Earnings Call Transcript - SAP Q1 2025

Operator, Operator

Good evening, everyone, and welcome. Thank you for joining us. With me today are CEO Christian Klein and CFO Dominik Asam. On this call, we will discuss SAP's First Quarter 2025 Results. You can find the deck supplementing this call as well as our quarterly statement on our Investor Relations website. During this call, we will 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 differ materially. Additional information regarding these risks and uncertainties may be found in our filings with the SEC, including but not limited to, the Risk Factors section of our annual report on Form 20-F for 2024. 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 a substitute for or superior to the measures of financial performance prepared in accordance with IFRS. Before we begin, I'd like to call your attention to our upcoming Financial Analyst Conference, which will take place on May 21st as part of our Sapphire event in Orlando, Florida. If you're interested in joining us in person, please reach out to our Investor Relations team for more information. For those who can't attend on-site, a live stream will be provided on our website. And with that, over to you, Christian.

Christian Klein, CEO

Yeah, thanks, Alexandra, and a warm welcome to everyone on the line. Q1 was a very fast-paced start to the year. Given the macroeconomic environment, I'm very happy to say that SAP did really well in the quarter. Thanks to our transformation, SAP ended the current phase of the world economy with greater resilience than ever. Our current cloud backlog expanded 29% to €18.2 billion in Q1. Our quarterly cloud revenue is now close to the €5 billion mark, showing a 26% increase. Overall, the share of more predictable revenue is now at 86%. Our very large cloud backlog and high recurring revenue share will be the foundation for double-digit total revenue growth in 2025 and for many years to come. Operating profit was up 58% in Q1 and our stellar cloud gross margin improved by 2.6 percentage points to 75%. Thanks to the diligent execution of SAP's transformation, our operating profit will also grow double-digit in 2025 and the years to come. Just last week, IDC and Gartner released new reports underlining our market momentum. IDC's update on software market share for the full year 2024 confirms SAP as the worldwide #1 enterprise application software vendor. And in cloud, according to IDC, SAP experienced the strongest year-over-year growth among the top 10 enterprise application SaaS companies. As for Gartner, in their WW Enterprise Software Report, SAP is the #1 by revenue in 2024 for overall ERP. Of course, no one can really predict how the global economy will develop throughout 2025. Without any doubt, uncertainty in the market remains high. However, several factors make us confident that SAP remains on track towards our 2025 outlook ranges. First, I just mentioned SAP's highly resilient business and financial model and our excellent market position. Second, our pipeline for the year continues to look very solid. Third, no other tech company can offer a solution portfolio that is more relevant in times of new regulations, tariffs, and business uncertainty. Our globalization team localizes SAP's portfolio, including solutions like Global Trade Services Management that enables our customers to manage every single global transaction in real-time and fully compliant in over 130 countries. To steer the company through uncertain times, our customers can run real-time financial simulations based on internal and external data with SAP Business Data Cloud. To adapt a company's business plan to new market realities, SAP's Analytics Cloud and IPP integrate in real-time sales, supply chain, HR, spend, and financial planning with each other to make cross-company decisions fast and in harmony. And finally, across our portfolio, embedded AI and Joule are boosting the productivity of a company to offset financial pressure. Net-net, this means SAP's portfolio is highly relevant. We can't change external uncertainty, but we can help our customers like no other company to manage those challenges, compliant with high agility and empowered by AI. Now, let me share a quick summary of the quarter. The figures underline once more that SAP's growth formula is solid. We have done our homework and we benefit from that. Current cloud backlog kept growing at a very high pace in Q1. Cloud revenue continued to grow strongly even as the base has expanded. Total revenue growth moved further into double-digit territory. Operating profit, operating margin, and cloud gross margin performance have and will heavily benefit from our transformation program. And again, about half of our cloud order entry included deals that contained AI use cases. The deals in Q1 offer a compelling insight into how customers are navigating the current business environment. Let me start with an impressive series of major deals in the automotive sector. As you know, the car industry is undergoing an extensive transformation. New business models and competitors are emerging, cost pressure is increasing, sustainability continues to be a challenge, and there is the need to adapt to a changing global trade system, including tariffs. How does the industry deal with these challenges? As our customer wins indicate, auto companies rely on SAP's industry best practices, solutions, and tools to transform their value chains by embracing the cloud and AI. In Q4, as you remember, Robert Bosch and Schaeffler signed up for their RISE journeys, and MAHLE went live. Now in Q1, others from the who's who in the industry joined the ranks, Hyundai, Kia, and Mazda, as well as the automotive supplier Webasto. Customers in other sectors rely as well on SAP's business transformation offering RISE. In Q1, HUGO BOSS, Tyson Foods, and the chemical group SYENSQO, and Japan Railway. And in the public sector, the German Federal Employment Agency, Bundesagentur für Arbeit, as well as the police force in the state of Baden-Württemberg decided to put their trust in SAP solutions and sovereign cloud technology. For all customers on their RISE journeys, we have been accelerating time to value while reducing the implementation costs of SAP projects with excellent AI tools such as Joule for Developer, Joule for Consultants, and business transformation tools like Signavio, LeanIX, and WalkMe. As for GROW with SAP, two-thirds of our deals in Q1 were net new customers, which underlines the attractiveness of our offering for fast-growing companies in the mid-market. One example is Gymshark, a fitness brand that selected us over a competitor. What convinced them to choose SAP was the scalability and broad functionality of our suite offering, as well as our industry-specific solutions for retail. Other examples include the sustainable steel company, Stegra, as well as VFS, a global provider of visa application services, selecting our end-to-end business suite applications. Finally, some Q1 customer examples from our lines of businesses. In supply chain management, we won KION GROUP, a global leader in supply chain and logistics solutions. In human capital management, we won the travel company Booking, and Axpo Services, the largest electricity provider in Switzerland, went live on SuccessFactors. In business networks, we won the media company, Times Group, India, and the mining firm, Amman Mineral. And the chocolate company, Alfred Ritter, home to the famous brand Ritter Sport, celebrated a go-live in our network. Last but not least, BASF Coatings went live in Q1 on our sustainability portfolio. All these customer stories show how we are winning with our modular business suite and our transformation offerings RISE and GROW with SAP, capturing every customer size and industry. Let me now summarize what happened in Q1 in terms of product innovation, commercials, and simplification. First, let me start with product innovation. In February, we presented one of SAP's most exciting innovations ever and the greatest opportunity since RISE, SAP Business Data Cloud. Business Data Cloud is the new center of gravity for business data. It unifies and governs all data, SAP and non-SAP, structured and unstructured. It builds a strong semantical layer with the context, connections, and meaning of data. Thanks to our new partnership with Databricks, Business Data Cloud will become the #1 offering in the data analytics market. Thanks to the Business Data Cloud's strong value proposition, the pipeline for the coming quarters is building up very nicely. In Q1 alone, we closed 20 deals including KION GROUP, Villeroy & Boch, the pharma company Ferring, and the metals manufacturer Tibnor. Business Data Cloud is not only groundbreaking in how it brings together data, but it is also a pillar for high-performing end-to-end AI agents. Why? Because it takes three things to build truly powerful AI agents. First, access to a harmonized data layer with strong semantics, that's SAP's Business Data Cloud. Second, a smart AI stack toying on the best GenAI modules and technologies; that is SAP Business AI. Third, fully integrated applications so agents can cover business processes end-to-end; that is our SAP Business Suite. SAP is the only company to have all three of these pillars in place, and that puts us in a unique and very strong position to win in the agentic AI space. When we work with customers, AI adoption is more than a one-time event, it's a journey. Take for example Standard Chartered Bank; they went live with the first AI use cases in SuccessFactors. They then released Joule to over 80,000 employees and are leveraging the GenAI hub. With all our AI customers, we systematically drive adoption from the first implementations of use cases all the way through to agentic AI. At Sapphire, we will make exciting announcements about our AI capabilities. Continuing now on the topic of innovation, we are also evolving our commercials. We are updating our RISE offering with enhanced packages. They now include the solutions for business transformation management, solutions well integrated into our business suite portfolio to accelerate time to value and cut SAP project costs. And with the flexible cloud addendum, we make it easier for customers to switch from private to public cloud within the existing contracts. Besides innovation, we continue to focus on our own productivity in these turbulent times, and we are transforming the company along the way. We are fully on track to deliver the internal AI efficiencies for this year. Let me share some examples with you. Our consultants save up to 90 minutes per day with Joule for Consultants. Joule helps them, for instance, to find and use best practices, analyze unfamiliar code, and prevent suboptimal design and implementation errors. And with AI tools such as Joule for Developers, our coders are 30% more productive, accelerating our innovation pace. Finally, in addition to the internal use of AI, we are rolling out a standardized and automated cloud contract starting this quarter, reducing the time from the quote to provisioning a system to under 24 hours. All-in-all, our productivity gains help us to decouple top-line growth from costs. They also give us flexibility to hire less than originally planned. And when we hire, we can focus on growth areas with targeted job profiles, for example, in AI. Now, let me conclude, we delivered a strong Q1. Customers seek our advice and solutions in uncertain times, and we have laid a very strong foundation for a resilient company, and we will continue to do so through product innovation, simplification, and an even better go-to-market setup. It is difficult to make projections for the entire year, but all the aspects I just mentioned make us confident for the longer term. We are in the right place, we are doing the right things, and this will pay off. At Sapphire, in May, we will go deeper into these areas and look at the next chapters of SAP's growth story. I would be delighted to see you all there. And with that, over to you, Dominik.

Dominik Asam, CFO

Thank you very much, Christian, and thank you all for joining us this evening. We kick off 2025 on a high note, driven by the continued acceleration of total revenue and a whopping increase in operating profit in the first quarter. Our current cloud backlog remains healthy despite the volatile and challenging macro environment. This performance reflects the strength of our strategy, the momentum of the cloud ERP suite, and the impact of our strict cost discipline, which renders our profitability and free cash flow more resilient. With the 2024 transformation program now concluded, we are well positioned to execute on our priorities this year, including focused investments as we expand our suite-first, AI-first approach throughout our portfolio. Across industries and organizations of all sizes, from the world's largest enterprises to growing businesses looking to scale quickly, we continue to see high customer engagement as companies turn to us for end-to-end business transformation. Now, let me provide more details around our financial highlights. Current cloud backlog reached €18.2 billion, up 29%. Cloud revenue grew by 26% year-on-year, supported by the strong performance of the cloud ERP suite, which maintained its high growth momentum with a 33% increase in Q1. It accounted for 85% of total cloud revenue in the first quarter, underlying its strengthening position as a key contributor to our growth. As cloud bookings were again very back-end loaded in the fourth quarter of last year, some cloud contracts that entered current cloud backlog as of year-end 2024 were provisioned only later during the first quarter, so they will only be visible in cloud revenues for a full quarter in Q2. And the deterioration in macroeconomic conditions continues to weigh on transactional cloud revenues. Software licenses turned out to be surprisingly resilient and decreased by only 10%, but given that Q1 tends to be a small quarter for software licenses, I would caution you not to extrapolate too much from that. Finally, total revenue came in at €9 billion, up 11%. So 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, Chile, Germany, India, Italy, South Korea, and Spain had outstanding performances, while Canada, China, France, Japan, Singapore, and the US were particularly strong. Now, moving down the income statement, our non-IFRS cloud gross margin for the quarter continued its upward trend and expanded by 2.6 percentage points to 75%, driving cloud gross profit up by 30%. IFRS operating profit increased to €2.3 billion in the quarter, positively impacted by a restructuring expense decline of €2.2 billion in the context of the 2024 transformation program. In the first quarter, non-IFRS operating profit was up 58% to €2.5 billion, way above the 26% to 30% growth rate we have guided for the full fiscal year 2025, a highly welcome head start to de-risk our bottom-line guidance in times of environment, which I trust you will all agree, has become much more risky. Both IFRS and non-IFRS operating profit growth benefited from the operational efficiencies realized through successful execution of the 2024 transformation program. The IFRS effective tax rate in Q1 was 27.2%, and the non-IFRS tax rate was 29.4%. Operating cash flow in the first quarter was up by 31% to €3.8 billion, and free cash flow increased by 36% to €3.6 billion. The increase was mainly attributable to the higher operating profit. Finally, basic IFRS earnings per share increased to €1.52, and non-IFRS earnings per share increased to €1.44. So moving on to the outlook. As you've likely seen in the quarterly statement published a little bit earlier today, we decided to leave our 2025 outlook across all metrics unchanged. While our pipeline remains healthy, conversion rates could be negatively affected by further deceleration of current trade disputes. Needless to say that the rapid unwinding of decades of productivity gains driven by the benefits of globalization in the context of an escalating trade war would likely result in a severe global recession. I want to stress that our outlook is not based on such an adverse scenario, but rather assumes conversion rates consistent with prior quarters and years. In light of the risk of escalation, we remain fully focused on disciplined execution and safeguarding both our bottom-line and free cash flow by prudent cost management and other elements within our control. In summary, Q1 reflects a strong start to the year, highlighted by continued total revenue acceleration and standout profitability. The momentum we continue to see in the cloud ERP suite provides a certain degree of visibility and reinforces our confidence in SAP's long-term success. As macro-uncertainty persists, we are more focused than ever on disciplined execution, protecting our bottom-line and free cash flow throughout the remainder of the year. Before we move on to the Q&A, I would like to say that we are very much looking forward to welcoming as many of you as possible to our Financial Analyst Conference in May. As Alexandra mentioned already, and Christian, too, it will take place again in conjunction with Sapphire in Orlando. It is a unique opportunity to do some serious tire-kicking of our solution portfolio and ecosystem, and the team and I are very much looking forward to meeting you there in person.

Operator, Operator

All right, thank you, Dominik. And with that, we will now take your questions. I would like to kindly remind you to only ask one question when prompted. Operator, please open the line.

Operator, Operator

Ladies and gentlemen, we will now start the question-and-answer session. The first question is from Michael Briest with UBS. Your line is now open.

Michael Briest, Analyst

Thank you. I'll start with a question about current trading. Some other companies have mentioned disruptions at the end of the quarter. Since we are almost through April, can you confirm if your assumption that historical close rates will continue is still valid considering what you've observed in the past few weeks? You highlighted successful examples in the automotive sector. Can you provide any additional insights to support your confidence in the cloud revenue guidance, particularly regarding the transactional business?

Christian Klein, CEO

Yeah, Michael, I can start, and then please, Dominik, comment as well. I mean, look, I just did travel to the United States, I was in Australia, I was in Korea, Seoul. And when you talk to our customers, also after all the new regulations hit the market, I mean, the conversation really centers around how can we help to gain resiliency in supply chain? How can we help to manage tariffs? I mean, all these, especially the multinationals, they have to run a compliant business everywhere in the world. On the sourcing side, how can we pick the right suppliers given all the tariffs that are in place? And then, obviously, what can we do on with the Business Data Cloud you just released which landed extremely well in the market to simulate and to adjust our plans to the new market reality? So, that actually gives me the confidence. I mean, Michael, what, of course, also came up is the cost for an SAP project. And there we are targeting also with Joule for Developers, Joule for Consultants, which are also again we're getting really, really good feedback about how can we cut costs in implementing our business suite? How can we accelerate the faster time to value? These are not the days where you can come to a customer and lay down a several hundred million dollar project without having also some instant value in the business case. And that actually has resonated really well in the last weeks. The pipeline, also, for the year, as I mentioned, remains intact. We really see that we have a solid, really good pipeline for the year. And so far, also not in April, we have not yet seen that there is any deterioration of conversion rates in the pipeline. But of course, Michael, I mean, who has a crystal ball these days? We are watching the geopolitics very closely and, of course, also observe what is coming.

Operator, Operator

The next question is from the line of Ben Castillo with BNP Paribas. Your line is now open.

Ben Castillo, Analyst

Good evening, and thanks very much for taking my question. Just on the cloud revenue growth decelerated a little from what we saw at Q4, how much of that deceleration was caused by, you mentioned, the later timing of some cloud deals that you signed in Q4? How much of that came from maybe some delayed ramp-ups from some deals? Or how much came from the transactional apps? If you could just help us break apart that slight deceleration? And I guess, as a follow-up, you need a bit of an acceleration here to get back to that guidance growth range for cloud revenue. When can we expect that to come back? Is that something that can come back in Q2 as those Q4 deals start to ramp up, or is that something that needs to happen later in the year? Thank you.

Dominik Asam, CFO

Maybe this is also a good opportunity to also answer the transactional revenue question, which has been also raised in the prior question. So, indeed the transactional revenues in Q1 were back to a slight decline. You recall in Q4 we were actually going up a little bit slightly up. So, indeed here, given that this is the most exposed business to macro, not surprisingly, it has also seen a relatively weak performance in the first quarter. On the back-end loading of the transactions, there is a certain lead time for provisioning these cloud deals. So, it's very clear that when you embark these deals in the backlog at the very end of the quarter in Q4; maybe January, February, they are not fully effective in revenues, and you then have a step-up in Q2 when it's full quarter effective. So, that's a meaningful delta and has been a little bit of that effect also seen in Q1s of prior years, but not to the same extent as this year. We do think that also in Q2, we'll see a certain acceleration again because the comps are frankly easier. Let's not forget that any single quarter in cloud revenue can always be a little bit distorted by what happened in the prior years and quarters in terms of maybe some de-booking. So, for instance, in Q2 last year, we had a hit with a customer that went into a financial distress situation that we stopped booking cloud revenues on; and that, of course, makes then the comps for Q2 easier. So, still, we believe that the CCB is a good indicator of how the next four quarters will look. It's the kind of contractually committed rolling four quarters ahead. Yes, we have to take the haircut from transaction revenues, which is maybe a little bit higher than what we had initially expected. And then, it also leaves a question about the macro, which we discussed in the prior question. I mean, needless to say that before the upper half of our guidance range to materialize on cloud revenues, we would need to see a pretty benign outcome of these trade disputes, that actually we would need to see some resolutions on these disputes quite quickly and to a large extent, in an adverse scenario, of course, it's anyone's guess what type of GDP impact that might be, and I think also that it is premature now to try to forecast. So, that is a little bit the color I want to give around that. So, not an easy environment, but as Christian mentioned, we are solidly on track. The fundamental pillars of our growth are stable, and customers are grappling for productivity gains and trying to reduce costs with our tools.

Operator, Operator

The next question is from the line of Toby Ogg with JPMorgan. Please go ahead.

Toby Ogg, Analyst

Yeah, hi, and thanks for the question. Perhaps just on the current cloud backlog, so 29% in the quarter stable versus the 29% exit rate in tracking, I know it's just Q1, but tracking above the current full year guidance for a slight deceleration. Has the current cloud backlog tracked above your expectations in Q1? And if so, what was the driver of that? And then, could you also just give us a sense for what you're seeing under the surface in the backlog, particularly in March and April across various end markets and customer groups? Are you seeing any different dynamics because of all the tariff uncertainty, with some verticals potentially holding back a bit but others perhaps moving a bit quicker? Or are you seeing very similar trends to what you've been seeing over the past few quarters despite all the incremental tariff uncertainty? Thank you.

Dominik Asam, CFO

Okay. Maybe on the CCB, it was actually expected because the same technical effect I described with the provisioning lead times is also affecting CCB. If you have these late quarter end closings, they are of course in the backlog, but for the CCB, they might not be for 12 months in the backlog, but maybe for 10 months or 11 months. And then, when you roll it forward to end of March, they are actually in the backlog for a full 12 months plus the ramps included in these deals. So, that was clearly something we'd expected. So, it's a little bit kind of an artifact I'd say from that back-end loading of the seasonality of Q4 which will normalize. So, we are still fully in line with the guidance we've given to a slight deceleration. Also, recall that towards the end of the year, the CCB boost by the acquisition of WalkMe will also fade out. So, we're very much on track, I'd say.

Christian Klein, CEO

Maybe on the industry question, do we see differences now in industry, how the pipeline and the conversion rates now unfold? No, I mean, you see that in Q1, we signed many auto companies. And to Dominik's point, in these conversations with the auto companies, oftentimes the business case is built around supply chain, is built around productivity with AI. It's also about the change of the business model around order to cash. So, it's not right to say these industries, which are maybe hit hard now short-term by tariffs, now buy less software. No, we are not seeing this correlation yet in the pipeline.

Operator, Operator

The next question is from the line of Charlie Brennan with Jefferies. Please go ahead.

Charlie Brennan, Analyst

Hi there. Thanks for taking my question. Understandably a lot of questions there on the macro and visibility in the business, but can we just touch on product innovation for a moment? There's obviously a lot of focus on the Business Data Cloud. Can you just give us a very simple explanation of how that differs from the original SAP Datasphere? And how do we think about that being incremental to what you're doing as opposed to just a rebranding of original data strategy? Thank you.

Christian Klein, CEO

Happy to do so, Charles. Datasphere was primarily focused on optimizing the technical integration between SAP systems like our business warehouse, HANA, and non-SAP data lakes to prevent costly data duplication and associated security risks. Therefore, Datasphere was a significant progression. However, Business Data Cloud offers much more and also reworks SAP's previous strategy regarding data. In the past, we didn’t share our data module, which is highly valuable for SAP. Now, with Business Data Cloud, we are enabling companies, such as retailers, to integrate consumer data from various SAP systems and also from non-SAP sources like marketing and social media. This integration has been a major challenge for businesses worldwide, as they seek to gain a comprehensive view of their customers, materials, suppliers, and employees. We are allowing customers to match and analyze all their customer data semantically, which enhances their understanding of customers on a deeper level. This approach simplifies data comprehension without needing extensive IT resources. With Business Data Cloud, businesses can better manage operations and improve customer satisfaction through a solid grasp of their data. Additionally, in terms of AI, we are witnessing the potential as our AI capabilities now utilize high-quality SAP data alongside semantic data from non-SAP sources. I believe you can see the significant value here. When we launched RISE, we experienced initial momentum, but compared to Business Data Cloud, we are currently observing an equal or possibly even stronger momentum in pipeline development.

Operator, Operator

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

Mohammed Moawalla, Analyst

Thank you. Hi, Christian. Hi, Dominik. I have a question about the increase in the number of deals over €5 million in order entry, which has risen to 54% from 52% a year ago, despite the current environment. You mentioned close rates, but in terms of these larger deals, are you observing any insights from customer discussions indicating they still want to move forward as planned regarding the size and scope of projects, or is there a tendency for uncertainty to lead to changes and delays? I would like to know if this trend is sustainable. Additionally, Dominik, regarding FX, you've assumed a rate of $1.08, while current rates are $1.14. Is there a specific reason for using the $1.08? Thank you.

Christian Klein, CEO

I mean, I can start on the large deals. And indeed, you see a tick up and to also further secure those large deals also in the quarters to come. I mean, we, of course, running an extremely diligent account planning process where we really want to understand the value of a deal, I mean, at quantified value, not only blah, blah, but really quantified value. What does it deliver? Not only TCO, but also ROI. Second, to which C level we are connected? Is the CFO in the loop? Is the CEO in the loop? Is the head of supply chain in the loop? Who is in the loop? IT is great, but we also need the lines of businesses, especially in times like that. And then, when you look into some of the larger deals, I mean, you see it actually every time when we report our total cloud backlog, you see there is a phasing in there. So, these €5 million plus deals; they are not hitting OpEx wise and right away in the P&L. There is a phasing. And this phasing is natural given the mission-critical nature of SAP projects. You need time for the architects to finalize the architecture, the way how to move to our business suite. You need time to work with the business on the business processes. It's more than only a commodity business where you move to a new hardware; I mean, it's really about business transformation. And that ramp is, of course, also good in times like that where customers, of course, want to see with the ramp of the subscription fee, of course, in the same way the value we are delivering, especially to those large customers. Dominik?

Dominik Asam, CFO

A weaker dollar presents a challenge for us in the mid to long term, but we have a system for forecasting at constant currencies. Last year, the average exchange rate was $1.08, which we are using as our guidance for 2025. With the weaker exchange rate, both revenues and operating profit are expected to decrease. The hedges we are putting in place are effective for free cash flow, although they are accounted for differently on non-IFRS operating profit. This reinforces our need for a constant currency methodology. For free cash flow, we’ve already hedged a significant portion of our exposure at higher rates, providing us with reasonable protection. The sensitivities indicate that for every $0.01 change in the euro-dollar exchange rate, we anticipate a decline of about €30 million in total revenues for the full year, with over half of that impact coming from cloud revenues. The mix of US dollar cloud revenue compared to total revenue is slightly higher in cloud revenues. Operating expenses are also likely to decrease due to dollar-denominated costs, which make up close to 40% of our expenses. While we have some protection for free cash flow in 2025, 2026 poses greater challenges due to the impact of the exchange rate decline. This is why we have provided guidance on constant currencies in the past regarding free cash flow, as the effect of currency fluctuations will be realized over time once the hedges expire.

Operator, Operator

The next question is from the line of Adam Wood with Morgan Stanley. Please go ahead.

Adam Wood, Analyst

Hi. Good evening, Christian. Good evening, Dominik. And congratulations on the first quarter. Maybe just first of all, I think Dominik, you've been reasonably clear that there's a willingness to protect both the profitability and cash flow of the business. Could you maybe, I mean, just actually reiterate that, but also more importantly, maybe just give us a little bit of a feeling for how much flexibility there is there? You obviously come into this year in a great position with headcount down slightly year-on-year and kind of flattish versus the fourth quarter, and how far you'd be willing to go in terms of protecting that if the top-line were to weaken further? And if I could sneak in just a cheeky follow-up on Charlie's question on the Business Data Cloud? I mean, we've talked about maintenance payments of a notional €20 million going up by 2x to 3x. I mean, in that context, could you give us a feel for how big those Business Data Cloud sales could be if a customer was also to add that into the contract as well as the other things they're upgrading when they go to RISE? Thank you.

Dominik Asam, CFO

Maybe on the profitability, yes, indeed, we are pretty low on headcount. I mean, we've seen about 3,000 people leave. We've rehired some people, but currently, we probably are looking for a little bit of more back-end loading to see how the situation on the trade dispute will evolve. So, yes, we are talking about, I'd say, a cushion of several thousand employees we can play with without having any major impact now. But at some point in time, we want to invest in important topics like AI, like Business Data Cloud, like the further integration of our portfolio. So, we will make sure that we balance the kind of near-term pressure versus the mid-to-long-term needs to be future-proof. There's also some more discretionary spending on marketing and topics like that. But again, I mean, for the time being, I would not see that we throw all that in. We have to watch what's happening. It's very unpredictable. But we just want to make the comment there are some levers and we are currently a little bit prudent on how we are going to phase these expenses to make sure that we have some room for maneuver should the situation deteriorate.

Christian Klein, CEO

To conclude, Dominik is absolutely right. We still have plenty of business ideas to explore. When examining our cloud gross margin, the total cost of ownership of our solutions, and the harmonization of our technical stacks, we are actively working to further align our delivery and lifecycle management with these solutions. We are optimizing our HANA cloud database, which is performing well, both in supporting our solutions and in extending our business suite concerning Clean Core and analytical scenarios. We have many operational strategies to enhance our cost ratios. Regarding the Business Data Cloud, there's significant variation. A key factor for larger deal sizes is whether a customer has a BW system, as these instances tend to be large and data-rich, similar to ERP systems. If a customer decides to migrate these BW systems to the cloud, what sets Business Data Cloud apart is the semantic layer, which can lead to substantial deals. Additionally, we have new customers who bypass BW and start smaller, integrating our data warehouse with our applications and exploring a few data products semantically before expanding. In these scenarios, it's exciting that we can position ourselves in a space we might not have entered without Business Data Cloud. When you visit us at Sapphire, you’ll see how we are developing a marketplace for these data products. We are not only creating semantics with our team but also collaborating with customers and partners to develop these data products. Over time, this will enable us to expand within existing BDC customers using these offerings.

Operator, Operator

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

Jackson Ader, Analyst

Great, thank you. Thanks for taking our questions, guys. In the event that there would be some potential disruption from the macro environment in the pipeline conversion rates, do you guys think that it would be maybe cloud migrations or it would be net new activity that would have maybe a bigger impact? I guess, asked in a different way, is there any part of your pipeline that you feel is better insulated from a potential macro disruption than another part of your pipeline? Thank you.

Christian Klein, CEO

I mean, as Dominik already shared, I mean, Q1, you saw some factors in the cloud revenue which had a lot to do with the heavy boost in order entry we have seen in Q4 and the time it takes to provision. Now, what Dominik also said is in Q2 you can assume already a slight acceleration of cloud revenue given the strong Q4 which we had on the CCB side. It's rather the other way around. I mean, obviously, this is now a large, large installed base Q2. It's also not volume-wise our biggest quarter. And now for the rest of the year, when you look at the kind of uncertainty we see, obviously, still Q2, partly Q3 will matter for our Q4 cloud revenue performance. Q4 itself will not have a big impact anymore on this year's guidance because the revenues will come in the next year. So, the good piece is when you read into this, I mean, there is not now a large swing on cloud revenue and total revenue, still obviously, we assume conversion rates like last year, like the last quarters, and still we are seeing this also happening. Now, with regard to, is it then more net new or installed base? Look, I mean, when I mentioned some net-new customers, I mean, VFS extremely successful. They have outgrown their current ERP by a lot. In order to now reach the next step they have to have a suite that allows them to scale their business. So, in this case, customers will buy software. And also in the installed base, I mean, it really depends on where the customer sits. If you are sitting on a very outdated ERP, I mean the time and the value of moving now, I mean, is in my eyes so big that still that the business cases should really actually make sense even if the macro now gets worse. Now, of course, how much does it get worse? I mean, are we walking into a recession? I mean, then we are talking about all kinds of scenarios which will, at some point in time, impact every business in the world. But this is hard to predict what we said, and this is why given what we see right now, the pipeline, the relevance of our portfolio, we actually remain confident for the rest of the year.

Operator, Operator

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

Frederic Boulan, Analyst

Hey, Christian and Dominik. Thanks for taking the question. If I can touch on EBIT and free cash flow, a very strong Q1. If you can discuss some of the moving parts into the rest of the year? Any phasing to bear in mind? We saw strong improvement in cloud margin. Any specific driver there in terms of mix or in private cloud in particular improvement there? And maybe as it leads to free cash flow, you significantly accelerated the buyback in April. You've reached more than 90% of the €5 billion plan now. So, what's next in terms of potentially further expanding your program considering your very healthy balance sheet? Thank you.

Dominik Asam, CFO

The margin composition showed a broad improvement with notable expansion. The gross profit increase was positive, and there was a significant enhancement in the selling expenses to sales ratio, as well as improvements in R&D and G&A ratios, the latter of which was already low, by leveraging new technology and managing headcount growth. Regarding free cash flow, we performed well, but it wouldn’t be wise to raise guidance on any of these parameters due to the current uncertainties. We are committed to completing our €5 billion share repurchase program and will consider our next steps after this year. There may be opportunities to acquire assets if valuations decline, but this depends on whether sellers adjust their price expectations appropriately. If no significant mergers or acquisitions occur, we still have the capacity to initiate a new program. Overall, our cash generation capability remains strong, instilling confidence in future capital return programs unless there are major M&A activities.

Operator, Operator

The next question is from the line of Mark Moerdler with Bernstein Research. Please go ahead.

Mark Moerdler, Analyst

Thank you very much, and congratulations on the strong start to the year and the reiteration of the guidance. I'd like to look at the question of tariffs more generally, how you think about that impacting your business? And more specifically, given the tariffs that are right now on hardware and servers and data center components, do you see that impacting your cloud gross margins? Is that something that you could pass along to the clients? Any color would be appreciated.

Christian Klein, CEO

Yeah, good question, Mark. I mean our strategy is mainly based on a four plus one strategy. So, what do we have? We have four hyperscalers plus our own converged cloud. And with these hyperscalers, I mean, you see the success we are having in the cloud. Obviously, we have closed multi-year contracts which give us some price security. And obviously, given that we are consuming really heavy volume still also today we feel we are really in a solid position when it comes to extending those contracts. And again, we are having four plus one; we also have our own converged cloud. And actually when we are looking at AI and the chips, I mean what we are actually seeing is now, of course, before tariffs that the cost for the hardware became, of course, materially cheaper with many new open source modules, with the technology becoming more mature, I mean that helped. And so, that's why net-net plus the TCO improvements what I mentioned, I mean all our product owners are incentivized to further bring down the TCO. We have more ideas to come. So, we first of all believe that especially on the hardware side, I mean, we are not purchasing hardware directly so much; we are consuming it oftentimes via the hyperscalers, there we have some kind of price security. We are not planning now short term. I mean, obviously, everything to be seen under the different macro environment that we have to increase now prices for our customers because of tariffs. We are not seeing this right now.

Dominik Asam, CFO

The supply chain for data center equipment is primarily located outside the US, with components manufactured and semiconductors and PCBs assembled abroad. While there is a potential for global trade barriers to escalate, we should not overreact at this moment. There may be a minor impact in the US since we have some equipment, like smartphones and PCs for our employees, that would need to be imported from the non-US supply chain. However, this isn't significant enough to alter our guidance. For now, we can manage this situation.

Operator, Operator

The next question is from the line of Sven Merkt with Barclays. Please go ahead.

Sven Merkt, Analyst

Great, good evening. I have a follow-up question on your own infrastructure business. I know you have de-emphasized this a few years ago, but given recent geopolitical events, have you received increased client interest in your own infrastructure offering? And are there perhaps any considerations to revitalize this somewhat or work with additional partners? Thank you.

Christian Klein, CEO

Yeah, very good question. And look, I mean, now we have so far not seen existing SAP customers changing the infrastructure because of geopolitical tensions or tariffs. Of course, there are customers now reaching out in one or the other country and saying, 'Hey, what would be the cost of moving to a SAP infrastructure or if to any kind of sovereign cloud offerings that we have?' But again, we are not seeing right now that really customers are now taking action, and the outreaches we get are rather few, not many. Now, on sovereign cloud and building up world-class data protection and data security offerings. I mean, you have seen in our Q1 we have signed a few deals, large deals in the public sector, and in Germany we have NS2, in the United States, a fully independent company of SAP and with a dedicated sovereign cloud offering, which we are heavily investing into for the United States, we have in Australia, Japan, et cetera. And so, we are building up these capabilities. But you also have to always educate our customers on, especially in the public sector, what sovereignty really means. I mean, sovereignty can mean a lot. You can have data location sovereignty, you can have sovereignty when it comes to who is touching the data. You can have sovereignty with regard to access of networks to global networks. And so, we are offering different levels. And so far, what we also have seen even in the public sector that it doesn't always need to have the highest degree of sovereignty. And so that is also a very positive sign that we oftentimes can also use our own data centers or hyperscaler data centers to offer sovereign cloud capabilities.

Operator, Operator

The next question is from the line of Keith Bachman with BMO. Please go ahead.

Keith Bachman, Analyst

Good evening, and thank you very much. I wanted to go back to the Business Data Cloud. Can you discuss what an average uplift on a client relationship or payments might look like over the next three years? Would it be around 10%, 20%, or higher? Additionally, is there a concern that the Business Data Cloud might take away from other areas of spending that would typically be allocated to SAP, or do you see this as purely an additive effort to create a new data lake that supports the wider ecosystem? Lastly, can you provide any insights regarding the margins associated with the Business Data Cloud? Given that Databricks is the underlying technology, does this business negatively impact margins as it develops? That's all from me, and congratulations on what I believe will be a strong software report compared to other software companies in the coming weeks. Thank you.

Christian Klein, CEO

Business Data Cloud is not meant to replace other assets in our portfolio. We have already phased out many data warehouse capabilities in our legacy and acquired stacks with our Data Warehouse cloud offering, and we are continuing this process. However, SAP software will not be replaced by BDC. In regard to customers with large BW systems, they are paying maintenance fees for those systems. Similar to our RISE journey with ERP, the transition will depend on the financial advantages of moving from on-premise support to cloud revenue. We are confident in our value proposition and believe we can price this asset with a healthy margin. As for the overall margin of BDC, it is important to note that Databricks receives a significant portion of these deals, resulting in an acceptable but not exceptional margin. The higher margins will come from the data products we are developing. While the foundational semantic layer is performing well, we aim to charge a premium for the semantic aspects and data products, where we anticipate a healthy margin in the coming years, linked to the value we provide our customers. Regarding your question about the percentage uplift from BDC, we are just beginning to roll out the data products. Technical integration with Databricks is complete, and we are now focused on developing those products. The roadmap is available for reference. There will definitely be an uplift, but whether it will be 10% or 20% is uncertain at this moment. What is clear is that our pipeline is growing robustly, and the financial outlook is positive.

Operator, Operator

Great. Thank you, Christian. And this concludes our call for the day. Thank you for joining us.

Operator, Operator

Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for joining and have a pleasant day. Goodbye.