Simcorp A/S

CSE:SIM

Earnings Call Transcript 2019-Q3

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Q3 Report 2019 Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, Friday, the 15th of November 2019. And I'd now like to hand the conference over to your speaker today, CEO, Klaus Holse. Please go ahead, sir.

[Klaus Holse, CEO & Member of Executive Management Board]

Thank you very much, and a warm welcome to all of you on this November date for a short conversation -- or long conversation about the Q3 and the first 9 months of the SimCorp results for 2019. If you flip to Page #2 (sic) [ Page #3 ], then you see the agenda for today, and very exciting. We have 5 agenda items. We only have 3. There's an agenda item on strategy, fourth one. But the usual 3 ones first. I'll take the Q3 highlights, and Michael, our CFO, is going to come on and talk about the financial review and the outlook. And then we go back to strategy and I'll do that one. And then we'll all take Q&A at the end.If you flip to Page 3 (sic) [ Page 2 ], then you'll see the usual disclaimer. And if you have not read that, I'll certainly encourage you to read through that because that governs what you're going to be seeing on the next few slides. If we then flip to Slide #4, which is the one that talks about Q3 at a glance, then what you will see is that Q3 was a strong quarter for SimCorp, kind of the underlying business growth was quite good. And there was a couple of extra items in there, but we'll get back to those. Order intake for the quarter was EUR 19 million. That's EUR 4 million up from the similar year last year, and that is -- we signed one new SimCorp Dimension and one new SimCorp Coric in the quarter. And then we had a conversion in the quarter of a contract and then good order intake to existing customers as well. Organic revenue growth of 40.8%, so that we're quite happy about. The 40% of that is the organic growth. If you look at the total reported revenue growth, that is 45.5%. EBITDA of EUR 35 million for the quarter, an increase of EUR 20 million over the similar quarter last year. And the 12-month rolling software updates and support growth is 12.1%. That's a very high number that comes out as we have completed projects. Things have gone live with the clients we've signed over the last years and so on. So that is a number that has ticked up. And in some senses, this has been ahead of the software growth, but that is kind of coming from prior quarters. Professional services had a good growth of 13% in -- 17% in reported currency and 15.7% in local currency and then 13.2% again organically without GAIN. Free cash flow up to EUR 21 million, up from EUR 18 million a year ago in the same quarter. So all in all, a strong third quarter for 2019. If we then add that -- move to the next page and add that to the previous 6 months, then the 9 month also shows a good performance. So 30 -- EUR 63 million in order intake, up EUR 18 million compared to the same 9 month. Organic revenue growth of 26% for the quarter. If -- in reported, that's almost 29% as we add currency and gain to it. EBIT of EUR 94 million, an increase of EUR 41 million compared to last year. Order book up -- or down by EUR 10 million, down to EUR 35 million, and that is because in Q3, we did recognize the large order we got in Asia at the end of Q4 last year that was recognized in August, just like we said in the previous call like this. And that took out of the order book, so that's now down by EUR 10.5 million for the year. Professional services had an organic growth of almost 10%. We grew almost 13% in reported currency. And if you add kind of gain in FX, that's the number you get to. Free cash flow, up a little bit over the same 9 month last year, up to EUR 66 million for the year. So overall, we feel good about the first 9 months of the year. And compared to the same 9 month of last year, that wasn't the strongest 9 month in the history of the company. That is -- of course, stands out as a good 9 month with an organic growth of 26.1%. If we move to the next slide, you see the list of new clients in 2019. And you'll see there's 10 clients on this list, which we're quite happy about. We finally move forward from this one to give you a little more flavor and color, so what it is that these clients are buying in. So we've kind of segmented the SimCorp Dimension side of the product in the dark blue, which is front office, middle office, back office, data warehouse and cloud, so whether we're hosting it or not. And then there's a Coric column and a GAIN column. That way, we think we can give you a little more color to what the customers actually bought in to. So we've revised the Q1 and Q2 to be more granular. And then in Q3, we signed an undisclosed investment manager in Singapore. And we signed the Pennsylvania Public School Employees Retirement System in the U.S. So 2 customers in the third quarter, 1 in Asia and 1 in the U.S., 2 markets where we've seen growth in [ Asia ] as well. So we're quite happy with that. Moving on to the next slide. We're back to the agenda slide and ready for the Q3 financial review, which Michael Rosenvold is going to take on.

[Michael Rosenvold, CFO & Member of Executive Management Board]

Thank you, Klaus, and I'm now on Slide 8 where we, using the waterfall diagrams, are showing the revenue growth and EBIT margin, and as Klaus said, solid organic growth of 41% in revenue. We had impact from M&A of 2% and also a tailwind from FX. So reported growth, 45.5%. And as Klaus correctly said, these numbers are, of course, inflated by revenue recognition of the big deal from Asia, which should be revenue recognized in some place, and this was in the quarter and then a conversion also in Asia. And even excluding these 2 items, it's still a pretty solid organic growth in the quarter, but of course also comparing to a relatively low Q3 2018. Looking at the margin. Again, due to the revenue increases basically from licenses, the margin went from 19% in Q3 2018 to 30% in Q3 2019. And also, if we adjust for FX and M&A impact, it is a 30.6%, you can say, underlying organic EBIT margin. Going to the next slide, Slide 9, quite similar picture also because we -- the first 2 quarters were pretty solid. So a revenue growth of EUR 29 million. And then adjusted for FX and M&A, an organic revenue growth of 26%. Again, if you want to adjust for the 2 Asian deals, it's still solid revenue growth also, excluding those 2. And looking at the margins, going from 20.7% in '18, 9 months '18, to 28.7% in 9 months '19. And again, adjusting for M&A and FX, the organic growth also solid at 29%. Then moving on to order intake, which Klaus also mentioned. You can say a modest growth in Q3 of EUR 4.4 million, but the growth, of course, also impacted by the conversion. CDD was slight -- was less in Q3 '19 compared with Q3 '18. So that was EUR 3 million less, EUR 1.5 million compared to EUR 4.5 million. So you can say the other increase was more -- not CDD, but real licenses. And then as stated several times, we had a number of regular add-ons and then one conversion. Then moving on to Slide #11, where we see the development of the order book. Very clearly, due to revenue recognition of the Asian deal, order book naturally goes up. That's a simple math. And then if we compare to the same period last year, the order book actually increased by EUR 4.6 million. Worth noting that of the EUR 35 million we have in our order book, EUR 18 million of those are CDD orders. Moving on to Slide 12, where we have made a split of the different revenue items and how we grow those. It's quite clear no matter how you view it, the license sales has been increasing quite a lot, both in Q3 but also for the 9 months. And -- but also very pleasantly that the software update and support have more than 10% growth. And also professional services, which actually had a 13% organic revenue growth in Q3 2019. So you can say all revenue types are increasing double digits, both in Q3 and in the full year -- sorry, in the first 9 months. Then we have the split on Slide #13, where we try to illustrate the different additional licenses items. So you have -- you can say you have additional regular license sales, then you have renewals, which is, of course, part of our business, our new business model, and then you have conversions. And if you look at the additional regular license sales, you can depict from these numbers that, that was EUR 22 million for the first 9 months of '19, come back with EUR 20 million for the first 9 months in '18. So you can say the underlying additional license sales has increased slightly in '19 compared to '18. And then if you look at the conversions, then you can say that the size of conversions for the first 9 months are more or less equal to the conversions we had for the full year last year. So there is a timing difference. So we have had more conversions for the first 9 months than we had for the first 9 months last year. But if you look at it and you don't expect more for the rest of the year, then it's the same size. Then going on to Slide #14, the cost development. It's quite clear that due to the high revenue growth, we have also expensed more to commissions and to bonuses. And we have also increased our R&D costs where normal development, but also starting off our cloud journey. So it's basically the R&D costs, the sales and marketing costs and the admin costs, which have increased, while cost of sales has increased less. And if you look at the cost of sales increase, it was 10% organically for the first 9 months following very well, you can say, the other line growth in our consultancy business. Then moving on to Slide #15, the cash flow development. Slightly better cash flow than 1 year ago. And if we look at the cash conversion, which is, you can say, the free cash flow divided by the net profit, so it's a like-for-like comparison. That has for the last 12 months been 74%. And maybe you remember that we gave the guidance for this year of between 60% and 80%. So you can say the 74% is well within the range we guided for, for this year. So cash conversion, we believe, is satisfactory. Then my last slide before I hand over to Klaus again will be on the guidance, where the headline is that we maintained our expectations for revenue growth and EBIT margin. So we do expect revenue growth in local currency to be between 12% and 17%. And for the EBIT margin, also in local currency, to be between 25% and 28%. We have adjusted our expectations to AIM Software slightly, so -- which is more or less rounding, where we rounded up to 2% in our previous announcement, and now we have rounded down to 1% impact from the AIM Software on revenue growth and kept the margin impact unchanged. So you can say a slight change of allocation between impact from acquisitions and organic growth, but it's not major. And then you can say from currency fluctuations, we now expect a positive impact on revenue growth of 1.7%. So when you look at the reported numbers, they should be higher than what we guide here. And the same for the EBIT margin, a positive impact of around 0.4%. Then I will hand over to Klaus to talk about the strategy.

[Klaus Holse, CEO & Member of Executive Management Board]

So we're back on the agenda, Slide #18, strategy. And if we move on to the next one, which is 19, then the strategy that we have put in place is basically that evolution of the strategy we've had for the past few years. It has a focus on kind of the evolving customer demand, and what we're seeing is that the customers are increasingly looking at cloud and a cloud delivery model and the ecosystem that surrounds a cloud delivery model. And that's something that you would expect to happen. It's happened slower in the investment management industry than in many other industries, one reason being that there's a slower adoption of at least some of the technologies that we sell, and there's also regulation that have kind of demanded these investments managers to have data in a specific country and data centers and so on. So the adoption has been a little slower in these [ 10 others ]. But what we're seeing now is that there's this move towards cloud. There's a move towards asking the vendors to do more, deliver more as a service, both the software and services on top of that. And then we're increasingly seeing kind of an open ecosystem of partners wanting to engage in having an open system rather than a system that has all the functionality inside. So those are kind of the ones that we are moving towards, and that's kind of the foundation of the strategy. On the next slide, we show our winning aspiration and that has not changed. We want to be #1 in our space. And in some sense, as we debate whether we already made that, we're the one who has 200 clients in our space. Nobody else has that for front-to-back systems. So in some senses, we will debate that. Are we the biggest in revenue, maybe or maybe not. But we are at least getting to a point where it's within reach to be able to say that we are the #1 in our space. But even when we get there, we want to keep expanding. We want to be the -- even more #1 in our space as we go. So that's our winning aspiration. And then kind of underlying that is a set of what we call strategic imperatives, and as you will notice, those 3 imperatives kind of adhere very well to kind of where the customer wants to go. So they're kind of based on this idea of a cloud technologies. And we are upgrading all of our systems to be cloud native and running as a service in the cloud. And then there's kind of 3 imperatives that sits on top of that. The first one is customer experience leadership. As we get towards a cloud-enabled solution, we are better able to understand the usage patterns and so on of the system and help our customers adopt the systems and use the system, creating more value, gaining the full value of what they bought from us. So we are forming inside the [ SimCorp 18 ], that we call the customer experience team, that's going to have discussions with our customers on adoption and use of the system and making sure they get the full value of the system. Our view is that if they get the full value of the system they have today, they are more likely to expand the usage into other areas as well. So it's kind of a -- it's a sales enabler, but it's also something that keeps the customer on the platform and keep them more happy. The next one is the everything as a service. We are increasingly seeing customers asking us to host the system, run the system, take care of some of the system desk jobs that are in there, take care of financing or kind of reconciling some of their positions and so on. So more and more, they are asking us to do some of the basic services that is associated with the system, and we will build services to do this. We'll automate those services. Our intent is not to have [ 1,000 ] people in India doing these jobs. We'll -- we might have a few people doing this, but the intent is to automate this and deliver it as an automated service to the customer. That's kind of the long term of where this needs to go. And then the last one is the ecosystem-enabled innovation. And this is where we will open up the systems. We'll build more APIs, application programming interfaces, that will allow partners to interact better with the system. We always have, but we have built quite a number of these APIs already. We've got partners that uses these. But we will keep opening up the system and we expect more and more partners would want to do this, creating an ecosystem that allows our customers to do even more with the system. So those are kind of the 3: making sure that customers are happy, adopting and using the system to its fullest extent, allowing us to deliver more to the customers along with the set of partners. That's kind of the idea based on a cloud platform. So that's that one. If we move to Slide #2 (sic) [ Slide #22 ], then it takes more into the customer experience. That's a complete offer. The customer success. We talked about data and analytics. So we will have more data, we'll have more analytics, we can give that back to the customers.And as I talked about, if you move to Slide #23, we are putting in place an organization that will kind of have specific areas for how do we land the new customers. So that's kind of selling new licenses to new customers. Then the adoption which is a new play where we are putting in customer experience managers to help customers fully adopt the system. And then based on this, drive an expansion of use of the system. And then ultimately, given that we are in a subscription-based licensing model now, you'll need a renewal at the end. So that is kind of a -- the cycle of landing a new customer, making sure they adopt the full -- system fully, expanding the use and then finally renewing. So that's kind of the way we're building. That's the organization we've built and is going into 2020 with. If you move to the next slide, it kind of talks about the everything-as-a-service. That is it makes it easier for the customer consuming what we have because they come out of a cloud. They don't need to install it, and maintain it and so on. We take some operational responsibilities for this, and then we standardize and automate all these services that we deliver to the customer. And lastly, it's the ecosystem-enabled platform, which is we are building an open platform. It's kind of the front-to-back version 2.0, if you will. And then we think there's co-creation between us and partners. There's co-creation between us and our customers that allow them to build on this more open architecture. So those are kind of where we are going. If you can think broadly about it over the next 3 to 5 years, those are the investments we are making in the system. In the short term, we're making a significant investment in lifting all of the technologies through a native [indiscernible]. And then we are investing in building these capabilities of more automation and so on as we go. If we then look at kind of the short term, what is it that's drive us in the short term, then you have that on the next page, Page #26, which is kind of an update must-win battle. And there, you will see that it's an evolution. So front office is still important to us. Alternative investments is still important to us. Making sure that it's easy to implement the system using the standard platforms is still important. And then there's kind of the cloud lift. That's the big investment we're making now and that we'll complete most of in 2020. We talked about this to our clients at the user conference we had in Amsterdam in September, and kind of laid out a full time line of how we get this done and get every client on this cloud platform by the end of '22. So that's the ambition that we're moving with on that one. And then the last one is SimCorp GAIN and data care. So us getting into the data management space with the acquisition we made of GAIN, both as a product and building -- kind of delivering data as a service as well back to the idea of everything-as-a-service. Then this comes in 2 versions, one where we delivered software and one where we actually just deliver the data as a service to the client. And today, we have customers in both of the options. If we move on to the next slide, 27, that talks about kind of the strategy we had on the people side of it. What is it that we want from our people? What is the cultural fit of the people at SimCorp? We spent quite a bit of time over last year kind of talking about and discussing with a broad group of people from the organization, what is it that drives us? What is the culture of the organization? What's our ambition? And I will say, in many ways, I'm -- I personally am quite proud that we ended up with kind of the statement that sits on the bottom of this slide that says, why we are really here, we're driven by our passion to create value for our customers. So this is why we're here. We are here to drive value and work with our customers in making sure that they get value from the system. So that's the core of this. And then we've kind of said, the way we do this is kind of with -- kind of 4Cs. We want to be collaborative, just -- not just internal SimCorp, but also with our customers. We have capabilities. We've built that over time. We'll continue to build that. We want to be curious. We were some of the first that went agile. We are the first ones out there doing new things in many ways. We want to be curious. We want to sail fast, move on and be curious and courageous. So make some of the bold moves and push forward in this. So that's kind of the people vision, and found on. We want to build value for our customers. Moving on to the next slide. The last one, which is where you, as investors, might think that's kind of what we were looking for. What's then, out of this strategy, kind of the long-term vision on the financial targets? And there, you can say our ambition is the same ambition that we've had for a number of years as we want to be able to grow at double-digit pace, and we want to be able to expand the margin year-over-year. So that's not changed. That sticks there. That's been the ambition for as long as I've been here. And in most years, we've been able to fulfill that expectation and ambition in a sense. But there's also been years where we were not able to fulfill that. And I think that's going to be the same going forward. This is our ambition, but there will be fluctuations. There'll be years where we have more renewals. There's going to years where we have less renewals from customers. There's going to be years where we have more deals. There's going to be years where we have less deals. There's going to be years where we invest a little more. There's going to years where we invest a little less. So there's fluctuations in this, but that doesn't take away the ambition of we want to grow at double digit and expanding margins also for the future. That was the last slide I have. That brings us to the very last slide on the deck, which is the Q&A slide.

[Operator]

[Operator Instructions] Your first question comes from the line of Claus Almer from Nordea.

[Claus Almer Nielsen, Senior Analyst of Capital Goods and IT]

A few questions for me. First of all, congratulations with the 5 years of your 2020 strategy plan because that has been well executed. The new plan does no time schedule. Is that a 3- or 5-year plan or just more a direction how you want to evolve and develop SimCorp? That will be the first question.

[Klaus Holse, CEO & Member of Executive Management Board]

Yes. I think that it's probably -- we didn't put a specific timeline on it. When we generate the strategy, we thought about what would the world look like in 2025. So that's kind of the ambition. So you can say in that sense, it's a 5-year plan. But the world is also, we think, a little more dynamic these days than it has been. So we didn't want to put a timeline on it that says it expires in '25. But it might expire in '22, year '24, but no later than '25, I would say. So your thinking of 3 to 5 years is right.

[Claus Almer Nielsen, Senior Analyst of Capital Goods and IT]

Okay. And then in previous calls, I think you have mentioned that you are planning to introduce a number that could better tell the underlying performance of SimCorp. That number or message has not been part of your new long-term target structure. Why is that?

[Klaus Holse, CEO & Member of Executive Management Board]

So I think that what you're referring to is the annual contract value that we're working on. We've now done 2 quarters of this with our Board. And we're kind of learning how the mechanics of this would work in our world. It's a little difficult because the annual contract value is actually something that's a good fit for our subscription-based business. And that is still less than 1/3 of our business. So we kind of -- we try to find a way where we portray that and also the rest of the business to you. So we didn't put it in as a long term in that sense. But in some senses, if you want to grow 10% every year, your contract value has to grow at that pace as well.

[Claus Almer Nielsen, Senior Analyst of Capital Goods and IT]

And then you also say cash flow, again coming back to the structure of your orders, then cash flow is becoming even more important or maybe a good way to track the underlying performance. But that seems not to be part of your DNA or the way you look at SimCorp.

[Klaus Holse, CEO & Member of Executive Management Board]

I don't know if it's part of our DNA or how we look at SimCorp. We think about cash, we think about the cash conversion we get. We show it every quarter in one of this and we've given you an indication, I think, of what we think the cash conversion is going to be. If it's subscription-based contracts that we do, then it has a slower cash conversion where the rest of our businesses, which is the consulting business, the hosting business and so on, have cash conversion rates that are different in that sense. But you're right, in the sense of the new licenses we signed have a slower cash conversion. It's hard -- given that, that fluctuates, it's hard to give a specific cash conversion number quarter-by-quarter.

[Michael Rosenvold, CFO & Member of Executive Management Board]

So look, your 2 comments are very much related. And I would say, for us, the annual contract value is a measurement for the future cash flow in terms of the subscription-based licenses. It will not cover everything. It will not cover the old perpetual. It will not cover professional services, but it will cover an increasingly part of our business. And that's why, for us, annual contract value is very important because that is exactly, as you are also indicating, a measurement for future cash flows.

[Claus Almer Nielsen, Senior Analyst of Capital Goods and IT]

Okay. Yes, sure. Exactly. Okay. And just my final question that comes to these client conversions or the one you had in Q3. It is this or is this impact from client conversion, is that reflected or included in your full year guidance? Or should we see this as an addition to the performance as this is very difficult to predict, obviously?

[Michael Rosenvold, CFO & Member of Executive Management Board]

Yes. I think what we have said at the time and what we stick to still is that you should expect or we, at least, expect and that is also what is in our guidance, that we expect something very similar to last year. So last year, we had in total about EUR 6 million in conversions. I think if you do the math right now, you get to something very similar now. And that also indicate that we in our guidance do not expect any further conversions. So you can say it's a little bit more. These are very, very difficult to time, so what is the timing of them. And it's not something -- the difficult part is also it's not something we plan ourselves. It's very often the customer who want to restructure that view, so it becomes -- and so they're going away from the perpetual and they go to a subscription, and we only do it if it is beneficial to both parties. So it should also be beneficial for us. So I'll say, to make it short, what we have stated beforehand is that our prices included the same amount as last year, give and take, and that is still the case.

[Operator]

Your next question comes from the line of Daniel Djurberg from Handelsbanken.

[Daniel Djurberg, Research Analyst]

It should be Djurberg, I believe. But congratulations to very strong earnings in Q3. First question would be on the order book in Q4. Also, if you remove the CDDs, then it was down some. Should we be worried on this? Or do you think we could have a similar pattern as you saw in Q4 '18? Or a really strong order intake in the fourth quarter? Can you comment a little bit on the pipeline that you see? And also, if this expansion of CDD is, to some extent, counterproductive to your new updated cloud native strategy?

[Klaus Holse, CEO & Member of Executive Management Board]

So let me see if I can separate that into 2 questions. One question about pipeline and executional pipeline, and then one on kind of the business model for CDD in some sense. On the pipeline, we've got a good healthy pipeline for Q4. Whether that gets executed on -- in November, December and whether that gets executed with an opt out or not is [ super hot ] to us as the case. So as you should, I would say. So you could see what we saw last year or you could see that it all comes in, in 2019 or some of them could slip into 2020. I will say of the pipeline we have for Q4, for the remainder of Q4 this year, we are little later in the game in the sense of, we were closer to final contracts at this time last year on a number of the deals that we have this year. So whether it's going to be one or the other, still hard to tell, but we're a little later this year than we were last year at the same time. So that's kind of -- that's the one on pipeline.

[Michael Rosenvold, CFO & Member of Executive Management Board]

Can I just add one thing to this? Because -- and that is also reflected in our guidance. So reflected in the guidance is that contracts are more evenly spread out throughout the year in '19 compared to '18. You can do the -- your math -- the math yourself. So what Klaus has just said here is also reflected in the guidance.

[Klaus Holse, CEO & Member of Executive Management Board]

Yes. Exactly. And then on CDD. CDD is, in many ways, a good business for us. It's not a business that we're pushing and setting targets for and so on. But it's a business that allows us to kind of help customers progress faster on some of the features that they would want in their product. So where a customer kind of wants to prioritize something that's in our backlog anyway, they get to do that with CDD. We're not pushing this. If the demands come up, that's good. What you're seeing is in -- as you saw in Q3 here, we have less inflow on CDD than we had in the same quarter a year ago and we're quite happy about that. It's not something that we are setting targets for. We did -- we set a target for this, for our teams. What's going to happen is they're going to go out and find features that customers want to build. And then it will be features we built for 1 or 2 customers that are not able to resell to other customers and that's not the intent. The intent is to build this and have it available for multiple customers as well.

[Daniel Djurberg, Research Analyst]

Okay. And then a follow-up, if I may, on your everything-as-a-service ambition here, 2025 timeline or something. Can you comment a little bit on the journey here because there might be so that some geographies, some customers are not so keen on this, that you need to keep up both the cloud-native R&D and on-premise? Can you sort of set out some -- get some efficiency when you're building the same -- on the same software platform or something?

[Klaus Holse, CEO & Member of Executive Management Board]

Yes. So what we're doing right now from a technology point of view is we are lifting kind of the existing SimCorp Dimension platform. We're lifting that to a 3-tier, fully cloud-native platform. What we have today actually runs okay in the cloud. We run it on IBM's private cloud for a number of our customers. And we also have a number of customers that run the system in the public cloud. So it's entirely feasible to run. But to optimize the system towards a cloud architecture, if you will, that will require us to get to a fully 3-tier architecture and so on. And we've now kind of figured out how to do that with all of the products and that's going to happen, almost all of it, in 2020. So that's something that happens there. You saw we hired a new CTO. All this has been built. Now 2020 is going to be the execution of most of this. The resulting product when we get to the end is a 3-tier product that will be able to run native cloud, private cloud and on-premise. It'll be accepting the same product that runs in all 3. It'll even be able to run on Azure and on Amazon as well. So what we've done is we've kind of -- we've architected it in a way where it kind of isolates from the underlying operating system platform, if you will. That's how it gets architected. So even going forward, the customers that are on-premise today, they'll get the new and updated system and they'll still be able to be on-premise. And we will still be developing only one platform.

[Operator]

Your next question comes from the line of Magnus Jensen from SEB.

[Magnus Thorstholm Jensen, Senior Equities Analyst]

I have 2 small questions, probably somewhat related. The first one is about your margin guidance for 2019, which you maintained at 25% to 28%. Even though you do 29% in the first 9 months of the year, is there any sort of headwinds we should expect in this -- in the fourth quarter, given that you only need to do around 16% or so to end up at the low end of the range?

[Michael Rosenvold, CFO & Member of Executive Management Board]

Yes. So you're saying why is the guidance lower than what we have achieved for the first 9 months. I think what we also said early on, embedded in the guidance, we do guide a lower guidance inflow compared to the year before and that has, of course, an impact on the margin in Q4. So you're right in your observation and statement and that's the main reason why.

[Magnus Thorstholm Jensen, Senior Equities Analyst]

Okay. My second question is about your, sort of your updated strategy. Is there any sort of short, maybe to midterm impact on costs and/or CapEx that we should be aware of?

[Michael Rosenvold, CFO & Member of Executive Management Board]

Sorry. Could you repeat the question? I didn't get it. Sorry.

[Magnus Thorstholm Jensen, Senior Equities Analyst]

Yes. Sure. I mean you're updating your strategy and you invest -- it sounds like you're going to invest more in cloud-based solutions. So I was just wondering if we should expect an increase in probably R&D cost and/or some sort of CapEx that could be related to this update?

[Michael Rosenvold, CFO & Member of Executive Management Board]

Yes. What we have done in the past and what we continue to look at is that we are aiming at having the R&D cost of about 20% of our revenue. As we grow revenue, we will also increase our investment into R&D. I think we have been a little lower than 20% in the past years, and we will most likely get closer to this 20%, especially with the investments into cloud. So if you ask, will there be any extra investments? At least, we will invest more into cloud and that has started now. So you can see some of it in Q3 and you'll see in Q4, but you will also see it in 2020.

[Operator]

Your next question comes from the line of Gautam Pillai from Goldman Sachs.

[Gautam Pillai, Equity Analyst]

I had one question on the pipeline and a couple of follow-ups on the subscription shift. So on the 4Q pipeline, obviously, 4Q is seasonally your strongest quarter, but you are kind of not raising guidance. And you also commented that this year was more front-end loaded than the previous years. But if I -- if you look at the health of the pipeline, does it mean that you have already converted most in qualified pipeline? And you are kind of hitting an air pocket in the next quarter or so, given the tough comparisons?

[Klaus Holse, CEO & Member of Executive Management Board]

So on the pipeline, I -- kind of at least what I intended to say when I tried to answer that question a minute ago is that the pipeline is still quite strong. We've got a number of good deals in the pipeline that could all get executed in the fourth quarter if we were lucky or whatever you want to call that. But we are a little later in those deals than we were at the same time this year. That means that the more likely scenario is that Q4 is going to be a little less in new licenses than it was last year, and then hopefully, some of this comes in Q1 next year. I think that's the easiest way to think about it. There's no air pocket. The pipeline is stronger than it's ever been.

[Gautam Pillai, Equity Analyst]

Got it. Very clear. And I had a couple of follow-ups on the subscription conversion. Firstly, what's the runway to go in converting your perpetual installed base into a subscription model? Is that your objective? Are you going after your customers and converting them into subscriptions? That's the first question. Second question. On the cloud delivery model, for somebody who has already moved from a perpetual to a subscription model, if they then adopt the cloud delivery model, is there a pricing change? And now in your longer-term strategy, would you just focus on converting an on-premise perpetual customer directly into a cloud subscription model?

[Klaus Holse, CEO & Member of Executive Management Board]

Yes. So on subscription, kind of the way -- it's kind of -- we are fully flexible, let me put it that way. Whether you want to run the system -- so the technology that we have today runs in the cloud or on-premise. The technology we'll have at the end of 2020 runs on-premise, private cloud and in the cloud. We're fully flexible on deployment model for the customer. So that has no impact on whatever, right? The licensing model is separate from that. So there's a technology side to it and then there's a licensing model to this. A few years ago, we shifted away from a perpetual licensing model towards a subscription-based model. That subscription-based model, we'll stick to as such and that will go whether the -- whether a new customer in, say, 2022, just to take the long view, will implement this on-premise, in the private cloud or the public cloud. It will still be subscription based. So all new customers, no matter how they decide to deploy our new technology, will be subscription based. So that doesn't change. The business model doesn't change there. We still have an agreement with the customers on how they'll operate every year. We still do 4 releases every year. So nothing is changing in the business model. Then when you look at our existing customers, we've got -- of the total population of customers we've got today, we've got less than 1/3 that is subscription based. It's probably more around 25% that is subscription based as it is today. We have no intention of going after the existing customers and forcing them onto a subscription-based model. Because there's no benefit for them for this and there's no benefit for us in doing this. Given that our business model is already a business model where they do upgrade every year, they do pay maintenance every year, so there's no reason for us to get them on a subscription-based model. The reason many other companies that are moving to a cloud-based model is trying to force their customers on to this model is because they had a different business model for their on-premise business. Most -- pretty much any other software company I know of is -- their on-premise business model is one where you sell the software on a perpetual license, you have no agreement on when the customer updates and you update the software every 3 years. That means often the customer ends up with 7-, 8-year-old software that are very hard to upgrade, and the vendor now has to work -- have teams working on 8-year-old software, making sure that they secure the cybersecurity and blah, blah, blah, which is quite cumbersome to have teams working on this. So for them to force customers to a cloud-based model where they're always up to date, where they're paying on subscription, blah, blah, blah, or this is very important. But given that we don't have that issue, we don't have the same impetus to push our customers to a cloud business model. So we can be agnostic in deployment models as long as they are in a subscription base for new customers. And for existing customers, we will leave them there unless there's a reason for them to convert like the one we did in this quarter where the customer has been with us for more than 10 years. They bought a lot of software in the past and they reconfigured in some of the countries they were in, they're no longer in, blah, blah, blah. Could they reconfigure this whole licensing, get rid of something, buy something new, get ready for the future and sign a longer-term agreement, so we kind of have a multiyear agreement with them. So net-net, for us, if you look at cash flows, it's slightly net positive on the cash flow. But is it one or the other? It's not really that much. But we now have a customer who we've got a multiyear contract with that has the software that they think they need for the next 5 years basically. So in that sense, we've got a more satisfied customer. We've got a customer that we have a longer-term agreement with. So it's good for them. It's good for us. Could we avoid recognizing that revenue upfront? That would be easier, then we wouldn't have the [ cloud-enabled ] discussion on conversions and/or this could start, but it is kind of the nature of IFRS 15 that we have to recognize the revenue that way. Now it's a very long answer to a short question.

[Michael Rosenvold, CFO & Member of Executive Management Board]

And then with respect to -- [indiscernible] as it is found in the disclosure about it. So you can do all your calculations yourself.

[Gautam Pillai, Equity Analyst]

No. That's really clear. Just if I may sneak in one more small question. So you started the subscription model, if I remember correctly, back in 2015, and probably 2016 spending kind of gain momentum. So you have signed a bunch of 5-year contracts back at that time, which should be coming up for renewal in 2020 and 2021. Is that a sort of an upside kind of a growth scenario, which we should be aware of?

[Michael Rosenvold, CFO & Member of Executive Management Board]

I think your rationale is right, but the assumption is not fully correct. With 2016, and that means a 5-year contract, the first renewals will be in 2021. So you will not have any impact in 2020. That's one thing. And the other thing is that we have also -- the first contract we made were 5-year contracts. Later on, most customers, they wanted longer-term contracts. So you can say we also have 7-years contract and 10-years contract. So it's not like you can just take everything we've been assigned in '17 and '18 and saying they're all 5-year contracts. They -- some of them are 7 years and 10 years. And also, on average, closer to 7 than 5 years.

[Klaus Holse, CEO & Member of Executive Management Board]

You should probably -- to return to the question, you should probably expect a little bit -- no tailwind in '20, probably a little bit of tailwind in '21, who knows about '22. And then there'll probably be a little bit of tailwind every year after that.

[Michael Rosenvold, CFO & Member of Executive Management Board]

Yes.

[Operator]

Your next question comes from the line of Poul Jessen from Danske Bank.

[Poul Ernst Jessen, Senior Analyst]

I have a small question more on the longer term, when you talk about the margins, which should go up over time. I was wondering if you could comment a little on the different revenue lines to contribute. What I'm thinking about is that if you add revenue in CDD or ASP hosting or outsourcing, adding to the professional services, that should be having lower margins than what you have on average, including the licenses. Are these lines going to grow more or less than the group level? That was one question. The second is more on the third quarter on the gross margin. Is the difference on the license margins in the quarter, if you take the revenue of a contract signed in the quarter and recognized in the quarter, then if you take it out of the backlog, is there a different gross margin on those 2 situations?

[Michael Rosenvold, CFO & Member of Executive Management Board]

I can answer the first one. I'll answer the first one, that leaves you one. That is -- there's no change. There's no difference. So we will not pay commissions before we recognize -- or we will not expense commission before we recognize the revenue. So if you have an order book where, if you have a release of an order book, then you will also have the commission in that quarter.

[Poul Ernst Jessen, Senior Analyst]

Okay. And then if I may follow-up. If you then do the -- if you take different lines, then it seems as if your professional service margins in the quarter must have been very strong or some other lines. Is that correct?

[Michael Rosenvold, CFO & Member of Executive Management Board]

Yes. Yes.

[Poul Ernst Jessen, Senior Analyst]

Is there a specific reason for that?

[Michael Rosenvold, CFO & Member of Executive Management Board]

These -- what happens from -- with professional services, there will be fluctuations from, be it from quarter-to-quarter due to the fact that some of them are lump-sum projects. And as we finalize them, we might have a contingency, which we then release when we have the full overview that we will not need it to complete the work. And a contingency release in a given quarter can have an impact because also the quarters are pretty low. It's not that many months. So a contingency release can have an impact. So that can vary from quarter-to-quarter.

[Klaus Holse, CEO & Member of Executive Management Board]

And on the first one, on the margin development, so I think your observation is absolutely correct. So that license growth will have to happen. The service growth will have to happen and so on. But for margin expansion to happen, we will have to be able to automate some of the services we deliver. If all the services we deliver is going to be by people, then it's going to be super hard to expand margins, then we're most likely going to stay where we are or even dilute margin to really get more hosting and so on, as we go. So kind of our thinking and the ambition in this one is we will be able to automate more and sell more automated services to customers. So that's kind of the -- that's how we think about it in a sense. So you still get the value, but you'll get it from automation.

[Poul Ernst Jessen, Senior Analyst]

And will that improve the gross margin or the OpEx? That's the gross margin improvement?

[Michael Rosenvold, CFO & Member of Executive Management Board]

Yes, I think -- well, our ambition and what we're aiming at is actually converting professional services into licenses. So then it will, by optimization and stabilization.

[Poul Ernst Jessen, Senior Analyst]

Okay. And then the last question, that is then when you go more to standard contracts and cloud-based solution, how will that impact the gross margin and the OpEx, respectively?

[Klaus Holse, CEO & Member of Executive Management Board]

I don't think that -- I'm not sure I understand the question 100%. So let me see if I can kind of qualify the question. So what you're saying is that once you move to cloud, it's going to get more standardized than it is. That's probably true. But every customer is still going to be different. It's going to be different. We configure for that customer and so on. So I don't think you're necessarily going to have -- it's not going to be an Office 365 contract we're going to have with the customer. They're going to be not that far from what we have today.

[Operator]

Your next question comes from the line of André Thormann from ABG.

[André Thormann, Analyst]

Just the first one here, in terms of your strategic goals, then I noticed that U.S. is out of there. Can you maybe elaborate on -- a bit on that? And what the expectations going forward are about the U.S.?

[Michael Rosenvold, CFO & Member of Executive Management Board]

North America, it's been very important for us, but we have now said that some of the other initiatives is actually covered also by North America. So when -- if you look at the front office, there's special focus on front office in North America. So instead of having North America as a separate strategic priority of [indiscernible], it is actually embedded into some of the others. So that's the way we are looking at it. But of course, from a growth perspective and from a prioritization perspective, North America is extremely important because this is where we have our, by far, largest growth potential. And that's also where we give as much dimension and attention as possible because it's so crucial for us. But also you could say it's now become one of our biggest business units. And there now it's kind of carrying its own weight in sort of prioritization and so on that happens inside of the company. Whereas if you go back 5 years ago, it was a small part of the company that needed special attention, special investments, special orders. Now they carry the -- I mean we've got more than 200 people in North America now. So it kind of carries its own weight.

[André Thormann, Analyst]

Okay. And then in terms of also the new strategy, is it correctly to interpret that, that focus going forward is more on the ALF side than the ILF side?

[Klaus Holse, CEO & Member of Executive Management Board]

No. It's still equally split across the 2. There's no doubt that getting closer to our existing customers is going to be of importance. But we still need to sign new clients through the platform every year to be able to grow at the pace we want to grow.

[André Thormann, Analyst]

Okay. And then in terms of this conversion, because you're also right that this client actually considered to do outsourcing, but then you convinced them to convert into that. So why did this customer consider outsourcing? And is this something you also see from other clients?

[Klaus Holse, CEO & Member of Executive Management Board]

I think that we have had 2 conversions in '19. And the one you are referring to here is the one we had earlier in the year where it's right that they consider outsourcing but decided to not do it, and thereby, restructured that deal. So this is not the new one. This is the one we had earlier in the year. And we have actually -- this part of outsourcing is going back and forth. Some considering outsourcing and some do it. Some of them, when they do it, they're actually using our system indirectly because the outsourcing provider is using our system, and thereby, it's not a big problem for us. For others, of course, if they're not using our system, it's a risk for us. But we have also now seen a few clients who have tried to do the outsourcing, found out that it was not very successful, then coming back to us and saying it didn't work for them, and thereby, they are expanding their activity level with us and that was the case for this customer.

[Operator]

Your next question comes from the line of Hannes Leitner from UBS.

[Hannes Leitner, Equity Research Analyst of Software]

Congrats to the good result. I have also a couple of questions. The first one is regarding ASP. You had quite a good growth throughout the year. You talked -- to one side, what is the visibility on it? And what is the element of recurring revenues? And then also, I think, at full year results, you indicated roughly 30 basis points marginal hit from ASP growth with respect into the guidance. How should we think about it over the long term? And then I have a couple of follow-ons.

[Michael Rosenvold, CFO & Member of Executive Management Board]

Yes. You're right that -- and that has been throughout. It's not this quarter specifically, it's throughout the period. And then there's, of course, coming on when you're starting to suffer that. But you're right, that we -- and also, when you look at our list, we have 4 of the new clients there actually on ASP solution. And we also had a few clients who went from an on-premise solution, existing clients moving from an on-prem solution to an ASP solution. So we now have 16 clients on ASP today and so there is a good growth in it. That's correct.

[Hannes Leitner, Equity Research Analyst of Software]

And regarding the recurring element of that ASP? So is this all literally like that's the base and it should continue to grow from it as those customers are migrating on?

[Klaus Holse, CEO & Member of Executive Management Board]

Exactly. So the ASP contract length is in line with the length of the subscription of the customer. So if the customer renews the subscription, you would expect them to also renew the ASP. Otherwise, they would have to stand up an operating environment internal.

[Hannes Leitner, Equity Research Analyst of Software]

Okay. Very well. And then regarding -- I think you touched upon it a little bit, but could you remind us about the split between the customers on still perpetualized and then already on subscription? How far are we in it in the conversion journey?

[Klaus Holse, CEO & Member of Executive Management Board]

Yes. So we have less than 1/3 on subscription so far, probably closer to 1/4, somewhere between that.

[Michael Rosenvold, CFO & Member of Executive Management Board]

As a matter, it is a number of value. So I think if this number is probably closer to a product as its value is closer to 1/4.

[Hannes Leitner, Equity Research Analyst of Software]

Okay. Understood. And the last question is on SOFIA, which most likely was Generali extending another 6 months their maintenance contract. Can you give us an update on that migration to Dimension? And when should it be expected to complete?

[Klaus Holse, CEO & Member of Executive Management Board]

So we're moving forward with the migration of the last parts of the Generali project. So far, we've put live most of the investment managers around the world, and now we're doing the conversion of the insurance accounting for Generali. And that's -- the process is making progress. But as you say, we probably renewed SOFIA with the customer in the quarter, could be Generali. And -- but the project is moving forward. There's no given deadline. It all depends on when Generali wants to go live and that's their judgment. We can't give you the date on their behalf.

[Operator]

And your final question comes from the line of Michael Briest from UBS.

[Michael Briest]

Sorry. Hannes asked the questions on our behalf.

[Operator]

There are no further questions. Please continue.

[Klaus Holse, CEO & Member of Executive Management Board]

Do we have any questions from the web?

[Michael Rosenvold, CFO & Member of Executive Management Board]

No. There's no written questions or web questions. So if there's no more questions on the audio, then I think we'll finish here.

[Klaus Holse, CEO & Member of Executive Management Board]

So last chance for questions. No?

[Operator]

No, there are no further questions.

[Klaus Holse, CEO & Member of Executive Management Board]

Perfect. Very good. Then all we have today is a very big thank you for calling in. Thank you for a lot of good questions, really appreciate it. Sorry about some of the long answers. I hope you have a wonderful Friday. And when you get to it, a nice weekend. Thank you very much.

[Operator]

That does conclude our conference for today. Thank you for participating. You may all now disconnect.