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Edited Transcript of AVV.L earnings conference call or presentation 12-Nov-19 9:30am GMT

Half Year 2020 AVEVA Group PLC Earnings Call

Cambridgeshire, Nov 29, 2019 (Thomson StreetEvents) -- Edited Transcript of AVEVA Group PLC earnings conference call or presentation Tuesday, November 12, 2019 at 9:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Craig Hayman

AVEVA Group plc - CEO & Executive Director

* James Kidd

AVEVA Group plc - Deputy CEO, CFO & Executive Director

* Matthew Springett

AVEVA Group plc - Head of IR

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Conference Call Participants

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* Deepshikha Agarwal

Goldman Sachs Group Inc., Research Division - Research Analyst

* Hannes Leitner

UBS Investment Bank, Research Division - Equity Research Analyst of Software

* John Peter King

BofA Merrill Lynch, Research Division - Research Analyst

* Michael J. Tyndall

HSBC, Research Division - UK MidCap Equity Analyst

* Peter McNally

Panmure Gordon (UK) Limited, Research Division - Research Analyst

* Stacy Elizabeth Pollard

JP Morgan Chase & Co, Research Division - Head of Software and IT Equity Research

* Sven Denis Merkt

Barclays Bank PLC, Research Division - Equity Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for holding, and welcome to today's AVEVA's First Half Results Conference Call. I would now like to hand the conference over to your first speaker today, Matt Springett, Head of Investor Relations. Please go ahead, sir.

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Matthew Springett, AVEVA Group plc - Head of IR [2]

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Good morning, and thank you for joining us. Before we start, I'd like to draw your attention to the safe harbor statement on Slide 2.

I'll now hand over to Craig Hayman, AVEVA's CEO, for some opening remarks.

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Craig Hayman, AVEVA Group plc - CEO & Executive Director [3]

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Thanks, Matt. Good morning, everyone, and thank you for joining us today. This is Craig Hayman, CEO of AVEVA, and I'm joined here in London by James Kidd, Deputy CEO and CFO; and David Ward, AVEVA Finance Director.

Please turn to Page 4 in the presentation. In every respect, AVEVA has delivered on the vision of the Digital Twin and performed well in the first half of fiscal 2020, with strong results and good progress against medium-term targets. Organic constant currency revenue grew 11.9% year-to-year. Adjusted EBIT grew 66.5% to GBP 90.6 million and a 23.1% margin. Recurring revenue, which is rental and subscription software license revenue plus support and maintenance revenue, grew in the first half of the year by 42.1% to 61.9% of total revenue.

18 months of focus on the integration of the heritage AVEVA and heritage Schneider Electric software businesses has positioned AVEVA well. Operational improvements are beginning to yield results, and the product portfolio is competitively well positioned with the launches of the new AVEVA Unified Engineering suite and the new AVEVA Unified Operations Control Centre. Customers in the industrial sector are increasingly focused on accelerating their digital transformation and looking to AVEVA as a trusted partner with a rich, innovative product road map.

With AVEVA, EPCs reduce risk, project duration and cost from capital projects and operators reduce operating cost by putting their data to work within weeks by the use of advanced data visualization, artificial intelligence and machine learning. The outlook remains positive with strong customer demand, and we are on track to meet our medium-term targets.

Let's turn to Page 5 for details of performance across each business unit and each geography. AVEVA delivered growth across all 4 business units and all through all 3 geographies and saw improved execution from both direct and indirect sales channels. The indirect sales channel represents approximately 1/3 of total revenue. Customer wins include Suncor Energy, Network Rail, Hyundai Heavy Industries and Worley. The Americas grew 7.2%, EMEA grew 4.4% and Asia Pacific grew 48.9%, resulting in a balanced revenue mix across the world. In Asia Pacific, there was strong growth in South Korea, China and Australia, with strength in the Engineering and Planning & Operations business units, including a large multiyear contract with a key customer in Australia. Across all geographies, and as planned, recurring revenue growth was offset by reductions in initial and perpetual licenses and training and services.

The Engineering business consists of design and simulation software and represented 42% of total revenue. Growth was strong at around 20% constant currency.

Within Monitoring & Control, the new token-based subscription program, AVEVA Flex, was received well by customers and partners as was the new Unified Operations Center for real-time performance management. Growth was in the low single digits with recurring revenue growth offset by the planned reduction in lower-margin services revenue.

Asset Performance Management continues to be well received by customers -- to be received well by customers, and it's strongly differentiated in the market. The completed acquisition of MaxGrip's software assets further strengthens AVEVA's predictive analytics capabilities and speed to the deployment of artificial intelligence for prescriptive maintenance. APM grew low double-digit in constant currency and now represents 14% of total revenue.

Strong rental and subscription growth within the Planning & Scheduling business was offset by a planned reduction in training and services, again, generating mid-teens growth in constant currency and 12% of overall revenue. Delivering overall growth in the first half at or above the market growth rate while substantially increasing the quality of the revenue with a focus on recurring revenue has been particularly satisfying.

Let me now hand it over to James Kidd for the financial review. James?

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James Kidd, AVEVA Group plc - Deputy CEO, CFO & Executive Director [4]

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Thanks, Craig, and good morning, everyone, and thanks for joining the call. I'll now take you through the financial review of the first half. Before we get started, just a quick comment on how we've presented the numbers. So you'll recall that we've previously presented pro forma numbers for the group because of the reverse accounting combination. Thankfully, we can now move away from those and return to presenting the numbers based on the statutory results, which makes life a bit simpler. We did present pro forma numbers for the first half of last year with the only difference being a fair value adjustment to deferred revenue in the statutory numbers of approximately GBP 6.5 million, and I'll explain more about that later.

So let's start by looking at the main highlights before we get into more detail. I'm delighted we've continued to show good momentum in the first half of this year, delivering a strong financial performance with the combined group continuing to perform well. On a statutory basis, revenue increased by 16.5% to just under GBP 392 million, driven by strong sales execution, stable end markets and some benefit from multiyear contracts, including some deals pulled forward from Q3. If you strip out the benefit from the foreign exchange tailwind and some small inorganic adjustments, our organic constant currency revenue growth was 11.9%. And I've included a revenue bridge later in the presentation, which walks you through those moving parts.

One of the highlights of the first half has been the significant change in the revenue mix. As you know, this has been a key strategic area for us, and we're delighted with the strong growth in recurring revenue, which is now just under 62%, and more on that later. The strong revenue performance flowed through to profit, driven by strong operating leverage and cost control, with adjusted EBIT up 66.5% to GBP 90.6 million for the first half.

We also showed a strong improvement in profit margin up 690 basis points to just over 23%, which fed through to a 65 % increase in adjusted EPS.

The Board remains committed to maintaining a progressive dividend and is proposing an interim dividend of 15.5p per share, which is up 10.7% on last year.

And finally, we closed the half with net cash of GBP 58.6 million, and we'll cover the movements in cash later in the presentation.

So let's look at the income statement. As Craig mentioned, we saw broad-based growth in all of our regions and business units, driven by strong sales execution from both our direct and indirect sales channels, supported by the ongoing trend of digitalization. From a regional perspective, Asia Pacific had a terrific first half, up 48% year-on-year. And from a product perspective, our Engineering business unit grew 20%, with market conditions remaining stable in the first half. Overall, our revenue was GBP 391.9 million, up 16.5% on a reported basis and 11.9% on organic constant currency. We've put a lot of effort and focus into our sales organization to improve margins, and we're pleased to see that come through in the first half, with a 400 basis point improvement in gross margins to 76.4%. We've also controlled our OpEx well with costs only up 3.5% on a constant currency basis, with the investments we've made in the business being offset by the savings from the cost synergy program.

The strong top line performance and operating leverage has driven a 66.5% increase in adjusted EBIT, with the margin improving by 690 basis points to 23.1%. The effective tax rate for the half year was 21.3%, which is in line with the same period last year. And as per our previous guidance, we expect the full year rate to be around 20%. So overall, as you can see, a very strong first half performance.

Let's now look at the moving parts in the revenue line with the bridge from last year. Starting on the left, we have last year's statutory revenue of GBP 336.5 million. And then we add back the deferred revenue haircut of GBP 6.5 million, which takes us to pro forma revenue of GBP 343 million for the first half of last year. We then strip out approximately 1% for the Wonderware Italy business, which we disposed of in April 2019. And then we have the organic constant currency growth of 11.9%, which is net of a 2% headwind from the planned reduction in services.

I should also say that within the organic growth, we have approximately GBP 20 million of benefit from contract renewals and expansions, which were originally planned for Q3, which we managed to bring forward into Q2. We then adjust for their inorganic effects on the half of Wonderware Italy and MaxGrip.

And finally, in the first half, we had a benefit from foreign exchange of 3.2%. However, it's worth noting that since the end of September, sterling has strengthened quite materially. So when you compare spot rates today to the average rate for the second half of last year, there's little FX benefit in the second half. But obviously, things could change from here. Once all these factors are taken into account, as you can see, the headline organic constant currency growth was 11.9% in the first half.

Okay. So that was the revenue bridge showing the year-on-year change. Let's now look at the breakdown of revenue. As you know, we have set recurring revenue as one of our key strategic aims as part of our medium-term plan, and I'm pleased with the progress we've made during the first half, with recurring revenue at 61.9%. The key driver behind the improvement in recurring revenue has been the increase in rental and subscription, which grew over 80% in the half. We've put in place various initiatives to drive this, including changing our sales incentive model to reward our salespeople more for closing these deals.

And we also launched an AVEVA Flex at the start of the year, which is our subscription offering, initially focused on the Monitoring & Control business unit. We have seen the sales team really drive this model and also our customers are shifting more to subscription. The pleasing thing is that we're seeing this across each of our 3 regions, including Asia Pacific, which more than doubled in the first half. And we're also seeing deals close even in places like Russia and China, where in the past they really would have been perpetual only.

We did also see an increase in multiyear contracts, which helped benefit the half, where customers are prepared to commit for longer periods. And I just wanted to remind you that these multiyear contracts do continue to be a feature of the business, and it's our job to manage these each year to minimize any lumpiness that could be caused in our revenue growth.

Commercially securing these customers on multiyear deals is important to be able to lock them in, provide more reliable cash flows and secure price increases. However, under IFRS 15, as you know, we have to recognize the license element upfront with around 2/3 recognized on a typical 3-year contract with invoicing on an annual basis. Therefore, in the first year, revenue is ahead of cash, which then unwinds in the subsequent years. And this explains the increase that we've seen in the contract assets on the balance sheet.

Please also remember, within the rental and subscription line, we did have a benefit of approximately GBP 20 million from the deals that were brought forward from Q3. But overall, the growth in rental and subscription helped drive a 42% increase in recurring revenue. And if you strip out the deals brought forward, recurring revenue was approximately 60% in the half.

And moving on to a look at the other revenue category, support and maintenance was flat year-on-year on an organic constant currency basis, which was really as expected as we continue to see customers switch from support contracts to new rental agreements with a corresponding uplift in value. And specifically, we did have some large Monitoring & Control customers in the U.S. move from support agreements to new multiyear contracts. Initial license fees declined by 11.7%, which again reflects the strategy to move customers to rental and subscription, and this is most pronounced in the Americas, which dropped GBP 10 million in the first half. Training services revenue declined by 7.4% to GBP 64 million as a result of the focus on higher-margin services and also to start moving some of our service work out to service partners. Again, this is mostly in the Americas where we saw this in the midstream oil and gas projects and also in the HMI SCADA business.

So let's move on and now look at the cost base. So total adjusted operating costs increased by 6.8% in reported terms and 3.5% in constant currency. Cost of sales decreased by 3.3% due to the focus on higher-margin services and more use of our offshore service delivery centers. Research and development costs were GBP 60.1 million, which is up 7.7%, as we continue to invest in our development programs and the product integration as well as the new product launches, such as Unified Engineering.

Selling costs increased by 7% to GBP 98.3 million due to the investments made in the sales team, both in account managers and presales, and also investment in marketing and building out the team, particularly in the area of demand generation. Administrative costs increased by 5.1%, and that reflects the investment we're making in our support functions, such as HR, finance, commercial and IT.

Moving on to look at the exceptional and normalized items. Acquisition and integration costs were GBP 12.5 million as we continued with the integration. This also includes the transaction costs from the acquisitions of MaxGrip and the disposal of Wonderware Italy made in the first half. The integration costs will continue into the second half, and there will be some which continue into FY '21. Restructuring costs relate to the cost of severance included in the year arising from the integration activities. And we also made a small profit on the disposal of the Wonderware Italy business of GBP 0.2 million.

Moving on to the balance sheet. The overall balance sheet hasn't really changed a great deal since the end of March. We did the acquisition of MaxGrip, which added approximately GBP 10 million of net assets to the balance sheet and GBP 11 million of goodwill. Contract assets have increased by approximately GBP 27 million, driven by the revenue recognition on the multiyear contracts, as I mentioned previously. Contract liabilities, which essentially represent deferred revenue, decreased by GBP 26 million due to the timing of renewals and the switch to rental and subscription from support and maintenance. And when you look at the net of these 2 balances, there's a net credit of GBP 21 million, which we suppose that our overall invoicing is still ahead of revenue. And finally, in terms of cash, we closed the half with GBP 58.6 million, which includes GBP 20 million drawn down under the revolving credit facilities to finance our working capital movements.

Turning to the cash flow with the reconciliation from adjusted EBIT to cash flow from operating activities. During the first half, we paid exceptional cost of GBP 17.5 million, which is approximately GBP 10 million higher than last year, and we also had higher bonus and sales commission payments in the half in respect of last year.

So cash flow from operations was GBP 43.5 million compared to GBP 44.6 million for H1 of last year, and this is impacted by the multiyear contracts, as I mentioned before, where under IFRS 15 we're recognizing the license element ahead of cash. We expect our cash conversion to significantly improve in the second half of the year, and we should be closer to 100% of adjusted EBIT for H2.

And finally, I wanted to provide an update on the progress of the integration. We've exited 80% of the transitional service agreements with Schneider with a huge amount of work gone into that. And we're also on track to deliver the GBP 25 million annualized savings in FY '21, with the majority of those initiatives already having been implemented.

In terms of what's left, we have work to do in IT both from moving the heritage side of the business on to new IT infrastructure and also with moving applications, such as the new ERP system. The new ERP system is progressing well with the design and build phase nearing completion, with the first deployment planned for the first half of next year, and we're looking forward to the efficiency benefits that, that will drive.

And finally, we have some office consolidation to complete with the major ones being Houston, Beijing, Tokyo and Sydney.

So that wraps up the finance review. As you can see, a very strong set of results in the first half, and we're on track for a good performance this year.

Thank you for your attention. I'd now like to hand back to Craig for his review.

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Craig Hayman, AVEVA Group plc - CEO & Executive Director [5]

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Thanks, James. So let's jump into the operational review on Page 17. Now this page represents the digitalization journey across different sectors. And while the industrial sector was one of the first to use digital technology, it is the last to use it at scale. Industries such as retail and financial services have already seen the productivity benefit of technology. And the industries that AVEVA serves are still early in their adoption. But now customers from oil and gas to marine, power, metal and mining and packaged goods are beginning to see the benefit from the secular trends of cloud, big data, analytics, industrial IoT and artificial intelligence. And they're accelerating their digital transformation and realizing the value of the Digital Twin. Surveys, including one from Smart Industry, reinforce what these industrial companies are telling us at AVEVA. In the past year, the number of companies with a formalized near-term digital strategy has doubled, and productivity improvement is a major driver, which brings us to Page 18 on a customer win at Suncor Energy.

Suncor Energy is Canada's largest integrated energy company, and they are on a journey to put data to work and put it in the hands of their employees. They are the first integrated energy company to leverage the cross-portfolio combination of AVEVA's PRiSM predictive asset analytics, together with real-time performance management and optimization capabilities of ROMeo, across their enterprise. AVEVA won the business by demonstrating trust, strategic partnership and innovation to the team at Suncor Energy. And we're delighted to be working with them on their digital journey or Suncor 4.0 as they describe it.

Let's now turn to Page 19 and another customer win. This time, it's with Worley a leading global provider of project and asset services in the energy, chemicals and resources sectors. Together with Worley, we developed the first cloud-based enterprise resources management solution optimized for the EPC market. It's deployed across Worley and leverages AVEVA Enterprise Resource Management and AVEVA Everything3D together with jointly developed modules. Worley are on their own digital journey, and we are again delighted to be a trusted partner, working with them to deliver innovation and deliver their customers' Digital Twins. It's through these types of partnerships that we're learning how to move more quickly. And the integration of AVEVA's research and development teams has helped us harden this insight into new integrated solutions.

On Page 20, we'll cover one of these new integrated solutions, the AVEVA Unified Engineering Solution. It's designed to reduce front-end design effort, increase in -- increase the engineering efficiency and reduce project schedules. It's unique in the industry. Unified Engineering deeply integrates process simulation and engineering design into one tool. It combines conceptual, front-end and detailed design, allowing real-time collaboration across multi-disciplined teams. It's currently available through an OE access program, and feedback has been very positive. Stay tuned for future updates on this exciting product.

Please turn to Page 21. And previously, I've covered our work with ADNOC on their Panorama Operations Control Center, which operates across a stunning 50-meter display. This work has been further productized by our research and development team and is now available beyond oil and gas with the launch of the AVEVA Unified Operations Center for mining and the Unified Operations Center for smart cities. Each allows customers to quickly deploy their own operations centers and help their leaders make fact-based decisions with their data in the context of their business and in real time. Customer wins include the Smart City of Atal Nagar and Assmang Mining.

Page 22 provides more detail on the newly launched AVEVA Partner Network. During the first half, our various partner programs were combined into a single AVEVA Partner Network program. Partners within the AVEVA Partner Network are encouraged to expand distribution and the selling of products across our different business units. Our partners also benefit from Schneider Electric, who now process sales leads through the partners within the AVEVA Partner Network. With a focus on simplification and cross-sell, a wholly-owned distributor in Italy was divested. We intend to also divest other wholly-owned distributors in Germany and Scandinavia. Helped by these actions, the indirect sales channel performed well with double-digit growth across all regions and is positioned well for the future.

Please turn to Page 23 where we'll cover recurring revenue. The transition to greater levels of recurring revenue is expected to increase long-term free cash flow generation. Rental and subscriptions offer customer benefits, including greater flexibility, lower upfront cost and simplicity in pricing. These benefits are reflected in higher customer lifetime value of a rental and subscription model versus a perpetual license model. Aligned with this strategy, our sales incentive structures were modified earlier in the year across the company to encourage recurring revenue growth and the new AVEVA Flex subscription offer was introduced for Monitoring & Control. In addition, there's been a focus on responding to the customer demand for public cloud-based solutions with an investment in cloud DevOps and cloud research and development. During the first half, recurring revenue accelerated, which included an increase in the volume of significant cloud order wins and cloud expansions. Monitoring & Control made substantial improvement in recurring revenue mix, and the AVEVA Cloud offerings achieved greater than 99.9% uptime for customers.

Turn to Page 24, please. Recurring revenue is one of the 3 medium-term targets set out at the September 2018 Capital Markets Day. Against those targets, we have made good progress, with overall revenue growing above the industry growth rate and adjusted EBIT margins also growing significantly.

Finally, on Page 25. AVEVA has delivered a strong first half. I'm pleased with these results and proud of the focus and execution of AVEVA that is realizing our ambition and vision for the digitalization of the industrial world. By working to understand our customers' needs, delivering innovation to accelerate their digital transformation and meticulous business execution, we are producing on all fronts and continue to build organizational strength with world-class talent that's being recruited globally.

Looking ahead, we see strong demand for digitalization and industrial software within the industries we serve and remain confident on the outlook.

Thank you so much for your time today. And with that, operator, let's open up the line for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question comes from the line of Stacy Pollard of JPMorgan.

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Stacy Elizabeth Pollard, JP Morgan Chase & Co, Research Division - Head of Software and IT Equity Research [2]

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Just -- so it looks like your move to subscriptions -- okay, so 62% of revenues or 60%, if you strip out the EPC deal signed early, is still already ahead of your midterm target. So would you be looking to extend the recurring target? Or do you think this is the right long-term balance?

And then just kind of on that, that move to subscriptions, how it's impacting your margin. Now I have to say, I would have thought that faster subs would have a negative impact on your margins, but that obviously doesn't seem to have been the case in H1. You're obviously running ahead of your -- it looks like you're running ahead of your mid-term schedule there as well. So maybe thoughts about margin going forward.

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Craig Hayman, AVEVA Group plc - CEO & Executive Director [3]

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Thanks, Stacy. I'll take the first half part of that question, and I'll hand to James for the second part of that question. So look, with respect to our medium-term targets, achieving recurring revenue of 62% or 60% minus a large deal or the pull forward is at or above our medium-term target. But I will say it's still early. We're really only in the first half. Most of our businesses is back-end loaded in the second half, so we're not ready to declare victory on these medium-term targets, although we are reassured that recurring revenue is moving quickly. And as we committed to you back at the Capital Markets Day, we'll keep you updated on how quickly we are moving.

As we move into the second half, we will look to see if there's other metrics we could put in place. I think many of you have encouraged us to put in place, in addition to recurring revenue, that to act as a lead indicator, but we're still very early in that, and we're taking your feedback seriously.

Now with respect to the margin discussion, James?

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James Kidd, AVEVA Group plc - Deputy CEO, CFO & Executive Director [4]

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Yes. So for the software selling, it's generally on-premise. Under IFRS 15, we're taking the license element of that upfront. So if it was cloud, it would be ratable in the period, and you would see a bigger impact on the margin. But because we're obviously growing strongly in the first half, the upfront recognition on the license element is helping improve our margins overall.

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Stacy Elizabeth Pollard, JP Morgan Chase & Co, Research Division - Head of Software and IT Equity Research [5]

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And just -- Sorry. One more follow-up, just on the sales force. Can you speak a little bit -- you had the slide, of course, that the investments in the direct sales force, are you doing a lot of new hirings? And then this realigning of the comp plans between Schneider and AVEVA heritage, I presume that's completely done. And the indirect sales force, that was very strong. Do you think there's even more leverage there as well sort of beyond -- maybe indirect would grow faster than direct even for a little bit longer?

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Craig Hayman, AVEVA Group plc - CEO & Executive Director [6]

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Yes. I think I'll sort of take you back to Chart 23. I think it is in the chart, maybe -- yes, this page. Yes. So let's just look -- go through the dynamics around recurring. As we've talked before, I talked about before that Monitoring & Control, which is the Wonderware business, was a business that really had very little recurring revenue to begin with. In fact, it didn't have a subscription offering. And so we introduced that subscription offering at the beginning of the year, that's AVEVA Flex, and it was also a business that was mostly channel-driven. And so it is satisfying to see the growth in recurring revenue in Monitoring & Control mostly driven by the channel. So the channel is responding well to subscription. They're responding well as it relates to Monitoring & Control. And then, of course, there's a little bit of cross-sell into Asset Performance Management. So with respect to channel growth, I think you know, we brought in new leadership around the channel. We spent time thinking about the programs. We listened hard to our distributors. And one result of that is the pointing leads from Schneider Electric through to our partner network. I think that's unchanged for us. We had to manage through that, but it creates a simpler model, and it's going well. It's still early though, Stacy, I'd say, in leveraging the channel. We're very bullish on the forward trajectory of the channel, and our channel partners are very excited about working with us. Currently, we have many, many people out at a customer conference down in the U.S. who are working through that.

Now with respect to the direct sales team and adding new -- more sellers, overall, we look to drive efficiency into the sales force together with backfilling and upgrading the sales team. So I think if you were to look at our overall spend on sales, we're roughly -- it's roughly the same, flat. We're just driving a lot more productivity into that sales team. And as we shared with you before, I do want to give you an example of how we pay the -- how a sales customer retire quota. If they sell subscription, they'll retire 120% or $1.20 on the dollar, whereas if they sell perpetual software, they will retire $0.33 on the dollar. So you see that, that creates quite an incentive for the salesperson. They'll retire their quota far more rapidly if they sell subscription software. And when incentives are aligned with the strategy, then behavior is aligned with the strategy, and that's what we saw in the first half.

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Operator [7]

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Your next question comes from the line of Don (sic) [John] King of Bank of America.

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John Peter King, BofA Merrill Lynch, Research Division - Research Analyst [8]

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Could you comment on the pipeline that you see at the moment? Obviously you pulled in most to close early a couple of deals. How does the pipeline compare to this time last year? Any kind of metrics you could let us know, and that would be helpful. And also, obviously, you performed very well. Am I right in saying it feels like oil and gas is the driver here? And can you perhaps talk about some of the win rates you're seeing there? Has anything changed? Or would you put this down to, I suppose, better execution with existing clients and -- or has anything changed competitively that's meaning you're doing a little bit better?

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James Kidd, AVEVA Group plc - Deputy CEO, CFO & Executive Director [9]

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Thanks, John. I'll take the first question on the pipeline. When we look at the second half, our pipeline coverage is in line with historic levels. So no change there, and it's growing year-on-year. So when we look at the pipeline for H2, the deals are there to be closed. It's really about execution and getting the move of the line. But our pipeline visibility is pretty good. Compared to last year, bear in mind, it was only around this time last year that we implemented the single CRM system, so we're really embarking upon that. So we're now, obviously, a year ahead of that. And our visibility is much better as we look into H2.

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Craig Hayman, AVEVA Group plc - CEO & Executive Director [10]

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Yes, absolutely, James. And look, on oil and gas win rates, there is this dynamic that's been much discussed, but I think we're starting to see it happening where EPCs and owner operators are starting to come together. And we think that we're helping with that and to improve the quality of the asset as it's handed over and to hand the asset over with less risk and more certainty, and that by handing over a digital asset as well as the physical asset. And clearly, that's right in our wheelhouse. That's the leadership portfolio that we've put together. We're getting more C-suite discussions with some of -- with the majors. And we're in the room around the discussions with the EPCs and the owner operators. So I think we feel good that, that's helping us have a more strategic discussion with those oil and gas customers. That's sort of one side of it.

The other side is those oil and gas companies are themselves transforming into energy providers. And insofar as we also assist them in that transformation to be an energy provider, I think that's also helping us. We see that with Suncor Energy as an example.

And then finally, for the operators, they're looking to take OpEx out and return some of that to their shareholders or for reinvestment. And of course, we're very, very good at doing that. So I think we feel good. We're well positioned about it. There is a chart in the backup that talks about avenues for growth where we split out revenue by business line. So oil and gas is Engineering, but we also -- that's more of an OpEx view. But also -- I'm sorry, it's more of a CapEx view. But also you see we have Engineering oil and gas revenue coming across the OpEx of businesses such as Asset Performance Management, Monitoring & Control and Planning and Ops. So with respect to oil and gas, we want to think about the CapEx aspect to that and then the OpEx, and you see the bulk of our revenue here is more OpEx-related into oil and gas.

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Operator [11]

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Your next question comes from the line of Sven Merkt of Barclays.

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Sven Denis Merkt, Barclays Bank PLC, Research Division - Equity Research Analyst [12]

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You signed a number of multiyear deals over the last 3 years. Could you maybe comment what the remaining potential within your client base is for multiyear deals before the first multiyear deal you signed is up for renewal?

And then secondly, could you just comment maybe on your cost base in the second half? You mentioned that in the first half, investments were partly offset by savings. How is this dynamic changing in the second half?

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Craig Hayman, AVEVA Group plc - CEO & Executive Director [13]

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James, do you want to take those?

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James Kidd, AVEVA Group plc - Deputy CEO, CFO & Executive Director [14]

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Yes. So on the multiyear deals, we have done a few of those in the last couple of years, that they are more a feature of the business than they have been going back further than that. It's a positive sign for our customers who are willing to commit to AVEVA. And for us, it's obviously good in terms of giving us good visibility and certainty around pricing and cash flows, et cetera. There are still more deals to do. We look at them very carefully and making sure that we are getting appropriate value from those contracts, but also balancing them out given that they do create some lumpiness in our revenue profile. So it's really a balance. And there are more deals in the pipeline in the second half.

In terms of the cost base in the second half. We are targeting a 26% margin for the full year. So that should help you in terms of how you think about costs. There is some investment going into the second half, and our costs are more slightly weighted towards the second half because of sales, commissions and bonuses. But no other sort of one-off that would necessarily impact H2.

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Operator [15]

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Your next question comes from the line of Hannes Leitner of UBS.

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Hannes Leitner, UBS Investment Bank, Research Division - Equity Research Analyst of Software [16]

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Yes. I have also a couple of questions. Maybe the first question is regarding the relationship with Schneider and also the relationship with other industrials, how has this developed? And how -- did you see any cut in business relationships with other majors?

And then the other question is regarding the trade war. Do you see any positive or negative impact for you, given that's more of a U.S.-China argument?

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Craig Hayman, AVEVA Group plc - CEO & Executive Director [17]

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Yes, Hannes, let me -- I'll weigh in first on the 2 tough topics. And the second one is a tough topic. And then James, if you have anything, please jump in.

So first, on our relationship with Schneider Electric. It's a relationship that's very well governed. We have operating agreements that are in place. They are a customer. They're also a shareholder, and they're very pleased with the relationship. We sell to Schneider Electric, and we sell through Schneider Electric. Roughly 10% of the business is with Schneider Electric, which leaves the other 90% that is sold in concert with other partners and other industrials around the world. And one of our value propositions is that our software works and provides interoperability with any industrial equipment that's around the world. And so we do well in terms of going into customers and interoperating together with other industrial hardware companies such as Rockwell Automation, such as ABB and many, many more. It's the reality of the world that it is heterogenous and that customers want interoperability between these companies. Maybe you don't get that impression or people don't get that impression from different companies' marketing materials, but that's the reality. The world is naturally diverse.

So we -- in that model, we see -- we do well. I'll come back to this point of, look, at some level, all PowerPoint charts look the same when it comes down to it is how quickly can you deploy a Digital Twin or digital transformation for a customer, and that's what we do very well.

With respect to the current trade situation, look, the world is, without a doubt, becoming more insular. And after a period of many, many -- of decades of removing trade barriers, more trade barriers are -- we're in a phase of trade barriers being put in place. What that does is it makes the physical flow of physical goods become harder. Well, a couple of points here. One is we're a software company. So we're actually ourselves not hampered by the distribution of our product. Secondly is our software optimizes the construction and operation of very large manufacturing facilities. And when the world had a very distributed supply chain, people didn't think twice about ordering a part from halfway around the world. Now as it becomes harder to do that, they work to optimize in-country facilities. And so that's where we -- that plays to our strength. So for example, predicting when a piece of equipment is going to fail before it fails so that you know that you don't have to order that replacement part.

And then finally, I would say, having spent -- well, being born in the U.K., 30 years in the U.S. and now back in the U.K., I think there is a little bit of a different posture of being a European company operating in Asia Pacific than there is of being a U.S. company. And I think that helps us, although it would be hard to quantify that. Anything you'd add, James?

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James Kidd, AVEVA Group plc - Deputy CEO, CFO & Executive Director [18]

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Yes, just one color on the Schneider relationship. So you'll see in the back of the interims, the related party revenue on the face of it has gone down with Schneider, but that's partly due to the change in how we are transacting with Schneider. So some of the deals are now going through our distribution channel, where Schneider gets a commission on those deals rather than the deal itself going through Schneider. So that partly accounts for the drop in revenue.

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Operator [19]

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And your next question comes from the line of Deepshikha Agarwal of Goldman Sachs.

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Deepshikha Agarwal, Goldman Sachs Group Inc., Research Division - Research Analyst [20]

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So just 2 questions, if I may. First one is, the growth was more broad-based across segments, so can you give some color around, like, what kind of upside that you're seeing from up-selling and cross-selling across these various business segments, especially in terms of is it easier in certain segments? Or is it more challenging in the others? So that will be the first one.

The second one would be on CapEx. So we saw a slight spike in CapEx in terms of the run rate that we saw last year. It's almost double that we saw in the first half FY 2020. So is there anything particular driving that? And was it something more one-off? Or is it going to regard going forward in the near-term or over the medium term?

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Craig Hayman, AVEVA Group plc - CEO & Executive Director [21]

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Sure. This is Craig. Thank you for the question. In terms of cross-selling, I would say, I put this in the category of self-help. We organized our sales team into a top 100 account team that can cross-sell anything into our portfolio into those integrated accounts, and they're doing very, very well. We laid out our objectives for that at the Capital Markets Day. And we're doing very, very well there. Some of these wins are -- that we've highlighted include a large amount of cross-sell.

And with respect to segments, I'd say there's a lot of cross-sell in oil and gas and in chemical. There is cross-sell in other markets, but perhaps not as much.

Now with respect to CapEx, I want to sort of come back to the CapEx. As we understand it through others, the -- we're not economists, but we talk to economists. In Oil & Gas, for example, the total CapEx spend is roughly around $250 billion a year. And that delta is a little bit up and down off that $250 billion. I know a few years ago, that was $450 billion, but it's really delta-ing off of $250 billion. So we're really -- that sort of -- we're not seeing a lot of change there. What we are seeing is the use of digital technology to optimize that CapEx spend. And so that's where -- that is my point about under-penetration of digital software in, for example, Oil & Gas CapEx spend. And that's our sort of, if you like, secular opportunity that we're driving into.

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Deepshikha Agarwal, Goldman Sachs Group Inc., Research Division - Research Analyst [22]

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So my question was more about the CapEx of AVEVA, as in the amount spent on the purchase of property, plant and equipment. The run rate has kind of doubled in the first half as compared to what we've seen in the last one half. So just wanted to understand if there's something specific driving that?

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James Kidd, AVEVA Group plc - Deputy CEO, CFO & Executive Director [23]

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Yes, sure. I mean that really relates to the integration. So the offices where we're combining offices and having to fit out new facilities and also some of the IT spend that we're incurring in terms of putting in a new IT infrastructure and application together, so that's why it's GBP 7.1 million for the first half compared to GBP 3.5 million in the previous half.

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Deepshikha Agarwal, Goldman Sachs Group Inc., Research Division - Research Analyst [24]

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Okay. And then -- it is something that would -- that is expected to recur? Or will it be like it will go back to the levels that we were seeing in the past half?

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James Kidd, AVEVA Group plc - Deputy CEO, CFO & Executive Director [25]

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It will continue as we work on the integration, so it will tail off once the integration is complete and we've consolidated all the offices and completed the IT integration.

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Operator [26]

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And your next question comes from the line of Michael Tyndall of HSBC.

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Michael J. Tyndall, HSBC, Research Division - UK MidCap Equity Analyst [27]

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It's Mike Tyndall from HSBC. I wonder if I could just have a look at Slide 17, which is your dots on the S curve. And I guess what I'm trying to understand is those dots seem to be fairly static, but the growth rates that you're showing are substantially ahead of the mid-single-digit type rate that you were suggesting for the industrial software market. So are we looking at a situation where the adoption rate is going up for those end markets? Or is it a situation where you are clearly taking share away from the competition, and that's the reason why you're outgrowing that underlying end market?

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Craig Hayman, AVEVA Group plc - CEO & Executive Director [28]

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Mike, this is Craig. I'll start. Look, I think as we've talked about before, you have our overall growth rate. But within our -- when you get below our overall growth rate, you have our software growth rate or recurring revenue growth rate. And our revenue -- and the software growth rate or the recurring revenue growth rate is dramatically above the market. It's dramatically above by any measure. So with respect to the question about are we taking share, we believe we are taking share. I mean, to be determined in time, but we believe we are taking share.

Now what's happening is that, that software growth rate or recurring revenue growth rate is offset by our shift towards subscription or recurring revenue and also not growing, in fact, declining in services, turning in services revenue. And so that brings us back down to a growth rate of around about 12% constant currency organic, which is we think is a good -- it's at or above the market growth rate.

Now where that is, look, to the industries that we serve, we see this digitalization accelerating. It's been a long time coming. It's pleasing to see. It's getting easier to have those discussions. We've shifted from 2 years ago, spending time sort of talking about the concept of Digital Twin, the concept of digital transformation with our customers. All of our customers in those dots down the bottom of that curve, the laggers, if you like, all get the digital transformation, the Digital Twin now. They all are beginning pilots or have projects, and they all believe that it's going to drive productivity improvement. And that is creating a good selling environment for us.

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Operator [29]

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(Operator Instructions) And your next question comes from the line of Peter McNally of Panmure Gordon.

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Peter McNally, Panmure Gordon (UK) Limited, Research Division - Research Analyst [30]

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I noticed that Asset Performance Management, it was in line with total revenue. It's not a bad performance, but it's a bit of a slowdown from where we were last year. I wonder if there's anything you'd like to say about it. Is it -- I know there's a mix factor involved as well. But is there anything that you're seeing on the competitive side? Or how should we look at that going forward?

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Craig Hayman, AVEVA Group plc - CEO & Executive Director [31]

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Yes. Asset Performance Management is very much still an area where there's a lot of innovation. There's a lot of advanced use cases that are being discovered by us and our customers and even competitors. I think I'd characterize this that we're all educating the market on the benefits of asset performance management. I mean the premise is a simple one, but it's hard for customers to realize that people that they've had working with a piece of equipment for many years have a lot of knowledge about that equipment. But digital technology can take that same data and look at it over a longer period of time, look at it more consistently and better predict when it will fail before it will fail. And technology can help you put a strategy in place to provide maintenance on that asset and understand which asset types to run predictive analytics around. Once they -- once customers understand that, they get addicted to it. They realize this is within their P&L, within their OpEx. They can free up OpEx relatively easily with relatively low risk. And of course, invest some of that in digital transformation. So us and others are driving that.

APM is the larger part of our revenue. It's 14% of our revenue. We think we're one of the largest APM providers out there. We think we're growing above the market growth rate. But as I said before, I think the market is still growing. We count within our TAM of GBP 15 billion, we include Asset Performance Management in that GBP 15 billion. We think that's representative of where we are in our market.

And with respect to the mix, we do, do with some advanced pilots, some engagements with customers, which are more labor-related, but we then turn those learnings into product, a hardened product. And Suncor Energy is a good example of that, of how we engage with them of existing capability, demonstrating new capability will be available as they came online and demonstrating real value to them. We remain very bullish on APM.

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James Kidd, AVEVA Group plc - Deputy CEO, CFO & Executive Director [32]

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Yes. And just within the mix for APM, there was the traditional effect from moving to rental subscription, which also compressed the overall growth rate, which is still double digit, but there was some of that transition effect as well.

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Operator [33]

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Thank you. There are no further questions at this time.

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Craig Hayman, AVEVA Group plc - CEO & Executive Director [34]

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Okay. Well, thank you, everybody. Thank you for joining us. Thank you for your interest. Thank you for your support. It's been an exciting first half of our fiscal year. We feel good to be building on that first half as we accelerate into the second half. As I mentioned upfront, we see strong demand for digitalization. Industrial software is a hot area. These are the industries we serve. We're pleased about that. And we're confident on the outlook, and we are on track to meet our medium-term targets. Thanks for your questions. Thanks for your time today. Thank you.

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Operator [35]

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Thank you, sir. Ladies and gentlemen, that does conclude your conference for today. Thank you for participating, and you may now disconnect.