Software AG reached a new milestone in its ongoing transition to the cloud and a SaaS and subscription business model this week as it refocused forward guidance on the Annual Recurring Revenue (ARR) metric favored by SaaS vendors rather than bookings. But despite meeting its targets for 2022, the company disappointed investors with muted guidance for 2023, and the stock price slumped by 15%. The new outlook projects weaker margins in FY2023, accompanied by a 4% reduction in headcount, while total revenue for the year is expected to fall short of its long-anticipated €1 billion goal.
Nevertheless, Sanjay Brahmawar, CEO, said the company was sticking to the goals of the Helix transformation program it had started back in 2019, of setting up the business "for long-term value creation." He summed up:
With the final year of Helix upon us, we are well placed to continue benefiting from our business model shift and our strong finish to 2022. Importantly, we are mindful of the macro environment and we have budgeted accordingly. On this, sales cycles may be lengthening, but underlying demand remains robust, and given the mission-critical nature of our products, we have not seen customers walking away from deals.
In product terms, the focus of Helix has been to reorient the company around what it calls its Digital Business products, which span hybrid integration and API management with its webMethods product family, IoT and analytics with Cumulocity, TrendMiner and Apama, and business transformation with ARIS. DataOps was added with the acquisition of StreamSets early in 2022. Overall, these products helped the company sign a record 330 new customer logos in the course of 2022, while its integration, API management and DataOps offerings showed particular strength. Brahmawar highlighted some of the biggest deals from Q4:
In webMethods, we won a fantastic SaaS renewal in DACH region with Airbus. With the support of Microsoft, we won a large expansion deal for our cloud integration and B2B stack with a modern leading logistics firm in North America. StreamSets also continues to grow strong. During Q4 we saw new synergy deals coming through, including a great win with Dubai airports. This landmark deal included integration technology from our broader digital business, building on the synergy success we had in Q3 with [regional partner] G42.
Sales and margin
The final quarter of 2022 also saw a boost to the company's longstanding Adabas and Natural (A&N) mainframe toolset, when a a large deal was brought forward by Israel's finance ministry to close ahead of schedule, combining migration of the A&N tools to the cloud with API technology from the digital business portfolio. This contributed to a 144% year-over-year jump in A&N bookings in the fourth quarter to €76.3 million, and a 23% boost to the full year bookings figure, bringing the total to €144.5 million.
The core digital business portfolio saw bookings grow 12% in line with guidance, to reach €555.6 million for the full year after adding in Streamsets. The new metric of ARR for this portfolio grew 11% year-on-year to end the year at €476.2 million, and represents 93% of total product revenue for the full year. ARR across all products reached €660.0 million at the end of Q4, a 10% year-on-year increase.
Total revenue, including Streamsets, came to €303.8 million in Q4 and €958.2 million for the full year, made up of €549.7 million from the Digital Business portfolio, €245.9 million from A&N and the remainder from professional services.
Operating margin, on an EBITA, non-IFRS basis, was within the prior guidance range, at 23.1% in Q4 and 21.2% for the full year, before adding in Streamsets. One-off costs due to the acquisition had a negative impact on margins, producing operating EBITA (non-IFRS) of €58.3 million in Q4 and €178.5 million for the full year. The impact of this and the ongoing transition to recurring revenue left free cash flow slightly negative at €-1.1 million in the full year, significantly down from the previous year's positive balance of €91.4 million.
The new guidance for FY2023 sees Digital Business ARR picking up the pace to 10-15%, while A&N will contribute between -2% and 2% in ARR. Overall product revenue is projected to grow at 6-10%, compared to 7% in 2022. Guidance for operating margin (EBITA, non-IFRS) falls to 16-18%, a drop from the 21.2% achieved in 2022.
Among the factors impacting margin, new CFO Daniela Bünger cited the impact of inflation on salaries and operating expenses, less favorable foreign exchange rates and the Streamsets acquisition costs, along with the ongoing transition to SaaS and subscription revenues, plus associated changes to the professional services business. She noted:
If we weren't moving forward with key strategic initiatives we've mentioned, our 2023 margin guidance would have been ahead of current market expectations for this year. However, we are running our business to create value in the long term, and we're very confident that these are the right steps.
The workforce reduction of 4% will affect around 200 employees and is expected to deliver a margin benefit of between €30 million and €35 million in 2023 and further benefit thereafter, but will incur one-off costs of €15-20 million in FY2023. Headcount had risen 4% during 2022 to reach just shy of 5,000 employees at year end.
While investors typically look favorably on SaaS as a business model, they are often intolerant of the margin and cashflow impact when a company transitions from one-off product sales to the recurring revenue streams of SaaS. That's especially true at a time of economic uncertainty, and Software AG has been caught in those headwinds. The pressure is intensified in this case by the €344 million funding that private equity investor Silver Lake put into Software AG just over a year ago. That convertible debt is repayable in four year's time unless the stock price climbs more than 20% above where it was at the time the deal was done. So far, it has gone in the other direction and is now some 40% lower.
In the circumstances, Software AG's management is showing tenacity in holding its nerve. The transition from conventional software licensing to become a cloud-first business has proved a rocky road for many vendors, but despite the difficulties it's the right path to follow. For now, the Silver Lake funding gives Software AG the resources to pull through the final stages of the transition and continue to grow its market presence. In his remarks, Brahmawar emphasized the opportunity for growth in the cloud application and data integration market and also noted that there's more the company can do to improve its sales execution and reduce complexity in its portfolio and processes. Despite stock market gloom, it seems the business outlook remains positive for now.