SAP SE
Q3 2014 Earnings Call Transcript

Published: 20 Oct 2014

[Operator:]

Ladies and gentlemen, thank you for standing by. This is your Chorus Call operator. Welcome to SAP 2014 Third Quarter Earnings Results Conference Call. Throughout today's recorded presentation, all participants will be in a listen-only mode. The presentation will be followed by a question-and-answer session. (Operator Instructions)

[Stefan Gruber:]

Good morning or good afternoon. This is Stefan Gruber, SAP Investor Relations. Thank you all for joining us to discuss our results for the third quarter 2014. I’m joined by Co-CEO, Bill McDermott and Luka Mucic, CFO, who will both make opening remarks on the call today. Also Executive Board Members, Rob Enslin, who leads Global Customer Operations and Bernd Leukert who leads production innovation are on the call and will join us for the Q&A. Before they get started, I would like to say a few words about forward-looking statements. 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 SAP’s filings with the SEC, including SAP’s Annual Report on Form 20-F for 2013, filed with the SEC on March 21, 2014. Participants of this call are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. Please keep in mind that unless otherwise noted, all numbers referred to on this conference call are non-IFRS and growth rates are non-IFRS as reported. With that, I would like to turn the call over to Bill McDermott.

[Bill McDermott:]

Thank you, Stefan, and thanks to everyone on the call for your time today. Over the past three quarters, we have accelerated SAP's aggressive strategy to help customers run simple. This has been made possible by a unique combination of the broadest cloud portfolio in the industry, the world's largest business network, and especially the great simplifier SAP HANA. In the third quarter, the momentum continued as we delivered very strong growth of 41% in cloud revenue. Our cloud revenue run rate has ramped up to US$1.7 billion. The order entry of new cloud business signed in Q3 exceeded one-third of license revenue. Let's be clear, if you are only looking at traditional license revenue, you're missing this transformation. Once the planned acquisition of Concur is completed later this year, we expect the share of cloud business will be even higher. Meanwhile, our total predictable revenue, including maintenance was 62% in Q3, up from 53% 3 years ago when we started this transition. This clearly indicates that we are rapidly shifting to high growth and more predictable revenue. I would like to emphasize this significant message to everyone on this call today, while less upfront revenue pressures margin in the short term, we expect higher profitability in the long-term due to the greater efficiency and the more recurring nature of the cloud model. Despite the accelerated shift to ratable revenues, we saw third quarter software and software related service revenue come in solidly within our annual guidance range, increasing 7% in Q3 with year-to-date growth of 8% at constant currencies. When you consider additional overall performance indicators, such as Interbrand’s recent ranking of SAP as the 25th most valuable brand in the world ahead of consumer brands like Facebook and Ikea, it’s clear that with our ever consistent strategy and our high trust global brand reputation, SAP has never been in a stronger position to continue driving the transformation of the business software industry. Now, I'd like to provide some color on the key growth drivers. The industry's transformation to the cloud is no longer news. Today, the news is that the SAP Cloud powered by HANA is the standard for depth, breadth, and the largest business network in the world. SAP is the only company with the portfolio to manage all key resources on one cloud platform; permanent employees, flexible workers, goods, services, and with the planned acquisition of Concur, travel and expenses, no competitor can do this. SAP is leading next-generation customer engagement and serving the customer on any device in any channel with the hybris omni-channel e-commerce platform in combination with Cloud for Sales. This business contributed yet another quarter of triple-digit growth. In fact, Gartner rates SAP hybris as a Magic Quadrant leader in digital commerce ahead of both IBM and Oracle for the first time. And customers recognize this value. TUI Travel, a leading international travel group shows SAP Cloud for customer solutions over Salesforce.com to engage more effectively with its customers and increase customer service across all channels. In combination with SAP HANA Enterprise Cloud, TUI Travel can manage a world of structured and unstructured customer data and has an unprecedented view of every customer in the future. Sony Computer Entertainment, maker of the number one selling video game console in the world, will use hybris software to simply the way 7,000 video game developers manage content for Sony's product catalog. Polo Ralph Lauren, one of the worlds most successful fashion brands has chosen hybris and Ariba to improve the consumer shopping experience through better omni-channel capabilities and improve cost and quality through the global procurement network. SAP's 43 years of leadership and mission critical systems is well known. Now with hybris, SAP also has a real-time customer engagement and commerce platform, driving incremental sales and growth for our customers. You can't do effective customer engagement without an end-to-end order-to-cash process that connects predicting of customer needs to commerce and fulfillment. No CEO I speak with is interested in Salesforce automation solutions to solve yesterday's administrative challenges. They are hungry for growth in an increasingly global and competitive environment, and only SAP solutions for customer engagement and commerce can deliver. The other big CEO agenda is the ability to manage their talent and workforce more effectively. This is not just about managing full time employees, but also the contingent workforce and crowd sourced labor. The combination of SuccessFactors in Fieldglass provides the unique solution that cannot be matched by Workday. Our SuccessFactors product is now rated as the leader in core HR management and the latest Forrester Wave outperforming Oracle Fusion HR. We are seeing strong growth to SuccessFactors in APJ and EMEA that shows the international strength of our SuccessFactors business. Fieldglass wins have accelerated since the acquisition, and we have become the de-facto standard for managing contingent labor workforces. We are moving our mission-critical ERP customers to the HANA Enterprise Cloud faster than ever. In Q3, we saw a significant ramp up over the prior quarter showing that our customers are increasingly comfortable in moving their ERP and BW environments to the cloud. SAP is also leveraging its deep industry experience by building the deepest and broadest industry cloud portfolio. I would note that our industry DNA was a crucial value proposition in our long-term growth performance. We believe this will remain our competitive advantage as companies look for domain expertise in their specific industry in the cloud. So what does all this mean for our customers? It means they can run their entire business, including mission-critical processes in the SAP cloud, every line of business, every industry, every cloud delivery model, public, private, hybrid, everywhere in the world. Our cloud competitors run point solutions, we run entire companies in the cloud. Let me give you some examples of customers moving their business to the SAP Cloud. Singapore Telecommunications Limited, a telco company with 500 plus million subscribers, an existing SAP customer selected SuccessFactors Human Capital Management suite, including Employee Central along with SAP Jam and SAP Cloud for travel to help them simply their IT infrastructure and drive their people transformation agenda. Because of this integrated portfolio of applications, we are winning against the competition with customers like Opus Capital, Delaware Consulting, and Smurfit Kappa choosing SAP Cloud solution to over work day. Coming back to our core theme of Run simple, it’s clear that customers recognize the fast time to value advantages of consuming solutions in the cloud. This leads to me to the other central aspect of our growth strategy SAP HANA. HANA is the great simplifier and customers are realizing massive business benefits with fast, real time processing and analytics, all while simplifying their infrastructure stack and shrinking their data footprint. Forrester estimates the customer seek 30 to 50% TCO savings with the HANA platform. We continue to see strong growth and widespread adoption with more then 1450 suite on HANA customers, up from 450 just the year ago. To put this in perspective, we now have more suite on HANA customers then work day’s total number of customers. This also shows that while suite on HANA is already an explosive growth story, we are yet in the early stages of the multi-year growth opportunity. Our longer term ambition is to have tens of thousands of customers running on HANA as the de-facto standard business platform for the enterprise. With our wins over the competition it’s clear this ambition is in full swing. For example, NTUC FairPrice, the largest supermarket chain in Singapore will simplify their overall architecture reduce TCO and accelerate the performance of their SAP system by replacing Oracle with HANA's in-memory database, suite on HANA will deliver a platform of growth and innovation, while lowering cost for NTUC FairPrice. We're also optimizing all applications on HANA in the cloud. Simple Finance was the first such application. La Trobe University, a multi-campus university in Australia with over 34,000 students has chosen the SAP Simple Finance Solution, powered by SAP HANA to support its future ready strategic plan. SAP Simple Finance in the cloud will provide instant insight, of course financial and operational processes to help the university drive value through planning, analysis, prediction and stimulation. Now, six months ago at Sapphire, we announced a new platform as a service offering, the HANA Cloud platform. It enables organizations to extend and customize SAP applications at a low cost in the cloud. This new offering from SAP is building significant momentum and already has over 50,000 active free trials. At SAP's upcoming TechEd event in Las Vegas, we plan on sharing some exciting news about the SAP HANA Cloud platform and we are looking forward to seeing you there. We're also expanding the vibrant HANA ecosystem. IBM and SAP have entered into a bold partnership to help customers run business critical applications in the cloud. Customers will now be able to benefit from the HANA Enterprise Cloud in additional markets on IBMs highly scalable, open and secure cloud datacenters across the world. In addition, over 1600 startups worldwide are building on HANA and many of these applications are commercially available today. Overall customer interest in HANA is increasing fast. According to Google trends, the interest for HANA has grown 71%. Despite a lot of noise coming out of some recent tech trade shows, Oracle Exadata only grew 3% by the same measure. So it’s clear that the momentum and credibility are with SAP HANA. Turning to another central component of our growth strategy, we continue to define the network of economy delivering real time Frictionless Commerce for more than 1.6 million connected companies. So businesses in network in real time is fast becoming the difference between winning and loosing. If the SAP business network were a country it would be ranked 21st by measure of GDP. Companies can't ignore marketplace of that size and increasingly they are using the SAP network as a primary sales channel. SAP's business network is transacting close to US$600 billion annually, that’s more than Amazon, eBay and Alibaba combined. Konica Minolta Business Solutions, a leader in advanced document management selected SAP Ariba solutions to address both its direct and in direct spend requirements. This will enhance collaboration and reduce transaction cost for buyers and sellers, while improving spend compliance and order visibility. Concur will provide another very significant network opportunity. This is about much more then having the market leading travel and expense solution. Concur is about adding to the 1.2 trillion corporate travel market an ecosystem to the business network, accelerating the network effect. Each new customer brings many more trading partners and related commerce to the network enabling SAP to scale revenues at lower cost compared to a traditional cloud business. With the unique combination of Ariba, Fieldglass, Concur and HANA at the core, SAP will also be able to deliver 360 degree business intelligence and predictive insights across all transactions, across all major category to spend all in real time. So to summarize, we believe the future of business will run in the cloud on the SAP HANA platform and over the business network, SAP Cloud plus HANA, plus Network equals simple. On this platform SAP and its ecosystem partners are building intuitive context to wear applications for any device. Further, we are connecting people, services and production in the Internet of things economy to transform business processes and re-invent business models. And last but not least, we are delivering beautiful consumer grade user experience to the enterprise of course our entire portfolio with SAP Theory. Before I hand it over to Luka, allow me to present a few details on the regions starting with EMEA. SAP had here another solid performance in EMEA despite uncertainties in the Ukraine and the Middle East. In EMEA, cloud transaction entrant – traction was exceptional beating the competition with cloud subscriptions and support revenue growing close to 60%. Software and software related service revenue increased by 8% year-over-year. Germany also saw a strong performance in both software and cloud subscription revenue. The America's regions saw a mix performance in Latin America, similar to other companies in the industry. SAP is seeing more difficult macro and political environment in Latin America, in particular in Brazil and Argentina combined with some execution issues. In the America's software and software related service revenue increased by 5% year-over-year and cloud subscriptions and support revenue grew 34%. The company had a very strong performance in APJ, software and software related service revenue grew by 10%, cloud subscriptions and support revenue grew by 57% and SAP achieved a turnaround in its business in Japan with solid double-digit growth. As Luka will shortly explain in more detail, with the powerful shift – shift to the cloud and stronger than expected organic cloud performance, we are once again raising the cloud outlook, while adjusting the operating income range to reflect less upfront and more subscription revenue. To summarize, we are delivering on our one simple strategy with faster growth in cloud, HANA and the business network. And we strongly believe our momentum will continue. Finally, I'd like to thank our more than 68,800 SAP employees; whose commitment to helping our customers we best run amazes me everyday. Thank you. Now, I'd like to turn the call over to Luka. Luka?

[Luka Mucic:]

Yeah. Thank you, very much Bill. As you heard from Bill, we had again a very strong third quarter result with excellent growth in both the cloud, as well as a solid performance in our core business. So let me now provide some additional color on our financials. I will start with the Cloud business. We saw fast growth in the cloud of cloud subscriptions and support revenue up 41% year-over-year. Calculated cloud billings increased 51% year-over-year. Deferred cloud subscriptions and support revenue was €498 million of September 30, a year-over-year increase of 30%. We also saw our new cloud business ramp up significantly relative to license revenue, as Bill mentioned, our total order entry for the new business in the cloud was more than 1/3rd of software license revenue in the third quarter 2014, that’s up significantly from a year ago. Not only are we ramping up our cloud business, but we continued to have a stable and growing core with solid significant growth in software and support revenue. 8% growth in support revenue was certainly again a highlight and it has been growing strongly like that for a number of quarters now. Our support contract renewal rate is consistently in the high 90% range. Growth in Enterprise support and premium support was especially strong. And once again, our enterprise support offering had an adoption rate in the high 90% range and continues to be the de-facto standard. As a consequence, we continue to lift the share of highly predictable cloud and support revenue. As Bill has mentioned before, the total of support revenue, as well cloud subscriptions and support revenue as a share of total revenue increased by 3 percentage point’s year-over-year to 62% in the third quarter of 2014. So as Bill already highlighted, we are seeing a very powerful mix shift to high growth more predictable revenue. This shift leads to large impression in the short term, which is simply a function of growing the cloud business at an accelerated pace, up from cloud sales and delivery cost increased as we signed more cloud deals, but revenues comes later, longer term though we see higher cloud profitability as we gain higher economies of scale with our cloud offerings. Consequently, our SSRS gross margin was down 100 basis points to 82.8%. The professional services margin decreased by 4.7 percentage point’s year-over-year to 13%. As mentioned in the previous quarter, the shift to cloud also means there is an ongoing structural change in the demand for traditional consulting services. We have been and we will continue to adapt to this changing market environment. We still expect this transformation to take some time and as such still expect the services profitability to be negatively impacted throughout the – rest of the year. As a result, our overall gross margin was 72.1%, a decrease of 40 basis points year-over-year. Despite the transformation of our business toward less upfront and more ratable revenue though, we were able to expand our operating profit by 5% in Q3, while our total operating margin was down only slightly. So let me emphasize this. We are managing this transformation which is stable to our business and very high growth rates in the cloud, while staying fiscally responsibly and expanding our operating profit. SAP is unique in being able to drive a combination of extremely strong cloud topline growth and expanding profit all at the same time. Our non-IFRS earnings per share was $0.84, up from $0.78 per share in the third quarter of 2013, resulting an 8% growth. This was also driven by the tax rate, which was slightly lower than we expected. The IFRS tax rate in the third quarter was 26.5%, almost year-on-year, while the non-IFRS tax rate in the third quarter was 27.7%, up 10 basis points year-over-year. As we see this trend solidifying, although we are maintaining our effective tax rate outlook range for the full year, we now actually expect to be at the lower end of that range. And now to cash flow and liquidity. Operating cash flow for the first nine months was €3.08 billion, up by 1% year-over-year, which was a strong result considering that whereby making the settlement payment for the Versata litigation. Our net debt position was at €1 billion, an improvement of more than €450 million compared to the end of 2013. As you've seen from the earnings release, we are updating our outlook for the full year. Based on the strong momentum in our cloud business, we are raising our cloud outlook again for the second time this year and now expect full year non-IFRS cloud subscriptions and support revenue to be in the range of between €1.04 to €1.07 billion at constant currencies. We continue to expect full year non-IFRS software and software related services revenue to increase by 6% to 8% at constant currencies. With the customer driven mix shift, and upfront to cloud subscription revenue, we now expect full year non-IFRS operating profit to be in range of between €5.6 billion to €5.8 billion at constant currencies. We expect the fast growing cloud business, along with growth in support revenue will drive a higher proportion of more predictable revenue in the future. And finally on currencies, SAP experienced negative effects from currency translation in the first half of the year which dissipated in the third quarter and are now expected to turn positive in the fourth quarter of 2014. We have to model this, if exchange rates remained at the September 2014 level for the rest of year, we would expect non-IFRS software and software related service revenue and non-IFRS operating profit growth rates of actual currency to both experience a positive currency at impact of approximately 3 percentage points for the fourth quarter of 2014. It would still be a negative currency effect of approximately 1 percentage points a new trillion tech [ph] respectively from both items for the full year 2014. So to summarize this again, we are confident this powerful shift will continue to drive solid topline growth, at the same time higher predictability and in the future higher profit for our shareholders. Thank you very much. And Bill and I will now be happy to take your questions, as well as the rest of the colleagues here around the table.

[Stefan Gruber:]

Thank you. Operator, you can now start the Q&A session please.

[Operator:]

Thank you. Ladies and gentlemen, at this time, we will begin the question-and-answer session. (Operator Instructions) And our first question today comes from the line of Adam of Morgan Stanley. Please go ahead.

[Adam Wood:]

Great. Thanks very much for taking the question. Just first of all on the cloud side, obviously seen a good acceleration raising the guidance there. Could you give us a little bit of feel for which products are driving that growth in the mix– is it now HANA Enterprise Cloud that’s taking up the growth [battle] (ph) there? And then secondly, as we think about the profitability, obviously there is a reduction this year because of that accelerated cloud transformation. As we think out to 2017 and the phasing of this, if that strength in cloud continues, should we maybe expect the pace of margin expansion to be weighted more towards the end of that period rather than the beginning? Thank you.

[Luka Mucic:]

Yeah, so I can take these questions, and then Bill feel free to add further flavor. So first of all, I think we saw a decent growth across all of the main elements of our cloud business portfolio in Q3. I think we mentioned already that the area of multi-channel e-commerce, especially our cloud for sale solution continues to grow tremendously in the triple digits, but we also saw a strong growth performance across our public cloud assets, like Ariba and SuccessFactors. Clearly, HANA Enterprise Cloud is now picking up, and from a revenue perspective due to the lagging effect of cloud revenue recognition, you don’t see this so tremendously in those revenue figures, so there it’s clearly mostly still coming from our public cloud solution portfolio. But in terms of our bookings performance, HANA Enterprise Cloud is already a strong contributor, although you don’t see it in deferred revenue as quickly as on the public cloud because the setup timing on HANA Enterprise Cloud is longer, and therefore our time to billing is also slightly longer than in our public cloud portfolio. In terms of you know, and the contribution of our cloud business to margins and the impact of 2017 targets, bare with us, we will want to end the year hopefully on a strong note, then we'll see our -- the cloud acceleration will continue, and then we will basically guide you also including the impact of a material acquisition of Concur to hopefully have closed by then on the implications on our mid term guidance.

[Bill McDermott:]

Adam, I would simply build on what Luka is saying by adding just a couple of thoughts, one is the integrated enterprise that’s now coming through in the cloud. You'll remember the Y2K transition, when the Best of Breed were best at something, but they didn’t breed, and it didn’t work long-term. We’re back there again, only now the battle is in the cloud. So the core is moving to the cloud, the line of business already is in the cloud in companies that have HANA in-memory platform for beautiful user experience with Fiori and can integrate these assets across the enterprise will win, and SAP will be a winner. So, I think about the quarter to cloud in the integrated enterprises as a major theme. We recently read a report that one of the competitions out in Northern California mentioned or certainly touted to 30% improvement in the pipe in the cloud, that’s interesting but our 80% is even more interesting. So that’s why as we guide going forward, we think very strongly about being the fastest growing mega cap IT company in the world in the cloud, having the de-facto standard in memory platform with SAP HANA, and looking at absolute operating income and the expansion thereof which exactly what we're doing with our strategy.

[Adam Wood:]

Thank you.

[Luka Mucic:]

Thank you.

[Stefan Gruber:]

Let’s move to the next question please.

[Operator:]

And our next question comes from the line of Gerardus Vos of Barclays. Please go ahead.

[Gerardus Vos:]

Hi, good afternoon. Thanks for taking my question. Just first of all, maybe if you could give some color around kind of macro weakness, have you've seen anything coming through in any kind of regions? Then secondly, just coming back on the prior question regarding the kind of profit reduction, if you just give – can give a little bit more kind of granularity, how much is really driven by kind of the mix, how much is impacted by perhaps a different kind of revenue stream coming through in the cloud with HANA Enterprise cloud which clearly required a bit more setup and also datacenters. And then finally, how much is perhaps driven by mix matching kind of OpEx whereby you are upgrading one side, the faster growing area, but you're not yet or you have not yet kind of restructured or lowered the kind of cost base of the maturing part of the equation. And then just one final question, on kind of Latin America, clearly now Q2 was already very tough for that kind of region, it looks that Q3 had a further step down despite the impact from the World Cup and dropping out, what is happening there and you mentioned execution, what are you guys doing there? Thank you.

[Bill McDermott:]

Well, thank you very much for the question, I'll start it and of course Luka as he wishes can jump in as well. On the macro weakness, I think the Ukraine matter in the Middle East on the rest is been well publicized and I think Brazil and Argentina are not just SAP issues we've seen this somewhat consistent across other significant IT companies as well. Having said that, I do want to point out that we have execution issues in Latin America and we dealt with them decisively firmly. And we're going to prove it [inaudible] back in charge of Latin America in addition to the alliance organization to provide the appropriate level of leadership there. We generally take actions when action is required. The other thing you said, in terms of the profit, I think its important to recognize had we taken that upfront revenue instead of putting into ratable continued increase in our cloud guidance, you wouldn’t have a 5

[Luka Mucic:]

Yeah, I mean, there is not a lots to be added here, its very clear that and when you try to look at our all margin profile, we continue to act very fiscally responsible on G&A expenses, also on the sales and marketing side we more or less have a situation without a big change on the margin profile. So the main change comes from SRRS margin and here its clearly combination of the delaying revenue recognition for more cloud revenues then we had thought about as a relative share to upfront licenses, as well then especially in the HANA Enterprise Cloud the additional set up costs. As Bill had alluded to we believe in the future through partnerships like the one IBM we will be able to utilize the infrastructure as a service offerings from IBM and concentrate really on the application management layer on top and driving our SAS revenues in that combination which is good for both partners and will help us with CapEx investments going into next year.

[Gerardus Vos:]

Okay.

[Stefan Gruber:]

Thank you.

[Gerardus Vos:]

Thank you.

[Stefan Gruber:]

And the next question please?

[Operator:]

And our next question comes from the line of Mohammed Moawalla of Goldman Sachs. Please go ahead.

[Mohammed Moawalla:]

Thank you very much. Look I wondered if you can just explain the kind of relationships between the billings and the subscription growth in the P&L. We saw a bit of disconnect this quarter, is this one-off effect or should we see more normal progression going forward? Thank you very much.

[Luka Mucic:]

Yeah, it’s a good question actually and I think I answered it already half way through. But as you know, I mean, cloud calculated billings are quite interesting and pretty complex metric. We showed 51% as reported growth there, while we had only 27% on an constant currency basis, that’s a much bigger spread then we are seeing it on other figures that we are reporting on and so let me maybe go into this a little bit – further in detail. First, this is a combined metric of a P&L metric and a balance sheet metric because we are adding the revenue of the current quarter to the change in deferred revenues which is obviously a balance sheet item. And while we are – basically measure all the constant currency figure on the revenue using the average exchange rates basically as a comparison, on the balance sheet item of deferred revenues we're taking a look at the difference between the closing and the opening balance of the current quarter, as well as the ending balance of the previous years quarter based on the currency exchange rate that existed at the starting point of the preceding quarter. So then you can get into a perfect storm if you have a situation like the one we had this time, where in Q3 last year we had substantial appreciation of the euro versus the US dollar and remember most of the deferred revenue balance is that we have in there are from the US and are denominated in US dollars. And this year we had exactly the opposite effect of a substantial strength in bringing up the US dollar. So put in a different way you could also see a positive that most of the realization of these deferred revenues and actual revenues as there are in US dollars assuming that the currencies will stay where they are today, will actually result in greater revenues that we see then in the P&L. So that maybe an explanation on why the discrepancy between actual and constant currencies is so huge on those figure. Now the other important element, is I said the HANA Enterprise Cloud, I mean, meanwhile while we don’t see it substantial revenue contribution at the HANA Enterprise Cloud due to effect that these goal lies you know have in many cases just taken place a few months ago are still in process of taking place. It is a huge part of our order entry that we have. So it’s already noticeable there. However in the HANA Enterprise Cloud due to the effect that we are migrating more complex industry specific, mission-critical scenarios to our infrastructure, it simply takes longer there than in the public cloud for our customers so to go live. And remember; only when we are live we can start to build and therefore also recognize the deferred revenue on the balance sheet. So that’s the main reason for the disconnect there and as the HANA Enterprise Cloud I think gets a bigger portion of our business, initially you may see a similar effect. However this should level outspend as the HANA Enterprise Cloud becomes a pervasive part of our ongoing business; both from an order enter as well as revenue recognition perspective. I hope that’s clear but it’s a complex topic. I apologize.

[Mohammed Moawalla:]

Right. So we should this as more of an anomaly this particular quarter?

[Luka Mucic:]

Yeah, in the combination definitely because the constant currency calculation was really extreme this time due to the big apprehension of the euro last year and then of the US dollar this year.

[Mohammed Moawalla:]

Great. Thank you very much.

[Stefan Gruber:]

Thank you. Let's take the next question please?

[Operator:]

And our next question comes from the line of Mark Moerdler of Sanford Bernstein. Please go ahead.

[Mark Moerdler:]

Thank you. Can you hear me?

[Luka Mucic:]

Yes. We can hear you. Please go ahead, Mark.

[Mark Moerdler:]

Excellent. So, again two cloud questions on, follow up so. The first is I'd like to clarify in the deferred cloud subscription and support growth, the reason just want to confirm, the reason its growing 30% in deferred while cloud is growing 41 is the fact that procurement network is usage build not build significantly in advance is that correct?

[Bill McDermott:]

Yeah, definitely. I mean, that’s how – this was true both the user business network, as well as for Fieldglass.

[Mark Moerdler:]

Okay. So, then – that’s we won't see the deferred grow as fast as revenue because of procurement?

[Bill McDermott:]

Yeah, exactly.

[Mark Moerdler:]

The second question is, in terms of how you're expensing all the cloud cost, all of the delivery costs and some of the sale and marketing etcetera. You're expensing those as you incur them not capitalizing them on a cloud side, correct?

[Bill McDermott:]

That’s correct for the delivery cost and its correct also for a good portion of the sales and marketing expenses. There are certain bonus plans in some parts of the world which were allowed to capitalize them, but it’s not the case for example for our bonus plans here in Germany and in many European markets.

[Mark Moerdler:]

Okay. So we're seeing much more of the expenses upfront on the cloud and they are not going to be visible, but they will get better basically as our revenue continues to decline and so [they] implemented?

[Bill McDermott:]

Exactly. So we have a – first year impact there, but already as of the second year our cloud contracts are actually showing a very decent profitability, so the more we add to a new business the higher the profitability will get, but of course this does not prevent us to go for as much a new business as we can, because that then in the long run allows us to even better capitalize on the investment that we have made in cloud delivery and lowered our backend infrastructure with as many users as we can.

[Mark Moerdler:]

Perfect. Excellent. I really appreciate. Thank you.

[Stefan Gruber:]

Thank you. Let's take next question please?

[Operator:]

And our next question comes from the line of John King of Merrill Lynch. Please go ahead.

[John King:]

Great. Thanks very much for taking the questions. Bill you said in the opening remarks the license to cloud shift is accelerating and that’s obviously in evidence, that’s an accretive shift for the long-term, but the shorter term as you look out into 2015, 2016, the more you shift the cloud, the more the EPS, as you’re obviously going to be dragged down a little bit. So in order first to understand that model, the business to the next year or two, could you just comment on how quickly you think that might progress and maybe you can give us some flavors to of the 4 billion or so of licenses, how much of that is coming from the edge applications which you all would imagine would go to the cloud valley quickly versus the more core ERP type licenses where obviously the transition is a lot more slower paced? Thanks.

[Bill McDermott:]

Sure, John. Thank you very much. So the license to the cloud move I think you're going to see a pretty consistent drum beat from what we're getting use to right now. There seems to be the rhythm that the customer wants us to operate in and there is still very viable on premise business, you'll see that in the SRS numbers as we guide forward. There is an outstanding cloud business and on the EDGE side of it, it’s probably about 25% of the revenues. It will be bigger on the core as you start thinking about moving the core to the cloud which is I think a real big competitive advantage for SAP. And then, obviously when Luka and I do guidance in January we'll have a lot to say about our growth, but I think what you'll hear from us is very strong growth in the cloud, a continued March forward is the cloud company [Inaudible] you'll hear very solid SRS offer related services and you'll hear very solid operating income in the expansion there-off. Its clear to us that there is lot of market share to be won the cloud, its clear to us that we have the solutions that the customers wants, and its clear to us as we have very high renewable revenue and we have very low cost to sale on the cloud. The operating income expansion can follow that as well. And that’s kind of the way we're guiding the company. We're going for growth.

[John King:]

Very clear. Thank you.

[Stefan Gruber:]

Thank you. Let's move to the next question please.

[Operator:]

And our next question comes from the line of Phil Winslow of Credit Suisse. Please go ahead.

[Philip Winslow:]

Hey, guys. Thanks guys for taking my question. Thanks for the commentary and just the color you guys gave about the just the geographies in Q3. I was hoping you could expand on that in terms of your Q4 guidance, obviously there’s been a lot of in the press about, potential macro economic weakness in Europe and Germany, as well as some the economies of Asia so. What don’t we just talk about sort of what you saw over the course of Q3 as you head into Q4 and then as you get in the Q4 guidance sort of how you incorporated that into your conversion rates or pipeline etcetera those assumptions that you're making? Thanks.

[Luka Mucic:]

Yeah, thank you very much Phil for the question. As you know and we covered earlier, the global macro economics scenarios was you know pretty well known by all. Keep in mind we have a very special brand in EMEA and in spite of the turbulence we performed extremely well and we anticipate that to continue. If you look at Latin America, I mentioned the Brazil and Argentina situation, and also execution with better execution, I expect some tailwind coming back into Latin America no doubt in my mind. Asia Pacific, Japan, Japan turnaround was very strong in Asia, very good leadership, very steady beat, you know, double-digit growth and significant growth in the cloud is going to continue there. And in America you know, I am really felling good about the pipeline, I’m really feeling good about our cloud business and I am really feeling like we have stable consistent core on the SRS side. So in spite of the global turbulence and the things that you're hearing I feel that SAP is extremely well positioned to execute in any environment, but even in this environment. And what I like the best about where we've got the company right now is our believe that vision, the strategy for the company is the right one with HANA as the in-memory, beautiful user experience with Fiori the cloud assets, of course the enterprise integrated, of course on HANA and then the business network checking into high gear, because that’s what the customer wants. And if the customer wants to rent it and they want on a ratable deal, I think that’s the advantage of the shareholder and if the customer wants to put it on premise and they want to own the asset because they look at it as a capital assets of their business they want to keep for long-term they should have the right to do that. So I really feel like this is very nice rhythm and a very nice balance and I feel very confident in the pipeline. I also want to go on record of saying a couple of things. We had a some media reports about some notification on expenses if you'll notice Luke and I've been saying every quarter, we're actually increasing the number of jobs in the company and we now have 68,800 colleagues. We started the year more close to 65,000. So we are coring the expenses because we already did all the hiring we needed to do. So that was a misinterpretation and in terms of the pipeline I've stated the pipeline in the cloud and in the core and they’re both very robust in and strong. And things I really like the most is we're having a field day with Salesforce.com with omni-channel, e-commerce and cloud to customer absolute field day. So I am not surprised that their sales director would want to talk about us. And on work day I think its fascinating how SuccessFactors is now highly rated in the eyes of Gartner and Forrester and with Feildglass bolted on so the contingent workforce which is fast as growing I think we have a great story to tell against work day and needless to say we continue to win with HANA against Oracle even though we're completed open to all partners. So I really like the fact that the company is growing for growth with a clear vision and clear strategy and I think its work in every environment.

[Philip Winslow:]

Great. Thanks. Best of luck into Q4.

[Luka Mucic:]

Thank you.

[Stefan Gruber:]

Thank you. Next question please.

[Operator:]

And our next question comes from the line of Rick Sherlund of Nomura. Please go ahead.

[Rick Sherlund:]

Yeah, thank you. For Bill and Bernd, I wondered if you could talk for moment about the simple suite. And maybe help us understand the positioning of this. So where does it stand now and going out to next year versus the business suite on HANA, how do you think the market reception at simple suite, what's the positioning and how excited should we about the potential for simple suite next year?

[Bill McDermott:]

Rick, thank you very much for the question. First of all we appreciate it. Today we're launching run simple the campaign for the company, and I just want to set it at a high level and then Bernd will take you through the technology roadmap which we're going to get more and more [bold] on as you pointed out. So first on one simple, complexity is the most interactable CEO issue of our generation. We have all the stats and facts to prove that more than 10% to 15% of operating profits of every company we talk to is being destroyed by the very complexity. So that’s why I think on move with HANA we see already with the cloud and the business network is all about run simple. We are putting our money where our mouth is. And the other thing is, we never said that that we're simple enough, we're not simple enough either. But we are road mapping a beautiful story for simple and it set the heart of your question, its started with simple finance and now Bernd's going to tell you how we're re-factoring the entire suite on HANA to change the world. Bernd?

[Bernd Leukert:]

Yeah. Thanks, Bill and thanks Rick for the question. So first of all just to repeat that our functionality is the richest and the best-in-class of all business we did – available on the market. And this functionality has undergone a significant transformation already leveraging the power of HANA as we speak today. And the business suite but as well all the industry applications runs a day on HANA and are available in the HANA Enterprise Cloud. So we are proud that not an individual industry is missing across our 25 industries and across all our line of business. Now as we move forward facing HANA market tendency enabled, we do not believe that providing these core applications in the cloud can only be provided. But revising every single line of code and disrupt the business as some other friends do, it would be even naïve to simply revise everything and opt our customers to right off all the investments they have done into SAP and convince them to go at disruptive path forward. That’s why we have chosen the much modest relative in place alignment and collaboration with our customers and user groups over the last couple of years already. And the strategy to follow in which we will also going forward, first of all we continue to offer the business suite on [NETP] even if this is yesterday's technology. But in addition to that we will offer as well to all customers to front the business suite on HANA and we even extended the maintenance window on to 2025 just last week. Why did we do that? As to outlined already, there is clear tendency that business we are going to the cloud and we will offer customers on proper state to run their complete businesses on the HANA Enterprise Cloud as we speak already today even including all the mission critical processes, all their enhancements and all their innovations. Now going forward, we will go beyond that. We are now optimizing all applications and maximize the advantage of HANA to the maximum extent. Simply finance is the first of these applications which we have launched to the market. This will be followed by a series of additional line of business applications, like material management, inventory management and so on. Ultimately all the core processes which are available today in ERP will then be available in a simple versions and then again just to repeat that an easy path to go from the current solution in the non-disruptive way to the future. In addition, we have build a complete new road based user experience which is changing the way people use to work with applications and the philosophy of hearing. So with the combination of core apps already in the managed cloud and the line of business public cloud, we have already delivered a unified cloud to our customer and we will not give up the huge advantage of integration as we are decomposing ERP in line of business applications we will deliver on our HANA Cloud platform predefined SAP integration content that allows our customers to decide on their own to move from the existing on term well into the cloud. So its not a single milestone where we ask our customers even in a disruptive way to move from today's world into the future by decomposing the complete ERP into simple innovation with pre defined delivered integration content its up to the customers to chose the area they want to start ultimately without loosing the cohesiveness and the comprehensive businesses which we have.

[Rick Sherlund:]

Thank you.

[Stefan Gruber:]

I think we now have time for two more questions. Operator, please go ahead.

[Operator:]

And our next question comes from the line of Ross MacMillan of RBC Capital Markets. Please go ahead.

[Ross MacMillan:]

Thanks very much. Two questions if I could, first just on the new cloud business order entry which you said was more than a third of new software license revenue that’s an impressive number. Can you just explain how you calculate that, that would be helpful? And then second, on the cloud gross margin, obviously there’s a lot of investment here including around HANA Enterprise Cloud, look I was just curious as to when you think we might see that plateau and sort of trough if you will, now that we're at 60% gross margin on cloud, are we close to that trough? Thanks.

[Bill McDermott:]

Yeah. And I will take both questions if I may. So first of all on the total order entry, this is what you would call total contract value, or TCV. So basically if you have so we have typically three year contract in the cloud then you would take this three year value and that’s total contract value and so all of the new cloud contracts that we sold was more than one third of the license revenue figure. On the investment into cloud delivery and infrastructure, I am fully with you. I think guided at the – in July at our earnings call and that we would see a half year to cloud margins improvement run, over half year one. Now SAP already in the cloud is quite a big truck so to say, so when you start to pull in the brakes it still goes for a while and that’s what you have seen in Q3 and now with the IBM partnership in place with the let say, can you remind us that -- I have given to the organization in terms of the limitation of further expense increases. I think we are seeing this plateau and I do not expect Q4 on cloud delivery margins to further drop.

[Ross MacMillan:]

Okay. Thank you.

[Stefan Gruber:]

Let’s take the last question please.

[Operator:]

And our next question comes from the line of Knut Woller of Baader Bank. Please go ahead.

[Knut Woller:]

Yeah, thank you. Just a quick one maybe for Luka as a follow up. You were mentioning on the services gross margins this year impacted and you expected to continue to be under pressure due to the shift to the cloud and to change of the business model, and do you expect to see a margin recovery then for that business line in 2015 that’s it? Thank you.

[Luka Mucic:]

Yeah. Thank you, Knut. I mean, as we said we are undergoing a complete business combination between our coinciding organization and our active globally support organization will take effect as of January next year. We will act then with one combined service catalog across all of our service teams. We will also cross fertilize the two different departments and groups. We will focus our service catalog on those services that are driving high software to service ratio, the higher between of standardized productized services as AGS for many years a successfully driven and delivered for our customers as you can also on the high growth rate that we are posting on our premium support engagement and with that I think we will optimize the contribution of our services business across the board and combining the classic -- business and with our [SSRS] business and that one for sure will have positive effects for SAP and going into 2015.

[Knut Woller:]

Great. Thank you.

[Stefan Gruber:]

Thank you very much. This completes our third quarter earnings call for today. Thank you all for joining and good bye.

[Operator:]

Ladies and gentlemen, this concludes the SAP 2014 third quarter earnings conference call. Thank you for joining. You may now disconnect.