Walldorf, Germany — SAP AG (NYSE: SAP) today announced its preliminary financial results for the fourth quarter and year ended December 31, 2006.
HIGHLIGHTS – Fourth Quarter 2006
- Product revenues for the 2006 fourth quarter were €2.2 billion (2005: €2.0 billion), which is an increase of 8% (12% at constant currencies¹) compared to the same period in 2005.
- Software revenues for the fourth quarter of 2006 were €1.3 billion (2005: €1.2 billion), representing an increase of 7% (12% at constant currencies¹) compared to the fourth quarter of 2005.
- Total revenues were €3.0 billion for the fourth quarter of 2006 (2005: €2.8 billion), which represented an increase of 7% (12% at constant currencies¹) compared to the fourth quarter of 2005.
- Operating income for the fourth quarter of 2006 was €1.1 billion (2005: €980 million), which was an increase of 10% compared to the fourth quarter of 2005. Adjusted operating income1 was €1.1 billion (2005: €1.0 billion) for the 2006 fourth quarter, representing an increase of 10% compared to the same period last year.
- The operating margin for the fourth quarter of 2006 was 36.6%, which was an increase of 1.0 percentage points compared to the fourth quarter of 2005. The adjusted operating margin1 for the 2006 fourth quarter was 37.7%, which was an increase of 0.9 percentage points compared to the 2005 fourth quarter.
- Net income for the 2006 fourth quarter was €799 million (2005: €619 million), or €0.66 per share (2005: €0.50 per share), representing an increase of 29% compared to the fourth quarter of 2005. Fourth quarter 2006 adjusted net income1 was €822 million (2005: €642 million), or adjusted €0.67 earnings per share¹ (2005: €0.52 per share), representing an increase of 28% compared to the fourth quarter of 2005. Fourth quarter 2006 net income, earnings per share, adjusted net income1 and adjusted earnings per share¹ were positively impacted by approximately €55 million, or €0.045 per share, from a reduced fourth quarter effective tax rate primarily due to various settlements with fiscal authorities in different countries on different items.
HIGHLIGHTS – Full-Year 2006
Software revenues and certain other full year 2006 financial data in this press release differ from the software revenues and certain other financial data originally provided in SAP’s January 11, 2007 press release titled “SAP Announces 2006 Preliminary Results.” The changes are due to the reduction of software revenue by €30 million in the third quarter of 2006 resulting from the modification of contracts from prior years to accommodate one individual customer. The modification occurred in the third quarter of 2006 (for more information, see footnote 2).
- Product revenues increased to €6.6 billion (2005: €6.0 billion) for the year-ended December 31, 2006, representing an increase of 11% (12% at constant currencies1) compared to the full-year 2005.
- Software revenues increased 10% (12% at constant currencies1) to €3.1 billion (2005: €2.8 billion) for the full-year 2006 compared to the same period last year.
- Total revenues were €9.4 billion (2005: €8.5 billion) for the 2006 full-year, which was an increase of 10% (11% at constant currencies1) compared to the same period last year.
Core Enterprise Applications Vendor Share³
2006 represented another year of strong share gains for SAP. Based on software revenues on a rolling four quarter basis, SAP’s worldwide share of Core Enterprise Applications vendors3, which account for approximately $16.4 billion in software revenues as defined by the Company based on industry analyst research, increased to 24.0% for the year ended December 31, 2006. This represented a gain of 2.8 percentage points for the full-year, and SAP continued to maintain more than twice the share of the next largest vendor.
- Operating income for 2006 was €2.6 billion4 (2005: €2.3 billion), which was an increase of 10% compared to the same period last year. Adjusted operating income1 for 2006 was €2.7 billion (2005: €2.4 billion), representing an increase of 12% compared to 2005.
- The operating margin for 2006 was 27.3%, which was down 0.1 percentage points compared to 2005. The adjusted operating margin1 was 28.8% for 2006, which was an increase of 0.5 percentage points compared to 2005.
- Net income for 2006 was €1.9 billion (2005: €1.5 billion), or €1.52 per share (2005: €1.21 per share), representing an increase of 25% compared to 2005. Adjusted net income1 for 2006 was €2.0 billion (2005: €1.6 billion), or adjusted €1.60 per share1 (2005: €1.25 per share), representing an increase of 27% compared to 2005. Full-Year 2006 net income, earnings per share, adjusted net income1 and adjusted earnings per share1 were positively impacted by approximately €85 million, or €0.07 per share, from reduced second and fourth quarter effective tax rates primarily due to various settlements with fiscal authorities in different countries on different items.
“While we did not achieve all of our targets in 2006, we ended with solid growth at constant currencies for both product revenues and software revenues – the fourth quarter alone marked our 12th consecutive quarter of double digit growth in software revenues at constant currencies – and at the same time we improved our profitability,” said Henning Kagermann, CEO of SAP. “Regional performance for the year was also strong – we reported double digit software revenue growth at constant currencies in each region, the first time we have accomplished such a strong, well-balanced, regional performance since the year 2000. On top of this, we continued to gain significant worldwide share among Core Enterprise Applications vendors. Our share increased by 2.8 percentage points to 24.0% for 2006.”
- Operating cash flow for 2006 was €1.8 billion (2005: €1.6 billion). Free cash flow1for 2006 was €1.5 billion (2005: €1.3 billion), which was 16% of total revenues for the year (2005: 16%). At December 31, 2006, the Company had €3.3 billion in cash and cash equivalents and short-term investments (December 31, 2005: €3.8 billion). The year-over-year decrease is primarily the result of an increase in share buybacks in 2006, expenditures on acquisitions and increased dividend payments.
Share Buy-Back Program
- For 2006, the Company bought back 27.9 million shares at an average price of €40.97 (total amount: €1.1 billion). This compares to 12.9 million shares bought back in 2005. At December 31, 2006, treasury stock stood at 49.25 million shares at an average price of €35.37. SAP’s current share buy-back program allows the Company to purchase up to 120 million shares. All share related numbers above have been adjusted to account for the capital share increase that took effect in December 2006 that effectively increased the number of shares outstanding four-fold. Given the Company’s strong free cash flow1 generation, SAP plans to further evaluate opportunities to buy back shares in the future.
“2006 was a cornerstone year for SAP, a year of significant innovation that led to the launch of many new products during the year, including CRM on-Demand, Duet, Analytics, and the first services enabled ERP solution in the industry,” said Mr. Kagermann. “We have already seen rapid adoption of mySAP ERP, with over 4,000 productive customers at year-end 2006. Initial customer feedback has been very positive on our new products.”
Mr. Kagermann continued, “2007 will be the year in which we successfully complete our roadmap by delivering services-enabled versions of the mySAP Business Suite and our established mid-market solution SAP All-in-One . Also in 2007, we will begin delivering on what we believe is the most innovative solution in the industry designed specifically for new segments in the midmarket – a consumption ready solution that provides our customers with fast time-to-value, quick and easy user adoption, high flexibility, low TCO, and is built by design on a fully-enabled enterprise services oriented architecture.”
Beginning in the first quarter of 2007, and also provided for the full-year 2006 for comparative purposes, the Company will realign its income statement to provide additional transparency for reporting potential new product revenue streams. Although currently not material, the Company added a new revenue line item called “subscription and other software related services revenue” as the basis of the realignment, in addition to changing the name of the line item “product revenues” to “software and software related services revenue.” Therefore, “software and software related services revenue” equals the total of “software revenue” plus “support revenue” (formerly called “maintenance revenue”) plus “subscription and other software related services revenue.” Total software and software related services revenue in 2006 were €6,605 million. SAP’s 2007 outlook is based on this realignment. In addition, the operating margin outlook for 2007 is based on U.S. GAAP numbers. In previous years, SAP provided its outlook for operating margin on an adjusted basis.
The Company provided the following outlook for the full-year 2007.
- The Company expects full-year 2007 software and software related services revenue to increase in a range of 12% – 14% at constant currencies1 compared to 2006 growth of 12% at constant currencies¹.
- In order to address additional growth opportunities in new, untapped segments in the midmarket, the Company will invest an additional €300 million – €400 million over eight quarters to build up a new business.
Depending on the exact timing of these accelerated investments, this is equivalent to the Company reinvesting approximately one to two percentage points of margin in 2007 into additional future growth opportunities.
Therefore, the Company expects the full-year 2007 operating margin to be in the range of 26.0% to 27.0% compared to the 2006 operating margin of 27.3%.
- The Company is projecting an effective tax rate of 32.5% – 33.0% for 2007.
1) Non-GAAP Measures
This review of operations discloses certain financial measures, such as adjusted operating income, adjusted operating margin, adjusted operating expenses, adjusted net income, adjusted earnings per share (adjusted EPS), and currency-adjusted year-on-year changes in revenue and operating income, which are not prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) and are therefore considered non-GAAP measures. The non-GAAP measures that SAP reports may not correspond to non-GAAP measures that other companies report. The non-GAAP measures that SAP reports should be considered as an additional measure to, and not as a substitute for or superior measure to, revenue, operating income, operating margin, net income, cash flows, or other measure of financial performance prepared in accordance with U.S. GAAP. The non-GAAP measures included in this report are reconciled to the nearest U.S.GAAP measure.
ADJUSTED OPERATING INCOME, ADJUSTED OPERATING MARGIN, ADJUSTED EXPENSES, ADJUSTED NET INCOME, ADJUSTED EARNINGS PER SHARE (EPS).
SAP believes that it is useful for investors to receive, in addition to financial data determined under U.S. GAAP, information on financial data (both past and future oriented) that are important to SAP’s management in running SAP’s business. SAP has implemented an integrated management approach. The Company manages the performance of the group on a consistent basis for its planning, forecasting, reporting, compensation, and external communications. This approach to manage the performance of the group generally holds both management and employees responsible for financial amounts they can actually influence, and not responsible for certain amounts they cannot directly influence. Management identified two operating cost elements that management and employees cannot influence directly: stock-based compensation and acquisition-related charges. SAP management and its employees cannot directly affect the expense for stock-based compensation because the fair value of SAP’s stock which directly impacts its share-based compensation expense is heavily influenced by factors outside of the control of the Company, including the overall stock market and the share price fluctuations of other companies in the same industry. As a substantial portion of SAP’s stock-based compensation plans are cash settled (i.e. liability-classified) plans, SAP’s stock based compensation expense – if not hedged – fluctuates in response to share price movements. Although acquisition-related charges include recurring items from past acquisitions such as amortization of acquired intangible assets, they also include an unknown component relating to current year acquisitions for which the Company has not yet finalized its purchase price allocation and therefore, cannot accurately assess the impact of the acquisition-related charges. Similarly, the Company’s adjusted net income also excludes any impairment-related charges resulting from other-than-temporary declines in the market value of minority investments, which by their very nature are outside of the Company’s control.
The following expenses are eliminated from adjusted expenses, adjusted operating income, adjusted operating margin, adjusted net income, adjusted EPS, and other adjusted income measures:
- Stock-based compensation, including expenses for stock-based compensation as defined under U.S. GAAP as well as expenses related to the settlement of stock-based compensation plans in the context of mergers and acquisitions.
- Acquisition-related charges, including amortization of identifiable intangible assets acquired in acquisitions of businesses or intellectual property.
- Impairment-related charges include other-than-temporary impairment charges on minority equity investments.
Adjusted expenses and adjusted operating income reconcile to the nearest U.S. GAAP measure as follows:
Adjusted net income and adjusted EPS reconcile to the nearest U.S. GAAP measure as follows:
The adjusted operating income measures disclosed are the same measures that SAP uses in its internal management reporting. Adjusted operating income is one of the criteria, alongside software revenue growth, for performance-related elements of management compensation.
In addition, SAP gives full year and long term guidance based on non-GAAP financial measures. The guidance is provided on adjusted operating performance excluding stock-based compensation expenses and acquisition-related charges to focus on components that reflect the operational performance that management can directly influence and reasonably forecast for the periods covered by the guidance. Furthermore, by providing guidance based on adjusted income measures, SAP avoids frequent changes to its market guidance due to changes in acquisition-related expenses and impairment-related charges (which are non-recurring) and to the cost of stock-based compensation, which fluctuates based on changes in the price of the Company’s shares (which management cannot directly influence). SAP does not provide guidance on U.S. GAAP operating margin and earnings per share measures because those measures include expenses such as stock-based compensation, impairment-related charges, and acquisition-related charges.
SAP believes that the adjusted income measures have limitations, particularly as a result of the elimination of certain cost elements that may be material to SAP. SAP therefore does not evaluate its own past performance without considering both, adjusted income measures and U.S. GAAP income measures. SAP also regularly analyzes the differences between adjusted income measures and the respective most directly comparable U.S. GAAP income measures. SAP cautions the readers of this report to follow a similar approach by considering the adjusted income measures only as an additional measure to, and not as a substitute for or superior measure to, revenue, operating income, operating margin, net income, cash flows, or other measure of financial performance prepared in accordance with U.S. GAAP.
CONSTANT-CURRENCY PERIOD OVER PERIOD CHANGES
SAP believes it is important for investors to have information that provides insight into its sales growth. Revenue amounts determined under U.S. GAAP provide information that is useful in this regard. Period over period changes in such revenue amounts are impacted by both growth in sales volume as well as currency effects. Under its business model SAP does not sell standardized units of products and services. Therefore, SAP cannot provide relevant information on sales volume growth by providing data on the growth in product and service units sold. In order to provide additional information that may be useful to investors in evaluating sales volume growth, SAP presents information about its revenue and income growth adjusted for foreign currency effects. SAP calculates constant-currency period over period changes in revenue and income by translating foreign currencies using the average exchange rates from the previous year instead of the current year.
Constant-currency period over period changes should be considered in addition to, and not as a substitute, or superior to, changes in revenues, expenses, income, or other measures of financial performance prepared in accordance with U.S. GAAP.
SAP believes that data on constant-currency period over period changes have limitations, particularly as the currency effects that are eliminated constitute a significant element of SAP’s revenue and cost and may severely impact SAP’s performance. SAP therefore limits its use of constant-currency period over period changes to the analysis of changes in volume as one element of the full change in a financial measure. SAP does not evaluate its growth and performance without considering both, constant-currency period over period changes and changes in revenues, expenses, income, or other measures of financial performance prepared in accordance with U.S. GAAP. SAP cautions the readers of this report to follow a similar approach by considering constant-currency period over period changes only in addition to, and not as a substitute, or superior to, changes in revenues, expenses, income or other measures of financial performance prepared in accordance with U.S. GAAP.
Constant currency period over period changes reconcile to the respective unadjusted period over period changes as follows:
2) In the process of preparing the consolidated financial statements for the year ended December 31, 2006, SAP re-evaluated and corrected the accounting treatment applied in the third quarter to the following transaction: To accommodate one of its U.S. customers, SAP, in the third quarter 2006, agreed to amend the contracts entered into with this customer in former years. Under the amendment the customer waived certain rights granted under the original contracts and received in lieu certain new rights which can be exercised in the future. The quarterly financial statements originally issued for the third quarter 2006 reflected an accounting treatment for this transaction under which revenue had not been reduced upon granting the new rights but revenue from that customer would have been reduced in the periods in which the customer exercises the new rights. However, this transaction should have been recorded by deferring, as of the date of the contract amendment, software revenue in an amount equal to the value of the new rights and to recognize such deferred revenue when the customer exercises the new rights. In the light of this additional software revenue deferral, certain accruals and the related expenses reported in the financial statements for the third quarter 2006 for third party royalties, variable compensation and income taxes need to be corrected to reflect the lower software revenue reported for the third quarter 2006. The transaction and the corrected accounting therefore has not impacted the value of licenses sold in the US in 2006. Neither has the correction any effect on SAP’s cash flows. It has however the following effects on the income statement for the third quarter 2006 as well as on the preliminary financial data originally provided in SAP’s January 11, 2007 press release titled “SAP Announces 2006 Preliminary Results”:
* based on the share count after the previously announced issuance of new shares
3) Core Enterprise Applications Vendor Share
In previous quarters, worldwide peer group share was provided based on a peer group of Microsoft Corp. (business solutions segment only), Oracle Corp. (business applications only) and Siebel Systems, Inc. The Company believes that after the large amount of consolidation that has occurred among the larger companies in the software industry, the peer group has become too small to provide an adequate metric for the purpose of measuring growth of sales share. Therefore, the Company will now be providing share data based on the vendors of Core Enterprise Applications solutions, which account for approximately $16 billion in software revenues as defined by the Company based on industry analyst research. For 2006, industry analysts project approximately 4% year-on-year growth for core Enterprise Applications vendors. For its quarterly share calculation, SAP assumes that this approximate 4% growth will not be linear throughout the year. Instead, quarterly adjustments are made based on the financial performance of a sub set (approximately 30) of Core Enterprise Application vendors.
4) In the process of preparing the consolidated financial statements for the year ended December 31, 2006, SAP re-evaluated and corrected the classification of the expense resulting from the amortization of the hedge premiums paid for the hedging activities in connection with SAP’s share based compensation program 2006 STAR in the second and third quarter 2006 (this correction was already reflected in the financial data originally provided in SAP’s January 11, 2007 press release titled “SAP Announces 2006 Preliminary Results”): SAP uses derivative financial instruments to hedge the cash flow exposures associated with unrecognized non-vested stock appreciation rights issued to SAP employees under SAP’s STAR program (STAR hedge). Beginning of 2006 SAP adopted SFAS 123R to account for its share based payments and accordingly started to recognize compensation expense related to its STAR programs based on the STARs’ vested portion of the fair value, in contrast to the intrinsic value which was the basis for SAP’s stock based compensation expense under APB 25 applied by SAP before adoption of SFAS 123R. Consequently, SAP ceased to evaluate the effectiveness of STAR hedge based on the intrinsic value of the hedged STARs and started to evaluate such effectiveness based on the STARs’ fair value beginning with the 2006 STAR program. Historically SAP reported in finance income the amortization expense of hedge premiums paid for the derivative financial instruments used for the STAR hedge as the change in time value was considered ineffective. However, such expense should, upon including the total fair value (including time value) in the effectiveness assessment, have been reported as compensation expense in operating income. While the correction has no effect on SAP’s cash flows it has effects on the income statements and balance sheets for the second and third quarter 2006.
Both this correction and the correction described in Footnote 2 have no effect on financial statements for the first quarter of 2006 or for any period before 2006. The financial statements for the second and third quarter 2006 have been restated as outlined below to reflect these two corrections.
Due to the corrected classification of the amortization expense of STAR hedge premiums as compensation expense in operating income, SAP now regards this expense as stock based compensation for the purpose of determining SAP’s adjusted operating income, adjusted operating expenses, adjusted operating margin and adjusted earnings per share (EPS). Accordingly neither adjusted operating income nor adjusted operating expenses and adjusted operating margin are affected by the corrected classification of the amortization expense. In contrast, adjusted EPS is affected by the correction as SAP did formerly, due to the classification in finance income, not regard the amortization expense of hedge premiums as stock based compensation expense.