SAP SE O.N. (NYSE:SAP) Q3 2020 Earnings Conference Call - Final Transcript

SAP SE O.N. (NYSE:SAP) Q3 2020 Earnings Conference Call - Final Transcript 2020-10-26T13:00:00+0000 Executives Stefan Gruber - SAP SE O.N., Christian Klein - SAP SE O.N., Luka Mucic - SAP SE O.N., Adaire Fox-Martin - SAP SE O.N., Analysts Adam Wood - Morgan Stanley, James Goodman - Barclays, Philip Winslow - Wells Fargo, Michael Briest - UBS, Alex Zukin - RBC Capital Markets, Charles Brennan - Credit Suisse, Kirk Materne - Evercore, Mark Moerdler - Bernstein Research, Chandra Sriraman - Bank of America, Julian Serafini - Jefferies, Neil Steer - Redburn Partners, Patrick Walravens - JMP Securities, Operator - Good day and welcome to the SAP Third Quarter 2020 Earnings Conference Call. As a reminder, today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Stefan Gruber, Head of Investor Relations. Please go ahead. Stefan Gruber - SAP SE O.N. Thank you. Good morning or good afternoon. This is Stefan Gruber. Thank you for joining us for our extended earnings call today to discuss our strategy update, as well as our third quarter results and the updated guidance. I'm joined by our CEO, Christian Klein, and our CFO, Luka Mucic, who will make opening remarks on the call today. And also joining us for Q&A is Executive Board member, Adaire Fox-Martin, who leads our Customer Success organization. And as usual, before we get started, I'd like to say a couple of words about forward-looking statements and our use of non-IFRS financial measures. Any statements made during this call, that are not historical facts, are 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 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 our filings with the U.S. Securities and Exchange Commission, the SEC, including SAP's annual report on Form 20-F for 2019, filed with the SEC on February 27th this year. Participants of this call are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. In addition, on the Investor Relations website, you can find a slide deck intended to supplement today's call available for download, the address is www.sap.com/investor. For those of you following the webcast, the slides will be shown, as we proceed through the prepared remarks. Unless otherwise noted, all financial numbers referred to, on this conference call are non-IFRS and growth rates and percentage points are non-IFRS at constant currencies 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 IFRS. And this extended earnings call today is being held in lieu of the Capital Markets Day we discussed last quarter. So with that, I'd like to turn things over to our CEO, Christian Klein. Thank you. Christian Klein - SAP SE O.N. Thank you, Stefan. Welcome and thanks for joining. I hope everyone is well and staying safe, as COVID infection rates are unfortunately increasing again, in most countries. Today's announcement mark an important milestone for SAP. We have not only published our Q3 results and updated our 2020 outlook, but more importantly, we are providing additional insight into how we are evolving our strategy. Our updated strategy is in response to the fundamental changes in the market caught on by the COVID-19 pandemic. COVID-19 is an inflection point for our customers. Many enterprises have real issues to produce, sell, and deliver a product in times of country lockdowns and people working from home. For most of our 400,000 customers, resiliency is achieved not just by accelerating the move to the cloud, but more importantly by driving a fundamental change in how their business operates end-to-end. It means transforming every process for the digital world, from the customer facing go-to-market function, all the way to supply chain management. SAP is uniquely positioned to partner with our customers, to make the transformation happen, combined with a move to the cloud, which is why we are determined to reinvent how businesses run, by co-innovating with our customers and partners across the broadest cloud solution portfolio in the market. Responding decisively to the requirements of our customers in a fast-changing world, results in our new financial mid-term ambition. But before going there, let's take first a quick look at Q3 and the updated 2020 outlook. In Q3, our resilient business model allowed us to continue to grow strongly in the cloud, and again, growing operating profit and margin. Apart from the Intelligent Spend business, our SaaS and PaaS cloud revenues were up by 26%. We continue to see a very rapid growth in categories such as commerce, S/4, supply chain, Qualtrics, and our foundation, the Business Technology platform. Current cloud backlog is up significantly by 16% to EUR6.6 billion. At the same time, the lack of recovery from COVID-19 is visible in the lower-than-expected transactional cloud revenue, because of our travel and expense solution, Concur, which is hard to sell in times of COVID. Our Software License performance is on a similar level compared to our Q2 result. On the bottom line, the benefits of our Best Run transformation project have continued to show tremendous focus. As stated, we yet again expanded significantly, our operating margin and free cash flow. In addition, 28,000 customer go lives over the last nine months, demonstrate our ability to deliver remotely in a challenging environment. Q3 also saw many notable customer wins, including some competitive replacements. Deals included, Lenovo for S/4HANA; Rabobank for S/4HANA Cloud. Swisscom and Barilla for Customer Experience, HP and Juniper for the business technology platform. LG for Ariba, Walgreens Boots Alliance for supply chain management. Lululemon for Qualtrics. Schwarzkopf for Industry Cloud, and Bahrain Airport for SuccessFactors. For SuccessFactors actually, more than 4,000 customers and around 45% of the Fortune 500 are already running on our core solution Employee Central. This quarter, we added more than 500 S/4HANA customers, around 45% were net new; take us to a total of more than 15,100 customers, 20% up over last year. In Q3, we also added a new deployment option, for our private cloud service HANA Enterprise Cloud. So far, we have offered deployment in SAP or hyperscalers data center. But there is also demand by customers who wanted services in their own data centers, managed by SAP. This is why we have now launched the HANA Enterprise Cloud customer addition, and we are very excited that in this quarter, Lenovo has decided to become a global partner for the Customer Edition, with their TruScale offering. This supplements the Global Greenlake partnership with VMware and HPE. Finally, Interbrand have issued their 2020 Best Global Brands report and I'm very proud that S&P came in at number 18 globally, up 2 spots versus last year and growing its brand value by 12%, to more than $28 billion. Luka will now provide additional insights into Q3, and our updated 2020 outlook. Luka, over to you. Luka Mucic - SAP SE O.N. Yeah, thanks very much, Christian and welcome also from my side. We again navigated through a challenging environment in Q3. Amidst COVID headwinds, we improved our operating profit and operating margin against a very strong prior-year comparison. Our cash flow saw an exceptional improvement, and our earnings per share was very strong. Our resilient business model with the consistent year-over-year increase in more predictable revenue, helped us to weather the storm in these unprecedented times. Now, let's go into more detail on the quarter, starting with the top line, where our current cloud backlog grew by 16%, reaching EUR6.6 billion, amid continued COVID-19 effects on our cloud business. Our cloud revenue was up 14%, with continued lower transactional revenues. This negatively impacted our cloud growth rate by 6 percentage points, especially in Concur. While our on-premise software license business continued to see scrutiny over large projects, as uncertainty persisted, our performance this quarter was similar to the one in Q2, especially considering the very good Q3 last year. From a regional perspective, Europe had a resilient performance this quarter, with strong results in Russia and Switzerland. Latin America had a remarkable performance, driven primarily by Brazil and Mexico. And in APJ, Japan had a solid quarter and Australia and India were highlights. In Q3, our cloud and software revenue grew by 2%. For the first nine months, our cloud and software revenue was up a solid, 4% even though the challenging demand environment did not further recover, as we had hoped. Our Services revenue was down 11%. While we continue to deliver most of our projects very efficiently and effectively remotely, we do see an impact, in particular, on our training business, as the reopenings of our global training centers have been delayed. As a result, our total revenue was flat year-over-year. Now moving on to the bottom line; in Q3, again, all of our businesses, cloud, on-premise and services, increased their gross margins. Our overall cloud gross margin continued its positive trend, and grew by 70 basis points year-over-year to 70%. All cloud business models contributed to this margin expansion. Our SaaS/PaaS margin grew by 110 basis points to 71%, our Intelligent Spend margin grew by 20 basis points to 78%, and our infrastructure-as-a service margin by 800 basis points to 33%. In Q3. our software licenses and support gross margin was up 60 basis points to 88%, despite the decrease in software licenses revenue. Our services gross margin increased significantly by 500 basis points and reached 31%. This was mainly driven by a larger share of our high margin premium engagement, business which has proven to be effective in this virtual environment. As you will recall, our operating profit, as well as our operating margin, was up significantly in Q3 of last year. This quarter, our operating profit grew strongly by 4%, and our operating margin expanded by 1.3 percentage points to 31.9%. As uncertainty persisted, we remain cautious on hiring and discretionary spend. On an IFRS basis, our operating profit and operating margin decreased, this was primarily due to higher share-based compensation expenses. Now turning to EPS and taxes; IFRS EPS increased by 26%. Non-IFRS EPS increased by 31%. This was mainly driven by yet another exceptional contribution from Sapphire ventures, which had a significant positive impact on our finance income, as well as in our IFRS and non-IFRS effective tax rate. Therefore, we now expect an improvement in our effective tax rates for 2020. Our IFRS tax rate is expected to be in a range of 27% to 28% and our non-IFRS tax rate is expected to be in a range of 26.5% to 27.5%. Now turning to cash flow; in particular, the bright spot. In the first nine months, our operating cash flow was strong, and improved by 54% to EUR5.1 billion. As expected, we experienced lower restructuring-related payments, and lower income tax payments. Our free cash flow was up even further, and grew by 79% to EUR4.2 billion. Free cash flow additionally benefited from lower capex compared with the previous year. Therefore, we are again raising our cash flow expectation for 2020. We now expect an operating cash flow of approximately EUR6 billion, and a free cash flow above EUR4.5 billion. Let me now turn to the remaining part of our previous 2020 outlook that was issued on April 8th, and reflected our best estimates concerning the timing and pace of recovery from the COVID-19 crisis. Back then, we had assumed that the demand environment would gradually improve in the third and fourth quarters. And while we still see robust customer interest in our solutions to drive digital transformation, regrettably, lockdowns have recently been reintroduced in some regions. Infection rates have reaccelerated, and as a result, demand recovery has been more muted. Further, and for the same reasons, we no longer anticipate a meaningful recovery in SAP Concur business travel related revenues, for the remainder of the year. Therefore, we now expect Cloud revenue in a range between EUR8 billion to EUR8.2 billion. Cloud and software revenue, in a range between EUR23.1 billion to EUR23.6 billion. Total revenue, in a range between EUR27.2 billion to EUR27.8 billion, and operating profit, in a range between EUR8.1 billion to EUR8.5 billion. So to summarize on Q3; this quarter, we showed tremendous resolve, as we continue to improve operating profit and margin, even against the strongest comparison. Based on a resilient topline performance, paired with discipline on the cost side. We had high double-digit free cash flow growth, and exceptional earnings per share numbers. All of this and our resilient business model, position us well to emerge stronger out of the crisis and meet our new mid-term ambition [Technical Issues] would like to discuss next. And for this, let me hand back to Christian. Christian Klein - SAP SE O.N. Yeah. Thank you, Luka. Now before looking at our strategy and mid-term ambition, let me start with a brief recap of what we have achieved over the last six to nine months. SAP was definitely not short of events. We have streamlined our operations. All of our customer facing operations were combined into one customer success organization, and all our application development within one product engineering unit to simplify SAP. Thanks to our dedicated focus on customer success across SAP, we have seen a very encouraging year-to-date customer satisfaction score. For the first time in several years, there is a clear positive trend. We have increased focus in our existing portfolio. We have decided to divest non-core assets, such as SAP Digital Interconnect, and we entered a partnership to co-innovate with industry leading companies like Siemens, Honeywell and Bosch. Instead of doing everything ourselves, we are co-innovating. Finally, we have started to establish SAP as a leading cloud platform company. We have always been the leading on-premise application platform. Thousands of partners and customers have built applications and extensions on SAP for almost 50 years. Our intention is to repeat that for the cloud. To position SAP as the leading cloud platform, to transform and change the way enterprises work in the digital age. To get there, we have put a lot of work into our cloud platform over the past 12 months, and we will continue to invest in innovation. And we are very pleased to see that hard work is being recognized. Gartner has ranked us leader for both, Enterprise and Integration platforms, and development platforms. The time, when SAP developed and engaged with customers and silos are over. Now, before we go deeper into our strategy, let me pause here for a moment and talk about why we are doing this now. The COVID-19 pandemic, which we all hoped would be easing by now, is gearing up for an additional wave. This crisis has created an inflection point for customer, a true catalyst to accelerate their transformation efforts, has put a spotlight on the resiliency, which is more than just about the underlying infrastructure, and its move to cloud. It is about changing the way our company wants to adapt to new digital business models and drive automation. Resiliency and sustainable long-term growth and profitability, comes only by transforming the company to the needs of the consumers and employees in a digital world. Take retail for example; when brick and mortar stores shut down because of the pandemic and supply chains were disrupted, retailers that have made the move to digital, did much better than those who hadn't. They were able to continue to sell via e-commerce, and the digital supply chain ensured that despite the lockdown, they can continue to sell, produce and deliver that product. To adapt new business model and to do so with agility, our customers' need innovative business software, a platform ensuring harmonized semantical models, who want new digital business models end-to-end. This is where SAP comes in. With our strategy, accelerated technical migration of our customers' most important business applications to the cloud, and we are agnostic, when it comes to their choice between SAP datacenter hyperscale. We can make it work. With the near best TCO in the market, no matter which choice our customers make. Second and more importantly, we will bring the full force of our business applications and platform, to drive holistic business transformation, by enabling our customers to seamlessly design, evolve all-in-one new business models with agility and speed. To do so, all our main solutions will adopt the cloud platform and share one semantical data model, one AI and analytics layer, one common security and authorization model, and same application business services, such as workflow management. With our cloud platform powered by SAP HANA, processes can be changed, enabling agile workflows. Innovations and extensions can be developed quickly by customers and partners, accessing our open platform, using exactly the same data model and business services, as our own SAP apps. We are convinced, that the real value driver of Intelligent Enterprises in the cloud, will be the ability to adapt and warn new business models holistically end-to-end with one consistent data model. This is where we take a different approach than other. Data import silos are the biggest inhibitors for enterprises to offer a seamless customer and employee experience. You need integration extensibility and innovation to truly drive business outcome- resiliency, profitability and sustainability. That is the only way forward. But this unique confidence at this unique time in our history is our position of strength, our progress today and our heritage. Our applications are more than EUR10 billion worth of workload. And we won them semantically consistent across the entire value chain. At SAP, we are drawing on almost 50 years of business expertise of defining, redefining and reinventing the most important processes of our customer. And only SAP can mobilize the partner ecosystem consisting of the best plans to fully realize the potential of any customer, no matter the size, to truly become an intelligent enterprise. This is in our DNA. It is our goal to enable every customer to become an intelligent enterprise. And we are determined to leave no customer behind. Especially now in times of COVID, we reaffirm our deep commitment to our customers to help them through the crisis. This new strategy and as well as macroeconomic factor have implications for our financials. They are the reasons for the change of our mid-term guidance, which I'm going to speak about next. So, coming from our previous financial mid-term ambition, what are the changes? Let me start with the two macroeconomic factors - currency and COVID. First, over the last three months, we have experienced currency headwind versus our previous assumption. This translates into a negative 3 to 4 percentage effect on revenue and operating profit. Second, we now anticipate a more conservative COVID-19 recovery. We assume that COVID will impact the economies, for at least the first half of next year. And then we have two strategic decisions, and we are adjusting the financial guidance to the new reality, and first and foremost, to the needs of our customers. One, as just discussed, we will win when our business is won, enabling our customers' business transformation in the cloud to gain higher resiliency. And consequent, we will accelerate the transition of our customer base to the cloud. Business' elevated move to the cloud will clearly add value over the long off, one, by increasing cloud revenue. And in the short term, there will be revenue mix effect as we see less on-premise and more cloud revenue, resulting in a negative operating margin impact of 4 to 5 percentage points in 2023. Two, we will continue to relentlessly execute on productivity improvements under the Best Run Program, as laid out last year's Capital Markets Day. We are not moving away from these commitments. By accelerating the move into the cloud, we will even further increase the productivity improvements in our cloud delivery operations. We have decided to speed up the modernization of our cloud-delivery to enable a more resilient and scalable cloud infrastructure. This will require additional investments in the next two years but allow us to largely complete the modernization in this timeframe and achieve a cloud gross margin of approximately 80% in 2025. We will provide more background on those two strategic decisions in a moment. But, first, I'll go a bit deeper on the macroeconomic impact. Nobody can predict the COVID-19 economic impact beyond 2020. But given recent developments, it is prudent to assume a more gradual recovery, which we have now done. For our on-premise business, we have seen significant investment delays in 2020 and were hard hit in the space. And across all industries and geographies, we see an increasing demand to accelerate to move to the cloud. We just expect software license revenues to decline further from today's levels also in the future, considering our accelerated cloud transition. For our cloud business, we assume that the negative COVID-19 impact will start to ease in mid-2021. Let's now move to the strategic decisions, starting with the accelerated cloud transition for our customer base. The increasing customer preference for cloud is ultimately positive for SAP as we are already the second largest enterprise cloud application vendor, and we continue to grow rapidly even amid the COVID-19 crisis. With the journey to the cloud, as previously outlined, we are further addressing this market need, accelerate the cloud transition and tripling our cloud revenue to more than EUR22 billion by 2025. The ambition is based on moving our large on-premise ERP workloads to the cloud, and gaining market share for our leading cloud applications, firmly establishing our platform as the basis for business transformation in the cloud, winning in new markets, increasing our R&D invest to deliver new innovations in the Industry Cloud Business Network for sustainability, strong focus on our customer success to ensure adoption higher than usual, and ultimately lifetime value. The incremental growth resulting from -- of this accelerated cloud transition will be even more profitable until 2025. To deliver on this target and to retain the profit focus, we have also decided to accelerate the modernization of our cloud delivery. Luka will now take us through the financial implications of both of those decisions and then how it all comes together in our new mid-term ambition. Luka? Luka Mucic - SAP SE O.N. Yes. Thanks, Christian. So let me first talk about the financial implications of moving our on-premise customer base to the cloud. Christian has already explained the strategic motivations, so let me now look at the financial rationale. To begin with, as you know, the cloud transition is not a new topic for SAP. You've seen the financial impact from this basically since the beginning of our cloud journey almost 10 years ago. And over the years, as we rapidly grew in the cloud during this first phase of the transition, we had very material negative revenue mix effect on margins simply because the profitability of those cloud businesses was lower than that of our on-premise business. But since most of that cloud growth came from greenfield opportunities, that phase of the transition was always accretive to total revenue and did not put significant pressure on absolute profit. And finally, by end of 2018, our cloud business has -- had reached the scale and efficiency that allowed us to deliver increasing operating margins in 2019 and also in 2020. This quarter was actually another strong proof point for that. Now the first important point to understand is that, what we'll be doing now is different, because this time, we'll be moving large parts of our ERP customer base from on-premise to the cloud, move them out of the upfront software licensing model and into the ratable subscription licensing model, a little bit like other players. For instance, Adobe have done it before, so it will not be as rapid in our case as we are talking about an option for the customers. Why does this make financial sense? That's the second important point, because we are increasing customer lifetime revenue as we are expanding our role from a software vendor to a cloud provider for a significant part of our portfolio. This means we not only deliver software and support services but also the required IT infrastructure and operational services. But we are effectively expanding our share of wallet. The potential uplift here is substantial, but even more important is the associated upselling potential of the Business Technology platform, additional SAP solutions and partner applications developed on top of it. An important thing to keep in mind here is that we do not have to deliver all of that ourselves, but just like today, can also procure required capacities from our strategic partners, bundled and at scale. However, as we all know, there are timing effects because the license model is upfront and a subscription model is ratable. Now, what you see here on this slide is actually a very simple model of what revenue looks like for our software license sale under the on-premise model versus, an otherwise, identical cloud subscription contract. And it doesn't matter if it's a new customer or an upsell to an existing customer. In a nutshell, what becomes clear is that, one, the cloud transition causes a push of revenue and thus profit to future periods. Two, the annual cloud revenue is a bit more than twice as high as the support revenue would have been. Three, customer lifetime revenue and value are thus substantially higher. And, four, for the transition, initial revenue and profit headwinds turned into tailwinds over time. And all that is for just the like-for-like comparison that still excludes the up-sell potential, I've mentioned. By 2025, the implications should get us to a total revenue greater than EUR36 billion with cloud revenue comfortably eclipsing all other revenue streams combined at more than EUR22 billion. This is why it is now even more important to expand our cloud gross margin. And to do that, we are now taking the final step in modernizing and harmonizing our cloud delivery, which I'll talk about next. But before going into the details, let me first put this into perspective a bit. Early last year, you reminded us that after years of rapid acquisition-driven cloud expansion, SAP structures and processes have reached a level of complexity and, in some cases, frankly, redundancy that called for reforms. You were right. We answered by setting up the Best Run transformation programs aimed at improving organizational efficiency and agility at the same time. One of the key aspects of Best Run is increasing the efficiency of our cloud delivery. And we have already made great progress in that regard as shown by the cloud gross margin expansion over the last two years. But in order to attain the full benefits of our cloud delivery modernization, we need to take a final step. As you can see on the left of this slide, we have already completed most of the required steps of our cloud delivery modernization. The final remaining step now is to lift the part of our cloud customer base that is still running on our legacy cloud delivery platforms onto either our internal converge cloud or the hyperscalers, in other words, our modernized and harmonized 4 plus one cloud delivery. And we are now planning to accelerate this move and complete most of that lift already by end of 2022. We expect this to drive a temporary acceleration of cloud investments through 2022, but the benefits of doing this will be significant. It will increase capacity utilization, it will allow us to procure infrastructure or infrastructure services at scale, and to automate managed services. That's what will allow us to achieve a cloud gross margin of approximately 80% by 2025. On top, it further increases the stability and resiliency of our cloud solutions and speeds up innovation, even in the applications, driving customer success and thus cloud revenue via more cross-selling and higher revenues. Again, that is what our customers rightly expect from us and we have every intent to deliver. So this all then comes together in the new 2025 ambition. The combined impact of what we just discussed, means that over the next two years, we expect to see muted growth of revenue, accompanied by a flat to slightly lower operating profit. After 2022, momentum will pick up considerably though. The initial headwinds of the accelerated cloud transition will start to turn into tailwinds for revenue and profit. In addition, we will have completed our increased investment into the accelerated cloud delivery modernization, and that translates into accelerated revenue growth and double-digit operating profit growth from 2023 onwards. And so by 2025, we expect this trajectory to take us to cloud revenue greater than EUR22 billion, total revenue, greater than EUR36 billion and an operating profit of greater than EUR11.5 billion. This 2025 ambition also means that, one, we will significantly increase our share of cloud revenue, making it, by far, the primary revenue stream. Two, we will significantly increase our more predictable revenue share to about 85%. And three, we will continue to focus on bottom-line efficiency. Rest assured, that we will continue to drive the Best Run project, streamlining SAP and setting it up for efficiency, simplicity and sustainable long-term success, aiming to come out of the transition of sustainable double-digit operating profit growth from 2023 to 2025 and beyond. I now hand back to Christian for closing remarks. Christian Klein - SAP SE O.N. Yeah. Thank you, Luka. And before we come to Q&A, let me close it out. We recognize this is a significant change when compared to the previous strategy, the former 2023 ambition. We are at an inflection point where customers are asking us to help accelerate their business transformation to gain resiliency and position them to emerge stronger out of the crisis. We see that as a unique opportunity to partner with our customers on their journey in a way that only SAP can, in large part, due to our deep knowledge of business processes, our innovative solutions and technology, and the trust we have established over our operating history. That's why we have adapted our strategy and financial ambitions. As the CEO of SAP, I firmly believe that prioritizing sustainable value creation has to be our top priority. Therefore we will not trade the success of our customers and the significant growth potential of SAP against short term margin maximization. Now, let's open it up for questions. Stefan Gruber - SAP SE O.N. Yeah. Thank you very much. I hand it back to the moderator. You can now start the Q&A session, please. Q & A Operator - Thank you. [Operator Instructions] We'll now take our first question. This question comes from Adam Wood from Morgan Stanley. Please go ahead, your line is now open. Adam Wood - Morgan Stanley Hi, good afternoon and thanks very much for taking the question. I've got two, please. Maybe just first of all, you've made very clear that there is a big move to cloud underway and I think everybody will understand that. But in the past you've given customers choice in terms of how they pay wherever they run between bringing licenses to hosting deals or paying subscription. We understand that, for you, there is a higher lifetime value of customer in subscription and obviously for customers that means then they're paying you more over the lifetime. So could you maybe just help us understand why these large SAP customers now want to run on subscription? Are you forcing that transitional or you continue to give choice? So any help you can give us on why that change is happening would be useful. And then maybe, secondly, on cloud revenue, you highlight now there is a much bigger part of that going to come from cannibalization as on-prem moves to cloud. Is there any way you could help us understand what the underlying growth of new business in the cloud is going to run off versus how much of that cloud revenue is going to come incrementally from cannibalizing the on-premise? Thank you. Christian Klein - SAP SE O.N. Yeah. Thanks a lot. Adam. Let me start and then, Luka, Adaire, you can build on top of that. I mean, first, what we have seen in the last six months is definitely when I'm talking to the CEOs, look, I mean, for many enterprises, the supply chain is heavily disrupted. They sometimes don't even know. Can they produce and deliver the next day? And that is the inflection point of our customers, where they are saying, "hey, I really want to move now to the cloud, I want to have a resilient operation, why should I still operate my own IT data?" And so that's the first point. And then the second point is doing a business transformation, Adam, is not easy. You have to change how a company works, you have to redesign business processes. And also our customers, including the large ones, believe, "let's move to the cloud, and also let SAP help us to transform our business, show us the best practices you have for the digital age, let us standardize our solutions, and now that the platform is ready, let's also build the extensions in the cloud and really consume regular innovations on the fly." So besides the commercial aspect, it's really about the resiliency and the transformation of their business. And where is this cloud revenue going to come from? First, yes, of course, there is a trench, as accelerated move of our installed base to the cloud. But second, this quarter, you have heard me saying 45% of our S/4HANA cloud customers are net new, which speaks, first, for the competitiveness of the solutions finally, and second, that we will also win, in the years to come, further market share, not only in S/4, but we really also will double down on HR procurement, on CX and focused areas in CX, and we will also invest into new innovations, the Industry Cloud. I mean, all of our customers are saying, all-in, please help us to really digitize also our industry-related business processes because, you know what? Again it all goes back into our ERP, it all goes back into our supply chain. Let's try massive business transformation on your platform with the Industry Cloud in conjunction with our LOP applications. And third, you heard us talking about land, adopt, consume and expand by putting all of our customer-facing functions together. First, you heard me saying our customer satisfaction score increased quite significantly and we are convinced that we will also see high renewal rate in the future. And with that, Luka, Adaire are there any comments? Luka Mucic - SAP SE O.N. Yeah, so I -- just to quickly add, I mean, there is undoubtedly going to be some cannibalization effect from customers, moving from established license and support agreements over to subscription. However, that is actually not the majority of the growth that we are expecting. We actually assume that we can run a CAGR that is approaching 20% with the new solutions that we are adding in Industry Cloud business network, and other adjacent areas that we have discussed before. The business technology platform growth that we expect, as well as also, the uptick that we expect coming out of the COVID crisis again, from some of the solutions that have particularly suffered now, that are actually clear market leaders, and therefore, can be expected to actually expand their lead and reach, after the crisis is over, such as, Concur. So the cannibalization impact, adds then, so to say, the cream on top of the growth rates, but it's not major, let alone the exclusive driver of growth. And we will be transparent with you. We will, starting next year, give you clear metrics of the number of customers that have transformed from installed base legacy license arrangements, to new subscription options, as well as net new customers, that we're adding to this as well. You know reporting from the S/4HANA side, but we will break it out, with a particular view to the cloud, starting from next year. Stefan Gruber - SAP SE O.N. Okay, thank you. Let's take the next question. Operator - Our next question comes from James Goodman from Barclays. Please go ahead, your line is now open. James Goodman - Barclays Thank you. Yes, good afternoon. Maybe I could ask a couple as well. The first is around the customer relationship. I mean, I sense within this guidance that you are increasing the emphasis of SAP, owning the customer relationship or providing your own infrastructure, or at least passing through more, within your own contractual terms, the hyperscaler infrastructure. So can I ask you what that means for your own IaaS expectations, as we look out through this transition and particularly as we look out to the 80% gross margin target for the cloud, I'm trying to think about the mix of IaaS within that. And the second question is really just a simple one around the cost investments. There is a lot of moving parts within the numbers. I just wondered, if you look at the 4 to 5 percentage points change that you've put out there for 2023, can you just help us with the split there in your own modeling between the gross profit impact from the lower revenue, and the transition that you spoke to, reverses the magnitude of the incremental investment that we will be annualizing in the business at that point? Thank you. Christian Klein - SAP SE O.N. Maybe I can start and then Luka, you can again build on top of that. Well, you said it very well actually, it's about owning the customer relationship, when it comes to their business transformation. And this is why -- so you know, key now for SAP, that the SAP cloud platform is really the foundation of all of our cloud applications, and that we are actually also delivering in the equation for hybrid landscapes, that we have in all platforms, and now that we are making tremendous progress on the integration front, we are maturing our business services on top of that platform. Think about it, when there is one semantical data model. Now we can tell our partners, why to modify the ERPs? Let's come to the platform and build the extensions there, because there is now one semantical data model, there's the workflow, there's the authorization. It's everything what you need to seamlessly expand the SAP solution portfolio, and this is why on top of our infrastructure-as-a-service business, definitely, we want to push now the platform and we definitely want to push all the applications on the software-as-a- service business, as that now comes together. At the end we are selling not the product, we are selling now, the digital intelligence enterprise. We are selling business processes designed for the digital age. This is what we are doing, and this is what we will also position in the year to come. Luka Mucic - SAP SE O.N. And to build on that, it's very important to understand that, we are not positioning the infrastructure-as-service solution here. We are positioning and a holistic solution, moving our customers to the cloud, and transforming and modernizing the landscape, based on our new ERP application architecture. This offering is therefore a software-as-a-service offering and not a infrastructure as a service offering, where the customer basically would just bring a license and then we would do the application management on top. That's just very important and therefore, this will not have a bearing on infrastructure-as-a-service. And secondly, on the margin side, we are of course anticipating the margin inflow from those additional customers that we're getting in core ERP together, with the development of the rest of the portfolio, to ultimately then reach the 80% gross margin by 2025. And just to also clarify on 2023, the investments that we are looking to put in and that we are planning to make to kind of reach the homestretch of our converged cloud modernization, are actually already going to turn into an operating profit tailwinds in 2023. So this is not negatively affecting 2023 any longer. The impact on 2023 margins, is basically, due to the changed revenue mix that we assume, and the shift of the business model to ratable recognition, which will then turn basically -- increasingly into a tailwind and will allow us to catch up and actually increase the margin again, starting from 2023. So from that perspective, those incremental investments are actually immediately accretive to operating profit, starting already in the year after they have been made. James Goodman - Barclays Thank you. Stefan Gruber - SAP SE O.N. Thank you. Let's take the next question please. Operator - Thank you. Our next question comes from Philip Winslow from Wells Fargo. Please go ahead. Your line is now open. Philip Winslow - Wells Fargo Great. Thank you for taking my question. A question for Christian & Adair. As I think back to the financial crisis, obviously, there are a lot of projects that were delayed into late '08 and '09 later. But we saw a a catch-up in 2010-2011, in terms of just the license sales. I mean in other words, projects just getting pushed. How do you think about our current situation? Obviously, you mentioned projects getting delayed and pushed. What are customers telling you about hey, have those projects simply been pushed? Have they been changed? Have they been shifted to the cloud and so the shape of the recovery is just simply different? I mean, how should we think about just sort of this crisis versus the financial crisis, in terms of how you think about sort of the shape of the recovery and what customers are telling you? Adaire Fox-Martin - SAP SE O.N. Yeah. Thanks for the question. I'll go first and then perhaps Christian or Luka can add any comments, if they have some. I think when we describe projects being pushed, I would describe it as the scale and the scope of the projects being pushed. I think it's very clear in the narrative that we have with our customers, that everybody understands the need for the digitization of key business processes, so that agility becomes part of their business landscape. So it isn't that the project is stopped, it isn't that -- it isn't a journey that the customer is on, I would describe it as a much more staged approach, than the approaches that we've seen in the past, where the work will continue over a period of time. And we can see that even in our own services utilization, where we still have a very significant number, in terms of utilized days in our services business. So I see it really as a more recurring element of project stages that the customer commits to, rather than a large scale program of work initially, and that's being what's underpinning some of the conversations that we've had with our customers. Christian Klein - SAP SE O.N. Yeah, and I can just comment on the cloud revenue side. I mean, obviously we are talking a lot about Concur, and yes if you exclude our Concord business for travel and expense management, our cloud revenue would be up by 20%. Our Software-as-a-Service solutions are increasing by 26%. So, you see, there is no real deceleration. And in all fairness to Concur, I mean after the quietest, this is the market leading solution in the market, full stop, and there will be of course a bounce back. It's cost depends on when can we travel again, when is business travel coming up. So while today I'm extremely confident that this business will of course come back, it's just a question of timing. Stefan Gruber - SAP SE O.N. Okay, thank you. We move to the next question please. Operator - Thank you. Our next question comes from Michael Briest from UBS. Please go ahead, your line is open. Michael Briest - UBS Thank you. Good afternoon. Two from me as well. Just in terms of the cloud gross margin trajectory, Luka? Obviously, there's investments for the next couple of years. Previously, you were looking for 75% gross margin in 2023. Could you give us a feel of whether that's still intact? And also how much lower the cloud gross margin might go in the next couple of years? And then, secondly, also, for you, I think, on the free cash flow side, previously you had a target of EUR8 billion in 2023. I suspect that's no longer there. But can you talk about cash flow out to '25 and on the capex side of things, give us some reassurance about what -- where that might go to? Thanks. Luka Mucic - SAP SE O.N. Yeah, so let me start with the cloud gross margin. I mean you have seen that we have continued to make progress even in 2020 despite the deceleration that we have seen in our Intelligent Spend Group, which was by far the highest gross margin and even Concur has still managed to increase its cloud gross margin despite their unique challenges that they are having. So I think it's very clear that we have an utmost focus as a company on this. And the investments, as I said that we are planning for next year and the year after to accelerate the harmonization of our cloud delivery infrastructure to our converged cloud, as I said before, on the question of James, I think it was, it will be immediately accretive starting from 2023. So from that perspective, we believe that there is no reason to anticipate any departure from what we had in mind for 2023. And, obviously, then see further acceleration up to the 80% that we are planning for 2025. For 2021 and 2022, we definitely -- you should assume that there is actually a slowing in progress, because we need to make the investments first. Not all of them will flow into cost of cloud. To be also quite precise, we will also see some investments in cost of R&D to make sure that some of the solutions that we have not yet fully shifted can run optimally on the new infrastructure. But, of course, a lot of it will hit cost of cloud and therefore, the progress in the next two years will be more muted as well. From a free cash flow perspective, look, first of all, we have made tremendous progress, obviously this year. Not only are we back to the levels of operating and free cash flow that we had committed at last year's Capital Markets Day, but we, of course, had a completely different profit expectation for our business in 2020. But we are actually seeing even an improvement against this original ambition when it comes to free cash flow. So something has happened here, which I believe is also going to be sustainable. And that is an improved and more disciplined working capital management and cash collection management. I have to give Adaire and her team a lot of credit here as well, and they have certainly intensified their collaboration with our collection teams and I believe that collaboration is sustainable and should continue to yield results and also after the prices. Nevertheless, you're obviously right that the free cash flow that we had anticipated for 2023 is also pegged to significantly expand to the profit levels that we are expecting. And since we are now expecting to reach these profit levels with -- around about two years delay, the free cash flow levels should also be expected to then also -- only be achieved in 2025. Having said that, that is a generalized statement based on all else being equal, and there are couple of factors that still play a role in this. On the positive side, as we have discussed, when Qualtrics completes their IPO, their previous cash-settled programs under the SAP set up and plan design would, to a largest extend, convert to equity-settled programs and that will have some relief as a consequence, when it comes to the cash flow. On the flip side, in 2021 and '22, we expect -- even though the -- our capex spend will remain muted, still a moderate step up from today's very low levels due to COVID in order to procure some of the additional infrastructure elements that we need for our own converge cloud. And so, those two factors will, to a certain extent, balance out each other, perhaps, providing a small tailwind. But other than that, of course, cash flow follows the profits. Michael Briest - UBS Thank you. And Christian, could you maybe give us some insight into the customer base on S/4 today? We got 8,100 live. How many of them would actually be on either the private cloud or the multi-tenant edition of S/4? Christian Klein - SAP SE O.N. Yeah, so, thanks for the question. I mean, first, we have seen now a massive acceleration of the move also to the cloud version of S/4HANA. As I mentioned before, COVID was indeed an inflection point and we will see this acceleration in the year to come also for some large enterprise customers. And we will put them on the wide deployment model. This is really, then, of course, relating to how standardized it is to customer, how designed are the processes to really fit into the standard, how consolidated is the IT landscape. So we will make that work, depending on the departure of the customer. And then second, for us, it's very important that we, of course, deliver in the differentiating capabilities. And next year, the public cloud version will have 80% of the functionality, but today our on-premise version have, it's significant, and we have delivered a new configuration, where you can change processes on the fly. We infuse AI and just to give you an example because there's so much talk about the value of S/4, just last week, I had an automotive customer of SAP and he said, "Christian, because of the move to S/4 and running on HANA, we actually could optimize our inventory." And they have savings of over EUR200 million, because now suddenly we can change our inventory and check it real time and can adjust it based on the demand what we are seeing and especially in times like these where you have such dynamic market. That is a huge, huge value for us. And this is something what we will be going to push further and with the new strategy, we're going to invest, we'll invest further in innovation, we'll invest further in R&D because this is the way to go, this is what our customers want. Luka Mucic - SAP SE O.N. And just to be precise, so currently we have close to 3,000 S/4 cloud customers. Stefan Gruber - SAP SE O.N. Okay, thank you. Let's take the next question please. Operator - Thank you. Our next question comes from Alex Zukin from RBC Capital Markets. Please go ahead, your line is now open. Alex Zukin - RBC Capital Markets Thank you guys for taking my questions. So just a quick one for me. Can you talk to how much of the delay in the spend that you're seeing were in the larger sales cycles due to macro versus evaluating some of your new cloud solutions? And if you think about the 2025 vision, approximately what percentage of customers do you expect to shift over the next kind of two to three years or is there a late cycle accelerated proportion of customers that are going to shift there, though? Adaire Fox-Martin - SAP SE O.N. Thanks for the question, Alex. I'll take the first part. In terms of the delay that we described, I would say it is less about the evaluation process and more about the uncertainty of the conditions. And after the start of the COVID process, we were in the fortunate position to be able to pivot our salesforce to a virtual engagement of our customer base. We have had in operation for a number of years, a very strong digital selling motion in our commercial sales organization and we were able to expand the use of those tools and techniques right across the entirety of our sales team. So we still managed to maintain a high level of engagement with our customers, albeit that we probably haven't met many customers typically in the last seven months. Therefore the delays tend to be delays around uncertainty in the business model, uncertainty in the business world, and uncertainty, I think, relative to the industry that the customer operates in, much more than to the evaluation process which is proceeding as per norm, albeit, virtually. Christian Klein - SAP SE O.N. And to your second part of the question, I mean, we will, of course, give customer the choice also in the future. But COVID will be an accelerator. And it really depends on the departure point of the customer. Look, when you -- we have customer, mid-sized services industry, they calibrate go-lives with S/4HANA cloud in 20 days. That's possible, that's absolutely possible. We have larger enterprise customers, they are now shifting their workloads to the cloud. But of course, for them, it takes some time to redesign the processes, to come to a standard, to move their modifications out of the ERP, so this will happen at accelerated pace, but every customer will move with its own feet. Alex Zukin - RBC Capital Markets Okay, thank you. Understood. And may be just one [Indecipherable] look at it. Yeah, I just -- I wanted to ask, is there a good -- like what's the right KPI for us to think about, that you would point us to, give us -- to give investors comfort in kind of that transition versus customers moving to a competitor -- back into to a competitor. What's the right KPI to look at for us during this transition point around that cloud revenue net? Luka Mucic - SAP SE O.N. My point of view is really the number of migrated customers. As you know, we have slightly more than 30,000 classic ERP customers, not systems, we have way more systems, but in terms of just customer count, that's what we have, and we have 15,000 customers for S/4HANA out there, as I said, close to 3,000 of them in the cloud. So that means another 12,000 basically, that have license on-premise and in the next couple of years, we want to move many thousands of those customers, and then of course net new customers to our core ERP cloud solutions, and therefore we intend to give you in the future, absolutely regular recurring updates, as part of the earnings process on those numbers, and certainly the progress that we have achieved there, where we will now break out between the different deployment forms, that should give you the confidence, that we are arriving fully in the cloud, come 2025. Alex Zukin - RBC Capital Markets Perfect, thank you. Stefan Gruber - SAP SE O.N. Thank you. Let's take the next question please. Operator - Thank you. The next question comes from Charlie Brennan from Credit Suisse. Please go ahead. Your line is now open. Charles Brennan - Credit Suisse Great, thanks for taking my questions. I'm going to go with 2 as well if that's possible. Firstly, just a clarification on your cash flow comments. I'm surprised you didn't commit to EUR1 billion of free cash flow, given the variables of Qualtrics and capex should be in that tailwinds. Are there any other variables we should be considering? For instance, is there any chance of another restructuring program, as you come to terms, in scale of the change over the next couple of years? And then secondly, on a set for a product related issue, how important is owning the platform layer of the stack in this strategy and to what extent do you think you've given up mindshare to Microsoft and Google, and how hard is it going to be to clawback that mindshare of the customers? Thank you. Luka Mucic - SAP SE O.N. First of all, on the cash flow side, you are absolutely right. Of course, we will have benefit from the Qualtrics IPO and of course, we also continue to have benefit, as you have seen in the significantly reduced levels of capex that we had in last two years, from our collaboration with the hyperscalers. But that being said still, the source of free cash flow on the operating cash flow side, is not entirely decoupled from the level of profit that we can drive as a company, and as we are achieving that level of profit, basically, with a two year shift in 2025, for our ambition that we have put out there. That is when also, I absolutely would expect that we are able to provide for those EUR8 billion in free cash flow. In the meantime, I very much believe that we actually can do better, all else being equal, in terms of the cash flow generation, because we have increased our cash inflow efficiency, our cash collection effectiveness, and working capital management. However, that will not be able to fully equalize the lower profit levels that we're now anticipating in the next few years, before that accelerates back again. And perhaps on the platform side, Christian? Christian Klein - SAP SE O.N. That is very good, Luka. I mean, this is a very valid question and the platform -- business platform definitely needs to be owned by SAP, and now moving our cloud applications over to this platform, by solving the integration issue, by making sure that every of our application is sharing the same data model -- is sharing the same authorization and workflow service. That's actually -- we'll also make sure, that the platform will just become a natural part of every sale we are doing, going forward. That's not anymore a standalone platform. That's our business transformation platform, let's call it like that, where we then also want to shift the ecosystem to. I mean, today, a lot of our SI partners are building -- build extensions in the on-premise world. We really now ask them and also incentivize them to join us, to move up with us to the cloud, to build the extensions on the platform, because now they can do it also in a much more seamless way. Yes, the platform is of the highest importance, and again, with the platform then comes also SAP HANA, and then, we get customers from. There, they can either choose the hyperscaler infrastructure, they can choose the SAP infrastructure, that was already there in the past, and that has to be proven, the right strategy. Stefan Gruber - SAP SE O.N. Okay. Thank you. Let's take the next question please? Operator - Thank you. Our next question comes from Kirk Materne from Evercore. Please go ahead. Your line is open. Kirk Materne - Evercore Thank you. If I could sneak in two, I'll try to as well. I guess just to be very clear; Luka, on the cloud revenue adjustments, outside of currency, is really that, from a business perspective, just simply Concur for the next year? Meaning, it sounds like Qualtrics had a good quarter, the other parts of the cloud business seem to be going well. Is there any other downshift, I mean, Concur, it makes sense while you're expecting a more slow rebound? I just want to double check on that. And then I guess, maybe for Adaire and/or Christian, the question is going to come up a lot is, why are you all seeing delays, when a lot of other software companies are frankly starting to see things pick back up? Is it the mix of your business around more impacted industries? Is it -- as you, I think, Adaire, mentioned, bigger ERP projects, just simply getting chopped up into smaller deals or having to rethink that? I think the big question I've got from investors today is, why are you all sort of seeing this, whereas -- at least over the last month or two, we haven't seen it. Perhaps everything just kind of came to a hit in September, but if you could discuss it a little bit, I think it'd be helpful. Thanks. Luka Mucic - SAP SE O.N. Yeah let me first start. So, first of all, it's not only Concur, what we're seeing in terms of impact for the full year. We're not talking about next year yet, by the way. So, just to make sure that we're talking about 2020. But Concur is about half the impact that we are seeing. Another quarter is the rest of Intelligent Spend. You probably have seen that in our segment reporting, we are showing that Concur is down in the quarter by 11%, and that is a business that otherwise would be expected to grow somewhere in the teens. And that is, of course, all due to COVID. But it's also the case that transactional revenues in Ariba, for example, are not as high as we would have expected. For the same reasons, I mean, due to COVID, a lot of companies are cutting back on spend, and if you have lower spend, then of course also spends at Concur -- and like Ariba, ensuring less variable expenses. It's still growing, that's the difference to Concur. But you have seen that Intelligent Spend overall in the quarter was down by 3 percentage points, and that, of course, means that also Ariba is down to a lower level than what otherwise would have been the case. And then, the last quarter is really, slight reductions in renewal rates or new cloud bookings across the entire rest of the spectrum, versus the levels that we would have targeted and planned for, in a normal, pre-COVID business, as usual scenario. Having said that however, that's something that we had planned for. The big shift is that on the transactional revenues, we had originally anticipated a recovery in the second half here, which we are now not planning for anymore. Christian Klein - SAP SE O.N. And I mentioned already the growth rate we are seeing in our software-as-a service platform, as a service business and with 26%, I would say we are definitely also lying in the upper end also, compared to competition. So this business developed under these circumstances extremely well. And there's, of course, also high confidence that, for the next year, that we will see similar growth. And then, of course also, we are talking about an acceleration later in the second half year, of 2021. When we talk supply chain, when we talk experience management, when we talk finance changing, license model to our customer, selling subscription, selling pay as you go, these are all solutions which are highly relevant for our customers. So yes, there is a high confidence that we will definitely also see a reacceleration then next year. Luka Mucic - SAP SE O.N. And perhaps to close this out, it works both ways. While in a classic subscription model the slowdown in revenues due to such a crisis situation, of course, is happening at a slower pace, but on the other hand side, to accelerate the subscription business also takes its time because, first you need to go through the selling, then the installation and then you start to recognize revenues. In a Business Network model, that is transaction volume based. Like with Concur and Ariba, both happens faster, so the downturn happens faster but also once the business picks up again and the spend increases and travel is happening again, then, of course, the variable revenues also start to kick in immediately. And hence, that's why we assume that if the COVID restrictions are lifted, then as of the second half year, we will see actually a quite -- a fast reacceleration back to normal levels. Adaire Fox-Martin - SAP SE O.N. And, finally, maybe, Kirk, let me address the question around the delay. And so, first of all, I think it's important to case this in the context of the overarching portfolio of SAP. So we have a very broad portfolio of products, which is something that, of course, continues to make us extremely relevant to our customers. In some of our pure play SaaS solutions, we defined a program that we call Amplify, which was a program focused on low upfront investments on deployment in days and weeks and very quick value realization for our customer base. And in those scenarios, we definitely saw some uptake of those solutions because the gap between speed and value was very, very small. And we saw over a 110 new customers over 1,100 deals under the auspices of that particular program. Then when you look at the actual underpinning business transformation that is predicated on S/4 as a core, I guess, the first point of discussion with customers is around cost and managing and mitigating cost in the current environment. And there are a series of activities that can be done to help manage that. Then the second range of conversations is about the migration itself or about the journey to value. And in the context of that, there are different departure points. Each of our customers, of course, has a very unique environment today, but then also different destination points and it is a matter of looking at that in a modular way so that are over the lifetime of that transformation journey, you're delivering value all along the way in relation to the priorities of the customers of SAP. And I do think there was an element of timing in terms of the last month of Q3 and as some of the changes that we saw in the resurgence of COVID, at the point where we had transactions in close process. So I think a combination of those things. We have different portfolios with different profiles of solution sets, long term transformation becoming modular, and then a little to do with the timing of our Q end. Kirk Materne - Evercore That's helpful. Thank you. Stefan Gruber - SAP SE O.N. Thank you. Let's take the next question, please. Operator - Thank you. We'll now take our next question from Mark Moerdler from Bernstein Research. Please go ahead, your line is now open. Mark Moerdler - Bernstein Research Thank you very much and I appreciate. I have two parts to my question. The first is, if the transactional headwind from COVID is expected to be over within the next year to two, then how should we think about 2023 in the transactional business? Is there going to be a permanent delay on the transactional side that you're modeling in or should it bounce back equivalently? And then as a second question, for new sales, which used to create license, how big a step down are you now expecting in license sales, specifically through 2023? As basically, should we be figuring license sales are basically going away by 2023? Thanks. Luka Mucic - SAP SE O.N. Yeah. Perhaps, I'll start with the last one and Adaire please augment this. I mean, licenses would not certainly go away by 2023. However, they will certainly continue to decline and I would estimate at a similar rate of what we are seeing now in 2020. And on the transactional business side, I see no reason why in two years' time, assuming that COVID is really past and behind us sometime next year, that transactional revenues should not, by 2023, be back at the level that they were before in 2019 and grow from there as they have done in the past. Sorry? Adaire Fox-Martin - SAP SE O.N. All good. Luka Mucic - SAP SE O.N. Yeah. Okay, good. So that makes this a joint statement from Adaire and I, so, then it must be true. Mark Moerdler - Bernstein Research Thank you. Stefan Gruber - SAP SE O.N. Okay, thank you. Let's take the next question, please. Operator - Thank you. Our next question comes from Chandra Sriraman. Please go ahead, your line is now open. Chandra Sriraman - Bank of America Yeah, hi, good afternoon. Thanks for taking my question. A couple, if I may. So when I look at your 2025 guidance, if my calculations are correct, there's a mid-single-digit drop in maintenance revenues through 2025. Now, I just wanted to check if the cloud business will be profitable enough to compensate for this drop as we go beyond 2023? And how should we see the move or the substitution of maintenance with subscription beyond 2023? The second question is more of a clarification. Luka, you mentioned that these ERP customers will move to the SaaS/PaaS model. So I was just wondering, would you continue selling the Infrastructure-as-a-Service, or will these customers be migrated to the SaaS/PaaS model? Thanks. Luka Mucic - SAP SE O.N. Yeah. So perhaps first with the question on maintenance versus cloud, I mean, that is one of the reasons why we are now accelerating and planning to kind of complete the migration to a converge cloud infrastructure more quickly because that is giving us a step-up in the cloud efficiency, that on a gross margin level already is in striking distance with our software and support business. And that is very positive, because if you then assume from a long term perspective, that the cloud business has an ever increasing share of renewal components and that are commanding a lower commission rates than a net new sale, actually, on the operating margin level, the cloud will then quickly catch up with the efficiency levels of our on-premise business. You have actually seen a part of that already at work today. But of course, that impact will be significantly higher even once we have build such a high base of cloud revenues. And on the Infrastructure-as-a-Service piece, I think you will see, over time, that certainly a growing proportion of our existing HANA enterprise cloud customers will move over to a more holistic SaaS offering that gives them the entire scope including also subscription. We actually offer this to our customers in -- within the HANA enterprise cloud already today as an option. But given our increased capabilities in the cloud that we are looking at, I think it will increase significantly now in attractiveness and will lead to more of pure HANA enterprise cloud customers making the move over. Stefan Gruber - SAP SE O.N. Okay, thank you. Chandra Sriraman - Bank of America Thank you. Stefan Gruber - SAP SE O.N. Let's take the next question, please. Operator - Our next question comes from Julian Serafini from Jefferies. Please go ahead, your line is now open. Julian Serafini - Jefferies Hi, thank you for taking my questions. I have two questions. I think number one is, Luka, I believe you mentioned the cloud plus multiplier that was around two times maintenance. Can you confirm that? So that would imply roughly a five-year crossover on the revenue side, assuming all things equal, that when a cold contract would be revenue accretive for SAP. And then the second question is on sales compensation, probably for Adaire. Will there be changes to sales compensation going forward then, I guess, to emphasize more cloud products away from the license and maintenance model? Luka Mucic - SAP SE O.N. I can quickly go first. So it's actually a bit more than twice to support revenue if you apply a multiplier or actually if you apply a 0.45 multiplier to a EUR1 million license contract, plus 20% support, that would translate into a EUR450,000 subscription at equal value, so slightly more than twice. Adaire Fox-Martin - SAP SE O.N. Julian, thank you for the question. Sales compensation is certainly one lever that facilitates change and transformation. This year, as Christian mentioned in his opening remarks, we brought together all of the customer-facing resources of SAP into a single organizational unit. That includes, not just sales, but also all of the services resources of the company, together with all of the customer-facing post-sales support resources. We underpinned this organizational change, with an operating model, that focuses not just on the landing or the bringing of a new customer into the SAP family, but also focuses very much on the adoption and the consumption of SAP solutions, in order to drive business outcome and business value for our customer. Therefore, in addition to this organizational change, in addition to this new operating model, in addition to the appropriate management and governance over the top of that, we will, of course, look at our compensation plans, in order to ensure that they're aligned with that strategy. And as I mentioned, that strategy focuses as much on the adoption and the consumption of our software, as it does on the initial transaction with our customer base. I also get a sense that the question was around how we would be addressing or directing our sales forces' efforts around different elements of the portfolio. And I think it's important, again, to emphasize that we have always been predicated on choice for our customers, and we will continue to be predicated on choice. There are absolutely some customers that, for a variety of reasons, would want to remain in an on-premise world. However, there is no doubt that the vast majority of our customers are orientated towards this cloud migration, and our compensation will take that into consideration. Julian Serafini - Jefferies Thank you. Stefan Gruber - SAP SE O.N. Thank you. Let's take the next question please? Operator - Thank you. Our next question comes from Neil Steer from Redburn Partners. Please go ahead. Your line is open. Neil Steer - Redburn Partners Hi. Thanks very much for taking my questions. I've got a couple, if I may. Firstly, Luka, could you confirm, in your response to a previous question, that we should be modeling the maintenance revenues declining mid-single digit levels, by the time we get beyond 2023? Was that what you seem to be confirming or not? Luka Mucic - SAP SE O.N. Yeah. Mid-single digit, negative decline CAGR, given the accelerated transformation to the cloud, is directionally correct. Neil Steer - Redburn Partners Okay. And then, just looking at the slides, I think I understand the revenue trajectory for cloud, obviously. But you seem to reference in the slide deck, that you're going to invest in industry cloud functionality. Other than the industry cloud functionality, where are specifically the other investments coming through, that hit the profitability so much in '21 and '22? Christian Klein - SAP SE O.N. Well, on the '21 and '22 thing, that is really related to plant infrastructure harmonization investment. So we are migrating customers that are still sitting on the legacy infrastructures of some of our -- particularly acquired cloud solutions, but also some of our own developed solutions to our converged cloud. And that has infrastructure investments, that has some, as I said, development efforts attached to it, to optimize the performance of those solutions on the new infrastructure. And of course, it also includes the pure migration costs for our customers. So that has nothing to do with investments that we are doing as part of our portfolio process on the R&D side, to build out new organic solutions, which we are nevertheless doing as well, and that's industry cloud, but it's also other areas of the portfolio we're investing significantly also, in our business technology platform. And of course, we continue to invest in those solutions, where we clearly have a leading position in the market, and want to retain it as well. Neil Steer - Redburn Partners Okay. So to ask a final question; in the past, when you talked about the converged cloud infrastructure, you've obviously talked about migrating over SuccessFactors, which I think is supposed to be done by the first half of last year. If you look at the proportion of subscribers or users on the legacy line of business cloud solutions. What in total also have been migrated over to the converged cloud infrastructure? And how much of those legacy line of business users need to move over, to the new -- to the cloud infrastructure now? Christian Klein - SAP SE O.N. Yeah. So -- thanks for raising this question, because I think it allows me to clarify something. The migrations that we have been talking about, about SuccessFactors and also Ariba, they were database migrations. We were migrating the underlying third-party database to HANA, and that was giving us already significant benefits, and you see them in the cloud gross margin today. What we have also done, is we have made sure that all of our cloud solutions run on one or more hyperscalers, and on our converged cloud infrastructure. What we have not done yet, is migrating all of the existing customers that are sitting on the previous legacy infrastructures, over to the new one, and that is what we are now giving a strong push and what we are looking to accelerate forward. And once we have accomplished this, we can retire our legacy platforms and we have various other benefits, in terms of automation, that we can leverage for greater efficiencies. But the database migration, that was what we were talking about in the past. And indeed, this has been accomplished already, with the current positive benefits for cloud margins that we are seeing already in our actual current numbers. Neil Steer - Redburn Partners And so, we can just [Indecipherable] roughly 100% is still -- in terms of users, are still on their existing legacy platforms today, is that correct? Christian Klein - SAP SE O.N. No, that's not right, because we have already, since some time, started to onboard new customers on those converged cloud landscapes. But it's correct that still a majority of the existing customers are on those legacy platforms, and that's what we are going to move over quickly now. Neil Steer - Redburn Partners Yeah, thank you. Stefan Gruber - SAP SE O.N. Okay. Thank you. Looking at the time, I think we have time for one final question. Operator - Thank you. We'll now take our last question from Patrick Walravens from JMP. Please go ahead. Your line is now open. Patrick Walravens - JMP Securities Oh great, thank you. And maybe this is a good way to wrap it up. So Christian, thank you for all the commentary and detail today. Given the stock drop, which I think is the biggest thing in quite a while, if there's one key message you'd like to convey to your investors here, what would that be? Christian Klein - SAP SE O.N. So thanks a lot for that question. I mean, indeed, of course, coming from the stock price, you see that we actually made today, a decision -- which is actually to respond to the needs of our customers and look, as the CEO of SAP, I cannot hold on to a financial mid-term ambition, which is actually again the needs of our customers. When they want to move, when they want to transform, when they want to see more organic innovation from SAP. This is for me, on the long term, the right thing to do for SAP, and this is actually my top priority as the CEO of this company, and this is why we're doing this change. And one thing for sure, because also related to the last question, we are not getting sluggish on our commitment to drive profitable growth in the future. I mean, all the impact you are now seeing is, weather related macroeconomics or you see the revenue mix effect coming through. But all the other productivity parameter, no matter if it's go-to-market related, G&A related, we are not getting sluggish. We will, of course, also have a high focus on productivity. And on the investment side, on the cloud operations, I mean, when you are doing this massive shift and already tripling your cloud revenues towards 2025, you don't want to feed your money into some legacy cloud infrastructure. This is why we want to do our homework now, and come back with double-digit growth in operating profit from 2023 onwards on; because, again, I don't want to feed money into legacy infrastructure. This is why we're doing this in combination and, as I said, finally, to wrap it up, we are doing it for our customers. Stefan Gruber - SAP SE O.N. Thank you very much. And this concludes -- thank you, Pat, for your last question. This concludes our earnings call for today. Thank you all for joining and you can now disconnect. Bye-bye. Luka Mucic - SAP SE O.N. Thank you. Bye-bye. Christian Klein - SAP SE O.N. Thank you. Take care.

SAP SE O.N. (NYSE:SAP) Q3 2020 Earnings Conference Call - Final Transcript

Oct 26, 2020 • 09:00 am ET

SAP SE O.N. (NYSE:SAP) Q3 2020 Earnings Conference Call - Final Transcript

Christian Klein

Stefan Gruber