Sage plans to up investment after hitting tough targets

A strong fourth quarter enabled Sage to deliver its tough targets for growing annual sales and profits, though the accounting software developer's profit margin will drop in the coming year as it ups investment.

The FTSE 100 group generated £1.8bn of revenue from continuing operation in the 12 months to 30 September, up 6.8% on the prior year versus management's guidance for 7% growth. Of this, recurring revenue increased 6.7% to £1.44bn, with subscription revenue from software as a service (SaaS) products jumping 25% to £839m or 46% of total turnover.

Organic operating profit margins dipped slightly to 27.8% from 28.0% the year before, but this was better than the 27.5% guidance. As a result, operating profit from continuing businesses increased £30m from a year earlier.

Earlier this month Sage promoted finance boss Steve Hare to chief executive after he'd successfully stepped in when previous CEO Stephen Kelly was ousted.

With the company making progress in the second half, after the front-loaded investment in the first half, Hare said: "The renewed focus on high-quality subscription and recurring revenue has generated momentum as we exited the year."

The second-half improvement was driven, he said, by a renewed focus on high-quality subscription and recurring revenue, with both August and September showing recurring revenue growth in excess of 7% year-on-year and sequential month-on-month growth, with similar continuing into the new year.

In line with the company's aim to become "a great SaaS business", around £60m of investment will be targeted on speeding the transition to SaaS. So, while 2019 organic revenue growth is expected at 8-9%, guidance for organic operating profit margin was lowered to 23-25% from the medium-term 27%. Underlying operating margins is expected to remain "broadly stable" outside of the extra investment, with management still “committed” to delivering 500 basis points of cost savings over time.

The transition to a business model with a higher proportion of revenue from SaaS is expected, over the coming years, to improve the quality of revenues while also enabling strong returns on investment.

In the short-term, organic revenue growth rate may decrease as the business accelerates the pace of transition towards subscription, while processing revenue are expected to be flat or decline mid-single digits.

"As CEO I will put customers, colleagues and innovation at the heart of everything we do to accelerate the transition to becoming a great SaaS business," said Hare. "That means investing further resource in Sage Business Cloud, a continued commitment to customer success and a culture which values the individuals and promotes collaboration. Increased investment in these areas will lead to an acceleration in high-quality sustainable recurring revenue growth."

With strong free cash flow of £356m a dividend of 16.5p was declared, up 7%.

Sage shares were down almost 4% to 515.8p on Wednesday morning.

Broker Shore Capital said the headline numbers were slightly ahead of City expectations on a "pleasing Q4 outturn", but the increased investment in SaaS and lower margins for 2019 was the "bigger news".

Average analyst expectations were for 6.6% revenue growth and underlying operating margin at 27.2%.

"We believe the market had been pricing Sage for some kind of margin reset under the new CEO Steve Hare, though the extent is now known," ShoreCap said, provisionally expecting to ease back its adjusted EBITDA and PBT estimates by circa 11%.