SAP cuts investment in ByDesign as net income falls

The quarter is the first to include the results from Business Objects

SAP AG is putting the brakes on the rollout of Business ByDesign, its offering for small businesses, as it reported first-quarter net income down 22% compared to a year earlier. Revenue was up 14%.

The quarter is the first to incorporate the results of Business Objects, which SAP acquired Jan. 21.

The company said it is cutting investment in Business ByDesign, and will miss its target of $1 billion in revenue and 10,000 customers for the product by 2010. It will now take a year to 18 months longer to reach that level, since it works with customers and partners to fine-tune the product, it said.

SAP is in no rush to deploy the product more widely until it is sure it can deliver it profitably, said co-CEO Henning Kagermann in a conference call with journalists and analysts.

"We have to work out how expensive it will be for SAP if we run this product in a hosted environment," he said. "We have to make sure we make enough money with the product."

To do that, SAP will take more time to optimize the end-to-end process of selling, delivering and running Business ByDesign, he said.

"We have too many manual steps in our hosting environment. We have to improve that," Kagermann said.

SAP reported signing up more than 1,570 small and midsize businesses as new customers in the first quarter, excluding those brought by Business Objects, but few of those are using ByDesign. SAP said it expects to engage with fewer than 1,000 Business ByDesign customers in total this year, and will concentrate its sales efforts on just six countries where the most productive early customers are based.

It will delay rolling Business ByDesign out to other countries until next year, and as a result will invest around $158 million less in the product this year than it previously planned, cutting investment to between $116 million and $194 million.

That will help boost SAP's operating margin, which dropped to 14.6% for the first quarter, down from 20.2% a year earlier.

The company reported net income of $377 million for the quarter, on revenue of $3.83 billion, compared to net income of $483 million on revenue of $3.36 billion a year earlier.

Analysts had expected revenue to rise around 40% to $3.96 billion, according to a consensus poll of 13 analysts by Thomson Financial Network.

The results incorporate those of Business Objects from Jan. 21, excluding some ongoing support revenue that Generally Accepted Accounting Principles (GAAP) prevent SAP from recognizing. The results are preliminary, and depend on the as yet undecided final purchase price allocation SAP must make for its acquisition of Business Objects.

Charges associated with that acquisition also dragged down SAP's operating income by $202 million, although those numbers "are simply accounting driven," said Chief Financial Officer Werner Brandt.

The strengthening of the euro against the U.S. dollar also hurt SAP's results, "resulting in a huge negative headwind for SAP, roughly 10 percentage points," said Kagermann.

He preferred to focus analysis on non-GAAP figures, excluding currency effects and acquisition costs. On that basis, SAP's first-quarter revenue rose 22%, and net income rose 7%, the company said.

Looking ahead, SAP expects full-year software and software-related service revenue to increase by between 24% and 27% at constant exchange rates. Around half of that growth will come from SAP's ongoing business, and half from Business Objects, it said.

Analysts see SAP's revenue growing at around 26.5% during the current quarter, but slipping back in the third quarter to around 16% for a full-year average of 26.9%, according to the Thomson poll.

SAP raised its operating margin expectations for the full year, to between 28.5% and 29% at constant exchange rates, compared to 27.3% in 2007. It had previously indicated a range of 27.5% to 28%. The expected improvement will come from the reduction in SAP's investment in Business ByDesign.

The company plans to maximize the return on its investment to date in Business ByDesign by reusing its innovations and technologies in existing products, a move it expects will contribute significantly to revenue in 2010. Nevertheless, the company said it maintains its full confidence in the Business ByDesign and the associated business model.

Business ByDesign was the brainchild of board member Peter Zencke, whom SAP recently revealed will leave the board at the end of the year. Zencke will serve in a consulting role on Business ByDesign.

Zencke's departure was not precipitated by the apparent problems SAP is having with Business ByDesign, said Bill McDermott, a board member and head of SAP's Americas and Asia Pacific Japan regions, in an interview Wednesday: "I wouldn't couple those two things.

"There's tremendous bench strength in the development arm of SAP," he asserted, adding that "[Zencke] certainly has SAP in his veins. He's not going away."

SAP is not concerned that delaying Business ByDesign's full rollout will affect its ability to command market share in the on-demand ERP space, he said. It constitutes a "killer app" and "no other company in the world has the development capacity to put [a comparable product] together in that window of time," he said.

Ray Wang, an analyst with Forrester Research, said via e-mail that SAP's decision to pare down expectations for Business ByDesign "reflects the realization that this is a hard market to scale and sell to."

SAP's earnings news and the Business ByDesign announcement come on the eve of its SAPPHIRE conference, set to begin in Orlando on Sunday.

Copyright © 2008 IDG Communications, Inc.

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