Currency Tailwinds and Cloud Business Lift SAP’s Q1 Results

European software major SAP SE (NYSE: SAP) posted better-than-expected first quarter results on April 21st. The company’s revenues and bottom line were aided by significant currency tailwinds resulting from a weaker Euro, which benefit its business outside Europe. Triple-digit growth in the cloud business helped SAP achieve non-IFRS revenue growth of 10% year on year on a constant currency basis. However, the shift from the traditional on-premise business model to a cloud-based continued to drag down operating margin, which fell by 140 basis points to 23.5%.

Further, SAP’s bet on SAP S/4HANA is off to a good start as the company closed 370 deals during the quarter. ^[1] Nevertheless, so far it is too early to tell if S/4HANA is on the way to achieving the same level of penetration as its predecessor.

SAP also used the earnings call to emphasize its focus on the Internet of Things (IoT). CEO Bill McDermott stated that IoT, with potentially 50 to 70 billion connected devices by 2020, represents a huge opportunity for the company. SAP has already signed on companies like Siemens and Kaeser Kompressoren as early customers of the SAP Internet of Things Big Data platform. Its aggressive push into IoT indicates that this nascent sector may play a major role in SAP’s long term strategy. (Read: SAP Prepares to Take On The Internet of Things, Announces String of New Partnerships)

We are currently updating our price estimate of $78 for SAP SE to reflect the first quarter results.

See our complete analysis for SAP SE here

Cloud Expansion Continues Unabated

SAP’s total revenues in the first quarter stood at €4.5 billion, 22% higher than its revenues in the same period previous year. The growth was led by a 130% expansion in revenues from cloud subscription and support, which now account for 11% of the company’s total revenues compared to the 5% in the same period previous year. However, a considerable portion of the revenue growth is attributed to favorable currency movements. Currency tailwinds contributed 12 percentage points to the overall revenue growth, while the impact on cloud revenues was as high as 35 percentage points. ^[2]

SAP now has 80 million cloud users, which it claims is the most in the enterprise software industry. ^[1] Cloud bookings also expanded by a commendable 121% year on year during the first quarter, indicating that the company is signing up more and more customers with each passing quarter.

Support and Maintenance Revenue Growth Slowing Down

Software support revenues, which account for 55% of the company’s total revenues, accelerated by 17% year on year to reach €2.5 billion in the first quarter. However, most of this growth was due to favorable currency movements. On a non-IFRS constant currency basis, software support revenues grew by just 7%, which is considerably lower than the growth rate seen in recent years.

The low software support revenue expansion is attributed to the transition to the “One Service” approach, which has done away with the high-margin premium support services. Instead of including such premium services in software support services, revenues therefrom are now included in the common Services revenue stream. As a result, a key component that was driving the growth of software support revenue is no longer considered part of this revenue stream.

Transition to Cloud Taking a Toll on Margins

SAP’s non-IFRS operating margin declined by 1.4 percentage points to 23.5% in the first quarter. This is primarily because of lower gross margins resulting from the transition from on-premise to cloud-based business model. The ongoing shift in product mix dragged down cloud and software gross margin by 50 basis points year on year in the first quarter.

Moreover, the services gross margin also suffered due to the transition from large-scale implementations to rapid deployment services in the cloud model. As a result, SAP’s overall gross margin contracted by 80 basis points year on year to fall to 68.6% in the first quarter. However, SAP expects the services gross margin to pick up from the second half of 2015 forward, once the optimization measures under the one-service approach are put into place.

SAP’s operating profit declined by 12% year on year to €638 million, but grew 15% in non-IFRS terms. The significant disparity is largely because of charges of €180 million arising out of the Concur acquisition and restructuring costs of €126 million. The IFRS operating profit was also dragged down by higher stock-based compensation costs resulting from the hiring of over 7,000 employees by SAP over the last year. It should be noted that the SAP does not plan any further acquisitions in the near future, so the substantial variation between IFRS and non-IFRS operating profit in the first quarter is largely a one-off instance.

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More Trefis Research

1. SAP 2015 First Quarter Earnings Call Transcript, Seeking Alpha, April 21, 2015 [↩] [↩]
2. SAP 2015 First Quarter SEC Filing [↩]