of 19% versus 13% in Q1 last year. This development demonstrates the increasing customer demand for SaaS, which will drive a significant portion of our 2023 growth. In Q4, we saw a very strong subscription led performance in A&N primarily due to the early closing of a large deal brought forward by Israeli [Financing] Ministry. As a result, this impacted A&N ARR growth in Q1 by 7% year-on-year. This represents 2% growth sequentially. Looking ahead, the strong performance in 2022 impacts of our 2023 expectations, which is reflected in our 2023 A&N, ARR guidance accordingly. Our total ARR grew 16% year-on-year and 2% sequentially to €704 million. Moving on to product revenue. Our digital business grew 8% year-on-year to €121 million. Due to the growing portion of SaaS licenses in our ARR mix, we experienced less upfront revenue recognition from subscription licenses, resulting in a temporary headwind on revenue growth. We expect this to shift towards us and our license mix. We expect the shift in our license mix to continue. At the same time, we will benefit from higher revenue contribution from SaaS licenses in future years as [indiscernible] is deeply spread over multiyear contracts. Therefore, this headwind will be temporary, and we will see more symmetrical ARR and revenue growth in the future. The product revenue coming from A&N decreased by 12% year-on-year to €49 million, partly driven by the earning closing of the large [Stefan] mentioned. Earlier in Q4, combining both segments, our total product revenue grew 1% year-on-year to [€170 million], in line with our expectations. When combined with professional services revenue of €41 million, group revenue ended at €211 million, representing growth of 2% year-on-year. Now turning to our cost development. Please be aware that all cost figures also reflect the full impact of the acquisition of StreamSets. Our total cost of sales were €61 million, increasing 23% year-on-year. This development was mainly driven by increased revenue contribution from SaaS, the impact on StreamSets, as well as investments into our implementation partner network as we shift our strategic focus from implementation to advisory services within professional services. On the other hand, the initiation of our cost-saving program of €30 million to €35 million per year continues to offset one-off increases in cost. So far, we have made good progress in the restructuring measures, which we announced earlier this year. This progress can also be seen in the reduction of the overall headcount number in Q1. Turning to profit. Our non-IFRS EBITDA margin was 11.2% for the quarter. Just as a reminder, our prior year comparator has been significantly higher than our user seasonality due to very strong A&N performance. As Sanjay mentioned earlier, this year's performance is in line with the seasonality we have planned. Therefore, we remain confident in our margin guidance for the full year. This brings me to cash flow. As in previous quarters, we have continued to see a negative technical impact on cash flow as a result of our business model transformation and subscription shift. Free cash flow was €21 million in quarter one, representing a significant improvement sequentially on Q4 and the comparable level to Q1 2022. Adjusting for StreamSets and factoring impacts, we would have seen a like-for-like improvement in cash flow. I'll now make a few comments on our outlook before I close and we move to Q&A. First, to reiterate what Sanjay has already outlined. Our guidance for the full year 2023 remains unchanged. Our Q1 performance in combination with our usual seasonality late in the year means we remain confident in delivering our full year guidance KPIs. The group's guidance ranges, except from margin are presented at constant currency as follows

Robert Hildebrandt: Thank you, Daniela. Ladies and gentlemen, you may now ask your questions. Please ask only one question at a time. Operator, please repeat instructions on how to proceed.

Operator: [Operator Instructions] The first question comes from Knut Woller from Baader-Helvea Bank.

Knut Woller: Just a question on the tailwind you should receive from CPI clauses in your maintenance contracts and also in subscriptions. Can you quantify this effect? And is this also the reason why in DB, we saw less maintenance development in the first quarter after many quarters of declines in the maintenance. Thank you.

Sanjay Brahmawar: It's Sanjay. Thank you for the question. So look, first of all, we do have very mission-critical software, and it's very critical for our customers, and therefore, we are able to have these conversations around price increases. And that's exactly what we're doing. This is in line with inflation. And so we are applying them as our contracts are coming up for renewals or we're having these discussions with customers.

Operator: The next question comes from Kathinka de Kuyper from UBS.

Kathinka de Kuyper: Just coming back on the ARR and digital business. So if we look at it sequentially, it's basically flat. You just added about 3 million in SaaS ACV. But if you're going through the transition, wouldn't we expect to see a larger number there?

Sanjay Brahmawar: Yes. Thank you. So on the ARR, we have added 7 million net of currency. So there is growth in the ARR and also Keep in mind, this is the weighting that we give to our first quarter. It's always a much lower weighting and then we have a growth with the SaaS coming through, and we have a large portion of SaaS in quarter one and that will build up towards the next three quarters in the year.

Daniela Bunger: And even though the total number doesn't sound very high, it's still a strong improvement from what we've seen in the same period last year. So yes, we're definitely seeing an improvement. And as Sanjay pointed out earlier, I mean, we definitely, as always, have a very strong seasonality. Semester two will be significantly stronger in our first semester. So this is totally in line with what we've been planning and what we have expected.

Kathinka de Kuyper: So maybe just a quick follow-up on that. So for Q2, how much sequential ARR growth in SaaS in DB would you expect?

Sanjay Brahmawar: Double digit.

Daniela Bunger: It would definitely be double digit. Obviously, it's always -- yes, double digit is the focus.

Operator: [Operator Instructions] We have a follow-up question from Ms. Kathinka de Kuyper from UBS.

Kathinka de Kuyper: Just coming back on your midterm ambitions. Can you just comment on the building blocks to get to the double-digit revenue growth and high [indiscernible] operating profit margins. Should that be kind of linear progression? Or would you see an acceleration towards the all two years?

Sanjay Brahmawar: Yes. I mean you will definitely see a steady growth in double digits for the next upcoming year as we are now giving you our numbers, including StreamSets, you already knew that Streamsets was growing at a healthy double-digit rate. And we are achieving the same on our -- the rest of the digital portfolio. So you would see that in the next years with, of course, an increased impact of SaaS and renewals coming through in the third and the full year.

Operator: We have a follow-up question from Knut Woller from Baader Bank.

Knut Woller: On the DB license side, should we expect a return to license growth in the coming quarters despite the higher share of SaaS that you highlighted?

Sanjay Brahmawar: Yes. Yes, Knut, you will see a return to growth in the subscription license side also. Having said that, what I will say is our experience in SaaS has been very positive in terms of the growth that we are seeing and the number of transactions is growing significantly. So it also ties up with the strategic priority that we've laid out this year that we really want to push very hard on cloud first and SaaS in the market. That doesn't mean that customers are still not buying in subscription and many large enterprises do procure both in subscription as well as in SaaS...

Operator: There are no further questions at this time. I hand back over to Robert Hildebrand for closing comments.

Robert Hildebrandt: Thank you very much. We would like to conclude the conference call. Ladies and gentlemen, we appreciate your participation and constructive questions. If there are further questions you would like to ask, please contact the IR team until next time. Goodbye. Thank you.

Daniela Bunger: Thank you. Bye.

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