Earnings Call: Q3 2021

Jul 29, 2021

Good morning, everyone. Welcome to the Q3 Trading Update Call for the Sage Group plc. Your presenter today will be Jonathan Howell, Chief Financial Officer, who is joined by James Sanford, Head of Investor Relations. I would now like to hand the conference over to Mr. Howell. Please go ahead, sir. Thank you very much. Good morning, everybody, and welcome to Sage's Q3 trading update. First, I'll run through the key numbers and the performance of the business. And after that, we can open for Q and A. Just as a reminder, all numbers in the trading statement are on an organic basis. Sage performed strongly in the first nine months. We've delivered recurring revenue growth of 5% to over €1,200,000,000 supported by software subscription growth of 11% to €920,000,000 And this means subscription penetration increased to 69%, up from 64% last year. Regionally, North America grew recurring revenue by 7% to €475,000,000 driven mainly by a good performance from Sage Intacct. In Northern Europe, recurring revenue grew by 4% to €292,000,000 This reflects accelerating growth in cloud native solutions, including Sage Accounting, and also further growth in Sage fifty Cloud Connected. And in the international region, recurring revenue also grew by 4% to €454,000,000 with particular strength in Cloud Connected. Looking at the portfolio view, recurring revenue for the future Sage Business Cloud opportunity increased by 7% to over €1,100,000,000 This was underpinned by strong growth in Cloud Native revenue of 32% to $2.00 €5,000,000 mainly through new customer acquisition and supported by migrations to both cloud native and cloud connected solutions. As Sage Business Cloud penetration increased to 66%, which is up from 60% last year. And finally, recurring revenue in the Other portfolio was down by 11%, in line with our strategy. Moving on to the third quarter. Recurring revenue grew by 6% to $4.00 9,000,000 driven principally by an acceleration in cloud native growth of 37% together with continued growth in cloud connected. This was strengthened by our program of additional strategic investment in sales, marketing and innovation. Now turning to other revenue. This decreased by 18% to €109,000,000 in line with expectations. And as a result, total revenue grew by 2.6% to over €1,300,000,000 And for Q3, this growth was 5% to $440,000,000 Now finishing on the outlook. Following a strong performance in the third quarter, we now expect full year recurring revenue growth to be slightly above our previous guidance range of 3% to 5%. The group's guidance across all other metrics remains unchanged. And so to summarize, we delivered a strong performance in the first nine months as momentum in the business continues to strengthen. Thank you. And now let's open for questions. Thank you. We'll now begin the question and answer session. Star one on your telephone keypad and wait for your name to be announced. To cancel your request, kindly press the hash key. Once again, star one if you have any questions. Question is from the line of Adam Wood from Morgan Stanley. You may ask your questions. I've got two, please. First of all, obviously, another nice middle raise in the guidance for the full year. I wonder if you could just talk about what you're seeing there. So I imagine the business was running a little bit better than expected in the third quarter. But could you also more importantly talk about what you're seeing on the leading indicators, particularly around any kind of qualitative comments on ARR? What are you seeing on new customer additions there? Could you give us a feel for what you think the run rate might be at the end of the year on that metric? And then secondly, again, another nice acceleration in the cloud native business. Could you talk there what's happening in terms of the different products contributing to that? And maybe specifically on Intact, where you're seeing the migrations from in that business? Adam, thanks very much indeed. First of as you say, we this is a very consistent performance with what we reported in the first half. The lines of the business that were doing well at the first half stage have continued to do well during the course of Q3. And effectively, all we're seeing is a moving forward of the numbers by another three months. We've slightly outperformed our expectations. And as you can see, in the year to date, recurring revenue grew at 5% for the full nine month period. For Q3 stand alone, we grew at 6.1%. The to answer the question around ARR progression, which is the lead indicator, at the first half stage, we indicated that we were at the bottom of the decline in the growth of ARR. And so we reported 4.2% ARR growth at the first half stage. What we're seeing now, as we expected and as we signaled, is an acceleration in ARR growth. And just to give you a sort of a feel, if we're raising our full year guidance for the year, which we are, to slightly above the 3% to 5% range, then as you would expect, ARR as the leading indicator will exit FY 'twenty one at a faster growth rate than that. Just to give a little bit more color on sequential growth, We are seeing sequential growth now. As you can see at the Q3 stage, on a constant currency basis for recurring revenue, sequential growth was about 2%. Q2, it's about 1%. And Q1, it was about 1% as well. So in sequential growth in recurring revenue, we're seeing an increase there, but it's almost double what we were seeing at the first half stage. In terms of products, it's the same products that we reported on that are driving this growth. Cloud native grew at 32% during the September period. The principal driver of that is Sage Intacct in terms of volume and value in The U. S, but very strong additions coming in Sage Accounting, particularly in The UK, Sage People, Auto Entry and Sage HR. So all of those are continuing to grow and to accelerate in terms of the growth rate. And just to put in context, as you know, Intact, we reported in The U. S, grew at 19% at the half year stage. It is now growing faster than that. But importantly, the other portfolio of cloud native products, in order to get to a 32% growth rate are therefore growing considerably faster than Sage Intacct. And all in all, we see a firm upwards trajectory in the growth rate of cloud native. Thank you, Adam. That's very helpful. Thank you very much. Thank you. Our next question is from the line of Ben Castillo from Exane BNP Paribas. Your line is now open. Hi, good morning. Thanks for taking my question. Question following on from the last one, the trajectory you expect in H2, your expectations for a continued sequential acceleration like you've seen Q3 over Q2 and Q1 or sort of plateauing there? Second question would be, could you just recap the expansion of the Sage Partner Cloud announced last week, what that will enable? What are your sort of future plans and expectations, particularly in regard to sort of hyperscale infrastructure, think, as you always mentioned in that press release? And then lastly, we could just touch on margins, how you're thinking about the trade off between your discretionary marketing spend for the rest of this year and into 2022, given the solid results you've seen so far this year and how you're thinking about that? Yes. Thanks very much. First of all, on sort of more color on sort of growth rates into the second half. We as we've given clear guidance for the full year. We're moving into the last quarter. So it's just sort of fine tuning at this stage. And I think one additional bit of color is on ARR growth. We don't report ARR at the Q1 or the Q3 stage, only at the half year and the full year. But I can give you a sort of a bit of color. Sequentially, in Q3, it grew at 2.5 sequentially, Q2, '2 percent and sequentially, Q1, '1 percent. And that's just drawing out the trend line that we described at the half year stage, and just putting a few little proof points on that. Sage Partner Cloud, yes, that's an important development for us in our major territories, France, U. K. And North America in particular. Taking the old BMS franchise and moving that into a hosted environment, either managed by Sage ourselves or one of our major partners. It has started well in Europe. The uptake is now just beginning to come through as well in North America. And put some color on the sort of the migrations from cloud connected. This is effectively sort of Sage two hundred and other products into cloud native. Of that growth of 32% that you see at the nine month stage in cloud native, about onefour of it comes from migrations. And some of that is Sage Partner Cloud. Some of that is moving to Sage HR, which is our cloud native HR solution. And some of it is also, as reported, although not too material at this stage, is movement from Sage fifty Cloud Connected to Intact, where we're seeing that beginning to happen in The U. K. And North America. And then your last question around margin. As revenue growth is ramping in the second half, therefore, our speed of spend is also ramping to sort of fall in line with the guidance that we set at the beginning of the year, which we reiterated at the first half stage and we're now reiterating at Q3. A very consistent story is that we anticipate that this additional spend will move the margin up to three percentage points lower than where we were at the end of FY 2020. And again, it's going to exactly the same places that we highlighted at H1, which is product and R and D and also sales and marketing. Those have been the big beneficiaries of the reduced the increased investments. And that and you can see the acceleration in cloud native NCA and upsell and cross sell, which we've reported today. Thank you. Thanks very much. Our next question is from the line of Will Wallace from Numis. Good morning. Thank you. I want to ask a quick question about the growth rates. Are there any sort of base effects in there? So for example, on a year on year basis, when you're looking back a year, had you been giving anyone discounts, for example, in the recurring revenue line that means that there's been a sort of one off improvement that's sort of not sustainable as you move back to normal pricing? And that's a question both on the year on year basis. And also, if you're looking at your ARR for the Q3 versus Q2, that 2.5% growth rate sounds very impressive. Is there any sort of base effect there as well? Yes. Thank you, William. Good question. I think there are just two things to be aware of in terms of sort of year on year comparators. One was, if you recall, Q3 last year was the first quarter that we operated in post the beginning of the lockdowns in our major territories. And if you recall that in April, we reported that NCA levels were running at about 60% of what they were on a pre COVID basis. So the first month or so, the first month at least of this quarter was severely impacted by the advent of lockdowns and government restrictions in relation to COVID. However, if you recall, by the end of the year, by the end of last financial year, we reported that our NCA levels were at about 80% to 90% of what they've been on a pre COVID basis. So a very rapid recovery during the course of last year's second half. In that context, it is a slightly weaker quarter that we've got as a comparator in Q3 last year. But I'd hasten to add, was still nonetheless quite strong. So we just reported a 6.1 recurring revenue growth in Q3 this year. It was 6.5% last year. So the overall growth rates were not too dissimilar. The big difference was the growth rate at this stage last year was declining. The growth rate this year is clearly accelerating. So a little bit of an impact on comparators being lapped, but not too much. And then secondly, in terms of pricing, this has been a year of very few price increases across the whole portfolio, a modest impact. There have been one or two isolated areas. For instance, in The U. K, we had unwind of pricing discounts, which had an impact. But if you take the whole portfolio across the whole group, a very, very limited impact from pricing during the course of this year. And so that should not be factored into the thinking. Just to sort of come back on that, did you give any sort of holidays payment holidays to any of your customers at the beginning of the pandemic, which have now effectively gone away because the customers are still there and now paying properly, and therefore, that helping the growth rate? Look, good question. And it's probably worthwhile just updating the commentary on that. So if you recall, our Q3 last year, full year last year and at H1 this year, again, was a very consistent story. We were offering our customers payment holidays or deferred credit terms on a case by case basis where we think that was would make us a real beneficial impact to a customer and was something that we wanted to do, the uptake on that was very, very low across our customer base. And I can sort of continue to report that the uptake is still very low. And the impact on the reported numbers last year and this year is completely not material. Great. Thank you. Our next question is from the line of Stacy Pollard from JPMorgan. Hi, thank you. Thanks for taking my questions. Two for me. You touched on ARR exiting the year. How do you think about midterm sustainable revenue growth rates? Do you think that the previous pre pandemic rates of sort of 7%, eight % growth are realistic as we think to the midterm? And secondly, how have you kind of measured or seen the success of your additional spend? So you've obviously been accelerating the business throughout this year. You're continuing to make the investments that you wanted for this year because of that success. Do you think you're now at the right level of investment base, meaning that kind of further top line acceleration would actually drop through to margins more aggressively starting from next year? Yes. So I think just in terms of the investments and return on investment, it's we've had a marked step up investment over the last eighteen months. We've kept you abreast of the significant increases, particularly in product and R and D, which is now at 17% of recurring revenue and similarly sales and marketing up 42%. And then literally with a sort of a lag of about a quarter or so, we're seeing this up uptick in growth rates, particularly in cloud native, where we're running a 37% growth in cloud native in Q3, with the fastest parts of the portfolio growth coming from non Intact. That is obviously, is measured against our normal ROI, LTV, LTV to CAC, and all of it is value generative for the business. And we will continue to invest, but only if we believe it is value generative and is the right thing to do for the medium term of the business. And in terms of trajectory, as we've said in the past, we've got a nice problem at the moment is that we're accelerating investments as growth accelerates. However, as we move forward into FY '20 '20 '2 and FY '20 '20 '3, our lead objective is growth in cloud native and growth in Sage Business Cloud. And then our second objective, but only over time, will be to very gradually improve the margin. So it will be growth led and not sort of margin led as we come through the next two years or so. In terms of medium term growth rates, I think if you go back sort of two to three years when we started this transition sort of second quarter first, second quarter FY twenty nineteen, '1 of the things that we cautioned against was extrapolating too much into immediate short term growth rates. And the reason for that was that we have a portfolio across in small and medium segments across a good number of territories with very different customer and cloud characteristics. And therefore, we knew that some periods of transition of the portfolio would be very rapid and would give an overperformance in growth rates and other periods would appear to be giving an underperformance either side of a medium term trend. And we saw exactly that in FY twenty '19 and the first half of FY twenty twenty when we migrated substantially all of the Sage fifty base and all of the Sage two hundred base very rapidly in North America and Northern Europe, which was also assisted by Making Tax Digital. And so we exited FY twenty twenty with an ARR growth rate of about 13%. And I think The UK recurring revenue growth rate was about 15% or 16%. That was an outperformance driven by those very rapid migrations. We were then sort of we've now sort of traded through much of the impact of the COVID environment and the business lockdowns that our customers have experienced, and we're heading back to a more normalized growth rate. We don't give medium term guidance, Stacy, but I think one of the things is if you look forward at FY 2022 consensus, it's around 7% or 8% recurring revenue growth at this stage. That seems a sensible place to be positioned as we sort of come to the back end of FY 2021 and are sort of just setting up our jump off point for next financial year. So when we get to the year end, off the back of that consensus of about 7% to 8% recurring revenue growth for FY 2022, we'll be able to give you some slightly more precise guidance. That's helpful. Thank you. The next question is from Mr. James Goodman from Barclays. Good morning. Thanks very much. Firstly, just on the nonrecurring business. Appreciate the very deliberate strategy there to decrease that line over time. But if I look at the comp, minus 35% last year, I had thought it might just bounce a little bit as some of your services come back. So just wondering if you might still expect that. And maybe if you could just comment on the extent to which there is still any real substitution still coming out of that line into the recurring line, albeit appreciate that that's now quite small. So any commentary around the anticipated development of that? And then secondly, just on Sage accounting specifically, I know we've discussed in the past metrics around this business and you don't want to give precise subscriber numbers. I happen to notice on your website that you're calling out 1,000,000 business owners on Sage accounting. So wondered if you could comment on that, whether that's users or you've sort of accelerated to that level of subscribers, anything on the sort of ARPU that we can discern from that, just the progression of that project product. And you also mentioned, I think just now, some migration, a small amount from SAGE 50C to Intact. I suspected you might see a little bit more the other way from SAGE 50C to SAGE accounting. So anything on that would be helpful. James, thanks very much. In terms of the other revenue line, I think in your question, are absolutely spot on. We're now, very much in an environment where the priorities of the business in small and medium segment is to build ARR through the cloud native product offerings that we've got. That is our one of our most critical and primary objectives that we're delivering on. That is where investment and focus is being placed. Secondly is still to move our remaining customer base into the Sage Business Cloud, and that is still growing well in terms of cloud connected. We're still seeing good growth in Cloud Connected revenues through very good upsell and cross sell of the Sage fifty base, particularly in The U. K. And North America, but also ongoing migrations of Sage fifty Payroll in The U. K. Has given us momentum this year into cloud connected. And then across Continental Europe, France and Spain in particular, the migrations are continuing into cloud connected for Sage fifty, Sage two hundred. We're about 60% of the way through that transition. That is the priority of the business. Then absolutely, as you say, the other revenue line, that is about onethree licenses and twothree professional services, those are not the focus of this business anymore. And as we've seen over the last three years, that revenue line will continue to decline. The rate of decline will vary from quarter to quarter, but will be ongoing and continuing. The rate of decline was a little bit lower than what we've seen over the last two years in Q3. And that was in particular and that was up against the Q3 comparators and the NCA discussions that I just had earlier in the call. So don't read too much into Q3. That revenue line will continue to decline. It is now, I think, if you look at the Q3 numbers, 7% or just below 7% of total revenue. And so it's really not a material driver on of our results or our growth rate. And then in terms of Sage accounting, yes, I mean, you said, we are focusing on a sustainable, balanced ARR growth of Sage accounting across the territories where it is offered to our customer base. That is picking up that growth rate. As you know, we are not focused absolutely on sub count, customer count. We're very much more focused on the professional user with a higher ACV and lower churn rates. And that is driving our strategy and go to market and also product upgrades. It's made a good start. The only guidance that I can give you is that it's growing faster than Intact. That portfolio outside of Intact is growing significantly faster. And we're very pleased with the progress to date. But as you say, we don't given the number of products and territories that we operate in, we're not breaking it down into individual sub count or ACV by product, by territory. We'll have a very big spreadsheet if I did that. No, that's helpful. Thank you. Did you say the 1,000,000 number though is users? Did you say that or just to be clear? Yes. Across the whole portfolio worldwide, that a number that resonates in terms of our small segment. Okay. Thank you. Excellent. Next question is from the line of Paul Pratz from Jefferies. I think first and foremost, is there any comment you can kind of make around the upsell and cross sell component of ARR? Has that started to recover? And I guess any color on renewal rates? The other question I also had as well is, I mean, you look at the R and D and S and M, that's ticked up pretty meaningfully. But have you also seen an improvement, I guess, in your customer acquisition economics? And this is basically just more efficient spend driving maybe more efficient growth than you had historically? And then maybe just two final questions on Segid. The valuation, I think, that came out, trying to remember which private equity firm looked pretty punchy. Does that maybe change your thoughts on your French business? And then finally, on NCA in the quarter, it looks like the number is almost as large as what you did in the second half of last year. Is that math correct? I mean any qualifications, I guess, on the size of NCA in the quarter or any comparison versus prior quarters would be helpful. Thanks very much for the questions. There were five there, think, or six, which is probably not fair on your colleagues in the analyst community. So if you don't mind, we'll take some of them and the rest we'll sort of take offline, if you don't mind. I think in terms of you were talking about renewal rates that we've seen across the portfolio and also cross sell and upsell. Renewal rates, if you recall, we sort of in the last year, the first half, we literally we're running as per normal at about 101% renewal rate by value across the whole portfolio. The second half, well, obviously, the impact of COVID, we were running at about 97% renewal rate by value. But that was consistent and flat during the second half. It wasn't deteriorating at all. And so therefore, we averaged out over the full twelve months to about ninety nine percent overall for the full year. At the first half, again, we reported ninety seven percent, so very much in line. And what I can tell you now is in Q3, year to date, we've seen a slight improvement in that. And we believe that that is now beginning to head in the right direction. Really, really good question around sort of cross sell, upsell. That is making a difference, particularly in small segment, particularly in The U. K. And also in North America. So customers who are taking the Sage accounting line are very rapidly moving to taking on Sage HR, which is the cloud native formerly KKR, cloud native HR solution. They're also taking Sage payroll in the cloud. AutoEntry, the automated accounting service, making tax digital and submitting your tax returns digitally and also bank payments and bank fees. All of those are cloud native products with a very high tax rate coming off Sage accounting. And so that's a very, very important offering in the Sage accounting space. Sorry, just remind me of one more what was your next question, I think, upon Yes. I think the most important question, I think, on my end is you've increased your investment in R and D and sales and marketing. And I guess any commentary on the efficiency of growth or LTV to CAC, I guess, so the unit economics of the business. Has that improved? Yes. So where we are really ramping up new customer acquisition and ramping up investment, we've seen a flattening or a slight reduction in some of the unit economics as we sort of gain territory and get a beachhead into particular customer segments. However, once that becomes a more established trend and the go to market is aligned exactly where we need to and we're getting benefit from the marketing campaigns that are now becoming much, much longer established, then we're seeing those unit economics improve. The one thing and I was one of the earlier questions, I think, from Stacy is that the one thing that we will not do is invest more money or invest any money where we do not see good unit economics on a SaaS basis. And it's the classic LTV and LTV to CAC metrics. We will not do that for the sake of gaining new territory or gaining new customer basis. We will always do it on an economic basis. Perfect. That's very clear. Thank you. Thank you. And that's all the time we have for a question. I will now hand the call over to Mr. Howell for closing remarks. Yes. Thank you very much indeed for attending today. Thank you for your good questions as ever. Absolutely, the right questions off the back of the announcement. James Samson and the IR team, and I will be fully available today for any further questions that you'd like to do. Thank you. Thank you. That concludes our conference for today. You may all disconnect. Thank you all for participating.