Software AG

XETRA:SOW

Earnings Call Transcript 2018-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. I'm Ira, your chorus call operator. Welcome, and thank you for joining the Software AG Release Q2 Results 2018 Conference Call. [Operator Instructions] I would now like to turn the conference over to Otmar Winzig, Head of Investor Relations. Please go ahead.

[Otmar F. Winzig, Senior VP & Head of Investor Relations]

Welcome to everybody. Welcome to Software AG's analyst conference call and webcast on the second quarter and first 6 months results 2018. This morning, we have published a full set of numbers as well as the presentations used in this call on our website. Today's call will start with CEO, Karl-Heinz Streibich; followed by CFO, Arnd Zinnhardt; and Chief Customer Officer, Eric Duffaut. Presentations will be followed by a Q&A session, and we'll keep the call in the regular 1-hour time frame.Before we start, there are some housekeeping remarks, as always. So this telephone conference will also be broadcast via web. Access to the webcast is via our Investor Relations website. The webcast will display the PowerPoint presentation charts related to this call and the same charts are on our website for download. After the presentations, you may ask questions. Please use only the dial-in phone number for posing questions. The dial-in numbers are also published on our website. For technical reasons, we cannot take any questions via e-mail during the conference call. Call and the webcast will be recorded and available for replay later today.With respect to capital market regulations, I have to make the following safe harbor statement. This presentation contains forward-looking statements based on beliefs of Software AG management. Such statements reflect 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, 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.Now thank you for your patience. And let us start. I hand over to Karl-Heinz Streibich, the CEO of Software AG.

[Karl-Heinz Streibich]

Thank you very much, Otmar. Ladies and gentlemen, welcome to our Q2 call also from my side. As you all know, this is my last quarterly call as CEO of Software AG. We've had some 60 quarterly calls during the last 15 years in total. Some of you have participated in all of them. Thank you very much for your contributions, your valuable input and your fairness in all these years.The good performance we've seen in Q2 and the strong increase of the momentum is based on a number of facts and activities. Let me summarize as follows: First, Adabas & Natural 2050+ program is showing big results. It is the fourth consecutive quarter we see growth in license in this great product line. As a reminder, we decided some 8 quarters ago to assure our customers that we will innovate and support our Adabas & Natural portfolio beyond 2015. Our customers appreciated this commitment very much. Some commented that they will use the Adabas & Natural transaction portfolio forever in their business. This is not only contributing to stabilizing the Adabas & Natural customer base, but also enables us to sell further Adabas & Natural innovations to those customers. In addition, we're selling to them the Digital Business Platform enabling Adabas & Natural customers to offer 24/7 services to their customers.That the mainframe market is still very viable can be seen by the Broadcom-CA transaction. CA gets some 50% of its revenue from its mainframe portfolio today according to the market communications. The buyer very much appreciates the constant cash flow in its revenue stream out of this business. We see the same in our equivalent portfolio, Adabas & Natural.And second, our Cloud & IoT portfolio. You know we raised the full year outlook during Q1 call for Cloud & IoT due to the dynamic performance in Q1 and the pipeline we have. We all know that on-premise license revenue is always volatile in a single quarter. However, the more stable cloud revenue, which is the major volume and driver of the new business, again in Q2, showed triple-digit organic growth. We now also report the annual recurring revenue, ARR, because this is the KPI closest to cash flow and somewhat consolidates a variety of revenue recognition possibilities under IFRS 15 as SaaS or pay-per-use in private and public cloud. We again have done very well regarding ARR for total DBP and ARR for Cloud & IoT. It grew by more than 100%. Our CFO, Arnd Zinnhardt, will go into more detail.In addition, we have made a key technology acquisition for our IoT and AI-enabler, TrendMiner. Now we can capture, real-time, time series data from devices or machines. This is highly relevant for the process industry as well as the machinery tooling industry where we are the undisputed leader through our ADAMOS ecosystem of partners. And[Audio Gap] We started the quarter with a good pipeline, good for 2 quarters, as our Chief Customer Officer, Eric Duffaut said. We've seen a great improvement of the momentum quarter-by-quarter. And we can say today that after Q2, Q3 also looks good due to a number of expected good deals in the pipeline and very promising start to Q3.By the way, Edge computing, which is on-prem, will play a major role in the future DBP business as well as the IoT business. But even more important, we're building up a great ecosystem of partners to ramp up our future IoT/Cloud business. In this context, I want to show to you the business logic behind it. Please have a look at Chart 1, which show the key characteristics of the digital platform business, which is exponential growth.During the first phase, the flat phase of the exponential curve, it is all about building up the ecosystem of partners. Being successful in this phase through winning partners is a prerequisite to achieving exponential relevant growth in Q -- in Phase 2. We are successful in Phase 1. We are winning those partnerships for the future growth.Please have a look at the next chart, the IoT platform economies of scale and partnerships. As you can see, we are winning new IoT/Cloud ecosystem partners in several industries: the machinery tooling with ADAMOS; in the manufacturing market, with Siemens, Bosch and Bilfinger; in the Digital City platform -- market, Darmstadt won the Digital City contest. There we are collaborating with utility providers because citizens want to have the services from the [ admin ] service of the city as well as the services of the utility provider. Our telcos have millions of connections with the customer and banking will be a subject of the future as well.I'm convinced ecosystems for and with customers are much stronger than single supplier relationships, regardless how big the single supplier is. Why is that? Please have a look at Chart 3. Partner ecosystems are a sharing economy. They are collaborating in those ecosystem communities on core innovation, on content sharing what they develop in the precompetitive phase, but also know-how sharing regarding their domain and risk sharing. Risk and cost sharing is as important as well. Only this kind of ecosystem partnerships give independence, self-determination [ is already ] here regarding innovation and customer relationship to the partner. This is, for example, what ADAMOS, our IoT partner ecosystem for the machinery market stands for. In contrary to that, a single supplier relationship creates dependencies and eliminates self-determination regarding innovation in customer relationships. This is why they have chosen Software AG.And finally, total product revenue and profitability also showed a good performance. Here, I want to mention not only the product growth, but also the continuing increase in our profitability as our CFO will explain in more detail.All in all, I can say Software AG is well established in all market segments that we're in. Everything we prepared for Adabas & Natural 2050+, the DBP pipeline as well as building up the IoT ecosystem suggest that the future of Software AG can be seen positively. Software AG's positioned to continue to be a winner in the digital world. I'm sure the new CEO, Sanjay Brahmawar, has all the prerequisites to succeed and further improve together with the team of Software AG. I wish him and the team much success for the future. Therefore, we also confirm our year-end outlook as of today. I'm looking forward to the question-and-answer sessions, but first our CFO, Arnd Zinnhardt, will go into more detail on the numbers, and Eric Duffaut on the go to market side, many things.

[Arnd Zinnhardt, CFO & Member of the Management Board]

Karl-Heinz, thank you very much. Good morning, ladies and gentlemen, a warm welcome to our conference call also from my side.Q2 was a good quarter, in which we were able to grow all relevant KPIs. Total revenue is up by 4%, and more strategically, total product revenue is up by 7%. This positive momentum is also true for the individual business lines with a growth in all individual product lines: Adabas & Natural, Digital as well as Cloud IoT; a dynamic performance regarding SaaS and usage-based revenue as well as ARR growth in the IoT/Cloud exceeding the 100% mark. Especially the ARR growth, an absolute number, which we discussed in detail in March and April, shows that the IoT/Cloud revenues are becoming and already are relevant numbers to Software AG as such, not in several years, but now and today.In addition, the profitability developed nicely as well. IFRS EBIT, absolute and margin wise as well as non-IFRS EBIT in absolute numbers and regarding margin do show growth. This development confirms my statement at the beginning of the year, and shall definitely answer the questions around future profitability raised in our January call.After this opening remark, I would like to start to discuss the numbers with our FX analysis. As expected and communicated, we again saw a strong FX impact on all revenue lines. This headwind is due to predominantly 2 currencies: U.S. dollar down by 7%; Brazilian real down by 18%. U.S. dollar and Brazilian real contribute almost 2/3 to our currency impact. Currently, I do expect some relief in the second half of the year due to the year-on-year comparison on the U.S. dollar-euro ratio.The digital business developed as expected and shows a growing momentum compared to Q1. Whereas the numbers shown on the slide predominantly disclose total digital, including cloud IoT, I will split my analysis into the 2 components: DBP, excluding Cloud/IoT; and Cloud & IoT. So let me start analyzing our digital performance, excluding IoT and Cloud. The product revenue increased in Q2 by 6% compared to previous year. This was basically driven by an 11% increase on the license side, maintenance growth at 3%. Eric will go into more details by talking about the regional split and some customers' wins in detail.Before I comment some aspects on operating costs, let me highlight that our recurring business measured in ARR again grew double digit at 13%. This number confirms our observation made 3 months ago. All operating costs are well under control and developed as expected. Cost of sales amount to EUR 9 million. The increases were related to a single deal with a higher portion of third-party products included and an increase of hosting costs linked to the Cloud SaaS business, which doubled in the last 12 months. As I mentioned 3 months ago, CeBIT for the first time took place in Q2. Consequently, you will find the respective costs in the today's numbers. This explains the major part of the cost increase in the quarter in sales and marketing. Looking into H1, this effect is neutralized.In the first 6 months of 2018, sales and marketing costs look unchanged to prior year. However, it should be noted that we increased our sales and marketing headcount by 5% compared to 12 months ago, predominantly to support the dynamic growth in IoT. Our R&D headcount is up by 4% compared to 12 months ago. On the other side, we managed to keep the costs flat. The explanation is a further improvement on our low-cost, high-cost mix. Bottom line, we continue to enjoy business result margin of close to 30%. 30% despite the fact that the majority of contracts signed in IoT/Cloud are SaaS and therefore lead to deferred revenues that will hit the P&L in the upcoming quarters.This statement leads me to Cloud/IoT. Like in Q1, the numbers disclosed on the chart are thereof of the total DBP business line. In the last 3 months, we saw an ongoing high interest of customers and prospects in our IoT & Cloud offering. This can be derived from the key numbers of the [ referred new ] line. In recent quarters, the majority of IoT customers opted for SaaS, usage-based deployment model rather than classic licenses on-premise model. This result in a recurring revenue stream that needs to be disclosed on a pro rata basis. The total contract value is consequently deferred over the contractual lifetime of the initial agreement. Due to the high adoption of SaaS and usage-based models in this environment, the 2 most important KPIs of this revenue line grew dynamically by more than 100%. The SaaS usage-based revenue is up by 103% and the ARR, the forward-looking KPI disclosing the future development increased by 106% year-on-year and/or [ 287.5% ] just looking to quarter-on-quarter. Both numbers clearly end up in our market success. They also demonstrate that this revenue line has become and continues to be more and more relevant factor for our entire business model and that's important to the valuation of our company. Regarding Adabas & Natural, we continued on the strong performance of the last 4 quarters and recorded a double-digit license growth. This growth was mainly generated by a number of sizable deals in North America. Eric will provide you with a more granular insight. Maintenance and all cost lines saw an expected development for the quarter. Cost of sales decreased as we realized additional efficiencies in our Adabas & Natural support organization. Due to a strong license performance, the segment result margin improved compared to last year to more than 70% for the quarter as well as H1. I believe these numbers speak for themselves.The focus in the Consulting business continues to remain on supporting our strategic license projects and simultaneously closely monitoring profitability. The revenue reduction is mainly due to the currency impact and a project in the U.K., for which the customer has decided to slow down the project due to budget constraints. As a consequence, margin was a bit below last year, but remained on a high double-digit level.As discussed on this last slide, our business performed nicely with continued strong Adabas & Natural revenues and a dynamic growth of IoT/Cloud, SaaS, usage-based revenue and ARR. Our gross margin is increased compared to last year due to a higher portion of product revenue. Like always, operating costs are well under control. In R&D, we increased our SaaS by 50 to 60 full-time equivalents. Simultaneously, we increased the percentage of low cost by 4 percentage points to 51%. So it's just a consequence that our EBIT is exceeding prior year's level with a margin even up by 220 basis points for the quarter and 230 basis points for H1.Let's turn to operating margin. In the quarter, we even topped the very successful Q2 2017 and shifted the margin up by 40 basis points to 29.9%. Regarding H1, we are 30 basis points above 2017 level. This development is very much in line with our guidance given 6 months ago. As a consequence, those of you that might have misinterpret our guidance [ currently ] or given at the beginning of the year should feel relief.Ladies and gentlemen, let me continue with the cash flow. After an extremely strong cash flow in Q1, the cash generation in Q2 was lower compared to last year. This development correlates to the license revenue generated in Q1. Nevertheless, the cash generation as well as cash -- revenue cash conversion rates are and remain on a high level. This statement can easily be validated by looking at H1 cash flow, which shows a modest increase in the margin in relation to revenue that further improved to 22.6%. Balance sheet is as solid as you're used to. Therefore, I would like to make only 4 remarks: a, after distributing the dividend in May, the net cash position amounts to EUR 73 million; b, receivables are reduced compared to 6 and 12 months ago due to working capital management; c, despite the currency development, deferred income is almost EUR 168 million; and d, the quarter on shareholder equity increased to almost 60% despite the dividend paid.Let's now come to the outlook. [ The correct ], as Karl-Heinz already mentioned, we confirm the outlook for the year. Adabas & Natural started with 2 strong quarters into the year. Although we are very pleased with this performance, H1, was somewhat expected. Consequently, we stick to our range, adding the flavor that we believe that we will close the year rather than at the upper end of the corridor.Digital ex IoT/Cloud demonstrated a Q2 performance, which is a bit higher than the midpoint of our guidance range. Also in the last couple of years, we observed a further growing momentum in H2. We believe this trend will continue.Regarding IoT/Cloud, we see ourself in a good position to grow the business dynamically between 100% and 135%. The KPIs representing recurring performance did exceed the 100% mark. Revenue achieved in H1 and ARR in combination with our pipeline confirm our expectation set.As mentioned earlier, H1 operating EBIT margin is north of last year. Therefore, it is fair to say that H1 was a good start into the year. This increases our confidence level even further. The very same is true for non-IFRS earnings per share. On this positive note, let me hand over to Eric. Eric, over to you.

[Eric Duffaut]

Thank you very much, Arnd. Ladies and gentlemen, good morning, and welcome, of course, to today's call as well. While Arnd has given you the full financial figures, I will, of course, focus more on the license revenue, showing double-digit growth at constant currency rate in every business line in Q2. ARR, which shows triple-digit growth as you've heard, and of course, the reporting business development trends, which should help you to estimate the implications for the full year.You've heard this, but it feels good to repeat. Adabas & Natural license revenue is up 38%. Digital Business Platform license revenue, excluding IoT, is up 11%. The total license revenue line -- the revenue is up 17%. IoT & Cloud revenue is up 56%. SaaS revenue is up 103% and ARR is up 106%. My American colleagues will call that a slam dunk.And just to highlight the regional performance as well, I mean, with the exception of few countries in EMEA, all other markets are showing growth in Q2. And I would like to highlight our DBP growth champion, let's say, for Q2 with North America, showing a really strong 22% growth; Germany, up 19%; and Latin America, overall, which is recovering definitely from a challenging 2017, with a 74% growth. This was indeed a strong quarter and with total confirmation that we are, as expected, catching up after Q1 and building the momentum that would ensure we reach our 2018 guidance.Taking a slightly longer viewpoint. I want to highlight the fundamental business trends. We had a record-breaking DBP license revenue in Q4 '17. We raised our DBP IoT & Cloud revenue guidance in Q1. And now we have delivered 5 consecutive quarters of A&N license growth and our best Q2 total license performance in the last 4 years. And ladies and gentlemen, the good news is that this growing momentum is propelling us into Q3. Only 12 working days into the first -- third quarter, and we already have closed about 18% of our quarterly goal for our total DBP license and IoT/Cloud revenue. And this momentum will continue throughout the year. And nowhere is this momentum more transformational and promising than in the Internet of Things. We are getting recognition from the ground-breaking market approach we are taking. After Bosch, Siemens, many telcos around the world, and our joint venture with who's who of German manufacturing companies, ADAMOS, which by the way, received the German Innovation Award presented by The German Design Council in the business-to-business category. We have continued to successfully expand our IoT ecosystem across many industries. And let me give you some examples.Complementing what we've done in the manufacturing industry with ADAMOS, we have started a strategic partnership with the market leader providing operational services to companies in the process industry, Bilfinger. Bilfinger's headquartered in Germany and is serving customers in the chemical, pharmaceutical and oil and gas industry in Europe, North America and the Middle East. The combination of Bilfinger's Connect Asset Performance service portfolio and our IoT platform capabilities will provide benefits to customers in the process industry, leveraging unrealized potential to increase the overall equipment efficiency beyond what has been possible until today.Procon, a German based machinery company is now using Cumulocity IoT for extending their smart manufacturing offering to visualization of machine data, including dashboarding, real-time analytics as well as predictive maintenance. Inseego, a U.S.-based SI, or system integrator and solutions provider, is serving over 664,000 global subscribers, including 198,000 fleet management customers with SaaS applications. Cumulocity IoT has been chosen to end up in Inseego's asset tracking solutions. The Abu Dhabi city municipality has decided to use our IoT solutions to realize their vision of smart city. The European 4.0 Transformation Center in Germany, which helps manufacturers achieve rapid digital transformation and Software AG have announced a partnership for digital transformation of e.GO Mobile AG, a visionary startup that produces economical and customer-centric electric car. And the European 4.0 Transformation Center will also showcase our IoT solutions to many other manufacturers in Europe.Ladies and gentlemen, these major partnerships with leading enterprises in many industries highlight the tremendous progress Software AG has taken in establishing a broad IoT ecosystem. You heard it from Karl-Heinz, we all know, you all know that a strong ecosystem is a promise of success and it brings massive scalability. And massive is the right word. IoT and consumption-based business model blurs the borders between partners, direct customers and their respective customers or consumers. This is an entire ecosystem that gets connected and that gets access to IoT services. The value chain can stretch from here to millions of devices and sensors. To scale our solutions across this almost infinite IT and business landscapes demands a strong ecosystem of depth and breadth, and this is exactly, exactly what we are doing.It is still early days. We know IoT is not yet mainstream, but we are at the beginning of this exponential curve that Karl-Heinz presented. Yes, we're laying the foundation now to successfully ride an accelerating growth wave when adoption really takes off. Every quarter brings new strategic partnership that further expands our addressable markets from one ecosystem to another. And I can tell you, more and more will come. For example, Dell and Software AG are in the final stages of signing a worldwide partnership agreement, which will put Software AG at the heart of the Dell IoT solutions. Dell will launch an IoT Edge appliance with Software AG Cumulocity IoT embedded in autumn this year. More details will, of course, follow at the official launch after the summer. But just imagine, how many IoT Edge machine Dell and its distribution ecosystem can potentially sell in the world. And you will get certainly as excited as we are.Back down to earth, the beautiful Adabas & Natural story just keeps continuing. 38% license growth in Q2, so what can I say? Well, at least, I hope that the most skeptics who thought that this business was dying, are finally reassured that our envisioning of an A&N portfolio is here to stay as a fundamental contributor of Software AG's financial strengths.But let me set clear expectations. Our A&N business is partly driven by yearly renewals. And while H1 was exceptionally strong, we do know that H2 will certainly not show the same license revenue growth. Looking forward, we are entering Q3 with strong momentum. For Adabas & Natural, Q3 should be another solid quarter, while as I said, not to the same extent as what we delivered in H1, but I believe that the upper end of our total year guidance is clearly in reach. For our DBP license, we have the pipeline and an exceptionally strong start and this should support another solid quarter as well.And finally, our DBP Cloud & IoT business will certainly continue to show exciting growth as our ecosystem will continue to expand. Yes, we have the pipeline, we have a rapidly expanding ecosystem, and I certainly remain confident that we will meet our targets for 2018.I thank you for your attention, and I'm very much looking forward to your questions.

[Otmar F. Winzig, Senior VP & Head of Investor Relations]

Ladies and gentlemen, you may now ask your questions. Operator, would you be so kind to read the procedure.

[Operator]

[Operator Instructions] The first question is from Stacy Pollard from JPMorgan.

[Stacy Elizabeth Pollard, Head of Software and IT Equity Research]

Three quick ones from me, all related to the Internet of Things business. Other than the ARR, what kind of visibility do you have around the IoT/Cloud revenues, perhaps, especially license? I know that it's a very small number. Should we expect that to potentially be bumpy along the way? Second question, how many of your sales people are dedicated to the IoT/Cloud business? Or are they kind of cross sold by the same DBP people? And then, thirdly, I know it's still small, but again would you at some point consider providing a segmental result for the IoT business?

[Eric Duffaut]

Okay. Stacy, this is Eric. I will take some of the questions, Arnd, you will for sure complement as well. Number one, let me comment on the second one, number of salespeople dedicated to IoT. Stacy, we have established a center of expertise in January 2018. We have roughly 35 people fully dedicated, but we should not only look at this number, obviously, because IoT being a key trend and a key topic of discussion with all our customers, or most of our customers, we have also, of course, enabled the entire sales force of Software AG. We just have, on top, invested in dedicated specialists both on the product side and to some extent on the sales side to support our entire sales force. So these are 35 dedicated supporting a team of 700 people in the field every day that can, of course, talk about IoT as well. When you talk about the visibility on license, ARR and others, I mean, it is clear that H1 and Q2, in particular, has shown that customer have opted rather for cloud, and I would say consumption-based model. I think you know that this is the way we want to go. I remind you the story of Siemens last year and the choice that we've made to go for consumption rather than going for license and upfront revenue recognition. We stay on our belief, which is the fact that while the immediate impact on the revenue is rather small, we're building this ecosystem, we're building this exponential curve that we know at some point will take off. So that's the trend and this is why the numbers are small as you rightfully said. The license number could be done via the quarter-by-quarter basis, but we look at this more on a yearly basis certainly and again, establishing the strong ecosystem that Karl-Heinz and I have mentioned. Arnd, I'll let you comment more on this ARR eventually and also this segmental question that Stacy had.

[Arnd Zinnhardt, CFO & Member of the Management Board]

Yes. Stacy, with respect to ARR, that is certainly a number that is highly visible. And if we just look to the IoT/Cloud ARR number, which is the EUR 24.8 million, that already indicates that the growth that we will see in Q3 will continue. And that is pretty easy calculation. If you just take the EUR 24.8 million, which is -- includes contracts, which are signed, which are in, which we just need to deliver on, and divide this number by 4, that gives you already a number, which is north of EUR 6 million, which will hit the P&L in Q3 without any additional contract being signed. So again, this confirms that we will continue on the growth path. With respect to the segmental results, this is a question of how we are going to manage this business line, and therefore, it's in line with your second question regarding sales people in R&D. So if we can allocate and separate people between the normal digital business on the one-hand side and Cloud/IoT on the other side, we will certainly divide it up and provide a full P&L for these 2 separated as long as we're just allocating numbers. This is an only controlling exercise, which is not relevant from a management perspective. And as long as it is this situation, we will inform you about the revenue and we'll aggregate these costs as we do it today.

[Operator]

The next question is from Woller, Knut from Baader Bank.

[Knut Woller, Analyst]

A couple of questions, if I may. Just one clarification question to start with for Eric. Did I get it right that after 12 working days, you already closed 18% of the traditional on-premise license deals for DBP and IoT in the quarter, which, out of my perspective, would clearly derisk Q3, given the backend-loaded nature of the traditional on-premise model? Then secondly, on the guidance, I mean, we have seen a good outperformance of A&N. You seem to be confident that, albeit at a lower rate, there will be an ongoing good performance. In the last couple of years, you used to outperform your initial margin guidance, and if A&N strength would persist, I think, there would be a chance that this pattern will continue or would you rather think that you will reinvest it in IoT? How do you think about that? And in terms of the cash flow, how should we think about the operating cash flow for the full year? And lastly, on the Dell partnership, did I get it right that you expect it to be signed in fall and that Dell will include Cumulocity in the full portfolio, so will that and how fast do you think this could ramp, given all the devices that have to be connected and basically the data flow that will be run on the Edge of all the devices that Dell is serving?

[Eric Duffaut]

Well, I'll start off here. Good morning, Knut, thanks for the questions. I will take the first one and the last one. Arnd will probably look at the 2 in the middle. So you got it almost right on my comment. It's in the first -- let me repeat it. In the first 12 working days, we have closed 18% of our total DBP license and IoT/Cloud when we combine them together. And the split of this value is roughly 60% on the IoT/Cloud and 40% on the DBP traditional license. But I know why you ask, and you said derisk the quarter, I mean, we can never talk about totally derisking something, but clearly this is an exceptional start. So on that part, your point is valid. We had a very, very strong start. And I believe that overall the month of July should be a strong month for us, which clearly is a change compared to the back-end loaded, let's say, quarters that we have in general. Regarding the Dell partnership, yes, we plan to launch this appliance in autumn. When you say, how fast will that ramp-up be, honestly, what we have seen as expectation also from there is very encouraging, I think it will certainly be more a 2019 impact than a 2018 impact, whether we will go together to get -- build the first lighthouse references customers, but with the effort that Dell is planning to put into this game in terms of marketing, distribution and so on, I believe this will be another major partnership that can help us to scale and accelerate likely, as I said, in 2019, while we expect some, let's say, nice first deals in Q4, the rest of the bulk should certainly be '19 and '20 and beyond.

[Arnd Zinnhardt, CFO & Member of the Management Board]

Knut, I'll take the second and the third question. The second one was on the guidance. It was absolutely right. So if we continue with our Adabas & Natural performance, and Eric and myself made already the additional comment that we will rather achieve the upper end of the revenue guidance, then the likelihood that we also reach the upper end of our margin corridor is very high. And any kind of investment, which will also foster future revenue growth will just hit the P&L for the last couple of days or months. So therefore, the impact for the entire year is not that material that it would change my statement, despite the strategic intent to invest into IoT in order to continue the dynamic growth path. With respect to cash flow, we believe that this will continue to be very strong. There is a strong belief that cash flow will be, at least, on the level of prior year, not to say that we will exceed the cash flow generation compared to last year.

[Knut Woller, Analyst]

All the best also to Karl-Heinz in the life after Software AG.

[Karl-Heinz Streibich]

Thank you, Knut.

[Operator]

The next question is from Adam Wood from Morgan Stanley.

[Adam Dennis Wood, European Technology Equity Analyst]

And also best wishes from me, Karl-Heinz, for the retirement and congratulations. Maybe a couple also from my side, maybe for Arnd. We've been discussed in the past on many occasions the impact of cloud on the margin profile of software companies. I think in the past, you suggested that the vast majority of your cloud or recurring revenue business would be managed by the customers. It would be usage-based rather than having to manage SaaS implementations having costs on your side. It felt as if the commentary feels a little bit different on the second quarter in terms of costs that are coming in. Could you, maybe, just give us an update on how you see how many costs Software AG has to incur as you grow this business? What the impact on margins could be? And how much you expect to continue to be more just usage-based and, therefore, much more accretive to the margin side of things? And then, secondly, just coming onto the Dell agreement you signed, could you give us any feel for what the ASP would be of putting Cumulocity in an Edge server just so we can have some sort of feel for what the available market for that could be?

[Arnd Zinnhardt, CFO & Member of the Management Board]

Thank you for the first question. And let me just repeat what I have said. I think, it was 9 months ago and some years ago, we're sure it's virtual, on a very granular and detailed level. The -- we need to differentiate between cloud margin and IoT margin. And within the IoT margin, we clearly need to look at our go-to-market model in detail. So let's take those individual elements. With respect to cloud, we, of course, have to do the hosting and all the related costs as well. So therefore, our cloud margin is not different to anybody else's clouds margin. So that's the first element. The second one is the IoT. And here we have, as you know, 2 roots to the market. The first one is a direct one, with our direct sales people, that Eric mentioned in answering Knut's question. This is in line with the normal profitability that we also enjoy on the digital side. And then, we've got the third element, which is are we adding Cumulocity in our product into platforms, such as MindSphere, such as ADAMOS, such as telecom, such as the second part of your question, the Dell. Here, we enjoy an extremely high margin, given the fact that in those areas, the distribution channel is the OEM partner. So therefore, we deliver our technology, and the distribution is done by those companies as an example that I mentioned before. So therefore, here, the margin is over proportionally high.

[Eric Duffaut]

Okay. On the Dell partnership. Adam, it's a bit early, clearly, to disclose the average sales price. I mean, we are finalizing this. But what I can tell you is that there will be 3 sizes of appliance, featured size, as we call them, small, large and extra-large Edge appliances. They will be sold on a subscription model. And what I can, I think, now share with you in advance of this announcement is that we're going to have roughly a 50-50 share. This is in discussion and to be finalized, but this is the direction we are taking as well. So this will be, I would say, potentially, a very significant revenue stream for Software AG in the future, assuming, again, they will be successful in selling these appliances. They will leverage their distribution channel. We are not hardware vendors. [ We aren't ] basically trying this like a Intel inside of your computer, this will be Cumulocity inside the Dell Edge appliance.

[Karl-Heinz Streibich]

And one additional remark. You can link what Arnd said and what Eric said. This is the kind of an OEM business. That means that the OEM business scales infinitely as the revenue scales because we don't have any direct incurred costs through the operation of a data center through selling the software and so on. This is the reason why these kind of business models have exponential performance curve because the more partners you gain in the flat curve, the better and the earlier you have the exponential growth path. And this also applies to the profitability on that. So it is a highly, highly attractive business for us as Arnd has outlined.

[Operator]

The next question is from Michael Briest from UBS.

[Michael Briest]

A couple from me as well. Just to clarify on the guidance. I might have misheard you. I think you were talking about being at the high end for Adabas & Natural. When I look at DBP, flat in the first half, excluding the IoT business, the guidance is 3% to 7%. Are you saying that you believe with the good Q3 start, you should be at the high end of that or were you not commenting? And then, secondly, could you just give us an update on Siemens and ADAMOS in terms of how they're adding their own end customers and scaling, and if that's in line with your expectations or there's more you would like to see? And then, just finally, on the SaaS revenues within cloud IoT, can you give us a feel for how much of that is IoT related and how much is the traditional products just consumed on a SaaS format?

[Arnd Zinnhardt, CFO & Member of the Management Board]

Shall I start with the guidance Eric? And then get your support on how you see it. So good morning, Michael. Now we are talking about additional giving flavors to our guidance, right? And Eric and myself have said that Adabas will be rather at the better end of the guidance. With respect to digital, we didn't make that comment and we did that intentionally. So therefore, we will stick to the range. And as you know and that is important, Michael, analyzing the last years. Q4 has become more and more important. So if you'll recall the last years, when I started 16 years ago, it was something like 35% of the license revenue of the non-Adabas & Natural side at that time was generated in Q4. If you look to last year, it was rather in the ballpark of 43% to 45%. This is the sign and indication of the relevance of the project that we signed. And we still have a situation in the market that people make their year-end decisions based on the budgets, which are still available and, therefore, decide on new projects and the route they want to go. So therefore, we anticipate a similar seasonality like we've seen in last year. So therefore, the major part of the business will happen in Q2. And therefore, we should stay on the general side. Adabas & Natural, on the other side, as you know, is highly predictable as we are just operating within the existing customer base and have a high visibility of contracts that we are approaching. As a consequence and also as a consequence of our H1 performance, I think, the margin performance is very, very solid. So therefore, if you think about we achieved 31.8% last year, we are now ahead of last year. That should give you some indication where we believe the final result will end up. ADAMOS, Siemens?

[Eric Duffaut]

Yes. Michael, let me start with Siemens. I will let Karl-Heinz to comment on ADAMOS. Regarding Siemens, we are now live or Siemens is live with a Version 3 of MindSphere, which include and embed the Software AG component since roughly 1.5 months. So we expect, and that's part of the plan, that we will start to see the first wins of Siemens MindSphere with the Version 3 in the second half of the year and that the revenue contribution from Siemens will again affect the second part of the year rather than it didn't affect the first part of the year. So this is accelerated growth for us, so potential for accelerated growth for us. We are on plan in terms of go-live and in terms of level of satisfaction and performance of the platform. So now it's about Siemens' success in the market together with us, of course, but we have some visibility, which gave us again good hope that we'll see some clear revenue contribution from Siemens from a consumption and cloud base, of course, in the second half of the year. Karl-Heinz, ADAMOS?

[Karl-Heinz Streibich]

The actual key take on that is a very positive one. I think it was about 3, 4 days ago, we had a partner event, and it was more than 35 machinery partners, who participated there, showing high interest in joining the ecosystem of ADAMOS. Second, the big players in there, the Dürr, the MORI and ZEISS, they have double-digit amount of projects to develop the apps to connect the machines, to start to analyze the data, to be predictive in what they do in the relationship of their customers with their machines. And there is so much activity going around there that the CEO of Dürr, Dieter, said, "I spent so much time on digitalization of the machinery business, and I'm so proud that we are so much ahead in what we do in IoT." And this was the original statement he had given. And we, Software AG, are in the middle of it. We are the enabler, we are the promoter, we are the content provider of digitalization, and this is a great contribution. Michael, a great contribution, now still in this last phase of the E curve, to ramp up the E curve there too. And you will see very, very soon, that the momentum of IoT and the IoT business is gearing up tremendously quarter-by-quarter, month-by-month. Okay, Michael?

[Michael Briest]

Yes. And all the best for your retirement, Karl-Heinz.

[Karl-Heinz Streibich]

Thank you, very much.

[Arnd Zinnhardt, CFO & Member of the Management Board]

Then, Michael, we don't forget your third question, which was the split of SaaS and IoT. If you recall, and you'll certainly do that, the way how we structured most of the platform contract, we said, well 2018 will be the time of the minimum commitments, yes, which is the attempt that everybody feels the pressure that he should speed up in order to connect as many machines as possible. And once that is done, then the usage base overtakes the minimum commitment. So as based on the explanation of Karl-Heinz as well as Eric, we are, as planned, on the minimum commitment curve on the IoT side for those big, big platforms, yes. And therefore, it is not surprising that the majority of the revenue in the IoT usage-based is on the IoT -- on the cloud side. And let me be precise here, we have been very successful in the last couple of quarters of selling, especially ARIS in the cloud as well as our Alfabet in the cloud. So we see huge success, which is very much in line with the overall performance that you see on the charts of 100% plus. So these 2 corridors are really the driving factors on the pure cloud side, and we are very confident that, that is going to continue moving forward. So therefore, it is a combination out of people connecting the machines, us selling directly into other situations, and we've got some interesting prospects in our pipeline and Eric mentioned them as well. And having the appliance of Dell is another example, which is another way of distributing our product and, of course, connecting the machines, and therefore growing the potential of the IoT side.

[Karl-Heinz Streibich]

And the nice success we have with cloud and also Alfabet cloud is big times also additional business. Customers, who are much easier onboarding with the cloud versions, so it is not that we are substituting the on-premise big time. It is big times, new business, new customers and therefore, you will see big time growth in there as well in the future.

[Operator]

The next question is from Martin Jungfleisch of Kepler Cheuvreux.

[Martin Jungfleisch, Junior Equity Research Analyst]

Two questions from me. The first one is on capital allocation. Could you comment on your preference between M&A and share buybacks? And do you still plan on doing a share buyback this year or it's potentially also larger M&A on the agenda? And regarding share buybacks, is there an issue with the foundations stake in Software AG? And my second question is regarding the IoT business. Do you expect the second half to be driven by license sales or by subscription and usage-based revenues? And could you also give an update on your pipeline of further Dell or Siemens' type customers, please?

[Arnd Zinnhardt, CFO & Member of the Management Board]

So Martin, thank you for your question. I'll take the first one, and Eric will talk about the second one. So as we speak and that is certainly not a surprise, the finance market is extremely open. I just received a letter from one of our banks that we worked since decades, was approaching me and giving assurance how much they are going to finance. This would easily be sufficient for doing big acquisitions and doing share buyback. So therefore, for the time being, and I don't see any kind of changes in the next 2 or 3 years, it will be not a limiting factor doing finance, so therefore we can easily do both. With respect to acquisitions, you saw that we did the TrendMiner acquisition at the very last days of the quarter. This is our approach to go the next step into our IoT portfolio and in order to be, from a product side, ready for the upcoming demand on the market side. As you know, Martin, that our M&A strategy is always around innovating external innovation for our product offering, which, we believe, is an important factor for growing the company moving forward. And that can easily be proven by the acquisitions that we did in the last couple of years, and I'll take just Cumulocity as one of the -- one example. Share buyback is something that we will consider. It is always a question of what is the best use of the money that we have, what is the best time. So therefore, we never did something that we'll have a share buyback on an ongoing basis. This was very much supported by the shareholders and investors that we talk to. We will continue with this. The foundation is, with respect to share buybacks, not a limiting factor. You know that the share -- that the foundation is already at 32%. So they can be also at 33%, 34%, after a potential share buyback in the future. So therefore, the foundation is easy, and there is no legal restriction, which would hinder us doing share buybacks because of the foundation's position.

[Eric Duffaut]

Good morning, Martin, this is Eric. I will address your question relating to IoT. The first part was, if I got it right, what is the, let's say, the outlook between IoT license and subscription or consumption, I will even say, Martin. It's hard to answer that question for one reason. We give choice to customers, and we believe by definition that a consumption-based model is the right model for IoT. Having said that, we do know already today, because we are working on some opportunities from already several months, I would say, that we should have potentially also some nice license deals in the second half of the year for IoT. But I insist again, we give choice to our customers. Consumption-based is the right model when you talk about connecting devices, volume of data, our API calls and things like that, and it will continue to be our preferred model where our success will be based on the customer or the partners' success first.

[Arnd Zinnhardt, CFO & Member of the Management Board]

Let me just confirm and add to what Eric has said. Of course, it's always a choice of the customer, and we will not convince or try to convince a customer to change the deployment model. That's the first remark. The second remark is, if I have the choice and would value a contract, which is cloud usage-based compared to a perpetual one, I would always go for the usage-based model, first of all, because it's recurring business where we believe that we will, at the end of the day, earn more money on a usage-based model. Secondly, typically, the usage-based model tends to be the more relevant to bigger contract, yes. So if you think about ADAMOS, if you think about Siemens, if you think about Dell, those are not perpetual licenses. So the big contracts, which are needle movers for the strategic development of our company, are SaaS and usage-based. So therefore, I personally do not look to the license for a quarter on the IoT side. What I do look at is what is our performance on development on the cloud usage-based side, and looking forward, what is the development of our ARR number. So those 2 numbers are for me strategically significantly more important than one hit on the license side.

[Eric Duffaut]

Fully agree. And Arnd's -- his preference for the model, Martin, is pretty clear. The second part of your question was, what's in the pipeline after Dell or Siemens. I mean, I remind you that, of course, while these 2 partnerships are very strategic and a promise of high volumes in the next quarters and next years, we have also many other game-changing partnership from our point of view. I mean, the telcos, VCs, of course, the Internet of Things as the next generation of network consumption and also solutions for them. We had there A1 that we had last quarter or NTT, Deutsche Telekoms, many other, KPN in the Netherlands. We continue and we will certainly continue to win major partnerships in the telco area, really major ones. Now we will also, and this is really important, while we are very good at landing and building this partnership, it is important now that we support and help also our partners to expand and succeed, which will be the element of monetization for us. So one of our strategy for the seasonality is also to make sure that we help our partners to succeed and that we see, as I mentioned before, the first monetization elements of our key strategic partnerships. So you will see a combination in a nutshell marking of digging up monetization of some of our key partnerships, such as Siemens, as I mentioned as well as new partnerships certainly being signed as we continue to expand our ecosystem going forward.

[Karl-Heinz Streibich]

And the reason why that is -- that we can use that in several industries is the following: The digital business is a platform business. It's a shared platform economy. That means the middleware-based digital platform that we have developed throughout the last years and now with the real-time extension, the IoT part, this is a digital platform, which can be used, as you've seen and heard, with the machinery market, but it can also be used with the telcos, with the digital cities, even with the banks, when they give loans to machinery companies that they then know exactly what is going on with the machines. So this platform is cross-industry scalable, and this is a huge potential we have, and the huge asset out of that is because we have that middleware foundation where the integration is key again. This makes us so strong in that business and so well positioned in that business.

[Eric Duffaut]

So operator, we can take one more question, please.

[Operator]

The last question for today is from Gregory Ramirez from Bryan Garnier.

[Gregory K. Ramirez, Financial Analyst]

Just a quick one on Consulting. You mentioned a [ fall ], which was essentially due to a client, which stopped a project in the U.K. I can imagine this is the one that generated significant revenues in Consulting. But do we have to expect a bit of decline in the next 2 to 3 quarters as well, which will prevent the Consulting business to increase again?

[Eric Duffaut]

Okay. Good morning, Gregory, this is Eric. Yes, I mean, it is true that -- in fact, there are 2 elements on the consulting side. The first one is this customer in the U.K., as mentioned. The second one is also one significant contract that, in fact, stopped earlier than expected in Spain. So we have 2 elements, let's say. Now are we going to catch up in H2? Not sure, to be honest. But I will not consider that as a critical challenge for Software AG overall. I keep saying to internally, and I will state it here, that the mission of our Global Consulting Services is, number one, to make our customers successful. Happy customers buy more software. We are a software company, not a services company, and we continue to deliver, by the way, very good margin on the consulting side. So we all -- we never bet on our Global Consulting Services to be an engine of growth, but more an engine, again, of customer success and license sales success. So not sure we're going to catch up. Meaning, maybe, we can be flattish or slightly negative at the end of the year based on what I can see in terms of revenue, but still at high profitable -- profitability as mentioned by Arnd before, and again with license sales and customer success as our key measure at the end of the day.

[Arnd Zinnhardt, CFO & Member of the Management Board]

Thank you, Eric. Let me just make one closing remark before Otmar is taking over. On behalf of the board, I would like to thank Karl-Heinz for his contribution over the last 15 years. And I think you guys should also know that we operated very well as a team together. So thank you very much, Karl-Heinz, for your contribution, your strategic direction over the last 15 years. And it was not always fun doing the 60 chorus, sometimes it was really fun, sometimes it was a little bit hard. But we survived them all, and I am pretty sure, you will miss the chorus next year. And perhaps Karl-Heinz will even show up in Q3 and make some comments on Q3. So Karl-Heinz, thank you very much, and all the best for you.

[Karl-Heinz Streibich]

Thanks a lot, Arnd. That's very nice. And yes, we had a very, very good collaboration in the board, in the company. We have a great culture in the company, which is the basis, which is a key software of a company anyway. And I would also like to say thank you to all of you. The lot of contacts I had, very good ones, but I must disappoint you, I will not miss the chorus. Thank you very much. All the best, and hope to see you, again. Bye-bye.

[Otmar F. Winzig, Senior VP & Head of Investor Relations]

So thank you Eric, Arnd and Karl-Heinz. That leaves me with one last personal remark from my side. It was really the 60th, I counted back, quarter. And my analog log file, a paper notebook at that time, your first was on the October 23, 2003. It was an on-site meeting, so with real people, 22 analysts in the conference room in Frankfurt. Actually, we had 2 conferences. We had one for press in German, and we had one for the analysts in English. Now times have changed. Since then, we have digitized under your leadership. And driven by your vision and enthusiasm, and as captain digital, you stayed course with whatever headway we had to find. Now it's a promising cover story insight. You leave the ship, but you may leave it with the satisfaction that we are almost completing our successful journey, which we started towards an unknown territory and some 15 years ago. So thank you also from my side for keeping course, and a safe journey onward to your new destinations.

[Karl-Heinz Streibich]

Thank you very much.

[Otmar F. Winzig, Senior VP & Head of Investor Relations]

Ladies and gentlemen, this will close this call. And you may assume we all have other assignments, especially Karl-Heinz. And all the rest of the open questions will be handled as usually by the IR team. Thank you for now, and talk to you soon. Goodbye.

[Operator]

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