SAP Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 18, 2023

There are 13 speakers on the call.

Operator

Gentlemen, thank you for standing by. Welcome and thank you for joining the SAP Q3 2023 Earnings Conference Call. Throughout today's recorded presentation, all participants will be in a listen only mode. The presentation will be followed by a question and answer session. I would now like to turn the conference over to Anthony Coletta, Chief Investor Relations Officer.

Operator

Please go ahead.

Speaker 1

Good evening, everyone, and thank you for joining us to discuss our Q3 results for 2023. With me on this call are CEO, Christian Klein CFO, Dominik Hazam and Scott Russell will lead customer success. You can find the deck supplementing this call as well as our quarterly statement on our Investor Relations website. During this call, we'll make forward looking statements, which are predictions, Objections are other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties that could cause actual results and outcomes to materially differ.

Speaker 1

Additional information regarding these risks and uncertainties may be found in our filings with the Securities and Exchange Commission, including but not limited to the Risk Factors section of SAP's Annual Report on Form 20F for 2022. Unless otherwise stated, all numbers on this call are non IFRS and growth rates and percentage point changes are non IFRS year over year at constant currencies. The non IFRS financial measures we provide should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with IFRS. Before turning over the call over to Christian, I would like to take a moment to organize a significant milestone for SAP. This quarter marked the 25 year anniversary of its listing on the New York Stock Exchange.

Speaker 1

Reflecting on this journey, SAP began With a primary listing in Frankfurt 35 years ago to now be standing as the number one company under DAX. This dual listing is a testament To an amazing growth story, it signifies our dedication to providing our investors with prime access across 2 major capital markets. As we celebrate this milestone, know that the focus on sustainable growth remains unwavering and that the company is poised to keep innovating and creating shareholder value. And with that, I'd like to turn the call over to Christian.

Speaker 2

Yes. Thank you, Anthony, and thanks, everyone, for joining us for our Q3 earnings call today. First of all, I want to express my shock and sadness at the heartbreaking events that have unfolded over the last few weeks. SAP condemns in the strongest possible terms all acts of terror, and We are deeply concerned by the escalating conflict. We offer our deepest sympathies to all those impacted and are committed to supporting our colleagues, customers and partners during this most difficult time.

Speaker 2

I'm sure I speak for everyone here at SAP when I say that we hope for a swift resolution To this tragic situation. Let me now turn to more positive news and SAP's earnings. Our results clearly reflect the strong foundation we built over the last 3 years for the next phase of SAP's transformation. In Q3, we once again achieved strong cloud growth and Double digit operating profit growth, up 16% for Q3 and 19% for the 1st 9 months. Confirming what we have said all along, 2023 is the year of double digit profit growth And underlining the fact that we have reached the 2nd phase of our transformation, the phase of acceleration.

Speaker 2

The numbers tell the story best. Current cloud backlog is up 25% again, driven by strong order entry across the portfolio and backed by significantly lower churn. Cloud revenue growth is 23%. Within that, SaaS and PaaS is up 26%. The foundation of SAP's success story is the Business Technology Platform, which underpins both our Wise and Quo offerings.

Speaker 2

BTP is also the foundation for SAP's Business AI to ensure high quality data and data privacy standards. Over 22,000 BTP Live customers contribute to almost 50% Cloud revenue growth in our past business. This business has a run rate of well over €2,000,000,000 We achieved the overall cloud growth despite pressure on transactional revenue, which was flat year over year Due to the macroeconomic situation, our total order entry combining on premise and cloud grew at the fastest rate in almost 2 years. Behind the strong numbers are many new and existing customers who turn to us to future proof their businesses. In the Q3, we saw key customer wins like Adobe and Al D Suite across our solution portfolio.

Speaker 2

We also saw a number of important go lives, including BMW Group, Ducati and Scott Sports. This quarter, we have once again seen significant momentum in our wise customer number, reaching Well over 4,300 wise customers. Key customer wins include Puma, Siemens Healthineers and LG With its energy solution and electronics units, there are multiple factors that drive the value of RISE with SAP for our customers. With the migration to the cloud, responsibility for IT operation shifts over to SAP and the hyperscaler. The combination of Cloud ERP and SAP's process expertise is key for business model transformation.

Speaker 2

Let's take LG Energy Solution, for example. They chose SAP to help meet the growing demand for electric vehicle batteries. Process standardization and embedded AI increase the productivity of customers in manufacturing, supply chain, HR and finance. And by always being on the latest release, our customers also gain greater agility through continuous innovation. Finally, we are removing the data silos revised with SAP and built one strong data layer to allow to steer the business 360 with real time data.

Speaker 2

Wise and Gro are also very exciting opportunities for SAP. The two offerings result in net new customers and an installed base maintenance conversion of more than 2x. At the heart of HorizonGrow, we have the Business Technology Platform. It is the B2B platform for customers, partners, hyperscalers And of course, our own developers, because it is the platform for the development of mission critical business applications to extend our core. And this is why it represents such a massive business opportunity also in the years to come.

Speaker 2

More than 80% of our Verizon quote customers use BTP to integrate and extend the cloud ERP portfolio With differentiating capabilities. And we are already seeing strong cross sell potential with customers replacing legacy ERP With public cloud ERP components such as SAP SuccessFactors, Ariba and Concur. That trend continues to grow. S4HANA Cloud customers are 4 times more likely to have 4 or more of our cloud LOB products With the BTP as the integration and extension layer for Cloud ERP. And finally, we are able to deliver innovation to customers much faster, meaning we can focus our R and D spend on innovation and not on maintenance and localization.

Speaker 2

It's a win win for our customers in SAP even under difficult macroeconomic conditions. Last week, we took Weisz to the next level. We have launched a new Premium Plus package for Weisz, including Differentiating AI, sustainability and advanced finance capabilities such as cash flow optimization. It also simplifies how our customers consume AI with a new consumption oriented license model. Furthermore, we have introduced a new conversion program for Wise with SAP.

Speaker 2

This program offers further commercial incentives Likewise, growth with SAP had also a great start with strong adoption among startups and companies new to SAP. After only 3 quarters, more than 440 customers in over 80 countries Have selected Grow with SAP's Cloud ERP to accelerate their business, innovate and grow around the world. Business transformation is much more than the pure technical migration of ERP legacy landscapes to the cloud. It's key to connect end to end processes and the entire data and system landscape to drive true transformation. In 2021, we acquired Signavio, covering the process perspective.

Speaker 2

And in Q3, we announced our intent to acquire LeanIX To cover the overall enterprise architecture perspective, making sure processes, systems and data are yielding the right outcome for every SAP customer. Together, LeanIX, Signavio And SAP Cloud Application Lifecycle Management create a unique business transformation suite. Earlier this year, we also introduced our business AI strategy to the market, bringing together our existing AI capabilities With the new potential of generative AI to transform how businesses run. We have already made a lot of progress over the last Few months, we have consent from thousands of customers to use their anonymized data to develop and train our AI use cases And foundational data model. The launch of our digital CoPilot Schuhl was a huge success, and we are starting to roll it out across our portfolio This fall.

Speaker 2

And just last week, we announced our new Wise Premium Plus commercial offering, as I mentioned already. SAP Business AI is reliable. We are making promising progress on building foundational models to enable generative And predictive capabilities from structured business data. SAP DataSphere combines structured SAP data with data from other sources To produce highly accurate results, which is so essential in the B2B world. And our new co pilot, JUUL, will be able to work Together with many LLM models to ensure we can offer this technology across the globe.

Speaker 2

And as a result, SAP Business AI is also more relevant. Our Co pilot speaks more than CRM. It can manage finance, HR, procurement, sales, marketing, industries and ESG data, providing answers and recommendations To even the most complex questions and automating many activities currently performed manually by millions of SAP end users. Recent announcements by key partners such as Accenture and Deloitte further underscore the central role played by SAP. Let's be clear.

Speaker 2

This is just the beginning. Over time, Business AI will have a revolutionary impact on the entire business landscape, And SAP will be at the center of that. So stay tuned for more exciting announcement at CXLive and TechEd next month. In closing, let me quickly summarize. We have had a strong Q3, and I'm excited by the results.

Speaker 2

First, SAP continues to deliver on our commitments to the market, and we are now well into the second phase of our transformation. 2nd, SAP's unique position at the nexus between business and technology allows us to continue to translate innovations into business outcomes for our customers. Meaning, certainly, despite ongoing macroeconomic headwinds, our cloud momentum remains strong And growth continues to accelerate. All in all, putting us well on track to achieve our 2025 ambition. This is just the beginning of the next phase.

Speaker 2

We will further accelerate innovation, try focusing our portfolio

Speaker 3

Thank you very much, Christian, and good evening, ladies and gentlemen. In light of the current macroeconomic environment, we are pleased with the results of the Q3 across the globe. And now with the added capabilities of LeanIX in June, SAP is even better positioned to develop and deliver unparalleled value to our stakeholders. In Q3, we saw continued momentum of our cloud business With current cloud backlog growing by 25% for the 3rd consecutive quarter. Cloud revenue in the 3rd quarter grew by 23%, maintaining the growth rate we had achieved in Q3 of last year.

Speaker 3

The trend towards larger cloud transactions continued with deals greater than €5,000,000 in volume contributing approximately half of our cloud order entry. Let me walk you through our financial performance. Current cloud backlog was €12,300,000,000 growing by 25%, fueled by the success of RISE with SAP offerings. Our combined SaaS and PaaS portfolio continued to grow by 26%, with SaaS cloud revenue up 23% And past cloud revenue even up 46%. This continued momentum was again fueled by the strong contribution of the business technology platform, which underpins every single SAP application.

Speaker 3

Software licenses revenue saw a decrease of only 14%, demonstrating the resilience, thanks to a few major transactions. Finally, total revenue was up 9%, driven by broad based strength across all predictable revenue streams. Now let's take a brief look at our regional performance. In the Q3, SAP's cloud revenue performance was particularly strong in APJ and EMEA and solid in the Americas region. Brazil, India and the Netherlands had outstanding cloud revenue growth, while Canada, China, France, Germany, Japan and Switzerland Performed particularly strong.

Speaker 3

Now let's move down the income statement. Our cloud gross profit grew by 28%, Driven by the effective leveraging of economies of scale and operational efficiencies, as evidenced by reduced cost ratios across the board. Growth in cloud gross margin, in turn, improved for the 3rd consecutive quarter, expanding roughly 2.9 percentage points to 73.7 In the Q3, non IFRS operating profit increased by 16%, supported by the resilience of our on premise Finally, the operating margin landed at 29.4%, which is a 1.9 percentage point improvement compared to Prior year, IFRS earnings per share in the quarter increased by 45% to €0.0109 The IFRS effective tax rate for Q3 was 27.8% and the non IFRS tax rate was 27 0.1%. Onto our cash generation. Free cash flow for Q3 increased to €865,000,000 driven by SAP's profitability, improvements in working capital and lower payments for CapEx and leasing.

Speaker 3

For the 1st 9 months, free cash flow was €3,400,000,000 an increase by €761,000,000 Now let's move on to our financial outlook. As you've likely seen by now, we are reiterating the outlook We had updated in July. For the detailed outlook, please refer to our quarterly statement published earlier today. Let's now discuss our non financial targets. We can confirm our non financial guidance for 2023 As we are well on track to meet our targets this year, in Q3, SAP once again had net carbon emissions of 0 kilotons.

Speaker 3

We continue to focus on achieving net 0 emissions across our value chain by 2,030. In summary, Q3 proved to be another solid quarter as evidenced by strong revenue and current cloud backlog growth. The structural move to the cloud and the interest of our customers in future proving their businesses remain unabated. Despite the persisting macro headwinds, SAP continues to be mission critical in helping our customers transform their businesses. LeanIX and JUUL are prime examples of our ongoing efforts to innovate around our solutions, giving customers access The full suite of tools to fundamentally change the way they run their businesses.

Speaker 3

In addition to the top line, We continue to balance growth and profitability, allowing us to boost our bottom line. All of this gives us confidence in our ability to

Speaker 1

All right. And I would like to kindly remind you to only ask one question when prompted, please. So operator, please open the line.

Operator

Ladies and gentlemen, at this time, we will begin with a question and answer session. If you are using speaker equipment today, please lift the handset before making your selections. Anyone who has a question may And there it already is. The first question comes from the line of Mark Mertler with Stanford C. Bernstein.

Operator

Go ahead. Your line is open.

Speaker 4

Thank you very much for taking my questions. Congratulations on the strong quarter. In fact, I'd like To ask about that specifically, ERP has generally been thought of as core workloads. That's not really impacted by macro. But we're seeing some of the vendors in the market that there is persistent macro concerns of slowing, slowing to the pipeline, etcetera.

Speaker 4

Can you give us some color on, are you seeing anything in terms of slowing in the pipeline build, time to transition through the pipeline? Is there any difference between Existing customers migrating versus new customers adoption, how should we think about that going forward? Thank you.

Speaker 2

Yes. Thanks a lot, Mark, for the question. I mean, look, 1st of all, from the customer base perspective, I mean, we see strong momentum both in converting our installed base, as you heard, with a very healthy Conversion factor to the cloud. But second, core with SAP has had also an exceptionally strong start, and these are really representing New customers to the SAP family. And with regard to the pipeline, look, I highlighted LG Electronics, for example.

Speaker 2

And this is a very good example on many of the ERP deals we are doing. This company is also going through a massive Transformation. Electric and batteries, they are producing this at mass scale. And this is a different business model to what they did in the past. And so they not only need a new ERP, they need a new way of how they want LG Electronics.

Speaker 2

And that's why they are deciding And approving this business case. And so this is essential to their business. And while, of course, the macroeconomic times are tough out there, We are extremely well aware to our customers' transformation. And on top, you heard the announcement around SAP Business AI. And Of course, we have to deliver that in the cloud.

Speaker 2

And that's, of course, another strong driver for our pipeline in the next quarters. But Scott, over to you to give some more Light on the quarter and the pipeline?

Speaker 5

Yes, sure. Happy to, Christian. So I think you said it well with the example of LGB. If I broaden that out, What we're seeing in the market across all geographies is companies small, medium and large are focusing on their core. What's mission critical?

Speaker 5

How do they get efficiency and then set themselves up to be able to take seize opportunities or Protect against threats in their business. And so that's why the ERP in the cloud is so important. It's not just the move in the cloud, It's the transformation of their business using our ERP Cloud and extended capabilities. And so that's why you see such resilience Because when things are uncertain or you need prudence, you make sure your core operating model of your company Is fit and match fit for the future that you're driving. So LG, but I think about customers like Adobe 3 ms, There's so many others that are going through this journey with us to be able to make sure that they can seize the future proof their business.

Speaker 5

The one other thing that I would highlight and Christian mentioned this in the opening comments is that when we see our customers, which we've had a lot of large Customers come in with RISE with SAP, they're not just looking at the core ERP, they're then looking at the extended capabilities To be able to resolve whether it be in Commerce or in HR or in Procurement or in Supply Chain, so the extended capability Through that integration that we've invested so heavily over the past few years, they're now able to seize upon that opportunity to be able to drive forward, Which means the future is obviously notwithstanding the macroeconomic conditions, we feel like we're well placed.

Speaker 6

Excellent. Thank you.

Speaker 1

Thank you, Ian. We'll take the next question, please.

Operator

The next question is from the line of Toby Och with JPMorgan Casanova Limited. Please go ahead.

Speaker 7

Yes. Hi, and thanks for the question. Perhaps just on the cloud revenue growth side. So the guidance implies Continued acceleration into Q4. I know there's the LipMOS divestiture, which is going to annualize, But I think you exited that in December, so probably not the full benefit there.

Speaker 7

Well, I guess just with that in mind, Dominic, what are the drivers of that implied cloud revenue growth acceleration into Q4? And How confident are you in achieving that? I guess just given the more difficult macro and also I guess the potential for transactional To be a headwind there as well.

Speaker 3

Yes. Maybe a little bit of granularity on some things you already mentioned like the Litmos impact. I mean, for the full year, we think that Littmost will add a good percentage point of basically headwinds. So when you look at the kind of cumulative year to date, It's already kind of pulled down by that. So the real underlying growth rate is already very close to the 24% or so we need to fulfill The low end of the guidance.

Speaker 3

Now on top of that, there is, of course, the discussion about the transactional business, where Q2 has already been difficult. We have been very slightly up, but Marginally, Q3 was actually flattish or even very slightly down. So we have not seen much relief on that front. And that's another thing that's, of course, something we will not see as such a strong headwind from our For quarters to come, but might be more temporary in nature. But when exactly that will happen is, of course, a little bit dependent on the macroeconomic environment.

Speaker 3

Logically, when you are in a soft environment, the first thing you do is cutting travel expenses, cutting contingent workforce. So that business has been very difficult. There are Parts in it which are growing fast, but the kind of decline, for instance, in contingent workforce has resulted in a flattish environment. So that's the acceleration we need. I also want to remind you that even if you jump off the kind of low end of the range For the guidance for this year, which is SEK 14,000,000,000 to our 2025 guidance, we need about 24%.

Speaker 3

So you think you see that we're really on the cloud revenue trajectory, Depolluted for it most depolluted for that kind of temporary headwind where we think that this will be more cyclical around that trend line, very much on track for that trajectory.

Speaker 2

And you also have to consider with regard to 2025, you have to consider that especially the large transactions they foresee a ramp. So when we are looking at the current cloud backlog of 12.04, now over SEK 12,000,000,000 ACV, obviously, there is a ramp included in the contracts, which are also going to Help us now in the years now that Wiese is out there for 3 years. The WAM flow will now going up. And with that, with the adoption, Of course, we will also going to see further cloud revenue acceleration in the years to come.

Speaker 8

That's great. Thank you.

Speaker 1

Thank you, Toby. And we will take the next question, please.

Operator

Next question is from the line of Adam Wood with Morgan Stanley and Co. Please go ahead.

Speaker 6

Hi, Christian. Hi, Dominic. Thanks for taking the question and congratulations I wanted to get back to the AI topic. You've obviously announced the products there, given us some details. I think some of your competitors have come out and said they feel that the AI co pilots and so on really are just kind of table stakes In the back, they don't feel there's room to extract

Speaker 9

a lot more value from customers. Could you talk

Speaker 6

a little bit about what's different in the SAP portfolio? Is it the data that you have access to, the complexity of the processes, the value of the roles that you can automate further that would make you different in terms of being able to extract value

Speaker 2

I mean, thanks a lot, Adam, for the question. And look, I can give you an example on Why SAP is so relevant in the business AI space? With our traditional use cases, which we have over 100, we actually, of course, Developed great individual use cases. So for example, in procurement, AI was helping to source out of 1 of thousands of suppliers, The best supplier based on cost, on quality, in the future also on ESG data. With generative AI, The opportunities and the relevance will significantly increase.

Speaker 2

Chul will be able to answer questions like, Please help me to reduce the carbon footprint in my supply chain by 10% while making sure that my profit is not Getting under pressure. Give me the suppliers. Give me the suppliers where I can still deliver on time, but on the same time also reduce my carbon footprint and Keep my 3rd party cost, the contingent cost actually at the same level. Because we can cross correlate the data, we build this foundational data model in the neural network. And then with DataSphere, we can also enhance that with actually also unstructured data.

Speaker 2

Yesterday, I just also met Satya in Berlin, and I mean, Microsoft is extremely interested on how can we join forces to also further combine our data. And what is also very important In the B2B world, I already mentioned it. I mean, in the B2C and you can ask Chegg CPT for a question for a speech and you get a proposal for a speech. In the B2B world, accuracy and data quality is of utmost importance. So all the work we did on BTP over the last 3 years To integrate but also to harmonize our data model is extremely now paying off in high quality data and is the foundation for SAP Business And last but not least, you can ask Juhl a question, but not every employee in every company should see your group P and L.

Speaker 2

So you need an authorization concept. And so this is also very important that we have the authorization layer for almost every business data in a company. And all of that It's a good example why SEP will be so relevant in that space.

Speaker 6

That's very helpful. Thank you.

Speaker 1

Thank you. Thank you, Adam. We'll take the next question, please.

Operator

The next question is from the line of Mohammad Moorwala with Goldman Sachs International. Please go ahead.

Speaker 10

Great. Thank you and well done on the quarter. I had one question for Dominic, please. Your implied operating profit growth guidance implies a sort of at the low end Yes, significant sort of decline. I'm just trying to understand around some of the cost dynamics, what we should think about in Q4 in particular.

Speaker 10

And I know you alluded to sort of some of the changes in the sales capitalization, but also is there anything on the kind of OpEx Base that we should be mindful of in Q4? Thank you.

Speaker 3

Yes. Excellent question. I mean, it's clear from the numbers that remain to do In Q4, it's kind of relatively manageable, it appears. And now what are the kind of elements Which drive that? First of all, it's on the software side.

Speaker 3

We had a really very mild decline in software in Especially Q1 and Q3. I think Q2 was a little bit closer to normal. And actually, on average, we have been declining More slowly than, for instance, in the prior year. If you think about the prior year, we were down 39% constant currency. And now Q2, which was a more typical quarter, mid '20s, I think, if I recall correctly.

Speaker 3

So we think that Q4 will be probably in that order of magnitude, somewhere between these two data points. It's not quite clear. I mean, it's notoriously difficult to predict that. And I think it's also clear that the Q4 is the biggest Quarter on licenses, so it has a big disproportionate impact. And I think it's also there's some good news in this, which means that we can be commercially quite rigorous On the software side, and we really can aggressively push on the cloud side.

Speaker 3

2nd point I want to highlight is there we have added a net You mentioned that kind of accelerated amortization of commissions that was still based on the software business where we see now The kind of shift to the cloud happening, that was a €65,000,000 ticket. By the way, we will See a similar order of magnitude in Q4. So that's another item I want to mention. And then I think it's very important to really look at the gross margin. It has evolved very strongly In Q3, but I want to say it's always a little bit dangerous to look at any single quarter.

Speaker 3

If you want to have a more stable estimate about how the gross margin is evolving, Take the 1st 9 months, and you see that we have basically expanded gross margin year on year by about 2.5percentor2.4percentagepoints. Now in the 2.4 percentage points, there is, I'd say, almost 1 percentage points of Tailwind from the famous cloud conversion program. So we had cost incurred still in the prior year, which is now gradually out of the equation. So that gives us a boost. So the kind of still underlying continuous improvement without that one strike project, so the cloud convergence project, is more about 1.5%, which by the way, again, It's putting us exactly on the trajectory for the 2025 cloud gross profit guides.

Speaker 3

So if you think about that kind of boost being Fully harvested. If you take these four elements I mentioned together, this is explaining why we have been more prudent on the Q4 year on year growth. I think it's very much in line with what also Luca has guided already a year ago, also driven on the year on year comparison by the Litmos divestiture, which was not there That will not be the end Q4.

Speaker 10

That's great. Thank you so much.

Speaker 1

Thank you, Mor. And We'll now take the next question, please.

Operator

The next question is from the line of Frederic Boulard with Bank of America. Please go ahead.

Speaker 8

Hi, good evening. If I can Ask a question around the cloud margin, so a bit follow-up on the previous one. So we saw some slight improvement in SaaS, but PaaS actually in Structured service improved quite strongly. If you can discuss what has been driving that and some further benefit to expect from the Optimization program, I think the minute you seem to say that we've kind of done the work now, so it's going to be smooth and going forward. And if I may ask a follow-up around S4.

Speaker 8

So could we get a bit of an update on where you are On the momentum in migration of those large complex customers, I mean you mentioned some of those. If you could share a bit of an update on where you are on S4 S4 Cloud Adoption and in particular for those large contracts and large migrations, That would be great. Thank you.

Speaker 2

And on PaaS and the cloud gross margin, let me take that first. And then Scott, you can take the question around the ERP and For momentum on the conversion of our LE customers. Made on pass, I mean, BTP is an extremely scalable platform. It's a native cloud platform and of course, we are continuously working and this is not only since we did the cloud conversion program, we actually also continuously work on TCO. For example, HANA Cloud, so a new cloud database, which gives us enormous scale out capabilities, which is extremely important not only for our TCO, by the way, But also for our large customers who actually can enjoy this new database in the cloud.

Speaker 2

2nd, we're also innovating with AWS on ARM. Yes. So we also embed further new technology. We are constantly also updating the capabilities within the database. And we still have a few ideas also for the year to come, and the platform is now the underlying platform for all of our business application.

Speaker 2

So it's the foundation. So it's really important for us to also have a scalable platform there. Scott, over to you for the ERP question.

Speaker 5

Yes. So I guess the I mentioned it before, but let me give you a bit more color. Customers aren't just moving to ERP Cloud, and I mentioned this, but it's Really important to understand in terms of the future for us, but also for our customers. They're not just going to S4HANA Cloud, They're transforming their business. They're making it lean.

Speaker 5

They're getting a clean core. They're able to optimize the way they run their process. That allows them then to then build and expand and then use that capability including generative AI Optimize, so these are on the large end customers multi year programs, multi year initiatives, Which we see from a financial point of view in our total cloud backlog and that and what you see in the ramp that Christian mentioned in his opening. But then even on their midsized customers doing these big changes to their business is the foundation for them the innovation in the future. So I guess what you will see there with a large end and Dominic also mentioned opening this call that we had a large proportion of customers of 5,000,000 In booking value in ACV, contributing to the overall performance that gives us Form for customers to do a multi year transformation of their business leveraging our innovation and they will weave In generative AI into that as we go forward because it's embedded including our recent announcement Of the premium offering that we launched a couple of days ago.

Speaker 2

And maybe one further example. I mean, Take, for example, Exxon. Exxon also decided to go with Wise for SAP. I mean, for Exxon, it's actually not differentiating to, 1, The ERP landscape further on prem and invest into really commodity IT activities. What is way more differentiating is to say, Let's move our system landscape into the hands of SAP and the hyperscaler and then build with our IT budget more differentiating capabilities For commodity and trade, for the new renewables business, to also build a more resilient supply chain.

Speaker 2

And so the IT budget Creates way more value if you can focus more on build and less on run. And the BTP is now their platform of choice to also extend the core Because all of these capabilities, what I just mentioned, they need to be, of course, seamlessly integrated into the core. And here we go again. This is the BTP. The BTP is The integration and the extension layer.

Speaker 2

The same is true for BMW and for many others LE customers in the meantime As they have selected to go with Wise with SAP.

Speaker 1

Thank you. And we'll take the next question, please.

Operator

The next question comes from the line of Kirk Materneve with Evercore Partners. Please go ahead.

Speaker 11

Yes, thanks very much. Congrats on the quarter and thanks for taking the question. I was wondering maybe this one might be for Scott, but I was just kind of curious what you're seeing in the Americas market. Obviously, Really strong quarters and acceleration in Europe and Asia Pac on a constant currency basis. America was down slightly Q over Q, but I was just kind of curious is that just Market dynamics, macro, is there anything sort of more competitive there going on?

Speaker 11

I was just kind of curious if you could add a little bit more color on what's going on in that particular region. Thanks.

Speaker 5

Yes, no problem. I'll answer this and Christian if you want to add anything please do so. So look as you saw in the performance, we had a very balanced Across the world, there is no doubt that the Americas and North America is our largest cloud market and also where A lot of the innovation that we're seeing around the world and it is definitely a market that has the macroeconomic pressure, but I wouldn't reflect it as unique against other economies around the world. We see the same macroeconomic pressure Points. I think what we are seeing in North America though is the combination of Grow and Rise that those 2 Really important, the mid market in North America looking where the smaller companies that are wanting to expand, but they need to do so really fast.

Speaker 5

They're not going to invest heavily into the technology migration, they need to be able to do so in a rapid way. And so the Gro offering has been really successful, in markets like North America. And at the upper end, We always recognize that even in the best of times, but right now they're taking multi year major investment journeys with us. So the way the market's working there is the question is not if they move to rise, it's how and when And that program and that's where we see those large bookings. So look it continues to be a market where Highly competitive and high expectations, but we remain strong in that the foundation of what we deliver to Around the world is equally is true in North America.

Speaker 5

Christian, if you want to add?

Speaker 2

Well said, Scott. I mean, maybe just one point more. I mean, The transactional business of Concur, Fieldglass and Ariba is, of course, also the dominant shares in the United States as These companies also were founded there and have most of their customer base there. And so and as Dominik also outlined, to be seen how this Business develops in Q4, but it was just last week in SAP Spend Connect. And when I remembered back in 3 years ago, these products were completely different products on different legacy stacks on different platforms.

Speaker 2

And when you see now our intelligent spend portfolio and you look at Source To Pay, you wouldn't even see which product is it. It's all about the end to end business It's a beautiful UX. The team did a wonderful job. And of course, there is now some macroeconomic headwind to be seen how this will develop In Q4, on a for next year and for the years to come, I feel much better from a product experience perspective than where we have been

Speaker 1

Thanks, Kirk. And we'll take the next question, please.

Operator

The next question comes from the line of James Goodman with Barclays Capital, please go ahead.

Speaker 6

Good evening. Thanks for taking mine. And I wanted to ask you just on the implied Guidance also, but around the revenues ex cloud, I think a bit like EBIT, it looks pretty conservative throughout the range. I mean, even taking into account The comments that you've made around the anticipated Q4 license trajectory. So Maintenance has been down, I think, 1% only 3 quarters in a row.

Speaker 6

Why should we see that suddenly sort of decelerating in Q4? And Maybe you can extend the answer to some commentary around maintenance for next year. I think we've now seen that you can raise prices up to 5% next year. So Should that offer sufficient support to maintenance to keep a sort of similar trajectory? Thank you.

Speaker 3

Yes. I think the key point is not really the maintenance, but as you say, the licenses where there's more volatility. And yes, we have been prudent on that front. Q4 is by far the biggest quarter in that context.

Speaker 12

I think

Speaker 3

it's not wise to extrapolate Q1, Q3 into Q4. I think it also gives us an opportunity To send a clear signal that there's commercial discipline on these license deals because our strategic trajectory is towards the cloud. And this is why I think this assumption makes sense now. Again, it's notoriously difficult to predict. So there can be a wide range of outcomes around that kind of Range, I have alluded to.

Speaker 3

And this is why we kept the range quite open on that front.

Speaker 2

Yes. And on cloud revenue, I mean, Let's also remember, I mean, we have put out there a 2025 guidance 3 years ago, and we weren't aware around What exactly will happen during COVID? We, of course, have not seen the exit of Russia. Now we are talking about the high inflation environment and some macroeconomic challenges. And still, we keep our 2025 guidance.

Speaker 2

And so I'm actually very happy with the underlying strength of our portfolio. But again, also to be seen how Q4 will now develop from a transactional revenue Standpoint. And but I find it remarkable the underlying strength of the portfolio despite all of These headwinds, what we have seen over the last years, I have to say. I mean, Russia, there will not be a comeback, and still we are maintaining our guidance for 2025.

Speaker 9

Thank you.

Speaker 1

Thank you, James. Next question, please.

Operator

The next question is from the line of Michael J. Briest with UBS Limited. Please go ahead.

Speaker 12

Yes. Good evening and my congratulations as well for the momentum. Maybe a little teaser on next year. I mean, your revenue outlook is driven by the cloud. It's pretty predictable and hopefully and fairly linear.

Speaker 12

The maintenance, You've given clear sort of indications on 2025. Is there any reason we shouldn't think that profits and cash flow grow in a fairly Linear progression between here and 2025. Is there any factors we should be thinking about that mean that that's unlikely to be the case? And then around stock based compensation, I noticed that the charge increased a little bit at low end. And I know you're thinking internally about How you treat that going forward?

Speaker 12

Is there any more light you can shed on whether that's still a charge that should be treated as an exceptional item in your view? Or maybe it's now a more predictable number and something that you can bring into the adjusted margin? Thank you.

Speaker 3

So maybe I will stab at 2024. First, as a reminder, we guide 2024 and January of 2024. So We have an ambition for 2025. And if you think about what are the priorities in the current planning process, which will then, of course, drive the budget for 2024, I'd say it's, Of course, derisking 2025 to make sure that it's really solid and deliver to that ambition. And secondly, I think we will also start To put more focus on the question, how can we kind of boost earnings growth beyond 2025?

Speaker 3

It's all nice to think about 2025, but The future is actually in the second half of the decade. And please bear with us till that kind of date in January when we have matured that planning process to really give you Then a solid guidance for the year. I don't want to kind of preempt that at this point of the year.

Speaker 2

Yes. And then to add to Dominik's point, I mean, Q4 is also in the cloud, Our biggest quarter from an order entry perspective, and that really can also create really still some swing on the cloud revenue one way for next year. And so, yes, more news to come in January.

Speaker 3

So now on the second point, I have noted charge. So That was sorry, can you just help me out on that?

Speaker 12

The stock based, sorry, stock based compensation.

Speaker 3

Yes, The stock based compensation, I mean, yes, given that we have a higher share of Equity settled stock based compensation, the volatility induced by the share price movements in that expense will go down. That's the one thing I can say. The other thing we clearly said is that we really want to kind of keep that number steady to dilute it somewhat as Percent of revenues over the coming years, and there's no change to that guidance that we really try to make it more stable. And then as Consequence, indeed, it would be easier to absorb it kind of in the non IFRS operating results. We are clearly seeing the stock based compensation Not as funny money, but a real expense.

Speaker 3

It's real value transferred from shareholders to employees basically. And that's why anything to embark it in all our steering is really a of the company. But again, in terms of 2024, we will let you know how we deal with this in more detail in January.

Speaker 12

Okay. Thank you.

Speaker 1

Thank you, Michael. Next question please.

Operator

The next question is from the line of Chandra Moli Suraman with Stifel Nicolaus Europe Limited. Please go ahead.

Speaker 10

Yes, thanks for taking my question and Congrats from my side as well. Just one on the amortization period change. I'm just wondering From a business sense, what it means for the end of support of R3 And how does this fit in with the license strength that you have seen in 2023? Thanks.

Speaker 3

I have a similar answer to that again. Okay. So it's an accounting policy which is applied steadily, and it's driven actually by forward looking assumptions as to the kind of lifetime Of the support revenues, now you should understand it's not a very linear calculation. So there are some factors that can make it somewhat volatile. And when we did the kind of, I'd say, first sneak preview of our planning here, we felt it's not prudent to keep the long 9 year period.

Speaker 3

By the way, there are some assumptions about renewals in there in Bakkt. So I wouldn't read too much into it except for that we felt that at this point in time On that commission, given that we want to clearly push from on prem into the cloud And that we see the bigger uptick in RISE. There is probably a shorter amortization period required, and this is what we've reflected. Also want to highlight, if you may ask, that this will not have a material impact on 2025 because by then, we will also benefit of having kind of taken Less capitalization and it kind of then should be breakeven, so to speak. So no worries on that front.

Speaker 3

I think for 2025, it does weigh, as I mentioned already, on Q3 and will weigh also on Q4.

Speaker 2

And with regard to the software momentum, look, the end of maintenance is coming for us, we, for our ECC And also for the older releases of S4HANA on prem, nevertheless, there is a maintenance commitment out there until 2,040 For our mainstream S4HANA customers, and this will stay, but we will definitely not move further the end of maintenance for the other releases as we have to, of course, also Focus on the innovation in the cloud and deliver this to our customers in an agile way. And when you look at the software number, of course, it can fluctuate quarter by quarter. It's a onetime license revenue. But you can also see the deals we are doing, probably Majority comes out of the regulated industries where customers are also still growing and they need more licenses, and this is the type of business Which we are still closing. Scott, did I say it right?

Speaker 5

Yes, you did, Christian. And it's actually a really important point. You're not seeing a decline on the cloud and their rise performance despite the software and that is a good sign. That's partly because of The segments that are there and you mentioned that on the regulated industries and also companies that are topping up their License where they're growing or expanding. So, the outlook doesn't have a bearing or a waiting On the Cloud side, other than to Dominic's point that we continue to drive and build the future on a Cloud as a part of our Strategic priority and our customers will continue to do that at scale whilst managing their software estate in the short term.

Operator

The next question is from the line of Johannes Schaller with Deutsche Bank. Please go ahead.

Speaker 9

Yes. Thanks. Good evening. Thanks for taking my question. Christian, thank you for providing a bit of detail on the AI side from a technical and functionality perspective.

Speaker 9

I wanted to ask a bit on pricing. I mean, you said on the last call, you talked about a 30% pricing uplift potentially with AI features or maybe The 30% higher revenue opportunity. Now 3 months later, can you talk a little bit about this feedback you're getting on this pricing strategy from your Customers. And also just in terms of how we should think about these AI revenues coming in, I take that the R and D is Pretty much in the run rate, but what we see in the field with some other AI offerings is maybe an initial phase of some customization, Some training with proprietary data of your customers, some costs that are coming in initially. How should we envisage the initial AI revenues.

Speaker 9

Will they be fairly profitable right away? Or will there also maybe some additional costs upfront? Thank you.

Speaker 2

Yes. Let me take it step by step. I mean, on the product engineering side, we are not doing only now earnings late night. We are So doing some engineering sessions late night, and I just looked last week at the overall architecture and the way how we actually why we are so confident also With regard to the consumption and the cost of running the architecture of Business AI is we are building the foundational data model. So for us, it's Key that we really infuse now all of our data in this neural network and that we have a knowledge graph, which then can find the right data depending on the kind of analytical Question or task activity, what the end user has.

Speaker 2

On the LLM side, so the large language model, we actually partner. We partner with a lot of players to also offer Jul, around the globe. And then with regard to the cost, of course, these modules are extremely hardware intensive. But what we are going to do is We use our existing MACH commitments with the hyperscalers, so we consume it out of that. And given now with Wise, we are the biggest operations partner for Customers, also the LE customer.

Speaker 2

So we are running billions of workloads. So of course, that also benefits us so that we now don't need to invest in a On the commercial model, look, We launched now in the meantime the Wise premium offering. And yes, the premium offering, premium price, but of Customer first. So we really looked at the value. So you find sustainability capabilities in there, advanced finance capabilities, cash flow optimization.

Speaker 2

We have the first customers We actually can improve the cash flow by 2% or 3% by better payment terms, etcetera, etcetera. And on top, we have AI. So it's a real premium package with real value, and we see actually positive customer feedback for those ones who actually are Our first customers. And then second, let's not forget, we're also offering AI embedded in our products on with a consumption based Pricing. So you don't have to go for the premium package all at once, but you can also consume AI, business AI as part of our solution in the pure consumption based Pricing model, so we give customers choice, which I feel is the right way to go.

Speaker 1

Well, thank you. Thanks, Rannis. And we'll take one final question now. Thank you.

Operator

The final question comes from the line of Castillo Benard Ben with BNP Paribas. Please go ahead.

Speaker 12

Good evening. Thanks very much for squeezing me in here. And just one question on the free cash flow, I guess, and the full year guidance. It looks like you're running Comfortably on track there. It's up close to 30% year to date.

Speaker 12

It would imply that Q4 free cash flow would be down year over year. I know we've talked about a couple of one offs, but Dominic, is there anything specific you could call out there just to justify that? And I know related to that, the topic of perhaps unwinding some of the extra factoring that was done last year had come up in conversations previously. Is that still on the agenda currently? Thanks very much.

Speaker 3

Yes. I mean, cash flow is, of course, because of the sometimes volatility in some payments from customers,

Speaker 8

A

Speaker 3

KPI, which is really difficult to predict at the end, but You mentioned some of the components already. What certainly is on the agenda to make sure that come 2025, there is a clean underlying free cash flow. We always said the €7,500,000,000 at that point in time should be clean. We are tracking well. There are, however, some phasing topics, so We have not updated the guidance for good reasons.

Speaker 3

And now how exactly that will pan out after we have seen all the receipts of payments at the end? We will tell you, of course, in the end, but I'm not expecting any wild surprises on that front. So we are on a very good trajectory, As you have said yourself on the free cash flow side.

Speaker 12

Got it. Thank you.

Speaker 1

And with that, we will conclude the call. So thank you. This concludes our call for today. Thanks for joining.

Speaker 2

Thanks a lot.

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Earnings Conference Call
SAP Q3 2023
00:00 / 00:00