Software AG

Otmar Winzig - Head of IR Karl-Heinz Streibich - CEO Arnd Zinnhardt - CFO Eric Duffaut - Chief Customer Officer

Michael Briest - UBS Knut Woller - Baader Bank Adam Wood - Morgan Stanley Stacy Pollard - JP Morgan

Good morning ladies and gentlemen. Welcome to Software AG's telephone conference and webcast on preliminary third quarter and first nine months results 2017.

This morning, we have published the full set of numbers as well as the presentations used in this call on our website. Today's call will start with CEO, Karl-Heinz Streibich; followed by CFO, Arnd Zinnhardt; and Chief Customer Officer, Eric Duffaut.

The presentations will be followed by a Q&A session. We will keep this call in the regular one-hour time frame.

Before we start there are some housekeeping remarks. This telephone conference will also be broadcast via web.

Access to the webcast is via our Investor Relations website. The webcast will display the presentation charts related to this call, the same slides that are on our website for download.

After the presentation, you may ask questions. Please use only the dial-in phone number for posing questions.

The dial-in numbers are also published on our website. For technical reasons, we cannot take any questions via e-mail during the conference call.

The call on the webcast will be recorded and available for replay later today. With respect to Capital Market regulations, I have to make the following safe harbor statement.

This presentation and call contains forward-looking statements based on beliefs of Software AG management. Such statements reflect current views of Software AG with respect to future events and results and are subject to risks and uncertainties.

Actual results may vary materially from those projected here due to factors including changes in general, economic and business conditions; changes in currency exchange; the introduction of competing products; lack of market acceptance of new products, services or technologies; and changes in business strategy. Software AG does not intend or assume any obligation to update these forward-looking statements.

Thank you for your patience. Now let us start.

I hand over to Karl-Heinz Streibich, the CEO of Software AG.

Thank you very much, Otmar. Hello and good morning, welcome to our Q3 call 2017.

I'm delighted to present to you today the significant acceleration of our IoT cloud business through winning new customers and new businesses in new markets. Specifically in the machinery and tooling equipment market, as you heard already weeks ago, through our ADAMOS team and in the manufacturing markets, markets that are preparing for the industry for the TRO [ph] transformation.

In continuation of our digital business platform strategy, we are building up a significant momentum in the IoT cloud area. Maybe, our strategic partnership with Bosch, which started in 2015 could be seen in hindsight as the turning point for our digital IoT business.

However during the last three months, we accelerated our success significantly by winning landmark IoT cloud deals with large companies in the industries I have mentioned on automation one side and big industry players on the other side. And we are convinced that this IoT cloud success will continue during the next quarter's and the coming years.

Core decisions we took ladies and gentlemen to build up this success had been first years ago we decided to extend our portfolio into the real-time technology platform area, which we did through the acquisitions of Universal Messaging through Terracotta in-memory, Apama Streaming Analytics, Zementis artificial intelligence and Cumulocity IoT cloud device management, all that is one platform today. And second, we decided to focus our go-to market on the German IoT markets first due to the high degree of industrialization and automation Germany.

And third, we network with the manufacturing and machinery tooling markets early which was new for us. We also increased our must-win focus on industry customer projects and used cases and we introduced technology leading innovations to achieve top ratings by Gartner and Forrester.

Ladies and gentlemen all that followed our master plan and that was to utilize the potential with the industry for the TRO, a concept offered to us. And four, we decided finally in Q3 2017 to switch core thesis from perpetual upfront customer payment into pay per use, recurring payments in the coming year.

I estimate we switch the potential of 10 to 15 million digital business licenses revenue outside the ADAMOS base in Q3 from the recurring payment through pay per use. Great decisions for the future, no question.

However not easy to sacrificing our front license revenue contributions for a quarter. So you might ask yourself what makes Software AG so successful, winning against all the dominant IT players in the IoT cloud area.

As you if have seen with ADAMOS on one side, other great industry example the other side. I want to focus on them that you have a clear picture of our differentiator.

First, it is Software AG's technological leadership in several IoT cloud technology areas this ensures our new customers that Software AG is a unique innovation partner for the digital IoT transformation roadmap. And second, Software AG's neutrality and not being a potential competitor of the manufacturing industry, our machine tooling customers.

This creates the trust required to join for the core innovation journey. And third, Software AG's mid-sized company culture as a global software players you have flexibility and agility.

This gives our customer the reassurance that we are totally customer centric and responsive. And fourth, Software AG's heritage of being software platform company since many years.

We understand the digital platform economy a huge strength compared to the application portfolio software member. And fifth, Software AG's go-to market model is direct customer ownership oriented.

The direct sales force and we combine it with our global consulting services which focuses then on fast customer value implementation. This gives customers the faster route to value creation in the digital world especially compared to pure indirect model.

And finally, point six, Software AG's home base in highly industrialized Germany, ladies and gentleman this is a pool position we have for market leadership in the IoT cloud area as well as in the entire industry for the TRO subject. As a result, we are the new preferred partner of those global champions as you have seen with the ADAMOS partner [indiscernible] SMPT and others will come soon, you will see.

They all direct users digitizing the business models through digital platform based IoT use cases. And in addition to that in addition to ADAMOS, we are mission critical IoT technology a component provider for large manufacturing companies and portion others to enable them to win in a digital, in the IoT world.

As you all know the IoT market is considered overcrowded because every IT company is now marketing IT products. In addition there are new entrants coming from the industrial side, the good news first, especially the industry players, all have a need for technology where we Software AG have a leading position.

So we are potentially inside. And you all remember I'm sure the Intel Inside campaign with PCs.

Second, we don't compete with their digital industry solutions, thus being a trusted and therefore very relevant partner for them now and in the future. All these reasons and successes are the consequences all of our focus and persistency since years in becoming a globally leading digital technology platform company.

Therefore we have decided to install and report a new third line of business for Software AG the IoT cloud business from 2018 onwards. Our estimate is that we will double this business year by year for the coming three to five years, which will be recurring IoT cloud-based revenue.

Our CFO, Arnd Zinnhardt will inform you in more details on that. Despite this dynamic growth, we expect only a small impact in the mid-term on our on-premise business growth.

The IoT cloud's revenue will be mostly incremental in coming from new market and manufacturing machinery tooling industry. And we are sure our success in the industry for the TRO related markets will have a positive spillover effect on all other markets which are in digital transformation process as well.

You all might have waited for quite a while for what is our bold move to the cloud. We responded we delivered.

We did it from the customers not through massive spending and acquisitions, but with a combination of focused technology acquisitions as I mentioned and organic growth. We were, we are and we will be a software platform company focusing on the architecture of the customers' digital infrastructures which are by nature on-premise, but increasingly also adding cloud applications and cloud-related revenue streams.

We tell our customers think architecture first and build up your own IoT expertise and they follow. Please also refer to our white paper mastering the challenge of digital transformation, which you can find in the Internet.

Ladies and gentleman we are in a great position that we can maintain our presence in different markets such as banking, insurance, public and others, and expand our IoT cloud transformation into new markets for us, with only a limited impact on our perpetual license business for the time being. And ladies and gentlemen this infrastructure cloud transformation is starting now and we are prepared because we prepared for that IoT cloud transformation years ago, but now it's taken into action and it's starting in Germany and we as Software G are there.

Therefore we see this third quarter of 2017 as a great start of an even greater future due to the industry for the TRO market potential for Software AG. We are for the first nine months with our digital business in growth mode, despite - and including the transformation of perpetualized potential into cloud payment terms.

And our pipeline is great for Q4. Therefore we confirm our in Q2 reporting already increased guidance for 2017 and we will also give you more details on our total year outlook.

Thank you very much for being with us in this great phase of our company. I hand over to my colleague Arnd Zinnhardt.

Thank you very much Karl-Heinz Good morning ladies and gentlemen, a warm welcome to our conference also from my side. Let me continue making some opening remarks with high strategic relevance.

We made significant progress with our IoT business resulting in major agreements. Karl-Heinz already mentioned our ADAMOS JF before, which is going to be the leading IoT platform for the manufacturing and plant engineering industry.

In addition to this innovative partnership we signed numerous other arrangements. Based on those contracts we are going to deliver our leading edge IoT product in our IoT partner and customer platforms in Germany as well as worldwide.

Among those agreement, our leading telco providers such as Deutsche Telekom and TNT, KPN, Telstra and Telia as well as other world leading IoT platforms of large globally operating manufacturers you all know and you all talk about. These multiple agreements give us a perfect diversified positioning for the future in the mega trend of IoT addressing various industries and various fields.

If you take an extremely conservative view on those contracts signed earlier, for instance, by just considering the contractual minimum commitment or the cloud deals in our books we have quite recently created an annual recurring revenue stream of more than 20 million per annum, which you will see already next year. On the same basis, our recurring revenue is multiplied in 2018.

And this is just the low case. With every device being connected and every partner joins the existing agreements and platforms, this number is going to increase quarter by quarter and year by year.

We are so excited about this business opportunity that starting Jan 1st we will set up a third product business line. Please also have in mind that we are nicely scaling out our R&D expenses by selling the products into digital, EDP and into our IoT opportunities.

Ladies and gentlemen this is a revolution in our industry as well as in our customer's industry. Therefore in order to harvest the full value of our IoT product offering we have launched a new IoT licensing model.

We now also offer usage based licensing models which have the following advantages. We offer to our customers a low barrier of entry into the IoT with modest minimum commitment.

To model mitigates uncertainties customers still might have. And on the other side it gives the potential to scale with the full upside of device connection end users.

The business model generates predictable recurring revenue which aided growth with every device being connected therefore it combines the advantages of cloud business model with further growth in existing contracts without the necessity of going through sales cycles again and again. Let me emphasize, this licensing model creates basis for dynamic growth as revenue will increase within existing contracts and additionally by signing new agreements.

These advantages let us tediously step away from our classic license agreements with perpetual license and revenue being recognized up front in the ballpark of eight digits, so more than 10 million. We did this as we realized in the discussion with our customers that we by no means would have maximized the business potential to its full and true value.

And let me be very clear on that. I'm talking about an additional transaction with a well-recognized IoT platform provider besides and in addition to ADAMOS.

Consequently, we need to evaluate our business performance by considering both the revenue recognized and the deals signed with cloud and usage based license metrics resulting in a sustainable recurring revenue stream of at least 20 million plus. After this strategic extremely relevant opening remarks I would now like to guide you through the numbers.

Last quarter we saw a negative ethics impact on all revenue lines. The headwind comes predominantly from US dollar, which was around 4% to 5% weaker compared to last year.

In case US dollar would stay on a level of 117 to 118, we anticipate an even stronger effect on Q4 revenue. The headwind could be in the magnitude of 8% to 9% for the US dollar only and 4% to 5% for the entire revenue.

As already mentioned in my introduction, the move towards the more cloud and usage based licensing had an impact on stated Q3 revenue. Simultaneously and consequently we created a substantial business that even in let's call it worst case scenario will create minimum 20 billion plus annual revenue in 2018 and on an ongoing basis just based one contract site.

Looking at these two components which are to a certain extent communicating pipes, we saw major achievements in our performance in summer. Eric will go in more detail.

In January we will give you a more concrete and precise outlook on this new part of the business line. But be ensured any number we will present is going to be north of the 20 million I just mentioned.

In Q3, maintenance continued its growth path with a plus of more than 5% and again reached a new historical record level. The combination of license performance and continued trend in maintenance led to a digital product level which again exceeded the 100 million mark despite the shift into more recurring business on the IT side.

Year-to-date we are performing in line with our guided range which continues to be between 5% and 10% revenue growth net of currency. Let's have a look to the cost lines.

All expenses well under control. The combination of top line and expenses well under control allowed the segment result increase by 7% and the margin to enhance by 30 basis points.

Regarding other perpetual licenses, we continued catching up and recorded a double-digit license growth. This is not unexpected result as already mentioned in our last calls.

Looking into Q4, the strength of the ADAMOS natural license business will continue. You all experienced in the past ADAMOS natural as a high degree of predictability as we sell into our existing longstanding customer base.

So the robustness is proven again by the maintenance performance. Maintenance showed an expected development in Q3.

One side remark, like in H1, also Q3 was impacted by cash accounting effects predominantly in Brazil a year ago. This is the reason for a slightly higher state of decline at Adabas & Natural on a pure operational basis, the maintenance showed a very modest decline of only 1% to 2%.

The focus in the consulting business continues to remain on supporting our strategic license project and simultaneously closely monitoring profitability. As a matter of fact this strategic set up combined with a good excellent consulting management team resulted in a continuous outstanding performance.

Revenues up by 3% against last year once again we delivered double-digit segment margin for the quarter as well as the first nine months. As discussed on the last three slides, our business progressed and developed nicely.

We built a good foundation of our new IoT business line which will grow dynamically. Regardless the IoT achievements, our digital shows a year-to-date product growth at the lower end of all our guidance and a good pipeline for the months to come.

Regarding Adabas & Natural, we delivered growth for the second consecutive quarter and we'll also do so in Q4. In addition, the consulting business remains successful.

Our EBIT and EBIT margin is in line with prior year. This is true for the quarter as well as for the first nine months.

The operating margin, our prime earnings KPI remains strong. In the quarter we achieved an operating margin of 32.2% in the quarter and 29.7% year-to-date.

The increase in share-based payments is linked to the positive shear price performance in recent months. As a result we had to recognize all future expenses of our stock incentive plan 2016 in Q3.

Consequently we will see the corresponding release in the upcoming quarters. Ladies and gentlemen let me continue with two general remarks to free cash flow.

The free cash flow for Q3 is 14% up against last year. And year-to-date, cash flows is impacted by the acquisition of property and land I mentioned six months ago in the magnitude of 17 million and higher tax payment of 5 million.

Balance sheet is solid as you are used to, net cash position amounts roughly to 22 million plus despite the fact that we spent 134 million on dividends and share buybacks in each one or 200 million altogether when adding the purchase price of the office building and of the company that we acquired at the end of March. Receivables are sustainably reduced compared to year end and 12 months ago resulting in an improved DSO rates of 83 days.

DSO rate is the best we have seen for more than five years. Shareholders equity remains on a very high level of 60%.

Ladies and gentlemen, we confirm our outlook for the year. Looking at the first nine months, the digital product business proves to be in the guided range, especially the recurring maintenance revenue again showed a healthy development.

We believe that we will close the year within the guided corridor, it's more likely at the lower end of the range. In addition to this performance, we are building up a new segment which we already achieved material three-digit growth and thus will play an important part of our business development moving forward.

After a slow start into the year, Adabas & Natural again showed a double-digit license growth. We are confident that license will remain to be strong in the last three months of the year.

Consequently, we confirmed our outlook. We will achieve a number which will be in the upper range of our guidance.

Given the margin achieved in the first nine months, the maintenance growth as well as the pipeline ahead of us, we will achieve a margin rather at the upper end of our guided range of 31% to 32%. With these encouraging messages let me know hand over to Eric who will comment on the go-to market and the business development as well as the pipeline for the rest of the year.

Eric over to you.

Thank you very much ladies and gentlemen I would also of course like to welcome you to today's call and thank you for your continued interest in Software AG. So that you've got the financial figures from Arnd, I'd like to review our business developments in Q3 and of course give you some color and insight into our 2017 business development.

As mentioned, Q3 was indeed a quarter of immense strategic importance for Software AG. We launched Cumulocity IoT, our cloud-based IoT portfolio for easy, fast and scalable IoT solutions to support enterprises of any size.

And the proof of the significance of Cumulocity IoT, customers such as AIA Insurance Group in Hong Kong, The Dutch telecommunications company KPN, Telstra in Australia, Telia, the dominant telecom company and mobile network operator in Sweden, Reliance Communications in India. Japan's NTT, [indiscernible], Comcast, and Nokia are all basing their IoT transformations on this platform.

And there is more we are indeed becoming the engine of choice for IoT platform providers such as Bosch, Deutsche Telekom, the ground breaking joint venture ADAMOS with who's who of German and international manufacturing. This is the game changing market approach showing the way for the software industry to work hand in hand with the manufacturing company in this case to set global IoT standards and offer the most comprehensive IoT portfolio to enterprises of any size anywhere in the world.

And we have now successfully closed another strategic partnership with another major German, but global IoT platform provider that we can't yet mention. So the fact is, Cumulocity IoT in becoming the engine powering leading IoT platforms not just ours.

We are becoming ubiquitous or to spare you my French accent we are everywhere. Ladies and gentlemen in total, these are 23 industry leaders that have chosen Software AG to power the IoTs for the platform since the beginning of the year, there off buying incremental in Q3 only.

And this is just the beginning. And this is what I'm passionate about because the opportunity is huge and Software AG is clearly on to something really big.

We are taking the German machinery manufacturing market by storm and we have the opportunity to get market share globally over the coming quarter and years in most exciting opportunity there is the industry or internet. As Karl-Heinz and Arnd mentioned, this is a massive future in front of Software AG.

The need a live version of the consumer world was big. But the industrial internets will dwarf it.

There are many more devices than people, think about how many of you, your car, smartphones, laptops, fridge, [indiscernible] allowance systems like alarms, driving style, your insurance policy and your blood pressure everything that can be measured will be and will be the source of digital services and new business models. Ladies and gentlemen let me give you again the bigger picture for 2017.

After the first nine months we are on track to meet our total year guidance both with Adabas & Natural product revenue where we confidently and to meet the upper half range as Arnd mentioned. And with a digital product revenue with a 5% year-to-date year on year growth we expect at least to reach the lower end of our total year's guidance while we expect acceleration of our cloud recurring revenue stream.

And yes, our reported growth rates are being augmenting by the transition to the cloud. With more than 70% growth in bookings year-to-date and likely threefold digit growth at the end of the year, our increasing IoT cloud successes demonstrate the consumption based usage of our products as exemplified by Arnd as mentioned Deutsche Telekom and others.

We say it once and we'll get revenue every month every quarter as customers deploy the IoT used cases and connect more and more devices. The cloud is a fundamental business model to the industrial Internet.

Every new device, every new digital sensors are potential new revenue drivers for us. And we have to accept that this is deferred revenue growth and it clearly doesn't impact the topline of a given quarter.

The IoT is a game changing market for Software AG. The example already mentioned by Karl-Heinz and Arnd should show you the magnitude of the impact of IoT on our business, deferred impact if you will.

Yes. We took the strategic decision with one of our key IoT customer, beside ADAMOS as we said, not to book a most likely 10 million plus license revenue as a perpetual license here now, but to book possible 30 million to 40 million cloud revenue for the same contract over the coming years.

It takes courage, but also a strong belief in our capabilities in establishing Software AG as a major player in the IoT market to make this decision. And this is just one [indiscernible].

Ladies and gentlemen, this is the game we are playing, the game we are changing and this is the true indication of our business momentum. In conclusion, needless to say, the fourth quarter is never, never just another quarter.

It is always a deciding one for Software AG, but also for clients. We know by experience that Q4 represents a much stronger compelling reason for our customers to close contracts.

Customers will use their full 2017 budget to prepare for the upcoming business opportunity and digital transformation. And based on what we already have, in final procurement steps, it already feels like a well advanced quarter.

In addition, in our Adabas & Natural line of business, Q4 like Q2 and Q3, will be a strong quarter with some massive renewals in progress. The rebound from Q1 continues, what we said will happen, has happened and will happen.

This is the level of predictability we have in this business line. Our total weighted digital pipeline is 17% bigger than the beginning of Q4, 2016 and our cloud pipeline, up to 80% more.

All of this are major sources of confidence for me. So in summary, we are on track for strong 2017 finish and are getting ready for accelerating our momentum in the cloud boosted by our fast growing leadership and industry relevance in IoT.

Ladies and gentlemen, we're in the cusp of further reinventing Software AG by moving into new fields, the real time cloud and IoT. And by doing so, accelerate scale and growth.

These are exciting times and a promising future for Software AG. Thank you for your attention.

Thank you, Eric. Ladies and gentlemen, it's now your time for asking questions and we have another 25 minutes to go.

Operator Jasmine, would you please repeat the procedure.

Thanks. Good morning.

And I guess congratulations for the progress on IoT. I've got to say, looking at the press release this morning, there wasn't so much of, as a disclosure around that 20 million of predictable revenues from next year and no evidence in the balance sheet I guess of any prepayments.

Can you maybe talk about the revenue model there and how that 20 million will build? Will it be 5 million a quarter or maybe star less and progress as the year goes on and what the billing model is?

And then from a cost perspective, how does this change your internal costs and how you will also go to marketing Q4? Is it going to be a push more towards doing these types of deals?

Will that not have an impact on the licenses? I'm struggling to see why you won't see some negative effect.

Thanks.

Yeah. Thank you, Michael.

Let me start with the first one on the 20 million billing. What we have experienced and that is very much through in all situations with new prospects, which have become customers at the end, we need to understand what is what they want to achieve.

Yeah. To give you an example, machines and Eric has mentioned some, of course very different.

If you think about a painting machine, that's a huge installation. So therefore, we need to treat that differently from a - at a retailer store.

But at the end of the day, it always boils down to the question on how much traffic data is exchanged from the machine from the device into the cloth or how much data is analyzed on the edge, so directly at the machine and we are the vendor that can deliver both and it is extremely important to deliver both, just because there is so much data analyzed at the edge. So when we talk to the machinery billing companies, they talk about 1.5 gigabyte per day to be analyzed on the edge.

So therefore, you must deliver both. In addition to that, it's also a question of how many API calls are done per second per minute.

So we very often talk about five calls per second. Yeah.

So you can imagine how much data is shifted from the machine, from the device into the data center. So those are the prime parameters, which at the end of the day, drives the revenue.

Now, the 20 million Michael is just calculated on the minimum commitments we have already received from the customers. So what I explained just before goes on top of the 20 million.

So therefore, the 20 million is very much spread evenly throughout the year. The extra which comes on top of the 20 million, which we are going to share with you when we talk about the guidance for 2018 will be then on top a growing business.

Yeah. So flat on the 20, because that is already signed, that is the minimum commitment that is the least number, the most conservative number that you can ever think about and then every machine that is connected in addition will give us additional revenue now.

Now with respect to the costs, we have some advantages. First of all, the products are already developed.

And they are sold in the digital business line and they are going to be sold in the IoT business line. So therefore if you talk about the Software AG as such, that is no incremental cost linked to that.

With respect to the contract that we have signed and Karl-Heinz has mentioned that, we are basically only aiming our product into the platforms. So, therefore, no additional sales and marketing effort requires in order to generate that revenue.

So therefore if you just think about those components, extremely margin rich business with scales out, which accelerates revenue within the existing contracts. Of course, we want to go after additional customers.

So therefore, we will spend sales and marketing efforts to that business line in order to have a dynamic growth also in the next years. Yeah.

Is that going to have an impact on our guidance for the year? No.

Not based on what we see and what I have just communicated. So therefore, it's a combination of delivering 5 to 10 for this year and being prepared for growth in 2018 plus these contracts that we have signed in the last, let's call it, 4 months, yean, and we are going to sign for the rest of the year, which then are the basis for the third business line, which will show compared to '17 growth, which is by no question three digits.

Thank you. I mean, can I just ask how many customers are now contributing to this 20 million plus.

I mean, there is obviously ADAMOS, but it sounds like that we're at a signature. And then, can you give any flavor for how much extra that you get from these traffic fees, this edge device management on top of the 20.

Yeah. So if we treat ADAMOS as one customer, yeah, because from Software AG perspective, it is one platform that we deliver.

We are already talking about more than 10 customers, big platforms and unfortunately, we cannot mention this big engineering IoT platform, but if I would mention the name, everybody would know that and it's extremely nice deal that we signed, because it diversifies our positioning. So at the end of the day, we deliver our product in various platforms and whatever platform wins the race over the next years, we are benefiting from them.

We believe and I want to be a little bit careful as we are just in the budgeting process, but I believe you will see a number, which is certainly around 50% higher than the 20 million that we will recognize next year on the IoT side. So it's a huge growth that we are going to show already next year.

And as Eric has said, a huge potential moving forward. So that is entirely game changing and in contrast to the pure cloud business, we have a margin which is dramatically higher, multiple times higher, as we do not have to mix the hosting.

The hosting is not part of the number that we mentioned, so that is just pure software component out of that and if you think about the margin on maintenance side, that is something you should think about when talking about the margin of that business. Hosting would come on top of that and has not a negative impact, but just adding a little bit of margin as well.

This number that I've talked about is extremely margin rich like the maintenance business.

Yeah. Good morning.

Thank you. Just a clarification question on what Michael just asked on the 50%, was that just relating to the API and edge traffic, so hence we should be rather thinking about 30 million and if I understand the model correctly, given the type of partnerships you signed, we basically see that as coming from the machine sold, so this will be probably then the base and then the more machines are sold in the years after this business will continue to scale and then on top of that the traffic handle, is that the right way to look at things?

And then secondly, there was recently an announcement from your side in the financial vertical where you won with CBA and here also the question then, how do you think this will impact your positioning in the financial sector going forward and also how do you see your competitive positioning against core banking vendors here on the back of your IoT offering, which could be given the size of the vertical, also an important driver for you going forward? Thank you.

Yeah. So, first of all, Knut, good morning.

You're absolutely right. So with every machine that is connected, we will generate additional revenue and that is one of the core elements and the core advantage against pure traditional cloud business.

I mean, if you sell a cloud contract, you have a number of seeds and you sell those number of seeds. Yeah.

And if you want to sell more, you have to again go to that customer and try to sell more. Here, the business model is a different one.

Yeah. Our customers connect their machines to the IoT platforms and as it is the core of their business to sell more machines, by definition, more machines are connected to the platform, without us going again to the customers.

Yeah. So Eric mentioned in his speech this other big engineering company, where we didn't want to take the perpetual license because we sold their business plan for the next three years and there is a potential of, I think, you call it, 30 million, 40 million.

So you see seed, that is just what is happening in the next three years and as machines have a pretty long time, they are in introduction, you will see year by year, even without doing anything anymore, an increase in the revenue line just because of the licensing model that we now came up with. Yeah.

I mean, the businesses are never that easy, we all know that. But that is the core fundamental difference to a classic cloud business, putting the hosting component aside because in all those contracts or most of those contracts, we do not do hosting or if so, we try the hosting separately.

Now this, IoTs part and I know I'm referring Knut to your second question with respect to CBA. The IoT part is always now in the industry where we connect machines, devices.

With respect to CBA, here, it is from a pure technologies perspective of course slightly different. We all know that banks have a long standing tradition with IT and thus having a very fragmented IT.

So therefore, the integration of the various applications is core to them. In addition to that, the connection to their customers is a second step they look after.

So it's a question of API management with their customers. That is what CBA is doing and most of the other banks are doing as well.

Yeah. So therefore, that is something very relevant.

When we talk about the core systems providing for banking stuff, that is applications. So we sit on top of that and digitize their connection to their customers in order to avoid them losing the direct contact to customers and that is something which is extremely important, not only for banks, but also for the industry companies.

One of the key parameters we always come across with is we want to have the ownership of the data. We do not want to lose the contact to the customers because otherwise we are just a commodity provider and we all know commodities only sold about price.

So therefore, our solution is extremely successful to them. And one of the CEOs made a very nice analogy, saying, well, we are - we do not want to be the tail of the [indiscernible] and I think that characterizes very nicely what we are talking about.

Knut, this is Karl-Heinz speaking. I would like to add the following two points.

First of all, the bank. As Arnd said, it's very easy to understand, you just have to differentiate between the business logic containers of a core bank system.

These are typically applications. And now comes the new digital world where the data availability, the data analytics reacting on the data available on the customer for transparency is data oriented use case.

This is why they need the digital platform, besides the business logic. And this is where we are in.

This is what we prepared five, six years ago already through the acquisition, the platform, the IoT part. What means the real time processing of mass data on a digital platform.

Now, we realize what we spoke about for years. So we just closed two segments.

There is a second statement I want to make. Our CFO, Arnd Zinnhardt had been deeply involved during the automotive process in the, let's call it, invention of that machine oriented by three business model and it is with great delight to see the CFO said he is extremely cost conscious and that he is marginally entered and positive growth oriented to see how infused and relied he is in seeing the huge potential this company has of this new business model out of the management of this new pricing model as well, so both gives me a great, great pleasure.

Excellent. Thank you very much.

And just to clarify as a quick last one if I may. Is it then fair to assume if I just add everything up that this new IoT offering and this new business line will help you also with regards to your mid-term margin targets against the backdrop of the high profitability, even if you reinvest something.

Is that a fair way to look at it?

Yes.

Excellent. Thank you.

I've got two if I could. I am just trying to understand again the shift between the perpetual licenses onto the pay per use model, I think traditionally we thought about the shift from licenses to perpetual or pay per use being something that divides licenses by two or maybe by three.

So if you sacrificed a 10 million perpetual license, you might get 3 million or 4 million of recurring revenue. In this case though, we seem to gain the other way around that sacrificing 10 million of perpetual actually doubles the amount of revenue you get over time.

Is that math that you're working on, can you maybe just walk us through how you get to that? And also from the customers' perspective, where they see this tradeoff between paying a small amount upfront and much larger money overtime?

Are you actively refusing to do licensed deals with those customers or is it the customers that are choosing this pay per use model? I'm sorry that's a long one.

But secondly, if I get back to your Capital Markets Day in 2016 and this is for Arnd, that time, I think it's fair to say you were pretty scathing of subscription and pay per use models. Could you maybe help us understand a little bit more what's changed since then or if nothing's changed, what the impact on the business is going to be?

Thanks so much.

Yeah. So I'll start with the last one actually, Adam and I anticipated the question coming from you.

Well, the difference is the following. The difference is the following.

A, we do not have to make hosting. So all those numbers that we talk about, yeah, are excluding hosting.

Yeah. And hosting is a service business.

Yeah. So when we do the hosting, we charge separately.

So taking ADAMOS as an example, yeah, we just delivered the software into the ADAMOS. The hosting is done by ADAMOS itself, yeah.

So therefore, everything that we realize is incremental business, thus incremental revenue, thus incremental profitability. So the margin on what we deliver to ADAMOS is very much in contrast to the clouds part is 100% margin.

Yeah. So I'm not saying that the entire business line is 100% margin, because we obviously want to get new customers as well, but just looking ADAMOS, 100% margin.

So that is from a concept totally different, because we just delivered the software based on how many devices are connected to the ADAMOS platform and that's it. All the residual sales effort, all the residual administration efforts, all the residual hosting efforts remain in space with ADAMOS.

In addition to that, we are going to deliver the products, yeah, take the integration service, take what methods of API into digital business as well. So therefore, if you look to Software AG as one unit, everything that we sell is incremental.

So that is very much different to what we were talking about back in 2016. So the second question, what is the rationale for customers.

The rationale for customers is the following. They have currently not a clear picture what is going to happen in five years, in ten years' time.

So therefore, they make a risk adverse offering to us, just taking those elements into consideration, where they are 100% that they are going to deliver to their customers. The entire upside potential is nothing they want to commit upfront.

So if you think and if you talk to them and if you look to their production units and what they are going to sell, how many machines they are going to sell, how the usage is of their machines, you come up with a business plan, which is multiple times higher than what you would get as a perpetual license and then it's an economical decision. And the comparison of this 10 perpetual to 30 million, 40 million can be something which is on average true, but we have already seen other examples where the future potential is significantly higher than the factor of three.

So, therefore, it's pretty clear that to utilize the full potential, we need to go through the usage based way. And therefore, it is at the end of the day, a bet that we take on IoT as such.

As we are in so many different platforms, so diversified, there is a big question that we have to answer is, are machines going to be connected? And I think we are all very clear on the answer, which is clearly yes.

And if so, then there is even more to come and we should do it right now because now is the time for setting the tone, defining the metrics in order to be able to scale up in the future. If you do it wrong today, you have missed such a big opportunity, you will never catch up again.

And Knut when you draw a graph of an e-curve, then you see the beginning is always flat. But you have the exponential growth potential and just in the ADAMOS group of customers, there are more than 500,000 machines already in the field.

And between 80,000 and 100,000 coming every year new. So now throughout the graph of an exponential curve and now just imagine what it takes a customer in the normal world to pay an upfront payment of 1 million, 2, 3, 4 or 5.

He invests into the unexpected because the e-curve is a promise that he has. The e-curve is a hope he has, but this e-graph is what we see in the digital world.

Therefore, as Bill Gates said, we all underestimate short term, sorry, we overestimate the short term and underestimate the mid-term and this is exactly the logic of the e-curve. And this is why - this is what Arnd meant.

Customers, it's not a factor of three that we have when we just take the cloud based revenue, it is in the long run, a multiple of it, because we accept that the customer doesn't have to pay front up and for that, he accepts because we are risk sharing. He accepts that we give more as we go along with him, because we continue to innovate.

This digital transformation is, I would say, transformation is a journey, it is not a project. The on-premise project we have historically are projects, but this is a journey, a co-innovation journey with the customer and this is why they accept that the more successful they are, the more we get in the future.

And this is the beauty of this new business model that Arnd also invented in the context with the ADAMOS project. [Technical Difficulty]

I was just saying I would try to be less predictable next quarter for Arnd.

Okay. To fulfill the full 30 minutes of Q&A, I would invite one more question please.

Hi. Thank you very much.

Another one on IoT. Can I just make sure I understand who is paying you.

Is that the machine manufacturer or is that the end customer who is paying for the use of the machines or is that both? Kind of the same question on salesforce, do you need specialist sales there, do they sell it to the machine manufacturer to get it onto the platform or do they also touch base with the end customer, you mentioned not wanting to be too far removed from the customer and then I had just one non IoT question.

So to get one in there, can you just explain again why the Adabas & Natural maintenance was declining and then what we should expect going forward?

Yeah. IoT, who is paying?

So when we talk about the IoT platforms, we are paid by the platform provider. Yes.

So the business model is the following. End customers are connected to the IoT platform, so therefore, the end customer is paying the IoT platform and then the IoT platform is paying Software AG based on the metrics that we have agreed upon.

So therefore, the sales force for those IoT platforms is also with the IoT platform and not with Software AG. Yeah.

So our sales pitch and our sales effort was already done between us and the platform provider. So that is, when we talk about the IoT platform providers.

Besides the platform providers, we also have industrial customers who wants to just digitalize their respective business and do not want to go onto a platform. With those, we have a direct access to this customer and therefore, those contracts are done by our sales force.

So, therefore as said, we are going to build up a sales force - dedicated sales force for IoT as well, which operates an outside to the platform as such.

And that's an important point, Stacy, this is Eric, that Arnd mentioned, right. We are something big.

We want to capture market share, we want to continue to build on what we have successfully done in Germany and other countries. So yes, we will - this was your question, I insist on what Arnd said.

We will build and we are starting to build a specialized sales force on IoT to take this opportunity and accelerate our market penetration. You will hear more when we enter 2018.

Yeah. And then on the - the last question was with respect to the maintenance and Stacy, you'll remember that we had difficulties in collecting the money in Brazil based on the overall difficulties in the Brazilian economy.

So therefore, we took a very prudent approach last year whereby we just recognized revenue once we received the money. So, we received money in Q3 2016 for previous periods, which were then recognized in that respected quarter.

So therefore, the comp was higher than the original or the normal operational one. So with the consequence that we had a slightly higher decline this year because the payment history now for the last 12 months in Brazil is normalized again.

So now, we are back to normal of a business operation in Brazil. Now looking forward, we should experience a decline on Adabas & Natural maintenance between 2% and 3% to be on the conservative side, so a bit better than what you see this quarter.

Thank you. I'm afraid, finally I now have to close this call.

So as always, if there are remaining questions, but I think we have at least covered the IoT part very extensively, so there shouldn't be too many questions. But for all those other figure related questions, the IR team is ready at the desk to answer your question.

Thank you for now and we'll be back if nothing happens in between at least in January with the Q4 numbers and more details on IoT business line and the projection for these business lines into 2018. Thank you very much and good bye for now.