Software AG with Sustained Earning Power
Third-quarter operational earnings up
Cost-cutting program shows success
Maintenance business remains stable
Demand for software licenses still low
Software AG, based in Darmstadt, Germany, has announced third-quarter 2002 revenue of 114.8 (2001: 141.5) million euros for the period ending September 30, 2002. This is a 19-percent drop over the same quarter in the company's record year of 2001. Revenue was seven percent lower than in second quarter 2002, which can be attributed to the typical relative weakness of any given third quarter. Rigorous cost management enabled the corporation to grow its operational earnings as compared to second quarter 2002 (5.7M euros) to
7.9 million euros. Net earnings totaled 5.6 (2001: 11.6) million euros or 0.21 euros per share.
Customers still reluctant to invest in IT
The recession plaguing all areas of the IT sector persisted in the third quarter of this fiscal year. The decline of third-quarter revenue year on year can be blamed primarily on significantly lower licensing sales, but also on the considerable fluctuations between the euro and the dollar. The weak US dollar alone shrank quarterly revenue by some 4 million euros. Licensing revenue for third quarter totaled 26.2 (2001: 43.3) million euros. The massive deferral of projects, which became apparent in spring 2002, continued to characterize this quarter. This trend, however, does not suggest jeopardized customer relationships.
Stable customer base ensures earning power
An excellent measure of customer loyalty – particularly in difficult economic times – is the maintenance business. Software AG's third-quarter maintenance revenue proved to be extremely stable, generating – as expected – the largest portion of total revenue with 48.4 (2001: 49.9) million euros. Taking into account the exchange rate effects of US dollar and euro, this figure represents a growth of two percent year on year.
Software AG responded to the current pressure in the project services market with an intensified focus on higher margin solutions. Software AG is a single-source provider of all phases of a project, including design, implementation and maintenance. Third-quarter projects worldwide generated 39.8 (2001: 48.0) million euros. A reduced reliance on external subcontractors enabled the corporation to better utilize its own software consultants.
IT investments with fast returns
Customers' investment decisions are heavily influenced by the expectation of direct benefits and short-term returns. As a result, their reduced IT budgets are primarily spent on the optimization of existing systems. Rather small-scale projects promising fast successes are the priority, whereas large investments in cutting-edge technologies continue to be postponed.
Low demand for upgrades
Many customers are reporting little or no growth as a result of the slow economy. This in conjunction with the fact that there is some free, unused IT capacity from past years of booming business are reasons for a low demand for upgrades. Software AG's classical products generated 66 percent of total licensing revenue with 17.3 (2001: 32.1) million euros in the third quarter. The sale of licenses for electronic business software totaled 8.9 (2001: 11.2) million euros. Despite improved sales of Tamino XML Server as compared to the first six months of 2002, a turnaround in this segment was not yet apparent.
Interest in electronic business gradually picking up
Although business with electronic business products is dominated by small-scale projects, customers are gradually starting to show interest in new technologies again. For example, Software AG developed a system for DaimlerChrysler for cross-enterprise management of diagnostic data. The solution stores all types of testing and diagnostic data needed for electronic control devices in Mercedes-Benz automobiles. DaimlerChrysler is one of the first auto manufacturer to employ the XML (eXtensible Markup Language) standard for this purpose. Software AG is confident that this solution may serve as a standard for the entire car industry based on ISO specifications. The two companies signed a marketing agreement as part of the project.
Cost-cutting program achieves desired goal
Software AG took immediate action at the end of the first quarter to improve earnings. Its cost-cutting program called for savings of more than 50 million euros with respect to the expense plan for the current fiscal year. This target was already met by September 30. In third-quarter 2002 operational costs were not only below forecasts, but 16 million euros less than in the same quarter last year. The anticipated reductions in staff were implemented. At the end of September 2002, Software AG employed a total of 3,064 (2001: 3,418) people. Of those, 1,259 (2001: 1,350) work in Germany.
Operational earnings improved again
Software AG reported third-quarter 2002 earnings before tax at 7.9 (2001: 20.8) million euros. There were no extraordinary expenses nor income. This result confirmed that the corporation was consistently able to improve its cost structure and earnings during the course of a challenging fiscal year. Its operational earnings in the first half of 2002 totaled 3.7 million euros.
Net profit for the third quarter was 5.6 (2001: 11.6) million euros or 0.21 euros per share.
Shareholders' equity on the balance sheet was 203.5 million euros on September 30, 2002. The shareholders' equity ratio continued to rise to 46 (2001: 34 percent. Software AG again had no bank debts or other financial liabilities. Cash on the balance sheet increased slightly totaling 67.3 million euros. Operational cash flow was 5.4 million euros in the third quarter.
Year-to-date results
For the nine months ended September 30, 2002, total revenue was down 17 percent to 354.6 (2001: 428.9) million euros from the same period in Software AG's record year of 2001. Taking this year’s weaker US dollar into account, there were no significant changes in the regional distribution of total revenue over last year. America generated one-third of revenue, and Europe 58 percent with 18 percent coming from Germany.
As a result of cost-cutting measures initiated in Q2, Software AG managed to partially compensate for the decline in sales. As of September 30, 2002, the company reported 17.4 (2001: 22.4) million euros in net earnings. The EBITDA (earnings before interest, tax, depreciation and amortization) margin increased to 16 (2001: 15) percent. Earnings per share for the nine-month period were 0.64 (2001: 0.84) euros.
Outlook
This year's market development has been extremely challenging and can be characterized by great reluctance of customers to invest, smaller-scale projects, long decision-making cycles, and by very volatile software licensing revenue. There are no indications that the remainder of the fiscal year will see an improved market climate. As a result, license business remains volatile, which makes it highly difficult to make precise revenue forecasts. It is unclear if – and to what extent – the traditional year-end upturn in revenue will take place in such a difficult year for the IT sector. However, the vast majority of Software AG's income is secured through services projects and maintenance contracts.
Based on the course of business thus far and the company’s effective cost-cutting program, Software AG's management expects to close the fourth quarter with a double-digit operational profit margin (EBITDA) and increased earnings from the first nine months of the year.