Q2 2019 Earnings Call
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On on par with music for the S.A.P. <unk> quarter, two 2019 half your earnings call.
Good day and welcome to the <unk> Q2, 2019 half your earnings Conference call. Today's conference is being recorded and at this time I would like to turn the conference over to Mr. Stefan Gruber head of Investor Relations. Please go ahead Sir.
Thank you. Good afternoon. This is Stefan Gruber head of Investor Relations at CP.
Thank you for joining us to discuss our results for the second quarter 2019.
I'm joined by our CEO , Bill Mcdermott and Bookable Judge our CFO will both make opening remarks on the call today.
Also joining us for Q and a our board members are there folks Martin President of our global customer operations, Jennifer Morgan President of our cloud business group and Chris Young our COO will these intelligence enterprise group.
Before we get started I would like to say a few words about forward looking statements and our use of non financial measures.
Any statements made during this call that are not historical SEC forward looking statements as defined in the U.S. Private Securities Litigation Reform Act of 1995.
Words, such as anticipate believe estimate expect forecast intend may plan project predict should outlook and will and similar expressions as they relate to Sep are intended to identify such forward looking statements that are dependent takes no obligation to publicly update or revise any forward looking statements. All forward looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from expectations.
The factors that could affect Sep switch financial results I'll discuss more fully in our filings with the US Securities and Exchange Commission the SEC, including Sep is annual report on form 20-F for 2018, but at the FCC in February 28 2019.
Participants of this call are cautioned not to place undue reliance on these forward looking statements, which speak only as of their dates with our Investor Relations website, you can find our quality statement, our half year report and a financial summary, slide deck, which are intended to supplement to our prepared remarks on this call today.
And include a reconciliation from our non IRS numbers to MFS numbers.
Unless otherwise noted all financial numbers referred to on this conference call, our non RFS and growth rates and percentage point changes are non IFRS as reported year over year.
The 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 by FRS.
Now looking forward to the end of the year on November 12, we will hold a special capital markets day in New York City.
Hero senior executives will lay out the details of several new initiatives to create.
Accelerate operational excellence and value creation.
We are looking forward to seeing you there and with that I'd like to turn things over to our CEO Bill Mcdermott.
Thank you Stefan good morning, and thanks to everyone for joining todays call S&P strong first half puts the company in position to deliver on our targets for the full year.
Thanks to the continued trust of our customers. We are a profitable growth company. The key growth drivers performed as we expected they would and the first half, giving us enormous confidence in our topline for years to come.
We're also a disciplined value creation company since we issued our revised margin aspirations in April we've already made progress FCP will deliver significant shareholder value as we target approximately 500 basis points of margin improvement by 2023, So let's take a look at some of the detail before Luca gives you. The overall financials and Q2, we delivered a solid double digit growth quarter across the board.
Cloud revenue was up 40% growing faster than key competitors, both cloud and software revenue and total revenue also grew in double digits as software license overall was good.
Even with the minor headwinds in Asia due to trade uncertainties, which did postpone some deals and specifically.
We'll get we didn't get everything we wanted on Asia, I am going to expand on that in a minute, but don't don't worry about it let me, let me start off with that.
The clear headline for Q2 is that Sep continued to grow fast in the cloud and it was driven by experience management as the.
Rio Rio catalyst I'd see and other analysts have said XM as the new frontier and we actually agree with that excess is also the new front end to every segment and the enterprise application software industry, including HCM CRM ERP and beyond.
The concept of category creation is actually worth discussing here since 2000. They were 4500 companies in the industry that were founded and took a series a investment only 75 of them made it through an IPO only 36 became the dominant category winners those winners now owns 76% of the entire addressable market in their respective categories. So when it comes to experience management, you're going to hear plenty of noise out there from others who'd like to catch this wave.
The question is who created the category and the answer of course is qual tricks, which is why we couldn't be happier to have the S&P global distribution channel behind their XM platform.
And its second quarter Qual tricks is proving to be the growth catalyst, we expected and more Brian Smith and his team are already making a huge positive impact and we're only getting started.
If you look at our HCM business is one example, successfactors is an early adopter of the XM vision with employee experience by combining the qual tricks and Successfactors offerings, we have differentiated against legacy HCM.
That's why our success factors portfolio had a strong quarter growing bookings bookings in high double digits year on year with multiple wins against workday and Oracle.
Market, leading companies like Merck in Germany are shifting away from old HCM in favor of employee experience in the quarters to come we will use all aspects of XM.
As the differentiator for the intelligent enterprise, including employee customer product and brand experience experienced management has superseded standalone digital transformation talk I personally shared this message with Ceos around the world. The reaction is unanimous every one of 'em wants XM.
Balancing our healthy topline operating profit was also up double digits for the company this quarter, you're seeing a dip in the eye FRS operating profit.
This reflects updated estimates from our restructuring program, which was actually more subscribers than anticipated due to more volunteers in Germany than planned.
Luca will take you through the onetime effects in a few minutes, including M&A tax and share based compensation.
The non I FRS operating profit was up a healthy 11% year over year, which is another significant feature in this double digit growth quarter.
On an organic basis, Theres actually a margin improvement in the core underlying business. When you back out the dilute of effects that Luca will discuss.
We also saw a three point improvement.
And our share of predictable revenue in the quarter, which continues to signal the broader success of the company's business model transformation.
So overall, we feel strongly about our topline and increasingly confident about the bottom line trajectory for the company.
Our best run Sep review is designed to accelerate this operational track record. We now have support from a highly regarded external partner, who is helping us identify opportunities across all corporate functions, even as we're in the early stages. The initial indications strongly reinforce our stated aspirations for example.
The underlying cloud gross margins improved four percentage points in the current quarter, reflecting the success of our Oracle converge cloud initiative and accelerating partnerships with Hyperscalers, we look forward to the capital markets day in November where we will unveil the comprehensive roadmap to deliver on the approximate 500 basis point margin improvement, we fully expect by 2023.
In terms of the challenges in the quarter on the software revenue.
The macro environment related to global trade, especially in Asia was a factor what you see here is large multinational companies carefully recalibrating their operations and global supply chains. In some cases. This causes a short term delay on technology purchasing decisions in our case, you actually see a net positive impact on the pipeline of Sep.
Many of our market units in Asia for example have higher pipeline forecast at this time in 2019 than they did one year ago.
And the forecast across the company are in good shape I triple checked every detail.
This is because the companies that decide to make changes due to trade uncertainty look to S&P to support their plans to reroute channels or invest in new geographic markets. So overall, while we've noticed the trade affect our customers demand more from us as they adapt to it in other words, the bill of materials is getting bigger on the deals.
One more note on this the temptation here might be to lessen the focus on China, which we would believe we believe to be a mistake I was just in Beijing for meetings with Premier Li a few weeks ago, while the short term uncertainty over trade negotiations is having an impact in many industries everyone recognizes these are the natural effects of globalization.
I can tell you that the long term health of the economy in China is obviously secure and keep in mind, there are more than $70 million enterprises operating in that country. So it's pretty good business opportunity in terms of Sep is vibrant China business, while some transactions were delayed past Q2, thats affect our pipeline in China remains ever robust and we have a very good prognosis for Q3 and Q4 another theme embedded in the quarter is in our cloud business, where we initiated our strategy to embrace our public cloud infrastructure partners. As a result, some workloads on certain S&P Hana enterprise cloud deals moved in favor of joint engagements with our cloud infrastructure partners. This strategy will pay dividends for us in the quarters and the years to come and significantly it will help us continue improving cloud gross margins, which we have committed to do through.
2023 and beyond.
When you exclude the infrastructure as a service tech business, our cloud bookings grew 27% year on year in Q2, which again reflects the overall health of our solutions portfolio and Im not even discussing network and consumption based cloud revenue, which you never see so big picture.
For years, the belief has been businesses have the data they need they just can't access it what you're seeing in this experience economy is this data assumption is wrong businesses don't have all the data they need because nearly all of their existing data was created by the business itself. We call. This operational data today's imperative is to go out and create a new dataset experience data that comes directly from the consumers and employees themselves only when you layer. The two datasets together the operational data from the business and the experience data from the people can you deliver true experience management. This is the catalyst of our intelligent enterprise strategy. This is a message and a strategy that only sep is delivering experienced management is a paradigm shift for how cxos run companies from the legacy inside out.
To the visionary outside end and armed with the right mix of experience data and operational data intelligent enterprises will always know the next action to better serve their customers and their employees. This ladies and gentlemen is the future of business and our ambition is not only to lead the XM movement. It is to help our customers win. It. This is the growth elixir that will uplift every solution in our portfolio as you saw with HCM and Q2.
Overall S&P continues to be the rarity in the industry with Thats for Hana adoption up to 11500 customers globally. Our core business is rock solid with solutions like concur continuing to grow in double digits on a global scale, our cloud portfolio couldn't be stronger.
Our technology assets, S&P, Hana and the cloud Sep cloud platform S&P, Leonardo and S&P analytics cloud have the strongest pipeline, we've ever seen and if you look at brands like Burger King, Brazil, Hitachi Kawasaki NH Hotel group delivery hero and many others. It's clear that S&P. His entire solution portfolio is resonating strongly on a global basis add more key partnerships and the story gets even stronger.
Intel a great company and S&P have entered into a partnership to optimize the features and technologies and S&P Hannah.
For Intel Xeon scalable processes, and Intel obtain DC persistent memory.
This will deliver customers industry, leading performance and CCOH advantage or Sep S. Four Hannah.
We will also jointly established a center of excellence, so customers can evaluate innovate and adopt Intel and S&P jointly develop technologies that power intelligent enterprises I'd like to give my good friend, Bob Swan, a big salute for his outstanding friendship and cooperation.
And safety is also partnering with Infosys to help clients invest in purposeful innovation to become an intelligent enterprise innovate eight four embrace leverages infosys industry knowledge. This is a platform delivered on a cloud hyperscale environment, where thats a paid digital solutions delivering end to end business outcomes at an accelerated pace. There are new multi year partnerships. We couldn't be more excited about these are ones that we're counting on and that will deliver upside big time.
In closing.
Even in the seasonally smaller Q2, the fundamentals of the company a rock solid we're poised to continue fast growth in the cloud we're focused on expanding our margin profile promises made will be promises kept our XM intelligent enterprise strategy is winning big time, our partner Eco system is fired up our employee morale is very high our brand value is higher than ever when you think about S&P as customers, though will inside our company to do whats right for them has never been stronger the best do run Sep and our commitment is to run this company at its very best. So we can continue to power a new generation of economic growth environmental sustainability and societal progress. That's what S&P is about helping the world run better and improving peoples lives I. Thank you for your time and attention today I look forward to taking.
Your questions. After Luca completes his remarks Luka over to you.
Yes, Thank you very much bill.
Let me start by echoing Bill's comments that the fundamentals of Sep are very strong.
Just look at our cloud momentum.
We have now grown our cloud revenue at 40% or higher in the last four quarters.
Thats impressive for a company at our scale.
I'm also pleased that our operational excellence measures have allowed us to achieve double digit non ofer as operating profit growth. This is also remarkable considering our second quarter revenue in the software was impacted by the recent short term trade related uncertainty in Asia.
Let me now provide you with some background on the key drivers behind this quarter.
First both cloud and software revenue as well as total revenue grew 11% this quarter.
Now revenue was obviously again, a big driver of this.
Our cloud revenue surged, 40% and as Bill said, we saw an amazing performance of our call tricks experienced management solutions.
New cloud bookings were up 17% to 494 million euros.
At up 27%, excluding our infrastructure as a service business.
Our customers are doing more infrastructure as a service business directly with our Hyperscale partners.
This is a good trend for us as it is positive for the margin profile of our cloud business.
And you can already see that immediate positive effect on our cloud gross margin this quarter.
Which I'll talk about in a few minutes.
In addition, as Bill mentioned, our Successfactors offerings had strong double digit bookings growth.
Driven by rapid early adoption of 12 tricks employee experience.
Software license and support revenue continues to grow at a solid 2% in the second quarter, even with the well publicized global trade effect.
If you look to the half year numbers, we had a great focus and growth performance in our rock solid core business.
Our business is also becoming increasingly resilient as bill said in Q2, the share of more predictable revenue had a strong three percentage points uptick and is now already approaching 70%.
Now to the regions, we had a solid performance in the EMEA region with cloud and software revenue, increasing 9% cloud revenue increased by 46% with Germany, and Spain being highlights.
In addition, Germany had another solid quarter in software license revenue.
France, and Italy, and had a strong quarter in software license revenue.
In the Americas region, we had a strong performance.
Cloud and software revenue increased by 16%.
Cloud revenue increased by 37% with the United States, Canada, and Brazil being highlights. In addition to US also had a solid quarter in software license revenue and Canada had a strong quarter.
In the DJ region, we had a solid performance despite the trade related macro headwinds cloud and software revenue was up by 8%.
Cloud revenue increased by 41% with Japan being a highlight.
Software license revenue, Australia, and India had a strong quarter.
Now, let's look at profitability and gross margins in the second quarter.
First of all we are very happy to report that all our individual cloud gross margins were again up year over year, leading to an overall cloud gross margin of 68%, which is up two percentage points sequentially and up sharply at four percentage points year over year.
In our most profitable cloud business the intelligent spend group, formerly business network. The gross margin increased by one percentage point year over year and reached 78%.
The gross margin of our other SaaS paas business expanded massive fleet by eight percentage points year over year, reaching 69%.
More importantly, this gross margin improved sequentially by five percentage points as we saw the first full quarter of success factors running solely on the converged cloud Hana based platform.
This is a crucial milestone as it gives us the ability to embed real time predictive capabilities and cutting edge future innovations, while providing expense relief as we retire duplicate infrastructure reduce third party support fees and rationalize resources.
For Hana Enterprise cloud, which is our infrastructure as a service offering the cloud gross margin improved by 11 percentage points to 22% year over year.
As we said, we expect to reach a level of 30% to 35% in 2020 .
We see it infrastructure as a service, becoming a smaller share of the cloud mix going forward as we continue to accelerate our hyperscale partnerships.
Overall, our cloud and software gross margin was a solid 81% for the quarter.
Our services gross margin was down two percentage points to 24% as we hire more consultants to specifically address the strong as for implementations backlog.
Overall operating profit was up 11% year over year, driven by a combination of a strong topline more focused hiring and continued efficiency gains in our cloud business.
This led to a stable operating margin in Q2, even with an acquisition headwind of approximately 40 basis points in the quarter.
For the first half we were able to expand our operating margin by 20 basis points.
Now turning to IFRS operating profit as well as EPS and Texas.
Two tool for us operating profit in areas, where both down 21% impacted by higher acquisition related charges as expected.
In addition, ofer as operating profit was impacted by higher share based compensation.
Both due to the call Trcs acquisition.
But also particularly the strong sep share price increase over the second quarter.
As well as additional restructuring charges, mainly due to a higher than expected estimated participation rate in the voluntary redundancy and early retirement programs in Germany.
Since these are very significant effects. This year, let me put some numbers to it.
If we compare the first half of 2018 to the first of this year.
We now have close to 100 million euro of higher acquisition related charges and revenue adjustments, mainly from the acquisition of 12 tricks.
We also have more than 600 million euro higher share based compensation expenses at approximately 1 billion euros higher restructuring charges.
But to be clear.
As a consequence, we obviously expect IRS operating profit to be sharply up in 2020 at even significantly higher growth rates than on a non io for as spaces as there will be no meaningful restructuring expenses and the general downward trend of acquisition related charges.
Moving onto EPS, we saw strong 11% increase year over year for the fourth quarter for the second quarter and 17% for the half year on a non IFRS basis.
Year over year, our IYR for us and not for us effective tax rates decreased slightly.
For us rate decreased by 0.9 percentage points to 28.6%, while the non Io for us rate decreased by 0.5 percentage points to 27%.
Our operating cash flow was 2.7 billion euros down 10% in the first six months.
As explained at our capital markets day, we expected our 2019 operating cash flow to be impacted by several items.
I'd like to provide you with an update for the first half 2019.
First operating cash flow experienced a year over year benefit of roughly 185 million euros from the application of ire for as 16, which we neutralize in an adapted definition for our free cash flow just to remind.
Also compared to the prior year, we had run higher restructuring payouts of close to 200 million euros.
Higher share based compensation payouts of around 230 million euros, and hire techs payouts of more than 400 million euros.
For the total year 2019, again as compared to the prior year. We currently expect higher restructuring payouts of somewhere between 550 to 750 million euros.
Higher share based compensation payouts of around $400 million Euro and hire techs payouts of around 600 million euros.
Due to the adverse impact of the items just mentioned, we now expect 2019 operating cash flow will be slightly lower than in 2018.
Similar to I refer as operating profit, we expect a steep increase in operating cash flow in 2020 as restructuring and tax payouts will sharply recede and we also do not expect significant increases of payouts for share based compensation.
Free cash flow for the first half also decreased by 10% to 2 billion euros, reflecting the lower operating cash flow.
But partially offset by topics, which came in 279 million euros lower.
We expect that this trend towards lower Capex will also continue in the second half.
Before I conclude I would like to give you an update on our non financial performance and sustainability highlights as well.
Our COO to admissions remained flat year over year at 75 kilo tons. Despite the addition of 12 tricks.
Our goal remains to be carbon neutral by 2025 gross sustainability policies, we have been able to achieve cost device avoidance of 238 million euros over the last three years.
Further we have now updated our global environmental policy and introduced a new target to phase out single use plastic completely by 2020 .
We continue to make progress on the social front as well.
As we continue to work to achieve gender equality, we're now at 26.2% women and management on track to achieving our goal of 30% by 2022.
So to summarize Q2 was a solid quarter as we continue our journey towards an sep that is leaner more agile and even more customer oriented than before.
We are very confident that the opportunities for operational improvements will continue.
We remain as confident in our 2019 outlook as we are in our mid term ambition.
And like we've said before we will provide additional details on our operational excellence initiatives and capital allocation policy at our special capital markets Day on November 12 in New York City.
Thank you and we will now be happy to take your questions.
And if you would like to ask a question. Please signal by pressing star one on your telephone keypad. If you are using a speaker phone. Please make sure. Your mute function is turned off to allow your signal to reach our equipment again that is star one to ask a question and we will take our first question from Walter Pritchard with Citi.
Please go ahead.
Hi, Thanks.
I think everybody understands the impact from the Hyperscalers qualitatively could you help us understand as we look forward in the year how much on the on the IR side, we expect to see the hyperscaler richest hyperscalers impacted QAD business and does that impact at all your longer term goals around cloud.
Yeah, and just to kind of netted out the hyperscalers will be a.
Our growth opportunity for Sep the safety cloud platform is at a mature phase now where it can grow into the hyperscalers environment.
That will lead the customer to many more of the cloud based solutions that Sep offers and that is the factor that probably no. One out there is counting on but it's coming.
And secondly, the Hana enterprise cloud now is being run by some real pros. So instead of a low margin business that was uninteresting financially.
It's now improving steadily and you're already over 22% with the margin performance of hacking will get into the mid Thirtys and it's actually performing at a quality standard commensurate with the Hyperscalers now it wasn't always it is now we have turned back on the valve many of our customers want the white glove treatment that comes along with their complete portfolio of Sep solutions and they want the heck and they are going to get it. The heck is 100 enterprise cloud.
Similarly, many of our customers have migrated and will migrate to the Hyperscalers and we're very well positioned and I think what you're not counting on is just how much cloud revenue will come as safeties way by leaning into those strategic partnerships so to be very clear the bookings scenario in the company is ever strong pipelines are entirely commensurate with what you would expect and what we guided for and count on the cloud to come through in the bookings and the revenue in the back ended the year command performance in the cloud on its way.
Thank you.
Let's take next question please.
And we'll take our next question from Charles Brennan with Credit Suisse.
Great. Thanks for taking the question.
Great. Thank you thanks for taking the question.
Can we just drill into what feels like it's been a bit of revenue weakness during the quarter.
I know you called out the trade rules in Asia.
But can you just remind us.
Our vision customers, primarily on premise or does that also impact the clouds and if it's not the Asian customers are impacting the current bookings, what's the bottleneck thats holding the count bookings back to high teens and on an organic basis. Thank you.
Yes, a couple of things first of all on the Asian market is fine.
China in this particular quarter wasn't as strong as we are used to seeing China, China, usually grows steeply and both the on premise and the cloud and there was postponed decisions in China. So we did see that.
What you are seeing in this environment is there a lot of companies that were manufacturing things in China that are actually moving supply chains and manufacturing facilities to alternative locations. Those locations include places like Malaysia, Vietnam, and even Mexico. So while that dislocation takes place it does impact Asia to some extent China specifically.
So thats the scenario and then what you do is you go in and you look at Okay, well what did the pipeline do.
Post quarter on because don't forget we ended the quarter on a Sunday.
On June Thirtyth and the G 20 discussion was happening at the end of that week in Japan.
So there was a lot of people hovering for the outcome of G. 20 in terms of some of their strategic calls most of those deals that were hanging out there have either closed or the bill of materials has expanded because when you change the supply chain you open up a new manufacturing facility you start operations in a new geography, even if it's in the dissimilar region. You have governance you have compliance you have many things to consider and I think thats one of the reasons why our digital supply chain cloud business grew in triple digits, because many of the customers are now counting on Sep to help them. So thats the big picture and as I look at Q3 on a pipeline and a forecasted level in that region right now and I have a dare sitting next to me if she'd like to make some color commentary is more than welcome everything looks very strong.
The coverage that we have in the pipeline is as good if not better than it's been all year long.
Yeah. Thanks, Thanks, Phil certainly as we enter Q3, we're entering it with their and multiple of coverage, but also more importantly, with a conversion history in this quarter and that will ensure a good outcome for us in terms of our business in Asia and I think when I look at Sep physician there of course, the supply chain and impact was significant on our China business, but we've got to remember we've been in Asia Pacific Japan for 30 years now we have very strong teams and very strong businesses across the region, which allows us to support our customers as they move these manufacturing capabilities into other regions.
And we are now working with those customers to delay some of those decisions to provide both commercial flexibility and certainty and from an Sep perspective in the face of lot political and economic uncertainties. So were very comfortable as we move into Q3 that will be able to.
Manage those transactions that did not happen in Q2, but also deliver a very strong Q3 from Asia for the company.
Are you able to give us a quantification.
Of the revenue slippage from Q2 into Q3.
You can basically look at.
The the light and the only thing you can point out right is the license you were negative five were negative six depending on where currency you want to look at it instead of flat or up you know or down to and you can attributed to that region, primarily so thats why were talking about Asia. Today, you got to remember these are a few percentage points. If you look at Q2 last year put the global trade thing on the shelf for a second our license in Q2 last year was down 5%.
It's a very similar thing to this year. So you got a lot of things going on NFC piece Q2, you guys Sapphire you got to Sunday quarter closed on June Thirtyth, you got the G. 20, you got the Asia supply chain and manufacturing dislocation. So I'd like wouldn't react to this because we are reiterating the guidance the pipeline and Asia is the highest coverage in terms of the pipe to the conversion of the license in the company. So whatever didnt happen will happen and it will happen at a larger scale bill material. We're also very well positioned politically and I think it's very important in these trying times that companies and their brands and their leadership is highly regarded as the top government offices around the world and Sep is positioned positively.
Whether it's Europe , the United States, or Asia, and specifically, China, very very well our brand is very highly thought of there and we'll be in good shape.
Okay. Thank you.
Let's take the next question please.
And we will take our next question from Phil Winslow with Wells Fargo.
Please go ahead.
Hey, Thanks, guys for taking my question, obviously, there's been a lot of comments on Asia on the call this quarter, but what I want to focus on Europe , and Germany in particular, and just the trends that you're seeing there obviously, if industrial production data points have not been great for Germany for several quarters, but as it keeps delivering this high single digit 10%.
Growth rates.
Bill in a day or two for that matter when you're talking to Ceos and customers what continues to drive that performance.
In Europe , but bolster particularly Germany.
Phil. Thank you for the question I think it's pretty well known that the Sep brand.
Is.
So highly regarded in Europe .
Digital transformation Sep is at the epicenter of changing business processes, whether it's the S. Four on a flagship platform or is the line of business business network and now XM cloud solutions.
If you look at Germany, we grew double digits in Germany, and in our business and I don't know too many companies in tech that are growing double digits in Germany.
And our core business is rock solid and Germany, and our cloud business is doing extremely well again I'm on the European round table, I think I might be the only American on the European round table running a substantially sized company I also enjoy that new business round table, the United States and I can tell you that Sep is revered in Europe and one of the examples I gave on the experienced management side was Merck you can talk to a CEO in Germany, France.
UK or anywhere else that isn't talking about Sep Cana as for Hana the cloud connections and now, especially experience management don't forget when a big Omnichannel ecommerce world.
Its mass personalization at scale.
Europe is very concerned with privacy of consumers. We are the British Standard Institute Platinum example of a company that protects the data of the customer and the consumer and in Europe , especially Germany. Since you mentioned it that's a really big deal. So again, it's a pristine reputation and we'll continue to do very well and double digit is absolutely where we need to be in Europe and will stay there.
And I feel very comfortable and very.
Very positive about our business in Europe and in Germany in particular.
We have a very strong installed base in the German market.
And a number of our larger transactions this quarter were transmix transactions that were transformational in nature.
Transactions that were moving our customers to next generation of S&P software on transactions that were taking into consideration how experienced management could add to the business outcomes of those consumers and we have a strong team right across Europe with tenure and we have deeper relationships with many of our customers. So we're looking forward to the ongoing migration of our customers in Europe to next generation technology and next generation experiences for their customers in the market.
Okay. Thank you. Thanks, Richard next question please.
Thanks, I will thank you for your question from Stacy Pollard with JP Morgan.
Hi, Thank you Barry go ahead.
Yes.
Hi, Thanks.
Network, just looking at networks closer to 70% constant currency growth in Q2.
Can you give some product trends there, maybe say where the weakness is coming from our relative weakness and then his team sustainable range or do you think it could get back up to about 20.
Yes.
This is Jennifer so.
In our business I feel really good about the intelligence span I don't think that there's anything anything to be concerned about a couple of our.
A couple of the Ariba deal slipped into the first second week of July , but we feel really good about where we're going with the network business. We've got some great innovation underway and we'll be talking about that a little bit more in our capital markets day. So.
Very good about the direction of that and the and the growth.
And they say one thing.
One thing that's very important Stacy fieldglass is doing great.
And concur is the bellwether of all cloud assets in the network and it's doing very very well. So there is no reason.
To think that this thing is slowing down it's going to be ever steady and I think you're going to actually see the growth rate tick up in the Q3 and Q4 timeframe as well.
Yes, especially over here in Asia concur really blew it out in Q in Q2 over here in Japan, and Singapore, right now and we're doing some pretty interesting partnerships with some of the banks that were working with so we're excited to share more of that at the capital markets day with what we're doing with the network.
Thanks, very much for you it sounds like it.
Thank you, let's take next question please.
And our next question comes from Adam Wyden with Morgan Stanley .
Please go ahead.
Hi, Bill Alex Thanks for taking the question two if I could just first of all on margins margins are flat.
On a constant currency basis in the first half I think if I look at the implied guidance were looking for maybe a 60 basis point improvement for the year Lou could you just maybe talk a little bit how you feel about that and maybe help us with the phasing of how restructuring benefits start to flow through to Pan out could we see most of that already in the second quarter do we see more of that through the full year and make the same on the cloud side too we have most of the benefits already in the pan out or is there more to come so just help us on the linearity and how you feel about where you are this year versus the full year guide our margins that would be great and kind of linked to that bill.
Obviously, you've got some fantastic opportunities around cloud and particularly bringing coal tricks into the business and broadening the apps could you just talk a little bit as to see how you balance driving the efficiency in the business and driving margins higher while making sure you're not cutting things that are important to take advantage of the opportunities things like project spring. Thank you.
Why don't I go first and then we'll finish up on the important financial questions with Luca on because I think it's a really important question that you ask.
Very clearly sep as a growth company, okay, and we are going to remain a growth company.
And the way I look at growth I look at Hana as the biggest best kept secret of all time, we're going after the database market with all we have I look at as for Hana as the flagship platform, we got lots more growth coming with us for Hana, especially as more and more of it comes in the cloud we have a new release in Q4, we'll start marketing. It in Q3, we're going after the upper market and the large enterprise and that hasn't even taken off yet and Meanwhile, we get 50% of our customers as net new when I think about the line of business. The network experience management, we've only scratched the surface with qual tricks as the front end to employee to customer to this whole idea of brand and ERP, it's going to set the world on fire, it's a sensational breakthrough and the way companies can now think of the world from the outside in instead.
From the inside out and we have the fundamental tools to enable business model innovation at mass scale for companies and individual consumers alike.
Huge growth story now.
Blending that with efficiency.
We will not be hiring people that do not develop software and S&P.
They have to develop software they do not necessarily have to be domiciled in Germany, or the United States for that matter. We can develop software with the greatest mines in the world and we can do that where the work needs to be done with the best people on and off the nets in lower cost locations I might add as well.
As it relates to sales customer facing assets, whether you're selling a customer pre selling a customer putting together the composition of the perfect enterprise in the way we design the experienced management and how we engineer that value for a customer and how we implement our software, particularly the multifaceted nature of our business, we will invest in those kinds of people.
Well the things in the Middle panel can do it and the ERP system that we run the company on cold as for Hana can do it we don't need people now what I will do.
And I have the complete backing of the CFO and the entire executive Board, we will manage head count with an iron fist, meaning what we hire into the company falls into what I, just told you and they have to be evaluated by several different people before we hire them. We have to have the best people in the world and the company. So that's kind of the deal where you get not only the growth, but you also gain the efficiencies now I'll tell you. Another thing I feel for you watching the restructuring and the oversubscription of it and all that but I will also say look that's what gives us the bright horizon.
We cleaned up the business model, we consumed a great company in Qual tricks and we gave ourselves some room to make sure that the margin can step up one percentage point per year between now and 2023 and even on the cash flow basis. The bad news is kind of out the window and all the good stuff is coming your way in 2020, So I'll, let Luca give his color on it did I answer your question Adam.
Yes, that's great. Thank you.
Yes, hi pleasure than the let me complete the answer was the margin progression and let's be clear.
First of all we have very confidently reiterated our guidance for the full year. So you can absolutly taken for granted that we will see the implied margin increases that are.
Implied in this guidance.
We are getting started right now and in the first half year, we still had to fight.
A couple of headwinds from the acquisition front, while at the same time the benefits from our restructuring program are really only now is starting to trickle in actually the lion's share of the improvements will come towards the far end of the year and then going into 2020 , we always believed that.
The margin uptick in 2019 would be more pronounced in the second half year first of all because of the operational excellence.
Initiatives needing some time to kick in but equally importantly, because the bar is getting lower in the second half years, well. If you remember in the second half of 2018, we didn't necessarily have the the best progress and best growth rates from a profit and margin perspective, now we have set up our cost basis in particular in the cloud we have focused on our hiring on those areas, where we can really add value. We have been extremely disciplined and therefore entering the second half year, which are much better opportunity coupled also with the relatively.
Lower comparisons on the software license figure in particular in Q3 to really outperform and therefore grow the margin. Similarly on the cloud no of course, we are not seeing the end of the journey.
In terms of our efficiency improvement potential is actually its the beginning as well.
We have been extremely successful through centralizing cloud delivery.
And our infrastructure portfolio management, including the purchase of hardware to bring down the capex inside of the company that was one of the sources that allowed us to expand the cloud margin. This is something that we can continue to piggyback on on and further drive down.
The.
Change in the depreciation of hardware that we were able to achieve due to the successful renegotiation of maintenance contracts with our hardware providers is going to benefit us all the way through the year and we had in Q2, the very first quarter of forgetting the benefits from Successfactors just to give you an idea.
In Q2 alone.
Due to this move we saved already almost 20 million 18 million to be precise. So we're perfectly in line to harvest those roundabout midst double digits that we originally projected for the first year and then the low triple digits.
Going into 2020 from that measure alone.
And there are still two quarters to come that we'll see this benefit.
And so from that perspective, we are on a very strong trajectory towards the 75% cloud gross margin target.
For 2023 in fact, when we started to talk about this one year ago and also our targets for 2020, when we were hovering around 62% I think I've been hearing a lot of concerns in question marks about our ability to pull this off well fast forward. One year later, we have already made half of the overlay to these 2023 targets that should give everybody a lot of confidence.
Brian . Thank you match the detail I appreciate it.
Thank you. Thank you thank you Adam.
Thank you lets move to the next question. Please.
And our next question is from Mohammad.
With Goldman Sachs.
Great. Thank you.
Great. Thank you very much.
Firstly Bill can you just give us an update on the cross selling of Cormatrix, where you are in terms of our pipelines and and sort of how quickly should we start to see this sort of getting on loss and where you see is this where the biggest opportunities.
In the near term second point was just to clarify what you said regarding the infrastructure revenue.
In the cloud that will sort of go away just to clarify you will be able to fully offset with incremental revenue from shows the Hana cloud platform sales could you clarify that and then thirdly for Luka just.
Are we still on track in terms of the migration of our revised offer Oracle and I assume the bulk of that benefit is still ahead of us in terms of gross margin in 2020, but could that.
When do you expect that migration to happen then the first quarterly benefit of that to come through thank you.
Hey, Thank you very much for the question Mohammed what I'll try to do is.
Trying to give you the big picture on on Qual tricks.
Jennifer Morgan can build on that I also will start off answering your question on the infrastructure side by saying.
Very clearly.
The bookings and the cloud growth trajectory of S&P will continue at a robust clip youre accustomed to.
You can say in certain cases, the lower of large numbers, but I can also say is very large geographies that are still unconquered with solutions already in our portfolio.
And don't forget as for Hana, we are driving an organic growth strategy in this company and we will take the EPS for Hana Road show in the cloud all over the world and that is going to be big.
Don't forget also Hana as a service will be hitting hyperscale clouds near you and it's a whole new vector of global growth along with analytics and on the Sep cloud platform, there will be a tremendous opportunity with the Sep cloud platform between that and the up selling opportunity of experienced management, yes, any dilute of effect to moving the infrastructure as a service and the embraced program will be compensated for and I want to also be clear.
And then Q2 is a little of an anomaly on the heck business in general because we have new management and there is doing a great job.
Making sure the operational excellence of the performance is at the standard of the Hyperscalers at least and also to make sure that the business, we put into the Hana enterprise cloud was at a margin rate commensurate with our our commitment to the 70.
Mid Seventys gross margin that Luca just talked about in the cloud gross margin. So we're just being a little bit more thoughtful when you get a little bit more thoughtful what happens people. So what does this mean and it does slow things down and the heck business, a little bit with that we're going to reinforce with the all hands with the company. The white glove business is wide open for business. The embrace is wide open for business. The FCP component of that and then also turning on the Hyperscalers to eliminate the various solutions in the enterprise of Sep is open for business and I gave you some color on our flagship products and how we intend to take them to the cloud and rotate them around the global economy to drive the growth machine. So there won't be nervous about Sep is cloud ambition it could not possibly be more.
More resilience perseverance and and committed on the part of this management team I think Jan might want to add some color on all trucks and then I think Lucas catch on a couple of financial points.
Thanks, Bill So we're really pleased with.
The talent the momentum there's kind of three areas, where we really see.
The focus number one is closer to has done a fantastic job.
Just continuing on their own pipeline building sales execution and conversion of their pipeline. So thats been a great source of continued growth.
Second as we put a real strong focus of enablement in execution with our success factor sales team and they have exceeded all expectations. We had at that business. In Q2, we had great growth and success factors and I really think much of that was driven by the broader conversation from simply talking about HR systems to really employee experience. So that was fantastic and then obviously with Rcs sales. So those two sales motion through those specialist teams have been really great and we exceeded our expectations quite significantly with that the synergies of those team and then finally, just the overall curiosity excitement from our entire customer base with our with our global sales team and really talking about would experience management means how yes.
Oh is that what acts as the why this past week, Ryan Smith, and I were in both Korea, and Japan, and our Sep select events and those are our CEO events, we had several hundred Ceos in both countries and this was the focus and I can tell you. This plays very very well in Asia. When you think about just the fact that many of the Asian brands have already understanding experience.
We had a great week the pipeline is off the charts now we closed our first deals in Korea last week and I think we're off to a really great start State Department closed Bill as Bill said Merck close the clothes Chello Gribbin UAE. So feel really good that we're continuing to execute individually we call for it as as they continue their growth and get great synergies working together with our team and we'll continue that focus.
And then finally or more just a very quick update on our rebar. So on our repo all of the applications both on the sourcing and on the procurement side have been migrated successfully by now to handle the same for all of the Ariba analytics.
We are in process of finalizing the migration for the network element of rebar. This will also be done this year.
And this will set US up then for the significant gross margin increase that we also expect through the migration of our Riva of Oracle similar to what you are seeing now from success factors as you know our target for the intelligent spend group cloud gross margins is to exceed 80% by 2020 . Currently we are at around 78%.
And that full year benefit from being off.
Oracle and on Hana in a rebound will be a big component of achieving this game.
Great. Thank you very much.
Thank you we have time for two more questions. Please.
And our next question will come from Michael Breeze for Tvs.
Please go ahead.
Yes. Thank you good afternoon and.
Start by congratulating you on the cloud margin performance.
Look I think 2017, CMD you said that.
He would not engage.
In debt financed buybacks.
Satisfy the you said the capital returns would be paid for from the higher profitability in the business.
Are you rooting out using debt to two further buybacks from here.
As you know, we will update the capital markets on our capital allocation policy thoughts and I will give also.
Clear picture on how we see the cash flow progression for the company for the next few years. So I don't really want to spend at this point of time.
Any thoughts on taking the Thunder away from the special capital markets Day on November 12.
So you will give get a full update there and we're preparing for this properly at this point in time, we're still under consideration.
Okay, maybe I could ask on the maintenance it grew 2% which is in the low end of the historical range are you seeing more of a shift now from maintenance customers into the cloud and specifically on Esfour public cloud.
Maybe Jennifer could talk about the adoption there either from net new ore from installed base customers. Thank you.
Yeah, let me handle the first part with the maintenance growth rates, and then I will actually hand over to Chris John <unk>, who is running the us for business for some color commentary on the pickup of.
As for on our cloud so on the maintenance side. There is absolutely no change in paradigms are maintenance at risk.
Rates, including the extensions towards cloud on premise solutions.
Are actually below the level that we are internally planning for so we are still seeing a very high end sticky high stickiness in the maintenance offering why is the growth rate.
Smaller in Q2 well.
You need to look back one year to Q2 in 2018, and where we had an exceptional 7% growth in support revenues that came from the fact that back then we had a very very steep drop in sales allowances due again to a very healthy development of our customer relationships and adoption of our solutions. This level of sales alone. This has kept at this low level, but of course they are for the growth that we're seeing sequentially as well as third quarter year over year.
It's a smaller so ours support fundamentals are in great shape, and though we continue to be right, where we wanted to be and you can see also for the half year with 3% growth. This is very robust and you absolutely should expect a similar performance for the full year.
So nothing more to add on that except for handing over to Christian. Thank you Luca and Michael So first of all let me outline I mean Q2 was definitely one of the best quarter ever for ways for Hana business.
In the on premise side, we have seen double digit growth, we already surpassed after half year one.
The 1 billion your license number and does also of course, we'll have.
Very positive impact on the correlating support revenue, but is also clearly shows that the hybrid strategy we are falling.
It's clearly the wide warranty costs also we see a very decent business together with their auto into upcoming quarters to us for Hana cloud.
I mean this is not anymore.
Small business I mean, when we look at the bookings number clearly this solution contributed to most cloud bookings new cloud bookings after concur in Q2.
The cloud revenue number already doubled.
Year over year and for 2020, we will generate a significant revenue run rate by S&P cloud subscription revenue stream.
And it's a high share of new customers coming and also Chuck to outline to give you. An example, how are the solution in the meantime, if we are serving in the meantime over 17 industries. So 17 industry and the installed base is growing and growing on the product side, we will deliver this year over 2000, new features across 21 end to end processes. So this will be clearly the most comprehensive ERP cloud suite.
By the end of the year on the AI side I mean, this was always our target to also deliver an innovative cloud suite. We are more than confident that we also can increase the productivity of our asphalt cloud customers in their core operations by at least 20% and then in Q4 the analytics cloud integration comes so the real time integration and then with that a real time saving across the company and call takes will be natively integrated to our asphalt costs. While also by Q4. So net net we are we confident also for the half year to outlook.
Perhaps just to conclude what gross churn essentially set now is that by now the combination of digital supply chain management and as for.
Is actually already representing more than 60% of our on premise license revenues.
And that is actually very good news because it is stabilizing.
Use this as part of the portfolio still grows in on premise and it will continue to grow while the rest has already to a large extent migrated to the cloud and that will also stabilize our on premise performance in the quarters and years to come quite nicely. So our mid term projection. So in terms of negative growth are certainly still prudent.
Great. Thank you. Thank you.
Now we move to the last question. Please.
And our final question will come from Stefan Slowinski with Exane BNP.
Please go ahead, yeah, hi, thanks, Thanks for taking my question, just two kind of related ones.
One on growth one on hiring so on cloud sales growth you mentioned the efficiencies in terms of head count going forward.
That could create headwinds in terms of your ability to drive growth. So I'm, just wondering what kind of organizational or other sales adjustments, you're making that Matt on their own can help you to continue cloud growth and kind of associated to that outside of the hiring discipline that you've outlined can you give us. Other examples of steps that are already being taken are already in place as part of the operational excellence program.
Thank you.
I'll comment on.
The overall cloud sales growth and then I'll, let Luca comment on the efficiency piece of your question Stephane a couple of things we are hiring.
Sales people all over the world.
I mean every day I get a new string emails on welcoming the next 50, great associates into the company with their pictures and they are linked in accounts and just how happy they are to be here. So don't take anything away from the impression of growth in sales head count we will continue to grow EPS, what we will cut back on his DNA, because we have Hana and we have as for Hannah and I think Christian gave you a good account of how great their product. So it does the work of like thousands of people. Okay. So GE in a down as up and Thats kind of where we're going as a a growth company I also want to make it clear the members of the executive board are accountable for organic growth.
So we have Jennifer Morgan now running the cloud business group.
We built some things and we bought some things and the things that we bought she's accountable for making them, even better and growing them around the world and she has a very specific.
Our sales force and pre Salesforce that works in conjunction with the Dare Fox Martin on the global customer operations and this way we can be best of breed.
And best of suite in the manner in which we manage the customer relationship. So the customer gets the best of both worlds from Sep and the coordination between Genentech. There has been long standing as they both managed global customer operations together and have been friends for a long time. So the other piece is Christian Cline.
Is accountable for the organic development.
Of the S 400 flagship and obviously, he's given you great feedback that its going extremely well.
And European Moeller has Hannah.
This whole movement of database as a service in the cloud as well as analytics and land auto and all of these solutions will be front ended by experienced management as we compose the intelligent enterprise for our customers. So what's different I'll tell you what's different is lots of focus on EPS.
Lots of focus on organic innovation, a very disciplined capital allocation strategy.
A very brisk pace and our pursuit of one point of margin per se improvement on a per annum basis, and holding people accountable for doing a great job and I do mean accountable. So thats kind of the environment will work and what I want to do is start talking about revenue per employee and how that metric is going to start growing. So that gives you an indication of how the places being steered Luca.
Yes, thanks, and just a complimentary so of course.
You know just hiring discipline is not a holistic strategy. So we have multiple pillars of operational excellence initiatives that we're currently working on again I don't want to go into too much detail here, but just to give you couple of examples over just currently going through the portfolio around and as I have also talked about at Sapphire, we have various areas of portfolio overlap.
We are currently in process of rationalizing, which will benefit the R&D efficiency will allow us to continue to invest into developers, but investors not in a duplicate of sense. The cloud efficiency is very very important and there next to the Oracle initiatives we have the.
Our cloud infrastructure centralization, the benefits and gains that we get from there we have an excellent best practice example, with quad tricks at the moment I mean, they are running their cloud margins at around 90%. So we are looking deep into architectural leave from an operations perspective from an elasticities elasticities perspective, what can we learn and adopt and bring over to the rest of the portfolio, which is a great opportunity for us that only we can really know as steeply inspectors and then also we have great opportunities on the DNA upside that we're starting to tap into obviously GE an a at the beginning of the year got a headwind because of the acquisition of 12 tricks and there is plenty of opportunity to bring that down over time, but we are taking for example, also steps such as lifting and shifting one complete shared service center.
In the finance area into Manila in the Philippines in a very low cost location. Therefore, you see injury in a little bit more hiring than you would expect at the moment, but this is low cost hiring that once the work is handed over we would result in reductions elsewhere and will benefit us on the DNA side and again there are many more examples that are already under way, but even more importantly, new ones that were just in the process of starting that we will be able to talk more about on November 12.
Great. Thanks, Thank you very much any information in the color guys.
Okay perfect. Thank you for the question.
Thanks very much. This concludes the second quarter 2019 earnings call of Sep. Thank you all for participating and goodbye.
Thank you everybody and thank you goodbye.
All right and this concludes today's conference. Thank you for your participation and you may now disconnect.