SOFTWARE AG SP ADR Q2 2010 Earnings Call Transcript

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 |  About: Software AG ADR (STWRY)
by: SA Transcripts

STWRY.PK - SOFTWARE AG SP ADR, (OTCQX:STWRY) Q2 2010 Earnings Call July 30, 2010 12:30 PM ET

Executives

Otmar Winzig - Senior VP Investor Relations and Compliance

Karl-Heinz Streibich – Chief Executive Officer

Arnd Zinnhardt – Chief Financial Officer

Analysts

Rajiv Bal – Piper Jeffery

[Mark Voda] – [Main First]

[Koriofla] – [Stoigan AG]

[Jonathan Kroze – [West Elby]

[Guna Plaga] - Nomura

Knut Bola - UniCredit

Operator

Good morning ladies and gentlemen, welcome to the Q2 2010 results conference call of Software AG. Please note that for the duration of the presentational participants will be in listen only mode and a conference is being recorded.

After the presentation there will be an opportunity to ask questions. (Operator Instructions). At this time I would like to turn the conference over to Otmar Winzig Senior VP Investor Relations and Compliance. Please go ahead Mr. Winzig.

Otmar Winzig

Thank Jason, good morning ladies and gentlemen. Before we start please allow me some housekeeping remarks of how to access the conference to dial in number for today’s call has been published by email and on our website. In addition the conference call will broadcast also via webcast in listen only mode. Access to the webcast via our investor relations website. The webcast will display the PowerPoint presentation charts used in this call, the same charts are on our website for download and the full presentation has been emailed to all invited parties in PDF format this morning.

The call on the webcast will be recorded and available for replay later today. The agenda of today’s call is the following Karl-Heinz Streibich will give you a summary of the achievements in the first half year and an update on the execution of our strategy including our outlook for fiscal 2010.

Then the CFO Arnd Zinnhardt will provide details on the Q2 2010 figures and the financial performance of Software AG. In addition we will explain the base model for evaluation as we go along.

After the presentations you may ask questions as the operator already indicated. With respect to capital market regulations I have to make the following statement. The presentation contains forward looking statements safe and beliefs of Software AG. Such statements reflect current views of Software AG’s management with respect to future events and results and are subject to risk and uncertainties. Actual results may vary materially from those projected here due to factors include changes in general economic and business conditions, changes in currency exchange, the introduction of competing products, like of market acceptance of new products, services or technology in charge of business strategy. Software AG does not intend or assume any obligation to these forward-looking statements.

Having said this let us now start and I’ll have over to Karl-Heinz Streibich the CEO of Software AG.

Karl-Heinz Streibich

Thank you very much Otmar, ladies and gentlemen good morning, I would like to give you the over view of our financial results for the second quarter of 2010 and an evaluation of the result from a strategic perspective.

I will also highlight several aspects of the company’s performance through the slides and finally illustrate the integration with idea share and a 2010 outlook.

My colleague Arnd Zinnhardt will give you more details concerning the numbers and all the financial supporting figures.

First a few key points, the operating policy EBIT improved by 33% to €58.9 million. And second [indiscernible] revenue was up by a stunning 31% in the quarter, and earnings per share increased by 29% to €1.32.

This clearly demonstrates that Software AG has returned another very strong order despite an ongoing economic crisis and despite tough competition in the software markets.

I would like to evaluate our results, first the second quarter of 2010 fully confirmed the growth strategy of Software AG.

[Indiscernible] business our business division with innovative middle way software for incorporating business applications and business process, continues to grow dynamically. After 8% growth of the business line in Q4 2009 and 9% in the first quarter this year WebMethods public future growth in Q2 18% stated.

This due to the increase maturity of our organization and the market full process optimization. We see an increase in both the number of large projects and in the average team size. The industry experts at Gardner Group expect double digit growth in the relevant markets in the coming years.

And second for the first time in the history of Software AG new products generated at Software AG more revenue than the traditional ones, this is a milestone in the company’s history.

The WebMethod business division is a blazing ETS the company’s growth driver if particularly planned. We are now witnessing the transitions of ETF’s our main business of many years into a so called cash [cow], but ETS will nevertheless follow foresee the future return robust sales figures in the high contribution to earnings and cash flow. And we achieved revenue stability in ETF’s through continued high maintenance premium rates and license revenue through additional [indiscernible] and natural products.

Earnings stability remained secure by sophisticated cost management and the symmetry possibilities provided by a growing company. This allows the growth of the mathematics business division to more than offset the gradually declining growth of ETS. [Indiscernible] enabling Software AG to continue the growth path of the last 7 years. And the integration of IDH share AG strengthened our growth trend and mid terms earnings momentum.

The product lines uniquely complement each other. The ARIS and the WebMethods products will be available by the end of this year as an integrated offering, for example the automatic transfer from process design to operational use of that process design in SAP and PPN and backwards to update the design description we call that model execute is a ground breaking innovation from which we can expect a significant sales impulse in the coming years.

Already we have won the first major ARIS projects within sizes that were seldom in the previous ARIS in the [indiscernible] and the biggest one for examining price. And we have access to 7,500 SAPU’s of carbon with the businesss know how of some 2000 IT consultants from IB share that offers us new edge particularly significant concerning revenue potential. And Software AG will be seen by a growing number of customers is the strategic supplier of middle layer for process innovation.

And we also have published the press release of such a customer DHL in Germany. I would now like to give you more details by means of slides concerning specific strategic parts. First as I already mentioned it’s a milestone in the company’s history, for the first time new products generated more revenue than the traditional products.

The WebMethods business division after it start appeared in 2004 and 2005 generated its first significant revenue just in 2006. The strategic direction of the business gained critical mess with a very successful acquisitional methods in 2007. And in the first half of 2010 and hence by revenue of the IB share ARIS the products provided already 55% of the Software AG’s group total revenue and those of you who are with us 6 years knows what that means.

And second the number of [tills] and average [till] size are here the relevant indicators. Number of tills and average till size has significantly improved in the first half of 2010, for example the number of large tills above €100,000 increased to 104 from 93 in the previous year. The average till size was close to €500,000. This is more than double the amount compared to the [rembark] [phonetic] phase of the WebMethods business a couple of years ago.

In addition another [indiscernible] the number of [indiscernible] with ETS customer base has also improved. The first half of 2009 we counted 52 combined deals for example ETS and the WebMethods product were sold together, but in the first half 2010 the number has increased more than 10%. More element is a fact that last year only 9 of these deals large WebMethods trails while this year we counted 18 more and double and the pipeline is very promising.

Reasons for the sales success for this significantly improved sales sufficiency are, we have a more mature sales organization in that area, we have a mature and well referenced product portfolio, we have a much higher customer acception through there and it is a growing master segment we are in.

Then the third chart the relevant market segment forward message products are growing at double digit rates.

First enterprise service parts and business [indiscernible] are the two main segments where customers invest in innovative middle ware and in those segments Software AG is one of the top sellers on a global scale. And third in a small, but very fast growing segment of [indiscernible] Software AG is the world market leader also according to market share.

And fourth now Software AG WebMethods products sales grows at market pace or even faster for example 14% in the first half 2010.

In the 4th chart business line development revenue first half 2010. In the first of 2010 has fully confirmed Software AG’s growth trend and growth strategy. The business line WebMethod continued its dynamic growth path and has grown by 14% compared to the first half of 2009. This strong and sustainable contribution has more than made up for the slower paid with ETS still showing the first half.

The integration of IDS Scheer added to the growth of the total revenue which surpassed the threshold of €500 million for the first time of company history. A significant remark on our way to 1 billion revenue in 2010.

Now let’s have a look at the region development in the next chart. The region showed a very mixed revenue development in the first half of 2010. Overall America showed strong growth where the [indiscernible] and Asia pacific were still lagging behind.

France and Switzerland were the positive exceptions in Europe. Cautious buying behavior in Spain and U.K., general weakness in Eastern Europe. Middle East and Africa was [indiscernible] by the Gulf region and slow down in South Africa and Israel. Australia showed growth for Asia Pacific, Japan continued to be difficult also due to the known interaction of our previous exclusive [indiscernible] over there.

The U.S., showed a strong rebound it significantly improved buying behavior from the customers, its return of large deals and a significant [indiscernible]

Overseas proved a continuous strength although the larger deals are expected for the second half of 2010.

Let’s have a look at the revenue by sectors. In recent years several micro developments concerned the markets. Our business model showed robust developments while the prices which stabilized since revenue in the financial sector over recent years despite the banking sects difficulty.

We also account for large and even a growing share from the public sector, now that as the government has announced budget cuts we will face a situation similar to the financial crisis 3 years ago. And like then we are absolutely confident that our business model will again be resilient.

The bulk of installed systems are part of the operational extent at the customers rather than new investments to our customers. On the other hand our WebMethod and ARIS product can help to modernize and optimize overdue public sector systems and heterogeneous IT infrastructure. In my view there are more opportunities than risks in this new scenario for us.

Next point let’s have a look at some strategic deals, we selected wins in the first half of 2010. In recent press conferences I mentioned the importance of large strategic customers. We are currently transitioning the company from being a project partner to long term strategic partner for our customer, a partner for process innovation with outstanding expertise in long term business transformation.

One reason for the success of WebMethods is our skilled and experience in last project, learn from our big tradition ETS deals. These experiences which lie in the DNA of Software AG are being transferred to the WebMethods and ARIS areas. I have a list of some customers [indiscernible] on this light, for example strategic partnerships with T Systems and more recently in Q2 with DHL. Software AG and DHL Global forwarding will build and integration backdoor. This is an IT transformation project integrating the heterogeneous IT landscape of DHL reducing the complexity of their IT applications and sustainability during their IT…by reducing their IT cost.

After just 4 months the first milestones was achieved. DHL Global Forwarding Freight now has improved transparency for shipments within Europe. You know our tech line get there faster here we showed it and implemented for the benefit of the customer. This newly gained transparency allows the optimization of business process, saving costs and providing a faster response to our customer’s requirements.

You can see on this slide many further strategic deals, for example new WebMethods cast, new processed [indiscernible] .Core selling of WebMethods to IDS [SAT] customers like for example [indiscernible] called where we won together one of the biggest WebMethods and ARIS deals in France in YouTube and concerning of WebMethods to the ETS customers and you can see this example that the core selling principle is working and we have just only begun.

I will now track briefly the integration of IDS Scheer. The integration is on schedule and I’m confident that with IDS Scheer we will repeat the successful acquisition story that was with WebMethods. The legal integration with IDS Scheers entering its final phase and the genral meeting of IDS Sheers on July the 8th 2010 the merger of both companies was approved. The merger will be legally valid when it is entered in the commercial register. Now we have to wait for the end of the objection cleared in August. As an indirect result of the merger decision we have been offered large amounts of shares from minority shareholders. As of yesterday we hold a total of 95.16% of IDS stock. So far we have executed on our integration plans, for example in Q1 integrated the back office functions and developed a synergy trading system. In Q2 [indiscernible] offices introduced a common go to market approach, we also hosted joint customer events shaded in the first quarter and processed world events in Berlin for Central Europe and in Washington for the Americas in the second quarter.

Next we will change our management structure to that of larger companies, details will be communicated next week. And as I already said we will work in the next two quarters on a common product portfolio that we call model to execute which I mentioned earlier. I am convinced that the new portfolio will be a tremendous success in the market and that the new product portfolio comes at just the right time. When the economy in all regions is again attractive and customers make significant investment to benefit from a new broad phase.

Finally the outlook, we set ourselves business goals at the beginning of the year. One of the few software firms that they had to forecast in the economic crisis you know that. That was [indiscernible] and is grounded on our robust business model and the portfolio that remains in demand in times of crisis even. The following slide shows the object and the result in the first quarter, based on the first half results the strong performance of WebMethods and the promising pipeline of the second half 2010 will confirm the outlook for a full year 2010 with total revenue growth of 25% to 30% net of currency affects.

Organic growth we’ll try the second half of 2010 and there will be only small effects from the consolidated IDS Scheer which started in August 2009. The pipeline for ETS still shows a rebound in the second half of 2010. Similar to the situation 2008 we expect a number of large deals in Q3 and Q4 2010 therefore by the [indiscernible] first half we are confident of reaching the forecast corridors for ETS product revenue and its lower end.

On the hand the strong performance of WebMethods, the outstanding performance of WebMethods should push the product revenue towards the upper end of 25% to 30% growth target for the full year 2010. The result the results of the first half have laid a good basis for the planned growth in net income and earnings per share of 8% to 12%.

Nevertheless we expect to achieve the profit targets at the upper end of the forecast and there’s unexpected developments in the whole economy or at the current [indiscernible] get in the way. To make it crystal clear we now raise the guidance for net income and earnings per share growth to 10% to 12%.

So many thanks in interest in Software AG, I now hand over to my colleague Arnd Zinnhardt.

Arnd Zinnhardt

Thank you, Karl-Heinz also from my side good morning ladies and gentlemen. Let’s start the financial overview with a quick view on the currency impacts. Revenue in foreign currencies followed our well balanced business structure. 42% of our revenues we invoiced in Euro up from 39% in fiscal 2009.

Strong results in the U.S., translated into a higher share of US Dollars in the second quarter of 2010. The proportion of revenues in USD increased slightly up to 23% of our revenues compared to a 22% in Q1 fiscal 2010. Furthermore [indiscernible] driven by a new legislation in the country had also a positive impact.

We realized €12.9 million or 4.9% of positive currency impacts around 5% positive currency impact in Q2 of 2010.

Let’s go deeper into the individual business lines starting with the ETS line. License revenue declined predominantly in the year, we need to mention U.K., and South Africa as well as Asia and here Japan in particular. We saw no ETS license growth in these countries during Q2.

Last year Q2 revenue especially in South Africa were mainly driven by one single very big ticket. The magnitude of that transaction is worth the entire revenue decline that we had year-on-year. Let me mention in this context and Karl-Heinz has already indicated that as well that we do anticipate some transactions of similar size for the second half of this year.

Whereas Japan remains to be a difficult environment throughout the entire year Brazil reached a very attractive [indiscernible] new level during the last quarter and we strongly believe that this trend will continue also in the second half of this year.

In our home market Germany the ETS business was roughly on previous year level with a good outlook for the second half of the year. With 50.4 million in maintenance revenue we grew that business line on a year-on year basis by 8% showing a healthy environment with a consistently high renewal rate.

Revenues of service and other revenues remain stable with a volume of close to 35.3 million. Sales and marketing costs dropped at 5% versus Q2 2009 and amounted up to €16.9 million.

For ETS we had R&D expenses of €7.8 million in the second quarter of 2010 a slight increase of 8% compared to the previous year’s quarter. This increase predominantly rose from currency effect and is a consequence out of our natural hat swing due to the R&D centers located in the U.S.

This allowed business line contribution again and a segment result margin north of 50%. In the first 6 months we increased the profitability level compared to H1 2009 by 50 basis points.

Our second business WebMethods again showed impressive growth in Q2. Product revenue grew by 21%. Key performance driver were out licenses which showed a very pleasant growth of 7 million or 31% in Q2. Maintenance also showed a very favorable development with a double digit growth compared to Q2 2009. Like in Q1 our U.S., boomed and we were able to double our sales success in that very important and highly competitive market.

Also service continued to be a strong business line, a strong growth driver of our revenue with a growth of 13% compared to previous years Q2. Looking into the entire P&L of that business line I would like to mention that we were able to improve our sales and marketing efficiency and therefore reduced sales and marketing costs by 6% year-on-year or even 11% like-for-like.

The R&D margin related to product revenue decreased to 20.3% in Q2 after 23.9% Q2 2009. The strong revenue growth combined with an ongoing success of our cost efficiency measures next to a doubling of the business line margin to 29% compared to a 13.5% last year. Also in absolute terms the contribution of the business segment was up to 25.8 million coming form 10.2.

Let me make a side remark again this quarter approves that WebMethods is a profitable growth driver. Also moving forward we will drive Software AG’s EBIT growth and because of that our market valuation. This becomes even more true once we’ve got a fully integrated product portfolio available and can for the entire product tech can talk about the topic of model to execute and Karl-Heinz has already mentioned that which is absolutely unique in the market place.

As you know we are working very intensively on the immigration of IDS Scheer and I’m very happy to report that we’ve got made steps forward and will realize cost synergies at the higher end of the guidance range. The respective restructuring costs has the accounting up now in H1 and we do not anticipate any further restructuring costs in the second half of this year.

We worked ARIS revenues in the amount of 17.5 million and further 58.2 million revenues from the core business of ARIS the consulting and the service area. The business line contribution showed first improvement and we feel quite comfortable with the compliance of perspective.

We saw a slight increase of our ARIS license revenue on a standalone basis, excluding the second part of the huge German army deal of 2009.

Consulting developed in line with the sector as a late [indiscernible] business and is still not in the recovery phase yet.

Let me make some comments on the sustainable profitability of our ETS business. The high and stable operation margin is received by A, sophisticated cost management and continuous improvement in productivity and B, economies of scale and synergy potentials of a growing company.

In recent years we started an internal programs for continuous improvement of activities and cost efficiency, let me talk about the individual cost lines starting with cost of sales; the share of services and related to all product sales was reduced over recent years with a positive impact on cost of sales. Sales and marketing remunerations is strictly tied to sales performance and therefore develops inline with air-revenue development.

R&D is focused on profit generating products segments, and you know that we have established a couple of years ago already the topic of re-growth engineering, while we listen to our customers and based on their feedback develop and future rather in hand all the products, that is driving our R&B efforts.

The new business is on track to reach the profit level of the traditional ETS line, ETS turning into a healthy cash-cow will continue to turn robust sales figures and high contribution to earnings and cash-flow through, continued high maintenance renewal rates, and also license revenue to additional our robust natural products and extended uses of installed systems.

ETS has reached a high level of revenue and profit over the recent years, going forward, the target is to keep the test and the rating units as a high marginal level in order to support our future growth of our business. The new business or the WebMethods as well as the ARIS business however has constantly improved its profit contributions, which fills out revenue growth per activity gains and scaling effects, it is also the potential to level and subsequently to exceed the profit shared from ETS in the midterm. And if you look to the chart, you see a significant uptake in the profitability of the WebMethods and RS not only in the last year, but over the last couple of years, and I think that is a very sound development which will continue also moving forward.

Let me now give you some comments on the P&L, as you know our cost of sales traded much more than double on a year-on-year basis due to the larger sale of services as their party product sales from idea share. As a consequence, our gross margins is reduced by some of the planning; having said that, our total operating expenses grew only by 29% while our total revenues increased by 52%, this positive development was predominantly driven by A, Sales and marketing, where we’ve got a cost ratio of 21.9% compared to total revenue this year comparing that to a 23.4% second quarter 2009.The further improvement correlates with the increased average steel size as well as increased amount of significant transactions as already mentioned by Karl-Heinz and B, your G&A cost, which are now down to 7.5% of total revenue after 9.2% in Q2 last year.

We continuously evaluate all of our cost positions even given the dynamic growth environment, moving forward, we will also benefit from the cost synergies realized in the meantime. Benefit position other income expense of 4.5 million is a large time effect caused by currency improvement especially due to the [indiscernible] and hear just one technical remarks, we switched from the very conservative the grey market rates to a rate which was just amount by a new law which was passed through in the country and based on that currency rate, we were able to bring money all of it to the market, so therefore that is now the rate that we will use moving forward.

All together, our EBIT is a historic high was in a distant gross of 33% year-on-year. In the second quarter we had financial expense of 2.9 million and for the first six months we booked 7.5 million related to our IDS Scheer acquisition. This is less than planned because of our advanced payment of loans enabled by a consistently high pre-cash flow.

Net income as well as ETS grew by 29% those compared to Q2 2009; once again the cash flow performance is in a very healthy shape, our pre-cash flow increased by 22% year-on-year, and if you look to the first six months, we’ve reached free cash flow level of close to 100 million and comparing that to net income, you will identify a cash conversion rates which is close to 150%.

Let me make some remarks to the balance sheet, first cash-and-cash equivalents; here cash and cash equivalent went down by roughly 62% compared to the end of the fiscal year 2009, due to the repayment of debts associated with IDS Scheer acquisition, the purchase of the 400,000 own share in conjunction with the merger as well as the dividend, we paid to all our investors in May.

With the 292 of net debt position, this is on the same level or like Q1 of 2010; compared to year end 2009, we reduced this position by roughly 20 million although the financial liabilities increased due to technical reasons by 42%. This is a topic that we now base on IFRS tenders do have to consolidate the entire 100% of all spending shares of IDS Scheer and therefore based on the IFRS requirements we have to book and put options for the remaining outstanding shares in financial liabilities, this put option remains as a number of 42 million which then close into the financial liabilities, so that’s just the closing issue and if you really want to look to the real performance, you need to deduct this 42 million and add this to the 20 million, so in all in all, we were able to reduce the net debt position compared to Q1 2010 by more than 60 million.

Trades receivables decreased by 5% compared with fiscal year 2009, and increased in Q1 by nearly 4%. Nevertheless, on the DSO level, we were able to make further improve that ratio. Total goods re-grew by 41 million just as a result of currency effects compared with the end of 2009 and shareholder equity expanded by roughly 6% to 670 million and this is an equity ratio which is again north of 40%. So having said that, I would like to pass over and hand over again to Otmar to introduce Q&A.

Otmar Winzig

Thanks Arnd, thank you Karl-Heinz, now ladies and gentlemen you may now ask questions and please operator repeat the instructions so that everybody can get access to Software AG.

Question-and-Answer Session

Operator

Thank you, we will now begin the question and answer session. (Operator instructions). The first question is from Rajiv Bal from Piper Jeffrey, please go ahead Sir.

Rajiv Bal – Piper Jeffery

Thanks, I was just looking to dig in to the ETS business and the confidence you have in the 2% to 4% gross guidance for the full year, how reliant is that on the last years that you’ve indicated during the pipeline and what’s your quality of divisibility of those deals, is it a number of deals that are awaiting probability is that one contract is very confident or something you could speak a little about the quality of divisibility that supports the guidance.

Karl-Heinz Streibich

The ETS bills we have in the pipelines for the second half emphasize that they will have stronger and positive impact on ETS resigned on the second quarter, we are in the ETS business now in a phase where the geographic expansion will not drive the ETS growth, that means the growth we are driving there is coming then from the head on, it is from the increase of midst of performance of the customers in this areas, and that is at the reasons why we believe that we can stabilize it as at least high level of profitability and revenue and as Arnd mentioned through further sophisticated cost measures even further improve the contribution it has for the profitability, but we in fact a way for the second quarter assuming basic number of bigger bills which will have a positive impact on the overall revenue so that we will achieve around the 2% growth rate ETS area for the full year.

Rajiv Bal – Piper Jeffery

Thanks, and just one follow up, it looks like the gross margin and ETS ditch a little year-over-year, are you seeing pricing pressure or that was purely volume driven?

Karl-Heinz Streibich

In the ETS area, we do not really have a price pressure because if you know we are the exclusive provider of the customers, however, when the times are more difficult as we have mentioned during our last telephone conference, when the times are more difficult then the customers are negotiating loans, this is what we said the last time but all in all, I’m absolutely sure that our excellent cost discipline and cost management performance will help to retain an excellent margin ETS.

Rajiv Bal – Piper Jeffery

Honestly, thank you.

Operator

The next question is from Knut Bola from UniCredit, please go ahead Sir.

Knut Bola - UniCredit

Yeah, hallo thanks, just some quick words from ETS just getting a feeling you are talking about the larger deal, so is it something from my understanding that you expect positive license growth in H2 year-over-year, or should we still expect declines but however in H2a more limited size than H1?

And then second on the dynamics of what methods, is it something like the 20% growth rate that we have seen we should expect to continue to see going forward and your feeling about the pipeline that you have, I mean from the sales side to realignment of IDS Scheer and all this I think you should benefit given sales records of six months from an ongoing good momentum and good pipeline here, thanks.

Karl-Heinz Streibich

Let’s split the answer Arnd will give ETS part, I will cover the WebMethods part.

Knut Bola - UniCredit

That is work share, are we getting that.

Arnd Zinnhardt

Yeah Knut you are absolutely right, we anticipate a number of plans in the year and the second half of the details of the year and this will result in ETS license growth for H2, let me just talk about ETS give you one additional comment regarding the margins, if you look to the first six months, we have expanded our margins by 50 basis points, so additional growth of the margin. If you just look at the second quarter then the margin is slightly reduced, and that is simply because of the one single big transaction that we had in Q2 2009; so all in all we believe that as Karl-Heinz has mentioned that we continue on that very high level.

Karl-Heinz Streibich

Work sharing is one of our success factors at work. The second question is WebMethods yes Knut, you are absolutely right, the results in Q3 are absolutely stunning and you know what makes us so positively looking forward is, it is not just a single sector that created the excellent result than our new growth product line, it is the company maturity level we have ourselves, it is the upswing in the market we have not only due to better economic situation but also because integration and BPM is more effective and customers increasingly invest in it last, but not least, it is the absolute market leadership we have from an innovation point of view.

I mentioned last time when customers make approval of contracts, in 8 out of 10 bills we win against the big ones because our products are much easier to use at a much lower towards cost of ownership and so are much more attractive to the customers, so do we expect in a few hours a 20% license increase for the next quarter? I think that would be an incredibly positive result. Will we achieve the 20% licensing growth every quarter looking forward to WebMethods? I cannot promise that, but we will definitely promise it will be a single digit and note the combinations Arnd mentioned with ARIS that we have this model to execute. That the customer can automatically transfers what they have designed with ARIS into BPM dimension that makes us really great and adds to our uniqueness. So we are with the right portfolio innovation leader and strongly extended marketing that makes us all positive about our outlook.

Knut Bola - UniCredit

Thank you.

Operator.

The next question is from [Mark Voda] from [Main First]. Please go ahead sir.

[Mark Voda] – [Main First] [Ph]

Yeah thanks final point on ETS maybe. To what extent does the guidance depend on you recovering some of the Japanese delayed revenues? Point one and maybe on the average deal size. To what extent of these does the functionality? What extent are you already seeing IDS/ARIS effects in selling the two product jointly? And a more conceptual request going forward, how are you going to define I presume these are licensed revenues that you are referring to in your sizing and how do you define joint ARIS and WebMethods deals are they going to be reported as part of this? Or how are you going to treat the two segments when you talk about [indiscernible] [0:46:35] going forward. Thank you.

Arnd Zinnhardt

Like I start with Japan. You know Japan recovery is included for that was an easy one and before I give Kalhans [indiscernible] just one additional comment on the disclosure moving forward and this is something that we plan for Q1 of next year then we will bring together ARIS as well as WebMethods in to one business line which will report as one business line as we sell the products together and this business line will then be called business process excellence. By that time then we then are able to report organic development and then it’s the only reason that it’s so trust for you to have this entire transparency for you that we still talk about the WebMethods on the one hand and the IDS Scheer in a separate business slide.

Karl-Heinz Streibich

And what Arnd just mentioned if driven through the nature of the portfolio ARIS and WebMethods it is driven by the customer being able to implement the full sided from strategy to design to implementation monitoring of process excellence and this is also the reason why we are already started and integrated the ARIS product sensitized with WebMethods to help people and what we see there out in the markets is very convincing. We have a number of co-selling patent and we have started especially initiative for co-selling and they are cooperating in excellent ways. So from the sale front starting co-selling is really working.

And last but not least we have a product from the IDS Scheer site which has been developed by the RC coordination. This is a very sophisticated way of presenting a (unclear). That user interface and we will use that also in the ETS area. So we will use technology that we invent for ARIS also on ETS, WebMethods in ETS so that our existing customer rises fully benefiting from the great innovation coming out of those. It means co-selling is really working and I have mentioned some triggers during my brief speech. So we are very positive about this co-selling opportunities ETS WebMethod, ARIS and ARIS into WebMethods and even ETS.

[Mark Voda] – [Main First] [Ph]

Can I just ask just one quick follow up on ETS? It just occurred to me the obviously there is the product launch by IBS on the mainframe site 11 coming or first year announced, do you think there was maybe there was some sector of this leading to the decline in ETS revenues in the run up of the new product launch and maybe and on the reverse positive from some positive effects going forward once customers might put the traditional, mainframe capacity and you recognizing some additional software revenue from the back of it going forward?

Karl-Heinz Streibich

No that was not the effect. I think the effect is you know in a business line you should just slow [indiscernible] growing when there are two or 3 big deals and it depends on which quarter they come so it might fluctuate a little bit from quarter to quarter but overall I said we think we can achieve that 2% as we had heard in our forecast.

[Mark Voda] – [Main First] [Ph]

Thank you.

Karl-Heinz Streibich

You are welcome Mark.

Operator

The next question is from [Guna Plaga] [Phonetic] from Nomura, please go ahead sir.

[Guna Plaga] - Nomura

Yes sir thank you I also wanted to come back once more on ETS I mean if I misunderstood you right you said gradually declining ETS. I mean strategically you’ve said longer term ETS should be able to grow Single digit. Is that still the case or should we probably model a bit more stable line going forward.

Karl-Heinz Streibich

I think look when you want to go under absolute sales side then model is [indiscernible] okay, but we think we will be able to have a low single digit growth going forward through the innovation that we can use from the ARIS they have the best solutions for example through the co-selling you know from the WebMethods been there modernizing the existing base. So it will be around that regarding revenue and as I mentioned we will further optimize our cost bases so that we advertise might even have a more positive effect.

[Guna Plaga] - Nomura

Okay, thank you.

Karl-Heinz Streibich

You are welcome.

[Guna Plaga] - Nomura

And as a follow up you mentioned the business process excellence for the better transfer of the software business in to WebMethods. I was wondering if you have now probably now a little more visibility into IDS. Can you tell us a little more a bit about what you see in terms of underlying margins in the converting business? Is the converting now of IDS at the moment profitable and how do you feel with the controlling system over those IDS systems so what visibility do you have into deals in the various regions.

Arnd Zinnhardt

[Guna] your last remark was exactly the right one. We need to look to individual countries. So that we have complete visibility by now. What we clearly do and that is something different from the past that we look in to the IDS Scheer business like we do that on the Software AG side in the sense that we look in to the individual profit centers. So as a consequence we incur spread on country by country and we segment the individual countries based on the ARIS business as well as on the SAT business and we of course also look to the profitability of the sales organization the support/maintenance organization as well as the consulting organization. So all this different dimension is something that we wanted to work very closely and therefore have by now a very clear picture on what is going on and as you know from the past we were therefore and we are currently doing that initiating individual initiatives in order to improve the margin to move forward.

Karl-Heinz Streibich

I would like to add the following. We are of the opinion that good consulting should be able to get [indiscernible] are we there in every country by no means. So the good news on that is there might be an improvement possibility we have there, but there are some countries who are already there. So the benefit of the IDS Scheer consulting is that they have number of things that they have this high end consulting and that makes us very confident also because they are process oriented in the implementation of SAT that their strong senior chief to BT. In the combination of ARIS and WebMethods. So as a summary we Software AG are at the right time in the market with a market leading portfolio and we prepared our teams already three years ago and that makes us so positive that we are now at the quantum shift we see where the ETS growth, but the BP the WebMethods growth is so strong that it has an absolute positive impact on the EBIT . So that we can all can and will continue with our possible growth as we have seen in the past.

[Guna Plaga] - Nomura

Thank guys it’s very helpful.

Karl-Heinz Streibich

Welcome

Operator

The next question is from Jonathan Kroze from West Elby. Please go ahead sir.

[Jonathan Kroze – West Elby] [ph]

Thanks I have two questions one is about acquisitions. I think your policy at the moment is to pay down the debt on the balance sheet. But are there ways in which you could make another significant acquisition before that happens? My first question and the second question is about the P&L of WebMethods. At constant currency year to date product revenues are up 10%. Sales and marketing costs are minus 7% and R&D is minus 8%. These are extremely unusual numbers. Could you explain how that is possible?

Karl-Heinz Streibich

I will take the first one you are asking a question is you able to make big acquisitions. I mean there are two answers to it one is. When there are opportunities which are equally relevant the strategic point of view of WebMethods was as IDS Scheer was then we will find ways we do it. The second top of the answer is which might be answered through the CFO. How much could we afford? Is that part of your question as well, was it?

[Jonathan Kroze – West Elby] [ph]

It was and I was also wondering if you would be prepared to use shares as an acquisition currency?

Karl-Heinz Streibich

So in principal talking to the banks and see there is a (unclear) of banks that we talked recently to has substantially grown over the last 12 months and that certainly that is some key (unclear) to also hear from other companies. So banks have returned to us talking about the willingness of financing transactions which have a size which is more than double of IDS Scheer. So the risk at the tide is here so therefore that is it doesn’t look to be an obstacle at these times. Are we willing to increase our shares outstanding well that is a question that only needs to be answered on a single situation basis? In principal we try to avoid that given the fact that the interest rate that we have to pay the banks still is pretty low and therefore from a pure financial prospectus it makes no sense to dilute you share holders but it’s rather favorable to leverage the balance sheet. Therefore that will be the first objective moving forward.

Arnd Zinnhardt

The other question regarding WebMethods revenue growth in decreased of sales and marketing and as well as R&D so therefore I think that it is something that you should give. So why is that to answer your question there is a number of reasons talking about average deal size is certainly one of the key drivers and I’m talking about that on a consistent quarterly basis. The average deal size drive efficiency is certainly the KPI and big critical success for sector for generating profitable business. Karl-Heinz has mentioned that over the last years we have substantially increased some numbers to that when we gave the acquisition of WebMethods which is now two years ago. The WebMethods sky we are talking about in average deal size of $200,000. Now Karl-Heinz has given you the indications that by now the average deal size is €500,000. So now we are talking about something tripling that average deal size that of course hasn’t been impact on the profitability. And then there is one other effect which also needs mentioning which had an impact on the sales and marketing as one from the R&D side which is cost synergies on immigration.

So where we did not save money or reduce our safe or stays on the customer’s facing side, yeah, on the customer’s facing side, because we sail of, we need to talk to our customers’ that is one of our key areas where we have to, what we have to do in order to generate our revenue. But on the marketing side, so on the pre close side we have the economies of scales and the efficiency gains to our via acquisition RS, and SAT, so give you one example, [Seebit] in Germany is a big fair, we don’t need two boost it, we just need one, just one very obvious example, and the very same is true for R&D. So within R&D if you drill into detail, R&D organization, you’ve got the guys coding, and you’ve got the guys making quality assurance, making the documentation etcetera, so what kind of support functions within R&D.

So, in those areas we also realize, synergies and what you see in front of you is what’s happened.

Now If you look to Q1 of 2010, we had sales and marketing of 20million, or 20.7, now we have got 22.1, that goes together with the increase license revenue, so the developer is due to commissions that we had to pay to the sales organization. So there is a core relation to license, but of course our big, big target is to be as efficient as possible and that is what you see in the numbers.

[Jonathan Kroze – West Elby] [ph]

One big follow up is there still a shift of R&D personnel offshore or is that done now?

Arnd Zinnhardt

The answer need to be discussed on the business line by business line, level and on the ETS side, we have our main troops in Germany and in the U.S. and you won’t find mainframe [no] in Bulgaria and India so therefore shifting resources to those two locations is not an option. Where we do have an no cost location is in the in the Baltic State Rorigo, that isn’t an area where you can develop mainframe applications. On the WebMethods side just looking at the WebMethods business line we are already at a level of fifty fifty, so 50% of the individuals are operating in India and Bulgaria, so that is something that should be presented also moving forward. On the RS side basically all these people are located in Germany, they are located in [indiscernible] which is cheaper than the area of Frankfurt so therefore the necessity of moving people abroad is not as high as we have talking about salaries in the [indiscernible] area or in the U.S.

[Jonathan Kroze – West Elby] [ph]

Ok, thank you very much.

Operator

The next questions is from Alla Koriofla from Stoigan [Phonetic] AG, please go ahead ma.

[Koriofla – Stoigan AG]

Thank you, good morning, two question this, going back to ETS again, do you expect any impact from hardware upgrades which we hear from some hardware manufacturers, customers, into buying your capacitys?

Arnd Zinnhardt

Second question.

[Koriofla – Stoigan AG]

Second question is regarding to your consul ting business. You’ve mentioned already that there has been no recurrence so far as cycle, is there a [cycle] business, when do you expect this to happen and do you have any means to sort of speed it up a little bit from your side or you are purely dependant on the overall market sentiment here?

Karl-Heinz Streibich

First of all the hardware upgrade are a continuous to process, for example we realize that in the banking area there was during the down turn there was tremendous increase of transactions and it’s a transaction that it the mid for that reasons. This is something that we expect with the ongoing development growing process and this is also a continued source of additional revenue that we can generate there.

How much did [indiscernible] extremely difficult to make an estimation and give you a figure part it is definitely source of revenue for the future. ARIS is a source of revenue for the future when two companies are merging. As the customers are buying ETS they buy the right to use other [indiscernible] they don’t buy the software. It’s okay because the software together with the element of the software we have invested more than 1 billion in the last 30 years or so. They buy the right and whenever something changes in the usage profiles the customer needs to pay. If in the outsourcer then he needs to pay in the outsourcer, he has to pay, so for that reason changes and consolidation is also generating ETS revenue that is the reason why we are very confident that we can stabilize this profitable revenue block for all us in the future impounded with strong growth as we see on the Method side.

The second message was consulting; a consulting part is an employing part. It is the implementation of our technology on the customer side and customers are looking for transformation partners, they do not just look for technologies they want to have a partner who is whom they can transform into the digitization of human work flow the digitization of the processors. This is next significant efficiency increase for example as Arnd and his team has done in Software AG by digitizing and by automating of a process on [indiscernible].

So there our consulting resources are the means to expertise the transformation of the customer side thus expedite the up sell possibilities for the next structures.

[Koriofla – Stoigan AG]

Right but within the consulting what exactly… which area do you expect to be the main driver for your business, I mean is it going to be a secure rate to cross selling or is it going to be the business gross management introduction or what exactly do you expect there?

Arnd Zinnhardt

You are absolutely right it’s more of the business process part in BPM broad checks as well as courses oriented in the implementation of SAP, but it is definitely the process automation which is mainly driving the consulting revenue and meddling the cost selling of our [inaudible] with our [BP] I mentioned.

[Koriofla – Stoigan AG]

Alright thank you.

Karl-Heinz Streibich

Looking at the time [indiscernible] speaking we now have to close the call if there is any remaining question please refer to the IIR department all lines are open. And I think [indiscernible] more work to do because it’s being introduced into the market if I look at the share price right now. So thank you very much for your questions and participation we talk again with Q3 results on October 26th. Or you can call before that. Thank you very much, good-bye.

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