Dassault Systèmes SE (DSY) Earnings Call Transcript & Summary

Okay. Good morning, everybody. Welcome to the second day of the conference. Thank you very much for joining us. My name is Adam Wood, I'm a after European Technology Research. I'm very pleased to have Rouven Bergmann with us. Rouven the CFO of Dassault Systèmes. Rouven, thank you very much for joining us in San Francisco.

Cool. Thank you, Adam. Great to be with you.

I'll get the boring stuff out of the way. So just on the disclosures for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representatives. So with that out of the way, I hope you can go on to some more interesting things. I wanted to start off, I guess the macro is on a lot of investors' minds. It feels and we've all been taught to be very kind of skeptical with the idea that this time could be different for technology spending in particular. But I think you've come through the slowdown such as it's been so far very well. I think in your industry, innovation is critical, increasing efficiency is critical. Could you maybe talk a little bit about the conversations you've had with your customers around their planning? Are they going to be able to maintain and sustain the investments and what the plans are?

Yes. So we're quite confident. And as you said, Adam, the situation really is that change and innovation is essential to any growth strategy. And there's so much going on, and I can talk about some of the end market and industry dynamics we see that without being focused on innovation and driving change, you will be questioned, right? So we are uniquely positioned to help our clients on this journey. And why is that? Because we have a platform approach. We -- when I speak to clients, they are not any longer focused on driving changes in certain functions of the company. So they look at the system level of looking into -- on transformation across multiple functions. So system engineering is one key imperative and strategic focus, for example, for the OEMs right now. And we have several conversations where we have large OEMs, large incumbents who have to retool and rethink the way they work in order to speed up their operation to deliver cars not every 7 years, but every 2 years at price points that are probably half or 1/3 of what they offer today, if they want to be competitive in the future. So how are you going to do that, not in the set of systems and operations you have today. Now, you have to massively integrate, you have to simplify. You have to think about your relationship with your value networks, your suppliers. So with our platform, we are mastering the systems engineering, much similar approach. We are integrating into, of course, product life cycle management is core of our offering, and it's becoming very strategic for our customers. And then we go downstream into manufacturing in order to master manufacturing, you have to design to manufacture. You have to design for waste. You have to design for recyclability. You have to design for sustainability. And that's just one example. So another great example that I want to touch on because I'm very excited about this, and I just came back from meetings yesterday. We have our Centric PLM company here out in California, which we also acquired in 2019. And they are really focused on apparel, fashion and beauty products which is a very different PLM system than what Dassault Systems typically deals within the industrial sector, right? It's all about the [indiscernible] management, collection management, campaign management, planning and pricing and a lot of data analytics and competitive intelligence because you need to understand how your competitors pricing their brands, what type of materials they have, what colors they use, how they position themselves. And there are massive companies right? We can talk all day long about the industrial sector, but we can also talk all day long about the fashion industry and the big brands we have in this sector and how well capitalized they are. So also this sector and industry is going through massive transformation for the reasons of sustainability because consumers are looking now at their labels of materials and they have to reformulate and look at sustainability. So that's something that's also very exciting to us, where we see lots of good conversations and an increasing very solid business performance.

Perfect. A very good examples. And I think that gives us a good idea of where you see the opportunities and why companies are continuing to spend. Maybe talking about this year specifically, you've guided to 8% to 9% ex currency revenue growth, which I think when you announced it, investors were positively surprised by. I think the share price reaction was probably a pretty good guide to that and you're normally regarded as reasonably conservative on the guide. Could you talk a little bit about the visibility you have into why you're so confident in giving that level of growth in a tougher environment? I guess the platform and the ability to cross-sell and the bigger deals that a platform approach brings could be part of it, but that would be interesting to get a feel for what went on behind.

Yes. I think it's -- the way I've -- we looked at this, we had a very good finish to 2020. Q4 was strong. Q3 was softer. We know there were seasonal aspects to this, but 2022 was in and itself, not an easy year. When we started 2022, we did not -- nobody plan for the macro and geopolitical situation we were running into shortly thereafter beginning of 2022. Also, the COVID situation in China certainly had an impact on our business, 7% of our software revenue is from China. So it's not very large, but it's also not smart because it can be big enough to have an impact. And the two things combined had around 1.5 to 2 points of growth headwind in 2022. Nevertheless, we stuck to our guidance of 9% to 10% and deliver 9-plus percent growth in 2022. Now transitioning to 2023. All of those aspects are factored already into our baseline. The trends that I mentioned before in the auto and industrial sector and in the consumer goods products. I can go on with life sciences, which is a quite a robust market. We have seen a very, very good track record over the last 2 to 3 years in our Life Sciences business, led by Medidata, but now more and more also supplemented with [BIOVIA] and our more downstream on the research side -- upstream, sorry. So there are -- I think we are very well positioned, right, in these industries, and that gives us the confidence. Now where we have some exposure and that we've been talking about is in the SMB market, where we have seen certainly some softness throughout 2022 in parts of Europe, not everywhere in Europe, but in parts of Europe and here mostly focused on our SOLIDWORKS business, where we really serve clients at the size of 3 to 20 seats per customer and which has been a growth engine for many, many years. But it has had some friction in 2022 as they are certainly the energy crisis in Europe and some constraints to hire and deal with still high levels of inflation has impaired some of those smaller companies. Now when this will come back with remains to be seen, right? I'm not here to predict that in 2023 when it will come. But as it relates to the more larger and more sophisticated enterprise level clients, those customers, they see through this macro and inflationary risks to really look more out 5 years plus to 10 years. To see here other strategic investments we need to make over the next 2 years to be ready to position the companies for 5 to 10 plus years out, right? So these investments are critical right now. And that's what also gives us the confidence in what's reflected in our pipeline to be maybe more precise to your question. The pipeline structure is very similar to what we have had coming into 2022. And so that's why we guided the way we guided. And of course, there can be quarter-to-quarter fluctuations. Nobody is immune to that. But as it relates to the full year, we are I think we are well positioned with this guide. And strategically, we are well positioned with our clients, the level of conversations we have and the relationship -- ships give us the confidence in the insights that we are on the right path.

And the SMB part of the business, SOLIDWORKS is about 20%, and then there'll be a part of the PLM business that would be exposed there as well. Is that the right order of magnitude?

Yes, it's really works. It's really SOLIDWORKS. And interestingly, for Centric PLM, where we also have some smaller apparel companies, it's not the case because the market that we are in there is much more still a market of spreadsheets and homegrown solutions that are easily to be displaced.

At a big opportunity, I think. Investors often kind of -- we often underestimate how much [excel] there is still to get out of businesses.

And that's a very good point, Adam. I think the way maybe to conclude to the question is the level of diversification that does the system for us today right, if protecting us as a company because we are in so many different parts of different industries. Now what we have to manage very carefully, and I know we want to talk about this as well is how do we manage our investment strategy to not be spread too thin. We focus in these end markets that we can really drive innovation and be the partner that our customers are looking for to make investments for the next decade, right? Because they are looking for partners who can help them in their journey and not just in the next 12 months, right, to solve a specific problem. Now we are a partner positioning us for a journey of transformation and change.

That brings me nicely on to the next question, which is around margins. So you guided to margins down in '22. You've guided to that again in '23. I think what we're all struggling with is how much of the margin pressure we're seeing at companies, the kind of normalization post cover of people not being able to hire as quickly as they wanted, inflationary pressures in the market versus are there any kind of structural issues or need for investments in businesses that could go on for longer. Could you just help us a little bit with where you are in that cycle?

Yes, yes, a very good question. Look, 2021 was a difficult year because we were -- it was difficult to hire and invest. And the market was extremely hot because many large many tech players overhired than overpaid. And now they're going through a correction phase. We have not done that. We stood to our principles, and we were maybe sometimes questioned, are you too conservative? Do you need to hire faster? Do we need to be more aggressive in the market? We weren't. We saw starting to see an increase in the hiring activity and growth at the end of 2021. And then in 2022, we were very explicit that we have to catch up from the lower level investment of 2021 because we didn't participate in this frenzy hiring of war of talent, right, that was going on. And so we hired 2000 -- we grew our headcount by next 2000, which is an increase of 10%. And which is fairly high on the standards of any of Dassault Systèmes over the last years. We grew, I would say, an average between 3% and 5% typically, excluding acquisitions on an organic basis. So now coming into 2023. So of course, with the hiring activities in 2022 and the constraints in 2021, you explained the margin dip between '21 and '22. And I think we prepared the markets already in 2021 to know that this is going to come. Now coming into 2023, the situation is, first, let's start with the top line. We're guiding to 8% to 9%. Our OpEx in 2022 grew 11% because of the hiring activity and growth activity and the inflation in 2022. In 2023, we are bringing the OpEx down to below 10% between 9% to 10%. And when you have the top line between 8% to 9% and your expenses at about 9%. You have some margins squeeze temporarily in 2023. That's what we have. Where is the margin squeeze coming from. It's really the carryover effect from the inflation and the hires that are now going to be in our base for a full 12 months in 2023, where they were joiners in 2022. That's about 6% to 7% of carryover effect coming into 2023, which gives us some level of flexibility but not too much, right? To put on top in 2023 for incremental investment and growth. So we will be in 2023, very much focused on driving productivity we say capitalizing on our investments of 2022, making sure that our people are at the right place. We are harvesting those investments we have made. And we'll be selective in hiring in 2023, but we are not planning any layer or restructuring, like what you have seen in other places.

Looking forward after that, there will be no reason to think.

The 2024 will be rebalanced back to 2022 where we were at around 33%, 33.5% operating margin. That's the sweet spot. I think for now, we want to be, which also gives us some good leverage points, to do further investments to offset dilution from acquisitions, if we were to make an acquisition. We have done that in the past, which was always important to have that muscle that we can bring the overall margin of the company back at the level where we'd like to be, which is part of our financial profile, operating leverage, but also cash flow to delever fast as we have done with Medidata. I want to remind the investors that the delevering is 1 year ahead of schedule. We will -- I don't know want to preempt Q1, but we will be delivered in Q1. So that's all good news, and that's part of our model, and that's what we want to retain, right? And that's why it's important to come back to the margin levels we were in 2024. And 2023 is like, I would say, like a little dip temporarily, but offsetting our investment strategy, which was strategic and important.

That's very clear. So one of the biggest discussions I have with investors around us is a lot of the European software companies on this journey to cloud from a delivery model and to subscriptions from a payment point of view, the payment model probably being the more disruptive of the two. There's a big debate around could us have to move more quickly, as we've seen happen at SAP. Would that lead to pressures on top line and margins. And you kind of said so far, no, it's going to be more gradual. Could you just talk a little bit about why you're making decisions around doing that shift more gradually and why there couldn't be a faster move in the business that could impact you?

Yes. Happy to. I think because you mentioned SAP, I think SAP is in a very different position than us. They've been threatened in their end market by companies that are putting a lot of pressure to them because they have a next generation of ERP system, which is cloud native, which questions and has much higher level of agility than what an SAP system can bring. They're in a very different spot. For them, it's only -- they have to -- I think the thoughts what they're doing. They're running as fast as they can to be on path, right, with those disruptors. I can testify and can assure here to you that we do not have the situation. We have not yet lost one deal because there is a company or a competitor who offers the cloud version of what we do, and that's what the customer preferred Industrial Systems could not operate a cloud-native or cloud version of our software. That has not happened so far. And so our customers are really focused on value and how they can drive change and transform their innovation life cycles and product life cycles. And therefore, we have -- all of our products can be run in the cloud as well as on-premise. We have even some of our products that they are only cloud-based and not on-premise available. 3DEXPERIENCE platform gives you the flexibility to also have hybrid and mixed deployments between on-prem and cloud. So what's really important for us is to follow the journey of our clients. To give them the flexibility and the choice that they can drive their transformation along the timelines and the roadmaps they have set, which also includes previous investments they have made. We have customers who are very successful using CATIA V5 for many, many years. And now they are realizing as their requirements are shifting as design is not just mechanical, it is electrical design, it is material design. It introduces new practices. So you are there. There, I would say, automatically or because the innovation for system or drives them to adopt new systems and implement the 3DEXPERIENCE platform from what maybe CATIA V5 as a legacy system used to be. But we do not need to force a client through a contractual arrangement to say, okay, this goes out of support at that point in time. And going forward, you can only use our software as a cloud deployment. And by the way, you have to transition to the new and next generation. In our world, that makes no sense right? I can rest assure you it makes no sense, right? We are working with our clients to move them gradually as they are building their road maps to drive innovation and value forward. Really disintegrating silos. And we are focused on a platform approach. That's really what makes the difference. Now from a business model standpoint. Of course, it's a strategic priority for us to increase the predictable share of revenue clear. Subscription revenue, which we have now highlighted much more clearly in our disclosures. 2022 was 15% growth in subscription revenue. We are projecting in 2023, this to grow by 200 to 300 basis points to 17% to 18% growth for the year. So clearly, when you look at the growth profile of Dassault Systems, it's driven by the subscription business. And the subscription business today is more than 1.5x of what the upfront license business is. So we have come a long way already to a point where the majority of the traction and the dynamics are in the subscription line item. And that trend will continue. While at the same point in time, there will be customers who will buy licenses certainly -- we have geographies where the licensing and CapEx model is preferred like in China. We have customers, maybe in public sector who are more used to CapEx budget instead of OpEx budget because they cannot commit every year again and again, for the same amount. They are -- they have structured cycles, they go and they fund the project. And in this [what did] they also fund for the software that they are purchasing. So why would we choose to not work with these customers because we have an artificial overhang because there are -- there's an artificial discussion that going forward, we do not like this. We want to have it this way. It makes no sense. That's our conviction. However, we are going to move gradually to a repeatable and more predictable business model. That's very clear, right? That's well understood. And that's also reflected in our pricing models, and that's the way we position our platform as well because the really -- the value for our clients with the platform it's much more and much better, how much higher if it comes in a subscription model because it gives clients the flexibility to use different domains across the platform in a more flexible subscription agreement. And then if you were to buy seats or licenses or a certain functionality, you cannot replace that. You have a certain state of licenses that you're done using but if your business processes are changing, if you need more flexibility to use -- to have the usage along the platform. The subscription model gives you the flexibility to do that. So there are good reasons for our customers to transition to subscription away from license as well. And that's what we are educating our clients to do. And then the last thing I would say is the power of the platform is also the power that when we introduced the platform, our deal sizes are much larger than what it used to be when we were offering, I would say, more best-of-breed solutions and products in design and simulation in PLM, et cetera. Now we have it all integrated into the platform. And so the deal values are significantly higher. And we are combining that with the move to the subscription. So there are many parts that are deeply connected. So it's -- and that's my last sentence, I would say this is all well underway and we will see that play out over time.

Perfect. That's a very clear response. I think actually, I could pick a theme at the conference on the second day. It would be around AI. And I think one of the really interesting things for companies is around some of the data sets that they have that they can lever. And I think in the Medidata business, potentially you have an absolute gold mine of data. Could you just talk a little bit about the opportunities you have to lever AI in that business, the data that you have and you can use?

Yes, for sure. So that's a very, very exciting opportunity for us. And it's -- I come to Medidata in a second, but I really want to make sure the data opportunity for Dassault Systems is beyond Medidata and it's well understood. And we have a division that we acquired [Exalead] a few years ago. And [Proxem] we now have renamed this to NETVIBES. And this business is growing very, very nicely. And here, interestingly, we more and more also compete with Palantir, for example so we are starting to be recognized certainly, in the industrial world, we're not in the public sector, but with our industrial clients to help them to make more -- to really use the data to accelerate innovation and drive change. And some examples are more I would say, not advanced. There are maybe more pattern analysis and machine learning examples where we have a massive amount of data around parts in our system. There's a significant opportunity for large conglomerates and customers who have multiple brands to standardize parts. So think about you using machine learning and pattern analysis to find similar parts and really make it a focused activity to standardize those parts and then optimize the parts maybe for rate, for recyclability, for cost maybe for volatility, if you have to think about your sourcing strategies. So there are multiple ways to drive value through spot standardization and optimization using machine learning. So there are great use cases and examples we have been doing this. And the way we drive that is through our NETVIBES business. So they are really coming with a data science experiment, but it's not a onetime exercise. It's a recurring business operation. I think that's also the difference to how we position us with our platform vis-a-vis Palantir and others who are coming more on a project-by-project basis but it's not something that is really here to stay and becomes part of an operation. It also gives us the ability, the data business is to get to new audiences and users. So we have examples where we have now users in procurement and in finance departments for material costing, for example, right, where we have a lot of volatility in resources and material prices that costing departments in typical ERP systems cannot answer those questions. You really have to go to the design and the part and understand where those parts are used and how they could be replaced in order to optimize your cost function and reduce the cost of, for example, in a car. So this is another way where we can expand through data science into new audiences. Generative design, I think there's a lot of debate around generative AI, right? We have generative design where we optimize parts for durability, for rate through models that we are creating. But it's always a combination of a design that's done by a human and a model that augments the design in order to further optimize it. And there are great examples where generative design has had a huge impact for our customers. And we talked about this in the past. Now to Medidata, what really characterizes Medidata is that the data set that Medidata has is highly proprietary. And I think if you want to create value with an analytics and data business, you need a few things. You need access to the data, you need to be able to aggregate that data, because the data always comes from different sources, right? It's not one client that gives you the data or one project. It has to be multiple customers, multiple projects. We need to have a way to standardize it. So there has to be a real fabric to do that, right? You have to automate that. And you have to have the use rights from your customers. They have to allow you to do that. Therefore, it has to be deidentified so that you can -- and you have to aggregate it. And then thirdly, probably mostly underestimated in the importance is you have to have the domain. Otherwise, you cannot work with the scientists of your customers to help augment what they are doing through your models that you're providing, right? They will -- you're not at par level because this is where the IP of the client is created, right? So the data, the rights, the domain and you have to bring all of this together to create insights. And examples are the synthetic control arms that we have been able to create or synthetic patient cohorts to represent the baseline of standard of care to advance clinical trials and evidence generation. So there's many things that we can do to close the loop between innovation, the data and trying -- and changing the way things are done, and it ties a lot of value. So I think we are uniquely positioned to take advantage of that.

That's very interesting and that it's useful to have the industrial side of the story as well as what's possible on the Medidata side. We're coming up against time or I've got another few pages of questions, but Rouven, thank you very much for joining us. Really appreciate the time, and thank you for [indiscernible]

Thank you, Adam. It's great to be here. Thank you.