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Executives

Stefan Gruber - Head of IR

Werner Brandt - CFO

Leo Apotheker - CEO

Bill McDermott - Executive, Global Field Operations

Analysts

Michael Briest - UBS

Phil Winslow - Credit Suisse

Ross MacMillan - Jeffries

Gerardus Vos - Citigroup

James Dawson - Morgan Stanley

Raimo Lenschow - Bank of America-Merrill Lynch

SAP AG (SAP) Q3 2009 Earnings Call October 28, 2009 10:00 AM ET

Stefan Gruber

Good morning or good afternoon, this is Stefan Gruber. Thank you for joining us to discuss SAP's third quarter 2009 results. I am joined by Leo Apotheker, Werner Brandt and Bill McDermott. Werner will discuss the Q3 financials in detail, Leo will comment on the current business environment, our strategy and product successes, and Bill will provide some color on our regional and industry performance and our go-to-market strategy. Following the prepared remarks, we have time for Q&A.

As usual, I will make a few remarks about forward-looking statements. Any statements made during this conference call that are not historical facts are forward-looking statements as defined in the US 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 SAP are intended to identify such forward-looking statements. SAP undertakes 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 SAP's future financial results are discussed more fully in SAP's filings with the US Securities and Exchange Commission, the SEC, including SAP's annual report on Form 20-F for 2008 filed with the SEC on March 26, 2009. Participants of this call are cautioned not to place undue reliance on these forward-looking statements which speak only as of their date.

And with that, I'd like to turn the call over to Werner.

Werner Brandt

Thank you, Stefan. Welcome to everybody on the call. Before I begin, let me inform you that I will be speaking mostly about non-GAAP figures. They are more in line to how we internally look at our operational performance. Also, these non-GAAP measures are the basis of our guidance.

The difference between US GAAP and non-GAAP figures in the third quarter of 2009 is a result of the exclusion of acquisition-related charges in the amount of €67 million. More detail on our non-GAAP measures, the reasons for their use and reconciliations to the most comparable US GAAP measures are provided in our earnings press release.

Also, let me remind you that all numbers that we have presented today are preliminary. Our final numbers will be presented in due course in our interim report. Subsequent events that may occur until then are to be reflected in our Q3 2009 financials as far as they are that they provide additional evidence with respect to conditions that existed at September 30, 2009.

Please note that we incurred restructuring expenses of €160 million in the first quarter, €5 million in the second quarter and €21 million in the third quarter of 2009 resulting from the previously announced reduction in position. Our non-GAAP measures are not adjusted for these restructuring expenses. Therefore, both our US GAAP and non-GAAP numbers are negatively impacted by these charges.

Moving forward let me say that we are pleased to report another quarter of increasing operating margins despite a challenging business environment.

Let me give you the highlights of the third quarter; non-GAAP software and software-related service revenues for the third quarter of 2009 were €1.94 billion, which represented a year-over-year decrease of 5% at constant currency. Sequentially non-GAAP software and software-related service revenues stayed relatively flat.

The year-over-year decrease in the third quarter was a result of a decline of 30% in software revenues at constant currencies and increase of 10% in non-GAAP support revenues at constant currency and an increase of 22% in subscription, other software-related service revenues also at constant currency.

In the third quarter of 2009, our recurring revenue stream accounted for 56% of our total revenue and 55% for the nine-month period. Let me take a moment to explain the development in support revenues. The slight sequential decline in support revenue was mainly caused by a strengthening Euro, especially against the US dollar and the transition of customers to the subscription model.

These two effects negatively impacted support revenue by approximately 20 million. In addition, there was a positive one-off effect of roughly €10 million that increased Q2 support revenue.

Third quarter professional service and other service revenue were €564 million which was a decrease of 25% at constant currency, consulting revenues of 484 million, decreased 22% and trading revenues decreased [43%]. The decrease in consulting and training revenues was not unexpected given the decline in software revenues over the past few quarters. Consulting revenues usually lag software revenues by around six to nine months.

Non-GAAP operating expenses decreased to €1.83 billion or 12% at constant currency, which represents a decrease of €243 million adjusted for currency. This number includes restructuring charges of 21 million related to our previously announced reduction of positions, which for the nine months totaled €186 million.

The number of positions reduced associated with the €186 million charge was approximately 2,900. Roughly 2,600 of these employees have already left the company as of September 30. The rest will leave in the following month according to the labor laws in the respective countries.

For the full year 2009, we continue to expect a total of around €200 million of restructuring charges related to the reduction of positions. For the first nine months, our total non-GAAP operating expenses declined by €593 million or €779 million excluding restructuring charges.

Non-GAAP R&D expenses decreased 4% to €380 million for the third quarter and represented 15.2% of total revenue, which is an increase of 1.1 percentage point compared to the third quarter of last year. The cost savings measures could not fully offset the decline in total revenues which resulted in a higher R&D ratio for the third quarter.

For the nine-month period, R&D as a percentage of total revenues remained flat year-over-year despite this percentage the reduction in R&D as part of our overall program to manage our cost structure our ability to innovate has not been effected as Leo will later talk more about the power to innovate.

Non-GAAP sales and marketing expenses decreased 19% to €497 million for the third quarter and represented 19.8% of total revenues, a decrease of two percentage points compared to last year third quarter. The decrease in certain marketing expenses was mainly a result of lower personal expenses due to headcount reduction and tight cost control in all areas.

Non-GAAP general and administrative expenses decreased 40% to $134 million for the third quarter and represented 5.3% of total revenues compared to 5.5% of total revenues for the third quarter of last year. The decrease in general and administrative expenses was a result of effective cost saving measures mostly in the areas of non-customer related third-party expenses, travel expenses and personnel expenses due to the headcount reduction.

Overall, the company's non-GAAP margins, operating margin at constant currencies were 27.2% for the third quarter, which represents an increase of 1.1 percentage point compared to the third quarter of 2008. Also keep in mind that the third quarter 2009 non-operating margin was negatively impacted by around 80 basis points due to restructuring charges associated with the reduction in position.

For the nine month period, the non-GAAP operating margin was 24.2% at constant currencies, representing an increase of 70 basis point restructuring charges had a negative effect of 250 basis points for the nine month period.

Let me now give you the details on the gross margins. The non-GAAP software and software related service margins was 81.1% for the third quarter of 2009, which was a decrease of 2.6 percentage points compared to the third quarter of last year. The lower margin was the result of a decline in software and software related service revenues by 5%, mitigated by lower headcount and expense savings.

The professional and service margins was 22.7% for the third quarter of 2009, which was an increase of 60 basis points compared to the same quarter of last year. This increase was mainly driven by higher consulting margins. Because of the slight business mix, the third quarter non-GAAP gross margins increased by 80 basis points to 67.9% or 60 basis points to 66.9 for the nine month period.

As our non-operating expenses were down by 48 million year-over-year, which was mainly the result of currency losses. The currency losses are mainly driven by one-time foreign exchanges losses related to our operations in Venezuela.

The US GAAP effective tax rate in the third quarter of 2009 was 21% compared to 31.9% for the third quarter of last year. It was affected by non-recurring acquisition related item, which positively impacted the Q3, 2009 tax rate by approximately 11.7 percentage points. In nine month period 2009, our US GAAP effective tax rate was 26.7% because of these one time effect on the Q3 tax rate we lowered our expected tax rate for the full-year of 2009 to be between 27% and 28%, which previously was spelled 29.5% to 30.5%.

Free cash flow for the first nine months of 2009 was 2.2 billion, which was an increase of 28% compared to the same period of last year. Operating cash flow for the 2009 nine month period was 2.4 billion, which was an increase of 21% year-over-year although underlying income from continuing operations increase only by 1%. The increase in operating cash flow is due a positive change in working capital, mainly driven by a decrease in account receivable. Conversely, our DSO went up by one day compared to the end of second quarter and seven days since the beginning of the year.

As of September 30, total Group liquidity was €3 billion including the net proceeds from the issuance of a private placement of a promissory note. Bank liabilities were €2.1 billion, which included €1.4 billion for the financing of a syndicated loan related to the acquisition of BusinessObjects and around €700 million from the private placement mentioned before; therefore net liquidity at the end of the third quarter was €920 million.

Let give you now an update on headcount. As you know, in general we’ve announced a reduction of positions to 48,500 FTEs by the end of this year. At the end of the third quarter, headcount stood at [47,804] FTEs, which is a decrease of 3,732 FTEs compared to the end of last year.

We now expect headcount to be round 48,000 FTEs by the end of 2009, which is slightly lower than our original projection. Let me finish by saying that we have updated our outlook for 2009. Please refer to the press release issued today for the complete outlook.

I would now like to pass it over to Leo.

Leo Apotheker

Thank you, Werner. Welcome everyone to today’s call. I am pleased to provide you with an update on the business environment and our product successes. I mentioned last quarter that we were carefully and cautiously optimistic that worst might be behind us, let’s hope for some improvement in 2010. We continue to believe this to be truth as we have reported a better year-over-year performance in the third quarter compared to the year-over-year performance in the second quarter.

However, while the environment has stabilized, we are still up against some difficult challenges created by the global economy recession that’s hindered our results for the quarter. This was especially hard in Japan and in some of the emerging markets which Bill will talk about later. One challenge that we face is a very emotional market where quick changes and sentiment good or bad can move the market in either direction rather quickly.

Other challenges include customers remaining hesitant about making investments and the unpredictability because you need to see when it comes to [on-contracts] as customers are still closely scrutinizing deals. Hence the approval process is slow. As we head into Q4, I don’t expect this to really change. As we witnessed throughout most of year, customers are continuing to buy SAP software. As the customer wants the (inaudible) software quickly and an increment over notable periods, it is relatively smaller deal sizes with low average selling prices and more phase deals.

Best or large upfront deals and we don’t expect to see this come back anytime soon. But encouraging signs we are seeing in the market. The power plant continues to build and we see a healthy pipeline in all the regions, I mean all the industry. Customers are beginning to speak more positively about their own businesses which we assume bodes well for the future as we get into 2010 and we continue to see good progress in our move towards a higher volume levels.

Finally, we are driving more multi-year agreement with space and subscription deals. This model is good for both SAP and our customers. You should remember that the model of revenue recognition over many deals is not new to us. In [perfect it is modeled] with our global enterprise agreement and what we have gained from the G&A’s is the experience on how customers want to buy a continued software based on [burning] our long term strategic roadmap over several year.

We are now taking this concept with some adjustments to take into account differentiated marketing down to the next 500 from the 80 largest customers. We expect this to open up tremendous opportunities for growth going forward. We believe this model of time and continued software over multiple periods that we are driving is an important trend in our industry and we have already proven that we have the tools, the knowledge and the experience to capitalize on these changing industry dynamics. Bill will talk about that later.

Helping us to add more volume in all segments and all markets and establishing these multi-year relationships with our customers are products from our Best-Run Now initiative, which offers solutions that acquaint to implement and provide (inaudible). The Business Suite 7, which is highly a modular design that there are customers who deploy their software at their own base in a step by step process and business user solutions like analytics and to risk compliance solutions does enable our customers to see that business more fairly.

As Werner already took you through our reported numbers for the third quarter, let me just briefly add some comments. Despite the economic crisis in the third quarter of 2008, we nevertheless reported 22% growth in non-GAAP software and software related service revenues at constant currencies in this quarter making this years third quarter as soft comparison.

Moreover, as I mentioned earlier, the environment remains challenging. Thus, as I mentioned earlier, the sequential performance on a year-over-year basis from Q2 to Q3 improved as we expected. On the expense side of the P&L, we continue to successfully manage our cost structure as demonstrated by 1.1 percentage point improvement in our non-GAAP operating margin at constant currencies. Excluding restructuring charges, this is now the fourth quarter in a row since the economic crisis that we've reported year-over-year margin growth.

As you know, last quarter we discussed that tough 2009 second half margin comparisons we expected due to the strict cost cutting initiatives put in place immediately subsequent to the Lehman’s and (inaudible) in this quarter. We expect the comparisons to remain difficult for Q4, but we will continue to effectively manage our operating income.

Now, let me turn it over to Bill to provide a brief update on the regions industry and our go-to-market strategy.

Bill McDermott

Thank you, Leo. In this challenging market environment, we continue to adapt our go-to-market strategy to the dynamic needs of our customer, while also focusing on solid quarterly execution. We're innovating our go-to-market strategy in line with how our customers consume value. We are developing longer term sustainable relationships with our customers, aligning business strategy, IT roadmap, and value delivery.

Let us now look at the regional performance. The regions performed better sequentially, but mix in the Asia Pacific region and emerging markets, which I'll talk about more in a moment. All the following information I'll share with you is in constant currency.

In EMEA, non-GAAP software and software related services revenues declined 1%. Germany was down 13% mostly due to a tough comparison from Q3 last year, when software and software related services revenue grew by 20%. Excluding Germany software and software related services revenue in the EMEA region actually grew by 6%, which resulted from strong performances in Southeast Europe, the Mideast and Iberia, while revenues were somewhat sluggish in the (inaudible) countries.

Across Europe, it is worthwhile to note that we are seeing increase interest of customers to engage in multi-year strategic partnerships with SAP.

In the Americas region, non-GAAP software and software related services were down 7% and the US down 9%. The US was impacted by longer decision cycles through small and mid-sized deals which resulted in slightly lower closure rate. The good news is that there is increased predictability with large enterprise customers and more net new customers, and the improved execution with these customers is reflected in the quarterly sequential software licenses growth for the Americas.

In the Asia Pacific, Japan region non-GAAP software and software-related services revenues were down 12%. Despite good performances in Korea and Australia and increasing volume, the overall performance in APJ was negatively impacted by Japan’s 25% decline in software and software-related services.

We and many other technology companies have been challenged by a perfect storm in Japan; a change in government resulting in investment policy reviews across the public and private sector, rising Yen, falling exports and low consumer and enterprise confidence.

These market developments froze customer spending during the quarter. The good news is that these deals were not cancelled simply deferred as reflected in our pipeline and the sentiment in our dialogue with customers.

The BRIC countries with the exception of Brazil were more volatile in the third quarter. To address this market opportunity in the emerging markets, we hired a seasoned executive to lead our fast growth market initiative and scale the important markets overtime.

Key contract wins in the EMEA region were Telefonica, [Dans], Supermarket, SeverStal and Afinity Pet Care. In the Americas, we signed Dr. Pepper Snapper Group, Continental Resources, Bob’s Discount Furniture and Banco Industrial. And in APJ key wins were Japan Post Holdings, Queensland Motorways and PetroChina, Planning and Engineering.

Now let’s take a look at out industry performance. We saw good results this past quarter in asset intensive industries like oil and gas as well as in public sector and financial services. In fact, financial services as a whole has been the best performing industry year-to-date. One reason is that in this environment financial services companies are eager to lower cost and improve productivity. The other reason is that they can run a more efficient and profitable business with the depth and breadth of functionality offered by SAP Solutions.

In one example the fastest growing bank in Columbia, Banco de Crédito with 39 offices throughout the country and international operations in Venezuela, Panama and the US went live with SAP at the start of 2009 and reached its goal of having a single platform with SAP in the quarter. In another example, [Banis] one of the top retail banks in Brazil has deactivated 15 legacy systems some created as long as 20 years ago after implementing SAP improved its efficiency and reduced its operating risk. The bank expects to achieve a strong return from its SAP project by a substantially improving operating profit. We are moving the needle.

In conclusion, let me comment on Q4 and our go-to-market strategy. We are further segmenting and specializing our sales force to focus on specific market segments. Premier customer network which I have talked about in the past, large enterprise, mid and small customers alike. We are tailoring our value proposition to longer term relationships at the top and volume at the mid and low end, while leveraging a multi-channel approach between partners inside sales and direct sales across all segments.

We do this in 25 industries across the world to ensure that our customer can leverage the full breadth of SAP products in our portfolio and do so in an industry context that they care about. We know that the product, industry thought leadership and the business content of our people is our competitive advantage. We therefore continue to create a learning culture, where we train our people on our solutions and the end-to-end value delivery of those solutions till their customers choose SAP as their trusted advisor for business performance.

Most importantly, with laser focused on Q4, we have a very tight execution plan aligned across all segments of SAP for functions and all regions, and I like to point out that we are leveraging our own analytical tools from business objects to not only manage and track our largest opportunities, but our entire pipeline and volume of deals.

This level of clarity is changing the way we manage our business in the real time. Our team is fully mobilized and committed to execution.

I’ll now turn it back over to Leo.

Leo Apotheker

Thank you, Bill. Let me provide a brief product update on a few key product areas. First, we’re seeing a strong start. With our new SAP BusinessObjects Explorer solution, which is an easy to use but powerful business intelligence tool that brings together search and navigation capabilities with the speed of in-memory database technology. We already are satisfied and actually enthusiastic last customers on the product, the [part] time is strong and we continue to receive positive feedback on its ease of use, its robust search and data analysis capabilities and its high performance and scalability

Second, our strategy around SME continuous to go well, despite the tough environment as we remain a to clear market leader in SME with a [violent] and growing market share lead. We owe our strong competitive performance in SME to our clearly defined market segment strategy to capture what we believe to be excellent growth opportunities with three distinctive products in a highly fragmented market.

First quarter trial, SAP Business One for the lower end of the SME segments; SAP Business ByDesign, the middle tier of SME segment; and SAP All-in-One for the upper end of the SME segment. As for SAP Business ByDesign, we remained on track with our rollout. We continued to add tons of customers during the past quarter who are starting their project on the current version, feature pack 2.0, which was released for productive use according to plan in July.

With feature pack 2.0, customers have access to 35 enter and process scenarios, and other enhancements of feature pack 2.0 include better decision making capabilities, with integration to the SAP Business Objects portfolio including Crystal Report software and Dashboards from [Xcelsius] Software. Our development team is already working on the next version of Business ByDesign which will be focusing on [multi-tenancy], flexibility and extensibility. We will provide you with more details early next year.

And third we are pleased by the progress we are making in extending our on-demand portfolio for large enterprises. As I mentioned last quarter, our on-demand portfolio includes SAP Business ByDesign for the mid-markets, SAP BusinessObjects on-demand solutions for both the mid-market and that enterprise, and SAP customer relationship management, SAP E-Sourcing and SAP Cap & Trade for large enterprises. You will hear more about our on-demand solutions for large enterprises also in 2010.

Over the past few weeks, there have been many rumors circulating in the market regarding our support relationship with Siemens. And as you probably read, we have put those rumors to rest, as we expanded our strategic relationship with Siemens, through Siemens selection of SAP SRM, for its E-Procurement operations and we renewed our service relationship with Siemens for global maintenance support for all SAP solutions, including support for some of Siemens in-house developed solutions that connect to SAP solutions. I think this demonstrates the value of our support offerings, and the strong relationships we have with so many of our customers for our software and support service.

Let me finish off by saying that we remain a growth company, and we are in an excellent position to achieve strong profitable growth when the economy rebounds. We have a robust, flexible business model that can provide us both top and bottom line growth. Importantly, despite the challenging times, we have continued to focus on innovation, and as a result our new product pipeline is very encouraging which is critical to driving our business forward. We are in a strong competitive position, twice the size of number two, allowing us to maintain our market leadership in large and small enterprises and in all regions of the world.

There are great opportunities in new emerging markets, and we have the broadest and deepest product portfolio and industry solutions in enterprise application. All of this combined, I feel encouraged about our mid-term prospects. With that, I want to thank you for listening, and we will now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Michael Briest from UBS. Please go ahead.

Michael Briest - UBS

Leo, I was wondering could you talk about the guidance for the fourth quarter and place it in the guidance for the year. Maybe you can talk around the close rate assumptions you are assuming for both the high-end or low-end of that whether you think there is any uptick in close rates versus Q3, the same or whether it’s getting worse or maybe where the maintenance will be maybe flattish sequentially because of the shift in the business well towards subscription? Thanks.

Leo Apotheker

Okay Werner and I will answer the question together. I’ll try to take the first part and Werner will give you some facts into the second part. We are in a bit of an interesting situation, Michael. What’s happening is that on the one hand we see some encouraging signs, pipeline is increasing, as to it has been increasing for quite sometime. We see that the trends and volumes is going into the right direction as well. So from that perspective one could say things are looking better.

On the other hand, we also know that the slightest change in mood has an impact on closure rates. So we are trying to give everyone a very, very conservative view on how we believe the quarter will play out. This is a very peculiar year and we should not apply normal metrics to a very peculiar year, which is one of the reasons why we have decided to give you the view, the hypothesis and now the guidance from what we believe could happen in Q4. Werner, maybe a few words on maintenance.

Werner Brandt

Yes. If you look to the support and for the first quarter we assumed that we might see a very slight increase in the support revenue quarter-over-quarter and I think it’s clear with this I want to reiterate this. With this assumption on SSS revenue in the range between 6% and 8%, it’s clear that we will see a decrease in software revenue. Michael you wrote this in your comment already. I only wanted to reiterate that this is a matter of fact for the first quarter. However, this doesn’t tell us anything about the future of SAP as a growth company as Leo said it before.

Michael Briest - UBS

Thank you. If I could just ask one more, you have obviously talked about phase deals increasing, maybe you could put some context on in Q3 what value of deals you signed or what the licenses would have looked like if they had been signed on the traditional upfront model? Thanks very much.

Werner Brandt

The only thing we can say Michael is that because the numbers of larger transactions decreased dramatically, that we had some larger transactions, I think we mentioned Telefónica for example as one of the largest transactions in the quarter but even if you have large transactions from a fewer revenue or commission perspective you cannot assume that the entire revenue can be realigned in the quarter besides the transactions. That’s one of the implication and the other event we see a strong increase in order entry flow subscriptions, but that’s something we cannot and will not bring down to details, on a deal-by-deal basis but more importantly is that we increase order entry through subscriptions and this is healthy for our business model going forward.

Operator

We will take our next question from Phil Winslow from Credit Suisse. Please go ahead.

Phil Winslow - Credit Suisse

Hi guys, just one more question, and back to pipelines. Leo, I assume that that you were starting to seeing an improvement in pipelines over the past multiple months and I guess it’s a question for both Bill and Leo is that when you think about just sort of pipelines improving, what is sort of the lead time when you actually think about those converting into license revenue? And sort of to a degree how should we think about that as we turn to 2010? And then also with your sort of implied Q4 guidance here, how should we think about just those big deals. You’ve been pretty cautious on those closing and reach a largest degree kind of flush those out of guidance for Q4? Thanks.

Bill McDermott

Yes, Phil this is Bill. Let me try to reemphasize what Werner has been trying to say to Michael a few moments ago. What is happening or what we are actually trying to do is to move a little bit away from this big deal one time short upfront revenue kind of a situation and that’s when you try to drive our business model towards a more balanced situation where we have similar stuff. There will always be similar stuff, but also when we will start to inform, some of these assets, (inaudible) be they subscription or be they phase.

So from that perspective, the transformation of the pipeline is actually, maybe a little bit slower than it normal is because we are living in a peculiar year. That was, you will not see is the either the usual peaks and valleys in the trough so the basically impact was, this was the other large transaction happening or not happening at a given day. So what we’re trying to do is to drive to a more sustainable and more long-term driven or medium term driven business model where we actually take some of these transactions and actually try to enter into multi-year agreements with our customers.

The good news about that is it is a very sustainable, a very healthy business model which is welcomed by our customers, it actually is welcomed by SAP as well, because as we are driving our business model towards this, it will give us actually better business and intrinsically better margins over the medium and long-term. By the way there is one or two reasons why we are trying to also transform our cost equation so that we can actually do it with an adjustment without having a hit on the margin.

Operator

We will take our next question from Ross MacMillan from Jeffries. Please go ahead.

Ross MacMillan - Jeffries

Thanks. Werner, can you just go back on the third point you mentioned on the support and maintenance revenue in the quarter. You said something about a 10 million deferred. I didn’t catch that. If you could just recap on that, that would be great.

Werner Brandt

Yes. That’s very easy Ross. We had a one time effect in Q2 of this year, which amounted to roughly 10 million and if you compare sequentially support revenue growth you have to eliminate this one, this one time effect in Q2 which actually was a catch up of the previous quarter.

Ross MacMillan - Jeffries

Yes, great, that’s what I thought. And then can you just recap on the sales allowance that you had at this juncture, at this point in the year for maintenance revenues that have not renewed.

Werner Brandt

Yes. I think what we normally do is we set up sales [allowance] at the beginning of the year in order to neutralize the risk we see on the maintenance invoices we send out to our customers. This is higher than last year. We talked about this already two times during the course of this year and I think the level stabilizes now and we see what we have to do on top in 2010. But there are not any extraordinary movements we saw in the third quarter now.

Ross MacMillan - Jeffries

Great, and then maybe just one for Leo. As you think about Q4, it sounds like there is a fairly wide sort of scenario here maybe a couple of 100 million on license sales. I think you also said earlier in a response to a question, you're trying to take a very conservative stance. I guess the question is, I mean, if we saw more of a kind of flush and more large deal activity. Do you think that your high-end of the range encapsulates all that, the high-end of the range that you’ve kind of laid out for 4Q? Thanks.

Leo Apotheker

I would suggest that we do not speculate on this. And, as I said earlier on, Q4 is going to be of course our largest quarter. It is going to be a significant quarter reporting about a lot of money that needs to be sold. Billions of people are busily doing that as we speak. And, we are trying to provide a hypothesis in that guidance to underpin our margin guidance. And, we are speaking to our margin guidance. We reconfirmed that again and that’s really the guidance that provides the rest of the space to be a hypothesis.

A lot of things can happen in this quarter, lot of things are depending on the mood, on the environment, but also, as I said earlier on, we do really want to drive a bit of a change in the way we go after these very large transactions. What is also very important we haven't really talked about that yet, there is still growth that we see in volumes coming in the lower end of our business.

Here actually we saw positive trends evolving in Q3 as well. So, all-in-all we have tried to give a management judgment on this and hence the hypothesis that we gave you and I would suggest we’ll leave it at that and we’ll see what the [Boards doing].

Operator

We will take our next question from Sarah Friar from Goldman Sachs. Please go ahead.

Unidentified Analyst

Hi. This is [Stephanie Weathers] for Sarah. So you emphasized that SAP remains a growth company and that this is a peculiar year. What can we expect, what types of levels of organic growth can we expect longer term as we return to a more normalized environment? And what would be kind of the key products or new delivery methods that you’d highlight in achieving that type of organic growth?

Leo Apotheker

[Stephanie], thank you for asking the question and it goes without saying that we’ll provide 2010 guidance in January and not now. I’m not going to try to be pin down this or the other number. But let me pick up the second part of your question and that is simply a very relevant one. We will be driving a lot of innovation into the market as we speak, and starting this business by design, where we are getting more optimistic as you move along and then we start to see some really great things happening there to what we are doing on the analytic side, ranging all the way through sustainability where we have announced a complete sustainability solution set.

Hence, things that we are doing on the technology side, which is in memory, things that we are working on in memory and looking at opportunities for (inaudible) all out together, which in turn will drive a whole new world of innovation again when it comes to transaction applications and actually the merge of analytics and transaction applications.

All of these solutions will be made available in network type of an environment, i.e. that we’ll be providing the vast majority of our solutions in the hybrid fashion, be it in the cloud or be it on premise or in the [expenses]. I think the opportunity is a very unique situation, we will continue to innovate on our product set. We have partners. We are innovating on type of our technology and looking out in to the future, happen to believe that SAP is the only as to-date turns solution set, but actually is going to strengthen that position significantly in a variety of industry.

Let me give you one example, when we talk about industry, we happen to be, I don’t think that we are known to it by mentioning it. We happen to be the leader in platform for smart meter. There will be a billions smart meters in the world in five years time. There is a highlight because with many of these smart meters would be running over the SAP platform. By the way that’s in the cloud. So, as you can see a lots of exciting things are happening, which motivate us to be rather optimistic for longer term future.

Unidentified Analyst

So, as you think about the SAP portfolio and achieving those goals, are there particular holes that you might like to fill through M&A?

Leo Apotheker

The wider your portfolio, the more interesting opportunities you create. You could look at vertical opportunities, there maybe some horizontal opportunities, there could be some geographical opportunities, there could be different channel opportunities and its not that we are not doing anything on M&A early, last quarter for example, we made an interesting transaction with the company called [IDeA], which actually gets into an even stronger position, when it comes to advance bidding for utilities among others and then we did a deal with a company called SAS, which is a leading company, when it comes to algorithm and particularly optimization in retail space have not only (inaudible) market leader in retail, but with this acquisition we have to make another leap forward. So we are not sitting still on that side either.

Operator

We will take our next question from Gerardus Vos from Citigroup. Please go ahead.

Gerardus Vos - Citigroup

First of all on the kind of cost base, from a sequential prospect OpEx came down by around 25 million. I know that there was sequential increase in R&D and G&A, while in both kind of areas, the headcount actually came down and I was wondering if you could clarify what was happening there. And then secondly, on enterprise support, what kind of milestones and when do you need to hit the kind of milestones to justify the increase going into 2010? Thank you.

Werner Brandt

Yes. Let me take the first question regarding the operating expenses. I think, the €28 million is a reduction of operating expenses from Q2 to Q3. Actually from my point of view it’s 28 million. Now please keep in mind that this includes and is diluted by stock-based compensation expenses of 40 million enter refactoring expenses of €21 million. So if you exclude this, we have a sequential reduction of €67 million and this represents going to 0.5% and I think this goes into the right direction, so if you dig a bit deeper you come to an answer to your question without raising the concern you raised with this question.

Leo Apotheker

And regarding the press report as you know, we have actually institutionalized something rather unique in the software industry, and we are going to make probably a series of PPIs that we want to help, you know that we justified (inaudible) and board these KPIs, I do for publication in the next week and then that will trigger application might be the next price increase for Enterprise Support.

Operator

We will take our next question from James Dawson from Morgan Stanley. Please go ahead.

James Dawson - Morgan Stanley

Just a couple of questions if I may, in terms of the cost, I take the point on the stock-based comp, it does seem that you're talking about the comp is getting much harder from here, but you do have your mid-term 35% target. I was wondering, are you still pretty comfortable with that in terms of a mid-term or three year target lets say and what can we see, is that mostly going to come from growth rather than cost cutting from here?

Secondly, you've changed that the management in the BRICs, is it fair to say it was an execution slip in some of the faster growing countries and that’s why you've changed the management team or is it something different. Lastly in terms of the cash [files] building quite nicely, should we still expect buybacks if you don’t do M&A, if you get to say $1.5 billion of net cash, is that a reasonable thing to think, Werner?

Werner Brandt

Before I answer the first and the third part of the question, in terms of target, you mentioned target. What do you refer to? We didn’t get this from the line. It was not clear enough.

James Dawson - Morgan Stanley

In the past, when you got the $1.5 billion plus of net cash you expended to buy back stock?

Werner Brandt

The first part of the question, which target did you refer to?

Leo Apotheker

Was the medium term margin operation of 35%?

James Dawson - Morgan Stanley

Your mid-term, you talked about trying to get to a 35% operating margin in the mid-term. Here I guess it looks like the costs, where you might be starting to be completed is going to be just growth for this number or is the more that you can do on costs?

Werner Brandt

First of all, it's always a combination of financial discipline regarding our spending, and of course growth. I think we shouldn't assume that we reach 35% only by cutting cost with no growth on the top line. I think if a company is in such a situation, it can close the door sooner or later.

The second part I can answer is regarding the cash position in our strong cash flow. What we have done so far is, you have seen we had $922 million in net liquidity. The first thing we did after the quarter in closing is that we paid back the loan for business uptick of $1.4 billion. And your question regarding the share buyback; as it stands today, it's too early to talk about the share buyback. We will re-evaluate this beginning of next year and come up with a clear position in our January earnings call where we also talk about the guidance for 2010.

James Dawson - Morgan Stanley

On the cost point, your R&D is up above 15% of sales. Is it fair to say that there's still plenty of room though to take some efficiencies or do more with less than R&D?

Werner Brandt

Yes, and it is not limited to R&D, it’s to get more out of R&D what we have today, and if growth comes back we also see a decrease in the ratio on top of it, and secondly, I would not leave out of the equation here, G&A where we also intend to bring this down to the range of 4% plus, but significantly below 5%.

Bill McDermott

And this is Bill McDermott. Just to touch on the question regarding BRIC countries. First, I just want to remind everybody that we have added about 10,000 new customers this year, 4,000 in Q3 and many of them do come from the BRIC countries. As an example APJ has been the growth engine of our business now for a few years and continues to do very, very well.

With the exception of Brazil, which is continuing to be strong, I said the BRIC countries were a bit more volatile in Q3 that should not be interpreted as the trend by any means. So we are still focused on robust growth in those wonderful markets.

I do want to make a couple of points on what we did, because there wasn’t an execution issue when I mentioned we hired a new executive to focus on the BRIC in emerging market. Instead what we wanted to do is take the best business practices that we have built over many years now in our large market and build those best practices in to our fast growth markets for scale.

We also wanted to establish a strategic planning discipline, so there is a three and five year horizon to the way we think about these markets, in addition to the quarterly execution which our regional Presidents and MDs doing at daily basis. So this is about [pulsing] up those markets.

Operator

We will take our next question from Raimo Lenschow from Bank of America. Please go ahead.

Raimo Lenschow - Bank of America-Merrill Lynch

Werner, just going back to one of your points that you made earlier, obviously, we can't turn off or see ourselves out of the crisis and at some point we - as market feel better, as your pipeline is growing we need to think about investing into the future again.

How do you see the investment paying out for you guys, maybe starting on the sales line. How do you think about adding sales people to kind of capture more of the volume? And at what point do you think it will become more comfortable and kind of adding more investments around the R&D line, and maybe select the strategic investments further on in terms of getting Business ByDesign and due to volume parts. Thank you.

Werner Brandt

First of all I want to reiterate what we said several times now. We want to ensure that this financial discipline holds and that the savings we have generated far are sustainable. If I go through the different areas Bill can talk to on actual sales and marketing. We will definitely first go to a shift and lift exercise in all of the regions in order to be sure that we can expect more out of what we have available today in terms of people and then thing about if growth comes and excellent growth comes that we then reinvest the part of it into the business meaning that we add additional people but before we go through this lift and shift exercise.

If you go R&D, first of all we have to see that we have a right organizational set up for R&D, which enables us to really get more out of R&D. And if this is done then we can think about along with accelerated growth about adding people. But that’s not something for 2010 but beyond 2010, because clearly the growth for 2010 from an industry perspective is somehow limited for the next year and the same would be true for [Jim] and Bill, anything to add from your end?

Bill McDermott

No I think you said is very well Werner. First of all the Board is a very cooperative and team-oriented Board, and the idea of lifting and shifting assets from one area of the company is working very well. And what customers want is they want real product knowledge, they want industry domain expertise, and they want SAP to help them deliver the value so they can gain the business outcome.

The more smart people we can get closer to the customer at SAP the better; and that would be not only in our core business but also in business objects. We also see an opportunity to galvanize inside sales and do even more there to increase the overall productivity of the sales force. So, I think Werner said it is very well and the company is committed to this kind of cooperation and the customer relationship.

Stefan Gruber

Thank you, Bill. Actually this was the last question we could take on this call. I would like to thank you all for joining and for discussion. Thank you very much and good bye.

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Source: SAP AG Q3 2009 Earnings Call Transcript
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