SAP Q2 FY2017 - smooth and relaxed

I'm late on getting my Q2 FY2017 assessment done so apologies for that. I'm also departing from my usual approach to these earnings reports.

In the past, I'd get the releases same as everyone else and at some point on the earnings day I'd get a call with one of the execs. In recent times that has been Markus Schwarz since this readership has been intently interested in S/4 HANA progress and he leads that endeavor. Still want the deal number? 6,300. Want the number of SuccessFactors Employee Central customers? 1,800.

On this occasion no-one anticipated any stand outs from the results and so instead, I sat in on the main analyst call and didn't take an individual call.

That was an interesting experience as it must be at least two years since I've done that with SAP. For anyone interested, I created a #SAPEarnings stream that highlights the content from the call that caught my eye. I also made a rough audio recording of snippets that caught my attention. It is perhaps telling that on a 70 minute call, I only heard enough by way of interesting questions to get less than 15 minutes of recorded content.

What do you need to know?

The results were good enough for the company to 'confidently' raise the full year revenue guidance to a range of €23.3 billion to €23.7 billion (statement) while also talking about a €500 million share buy back. Earnings were lower than expected for the quarter but that was attributed to continuing investments in replatforming SuccessFactors over to HANA combined with data center expansion. I would like to see SAP break out the data center investments because we know from seeing Amazon and Microsoft do the same that these are strategic spend categories with specific payback patterns that are dis-similar to software and cloud apps sales.

From an overall performance perspective, Luca Mucic, CFO did a good job explaining how investments SAP has committed should bring bottom line rewards from 2018. More interesting to me though was the manner in which SAP laid out its battle plans going forward.

Bill McDermott, CEO SAP has never been short of an eye catching expression but on this occasion we didn't hear one. There was no '99 mile  an hour fastball' metaphors or other quirky expressions. Instead, we heard a carefully metered account of how the company sees things working out.

It is clear for example that SAPs hybrid IT strategy continues to appeal, even while it pushes hard on cloud deals. That was evidenced from Mucic's relaxed view on maintenance income decline. That decline has long been anticipated and in the past, I was of the view that unless SAP had a strong cloud story by 2017, then it could be looking at revenue falling off the proverbial cliff. I was wrong. On the call, Mucic said:

I think in general of course, we will see over time small declines of the support growth rates, but support and license and support in total will continue to be a positive contributor to our revenue growth definitely until 2020, because we continue to have very, very robust retention rates in software support and we have a high value realisation by our customers.

OK - let's stop here and consider what he is saying but let's also couple that with McDermott's assertion that despite 'high growth' in S/4 HANA and HANA adoption, it is still early in the transformation game as it applies to customers.

Sticky plus Leonardo wins

SAP is unquestionably sticky and especially in financials, the application area where it placed the most S/4 R&D effort in the 2013-15 period. It had to. Now think about value. On the call, the company subtly reinforced its value based pricing story which, to some extent, has been the bugga-boo in the indirect access story. Drop in on top of that the Leonardo story which is very clearly consulting led and where SAP is expecting to match IBM income performance. Finally, wave a hand at Google and others as in these quotes:

Google and its parent company Alphabet have chosen to work with SAP to drive operational excellence in Treasury and IT Management by implementing these functions on SAP S/4HANA running on Google Cloud.

Google expects improved efficiency and finance operations and greater transparency through real time insights. We also announced that Sapphire that we have expanded our co-innovation partnership with Google Cloud to deliver integrated cloud solutions for our customers. Many other leading companies also went live on S/4 in Q2, including MG [ph] and Bloomberg.

...We're focused on scaling breakthrough innovation, going beyond the proliferation of prototypes in the enterprise. That's why leading companies such as Google, Deloitte, Aldo and Centrica are all collaborating with SAP to build new capabilities, re-imagine business models and accelerate digital transformation with SAP Leonardo.

SBB AG and Roche adopted SAP Leonardo IoT solutions in the second quarter. ZIM, a leader in global container shipping is embracing SAP Leonardo to re-imagine their business and create the AirBnB for the container space.

The autonomous province of Bolzano, Italy is partnering with SAP to develop personal ID document authentication with SAP Blockchain solutions. All of this is being delivered to our customers through the design thinking and innovation approach that SAP has scaled globally.

And what have you got? This:

Our more predictable support and cloud subscription revenue is on target to reach 70% to 75% of total revenue by 2020. Our sustained growth and cash generation provide strategic flexibility for capital allocation to deliver shareholder value. One example is the share buyback we just announced. Another example is our consistent and attractive dividend payout. It's clear that SAP remains a strong reliable investment in an uncertain world economy.

Bulk carrier

SAP has now expanded its portfolio to the point where the much anticipated decline in maintenance, which still forms the company's most profitable bread and butter line item, is no longer the problem it once was. More to the point, SAP has understood that in order to drive the kinds of transformation that business is anticipating, it cannot leave the story telling entirely to its partners, hence the emphasis on Leonardo and Mucic's insistence upon relatively high consulting margins.

Taken together, it is easy to understand SAP's confidence in projections both for the immediate financial year and out to 2020.

Risks

Are there any risks? Possibly. SAP remains a premium solution provider at a time when there is rampant commodification and where remarks by McDermott about competitors suggest SAP doesn't always get its own way. Check these selected quotes from McDermott:

Workday can hold their own. If you're - especially if you're in the United States and you're dealing directly with the Human Capital Management Executive. It gets a little bit more interesting for us when it's a more comprehensive decisions for companies than just HR Director.

For example, they don't really have a platform. So the SAP Cloud platform and the extensibility of that. If you think about S/4HANA and the nucleus of the 21st Century Enterprise and all line of business executives evolving their use of their individual line of business with the center of gravity, the data and the process of the company. You know, that's game set match for SAP.

And when you talk Total Workforce Management, we're the only one with the network around contingent labor and therefore Total Workforce Management and that's why Gartner and others say, if you have more than 5000 employees it's all about SAP, because what you see with Workday against SAP is a good fight with the LOB HR director in the United States.

But when you get beyond the United States and you start to get into more complex industries and companies, we do extremely well. And I can only tell you that based upon the way they've been purporting themselves in the market with letters, with fake news to customers and things like that we're bringing our A-game.

Ouch!

My take

The Q2 FY2017 story was well told with plenty of morsels to keep the most ardent financial analyst happy. But it doesn't end there.

SAP needs a value based story in order to feed the revenue beast and that will work perfectly well for its lighthouse customers. However, SAP needs to exercise care that it doesn't become complacent and assume that all its customers will simply buy into the story. Life isn't like that. We know from the rumblings among user groups that SAP has plenty of questions it needs to answer among the 80% by volume that make up its customer base.

Oh yes - not a word about the South African issue on the call though I give SAP a lot of credit for getting out in front of it in the main earnings press release. As was predicted in back channels - financial analysts don't care. Until it becomes a problem.