Software AG

XETRA:SOW

Earnings Call Transcript 2021-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. I'm Haley, your Chorus Call operator. Welcome, and thank you for joining the Software AG Q2 Results Call 2021. [Operator Instructions] And I would now like to turn the conference over to Senior Vice President, Corporate Development, Robin Colman. Please go ahead.

[Robin Colman]

Thank you, Haley, and good morning, ladies and gentlemen. Welcome to Software AG's Analyst Call and Webcast on the Preliminary Q2 and Half Year Results for 2021. This morning, Software AG has published preliminary results for the reported quarter in the first half of 2021 as well as the presentation used on this call. Today's call will start with our CEO, Sanjay Brahmawar; followed by Scott Little, Software AG's CIO; and our CFO, Dr. Matthias Heiden. We will try to keep this call in the regular 1-hour time frame and cover as many questions as possible. Before we start, there are some housekeeping remarks. This conference call is also broadcast via the web. You may access the webcast via our Investor Relations website, and the webcast will display the presentation slides related to this call, and the same slides are available for download on our website. The webcast, including the full call with questions, answers and the names of questioners will be recorded and made available for replay later today. Finally, let me remind you of our Safe Harbor statements, which is shown at the beginning of the slide presentation and is valid for the entire call. Thank you for your patience. Now over to Sanjay.

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

Thank you, Robin. Good morning, and welcome to our Q2 and H1 earnings call. Q2 was a strong quarter. I am extremely proud of the team and what they've achieved. Thanks to the whole organization's effort, we closed out the first half in line with our plan. We have recommitted to our full year guidance ranges and 2023 ambitions. For me, the most striking aspect of our second quarter delivery is the 10% growth in digital business product revenue. This is a major landmark for our transformation and a key contributor to the fact that this is the first time in a long time we've delivered double-digit total revenue growth in a quarter. Sustainable, profitable revenue growth, and particularly, digital business revenue growth is the fundamental rationale for our Helix program. We have worked hard to drive bookings momentum and our subscription shift, confident that these efforts would translate into green shoots of revenue momentum. Q2 shows these first green shoots appearing. We know that the job isn't done yet, but we've taken a big step forward in closing a key transformation loop. We have shown that bookings momentum translates to revenue success. From here, our top line will continue to build as we capitalize on the accelerating trend towards digital transformation and take share in the $28 billion truly connected enterprise opportunity we see by 2024. At our Capital Markets Day, we spoke about building blocks of our future product revenue, and building on 2021, how we drive annual product revenue growth of between 10% and 13% between 2022 and 2023. With each passing quarter, we are gathering proof points and building an even clearer path to sustainable profitable growth in future. Let's look over the headline numbers for Q2 and H1. In our digital business, Q2 bookings growth of 8% was a solid performance. For the first half, bookings growth was 13% with a solid pipe for H2 and with the revenue growth from subscription and SaaS starting to impact our overall top line, we feel confident in our digital business heading into the rest of the year. In A&N, our Q2 performance was very strong, thanks to great execution along with several large deals, which either slipped from Q1 or closed earlier than expected. This drove second quarter bookings growth of 48% and Q2 product revenue growth of 32%. Our half year return was 8% growth in bookings and 9% growth in product revenue. As a reminder, our expectation remains that A&N performance this year will still stand roughly in line with 2019 levels. For the group, bookings grew 18% in Q2 while product revenue grew 17%. In the first half, bookings growth was 12% while product revenue grew 6%. Our transformation lead indicators continue to point to future success. Digital bookings from subscription and SaaS were 94% in Q2 and 88% in H1, while ARR growth in our digital business was 9%. Recurring revenue reached 94% of the product revenue in Q2 and was 91% for the first half overall. This is above our midterm ambition of between 85% and 90%. This recurring revenue figure is the clearest indicator yet that our growth is being driven by higher quality, more predictable recurring revenue streams. Finally, along with our prudent approach to investment in Helix, the strong revenue results drove operating margin 28% for Q2 and 21% for H1. Looking behind the numbers. We continue to deliver Helix acceleration through a cultural transformation, pivoting our collective mindset towards growth. Our employee base, enabled with new training and new tools, is delivering results balanced across 3 business growth levers: winning new business, driving upside as we migrate existing customers to subscription and capturing the customer lifetime value potential at the moment of a subscription renewal. 72 new logos is a Q2 record for our business and a 33% increase on Q2 2020. We achieved 140 new logos in H1 overall. And as we look into the second half, I believe we are tracking to a record new logo year. Our improved ability to hunt in the market gives us real confidence that our new business engine under Scott's leadership will deliver the sustainable growth we're targeting in the coming years. There are a couple of great examples of repeatability in the food services sector I'd like to highlight. We won a great deal with Sodexo, the EUR 22 billion food services and facilities company. And we won another with the Nutrition division of Otsuka Pharmaceuticals, the multibillion euro Japanese health care company. This latter API management win beyond webMethods will see us digitize the client's transport operations, simplifying their interactions with staff and helping them reduce the cost and time it takes to deliver crucial information. We've also seen early success with our investment targeting the German Mittelstand, which Scott will discuss later. On migrations, we've continued to shift our customer base towards subscription. This allows us to increase customer lifetime value through the renewal cycle and gain a contract value multiplier when we migrate. This multiplier continued to average around 1.4x in Q2. A Q2 example is Woolworths. This large Australian supermarket chain and webMethods customer has now expanded into hybrid integration with webMethods.io as we beat competition from MuleSoft and Informatica to secure the iPaaS elements of a new agreement. Through the deal, we will integrate Woolworths' hybrid multi-cloud architecture and help it become more data-oriented. This is another co-selling success from our partnership with Microsoft, which continues to go from strength to strength. Finally, on renewals, we are starting to secure deals, which show the potential of this revenue stream from 2022 onwards. During Q2, we won a significant renewal with a large Dutch global investment bank or ARIS Cloud as we enable it to deal more effectively with the huge demand on its data processing capability. Across renewals, we have a number of early examples of good net retention rates for our digital business. And with our renewal cohort building into 2022 and 2023, these examples indicate the scale of customer lifetime value opportunity ahead of us. Our business growth is underpinned by the work taking place across our transformation pillars: focus, execution and team. In each pillar, we are seeing clear links between investments made and returns achieved. In focus and execution, we continue to invest behind innovations that help our sales organization convert leads in the field to wins on the board. We are often asked 2 questions: one, which parts of our product portfolio are driving growth; and two, which customer problems do our products solve? The answer to the question one is simple. We are seeing strong growth in product families that help customers transform into truly connected enterprises. This is a key area in which our independence, the breadth of our offer and the quality of our self-serve data and analytics tools differentiate us from our peers. In Q2 and indeed, over the first half, our iPaaS product bookings increased triple digits, delivering multimillion euro bookings growth. Our IoT Analytics family and our API management platform also grew in strong double digits. In business transformation, we saw strong growth as companies continue to invest in digitalization in response to COVID. Here, great product experiences like our new in-product customer onboarding process for ARIS SaaS helped us drive our process mining and process analysis offering to good double-digit growth. Our ARIS products were also recognized in Everest Group's assessment of the best process mining vendors where we ranked just behind leader, Celonis, but ahead of other players like Signavio. The answer to the second question is simple, too. Our mission-critical products help customers streamline and digitize their operations in the way that best suits them. For example, the continued stream of innovation in TrendMiner was a key driver behind a fantastic up-sell secured by the -- with the large French specialty chemicals business Arkema. Our ability to blend cloud and on-premise solutions was a major factor in Rolls-Royce's submarine division choosing our hybrid integration platform over Boomie. Our solution was something they couldn't find anywhere else. Our A&N 2050+ program also continues to help customers combine A&N's huge processing power with the benefits of total -- lower total cost of ownership via the cloud. During Q2, the state of Washington Development of Retirement Systems successfully migrated its A&N applications to Azure. This lighthouse project represents a significant and repeatable use case in modernizing A&N, showing customers that they can retain massive data computing power and run completely in the cloud. Notably, Washington DRS is the first of 7 clients signed up for this transition to go live. In IoT, Cumulocity won a great new logo with Pacific Hoist. In this use case, we will help Pacific Hoist, the Australian listing, digitize its safety processes and enable life condition monitoring for its equipment. We'll also deliver use-based servicing and provide realtime access to data. This will extend the life of the company's assets while making its operations more economical and safer. The impact of our innovations is best viewed through the lens of our customers and peers. Gartner's Peer Insights Portal, which carries reviews submitted by industry users, give Cumulocity an average rating of 4.6 out of 5 and 90% of reviewers recommended the platform. Our webMethods API Gateway and webMethods.io iPaaS platform both have an average score of 4.8, making all 3 among the top ranked platforms in their field. This transparent feedback mechanism is becoming increasingly important in Gartner's assessment methodology and also an important shop window for potential customers. This powerful feedback gives us confidence to keep bringing a continuous stream of innovation to market. For example, in Q2, Cumulocity introduced its thin-edge.io product, enabling connectivity for resource-constrained IoT devices and control boards used in electronics. TrendMiner also introduced data scientists in the loop, which enables subject matter experts and data scientists to collaborate on advanced analytics, including predictive quality and predictive maintenance. All this innovation, combined with excellent customer service, drove our product NPS to plus 57 at the end of Q2, in line with the record high we achieved in Q3 2020. We also continue to explore ways of attacking more of our total addressable market through our string of bold M&A strategy. We are assessing opportunities to add product innovation and go-to-market enhancements, which will help us augment our existing platform and drive accelerated future growth. Finally, in our team pillar, we have been working hard to strengthen and build resilience across our whole organization. Since the start of Helix, we welcomed amazing talent and new colleagues like our new CMO, Don Pelosi; and our new APJ leader, Nicolas Betbeder-Matibet have helped us seamlessly manage recent change in the business. Today, I'd like to share how our investment in existing talent is providing strong leadership succession, leadership which will be crucial as our transformation accelerates out of 2021. I am very happy to announce that Scott Little and Dr. Benno Quade will hold new roles in our organization as of August 1, joining me and my board colleagues to form an extended management team. Scott Little will become Chief Revenue Officer, and Benno Quade will become Chief Customer Success Officer. I'm also delighted to announce that Mike Haugen will succeed Scott in taking over as a sales leader for the Americas. These appointments will strengthen our customer focus and reflect the progress of Helix transformation. They will also increase collaboration, flatten hierarchy and make us even more agile in responding to customer and market needs. Scott served as a global head of sales since the beginning of the year and has shown true strength in executing our go-to-market strategy. Benno has been with Software AG for 10 years in various management roles, most recently as the Chief Operating Officer for go-to-market. As Chief Customer Success Officer, Benno will lead to customer success, renewals and professional services, 2 great leaders who will do great things. Our whole team's physical and mental well-being remains front of mind. And like many responsible global businesses, we have been augmenting COVID vaccination drives in countries we call home. We were able to offer vaccinations to colleagues in Germany, Austria and perhaps most crucially in India, where more than 600 employees have now received vaccines. We also launched our quarterly Wellness Wednesday program, a 1-day a quarter dedicated solely to encouraging balance in our people's working lives. It's proving very popular in addition to Meeting-Free Monday, which also remains in place worldwide. So overall, I believe the quarter and first half shows our strategy is working. We continue to deliver on our commitments and are confident as we enter into the second half. I'll now pass on to Scott to spend a few minutes looking more closely at our progress in sales in our H2 pipeline. Over to you, Scott.

[Scott Little]

Thanks, Sanjay, and hello, everyone. It's great to be here talking to you again after what is now around 6 months in my role. I've been totally focused on sharpening up our sales execution capability, and I'm pleased with the results we've delivered. When we spoke at our Capital Markets Day, I explained that Software AG has an amazing product offering that can change the game for our customers. And when we get into the room, we're executing better than ever. To translate our technology into sustained results, all we needed was to be invited to the dance a little more often. With another half year of hard work behind us, I'm happy to say our plan is working. The elements of our sales execution improves the point. Through the first half, our additional business bookings conversion rate tracked materially ahead of our 2020 average. In the quarter, we saw deal volumes grow in all deal bands for EUR 250,000 through to EUR 1 million plus, making us less reliant on single large transactions. This increased execution ability is why I'm so focused on raising our profile creating new opportunities for our salespeople to convert. Two great examples of the boost we've given our brand in recent months are our North American awareness campaign and Mittlestand campaign Sanjay mentioned earlier. In our North America campaign, we used customer intent data to target 500 key accounts early in our buying set. Restructured digital campaigns to match their online buying preferences and have seen great results. In the first few months, we have seen over 50% of our target accounts engaged with us multiple times. This shows our additional first approach, perfectly matches our customers' preferred engagement method. Our goal is to now make this move this top of funnel demand in a qualified pipeline for the quarters ahead. In Mittlestand, along with the 18 new deals in these first few months, we've also increased the number of opportunities in our pipeline from 70 in Q1 to over 200 in Q2. As an example of the quality of deal we're winning here, we had a great land and expand win with HeyJobs, the talent acquisition platform based in Berlin. Our efforts to expand this agreement after close has seen us in billable its contract value already as we work with the client to seamlessly integrate its talent sourcing platform with its customer HRIS systems using [ webMethods.io ]. Now beyond in North America, we've seen good progress in all our other geographies. Operations have performed in line with their plan and EMEA, in particular, delivered very strong growth. Next, I want to touch on the steady progress we're making with our partner Ecosystem. The relationships we're building give us an additional route to market which helps us access more of our dam. And in case of partnerships that do not involve [ co-solution ] it offers us an opportunity to lower the cost of sale and lower the cost of customer acquisition. From a demand generation standpoint, we continue to execute well. Our new deal registration capability allows partners to register opportunities in our CRM. This has provided more than EUR 45 million of net new pipeline in the first half. We expect plenty of this to translate into incremental [indiscernible]. During the first half, we also saw incremental digital bookings from partners make up 13% of our digital business pool, up from 7% [indiscernible]. These bookings come from partner deals who registered with us. They are often in accounts we do not sell into directly or with OEMs in better technology into their own solutions before selling that solution to their end customer. For example, in the quarter, we secured a great OEM win with North America via Adobe and added a total of 6 new partners through our OEM roster. In addition, our cloud partners, namely Microsoft and AWS, are also delivering marquee wins. As well as the Woolworths contract you've heard about, we secured 2 major wins from the growing AWS relationship. One of this was with another major technology player in the life sciences space. When you add this to the 3 medtech deals we've won in the last 3 quarters, we can see we're making significant impact with our scalable and repeatable offering in this market segment. With Microsoft supporting in our earlier deals and with this latest engagement with AWS, we can see the benefits of partnering with global cloud players for these worldwide deployments. Lastly, the increasing returns from our partner-led business are underpinned by the new partner [indiscernible] brand we launched at the start of the year. This now includes tiers, which are -- through which we reward our partners with higher incentives and return or higher skill levels and increased demand execution. In general, to date, more than 75% of our existing partners have migrated to the new program, and we expect to transition the majority across by the end of the year. As we look towards the second half, I'm confident that our pipeline, especially in digital, is in the right place to see us deliver on our full year objectives. Even though we're just a few weeks in, we've built a very good Q3 foundation. We're driving [indiscernible] towards the full year to 2023 and, of course, beyond. Matthias, over to you for the financial deep dive.

[Matthias Heiden, CFO & Member of Executive Board]

Thanks, Scott, and hello, everyone. Let's now take a closer look at the numbers. During the next few minutes, I will explain the key bookings dynamics from both the quarter and the half year. Deep dive on revenue and profit and touch briefly on a few other financial elements that help complete the picture of our performance so far in 2021. Turning first to bookings. Our overall bookings of EUR 126.6 million in the quarter represents a solid result. This 18% year-on-year growth means that for the first half, we delivered bookings of EUR 215.4 million or growth of 12%. Now digital business second quarter bookings were EUR 86.1 million, representing 8% growth. For the half year, our bookings were EUR 153.5 million, representing growth of 13%. Please also note that digital bookings growth, excluding the maintenance baseline from migrations, was 10% for the second quarter, another indicator of the double-digit underlying momentum in growth comes from new business. By deployment model, we continue to see the growing influence of our subscription shift on our digital business, in line with the annual development trajectory we shared at the Capital Markets Day. At the halfway stage in the year, subscription bookings represented 68% of our digital business booking and grew 25% year-on-year. Over the same period, SaaS bookings represented 21% of our digital business total and grew 22% year-on-year. In A&N, our bookings of EUR 40.6 million were underpinned by superb execution and more than 10 large bookings deals, both in Germany and in North America. Some of these were slips from Q1 and some were in plan for later in the year. Within Q2, we also saw strong uptake of subscription from our A&N customers with subscription bookings up 63% in the quarter. For the first half, this meant A&N bookings were EUR 61.9 million, up 8% year-over-year. In terms of bookings to revenue conversion rate, year-to-date, 45% of our digital bookings translated to product revenue, right in line with our full year planning assumption. In A&N, 74% of our first half bookings translated to product revenue. At this stage of the year, this is ahead of our 68% full year planning assumption that A&N saw a higher portion of longer-term subscription agreements in Q2 than we have seen in previous quarters. Please also note that our weighted average contract length for subscription at the end of the first half was in line with our full year expectation of 3 years. As evidenced by an important renewal with a very large U.S. sports and [indiscernible] brand, we're also seeing a large portion of 1-year contract renewing as multiple deals at the first renewal moment. This indicates we are delivering strong customer experience and good time to value with our technology, which is driving customer satisfaction and continued engagement. As we look towards the second half and full year bookings performance, we expect A&N to show a material year-on-year decline such that our full year outlook remains unchanged. This is because the large A&N deals that grow our [ Q2 ] performance are no longer in our second half [indiscernible]. Regarding our digital business, which is typically weighted towards the second half, the pipeline we have in place, combined with improving sales execution, does give me confidence we will deliver on our stated guidance range for the full year. Digital business product revenue in the second quarter was EUR 113.7 million, up 10% year-on-year. For the first half, digital product revenue of EUR 212.7 million represented growth of 5%. This performance shows our transformation is working. Our digital revenue stream is also increasingly based on subscription and SaaS, with subscription revenue growing 66% and SaaS revenue growing 45% in the first half. This means we have more high-quality, highly visible and highly predictable revenue to rely on each quarter. In the second half, we expect digital business revenue to continue to grow. In line with the development we shared at our CMD, we will have a higher share of recurring revenue won in prior periods coming through, and we will see conversion from a greater pool digital bookings given our second half weighted seasonality. A&N product revenue for the second quarter was EUR 67.2 million, giving us growth of 32% year-on-year. This gave us first half A&N product revenue of EUR 114.7 million or 9% growth year-over-year. As with A&N bookings, we expect A&N product revenue to soften materially during the remainder of 2021. These business line dynamics gave us total product revenue for the second quarter of EUR 180.9 million, which represented a very strong growth of 17%. Our product revenue for the first half was EUR 327.4 million or growth of 6%. Next, our professional services revenue in the second quarter was EUR 37.3 million and for the half year was EUR 73.9 million. When adjusted for the sale of our Spanish business sold in June last year, growth in our professional services business was a solid 7% in the quarter and 6% in the half. We also did well on profit in professional services, growing our segment results by 24% in the quarter and 67% in the half. Please note, the second quarter is the last in which our Spanish business will be [ prime ] in our prior year comparative base. The combination of product revenue and professional services revenue gave us total revenue for the second quarter of EUR [218.2] million, which represented a growth of 10% year-over-year. For the first half overall, this means total revenue was EUR 401.3 million or growth of 1%. Total ARR at the end of Q2 was EUR 539.4 million, which represents growth of 8% year-on-year. ARR within our digital business was EUR 380.3 million or growth of 9% year-over-year. The portion of our ARR from subscription continued to push ahead during the second quarter, showing 97% year-on-year growth. The portion from SaaS grew 48% and as expected from the transformation of our existing customer base to subscription, ARR from perpetual maintenance contract declined 15% year-over-year. Over on the right of the chart, we have our usual representation of recurring revenue, which during the second quarter grew to EUR 169.1 million, showing 19% growth year-on-year. For the half year, that gave us recurring revenue of EUR 298.8 million, representing 13% year-on-year growth and the contribution of 91% of our product revenue total. Specifically within our digital business, growth over the first half was 9%. While recurring total product revenue from subscription and SaaS grew 89% and 44%. This further validates our view that these contract types will be the key driver of the long-term growth in our recurring revenue stream. Now moving from our top line to our cost development. On costs, as stated for the second quarter were EUR 168.1 million, a decrease of EUR 4.6 million or 3% on the same period last year. For the first half, stated costs were EUR 335.9 million, down EUR 15.1 million or 4% year-on-year. At first sight, these stated declines may surprise given the level of investment we are making in [indiscernible] this year. However, when we account for prior year costs related to our Spanish professional services business, COVID-related reductions in spending on activities like in-person events and a meaningful lowering effect from FX, costs in the first half would have risen by roughly EUR 15 million. This represents around 50% of this year's expected additional costs related to Helix with investments so far in demand generation to help them cover more opportunities; customer experience to help us drive greater lifetime value; culture and capabilities that will help make other transformation sticky; and the company's IT and cybersecurity capabilities, enabling a modern, secure, hybrid working environment. As communicated at the start of the year, we expect to invest roughly the same amount over the remainder of 2021 while ensuring we align our cost base with the full year guidance we have provided by our non-IFRS EBITA margin. Ultimately, the combination of higher revenue and slightly lower-than-expected costs drove our operating margin for the second quarter to 28%, ahead of our expectations. For the half year, our margin was 21%. Looking towards the full year, the combination of lower second half revenues in A&N and continued investment in Helix will see our full year margin land within the stated guidance corridor of between 16% and 18%. As usual, I'll just spend a moment on our balance sheet before we move on to cash flow. I'll keep my remarks short, knowing further detail is available in the presentation you will find on line. Our approach to managing our financial footprint means Software AG remains a resilient business with sufficient flexibility in our balance sheet to finish in very broad range of potential up and downside scenarios. Our net cash increased to EUR 232.9 million giving us the cash we need to pursue our active M&A ambitions and to preserve even further optionality. At our recent AGM, we renewed the authorization we have to pursue share buybacks should we opt to do so. On cash flow, during Q2, our free cash flow was EUR 18.5 million and was EUR 58.2 million for the first half. This performance benefited from our focus on cash collection processes and payment term structuring. This gives me confidence in our ability to deliver strong cash flow in the future. But please remember, 2021 is our trough cash flow year in our Helix transformation. Our progress measures the trend we shared at our CMD this year. And our cash flow will begin a sustainable return to growth from 2022 onwards. And just one final part direction. The FX in the quarter provided a revenue headwind of EUR 6.4 million in the second quarter and EUR 15.2 million in the first half due to continued strength of the euro against the U.S. dollar. Based on our revenue mix, all other currencies affected the stated numbers only to a minor degree. That remark concludes my presentation. But before we head over to Q&A, I think it's just worth reiterating a few key points from today's session. First, we had a strong Q2 and first half overall. Our transformation continues to move forward [indiscernible]. Second, we have delivered revenue growth in our digital business. This is an important achievement that brings us back to the original motivation for Helix, profitable, sustainable growth. And last, we have today reiterated our guidance expectations for the full year 2021. We remain confident in our outlook, and we look forward to driving hard towards our goals in the rest of the year. Thank you for your attention. And now it's time for questions.

[Scott Little]

Thank you, Matthias, Sanjay and Scott. Ladies and gentlemen, you may now ask your questions. Haley, please repeat the instructions on how to proceed.

[Operator]

[Operator Instructions] And the first question comes from the line of Sven Merkt of Barclays.

[Sven Denis Merkt, Equity Research Analyst]

Great. I have 2, if I may. The first one is just on the cost side. Matthias, can you help us to reconcile the underlying cost growth you mentioned with the limited headcount growth? So where did you spend this EUR 15 million that you mentioned? And then secondly, could you also comment if there was any pull-forward or catch-up on the digital business side?

[Operator]

We can hear your question. We're just waiting for the speakers.

[Sven Denis Merkt, Equity Research Analyst]

Okay. Great.

[Robin Colman]

Sven, this Robin. Can you hear me?

[Sven Denis Merkt, Equity Research Analyst]

Yes. I can hear you, Robin.

[Robin Colman]

Okay. Just give it a second. It looks like they have a technical issue in their volume, so just bear with us for a moment. [Technical Difficulty]Okay. Can you hear us now operator?

[Operator]

Yes, we can hear you.

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

All right. Good. Well, sorry for that technical issue. We're here now answer the questions. So please go ahead with the Q&A.

[Operator]

Sven Merkt, please go ahead with your question.

[Sven Denis Merkt, Equity Research Analyst]

Great. Yes, I have 2, please. So the first one was, Matthias, it was just around the underlying cost development. And if you could help us to reconcile kind of the EUR 15 million underlying cost increase you spoke to with a limited headcount growth in the first half? And then the second question was just if there was any pull-forward or catch-up on the digital business side.

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

Great. Maybe -- so it's Sanjay. I'll just take the second one, which is about, Sven, about the pull-forward on the digital business. Well, I mean, we feel that in terms of Q2, our digital business was right in plan. So in terms of the bookings growth, it was very much aligned with what we had planned for the first half. So we didn't see any specific pull-forward, but a very strong performance across our first half. And if you look at the second half, as Scott mentioned, the pipeline is strong. And so we are confident about the 15% to 25% guidance we've given you. So I'll pass it on to Matthias to talk about the cost development.

[Matthias Heiden, CFO & Member of Executive Board]

Yes. Happy to, Sanjay. And again, as a reminder, you need to strip out the cost base for the professional services business in Spain, which is around EUR 18 million. Then you have somewhere between EUR 5 million and EUR 6 million onetime from last year travel in [ Q2] COVID, and the rest is at around EUR 6 million effect, if you do the number crunching and adjustments, you come to the EUR 15 million. That's the first half of the answer. The second half of the answer was you alluded to, so where did the money go? Given your observation around limited headcount development, at least that first slide, I will give 2 elements on this answer, number one. We are in line with our hiring plan and [indiscernible] is set up nicely for the second half of the year. There has been some attrition, for example, pandemic-related R&D in India, but we are tracking well, and it looks as if we are set up nicely again for the second half of the year. And then the second element of the answer is I will need to repoint you to the 3 buckets shared at CMD: go-to-market, 50%; 40%, R&D; 10%, people and culture. That still holds true in terms of where the money is going, and Sanjay gave you a good rundown as to the returns on investment in his part.

[Operator]

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

[Michael Briest]

A little bit of a follow-up on the headcount issue. I mean in North America, year-to-date, you're down 3% on headcount. And I can't believe that's sort of planned. And we know from many other companies that there's a bit of a war for talent going on. Can you talk about that? And then as we think about cost, this is the last year of Helix with a lot closer to the end of the year and start of 2022. I mean, Sanjay, can you confirm that you're confident that all the building blocks are in place to accelerate next year without any incremental costs around that?

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

Michael, it's Sanjay. Let me take the second one, and then I'll pass it on to Scott to make some comments about our North American sales team. So look, when we started the transformation, we told you in 2019, foundations put in place. So made changes in terms of the sales force, major changes in terms of type of profile. And obviously, the big changes we had to do in terms of the product, that investment was done in 2019. However, we came back in 2020 and said that we needed to continue that phase of investment and, in fact, we were putting some more money and bringing some investments forward. And I believe that those changes that we needed to make to now consistently demonstrate quarter-by-quarter, those are well in place. Of course, as for our midterm plan, we will continue to keep some investment into our product areas because competition is not sitting still. We need to compete effectively on the areas of business transformation, IoT, hybrid integration, API management. So that will continue. But no, I don't believe there are fundamental blocks that are now not addressed and have not been taken care of. So Scott, a bit about the U.S. population.

[Scott Little]

Yes. Michael, this is Scott. You bring up a very good point, and we'll just be straightforward. We have seen some attrition on the sell side in North America from competition. It's a double-edged sword. We're doing well, both in terms of performance and, in general, with the product. When you raise your visibility, it makes your people a little more vulnerable. With respect to new hiring, we're on track with new hiring, and we believe we've got the right pipeline of people to fit the attrition in the second half. And again, I reiterate my guidance and my confidence about H2. I think we will hit our numbers for H2, and we'll be able to manage through the attrition situation in North America.

[Operator]

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

[Alastair P. Nolan, Equity Analyst]

Just 2 quick ones for me. The first is for Matthias on just to get a better understanding on the split between 1 year and 3 year in the quarter. I know you mentioned you're seeing kind of a positive trend towards multiyear, but just wanted to see how that compared versus 2Q 2020 and that split because we do know there's a favorable revenue recognition on the multiyear deals. And then the second question just quickly would be on ARR. I know you gave a little bit of a feel for the kind of components there, but it does seem a little bit surprising that, that has slowed despite kind of positive momentum elsewhere. So just trying to get a better feel for what exactly is driving that essentially.

[Matthias Heiden, CFO & Member of Executive Board]

So Alastair, thanks for the questions. I will take both questions. I'll start with the second one on ARR. I Believe there is 3 elements to be mindful of. One is we're growing off a higher base to begin with. Number two, the new logos that we are acquiring, they come on average with a lower ACV. And thirdly, let's not forget that the subscription reset, the migration in motion is, and I will use Scott's wording there, double-edged sword, in the sense that it does impact ARR, but at the same time, it opens the opportunity for the customer lifetime value journey, of course. On the first question, this is one of my favorite questions also already from the last quarter. I will try to answer like this because I certainly respect the need to have a closer look, and I also fully understand the revenue recognition demand. Now overall, the point being that the bookings to transformation products -- sorry, the bookings to product revenue transformation ratios, I have covered in my scripted part. We are fully on track with the numbers stated at CMD, and we assume that this holds true for the full year as well. We are a little bit above on A&N and potentially also a little much above the number that we said at CMD at the end of the year. This will play out over the remainder of the year. Overall, in the contractual portfolio, we have around 1/3 of the subscription contracts that come with 1 year revenue recognition. That is as far as I will go. The other piece though is, let's stay mindful of one aspect, and that is why I have the specific customer example in my part for everyone. One thing is that the journey starts with either a 1-year contract or a contract that contains the termination work. But in my example, the 1-year contract, when it expired, was extended for 3 years. Yes, it is true that, that has a short-term revenue recognition impact. And you can also see Q2 to Q1 comparison that this was slightly in favor of the digital business. However, let's not forget one very important aspect of the Helix transformation journey, and that is the customer lifetime journey and the stickiness -- the proof point of the stickiness of the products that we sell. And I hope that if you connect the dots and take it all together, Alastair, that answers your first question.

[Operator]

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

[Knut Woller, Analyst]

Actually, 2 questions as well. The first one, can you provide an update which percentage of the installed base has now been migrated to subscriptions? And then secondly, you cited that the pipeline for DB is encouraging for the second half. Can you provide you some more color with regards to pipeline coverage and also whether there are some larger transactions here in the pipe that you expect to be basically turned into revenues in the second half?

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

Knut, the first one Matthias will take. And the second one, Scott will give you a feedback on the pipeline.

[Matthias Heiden, CFO & Member of Executive Board]

I will start. I'm sorry, I was just getting to the right number. Apologies, Knut. You might recall that I think actually it was Scott at CMD who talked about the 10% conversion that we have at that point and the runway we were still left with. So if we apply that to where we stand today, so far, we have migrated roughly 14%, 1-4, of our perpetual maintenance base our stopping base beginning of 2020, if that helps.

[Scott Little]

And I'll take the -- this is Scott. I'll take the pipeline and transaction questions here. Pipeline-wise, we're tracking approximately where we expect to be, which is roughly 3x, pipeline expectations for second half. And as always, we do have large transactions in every quarter that we would expect to close. But I would say no more, no less than we normally do. And you add that with really good execution in the first half, that's what gives me confidence that we're on track to deliver H2 in general. Knut, I hope that helps.

[Operator]

The next question is from Stacy Pollard of JPMorgan.

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

Just a little bit of follow-up on the digital, given that you sounded very confident and good acceleration of digital bookings in H2, can we also now assume a more stable digital revenue growth each quarter? Because you kind of mentioned that bookings are showing up in the revenues in a more consistent pattern, so maybe just some thoughts there. And second one, you mentioned active M&A ambition. Can you maybe talk a bit about that, what areas, size, timing, et cetera?

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

Stacy, it's Sanjay. Let me take the second one, M&A, and then Matthias will cover the first one. So Stacy, as we said also when I was mentioning in my piece that we are now really definitely looking consistently in terms of area in products and innovation where we can increase our TAM significantly. Of course, we're not in a rush. And we want to make sure that when we take the step, it is one that fits very well into the strategy, particularly in the areas of focus that we have established, but also it fits well into the gold market that would allow us to really leverage and accelerate and capture that additional TAM. So just simply hunting and process is going very well. They're in good shape. But also, we were not in a rush. We want to make the right choice and decision here. So Matthias, [indiscernible].

[Matthias Heiden, CFO & Member of Executive Board]

Yes. Happy to take the question on the digital business product type revenue. We have reached the milestone at the half year last in the positive territory. I think that goes hand-in-hand with our confidence as to the full year, the important milestone for the Helix transformation. However, if you do the math, and I just want to manage expectations accordingly, if you do the math across the second half of the year, and you know our overall product revenue guidance, which includes both [indiscernible] the digital business and A&N, we cannot exclude that along the way there might be fluctuations. Yet we are relatively confident around positive product revenue development in digital business going forward, which I believe we also commented on in the script part. If I may make a housekeeping remark for everybody. First of all, our sincere apologies for the technical glitch. There was nothing we could do on this end. And I'm quick to underline this was not due to Software AG technology, to avoid any misunderstanding. But what we would certainly like to offer because Q&A is always very important to us, we are happy to take two more participants on with questions. For those of you who can stay on, we really appreciate that. Again, apologies. We totally understand this is a very busy day for many of you.

[Operator]

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

[Gautam Pillai, Equity Analyst]

Just a follow-up on the digital bookings growth. It does imply a significant acceleration into the second half to come into the guidance window. Scott, you talked about some of the kind of the drivers there. Perhaps, can you also provide an update on the pipeline coverage you're seeing both in DBP and perhaps in the IoT business, if possible? And secondly, on the cost development, Matthias provide a lot of kind of interesting color there. Obviously, your gross margins are increasing both the Spanish Services divestment. So is there kind of an element of conservatism in kind of maintaining that margin guidance in the second half? If you can provide some color on that, that would be great.

[Matthias Heiden, CFO & Member of Executive Board]

Gautam, could you just repeat the last part of the second question? Did you ask about conservatism with regards to spending in the second half of the year?

[Gautam Pillai, Equity Analyst]

Conservatism on the margin guidance itself.

[Matthias Heiden, CFO & Member of Executive Board]

Yes, yes. I understand. So who do we...

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

So I'll take the first one just in terms of what is driving the digital bookings. Gautam, it's Sanjay. First of all, we are seeing great traction as I mentioned in [indiscernible] around our iPaaS, APM management, our IoT [indiscernible] but also significant uptake on to our process mining and our innovation that we've brought through. So these areas are really kind of driving the pull in terms of the digital booking. And we can see that -- and Scott will mention about the pipeline, but we can see that in strong opportunities, specific opportunities that we have along the second half list of customers. So that's what's driving the demand. But Scott, do you want to mention about the pipeline of it?

[Scott Little]

Yes. I'll just add, Gautam. Thank you. Well, I'll maybe comment about [5.3x] to the pipeline, that is specifically around digital business. We don't typically need the same kind of pipeline coverage in our [A&N] business. So 3x is where we're sitting for the second half of that digital business. In terms of reflection, it's pretty well balanced. I will say, surprisingly good surprising way we've seen a significant [indiscernible] in our ARIS and [indiscernible] pipeline, specifically around our SaaS deployment. It seems to be a hot topic right now. You can see that a little bit in the market with Celonis and [indiscernible] situation, and we're benefiting from that as well.

[Matthias Heiden, CFO & Member of Executive Board]

So that takes us to the second question on cost development or rather on the margin guidance perhaps. I think we have covered the digital business part sufficiently enough around what we expect for the second half. But with that said, let's remind ourselves of the A&N element. Because if you think back to the guidance, and we explained the mechanics what we have sold in Q2, I cannot sell in the second half of the year. That means that, that goes hand-in-hand with a drop in contribution from A&N, which also impacts the margin. Then I believe it was Michael who asked Sanjay about the building blocks, will they be in place until the end of the year so that we can accelerate in 2022. If I had answered the question, I would have obviously given that the CFO spin and would have come back to the EUR 15 million. That is exactly what we need to invest to have those building blocks in place. And the way I would like you to think about it in rough terms as to the distribution across the quarters is 6 and 9. Around 6 in the third quarter and around 9 -- sorry, yes, in the third quarter, it's around 9 in the fourth quarter. So if we sum that all up, yes, we are confident that we will make it into the guidance corridor, and we feel we have the levers under control to manage that. But I don't think necessarily that right now as of this day in July that we should be talking about conservatism with regard to the margin guidance. We can return to this question at the end of Q3, and then I'll be happy to give you an update.

[Gautam Pillai, Equity Analyst]

If I can squeeze in one more there. And I think a follow-up to the earlier question about digital revenue growth. You did comment that it's going to be a bit up and down on a quarterly basis. But in a 4 quarter rolling basis. Is it fair assume that you basically need [indiscernible] target in 2023? Is that still the assumption which we should work with?

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

Gautam, it was a very faint and broke up a little bit at the end. Could you just repeat that last portion of your question? The -- you said the digital business revenue fluctuation, and then we lost you from there.

[Gautam Pillai, Equity Analyst]

Just about the digital group. I think Matthias commented that it's going to be volatile [indiscernible] basis, which is understandable. Linked-quarter basis, is it fair to assume that you should be at high single-digit to low double-digit revenue growth pace in digital revenues to get to the EUR 1 billion target by 2023?

[Matthias Heiden, CFO & Member of Executive Board]

So with regards to -- and thank you for repeating it. With regards to this, I would point you back to what we shared at the CMD. All I meant to explain is that you shouldn't extrapolate H1 into H2 just like that. Because, of course, we are a little back-end loaded at the end of the day in DPD. But on this, you can just stick to what we shared at CMD with regard to '22 and '23 in terms of digital business CAGR. And I hope that, that was what you actually asked for.

[Robin Colman]

Ladies and gentlemen, we have time just for one more as Matthias said. So Haley, could you open up the line just for the final question, please.

[Operator]

And the final question is from the line of Martin Jungfleisch of Kepler Cheuvreux.

[Martin Jungfleisch, Junior Equity Research Analyst]

I have 2, if I may as well. The first one is on your 2023 ambition. You said that digital bookings growth, excluding the maintenance migration, was 10% in Q2. And I assume it's probably flattish when accounting for renewals. In order to meet the EUR 1 billion sales ambition, how much growth does actually need to come from new customers or upselling in your view? And can you potentially get close to that EUR 1 billion target by just migrating the existing base as you get that 40% or more uplift in revenues? And then the second question is on your cost base again. Given the rather flattish cost in development H1, would you still expect cost growth to peak this year as you pointed out at the CMD earlier this year? That is it.

[Matthias Heiden, CFO & Member of Executive Board]

So I will start with the second question. At the risk of becoming repetitive, cost development was not flattish. That is why I explained the EUR 15 million investment and how you get to the EUR 15 million if you strip out. So we did invest in the first half. I just said or explained how to think about the second half of the year where we will add another EUR 15 million. That gives you the EUR 30 million overall, which would be back in line with the EUR 30 million to EUR 40 million in terms of investment volume that we shared at the CMD going into the year. With that said, we stand by what we said that this should be the investment peak. That does not mean that we will not invest in the future. But what we did say and we also stand by that is that we will invest at a lower pace. We will become more efficient. And as product revenue will continue to grow, that will take us towards our 2023 ambition. Now give me a moment to return to your first question, which was, as far as I recall, related to new business and how much would be needed in terms of the contribution to get to 2023. On that, we don't strive for a certain portion of new business but want to increase the share on a midterm basis. So with that said, we need to ensure that in any case, the sales capacity, so Scott and his troops, are focused on this as well as the execution of the steadily increasing renewal base. So if you like, it is an interplay of the 2 elements that we will just need to balance out. Right now, the trajectory is promising on new business and new logo business. It is increasing. We see the returns from both Dutch Mittelstand and the North America campaign, and we closely monitor how we convert this into tangible business. And we also show how this works with regards to land and expand. And then obviously, what we land and expand or what we land, whichever way you look at it, then gives you the renewal foundation, the portion for the future. And that we will carefully balance out. We have updated you on the growing importance of renewals. But as the last comment, and again, also as a reminder, given the 3-year average duration '19, '22, 2023, the importance of renewals, including positive net retention target truly kicks in from 2022 onwards.

[Robin Colman]

Thank you, Matthias and thank you everybody, for your time today, and apologies as mentioned for the technical hiccup in the middle. And if there are any further questions, feel free to drop a note to the IR team. But with that, I wish you all a wonderful summer and holiday, and we'll speak to you in the early autumn. Thank you.

[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.