SAP - Q1 2024

Transcript

Operator (participant)

I would now like to turn the conference over to Anthony Coletta, Chief Investor Relations Officer. Please go ahead.

Anthony Coletta (Chief Investor Relations Officer)

Good evening, everyone, and welcome. Thank you for joining us. With me today are CEO Christian Klein, CFO Dominik Asam, and Scott Russell, Head of Customer Success. On this call, we will discuss SAP's First Quarter 2024 Results. You can find the deck supplementing this 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 2023.

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 custom currencies. The non-IFRS financial measures we provide should not be considered a substitute for or superior to the measures of financial performance prepared in accordance with IFRS. Before we start, I'd like to first remind everyone of the adjustment to our reporting practices announced on December 18th last year. This adjustment, notably incorporating share-based compensation into our non-IFRS results, are now fully reflected in our Q1 results. I would also like to call your attention to our upcoming Financial Analyst Conference, which will take place on June 5th as part of our Sapphire event in Orlando, Florida. This will be broadcast on our website. With that, I'd like to now turn the call over to Christian.

Christian Klein (CEO)

Yeah. Thank you, Anthony, and thanks to everyone on the line for joining our First Earnings Call for 2024. When we look at SAP's longer-term growth journey, 2024 is the key year. It's the year to scale up revenue and profitability. I'm so proud to say, what we saw in Q1 makes us very confident about our goals. We are off to a strong start, and we have laid a solid foundation for 2025 and beyond. Let's look at the key metrics for Q1. Current cloud backlog grew 28% to EUR 14.2 billion. This is the fastest growth on record and demonstrates the strong momentum across our portfolio with Business AI as an enabling factor, with a strong impact already on our Q1 backlog. Cloud revenue increased 25% and reached EUR 3.9 billion.

Our operating profit came in at EUR 1.5 billion in Q1, 19% higher than a year ago. The new disclosure of Cloud ERP Suite creates transparency for you and us. It shows how we are executing on moving our installed base to the cloud, and how we are driving SAP's ERP leadership position with our land and expand strategy. The Cloud ERP Suite contains all the modules for a company's core processes, from finance, spend management, and HR, to supply chain, commerce, and our business technology platform, including data and analytics. Together, these modules have the same functional scope as our monolithic on-premise ERP. Our modular and integrated cloud ERP is unmatched in covering the core processes for over 25 industries and 130 countries in the world, and represents a $700 billion market opportunity by 2027.

In Q1, revenue from the Cloud ERP Suite was up 32% and reached EUR 3.2 billion. We have seen exponential growth in this metric for two consecutive years as we are successfully expanding our footprint in our installed base. The land and expand strategy works beautifully. Every customer right now has to redesign core processes end to end to master the business transformation in their industry. And this is only the beginning. The flywheel has just started to spin. I will go deeper into that in a minute. There are many exciting customer stories behind our strong start to the year. In Q1, a range of exciting companies signed up for RISE with SAP. To name just a few examples, the premium chocolate maker, Lindt & Sprüngli, the global manufacturing company, SKF, and the U.S. aerospace company, Curtiss-Wright.

We also saw great customer uptake across the portfolio. Maersk, a world leader in container logistics, adopted the BTP, as the integration, and development platform, spanning across the SAP and non-SAP IT landscape. Our GROW with SAP offering was very successful, with hundreds of new customers and a 64% share of net new customers in Q1. One of them is the carbon capture startup, Climeworks. As for our sustainability solutions, we won another 100 customers in Q1, on top of more than 1,000 we had before. New customers like Ericsson, the global leader in wireless technologies, and Vaillant, a leader in energy-saving technologies, chose SAP Sustainability Control Tower for their regulatory ESG reporting. So in summary, we had a strong start in Q1, and we are happy to confirm our 2024 outlook, as well as our 2025 ambition.

We are also very confident about the resilience of our growth story beyond 2025, because we have all the right ingredients in place. Our three growth drivers are: RISE with SAP as the leading transformation offering for our installed base. GROW with SAP for net new customers, smaller subsidiaries and acquisitions, and the innovations we delivered, and we will release in the upcoming years, above all, Business AI. Let's first look at RISE with SAP. Our installed base is large, with over EUR 11 billion remaining support revenue to be converted to the cloud, typically by a factor of around two to three. On top, the EUR 700 billion cloud ERP market offers significant cross-selling opportunities, and I have no doubt that SAP's integrated best of suite capabilities will win in the core business of our customers.

As part of RISE and via the Clean Core journey, SAP and our ecosystem will help our customers to remove their ERP custom code and instead develop integrated ERP extensions on BTP. This gives us an immense additional revenue potential, considering that customers in the on-premise world spend up to EUR 7 on custom code for every EUR 1 they invest in ERP software. Customers like Hitachi High-Tech, for example, reduced the number of custom code add-ons by over 19%. RISE has just become the de facto standard for our installed base. It offers a holistic business process redesign, combined with the migration to our modular cloud ERP, resulting in fast time to value and being always on the latest release, consuming new innovations without time-intensive ERP upgrades like in the past. Let's have a brief look at GROW with SAP, our second growth driver.

As SAP's Greenfield cloud ERP offering for net new customers or new business units of large enterprises, GROW delivers go lives in weeks for every business model, in every industry, in every country. With our ERP solution, SME customers can grow and scale their business without migrating to a new ERP. Ultimately, RISE and GROW offer customers similar advantages, innovation, modularity, scalability, and integration. Coming to the third driver of our growth, which is innovation, with Business AI at the core. SAP Business AI will once again transform how business is won and how end users will work in the future. At SAP, we infuse Business AI across our portfolio. First of all, Joule will be our new user experience via natural language, our one front end. We have based our Joule roadmap on an analysis of the most frequent business and analytical transactions of our end users.

This way, we make sure that the most heavily used transactions will be fully AI-enabled by the end of this year. Second, we are embedding Gen AI directly in our cloud products. Since Q4, we have released over 30 new AI scenarios across our cloud portfolio. Additional ones come out almost every week, with more than 100 in the pipeline for the remainder of the year. Third, our customers, partners, and SAP can use the AI foundation on the BTP, including the Gen AI Hub, to build custom AI scenarios. Over 60 ecosystem partners are taking advantage of these capabilities already and working on over 80 use cases right now. Among the over 27,000 customers already using our Business AI is ZF Friedrichshafen, a leading automotive supplier. ZF is lifting significant financial value by optimizing demand and supply chain planning with embedded AI.

Together with our partner, NVIDIA, we are currently building new Gen AI capabilities. One use case will revolutionize how software will be developed in the future. Jensen and I are looking forward to telling you more about this partnership at Sapphire. Commercially, customers can buy SAP Business AI as consumption-based AI units, which can be used across the entire portfolio, or via our premium RISE and GROW offerings that include AI units, so customers can get started right away. Both commercial offers have already seen high demand, and many Q1 deals were influenced by SAP Business AI. Overall, we offer a unique value proposition versus the competition with three elements. SAP Business AI works out of the box.

For their own Gen AI-enabled extensions, customers and partners have full choice which leading model they want to use, including modules from OpenAI, Google, the best open source alternatives, or using their own modules. SAP Business AI comes with our leading enterprise standards and is deeply integrated with our data and security models. In summary, we had a strong start to 2024, and we are confident we will achieve our goals for the year. Looking ahead, we have powerful growth drivers in place and many innovations in our R&D pipeline. The strong development of our cloud backlog is a testament to that momentum. With regard to our transformation program, we are making even better progress than expected, especially with hiring new talent for future-oriented areas such as AI.

The program will help us to capture growth and increase efficiency at the same time, among other things, by pushing the internal use of AI. We expect a triple-digit million amount in efficiencies from embedding AI across all our processes. Equally important for us as an employer, wherever SAP colleagues are affected by restructuring, we are moving with care and empathy, always aware of our social responsibility. With that, I'm handing over to you, Dominik.

Dominik Asam (CFO)

Thank you, Christian, and thank you all for joining us this evening. Let me start by echoing Christian's sentiment that the fundamentals remain exceptionally strong. March marked my first anniversary as SAP CFO, and I consider myself very fortunate to have joined the company just in time with the business in pole position to capitalize on the tremendous AI opportunity lying ahead of us. The hard work of the prior years starts to pay off handsomely, also for those investors who kept the faith in the company during these turbulent times. It is because of the dedication of our workforce that we continue to experience strength across the business. Our solutions are becoming increasingly differentiated, demonstrated by continued revenue growth throughout the world, expanding cloud gross profit, and improved cash conversion. We've kept the promise and walked the talk, setting the stage for sustained growth in the coming years.

Fiscal year 2024 is already off to a strong start. We continue to build on our robust foundation, as evidenced by the impressive growth of our current cloud backlog and continued momentum of our cloud revenue. In addition, non-IFRS operating profit showed significant double-digit growth, even when including stock-based compensation. Our key priorities, including our investments in Business AI, demonstrate our commitment to leading the charge in this new era of business transformation and exemplify our relentless drive for growth and operational excellence. The company-wide transformation program we initiated in January is progressing well, focusing on enhancing our operational efficiencies and setting the stage for improved financial performance. We're also deploying our own AI solutions internally as a powerful lever to drive productivity. Digital transformation is imperative in today's evolving landscape, and SAP remains the partner of choice.

Building on our strategic commitment, the introduction of the Cloud ERP Suite is a pivotal step in aligning our product offering more closely with our core ERP and integrated business solutions. All of this has helped foster the trend towards larger cloud transactions, with deals greater than EUR 5 million in volume, contributing more than half of our cloud order entry. This is remarkable for the first quarter of the year. I will now go into further details on our financial highlights. Current Cloud Backlog was EUR 14.2 billion, accelerating its impressive growth to 28%, solidly keeping us on the trajectory towards our fiscal year 2024 outlook and fiscal year 2025 top-line ambition. Cloud revenue grew 25% YoY, mainly driven by the continued strength of our Cloud ERP Suite.

It grew by 32% in Q1, its ninth consecutive quarter of growth in the thirties. This sustained momentum underscores our expectations that Cloud ERP Suite will continue to capture a growing share of our cloud business, thanks to its critical role in our customers' digital transformation journeys. It actually already represents 84% of our combined past SaaS revenue, up three percentage points as compared to the prior year's quarter. Software license revenue saw a decrease of 25%. The dilution of its share of the total revenue from 9% to 5% in only one year impressively illustrates the continued secular shift in market preference towards cloud-based solutions in the enterprise. Finally, total revenue surpassed EUR 8 billion in Q1, up 9% YoY, showing unabated growth momentum. Now, let's take a brief look at our regional performance.

In the first quarter, SAP's cloud revenue performance was particularly strong in APJ and EMEA, and robust in the Americas region. Brazil, Canada, Germany, Italy, the United Arab Emirates, India, and South Korea had outstanding performances in cloud revenue growth, while the U.S., Japan, and Spain were particularly strong. Now let's move further down the income statement. Our cloud gross profit grew by 28%, driven by cloud revenue growth and further efficiency gains. This resulted in cloud gross margin improving from the year ago period, expanding by 1.8 percentage points to 72.5%. IFRS operating profit in the first quarter was impacted by EUR 2.2 billion of restructuring provisions associated with the transformation program initiated in January. This resulted in an IFRS operating loss of EUR 787 million....

This accrual represents the vast majority of the total restructuring expenses we currently expect to incur in the context of the program. The amount is closer to the upper end of what we had anticipated initially, which is primarily driven by the strong share price performance in the first quarter, and the higher than expected acceptance rate of the early retirement program in the U.S. We continue to be in the very early stages of executing the program, which we expect to be concluded by the beginning of 2025, and projected expenses are based on preliminary assumptions. We expect visibility to further improve over the course of the second quarter, and plan to provide an update once the related measures are fully assessed. Finally, non-IFRS, non-IFRS operating profit grew by 19%, evidencing our sustained push towards enhanced profitability.

The underlying profit extension, expansion was tempered by a EUR 135 million increase in stock-based compensation expense, mainly as a result of a very strong appreciation of our share price in the first quarter. Q1 2024 was actually the quarter with the highest increase in SAP's market capitalization ever. As we settled for the last time the entire tranche of our obligations under the 2021 Move SAP program in Q1, fully in cash, we expect a significantly lower sensitivity in the coming quarter as we move to equity settlement. Therefore, the non-IFRS operating profit outlook is reaffirmed for the full year 2024, despite this headwind. Non-IFRS earnings per share in the quarter increased 8% to EUR 0.81. The IFRS effective tax rate for Q1 was 16%, and the non-IFRS tax rate was 32.4%. Now, on to our cash generation.

Free cash flow for Q1 came in at EUR 2.49 billion, up 28%, again, putting us on the right trajectory to maintain our full-year outlook. There was only a minor cash flow impact from our transformation program in the first quarter. We reiterate our 2024 outlook on all parameters. For the detailed outlook, please refer to our quarterly statement published earlier today on our investor relations website. In summary, Q1 marks a strong start to the year, highlighted by continued growth in both our current cloud backlog and cloud ERP suite. Business traction, combined with focus on execution, is positioning us well to meet our objectives for the remainder of the year. Before we open it up to Q&A, I would like to say that we are very much looking forward to welcoming you to our financial analyst conference in June.

As already mentioned by Anthony, it will take place in conjunction with Sapphire in Orlando, and the team and I are very much looking forward to meeting you there in person. So thank you, and we'll now be happy to take your questions.

Anthony Coletta (Chief Investor Relations Officer)

Operator, please open the line.

Operator (participant)

Ladies and gentlemen, at this time, we will begin the question and answer session. Anyone who wishes to ask a question may press hash, followed by one on their touchtone telephone. If you wish to remove yourself from the question queue, you may press hash followed by three. If you are using speaker equipment today, please lift the handset before making your selections. Anyone who has a question may press hash followed by one at this time. One moment for the first question, please. There it already is. The first question is from the line of Toby Ogg with JPMorgan Cazenove Ltd. Go ahead. Your line is open.

Toby Ogg (Equity Research Analyst)

Yes, hi, and thanks for the question. Perhaps just sort of taking a step back on the margin side. Clearly there's a big step up in the margins embedded in your EUR 10 billion EBIT guidance for 2025. And I know, Dominik, you talked at Q4 about the potential for continued margin expansion beyond 2025. And I know that the Rule of 40 is something that's being discussed in the market, and when looking at the software ecosystem. Could you perhaps just give us a sense for how you're thinking about the Rule of 40, and whether this is something you think SAP could achieve? Thank you.

Dominik Asam (CFO)

Well, I mean, the Rule of 40 is simply an observation if we do benchmarking with our core competitors, and we look at the median or the average, it doesn't actually matter, you see that that's what they trade at. The stats show us that for 2023, we are at 25%, if you combine our free cash flow to sales margin plus the growth we achieved in that year. If you look at the midpoint of the ambition or the ambition 2035, basically, you will see that would kind of bring us a little bit more than half the way towards that. Now, the rest is really much, very much dependent on how much can we accelerate revenue growth. This is why we highlight again and again, the revenue mix improving.

I highlighted 84% of the SaaS PaaS revenue is already in Cloud ERP suite, which is kind of running at 30%+ growth rates on a YoY basis. We also highlight that the strongest headwind, the decline in the software business, is becoming smaller and smaller. It's now down to 5% of the revenues, so the fundamentals are actually there to support strong revenue growth. And then, of course, there's also some improvement in margins. We said that we wanna clearly scale the cost base, not at the same growth rate as revenues. But again, we look at benchmarking and see that our core competitors achieve between 80%-90% growth of the cost base versus the revenue base. That's an indication of the kind of ballpark we aim at with our transformation program.

Now then you can basically play the math of rolling these numbers forward to see how long it will take us to come to that Rule of 40. Which, by the way, we have no idea where it will be 5, 10 years down the road, because, of course, our competitors will also not stand still. But that's the way I can describe it, so don't take it, like, as a guidance that we can-

... get there at any specific given quarter, but obviously, we have to acknowledge that this is where the market is running, and this is a little bit of the North Star we have on top of our head. And I think with the measures we are taking, now to really, A, kind of cover more than half of the gap we currently have, and then B, to accelerate growth and also to grow cost more slowly than revenues, we have the ingredients to gradually move towards the target.

Toby Ogg (Equity Research Analyst)

That's great. Thank you.

Anthony Coletta (Chief Investor Relations Officer)

Thank you, Toby. We'll take the next question, please.

Operator (participant)

The next question comes from the line of Adam Wood with Morgan Stanley. Go ahead. Your line is open.

Adam Wood (Senior Account Manager)

Hi, good evening. Thanks for taking the question. I wanted to first of all, just on the AI side, if you could help us a little bit around how that's being monetized today. Is this more that customers are accelerating the shift to S/4 because they want to take advantage of the tools that will be available there in the future? Or actually, are you starting to monetize already that Business AI feature and charging directly for that? And then maybe just secondly, you talked about EUR 7 of custom code versus EUR 1 of software. Obviously, a massive opportunity if you could capture more of that. How realistic is it that you can cover enough of the custom areas to be able to capture that? Or is this more monetization of the platform as companies and partners develop on the BTP?

Thank you.

Christian Klein (CEO)

Thanks a lot for the questions, Adam. I mean, on AI, first, when you look at the commercial model, we actually included some, you know, standard AI use cases, you know, for automation of repetitive tasks in our base packages. On top, of course, we are now delivering more and more Gen AI models, which also require high computing power. And, you know, I talked about Joule, and Joule will cover the most used transactions of our end users by the end of the year. So no matter if you do work on travel, on finance, on supply chain, on procurement, it will all happen via human language. And that is included in our premium AI offering, which is consumption-based. We package it, some AI units already in our RISE and GROW packages, and that is actually running extremely well.

And on top, of course, you can also, of course, consume Business AI by, of course, you know, buying more consumption packages of our offerings. And with regard to the adoption, I mean, the way how it works, Adam, is, of course, Joule will become the de facto user experience front end for our end users. Second, when you are then talking to the customers, what we are already doing, they will, you know, use our Gen AI scenarios for asset management, you know, for manufacturing, for shop floor automation, for more personalization of their offerings, of their services, of their products via our configurator, or they also build custom AI use cases. Why? Why do you do that with our Gen AI Hub on BTP? Because you get the native integration into the data. We can also pre-train some modules.

You have integration into the security and authorization, which matters in the business world. And these are all the benefits, the value, why our partners and customers already start to develop new AI use cases custom for their individual business. And with regard to your second question, I guess here it's also very important to mention that when you look at the momentum of our top line, I mean, it's evident that you know we are not only scaling our business with S/4HANA Finance. I mean, I'm sitting in many of these RISE mega transformations, and what we are often doing is we start with finance, then we go into Hire to Retire. We go into finance and payroll. We talk about total workforce. We Fieldglass and SuccessFactors.

So we are closing mega deals, but we are doing it step by step in a modular way, given our architecture, which ensures fast time to value. And then you scan the custom code, and the custom code is actually, you know, sometimes seven times more than standard code, ERP standard code on-prem. And then you are looking into what kind of extensions have been built. Then, for example, in oil and gas, we brought now the 10 largest oil and gas companies of the world together. We talk about trade promotion, we talk about Production Revenue Accounting, all the extensions which make a ton of sense to not custom code it anymore in ERP, to sit always on the latest release, but then developing it side by side because you need a native integration into the data module of SAP.

And of course, the security concept plays in there as well. And indeed, Adam, this is a massive uptick what we have, and it's platform consumption. And, you know, customers, partners can actually then also develop their own IP, can offer it in our app store, and then again, as I just said, for oil and gas, same will happen for retail, for manufacturing, can cross-sell it across the industry. And with that, I guess you also feel that this is also a massive transformation for our ecosystem. No custom coding, but rather building, developing software on the platform and building a massive ecosystem around our cloud ERP.

Adam Wood (Senior Account Manager)

That's great. Appreciate all the detail there. Thank you.

Anthony Coletta (Chief Investor Relations Officer)

Thank you, Adam. We will take the next question, please.

Operator (participant)

The next question is from the line of Johannes Schaller with Deutsche Bank. Please go ahead.

Johannes Schaller (Head of European Software and IT Services Sector Team)

Yeah, thanks for taking my question. Christian, you mentioned you've seen already noticeable impact on CCB from AI, and obviously last year, I think the CCB soft target was in the mid-20s. Now it looks like we're more at 27-28. I mean, it's tough to quantify the impact, I guess, but is the delta that largely AI-driven? And also, should we look at the kind of high 20s as the more sustainable growth run rate for CCB now going forward?

Christian Klein (CEO)

I mean, on Business AI, to answer your first question, I mean, Scott is also on the line, and please comment, Scott. I mean, I have no C-level conversation anymore without, you know, talking about Business AI and the impact on the business. And just, you know, last week, I had a conversation about production downs in manufacturing and how our Gen AI Hub can help, to get the machines, you know, faster up and running again, which actually would result in hundreds of millions of efficiency gains for this large chemical company. And you see in these conversations, are these AI use cases already live and fully adopted?

No, they are now in the making, but with that comes, you know, more and more consumption, and we're gonna monetize that in the upcoming quarters and in the upcoming years, and we have many more of them. And of course, when you are now using SuccessFactors, Concur, everyone is looking, you know, for more efficiencies, for a new way of working, so Joule will become the de facto standard. And with that, we're gonna see an uptick of all of our premium packages now we are building for each line of business and, of course, also for RISE and GROW. With regard to CCB, I mean, we are very confident when we look at the pipeline for the year, we see, you know, healthy renewals. We see a good pipeline, you know, to close business in the upcoming quarter.

Sapphire is around the corner, where we also make some exciting announcements around data and, of course, AI. Yeah, so we are very confident also when it comes to CCB for the remainder of the year. But Scott, Dominik, please feel free to comment as well.

Scott Russell (Head of Customer Success)

Yeah, I'll probably give two additional data points just to add on what you described, Christian. So first, as you saw in the update, the Cloud ERP Suite growth, and that covers the end-to-end capability for an enterprise, is growing, and it continues to grow strongly, ninth quarter in a row, 30% plus. But the reasons why are evolving. There is no doubt companies want best-in-class processes, be able to automate their enterprise, build in efficiency, but what they're clearly now seeing is not all data is equal. Not all data in the enterprise is equal. The data that sits in the SAP platforms is the most valuable data that they have.

And when they think forward, and they look at our innovation roadmap with Business AI, and they see the capabilities that we bring inside the core, not only will they get the benefit out of the generative AI capabilities that we do in our pl- and generative AI hubs, but then the data that is the most valuable to them is in... It's got the integrity, it has got the context, it's got the metadata, it's got the semantics, and then you can get the innovation insights. And a lot of the growth that we're now seeing, to Christian's point, there is not a single conversation that SAP is having with customers that is not linking best-in-class innovation, underlying valuable data, and the generative AI capabilities in that combination. And that's why they are excited about the roadmap, but it's already stimulating the growth.

To give you one additional data point, our cloud pipeline growth. So the pipeline that we generated in first quarter was the best on record. We continue to see strong demand, not only in what we booked and what we're generating in the cloud backlog, but also the interest from the market, and a lot of that is stimulated by our Business AI roadmap.

Dominik Asam (CFO)

Maybe just to complement that view on the kind of dynamics in the business to the financial model. You know that the biggest, single most important dilutive factor, so to speak, from CCB down to cloud revenue growth with a certain time lag, is actually the transactional business. This is now, kind of stagnating. It's actually very, very slightly even decreasing. The macro isn't great. There's also these changes in the kind of, supplier network happening. And, we think that over time, that will become smaller in the mix. By the way, that dilutive effect is also embarked in our Cloud ERP Suite growth numbers. So we show that 30%, 32% growth despite that headwind, but that's the biggest bridge item between CCB and cloud revenues.

Now, if you look at what we've kind of indicated in our Ambition '25, you see that with 28% CCB, you don't need to see much acceleration to basically get there, because you take off the dilutive effect on 5% of the revenue is basically stagnating. And we do believe that in '25, there will be some acceleration there. So it's what we really take to get to our 2025 ambition. So anything beyond that would be upside, in summary.

Christian Klein (CEO)

Yeah. And last but not least, when you look at the current cloud backlog, we release ACV numbers, at the end, we are going to talk about TCV, but customers are also trending more and more to also now sign longer term commitments, with ramps, you know, which are also then, you know, going over, you know, five years. And of course, there is enough in the books also when it comes to CCB TCV, and there, the growth is even higher than in the ACV.

Johannes Schaller (Head of European Software and IT Services Sector Team)

Very clear. Thank you very much.

Anthony Coletta (Chief Investor Relations Officer)

Thanks, Johannes. We will take the next question, please.

Operator (participant)

The next question is from the line of Frederic Boulan with Bank of America. Please go ahead.

Frederic Boulan (Head of European Software, Payments, and IT Services research)

... Hi, good evening. Two quick questions, please. So first of all, coming back on the CCB, so you mentioned the CCB is being held by the demand for AI, but can you discuss a bit more specifically what's driving that sequential acceleration? Any specific modules or areas where you see demand, or is it just the momentum in S/4? And then second question on the cloud migration, if you can give us an update on your current ERP landscape, percentage of customers that have migrated to the cloud, and what are you seeing in terms of momentum? Are we seeing some of those largest customers continuing to migrate? So any update on that would be great. Thank you.

Christian Klein (CEO)

Yeah, happy to take that question, and Scott, please feel free to comment as well. I mean, first, your second question is also actually related to your question number one. What we are seeing now with Business AI is actually that a lot of customers who probably, you know, planned their, you know, migration start date for S/4, you know, end of this year or, you know, next year, that they actually now want to move faster because they see the, the, the capabilities with SAP Business AI, as I mentioned, on asset management, on just automating many, many workflows in their company. But also when it comes to analytics, especially in the supply chain planning, which is an extremely important part of many companies right now. And that actually also has driven now, yeah, the sequential increase.

But, you know, this is not only Business AI standalone. Business AI helps us to sell more supply chain, to sell more HR, to sell more finance. And then last but not least, which makes me so confident also about the growth potential for 2025. Plus, I mean, when you start with finance and you talk about your business model, you talk immediately about the billing, about the commissions, then you're actually moving, you know, into the supply chain. And when you're doing demand and supply, you're also then talking about Design-to-Operate. And now we are seeing a huge uptick in our manufacturing cloud business.

Then you're going module by module, because when you talk to these customers, they see more and more that the best of breed really doesn't work when you have to stitch together manually, you know, data modules or the identity or the authorization. So what we are seeing in many RISE customers over time, that there are a lot of cross-sell potential and that it's the first phase is only about landing, and then start provisioning, start to redesign the process landscape, and then we go. We already talked about the custom code and the ecosystem. We are more and more building on BTP to also remove the custom code and move to the Clean Core.

Scott Russell (Head of Customer Success)

I'll just add one additional comment to what Christian described, and that is the growth on the CCB is consistent around the world, and so this is not a particular region. Across all regions, we saw healthy growth. Obviously, APJ and parts of Europe and Greater China were strong, but you know, across the world. Secondly, it is across that portfolio. People aren't doing a move only. They're doing a move and transform, and that requires those extended capabilities. If I just link it back, if you've already got the data architecture of SAP, and it's the most valuable, then you can do so many more things, not only AI-related, but also innovation-related that you can do within your business.

It is definitely means that our short, mid, and long-term growth has, you know, it's definitely got confidence based on the capabilities, the innovation roadmap, but also the buying signals that we see from the market here and now.

Frederic Boulan (Head of European Software, Payments, and IT Services research)

Okay, thanks.

Anthony Coletta (Chief Investor Relations Officer)

Thank you, Fred. Next question, please.

Operator (participant)

The next question is from the line of Jackson Ader with KeyBanc Capital Markets. Go ahead.

Jackson Ader (Managing Director)

Great. Thanks, guys, for taking our question. Just one on the large deal strength. So I think, Christian, or maybe Dominik, you called it out in terms of the $5 million+ deals driving a lot of strength in cloud ERP. Just curious, are you seeing, I mean, I assume the preponderance of that is migrations or RISE with SAP, but are you seeing any large deals for net new customers or net new lands that are also driving some of the CCB growth? Thank you.

Christian Klein (CEO)

Scott?

Do you want to go first?

Scott Russell (Head of Customer Success)

Let me, let me kick it off, and then, Christian, please add in. So, I, I think we've got to be clear, when customers decide to move to RISE, they're not just doing a move of their current environments and, and replicating the same capability. In fact, far from it. They're trying to transform operationally, process all of their data, all of their capability to serve now and into the future. They're setting their business up. And so when they look at these, which is why, to answer your question, the larger deals are because they look at a multi-year roadmap of capability, transitioning from a, an older state, including non-SAP.

So what we see is many situations where our customers will say, "Okay, I might be using SAP for core finance, but I'll then extend, i.e., ERP suite, the other capabilities," and then we're able to have a competitive displacement. That happens on a regular. So whether you look at the SKF's, the Curtiss-Wright's, and the others that Christian mentioned in his opening, and then you see the chart of all the other RISE customers, they're nearly always bringing the BTP, which is displacing other technology platforms and using that as the innovation platform. They're using other extension, whether it be Ariba, Concur, SuccessFactors, to be able to provide its people its spend.

So yes, we are seeing that, but then the compelling event is obviously an initial move and then a multi-year journey when they're on a large deal, which makes up a big portion of the, the Q1 results that you see.

Christian Klein (CEO)

... Maybe to shed some more light on top, on the numbers is, I mean, what, what you also see with RISE, it's not only that we are landing, of course, and converting maintenance with a factor of 2 to 3x, to the cloud. What we are then seeing after is that, next on land and expand, customers who wanna replace their HCM module, and this is then oftentimes a double-digit success factor, Employee Central deal. Needless to say, payroll is a massive business, which we are also more and more now shifting to the cloud. So there are, you know, a lot of cross-sell, large cross-sell opportunities after we landed with RISE. On BTP, I mentioned one customer.

Actually, for BTP, we also oftentimes see now, you know, double-digit ACV deals, you know, with our large customers, as they are not only using the platform for integration, but also for the extension, yeah, for the Clean Core journey. Then last but not least, when it comes to the volume business growth, that's rightfully driven by our ecosystem, by our resellers, but oftentimes you start with a EUR 500,000 deal with some users, it scales, and then you start finance, HR, and then you expand into manufacturing cloud or into billing, et cetera. In the meantime, you see that customers are growing from EUR 500,000 to EUR 2 million-EUR 3 million ACV.

And of course, this is not the end, but you see that this massive volume business will also further contribute to the growth, and these customers will also become, after landing and signing deals, net new customers, will also become way bigger over time.

Anthony Coletta (Chief Investor Relations Officer)

Thank you, Jackson?

Jackson Ader (Managing Director)

Excellent. Thank you.

Anthony Coletta (Chief Investor Relations Officer)

Next question, please.

Operator (participant)

The next question is from the line of Michael Briest with UBS Ltd. Please go ahead. Your line is open.

Michael Briest (Managing Director and Senior Equity Analyst)

Yes, good evening. Just on, on, your comments, Christian, about applying AI internally, I think you mentioned a figure of sort of triple-digit million. Can you give a sense of where that comes from? And, you know, is this EUR 100 million-EUR 150 million or a high triple-digit million, and over what time you might realize that? And just a quick clarification, Dominic, on the free cash flow, it's obviously very good. Did that include the final repayment of the factoring of, I think, about EUR 200 million that spilled over from last year? And obviously, you're saying that the restructuring is not quite finalized yet, potentially. Clearly, your, your EUR 3.5 billion number is, is safe, even if that number does creep up a bit. Thank you.

Christian Klein (CEO)

Yeah, I can start on the internal rollout of AI. And yes, indeed, it's a triple-digit million of efficiencies and what we are already doing right now, we roll out Joule, especially for SAP SuccessFactors, so job description, learning with Copilot, interviews, feedback, that's all automated now via Joule. In procurement, we have content recommendations rolled out in category tools. In IT, or in the cost functions, for example, take F&A, we have to screen, you know, hundreds of thousands of contracts every year. That's now completely automated with generative AI. In Scott's world, in the sales world, we actually also use now AI for content generation, for demo, demo, actually for the business case creation, which saves a lot of time. So we are rolling out AI, development, of course.

We have GitHub, but then also we are using our own SAP Build automated code generation tool, for example, for ABAP. And if you think about that, we can, you know, increase the productivity of each developer by up to 30%-40% already this year, you know, by our own SAP Build solution, and also by GitHub. You can imagine, you know, the scale and the efficiencies we are going to generate in the years to come, also by applying AI internally. Dominik?

Dominik Asam (CFO)

On the free cash flow side, and you ask about the kind of discontinuation of the factoring. I would say, it was, yes, partially, not fully, because there are some deals which might span longer term, but we basically, in 2024 discontinued this practice, so you already see a part of the roll-off. I wanna highlight, though, that, the bigger, thing, so to speak, in Q1, still is that we paid the fines and the famous $4.2 billion on DOJ, and other authorities. So that was weighing, in Q1 and is already digested. So, so we are also very pleased with the free cash flow performance in Q1.

Anthony Coletta (Chief Investor Relations Officer)

Thank you, Michael. We'll take the next question, please.

Operator (participant)

The next question is from the line of James Goodman with Barclays Capital. Please go ahead.

James Goodman (Managing Director of Equity Research for European Software, Fintech, and Payments)

Great. Thank you very much. Maybe with investor focus, I think increasingly shifting beyond 2025. Now, I wanted to come back just to some commentary around the transition at a high level, and specifically sort of framing that in a financial sense. The maintenance base that still remains in the business today, can you help us a little bit with just how much of that really needs to transition to cloud? I mean, I'm conscious that there was sales, for example, of S/4 before the RISE program, for example, came in. And really then, just when does that substantially need to be done by, given the 2027 deadline, but also the extended support period beyond that? So, just how much of the base really and over what period?

Just a related second question, just around the services business only growing 1% this quarter. I know it's a slightly tougher comp, but given the demand for, you know, implementation work and such like here around S/4, I might have expected that to be a little higher. Are you expecting it to pick back up, or is there a structural reason that it remains lower? Thank you.

Dominik Asam (CFO)

Sorry, now I was focused on the services. The first one was the

James Goodman (Managing Director of Equity Research for European Software, Fintech, and Payments)

Sorry, the maintenance.

Dominik Asam (CFO)

So maintenance, a little bit more than half of our EUR 11 billion maintenance base we have today is in products which go out of regular maintenance by end of 2027. And then the question is how much of that will still not convert to cloud, but will go to extended maintenance at a higher cost? So that's the parameter, and I think it's safe to assume that the lion's share of all that by 2030 will, in some fashion, disappear. Because we will not, as we say so many times, prolong maintenance on these products.

Of course, the rest being on other products, also, of course, on S/4 which, you know, has a kind of lifetime through 2040, so there's ample room there. But, indeed, there is an anticipation that there will be an acceleration in conversions from that angle, as people need to transition from ECC to cloud, given what I just described.

Christian Klein (CEO)

On the services business, I mean, Scott, please also feel free to comment. I mean, look, on, on services, first of all, we are delivering 90% of our projects via ecosystem. And, you know, the remainder, the 10% share, of course, what we are doing there, yes, there was some seasonality with the Easter holidays now in Q1. We had some one-timers last year in Q1. But in a nutshell, you know, of course, this business will, of course, continue to also show growth going forward. And what is very important with regard to our services business, what we are focusing is more on the high margin services. Like when you're going in into a RISE deal, you need a great architect, yeah, who connect the process, the system, and the data layer to drive this holistic transformation.

Then we have the best process experts. Yeah, when you talk about business model transformation, when you talk about Design-to-Operate, obviously, of course, our consultants need to be leading and also sharing best practices of other customers. While, of course, main parts of the technical migration, of the technical consulting will be delivered by our ecosystem, rightfully delivered by our ecosystem.

Scott Russell (Head of Customer Success)

I just wanted to add one thing on the back onto the support revenue that that Dominik described. Bear in mind that when we talk on one hand about large deals, when you've got these large programs of transformation, that includes a period of coexistence, where customers will keep the maintenance of their of their on-premise capability until such time that they've they've transformed into the cloud. So not only do you have that that steady progress, accelerated transformation, it's happening in tandem. So as you see the cloud revenue growth, you will also see the corresponding drop takedown of the the support revenues. But it is in light of a customer's transformation.

So all the RISE customers that were existing customers that you saw in Q1 and quarters in the past go through that journey, and so you can see a measured and managed downgrade of the support in line with the cloud uplift correspondingly.

Christian Klein (CEO)

Maybe one word regarding the maintenance, because I guess, yeah, this is an important factor in all the modules, in all the models. I mean, look, there are certain parts of an ERP. As I also mentioned at the beginning, it's a monolithic ERP architecture, and in there is, for example, also a BW system. And for example, a BW system is not so easily replaced. There's also a lot of custom code build. It's a massive reporting engine. And with Datasphere and with our partners, we of course also now more and more shifting this to the cloud. Will all BWs completely migrated to the cloud by 2027? No. But we will of course, partially replace them, you know, over time. So it's fair to assume that, of course, some maintenance revenue will also be after 2027.

That's all modeled in, and I rather see now with Business AI, the upside in, you know, accelerating the move of our installed base. Because every customer now finally gets it, that in the cloud, there is so much innovation, there's also with AI, differentiation. So I actually expect that we see a further acceleration of our installed base move to the cloud.

James Goodman (Managing Director of Equity Research for European Software, Fintech, and Payments)

Very helpful. Thank you.

Anthony Coletta (Chief Investor Relations Officer)

Thank you, James. We have time for two more questions, so we'll take the next one, please.

Operator (participant)

The next question is from the line of Mohammed Moawalla with Goldman Sachs International. Please go ahead.

Mohammed Moawalla (Research Analyst)

Great, thank you. I had two quick ones, if I may. First one for Dominik. You, you talked about kind of a minimal amount of the transformation charge taken in Q1. How should we think of the phasing of that over the course of the year? You know, and then I kind of understand that you're still kind of in discussion with kind of affected employees. And, how should that kind of phase through the course of the year? And then secondly, for Dominik as well, you, you alluded to earlier in the year that your kind of 2025 guidance still doesn't assume any significant working capital kind of improvements. But I know there's seasonality in the working capital, particularly in Q1. Are there any kind of plans or initiatives, whether it's around sort of shifting-...

The kind of the invoicing to annual or other kind of collections that, the levers that you can, you can press on? And would you be inclined to perhaps, you know, pass on some of those savings else to our investments in the business, or could that be seen as a potential upside risk? Thank you.

Dominik Asam (CFO)

Well, thanks. A lot of questions in one go, so to speak, almost like a planning discussion. So in terms of phasing, what I mentioned is that of the EUR 2.2 billion accrued for restructuring, very little, if anything, has been kind of paid already in Q1. So I talked about the cash out as opposed to the accrual. The accrual has been taken, and we said that the vast majority of the accruals we currently expect have been taken in Q1. Now, the program will run throughout the year and actually into Q1 2025. So it's not the final number yet. There are voluntary programs in there where we have to wait for the acceptance rate. There are still negotiations with social partners.

I did mention that in the U.S., we actually had a very high acceptance rates, which kind of drove that accrual up a little bit. Also, the share price increase has grown driven the accrual up a little bit because obviously we have to compensate more for the entitlements of the people that are leaving, because they are good leavers if we want them to leave, so to speak. But we also said that let's see what's coming beyond that, if anything. Of course, we will only go for more reductions than what we've planned in case there is a good business case. Otherwise, it wouldn't make sense. So I think you can rest assured on that one.

Now, with regards to the cash flow 2025, you mentioned that we have been not super aggressive in terms of working capital improvements in 2025. We are making some progress as we speak. I want to caution that we have really a very comprehensive transformation program, and really executing the headcount reductions is of utmost importance, so that's the key priority right now. There are certainly opportunities. We did mention that the EUR 8 billion free cash flow ambition for 2025 was assuming no spillover of restructuring cash out into 2025. So that is kind of a potential risk there, that if we spill over some cash out from 2024 or restructuring into 2025, that will weigh on that. But then the question is, I mean, to what degree can we offset?

So, I don't want to kind of go into more detail at that point in time, but obviously, this is one of the questions. As we mature our restructuring program with more clarity on how many people are leaving, at what cost, with the phasing of the cash out, we can sharpen pencil and update you later.

Christian Klein (CEO)

Yeah. But maybe one word from my side on the workforce transformation. I mean, it's as Dominik is saying, yeah, we are a little bit ahead after we started a restructuring program on, you know, people leaving SAP, and we do this in a very controlled manner. Yeah, we have identified the job profiles, which we either reskill or, you know, actually want to reduce also via restructuring. And then second, we bring all the data scientists and new capabilities also on board for the platform, which we need to capture our future growth opportunity. And if there are more levers, of course, the business case needs to make sense. So you can actually expect that we also then, of course, manage this also tightly in the next quarters.

Anthony Coletta (Chief Investor Relations Officer)

Thank you, Mo.

Mohammed Moawalla (Research Analyst)

Thank you.

Anthony Coletta (Chief Investor Relations Officer)

We will take one final question now.

Operator (participant)

Yes, the final question for today comes from the line of Charles Brennan with Jefferies. Please go ahead. Your line is open.

Charles Brennan (SVP of Equity Research)

Great, thanks very much for squeezing me in. I was wondering if you could just say something very quickly about the cloud incentives that you rolled out in Q1. I know you started those in Q4 of last year. It sounds like they were a bit more extensive in the quarter. Do you think that made much of an impact to the accelerating CCB? And I know the incentives were only for the first year of the transformation. Does it actually act as a potentially a headwind to the CCB? And then secondly, can I just squeeze a financial clarification in, just on the stock-based comp? I think you said it was EUR 100 million incremental charge in the quarter, but what are you assuming on a full year basis?

In your unchanged EBIT guidance, what's helping to offset that higher share-based comp? Thank you.

Christian Klein (CEO)

I mean, Scott, I can go first and please build on it. I mean, first of all, on the migration incentives, I guess the major change which we did, which is not impacting margins, is that we are not only incentivizing now anymore S/4HANA Finance, but we incentivizing cloud ERP, as we have to also move, you know, our monolithic ERP on-premise system to the cloud. And there, we are talking about HR, travel, procurement, all the modules I mentioned already at the beginning of the call. And they are now also incentivized to migrate, which is, makes a ton of sense, because you actually have, you know, a one-time migration fund, but then you actually have a building, a recurring revenue stream. And these deals, you know, you also see it in the multiple, the multiple has not going down, are extremely healthy.

And then while you have these one-time efforts on the migration fund, you see then the recurring revenue coming in, the cross sell, the upsell we do over the course of the years. So I actually see this as a very positive incentive for our customers, and it will also, of course, also help us, yeah, to further expand our footprint in the installed base. Scott?

Scott Russell (Head of Customer Success)

... Yeah, I think just two things to add to what you described, Christian. The first is, these customers, many of these customers have invested heavily with SAP over a long period of time. And we acknowledge that with those investments made in the past, our role about helping them on the transformation becomes more important than ever. So the transformation incentive to be able to migrate is a part of a broader picture, helping them on an ongoing roadmap, driving to that Clean Core architecture, making sure they can leverage the Business AI. So it not just provides a financial benefit, but is also the role and the method and the tooling that SAP brings to help them on that journey. And the two in combination then becomes a more compelling factor for customers to drive.

And then secondly, it can be applied in multiple ways. So the incentive can be used against not only on the, maybe their maintenance, but also for services and for other capabilities, including our ecosystem partners, to help them drive that.

Christian Klein (CEO)

Yeah. And one last word on the TCO and on cloud gross margin. I mean, you have seen, if you would now exclude the stock-based and, you know, the higher share price in Q1, actually, we have a very healthy expansion of our cloud gross margin. And what is coming from a TCO perspective, in the next weeks, months, quarters, is we are now embedding, you know, ARM processors into our solutions. We are moving more and more of our solutions also now to HANA Cloud in a non-disruptive way. It's already all baked in, also cost-wise in our guidance, which will also give us enormously more scale to also balance, you know, peak workloads much better in the future.

And then when you look at the RISE journey, I mean, the customers, you know, are now at 20%-30% of the migration done. And of course, the more workloads you're putting, you know, on the architecture, on the infrastructure, the more economies of scale you are getting. So we are also very happy with the progress we are seeing on margin, especially profits in the private cloud. So no, actually, we, I'm very confident also about a further gross margin expansion, then also not only this year, but also in the years to come.

Dominik Asam (CFO)

Maybe on the stock-based compensation, Charles. So, the kind of EUR 135 million increase was kind of the order of magnitude, which was unexpected, because we actually said that we had EUR 2.2 billion stock-based compensation last year in 2023. We said that in our ambition update when we included stock-based compensation, we included about EUR 2 billion in 2025. We also said that 2024 would be somewhere in the middle. What we now see that because of that very, very strong share price increase in Q1, that kind of EUR 135 million increase will basically feed through the year. Why don't we think that will reoccur? Because simply there are two parts to that which drove it up. One is the exceptionally higher increase in the share price.

I mean, if you think about the 29%-30% we've seen in Q1, and you compare it to the normal standard deviation you have in any given quarter over the last 10, 20 years, it's actually a 2.3-2.4 standard deviation variance. So it happens once every 100 quarters, actually, from a statistical point of view. Secondly, we are losing the sensitivity, so to speak, because this was the last kind of fully cash settled tranche under this Move 2021 program, which is by far the largest. And as we move to more equity settled, which is not flowing through the P&L, we don't expect that sensitivity to stay so high.

So now, yes, we did compensate to a certain degree in our guidance, and that's simply that we kind of grind on all corners to see how we can make up for that, because we don't want to kind of be burdened by that, but compensate. It also demonstrates how important it is to embed stock-based compensation in the overall equation. It's a real factor, and actually, it becomes more and more valuable, the better the company performs. So from that perspective, I think it was the right decision to make sure we manage it holistically, the cost base, including stock-based compensation.

Anthony Coletta (Chief Investor Relations Officer)

Thank you, Charlie, for your question and for coming. Thanks, Christian, Scott, and Dominik, and we will conclude the call for today. Thanks for joining.

Christian Klein (CEO)

Thank you.

Dominik Asam (CFO)

Thank you. Bye-bye.