SAP Q4 FY2017 earnings - a call with Luka Mucic, CFO

If anyone was expecting a blockbuster quarter from SAP then they will be disappointed. Rather, SAP reported steady top and bottom line results pretty much in line with expectations and a largely unchanged forward outlook. Here's the summary:

 

As you might expect, the company talked up the cloud momentum as follows:

 

As always with financial reporting, the devil is in the detail and I wanted to get some clarity on some of the numbers as well as additional color from Luka Mucic, CFO SAP.

Note - the answers represent an annotated version of the call we shared today.

Qu: While SAP talks about Cloud Subscriptions and Support Backlog representing €7.5bn in future revenue (up 38%), deferred revenue was stated at €2,771, up 16% from €2,383. Where does the difference lay?

A: Backlog is uncontracted volumes in the cloud. On deferred, please remember they're no longer broken out anymore between cloud and other lines of revenue as we transition to IFRS15 which has a different form of contract liability, hence you can't really compare those growth figures because one is a cloud backlog figure and the other is a total deferred figure reported under IFRS. We have a substantial piece that is secured in the deferred figure. But what I can tell you is that the numbers you're seeing are all consistent with the growth we believe will be there. So total contract value (TCV) is up 35% whereas the cloud annual contract value (ACV) is up 30% so what you get out of that is that we are able to contract with cloud agreements for a longer period of time so average contract duration has been increasing and now is up to 3.6 years. You can also expect to see us ramp up.

 Qu: We've seen numbers from DSAG that suggest SAP has a long way to go to convince customers that moving to S/4 HANA and cloud is the right strategy. Do you have a time period over which you'd anticipate that customers will move forward in larger numbers than is the case today? I'm really talking about adoption rather than license sales because adoption provides a growth flywheel in SaaS.

A: I would say that in terms of S/4 HANA adoption, having close to 8,000 is not bad in the first place. It is certainly a quicker adoption than we've seen in previous major ERP cycles. I am very pleased that we get more transformational and holistic deals than previous where the deals were more line of business and now with companies like Emirates and Standard Chartered doing complete competitive replacements of ERP and cloud solutions. On the move to the cloud, that is dependent upon the use case. Where customers don't need extensive customizations S/4 HANA is becoming a valid choice. I think this will be a gradual move where customers will get more comfortable with consuming S/4 HANA cloud. We see for subsidiaries, S/4 HANA cloud is becoming very attractive. Germany is still a market that's very open to on-premise deployments. But in the long term, we expect customers to move before the maintenance and support runs out - that's 2025 but before then.

Qu: During the press event, Bill seemed very upbeat about the global economy and so why is the forward-looking view little changed from what we already knew?

A: We continue to see very good prospects for SAP and it is indeed the case that the economic environment looks very positive in most of the major markets, it is certainly true for the U.S., also true for Central Europe with Germany remaining very strong and France having many prospects. It's important to remember that we have reiterated our 2020 vision despite adverse currency conditions. That's not strictly a constant currency ambition. When we made our forward guidance, we thought it would happen in an unchanged currency. Of course that hasn't happened but we're retaining guidance.

Qu: Following on,  I can see why the incentives to repatriate income to the U.S make business leaders happy. But then I see plenty of commentators suggesting that any upturn is likely to be short-lived because the expectation is that the implied investment bounce is unlikely to address the structural issues the U.S. faces in its labor force. Do you have thoughts on that?

A: Economists are always right, it's just a question of when.

Qu: Finally and as it relates to CallidusCloud. I said in my earlier story that I see several challenges for SAP. Integration is one but I see you've partially answered that. I assume the long-term goal will be to present CallidusCloud functions via the Fiori framework, enriched with SAP native data. Correct? Also, I have always viewed CallidusCloud as primarily a mid-market solution. The number of customers attests to that. Does that have any impact on your outlook for this solution? And, my last question on this, do you have a view on how you'll navigate the competitive position given that CallidusCloud positions Salesforce and Workday as partners yet they are fierce competitors?

A: Our chairman (Hasso Plattner) as you know is a great proponent of integration that we create a seamless end-to-end experience for our customers. Internally, we have created for Callidus a Fiori Life Experience. We render through our solution the Callidus functionality for our salesforce which we call Harmony Inside. We will continue those integrations but the big step is to migrate them to HANA which we will drive as a priority. In Leslie Stretch (CEO CallidusCloud) we have a great believer in integration. There is more to that; there are aspects of master data integration and we are currently working on a cloud master data management solution (MDM). We have a great asset in Gigya which provides the customer identity management component which we need across all the front office and market facing applications.

I think they have customers across all size classes and I can tell you that internally, we have taken a look at their SPM and CPQ components as part of a competitive situation and view them as extremely scalable. We have rolled out their SPM tool for 17,000 people and it has resulted in a light years improvement for us in terms of robustness and visibility for the sales people. We have unfortunately very complex sales processes and the tool was able to master our complexity with a very strong performance. We are happy this will scale to the largest organizations.

In terms of competitors, we are relaxed. We are very open to retaining an open offering and we don't intend to close any doors. We want to retain those relationships and partnerships. We see this as a value but we are strong enough to grow this on our own if necessary.

See also my assessment of the CallidusCloud acquisition

My take

As always in my discussions with Mucic, I enjoy the extent to which he is prepared to be open and transparent.

Why didn't I discuss machine learning, IoT and the like? SAP has work going on there but it is barely reflected in the customer base and will be a topic for the future. SAP has Leonardo but as we have said many times this is not a product but a consulting-led toolset where SAP has to get past the buzzword bingo zeitgeist.

I am conflicted on the outlook. Much depends on what SAP customers in the U.S. do with the tax breaks they are getting in 2018. I am for example mindful of the way AT&T made a big noise about giving out bonuses and then immediately fired 5,000 people.

Skeptics believe that large companies will use the tax breaks as a way of primarily giving back to investors. That's not going to result in trickle down value needed to sustain economic growth as evidenced by consumer spending. But, even if the economic uptick is not sustained, history suggests that cloud plays fare better than on-premise.

It is perhaps telling that despite the currency headwinds to which Mucic refers that SAP is retaining its 2020 vision. Quiet confidence tinged with a conservative view? Probably.

A cynic might say that this is dull but then I don't find anything dull about a company that looks forward to €30 billion in profitable, cash flow positive revenue.

Since both SAP and CallidusCloud are in pre-deal mode, there are some technical aspects that cannot be discussed with any degree of certainty and that's OK. It is encouraging that SAP has already built Fiori front ends as these could form the basis of templates for fast-track adoption by SAP customers. However, if past history is an indicator (think SuccessFactors) then SAP will have its work cut out to get CallidusCloud solutions onto HANA. Even so, SAP salespeople have an expanded playbook from which to tell the omnichannel story in retail and other markets.