Earnings Call Transcript - SAP Q1 2023

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome, and thank you for joining the SAP Q1 2023 Earnings Conference Call. Throughout today’s recorded presentation, all participants will be in a listen-only mode. The presentation will be followed by a question-and-answer session. I would now like to turn over the conference to Anthony Coletta, Chief Investor Relations Officer. Please go ahead.

Anthony Coletta, Chief Investor Relations Officer

Good afternoon, 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 results for the first quarter of 2023. 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 2022. 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. Non-IFRS financial measures we provide should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with IFRS. Before we start, I would like to welcome Dominik, who joined SAP as our new CFO in March. It is great to have you on board, Dominik. I know the financial community is very much looking forward to speaking with you. I would also like to call your attention to our upcoming financial analyst conference which will take place on May 16 as part of our supplier event in Orlando, Florida. This will be broadcast on our website. And with that, I'd like to turn the call over to Christian.

Christian Klein, CEO

Yes. Thank you, Anthony, and thanks to all of you for joining our first earnings call of 2023. This has been a very good Q1. We continue to see strong demand across our portfolio with customers choosing our solutions to solve their most strategic and pressing needs. The strong momentum is reflected in our top line numbers. Current cloud backlog stands at over €11 billion, up 25% this quarter. Cloud revenue grew 22%, up from 21% last quarter. For S/4HANA specifically, cloud revenue grew 75% and current cloud backlog grew 79%. This strong performance has led to total Q1 revenue growth of 9%. And importantly, in Q1, we delivered double-digit operating profit growth, demonstrating the significance of Q4 2022 as a tipping point of our transformation. We have now entered a new phase. Our innovative portfolio is at the heart of our continued growth. In 2023, we are continuing to execute on our focused growth strategy, with S/4HANA and BDP at the core. Our announcement in March that we came to an agreement to sell our stake in Qualtrics is an example of this focus on our portfolio. We believe that these transactions will unlock significant value for both companies and their shareholders. For SAP, to focus more on our core cloud growth and profitability. For Qualtrics, to expand its leadership in the XM category that it pioneered. This quarter, we also introduced powerful new offerings and innovations to help our customers generate significant new sources of value from their IT investments. I'd like to cover three examples: Grow with SAP, the launch of SAP Datasphere and the work we are doing to embed AI across our portfolio. Let's start with our new offer Grow with SAP. We see significant growth potential with mid-market customers new to SAP. These are the companies that we expect to experience significant growth as they build their businesses. This new offering, Grow with SAP, provides them with a native ERP solution that can grow and scale with them with agility and speed. It includes our leading cloud-native ERP solution S/4HANA cloud. Through rapid adoption services and our modular stack, mid-market customers can go live and see rapid results within weeks at a fixed price. Grow with SAP also includes SAP business technology platform so customers can design and automate business processes in a cloud-native way using SAP build and create industry or LOB-specific enterprise apps without writing code. The second game-changing offering I'd like to discuss is the launch of SAP Datasphere. SAP Datasphere collects and federates business data across a customer's entire landscape, no matter where the data resides, including data from SAP and non-SAP sources. Importantly, this is not only a technical integration. Datasphere enables the business data fabric, a powerful semantically rich layer that builds the foundation for managing and steering the business end-to-end as well as applying AI based on high-quality, contextualized business data. Our engineering teams are working closely together with four new strategic open data partners: Collibra, Confluent, Databricks and DataRobot, to integrate with SAP's Datasphere and deliver a superior data and AI layer for our customer. Datasphere is a great example of the power of our ecosystem-centric strategy. As another example today, we announced our partnership with UiPath to offer the UiPath automation platform to customers which builds upon the strong momentum of SAP build process automation. UiPath is also committed to their continued adoption of S/4HANA cloud to run their own business operations. Finally, let me touch on our efforts to embed AI across our portfolio. Our AI is built for business, with AI capabilities built in to deliver strong business outcomes for our customers' most critical business functions. And with Datasphere, we laid the strongest data foundation in business. We are in advanced stages to apply generative AI across our portfolio, and we are working as an early release partner of OpenAI and together with other vendors. We are planning to announce new disruptive AI use cases. Stay tuned for Sapphire. Let's now look at how our strategy and the strength of our portfolio and innovation is addressing the specific needs of our customers in today's challenging macroeconomic environment. SAP strategy is geared towards the world where business transformation is foundational to their success, both now and in the future where every organization benefits from being part of a collaborative network able to effectively manage today's supply chain challenges and where everything can operate sustainably. Our offerings provide a pathway to solve many of the fundamental challenges that companies are facing today. This is behind the strong customer momentum we saw in Q1. RISE with SAP has become the preferred choice for our customers transforming their businesses in the cloud. We are developing deep, broad-based partnerships around the globe. Here are some examples. In January, we announced the expansion of our long-standing partnership with BMW Group. This will help them accelerate their digital transformation and manage their end-to-end business processes in the cloud. Henkel has selected RISE with SAP to transform their digital landscape and move to the cloud. Dolce & Gabbana, the renewed luxury goods leader, recently chose RISE to drive their finance transformation. And HP, the global technology leader operating in 170 countries, selected RISE with SAP and expanded its investment in Q1 to support business transformation for its customers around the globe. This quarter, we also saw significant enterprise live for RISE with SAP, including AMD and Air India. With S/4HANA public cloud, we are seeing strong adoption across the broad range of enterprise mid-market and startup customers. Significant enterprise wins for S/4HANA public cloud include NEC Networks and System Integration Corporation and the benefits and reward services activity of the Sodexo Group, a global leader in employee benefits and engagement. We are also seeing strong adoption for S/4HANA public cloud and Grow with SAP with startups and companies new to SAP. Examples include the French aeronautic startup Flying Wells. In the U.S., Nine Top Energy, a sustainable energy provider who got up and running in just 10 weeks. And RepetCo, the European plastics recycling company. We continue to also see excellent cross-sell and upsell through our success RISE with SAP and S/4HANA cloud. Our solution area momentum includes HCLTech, one of the world's leading technology companies, leading their HR transformation with SAP SuccessFactors, a competitive win against Workday; Hitachi High-Tech Corporation of Japan; and The Pawn, the Mexican food company choosing SAP business technology platform; A.S. Watson, the world's largest health and beauty retailer, renewing their investment in SAP Commerce Cloud; and continued momentum for our sustainability solutions, SAP Sustainability Control Tower and SAP Product Footprint Management, including the adoption of SAP Sustainability Control Tower by Soleum, the Brazilian producer of sustainable raw materials. Let me turn now to our outlook and ambitions. These customer examples show how SAP is continuing to deliver despite the continued challenges being faced across nations and industries today. This is because our vision is directly tied to solutions that fortify our customers against those challenges and lead to stronger companies. Our strategic transformation has reached a new phase where we are now a force for transformation across industries worldwide. We remain committed to our 2023 guidance updated to reflect Qualtrics as a discontinued operation. We plan to update our 2025 ambition during our Sapphire Financial Analyst Conference on May 16 and look forward to talking with many of you there. In closing, we see significant opportunities for continued growth based on our own transformation into a leading cloud company. First, the strength of our current cloud backlog provides the foundation to grow and scale through increased upsell and cross-sell to our existing customer base. Second, we expect that our new offerings will power our growth in new markets and with those customers new to SAP, for example, with mid-market customers. We have a leaner and more agile operating structure. And our game-changing solutions are creating sustainably end-to-end business processes across industries. We are off to a good start in 2023 and remain optimistic about the unique value we offer our customers. Finally, I'm of course very happy to welcome Dominik Asam to SAP, our new CFO since March 7. Dominik, welcome to SAP, and welcome to your first earnings call. Over to you.

Dominik Asam, CFO

Yes, thank you, Christian, for the warm introduction and good afternoon, ladies and gentlemen. It's my pleasure to speak with you for the first time ever as SAP's CFO, and I look forward to meeting as many of you as I can over the coming months. I'm delighted to join Christian and the rest of the management team and to actively contribute to the continued success of SAP around the globe. First off, in March, we announced the sale of our stake in Qualtrics, which is now pending customary regulatory clearances. As such, all numbers today are based on continuing operations, i.e., excluding contributions from Qualtrics. That said, fiscal year 2023 is already off to a solid start. In the first quarter, current cloud backlog and cloud revenue grew sequentially, while non-IFRS operating profit was back to double-digit growth in constant currencies. Cloud revenue was €3.2 billion, up 22% year-over-year, and the trend towards larger cloud transactions continued with deals greater than €5 million in value contributing 45% of our cloud order entry. This was driven by RISE with SAP. Software license revenues saw only a moderate decrease of 13%, mainly due to the favorable phasing of a few major transactions. Now let me talk and walk you through our financial performance. Current cloud backlog was €11.1 billion, continuing its growth at scale by 25%. And S/4HANA current cloud backlog kept its strong momentum at 79%, driven by the strong adoption of RISE with SAP. In Q1, we added more than €200 million to our S/4HANA current cloud backlog leading to a total of €3.4 billion. Our combined SaaS and PaaS portfolio continued to grow by 25%, with the SaaS cloud revenue up 22% and PaaS cloud revenue up 45%. This continued cloud momentum was again fueled by the strong contribution of S/4HANA cloud and business technology platform, supported by the underlying performance across all our revenue streams, total revenue was up 9% year-over-year, staying on the right trajectory. Now let's take a brief look at our regional performance. In the first quarter, all regions delivered a robust cloud performance. Brazil, Germany, and India achieved outstanding cloud revenue growth, while China, Japan, Mexico, the Netherlands, Switzerland, and the United States performed particularly strong. Now moving on to the bottom line. Our cloud gross profit grew by 27%, 5 percentage points faster than the cloud revenues, driven not only by cloud revenue but also further efficiency gains. This resulted in cloud gross margin improving from the year-ago period, expanding 2.9 percentage points to 71.4%. In the first quarter, IFRS operating profit decreased 45%, primarily driven by the increase in share-based compensation expense by €434 million, mainly reflecting the increase in our share price over the first quarter this year as compared to last year's decline over the same period. Our targeted restructuring program of €260 million; and finally, €170 million provision for pre-existing regulatory compliance matters. Finally, non-IFRS operating profit grew by 12%, evidencing our return to more profitable growth in the future. Earnings per share in the quarter increased by 8% to €1.08. For IFRS earnings per share, please also keep in mind that the sale of Qualtrics is expected to be accretive to earnings per share. A significant stock-based compensation expense, including grants related to its IPO will be removed with the divestiture. The IFRS effective tax rate of Q1 was 40.5% and the non-IFRS tax rate was 28.3%. Now looking to our cash generation. Free cash flow for Q1 came in at €1.95 billion, down 9%, mainly due to the impact of the sale of trade receivables in the fourth quarter last year, which was weighing on Q1 and some first cashout for our restructuring program. If adjusted for these effects, the underlying cash flow development was positive compared to the prior year, actually quite in line with the increase in operating profit. Now let's move on to our financial outlook. Let me reiterate that we have now reflected the anticipated sale of our stake in Qualtrics and have updated the outlook accordingly. We are reaffirming our 2023 outlook for underlying continuing operations. Keep in mind, the disposal gain realized upon closing of the Qualtrics transaction will be included in profit after tax from discontinued operations. This will not impact operating profit and free cash flow for continuing operations. So please refer to our quarterly statements for additional details. Let's now discuss our non-financial targets. Our greenhouse gas emissions were 0 kilotons. We continue to be on track to be net neutral in our operations this year and are on track to achieve net zero across the entire value chain by 2030. SAP has successfully closed a new sustainability-linked revolving credit facility with a volume of €3 billion and a tenor of five years plus two one-year extension options, replacing the existing €2.5 billion facility. In line with SAP's strategic commitment, a sustainability component has been embedded for the first time that links the margin of the new facility to the company's net zero carbon and women in management ambitions. So our Q1 results give us confidence that we are moving in the right direction and are in a good position to achieve our goals for the year. We continue to build on our cloud momentum and remain focused on ushering our customers into the new digital world. Before moving to Q&A, I would like to say that we are very much looking forward to welcoming you to our financial analyst conference where we will provide updates to our 2025 ambition. As Anthony mentioned earlier, it will take place in conjunction with Sapphire in Orlando, and I'm looking forward to meeting you all there in person. Thank you and we'll now be happy to take your questions.

Anthony Coletta, Chief Investor Relations Officer

Thank you. Operator, please open the line.

Operator, Operator

The first question is from Stefan Slowinski with Exane BNP Paribas. Go ahead, your line is open.

Stefan Slowinski, Analyst

Welcome to Dominik from the SAP analyst and investor community. I’m eager to discuss things with you. To start, I have a question and a follow-up. SAP has previously indicated expectations for double-digit revenue growth in 2024. Given the Q1 performance so far, do you believe you're still on track for that? Additionally, regarding the free cash flow conversion at SAP, what opportunities do you see that could help enhance free cash flow performance?

Christian Klein, CEO

I can start, and Dominik, you can build on top of it. I mean with regard to the question, Stefan, around the double-digit total revenue growth, I mean Q1, we were pretty close to it, I have to say, with 9% at constant. And look, I mean, over the course of the year, we expect continued strong cloud momentum. So the weight of our cloud revenue will become higher and higher. And I guess it's fair to say from 2024 onwards, SAP will deliver total revenue double-digit growth as we just have such a high recurring revenue stream and it will become a more and more predictable business. And with regard to the cloud revenue itself, maybe one last word there, I actually have to congratulate Scott and the team, and also, Scott, congratulations to your contract extension where we're happy to have you on board also for the upcoming years. I mean with the launch, what I just mentioned around SAP Grow and Datasphere, I mean we are also expanding now our innovation pipeline, and we actually will also harvest new bookings growth sources for the quarters to come. So we are actually very confident with regard to the total revenue growth and double digit in 2024 onwards.

Dominik Asam, CFO

To improve cash, you need to increase profit and the cash-related aspects of it, which involves cost management. This is already reflected in our guidance. When discussing cash conversion, it's important to consider elements like working capital. We've talked about prepayments to certain suppliers and accounts receivable, so improving collection is a significant focus. I believe there’s potential for better cash conversion, and we plan to provide more insight into how our profit translates into cash during the Sapphire Conference. This is something I clearly have on my agenda.

Operator, Operator

The next question is from the line of Frederic Boulan, Bank of America. Go ahead. Your line is open.

Frederic Boulan, Analyst

Christian and Dominik, welcome as well from my side. If I can ask a question on the macro level, we've seen a number of peers in the U.S. and elsewhere experiencing some learning demand. So you seem to be flagging so very strong growth in U.S., Germany, a number of Asian countries. So can you maybe explain a little bit whether there's a shift in the type of projects, the demand you're seeing in any verticals or regions where there is some change in dynamics, any reprioritization of projects. I mean, cloud in particular, it's a big ticket for organizations. Are you seeing any shift in the pace of demand for that? Or on the contrary, the kind of underlying trends remain very much unchanged?

Scott Russell, Head of Customer Success

Yes, I'll start. This is Scott here. First, SAP is not immune to the current macroeconomic environment we all face, but there are key points reflected in our Q1 results and our outlook. Customers are focusing on their essential processes, workflows, and data to drive their businesses towards profitable growth. They need reliable, scalable, and innovative technology in the cloud to support these goals. This is evident in the strong performance of S/4 cloud in both public and private editions, allowing them the agility to navigate market uncertainties. While other cloud elements may experience varied conditions, the demand for core business processes remains robust, and we have positive expectations. Additionally, the launch of capabilities like Datasphere is crucial. Companies seek not just to maintain mission-critical operations but also to utilize an agile, innovative platform for real-time insights from both SAP and non-SAP data to enhance decision-making. The integration of AI and orchestration within our open ecosystem shows strong demand. I anticipate shorter project timelines and engagements. Core processes and data continue to be central, aligning well with SAP's strengths historically. Despite the macroeconomic challenges, we remain confident about our outlook. Christian, would you like to add anything?

Christian Klein, CEO

Look, I guess one important indicator is also just, I mean, we are reporting current cloud backlog ACV, but when you look at our TCV, the number is, of course, even much higher. Because especially our large enterprises, large clients, they really need time to fully migrate to the cloud. But I'm not aware of any single project where a customer now said, 'I'm going to stop or pause my ERP migration, my supply chain migration to the cloud.' So also on the adoption side, we see continuous and seamless execution.

Frederic Boulan, Analyst

And I don't know if I may, but on that cloud point, any change in dynamics in terms of private versus public demand?

Christian Klein, CEO

As Scott just said, I mean, we have seen now an accelerated momentum in Q1. We reconfirmed our outlook for the year. We see a very healthy and strong pipeline for the year. So, we're currently thinking to execute strong in the cloud.

Anthony Coletta, Chief Investor Relations Officer

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

Operator, Operator

The next question is from the line of Michael J. Briest, UBS Limited. Go ahead. Your line is open.

Michael Briest, Analyst

Yes. You've obviously updated the guidance today for Qualtrics. There was a couple of things in the annual report, which I guess were put there when Qualtrics was still part of scope. And that was current cloud backlog would grow at basically the same rate as last year at 24% and that you hope to be at a mid-70s gross margin in the cloud exiting the year. I wonder if you can address those two matters. I mean, I guess, Qualtrics is growing more slowly, so presumably the cloud backlog growth rate should increase a bit from 24%?

Dominik Asam, CFO

Yes. Regarding the change in guidance for continuing operations, we aimed to align it with what was previously stated for Qualtrics. It is true that Qualtrics’ cloud gross margin was higher than the group average, which slightly impacts the direct correlation. However, we are actively focusing on improving the overall cloud gross margin.

Christian Klein, CEO

Yes. And I guess, Michael, important to note, what we also said last quarter is when you look at the second half of the year, but even more so next year, not only that S/4HANA and BDP are already growing stronger than Qualtrics today, but also our overall cloud revenue will also then overpace the Qualtrics revenue. So we see actually in the outer years that it will actually help to accelerate our percentage growth rates, especially in the core business but also for our overall cloud revenue stream.

Michael Briest, Analyst

Okay. And also, Dominik, I think the free cash flow guidance assumed that you would have a high triple-digit million factoring level in 2025. Can you just explain the logic of the factoring and whether it's something you think makes sense?

Dominik Asam, CFO

What I can explain is what we've seen to start with at the end of last year. So basically, we have two different types of transactions on the front. One is a very, I'd say, common vendor financing type of approach. I would call it where we give very extended payment terms to certain customers who have liquidity crunches. And as we don't want to become a bank, frankly, because we have much better return opportunities in the operational business, we are saying these. So I think that's a practice which makes a lot of sense. And now on top of that is also some more from our side induced factoring, which I need to look into, frankly. I understand this is embarked in the guidance. So it's not going in the numbers we have shown you on the cash flow update. We've done just an adjustment for Qualtrics, not for any change on that front yet. But we really need to stick our heads together also on that technique, whether that makes a lot of sense for us or not. Should we change that, then that would have, of course, an impact on the free cash flow one for one, it's quite straightforward.

Anthony Coletta, Chief Investor Relations Officer

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

Operator, Operator

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

Adam Wood, Analyst

Also welcome, Dominik, from my side. I guess this is fully Dominik. I think it's always interesting to have a fresh view on things from a new CFO. Obviously, you've had to step in and assume a guidance that had been made previously by the Company. I think the feedback generally has been you seem to be more cautious on guidance in previous roles. Could you just talk a little bit about the work that you've done to get yourself comfortable with the outlook for this year and how you see that outlook relative to how you've guided and what you've looked at in previous companies and previous roles, please?

Dominik Asam, CFO

Sure. I'm not quite sure how I earned that reputation, I always try to provide as accurate guidance as possible, as humanly possible, but still, of course, there's uncertainties around guidance, which also means that the further you move out, the more difficult it is to do so. So, kudos to the team here who had the courage to go for that kind of '25 guidance at a time where they have entered into a very difficult transition. So, I'm really impressed how closely we've been tracking to that now with the benefit of hindsight vision. Now of course, I get myself comfortable with that guidance. Otherwise, I wouldn't sit here and read it out to you. I think it has been very solidly derived, with a lot of logic. And yes, I did spend quite some time on that. And I will now really focus from now to Sapphire on what's happening over the next couple of years. But so far, I'm very encouraged by the solidity and insightful way this has been derived. Don't forget there is this kind of already 82% of more predictable revenues. So that, frankly, makes it a little bit easier. And obviously, when you have a business model that has less uncertainty, it's also easier to predict and then you don't need to kind of put some cushion in for invulnerability. So, I think the quality of the business model is also part of how precisely you can guide or not.

Anthony Coletta, Chief Investor Relations Officer

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

Operator, Operator

The next question comes from the line of Toby Ogg with JPMorgan. Go ahead. Your line is open.

Toby Ogg, Analyst

And welcome from my side as well, Dominik. Just on the free cash flow, €1.95 billion, I know we've talked about the various moving parts there, working capital restructuring, extra licenses in the quarter with a bit of tailwind. Just looking forwards on that, what specifically gives you the confidence that you can achieve the €4.9 billion guidance for the year? And then just more broadly, Dominik, you talked about certain aspects of the working capital there. What are some of the other aspects of the business that are going to be a priority for you?

Dominik Asam, CFO

For this year, we have a comprehensive bottom-up process that we've thoroughly reviewed. You can use some general guidelines as I mentioned earlier. In the first quarter, if you exclude the factoring impact that affected the quarter, and consider the mid-double-digit millions already disbursed from the €260 million restructuring plan, you'll see that cash flow is improving compared to last year, thanks to better operating profit. There's also a tax aspect to consider. If you apply similar logic for the entire year, and assume the full €260 million is utilized for restructuring while factoring continues as planned, we are looking at a reasonable estimate. I'm not sure why this number wouldn’t hold. As mentioned, we need to evaluate our factoring strategy and explore opportunities in working capital. Another significant factor is the difference between cash-settled and equity-settled stock-based compensation, which should increasingly favor equity settlements over time, leading us to consider how to manage the resulting dilution. Additionally, we must address what to amortize and capitalize, including bonuses for new deals and necessary capital expenditures. I aim to establish a straightforward model to determine our capital needs, particularly if we're aiming for an additional €1 billion in revenue as we approach our 2025 business model, which is essential for your valuation considerations. I plan to devote time to this analysis in the upcoming weeks.

Anthony Coletta, Chief Investor Relations Officer

Thank you, Toby. And we will take the next question, please.

Operator, Operator

Yes. The next question comes from the line of Mark Moerdler with Bernstein. Go ahead. Your line is open.

Mark Moerdler, Analyst

Congratulations on the strong quarter when so many others are seeing weakness, especially in cloud. Dominik, welcome on board, and we're looking forward to spending time with you. We saw a really nice acceleration in the gross margin of the business platform. Can you give us more color on what is driving the margin improvement? How you see the trajectory of that margin going forward and how does this translate into overall S/4HANA cloud gross margin?

Christian Klein, CEO

Yes, Mike, happy to take that question. I mean, look, with every RISE deal, but actually also with every LOB deal we are going to sell in the future, the business technology platform is front and center. We just also got a great Gartner rating that in the meantime, we have the best integration suite, and we see an extremely high adoption, not only SAP to SAP where we are heavily criticized for on, which we really now fix and leading, but also to non-SAP. I mean you just have heard about all of our announcements, and we also have a very open API layer on the platform, which is really API first across all of our products. And then second, even more important, we see that, of course, our own services organization, but even more so the ecosystem, where we have over 500,000 SAP consultants out there that they are doing with us the move from NetWeaver to PDP. And our promise is we are not only lifting and shifting ERPs and supply chains to the cloud, but we are also transforming those and reducing complexity. And now when the whole application logic sits on PDP, the easiest thing is then to build all of these industry LOB extensions on the platform which drives consumption, adoption. And with that, more and more cloud revenue. For me, personally, the BDP is one of the biggest growth assets we have in the years to come.

Anthony Coletta, Chief Investor Relations Officer

Thank you, Mark. Operator, we can take the next question, please.

Operator, Operator

The next question comes from the line of James Goodman with Barclays. Go ahead. Your line is open.

James Goodman, Analyst

Great. Financial one from me to welcome Dominik. I mean there's a debate in the market on the OpEx intensity of SAP. You've got global peers cutting heads and costs. But of course, investors are wanting SAP to invest in growth. So I wondered if I could ask you about your first impressions around the sort of cost ratios in the business and maybe specifically what that means for the current restructuring program and how much of that needs to necessarily be reinvested in the business in your view? And also specifically on stock-based compensation, you explained why it's slightly elevated at the moment because of the stock price, that it's approaching 7% of sales. I mean should we expect that to trend back down towards sort of 5% of sales over time in line with previous comments?

Dominik Asam, CFO

Yes. In general, operational expenses are notably high compared to what I've observed in other industries, particularly concerning the go-to-market costs, and I still need to understand why that's essential. As a former customer of SAP, I notice that we have many loyal customers, and it's more about nurturing those relationships than seeking new ones. Typically, this nurturing requires in-depth technical discussions. I'm sure Scott has his insights on this as well. Regarding research and development, we have a diverse portfolio, making it hard to compare to pure-play companies. However, that's also the advantage of our portfolio, allowing us to upsell and cross-sell effectively. I believe that in any category we engage with, we should aim to lead in the resources we allocate because the tech industry tends to favor those who dominate the market, necessitating caution on that front. Concerning administration, there are always chances to achieve operational leverage by expanding without significantly increasing the general and administrative expenses. I hope to see a reduction in the G&A base over time. At SAP, we focus on enhancing productivity and automation, and we need to model that ourselves. Therefore, there are certainly opportunities in this area. On stock-based compensation, I've asked around to understand the numbers presented, and it does make sense. We recognize it as an economic burden; it’s not just an arbitrary figure. As someone new to the industry, I find it puzzling that many other companies can present non-stock-based compensation or pre-stock-based compensation figures. We need to consider how we approach this, especially as some large firms are reevaluating their strategies in this regard. Clearly, it’s an issue we need to monitor to minimize dilution for our shareholders.

James Goodman, Analyst

By way of a quick follow-up, could I just ask if the Board's reached any conclusions on the use of the Qualtrics proceeds?

Dominik Asam, CFO

First of all, the proceeds are not in the bank yet, so we are going to close that transaction in the second half of the year. And the answer is, frankly, no. But of course, it's an item we have on the agenda. And what I want to say is, from my perspective, providing us with great optionality. I mean, the deployment of the capital, what we can do with it, it's crystal clear. And so we need to establish our pecking order, so to speak. And of course, it also depends on the strategic part. So we have some colleagues in the room who are taking care of that. Again, coming here, what is very interesting is the huge organic growth opportunity we have. So I always like to be in a situation where M&A is a tool which can be done we kind of call bloodily on the merits of the strategy, on the merits of the financials, we are not desperate to do anything because we have a strong organic growth opportunity. But still, there might be opportunities even with lower valuations, and that will play a role, too.

Anthony Coletta, Chief Investor Relations Officer

Thank you, James. And we will take the next question, please.

Operator, Operator

The next question is from the line of Amit Harchandani with Citi Investment Research. Please go ahead. Your line is open.

Amit Harchandani, Analyst

Amit Harchandani from Citi. And welcome from my side as well, Dominik. Look forward to working with you. The question I have is with regards to how SAP is thinking about supporting not just cloud deployment but also on-premise deployments going forward, particularly as it relates to driving through new innovation. There is still a significant proportion of your base that potentially needs to be migrated or is likely to want to stay on-premise longer. So I would appreciate your thoughts on the same, where we are today, how much is left to go and how are you thinking about balancing on-premise versus cloud?

Christian Klein, CEO

I can start, and then Scott, please also build on top of it. It's a very good question, and I'd love to answer it. And now, first, I mean, look, we have a huge installed base which is, first of all, a gift to have. And then second, what we now already communicated is that there is the end of standard maintenance for all ERP releases lower than S/4HANA by the end of 2027. And I really would like to also say this today where we, clearly, there will be no extension of this timeline. Because why? Because at the end, we want to also use our R&D capacity and investments in the most effective way, and there are so many new technologies which we really want to embark on that we really want to deploy those in the cloud. Also customers, by the way, get the most value out of it, just when we look at the announcements we are doing around Sapphire, around ChatGPT. And then you also have to see that the world is becoming more and more isolated. And we actually differentiate also against many others in the market around our investments into globalization into adhering to local regulations, data privacy requirements. And this is, of course, what we're going to continue to do, but cannot continue to do for all the other releases out there below S/4HANA. And that's why we definitely want to stick to our commitment to not extend our maintenance commitment, standard maintenance commitment beyond 2027 for everything below S/4HANA. Scott?

Scott Russell, Head of Customer Success

Yes, I want to emphasize from a customer perspective that our large installed base has already decided to transition to the cloud, but their transformation journeys will vary. It's important to remember that our announcement of RISE was not just about moving to a cloud target architecture; it was about supporting customers on a transformation journey that aligns with their specific landscape. Some customers may take longer to utilize their on-premise architecture, while others may opt for a fresh start in the cloud using our public edition. Regardless of the path taken, SAP offers various capabilities. Christian highlighted the growth of the BTP platform, which benefits our entire customer base, as well as our top-tier line of business applications and our leadership in sustainability. My feedback is that all customers are progressing towards cloud-based architectures. They are seeking innovation and the ability to comply with local regulations while adopting new technologies quickly. They also have a transformation roadmap with SAP, receiving personalized support to reach their goals. This approach differs from many other cloud companies that may promise an outcome but provide little guidance on how to achieve it. SAP focuses on the journey, making it easier for customers to navigate their future while benefiting from our ongoing investments and innovations.

Anthony Coletta, Chief Investor Relations Officer

Thank you, Amit. And we will take time for two more questions. So we can take the next one, please.

Operator, Operator

The next question comes from the line of Kirk Materne with Evercore ISI. Please go ahead. Your line is open.

Kirk Materne, Analyst

Congratulations on the strong first quarter results. I was curious if you could provide an update on the status of the cloud portfolio aside from S/4HANA. How are those businesses performing? It seems like they are experiencing stable, low double-digit growth. Do you believe there is potential for acceleration? What should we anticipate regarding the cloud business outside of S/4HANA in the next 12 months? Are there any factors we should consider?

Christian Klein, CEO

I can start, and then, Scott, please add your thoughts. Firstly, our win rates are undeniably strong, which gives me optimism about our new offering, Grow with SAP. Our win rates for new clients are particularly high in the ERP and platform sectors. However, the landscape in the lines of business is more challenging. Still, it’s crucial to highlight that SAP is succeeding in every situation where we can expand from our core services. You heard about HCL when discussing total workforce management and innovative packaging of certain offerings; this all needs to align with payroll and HCL's finance system, and it's also vital to emphasize customer experience. We are restructuring in this area, yet we remain committed to customer experience, just in a different manner. Whenever we leverage our industry expertise, I believe we have a superior understanding of the industry compared to anyone else. We are partnering with key customers to enhance customer loyalty, utilizing data from ERP to create end-to-end value chains that connect commerce, inventory, and supply chain. This is where our successes lie, and we are focused on this direction. Additionally, we are witnessing strong win rates across other lines of business. I'm particularly pleased to see Concur’s performance. Despite facing challenges during the pandemic, they have delivered another impressive quarter and I’m glad to see Concur back on the path to success.

Scott Russell, Head of Customer Success

Yes. Maybe two additional comments if I can add to what you described, Christian. The first is our core LOB solutions outside of S/4HANA cloud and BTP are actually still growing quite strongly, and Christian mentioned Concur is a good example of that. So double-digit revenue growth that are strong. Each of them have their own competitive markets and dimensions, but the portfolio strengthens. And I do want to highlight transaction volumes, particularly Concur, BTP, Ariba, etc., where we're seeing a higher supply network, where we're seeing higher transaction volumes come back, which also helps from a sustainable revenue growth. The second comment that I would make and we'll share more at this at Sapphire in more detail, but the ability for us to upsell, cross-sell our broader portfolio once you've got the base S/4 cloud and BTP, the multiples are undeniable. So as our customers move their mission-critical processes into the cloud, then their ability and the ease of which they can expand the SAP portfolio, whether it be supply chain, procurement, contingent labor, HR, they are able to do so in a really agile way. And that comes on the back of the real heavy lifting our engineering teams have done around the integration of the SAP portfolio that Christian mentioned before that now comes to life to our customers. So that gives me confidence that the two go hand-in-hand. It's not about winning only in those independent markets, but the portfolio coming together and making it easier for customers to get the innovation value that they're looking for.

Anthony Coletta, Chief Investor Relations Officer

Thank you, Kirk. And then, we will take time for one final question.

Operator, Operator

Yes, the final question comes from the line of Mohammed Moawalla with Goldman Sachs. Go ahead. Your line is open.

Mohammed Moawalla, Analyst

Dominik, nice to speak to you. Dominik, my question is around sort of SAP sort of cost structure as you look kind of going forward. No doubt there's going to be leverage around the sort of gross margin. But as you look at some of the other line items, where do you think there's sort of scope for kind of efficiency? And I know, Christian, you've talked about potentially some R&D leverage in kind of the current plan. But as you talk about the great organic opportunities, and given you're unlikely to do any large-scale M&A, how do you think of some of the kind of leverage areas around the cost outside of the gross margin?

Dominik Asam, CFO

Well, I think there is, of course, a kind of natural pecking order in that type of industry. What are the things that need to scale with revenue? What are the things that can be kind of providing some good operating leverage? It's a little premature, frankly, for me to now jump to conclusions to say this is what we're going to do. What I can say is that whenever I've seen businesses really delivering improvements on that front, these were rarely kind of quantum leaps; it was more about a kind of grinding over many years where people have been driving operational excellence through continuous improvement. And I think there are great opportunities. Frankly, I think the low-hanging fruit is probably harvested and we have to now deploy some more sophisticated techniques. And what I would like to see here is that we create to spin that flywheel more strongly with a stronger focus on free cash flow. So don't expect any wide leaps in the near term on that. It will be a grinding work over many years to really mature the margin side even further.

Christian Klein, CEO

And just a few comments from my side. I mean today also for me personally is a very important point in our transformation. I mean, we came to you 2.5 years ago with a new guidance, and we also asked you give us the permission for certain investments to reduce our technical debt. And we did our homework. Looking at the gross margin and the gross profit performance in Q1, I hope you see that we delivered. Now to Dominik's point, we have to find also additional levels. And the good piece is, yes, we have those. I mean, first of all, when you look at these RISE contracts in cloud, it's all around economies of scale, and especially in the outer years, this is where still a lot of workloads will be migrated to the cloud, and that actually allows us to scale the cloud operations also in at a higher scale. And second, I mean, Thomas and Jurgen, they will continue to invest. And I want to emphasize, no additional invest, but they will continue to invest to put in, in touching and supporting the stack. And by the way, ChatGPT will play even a role in that in cyber and support and our cloud systems. So, we have additional levers, and we will continuously work on that.

Anthony Coletta, Chief Investor Relations Officer

Right. Thank you, Christian, and thank you, Mohammed. And this concludes our call for today. Thanks for joining.

Christian Klein, CEO

Thank you, everyone. Thank you.

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.