SAP Q1FY14 Quick Take: On-Premise Revenues Contract, On-Demand Sales Accelerate

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First quarter results for SAP AG (NYSE:SAP), reported on April 17, fell short of analyst expectations. The German software developer reported IFRS revenues of €3.7 billion compared to our estimate of €3.8 billion. Consensus first quarter estimates for SAP also were approximately €3.8 billion. Non-IFRS  revenues, which exclude currency fluctuations and deferred revenue adjustments, expanded 6% to reach €3.9 billion for the first quarter.

The company continued to impressively scale its on-demand business. IRFS Cloud revenues grew an 60% to €219 million over the prior year level, which excludes the deferred revneu of acquired businesses.   More tellingly, non-IFRS  revenues for the company (excluding currency effects and including this deferred revenue) expanded 38% year on year to reach €231 million for the quarter. This revenue growth rate of 38% stands higher than its earlier guidance for FY14. We believe the acceleration in cloud revenues for SAP is a result of strong demand for cloud solutions powered by SAP HANA, in addition to good operational performances from Ariba, SuccessFactors and hybris. Going forward, we expect further acceleration in revenue growth for the cloud business through organic and inorganic channels to meet its 2017 revenue target of €3 billion – €3.5 billion.

However, revenues from on-premise software offerings declined in the quarter. New license revenues for on-premise offerings stood at €623 million, 5% lower than revenues from a similar period last fiscal. Comparatively, new license revenues for on-premise offerings from SAP were 3% higher in Q1FY13 on a year-on-year basis. In this earnings note, we present a quick takeaway of SAP’s Q1FY14 earnings.

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Is SAP Sacrificing On-Premise Growth To Expand Cloud Footprint?

The on-demand business for SAP has shown strong momentum since its inception. In fact, the first quarter, it attained an annual revenue run-rate (includeing both subscription & support and cloud-related professional services revenues) of  €1.1 billion. Comparatively, cloud revenue run-rate for fiscal 2013 at the end of Q1FY13 stood at €840 million. Fiscal 2013 cloud revenues ended at €787 million, lower than the actual revenue run-rate due to business seasonality. Accounting for seasonality in subscriptions, overall FY14 revenues for the cloud business should be comparatively lower than the calculated run-rate of €1.1 billion. The company previously guided cloud revenues between €950 million – €1,000 million for FY14, which looks more plausible at the moment.

However, on-premise sales have taken a beating this quarter, falling 5% on an IFRS basis. This fall in IFRS revenues is much steeper compared to previous quarters. In the recently concluded fiscal 2013, SAP reported a 2% decline in software (new license) revenues on an IFRS basis. Even on a non-IFRS constant currency basis, revenue recognition slowed down considerably. Non-IFRS constant currency revenues for new on-premise licenses expanded by 1% this quarter, compared to 4% for fiscal 2013.

A slowdown in new license revenues may well have been augmented by SAP’s aggressive push into developing its on-demand business. Business usually find the cloud model easier to deploy and consume at reduced costs, despite concerns on data privacy and security. This enterprise shift to on-demand consumption of IT solutions impacted many legacy software players such as SAP, Oracle and IBM in recent times. The company has lost its CRM market leadership to pure-play operator Salesforce in 2012, and has been under pressure from other cloud operators such as Netsuite and Workday in the ERP and HCM verticals.

With its focused cloud strategy, SAP is benefiting from the move to cloud-based solutions, as customers cut back in investments in more traditional architectures. On a longer term, this strategy of funneling growth in new licenses onto its cloud offerings should bode well for the company. However, we could see a decline in new license sales for the company for the next few quarters as customers shift from on-premise deployments to its cloud offerings.

We are currently reviewing our $95 Trefis price estimate for SAP and will follow up with a detailed analysis of the Q1FY14 earnings for the company.