Sage results show impact on SMB market

Earlier today, Sage, the UK's largest software vendor announced its full year results to 30th September and provided an update on how it sees the market going forward. Both the UK and US markets are the most affected by the economic downturn. In his review, CEO Paul Walker said that the remainder of the European Union and other territories were remarkably strong. These markets are dwarfed by the top line contribution it gets from UK/North America which together account for 57% of total revenue. The impact is best understood when you note that top line growth in the US was 1%, the UK 10% but overall growth was pegged to 7% at £1.295 billion ($1.93 billion.)

The second half was softer with 1% growth in the UK and a fall of 2% (excluding Healthcare)in the US. This is the firmest indication yet of where the impact is being most felt. (see graphic above)

Sage derives 61% of its revenue from support and service. So far, the company says there has been no discernible softening in subscription renewal rates but its big months are yet to come. December and January is the key period and as I said elsewhere:

I expect Sage will announce what happened in that period as this is such a huge contributor to bottom line profitability and cash flow

We could therefore know as early as February 2009 how well its support fees are standing up.

Its real troubles lay in the US Healthcare Division where revenues retreated 11%, aging products like Peachtree which was flat on growth and industry specific solutions where it managed a miserly 3% growth for the whole year. The other warning sign was an overall fall in margin from 20% to 18%.

While none of this should be surprising, Sage is vulnerable in part because it is carrying £541 million ($808 million) in net debt. If there is any appreciable softening in service revenue then its bottom line plummets. While it has plenty of interest cover today (10x on EBITDA, covenant 4x), the margin impact of any fall in maintenance revenue could become a genuine concern. CEO Paul Walker says there is a 'mixed picture' but seems to be hanging his hat on one off events like tax changes to keep the maintenance business ticking along.

Much of the formal presentation was devoted to explaining how the healthcare management team has been strengthened over the last year but even so, there is no masking the fact that Sage has not been able to make money on this $565 million investment. Last year I said:

When Sage acquired Emdeon, I felt they’d paid a hefty premium and earlier in the year it became obvious this division really was not performing at all well. In July, Andy Corbin who ran the unit was fired and at the time I said:

It would now seem that Mr Corbin wasn’t up to snuff as far as Sage is concerned and has paid the price. It will be interesting to see what happens over the next few months.

Interesting indeed.

Sage cannot continue to let this lame duck remain a drag but it has little choice. It talks about operational efficiency but what about product investment? This should be a market that is relatively recession proof yet Sage is losing out.

While Sage does not have to report again until May 2009, it will want to do what it can to protect its share price. That's why I believe we'll see fresh updates earlier rather than later. That cannot be a bad thing because everyone is watching everyone else to see just how rough 2009 will be.