Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Otmar Winzig - Senior Vice President, Investor Relations and Compliance.

Arnd Zinnhardt - Chief Financial Officer

Analysts

Raimo Lenshaw – Barclays Capital

Knut Woller – Unicredit

Thomas Becker - Commerzbank

Amit Roy - Numura

Adam Wood – Morgan Stanley

Thomas Le Quang - Natixis

Gregory Ramirez –Bryan, Garnier & Company

Fred Grieb - Credit Suisse

Derric Marcon - Societe Generale

Sebastien Sztabowicz - Kepler Capital

Julian Levy - Bank of America Merrill Lynch

Software AG (OTCQX:STWRY) Q3 2010 Earnings Conference Call October 26, 2010 12:30 PM ET

Operator

Ladies and gentlemen, welcome to the Q3 2010 Results Conference Call of Software AG. 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

Good morning ladies and gentlemen, friends of our community. Before we start as always, please let me make some housekeeping remarks. As regards to the conference, whoever is in has learnt this procedure, we send the dialing number by mail and rest of the participants have received the numbers for the Q & A dialog, in addition the conference will be broadcast via web in a listen-only mode and access to the web is via our investor relations website. The webcast will display all the power point presentations, the charts which are related to this call are the same charts that are in our website for download, and the full presentation was sent earlier this morning in PDF format to all the invited parties. The call in the webcast will be recorded and available for replay later today. The agenda of today’s call is the following. The CFO Arnd Zinnhardt will provide details of the Q3 and 9 months’ 2010 figures and the financial performance of Software AG and those who are familiar with our calls may recognize the change in procedure, from now on, the CEO will be backed for commenting on major events and half and full year results, for the next time on January 27th, 2011 or if something major happens in between.

After the presentation of Arnd Zinnhardt, you may ask questions. Please use only the dialing phone number for posing questions, otherwise, we cannot hear you. For technical reasons, we cannot take questions via email in this room here.

With respect to the capital market regulations, I have to now make the following statement. This presentation contains forward-looking statements based on beliefs of Software AG management. Such statements reflect current views of Software AG, with respect to future events and results and are subject to risks and uncertainties. Actual results may vary materially from those predicted here due to factors including change of internal, economic and business conditions, change in currency exchange, introduction of competing products, like of market acceptance of new products, services or technology and change of business strategy. Software AG does not intend or assume any obligations to update these forward-looking statements.

Now having said this, let us start and I hand over to Arnd Zinnhardt, the CFO of Software AG.

Arnd Zinnhardt

Good morning, ladies and gentlemen. Before I start, I would like to make some introductory remarks concerning the Q3 2010 reporting. We saw a recovery of our ETS business compared to the first two quarters of 2010. What metrics grows, strong over the last 6 – 9 months, and particularly strong in Q2, slowed down a little, when comparing that to the previous quarter. On the other side, [indiscernible] performance was very [indiscernible] resulting in a double digit growth of our newly formed BPE, business process excellence business line. In addition, our revenues from service and consulting activities came in quite strong. B; you will see the current CEC impact was material in Q3 and c; we saw a positive idea share acquisition synergy effect in Q3.

Having said that let me start with the currency impact on Q3, as well as for the first nine months. 43% of our total revenue was generated in the euro zone in the first 9 months. The remaining part of the business is generated in foreign currency. Besides, our strong US based business which contributes 23% of our currency related revenues, only the Brazilian Riyal had some larger impact on our business.

In Q3, license and maintenance revenue were equally affected. The currency effect for the first nine months 2010 is roughly 31 million. For the remaining quarter, we do not anticipate this development continuing and are more cautious especially regarding the Foreign Exchange effects in the US dollar.

What about our regional performance? As in last quarter, the Americas showed strong momentum during Q3. Our major market, the US market kept on track and was very positive, in the quarter, as well as year-to-date. Even though there are various opinions that are causes due to macro-economic uncertainties, like higher employment, lower than expected economic rebound and some more reluctant investment mood.

On the other side, India showed a mixed picture, whereas Dutch, Germany, Austria and Switzerland, the Nordic region as well as Middle East, were strong. Iberia and UK showed more challenging business environment. APJ was driven by a very dynamic performance in Australia, while Japan continued to be demanding. As you know, we have a diversified business model and our clients come from many industries. In comparison to last year, we sold a stable proportion of our business in the financial sector. On the other hand, even as governments implemented cost cutting programs, predominantly in Spain and the UK, the revenue share in this area grew year-on-year. From our perspective, the quality of IT infrastructure is key to modern cost efficient processes also in the public sector.

Looking into individual segments, I would like to kick off with our ETS business. We were able to increase our revenues from both, business and maintenance compared to Q3, 2009. In likeness, we booked revenue of 36.7 million, which equaled a quarterly increase of 6%. Maintenance revenue saw a plus of 6%, to 51.5 million. While [indiscernible] revenue in Q3 was below the previous year’s level, so a continuous trend, that we also have experienced in previous quarters and as a consequence, total revenue of the ETS business line was at a level of 101.4 million in the actual quarter, 2% more than in Q3 last year.

So far good news. We were able to close the gap from last quarter, but as you know, there are still more work to be done to reach our projected growth targets for the ETS product revenue for the fiscal year 2010, at least at the low end.

We still see some bigger tickets in the pipeline, that always have been projected for Q4, and we are focusing on closing these opportunities within the remaining months of the year. Looking at the ETS segment contribution margin of 57% in Q3 and 54% year-to-date, you will see an increase versus the respective prior year’s period of more than 100 basis points. Or to be more precise, if you compare your Q3 numbers, we are up by 250 basis points, while the year-to-date number is up by 120 basis points.

As you know, ETS is now substituted by our BPE business as being the growth driver. Consequently, we do have a close look to the margin development of this part of the business. The newly formed business line BPE includes our product lines webMethods and RS, which is our strategic approach moving forward. BPE shows double digit growth on license as well as maintenance. Like in Q2, we have realized some revenue synergies in the 3 last months. Let me highlight that we again managed to close RS deals exceeding 500 K each. This shows that we are right on track in our operational integration efforts. The webMethods product business, is as I mentioned, for an integral part of our BPE business. Once again, the sales teams are now fully integrated and we do not focus anymore on the individual product portfolios of webMethods and RS, but on the entire BPE offering.

Moving forward, we expect closer dynamic growth based on a strong sales pipeline, especially, but not only in the US. As we announced last week, we acquired a small company in the field of master data management, we think, this technology acquisition contributes to our positioning of being a technology and market leader.

Also service in other revenues improved by 23% in the quarter and 15% year to date. And allow me to make this side note, strong performance in contrast to the overall market environment. This positive development as well as the year to date license growth, proves the success of product offering. And I do anticipate some questions around the webMethods license revenue and I would like you to focus on the year to date numbers and this tells you more about the overall [indiscernible] as well as long term development than just a single quarter.

The segment contribution for the third quarter, and for the first nine months were enhanced by 600 basis points in Q3 2009, and more than 11% points respectively for the first nine months in 2009. Both numbers demonstrate a substantial improvement regarding the profitability of the business line. Particularly cost reduction in the sales marketing area as a result of closer improved sales efficiency, led to a margin of 31% for the third quarter.

Once more, we have been able to close more relevant webMethods transactions. In the first nine months, the number of last year’s increased to 174, coming from 115, which is an increase of 16%. In addition to that, average yield size shows an increase. Also, and that goes in addition to those numbers I just mentioned, we saw a number of larger mixed yields, which are not shown here, where we showed ETS and webMethods altogether. So yield respective number is 84, in total. Our sales success is based on good [indiscernible] you know how?. Close relationship with our customers, and more matured product portfolio as well as an increased track record in specific industries.

As you are aware of the [indiscernible] idea share revenues from August 2009 on, 38.6 million net including Q3, 2009. We are quite happy with the integration process of idea share and we do not anticipate any further restructuring costs. As communicated before, we are investing into R&D, to connect RS and webMethods [indiscernible]to a sheet, revenues achieved, even more revenues achieved than achieved so far in the upcoming years. The segment contribution amounts to 15 million more than double in comparison to Q3 last year and even exceeds the segment results of the first 6 months of 2010 by approximately 30%. This number clearly shows the progress of the integration process and the acceleration of profits also in this part of our operation. After merging both companies, the new product business with ARS is becoming much more attractive and we see further chances of profitable consulting business. As planned, we are starting realizing cost energy in Q3 and are certain to maintain this trend for the entire second half of 2010.

Our product revenue in Q3 was 17.7 million, an increase of more than 10 million contracts than the previous year. Our growth engine BPE, is a perfect combination. The feedback from customers is very positive and as announced, we will offer combined product suite in Q4 2010. This combined product offering addresses among others the following topics - A; High complexity of processes within customers’ operations, b; high manual efforts to realize the true color [indiscernible] if those product types are not fully integrated to each other, and c; high amount of digitize information at customers’ side.

We are a unique company, able to offer a tremendous improvement for the IT landscape and inherent processes to our customer (indiscernible). As a consequence, out of this strategic fit, the BPE now contributes more than 60% of the company’s revenues.

Revenues one side, profitability is another topic. And here, not only on a relative basis but also absolute numbers to get an impression of how dynamically we are growing. I am happy to report on a tremendous increase in the contribution of our different business divisions, starting in 2006.

Take this an evidence of a new phase of profitable growth of Software AG. It certainly underpins the success of AG as well as its execution. The webMethods acquisition is without any doubt a success story and the Idea Share acquisition also shows [indiscernible] clear evidence that we can, let me say that we will repeat this story. Obviously, this was another really good quarter for Software AG. The year to date growth amounts to approximately 43%. Our revenue stream comes from our well balanced business portfolio. Our business line increasingly able to balance fluctuations within the regions and industries.

A bit more detail of our P&L and a breakdown of our profitability on the next slide. Because of the increased proportion of services sold during Q3 2010, cost of sales increased. However, as in Q2, cost of sales margin improved due to better utilization of our consultants. In all relevant cost areas, we have increased efficiency quite substantially. And as a consequence, we reached a very healthy EBIT margin of 25% in the quarter. This means a strong step forward compared to Q2, where we just reached a level of 22%. Compared to previous year, EBIT grew more than 20% in the quarter, as well as year to date.

We saw a first decline on our financial expanses base on the pay back of debt related to the Idea share acquisition. Our cost management and increased sales efficiency led us to a tremendous increase in our net results as well as ETS. Profit before tax and net income increased by 20% respectively 19% in the quarter. The cash flow statements show a strong cash flow increase generated by operating activities. During the first nine months, we booked 145 million compared to 127 in 2009. Within Q3, it was a not slower, but still very strong. This is due to [indiscernible] activities in conjunction with the financing of the Idea share acquisition 12 months ago.

As you know, financial markets at those times, were very difficult. Therefore, we also used this financial (indiscernible) to structure our financing. Excluding this effect, cash flow grew, also double digit in Q3. During the last quarter, we started paying back debt associated with Idea share. As planned, we used our cash generated out of the operations pay back the promissory note of 70 million euros. We believe that our cash flow for the entire fiscal year of 2010 will exceed 200 million euros, another significant improvement compared to previous year.

Let us now take a look at the balance sheet.

Let us now take a look at the balance sheet. Cash and cash equivalent went down by roughly 93 million compared to the end of Q3 2009, due to the repayment of debt associated with Idea share acquisition, I already mentioned that. With 250 million, our debt position is 42 million lower than in the previous quarter. Q2, it was 292 million. The liability for acquiring the remaining outstanding Idea share in the magnitude of 22 million is included in financial liability following ISO resolute. Not included and that also follows ISO resolute, in this figure are our own shares which we bought for the merger activities, the respective amounts, the acquisition amount for those shares was 33 million. By the way the current market value amounts to 38 million.

The financial liabilities cover the promissory note of 150 million except for the loan for Software AG foundation, of 45 million and some things known 150 million which are in conjunction with webMethods financing.

Trade receivables decreased by 6% compared to end of fiscal 2009, and 2% compared to Q2 2010. The fourth quarter rolling DSL was at 97 days, an improvement of 6% compared to Q2, and let me highlight this is a continuation of the improved trend on ESL.

Shareholders equity expanded by roughly 11% to 679 million compared to Q2 2010, where the equivalent number was 672. Our equity ratio remained north of 40 million, 40%, due to a decrease of total assets to 1,551,000.

Outlook - Based on our 9 months results, we confirmed the outlook for fiscal year 2010 with total revenue growth of 25% to 30% [indiscernible]. In the second half of 2010, organic gross will determine our success because of the much smaller consultation of idea share. As you can see, we are still confident in reaching the ETS guide, we showed [indiscernible] as much sales in Q3, and are expecting some more to come in Q4 2010. In the first 9 months we achieved a gross of net income in the amount of 20%. As discussed earlier, this is due to a; Positive currency impact, b: cost synergy [indiscernible] c; economies of scale d; operational excellence in managing the cost basis

As a consequence, we are happy to report an increase of the guided profitability. Now we see a lower end of our profitability level of 166 million net income and 5 euro 80 for the EPS number. [Indiscernible] we are targeting is nowbetween 18% and 20%, after 10 – 12% guided earlier.

So far my explanations for the Q3 and I’ll now hand over back to Otmar.

Otmar Winzig

Ladies and gentlemen, you may now ask questions, and operator, please instruct the audience how to do that.

Question-and-Answer session

Operator

Thank you. We will now begin our question and answer session (Operator instructions). The first question is from Raimo Lenshow from Barclays Capital. Please go ahead.

Raimo Lenshaw – Barclays Capital

Good morning and well done, on the quarter. A quick question on the cost line, especially surprised on the sales and marketing side of the business, you know you are having a run rate now that is lower that Q1, is that kind of driven by dynamic purchasing, because the license and revenue number did not come through as much and is that sustainable number going forward or this is one-off that brought the run rate down? Thank you.

Arnd Zinnhardt

Hi Raimo, you are right, we are managing every individual cost line and we are in a good shape not only regarding sales and marketing but also admin and R & D. But you are right, we are also looking dynamic budgeting and therefore look very closely to the sales and marketing line and one of the effects is due to the --- as the total cost in the business, cost line regarding sales and marketing is now at a level of roughly speaking 21% or 20% in the quarter. Moving forward, one additional remark, the additional efficiency that we hear in that business line is also driven by the increased number of relevant transactions, I mean, if you take a normal transaction, the typical deal cycle as you know is between 6 & 9 months and it will then increase also the average amount that you achieve, then of course the efficiency of a sales organization improves, that is by the way that we also see moving forward.

With respect to how sustainable is that margin, I would model something around 21 – 22 for the entire years moving forward, we would continue with dynamic budgeting also in next year, on the other side, we also believe the business will also grow, moving forward, so looking at the BPE business line, we project gross for the next year will be around double digits, we will see increase sales and marketing assets in absolute terms, but not so much in relative terms.

Raimo Lenshaw – Barclays Capital

Thanks.

Operator

The next question is from Knut Woller from Unicredit. Please go ahead.

Knut Woller – Unicredit

Hello good morning and thanks for taking the question. Just regarding the license business in Q4, we are very high comparable on the webMethods side and we are also pretty good in Q4 on the ETS side. So, do you overall expect on the group level also at constant currency, positive license growth, because we have seen in the first 3 quarters a constant currency, still license decline so I am just trying to get this. Just getting back to the cost ratio to what Rymel just asked, if I look at the business lines, sales and marketing has been up on the ETS, and it was down on the webMethods side, so I am still trying to get the math here, because if I look at the ETS license revenues were down and still sales and marketing up so I am just trying to understand the logic behind and the dynamics behind that. Thank you very much.

Arnd Zinnhardt

Let me answer you first question. If you looking to the Q4 license revenue, yes, we project a growth of alternative currency for both business lines moving forward. Of course it’s also true for the ETS business line. So that if something that we do see based on the pipeline that we have in front of us.

Regarding the cost ratios, looking into the ETS development, you are right, ETS group, in the quarter if you look year to date number, we are very much flat on the other side, one additional effect you should recognize is the currency impact. So we see a positive currency impact on the license side and then we talk about natural (indiscernible) and as we have a predominant US operation in the ETS side as well as Brazil, we of course by purely translating the figures into the Euro, we have seen increase because of the different currency ratios. That is one remark.

The other remark is of course, we do in dynamic budgeting focus on individual cost centers and as we have some cost centers that are purely webMethods, and other cost centers which are purely ETS, the dynamic budgeting refers to that specific cost or profit center. So therefore, that is the concept within the dynamic budgeting we do have the situations that people might invest additional money in webMethods, whereas ETS is on a hiring spree or the other way round.

Knut Woller – Unicredit

Ok, got it. Thank you.

Operator

The next question is from Thomas Becker, from Commerzbank. Please go ahead

Thomas Becker - Commerzbank

Good morning, thank you for taking my question. Actually I am little bit more interested in the consulting business. Could you like to share if the consulting as a whole is profitable and could you give an idea as to what the current utilization is and probably another question, your guiding for ETS up let’s say 20% this year and the company already reached 19% after 9 months. So I am wondering if this is given the fact that you said that Q4 will be up with respect to license sales even this is not a bit too conservative.

Arnd Zinnhardt

I will start with the consulting business first, Thomas. The answer on the consulting must be give based on the individual business lines. So ETS, BPEs and FATs and what we have seen here is on the ETS side, that the revenue is decreasing over the last years and we anticipate that this trend will not turn around. So therefore, we are adjusting the FTE basis on that part of the business in order to keep utilization rate up. On the webMethods side, we are heavily investing into resources with the growth of that part of the business of more 20%, so we are heavily investing in all regions, at the prime point of time, we are also in addition to activities in the individual countries, renting up off shore resources in eastern Europe and also in India. And we even hired additional HR people in order to operate these hiring processes. This will be dynamic process especially going on in year as we see a growing demand for resources out of India. Therefore, utilization on the webMethods side is at the maximum. So all the people completely fully utilized. The same is true on the RS side, on the Idea share side, on the SAP side, we had a strong positive development in Q3 compared to Q2, we are now back to the budget utilization rate especially in Germany, we see additional improved in the European countries, coming from a lower level, although we see some challenges in China as well as Japan regarding the SAP business. Utilization rate as I said is on the budget level, so therefore, as also on the idea share side where we also anticipate modest revenue growth, we are currently in the process of hiring of consultants.

Thomas Becker - Commerzbank

Ok

Arnd Zinnhardt

Next question was with regards to ETS. You are right, ETS growth was around 20%, the guided range is between 18% and 20%, you know that the volatility of licenses and the uncertainty whether you have got a license at the end of the year also highly determines whether you have reached year’s guidance, so therefore we clearly did not want to be in a position to make some kind of lowering our ETS guidance went reporting above on the Q4 numbers, so therefore you might call that a positive approach, I would call it as a professional approach.

Thomas Becker - Commerzbank

Ok. So you say that you are more positive with respect to webMethods and ETS with respect to Q4?

Arnd Zinnhardt

Yeah, we see growth in both business lines, and we also see positive development on the idea share side.

Thomas Becker - Commerzbank

Follow up question and then I go away. Could you comment once again on the performance of webMethods and ETS per region. I got it that the ETS is strong in Brazil, it seems that it is strong in the US, and also true for webMethods as well? You were so strong in India or little bit weaker or mixed?

Arnd Zinnhardt

US was also very strong, like in Q2, very very strong growth rates, it was weaker in the UK, I said that in my presentation, the UK government very dramatically stopped investments, so therefore, that certainly gives us some room for improvement in upcoming years to catch up again in the UK, so UK is a difficult area, same with Spain, we achieved more revenue in the webMethods area in Germany but also in France, if you take BPE as a new business line, we saw also very nice yields with two consulting companies, and probably should not comment on that and therefore, two deals with consulting companies that were closed in a combination of France plus UK which had a worldwide effect, so those consulting companies will now moving forward use our technology, for their process practice. So we hope that this has a leveraging effect also into their customer base so that ours becomes more and more standard and as a consequence, once the product offerings of webMethods and RS are fully integrated, will directa [indiscernible] webMethods revenue.

One -- just one additional question regarding the reporting logic, you saw that we for the first time provided you numbers with BPE, from an operational perspective, we already managed the company for BPE, rather than for webMethods and RS and therefore, we’ve started a now a step by step give you the respective information also for BPE, as starting of Q1 of next year, we will only report on BPE rather than on webMethods and RS individually.

Thomas Becker - Commerzbank

Alright, great. That's it thank you.

Operator

The next question is from Guna Sagar from Nomura. Please go ahead Sir.

Amit Roy - Nomura

Hi this is Amit on behalf of Guna. Regarding your ETS business, how do you think you could increase your profitability from a pricing perspective and given that there seems to be some difficulty on the growth margin and limited scope for transferring further staff into offshore locations? And I also have a follow up.

Arnd Zinnhardt

If you look through the profitability, you see the profitability on the ETS side has enhanced and not being reduced. So, I just repeat the numbers once again. If you look at Q3 as against Q3 2009, the segment result has increased by 250 basis points so it’s quite nicely up. Looking through the first 9 months, it’s up by 120 basis points, so we still see an improvement already on a very high level. Nevertheless, your question is also regarding low cost operations. Here the answer is predominantly around the R & D activities, as you might know the knowledge of mainframe business in India is not so wide [indiscernible], so India is not an option. However, there is sufficient knowledge of mainframe businesses in Eastern Europe, especially in the former Soviet Union, so therefore we do have R & D activities operating out of Regal, as being the low cost operations for the ETS area, in addition to that as you certainly also know that we have got R & D activity also in Bulgaria, that was basically founded for the webMethods activities, we are now starting also to integrate ETS in that operation.

Amit Roy - Nomura

Ok. Thank you. As a follow up if I may, with your consulting operation reporting such strong numbers, you have already commented on this, but would you actually start for strong cross selling of webMethods into SAP base as a specific target?

Arnd Zinnhardt

Sure that is a target. That is a natural target; we do see a combined approache to customers of Software AG and SAP where we offer a combined stack of SAP technology together with webMethods plus RS technology.

Amit Roy - Nomura

Ok, thank you

Arnd Zinnhardt

Sure

Operator

The next question comes from Adam Wood from Morgan Stanley. Please go ahead

Adam Wood – Morgan Stanley

Good morning, thanks for taking the question. Just first of all, on the cost run rate for Q3, we have spoken a little bit about the cost control dynamic budgeting and everything. I wonder if you help us understand the cost of synergies through to come through the idea share acquisition. Could you help us understand how much more cost control run rate come down, I probably assuming in the first half of next year. And then secondly, just on the pipelines for licenses in Q4, could you please give us a little more visibility, you probably had a good quarter on the ETS side and the third quarter closing some of the sales, the larger ones were maybe not there in the first half, is there normal seasonality, is there also an upside you are expecting, any insights you would give us on the pipelines would be helpful.

Arnd Zinnhardt

I will start with the first question with regards to the synergies. You know that the original guidance of synergies, cost synergies, was between 25 & 30 million. I believe it will be rather 30 million +. Coming out of this area, in addition to that, if you look to the growth effect at 50% of that respective range, should be real life in 2010, whereas the entire effort would come through in 2011, we see that we have received by far more than the 50% by this year, I am happy to report that all those areas that have a personnel related effect, and you know from an operational point of view, that is hard to achieve, and our executed so therefore, it is basically what needed to be done from an operational perspective is executed. So therefore we can now harvest the respective cost synergies.

On the pipeline perspective, you are absolutely right; we have got a normal seasonality in our business which will result in higher Q4 license numbers, we see that if we manage to get these figures especially on the ETS side, then we will see an over proportional development compared to the normalized “seasonality”.

Adam Wood – Morgan Stanley

May be this is a quick follow up on the synergy side, when you say you have achieved more than 50% in 2010, does that mean 60% or 80% of it is already through, just to give us a feel of how far along you are on the synergy.

Arnd Zinnhardt

I would be in the middle of that. I would say two-thirds.

Adam Wood – Morgan Stanley

Ok, thank you very much.

Operator

The next question is from Analyst Thomas Le Quang from Natixis

Thomas Le Quang - Natixis

Thank you for asking my question, it is regarding the webMethods license in Q3. Could you provide us with an explanation on the -5% decrease in the customer currency and what you expected? Did it amount to according to you, did you lose deals to your competitors? Thank you.

Arnd Zinnhardt

Now there is a rate of prospect changed to signatures in unchanged, we are pretty much talking about the basic effect, number one, 1 million already makes a huge difference, and we also made a tremendous growth in Q2, so we had a gross of more than 200% in Q2 which resulted in you be closed earlier than what we from an operational perspective would have anticipated. So therefore it is rather a year to date performance than one individual quarter, one additional remark, in contrast to the ETS business line, we generate new customers net new customers on the webMethods side every single quarter, so therefore, the volatility of this part of the business is higher than the ETS, so therefore I would like you not to just focus on one individual quarter, even if it is an outstanding quarter like Q2, rather look to development over a couple of quarters.

Thomas Le Quang - Natixis

Ok, thank you.

Operator

Our next question is from Daud Khan from JPMorgan

Daud Khan - JPMorgan

Thank you for taking question. Can you talk about the larger number of larger deals in webMethods, is that affected by the services revenue that you are now seeing? That's the first question. Second question would be, can you tell from the revenue impact from acquisitions for Q and third question, you talked a little bit about factoring last year’s impact, is there any impact from Q4 last year that we need to take into consideration for comparison purposes.

Arnd Zinnhardt

Just repeat the last one.

Daud Khan - JPMorgan

You talked about the factoring in last year, and the last one is the cash outflow in payables liabilities, on the cash flow statement, if you could explain that, that would be great.

Arnd Zinnhardt

Ok. I start with the webMethods average yield size and the average growth of it excluding consulting revenues. So what we meant in there is what we call or what the industry calls booking which is license revenue and first year’s maintenance. So the respective consulting revenue goes in addition to those numbers shown under the respective slides. Why are we able to increase the average yield size and by the way, that is a very positive development over the last 3 years, if you turn back time 3 years ago, we were talking about average yield size of $200,000 instead of 500,000 euros. Why is that, that is because the concept of sore integration and process automation has become more mature, in the business and market as such, so therefore, people do understand the concept, do see the advantages to individual business models and therefore willing to invest more in these kinds on concepts and technologies. We do see that this going to continue and we see a trend that within the next couple of quarters, 4 – 8 quarters, operations are setting their standards for integration. Therefore we do expect the average yield size to continuously growing also for the next 2 or 3 years. With respect to the acquisition, the second question that in Q4, obviously no impact on revenue of Q3, that revenue acquisition is pure technology acquisition, so there is no factor coming out of complicating the acquisition. The number 3, factoring that was a specific situation that we faced in Q3 2009, as you know, the financing possibilities within the banking sector was difficult that time, banks had the tendency to generate commissions, rather than open their balance sheets for granting loans, so therefore, we looked at the various financing improvements to aid to get to the resources necessary for doing the acquisition but we also look into the best, in other words, cheaper ways of financing, so therefore one of the ways for doing was texturing, so it was a one-off especially for Q3 2009. The Q3 2009 effect on Q3 2010 is 0.

Daud Khan - JPMorgan

And then just the last question on the cash outflow, in payables and liabilities, we have not seen cash flow (indiscernible)

Arnd Zinnhardt

But there is nothing special to be mentioned that is pure operational development that we have. No special item.

Daud Khan - JPMorgan

So we would not expect that in the next quarter? Ok, than you very much

Operator

Next question is from Gregory Ramirez from Bryan, Garnier & Company. Please go ahead.

Gregory Ramirez –Bryan, Garnier & Company

Thank you for taking my question. I just have one simple question regarding deferred revenues especially the deferred revenue coming down in Q3 by 12 million euros, is that related to normal seasonality or is that related to something which could be specifically related to life sensors or consulting projects.

Arnd Zinnhardt

Just to repeat your question, you are talking about the deferred revenue, aren’t you?

Gregory Ramirez –Bryan, Garnier & Company

Yes.

Arnd Zinnhardt

The deferred revenue is something that is very interesting over the development, to answer your question, it is around the future maintenance revenue, ok, if you look at the profile on how we do our maintenance business, the concept is the following, we sign contracts with our customers for a period of 12 months, or looking to the US and UK, it is usually longer periods, between 3 & 5 years. So typically as the cash flow is at the beginning of the period, so let’s assume you have got a contract starting on January 1st to December 31st, we invoice our customers on January respective cash into Q-1, so that is also the reason, one of the two reasons why cash flow in Q1 is particularly strong. So as we are not allowed to show that money in-flow as revenue, maintenance revenue is shown on a pro-rata basis, we book that into the deferred income, and then deferred income becomes the maintenance revenue once the maintenance services are delivered to our customers. Therefore the increase of deferred income is also an indication for a grown number of maintenance paying customers and growth of future maintenance revenue.

Gregory Ramirez –Bryan, Garnier & Company

So that does not have any impact on Q3.

Arnd Zinnhardt

That has no impact on Q3 or for the upcoming quarters.

Gregory Ramirez –Bryan, Garnier & Company

Thank you

Arnd Zinnhardt

Yeah

Operator

The next question is from Fred, Credit Swiss. Please go ahead.

Fred Grieb - Credit Suisse

Hey nice quarter for you guys, just two quick ones from me, the first one is, could you give us more detail around the customer buying behavior the large deals,. What caused large sales in Q3 to close and what confidence you have that in Q4 it won’t close? And then the second question will be an update on the dynamics in the modular space.

Arnd Zinnhardt

I will start with the customer buying behavior. Here we need to differentiate between ETS business and BPE business. On the ETS side the question is not so much, if whether a customer buys, it is more a question of when we get the contract signed, typically what we see based on the contractual situation that we have with the respective customer, we have a triggering effect coming up in certain quarter. Therefore, we start our activities regarding the specific customer work before this time arises so therefore if there is legal necessity to sign an additional contract on the ETS side, we have got a pretty grip on when this deal really happens. So it is more a question of this quarter or next quarter but it is not a question of is it happening as such or deal extending for 2 or more quarters. So therefore the creditability on the ETS side is high.

On the webMethods side, the story line is of course a different one, here, the most important question is, is there a budget available, it is an important question because hunting opportunity when the customer has no money loses. The probability becomes high that we get the deal done once we have delivered a proof that we accept successfully. So within the sales title, customers do ask us to deliver a conceptual solution based on his requirement. And then typically the vendors being on the shortlist have to approve their list and then at the end of this, it is valued against the PS. Typically, if we are able to come to the shortlist, then the probability of being selected at the end of the day is pretty high, so once a proof of concept is done, we view on whether we are able to close a contract.

Fred Grieb - Credit Suisse

Thanks. And then the on the competitive dynamics and the modular space?

Arnd Zinnhardt

Competitive environment, pretty much [indiscernible] as last quarter, I believe the most active parties in the market are Oracle and IBM that has not so much changed as such. So therefore that continues, that is the vendor side, we also got to look at the customer’s side. Growing demand for individual components and that is why we acquired the MVM company, because we see an increasing demand out of the entire universe in the integration tech, that is a normal development that we will continue, that the market is moving in one or the other direction. We always need to consider if time to market is crucial, if yes, then if the topic is strategic one, then we see tech acquisition, if time to market is not that crucial, then we do with our own R & D resources.

Fred Grieb - Credit Suisse

Thanks a lot

Arnd Zinnhardt

Sure

Operator

Next question is from Derric Marcon from Societe Generale

Derric Marcon - Societe Generale

Hey good morning Tom. You hear me

Yeah sure

Derric Marcon - Societe Generale

A very simple question, I see the ETS revenue decline in Q3 that we are seeing I would say a positive momentum between Q1 and Q2 and I was wondering why this trend has reversed in Q3 and what did you expect in Q4?

Arnd Zinnhardt

For Q4 we again see a growing ETS number, each smaller fluctuation is linked to what we call a back maintenance. Let me explain back maintenance, it is typical revenue recognition pattern is the one I have just explained, to collect the money and post the maintenance revenue it on a pro-rata basis. However there are some geographies where the likelihood of collecting money is not as high as in western Europe and also America so therefore we take a more cautious approach, which is also outlined and post the reeve after that point in time that we actually collect the cash. It happens that in one quarter, maintenance revenue flowing in for 1,2,3 or 4 previous quarters. So this cautions approach is till the time we collect the money, so these are the small fluctuations you always see on the maintenance side.

Derric Marcon - Societe Generale

Thank you

Operator

The next question is from Sebastien Sztabowicz from Kepler Capital

Sebastien Sztabowicz - Kepler Capital

Good morning everyone? Got a question with regards to capita margin for the full year 2010, how that translates into the full year.

Arnd Zinnhardt

If you calculate, the old margins would have left to a margin on 22%, if you do the same exercise with the new margin, you would with the new guidance range, the new margin is 24% plus.

Sebastien Sztabowicz - Kepler Capital

Ok thank you.

Arnd Zinnhardt

Can we take one more question now as we reach the end of the session?

Operator

The next question is from Julian Levy from Bank of America Merrill Lynch.

Julian Levy - Bank of America Merrill Lynch

Congratulations on a good quarter. Just a general question on the mix. What do you see as your long term mix for services and maintenance shifting around the BPE business.

Arnd Zinnhardt

I answerthe question on total company numbers first and then I go into the BPE side if I may.

Julian Levy - Bank of America Merrill Lynch

Sure

Arnd Zinnhardt

We project that on the overall company level the product level will grow proportionately, and the service plus consulting number which is now at around 40% will decrease down to 36% whereas the product side will grow proportionately. If you lock at the BPE business, the license will grow double digit, we also anticipate that maintenance will grow double digit, very much the same on the consulting side, here we got a product mix, as we got one third, one third, one third, that is something I also foresee moving forward. Having said that, in excellent terms, the number of maintenancepayingcustomers, the contracted volume on the maintenance side also increases, and also the margin in this segment as well, if you see a last couple of years, you see this happening ad I communicated that we are in the margin of abbot 31% for the quarter, I see that this margin will also extend as we move forward because of the increase in sales volume.

Julian Levy - Bank of America Merrill Lynch

Thanks. Could I ask one more question about data foundation acquisition?

You obviously build a lot of components, can we see a lot around ted data foundation policy as well?

Arnd Zinnhardt

That will be one area that we will look at. How do we do that, we listen very carefully to the customers, we don’t have a process implemented, to the technology board, and based on these kind of requirements, we made our decisions.

Julian Levy - Bank of America Merrill Lynch

Cool, ok and we should model that as increment to the average sales side?

Arnd Zinnhardt

Yeah

Julian Levy - Bank of America Merrill Lynch

Thank you.

Arnd Zinnhardt

Thank you

Otmar Winzig

Ladies and gentlemen, I am afraid I got to close this call now due to other assignments. Thank you all

Further questions will be handled by the IR team, let me just add that we will be back at our desks within 60 minutes. Q4 results will be reported on January 26th 2011 (inaudible), nevertheless, I would swish a nice season for the rest of the year, thank you. Bye bye.

Arnd Zinnhardt

Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Software AG Management Discusses Q3 2010 Results – Earnings Call Transcript
This Transcript
All Transcripts