Good morning, ladies and gentlemen. Welcome to TomTom's call regarding accounting standards IFRS 15 and IFRS 16. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of today's prepared remarks, at which time, if you would like to ask a question, you may do so by pressing star one on your telephone. If at any time during the call you require audio assistance, please press star zero and a conference coordinator will be happy to assist you. Please note that this conference is being recorded. I will now turn the call over to your hostess for today's conference, Bisera Grceva, Head of Treasury and Investor Relations. You may begin.
Thank you, operator. Good morning, everybody, welcome to our conference call regarding the adoption of IFRS 15 and 16 accounting standards by TomTom. With me today are Taco Titulaer, TomTom CFO, and Dirk Ypma, Head of Group Accounting. You can also listen to the call on our website, a recording of the call will be available shortly afterwards. As usual, I would like to point out that Safe Harbor applies. We will start today's call with Taco, who will provide an explanation of the new accounting standards and the directional impact hereof on our financial reporting. We will then take your questions. Before we start, I would like to underline that today's call is only related to the adoption of the new accounting standards. Therefore, we will only take questions in relation to this topic.
Questions on any other subject, for example, strategy, customers, financial performance, forward-looking statements, will not be taken nor answered in today's call. We highly appreciate your cooperation on this. With that, Taco, I would like to hand over to you.
Thank you, Bisera. Good morning and welcome, ladies and gentlemen. Thank you for joining us today. Let me start today's call with a short introduction. Today, we will provide an explanation of the new accounting standards and the directional impact hereof on TomTom's financial reporting. On the first of January 2018, TomTom will adopt IFRS 15, revenue from contracts with customers, and IFRS 16 leases accounting standards. The IFRS 16 standard is early adopted in order to have only one transition year. This transition will involve making transition adjustments to the opening balance and providing appropriate forward-looking comments reflecting a new accounting methodology. TomTom will apply the full retrospective implementation approach in 2018, with restatement of comparative figures for 2017. Restated comparative figures for 2017 will be made available on the sixth of February, the day when we announce our 2017 full-year results.
I want to point out that both IFRS 15 and IFRS 16 only impact accounting. The standards do not change the underlying economics. For example, they have no impact on our net cash generated. Let me first highlight the structure of today's presentation. We will first discuss IFRS 15, revenue from contracts with customers for each segment. This standard is expected to primarily impact the timing of revenue recognition of certain customer contracts, as well as certain revenue of hardware sales in Telematics. Certain customer contracts in Automotive, that is. Subsequently, we will discuss IFRS 16 leases. At the group level, this standard is expected to result in recognition of additional leased tangible fixed assets and their corresponding lease liability on our balance sheet. Let me now turn to slide two. We have included a legend of the indication of the impact as currently expected.
We will use this legend throughout today's call. With a small impact, we mean a delta of up to EUR 5 million. With a medium impact, we mean a delta of between five and EUR 25 million. With a large impact, we mean a delta of EUR 25 million. Each impact is accompanied with an increase or decrease sign. I would like to stress that the directional impact is an estimate. It is non-audited and thus subject to change. The numbers presented reflect the year 2017. Let's move on to the accounting effects of IFRS 15 at the group level, indicative for 2017. This is on slide four. We have summarized this for the P&L, the balance sheet, and the cash flow. Group revenue is expected to show a limited change or a small change. Gross profit is expected to show a medium positive impact.
This is mainly caused by Automotive, to an extent offset by Consumer, and the net result is expected to show a medium positive impact. Group assets are expected to show a medium decline, mainly due a decrease of Automotive customer-specific intangible assets, and the group liabilities are expected to show a medium increase. This is mainly caused by higher liabilities for Telematics, partly offset by lower Automotive liabilities. As we have mentioned earlier, group cash flow is not impacted and remains unchanged. Let's move on to slide five. As of the start of 2018, we have changed the name of our licensing segment to Enterprise, as it better reflects the nature of activities, customers, and target markets. Automotive and Enterprise generate revenues via licensing of content, services, and software. In some situations, customization and/or integration efforts are funded by customers. Especially the revenue recognition for licensing of content is impacted.
However, the impact is different on a contract-to-contract basis, and not all contracts are impacted. Impact will be primarily on license of a map as a master copy. TomTom must assess whether there's a right to use the content as it exists at the point of time, or a right to have access to our content over a period of time. Overall, in 2017, we expected to defer less revenue versus the current situation as applicable under IAS 18. That's the current accounting standard for revenue recognition. Revenue and development costs associated with customization efforts that are paid upfront by our customers must be recognized at the start of production if related to delivery of software to an OEM. As these development efforts are sometimes quite significant, this can result in a material one-off revenues and related costs in a quarter.
Let me summarize the indicative impact for Automotive and Enterprise for the 2017 numbers. For the P&L, the revenue and the net results are expected to show a medium positive impact. This is all due to Automotive. For the balance sheet, the intangible assets and liabilities are expected to show a medium decline, and this is also mainly Automotive. Let's now move to slide six, and that is Telematics. Telematics business provides a range of services for businesses with a fleet of connected vehicles. These services most often contain a Telematics control unit, TCU, that enables collection of data from the vehicle. The TCU hardware revenue is not considered a distinct performance obligation under IFRS 15, and as such, the hardware revenue cannot be recognized at the moment we ship the hardware revenue. Instead, the revenue must be allocated over the expected service period.
As a result, we must book deferred revenue instead of immediate revenue recognition. On the other side, we will recognize a contract as asset instead of recording cost of sales. Both the deferred revenue as well as the contract asset will be released over a five-year period to the income statement. Let me now summarize the directional impact for Telematics for the 2017 numbers. For Telematics, we expect a small increase in revenues as releases from historic TCU sales will be higher than deferred TCU revenue in 2017. Net liabilities are expected to show a medium increase. Now moving on to Consumer. Consumer sometimes contributes to marketing development funds and co-op advertising of its customers to stimulate sales. Under the new accounting rules, such payments will be reduced from revenue. As this will lower both revenue and the OPEX, this will not impact the bottom line.
This concludes our comments on IFRS 15, and we now continue on some high-level comments on IFRS 16 on slide nine. The effects of IFRS 16 to TomTom are relatively straightforward, as the main impact is driven by lease contracts for buildings and cars. IFRS 16 will require almost all leases of companies to be on the balance sheet of the lessees. The current lease expense will be broken down in an amortization or D&A expense and an interest expense, as can be seen on slide nine. On slide 10, we briefly explain the indicative impact for TomTom for the P&L and the balance sheet. For the P&L, the EBITDA is expected to show a medium positive impact as the lease expense will be classified as D&A and interest. Operating lease expense for 2016 were EUR 20 million. The net result will show a small positive impact.
This is because the calculated interest costs in the earlier years of the contract are higher versus the later years of the contract. On average, our lease contracts are in the latter stage of the contract period. The balance sheet is expected to show a large impact. This is due to the recognition of both a lease asset as well as a lease liability.
Our off-balance operating lease commitments at the end of 2016 were EUR 77 million. The total cash flow is not impacted and remains unchanged. There will be a reclassification between cash from operation and cash from financing activities, but again, the overall total cash flow is not impacted. To conclude, I would like to note that any forward-looking statements, if applicable, will only be provided using IFRS 15 and 16 accounting standards, linking into the changes to our planning and budgeting processes. Operator, I would now like to start with the Q&A session.
Thank you. If you would like to ask a question, please press the star or asterisk key followed by the digit 1. Please ensure the mute function on your telephone is switched off to allow your signal to reach our equipment. Again, please press star 1 to ask a question. We will now take our first question from François-Xavier Bouvignies from UBS. Please go ahead.
Hi. Thank you guys for taking my question. I have a couple, if I may. The first one is, given the shift that you have in your revenues within businesses, you target 15% CAGR for the non-consumer businesses. Does it change these targets? Or is it still the same given the accounting changes on the revenue side, given that it's non-consumer? Even if it's more at the group level, you move consumer, does it change it for the rest? The other question I had, from what I can understand, the timing of the contracts are important in this IFRS 15. It's very important to know where you kick in the transformation phase, where you incur more of the cost in the early days with no revenues. You may have some loss-making contract in the beginning. I just wanted to confirm with that.
Can you update us, where are you in your order intake recognition? For example, in 2017, did you recognize 2014, 2015? Where are we in that? The last one I had, it's on your capitalization of cost. Should we expect an increase of capitalization costs with this change? Thank you very much.
Thanks, François. I will take two questions that you asked about CAGR. That's the first one. As I mentioned in my introduction remarks, this is a question about forward-looking statements, and today's call is not about that. We will park that question until we come out with our quarterly results in February. The second question you asked about order recognition. As you may know, order intake is not anything recognized on balance sheet, on P&L, et cetera. For that question, I'll leave it with that. For the other two question, I'm handing over to Dirk.
Yeah, you asked whether contracts can be loss-making at the start of the contract, if I rephrase your question. I would say that IFRS 15 really needs to be determined on a contract by contract basis, potentially it could be that more costs need to be taken upfront. Your other question was, will there be an increase in CapEx? I think there would be no increase in CapEx. It will either be flat or show a small decline.
Okay. Thank you very much. That's clear.
We will now take our next question from Marc Hesselink from ABN AMRO. Please go ahead.
Yes. Thanks. My main question, actually, obviously, no impact on the cash flows. Is that something that you will be talking about in the future, given that this is the only part that didn't change because of the accounting standard? Obviously not asking for that number, but just the fact that we will talk about the free cash flows in your forward-looking statements at a later stage.
Marc, I'll take that question as well. Any question, as I said, about forward-looking statements or planning, et cetera, needs to be parked until 6th of February. Thank you.
Okay. The other part, just the fact that in general, you will have lower deferred revenue. In part, you obviously give a lot of attention to that part, just to explain that. Are you therefore a bit happy with this change so that it becomes more clear that because you will have lower deferred revenue?
Well, lower deferred revenue. If you look at Telematics, the total amount of deferred revenue will increase if you go from the old accounting standard to the new accounting standard. As Telematics will start to defer the TCUs, the hardware, that will have a significant effect on the absolute deferred revenue. Going forward, apples to apples, it is indeed so that you defer less. The one-off effect, again, is that the deferred revenue position will materially grow.
Once we go off to the new accounting standard.
Will therefore imply that the EPS number that you will report going forward, that it is more of a true EPS number than it used to be in the previous reporting?
Well, I don't know exactly what you mean with true, but, as always, we will disclose the deferred revenue position, and we try to help our analysts and investors by making clear what part of our revenue is deferred in each period.
Okay. Thanks.
The only thing is that deferred revenue was mainly a topic for our Consumer business and for Automotive. Now it will also be significant for Telematics as well. That's kind of new. Again, the Telematics is linked to the size of the install base. You defer for a period of five years. As the install base is still growing, but the growth is fairly stable, that means that the effect of the new accounting rule is quite minimal because every period, you defer almost the same as you release. That's quite different from consumer, for example, where we have seen, in 2017, that there's a net release and a significant net release, meaning over EUR 10 million. Also, for Automotive, there is a significant increase, also more than EUR 10 million.
Those effects are a lot bigger than what we see in telematics.
Okay, that's clear. Thanks.
Again, as a reminder to ask a question today, please press star one. We will now take our next question from Marc Zwartsenburg from ING. Please go ahead.
Yeah. Thank you for taking my questions. Taco, Bisera, I had a bit of issues with the fastest of the slides and the delays there. I'm going to probably ask a few questions to clarify what was going on on slide two or three. The impact from IFRS. I think you showed first a slide where you saw the group impact. I can't go back to that slide, but is it true that that slide says that the impact on gross profit and net result from IFRS 15 is medium positive on 2017? Is that correct?
That's correct.
Indeed, what Marc says is on the deferred revenues, the part you defer will going forward be less than it used to be. There's less revenues that need to be deferred over the automotive contracts, for instance. Is that correct?
If you restate 2017, according to new accounting, this is the effect.
A major positive.
Not a major positive, a medium positive.
Medium in your, with EUR 5 million-EUR 25 million on the consensus EBIT, that's a major positive actually for estimates. That's how we should see it.
It is, again, it is completely cash neutral.
No, fair enough. You're bringing the operational leverage forward. Can you explain me what was the old situation and exactly in automotive, in a contract, how much you deferred and what you now have to defer? Can you explain that in very simple words, perhaps, again? Sorry for asking that.
That is a bit of a difficult question as this depends really on a contract by contract basis. On a contract by contract basis, we have looked at all contracts in 2017. For example, if there is a start of production of a contract, then you can take your revenues related to the customization efforts on that specific software immediately. Also the expenses on customization efforts needs to be taken immediately. Those kind of one-off effects at the start of a contract can have a big effect on an annual performance if some big contracts go live in one year or another year. These things also take place in 2017. You see, for example, you could potentially see less cost as these have been fully amortized at the start of production of a contract that went live in 2016.
Costs are not in 2017. It's really on a contract by contract basis that we determine this, and then the effect of 2017 is positive, medium positive for 2017.
If you have the start of a new contract, and let's isolate one new contract, then you say, okay, dependent a bit on how it starts. Normally generalizing this, a new contract will be negative or positive in one year when it starts, just to get a feel for a new contract or an old one.
Again, it depends on the contract and what kind of deal we had in that specific situation. Some could potentially be negative at the start of production. Others could be positive.
Okay. Is this one-off from customization a big one in 2017? Because I need to have a bit of a proxy going forward. What will happen to ongoing contracts when there's no new one? 2017
Well, it is difficult to say. I understand your question, but it's just very hard for us to give that answer, because every deal is different. If there's customer-specific work, where we are remunerated for, then indeed, whatever we agree up front, that revenue is taken at the start of first shipment or start of production, but also the related costs are taken directly. That doesn't really mean that is highly profitable from that moment. Whatever you need to do specific for that contract.
It seems that the new contract is normally more negative because you have the cost immediately and perhaps the revenues later. Still, you have a big positive over 2017. That means apart from the new contract, the old contracts are far more profitable, or am I wrong here?
The thing is that there is no general rule in automotive. I can't give you that specific guidance. If you have a contract, the value, let's say, for an automotive contract is EUR 10, the amount of specific work we have to do for an OEM is always a fraction of that amount, because most of the cost, most of the value we deliver to our customer are sunk cost. Is software and is content that is already available to all. There can be specific work, sometimes we are remunerated for that, or sometimes the customer doesn't want to pay for that and say, it's part of the whole deal.
How should we deal with this going forward then in terms of modeling? Because now I have the feeling that we get some guidance on 2017, which has no relation whatsoever as a proxy for 2018, 2019, 2020, whatsoever. How can we deal with that going forward? Because I'm a bit in the dark.
Yeah.
What will be going forward, the way of modeling this? Should I take 2017 as a proxy or not?
Yeah, for sure. 2017 is the new accounting standard, that is the new way of looking at things. We hope to give as much clarity as possible that we can do, and that's also in our liberty to do with what we can tell about our customer-specific arrangements.
Should I take that as a good proxy for 2018, or am I wrong? Because that's the thing. We should also, going forward, have some tangible tools.
Marc, I don't really understand your question.
No, you're telling me that 2017
I'm talking of 2017
that everything is contract specific. Going forward, everything will be contract specific. What should I do for 2018? Can the impact then all of a sudden be negative? If I put in a big positive for 2017, do I have a big negative for 2018? I have no clue now. I think all the other analysts also fighting with that.
Okay. For automotive, there are 2 differences. you have
Yeah
in general, the revenue recognition used to be unit-based.
Okay.
If you start producing, you have royalty reporting, and you have several thousand cars that come to market, and you do the times a certain price, and that is the revenue that you get from that customer.
Yeah.
The new accounting rule will be more time-based. You look at the overall contract period, and you make an estimate of how many cars will be shipped with your product, and you spread that out over that period. That can be flattened out.
Yep.
On the other hand, there's a specific treatment for customer-specific work, non-recurring engineering. In the past, we used to capitalize that work, and we took that cost through our cost of sales when we start to ship for that car line or for that OEM. The new treatment, that will be different, then the customer-specific work will be taken at once at the start of production. Also the revenue related to that will be recognized directly.
Okay.
Those are the two main differences, big changes, is that, one, the automotive contract will be valued. It's more similar to what we're already doing with Enterprise. The contracts that we have with the Enterprise customers are more one fee for usage. That's also the approach more and more that we look at automotive, then we make an estimate of period three, four, or five years and say, "Well, we think we will ship 1 million maps over a period of five years. Let's spread that over that period times a certain ASP.
Okay. On the first part where you say it's now time-based, actually you're taking more of the revenues already forward. That's why you have less deferred revenues. Is that correct?
Yeah, that's correct. Also, the normal trend was that in the final years of the contract or the end of the contract, there could be a difference here.
Yeah, of course.
The curve is going to change.
Yeah. Now I understand that. Yeah, the total amount of deferred revenues, can you give us the old number and what will be the impact versus the new accounting on 2017?
Marc, that's a question for 6th of February.
The old number is the number that we reported on the 31st of December 2017, that's not public information at this point.
Right. Okay. If we isolate your medium impact on an EPS level 17, just the accounting impact, what will be the positive impact on EPS?
No, we can't do that now, Marc.
No, without giving, say, the Q4s away. Just simply accounting. Is that possible, or is it
No, I don't want to go there.
Okay. All right, that's it from my side. Thank you very much.
Okay, thank you.
We will now take our next question from Andrew Gardiner from Barclays. Please go ahead.
Good morning. Thanks for taking the question. I just had another sort of follow-up on the prior discussion. This distinction within auto of sort of unit versus time accounting. In terms of how these contracts are negotiated, are they generally a flat number for the life of the contract and therefore, you can recognize it equally over time with sort of no risk in the out years of the contract or, my understanding had been, and perhaps this was incorrect, that there was always an underlying unit assumption there anyway. Is there the potential that if the automaker you're working with perhaps doesn't sell what they think they're going to sell or what you think they're going to sell, is there a risk sort of in the latter stages of a contract that you may cause some sort of revenue recognition problems or cost recognition problems?
Yeah, you're right, Andrew. Part of the RFQs is also a forecast that we receive from the OEM of how many units they will ship. That is also the basis for us to calculate the total value of the contract. It often happens that it changes for the bad or for the good. Dirk, maybe you can comment on that, how we correct for that then.
On a periodic basis, we need to assess whether our estimate of the total contract value is still accurate. If we see during the contract that the value will increase or decrease, we need to book a cumulative catch-up contract to date of that effect. That could have an impact on a quarterly result in a quarter.
Okay. Understood. Thank you. You may not want to sort of comment on this, but I presume your view is that over time, as the number of contracts grow and, relative to where we are today, perhaps sort of earlier stages in the automotive business, that over time, this all will probably smooth out.
Yes.
Okay. Thank you very much.
That will be effective, indeed.
Thanks, Andrew. This was the last question for today's call. I want to remind everybody that there is a recording of the call as well as the slides of today's call. Those are available on our website. If there are any further questions, you can reach out to our IR department. For now, I would like to thank you all very much. Operator, you can close the call.
That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.