Software AG (OTC:SWDAF) Q4 2019 Results Conference Call January 29, 2020 3:30 AM ET
Otmar Winzig – Investor Relations
Sanjay Brahmawar – Chief Executive Officer
John Schweitzer – Chief Revenue Officer
Arnd Zinnhardt – Chief Financial Officer
Elke Frank – Chief Human Resources Officer
Stefan Sigg – Chief Product Officer
Conference Call Participants
Alastair Nolan – Morgan Stanley
Michael Briest – UBS
Gautam Pillai – Goldman Sachs
Knut Woller – Badder Bank
Charlie Brennan – Credit Suisse
Den Merkt – Barclays
Good morning, ladies and gentlemen. Welcome to Software AG’s Analyst and Media Telephone Conference and webcast on preliminary fourth quarter and full year 2019 results. Last night, Software AG has pre-announced preliminary results for the reported quarter and fiscal 2019. This morning, we have published a presentation used in this call.
Today’s call will start with CEO, Sanjay Brahmawar; followed by Chief Revenue Officer, John Schweitzer; and finally CFO, Arnd Zinnhardt. The presentations will be followed by a Q&A session. Our board members Elke Frank and Stefan Sigg are also on this call to answer your questions. We will try to keep this call in the regular one hour timeframe and cover as many of your questions as possible.
Before we start, there are some housekeeping remarks. This telephone conference will also be broadcast by accessing webcast is via our Investor Relations Web site. The webcast will display the PowerPoint presentation charts related to this call. The same slides are on our website for download. After the presentations, you may ask questions. Please use only the dial-in phone number for posting questions. The dial-in numbers are also published on our Web site. For technical reasons, we cannot take any questions via e-mail during conference call.
The call and the webcast will be recorded and available for replay later today. With respect to capital market regulations, I would like to make the following safe harbor statements. Statements and presentations made in the course of the conference call and webcast include forward-looking statements based on the beliefs of Software AG management. Such statements reflect current belief of Software AG management. Such statements refer current views of Software AG with respect to future events and results and are subject to risks and uncertainties.
Actual results may vary materially from those projected here due to factors including changes in general, economic and business conditions, changes in currency exchange; the introduction of competing products, lack of market acceptance of new products, services or technologies and changes in business strategy.
Software AG does not intend to assume any obligation to update these forward-looking statements. Statements and presentations of this call and webcast constitute neither an offer nor a recommendation to subscribe or buy in any other way securities of Software AG and any of the companies that are members of the group at present or in future, nor does it form a part of such an offer and it should not be understood as such.
Statements and presentations of this webcast do not constitute an offer of sale of securities in the United States of America. The securities may not be offered or sold in the United States of America without registration for exemption, for registration in accordance with the U.S. Securities Act 1933 in its currently valid form.
Thank you for your patience. Now let us start, and I hand over to Sanjay Brahmawar, the CEO of Software AG. Sanjay?
Otmar, thank you and hello, everyone. There’s a lot of ground to cover today. You would have seen in our results and the new 2020 guidance we issued overnight. Before we dive into details, I want to take a moment to set the scene. Almost one year ago we launched Helix, our plan to transform our company and create a sustainable, profitable future for Software AG.
It is a bold plan for a big challenge; the challenge of investing and working with clarity to address under investment in our products, sales force and go-to-market; the challenge of building a new partner ecosystem to help us scale and grow; the challenge of transforming our culture and pivoting ourselves towards growth. This transformation is working. Everything I have seen in 2019 in our transformation, in our energy, in the winds we are securing and in the way we have risen to our challenges, makes me believe that we are as right to be bold today as we were 12 months ago. I am proud of our team and proud of the progress we have made.
The investments we made in 2019 have started to pay off and further clarify our way forward.
And further clarify our way forward. This clarity underpins our belief that now is the right time to make further investments in 2020 without losing sight of our medium term goal. It also helps us understand where and how to make that investment.
We exit year one having laid a strong foundation for our future. We have a clear market opportunity in front of us and we have a team that is match fit to chase and converted it. If we invest now to backup strengths and capture a market in takeoff mode, we believe we have the opportunity to deliver higher sales growth earlier than planned. 2019 has seen us focus our investment around four major work streams; product clarity, go to market effectiveness, our shift to subscription and turbo charging our partnerships. More than 95% of the work we set out has been done on track and has the potential to really move the dial on our momentum in 2020.
We have brought clarity to our product set. It was already best in class but too broad, too complex. Now, best in class is better, still and simpler to spell. We have dramatically simplified our offering, reducing 900 individually priced features and functions to 40 simple and easily understood bundles. We have created cloud offerings for every product set and our customers love what we are doing. Our product NPS is up to plus 40 for 2019 and plus 44 for Q4 both record highs.
With the new clarity around our product message has helped us significantly improve our sales effectiveness. There is hunger in our teams and we are shaking up the competitive dynamic of our sector. Our EMEA and APJ businesses are both now growing double digit. We now have a North American business, which is stable, predictable and ready for growth. Globally, we have won 342 new logos this year, representing 42% year-on-year growth and in the process displace competition from IBM, PTC, Apogee, MuleSoft, TIBCO and others to make a major impact in our market.
We have changed how we sell, transitioning with purpose to subscription. You can see the impact of these efforts in the new KPIs we introduced at our Capital Markets Day last year. For the full year 2019, our DBP business, including cloud and IoT, delivered 51.5% of its bookings through subscription and SaaS, up from 26.5% last year. 21% of its revenue is now subscription and SaaS, up from 11% last year and ARR here grew 10% year-on-year.
We have also invested in changing who we sell with. We started 2020 working hand in hand with fantastic partners like Adobe, Microsoft, AWS, Deutsche Telekom, and others. The power of these partnerships is beginning to show through in revenue with our first deal with Adobe Marketo, OEM closed Q4. Early days, but each one a brand new logo for us.
None of this has been easy or without challenge. No transformation of this magnitude ever is, but we are now a business that is fitter, shaper and hungrier for growth in every way. During 2019, we have seen the theory of Helix begin to translate into practice. I believe that the right thing to do in 2020 is to back our conviction, take advantage of our position and turn our hunger into real momentum and impact.
Our products, our sales hunger, our subscription model and our partner alliances all align with the way our market is moving. After 12 months of intense learning and focus, our people now think in the way our customers’ think. Elke Frank, our CHRO, and her team have started a tremendous cultural shift within our organization, pivoting to a new mindset across the company, something she will talk more about at our Capital Markets Day next week.
What we and our customers are now thinking about is change. Since 2000, 50% of the fortune 500 companies have been acquired, merged, or declared bankrupt. Their world has changed and now they must change too. In 2020, analysts expect global public cloud to grow by 17%. They also expect hybrid cloud to grow at the CAGR of 23% in the five years to 2023. KPMG tells us that enterprises have received the biggest budgets for 15 years to transform, automate, implement IoT, and tackle cyber security.
This world of change is where we fit and our products have a real role to play right at the center. As digital transformation gather space, our own transformation inside Software AG has positioned us to take share, innovate and expand our customer footprint. I’m going to come back to three specific 2020 opportunities for us before we move to the Q&A.
For now, let me move for a moment to the 2019 numbers. Against a backdrop of a year of significant transformation, today we are reporting a solid full year performance in line with our expectations for the Group. Group revenue and Group product revenue both grew 1% year on year at constant currency. That’s a solid performance against the backdrop of significant transformation in our business. Group EBIT was down 7% as expected with good cost control. And we delivered a non IFRS operating margin of 29.2% right in the middle of our guidance range.
At this point, I do have to acknowledge that our IoT performance was weaker than we had liked, up 38% year on year at constant currency, but not the growth we have pushed for. As we grow our IoT business from a relatively small base, we remain dependent on the timing of certain anchor deals to make our numbers in each quarter. Our Q4 performance in IoT saw a growth of 16%, which was held back by the slippage of one very large deal into Q1 of this year. That deal, another landmark five-year IoT agreement, has now been signed. It is an agreement with Schindler, the industry leading elevator and escalator manufacturer.
Schindler will adopt our Cumulocity IoT platform to connect more than 1 million devices and serve more than 1 billion users globally. Schindler is putting its trust in us to automate and customize innovations on a massive scale. I see this as another landmark step forward for our IoT business and a major show of faith in our industrial IoT capability. We fought hard to win it to beating competition from IBM and others.
In 2019, our pitch to help companies democratize their data secured us 79 new logos in IoT. In Q4, we saw new logo gains across all parts of our footprint. In the DACH, we landed a new IoT mandate with Trailer, a groundbreaking solar transportation solution developed by Deutsche Post DHL. Cumulocity will serve as the data backbone to a solar panel and factory powered fleet that is central to DHL’s target to achieve zero emissions by 2050.
In North America, Swift Labs joined our IoT customer list, selecting Cumulocity to help drive significant unit sales of a wireless IoT cellular platform in 2020. BSA, in Australia, chose to work with us to combining Cumulocity and web methods I/O to collect, analyze and act on vast quantities of data across its building and system footprint.
And remember, our IoT sales strategy isn’t just about land, its also about expand. NTT communications, a Cumulocity customer since 2017, agreed in Q4 to white label Cumulocity IoT as the foundation for its NTT things cloud. It’s also licenses our device connectivity and device management products, as well as our streaming analytics Cumulocity IoT Edge, and most recently the new Cumulocity IoT DataHub solution. Its wins like this that reminds me and make me a firm believer in our ability to drive IoT growth in momentum.
Looking at our IoT pipeline also gives me comfort. Our IoT pipeline is strong, both in terms of its absolute size and in terms of the quality and scale of opportunity within it. To qualify that for you, our 2020 IoT pipeline is now larger than ever, in fact, well over EUR100 million. We are seeing deals make up a meaning meaningful portion of the pie. As the only vendor in the market that can offer IoT capabilities, integration and integration flow technologies all woven together as one, I’m excited about our ability to continue growing in IoT, particularly with the market now beginning ignite.
So having built our foundation in 2019, 2020 for us is all about momentum. We can see our plan is working in product, sales and go-to-market, in our partner ecosystem and in subscription. With the wheels turning and our path becoming clear, I believe we are now in a unique position to bring forward some of the benefits of our transformation.
To achieve that, we believe it’s the right time to increase key investments in our sales efforts. Helping us reinforce and enhance our presence in key regions, we need to respond to the success we are having on subscription, investing to accelerate the build out of our customer success function. We need to put more resource into marketing, helping our teams continue their contribution to our newly energized pipeline. And with fantastic partners now in place, we also need to bring forward investments designed to truly activate our channel in a growing market.
You will have seen these investments captured in our revised guidance for 2020 and our targets for the medium term. Crucially, we expect these investments to lead to higher growth rate in our 2020 top line metrics than previously forecast. Conditions are such that these investments should allow us to capture more market share and grow faster in year two of our transformation than first thought.
The decision to invest now behind this growth opportunity has an impact on our 2020 margin guidance. But we believe this short term investment of margin is right if we are to deliver on a medium term potential. You will also note some changes to our guidance metrics, reflecting the business we have become. We will now guide on four KPI metrics going forward. One that remains a constant, our non-IFRS EBITA margin and three that are new.
These new metrics will not chart revenue in our three business lines, instead, they will chart bookings, the true way to measure our momentum as we evolve our subscription story. For 2020, we anticipate DBP ex-IoT bookings plus 10% to plus 15% year-on-year growth; IoT and Cloud bookings plus 40% plus 60% year-on-year growth; A&N bookings minus 3% to plus 3% year-on-year; and non IFRS EBITDA margin 20% to 22%.
Looking further ahead out towards 2023 and the medium term, we’re also updating our targets to reflect the inputs and outputs of our accelerated investments. We are revising our target for growth in our digital business from 10% of CAGR to approximately 15% CAGR. Our recurring revenue target within our digital business of 85% to 90% remains unchanged. Our free cash flow and consistent dividend policy guidance is also unchanged. And as we invest to accelerate top line growth, our medium term operating margin target is revised from 30% to a corridor of between 25% and 30%. These are investments targeted at growth. On the basis of the planned investments outlined today, we now target group revenue to cross the EUR1 billion mark in 2023.
Let me now turn to the wider business. As you know, our Helix strategy is segmented into three key pillars, which we call focus, execution and team. I’ve spoken in the past about the three pillars at distinct areas of work. The reality is that we entered 2020 in a much stronger position, because of the mindset and the momentum these three work streams together have created. I talked earlier about our products and I could talk about them all day. In 2019, we brought new innovation to market every single quarter, increased our development velocity by 37%. Our product leadership was recognized in 10 rankings by Gartner and Forrester. But good product alone means nothing. When we launched Helix, I was clear that the transformation we wanted to lead would be different from those of the past. This transformation would yield real behavioral change and nowhere has that change been clearer than in our go-to-market execution.
This has been a major lift but we’ve made major progress. John Schweitzer’s efforts have given us a much more Agile failed engine with which to target our 2020 goals. I want him to say a few words about this now and give a sense of where he’s going to take the go-to-market in 2020. Over to you, John.
2019 was a year of consolidate and expand the sales and go-to-market organization at Software AG. As a result, we’ve seen extremely good performance in EMEA, consistency in our APJ business and new stability and predictability in North America. The importance of our North America progress can’t be under-estimated. During 2019, we dealt with historic underinvestment in the region, moved away from negative behaviors hampering growth and developed a pipeline we can trust.
As Sanjay said, we now feel we can trust the business to deliver plan or better. How we sell has an expected direct impact on our ability to win in this marketplace, as well as landmark wins in the first three quarters with the likes of Michelin, Novo Nordisk, National Cancer Institute and FIFA. During Q4, we continued to take market share from our competitors and prove our ability to win.
In integration and API management we won contracts with Fujitsu and Siemens for our cloud-enabled webMethods.io offering. The agreement with Fujitsu and APJ will see us facilitate the integration of its business applications with those of its third party vendors. Siemens has chosen webMethods.io also as its hybrid integration backbone for its global MindSphere rollout.
Also during the quarter, we were proud to expand our relationship with Estes, a leading truck operator in the logistics industry. We enabled them to deliver end to end transportation and customer logistics solutions. We are already a mission critical provider to this longstanding integration customer. However, we are now providing our IoT solutions to help track their assets and other container attributes as they move their fleets around the world.
In business transformation, we expanded our relationship with Australia Post as it seeks to increase to the level of automation in its systems and processes. And we also expanded at Suncor, supporting a number of significant business architecture and strategic planning initiatives. In A&N, we continue our strong performance, expanding our agreement with Nissan, which already uses Autobots technology to manage its spare part system, manage its vehicle quantity requirements and run its dealer auction systems.
These wins give us significant momentum into 2020, but they also inform me of where go to market efforts must go next. First, there’s no doubt that the subscription model is helping us to be even more competitive. In fact, customers expect this contracting approach. Having played catch ups here in 2019, it is now helping us run right to the front of the pack on deals we couldn’t access before.
Looking forward, we will continue to step up our investments in delivering subscription sales, investing particularly in our customer success function and how we price impacted our solutions. The second, we’ll be working to accelerate our demand gen. As we sell our plans pipeline, I believe we are really on to something with these changes in our market approach, something Paz Macdonald, our CMO, will talk to more about at the CMD.
Last quarter, we talked about 40% contribution coming from marketing qualified leads. In Q4 that mark hit nearly 50%. Continuing to invest in targeted customer messaging, value based selling, and a more robust end to end lead flow is critical to our continued success. And third we’ll seek to ignite our partner channel to help unlock the power of these new routes to revenue.
During 2019, we began to work productively with a host of hyperscaler partners. These are organizations with which we can stay meaningfully together as a provider of choice to supplement all enable their existing offerings and grow together in the process. We are now working hand in hand with the industry’s most visionary names. Adobe, Microsoft, AWS, Dell, Deutsche Telekom, ADAMOS and others, who have put their faith in us because they know what we can do.
These relationships already — are already beginning to bet down and take off. The relationships with Microsoft and Adobe in particular have already started to show initial proof points. With Microsoft, our focus does that help their customers move applications and other workloads to Azure quicker. The customer value proposition is strong and the combined sales teams have already built a pipeline of more than EUR 20 million in Q4 alone. I expect to close the first year in this quarter. And with Adobe in Q2, we announced a strategic partnership to help companies, transform their customer experience by bringing together customer data across multiple enterprise systems into Adobe’s experience platform.
As a first proof point of this customer value proposition, we’ve matched a certified connector, integrates the user’s SAP service cloud solution or sales cloud solution with Adobe Marketo Engage, establishing a direct connection between the customer’s data and Adobe’s customer experience management tools. Customer demand has driven this innovation. The pipeline is building, and I am very happy to announce the first deals have been looked at close in Q4, 2019. We also continue to expand our influence in the areas of industry for that up, joining the open industry for alliance in August and continuing to build our position as a leader within ADAMOS.
Our Cumulocity solution now underpins more than 60% of ADAMOS IoT applications and growing stable open, leading-edge IoT solutions for adaptive manufacturing. All of this is a great source of confidence as we build towards our medium term goal of generating an meaningful portion of our overall revenue for our partner base. I intend to increase our investments in activating this channel in 2020. Something we’ll get more detailed at our Capital Markets Day next week.
Now let me hand over to Arnd, who will cover the 2019 financials in more detail and also add his technical perspective to our outlook. In particular, he can help you understand the different layers of investment as it relates to our margin guidance. Over to you, Arnd.
Thank you, John. Good morning, ladies and gentlemen and a warm welcome to our conference call from my side. In the following, I would like to focus on the analysis of Q4 and fiscal year 2019. For total fiscal year 2019, our results can be summarized as follows.
Adabas & Natural showed a fantastic year, and we experienced a growth of 3% of product revenue. This corresponds to the upper end of our guidance, which was positively adjusted after that three months in the year. Adabas Natural license even showed a growth of 7%. Our annual recurring revenue ARR is an important metric for our transformation, you know that. We grew ARR close to 10% for total digital. As expected during the year, the digital business was heavily influenced by our restructuring process in North America. Over the full year, we saw a decline of 3%, which is within the ballpark of our adjusted guidance.
At the end of the day, we must admit that our cloud and IoT performance was disappointing. However, over the year we saw a growth of 38%. Also we noticed a strategic deal slipping into one, Sanjay mentioned that already. And as we speak, this deal is closed. All parameters regarding net asset position and liquidity are in line with our expectation, such as cash flow, balance sheet ratios and net income. As you can imagine, I’m very happy to report that the operating margin is at 29.2%, which is north of the midpoint of our guidance range.
After these opening remarks, I would like to guide you through the numbers. Over the course of the year, we saw a continued tailwind of 16.5 million in total due to a slight euro weakening against the U.S. dollar. Based on our revenue mix, all other currencies affected the stated numbers only to a minor degree. As expected and communicated, the DBP license business recorded a result below last year’s levels.
The EMEA region contributed a strong growth, which was healthy indeed, while the restructuring in North America remains ongoing, and as John explained on track. For maintenance DBP excluding cloud and IoT, we grew by 3% for the quarter and — 4% for the quarter and 3% year-to-date in line with the license performance.
The revenue development for the three months confirms the revised fiscal year 2019 outlook we gave in summer. In 2019, digital excluding IoT and cloud, showed decline of 3%, which corresponds to the midpoint of our revised guidance. Regarding ARR, our positive development keeps marching on. In 2019 we were able to achieve a growth of 10% and posted the number to 340 million, this number puts us on track in our journey towards the business model that is driven by a high portion of current revenue.
While for the entire year, we continue to see sales and marketing spend at a higher level plus 7% we will observed the slide reduction for the quarter in line with less sales commissions being paid. The R&D extended senses were up for the year as well and increased by 4.5 million due to further investments into IoT and Cloud R&D tools. Let me close the analysis of this chart by referring to the cost of sales, this expense line increased by 12% for the year and 19% for the quarter because of our growing SaaS cloud business driving the related hosting costs up.
Now on to Cloud and IoT. Even though IoT Cloud grew by 38% it showed a week performance than expected. As Sanjay mentioned we were not able to close some major leads, which less to escape the revenue below guidance. As you would expect IoT Cloud is mainly driven by new logos, therefore, we still do face certain lumpiness here. On the positive note, we are winning projects that are strategic to our customers, like the ones that slipped into Q1 sometimes it’s required a bit more time on our part to convince the respective organizations.
2019 was a great year for all of us natural and as expected we close the year in this segment at the upper end of our adjusted guidance with a growth of 3% year on year. Maintenance the indicator for customer loyalty showed growth of 1% net of currency year-over-year and outstanding performance and a direct result of our hard work we have done in recent years.
Additionally, costs are well under control for the quarter and for the last 12 months. Consequently the margin remained on a very high level around 70% resulting in the segment revived up close to 160 million. Professional service business lines performed as expected over the final month of the year. The focus in the segment remains on supporting our strategic license projects and simultaneously closing monetary profitability. With a segment of 12% for the year I can present again a pleasing result.
The flattish revenue was in line with our expectation as we cut back on non-strategic services and shift resources to enhance implementation and partner support our co-products. As you may know, we have a big consulting organization in Spain which generates a total turnover of approximately 40 million. While we are delivering high quality services, major parts of their business are outside of our co-offering.
In line with our communication one year ago as well as in line with our new strategy, we have now sold the Spanish service operations to a Spanish consulting company which will operate as an implementation partner for Software AG moving forward. I am very happy to announce that together with our new partner Barbell, we can continue to deliver support to our customers at a very high level and b, we have found a partner who share our business values. They will give our employees a good new home as the possibilities for growth in their individual careers, which is a compelling.
Closing on the transaction is expected midyear 2020, under this assumption; the revenue impact will be around 15 million to 20 million for fiscal 2020. On this note, I want to ensure our Spanish customers that we will without any question, support them with our local Spanish product team also moving forward. We, as a Board of Software AG, view Spain to be irrelevant, interesting markets that we want to continue doing business in. During the first year of all transformation, total revenues for the growth of 1% of currency.
Our increased investments into sales and marketing predominantly in North America and central marketing lead to higher expenses of €7 million or 6% for fiscal 2019. In addition R&D expenses were up by 7 million year to date, mainly driven by an increase in R&D workforce of more than 100 FTEs. Despite the higher cost and thanks to all us from natural business line, we were able to achieve an attractive EBIT performance. The overall margin development for 2019 is in line with the expectation we shared with you at the beginning of the year.
Equally, the development of our operating margin was well in the range of our expectations. For the quarter, the delta between IFRS EBIT and operating EBITA, amounts to EUR 18 million, which may be termed as normal pattern. All in all, this leads for a margin which is North of the midpoint of our guidance.
The operating cash flow in 2019 developed as expected due to investments in conjunction with Helix the operating cash flow remains lower than in 2018, but remains at a consistently high level. The balance sheet, I can be short and crisp. As usual, our balance sheet is solid. In the interest of time, I will not give any comments, but obviously, I’m happy to answer any questions if necessary.
Before coming to my closing remarks, I would like to make some technical remarks regarding the guidance of 2020. The market success of a company must be derived from the customers’ adoption of its products. In this context, the development and the consumption model of its product is irrelevant. However, honoring IFRS standards the mode of deployment determines point in time when revenue is recognized.
Perpetual licenses are recognized upfront, subscription licenses for the first year of commitment and software as a service contracts are recognized for pro rata. So it becomes obvious that I FRS revenue is not the best metric to measure up sale success when using a mixed license model. Therefore, we introduced bookings as a new KPI to track customer adoption and to measure sale success.
The way we defined booking is a normalized three years commitment of a customer follow up products. It does not make any difference whether the customer consumes a product as a perpetual license, as subscription or as a service. At our Capital Market Day next week, we will dig into the concept in far more detail. However, to give you a first sneak view and to enable you to start building your models, let me give you two further explanations.
Number one, based on the assumption that the split between perpetual, subscription and SaaS is approximately 50, 40, 10 based on total bookings and the percentage of subscription with a one year cancellation cloth compare to subscriptions without a cancellation option. And therefore with an upfront license booking is assumed to be roughly 50-50. Group product revenue should be flattish on 2020. And secondly, we assume that Adabas Natural will remain predominantly perpetual.
Ladies and gentlemen, just a personal note at the end. I joined Software AG 18 years ago and one of the first is, I know that start is, I read in those days written by the then young financial analyst Gregory Ramirez, quoted, “Conditions far from excellent for Software AG”. I took the challenge. And at that time a lot of analysts like Adam Wood, Knut Woller, Stacy Pollard, only to name a few, started challenging me.
Some of your financial institutions from the years in 2002 no longer exists today. But you, as professional individuals, accompanied Software all the time. After 72 quarters, ups and downs some thousands of meetings and call with more than 5,000 people, countless kilometers on the road or miles on the road in the air and on the rail, some sleepless nights and sometimes hard times. I want to thank you all investors and analysts, for keeping an eye on me and for your encouraging and of course sometimes challenging words.
I enjoyed the interaction with you. Many conversations gave me food for thought and drove decisions I made. I have loved it. Many thanks also go to my colleagues and friends here in Darmstadt and all around the globe for supporting me over the years. And special thanks to Otmar. Happy birthday, Otmar who was my teacher at the beginning, supported me all the years and was a mirror of the financial market in uncounted discussions, especially when the quarter did not meet mine and your expectations. And was instrumental to win all the investor relations awards we received over the years. Many thanks to you all. Goodbye for now and hopefully [indiscernible].
Arnd, thank you very much. I just want to take a moment to recognize all Arnd has contributed to Software AG in its 18 years with the firm. He has been a source of energy, expertise and leadership to many and a true partner to me. He will be the same partner to Matthias as he helps bring him on board.
So to conclude, the key takeaway from today’s call should be that we are going to deliver growth in 2020 and invest in building momentum towards our Helix ambitions. We have stronger business with a clear market opportunity in front of us. Earlier, I had promised to highlight three particular opportunities I see open to us in 2020. So let me close on those now.
First there is the connected customer experience, connected customer enterprise. For 50 years quality, consistency and reliability have been key differentiators in our industry. Not anymore. Instead, customer experience is a starting point of all products and service redesigns. Our worked for Smart City Dubai proved that we notice and that we are able to position webMethods as the backbone of a plan to make Dubai nothing short of the happiest city on earth.
Second hybrid cloud and multi-cloud. Cloud isn’t easy or straightforward. Platform polarization creates real challenges for global companies. Multi-cloud is going to be the new norm and on premise will for some applications remain the standards. All of this complexity makes a thin, independent integration layer critical to success in the cloud. This is what Walgreens has already trusted us to provide. That is why Microsoft partners with us to speed it’s a real migration.
Third, there is operational excellence, the lifeblood of modern enterprise, data managing, analyzing, and learning from that data is a key challenge for all businesses. They only benefit from the data if they use it to learn quickly from custom insights and respond to them to stay ahead. To do this, they need to democratize their data so that the whole business can utilize it, not just a team of data scientists.
This is what Cumulocity, our IOT platform is doing for Nordex, optimizing its wind turbine operations through predictive analytics. It’s also where RS is helping Outokumpu, Europe’s largest stainless steel producer to improve its operations through data driven process mining. So three key drivers of opportunity, one stronger organization ready to target them, one strong product set with skin already in the game.
With that, I’ll hand back to Otmar for the Q&A.
Thank you, Sanjay. Thank you all the board members that presented here. This took a bit longer than normal as a special day obviously but I promise as you get the 30 minutes of Q&A. Operator Hailey, please would you repeat the procedures that everybody can get in.
[Operator Instructions] And the first question comes from the line of Alastair Nolan of Morgan Stanley. Please go ahead.
I’ve got three quick ones placed. Firstly, on the IOT deal, which moved into the first quarter and you’ve now closed. Could you just confirm or maybe provide some more detail? Would you have hit your guidance range of 75% to 125% had that deal closed in, in 4Q. And then secondly on the bookings metrics you’ve provided. You mentioned it’s a normalized three year commitment. Is that essentially then converting it into what would be a one year number? And maybe could you just touch on the, the assumptions around the splits that you were making, and also confirm that you said group product do you expect to be flat? And then just finally on the upgraded guidance for DVP on the midterm basis, 10% to 15% given the, this division has been, I guess we haven’t seen all that much of an acceleration in growth just yet, what has given you kind of the confidence to upgrade that midterm guide?, So what kind of timeframe are we talking about? Thank you.
Alistair, it’s Sanjay. I’ll take the first one to just explain because recently just being as a CEO and completing the deal, this is a significant deal for us, a very important one as you know, we were working on in Q4. It is big enough to be able to sort of cover majority of the gap that we would have had as we progress into Q1 we will give you more details on this. But, we are very pleased and very proud to be chosen by Schindler as their global partner.
I take note of the next one. Booking normalized for a year. So the number that we have in the guidance, is it three years numbers Alastair, let me just give one example of how we calculate that. And I’ll give you two examples. The first one is a professional license of five years. Let’s assume that, then we’d basically take the total contract value, which is a five year contract obviously based on my example. Then we’ve got divided by five years intensify three in order to normalize that into three years. On the other side if we would get a two year contract and we know that we have a high retention rate of all our customers.
The retention rate of all our customers, we would divide this is the multiplied by three. So to also to take into consideration that’s the view we renewed offset the time. So it’s always normalized on, on three years. A group product it’s less that is — that is correct just confirm that. Based on the assumptions that I gave in my presentation and once again I’ll just repeat them. So the perpetual subscription and SaaS has a split between 50 perpetual, 40 subscription and the around 10 SaaS. And out of the 40 subscription 50% has no cancellation rate, and the other 50% of cancellation rates of one year. And this is the growth I think it goes to you.
So Alastair, back on to your question on digital and what’s giving us the confidence. I would say three things really. Number one is pipeline. Pipeline is exceptionally strong. We can see that our coverage in the pipeline is way above the three mark. We are obviously targeting to get to full, but we are we have very strong on our pipeline. IoT pipeline already gave you the number. It’s EUR 100 million already. So, it’s number one.
Number two is the wins that we’re having in the market. A competitive wins really, we beat Apigee and Michelin, we beat and we are replacing TIBCO and Hellman, we’d beat IBM at Schindler. So the — these wins are giving us a lot of, lot of confidence that our capability in integration and API management, and covering the hybrid landscape is really strong. And number two, it is the only independent two independent layer that companies can add.
And the third one is really about the strengthening of the sales team and what John talks about. This trends in the go-to-market, this stability in the go-to-market and with improvement of average, sales for seller is what is giving us confidence that we will be able to drive the DBB growth now finally for ourselves. Thank you.
The next question comes from the line of Michael Briest with UBS. Please go ahead.
Just in terms of the — the guidance framework that you’ve talked to through the bookings expectations there aren’t. I mean from a revenue point of view. So you are going to be putting this one year cancellation in, so even if the customer signed a perpetual subscription deal, you would be in the P&L at least taking that as one year. Can you explain, what your assumptions are on the or whether that is the case and therefore the revenues will be one year subscription deals for the 40% that you’re assuming there. And then secondly, on the margin outlook, earlier in the year — earlier in 2019 you said there’s about 200 basis points to 300 basis point impact on margins from the subscription shifts. How we to assume that’s the case? And then the rest of this is discretionary investments, in which case, Sanjay, can you give a bit more color as to where that money is going? And how quickly those costs ramp up through the year? Thanks.
I take the first one Sanjay I takes a first part of second question then you take the second one. On the treatment of the individual contracts so let me start with the perpetual. The perpetual is 50%, I’ll see total business 50% and if perpetual deal the customer acquired us or right to use our software in perpetuity. By definition that cannot have a cancellation, regular full flow one year because you already acquires for — in perpetuity. So that’s the first element.
On the subscription side, he acquires the right to use the software for a certain period in time, typically a three years contract. It depends on whether we want to offer the customer is right or whether we do not want to have that. That has something to do with do we just implement a product for instance or is it customer already in use for many years if it’s already in use for many years, the risks that we are taking was offering an additional one year cancellation rate is very much limited because we know that the customer retention is extremely high. So therefore it will be decided on a one-to-one basis based on what we sold in the countries and what we feedback we received from the countries, this 50-50 split is most reasonable split between the two ways of setting up the contracts.
The technical squeeze, the second question, Michael. I was talking about 200 to 300 basis points in Q3 reporting. Actually, we even achieved a higher adoption of subscription Sanjay mentioned that in his speech. So therefore in the current budget submission and our forecast, which is a basis for the guidance, we assume a technical squeeze of 350 basis points plus/minus, and then the rest is incremental investment that Sanjay will talked about.
Michael, so the investments that we are putting into 2020, after seeing the 2019 investments really settle down and really supporting the foundation year. It’s mainly five areas, Michael. Now first one is a customer success organization because you know, our subscription success is obviously putting us into a different mode of engagement with the customers and we need to make sure that we’ve got a very strong success — customer success organization that manages the ongoing relationships.
Second is the partners you saw that our pipeline with Microsoft and Adobe, we are creating dedicated team on Microsoft a set of people working full time on Adobe. We believe these two primary partnerships will drive significant growth for us. So it’s putting the right kind of team to really drive these hyperscalers partnerships.
Number third is adding some sales capacity into geographies, primarily EMEA and APJ, I told you about EMEA, APJ. EMEA and APJ both are growing at 20% plus. And then fourth one is putting some money into marketing, which is to step up our demand generation engine. This is what John talked about. We want to really fill and flood our pipeline and support the sales execution.
And finally, we are putting some money into our culture and transformation. It is a very important part of making this transformation stick and making sure it’s sustainable and hence we have some money put aside to do that. So that’s, that’s the investment. I’m sorry your last part of the question was it about the phasing — And obviously the people addition that we want to do to get the impact in the year that is a front loaded or starts in Q1 and then obviously the spends like marketing and culture transformation, et cetera, all phased out in the year.
And margin tough in 2020, is that assume?
That’s the margin range you mean or…
So the 20% to 22% guidance for this year is the bottom 2021 being lower than that?
That is better the guidance, exactly.
The next question Gautam Pillai of Goldman Sachs. Please go ahead.
So on the firstly can you give me an idea of the trend in bookings growth in the digital business in Q4 versus the 10% growth you have seen in the full year so that we can get my idea about the exit rate of growth. And secondly coming back to your comments on the raising of guidance for the digital business, can you talk about the different key products which is driving this good momentum and also the different moving parts in this guidance including marketing shifts which you’re assuming, and also can you talk about the underlying growth assumption for the IOT business within the digital guidance? And finally on the subscription transition, do you expect the transition to be more or less complete by 2023? In other words, will your majority of the 80% to 85% to 90% recurring revenues individually business be on subscriptions by 2023? Thanks.
So let me take two of those questions and then I’ll ask Arnd to talk a little bit about our exit rates. But first and foremost in terms of your point about our target around 2023. Yes, we are, we believe we are firmly on track for that target to get to that 85% to 90% recurring revenue. Arnd mentioned we already grew by 10%. So we’re at 70% now, which means we are well on track number one. Number two, what is the underlying growth of IOT business?
So I mentioned two particular trends. One was this connected customer enterprise, which is effectively bringing together the data and making sure products are connected to be able to create this experience for the customer. And it’s not just enough to deliver quality, it’s not just enough to deliver consistency and reliability. You have to be able to deliver this connected experience and all the data associated with it. And that’s where IOT growth is coming forward. We can see with the deals that we are signing, Schindler is a fantastic example of them connecting 1 million elevators to be able to offer not just the data for maintenance but also create in, in elevator experience for their customer, so that’s kind of one thing around the IOT.
The second thing of course is in terms of being able to drive solutions for other customers such as Deutsche Telekom or Telstra in Australia who created water management solutions. So it’s working with these partners and helping them build solutions for industries. That’s where the drive off the IOT is coming.
Last thing I would say on IOT, Gautam, is that the size of the deals are now getting exciting. We start seeing five figures, six figures, seven figures, and now eight figure deal. And this is really exciting now because it starts getting material. Now, the third question you had was on the key products, so clearly, you know, our emphasis is on integration, API management, IOT analytics. This together for us is about a $20 billion market size, which is growing at double digit speed. So this is where we continue to keep our focus. And we know we launched several new innovations in integration API management. We now believe that we are one of the strongest independent hybrid integration providers.
So this covers integration, API management and iPad. And then on the other side with IOT and self serve analytics. So that’s kind of the key product. And on the exit growth rate, so you’re right. The majority of the 2023 recurring revenue will be subscription, but please don’t forget that, which is obviously also recurring. And then the remaining portion of the maintenance out of the perpetual contracts that will be still around 23, like your base assumption is right yet.
And on the exit rate of bookings growth in Q4?
On the exit rate of bookings growth is very much in line with our ambition of 2020. Gautam, so you know that we are forecasting between 10% to 15% on the DBP. So we have a strong development on integration and API management and of course our business transformation tools RS and Alphabet. Both have a — have a strong exit rate, which allows us to feel confident about the first half of 2020.
The next question is from the line of Knut Woller of Badder Bank. Please go ahead.
A couple of actually, if I’ve done the math correctly, your additional investors around EUR 40 million this year, can you break out a bit, what of that is one time nature and what of that is recurring? So to get a better feeling for the — for the part that would stay on the P&L, and also in conjunction with that, just to double check on Michael’s question. So is there a commitment for margin expansion event from 2021 on and how should we think about the margin progression to get towards your mid-term target range of 25% to 30%. Then lastly, a question for John on the U.S. restructuring. Can we get here an update? You said there are still some spillover effects in 2020. So can we get just a feeling when that is going to be finalized? How much headcount that involves, and then I think we should — do if you find with the view that we should see continuing uptake in the momentum that we saw in Q3 and also in Q4 based on your currency contribution in U.S. dollar noted in your presentation also on the back of the moment sales cycles you have in that business. Thank you.
I’ll take the first one and then I hand over to Sanjay and then, I think John with the third one. The first one was regarding the 40, or let me call it EUR 40 million to EUR 50 million in investments most of them is recurring. So the majority of that is additional people. Joining Software AG with a big majority obviously in sales and sales related areas. So therefore these are costs that you would see also in ’21. Some of the non-people related costs. So out-of-pocket expenses, they are onetime, but they are a smaller portion out of the entire bucket.
On the question about the margin commitment towards our mid-term, first and foremost we are fully committed to our margin guidance that we’ve given for the mid-term to 25 to the 30. And of course, if you go now through the next years, we are still continuing our transformation to subscription. So, we will — we will continue to see a shift to subscription in 2021. But we will start seeing the return towards our margin expansion towards the 25 to 30 for the mid-term. So, now it’s a journey towards — towards our mid-term goal.
Yes, Sanjay, I can add. So on the North America side, extremely pleased as you’ve heard that over quarters now, last two quarters with the progress in North America, in the quarter in Q4 a we’re welcomed a North American leader, who has very strong industry experience across, medium, large companies that is going really going to help us with scale there. He’s really worked about as leadership team in the quarter as well as in Q1 here. So sub-reason leadership is in place. We’re attracting leaders from big competitors, I might add.
The other thing that’s really interesting, we’ve seen these large competitor salespeople and managers come to us in more recently with MuleSoft lockup expiring with Salesforce. So that’s an interesting trend. But overall I have the strength in North America I think really resides on the strength of the pipeline that type I was closed as I mentioned last quarter with building an expanding on it, the predictability of that business is improving a month, a month. And I think we should continue to expect that shrink continuous in more of a beat-and-raised scenario each quarter going forward.
The next question comes from the line of Charlie Brennan of Credit Suisse. Please go ahead.
I’ve got two questions actually. Firstly a lot of the investor feedback that I’ve had this morning has all been around whether they should back management through this investment phase. And I guess at the back of people’s minds, they’ve got a previous investment into DBP that ultimately didn’t deliver the returns that people hoping for. I’m still not exactly clear on what the metrics are here, but the demonstrate the initial investment into 2019 is paid off and why further investment is going to accelerate growth. And I guess specifically if I think about Q4 momentum, it feels like it’s slightly weaker than Q3 momentum. Is there anything that you can say around pipeline conversion in Q4 or anything you can give us that gives us genuine comfort the business has been accelerating on an underlying basis? And the second question is just a clarification. Arnd can you just remind me what you said on the Spanish consulting business? Was it annualized EUR 14 million of revenue on the disposal kicks in at the half year, which is why there’s a 20 million impact this year?
I’ll just begin it with a second one because that’s easier. A good morning Charlie. Yeah, so the annual license revenue is 40 million, you’re absolutely right. And assuming that the closing will be done throughout the summer, it’s half year effect for this year, which makes it 15 million to 20 million.
I’ll address the first part of your question then I’ll ask John to make a comment on the pipeline from the go to market business. So your question around what is different in terms of what other metrics? So first thing I think what is different from this transformation compared to the previous one is we have actually gone and addressed the clear areas of undressed investment, particularly North America and fixed the problems that we’ve had for many, many years so that’s kind of one thing and taking some difficult challenges, broken them down and really address the root cause problems, that’s one.
Second thing is, what we are looking at as leading indicators that give us the confidence that this is going now in the right direction, Arnd talking about one, recurring revenue. Recurring revenue is building and growing and 10% up. The second one is the subscription transformation. Is it really working? Actually with that 56% of the new bookings that shows us that both the customers are buying in subscription left, it opens up new doors to us in subscription. That’s kind of the second one.
And then I think the third one is these wins in the new logos. The problem with us in the past was we were doing too much farming and as a result, we were not opening up the doors to be able to land and expand with 342 new logos we’ve added these new customers, net new customers, that actually allows us the opportunity to grow and expansion there is a net new customer for us. So those are the signs that basically tell us this investment is settling, paying and now giving us the platform to accelerate growth. So with that, I’m going to hand it to John who can make a few comments on the pipeline, the strength of the pipeline.
So let me maybe dovetail off of Sanjay’s comment on new logos. So 342 represents exactly 27% year over year growth. There’s a really encouraging sign, I’d just echo a comment there. Pipe conversion, yes, it’s up, for sure. But the other things I look at our average deal size, which is also trending in the right direction for me. The other, sort of KPIs and I use it operational levels around productivity and efficiency specifically if I look at the sales force or the percentage attainment, which is more an emotional metric from a sales, side of things but also participation. Participation rates are up, significantly meaning, how many of our sellers are selling something in the quarter. And so I sort of use that combination or these combinations of productivity efficiency to guide my forecast, my comments earlier today in the call.
And can I just follow up with the third question? You keep talking about the medium term targets and I guess the margin target of 25 to 30%. What’s the timeline for your medium term? Does that align with 2023 target to deliver a billion of revenue?
Charlie, we are fully fixed on this medium term. When we started, we defined the five year journey with helix. So nothing has changed in the medium term. We are convinced that we can cross this billion mark in 2023.
The next question is from Den Merkt of Barclays. Please go ahead.
Thank you for taking my questions. Previously as guided to a dip in revenues in 2020. Now you expect flat product revenues. What has really changed? Is it that the condition is slower? Is it because you expect now that half of the subscription deal will not have this one year constellation, right? Or is it simply you seeing better growth. And then secondly, I appreciate you’re planning to do most of the hiring now in Q1, but some of these cost risk will annualized next year. So if you’re now thinking about the OPEC space from 20 into 21, well this one off investments largely offset the annualization of the hiring costs or how should we think about OpEx growth from ’20 to ’21. Thank you.
So when I take the first one and to actually you go to your spot on your, was your comment. If you go to the midterm guidance, and let me just take this as an anchor point. Last year on our capital markets day, we were talking about a CAGR growth of 10%. Sanjay reported on a 50% expectation today. So therefore the incremental momentum on the top line basically drives also not just bookings but also impacts revenue positively. And this is why it isn’t slightly down flattish.
And your point about the costs, the operational costs that we are adding. First and foremost, the people that we are adding are basically, as I said in the two markets that are the growth markets for us, our growth is in the kind of hyper growing markets and we want to add more capacity. And the second thing is that in the customer success function, so indeed those costs will obviously carry on into 2020.
Then we are putting some obviously in increased investment right now into the areas of marketing and people culture transformation, which we need to do this year. And I don’t see that level of investment needed as we continue, because at the moment, we need to create a higher push in the demand generation and pipeline focus that we needed. So I think the main area that is continuing is primarily the people that we are adding in the two areas I mentioned.
So excluding that cost inflation, the OpEx base should be relative flat from ’20 to ’21. Is that correct?
And there are no more questions at this time. I hand back to Otmar Winzig for closing comments.
Thank you, Anne. Ladies and gentlemen, now we will close this call and we all have other assignments, but I’m happy that we have got all questions into the extended time frame. Please let me remind you that we will offer more details and time for questions also at our Capital Markets Day in London next Tuesday, so February 05. In case you want to come, please sign up by mail to the IR department. Otherwise, you’re welcome to follow the main presentation during the morning via webcast. So thank you all for now for your participation and the strong interest in Software AG and goodbye and in London, we’ll speak to you again then. Bye-bye for now.