Software AG

XETRA:SOW

Earnings Call Transcript 2019-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. I am Emma, your Chorus Call operator. Welcome, and thank you for joining the Software AG Management Conference Call. [Operator Instructions] I would now like to hand the conference over to Otmar Winzig, Head of Investor Relations. Please go ahead.

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

Thank you, Emma. Good morning, ladies and gentlemen. Welcome to Software AG's Analyst and Media Telephone Conference and Webcast on Preliminary Second Quarter 2019. Yesterday evening, late evening, Software AG has preannounced preliminary results for the reported quarter. This morning, we also have published the P&L presentation used in this call and the full set of numbers, including the balance sheet and cash flow statement, will be published as planned on July 23, the regular reporting date. Today's call will start with CEO, Sanjay Brahmawar; followed by CFO, Arnd Zinnhardt. The presentations will be followed by a Q&A session. Our Chief Revenue Officer, John Schweitzer and our Chief Product Officer, Stefan Sigg are on the call to answer your questions. We will try to keep this call in the regular 1-hour time frame and cover as many of your questions as possible. Before we start, there are some housekeeping remarks. So this telephone conference will also be broadcast via web, and then 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. Dial-in numbers are also published in our website. For technical reasons, we cannot take any questions via e-mail during the conference call. The call and the webcast will be recorded and available for replay later today. With respect to capital market regulations, I would like to make the following safe harbor statements. Statements and presentations made in the course of this conference call and webcast include forward-looking statements based on the 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; the introduction of competing products, lack of market acceptance of new products, services or technologies and changes in business strategy. Software AG does not intend to assume any obligation to update these forward-looking statements. Statements and presentations of this call and webcast constitute neither an offer nor a recommendation to subscribe or buy in any other way securities of Software AG or any of the companies that are members of the group at present or in future, nor does it form part of such an offer and it should not be understood as such. Statements and presentations of this webcast will not constitute an offer of sale of securities in the United States of America. The securities may not be offered or sold in the United States of America without registration or exemption from registration in accordance with the U.S. Securities Act 1933 in its current valid form. Thank you for your patience. Now let us start, and I hand over to Sanjay Brahmawar, the CEO of Software AG. Sanjay?

[Sanjay Brahmawar, Chairman of the Management Board & CEO]

Thank you, Otmar, and hello, everyone. Before I dive into the numbers, it's worth setting some context. We are now roughly 5 months into the implementation of Helix, our multiyear transformation strategy designed to return our company to sustainable profitable growth. The strategy launched at our Capital Market Day in February addresses 3 key areas where we need to be stronger to fulfill our potential and to grow. First, it's sharpening our focus on market segments with good growth potential, like Hybrid Integration and IoT platforms. Second, it's reshaping our ability to execute in the market. And third, it's strengthening our team, both inside Software AG to upskilling and empowering our people and outside through nurturing and building a thriving partner ecosystem. I'll come back to each of these pillars later, but I want to give you a flavor of each before we move on. In focus, we have reallocated more than 20% of our R&D dollars into the areas of greatest priority. That includes Hybrid Integration where we have brought our new webMethods.io to the market. It also includes IoT, which has grown 144% compared to last year. In execution, we have moved forward with preparing our business for subscription. SaaS and subscription bookings in DBP, including our Cloud & IoT, now represent more than half of the bookings total. We have also added more than 60 net new logos in that period. And in team, we have continued the expansion of our partner ecosystem, signing important agreements with Adobe, Microsoft and Deutsche Telekom T-Systems in the quarter, each of which provides real revenue and scale potential for our business in the future. While still early in our transformation, this activity has driven overall solid numbers for the first half. Let me turn to those now. In terms of the first half to June 2019, group revenue growth was 5% year-on-year. Within that, total product revenue growth was 6% year-on-year. Total license revenue also showed the first signs of growth. Albeit, not across all regions and not yet at the levels we want to achieve over the medium term. As expected, group EBIT for the first half was down by 5%, and our non-IFRS EBIT margin down 250 basis points year-on-year. This was in line with our full year guidance. Overall, given the group is in a transition and transformation period, I think this performance represents a solid development. For the second quarter itself, group revenue and group product revenue both grew 2% year-on-year. We saw a particularly strong performance in the important IoT market, where we grew revenue more than 144% year-on-year. Total license revenue, on the other hand, was down 6% year-on-year. We delivered second quarter EBIT of EUR 47.7 million, in line with consensus, and our Q2 non-IFRS EBITDA margin came in at 26.7%, broadly in line with the market expectations. On a geographic basis, while EMEA continued to grow double-digit across all business lines, North America, particularly in DBP, continues to underperform. During the past 8 months, our new Chief Revenue Officer, John Schweitzer, has dedicated time and energy to diving deeper into our North America business and structure. Together, we have come to the conclusion that our challenges in North America will take more time and energy to fix than we first anticipated. We knew we had challenges in this market, but it is clear that the roots of those challenges go deeper than we understood at the start of the year. The reasons for this go back a long way. For many years, we have underinvested in North America in our marketing efforts, our brand awareness, our sales capacity and our operational infrastructure. We have changed our sales structure several times. Each time disrupting our customer relationships and hampering our ability to interact meaningfully with the C-suite. Short-term revenue tactics have also distracted us from building meaningful long-term relationships with the customer base in this key market. So those are our challenges. There are challenges we can now see and we have a plan to tackle them under John's leadership. For example, we have reviewed our North America sales pipeline and significantly de-risked it, removing opportunity from the pipe that would come through short-term approaches and focusing only on the book of business we want to build. After significant underinvestment, we now have a restructured, refocused, specialized sales organization, which is staffed to capacity. This organization is pursuing a more specialized, more customer-centric, more solutions-based sales approach, which is exactly the model we need to drive adoption of our digital products. We have transferred one of our best-performing sales leaders in the U.K. to the U.S. to strengthen our refreshed North America sales efforts. Our global teams also have full focus on supporting North America for an accelerated recovery. I would have liked to see change happen faster in North America. I am disappointed that we have not made more meaningful progress here. But I do have confidence that we now clearly see the issues at hand, the blockages they are causing and the formula for addressing them. Driving this change will be a key priority for John moving forward. Nevertheless, the slower-than-anticipated progress in the first half requires us to amend our guidance for the full year. On a divisional basis, for DBP, excluding Cloud & IoT, we have taken a thorough and prudent approach and now expect a new corridor of minus 6% to 0% within DBP in full year 2019. For Cloud & IoT and for Adabas & Natural, our guidance remains unchanged. And at the group level, our EBIT guidance is also unchanged. As I mentioned earlier, we made real progress in each of our Helix levers during the first half of 2019, and I'm proud of our transformation achievement so far and what the team has done. On focus, at our Capital Market Day in February, we were clear in our desire to make the most of our strengths in IoT and integration. We are attacking an IoT market, that according to McKinsey will be worth $25.6 billion by 2023 and an integration market, according to Gartner, will be worth $18 billion by 2022. Our reallocation of R&D dollars to important areas like hybrid integration is already helping customers unite their legacy systems with the range of new cloud-enabled, subscription-based solutions they're utilizing at the same time. As a result, we have increased our development velocity by 37%, enabling us to bring our refreshed integration product, webMethods.io to the market in a matter of months. This new hybrid integration offer -- offering allows webMethods to be deployed, both on-premise and in the cloud, to provide maximum flexibility to customers. It's a low-code, high-controlled suite for enterprise and represents how the new Software AG is going to market around iPaaS. This hybrid approach is the only way to succeed in the integration space going forward. Despite the shift to the cloud, large enterprises will have significant portion of the application landscape on-premises for the foreseeable future. We will need to be patient as we build pipeline for our new product, and we won't see the impact on stated revenue in the short term, but we are now in the right place to win in the market. The early responses and feedback to this upgraded product have been outstanding. We really have marquee wins under our belt that reinforce our confidence. For example, Walgreens, the U.S.' second largest pharmacy chain is already using our cloud migration accelerator. Based on webMethods.io to migrate 70% of its operations to Microsoft Azure while staying connected to the on-premise components of its IT systems. In IoT, we also made great strides in the first half. This is a key area for our business. And Q2 growth of more than 140% brings us back to our stretching guidance range for the full year. ARR, annual recurring revenue, growth in cloud and IoT was 60% year-on-year. Here, we have benefited from our expanding partnerships, including a significant agreement with Deutsche Telekom's Enterprise business unit, T-Systems, as the work done to enhance our sales approach and ecosystem is helping us win against peers in the market. We also saw a great IoT performance in our DOC region, which grew, albeit, from a low base. Our IoT products also continue to be recognized as best-in-class by our industry. During the quarter, we were recognized by Gartner as a visionary in its industrial IoT Magic Quadrant. We scored highest in all 3 use cases evaluated by its critical capabilities report on industrial IoT platforms. And in Adabas & Natural, our focus continues to rest on reassuring customers about their investments through the Adabas & Natural 2050 program. Here, our new zIIP and containerization technologies continue to deliver stable revenue performance, which is great to see. Our efforts to ready the business for subscription sales are on track. During the quarter, we have significantly simplified the way we engage with customers from a contracting perspective. As I mentioned earlier, we have seen a structural shift in the half in our bookings within DBP, including Cloud & IoT. SaaS and subscription now account for more than half of the bookings total. Our enhanced sales approach also saw us continue to stride out and claim new ground in areas of the marketplace through our direct channel, with more than 60 net new logos added in the quarter. In integration, we expanded our relationship with Australian retailer, Woolworths, a long-term software AG customer, strengthening the availability of their platform in a highly competitive consumer market. We also had a fantastic integration win with Schindler Group, a world leader in escalators and elevators. Here, we created a complete solution, leveraging ARIS and Webmethods to increase the speed of development, responsiveness, simplicity and visibility of its enterprise applications. In business transformation, we signed a large subscription agreement with Tesco for business process analytics using ARIS. Tesco will use ARIS to drive and underpin the new Tesco service model made up of 10 core processes, which cascade down to thousands of further processes touching the full extent of Tesco's operations across all of its countries. Again, in business transformation, much like the agreement we announced with the British Army in Q1, the U.S. Navy chose ARIS for its enterprise architecture to accelerate its business transformation initiatives. And in IoT, we continue to develop innovative use cases, breaking important new ground with Microsystems and Telstra during the quarter. With Telstra, we have expanded our existing relationship for water management systems. And with Microsystems, we are deploying Cumulocity to support multitenancy and pre-configured features as well as managing another IoT service provider under the Cumulocity banner. Our growing presence in the market is helping us become the partner of choice to some of the world's leading organizations. Having announced a major agreement with Amazon Web Services in Q4 last year, the best names in our industry continue to coalesce around us in Q2. In May, we announced a landmark partnership with Adobe to integrate our Webmethods and API management offerings with the Adobe Experience Platform. This gives Adobe's hundred thousand enterprise customers the ability to move key enterprise data from -- with ease from a range of systems into the Adobe Experience Platform. This allows them to gain a more complete view of the customer journey and deliver truly personalized experiences to their own customers at scale. As we speak, in fact, at 10 a.m. today, we are announcing a new partnership with Microsoft. We are launching a new cloud migration accelerator based on webMethods.io, designed to help businesses overcome the significant challenge of cloud integration faster and more easily than ever before. Migrating existing applications into the cloud involves a continuous need to connect or reconnect applications from existing on-premise technology to new cloud services or a continuous need to connect new cloud services to one another. With this agreement in place, our platform will provide new Azure users with all important connective tissue to allow ongoing business operations to continue, while migration takes place. And last week, we also announced a major agreement with Deutsche Telekom to deliver IoT services on a global scale via Cumulocity IoT platform, working with Deutsche Telekom's enterprise customer unit T-Systems we'll pool expertise and resources to expand our IoT presence across United States, Germany and wider European markets. I really want to reemphasize the power and potential of these agreements for Software AG, not just in terms of brand recognition and market presence we gain from proximity to these names, but also in terms of revenue potential they carry for the medium term. We already have resell agreements in place with Dell and AWS. Together, we believe partnerships we've signed so far during the year represent a significant revenue growth opportunity. And lastly, on our own team, we continue to see evidence of our growing employer brand in the market through the talent we are attracting. During the quarter, we've hired some of the best talent in the market, including Elke Frank, who joins us on the Executive Board as our new Chief Human Resources Officer. We are excited to welcome new team members from the world's most innovative companies. So in summary, I remain 100% confident in our Helix strategy. Since launch in February, we've made huge progress. The transformation we want to see in our company has begun to take shape. We have the right team in place to deliver on our plans. And while there have been challenges, we have the right plan and accountability in place to resolve them. So Arnd, let me hand over briefly to you, as I know, you have some additional financial detail you wish to share.

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

Thank you very much, Sanjay. Good morning, ladies and gentlemen and warm welcome also from my side. In sum, Q2 was a mixed quarter with a challenging digital environment and a nice IoT performance. Therefore, I would like to frame some opening remarks regarding Q2 and H1. Total revenue grew in the quarter by 1% net of currency. Adabas & Natural showed a strong performance during the first 6 months, with growth rates of almost 10% net of currency. Cloud and IoT caught up and is now within our full year guidance corridor. We saw a growth more than 140% in the quarter, resulting in almost 90% net of currency for the first 6 months compared to the previous year. Profitability-wise, we are well in line with our annual outlook. Non-IFRS operational EBITA came in for the quarter at a margin of 26.7%. As of June 30, we are well on track for our forecasted number. After the opening remark, I would like to start discussing the numbers with the FX analysis. As expected and communicated, we saw continued tailwind also in Q2 due to a slighter -- slight euro weakening against the U.S. dollar. All other currencies had basically no or just a tiny effect on the stated numbers. The DBP license recorded in Q2 showed a slowdown to EUR 28.3 million. This decline is predominantly due to a substantial restructuring of our sales organization in North America, which turned to be out more severe than planned. I'm afraid we have not had to expect this to continue until the rebuild of the sales force will be achieved by approximately by the end of this fiscal year or 2020. Sanjay addressed this in his part of the presentation and John will answer respective question on this topic during today's Q&A session. Maintenance showed an increase of 2% net of currency, resulting in a 6% decline for the business line revenue, digital, excluding Cloud & IoT. In line with our strategy project Helix, we continued investing into sales and marketing. As a consequence, the respective costs increased by 11% to EUR 49 million. The corresponding investments are intended to strengthen, first of all, our positioning in North America as well as the central marketing team. The R&D expenses stayed flat for the quarter and increased by EUR 5 million or 11% in H1. This increase is mainly due to acquisitions done last year and to further investments into our existing IoT and Cloud R&D teams. This development is very much in line with the head count growth observed. At the end of Q2, we had 1,348 individuals working on R&D, 12% more than the same time the year in 2018. Our ARR growth remained on a solid track, showing a growth of around 10%. Now on to Cloud & IoT. Cloud & IoT really made up leeway in the last quarter. License revenue amounted to EUR 5.7 million versus only 200,000 in Q2 of 2018. The overall Cloud and IoT business showed a dynamic growth of more than 440%. In particular, DACH and APJ contributed to this positive quarterly result. SaaS and usage base grew by 23%. This positive development is due to the joint efforts made by the teams in all our business regions around the globe. Thus, after 6 months in fiscal 2019, we can record that the revenue growth of the segment, Cloud & IoT, is well within the full year guided range of plus 75 to 125. As planned, Adabas & Natural continued to generate a stable total revenue. After an extraordinary Q1, the segment continued with the strong revenue development, which is not an unexpected result, as already mentioned in our last call. On balance, it was a very solid quarter and the decline in license revenue was compensated by a growth on the maintenance side of some 4%. This maintenance performance is clearly above of what we have observed in the last years. Costs are very well under control for the quarter and also for the first 6 months of the year. All those elements led to a segment result of 69% to 71% for the second quarter and for the first 6 months. Due to this performance and a visible calendar of renewals, we confirm our full year outlook of 2019 of plus/minus 3%. The professional service business confirms the expected development over the last 3 months. The focus on this segment stays on supporting our strategic license projects and simultaneously closely monitoring profitability. Thus, the revenue was in line with our expectation. With a Q2 segment margin of 14.3%, I can present a pleasing result, actually exactly on the same level we enjoyed in the first 3 months of the year. Despite the challenges caused by our ongoing transformation, total revenue remained quite stable. We are on our path implementing Helix announced at our Capital Markets Day in February. On this subject, I would like to inform you that some of the projects discussed in February in London are finalized by now, whereas others are still going -- ongoing, but tracking well. Our increased investments into sales and marketing, predominantly in North America and central marketing, led to higher expenses of EUR 6 million or 9% for the quarter and EUR 15 million or 12% in H1 compared to the respective last year's periods. Despite the higher cost level, and thanks to a strong Adabas & Natural business line, we were able to achieve an EBIT on an attractive and expected level. The overall margin development is in line with our expectation shared with you at the beginning of the year. Comments regarding the operating margin can be short and crisp. Based on the underlying set of numbers, we observed in general, "a normal pattern." The delta between IFRS EBIT and operating EBITA amounts to EUR 8 million. The reduction expenses for share-based payment results from the -- results from the general development of the stock price as well as a later start of the management incentive plan 2019. This leads to a margin, which is in line with our guidance given 6 months ago. Ladies and gentlemen, let me continue with the cash flow statement, which is, as I reported in conjunction with the Q1 numbers, impacted by the new IFRS 16 standard. The operating cash flow in Q2 developed in line with the first 3 months of the fiscal year. Due to investments in conjunction with Helix, the operating cash flow remains slightly lower than 2018, but continues staying on a high level. Our balance sheet is just as solid as always. Therefore, just some quick remarks. Net cash remains unchanged compared to December 31, despite distributing dividends in Q2. Trade receivables are at EUR 231 million, in line with our position 1 year ago. Deferred income amounts to EUR 133 million (sic) [ EUR 173 million ] a bit more than last year, also reflected -- reflecting the positive maintenance development and shareholder's equity remained also unchanged showing a ratio of 62%. With this, I would like to close my number-related remarks and explanations on Q2 and H1. Let me end on a positive note regarding our way forward. In the meantime, we have implemented a new steering logic required for running a full subscription model, which we will, as you know, need starting 2020. After 4 to 5 months, we're already fully operational to support our 2020 planning process and deliver all relevant KPIs real time to our managers at their desk as well as on their mobile devices. And as I just talked about the subscription model, also our process in this area is tracking well. This is very much true for the back office, but also for the areas such as go-to-market and the product side. So thank you very much, and Otmar, over to you.

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

Thank you, Arnd. Thank you, Sanjay. Now ladies and gentlemen, this is time for asking questions. And before we start, I just hand over to the operator to give you the instructions once more. Emma?

[Operator]

[Operator Instructions] The first question is from the line of Gautam Pillai with Goldman Sachs.

[Gautam Pillai, Equity Analyst]

Three, if I may. First, can I dig a bit more into the North America execution issues. And Sanjay, you flagged the historical underinvestments in this region. And can you please clarify the specific steps you're taking to rebuild the sales force and changing the sales compensation structure? Maybe you can also give some indication on the sales force attrition rates? And on the DBP comment, can you please confirm if that you anticipate DBP to come back to growth by 2020? That's my first question. My second question is on IoT Cloud. And can you give us some color on how this segment performed in North America? Is there any contingent risk from the sales execution issues in DBP into IoT Cloud in the region? And finally, one on margins. Do you see incremental investments outside of your guidance to kind of fix the issues which you're seeing in North America? If I look at the margin guidance 1H is tracking at around 26.2% versus your guidance of 28% to 30%. We know that seasonally Q4 second half is a bigger -- bigger half year to fix that issue. But I just want to understand, is there a risk on that margin guidance at all?

[Sanjay Brahmawar, Chairman of the Management Board & CEO]

Gautam, it's Sanjay. Thanks for your questions. So look, let me talk about the DBP and the return to growth, and then I'll hand over to John to answer your questions around specific steps in North America and Arnd will take on the margin question. So with DBP, let me emphasize our entire strategy was around bringing the attention and focus back on to integration in API. And that is something that we have totally driven in our company now. We have a separate business unit for integration API. General Manager running that full end-to-end accountability. And we have targets across our regions to really focus on integration API. So we are competing now head-on, and we are winning in the market, and we are beating Apogee and others in this space. So that gives me a lot of confidence about how indirect selling we are going after the DBP potential -- integration API. But I think even more important is what we have now signed up with Adobe and Microsoft. Think about, as I said, Adobe has 100,000 enterprise customers. We have signed up with Adobe engagement platform to be able to attach webMethods.io with every opportunity they have to introduce the platform. That itself is a tremendous scaling opportunity for us, number one. Number two, we stuck a very significant partnership with Microsoft a couple of weeks ago, and the partnership is all about speeding up Azure migrations and giving confidence to the organizations that after the migration or during the migration, they do not have any integration problems. And that's again tying up webMethods.io with Azure migration. So it's not only direct sales, but it's also scaling through these very tight partnerships, including resells that we believe that DBP will be back into the right shape. So that's the answer to DBP. Let me hand over to John to talk about North America.

[John Schweitzer]

Sure, Sanjay. Thanks, Gautam, for your question. Look, before I get started, this is my second full quarter in taking the reins of our field organization and alliances and channel. What's really clear for me on North America is that we have 3 problems that are greater than we first anticipated. You heard them from Sanjay, underinvestment in NAM over time, several sales structural changes in the last 3 years and then some short-term revenue tactics that while it filled some revenue gaps we're going to be taking a slightly different approach going forward. So what are we doing? For me and the team, there's really 4 areas, Gautam, that very specifically focus on and have a high confidence around. One is the building and rebuild of a high-quality pipeline with a focus on 4-quarter rolling at a rate of 4x cover on that pipeline. Specifically, in Q2, the team and I have drilled down at a very, very detailed level and completed a thorough analysis on this pipeline, requalified the deals, and analyzed at very in-depth level. In doing so I've applied what I believe is realistic, but also prudent assumption here and actually put a couple of hedges on top of region like North America. This gives me a high degree of confidence to make sure that we fall well within the range of 0 to minus 6. Other focus areas, we really have done a fantastic job historically of focusing on up-selling current contracts. We need to cross-sell the new use cases and get very good at opening up new accounts. So while 60 net new logos is great and it's greater as a comparison to last year, it's not where I expect it to be. So we'll continue to focus there with things like the incentive compensation plan for net new use cases and net new logos. Number two, hiring and retaining the best people. As I mentioned last time Sanjay did with you all, we performance managed out the folks that we didn't feel like were performing. We've got a great team in place today. We've hired to capacity, we're training those people and enabling them on new messaging and new sales process. In fact, we completely retooled our sales methodology, and we're implementing a system called Altify to standardize that, which is a solution that I've implemented 4 different times in my career across 20 years. The specialization model and new customer segmentation that we've implemented are bedding down right now. And we're making sure that our team, our salespeople are focused on the customer and customer success. So I expect that to continue to bed down as well. And the last one, number four, you've heard from Sanjay around new partnerships. Over the mid-term, this will have a significant impact, we're not just talking about the drafting on branding and associating ourselves with these key partners like AWS, Adobe, Microsoft and Dell, I am personally taking the responsibility to create resell arrangements and contracts with my peers at these companies. We've already done this at Dell and AWS, and I expect the same from Adobe, Microsoft and others. And I look forward to sharing the additional companies in future calls. So I guess just in summary, Gautam, and thanks again for your question. The 4 areas: building high-quality pipeline, hiring and retaining the best, implementing the specialization model and driving new partnerships gives me extreme confidence that not only will we get North America back on track, but we'll continue to see consistent growth across other regions in the world.

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

Then, Gautam, good morning. I'm going to take your last question on the margin impact. Let me answer the following way. We have done a very thorough analysis and scenario calculation based on the picture that we see as of today. And in part of that analysis, I would like to divide that up into North America and all the other areas of the business. With respect to North America, I just referred to what John and Sanjay have just explained. In all the other areas or other regions, central marketing, branding, Helix, we will continue our investment as planned. Now with all these kind of assumptions, which also supports the future development, transition and growth of the company, we are very confident to meet the guidance range of 28% to 30%.

[Operator]

The next question is from the line of Charlie Brennan with Crédit Suisse.

[Charles Brennan, Research Analyst]

I've got 3 questions as well actually. Firstly, just on DBP. You're attributing most of the problems to the U.S. Would it be possible to give us what the growth number was outside of the U.S. for DBP? Secondly, I know the big subscription switch was supposed to happen in 2020, but is there any suggestion here that licenses have moved to subscription and that's contributed to the revenue shortfall? And then the third unrelated question is, it appears that the stock markets implying a limited level of conviction in your strategy going forward. There's always been some of the parts debates at Software AG, have you thought about value creation in other ways?

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

So good morning, Charlie. I'll take the first 2 questions, then I hand over to Sanjay. So the first question was with respect to digital outside the U.S. I already made some comments regarding Cloud and IoT outside U.S. So on the IoT side, we saw very nice development out of Germany and APJ. On the cloud side, all regions contributed to this positive performance. Looking to the other regions as one, we are in line with our expectation that also revenue growth that we gave at the beginning of the year. So all other regions, as a sum, are tracking as expected. With respect to the subscription, there is no revenue impact due to the switch to subscription, and we are moving our customers towards a subscription and we see a lot of interest from our customers here. You know that based on the IFRS rules, subscription must be recognized upfront like perpetual licenses unless you have to be recognized upfront. So therefore, you don't see any kind of impact. Moving in 2020, and that is probably driving your question. We are changing the way of how we define and set the contract. Starting 2020, like all the other players who have already gone through the process of subscription, we will offer our customers an annual cancellation rate, which will then result in a recognition of a 12 months' period and then the second 12 months' period and then third 12 months' period and et cetera, et cetera. So therefore, in a nutshell, no impact on revenue today, 2020 and this will be reported in a separate way. We will see an impact and have communicated this kind of impact already on our Capital Market Day in London.

[Sanjay Brahmawar, Chairman of the Management Board & CEO]

Charlie, it's Sanjay. Thank you for your question. So look, let me emphasize. We are 100% confident that our strategy is a right path for our company. Now look, our transformation is not about 1 or 2 quarters, Charlie. It's about making the right changes in this company that will allow us to grow over the mid-term and create a sustainable growth business. And that actually really means, first and foremost, improving our brand awareness and visibility. And we have really made a big start on this. Number two, it means focusing on the right products, integration API, IoT analytics, and we have created that focus and we can see that focus coming through. And number 3 is really building these partnerships that are going to allow us to scale. And you can see that the likes of these big names, like Adobe, Microsoft and AWS and Dell, Deutsche Telekom, they are not signing up these partnerships with us because they just need another partner. It's because they see the value of the webMethods.io capability, and they see industrial IoT, Cumulocity IoT platform as the leading platform. So in that term, the signals that show us that we're going in the right direction are the leading indicators that we're focused on, Charlie. For example, that how is our ARR progressing. We are 60% year-on-year growth on ARR. How is our portion of subscription and SaaS bookings of the total DBP and IoT bookings progressing? It's now 50% of the total bookings. And what kind of market leaderships are we demonstrating in terms of industrial IoT where we want to excel and capture the market? So I think yes, we have to acknowledge that we've got challenges in North America, and it's a market which is very significant and important for us. But if we look outside of that region and look at our other regions, then our other regions are healthy and look at EMEA, growing double digit. So it gives us confidence that if we can address these issues that we have in the significant market of North America, that should support all the other activities that we are doing on our strategy around Focus, Execution and Team. So that's to answer your question.

[Charles Brennan, Research Analyst]

Are you convinced you need both DBP and A&N under the same group structure?

[Sanjay Brahmawar, Chairman of the Management Board & CEO]

Well, I think -- when I started here, if somebody asked me the question, what is your view on A&N Sanjay? How would you see it? Look, see, I think, I've gone and met literally 30 to 40 A&N customers. Just for clarity, we have 55% of the Fortune 500 customers are Adabas & Natural customer. They have massive wallets. Of course, we have a small share of that wallet today, but it gives us the opportunity to have very exciting discussions like with Bank of America, with Woolworths, with Commonwealth Bank of Australia, et cetera. These customers, we have relationships over 20 to 30 years. So I see Adabas & Natural, of course, it is a very strong source of profit for us and cash for us. But at the same time, we need to leverage the relationships that we have in these Adabas & Natural customers and be able to discuss digital transformation, IoT sell-side analytics with them. And we are now getting great examples, Bank of America itself is a great example where we're having fantastic engagements around integration, API and analytics.

[Operator]

The next question is from the line of Stacy Pollard with JPMorgan.

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

Just some quick follow-ups. On the partnerships, Microsoft, Adobe, T-Systems. Can you talk -- I don't know if you can put -- quantify in any way revenue potential there, but also are they royalty based? And are they definitely all recurring? So that's one question. And the second one was just a follow-up on the margin question earlier. What are you now thinking about margins for sort of 2020 and going forward? Or just even broadly, how that progresses?

[Sanjay Brahmawar, Chairman of the Management Board & CEO]

Yes. So Stacy, it's Sanjay. Thank you for the question. So on the partnerships, the agreements that we're doing, for example, with Dell, we have agreements of Dell reselling Cumulocity IoT preloaded onto all of their Edge servers. So I think we have introduced that in the last quarter to you as a partnership. AWS, we have the same kind of agreement. With Adobe, we are building an agreement for putting together our webMethods.io capability with their Marketo and Adobe Engagement Platform. So it is exactly what you said attaching the product and giving the ability to Adobe sellers and their partners and their ecosystem, not to have to come back and have conversations on pricing, et cetera, with us. We are doing the same with Microsoft, which is about attaching webMethods.io to Azure. Every time -- Microsoft is already available on Azure marketplace by the way and allowing them to white label our capabilities so that when they offer an Azure migration to a customer, they can embed this capability to ensure that the integration happens with the on-prem capabilities as well as the cloud capabilities during the migration. So these arrangements that we are making -- by the way, we've been very selective, Stacy, in not going and trying to make partnerships with 50 companies. We have chosen 4 companies to do these partnerships, and we have built very strong teams within our own organization to create the governance and the monthly follow-up on these partnerships. So our relationships with each of these companies are with their CEOs, with Shantanu, with Satya, with AWS, with Andy Jassy, et cetera, and we are driving this in a strategic way, not from a perspective of the usual partnership models.

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

Stacy, it's Arnd. I'll take your margin question. So in -- we have communicated the margin development on our Capital Markets Day in London. And this communication holds true also today. So that's the first and important opening remark. Secondly, Charlie was already referring to the way how to recognize subscription revenue. As reported in London, we will see a shift in our terms and conditions on those subscription model, adopting the market standard moving forward, which would result as we showed "only the annual potential" of that deal moving forward and then have a consistent recurring revenue stream following thereafter. So because of that, we will and we already do and report on ARR the booking and the cash flow. So therefore, it is very important for starting 2020 to look to those KPIs in order to validate the progress that we have made in a certain period in a given quarter. So therefore, 2020, and I just reiterate what I said in London, we'll see a margin squeeze of roughly speaking 200 basis points. And then over time, we will come back again to the reported margins that we have seen in the past. And if we do it right and if we can adopt the same like others, we will go to this rule of 40 concept where adding up revenue growth and margin will end up to 40. And I think we have all the ingredients to achieve that.

[Operator]

The next question is from the line of Michael Briest with UBS.

[Michael Briest]

A couple from me as well. Just turning to the sort of sales reorganization in North America. What can you say about the situation in EMEA and Asia? Should we expect that once North America is fixed that the same issues might recur in these territories? Or are you very comfortable with how those regions are run and organized? And then secondly, sort of continuing on the theme of SaaS and subscription. It's very impressive to hear. It's half of the bookings. Can you talk about the cash flow profile? Because I'm assuming a customer buying a license plus maintenance would be used to buying sort of perpetual license and paying quite a lot upfront. But as you said on, I think, in London that it's about a 3-year equivalent of license and maintenance. How does the cash flow compare between the 2 models? Should we expect to see a drop in cash flow initially as the business model shifts?

[John Schweitzer]

Michael, it's John. Maybe I'll make a comment on Rest of World go-to-market changes. So the Rest of World is also bedding down in Helix. The specialization models and segmentation that I mentioned previously in North America also apply to the Rest of World. They're implementing and bedding down along those lines. The thing that's different is the average tenure in these markets continues to go up because we've gotten less than average attrition, which is very good. So logically, as the tenure increases, those account executives and teams understand the selling motion they have strong relationships with our customers. So I expect for that growth to continue as a result. Pipeline growth is consistent at the moment. I'm really happy with what's happening in Rest of World.

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

Okay. Good morning, Michael. Then I take the question on the cash flow at the subscription side. Yes. We are anticipating on average a 3-year term, which was then renewed afterwards, which then lead into a recurring revenue stream. From a cash flow perspective, yes, you're right. We would see an annual payment and an annual upfront payment to be precise. This is certainly different from the subscription -- from the perpetual model. However, we have seen also extended payment terms in the past, which we, I think, managed quite nicely. So therefore, there's a compensatory effect between the 2 elements. The net-net of that is that I do not foresee a significant impact -- negative impact on the cash flow side.

[Michael Briest]

Okay. And just an add-on. Some of your peers have talked about macro issues, trade wars and things like that affecting sales execution. Do you believe there was any impact, either in North America or elsewhere from macro-related factors?

[John Schweitzer]

Yes, maybe I'll start. This is John again. We don't have a significant contribution coming from -- for example, from China. So it doesn't have a massive impact on our business. I didn't see a material impact on transactions slipping or moving in any way. So from my perspective, I don't see a material impact.

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

I couldn't agree more. And if we expand the question from China to Brexit, also here, we don't see anything.

[Operator]

The next question is from the line of Knut Woller with Baader Bank.

[Knut Woller, Analyst]

Just briefly on, A&N, Arnd, I mean we have been tracking well ahead of expectations. And I know this business depends on renewals, and you have a good visibility into the pipe. However, I mean it looks like that the pipeline is pretty conservative at this level, would you agree on that? And then secondly, I mean you have a good cash pile. And looking at the valuation of the shares, I mean we discussed buybacks in the past. Is that something also in the absence of any larger acquisitions you have done you are considering more intensively at these levels?

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

Yes. Thank you, Knut, for your question. On Adabas & Natural, yes. I mean we are at 10% growth today. It's well above the margin. So therefore, I would not be surprised if we rather come at the better end of the guidance range by the end of the year. So if you call it conservative, yes, then it's conservative. Buyback, yes, that is something that we certainly will evaluate now given the share price that we currently see. In fact, and that is -- that also goes together with Michael's question. Share buyback has number of elements that need to be considered based on our way of looking to the topics. First of all, possibility to make acquisitions, is it impacted, yes or no. I believe given the strong margins that we have and the open capital markets, we will be able to acquire all potential targets that we are interested in, okay? So that's the first one. So if there is an acquisition target that will not be negatively impacted by any kind of dividend share buybacks stuff. So I think that this year's traffic light, it shows green. And then we look to the individual share price status. This is certainly something where we could consider doing a share buyback as well. And then from a cash flow perspective, we, of course, also look at what is our projection on the cash flow moving forward. And as I said, we believe that the cash flow generation will remain strong, also going into 2020 and 2021. So therefore, green light here as well.

[Operator]

The next question is from the line of Sven Merkt with Barclays.

[Sven Denis Merkt, Equity Research Analyst]

Following the reduction of DBP guidance for 2019, how should we think about your mid-term guidance of more than 10% growth? After the weakness this year, when would you expect to grow at this run rate? And then secondly, industrial demand in Europe has been weaker recently. How would you expect will this impact your IoT business? Is it the right way to think about it that usage-based contracts might result in lower revenue in the near term, but given the slowing demand in cap goods, firms are looking more intensively for cost-saving opportunities, which could benefit you over the medium term?

[Sanjay Brahmawar, Chairman of the Management Board & CEO]

Sven, it's Sanjay. Thank you for the questions. Look, on DBP, we feel very confident about our mid-term guidance. We don't see a challenge. As John told you, for the Rest of the World, we have really good progress in the markets. We are bedding down the new behaviors and relationships that we require. So we are happy with the growth and the progress in the rest of the market. We understand now the challenges of North America, and we are working diligently on that. So that also gives us the confidence that over the mid-term, we will definitely have those issues in control by 2020. And so we will see that market bounce back. Then the point is really about is there potential in the market? Well, the market of digitalization is still growing at a very rapid pace. We can see -- every company has to think about how they're bringing data together. Data is sitting in disparate landscape all across the board with the on-prem applications, cloud application, private or public and also on the Edge. And if you cannot bring this data together, you really cannot convert that into value. The only way to do that is through hybrid integration today. And if you look across and think about the number of companies that are available, reliable in the hybrid integration market, you will find that we are the one independent healthy company that is still available. So therefore, we feel very confident that we will capture our fair share out of this hybrid integration market. Then the other question you raised is about the industrial IoT and whether the dampness of the news around the auto sector, et cetera, is that having an impact for us? Well, the important thing, first and foremost, for us is we are really focused on use cases that are around predictive maintenance, condition-based monitoring, optimizing and improving efficiency and reducing cost. In this world, that becomes more and more relevant and more and more important. We see the adoption of Cumulocity IoT platform and our analytics capabilities across the board. To give you an example, in the ADAMOS partnerships we have Dürr is leveraging analytics builder on top of Cumulocity to deliver these solutions to many manufacturing companies. So I don't -- and because we have such a diversified range of customers, I don't see the challenge for us since we're focused on use cases that actually help companies optimize their operations and deliver more productivity.

[Operator]

The next question is from the line of Alastair Nolan with Morgan Stanley.

[Alastair P. Nolan, Research Associate]

Just a couple from me as well. I guess first of all, I just wanted to touch on the weakness in DBP. Is there any concern there that this is more of a product issue as opposed to just a sales issue, so maybe if you could comment on that? And then following on from that, what do you think the risk is that the reorganization in North America, perhaps takes a little bit longer and requires some more investment maybe acting as a drag into the fiscal year '20? And then just finally, on the SaaS transition. Is there -- is the plan here to complete that in just 1 year? Or should we be expecting this transition to take -- is this a multiyear transition that could act as a longer-term drag on margins?

[Sanjay Brahmawar, Chairman of the Management Board & CEO]

Alastair, it's Sanjay. Let me take the first question around DBP. I think the second one, John will take and the third one, Arnd will answer. So on the DBP, no, it's definitely not a product issue. And the proof points for me that is not a product issue are the following. We had Walgreens Boots, I mentioned that in my starting. They are migrating 70% of their portfolio into Azure. And we have a partnership together with Microsoft there supporting them with their migration with webMethods.io, that's really great proof point that how important our product is for the success of Walgreens Boots.And the response that we've got with webMethod.io across the board is very positive. And the second thing is, Adobe and Microsoft would not partner with us this intensively, if our product capabilities were not good. That is absolutely clear in my mind. So I can assure -- I don't see -- I have no hesitation around our products trend. I think these partnerships and also enabling our people in the field to be able to talk about the capabilities and the value of this solution is what is going to drive the growth in hybrid integration for us, but feel very confident about that. Over to you, John.

[John Schweitzer]

Sorry, Alastair, yes, can you repeat the second part of your question around reorganization?

[Alastair P. Nolan, Research Associate]

Sure. I guess it was just mainly around, is there any risk that this reorganization takes longer and maybe acts as a drag on the business further into fiscal year '20? Or is there kind of confidence that this is something that can be fixed by year-end?

[John Schweitzer]

Yes. It's a very good question. So -- and this is one of the reasons why you take a look at DBP in North America why we're seeing an impact on that number. We've reorganized as a business over the last 3 years how we approach customers, for example, horizontal or geographic-based versus vertically-based. And because of that, we changed customer relationships. So those customer relationships now based on our new structure need to bed down and that does take time. I don't anticipate that that's going to solve itself in 2019. I'm highly confident it solves itself in 2020. However, the range that I provided to my Board colleagues here and the confidence around that is based on the current pace of that, our plans there, in the current pipeline, okay? So -- but I do expect further acceleration as it's -- for example, things like our average tenure, it goes up in North America, our relationships improve in the C-suite going into next year and we have just, frankly, more time with customers.

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

Okay. So then I take the last one, which was the question regarding, is the SaaS subscription switch just 1-year exercise or a multiyear exercise? The answer is the following, Alastair. So looking to our peers and we have talked to many peers, this will be a multiyear exercise. I think we need to divide up the entire transition based on -- are we talking to a net new customer or are we selling some net new solution into an existing customer. Here, we believe that the adoption rate of SaaS subscription will be fairly high. With respect to the existing customers, it will be a step-by-step approach. So whenever a contract comes up for renewal, we will discuss with that respective customer the move to subscription, and we'll certainly discuss it in very much detail about the advantages of the subscription model. But as not all the contracts come up in 1 single year, this will be a step-by-step approach.

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

Okay. Now we have to close the list of questions here for time constraints. But before we let you go, Sanjay would like to close this call with some closing remarks.

[Sanjay Brahmawar, Chairman of the Management Board & CEO]

Okay. Thank you, Otmar. Well, first and foremost, thank you very much for your time and listening to our comments and our statements. I would like to just emphasize that we really are very confident that this strategy is the right path for our company. And I hope that we have given you enough proof points that let you see that the changes that we are making along focus, execution and partnerships are really bedding down now. We have enough proof points that tell us that the strategy progressing in the right direction at the pace that we wanted to progress. And the third thing is, of course, we understand the challenge around North America. It is a very important market for us, and we are fully committed and we have the right structures in place to fix those problems, which are a result of many years of neglect. And so it's important is to get the right focus and being able to now convert that into and share with you the results of this transformation. So I look forward to continuing to share with you how we're progressing in our strategy, and I wish you a good day. Thank you so much.

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

Thank you, Sanjay, and thank you for all the questions outside. As always, if there are remaining questions, our team is happy to help you for now. And don't forget, we have a full set of numbers out on Tuesday, July 23, but there will be no public call then. Thank you for now. Thank you. Until next time.

[Operator]

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