SAP SE (SAP) Q2 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the SAP 2013 Second Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Mr. Stefan Gruber. Please go ahead, sir.

Thank you very much. Good morning or good afternoon. This is Stefan Gruber, SAP Investor Relations. Thank you for joining us to discuss SAP's results for the second quarter 2013. I'm joined by co-CEOs, Bill McDermott and Jim Hagemann Snabe; and our CFO, Werner Brandt. Bill and Jim will begin the call with remarks on this quarter's performance, and then Werner will review the financial highlights. Then, we have time for Q&A. Before they get started, I want to say a few words about forward-looking statements. Any statement made during this call that are not historical facts are forward-looking statements as defined in the U.S. Private Securities Litigation Reform Act of 1995. Words such as anticipate, believe, estimate, expect, forecast, intend, may, plan, project, predict, should, outlook and will and similar expressions as they relate to SAP are intended to identify such forward-looking statements. SAP undertakes no obligation to publicly update or revise any forward-looking statements. All forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from expectations. The factors that could affect SAP's future financial results are discussed more fully in SAP's filings with the U.S. Securities and Exchange Commission, the SEC, including SAP's annual report on Form 20F for 2012, filed with the SEC on March 22, 2013. Participants of this call are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. Please keep in mind that unless otherwise noted, all numbers referred to on this conference call are non-IFRS and growth rates are non-IFRS on a constant-currency basis. Regional software and cloud subscription numbers represent the combination of software revenue based on location of negotiation and cloud subscription support for revenue based on customer locations. And with that, I would like to turn the call over to Bill McDermott.

Thank you, Stefan, and thanks, everyone, for joining us on the call today. The world is clearly being transformed by the rapid adoption of cloud and in-memory technologies, and we have reached an inflection point in the business of technology. More than technology, this is a business inflection point where companies are shifting their investments to the cloud and radically simplifying their IT landscape on in-memory technology. In 2010, as you know, SAP embarked on a strategy of innovation in cloud, in-memory and mobile, all on a stable and consistent core of applications and analytics. With this strategy, we doubled our addressable market to USD 220 billion marketplace, and we placed our bet on software as the innovation layer in the IT stack instead of consolidating the stack with hardware. This is proving to be the winning strategy. We have consistently outperformed our primary competition over the last 18 months, and we're driving the innovation agenda across the software industry. In the second quarter, we continued our double-digit growth momentum in a challenging market environment and against tough year-on-year comparisons. SAP had another solid quarter, with 10% growth in software and software-related services revenue to EUR 3.35 billion at constant currencies. That's 3 straight years of double-digit SSRS growth. Software and cloud subscription revenue in Q2 reached EUR 1.17 billion, representing 7% growth. And total revenue was over EUR 4 billion, the first time total revenue exceeded EUR 4 billion in a second quarter. About the cloud, our growth in the second quarter is driven by our cloud innovations. Cloud is the top strategic priority for SAP, and we are seeing the IT industry is moving to the cloud. This quarter marked a significant milestone for SAP in our ambition to lead in the cloud. On a sequential quarterly growth…

Thank you very much, Bill. In 2010, we started a remarkable journey to transform the industry based on innovations in in-memory, in cloud and on the mobile. We anticipated then that data would move off disk into main memory, that data centers would move off premise into a secure cloud and that users would be on the move with mobile devices. Today, we lead in all these innovation areas and give our customers not just a competitive edge, but a strategic advantage, and we are driving the transition of our industry. As a result, we are consistently outperforming the market also this quarter and winning against the competition, both traditional and now also, in the cloud. Why are we winning in such a challenging market? Well, if you look at where we are today, we are the only company in our industry to have our entire portfolio now in the cloud and running on next-generation in-memory database technology. Our solutions are designed mobile first with a beautiful user experience, and we offer choice to customers and continue to innovate faster than competition. As Bill mentioned, unlike our competition, we do not outsource innovation. We disrupted the traditional software architecture by developing our own breakthrough in-memory technology. We complemented this with the right strategic acquisitions to lead in the cloud and to drive enterprise mobility. And without the burden of heavyweight hardware assets, we are radically simplifying the IT stack of our customers. We focus on software, which is the innovation and growth layer rather than hardware or services. That's why we are more relevant to our customers today than ever before, and that's why we grow faster than anyone else. The transformation of the industry happens at a different pace, depending on the region. The move to the cloud in…

Thank you, Jim. Both Bill and Jim gave you an overview of the solid second quarter. As mentioned, we achieved 3 years of double-digit SSRS growth. I would like to give you more insight on our Q2 results. Before I -- but before I do that, let me talk a little bit about the currency effect in the second quarter. To the top line, our software revenue was negatively impacted by 4 percentage points. Non-IFRS SSRS revenue was negatively impacted by 3 percentage points, and our non-IFRS total revenue was negatively impacted by 4 percentage points. To the bottom line, our non-IFRS operating profit was negatively impacted by 6 percentage points, which resulted in an 80 basis point negative impact on our non-IFRS operating margin. Now to Q2. You already heard about our single-digit growth performance on the software and cloud subscription revenue side, which was mainly due to the slowdown in our on-premise software revenue, which was caused by the shift to the cloud and the challenging macro environment in Asia Pacific. Let me talk about recurring revenue. Non-IFRS support revenue increased in constant currencies by strong 11% year-over-year, in line with our expectations. Once again, we saw strong adoption of the Enterprise Support offering at 98%. Non-IFRS cloud subscription and support revenue increased to EUR 183 million in the second quarter, up 171% year-over-year at constant currency. We continue to see an increasing sales synergies between SAP SuccessFactors and Ariba. Non-IFRS deferred cloud subscription support revenue was EUR 361 million at the end of Q2, which is an increase of 68% year-over-year. Before I talk about gross margin, I want to make a few comments on our cloud division profitability. With a EUR 23 million segment profit in the second quarter compared to minus EUR 19 million in…

Yes, thank you very much. We'll now start the Q&A session. I hand it back to the operator.

[Operator Instructions] The first question is from Richard Sherlund of SAP (sic) [Nomura].

The first question is on Oracle, and they're alluding now to an in-memory product coming out, 12.1c, at the end of the year. And we've seen both IBM and Microsoft announce hybrid products that ship next year as well. I'm just kind of curious if we can -- if you can give us a bit of a tutorial on in-memory HANA versus the traditional products that seem to be adopting more in-memory capabilities, how that might affect the market. And second, on this transition to the cloud, again, I'm sure we're all concerned about the impact on on-premise, but at the same time, we're excited about the move to the cloud. And is there something special about SAP's book of business because you can integrate with the system of record that your cloud business should grow a lot faster than everybody else's business, in other words, you could actually cannibalize your on-premise business? I hate to say cross-selling, but is that a fertile market? And while we're going to feel badly that business is going away faster, but could the cloud business grow a lot faster than maybe we're thinking because of the facilitation that's enabled with your existing customer base and integration with your existing systems?

Thanks, Rick. Jim here. I'll try and give you the download on the in-memory. See, it's a very interesting development. Three years ago, we argued the world must move to an in-memory-based database, and the competitive reaction was a hint that we must be visiting pharmacies and be on drugs. Now, they're all announcing it. And I'd like to make 2 points on what really describes HANA because calling it in-memory is probably too simple. It is the fact that we have an architecture where all data you use for business is in-memory all the time and not a hybrid model, where you swap data between other media and memory. This is important because then you get a massive simplicity as a consequence, and the TCO goes down, not up. And secondly, we always argued that maybe the real beauty of HANA is the column store idea. That is important because that is a technology that takes full advantage of parallel processing, and with that, we have the opportunity of constantly increase the speed of HANA with the technology updates in hardware without any overhead on parallels [ph]. This is key, and that describes HANA. Now we have seen competitors come out with arguments. Now I was asked a couple of years ago, "How far ahead do you think you are on in-memory-based technology column store?" And I said at that time, "I think we're at least 2 years ahead." With the recent announcements, we now know that we are at least 4 years ahead, so that's good. And I think that we can extend that lead because the moment -- in the moment, we are adding -- we're moving all our stuff to run on HANA, which means the value of HANA goes up every single quarter. So that's basically where we are. We know this technology now since 3 years. We have mission-critical systems running on it. And let's see where competition goes. We would never announce a future functionality in the next -- after next release because it would completely invalidate the current and the next release, so I wonder why they did that. But that's another personal remark. When it comes to the cloud, I think you are seeing a very beautiful combination of the cloud extending the core, which is why we don't see a lot of cannibalization happening. And yes, we could, of course, accelerate that, if we wanted to, because the HANA enterprise cloud is now offered as a bring your own license model, and we could change that if we wanted to. You can maybe guide us on how fast that transition is healthy [ph], but we certainly love the business model of the cloud.

[Audio Gap] is the new frontier, the leadership architecture and the Business Suite is the most integrated business suite [Audio Gap] and integrating also with the line of business solutions. I met with a CEO of very large bank yesterday. He told me, he said, "My goal is to whittle down the number of vendors I do business with. I have no interest in complexity with lots of different vendors. I want to standardize on the few that matter, and SAP is at the top of the list." And I think our move to be the cloud company, led by HANA, is the right move for the company, and we're going to accelerate that.

Next question is from Brad Zelnick from Macquarie.

So I appreciate SAP's cloud offerings, extend the core and you're driving lifetime value for customers. And it seems, in Q2, more customers than you expected chose cloud solutions over perpetual-license solutions. What's your expectation on how that take rate progresses? And what's embedded in your guidance as it relates to that choice?

So maybe I can just give a color. I did go through the regional setup, and you see a very different regional characteristic on the move to the cloud. U.S., 25% of the revenue in software and cloud is now cloud. The move there is very rapid. It is also growing fast in Europe, but not at the same pace. And I think Asia will remain an on-premise mainly market for a while, but we'll be the first to bring the cloud there. So as you look at that, you understand that when we don't have so strong software revenue, it's partly because of this, but mainly because the biggest on-premise market with growth is Asia and the performance in Asia [Audio Gap] it was below expectations due to the macroeconomic environment. If you look at Germany with its high-single digit growth, and this also comes from growth in the core, that the customers in the suite are typically much fewer users, and therefore, we always predicted that, that market will be there in the future. But the big market is line of business, and that's why we went for the strategic acquisitions.

And if you look to the SAP cloud revenue, we've had to review [ph] -- from a half-year perspective, we also have double-digit growth rates, but they're lower than those we see for the SuccessFactors and Ariba cloud subscription revenues.

Okay. One other quick question. Should we expect going forward to see this accelerated move to the cloud and continuing some level of weakness on the core?

I would just say that, Mark [ph], that the reality is we are innovating and pushing the cloud message as fast and as hard as we can. In the future, I think you're going to see a HANA enterprise cloud business that becomes a major part of the story, but that'll be back-end loaded since we just announced it at SAPPHIRE. And you'll see the line of business continue to grow. And we want to innovate and take the customer where the customer wants to go. And if the customer can put it in the cloud and it's more efficient and it's better for their employees and their customers and their shareholders, then that's what they're going to do. I do think you should note the core will be in the cloud. So if you take our core Business Suite on HANA and the HANA enterprise cloud, the core will be there. And there will be the necessary financial models to recognize that revenue. So it didn't go away. It's going to go to a different place, and we will have the necessary models on the OpEx and the CapEx side to give the senior decision-maker in businesses what they need from SAP.

And I would put one argument on top. I think I would never talk about weakness in the core. Remember, we have regions where the core is very important, and Jim referred to this. In Asia Pacific, it's the core which is important for our customers across the board. It's the same in Latin America. So you have parts in the world, emerging markets, where the core is absolutely the driver for growth. And on top -- we have some industries where the core is the driver of growth, think of retail, think of financial services and so on. So from that end, I would not support this comment you made earlier in your question.

And also, Werner, you're absolutely right. Think about the move we made with hybris and e-commerce platform with the next-generation omni-channel CRM. There is not a CEO in the world that in their boardroom are not talking about the business to business, to consumer problem that has to be solved. If they can know their consumer better than their competitor, they win the game. And that's going to happen on SAP's core CRM end-to-end platform, and incidentally, that can also be provisioned in the cloud.

Yes, and it's running on HANA at the end of the day [ph], and that's a big advantage for all of our customers.

The next question is from Ross MacMillan of Jefferies. Ross MacMillan - Jefferies & Company, Inc., Research Division: I wonder if maybe you could -- Bill, you alluded to HANA and the notion that you're going to see proof of concepts convert to, I think, production and more revenue from existing customers as we move through the back end of the year. I was just curious as to whether this was -- your sort of conviction on the HANA number is based on go-lives at existing customers that are expanding or whether it's really more tied to more customers adopting Business Suite on HANA.

Yes, it's a mixture, Ross. So right now, the HANA pipeline -- so the first measurements that we use at SAP, because we actually run the company on our own software, is the pipeline. And the pipeline is bigger for HANA as an absolute number and as a multiple than in the history of the HANA story, which is really encouraging. There are several proof of concepts with great use cases out there in customer establishments right now that are mind boggling in terms of the value that HANA delivers to the customer. And then, there's also this HANA enterprise cloud, where we take the suite on HANA and we run it in the HANA enterprise cloud. We think that is a major kicker for our business going forward. Because we just announced it at SAPPHIRE, we think that'll be a back-end loaded part of our story to this year. So that's it in a nutshell, and it's a combination of a lot of good things. Keep in mind, with regard to HANA, it's an amazing number. Right now, we have like 2,500 HANA customers when you count the smallest ones, as well as the HANA customers themselves. So we have developers and small accounts out there in the Amazon cloud pooling [ph] at HANA, as well as 1,800 significant customers. And incidentally, in all of those 1,800 significant customers, HANA is the hand that keeps on giving because as they expand the use cases of HANA, so, too, do our revenues and our profits expand with the customer value.

Maybe I can add just one comment to understand the dynamics here. The first phase of HANA we went for value which means big transactions, where companies really wanted the power of HANA to change their business. With the onetime license opportunity to run the Suite on HANA, we have a much, much lower price point, where companies can see the value of HANA in a very simple way and then they can expand. We've seen an enormous uptick in terms of volume, so many customers who bought the smaller license, the onetime license, and I think this gives us a pipeline for the full license of HANA later on.

Next question is from Stacy Pollard of JPMorgan. Stacy Pollard - JP Morgan Chase & Co, Research Division: Just 2, really, on HANA. First of all, Oracle says they don't see you in the market. Can you explain why that would be? And then, excluding HANA, can you discuss growth rates in the on-premise business? How much is Business Intelligence? How much is ERP, et cetera, just a broad idea? And then kind of second question, how exactly do you incentivize your sales force to sell cloud product versus on-premise? Presumably, the commission is different. Or just how does that work?

Yes, maybe I could just take a start at it. Why Oracle might not see us in the marketplace, they may be spending too much time in internal meetings because we're out there. And I can tell you that their customers know we're there and our customers certainly know we're there. In fact, one of the really well-known companies in our industry has a CEO that said something to me day before yesterday I felt was quite striking. He said that HANA, without question, will be the de facto standard platform for in-memory computing and business analytics in the world. So I think most people know we're around. And as it relates to the various growth rates and so on, I'll let Werner comment on that and Jim.

Yes. Let me make one comment here because we also, of course, heard that there's a comment made in the conference call from Oracle and I quote here, "Some of SAP's largest customers, giant German industrial companies bought Exadata not HANA, like Siemens." And I talked to Siemens personally, and this statement is simply incorrect. I talked to my counterpart at Siemens, Joe Kaeser, and he gave me the permission to say that Siemens has invested significantly in SAP HANA and is using our database. And he stated that there obviously was an error on Oracle's side that Siemens does not use HANA. And if you want to talk to Siemens, call their communications department because he wanted to give this also back to them so that they can answer any question which might still be open -- left open.

And on sales force, one of the things that we wanted to do is equalize sales compensation between cloud and the on-premise business because we never want the customer to get caught in the middle of what's right with a sales professional not giving them every option that they could possibly hope for from SAP. So they get paid the same on cloud as they do the on-premise, perpetual, and we completely equalize that in the company.

So the core without HANA, so you saw the HANA growth was 21% this quarter. We have focused on the volume, and so we have a large, strong pipeline for the value for the rest of the year and beyond. That's why we are very firm on our guidance. And if you look at the applications and the analytics split, you'll see a growth in analytics. So that means that there is a reduction in applications and very much due to the situation in Asia Pacific. Again, if you're looking at Germany, we actually had growth in the core in Germany, so it's possible. And we believe it will come back. Stacy Pollard - JP Morgan Chase & Co, Research Division: Just a quick -- sorry, is it possible to just -- because you mentioned Asia, that Asian weakness that you've been talking about, does the pipeline suggest that it will continue into H2, the weakness will continue into H2?

I had an opportunity personally to review the Asia business with every leader across the Asia Pacific/Japan region this week. It is clear that the pipeline continues to grow in Asia, and the pent-up demand is evident in the metrics. How quickly that flows through remains to be seen now in the execution. But the health of the business and the inspiration of the management team couldn't possibly be better.

And if you look to it from a macroeconomic perspective, I think we all know that some of the trading partners in Southeast Asia, off China, including Japan, are suffering from the situation in China. And if you look, for example, to Australia, they are faced with the lowest GDP growth over the last 10 years. So from my perspective, we will not see a change for -- during the rest of the year. But going into 2014, I think there are positive signs, and that's one of the reasons why we haven't cut down our investment into this market, because we are convinced that this market will come back, but not in the second half of this year, more into 2014, '15.

The next question is from Adam Wood from Morgan Stanley.

I've got 2, if I could. Just, first of all, on the margins, when we look at the full year guidance, you've obviously increased, quite a bit, the margin expansion that you look for this year versus previously. And that kind of ties in with SAP in the past when maybe the macro is impacted and the license growth has slowed. You've used the margins to protect the EPS growth. Is that the right way to read the move in the guidance for this year? And could you maybe give us a little bit of a feel for how much more room you've got to play with that if, for example, the macro remains weak and broadens a little bit through the second half of the year? And then just secondly, on HANA, you've highlighted a lot of confidence on the pipeline. Just in terms of what happens sort of through the second quarter and third quarter, is it possible that with so many product announcements that customers have sat back a little bit to consider where they prioritize the investments, whether it's the Business Warehouse, whether it's Suite and that's caused a little bit of a hiatus in growth and that comes back in the fourth quarter as you educate and those customers to start make decisions?

Yes, maybe I'll take the question related to the margins. You know that the -- that we reiterated our guidance on the non-IFRS operating income, not the margin itself, and we are committed to deliver this income. Of course, this has implications on the margin, and you saw, in the second quarter, that even under -- in a very tough environment, we are able to expand our margin in the organic -- on the organic side to 100 basis points. And that's, I think, a continuation you will see into the second half of the year, and we will do everything in order to protect the -- this operating income number we want to achieve.

And in terms of HANA and the customers perhaps taking a pause, which is what you implied in your question, it is a fair question because we did just recently announce the Business Suite on HANA. So now you only need 1 database, it's called HANA. That's kind of a big shift in the marketplace. Also, at SAPPHIRE in May, we announced the HANA Enterprise Cloud, where a customer can run the entire Business Suite on HANA in a cloud environment. That's another big transformational idea. So it's possible that customers are absolutely thinking about how they can move the core into the cloud and do that on HANA in a way that transforms their business model because those are the kinds of conversations we are in. We feel that we've fairly compensated for that in our guidance in the update that you're getting today. But I can tell you, the HANA business is beautiful. It's gorgeous. And when you look at the pipeline, you can only be proud to be an SAP employee when you look at the HANA pipeline.

Adam, the way I put it was we're becoming very strategic to our customers. We're sitting with the CEO at the table, and that's a very good position to be in. It may have dragged some decisions, but clearly, it's an opportunity.

And the last question is from Phil Winslow of Crédit Suisse. Philip Winslow - Crédit Suisse AG, Research Division: Bill, you've already commented on your expectations for the second half in APAC. But I wonder if you could give us a comment on just what you're hearing from customers in the U.S. and Europe and sort of in South America, too. There's a lot of just mixed data points between sort of yourselves, IBM and Oracle about sort of what's happening in these geographies. So if you can give us an update on your thoughts there, that would be great. And then one for Jim, too. Obviously, we spent a lot of time on this call talking about HANA, which I think we all love, too. But wonder if you could give us an update on the mobile side. I think you guys talked about 76% year-over-year license growth last quarter. I wonder if you could give us just a broad update there.

Maybe I'll just start on the geographies, Phil. The U.S., obviously, I think Jim covered it earlier, there's a strong acceleration to the cloud. We know the multi-tenant line of business has been well known for some time now. We think taking the suite or the core, moving it into the HANA Enterprise Cloud, whether it's ours, our partners' or private cloud environment for our customers, is a major way to get things really going, not fight the cloud, let's feed the cloud, let's lead the cloud and let's demonstrate innovation in the cloud. And that's what really SAP is doing as the cloud company powered by HANA. On the subject of South America, it's very good for us. Brazil is very, very strong. I think we've become the de facto standard there. Recently, someone told me more than 70% of the GDP of Brazil now is running on SAP. And Mexico has become a major story now in our execution, more free trade agreements in any -- than any place else in the world out of Mexico, so we understand that. And the customers there respect SAP as the global company that can help them expand beyond their borders, so that's going really well. And even in Europe, I mean, if you look at other IT companies, it's not robust growth in Europe. We know that. But a lot of IT companies are struggling just for negative results. We, at least, are growing in Europe, and there are bright spots within Europe as well. When you look at a core market like Germany growing in high-single digits, when you look at the Middle East and North Africa, you look at southern Europe actually turning the corner and when you look at our results, underneath that European number is southern Europe and some of the Portugal, Italy, Greece and Spain numbers actually going into double-digit territory now. So we think we've got the premier brand in Europe. And when Europe does turn, we think we're best positioned to capture that in faster growth rates on a go-forward basis. So that's it on the regions you asked about.

And maybe, Phil, let's talk a little bit about mobile. The reason we haven't spelled it out so much is that mobile is becoming the default. It's becoming less of a separate category. All of our applications are now consumed through the mobile. And some of that revenue will be in the apps world rather than a separate category for mobile. If you look at the first half, we have a strong double-digit growth in mobile as a category, but it's becoming less and less relevant to look at as standalone.

Well, thank you very much, and this concludes the financial analyst earnings call for today. Thank you, all, for joining, and goodbye.

Ladies and gentlemen, this concludes the SAP 2013 Second Quarter Earnings Conference Call. Thank you for your participation. You may now disconnect.