Earnings Call: H2 2014

Dec 3, 2014

Hello, and good morning. I am delighted to be here and welcome you to the Sage 2014 results announcement. You will know that it is the first time that Steve Hare, our Chief Financial Officer, and I have combined to present results, so it is nice to see so many familiar faces in the audience, and it is good to be back. In terms of myself, I think it is probably worth just opening and saying this for me, at Sage, is my dream job. That is not just sentimental. If you look at what I have done for 30 years in my professional career, there is a couple of things I am really excited about. One is SMEs, small to medium enterprises, and entrepreneurs. This is the powerhouse of the U.K. and all developed economies, employing 60-plus percent of the folks out there across the U.K. The folks who give up their lives and work night and day to build their businesses, has always inspired me. Many of you know also that I am an angel investor of multiple small to medium enterprises. I have been a director. Actually, I have led as a chief executive for small to medium enterprise, so I have stood in their shoes, and I clearly understand what it takes to build businesses and grow businesses. The other thing I did for the last three years was a duty, I guess, a responsibility around public service. For the last three years, I have been working with the British government, and transformed the lives. One of the things we did was transform the business relationship between government and small to medium enterprises with spectacular results. That has really put a lot of small to medium enterprises in good shape in the U.K. and their dealings with the U.K. government. The final thing I would say around this is the small to medium enterprises is something that definitely inspires me. But when you add that to the second element, I have spent 30 years in the world of technology. Technology is within my DNA, and many of you know me from either the NASDAQ Technology that delivered great success or, more recently, the FTSE company, where I was fortunate enough to be chief executive, and again, deliver some success there. When you combine these elements of passion about small to medium enterprises and the love of technology and seeing the future of technology and mapping that to customer needs, then I think I am in an ideal place at Sage, and I feel very fortunate to be standing in front of you today having the responsibility as chief executive of Sage. Maybe in terms of today, what is appropriate is to just have some opening comments from myself and remarks after, I think this is my 21st working day. After 21 working days, it is fair to say you would not expect conclusions, but I have certainly got some observations to share with you. Then have the meat of the presentation today with Steve Hare, our chief financial officer, who will take us through and give us a great insight into 2014 and the results. So let me start with some opening remarks. First of all, around the results themselves, I think they're a great set of results. Credit to Guy and the existing management team for delivering those results with 5% organic growth and 27.5% operating margins, a very solid and good set of results. I think that gives us, as a management team, strong confidence to actually reaffirm management's guidance, supported with the board, for 2015, of 6% revenue growth and 28% operating margin. I think the other thing that you have to fundamentally read into the results, and the reaffirmation and confidence of the management team, is the strategy's paying off. Again, credit to Guy for the work done back in 2012, and the strategies put together again. I think our view, and Steve, my early views is it's a lot about acceleration and execution of those strategies that will hold us in good, profitable growth territory going forward. Good results, reaffirmation of guidance, and strategy is working. Now, if I look at my reasons to want to be the Chief Executive of Sage, there's a couple of things that are probably worth sharing with you. In the last 21 days, these have been reinforced strongly. First of all, Sage has got a global footprint. Secondly, I think it's got a very robust and strong business model. The third aspect that was quite important to me is it's got a heritage of 30 years, and it's been proven over those 30 years to be there and ahead of the technology curve and disruption in the technology marketplace for its customers. I think those three things are pretty fundamental. What I wanted to do in my first 21 days is test those, and for me, the rubber always hits the road to go and see customers and our people, and connecting our people, delivering fantastic value for our customers. It resonates for me, and any Chief Executive. What I've done in 15 of those 21 days is actually get on a plane and go over 25,000 miles and visit pretty much all the locations in North America. Actually, some of you have followed me on Twitter, which is great, on the road trip. Over that period of time, literally of three weeks, I've been right through all of the U.S. hubs. I've been down in Africa, and I've seen all the major European hubs. So I've got a pretty clear validation. It's not completely extensive, but within that, I met over 5,000 of our colleagues around the world and almost 100 customers and partners. There's a couple of things, particularly from the customer sessions that I ran and customer forums, where I got a really strong insight, which I think is worthy of sharing with you today. During the customer sessions, there's a couple of things from the human point of view. The diversity of these businesses is fascinating. I met people in the business of metalwork and electrical businesses, engineering companies, chemical companies, street cleaning companies, beauty products, soap products. Such a diverse, enormous range of businesses we serve across the millions of customers, and the SMEs out there. The second thing is the human story. There was three occasions where I met multi-generational Sage customers. A mum and dad in a bakery business had actually set up their two children, daughter and son, in a video editing media business. We have a Sage 50 customer in the bakery business and a Sage One customer in the cloud for the younger generation. I think, again, testimony to being there, but also getting ahead and actually supporting the entrepreneurs of tomorrow grow and be successful in their businesses. The other thing, there is probably three things that did resonate strongly. As I sat in these customer sessions, probably half a dozen customers around the table with myself, talking about their businesses and what they see in terms of their business challenges. On my iPad, I made a note. There was a number of times, probably at least half a dozen times, where the customers just said two words, "Great product." Sage, great product. I made a note of that. Second thing, a number of the customers said is indispensable. Indispensable. Indispensable. We see you not only here today, but absolutely our strategic partner to take us into the world where there is technology disruption and mobility and all the exciting things around social communities and the cloud. Great product, indispensable, were really resonating. The third thing I think is really important to recognize, particularly in our European businesses, is the value and the strength of the local support. Being able to pick up the phone or go on the web and dealing with someone who understands that compliance regime, that regulatory regime, that detailed, fundamental element that is relevant to, say, the German accounting marketplace. It just came back stronger and stronger around the quality of the support that Sage provides its customers, and the value derived from that, and that they are local and available. There were three things that the customers came back, which leads me onto the colleagues. I met over 5,000 colleagues, and it is really important to just share a couple of thoughts with you. I said, most of what we really focused on is around core execution. You will know people like Steve and I are very operational and very focused on execution. How that played out with our people when I did these all-hands town hall meetings was, definitely people in Sage are up for increase in pace, increase in pace of execution. That is a message that I am resonating around the world within Sage, increase in pace. The other thing that is fundamental is, where it is appropriate, one Sage. Again, our people are really up for combining, and we have seen with some of the success, in terms of the numbers of Sage One with 150% growth in paid subscription, the value of global products and ultimately global initiatives that make sense, and then are delivered through this really strong network of local businesses close to the customer. One Sage, an increase in pace for our people are fundamental elements. Now, in terms of our thoughts, today is really all about 2014 results, and obviously reaffirmation of management's guidance around 2015. What we are doing over the next few months, and just to make you aware, I think it is probably too early, and you wouldn't expect me to say, I have got all the answers. I've got lots of thoughts, lots of questions, and I've validated the core principles that this is a robust business and it's a business built for growth. Over the next few months, we'll be doing more work and business modeling and things you'd expect us to do to be able to come to you after the IMS and after interims in the summer of 2015. We're, at that point in time, planning a Capital Markets Day, to share with you the strategy and the opportunities we face in Sage. Just to mark your calendars ahead, that's probably the right and appropriate time to think about really lifting our eyes and looking forward on the opportunities for the future. At that point, I'd like to introduce Steve Hare, who will take us through the 2014 numbers, then I'll come back and we'll open up for questions and answers. Thanks, Steve. Thank you, Stephen, and morning everyone. It's great to be here to present the first full set of results. Obviously, I was here at the interims, but to be here to present the first full set is great, and it's obviously also encouraging that it's such a good set of results. I think these results really show that Sage has got some momentum, and momentum in a number of areas. Momentum in the cloud, momentum in subscription, and most critically, momentum towards achieving the financial targets which we've set for ourselves. I'm going to cover first the financial highlights. 5% organic growth, as Stephen's already said, is a key milestone on the route to 6% in 2015. I do expect in 2015 that more of that growth will come in the second half than in the first half. I think the first half revenue growth is more likely to be at the lower end of the range. Recurring revenue growth of 7%, I think is very significant. This highlights both the quality of the growth, but also the momentum, and the fact that recurring revenue is now 73% of total revenue is also important. Also underpinning that growth was the move to subscription, which I'll come back to. Organic operating margin of 27.5% demonstrates our continued discipline with respect to profitable growth and cost management. Also the underlying EPS growth of 8% reflects that profitable growth, but also a slightly lower tax rate, and also the impact of the share buyback program. We've also accompanied this with an increase in the dividend of 7%. I should mention that as a result of the review of goodwill, we do have an impairment charge of GBP 44 million with respect to Brazil. This is largely due to the fact that there are now tougher economic conditions compared to the time at which we did the acquisition. At the time we did the acquisition, GDP growth was 8%-9%. It is now closer to 1%. The business, however, did achieve 9% organic growth in FY14, and we remain optimistic about the prospects for the business. This is more of a non-cash accounting adjustment than a reflection of any change in the view of the business prospects. Overall, financially, a good set of numbers, which also support our financial targets for FY15. On to the non-financial KPIs. We have seen a 29% increase in the annualized value of the software subscriber base, increasing the rate of growth, which we reported at the interims when it was 24%. We are growing our subscription base, and this will continue to be a feature as we continue to attract new customers, mainly through Sage One; reactivate existing customers, particularly through core product modernization; and also migrate from existing maintenance and support contracts to subscription. It was an important, even pivotal, year for cloud adoption, with an increase of 150% in the number of Sage One paying subscriptions to 86,000. This was led by the U.K. and Ireland, and also South Africa achieving a very strong performance. The progress in North America was below where we want to be, but we are addressing this, but it will take time. Hybrid cloud is also starting to get some traction with 1,500 subscriptions, but this is more of a future enabler of growth. Sage ERP X3 growth of 7% was below our double-digit ambitions, and this reflects the weakness that we have in France, which we highlighted at the interims, mainly in the direct channel. Outside of France, the growth in Sage ERP X3 was 20%. Integrated Payments growth of 14% was okay, but I do think there is a very significant opportunity as the penetration of the installed base for Integrated Payments remains low. If we turn now to revenue growth, this slide gives you an update of the sources of growth similar to that which we presented at the interims. The theme is very similar, with software subscription being the primary growth driver. As I said at the interims, this is increasingly significant. We are finding that customers like subscription, particularly small business. It gives predictability of cash flow and access to all the latest features. It also gives Sage a more predictable revenue stream with lower levels of customer attrition. We continue to manage this transition while still delivering on organic growth, margin, and free cash flow targets. The operating margin is progressing as we forecast and is on track for the 28% FY15 target. I am going to turn now and just talk a little bit about the regions, starting with Europe. We saw a good increase in growth to 4% from 2% last time. The real highlight that I would like to pull out is recurring revenue of 7%. Just to pause on that means that Europe is in line with the group in terms of recurring revenue growth. It is not dilutive to the group. That recurring revenue growth has been driven principally by the move to subscription in both France and the U.K. and Ireland. As I also commented on at the interim, Southern Europe has now stabilized with both Spain and Portugal showing some growth. Mid-market was highlighted at the interims as being an area of some weakness. Actions have been taken to address this, including some leadership changes. Although I remain cautious for the first half, I think there are some significant opportunities in mid-market Europe. Looking forward to FY 2015, we can see the trajectory, therefore, in Europe is supporting our overall 6% growth target. The operating margin nudged up slightly to 28.6%, which was in line with our expectations. Turning to the Americas, we saw overall growth in the Americas of 5%, with North America at 4% and Brazil at 9%. Recurring revenue was up at 6% as the premium contract upsell initiative that we've been running in North America continued, and we also saw further subscription growth in Brazil. The North American growth rate of 4% was weaker than last year, due mainly to softness in payments, particularly in the second half. The situation is now stabilized in the payments business, and we expect to see the payments business return to growth. But I would be cautious about how much we see in the first half. Sage ERP X3 grew strongly from a low base in North America, and Brazil was also good at 9%, given the economic environment in Brazil. The acquisition of PayChoice was completed after the year-end, and we're focused on the integration of this business, which is progressing in line with plan. The operating margin was in line with our expectations, at 25.7%. Turning now to EMEA, where we saw 12% organic growth. This was led by South Africa, which achieved 16%, and this in a country experiencing pretty difficult economic conditions. So I think this was an excellent performance and was underpinned by strength in the mid-market. Australia was solid at 6%, and in EMEA we saw a decline in the operating margin due to some additional investment and a greater level of lower-margin professional services. So we continue to focus on moving our resources towards invest products. This remains a very important ingredient of how we're funding the transition of the business. Stephen and I see this as an area of continued focus to ensure that we are allocating resources to the areas that give greatest benefit to both Sage and also to its customers. So cash flow. Very important that we don't lose sight of how important free cash flow is. We want to grow this business and continue to grow this business, but we also want to generate free cash flow. For this year, I've retained the conversion methodology that's been used in the past to give consistency, which gives a conversion rate of 107%, slightly lower than the half-year due to some working capital timing. However, going forward, I'm going to change the calculation in order that we use underlying cash from operations after operating capital expenditure. So on this basis, the cash conversion would have been 99%. The reason for doing this is that I think it gives a better measure in terms of tracking operational performance, but also gives greater consistency in terms of how we measure cash conversion internally. Leverage at the year-end was 1.1 times. Pro forma after the PayChoice acquisition, it would have been 1.3 times. Free cash flow of GBP 229 million, or around 18% of revenue, remains a strong number. In terms of how we use that free cash flow, we completed our acquisition in Germany. We settled the put and call option on the remaining 25% of our business in Brazil, with the PayChoice acquisition completing post the year-end. We also continued the share buyback program and implemented our progressive dividend policy. I would now like to talk about some of the things which support the future. I am going to talk first about the momentum that we have with subscription, and also how the cloud and the growth opportunities we have across our portfolio underpins our confidence in 2015 and beyond. Firstly, the move to high-quality subscription revenue continues. As I mentioned, recurring revenue is now 73% of total revenue. This is up from 71% 12 months ago, and likewise, software subscription is up from 13% to 16% of the total. Over time, you will also see a switch within these numbers as we move more maintenance and support customers to subscription. I expect that that 16% will continue to increase. How is Sage going about encouraging customers to move to subscription? The cloud is very important to Sage and to its customers, and it enables everything that we are doing, particularly in driving subscription. Our cloud solutions, core product modernization initiatives, and a growing portfolio of connected services are providing subscription catalysts to our customers. Our philosophy, which we have stated a number of times before, is that we offer customers choice. We therefore incentivize our customers to move, whether it be to migrate to new products or whether it be to migrate to subscription. Core product modernization is a great example of how this incentive works for the installed base. This enables existing customers to access new services, and we have millions of small and medium-sized businesses that use our products and services, and these modernized core products are now helping to drive adoption of subscription as we sell licenses via subscription rather than license upgrades. I am going to give some examples in a minute, but what this does is allow our existing customers to have all the benefits of maintaining their on-premise environment, but with the additional benefit of cloud connectivity and mobility. When you think about subscription for Sage within the install base rather than for new customers, don't just think about it as new license revenue displacement. Think about three areas where our installed base gives us opportunities. Firstly, reactivating existing customers. This drives higher attachment rates, particularly with small business. Migrating existing customers to higher-value offerings. This drives higher average revenue per user and customer stickiness through migrating existing maintenance and support customers to premium solutions with value-added features. Cross-sell. Cross-sell to existing customers, driving a higher share of wallet from those customers. All of these are new sources of revenue which contribute to growth, and the cloud provides the building blocks to enable it. What I would like to do is illustrate with three examples, all of which have contributed to revenue growth in FY 2014. The first is Sage Ciel Flex in France. This is a reactivation story. This is small businesses being attracted to the top tier of subscription with offers which allow mobile cloud capability. All new revenue, no displacement of existing revenue. The second example is Sage 100 i7. This is a migration of existing on-prem customers. On-prem customers who already have a maintenance and support contract, but migrating them to a premium product, which is only available on subscription. As a premium product, customers are attracted to the added value over what they are currently buying, and this is the catalyst for them to switch from a standard maintenance and support contract to a subscription contract. In this particular case, for this migration, we also charge an upfront activation fee, which therefore offsets anything we would have had as an upgrade license fee. The third example is auto-enrolment in the U.K. Pension auto-enrolment is a headache for small businesses, and the U.K. have introduced a connected service which allows our customers to deal with this. Previously, this feature is something we would have probably bundled into an existing payroll product, but we decided to offer it as a feature on subscription. That has had a very high take-up. I think something like 60% of our existing Sage 50 payroll customers have taken this feature, and it is all additional revenue. Adding value to existing customers is very important, but so is acquiring new ones. We acquire new customers in a number of areas, but there are two key areas where I would like to talk about it. One is small customers, principally through Sage One, and the other is mid-market ERP through Sage ERP X3. For small customers in the U.K. alone, it is estimated that over 1.5 million small businesses still use spreadsheets. This is a significant amount of white space, and these potential new customers are clearly attracted to the cloud. It offers ease of use and no upfront costs. For less than the cost of your monthly mobile phone bill, you can start to enjoy the convenience of using Sage One. In mid-market with Sage ERP X3 version 7, we have a very attractive product, which is using all of the benefits of the cloud to give a compelling offer to customers. Adoption and pace of change in mid-market is slower than small businesses, but it is important to be able to offer connected solutions in this segment. As I said earlier, it was a pivotal year for Sage One. This offering is now available in 10 markets with the number of subscriptions increasing by 150% to 86,000. As part of our global focus, we redesigned some of the SaaS offerings to make them part of the Sage One family. If you exclude these redesigned offerings, the Sage One base would have been 53,000. I am just giving you the numbers so you can relate them back to what we have disclosed previously. Of those 53,000, 47,000 was in the U.K. and Ireland. We have been very pleased to see the strong momentum in both U.K. and Ireland, but also in South Africa. If you look at this graph, which is for U.K. and Ireland, you can see that we were somewhat late to market with our Sage One product. However, now that we are in the market with both accounting and payroll products, if you look at the adoption rate over the last couple of years, you can start to see how we are catching up. As I said, North America is behind our ambitions. But again, compared to the U.K., we were a bit later to market in terms of introducing Sage One into the U.S. Sage One Extra, which is the product with deeper functionality, which is available in the U.K., is only just about to be introduced in the U.S. So if you look at this graph, compare it to the U.S. in terms of rate of adoption and when we went into the market, that helps explain why we have a bit more work to do in the U.S. in order to get to where we need to be. Also, secondly, we have some work to do around the channel, particularly the accountants channel, which is less well developed than it is in the U.K. So cloud is making a big difference to Sage, and we're using it to improve customer experience for all our customers, both existing and new customers. Sage is here to serve customers of all generations, from young people starting up for the first time, through to customers who've been with us for 30 years plus. This slide uses subscription as an example to show the progress and the momentum that Sage has and how we continue to offer customers choice. We aim to have customers for life, and so the move to subscription will be progressive, with greatest pace taking place with smaller customers. We're pleased with the progress we're making. We've built a strong platform for future growth, but in a way that our customers appreciate and value. To conclude, we exit the year with momentum in the cloud, with momentum in subscription, and with momentum in revenue growth, particularly evidenced by the 7% recurring revenue growth. We reaffirm our guidance of achieving 6% organic revenue growth and 28% operating margin in FY15, and we will achieve these targets with momentum and underpinned by strong free cash flow. Stephen and I are already developing a good partnership, and we're looking forward to seeing you at the Capital Markets Day and presenting more around how we see increasing the pace of execution in Sage. We look forward to seeing you then. Thank you. Thanks very much, Steve. What we'll do now is open it up to your questions. We've also a couple of things. We've got questions on the conference call line as well, so I might interject those. But it'd be really helpful if you could just say your name and the institution you represent as well when you kick off. Do you want to go first? You've got a roving mic as well. I should have said that, sorry. Thanks. It's Adam Wood from Morgan Stanley. I've got two, if I could. Yeah. Just first of all, around investment, could you give us a little bit of a feel? Obviously, the software industry is going through a big transition towards cloud software as a service. How do you think the product portfolio at Sage is set up for that? Following on from that, with a greater move towards subscription and maybe some need to invest, how do you balance that investment? Is it the right time to be taking margins up versus maybe investing more in the product portfolio and accelerating that move towards subscriptions? Secondly, I think there's around 2 million customers on support and a 6 million, roughly, customer installed base. In terms of the 4 million opportunity of getting them onto some sort of payment model, how do you think about that? How confident are you that those 6 million customers are actually there, still able to be sold to? Would you think about a forced subscription model rather than a more gentle push towards it? Thank you. Okay. Maybe a couple of things from the customer switch, then I'll pass to Steve from a financial perspective. So two things. One is, honestly, I get very excited about technology. Really excited. So, iPads and stuff, I've got about four devices. When I go and talk to our customers, particularly in places like Germany, France, Spain, I see the reality that we're ahead of the curve. When they're looking at their business and using words like indispensable, and we want to help understand this. In Germany, there's still all the concerns about data security in the cloud, all that sort of stuff. I've got replay. In fact, in the session I did in Bad Homburg in Frankfurt, they were saying, "Hang on, Stephen, you're going way too fast on this stuff." So just let's balance it. Now what we're seeking to do, there's two parts to cloud really. One is the technology innovation, mobility, and all the stuff, SMAC, analytics, all that great stuff. The other thing is the business model change. What we've done through a shift to subscription is mirror, effectively, a cloud revolution in terms of what it means. It means I pay per play, which is great. If you think about it from a cash flow planning for a small business, they want to have security, and if they have to lay off folks, they want to pay less. If they take on more folks, they need to expand their cost base accordingly. Effectively, we're doing a lot of things through what Steve talked about and the shift to subscription and away from the annuity of support and maintenance to actually mirror that reality. The other thing we say, in terms of the shift, and I think this is credit to Guy and the management team, is 2012, clear strategy around embracing the cloud, also shifting the investment model towards fundamentally the new world and making sure that we always gave our customers a choice, though. I think it's slightly different with some of the other folks, particularly in the U.S., who are doing forced migrations. I think something customers love about Sage is we give them a choice. If they're not ready to move their business because they're opening up in a different geography or they're taking on more staff, the last thing they want to do is worry about technology migration. To have that security that they have the choice from Sage, I think is important. Steve, anything on the financial side? Yeah, I think on the customer numbers, I think the way to think about it is, as you said, Adam, roughly 2 million already on existing contracts, whether subscription or maintenance and support. There's close to probably another 1 million customers with whom we've had some sort of economic transaction in the last three years. It means they've bought a product, but they've gone off plan, so they don't have a maintenance and support contract. It's those people who are the first priority. They're the people we've had the most recent contact with, and they're the people who we want to use features, new product modernization, et cetera, to tempt them back into the net. Then, in terms of the 6 million, there's obviously people out there who have bought products a long time ago, and it's more costly, probably lower probability in terms of targeting them. We're taking them in that sort of order, people who we've had more recent contact with first. The other thing is what I said about white space. I think particularly with Sage One, not just in the U.K., but in all the other markets in which we offer Sage One, there's a significant opportunity to get people to come into the net for the first time, and I think that is an important focus as well as reactivating existing customers. I think in terms of the forced subscription model, what we're trying to do is a balance where there are some features, I used auto-enrolment in the U.K. as an example, where we're not forcing customers to take auto-enrolment, but if you want it's only available on a subscription. We're trying to use a gentle. It's still offering choice, but we're not guaranteeing that everything we offer will have both license and subscription, but you get to choose whether you want to take that additional feature. Good. I think Charlie's holding the microphone. You have- Yeah. Charlie Brennan here from Credit Suisse. I've got four, but they're very short questions. The first is just on Sage 50. You launched an updated version of that, including a subscription offer. Can you give us the stats around the numbers of people that took the license option versus the number of people that took the subscription option for Sage 50? The second question is just around your active contract number that looks like it's fallen year-on-year. How do we reconcile falling active customers with your commitment to ongoing growth? The third one is just on Sage One. There was obviously some very aggressive discounting around August and September. Can you give us some metrics there around the average revenue per user on Sage One? The last one, just on R&D. The headline number looks like it's fallen about 9% year-on-year. Can you just give us what the organic trend was there? Thank you. You got those four for the price of one, Charlie. Steve. Starting with Sage 50. When we first launched the upgrade around August time, we did offer some discounting around the upfront license. We gave greater choice in the initial launch phase. Then what we did in September, partway through September, and what we're doing now is we're making the subscription a lot more attractive. If you look at what's happened in September and you look at what's happened over the last couple of months, there is the vast majority of people signing up to the new version of Sage 50 are going subscription. But in August it was the other way around, but it was only for that one month. In terms of active contracts, there has been some consolidation of contracts, and this is partly as a result of the move from maintenance and support to subscription. Because what happens in maintenance and support contracts is that typically they're product driven. If you take out a maintenance and support contract, let's use Sage 50 as an example, you'll take it out for Sage 50 accounts, and then when you sign up for the payroll product, you'll have a separate contract for Sage 50 payroll. As an individual, you would have two contracts because you've got two separate support contracts for those two products. When you go to subscription, it's bundled, so that two contracts becomes one. Actually, the number of true active customers hasn't really fallen. But what you have seen is a switch. Because of the switch, particularly from maintenance support to subscription, the number of contracts is lower, but the number of customers is not. On Sage One, everyone in the small business space attracting new customers is offering deals. Everyone offers free trials, everyone offers discounts in the early phases in order to attract customers, and we do exactly the same. In terms of long-term, once you've signed up, what we're charging for Sage One isn't particularly that much different from what we were charging before. There's just a lot of attractive offers to sign you up in the first place. To give you a feel for average revenue, it's obviously early days. We quoted that we had 86,000 Sage One subscribers or Sage One subscriptions, and the revenue was just over GBP 2 million in FY 2014. On R&D, R&D on an organic basis continues to track at around 10% of revenue. I think the way Stephen and I see R&D is that it's something that we're very focused on in terms of how we allocate between the invest products and the other products. But what I would say is that we have something like 2,200, 2,300 R&D engineers. Sometimes people say, "Well, are you sure you're spending enough on R&D?" 2,200 engineers feels like a lot to me. Yeah. On that, Charlie, I'll just pick that up. I'm aware of companies, in the last 10 years I've been involved around the cloud, who have got products to market in 3 to 6 months. One of the competitors in our space has got 20 engineers. 20. Two zero. Another one has got 12 engineers. We've got over 2,000 engineers. That's why shifting the dial around execution and productivity, and the strategy's all well and good, but then it's all about the execution of that. I think we've got plenty of firepower, we feel, in our engineering function to actually look after our customers as they are today with the on-premise, pursue the strategy around moving to invest, but also significant firepower to build some of the global products like Sage One in the cloud and exploiting the new technologies. We'll go with Michael. Thanks. Michael Briest at UBS. Steve, I think you said that for the first half you expected growth to be at the low end of the range. Can you say what that range is or why it will be at the slower first half? In terms of the acquisition stroke investments, I notice you don't repeat the 1 times leverage target. You talk about potentially doing periodic returns of excess cash. Can you talk a little bit about what the balance sheet should look like? Do you think that maybe the business can run with more leverage than the 1 times target you've had historically? Just finally, on Sage One, can you say maybe what the churn rate is in the U.K.? It's been running now for a few years. You should have a feel for that statistic. Thanks. You want me to start this? Yeah. So H1 growth. The reason I am being a bit cautious around H1 growth is because I think the areas of weakness that we have pointed to of U.S. payments and European mid-market, where I think we have done a lot of the right things. I am just a bit cautious about how the pipeline converts. I can see that it is starting to happen, but I am just a bit cautious around it. I think you will see we have just reported for the year 4.9% growth. H1 will be above that, but I just do not particularly want to be drawn how far above it. But you have seen from both Steve Hare and I, there is no kind of hesitation whatsoever in reconfirming the guidance for FY15. We just think it might be a bit more backend loaded. On the capital structure, the 1x leverage remains the guidance that we are aiming to be there or thereabout. We are not going to be a slave to it arithmetically, so sometimes we might be slightly above, sometimes we might be slightly below. But as a guidance, we still expect roughly to be at 1x. If we do bolt-on acquisitions, we may go above that to do those acquisitions and then bring it back down again as we generate cash. But there hasn't been any change of policy. But we see it as a guiding principle rather than something that we are a slave to. On Sage One, in the U.K., the churn rates are now down into single digits. Yeah, just picking up as well. Final point, Steve Hare has spent time reaffirming the plans in terms of 15, and that is why we can stand up here with confidence. Obviously you would expect me, many of you know me, having met every country manager of 90% of the revenue for the fiscal year, ask them the question and look them in the eyes to stand up here today. So that is the first 3 weeks of my life at Sage was going around meeting customers, people, and spending a little bit of time with country managers and making sure they clearly know our responsibilities. Do you want to. Stacy, we will go. Just for ease of microphone. We will come back to you. Stacy? Thanks. Stacy Pollard with J.P. Morgan. Just to dig in a little bit around the pricing. So a pricing question. How does your cloud pricing and subscription pricing compare to your on-premise license and support? Is it the typical 3- to 4-year total cost, or from your perspective, total revenue where that line crosses? That is one question, and then the second one, again, to follow up on acquisitions. Are you still interested in acquisitions? To what purpose would that be? For technology or geography or what interest? Okay. Do you want to Maybe. Well Shall I flip them around? Sure. Do acquisitions first. Consistency of strategy, consistency with what the board and I have worked on, consistency of 2012. PayChoice is a good example of that. If we can accelerate the strategy, then we consider acquisitions. But Steve and I are very execution-focused. The other thing I think we should say is around the organic strategy, the world of the cloud and what that offers is we can develop products quicker than we could have done 10 years ago. We'll certainly focus on that area. Then maybe you do the first question. Yeah. On the pricing, Sage has historically been a very decentralized business. There isn't one answer for every country. France, U.K., South Africa, Brazil, North America are doing slightly different things depending on what they think the market conditions are. Also, we are depending on what's common in the marketplace. In some cases, like the example I quoted in France, we're using activation fees. We're not necessarily making the migration to subscription completely free of charge, whereas in other countries we are. To answer the question at a higher level, if you compare license fees to what we then charge for monthly subscription, it tends to be at the lower end of that range that you're talking about. If you look at how we're pricing subscription, it tends to be more in the 2 to 3 years than the 3 to 4. In some cases, it may even be lower. But where it's lower, it's not necessarily a like-for-like comparison. Because where we sell the license, we're giving the customer the software with 100% of the functionality. When we move it to subscription, and particularly where we're using cloud products, the starting point is a lower level of functionality, which you then add to as you go up through the various tiers. You can go on the website and you can compare the different pricing between licensing and subscription, but it's not straightforward to compare apples with apples. Should take one from over here, and then we'll come back to there. Go for it, David. Thanks, guys. David Toms from Numis. Just a couple from me. Digging into Charlie's question a bit about ARPU and the implied ARPU, if we assume 50,000 or so average subscribers for the year on cloud and 2 million of revenue, that's implying an ARPU of about GBP 3 a month. The figure we were given a year ago was about GBP 8.50 a month. Now, I realize these might not be entirely like for like, but that's a very big difference. Can you just explain why the delta is so great there? Secondly, just on working capital, you had a slight throwaway comment when you're running through the numbers, Steve, saying that the working capital had been a little bit light. Given the increasing importance of recurring revenue in the business and the decreasing importance of SSRS, why aren't we seeing working capital being a little bit better as you collect that upfront cash from people? Yeah. So if we take the ARPU first, if you look at the rate of adoption of Sage One, it's more backend loaded. Also, these are worldwide figures now, so they include South Africa. So pricing in South Africa is generally lower. So, I think because of the early discounting, because of what it takes to acquire customers, it is true that the ARPU is going to be lower in the early stages of us acquiring these customers because we don't just offer free trials, we offer half-price deals. We offer very significant discounting in those early months. But that's the way the model works in this environment. We're competing against people who offer products for free, who offer extremely low pricing. And we need to capture the customer. We need to get the customer into the Sage One family, get them to understand the benefits of the product, and then we need to get them to a place where the ARPU makes sense. But in the early days of customer acquisition, you will see periods where the ARPU is low. On the working capital, to be honest, the biggest reason for the slight drop in conversion is, we said in the Q3 IMS that Q3 hadn't been a little bit weaker than we'd expected, so therefore, by definition, Q4 was a bit stronger. So the revenue's been a bit more backend loaded in Q4. Although, France would be a good example. In France, most of the subscription, and most of the maintenance and support contracts, we invoice upfront. So we invoice annual contracts upfront. But we still give people credit. So, people still get 30, 60 days credit. The DSOs have gone up a little bit in France at the year-end. We haven't seen any real impact going to subscription, in terms of how it's affected cash flow, because most of the maintenance and support contracts were already annual in advance. So even though we switched to subscription, most of them are still annual in advance. In some cases, we are going to monthly. So the U.K., for example, Sage 50 subscription is monthly. It's monthly direct debit. So, if we see more of a switch to monthly, we may see some temporary dips in cash conversion because if we go from full annual to monthly, we may see a dip. We haven't seen that yet, but it's a possibility. So I think there could be some inconsistency on a period-by-period basis in terms of the cash conversion. But if you look long term in terms of the trend, the more we can get people onto automated billing, automated collection, direct debit, that type of thing, you're going to get much more predictable cash flows. And that's where we're trying to get to. Great stuff. Thanks. It's John King from Merrill Lynch. Just a couple of questions, if it's okay, to follow up on the Sage One side of things. Yeah. Could you give us any sense as to the adoption in Sage One Extra in the U.K.? Obviously, you've launched that for a little bit of time now, so just wondering if you're seeing the pickup there as well. And I suppose related to that, if you could just give a view, referring back to the R&D question, how much of your customer base today would have the opportunity if they wanted to go out and migrate to a public cloud solution? And if you look forward at the current rate of development, where would that number stand in 12 months hence? How quickly could we see a full portfolio of offerings where your customers could move to the cloud as and when they want to? Maybe I will start on taking that. I think pretty clearly, we have done a good job of loving customers, but the reality is we know there is a lot of white space, Steve referenced the Excel users, and also a lot of new entrepreneurs starting businesses. That is the target audience that we are pursuing with products like Sage One. What we plan to do in terms of the wider question on R&D and the strategy looking ahead is actually host you back in the summer and give you a view of the strategy. But Steve, do you have the data in front of you? Yeah. For Sage One X we have got just under 3,000 of that 86,000 is Sage One X. Go for it, Milan. Thank you. Milan Radul from Jefferies. First on X3, I guess it continues to attract less attention than Sage One, Sage One Extra as we have seen today. Where have you got to now in terms of number of partners, the average deployment value there, and where could X3 be in, say, 3 years times the proportion of revenue? Then on the cloud kind of competitive landscape, we have seen NetSuite and others obviously emphasize their European expansion plans, witness your own war of words with one of those companies on Twitter. Are you doing enough to establish your cloud credentials in territories such as Germany? We have heard a little bit about France and the U.K., but not much discussion around some of those other European countries where the competitors are obviously laying out some infrastructure. Okay, maybe a double header. I will start and then pass to you. I think it is interesting everybody gets very excited about the cloud. The opportunity on the revenue side as well is in the mid-market. We have got great credentials there with the X3 product line. I will not break these out probably every time we get together, but for this occasion, last year we won 561 new customers with the X3 product line. Interestingly enough, as you mentioned, one of the companies, we always welcome competition and it is good for the market, good for customers, good for us to innovate our product. We always welcome lots of healthy competition. We saw lots of adverts in the Financial Times and welcome companies investing in British advertising. That is always something we relish. The reality though is, say, take the U.K. as a microcosm, on the X3 product line, we had a win rate of 66% of sales campaigns we were involved in. That particular company was seen on less than a handful of transactions. Actually, again, the reality of all these things is the customer. The customer feedback on those where we had a really high win rate was three reasons why they choose Sage X3. One, its functionality is superior. Secondly, big reason around total cost of ownership being less. The third reason actually plays straight into our core strength, particularly in Europe, is around local support. They really value local support from local language people, basically down the road or on the phone. They were the kind of things that resonated strongly. I would say we sit here and think that is actually an opportunity for probably better execution. Certainly, as a global product, we have had some success. We have highlighted the soft spot in terms of France. We have made some management changes around that, and I think we have certainly got our arms around what needs to be fixed there. Steve, do you want to add on that? Yeah. At the year-end, we got about 4,800 customers for X3, and we have got about 290 business partners. In terms of where that revenue could get to over, say, three years? I don't give guidance. That's a great question for the summer. Great question for the summer, and something on our minds for the next few months. Go on. Go for it. Yeah. Then we'll go back. Good morning. Amit Harchandani from Citigroup. Just one question in terms of your outlook of guidance for 2015. Come across as fairly confident about achieving the same on the top line. If you could just elaborate a bit more on the various drivers that underpin this particular level of confidence. Is this the recurring revenue performance in Europe? Is it the stabilization in North America and the potential improvements? If you could maybe distill down which drivers you expect to remain stable, and where do you expect more confidence to come through the course of the next 12 months? Thank you. Yeah, I think one of the critical ingredients is Europe. If you look back over the last three years, most people's skepticism around the growth trajectory of Sage was around whether Europe as a whole would be a continuing drag on that growth, and could we really grow Europe at something around the 6% mark. I think the fact that we've achieved 7% recurring revenue growth in Europe is pretty significant. We have very strong growth in both the U.K. and France, which are the two biggest countries. We have a lot of momentum around subscription in both of those countries. And also, although I'm a bit cautious in the first half, I think the opportunity for recovery in mid-market Europe could be a significant part also of the building block. And we see North America, which has had 4% growth this year. It was okay, but we can see reasons why that'll bump up a bit next year. So I think if you take EMEA, and Brazil as relatively small, but if you take EMEA and Brazil as continuing to be kind of the cornerstone contributors that they've been in the past, and then both Europe and North America continue with some of the trajectory that we can currently see, you get to 6%. Great. Do you want to try into the middle one there? Yeah. It's Mohammed Moawalla from Goldman Sachs. Stephen, can you talk a bit about the product portfolio? You talked about the feedback from the customers. You also kind of touched on the big R&D base you have. Is there room to further accelerate or simplify the product range as you look forward, particularly as you move to these multi-geography cloud products? And how big of a lever this could be on the longer-term margin? Secondly, just to follow up on the payments business in North America, can you just drill a bit, Steve, on to is this a competitive issue or an execution issue? And you alluded to kind of still a tough first half next year, but what the kind of medium-term outlook for that business is. Okay, maybe I'll take the first and then second. I guess many of you know Steve, myself, and I think the opportunity we have with 2,000 engineers around threading the one Sage message and taking forward the 2012 strategy. What that said is product rationalization, shift the investment towards invest in growth, and obviously exploit the opportunities and disruption in the cloud. It's kind of our job as the management to ensure that we accelerate that. The answer is obviously yes. Could we do better? Yes, no doubt about it. There's always, any business of our scale, there's areas we could do better and improve on. In terms of where I see a bit of a sneak preview into the summer, when we'd love to get you back together and lift our eyes to the next few years of how we can build global products that essentially, from the U.S., from the German visit, broadly, payroll's probably more country specific. But generally, it's 60% to 70% global requirements, and then the regulatory local requirements are the additional 30%. In some of the core accounting products, it's probably 80%. That sort of tells me strategies around Sage One and these global products we're driving, X3, absolutely means that we've got an excellent position. And actually, ironically, being a European company and understand the complexity of the countries around Europe and the different regulatory environment and the compliance requirement, probably is quite a significant advantage to us. Then it all comes back to better execution. What we'd love to do, again, maybe around that, make some progress over the next few months, but in reality, come back to you in the summer and lift our eyes up about the opportunity going forward. Do you want to talk to the payments business initiative? The payments business for FY 2014 was essentially flat. Some of that's market. I think a number of players, including Intuit, have pointed to the market being a bit more competitive and pricing being tough. But I do think also we've had some execution issues in terms of how we've gone about addressing the market. We did lose one of our channel partners, which also had an impact on the numbers this year. And I think with some of the actions that we've taken, there's reasons why we'll start to see that recover and that business returning to growth. But the reason I'm cautious is the same reason I'm cautious in mid-market. When businesses are turning, I've just seen it so many times before, where the pipeline starts to fill, but the time it takes to really start to convert that pipeline and really start to see the traction returning to the business. I'm always a bit cautious about how long that's going to take. Hopefully, I'll be positively surprised, but I'm the CFO, so I'm paid to be cautious. That's good, Steve, is cautious. On some of these things, we don't want to get ahead of ourselves. Steve's been here less than a year. I've been here 21 working days. Today was all about good results, reaffirmation of guidance, and then pointing us to the summer where we'll lift our eyes and answer a lot of these questions that are on your minds. Maybe one more question. Can I go to the phones first, though. We've got a question that'll hopefully be the voice of God. We have audio question from Gerard du Bos from Barclays. Please go ahead. Hi, thanks for taking my question. Two, if I may. First of all, on the kind of future growth. If you look for on Sage over the last kind of cycle or so, support growth has always been relatively decent, but SSRS has remained weak. Again, that was the case in the second half and then for the full year. When do you think that will kind of come back to growth and what kind of growth. Secondly, coming back on the payment business, the largest proportion, I believe is in the U.S., where you're competing with larger players, and that market is simply commoditizing. So that's probably tough for you guys to find effort or a significant kind of growth. My question on the U.S. there is, would you double up there to gain the kind of scale you need, or is this potentially something you need to kind of build down? In Europe where there is more growth, still a very fragmented industry, but again, Sage Pay is relatively small. Again, there are similar kind of question, do you need to consider acquisitions there to accelerate the kind of growth? Thank you. Steve. Yeah. If you take the revenue growth question first, we don't really expect to see SSRS return to growth as part of the plans of achieving the 6% organic growth. The only exception to that would be that we will start to see potentially some greater impact from mid-market, and mid-market is more likely to be licensed than it is subscription, just because of the nature of the way that market's working. But the reason we don't expect to see strong SSRS growth is because we're driving subscription. SSRS is largely driven by license fees, which are getting replaced by subscription. From time to time, we'll see some pickup because of mid-market and also because of professional services. But if you take the trend over a long period of time, we're not expecting to see SSRS growth. On payments, I guess two parts to that or two parts to the answer. The first is with all the payments businesses, part of the reason we own payments businesses is cross-sell. So whilst the market is more competitive, we also have a compelling story to our existing installed base about integrating payments into the offering. As I said earlier, the penetration of that cross-sell, although it's greater in North America than it is in Europe, there still remains a significant opportunity and a significant advantage to our customers for offering them integrated solutions, including payments. On the acquisition side, I guess I would see payments very similar to the rest of the business in that the right bolt-on acquisitions might well be appropriate for payments, just like they might well be appropriate for the rest of the business. At the moment, we're not singling out payments in any way to say that that's more of a strategic imperative in payments than it is anywhere else. It may be, but it's not something that's a burning platform that we feel we need to action, in order to be successful. Good, Steve. We would love to take loads more of your questions, but I think the last one today is in the middle. Neil Steer, Redburn. In fact, I think, Steve, you partially answered this question, but it was during the presentation, you referred to the integration of the most recent acquisition. Obviously, integration and leverage from M&A activity is not something we are accustomed to seeing in the past from Sage. The question was really, what are you doing different in terms of integrating that business now that we perhaps would not have seen under the previous management team? Well, I think, I would refer to Stephen's comments around one Sage. I think in the past, Sage was perhaps organized, or historically this has slightly changed over time, but originally was organized really almost as a series of individual businesses, so very independent businesses. So when an acquisition took place, apart from that business joining the family, it largely continued to operate in a similar or even the same way as it did before we bought it. When we buy now, it will be because we see synergies. We are not going to acquire things to acquire revenue, and just leave it standalone. We will buy things because either from a technology perspective, we think we can integrate into our existing suite of products and services to sell to a wider customer base, or it will be because we want to acquire customers, which we then cross-sell our existing products into as well. PayChoice is a good example of that. The reason we bought PayChoice is because they have a SaaS payroll product. There is a two-way opportunity. We acquire both technology and customers. The customers we acquire, we will over time be introducing them to the wider suite of Sage products. But also we want the payroll SaaS platform to sell into our existing installed base. There are clear synergies, and that is the type of deal that you are likely to see us doing in the future. It is important that there is synergistic value. Just to be clear, that is internationally transferable, is it? Yeah. Actually, in the case of PayChoice, for the time being, it is a U.S. solution. It could be that we build on that, but the reason we did it in the U.S. was because we did not have a U.S. payroll product really, whereas we do in Europe. That is great. Thank you very much, for your attention and support. Also, I just want to say thanks to Guy and the existing management team for a good set of results. Our commitment, Steve and I, as the management team and the board, is to absolutely assure everybody here we are very committed to short, medium, and long-term success for our investor community, our growth investors, and to deliver them excellent returns for-