Earnings Call Transcript
SAP SE (SAP)
Earnings Call Transcript - SAP Q3 2020
Operator, 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, Head of Investor Relations
Thank you. Good morning or good afternoon. This is Stefan Gruber. Thank you for joining us for our extended earnings call 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. Also joining us for Q&A is Executive Board member, Adaire Fox-Martin, who leads our customer success organization. As usual, before we get started, I would like to say a few 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 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, along with 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, including SAP's annual report on Form 20-F for 2019 filed with the SEC on February 27, 2020. 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 point changes 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 compared in accordance with IFRS. This extended earnings call today is being held in lieu of the Capital Markets Day we discussed last quarter. With that, I'd like to turn things over to our CEO, Christian Klein.
Christian Klein, CEO
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 announcements 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 brought on by the COVID-19 pandemic. COVID-19 is an inflection point for our customers. Many enterprises have real issues in producing, selling, and delivering their products during 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 this transformation happen, combined with the 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 midterm ambition. But before going there, let's take 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 grow operating profit and margin. Apart from the Intelligent Spend business, our SaaS and PaaS cloud revenues were up by 26%. We continue to see 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 €6.6 billion. At the same time, the lack of recovery from COVID-19 is visible in the lower-than-expected transactional cloud revenue, mainly due to 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 great 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 our operating margin significantly 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 customers, including competitive replacements. Deals included Lenovo for S/4HANA, Rabobank for S/4HANA Cloud, Swisscom and Barilla for Customer Experience, HPE and Uniper for the business technology platform, Elshi for Ariba, Walgreens Boots Alliance for supply chain management, Lululemon for Qualtrics, Schwarz Group for industry cloud, and Bahrain Airport for SuccessFactors. For SuccessFactors, 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% of which were net new. This takes us to a total of more than 15,100 customers, a 20% increase 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 centers. However, there is also demand from customers who want these services in their own data center, managed by SAP. This is why we have now launched the HANA Enterprise Cloud Customer Edition. We are also very excited that, in this quarter, Lenovo has decided to become a global partner for the Customer Edition with their Lenovo TruScale offering, which supplements the global GreenLake partnership with VMware and HP. Finally, Interbrand just issued their 2020 Best Global Brands report, and I'm very proud that SAP came in at number 18 globally, up two spots versus last year and improving 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, CFO
Thank you very much, Christian, and welcome also from my side. We again navigated through a challenging environment in Q3. Amid 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 a 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 €6.6 billion amid continued COVID-19 effects on our cloud business. Our cloud revenue was up 14%, with continued lower transactional revenues negatively impacting 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 that 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. 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 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, particularly on our training business, as the reopening of our global training centers has been delayed. As a result, our total revenue was flat year-over-year. Now moving on to the bottom line, where, 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 grew 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 remained cautious on hiring and discretionary spending. 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 rates. 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, a bright spot. In the first nine months, our operating cash flow was strong and improved by 54% to €5.1 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 €4.2 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 €6 billion and a free cash flow above €4.5 billion. Let me now turn to the remaining part of our previous 2020 outlook that was issued on April 8 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, 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 the range between €8 billion to €8.2 billion, cloud and software revenue in a range between €23.1 billion to €23.6 billion, total revenue in a range between €27.2 billion to €27.8 billion, and operating profit in the range between €8.1 billion to €8.5 billion. To summarize on Q3, this quarter, we showed tremendous results as we continued to improve operating profit and margin even against the strongest comparison. Based on a resilient top-line 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 midterm ambition, which we would like to discuss next. And for this, let me hand back to Christian.
Christian Klein, CEO
Thank you, Luka. Now before looking at our strategy and midterm 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 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. We entered partnerships 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 achieve this, we have put a lot of work into our cloud platform over the past 12 months, and we will continue to invest in innovation. We are very pleased to see that hard work is being recognized. Gartner has ranked us a leader for both enterprise integration platforms and development platforms. The times when SAP developed and engaged with customers in 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 customers, a true catalyst to accelerate their transformation effort, putting a spotlight on the resiliency, which is more than just about the underlying infrastructure and its move to the cloud. It is about changing how our company wants to adapt to new digital business models and drive automation. Resiliency and sustainable long-term growth and profitability come only by transforming the company to meet the needs of 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 had made the move to digital performed 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 could continue to sell, produce, and deliver their product. To adapt new business models and do so with agility, our customers need innovative business software, a platform ensuring harmonized, semantical data models to run new digital business models end to end. This is where SAP comes in. With our strategy, we will accelerate the technical migration of our customers' most important business applications to the cloud, and we are agnostic when it comes to their choice between an SAP data center or hyperscalers. We can make it work with the best PCO 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 and evolve all-in-one new business models with agility and speed. To do so, all our main solutions will adapt to the cloud platform and share one semantical data model, one AI and analytics layer, one common security and authorization model, and the same application business services such as workflow management. With our cloud platform powered by SAP HANA, processes can be changed, enabling agile workflow. 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 run business models holistically end to end with one consistent data model. This is where we take a different approach than others. Data and process 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 outcomes, resiliency, profitability, and sustainability. That is the only way forward. What gives me confidence at this unique time in our history is our position of strength, our progress today, and our heritage. Our applications are worth more than €10 billion worth of workload, and we want them semantically consistent across the entire value chain. At SAP, we draw on almost 50 years of business expertise, defining, redefining, and reinventing the most important processes for our customers. 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’s 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 helping our customers through the crisis. This new strategy and macroeconomic factors have implications for our financials. They are the reason for the change in our midterm guidance, which I'm going to speak about next. Coming from our previous financial midterm ambition, what are the changes? Let me start with two macroeconomic factors – currency and COVID. First, over the last three months, we have experienced currency headwinds versus our previous assumption. This translates into a negative 3% to 4% effect on revenue and operating profit. Second, we now anticipate a more conservative COVID-19 recovery. We assume that COVID will impact the economies through at least the first half of next year. Then we have two strategic decisions. We are charting the financial guidance to the new reality and, first and foremost, to the needs of our customers. One, as just discussed, we will reinvent how businesses run, enabling our customers’ business transformation in the cloud to gain higher resiliency. In consequence, we will accelerate the transition of our customer base to the cloud. This accelerated move to the cloud will clearly add value over the long run by increasing cloud revenue. In the short term, there will be revenue mix effects 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. Second, we will continue to relentlessly execute on productivity improvements under the Best Run program as laid out at 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% by 2025. We will provide more background on those two strategic decisions in a moment. But first, I'll go a bit deeper into 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 in several hard-hit industries. Across all industries and geographies, we see an increasing demand to accelerate the move to the cloud. However, we also expect software license revenues to decline further from today's levels also in the future, considering our accelerated transition to the cloud. 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 decision, 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. We continue to grow rapidly even amid the COVID-19 crisis. With the journey to the cloud I previously outlined, we are further addressing this market need, accelerating the cloud transition and tripling our cloud revenue to more than €22 billion by 2025. This 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 investment to deliver new innovations in industry cloud, business network, or sustainability; and maintaining a strong focus on our customer success to ensure adoption, higher renewals, and ultimately lifetime value. The incremental growth resulting from 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 these decisions and then how it all comes together in our new midterm ambition. Luka?
Luka Mucic, CFO
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 motivation, 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. We have seen the financial impact from this basically since the beginning of our cloud journey almost 10 years ago. Over the years as we grew rapidly in the cloud during this first phase of the transition, we had very material negative revenue mix effects on margins, simply because the profitability of those cloud businesses was lower than that of our on-premise business. However, 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. By the end of 2018, our cloud business 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. This time, we'll be moving large parts of our ERP customer base from on-premise to the cloud, moving them out of the upfront software licensing model and into the ratable subscription licensing model, similar to what other players have done. For instance, Adobe did it before, although it will not be as rapid in our case since we are talking about an option for customers. Why does this make financial sense? That's the second important point because we're increasing customer lifetime revenue as we're 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. So, we are effectively expanding our share of wallet. The potential uplift here is substantial. Even more importantly is the 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. Just like today, we can procure the 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 the subscription model is ratable. Now, what you see here on this slide is actually a very simple model of what revenue looks like for a software license sale under the on-premise model versus an otherwise identical cloud subscription contract. 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 turn into tailwinds over time. All of that is just for the like-for-like comparison that still excludes the upsell potential I mentioned. By 2025, the implication should get us to a total revenue greater than €36 billion, with cloud revenue comfortably eclipsing all other revenue streams combined at more than €22 billion. This is why it is now even more important to expand our cloud gross margin. To do that, we are now taking the final step in modernizing and harmonizing our cloud delivery, which I'll talk about next. 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 had reached a level of complexity and, in some cases, frankly, redundancy that called for reform. 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. We have already made great progress in that regard, as shown by the cloud gross margin expansion over the last two years. However, to attain the full benefits of our cloud delivery modernization, we need to take a final step. 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 converged cloud or the hyperscalers. In other words, we are modernizing and harmonizing our cloud delivery. We are now planning to accelerate this move and complete most of that lift already by the 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, allow us to procure infrastructure or infrastructure services at scale, and automate managed services. That's what will allow us to achieve a cloud gross margin of approximately 80% by 2025. On top of that, 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 renewals. 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 onward. By 2025, we expect this trajectory to take us to cloud revenue greater than €22 billion, total revenue greater than €36 billion, and an operating profit of greater than €11.5 billion. This 2025 ambition also means that, one, we will significantly increase our share of cloud revenue, making it 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, assuring you that we will continue to drive the Best Run project, streamlining SAP and setting it up for efficiency, simplicity, and long-term success, aiming to emerge from the transition with sustainable double-digit operating profit growth from 2023 to 2025 and beyond. I'll now hand back to Christian for closing remarks.
Christian Klein, CEO
Thank you, Luka. Before we come to Q&A, let me close it out. We recognize this is a significant change 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 from the crisis. We see that as a unique opportunity to partner with our customers on their journey in a way that only SAP can, largely 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 ambition. 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, Head of Investor Relations
Thank you very much. I hand it back to the moderator. You can now start the Q&A session, please.
Operator, Operator
We’ll now take our first question. This question comes from Adam Wood from Morgan Stanley.
Adam Wood, Analyst
I've got two, please. Maybe just, first of all, you've made very clear that there's 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's a higher lifetime value of customer in subscription. And obviously, for customers, that means they end up paying you more over their lifetime. So, could you maybe just help us understand why these large SAP customers now want to run on subscription? And are you forcing that transition, or will you continue to give choice? So, any help you could give us on why that change has happened would be useful. And then, maybe secondly, you highlight now there's 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 at versus how much of that cloud revenue is going to come incrementally from cannibalizing the on-premise? Thank you.
Christian Klein, CEO
Let me start and then, Luka, Adaire, you can build on top of that. First, what we have seen in the last six months is definitely, when I’m talking to CEOs, for many enterprises, the supply chain is heavily disrupted. They sometimes don't even know if they can produce and deliver the next day. 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 center?' So, that's the first point. The second point is that doing a business transformation is not easy. You have to change how a company works; you have to redesign business processes. Also, our customers, including the large ones, believe, 'Let's move to the cloud and 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 the business. Where's this cloud revenue going to come from? First, yes, of course, there is a change. There’s an accelerated move of our installed base to the cloud, but secondly, you heard me saying 45% of our S/4HANA cloud customers are net new, which speaks well for the competitiveness of the solution, and it shows that we will also win additional market share in the years to come, further investing in areas in HR, procurement, CX, and focused areas in CX, along with new innovation in the industry cloud. All our customers are saying, 'All in, please help us to really digitize our industry-related business processes because, you know what, it all goes back to 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 LoB applications. And third, you heard others talking about land, adopt, consume, and expand. With our structured customer-facing functions together, our customer satisfaction score increased quite significantly. We are confident that we will also see high renewal rates in the future. With that, Luka or Adaire, any comments?
Luka Mucic, CFO
Yes, just to quickly add, there is undoubtedly going to be some cannibalization effects from customers moving from established license and support agreements over to subscription. However, that is not the majority of the growth that we are expecting. We actually assume that we can run a CAGR approaching 20% with the new solutions that we're adding in industry cloud, business network, and other adjacent areas we've discussed before, as well as the expected uptick that we see coming out of the COVID crisis from some of the solutions that have particularly suffered, which are clear market leaders and can be expected to expand their lead after the crisis is over, such as Concur. So, the cannibalization impact has been, so to say, the cream on top of the growth rates, but it's not the primary driver. We will transparently provide metrics of the number of customers that have transformed from legacy license arrangements to new subscription options, along with net new customers we are adding. You know this from the S/4HANA side, but we will break it out with a particular view to the cloud starting next year.
Operator, Operator
Our next question comes from James Goodman from Barclays.
James Goodman, Analyst
Maybe I could ask a couple as well. The first is around the customer relationship. I sense within this guidance that you are increasing the emphasis of SAP owning the customer relationship, providing your own infrastructure or at least passing through more than your own contractual terms to the hyperscaler infrastructure. Can I ask you what that means for your own IaaS expectations as we look out through this transition? Particularly as we look out to the 80% gross margin targets for the cloud, I'm trying to think about the mix of IaaS within that. The second question is really just a simple one around the cost investments. There are 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 modeling between the gross profit impact from lower revenue in the transition that you spoke to versus the magnitude of the incremental investment that we'll be annualizing in the business at that point? Thank you.
Christian Klein, CEO
Maybe I can start, and Luka, you can build on top of that. You said it very well actually. It's about owning the customer relationship regarding their business transformation. This is why it's so key now for SAP that the SAP cloud platform is really the foundation of all our cloud applications and that we're delivering the integration for hybrid landscapes that we now have in platforms. As we make tremendous progress on the integration front, we are maturing our business services on top of that platform. The thing about it is that when there is one semantical data model, we can tell our partners why to modify the ERP. Let’s come to the platform and build the extensions there where they were able to do it because there is now one semantical data model, there’s the workflow, there’s the authorization, and everything you need to seamlessly expand the SAP solution portfolio. On top of our infrastructure-as-a-service business, we definitely want to push the platform and push all the applications from the software-as-a-service business, which now comes together. At the end of the day, we are selling not just a product, we are selling the digital intelligent enterprise, we are selling business processes designed for the digital age. That is what we will also position in the years to come.
Luka Mucic, CFO
To build on that, it's crucial to understand that we are not positioning an infrastructure-as-a-service solution here. We’re positioning a holistic solution, moving our customers to the cloud and transforming and modernizing the landscape based on our new ERP application architecture. Therefore, this offering is a software-as-a-service offering, not an infrastructure-as-a-service offering where the customer simply brings a license and we do the application management on top. It's just very important. Hence, this will not bear on infrastructure-as-a-service. Secondly, on the margin side, we anticipate the margin inflow from those additional customers we are getting in core ERP together with the development of the rest of the portfolio to ultimately then reach the 80% gross margin by 2025. Just to clarify regarding 2023, the investments we are planning to make to reach the homestretch of our converged cloud modernization will actually turn into an operating profit tailwind in 2023. This is not negatively affecting 2023 any longer. The impact on 2023 margins is due to the changed revenue mix we assume and the shift of the business model to ratable recognition. It will turn into a tailwind allowing us to catch up and increase margin from 2023.
Operator, Operator
Next question comes from Philipp Winslow from Wells Fargo.
Philipp Winslow, Analyst
A question for Christian and Adaire. Reflecting on the financial crisis, many projects were delayed into 2008 and 2009. Afterward, you saw a catch-up in 2010 and 2011 concerning license sales, projects that were simply pushed back. Considering our current situation, you mentioned projects getting delayed and pushed. What are customers telling you? Have those projects been pushed, changed, or shifted to the cloud? Is the shape of recovery simply different? How should we think about this crisis compared to the last in terms of the recovery shape and what customers are communicating?
Adaire Fox-Martin, Executive Board Member, Customer Success
Thanks for the question. I'll go first, and then perhaps Christian or Luka can add any comments if they have them. I think when we describe projects being pushed, I would characterize it as the scale and 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 a part of their business landscape. 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 we have seen in the past, where the work will continue over a period of time. We can see that even in our services utilization, where we still have a very significant number concerning 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. That is underpinning some of the conversations we’ve had with our customers.
Christian Klein, CEO
I can comment on the cloud revenue side. When excluding our Concur 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. In all fairness to Concur, this is the market-leading solution, and after the crisis, this market will bounce back. Of course, it depends on when we can travel again and when business travel resumes. So, I am extremely confident that this business will indeed come back; it's just a question of timing.
Operator, Operator
Our next question comes from Michael Briest from UBS.
Michael Briest, Analyst
Two from me as well. Just in terms of the cloud gross margin trajectory, Luka, obviously, there are investments for the next couple of years. Previously, you were looking for a 75% gross margin in 2023. Could you give us a feel of whether that's still intact? Also, how much lower the cloud gross margin might go in the next couple of years? Secondly, also for you, I think, on the free cash flow side, previously you had a target of €8 billion in 2023. I suspect that's no longer there. But can you talk about cash flow out to 2025? On the CapEx side of things, provide some reassurance about where that might go. Thanks.
Luka Mucic, CFO
Let me start with the cloud gross margin. You've seen that we have continued to make progress in 2020 despite the deceleration we saw in our Intelligent Spend group, which has by far the highest gross margin. Concur has still managed to increase its cloud gross margin despite its unique challenges. I think it's clear that we have an utmost focus as a company on this. The investments for next year and beyond will have immediate accretive effects starting in 2023. Therefore, we believe the trajectory we outlined for 2023 regarding the cloud gross margin is still intact. Obviously, acceleration toward the planned 80% gross margin by 2025 remains our aim. In 2021 and 2022, you should assume that we will see a slowdown in progress as we need to make investments first. Not all these will flow into cloud costs. There will be some investments in R&D as well. However, a significant portion will indeed impact cloud margins. Our progress will be more muted during those two years. From a free cash flow perspective, we've made tremendous progress, obviously, this year. We are not only back to the levels of operating and free cash flow we had committed at our last year's Capital Markets Day, but we're actually seeing improvement against the original ambition for 2020. We have seen sustainable working capital management and cash collection improvements, which I believe will also be sustainable after the crisis. However, you are right that the free cash flow we anticipated for 2023 is tied to the profit levels we expect, and since those levels are now delayed by around two years, we expect to reach free cash flow levels closer to 2025. Having said that, when Qualtrics completes their IPO, that would convert many of the previous cash-settled programs into equity-settled programs, providing some relief regarding cash flow. While in 2021 and 2022, we expect a modest step up in CapEx from today’s low levels due to COVID to procure additional infrastructure for our converged cloud. Those factors will balance each other, perhaps providing a small tailwind. However, cash flow will follow profits overall.
Michael Briest, Analyst
Christian, could you give us an insight into the customer base on S/4 for today? We’ve got 8,100 live. How many of them would be on either the private cloud or the multi-tenant S/4?
Christian Klein, CEO
First, we have seen a massive acceleration of the move also to the cloud version of S/4HANA. As I mentioned, COVID was an inflection point. We will see this acceleration for some large enterprise customers. We will also consider how standardized the customer is, how designed their processes are, and how consolidated their IT landscape is to make that work. It’s vital that we’re delivering the differentiating capabilities. Next year, the public cloud version will have 80% of the functionality that our on-premise version now has. This is significant. We’ve delivered a new configuration where you can change processes on the fly. Just last week, an automotive customer told me that because of the move to S/4 and running on HANA, they optimized their inventory and saved over €200 million. They can now change inventory and check it in real time, adjusting based on the demand they see, especially in dynamic markets. This is a huge value for us, and this is what we will push further. We currently have close to 3,000 S/4 cloud customers.
Operator, Operator
Our next question comes from Alexandra from RBC Capital Markets.
Alexandra, Analyst
Just a quick one for me. Can you talk to how much of the delay in the spend you're seeing is 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 over?
Adaire Fox-Martin, Executive Board Member, Customer Success
I'll take the first part. In terms of the delay that we described, I would say it’s less about the evaluation process and more about the uncertainty of conditions. At the start of the COVID process, we were fortunate to be able to pivot our sales force to a virtual engagement with our customer base. For many years, we have maintained a strong digital selling motion in our commercial sales organization and extended those tools right across our sales team. Therefore, we managed to maintain a high level of engagement with our customers, albeit that we probably haven't met many customers physically in the last seven months. Therefore, the delays tend to revolve around uncertainty in the business model, uncertainty in the business world, and uncertainty relative to the industry that a customer operates in, much more than affecting their evaluation process, which is proceeding as usual albeit virtually.
Christian Klein, CEO
Regarding your second question, we will, of course, give customers choice in the future, but COVID will be an accelerator. It depends on the point of departure of the customer. We have customers in the mid-sized services industry who celebrate a go-live with S/4HANA cloud in just 20 days. That’s incredible. Large enterprise customers are now shifting workloads to the cloud, but for them, it takes more time to redesign their processes and move modifications out of the ERP. This shift will happen at an accelerated pace, but every customer will move at their own speed.
Alex Zukin, Analyst
I wanted to ask, what's the right KPI for us to look at that would give investors comfort regarding cloud revenue transition versus customers moving to a competitor or defecting to one? What would be the most appropriate key performance indicator around that?
Christian Klein, CEO
The KPI is really the number of migrated customers. We have slightly more than 30,000 classic ERP customers. We have around 15,000 customers for S/4HANA, and currently, close to 3,000 of them are on the cloud. That implies another 12,000 that are licensed on-premise. We aim to move many thousands of those customers and also net new customers to our core ERP cloud solutions. We will provide regular recurring updates during our earnings process on those numbers and the progress we have made in breaking out the different deployment forms.
Operator, Operator
The next question comes from Charlie Brennan from Credit Suisse.
Charlie Brennan, Analyst
I have two as well, if that's possible. Firstly, just a clarification on your cash flow comments. I'm surprised you didn't commit to €8 billion of free cash flow given the net tailwinds of Qualtrics and CapEx. Are there any other variables we should be considering? For instance, is there a chance of another restructuring program as you come to terms with the scale of the change over the next couple of years? Secondly, on a separate product-related issue, how important is owning the platform layer of a stack in this strategy? To what extent do you think you've given up mindshare to Microsoft and Google? How hard will it be to claw back that mindshare with customers?
Luka Mucic, CFO
First of all, on the cash flow side, you are absolutely right; we will have benefits from the Qualtrics IPO. Additionally, we continue to experience benefits from significantly reduced levels of CapEx over the last two years through our collaboration with hyperscalers. That being said, the source of free cash flow on the operating cash flow side is not entirely decoupled from the profit levels we can drive as a company. We will achieve those profit levels with a delay of around two years, which is when I expect that we should be able to provide for those €8 billion in free cash flow. Meanwhile, I believe we can do even better, assuming everything remains equal, due to improved cash inflow efficiency, cash collection effectiveness, and working capital management, which has been positively impacted by some of Adaire's team's efforts. However, that will not fully equalize the lower profit levels we anticipate over the next few years before growth accelerates again. Regarding the platform side, Christian?
Christian Klein, CEO
This is a very valid question. The business platform definitely needs to be owned by SAP. Moving our cloud applications onto this platform by addressing the integration issue ensures that every application is sharing the same data model and is able to expand seamlessly. Today, many of our partners build extensions in the on-premise world. We're incentivizing them to migrate with us to the cloud to build the extensions on the platform, as it offers a more seamless experience. The platform is of paramount importance. With the platform also comes S/4HANA, and customers will decide whether they want to choose the hyperscaler infrastructure or our own. That strategy has already proved successful.
Operator, Operator
Our next question comes from Kirk Materne from Evercore.
Kirk Materne, Analyst
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, and the other parts of the cloud business seem to be going well; is there any other downturn at Concur that makes sense while you're expecting a slower rebound? I want to double-check on that. Secondly, for Adaire and/or Christian, many are wondering why you're seeing delays when several other software companies are witnessing activity increase. Is it the mix of your business around more impacted industries? As I think Adaire mentioned, are bigger ERP projects getting split into smaller deals? I believe the main question from investors today is why you’re experiencing this, while many others haven’t recently.
Christian Klein, CEO
First of all, it’s not only Concur that we’re seeing impacting full-year results. We’re not currently discussing next year. We’re in 2020. Concur represents about half of the impact we’re experiencing. Another quarter is the rest of our Intelligent Spend. You likely saw in our segment reporting that Concur was down in the quarter by 11%, and that is a business that otherwise would have been expected to grow in the teens, all due to COVID. The decrease is also evident in transactional revenues in Ariba, for example, which aren't as high as expected for the same reasons, with many companies now cutting back on spending. A reduced spend means lower variable expenses for Ariba. However, you’ve seen that the Intelligent Spend overall in the quarter was down by 3 percentage points. The final quarter consists of slight reductions in renewal rates or new cloud bookings across the entire spectrum versus levels we had targeted in a typical pre-COVID scenario. Nevertheless, we had planned for this. The significant change is that we originally anticipated a recovery in the second half, which we no longer plan for.
Luka Mucic, CFO
I mentioned the growth rate we're seeing in our software as a service and platform as a service business. With 26%, we are definitely lying in the upper end compared to competition. This business is developing extremely well under these circumstances as well. There’s a high confidence that we will see similar growth for next year and then a significant acceleration in the second half of 2021 when we talk about supply chain, experience management, and finance changing, the licensing model to our customer to subscription, pay as you go, which are all solutions that are highly relevant for our customers. Given that, we maintain high confidence we will see reacceleration next year.
Christian Klein, CEO
It works both ways. While the classic subscription model causes a slowdown, the downturn in revenues during a crisis situation occurs faster. However, when business picks up again and spending increases, those variable revenues will start to kick in immediately. Therefore, we're assuming that if COVID restrictions are lifted, we'll see quite a rapid resumption back to normal levels starting in the second half of the year.
Adaire Fox-Martin, Executive Board Member, Customer Success
Finally, Kirk, let me address the question regarding delays. It’s essential to place this in the context of SAP’s broad product portfolio. We have a varied portfolio, which continues to make us extremely relevant to customers. For purely SaaS solutions, we initiated a program called Amplify, focusing on minimal upfront investment and rapid deployment, with quick value realization for our customer base. We saw 110 new customers and 1,100 deals under that program. When looking at the broader business transformation that hinges on S/4 as an essential core, the first discussions with customers will naturally revolve around cost management and how to mitigate costs in the current environment through manageable activities. Next are migration discussions, which depend on the unique departure and destination points of each customer, allowing for modular transformation over time to maximize delivered value.
Christian Klein, CEO
To finalize, some recent changes in COVID have affected transactions around the end of Q3. I think that variety of factors is pivotal in impacting timing. However, we remain confident that new opportunities abound.
Operator, Operator
We’ll now take our next question from Mark Moerdler from Bernstein Research.
Mark Moerdler, Analyst
I have two parts to my question. First, if the transactional headwind from COVID is expected to resolve within the next year to two, how should we consider 2023 in the transactional business? Will there be a permanent delay, or should we expect it to bounce back? Regarding new sales, which historically created licenses, how significant a step down do you now expect in licensed sales, specifically through 2023? Should we be anticipating that license sales essentially disappear by 2023?
Christian Klein, CEO
Regarding the last point, licenses certainly will not disappear by 2023. However, they will decline, likely at a rate similar to the one we are seeing now in 2020. As for transactional business, barring COVID persisting beyond next year, I see no reason why transactional revenues should not return to pre-2019 levels by 2023, and grow from there, as they have historically.
Operator, Operator
Our next question comes from Chandramouli Sriraman.
Chandramouli Sriraman, Analyst
A couple, if I may. When I look at your 2025 guidance, if my calculations are correct, there’s a mid-single digit drop in maintenance revenues through 2025. I would like to confirm if the cloud business will be profitable enough to compensate for this drop beyond 2023. How should we see the substitute of maintenance with subscription beyond 2023? The second question is a clarification. Luka, you mentioned that these ERP customers will move to the SaaS/PaaS model. So, will you continue selling infrastructure as a service, or will these customers migrate to the SaaS/PaaS model?
Christian Klein, CEO
Addressing your first question, that's one reason we are now actively planning to accelerate our migration to the converged cloud infrastructure quicker. This shift allows us to improve cloud efficiency to a level that, on a gross margin basis, is in striking distance of our software and support business. That’s very positive because once we've established a solid base of cloud revenues, we’re aligned to maintain comparable efficiency levels to our on-premise business. You've already seen that impact reflected in our current numbers. Regarding the infrastructure as a service piece, over time, you will see a growing percentage of our existing HANA enterprise cloud customers moving toward a more holistic SaaS offering that includes the full scope and also subscription. We already provide this option within the HANA enterprise cloud today, and given the increased capabilities in cloud, its attractiveness will rise.
Operator, Operator
Next question comes from Julian Serafini from Jefferies.
Julian Serafini, Analyst
I have two questions. First, Luka, I believe you mentioned the cloud-plus multiplier. It was around 2 times maintenance. Can you confirm that? Would that imply roughly a five-year crossover when contract revenue becomes accretive for SAP? Secondly, on sales compensation for Adaire, will there be changes to sales compensation going forward, to emphasize more cloud products over the license and maintenance model?
Luka Mucic, CFO
It’s actually a bit more than twice the support revenue. If you apply a multiplier – or actually, if you apply a 0.45 multiplier to a €1 million license contract plus 20% support revenue, that would translate into a €450,000 subscription at equal value. So, slightly more than twice the support revenue.
Adaire Fox-Martin, Executive Board Member, Customer Success
Sales compensation is certainly one lever that can facilitate change and transformation. This year, as Christian mentioned in his opening remarks, we consolidated all customer-facing resources of SAP into a single organizational unit. This includes not just sales, but all services and post-sales support as well. This organizational change is paired with an operating model emphasizing not only the acquisition of new customers, but also focusing on their adoption and consumption of SAP solutions to drive outcomes and value. Hence, our compensation plans will be reviewed to align with that strategy. Our intent is for compensation to address adoption and consumption as crucial metrics. Also, while you referenced how focus as completely shifted to the cloud, customers will still have the choice to remain on-premise for various reasons.
Operator, Operator
Our next question comes from Neil Steer from Redburn Partners.
Neil Steer, Analyst
I have a couple of queries, if I may. Firstly, Luka, could you confirm your previous comments regarding maintenance revenues declining mid-single-digit levels by when we get to 2025? Was that what you were confirming? Also, with the reference to revenue trajectories for the cloud in your slide deck, I understand you're going to invest in industry cloud functionality. Other than that, where specifically are the other investments coming through that hit profitability so hard in 2021 and 2022?
Luka Mucic, CFO
The mid-single-digit negative decline CAGR, given the accelerated transformation to the cloud, is directionally correct. Concerning the 2021 and 2022 investments, they relate to the planned infrastructure harmonization investments. We're migrating customers from the legacy infrastructures of certain cloud solutions, including those we acquired. Those migrations entail infrastructural investments, as well as development efforts for optimizing solutions on new systems. Those costs are not related to R&D for new organic solutions. We are making investments in the industry cloud, our business technology platform, and also in maintaining our position in leading market solutions.
Neil Steer, Analyst
In earlier discussions around the converged cloud infrastructure, you highlighted migrating SuccessFactors. That was initially supposed to be accomplished by the first half of last year. What proportion of subscribers or users have migrated to the converged cloud, and how many legacy line-of-business users still need that migration?
Christian Klein, CEO
Thanks for bringing this up; it allows me to clarify. The migrations concerning SuccessFactors and Ariba were primarily database migrations. We migrated the underlying third-party database to HANA, which already provided significant benefits, hence the gains seen in current cloud gross margins. What we have yet to complete is migrating all existing customers on legacy infrastructures over to our new system. That is what we are now pushing to accelerate. Once accomplished, we can retire our legacy platforms and leverage automation benefits for greater efficiencies. While database migrations are completed, we must ensure the migration of our existing customer base to the modern infrastructure.
Stefan Gruber, Head of Investor Relations
Looking at the time, I believe we have time for one final question.
Operator, Operator
We’ll now take our last question from Patrick Walravens from JMP.
Patrick Walravens, Analyst
This might serve as a good way to conclude. Thank you for all the commentary and detail today. Given the stock drop, which I think is the largest in quite a while, if there’s one key message you'd like to convey to your investors, what would that be?
Christian Klein, CEO
Indeed, the stock price reflects that we made a decision today to respond to our customers' needs. As CEO, I cannot cling to a financial mid-term ambition that doesn’t align with what our customers need. When they want to move and transform, looking for more organic innovation from SAP, that’s my top priority as CEO, and that’s why we’re implementing this change. One thing is certain, related to your last question: we aren't being complacent in our commitment to drive profitable growth in the future. All impacts you’re seeing relate to macroeconomics or changes in revenue mix. Nonetheless, the productivity parameters related to our go-to-market and general and administrative expenses remain a main focus. And, when pursuing investments in cloud operations, with our ambition to triple cloud revenues by 2025, we will not continue to allocate money to legacy cloud infrastructures. Therefore, we're betting on making the right investments for our customers.
Stefan Gruber, Head of Investor Relations
This concludes our earnings call for today. Thank you all for joining. You can now disconnect. Bye-bye.
Luka Mucic, CFO
Thank you. Bye-bye.
Christian Klein, CEO
Thank you. Take care.