Software AG

XETRA:SOW

Earnings Call Transcript 2017-Q4

[Operator]

Ladies and gentlemen, thank you for standing by. I'm Mia, your Chorus Call operator. Welcome for joining the Software AG release Fourth Quarter and Full Year 2017 Conference Call. [Operator Instructions] I would now like to turn the conference over to Otmar Winzig, Head of Investor Relations. Please go ahead.

[Otmar F. Winzig]

Good morning. Thank you. Good morning, ladies and gentlemen, welcome to Software AG's analyst media and telephone conference and webcast on preliminary fourth quarter and full year results 2017. This morning as planned, we have published the full set of numbers with the presentations used in this call. Today's call will start with CEO, Karl-Heinz Streibich; followed by CFO, Arnd Zinnhardt; and Chief Customer Officer, Eric Duffaut. The presentations will be followed by a Q&A session. We will keep this call within the regular 1-hour time frame. Before we start, there are some housekeeping remarks as always. This telephone conference will also be broadcast via web. Access to the webcast is via our Investor Relations website. The webcast will be displayed as the presentation charts related to this call and the same slides are on our website for download. After the presentation, you may ask questions. Please use only the dial-in phone number for posing questions. The dial-in numbers are published via press release and also on our website. For technical reasons, we cannot take any questions via e-mail during the conference call. The audio webcast will be recorded and available for replay later today.With respect to capital market regulations, I have to make the following safe harbor statement: Presentation contains forward-looking statements based on beliefs of Software AG management. Such statements reflect current views of Software AG with respect to future events and results and are subject to risks and uncertainties. Actual results may vary materially from those projected here, due to factors including changes in general economic and business conditions, changes in currency exchange, 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 or assume any obligation to update these forward-looking statements.Thank you for your patience. Now, let us start. I hand over to Karl-Heinz Streibich, the CEO of Software AG.

[Karl-Heinz Streibich]

Thank you very much, Otmar. Hello and welcome from my side for our Q4 call and also Outlook 2018. This is what I will cover. I will briefly cover 2017. And then also give you strategic outlook on 2018. As you have seen, 2017 was probably the most successful year for Software AG. Among others, 2017 is the year with 2 fundamental breakthroughswe have achieved at Software AG. First, we became the undisputed global leader in the IoT technology and partnership space. As you know, when you recap, while we achieved that, we started already some 6 years ago to invest into real-time technology through the acquisition of Terracotta, additional acquisitions to extend our digital platform through further big data capabilities have been Apama for Streaming Analytics, Universal Messaging and Cumulocity IoT for industry device connectivity. Based on this early start, we gain technological leadership, which was the entry to get into the industry for [ terra ] market with mega use case of IoT. You may have read it last week, the Computerworld stated in a large article, Software AG IoT is far ahead of Microsoft and SAP also in creating an ecosystem in the market. This great rating for our IoT activities was not only inspired by our IoT flagship achievement ADAMOS, which will begin to generate revenue in 2018 and is a joint venture as you know with a leading German machinery companies but also by being the strategic IoT technology provider for global flagship high-tech companies such as Siemens, Bosch and telcos, as Deutsche Telekom, NTT in Japan, Telstra in Australia. And the second breakthrough that we have achieved is -- and must be seen in the context of our Adabas & Natural 2050+ program, which shows clear signs of significant improvements regarding the customer base. We see 2 key improvements here. This program helps to stabilize more and more Adabas & Natural install base, and we are generating additional modernization businesses with DBP portfolio at the Adabas & Natural customer base. So all-in-all, we are beginning to grow with the Adabas & Natural customer base again by increasing our footprint, our share of wallet through additional revenue on the DBP portfolio side. You know, doing more business with existing customers is the most efficient and profitable way to grow. As a result, our key KPIs and significant expansion of new customer base or the industrial markets, all point into one direction. The biggest success is still to come. In order to generate confidence on your side, I want to mention what I consider the 3 main drivers of our success 2017 and even more in the years to come. First, our continuous effort for operational excellence is much more than just efficiency improvements and cost reductions. We are convinced that the best companies are best in everything they do. And this is what is driving us. And the second driver for success, our technological leadership is based on early predictions, what the relevant technological development might be. Our book project 5 years ago, the Digital Enterprise was more or less the intellectual platform to show the direction. And the first digital business platform in the market was already the first key deliverable. The third main driver, our one team go-to-market focus since 3 years. It is and was always our conviction that go-to-market excellence is as important as technological excellence for software company. And we see success throughout the world, sure. We are spearheading industry for the [ terra IT ] through the partnerships, we build in the machinery market in Germany, but you will soon see the spillover also to other markets in the U.S., Asia Pacific but also France and Italy and Europe. The fact that our share price is an 18-years high is the result of our achievements and the further potential we have throughout the consequent positioning we have sustained throughout the years. We help our customers to win in the digital world, not more, not less. Customers appreciate our authentic passion for their success. We are their trusted advisors for their digital transformation. We are partners in the fast way to value creations through our more than 2,000 consultants [ CCS ]. And we are their co-innovation partner forward. They know, that digital transformation is a journey always taking a bit longer than expected. It is not a project and they choose Software AG more and more as a trusted partner for this journey. So looking forward to 2018, we see the following. First, a strong outermost IoT partner ecosystem where revenue will begin to take off as planned in 2018, as well as a growing pay-per-use revenue stream with the other strategic industry partners, telco IoT customers. And second, the integration market being more relevant than ever through increased cloud architecture complexities. And third, the bundling of Aris and Alfabet to provide a platform for 360 degree Digital Twin for the enterprise will create significant growth in that segment since every company has to create a Digital Twin to arrive in the digital world. And fourth, our Adabas & Natural 2050 program reaches more and more of our installed base customers in the hearts and minds. The modernization aspect is evident. The value is proven. Our customers follow our advice. And fifth, the continuous improvement of our go-to-market efficiency and capability under the leadership like before will in itself be a further growth enabler in 2018 compared to 2017 and we have installed a Scientific Advisory Board to prepare the next big thing in the areas you already heard of. They are Artificial Intelligence, where we started through an acquisition, Zementis. It provides deep learning algorithms through data-centric usage models or blockchain to provide trusted processes beyond the enterprise boundaries for our customers. This topic, ladies and gentlemen, will create new use case and growth market for us and most important for all of you. All these use cases are and will use our Digital Business Platform as the foundation. By the way, adding the investments we have made into that foundation also keeps us ahead even of the largest IT company. It sums up to around 1 billion during the last 10 years plus all the R&D investments year-by-year. We are ahead of the competition because we started early through operational excellence, through the innovation spirit, and through the passionate focus on customer value creation. We will create another year of success for Software AG in 2018. We are prepared for it better than anyone else in our market segment. You remember, the winner takes it all in the platform market and we Software AG have the pull position to be the winner in the digital IoT world, in the world where IOT technology and solutions is driving growth. Therefore, we will go for another year of growth driven through further stabilization of the Adabas & Natural customer base plus up to 50% to 100% growth potential we see in the IoT cloud space. By the way, our guidance is 70% to 100% growth potential as you have read. And all that is largely complementary to our classic DBP business. And I think, that makes us really unique. Our CFO, Arnd Zinnhardt will be the next speaker. He will also go into more details of the 2018 outlook figure we expect. Thank you very much from my side and looking forward to the Q&A session.

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

Thank you, Karl-Heinz, and good morning, ladies and gentlemen. A warm welcome also from my side.I would like to continue making some strategic opening remarks, on aspect Eric will also cover from his perspective. Let's start with the traditional business. Adabas & Natural developed as expected. Like in previous periods, we enjoyed a high customer loyalty and therefore generated profitable revenue in the expected magnitude. Our Digital Business line delivered license and maintenance on record levels. In addition, we show dynamic growth with our cloud product with an even growing momentum. In October, we informed you about setting up a third business line. When talking about the outlook, I will spend some more time on the growth numbers in detail. In 2017, we made significant progress with our IoT business resulting in major strategic agreement bringing Software AG into a market-leading position. During our Q3 call, we informed you about ADAMOS becoming the leading IoT platform for manufacturing and plant engineering companies. In addition to this innovative partnership, we signed numerous other transactions. Among those agreements is the strategic partnership with Siemens MindSphere.We also closed additional deals with [ further ] telco companies with a consequence that up to now 15 to 20 well-known telecom companies use our technology in their IoT platforms. For the IoT market segment, we introduced a new license model which is truly usage-based. It enables our customers to start their IoT journey with extremely low cost of entry. This pricing metrics result in true partnerships between Software AG and its customers as risks and upside potential are shared. The new license metrics for IoT added to the existing perpetual and cloud-based models which are well established. Consequently, the customer has a luxury of having full choice of pick and choose a metric that fits best their business requirements. So altogether, great progress has been made in the pricing model, in our back office operations as well as at the customer side. Without any doubt, we are on something big and something which is changing the way most companies do business and interact with their customers from now on. This is significant for Software AG and I believe, we are just about adding a new big wave to our company history. Now, it's all about gaining market share and growing the business. If we play it right and execute well, this is going to be significant.After the opening remarks, I would like to guide you through the numbers. Last quarter, we saw a strong negative FX impact on all revenue lines. This headwind comes as expected and communicated predominantly from the U.S. dollar, which is more than 9% weaker compared to last year and contributed a headwind of almost EUR 9 million. Regarding full year, the entire impact results out of the U.S. dollar weakness. In case, U.S. dollar would stay on a level of $1.22 and actually I just had a look through the charts and to the actual market, which is $1.24, so even worst. We anticipate again a strong effect on Q1 revenue. This headwind could be in the magnitude of more than 10% just for the U.S. dollar and around 5% for the entire revenue.As already mentioned in my introduction, we had a strong year-end [indiscernible] and close the year on a growth we had anticipated. Let me underline this with the following observation. We achieved the highest Q4 license revenue ever, the highest maintenance revenue ever Q4 and total year resulting in the highest Q4 and total year digital product revenue ever. Strong double-digit growth in cloud order entry for the year and even more than 100% for the quarter. And also extremely strategic significant progress on the IoT market with additional partners such as Siemens and more telcos, for example, one in China moving their IoT platforms on to our products specs. Eric will go into more details.Let's have a look to the cost lines. All expenses well under control. Nevertheless, we continuously wisely invest into R&D to secure and enhance our market-leading position. This can be easily derived from the following KPI. Number of R&D FTEs, so full-time equivalents increased by almost 20% in the last 2 years. Let me mention one minor detail for your excel spreadsheet and completeness purposes. We reallocated some expenses amounting to EUR 2.5 million from sales and marketing to cost of sales. So if you look to the numbers, take the net effect. Because of the top line growth and despite the increased investments into R&D, we delivered a growing segment result. Q4 as well as total fiscal year. Regarding Adabas & Natural license, we continued a strong Q3 performance and recorded a double-digit license growth. This is not unexpected result as already mentioned in our last call. You all experienced in the past, Adabas & Natural has a high degree of predictability as we sell into our existing longstanding customer base. For fiscal year 2017, we close the books on the product number that is in line with our communication before. Maintenance show the expected development for the full year eliminating cash accounting effects that I talked about in previous calls that has an impact on the 2016 numbers. We show even a more stable maintenance development of only minus 1% to minus 2%. Segment results improved further resulting in margins for the quarter and for the entire year on 70% plus. The focus in our consulting business continues to remain on supporting our strategic license project and simultaneously closely monitoring profitability. As a matter of fact, this strategic setup combined with the excellent consulting management team continuously performs with outstanding results. Revenue is a bit up against last year and we delivered double-digit segment margin for the full year of 2017. As discussed on the last 3 slides, our business progressed and developed nicely. Both product business lines, Digital, and Adabas & Natural generated the revenue as expected and guidance to the financial market. We continued building a strong foundation for our new IoT business line, which will grow dynamically. Regardless, the IoT and cloud achievements, our digital business line set a new record level. Despite our incremental investments into R&D, we generated a strong EBIT performance. Q4 EBIT grew by 10% and we've enjoyed a margin expansion of 230 basis points. I do not remember a higher quarterly EBIT in the company's history. This positive trend is of course also true for the entire year.Let's turn to the operating margin. Our prime earnings KPI for the year 2017. In the quarter, we even topped the very successful Q4, 2016 and shifted the margin to a new level of 36.7%. As a consequence, we close the entire year at 31.8%, higher than expected at the beginning of the year and also at the higher end of our increased guidance. Ladies and gentlemen, this is the highest margin we ever achieved. Let me highlight one effect that also will positively impact the upcoming year. The increase in share-based payments, you see on the chart is linked to the positive share price performance in recent months. As the options of our stock initiative plan 2016 came in the money, we recognized all 2018 related expenses already in 2017. Consequently, we will see the corresponding relief of a couple of millions in the 2018 IFRS EBIT. Let me continue with 2 general remarks on free cash flow. The free cash flow for Q4 is strong, as you are meanwhile used to. Year-to-date cash flow is impacted by the acquisition of property and land that I mentioned 9 months ago, in the magnitude of [ EUR 70 million ] and higher tax payments. Balance sheet is as solid as you're used to. Therefore, I only want to make 4 remarks. Net cash position amounts to roughly plus EUR 55 million despite the fact that we spent approximately EUR 200 million for purchasing the office building in Darmstadt, a company we acquired end of March, so Cumulocity, as well as dividends and share buybacks. Receivables are substantially reduced compared to 12 months ago, resulting in an improved DSO rate of 103 days. Deferred income is predominantly impacted by the U.S. dollar-euro conversion rate. And finally, shareholders' equity remain on a high level in the range of 60% despite the dividends and share buybacks as mentioned before.Let's now come to the most interesting part, the outlook for 2018.Moving forward, we will give you guidance on 3 revenue lines of business. The digital business line will be divided up into A, digital business excluding cloud and IoT and cloud and IoT. Let me define cloud and IoT to provide you with a full transparency. Cloud and IoT include in general, the following revenues; number one, transactions that include Cumulocity, so IoT connectivity and or Zementis, Artificial Intelligence; secondly, use cases that are meant to connect physical devices; thirdly, upselling on those 2 types of transactions; and number four, SaaS-based contracts.All residual contracts are reported in the line, Digital Business Platform excluding cloud and IoT. Please note that many of the products might and will be used in those business lines. And despite the fact that we set up a sales competency center for IoT, many cost will be shared between the 2 lines of business. We will utilize economies of scale between both businesses accordingly. Consequently, most of the respective costs can only be allocated based on generic rules. Therefore, we decided not to calculate any theoretical segment result on cloud and IoT, but focus on what is really of strategic relevance, which is revenue growth.Having said that, let's talk numbers. DBP excluding cloud and IoT is expected to grow between 3% and 7%. In 2017, we saw the revenue growth of 5% which is just the midpoint of this range. Due to IFRS regulations, major parts of our market success in cloud and IoT which is now the new business line were not booked as a revenue in 2017. Consequently, this comparison is almost like-for-like.Setting up the third business line will disclose the fastest growing segment to the public. Based on Gartner and McKenzie, the IoT market is expected to grow by approximately 30%. We will outperform the market and grow the business by 70% to 100%. Compared to the figure given in October, which was already north of market growth, growth of [ EUR 70 million to EUR 100 million -- percent ], leading to EUR25 million to EUR30 million, financial revenue is a substantial outperformance. Given the contract signed, the recurring revenue assigned to those deals and given the strong pipeline, we are very confident to achieve the guided range. Ladies and gentlemen, this line of business is all about growth and getting market share. We will continuously report on the progress made and on the next strategic steps. Adabas & Natural will continue to be a solid part of our business. We do not foresee any material change compared to what we have experienced in 2017.We are currently experiencing interesting times. At the very beginning of my speech, I talked about adding a new revenue wave. Typically, this goes together with material investments into R&D and sales. And yes, we will invest into R&D and sales and marketing. However, we have the beauty of being able to use synergies between the 2 business lines. Also, we are present in many IoT platforms globally and even will extend our presence moving forward. Consequently, we have started to set up an OEM sales model, which is adjacent to our classic go-to-market approach. This OEM model will generate nice revenues, as well as nice profit contributions. Therefore, we are facing effects that are netting of each other. All-in-all, we expect the group operating margin to stay like in 2017 in a high-level corridor of 30% to 32% as I just have outlined to you. The wider corridor is reflecting the lower visibility on the revenue mix going forward. Let me explain that. This is due to especially that we do not know the customer preferences in respect to deployment and licensing models i.e. [ thus ] private cloud usage-based and perpetual licenses on-premise et cetera. This is relevant as these models are treated differently under the new IFRS 15 rules. So second, the lower end is rather driven by IFRS and deployment models than by operational performance. In combination and in top of our business expansion, our shareholders will benefit from reduced tax burden on our strong U.S. business which generates good part of our global revenue and even better part of our profit. Due to these factors, business development on one hand side and lower recurring, let me stress that recurring group tax rate, we expect operating EPS, non-IFRS to grow by 5% to 15% year-on-year. Also, this element should give you comfort on the profitability side and we will not neglect this key KPI, that is promised. Eric, over to you.

[Eric Duffaut]

Thank you very much, Arnd. Good morning. Ladies and gentlemen, I would like also, of course, to welcome you to today's call and thank you for your continued interest in Software AG.In short, and as you have heard it before, Q4 was certainly a sensational quarter in all business areas, accelerating the momentum we have been building for the last 3 years, by strengthening our portfolio and reshaping our go-to-market. We meet our 2017 product revenue growth targets while further accelerating our cloud and IoT portfolio market adoption. And in the Internet of Things, as you know and heard, we have now established Software AG as a strong market force rapidly becoming the platform of choice for the manufacturing industry and IoT platform and services provider.Ladies and gentlemen, we have changed and we continue to change the game, and this is how. As said 2 years ago that the fourth quarter of 2015 was the best ever single quarter in the history of the company for Digital Business Platform. I corrected that last year when the fourth quarter of 2016 was the best ever. Well, I need to correct that again. The fourth quarter of 2017 was yes simply the best ever, single quarter in terms of license and product revenue in the history of the company for Digital Business Platform.We have bettered our best yet again. And we have bettered our best despite our marketwide transformation to cloud and subscription-based licensing, which as you know is deferred growth from one perspective. In the fourth quarter, DBP license and maintenance as you heard it from Arnd were both up nearly 6% at constant currency. Cloud order entry was up by 110% and combining both license and cloud order entry, we show growth of 8% in terms of adoption of our digital portfolio compared to Q4 2016, our previous best-ever quarter. And this is nothing less than a really strong performance. In addition, as I told you, Adabas & Natural had a phenomenal license growth of 37% in the quarter and product revenue up 14%, yes as expected for this relatively predictable line of business. And as Karl-Heinz mentioned, this is yes, clearly the result of the strong customer loyalty we have driven by our industry-first commitment to support and innovate, our Adabas & Natural portfolio beyond 2050. And on top, an increasing profitable growth contribution from our Global Consulting Services business, thanks to our continuous move to high-value digital project and services to support our customers in their strategic digital journeys with Software AG.The IoT, ladies and gentlemen, is also demanding increasing skills and know-how. And we have much in-depth knowledge through projects with Octo, Bosch, Siemens, DMG MORI and Dürr AG to name of few. Looking at the total year, the momentum generated by this powerhouse Q4 has resulted in Software AG hitting its product revenue guidance for 2017. We have also returned an all-time high maintenance revenue, higher productivity, higher profitability and higher customer commitment and [ loyalty ]. Our cloud order entry was up by 75% and the cloud revenue up by 50% for the total year. Behind these numbers, and the huge impact, of course, we are making in the Internet of Things. Arnd also mentioned -- like my colleagues did the groundbreaking project with major enterprises already, and our market penetration continues to increase, market penetration with major global enterprises in 2017.These are 29 enterprises deciding to base their IoT infrastructure on Software AG's Cumulocity IoT platform. This is a huge testimonial to our technology and market approach and [indiscernible]. We are onto something big, really big. And this is, of course, giving us increased momentum to further accelerate as we enter 2018 and as we transform every aspect of how we conduct business of how we focus on maximizing customer value from core innovation to joint ventures such as ADAMOS, we are transforming every facet of how we build our customer relations, how we drive the success and ultimately how we deliver, ever-increasing profitable growth and record share price.Ladies and gentlemen, customer centricity from my point of view knows no bounds. To be truly strategic partner to our customers, we have to support them in all areas of their business conduct our business in synchronization with theirs in other words. We have an incredible track report in providing the technology, the development, the support services, that enable our customers to transform themselves into digital enterprises. This is why we say, our customer success is clearly the key measure of our own success. There is no truer statement.And now, in January 2018, we are ready to announce to our customer base, the largest, overall of Software AG's pricing and licensing model ever. We have bundled over 300 of our products into a more manageable set of simpler packages. We are introducing totally new subscription and consumption licensing models, liberating the customer to an unprecedent degree. Models designed for applications built to last have been augmented by licensing models design for application built to change. Licensing build for perpetuity has been augmented by licensing for a rapidly transforming world. We are not only offering full choice in terms of deployment models on-premise in the cloud or hybrid. But now, we add flexibility and choice in the way our customers want to buy. Perpetual license or subscription base for our Digital Business Platform and consumption base for Cumulocity IoT. This is now for our customer, the way they want to deploy and the way they want to buy regardless again of the deployment model full choice. We are getting simpler and smarter for 1 goal, further accelerating scale. And this is just the latest development in Software AG's own transformation in our journey from good to great. We have by the way, constantly encouraged every one of you to look at the bigger picture, at the longer timeframes, and it gives a more dynamic picture and highlights real business trends. It is clear that our -- the new go-to-market approach that I announced in January [ 2015 ] is truly paying off. Looking at our total business development since 2014, the impact of our 3 years go-to-market transformation will look like this. Solution-based, business value driven selling has increased our average deal size by 23% with our deals over EUR 1 million up by 56%.Our partner contribution in terms of influencing the market is up over 100% and our DBP or Digital Business Platform revenue generating sales task productivity is up by nearly 50%. This are ladies and gentlemen, massive improvement that we expect to continue. This transformation to providing higher customer value in more strategy game-changing projects is also reflected our customer satisfaction rating from a product vendor with a net promoter score of minus [ 24% ] in 2014. We have now reached a plus [ 19% ] in net promoter score in 2017 by becoming a partner of choice. Our move to the cloud as you heard is accelerating with order entry up by 223% since 2014. Our cloud revenue growth is even greater with 353% over 3 years and of course efficiency to further drive profits. Transformation from a product company to a strategic business partner, transformation from perpetual licenses to a license model synchronized with customer business requirement, transformation to the IoT platform of choice, transformation through a streamlined and efficient sales machine building the global expertise needed to support enterprises in their own digital transformation, no matter what direction that might be in. And all of that, all of that while steadily increasing our profit margin. That is game-changing, ladies and gentlemen. Game-changing transformation for any company and we have successfully managed it.And what about 2018. You would say. Well, the transformation continues. We have the portfolio more relevant to all major IT and business trend than ever. A growing reputation as the platform of choice for digital transformation and we are accelerating our IoT market penetration and preparing for the next phase. I'm pleased to inform you that in 2018, we are rolling out a global field force of specialized sales and solution engineers dedicated to IoT and we will take market share. Our commitment to customer success continues to pay dividends literally and this will only increase as we transform ourselves into the best example of an enabler of digital enterprises that you will find anywhere. In 2018, ladies and gentlemen, we are committed to go simpler, smarter, stronger. Thank you for your attention.

[Otmar F. Winzig]

Thank you, Eric, Arnd and Karl-Heinz for your comments. Ladies and gentlemen, this is now the time to ask questions and the operator please repeat the procedure for that.

[Operator]

Ladies and gentlemen, at this time we will begin the question-and-answer session. [Operator Instructions]And the first question is from the line of Stacy Pollard with JP Morgan.

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

Can you say how much of your IoT is cloud and then you mentioned a license model as well? Can you maybe explain what the breakdown of the [ EUR 50 million ] was in 2017?How you think about it going forward? And really, what I'm getting at here is, how much of that is recurring and how should we think about that? And then the second quick question is there was some press yesterday evening about Karl-Heinz potentially retiring. Is there any truth to that and any thoughts on next CEO?

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

Then I go with the first question on the [ EUR 50 million ]. Good morning, Stacy. So both of the [ EUR 50 million ] is cloud. Cloud is out of that approximately around EUR 10 million to EUR 11 million. The residual part is basically maintenance with very small portion of perpetual revenue. So I would say, more than 80% is recurring. Usage space, Stacy, is nothing in 2017 as all the contract that I mentioned in my presentation. So ADAMOS, Siemens and others have not generated any revenue in 2017 despite the fact that the contracts are already signed in 2017 with a consequence that this is incremental revenue in '18 which has basically started on January 1.

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

So when you talk about EUR 20 million to EUR 30 million into 2018 obviously, your range is now EUR 25 million to EUR 30 million. Is this the baseline or you at one point mentioned there was upside based on usage, I think, [ potentially ].

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

I mentioned in the Q3 call EUR 20 million. So now if you calculate the [ EUR 70 million to EUR 100 million ] that is EUR 25 million to EUR 30 million. So most of that part is a recurring business. But given the fact that we cannot foresee at the current point of time what is the deployment model people will choose in Q4 for instance, so Q4 2018. This is an additional complexity and that is basically also driving these the margin range from 30% to 32%. Without this additional complexity, the margin would have been narrower in the range that you have experienced this year.

[Karl-Heinz Streibich]

Stacy, this Karl-Heinz speaking. You asked regarding the retiring. It is known since long time that my contract will expire at the end of July this year. And the Supervisory Board has established quite a while ago a process for succession and the expectation is that this will be the results of that process will be announced soon, Stacy. So it's not a surprise for anyone. It is planned and long time ago. The date was established through the 5-year contract I had and I mean at the moment. Is that okay as an answer, Stacy?

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

Does that mean you have some easier days ahead, starting in July? Or you're not confirming it away?

[Karl-Heinz Streibich]

I'm the CEO till the end of July and everyone who knows me is -- I will serve this company till the last second of my contract.

[Operator]

So the next question is from the line of Gautam Pillai with Goldman Sachs.

[Gautam Pillai, Research Analyst]

Can you plus please help reconcile the IoT and the core DBP business guidance? Historically, you've guided the DBP segment at around 5% to 10% product growth and at that time, IoT was a very small part of your revenues. And now, given a lot of the IoT businesses now incremental, does it mean that your outlook for the core DBP pipeline has become a bit soft. So that's my first question. And secondly on ADAMOS at the time of announcement you were anticipating to sign more partners to expand the ecosystem. Can you please provide an update on how this is progressing? And lastly as a housekeeping, can you give an indication of the inorganic contribution from Zementis and Cumulocity in 2017.

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

So I start with the second one, Guatam. Zementis and Cumulocity for the year is low, very, very low-single digit in million from a revenue perspective. From a margin or profit perspective, nothing. So this is not influencing any number in any material aspect. So digital revenue line -- but having said that, just 1 additional remark. You know that 1 of the strategic initiatives on the M&A side is buying excellent market-leading technology and that this is the rationale for making the acquisition in Cumulocity and Zementis. And given the fact and that leads to your first question also, given the fact that we are about setting up a third business line with the main contributors being those 2 products to see how relevant that is moving forward and how important it is and how successful we are in integrating acquired companies. Then coming to your first question, which was around the digital guidance. I said that we are projecting a 3% to 7% on the digital side. And if you look to the historic numbers, we delivered pretty much just in the middle of that guided range. And then I said IoT cloud plus 70% to 100% and given the fact that refers to the question that Stacy has also asked. This is supported by the recurring business that we have seen in '17 which will continue also in '18. So we have already a platform that we build upon plus the contracts such as Siemens and ADAMOS which is also a platform that is already in the bank.

[Karl-Heinz Streibich]

And this is Karl-Heinz speaking. Based on what Arnd said. I will lead over to ADAMOS. Key is that those decisions to -- for an IoT platform and to base the digitization transformation on the IoT platform is always a strategic decision in those companies. All the CEO and the board is involved in making that decision. And as you know, we have a very positive response in the press and also mentioned from other machinery company, so we have a number of companies where we have discussion, we have a pipeline. We have a long list, a long pipeline of companies where we have discussion. I would say, this is probably a major activity we have at the moment in the ADAMOS team in speaking with those partners and informing them on the technical side, on the contractual side, but doesn't mean a partnership. And this context, also advising them what a digital transformation is for them. And therefore, the answer is point one, yes, sure we expect further partners in ADAMOS as we go forward. Second, it is a highly attractive concept from the machinery companies for the machinery companies. It gives them the possibility that they are digitizing with partners and they are not on their own. And they also learn from the others from their experience from partners who are in different regions, in different segments but who are also in that machinery market. So all-in-all, yes. We expect one by one now in the coming weeks and months to extend the ADAMOS team.

[Operator]

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

[Knut Woller, Analyst]

Actually a couple of questions and firstly around IoT. When we started the whole journey, I think it was for you guys probably more a push exercise that you had to convince and evangelize your customers. Are you seeing now increasingly against the back names that won for IoT that this is more going into a pull effect, that you get more and more potential interest getting in your camp? Then on the margin side of IoT, if I just understand things correctly, we should be broadly for this year in a similar margin range as for your [ DBP ex ] IoT business. Is that broadly correct? And then looking a bit further down the road, given that you mentioned an OEM approach and stuff like that. And when we should compare both profitabilities of DBP excluding IoT and cloud and the new business line? Which one has the higher margin potential over a medium term, out of your perspective? And then, just briefly on A&N. We have seen a pretty back-end loaded year, in '17. Is it fair to model a more front-end loaded year for -- for this year?

[Karl-Heinz Streibich]

Okay. I start with. Knut, hello. This is Karl-Heinz speaking. I start with your first question IoT evangelization. Is it now beginning to take off and so on. You are 100% right. Being one of the first ones who are offering a digital platform and then the real-time IoT segment means that you are -- that you must live through the flat phase of such a curve which is not linear but which is exponential if you all know in the platform business. So the interest, the talks we have I would say, it's a sector [ 3 to 5 ] more talks we have with board member, with companies on the IoT subject. We think we believe in the next 1.5 years probably 60% to 70% of the relevant companies will make decisions with which platform they go. In the meanwhile, they all start with proof of concepts, with first trials. We just had 3 days ago, a very good talk with a auto machinery company about [ EUR 3 billion ] in size and they said, look, we start [indiscernible] really very interesting. They said, look we started about 2 years ago with first trials on IoT and the reason was why we started ourselves because we have been so far away from IT and even using IT in our core business. That we had to start ourselves. But now we realize that we can't do it ourselves, that we need a partnership. And this combination we offer with -- in the outermost context that is the partnership of machinery companies to independent platform for the machinery company and with Software AG as an advisor, as a partner, as a technology partner who is a leader on the technology side is a perfect mix. And this is a response we get in all the talks we have. And Eric, do you want to add some...

[Eric Duffaut]

Knut, good morning. Thanks for the question. I think to complement what Karl-Heinz said. You talk about a push model and I assume that -- what you have in mind also is the -- is the opposite being are we starting to enjoy the pull model effect from the first successes we have. I would say, Knut, that in '18 my expectation is moving from the pure push model to push and pull model. We will for sure continue to push. We want to take market share and we will go aggressively after our new customers, 29 as I mentioned in '17 and we expect many, many more in '18, but we will start to benefit clearly from the pull effect as well, both in terms of the realization of our partnerships that we have in particular I mentioned Siemens as we had a meeting recently where we know that they will migrate to their new platform, which include Cumulocity IoT as you know, and they will migrate fast and they're already connecting hundreds of thousands, to not say million of object or devices. So we will see the benefit of that acceleration. As well as clearly more and more market interest as Karl-Heinz said. I would like also to point out that many large partners are approaching us to discuss how they can further accelerate also their IoT play with Software AG and Cumulocity IoT. So I think, we will move progressively from a pure push model or market maker to an aggressively market share taker, still push as well as enjoying the pull.To comment on your A&N question, Arnd will maybe build on that as well and certainly take the question around the profitability that you have, Knut. As I mentioned, many times, a quarter for A&N is never a trend. Our business is now more and more let's say driven by 2 elements. The first one being the ELA renewals, which by definition are spread around the year and the year of 2018 will certainly not look exactly like the year of 2017 as these renewals come after 3, 4, 5 years, and they are not linear of course compared to a year before. So yes, to this extent, I would say, we knew that '17 will be a very back-end loaded and we can expect that for the year, renewal it will be certainly a bit less even if Q4 will remain certainly the biggest quarter. And it is also driven by this modernization project that we have mentioned, which by definition are more classically spread around the quarter. So yes, you can expect, I would say less back-end loaded but still, of course, don't forget that Q4 will remain and always remain our biggest quarter for total year. Arnd, back to you.

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

Good morning, Knut. So I take the first margin question which was short-term margin, IoT. Correct, very precise, Knut. In the magnitude of the DBP margin. Moving forward and that was the OEM part of your margin question. Yes, the margin potential is significantly higher. We benefit from the sales which is done on sales and marketing efforts, which is done by our partners, which then try to move more and more customers on to their platforms and as this licensing agreement and the prediction of the customers that has a very -- [ or has ] already been done. That, of course, has a huge margin potential upwards. So moving forward, I truly believe that the IoT business line will be and has the potential of being more profitable than the digital business line, on a classic version.

[Operator]

Next question is from the line of Michael Briest with UBS

[Michael Briest]

Just on to clarification, I mean your definition of what would go into the IoT [ sat line ] that suggest the upsell may be possible. And I'm trying to think back to 2016 when you announced the Bosch and Octo as customers. [ I think ] Bosch came with Apama, but it was referenced as a large IoT license deal. Can you -- would you expect in 2018, there will be more such deals where licenses could be a meaningful part of this EUR 25 million to EUR 30 million? And then secondly, just in terms of currency, appreciate the revenue guidance is constant currency, as well as your headcount, maybe 12% in the U.S., but a significant percentage of revenues are in dollars. Is currency a risk or a headwind to margins thus in the guidance or over and above? And then just finally, and over to you, Arnd, IFRS 15, I didn't see any mention of how it impacts you. Is there no impact? I take it from today's statement.

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

Michael, let me start with the second one and Karl-Heinz is going to take the first one. Currency, of course, has an impact on the revenue, as you know that to a very small extent only on the margin side. As we've got the natural hedge with the troops being located in the U.S. dollar zone as well as balance sheet positions which are denominated in U.S. dollars, that's almost a wash on the side, slightly negative, but not material. And of course, already effected into the guidance. So nothing which will cost us throughout the year to lower the guidance.

[Karl-Heinz Streibich]

Okay. This is Karl-Heinz speaking. And now your question regarding Apama. There are 2 possibilities when Apama which is in the IoT platform in the cloud version of the IoT platform as well. When Apama is sold in the IoT direct context as Arnd has described it then it will be mentioned there and summed up there. On the other side, you know that our business in general also cover customers who want to optimize their existing IT infrastructure and is to 95% on-premise. Therefore, we will see for long time the coming years big project in the on-premise business and even big cloud companies as you probably know, we are selling big on-premise projects to optimize their IT architecture and infrastructure. Long story short, Apama will be seen on the on-premise side as well as the integral part on with the Cumulocity IoT platform.

[Eric Duffaut]

And I just like to add to what Karl-Heinz said, Michael. This is Eric. I think you will still see deals like Bosch, but you will see also many, many more IoT deals which are consumption-based which will give us the hockey stick recurring revenue, growing revenue that we were talking about such as for instance Siemens and others. And I think that this trend will be certainly super important for us going forward in terms of accelerating market penetration with lower barrier to entry will end and then we expand as of course, our customers connect more and more devices on our platform. So that's the kind of model that you're going to see also more and more going forward for sure.

[Michael Briest]

Okay. And IFRS 15, Arnd?

[Eric Duffaut]

Pardon me.

[Michael Briest]

IFRS 15, is there any impact on revenue recognition?

[Eric Duffaut]

Yes, but that is a lecture, Knut. Michael, sorry, which will take more than an hour. And by the way, we plan to do that on the Capital Markets Day in all detail. But there are effects when it comes to the question of how to recognize usage-based models, how to recognize private cloud models, et cetera. So that is something which is going to be material and we will talk about that in all details, I think in March. Overall, that is already factored into the guidance. We are pretty sure given the contract signed that we will do the revenue if there is more perpetual, of course, that gives us some additional tailwind but that is something that we need to consider in all [ detail ] and talk about in all details.

[Karl-Heinz Streibich]

And I think, we can even say, Arnd that this new IFRS 2015 rule, Michael give us the opportunity to announce also, as I said this pricing model for our classic on-premise business offering subscription, as this will have no impact in terms of revenue recognition sense to IFRS 2015. So overall, rather positive impact for us in terms of flexibility to do business with customers.

[Operator]

Next question is from the line of Adam Wood with Morgan Stanley.

[Adam Dennis Wood, European Technology Equity Analyst]

Sorry to just come back on IFRS 15. Again, I appreciate it's complicated topic. But Arnd, when you were talking about the margin guidance, you were suggesting that the combination of IFRS 15 and the way the business is done, whether it's cloud or on-prem would impact and maybe drive into the lower end of that margin guide. As I understood it from IFRS 15, the impact on the cost side would likely be that you capitalize sales costs where you have ongoing agreements. So I am just struggling to understand why that IFRS 15 ruling would be a negative for you on margins. So should I take it that it's much more the way that you sell that drives the margins down? Maybe the assumption if more business comes in on the recurring or transactional model that would be what put you at the lower end of that margin guide. And then maybe just secondly just on capital allocation. Obviously, good cash generation, strong balance sheet. Could you maybe give us a quick update on your thoughts of M&A pipeline versus further buybacks? Thank you.

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

Adam, you were part of the discussion with -- in [ London ] with a guy. So I realize that again with your questions. Well-thought through. And you are right. So there is an implication on the cost side of capitalizing the sales and marketing cost that is not a material aspect because that is what we have to book on day 1 with respect to the maintenance contracts predominantly and the cloud contracts in the opening balance and then have to depreciate that on the other side we are allocating sales and marketing expenses for the contract that we closing in '18. The net effect is absolutely immaterial. So nothing that we should consider when talking about the guidance. So, therefore, your assumption is absolutely right that it has something to do with the deployment model. And here, in contrast to the perpetual model that we have depending on how customers deploy, how is a truce between cloud versus private cloud as of SaaS versus private cloud versus usage-based versus perpetual drives the revenue that can be recognized in a given period. And as the incremental cost for deploying a license is next to nothing in our business model as we all know that, of course, has an impact on the profitability as such. So therefore and I think that is very important to understand, it has nothing to do with the operational performance. It has just was something to do with the way of when to recognize a certain business potential that has been signed. And I must say, and you know the discussions that we all had with the [ Standard Chartered ] in detail. We as a [ vertical ] as the IT industry do not feel very much comfortable about the way how IFRS is put. Nevertheless, it's now decided upon, so therefore we need to live with that. So therefore we also need to consider I think as the IT industry to come up with incremental KPIs, where you can have the better possibility to track our progress that we do in the business than rather looking to IFRS revenue.

[Karl-Heinz Streibich]

This is Karl-Heinz speaking, I would like to add something to what Arnd said. [ Sans all complexes ] cloud-based revenue, deferred revenue with pay-per-use and on-premise and all that. Sure, we have given a wider guidance on margin, 30% to 32%. But as you know, and everyone who knows us, we are always striving very hard, very hard to get the best value out of it and in the past years, you almost have been on the other side. On the margin side, and this is what we are working on and you can really reckon that we do not change anything on that spirit. And as Arnd said, we have all the benefits of the cloud business that it is incremental business using our platform and that we do not have the capital expenditure of a IAS platform. So that means we remain to be a software company and have the benefit of the upside potential. And we believe for that reason that we have a good potential to be as we have achieved it in the last years, that we are more on the other side, on the guidance on that, but, the year will show, and we will report you quarter-by-quarter. But this is the whole story why we have put the range a bit wider than the year before.

[Otmar F. Winzig]

Thanks, Karl-Heinz. We have exceeded our regular timeframe, but I just want to make sure that we don't leave any uncertainty in the market as we have some of this discussion around margin, everything. So we have a couple more questionnaires out there. My only request is keep your questions short and only focused on those elements that have not been addressed yet, so we can give you another 5-10 minutes to close this up. Operator, please, next question.

[Operator]

The next question is by the line of Charlie Brennan with Credit Suisse.

[Charles Brennan, Research Analyst]

Given the time, I'll just focus on the modeling one. You talked about the tax rate increasing earnings by 5% to 10%, but can you actually give us what you think the tax rate will be in percentage terms for the current year? thank you.

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

That's an easy one. Around 31%.

[Operator]

Next question is from the line of Thomas Becker with Commerzbank.

[Thomas Becker, Analyst]

Actually 2 questions, first of all, Eric, can you talk a little bit about Q4, the regional performance which you have seen, and one thing I noticed in your slide deck is that you reduced the number of employees in the U.S. from September to December minus 3% and [ all through the year ] it has gone down 4%. How does it fit together with the increased pace you want to bring on the 3 tiers?

[Eric Duffaut]

Okay. Well, good morning, Thomas. Thanks for the question. So in terms of regional performance, I mean the good news #1 is that if you look at the DBP products revenue and I guess that is what as your interest and focus more than Adabas & Natural. All regions around the world are showing growth on the product revenue side. Now, if you look at Q4, and if you look at license, in particular, the key performing markets that I can mention Thomas would be U.S. and that's good news with 24% growth. We had great performance in Austria, U.K. is back on track, I mean with even triple-digit growth in Q4 on the DBP license side, okay, you could say, yes, 2016 was difficult as you know there. So this is a low baseline, but we believe that in H2, we have brought this business back on track, which was an area of concern, you might remember that. Iberia, strong growth. Benelux, really strong growth. Australia and Asia, really strong growth as well. In fact, triple-digit growth in Asia and close to triple-digit growth also in Australia with also good performance in Brazil and Argentina. So that's the regional spread, of course, you always have, you know, some countries performing better than others in a given quarter as you can imagine, Thomas. But again for me, the important element is that both in Q4 and in 2017 overall, every single region, and not country of course, but region has delivered growth. In terms of headcount, then in the U.S., I think and I will look at my colleague Arnd, here. But it is certainly not on the sales and marketing side. I think that we had some shift in terms of headcount in some other area, primarily in the R&D area. If I recall, so, on the contrary, you will see, and I insist on that as well some investment in terms of sales and marketing headcount in 2018, U.S. remains certainly our major market and there is no reason for us based on the success that we had there and the potential in particular when we think IoT that we will revive this position.

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

Yes. I just can confirm that it's predominantly on the R&D side where we operate on this mix model with high-cost and low-cost and you will see that the R&D headcount has increased throughout the year or even saying throughout the years.

[Thomas Becker, Analyst]

Understood. Probably, just 1 thing. Is there any larger, really, really larger deal in Q4 which you will remind us next year on, so is there anything really which has come in, which is distorting the quarter in a very positive way?

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

Yeah. Well, Thomas, we have, of course, large deal in Q4. And we will still have some large deal in Q4. So I certainly don't want to use already in advance a kind of future excuse for a given quarter. There will be always these happening. So I don't want to mention anything in particular.

[Karl-Heinz Streibich]

So the most -- the most important one is the [ Siemens ] deal actually [indiscernible] but a huge revenue potential for '18. I think that is the most strategic, is the most relevant one.

[Operator]

Next question is from the line of Sven Merkt with Barclays.

[Sven Denis Merkt, Research Analyst]

Just a quick one. Excluding IoT, the guidance for DBP is clearly lowered than last year. Could you discuss why this is, and which product categories within the remaining DBP line are you expecting to grow well next year, and if this could accelerate going forward?

[Karl-Heinz Streibich]

The real point is that we carve out this strong growth elements out of the digital side, yes, you know that predominantly that the cloud business was part of the digital side before in the '17 guidance. So therefore I mean, just a question of [ XL ] carve out is the most growing part and puts that separately, that the remaining part is slightly lower. But we feel very comfortable with 3% to 7% and I want just to remind you to the 70% and 100% compared to a market growth of 30%. So, therefore, we feel pretty comfortable with those number.

[Eric Duffaut]

I think, and this is Eric, we should not forget that overall, the total DBP and IoT license revenue combined will be an axillary growth for the company. So we have an axillary growth here and not being shy on that, on the country, when you mentioned what are the products we believe in the DBP product could drive growth? I think that's integration. Our integration portfolio remains #1, our core. #2 as customers more -- move to hybrid integration and add some markets and I will come back to this dimension later on. Also, accelerate their digitalization or journey, we believe this will continue to be a growth area for us. We also see in our [ areas ] and business and IT transformation some gross potential like we have proven by the way in '17. Karl-Heinz mentioned, the fact that this is key for us. So these are the 2 elements that I can mention knowing that, of course, again, IoT is the accelerated growth engine. So that's the situation. And then, of course, I will say 1 element, which is not only related to the portfolio itself but the geographic coverage we have, digitilization is a wave and we see now acceleration of this. As I mentioned, when I was asked to comment on our regional performance in some emerging markets, Asia, I mentioned, on a really, really strong growth. We see Latin America to some extent coming back and so on and so forth. So we can expect that some of these markets will also help us to boost the overall DBP license revenue going forward.

[Otmar F. Winzig]

Thank you, Eric. Ladies and gentlemen. I am afraid, we really have to close this call now due to other assignments. There are couple of interviews lined up and my colleague was so nice to postpone them already. So now we close this. Any further questions, therefore, will be handled by the IR team. Before I close, however, let me remind you of the Capital Market Day which is scheduled for Monday, March 12. Here in Darmstadt, and we are looking forward to provide you with news on products, go-to-market and customer experience, especially for the new IoT business and the revenue recognition related like to that. Thank you all for your participation and interest in Software AG. And as I said, further questions, we will handle in the team. Thank you for now and goodbye. We close this call.

[Operator]

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