SAP SE (SAP) Q3 2010 Earnings Report, Transcript and Summary

Welcome to the SAP Q3 earnings financial analyst conference call. I am the operator to this conference. All participants will be in a listen-only mode. The conference is being recorded. After the presentation there will be an opportunity to ask questions. (Operator Instructions) At this time I would like to turn the conference over to Mr. Stefan Gruber. Please go ahead, sir.

Yes, thank you. Good morning or good afternoon. This is Stefan Gruber. Thank you for joining us to discuss SAP's third-quarter 2010 results. I am joined by Bill McDermott, Jim Hagemann Snabe, and Werner Brandt. Werner and Jim will have prepared remarks for this call. Following their prepared remarks we will have time for Q&A. I will now make a few remarks about forward-looking statements. Any statements made during this call that are not historical facts are forward-looking statements as defined in the US Private Securities Litigation Reform Act of 1995. Words such as anticipate, believe, estimate, expect, forecast, intend, may, plan, project, predict, outlook, should 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 US Securities and Exchange Commission, including SAP's Annual Report on Form 20-F for 2009 filed with the SEC on March 25, 2010. Participants of this call are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. Now with that I would like to turn the call over to Werner.

Yes, thank you, Stefan, for this introduction. Before I begin let me tell you that I will focus on our non-IFRS figures as they are more in line with how we internally look at our operational performance. Also, these non-IFRS measures are the basis of our guidance. Please do also note that our third-quarter and year-end 2010 numbers include the revenue of it end cash flows from Sybase for the period since the acquisition on July 26, 2010, while the comparative prior-year numbers do not include any Sybase revenues, profits or cash flows. Let me give you the highlights of the third quarter. As the economy continues to stabilize, we are pleased to report double-digit growth in software and software-related service revenue. All regions reported growth in the third quarter, with particular strength in the United States and the emerging markets of Asia, Europe and Latin America. We saw good mix of revenues among small, mid-size and large enterprises, and we had an increase in deal volume. Non-IFRS software and software-related service revenues grew 21% or 13% at constant currencies to EUR2.35 billion. SAP's business accounted for 7 percentage points of the constant currency growth, and Sybase contributed 6 percentage points to the growth. The SSRS performance was driven by a constant currency increase of 15% in software revenues and a very strong 11% in the support business. As you know, we have seen strong retention and adoption of Enterprise Support within our customer base. In fact, September 30th was the deadline for customers to make their decisions on their Enterprise Support or Standard Support for 2011. Nearly 100% of current Enterprise Support customers remained on Enterprise Support. As a result of the strong top line, the non-IFRS SSRS gross margin increased by 1.3 percentage points or 130 basis points…

Thank you very much, Werner. And thank you all for taking the time to joining the call, we really appreciate it. We at SAP are pleased to report double-digit non-IFRS SSRS growth of 21% or 13% at constant currencies. This represents another strong quarter of growth for the company. The markets are moving in a positive direction. Enterprises are becoming more confident. And strategic buying decisions and our strategy is validated as companies want to be real-time, unwired. And they want to partner with a company that has an open ecosystem, one that does not lock customers into a stack, but gives them choice. We saw strong double-digit growth in all the growth engines of our business, including Business Analytics, the BRIC markets and SME. We are also seeing continued strength in our focus industry segments like banking and retail. We remain market leader in the enterprise software industry. Our customer-focused strategy to provide solutions to customers on-premise, on-demand and on-device is finding broad market acceptance. We are pleased to see that Gartner shares our view of the future in their recent release of the top 10 technologies for 2011 with cloud, mobile and next-generation analytics taking the first three spots. Our three pillar strategy, our Sybase acquisition and our continued innovation and growth in Business Analytics is motivating customers, partners and employees all over the world. As for the regions, in EMEA we saw good performance and a strong turnaround from the second quarter amid a still cautious environment. We are starting to see customers more willing to commit to purchases and a return of some larger deals. Importantly, deal volume has also increased. The emerging markets and EMEA were particularly strong. In Germany the economic recovery supports the continuing turnaround in our business. Key customer wins in EMEA…

Thank you very much, Bill, and thank you, Werner. As Werner and Bill stated, Q3 was another strong quarter from a financial point of view. Let's look at the quarter from a strategic point of view. Product innovation, contrary to consolidation from some of our competitors, is a key reason that we continue to report strong growth. We continue to open up new growth opportunities for SAP and our customers through accelerated innovation in our solutions for on-premise, on-demand and on-device. As Bill said, customer focus and innovation is key to differentiate SAP from its competitors, many of which insist on just piecing together legacy hardware and software solutions. In on-premise enterprise applications we are the clear market leader. The SAP Business Suite remains the preferred application platform in 25 industries. It is the only end-to-end fully integrated, consistent business process platform in a modern service-oriented architecture that is available now, not in the future, and not pieced together through expensive middleware. Most importantly, with enhancement packages we offer innovation to the SAP Business Suite without disruption. This is extremely important for customers. The continued success of SAP Business Suite, our high competitive win rate and our strong market share demonstrates customers' commitment to SAP to help them transform their business and run their business better. In banking the Gartner Core Banking Magic Quadrant 2010 was recently published, and we continue to be rated as a leader in this important report for 2010. SAP remains clearly separated as the vendor with the best rating on the vision. And we have again improved our position in the ability to execute dimension. Continuing with the on-premise business, business analytics remains a top priority for our customers, as reflected in our strong quarterly results in this segment. Most importantly, what is really helping…

We will now begin the question and answer session. (Operator Instructions) The first question is from Mr. Phil Winslow from Credit Suisse. Please go ahead sir. Phil Winslow – Credit Suisse: Good quarter. Bill, just a question for you on just the sales force and the pipeline. When you talk about just a recovery in the pipeline for license revenue and sales, how should we think about the headcount demands in the sales force? How do you think about layering headcount in versus bringing productivity back up, and what is the right mix? And then, also, just Bill and Jim, I wonder if you could comment about the pipeline for Q4. How should we think about this recovery, let's say, versus the post bubble recovery year in 2004? Thanks.

Well, thank you very much for the questions. First on the sales force, obviously we have a well known direct sales force model that works quite beautifully. And in terms of business value for customers and business outcome for customers, we think we are pretty world-class in that area. Where you will see us focus is a lot more on the indirect. And we consistently tell you how our SME business and our volume is improving with things like inside sales, indirect channels, and we are really expanding the network and the footprint of SAP. And obviously that comes at a very attractive value for shareholders. And where we do need to add headcount, Jim, myself and the Board have worked very closely together in lifting and shifting assets to get more on the front line, where the yield for shareholders is much greater and customers get a lot more thought leadership. So that is working good. We don't see any big hiring needs in the sales department. And then, finally, on Q4, our pipeline is very healthy. The company is in good shape. If you look at all the major geo's, they are all growing in double digits; the BRIC growing at least two times them. And the pipeline is reflective of that as well for Q4. So right now we are feeling very confident in our business.

Next question please.

The next question is from Ross MacMillan from Jefferies. Please go ahead sir. Ross MacMillan – Jefferies:

Well, I can maybe start on that and just give you our perspective here. We have with our product strategy basically doubled the addressable market of SAP. And that gives us a strong opinion that we can grow sustainable double-digit in time to come. We have opened up new markets like the on-demand market. We have opened up new markets like the mobile market. And we have opened up the new market – a very fascinating market around the in-memory computing. All of these will be elements of our growth strategy. Now where will this growth come from? We still believe there is a lot of growth in the on-premise world as well. We actually see key industries like banking, like retail, like utilities investing heavily in standardization of software. We also see geographies like China, BRIC countries that want to become global players and standardize on a global infrastructure. SAP has proven to be able to do that. So it is a combination of on-premise extending the leadership, and then adding these new businesses of on-demand, mobility and in-memory computing to really show a leadership from an innovation point of view. Ross MacMillan – Jefferies: Bill, one for you, if I could. You talked about how SAP is somewhat differentiated from others in the sense that you are working more aggressively with partners perhaps than ever before. Can you give us a sense if we should expect to see any new relationships or deeper relationships emerge? I guess I'm thinking specifically as to kind of how we should think about your partnership strategy and how that may evolve over the next year.

Well, thank you. I would say yes and yes. Yes to new, and yes to deeper. The well-known brands that you are familiar with are more and more getting close to SAP. I believe Jim gave a great example of RIM, and Jim Balsillie actually getting up on stage demo'ing our on-device applications, which is pretty exciting, on his new devices. That is an example of a partnership we are involved in yesterday. The big high-tech manufacturers are all embracing us. And the new ones will be the extension of our ecosystem, as we build new partners and new routes to market in new channels and new geographies all over the world. Business ByDesign gives us a tremendous opportunity to do that. Jim talked about China. If you think about Sybase and the fact that they are the number one database company in China, there is an example. So every angle on partners is something SAP looks at from a force multiplication point of view. And our customers keep telling us they don't want to get locked into stacks and they don't like vendor lock-in, they want innovation.

I think to that point, maybe to add, you are basically seeing two trends. There are some companies who are consolidating and they want to own the whole stack, and that is their strategy. And then you have innovators, who say “I stay focused on my path, but then I run faster, I innovate faster”. And we believe that is a superior strategy. And for that to work you need strong partnerships so you still get the end-to-end stack to the customer. We think that that combined stack of focused companies with innovation as their strategic imperative is a better combination for the customer. And it gives them choice. And that is what we hear from the customers.

Thank you. Next question please.

The next question is from Michael Briest from UBS. Please go ahead sir. Michael Briest – UBS: Thanks and good afternoon. Werner, firstly for you, the balance sheet doesn't look very efficient at the moment. There is an awful lot of cash and an awful lot of debt. Can you maybe talk about whether you're going to restructure that and pay down some of the debt so that interest charges are more efficient for you? And then, secondly, Bill, in terms of order intake, in the past we've got the proportion of deals over EUR5 million you've signed. I'm wondering if you could give that for Q3, and maybe the trends that you are seeing in GEAs and SLAs, whether the subscription model is taking a traction? Thanks.

Let me start Michael with the question related to our debt. First of all, we have liquidity of 2.8 billion. We have a net debt of 1.6 billion. The majority of the debt will be due in 2012. And as we already said, the financing for the acquisition of Sybase will be paid as soon as possible, so that will be the case in 2012. Nevertheless, we are looking also to enhance our financing structure. And the first thing we will approach now is that we look into the syndicated loan facility we have agreed upon, which has a duration until, I think, 2013, and we will renew this and take advantage of the lower interest rates and maybe the one or the other fund. In essence, we want to pay down the debt associated with the Sybase transaction as soon as possible. The majority of the debt will be paid back in 2012, and then we’ll see how we proceed going forward.

Okay. And Michael just to answer your question on kind of the deal flow in GEA and SLA, the deal flow – if you think of it this way, almost in the 60/40 model, to use round numbers. 60% are coming in less than 1 million, 40 above 1 million. And the ones at the very top are relatively consistent quarter-to-quarter with some minor variations on a deal here or there. So think of it more as 60/40. And on the GEAs and the SLAs, they have done what we expected them to do. That was a 2009 option for a lot of customers that as you know were constrained for CapEx and had OpEx. And they were really pushing for that. Now it has pretty much flattened out, and the traditional business model is more in vogue. So we are right where we thought we would be with GEA and SLA, you know, double-digit amounts of them globally, not really growing at a rapid pace, which is consistent with our business model. Michael Briest – UBS:

I would say it grew consistent with the license in the quarter. Michael Briest – UBS: Thank you.

Thank you. Next question please.

The next question is from Jonathan Tseng from Merrill Lynch. Please go ahead sir. Jonathan Tseng – Merrill Lynch:

Well, maybe I’ll take these questions. If you look to the performance in the quarter, you see that we have extended our margin by 80 basis points. If you look to it for the nine months we also have an expansion of our margin. You see that we have not changed our guidance, so we are 100% committed to deliver 30 to 31% for the full year on the margin side. Going forward, I would argue that we have a clear ambition to extend our margin by roughly 100 basis points year-over-year. And if you make your own calculations you can see when we might achieve our 35%, which is our ultimate objective from a margin perspective. Jonathan Tseng – Merrill Lynch: Thanks. And just one follow-up. You talked about 7% growth coming from the legacy SAP business. I am just wondering if you can drill down to that by geography or region on the software and software-related services side? Thanks.

That is something we do not do. We, I think, have a clear understanding that we provide the contribution of Sybase, but not going into a further detail from a regional perspective. If you will see our quarterly report we will file with the stock exchange, you will see that we have a segment called Sybase, so we will be transparent going forward, but not in the detailed level as you just requested. Jonathan Tseng – Merrill Lynch: Cool, thanks very much.

Okay, thank you. Next question please.

The next question is from Raimo Lenschow from Barclays Capital. Please go ahead sir. Raimo Lenschow – Barclays Capital: Thanks for taking my question. Two if I may. First for Bill. Obviously, your main competitor will have a new product cycle potentially starting next year. In the past that has kind of meant some implications for the guy that was competing with them. Can you maybe talk a little bit about your strategy around that? And then one for Jim, quickly. On HANA, obviously it is a very exciting new product, but the incumbent player on the database side will obviously point out there is some risk of taking new technology. What is the feedback you have seen in the market so far from the customers? And also, maybe some early comments on what are you thinking about pricing – not on your price per device appliance, but just more pricing in general? Thank you.

Raimo thank you very much for the question. This is Bill. First of all, in relation to the competitor bringing in a new product to market, considering it is several years late now, it still remains to be seen if it won't yet be another year late. So let's see if they are continuing to be late. The fact of the matter is they don't do very well in generation one releases, which is why I think they have watered down the messaging to basically sort of beta'ing and testing with some customers on "the new product". We look forward to the day that they may have some kind of a new product or a new release level, because that will then put all those customers in their existing installed base of all the rollouts that they have done on the M&A front in a buying mode. They will have to make a decision. They will have to make a decision to keep the legacy and the maintenance on that or they will have to make a decision to switch. If they consider switching to a new platform or a new application from Oracle, you and I and everyone else on this call know that they're going to shop it against SAP, if for no other reason than just to keep Oracle honest on price. Which means we come to the table in a buying decision with a customer. When we are at that table in 25 industries and all geographies and market segments around the world, my money is on SAP.

And let me talk a little bit about HANA, because I think HANA is a good example of how we innovate without disruption for our customers to counter exactly that. Where we believe the benefit we have is that we don't need to rip and replace what they have. We can build on what they have, because it is a very modern platform. HANA was conceptualized in March. We talked about it at SAPPHIRE in May, and we are delivering the product end in of this quarter. So what you see is, first of all, the very rapid innovation cycle that we now have in SAP. Secondly, you asked what are the customer reactions? Since the launch of the product at SAPPHIRE in May, where we first time talked about it, we said we will work with 50 customers to make sure the product is the right product and has the right characteristics. And that list has been oversubscribed significantly. So the interest in the market is very, very high. And we now need to make sure that we can accelerate and deliver this solution as fast as possible. We don't want to do it too fast. I think quality has become a very important part of our strategy as well, so we will ramp this up as fast as possible. Now coming back to the pricing question, there is no doubt that this technology represents true breakthrough innovation and significant value creation for the customer. We will price the appliance based on the size of beta that is being analyzed. And with that we have an opportunity to get value, which is linked to the value that we create for the customer. Raimo Lenschow – Barclays Capital: Perfect, thank you.

Thank you. Next question please.

The next question is from Mr. Mohammed Moawalla from Goldman Sachs. Please go ahead sir. Mohammed Moawalla – Goldman Sachs: Yes, thank you. Bill, I wonder if you can just drill into a bit more detail on some of the territories within Western Europe? I know that was disappointing in Q2 and showed some improvement this quarter. But what is specifically going on here, and to what extent does your Q4 – implicit Q4 guidance – rely on a recovery here?

Yeah, we obviously are very pleased with the change between Q3 and Q2 in EMEA in general. And as I look at Western Europe in particular, we have very good leadership, very strong pipeline, and every reason to believe that EMEA will do exactly what we plan for them to do in Q4, and of course, achieve their goal. So I would not worry a minute about Western Europe or EMEA in terms of our ability to execute at this time. Mohammed Moawalla – Goldman Sachs: Great, thank you.

Thank you. We have time for two final questions.

The next question is from Knut Woller from UniCredit. Please go ahead sir. Knut Woller – UniCredit: And then second on Sybase, I am aware that you so far did not disclose any synergies, neither top line nor cost side, and always mentioning that it is a top line-driven acquisition. Can you give us an idea how we should think about growth rates from Sybase going forward? Are these growth rates that you also achieved, or that could be comparable to what you achieved at BObj, or is there a reason not to believe this would be the case?

I am happy to answer the ByDesign. As you know, we have been holding back on the volume-ready solution on ByDesign, and we shipped that one end of July this year. So that is the first time we are in the market where we have an ability to be going after volume. And so that is two months of the quarter only. We always said that we will go after volume first, so that is the number of customers we can attract. Don't forget these are SME companies with a subscription model, so right now it is not a lot of revenue. But with the channel multiplier we believe that this can be a very profitable business for the future. So that is what I can say at this stage. The launch was very successful. We see competitive wins of customers who have already on-demand experience going to this, which means we have a competitive solution.

And coming to the Sybase-related question, as you rightfully said, we are not willing to disclose any potential synergies of this tremendous important combination for SAP. But I can tell you that besides the fact that we keep both companies separate that we will have a lot of cross-selling opportunities, meaning that we at SAP sell Sybase product, and Sybase is going to sell SAP product into their installed base or into new customers. And if you make the analogy to business uptake, I think we all know that in 2009 and in 2010 BusinessObjects-related products, so the business user as our customer provided tremendous growth to SAP. And we have no doubt that we foresee this also for Sybase product in the future. If you look to the mobile capabilities, if you look to the in-memory capabilities supported by the database infrastructure provided by Sybase and the Business Intelligence platform, we can combine effectively with our product base to optimize all the core products on the customer side. Knut Woller – UniCredit: Great. Thanks.

Thank you. So the final question please.

The next question is from Adam Wood from Morgan Stanley. Please go ahead sir. Adam Wood – Morgan Stanley: All right, thanks very much for taking my question. Just first of all coming back to the growth, you talked about being able to grow sustainably double-digits. Just first of all, is that organic growth that you're talking about, will that need to be – to continue to be driven by acquisitions? And then when we think about the move to that type of growth rate, a lot of the products you have talked about today coming from the Sybase acquisition or are on the on-demand side also need some buildup, because they are subscription-based. Is this is something we should be thinking about as the cross-selling comes into effect more in the second half of next year rather than the first half, given the timings of ramp ups, cross-selling and so on and so forth? And then, just secondly, on the FX aside. I think, Bill, you highlighted there was a tail wind in the quarter. I am just trying to understand that, because I thought there were some benefit in the quarter. Was that going forward you were talking about? And maybe you just update us on the impact of Sybase on the FX exposure on the expense side?

Okay, well, let me start off just a little bit on the double-digit that Jim, Werner and I have all reinforced. When we speak of double-digit, we are talking organic growth. And if you look at Sybase, I think Werner did a great job of talking about the cross-sell and the up-sell opportunity within Sybase and within SAP, and that is non-trivial. Think about Sybase ASE, for example, compatibility with SAP Business Suite in our own installed base to complement the choices we already provide customers as one example. Think about Business Analytics and IQ in combination with what we do today with our Business Objects portfolio and a new release level we call Aurora. And think about the Unwired platform pulling through the business process, the mobile, and the innovation of business applications and analytics, and other people building on top of our developer kit that Jim talked about. And all of this coming together in a solution set for customers. It is really mind-numbing what we can do to help customers innovate their business. And on-demand is beautiful because it is another consumption model and it is an incremental add to our revenue streams, it is not a take away from anything. In fact, it is takeaway from market share from the competitors, particularly as we consolidate point solution on-demand into Business ByDesign and we start taking over the cloud in small and mid. So this is a growth story that is pretty exciting. And in terms of my comments on the tail wind, and perhaps Werner would want to comment further, if you look at the actual numbers themselves, we are reporting 21% SSRS growth. And when you put that in constant currency terms it turns into 13%. That is what I meant by tail wind.

And I think Adam, by purpose we focused in our guidance on constant currency, otherwise we would need speculation about the – mainly the US dollar/euro exchange rate. And that is something we cannot predict and we shouldn't predict from our end. We should concentrate on our operational performance, how we do in the countries, and that should be our major focus also going forward.

Thank you very much. This concludes the Q3 earnings call. Thank you all for joining, and hope to see you soon. Thank you and goodbye.

Ladies and gentlemen, the conference is now concluded and you may disconnect your telephone. Thank you for joining, and you have a pleasant day.