SAP SE (NYSE:SAP) Q4 2022 Earnings Call Transcript

SAP SE (NYSE:SAP) Q4 2022 Earnings Call Transcript January 26, 2023

Operator: Ladies and gentlemen, thank you for standing by. Welcome, and thank you for joining the SAP Q4 Earnings Conference Call. Throughout today’s recorded presentation, all participants will be in a listen-only mode. The presentation will be followed by a question-and-answer session. I would now like to turn the conference over to Anthony Coletta, Chief Investor Relations Officer. Please, go ahead.

Anthony Coletta: Good morning, everyone, and thanks for joining us today. With me on the call are CEO, Christian Klein; CFO, Luka Mucic; and Scott Russell, Head of Customer Success. On this call, we will discuss SAP’s fourth quarter and full year results for 2022. You can find the deck supplementing today’s call, as well as our quarterly statement on our Investor Relations website. During this call, we’ll make forward-looking statements which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties that could cause actual results and outcomes to materially differ. Additional information regarding these risks and uncertainties may be found in our filings with the Securities and Exchange Commission, including but not limited to the risk factors section of SAP’s annual report on Form 20-F for 2021.

Unless otherwise stated, all numbers on this call are non-IFRS and growth rates and percentage point changes are non-IFRS year-on-year at constant currencies. The non-IFRS financial measures we provide should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with IFRS. As you know, this is Luca’s final earnings call with SAP. So before we start, I would like to take a moment to express my personal gratitude to you, Luka, for the close collaboration over the years, for the great partnership and for the strong engagement with our investors. Congratulations on 27 years at SAP and a fantastic ride. So it has been a distinct honor to work with you, with lots of great memories. So I wish you nothing but the best of success.

On behalf of the SAP family and the broader community, many thanks, Luka. And with that, I’d like to turn the call over to Christian.

Christian Klein: Yes. Thank you, Anthony, and really well said, and thanks to all of you for joining us today, and welcome to 2023. This has been a good Q4 and a very important year for SAP, bringing to a close a year of great momentum. Our results in Q4 show once again a strong demand for our products and services, reflecting the confidence and trust companies have in working with SAP. Let me call out some key highlights for Q4. Current cloud backlog exceeded €12 billion, up 24% this quarter against a strong compare last year. Cloud revenue grew 22%, and cloud revenue for S/4HANA further accelerated once again, growing at 90%. We reached a tipping point in our transformation, as we returned to positive operating profit growth of 2%, with a recurring revenue share of 76%, which is up 6 percentage points compared to Q4 2021.

For 2023, this is setting us up to deliver expected accelerated total revenue and our promise of double-digit operating profit growth. For full year 2022, we delivered upon all our top and bottom line guidance, with cloud revenue growing 24%, up five percentage points from 19% in 2021. S/4HANA cloud revenue grew 79% for the full year. This is compared with 47% full year growth in 2021 and putting our S/4HANA cloud revenue to over €2 billion for the first time ever. Our cloud transformation is in full swing, and we have also built a highly resilient business with recurring revenue up from 75% in 2021 to 79% in 2022. I believe we will look back at 2022 as one of the most important years in our history. It is now over two years since we launched our strategy for transformation.

We kept our promise and delivered despite the combined impact of three factors; our exit from Russia; our divestiture of Litmos; and the macroeconomic volatility facing the world. Why is our position so much stronger and SAP more relevant than ever? Because our RISE with SAP offering is much more than only a shift of our technology to the cloud. It is a true business transformation offering and we are focused on helping our customers solve their biggest challenges. First, we enable companies to transform their existing business models and drive simplification and automation of their core business processes to offset inflation pressure. Second, SAP enables supply chain resilience. Supply chains are disrupted and need to be diversified as a result of the pandemic, geopolitic tensions and shifting business dynamics.

We are helping our customers to build more resilient supply chains by connecting the suppliers and providers from the raw material provider to the manufacturer. SAP’s business network facilitated over $4.9 trillion of global commerce and €730 million of B2B transactions in Q4 alone. Third, we are delivering the green letter for every industry and every customer to measure ESG based on actual instead of average data, data that is fully orderable and based on industry specific standards. With Scope 3 emission tracking across value chains via our network, and we will give our customers the ability to act by embedding sustainability into every business process and every company decision. RISE with SAP is at the heart of our strategy and is one of our most successful offerings ever.

As stated, it is much more than a technical lift and shift to the cloud for our installed base. It is a true business transformation offering and around 50% of our customers are net new customers to SAP. I’d like to walk you through some of our RISE with SAP Q4 wins. As part of Merck’s long-term collaboration with SAP, they will be using SAP S/4HANA cloud to help further digitize their business processes and make them more efficient, agile and adaptable. This will enable them to act to disruptions and capitalize on business opportunities more quickly. Porsche, the German sports car manufacturer has selected RISE with SAP to support their move to the cloud and maximize value through innovation and speed. PwC, one of the largest professional services networks in the world, significantly increased their user base for SAP S/4HANA public cloud.

To support Lenovo’s Group Everything as a Service transformation strategy, a fundamental change of their business model will €“ they will be moving their digital core to S/4HANA cloud. Earlier this month, I had the pleasure of meeting with the leadership team of Al-Futtaim Group from the United Arab Emirates. They operate across a number of sectors and will be embarking on a full digital transformation powered by Wise with SAP. We also announced a joint collaboration with ExxonMobil to establish and adopt industry best practices and help them with their sustainability efforts. Finally, we are very proud to announce that we signed a long-term strategic deal with BMW this week based on Wise with SAP. We have been partners for more than 30 years and their cloud strategy is based on SAP across all dimensions on all key end-to-end business processes.

The SAP business technology platform is the foundation behind Wise and our portfolio momentum. Already today, more than 80% of Wise with SAP deals include the business technology platform as the foundation for integration and extensibility. This is powered by thousands of APIs, integration flows and low-code, no-code content packages. Lockheed Martin of the US is an example of this. Lockheed’s collaboration with SAP began in 1998. They will be now leveraging Wise with SAP to move their core business processes to a secure, managed fab ramp compliant cloud. They will be using the SAP business technology platform for emerging technology and the SAP Analytics Cloud to enhance their strategic data management. With S/ 4HANA and BTP at the core, our line of business applications also benefit from a flywheel effect as it is twice as likely that these ERP customers buy another SAP line of business application.

More than 30% of SAP’s current customers use two or more SAP solutions, and we see this increasing through this flywheel effect created by the business technology platform. At the same time, coming out of a strong year, we will not rest as we continue to focus on our cost trends to increase both win rates and productivity. In previous quarters, we spoke with you about our continued focus to simplify and consolidate our portfolio with S/4HANA and BTP at the core. Our divestiture of Litmos in Q4 is an example of this. In 2023, we intend to sharpen this portfolio focus further. As we continue to build on our core strengths, we will be pivoting our CX and industry areas to be more focused on specific industries, complemented by a strong ecosystem.

This focus on our core, together with our ongoing optimization of SAP’s structure for cloud success are behind the announcement we made today. The intent to carry out a targeted restructuring in select areas of the company. This will impact up to 3,000 positions and will include a headcount reduction amounting to about 2.5% of our workforce. While we know these changes are necessary, it is never easy to make decisions that affect our colleagues in this way. In the same context, SAP has determined to explore a sale of its stake in Qualtrics. This would be a continuation of the strategy we set at the time of the Qualtrics IPO in 2021. SAP believes that this potential transaction could unlock significant value for both companies. For SAP, to focus more on its core business and profitability; and for Qualtrics, to extend its leadership in the XM category that it pioneered.

Since the acquisition, Qualtrics has increased revenue by 3.5x to US$1.5 billion, while delivering profitability, and has significantly expanded its offerings and enterprise customer adoption. In the event of a successful transaction, SAP intends to remain a close partner. A final decision is subject to market conditions, agreement on acceptable terms, regulatory approvals and the approval of the SAP SE Supervisory Board. SAP has retained Morgan Stanley as financial adviser to assist in the exploration of the sale of its stake in Qualtrics. I’d like to close by taking a look at our outlook and ambitions. As these results have shown, the power of SAP solutions in an increasingly uncertain world is clear. We are providing strong guidance for 2023 despite the continued macroeconomic pressures.

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The strategic transformation we announced over two years ago is in full swing and has reached a significant inflection point. The strength of our recurring revenue base is the foundation, which will power our next 50 years at the forefront of business and technology. We will already see a positive impact in 2023, including the promise we made to return to double-digit operating profit growth as well as accelerated cloud and total revenue growth. For our 2025 ambitions, we are ahead of plan and expect to provide an update to these ambitions later in the first half after the arrival of Dominik Asam, our new CFO. In closing, I can sense both, the possibilities as well as the caution that will be required to navigate today’s uncertain world. And lastly, on a more personal note, you all know that our CFO, Luka Mucic, is passing the torch to Dominik Asam on March 7.

Luka, as Anthony said, you have enjoyed an impressive career at SAP. And of course, the whole SAP family will be always grateful for your commitment and your contributions to our success. I guess today also marks the 37th earnings in your CFO career. And personally, I would like to say you not only many, many thanks, especially over the last two years as the CFO and supporting this significant transformation, but as well for your partner and even more important, your personal mentorship. So many thanks to you, Luka, and all the best.

Luka Mucic: Yes. Thank you very much, Christian. It’s a bit hard to follow with business as usual. Thank you so much for your kind words. But also from my side, a happy and healthy 2023 to everyone. Let me start by saying that I’m extremely proud of SAP’s solid finish to 2022, demonstrating great resilience in the year that saw certainly many challenges. But despite the extremely volatile business environment, we delivered on our financial commitments for 2022. And we are likewise on track to deliver our growth and profitability commitments for 2023. Our financial performance shows that we kept our promise and thoroughly executed on our plan by being laser-focused on building cloud momentum through agility and great cost discipline.

This resulted in a successful finish to the year, and I am personally extremely confident that we will carry this strong momentum into the new year. Customers around the globe continue to choose RISE with SAP to drive their end-to-end business transformations. Large cloud transactions with a volume greater than €5 million contributed 48% to our cloud order entry for the full year and an impressive 50% in Q4, the highest number on record. Now, let me dive into more details around our financial highlights. Current cloud backlog now exceeds €12 billion, continuing its growth at scale to 24%, despite being negatively impacted by approximately 1.5 percentage points from the divestiture of our Litmos business and the wind down of our business operations in Russia and Belarus.

S/4HANA current cloud backlog growth accelerated to 82%, driven by the strong adoption of RISE with SAP. In Q4 alone, we added more than €500 million to our S/4HANA current cloud backlog, leading to a total of €3.17 billion. Cloud revenue this year surpassed support revenue and became the largest single revenue stream for SAP. Our combined SaaS and PaaS portfolio for 2022 continued to grow an impressive 27%, with SaaS cloud revenue up 25% and PaaS cloud revenue up 45%. This strong cloud growth was primarily the result of an outstanding contribution of S/4HANA cloud and the business technology platform. Driven by this strong double-digit cloud growth and an outstanding performance in services, total revenue was up 5% year-over-year, showing great traction compared to the year ago period.

Now, let’s take a brief look at our regional performance, where in the fourth quarter, all regions delivered a strong double-digit cloud performance with Brazil, Germany, and Japan being standouts. For the full year, the Americas increased by 22%, EMEA by 26%, and APJ likewise by 26%. Germany, the United States, and Japan had outstanding performances, while Brazil, Chile, China, Italy, Saudi Arabia, South Korea, and Switzerland were all particularly strong. Now, moving on to the bottom-line, where our cloud gross margin for the full year continued its upward trend from last year and expanded 2.1 percentage points to 71.3%. This increase was driven by expanding gross margins across all cloud business models, with efficiency gains overcompensating increased investments into the next-generation cloud delivery program.

The improvement of the cloud gross margin contributed nicely to our cloud gross profit growth of 28%. In the fourth quarter, non-IFRS operating profit grew by 2%, reaching an inflection point in our cloud transformation towards double-digit growth in 2023. Full year 2022 non-IFRS operating profit came in at €8.03 billion, a 7% decline, mainly impacted by the decision to wind down business operations in Russia and Belarus, a reduced contribution from software licenses revenue, as well as accelerated investments into R&D and sales and marketing to capture current and future growth opportunities. Earnings per share decreased 39% to €4.08. The year-over-year decline reflects the contribution to financial income by Sapphire Ventures, that due to market conditions faced throughout the year was significantly lower than in the same period last year.

The IFRS effective tax rate for the full year was 44.6% and the non-IFRS tax rate was 29.5%. This year-over-year increase mainly also resulted from changes in tax exempt income related to Sapphire Ventures. Free cash flow for the full year came in at €4.35 billion, in line with the revised outlook of approximately €4.5 billion. This is predominantly due to lower profitability and adverse working capital impacts in other assets. While tax payments developed positively, smaller negative impacts came from share-based payments as well as capital expenditures and leasing. In addition, the increased volume of trade receivables sold in 2022 amounting to €800 million versus €500 million in 2021 had a positive impact on free cash flow. As you already heard from Christian, we will be initiating a targeted restructuring program this year with two main objectives.

First, to focus our portfolio on our key strategic growth areas; and second, to improve overall process efficiency as we continue to accelerate our cloud transformation. We are highly confident in our short and mid-term prospects. We see 2023 as another pivotal year that will help deliver on the accelerating top line and double-digit operating profit growth that is reflected in our outlook. Finally, let’s discuss our non-financial targets. Our greenhouse gas emissions were 95 kilotons within our adjusted target range. We remain on track to be net neutral in our own operations this year and we are continuing on the path to achieve net zero across the entire value chain by 2030. Employee Engagement Index was down three percentage points. This decrease is in line with global industry trends and related to external factors, such as the lasting impact of the pandemic and macroeconomic conditions.

We achieved 35% of women in the overall workforce and 29.4% women in management. In November, we brought the latest release of SAP Sustainability Control Tower to market, which effectively shares and organizes ESG data so companies can more accurately and readily report their performance to various reporting requirements and frameworks. This enables companies to set targets in actionable insights into core processes and create role specific actions to improve sustainability performance. As many of you may know, I not only have a passion for the financials, but also for sustainability and non-financial metrics. It has been an honor to drive this topic together with my colleagues during my tenure. We have been a pioneer in integrated reporting, and it has been a privilege to have a role in shaping this area.

So to summarize, 2022 was another strong year for SAP, highlighted by our cloud performance across all regions despite the macroeconomic environment. This demonstrates our continued progress with customers who want to transform their businesses into more intelligent enterprises. Even with the challenges that we are seeing in the world today, we are confident in the opportunity ahead. Our 2023 outlook best illustrates that we are now entering the next phase with a pivotal year characterized by business momentum acceleration. And finally, on a personal note, again, as you all know, this is my 37th and final earnings call with SAP. And I’m proud to have been part of such a great company. As I’m about to pass the torch, it is exciting to see that SAP is in such a position of strength and moving along on its growth trajectory.

Let me also take the opportunity to share my own personal appreciation to all of you and to the broader financial market community. Providing transparency in an open and constructive dialogue has always been my goal. I hope that I was able to live up to this goal, despite the often volatile times and the unprecedented transformation of our company in the last nine years. It has always been a privilege. Thank you very much, and we will now be happy to take your questions.

Anthony Coletta: All right. Thank you, Luka. And I would like to remind you to limit yourself to one question only, please. So, Natalie, please open the line.

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Q&A Session

Operator: Ladies and gentlemen, at this time we will begin the question-and-answer session. And our first question is from the line of Adam Wood from Morgan Stanley. Please, go ahead.

Adam Wood: Hi. Good afternoon, Christian. Good afternoon, Luka. And also, Luka, best wishes from my side for the future. So the question was just around the fourth quarter cloud growth. We went into the quarter with the 26% cloud backlog growth and ended Q4 with 24%. And yet the cloud growth was 22%. Could you just help us understand why that anomaly is there? And also help us understand how that accelerates into a higher level 22% to 25% in 2023? Specifically, is there any issue with rational revenue growth in that side of the business that you’re seeing in the fourth quarter that would have explained that, please. Thanks so much.

Luka Mucic: Yes. Thanks for the question, Adam. And let me get started and then in the overarching momentum. Perhaps Christian, you might want to add some comments or also, Scott, on what you see in the market. So, essentially, in the fourth quarter, I think, you have to remember a couple of effects. One, and that is something that I flagged on the CCB growth to be expected, we had the divestiture of Litmos, which obviously affected CCB negatively, and together with the continued effect from the Russia exit that resulted in the 24% CCB growth versus the 26% that we had. Actually, it is also sometimes a matter of rounding where you exactly end up on that. But we are actually very happy with the 24% that we reached. And I can also spend a few words on how we expect this to unfold in 2023.

But just to round this up, on the revenue front, you need to take into account that next to all of those impacts, of course, the divestiture of Litmos also meant that we lost some revenue due to the closure up to early December. We had also the anniversary of the Clarabridge acquisition that Qualtrics had done in the fourth quarter a year prior. And that obviously then brought the year-over-year growth rates down a bit, together with all of the other effects. Transactional revenues were actually quite resilient in particular in Concur. I have to say that business is back. And I was surprised actually a bit that in Q4, they were already back in volumes to the pre-pandemic levels. So they grew actually in the 20s, which is a very decent performance.

So it’s really mainly down to those divestiture impacts and the anniversary of Clarabridge. When we think about 2023, I would expect general re-acceleration throughout the year already starting in Q1 because of the strong backlog that we have been building that always comes into the revenue lines with one to two quarters of delay. And so you should see already a reacceleration in Q1 that would then further build up during the year. I’m sure there will be more questions around seasonality, but I’ll leave it on that comment for cloud revenues. And then in terms of the forward-looking momentum, I think Christian has already talked about the great success that we had with BMW, the signing yesterday. But perhaps you want to add some more comments around what you see in the market.

Christian Klein: Yeah. Luka, and also adding from my side, I guess we also provided for the first time today also the total cloud backlog, including not only the annual contract value, but the total value over the lifetime of the contracts. And there you’re also going to see that we are also, in the meantime, have that €34 billion in the books. And this has increased by 35% versus the 27% we saw a normal growth in Q4. And so this is also a signal that deals like BMW, I mentioned Porsche, I mentioned Merck, there are a lot of large enterprises now following our move. And, of course, they have a certain ramp in their contract. So we’re actually super confident that we already have the backlog to deliver on our ambition for 2023.