By Douglas Busvine
FRANKFURT (Reuters) - SAP (DE:SAPG) told investors not to expect a major improvement in margins before next year as the German business software group reported a 21% decline in second-quarter operating profit on Thursday, weighed down by one-off costs.
Europe's most valuable tech firm reiterated its forward guidance and CEO Bill McDermott expressed his "absolute commitment" to meeting a strategic goal of expanding margins by 5 percentage points through 2023.
Shares fell 6.6% in early trading as revenue and adjusted operating profit came in below expectations.
Investors, including U.S. activist fund Elliott, had driven SAP's shares to all-time highs after management launched an efficiency drive in April, and are keen to see evidence that it is starting to pay off.
They also anticipate significant share buybacks, to be announced at a capital markets day in November, with JPMorgan (NYSE:JPM) seeing potential to return between 11 billion euros (£10 billion) and 23 billion euros ($12-$26 billion) to shareholders over four years.
The spring quarter was, however, marked by a decline in licence revenue, the result of trade tensions that took their toll on Asian markets in particular.
But, McDermott told Reuters, a 4-point expansion in gross margins at SAP's fast-growing cloud business showed that its operational performance was on track: "We're very happy with the direction this is moving," he said in an interview.
That trend is being supported by SAP's growing partnerships with 'hyperscale' cloud computing giants Amazon (O:AMZN), Microsoft (O:MSFT) and Google (O:GOOGL).
Such remotely hosted services are subscription based - a model that is generating growth rates of 40% and is easier to forecast than the software licences that still account for the bulk of SAP's revenue.
That, in turn, helped SAP lift its share of predictable revenue to 69% in the quarter. It targets a 71% share next year and 75% in 2023.
McDermott, 57, said he was not unduly concerned by the dip in licence fees. Experience showed that clients in wait-and-see mode often come back with bigger orders later as they reconfigure supply chains in response to changing conditions.
"As people see the need to reorient supply chains, or think differently about the regulatory environment, they tend to broaden the spectrum of what they buy from us," he said.
Graphic: SAP versus The Rest - https://tmsnrt.rs/2Od1Dck
ONE-OFFS WEIGH
Operating profit of 827 million euros was hit by charges arising from restructuring that will see more than 4,000 staff leave SAP, the $8 billion acquisition of customer sentiment tracking firm Qualtrics and cash-settled staff bonuses.
Year-on-year comparisons would become more favourable in the second half of the year, CFO Luka Mucic said, adding that he expected a "very meaningful step upwards" in profitability from next year.
SAP competes in areas such as finance and logistics, known as Enterprise Resource Management, with Oracle (N:ORCL), which recently reported stronger-than-expected earnings. It competes with Salesforce (N:CRM) in Customer Relationship Management.
After adjusting for one-offs, SAP's operating profit at constant currencies rose 8% in the second quarter - in line with revenue growth but just shy of Eikon Refinitiv estimates. Adjusted operating margins were flat at 27.3 percent.
SAP reiterated its guidance for adjusted operating profit to grow by between 9.5% and 12.5% this year.