Sage Group's (SGGEF) Management on Q3 Trading Update - Call Transcript

| About: Sage Group (SGGEF)

Sage Group Plc. (OTC:SGGEF) Q3 Trading Update Conference Call July 26, 2016 1:00 PM ET

Executives

Steve Hare – Chief Financial Officer

Analysts

David Toms – Numis

James Goodman – Barclays

Stacy Pollard – JP Morgan

Milan Radia – Jefferies

Vijay Anand – Mirabaud

George O’Connor – Panmure

Operator

Good day, and welcome to the Sage Q3 Trading Update Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Steve Hare. Please go ahead, sir.

Steve Hare

Thank you very much. And welcome, everyone, to the call. I'm speaking to you today from Sage Summit here in Chicago. So, I'd like to start by thanking everyone for accommodating the different time. But, we wanted to hold today's call at the time that works for people on both sides of the Atlantic. This is a trading update, which I would put very much into the category of in line, with actually very little to highlight. But, I will just pull out a few things from the statement, the organic revenue growth year-to-date of over 6%, recurring revenue growth year-to-date of over 10%, and again underpinned by 33% subscription growth, so all three of those very much in line with what we've reported in the first half and in previous quarters.

Likewise, processing revenue growth continued to be in line with our expectations. And from a geographical perspective, all three regions continued to show momentum with an improved performance from International in the third quarter. We're maintaining full-year guidance delivering at least 6% organic revenue growth and 27% organic operating margin. And the transformation remains on track. We don't see any material impacts from Brexit. We have – we will continue to monitor that and very conscious of the various revised growth forecasts that are around at the moment. But, from our perspective, we're not seeing any impact.

Actually, I will just read my quote because I think it's a good summary of how we see things and the momentum that we see going into Q4 and beyond. So, the performance for the year-to-date demonstrates sustained momentum. And I think that's a key word, momentum. And we are encouraged by the continued double-digit growth in our high-quality recurring revenue. Our business transformation remains on track, and we're focused on its execution, whilst continuing to deliver on our commitments to shareholders, customers, and the communities we serve. We take great confidence in the resilience of our strategy and our business model to deliver sustainable and high-quality growth. So, that's the summary there, the highlights.

And I'd now like to open up for questions.

Question-and-Answer Session

Operator

Thank you, sir. [Operator Instructions] We’ll now take our first question from David Toms from Numis. Please go ahead. Your line is open.

David Toms

Hi, Steve. Thanks for taking the questions. Just a quick one on potential impact of changes in global growth. There's not been a period in the last 15 years where Sage has accelerated when European GDP growth has fallen. So, if European GDP growth does fall and takes Sage with it, what kind of actions do you have up your sleeve that you could take that would mitigate out the impact?

Steve Hare

Yes, thanks, David. I think, first of all, I think, compared to where we've been in the past, I do think our business model is more resilient. I think we have a higher proportion of recurring revenue. And I think the breadth of what we're selling to our customers, particularly through subscription, is greater. I think the area where potentially you could see the first impact would be in the enterprise market. Traditionally, in the enterprise market, customers can take longer to make decisions where there's uncertainty. People can defer decisions around migrating or upgrading.

So, a good example would be, say, 300 customers thinking of migrating to X3 might just decide to delay that decision. So, we're keeping a very close eye on the pipeline, looking to – for leading indicators in case that happens. As everyone's aware, we’re very focused on making our cost structure more efficient, taking cost out of G&A, which we are reinvesting into sales and marketing. So, if we saw our growth slowing due to economic impact, we could protect the bottom line by just making choices about how we allocate cost savings and slowing down investment if we thought that was appropriate. But, I must emphasize that, at this point in time, we don't see that. We don't see any evidence of any impact, but we will monitor the leading indicators.

David Toms

Great. Thanks very much.

Steve Hare

Thanks, David.

Operator

Thank you. Our next question comes from James Goodman from Barclays. Please go ahead. The line is open.

James Goodman

Yes, thanks, Steve. The growth in the third quarter, 6%, it was 6.6% in the first quarter I think, and the second quarter clearly had the tough Malaysian comp. Is there anything we should consider in this quarter in terms of comparatives or anything out of the ordinary, or was it just slightly slower than at the beginning of the year? And if I could ask something on the product side as well, we've talked a lot about Sage Live in the past. I imagine you're talking about it a lot at the Summit as well. Can you give us an update on how the launch of that product has gone? Thanks.

Steve Hare

Sure. So, if we start with Q3, no, I mean look, we're talking pretty small decimal point percentages here. I think the key thing I would point to is the recurring revenue growth continues to be strong, continues to be double digit, and continues to be underpinned by software subscription revenue, north of 30%. So, I think that’s all on track. And on a quarter-by-quarter basis, we are going to see different levels of SSRS. We flagged at the half year SSRS is now declining as we really push hard to the shift of subscriptions, nothing in Q3.

On the product side, Sage Live, yes, we’re fully live with paying customers, both in the U.K. and the U.S. We’ve been launching new versions every month. And we’ve here in Sage Summit talked about some further enhancements, particularly also in terms of how we’re partnering with other applications providers to give an integrated – a greater integrated offering around Sage Live. So, we’re very pleased with the progress. We haven’t collected any sort of customer numbers, but I can say we have live customers. We’re now looking at launches into other countries. And we’ll give a more wholesome update at the year end.

James Goodman

Okay. Thank you.

Steve Hare

Thanks, James.

Operator

Thank you. We’ll take our next question from Stacy Pollard from JP Morgan. Please go ahead.

Stacy Pollard

Hi, thank you. Can I just touch on something, the Sage Integration Cloud, and how we can think about this from a financial perspective? Do we think – is there something additive here? Do you think it will help drive cross-selling? And then which countries has it been launched in? And then a second one, and sort of standard is, can you just talk about the pricing and competitive environment? I doubt that you have many changes quarter-to-quarter, but always interested to see if you’re seeing anybody move in or out of your home market, the UK, or other markets where you’re competitive.

Steve Hare

Yes, so, I think Sage Integration Cloud, which we announced today at Summit, I think the way to think about it from a financial point of view is that –is exactly it should help drive greater integration and greater cross sell in terms of whether we monetize it direct. I wouldn’t be building any material revenues in to the model for the Integration Cloud per se I think it is the cross sell that is the exciting opportunity. And actually it is very similar with the bot, if anybody here was watching we launched this bot interface called PEG, which is a similar thing. What it’s trying to do is change the way you’re able to bring what you’re using together and improve the usability and customer experience. And I think, what you’ll see us doing is using those things in order to drive an improved customer experience and drive greater cross-sell and integration, rather than monetizing these interfaces in isolation.

And then on the pricing and competition, we haven’t really seen any changes since we updated at the half year. Obviously, there’s most of our customers – we have some customers who trade across border and, therefore, ultimately are going to be affected by changes in exchange rate, weakness of sterling, et cetera. And that could ultimately I guess start to have an impact in terms of, for example, some of the dynamics with our U.S. competitors. But, at this point in time and in the quarter that we’re talking about, we haven’t seen any changes.

Stacy Pollard

Great. Thanks.

Steve Hare

Thanks, Stacy.

Operator

Our next question comes from Milan Radia from Jefferies. Please go ahead.

Milan Radia

Thanks very much. Just thinking about the cost-reduction program, assuming you’re on track to deliver the 50 million of savings for the full year, how should we think about the margin trajectory over the next two or three years? You said in the comments here something to be in the – some of the heavy lifting in terms of the customer business centers and digital marketing investment seems to be out of the way. And there’s also repeated emphasis on doing more with reallocation of resources rather than necessary spending more. So, the 50 million seems to point to some sort of margin expansion trend, perhaps even from next year onwards. Would that be fair?

Steve Hare

So, Milan, I admire your aspiration to get me to open up in terms of longer-term margin trajectory. But, the cost reduction, yes, is on track. I said that at half year. I can see the route to the 50 million of saving. And then I think I’ve said before, I think in terms of longer-term kind of structural – the cost structure, the business is clearly capable of making a margin higher than 27%. But, at the moment, we’ve said that, during the transitional period, we want to reserve the right to reinvest those savings to ensure that we’re building that capability to – for the business to grow more quickly. And you I’m sure forgive me in a trading update for declining to be drawn in terms of exactly when that timescale might be. But, it’s clearly a possibility at some point in the future.

Milan Radia

Fair enough. And just one follow-up on license sales. So, within the SSRS decline, how did X3 fair in the period? Is it still trending on sort of double-digit blended growth rates?

Steve Hare

Yes, I mean X3, yes, is still trending double-digit. And most of the X3 sales remain on perpetual license. We do have some X3 on subscription. But, the majority is licensed. And yes, it is growing, continuing to grow double digit.

Milan Radia

Perfect. Thanks very much.

Steve Hare

Thanks, Milan.

Operator

Thank you. Our next question comes from Vijay Anand from Mirabaud. Please go ahead. Your line is open.

Vijay Anand

Hi, Steve. I have two questions. My first question is also on G&A, unfortunately. With the cost savings coming from the second half, looks like G&A will reduce by 300 basis points this fiscal year from 19% of sales to 16%. 16% still looks quite high to me relative to peers. So, I was wondering if you could give us your thoughts about how you think about G&A and whether there might be another efficiency program as we think about 2017. And linked to that, obviously, there are some product headlines coming out of Summit. So, I wondered if you could share the current thought process on product innovation and whether 10% of sales is still the right level for R&D and I have a follow-up.

Steve Hare

Sure. So, on G&A, I would completely agree and I mean and your numbers are about right. 16% remains too high. Obviously, the savings that we’ve secured in G&A have been somewhat backend loaded. So, we have a trajectory to get below 16% anyway. I mean I think, longer-term, we should be somewhere closer to the kind of low-double digit. I can see that probably in 2017, we may be somewhere more around 13%, 14%. And then we will continue to keep very focused on our efficiency. I don’t see that as an endpoint. I see it as a journey. So, I see no reason, ultimately, why our G&A shouldn’t be somewhere close to 10%. Whether we get it absolute to 10%, we’ll see, but that sort of order.

And then on Summit and product innovation, yes, we’ve been announcing a number of innovative things that we’ve been doing in the Sage Labs. At the moment, we still think that around 10% is the right number. We have over 2,500 engineers. And we’re very focused on making sure that they’re working on those products and technology innovation that allows us to both serve our existing customers and continuing to give them an upgrade path on their existing products whilst, at the same time, producing the next generation of Cloud products.

And at the moment, we think we have sufficient resources to do that. If we at any point think that’s not the case, then you – we reserve the right, obviously, to allocate some of our additional investment into technology if we think that’s more appropriate than putting into sales and marketing. But, at the moment, we don’t feel that that’s something we need to do.

Vijay Anand

Great, understood. And secondly, on the EU referendum, clearly, you’re saying you don’t expect a material impact on the business. However, I wondered if you could talk about perhaps some of the opportunities that this might create, as presumably things like accounting regulations, VAT rules, et cetera, are likely to change once the exit is finalized. And historically, you’ve used such changes to expand your subscription base, so perhaps some high-level thoughts on the medium-term implications for Sage.

Steve Hare

Yes, I mean I think the good news is that Sage has deep domain knowledge when it comes to accounting and payroll in all of the major European countries, including the UK, obviously, France, Germany, Spain, et cetera. And so, I think, wherever we end up, from a regulatory perspective, we will be well placed to respond to that. And we will continue to use our innovation to help our customers simplify and deal with those, like all regulations. And the degree to which the UK kind of diverges away or has more unique regulations, it is likely compared to our competitors that we will be better placed to deal with that.

So, you could see that coming through as an opportunity. You could also see some of our UK customers who are exporters benefiting from the weaker sterling. But, I think, if you take it in the round, nobody really knows because nobody really – we don’t know what trade deals will be struck. We don’t know what the environment will look like. And I think, going back to some of the earlier questions, the key thing we need really is people need to understand or have certainty about what’s going to happen. And then they can deal with it.

And so, the worst thing for business is a lack of business confidence because of uncertainty. And what we’re – we remain hopeful, and we’re very confident in our own business model being very resilient. But, we’re looking for similar leadership across governments, across financial services, et cetera, because we can’t predict – if the banks stop lending and suddenly small, medium businesses can’t access capital, then we’re obviously not immune from that.

Likewise, if credit remains available and confidence remains stable, then I think we’re well placed to continue to benefit and continue to grow. So, I think we’ve got probably time for one more question.

Operator

Thank you. We’ll now take our last question from George O’Connor from Panmure. Please go ahead. Your line is open.

George O’Connor

Good evening from Panmure. I missed the start of the call, Steve. I just wondered. Did you give the Sage One customer count?

Steve Hare

I didn’t, George, no.

George O’Connor

Okie-dokie. Did you talk about revenue phasing in the quarter, anything different than usual?

Steve Hare

Yes, no, it was – I described it as a sort of pretty normal, in-line quarter with not very much to highlight.

George O’Connor

Okay. Did you talk at all about the bookings, given the strength in the subscription revenue?

Steve Hare

I didn’t, no.

George O’Connor

Okay. I guess we can pick it up at Q4 then.

Steve Hare

Yes, obviously, this is – in a trading update, we tend to give less detail. And then obviously, at the year end, we’ll give a fuller update.

George O’Connor

Good stuff. I’ll let you run, literally.

Steve Hare

Excellent. Well, good to speak to you, George. Thanks for your question.

George O’Connor

Good stuff. Okie-dokie. Thank you.

Operator

There are no further questions. That will conclude today’s conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.

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