SAP SE (SAP) Q3 2012 Earnings Report, Transcript and Summary

Stefan Gruber - Vice President of Investor Relations William R. McDermott - Co-Chief Executive Officer, Member of Global Managing Board, Member of The Executive Board, Chief Executive Officer of Global Field Operations and President of Global Field Operations Jim Hagemann Snabe - Co-Chief Executive Officer, Corporate Officer, General Manager of Industry Solutions, Member of Executive Board, Head of Development for The SAP Business Suite and Member of Global Managing Board Werner Brandt - Chief Financial Officer, Member of Executive Board, Acting Labor Relations Director, Interim Head of Global Hr and Member of Global Managing Board

Adam Wood - Morgan Stanley, Research Division Philip Winslow - Crédit Suisse AG, Research Division Walter H. Pritchard - Citigroup Inc, Research Division Ross MacMillan - Jefferies & Company, Inc., Research Division Laura Lederman - William Blair & Company L.L.C., Research Division Michael Briest - UBS Investment Bank, Research Division Richard G. Sherlund - Nomura Securities Co. Ltd., Research Division

Ladies and gentlemen, thank you for standing by. Welcome to the SAP 2012 Third Quarter Earnings Results Conference Call. [Operator Instructions] I would now like to turn the conference over to Mr. Stefan Gruber. Please go ahead, sir.

Thank you. Good morning or good afternoon. This is Stefan Gruber, SAP Investor Relations. Thank you for joining us to discuss SAP's results for the third quarter 2012. 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. We'll then have time for Q&A. Before they get started, I want to say a few words about forward-looking statements. Any statements made during this call that are not historical facts, 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 expectation. 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, including SAP's annual report on Form 20-F for 2011 filed with the SEC on March 23, 2012. Participants of this call are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their date. Please keep in mind that unless otherwise noted, all numbers and growth rates referred to on this conference call are non-IFRS on as-reported basis. In addition, starting with the third quarter 2012, SAP will report a separate Cloud segment to provide greater transparency into our Cloud business. Werner will discuss this in more detail shortly. With that, I would like to turn the call over to Bill.

Thank you, Stefan, and thanks, everyone, for joining the call today. SAP's momentum continues at full speed. Q3 was our best ever third quarter. We once again set new records. We exceeded EUR 1 billion in software revenue for the first time in the third quarter. We delivered triple-digit growth across all of our new innovation categories, including the Cloud, HANA and Mobile. We beat market expectations for revenue growth, and we achieved strong 17% year-over-year organic growth in software licenses, 12% at constant currency; and 19% in software and software-related services revenue, 13% at constant currency. This was our 11th consecutive quarter of double-digit software and software-related services growth. Our more than 61,000 employees worldwide continue a sweet devotion to co-innovating with our customers. The success of our strategy is also evidenced by the 8% year-over-year increase in SAP's brand value as determined in a recent study by Interbrand. We feel like we're in pretty good company, between American Express and Nike. SAP Solutions, a combination of our core applications, analytics and key innovations are winning. We are growing twice as fast as our closest competitor. We are taking market share in a continued uncertain environment because customers are looking for more efficiency and innovative ways to drive growth. These results make it clear that there is a nexus of forces transforming the market, and our strategy is at the center of this cycle. SAP solutions give our customers the tools to win by combining our market-leading applications, core and analytics with our innovations that address big data, mobile and the cloud. Let me give you some more details on our regional performance. First, the Americas. The Americas delivered an outstanding Q3 with 37% software growth, 29% at constant currency. Among the highlights is a great new partnership for…

Thank you, Bill. In 2010, we laid out an innovation-based strategy for SAP. We decided to accelerate our innovations in our core business, and to expand into 3 new innovation areas, mobile, cloud and in-memory computing. In a market where most IT companies are now reporting negative growth we, today, reported, as Bill mentioned, the 11th consecutive quarter of double-digit growth. What I, in particular, like about the quarter is the clarity. We clearly chose the right strategy. And the trust from our customers is very high, that's why we're winning market share in all areas. Bill reported our top line performance in the quarter. I'd like to briefly comment on our innovations in our 5 market categories so you better understand our competitive strength in terms of innovation. This time let's start with the new innovation categories, cloud, mobile and database. Let's first talk about the cloud. SAP has become a major player in the cloud. If we include Ariba, the SAP cloud business is an EUR 800 million revenue run rate business today, that's more than USD 1 billion. Over 12 months, new and upsell cloud billings increased 14x. On an apples-to-apples basis, including SuccessFactors in our 2011 numbers, billings grew 116%. And SuccessFactors standalone billings grew 92%, which shows an acceleration of their extreme growth rate as part of the SAP family. We now have more than 17 million users in the cloud, that's 4x more than #2. So we're big in the cloud, and we are growing very fast. The engineering team under Lars Dalgaard have delivered some amazing new versions of all of our 4 line of business cloud categories: my people, my money, my customers and my suppliers. With these new innovations, SAP is competing head-to-head with the incumbent cloud vendors, and we are…

Thank you, Jim. Both Bill and Jim gave you an overview, solid third quarter coming off a very tough comparison from last year, especially on the margin. Q3 marked our 11th consecutive quarter of double-digit growth in software and software-related service revenue. I would like to give you more insight on these results. Before I do that, I want to give you few details on 3 topics, effects on the TomorrowNow provision, non-IFRS adjustments and changes made to our internal management reporting, which also affects our external segment reporting. Regarding TomorrowNow, I wanted to remind you that our IFRS profit and margin were impacted by the reduction in the provision for the TomorrowNow litigation in the third quarter of 2011. This positively influenced our IFRS results in the third quarter of 2011 by EUR 723 million. For the 9 months ended September 30, 2011, our IFRS results are positively influenced by EUR 711 million. For this reason, the 2012 and 2011 IFRS results are not fully comparable. In the third quarter of this year, we recorded non-IFRS adjustments of EUR 380 million, largely driven by EUR 152 million for share-based compensation. The share-based compensation expense increased primarily because of the higher share price in the third quarter. Please also note that we have increased our estimate for the non-IFRS adjustments for the full year 2012 compared to the estimate we gave earlier this year. Last quarter, we told you that due to the increased focus on the cloud business, we would establish a separate cloud division. We have now adjusted our internal management reporting to reflect this change. As our external segment reporting is derived from our internal management reporting, we have the following changes in our segment reporting. As of the third quarter, we now have 2 divisions, which…

Thank you. Operator, please start the Q&A session now.

[Operator Instructions] And the first question is from Adam Wood from Morgan Stanley.

[Audio Gap] and obviously a very strong quarter in a tough environment. Just wanted to come back on the cloud. Jim, you flagged how SuccessFactors has very clearly accelerated both in revenues and in the billings since you've taken charge of it. As we look to Ariba and you've had a little bit more time to look around that, is there any reason as you're looking at business that we shouldn't expect a similar acceleration in Ariba? Could you maybe talk a little bit about the opportunities you see there, and maybe particularly around the network as you start pushing that into your installed base? And then secondly just on the operating leverage in the business, Werner, you've talked about the rate of hiring and obviously the dilution from SuccessFactors. Could you give us maybe a little bit of a feel of how you're seeing this going forward? Does the hiring calm down as we go into 2013? When do we get the benefits of that sales hiring? And maybe just with Q4 specifically, should we expect the operating margins, is it possible for them to be up year-on-year in 4Q this year?

I'll -- Jim here, start with your cloud question. Clearly, our acquisition strategy has been one of accelerating innovation in top line as the synergy case for the acquisition, and the same will be true for Ariba. It is only 20 days ago that we finalized the acquisition, and so right now the teams are working in full motion to be ready for SAPPHIRE with all roadmap decisions that we are making. And the biggest opportunities that we see is the effect of the network as you mentioned. We have the largest or most relevant installed base in the industry. We believe they touch 62% of all world transactions. You combine that with a large network of [indiscernible], you have something that potentially can accelerate really, really well. And so we will see the same effects, hopefully with Ariba, that the growth rate which was impressive before the acquisition will accelerate as part of SAP.

Yes. And Adam, your question regarding the hiring. I think we made it clear in the first half that the accelerated hiring across all functions in SAP was a clear focus on revenue-generating FTEs. Now in the third quarter, you have seen that we brought it down to roughly 350, still mainly in the area of sales and marketing. And you can be sure that going forward, we will do the same, also looking for adding resources where we need them on new topics. And if we hire externally, then it's very limited with a clear focus on those areas where we serve our customers back. This can be in sales and marketing, but this also could be in the area of HANA where we have a huge, huge traction for our product going forward. So from that end, you cannot anticipate that we go with the same hiring pace into 2013.

Next question is from Philip Winslow from Credit Suisse. Philip Winslow - Crédit Suisse AG, Research Division: Just 2 questions, and starting first with Bill. Obviously, you guys put up another great HANA number, essentially flat quarter to quarter. And that's pretty impressive considering it tripled quarter-to-quarter, Q1 to Q2. What are you seeing in HANA here? What's the feedback from customers, in particular, regarding business warehouse on top of HANA, just what traction are you seeing there? And then, Jim, really appreciate the fact that you guys are breaking out the profitability of the cloud business. You talked about in 2015 hitting a profitable -- having a profitable cloud business. Wonder if you can help us think about how this business model should evolve there?

This is Bill. About half of our HANA business is coming from the BW to HANA, which is very encouraging so the acceptance rate is high. And I can only tell you, the combination of HANA and the mobile, as well as the cloud, is such unbelievable value to our customers. One such example was in Milan yesterday where the owner and founder of a very well-known retail company, high-end, was just citing the fact that under any economic circumstance, his question to me was not whether he could afford it, it's how quickly we could execute to make it viable in his business model so he could begin captivating his customers and also his employees on the digital promise of the device powered by HANA so there would be no latency between the transaction and the information back to the company, but also that there'd be perfect execution between the retailer and his consumer. It's examples like this that make HANA such a clear choice to our customers. So we feel great about the HANA business, whether it's BW to HANA or just net new examples of innovation. One thing I would underscore is we're applying this design-thinking and innovation concept to these customer relationships where you'll actually see SAP go into design-thinking exercise, business transformational consultants and value engineerings, so the customer understands how we can impact the process and drive the business outcome. A lot of the value coming from HANA is the ability to connect at that solutions level with the customer.

And Philip, thanks for the question on the cloud side, very important, and we do appreciate you noticing the transparency we're creating here. It's not everyone in the market who is willing to create that kind of transparency. We think it's important because we want to drive a profitable business in the cloud, and we've stated that we will be the first to do that. And here's the logic. There are basically 2 factors. So first of all, no one is profitable in the cloud today. We know that. There's been recent IPOs and all of these companies are losing money. There are 2 factors that make you get the opportunity to create profits and is making you lose money at the beginning. The first one is you need to invest upfront in building an application and the infrastructure for all customers, but you will have no customers before you're done. And then, it's all about getting more customers on, so that cost base will grow with manual small steps as you add more customers but your revenue will be exponentially growing. And so you just need volume of customers once you've done the investment to get profitable. Secondly, you need a sales force. And so what we are seeing in the players who are pure play cloud that they don't have a sales force when they begin. And whenever they get close to a profitability, they need to invest all the money in marketing and sales. And this is where SAP is different, we do have a sales force. We already have the customers. And we are seeing that the customers appreciate having both the cloud and the on premise solution from one vendor pre-integrated out-of-the-box. That's why we believe we can be faster profitable in the cloud. And maybe a last comment. If you don't build for cloud but you move stuff that was never built for cloud into the cloud, my prediction is you'll never be profitable in the cloud. Because you don't have the simplicity of your infrastructure that you need to have the cost structure to be profitable ever. That's why all the assets we have in the cloud were built for the cloud from the beginning, including of course SuccessFactors who grew up in the cloud.

And the next question is from Walter Pritchard from Citigroup.

It's Walter Pritchard from Citi. I'm wondering just on the SuccessFactors side, you had impressive growth there. I'm wondering if you could talk about the installed base growth versus SuccessFactors standalone and where you saw the source of that growth acceleration? And then also related to the cloud, you've had a $2 billion – or EUR 2 billion goal pre-Ariba, I'm wondering if there's any care to update that number given you did buy a significant player in the cloud that does add to revenue?

We actually see most of the growth and the acceleration of SuccessFactors coming from the installed base, and that's I think the good news. It shows that the strategy of combining a cloud player with a pure cloud model into the SAP installed base was the right choice. And we believe that will continue. And we have accelerated the innovation pace in the cloud, and we now have a complete HR solution, a finance solution, a CRM solution and a supplier solution with Ariba, which means we also have the most complete portfolio in the cloud, and this will drive now the acceleration of our growth in the cloud going forward. You mentioned the EUR 2 billion. So we have a run rate today of EUR 800 million if you take the last quarter including Ariba. And actually, the EUR 2 billion included the acquisition of Ariba as well. We will see how this thing is evolving, but clearly we are a major player today and we are the fastest-growing.

Next question is from Ross MacMillan from Jefferies. Ross MacMillan - Jefferies & Company, Inc., Research Division: Two questions if I could. So the first is just, we see a really strong growth in the biller value of deals. And I was just curious, if you could touch on that again and help us understand what's driving that? Is it a function of the macro environment, i.e. larger customers are spending more, or is there something else there? And then second of all, I was really curious. As I look at the x HANA, x mobility license growth on a constant currency basis, you're still actually growing that core business at a reasonably good rate. But looking forward, as you think about porting the suite onto HANA, what's your thoughts around the potential for the core to accelerate as we move beyond 2012?

A couple of things. In terms of the deal size, particularly in the greater than EUR 5 million category, there were more larger deals in the quarter in that category of our business, that segment. And what you're seeing is, when you innovate and you have the installed base that SAP has, customers tend to not just focus on any one thing, they look at the bill of materials across the enterprise in a more broad way. And I can say that prices are holding ever steady. So it's not any sales technique, it's simply customers looking at the enterprise value of an SAP relationship in all aspects of the 5 market category and that strategy. We had some very signature wins, some of them that we've told you about and some of them that we didn't get the release from the customer to tell you about, but they are really stunningly interesting. And then HANA and mobility, you're absolutely right. About half the growth rate is made up of that, but that just means that half the growth rate is left in the core and that's still growing ever steady. The one thing I can tell you, and that I'm sure Jim would like to add his comments as well, looking forward to the suite on HANA, there's several different ways to monetize that. One is the suite on HANA itself. One is HANA as a solution within say, an industry or a specific buying center. And then one is just simply putting HANA in component parts of things we're already doing. There's basically 3 different angles that we're looking at to keep it simple for the customer, make it bite-size enough where it has to be industry-specific enough where it should be. And then also if customers want to commit the whole suite and the whole enterprise to HANA, they should be able to do that too. SAP will be able to do execute on those 3 angles for the customer.

And I can comment on the suite on HANA just briefly. We always had the intent that eventually transactional systems would run on HANA. And we today have Business One running on HANA, and we are working in the lab on the suite on HANA. We've not released this product, I want to just make sure you understand that. Why is this so important? Because the moment the transactional system runs on HANA, we can drive the next wave of simplification of infrastructure. At that moment, there's no reason to have separate business warehouses that have separate storages. They can just read the data directly from HANA. And with that, you can get rid of a lot of the complexity, reduce, again, hardware cost in the company and free up money for innovative software. So that's really the strategic intent behind this and you'll see us moving ahead at high speed on that topic.

Next question is from Laura Lederman from William Blair. Laura Lederman - William Blair & Company L.L.C., Research Division: Can you talk a little bit about where the billing in the quarter, in U.S. and Europe from others on your subscriber base and some, kind of issues with deterioration in the U.S. Obviously, you've had a good quarter in U.S. but I wanted to understand ratability. And the same thing in Europe and then I have a follow-up question.

Yes. So Laura, the quarter was not inconsistent with other third quarters in terms of the linearity that was in the quarter. And when we looked at the history, it came in typically for a third quarter. Oh, you're not asking -- you're talking about the percentage out of the regions, is that what I'm here? Or linearity...

Also climate in Europe and linearity in the quarter.

Okay. So let's just talk about the linearity first. So the linearity was consistent with other third quarters. They're pretty back-end loaded with holiday in Europe and so on. So that wasn't anything awe-inspiring. And then the growth rates, you're familiar with. So what is it about your question, like what percentage of the revenue came out of each region? I'm not quite sure what you want. Laura Lederman - William Blair & Company L.L.C., Research Division: No, no, no, just linearity. In other words, was it a normal [indiscernible] in terms of linearity in Europe and in U.S.? And was there any weakening at the end of the quarter from the U.S. like other vendors have seen?

Right. That's what I thought you were asking. Yes, so it was consistent with other quarters in Q3 which were back-end loaded. And no, it did not decelerate. So when we finished up the quarter, we finished up the quarter where we basically had expected to finish up the quarter. What was interesting about this Q3, as you know, it finished on a weekend. And those are never peaceful weekends, and this one was no exception. But it wasn't anything unexpected. It's consistent with other Q3s. We looked at the linearity and compared it to other years, it's okay. And the pipeline right now in Q4 is commensurate with our reiterating the guidance at the upper end. So we got a good handle on the overall business. Laura Lederman - William Blair & Company L.L.C., Research Division: And the second question's on HANA and how much of the HANA buys are second or third buys? And how much is still in proof of concept. I'm trying to get a sense of existing customers of HANA buying more and more and using them for different use cases and how often you see that?

What we saw at the beginning of the HANA era was the companies excited about the technology going for proof of concepts or smaller projects. And clearly, we're seeing now 2 things happening. Those companies were very, very excited. I think we exceeded their expectations on what HANA can do and they're now going ahead. We're seeing the first enterprise kind of decisions for HANA, which means they're betting on HANA to be their future infrastructure base. And then of course, we're getting the volume through now that much more companies are going for HANA because it's a proven technology. And that creates now another base for up sales in second phases.

Yes, indeed. And the other thing is, just to build on what Jim is saying, we are in a lot of conversations now which are non-SAP environments on HANA, which is particularly encouraging. And I would also say, seeing companies like P&G make a move to the ASE is further evidence that we're a power player in the database industry, which includes HANA but is not limited to HANA in certain instances. So non-SAP, big installed customers now looking at SAP as a database leader and then of course the part that has us very excited is where we're in non-SAP environments and HANA is clearly the Trojan horse into these accounts.

Next question is from Michael Briest from UBS.

I guess following up on Ross' question. The large deal count was significant this quarter and last quarter, and typically these large deals don't all get recognized in the quarter. So it strikes me that you're building up a good degree of backlog and visibility. I just wonder if you can talk about as you go into Q4, how your visibility on phased deals is this year compared to say last year? And then secondly, just in terms of acquisitions. I think, Bill, you were quoted in the press a few weeks ago saying that there's no further need to do large cloud deals. Some cloud companies are very highly valued despite not having much in the way of revenues. Can you sort of clarify what you might consider to be a large deal and indeed decide whether you're going to do any more or not?

Go ahead, Werner.

First of all, regarding the large deal contribution, in the third quarter roughly 80% of the software revenue came from deals larger than EUR 5 million. Normally, they're in the range of 20% to 35%. This shows that we had a very clear focus on large deals in the third quarter, and we see this continuing going into the fourth quarter.

And then on the acquisitions, Michael, the fact is we had identified these 5 market categories as we've repeatedly stated as the strategy for the company. And when we made the move on SuccessFactors, it was the DNA. It was also the leader and with Bob, we got a beautiful business network here with Ariba, Bob Calderoni and his management team. And right now, there is just no impending event for such a large acquisition. We feel like we have the assets we need to execute on our strategy and deliver for our shareholders.

And the question comes from Rick Sherlund from Nomura.

First on competition. I wonder if you could just talk for a moment about Workday, what you're seeing, what your thoughts are there going forward on a competitive side? And also on the competition side, if you'd touch, Jim, maybe on what we heard from Oracle recently in terms of their multitenant database versus multitenancy on the application side and share with us your thoughts as they try to promote the idea of running through a multitenant database and in-house sort of behind the firewall hosted private cloud application?

Right. So Jim here. Let's talk a little bit about competition in the cloud. Clearly, we see the pure play cloud players as the biggest competitors in the cloud. Most of the traditional players don't really understand cloud, in my opinion, and it took us a while as well. We are seeing, at customers now significant win rates against the pure play players. And I believe that there are 2 main reasons for that. First of all, our cloud solution is very competitive in all of the categories that we're in. And it's pre-integrated with the stuff that SAP customers already have, but open to any back end. I think this gives customers a significant reduction of effort when they choose point solutions for the cloud. And as you see us involved, the user experience, we believe will play a major role, and I really encourage you to take a look at the user experience that we've been delivering in the latest versions, it's second to none. We will win because of user experience. So that is one very important part. The other one is actually to the profitability. Customers are concerned that their choice of vendor, if they keep making losses, might not be around. And there, of course, we have a huge benefit of being SAP and having the cash flow that we have. So that's the competitive situation. Maybe a last comment on that. We now cover all the 4 dimensions of the business from a line of business: my people, my money, my customers, my suppliers, which means you can have one company doing all, and that is of course a competitive advantage. On the multitenant database side, I don't believe that the technology discussion is what makes the cloud successful. What you need to be in the cloud is you need a system that is designed for the cloud, which makes it easy to consume for the customer and have low TCO for you as a supplier. And we believe that, that requires multi-tenancy, not just on the database. And all our solutions have that today. And at the end of the day, we can have a lot of tech talk but you measure it on how many customers are consuming it and what is your cost of supporting them, and that's where we believe we'll be the most profitable business, and the first profitable business in the cloud.

And Rick, one of the examples that I would give you to support what Jim had said about SAP and the strong loyalty of our customers in the installed base, you take a company like Timken in Ohio, which was one of the examples cited today, they saw all the alternatives, all of the alternatives, in fact, were not prepared to even go with SAP. But when they saw SuccessFactors, understood the integration of that solution with what they had already invested in with SAP and the relationship plan going forward and our roadmap, that's what won the day. And that is why the win rate that SuccessFactors and SAP cloud is now enjoying is much, much higher. As time goes on, it keeps getting better and better. So keep an eye out for that.

And can you update us on the success you're having with the integration with SuccessFactors? Has that completed? And I know Lars was enthusiastic about uncoupling financials and HR from ByDesign and selling them as a line of business, has that been accomplished and is that gaining traction in the market now?

Rick, the answer to both question is yes. We have -- before we started the segment reporting, we have worked out all of the ingredients for the cloud business. So we have now a cloud business, which includes SuccessFactors and the SAP side, managed by Lars and his team, fully functional, fully integrated, if you will. And then on the product side, Jim referred to this one, we have made a big step forward with the 4 categories: my money, my supplier, my customer and my people, with the basis being the HCM solution from Success Factors. But on top, we have Business ByDesign, and all is integrated with on premise. So from a customer perspective, what do you want more?

The one thing that you guys got to keep in mind, too, is Business One on HANA. This is a category killer. If you think about some fast-moving markets, whether it's Brazil or it's China as an example, once the light bulb goes on, that SAP can provision Business One in the cloud on HANA and make these small enterprises real-time, easy to implement, low-cost, it is totally a game changer. And we are localizing Business One on HANA in Brazil as an example. It'll be a big hit in China, too. Keep an eye on Business One on HANA in the cloud.

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