SAP pre-announces revenue miss for Q1 FY2016, maintains full year guidance - an analysis

Profile picture for user gonzodaddy By Den Howlett April 10, 2016
Summary:
SAP slipped up on closing deals in Q1 FY2016. Of itself that's not important. The bigger issue is how SAP plugs what is a gap with S/4 HANA. Right now there's little detail upon which to go but there are plenty of questions we can ask.

Last Friday after markets closed in the US and while European market makers were likely in bed, SAP slipped out its Q1 2016 earnings pre-announcement saying the company hit €4.73 billion in revenue with an operating profit of €0.81 billion. 95 or more percent of technology companies would likely be very happy with that result, but the fact remains SAP missed top line expectations by about €70 million, hinting that deals fell into Q2. SAP said it needed to make the announcement early since the difference was material. I say that's a tad fanciful because in accounting terms for a company of this size, anything below 3% is a rounding error. In SAP's case, the miss is equivalent to 1.46%. What's going on?

Taken in the round, the raw numbers are not bad. See below:

SAP Q1 2016

In fairness to SAP, it is normally very good at making sure the markets are made aware early if there are any surprises in store and tends to err on the side of caution. This is no different. But it is a while since SAP had an earnings miss, having gone through a bumpy period in 2013-14. This result will no doubt be a wake up call to a company which has become better at managing market expectations since Luka Mucic took the CFO's position in July 2014. Even so, there are questions to be answered.

The 13% decline in software licenses from €0.7 billion to €0.61 billion is clearly the stand out but that is more than offset by 36% growth in cloud subscriptions and support from €0.5 billion a year ago to €0.68 billion. What may be of greater concern to analysts is the software bookings number which rose 22% to €0.14 billion and the fact that cloud growth was lower when compared to its main rival Oracle, which recently reported a 40% climb in cloud revenue.

Looking at SAP's business as a whole, cloud revenue now represents about 14.5% of total revenue compared to 11.1% in the previous year. Of itself that might not seem overly significant but the more important number is cloud growth relative to traditional license and support where cloud grew €180 million while the total for what I term the 'legacy' business grew a mere €20 million. Taking these figures, it is clear that the €70 million miss was significant.

The S/4 HANA problem

SAP has not elaborated upon where the miss occurred although it says S/4 HANA customer numbers have grown to 3,200 from a previously reported 2,700. It is difficult to say what kinds of customer are represented by the S/4 numbers nor the kind of functionality being acquired but it is notable that a search for "SAP S/4 HANA customers" reveals nothing of substance. SAP says that the customer count includes a third net new which is encouraging but a third of what?

In January, China Martens on ASUG News reported that 100 customers are live on S/4 HANA but did not elaborate upon what they are live. This could be as simple as a marketing solution. I doubt very much whether SAP has any substantial numbers for S/4 HANA AR, AP or GL either bought or live. That should not surprise.

Financials is where ERP has its birthplace and that work is substantially done among the whole of SAP's R/3-ECC user base. There may be ECC upgrades on the go but users groups consistently say they struggle to find a solid use case for the switch to S/4 HANA applications. Short of a Y2K apocalypse style event, I cannot see substantial customer numbers moving to S/4 HANA for financials any time soon. There are huge functional gaps in S/4 HANA Financials but that is not the main problem.

Switching out core financials for something more modern is not an SAP specific problem but an industry issue. Oracle for example has done well with its cloud HR solutions but customers are not overly willing to move financials - yet. Workday has been pressing hard to get customers onto its financials solution but until recently, it has been comparatively slow going. You can infer the same from reports analyzing Infor's recent progress. Most recently. Phil Wainewright discussed what is going on at Unit4:

But WSP [customer] is not moving to the cloud yet, nor are others that I met last week. Unit4 faces the same challenge that other vendors with an established customer base are facing — despite all the exciting potential that a cloud-first, mobile-first, intelligent software product offers, its customers have to balance that against their other priorities. Often the incentive to move is simply not strong enough, or the change appears too daunting.

There you have it in a nutshell. Should SAP worry? Yes and no. Let's consider SAP's portfolio of solutions.

Analyzing the portfolio

Like other legacy vendors going through the current on-premise to cloud transition, SAP is concentrating upon its growth drivers but in SAP's case, that is almost wholly coming from acquired solutions.

That is less of a problem than it might have been a year or so ago, largely because SAP is doing a good job of bolstering the acquired SuccessFactors with its own transitioning HR admin solution aka Employee Central and Fieldglass, the acquired solution for VMS based contingent labor. That combination has stemmed some of the flow away from SAP for those solutions, although consultants on the ground complain there are too many 'legacy thinkers' among the SAP HR consulting base.

We now see a renewed vigor at Ariba after a period of lethargy. That should be a good thing given the fact that there is plenty of room to optimize spend management.

Regardless of what my colleagues might think, I firmly believe Concur is/will be a major driver for solving some of the most irritating corporate problems. People will pay for that. I do with the still under developed TripitPro but there is much more to Concur than that.

Paradoxically, SAP's relative market position in ERP is so strong that its core ECC solution virtually sells itself, comparatively speaking, and any competitor will quietly acknowledge that SAP remains the company to beat. The trouble is SAP knows that and so you have to wonder the extent to which the sales folk might have been a tad complacent. Not anymore.

All of that is fine but it still leaves a gap and that's where S/4 HANA ought to fill in but which is lacking in content. My concern is that  ASUGNews recently mentioned there are five different versions of S/4 HANA. SAP touts them as deployment options but that's a stretch. I view them as versions. If they were deployment options then you'd be looking at a single code line but that's not the case although SAP dresses them up as 'subsets.' Here are the tells:

The private cloud edition is for those customers looking for more security and more control about how and when updates come in as well as pre-configured software...For the full-blown SaaS edition, SAP is still working on simplifying certain modules for S/4HANA, for instance, in governance, risk and compliance (GRC) and in transportation management...So, for now, the private cloud option is more feature-rich than the public cloud edition. At the same time, the end goal is not so much about achieving functional parity so much as it is rethinking existing processes to take full advantage of HANA’s in-memory technology.

[My emphasis added.] I don't know about others, but I am struggling to make sense of that last observation and, as a decision maker, I'd want to be much clearer about how the versions fit into my use case needs.

The free S/4 HANA trials are available, I've tried some of the cloud modules but if I'm candid, they're a tad anemic and barely qualify as modern. I poked around in the financials and the marketing module the last day or so and found that while holding promise, SAP hasn't taken advantage of modern idioms to present a truly compelling offering. Asking me to select a company by its number and not its name for instance seems arcane. Asking me to name product segments with underscores between names is geeky and requires extra thinking.

The on-premises trials are confusing unless you're aware that SAP deploys these trials using AWS instances which you have to pay for.

Taken together, S/4 HANA must be viewed as a work in progress. On the upcoming earnings call, I am hoping that SAP will provide some clarity around S/4 HANA beyond the customer counts.

Elsewhere, we should not forget BusinessOne, Business ByDesign (yes, it's still very much alive and kicking) and the growing digital products. Taken together, they're not a large part of what SAP has to offer but they are important for SAP's SMB's. Here I think SAP has an opportunity to take advantage of a market segment that has been underserved. You don't see the mega deals with which SAP is familiar but you do see the potential for volume that the likes of NetSuite is turning into what looks like a billion dollar baby.

Final words

SAP is coming into 2016 off a good 2015 but is being cautious. In the release, SAP reiterated guidance for 2016 which should not be surprising given the wiggle room it gave itself in the original forecast. Macro trends will always play into the outcomes for a company of SAP's size but the gaps that once were not a problem are starting to look worrisome. Despite my reservations, Mucic has done a first rate job managing the operating profit and so while analysts who contacted me were grumpy that SAP chose to put out a pre-release when everyone who matters was not paying attention, they will now be sharpening their pencils to get into the detail on April 20th, the company's scheduled earnings call date. The bigger tell will come from the atmosphere at SAPPHIRE, which comes up in May.