SAP SE (SAP) Earnings Call Transcript & Summary

Hello, everyone. I'm Amit Harchandani, Head of Citi's European Tech Research team and your host for this virtual keynote session on SAP as part of Citi's 27th Global Technology Conference. Thanks for joining us, and I do hope you and your loved ones are safe and healthy. Before I move on to introducing our main speaker, I would like to highlight that we are keen to take questions from investors joining us on this fireside chat. So please do send those over directly to me at amit.harchandani@citi.com, and I shall ask them on your behalf. Alternatively, there's also a box on the right-hand side of the interface, if you would like to type in and send those across. As a next step, it is my pleasure to introduce our keynote speaker, SAP's CFO, Luka Mucic. Luka, it is a pleasure to have you with us, and thanks for supporting our conference every year. I would also add that SAP Head of IR, Stefan Gruber, is on the call as well. Right. So there's one last thing I need to do before we go into Q&A with Luka, which is to read a short safe harbor statement. So here comes my best imitation of Mr. Gruber. Please note that except for certain information, matters discussed today -- during today's presentation may contain forward-looking statements, which 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 most recent filings with the Securities and Exchange Commission.

All right. So the disclaimer is out of the way, let us begin Luka. And I would like to start our discussion with the focus on one of the core elements of SAP's Intelligent Enterprise strategy, which is sustainability and Climate '21, help us better understand how this fits into the overall SAP road map. And how SAP is helping its customers manage their green line, which in turn will translate into an impact, I guess, for SAP's bottom line?

Yes. Thanks a lot, Amit, for having me, and thanks for the great imitation of Stefan Gruber as well. And particular thanks for starting off with a question that is indeed close to my heart and that I'm passionate about also as SAP's internal cosponsor for our own sustainability efforts. We have been a long-term believer in the significance of focusing, as a company, not only on our financial performance, but also on our environmental and social performance. And we have adopted integrated steering mechanisms in order to support that. But while we have been, for many years, the leader in the Dow Jones Sustainability Index for our industry, we believe that we can make an even greater impact as an enabler through our customer base. Let there be no doubt, while, of course, at the moment, everybody is occupied with the short-term challenges that the pandemic is bringing to us, the 21st century's greatest challenge remains, by far, climate change and how we can rally together to fight it. And for many companies in different industries, I can attest to this being -- sitting on the Supervisory Board of a cement company, for example, the environmental performance, the ability to bring down the carbon footprint is really becoming a matter that is defining the license to operate. And we believe that we are uniquely positioned by integrating the data models and the data logics that are necessary to identify across the entire value chain of companies, the individual elements that drive the carbon footprint and then defining through intelligent digital business processes ways to bring them down, that we can make a huge impact towards an integrated environmental and carbon footprint management system for our companies. That's what we are striving to achieve, starting with S/4HANA, where the S/4 application will include the data logic to really get a full visibility across the end-to-end business process landscapes of our customers adopting S/4 around their carbon performance. And we see a lot of interest from customers that want to co-innovate and that want to lead with us. And it's a great factor, therefore, that will further accelerate the move and the migration to S/4HANA. So we couldn't be more excited about that. And in return, we believe that this will also have a very positive impact on our economic performance, too. You're on mute, Amit?

Sorry. Maybe moving on to another element of the firm's strategy, which I believe Christian has referred to as doubling down on categories where SAP has the right to win. I sense this sharper emphasis, which is a shift versus what we've heard in the past, for example, from Bill, as SAP continues its multiyear transition to the cloud. Your thoughts on that, please.

Yes. There is no doubt that focus is an essential part of our strategy that we have defined jointly in the Executive Board. Look, we have an extremely broad portfolio of software solutions. And many of them luckily are market leaders where we have a very strong position, where we are the #1 and #2. And indeed, we have -- we believe that we still have great runway across all of those respective markets, and we want to double down on extending our lead in this respect. That would clearly comprise areas like core ERP and supply chain management. It comprises areas like spend management, where we're also clearly the market leader. But also areas like human experience management with the combination of SuccessFactors and Qualtrics analytics, data management with our HANA platform, and certain elements of our customer experience portfolio like e-commerce, for example, where we see very, very strong demand. Next to that, we believe that we absolutely have an opportunity to strengthen and cross-fortify the market position that those assets individually have through focusing on integration. That's another aspect that Christian has been very clear about that this is a core priority for SAP. We invest 10% to 15% of our portfolio capacity in really deep-level end-to-end business process integration across those assets. And that will continue to solidify our market position in those stronghold markets and allow us to grow. But we are not only playing defense, we clearly see a great growth opportunity in adjacent capabilities where we have equally a right to win. So this is not only what we have today, but also what we want to build in the future. One key category is to build native cloud applications for industry-specific processes and new scenarios where we have a strong trust of our customers due to our strong industry business process, heritage. Other areas would relate to additional business networks beyond spend management like supply chain networks or logistics networks and also new platform capabilities such as, for example, business process, intelligence. And we believe that this is, first of all, a strategy that has an optimal risk and reward profile for SAP, and some of those new adjacent areas have actually a tremendous total addressable market. So they offer lots of space for SAP. The flip side is though that we are also going to be disciplined about looking at alternative options for areas of the portfolio where we have not been able to build such a strong position over the course of quite many years. And in those areas, it does not mean that we're exiting the market but we have smart partnership opportunities, for example, you have seen our recent announcement around the partnership with Siemens in product life cycle management and certainly, we are looking at a few more of those examples, which, again, are going to be accretive to our growth opportunity. We are very bullish about the strategy.

Indeed, and we'll touch upon some of those aspects like partnerships and integration as we move through this discussion. But I've already seen one question which has come in. So let me weave it in because maybe it fits in here, which is, so what does this mean for the whole strategy around C/4HANA, and in particular, the customer relationship market? How should we think about that versus what we've heard from SAP in the past?

So first of all, customer experience is absolutely a key market in which we want to be a significant player, but with the focus on those categories where we clearly see that there is potential for SAP to be a strong #1 or #2 player. There is a very obvious one, in which we are leading the market. That's the whole area of experience management, where we have with Qualtrics, a category leader, and that we're truly excited about. And we're obviously looking at a partial IPO of Qualtrics if we even further exemplify and magnify our growth opportunities. The other area, as I mentioned before, is e-commerce, where we have, with Hybris, a very strong cloud asset that is growing in the high double digits. That is in huge demand these days, in particular, with the challenges introduced by COVID, one of the core investment priorities for many companies around the globe. And then also areas like customer data cloud, for example, where we also have a leading solution that can help customers manage the GDPR intricacies of digital sales motions in a way that is conducive to consumer preferences. So in those areas, we absolutely continue to invest, and we see great growth opportunities. In others that from our perspective, more translate into commodity markets, where the growth rates are coming down and where, admittedly, there is clear market leadership by others. We might look also at one or the other partnership opportunity. And in the meantime, of course, we see that the tide lifts many boats in many of those areas. And so we will continue to look tactically at an opportunity to participate in this growth, but we don't necessarily see it as an area in which we would dramatically double down in investments. But clearly, CX remains a critical pillar of our cloud strategy, just in a little bit more focused sense.

Thank you, Luka. Thank you for that clarification. Another element, if I may, of course, of your strategy is the whole move towards industry cloud. And you talked about Siemens earlier, right? You entered into these strategic partnerships with, of course, Siemens, there was the announcement with Honeywell. Could you give us a sense for what's been the customer feedback so far? And how can we, as the financial community, track your progress? Do you plan to provide us with further disclosure on this topic?

Yes. First of all, customer feedback is extremely positive. There are actually quite a few more early examples already of customers who are co-innovating with us around some of those new cloud-native industry-specific applications. Utilities is another example where we have closed earlier this year, strategic partnership and a significant commercial arrangement with the German utility, E.ON, to provide a next-generation cloud-based billing solution for them to support their industry transformation, and they are further down the road. We believe that we have a natural right to win in this space for various reasons. First of all, there is clear demand now accelerated by COVID, customers learn to appreciate that digital, agile capabilities to devise new ways of going to market, new business processes and next-generation Industry 4.0 scenarios in the cloud are of paramount importance. They see SAP as a trusted co-innovator because of our strong heritage and industry know-how that we have. It's a natural playground for partnerships as well because many of our key global SI partners and other critical software development partners have industry-specific core competencies that they can bring to bear by co-innovating with us on the SAP Cloud Platform, which will be the key delivery mechanism from a platform perspective on which those cloud apps will all be developed so that they can ensure seamless integration in our S/4 core, digital core as well. And that's why we believe that we can scale and accelerate pretty fast because we do need to do all of the grinding work by ourselves. We will lead key development efforts across some of the core industries where we are particularly strong in other areas, and co-innovation is absolutely a viable option. And the early demand from the market is signaling a very, very positive business case for the next couple of years in this respect. And of course, we will continue to update the markets transparently around our progress through the earnings calls, through Capital Markets Days, through individual interactions, sharing also some of the examples as we do usually, where we have had significant wins with customers. What is not likely is that we would break out industry cloud as a separate reporting segment because it's very close to our core R&D efforts. It will be basically mainly an organic development effort, so closely embedded with our functional organization. But we will find other ways to provide you the transparency that you have come to appreciate from SAP.

Thank you, Luka. And again, maybe staying -- still staying with this topic of sharpening the focus. It appears to me at least that the management is not shy of drawing the line between the infrastructure layer and the stack above. So help us understand your views on the ownership of the application layer, if I could call it that way. And what that means for your relationship with the hyperscalers?

Yes. It's a good question, but one where it's also very important to clarify that we absolutely love and stay extremely loyal to the strategy that we have embarked on a couple of years ago to display openness when it comes to the infrastructures of choice of our customers and making sure that our applications can run on all of the hyperscaler infrastructures, whether that's Azure or whether that's AWS, Google Cloud; or in Asia, in China, also Alibaba. I think that strategy has helped us to scale our business very successfully. It's much appreciated by customers and definitely preferred over an attempt to lock in customers in an end-to-end way across an entire stack of the IT industry, and we will remain focused on this strategy. Now having said this, it is a very complementary strategy that allows our hyperscale partners to make sure that significant workloads, some of the SAP applications, in particular, ERP applications, of course, have a huge volume that they can bring to their infrastructure. And so therefore, we have a strong partnership with them in order to make sure that we successfully migrate our customers to hyperscale our infrastructure. It's also our own preferred deployment model next to our own Converged Cloud infrastructure for our own public cloud SaaS applications. So this is perfectly complementary. What we want to make clear is that in all of those conversations, the application layer as well as the platform layer, so where integration happens, where innovation happens, where analytics processes on top of SAP data are run, we really want to keep, retain and own these layers on behalf of our customers. And that's for a very simple reason, only SAP will be optimally able to translate the data models of our applications in corresponding platform services that our customers can then utilize to innovate on top and that is a proposition that we definitely want to keep. And we are making this clear in all of the relationships, which nevertheless are mutually beneficial. And yes, there might be some areas of overlap and coopetition as a result of the fact that also the hyperscalers are going up the stack. But that has always been a reality in our industry, I believe there is much more to be gained by cooperating in this respect. It's just important that the rules of engagement are clear.

All right. I think you've phrased it nicely. It's the rules of engagement that need to be laid out clearly. Let's go back to a term you briefly mentioned earlier in one of your responses, integration. And I note that the firm targets 90% integration completion in terms of some of the key items on the road map by the end of this year. Help us understand where we are today in terms of the progress? And to what extent do you think would this drive, this integration drive the financial performance of the firm and the adoption of S/4HANA?

Yes. Let me back up first and explain what 90% integration means because 90% of what is a very valid question. So what we have said is that we want to make sure that across the core end-to-end business processes that are typically running through SAP applications. There are 4 of them, quite frankly. There is obviously Hire to Retire in the HR side of the house. There's Procure to Pay between spend management and S/4HANA. There's Lead to Cash with or C/4 and S/4HANA, and there's design to operate. We want to make sure that our respective applications that are covering those end-to-end business processes by the end of the year are able to achieve a couple of very important deep-level integration qualities. This is not only high-level technical API-based integration, which we have had for many years, we're talking about a common user experience, a common analytics layer, common reporting structures based on SAP Analytics Cloud, and that is permeated across all of the applications as a consistent analytics layer, a common data model, extremely important so that master data definitions, for example, are the same that we are talking about, a supplier in the same language, whether you're in Ariba or an S/4, the same for an employee between SuccessFactors as well as for -- and so on and so forth. And then a common application life cycle management and user management and a common layer of security across all of those applications. And that's where we are currently more than 50% complete in achieving this across those 4 business processes and will be 90% complete by the end of this year. What does this mean? It means that the implementation effort for customers that are adopting a variety of our solutions across multiple pillars will go down because they don't need to invest into project-driven integration through the technical means that exist and are available. That means there is more money left to invest into the core, into software-based innovation. It will bring down barriers to adoption as well because it will shrink the complexity of going through implementations across various application pillars. And so for us, it is a key conduit to our ambition to actually accelerate as we move out of the crisis and see the tail end of COVID coming to accelerate our growth in the cloud. That's why it's of strategic importance. And last but not least, it's a clear customer demand, and you're always wise to respond to prioritized customer demand as well.

Thank you, Luka. I guess you've talked about some of the strategic topics, but one of the critical debates, which comes around the SAP investment case, and this has been the case for a while now, is the balance of growth and margin. And at SAPPHIRE, most recently, we got the impression that management believes its first priority remains to capture growth, including the incremental opportunities, which may emerge post the pandemic, but margins may be being second. So can you reassure us as we look forward to the targeted 500 basis points of margin expansion, that still remains a critical objective for the firm?

Yes. First of all, I think we have just, after Q2, reaffirmed our 2023 ambition. And that has all elements, included the top line as well as the bottom line and the margin target, so there should actually not be any doubt towards our commitment, towards not only driving for growth, but also increasing efficiency across our business. And you should have seen some of this at play as well now through the crisis, we actually managed so far in the first half year to further increase the margin despite the challenges that we have seen on the top line. Now we have taking immediate measures to curtail discretionary expenses, but not at the cost of the long-term growth. So we keep investing in R&D, for example, all in line with this striking, this healthy balance to set us up for the growth opportunities that we see when we reach the tail end of the crisis. And as a result of that, you continue to see a healthy gross margin development across all of our business models, and that's something that we absolutely aspire to achieve also in the future. Now let me be clear, when you take a look at our 2023 ambition, it's very clear that there is a sequence in those targets. There's always been. It starts off with our goal to reach $15 billion or more in cloud revenues. It follows with the through total revenue ambition of $35 billion plus, then come the gross margin targets of 75% for the cloud. And then, of course, also the company-level margin target. But we believe that in order to support the long-term sustainability of our business, job #1 is to make sure that we maximize our opportunities that come with our business model transformation for predictable recurring revenues in the cloud. We actually see that despite the fact that COVID has a dampening impact, in particular, on our transactional revenues, through some of the new initiatives that we have been talking about and the great demand and excitement that we see in the market, we have an opportunity to double down on this growth and potentially accelerate it as we exit the crisis. And we would not sacrifice this opportunity for SAP by staying one dimensionally focused on the company-level margin target. So we will know a lot better as we move through the tail end of this year as well as size up the opportunity that the new strategy is bringing to us, which is not the easiest feat, as you might appreciate in the current uncertainty that you're facing about how this mechanically then plays out, and we'll update the markets as we speak. But our commitment, and Christian has made this very clear also at our recent earnings event towards driving for efficiency across all aspects of our business remains absolutely strong and will always remain strong because we know that we have lots of runway left to optimize our performance in this respect.

All right. So you've talked some big pictures, some strategic questions. Let's maybe take a pivot toward some of the near-term dynamics now, Luka, starting, of course, with the announcement to IPO Qualtrics. Can you give us an update on where we are in the process, potential applications for second half of the year and even further out as you look towards some of your medium-term targets?

Yes. First of all, the excitement is still absolutely there across all of SAP, of course, first and foremost, at Qualtrics, but also at SAP equally because we believe this is a perhaps unexpected but extremely promising move to set up Qualtrics for a greater independence that will allow them to more effectively penetrate non-SAP ecosystems. That's the primary strategic purpose of us going ahead with the IPO. And while we do that, we will absolutely remain focused on penetrating the installed base through the great partnership that we have established across the firm in selling Qualtrics into our installed base, combining joint SKUs of solutions with SuccessFactors, for example, with CX and other areas that we are working on and to bring them to bear as OEM vendors for our customers. So it's really the best of both worlds what we try to achieve with the IPO. And I believe this will set up Qualtrics as an absolute category leader in a market that is already at around about USD 50 billion and strongly growing in terms of total addressable market. And we are currently busy, as you have asked for the status, in preparing for all of the documentation that you need to submit as you file for an IPO, that's quite a tedious amount of work that is happening these days. We're not done yet with this. And I cannot give you at the moment a precise point in time where we would then ultimately look to file. But of course, we try to do this as expeditiously but also as diligently as we need to. In terms of the impact on SAP, be it in the second half year or also into the future, there is actually, if anything, only an impact to be expected in terms of fully harvesting the growth potential of Qualtrics. We will continue to fully consolidate the results of Qualtrics as we have every intention to stay a long-term majority shareholder of the company. And so from that perspective, the sheer effect of the IPO will not have an impact on the company and its performance. Of course, Qualtrics will have a traditional equity-based share-based compensation plan going forward, whereas our own SAP plans, our cash settled program. So you will see a certain trade-in of cash-settled impacts versus equity-settled dilution at Qualtrics later on. That should, in aggregate, actually, for especially cash flow-focused investors, a positive. But other than that, it's going to be all about setting up Qualtrics for growth and enjoying that growth as part of the combined SAP Group P&L.

Thanks, Luka. All right. So picking up pace, let's start talking a bit more about the second half of the year now. Your outlook assumes a gradual improvement. Can you give us an update on what you've seen in July and August so far as since, particularly for some of that business, which is more transactional, and whether there's a recovery coming through that's in line with your expectations?