SAP Pre-Earnings: Fiscal 2014 Outlook In Focus

SAP AG (NYSE:SAP) reported preliminary unaudited results for fiscal 2013  on January 10, 2014. In dollar terms, total revenues grew 4% to €16.81 billion compared to fiscal 2012. Constant currency revenues on the other hand grew 8% for the fiscal, indicating significant erosion on volatile currencies during 2013. Comparatively, constant currency and reported revenues grew 9% and 14% during fiscal 2012.

Cloud subscription revenues posted growth of 158% to €697 million over fiscal 2012. On-premise software license sales, however, continued their downward trend due to the migration of businesses from on-premise application software to on-demand SaaS offerings. Revenues from SAP’s software division declined about 3% over fiscal 2012, reaching close to €4.51 billion. Software-related service revenues also witnessed a slowdown with 6% growth compared to 14.5% last fiscal. In addition, revenues from SAP’s professional services division shrunk approximately 6% for the fiscal period.

IFRS operating profit for the fiscal stood at approximately €4.47 billion, compared to €4.07 billion a year ago. The 10% growth in operating income despite the slowdown in revenues resulted in 1.5% expansion in IFRS operating profit margin. However, these margins were comparatively lower than the 34% observed in fiscal 2011.

Here we highlight key takeaways from the preliminary results. The company will announce its audited fiscal 2013 results on January 21, and we want to study the impact of the ongoing cloud migration on SAP’s top line prospects with regards to the outlook for fiscal 2014. We will also shed some light on future margin prospects for the company in our earnings article.

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Declining Software Revenues To Continue In The Short Term

The decline in SAP’s software revenue stems from the migration of businesses from deploying applications on-premise to the cloud. This is evident from SAP’s preliminary fiscal 2013 results. In reported terms, software revenues declined 3% compared to 13.5% growth in fiscal 2012. On a constant currency basis, software revenues gained 2% in fiscal 2013, compared to 11% growth in fiscal 2012. This is a sharp deceleration in revenues and a continuity in this trend could very well lead to negative top line growth for the company. On the other hand, cloud subscription revenues, which are expected to make up for the decline in on-premise software sales, are still at an early stage for the company. Despite the impressive triple digit growth rate in 2013, the revenues of €697 million (just 4% of total revenues) are still small in absolute terms.

The decline in software license sales has also impacted software-related service revenues. Software-related service revenues in 2013 were €8.73 billion, compared to €8.24 billion in 2012 and €6.97 billion in 2011. This represents a growth rate of 6% compared to 18% a year ago. In its Q4 earnings call on January 21, we expect to gain insights into SAP’s stance on its software license division in terms of its fiscal 2014 outlook. Although SAP is expanding the integration of the HANA platform with its application software, we expect to see a further slowdown in software and software-related service revenues for the first two quarters of fiscal 2014.

Margins To See Gradual Expansion Due To Increasing Cloud Adoption

According to SAP’s unaudited financial results, operating margins expanded from 25.1% in 2012 to 26.6% in 2013. We believe this expansion is a result of an increase in adoption of cloud services from SAP’s customers. Going forward, we expect margins to expand further as SAP customers continue to adopt cloud subscription services. Additionally, the integration of SAP HANA into its application software subscriptions as a bundle package could contribute to better margins due to its relatively higher pricing. Currently, 77 industry applications and analytical solutions are being powered by HANA, and all the product offerings are expected to be ready for HANA soon. We expect SAP to continue to benefit from the expansion in margins by integrating its application offerings with the HANA platform to boost business productivity for its customers.

We will revise our $80 Trefis price estimate for SAP after the release of audited results on January 21.

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